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EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - PRGX GLOBAL, INC.ex211201410k.htm
EX-23.1 - CONSENT OF BDO USA, LLP - PRGX GLOBAL, INC.ex231201410k.htm
EX-32.1 - CERTIFICATION OF THE CEO AND CFO PURSUANT TO SECTION 906 - PRGX GLOBAL, INC.ex321201410k.htm
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - PRGX GLOBAL, INC.ex312201410k.htm
EX-10.43 - EMPLOYMENT AGREEMENT - PRGX GLOBAL, INC.ex1043201410k.htm
EX-10.42 - EMPLOYMENT AGREEMENT - PRGX GLOBAL, INC.ex1042201410k.htm
EX-10.29 - SEVENTH LOAN DOCUMENTS MODIFICATION AGREEMENT - PRGX GLOBAL, INC.ex1029201410k.htm
EXCEL - IDEA: XBRL DOCUMENT - PRGX GLOBAL, INC.Financial_Report.xls
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - PRGX GLOBAL, INC.ex311201410k.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________
FORM 10-K 
________________________________________
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2014
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
 PRGX Global, 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.)
 
 
 
600 Galleria Parkway
 
30339-5986
Suite 100
 
(Zip Code)
Atlanta, Georgia
 
 
(Address of principal executive offices)
 
 
Registrants telephone number, including area code: (770) 779-3900
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered

Common Stock, No Par Value

The NASDAQ Stock Market LLC (The Nasdaq Global Select Market)

Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.   Yes  ¨    No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes  ¨    No  ý
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
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  ý    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.  ý
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
¨  Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
The aggregate market value, as of June 30, 2014, of common shares of the registrant held by non-affiliates of the registrant was approximately $174.7 million, based upon the last sales price reported that date on The Nasdaq Global Select Market of $6.39 per share. (Aggregate market value is estimated solely for the purposes of this report and shall not be construed as an admission for the purposes of determining affiliate status.)
Common shares of the registrant outstanding at March 6, 2015 were 26,049,965.
Documents Incorporated by Reference
Part III: Portions of Registrant’s Proxy Statement relating to the Company’s 2015 Annual Meeting of Shareholders.
 
 
 
 
 




PRGX GLOBAL, INC.
FORM 10-K
December 31, 2014
INDEX
 
 
Page No.
Part I
 
 
 
Part II
 
Part III
 
Part IV
 



Cautionary Statement Regarding Forward-Looking Statements
The following discussion includes “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are at times identified by words such as “plans,” “intends,” “expects,” or “anticipates” and words of similar effect and include statements regarding the Company’s financial and operating plans and goals. These forward-looking statements include any statements that cannot be assessed until the occurrence of a future event or events. Except as otherwise indicated or unless the context otherwise requires, “PRGX,” “we,” “us,” “our” and the “Company” refer to PRGX Global, Inc. and its subsidiaries.
These forward-looking statements are subject to risks, uncertainties and other factors, including but not limited to those discussed herein and below under Item 1A “Risk Factors.” Many of these risks are outside of our control and could cause actual results to differ materially from the results discussed in the forward-looking statements. Factors that could lead to material changes in our performance may include, but are not limited to:
our ability to successfully execute our recovery audit growth strategy;
our continued dependence on our largest clients for significant revenue;
the use of internal recovery audit groups by our clients, reducing the amount of recoveries available to us;
commoditization of our services and the effects of rate reductions;
the significant control that our clients have over assertion or acceptance of recovery audit claims against their suppliers and the corresponding impact on our revenue;
changes to Medicare and Medicaid recovery audit contractor (“RAC”) programs administered by the Centers for Medicare and Medicaid Services (“CMS”) and other government agencies, and our role in the national Medicare RAC program, the results of operations of which are included in our Healthcare Claims Recovery Audit Services segment;
changes to revenue as a result of our decision to withdraw from the Medicare RAC program rebid process;
revenue that does not meet expectations or justify costs incurred;
our ability to develop material sources of new revenue in addition to revenue from our core accounts payable recovery audit services;
changes in the market for our services;
client and vendor bankruptcies and financial difficulties;
our ability to retain and attract qualified personnel and effectively manage our global workforce;
our inability to protect and maintain the competitive advantage of our proprietary technology and intellectual property rights;
our reliance on operations outside the U.S. for a significant portion of our revenue;
our ability to effectively manage foreign currency fluctuations;
the highly competitive environments in which our recovery audit services and Adjacent Services businesses operate and the resulting pricing pressure on those businesses;
our ability to integrate recent and future acquisitions;
our ability to realize operational cost savings and the transformation severance and related expenses we may incur to generate these savings;
uncertainty in the global credit markets;
our ability to maintain compliance with the financial and non-financial covenants in our financing arrangements;
our tax positions and other factors that could affect our effective income tax rate or our ability to use our existing deferred tax assets;
a cyber-security incident involving the misappropriation, loss or unauthorized disclosure or use of confidential information of our clients;
effects of changes in accounting policies, standards, guidelines or principles; or
terrorist acts, acts of war and other factors over which we have little or no control.


i


Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time and it is not possible for management to predict all such factors.

ii


PART I
ITEM 1. Business
PRGX Global, Inc., together with its subsidiaries, is an analytics-powered information and professional services firm based in the United States of America (“U.S.”). PRGX Global, Inc. was incorporated in the State of Georgia in 1996. At the heart of our client services portfolio is the core capability of mining client data to deliver “actionable insights.” Actionable insights allow our clients to improve their financial performance by reducing costs, improving business processes and increasing profitability.
Our core business is “recovery audit,” a service based on the mining of a tremendous amount of our clients’ purchasing data, looking for overpayments to their third-party suppliers. PRGX is the world's leading provider of accounts payable recovery audit services of recovery audit services principally to large businesses and government agencies with high volumes of transactions and complex pricing arrangements with vendors. We audit over 75% of the top 20 global retailers and earn the largest portion of our revenues from our retail clients. Recovery audit is a mature service offering in the retail industry and we have been serving a number of our clients for decades. Pricing of merchandise for resale in the retail industry is extremely complex due to the high volume of promotions, allowances and rebates provided by suppliers. The second largest portion of our business is referred to within the recovery audit business as “commercial.” Commercial recovery auditing is the delivery of recovery audit services to industries other than retail and healthcare, such as automotive and industrial manufacturing, oil and gas, financial services, mining and transportation. Recovery audit in the industries represented within commercial is typically less mature in terms of complexity of vendor pricing, scope of purchase transactions made available for audit and depth of audit programs within individual companies. “Contract compliance” auditing is a specific type of recovery auditing which is more heavily utilized by commercial clients and is a growing part of our business. This service offering focuses on auditing supplier billings against large and complex service, construction and licensing contracts, and is particularly relevant to oil and gas, mining, technology, media and brand dependent manufacturing companies. In addition to recovery audit services, PRGX offers a number of data transformation, data analytics and associated advisory services in our Adjacent Services segment. These service offerings are increasingly important to our business and are applicable to clients in both retail and commercial industries. PRGX is also active in the healthcare industry, delivering healthcare claims auditing and related services primarily as part of the Medicare and certain Medicaid recovery audit contractor (“RAC”) programs, as well as to private payers. The majority our healthcare claims work has been associated with the Medicare RAC program, and as a result, the volume of our healthcare claims auditing has decreased dramatically since mid-2013 as a result of significant changes imposed by the Centers for Medicare and Medicaid Services (“CMS”) on all Medicare RAC program auditors at that time.
PRGX is unique in that we are a global recovery audit services provider, serving clients in over 30 countries across a multitude of industries. We conduct our operations through four reportable segments: Recovery Audit Services - Americas, Recovery Audit Services - Europe/Asia-Pacific, Adjacent Services and Healthcare Claims Recovery Audit Services. The Recovery Audit Services - Americas segment represents recovery audit services (excluding Healthcare Claims Recovery Audit Services) we provide in the U.S., Canada and Latin America and is our largest segment in terms of clients served and revenues generated. The Recovery Audit Services - Europe/Asia-Pacific segment represents recovery audit services we provide in Europe, Asia and the Pacific region and is responsible for a significant portion of our revenue. Our Adjacent Services offerings are generally provided to clients on a global basis, while our Healthcare Claims Recovery Audit Services are provided only in the United States. We report the unallocated portion of corporate selling, general and administrative expenses not specifically attributable to the four reportable segments in Corporate Support. For additional financial information relating to our reporting segments, see Note 2 - Operating Segments and Related Information of our Consolidated Financial Statements included in Item 8 of this Form 10-K.


