PART I
Cautionary Statement Regarding Forward-Looking Information
This Annual Report on Form 10-K contains, in addition to historical information, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this Annual Report on Form 10-K, including statements regarding our future results of operations and financial position, strategy and plans, and our expectations for future operations, are forward-looking statements. The words “believe,” “may,” “estimate,” “continue,” “anticipate,” “design,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, strategy, short-term and long-term business operations and objectives, and financial needs. Forward-looking statements include, but are not limited to, statements about:
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our opportunities and expectations for growth in the student lending, healthcare and other markets;
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anticipated trends and challenges in our business and competition in the markets in which we operate;
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our client relationships and future growth opportunities;
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the adaptability of our technology platform to new markets and processes;
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our ability to invest in and utilize our data and analytics capabilities to expand our capabilities;
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our growth strategy of expanding in our existing markets and considering strategic alliances or acquisitions;
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our ability to meet our liquidity and working capital needs;
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maintaining, protecting and enhancing our intellectual property;
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our expectations regarding future expenses;
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expected future financial performance; and
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our ability to comply with and adapt to industry regulations and compliance demands.
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These statements reflect current views with respect to future events and are based on assumptions and subject to risks and uncertainties. There are a variety of factors could cause actual results to differ materially from the anticipated results or expectations expressed in our forward-looking statements. These risks and uncertainties include, but are not limited to, those risks discussed in Item 1A of this report. Given these uncertainties, you should not place undue reliance on these forward-looking statements.
Forward-looking statements contained in this report present management’s views only as of the date of this report. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our quarterly reports on Form 10-Q and current reports on Form 8-K filed with the Securities and Exchange Commission.
ITEM 1. Business
Overview
We provide technology-enabled audit, recovery, outsource customer services, and related analytics services in the United States. Our services help identify improper payments, and in some markets, restructure and recover delinquent or defaulted assets and improper payments for both government and private clients in a broad range of markets. Our clients typically operate in complex and regulated environments and outsource their audit and recovery needs in order to reduce losses on billions of dollars of defaulted student loans, improper healthcare payments and delinquent state tax and federal treasury and other receivables. We also provide complex outsource customer services for clients across our various markets. We generally provide our services on an outsourced basis, where we handle many or all aspects of our clients’ audit and recovery processes.
We believe we have a leading position in our markets based on our technology-enabled services platform, long-standing client relationships and the large volume of claims or funds we have audited and recovered for our clients. In the student loan recovery market, we have relationships with a large number of the active Guaranty Agencies (GAs), which are state or non-profit agencies that administer and rehabilitate student loans issued under the former federally-governed student loan program. In the healthcare market, we have been a Medicare Recovery Audit Contractor (RAC), in the United States for the Centers for Medicare and Medicaid Services (CMS), for over ten years, and are currently servicing two RAC contracts and
an additional Medicare Secondary Payer Commercial Repayment Center (CRC) contract. We have also expanded our client base to include multiple insurance providers in the private healthcare market.
We believe that our business platform is easily adaptable to new markets and processes. Over the past several years, we have successfully extended our platform into additional markets with significant recovery opportunities. For example, we utilized the same basic platform previously used primarily for student loan recovery activities to enter the state tax, federal treasury receivables and healthcare recovery markets. We continue to enhance our platform through investment in new data and analytics capabilities, which we believe will enable us to provide additional services such as services relating to the detection of fraud, waste and abuse. We endeavor to automate and optimize what traditionally have been manually intensive processes in order to drive higher workforce productivity. In 2018, we generated in excess of $100,000 of revenue per employee, based on the average number of employees during the year.
Our revenue model is generally success-based as we earn fees based on a percentage of the aggregate correct audits, and/or amount of funds that we enable our clients to recover. Our services do not require any significant upfront investments by our clients, and we offer our clients the opportunity to recover significant funds otherwise lost. Because our model is based upon the success of our efforts, our business objectives are aligned with those of our clients and we are generally not reliant on their spending budgets. Furthermore, our business model does not require significant capital as we do not purchase loans or obligations.
For the year ended
December 31, 2018
, we generated approximately
$155.7 million
in revenues,
$8.0 million
in net loss,
$(5.2) million
in adjusted EBITDA and
$14.3 million
in adjusted net loss. See “Management's Discussion and Analysis of Financial Condition and Results of Operations - Adjusted EBITDA and Adjusted Net Income” in Item 7 below for a definition of adjusted EBITDA and adjusted net income and reconciliations of adjusted EBITDA and adjusted net income to net income determined in accordance with generally accepted accounting principles.
Our Markets
We operate in markets characterized by strong growth, a complex regulatory environment and a significant amount of delinquent, defaulted or improperly paid assets.
Student Lending
Government-supported student loans are authorized under Title IV of the Higher Education Act of 1965. Historically, there have been two distribution channels for student loans: (i) the Federal Direct Student Loan Program, or FDSLP, which represents loans made and managed directly by the Department of Education; and (ii) the Federal Family Education Loan Program, or FFELP, which represents loans made by private institutions and currently backed by any of the 25 GAs.
In July 2010, the government-supported student loan sector underwent a structural change with the passage of the Student Aid and Fiscal Responsibility Act, or SAFRA. This legislation transitioned all new government-supported student loan originations to the FDSLP, and away from originations made by private institutions within the FFELP that had previously utilized the GAs to guarantee, manage and service loans. The GAs are non-profit 501(c)(3) public benefit corporations operating under contract with the U.S. Secretary of Education, pursuant to the Higher Education Act of 1965, as amended, solely for the purpose of guaranteeing and managing student loans originated by lenders participating in the FFELP. Consequently, the original distribution channels for student loans have been consolidated solely into the Department of Education. Despite this transition of all new loan originations to the FDSLP, GAs continue to manage a significant amount of defaulted student loans due to their outstanding portfolios of loans originated prior to July 2010. The outstanding portfolios of defaulted FFELP loans managed by the GAs will, therefore, require recovery for the foreseeable future, although at progressively lower volumes.
The Department of Education estimates that the balance of defaulted loans was approximately $101.4 billion in the FDSLP and approximately $38.9 billion in the FFELP as of September 30, 2018. The total amount of federally managed loans in default is $140.3 billion. The collective amount of defaulted loans serviced by the GAs as of September 30, 2018 was $26.1 billion. Given the operational and logistical complexity involved in managing the recovery of defaulted student loans, the GAs and the Department of Education have historically chosen to outsource these services to third parties.
Healthcare
The healthcare industry represents a significant portion of the U.S. Gross Domestic Product (GDP). According to CMS, U.S. healthcare spending grew 3.9 percent in 2017, reaching $3.5 trillion or $10,739 per person. As a share of the nation's GDP, health spending accounted for 17.9 percent. Currently, national health spending is projected to grow at an average
rate of 5.5 percent per year for 2018-27 and to reach nearly $6.0 trillion by 2027. Federal government-related spending grew 4.2% to $705.9 billion in 2017 for Medicare, which provides a range of healthcare coverage primarily to elderly and disabled Americans and grew 2.9% to $581.9 billion in 2017 for Medicaid, which provides federal matching funds for states to finance healthcare for individuals at or below the public assistance level.
Medicare was initially established as part of the Social Security Act of 1965 and consists of four parts: Part A covers hospital and other inpatient stays; Part B covers hospital outpatient, physician and other services; Part C is known as Medicare Advantage, under which beneficiaries receive benefits through private health plans; and Part D is the Medicare outpatient prescription drug benefit.
The Department of Health and Human Services estimated that for Medicare Part A and Part B spending in 2018, approximately $31.6 billion, or approximately 8.1%, was improper. Medicare improper payments generally involve incorrect coding, procedures performed which were not medically necessary, and incomplete documentation or claims submitted based on outdated fee schedules, among other issues.
In accordance with the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, a demonstration program was conducted from March 2005 to March 2008 in six states to determine if recovery audit contractors could be effectively used to identify improper payments for claims paid under Medicare Part A and Part B. Due to the success of this demonstration, under The Tax Relief and Health Care Act of 2006, the U.S. Congress authorized the expansion of the recovery audit program nationwide. CMS relies on third-party contractors to execute the recovery audit program to analyze millions of Medicare claims annually for improper payments to healthcare providers. The program was implemented by designating one prime contractor in each of the four major regions in the United States: West, Midwest, South, and Northeast. Contracts with recovery audit contractors, or RACs, were initially awarded in 2009. These contracts effectively expired in 2016 and new contracts were awarded in October 2016.
In addition to government-related healthcare spending, significant growth in spending is expected in the private healthcare market. According to CMS’ National Health Expenditures Projections (NHE), the private healthcare market accounted for approximately $1.2 trillion in spending in 2017, and private expenditures are projected to grow by 5.1% per year on average between 2020 and 2027.
Other Markets
State Tax Market
As state governments struggle with revenue generation and face significant budget deficits, many states have focused on recovery of delinquent state taxes. According to the Center on Budget and Policy Priorities, an independent think tank, 31 U.S. states faced projected budget shortfalls totaling $46.1 billion in 2017 and 2018. The economic recession beginning in 2008 led to lower income and sales taxes from both individuals and corporations, reducing overall tax revenues and leading to large budget deficits at the state government level. Although there has been some improvement (from $55 billion in 2013 to $46.1 billion in 2017 and 2018), the budget deficits continue to be a challenge for these states. While many states have received federal aid, most have cut services and increased taxes to help close the budget shortfall and have evaluated outsourcing at least some aspect of delinquent tax recovery.
Federal Agency Market
The federal agency market consists of government debt subrogated to the Department of the Treasury by numerous different federal agencies, comprising a mix of commercial and individual obligations and a diverse range of receivables. These debts are managed by the Bureau of the Fiscal Service (formerly the Department of Financial Management Service), or FS, a bureau of the Department of the Treasury.
Federal Tax Market
In September 2016 the Internal Revenue Service(IRS) announced its plans to begin private collection of certain federal tax debts starting in the spring of 2017 and named Performant as one of four companies to perform these recovery services. The new program, authorized under a federal law, calls for the use of private companies to recover, on the government’s behalf, outstanding inactive tax receivables. In Fiscal 2018, this program returned over $82 million, before costs to the U.S. Treasury.
Our Competitive Strengths
We believe that our business is difficult to replicate, as it incorporates a combination of several important and differentiated elements, including:
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Scalable and flexible technology-enabled services platform.
We have a technology platform that is highly flexible, intuitive and easy to use for our audit, recovery and claims specialists. Our platform is easily configurable and deployable across multiple markets and processes. For example, we have successfully extended our platform from the student loan market to the state and federal tax, federal treasury receivables and the healthcare recovery markets, each having its own industry complexities and specific regulations.
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Advanced, technology-enabled workflow processes.
Our technology-enabled workflow processes, developed over many years of operational experience in recovery services, disaggregate otherwise complex recovery processes into a series of simple, efficient and consistent steps that are easily configurable and applicable to different types of recovery-related applications. We believe our workflow software is highly intuitive and helps our audit, recovery and claims specialists manage each step of the recovery process, while automating a series of otherwise manually-intensive and document-intensive steps in the recovery process. We believe our streamlined workflow technology drives higher efficiencies in our operations, as illustrated by our ability to generate in excess of $100,000 of revenues per employee during 2018, based on the average number of employees during the year. We believe our streamlined workflow technology also improves recovery results relative to more labor-intensive outsourcing models.
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Strong data and analytics capabilities.
Our data and analytics capabilities allow us to achieve strong audit results and recovery rates for our clients. We have a proprietary data management and analysis platform which we use throughout our business. In some of our businesses, we have collected recovery-related data for over two decades, which we combine with large volumes of client and third-party data to effectively analyze our clients’ delinquent or defaulted assets and improper payments. We have also developed a number of analytical models for claims auditing, and analytics tools that we use to score our clients’ recovery inventory, determine the optimal recovery process and allocation of resources, and achieve higher levels of recovery results for our clients. In addition, we utilize analytics tools to continuously measure and test our recovery workflow processes to drive refinements and further enhance the quality and effectiveness of our capabilities.
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Long-standing client relationships.
We believe our long-standing focus on achieving superior recovery performance for our clients and the significant value our clients derive from this focus have helped us achieve long-tenured client relationships, strong contract retention and better access to new clients and future growth opportunities. We have business relationships with 14 GAs either as clients or through our contracts with ECMC and Navient and these relationships average more than eight years in length. In the healthcare market, we have a relationship with CMS that exceeds ten years. In October 2016 we were awarded two contracts out of the second recovery audit program procurement process, including for a region consisting of 11 states in the Northeast and Midwest and the national DMEPOS and home health contract. In October 2017, we were awarded a national exclusive (MSP CRC) contract by CMS.
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Extensive domain expertise in complex and regulated markets.
We have extensive experience and domain expertise in providing recovery services for government and private institutions that generally operate in complex and regulated markets. We have demonstrated our ability to develop domain expertise in new markets such as healthcare and state tax and federal Treasury receivables. We believe we have the necessary organizational experience to understand and adapt to evolving public policy and how it shapes the regulatory environment and objectives of our clients. We believe this helps us identify and anticipate growth opportunities. For example, we successfully identified government healthcare as a potential growth opportunity that has thus far led to the award of five contracts to us by CMS. Together with our flexible technology platform, we have the ability to adapt our business strategy, to allocate resources and to respond to changes in our regulatory environment to capitalize on new growth opportunities.
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Proven and experienced management team.
Our management team has significant industry experience and has demonstrated strong execution capabilities. Our senior management team, led by Lisa Im, has been with us for an average of approximately 18 years. This team has successfully grown our revenue base and service offerings beyond the original student loan market into healthcare and delinquent state and federal tax and private financial institutions receivables. Our management team’s industry experience, combined with deep and specialized understanding of complex and highly regulated industries, has enabled us to maintain long-standing client relationships and strong financial results.
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Our Growth Strategy
Key elements of our growth strategy include the following:
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Expand our recovery services in the healthcare market.
According to CMS, Medicare spending totaled approximately $705.9 billion in 2017 and is expected to grow by 7.6% per year on average between 2020 and 2027. In the private healthcare market, spending totaled $1.2 trillion in 2017 and expenditures are projected to grow by 5.1% per year on average between 2020 and 2027, according to CMS’ NHE Projections. As these large markets continue to grow, we expect the need for audit and recovery services to increase in the public and private healthcare markets. In October 2016, we were awarded new RAC contracts for Region 1 which consists of 11 states in the Northeast and Midwest, and Region 5, which covers claims for durable medical equipment, prosthetics and orthotics and home health and hospice payment claims across the U.S. In October 2017, we were awarded the national exclusive MSP CRC contract by CMS. We have also entered into numerous private insurance payer contracts and are pursuing additional opportunities to provide audit, recovery and analytics services in the private healthcare market. In addition, we intend to pursue opportunities to find and eliminate losses prior to payment for healthcare services, including the detection of fraud, waste and abuse in the public and private healthcare markets.
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Maintain our position in the student loan market.
The balance of defaulted government-supported student loans was approximately $140 billion as of September 30, 2018. We have long-standing relationships with some of the largest participants in the government-supported student loan market. Although the Department of Education announced in January 2018 that we were selected as one of two recovery contractors under its award for new student loan recovery contracts, we were notified on May 3, 2018 that the Department of Education has decided to cancel the current procurement in its entirety, and as a result terminated our contract award. Protests have been filed by certain of the unsuccessful bidders of the procurement of the new contracts from the Department of Education, and at this time, we cannot speculate on the outcome of any such protest or when work will begin under our new contract award.
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Expand outsource services, and recovery services in other markets
. We intend to expand our outsource services, and recovery services in other markets, including the private healthcare recovery market, state and federal tax and federal treasury receivables. We intend to capitalize on our extensive experience and domain expertise and our highly-flexible technology platform to seek opportunities in these additional markets.
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Pursue strategic alliances and acquisitions.
We intend to selectively consider opportunities to grow through strategic alliances or acquisitions that are complementary to our business. These opportunities may enhance our existing capabilities, enable us to enter new markets, expand our product offerings and allow us to diversify our revenues.
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Our Platform
Our data management, analytics, and technology-enabled services platform is proprietary and based on over two decades of experience in auditing and recovering large amounts of funds on behalf of our clients across several markets. The components of our platform include our data management expertise, analytics capabilities and technology-based workflow processes. Our platform integrates these components to allow us to achieve optimized outcomes for our clients in the form of increased efficiency and productivity and high recovery rates. Our platform and workflow processes are also intuitive and easy to use for our recovery and claims specialists and allow us to increase our employee retention and productivity.
