Document
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-35628
 
 
PERFORMANT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
20-0484934
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
Performant Financial Corporation
333 North Canyons Parkway
Livermore, CA 94551
(925) 960-4800
(Address, including zip code and telephone number, including area code of registrant’s principal executive offices)
 
Indicate by check mark whether the registrant (1) has filed all reports required 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  x    No  ¨
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 (§ 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  x    No  ¨
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). (Check one):
Large accelerated filer
¨
  
Accelerated filer
x
 
 
 
 
Non-accelerated filer
¨
  
Smaller reporting company
¨
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§ 230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§ 240.12b-2 of this chapter).
x Emerging growth company


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o If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    No  x
The number of shares of Common Stock outstanding as of August 8, 2017 was 50,797,652.
 
 
 
 
 


Table of Contents
PERFORMANT FINANCIAL CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED June 30, 2017
INDEX


 
 
Page
 
 
 
 
 
 
Consolidated Balance Sheets June 30, 2017 (unaudited) and December 31, 2016
 
Consolidated Statements of Operations Three and Six Months Ended June 30, 2017 and 2016 (unaudited)
 
Consolidated Statements of Comprehensive Income (Loss) Three and Six Months Ended June 30, 2017 and 2016 (unaudited)
 
Consolidated Statements of Cash Flows Six Months Ended June 30, 2017 and 2016 (unaudited)
 
Notes to Consolidated Financial Statements Three and Six Months Ended June 30, 2017 and 2016 (unaudited)
 
 
 
 
 
 
Item 3.
Item 4.
Item 5.
 


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PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)





 
June 30,
2017
 
December 31,
2016
 
(Unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
21,260

 
$
32,982

Restricted cash
6,000

 
7,502

Trade accounts receivable, net of allowance for doubtful accounts of $0 and $224, respectively
11,267

 
11,484

Deferred income taxes

 
5,331

Prepaid expenses and other current assets
14,492

 
12,686

Income tax receivable
2,637

 
2,027

Total current assets
55,656

 
72,012

Property, equipment, and leasehold improvements, net
22,805

 
23,735

Identifiable intangible assets, net
5,269

 
5,895

Goodwill
81,572

 
82,522

Deferred income taxes
3,534

 

Other assets
915

 
914

Total assets
$
169,751

 
$
185,078

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current maturities of notes payable, net of unamortized debt issuance costs of $29 and $1,294, respectively
$
1,071

 
$
9,738

Accrued salaries and benefits
4,509

 
4,315

Accounts payable
715

 
628

Other current liabilities
4,186

 
4,409

Estimated liability for appeals
19,179

 
19,305

Net payable to client
13,104

 
13,074

Total current liabilities
42,764

 
51,469

Notes payable, net of current portion and unamortized debt issuance costs of $1,136 and $272, respectively
41,878

 
43,878

Deferred income taxes

 
1,130

Other liabilities
2,285

 
2,356

Total liabilities
86,927

 
98,833

Commitments and contingencies


 


Stockholders’ equity:
 
 
 
Common stock, $0.0001 par value. Authorized, 500,000 shares at June 30, 2017 and December 31, 2016; issued and outstanding 50,785 and 50,234 shares at June 30, 2017 and December 31, 2016, respectively
5

 
5

Additional paid-in capital
67,628

 
65,650

Retained earnings
15,191

 
20,590

Total stockholders’ equity
82,824

 
86,245

Total liabilities and stockholders’ equity
$
169,751

 
$
185,078

See accompanying notes to consolidated financial statements.

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PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)


 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2017
 
2016
 
2017
 
2016
Revenues
 
$
35,907

 
$
38,074

 
$
69,016

 
$
76,353

Operating expenses:
 
 
 
 
 
 
 
 
Salaries and benefits
 
20,450

 
20,060

 
41,146

 
41,397

Other operating expenses
 
16,082

 
13,733

 
29,523

 
28,090

Total operating expenses
 
36,532

 
33,793

 
70,669

 
69,487

Income (loss) from operations
 
(625
)
 
4,281

 
(1,653
)
 
6,866

Interest expense
 
(1,618
)
 
(1,841
)
 
(3,224
)
 
(4,273
)
Income (loss) before provision for income taxes
 
(2,243
)
 
2,440

 
(4,877
)
 
2,593

Provision for income taxes
 
197

 
963

 
522

 
1,036

Net income (loss)
 
$
(2,440
)
 
$
1,477

 
$
(5,399
)
 
$
1,557

Net income (loss) per share
 
 
 
 
 
 
 
 
Basic
 
$
(0.05
)
 
$
0.03

 
$
(0.11
)
 
$
0.03

Diluted
 
$
(0.05
)
 
$
0.03

 
$
(0.11
)
 
$
0.03

Weighted average shares
 
 
 
 
 
 
 
 
Basic
 
50,579

 
50,075

 
50,443

 
49,860

Diluted
 
50,579

 
50,527

 
50,443

 
50,347

See accompanying notes to consolidated financial statements.

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PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
(Unaudited)


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
(2,440
)
 
$
1,477

 
$
(5,399
)
 
$
1,557

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(2
)
 
11

 
(5
)
 
25

Comprehensive income (loss)
$
(2,442
)
 
$
1,488

 
$
(5,404
)
 
$
1,582

 
See accompanying notes to consolidated financial statements.





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PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)


 
Six Months Ended 
 June 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(5,399
)
 
$
1,557

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Loss on disposal of assets
10

 
9

Impairment of goodwill and intangible assets
1,081

 

Depreciation and amortization
5,668

 
6,806

Deferred income taxes
667

 
(1,247
)
Stock-based compensation
2,290

 
2,340

Interest expense from debt issuance costs
696

 
550

Write-off unamortized debt issuance costs

 
468

Interest expense paid in kind
217

 

Changes in operating assets and liabilities:
 
 
 
Trade accounts receivable
217

 
6,359

Prepaid expenses and other current assets
(1,806
)
 
228

Income tax receivable
(610
)
 

Other assets
(1
)
 
8

Accrued salaries and benefits
194

 
2,479

Accounts payable
87

 
195

Other current liabilities
(221
)
 
268

Income taxes payable

 
63

Estimated liability for appeals
(126
)
 
287

Net payable to client
30

 
393

Other liabilities
(71
)
 
(110
)
Net cash provided by operating activities
2,923

 
20,653

Cash flows from investing activities:
 
 
 
Purchase of property, equipment, and leasehold improvements
(4,253
)
 
(3,645
)
Net cash used in investing activities
(4,253
)
 
(3,645
)
Cash flows from financing activities:
 
 
 
Repayment of notes payable
(11,285
)
 
(27,038
)
Restricted cash for repayment of notes payable
1,502

 
(7,511
)
Debt issuance costs paid
(296
)
 
(410
)
Taxes paid related to net share settlement of stock awards
(339
)
 
(205
)
Proceeds from exercise of stock options
31

 
330

Income tax benefit from employee stock options

 
99

Payment of purchase obligation

 
(292
)
Net cash used in financing activities
(10,387
)
 
(35,027
)
Effect of foreign currency exchange rate changes on cash
(5
)
 
25

Net decrease in cash and cash equivalents
(11,722
)
 
(17,994
)
Cash and cash equivalents at beginning of period
32,982

 
71,182

Cash and cash equivalents at end of period
$
21,260

 
$
53,188

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes
$
439

 
$
2,096

Cash paid for interest
$
2,328

 
$
3,258


See accompanying notes to consolidated financial statements.

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PERFORMANT FINANCIAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2017 and 2016
(Unaudited)



1. Organization and Description of Business
(a)
Basis of Presentation and Organization
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles, or U.S. GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, the unaudited interim financial statements furnished herein include all adjustments necessary (consisting only of normal recurring adjustments) for a fair presentation of our and our subsidiaries’ financial position at June 30, 2017, the results of our operations for the three and six months ended June 30, 2017 and 2016 and cash flows for the six months ended June 30, 2017 and 2016. Interim financial statements are prepared on a basis consistent with our annual consolidated financial statements. The interim financial statements included herein should be read in conjunction with the consolidated financial statements and related notes included in our annual report on Form 10-K for the years ended December 31, 2016, 2015, and 2014.
The Company is a leading provider of technology-enabled recovery and analytics services in the United States. The Company's services help identify, restructure and recover delinquent or defaulted assets and improper payments for both government and private clients in a broad range of markets. The Company's 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 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), Performant Technologies, Inc., and Performant Europe Ltd. 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. All significant intercompany balances and transactions have been eliminated in consolidation.
The Company is managed and operated as one business, with a single management team that reports to the Chief Executive Officer.
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.
(b)
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 Medicare Recovery Audit Contractor, or RAC, contract with Centers for Medicare and Medicaid Services, or CMS, the Company recognizes revenues when the healthcare provider has paid CMS for a given claim or has agreed to an offset against other claims by the provider. 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 at the time revenue is recognized based on the Company's estimate of the amount of revenue probable of being refunded to CMS following successful appeal. In addition, if the Company's estimate of the liability for appeals with respect to revenues recognized during a prior period changes, the Company increases or decreases current period accruals based on such change in estimated liability. At June 30, 2017, a total of $18.8 million was presented as an allowance against revenue, representing the Company’s estimate of claims audited under the CMS contract that may be overturned. Of this, none was related to accounts receivable and $18.8 million was related to commissions which had already been received. The zero allowance against accounts receivable at June 30, 2017 is due to the fact that the receivable from CMS is netted against an offsetting payable for overturned audits, and at June 30, 2017, the amount of the payable exceeded the amount of the receivable as discussed in note 1(c). In addition to the $18.8 million related to the RAC contract with CMS, the Company has accrued $0.4

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million of additional estimated liability for appeals related to other healthcare contracts. The total accrued liability for appeals of $19.2 million has been presented in the caption estimated liability for appeals at June 30, 2017.  At December 31, 2016, the total appeals-related liability was $19.3 million. The $19.2 million balance at June 30, 2017 and $19.3 million at December 31, 2016, represent the Company’s best estimate of the probable amount of losses related to appeals of claims for which commissions were previously collected. In addition to the $19.2 million amount accrued at June 30, 2017, the Company estimates that it is reasonably possible that it could be required to pay an additional amount up to approximately $5.4 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.
(c)
Net Payable to Client
The Company nets outstanding accounts receivable invoices from an audit and recovery contract against payables for overturned audits. The overturned audits are netted against current fees due on the invoice to the client when they are processed by the client’s system. The “Net payable to client” balance of $13.1 million at June 30, 2017 and December 31, 2016, represent the excess of payables for overturned audits. The Company expects that the net payable to client balance will be paid to the client within the next twelve months.
(d)
Prepaid Expenses and Other Current Assets
At June 30, 2017, prepaid expenses and other current assets includes $5.6 million of amounts estimated to become due from subcontractors. The Company employs subcontractors to audit claims as part of an audit & recovery contract, and to the extent that audits by these subcontractors are overturned on appeal, the fees associated with such claims are contractually refundable to the Company. At June 30, 2017, the receivable associated with estimated future overturns of subcontractor audits was $5.6 million. In addition, at June 30, 2017, prepaid expenses and other current assets includes a net receivable of $3.8 million for subcontractor fees for already overturned audits refundable to the Company once the Company refunds its fees to the client as prime contractor. By comparison, at December 31, 2016, prepaid expenses and other current assets included $5.7 million of estimated future overturns of subcontractor audits, as well as a net receivable of $3.7 million for subcontractor fees for already overturned audits refundable to the Company once the Company refunds its fees to the client as prime contractor.
(e)
Impairment of Goodwill and Long-Lived Assets
Goodwill and 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. For the six months ended June 30, 2017, an impairment expense of $1.1 million was recognized to account for the write-off of goodwill and intangible assets in one of our subsidiaries, Performant Europe Ltd., due to the Company's decision to wind down activity in this business. The expense has been included in other operating expenses in the consolidated statements of operations. There was no impairment expense for goodwill and long-lived assets for the six months ended June 30, 2016.
(f)
Restricted Cash
At June 30, 2017, and at December 31, 2016, restricted cash included in current assets on our consolidated balance sheet was $6.0 million and $7.5 million, respectively. In May 2017, the Company paid $7.5 million to the lenders and deposited $6.0 million into a segregated deposit account in connection with the Eighth Amendment to our Prior Credit Agreement (as defined below). The cash in this segregated deposit account is restricted because it was subject to the exclusive control of the administrative agent as set forth in our Prior Credit Agreement. On August 3, 2017, all of this $6.0 million of restricted cash was paid to the administrative agent for the benefit of the lenders under our Prior Credit Agreement.
(g)
New Accounting Pronouncements
Recently Adopted Accounting Standards
In November 2015, the FASB issued ASU 2015-17, "Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes" ("ASU 2015-17"), which simplifies the reporting requirements of deferred taxes by requiring all organizations to classify all deferred tax assets and liabilities, along with any related valuation allowance, as noncurrent. The guidance is

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effective for public companies with annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. We adopted ASU-2015-17 during our first quarter of 2017 on a prospective basis.
During the first quarter 2017, the Company adopted Accounting Standards Update (ASU) No. 2016-09, "Improvements to Employee Share-Based Payment Accounting" (ASU 2016-09) on a prospective basis.  As a result of the adoption, the Company recognized $27 thousand of income tax benefit related to share-based payments for the three months ended June 30, 2017 and $84 thousand of income tax expense for the six months ended June 30, 2017.  These tax benefits, or shortfalls, were historically recorded in equity.  In addition, cash flows related to excess tax benefits, or shortfalls, are now classified as an operating activity.  Cash paid on employees’ behalf related to shares withheld for tax purposes is classified as a financing activity, consistent with prior year’s presentation.
Recently Issued Accounting Standards
In May 2014, the FASB issued an ASU that amends the FASB ASC by creating a new Topic 606, "Revenue from Contracts with Customers". The new guidance will supersede the revenue recognition requirements in Topic 605, "Revenue Recognition", and most industry-specific guidance on revenue recognition throughout the Industry Topics of the Codification. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply a five step model for recognizing and measuring revenue from contracts with customers. In addition, an entity should disclose sufficient qualitative and quantitative information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The new revenue recognition guidance, including subsequent amendments, is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, with the option to early adopt the standard for annual periods beginning after December 15, 2016. We have not adopted this guidance early and are currently evaluating the effect on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, “Leases”, which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. This new guidance is effective for annual reporting periods beginning after December 15, 2018 with early adoption permitted. We have not adopted this guidance early and are currently evaluating the effect on our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments” which provides guidance on the presentation of certain cash receipts and cash payments in the statement of cash flows in order to reduce diversity in existing practice. This new guidance is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. This new standard requires retrospective adoption, with a provision for impracticability. We have not adopted this guidance early and are currently evaluating the effect on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment" to simplify the goodwill impairment testing process. The new standard eliminates Step 2 of the goodwill impairment test. If a company determines in Step 1 of the goodwill impairment test that the carrying value of goodwill is less than the fair value, an impairment in that amount should be recorded to the income statement, rather than proceeding to Step 2. This new guidance is effective for annual reporting periods, and interim periods with goodwill impairment tests within those years, beginning after December 15, 2019, and early adoption is permitted for testing periods after January 1, 2017. We have not adopted this guidance early and are currently evaluating the effect on our consolidated financial statements.

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2. Property, Equipment, and Leasehold Improvements
Property, equipment, and leasehold improvements consist of the following at June 30, 2017 and December 31, 2016 (in thousands):
 
June 30,
2017
 
December 31,
2016
Land
$
1,122

 
$
1,122

Building and leasehold improvements
6,223

 
6,203

Furniture and equipment
5,740

 
5,656

Computer hardware and software
71,909

 
67,861

 
84,994

 
80,842

Less accumulated depreciation and amortization
(62,189
)
 
(57,107
)
Property, equipment and leasehold improvements, net
$
22,805

 
$
23,735

Depreciation expense of property, equipment and leasehold improvements was $2.7 million and $2.4 million for the three months ended June 30, 2017 and 2016, respectively, $5.2 million and $4.9 million for the six months ended June 30, 2017 and 2016, respectively.
3. Credit Agreement
On March 19, 2012, we, through our wholly owned subsidiary, entered into a $147.5 million credit agreement, as amended and restated, with Madison Capital Funding LLC as administrative agent, ING Capital LLC as syndication agent, and other lenders party thereto (as amended, the "Prior Credit Agreement"). The senior credit facility consists of (i) a $57.0 million Term A loan that matured and was fully paid in March 2017, (ii) a $79.5 million Term B loan that matures in June 2018, and (iii) a $11.0 million revolving credit facility that expired and was fully paid in March 2017. On June 28, 2012, we amended the Credit Agreement to increase the amount of our borrowings under our Term B loan by $19.5 million.
On November 4, 2014, February 19, 2016, July 26, 2016, October 27, 2016, and March 22, 2017, the Prior Credit Agreement was further amended to, among other things, modify a number of existing covenants and add new covenants requiring the Company to maintain a minimum cash balance, comply with an interest coverage ratio and achieve minimum EBITDA levels. On May 3, 2017, we further amended the credit agreement (the "Eighth Amendment") to extend the maturity date of the Term B loan to June 19, 2018. As a result of this extension, regularly scheduled quarterly amortization payments of $247,500 will also extend through March 31, 2018, with the remaining outstanding principal amount being due on the June 19, 2018 maturity date. Interest on the Term B loan charged under the credit agreement was also increased by 3.00% per annum, however the amount of such increased interest will be payable in kind. Pursuant to the Eighth Amendment, the quarterly and annual financial reporting covenants were also modified to require that the Company’s financial statements not contain a qualification, if required by GAAP, with respect to our ability to continue as a going concern.
On August 7, 2017, we, through our wholly-owned subsidiary Performant Business Services, Inc. (the "Borrower"), entered into a new credit agreement with ECMC Group, Inc. (the “New Credit Agreement”).  The New Credit Agreement provides for a term loan facility in the initial amount of $44 million (the “Initial Term Loan”) and for up to $15 million of additional term loans (“Additional Term Loans”; and together with the Initial Term Loan, the “Loans”) which Additional Term Loans may be drawn until the second anniversary of the funding of the Initial Term Loans, subject to the satisfaction of customary conditions.  On or around August 11, 2017, and subject to the satisfaction of customary conditions, we expect the Initial Term Loan will be advanced (the "Closing Date") and when advanced the proceeds will be applied to repay all outstanding amounts under the Prior Credit Agreement.  Approximately $2 million of contingent reimbursement obligations with respect to outstanding but undrawn letters of credit will remain outstanding under the Prior Credit Agreement, however, those contingent reimbursement obligations will remain cash collateralized with the administrative agent.
The Loans will mature on the third anniversary of the Closing Date, however we will 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 will 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.  The Initial Term Loan will initially bear interest at LIBOR plus 7.0% per annum.  We will be required to repay 5% of the original principal balance of the Loans annually in quarterly installments and to offer 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.  In addition to mandatory prepayments for excess cash flow, we will also be required to offer to prepay the Loans with the net cash proceeds of certain asset dispositions and with the issuance of debt

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not otherwise permitted under the New Credit Agreement.  Except in connection with a change of control and the payment of a 1% premium, we will not be permitted to voluntarily prepay the Loans until after the first anniversary of the Closing Date.  We will be permitted to prepay the Loans during the second year after the Closing Date if accompanied by a prepayment premium of 1%.  Thereafter, we will be permitted to prepay the Loans without any prepayment premium.
The New Credit Agreement contains certain restrictive financial covenants which will become effective on the Closing Date. Such covenants, will require, among other things, that we meet a minimum fixed charge coverage ratio of 0.5 to 1.0 through December 31, 2019, 1.0 to 1.0 through June 30, 2020 (or until December 31, 2020 if the maturity date of the Loans is extend until the fourth anniversary of the Closing Date), 1.25 to 1.0 through June 30, 2021 if the maturity date of the Loans is extended until the fourth anniversary of the Closing Date and 1.25 to 1.0 through June 30, 2022 if the maturity date of the Loans is extended until the fifth anniversary of the Closing Date. In addition, we will be required to maintain, a maximum total debt to EBITDA ratio of 6.00. The New Credit Agreement also contains covenants that will restrict the Company and its subsidiaries’ ability to incur certain types or amounts of indebtedness, incur liens on certain assets, make material changes in corporate structure or the nature of its business, dispose of material assets, engage in a change in control transaction, make certain foreign investments, enter into certain restrictive agreements, or engage in certain transactions with affiliates.
The obligations under the New Credit Agreement will be secured by substantially all of our United States domestic subsidiaries' assets and will be guaranteed by the Company and its United States domestic subsidiaries, other than the Borrower.
In consideration for, and concurrently with, the extension of the Initial Term Loan in accordance with the terms of the New Credit Agreement, we will issue 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 GAAP for the most recent fiscal quarter) with an exercise price of $1.92 per share. Upon our election to borrow any 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 GAAP for the most recent fiscal quarter) for each $1,000,000 of such Additional Term Loans.
4. Commitments and Contingencies
We have entered into various non-cancelable operating lease agreements for certain of our office facilities and equipment with original lease periods expiring between 2017 and 2022. Certain of these arrangements have free rent periods and /or escalating rent payment provisions, and we recognize rent expense under such arrangements on a straight-line basis.
Future minimum rental commitments under non-cancelable leases as of June 30, 2017 are as follows (in thousands):
 
 
Year Ending December 31,
Amount
Remainder of 2017
$
932

2018
1,874

2019
1,808

2020
1,679

2021
1,007

Thereafter
585

Total
$
7,885

Operating lease expense was $0.7 million and $0.7 million for the three months ended June 30, 2017 and 2016, respectively, and was $1.4 million and $1.4 million for the six months ended June 30, 2017 and 2016, respectively.
5. Stock-based Compensation
(a) Stock Options
Total stock-based compensation expense charged as salaries and benefits expense in the consolidated statements of operations was $1.2 million and $1.1 million for the three months ended June 30, 2017 and 2016, respectively, and $2.3 million and $2.3 million for the six months ended June 30, 2017 and 2016, respectively.