1


The Recovery Audit Industry and PRGX
Many businesses and government agencies generate substantial volumes of payment transactions involving multiple vendors, numerous discounts and allowances, fluctuating prices and complex pricing arrangements or rate structures. Although these entities correctly process the vast majority of payment transactions, errors occur in a small percentage of transactions. These errors include, but are not limited to, missed or inaccurate discounts, allowances and rebates, vendor pricing errors, erroneous coding and duplicate payments. Many factors contribute to the errors, including communication failures between the purchasing and accounts payable departments, complex pricing arrangements or rate structures, personnel turnover and changes in information and accounting systems. In the aggregate, these transaction errors can represent meaningful amounts of reduced cash flow and lost profits for these entities. Recovery auditing is a business service focused on finding overpayments created by these errors. These audits typically entail comprehensive and customized data acquisition from the client, frequently including purchasing, receiving, point-of-sale, pricing and deal documentation, emails, and payment data.
PRGX, like most companies in the recovery audit services industry, generates the majority of its revenue through contingent fee arrangements, sharing a pre-determined percentage of successful claims or “recoveries” generated from an audit. There are certain recovery audit services or types of audits that are billed as a fixed fee or on a time and materials basis, but the vast majority of our revenues are generated through contingent fee contracts.
Recovery audit clients generally recover claims by either (a) taking credits against outstanding payables or future purchases from the involved vendors or service providers, or (b) receiving refund checks directly from those vendors or service providers. Industry practice generally dictates the manner in which a client receives the benefit for a recovery audit claim. In many cases, we must satisfy client-specific procedural guidelines before we can submit recovery audit claims for client approval.
Contracts with recovery audit clients generally vary in length from one year to three years, with some being evergreen. Most of our recovery audit contracts provide that the client may terminate the contract without cause prior to the completion of the term of the agreement by providing relatively short prior written notice of termination.
As businesses have evolved, PRGX and the recovery audit industry have evolved with them, innovating processes, error identification tools, and claim types to maximize recoveries. The following are a number of factors impacting the recovery audit industry:
Data Capture and Availability. Businesses increasingly are using technology to manage complex procurement and accounts payable systems and realize greater operating efficiencies. Many businesses worldwide communicate with vendors electronically - whether by Electronic Data Interchange (“EDI”) or the Internet - to exchange inventory and sales data, transmit purchase orders, submit invoices, forward shipping and receiving information and remit payments. These systems capture more detailed data and enable the cost effective review of more transactions by recovery auditors.
Increased Role of Email Documentation in Client Transaction Data. Clients and vendors increasingly document transaction terms in email correspondence that is not integrated into their financial systems and increases opportunities for errors. To efficiently identify these errors, recovery audit firms must use sophisticated tools that are able to ingest and search through massive volumes of emails to identify potential errors that then are investigated by the auditors. A comprehensive recovery audit requires the effective use of email search tools and techniques.
Increasing Number of Auditable Claim Categories. Traditionally, the recovery audit industry identified simple, or “disbursement,” claim types such as the duplicate payment of invoices. Enhancements to accounts payable software, particularly large enterprise software solutions used by many large companies, have reduced the extent to which these companies make simple disbursement errors. However, the introduction of creative vendor discount programs, complex pricing arrangements and activity-based incentives has led to an increase in auditable transactions and potential sources of error. These transactions are complicated to audit, as the underlying transaction data is difficult to access and recognizing mistakes is complex. Recovery audit firms such as PRGX with significant industry-specific expertise and sophisticated technology are best equipped to audit these complicated claim categories.
Globalization. As the operations of major retailers and other business enterprises become increasingly global, they often seek service providers with a global reach. Sophistication in systems and processes varies markedly across the global network of suppliers which further drives the need for our services.
Significant Promotional Activity. Trade promotion spending is substantial within the retail trade and significant sums are being spent in categories with numerous transactions and a high potential for errors, such as scan downs, or discounts at the point of sale. Because of the high volume of trade promotion within retail, there are significant opportunities for mistakes and, therefore, auditable claims.
We expect the evolution of the recovery audit industry to continue. In particular, we expect that the industry will continue to move towards the electronic capture and presentation of data, more automated, centralized processing and auditing closer to the time of the payment transaction.

2


Adjacent Services
Our Adjacent Services business targets client functional and process areas where we have established expertise, enabling us to provide services to finance and procurement executives to improve working capital, optimize purchasing leverage in vendor pricing negotiations, improve insight into product margin and true cost of goods for resale, identify and manage risks associated with vendor compliance, improve quality of vendor master data and improve visibility and diagnostics of direct and indirect spend. Our Adjacent Services also include the CIPS Sustainability Index, an Internet-based supplier sustainability assessment offered in the UK through our strategic alliance with the Chartered Institute of Purchasing & Supply ("CIPS"). As our clients’ data volumes and complexity levels continue to grow, we are using our deep data management experience to develop new actionable insight solutions, as well as to develop custom analytics and data transformation services. Taken together, our deep understanding of our clients’ procure-to-pay data and our technology-based solutions provide multiple routes to help our clients achieve greater profitability
Healthcare
In addition to our retail and commercial recovery audit services, we also provide recovery audit services relating to healthcare claims to identify overpayments and underpayments made by healthcare payers to healthcare providers, such as hospitals and physicians’ practices. We identify such improper payments by using various methods, including proprietary tools and algorithms which are comparable to the proprietary techniques we developed through many years of performing other types of recovery audits involving massive volumes of transaction data. Auditing medical claims data requires in-depth expertise in healthcare procedures and billing processes. We have derived the vast majority of our Healthcare Claims Recovery Audit revenue to date from our participation as a recovery auditor in the Medicare RAC program.
Clients
PRGX provides its services principally to large businesses and government agencies having a tremendous volume of payment transactions and complex procurement environments. Retailers continue to constitute the largest part of our client and revenue base. Our five largest clients contributed approximately 32.2% of our revenue in 2014 and 30.4% in 2013 and 28.2% in 2012. No client accounted for 10% or more of total revenue in 2014, 2013 or 2012.
Some organizations (primarily large retailers) maintain internal recovery audit departments to recover certain types of payment errors and identify opportunities to reduce costs. Despite having such internal resources, many companies also retain independent recovery audit firms, such as PRGX, due to their specialized knowledge and focused technologies. In the U.S., Canada, the United Kingdom, France, Mexico, Brazil, and Australia, large retailers routinely engage independent recovery audit firms as a standard business practice. It is typical in the retail industry for large firms to engage a primary audit firm at one contingency fee rate and a secondary firm to audit behind the primary at a higher rate. Our commercial recovery audit clients are typically Fortune 200 companies with multi-billion dollars of purchase transactions to be audited. These clients range from large multi-national oil and gas companies, to large regional or national financial services institutions to global high tech software organizations. The audit specialty practice of contract compliance is applicable across most of our clients, but is particularly relevant to large oil and gas, mining, industrial manufacturing and brand-dependent service and manufacturing companies.

3


The PRGX Strategy
PRGX primarily serves the retail industry by providing recovery audit, procure-to-pay performance improvement, and risk management services. We plan to achieve higher profitability and growth through the following strategy:
1.Deliver value, operational efficiency and innovative services to our customers;
2.Differentiate our service offerings and capabilities;
3.Expand into new high potential industry verticals; and
4.Attract and develop highly qualified and motivated professionals with deep industry knowledge and technical skills.
Deliver value, operational efficiency and innovative services to our customers
Our value delivery, operational efficiency and service innovation efforts start with a solid foundation of technology infrastructure and lean process design. We are consolidating our clients’ data into a centralized, high performance technology infrastructure, deploying global best practices and rolling out world class and proprietary audit tools to drive deeper recoveries and enable next generation audit concepts. We expect to achieve our objectives through process redesign coupled with investing in new infrastructure and aggressively rolling out new technologies across our global audits. These investments in infrastructure and processes are fundamental to optimization and efficiency. They also serve as the foundation for service innovation efforts in our core recovery audit business and in Adjacent Services.
Differentiate our service offerings and capabilities
We plan to differentiate our service offerings and capabilities through meaningful and sustainable innovation such as:
Audit acceleration. Our clients are constantly seeking to accelerate the audit process to deliver audit results closer to the time of the transaction to increase recovery yields, provide a greater opportunity to address process errors, and reduce supplier abrasion. We believe that our deep and broad business process experience across thousands of audits, together with new technology initiatives will put us in a unique position to achieve superior acceleration results for our clients.
Global audit programs. Our global programs take advantage of our operations that span over 30 countries to provide true global audit capabilities to multi-national companies. This unique perspective gives our clients visibility to their business practice variations around the world and creates value for our clients by allowing them to see their data in new ways.
Expand into new high potential industry verticals
Our plans include continuing to build our commercial recovery audit practice, which serves industries outside of retail and healthcare, in order to reduce our industry concentration. We have organized the commercial recovery audit practice into industry verticals such as oil and gas, financial services and manufacturing and are building focused practice areas with targeted service offerings for each industry.
Attract and develop highly qualified and motivated professionals with deep industry and technical skills
We are building a culture of results-oriented performance where professionals can share ideas and work together to capture, understand, and deploy the very best practices consistently across every client globally.
In line with our focus on delivering value and operating efficiently, we have identified and are executing on these near-term initiatives:
Continue our focus on consistent delivery excellence through standard processes, methodologies and tools across all of our geographic territories;
Accelerate the implementation of our global shared service delivery model centered on our regional and global shared service centers; and
Leverage state of the market technologies to drive faster processing and deeper analytics with the massive amount of data we receive from our clients. Technologies enabling large data manipulation and unstructured data analysis are evolving at a very rapid rate. We plan to remain at the forefront of these technologies and maintain the most secure and trusted infrastructure environment in our industry.