The components of our platform include the following:
Data Management Expertise
Our platform manages and stores large amounts of data throughout the workflow process. This includes both proprietary data we have compiled over two decades, as well as third-party data which we can integrate efficiently and in real-time to reduce errors, reduce cycle time processing and, ultimately, improve audit finding and recovery rates. The strength of our data management expertise augments our analytics capabilities and provides our recovery and claims specialists with powerful workflow processes.
Data Analytics Capabilities
Our data analytics capabilities efficiently screen and allocate massive volumes of inventory. For example, in our student loan business, we utilize our proprietary algorithms to assist us in determining the most efficient recovery process and the optimal allocation of recovery specialist resources for each loan. In the healthcare market, we analyze millions of healthcare
claims to find potential correlations between claims data and improper payments, which enhance our finding rates. Across all of our current markets, we utilize our proprietary analytics tools to continuously and rigorously test our workflow processes in real-time to drive greater process efficiency and improvement in recovery rates.
Furthermore, we believe our analytics capabilities will extend our potential markets, permitting us to pursue significant new business opportunities. For example, we have expanded the use of our data analytics capabilities in the healthcare sector to offer a variety of services from post- and pre-payment audit of healthcare claims in both the public and private healthcare sector, to detection of fraud, waste and abuse of healthcare claims, to coordination of benefits and pharmacy fraud detection.
Workflow Processes
Over many years, we have developed and refined our workflow processes, which we believe drive higher efficiency and productivity and reduce our reliance on labor-intensive methods relative to more traditional outsourcing models. Our patented technology that supports our proprietary workflows to disaggregate otherwise complex processes into a series of simple, efficient and consistent steps that are easily configurable and applicable to different types of applications. Our workflow processes integrate a broad range of functions that encompass each stage of a workflow process.
The following recovery diagram illustrates how the various components of our platform work together to solve a typical recovery client workflow:
Our Services
We use our technology-enabled services platform to provide recovery and analytics services in a broad range of markets for the identification and recovery of student loans, improper healthcare payments and delinquent state and federal tax and federal treasury receivables. The table below summarizes our recovery services and related analytics capabilities and the markets we serve.
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Recovery Services
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Analytics
Capabilities
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Student Loans
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Healthcare
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Other Markets
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• Provide recovery services to clients in Federal guaranteed student loan program and private institutions
• Identify and track defaulted borrowers across our clients’ portfolios of student loans
• Utilize our proprietary technology, our history of borrower data and our analytics capabilities to rehabilitate and recover past due student loans
• Earn contingent, success-based fees calculated as a percentage of funds that we enable our clients to recover
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• Provide audit and recovery services to identify improper healthcare payments for public and private healthcare clients
• Identify improper payments typically resulting from incorrect coding, procedures that were not medically necessary, incomplete documentation or claims submitted based on outdated fee schedules
• Earn contingent, success-based fees based on a percentage of claim amounts recovered
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• Provide tax recovery services to state and municipal agencies and the IRS
• Recover government debt for numerous different federal agencies under a contract with the Treasury
• Enable financial institutions to proactively manage loan portfolios and reduce the incidence of defaulted loan assets
• Earn contingent, success-based fees calculated as a percentage of the amounts recovered, fees based on dedicated headcount and hosted technology licensing fees
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• We use our enhanced data analytics capabilities, which we refer to as Performant Insight, to offer a variety of services from post- and pre-payment audit of healthcare claims to detection of fraud, waste and abuse of healthcare claims, to coordination of benefits and pharmacy fraud detection
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Recovery Services
Student Loans
We provide recovery services primarily to the government-supported student loan industry, and our current clients include several of the largest GAs, as well as private financial institutions. We use our proprietary technology to identify, track and communicate with defaulted borrowers on behalf of our clients to implement suitable recovery programs for the repayment of outstanding student loan balances.
Our clients contract with us to provide recovery services for large pools of student loans generally representing a portion of the total outstanding defaulted balances they manage, which they provide to us as “placements” on a periodic basis. Generally, the volume of placements that we receive from our clients is influenced by our performance under our contracts and our ability to recover funds from defaulted student loans, as measured against the performance of competitors who may service a similar pool of defaulted loans for the same client. To the extent we perform well under our existing contracts and differentiate our services from those of our competitors, we may receive a relatively greater number of student loan placements under these contracts and may improve our ability to obtain future contracts from these clients and other potential clients.
We use algorithms derived from over two decades of experience with defaulted student loans to make reasonably accurate estimates of the recovery outcomes likely to be derived from a placement of defaulted student loans.
We also restructure and recover student loans issued directly by banks to students outside of federal lending programs. These types of loans typically supplement government-supported student loans to meet any shortfall in supply of student loan needs that cannot be met by grants or federal loans. Unlike government-supported student loans, private student loans do not have capped interest rates and, accordingly, involve higher instances of default relative to federally-backed student loans. Additionally, with the burgeoning personal loan industry we believe there is more opportunity for us to expand services into this private sector.
Healthcare
We provide audit and recovery services related to improper payments in the healthcare market. In October 2016 we were awarded two new RAC contracts by CMS. One new award covers Parts A and B Medicare payments in a region consisting of 11 states in the Northeast and Midwest. The second award involves post-payment review of DMEPOS and home health and hospice claims across the U.S. In addition, in October 2017 we were awarded the national exclusive
MSP CRC contract by CMS. In addition, we have entered into numerous private insurance payer contracts and are pursuing additional opportunities to provide audit, recovery and analytic services in the private healthcare market.
Under our RAC contracts with CMS, we utilize our technology-enabled services platform to screen Medicare claims against several criteria, including coding procedures and medical necessity standards, to determine whether a claim should be further investigated for recoupment or adjustment by CMS. We conduct automated and, where appropriate, detailed medical necessity reviews. If we determine that the likelihood of finding a potential improper payment warrants further investigation, we request and review healthcare provider medical records related to the claim, utilizing experts in Medicare coding and registered nurses. We interact and communicate with healthcare providers and other administrative entities, and ultimately submit the claim to CMS for correction.
In the private healthcare market, we utilize our technology-enabled services platform to provide audit, recovery and analytical services for private healthcare payers. Our experience from our RAC contracts has helped establish our presence in the private healthcare market by providing us the opportunity to provide audit and recovery services for several national commercial health plans. Our audit and analytics capabilities have allowed us not only to expand our services with these initial private healthcare clients, but also gain entry into other related private healthcare opportunities. Additionally, following our acquisition of Premiere Credit of North America in August of 2018, we now also help hospitals and other medical providers recover payments directly from patients.
Other Markets
We also provide recovery services to several federal, state and municipal tax authorities, the Department of the Treasury and a number of financial institutions.
In September 2016 the Internal Revenue Service, or IRS, announced its plans to begin private collection of certain federal tax debts starting in the spring of 2017 and named us as one of four companies to perform these recovery services. The new program, authorized under a federal law, calls for the use of private companies to recover, on the government’s behalf, outstanding inactive tax receivables. Although the initial placement volumes were low when we commenced work under this contract in April 2017 reflecting the IRS’s objective of a methodical contract start, by the end of 2018, the number of placements of federal tax receivables we received from the IRS more than doubled from what we had processed in 2017. In the 2018 fiscal year, this new recovery program returned an aggregate of over $82 million, before costs, to the U.S. Department of the Treasury.
For state and municipal tax authorities, we analyze a portfolio of delinquent tax and other receivables placed with us, develop a recovery plan and execute a recovery process designed to maximize the recovery of funds. In some instances, we have also run state tax amnesty programs, which provide one-time relief for delinquent tax obligations, and other debtor management services for our clients. We currently have relationships with numerous state and municipal governments. Delinquent obligations are placed with us by our clients and we utilize a process that is similar to the student loan recovery process for recovering these obligations.
For the Department of the Treasury, we recover government debt subrogated to it by numerous different federal agencies. The placements we are provided represent a mix of commercial and individual obligations. We are one of four contractors for the most recent Treasury contract.
We also provide risk management advisory services that enable these clients to proactively manage loan portfolios and reduce the incidence of defaulted loan assets over time. Our experience suggests that proactive default prevention practices produce significant net yield and earnings gains for our clients. We deliver these services in two forms. First, we contact and consult with borrowers to implement a repayment program, including payment through automatic debit arrangements, prior to the beginning of the repayment period in order to increase the likelihood that payments begin on time. Second, we offer a service that involves contacting delinquent borrowers in an effort to cure the delinquency prior to the loan entering default.
Analytics Capabilities
For several years, we have leveraged our data analytics tools to help filter, identify audit claims and recover delinquent and defaulted assets and improper payments as part of our core services platform. Through our data analytics capabilities, which we refer to as Performant Insight, we are able to review, aggregate, and synthesize very large volumes of structured and unstructured data, at high speeds, from the initial intake of disparate data sources, to the warehousing of the data, to the analysis and reporting of the data. We believe we have built a differentiated, next-generation “end-to-end” data processing solution that will maximize value for current and future customers.
Performant Insight provides numerous benefits for our audit and recovery services platform. Performant Insight has not only enhanced our existing recovery services under our RAC contracts and other private healthcare contracts by analyzing significantly higher volumes of healthcare claims at faster rates and reducing our cycle time to review and assess healthcare claims, but has also enabled us to develop improved and more sophisticated business intelligence rules that can be applied to our audit processes. We believe our analytics capabilities will extend our potential markets, permitting us to pursue significant new business opportunities. We have expanded the use of our data analytics capabilities in the healthcare sector to offer a variety of services from post and pre-payment audit of healthcare claims in both the public and private healthcare sector, to detection of fraud, waste and abuse of healthcare claims, to coordination of benefits and pharmacy fraud detection.
Our Clients
We provide our services across a broad range of government and private clients in several markets.
Guaranty Agencies
We restructure and recover defaulted student loans issued by private lenders and backed by GAs under the FFELP. As a result of the transition from FFELP to FDSLP that commenced in 2010, the volume of defaulted student loans managed by the GAs has begun to decline over the last few years and is expected to continue to decline. When a borrower stops making regular payments on a FFELP loan, the GA is obligated to reimburse the lender approximately 97% of the loan’s principal and accrued interest. GAs then seek to recover and restructure these obligations. The GAs with which we contract generally structure one to three-year initial term contracts with multiple renewal periods.
We have a relationship with 14 GAs in the U.S. either as clients or through our contracts with ECMC and Navient; these relationships average more than eight years in length. On June 15, 2017, we received a termination notice from one of our significant GA clients, Great Lakes Higher Education Guaranty Corporation (Great Lakes). The termination of this contract was based on Great Lakes' decision to bundle its student loan servicing work, a service that we currently do not provide, along with its student loan recovery work to a single third-party vendor. In September 2017, we entered into a contract with Navient, who is now servicing the Great Lakes portfolio, to act as a recovery subcontractor on the Great Lakes' portfolio. This contract has no set term, and Navient has the right to terminate the contract at will.
CMS
Our relationship with CMS extends beyond ten years in duration. Under our first RAC contract with CMS, which was awarded in 2009 and expired in 2016, we were responsible for identifying and facilitating the recovery of improper Part A and Part B Medicare payments in the Northeast region of the United States. On January 31, 2018, CMS issued to us their final Letter of Demand which reconciled all outstanding payables to CMS for the old Region A contract. Accordingly, we released an aggregate of approximately $27.8 million and $0.6 million of the estimated liability for appeals and the Net payable to client balances, during the first quarter and third quarter of 2018, respectively. This increased first quarter 2018 revenue by $27.8 million and third quarter revenue by $0.6 million. In conjunction with the release, we also derecognized approximately $9.0 million of prepaid expenses and other current assets, with a charge to other operating expenses, reflecting accrued receivables associated with amounts due to us from our subcontractors for decided and yet-to-be decided appeals. In October 2016, we were awarded two new RAC contracts. We received the contract to audit improper payments for claims made under Medicare Parts A and B in Region 1, which consists of Connecticut, Michigan, Indiana, Maine, Massachusetts, New Hampshire, New York, Ohio, Kentucky, Rhode Island and Vermont, and the contract for Region 5, which involves post-payment review of claims related to DMEPOS and home health and hospice across the U.S. The fees that we receive for identifying improper payments from CMS under these contracts are entirely contingency-based, and the contingency-fee percentage depends on the methods of recovery, and, in some cases, the type of improper payment that we identify. Our audit activity on the new RAC contracts is limited at this time to approximately 0.5% of claims; however, CMS has indicated that there may be an opportunity to increase the audit activity percentage based on provider error rates. Additionally, in October 2017 we were awarded the national exclusive
MSP CRC contract by CMS.
Under this MSP CRC contract, we are responsible for identifying and recovering payments in situations where Medicare should not be the primary payer of healthcare claims because a beneficiary
has other forms of insurance coverage, such as through an employer group health plan or certain other payers.
In February of 2018 we commenced operations on the MSP CRC contract with activity increasing during the year.
Department of Education
We have provided student loan recovery services to the Department of Education for approximately 25 years; the Department of Education had historically been our largest or one of our largest clients, accounting for 15.5%, 23.8%, and 27.2% of our revenues in 2016, 2015 and 2014, respectively. However, following the expiration of our most recent contract in April 2015, and the subsequent decline of student loan placement volumes, revenues from the Department of Education fell to 4% of our 2017 revenues. Although the Department of Education announced in January 2018 that we were selected as one of two recovery contractors under its award for new student loan recovery contracts, no work was completed under that contract and we were subsequently notified on May 3, 2018 that the Department of Education had decided to cancel the current procurement in its entirety, and as a result terminated our contract award.
Private Healthcare
In the private healthcare market, we utilize our technology-enabled services platform to provide audit, recovery and analytical services for private healthcare payers. Our experience from our RAC contracts has helped establish our presence in the private healthcare market by providing us the opportunity to provide audit and recovery services for several national commercial health plans. Our audit and analytics capabilities have allowed us not only to expand our services with these initial private healthcare clients, but also gain entry into other related private healthcare opportunities.
U.S. Department of the Treasury
We have assisted the Department of the Treasury for over 20 years in the recovery of delinquent receivables owed to a number of different federal agencies. The debt obligations we help to recover on behalf of the Department of the Treasury include commercial and individual debt obligations. We are one of the six firms servicing the current Department of the Treasury contract. Similar to our other recovery contracts, our fees under this contract are contingency-based. We view this as an important strategic relationship, as it provides us valuable insight into other business opportunities within the federal government.
State Tax Agencies
We provide recovery services for individuals’ delinquent state tax obligations on a hosted model. We currently have relationships with a number of state governments.
Private Lenders
We provide recovery services for private student loans, which supplement federally guaranteed loans, and home mortgages to private lenders. Additionally, with the burgeoning personal loan industry we believe there is more opportunity for us to expand services into this private sector.
Internal Revenue Service
In September 2016 the Internal Revenue Service, or IRS, announced it plans to begin private collection of certain federal tax debts starting in 2017 and awarded us a contract to perform these recovery services. The new program, authorized under a federal law enacted by Congress, enables us, along with three other contractors to collect, on the government’s behalf, outstanding inactive tax receivables. Our ability to recover these receivables will be limited to accounts where taxpayers owe money, but the IRS is no longer actively working their accounts. Although the initial placement volumes were low when we commenced work under this contract in April 2017 reflecting the IRS’s objective of a methodical contract start, by the end of 2018, the number of placements of federal tax receivables we received from the IRS more than doubled from what we had processed in 2017.
Sales and Marketing
Our new business opportunities have historically been driven largely by referrals and natural extensions of our existing client relationships, as well as a targeted outreach by our sales team and senior management. Our sales cycles are often lengthy, and demand high levels of attention from our senior management. At any point in time, we are typically focused on a limited number of potentially significant new business opportunities. As a result, to date, we have operated with a small staff of experienced individuals with responsibility for developing new sales, relying heavily upon our executive staff, including an appropriate sales and marketing team covering various markets.
Technology Operations
Our technology center is based in Livermore, California, with a redundant capacity in our Grants Pass, Oregon office. Additionally, Performant Insight, our data analytics business, is supported by staff in Sunrise, Florida. We have designed our infrastructure for scalability and redundancy, which allows us to continue to operate in the event of an outage at either datacenter. We maintain an information systems environment with advanced network security intrusion detection and prevention with 24x7 monitoring and security incident response capabilities. We utilize encryption technologies to protect sensitive data on our systems, all data during transmission and all data on redundancy or backup media. We also maintain
a comprehensive enterprise wide information security program based on industry standards such as NIST 800-53 and PCI/DSS.
