Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
(cid:1) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2012
or
For the transition period from to
Commission File Number: 001-35628
PERFORMANT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
333 North Canyons Parkway, Livermore, CA
(Address of principal executive offices)
20-0484934
(I.R.S. Employer
Identification No.)
94551
(Zip Code)
Registrant’s telephone number, including area code: (925) 960-4800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Common Stock, par value $.0001 per share
Name of each exchange on which registered:
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:1) No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes (cid:1) No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes No (cid:1)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No (cid:1)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Large accelerated filer (cid:1)
Non-accelerated filer (Do not check if a smaller reporting company)
(cid:1)
Accelerated filer
Smaller reporting company (cid:1)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes (cid:1) No
The number of shares of Common Stock outstanding as of March 20, 2013 was 46,720,569. The aggregate market value of the Common
Stock held by non-affiliates as of March 20, 2013, was approximately $284,090,352 based upon the last reported sales price for such date on the
NASDAQ Global Select Market. The Common Stock was not traded on June 30, 2012, the last day of the second fiscal quarter in 2012.
All or a portion of Items 10 through 14 in Part III of this Form 10-K are incorporated by reference to the Registrant’s definitive proxy
statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if the
Registrant’s Schedule 14A is not filed within such period, will be included in an amendment to this Report on Form 10-K which will be filed
within such 120 day period.
Documents Incorporated By Reference
Table of Contents
TABLE OF CONTENTS
PART I
ITEM 1.
ITEM 1A.
ITEM 1B.
ITEM 2.
ITEM 3.
ITEM 4.
PART II
ITEM 5.
ITEM 6.
ITEM 7.
ITEM 7A.
ITEM 8.
ITEM 9.
ITEM 9A.
ITEM 9B.
PART III
ITEM 10.
ITEM 11.
ITEM 12.
ITEM 13.
ITEM 14.
PART IV
ITEM 15.
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
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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 facts 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;
anticipated trends and challenges in our business and competition in the markets in which we operate;
our client relationships and future growth opportunities;
the adaptability of our technology platform to new markets and processes;
our ability to invest in and utilize our data and analytics capabilities to expand our capabilities;
our growth strategy of expanding in our existing markets and considering strategic alliances or acquisitions;
our ability to meet our liquidity and working capital needs;
maintaining, protecting and enhancing our intellectual property;
our expectations regarding future expenses;
expected future financial performance; and
our ability to comply with and adapt to industry regulations and compliance demands.
These statements reflect current views with respect to future events and are based on assumptions and subject to risks and uncertainties.
We note that a variety of factors could cause actual results and experience to differ materially from the anticipated results or expectations
expressed in our forward-looking statements. Given these uncertainties, you should not place undue reliance on these forward-looking
statements. Forward-looking statements are also subject to risks and uncertainties that could cause actual results to differ materially from those
expected. These risks and uncertainties include, but are not limited to, those risks discussed in Item 1A of this report.
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
reports filed with the Securities and Exchange Commission.
ITEM 1. Business
Overview
We provide technology-enabled recovery and related analytics services in the United States. Our services help identify 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 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 receivables. We generally provide our services on an
outsourced basis, where we handle many or all aspects of our clients’ recovery processes.
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We believe we have a leading position in our markets based on our proprietary technology-enabled services platform, long-standing client
relationships and the large volume of funds we have recovered for our clients. In 2012, we provided recovery services on approximately $8.2
billion of combined student loans and other delinquent federal and state receivables and recovered approximately $482 million in improper
Medicare payments. Our clients include 11 of the 31 public sector participants in the student loan industry and these relationships average more
than 10 years in length, including a 22-year relationship with the Department of Education. According to the Department of Education, total
government-supported student loan originations were estimated to be approximately $115 billion in 2012, and, as of September 30, 2012,
approximately $78 billion of government-supported student loans were in default. In the healthcare market, we are currently one of four prime
Medicare Recovery Audit Contractors, or RACs, in the United States for the Centers for Medicare and Medicaid Services, or CMS. According to
the Government Accountability Office, Medicare paid $554 billion of claims in 2011, of which approximately $43 billion were estimated to be
improper payments.
We utilize our technology platform to efficiently provide recovery and analytics services in the markets we serve. We have continuously
developed and refined our technology platform for almost two decades by using our extensive domain and data processing expertise. Our
technology platform allows us to disaggregate otherwise complex recovery processes into a series of simple, efficient and consistent component
steps, which we refer to as workflows, for our recovery and healthcare claims review specialists. This approach enables us to continuously refine
our recovery processes to achieve higher rates of recovery with greater efficiency. By optimizing what traditionally have been manually-
intensive processes, we believe we achieve higher workforce productivity versus more traditional labor-intensive outsourcing business models.
For example, we generated in excess of $150,000 of revenues per employee during 2012, based on the average number of employees during the
year.
We believe that our 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 healthcare market. We have enhanced 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.
Our revenue model is generally success-based as we earn fees based on a percentage of the aggregate 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 and the dollars we enable for our clients to
recover, our business objectives are aligned with those of our clients and we are generally not reliant on their spending budgets. Further, our
business model does not require significant capital expenditures and we do not purchase loans or obligations.
We believe we benefit from a significant degree of revenue visibility due to reasonably predictable recovery outcomes in a substantial
portion of our business. For the year ended December 31, 2012, we generated approximately $210.1 million in revenues, $23.0 million in net
income, $69.6 million in adjusted EBITDA and $30.6 million in adjusted net income. See “Adjusted EBITDA and Adjusted Net Income” 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.
We commenced our operations in 1976 under the corporate name Diversified Collection Services, Inc., or DCS. We were incorporated in
Delaware on October 8, 2003 under the name DCS Holdings, Inc. and subsequently changed our name to Performant Financial Corporation in
2005.
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.
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Student Lending
Student lending is a large and critically-important market in the United States. According to the Department of Education, total
government-supported student loan originations were estimated to be approximately $115 billion in the year ended September 30, 2012, and the
aggregate dollar amount of these loans has grown at a compound annual growth rate of 11% from 2002 through 2012. This growth has been
supported by general demographic trends, increased enrollment, and rising costs of tuition and other expenses that increase the need for
borrowed funds among students. In addition to strong underlying origination growth, the default rates among student loan borrowers have
increased in recent years. The “cohort default rate,” which is the measure utilized by the Department of Education to track the percentage of
government-supported loan borrowers that enter repayment in a certain year ended September 30 and default by the end of the next year ended
September 30, has risen from approximately 5% in 2006 to approximately 9% in 2010, the last year for which data is available.
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 31 GAs.
In July 2010, the government-supported student loan sector underwent a structural change with the passage of 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, while the original
distribution channels for student loans have been consolidated into one channel, the Department of Education, this does not impact the volume of
government-supported student loan origination, which is a key driver of the volume of defaulted student loan inventory. In addition, despite this
transition of all new loan originations to the FDSLP, GAs will continue to manage a significant amount of defaulted student loans for some
period of time, due to their large outstanding portfolios of loans originated prior to July 2010. The outstanding portfolios of defaulted FFELP
loans will, therefore, require recovery for the foreseeable future.
The Department of Education estimates that the balance of defaulted loans was approximately $44.7 billion in the FDSLP and
approximately $32.7 billion in the FFELP as of September 30, 2012. These programs collectively guaranteed approximately $706 billion of
federal government-supported student loans according to the Congressional Budget Office as of September 30, 2011. Given the operational and
logistical complexity involved in managing the recovery of defaulted student loans, the Department of Education and the GAs generally choose
to outsource these services to third parties.
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The tables below show government-supported student loan originations and government-supported default inventory for the years ended
2007 through 2012 as reported by the Department of Education.
Healthcare
The healthcare industry represents a significant portion of the U.S. GDP. According to CMS, U.S. healthcare spending reached $2.7 trillion
in 2011 and is forecast to grow at a 6% annual rate through 2021. In particular, CMS indicates that federal government-related healthcare
spending for 2011 totaled approximately $1.2 trillion. This government-related spending included approximately $554 billion for Medicare,
which provides a range of healthcare coverage primarily to elderly and disabled Americans, and $408 billion for Medicaid, which provides
federal matching funds for states to finance healthcare for individuals at or below the public assistance level.
The tables below show total U.S. healthcare expenditures from 2011 through 2021 and total Medicare spending from 2011 through 2021 as
estimated by CMS.
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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.
Of the $554 billion of 2011 Medicare spending, the Department of Health and Human Services estimated that approximately $43 billion,
or 8%, was improper, and is the federal program with the largest amount of improper payments. Medicare improper payments generally involve
incorrect coding, procedures performed which were not medically necessary, incomplete documentation or claims submitted based on outdated
fee schedules, among other issues. Likewise, Medicaid improper payments were estimated to be $22 billion, or 5%, of total Medicaid payments
for 2011. The following table illustrates the proportion of improper payments among federal programs in the year ended September 30, 2011,
according to the Office of Management and Budget.
Top Federal Programs with Improper Payments in the Year Ended September 30, 2011
Total = $115 billion
(1) Other includes National School Lunch, Pell Grant, and 67 additional programs.
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 the RAC program 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 RAC program nationwide. CMS relies on third-party contractors to execute the RAC
program to analyze millions of Medicare claims annually for improper payments that have been paid 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.
In addition to government-related healthcare spending, significant growth is expected in the private healthcare market. According to CMS’
National Health Expenditures Projections, the private healthcare market accounted for approximately $1.5 trillion in spending in 2011 and
private expenditures are projected to grow more than 5% annually through 2021.
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Other Markets
State Tax Market
We believe that the demand for recovery of delinquent state taxes will grow as state governments struggle with revenue generation and
face significant budget deficits. According to the Center on Budget and Policy Priorities, an independent think tank, 43 U.S. states faced budget
shortfalls totaling $107 billion in the year ended September 30, 2012, with at least 31 states anticipating deficits for fiscal year 2013. The
economic recession has 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. 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
Department of Financial Management Service, a bureau of the Department of the Treasury, or FMS. Since 1996, the FMS has recovered more
than $54 billion in delinquent federal debt. For the year ended September 30, 2011, federal agency recoveries in this market totaled more than
$6.2 billion, an increase of more than $700 million over 2010. A significant portion of these collections are processed by private collection firms
on behalf of the FMS.
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 built a proprietary technology platform that is highly flexible,
intuitive and easy to use for our 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 tax,
federal treasury receivables and the healthcare recovery markets, each having its own industry complexities and specific regulations.
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 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
$150,000 of revenues per employee during 2012, 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.
Enhanced data and analytics capabilities. Our data and analytics capabilities allow us to achieve strong recovery rates for our
clients. 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 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. Finally, through a
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strategic investment, we have acquired enhanced data analytics capabilities, which we refer to as Performant Insight. This investment
allows us to expand our capabilities into several new areas including the detection of fraud, waste and abuse in various markets and
has assisted in our recovery activities for CMS.
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 11 of the 31 public
sector participants in the student loan market and these relationships average more than 10 years in length, including an approximate
22-year relationship with the Department of Education. In the healthcare market, we have a seven-year relationship with CMS and
are currently one of only four prime Medicare RAC contractors.
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 three 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.
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 10 years. This
team has successfully grown our revenue base and service offerings beyond the original student loan market into healthcare and
delinquent state 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.
Our Growth Strategy
Key elements of our growth strategy include the following:
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Expand our student loan recovery volume. According to the Department of Education, total government-supported student loan
originations were estimated to be approximately $115 billion in 2012, and have grown at a 11% compound annual growth rate from
2002 through 2012. The balance of defaulted government-supported student loans was estimated to be approximately $78 billion as
of September 30, 2012. While we have long-standing relationships with some of the largest participants in the government-supported
student loan market, we believe there are significant opportunities within this growing market to increase the volume of student loans
placed with us by existing and new clients. For example, under our contract with the Department of Education, we believe there is an
opportunity to grow our placement volume through strong performance. Further, as a result of our relationships with five of the seven
largest GAs, we believe we are well-positioned to benefit as a result of any consolidation of smaller GAs over the coming years.
Expand our recovery services in the healthcare market. According to CMS, Medicare spending totaled approximately $554 billion
in 2011 and is expected to increase to $1 trillion in 2021, representing a compound annual growth rate of 6%. In the private
healthcare market, spending totaled $1.5 trillion in 2011 and is expected to grow more than 6% annually through 2021, according to
CMS’ National Health Expenditures Projections. As these large markets continue to grow, we expect the need
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for recovery services to increase in the public and private healthcare markets. In the public healthcare space, we intend to utilize the
experience gained through our contracts with CMS to pursue additional recovery opportunities in areas such as Medicare Secondary
Payor Recovery and state Medicaid recovery. In addition, through our enhanced analytics capabilities, 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.
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 capability or enable us to enter
new markets or provide new products or services, such as our licensing of new applied data modeling analytics capabilities that can
be used to identify fraudulent or erroneous healthcare claims prior to payment.
•
Our Platform
Our technology-enabled services platform is based on over two decades of experience in 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 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 recovery inventory. For example, upon receipt of each
placement of student loans, 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 Medicare claims to find potential
correlations between claims data and improper payments, which enhance our future recovery 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 enhanced analytics capabilities will extend our potential markets, permitting us to pursue significant new
business opportunities. We intend to accelerate 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 recovery workflow processes, which we believe drive higher efficiency and
productivity and reduce our reliance on labor-intensive methods relative to more traditional
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recovery outsourcing models. We refer to the patented technology that supports our proprietary workflows as “Smart Bins.” Smart Bins
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. Our workflow processes integrate a broad range of functions that encompass each
stage of a recovery process.
Smart Bins have been designed to be highly intuitive and help our recovery and claims specialists manage each step in the recovery
process and enhance their productivity to high levels, regardless of skill differences among specialists. Smart Bins direct specialists toward the
most efficient and effective action, or step with respect to the management and recovery of a defaulted student loan, with some input by
specialists. Our technology places expert system rules into the workflow engine, allowing employees at different skill levels to manage the more
complex work steps that highly experienced workers would perform, while automating document management and compliance functionality as
industry regulations and compliance demands change.
The following recovery diagram illustrates how the various components of our platform work together to solve a typical client workflow:
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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 tax and federal treasury receivables. The table
below summarizes our recovery services and related analytics capabilities and the markets we serve.
Student Loans
• Provide recovery services to the
Department of Education, GAs
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
Recovery Services
Student Loans
Recovery Services
Healthcare
• Provide recovery services to
identify improper healthcare
payments
Other Markets
• Provide tax recovery services
to state and municipal
agencies
• Analyze millions of Medicare
• Recover government debt for
Parts A and B claims as the
prime contractor for
recovery services for
improper payments in the
Northeast region of the
United States
numerous different federal
agencies under a contract
with the Treasury and
provide recovery and audit
services for the Department
of Education
• 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
• 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
Analytics
Capabilities
• Provide claims audit,
pharmacy management
and coordination of
benefits functions for one
of the nation’s largest
health care organizations
• 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
We provide recovery services primarily to the government-supported student loan industry, and our clients include the Department of
Education and 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
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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.
Healthcare
We provide recovery services related to improper payments in the healthcare market. In 2009 we were awarded the role as one of four
prime RAC contractors in the United States, with exclusive responsibility for the Northeast region. Under our RAC contract, we identify and
facilitate the recovery of improper Parts A and B Medicare payments. Our geographical region accounted for approximately 23% of all Medicare
spending in 2009 according to CMS. Our relationship with CMS began in 2005 with an initial demonstration contract to recover improper
payments for Medicare Secondary Payor claims.
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 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.
To accelerate our ability to provide Medicare audit and recovery services across our region following our award of the RAC contract, we
outsource certain aspects of our healthcare recovery process to three different subcontractors. Two of these subcontractors provide a specific
service to us in connection with our claims recovery process, and one subcontractor is engaged to provide all of the audit and
recovery services for claims within a portion of our region. According to CMS, the geographic area allocated to this subcontractor represented
approximately 17% of the total Medicare spending in our region in 2009.
Other Markets
We also provide recovery services to several state and municipal tax authorities, the Department of the Treasury, the Department of
Education and a number of financial institutions.
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 ten 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.
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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 and recover delinquent and defaulted assets and
improper payments as part of our core recovery services platform. Through a strategic investment, we acquired enhanced data analytics
capabilities, which we refer to as Performant Insight. Performant Insight added new capabilities in data warehousing and data processing tools
that accelerated our ability 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 recovery services platform. Performant Insight has not only enhanced our existing
recovery services under our RAC contract 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 enhanced analytics capabilities will extend our potential markets, permitting us to pursue
significant new business opportunities. We intend to accelerate 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. For example, in February 2013, we announced a strategic
relationship to offer recovery services to identify improper coding, billing and payments for the specialty pharmacy customers of Magellan
Health Services Inc. (NASDAQ: MGLN).
While our revenues from analytics services are limited to date, we believe these services represent a meaningful future opportunity. We
currently offer analytics services to one of the largest national healthcare organizations where our analytics services provide real-time financial
and operational cost analyses to help support a broad range of compliance and fiscal management functions across the organization, including
claims audit, pharmacy management and coordination of benefits. In addition, we are developing strategies to deploy these services in markets
other than healthcare.
Our Clients
We provide our services across a broad range of government and private clients in several markets.
Department of Education
We have provided student loan recovery services to the Department of Education for approximately 22 years. We restructure and recover
defaulted student loans distributed directly by the Department of Education as part of the FDSLP. Due to its limited resources and recovery
capabilities, the Department of Education outsources much of its defaulted student loan portfolio to third-party vendors for recovery. Recovery
fees are
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entirely contingency-based, and our fee for a particular recovery depends on the type of recovery facilitated. We also receive incremental
performance incentives based upon our performance as compared to other contractors with the Department of Education, which are comprised of
additional inventory allocation volumes and incentive fees. To participate in the Department of Education contracts, firms must follow a highly
competitive selection process. For the latest Department of Education contract, the fourth major contract the Department of Education has
outsourced to selected vendors, we were selected as one of 17 unrestricted vendors and initiated work on this contract in the fourth quarter of
2009. Because all federally-supported student loans are being originated by the Department of Education as a result of SAFRA, our relationship
with the Department of Education will become increasingly more important over time. The Department of Education was responsible for
approximately 13.8% of our revenues for the year ended December 31, 2012.
In addition, we were awarded a contract in January 2013 with the Department of Education to conduct a payment recapture of goods and
services, which excludes grants and student loans, contracted for by the department. Under this contract, we identify, evaluate and report the
causes for contract overpayments and provide recovery services to assist the Department of Education in recovering these improper payments.
Guaranty Agencies
We restructure and recover defaulted student loans issued by private lenders and backed by GAs under the FFELP. Despite the transition
from FFELP to FDSLP, we believe GA default volumes will continue to rise for several years as there is a lag between originations and defaults
of at least three to four years. 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, and the fees that we receive are generally
similar to the fees we receive from the Department of Education contract. For some GA clients, we provide services through MSAs, under which
we manage a GA’s entire portfolio of defaulted student loans and, for certain clients, engage subcontractors to provide a portion of the recovery
services associated with a GA’s student loan portfolio.