4


Technology
PRGX uses advanced, proprietary information systems and processes and a large-scale technology infrastructure to conduct its audits of clients’ payment transactions. Because of the ever-increasing volume and complexity of the transactions of our clients, we believe that our proprietary technology and processes serve as important competitive advantages over both our principal competitors and our clients’ in-house internal recovery audit functions. To sustain these competitive advantages, we continually invest in technology initiatives to deliver innovative solutions that improve both the effectiveness and efficiency of our services.
We aim our data acquisition, data processing and data management methodologies at maximizing efficiencies and productivity and maintaining the highest standards of transaction auditing accuracy. At the beginning of a typical recovery audit engagement, we use a dedicated staff of data acquisition specialists and proprietary tools to acquire a wide array of transaction data from the client for the time period under review. We typically receive this data by secured electronic transmissions, digital media or paper. For paper-based data, we use a custom, proprietary imaging technology to scan the paper into electronic format. Upon receipt of the data, we secure, catalog, back up and convert it into standard, readable formats using third party and proprietary tools.
Our technology professionals clean and map massive volumes of client data, primarily using high performance database and storage technologies, into standardized layouts at one of our data processing facilities. We also generate statistical reports to verify the completeness and accuracy of the data.
We then process the data using proprietary algorithms (business rules) leveraging over thirty years’ experience to help uncover patterns or potential problems in clients’ various transactional streams. We deliver this data with a high probability of transaction errors to our auditors who, using our proprietary audit software, sort, filter and search the data to validate and identify actual transaction errors. We also maintain a secure database of audit information with the ability to query on multiple variables, including claim categories, industry codes, vendors and audit years, to facilitate the identification of additional recovery opportunities and provide recommendations for process improvements to clients.
Once we identify and validate transaction errors, we present the information to clients for approval and submission to vendors as “claims.” We offer a proprietary web-based claim presentation and collaboration tool to help the client view, approve and submit claims to vendors.
In providing our spend analytics services, we use proprietary algorithms and technologies to clean and classify a client’s vendor spend data down to the line item level. We then are able to present this information to the client as a multi-dimensional data cube over a web-based interface. We believe these proprietary algorithms and technologies provide us with a competitive advantage over many of our competitors.
Competition
Accounts Payable Recovery Audit Services
We believe that the principal providers of domestic and international accounts payable recovery audit services in major markets worldwide consist of PRGX, two substantial competitors, and numerous other smaller competitors. The smaller recovery audit firms generally do not possess multi-country service capabilities and do not have the centralized resources or broad client base required to support the technology investments necessary to provide comprehensive recovery audit services for large, complex accounts payable systems. These smaller firms, therefore, are less equipped to audit large, data-intensive purchasing and accounts payable systems. In addition, many of these firms have limited resources and may lack the experience and knowledge of national promotions, seasonal allowances and current recovery audit practices. As a result, we believe that compared to most other firms providing accounts payable recovery audit services, PRGX has competitive advantages based on its domestic and international presence, well-trained and experienced professionals, and advanced technology.
While we believe that PRGX has the greatest depth and breadth of audit expertise, data and technology capabilities, scale and global presence in the industry, we face competition from the following:
Client Internal Recovery Audit Departments. A number of large retailers (particularly those in the discount, grocery and drug store sectors) have developed an internal recovery audit process to review transactions prior to turning them over to external recovery audit firms. Regardless of the level of recoveries made by internal recovery audit departments, we have observed that virtually all large retail clients retain at least one (primary), and frequently two (primary and secondary), external recovery audit firms to capture errors not identified by their internal recovery audit departments.
Other Accounts Payable Recovery Audit Firms. The competitive landscape in the recovery audit industry is comprised of:
Full-service accounts payable recovery audit firms. We believe that only one company other than PRGX offers a full suite of U.S. and international recovery audit services;

5


A large number of smaller accounts payable recovery firms which have a limited client base and which use less sophisticated tools to mine disbursement claim categories at low contingency rates. These firms are most common in the U.S. market. Competition in most international markets, if any, typically comes from small niche providers;
Firms, including one of our two substantial competitors, that offer a hybrid of audit software tools and training for use by internal audit departments, or general accounts payable process improvement enablers; and
Firms with specialized skills focused on recovery audit services for discrete sectors such as sales and use tax, telecom or real estate.
Other Providers of Recovery Audit Services. The major international accounting firms provide recovery audit services; however, we believe their practices tend to be primarily focused on tax-related services.
Adjacent Services
Our Adjacent Services business faces competition from regional and local consulting firms; privately and publicly held global and national firms; large, well-known ERP software vendors; procurement-specific software providers and smaller, very specialized analytics providers. These businesses generally compete on the basis of the breadth, quality and cost of the services and products provided to clients. We believe that we differentiate ourselves from our competitors through our in-depth knowledge of our clients’ purchasing processes, systems and data and our direct channel to existing accounts payable recovery audit clients.
Healthcare Claims Recovery Audit Services
A number of national and regional private payers have developed their own post-payment recovery audit capabilities. Nevertheless, these private payers typically also retain or engage one or more third party post payment audit service providers. The competitive landscape in our Healthcare Claims Recovery Audit Services business includes:
Firms that provide recovery audit services across multiple industries including healthcare;
Firms that provide healthcare IT solutions and services to both the government and private payers; and
Firms that contract with federal and state governments’ integrity programs.
Auditor Hiring, Training and Compensation
Many of our auditors and specialists formerly held finance-related management positions in the industries we serve. Training primarily is provided in the field by our experienced auditors enabling newly hired auditors to develop and refine their auditing skills and improve productivity. We also use various other training materials such as process manuals and documented policies and procedures to supplement the field training provided by our experienced auditors. We periodically upgrade our training programs based on feedback from auditors and changing industry protocols. Many of our auditors and specialists participate in one of our incentive compensation plans that link compensation of the auditor or specialist to audit performance.
Proprietary Rights
From time to time, we develop new software and methodologies that replace or enhance existing proprietary software and methodologies. We rely primarily on trade secret and copyright protection for our proprietary software and other proprietary information. We capitalize the costs incurred for the development of computer software that will be sold, leased, or otherwise marketed or that will be used in our operations beginning when technological feasibility has been established. We consider the costs associated with developing or replacing methodologies to be research and development costs and expense them as incurred. Research and development costs, including the amortization of amounts previously capitalized, were approximately $3.1 million in 2014, $6.0 million in 2013 and $4.0 million in 2012.
We own or have rights to various trademarks, trade names and copyrights, including U.S. and foreign registered trademarks and trade names and U.S. registered copyrights, that are valuable assets and important to our business. We monitor the status of our copyright and trademark registrations to maintain them in force and renew them as appropriate. The duration of our active trademark registrations varies based upon the relevant statutes in the applicable jurisdiction, but generally endure for as long as they are used. The duration of our active copyright registrations similarly varies based on the relevant statutes in the applicable jurisdiction, but generally endure for the full statutory period. Our trademarks and trade names are of significant importance and include, but are not limited to, the following: PRGX®, Discover Your Hidden Profits®, SureF!nd®, PRG-Schultz™, imDex™, Profit Discovery™, GET™; PRGX APTrax™, PRGX AuditTrax™, PRGX ClaimTrax™, PRGX MailTrax™, PRGX FraudTrax™, PRGX MerchTrax™, and PRGX SpendTrax™

6


Regulation
Various aspects of our business, including, without limitation, our data acquisition, processing and reporting protocols, are subject to extensive and frequently changing governmental regulation in both the U.S. and internationally. These regulations include extensive data protection and privacy requirements. In the U.S., we are subject to the provisions of the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) with respect to our Healthcare Claims Recovery Audit work. Internationally, we must comply with the European Data Protection Directive that various members of the European Union have implemented, as well as with data protection laws that exist in many of the other countries where we serve clients. Failure to comply with such regulations may, depending on the nature of the noncompliance, result in the termination or loss of contracts, the imposition of contractual damages, civil sanctions, damage to our reputation or in certain circumstances, criminal penalties.
Employees
As of January 31, 2015, PRGX had approximately 1,500 employees, of whom approximately 580 were in the U.S. The majority of our employees are involved in the recovery audit function.
Website
PRGX makes available free of charge on its website, www.prgx.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports. PRGX makes all filings with the Securities and Exchange Commission available on its website no later than the close of business on the date the filing was made. In addition, investors can access our filings with the Securities and Exchange Commission at www.sec.gov.
We also post certain corporate governance materials, including our Board of Directors committee charters and our Code of Conduct and Code of Ethics For Senior Financial Officers, on our website under the heading “Corporate Governance” on the “Investors” page. From time to time, we may update the corporate governance materials on our website as necessary to comply with rules issued by the SEC or NASDAQ, or as desirable to further the continued effective and efficient governance of our company.

7


ITEM 1A. Risk Factors
Revenue from our accounts payable recovery audit business generally has declined in the past several years. We must successfully execute our growth strategy in order to increase our revenue, and must lower our cost of delivery in order to maintain profitability.
Over time, our clients tend to resolve recurring transaction processing deficiencies. In addition, many of our clients have an internal staff that audits the transactions before we do. As the skills, experience and resources of our clients’ internal recovery audit staffs improve, they will identify many overpayments themselves and reduce some of our audit recovery opportunities. Based on these and other factors, including competitive rate pressures, our dependency on client approval of identified claims, and loss of clients and reduced audit scope at existing clients from time to time, without improved audit execution, rate stabilization and acquisition of new clients, we believe that our accounts payable recovery audit business will experience revenue declines and may incur losses.
We depend on our largest clients for significant revenue, so losing a major client could adversely affect our revenue and liquidity.
We generate a significant portion of our revenue from our largest clients. Our five largest clients collectively accounted for 32.2% of our annual revenue in 2014, 30.4% in 2013 and 28.2% in 2012. No client accounted for 10% or more of total revenue in 2014, 2013 or 2012. If we lose any of our major clients, our results of operations and liquidity could be materially and adversely affected.
Although we continually seek to diversify our client base, we may be unable to offset the effects of an adverse change in one of our key client relationships. For example, if our existing clients elect not to renew their contracts with us at the expiration of the current terms of those contracts, or reduce the services they purchase thereunder, our recurring revenue base will be reduced, which could have a material adverse effect on our business, financial position, results of operations, and cash flows. In addition, we could lose clients if they cancel their agreements with us, if we fail to win a competitive bid at the time of contract renewal, if the financial condition of any of our clients deteriorates or if our clients are acquired by, or acquire, companies with which we do not have contracts, any of which could materially and adversely affect our business, financial position, results of operations, and cash flows.
Our strategy may not be successful.
As discussed in Item 1 “The PRGX Strategy,” our objectives are to achieve higher profitability and growth by delivering value, operational efficiency and innovative services, differentiating our service offerings and capabilities, expanding into new industry verticals and attracting and developing highly qualified professionals. These efforts are ongoing, and the results of our efforts will not be known until sometime in the future. Successful execution of our strategy requires sustained management focus, innovation, organization and coordination over time, as well as success in building relationships with third parties. If we are unable to execute our strategy successfully, our business, financial position, results of operations and cash flows could be adversely affected. In addition, execution of our strategy will require material investments and additional costs that may not yield incremental revenue and improved financial performance as planned.
Our acquisitions, investments, partnerships and strategic alliances may require significant resources and/or result in significant unanticipated losses, costs or liabilities.
Acquisitions have contributed to our revenue. Although we cannot predict our rate of growth as the result of acquisitions with complete accuracy, we believe that additional acquisitions, investments and strategic alliances will be important to our growth strategy.
We may finance future acquisitions by issuing additional equity and/or debt. The issuance of additional equity in connection with any such transaction could be substantially dilutive to existing shareholders. The issuance of additional debt could increase our leverage substantially. In addition, announcement or implementation of future transactions by us or others could have a material effect on the price of our common stock. We could face financial risks associated with incurring additional debt, particularly if the debt results in significant incremental leverage. Additional debt may reduce our liquidity, curtail our access to financing markets, impact our standing with credit agencies and increase the cash flow required for debt service. Any incremental debt incurred to finance an acquisition could also place significant constraints on the operation of our business.
Furthermore, any future acquisitions of businesses or facilities could entail a number of additional risks, including:
problems with effective integration of acquired operations;
the inability to maintain key pre-acquisition business relationships;
increased operating costs;
the diversion of our management team from our other operations;