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The following table shows stock option activity for the six months ended June 30, 2017:
 
Outstanding
Options
 
Weighted
average
exercise price
per share
 
Weighted
average
remaining
contractual life
(Years)
 
Aggregate
Intrinsic Value
(in thousands)
Outstanding at December 31, 2016
3,506,529

 
$
7.32

 
5.04
 
$
1,367

Granted

 

 
 
 
 
Forfeited
(123,794
)
 
4.15

 
 
 
 
Exercised
(61,459
)
 
0.50

 
 
 
 
Outstanding at June 30, 2017
3,321,276

 
$
7.56

 
4.51
 
$
1,007

Vested, exercisable, expected to vest(1) at June 30, 2017
3,308,040

 
$
7.57

 
4.50
 
$
1,006

Exercisable at June 30, 2017
3,043,139

 
$
7.65

 
4.28
 
$
991

 
(1)
Options expected to vest reflect an estimated forfeiture rate.
The Company recognizes share-based compensation costs as expense on a straight-line basis over the option vesting period, which generally is four to five years.
(b) Restricted Stock Units and Performance Stock Units
The following table summarizes restricted stock unit and performance stock unit activity for the six months ended June 30, 2017:
 
Number of Awards
 
Weighted
average
grant date fair value
per share
Outstanding at December 31, 2016
2,060,240

 
$
2.70

Granted
1,237,500

 
2.44

Forfeited
(158,375
)
 
3.00

Vested and converted to shares, net of units withheld for taxes
(489,642
)
 
2.18

Units withheld for taxes
(186,985
)
 
2.18

Outstanding at June 30, 2017
2,462,738

 
$
2.69

Expected to vest at June 30, 2017
2,339,601

 
$
2.69

Restricted stock units and performance stock units granted under the Performant Financial Corporation 2012 Stock Incentive Plan generally vest over periods ranging from one to four years.
6. Income Taxes
Our effective income tax rate changed to a negative rate of (10.7)% for the six months ended June 30, 2017 from 40.0% for the six months ended June 30, 2016. The decrease in the effective tax rate is primarily due to loss from operations generated in the six months ended June 30, 2017 for which no tax benefit is recognized compared to the income tax expense recorded on income from operations for the six months ended June 30, 2016.
We file income tax returns with the U.S. federal government and various state jurisdictions. We operate in a number of state and local jurisdictions, most of which have never audited our records. Accordingly, we are subject to state and local income tax examinations based upon the various statutes of limitations in each jurisdiction. For tax years before 2012, the Company is no longer subject to Texas and certain state tax examinations. For tax years before 2013 the Company is no longer subject to Federal and certain other state tax examinations. We are currently being examined by the Franchise Tax Board of California for tax years 2011 through 2014. For tax years before 2011, the Company is no longer subject to California tax examinations.

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7. Earnings per Share
For the three and six months ended June 30, 2017 and 2016, basic income per share is calculated by dividing net income by the sum of the weighted average number of shares of Common Stock outstanding during the period. Diluted income per share is calculated by dividing net income by the weighted average number of shares of Common Stock and dilutive common share equivalents outstanding during the period. Common share equivalents consist of stock options, restricted stock units, and performance stock units. When there is a loss in the period, dilutive common share equivalents are excluded from the calculation of diluted earnings per share, as their effect would be anti-dilutive. For example, for the three months and six months ended June 30, 2017, dilutive common share equivalents have been excluded, and diluted weighted average shares outstanding are the same as basic average shares outstanding. When there is net income in the period, the Company excludes stock options, restricted stock units, and performance stock units from the calculation of diluted earnings per share when the combined exercise price, unamortized fair value and excess tax benefits of the options exceed the average market price of the Company's common stock because their effect would be anti-dilutive. For the three months and six months ended June 30, 2016, the Company excluded 3,598,325 and 4,472,779 options, respectively, from the calculation of diluted earnings per share because their effect would be anti-dilutive.
The following table reconciles the basic to diluted weighted average shares outstanding using the treasury stock method (shares in thousands):
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2017
 
2016
 
2017
 
2016
Weighted average shares outstanding – basic
 
50,579

 
50,075

 
50,443

 
49,860

Dilutive effect of stock options
 

 
452

 

 
487

Weighted average shares outstanding – diluted
 
50,579

 
50,527

 
50,443

 
50,347

8. Subsequent Events
On August 7, 2017, we, through our wholly-owned subsidiary entered into a new credit agreement with ECMC Group, Inc. (the “New Credit Agreement”).  The New Credit Agreement provides for a term loan facility in the initial amount of $44 million (the “Initial Term Loan”) and for up to $15 million of additional term loans (“Additional Term Loans”; and together with the Initial Term Loan, the “Loans”) which Additional Term Loans may be drawn until the second anniversary of the funding of the Initial Term Loans, subject to the satisfaction of customary conditions.  On or around August 11, 2017, and subject to the satisfaction of customary conditions, we expect the Initial Term Loan will be advanced (the "Closing Date") and when advanced the proceeds will be applied to repay all outstanding amounts under the Prior Credit Agreement.  Approximately $2 million of contingent reimbursement obligations with respect to outstanding but undrawn letters of credit remain outstanding under the Prior Credit Agreement, however, those contingent reimbursement obligations will remain cash collateralized with the administrative agent.
The Loans will mature on the third anniversary of the Closing Date, however we will 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 will 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.  The Initial Term Loans will initially bear interest at LIBOR plus 7.0% per annum.  We will be required to pay 5% of the original principal balance of the Loans annually in quarterly installments and to offer 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.  In addition to mandatory prepayments for excess cash flow, we will also be required to offer to prepay the Loans with the net cash proceeds of certain asset dispositions and with the issuance of debt not otherwise permitted under the New Credit Agreement.  Except in connection with a change of control and the payment of a 1% premium, we will not be permitted to voluntarily prepay the Loans until after the first anniversary of the Closing Date.  We will be permitted to prepay the Loans during the second year after the Closing Date if accompanied by a prepayment premium of 1%. Thereafter, we will be permitted to prepay the Loans without any prepayment premium.
The New Credit Agreement contains certain restrictive financial covenants which will become effective on the Closing Date. Such covenants will require, among other things, that we meet a minimum fixed charge coverage ratio of 0.5 to 1.0 through December 31, 2019 and 1.0 to 1.0 through June 30, 2020 (or until December 31, 2020 if the maturity date of the Loans is extend until the fourth anniversary of the Closing Date), 1.25 to 1.0 through June 30, 2021 if the maturity date of the Loans is extended until the fourth anniversary of the Closing Date and 1.25 to 1.0 through June 30, 2022 if the maturity date of the Loans is extended until the fifth anniversary of the Closing Date. In addition, we will be required to maintain, a maximum total debt to EBITDA ratio of 6.00. The New Credit Agreement also contains covenants that will restrict the Company and its

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subsidiaries’ ability to incur certain types or amounts of indebtedness, incur liens on certain assets, make material changes in corporate structure or the nature of its business, dispose of material assets, engage in a change in control transaction, make certain foreign investments, enter into certain restrictive agreements, or engage in certain transactions with affiliates.
The obligations under the New Credit Agreement will be secured by substantially all of our and our United States domestic subsidiaries’ assets and are guaranteed by the Company and its United States domestic subsidiaries, other than the Borrower.
In consideration for, and concurrently with, the extension of the Initial Term Loan in accordance with the terms of the New 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 GAAP for the most recent fiscal quarter) with an exercise price of $1.92 per share. Upon our election to borrow any 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 GAAP for the most recent fiscal quarter) for each $1,000,000 of such Additional Term Loans.


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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion in conjunction with our condensed consolidated financial statements (unaudited) and related notes included elsewhere in this report. This report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The words “believe,” “may,” “will,” “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. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors” under Item 1A of Part II of this report. In light of these risks, uncertainties and assumptions, the forward-looking events and trends discussed in this report may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Forward-looking statements include, but are not limited to, statements about 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 our ability to maintain such client relationships; our ability to maintain compliance with the covenants in our debt agreements; 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; the sufficiency of our appeals reserve; 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. The forward-looking statements in this report speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
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.
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.

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Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
 
(in thousands)
Student Lending:
 
 
 
 
 
 
 
                Department of Education
$
1,257

 
$
6,982

 
$
2,944

 
$
14,337

                Guaranty Agencies and Other
26,202

 
21,804

 
49,064

 
44,073

                            Total of Student Lending
27,459

 
28,786

 
52,008

 
58,410

Healthcare:
 
 
 
 
 
 
 
                CMS RAC
66

 
2,268

 
148

 
3,464

                Commercial
2,022

 
1,083

 
3,587

 
2,616

                            Total of Healthcare
2,088

 
3,351

 
3,735

 
6,080

Other:
6,360

 
5,937

 
13,273

 
11,863

Total Revenues
$
35,907

 
$
38,074

 
$
69,016

 
$
76,353

Student Lending
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. Our clients in the student loan recovery market mainly consist of several of the largest guaranty agencies, or GAs. In addition, we have a long history of also providing recovery services to the Department of Education. However, in December 2016, the Department of Education awarded contracts for student loan recovery services to seven contractors and we were not a recipient of one of these contract awards. We, along with 19 other contractors who did not receive contract awards from the Department of Education, filed protests with the GAO regarding the Department of Education’s award of these contracts. In March 2017, the GAO upheld our protest. The Department of Education requested resubmittal of new contract proposals and is currently undergoing a re-evaluation process with respect to such proposals. The Department of Education has indicated a target date towards the end of August 2017 for the award of the new contracts. We have been one of the Department of Education’s unrestricted student loan recovery contractors for more than 20 years until our prior contract expired in April 2015.
We believe the size and the composition of our student loan inventory at any point provides us with a significant degree of revenue visibility for our student loan revenues. 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.
Our key metric in evaluating our student lending business is 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.
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
(in thousands)
Student Lending Placement Volume:
 
 
 
 
 
 
 
 
          Department of Education
 
$

 
$

 
$

 
$
5,082

          Guaranty Agencies and Other
 
891,387

 
1,280,988

 
1,574,660

 
1,861,087

Total Student Lending Placement Volume
 
$
891,387

 
$
1,280,988

 
$
1,574,660

 
$
1,866,169

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

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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, except that beginning in July 2015, our contract with the Department of Education has provided for a fixed fee of $1,710 for each rehabilitated loan. The fees we are paid vary by recovery outcome as well as by contract. In addition, under our contracts with our GA clients, we generally recognize revenue when our GA clients rehabilitate and recall the loans which has been placed with us. At times, our GA clients may be delayed in recalling loans or may wait to rehabilitate loans based on events that are not in our control. 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.
Student Loan Recovery Outcomes
Full Repayment
 
Recurring Payments
 
Rehabilitation
 
Loan Restructuring
 
Wage Garnishment
•    Repayment in full of the loan
 
•    Regular structured payments, typically according to a renegotiated payment plan
 
•    After a defaulted borrower has made nine consecutive recurring payments, the loan is eligible for rehabilitation
 
•    Restructure and consolidate a number of outstanding loans into a single loan, typically with one monthly payment and an extended maturity
 
•    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 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 or for the Department of Education, a fixed fee
 
•    We are paid based on a percentage of overall value of the restructured loan
 
•    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, in contrast 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 June 30, 2017, we had two MSA clients in the student loan market. On June 15, 2017, we received a 30-day termination notice from one of our significant GA clients, Great Lakes Higher Education Guaranty Corporation. The termination of this contract was based on Great Lake’s decision to bundle its student loan servicing work, a service that we currently do not provide, along with its student loan recovery work to a single third party vendor. Since we received the termination notice from Great Lakes, we have received notices from Great Lakes to allow us to continue to provide certain student loan services for three additional 30-day periods.
In October 2014, the Department of Education announced a change in the structure for the payment of fees to recovery contractors upon rehabilitation of student loans under the existing recovery contract. The new fee structure provides for a fixed fee of $1,710 for each loan that is rehabilitated. Previously, the fee had been based on a percentage of the principal amount of the rehabilitated loan. The change to the fee structure became effective for student loans rehabilitated on or following July 1, 2015. 
Further, the Bipartisan Budget Act of 2013 reduced the compensation paid to GAs for the rehabilitation of student loans, effective July 1, 2014. This “revenue enhancement” measure reduced the amount that GAs can charge borrowers from 18.5% to 16.0% of the outstanding loan balance, when a rehabilitated loan is sold by the GA and eliminated entirely the GAs retention of 18.5% of the outstanding loan balance as a fee for rehabilitation services. The reduction in compensation the GAs receive resulted in a decrease in the contingency fee percentage that we receive from the GAs for assisting in the rehabilitation of defaulted student loans.

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Healthcare
We derive revenues from the healthcare market primarily from our RAC contracts, under which we are responsible for detecting improperly paid Part A and Part B Medicare claims. Revenues earned under the RAC contracts 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.
Our first RAC contract was wound down and then terminated in 2016 in connection with CMS's plan to award new contracts. 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, there is uncertainty regarding the scope of audit that will be permitted by CMS under the new RAC contracts. In connection with the wind down of our first RAC contract, CMS adopted a series of contract transition procedures and other restrictions, beginning in 2013, that limited the types of claims we are permitted to audit and our ability to request medical records for audit and CMS suspended our ability to perform any audit services for certain periods of time, thus materially adversely affecting our revenues under that contract. In May 2016, CMS announced that the recovery audit contractors would not be able to request documents from providers for audit after May 16, 2016 and would not be able to submit claims for improper payments after July 29, 2016, effectively terminating additional revenue generating activity under our first RAC contract. Revenues for the year ended December 31, 2016 from our first RAC contract were $5.7 million, compared with $12.5 million for 2015 and $29.2 million in 2014. We do not expect to recognize significant revenues from the newly awarded RAC contracts for four to six months after the start date of April 2017 for the new RAC contracts meaning that these new contracts will not have a significant impact on 2017 revenues, although we will incur related start-up expenses in 2017.
In connection with our first RAC contract, CMS announced a settlement offer to pay hospitals 68% of what they have billed Medicare to settle a backlog of pending appeals challenging Medicare's denials of reimbursement for certain types of short-term care. The implication of this settlement offer related to claims for which fees have already been paid to recovery auditors under existing RAC contracts is unclear at this time, but we may be obligated to repay certain amounts that we previously received from CMS depending on the final terms of any such settlement. 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. The $18.8 million balance as of June 30, 2017, represents our best estimate of the probable amount of we may be required to refund 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 an additional amount up to approximately $5.4 million as a result of potentially successful appeals in excess of the amount we accrued as of June 30, 2017.
In connection with the award of our first RAC contract, we outsourced certain aspects of our healthcare recovery process to three different subcontractors. Two of these subcontractors provided a specific service to us in connection with our claims recovery process, with the third subcontractor, whose services were terminated in December 2016, formerly providing all of the audit and recovery services for claims within a portion of our region. We recognize all of the revenues generated by the claims recovered through our subcontractor relationships, and we recognize the fees that we pay to these subcontractors in our expenses.
For our commercial healthcare business, our business strategy is focused on utilizing our technology-enabled services platform to provide audit, recovery and analytical services for private healthcare payors. We have entered into contracts with several private payors, although these contracts are in the early stage of implementation. Revenues from our commercial healthcare clients were $2.0 million for the quarter ended June 30, 2017, compared to revenues of $1.1 million that we earned from our commercial healthcare clients in the quarter ended June 30, 2016.
Other
We also derive revenues from the recovery of delinquent state taxes, and federal Treasury and other receivables, specialty administrative customer care functions, 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.