We have a relationship with 11 of the 31 active GAs in the U.S., including Great Lakes Higher Education Guaranty Corporation, American
Student Assistance Corporation and American Education Services, each of which was responsible for 18.7%, 12.1% and 10.7%, respectively, of
our revenues for the year ended December 31, 2012. We have had relationships with GA clients for over 25 years.
CMS
We have a seven-year relationship with CMS. Under our RAC contract with CMS awarded in 2009, we identify and facilitate the recovery
of improper Parts A and B Medicare payments in the Northeast region of the United States and which accounted for approximately 25.8% of our
revenues for the year ended December 31, 2012. The fees that we receive for identifying these improper payments from CMS 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.
U.S. Department of the Treasury
We have assisted the Department of the Treasury for 15 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 four 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.
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State Tax and Municipal Agencies
We provide outsourced recovery services for individuals’ delinquent state tax and other municipal obligations on a hosted model and under
MSAs. We currently have relationships with ten state and municipal governments.
Private Lenders
We provide recovery services for private student loans, that supplement federally guaranteed loans, and home mortgages to private lenders.
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 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 a Senior Vice President of Sales and Marketing and a sales 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 new data analytics business, is supported by staff in Miami Lakes, 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 system based upon recognized standards, including
the NIST800 53 and ISO 27002 Code of Practice for Information Security Program Management, to uphold high security standards needed for
the protection of sensitive information.
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. For example, we are one of 17 unrestricted providers of recovery services on the current Department
of Education contract, while some of the GAs may only engage a few recovery vendors at any time. 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. Clients such as the Department of Education
typically 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 most of 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.
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In the recovery of improper healthcare payments, we faced a highly competitive process, involving a large number of bidders, to become
one of the four prime RAC contractors in the United States. CMS issued a request for quotes in connection with the re-bidding for the RAC
contract in February 2013. Although our RAC contract is currently set to expire in 2014, CMS may terminate our RAC contract as early as
August 2013 in connection with this re-bidding process. We expect that our competition will include the other three RAC service providers:
Health Management Systems, Inc., Connolly Consulting, Inc. and CGI Group. We also may face competition from the subcontractors of the
current prime RAC contractors, who may seek to use their experience as subcontractors to become prime contractors, and a variety of healthcare
consulting and healthcare information services companies are potential competitors. Some of these potential competitors for the second RAC
contract may have greater financial and other resources than we do. According to the request for quotes, the competitive factors for this new
RAC contract are 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. We believe
that our seven year relationship with CMS and our related experience in providing recovery services to identify improper payments allows us to
compete favorably with respect to many of these factors. We expect that our performance in identifying claims, managing the claims processes
under the current RAC contract, and established systems integration with CMS and related Medicare administrative contractors will also be key
factors in determining our continued service to CMS.
Government Regulation
The nature of our business requires that we adhere to a complex array of federal and state laws and regulations. These include HIPAA, the
FDCPA, the FCRA, 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.
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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 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 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 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 system based upon recognized standards, including the NIST800 53
and ISO 27002 Code of Practice for Information Security Program Management, to uphold high security standards needed for the protection of
sensitive information. 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, conduct an annually 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
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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.
Debt recovery activities are also regulated at 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 of 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, monitoring of performance, and periodic review
and risk assessments. 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, attorneys 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.
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. Many states 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. 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 maintain 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.
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Intellectual Property
Our intellectual property is a significant component of our business, 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, 2012, we have 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 December 2019. 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, 2012, we own five trademarks registered with the U.S. Patent and Trademark office: Performant, Performant
Recovery, Performant Technologies, Discovery Analytics and Performant Business Services. We are in the process of registering additional
trademarks supporting our business, and we claim common law trademark rights in numerous additional trademarks.
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, 2012, we had approximately 1,500 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 the 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. All reports that we file with the
SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC, 20549. Information about the
operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.
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.
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Risks Related to Our Business
Revenues generated from our five largest clients represented 81% of our revenues for the year ended December 31, 2012, and any
termination of or deterioration in our relationship with any of these clients would result in a decline in our revenues.
We derive a substantial majority of our revenues from a limited number of clients, including the Department of Education, CMS and three
GAs. Revenues from our five largest clients represented 81% of our revenues for the year ended December 31, 2012. We expect that our
revenues will become increasingly concentrated with our major clients as a result of rising business volumes under our RAC contract, which
accounted for approximately 25.8% of our revenues in 2012, compared to approximately 13.2% of our revenues in 2011. 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 subject to periodic renewal or re-bidding
processes, are not exclusive and do not commit our clients to provide specified volumes of business and, 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 loan and other receivables, which represented approximately 63.0% of
our revenues in 2012, 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. Our contracts generally are subject to a periodic rebidding process at the end of the contract
term. 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 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 loans and receivables clients, which include four of our five
largest clients in 2012, do not renew their agreements with us upon contract expiration, 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. For example, we have been advised that our contractual arrangement with the
Department of Education is under review as a result of the Department of Education’s decision to have its recovery vendors promote income-
based repayment, or IBR, to defaulted student loans. The IBR program provides flexibility on the required monthly payment for student loan
borrowers at an amount intended to be affordable based on a borrower’s income and family size. As a result of the increased application of the
IBR program to defaulted student loans, we expect that there will be an increase in the number of loans that become eligible for rehabilitation
because more defaulted student loan borrowers will be able to make qualifying payments. In connection with the implementation of the IBR
program, we have been advised that the Department of Education will reduce the contingency fee rate that we will receive for rehabilitating
student loans by approximately 18% effective March 1, 2013, although this change is still subject to further review and finalization by the
Department of Education. Any changes in the contingency fee percentages or other compensation terms that we are paid under existing and
future contracts could have a significant impact on our revenues and operating results.
We face significant competition in all of the markets in which we operate 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
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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.
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.
Similarly, we faced a highly competitive bidding process to become one of the four prime RAC contractors that provide recovery services
for improper Medicare payments. CMS issued a request for quotes in connection with the re-bidding for the RAC contract in February 2013.
Although our RAC contract is currently set to expire in 2014, CMS may terminate our RAC contract as early as August 2013 in connection with
the re-bidding process for new RAC contracts. We expect that this process will be competitive. The failure to retain this contract or a significant
adverse change in the terms of this contract, which generated approximately 25.8% of our revenues in the year ended December 31, 2012, would
seriously harm our ability to maintain or increase our revenues and operating results.
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, 2012, revenues under contracts with the U.S. federal government accounted for approximately 42% of our total
revenues, compared to 27% for the year ended December 31, 2011. In addition, fees payable by the U.S. federal government are expected to
become a larger percentage of our total revenues over the next several years as a result of legislation that has transferred responsibility for all
new student loan origination to the Department of Education. The continuation and exercise of renewal options on existing 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, the Obama
Administration’s proposed budget for the year ending September 30, 2013, included a proposal designed to redirect federal government spending
to an alternative federal program by decreasing the amount that GAs are compensated when they rehabilitate defaulted loans. While the Obama
Administration’s budget proposal was not approved by Congress, in June 2012, a bill containing similar provisions reducing the compensation of
GAs for rehabilitation of defaulted student loans was subsequently introduced in the U.S. Senate. 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, SAFRA significantly
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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 31 government-supported
GAs. This legislation, and 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.
Our business relationship with the Department of Education has accounted for a significant portion of our revenues and will take on
increasing importance to our business as a result of SAFRA. Our failure to maintain this relationship would significantly decrease our
revenues.
The majority of our historical revenues from the student loan market have come from our relationships with the GAs. As a result of
SAFRA, the Department of Education will ultimately become the sole source of revenues in this market, although the GAs will continue to
service their existing student loan portfolios for many years to come. As a result, over time, defaults on student loans originated by the
Department of Education will predominate and our ability to maintain the revenues we had previously received from a number of GA clients will
depend on our relationship with a single client, the Department of Education. While we have 22 years of experience in performing student loan
recovery services for the Department of Education, we are one of 17 unrestricted recovery service providers on the current Department of
Education contract. In 2012, student loan recovery work for the Department of Education generated revenues of $29.0 million, or approximately
13.8% of our total revenues. The Department of Education is expected to initiate a contract re-compete process during the first half of 2013. If
our relationship with the Department of Education terminates or deteriorates or if the Department of Education, ultimately as the sole holder of
defaulted student loans, requires its contractors to agree to less favorable terms, our revenues would significantly decrease, and our business,
financial condition and results of operations would be harmed.
We could lose clients as a result of consolidation among the GAs, which would decrease our revenues.
As a result of SAFRA, which terminated the ability of the GAs to originate government-supported student loans, some have speculated that
there may be consolidation among the 31 GAs. 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. We currently have relationships with 11 of the 31 GAs and three of our GA clients were each responsible for
more than 10% of our total revenues in 2012. 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 ability to derive revenues under our RAC contract will depend in part on the number and types of potentially improper claims that we
are allowed to pursue by CMS as well as the amounts that we are allowed to recover for CMS, and our results of operations may be harmed if
the scope of claims that we are allowed to pursue is limited.
While we are the prime contractor responsible for review of Medicare records for all Part A and Part B claims in our region pursuant to the
terms of our RAC contract with CMS, we are not 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. While the revenues we earn under our contract with CMS are determined primarily by the aggregate volume of Medicare claims
in our region and our ability to successfully identify improper payments within these claims, the long-term growth of the revenues we derive
under our RAC contract will also depend in part on CMS expanding the scope of potentially improper claims that we are allowed to pursue
under our RAC contract. If we are unable to continue to identify improper claims within the types of claims that we are permitted to pursue from
time to time or if CMS does not expand the scope of potentially improper claims that we are allowed to pursue, our results of operations could be
adversely affected.
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Further, the improper claims approved by CMS and identified by us may be challenged by affected parties and these challenges may lead
to changes in our RAC contract instituted by CMS. For example, in November 2012 the American Hospital Association and four hospitals filed
a lawsuit against Kathleen Sebelius, the Secretary of the Department of Health and Human Services. The lawsuit claims, among other things,
that CMS is acting improperly in completely denying payment for claims initially made under Medicare Part A (inpatient) that should have been
made under Medicare Part B (outpatient), rather than remitting the difference between the Part A and Part B payments. This type of improper
claim has accounted for a substantial portion of the claims we have identified under our RAC contract. If our contingency fee payment from
CMS for identifying these claims is based on the difference between a Part A and Part B payment, our revenues may be harmed.
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:
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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;
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 contract;
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.
For example, a technology system upgrade at the Department of Education caused fluctuations in our operating results. This upgrade
significantly decreased the volume of student loan placements by the Department of Education to all recovery vendors, including us, during 2011
and through September 30, 2012. While we and the other recovery vendors have recently received substantially larger placement volume in the
fourth quarter of 2012 as a result of the completion of this technology system upgrade, the majority of the revenues from these placements will
be delayed until the third quarter of 2013 because we do not begin to earn rehabilitation revenues from a given placement until at least nine
months after receipt of a placement. In addition, for approximately twelve months beginning in September 2011, this technology system upgrade
prevented the Department of Education from processing a portion of rehabilitated student loans and accordingly we were not able to recognize
certain revenues associated with rehabilitation of loans for this client. However, the Department of Education continued to pay us based on
invoices submitted and we recorded these cash receipts as deferred revenues on our balance sheet.
Further, our claim recovery volume is currently impacted by a system adjustment that is being implemented by CMS for its Periodic
Income Payment providers, or PIP providers. PIP providers are reimbursed for Medicare claims through different processes than other healthcare
providers, and CMS is in the process of making certain system adjustments in order to allow these claims to be processed. Prior to April 2012,
we were not permitted to audit Medicare claims for these PIP providers, which we estimate to account for approximately 20% of Medicare
claims in our region. The improper payments to PIP providers that we have identified were not processed by CMS from April 2012 until January
2013, when a small portion of such payments began to be processed manually. As a result, we will not recognize any revenues from identified
improper payments to PIP providers as of December 31, 2012, but we have incurred expenses related to these claims. We estimate that this
delayed our recognition of approximately $6 million in revenues in 2012, although we began to recognize a portion of these revenues starting in
the first quarter of 2013. CMS remains in the process of implementing the necessary changes
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to its systems that would allow these claims to be processed automatically and allow us to recognize these revenues and we believe that the
necessary upgrade will be complete in the second quarter of 2013. While we believe that this delay in automatic processing is temporary, we are
uncertain as to when automatic processing will begin and the failure of CMS to process these and future claims on a timely basis will delay our
recognition of the revenues until this is resolved. Because our revenues are dependent on many factors, some of which are outside of our control,
we may experience significant fluctuations in our results of operations and as a result volatility in our stock price.
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. Changes in these factors 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. In addition, 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 delaying our ability to recognize revenues from these rehabilitated loans.
We may not be able to maintain or increase our profitability, and our recent financial results may not be indicative of our future financial
results.
We may not succeed in maintaining our profitability on a quarterly or annual basis and could incur quarterly or annual losses in future
periods. We have incurred additional operating expenses associated with being a public company and we intend to continue to increase our
operating expenses as we grow our business. We also expect to continue to make investments in our proprietary technology platform and hire
additional employees and subcontractors as we expand our healthcare recovery and other operations, thus incurring additional expenses. If our
revenues do not increase to offset these increases in expenses, our operating results could be adversely affected. Our historical revenues and net
income growth rates are not indicative of future growth rates.
We may not be able to manage our growth effectively and our results of operations could be negatively affected.
Our business has expanded significantly, especially in recent years with the expansion of our services in the healthcare market, and we
intend to maintain our focus on growth. However, our continued 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 growth effectively. In order to successfully manage our growth, 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.
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
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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 most of our subcontractors provide specific services to us, we engage one
subcontractor to provide all of the audit and recovery services under our contract with CMS within a portion of our region. According to CMS,
the
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geographic area allocated to this subcontractor accounted for approximately 17% of total Medicare spending in our region in 2009. 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, as amended, or HIPAA, 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 audit and recovery services under our contract 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 requires 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, or 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, or 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,
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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, or 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. Changes to existing regulations or the adoption of new regulations could adversely affect our business and results of operations if we are
not able to adapt our services and client relationships to meet the new regulatory structure.
The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and
retain executive management and qualified board members.
As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-
Oxley Act, the Dodd-Frank Act and other applicable securities rules and regulations. Compliance with these rules and regulations has increased
our legal and financial compliance costs, made some activities more difficult, time-consuming or costly and increased or will continue to
increase demand on our systems and resources, particularly after we are no longer an “emerging growth company.” The Exchange Act requires,
among other things, that we file annual, quarterly and current reports with respect to our business and operating results. The Sarbanes-Oxley Act
requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order
to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard,
significant resources and management oversight may be required. As a result, management’s attention may be diverted from other business
concerns, which could adversely affect our business and operating results. Although we have already hired additional employees to comply with
these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses.
In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for
public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and
standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may
evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding
compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We will continue to invest
resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative
expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to
comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related
to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be adversely affected.
However, for as long as we remain an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the
JOBS Act, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that
are not “emerging growth companies,” including, but not limited to, not being required to comply with the auditor attestation requirements of
Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy
statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval
of any golden parachute payments not previously approved. We may take advantage of these reporting exemptions until we are no longer an
“emerging growth company.”
We will remain an “emerging growth company” for up to five years following our initial public offering in August 2012, although if the
market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 before that time, our revenues exceed $1
billion, or we issue more than $1 billion in non-convertible debt in a three-year period, we would cease to be an “emerging growth company” as
of the following December 31.
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As a result of disclosure of information as a public company, our business and financial condition have become more visible, which we
believe may result in threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business
operations and financial results could be adversely affected, and even if the claims do not result in litigation or are resolved in our favor, these
claims, and the time and resources necessary to resolve them, could divert the resources of our management and adversely affect our business
operations and financial results. These factors could also make it more difficult for us to attract and retain qualified employees, executive officers
and members of our board of directors.
Failure to achieve and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley would impair our ability to
produce accurate and reliable financial statements, which would harm our stock price.
We are subject to reporting obligations under Section 404 of the Sarbanes-Oxley Act that require us to include a management report on our
internal control over financial reporting in our annual report, which contains management’s assessment of the effectiveness of our internal
control over financial reporting. These requirements will first apply to our annual report on Form 10-K for the year ending December 31, 2013
and complying with these requirements can be difficult. For example, in June 2012, our independent registered public accounting firm
determined that we had incorrectly accounted for our mandatorily redeemable preferred stock, which required audit adjusting entries for the
three-year period ended December 31, 2011. Our failure to detect this error was deemed to be a deficiency in internal control and this deficiency
was considered to be a material weakness. To address this situation, our independent registered public accounting firm recommended that the
Company emphasize the importance of thoroughly researching all new accounting policies and revisiting accounting policies set for existing
transactions when changes in the business or reporting requirements occur or are expected to occur. To prevent issues like these in the future, we
have bolstered our technical accounting expertise and, where appropriate, engaged outside consultants with specialized knowledge.
Our management may conclude that our internal control over our financial reporting is not effective. As we only recently became a public
company following the completion of our initial public offering on August 15, 2012, we have limited accounting personnel and other resources
with which to address our internal controls and procedures. If we fail to timely achieve and maintain the adequacy of our internal control over
financial reporting, we may not be able to produce reliable financial reports or help prevent fraud. Our failure to achieve and maintain effective
internal control over financial reporting could prevent us from filing our periodic reports on a timely basis, which could result in the loss of
investor confidence in the reliability of our financial statements, harm our business and negatively impact the trading price of our common stock.
We are required to disclose changes made in our internal controls and procedures on a quarterly basis. However, our independent
registered public accounting firm is not required to formally attest to the effectiveness of our internal control over financial reporting pursuant to
Section 404 until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an
“emerging growth company” as defined in the JOBS Act, if we continue to take advantage of the exemptions contained in the JOBS Act. At such
time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which
our controls are documented, designed or operating. Our remediation efforts may not enable us to avoid a material weakness in the future.
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
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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.
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 delays associated with technology or system
implementations, such as the delays experienced with the implementation of our RAC contract with CMS due to an appeal by competitors who
were unsuccessful in bidding on the contract. 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 results of operations could be adversely affected.
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. Any infringement or misappropriation of our patents, trademarks, 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.
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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.
Our current or future 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.
As of December 31, 2012, our total debt was $147.8 million. For the year ended December 31, 2012, our consolidated interest expense was
approximately $12.4 million. Our ability to make scheduled payments or to refinance our debt obligations 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. 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 agreements contain, and any agreements to refinance our debt likely will contain, 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.
If securities analysts do not publish research or if securities analysts or other third parties publish inaccurate or unfavorable research about
us, the price of our common stock could decline.
The trading market for our common stock relies in part on the research and reports that securities analysts and other third parties choose to
publish about us. We do not control whether these analysts or other third parties provide research regarding our company. The price of our
common stock could decline if one or more securities analysts downgrade our common stock or if one or more securities analysts or other third
parties publish inaccurate or unfavorable research about us or cease publishing reports about us.
Risks Related to Our Common Stock
We are subject to certain phase-in provisions of the NASDAQ Marketplace Rules and, as a result, we will not immediately be subject to
certain corporate governance provisions.