8


problems with regulatory agencies;
exposure to unanticipated liabilities;
difficulties in realizing projected efficiencies, synergies and cost savings; and
changes in our credit rating and financing costs.
The terms of our credit facility place restrictions on us, which create risks of default and reduce our flexibility.
Our current credit facility contains a number of affirmative, negative, and financial covenants that may limit our ability to take certain actions and require us to comply with specified financial ratios and other performance covenants. No assurance can be provided that we will not violate the covenants of our secured credit facility in the future. If we are unable to comply with our financial covenants in the future, our lenders could pursue their contractual remedies under the credit facility, including requiring the immediate repayment in full of all amounts outstanding, if any. Additionally, we cannot be certain that, if the lenders demanded immediate repayment of any amounts outstanding, we would be able to secure adequate or timely replacement financing on acceptable terms or at all.
Our ability to make payments due on debt we may have outstanding will depend upon our future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control. If the cash flow from our operating activities is insufficient to make these payments, we may take actions such as delaying or reducing capital expenditures, attempting to restructure or refinance our debt, selling assets or operations or seeking additional equity capital. Some or all of these actions may not be sufficient to allow us to service our debt obligations and we could be required to file for bankruptcy. Further, we may be unable to take any of these actions on satisfactory terms, in a timely manner or at all. In addition, our credit agreements may limit our ability to take several of these actions. Our failure to generate sufficient funds to pay our debts or to undertake any of these actions successfully could materially and adversely affect our business, financial position, results of operations and cash flows.
We have incurred and will continue to incur significant costs in connection with our Medicare, Medicaid and other healthcare claims audit recovery work.
We have expended substantial resources in connection with preparing for and providing healthcare claims recovery audit services, including those under the Medicare RAC program. We have withdrawn our bids for new Medicare RAC program contracts, but will continue to incur significant costs during the wind-down phase of our current subcontracts and expect to incur losses in providing services under these subcontracts as a result. There are complex regulations governing many healthcare payments and recoupments, including a multi-layered scheme for provider appeals of overpayment determinations under the Medicare RAC program. These regulations, the terms of the Company’s Medicare RAC subcontracts and the complexity of Medicare and other healthcare data, systems and processes, generally make it more difficult and require more time to achieve recoveries from healthcare claims recovery auditing than in other areas of our recovery audit business. Finally, to the extent that auditing under the current Medicare RAC program is extended and continues to be subject to significant audit scope restrictions, the results of our operations from participation in the program will be adversely impacted.
Our participation in the Medicare recovery audit program is as a subcontractor, and, consequently, is subject to being reduced or eliminated should our subcontracts be terminated or should the prime contractors with whom we have contracted have their prime contracts with CMS terminated.
Under the Medicare RAC program, we are participating as a subcontractor in three of the program’s four geographic regions. Accordingly, we have entered into three separate subcontracts with the prime contractors and are not directly contracting with CMS. Under these circumstances, we generally bear the risk that the prime contractors will not meet their performance obligations to CMS under the prime contract, that the prime contractors will not pay us amounts due under the subcontracts and that the prime contractors will seek to terminate our subcontracts or otherwise minimize our role in the Medicare RAC program. Furthermore, the failure of a prime contractor to perform its obligations to CMS could result in the termination of the associated contract with CMS, which would, in turn, result in the termination of our subcontract. The termination of any of these subcontracts or the failure of the prime contractors to make required payments to us could have a material adverse effect on our business, financial position, results of operations, and cash flows.
We may be unable to protect and maintain the competitive advantage of our proprietary technology and intellectual property rights.
Our operations could be materially and adversely affected if we are not able to protect our proprietary software, audit techniques and methodologies, and other proprietary intellectual property rights. We rely on a combination of trade secret and copyright laws, nondisclosure and other contractual arrangements and technical measures to protect our proprietary rights. Although we presently hold U.S. registered copyrights on certain of our proprietary technology and certain U.S. and foreign registered trademarks, we may be unable to obtain similar protection on our other intellectual property. In addition, our foreign registered trademarks may not receive the same enforcement protection as our U.S. registered trademarks.

9


Additionally, to protect our confidential and trade secret information, we generally enter into nondisclosure agreements with our employees, consultants, clients and potential clients. We also limit access to, and distribution of, our proprietary information. Nevertheless, we may be unable to deter misappropriation or unauthorized dissemination of our proprietary information, detect unauthorized use and take appropriate steps to enforce our intellectual property rights. In spite of the level of care taken to protect our intellectual property, there is no guarantee that our sensitive proprietary information will not be improperly accessed or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. Moreover, although we are not aware of any infringement of our services and products on the intellectual property rights of others, we also are subject to the risk that someone else will assert a claim against us in the future for violating their intellectual property rights.
Cyber-security incidents, including data security breaches or computer viruses, could harm our business by disrupting our delivery of services, damaging our reputation or exposing us to liability.
We receive, process, store and transmit, often electronically, the confidential data of our clients and others. Unauthorized access to our computer systems or stored data could result in the theft or improper disclosure of confidential information, the deletion or modification of records or could cause interruptions in our operations. These cyber-security risks increase when we transmit information from one location to another, including transmissions over the Internet or other electronic networks. Despite implemented security measures, our facilities, systems and procedures, and those of our third-party service providers, may be vulnerable to security breaches, acts of vandalism, software viruses, misplaced or lost data, programming and/or human errors or other similar events which may disrupt our delivery of services or expose the confidential information of our clients and others. Any security breach involving the misappropriation, loss or other unauthorized disclosure or use of confidential information of our clients or others, whether by us or a third party, could (i) subject us to civil and criminal penalties, (ii) have a negative impact on our reputation, (iii) expose us to liability to our clients, third parties or government authorities, and (iv) cause our present and potential clients to choose another service provider. Any of these developments could have a material adverse effect on our business, results of operations, financial position, and cash flows.
Operational failures in our data processing facilities could harm our business and reputation.
An interruption of data processing services, including an interruption caused by damage or destruction of facilities or a failure of data processing equipment, could result in a loss of clients, difficulties in obtaining new clients and a reduction in revenue. In addition, we also may be liable to third parties or our clients because of such interruption. These risks would increase with longer service interruptions. Despite any disaster recovery and business continuity plans and precautions we have implemented (including insurance) to protect against the effects of service delivery interruptions, such interruptions could result in a material adverse effect on our business, results of operations, financial position, and cash flows.
Our investment of substantial capital in information technology systems, and a failure to successfully implement such systems could adversely affect our business.
We have invested and continue to invest substantial amounts in the development and implementation of information technology systems. Although investments are carefully planned, there can be no assurance that such systems will justify the related investments. If we fail to realize the benefits expected from our information technology system investments, or if we fail to do so within the envisioned time frame, it could have an adverse effect on our results of operations, financial position, and cash flows.
Client and vendor bankruptcies and financial difficulties could reduce our earnings.
Our clients generally operate in intensely competitive environments and, accordingly, bankruptcy filings by our clients are not uncommon. Bankruptcy filings by our large clients or the significant vendors who supply them or unexpectedly large vendor claim chargebacks lodged against one or more of our larger clients could have a materially adverse effect on our financial condition, results of operations, and cash flows. Similarly, our inability to collect our accounts receivable due to other financial difficulties of one or more of our large clients could adversely affect our financial position, results of operations, and cash flows.
Economic conditions which adversely impact our clients and their vendors in the retail industry in the United Kingdom and Europe may continue to have a negative impact on our revenue. Specifically, client liquidity and the liquidity of client vendors can have a significant impact on claim production, the claim approval process, and the ability of clients to offset or otherwise make recoveries from their vendors.
If a client files for bankruptcy, we could be subject to an action to recover certain payments received in the 90 days prior to the bankruptcy filing known as “preference payments.” If we are unsuccessful in defending against such claims, we would be required to make unbudgeted cash payments which could strain our financial liquidity, and our earnings would be reduced.