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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. 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 over the long term. As a result, we expect our overall expenses to modestly decline as a percentage of 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, client retention 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.
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, the fees that we earned under our contractual arrangement with the Department of Education were subject to unilateral change by the Department of Education as a result of the Department of Education’s decision to have its recovery vendors promote IBR to defaulted student loans. In connection with the implementation of the IBR program, the Department of Education reduced the contingency fee rate that we receive for rehabilitating student loans by approximately 13% effective March 1, 2013.
Further, the Department of Education changed its fee structure to a fixed recovery fee of $1,710 for each rehabilitated loan, effective as of July 1, 2015. The fixed recovery fee is payable for each loan that is rehabilitated and replaced a recovery fee structure that historically had been based on a percentage of the balance of the rehabilitated loan.
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

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portfolio of defaulted student loans toward the Department of Education for which we are no longer a contractor (subject to resolution of our recently upheld protest). 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 Retention
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 2016 and 2015, three providers of student loans each accounted for more than 10% of our revenues and they collectively accounted for 55% of our total revenues in each year. Our contract with the Department of Education, which generated 16% of our revenues in 2016, expired in April 2015 and we were not selected as a vendor on the new contract announced in December 2016. We, along with 19 other contractors who did not receive contract awards from the Department of Education, filed protests regarding the Department of Education’s award of these contracts. In March 2017, our protest was upheld. The Department of Education requested resubmittal of new contract proposals and is currently undergoing a re-evaluation process with respect to such proposals. The Department of Education has indicated a target date towards the end of August 2017 for the award of the new contracts. If we are not successful in obtaining a new contract as a result of a conclusive award process, the absence of a contract with the Department of Education will have a material adverse effect on our financial condition and results of operations in 2018 and beyond. Our contracts with our other large clients entitle them to unilaterally terminate their contractual relationship with us at any time without penalty. In June 2017, one of the Company's principal customers, Great Lakes Higher Education Guaranty Corporation, notified the Company that it is terminating the Company's student loan recovery contract. If we lose one of our other 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.
The award of our two new RAC contracts in October 2016 has removed the uncertainty related to the retention of our relationship with CMS. However, while audit and recovery activity under the new contracts has commenced, the scope of our permitted audit activity remains uncertain. We do not expect to recognize significant revenue under our newly awarded RAC contracts for four to six months after we were permitted to begin performing recovery services under the new RAC contracts in April 2017.
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 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.

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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 contracts with CMS, we recognize revenues when the healthcare provider has paid CMS for a claim or has agreed to an offset against other claims by the provider. Healthcare providers have the right to appeal a claim and may pursue additional level of appeals if the initial appeal is found in favor of CMS. We accrue an estimated liability for appeals at the time revenue is recognized based on our estimate of the amount of revenue probable of being returned to CMS following successful appeal based on historical data and other trends relating to such appeals. In addition, if our estimate of liability for appeals with respect to revenues recognized during a prior period changes, we increase or decrease the estimated liability for appeals in the current period.
This estimated liability for appeals is an offset to revenues on our income statement. Resolution of appeals can take a very long time to resolve and there is a significant backlog in the system for resolving appeals, as over the course of our existing RAC contract, healthcare providers have increased their pursuit of appeals beyond the first and second levels of appeal to the third level of appeal, where cases are heard by administrative law judges, or ALJs. In our experience, decisions at the third level of appeal are the least favorable as ALJs exercise greater discretion and there is less predictability in the ALJ decisions as compared to appeals at the first or second levels. This increase of ALJ appeals and backlog of claims at the third level of appeal is the primary reason our total estimated liability for appeals (consisting of the estimated liability for appeals plus the contra-accounts-receivable estimated allowance for appeals) has remained at a consistent level despite decreasing revenue from CMS. The balance of the estimated liability for appeals remained at $18.8 million as of June 30, 2017 primarily due to the relatively slow pace of the decisions at the ALJ level. In addition to the $18.8 million related to the RAC contract with CMS, the Company has accrued $0.4 million of additional estimated liability for appeals related to other healthcare contracts. The total accrued liability for appeals is therefore $19.2 million at June 30, 2017.
The $19.2 million balance as of June 30, 2017, 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 $5.4 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.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued an ASU that amends the FASB ASC by creating a new Topic 606, Revenue from Contracts with Customers. The new guidance will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance on revenue recognition throughout the Industry Topics of the Codification. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply a five step model for recognizing and measuring revenue from contracts with customers. In addition, an entity should disclose sufficient qualitative and quantitative information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The new revenue recognition guidance, including subsequent amendments, is effective for annual reporting periods beginning on or after December 15, 2017, including interim periods within that reporting period, with the option to early adopt the standard for annual periods beginning on or after December 15, 2016.
We are currently in the process of assessing the impact from the adoption of this guidance on our consolidated financial statements. As part of this process, we are considering our major revenue streams and evaluating our significant contracts therein for potential changes in the amounts and timing of revenue recognition under the new guidance. Based on the work performed to date, we have determined that the following areas are of primary focus: consideration of termination rights and resulting impact on the duration of a contract, applicability of treatment as variable consideration for refund rights and certain incentive payments, including the impact of constraints, applicability of the variable consideration allocation exception to allocate purchase consideration to performance obligations considered to be a series, and ability to use the ‘right to invoice’ practical expedient for measuring satisfaction of performance obligations within certain contracts. We are also in the process of evaluating our various commission and bonus programs to identify costs that may be subject to potential deferral and amortization as costs to obtain a contract. In addition, we are evaluating the disclosure requirements of the new guidance, subject to the above determinations on areas most likely to be impacted by our adoption. We expect to have our preliminary evaluation, including the selection of an adoption method, completed by the end of the third quarter of 2017. We expect to adopt the new revenue recognition guidance in the first quarter of 2018.

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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.
We assess goodwill for impairment on an annual basis as of November 30 of each year or more frequently if an event occurs or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying amount. We have the option to perform a qualitative assessment to determine if an impairment is more likely than not to have occurred. If we can support the conclusion that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then we would not need to perform the two-step impairment test. If we cannot support such a conclusion, or we do not elect to perform the qualitative assessment, then 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 carrying amount, including goodwill. We performed a qualitative assessment of whether it is more likely than not that the reporting unit fair value is less than its carrying amount as of June 30, 2017, and concluded that based on our decision to wind down the activity of Performant Europe Ltd., the fair value is more likely than not less than its carrying amount. Accordingly, the goodwill balance for the healthcare audit acquisition was $0.9 million, and we recognized a goodwill impairment loss of this amount as of June 30, 2017. Based on our qualitative analysis, there was no need to perform an additional impairment test.
Impairments of Depreciable Intangible Assets
The balance of depreciable intangible assets was $5.3 million as of June 30, 2017. 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. For the six months ended June 30, 2017, an impairment expense of $0.1 million was recognized to account for the impairment charge in Performant Europe Ltd. due to the Company's decision to wind down this subsidiary, and has been included in other operating expenses in the consolidated statements of operations. For the year ended December 31, 2016, an impairment expense of $15.4 million was recognized relating to the Department of Education customer relationship and was presented as a separate caption in the consolidated statements of operations.
Recent Accounting Pronouncements
See "Recent Accounting Pronouncements" in Note 1(g) of the Consolidated Financial Statements included in Part I - Item 1 of this report.
Results of Operations
Three Months Ended June 30, 2017 compared to the Three Months Ended June 30, 2016

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The following table represents our historical operating results for the periods presented: 
 
Three Months Ended June 30,
 
2017
 
2016
 
$ Change
 
% Change
 
(in thousands)
Consolidated Statement of Operations Data:







Revenues
$
35,907

 
$
38,074

 
$
(2,167
)
 
(6
)%
Operating expenses:
 
 
 
 
 
 
 
       Salaries and benefits
20,450

 
20,060

 
390

 
2
 %
       Other operating expenses
16,082

 
13,733

 
2,349

 
17
 %
Total operating expenses
36,532

 
33,793

 
2,739

 
8
 %
Income (loss) from operations
(625
)
 
4,281

 
(4,906
)
 
(115
)%
       Interest expense
(1,618
)
 
(1,841
)
 
(223
)
 
(12
)%
Income before provision for income taxes
(2,243
)
 
2,440

 
(4,683
)
 
(192
)%
       Provision for income taxes
197

 
963

 
(766
)
 
(80
)%
Net income (loss)
$
(2,440
)
 
$
1,477

 
$
(3,917
)
 
(265
)%
Revenues
Revenues were $35.9 million for the three months ended June 30, 2017, a decrease of approximately 6%, compared to revenues of $38.1 million for the three months ended June 30, 2016.
Student lending revenues were $27.5 million for the three months ended June 30, 2017, representing a decrease of $1.3 million, or 5%, compared to the three months ended June 30, 2016. The decrease was primarily a result of the reduction of revenues from the Department of Education as we have not received new placements of student loans from the Department of Education since our contact expired in April 2015. The overall decrease in student lending revenues during the quarter was partially offset by approximately $4.3 million of revenue during the quarter based on delayed student rehabilitation revenues we received from one of our GA clients.
Healthcare revenues were $2.1 million for the three months ended June 30, 2017, representing a decrease of $1.3 million, or 38%, compared to the three months ended June 30, 2016. This decrease was due primarily to the wind down of our first RAC contract and that we will not start to recognize revenues under our new RAC contracts until four to six months are services began in April 2017.
Salaries and Benefits
Salaries and benefits expense was $20.5 million for the three months ended June 30, 2017, an increase of $0.4 million, or 2%, compared to salaries and benefits expense of $20.1 million for the three months ended June 30, 2016. The increase in salaries and benefits expense was primarily due to increased headcount.
Other Operating Expenses
Other operating expenses were $16.1 million for the three months ended June 30, 2017, an increase of $2.3 million, or 17%, compared to other operating expenses of $13.7 million for the three months ended June 30, 2016. The increase in other operating expenses was primarily due to goodwill and intangible impairment charges for Performant Europe Ltd. and higher outside services consulting expenses.
Income (loss) from Operations
Loss from operations was $0.6 million for the three months ended June 30, 2017, compared to income from operations of $4.3 million for the three months ended June 30, 2016, representing a decrease of $4.9 million or 115%. The decrease was primarily the result of lower revenues and increased other operating expenses.

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Interest Expense
Interest expense was $1.6 million for the three months ended June 30, 2017, compared to $1.8 million for the three months ended June 30, 2016. Interest expense decreased by approximately $0.2 million or 12% due to repayments of principal under our credit agreement, resulting in a lower outstanding balance.
Income Taxes
We recognized an income tax expense of $0.2 million for the three months ended June 30, 2017, compared to an income tax expense of $1.0 million for the three months ended June 30, 2016. Our effective income tax rate decreased to a negative rate of (8.8)% for the three months ended June 30, 2017, from 39.5% for the three months ended June 30, 2016. The decrease in the effective tax rate is primarily due to loss from operations generated in the three months ended June 30, 2017 for which no tax benefit is recognized compared to the income tax expense recorded on income from operations for the three months ended June 30, 2016.
Net Income (Loss)
As a result of the factors described above, net loss was $2.4 million for the three months ended June 30, 2017, which represented a decrease of $3.9 million, or 265% compared to net income of $1.5 million for the three months ended June 30, 2016.
Six Months Ended June 30, 2017 compared to the Six Months Ended June 30, 2016
The following table represents our historical operating results for the periods presented:
 
Six Months Ended June 30,
 
2017
 
2016
 
$ Change
 
% Change
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenues
$
69,016

 
$
76,353

 
$
(7,337
)
 
(10
)%
Operating expenses:
 
 
 
 
 
 
 
       Salaries and benefits
41,146

 
41,397

 
(251
)
 
(1
)%
       Other operating expenses
29,523

 
28,090

 
1,433

 
5
 %
Total operating expenses
70,669

 
69,487

 
1,182

 
2
 %
Income (loss) from operations
(1,653
)
 
6,866

 
(8,519
)
 
(124
)%
       Interest expense
(3,224
)
 
(4,273
)
 
(1,049
)
 
(25
)%
Income before provision for income taxes
(4,877
)
 
2,593

 
(7,470
)
 
(288
)%
       Provision for income taxes
522

 
1,036

 
(514
)
 
(50
)%
Net income (loss)
$
(5,399
)
 
$
1,557

 
$
(6,956
)
 
(447
)%
Revenues
Revenues were $69.0 million for the six months ended June 30, 2017, a decrease of approximately 10%, compared to revenues of $76.4 million for the six months ended June 30, 2016.
Student lending revenues were $52.0 million for the six months ended June 30, 2017, representing a decrease of $6.4 million, or 11%, compared to the six months ended June 30, 2016. The decrease was primarily a result of the reduction of revenues from the Department of Education due to the lack of placements of new student loans from the Department of Education since our contract expired in April 2015, which was partially offset by an increase in the number of borrowers that are participating in the rehabilitation programs with our Guaranty Agency clients.
Healthcare revenues were $3.7 million for the six months ended June 30, 2017, representing a decrease of $2.3 million, or 38%, compared to the six months ended June 30, 2016. This decrease was due primarily to the CMS RAC contract transition, partially offset by an approximately $1.0 million increase in revenues from commercial healthcare customers.

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Salaries and Benefits
Salaries and benefits expense was $41.1 million for the six months ended June 30, 2017, a decrease of $0.3 million, or 1%, compared to salaries and benefits expense of $41.4 million for the six months ended June 30, 2016. This decrease in salaries and benefits expense was primarily due to reduced incentive compensation.
Other Operating Expenses
Other operating expenses were $29.5 million for the six months ended June 30, 2017, an increase of $1.4 million, or 5%, compared to other operating expenses of $28.1 million for the six months ended June 30, 2016. The increase in other operating expenses was primarily due to goodwill and intangible impairment charges for Performant Europe Ltd. and higher outside services consulting expenses, which was offset by lower amortization related to a $15.4 million Department of Education customer relationship intangible impairment charge in 2016.
Income (Loss) from Operations
Loss from operations was $1.7 million for the six months ended June 30, 2017, compared to income from operations of $6.9 million for the six months ended June 30, 2016, representing a decrease of 8.5 million which was primarily due to the reduction in revenues as discussed above.
Interest Expense
Interest expense was $3.2 million for the six months ended June 30, 2017, compared to $4.3 million for the six months ended June 30, 2016. Interest expense decreased $1.0 million due to repayments of principal under our credit agreement, resulting in a lower outstanding balance.
Income Taxes
We recognized an income tax expense of $0.5 million for the six months ended June 30, 2017, compared to an income tax expense of $1.0 million for the six months ended June 30, 2016. Our effective income tax decreased to a negative rate of (10.7)% for the six months ended June 30, 2017, from 40.0% for the six months ended June 30, 2016. The decrease in the effective tax rate is primarily due to loss from operations generated in the six months ended June 30, 2017 for which no tax benefit is recognized compared to the income tax expense recorded on income from operations for the six months ended June 30, 2016.
Net Income (Loss)
As a result of the factors described above, net loss was $5.4 million for the six months ended June 30, 2017, which represented a decrease of $7.0 million, or 447% compared to net income of $1.6 million for the six months ended June 30, 2016.
Adjusted EBITDA and Adjusted Net Income
To provide investors with additional information regarding our financial results, we have disclosed in the table below 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:

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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;
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 each of the periods indicated:
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
(in thousands)
Adjusted EBITDA:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(2,440
)
 
$
1,477

 
$
(5,399
)
 
$
1,557

Provision for income taxes
 
197

 
963

 
522

 
1,036

Interest expense
 
1,618

 
1,841

 
3,224

 
4,273

Transaction expenses (1)
 
444

 

 
444

 

Restructuring and other expenses (5)
 

 
51

 

 
283

Depreciation and amortization
 
2,894

 
3,416

 
5,668

 
6,806

Impairment of goodwill and customer relationship (3)
 
1,081

 

 
1,081

 

Stock-based compensation
 
1,187

 
1,136

 
2,290

 
2,340

Adjusted EBITDA
 
$
4,981

 
$
8,884

 
$
7,830

 
$
16,295

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
(in thousands)
Adjusted Net Income (Loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(2,440
)
 
$
1,477

 
$
(5,399
)
 
$
1,557

Transaction expenses (1)
 
444

 

 
444

 

Stock-based compensation
 
1,187

 
1,136

 
2,290

 
2,340

Amortization of intangibles (2)
 
217

 
933

 
488

 
1,869

Impairment of goodwill and customer relationship (3)
 
1,081

 

 
1,081

 

Deferred financing amortization costs (4)
 
330

 
272

 
696

 
1,018

Restructuring and other expenses (5)
 

 
51

 

 
283

Tax adjustments (6)
 
(1,304
)
 
(957
)
 
(2,000
)
 
(2,204
)
Adjusted Net Income (Loss)
 
$
(485
)
 
$
2,912

 
$
(2,400
)
 
$
4,863

 
(1)
Represents costs and expenses related to the refinancing of our existing indebtedness.

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(2)
Represents amortization of capitalized expenses related to the acquisition of Performant by an affiliate of Parthenon Capital Partners in 2004, and also an acquisition in the first quarter of 2012 to enhance our analytics capabilities.
(3)
Represents goodwill and impairment charges related to our Performant Europe Ltd. subsidiary.
(4)
Represents amortization of capitalized financing costs related to financing conducted in 2012 and costs related to the amendments of the terms of the note payable in 2014, 2016, and 2017.
(5)
Represents restructuring costs and severance and termination expenses incurred in connection with termination of employees and consultants.
(6)
Represents tax adjustments assuming a marginal tax rate of 40%.
Liquidity and Capital Resources
Our primary source of liquidity is cash on hand and cash flows from operations. Cash and cash equivalents, which excludes restricted cash, totaled $21.3 million as of June 30, 2017, and consists primarily of cash on deposit with banks. Due to our operating cash flows and our existing cash and cash equivalents and our ability to restructure both our variable and fixed expenses, we believe that we have the ability to meet our working capital and capital expenditure needs through the second quarter of 2018. See "Long-term Debt" below.
The $11.7 million decrease in the balance of our cash and cash equivalents from December 31, 2016, was primarily due to principal repayments of $11.3 million on our long-term debt, and $2.1 million paid as deposits to collateralize our outstanding Letters of Credit as our revolving credit facility expired in March 2017.
Cash flows from operating activities
Cash provided by operating activities was $2.9 million for the six months ended June 30, 2017, and included a decrease in prepaid expenses and other current assets of $1.8 million and a decrease in income tax receivable of $0.6 million. Cash provided by operating activities in the six months ended June 30, 2016 was $20.7 million.
Cash flows from investing activities
Cash used in investing activities of $4.3 million for the six months ended June 30, 2017 was mainly for capital expenditures related to information technology, data storage, hardware, telecommunication systems and security enhancements to our information technology systems. Cash used in investing activities in the six months ended June 30, 2016 was $3.6 million.
Cash flows from financing activities
Cash used in financing activities of $10.4 million for the six months ended June 30, 2017 was primarily attributable to repayments of principal of $11.3 million on long-term debt. Cash used in financing activities in the six months ended June 30, 2016 was $35.0 million.
Restricted Cash
As of June 30, 2017, restricted cash included in current assets on our consolidated balance sheet was $6.0 million. In May 2017, the Company paid $7.5 million to the lenders and deposited $6.0 million into a segregated deposit account in connection with the Eighth Amendment to our Prior Credit Agreement (as defined below). The cash in this segregated deposit account is restricted because it was subject to the exclusive control of the administrative agent as set forth in our Prior Credit Agreement. On August 3, 2017, all of this $6.0 million of restricted cash was paid to the administrative agent for the benefit of the lenders under our Prior Credit Agreement.
Estimated liability for appeals and net payable to client
The June 30, 2017 balances of $19.2 million and $13.1 million for the estimated liability for appeals and the net payable to client, respectively, represent obligations that we expect to pay in the near term, although it is difficult to predict the precise timing of the associated cash outflows as they are dependent on the processing and resolution of audit appeals.