Because of our public offering in February 2013, Parthenon Capital Partners no longer controls a majority of our common stock. As a
result, we will no longer be a “controlled company” within the meaning of the corporate governance standards of the NASDAQ Global Select
Market. However, we will rely on phase-in provisions for certain stock exchange corporate governance requirements, including:
•
•
the requirement that a majority of the board of directors consists of independent directors;
the requirement that nominating and corporate governance matters be decided solely by independent directors; and
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•
the requirement that employee and officer compensation matters be decided solely by independent directors.
We intend to utilize each of these phase-in provisions. As a result, we do not have a majority of independent directors and our nominating
and corporate governance and compensation functions are not decided solely by independent directors. Accordingly, you do not have the same
protections afforded to stockholders of companies that are subject to all of the stock exchange corporate governance requirements.
The price of our common stock could be volatile.
Since our initial public offering in August 2012, the price of our common stock, as reported by NASDAQ, has ranged from a low sales
price of $7.55 on November 27, 2012 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; termination of lock-up agreements or other
restrictions on the ability of our existing stockholders to sell their shares after our public offering in February 2013 and our initial public
offering; changes in our capital structure, such as future issuances of debt or equity securities; 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.
Future sales, or the perception of future sales, of our common stock may lower our stock price.
If our existing stockholders sell a large number of shares of our common stock, the market price of our common stock could decline
significantly. In addition, the perception in the public market that our existing stockholders might sell shares of common stock could depress the
market price of our common stock, regardless of the actual plans of our existing stockholders. As of March 20, 2013, a total of 46,720,569 shares
of common stock were outstanding, assuming that there are no exercises of options after December 31, 2012. Of these shares, the 9,200,000
shares of common stock sold in our February 2013 offering and the 10,350,000 shares that were sold in our initial public offering, will be freely
tradable in the public market without restriction or further registration under the Securities Act of 1933, or the Securities Act, unless these shares
are held by “affiliates,” as that term is defined in Rule 144 under the Securities Act. 27,728,773 shares are subject to lock-up agreements entered
into in connection with our February 2013 offering restricting the sale of those shares until May 2013, unless otherwise extended. The
underwriters may waive the lock-up restriction and allow any of the stockholders subject to this restriction to sell their shares at any time.
Our significant stockholder has the ability to control significant corporate activities and our majority stockholder’s interests may not coincide
with yours.
Parthenon Capital Partners beneficially owned approximately 48.7% of our common stock as of March 20, 2013. As a result of its
ownership, Parthenon Capital Partner has the ability to influence the outcome of matters submitted to a vote of stockholders and, through our
board of directors, the ability to control decision-making with respect to our business direction and policies. Parthenon Capital Partners 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 can, directly or indirectly, exercise influence include:
•
•
the election of our board of directors and the appointment and removal of our officers;
mergers and other business combination transactions, including proposed transactions that would result in our stockholders receiving
a premium price for their shares;
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•
•
•
•
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 at such time as Parthenon Capital Partners no longer beneficially owns a
majority of our outstanding shares; 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 at such time as Parthenon Capital Partners no longer beneficially owns a majority of our outstanding
shares; 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 after the time when Parthenon Capital Partners ceased to beneficially own a majority of our outstanding shares, which occurred in
February 2013; and limiting the determination of the number of directors on our board of directors and, when Parthenon Capital Partners is no
longer our majority stockholder, 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.
Because we do not intend to pay cash dividends in the foreseeable future, you may not receive any return on investment unless you are able
to sell your common stock for a price greater than your purchase price.
For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not
anticipate paying any cash dividends on our common stock. In addition, our ability to pay dividends is subject to restrictive covenants contained
in our credit agreement. As a result, you may not receive any return on investment unless you are able to sell your common stock for a price
greater than your purchase price.
ITEM 1B. Unresolved Staff Comments
None.
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ITEM 2. Properties
Facilities
As of December 31, 2012, we operated five 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
represents approximately 50,291 square feet and has a lease expiration of September 2017. 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.
PART II
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market For Our Common Equity
Our common stock began trading on the NASDAQ Global Select market under the symbol “PFMT” on August 10, 2012. Prior to that,
there was no public market for our common stock. The table sets forth, for the periods indicated below, the high and low sales prices per share of
our common stock as reported by NASDAQ since August 10, 2012.
2012
Third Quarter (beginning August 10, 2012)
Fourth Quarter
High
12.18
11.84
Low
9.20
7.55
On March 20, 2013, the closing price as reported by NASDAQ of our common stock was $13.00 per share.
Stockholders
As of December 31, 2012, we had approximately 38 holders of record of our common stock.
Dividends
Our board of directors does not currently intend to pay regular dividends on our common stock. However, we expect to reevaluate our
dividend policy on a regular basis and may, subject to compliance with the covenants in our credit agreement and other considerations,
determine to pay dividends in the future. Our ability to pay dividends is subject to restrictive covenants contained in our credit agreement.
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Securities Authorized for Issuance Under Equity Compensation Plans
Information regarding the securities authorized for issuance under our equity compensation plans can be found under Item 12 of this
Annual Report on Form 10-K.
Unregistered Sales of Equity Securities
In connection with the consummation of our IPO, we paid $0.9 million to FTP Securities LLC, or FT Partners, through the issuance of
103,500 shares of our common stock valued at $9.00 per share as consideration for financial advisory services provided by FT Partners. The
securities issued were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.
Issuer Purchases of Equity Securities
None.
ITEM 6.
Selected Financial Data
The selected consolidated balance sheet data as of December 31, 2012 and 2011, and the selected consolidated statements of operations
data for each year ended December 31, 2012, 2011 and 2010, have been derived from our audited consolidated financial statements which are
included elsewhere in this annual report. The selected consolidated balance sheet data as of December 31, 2010, 2009 and 2008, and the selected
consolidated statements of operations data for the years ended December 31, 2009 and 2008 have been derived from our audited consolidated
financial statements not included in this annual report. Historical results are not necessarily indicative of future results. You should read the
following selected consolidated historical financial data below in conjunction with the section titled “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and the consolidated financial statements, related notes, and other financial information included
in this Annual Report on Form 10-K. The selected consolidated financial data in this section is not intended to replace the consolidated financial
statements and is qualified in its entirety by the consolidated financial statements and related notes and schedule included in this Annual Report
on Form 10-K.
Consolidated Statement of Operations Data:
Revenues
Operating expenses:
Salaries and benefits
Other operating expense
Impairment of trade name
(1)
Total operating expenses
Income from operations
Debt extinguishment costs
Interest expense
Interest income
Income before provision for income taxes
Provision for income taxes
Net income
Accrual for preferred stock dividends
Net income (loss) available to common shareholders
33
2012
2011
Year Ended December 31,
2010
(in thousands)
2009
2008
$ 210,073 $ 162,974 $ 123,519 $ 109,832 $ 98,967
83,002
71,305
—
154,307
55,766
(3,679 )
(12,414 )
64
39,737
16,786
67,082
49,199
13,400
129,681
33,293
—
(13,530 )
125
19,888
7,516
49,109
26,730
—
75,839
23,128
—
(16,361 )
217
6,984
3,113
$ 22,951 $ 12,372 $ 9,975 $ 5,010 $ 3,871
4,556
(685 )
53,728
32,110
—
85,838
23,994
—
(16,017 )
104
8,081
3,071
58,113
33,655
—
91,768
31,751
—
(15,230 )
118
16,639
6,664
$ 20,913 $ 5,877 $ 4,204 $
5,128
(118 ) $
6,495
2,038
5,771
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Net income (loss) per share attributable to common shareholders
Basic
Diluted
Weighted average shares (in thousands)
Basic
Diluted
2012
Year Ended December 31,
2010
2009
2011
2008
(2)
$ 0.48
$ 0.44
$ 0.14
$ 0.13
$ 0.10
$ 0.09
$ (0.00 )
$ (0.00 )
$ (0.02 )
$ (0.02 )
43,985
47,599
42,962
45,742
42,962
45,019
42,962
42,962
42,653
42,653
(1) Represents debt extinguishment costs comprised of approximately $3.3 million of fees paid to lenders in connection with our new credit
facility and approximately $0.3 million of unamortized debt issuance costs in connection with our old credit facility.
(2) Please see Note 1 to our consolidated financial statements for an explanation of the calculations of our basic and diluted net income per
share of common stock.
Consolidated Balance Sheet Data:
Cash and cash equivalents
Total assets
Total debt
Total liabilities
Redeemable preferred stock
Total stockholders’ (deficit) equity
2012
2011
As of December 31,
2010
(in thousands)
2009
2008
$ 37,843
211,745
147,769
187,672
—
24,073
$ 20,004
182,299
103,383
139,756
58,248
(15,705 )
$ 11,078
181,390
117,331
151,231
51,753
(21,594 )
$ 8,924
180,735
127,298
161,077
45,982
(26,324 )
$ 9,108
183,783
134,215
167,617
40,854
(26,688 )
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We provide technology-enabled recovery and related analytics services in the United States. Our services help identify 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 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 generally provide our
services on an outsourced basis, where we handle many or all aspects of our clients’ recovery processes.
Our revenue model is generally success-based as we earn fees on the aggregate amount of funds that we enable our clients to recover. Our
services do not require any significant upfront investments by our clients and offer our clients the opportunity to recover significant funds
otherwise lost. Because our model is based upon the success of our efforts and the dollars we enable our clients to recover, 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 expenditures and we do not purchase loans or obligations.
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Sources of Revenues
We derive our revenues from services for clients in a variety of different markets. These markets include our two largest markets, student
lending and healthcare, as well as our other markets which include but are not limited to delinquent state taxes and federal Treasury and other
receivables.
Student Lending
Healthcare
Other
Total Revenues
Student Lending
2012
$ 132,445
54,747
22,881
$ 210,073
Year Ended
December 31,
2011
(in thousands)
$ 122,253
21,549
19,172
$ 162,974
2010
$ 103,672
1,821
18,026
$ 123,519
We derive the majority of our revenues from the recovery of student loans. These revenues are contract-based and consist primarily of
contingency fees based on a specified percentage of the amount we enable our clients to recover. Our contingency fee percentage for a particular
recovery depends on the type of recovery facilitated. We also receive incremental performance incentives based upon our performance as
compared to other contractors with the Department of Education, which are comprised of additional inventory allocation volumes and incentive
fees.
Based on data compiled from over two decades of experience with the recovery of defaulted student loans, at the time we receive a
placement of student loans, we are able to make a reasonably accurate estimate of the recovery outcomes likely to be derived from such
placement and the revenues we are likely able to generate based on the anticipated recovery outcomes.
There are five potential outcomes to the student loan recovery process from which we generate revenues. These outcomes include: full
repayment, recurring payments, rehabilitation, loan restructuring and wage garnishment. Of these five potential outcomes, our ability to
rehabilitate defaulted student loans is the most significant component of our revenues in this market. Generally, a loan is considered successfully
rehabilitated after the student loan borrower has made nine consecutive qualifying monthly payments and our client has notified us that it is
recalling the loan. Once we have structured and implemented a repayment program for a defaulted borrower, we (i) earn a percentage of each
periodic payment collected up to and including the final periodic payment prior to the loan being considered “rehabilitated” by our clients, and
(ii) if the loan is “rehabilitated,” then we are paid a one-time percentage of the total amount of the remaining unpaid balance. The fees we are
paid vary by recovery outcome as well as by contract. For non-government-supported student loans we are generally only paid contingency fees
on two outcomes: full repayment or recurring repayments. The table below describes our typical fee structure for each of these five outcomes.
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Full Repayment
• Repayment in full of
the loan
Student Loan Recovery Outcomes
Recurring Payments
• Regular structured
Rehabilitation
Loan Restructuring
• After a defaulted
• Restructure and
payments, typically
according to a
renegotiated payment
plan
borrower has made
nine consecutive
recurring payments,
the loan is eligible
for rehabilitation
consolidate a number
of outstanding loans
into a single loan,
typically with one
monthly payment and
an extended maturity
• We are paid a
percentage of the
full payment that is
made
• We are paid a percentage
of each payment
• We are paid based
on a percentage of
the overall value of
the rehabilitated
loan
• We are paid based on a
percentage of overall
value of the
restructured loan
Wage Garnishment
• If we are unable to
obtain voluntary
repayment, payments
may be obtained
through wage
garnishment after
certain
administrative
requirements are met
• We are paid a
percentage of each
payment
For certain guaranty agency, or GA, clients, we have entered into Master Service Agreements, or MSAs. Under these agreements, clients
provide their entire inventory of outsourced loans or receivables to us for recovery on an exclusive basis, rather than just a portion, as with
traditional contracts that are split among various service providers. In certain circumstances, we engage subcontractors to assist in the recovery
of a portion of the client’s portfolio. We also receive success fees for the recovery of loans under MSAs and our revenues under MSA
arrangements include fees earned by the activities of our subcontractors. As of December 31, 2012, we had three MSA clients in the student loan
market.
Healthcare
We derive revenues from the healthcare market primarily from our RAC contract, under which we are the prime contractor responsible for
detecting improperly paid Part A and Part B Medicare claims in 12 states in the Northeastern United States. Revenues earned under the RAC
contract are driven by the identification of improperly paid Medicare claims through both automated and manual review of such claims. We are
paid contingency fees by CMS based on a percentage of the dollar amount of claims recovered by CMS as a result of our efforts. We recognize
revenue when the provider pays CMS or incurs an offset against future Medicare claims. The revenues we recognize are net of our estimate of
claims that will be overturned by appeal following payment by the provider.
To accelerate our ability to provide Medicare audit and recovery services across our region following our award of the RAC contract, we
outsourced certain aspects of our healthcare recovery process to three different subcontractors. Two of these subcontractors provide a specific
service to us in connection with our claims recovery process, and one subcontractor is engaged to provide all of the audit and
recovery services for claims within a portion of our region. According to CMS, the geographic area allocated to this subcontractor represented
approximately 17% of the total Medicare spending in our region in 2009. We recognize all of the revenues generated by the claims recovered
through these subcontractor relationships, and we recognize the fees that we pay to these subcontractors in our expenses.
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Other
We also derive revenues from the recovery of delinquent state taxes, and federal Treasury and other receivables, default aversion services
for certain clients including financial institutions and the licensing of hosted technology solutions to certain clients. For our hosted technology
services, we license our system and integrate our technology into our clients’ operations, for which we are paid a licensing fee. Our revenues for
these services include contingency fees, fees based on dedicated headcount to our clients and hosted technology licensing fees.
Operating Metrics
We monitor a number of operating metrics in order to evaluate our business and make decisions regarding our corporate strategy. These
key metrics include Placement Volume, Placement Revenue as a Percentage of Placement Volume, Net Claim Recovery Volume and Claim
Recovery Fee Rate.
Student Lending:
Placement Volume
Placement Revenue as a percentage of Placement Volume
Healthcare:
Net Claim Recovery Volume
Claim Recovery Fee Rate
2012
Year Ended
December 31,
2011
(dollars in thousands)
2010
$ 5,768,945
2.30 %
$ 6,241,483
1.96 %
$ 5,294,971
1.96 %
$ 482,202
11.35 %
$ 188,573
11.43 %
$
15,494
11.76 %
Placement Volume. Our Placement Volume represents the dollar volume of defaulted student loans first placed with us during the
specified period by public and private clients for recovery. Placement Volume allows us to measure and track trends in the amount of inventory
our clients in the student lending market are placing with us during any period. The revenues associated with the recovery of a portion of these
loans may be recognized in subsequent accounting periods, which assists management in estimating future revenues and in allocating resources
necessary to address current Placement Volumes.
Placement Revenue as a Percentage of Placement Volume. Placement Revenue as a Percentage of Placement Volume is calculated by
dividing revenues recognized during the specified period by Placement Volume first placed with us during that same period. This metric is
subject to some level of variation from period to period based upon certain timing differences including, but not limited to, the timing of
placements received by us within a period and the fact that a significant portion of revenues recognized in a current period is often generated
from the Placement Volume received in prior periods. However, we believe that this metric provides a useful indication of the revenues we are
generating from Placement Volumes on an ongoing basis and provides management with an indication of the relative efficiency of our recovery
operations from period to period.
Net Claim Recovery Volume. Our Net Claim Recovery Volume measures the dollar volume of improper Medicare claims that we have
recovered for CMS during the applicable period net of any amount that we have reserved to cover appeals by healthcare providers. We are paid
recovery fees as a percentage of this recovered claim volume. We calculate this metric by dividing our claim recovery revenues by our Claim
Recovery Fee Rate. This metric shows trends in the volume of improper payments within our region and allows management to measure our
success in finding these improper payments, over time.
Claim Recovery Fee Rate. Our Claim Recovery Fee Rate represents the weighted-average percentage of our fees compared to amounts
recovered by CMS. This percentage primarily depends on the method of recovery and, in some cases, the type of improper payment that we
identify. This metric helps management measure the amount of revenues we generate from Net Claim Recovery Volume.
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Costs and Expenses
We generally report two categories of operating expenses: salaries and benefits and other operating expense. Salaries and benefits expenses
consist primarily of salaries and performance incentives paid and benefits provided to our employees. Other operating expense includes expenses
related to our use of subcontractors, other production related expenses, including costs associated with data processing, retrieval of medical
records, printing and mailing services, amortization and other outside services, as well as general corporate and administrative expenses. In
addition to our main components of operating expenses, in 2011 we incurred a $13.4 million impairment expense to write off the carrying
amount of the trade name intangible asset due to our plan to retire our Diversified Collection Services, Inc. trade name, which we report as
impairment of trade name. We expect a significant portion of our expenses to increase as we grow our business. However, we expect certain
expenses, including our corporate and general administrative expenses, to grow at a slower rate than our revenues. As a result, and over the long
term, we expect our overall expenses to modestly decline as a percentage of revenues.
We also expect to incur additional professional fees and other expenses resulting from future expansion and the compliance requirements
of operating as a public company, including increased audit and legal expenses, investor relations expenses, increased insurance expenses,
particularly for directors’ and officers’ liability insurance, and the costs of complying with Section 404 of the Sarbanes-Oxley Act. While these
costs may initially increase as a percentage of our revenues, we expect that in the future these expenses will increase at a slower rate than our
overall business volume, and that they will eventually represent a smaller percentage of our revenues.
Factors Affecting Our Operating Results
Our results of operations are influenced by a number of factors, including allocation of placement volume, claim recovery volume,
contingency fees, regulatory matters, effects of client concentration and macroeconomic factors.
Allocation of Placement Volume
Our clients have the right to unilaterally set and increase or reduce the volume of defaulted student loans or other receivables that we
service at any given time. In addition, many of our recovery contracts for student loans and other receivables are not exclusive, with our clients
retaining multiple service providers to service portions of their portfolios. Accordingly, the number of delinquent student loans or other
receivables that are placed with us may vary from time to time, which may have a significant effect on the amount and timing of our revenues.
We believe the major factors that influence the number of placements we receive from our clients in the student loan market include our
performance under our existing contracts and our ability to perform well against competitors for a particular client. To the extent that we perform
well under our existing contracts and differentiate our services from those of our competitors, we may receive a relatively greater number of
placements under these existing contracts and may improve our ability to obtain future contracts from these clients and other potential clients.
Further, delays in placement volume, as well as acceleration of placement volume, from any of our large clients may cause our revenues and
operating results to vary from quarter to quarter.
