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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
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 0-28000
THE PROFIT RECOVERY GROUP
INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
GEORGIA 58-2213805
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2300 WINDY RIDGE PARKWAY 30339-8426
SUITE 100 NORTH (Zip Code)
ATLANTA, GEORGIA
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (770) 955-3815
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Common shares of the registrant outstanding at February 28, 1997 were
18,154,751. The aggregate market value, as of February 28, 1997, of such common
shares held by non-affiliates of the registrant was approximately $104,129,000
based upon the last sales price reported that date on The Nasdaq Stock Market of
$16.25 per share. (Aggregate market value estimated solely for the purposes of
this report. This shall not be construed as an admission for the purposes of
determining affiliate status.)
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of Registrant's Proxy Statement relating to the Annual
Meeting of Shareholders to be held on May 15, 1997.
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THE PROFIT RECOVERY GROUP INTERNATIONAL, INC.
FORM 10-K
DECEMBER 31, 1996
PAGE
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Part I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 9
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......... 9
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 9
Item 6. Selected Consolidated Financial Data........................ 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 11
Item 8. Financial Statements........................................ 19
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 37
Part III
Item 10. Directors and Executive Officers of the Registrant.......... 38
Item 11. Executive Compensation...................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 38
Item 13. Certain Relationships and Related Transactions.............. 38
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 38
Signatures.............................................................. 41
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PART I
ITEM 1. BUSINESS
The Profit Recovery Group International, Inc., a Georgia corporation (the
"Company"), is a leading provider of accounts payable and other recovery audit
services to large retailers and other transaction-intensive companies. In
businesses with large purchase volumes and continuously fluctuating prices, some
small percentage of erroneous overpayments to vendors is inevitable, resulting
in "lost profits." The Company identifies and documents these overpayments by
using sophisticated proprietary technology and advanced audit techniques and
methodologies, and by employing highly trained, experienced recovery audit
specialists. The Company continuously updates and refines its proprietary
databases that serve as a central repository reflecting its auditors'
experiences, vendor practices and knowledge of regional and national pricing
information, including seasonal allowances, discounts and rebates, but excluding
confidential client data.
The earliest of the Company's predecessors were formed in November 1990,
and in early 1991 acquired the operating assets of Roy Greene Associates, Inc.
and Bottom Line Associates, Inc. which were formed in 1971 and 1985,
respectively. In January 1995, the Company's predecessors acquired the operating
assets of Fial & Associates, Inc., a direct competitor.
The predecessor business entities that comprised the Company generally were
either Subchapter S corporations or partnerships, all under common ownership and
control. In April 1995, the Company's predecessors reorganized and its
international entities became C corporations. Additionally, prior to the
Company's March 1996 initial public offering, all domestic entities became C
corporations. Subsequent to the Company's initial public offering, the Company
has conducted its operations through its various wholly-owned domestic and
international subsidiaries.
In January 1997, the Company acquired the net operating assets of Shaps
Group, Inc., a California-based company providing recovery audit services to
manufacturers, and high technology companies. In February 1997, the Company
acquired all of the common stock of Accounts Payable Recovery Services, Inc., a
Texas-based company providing recovery audit services to healthcare entities and
energy companies.
The Company has operations outside the United States in Australia, Belgium,
Canada, France, Germany, Mexico, The Netherlands, New Zealand, the United
Kingdom and portions of Asia, including Hong Kong, Indonesia, Malaysia,
Singapore, Taiwan and Thailand. See Note 11 of Notes to Consolidated Financial
Statements for international segment data concerning revenues, operating income
(loss) and identifiable assets.
THE RECOVERY AUDIT INDUSTRY
Large businesses with substantial volumes of purchase transactions
involving multiple vendors, numerous discounts and allowances, fluctuating
prices and complex pricing arrangements find it difficult to detect all payment
errors. These businesses include retailers, such as discount, department,
specialty, grocery and drug stores, wholesale distributors, manufacturers and
distributors of high technology products and certain governmental agencies and
healthcare providers. Although these businesses process the vast majority of
payment transactions correctly, a small number of errors occur principally
because of communication failures between purchasing and payables departments,
personnel turnover and changes in information and accounting systems. These
errors include vendor pricing errors, missed or inaccurate discounts, allowances
and rebates, incorrect freight charges and duplicate payments. In the aggregate,
these transaction errors can represent meaningful "lost profits," especially for
businesses with relatively narrow profit margins. Although internal recovery
audit departments identify some accounts payable errors, independent recovery
audit firms often are retained by these businesses to identify additional
overpayments.
In the U.S., large retailers routinely engage independent recovery audit
firms as standard business practice. Outside the U.S., large retailers
increasingly are retaining independent recovery audit firms. The U.S. retailing
industry represented approximately $2.3 trillion in revenues in 1995. The top
100 retailers worldwide had aggregate revenues of approximately $1.4 trillion in
1995. The Company believes that a typical U.S.
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retailer makes payment errors that are not discovered internally, which in the
aggregate can range from several hundred thousand dollars to more than $1.0
million per billion dollars of revenues. In addition, the Company believes that
large transaction-intensive businesses other than retailers also make accounts
payable errors.
Increasingly, businesses use technology to manage complex accounts payable
systems and realize greater operating efficiencies. Many businesses worldwide
communicate with vendors electronically to exchange inventory and sales data,
transmit purchase orders, submit invoices, forward shipping and receiving
information and remit payments. These paperless transactions are widely referred
to as EDI (Electronic Data Interchange) and the Company believes that
implementation of this technology is accelerating. EDI streamlines processing
large numbers of transactions, but does not eliminate payment errors because
operator input errors may be replicated automatically in thousands of
transactions. EDI systems typically generate significantly more individual
transaction details in electronic form, making these transactions easier to
audit than traditional paper-based accounts payable systems. Recovery audit
firms, however, require sophisticated technology in order to audit EDI accounts
payable processes effectively.
Many transaction-intensive businesses historically have maintained internal
recovery audit departments that review transactions before engaging independent
recovery audit firms. The Company believes that these businesses increasingly
are outsourcing internal recovery functions to independent recovery audit firms.
Factors contributing to this trend include (i) a need for significant
investments in technology, especially in an EDI environment, which the Company
believes are greater than even large businesses often can justify, (ii) an
inability to duplicate the breadth of industry and auditing expertise of
independent recovery audit firms, (iii) a desire to focus limited resources on
core competencies, and (iv) a desire for larger and more timely recoveries.
The domestic and international recovery audit industry is characterized by
several large and many small, local or regional firms. Most local and regional
recovery audit firms lack the centralized resources or broad client base to
support technology investments required to provide comprehensive recovery audit
services for large, complex accounts payable systems. These firms are even less
equipped to audit large EDI accounts payable systems. In addition, because of
limited resources, most of these firms subcontract work to third parties and may
lack experience and the knowledge of national promotions, seasonal allowances
and current recovery audit practices. As a result, the Company believes
significant opportunities exist for recovery audit firms with a national and
international presence, well-trained and experienced professionals and the
advanced technology required to audit increasingly complex accounts payable
systems.
THE PROFIT RECOVERY GROUP SOLUTION
The Company provides its domestic and international clients with
comprehensive recovery audit services by using sophisticated proprietary
technology and advanced audit techniques and methodologies, and by employing
highly trained, experienced recovery audit specialists. As a result, the Company
believes it is able to identify significantly more payment errors in both
traditional paper-based and EDI accounts payable systems. By leveraging its
technology investment across a large client base, the Company is able to
continue developing proprietary software tools and expand its technology
leadership in the recovery audit industry.
The Company is a leader in developing and utilizing sophisticated software
audit tools and techniques that enhance the identification and recovery of
payment errors. In EDI accounts payable systems, the Company's proprietary
software audit tools and data processing capabilities enable auditors to sort,
filter and evaluate transactions in greater line-item detail. The Company has
developed and continuously updates and refines its proprietary databases that
serve as a central repository reflecting its auditors' experiences, vendor
practices and knowledge of regional and national pricing information, including
seasonal allowances, discounts and rebates. These proprietary databases do not
include confidential client information. The Company's technology provides a
uniform platform for its auditors to offer consistent and proven audit
techniques and methodologies regardless of the client's size, industry or
geographic scope of operations.
The Company also is a leader in establishing new recovery audit practices
to reflect evolving industry trends. The Company's auditors are highly trained
and many have joined the Company from finance-related management positions in
the retailing industry. To support its auditors, the Company provides data
processing, marketing, training and administrative services.
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THE PROFIT RECOVERY GROUP STRATEGY
The Company's objective is to become the leading worldwide provider of
recovery audit services. The Company believes that it will have to increase
significantly its revenues to achieve this objective. Its strategy consists of
the following elements:
- Expand International Presence. The Company believes international
markets represent significant business opportunities and intends to expand
its international presence. For example, based on 1995 sales, 60 of the
top 100 retailers worldwide were headquartered outside the U.S. Through
sales and marketing efforts, the Company targets countries having a
concentration of large transaction-intensive businesses. The Company also
enters new international markets by supporting its U.S. clients'
international operations. During 1996, the Company commenced operations in
Australia, Germany and New Zealand.
- Expand Client Base. The Company seeks to increase its worldwide retail
client base and expand its recovery audit services to other
transaction-intensive industries such as transportation,
telecommunications and financial services. The Company recently has
expanded its recovery audit services to the healthcare and high technology
industries. The Company believes that its proprietary technology and audit
techniques and methodologies also can be applied to these industries. The
Company believes that its ability to attract new clients is enhanced
because under the typical fee arrangement, the client pays a contractually
negotiated percentage of overpayments recovered for clients. The Company
intends to leverage existing client relationships into new audit
engagements for clients' other operating units. Based on 1995 retail
sales, 32 of the top 100 retailers worldwide, each of which had sales of
at least $4.4 billion, were clients of the Company in 1996. Although the
Company targets clients principally with $500 million or more in annual
revenues, smaller businesses may be suitable clients if they are
sufficiently transaction-intensive and offer significant growth prospects.