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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, as amended and restated, with Madison Capital Funding LLC as administrative agent, ING Capital LLC as syndication agent, and other lenders party thereto (as amended, the "Prior Credit Agreement"). The senior credit facility consists of (i) a $57.0 million Term A loan that matured and was fully paid in March 2017, (ii) a $79.5 million Term B loan that matures in June 2018, and (iii) a $11.0 million revolving credit facility that expired and was fully paid in March 2017. On June 28, 2012, we amended the Credit Agreement to increase the amount of our borrowings under our Term B loan by $19.5 million.
On November 4, 2014, February 19, 2016, July 26, 2016, October 27, 2016, and March 22, 2017, the Prior Credit Agreement was further amended to, among other things, modify a number of existing covenants and add new covenants requiring the Company to maintain a minimum cash balance, comply with an interest coverage ratio and achieve minimum EBITDA levels. On May 3, 2017, we further amended the credit agreement (the "Eighth Amendment") to extend the maturity date of the Term B loan to June 19, 2018. As a result of this extension, regularly scheduled quarterly amortization payments of $247,500 will also extend through March 31, 2018, with the remaining outstanding principal amount being due on the June 19, 2018 maturity date. Interest on the Term B loan charged under the credit agreement was also increased by 3.00% per annum, however the amount of such increased interest will be payable in kind. Pursuant to the Eighth Amendment, the quarterly and annual financial reporting covenants were also modified to require that the Company’s financial statements not contain a qualification, if required by GAAP, with respect to our ability to continue as a going concern.
On August 7, 2017, we, through our wholly-owned subsidiary Performant Business Services, Inc. (the “Borrower”), entered into a new credit agreement with ECMC Group, Inc. (the “New Credit Agreement”).  The New Credit Agreement provides for a term loan facility in the initial amount of $44 million (the “Initial Term Loan”) and for up to $15 million of additional term loans (“Additional Term Loans”; and together with the Initial Term Loan, the “Loans”) which Additional Term Loans may be drawn until the second anniversary of the funding of the Initial Term Loans, subject to the satisfaction of customary conditions.  On or around August 11, 2017, and subject to the satisfaction of customary conditions, we expect the Initial Term Loan will be advanced (the “Closing Date”) and, when advanced the proceeds will be applied to repay all outstanding amounts under the Prior Credit Agreement.  Approximately $2 million of contingent reimbursement obligations with respect to outstanding but undrawn letters of credit will remain outstanding under the Prior Credit Agreement, however, those contingent reimbursement obligations will remain cash collateralized with the administrative agent.
The Loans will mature on third anniversary of the Closing Date, however will 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 will 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.  The Initial Term Loan will initially bear interest at LIBOR plus 7.0% per annum.  We will be required to repay 5% of the original principal balance of the Loans annually in quarterly installments and to offer 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.  In addition to mandatory prepayments for excess cash flow, we will also be required to offer to prepay the Loans with the net cash proceeds of certain asset dispositions and with the issuance of debt not otherwise permitted under the New Credit Agreement.  Except in connection with a change of control and the payment of a 1% premium, we will not be permitted to voluntarily prepay the Loans until after the first anniversary of the Closing Date.  We will be permitted to prepay the Loans during the second year after the Closing Date if accompanied by a prepayment premium of 1%.  Thereafter, we will be permitted to prepay the Loans without any prepayment premium.
The New Credit Agreement contains certain restrictive financial covenants which will become effective on the Closing Date. Such covenants, will require, among other things, that we meet a minimum fixed charge coverage ratio of 0.5 to 1.0 through December 31, 2019, 1.0 to 1.0 through June 30, 2020 (or until December 31, 2020 if the maturity date of the Loans is extend until the fourth anniversary of the Closing Date), 1.25 to 1.0 through June 30, 2021 if the maturity date of the Loans is extended until the fourth anniversary of the Closing Date and 1.25 to 1.0 through June 30, 2022 if the maturity date of the Loans is extended until the fifth anniversary of the Closing Date. In addition, we will be required to maintain a maximum total debt to EBITDA ratio of 6.00. The New Credit Agreement also contains covenants that will restrict the Company and its subsidiaries’ ability to incur certain types or amounts of indebtedness, incur liens on certain assets, make material changes in corporate structure or the nature of its business, dispose of material assets, engage in a change in control transaction, make certain foreign investments, enter into certain restrictive agreements, or engage in certain transactions with affiliates.
The obligations under the New Credit Agreement will be secured by substantially all of our United States domestic subsidiaries’ assets and will be guaranteed by the Company and its United States domestic subsidiaries, other than the Borrower.

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In consideration for, and concurrently with, the extension of the Initial Term Loan in accordance with the terms of the New Credit Agreement, we will issue 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 GAAP for the most recent fiscal quarter) with an exercise price of $1.92 per share. Upon our election to borrow any 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 GAAP for the most recent fiscal quarter) for each $1,000,000 of such Additional Term Loans.
ITEM 3. 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 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 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 $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 4. DISCLOSURE 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 Accounting 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 Accounting 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 quarter covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Accounting Officer concluded that our disclosure controls and procedures were functioning effectively at the reasonable assurance level as of June 30, 2017.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the quarter ended June 30, 2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
ITEM 1. 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 1A. RISK FACTORS
Our business, financial condition, results of operations and liquidity are subject to various risks and uncertainties, including those described below, and as a result, the trading price of our common stock could decline.
Risks Related to Our Business
Revenues generated from our three largest clients represented 55% of our revenues in both 2016 and 2015 and our relationships with two of these clients, the Department of Education and Great Lakes Higher Education Guaranty Corporation, have been terminated. 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, including the Department of Education, and several GAs. Revenues from our three largest clients represented 55% of our revenues for the year ended December 31, 2016 and 55% of our revenues for the year ended December 31, 2015. The Department of Education was responsible for approximately 16% of our revenues for the year ended December 31, 2016 and the Department of Education announced in December 2016 that we were not selected as one of the contractors under its new student loan recovery contract. While our protest of this contract decision was recently upheld by the GAO, there is no assurance that this decision will result in our ultimately obtaining a contract award. The Department of Education has requested resubmittal of new contract proposals and is currently undergoing a re-evaluation process with respect to such proposals. The Department of Education has indicated a target date towards the end of August 2017 for the award of the new contracts. During 2016, we had numerous relationships with GAs in the U.S. including Great Lakes Higher Education Guaranty Corporation and Pennsylvania Higher Education Assistance Authority, which were responsible for 24% and 16%, respectively, of our revenues for the year ended December 31, 2016. On June 15, 2017, we received a 30-day termination notice, with respect to our contract with Great Lakes Higher Education Guaranty Corporation. The termination of this contract was based on Great Lakes’ decision to bundle its student loan servicing work, a service that we currently do not provide, along with its student loan recovery work to a single third party vendor.
If we are not ultimately successful in obtaining a new contract award from the Department of Education in the bid re-evaluation process referred to above, our business will become even more dependent on our business relationships with our GA clients and there is no assurance that we will be able to maintain these relationships. All of our contracts with our significant clients are subject to periodic renewal and re-bidding processes and if we lose one of these clients or if the terms of our relationships with any of these clients become less favorable to us, our revenues would decline, which would harm our business, financial condition and results of operations.
Many of our contracts with our clients for the recovery of student loans and other receivables are not exclusive and do not commit our clients to provide specified volumes of business. In addition, the terms of these contracts may be changed unilaterally and on short notice by our clients. As a consequence, there is no assurance that we will be able to maintain our revenues and operating results.
Substantially all of our existing contracts for the recovery of student loans and other receivables, which represented approximately 95% of our revenues for the six months ended June 30, 2017 and 92% of our revenues in the year ended December 31, 2016, 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. These include our contracts with Great Lakes Higher Education Guaranty Corporation and Pennsylvania Higher Education Assistance Authority, which were responsible for 24% and 16%, respectively, of our revenues for the year ended December 31, 2016. As stated above, in June 2017, Great Lakes Higher Education Guaranty Corporation gave us notice of the termination of our contract. 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

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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, which include our five largest clients in 2016 and four of our five largest clients in 2015, 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, effective July 1, 2015, the Department of Education implemented a fixed fee of $1,710 payable for each loan that is rehabilitated in place of a recovery fee that historically had been based on a percentage of the balance of the rehabilitated loan. Further, in December 2016, the Department of Education announced the award of seven new contracts and we did not receive one of the new awards. We, along with 19 other contractors who did not receive contract awards from the Department of Education, filed protests with the GAO regarding the Department of Education’s award of these contracts. While our protest of this contract decision was recently upheld by the GAO, there is no assurance that this decision will result in our ultimately obtaining a contract award. If we are not successful in obtaining a contract award from the Department of Education through this process, the volume of student loan placements to us will be significantly harmed, which will result in a material negative impact on our results of operations and cash flows and our ability to repay or refinance our indebtedness.
The Department of Education, our longstanding and significant client, recently announced that we would not receive a new contract for the recovery of student loans. While we were successful with the protest we filed in connection with the original contract decision, if we are not successful in obtaining a contract award from the Department of Education through this process, our results of operations and cash flows will be harmed and it will be more difficult for us to repay or refinance our indebtedness.
We have had a more than 25 year relationship with the Department of Education as a key contractor in the recovery of student loans and this relationship has been responsible for a significant portion of our annual revenues.  Our revenues from the Department of Education were $21.9 million in 2016, $37.9 million in 2015 and $53.2 million in 2014, representing 15.5%, 23.8% and 27.2% of our revenues, respectively.  Further, we expected the Department of Education to become an increasingly important client because all federally-supported student loans have been originated by the Department of Education since 2010, meaning that there will be no further growth in student loans held by the GAs.  Our most recent contract with the Department of Education expired in April 2015, and we have not received new placements of student loans from the Department of Education since that time pending the award of new contracts.   
In December 2016, the Department of Education announced the award of seven new contracts and we did not receive one of the new awards. We, along with 19 other contractors who did not receive contract awards from the Department of Education, filed protests with the GAO regarding the Department of Education’s award of these contracts. In March 2017, the GAO upheld this protest. The Department of Education requested resubmittal of new contract proposals and is currently undergoing a re-evaluation process with respect to such proposals. The Department of Education has indicated a target date towards the end of August 2017 for the award of the new contracts. If we are not successful in obtaining a new contract as a result of a conclusive award process, the absence of a contract with the Department of Education will have a material adverse effect on our financial condition and results of operations in 2018 and beyond.
Over the course of our first RAC contract, there has been an increase in the number of appeals by healthcare providers to the third, or ALJ, level of appeal relating to claims we have audited, and there can be no assurance that our estimated liability for such appeals will be adequate.
Under our RAC contract with CMS, we recognize revenues when the healthcare provider has paid CMS for a claim or has agreed to an offset against other claims by the provider. Healthcare providers have the right to appeal a claim and may pursue additional levels of appeal if the initial appeal is found in favor of CMS. We accrue an estimated liability for appeals at the time revenue is recognized based on our estimate of the amount of revenue probable of being refunded to CMS following successful appeal based on historical data and other trends relating to such appeals. In addition, if our estimate of liability for appeals with respect to revenues recognized during a prior period changes, we increase or decrease the estimated liability reserve in the current period. Over the course of our first RAC contract, healthcare providers have increased their pursuit of appeals beyond the first and second levels of appeal to the third level of appeal, where cases are heard by administrative law judges, or ALJs. In our experience, decisions at the third level of appeal are the least favorable as ALJs exercise greater discretion and there is less predictability in the ALJ decisions as compared to appeals at the first or second levels. The pursuit of third level appeals by healthcare providers has also resulted in a backlog of claims at that level of appeal. This increase of ALJ appeals and backlog of claims at the third level of appeal is the primary reason our total estimated liability for appeals (consisting of the estimated liability for appeals plus the contra-accounts-receivable estimated allowance for appeals) has

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grown from a balance of $16.4 million at December 31, 2013 to $18.6 million as of December 31, 2014 to $19.0 million as of both December 31, 2015, and December 31, 2016, and decreased to $18.8 million as of June 30, 2017. Our estimates for our appeal reserve are subject to uncertainties, and accordingly we may underestimate the number of successful appeals or the financial impact of successful appeals in a given year or period. To the extent that the amount of commissions that we are required to return to CMS as a result of successful appeals exceeds our estimated appeals reserve, our revenues in the applicable period will be reduced by the amount of such excess. If we underestimate the amount of commissions that are subject to successful appeal, our revenues in future periods could be adversely affected. In addition, each of the subcontractors we engaged to assist in the recovery services under our RAC contract are similarly obligated to refund fees that they received from claims that are later overturned on appeal. To the extent any of our subcontractors fail to refund amounts that are due upon an appeals relating to claim that they were responsible for, we may be obligated to pay such amounts directly to CMS, which could have a material impact on our financial position.
Further, in August 2014 CMS offered to pay hospitals 68% of what they have billed Medicare to settle a backlog of pending appeals challenging Medicare’s denials of reimbursement for certain types of short‑term care. The implication of these settlement offers related to claims for which recovery auditors have already been paid under the first RAC contracts remain uncertain at this time. Any payments we are required to make to CMS under our first RAC contract in connection with such settlement offers may be significant and in excess of the amount we have reserved for appeals, which could have a material negative impact our financial position and liquidity.
Limitations on the scope of recovery services we can provide under our new RAC contract will have a material impact on our revenues and these limitations may continue under the newly awarded RAC contracts.
Our ability to make claims under the first RAC contract was limited during each of the last three years by restrictions imposed on the scope of our audit activities and by contract transition rules announced by CMS that involved periodic suspension of audit activities. These limitations had a material adverse effect on our revenues and operating results. Our revenues from CMS during the six months ended June 30, 2017 were $0.1 million compared to $3.5 million during the same period in 2016. While we have been awarded two new RAC contracts, we are uncertain about the scope of permitted audit and if the scope of audit is not increased, our revenues and the value of the new RAC contracts will be constrained. In addition, we expect there will be an approximately four to six month period from the date that we are permitted to start performing recovery services until we start to recognize revenues under our new RAC contracts. Accordingly, the start date of April 2017 for the new RAC contracts means that these new contracts will not have a significant impact on our 2017 revenues, although we will incur related start-up expenses in 2017.
Our ability to derive revenues under our new RAC contracts will depend in part on the number and types of potentially improper claims that we are allowed to pursue by CMS, and our results of operations may be harmed if the scope of claims that we are allowed to pursue and be compensated for is limited.
Under CMS’s Medicare recovery audit program, RAC contractors have not been permitted to seek the recovery of an improper claim unless that particular type of claim has been pre-approved by CMS to ensure compliance with applicable Medicare payment policies, as well as national and local coverage determinations. As work under the first RAC contract progressed, CMS placed increasing restrictions on the scope of audits permitted by RAC contractors and has not indicated that those restrictions will be relaxed when work commences under the newly awarded RAC contracts. Accordingly, the long-term growth of the revenues we derive under our two newly awarded RAC contracts will also depend in significant part on the scope of potentially improper claims that we are allowed to pursue.
In particular, in September 2013, CMS implemented rules that prevent RAC contractors from being able to review and audit (i) whether inpatient care delivered to patients with hospital stays lasting less than two midnights was medically necessary and therefore deserving of the higher reimbursement levels under Medicare Part A or (ii) whether inpatient treatment was medically necessary for admissions spanning more than two midnights.  In connection with these restrictions, hospitals cannot bill CMS for outpatient services on hospital stays lasting less than two midnights during such period.   Fees associated with recoveries initiated by us based upon improper claims for inpatient reimbursement of these short stays had represented a substantial portion of the revenues we have earned under our RAC contract. The continued suspension of this type of review activity has had and may continue to have a material adverse effect on our future healthcare revenues and operating results, depending on a variety of factors including, among other things, CMS’s evaluation of provider compliance with the new rules, the rules ultimately adopted by CMS with respect to medical necessity reviews of Medicare reimbursement claims associated with short stay inpatient admissions and, more generally, the scope of improper claims that CMS allows us to pursue and our ability to successfully identify improper claims within the permitted scope.

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We face significant competition in connection with obtaining, retaining and performing under our client contracts, and an inability to compete effectively in the future could harm our relationships with our clients, which would impact our ability to maintain our revenues and operating results.
We operate in very competitive markets. In providing our services to the student loan and other receivables markets, we face competition from many other companies. Initially, we compete with these companies to be one of typically several firms engaged to provide recovery services to a particular client and, if we are successful in being engaged, we then face continuing competition from the client’s other retained firms based on the client’s benchmarking of the recovery rates of its several vendors. In addition, those recovery vendors who produce the highest recovery rates from a client often will be allocated additional placements and in some cases additional success fees. Accordingly, maintaining high levels of recovery performance, and doing so in a cost-effective manner, are important factors in our ability to maintain and grow our revenues and net income and the failure to achieve these objectives could harm our business, financial condition and results of operations. Some of our current and potential competitors in the markets in which we operate may have greater financial, marketing, technological or other resources than we do. The ability of any of our competitors and potential competitors to adopt new and effective technology to better serve our markets may allow them to gain market strength. Increasing levels of competition in the future may result in lower recovery fees, lower volumes of contracted recovery services or higher costs for resources. Any inability to compete effectively in the markets that we serve could adversely affect our business, financial condition and results of operations.
The U.S. federal government accounts for a significant portion of our revenues, and any loss of business from, or change in our relationship with, the U.S. federal government would result in a significant decrease in our revenues and operating results.
We have historically derived and are likely to continue to derive a significant portion of our revenues from the U.S. federal government. For the year ended December 31, 2016, revenues under contracts with the U.S. federal government accounted for approximately 24% of our total revenues. The continuation and exercise of renewal options on government contracts and any new government contracts are, among other things, contingent upon the availability of adequate funding for the applicable federal government agency. Changes in federal government spending could directly affect our financial performance. 
For example, the Bipartisan Budget Act of 2013 reduced the compensation paid to GAs for the rehabilitation of student loans, effective July 1, 2014. This “revenue enhancement” measure reduced from 18.5% to 16.0% of the outstanding loan balance, the amount that GAs can charge borrowers when a rehabilitated loan is sold by the GA and eliminated entirely the GAs retention of 18.5% of the outstanding loan balance as a fee for rehabilitation services. The reduction in compensation the GAs receive resulted in a decrease of approximately 25.0% in the contingency fee percentage that we receive from the GAs for assisting in the rehabilitation of defaulted student loans. 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 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 30 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.
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 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 were each responsible for more than 10% of our total revenues in the year ended December 31, 2016: Great Lakes Higher Education Guaranty Corporation and Pennsylvania Higher Education Assistance Authority were