Typically we are able to anticipate with reasonable accuracy the timing and volume of placements of defaulted student loans and other
receivables based on historical patterns and regular communication with our clients. Occasionally, however, placements are delayed due to
factors outside of our control. For example, a technology system upgrade at the Department of Education significantly decreased the volume of
student loan placements by the Department of Education to all recovery vendors, including us. While we and the other recovery vendors have
recently received substantially larger placement volume in the fourth quarter of 2012 as a result of the completion of this technology system
upgrade, the majority of the revenues from these placements will be delayed until the third quarter of 2013 because we do not begin to earn
rehabilitation revenues from a given placement until at least nine months after receipt of a placement. In addition, for approximately twelve
months beginning in September 2011, the Department of Education was not able to process a portion of
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rehabilitated student loans and accordingly we were not able to recognize certain revenues associated with rehabilitation of loans for this client.
However, the Department of Education continued to pay us based on invoices submitted and we recorded these cash receipts as deferred
revenues on our balance sheet. The amount of placement volume that we receive is also dependent on the client relationships that we maintain.
We analyze the profitability of each of our student lending clients, and sometimes determine that our resources servicing a specific client should
be allocated elsewhere. As a result of this process, we decided to terminate an unprofitable contract with a commercial bank, which we do not
expect will have a significant effect on revenues or net income in future periods. Our decision to terminate this contract, as discussed above,
accounts for a substantial portion of the 7.6% decrease in Placement Volume in the year ended December 31, 2012, compared to the prior year
period.
Claim Recovery Volume
While we are entitled to review Medicare records for all Part A and Part B claims in our region, we are not permitted to identify 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. The growth of our revenues is determined primarily by the aggregate volume of
Medicare claims in our region and our ability to identify improper payments within these claims. However, the long-term growth of these
revenues will also be affected by the scope of the issues pre-approved by CMS.
Further, our claim recovery volume is currently impacted by a system adjustment that is being implemented by CMS for its PIP providers.
PIP providers are reimbursed for Medicare claims through different processes than other healthcare providers, and CMS is in the process of
making certain system adjustments in order to allow these claims to be processed. Prior to April 2012, we were not permitted to audit Medicare
claims for these PIP providers, which we estimate to account for approximately 20% of Medicare claims in our region. The improper payments
to PIP providers that we have identified were not processed by CMS from April 2012 until January 2013, when a small portion of such payments
began to be processed manually. As a result, we will not recognize any revenues from identified improper payments to PIP providers as of
December 31, 2012, but we have incurred expenses related to these claims. We estimate that this delayed our recognition of approximately $6
million in revenues in 2012, although we began to recognize a portion of these revenues starting in the first quarter of 2013. CMS remains in the
process of implementing the necessary changes to its systems that would allow these claims to be processed automatically and allow us to
recognize these revenues. While we believe that this delay in automatic processing is temporary, we are uncertain of when automatic processing
will begin and the failure of CMS to process these and future claims on a timely basis will delay our recognition of the revenues until this is
resolved.
In addition, the improper claims approved by CMS and identified by us may be challenged by affected parties and these challenges may
lead to changes in our RAC contract instituted by CMS. For example, in November 2012 the American Hospital Association and four hospitals
filed a lawsuit against Kathleen Sebelius, the Secretary of the Department of Health and Human Services. The lawsuit claims, among other
things, that CMS is acting improperly in completely denying payment for claims initially made under Medicare Part A (inpatient) that should
have been made under Medicare Part B (outpatient), rather than remitting the difference between the Part A and Part B payments. This type of
improper claim has accounted for a substantial portion of the claims we have identified under our RAC contract. If our contingency fee payment
from CMS for identifying these claims is based on the difference between a Part A and Part B payment, our future revenues may be effected.
Contingency Fees
Our revenues consist primarily of contract-based contingency fees. The contingency fee percentages that we earn are set by our clients or
agreed upon during the bid process, and may change from time to time either under the terms of existing contracts or pursuant to the terms of
contract renewals. For example, we have been advised that our contractual arrangement with the Department of Education is under review as a
result of the Department
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of Education’s decision to have its recovery vendors promote IBR to defaulted student loans. The IBR program provides flexibility on the
required monthly payment for student loan borrowers at an amount intended to be affordable based on a borrower’s income and family size. As a
result of the increased application of the IBR program to defaulted student loans, we expect that there will be an increase in the number of loans
that become eligible for rehabilitation because more defaulted student loan borrowers will be able to make qualifying payments. In connection
with the implementation of the IBR program, we have been advised that the Department of Education will reduce the contingency fee rate that
we will receive for rehabilitating student loans by approximately 18% effective March 1, 2013, although this change is still subject to further
review and finalization by the Department of Education. We expect that revenues derived from the increased volume of rehabilitated students
loans will offset the decrease in contingency fee rates that we receive from the Department of Education.
Regulatory Matters
Each of the markets which we serve is highly regulated. Accordingly, changes in regulations that affect the types of loans, receivables and
claims that we are able to service or the manner in which any such delinquent loans, receivables and claims can be recovered will affect our
revenues and results of operations. For example, the passage of the Student Aid and Fiscal Responsibility Act, or SAFRA, in 2010 had the effect
of transferring the origination of all government-supported student loans to the Department of Education, thereby ending all student loan
originations guaranteed by the GAs. Loans guaranteed by the GAs represented approximately 70% of government-supported student loans
originated in 2009. While the GAs will continue to service existing outstanding student loans for years to come, this legislation will over time
shift the portfolio of student loans that we manage toward the Department of Education, and further concentrate our sources of revenues and
increase our reliance on our relationship with the Department of Education. In addition, our entry into the healthcare market was facilitated by
passage of the Tax Relief and Health Care Act of 2006, which mandated CMS to contract with private firms to audit Medicare claims in an effort
to increase the recovery of improper Medicare payments. Any changes to the regulations that affect the student loan industry or the recovery of
defaulted student loans or the Medicare program generally or the audit and recovery of Medicare claims could have a significant impact on our
revenues and results of operations.
Client Concentration
Our revenues from the student loan market depend on our ability to maintain our contracts with some of the largest providers of student
loans. In 2012, four providers of student loans each accounted for more than 10% of our revenues during such period and they collectively
accounted for 55% of our total revenues during this period. Our contracts with these clients entitle them to unilaterally terminate their contractual
relationship with us at any time without penalty. If we lose one of our significant clients, including if one of our significant clients is
consolidated by an entity that does not use our services, if the terms of compensation for our services change or if there is a reduction in the level
of placements provided by any of these clients, our revenues could decline.
Our contract with CMS for the recovery of improper Medicare payments began generating significant revenues during 2011 and
represented 25.8% of our total revenues in the year ended December 31, 2012. CMS issued a request for quotes in connection with the re-
bidding for the RAC contract in February 2013. Although our RAC contract is currently set to expire in 2014, CMS may terminate our RAC
contract as early as August 2013 in connection with this re-bidding process. While we believe our performance under the existing agreement and
the experience we have gained in performing this contract position us well to renew the agreement, failure to renew the agreement or renewal on
substantially less favorable terms could significantly harm our revenues and results of operations.
Macroeconomic Factors
Certain macroeconomic factors influence our business and results of operations. These include the increasing volume of student loan
originations in the U.S. as a result of increased tuition costs and student enrollment, the default rate of student loan borrowers, the growth in
Medicare expenditures resulting from
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increasing healthcare costs, as well as the fiscal budget tightening of federal, state and local governments as a result of general economic
weakness and lower tax revenues.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or
GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different
accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period.
Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material
differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and
cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future
performance, as these policies relate to the more significant areas involving management’s judgments and estimates.
Revenue Recognition
The majority of our contracts are contingency fee based. We recognize revenues on these contingency fee based contracts when third-party
payors remit payments to our clients or remit payments to us on behalf of our clients, and, consequently, the contingency is deemed to have been
satisfied. Under our RAC contract with CMS, we recognize revenues when the healthcare provider has paid CMS for a given claim or incurs an
offset against future Medicare claims. Providers have the right to appeal a claim and may pursue additional appeals if the initial appeal is found
in favor of CMS. We accrue an estimated liability for appeals based on the amount of commissions received which are subject to appeal and
which we estimate are probable of being returned to providers following successful appeal. This estimated liability for appeals is an offset to
revenues on our income statement. Our estimates are based on our historical experience with appeals activity under our CMS contract since
January 2010. During the year ended December 31, 2012, we reserved an amount equal to 14% of gross revenues from our CMS contract. We
have increased our estimated liability for appeal in 2012 due to recent trends in our historical data related to the likelihood of successful appeals.
Commencing on December 31, 2011, we established a separate line item in the current liabilities section of our balance sheet entitled “Estimated
liability for appeals” to reflect our estimate of this liability. The $4.4 million balance as of December 31, 2012, represents our best estimate of
the probable amount of losses related to appeals of claims for which commissions were previously collected. We estimate that it is reasonably
possible that we could be required to pay up to an additional approximately $1.5 million as a result of potentially successful appeals. To the
extent that required payments by us related to successful appeals exceed the amount accrued, revenues in the applicable period would be reduced
by the amount of the excess. We similarly accrue an allowance against accounts receivable related to commissions yet to be collected, which was
$1.2 million as of December 31, 2012, based on the same estimates used to establish the estimated liability for appeals of commissions received.
Our inability to correctly estimate the estimated liabilities and allowance against accounts receivable could adversely affect our revenues in
future periods.
Goodwill
We periodically review the carrying value of intangible assets not subject to amortization, including goodwill, to determine whether an
impairment may exist. GAAP requires that goodwill and certain intangible assets not subject to amortization be assessed annually for
impairment using fair value measurement techniques.
Specifically, goodwill impairment is determined using a two-step test. The first step of the goodwill impairment test is used to identify
potential impairment by comparing the fair value of a reporting unit with its book value, including goodwill. If the fair value of the reporting unit
exceeds its book value, goodwill is considered not impaired and the second step of the impairment test is unnecessary. If the book value of the
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reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if
any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the book value of that
goodwill. If the book value of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in
an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a
business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit
had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. In
September 2011, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2011-08, Intangibles—
Goodwill and Other (Topic 350): Testing Goodwill for Impairment . This ASU permits an entity to make a qualitative assessment of whether it is
more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an
entity concludes it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it need not perform the two-
step impairment test. The ASU permits early adoption, and based on our qualitative assessment we concluded that we are not required to perform
the two-step impairment test at December 31, 2011 and December 31, 2012.
Impairments of Depreciable Intangible Assets
We evaluate depreciable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount
of such assets may not be recoverable. Depreciable intangible assets consist of client contracts and related relationships, and are being amortized
over their estimated useful life, which is generally 20 years. We evaluate the client contracts intangible at the individual contract level. The
recoverability of such assets 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 the 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. There was no impairment expense for depreciable intangible assets in 2012,
2011 or 2010.
Results of Operations
Year Ended December 31, 2012 compared to the Year Ended December 31, 2011
The following table represents our historical operating results for the periods presented:
Consolidated Statement of Operations Data:
Revenues
Operating expenses:
Salaries and benefits
Other operating expense
Impairment of trade name
Total operating expenses
Income from operations
Debt extinguishment costs
Interest expense
Interest income
Income before provision for income taxes
Provision for income taxes
Net income
Accrual for preferred stock dividends
Net income available to common shareholders
Year Ended December 31,
2012
2011
$ Change % Change
(in thousands)
$ 210,073
$ 162,974
$ 47,099
29 %
83,002
71,305
—
154,307
55,766
(3,679 )
(12,414 )
64
39,737
16,786
$ 22,951
2,038
$ 20,913
67,082
49,199
13,400
129,681
33,293
—
(13,530 )
125
19,888
7,516
$ 12,372
6,495
$ 5,877
15,920
22,106
(13,400 )
24,626
22,473
(3,679 )
1,116
(61 )
19,849
9,270
$ 10,579
(4,457 )
$ 15,036
24 %
45 %
-100 %
19 %
68 %
0 %
-8 %
-49 %
100 %
123 %
86 %
-69 %
256 %
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Revenues
Total revenues were $210.1 million for the year ended December 31, 2012, an increase of $47.1 million or 28.9%, compared to total
revenues of $163.0 million for the year ended December 31, 2011. This increase in revenues is primarily due to an increase of $33.2 million in
revenues received from CMS under our RAC contract as a result of higher claim recovery volume and an increase of $4.8 million generated
from a new default-aversion service contract that commenced in May 2012, for a new service offering we provide in other markets we serve.
Revenues from student lending increased by 8.3% in 2012 to $132.4 million from $122.2 million in the prior year period.
Salaries and Benefits
Salaries and benefits expense was $83.0 million for the year ended December 31, 2012, an increase of $15.9 million, or 23.7%, compared
to salaries and benefits expense of $67.1 million for the year ended December 31, 2011. This increase is primarily due to hiring of new
employees to provide services under our RAC contract with CMS, an increase in expenses associated with the engagement of additional software
engineers to assist in the integration of a recently acquired software license and an increase in expenses associated with the hiring of additional
administrative employees.
Other Operating Expense
Other operating expense was $71.3 million for the year ended December 31, 2012, an increase of $22.1 million, or 44.9%, compared to
other operating expense of $49.2 million for the year ended December 31, 2011. This increase is primarily due to (i) an additional $10 million of
subcontractor fees incurred in connection with increased services provided under the RAC contract and MSA contracts and (ii) $1.3 million paid
to an affiliate of Parthenon Capital Partners in connection with the termination of an advisory services agreement, and an additional $0.9 million
paid to Parthenon Capital Partners at the closing of our initial public offering also as a result of the termination of the advisory agreement.
Impairment of Trade Name
We did not recognize an impairment expense for intangible assets in 2012. In 2011, we recorded $13.4 million of impairment expense to
write off the carrying value of our former trade name, Diversified Collection Services Inc., due to our decision to retire that trade name.
Income from Operations
As a result of the factors described above, income from operations was $55.8 million for the year ended December 31, 2012, compared to
$33.3 million for the year ended December 30, 2011, representing an increase of $22.5 million, or 67.5%.
Debt Extinguishment Costs
As a result of the entry into our new credit facility and the repayment of all amounts owed under our then existing credit facility in March
2012, we incurred debt extinguishment costs of $3.7 million, comprised of approximately $3.3 million in fees paid to the lenders in connection
with our new credit facility and approximately $0.3 million of unamortized debt issuance costs associated with our old credit facility. We did not
incur a similar expense in the year ended December 31, 2011.
Interest Expense
Interest expense was $12.4 million for the year ended December 31, 2012 compared to $13.5 million for the year ended December 31,
2011, representing a decrease of 8.2% due to lower interest rates under the new credit agreement as compared to the interest rates under our old
credit agreement.
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Income Taxes
Income tax expense was $16.8 million for the year ended December 31, 2012 compared to $7.5 million for the year ended December 31,
2011, representing an increase of 123.3% consistent with the increase in income before provision for income taxes. Our effective income tax rate
increased to 42.2% for the year ended December 31, 2012 from 37.8% for the year ended December 31, 2011. Approximately 2.5% of the
increase results from changes in the state tax rate, which include a 2011 one-time benefit from a change in California tax law of 2.3%. In
addition, approximately 1.9% of the increase was due to the non-deductible termination of an advisory services agreement in 2012.
Net Income
As a result of the factors described above, net income was $23.0 million for the year ended December 31, 2012, which represented an
increase of $10.6 million compared to net income of $12.4 million for the year ended December 31, 2011.
Year Ended December 31, 2011 compared to the Year Ended December 31, 2010
The following table presents our historical operating results for the periods presented:
Consolidated Statement of Operations Data:
Revenues
Operating expenses:
Salaries and benefits
Other operating expense
Impairment of trade name
Total operating expenses
Income from operations
Interest expense
Interest income
Income before provision for income taxes
Provision for income taxes
Net income
Revenues
Year Ended December 31,
2010
2011
$ Change
% Change
(in thousands)
$ 162,974
$ 123,519
$ 39,455
67,082
49,199
13,400
129,681
33,293
(13,530 )
125
19,888
7,516
$ 12,372
58,113
33,655
—
91,768
31,751
(15,230 )
118
16,639
6,664
$ 9,975
8,969
15,544
13,400
37,913
1,542
1,700
7
3,249
852
2,397
32 %
15 %
46 %
0 %
41 %
5 %
-11 %
6 %
20 %
13 %
24 %
Total revenues were $163.0 million for the year ended December 31, 2011, an increase of $39.5 million, or 31.9%, compared to total
revenues of $123.5 million for the year ended December 31, 2010. Of this increase, $19.7 million is attributable to increased recovery activity on
our RAC contract with CMS and reflects the first full-year of our recovery activity related to this contract. The remaining increase was primarily
a result of an increase in revenues from our student lending markets, due largely to an approximately 17.9% increase in placement volume from
2010 to 2011.
Salaries and Benefits
Salaries and benefits was $67.1 million for the year ended December 31, 2011, an increase of $9.0 million, or 15.4%, compared to salaries
and benefits expense of $58.1 million for the year ended December 31, 2010. This increase is primarily due to an increase in employee
headcount associated with hiring to staff our operations under the RAC contract. Our employee headcount was 1,280 as of December 31, 2011,
an increase of 160, or 14.3%, over the employee headcount of 1,120 as of December 31, 2010.
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Other Operating Expense
Other operating expense was $49.2 million for the year ended December 31, 2011, an increase of $15.5 million, or 46.2%, compared to
other operating expense of $33.7 million for the year ended December 31, 2010. This increase is primarily due to the use of subcontractors as we
expand our operations in our healthcare market to help address the new and significant claims activity, along with increases in payments to
healthcare providers for the transfer of medical records as required under the RAC contract. In addition, we recorded a $1.2 million expense in
2011 related to a legal settlement that was paid out in the first quarter of 2012.
Income From Operations
As a result of the factors described above, income from operations was $33.3 million, for the year ended December 31, 2011, as compared
to $31.8 million for the year ended December 31, 2010. This reflects an expense of $13.4 million related to impairment expenses to write off the
carrying amount of the trade name intangible assets due to the retirement of a former trade name. Income from operations excluding this expense
totaled $46.7 million for the year ended December 31, 2011, which represents an increase of $14.9 million, or 47.1%, as compared to income
from operations for the year ended December 31, 2010.
Interest Expense
Interest expense was $13.5 million for the year ended December 31, 2011, a decrease of $1.7 million from $15.2 million for the year ended
December 31, 2010. The reduction in interest expense is due primarily to lower notes payable balances resulting from principal repayments.
Income Taxes
Income tax expense of $7.5 million for the year ended December 31, 2011, represented an effective tax rate of 37.8% of income before
provision for income tax. Income tax expense of $6.7 million was recorded for the year ended December 31, 2010, and represented an effective
tax rate of 40%.
Net Income
As a result of the factors described above, net income was $12.4 million for the year ended December 31, 2011, which represented an
increase of $2.4 million over net income of $10.0 million for the year ended December 31, 2010. Excluding the impairment expenses to write off
the carrying amount of the trade name, net income would have been $20.7 million for the year ended December 31, 2011.
