Performant Financial Corp files 10-Q

Performant Financial Corp revealed 10-Q form on May 14.

We have the option to extend the maturity of the Loans for two additional one-year periods, subject to the satisfaction of customary conditions.  The Loans bear interest at the one-month LIBOR rate (subject to a 1% per annum floor) plus a margin which may vary from 5.5% per annum to 10.0% per annum based on our total debt to EBITDA ratio. Our annual interest rate at March 31, 2019 was 8.0% and 8.0% at December 31, 2018. We are required to pay 5% of the original principal balance of the Loans annually in quarterly installments and to make mandatory prepayments of the Loans with a percentage of our excess cash flow which may vary between 75% and 0% depending on our total debt to EBITDA ratio and from the net cash proceeds of certain asset dispositions and debt not otherwise permitted under the Credit Agreement, in each case, subject to the lender’s right to decline to receive such payments. The Loans may be voluntarily prepaid at any time, together with a prepayment premium of 1% for all voluntary prepayments prior to August 11, 2019.

In consideration for, and concurrently with, the origination of the Initial Term Loan in accordance with the terms of the Credit Agreement, we issued a warrant to the lender to purchase up to an aggregate of 3,863,326 shares of the Company’s common stock (representing approximately up to 7.5% of our diluted common stock as calculated using the ‘treasury stock’ method as defined under U.S. GAAP for the three month period ended June 30, 2017) with an exercise price of $1.92 per share (the “Exercise Price”). In connection with the October 15, 2018 Additional Term Loan borrowing of $4 million, we were required to, and did, issue a warrant to the lender to purchase an aggregate of 309,066 shares of the Company’s common stock at the same Exercise Price of $1.92 per share. Upon any further borrowing of the Additional Term Loans, we will be required to issue additional warrants at the same Exercise Price to purchase up to an aggregate of 77,267 additional shares of common stock (which represents approximately 0.15% of our diluted common stock calculated using the ‘treasury stock’ method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017) for each $1.0 million of such Additional Term Loans. Similarly, upon our election to extend the maturity of the loans for two additional one year periods, we will be required to issue additional warrants at the same Exercise Price to purchase up to an aggregate of 515,110 additional shares of common stock for the first year, and to purchase up to an aggregate of 772,665 additional shares of common stock for the second year (which represent approximately 1.0% and 1.5% of our diluted common stock for the first and second years, respectively, calculated using the ‘treasury stock’ method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017).

Our effective income tax rate changed to (2.1)% for the three months ended March 31, 2019 from 22.8% for the three months ended March 31, 2018. The change in the effective tax rate is primarily driven by the overall losses from operations for the three months ended March 31, 2019 for which no benefit is recognized due to valuation allowance.

On April 5, 2019, the Company borrowed $5 million of the $21 million available as Additional Term Loans under the Credit Agreement as amended. In connection with this borrowing, we issued a warrant to the lender to purchase an aggregate of 386,333 shares of the Company’s common stock (representing approximately 0.75% of our diluted common stock calculated using the “treasury stock” method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017) with an exercise price of $1.92 per share.

On October 26, 2016, CMS awarded new RAC contracts and we received RAC contracts for audit Regions 1 and 5. The RAC contract award for Region 1 allows us to continue our audit of payments under Medicare’s Part A and Part B for all provider types other than DMEPOS and home health and hospice within an 11 state region in the Northeast and Midwest. The Region 5 RAC contract provides for the post-payment review of DMEPOS and home health and hospice claims nationally. While audit and recovery activity under the new contracts commenced in April 2017, the scope of audit permitted by CMS under the new RAC contracts has been limited to 0.5% of claims. We do not expect to recognize significant revenues from the newly awarded RAC contracts until the percentage of claims we are able to audit increases from the current 0.5% of the claims.

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 means that there will be no further growth in student loans held by GAs. Further, we are seeing a larger amount of defaulted student loans in our GA clients’ portfolios that have been previously rehabilitated and by regulation are not subject to rehabilitation for a second time. 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.

Revenues were $34.9 million for the three months ended March 31, 2019, a decrease of approximately 39%, compared to revenues of $57.0 million for the three months ended March 31, 2018.

Student lending revenues were $12.9 million for the three months ended March 31, 2019, representing a decrease of $6.2 million, or 32%, compared to the three months ended March 31, 2018. The decrease was primarily the result of reduced revenues from Great Lakes Higher Education Guaranty Corporation, which had revenues of $1.2 million in the first quarter of 2019, compared to $10.0 million in the prior year period, partially offset by a $2.6 million increase in revenues from other guaranty agencies.