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responsible for 24% and 16%, respectively, of revenues for the year ended December 31, 2016. The consolidation of our GA clients with others and the failure to provide recovery services to the consolidated entity could decrease our revenues, which could negatively impact our business, financial condition and results of operations.
Our results of operations may fluctuate on a quarterly or annual basis and cause volatility in the price of our stock.
Our revenues and operating results could vary significantly from period-to-period and may fail to match our past performance because of a variety of factors, some of which are outside of our control. Any of these factors could cause the price of our common stock to fluctuate. Factors that could contribute to the variability of our operating results include:
the amount of defaulted student loans and other receivables that our clients place with us for recovery;
the timing of placements of student loans and other receivables which are entirely in the discretion of our clients;
the schedules of government agencies for awarding contracts including the result of our recent successful appeal against the Department of Education’s contract award decision;
our ability to successfully identify improper Medicare claims and the number and type of potentially improper claims that CMS authorizes us to pursue under our RAC contact;
the loss or gain of significant clients or changes in the contingency fee rates or other significant terms of our business arrangements with our significant clients;
technological and operational issues that may affect our clients and regulatory changes in the markets we service; and
general industry and macroeconomic conditions.
Downturns in domestic or global economic conditions and other macroeconomic factors could harm our business and results of operations.
Various macroeconomic factors influence our business and results of operations. These include the volume of student loan originations in the United States, together with tuition costs and student enrollment rates, the default rate of student loan borrowers, which is impacted by domestic and global economic conditions, rates of unemployment and similar factors, and the growth in Medicare expenditures resulting from changes in healthcare costs. For example, during the global financial crisis beginning in 2008, the market for securitized student loan portfolios was disrupted, resulting in delays in the ability of some GA clients to resell rehabilitated student loans and, as a result, delays our ability to recognize revenues from these rehabilitated loans. Changes in the overall economy could lead to a reduction in overall recovery rates by our clients, which in turn could adversely affect our business, financial condition and results of operations.
We may not be able to manage our potential growth effectively and our results of operations could be negatively affected.
Our newly awarded RAC contracts provide the potential opportunity to restore the growth in our business. However, our focus on growth and the expansion of our business may place additional demands on our management, operations and financial resources and will require us to incur additional expenses. We cannot be sure that we will be able to manage our performance under any significant new contracts effectively. In order to successfully perform under any significant new contracts, our expenses will increase to recruit, train and manage additional qualified employees and subcontractors and to expand and enhance our administrative infrastructure and continue to improve our management, financial and information systems and controls. If we cannot manage our growth effectively, our expenses may increase and our results of operations could be negatively affected.
Our indebtedness could adversely affect our business and financial condition and reduce the funds available to us for other purposes, and our failure to comply with the covenants contained in our credit agreement could result in an event of default that could adversely affect our results of operations.
Our ability to make scheduled payments 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

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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, certain financial and restrictive covenants that limit our ability to incur additional debt, including to finance future operations or other capital needs, and to engage in other activities that we may believe are in our long-term best interests, including to dispose of or acquire assets. Our failure to comply with these covenants may result in an event of default, which, if not cured or waived, could accelerate the maturity of our indebtedness or result in modifications to our credit terms. If our indebtedness is accelerated, we may not have sufficient cash resources to satisfy our debt obligations and we may not be able to continue our operations as planned.
A failure of our operating systems or technology infrastructure, or those of our third-party vendors and subcontractors, could disrupt the operation of our business.
A failure of our operating systems or technology infrastructure, or those of our third-party vendors and subcontractors, could disrupt our operations. Our operating systems and technology infrastructure are susceptible to damage or interruption from various causes, including acts of God and other natural disasters, power losses, computer systems failures, Internet and telecommunications or data network failures, operator error, computer viruses, losses of and corruption of data and similar events. The occurrence of any of these events could result in interruptions, delays or cessations in service to our clients, reduce the attractiveness of our recovery services to current or potential clients and adversely impact our financial condition and results of operations. While we have backup systems in many of our operating facilities, an extended outage of utility or network services may harm our ability to operate our business. Further, the situations we plan for and the amount of insurance coverage we maintain for losses as result of failures of our operating systems and infrastructure may not be adequate in any particular case.
If our security measures are breached or fail and unauthorized access is obtained to our clients’ confidential data, our services may be perceived as insecure, the attractiveness of our recovery services to current or potential clients may be reduced, and we may incur significant liabilities.
Our recovery services involve the storage and transmission of confidential information relating to our clients and their customers, including health, financial, credit, payment and other personal or confidential information. Although our data security procedures are designed to protect against unauthorized access to confidential information, our computer systems, software and networks may be vulnerable to unauthorized access and disclosure of our clients’ confidential information. Further, we may not effectively adapt our security measures to evolving security risks, address the security and privacy concerns of existing or potential clients as they change over time, or be compliant with federal, state, and local laws and regulations with respect to securing confidential information. Unauthorized access to confidential information relating to our clients and their customers could lead to reputational damage which could deter our clients and potential clients from selecting our recovery services, or result in termination of contracts with those clients affected by any such breach, regulatory action, and claims against us.
In the event of any unauthorized access to personal or other confidential information, we may be required to expend significant resources to investigate and remediate vulnerabilities in our security procedures, and we may be subject to fines, penalties, litigation costs, and financial losses that are either not insured against or not fully covered through any insurance maintained by us. If one or more of such failures in our security and privacy measures were to occur, our business, financial condition and results of operations could suffer.
Our business may be harmed if we lose members of our management team or other key employees.
We are highly dependent on members of our management team and other key employees and our future success depends in part on our ability to retain these people. Our inability to continue to attract and retain members of our management team and other key employees could adversely affect our business, financial condition and results of operations.

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The growth of our healthcare business will require us to hire and retain employees with specialized skills and failure to do so could harm our ability to grow our business.
The growth of our healthcare business will depend in part on our ability to recruit, train and manage additional qualified employees. Our healthcare-related operations require us to hire registered nurses and experts in Medicare coding. Finding, attracting and retaining employees with these skills is a critical component of providing our healthcare-related recovery and audit services, and our inability to staff these operations appropriately represents a risk to our healthcare service offering and associated revenues. An inability to hire qualified personnel, particularly to serve our healthcare clients, may restrain the growth of our business.
We rely on subcontractors to provide services to our clients and the failure of subcontractors to perform as expected could harm our business operations and our relationships with our clients.
We engage subcontractors to provide certain services to our clients. These subcontractors participate to varying degrees in our recovery activities with regards to all of the services we provide. While we believe that we perform appropriate due diligence before we hire subcontractors, our subcontractors may not provide adequate service or otherwise comply with the terms set forth in their agreements. In the event a subcontractor provides deficient performance to one or more of our clients, any such client may reduce the volume of services we are providing under an existing contract or may terminate the relevant contract entirely and we may face claims for breach of contract. Any such disruption in our relations with our clients as a result of services provided by any of our subcontractors could adversely affect our revenues and operating results.
If our software vendors or utility and network providers fail to deliver or perform as expected our business operations could be adversely affected.
Our recovery services depend in part on third-party providers, including software vendors and utility and network providers. Our ability to service our clients depends on these third-party providers meeting our expectations and contractual obligations in a timely and effective manner. Our business could be materially and adversely affected, and we might incur significant additional liabilities, if the services provided by these third-party providers do not meet our expectations or if they terminate or refuse to renew their relationships with us on similar contractual terms.
We are subject to extensive regulations regarding the use and disclosure of confidential personal information and failure to comply with these regulations could cause us to incur liabilities and expenses.
We are subject to a wide array of federal and state laws and regulations regarding the use and disclosure of confidential personal information and security. For example, the federal Health Insurance Portability and Accountability Act of 1996, 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

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on us to the extent adverse credit information reported to a credit bureau is false or inaccurate. Our compliance with the FDCPA, FCRA and other federal and state regulations that affect our student loan recovery business may result in significant costs, including litigation costs. We may also become subject to regulations promulgated by the United States Consumer Financial Protection Bureau, 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. In addition, the CFPB has investigatory and enforcement authority with respect to whether persons are engaged in unlawful acts or practices in connection with the collection of consumer debts.
Litigation may result in substantial costs of defense, damages or settlement, any of which could subject us to significant costs and expenses.
We are party to lawsuits in the normal course of business, particularly in connection with our student loan recovery services. For example, we are regularly subject to claims that we have violated the guidelines and procedures that must be followed under federal and state laws in communicating with consumer debtors. We may not ultimately prevail or otherwise be able to satisfactorily resolve any pending or future litigation, which may result in substantial costs of defense, damages or settlement. In the future, we may be required to alter our business practices or pay substantial damages or settlement costs as a result of litigation proceedings, which could adversely affect our business operations and results of operations.
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 first 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. In particular, we may not be able to protect our trade secrets, know‑how and other proprietary information adequately. Although we use reasonable efforts to protect this proprietary information and technology, our employees, consultants and other parties may unintentionally or willfully disclose our information or technology to competitors. Enforcing a claim that a third party illegally obtained and is using any of our proprietary information or technology is expensive and time consuming, and the outcome is unpredictable. We rely, in part, on non‑disclosure, confidentiality and invention assignment agreements with our employees, consultants and other parties to protect our trade secrets, know‑how and other intellectual property and proprietary information. These agreements may not be self‑executing, or they may be breached and we may not have adequate remedies for such breach. Moreover, third parties may independently develop similar or equivalent proprietary information or otherwise gain access to our trade secrets, know‑how and other proprietary information. Any infringement, misappropriation or other violation of our patents, trademarks, copyrights, trade secrets, or other intellectual property rights could adversely affect any competitive advantage we currently derive or may derive from our proprietary technology platform and we may incur significant costs associated with litigation that may be necessary to enforce our intellectual property rights.
Claims by others that we infringe their intellectual property could force us to incur significant costs or revise the way we conduct our business.
Our competitors protect their proprietary rights by means of patents, trade secrets, copyrights, trademarks and other intellectual property. Any party asserting that we infringe, misappropriate or violate their intellectual property rights may force us to defend ourselves, and potentially our clients, against the alleged claim. These claims and any resulting lawsuit, if successful, could be time-consuming and expensive to defend, subject us to significant liability for damages or invalidation of

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our proprietary rights, prevent us from operating all or a portion of our business or force us to redesign our services or technology platform or cause an interruption or cessation of our business operations, any of which could adversely affect our business and operating results. In addition, any litigation relating to the infringement of intellectual property rights could harm our relationships with current and prospective clients. The risk of such claims and lawsuits could increase if we increase the size and scope of our services in our existing markets or expand into new markets.
We may make acquisitions that prove unsuccessful, strain or divert our resources and harm our results of operations and stock price.
We may consider acquisitions of other companies in our industry or in new markets. We may not be able to successfully complete any such acquisition and, if completed, any such acquisition may fail to achieve the intended financial results. We may not be able to successfully integrate any acquired businesses with our own and we may be unable to maintain our standards, controls and policies. Further, acquisitions may place additional constraints on our resources by diverting the attention of our management from other business concerns. Moreover, any acquisition may result in a potentially dilutive issuance of equity securities, the incurrence of additional debt and amortization of expenses related to intangible assets, all of which could adversely affect our results of operations and stock price.
The price of our common stock could be volatile, and you may not be able to sell your shares at or above the public offering price.
Since our initial public offering in August 2012, the price of our common stock, as reported by NASDAQ Global Select Market, has ranged from a low sales price of $1.50 on March 16, 2017 to a high sales price of $14.09 on March 4, 2013. The trading price of our common stock may be significantly affected by various factors, including: quarterly fluctuations in our operating results; the financial projections we may provide to the public, any changes in those projections or our failure to meet those projections; changes in investors’ and analysts’ perception of the business risks and conditions of our business; our ability to meet the earnings estimates and other performance expectations of financial analysts or investors; unfavorable commentary or downgrades of our stock by equity research analysts; changes in our capital structure, such as future issuances of debt or equity securities; our success or failure to obtain new contract awards; lawsuits threatened or filed against us; strategic actions by us or our competitors, such as acquisitions or restructurings; new legislation or regulatory actions; changes in our relationship with any of our significant clients; fluctuations in the stock prices of our peer companies or in stock markets in general; and general economic conditions.
Our significant stockholders have the ability to influence significant corporate activities and our significant stockholders' interests may not coincide with yours.
Parthenon Capital Partners and Invesco Ltd. beneficially owned approximately 26.6% and 17.4% of our common stock, respectively, as of June 30, 2017. As a result of their ownership, Parthenon Capital Partners and Invesco Ltd. have the ability to influence the outcome of matters submitted to a vote of stockholders and, through our board of directors, the ability to influence decision‑making with respect to our business direction and policies. Parthenon Capital Partners and Invesco Ltd. may have interests different from our other stockholders’ interests, and may vote in a manner adverse to those interests. Matters over which Parthenon Capital Partners and Invesco Ltd. can, directly or indirectly, exercise influence include:
mergers and other business combination transactions, including proposed transactions that would result in our stockholders receiving a premium price for their shares;
other acquisitions or dispositions of businesses or assets;
incurrence of indebtedness and the issuance of equity securities;
repurchase of stock and payment of dividends; and
the issuance of shares to management under our equity incentive plans.
In addition, Parthenon Capital Partners has a contractual right to designate a number of directors proportionate to its stock ownership. Further, under our amended and restated certificate of incorporation, Parthenon Capital Partners does not have any obligation to present to us, and Parthenon Capital Partners may separately pursue, corporate opportunities of which it becomes aware, even if those opportunities are ones that we would have pursued if granted the opportunity.

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Anti-takeover provisions contained in our certificate of incorporation and bylaws could impair a takeover attempt that our stockholders may find beneficial.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents include the following provisions: establishing a classified board of directors so that not all members of our board are elected at one time; providing that directors may be removed by stockholders only for cause; authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock; limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting; limiting our ability to engage in certain business combinations with any “interested stockholder,” other than Parthenon Capital Partners, for a three-year period following the time that the stockholder became an interested stockholder; requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors; requiring a super majority vote for certain amendments to our amended and restated certificate of incorporation and amended and restated bylaws; and limiting the determination of the number of directors on our board of directors and the filling of vacancies or newly created seats on the board, to our board of directors then in office. These provisions, alone or together, could have the effect of delaying or deterring a change in control, could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Sale of Unregistered Securities
On August 7, 2017, in consideration for, and concurrently with, the extension of the loans in accordance with the terms of our new credit agreement with ECMC Group, Inc., we will issue a warrant to ECMC to purchase up to an aggregate of 3,863,326 shares of the Company’s common stock (representing approximately up to 7.5% of the our diluted common stock as calculated using the “treasury stock” method as defined under GAAP for the most recent fiscal quarter) with an exercise price of $1.92 per share. The warrant will be issued in a private placement exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof. Upon our election to borrow any of the additional term loans under the new credit agreement, 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 the our diluted common stock calculated using the “treasury stock” method as defined under GAAP for the most recent fiscal quarter) for each $1,000,000 of such additional term loans. Upon the closing under our new credit agreement, we will execute a registration rights agreement with ECMC Group, Inc. under which we will be obligated to file a registration statement to register the resale of shares of our common stock acquired upon exercise of the warrants described above.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
None
ITEM 5. OTHER INFORMATION
Entry into a Material Definitive Agreement
On August 7, 2017, we, through our wholly-owned subsidiary Performant Business Services, Inc. (the “Borrower”), entered into a new credit agreement with ECMC Group, Inc. (the “New Credit Agreement”).  The New Credit Agreement provides for a term loan facility in the initial amount of $44 million (the “Initial Term Loan”) and for up to $15 million of additional term loans (“Additional Term Loans”; and together with the Initial Term Loan, the “Loans”) which Additional Term Loans may be drawn until the second anniversary of the funding of the Initial Term Loans, subject to the satisfaction of customary conditions.  On or around August 11, 2017, and subject to the satisfaction of customary conditions, we expect the Initial Term Loan will be advanced (the “Closing Date”) and, when advanced the proceeds will be applied to repay all outstanding amounts under the Prior Credit Agreement.  Approximately $2 million of contingent reimbursement obligations with respect to outstanding but undrawn letters of credit will remain outstanding under the Prior Credit Agreement, however, those contingent reimbursement obligations will remain cash collateralized with the administrative agent.
The Loans will mature on third anniversary of the Closing Date, however will 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 will 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.  The Initial Term Loan will initially bear interest at LIBOR plus 7.0% per annum.  We will be required to repay 5% of the original principal balance of the Loans annually in quarterly installments and to offer 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.  In addition to mandatory prepayments for excess cash flow, we will also be required to offer to prepay the Loans with the net cash proceeds of certain asset dispositions and with the issuance of debt not otherwise permitted under the New Credit Agreement.  Except in connection with a change of control and the payment of a 1% premium, we will not be permitted to voluntarily prepay the Loans until after the first anniversary of the Closing Date.  We will be permitted to prepay the Loans during the second year after the Closing Date if accompanied by a prepayment premium of 1%.  Thereafter, we will be permitted to prepay the Loans without any prepayment premium.
The New Credit Agreement contains certain restrictive financial covenants which will become effective on the Closing Date. Such covenants, will require, among other things, that we meet a minimum fixed charge coverage ratio of 0.5 to 1.0 through December 31, 2019, 1.0 to 1.0 through June 30, 2020 (or until December 31, 2020 if the maturity date of the Loans is extend

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until the fourth anniversary of the Closing Date), 1.25 to 1.0 through June 30, 2021 if the maturity date of the Loans is extended until the fourth anniversary of the Closing Date and 1.25 to 1.0 through June 30, 2022 if the maturity date of the Loans is extended until the fifth anniversary of the Closing Date. In addition, we will be required to maintain a maximum total debt to EBITDA ratio of 6.00. The New Credit Agreement also contains covenants that will restrict the Company and its subsidiaries’ ability to incur certain types or amounts of indebtedness, incur liens on certain assets, make material changes in corporate structure or the nature of its business, dispose of material assets, engage in a change in control transaction, make certain foreign investments, enter into certain restrictive agreements, or engage in certain transactions with affiliates.
The obligations under the New Credit Agreement will be secured by substantially all of our United States domestic subsidiaries’ assets and will be guaranteed by the Company and its United States domestic subsidiaries, other than the Borrower.
In consideration for, and concurrently with, the extension of the Initial Term Loan in accordance with the terms of the New Credit Agreement, we will issue 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 GAAP for the most recent fiscal quarter) with an exercise price of $1.92 per share. Upon our election to borrow any 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 GAAP for the most recent fiscal quarter) for each $1,000,000 of such Additional Term Loans.

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ITEM 6. EXHIBITS
(A) Exhibits:
Exhibit No.
Description
 
 
10.1
Credit Agreement, dated as of August 7, 2017, by and among Performant Business Services, Inc., and ECMC Group, Inc.
 
 
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
 
 
31.2
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
 
 
32.1(1)
Certification of the Chief Executive Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
32.2(1)
Certification of the Principal Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101.INS(2)
XBRL Instance Document
 
 
101.SCH(2)
XBRL Taxonomy Extension Scheme
 
 
101.CAL(2)
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.DEF(2)
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB(2)
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE(2)
XBRL Taxonomy Extension Presentation Linkbase
 
(1)
The material contained in Exhibit 32.1 and Exhibit 32.2 is not deemed “filed” with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing, except to the extent that the registrant specifically incorporates it by reference.

(2)
In accordance with Rule 406T of Regulation S-T, the information furnished in these exhibits will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act.