Liquidity and Capital Resources
Our principal sources of liquidity are cash flows from operations, term loans, and the proceeds received from our initial public offering in
August 2012. Cash and cash equivalents, which totaled $37.8 million as of December 31, 2012, consist primarily of cash on deposit with banks.
We expect that operating cash flows will continue to be a primary source of liquidity for our operating needs. There are currently no borrowings
outstanding under our revolving credit facility other than a $1.4 million letter of credit. Due to our operating cash flows, our existing cash and
cash equivalents and availability under our revolving credit facility, we believe that we have the ability to meet our working capital and capital
expenditure needs for the foreseeable future.
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The following table presents information regarding our cash flows for the years ended December 31, 2012, 2011 and 2010:
Net cash provided by operating activities
Net cash used in investing activities
Net cash used in financing activities
Cash flows from operating activities
Year Ended
December 31,
2011
(in thousands)
$ 28,985
(6,111 )
(13,948 )
2012
$ 37,005
(12,193 )
(6,973 )
2010
$ 18,214
(4,921 )
(11,139 )
Operating activities provided $37.0 million of cash during the year ended December 31, 2012, an increase of $8.0 million, compared to
cash provided by operating activities of $29.0 million for the year ended December 31, 2011 primarily due to the increase in net income for the
year ended December 31, 2012 to $23.0 million compared to $12.4 million for 2011. Cash used to pay accrued salary and benefits totaled $9.3
million in 2012, as compared to the $7.1 million in accrued salaries and benefits payable for the comparable period in 2011. Accounts payable
increased $1.3 million in 2012 compared to 2011, primarily due to timing. The estimated liability for appeals for revenue received from CMS
totaled $4.4 million in 2012, compared $0.5 million in 2011, due to higher claim recovery volumes under our RAC contract with CMS.
We generated $29.0 million of cash from operating activities during the year ended December 31, 2011, primarily resulting from our net
income of $12.4 million, non-cash depreciation and amortization of $7.8 million, an impairment expense to write off the carrying amount of the
trade name intangible asset due to the retirement of the Diversified Collection Services, Inc. trade name of $13.4 million and changes in
operating assets and liabilities of $3.8 million, offset by non-cash deferred income taxes of $9.6 million.
We generated $18.2 million of cash from operating activities during the year ended December 31, 2010, primarily resulting from our net
income of $10.0 million, non-cash depreciation, amortization and impairment of intangible assets of $7.2 million and interest expense from debt
issuance costs of $2.0 million, partially offset by non-cash changes in operating assets and liabilities of $1.5 million.
Cash flows from investing activities
Investing activities resulted in cash outflow of $12.2 million during the year ended December 31, 2012. The primary uses of cash
associated with investing activities in 2012 were $11.4 million for property, equipment and leasehold improvements, to enhance our proprietary
technology platform, improve our telecommunications systems, upgrade our IT infrastructure for storage and operating activities, and $0.8
million for the purchase of a perpetual software license. We used $6.1 million and $4.9 million of cash in investing activities for the purchase of
property, equipment and leasehold improvements during the years ended December 31, 2011 and 2010, primarily for investments in information
technology systems and infrastructure to support increased business volumes.
Cash flows from financing activities
For the year ended December 31, 2012, our primary financing activities were $156 million in proceeds from term loans, $12.8 million of
net proceeds from our IPO which was completed in August 2012, and $4.5 million in revolving credit facility borrowings. These proceeds were
offset by $103.4 million used for the repayment of our old notes payable and repayment of principal on our new term loans, $12.7 million used
for the repayment of our old and new lines of credit, $60.3 million used to redeem 5.3 million shares of preferred stock, and $3.1 million used
for debt issuance costs.We used $13.9 million of cash in financing activities for the repayment of notes payable during the year ended
December 31, 2011. We used $11.1 million of cash in financing activities during the year ended December 31, 2010, comprised of $10.0 million
used for the repayment of notes payable and $1.2 million used for debt issuance costs.
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Long-term Debt
On March 19, 2012, we, through our wholly owned subsidiary, entered into a $147.5 million credit agreement with Madison Capital
Funding LLC as administrative agent, ING Capital LLC as syndication agent, and other lenders party thereto. The senior credit facility consists
of (i) a $57.0 million term A loan that matures in March 2017, (ii) a $79.5 million term B loan that matures in March 2018 , and (iii) a $11.0
million revolving credit facility that expires in March 2017, which had a borrowing capacity of $9.6 million as of December 31, 2012. On
June 28, 2012, we increased the amount of our borrowings under our term B loan by $19.5 million. We may also request the lenders to increase
the size of the term B loan or other term loans by up to an additional $10.5 million at any time prior to March 19, 2014.
All borrowings under the credit agreement bear interest at a rate per annum equal to an applicable margin plus, at our option, either (i) a
base rate determined by reference to the highest of (a) the prime rate published in the Wall Street Journal or another national publication, (b) the
federal funds rate plus 0.5%, and (c) 2.5% or (ii) a London Interbank Offered Rate, or Libor, rate determined by reference to the highest of (a) a
Libor rate published in Reuters or another national publication and (b) 1.5%. The term A loan and the revolving credit facility have an applicable
margin of 4.25% for base rate loans and 5.25% for Libor rate loans. The term B loan has an applicable margin of 4.75% for base rate loans and
5.75% for Libor rate loans. The minimum per annum interest rate that we are required to pay is 6.75% for the term A loan and revolving credit
facility and 7.25% for the term B loan. Interest is due at the end of each month for base rate loans and at the end of each Libor period for Libor
rate loans unless the Libor period is greater than 3 months, in which case interest is due at the last day of each 3-month interval of such Libor
period.
The credit agreement requires us to prepay the two term loans on a prorated basis and then to prepay the revolving credit facility under
certain circumstances: (i) with 100% of the net cash proceeds of any asset sale or other disposition of assets by us or our subsidiaries where the
net cash proceeds exceed $1 million, (ii) with a percentage of our annual excess cash flow each year where such percentage ranges from 25%-
75% depending on our total debt to EBITDA ratio reduced by any voluntary prepayments that are made on our term loans during the same
period and (iii) with any net cash proceeds from a qualified initial public offering by us, less net proceeds applied to redeem any outstanding
preferred equity or convertible debt, to pay a common shareholder dividend not to exceed $20 million or, if we comply with an adjusted
EBITDA ratio set forth in the agreement, to our cash balances in an amount not to exceed $75 million. We applied the proceeds from our initial
public offering to our cash balances.
We have to abide by certain negative covenants for our credit agreement, which limit the ability for our subsidiaries and us to:
•
•
•
•
•
•
•
•
•
•
•
incur additional indebtedness;
create or permit liens;
pay dividends or other distributions to our equity holders;
purchase or redeem certain equity interests of our equity holders, including any warrants, options and other security rights;
pay management fees or similar fees to any of our equity holders;
make any redemption, prepayment, defeasance, repurchase or any other payment with respect to any subordinated debt;
consolidate or merge;
sell assets, including the capital stock of our subsidiaries;
enter into transactions with our affiliates;
enter into different business lines; and
make investments.
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The credit agreement also requires us to meet certain financial covenants, including maintaining a fixed charge coverage ratio and a total
debt to EBITDA ratio as such terms are defined in our credit agreement. These financial covenants are tested at the end of each quarter
beginning on December 31, 2012. The table below further describes these financial covenants, as well as our status under these covenants as of
December 31, 2012.
Financial Covenant
Fixed charge coverage ratio (minimum)
Total debt to EBITDA ratio (maximum)
Covenant
Requirement
1.20 to 1.0
3.25 to 1.0
Actual Ratio at
December 31, 2012
1.93
2.11
Contractual Obligations
The following summarizes our contractual obligations as of December 31, 2012:
Contractual Obligations
Long-Term Debt Obligations
Interest Payments
Operating Lease Obligations
Purchase Obligations
Total
Total
$ 147,769
45,785
6,754
3,698
$ 204,006
Payments Due by Period
Less
Than
1 Year
$ 11,040
10,446
1,740
3,650
$ 26,876
1-3
Years
$ 22,080
18,611
3,178
48
$ 43,917
3-5
Years
$ 21,293
15,255
1,771
—
$ 38,319
More
Than
5 Years
$ 93,356
1,473
65
—
$ 94,894
(1) We entered into our new credit agreement on March 19, 2012 and amended it on June 28, 2012, with all outstanding indebtedness under
our prior loan facility paid in full. Long-term debt obligations and interest payments presented in this table relate solely to our new credit
agreement, as amended.
Adjusted EBITDA and Adjusted Net Income
To provide investors with additional information regarding our financial results, we have disclosed in the table below and within this report
adjusted EBITDA and adjusted net income, both of which are non-GAAP financial measures. We have provided a reconciliation below of
adjusted EBITDA to net income and adjusted net income to net income, the most directly comparable GAAP financial measure to these non-
GAAP financial measures.
We have included adjusted EBITDA and adjusted net income in this report because they are key measures used by our management and
board of directors to understand and evaluate our core operating performance and trends and to prepare and approve our annual budget.
Accordingly, we believe that adjusted EBITDA and adjusted net income provide useful information to investors and analysts in understanding
and evaluating our operating results in the same manner as our management and board of directors.
Our use of adjusted EBITDA and adjusted net income has limitations as an analytical tool, and you should not consider it in isolation or as
a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
•
•
•
•
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in
the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital
expenditure requirements;
adjusted EBITDA does not reflect interest expense on our indebtedness;
adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
adjusted EBITDA does not reflect tax payments;
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•
•
•
adjusted EBITDA and adjusted net income do not reflect the potentially dilutive impact of equity-based compensation;
adjusted EBITDA and adjusted net income do not reflect the impact of certain non-operating expenses resulting from matters we do
not consider to be indicative of our core operating performance; and
other companies may calculate adjusted EBITDA and adjusted net income differently than we do, which reduces its usefulness as a
comparative measure.
Because of these limitations, you should consider adjusted EBITDA and adjusted net income alongside other financial performance
measures, including net income and our other GAAP results.
The following tables present a reconciliation of adjusted EBITDA and adjusted net income for the years ended December 31, 2012, 2011
and 2010 to actual net income for these periods:
Reconciliation of Adjusted EBITDA:
Net income
Provision for income taxes
Interest expense
Interest income
Debt extinguishment costs
Depreciation and amortization
Impairment of trade name
(2)
Non-core operating expenses
Advisory fee
(4)
Stock based compensation
Adjusted EBITDA
(3)
(1)
(1)
(2)
Reconciliation of Adjusted Net Income:
Net income
Debt extinguishment costs
Impairment of trade name
Non–core operating expenses
Advisory fee
(4)
Stock based compensation
Amortization of intangibles
Deferred financing amortization costs
Tax adjustments
(7)
Adjusted net income
(3)
(6)
(5)
2012
Year Ended December 31,
2011
(in thousands)
2010
$ 22,951
16,786
12,414
(64 )
3,679
9,505
—
47
2,641
1,614
$ 69,573
$ 12,372
7,516
13,530
(125 )
—
7,766
13,400
2,548
634
120
$ 57,761
$ 9,975
6,664
15,230
(118 )
—
7,213
—
1,108
759
629
$ 41,460
2012
Year Ended December 31,
2011
(in thousands)
2010
$ 22,951
3,679
—
47
2,641
1,614
3,676
1,161
(5,126 )
$ 30,643
$ 12,372
—
13,400
2,548
634
120
3,043
1,254
(8,400 )
$ 24,971
$ 9,975
—
—
1,108
759
629
3,043
1,997
(3,014 )
$ 14,497
(1) Represents debt extinguishment costs comprised of approximately $3.3 million of fees paid to lenders in connection with our new credit
facility and approximately $0.3 million of unamortized debt issuance costs in connection with our old credit facility.
(2) Represents impairment expenses to write off the carrying amount of the trade name intangible asset due to the plan to retire the Diversified
Collection Services, Inc. trade name.
(3) Represents professional fees and settlement costs related to strategic corporate development activities and a $1.2 million legal settlement in
2011.
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(4) Represents expenses incurred under an advisory services agreement with Parthenon Capital Partners, which was terminated in April 2012.
See Note 11 “Related Party Transactions.”
(5) Represents amortization of capitalized expenses related to the acquisition of Performant by an affiliate of Parthenon Capital Partners in
2004 and an acquisition in the first quarter of 2012 to enhance our analytics capabilities.
(6) Represents amortization of capitalized financing costs related to debt offerings conducted in 2009, 2010 and 2012.
(7) Represents tax adjustments assuming a marginal tax rate of 40%.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Recent Accounting Pronouncements
Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those
standards apply to private companies. However, we do not intend to elect to take advantage of this extended transition period provided in
Section 7(a)(2)(B) of the Securities Act as allowed by Section 107(b)(1) of the JOBS Act.
In December 2011, FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities . ASU
2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of financial statements to understand
the effect of those arrangements on its financial position, and to allow investors to better compare financial statements prepared under GAAP
with financial statements prepared under International Financial Reporting Standards (IFRS). The new standards are effective for annual periods
beginning January 1, 2013, and interim periods within those annual periods. Retrospective application is required. We have implemented the
provisions of ASU 2011-11 as of January 1, 2013. We do not believe our adoption of the new guidance will have an impact on our consolidated
financial statements.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income . Under this
ASU, an entity will have the option to present the components of net income and comprehensive income in either one or two consecutive
financial statements. The ASU eliminates the option in GAAP to present other comprehensive income in the statement of changes in equity. An
entity should apply the ASU retrospectively. For a nonpublic entity, the ASU is effective for fiscal years ending after December 15, 2012, and
interim and annual periods thereafter. Early adoption is permitted. In December 2011, the FASB decided to defer the effective date of those
changes in ASU 2011-05 that relate only to the presentation of reclassification adjustments in the statement of income by issuing ASU 2011-12,
Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of
Accumulated Other Comprehensive income in Accounting Standards Update 2011-05 . We adopted this new guidance with no impact to our
consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and IFRS . The new standards do not extend the use of fair value but, rather, provide
guidance about how fair value should be applied where it already is required or permitted under IFRS or GAAP. For GAAP, most of the changes
are clarifications of existing guidance or wording changes to align with IFRS. A nonpublic entity is required to apply the ASU prospectively for
annual periods beginning after December 15, 2011. We adopted this new guidance with no impact to our consolidated financial statements.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
We do not hold or issue financial instruments for trading purposes. We conduct all of our business in U.S. currency and therefore do not
have any direct foreign currency risk. We do have exposure to changes in interest
50
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rates with respect to the borrowings under our senior secured credit facility, which bear interest at a variable rate based on the prime rate or
LIBOR. For example, if the interest rate on our borrowings increased 100 basis points (1%) from the credit facility floor of 1.5%, our annual
interest expense would increase by approximately $1.5 million. In July 2012, we entered into an interest rate cap agreement per the terms of our
senior secured credit agreement. The interest rate cap agreement is effective beginning in October 2012, and matures in October 2014, with a
total notional amount of $75 million and a cap on LIBOR at 2.0%. If the LIBOR rate were to increase by 100 basis points (1.0%) above the
credit facility floor of 1.5% for a year, we would receive a payment from the interest rate cap of approximately $0.4 million.
While we currently hold our excess cash in an operating account, in the future we may invest all or a portion of our excess cash in short-
term investments, including money market accounts, where returns may reflect current interest rates. As a result, market interest rate changes
impact our interest expense and interest income. This impact will depend on variables such as the magnitude of interest rate changes and the
level of our borrowings under our credit facility or excess cash balances.
ITEM 8.
Financial Statements and Supplementary Data
Our consolidated financial statements and notes thereto and the reports of KPMG LLP are set forth in the Index to Financial Statements
under Item 15, Exhibits, Financial Statement Schedules, and is incorporated herein by reference.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed in the
Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities
and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief
Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control objectives.
Management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our
disclosure controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act, as of the fiscal year covered by this Annual Report on
Form 10-K. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were functioning effectively at the reasonable assurance level as of December 31, 2012.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the
preparation of our consolidated financial statements for external purposes in accordance with United States Generally Accepted Accounting
Principles (“US GAAP”). Under the supervision of, and with the participation of our Chief Executive Officer and Chief Financial Officer,
management assessed the effectiveness of internal control over financial reporting as of December 31, 2012. Management based its assessment
on criteria established in “Internal Control Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”). Based on this evaluation, management concluded that its internal control over financial reporting was effective as of
December 31, 2012.
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Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the quarter ended December 31, 2012, that has materially
affected, or is reasonably likely to materially affect, our internal control over financial reporting, other than those noted above.
ITEM 9B. Other Information
None.
ITEM 10. Directors, Executive Officers and Corporate Governance
PART III
This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the
close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment
to this Report on Form 10-K.
ITEM 11. Executive Compensation
This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the
close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment
to this Report on Form 10-K.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the
close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment
to this Report on Form 10-K.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the
close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment
to this Report on Form 10-K.
ITEM 14.
Principal Accounting Fees and Services
This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the
close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment
to this Report on Form 10-K.
ITEM 15.
Exhibits, Financial Statement Schedules
(a) Financial Statements
PART IV
Financial Statements. The financial statements filed as part of this report are identified in the Index to Consolidated Financial Statements
on page F-1.
Financial Statement Schedules . See Item 15(c) below.
Exhibits . See Item 15(b) below.
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(b) Exhibits
The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the Securities and Exchange
Commission. The Company shall furnish copies of exhibits for a reasonable fee (covering the expense of furnishing copies) upon request.