Competition
We face significant competition in all aspects of our business. In recovery services for delinquent and defaulted assets, we face competition from a number of companies. Holders of these delinquent and defaulted assets typically engage several firms simultaneously to provide recovery services on different portions of their portfolios. The number of recovery firms engaged varies by client. Initially, we compete to be one of the retained firms in a competitive bidding process and, if we are successful, we then face continuing competition from the client’s other retained firms based on the client’s benchmarking of the recovery performance of its several vendors. Some clients will allocate additional placements to those recovery vendors producing the highest recovery rates. We believe that we primarily compete on the basis of recovery rate performance, as well as maintenance of high standards of recovery practices and data security capabilities. We believe that we compete favorably with respect to these factors as evidenced by our long-standing relationships with our clients in these markets. Pricing is not usually a major competitive factor as all recovery services vendors in these markets typically receive the same contingency-based fee rate.
In the audit and recovery of improper healthcare payments, we face competition in the bidding process for commercial healthcare contracts, and the RAC contracts awarded by CMS. However, based on our structured, highly professional and effective recovery process within the healthcare market, we believe these are contracts for which we are uniquely qualified. This qualification allows us to compete more effectively for contracts such as the
MSP CRC contract, which we were awarded in October 2017.
In the most recent RAC bidding process, the identified competitive factors were demonstrated experience in effective recovery services in the healthcare market, sufficient capacity to address claims volumes, maintenance of high standards of recovery practices, financial capability to perform under the RAC contract and recovery fee rates. In the commercial healthcare space, those same factors are generally applicable. Our competition in the private healthcare arena includes the other RAC service providers, Health Management Systems, Inc. and Cotiviti, LLC, and a variety of healthcare consulting and healthcare information services companies. Many of these companies have greater financial, technological and other resources than we do.
Government Regulation
The nature of our business requires that we adhere to a complex array of federal and state laws and regulations. These include the Health Insurance Portability and Accountability Act, or HIPAA, the Fair Debt Collection Practices Act, or FDCPA, the Fair Credit Reporting Act, or FCRA, the rules and regulations established by the Consumer Financial Protection Bureau, or CFPB, and related state laws. We are also governed by a variety of state laws that regulate the collection, use, disclosure and protection of personal information. We have implemented and maintain physical, technical and administrative safeguards intended to protect all personal data and we have processes in place to assist us in complying with applicable laws and regulations regarding the protection of this data. Our compliance efforts include training of personnel and monitoring our systems and personnel.
HIPAA and Related State Laws
Our Medicare recovery business subjects us to compliance with HIPAA and various related state laws that contain substantial restrictions and requirements with respect to the use and disclosure of an individual’s protected health information. HIPAA prohibits us from using or disclosing an individual’s protected health information unless the use or disclosure is authorized by the individual or is specifically required or permitted under HIPAA. Under HIPAA, we must establish administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic protected health information maintained or transmitted by us or by others on our behalf. We are required to notify affected individuals and government authorities of data security breaches involving unsecured protected health information. The Department of Health and Human Services Office of Civil Rights enforces HIPAA privacy violations; CMS enforces HIPAA security violations and the Department of Justice enforces criminal violations of HIPAA. We are subject to statutory penalties for violations of HIPAA.
Most states have enacted patient confidentiality laws that protect against the unauthorized disclosure of confidential medical information, and many states have adopted or are considering further legislation in this area, including privacy safeguards, security standards and data security breach notification requirements. These state laws, if more stringent than HIPAA requirements, are not preempted by the federal requirements, and we must comply with them even though they may be subject to different interpretations by various courts and other governmental authorities. In addition, numerous other state laws govern the collection, dissemination, use, access to and confidentiality of individually identifiable health and healthcare provider information.
Our compliance efforts include the encryption of protected health information that we hold and the development of procedures to detect, investigate and provide appropriate notification if protected health information is compromised. Our employees and contractors receive initial and periodic supplemental training and are tested to ensure compliance. As part of our certification and accreditation process, we must undergo audits by federal agencies as noted below. CMS regularly audits us for, among other items, compliance with their security standards.
Privacy Act of 1974
The Privacy Act of 1974 governs the collection, use, storage, destruction and disclosure of personal information about individuals by a government agency and extends to government contractors who have access to agency records performing services for government agencies. The Privacy Act requires maintenance of a code of conduct for employees with access to the agency records addressing the obligations under the Privacy Act, training of employees and discipline procedures for noncompliance. The Privacy Act also requires adopting and maintaining appropriate administrative, technical and physical safeguards to insure the security and confidentiality of records and to protect against any anticipated threats or hazards to their security or integrity.
As a contractor to federal government agencies we are required to comply with the Privacy Act of 1974. Our compliance effort includes initial and ongoing training of employees and contractors in their obligations under the Privacy Act. In addition, we have implemented and maintain physical, technical and administrative safeguards and processes intended to protect all personal data consistent with or exceeding our obligations under the Privacy Act.
Certification, Accreditation and Security
Business services that collect, store, transmit or process information for United States government agencies and organizations are required to undergo a rigorous certification and accreditation process to ensure that they operate at an acceptable level of security risk. As a government contractor, we currently have Authority to Operate, or ATO, licenses from both the Department of Education and CMS.
We maintain a comprehensive enterprise-wide information security program based on industry standards such as NIST 800-53 and PCI/DSS. In addition, we hold SSAE – SOC 1 Type II certification, which provides assurance to auditors of third parties that we maintain the necessary controls and procedures to effectively manage third party data. We undergo an independent audit by our government agency clients on the award of the contract and periodically thereafter. We also conduct periodic self-assessments.
Our regulatory compliance group is charged with the responsibility of ensuring our regulatory compliance and security. All our facilities have security perimeter controls with segregated access by security clearance level. The information systems environment maintains advanced network security intrusion detection and prevention with 24x7 monitoring and security incident response capabilities. We utilize encryption technologies to protect sensitive data on our systems, all data during transmission and all data on redundancy or backup media. Employees undergo background and security checks appropriate to their position. This can include security clearances by the Federal Bureau of Investigation. We also maintain compliant disaster recovery and business continuity plans, annually conduct two table top disaster exercises, conduct routine security risk assessments and maintain a continuous improvement process as part of our security risk mitigation and management activity.
FDCPA and Related State Laws
The FDCPA regulates persons who regularly collect or attempt to collect, directly or indirectly, consumer debts owed or asserted to be owed to another person. Certain of our debt recovery and loan restructuring activities may be subject to the FDCPA. The FDCPA establishes specific guidelines and procedures that debt recovery firms must follow in communicating with consumer debtors, including the time, place and manner of such communications. Further, it prohibits harassment or abuse by debt recovery firms, including the threat of violence or criminal prosecution, obscene language or repeated telephone calls made with the intent to abuse or harass. The FDCPA also places restrictions on communications with individuals other than
consumer debtors in connection with the collection of any consumer debt and sets forth specific procedures to be followed when communicating with such third parties for purposes of obtaining location information about the consumer. In addition, the FDCPA contains various notice and disclosure requirements and prohibits unfair or misleading representations by debt recovery firms. Finally, the FDCPA imposes certain limitations on lawsuits to collect debts against consumers.
Prior to the adoption of amendments to the FDCPA as part of the Dodd-Frank Act, no federal agency had the authority to issue interpretative regulations for the FDCPA. As a result, judicial determinations and non-binding interpretative positions issued by the Federal Trade Commission under the FDCPA created compliance difficulties for the consumer debt collections industry. With the adoption of the amendments to the FDCPA as part of the Dodd-Frank Act in 2011, however, as well as specific statutory authority to issue implementing regulations for the FDCPA, primary jurisdiction for the FDCPA was transferred to the Consumer Financial Protection Bureau, or CFPB. Subsequently, the CFPB has indicated that it may issue proposed regulations under the FDCPA.
Debt recovery activities are also regulated at the state level. Most states have laws regulating debt recovery activities in ways that are similar to, and in some cases more stringent than, the FDCPA. In addition, some states require debt recovery firms to be licensed.
Our compliance efforts include written procedures for compliance with the FDCPA and related state laws, employee training and monitoring, auditing client calls, periodic review, testing and retraining of employees, and procedures for responding to client complaints. In all states where we operate, we believe that we currently hold all required state licenses or are exempt from licensing. Violations of the FDCPA may be enforced by the U.S. Federal Trade Commission, or FTC, or by a private action by an individual or class. Violations of the FDCPA are deemed to be an unfair or deceptive act under the Federal Trade Commission Act, which can be punished by fines for each violation. Class action damages can total up to one percent of the net worth of the entity violating the statute. Attorney fees and costs are also recoverable. In the ordinary course of business, we are sued for alleged violations of the FDCPA and comparable state laws, although the amounts involved in the disposition or settlement of any such claims have not been significant.
TCPA
The Telephone Consumer Protection Act, or TCPA, regulates the initiation of calls (which includes text messages) to residential or cellular telephones, including the use of automatic telephone dialing systems as well as artificial or prerecorded voices. The TCPA requires callers to obtain prior express consent or, in some cases, prior express written consent from individuals before placing restricted calls. Our compliance efforts include confirming a consumer has provided prior express consent consistent with the requirements of the law. Violations of the TCPA may be enforced by the U.S. Federal Communications Commission, or FCC, or by a private action by an individual or class. Violations of the TCPA can be punished by recovery of damages or penalties up to $1,500 per violation for willful violations. Attorney fees and costs are also recoverable. In the ordinary course of business, we are sued for alleged violations of the TCPA and comparable state laws, although the amounts involved in the disposition or settlement of any such claims have not been significant.
FCRA
We are also subject to the Fair Credit Reporting Act, or FCRA, which regulates consumer credit reporting and which may impose liability on us to the extent that the adverse credit information reported on a consumer to a credit bureau is false or inaccurate. State law, to the extent it is not preempted by the FCRA, may also impose restrictions or liability on us with respect to reporting adverse credit information. Our compliance efforts include initial and ongoing training of employees working with consumer credit reports and the monitoring of usage. Violations of FCRA, which are deemed to be unfair or deceptive acts under the Federal Trade Commission Act, are enforced by the FTC or by a private action by an individual or class. Civil actions by consumers may seek damages per violation, with punitive damages, attorney's fees and costs also recoverable. Under the Federal Trade Commission Act, penalties for engaging in unfair or deceptive acts can be punished by fines for each violation.
CFPB
The CFPB was created as part of the Dodd-Frank Act in 2011, with primary implementing and interpretative authority for many federal consumer protection laws, for example the FDCPA, transferred to the CFPB. Among other things, the CFPB was given the authority to issue interpretive regulations for the FDCPA.
In addition to its authority in regard to federal consumer protection laws, the CFPB was also provided direct jurisdiction over certain consumer financial service providers. In October of 2012, the CFPB issued a rule asserting direct jurisdiction over large consumer debt collectors, which includes debt collectors with annual assets of more than $10 million. In accordance with the calculations included in this rule, we are subject to direct jurisdiction of the CFPB and in the future may be
directly examined and supervised by the CFPB. In that regard, the CFPB has also released examination guidance that its examiners will use when reviewing compliance by debt collectors subject to its direct supervision
.
The CFPB focuses on service providers involved in collecting debt related to any consumer financial product from committing unfair, deceptive, or abusive acts or practices, or UDAAPs, in violation of the Dodd-Frank Act. UDAAPs include actions that are unfair and likely to cause substantial injury to consumers, deceptive actions that mislead or likely to mislead a consumer and abusive acts that interfere with the ability of a consumer to understand a term or condition of a consumer financial product or takes unreasonable advantage of a consumer’s lack of understanding of a consumer financial product. Although abusive acts or practices may also be unfair or deceptive, each of these prohibitions are separate and distinct, and are governed by separate legal standards. Original creditors and other covered persons and service providers involved in collecting debt related to any consumer financial product or service are subject to the prohibition against UDAAPs. The CFPB has indicated that it will continue to review closely the practices of those engaged in the collection of consumer debts for potential UDAAPs in violation of the Dodd-Frank Act.
State Law Compliance and Security Breach Response
Many states impose an obligation on any entity that holds personally identifiable information or health information to adopt appropriate security to protect such data against unauthorized access, misuse, destruction, or modification. All fifty states and the District of Columbia have enacted laws requiring holders of personal information to take certain actions in response to data breach incidents, such as providing prompt notification of the breach to affected individuals and government authorities, and in some cases offering credit monitoring services. In many cases, these laws are limited to electronic data, but states are increasingly enacting or considering stricter and broader requirements. Massachusetts has enacted a regulation that requires any entity that holds, transmits or collects certain personal information about its residents to adopt a written data security plan meeting the requirements set forth in the statute. We have implemented and maintained physical, technical and administrative safeguards intended to protect all personal data and have processes in place to assist us in complying with applicable laws and regulations regarding the protection of this data and properly responding to any security incidents. We have adopted a system security plan and security breach incident response plans to address our compliance with these laws.
Intellectual Property
Our intellectual property is a significant component of our business, including, most notably, the intellectual property underlying our proprietary technology-enabled services platform through which we provide our defaulted asset recovery and other services. To protect our intellectual property, we rely on a combination of intellectual property rights, including patents, trade secrets, trademarks and copyrights. We also utilize customary confidentiality and other contractual protections, including employee and third-party confidentiality and invention assignment agreements.
As of December 31, 2018, we had two U.S. patents, both covering aspects of the workflow management systems and methods incorporated into our technology-enabled services platform. These patents will expire in September 2024. We routinely assess appropriate occasions for seeking additional patent protection for those aspects of our platform and other technologies that we believe may provide competitive advantages to our business. We also rely on certain unpatented proprietary expertise and other know-how, licensed and acquired third-party technologies, and continuous improvements and other developments of our various technologies, all intended to maintain our leadership position in the industry.
As of December 31, 2018, we had six trademarks registered with the U.S. Patent and Trademark office: DCS, Performant Recovery, Performant Technologies, Discovery Analytics, Performant Insight, and Premiere Credit.
We have registered copyrights covering various copyrighted material relevant to our business. We also have unregistered copyrights in many components of our software systems. We may not be able to use these unregistered copyrights to prevent misappropriation of such content by unauthorized parties in the future; however, we rely on our extensive information technology security measures and contractual arrangements with employees and third-party contractors to minimize the opportunities for any such misuse of this content.
We are not subject to any material intellectual property claims alleging that we infringe, misappropriate or otherwise violate the intellectual property rights of any third party, nor have we asserted any material intellectual property infringement claim against any third party.
Employees
As of
December 31, 2018
, we had approximately 1,892 full-time employees. None of our employees is a member of a labor union and we consider our employee relations to be good.
Available Information
The SEC maintains an Internet site at http://www.sec.gov that contains our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, if any, or other filings filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, proxy and information statements.
ITEM 1A. Risk Factors
Our business, financial condition, results of operations and liquidity are subject to various risks and uncertainties, including those described below, and as a result, the trading price of our common stock could decline.
Risks Related to Our Business
Revenues generated from our three largest clients represented
61%
of our revenues in 2018 and 63% of our revenues in 2017. Our relationships with one of these clients, Great Lakes Higher Education Guaranty Corporation, was terminated in 2017. Any termination of or deterioration in our relationship with any of our other significant clients would result in a further decline in our revenues.
We have derived a substantial majority of our revenues from a limited number of clients. Revenues from our three largest clients represented
61%
of our revenues for the year ended December 31, 2018 and 63% of our revenues for the year ended December 31, 2017. We have had relationships with numerous GAs in the U.S. including Pennsylvania Higher Education Assistance Authority and Great Lakes, which were responsible for 17% and 17%, respectively, of our revenues for the year ended December 31, 2018. On June 15, 2017, we received a 30-day termination notice with respect to our contract with Great Lakes, based on Great Lakes’ decision to bundle with a single third-party vendor its student loan servicing work, a service that we currently do not provide, along with its student loan recovery work. While we subsequently obtained a subcontract for student loan recovery work from Navient, the new provider of servicing and defaulted portfolio management to Great Lakes, this contract has no set term or volume, and Navient has the right to terminate the contract at will. Because the Department of Education terminated our January 2018 contract and the current procurement in its entirety, we now will become even more dependent on our business relationships with our remaining GA clients for our student loan revenues. In that regard, we believe that the portfolios of our GA clients will continue to decrease over time due to (i) the effect of federal legislation in 2010 that requires all student loan originations to come from the Department of Education (which means that there will be no further growth in student loans held by GAs), and (ii) because we are seeing a larger amount of defaulted student loans in our GA client portfolios that have been previously rehabilitated and by regulation are not subject to rehabilitation for a second time. All of our contracts with our significant clients are subject to periodic renewal and re-bidding processes and if we lose one of these clients or if the terms of our relationships with any of these clients become less favorable to us, our revenues would decline, which would harm our business, financial condition and results of operations.
Many of our contracts with our clients for the recovery of student loans and other receivables are not exclusive and do not commit our clients to provide specified volumes of business. In addition, the terms of these contracts may be changed unilaterally and on short notice by our clients. As a consequence, there is no assurance that we will be able to maintain our revenues and operating results.