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SIGNATURES


Pursuant to the requirement 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
Date:
August 9, 2017
 
 
 
 
 
 
 
By:
 
/s/ Lisa Im
 
 
 
 
 
Lisa Im
 
 
 
 
 
 
 
 
 
Chief Executive Officer (Principal Executive Officer)
 
 
 
 
 
 
 
 
By:
 
/s/ Ian Johnston
 
 
 
 
 
Ian Johnston
 
 
 
 
 
 
 
 
 
 
Vice President and Chief Accounting Officer

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EXHIBIT INDEX
Exhibit No.
Description
 
 
10.1
Credit Agreement, dated as of August 7, 2017, by and among Performant Business Services, Inc., and ECMC Group, Inc.
 
 
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
 
 
31.2
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
 
 
32.1(1)
Certification of the Chief Executive Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
32.2(1)
Certification of the Principal Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101.INS(2)
XBRL Instance Document
 
 
101.SCH(2)
XBRL Taxonomy Extension Scheme
 
 
101.CAL(2)
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.DEF(2)
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB(2)
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE(2)
XBRL Taxonomy Extension Presentation Linkbase
 
 
(1)
The material contained in Exhibit 32.1 and Exhibit 32.2 is not deemed “filed” with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing, except to the extent that the registrant specifically incorporates it by reference.

(2)
In accordance with Rule 406T of Regulation S-T, the information furnished in these exhibits will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act.

42
Exhibit
Exhibit 10.1

____________________________________________________
____________________________________________________



CREDIT AGREEMENT
dated as of August 7, 2017
between
PERFORMANT BUSINESS SERVICES, INC.,
as Borrower,
and
ECMC GROUP, INC.,
as Lender


____________________________________________________
____________________________________________________





TABLE OF CONTENTS
Page
Section 1.Definitions; Interpretation.    1
1.1.Definitions.    1
1.2.Interpretation.    15
1.3.Accounting Changes.    15
Section 2.Credit Facilities.    16
2.1.Commitments.    16
2.1.1.Closing Date Term Loan Commitments.    16
2.1.2.Delayed Draw Term Loan Commitments.    16
2.2.Borrowing Procedures.    16
2.3.Extension of Maturity Date.    16
2.4.Loan Accounting.    17
2.4.1.Recordkeeping.    17
2.4.2.Notes.    17
2.5.Interest.    17
2.5.1.Interest Rates.    17
2.5.2.Interest Payment Dates.    17
2.5.3.Computation of Interest.    18
2.6.Prepayment.    18
2.6.1.Voluntary Prepayment.    18
2.6.2.Mandatory Prepayment.    18
2.6.3.All Prepayments.    19
2.7.Repayment.    19
2.7.1.Closing Date Term Loan.    19
2.7.2.Delayed Draw Term Loans.    19
2.8.Payment.    19
2.8.1.Making and Settlement of Payments.    19
2.8.2.Application of Payments and Proceeds.    19
2.8.3.Payment Dates.    20
2.8.4.Set-off.    20
2.8.5.Tax Treatment.    21
Section 3.Taxes; Yield Protection.    21
3.1.Taxes.    21
3.2.Increased Cost.    24
3.3.Manner of Funding; Alternate Funding Offices.    24
3.4.Conclusiveness of Statements; Survival.    25
Section 4.Conditions Precedent.    25
4.1.Initial Credit Extension.    25
4.1.1.Prior Debt.    25

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4.1.2.Warrants; Registration Rights Agreement.    25
4.1.3.Fees.    25
4.1.4.Delivery of Loan Documents.    25
4.1.5.Representations and Warranties.    26
4.1.6.Absence of Event of Default.    26
4.2.Delayed Draw Term Loans.    26
Section 5.Representations and Warranties.    27
5.1.Organization.    27
5.2.Authorization; No Conflict.    27
5.3.Validity; Binding Nature.    27
5.4.Financial Condition.    27
5.5.No Material Adverse Change.    28
5.6.Litigation.    28
5.7.Ownership of Properties; Liens.    28
5.8.Capitalization.    28
5.9.Pension Plans.    28
5.10.Investment Company Act.    29
5.11.No Default.    29
5.12.Margin Stock.    29
5.13.Taxes.    29
5.14.Solvency.    29
5.15.Environmental Matters.    29
5.16.Insurance.    30
5.17.Information.    30
5.18.Intellectual Property.    30
5.19.Labor Matters.    30
5.20.Bank Accounts.    31
Section 6.Affirmative Covenants.    31
6.1.Information.    31
6.1.1.Annual Report.    31
6.1.2.Interim Reports.    31
6.1.3.Additional Information.    31
6.1.4.Reports to SEC and Shareholders.    32
6.1.5.Notice of Default; Litigation; ERISA Matters.    32
6.1.6.Subordinated Debt Notices.    33
6.1.7.Subsidiary Capitalization.    33
6.1.8.Other Information.    33
6.2.Books; Records; Inspections.    33
6.3.Maintenance of Property; Insurance.    33

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6.4.Compliance with Laws; Payment of Taxes and Liabilities.    34
6.5.Maintenance of Existence.    34
6.6.Employee Benefit Plans.    35
6.7.Environmental Matters.    35
6.8.Further Assurances.    35
Section 7.Negative Covenants.    35
7.1.Debt.    36
7.2.Liens.    37
7.3.Restricted Payments.    39
7.4.Mergers; Consolidations; Asset Sales.    40
7.5.Modification of Organizational Documents.    41
7.6.Use of Proceeds.    41
7.7.Transactions with Affiliates.    41
7.8.Inconsistent Agreements.    42
7.9.Business Activities.    42
7.10.Investments.    42
7.11.Restriction of Amendments to Certain Documents.    44
7.12.Fiscal Year.    44
7.13.Bank Accounts.    44
7.14.Financial Covenants.    44
7.14.1.Fixed Charge Coverage Ratio.    44
7.14.2.Total Debt to EBITDA Ratio.    45
7.14.3.Equity Cure Right.    45
Section 8.Events of Default; Remedies.    46
8.1.Events of Default.    46
8.1.1.Non-Payment of Credit.    46
8.1.2.Default Under Other Debt.    46
8.1.3.Bankruptcy; Insolvency.    46
8.1.4.Non-Compliance with Loan Documents.    47
8.1.5.Representations; Warranties.    47
8.1.6.Pension Plans.    47
8.1.7.Judgments.    47
8.1.8.Invalidity of Collateral Documents.    48
8.1.9.Invalidity of Subordination Provisions.    48
8.1.10.Change of Control.    48
8.2.Remedies.    48
Section 9.Miscellaneous.    48
9.1.Waiver; Amendments.    48
9.2.Notices.    49

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9.3.Computations.    49
9.4.Costs; Expenses.    49
9.5.Indemnification by Borrower.    50
9.6.Marshaling; Payments Set Aside.    50
9.7.Nonliability of Lender.    50
9.8.Assignments.    50
9.9.Confidentiality.    51
9.10.Captions.    52
9.11.Nature of Remedies.    52
9.12.Counterparts.    52
9.13.Severability.    52
9.14.Entire Agreement.    52
9.15.Successors; Assigns.    52
9.16.Governing Law.    53
9.17.Forum Selection; Consent to Jurisdiction.    53
9.18.Waiver of Jury Trial.    53

Annex
Annex I
Addresses

Exhibits
Exhibit A
Form of Compliance Certificate
Exhibit B
Form of Note
Exhibit C
Form of Borrowing Notice
Exhibit D
Form of Excess Cash Flow Certificate
Exhibit E        Form of Warrant
Exhibit F        Forms of Tax Compliance Certificates




-iv-


CREDIT AGREEMENT

This Credit Agreement ("Agreement") dated as of August 7, 2017 between Performant Business Services, Inc., a Nevada corporation ("Borrower"), and ECMC Group, Inc., a Delaware non-profit corporation (“Lender”).
In consideration of the mutual agreements herein contained, the parties hereto agree as follows:
Section 1.
Definitions; Interpretation.
1.1.    Definitions.
When used herein the following terms shall have the following meanings:
Acceleration Event means the occurrence and continuance of any of the following: (a) an Event of Default under Section 8.1.1 as a result of the failure to pay in full the Closing Date Term Loan and any Delayed Draw Term Loans on the Maturity Date; (b) an Event of Default under Section 8.1.3(b); or (c) any other Event of Default under Section 8.1 and the declaration by Lender that the Obligations are due and payable in accordance with Section 8.2.
Account has the meaning set forth in the Guarantee and Collateral Agreement.
Account Debtor means any Person who is obligated to Borrower or any Subsidiary with respect to any Account.
Accounting Changes has the meaning set forth in Section 1.3.

Acquisition means any transaction or series of related transactions for the purpose of or resulting, directly or indirectly, in (a) the acquisition of all or substantially all of the assets of a Person, or of all or substantially all of any business or division of a Person, (b) the acquisition of in excess of 50% of the capital stock, partnership interests, membership interests or equity of any Person, or otherwise causing any Person to become a Subsidiary, or (c) a merger or consolidation or any other combination with another Person (other than a Person that is already a Subsidiary).
Adjusted EBITDA means, for any period, the sum of EBITDA for such period plus, to the extent a Permitted Acquisition or Investment permitted under Sections 7.10(o) or 7.10(q) (to the extent such Investment is an Investment in a Loan Party) has been consummated during such period, Pro Forma EBITDA attributable to such Permitted Acquisition or Investment (to the extent such Investment is an Investment in a Loan Party) permitted under Sections 7.10(o) or 7.10(q) (but only that portion of Pro Forma EBITDA attributable to the portion of such period that occurred prior to the date of consummation of such Permitted Acquisition or Investment permitted under Sections 7.10(o) or 7.10(q) (to the extent such Investment is an Investment in a Loan Party), including but not limited to, EBITDA of any Target in a Permitted Acquisition or any such Investment for any period prior to the consummation of such Permitted Acquisition or such Investment).
Adjusted Working Capital means the remainder of (a) the consolidated current assets of Parent, Borrower and the Subsidiaries minus the amount of cash and cash equivalents included in such consolidated current assets, minus (b) the consolidated current liabilities of Parent, Borrower and the Subsidiaries (excluding all accruals relating to accrued interest expense and income taxes payable) minus the amount of consolidated short-term Debt (including current maturities of long-term Debt) of Parent, Borrower and the Subsidiaries included in such consolidated current liabilities; provided, however, the foregoing shall exclude the effects of any Permitted Acquisition or Investment permitted under Sections 7.10(o) or 7.10(q),

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consummated during such period of determination; provided that, any Adjusted Working Capital attributable to any Equity Interest of third parties in non Wholly-Owned Subsidiaries shall be disregarded from the calculation of Adjusted Working Capital.
Affiliate of any Person means (a) any other Person which, directly or indirectly, controls or is controlled by or is under common control with such Person, (b) any officer or director of such Person and (c) with respect to Lender, any entity administered or managed by Lender or an Affiliate or investment advisor thereof which is engaged in making, purchasing, holding or otherwise investing in commercial loans. A Person shall be deemed to be "controlled by" any other Person if such Person possesses, directly or indirectly, power to vote 10% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managers or power to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. Unless expressly stated otherwise herein, Lender shall not be deemed an Affiliate of Borrower or of any Subsidiary.
Agreement has the meaning set forth in the Preamble.
Applicable Margin means the applicable rate per annum set forth below:
Total Debt to EBITDA Ratio
Applicable Rate
≥ 4.5:1.0
10.0%
< 4.5:1.0, ≥ 3.5:1.0
8.5%
< 3.5:1.0, ≥ 2.50:1.0
7.0%
< 2.5:10
5.5%

The Applicable Margin shall be adjusted quarterly, to the extent applicable, as of the first day of the month following the date on which financial statements are required to be delivered pursuant to Section 6.1.2 (including with respect to the last Fiscal Quarter of each Fiscal Year) after the end of each related Fiscal Quarter based on the Total Debt to EBITDA Ratio as of the last day of such Fiscal Quarter; provided that from the Closing Date until the date on which the first quarterly adjustment occurs, the Applicable Margin shall be 7.0%.
If, as a result of any restatement of or other adjustment to the financial statements of the Loan Parties or for any other reason, Lender determines that (a) the Total Debt to EBITDA Ratio as calculated by Borrower as of any applicable date was inaccurate and (b) a proper calculation of the Total Debt to EBITDA Ratio would have resulted in different pricing for any period, then (i) if the proper calculation of the Total Debt to EBITDA Ratio would have resulted in higher pricing for such period, Borrower shall automatically and retroactively be obligated to pay to Lender, an amount equal to the excess of the amount of interest and fees that should have been paid for such period over the amount of interest and fees actually paid for such period; and (ii) if the proper calculation of the Total Debt to EBITDA Ratio would have resulted in lower pricing for such period, Lender shall not have any obligation to repay any interest or fees to Borrower; provided that if, as a result of any restatement or other event a proper calculation of the Total Debt to EBITDA Ratio would have resulted in higher pricing for one or more periods and lower pricing for one or more other periods (due to the shifting of income or expenses from one period to another period or any similar reason), then the amount payable by Borrower pursuant to clause (i) above shall be based upon the excess, if any, of the amount of interest and fees that should have been paid for all applicable periods over the amount of interest and fees paid for all such periods.

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Authorized Officer means any of the (a) chief executive officer, (b) president, (c) chief financial officer or (d) senior financial officer.
Borrower has the meaning set forth in the Preamble.
Borrowing Notice means a notice in substantially the form of Exhibit C.
Business Day means any day on which commercial banks are open for commercial banking business in New York, New York, Minneapolis, Minnesota and, in the case of a Business Day which relates to the determination of the LIBOR Rate, on which dealings are carried on in the London interbank eurodollar market.
Capital Expenditures means all expenditures which, in accordance with GAAP, would be required to be capitalized and shown on the consolidated balance sheet of Borrower.
Capital Lease means, with respect to any Person, any lease of (or other agreement conveying the right to use) any real or personal property by such Person that, in conformity with GAAP, is accounted for as a capital lease on the balance sheet of such Person.
Cash Equivalent Investment means, at any time, (a) any evidence of indebtedness, maturing not more than one year after such time, issued or guaranteed by the United States Government or any agency thereof, (b) commercial paper, or corporate demand notes, in each case rated at least A-l by Standard & Poor's Ratings Group or P-l by Moody's Investors Service, Inc., (c) any certificate of deposit (or time deposit represented by a certificate of deposit) or banker's acceptance maturing not more than one year after such time, or any overnight Federal Funds transaction that is issued or sold by a commercial banking institution that is a member of the Federal Reserve System and has a combined capital and surplus and undivided profits of not less than $250,000,000, (d) any repurchase agreement entered into with a commercial banking institution of the nature referred to in clause (c) above which (i) is secured by a fully perfected security interest in any obligation of the type described in any of clauses (a) through (c) above and (ii) has a market value at the time such repurchase agreement is entered into of not less than 100% of the repurchase obligation of such commercial banking institution thereunder, (e) mutual funds and money market funds whose assets are at least 95% invested in the foregoing types of investments, (f) other short term liquid investments approved in writing by Lender (such approval not to be unreasonably withheld, delayed or conditioned), (g) marketable direct obligations issued by any state of the United States or political subdivision or public instrumentality thereof maturing within one year after such issuance or the acquisition of such obligation and having the highest rating obtainable from the S&P and Moody's, and (h) money market accounts which invest exclusively in assets satisfying the foregoing requirements and money market mutual funds.
Closing Date means the date on which Lender makes the Closing Date Term Loan hereunder.
Closing Date Term Loan Commitment means $44,000,000.
Closing Date Term Loan has the meaning set forth in Section 2.1.1.
Collateral has the meaning set forth in the Guarantee and Collateral Agreement.
Collateral Access Agreement means an agreement in form and substance reasonably satisfactory to Lender pursuant to which a lessor of real property on which Collateral is stored or otherwise located, or a warehouseman, processor or other bailee of Inventory or other property owned by any Loan Party, acknowledges the Liens of Lender and waives or subordinates any Liens held by such Person on such property, and, in the case of any such agreement with a lessor, permits Lender reasonable access to any Collateral stored or otherwise located thereon.

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Collateral Documents means, collectively, the Guarantee and Collateral Agreement, any mortgage, any Collateral Access Agreement, each account control agreement and each other agreement or instrument pursuant to or in connection with which any Loan Party grants a security interest in any Collateral securing the Obligations to Lender, each as amended, restated or otherwise modified from time to time.
Commitment means the Closing Date Term Loan Commitment and the Delayed Draw Term Loan Commitment.
Competitor of any Person means (a) any other Person which directly engages in the same business as such Person, (b) any Disqualified Person or (c) any other Person, other than ECMC Group, Inc. or a Subsidiary thereof (excluding any Subsidiary of ECMC Group, Inc. that is a Person described in clauses (a) or (b)), that possesses, directly or indirectly, power to vote at least a majority of the securities (on a fully diluted basis) of a Person described in clauses (a) or (b).
Compliance Certificate means a certificate substantially in the form of Exhibit A.
Computation Period means each period of four consecutive Fiscal Quarters ending on the last day of a Fiscal Quarter.
Consolidated Net Income means, with respect to Parent, Borrower and the other Loan Parties for any period, the consolidated net income (or loss) of Parent and the Subsidiaries for such period, excluding (a) consolidated net income of any Target in a Permitted Acquisition or any Investment permitted under Sections 7.10(o) or 7.10(q) except as provided in the definition of "Adjusted EBITDA" and "Pro Forma EBITDA" for any period prior to the consummation of such Permitted Acquisition and (b) the net income (or loss) of any Person that is not a Loan Party or that is accounted for by the equity method of accounting.
Contingent Obligation means any agreement, undertaking or arrangement by which any Person guarantees, endorses or otherwise becomes or is contingently liable upon (by direct or indirect agreement, contingent or otherwise, to provide funds for payment, to supply funds to or otherwise to invest in a debtor, or otherwise to assure a creditor against loss) any Debt, or guarantees the payment of dividends or other distributions upon the shares of any other Person. The amount of any Person's obligation in respect of any Contingent Obligation shall (subject to any limitation set forth therein) be deemed to be the principal amount of the debt, obligation or other liability supported thereby or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by such Person in good faith.
Controlled Group means all members of a controlled group of corporations and all members of a controlled group of trades or businesses (whether or not incorporated) under common control which, together with a Loan Party, are treated as a single employer under Section 414 of the IRC or Section 4001 of ERISA.
Cure Amount has the meaning set forth in Section 7.14.3.
Debt of any Person means, without duplication, (a) all indebtedness of such Person for borrowed money, (b) all indebtedness evidenced by bonds, debentures, notes or similar instruments (including, without limitation, any notes issued to sellers in connection with an Acquisition), (c) all obligations of such Person as lessee under Capital Leases which have been or should be recorded as liabilities on a balance sheet of such Person in accordance with GAAP, (d) all obligations of such Person to pay the deferred purchase price of property or services (excluding accrued expenses, licenses and purchases of software to the extent that such Person may terminate the payment obligations thereunder at will, and trade accounts payable), (e) all indebtedness secured by a Lien on the property of such Person, whether or not such indebtedness shall have been assumed by such Person, (f) all obligations, contingent or otherwise, with respect to letters of credit (whether or not drawn), banker's acceptances and surety bonds issued for the account of such Person, (g)  all Contingent Obligations of such Person, (h) all indebtedness of any partnership of which such Person is a

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general partner and (i) all obligations of such Person under conditional sale or other title retention agreements relating to property or assets purchased by such Person. For the avoidance of doubt, Permitted Seller Debt and Permitted Earn-Outs shall constitute Debt.
Declined Proceeds has the meaning set forth in Section 2.6.2.
Default means any event described in Section 8.1 that, if it continues uncured during an applicable grace period, will, with the lapse of such grace period or the giving of notice or both, constitute an Event of Default.
Delayed Draw Term Loan Commitment means $15,000,000.
Delayed Draw Term Loans has the meaning set forth in Section 2.1.2.
Diluted Common Equity means the number of outstanding shares of common stock of Parent as calculated using the “treasury stock” method as defined under GAAP for the three (3) month period preceding the applicable measurement date.