Exhibit
Number
Description
3.1
3.2
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1(b) to the Company’s Registration
Statement on Form S-1/A filed July 23, 2012)
Amended and Restated Bylaws of Registrant (incorporated by reference to Exhibit 3.2(b) to the Company’s Registration
Statement on Form S-1/A filed July 23, 2012)
Amended and Restated Registration Rights Agreement, dated as of August 15, 2012, among the Registrant and the persons listed
thereon (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Form of Indemnification Agreement between the Registrant and its officers and directors (incorporated by reference to Exhibit
10.1 to the Company’s Registration Statement on Form S-1/A filed July 30, 2012)
2004 Equity Incentive Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.2 to the Company’s
Registration Statement on Form S-1 filed July 3, 2012)
2004 DCS Holdings Stock Option Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.3 to the
Company’s Registration Statement on Form S-1 filed July 3, 2012)
2007 Stock Option Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.4 to the Company’s
Registration Statement on Form S-1 filed July 3, 2012)
Recovery Audit Contractor contract by and between Diversified Collection Services, Inc. and Center for Medicare and Medicaid
Services dated as of October 3, 2008, as amended (incorporated by reference to Exhibit 10.5 to the Company’s Registration
Statement on Form S-1/A filed July 23, 2012)
Credit Agreement, dated as of March 19, 2012, by and among DCS Business Services, Inc., the Lenders party Hereto, Madison
Capital Funding LLC, and ING Capital (incorporated by reference to Exhibit 10.6 to the Company’s Registration Statement on
Form S-1/A filed July 23, 2012)
Form of Change of Control Agreement, as amended (incorporated by reference to Exhibit 10.7 to the Company’s Registration
Statement on Form S-1/A filed July 30, 2012)
Employment Agreement between the Registrant and Lisa Im, dated as of April 15, 2012, as amended (incorporated by reference
to Exhibit 10.8 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Employment Agreement between the Registrant and Jon D. Shaver dated as of March 31, 2003, as amended (incorporated by
reference to Exhibit 10.9 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Repurchase Agreement between the Registrant and Lisa C. Im dated as of July 3, 2012 (incorporated by reference to Exhibit
10.10 to the Company’s Registration Statement on Form S-1 filed July 3, 2012)
Repurchase Agreement between the Registrant and Jon D. Shaver dated as of July 3, 2012 (incorporated by reference to Exhibit
10.11 to the Company’s Registration Statement on Form S-1 filed July 3, 2012)
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Exhibit
Number
10.12
10.13
10.14
10.15
21
23
24
31.1
31.2
32.1
32.2
101.INS
101.SCH
101.CAL
101.DEF
101.LAB
101.PRE
Description
Director Nomination Agreement between the Registrant and Parthenon DCS Holdings, LLC dated as of July 20, 2012
(incorporated by reference to Exhibit 10.12 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Advisory Services Agreement between Diversified Collection Services, Inc. and Parthenon Capital, LLC dated as of January 8,
2004, as amended (incorporated by reference to Exhibit 10.13 to the Company’s Registration Statement on Form S-1/A filed
July 23, 2012)
Termination of the Advisory Services Agreement between Diversified Collection Services, Inc. and Parthenon Capital, LLC
dated as of January 8, 2004, as amended, dated as of April 13, 2012 (incorporated by reference to Exhibit 10.14 to the
Company’s Registration Statement on Form S-1/A filed July 23, 2012)
2012 Stock Incentive Plan (incorporated by reference to Exhibit 10.15 to the Company’s Registration Statement on Form S-1/A
filed July 23, 2012)
List of Subsidiaries
Consent of KPMG LLP, Independent Registered Public Accounting Firm
Powers of Attorney (included in the signature page to this report)
Rule 13a-14(a)/15d-14(a) Certification, executed by Lisa C. Im
Rule 13a-14(a)/15d-14(a) Certification, executed by Hakan L. Orvell
Furnished Statement of the Chief Executive Officer under 18 U.S.C. Section 1350
Furnished Statement of the Chief Financial Officer under 18 U.S.C. Section 1350
XBRL Instance Document
XBRL Taxonomy Extension Scheme
XBRL Taxonomy Extension Calculation Linkbase
XBRL Taxonomy Extension Definition Linkbase Document
XBRL Taxonomy Extension Label Linkbase
XBRL Taxonomy Extension Presentation Linkbase
Schedules not listed above have been omitted because they are not applicable or required, or the information required to be set forth therein
is included in the Consolidated Financial Statements or Notes hereto.
54
Table of Contents
Index to Consolidated Financial Statements
Consolidated Financial Statements of Performant Financial Corporation and Subsidiaries For the Years Ended December 31,
2012, 2011 and 2010
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Redeemable Preferred Stock and Stockholders’ Equity (Deficit)
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
F-1
Page
F-2
F-3
F-4
F-5
F-6
F-7
Table of Contents
The Board of Directors and Stockholders
Performant Financial Corporation
Report of Independent Registered Public Accounting Firm
We have audited the accompanying consolidated balance sheets of Performant Financial Corporation and subsidiaries as of December 31, 2012
and 2011, and the related consolidated statements of operations, changes in redeemable preferred stock and stockholders’ equity (deficit), and
cash flows for each of the years in the three-year period ended December 31, 2012. These consolidated financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Performant
Financial Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
San Francisco, California
March 21, 2013
/s/ KPMG LLP
F-2
Table of Contents
PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share amounts)
Assets
Current assets:
Cash and cash equivalents
Trade accounts receivable, net of allowance for doubtful accounts of $65 and $77, respectively and
estimated allowance for appeals of $1,199 and $484, respectively
Liabilities, Redeemable Preferred Stock and Stockholders’ Equity (Deficit)
Deferred income taxes
Prepaid expenses and other current assets
Debt issuance costs, current portion
Total current assets
Property, equipment, and leasehold improvements, net
Identifiable intangible assets, net
Goodwill
Debt issuance costs
Other assets
Total assets
Liabilities:
Current liabilities:
Current maturities of notes payable
Accrued salaries and benefits
Accounts payable
Other current liabilities
Income taxes payable
Deferred revenue
Estimated liability for appeals
Total current liabilities
Notes payable, net of current portion
Line of credit, drawn
Deferred compensation
Deferred income taxes
Other liabilities
Total liabilities
Commitments and contingencies
Redeemable preferred stock
December 31,
December 31,
2012
2011
$ 37,843
$ 20,004
23,044
3,798
2,876
1,125
68,686
20,669
36,244
81,572
3,844
730
$ 211,745
$ 11,040
9,288
1,403
8,252
430
2,187
4,378
36,978
136,729
—
—
11,271
2,694
187,672
19,398
5,348
3,292
595
48,637
14,915
36,516
81,572
—
659
$ 182,299
$
8,134
7,138
60
8,475
470
2,214
450
26,941
87,051
8,198
1,761
14,647
1,158
139,756
Series A convertible preferred stock, $0.0001 par value. Authorized, 50,000 and 18,000 shares; issued
and outstanding, 0 and 5,296 shares at December 31, 2012 and 2011, respectively
Stockholders’ equity (deficit):
Due from stockholders
Common stock, $0.0001 par value. Authorized, 500,000 and 50,000 shares at December 31, 2012 and
2011, respectively; issued and outstanding 45,392 and 37,667 shares at December 31, 2012 and
2011, respectively
Additional paid-in capital
Accumulated deficit
Total stockholders’ equity (deficit)
Total liabilities, redeemable preferred stock, and stockholders’ equity (deficit)
—
58,248
—
(2,266 )
4
35,970
(11,901 )
24,073
$ 211,745
4
19,371
(32,814 )
(15,705 )
$ 182,299
See accompanying notes to consolidated financial statements.
F-3
Table of Contents
PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share amounts)
For the Years Ended December 31,
2011
$ 162,974
2012
$ 210,073
2010
$ 123,519
83,002
71,305
—
154,307
55,766
(3,679 )
(12,414 )
64
39,737
16,786
$ 22,951
2,038
$ 20,913
67,082
49,199
13,400
129,681
33,293
—
(13,530 )
125
19,888
7,516
$ 12,372
6,495
$ 5,877
58,113
33,655
—
91,768
31,751
—
(15,230 )
118
16,639
6,664
$ 9,975
5,771
$ 4,204
$
$
0.48
0.44
$
$
0.14
0.13
$
$
0.10
0.09
43,985
47,599
42,962
45,742
42,962
45,019
Revenues
Operating expenses:
Salaries and benefits
Other operating expenses
Impairment of trade name
Total operating expenses
Income from operations
Debt extinguishment costs
Interest expense
Interest income
Provision for income taxes
Income before provision for income taxes
Net income
Accrual for preferred stock dividends
Net income available to common shareholders
Net income per share attributable to common shareholders (see Note 1)
Basic
Diluted
Weighted average shares (see Note 1)
Basic
Diluted
See accompanying notes to consolidated financial statements.
F-4
Table of Contents
Balance, December 31, 2009
PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Redeemable Preferred Stock and Stockholders’ Equity (Deficit)
For the Years Ended December 31, 2012, 2011 and 2010
(In thousands)
Redeemable Preferred
Stock
Series A
Convertible Preferred Stock Due From
Amount
Stockholders
Shares
5,296 $
45,982 $
(2,161 ) 37,667 $
Common Stock
Shares Amount
Accumulated
Additional
Paid-In
Capital
Deficit
4 $ 18,728 $ (42,895 ) $ (26,324 )
Total
Balance, December 31, 2010
Increase in redemption value of Series A
Interest on notes receivable from
preferred stock
stockholders
Stock-based compensation expense
Net income
Increase in redemption value of Series A
Interest on notes receivable from
preferred stock
stockholders
Stock-based compensation expense
Net income
Balance, December 31, 2011
—
5,771
— — — —
(5,771 ) (5,771 )
—
—
—
5,296
—
—
—
51,753
(103 ) — — —
106 — —
523
— — — —
4 19,251
(2,158 ) 37,667
—
—
(103 )
629
9,975 9,975
(38,691 ) (21,594 )
—
6,495
— — — —
(6,495 ) (6,495 )
—
—
—
5,296
—
—
—
58,248
(108 ) — — —
— — —
120
— — — —
4 19,371
(2,266 ) 37,667
—
—
(108 )
120
12,372 12,372
(32,814 ) (15,705 )
Increase in redemption value of Series A
preferred stock
—
2,038
— — — —
(2,038 ) (2,038 )
Conversion of Series A preferred stock
to Series B preferred stock which was
immediately redeemed for cash
Conversion of Series B preferred stock
to common
Exercise of stock options
Issuance of stock
Purchase of treasury stock
Interest on notes receivable from
Repayment of notes receivable from
stockholders
stockholders
Stock-based compensation expense
Income tax benefit from employee stock
—
(60,286 )
— — — —
— —
(5,296 )
—
—
—
—
—
—
—
— 5,296 — —
—
175
284 —
— 2,243 — 15,420
(98 ) — (1,225 )
—
— —
—
175
— 15,420
— (1,225 )
—
—
(57 ) — — —
—
(57 )
—
—
—
—
2,323 — — —
— — — 1,614
— 2,323
— 1,614
options
Net income
Balance, December 31, 2012
—
—
— $
—
—
— $ — 45,392 $
— — —
615
— — — —
615
22,951 22,951
4 $ 35,970 $ (11,901 ) $ 24,073
—
See accompanying notes to consolidated financial statements.
F-5
Table of Contents
PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Loss on disposal of assets
Impairment of intangible asset
Depreciation and amortization
Write-off of unamortized debt issuance costs
Deferred income taxes
Stock-based compensation
Interest expense from debt issuance costs and amortization of discount note payable
Interest income on notes receivable from stockholders
Changes in operating assets and liabilities:
Trade accounts receivable
Prepaid expenses and other current assets
Other assets
Accrued salaries and benefits
Accounts payable
Other current liabilities
Income taxes payable
Deferred revenue
Estimated liability for appeals
Other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of property, equipment, and leasehold improvements
Purchase of perpetual software license and computer equipment
Net cash used in investing activities
Cash flows from financing activities:
Borrowing under notes payable
Borrowing under line of credit
Redemption of preferred stock
Repayment of notes payable
Repayment of line of credit
Debt issuance costs paid
Proceeds from exercise of stock options
Proceeds from issuance of stock
Repayment of promissory notes from stockholders
Income tax benefit from employee stock options
Payment to stockholders
Purchase of treasury stock
Payment of purchase obligation
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information:
Cash paid for income taxes
Cash paid for interest
Cash paid as debt extinguisment
Supplemental disclosure of non-cash investing and financing activities:
Obligation to sellers of perpetual license
Issuance of common stock as part of debt issuance costs
See accompanying notes to consolidated financial statements.
F-6
For the Years Ended December 31,
2011
2012
2010
$
22,951
$
12,372
$
9,975
51
—
9,505
335
(1,826 )
1,614
1,272
(57 )
(3,646 )
416
(71 )
2,150
1,343
(1,223 )
(40 )
(27 )
3,928
330
37,005
(11,356 )
(837 )
(12,193 )
156,000
4,500
(60,286 )
(103,416 )
(12,698 )
(3,074 )
175
12,624
2,323
615
(1,761 )
(1,225 )
(750 )
(6,973 )
17,839
20,004
37,843
18,037
11,178
3,344
3,250
2,796
$
$
$
$
$
$
—
13,400
7,766
—
(9,640 )
120
1,254
(108 )
(5,392 )
(94 )
372
2,542
(3 )
4,714
470
2,214
450
(1,452 )
28,985
(6,111 )
—
(6,111 )
—
—
—
(13,948 )
—
—
—
—
—
—
—
—
—
(13,948 )
8,926
11,078
20,004
15,830
12,246
—
—
—
$
$
$
$
$
$
—
—
7,213
—
32
629
1,997
(103 )
1,610
(664 )
(394 )
(69 )
(255 )
(1,882 )
—
—
—
125
18,214
(4,921 )
—
(4,921 )
—
—
—
(9,967 )
—
(1,172 )
—
—
—
—
—
—
—
(11,139 )
2,154
8,924
11,078
6,209
13,048
—
—
—
$
$
$
$
$
$
Table of Contents
PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements
For the Years Ended December 31, 2012, 2011 and 2010
1.
Summary of Significant Accounting Policies
(a) Organization and Nature of Business
Performant Financial Corporation (the Company) is a leading provider of technology-enabled recovery and analytics services in the
United States. Company 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. Company clients typically operate in complex and regulated
environments and outsource their 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 receivables. The Company generally provides our services on an
outsourced basis, where we handle many or all aspects of the clients’ recovery processes.
The Company’s consolidated financial statements include the operations of Performant Financial Corporation (PFC), its wholly
owned subsidiary Performant Business Services, Inc., and its wholly owned subsidiaries Performant Recovery, Inc. (Recovery), and
Performant Technologies, Inc. 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.
PFC is a Delaware corporation headquartered in California and was formed in 2003. 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 U.S. Generally Accepted Accounting
Principles, or U.S. GAAP. The Company consolidates entities in which it has controlling financial interest, and as of December 31,
2012, 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, accrued expenses, 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) Stock Split
On July 26, 2012, the Company effected a two-for-one stock split of the Company’s shares of Common Stock. Accordingly, all per
share amounts, average shares outstanding, shares outstanding, and equity based compensation presented in the consolidated
financial statements and notes have been adjusted retroactively to reflect the stock split. Shareholders’ deficit has been retroactively
adjusted to give
F-7
Table of Contents
effect to the stock split for all periods presented by reclassifying the par value of the additional shares issued in connection with the
stock split to additional paid-in capital. Concurrently with the stock split, the authorized Common Stock was increased from
25,000,000 shares to 60,000,000 shares. On August 15, 2012, the authorized Common Stock was increased to 500,000,000 shares
and the authorized preferred stock was increased to 50,000,000 shares.
(e) Cash and Cash Equivalents
Cash and cash equivalents include demand deposits and highly liquid debt instruments with original maturities of three months or
less when purchased. These investments can include money market funds that invest in highly liquid 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 12(a)).
(f) Hosted Service Installation and Implementation Deliverables
In 2008, the Company entered into a long-term contract to provide hosted services to a client beginning in March 2009. The
Company determined that certain installation and implementation deliverables were not separate units of accounting within the
contract, and should be combined for revenue recognition purposes with the hosted service deliverable. Accordingly, revenue for
these contract elements is being taken ratably from the commencement of hosted services in March 2009 through the contract period
of March 2018. Additionally, the Company deferred the direct incremental costs associated with the installation and implementation
deliverables, with the costs being expensed ratably from the March 2009 commencement of services through March 2018.
(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. In accordance with
Accounting Standard Update (ASU) 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment , the
Company performed a qualitative assessment of whether it is more likely than not that goodwill fair value is less than its carrying
amount for 2012, and concluded that there was no need to
F-8
Table of Contents
perform an impairment test. The Company performed a qualitative assessment of whether it is more likely than not that goodwill fair
value is less than its carrying amount for 2011, and again concluded that there was no need to perform an impairment test. The
Company applied impairment tests to its goodwill and determined that no impairment loss had occurred during 2010.
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 – 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 did not recognize an impairment expense for intangible assets in 2012 and 2010.
In 2011, the Company recorded $13.4 million of impairment expense to write off the carrying amount of its former trade name,
Diversified Collection Services, Inc. (DCS). The Company determined that the DCS trade name would not be used in the future, and
retired the trade name intangible asset accordingly.
(j)
System Developments
The Company follows the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Update (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 2012, 2011 and 2010, costs of $5.4 million, $2.5 million and $2.1
million respectively, were capitalized for projects in the application stage of development, with depreciation expense of $2.4 million,
$2.1 million and $1.5 million respectively, for completed projects.
(k) Debt Issuance Costs
Debt issuance costs represent loan and legal fees paid in connection with the issuance of long-term debt. Debt issuance cost is
amortized to interest expense in accordance with key terms of the notes as amended.
(l) Revenues, Accounts Receivable, and Estimated Liability for Appeals
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 RAC contract with CMS, the Company recognizes revenues when the healthcare
provider has paid CMS for a given claim or offset. Providers have the right to appeal a claim and may pursue additional appeals if the
initial appeal is found in favor of CMS. The Company accrues an estimated liability for appeals based on the amount of commissions
received which are subject to appeal and which the Company estimates are probable of being returned to providers following
successful appeal. At December 31, 2012, a total of $5.6 million was presented as an allowance against revenue, representing the
Company’s estimate of claims that may be overturned. Of this amount, $1.2 million was related to amounts in accounts receivable
and $4.4 million was related to commissions which had already been received. The balances at December 31, 2012 and 2011, were
$4.4 million and $0.5 million, respectively, represent the Company’s best estimate of the probable amount of losses related to
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Table of Contents
appeals of claims for which commissions were previously collected. In addition to the $4.4 million amount accrued at December 31,
2012, the Company estimates that it is reasonably possible that it could be required to pay an additional amount up to approximately
$1.5 million as a result of potentially successful appeals. To the extent that required payments by the Company exceed the amount
accrued, revenues in the applicable period would be reduced by the amount of the excess.
For the year ended December 31, 2012, the Company had 5 clients whose individual revenues exceeded 10% of the Company’s total
revenues. The dollar amount and percent of total revenue of each of the 5 clients is summarized in the table below (in thousands):
Rank
1
2
3
4
5
2012 Revenue
$ 54,130
39,183
29,027
25,469
22,397
Percent of
total revenue
25.8 %
18.7 %
13.8 %
12.1 %
10.7 %
For the year ended December 31, 2011, the Company had 5 clients whose individual revenues exceeded 10% of the Company’s total
revenues. The dollar amount and percent of total revenue of each of the 5 clients is summarized in the table below (in thousands):
Rank
1
2
3
4
5
2011 Revenue
$ 30,732
28,504
21,812
21,549
17,934
Percent of
total revenue
18.9 %
17.5 %
13.4 %
13.2 %
11.0 %
For the year ended December 31, 2010, the Company had 4 clients whose individual revenues exceeded 10% of the Company’s total
revenues. The dollar amount and percent of total revenue of each of the 4 clients is summarized in the table below (in thousands):
Rank
1
2
3
4
2010 Revenue
$ 27,881
20,776
17,287
15,445
Percent of
total revenue
22.6 %
16.8 %
14.0 %
12.5 %
Revenue from the largest three customers was 58%, 50% and 53% of total revenue in 2012, 2011 and 2010, respectively. Accounts
receivable due from these three customers were 63%, 25% and 41% of total trade receivables at December 31, 2012, 2011 and 2010,
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 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 $0.1 million and $0.1 million at December 31, 2012 and 2011, respectively.
(m) Legal Expenses
The Company recognizes legal fees related to litigation as they are incurred.
F-10
Table of Contents
(n) Comprehensive Income
The Company has no components of comprehensive income other than its net income. Accordingly, comprehensive income is
equivalent to net income.
(o) Fair Value of Financial Instruments
The Company’s 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.
(p)
Income Taxes
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.