10


Our failure to retain the services of key members of our management team and highly skilled personnel could adversely impact our operations and financial performance.
Our future success depends largely on the efforts and skills of our management team, including our executive officers and other key employees. As such, we have entered into employment agreements with key members of our management team. While these employment agreements include limits on the ability of key employees to directly compete with us in the future, nothing prevents them from leaving our company. We also do not maintain “key person” life insurance policies on any of our executive officers or other key employees. Thus, we may have to incur costs to replace such employees if we were to lose their services, and our ability to execute our business strategy could be impaired if we are unable to replace such employees in a timely manner.
In addition, it is especially challenging to attract and retain highly qualified skilled auditors and other professionals in an industry where competition for skilled personnel is intense. Accordingly, our future performance also depends, in part, on the ability of our management team to work together effectively, manage our workforce, and retain highly qualified personnel.
We rely on operations outside the U.S. for a significant portion of our revenue and are increasingly dependent on operations outside the U.S. for supporting our operations globally.
Operations outside the U.S. generated 44.3% of our annual revenue in 2014, 40.7% in 2013 and 40.4% in 2012. These international operations are subject to numerous risks, including:
greater exposure to the possibility of economic instability, the disruption of operations from labor and political disturbances, expropriation or war in the international markets we serve;
difficulties in staffing and managing foreign operations and in collecting accounts receivable;
fluctuations in currency exchange rates, particularly weaknesses in the British pound, the euro, the Canadian dollar, the Mexican peso, the Brazilian real, the Australian dollar, the Indian rupee and other currencies of countries in which we transact business, which could result in currency translations that materially reduce our revenue and earnings;
costs associated with adapting our services to our foreign clients’ needs;
unexpected changes in regulatory requirements and laws;
expenses and legal restrictions associated with transferring earnings from our foreign subsidiaries to us;
difficulties in complying with a variety of foreign laws and regulations, such as those relating to data content retention, privacy and employment as well as U.S. laws affecting operations outside of the United States;
business interruptions due to widespread disease, potential terrorist activities, or other catastrophes;
reduced or limited protection of our intellectual property rights;
longer accounts receivable cycles; and
competition with large or state-owned enterprises or regulations that effectively limit our operations and favor local competitors.
Because we expect a significant portion of our revenue to continue to come from operations outside the U.S., and expect to continue transitioning certain of our operations to locations outside the U.S., the occurrence of any of these events could materially and adversely affect our business, financial position, results of operations, and cash flows.
In 2014, our European operations accounted for 22.9% of our consolidated revenue. There have been continuing concerns and uncertainties regarding the stability of certain European economies. A continued decline in the economic conditions in Europe may materially and adversely affect our operations both in Europe and on a consolidated basis.
Furthermore, in 2010 we began transitioning certain of our core data processing and other functions to locations outside the U.S., including India, where 19% of our employees were located on December 31, 2014. While our operations in India have been key to serving clients more efficiently and cost-effectively under our improved service delivery model, India has from time to time experienced instances of civil unrest and hostilities with neighboring countries. Geopolitical conflicts, military activity, terrorist attacks, or other political uncertainties in the future could adversely affect the Indian economy by disrupting communications and making business operations and travel more difficult, which may have a material adverse effect on our ability to deliver services from India. Disruption of our Indian operations could materially and adversely affect our profitability and our ability to execute our growth strategy.

11


Our Recovery Audit, Healthcare Claims Recovery Audit and Adjacent Services businesses operate in highly competitive environments and are subject to pricing pressure.
The environment in which our business operates is highly competitive, with numerous other recovery audit firms and other service providers. In addition, many of our recovery audit clients have developed their own internal recovery audit capabilities. As a result of competition among the providers of these services and the availability of certain recovery audit services from clients’ internal audit departments, our business is subject to intense rate pressure. Our Adjacent Services business also has numerous competitors varying in size, market strength and specialization, many of whom have established and well-known franchises and brands. Intense price competition faced by all of our service lines could negatively impact our profit margins and have a potential adverse effect on our business, financial position, results of operations, and cash flows.
Our client contracts generally contain provisions under which the client may terminate our services prior to the completion of the agreement.
Many of our client contracts provide that the client may terminate the contract without cause prior to the end of the term of the agreement by providing us with relatively short prior written notice of the termination. As a result, the existence of contractual relationships with our clients is not an assurance that we will continue to provide services for our clients through the entire term of their respective agreements. If clients representing a significant portion of our revenue terminated their agreements unexpectedly, we may not, in the short-term, be able to replace the revenue and income from such contracts and this would have a material adverse effect on our business, financial condition, results of operations and cash flows. In addition, client contract terminations also could harm our reputation within the industry which could negatively impact our ability to obtain new clients.
Our charges to earnings resulting from acquisition, restructuring and integration costs may materially adversely affect the market value of our common stock.
We account for the completion of our acquisitions using the purchase method of accounting. We allocate the total estimated purchase prices to net tangible assets, amortizable intangible assets and indefinite-lived intangible assets, and based on their fair values as of the date of completion of the acquisitions, record the excess of the purchase price over those fair values as goodwill. Our financial results, including earnings per share, could be adversely affected by a number of financial adjustments required in purchase accounting including the following:
we will incur additional amortization expense over the estimated useful lives of certain of the intangible assets acquired in connection with acquisitions during such estimated useful lives;
we will incur additional depreciation expense as a result of recording purchased tangible assets; and
to the extent the value of goodwill or intangible assets becomes impaired, we may be required to incur material charges relating to the impairment of those assets.
Our failure to comply with applicable governmental privacy laws and regulations could substantially impact our business, operations, financial position, and cash flows.
We are subject to extensive and evolving federal, state and foreign privacy laws and regulations. Changes in privacy laws or regulations or new interpretations of existing laws or regulations could have a substantial effect on our operating methods and costs. Failure to comply with such regulations could result in the termination or loss of contracts, the imposition of contractual damages, civil sanctions, damage to the Company’s reputation, or in certain circumstances, criminal penalties, any of which could have a material adverse effect on our results of operations, financial position, cash flows, business and prospects. Determining compliance with such regulations is complicated by the fact that many of these laws and regulations have not been fully interpreted by governing regulatory authorities or the courts, and many of the provisions of such laws and regulations are open to a wide range of interpretations. There can be no assurance that we are or have been in compliance with all applicable existing laws and regulations or that we will be able to comply with new laws or regulations.
The ownership change that occurred as a result of our 2006 exchange offer limits our ability to use our net operating losses.
We have substantial tax loss and credit carry-forwards for U.S. federal income tax purposes. On March 17, 2006, as a result of the closing of its exchange offer, the Company experienced an ownership change as defined under Section 382 of the Internal Revenue Code (“IRC”). This ownership change resulted in an annual IRC Section 382 limitation that limits the use of certain tax attribute carry-forwards. Of the $87.6 million of U.S. federal net loss carry-forwards available to the Company, $15.2 million of the loss carry-forwards are subject to an annual usage limitation of $1.4 million. The Company has reviewed subsequent potential ownership changes as defined under IRC Section 382 and has determined that on August 4, 2008, the Company experienced an additional ownership change. This subsequent ownership change did not decrease the original limitation nor did it impact the Company’s financial position, results of operations, or cash flows. However, future ownership changes may result in additional limitations and the loss of portions of these carry-forwards and may significantly increase our projected future tax liability.

12


Certain of our tax positions may be subject to challenge by the Internal Revenue Service and other tax authorities, and if successful, these challenges could increase our future tax liabilities and expense.
For U.S. federal income tax purposes, as well as local country tax purposes in the jurisdictions where we operate, from time to time we take positions under provisions of applicable tax law that are subject to varying interpretations. Certain of our tax positions may be subject to challenge by the applicable taxing authorities, including, in the U.S., the Internal Revenue Service. If our tax positions are successfully challenged, our future tax liabilities and expense could significantly increase.
While we believe that our tax positions are proper based on applicable law and we believe that it is more likely than not that we would prevail with respect to challenges to these positions, we can make no assurances that we would prevail if our positions are challenged or that business economics would justify the mounting of a legal defense against such challenges. If our tax positions are successfully challenged by the U.S. or non-U.S. taxing authorities, it could increase our future tax liabilities and expense and have a material adverse impact on our financial position, results of operations and cash flows.
We may have exposure to additional income tax liabilities or additional costs if the U.S. government changes certain U.S. tax rules or other laws applicable to U.S. corporations doing business in foreign jurisdictions.
We are a U.S. corporation that conducts business both in the U.S. and in foreign jurisdictions. From time to time, proposals for changes to tax and other laws are made that may negatively impact U.S. corporations doing business in foreign jurisdictions, including proposals for comprehensive tax reform. While the scope of future changes remains unclear, proposed changes might include limiting the ability of U.S. corporations to deduct certain expenses attributable to offshore earnings, modifying the foreign tax credit rules and taxing currently certain transfers of intangible assets offshore or imposing other economic disincentives to doing business outside of the U.S. The enactment of some or all of these proposals could increase the Company’s effective tax rate or otherwise adversely affect our profitability.
Future impairment of goodwill, other intangible assets and long-lived assets would reduce our future earnings.
As of December 31, 2014, the Company’s goodwill and other intangible assets totaled $22.5 million. We must perform periodic assessments to determine whether some portion, or all, of our goodwill, intangible assets and other long-lived assets are impaired. We recorded an impairment charge of $4.2 million in 2013 relating to certain internally developed software assets. Future impairment testing could result in a determination that our goodwill, other intangible assets or our other long-lived assets have been impaired. Future adverse changes in the business environment or in our ability to perform audits successfully and compete effectively in our markets or the discontinuation of our use of certain of our intangible or other long-lived assets could result in impairment which could materially adversely impact future earnings.
Claims under our self-insurance program may differ from our estimates, which could materially impact our results of operations.
We use a combination of insurance and self-insurance plans to provide for the potential liabilities for healthcare benefits for our employees. We estimate the liabilities associated with the risks that we retain by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. Our results could be materially impacted by claims and other expenses related to such plans if future occurrences and claims differ from these assumptions and historical trends.
Our articles of incorporation, bylaws and Georgia law may inhibit a change of control that shareholders may favor.
Our articles of incorporation, bylaws and Georgia law contain provisions that may delay, deter or inhibit a future acquisition of PRGX that is not approved by our Board of Directors. This could occur even if our shareholders receive attractive offers for their shares or if a substantial number, or even a majority, of our shareholders believe the takeover is in their best interest. These provisions are intended to encourage any person interested in acquiring us to negotiate with and obtain the approval of our Board of Directors in connection with the transaction. Provisions that could delay, deter or inhibit a future acquisition include the following:
a classified Board of Directors;
the requirement that our shareholders may only remove directors for cause;
specified requirements for calling special meetings of shareholders;
the ability of the Board of Directors to consider the interests of various constituencies, including our employees, clients and creditors and the local community, in making decisions; and
the ability of the Board of Directors to issue shares of preferred stock with such designations, powers, preferences and rights as it determines, without any further vote or action by our shareholders.