- Maintain High Client Retention Rates. The Company intends to maintain
and improve its high client retention rate by providing comprehensive
recovery audit services, utilizing highly trained auditors, and by
continuing to refine its advanced audit technology. Of the Company's
accounts payable audit clients in 1995 from which the Company derived
revenues exceeding $100,000, 89.2% continued to utilize the Company's
services in 1996.
- Maintain Technology Leadership. The Company believes its proprietary
technology provides a significant competitive advantage, especially in
audits of EDI accounts payable systems. The Company intends to continue
making substantial investments in technology to maintain its leadership
position and systems capabilities.
- Pursue Strategic Acquisitions. The Company intends to pursue the
acquisition of domestic and international businesses including both direct
competitors and businesses providing complementary recovery audit
services. As examples, in January 1995, the Company successfully completed
the acquisition of Fial & Associates, Inc., a direct competitor; in
January 1997, the Company acquired Shaps Group, Inc., a firm providing
recovery audit services to manufacturers and high technology companies;
and in February 1997, the Company acquired Accounts Payable Recovery
Services, Inc., a firm providing recovery audit services to healthcare
entities and energy companies. The Company may pursue much larger
acquisitions in the future than those consummated to date.
- Promote Outsourcing Arrangements. The Company seeks to capitalize on the
growing trend of businesses to outsource internal recovery audit efforts.
The Company believes that its outsourcing clients benefit significantly
from these arrangements because their recoveries generally are larger and
completed more quickly. The Company further believes that as clients
convert their systems to EDI, outsourcing arrangements involving recovery
audit work will become increasingly prevalent due in part to the absence
of traditional "audit trail" documents.
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THE PROFIT RECOVERY GROUP SERVICES
The Company provides comprehensive accounts payable and other ancillary
recovery audit services. In 1996, accounts payable recovery audit services
represented approximately 96.4% of the Company's revenues.
Accounts Payable Recovery Audit Services
Using its proprietary technology, audit techniques and methodologies, the
Company conducts either primary or secondary accounts payable audits. In primary
audits, the Company is the first independent recovery audit firm engaged. In
secondary audits, the Company audits behind another independent recovery audit
firm. In 1996, approximately 88.6% of the number of the accounts payable audits
conducted by the Company were primary audits.
Primary Audits. Although the Company is flexible in structuring recovery
audit programs to meet the individual needs of its clients, there are two basic
types of primary accounts payable audits conducted by the Company: (i) periodic
audits, which are usually performed nine to 18 months after a client's fiscal
year end; and (ii) continuous audits, marketed as RecoverNow, which are
performed more closely following transaction dates.
In most periodic audits, which constitute the vast majority of the
Company's present audit engagements, the client's internal recovery audit
department conducts a preliminary review of accounts payable records to identify
payment errors. Upon completion of the client's internal recovery audit review
process, which may be as long as nine to 18 months after the client's fiscal
year end, the Company begins its independent recovery audit.
Under the Company's RecoverNow program, clients provide the Company with
accounts payable data on a regular basis, often within 90 days following the
payment transaction. The Company believes its RecoverNow program generates
larger client recoveries for several reasons, including: (i) transaction data,
especially paper-based records, are more complete and accessible; (ii) the
impact of vendor bankruptcies is minimized because claims are made more timely
and continuously throughout the year; and (iii) certain recoveries are
facilitated when claims are made prior to the expiration of seasonal or other
special pricing promotions. In addition, vendor relationships are improved
because of timely communications regarding billing and payment practices.
In some cases, the Company's clients outsource all or a portion of their
internal recovery audit functions to the Company. In these cases, the client
does not conduct an internal review prior to the Company's audit. In its
outsourcing engagements, the Company also may use client staff in the review
process. The Company believes that more businesses will outsource their recovery
audit functions in an effort to control personnel and technology costs, focus
resources on their core business functions, and increase recoveries.
Secondary Audits. In secondary audits, the Company conducts an accounts
payable audit after another independent recovery audit firm has completed its
audit. The Company usually receives a higher percentage recovery fee than
received from primary audits because it generally is more difficult to detect
payment errors in secondary audits. In most cases, the Company is able to
identify significant payment errors not previously detected by a client's
primary independent recovery audit firm. The Company utilizes secondary audits
as a marketing strategy to obtain new, primary audit clients and believes it has
been successful in implementing this strategy. Of the 20 secondary audit clients
served in 1994 which individually provided revenues to the Company exceeding
$100,000, 5 were converted to primary audit clients prior to December 31, 1996.
Ancillary Audit Services
In addition to accounts payable recovery audit services, the Company also
offers ancillary recovery audit services. These ancillary services may be
offered individually or in conjunction with accounts payable recovery audit
services.
- Freight Audits. The Company provides domestic freight audits using
FreightPro, the Company's proprietary freight recovery audit software. The
Company also maintains centralized domestic freight
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and shipping databases and has auditors who specialize in freight audits.
Freight audits are usually conducted in conjunction with accounts payable
recovery audits.
- Lease Compliance Audits. Real estate lease and landlord compliance
audits involve an examination of all aspects of a client's facility lease
arrangements to assist the client in identifying lease overpayments or
expenses incurred through landlord noncompliance with lease terms.
- Telecommunications Audits. This program assists clients in reducing
their overall telecommunications costs. For example, overpayments often
can result from the incorrect application of rates and tariffs. Auditors
also review clients' equipment, usage and systems configuration needs and
make recommendations on how to reduce future telecommunications costs.
- Utility Audits. Auditors also review clients' electrical and natural gas
requirements and analyze alternative rates and billing plans to verify
that billing was proper and that the proper tariff rate was applied.
Client Contracts
The Company's standard client contract provides that the Company is
entitled to a contractual percentage of overpayments recovered for clients.
Clients generally recover claims by taking credits against outstanding payables
or future purchases from the involved vendors. In many cases, the Company's
auditors work on site with client personnel and continually monitor credits
taken. In other situations, Company auditors schedule periodic reconciliations
with clients to determine which claims have been processed for credit. The
Company's standard client contract imposes a duty on the client to process
promptly all claims against vendors. In the interest of maintaining good vendor
relations, however, many clients modify the standard client contract with the
Company to provide that they retain discretion on whether to pursue collection
of a claim. In the Company's experience, it is extremely unusual for a client to
forego the collection of a large, valid claim. In some cases, a vendor may
dispute a claim by providing additional documentation or information supporting
its position. Consequently, many clients revise the Company's standard client
contract to clarify that the Company is not entitled to payment of its fee until
the client recovers the claim from its vendor.
In addition to the client contracts, most clients establish specific
procedural guidelines that the Company must satisfy prior to submitting claims
for client approval. These guidelines are unique to each client and impose
specific requirements on the Company prior to submitting claims. The Company
recognizes revenues at the time overpayment claims are presented to and approved
by its clients, as adjusted for estimated uncollectible claims. Estimated
uncollectible claims initially are established, and subsequently adjusted, for
each individual client based on a number of factors including historical
experience. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview" and Note 1(c) of Notes to Consolidated
Financial Statements.
TECHNOLOGY
The Company believes that its proprietary software audit tools and
proprietary databases, together with its centralized data processing
capabilities, provide it a competitive advantage over smaller local and regional
firms, especially when auditing complex EDI accounts payable systems. The
Company has devoted more than five years and has made substantial financial
investments in developing its proprietary technology. At December 31, 1996, the
Company's information services department had 53 employees, 8 of whom were
dedicated to software development activities, including updating and modifying
the Company's existing proprietary software.
Centralized Data Preparation and Verification
At the beginning of a typical audit, magnetic media containing accounts
payable transaction data are delivered to the Company's central data processing
facility. Experienced programmers in the Company's information services
department write specialized conversion programs that permit this data to be
reformatted into standardized and proprietary formats using IBM ES 9000
mainframe and IBM AS 400 midrange
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computers and Windows NT and OS/2 Warp Connect servers. Statistical reports are
then prepared to verify the completeness and accuracy of the data. Generally, it
is not necessary to rewrite conversion programs for clients for each successive
audit. This reformatted data is compressed onto CD-ROM media and delivered to
the Company's auditors who, using the Company's proprietary field audit
software, sort, filter and search the data for overpayments. Standard reports
and client-specific statistical data also are produced for auditors.
PC-Based Software Modules
The Company has developed PC-based proprietary software modules for use
primarily in the field by its auditors. These software modules include the
following:
- AuditPro is used in non-EDI systems to facilitate auditor-defined
searches of reformatted client accounts payable records for patterns
indicative of potential overpayments. In addition to using the standard
analytical reports produced by AuditPro, auditors may design sophisticated
custom inquiries to sort, filter and print client records.
- EDI Inquiry is a comprehensive module used to sort, filter and print
purchasing, receiving and payment records at the line-item level for
clients operating in an EDI environment. By utilizing line-item detail,
this module facilitates the search of a significantly greater number of
transaction records and improves auditor productivity.
- Claims Management System enables the auditor to compile, print and report
on claims information by individual audit. This module also is used to
summarize audit findings for management reports that are typically
provided to clients at the conclusion of each engagement.
- FreightPro is used to audit and produce claims from electronic freight
records. Client freight billing data is compared with vendor routing guide
instructions to isolate potential overcharges.
- ReportPro is a specialized report generator designed to create and
display customized reports in conjunction with the Company's other
proprietary software modules from a hard drive or CD-ROM.