Substantially all of our existing contracts for the recovery of student loans and other receivables, which represented approximately 64% of our revenues for the year ended December 31, 2018 and 92% of our revenues in the year ended December 31, 2017, enable our clients to unilaterally terminate their contractual relationship with us at any time without penalty, potentially leading to loss of business or renegotiation of terms. Further, most of our contracts in these markets allow our clients to unilaterally change the volume of loans and other receivables that are placed with us or the payment terms at any given time. In addition, most of our contracts are not exclusive, with our clients retaining multiple service providers with whom we must compete for placements of loans or other obligations. Therefore, despite our contractual relationships with our clients, our contracts do not provide assurance that we will generate a minimum amount of revenues or that we will receive a specific volume of placements. Our revenues and operating results would be negatively affected if our student loan and receivables clients reduce the volume of student loan placements provided to us, modify the terms of service, including the success fees we are able to earn upon recovery of defaulted student loans, or any of these clients establish more favorable relationships with our competitors.
We typically face a long period to implement a new contract which may cause us to incur expenses before we receive revenues from new client relationships.
If we are successful in obtaining an engagement with a new client or a new contract with an existing client, we typically have a subsequent long implementation period in which the services are planned in detail and we integrate our technology, processes and resources with the client’s operations. If we enter into a contract with a new client, we typically will not receive revenues until implementation is completed and work under the contract actually begins. Our clients may also experience delays in obtaining approvals or managing protests from unsuccessful bidders, or delays associated with technology or system implementations, such as the delays experienced with the implementation of our first RAC contract with CMS. Because we generally begin to hire new employees to provide services to a new client once a contract is signed, we may incur
significant expenses associated with these additional hires before we receive corresponding revenues under any such new contract. If we are not successful in maintaining contractual commitments after the expenses we incur during our typically long implementation cycle, our cash flows and results of operations could be adversely affected.
We may not have sufficient cash flows from operations and availability of funds under our credit agreement to fund our ongoing operations and our other liquidity needs, which could adversely affect our business and financial condition.
Our ability to fund our business plans, capital expenditures and to fund our other liquidity needs depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot make assurances that we will maintain a level of cash flows from operating activities sufficient to permit us to fund our ongoing and planned business operations and to fund our other liquidity needs. If our cash flows and capital resources are insufficient to fund our planned business operations or to fund our other liquidity needs, we may be forced to reduce or delay capital expenditures, alter our business plans, sell assets or operations, seek additional capital or restructure or refinance our indebtedness, any of which could have an adverse effect on our financial condition and results of operations.
Our indebtedness could adversely affect our business and financial condition and reduce the funds available to us for other purposes, and our failure to comply with the covenants contained in our Credit Agreement could result in an event of default that could adversely affect our results of operations.
Our ability to make scheduled payments under our credit agreement and to fund our other liquidity needs depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot make assurances that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness and to fund our other liquidity needs. If our cash flows and capital resources are insufficient to fund our debt service obligations and allow us to maintain compliance with the covenants under our Credit Agreement or to fund our other liquidity needs, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We cannot ensure that we would be able to take any of these actions, that these actions would be successful and permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements, including our Credit Agreement with ECMC. If we cannot make scheduled payments on our debt, we will be in default and, as a result, our debt holders could declare all outstanding principal and interest to be due and payable, the lenders under our Credit Agreement could terminate their commitments to lend us money and foreclose against the assets securing our borrowings and we could be forced into bankruptcy or liquidation.
Our debt agreement contains, and any agreements to refinance our debt likely will contain, certain financial and restrictive covenants that limit our ability to incur additional debt, including to finance future operations or other capital needs, and to engage in other activities that we may believe are in our long-term best interests, including to dispose of or acquire assets. Our failure to comply with these covenants may result in an event of default, which, if not cured or waived, could accelerate the maturity of our indebtedness or result in modifications to our credit terms. If our indebtedness is accelerated, we may not have sufficient cash resources to satisfy our debt obligations and we may not be able to continue our operations as planned.
Our ability to derive revenues under our new RAC contracts will depend in part on the number and types of potentially improper claims that we are allowed to pursue by CMS, and our results of operations may be harmed if the scope of claims that we are allowed to pursue and be compensated for is limited.
Under CMS’s Medicare recovery audit program, RAC contractors have not been permitted to seek the recovery of an improper claim unless that particular type of claim has been pre-approved by CMS to ensure compliance with applicable Medicare payment policies, as well as national and local coverage determinations. As work under the first RAC contract progressed, CMS placed increasing restrictions on the scope of audits permitted by RAC contractors and these restrictions have not been relaxed under the newly awarded RAC contracts. Accordingly, the long-term growth of the revenues we derive under our two newly awarded RAC contracts will depend in significant part on the scope of potentially improper claims that we are allowed to pursue. Revenues from our RAC contracts with CMS during the year ended December 31,2018 were $1.7 million (excluding the effects of the release of the $28.4 million appeal reserve in connection with the termination of our first CMS RAC contract).
In particular, in September 2013, CMS implemented rules that prevent RAC contractors from being able to review and audit (i) whether inpatient care delivered to patients with hospital stays lasting less than two midnights was medically necessary
and therefore deserving of the higher reimbursement levels under Medicare Part A or (ii) whether inpatient treatment was medically necessary for admissions spanning more than two midnights. In connection with these restrictions, hospitals cannot bill CMS for outpatient services on hospital stays lasting less than two midnights during such period. Fees associated with recoveries initiated by us based upon improper claims for inpatient reimbursement of these short stays had represented a substantial portion of the revenues we had earned under our prior RAC contract. The continued suspension of this type of review activity has had and may continue to have a material adverse effect on our future healthcare revenues and operating results, depending on a variety of factors including, among other things, CMS’s evaluation of provider compliance with the new rules, the rules ultimately adopted by CMS with respect to medical necessity reviews of Medicare reimbursement claims associated with short stay inpatient admissions and, more generally, the scope of improper claims that CMS allows us to pursue and our ability to successfully identify improper claims within the permitted scope.
We may not be able to manage our potential growth effectively and our results of operations could be negatively affected.
Our newly awarded RAC contracts, MSP CRC contract, and other commercial healthcare contracts provide the potential opportunity to restore the growth in our recovery businesses. However, our focus on growth and the expansion of our business may place additional demands on our management, operations and financial resources and will require us to incur additional expenses. We cannot be sure that we will be able to manage our performance under any significant new contracts effectively. In order to successfully perform under any significant new contracts, our expenses will increase to recruit, train and manage additional qualified employees and subcontractors and to expand and enhance our administrative infrastructure and continue to improve our management, financial and information systems and controls. If we cannot manage our growth effectively, our expenses may increase and our results of operations could be negatively affected.
We face significant competition in connection with obtaining, retaining and performing under our client contracts, and an inability to compete effectively in the future could harm our relationships with our clients, which would impact our ability to maintain our revenues and operating results.
We operate in very competitive markets. In providing our services to the student loan and other receivables markets, we face competition from many other companies. Initially, we compete with these companies to be one of typically several firms engaged to provide recovery services to a particular client and, if we are successful in being engaged, we then face continuing competition from the client’s other retained firms based on the client’s benchmarking of the recovery rates of its several vendors. In addition, those recovery vendors who produce the highest recovery rates from a client often will be allocated additional placements and in some cases additional success fees. Accordingly, maintaining high levels of recovery performance, and doing so in a cost-effective manner, are important factors in our ability to maintain and grow our revenues and net income and the failure to achieve these objectives could harm our business, financial condition and results of operations. Some of our current and potential competitors in the markets in which we operate may have greater financial, marketing, technological or other resources than we do. The ability of any of our competitors and potential competitors to adopt new and effective technology to better serve our markets may allow them to gain market strength. Increasing levels of competition in the future may result in lower recovery fees, lower volumes of contracted recovery services or higher costs for resources. Any inability to compete effectively in the markets that we serve could adversely affect our business, financial condition and results of operations.
The U.S. federal government accounts for a significant portion of our revenues, and any loss of business from, or change in our relationship with, the U.S. federal government would result in a significant decrease in our revenues and operating results.
We have historically derived and are likely to continue to derive a significant portion of our revenues from the U.S. federal government. For the year ended December 31, 2018, revenues under contracts with the U.S. federal government accounted for approximately 35% of our total revenues. The continuation and exercise of renewal options on government contracts and any new government contracts are, among other things, contingent upon the availability of adequate funding for the applicable federal government agency. Changes in federal government spending could directly affect our financial performance.
For example, although the Department of Education announced in January 2018 that we were selected as one of two recovery contractors under its award for new student loan recovery contracts, we were notified on May 3, 2018 that the Department of Education has decided to cancel the current procurement in its entirety, and as a result terminated our contract award. Protests have been filed by certain of the unsuccessful bidders of the procurement of the new contracts from the Department of Education, and at this time, we cannot speculate on the outcome of any such protest or when work will begin under our new contract award. The loss of business from the U.S. federal government, or significant policy changes or financial
pressures within the agencies of the U.S. federal government that we serve would result in a significant decrease in our revenues, which would adversely affect our business, financial condition and results of operations.
Future legislative or regulatory changes affecting the markets in which we operate could impair our business and operations.
The two principal markets in which we provide our recovery services, government-supported student loans and the Medicare program, are a subject of significant legislative and regulatory focus and we cannot anticipate how future changes in government policy may affect our business and operations. For example, Student Aid and Fiscal Responsibility Act, (SAFRA) significantly changed the structure of the government-supported student loan market by assigning responsibility for all new government-supported student loan originations to the Department of Education, rather than originations by private institutions and backed by one of the remaining 25 government-supported GAs. Any future changes in the legislation and regulations that govern these markets, may require us to adapt our business to the new circumstances and we may be unable to do so in a manner that does not adversely affect our business and operations.
The reduction in the number of government-supported student loans originated by our GA clients may result in a lower amount of student loans that we are able to rehabilitate, and may result in the consolidation among the GAs, either of which would decrease our revenues.
As a result of SAFRA, which terminated the ability of the GAs to originate government-supported student loans, the overall number of defaulted student loans that we are able to service on behalf of our GA clients has begun to decline. Further, we are seeing a larger amount of defaulted student loans within our GA client portfolios that have previously been rehabilitated, which, according to current regulations, prevents us from rehabilitating any such student loan for a second time. This overall reduction in the number of defaulted student loans in our GA client portfolios, and the larger percentage of defaulted student loans that have been previously rehabilitated, may result in a decrease in revenues from our GA clients, which could negatively impact our business, financial condition and results of operations.
Further, some have speculated that there may be consolidation among the remaining GAs. This speculation has heightened as a result of the reduction of fees that the GAs will receive for rehabilitating student loans as a result of the Bipartisan Budget Act of 2013. If GAs that are our clients are combined with GAs with whom we do not have a relationship, we could suffer a loss of business. Two of our GA clients: Great Lakes and Pennsylvania Higher Education Assistance Authority were responsible for 17% and 17%, respectively, of revenues for the year ended December 31, 2018. The consolidation of our GA clients with others and the failure to provide recovery services to the consolidated entity could decrease our revenues, which could negatively impact our business, financial condition and results of operations.
Our results of operations may fluctuate on a quarterly or annual basis and cause volatility in the price of our stock.
Our revenues and operating results could vary significantly from period-to-period and may fail to match our past performance because of a variety of factors, some of which are outside of our control. Any of these factors could cause the price of our common stock to fluctuate. Factors that could contribute to the variability of our operating results include:
• the amount of defaulted student loans and other receivables that our clients place with us for recovery;
• the timing of placements of student loans and other receivables which are entirely in the discretion of our clients;
• the schedules of government agencies for awarding contracts;
• our ability to maintain contractual commitments after the expenses we incur during our typically long implementation cycle for new customer contracts;
• our ability to successfully identify improper Medicare claims and the number and type of potentially improper
claims that CMS authorizes us to pursue under our RAC contact;
• our ability to continue to generate revenues under our private healthcare contracts;
• the loss or gain of significant clients or changes in the contingency fee rates or other significant terms of our
business arrangements with our significant clients;
• technological and operational issues that may affect our clients and regulatory changes in the markets we service;
and
• general industry and macroeconomic conditions.
Downturns in domestic or global economic conditions and other macroeconomic factors could harm our business and results of operations.
Various macroeconomic factors influence our business and results of operations. These include the volume of student loan originations in the United States, together with tuition costs and student enrollment rates, the default rate of student loan borrowers, which is impacted by domestic and global economic conditions, rates of unemployment and similar factors, and the growth in Medicare expenditures resulting from changes in healthcare costs. For example, during the global financial crisis beginning in 2008, the market for securitized student loan portfolios was disrupted, resulting in delays in the ability of some GA clients to resell rehabilitated student loans and, as a result, delays our ability to recognize revenues from these rehabilitated loans. Changes in the overall economy could lead to a reduction in overall recovery rates by our clients, which in turn could adversely affect our business, financial condition and results of operations.
A failure of our operating systems or technology infrastructure, or those of our third-party vendors and subcontractors, could disrupt the operation of our business.
A failure of our operating systems or technology infrastructure, or those of our third-party vendors and subcontractors, could disrupt our operations. Our operating systems and technology infrastructure are susceptible to damage or interruption from various causes, including acts of God and other natural disasters, power losses, computer systems failures, Internet and telecommunications or data network failures, operator error, computer viruses, losses of and corruption of data and similar events. The occurrence of any of these events could result in interruptions, delays or cessations in service to our clients, reduce the attractiveness of our recovery services to current or potential clients and adversely impact our financial condition and results of operations. While we have backup systems in many of our operating facilities, an extended outage of utility or network services may harm our ability to operate our business. Further, the situations we plan for and the amount of insurance coverage we maintain for losses as result of failures of our operating systems and infrastructure may not be adequate in any particular case.
If our security measures are breached or fail and unauthorized access is obtained to our clients’ confidential data, our services may be perceived as insecure, the attractiveness of our recovery services to current or potential clients may be reduced, and we may incur significant liabilities.
Our recovery services involve the storage and transmission of confidential information relating to our clients and their customers, including health, financial, credit, payment and other personal or confidential information. Although our data security procedures are designed to protect against unauthorized access to confidential information, our computer systems, software and networks may be vulnerable to unauthorized access and disclosure of our clients’ confidential information. Further, we may not effectively adapt our security measures to evolving security risks, address the security and privacy concerns of existing or potential clients as they change over time, or be compliant with federal, state, and local laws and regulations with respect to securing confidential information. Unauthorized access to confidential information relating to our clients and their customers could lead to reputational damage which could deter our clients and potential clients from selecting our recovery services, or result in termination of contracts with those clients affected by any such breach, regulatory action, and claims against us.
In the event of any unauthorized access to personal or other confidential information, we may be required to expend significant resources to investigate and remediate vulnerabilities in our security procedures, and we may be subject to fines, penalties, litigation costs, and financial losses that are either not insured against or not fully covered through any insurance maintained by us. If one or more of such failures in our security and privacy measures were to occur, our business, financial condition and results of operations could suffer.
Our business may be harmed if we lose members of our management team or other key employees.
We are highly dependent on members of our management team and other key employees and our future success depends in part on our ability to retain these people. Our inability to continue to attract and retain members of our management team and other key employees could adversely affect our business, financial condition and results of operations.
The growth of our healthcare business will require us to hire and retain employees with specialized skills and failure to do so could harm our ability to grow our business.
The growth of our healthcare business will depend in part on our ability to recruit, train and manage additional qualified employees. Our healthcare-related operations require us to hire registered nurses and experts in Medicare coding. Finding, attracting and retaining employees with these skills is a critical component of providing our healthcare-related recovery and audit services, and our inability to staff these operations appropriately represents a risk to our healthcare service offering and associated revenues. An inability to hire qualified personnel, particularly to serve our healthcare clients, may restrain the growth of our business.
We rely on subcontractors to provide services to our clients and the failure of subcontractors to perform as expected could harm our business operations and our relationships with our clients.
We engage subcontractors to provide certain services to our clients. These subcontractors participate to varying degrees in our recovery activities with regards to all of the services we provide. While we believe that we perform appropriate due diligence before we hire subcontractors, our subcontractors may not provide adequate service or otherwise comply with the terms set forth in their agreements. In the event a subcontractor provides deficient performance to one or more of our clients, any such client may reduce the volume of services we are providing under an existing contract or may terminate the relevant contract entirely and we may face claims for breach of contract. Any such disruption in our relations with our clients as a result of services provided by any of our subcontractors could adversely affect our revenues and operating results.
If our software vendors or utility and network providers fail to deliver or perform as expected our business operations could be adversely affected.