13


Our stock price has been and may continue to be volatile.
Our common stock is currently traded on The Nasdaq Global Select Market. The trading price of our common stock has been and may continue to be subject to large fluctuations. For example, for the year ended December 31, 2014, our stock traded as high as $7.42 per share and as low as $3.97 per share. Our stock price may increase or decrease in response to a number of events and factors, including:
future announcements concerning us, key clients or competitors;
quarterly variations in operating results and liquidity;
changes in financial estimates and recommendations by securities analysts;
developments with respect to technology or litigation;
changes in applicable laws and regulations;
the operating and stock price performance of other companies that investors may deem comparable to our
company;
acquisitions and financings; and
sales and purchases of our stock by insiders.
Fluctuations in the stock market, generally, also impact the volatility of our stock price. Finally, general economic conditions and stock market movements may adversely affect the price of our common stock, regardless of our operating performance.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2. Properties
Our principal executive offices are located in approximately 58,000 square feet of office space in Atlanta, Georgia. We have subleased approximately 7,000 square feet of our principal executive office space to independent third parties. In January 2014, we amended the lease for our principal executive offices to extend the term through December 31, 2021, reduce the lease payment for 2014, and reduce the space under lease to approximately 58,000 square feet effective January 1, 2015. This space is used by our Recovery Audit Services - Americas, Healthcare Claims Recovery Audit Services and Adjacent Services segments and is the primary location of our Corporate Support personnel. Our various operating units lease numerous other parcels of operating space elsewhere in the U.S. and in the various other countries in which we currently conduct our business.
Excluding the lease for our principal executive offices, the majority of our real property leases are individually less than five years in duration. See Contractual Obligations and Other Commitments in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 of this Form 10-K and Note 6 of “Notes to Consolidated Financial Statements” included in Part II, Item 8 of this Form 10-K for a discussion of costs we may incur in the future to the extent we (i) reduce our office space capacity or (ii) commit to, or occupy, new properties in the locations in which we operate.
ITEM 3. Legal Proceedings
We are party to a variety of legal proceedings arising in the normal course of business. While the results of these proceedings cannot be predicted with certainty, management believes that the final outcome of these proceedings will not have a material adverse effect on our financial position, results of operations or cash flows.
ITEM 4. Mine Safety Disclosures
Not applicable.

14


PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded under the symbol “PRGX” on The Nasdaq Global Select Market (Nasdaq). The Company has not paid cash dividends on its common stock since it became a public company in 1996 and does not intend to pay cash dividends in the foreseeable future. Moreover, restrictive covenants included in our secured credit facility specifically prohibit payment of cash dividends. As of February 27, 2015, there were 141 holders of record of our common stock and management believes there were approximately 3,800 beneficial holders. The following table sets forth, for the quarters indicated, the range of high and low sales prices for the Company’s common stock as reported by Nasdaq during 2014 and 2013.
2014 Calendar Quarter
 
High
 
Low
1st Quarter
 
$
7.42

 
$
5.82

2nd Quarter
 
6.90

 
5.95

3rd Quarter
 
6.89

 
5.50

4th Quarter
 
6.05

 
3.97

 
 


 


2013 Calendar Quarter
 
High
 
Low
1st Quarter
 
$
7.30

 
$
5.84

2nd Quarter
 
7.01

 
4.80

3rd Quarter
 
6.73

 
5.35

4th Quarter
 
7.76

 
5.89

Issuer Purchases of Equity Securities
A summary of our repurchases of our common stock during the fourth quarter ended December 31, 2014 is set forth below.
 
2014
 
Total Number
of Shares
Purchased (a)
 
Average Price
Paid per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs (b)
 
Maximum Approximate
Dollar Value of Shares
that May Yet Be
Purchased Under the
Plans or Programs
 
 
 
 
 
 
 
 
(millions of dollars)
October 1 - October 31
 

 
$

 

 
$

November 1 - November 30
 
122,080

 
$
5.43

 
122,080

 
$

December 1 - December 31
 
365,785

 
$
5.53

 
365,785

 
$

 
 
487,865

 
$
5.50

 
487,865

 
$
17.3

 
(a)
All shares purchased during the quarter were purchased as part of the Company's stock repurchase program.
(b)
On February 21, 2014, our Board of Directors authorized a stock repurchase program under which we could repurchase up to $10.0 million of our common stock from time to time through March 31, 2015. On March 25, 2014, our Board of Directors authorized a $10.0 million increase to the stock repurchase program, bringing the total amount of its common stock that the Company could repurchase under the program to $20.0 million. On October 24, 2014, our Board of Directors authorized a $20.0 million increase to the stock repurchase program, increasing the total share repurchase program to $40.0 million, and extended the duration of the program to December 31, 2015. From the February 2014 announcement through December 31, 2014, the Company repurchased a total of 3,605,142 shares under this program for an aggregate purchase price of $22.7 million. The timing and amount of future repurchases, if any, will depend upon the Company’s stock price, the amount of the Company's available cash, regulatory requirements, and other corporate considerations. The Company may initiate, suspend or discontinue purchases under the stock repurchase program at any time.

15


Performance Graph
Set forth below is a line graph presentation comparing the cumulative shareholder return on our common stock, on an indexed basis, against cumulative total returns of The Nasdaq Composite Index and the RDG Technology Composite Index. The graph assumes that the value of the investment in the common stock in each index was $100 on December 31, 2009 and shows total return on investment for the period beginning December 31, 2009 through December 31, 2014, assuming reinvestment of any dividends. Notwithstanding anything to the contrary set forth in any of the Company’s filings under the Securities Act of 1933 or the Securities Exchange Act of 1934 that might incorporate future filings, including this Annual Report on Form 10-K, in whole or in part, the Performance Graph presented below shall not be incorporated by reference into any such filings.
Cumulative Total Return
 
 
12/09
 
12/10
 
12/11
 
12/12
 
12/13
 
12/14
PRGX Global, Inc.
 
100.00

 
107.11

 
100.68

 
109.14

 
113.71

 
96.79

NASDAQ Composite
 
100.00

 
117.61

 
118.70

 
139.00

 
196.83

 
223.74

RDG Technology Composite
 
100.00

 
111.01

 
110.85

 
126.07

 
167.16

 
193.22


16


ITEM 6. Selected Financial Data
The following table sets forth selected consolidated financial data for the Company as of and for each of the five years in the period ended December 31, 2014. The following data reflects the business acquisitions that we have completed through December 31, 2014. We have included the results of operations for these acquired businesses in our results of operations since the date of their acquisitions. We have derived this historical consolidated financial data from our Consolidated Financial Statements and Notes thereto, which have been audited by our Independent Registered Public Accounting Firm. The Consolidated Balance Sheets as of December 31, 2014 and 2013, and the related Consolidated Statements of Operations, Comprehensive Income (Loss), Shareholders’ Equity and Cash Flows for each of the years in the three-year period ended December 31, 2014 and the report of the Independent Registered Public Accounting Firm thereon are included in Item 8 of this Form 10-K.
The data presented below should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-K and other financial information appearing elsewhere in this Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Certain reclassifications have been made to the prior periods to conform to the current period presentation.
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
 
2011
 
2010
Statements of Operations Data:
 
(In thousands, except per share data)
Revenue
 
$
164,192

 
$
195,216

 
$
208,503

 
$
203,117

 
$
184,081

Operating expenses:
 
 
 
 
 
 
 
 
 
 
Cost of revenue
 
115,959

 
126,102

 
137,351

 
139,431

 
128,482

Selling, general and administrative expenses
 
40,788

 
49,200

 
49,566

 
47,153

 
38,322

Depreciation of property and equipment
 
6,216

 
8,231

 
7,084

 
5,401

 
4,903

Amortization of intangible assets
 
3,531

 
4,997

 
7,224

 
4,991

 
4,131

Impairment charges
 

 
4,207

 

 

 

Total operating expenses
 
166,494

 
192,737

 
201,225

 
196,976

 
175,838

Operating income (loss)
 
(2,302
)
 
2,479

 
7,278

 
6,141

 
8,243

Foreign currency transaction (gains) losses on short-term intercompany balances
 
2,003

 
(13
)
 
(377
)
 
417

 
422

Interest expense (income), net
 
(77
)
 