Proprietary Databases
The Company has developed and continuously updates and refines its
proprietary databases that serve as a central repository reflecting its
auditors' experiences, vendor practices and knowledge of regional and national
pricing information, including seasonal allowances, discounts and rebates. These
proprietary databases do not include confidential client information. Auditors
use these databases to identify discounts, allowances and other pricing
information not previously detected.
AUDITOR HIRING AND TRAINING
Many of the Company's auditors formerly held finance-related management
positions in the retailing industry. These experienced auditors provide
important insights into certain aspects of the retailing industry. The Company
also has relied on its auditors to assist in creating its auditor training
programs and techniques and in developing its proprietary audit software. To
meet its growing need for additional auditors, the Company has begun hiring
recent college graduates, particularly those with multi-lingual capabilities.
While the Company has been able to hire a sufficient number of new auditors to
support its growth, there can be no assurance that the Company will be able to
continue hiring sufficient numbers of qualified auditors to meet its future
needs.
The Company's training program for auditors consists of intensive training
classes employing specialized computer-based training modules, and on-the-job
training. The in-house training program is continuously upgraded based on
feedback from auditors and on changing industry protocols. Additional on-the-job
training by experienced auditors enhances classroom education and enables newly
hired auditors to refine their skills. Because auditor compensation is based on
team performance rather than individual results, the Company believes senior
auditors are motivated to continue training new auditors to maximize client
recoveries and audit team compensation. As the Company hires new auditors, there
can be no assurance that it will be able to
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continue providing the same in-depth training or have sufficient numbers of
experienced auditors to continue its on-the-job training program.
CLIENT BASE
The Company provides its services principally to large
transaction-intensive businesses that include retailers, such as discount,
department, specialty, grocery and drug stores, wholesale distributors,
manufacturers and distributors of high technology products and certain
governmental agencies and healthcare providers. Based on 1995 retail sales, 32
of the top 100 retailers worldwide, each having sales in excess of $4.4 billion,
were clients of the Company in 1996. Although the Company targets clients
principally with $500 million or more in annual revenues, smaller businesses may
be suitable clients if they are sufficiently transaction-intensive and offer
significant growth prospects.
For the year ended December 31, 1996, the Company derived 14.4% of its
revenues from Wal-Mart Stores, Inc. and its affiliates ("Wal-Mart"), and 34.6%
of its revenues from its five largest clients (including Wal-Mart), as compared
to 12.7% and 30.1%, respectively, for 1995 and 15.5% and 44.0%, respectively,
for 1994. The Company anticipates that its reliance on any individual client or
its five largest clients will decrease over time as its client base increases.
Nevertheless, there can be no assurance that the Company's client base will
increase or that the Company's largest clients will continue to utilize the
Company's services on the same level and, should one or more of such large
clients file for bankruptcy or otherwise cease to do business with the Company,
the Company's business, financial condition and results of operations could be
materially and adversely affected.
SEASONALITY
The Company has experienced and expects to continue to experience
significant seasonality in its business. The Company typically realizes higher
revenues and operating income in the last two quarters of its fiscal year, with
its highest revenues and operating income typically realized in the third
quarter. This trend is expected to continue and reflects the inherent purchasing
and operational cycles of the retailing industry, which is the principal
industry served by the Company. Should this trend not continue, the Company's
profitability for any affected quarter and the entire year could be materially
and adversely impacted due to ongoing selling, general and administrative
expenses that are largely fixed over the short term.
SALES AND MARKETING
The Company markets its services primarily through one-on-one meetings with
executives of targeted clients. The decision to engage a recovery audit firm is
similar to the decision to engage most professional service firms and usually
involves a lengthy period of familiarization, investigation and evaluation by
the prospective client. The sales cycle often exceeds one year in both domestic
and international markets. In the U.S. and Canada, where the use of recovery
audit services is a generally accepted business practice among retailers, the
Company generally must displace a competing firm in order to expand market
share. Internationally, recovery audit is a relatively new business service that
requires an initial educational process in order to gain acceptance.
At December 31, 1996, the Company's domestic marketing staff consisted of
13 persons headed by a senior officer. The Company plans to expand its marketing
staff in the U.S. and internationally as its business grows and it enters new
markets.
PROPRIETARY RIGHTS
The Company continuously develops new recovery audit software and enhances
existing proprietary software. The Company regards its proprietary software as
protected by trade secret and copyright laws of general applicability. In
addition, the Company attempts to safeguard its software through employee and
third-party nondisclosure agreements and other methods of protection. Despite
these precautions, it may be possible for unauthorized third parties to copy,
obtain or reverse engineer certain portions of the Company's software or
otherwise to obtain or use other information the Company regards as proprietary.
While the
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Company's competitive position may be affected by its ability to protect its
software and other proprietary information, the Company believes that the
protection afforded by trade secret and copyright laws is less significant to
the Company's success than the continued pursuit and implementation of its
operating strategies and other factors such as the knowledge, ability and
experience of its personnel.
The Company has filed an application to register its copyrights for
AuditPro, EDI Inquiry, Claims Management System, FreightPro and RecoverNow with
the U.S. copyright office. Third parties with functionally similar software
could assert claims under the Copyright Act of 1986, as amended, the federal
patent law or state trade secret laws that the Company's proprietary recovery
audit software application products infringe or may infringe the proprietary
rights of such entities. These third parties may seek damages from the Company
as a result of such alleged infringement, demand that the Company license
certain proprietary rights from them or otherwise demand that the Company cease
and desist from its use or license the allegedly infringing software. Such
action may result in protracted and costly litigation or royalty arrangements or
otherwise have a material adverse effect on the Company's business, financial
condition or results of operations. Although the Company believes that its
recovery audit software does not infringe on the intellectual property rights of
others and the Company knows of no such pending or other extended claims of
infringement, there can be no assurance that such a claim will not be asserted
against the Company in the future.
The Company's trademarks include "Profit Recovery Group International,"
"PRG," "AuditPro," "EDI Inquiry," "Claims Management System," "FreightPro,"
"ReportPro" and "RecoverNow." The Company has registered "Profit Recovery Group
International" and "AuditPro" as federal trademarks and applications to register
"RecoverNow" and the Company's logo are pending with the U.S. Patent and
Trademark Office. There can be no assurance, however, that the Company will be
successful in its attempt to register such trademarks or that it otherwise will
be able to continue to use any of the foregoing trademarks.
The Company has filed applications for protection of certain of its
trademarks outside of the U.S. in the various countries where the Company
conducts business and such protection is available. There can be no assurance,
however, that the Company will be successful in its attempt to register or
continue to use such trademarks outside of the U.S.
COMPETITION
The recovery audit business is highly competitive. The competitive factors
affecting the market for the Company's recovery audit services include:
establishing and maintaining client relationships, quality and quantity of
claims identified, experience and professionalism of audit staff, rates for
services, technology and geographic scope of operations. The Company's principal
competitors for recovery audit services include local and regional firms and one
firm, Howard Schultz & Associates, with a network of affiliate organizations in
the U.S. and abroad. The Company believes that Howard Schultz & Associates has
been in operation longer than the Company and may have achieved greater revenues
than the Company in 1996. There can be no assurance that the Company will
continue competing successfully with such firms.
The Company believes that as large, transaction-intensive businesses expand
internationally and implement EDI accounts payable systems, smaller recovery
audit firms will lack the technology and infrastructure necessary to remain
competitive unless they make substantial investments to upgrade and expand their
skills, technologies and geographic scope of operations.
EMPLOYEES
At December 31, 1996, the Company had 694 employees. Of these, 498 persons
were located in the U.S., with 292 persons in the audit function, 13 persons in
sales and marketing, 53 persons in information services and the remainder in
corporate, finance and administrative functions. In addition to its 196
employees located outside the U.S., internationally the Company engaged 12
independent contractors at December 31, 1996. The Company believes employee
relations are good.
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ITEM 2. PROPERTIES
The Company's principal executive office is located in approximately 45,000
square feet of office space in Atlanta, Georgia. The Company subleases this
space through December 30, 2002 and has an option to renew the lease for five
years contingent upon the prime lease being renewed. The Company leases 25,000
square feet of office and warehouse space in Bentonville, Arkansas. This lease
has an initial five-year term that commenced on April 19, 1996, with an option
to renew for an additional five-year period. In addition, the Company maintains
22 other offices in close proximity to certain of its larger clients. The leases
for these offices vary in term and range from 1,000 to 10,000 square feet. The
Company anticipates that additional space will be required as business expands
and believes that it will be able to obtain suitable space as needed. See Note 4
of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings, individually or in the
aggregate, that it believes could have a material adverse effect on its
business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fiscal fourth quarter covered by this report, no matter was
submitted to a vote of security holders of the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded under the symbol "PRGX" on The Nasdaq
Stock Market (Nasdaq). During 1995 and the first quarter of 1996, the Company's
predecessors paid dividends and distributions to then-current equity owners
totalling $10.7 million and $4.9 million, respectively. The Company has not paid
cash dividends since its March 26, 1996 initial public offering and does not
intend to pay cash dividends in the foreseeable future. Moreover, restrictive
covenants included in the Company's bank credit facility specifically prohibit
payment of cash dividends. At February 28, 1997 there were approximately 1,200
beneficial holders of the Company's common stock and 79 holders of record. The
following table sets forth, for the quarters indicated, the range of high and
low prices for the Company's common stock as reported by Nasdaq since the
Company's initial public offering.
1996 CALENDAR QUARTER HIGH LOW
--------------------- ------- -------
1st Quarter (From March 26, 1996 through March 31, 1996).... $16 1/2 $11(1)
2nd Quarter................................................. $22 1/2 $15 1/4
3rd Quarter................................................. $24 1/4 $11 1/2
4th Quarter................................................. $21 1/2 $11 1/4
- ---------------
(1) Initial public offering price.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the
Company as of and for the five years ended December 31, 1996. Such historical
consolidated financial data as of and for the five years ended December 31, 1996
have been derived from the Company's Consolidated Financial Statements and Notes
thereto, which have been audited by KPMG Peat Marwick LLP, independent auditors.