Healthcare revenues were $10.2 million for the three months ended March 31, 2019, representing a decrease of $21.1 million, or 67%, compared to the three months ended March 31, 2018. This decrease was due primarily to the one-time release of a $27.8 million appeals reserve in connection with the termination of our 2009 CMS Region A contract in the first quarter of 2018. Excluding the $27.8 million impact of the termination of the 2009 CMS Region A contract, healthcare revenues in the first quarter of 2019 increased $6.7 million, or 191%, when compared to $3.5 million in the prior year period.

Other revenues were $11.8 million for the three months ended March 31, 2019, representing an increase of $5.2 million, or 79%, compared to the three months ended March 31, 2018. This increase was primarily due to revenues from Premiere, which was acquired on August 31, 2018.

Salaries and benefits expense was $29.1 million for the three months ended March 31, 2019, an increase of $7.3 million, or 34%, compared to salaries and benefits expense of $21.8 million for the three months ended March 31, 2018. The increase in salaries and benefits expense was primarily due to an increase in headcount as a result of the acquisition of Premiere, and increased headcount in anticipation of ramp up activity related to new clients and contracts.

Other operating expenses were $13.0 million for the three months ended March 31, 2019, a decrease of $10.1 million, or 44%, compared to other operating expenses of $23.0 million for the three months ended March 31, 2018. The decrease in other operating expenses was primarily due to a $7.1 million derecognition of subcontractor receivable associated with the termination of the 2009 CMS Region A contract and a $1.9 million allowance for doubtful accounts against subcontractor receivable, both of which occurred in the first quarter of 2018.

Interest expense was $1.1 million for the three months ended March 31, 2019, compared to $1.3 million for the three months ended March 31, 2018. Interest expense decreased by approximately $0.1 million or 11% due to lower outstanding balance and lower interest rate in 2019 compared to 2018.

We recognized an income tax expense of $0.2 million for the three months ended March 31, 2019, compared to an income tax expense of $2.5 million for the three months ended March 31, 2018. Our effective income tax rate decreased to (2)% for the three months ended March 31, 2019, from 23% for the three months ended March 31, 2018. The change in the effective tax rate is primarily driven by the overall losses from operations for the three months ended March 31, 2019 for which no benefit is recognized due to valuation allowance.

As a result of the factors described above, net loss was $8.5 million for the three months ended March 31, 2019, which represented an increase of $16.9 million, or 200% compared to net income of $8.5 million for the three months ended March 31, 2018.

We have the option to extend the maturity of the Loans for two additional one year periods, subject to the satisfaction of customary conditions. The Loans bear interest at the one-month LIBOR rate (subject to a 1% per annum floor) plus a margin which may vary from 5.5% per annum to 10.0% per annum based on our total debt to EBITDA ratio. Our annual interest rate at March 31, 2019, was 8.0%, and at December 31, 2018 was 8.0%. We are required to pay 5% of the original principal balance of the Loans annually in quarterly installments and to make mandatory prepayments of the Loans with a percentage of our excess cash flow which may vary between 75% and 0% depending on our total debt to EBITDA ratio and from the net cash proceeds of certain asset dispositions and debt not otherwise permitted under the Credit Agreement, in each case, subject to the lender’s right to decline to receive such payments. The Loans may be voluntarily prepaid at any time, together with a prepayment premium of 1% for all voluntary prepayments prior to August 11, 2019.

In consideration for, and concurrently with, the extension of the Initial Term Loan in accordance with the terms of the Credit Agreement, we issued a warrant to the lender to purchase up to an aggregate of 3,863,326 shares of the Company’s common stock (representing approximately up to 7.5% of our diluted common stock as calculated using the ‘treasury stock’ method as defined under U.S. GAAP for the most recent fiscal quarter, with an exercise price of $1.92 per share (the “Exercise Price”)). In connection with the October 15, 2018 Additional Term Loan borrowing of $4 million, we were required to, and did, issue a warrant to the lender to purchase an aggregate of 309,066 shares of the Company’s common stock at the same Exercise Price of $1.92 per share. Upon any further borrowing of the Additional Term Loans, we will be required to issue additional warrants at the same Exercise Price to purchase up to an aggregate of 77,267 additional shares of common stock (which represents approximately 0.15% of our diluted common stock calculated using the ‘treasury stock’ method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017) for each $1.0 million of such Additional Term Loans. Similarly, upon our election to extend the maturity of the Loans for additional one year periods, we will be required to issue additional warrants at the same Exercise Price to purchase up to an aggregate of 515,110 additional shares of common stock for the first year’s extension, and to purchase up to an aggregate of 772,665 additional shares of common stock for the second year’s extension (which represent approximately 1.0% and 1.5% of our diluted common stock for the first and second years, respectively, calculated using the ‘treasury stock’ method as defined under U.S. GAAP for the fiscal quarter ended June 30, 2017).