Our recovery services depend in part on third-party providers, including software vendors and utility and network providers. Our ability to service our clients depends on these third-party providers meeting our expectations and contractual obligations in a timely and effective manner. Our business could be materially and adversely affected, and we might incur significant additional liabilities, if the services provided by these third-party providers do not meet our expectations or if they terminate or refuse to renew their relationships with us on similar contractual terms.
We are subject to extensive regulations regarding the use and disclosure of confidential personal information and failure to comply with these regulations could cause us to incur liabilities and expenses.
We are subject to a wide array of federal and state laws and regulations regarding the use and disclosure of confidential personal information and security. For example, the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA), as amended, and related state laws subject us to substantial restrictions and requirements with respect to the use and disclosure of the personal health information that we obtain in connection with our contracts with CMS and we must establish administrative, physical and technical safeguards to protect the confidentiality of this information. Similar protections extend to the type of personal financial and other information we acquire from our student loan, state tax and federal receivables clients. We are required to notify affected individuals and government agencies of data security breaches involving protected health and certain personally identifiable information. These laws and regulations also require that we develop, implement and maintain written, comprehensive information security programs containing safeguards that are appropriate to protect personally identifiable information or health information against unauthorized access, misuse, destruction or modification. Federal law generally does not preempt state law in the area of protection of personal information, and as a result we must also comply with state laws and regulations. Regulation of privacy, data use and security require that we incur significant expenses, which could increase in the future as a result of additional regulations, all of which adversely affects our results of operations. Failure to comply with these laws and regulations can result in penalties and in some cases expose us to civil lawsuits.
Our student loan recovery business is subject to extensive regulation and consumer protection laws and our failure to comply with these regulations and laws may subject us to liability and result in significant costs.
Our student loan recovery business is subject to regulation and oversight by various state and federal agencies, particularly in the area of consumer protection. The Fair Debt Collection Practices Act(FDCPA), and related state laws provide specific guidelines that we must follow in communicating with holders of student loans and regulates the manner in which we can recover defaulted student loans. Some state attorney generals have been active in this area of consumer protection regulation. We are subject, and may be subject in the future, to inquiries and audits from state and federal regulators, as well as frequent litigation from private plaintiffs regarding compliance under the FDCPA and related state regulations. We are also subject to the Fair Credit Reporting Act(FCRA), which regulates consumer credit reporting and may impose liability on us to the extent adverse credit information reported to a credit bureau is false or inaccurate. Our compliance with the FDCPA, FCRA and other federal and state regulations that affect our student loan recovery business may result in significant costs, including
litigation costs. We may also become subject to regulations promulgated by the United States Consumer Financial Protection Bureau(CFPB), which was established in July 2011 as part of the Dodd-Frank Act to, among other things, establish regulations regarding consumer financial protection laws. In addition, the CFPB has investigatory and enforcement authority with respect to whether persons are engaged in unlawful acts or practices in connection with the collection of consumer debts.
Litigation may result in substantial costs of defense, damages or settlement, any of which could subject us to significant costs and expenses.
We are party to lawsuits in the normal course of business, particularly in connection with our student loan recovery services. For example, we are regularly subject to claims that we have violated the guidelines and procedures that must be followed under federal and state laws in communicating with consumer debtors. We may not ultimately prevail or otherwise be able to satisfactorily resolve any pending or future litigation, which may result in substantial costs of defense, damages or settlement. In the future, we may be required to alter our business practices or pay substantial damages or settlement costs as a result of litigation proceedings, which could adversely affect our business operations and results of operations.
If we are unable to adequately protect our proprietary technology, our competitive position could be harmed, or we could be required to incur significant costs to enforce our rights.
The success of our business depends in part upon our proprietary technology platform. We rely on a combination of copyright, patent, trademark, and trade secret laws, as well as on confidentiality procedures and non-compete agreements, to establish and protect our proprietary technology rights. The steps we have taken to deter misappropriation of our proprietary technology may be insufficient to protect our proprietary information. In particular, we may not be able to protect our trade secrets, know how and other proprietary information adequately. Although we use reasonable efforts to protect this proprietary information and technology, our employees, consultants and other parties may unintentionally or willfully disclose our information or technology to competitors. Enforcing a claim that a third party illegally obtained and is using any of our proprietary information or technology is expensive and time consuming, and the outcome is unpredictable. We rely, in part, on non disclosure, confidentiality and invention assignment agreements with our employees, consultants and other parties to protect our trade secrets, know how and other intellectual property and proprietary information. These agreements may not be self executing, or they may be breached and we may not have adequate remedies for such breach. Moreover, third parties may independently develop similar or equivalent proprietary information or otherwise gain access to our trade secrets, know how and other proprietary information. Any infringement, misappropriation or other violation of our patents, trademarks, copyrights, trade secrets, or other intellectual property rights could adversely affect any competitive advantage we currently derive or may derive from our proprietary technology platform and we may incur significant costs associated with litigation that may be necessary to enforce our intellectual property rights.
Claims by others that we infringe their intellectual property could force us to incur significant costs or revise the way we conduct our business.
Our competitors protect their proprietary rights by means of patents, trade secrets, copyrights, trademarks and other intellectual property. Any party asserting that we infringe, misappropriate or violate their intellectual property rights may force us to defend ourselves, and potentially our clients, against the alleged claim. These claims and any resulting lawsuit, if successful, could be time-consuming and expensive to defend, subject us to significant liability for damages or invalidation of our proprietary rights, prevent us from operating all or a portion of our business or force us to redesign our services or technology platform or cause an interruption or cessation of our business operations, any of which could adversely affect our business and operating results. In addition, any litigation relating to the infringement of intellectual property rights could harm our relationships with current and prospective clients. The risk of such claims and lawsuits could increase if we increase the size and scope of our services in our existing markets or expand into new markets.
We may make acquisitions that prove unsuccessful, strain or divert our resources and harm our results of operations and stock price.
We may consider acquisitions of other companies in our industry or in new markets. We may not be able to successfully complete any such acquisition and, if completed, any such acquisition may fail to achieve the intended financial results. We may not be able to successfully integrate any acquired businesses with our own and we may be unable to maintain our standards, controls and policies. Further, acquisitions may place additional constraints on our resources by diverting the attention of our management from other business concerns. Moreover, any acquisition may result in a potentially dilutive issuance of equity securities, the incurrence of additional debt and amortization of expenses related to intangible assets, all of which could adversely affect our results of operations and stock price.
The price of our common stock could be volatile, and you may not be able to sell your shares at or above the public offering price.
Since our initial public offering in August 2012, the price of our common stock, as reported by NASDAQ Global Select Market, has ranged from a low sales price of $1.25 on November 16, 2018 to a high sales price of $14.09 on March 4, 2013. The trading price of our common stock may be significantly affected by various factors, including: quarterly fluctuations in our operating results; the financial projections we may provide to the public, any changes in those projections or our failure to meet those projections; changes in investors’ and analysts’ perception of the business risks and conditions of our business; our ability to meet the earnings estimates and other performance expectations of financial analysts or investors; unfavorable commentary or downgrades of our stock by equity research analysts; changes in our capital structure, such as future issuances of debt or equity securities; our success or failure to obtain new contract awards; lawsuits threatened or filed against us; strategic actions by us or our competitors, such as acquisitions or restructurings; new legislation or regulatory actions; changes in our relationship with any of our significant clients; fluctuations in the stock prices of our peer companies or in stock markets in general; and general economic conditions.
Our significant stockholders have the ability to influence significant corporate activities and our significant stockholders' interests may not coincide with yours.
Parthenon Capital Partners and Invesco Ltd. beneficially owned approximately 25.5% and 19.3% of our common
stock, respectively, as of December 31, 2018. As a result of their ownership, Parthenon Capital Partners and Invesco Ltd. have the ability to influence the outcome of matters submitted to a vote of stockholders and, through our board of directors, the ability to influence decision making with respect to our business direction and policies. Parthenon Capital Partners and Invesco Ltd. may have interests different from our other stockholders’ interests and may vote in a manner adverse to those interests. Matters over which Parthenon Capital Partners and Invesco Ltd. can, directly or indirectly, exercise influence include:
• mergers and other business combination transactions, including proposed transactions that would result in our
stockholders receiving a premium price for their shares;
• other acquisitions or dispositions of businesses or assets;
• incurrence of indebtedness and the issuance of equity securities;
• repurchase of stock and payment of dividends; and
• the issuance of shares to management under our equity incentive plans.
In addition, Parthenon Capital Partners has a contractual right to designate a number of directors proportionate to its stock ownership. Further, under our amended and restated certificate of incorporation, Parthenon Capital Partners does not have any obligation to present to us, and Parthenon Capital Partners may separately pursue, corporate opportunities of which it becomes aware, even if those opportunities are ones that we would have pursued if granted the opportunity.
Anti-takeover provisions contained in our certificate of incorporation and bylaws could impair a takeover attempt that our stockholders may find beneficial.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents include the following provisions: establishing a classified board of directors so that not all members of our board are elected at one time; providing that directors may be removed by stockholders only for cause; authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock; limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting; limiting our ability to engage in certain business combinations with any “interested stockholder,” other than Parthenon Capital Partners, for a three-year period following the time that the stockholder became an interested stockholder; requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors; requiring a super majority vote for certain amendments to our amended and restated certificate of incorporation and amended and restated bylaws; and limiting the determination of the number of directors on our board of directors and the filling of vacancies or newly created seats on the board, to our board of directors then in office. These provisions, alone or together, could have the effect of delaying or deterring a change in control, could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2. Properties
Facilities
As of
December 31, 2018
, we operated seven separate office locations throughout the United States. The largest of these facilities is in Livermore, California and serves as our corporate headquarters, as well as a data center and production location. Our Livermore facility is comprised of approximately 50,000 square feet of space and has a lease expiration of November 2022. We also lease production centers in California, Oregon, Florida and Texas and own a production/data center in Oregon.
We believe that our facilities are adequate for current operations and that additional space will be available as required. See Note 6 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for information regarding our lease obligations.
ITEM 3. Legal Proceedings
We are involved in various legal proceedings that arise from our normal business operations. These actions generally derive from our student loan recovery services, and generally assert claims for violations of the Fair Debt Collection Practices Act or similar federal and state consumer credit laws. While litigation is inherently unpredictable, we believe that none of these legal proceedings, individually or collectively, will have a material adverse effect on our financial condition or our results of operations.
ITEM 4. Mine Safety Disclosures
Not applicable.
Notes To Consolidated Financial Statements
For the Years Ended
December 31, 2018
,
2017
and
2016
|
|
1.
|
Summary of Significant Accounting Policies
|
|
|
(a)
|
Organization and Nature of Business
|
Performant Financial Corporation (the "Company" or "we") is a leading provider of technology-enabled recovery and analytics services in the United States. The Company's services help identify, restructure and recover delinquent or defaulted assets and improper payments for both government and private clients in a broad range of markets. Clients of the Company typically operate in complex and regulated environments and contract for their recovery needs in order to reduce losses on defaulted student loans, improper healthcare payments and delinquent state tax and federal treasury receivables. The Company generally provides our services on an outsourced basis; handling many or all aspects of the clients’ recovery processes.
The Company’s consolidated financial statements include the operations of Performant Financial Corporation (Performant), its wholly-owned subsidiaries Premiere Credit of North America, LLC (Premiere) and Performant Business Services, Inc., and its wholly-owned subsidiaries Performant Recovery, Inc. (Recovery), Performant Technologies, Inc., and Performant Europe Ltd. Effective August 13, 2012, we changed the name of our wholly-owned subsidiary from DCS Business Services, Inc. (DCSBS) to Performant Business Services, Inc., and DCSBS’ wholly-owned subsidiaries from Diversified Collection Services, Inc. (DCS), and Vista Financial, Inc. (VFI), to Performant Recovery, Inc., and Performant Technologies, Inc., respectively. Performant is a Delaware corporation headquartered in California and was formed in 2003. Premiere is an Indiana limited liability company acquired by Performant on August 31, 2018. Performant Business Services, Inc. is a Nevada corporation founded in 1997. Recovery is a California corporation founded in 1976. Performant Technologies, Inc. is a California corporation that was formed in 2004.
The Company is managed and operated as
one
business, with a single management team that reports to the Chief Executive Officer.
|
|
(b)
|
Principles of Consolidation
|
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The Company consolidates entities in which it has controlling financial interest, and as of
December 31, 2018
, all of the Company’s subsidiaries are
100%
owned. All significant intercompany balances and transactions have been eliminated in consolidation.
|
|
(c)
|
Use of Estimates in the Preparation of Consolidated Financial Statements
|
The preparation of the consolidated financial statements in conformity with U.S. GAAP, requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, primarily accounts receivable, intangible assets, goodwill, estimated liability for appeals, earnout payable, other liabilities, deferred income taxes and income tax expense, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Our actual results could differ from those estimates.
|
|
(d)
|
Acquisition of Premiere Credit of North America
|
On August 31, 2018, the Company completed its acquisition of Premiere. Premiere is a leading provider of recovery services to government, student loan and commercial clients with approximately
330
employees located in Indianapolis and Nashville. As part of the transaction, Performant has expanded its existing commercial relationship with the ECMC Group (“ECMC”) which was the former parent of Premiere. ECMC is also the lender under our existing credit agreement. The Company funded the acquisition with issuance of
1,000,000
Performant shares to ECMC and additional shares over the
five
-year period following the closing based on revenue associated with Premiere’s business in each year. At closing, Performant entered into a long-term agreement to be ECMC’s primary student loan recovery vendor. In addition, Performant also executed an amendment to its existing credit agreement with ECMC as discussed in Note 4.
Consideration:
After the September 30, 2018 financial statements were filed in the Form 10-Q, the Company received a final valuation report from a third-party valuation firm. After considering the results of that valuation report, the Company has estimated that the fair value of the earn-out consideration to be
$2.2 million
instead of the preliminary value of
$1.9 million
, an increase of
$0.3 million
. The estimated consideration of
$4.3 million
has been revised as follows:
|
|
|
|
|
|
|
|
|
|
Preliminary
|
|
Final
|
|
(In thousands except per share amount)
|
Initial shares consideration
|
1,000
|
|
|
1,000
|
|
Closing stock price per share
|
$
|
2.42
|
|
|
$
|
2.42
|
|
|
2,420
|
|
|
2,420
|
|
Earn-out consideration
|
1,876
|
|
|
2,154
|
|
Total consideration
|
$
|
4,296
|
|
|
$
|
4,574
|
|
The contingent earn-out consideration was valued based on a Monte Carlo simulation.
Purchase price allocation:
In accordance with U.S. GAAP, the total purchase price has been allocated to the tangible and intangible assets acquired based on management’s estimates of their fair values. The Company has adjusted the provisional amount of certain assets and liabilities as follows: Cash of
$2.3 million
increased by
$0.6 million
. The amount of
$1.7 million
presented in the September 30, 2018 financial statements initially netted a
$0.6 million
payment made to the seller shortly after the close against cash of
$2.3 million
. The increase in cash is offset by a corresponding
$0.6 million
increase in other current liabilities. In addition, Property, equipment and leasehold improvements increased
$0.3 million
from
$2.9 million
to
$3.2 million
.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. The purchase price allocation of
$4.3 million
at August 31, 2018 and the revised price, were as follows:
|
|
|
|
|
|
|
|
|
|
Preliminary
|
|
Final
|
|
(In thousands)
|
Cash and cash equivalents
|
$
|
1,669
|
|
|
$
|
2,285
|
|
Trade accounts receivable, net
|
1,690
|
|
|
1,690
|
|
Other current assets
|
576
|
|
|
576
|
|
Property, equipment, and leasehold improvements, net
|
2,896
|
|
|
3,174
|
|
Customer relationship intangible asset
|
50
|
|
|
50
|
|
Other assets
|
34
|
|
|
34
|
|
Total identifiable assets acquired
|
6,915
|
|
|
7,809
|
|
Accounts Payable
|
(328
|
)
|
|
(328
|
)
|
Accrued salaries and benefits
|
(970
|
)
|
|
(970
|
)
|
Other current liabilities
|
(1,186
|
)
|
|
(1,802
|
)
|
Other liabilities
|
(135
|
)
|
|
(135
|
)
|
Net assets acquired
|
$
|
4,296
|
|
|
$
|
4,574
|
|
The estimated fair value and useful life for the customer relationship intangible asset is as follows:
|
|
|
|
|
|
|
|
Estimated Fair Value
|
|
Estimated Useful Life
|
|
(In thousands)
|
|
(In years)
|
Customer Relationships
|
$
|
50
|
|
|
4
|
The fair value of the customer relationship and the amortization method were determined using the excess earnings method that relies on projected future net cash flows including key assumptions for the customer attrition rate and discount rate. The estimated weighted average useful life reflects the time period and pattern that Performant expects for projected benefits.