The audited Consolidated Balance Sheets as of December 31, 1996 and 1995 and the
related Consolidated Statements of Earnings, Shareholders' Equity (Deficit) and
Cash Flows for each of the years in the three-year period ended December 31,
1996 are included elsewhere herein. The selected pro forma Statements of
Earnings data for the five years ended December 31, 1996 are unaudited. The data
presented below should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and other financial information appearing elsewhere
in this Form 10-K including Management's Discussion and Analysis of Financial
Condition and Results of Operations.
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1996 1995(1) 1994 1993 1992
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENTS OF EARNINGS DATA:
HISTORICAL
Revenues.................................... $77,330 $56,031 $34,690 $25,262 $17,156
Cost of revenues............................ 40,330 30,554 18,163 13,299 9,137
Selling, general and administrative
expenses.................................. 25,961 19,035 12,343 8,899 7,915
------- ------- ------- ------- -------
Operating income....................... 11,039 6,442 4,184 3,064 104
Interest expense, net....................... 100 1,630 544 874 1,301
Debt refinancing expenses................... -- -- -- 414 --
------- ------- ------- ------- -------
Earnings (loss) before income taxes.... 10,939 4,812 3,640 1,776 (1,197)
Income taxes(2)............................. 7,789 305 -- -- --
------- ------- ------- ------- -------
Net earnings (loss).................... $ 3,150 $ 4,507 $ 3,640 $ 1,776 $(1,197)
======= ======= ======= ======= =======
Cash dividends per share.................... $ .28 $ .93 $ .10 $ -- $ --
======= ======= ======= ======= =======
PRO FORMA(3)
Historical earnings (loss) before income
taxes..................................... $10,939 $ 4,812 $ 3,640 $ 1,776 $(1,197)
Pro forma income taxes (benefit)............ 4,271 1,877 1,420 692 (15)
------- ------- ------- ------- -------
Pro forma net earnings (loss).......... $ 6,668 $ 2,935 $ 2,220 $ 1,084 $(1,182)
======= ======= ======= ======= =======
Pro forma earnings per common and
common equivalent share................... $ .39 $ .21
======= =======
Weighted average common and common
equivalent shares outstanding(4).......... 17,457 14,948
======= =======
DECEMBER 31,
-----------------------------------------------
1996(5) 1995 1994 1993 1992
------- ------- ------- ------- -------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents................... $16,891 $ 642 $ 1,284 $ 98 $ 375
Working capital............................. 30,004 6,738 4,889 2,068 2,425
Total assets................................ 68,318 30,268 13,779 11,045 10,066
Long-term debt, excluding current
installments.............................. 692 17,629 2,741 4,256 7,613
Loans from shareholders..................... -- 1,075 1,075 208 --
Total shareholders' equity (deficit)........ 40,559 (3,402) 2,356 (167) (1,941)
- ---------------
(1) Effective January 1, 1995, the Company acquired Fial & Associates, Inc. See
Note 8 of Notes to Consolidated Financial Statements.
(2) In April 1995, the Company's predecessors reorganized and its international
entities became C corporations. Additionally, in connection with the
Company's March 1996 initial public offering, all domestic entities became
C corporations. As a result of these conversions to C corporations, the
Company incurred charges to operations of $305,000 in 1995 and $3.7 million
in 1996 for cumulative deferred income taxes.
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The Company's 1996 provision for income taxes of $7.8 million consists of
the above-mentioned $3.7 million charge for cumulative deferred income
taxes combined with $4.1 million in tax provisions at a 39.0% composite
effective rate for the three quarters subsequent to the March 26, 1996
initial public offering.
(3) The Company's predecessor entities prior to its initial public offering on
March 26, 1996 generally were either corporations electing to be taxed as
Subchapter S corporations or partnerships. As a result, any income tax
liabilities were the responsibilities of the respective shareholders and
partners. Pro forma net earnings (loss) reflect, where applicable, a
provision for income taxes to include the additional tax expense (benefit)
as if the Company had been subject to federal and state income taxes for
all periods presented rather than the individual shareholders and partners.
(4) Includes all common equivalent shares issued in 1995 as exercised and
outstanding using the treasury stock method, as applicable, for the
entirety of 1995 and for the first quarter of 1996. Also includes the
effect of the two-for-one stock split effected in the form of a stock
dividend at the time of the Company's March 26, 1996 initial public
offering. See Note 1(k) of Notes to Consolidated Financial Statements.
(5) Balance Sheet Data as of December 31, 1996 reflect the receipt of net
proceeds from the Company's March 26, 1996 initial public offering together
with the partial use of such proceeds to repay substantially all debt
obligations other than certain convertible debentures which were converted
to equity immediately prior to the offering. See Notes 3 and 7 of Notes to
Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leading provider of accounts payable and other recovery
audit services to large retailers and other transaction-intensive companies. In
businesses with large purchase volumes and continuously fluctuating prices, some
small percentage of erroneous overpayments to vendors is inevitable, resulting
in "lost profits." The Company identifies and documents these overpayments by
using sophisticated proprietary technology and advanced audit techniques and
methodologies, and by employing highly trained, experienced recovery audit
specialists. The Company receives a contractually negotiated percentage of
amounts recovered.
The earliest of the Company's predecessors were formed in November 1990,
and in early 1991 acquired the operating assets of Roy Greene Associates, Inc.
and Bottom Line Associates, Inc., which were formed in 1971 and 1985,
respectively. In January 1995, the Company purchased certain assets of Fial &
Associates, Inc., a U.S. competitor, which had 1994 revenues of $9.6 million. In
the year ended December 31, 1995, former Fial & Associates accounts represented
revenues of $12.1 million. In January 1997, the Company acquired the net
operating assets of Shaps Group, Inc., a California-based company providing
recovery audit services to manufacturers, and distributors of high technology
products. In February 1997, the Company acquired all of the common stock of
Accounts Payable Recovery Services, Inc., a Texas-based company providing
recovery audit services to healthcare entities and energy companies. The Company
intends to continue pursuing domestic and international strategic acquisitions,
including direct competitors and complementary businesses. See Note 8 of Notes
to Consolidated Financial Statements.
At present, the Company's revenues primarily are derived from large retail
clients, such as discount, department, specialty, grocery and drug stores, as
well as wholesale distributors. The Company also serves certain governmental
agencies and healthcare providers. Revenues are recognized at the time
overpayment claims are submitted to and approved by clients, as adjusted for
estimated uncollectible claims. Claims submitted by the Company that are not
approved by clients for whatever reason are not considered when recognizing
revenues. Approved claims are processed by clients and generally taken as
credits against outstanding payables or future purchases from the vendors
involved. Once credits are taken, the Company invoices its clients for a
contractually stipulated portion of the recoveries. The Company's contract
receivables are largely unbilled because it does not control either the timing
of a client's claims processing activities or the timing of a client's payments
for purchases from the vendors involved. See Note 1(c) of Notes to Consolidated
Financial Statements. Although the Company records non-management auditor
compensation expense at the time of related revenue recognition, substantially
all compensation payments to these employees are made only from collected
revenues.
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Estimated uncollectible claims are initially established, and subsequently
adjusted, for each individual client based on historical collection rates, types
of claims identified, current industry conditions, and other factors which, in
the opinion of management, deserve recognition. The Company records revenues at
estimated net realizable value without reserves. Accordingly, adjustments to
uncollectible claim estimates are directly charged or credited to earnings, as
appropriate. There can be no assurance that estimates of uncollectible claims
will be adequate and, if underestimated, the Company's financial condition and
results of operations could be materially and adversely affected. See Note 1(c)
of Notes to Consolidated Financial Statements.
The Company has achieved significant revenue growth in recent years.
Revenues for the years ended December 31, 1996, 1995 and 1994 increased by
38.0%, 61.5% and 37.3%, respectively. Excluding the impact of the Fial &
Associates acquisition, 1995 revenues grew 26.6%. There can be no assurance that
the Company will continue to achieve these high rates of revenue growth.
The Company has successfully maintained high client retention rates with
respect to larger accounts payable audit clients whose annual audit claims
volumes are of sufficient size to be mutually beneficial. The Company has
generally found that it may not be economically viable to provide recovery audit
services to clients where annual revenues to the Company do not exceed $100,000.
For the year ended December 31, 1996, the Company derived 14.4% of its
revenues from Wal-Mart Stores, Inc. and its affiliates ("Wal-Mart") and 34.6% of
revenues from its five largest clients (including Wal-Mart) as compared to 12.7%
and 30.1%, respectively, for 1995 and 15.5% and 44.0%, respectively, for 1994.
The Company anticipates that its reliance on any individual client or its five
largest clients will decrease over time as its client base increases.
Nevertheless, there can be no assurance that the Company's client base will
increase or that the Company's largest clients will continue to utilize the
Company's services at the same level. In addition, should one or more of such
large clients file for bankruptcy or otherwise cease to do business with the
Company, the Company's business, financial condition and results of operations
could be materially and adversely affected.
During the third quarter of 1996, the Company was notified by a large
international grocery client that the Company will not be retained to serve as
primary recovery auditor in 1997 with respect to the client's domestic
operations. This client represented one of the five largest accounts of the
Company during 1996, based on revenues, and 1996 domestic revenues derived from
this client of $2.9 million represented 4.6% of all domestic revenues earned
during 1996. The Company does not believe that the reduction in domestic
revenues from this grocery client during 1997 will have a materially adverse
effect on the Company's aggregate domestic revenues.