(77
)
 
966

 
1,616

 
1,305

Other (income) loss
 
57

 

 

 

 

Loss on debt extinguishment and financial restructuring
 

 

 

 

 
1,381

Income (loss) before income taxes
 
(4,285
)
 
2,569

 
6,689

 
4,108

 
5,135

Income tax expense (1)
 
3,241

 
2,755

 
1,297

 
1,292

 
1,882

Net income (loss)
 
$
(7,526
)
 
$
(186
)
 
$
5,392

 
$
2,816

 
$
3,253

Basic earnings (loss) per common share
 
$
(0.26
)
 
$
(0.01
)
 
$
0.21

 
$
0.11

 
$
0.14

Diluted earnings (loss) per common share
 
$
(0.26
)
 
$
(0.01
)
 
$
0.21

 
$
0.11

 
$
0.13



17


 
 
December 31,
 
 
2014
 
2013
 
2012
 
2011
 
2010
Balance Sheet Data:
 
(In thousands, except per share data)
Cash and cash equivalents
 
$
25,735

 
$
43,700

 
$
37,806

 
$
20,337

 
$
18,448

Working capital
 
36,006

 
50,506

 
37,445

 
16,319

 
17,678

Total assets
 
102,782

 
132,829

 
143,586

 
126,413

 
106,321

Long-term debt, excluding current installments
 

 

 
3,000

 
6,000

 
9,000

Total shareholders' equity
 
$
70,986

 
$
93,828

 
$
84,652

 
$
59,090

 
$
48,843


(1)
The taxes recorded for 2014 were primarily related to the recording of a valuation allowance on the future use of net losses in our UK operations. The high effective tax rate relative to the U.S. federal statutory rate in 2013 is due to taxes on income of foreign subsidiaries with no benefit recognized for losses incurred in the U.S. due to the Company having a deferred tax asset valuation allowance. The low effective tax rate in 2012 is attributable to recognition of certain previously unrecognized tax benefits. See Note 1 (i) and Note 7 of “Notes to Consolidated Financial Statements” included in Item 8 of this Form 10-K.

18


ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
We conduct our operations through four reportable segments: Recovery Audit Services – Americas, Recovery Audit Services – Europe/Asia-Pacific, Adjacent Services and Healthcare Claims Recovery Audit Services. The Recovery Audit Services – Americas segment represents recovery audit services (other than Healthcare Claims Recovery Audit Services) we provide in the U.S., Canada and Latin America. The Recovery Audit Services – Europe/Asia-Pacific segment represents recovery audit services we provide in Europe, Asia and the Pacific region. The Adjacent Services segment, which was formerly formerly referred to as our Profit Optimization services business, represents data transformation, data analytics and associated advisory services. The Healthcare Claims Recovery Audit Services segment represents recovery audit services that involve the identification of overpayments and underpayments made by healthcare payers to healthcare providers such as hospitals and physicians’ practices and includes services we provide as a subcontractor to three of the four prime contractors in the Medicare Recovery Audit Contractor program (the “Medicare RAC program”) of the Centers for Medicare and Medicaid Services (“CMS”). We include the unallocated portion of corporate selling, general and administrative expenses not specifically attributable to the four reportable segments in Corporate Support.
Recovery auditing is a business service focused on finding overpayments created by errors in payment transactions, such as missed or inaccurate discounts, allowances and rebates, vendor pricing errors, erroneous coding and duplicate payments. Generally, we earn our recovery audit revenue by identifying overpayments made by our clients, assisting our clients in recovering the overpayments from their vendors, and collecting a specified percentage of the recoveries from our clients as our fee. The fee percentage we earn is based on specific contracts with our clients that generally also specify: (a) time periods covered by the audit; (b) the nature and extent of services we are to provide; and (c) the client’s responsibilities to assist and cooperate with us. Clients generally recover claims by either taking credits against outstanding payables or future purchases from the relevant vendors, or receiving refund checks directly from those vendors. The manner in which a claim is recovered by a client is often dictated by industry practice. In addition, many clients establish client-specific procedural guidelines that we must satisfy prior to submitting claims for client approval. Our recovery audit business also includes contract compliance services which focus on auditing supplier billings against large and complex services, construction and licensing contracts. Such services include verification of the accuracy of third party reporting, appropriateness of allocations and other charges in cost or revenue sharing types of arrangements, adherence to contract covenants and other risk mitigation requirements and numerous other reviews and procedures to assist our clients with proper monitoring and enforcement of the obligations of their contractors. For some services we provide, such as certain of our services in our Adjacent Services segment, we earn our compensation in the form of a fixed fee, a fee per hour, or a fee per other unit of service.
We earn the vast majority of our recovery audit revenue from clients in the retail industry due to many factors, including the high volume of transactions and the complicated pricing and allowance programs typical in this industry. Changes in consumer spending associated with economic fluctuations generally impact our recovery audit revenue to a lesser degree than they affect individual retailers due to several factors, including:
Diverse client base – our clients include a diverse mix of discounters, grocery, pharmacy, department and other stores that tend to be impacted to varying degrees by general economic fluctuations, and even in opposite directions from each other depending on their position in the market and their market segment;
Motivation – when our clients experience a downturn, they frequently are more motivated to use our services to recover prior overpayments to make up for relatively weaker financial performance in their own business operations;
Nature of claims – the relationship between the dollar amount of recovery audit claims identified and client purchases is non-linear. Claim volumes are generally impacted by purchase volumes, but a number of other factors may have an even more significant impact on claim volumes, including new items being purchased, changes in discount, rebate, marketing allowance and similar programs offered by vendors and changes in a client’s or a vendor’s information processing systems; and
Timing – the client purchase data on which we perform our recovery audit services is historical data that typically reflects transactions between our clients and their vendors that took place 3 to 15 months prior to the data being provided to us for audit. As a result, we generally experience a delayed impact from economic changes that varies by client and the impact may be positive or negative depending on the individual clients’ circumstances.
While the net impact of the economic environment on our recovery audit revenue is difficult to determine or predict, we believe that for the foreseeable future, our revenue will remain at a level that will not have a significant adverse impact on our liquidity, and we have taken steps to mitigate the adverse impact of an economic downturn on our revenue and overall financial health. These steps include devoting substantial efforts to develop an improved service delivery model to enable us to more cost effectively serve our clients. Further, we continue to pursue our ongoing growth strategy to expand our business beyond our core recover

19


y audit services to retailers by growing the portion of our business that provides recovery audit services to enterprises other than retailers, such as our offerings to commercial clients; contract compliance service offerings; expansion into new industry verticals, such as oil and gas; and growth within our Adjacent Services segment.
Our Adjacent Services business targets client functional and process areas where we have established expertise, enabling us to provide services to finance and procurement executives to improve working capital, optimize purchasing leverage in vendor pricing negotiations, improve insight into product margin and true cost of goods for resale, identify and manage risks associated with vendor compliance, improve quality of vendor master data and improve visibility and diagnostics of direct and indirect spend. Our Adjacent Services also include the CIPS Sustainability Index, an Internet-based supplier sustainability assessment offered in the UK through our strategic alliance with the Chartered Institute of Purchasing & Supply (“CIPS”). As our clients’ data volumes and complexity levels continue to grow, we are using our deep data management experience to develop new actionable insight solutions, as well as to develop custom analytics and data transformation services. Taken together, our deep understanding of our clients’ procure-to-pay data and our technology-based solutions provide multiple routes to help our clients achieve greater profitability
During 2013, auditing under our current Medicare RAC program subcontracts became subject to significant additional restrictions imposed by CMS on all Medicare recovery auditors, including deadlines for requesting medical records from providers and submitting claims and the types of claims that may be audited. These restrictions began to limit our Medicare RAC program revenue in the third quarter of 2013 and had a significant negative impact on our fourth quarter 2013 and annual 2014 Medicare RAC program revenue. We expect our Medicare RAC program revenue to be minimal during 2015. For a number of reasons, including the significant uncertainties and financial risks inherent in the Medicare RAC program, we withdrew from the Medicare RAC program rebid process in February 2014. We have incurred losses since these additional restrictions were imposed, and expect to continue to incur losses for the remainder of the contract term. We expect to continue auditing claims under the existing contracts and to continue collection and appeal defense efforts through the end of 2015. We have adjusted our cost structure to reflect the lower claim volumes we currently are generating, and will continue to lower costs in order to minimize our losses during the wind-down of these contracts while maintaining adequate resources to enable us to continue to meet our contractual obligations.
Non-GAAP Financial Measures
EBIT, EBITDA and Adjusted EBITDA are all “non-GAAP financial measures” presented as supplemental measures of the Company’s performance. They are not presented in accordance with accounting principles generally accepted in the United States, or GAAP. The Company believes these measures provide additional meaningful information in evaluating its performance over time, and that the rating agencies and a number of lenders use EBITDA and similar measures for similar purposes. In addition, a measure similar to Adjusted EBITDA is used in the restrictive covenants contained in the Company’s secured credit facility. However, EBIT, EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as substitutes for analysis of the Company’s results as reported under GAAP. In addition, in evaluating EBIT, EBITDA and Adjusted EBITDA, you should be aware that, as described above, the adjustments may vary from period to period and in the future the Company will incur expenses such as those used in calculating these measures. The Company’s presentation of these measures should not be construed as an inference that future results will be unaffected by unusual or nonrecurring items.