The Company recorded
$0.2 million
of acquisition-related costs in other operating expenses.
The results of Premiere have been included in the Company’s consolidated financial statements from the date of acquisition. Revenues from Premiere included in the Company’s results for the twelve months ended December 31, 2018 were
$7.0 million
. Net loss for Premiere included in the Company’s results for the twelve months ended December 31, 2018 was
$1.4 million
.
Pro forma information:
The following table presents selected unaudited pro forma information for the Company assuming the acquisition of Premiere had occurred as of January 1, 2017. This pro forma information does not purport to present what the Company’s actual results would have been if the acquisition occurred as of the date indicated or what such results would be for any future periods.
|
|
|
|
|
|
|
|
|
|
Unaudited
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
(In thousands, except per share amounts)
|
Total revenues
|
$
|
170,893
|
|
|
$
|
160,759
|
|
Net loss
|
$
|
(12,672
|
)
|
|
$
|
(15,200
|
)
|
Earnings per share:
|
|
|
|
Basic
|
$
|
(0.24
|
)
|
|
$
|
(0.30
|
)
|
Diluted
|
$
|
(0.24
|
)
|
|
$
|
(0.30
|
)
|
|
|
(e)
|
Cash and Cash Equivalents
|
Cash and cash equivalents include demand deposits and highly liquid debt investments with original maturities of three months or less when purchased. These investments can include money market funds that invest in U.S. government and agency obligations, certificates of deposit, bankers’ acceptances, and commercial paper.
The Company collects monies on behalf of its clients. Cash is often held on behalf of the clients in various trust accounts and is subsequently remitted to the clients based on contractual agreements. Cash held in these trust accounts for contracting agencies is not included in the Company’s assets (Note 11(a)).
At
December 31, 2018
and
2017
, restricted cash included in current assets on our consolidated balance sheet was
$1.8 million
and $
1.8 million
, respectively. In May 2017, the Company paid
$7.5 million
to the lenders and deposited
$6.0 million
into a segregated deposit account. On August 3, 2017, all of this
$6.0 million
of restricted cash was paid to the administrative agent for the benefit of the lenders under our prior credit agreement. In November 2017, the Company deposited
$1.8 million
in restricted cash as collateral for new letters of credit issued to replace letters of credit terminated under our prior credit agreement.
|
|
(g)
|
Property, Equipment, and Leasehold Improvements
|
Property, equipment, and leasehold improvements are stated at cost, net of accumulated depreciation. Furniture and equipment are depreciated using the straight-line method over estimated useful lives ranging from
5
to
7
years. Buildings are depreciated using the straight-line method over
31.5
years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated life of the asset or the remaining term of the lease. Computer software and computer hardware are depreciated using the straight-line method over
3
years and
5
years, respectively.
Maintenance and repairs are charged to expense as incurred. Improvements that extend the useful lives of assets are capitalized.
When property is sold or retired, the cost and the related accumulated depreciation are removed from the consolidated balance sheet and any gain or loss from the transaction is included in the consolidated statements of operations.
|
|
(h)
|
Goodwill and Other Intangible Assets
|
Goodwill represents the excess of purchase price and related costs over the fair value assigned to the net assets of businesses acquired. Goodwill is not amortized, but instead is reviewed for impairment at least annually. Impairment is
the condition that exists when the carrying amount of goodwill is not recoverable and its carrying amount exceeds its fair value. The Company performs its assessment of whether it is more likely than not that goodwill fair value is less than its carrying amount in November of each year to allow the Company additional time to evaluate its assessment prior to reporting its results. The Company performed a quantitative impairment assessment of whether it is more likely than not that goodwill fair value is less than its carrying amount as of November 30, 2018, and concluded that there was no need to impair goodwill.
During the second quarter of 2017, the Company decided to wind down the activity of Performant Europe Ltd. Based on this decision, the Company concluded that the fair value of Performant Europe Ltd. was more likely than not less than its carrying amount. Accordingly, the goodwill balance related to the healthcare audit acquisition was
$0.9 million
, and we recognized a goodwill impairment loss of this amount as of June 30, 2017.
The Company performed a qualitative assessment of whether it is more likely than not that goodwill fair value is less than its carrying amount as of November 30, 2017, and concluded that there was no need to perform an impairment test.
Identifiable intangible assets consist of customer contracts and related relationships, a perpetual license, and covenants not to compete. Customer contracts and related relationships are amortized over their estimated useful life of
4
to
20
years. The perpetual license is amortized over its estimated useful life of
5
years.
|
|
(i)
|
Impairment of Long-Lived Assets
|
Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.
The Company follows the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Subtopic 350-40,
Internal-Use Software
, which specifies that costs incurred during the application stage of development should be capitalized. All other costs are expensed as incurred. During
2018
,
2017
and
2016
, costs of
$5.5 million
,
$5.1 million
and
$6.9 million
respectively, were capitalized for projects in the application stage of development. Depreciation expense for completed projects during 2018, 2017 and 2016 were
$6.8 million
,
$6.7 million
and
$5.8 million
, respectively.
Debt issuance costs represent loan and legal fees paid in connection with the issuance of long-term debt. Debt issuance costs are deducted from current and non-current notes payable and are amortized to interest expense under the effective interest method in accordance with key terms of the notes as amended.
|
|
(l)
|
Revenues, Accounts Receivable, and Estimated Liability for Appeals
|
The Company derives its revenues primarily from providing recovery services. Revenues are recognized when control of these services is transferred to its customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services.
The Company determines revenue recognition through the following steps:
•
Identification of the contract with a customer
•
Identification of the performance obligations in the contract
•
Determination of the transaction price
•
Allocation of the transaction price to the performance obligations in the contract
•
Recognition of revenue when, or as, the performance obligations are satisfied
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.
The Company’s contracts generally contain a single performance obligation, delivered over time as a series of services that are substantially the same and have the same pattern of transfer to the client, as the promise to transfer the individual services is not separately identifiable from other promises in the contracts and, therefore, not distinct. For contracts with multiple performance obligations, the Company would allocate the contract’s transaction price to each performance obligation using its best estimate of the standalone selling price of each distinct service in the contract. The Company determines the standalone selling prices by taking into consideration the value of the services being provided, the client type and how similar services are priced in other contracts on a standalone basis.
The Company’s contracts are composed primarily of variable consideration. Fees earned under the Company’s recovery service contracts consist primarily of contingency fees based on a specified percentage of the amount the Company enables its clients to recover. The contingency fee percentage for a particular recovery depends on the type of recovery or claim facilitated. In certain contracts the Company can earn additional performance-based consideration determined based on its performance relative to the client’s other contractors providing similar services.
Revenue from contingency fees earned upon recovery of funds is generally recognized as amounts are invoiced based on either the ‘as-invoiced’ practical expedient when such amounts reflect the value of the services completed to-date, or an output measure based on milestones which is used to measure progress of the satisfaction of its performance obligation. The Company estimates any performance-based variable consideration and recognizes such revenue over the performance period only if it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Under certain contracts, consideration can include periodic performance-based bonuses which can be awarded based on the Company’s performance under the specific contract. These performance-based awards are considered variable and may be constrained by the Company until there is not a risk of a material reversal.
For contracts that contain a refund right, these amounts are considered variable consideration and the Company estimates its refund liability for each claim and recognizes revenue net of such estimate.
The following table presents revenue disaggregated by category (in thousands) for the year ended December 31, 2018, 2017 and 2016.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
|
(in thousands)
|
Student Lending:
|
|
|
|
|
|
Great Lakes Higher Education Guaranty Corporation
|
$
|
26,702
|
|
|
$
|
46,090
|
|
|
$
|
36,956
|
|
All Other Guaranty Agencies
|
39,796
|
|
|
48,215
|
|
|
72,609
|
|
Total of Student Lending
|
66,498
|
|
|
94,305
|
|
|
109,565
|
|
Healthcare:
|
|
|
|
|
|
CMS RAC and MSP CRC
(1)
|
41,859
|
|
|
1,437
|
|
|
5,733
|
|
Commercial
|
14,088
|
|
|
8,549
|
|
|
5,662
|
|
Total of Healthcare
|
55,947
|
|
|
9,986
|
|
|
11,395
|
|
Other
(2)
|
33,223
|
|
|
27,758
|
|
|
20,400
|
|
Total Revenues
|
$
|
155,668
|
|
|
$
|
132,049
|
|
|
$
|
141,360
|
|
(1)
Includes $
28.4 million
related to the termination of the 2009 CMS Region A contract
(2)
Represents outsource services, tax, and IRS
The Company generally either applies the as-invoiced practical expedient where its right to consideration corresponds directly to its right to invoice its clients, or the variable consideration allocation exception where the variable consideration is attributable to one or more, but not all, of the services promised in a series of distinct services that form part of a single performance obligation. As such the Company has elected the optional exemptions related to the as-invoiced practical expedient and the variable consideration allocation exception whereby the disclosure of the amount of transaction price allocated to the remaining performance obligations is not required.
The Company has applied the as-invoiced practical expedient or the variable consideration allocation exception to contracts with performance obligations that have an average remaining duration of less than a year.
Revenue is recognized upon the collection of defaulted loan and debt payments. Loan rehabilitation revenue is recognized when the rehabilitated loans are sold (funded) by clients. Incentive revenue is recognized upon receipt of official notification of incentive award from customers.
Under the Company’s Medicare Secondary Payer (MSP), Commercial Payment Center (CPC) contract with Centers for Medicare and Medicaid Services (CMS), the Company recognizes revenues when insurance companies or other responsible parties remit payment to reimburse CMS for claims for which they are responsible, and the remittance has been applied in the CMS database. Under the Company’s Medicare Recovery Audit Contractor (RAC), contract with CMS, the Company recognizes revenues when the healthcare provider has paid CMS for a given claim or has agreed to an offset against other claims by the provider.
Under other healthcare contracts, the Company may recognize revenue upon delivering the results of claims audits, when sufficient reliable information is available to the Company for estimating the variable consideration earned, as it is a reasonable measure of the Company’s progress toward complete satisfaction of our performance obligation.
Healthcare providers have the right to appeal a claim and may pursue additional appeals if the initial appeal is found in favor of CMS or other healthcare clients. Total estimated liability for appeals was
$0.2 million
and
$18.8 million
as of December 31, 2018 and 2017, respectively. This represents the Company’s best estimate of the probable amount of losses related to appeals of claims for which commissions were previously collected. As a result of the termination of the 2009 CMS Region A contract on January 31, 2018, the estimated liability for appeals related to CMS was
$0.0 million
as of December 31, 2018 as compared to
$18.5 million
as of December 31, 2017.
For the year ended
December 31, 2018
, the Company had
3
clients whose individual revenues exceeded
10%
of the Company’s total revenues. The dollar amount and percent of total revenue of each of the
3
clients is summarized in the table below (in thousands):
|
|
|
|
|
|
Rank
|
|
2018 Revenue
|
|
Percent of
total revenue
|
1
|
|
$41,859
|
|
26.9%
|
2
|
|
$26,908
|
|
17.3%
|
3
|
|
$26,702
|
|
17.2%
|
For the year ended
December 31, 2017
, the Company had
2
clients whose individual revenues exceeded
10%
of the Company’s total revenues. The dollar amount and percent of total revenue of each of the
2
clients is summarized in the table below (in thousands):
|
|
|
|
|
|
Rank
|
|
2017 Revenue
|
|
Percent of
total revenue
|
1
|
|
$43,189
|
|
32.7%
|
2
|
|
$27,367
|
|
20.7%
|
For the year ended
December 31, 2016
, the Company had
3
clients whose individual revenues exceeded
10%
of the Company’s total revenues. The dollar amount and percent of total revenue of each of the
3
clients is summarized in the table below (in thousands):
|
|
|
|
|
|
Rank
|
|
2016 Revenue
|
|
Percent of
total revenue
|
1
|
|
$33,243
|
|
23.5%
|
2
|
|
$23,196
|
|
16.4%
|
3
|
|
$21,949
|
|
15.5%
|
Revenue from the largest three customers was
61%
,
63%
and
55%
of total revenue in
2018
,
2017
and
2016
, respectively. Accounts receivable due from these three customers were
62%
,
31%
and
57%
of total trade receivables at
December 31, 2018
,
2017
and
2016
, respectively. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Amounts collected on trade accounts receivable are included in net cash provided by (used in) operating activities in the consolidated statements of cash flows. The Company determines the allowance for doubtful accounts by specific identification. Account balances are charged off against the allowance after all means of
collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts was
$0.02 million
and
$0.04 million
for
December 31, 2018
and December 31,
2017
, respectively.
The Company determined that it does not have any costs related to obtaining or fulfilling a contract that are recoverable and as such, these contract costs are expensed as incurred
Contract assets are included in trade accounts receivable in the consolidated balance sheets. The Company has contract assets of
$3.0 million
and
$1.6 million
as of December 31, 2018 and December 31, 2017, respectively. The contract assets relate to the Company’s rights to consideration for services completed during the year ended December 31, 2018, and December 31, 2017, but not invoiced at the reporting date. Contract assets are recorded to accounts receivable when the rights become unconditional and amounts are invoiced.
Contract liabilities are included in Deferred revenue in the consolidated balance sheets. The Company has contract liabilities of
$1.1 million
as of December 31, 2018 and
none
as of December 31, 2017. The Company’s contract liability relates to an advance recovery commission payment received from a customer during the first quarter of 2018, for which the Company anticipates revenue to be recognized as services are delivered.
|
|
(m)
|
Net Payable to Client
|
The Company nets outstanding accounts receivable invoices from an audit and recovery contract against payables for overturned audits. The overturned audits are netted against current fees due on the invoice to the client when they are processed by the client’s system. As a result of the termination of the 2009 CMS Region A contract on January 31, 2018, the net payable to client balance was
$0.0 million
as of December 31, 2018. The net payable to client balance of
$12.8 million
at December 31, 2017, represents the excess of payables for overturned audits.
|
|
(n)
|
Prepaid Expenses and Other Current Assets
|
The Company employed subcontractors to audit claims as part of the 2009 CMS Region A contract, and to the extent that audits by these subcontractors were overturned on appeal, the fees associated with such claims were contractually refundable to the Company. At
December 31, 2018
, the receivable from subcontractor fees associated with estimated future overturns and for already overturned subcontractor audits was
$0.0 million
as a result of the termination of the 2009 CMS Region A contract on January 31, 2018. By comparison, at
December 31, 2017
, the receivable associated with the estimated future overturns of subcontractor audits was
$5.6 million
, and the receivable for subcontractor fees for already overturned audits refundable to the Company once the Company refunds its fees to the client as prime contractor was
$3.7 million
.
The Company recognizes legal fees related to litigation as they are incurred.
|
|
(p)
|
Comprehensive Income (Loss)
|
The Company has a single component of comprehensive income (loss) on the consolidated statements of comprehensive income (Loss) related to foreign currency translation adjustments for its subsidiary Performant Europe Ltd. for the years ended December 31,
2018
,
2017
and
2016
.
|
|
(q)
|
Fair Value of Financial Instruments
|
The Company’s consolidated financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, short-term debt and long-term debt. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate their fair values based on or due to their short-term maturities. The carrying values of short-term debt and long-term debt approximate fair value, in which their variable interest rates approximate market rates.
The Company accounts for income taxes under the asset-and-liability method. Deferred income tax assets and liabilities are recognized for future tax consequences attributable to differences between the carrying value of assets and liabilities for financial reporting purposes and for taxation purposes. Deferred income tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred income tax assets
and liabilities is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than
50%
likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Interest expense and penalties related to unrecognized tax benefits are recorded in income tax expense.
The Company accounts for its employee stock-based compensation awards in accordance with FASB ASC Topic 718,
Compensation – Stock Compensation
. FASB ASC Topic 718 requires that all employee stock-based compensation is recognized as a cost in the consolidated financial statements and that for equity-classified awards, such cost is measured at the grant date fair value of the award. The Company estimates grant date fair value using the Black-Scholes-Merton option-pricing model.
FASB ASC Topic 718 also requires that excess tax benefits recognized in equity related to stock option exercises are reflected as financing cash inflows. The Company recognized an income tax benefit resulting from the exercise of stock options in
2018
,
2017
and
2016
of $
0.0 million
, $
0.0 million
and $
0.1 million
, respectively.