The Company has operations outside the United States in Australia, Belgium,
Canada, France, Germany, Mexico, The Netherlands, New Zealand, the United
Kingdom and portions of Asia, including Hong Kong, Indonesia, Malaysia,
Singapore, Taiwan and Thailand. Operations in Australia, Germany and New Zealand
represented new Company initiatives in 1996. International operations have been
phased in since 1992 and accounted for 18.9%, 12.5% and 14.1% of total Company
revenues for the years ended December 31, 1996, 1995 and 1994, respectively.
Excluding the $12.1 million of domestic revenues achieved in 1995 as a result of
the Fial & Associates acquisition, international revenues represented 16.0% of
total revenues in 1995.
The Company intends to initiate operations in South Africa and South
America during 1997. The Company currently conducts all international operations
through wholly-owned subsidiaries and intends to continue to do so where
practicable. Alternatively, the Company will consider joint ventures and other
partnering arrangements where dictated by local business practice.
Continued international growth is an integral component of the Company's
current strategic growth plans. Although the Company's recovery audit services
constitute a generally accepted business practice among retailers in the U.S.
and in certain other countries, there are countries where the types of services
offered by the Company have not yet become generally accepted retailing business
practice. There can be no assurance that the Company's services will be accepted
by businesses, vendors or other involved parties in such international markets.
The failure of such parties to accept and utilize the services offered by the
Company
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could have a materially adverse effect on the Company's results of operations
and growth. Additionally, in the Company's experience, entry into new
international markets requires significant management time as well as start-up
expenses for market development, hiring and establishing office facilities
before any significant revenues are generated. As a result, initial operations
in a new market may be at low margins or unprofitable.
The Company is developing a revised compensation program for its
non-management domestic field auditors which it believes will more equitably
compensate these individuals for their unique experience, skills and
contributions in meeting Company objectives. This revised program has been
designed with considerable input from auditor focus groups, has been subjected
to thorough in-house testing, and is currently undergoing extensive field tests.
The revised program could be implemented as early as the second quarter of 1997.
The Company has attempted to design the revised program such that future
aggregate domestic auditor compensation expense will be unchanged from aggregate
amounts which would otherwise be paid under the existing program. Although the
Company and certain of its domestic auditors have expended considerable time and
resources to design the revised program, there can be no assurance that it will
meet its design objectives if it is implemented. If the revised compensation
program is implemented and its design objectives are not met, the Company's
domestic costs and revenues could be materially and adversely affected.
The Company does not capitalize the costs of internally developed software.
Accordingly, the costs of creating, upgrading and maintaining the Company's
proprietary audit software tools are charged to operations as incurred.
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenues represented by
certain items in the Company's Consolidated Statements of Earnings for the
periods indicated:
YEARS ENDED DECEMBER 31,
---------------------------
1996 1995 1994
----- ----- -----
HISTORICAL
Revenues.............................................. 100.0% 100.0% 100.0%
Cost of revenues...................................... 52.1 54.5 52.3
Selling, general and administrative expenses.......... 33.6 34.0 35.6
----- ----- -----
Operating income.............................. 14.3 11.5 12.1
Interest expense, net................................. 0.2 2.9 1.6
----- ----- -----
Earnings before income taxes.................. 14.1 8.6 10.5
Income taxes.......................................... 10.0 0.6 --
----- ----- -----
Net earnings.................................. 4.1% 8.0% 10.5%
===== ===== =====
PRO FORMA
Historical earnings before income taxes............... 14.1% 8.6% 10.5%
Pro forma income taxes................................ 5.5 3.3 4.1
----- ----- -----
Pro forma net earnings........................ 8.6% 5.3% 6.4%
===== ===== =====
1996 COMPARED WITH 1995
Revenues. The Company's revenues consist principally of contractual
percentages of overpayments recovered for clients that are primarily in the
retailing industry. Revenues increased 38.0% to $77.3 million for 1996, up from
$56.0 million in 1995. Of this $21.3 million increase, $13.7 million, or 64.3%,
related to existing and new domestic accounts and $7.6 million, or 35.7%,
related to revenue growth from international operations. Domestic revenue growth
in 1996 of $13.7 million consisted of $5.7 million related to 35 new client
accounts and $8.0 million related to provision of additional services to
existing accounts.
The Company considers international operations to be all operations located
outside of the U.S. International revenues grew 108.1% to $14.6 million for
1996, up from $7.0 million for 1995. International revenues grew from 12.5% of
total revenues in 1995 to 18.9% during 1996. The Company expects that
13
16
revenues from international operations will grow at a more rapid rate than
domestic revenues for the foreseeable future. There can be no assurance,
however, that recent international growth trends will continue.
Cost of Revenues. Cost of revenues consists principally of commissions
paid or payable to the Company's auditors and regional managers based primarily
upon the level of overpayment recoveries. Also included are other direct costs
incurred by these personnel including rental of field offices, travel and
entertainment, telephone, utilities, maintenance and supplies, and temporary
clerical assistance. Cost of revenues decreased to 52.1% of revenues in 1996,
down from 54.5% for 1995.
Domestically, the Company's cost of revenues as a percentage of revenues
decreased to 52.7% of revenues in 1996, down from 55.6% for 1995 due primarily
to Fial & Associates contracts-in-progress acquired in January 1995. These
auditor contracts, substantially all of which were concluded by December 31,
1995, carried higher auditor compensation rates than those customarily paid by
the Company. Excluding the effect of this temporary $1.9 million rate-related
differential, domestic cost of revenues as a percentage of domestic revenues
would have been 51.7% in 1995.
Internationally, cost of revenues increased to 49.7% of international
revenues in 1996, up from 47.2% during 1995. This increase resulted from an
increase in initial auditor compensation guarantees resulting from various new
markets entered by the Company in 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include the expenses of sales and marketing activities,
information technology services and the corporate data center, human resources,
legal and accounting, administration, headquarters-related depreciation of
property and equipment and amortization of intangibles. Selling, general and
administrative expenses as a percentage of revenues decreased to 33.6% in 1996
from 34.0% in 1995.
Domestic selling, general and administrative expenses as a percentage of
domestic revenues were relatively flat at 30.2% in 1996 and 30.4% in 1995. The
Company's domestic selling, general and administrative expenses grew during 1996
at a rate approximately commensurate with its domestic revenue growth due
primarily to space, equipment and personnel additions at its corporate
headquarters facility in Atlanta, Georgia.
International selling, general and administrative expenses decreased to
47.9% of international revenues in 1996, down from 58.7% during 1995 due
principally to the 108.1% growth in international revenues in 1996 without a
proportionate increase in selling, general and administrative expenses.
Intangible assets result primarily from acquisitions of other companies and
are amortized on a straight-line basis over the respective periods benefited.
Amortization of intangible assets totaled $1.2 million in both 1996 and 1995.
Operating Income. Operating income increased 71.4% to $11.0 million in
1996, up from $6.4 million in 1995. Operating income was 14.3% and 11.5% of
revenues for 1996 and 1995, respectively. Excluding the effect of the temporary
$1.9 million auditor compensation rate differential relating to
contracts-in-progress acquired in January 1995 from Fial & Associates, operating
income for 1995 would have been $8.3 million, or 15.0% of revenues.
Interest Expense, Net. Interest expense, net, decreased to $100,000 in
1996, down from $1.6 million in 1995. Interest expense, net, for 1996 consisted
of $495,000 of net interest expense incurred in the first quarter prior to the
Company's March 26, 1996 initial public offering, less $395,000 of net interest
income derived primarily from the net initial public offering proceeds during
the remaining three quarters of the year.
Earnings Before Income Taxes. Earnings before income taxes increased
127.3% to $10.9 million, up from $4.8 million in 1995. As a percentage of total
revenues, earnings before income taxes were 14.1% in 1996 and 8.6% in 1995.
Excluding the effect of the temporary $1.9 million auditor compensation rate
differential relating to contracts-in-progress acquired in January 1995 from
Fial & Associates, earnings before income taxes for 1995 would have been $6.7
million, or 12.1% of revenues.
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Income Taxes. The predecessor business entities that comprised the Company
generally were either Subchapter S corporations or partnerships. As a result,
income tax liabilities were the responsibilities of the respective shareholders
and partners. In April 1995, the Company's predecessors reorganized and its
international entities became C corporations. Additionally, in connection with
the Company's March 1996 initial public offering, all domestic entities became C
corporations. As a result of these conversions to C corporations, the Company
incurred charges to operations of $305,000 in 1995 and $3.7 million in 1996 for
cumulative deferred income taxes. The Company's 1996 provision for income taxes
of $7.8 million consists of the above-mentioned $3.7 million charge for
cumulative deferred income taxes combined with $4.1 million in tax provisions at
a 39.0% composite effective rate for the three quarters subsequent to the March
26, 1996 initial public offering.
Pro Forma Income Taxes. The results of operations for 1996 and 1995 have
been adjusted on a pro forma basis to reflect federal and state income taxes at
a combined effective rate of 39.0% as if the Company's predecessors had been C
corporations throughout such periods.
1995 COMPARED WITH 1994
Revenues. Revenues increased 61.5% to $56.0 million for 1995, up from
$34.7 million in 1994. Of this $21.3 million increase, $12.1 million, or 56.8%,
related to domestic client accounts acquired through the Fial & Associates
acquisition, $7.1 million, or 33.3%, related to revenue growth from existing and
new domestic accounts other than those acquired from Fial & Associates, and $2.1
million, or 9.9%, related to revenue growth from international operations.
Non-Fial & Associates domestic revenue growth of $7.1 million in 1995 consisted
of $3.0 million related to 28 new client accounts and $4.1 million related to
provision of additional services to existing accounts.
International revenues grew 44.0% to $7.0 million for 1995, up from $4.9
million for 1994. Excluding the effect of the Fial & Associates acquisition on
the Company's 1995 revenues, international revenues grew to 16.0% of total
revenues in 1995, up from 14.1% in 1994.