Disclosure Letter means the disclosure letter, dated as of the Closing Date, and addressed to Lender containing certain schedules referenced herein.
Disposition means, as to any asset or right of any Loan Party, (a) any sale, lease, assignment or other transfer (other than to Borrower or any of its Domestic Subsidiaries), (b) any loss, destruction or damage thereof or (c) any condemnation, confiscation, requisition, seizure or taking thereof by a Governmental Authority, in each case excluding (i) Dispositions in any Fiscal Year, the Net Cash Proceeds of which do not in the aggregate exceed $1,000,000, (ii) the sale or other transfer of Inventory in the ordinary course of business, (iii) dispositions in the ordinary course of business, (iv) dispositions under clauses (iii), (iv), (v), (vi), (viii), (ix), (x), or (xi) of Section 7.4(b), (v) the termination, surrender or sublease of a real estate lease of a Loan Party in the ordinary course of business, or (vi) the cancellation of any intercompany Debt.
Disqualified Persons means any Person set forth on Schedule 1.1 to the Disclosure Letter.
Dollar and $ mean lawful money of the United States of America.
Domestic Subsidiary means any Subsidiary that is incorporated or organized under the laws of a State within the United States of America or the District of Columbia.
EBITDA means, for any period, Consolidated Net Income for such period plus any losses or minus any gains from sales, leases, losses, condemnation or other dispositions of assets, extraordinary items (as defined in accordance with GAAP), discontinued operations, reappraisal, revaluation or write-up or write down of assets or from the cumulative effect of changes in accounting principles, and plus, to the extent deducted in determining such Consolidated Net Income, (i) interest expense, amortization of debt discounts and commissions, income tax expense, depreciation, amortization, charges for impairment of goodwill and other intangibles for such period, (ii) fees and expenses (including Legal Costs) with regard to this Agreement, in each case to the extent deducted in determining such Consolidated Net Income, (iii) reasonable and customary fees and expenses (including Legal Costs) in connection with Permitted Acquisitions, and Investments permitted under Sections 7.10(o) or 7.10(q), (iv) other extraordinary and non-recurring costs and expenses that are satisfactory to Lender, (v) non-cash expenses in the form of options granted by Borrower or Parent and other non-cash expense with respect to deferred compensation and stock options, (vi) documented severance expenses and service provider contract breakage fees, (vii) all usual and customary costs, fees, expenses and charges paid during such period in connection with any issuance of Equity Interests or Debt permitted under this Agreement, (viii) business interruption insurance proceeds received in cash during such period, (ix) all non-cash adjustments to the valuation of earn-out payments or other consideration

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relating to Investments permitted hereunder, (x) restructuring costs incurred in connection with a Permitted Acquisition or Investment in a Loan Party permitted under Sections 7.10(o) or 7.10(q), (xi) all non-cash charges, losses or expenses (or minus non-cash income or gain) included or deducted in calculating net income (or loss) for such period including, without limitation, any non-cash loss or expense (or income or gain) due to the application of FASB ASC 815-10 regarding hedging activity, FASB ASC 350 regarding impairment of goodwill and intangibles, FASB ASC 480-10 regarding accounting for financial instruments with Debt and equity characteristics, FASB ASC No. 715 regarding post-retirement benefits, FASB ASC No. 805 regarding the accrual of earnouts, and non-cash foreign currency exchange losses (or minus gains), but excluding any non-cash loss or expense (a) that is an accrual of a reserve for a cash expenditure or payment to be made, or anticipated to be made, in a future period or (b) relating to a write-down, write off or reserve with respect to Accounts and Inventory, (xii) costs, fees or expenses incurred in connection with the credit agreement applicable to the Prior Debt, (xiii) Permitted Addbacks and (xiv) solely for the purposes of determining compliance with Sections 7.14.1 and 7.14.2, any Cure Amount contributed pursuant to Section 7.14.3.
ECF Percentage means, for any Fiscal Year, 75% if the Total Debt to EBITDA Ratio equals or exceeds 3.5:1.0 as of the last day of such Fiscal Year; 50% if the Total Debt to EBITDA Ratio is less than 3.5:1.0 and equals or exceeds 2.5:1.0 as of the last day of such Fiscal Year; and 0% if the Total Debt to EBITDA Ratio is less than 2.5:1.0 as of the last day of such Fiscal Year.
Environmental Claims means all written claims by any governmental, regulatory or judicial authority or other Person alleging potential liability or responsibility for violation of any Environmental Law, or for release or injury to the environment or any Person or property.
Environmental Laws means all present or future federal, state or local laws, statutes, common law duties, rules, regulations, ordinances and codes, together with all binding and enforceable administrative orders, directed duties, requests, licenses, authorizations and permits of, and agreements with, any governmental authority, in each case relating to any matter arising out of or relating to health and safety, or pollution or protection of the environment or workplace, including any of the foregoing relating to the presence, use, production, generation, handling, transport, treatment, storage, disposal, distribution, discharge, release, control or cleanup of any Hazardous Substance.
Equity Interest means the interest of any (a) shareholder in a corporation; (b) partner in a partnership (whether general, limited, limited liability or joint venture); (c) member in a limited liability company; or (d) other Person having any other form of equity security or ownership interest.
ERISA means the Employee Retirement Income Security Act of 1974, as amended.
Event of Default means any of the events described in Section 8.1.
Excess Cash Flow means, for any period, the remainder of (a) the sum of (i) EBITDA for such period, plus (ii) any net decrease in Adjusted Working Capital during such period, minus (b) the sum, without duplication, of (i) scheduled repayments of principal of the Loans (excluding mandatory prepayments thereof) and other Debt of Parent, Borrower and the Subsidiaries (in respect of Debt permitted in accordance with Section 7.1) made during such period, plus (ii) capital expenditures made in such period (not financed with the proceeds of Debt), plus (iii) all federal, state, local and foreign income taxes of Borrower and the Subsidiaries, or of Parent with the proceeds of distributions by Borrower, paid in cash during such period, net of any federal, state, local or foreign income tax refunds received in cash by Parent, Borrower and the Subsidiaries in such period, plus (iv) all Interest Expense in respect of Debt permitted in accordance with Section 7.1 of Parent, Borrower and the Subsidiaries during such period, plus (v) any net increase in Adjusted Working Capital during such period, plus (vi) without duplication of clause (a) above, Legal Costs, plus (vii) any expenses and indemnifications paid in cash, plus (viii) any other cash expenses that are added back to

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Consolidated Net Income in the calculation of EBITDA, plus (ix) Permitted Acquisitions, Investments and Restricted Payments not financed with the proceeds of the issuance of equity or with the proceeds of Debt, plus (x) cash payments with respect to installments owing for the purchase or license of software, plus (xi) other payments added back to EBITDA in the definition thereof.
Excess Cash Flow Certificate means a certificate substantially in the form of Exhibit D.
Excluded Foreign Holding Company means a Domestic Subsidiary that is treated as a corporation for U.S. federal income tax purposes and has no assets other than the equity interests of one or more Foreign Subsidiaries or an immaterial amount of other assets.
Excluded Issuance means the issuance of equity securities (a) to members of the management, employees or directors of Loan Party who have a right, option, warrant, conversion right or other similar agreement or understanding for the purchase or acquisition of any equity interest of Parent, Borrower or any Subsidiary, (b) to any Person, the proceeds of which will be used, promptly following the issuance thereof, solely to fund the purchase price of Permitted Acquisitions (including earnouts, working capital adjustments and purchase price adjustments), Investments permitted under Section 7.10 or Capital Expenditures or in which constitutes "rollover equity" with respect to Permitted Acquisitions, in each case, in an amount equal to the Net Cash Proceeds of such issuance, or (c) to any Person that owns securities of Parent or any Subsidiary on the Closing Date.
Excluded Taxes means any of the following Taxes imposed on or with respect to a Lender or required to be withheld or deducted from a payment to Lender: (a) Taxes imposed on or measured by net income (however denominated), franchise Taxes, and branch profits Taxes, in each case, (i) imposed as a result of Lender being organized under the laws of, or having its principal office or, in the case of Lender, its applicable lending office located in, the jurisdiction imposing such Tax (or any political subdivision thereof) or (ii) that are Other Connection Taxes, (b) in the case of a Lender, U.S. federal withholding Taxes imposed on amounts payable to or for the account of such Lender with respect to an applicable interest in a Loan or Commitment pursuant to a law in effect on the date on which (i) such Lender acquires such interest in the Loan or Commitment or (ii) such Lender changes its lending office, except in each case to the extent, that pursuant to Section 3.1, amounts with respect to such Taxes were payable either to such Lender’s assignor immediately before such Lender became a party hereto or to such Lender immediately before it changed its lending office, (c) Taxes attributable to such Lender’s failure to comply with Section 3.1(g) and (d) any U.S. federal withholding Taxes imposed under FATCA.

Exempt Accounts means any deposit accounts, securities accounts or other similar accounts (i) into which there is deposited no funds other than those intended solely to cover wages for employees of the Loan Parties; (ii) constituting employee withholding accounts and contain only funds deducted from pay otherwise due to employees for services rendered to be applied toward the tax obligations of such employees; (iii) constituting Trust Accounts or other escrow accounts and any lockbox, clearing or other pass through account established for the purpose of transferring funds  to or from a Trust Account or other escrow account; (iv) in which there is not maintained at any point in time funds on deposit greater than $250,000 in the aggregate for all such accounts pursuant to this clause (iv); and (v) in which there is deposited cash collateral in respect of Debt permitted by Section 7.1(n).
FATCA means Sections 1471 through 1474 of the IRC, as of the date of this Agreement (or any amended or successor version that is substantively comparable and not materially more onerous to comply with), any current or future regulations or official interpretations thereof and any agreements entered into pursuant to Section 1471(b)(1) of the IRC.
Fiscal Quarter means a fiscal quarter of a Fiscal Year.

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Fiscal Year means the fiscal year of Parent, Borrower and the Subsidiaries, which period shall be the 12‑month period ending on December 31 of each year.
Fixed Charge Coverage Ratio means, for any Computation Period, with respect to Parent, Borrower and the Subsidiaries, determined on a consolidated basis, the ratio of (a) the total for such period of EBITDA minus the sum of (i) all income taxes paid in cash, (ii) all unfinanced Capital Expenditures, paid in cash, and (iii) other restricted payments made pursuant to Section 7.3 (excluding restricted payments funded with Net Cash Proceeds of Subordinated Debt or an equity issuance by Parent), to (b) the sum for such period of (i) Interest Expense paid in cash (but excluding prepayment and other fees and expenses with regard to this Agreement and Legal Costs paid during such Computation Period to the extent such amounts are classified as interest expense for GAAP purposes) plus (ii) scheduled payments of principal of Debt (excluding any mandatory prepayments); provided, that with respect to Computation Periods ending prior to the first anniversary hereof, (i) Interest Expense and payments of principal of Debt shall be deemed to be the amounts from September 1, 2017, through the date of calculation, divided by the number of months during such period, and multiplied by 12.
Foreign Lender means a Lender that is not a U.S. Person.
Foreign Subsidiary means any Subsidiary (a) that is not incorporated or organized under the laws of a State within the United States of America or the District of Columbia, and that is a "controlled foreign corporation" within the meaning of Section 957 of the IRC with respect to which a Loan Party is a "US Shareholder" within the meaning of Section 951(b) of the IRC or (b) that has no material assets other than the capital stock of one or more Subsidiaries described in clause (a) and other assets relating to an ownership interest in any such capital stock or subsidiaries.
FRB means the Board of Governors of the Federal Reserve System or any successor thereto.
GAAP means generally accepted accounting principles in effect in the United States of America set forth from time to time in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board (or agencies with similar functions of comparable stature and authority within the U.S. accounting profession), which are applicable to the circumstances as of the date of determination; provided, that Financial Accounting Standard No. 150 shall be disregarded of the purposes of this Agreement.
Governmental Authority means any nation or government, any state or other political subdivision thereof, and any agency, branch of government, department or Person exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government.
Guarantee and Collateral Agreement means the Guarantee and Collateral Agreement dated as of the Closing Date by each Loan Party signatory thereto in favor of Lender.
Guarantor has the meaning set forth in the Guarantee and Collateral Agreement.
Hazardous Substances means hazardous waste, hazardous substance, pollutant, contaminant, toxic substance, oil, hazardous material or chemical or other hazardous of toxic substance regulated by any Environmental Law.
Hedging Obligation means, with respect to any Person, any liability of such Person under any interest rate, currency or commodity swap agreement, cap agreement or collar agreement, and any other agreement or arrangement designed to protect a Person against fluctuations in interest rates, currency exchange rates or commodity prices.
Indemnified Liabilities has the meaning set forth in Section 9.5.

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Indemnified Taxes means (a) Taxes, other than Excluded Taxes, imposed on or with respect to any payment made by or on account of any obligation of any Loan Party under any Loan Document and (b) to the extent not otherwise described in (a), Other Taxes.

Intellectual Property has the meaning set forth in the Section 5.18.
Interest Expense means for any period the consolidated cash interest expense of Parent, Borrower and the Subsidiaries for such period (including that portion of payments on Capital Leases determined in accordance with GAAP to be characterized as interest payments).
Inventory has the meaning set forth in the Guarantee and Collateral Agreement.
Investment means, with respect to any Person, (a) the purchase of any debt or equity security of any other Person, (b) the making of any loan or advance to any other Person, (c) becoming obligated with respect to a Contingent Obligation in respect of Debt of any other Person (other than travel and similar advances to employees in the ordinary course of business) or (d) the making of an Acquisition. The amount of any Investment shall be the amount actually invested, without adjustment for subsequent increases or decreases in the value of such Investment but giving effect to any returns or distributions received by such Person with respect thereto (but in any event, for purposes of determining compliance with Section 7.10, after giving effect to such returns and distributions the aggregate outstanding Investments shall in no event be less than zero).
Investment Period has the meaning set forth in Section 7.14.3.
IRC means the U.S. Internal Revenue Code of 1986, as amended.
Legal Costs means (a) with respect to Lender pursuant to Section 9.4, (i) all reasonable and documented out-of-pocket fees and expenses of any one outside counsel to Lender, (ii) all reasonable and documented out-of-pocket fees and expenses of necessary outside local counsel to Lender, and (iii) all court costs and similar legal expenses, in each case, to the extent reimbursable by Borrower under this Agreement, (b) with respect to Lender Parties pursuant to Section 9.5, (i) all reasonable and documented out-of-pocket fees and expenses of any one outside counsel to all Lender Parties (taken as a whole) to the extent no conflict exists (but if any conflict exists, the outside counsel for each such Lender Party requiring separate counsel because of such conflict) and (ii) all court costs and similar legal expenses, in each case, to the extent reimbursable by Borrower under this Agreement and (c) with respect to all other Persons, (i) all reasonable fees and charges of any counsel, accountants auditors, appraisers, consultants and other professionals to such Persons and (ii) all court costs and similar legal costs.
Lender has the meaning set forth in the Preamble.
Lender Party has the meaning set forth in Section 9.5.

LIBOR Rate means, with respect to any Loan, the greater of (a) a rate per annum equal to the offered rate for deposits in Dollars for a one-month period and for the amount of the applicable Loan that appears on the Reuters Screen LIBOR01 Page at 11:00 a.m. London time (or, if not so appearing, as published in the "Money Rates" section of The Wall Street Journal) two Business Days prior to the date of determination; provided that if neither of the foregoing is available, the rate shall be the arithmetic mean of the rates quoted by three major banks in New York City, selected by the Lender at approximately 11:00 a.m., New York time, two (2) Business Days prior to the date of determination for loans in U.S. Dollars to leading European banks for a one-month period and in a principal amount of not less than U.S. $1,000,000, and (b) 1.00% per annum.

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Lien means, with respect to any Person, any interest granted by such Person in any real or personal property, asset or other right owned or being purchased or acquired by such Person which secures payment or performance of any obligation and shall include any mortgage, lien, encumbrance, charge in the nature of a security interest, whether arising by contract, as a matter of law, by judicial process or otherwise.
Loan Documents means this Agreement, the Notes, the Collateral Documents, and all documents, instruments and agreements delivered in connection with the foregoing, but excluding any agreement entered into in respect of Hedging Obligations.
Loan Party means Parent, Borrower and each Guarantor.
Loans means the Closing Date Term Loan and the Delayed Draw Term Loans, collectively.
Margin Stock means any "margin stock" as defined in Regulation T, U or X of the FRB.
Material Adverse Effect means (a) a material adverse change in, or a material adverse effect upon, the financial condition, operations, assets, business or properties of Loan Parties taken as a whole, (b) a material impairment of the ability of the Loan Parties taken as a whole to perform any of their Obligations under any Loan Document or (c) a material adverse effect upon any substantial portion of the Collateral under the Collateral Documents or upon the legality, validity, binding effect or enforceability against any Loan Party of any Loan Document.
Maturity Date means (a) the later of (i) the third anniversary of the Closing Date or (ii) if Borrower exercises the first or second extension option pursuant to Section 2.3, the date set forth in Section 2.3, or (b) such earlier date on which the Commitments terminate pursuant to Section 8.
Multiemployer Pension Plan means a multiemployer plan, as defined in Section 4001(a)(3) of ERISA, to which Borrower or any Loan Party may have any liability, including any liability by being a member of a Controlled Group with any other entity or trade or business other than Borrower or any Loan Party.
Net Cash Proceeds means, with respect to any Disposition, the aggregate cash proceeds (including cash proceeds received pursuant to policies of insurance (other than business interruption insurance unless required to be paid to Lender during the continuance of an Event of Default) and by way of deferred payment of principal pursuant to a note, installment receivable or otherwise, but only as and when received) received by any Loan Party pursuant to such Disposition net of (i) the reasonable direct costs, fees and expenses relating to such Disposition (including the cost of preparing such assets for sale, costs incidental to the sale of such assets, sales commissions and legal, accounting and investment banking fees, commissions and expenses), (ii) any portion of such proceeds deposited in an escrow account pursuant to the documentation relating to such Disposition (provided that such amounts shall be treated as Net Cash Proceeds upon their release from such escrow account to the applicable Loan Party), (iii) taxes paid or reasonably estimated by Borrower to be payable as a result thereof (after taking into account any available tax credits or deductions arising from such sale and any tax sharing arrangements in respect thereof), (iv) amounts required to be applied to the repayment of any Debt secured by a Lien that has priority over the Lien of Lender on the asset subject to such Disposition and (v) any reserves taken in accordance with GAAP for so long as such reserves are required by GAAP, (vi) (A) with respect to any Disposition described in clause (a) of the definition thereof, all money actually applied within 180 days (or prior to such date be subject to a binding commitment to so replace such assets using such Net Cash Proceeds within 270 days of original receipt of such cash proceeds) to acquire assets used or useful in the Loan Parties' business, and (B) with respect to any Disposition described in clause (b) or (c) of the definition thereof, all money actually applied within 180 days (or prior to such date be subject to a binding commitment to so replace such assets using such Net Cash Proceeds

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within 270 days of original receipt of such cash proceeds) to repair, replace or reconstruct damaged property or property affected by loss, destruction, damage, condemnation, confiscation, requisition, seizure or taking.
Note means a promissory note executed by Borrower in favor of a Lender hereunder pursuant to this Agreement, substantially in the form of Exhibit B.
Obligations means all liabilities, indebtedness and obligations (monetary (including post-petition interest, allowed or not) or otherwise) of any Loan Party under this Agreement, any other Loan Document, in each case howsoever created, arising or evidenced, whether direct or indirect, absolute or contingent, now or hereafter existing, or due or to become due.
OFAC has the meaning set forth in Section 6.4(a).