(q) Preferred Stock
The carrying amounts of preferred stock are periodically increased by amounts representing dividends not currently declared or paid,
but which would be payable under certain redemption features. Such increases in carrying amounts are recorded against retained
earnings.
(r) Stock Options
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
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 income tax benefits resulting from the exercise of stock options in 2012, 2011 and
2010 of $0.6 million, $0 million and $0 million, respectively.
F-11
Table of Contents
(s) Earnings per Share
Basic earnings per share is calculated by dividing net income available to common shareholders by the sum of the weighted average
number of common shares outstanding during the period plus the weighted average number of Series A preferred shares outstanding
during the period. The Series A shares are included in the basic denominator because they could be converted into common shares
for no cash consideration (via conversion units as further described in Note 7), and were thus considered outstanding common shares
in computing basic earnings per share. 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.
The following table reconciles the basic to diluted weighted average shares outstanding using the treasury stock method (shares in
thousands):
Weighted average shares outstanding – basic
Dilutive effect of stock options
Weighted average shares outstanding – diluted
For the year ended December 31, 2012, the Company excluded from the calculation of diluted earnings per share options to purchase
2,364,000 shares because such outstanding options’ combined exercise price, unamortized fair value and excess tax benefits were
greater than the average market price of our common shares in each of those periods because their effect would be anti-dilutive (i.e.,
including such options would result in higher earnings per share).
Year Ended December 31,
2011
42,962
2,780
45,742
2012
43,985
3,614
47,599
2010
42,962
2,057
45,019
(t) Recent Accounting Pronouncements
In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and
Liabilities . ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of
financial statements to understand the effect of those arrangements on its financial position, and to allow investors to better compare
financial statements prepared under U.S. GAAP with financial statements prepared under International Financial Reporting
Standards (IFRS). The new standards are effective for annual periods beginning January 1, 2013, and interim periods within those
annual periods. Retrospective application is required. The Company implemented the provisions of ASU 2011-11 as of January 1,
2013. The Company does not believe its adoption of the new guidance will have an impact on its consolidated financial statement.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income . Under
this ASU, an entity will have the option to present the components of net income and comprehensive income in either one or two
consecutive financial statements. The ASU eliminates the option in U.S. GAAP to present other comprehensive income in the
statement of changes in equity. An entity should apply the ASU retrospectively. For a nonpublic entity, the ASU is effective for
fiscal years ending after December 15, 2012, and interim and annual periods thereafter. Early adoption is permitted. In December
2011, the FASB decided to defer the effective date of those changes in ASU 2011-05 that relate only to the presentation of
reclassification adjustments in the statement of operations by issuing ASU 2011-12, Comprehensive Income (Topic 220): Deferral of
the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive
income in Accounting Standards Update No. 2011-05. The Company adopted this new accounting guidance with no impact to our
consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and IFRSs . The new standards do not extend the use of fair value but,
rather, provide guidance about how fair
F-12
Table of Contents
value should be applied where it already is required or permitted under IFRS or U.S. GAAP. For U.S. GAAP, most of the changes
are clarifications of existing guidance or wording changes to align with IFRS. A nonpublic entity is required to apply the ASU
prospectively for annual periods beginning after December 15, 2011. The Company adopted ASU 2011-04 in 2012 with no impact to
our consolidated financial statements.
(v) Reclassifications
Certain reclassifications have been made to the 2011 balances to conform to the 2012 presentation. Such reclassifications have no
effect on net income or retained earnings as previously reported.
2. Acquisition
In February 2012, the Company purchased a perpetual software license and computer equipment from HOPS, a non-public Florida
company, in a transaction valued at $3.68 million. The purchase agreement calls for a total of $4.0 million in cash payments to be made
over an approximate 3 year period, beginning with an initial payment of $0.8 million which was made in February 2012, followed by
quarterly payments of $0.3 million. As part of the transaction valuation, these payments were discounted to a present value using an
estimate of our incremental borrowing rate.
The HOPS proprietary software platform provides data filtering services for government and commercial health plans to help identify
improper payments made to health providers, and enhances our existing service offering in recovery of improper payments.
The purchase is being treated as a business combination for accounting purposes; the following table summarizes the estimated fair values
of the assets acquired at the acquisition date (in thousands):
Computer equipment
Perpetual license
Customer relationships
Total identifiable assets acquired
February 1,
2012
$
280
3,250
150
$ 3,680
The acquired intangible assets will be amortized over their estimated useful lives, which are 5 and 4 years for the perpetual license and
customer relationships, respectively.
F-13
Table of Contents
The following represents our pro forma Consolidated Statements of Income as if HOPS had been included in our consolidated results for
the years ending December 31, 2012 and 2011 ( in thousands, except for per share data):
Total revenue
Net income available to common shareholders
Earnings per share attributable to common shareholders
Basic
Diluted
For the year ended
December 31,
2012
$ 211,329
$ 18,751
2011
$ 164,230
$ 3,715
$
$
0.43
0.39
$
$
0.09
0.08
3.
Property, Equipment, and Leasehold Improvements
Property, equipment, and leasehold improvements consist of the following at December 31, 2012 and 2011 (in thousands):
Land
Building and leasehold improvements
Furniture, equipment, and automobile
Computer hardware and software
Less accumulated depreciation and amortization
Property, equipment and leasehold improvements, net
December 31,
December 31,
2012
$
1,767
5,500
4,408
40,886
52,561
(31,892 )
$ 20,669
2011
$
1,767
4,797
3,612
31,197
41,373
(26,458 )
$ 14,915
Depreciation and amortization expense of property, equipment and leasehold improvements was $5.8 million, $4.7 million and $4.2
million for the years ended December 31, 2012, 2011 and 2010, respectively.
4.
Identifiable Intangible Assets
Identifiable intangible assets consist of the following at December 31, 2012 and 2011 (in thousands):
December 31, 2012
Amortizable intangibles:
Customer contracts and related relationships
Perpetual license
Total intangible assets
December 31, 2011
Amortizable intangibles:
Customer contracts and related relationships
Total intangible assets
F-14
Gross
Amounts
$ 62,198
3,250
$ 65,448
Gross
Amounts
$ 62,046
$ 62,046
Accumulated
Amortization
Net
$ (28,608 )
(596 )
$ (29,204 )
Accumulated
$ 33,590
2,654
$ 36,244
Amortization
Net
$ (25,530 )
$ (25,530 )
$ 36,516
$ 36,516
Table of Contents
For the years ended December 31, 2012, 2011 and 2010, amortization expense related to intangible assets amounted to $3.7 million, $3.0
million and $3.0, respectively.
The estimated aggregate amortization expense for each of the five following fiscal years is as follows (in thousands):
Year Ending December 31,
2013
2014
2015
2016
2017
Thereafter
Total
5. Credit Agreement
Amount
$ 3,731
3,731
3,731
3,696
3,097
18,258
$ 36,244
On March 19, 2012, the Company recapitalized entering into a credit agreement (the Agreement) consisting of a Term A Loan of $57.0
million, a Term B Loan of $79.5 million, and a revolving credit facility of $11.0 million. In connection with the recapitalization, our old
credit facility, scheduled to mature in 2012, was extinguished, and our indebtedness on the old facility was paid in full. As of December
31, 2011, the indebtedness on the old facility consisted of $33.2 million under the Term A-2 Loan, $62 million under the Term B Loan and
$8.2 million under the line of credit. On June 28, 2012, the Agreement was amended to increase the Term B Loan to $99 million. Payments
under the Agreement are as follows (in thousands):
Year Ending December 31,
2013
2014
2015
2016
2017
Thereafter
Total
Amount
$ 11,040
11,040
11,040
11,040
10,253
93,356
$ 147,769
Proceeds from the new Term A, Term B, and revolving credit facility borrowings were used along with $14.5 million of our cash to repay
our old notes payable and line of credit in the amount of $103.4 million and to redeem 3,897,000 shares of Series A Convertible Preferred
Stock plus accrued dividends for a total of $44.0 million. Fees paid in conjunction with the credit agreement totaled $8.1 million, including
an agency fee for $1.5 million to an entity associated with our majority stockholder, and an agreement to grant 215,000 shares of Common
Stock valued at approximately $2.8 million to an investment bank acting as advisor.
Proceeds from the additional Term B borrowings were used to redeem the remaining 1,399,000 shares of Series A Convertible Preferred
Stock outstanding plus accrued dividends for a total of $16.3 million. Fees paid in conjunction with the credit agreement totaled
$0.8 million, including an agency fee for $0.2 million to an entity associated with our majority stockholder. Remaining proceeds of $2.3
million were used along with existing cash to pay off the line of credit balance of $4.5 million.
The Term A Loan is charged interest either at Prime (subject to a 2.50% floor) +4.25% or LIBOR (subject to a 1.50% floor) +5.25%,
which was 6.75% at December 31, 2012. The Term A loan requires quarterly payments of $2.5 million beginning in June 2012, with the
remaining outstanding principal balance due March 19, 2017. As of December 31, 2012, the Term A loan ending balance, including the
current portion was $49.5 million.
The Term B loan is charged interest at Prime +4.75% (subject to a 2.50% floor) or LIBOR (subject to a 1.50% floor) +5.75% which was
7.25% at December 31, 2012. The Term B loan requires quarterly
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Table of Contents
payments of $0.2 million beginning in June 2012, with the outstanding principal balance due March 19, 2018. As of December 31, 2012,
the Term B loan ending balance, including the current portion was $98.3 million.
The Company has a line of credit under the Agreement which allows for borrowings of up to $11 million. Borrowings accrue interest at
Prime + 4.25% or LIBOR + 5.25%, which was 6.75% at December 31, 2012. Both the Prime and the LIBOR alternatives are subject to
minimum rate floors. In addition, a facility fee of 0.5% is assessed on the commitment amount. There were no outstanding borrowings
under this line of credit at December 31, 2012, and a letter of credit outstanding in the amount of $1.4 million, leaving remaining
borrowing capacity under the line of credit of $9.6 million at December 31, 2012. The line of credit expires in March 19, 2017.
The Agreement contains certain restrictive financial covenants, which require, among other things, that we meet a minimum fixed charge
coverage ratio of 1.20 and maximum total debt to EBITDA ratio of 3.25. Additionally, these covenants 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. We were in compliance with all such
covenants at December 31, 2012.
During our March 19, 2012 recapitalization, debt issuance costs of $5.0 million were capitalized, including $1.5 million of agent fees paid
to an entity associated with our majority stockholder, and $0.8 million paid to third parties for legal and other services and a grant of
215,044 shares of Common Stock issued as compensation to an investment bank acting as financial advisor valued at approximately $2.8
million, based upon a price of $13 per share. These costs are being amortized to expense over the life of the new loans.
The Company capitalized an additional $0.8 million related to our June 28, 2012 amendment to the Agreement, which included $0.2
million of agent fees paid to an entity associated with our majority stockholders, and $0.04 million paid to third parties for legal and other
services. Debt issuance costs are being amortized to interest expense over the life of the new loans. Accumulated amortization of debt
issuance costs amounted to $0.9 million at December 31, 2012.
Debt extinguishment costs of $3.7 million were expensed, including $3.3 million of fees paid to lenders, and $0.3 million of unamortized
debt issuance costs associated with the old credit facility.
6. Commitments and Contingencies
The Company leases office facilities and certain equipment. In January 2012, we renewed two of our facilities leases and entered into a
new lease agreement for approximately 6,000 square feet in Livermore, California.
Future minimum rental commitments under non-cancelable leases as of December 31, 2012 are as follows (in thousands):
Year Ending December 31,
2013
2014
2015
2016
2017
Thereafter
Total
Amount
$ 1,740
1,769
1,409
986
785
65
$ 6,754
Lease expense was $2.4 million, $1.9 million and $1.9 million for the year ended December 31, 2012, 2011 and 2010, respectively.
F-16
Table of Contents
7. Capital Stock
Prior to August 15, 2012, the total number of shares of capital stock that the Company has authority to issue is 96,000,000, consisting of
18,000,000 shares of Series A Participating Senior Preferred Stock (Series A Preferred Stock), $0.0001 par value per share (Series A
Preferred Stock); 18,000,000 shares of Series B Redeemable Senior Preferred Stock, $0.0001 par value per share (Series B Preferred
Stock); and 60,000,000 shares of Common Stock, $0.0001 par value per share. On August 15, 2012, the authorized Common Stock was
increased to 500,000,000 shares and the authorized preferred stock was increased to 50,000,000 shares.
(a) Series A Preferred Stock
Issuanc e – On May 23, 2006, the Company sold 5,295,676 shares of Series A Preferred Stock to shareholders at a price of $5.67 per
share, receiving gross proceeds of $30,000,000, and net proceeds of $29,925,000 after issuance costs of $75,000.
Dividends – The holders of Series A Preferred Stock were entitled to receive dividends as declared by the board of directors. The
dividends accrued on a daily basis at the rate of 12% per annum on the sum of the Liquidation Value plus accumulated dividends and
accrued and unpaid dividends thereon from the date of issuance of the Preferred Stock. As of December 31, 2011, the Company had
accrued dividends payable of $28,248,000 recorded as an increase to the Series A Preferred Stock.
Voting – Each share of Series A Preferred Stock entitled the holder to cast a number of votes per share equal to the number of votes that
the holder would be entitled to cast assuming that such shares of Series A Preferred Stock had been converted into shares of Common
Stock.
Liquidation – In the event of any liquidation, dissolution, or winding up of the Company, before any distribution or payment to holders of
Common Stock, but on parity with the holders of Series B Preferred Stock, holders of shares of Series A Preferred Stock were entitled to
be paid an amount equal to the Liquidation Value of $5.67 per share plus any accumulated or accrued but unpaid dividends thereon. In
addition to the payments set forth above, the holders of shares of Series A Preferred Stock were entitled to participate, on a parity and
ratably on a per-share basis with the holders of Common Stock, with respect to all such distributions or payments that the holders of
Series A Preferred Stock would have been entitled to receive with respect to the number of shares of Common Stock into which such
holders’ shares of Series A Preferred Stock were convertible immediately prior to any relevant record date or payment date in connection
with liquidation, dissolution, or winding up, but only to the extent that shares of Common Stock would have participated in such
distributions or payments (and such payment shall be junior to all equity securities of the Company that rank senior to the Common Stock,
including without limitation the Series B Preferred Stock).
Conversion – The Series A Preferred Stock was convertible into Conversion Units (as defined below), at a rate of one Conversion Unit for
one share of Series A Preferred Stock. A Conversion Unit consisted of (i) the number of shares of Common Stock determined by dividing
the Liquidation Value of the Series A Preferred Stock by the Conversion Price then in effect (the Common Portion) and (ii) one share of
Series B Preferred Stock (the Series B Portion) subject to adjustments. If upon conversion there were any unpaid, accrued, or accumulated
dividends due on the shares of Series A Preferred Stock, such dividends continued to be deferred, but were considered unpaid, accrued, or
accumulated dividends (as the case may be) due on the Series B Preferred Stock.
•
•
Optional conversion – Each share of Series A Preferred Stock was convertible, at the option of the holder thereof, into a Conversion
Unit at any time after the date of issuance of such share.
Automatic conversion – Each share of Series A Preferred Stock automatically could have been converted into Conversion Units on
the date specified by written consent or agreement of the holders of a majority of the then outstanding shares of Series A Preferred
Stock.
F-17
Table of Contents
•
Conversion price – The initial Conversion Price of the shares issued in May 2006 was $5.67 per share. In order to prevent dilution of
the conversion rights granted to the holders of the Series A Preferred Stock, the Conversion Price was subject to adjustment from
time to time under certain circumstances. If the Company (i) declared a dividend on the Common Stock payable in shares of its
capital stock (including Common Stock), (ii) subdivided the outstanding Common Stock, (iii) combined the outstanding Common
Stock into a smaller number of shares, or (iv) issued any shares of its capital stock in a reclassification of the Common Stock, then, in
each such case, the Conversion Price was to be proportionately adjusted so that, in connection with a conversion of the shares of
Series A Preferred Stock after such date, the holder of shares of Series A Preferred Stock would have been entitled to receive the
aggregate number and kind of shares of capital stock, which, if the conversion had occurred immediately prior to such date, the
holder would have owned upon such conversion and been entitled to receive by virtue of such dividend, subdivision, combination, or
reclassification.
(b) Redemption of Series A Preferred Stock
On March 19, 2012, the Company recapitalized. As part of the recapitalization, 3,897,000 shares of Series A Convertible Preferred Stock
were converted into conversion units, which consisted of one share of Series B Preferred Stock and one share of Common Stock. The
Series B Preferred shares plus accrued dividends were redeemed for cash of $44 million, and 3,897,000 shares of Common Stock were
issued to the holders of the redeemed Series A Convertible Preferred Stock.
In June 2012, the remaining 1,399,000 shares of Series A Convertible Preferred Stock were converted into conversion units of one share of
Series B Preferred Stock and one share of Common Stock. The shares Series B Preferred Stock plus accrued dividends were redeemed for
cash of $16.3 million and 1,399,000 shares of Common Stock were issued to the holders of the redeemed Series A Convertible Preferred
Stock.
(c)
Issuance of Shares of Common Stock as Compensation
As part of the March 19, 2012 recapitalization, the Company issued to its financial advisor as compensation in connection with the debt
portion of the recapitalization 215,000 shares of Common Stock valued at approximately $2.8 million based upon a price of $13 per share.
This amount represents debt issuance costs and is being amortized to expense over the 5 to 6 year life of the loans described in Note 5.
(d)
Initial Public Offering
In August 2012, the Company completed its initial public offering (IPO) in which we issued and sold 1,924,000 shares of Common Stock
at a public offering price of $9.00 per share. The Company received net proceeds of $12.6 million after deducting underwriter discounts
and commissions of $1.0 million and other offering expenses of approximately $3.6 million. In addition, a financial advisor to the
Company was paid $0.9 million through the issuance of 103,500 shares of Common Stock valued at $9.00 per share.
8.
Stock-based Compensation
(a) Stock Options
The Company has established the 2004 DCS Holdings Stock Option Plan, the DCS Holdings, Inc. 2004 Equity Incentive Plan (Performant
Financial Corporation is the new name of DCS Holdings, Inc.), the Performant Financial Corporation 2007 Stock Option Plan, and the
Performant Financial Corporation 2012 Stock Incentive Plan (the Plans). Under the terms of the 2004 DCS Holdings Stock Option Plan,
stock options may be granted for up to 4,000,000 shares of the Company’s authorized but unissued Common Stock. The 2004 DCS
Holdings Stock Option Plan was terminated on the completion of the Company’s initial public offering in August 2012. No shares of our
common stock are available under our 2004 Stock Option Plan other than for satisfying exercises of stock options granted under this plan
prior to termination.
F-18
Table of Contents
Under the terms of the DCS Holdings, Inc. 2004 Equity Incentive Plan, incentive and nonqualified stock options, stock bonuses, and rights
to acquire restricted stock may be granted for up to 3,600,000 shares of the Company’s authorized but unissued Common Stock. Options
granted under the DCS Holdings, Inc. 2004 Equity Incentive Plan generally vest over a four-year period. The Company’s DCS Holdings,
Inc. 2004 Equity Incentive Plan was terminated on the completion of its initial public offering in August 2012. No shares of our common
stock are available under our 2004 Equity Incentive Plan other than for satisfying exercises of stock options granted under this plan prior to
termination.