Cost of Revenues. Cost of revenues was 54.5% in 1995, up from 52.3% in
1994.
Domestically, the Company's cost of revenues as a percentage of revenues
increased to 55.6% in 1995 from 51.5% in 1994 due primarily to Fial & Associates
contracts-in-progress acquired in January 1995. These auditor contracts,
substantially all of which were concluded by December 31, 1995, carried higher
auditor compensation rates than those customarily paid by the Company. Excluding
the effect of this temporary $1.9 million rate-related differential, domestic
cost of revenues as a percentage of domestic revenues would have been 51.7% in
1995.
Internationally, cost of revenues decreased to 47.2% of international
revenues in 1995 from 57.6% during 1994. This decrease resulted from the gradual
reduction of initial auditor compensation guarantees in various newer markets as
auditor commissions were earned on increasing international revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of revenues decreased to 34.0% in 1995
from 35.6% in 1994. This reduction resulted primarily from the domestic
assimilation and subsequent growth of client accounts acquired in January 1995
from Fial & Associates without proportional increases in selling, general and
administrative expenses. In addition, international selling, general and
administrative expenses decreased to 58.7% of international revenues during 1995
from 65.1% during 1994 due principally to the 44.0% growth of international
revenues in 1995.
Amortization of intangible assets totaled $1.2 million in 1995 and $1.1
million in 1994.
Operating Income. Operating income increased 53.9% to $6.4 million in
1995, up from $4.2 million in 1994. Operating income was 11.5% and 12.1% of
revenues for 1995 and 1994, respectively. Excluding the effect of the temporary
$1.9 million auditor compensation rate differential relating to
contracts-in-progress acquired in January 1995 from Fial & Associates, operating
income for 1995 would have been $8.3 million, or 15.0% of revenues.
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Interest Expense, Net. Interest expense, net, increased to $1.6 million in
1995 from $544,000 in 1994. Of this $1.1 million increase, $450,000, or 41.4%,
related to debt incurred in connection with the Fial & Associates acquisition,
and the remaining $636,000, or 58.6%, resulted from additional bank debt and
other borrowings used to finance the Company's worldwide expansion efforts.
Earnings Before Income Taxes. Earnings before income taxes increased 32.2%
to $4.8 million in 1995 from $3.6 million in 1994. As a percentage of total
revenues, earnings before income taxes were 8.6% and 10.5% for 1995 and 1994,
respectively. Excluding the effect of the temporary $1.9 million auditor
compensation rate differential relating to contracts-in-progress acquired in
January 1995 from Fial & Associates, earnings before income taxes for 1995 would
have been $6.7 million, or 12.1% of revenues.
Income Taxes. The predecessor business entities that comprised the Company
generally were either Subchapter S corporations or partnerships. As a result,
income tax liabilities were the responsibilities of the respective shareholders
and partners. In April 1995, the Company's predecessors reorganized and its
international entities became C corporations. In connection with this 1995
reorganization, the Company established a net deferred tax liability of $305,000
and recorded a charge to the 1995 Consolidated Statement of Earnings related to
this termination of Subchapter S corporation status for the international
entities.
Pro Forma Income Taxes. The pro forma provision for income taxes reflects
the additional income tax expense as if the Company were liable for federal and
state income taxes rather than the individual shareholders and partners. Pro
forma income taxes for 1995 and 1994 were calculated at a combined effective
rate of 39.0% as if the Company's predecessors had been C corporations
throughout such periods.
QUARTERLY RESULTS
The following tables set forth certain unaudited quarterly financial data
for each of the Company's last eight quarters and such data expressed as a
percentage of the Company's revenues for the respective quarters. The
information has been derived from unaudited consolidated financial statements
that, in the opinion of management, reflect all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of such
quarterly information. The operating results for any quarter are not necessarily
indicative of the results to be expected for any future period.
1996 QUARTER ENDED 1995 QUARTER ENDED
------------------------------------------ ------------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31
-------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
Revenues............................. $15,615 $17,963 $21,964 $21,788 $10,722 $12,999 $16,249 $16,061
Cost of revenues..................... 8,623 9,480 11,002 11,225 6,662 6,867 8,364 8,661
Selling, general and administrative
expenses........................... 6,031 6,040 6,623 7,267 4,005 4,430 5,008 5,592
------- ------- ------- ------- ------- ------- ------- -------
Operating income............. 961 2,443 4,339 3,296 55 1,702 2,877 1,808
Interest expense (income), net....... 495 (106) (162) (127) 221 389 479 541
------- ------- ------- ------- ------- ------- ------- -------
Earnings (loss) before income
taxes...................... 466 2,549 4,501 3,423 (166) 1,313 2,398 1,267
Income taxes......................... 3,700 994 1,759 1,336 -- 305 -- --
------- ------- ------- ------- ------- ------- ------- -------
Net earnings (loss).......... $(3,234) $ 1,555 $ 2,742 $ 2,087 $ (166) $ 1,008 $ 2,398 $ 1,267
======= ======= ======= ======= ======= ======= ======= =======
PRO FORMA
Historical earnings (loss) before
income taxes..................... $ 466 $ 2,549 $ 4,501 $ 3,423 $ (166) $ 1,313 $ 2,398 $ 1,267
Pro forma income taxes (benefit)... 182 994 1,759 1,336 (65) 512 935 495
------- ------- ------- ------- ------- ------- ------- -------
Pro forma net earnings
(loss)..................... $ 284 $ 1,555 $ 2,742 $ 2,087 $ (101) $ 801 $ 1,463 $ 772
======= ======= ======= ======= ======= ======= ======= =======
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19
1996 QUARTER ENDED 1995 QUARTER ENDED
------------------------------------------ ------------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31
-------- -------- --------- -------- -------- -------- --------- --------
Revenues............................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues..................... 55.2 52.8 50.1 51.5 62.1 52.8 51.5 53.9
Selling, general and administrative
expenses........................... 38.6 33.6 30.1 33.4 37.4 34.1 30.8 34.8
----- ----- ----- ----- ----- ----- ----- -----
Operating income............. 6.2 13.6 19.8 15.1 0.5 13.1 17.7 11.3
Interest expense (income), net....... 3.2 (0.6) (0.7) (0.6) 2.0 3.0 2.9 3.4
----- ----- ----- ----- ----- ----- ----- -----
Earnings (loss) before income
taxes...................... 3.0 14.2 20.5 15.7 (1.5) 10.1 14.8 7.9
Income taxes......................... 23.7 5.5 8.0 6.1 -- 2.3 -- --
----- ----- ----- ----- ----- ----- ----- -----
Net earnings (loss).......... (20.7)% 8.7% 12.5% 9.6% (1.5)% 7.8% 14.8% 7.9%
===== ===== ===== ===== ===== ===== ===== =====
PRO FORMA
Historical earnings (loss) before
income taxes..................... 3.0% 14.2% 20.5% 15.7% (1.5)% 10.1% 14.8% 7.9%
Pro forma income taxes (benefit)... 1.2 5.5 8.0 6.1 (0.6) 3.9 5.8 3.1
----- ----- ----- ----- ----- ----- ----- -----
Pro forma net earnings
(loss)..................... 1.8% 8.7% 12.5% 9.6% (0.9)% 6.2% 9.0% 4.8%
===== ===== ===== ===== ===== ===== ===== =====
The Company has experienced and expects to continue to experience
significant seasonality in its business. The Company typically realizes higher
revenues and operating income in the last two quarters of its fiscal year, with
its highest revenues typically realized in the third quarter. This trend is
expected to continue and reflects the inherent purchasing and operational cycles
of the retailing industry, which is the principal industry served by the
Company. Should this trend not continue, the Company's profitability for any
affected quarter and the entire year could be severely and adversely impacted
due to ongoing selling, general and administrative expenses that are largely
fixed over the short term.
LIQUIDITY AND CAPITAL RESOURCES
Through December 31, 1996, the Company's predecessors had acquired and
assimilated three operating companies and financed these acquisitions primarily
through a combination of bank and seller financing. Ongoing Company operations
and capital requirements prior to the Company's initial public offering were met
primarily with cash flows provided by operating activities and, to a lesser
extent, with the proceeds from bank and shareholder loans. On March 26, 1996,
the Company's initial public offering of its common stock was declared effective
by the United States Securities and Exchange Commission. On April 1, 1996, the
Company received its $34.8 million portion of the proceeds (net of underwriting
discounts and commissions) from the offering. Of these proceeds, approximately
$1.1 million was subsequently utilized to pay expenses of the offering,
approximately $4.9 million was used to pay previously declared and unpaid
Subchapter S shareholder distributions and partnership distributions, and
approximately $14.6 million was used to pay principal and accrued interest on
substantially all outstanding interest-bearing debt (other than that portion of
certain convertible debt that was converted to common stock concurrent with the
initial public offering). Substantially all of the remaining $14.2 million
continued to be available as of December 31, 1996 to expand international
operations, to acquire complementary businesses and for general corporate
purposes, including working capital.
In September 1996, the Company executed a $20.0 million credit facility
with NationsBank N.A. (South). The facility permits the Company to borrow up to
$20.0 million on a term loan basis to finance mergers and acquisitions.
Alternatively, the Company, at its option, may utilize up to $10.0 million as a
revolving line of credit for working capital and employ the remaining $10.0
million for mergers and acquisitions. Through February 28, 1997, the Company had
made no draws against this credit facility pursuant to which borrowings can be
made through September 1998. See Note 3 of Notes to Consolidated Financial
Statements.
Net cash provided by operating activities was $1.9 million, $2.5 million
and $3.6 million for 1996, 1995 and 1994, respectively. During 1996, the Company
overestimated its federal and state income tax liabilities resulting in $2.0
million in refundable income taxes on its Consolidated Balance Sheet at December
31, 1996.