Operating Lease means any lease of (or other agreement conveying the right to use) any real or personal property by Borrower or any Subsidiary, as lessee, other than any Capital Lease.
Other Connection Taxes means, with respect to any Lender, Taxes imposed as a result of a present or former connection between such Lender and the jurisdiction imposing such Tax (other than connections arising from such Lender having executed, delivered, become a party to, performed its obligations under, received payments under, received or perfected a security interest under, engaged in any other transaction pursuant to or enforced any Loan Document, or sold or assigned an interest in any Loan or Loan Document).

Other Taxes means all present or future stamp, court or documentary, intangible, recording, filing or similar Taxes that arise from any payment made under, from the execution, delivery, performance, enforcement or registration of, from the receipt or perfection of a security interest under, or otherwise with respect to, any Loan Document, except any such Taxes that are Other Connection Taxes imposed with respect to an assignment.

Paid in Full, Pay in Full or Payment in Full means, with respect to any Obligations, the payment in full in cash of all such Obligations (other than contingent indemnification obligations to the extent no claim giving rise thereto has been asserted).

Parent means Performant Financial Corporation, a Delaware corporation.
PBGC means the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA.
Pension Plan means a "pension plan", as such term is defined in Section 3(2) of ERISA, which is subject to Title IV of ERISA (other than a Multiemployer Pension Plan), and to which Borrower or any Loan Party has any liability, including any liability (i) by reason of having been a substantial employer within the meaning of Section 4063 of ERISA at any time during the preceding five years, (ii) by reason of being deemed to be a contributing sponsor under Section 4069 of ERISA or (iii) by reason of being a member of a Controlled Group with any other entity or trade or business other than Borrower or any Loan Party.
Permitted Acquisition means any Acquisition by any Loan Party in each case to the extent that:
(a)    each of the following conditions precedent shall have been satisfied in a manner reasonably satisfactory to Lender;
(i)    Lender shall receive not less than ten (10) Business Days' prior written notice of such Acquisition, which notice shall include a reasonably detailed

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description of the proposed terms of such Acquisition and identify the anticipated closing date thereof;
(ii)    such Acquisition shall be structured as (A) an asset acquisition by Borrower or a Guarantor, (B) a merger of the Target with and into Borrower or a Guarantor, with Borrower or such Guarantor as the surviving corporation in such merger, or (C) a purchase of no less than 100% of the equity interests of the Target by Borrower or a Guarantor;
(iii)    Lender shall receive evidence that effective as of the closing date of such Acquisition the applicable Target has in place insurance satisfying the requirements of Section 6.3;
(iv)    Lender (A) is granted a first priority perfected Lien (subject only to Permitted Liens) on all Collateral being acquired pursuant to such Acquisition (and, in the case of an Acquisition involving the purchase of any applicable Target's equity interests, all of such purchased equity interests to the extent constituting Collateral shall be pledged to Lender, and such Target shall guarantee the Obligations and grant to Lender, a first priority perfected Lien (subject only to Permitted Liens) on such Person's assets), in each case, as required by Section 6.8 and (B) will be provided such other documents, instruments and legal opinions (consistent with Section 4.1) as Lender shall reasonably request in connection therewith, all such documents, instruments and opinions to be delivered no later than 30 days after the closing of such Acquisition (or such longer period as agreed by Lender in its sole discretion) and shall each be in form and substance reasonably satisfactory to Lender;
(v)    all material consents necessary for such Acquisition (including such consents as Lender deems reasonably necessary) have been acquired and such Acquisition is consummated in accordance with the applicable acquisition documents and applicable law;
(vi)    after giving effect to such Acquisition and the incurrence of any Loans, other Debt or Contingent Obligations in connection therewith, Parent shall have a Total Debt to EBITDA Ratio of not greater than 5.0:1.0 recomputed for the most recently ended Fiscal Quarter for which financial statements for the applicable Target and for Parent and its subsidiaries are available; and
(vii)    after giving effect to such Acquisition, Parent, Borrower and its Subsidiaries have Unrestricted Liquid Assets in excess of $2,500,000;
(b)    such Acquisition shall not be hostile and shall have been approved by the board of directors (or other similar body) and/or the stockholders or other equityholders of the Target; and
(c)    no Event of Default is in existence or would occur immediately after giving effect to such Acquisition.
Permitted Addbacks means, in connection with any new Department of Education or another similar recovery contract in any of the Loan Parties’ lines of business that may be entered into by one or more of the Loan Parties following the Closing Date, in respect of any fiscal month commencing with the first fiscal month in respect of which Borrower elects (subject to the requirements set forth below) to add amounts set forth below with respect to such contract to Consolidated Net Income for purposes of the calculation of EBITDA and ending nine (9) consecutive months thereafter, the direct costs of the Loan Parties incurred following the Closing Date in connection with the startup of such contract (to the extent in any month in excess of the revenue of the Loan Parties received under such contract during such month) that are incurred

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in connection with the Loan Parties' work as a prime contractor under such contract (excluding any overhead or shared cost allocations that are not directly related to such contract).
Permitted Debt has the meaning set forth in Section 7.1.

Permitted Earn-Outs means, with respect to any Person, unsecured obligations of such Person arising from a Permitted Acquisition or an Investment permitted under Section 7.10 which are payable based on the achievement of specified financial results over time. The amount of any Permitted Earn-Outs for purposes of the financial covenants set forth in this Agreement shall be the amount earned and due to be paid at such time and for the avoidance of doubt, shall not include any amounts, contingent or otherwise, that are not due and payable as of the date of determination.
Permitted Investment has the meaning set forth in Section 7.10.

Permitted Liens means Liens permitted by Section 7.2.
Permitted Seller Debt means unsecured Debt incurred in accordance with Section 7.1(h) and in connection with a Permitted Acquisition or Investment permitted under Sections 7.10(o) or 7.10(q), payable to the seller in connection therewith.
Person means any natural person, corporation, partnership, trust, limited liability company, association, governmental authority or unit, or any other entity, whether acting in an individual, fiduciary or other capacity.
Prior Debt means the Debt listed on Schedule 4.1.1 to the Disclosure Letter.
Pro Forma EBITDA means, at any time with respect to any Target acquired in a Permitted Acquisition or an Investment permitted under Sections 7.10(o) or 7.10(q) (to the extent such Investment is in a Loan Party), EBITDA for such Target for the most recent twelve (12) month period for which financial statements of such Target are made available to Lender with such adjustments to EBITDA to reflect extraordinary expenses, increased costs, identifiable and verifiable expense reductions, excess management compensation and any other such adjustments, in each case to the extent applicable as calculated by Borrower and approved by Lender in its reasonable discretion.
Register has the meaning set forth in Section 9.8(b).
Rejection Notice has the meaning set forth in Section 2.6.2.
Restricted Payment Conditions means, with respect to any redemption or distribution of the equity interests of the Parent or repayment or payment on any Subordinated Debt, (a) immediately prior to and after giving effect to such redemption or distribution, no Event of Default or Default exists or would result therefrom, (b) after giving effect to such redemption or distribution, Parent, Borrower and its Subsidiaries have Unrestricted Liquid Assets in excess of $2,500,000, (c) the Total Debt to EBITDA Ratio recomputed after giving effect to such redemption or distribution for the most recently ended month of Parent for which financial statements for Parent, Borrower and its Subsidiaries are available, is less than or equal to 3.0:1.0.
Subordinated Debt means any unsecured Debt of Parent, Borrower or a Subsidiary which has subordination terms which have been approved in writing by Lender and other terms reasonable and customary for such Subordinated Debt.
Subsidiary means, with respect to any Person, a corporation, partnership, limited liability company or other entity of which such Person owns, directly or indirectly, such number of outstanding Equity Interests as to have more than 50% of the ordinary voting power for the election of directors or other managers of

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such corporation, partnership, limited liability company or other entity. Unless the context otherwise requires, each reference to Subsidiaries herein shall be a reference to Subsidiaries of Borrower.
Target means the Person, or business or substantially all of the assets of a Person, acquired in an Acquisition.
Taxes means all present or future taxes, levies, imposts, duties, deductions, withholdings (including backup withholding), assessments, fees or other charges imposed by any Governmental Authority, including any interest, additions to tax or penalties applicable thereto.
Termination Date means the earliest to occur of (a) the date on which Lender has funded Delayed Draw Term Loans in an aggregate principal amount equal to the Delayed Draw Term Loan Commitment, (b) second anniversary of the Closing Date and (c) the date on which the Delayed Draw Term Loan Commitment terminates pursuant to Section 8.
Total Debt means all Debt (other than (a) (i) Debt described in clauses (f), (g), and (h) (to the extent the obligations under (h) are not due and owing) of the definition thereof and (ii) Permitted Seller Debt and Permitted Earn-Outs (to the extent such Permitted Seller Debt or Permitted Earn-Outs are not due and owing), unless, in each case, such Debt is reflected on the balance sheet of Parent as a liability in accordance with GAAP) and (b) all Hedging Obligations that mature more than one year from the date of its creation) of Parent, Borrower and the Subsidiaries, determined on a consolidated basis.
Total Debt to EBITDA Ratio means, as of the last day of any Fiscal Quarter, the ratio of (a) Total Debt as of such day minus up to $10,000,000 of actual Unrestricted Liquid Assets to (b) Adjusted EBITDA for the Computation Period ending on such day.
Trust Accounts means those trust accounts maintained by Borrower or its Subsidiaries to receive and hold in trust for payment to the federal government of the United States of America, payments on the account of holders of student loans.
Unrestricted Liquid Assets shall mean cash and Cash Equivalent Investments owned directly by the Loan Parties maintained in accounts in the United States, which are unrestricted and unencumbered (other than Liens on such cash and Cash Equivalent Investments in favor of Lender under the Collateral Documents or bankers liens and rights of setoff or offset with respect to customary depository arrangements entered into in the ordinary course of business) and which are held in accounts subject to a tri-party control agreement in form and substance satisfactory to Lender, minus accounts payable of such Loan Parties.
U.S. Person means any Person that is a “United States Person” as defined in Section 7701(a)(30) of the IRC.

U.S. Tax Compliance Certificate has the meaning specified in Section 3.1(f).
    
Warrants means warrants of Parent in substantially the form of Exhibit E.

Wholly-Owned Domestic Subsidiary means a Wholly-Owned Subsidiary that is a Domestic Subsidiary.
Wholly-Owned Subsidiary means, as to any Person, another Person all of the equity interests of which (except directors' or employees' qualifying shares or other minimal share allocations required by the law of the jurisdiction of organization or allocated for tax considerations) are at the time directly or indirectly owned by such Person and/or another Wholly-Owned Subsidiary of such Person.
Withholding Agent means any Loan Party.

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1.2.    Interpretation.
In the case of this Agreement and each other Loan Document, (a) the meanings of defined terms are equally applicable to the singular and plural forms of the defined terms; (b) Annex, Exhibit, Schedule and Section references are to such Loan Document unless otherwise specified; (c) the term "including" is not limiting and means "including but not limited to"; (d) in the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including"; the words "to" and "until" each mean "to but excluding", and the word "through" means "to and including"; (e) unless otherwise expressly provided in such Loan Document, (i) references to agreements and other contractual instruments shall be deemed to include all subsequent amendments, restatements, supplements, replacements, extensions, renewals, and other modifications thereto, but only to the extent such amendments and other modifications are not prohibited by the terms of any Loan Document, and (ii) references to any statute or regulation shall be construed as including all statutory and regulatory provisions amending, replacing, supplementing or interpreting such statute or regulation; (f) this Agreement and the other Loan Documents may use several different limitations, tests or measurements to regulate the same or similar matters, all of which are cumulative and each shall be performed in accordance with its terms; and (g) all references to "knowledge", "aware" or "awareness" or other similar terms of any Loan Party means the actual knowledge of a Responsible Officer, (i) the words "asset" and "property" shall be construed as having the same meaning and effect and to refer to any and all tangible and intangible assets and properties, including cash, securities, accounts and contract rights in this Agreement and the other Loan Documents are the result of negotiations among and have been reviewed by counsel to Borrower, Lender and the other parties hereto and thereto and are the products of all parties; accordingly, they shall not be construed against Borrower or Lender merely because of Borrower’s or Lender’s involvement in their preparation.
1.3.    Accounting Changes.
It is understood that all financial statements delivered pursuant to Section 6.1 shall be prepared in accordance with GAAP as in effect on the date of their respective preparation. In the event that any "Accounting Change" (as defined below) shall occur and such change results in a change in the method of calculation of financial covenants, standards or terms negotiations in order to amend such provisions of this Agreement so as to equitably reflect such Accounting Changes with the desired result that the criteria for evaluating Borrower's financial condition shall be the same after such Accounting Changes as if such Accounting Changes had not been made. Until such time as such an amendment shall have been executed and delivered by Borrower and Lender, all financial covenants, standards and terms in this Agreement shall continue to be calculated or construed as if such Accounting Changes had not occurred. "Accounting Changes" refers to changes in accounting principles required by the promulgation of any rule, regulation, pronouncement or opinion by the Financial Accounting Standards Board of the American Institute of Certified Public Accountants or, if applicable, the Securities and Exchange Commission (or successors thereto or agencies with similar functions). Notwithstanding any other provision contained herein, (i) all terms of an accounting or financial nature used (and all financial reporting requirements set forth) herein shall be construed and all computations of amounts and ratios referred to herein shall be made, (x) without giving effect to any election under Statement of Financial Accounting Standards 159 (Codification of Accounting Standards 825-10) to value any Debt or other liabilities of any Loan Party or any Subsidiary at "fair value", as defined therein and (y) without giving effect to any requirement of GAAP requiring consolidation of limited partnerships because of deemed control by the general partner, and (ii) to the extent that any change in GAAP after the Closing Date results in leases which are, or would have been, classified as operating leases under GAAP as it exists on the Closing Date being classified as a capital lease under as revised GAAP, such change in classification of leases from operating leases to capital leases shall be disregarded and eliminated for purposes of the operation of the terms and covenants (and the related calculations thereunder) in this Agreement unless Borrower and Lender shall otherwise mutually agree in writing.

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Section 2.
Credit Facilities.
2.1.    Commitments.
On and subject to the terms and conditions of this Agreement, Lender agrees as follows:
2.1.1.    Closing Date Term Loan Commitments.
Lender agrees to make a loan to Borrower (each such loan, a "Closing Date Term Loan") on the Closing Date in an amount equal to the Closing Date Term Loan Commitment. The Commitment of Lender to make Closing Date Term Loan shall terminate concurrently with the making of the Closing Date Term Loan on the Closing Date. To the knowledge of Lender either, (i) no portion of the Closing Date Term Loan shall be funded or held with the "plan assets" of any "benefit plan investor" within the meaning of Section (3)(42) of ERISA or (ii) the Closing Date Term Loan will not constitute or result in a non-exempt prohibited transaction under Section 406 of the ERISA or Section 4975 of the IRC. The Closing Date Term Loan which is repaid or prepaid by Borrower, in whole or in part, may not be reborrowed.
2.1.2.    Delayed Draw Term Loan Commitments.
Lender agrees to make a loan to Borrower (each such loan, a "Delayed Draw Term Loan") from time to time after the Closing Date in a principal amount not to exceed the Delayed Draw Term Loan Commitment. The Commitment of Lender to make Delayed Draw Term Loans shall terminate on the Termination Date. To the knowledge of Lender either, (i) no portion of the Delayed Draw Term Loans shall be funded or held with the "plan assets" of any "benefit plan investor" within the meaning of Section (3)(42) of ERISA or (ii) the Delayed Draw Term Loans will not constitute or result in a non-exempt prohibited transaction under Section 406 of the ERISA or Section 4975 of the IRC. Delayed Draw Term Loans which are repaid or prepaid by Borrower, in whole or in part, may not be reborrowed.
2.2.    Borrowing Procedures.
Borrower shall give written notice or telephonic notice (followed promptly by written confirmation thereof) to Lender of each proposed borrowing of a Delayed Draw Term Loan not later than 1:00 p.m. Minneapolis time at least five (5) Business Days prior to the proposed date of such borrowing. Each such notice shall be effective upon receipt by Lender, shall be irrevocable, and shall specify, in the form of a Borrowing Notice, the date and amount of such borrowing. Not later than 1:00 p.m. Minneapolis time on the date of a proposed Delayed Draw Term Loan borrowing, Lender, so long as the conditions precedent set forth in Section 4.2 with respect to such borrowing have been satisfied, shall pay over the requested Delayed Draw Term Loan to Borrower on the requested borrowing date. Each borrowing shall be on a Business Day. Each borrowing of Delayed Draw Term Loans shall be in an aggregate amount of at least $3,000,000 and an integral multiples of $1,000,000 (or if less, the remaining undrawn amount of the Delayed Draw Term Loan Commitment).
2.3.    Extension of Maturity Date.
Borrower may, by written notice to Lender given no later than July 31, 2020, extend the Maturity Date for a one year period commencing on the then applicable Maturity Date and ending on fourth anniversary of the Closing Date, provided that concurrently with such written notice Borrower shall deliver to Lender Warrants representing the right to acquire 1% of the Diluted Common Equity of Parent. If Borrower extends the Maturity Date pursuant to the immediately preceding sentence, Borrower may, by written notice to Lender given no later than July 31, 2021, extend the then applicable Maturity Date for an additional one year period commencing on the then applicable Maturity Date and ending on the fifth anniversary of the Closing Date, provided that concurrently with such written notice Borrower shall deliver to Lender Warrants representing the right to acquire 1.5% of the Diluted Common Equity of Parent. In no event shall the Maturity Date be

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extended beyond the fifth anniversary of the Closing Date. In addition to the issuance of the warrants described above, the right of the Borrower to make any extension under this Section 2.3, is subject to satisfaction of the following conditions on the date of notice of extension from the Borrower and on effective date of such extension:
(a)    the representations and warranties of Borrower or any other Loan Party set forth in this Agreement and the other Loan Documents shall be true and correct in all material respects with the same effect as if then made (except to the extent stated to relate to a specific earlier date, in which case such representations and warranties shall be true and correct in all material respects as of such earlier date); and
(b)    no Event of Default or Default shall have then occurred and be continuing.
2.4.