For the years ended
December 31, 2018
,
2017
, and
2016
, basic loss per share is calculated by dividing net loss attributable to common shareholders by the sum of the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares and dilutive common shares equivalents outstanding during the period. The Company’s common share equivalents consist of stock options, restricted stock units(RSUs), and performance stock units. When there is a loss in the period, dilutive common share equivalents are excluded from the calculation of diluted earnings per share, as their effect would be anti-dilutive.
The following table reconciles the basic to diluted weighted average shares outstanding using the treasury stock method (shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Weighted average shares outstanding – basic
|
52,064
|
|
|
50,688
|
|
|
50,038
|
|
Dilutive effect of stock options
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average shares outstanding – diluted
|
52,064
|
|
|
50,688
|
|
|
50,038
|
|
The following table shows the number of shares of common stock subject to options and restricted stock awards that were outstanding for the years ended
December 31, 2018
,
2017
and
2016
, which were not included in the net loss per diluted share calculation because to do so would have been anti-dilutive:
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Number of shares
|
4,828,278
|
|
4,604,218
|
|
3,996,701
|
|
|
(u)
|
New Accounting Pronouncements
|
Recently Adopted Accounting Standards
In August 2016, the FASB issued Accounting Standards Update (ASU) 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments” which provides guidance on the presentation of certain cash receipts and cash payments in the statement of cash flows in order to reduce diversity in existing practice. This new guidance was effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2017, and early adoption was permitted. This new standard required retrospective adoption, with a provision for impracticability. The Company adopted this guidance on January 1, 2018 and it did not have any impact on our consolidated financial statements.
In May 2014, the FASB issued an ASU that amends the FASB ASC by creating a new Topic 606, "Revenue from Contracts with Customers". The new guidance supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition", and most industry-specific guidance on revenue recognition throughout the Industry Topics of the Codification. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply a five-step model for recognizing and measuring revenue from contracts with customers. In addition, an entity should disclose sufficient qualitative and quantitative information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
The Company adopted Topic 606 as of January 1, 2018, utilizing the full retrospective method of transition. The Company applied Topic 606 retrospectively for all reporting periods presented before January 1, 2018, the date of the initial application. There was no impact of adopting Topic 606 on the Company’s 2017 and 2016 consolidated financial statements.
Recently Issued Accounting Standards
In February 2016, the FASB issued ASU 2016-02, “Leases”, which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC Topic 840 Leases. The guidance is effective for our fiscal year beginning January 1, 2019 and should be applied using a modified retrospective approach. Early adoption is permitted. The Company plans to adopt this new standard in the first quarter of our fiscal 2019 with the cumulative effect of adoption recognized to retained earnings on January 1, 2019. Upon adoption, the Company will recognize right-of-use assets and operating lease liabilities on the consolidated balance sheets, which will increase the total assets and total liabilities. In July 2018 the FASB issued ASU No. 2018-11,
Targeted Improvements
, which provides us with the option to apply the new leasing standard to all open leases as of the adoption date. The Company has elected to adopt this pronouncement using the optional transition method under ASU 2018-11 as of January 1, 2019 and Management estimates that the adoption will result in recognition of right-of-use assets of
$9.1 million
and lease liabilities for operating leases of approximately
$10.2 million
, including a reclassification of deferred rent for
$1.1 million
, on its Consolidated Balance Sheets. Management does not believe the new standard will have a material impact on the consolidated statements of operations, nor will it have a notable impact on the Company’s liquidity. The standard will also have no impact on the Company’s debt-covenant compliance under its current agreements.
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment" to simplify the goodwill impairment testing process. The new standard eliminates Step 2 of the goodwill impairment test. If a company determines in Step 1 of the goodwill impairment test that the carrying value of goodwill exceeds its fair value, an impairment in that amount should be recorded to the income statement, rather than proceeding to Step 2. The Company elected to
early adopt the proposed guidance for the year ended December 31, 2018 on a prospective basis. The early adoption of this guidance did not have a material impact on the consolidated financial statements and related disclosures
.
2. Property, Equipment, and Leasehold Improvements
Property, equipment, and leasehold improvements consist of the following at
December 31, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
December 31, 2017
|
Land
|
$
|
1,943
|
|
|
$
|
1,122
|
|
Building and leasehold improvements
|
8,076
|
|
|
6,410
|
|
Furniture and equipment
|
6,248
|
|
|
5,763
|
|
Computer hardware and software
|
78,743
|
|
|
72,044
|
|
|
95,010
|
|
|
85,339
|
|
Less accumulated depreciation and amortization
|
(72,755
|
)
|
|
(64,395
|
)
|
Property, equipment and leasehold improvements, net
|
$
|
22,255
|
|
|
$
|
20,944
|
|
Depreciation and amortization expense of property, equipment and leasehold improvements was
$9.5 million
,
$10 million
and
$9.6 million
for the years ended
December 31, 2018
,
2017
and
2016
, respectively.
3. Identifiable Intangible Assets
Identifiable intangible assets consist of the following at
December 31, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
Gross
Amounts
|
|
Accumulated
Amortization
|
|
Net
|
Amortizable intangibles:
|
|
|
|
|
|
Customer contracts and related relationships
|
$
|
25,378
|
|
|
$
|
(24,264
|
)
|
|
$
|
1,114
|
|
Less: Impairment of customer contracts and related relationships
|
(2,988
|
)
|
|
2,988
|
|
|
—
|
|
Add: Customer relationship intangible asset
|
50
|
|
|
(4
|
)
|
|
46
|
|
Perpetual license
|
3,250
|
|
|
(3,250
|
)
|
|
—
|
|
Total intangible assets
|
$
|
25,690
|
|
|
$
|
(24,530
|
)
|
|
$
|
1,160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
Gross
Amounts
|
|
Accumulated
Amortization
|
|
Net
|
Amortizable intangibles:
|
|
|
|
|
|
Customer contracts and related relationships
|
$
|
23,209
|
|
|
$
|
(18,345
|
)
|
|
$
|
4,864
|
|
Less: Impairment of customer contracts and related relationships
|
(1,081
|
)
|
|
1,081
|
|
|
—
|
|
Perpetual license
|
3,250
|
|
|
(3,250
|
)
|
|
—
|
|
Total intangible assets
|
$
|
25,378
|
|
|
$
|
(20,514
|
)
|
|
$
|
4,864
|
|
For the years ended
December 31, 2018
,
2017
and
2016
, amortization expense related to intangible assets amounted to
$0.8 million
,
$0.9 million
and
$3.7 million
, respectively. For the year ended December 31, 2018, an impairment expense of
$3.0 million
was recognized relating to the Great Lakes Higher Education Guaranty Corporation customer relationship and has been presented as a separate caption in the consolidated statements of operations. For the year ended December 31, 2017, an impairment expense of
$0.1 million
was recognized to account for the impairment charge in Performant Europe Ltd. due to the Company's decision to wind down this subsidiary. For the year ended December 31, 2016, an impairment expense of
$15.4 million
was recognized relating to the Department of Education customer relationship.
The estimated aggregate amortization expense for each of the five following fiscal years is as follows (in thousands):
|
|
|
|
|
Year Ending December 31,
|
Amount
|
2019
|
$
|
235
|
|
2020
|
235
|
|
2021
|
235
|
|
2022
|
232
|
|
2023
|
223
|
|
Thereafter
|
—
|
|
Total
|
$
|
1,160
|
|
4. Credit Agreement
On August 7, 2017, we, through our wholly-owned subsidiary Performant Business Services, Inc. (the "Borrower"), entered into a credit agreement with ECMC Group, Inc. (as amended, the “Credit Agreement”). Before the amendment described below, the Credit Agreement provided for a term loan facility in the initial amount of
$44 million
(the “Initial Term Loan”) and for up to
$15 million
of additional term loans (“Additional Term Loans”; and together with the Initial Term Loan, the “Loans”) which original Additional Term Loans were initially able to be drawn until the second anniversary of the funding of the Initial Term Loans, subject to the satisfaction of customary conditions. On August 11, 2017, the Initial Term Loan was advanced (the "Closing Date") and the proceeds were applied to repay all outstanding amounts under our prior credit agreement with Madison Capital Funding LLC as administrative agent ("the Prior Credit Agreement"). On August 31, 2018, we entered into Amendment No. 2 to the Credit Agreement to among other things (i) extend the maturity date of the Initial Term Loan and any Additional Term Loans by one year to August 2021, (ii) expand the Additional Term Loans commitment from
$15 million
to
$25 million
, (iii) extend the period during which Additional Term Loans can be borrowed by one year to August 2020, and (iv) relieve the Borrower from its obligation to comply with
the financial covenants in the Credit Agreement during the six fiscal quarters following the Premiere acquisition. On October 15, 2018, the Company borrowed
$4 million
of the
$25 million
available as Additional Term Loans under the Credit Agreement. As of December 31, 2018,
$45.8 million
was outstanding under the Credit Agreement. On March 21, 2019, we entered into Amendment No. 3 to the Credit Agreement to among other things relieve the Borrower from its obligation to comply with the financial covenants in the Credit Agreement until the quarter ending June 30, 2020.
We have the option to extend the maturity of the Loans for
two
additional
one year
periods, subject to the satisfaction of customary conditions. The Loans bear interest at the one-month LIBOR rate (subject to a
1%
per annum floor) plus a margin which may vary from
5.5%
per annum to
10.0%
per annum based on our total debt to EBITDA ratio. Our annual interest rate at December 31, 2018, was
8.0%
, and at December 31, 2017 was
8.6%
. We are required to pay
5%
of the original principal balance of the Loans annually in quarterly installments and to make mandatory prepayments of the Loans with a percentage of our excess cash flow which may vary between
75%
and
0%
depending on our total debt to EBITDA ratio and from the net cash proceeds of certain asset dispositions and debt not otherwise permitted under the Credit Agreement, in each case, subject to the lender's right to decline to receive such payments. The Loans may be voluntarily prepaid at any time, together with a prepayment premium of
1%
for all voluntary prepayments prior to August 11, 2019.
The Credit Agreement contains certain restrictive financial covenants which are not effective until the quarter ending June 30, 2020, at which point, we will be required to (1) achieve a minimum fixed charge coverage ratio of
1.0
to
1.0
through December 31, 2020,
1.25
to
1.0
through June 30, 2021, and
1.25
to
1.0
through June 30, 2022 if the maturity date of the Loans is extended until the fifth anniversary of the Closing Date and (2) maintain a maximum total debt to EBITDA ratio of
6.00
to
1.00
. The Credit Agreement also contains covenants that restrict the Company and its subsidiaries’ ability to incur certain types or amounts of indebtedness, incur liens on certain assets, make material changes in corporate structure or the nature of its business, dispose of material assets, engage in a change in control transaction, make certain foreign investments, enter into certain restrictive agreements, or engage in certain transactions with affiliates. The Credit Agreement also contains various customary events of default, including with respect to change of control of the Company or its ownership of the Borrower.
The obligations under the Credit Agreement are secured by substantially all of our United States domestic subsidiaries' assets and are guaranteed by the Company and its United States domestic subsidiaries, other than the Borrower.
As a result of our entry into our Credit Agreement, and the repayment of all amounts owed under our Prior Credit Agreement, we wrote off debt issuance costs related to our Prior Credit Agreement of approximately
$1.0 million
in August 2017.
Scheduled payments under the Credit Agreement for the next five years and thereafter are as follows (in thousands):
|
|
|
|
|
Year Ending December 31,
|
Amount
|
2019
|
$
|
2,350
|
|
2020
|
2,400
|
|
2021
|
41,050
|
|
2022
|
—
|
|
Total
|
$
|
45,800
|
|
The Company made principal payments of
$2.2 million
for the year ended December 31, 2018.
In consideration for, and concurrently with, the extension of the Initial Term Loan in accordance with the terms of the Credit Agreement, we issued a warrant to the lender to purchase up to an aggregate of
3,863,326
shares of the Company’s common stock (representing approximately up to
7.5%
of our diluted common stock as calculated using the “treasury stock” method as defined under U.S. GAAP for the most recent fiscal quarter), with an exercise price of
$1.92
per share (the "Exercise Price"). In connection with the October 15, 2018 Additional Term Loan borrowing of
$4 million
, we were required to, and did, issue a warrant to the lender to purchase an aggregate of
309,066
shares of the Company's common stock at the same Exercise Price of
$1.92
per share. Upon any further borrowing of the Additional Term Loans, we will be required to issue additional warrants at the same Exercise Price to purchase up to an aggregate of
77,267
additional shares of common stock (which represents approximately
0.15%
of our diluted common stock calculated using the “treasury stock” method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017) for each
$1.0 million
of such Additional Term Loans. Similarly, upon our election to extend the maturity of the Loans for additional
one year
periods, we will be required to issue additional warrants at the same Exercise Price to purchase up to an aggregate of
515,110
additional shares of common stock for the first year's extension, and to purchase up to an aggregate of
772,665
additional
shares of common stock for the second year's extension (which represent approximately
1.0%
and
1.5%
of our diluted common stock for the first and second years, respectively, calculated using the “treasury stock” method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017).
The Company has accounted for these warrants as equity instruments since the warrants are indexed to the Company’s common shares and meet the criteria for classification in shareholders’ equity. The relative fair value of the warrants issued on August 11, 2017 and October 15, 2018, were approximately
$3.3 million
and
$0.2 million
, respectively, and were treated as a discount to the associated debt. These amounts are being amortized to interest expense under the effective interest method over the life of the loans. The Company estimated the value of the warrants using the Black-Scholes-Merton model. The key assumptions used to value the warrants are as follows:
|
|
|
|
|
August 2017 Issuance
|
October 2018 Issuance
|
Exercise price
|
$1.92
|
$1.92
|
Share price on date of issuance
|
$1.85
|
$1.93
|
Volatility
|
50.0%
|
55.0%
|
Risk-free interest rate
|
1.83%
|
3.01%
|
Expected dividend yield
|
—%
|
—%
|
Contractual term (in years)
|
5
|
5
|
In addition, at the closing of the Initial Term Loan, the Company paid transaction costs of
$0.6 million
, which were recorded as a discount on the debt and are being amortized to interest expense using the effective interest method over the life of the Loans, which is a period of
48 months
.
Outstanding debt obligations are as follows (in thousands):
|
|
|
|
|
|
December 31, 2018
|
|
Principal amount
|
$
|
45,800
|
|
Less: unamortized discount and debt issuance costs
|
(2,471
|
)
|
Loan payable, net of unamortized discount and debt issuance costs
|
43,329
|
|
Less: current maturities
|
(2,224
|
)
|
Long-term loan payable, net of current maturities
|
$
|
41,105
|
|
5. Related Party Transactions
As discussed in Note 1(d), in August of 2018, the Company purchased Premiere from ECMC, with the purchase consideration including the issuance of
1,000,000
shares of Company common stock to ECMC and a commitment to issue ECMC additional shares of common stock as part of an earn-out agreement. Additionally, as discussed in Note 4, since August 2017, ECMC has served as a lender to the Company with a Credit Agreement initially funded in August 2017 at
$44 million
, and a balance outstanding of
$45.8 million
at December 31, 2018. In connection with the Credit Agreement, the Company has issued ECMC warrants to purchase
4,172,392
shares of common stock through December 31, 2018, and ECMC’s beneficial ownership percentage on that date was approximately
9.0%
. The Company has a relationship with ECMC as a customer, with revenues of
$15.5 million
in 2018. Given the breadth of ECMC’s involvement with the Company as of December 31, 2018, we have concluded that ECMC is a related party for purposes of financial statement presentation and disclosure.
6. Commitments and Contingencies
The Company has entered into various non-cancelable operating lease agreements for certain of the Company's office facilities and equipment with original lease periods expiring between 2018 and 2025. Certain of these arrangements have free rent periods and /or escalating rent payment provisions, and the Company recognizes rent expense under such arrangements on a straight-line basis. In October 2017, the Company renewed our lease agreements for office space for approximately
50,000
square feet in Livermore, California. In December 2017, the Company entered
two
new lease agreements for office space for approximately
26,000
square feet in San Angelo, Texas and
32,000
square feet in Sunrise, Florida.
Future minimum rental commitments under non-cancelable leases as of
December 31, 2018
are as follows (in thousands):
|
|
|
|
|
Year Ending December 31,
|
Amount
|
2019
|
$
|
3,427
|
|
2020
|
3,393
|
|
2021
|
2,514
|
|
2022
|
1,901
|
|
2023
|
800
|
|
Thereafter
|
1,390
|
|
Total
|
$
|
13,425
|
|
Lease expense was
$3.9 million
,
$2.7 million
and
$2.8 million
for the years ended
December 31, 2018
,
2017
and
2016
, respectively. Deferred rent is included in other liabilities on the consolidated balance sheets and was
$1.2 million
and
$0.7 million
as of December 31, 2018 and 2017, respectively.