17
20
Excluding the effect of having made this $2.0 million in excess payments, net
cash provided by operating activities would have been $3.9 million in 1996.
The Company historically has earned revenues on a relatively ratable basis
within a given quarter of operations. During the third and fourth quarters of
1996, unusually large proportions of total quarterly revenues were earned in the
last halves of such quarters resulting in a higher than planned level of
accounts receivable on the Company's Consolidated Balance Sheet at December 31,
1996. The Company does not believe that the revenue achievement patterns
experienced within the third and fourth quarters of 1996 are indicative of a
developing trend. There can be no assurance, however, that historically
experienced intra-quarterly revenue achievement patterns will continue.
Net cash used in investing activities was $5.1 million, $2.6 million and
$419,000 for 1996, 1995 and 1994, respectively. Due to the Company's rapid
growth, the Company doubled the size of its Atlanta home office during 1996 to
approximately 45,000 square feet. This project was completed in the third
quarter of 1996 and, combined with ongoing computer-related equipment additions,
comprised the majority portion of the Company's property and equipment additions
for 1996.
Net cash provided by financing activities in 1996 was $19.4 million, and
reflects proceeds from the Company's initial public offering, net of repayments
of debt and other obligations paid from those proceeds. Net cash used in
financing activities was $586,000 and $2.0 million, respectively, for 1995 and
1994.
The Company believes that its current working capital, its existing line of
credit and cash flow generated from future operations will be sufficient to meet
the Company's working capital and capital expenditure requirements through March
31, 1998.
FORWARD-LOOKING STATEMENTS
Statements made in this 1996 Form 10-K that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of the
future are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. It is important to note that the
Company's actual results could differ materially from those contained in such
forward-looking statements. Additional information concerning factors that could
cause actual results to differ materially from those in forward-looking
statements is contained from time to time in the Company's SEC filings,
including the Risk Factors section of the Company's Prospectus dated March 26,
1996, included in its registration statement on Form S-1 (file number 333-1086).
18
21
ITEM 8. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
PAGE
NUMBER
------
Independent Auditors' Report................................ 20
Consolidated Statements of Earnings for the Years ended
December 31, 1996, 1995 and 1994.......................... 21
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... 22
Consolidated Statements of Shareholders' Equity (Deficit)
for the Years ended December 31, 1996, 1995 and 1994...... 23
Consolidated Statements of Cash Flows for the Years ended
December 31, 1996, 1995 and 1994.......................... 24
Notes to Consolidated Financial Statements.................. 25
19
22
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
The Profit Recovery Group International, Inc.:
We have audited the accompanying Consolidated Balance Sheets of The Profit
Recovery Group International, Inc. and subsidiaries as of December 31, 1996 and
1995, and the related Consolidated Statements of Earnings, Shareholders' Equity
(Deficit), and Cash Flows for each of the years in the three-year period ended
December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The Profit
Recovery Group International, Inc. and subsidiaries as of December 31, 1996 and
1995, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1996 in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Atlanta, Georgia
January 24, 1997, except for
the final paragraph of Note 8,
as to which the date is
February 11, 1997
20
23
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
Revenues.................................................... $77,330 $56,031 $34,690
Cost of revenues............................................ 40,330 30,554 18,163
Selling, general, and administrative expenses............... 25,961 19,035 12,343
------- ------- -------
Operating income.................................. 11,039 6,442 4,184
Interest expense, net (Note 2).............................. 100 1,630 544
------- ------- -------
Earnings before income taxes...................... 10,939 4,812 3,640
Income taxes (Note 5)....................................... 7,789 305 --
------- ------- -------
Net earnings...................................... $ 3,150 $ 4,507 $ 3,640
======= ======= =======
(Unaudited) pro forma information:
Historical earnings before income taxes................... $10,939 $ 4,812 $ 3,640
Pro forma income taxes (Note 5)........................... 4,271 1,877 1,420
------- ------- -------
Pro forma net earnings................................. $ 6,668 $ 2,935 $ 2,220
======= ======= =======
Pro forma earnings per common and common equivalent
share.................................................. $ .39 $ .21
======= =======
Weighted average common and common equivalent shares
outstanding............................................ 17,457 14,948
======= =======
See accompanying Notes to Consolidated Financial Statements.
21
24
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------
1996 1995
------- -------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $16,891 $ 642
Receivables:
Billed contract receivables............................ 3,864 3,203
Unbilled contract receivables.......................... 30,734 15,961
Employee advances...................................... 1,363 560
------- -------
Total receivables................................. 35,961 19,724
------- -------
Refundable income taxes................................... 2,049 --
Prepaid expenses and other current assets................. 528 302
------- -------
Total current assets.............................. 55,429 20,668
------- -------
Property and equipment:
Computer and other equipment.............................. 5,753 2,697
Furniture and fixtures.................................... 1,569 615
Leasehold improvements.................................... 1,183 117
------- -------
8,505 3,429
Less accumulated depreciation and amortization............ 2,272 918
------- -------
6,233 2,511
------- -------
Noncompete agreements, less accumulated amortization of
$2,759 in 1996 and $1,725 in 1995......................... 4,509 5,543
Deferred loan costs, less accumulated amortization of $8 in
1996 and $133 in 1995..................................... 56 867
Goodwill, less accumulated amortization of $157 in 1996 and
$79 in 1995............................................... 393 471
Deferred income taxes (Note 5).............................. 1,174 --
Other assets................................................ 524 208
------- -------
$68,318 $30,268
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Notes payable to bank..................................... $ -- $ 1,763
Current installments of long-term debt (Note 3)........... 79 2,522
Accounts payable and accrued expenses..................... 1,383 1,504
Accrued payroll and related expenses...................... 16,356 7,836
Deferred income taxes (Note 5)............................ 7,607 305
------- -------
Total current liabilities......................... 25,425 13,930
Long-term debt, excluding current installments (Note 3)..... 692 17,629
Loans from shareholders (Note 2)............................ -- 1,075
Deferred compensation (Note 6).............................. 1,642 1,036
------- -------
Total liabilities................................. 27,759 33,670
------- -------
Shareholders' equity (deficit):
Common stock (Notes 7 and 9).............................. 18 58
Additional paid-in capital (Notes 7 and 9)................ 34,188 (1,108)
Cumulative translation adjustments........................ (31) (51)
Retained earnings (accumulated deficit)................... 6,384 (2,301)
------- -------
Total shareholders' equity (deficit).............. 40,559 (3,402)
Commitments (Notes 2 and 4).................................
------- -------
$68,318 $30,268
======= =======
See accompanying Notes to Consolidated Financial Statements.
22
25
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
RETAINED TOTAL
ADDITIONAL CUMULATIVE EARNINGS SHAREHOLDERS'
COMMON PAID-IN SUBSCRIPTIONS TRANSLATION (ACCUMULATED EQUITY
STOCK CAPITAL RECEIVABLE ADJUSTMENTS DEFICIT) (DEFICIT)
------ ---------- ------------- ----------- ------------ -------------
(IN THOUSANDS)
BALANCE AT DECEMBER 31,
1993........................ $ 54 $ -- $-- $(14) $ (207) $ (167)
Net earnings.................. -- -- -- -- 3,640 3,640
Issuance of common stock...... 3 -- (3) -- -- --
Distributions................. -- -- -- -- (1,075) (1,075)
Cumulative translation
adjustments................. -- -- -- (42) -- (42)
---- -------- --- ---- ------- -------
BALANCE AT DECEMBER 31,
1994........................ 57 -- (3) (56) 2,358 2,356
Net earnings.................. -- -- -- -- 4,507 4,507
Proceeds from subscription
receivable.................. -- -- 3 -- -- 3
Effect of reorganization
(Note 1(a))................. -- (1,550) -- -- 1,550 --
Distributions................. -- -- -- -- (10,716) (10,716)
Cumulative translation
adjustments................. -- -- -- 5 -- 5
Issuance of common stock in
acquisition of Fial &
Associates, Inc............. 1 442 -- -- -- 443
---- -------- --- ---- ------- -------
BALANCE AT DECEMBER 31,
1995........................ 58 (1,108) -- (51) (2,301) (3,402)
Net earnings.................. -- -- -- -- 3,150 3,150
Effect of stock split......... (57) 57 -- -- -- --
Issuance of shares under
employee stock option
plans....................... -- 132 -- -- -- 132
Tax effect of issuance of
option shares to
employees................... -- 115 -- -- -- 115
Effect of reorganization,
including termination of
Subchapter S and partnership
status (Note 1(a)).......... 2 (10,464) -- 51 10,411 --
Distributions................. -- -- -- -- (4,876) (4,876)
Cumulative translation
adjustments................. -- -- -- (31) -- (31)
Issuance of common stock...... 4 34,008 -- -- -- 34,012
Conversion of 5% convertible
debentures.................. 11 11,448 -- -- -- 11,459
---- -------- --- ---- ------- -------
BALANCE AT DECEMBER 31,
1996........................ $ 18 $ 34,188 $-- $(31) $ 6,384 $40,559
==== ======== === ==== ======= =======
See accompanying Notes to Consolidated Financial Statements.