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 material direct foreign currency risk. We do have exposure to changes in interest rates with respect to the borrowings under our senior secured credit facility, which bear interest at a variable rate based on LIBOR. For example, if the interest rate on our borrowings increased 100 basis points (1%) from the credit facility floor of 1.0%, our annual interest expense would increase by approximately $0.4 million.

Revenues generated from our three largest clients represented 61% of our revenues in 2018 and 63% of our revenues in 2017. Our relationships with one of these clients, Great Lakes Higher Education Guaranty Corporation, was terminated in 2017. Any termination of or deterioration in our relationship with any of our other significant clients would result in a further decline in our revenues.

We have derived a substantial majority of our revenues from a limited number of clients. Revenues from our three largest clients represented 61% of our revenues for the year ended December 31, 2018 and 63% of our revenues for the year ended December 31, 2017. We have had relationships with numerous GAs in the U.S. including Pennsylvania Higher Education Assistance Authority and Great Lakes, which were responsible for 17% and 17%, respectively, of our revenues for the year ended December 31, 2018. On June 15, 2017, we received a 30-day termination notice with respect to our contract with Great Lakes, based on Great Lakes’ decision to bundle with a single third-party vendor its student loan servicing work, a service that we currently do not provide, along with its student loan recovery work. While we subsequently obtained a subcontract for student loan recovery work from Navient, the new provider of servicing and defaulted portfolio management to Great Lakes, this contract has no set term or volume, and Navient has the right to terminate the contract at will. Because the Department of Education terminated our January 2018 contract and the current procurement in its entirety, we now will become even more dependent on our business relationships with our remaining GA clients for our student loan revenues. In that regard, we believe that the portfolios of our GA clients will continue to decrease over time due to (i) the effect of federal legislation in 2010 that requires all student loan originations to come from the Department of Education (which means that there will be no further growth in student loans held by GAs), and (ii) because we are seeing a larger amount of defaulted student loans in our GA client portfolios that have been previously rehabilitated and by regulation are not subject to rehabilitation for a second time. All of our contracts with our significant clients are subject to periodic renewal and re-bidding processes and if we lose one of these clients or if the terms of our relationships with any of these clients become less favorable to us, our revenues would decline, which would harm our business, financial condition and results of operations.

Substantially all of our existing contracts for the recovery of student loans and other receivables, which represented approximately 64% of our revenues for the year ended December 31, 2018 and 92% of our revenues in the year ended December 31, 2017, enable our clients to unilaterally terminate their contractual relationship with us at any time without penalty, potentially leading to loss of business or renegotiation of terms. Further, most of our contracts in these markets allow our clients to unilaterally change the volume of loans and other receivables that are placed with us or the payment terms at any given time. In addition, most of our contracts are not exclusive, with our clients retaining multiple service providers with whom we must compete for placements of loans or other obligations. Therefore, despite our contractual relationships with our clients, our contracts do not provide assurance that we will generate a minimum amount of revenues or that we will receive a specific volume of placements. Our revenues and operating results would be negatively affected if our student loan and receivables clients reduce the volume of student loan placements provided to us, modify the terms of service, including the success fees we are able to earn upon recovery of defaulted student loans, or any of these clients establish more favorable relationships with our competitors.

We have historically derived and are likely to continue to derive a significant portion of our revenues from the U.S. federal government. For the year ended December 31, 2018, revenues under contracts with the U.S. federal government accounted for approximately 35% of our total revenues. The continuation and exercise of renewal options on government contracts and any new government contracts are, among other things, contingent upon the availability of adequate funding for the applicable federal government agency. Changes in federal government spending could directly affect our financial performance.

Further, some have speculated that there may be consolidation among the remaining GAs. This speculation has heightened as a result of the reduction of fees that the GAs will receive for rehabilitating student loans as a result of the Bipartisan Budget Act of 2013. If GAs that are our clients are combined with GAs with whom we do not have a relationship, we could suffer a loss of business. Two of our GA clients: Great Lakes and Pennsylvania Higher Education Assistance Authority were responsible for 17% and 17%, respectively, of revenues for the year ended December 31, 2018. The consolidation of our GA clients with others and the failure to provide recovery services to the consolidated entity could decrease our revenues, which could negatively impact our business, financial condition and results of operations.

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