Under the terms of the Performant Financial Corporation 2007 Stock Option 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 Performant Financial
Corporation 2007 Stock Option Plan generally vest over a five-year period. Performant Financial Corporation 2007 Stock Option Plan was
terminated on the completion of its initial public offering in August 2012. No shares of our common stock are available under our 2007
Stock Option 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 provides for the granting of incentive stock options within
the meaning of Section 422 of 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
4,300,000 shares of common stock under the 2012 Plan. Options granted under the Performant Financial Corporation 2012 Stock Incentive
Plan generally vest over a five-year period.
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 Plans have a
maximum term of 10 years and vest over schedules determined by the board of directors. Options issued under the Plans generally provide
for immediate vesting of unvested shares in the event of a sale of the Company.
Total stock-based compensation expense charged as salaries and benefits expense in the consolidated statements of operations was $1.6
million, $0.1 million and $0.6 million for the years ended December 31, 2012, 2011, and 2010, respectively.
F-19
Table of Contents
The following table sets forth a summary of our stock option activity for the year ended December 31:
Outstanding at December 31, 2009
Granted
Forfeited
Exercised
Outstanding at December 31, 2010
Granted
Forfeited
Exercised
Outstanding at December 31, 2011
Granted
Forfeited
Exercised
Outstanding at December 31, 2012
Vested or expected to vest
Exercisable at December 31, 2012
(1)
at December 31, 2012
Weighted
average
exercise price
Weighted
average
remaining
contractual life
Aggregate
Instrinsic Value
per share
(Years)
(in thousands)
$
$
$
$
0.61
1.50
0.56
—
0.64
5.50
0.74
0.50
0.80
10.32
7.99
0.61
3.85
3.66
0.64
6.90
6.00
5.20
5.89
5.64
3.86
$
$
$
49,410
48,387
45,927
Outstanding
Options
5,443,500
202,000
(134,750 )
—
5,510,750
180,000
(25,282 )
(718 )
5,664,750
2,549,109
(19,077 )
(285,058 )
7,909,724
7,514,238
4,854,960
(1)
Options expected to vest reflect an estimated forfeiture rate.
The weighted-average grant-date exercise price of stock options granted during the years ended December 31, 2012, 2011 and 2010 was
$10.32, $5.50 and $1.50, respectively, per share. 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, 2012, 2011
and 2010, was $2.9 million, $0 million and $0 million, respectively. At December 31, 2012, 2011, and 2010, there was $12.0 million, $0.6
million and $0.4 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 4.21 years as stock-based compensation
expense.
Net cash proceeds from the exercise of stock options were $0.2 million, $0 million and $0 million during 2012, 2011 and 2010,
respectively. For the years ended December 31, 2012, 2011 and 2010, we realized a $0.6 million, $0 million and $0 million tax benefit
from the exercise of stock options, respectively.
The fair value of each option grant was estimated using the Black-Scholes 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. Separate groups of employees
that have similar groups of employees with similar historical exercise behavior are considered separately for valuation purposes.
F-20
Table of Contents
We estimated the fair value of options granted using a Black-Scholes option pricing model with the following assumptions:
Expected volatility
Expected dividends
Expected term (years)
Risk-free interest rate
Weighted-average estimated fair value of options granted during
the year
2012
48.3 %
0.0
6.5
1.01 %
For the Year Ended December 31,
2011
39.8 %
0.0
6.3
1.2 %
2010
40.6 %
0.0
6.3
2.8 %
$ 5.22
$ 2.23
$ 0.66
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 (Staff Accounting Bulletin No. 107) for estimating the expected term of the stock-based award.
Expected Volatility – Because there is insufficient history of the Company’s stock price returns, the Company lacks sufficient
historical volatility data for its equity awards. Accordingly, the Company calculates the expected volatility using comparable peer
companies over a term comparable to the expected term of the options issued.
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 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
Option Agreements issued under the 2004 DCS Holdings Stock Option Plan allow for the participants to exercise options whether or not
vesting has occurred, provided that the participants enter into a restricted stock agreement. The restricted stock agreement is to specify that
the stock issued for unvested options will continue vesting, with the unvested shares subject to repurchase at the lower of original cost and
fair market value.
In January 2005, two executives exercised a portion of their options, including unvested options, by entering into restricted stock
agreements with the Company. The restricted stock agreements allow for the executives to receive dividend payments, subject to forfeiture
if the executives leave the Company prior to the vesting of the restricted shares. On February 4, 2005, forfeitable dividends of $1 million
were paid on the executives’ unvested restricted shares. This amount has been recorded as “due from stockholders” in the equity caption of
the consolidated balance sheet, and is being amortized into compensation expense as the underlying unvested restricted shares vest.
Compensation expense associated with the forfeitable dividends received on unvested restricted shares was $0 million, $0 million and $0.1
million in 2012, 2011 and 2010, respectively.
F-21
Table of Contents
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 Internal Revenue Code for such plans.
Employer contributions are discretionary. No matching contributions were made during 2012, 2011 and 2010.
10.
Income Taxes
The Company’s income tax expense (benefit) consists of the following (in thousands):
Current:
Federal
State
Deferred:
Federal
State
Total Expense (Benefit)
2012
2011
2010
$ 15,142
3,470
18,612
$ (1,599 )
(227 )
(1,826 )
$ 16,786
$ 14,053
3,103
17,156
$ (7,350 )
(2,290 )
(9,640 )
$ 7,516
$ 5,500
1,132
6,632
$ (172 )
204
32
$ 6,664
A reconciliation of the income tax expense calculated using the applicable federal statutory rates to the actual income tax expense for the
years ended December 31, 2012, 2011 and 2010 is as follows:
Federal income at the statutory rate
State income tax, net of federal benefit
Permanent differences
Other
2012
35 %
5 %
2 %
0 %
42 %
2011
35 %
3 %
1 %
-1 %
38 %
2010
35 %
5 %
2 %
-2 %
40 %
F-22
Table of Contents
The following table summarizes the components of the Company’s deferred tax assets and liabilities as of December 31, 2012, and 2011
(in thousands):
Deferred tax assets:
Bad debt reserve
Vacation accrual
Remeasurement expense nonqualified stock options
Amortization of deferred finance costs
Acquisition costs
Bonus accrual
State tax deferral
Stock option compensation
Deferred revenue
State tax credits
Estimated liability for appeals
Other
Valuation allowance
Deferred tax liabilities:
Identifiable intangible assets
Book versus tax depreciation
Amortization of deferred finance costs
Other
Net deferred tax liabilities
2012
2011
$
26
909
1,767
3,082
197
—
1,373
—
91
566
1,260
82
9,353
(351 )
9,002
(13,007 )
(3,446 )
—
(22 )
(16,475 )
$ (7,473 )
$
30
315
1,137
1,822
229
483
1,041
690
1,284
386
366
559
8,342
(148 )
8,194
(14,307 )
(3,029 )
(135 )
(22 )
(17,493 )
$ (9,299 )
The Company believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize
the deferred tax assets, except for certain state tax credits. Income tax expense is allocated to the subsidiaries included in the consolidated
tax return on the basis of the subsidiaries’ stand-alone tax provision.
The Company has a valuation allowance of approximately $0.4 million as of December 31, 2012 related to California enterprise zone tax
credits for which it is not more likely than not that the tax benefit will be realized. The total amount of the valuation allowance represented
includes increases from the amount recorded as of December 31, 2011 due to the generation of additional tax credits in 2012, for which it
is not more likely than not that the tax benefit will be realized.
The Company has state tax credits of $0.6 million which can be carried forward indefinitely. The Company has state net operating loss
carryforwards of $0.4 million which expire in 2020. The following table reconciles the Company’s unrecognized tax benefits as of
December 31, 2012 from its unrecognized tax benefits as of December 31, 2011 (in thousands):
Unrecognized tax benefits balance at December 31, 2011
Increase related to prior year tax positions
Decrease related to prior year tax positions
Increase related to current year tax positions
Settlements
Lapse of statute of limitations
Unrecognized tax benefits balance at December 31, 2012
F-23
$ —
115
—
164
—
—
$ 279
Table of Contents
At December 31, 2012 and 2011, we had approximately $0.3 million and $0 million of unrecognized tax benefits, respectively. We do 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 selling, general, and administrative expenses. The amount of accrued interest was not
material at December 31, 2012 and 2011, respectively. No penalties were recognized in 2012 or accrued at December 31, 2012 and 2011,
respectively. Unrecognized tax benefits of approximately $0.3 million which, if recognized, would favorably affect the Company’s
effective income tax rate.
The Company files federal and state income tax returns. For years before 2008, the Company is no longer subject to federal or state tax
examinations.
11. Related Party Transactions
Our notes payable, both before and after the recapitalization of March 19, 2012, are held by a number of lenders, some of whom also
invested in our stock. As a result, these entities are considered related parties. Interest expense under these arrangements totaled $11.1
million, $12.3 million and $13.2 million for the years ended December 31, 2012, 2011 and 2010, respectively, and the debt extinguishment
expense associated with the recapitalization totaled $3.3 million for the year ended December 31, 2012.
In an agreement dated April 13, 2012, the Company and an affiliate of Parthenon Capital Partners terminated an existing advisory services
agreement, which called for quarterly payments of $0.1 million. As part of the April 13, 2012 termination agreement, the Company agreed
to pay Parthenon Capital $1.3 million in equal quarterly installments of $0.1 million beginning in April 2012, provided that the remaining
balance will become due and payable immediately upon the closing of an IPO or the sale of the Company. The Company paid two
quarterly installments of $0.1 million and paid the remaining balance of $1.1 million on August 15, 2012, the date the IPO closed. In
addition, the agreement specifies that the affiliate will be due a fee equal to 1% of the aggregate gross proceeds of an IPO offering or 1% of
the aggregate consideration paid in connection with the sale of the Company, as applicable. The Company expensed and paid $0.9 million
to Parthenon Capital Partners in August 2012 upon successful closing of the IPO.
12. Other Commitments and Contingencies
(a) Trust Funds
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 assets and liabilities. Cash held in trust for customers totaled $1.4 million and $1.8 million at December 31,
2012 and 2011, respectively.
(b) Litigation
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 financial position or results of operations or cash flows.
13. Subsequent Events
In January 2013, the Company completed a secondary offering in which selling stockholders issued and sold 9,200,000 shares of common
stock at a public offering price of $10.65 per share. The Company did not receive any proceeds from the sale of the shares by the selling
stockholders. The Company paid the related offering expenses.
F-24
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
PERFORMANT FINANCIAL CORPORATION
By:
/s/ Lisa C. Im
Lisa C. Im
Chief Executive Officer
Date: March 21, 2013
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Lisa C. Im and
Hakan L. Orvell, and each of them, his or her true and lawful attorneys-in-fact, each with full power of substitution, for him or her in any and all
capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
Name
/s/ Lisa C. Im
Lisa C. Im
/s/ Hakan L. Orvell
Hakan L. Orvell
/s/ Dr. Jon D. Shaver
Dr. Jon D. Shaver
/s/ Todd R. Ford
Todd R. Ford
/s/ Brian P. Golson
Brian P. Golson
/s/ William D. Hansen
William D. Hansen
/s/ William C. Kessinger
William C. Kessinger
/s/ Jeffrey S. Stein
Jeffrey S. Stein
Title
Date
Chief Executive Officer (Principal Executive
Officer) and Director
March 21, 2013
Chief Financial Officer (Principal Financial and
Accounting Officer)
March 21, 2013
Chairman of the Board and Director
March 21, 2013
Director
Director
Director
Director
Director
March 21, 2013
March 21, 2013
March 21, 2013
March 21, 2013
March 21, 2013
Table of Contents
SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS
For the years ended December 31, 2012, 2011 and 2010
Allowance for doubtful accounts (in thousands):
Description
2012
2011
2010
Balance at
Beginning of
Period
$
$
$
77
45
221
Additions
Charged
against Revenue
—
28
37
Recoveries
2
14
—
Charge-offs
(14 )
(10 )
(213 )
Balance at
End of Period
65
$
77
$
45
$
Estimated allowance and liability for appeals – RAC Contract (in thousands):
Description
2012
2011
2010
Balance at
Beginning of
934
$
$
101
$ —
Additions
Charged
against Revenue
8,589
1,743
101
Appeals found
in Providers
Favor
(3,946 )
(910 )
—
Balance at
End of Period
$
5,577 *
934 *
101 *
* Includes $1,199, $484 and $101 related to the estimated allowance for appeals that apply to uncollected accounts receivable as of 2012, 2011
and 2010, respectively.
Table of Contents
Exhibit
Number
Description
EXHIBIT INDEX
3.1
3.2
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1(b) to the Company’s Registration
Statement on Form S-1/A filed July 23, 2012)
Amended and Restated Bylaws of Registrant (incorporated by reference to Exhibit 3.2(b) to the Company’s Registration
Statement on Form S-1/A filed July 23, 2012)
Amended and Restated Registration Rights Agreement, dated as of August 15, 2012, among the Registrant and the persons listed
thereon (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Form of Indemnification Agreement between the Registrant and its officers and directors (incorporated by reference to Exhibit
10.1 to the Company’s Registration Statement on Form S-1/A filed July 30, 2012)
2004 Equity Incentive Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.2 to the Company’s
Registration Statement on Form S-1 filed July 3, 2012)
2004 DCS Holdings Stock Option Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.3 to the
Company’s Registration Statement on Form S-1 filed July 3, 2012)
2007 Stock Option Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.4 to the Company’s
Registration Statement on Form S-1 filed July 3, 2012)
Recovery Audit Contractor contract by and between Diversified Collection Services, Inc. and Center for Medicare and Medicaid
Services dated as of October 3, 2008, as amended (incorporated by reference to Exhibit 10.5 to the Company’s Registration
Statement on Form S-1/A filed July 23, 2012)
Credit Agreement, dated as of March 19, 2012, by and among DCS Business Services, Inc., the Lenders party Hereto, Madison
Capital Funding LLC, and ING Capital (incorporated by reference to Exhibit 10.6 to the Company’s Registration Statement on
Form S-1/A filed July 23, 2012)
Form of Change of Control Agreement, as amended (incorporated by reference to Exhibit 10.7 to the Company’s Registration
Statement on Form S-1/A filed July 30, 2012)
Employment Agreement between the Registrant and Lisa Im, dated as of April 15, 2012, as amended (incorporated by reference
to Exhibit 10.8 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Employment Agreement between the Registrant and Jon D. Shaver dated as of March 31, 2003, as amended (incorporated by
reference to Exhibit 10.9 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Repurchase Agreement between the Registrant and Lisa C. Im dated as of July 3, 2012 (incorporated by reference to Exhibit
10.10 to the Company’s Registration Statement on Form S-1 filed July 3, 2012)
Repurchase Agreement between the Registrant and Jon D. Shaver dated as of July 3, 2012 (incorporated by reference to Exhibit
10.11 to the Company’s Registration Statement on Form S-1 filed July 3, 2012)
Director Nomination Agreement between the Registrant and Parthenon DCS Holdings, LLC dated as of July 20, 2012
(incorporated by reference to Exhibit 10.12 to the Company’s Registration Statement on Form S-1/A filed July 23, 2012)
Advisory Services Agreement between Diversified Collection Services, Inc. and Parthenon Capital, LLC dated as of January 8,
2004, as amended (incorporated by reference to Exhibit 10.13 to the Company’s Registration Statement on Form S-1/A filed July
23, 2012)
Table of Contents
Exhibit
Number
10.14
10.15
21
23
24
31.1
31.2
32.1
32.2
101.INS
101.SCH
101.CAL
101.DEF
101.LAB
101.PRE
Description
Termination of the Advisory Services Agreement between Diversified Collection Services, Inc. and Parthenon Capital, LLC
dated as of January 8, 2004, as amended, dated as of April 13, 2012 (incorporated by reference to Exhibit 10.14 to the
Company’s Registration Statement on Form S-1/A filed July 23, 2012)
2012 Stock Incentive Plan (incorporated by reference to Exhibit 10.15 to the Company’s Registration Statement on Form S-1/A
filed July 23, 2012)
List of Subsidiaries
Consent of KPMG LLP, Independent Registered Public Accounting Firm
Powers of Attorney (included in the signature page to this report)
Rule 13a-14(a)/15d-14(a) Certification, executed by Lisa C. Im
Rule 13a-14(a)/15d-14(a) Certification, executed by Hakan L. Orvell
Furnished Statement of the Chief Executive Officer under 18 U.S.C. Section 1350
Furnished Statement of the Chief Financial Officer under 18 U.S.C. Section 1350
XBRL Instance Document
XBRL Taxonomy Extension Scheme
XBRL Taxonomy Extension Calculation Linkbase
XBRL Taxonomy Extension Definition Linkbase Document
XBRL Taxonomy Extension Label Linkbase
XBRL Taxonomy Extension Presentation Linkbase
SUBSIDIARIES
Company Name
Performant Business Services, Inc.
Performant Recovery, Inc.
Performant Technologies, In.
State of Incorporation
Nevada
California
California
Exhibit 21
Consent of Independent Registered Public Accounting Firm
Exhibit 23
The Board of Directors
Performant Financial Corporation:
We consent to the incorporation by reference in the registration statement on Form S-8 (No. 333-184657) of our report dated March 21, 2013
with respect to the consolidated balance sheets of Performant Financial Corporation and subsidiaries as of December 31, 2012 and 2011, and the
related consolidated statements of operations, changes in redeemable preferred stock and stockholders’ equity (deficit), and cash flows for each
of the years in the three year period ended December 31, 2012, which report appears in this Form 10-K.
/s/ KPMG LLP
San Francisco, California
March 21, 2013
Exhibit 31.1
I, Lisa C. Im, certify that:
1. I have reviewed this annual report on Form 10-K of Performant Financial Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Dated: March 21, 2013
/s/ Lisa C. Im
Lisa C. Im
Chief Executive Officer
Exhibit 31.2
I, Hakan L. Orvell, certify that:
1. I have reviewed this annual report on Form 10-K of Performant Financial Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Dated: March 21, 2013
/s/ Hakan L. Orvell
Hakan L. Orvell
Chief Financial Officer
SECTION 1350 CERTIFICATIONS
Exhibit 32.1
I, Lisa C. Im, Chief Executive Officer of Performant Financial Corporation (the “Company”), certify, pursuant to 18 U.S.C. § 1350, as adopted
pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge the Annual Report on Form 10-K of the Company (the “Report”),
which accompanies this Certificate, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and
all information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: March 21, 2013
/s/ Lisa C. Im
Lisa C. Im
Chief Executive Officer
SECTION 1350 CERTIFICATIONS
Exhibit 32.2
I, Hakan L. Orvell, Chief Financial Officer of Performant Financial Corporation (the “Company”), certify, pursuant to 18 U.S.C. § 1350, as
adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge the Annual Report on Form 10-K of the Company (the
“Report”), which accompanies this Certificate, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934, and all information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
Dated: March 21, 2013
/s/ Hakan L. Orvell
Hakan L. Orvell
Chief Financial Officer