23
26
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
-------- -------- -------
(IN THOUSANDS)
Cash flows from operating activities:
Net earnings.............................................. $ 3,150 $ 4,507 $ 3,640
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization.......................... 2,460 1,810 1,258
Loss on sale of property and equipment................. -- 79 --
Deferred compensation expense.......................... 606 474 241
Deferred income taxes.................................. 6,823 305 --
Foreign translation adjustments........................ (31) 5 (42)
Changes in assets and liabilities, net of effect of
acquisition:
Receivables.......................................... (16,237) (6,755) (2,362)
Prepaid expenses and other current assets............ (226) (237) 42
Refundable income taxes.............................. (2,049) -- --
Other assets......................................... (316) (132) (67)
Accounts payable and accrued expenses................ (816) 957 240
Accrued payroll and related expenses................. 8,520 1,518 660
-------- -------- -------
Net cash provided by operating activities......... 1,884 2,531 3,610
-------- -------- -------
Cash flows from investing activities:
Purchases of property and equipment....................... (5,076) (2,048) (486)
Acquisition of Fial & Associates, Inc..................... -- (550) --
Net decrease in notes receivable from affiliates.......... -- 11 67
-------- -------- -------
Net cash used in investing activities............. (5,076) (2,587) (419)
-------- -------- -------
Cash flows from financing activities:
Net increase in (repayments of) note payable to bank...... (1,763) 1,763 --
Proceeds from issuance of long-term debt.................. -- 12,800 3,739
Proceeds from loans from shareholders..................... 2,600 -- 1,654
Repayments of long-term debt.............................. (7,104) (2,853) (5,515)
Payments of deferred loan costs........................... -- (1,000) --
Repayments of loans from shareholders..................... (3,675) (580) (808)
Net proceeds from common stock............................ 34,259 1 --
Distributions............................................. (4,876) (10,717) (1,075)
-------- -------- -------
Net cash provided by (used in) financing
activities...................................... 19,441 (586) (2,005)
-------- -------- -------
Net change in cash and cash equivalents........... 16,249 (642) 1,186
Cash and cash equivalents at beginning of year.............. 642 1,284 98
-------- -------- -------
Cash and cash equivalents at end of year.................... $ 16,891 $ 642 $ 1,284
======== ======== =======
Supplemental disclosure of cash flow information:
Cash paid during the year for interest.................... $ 1,091 $ 1,207 $ 491
======== ======== =======
Cash paid during the year for income taxes................ $ 3,585 $ -- $ --
======== ======== =======
See accompanying Notes to Consolidated Financial Statements.
24
27
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business and Basis of Presentation
Description of Business
The principal business of The Profit Recovery Group International, Inc. and
subsidiaries (the "Company") is providing accounts payable and other recovery
audit services to large retailers and other transaction intensive companies.
Such large retail clients include discount, department, specialty, grocery, and
drug stores as well as wholesale distributors. The Company also serves certain
governmental agencies and healthcare providers. The Company provides its
services throughout North America, Western Europe, and the far eastern countries
of Asia.
On March 26, 1996, the Company completed the initial public offering of its
common stock.
Basis of Presentation
Prior to a reorganization in April 1995, the Company was a combination of
the following eight entities with common control: The Profit Recovery Group,
Inc. ("PRG"); The Profit Recovery Group International, L.P. ("PRG L.P."); PRG
International Inc.; The Profit Recovery Group Asia, Inc. ("Asia"); The Profit
Recovery Group Canada, Inc. ("Canada"); The Profit Recovery Group France, Inc.
("France"); The Profit Recovery Group Mexico, Inc. ("Mexico"); and The Profit
Recovery Group U.K., Inc. ("UK").
The April 1995 reorganization principally included the contribution of the
capital stock in Asia, Canada, France, Mexico, and the UK (collectively referred
to as the "Foreign Operating Companies") to a newly formed subsidiary of PRG
L.P., PRG International Holding Co. ("PRG Holdco"). Subsequent to this
reorganization, the Company was a combination of the following three entities
with common ownership: The Profit Recovery Group International I, Inc.
("PRGI" -- formerly PRG), PRG L.P., and PRG Holdco and its five wholly owned
subsidiaries, which are the Foreign Operating Companies. All reorganization
transactions were between parties under common control and, accordingly, were
accounted for in a manner similar to that in a pooling-of-interests.
In connection with the Company's March 1996 initial public offering of its
common stock, a further reorganization was effected. Immediately subsequent to
this reorganization, the Company consisted of The Profit Recovery Group
International, Inc. as the publicly traded parent company and seven wholly owned
subsidiaries: PRGI, Asia, Canada, France, Mexico, UK, and The Profit Recovery
Group Belgium, Inc. ("Belgium"). All reorganization transactions were between
parties under common control and, accordingly, were accounted for in a manner
similar to that in a pooling-of-interests. Upon completion of the March 1996
reorganization, United States operations were conducted through PRGI and the
international operations through the other six subsidiaries.
Subsequent additions of international operating entities included The
Profit Recovery Group Australia, Inc. (May 1996), The Profit Recovery Group New
Zealand, Inc. (May 1996), The Profit Recovery Group Netherlands, Inc. (May
1996), The Profit Recovery Group Germany, Inc. (June 1996), and The Profit
Recovery Group Singapore PTE LTD (October 1996).
(b) Principles of Consolidation
The consolidated financial statements of the Company in 1996 and the
combined financial statements of the Company for 1995 and 1994 include the
financial statements of the aforementioned entities. All significant
intercompany balances and transactions have been eliminated in consolidation or
combination.
The consolidated or combined financial statements have been prepared in
conformity with generally accepted accounting principles. In preparing these
financial statements, management is required to make a
25
28
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
number of estimates and assumptions relating to the reporting of assets and
liabilities and the disclosure of contingent assets and liabilities. Actual
results could differ from those estimates. A material estimate that is
particularly susceptible to change is the estimation of uncollectible claims
(see (c) Revenue Recognition).
(c) Revenue Recognition
The Company's revenues are based on specific contracts with its clients.
Such contracts generally specify (a) time periods covered by the audit, (b)
nature and extent of audit services to be provided by the Company, (c) client's
duties in assisting and cooperating with the Company, and (d) fee payable to the
Company expressed as a specified percentage of the amounts recovered by the
client resulting from liability overpayment claims identified. In addition to
contractual provisions, most clients also establish specific procedural
guidelines which the Company must satisfy prior to submitting claims for client
approval. These guidelines are unique to each client and impose specific
requirements on the Company such as adherence to vendor interaction protocols,
provision of advance written notification to vendors of forthcoming claims,
securing written claim validity concurrence from designated client personnel
and, in limited cases, securing written claim validity concurrence from the
involved vendors. The Company defers revenue recognition until client
guidelines, of whatever nature, have been satisfied.
With respect to each identified and documented claim for which
client-imposed procedural guidelines have been satisfied, the Company believes
that it has completed substantially all contractual obligations to its client at
the time such claim is presented to, and approved by, appropriate client
personnel. The Company further believes that at the time a claim is submitted
and accepted by its client, such claim represents a valid overpayment due to the
client from its vendor. Accordingly, the Company believes that it is entitled to
its fee upon acceptance of such claim by its client, subject to (a) customary
and routine claim disallowance adjustments by the vendor resulting primarily
from the receipt of previously unknown information, and (b) applicable laws.
Disallowances of client-approved claims are susceptible to experience-based
estimation.
The Company's standard client contract imposes a duty on the client to
process promptly all claims against vendors. In the interest of vendor
relations, however, many clients modify the standard client contract with the
Company to provide that they retain discretion whether to pursue collection of a
claim. In the Company's experience, it is extremely unusual for a client to
forego the collection of a large, valid claim. In some cases, a vendor may
dispute a claim by providing additional documentation or information supporting
its position. Consequently, many clients revise the Company's standard client
contract to clarify that the Company is not entitled to payment of its fee until
the client recovers the claim from its vendor.
Revenues are recognized at the time overpayment claims are presented to and
approved by clients, as adjusted for estimated uncollectible claims. Submitted
claims that are not approved by clients for whatever reason are not considered
when recognizing revenues. Estimated uncollectible claims are initially
established, and subsequently adjusted, for each individual client based on
historical collection rates, types of claims identified, current industry
conditions, and other factors which, in the opinion of management, deserve
recognition. The Company records revenues at estimated net realizable value
without reserves. Accordingly, adjustments to uncollectible claim estimates are
directly charged or credited to earnings, as appropriate.
Approved claims are processed by clients and generally taken as credits
against outstanding payables or future purchases from the vendors involved. Once
credits are taken, the Company invoices its clients for a contractually
stipulated percentage of the amounts recovered. The Company's contract
receivables are largely unbilled because it does not control (a) the timing of a
client's claims processing activities, or (b) the timing of a client's payments
for current and future purchases. In the Company's experience, material
receivables are expected to be collected within one year after such receivables
are recorded.
26
29
THE PROFIT RECOVERY GROUP INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) Cash Equivalents
Cash equivalents at December 31, 1996 consisted of an $11.9 million reverse
repurchase agreement with NationsBank, N.A. (South) which was fully
collateralized by United States of America Treasury Notes in the possession of
such bank. The reverse repurchase agreement in effect on December 31, 1996,
matured and was settled on January 2, 1997.
The Company does not intend to take possession of collateral securities on
future reverse repurchase agreement transactions conducted with banking
institutions of national standing. The Company does insist, however, that all
such agreements provide for full collateralization using obligations of the
United States of America having a current market value equivalent to or
exceeding the reverse repurchase agreement amount.
(e) Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized using the straight-line method over the
shorter of the lease term or estimated life of the asset.
(f) Direct Expenses
Direct expenses incurred during the course of the accounts payable audits
and other audit services are expensed as incurred.
Non-management auditor compensation expense is recorded at the time of
related revenue recognition and subsequently paid as such revenue is collected.
Previously established auditor compensation accruals are subsequently adjusted
on a monthly basis to correspond with adjustments to uncollectible claim
estimates. All other Company employees are compensated on the basis of salary
and in certain cases, bonuses, which are charged to operations as incurred.
(g) Software Development Costs
Software development costs related to the development of the Company's
proprietary audit software are expensed as incurred.
(h) Intangibles
Goodwill. Goodwill represents the excess of the purchase price over the
estimated fair market value of net assets of acquired businesses. The Company
evaluates the unique relevant aspects of each individual acquisition when
establishing an appropr