7. Capital Stock
Since August 15, 2012, the authorized common stock has been
500,000,000
shares and the authorized preferred stock has been
50,000,000
shares.
|
|
8.
|
Stock-based Compensation
|
Under the terms of the Performant Financial Corporation 2007 Stock Option Plan (2007 Plan), incentive and nonqualified stock options may be granted for up to
4,000,000
shares of the Company’s authorized but unissued common stock. Options granted under the 2007 Plan generally vest over a
five
-year period. The 2007 Plan was terminated on the completion of its initial public offering in August 2012.
No
shares of the Company's common stock are available under our 2007 Plan other than for satisfying exercises of stock options granted under this plan prior to termination.
The terms of the Performant Financial Corporation 2012 Stock Incentive Plan (2012 Plan) provide for the granting of incentive stock options within the meaning of Section 422 of the Internal Revenue Code (the Code) to employees and the granting of nonstatutory stock options, restricted stock, stock appreciation rights, stock unit awards and cash-based awards to employees, non-employee directors and consultants. The Company has reserved
10,550,000
shares of common stock under the 2012 Plan. Options granted under the 2012 Plan generally vest over periods of
four
or
five
years.
The exercise price of incentive stock options shall generally not be less than
100%
of the fair market value of the common stock subject to the option on the date that the option is granted. The exercise price of nonqualified stock options shall generally not be less than
85%
of the fair market value of the common stock subject to the option on the date that the option is granted. Options issued under the two plans have a maximum term of
10
years and vest over schedules determined by the Company's Board of Directors.
Total stock-based compensation expense charged as salaries and benefits expense in the consolidated statements of operations was
$2.8 million
,
$3.7 million
and
$4.7 million
for the years ended
December 31, 2018
,
2017
, and
2016
, respectively. The following table sets forth a summary of the Company's stock option activity for the years ended December 31,2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
Options
|
|
Weighted
average
exercise price
per share
|
|
Weighted
average
remaining
contractual life
(Years)
|
|
Aggregate
Intrinsic Value
(in thousands)
|
Outstanding at January 01, 2017
|
3,506,529
|
|
|
7.32
|
|
|
5.04
|
|
|
Granted
|
—
|
|
|
—
|
|
|
|
|
|
Forfeited
|
(260,175
|
)
|
|
5.4
|
|
|
|
|
|
Exercised
|
(310,156
|
)
|
|
0.50
|
|
|
|
|
|
Outstanding at December 31, 2017
|
2,936,198
|
|
|
8.21
|
|
|
4.48
|
|
|
Granted
|
—
|
|
|
—
|
|
|
|
|
|
Forfeited
|
(208,346
|
)
|
|
8.96
|
|
|
|
|
|
Exercised
|
(268,750
|
)
|
|
0.69
|
|
|
|
|
|
Outstanding December 31, 2018
|
2,459,102
|
|
|
$
|
8.97
|
|
|
3.25
|
|
$
|
273
|
|
Vested, exercisable, and expected to vest
(1)
at December 31, 2018
|
2,458,640
|
|
|
$
|
8.97
|
|
|
3.24
|
|
$
|
273
|
|
Exercisable at December 31, 2018
|
2,449,857
|
|
|
$
|
8.99
|
|
|
3.23
|
|
$
|
271
|
|
|
|
(1)
|
Options expected to vest reflect an estimated forfeiture rate.
|
There were no stock options granted during the years ended December 31, 2018 and December 31, 2017. The aggregate intrinsic value of our stock options (the amount by which the market price of the stock on the date of exercise exceeded the exercise price of the option) exercised during the years ended
December 31, 2018
and
2017
was
$0.5 million
and
$0.4 million
, respectively. At
December 31, 2018
and
2017
, there were
$0.01 million
and
$0.3 million
, respectively, of unrecognized stock-based compensation expense related to non-vested stock-based compensation arrangements, which the Company expects to recognize over a weighted-average period of
0.41
years as stock-based compensation expense.
Net cash proceeds from the exercise of stock options were
$0.2 million
and
$0.2 million
during
2018
and
2017
, respectively.
The fair value of each option grant was estimated using the Black-Scholes-Merton option pricing model. Expected volatilities are calculated based on the historical volatility data of comparable peer companies over a term comparable to the expected term of the options issued. The expected term of the award is determined based on the average of the vesting term and the contractual term. Management monitors share option exercise and employee termination patterns to estimate forfeiture rates within the valuation model.
We estimated the fair value of options granted using a Black-Scholes-Merton option pricing model with the following assumptions:
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Expected volatility
|
—%
|
|
—%
|
|
51.5%
|
Expected dividends
|
—%
|
|
—%
|
|
—%
|
Expected term (years)
|
—
|
|
—
|
|
6.1
|
Risk-free interest rate
|
—%
|
|
—%
|
|
1.4%
|
Weighted-average estimated fair value of options granted during the year
|
$—
|
|
$—
|
|
$0.86
|
Valuation and Amortization Method –
The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option pricing model. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Stock options typically have a
ten
year life from the grant date and vesting periods of
four
to
five
years. The fair value of the Company’s common stock is based on the market price of the stock on the date of grant.
Expected Term –
The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding. For awards granted subject only to service vesting requirements, the Company utilizes the
simplified method under the provisions of FASB ASC 718-10-S99-1 for estimating the expected term of the stock-based award.
Expected Volatility –
There were
no
stock options granted during the year ended December 31, 2018 and December 31, 2017. If stock options had been granted, as of December 31, 2018, expected volatility is comprised of a
100%
company weighting. Before 2018, the Company calculated the expected volatility using a composite made up of comparable peer companies. As of December 31, 2017, an approximate
88%
company weighting would have been used.
Expected Dividend –
The Company has never paid dividends on its common shares and currently does not intend to do so. Accordingly, the dividend yield percentage is
zero
for all periods.
Risk-Free Interest Rate –
The risk-free interest rate used in the Black-Scholes-Merton valuation method is based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected life of our stock options.
|
|
(b)
|
Restricted Stock Units
|
The following table summarizes restricted stock unit activity for the years ended December 31, 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
average
|
|
Number of
|
|
grant date
|
|
Awards
|
|
fair value
|
Outstanding at January 01, 2017
|
2,060,240
|
|
|
$
|
2.70
|
|
Granted
|
1,701,252
|
|
|
2.32
|
|
Forfeited
|
(417,725
|
)
|
|
2.93
|
|
Vested and converted to shares, net of units withheld for taxes
|
(540,673
|
)
|
|
2.75
|
|
Units withheld for taxes
|
(211,507
|
)
|
|
2.75
|
|
Outstanding at December 31, 2017
|
2,591,587
|
|
|
$
|
2.39
|
|
Granted
|
2,106,536
|
|
|
2.70
|
|
Forfeited
|
(871,184
|
)
|
|
2.37
|
|
Vested and converted to shares, net of units withheld for taxes
|
(645,560
|
)
|
|
2.80
|
|
Units withheld for taxes
|
(248,143
|
)
|
|
$
|
2.80
|
|
Outstanding at December 31, 2018
|
2,933,236
|
|
|
$
|
2.50
|
|
Expected to vest at December 31, 2018
|
2,786,574
|
|
|
$
|
2.50
|
|
Share-based compensation cost for restricted stock units (RSUs) is measured based on the closing fair market value of the Company's common stock on the date of grant. The Company recognizes share-based compensation cost over the award's requisite service period on a straight-line basis for time-based RSUs and on a graded basis for RSUs that are contingent on the achievement of performance conditions.
The majority of RSUs that vested in
2018
and
2017
were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes and remitted the cash to the appropriate taxing authorities. The total shares withheld were approximately
248,000
shares for
2018
and approximately
212,000
shares for
2017
, and were based on the value of the RSUs on their respective vesting dates as determined by the Company’s closing stock price. These net-share settlements had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company.
At
December 31, 2018
and
2017
, there was $
5.4 million
and
$4.3 million
of compensation expense yet to be recognized related to non-vested restricted stock units. The unrecognized expense as of
December 31, 2018
is expected to be recognized over the remaining weighted-average vesting period of
2.82
years.
893,703
and
752,180
of the restricted stock units vested during the years ended
December 31, 2018
and
2017
, respectively. Restricted stock units granted under the 2012 Plan generally vest over periods between
one
and
four
years.
9. Employee Benefit Plan
The Company has a 401(k) Salary Deferral Plan (the Plan) covering all full-time employees who have met certain service requirements. Employees may contribute a portion of their salary up to the maximum limit established by the Code for such plans. Employer contributions are discretionary.
No
matching contributions were made during
2018
,
2017
and
2016
.
10. Income Taxes
The Company’s income tax expense (benefit) consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Current:
|
|
|
|
|
|
Federal
|
$
|
275
|
|
|
$
|
(5,427
|
)
|
|
$
|
3,835
|
|
State
|
777
|
|
|
369
|
|
|
(1,293
|
)
|
|
1,052
|
|
|
(5,058
|
)
|
|
2,542
|
|
Deferred:
|
|
|
|
|
|
Federal
|
$
|
(52
|
)
|
|
$
|
2,643
|
|
|
$
|
(5,379
|
)
|
State
|
542
|
|
|
1,090
|
|
|
(1,533
|
)
|
|
490
|
|
|
3,733
|
|
|
(6,912
|
)
|
Total expense (benefit)
|
$
|
1,542
|
|
|
$
|
(1,325
|
)
|
|
$
|
(4,370
|
)
|
The reconciliation between the amount computed by applying the U.S. federal statutory rate of 21% for 2018, and 34% for 2017 and 2016, to income before taxes and the Company's tax provision for 2018, 2017, and 2016 is as follows:
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Federal income at the statutory rate
|
21
|
%
|
|
34
|
%
|
|
34
|
%
|
State income tax, net of federal benefit
|
(18
|
)%
|
|
(8
|
)%
|
|
11
|
%
|
Permanent differences
|
(4
|
)%
|
|
1
|
%
|
|
(1
|
)%
|
Work Opportunity Credit
|
—
|
%
|
|
2
|
%
|
|
1
|
%
|
Return to provision true-up
|
(4
|
)%
|
|
(1
|
)%
|
|
(1
|
)%
|
Valuation allowance
|
(18
|
)%
|
|
(13
|
)%
|
|
(18
|
)%
|
Rate change on deferreds
|
—
|
%
|
|
(6
|
)%
|
|
—
|
%
|
Other
|
—
|
%
|
|
—
|
%
|
|
2
|
%
|
|
(23
|
)%
|
|
9
|
%
|
|
28
|
%
|
The following table summarized the components of the Company's deferred tax assets and liabilities as of
December 31, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
Deferred tax assets
|
|
|
|
Bad debt reserve
|
$
|
—
|
|
|
$
|
11
|
|
Vacation accrual
|
551
|
|
|
510
|
|
Workers compensation
|
138
|
|
|
241
|
|
Nonqualified stock options
|
3,361
|
|
|
3,917
|
|
Debt issuance costs
|
6
|
|
|
27
|
|
Acquisition costs
|
—
|
|
|
23
|
|
State tax deferral
|
502
|
|
|
384
|
|
Deferred revenue
|
—
|
|
|
15
|
|
State tax credits
|
452
|
|
|
452
|
|
Net operating loss
|
3,876
|
|
|
453
|
|
Estimated liability for appeals
|
67
|
|
|
3,956
|
|
Identifiable intangible assets
|
153
|
|
|
—
|
|
Interest expense limitation
|
1,498
|
|
|
—
|
|
Other
|
497
|
|
|
448
|
|
Total deferred tax assets
|
11,101
|
|
|
10,437
|
|
Valuation allowance
|
(8,397
|
)
|
|
(5,772
|
)
|
Total deferred tax assets net of valuation allowance
|
2,704
|
|
|
4,665
|
|
Deferred tax liabilities:
|
|
|
|
Identifiable intangible assets
|
—
|
|
|
(733
|
)
|
Fixed assets
|
(2,692
|
)
|
|
(3,430
|
)
|
Other
|
(34
|
)
|
|
(34
|
)
|
Total deferred tax liabilities
|
(2,726
|
)
|
|
(4,197
|
)
|
Net deferred tax assets (liabilities)
|
$
|
(22
|
)
|
|
$
|
468
|
|
As of
December 31, 2018
, and 2017, the Company recorded a valuation allowance against deferred tax assets that are not more likely than not realizable based upon the assessment of all positive and negative evidence. The total amount of the valuation allowance at
December 31, 2018
is
$8.4 million
, which is an increase of
$2.6 million
from the amount recorded as of
December 31, 2017
.
On December 22, 2017, President Trump signed into law the “Tax Cuts and Jobs Act” (TCJA) that significantly reforms the Internal Revenue Code of 1986, as amended. The TCJA, among other things, includes changes to U.S. federal tax rates, imposes significant additional limitations on the deductibility of interest, allows for the expensing of capital expenditures, and puts into effect the migration from a “worldwide” system of taxation to a territorial system. The Company calculated the impact of the Tax Act in its year end income tax provision in accordance with its understanding of the Tax Act and guidance available at the time, and provided for the provisional income tax expense in the fourth quarter of 2017. The Company completed its analysis of the impacts of the 2017 Tax Act in the fourth quarter of 2018 with no change to its provisional estimates.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income and tax-planning strategies in making this assessment. Based upon the Company’s cumulative three year loss position and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will be unable to realize the benefits of these deductible differences. The amount of the deferred tax asset considered realizable, however, could change in the near term if estimates of future taxable income during the carryforward period change.
The Company has state tax credits of
$0.5 million
, which will expire in 2024. The Company has state net operating loss carryforwards of
$20.7 million
which will start to expire in 2020 and a federal net operating loss carryforward of
$8.9 million
which will can be carried forward indefinitely. The Company has
$0.2 million
of federal tax credit carryforwards which begin to expire in 2037.
The following table reconciles the Company’s unrecognized tax benefits as of
December 31, 2018
from its unrecognized tax benefits as of
December 31, 2016
(in thousands):
|
|
|
|
|
Unrecognized tax benefits balance at December 31, 2016
|
$
|
987
|
|
Increase related to prior year tax positions
|
362
|
|
Decrease related to prior year tax positions
|
—
|
|
Increase related to current year tax positions
|
—
|
|
Settlements
|
—
|
|
Lapse of statute of limitations
|
(267
|
)
|
Unrecognized tax benefits balance at December 31, 2017
|
1,082
|
|
Increase related to prior year tax positions
|
602
|
|
Decrease related to prior year tax positions
|
—
|
|
Increase related to current year tax positions
|
—
|
|
Settlements
|
—
|
|
Lapse of statute of limitations
|
(83
|
)
|
Unrecognized tax benefits balance at December 31, 2018
|
$
|
1,601
|
|
At
December 31, 2018
and
2017
, the Company had approximately
$1.6 million
and
$1.1 million
of unrecognized tax benefits, respectively. The Company does not expect any significant change in unrecognized tax benefits during the next twelve months. The Company records interest expense and penalties related to unrecognized tax benefits in income tax expense. The amount of accrued interest was
$0.2 million
and
$0.2 million
at
December 31, 2018
and
2017
, respectively.
No
penalties were recognized in 2018 or accrued at
December 31, 2018
, and
2017
respectively. The Company has unrecognized tax benefits of approximately
$1.6 million
which, if recognized, would favorably affect the Company’s effective income tax rate.
We file income tax returns with the U.S. federal government and various state jurisdictions. The Company operates in a number of state and local jurisdictions, most of which have never audited the Company's records. Accordingly, the Company is subject to state and local income tax examinations based upon the various statutes of limitations in each jurisdiction. For tax years before 2015, the Company is no longer subject to Federal and certain other state tax examinations. The company is currently being examined by the Franchise Tax Board of California for tax years 2011 through 2014.
11. Other Commitments and Contingencies
The Company collects principal and interest payments and collection costs on defaulted loans for various contracting agencies. Cash collections for some of the Company’s customers are held in trust in bank accounts controlled by the Company. The Company remits trust funds to the contracting agencies on a regular basis. The amount of cash held in trust and the related liability are separated from and not included in the Company’s consolidated financial statements. Cash held in trust for customers totaled
$3.2 million
and
$0.7 million
at
December 31, 2018
and
2017
, respectively.
The Company, during the ordinary course of its operations, has been named in various legal suits and claims, several of which are still pending. In the opinion of management and the Company’s legal counsel, such legal actions will not have a material effect on the Company’s consolidated financial position or results of operations or cash flows.
12. Subsequent Events
The Company has evaluated subsequent events through the date these consolidated financial statements were issued and there are no other events that have occurred that would require adjustments or disclosures to the consolidated financial statements, other than the amendment to the Credit Agreement as discussed in Note 4.