20


Results of Operations
The following table sets forth the percentage of revenue represented by certain items in our Consolidated Statements of Operations for the periods indicated: 
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Revenue
 
100.0
 %
 
100.0
 %
 
100.0
 %
Operating expenses:
 
 
 
 
 
 
Cost of revenue
 
70.6

 
64.6

 
65.9

Selling, general and administrative expenses
 
24.8

 
25.2

 
23.8

Depreciation of property and equipment
 
3.8

 
4.2

 
3.4

Amortization of intangible assets
 
2.2

 
2.6

 
3.4

Impairment charges
 

 
2.1

 

Total operating expenses
 
101.4

 
98.7

 
96.5

Operating income (loss)
 
(1.4
)
 
1.3

 
3.5

 
 
 
 
 
 
 
Foreign currency transaction (gains) losses on short-term intercompany balances
 
1.2

 

 
(0.2
)
Interest expense, net
 

 

 
0.5

Income (loss) before income taxes
 
(2.6
)
 
1.3

 
3.2

Income tax expense
 
2.0

 
1.4

 
0.6

 
 
 
 
 
 
 
Net income (loss)
 
(4.6
)%
 
(0.1
)%
 
2.6
 %

Year Ended December 31, 2014 Compared to Prior Years
Revenue. Revenue was as follows (in thousands): 
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$
106,533

 
$
118,649

 
$
121,638

Recovery Audit Services – Europe/Asia-Pacific
 
44,319

 
46,436

 
53,783

Adjacent Services
 
10,700

 
13,183

 
14,990

Healthcare Claims Recovery Audit Services
 
2,640

 
16,948

 
18,092

Total
 
$
164,192

 
$
195,216

 
$
208,503

Total revenue decreased by $31.0 million, or 15.9%, in 2014, and decreased $13.3 million, or 6.4%, in 2013. Below is a discussion of our revenue for our four reportable segments.
Recovery Audit Services – Americas revenue decreased by 10.2% in 2014 and decreased by 2.5% in 2013. We experience changes in our reported revenue based on the strength of the U.S. dollar relative to foreign currencies. Changes in the value of the U.S. dollar relative to currencies in Canada and Latin America negatively impacted reported revenue in both 2014 and 2013. On a constant dollar basis, adjusted for changes in foreign exchange (“FX”) rates, 2014 revenue decreased by 8.6% compared to a decrease of 10.2% as reported, and 2013 revenue decreased by 1.4% compared to a decrease of 2.5% as reported.
The changes in our Recovery Audit Services – Americas revenue in 2014 and 2013 were due to a number of factors in addition to changes in FX rates. Revenue increased 2.7% in 2014 and 1.6% in 2013 due to revenue from new clients. Revenue from existing clients decreased 12.9% in 2014 and 4.2% in 2013. The revenue decreases in both 2014 and 2013 is due primarily to lower revenue from a significant retail client that has increased its internal resources and is identifying more claims itself, scope restrictions at another significant client, and lower contingency fee rates at a few clients.
Recovery Audit Services – Europe/Asia-Pacific revenue decreased by 4.6% in 2014 and decreased by 13.7% in 2013. The changes in the strength of the U.S. dollar relative to foreign currencies in Europe, Asia and the Pacific region positively

21


impacted reported revenue in 2014, but negatively impacted reported revenue in 2013. On a constant dollar basis, adjusted for changes in FX rates, 2014 revenue decreased by 5.3% compared to a decrease of 4.6% as reported, and 2013 revenue decreased by 13.1% compared to a decrease of 13.7% as reported. Revenue increased 3.5% in 2014 and 6.6% in 2013 due to new clients and new geographic territories for existing clients. Revenue from existing clients decreased 7.9% in 2014 and decreased 8.3% in 2013. The 2014 revenue decrease is due primarily to lower revenue from various retail clients in Europe as a result of scope restrictions and lower contingency fee rates at a few clients, partially offset by an increase in revenue in the Pacific region. The 2013 decrease resulted primarily from several clients that entered administration (similar to bankruptcy) in late 2012 for which we generated much lower revenue in 2013, the loss of an audit in one geographic territory for a significant client, and a decrease in scope at another significant client.
Adjacent Services revenue decreased by 18.8% in 2014 and decreased by 12.1% in 2013. The decrease in Adjacent Services revenue in 2014 compared to 2013 is primarily due to a weak backlog of projects at the beginning of 2014 compared to 2013 as well as our strategic decision to wind-down certain service offerings and refocus on other growth opportunities in this segment that are more closely aligned with the recovery audit business. We continue to rationalize and refine the remaining service offerings in this segment to ensure that they are aligned with the Company's long-term strategic growth plan. As part of the rationalization of our Adjacent Services offerings, on October 1, 2014 we sold our Chicago, Illinois-based consulting practice.
Healthcare Claims Recovery Audit Services revenue decreased by 84.4% and 6.3% in 2014 and 2013, respectively. Our Healthcare Claims Recovery Audit Services business continued to grow until late in the third quarter of 2013, when additional restrictions imposed on all Medicare RAC program auditors severely impacted our revenue and caused a decline in revenue for both 2013 and 2014. As disclosed previously, we withdrew from the Medicare RAC program rebid process during 2014. Given the restricted scope of auditing under the Medicare RAC program, we believe that 2015 revenue will be consistent with or lower than 2014 revenue.
Cost of Revenue (“COR”). COR consists principally of commissions and other forms of variable compensation we pay to our auditors based primarily on the level of overpayment recoveries and/or profit margins derived therefrom, fixed auditor salaries, compensation paid to various types of hourly support staff and salaries for operational and client service managers for our recovery audit services and our Adjacent Services businesses. COR also includes other direct and indirect costs incurred by these personnel, including office rent, travel and entertainment, telephone, utilities, maintenance and supplies and clerical assistance. A significant portion of the components comprising COR is variable and will increase or decrease with increases or decreases in revenue.
COR was as follows (in thousands): 
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$
68,163

 
$
65,977

 
$
69,341

Recovery Audit Services – Europe/Asia-Pacific
 
31,103

 
34,945

 
39,540

Adjacent Services
 
11,624

 
11,931

 
14,277

Healthcare Claims Recovery Audit Services
 
5,069

 
13,249

 
14,193

Total
 
$
115,959

 
$
126,102

 
$
137,351

COR as a percentage of revenue for Recovery Audit Services – Americas was 64.0% in 2014, 55.6% in 2013 and 57.0% in 2012. We are investing in our various growth and other strategic initiatives, and include portions of these costs in Recovery Audit Services – Americas COR each year. The increase in COR expenses as a percentage of revenue for 2014 compared to 2013 is due to costs not decreasing in proportion to decreases in revenue, and the cost of personnel we added to extend our service offerings into new areas, such as contract compliance, and to expand into new industry verticals, such as oil and gas. In addition, there was in increase of $0.8 million in transformation expenses in 2014 compared to 2013. These transformation expenses were generated mainly in the fourth quarter of 2014. The improvement of COR expenses as a percentage of revenue for 2013 compared to 2012 is mainly due to efficiencies gained through strategic initiatives and cost reductions implemented in 2013.
COR as a percentage of revenue for Recovery Audit Services – Europe/Asia-Pacific was 70.2% in 2014, 75.3% in 2013 and 73.5% in 2012. COR decreased 11.0% in 2014 compared to 2013 and 11.6% in 2013 compared to 2012. The 2014 and 2013 decreases are due mainly to cost reductions, primarily compensation-related, in our European operations as we continued to implement service delivery model changes in the geographic region. For 2013 and 2012, the auditors in this segment generally earned fixed salaries with only a small amount of variable compensation, primarily bonuses. As their pay had only a limit

22


ed dependency on revenue generated, the decrease in revenue in the segment had a greater negative impact on COR as a percentage of revenue than would have occurred under a more variable compensation plan, such as the commission-based pay plan we generally utilize in the U.S. and Canada. Beginning in the fourth quarter of 2013, we migrated many of our auditors in this segment to a commission-based pay plan, and migrated others in 2014. These changes, along with our continuing efforts to increase revenue and centralize and standardize the recovery audit processes in this segment enabled us to lower our COR as a percentage of revenue in this segment in 2014.
The higher COR as a percentage of revenue for Recovery Audit Services – Europe/Asia-Pacific (70.2% for 2014) compared to Recovery Audit Services – Americas (64.0% for 2014) is due primarily to differences in service delivery models, scale and geographic fragmentation. The Recovery Audit Services – Europe/Asia-Pacific segment generally serves fewer clients in each geographic market and generates lower average revenue per client than those served by the Recovery Audit Services – Americas segment.
Adjacent Services COR relates primarily to costs of our service delivery, which consist mainly of fixed personnel costs. Due to the nature of these costs and the reduced Adjacent Services revenues, COR as a percentage of revenue increased to 108.6% in 2014 from 90.5% in 2013, which in turn increased from 78.9% in 2012.
COR for Healthcare Claims Recovery Audit Services declined by 61.7% in 2014 from 2013 due mainly to personnel reductions. These staff reductions were not sufficient to enable us to maintain revenue in excess of COR for our services under the Medicare RAC program, resulting in COR exceeding revenue in 2014. We anticipate that these expenses will continue to exceed revenue in 2015.
Selling, General and Administrative Expenses (“SG&A”). SG&A expenses for all segments other than Corporate Support include the expenses of sales and marketing activities, information technology services and allocated corporate data center costs, human resources, legal, accounting, administration, foreign currency transaction gains and losses other than those relating to short-term intercompany balances and gains and losses on asset disposals. Corporate Support SG&A represents the unallocated portion of SG&A expenses which are not specifically attributable to our segment activities and include the expenses of information technology services, the corporate data center, human resources, legal, accounting, treasury, administration and stock-based compensation charges.
SG&A expenses were as follows (in thousands):
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$
10,211

 
$
14,140

 
$
14,746

Recovery Audit Services – Europe/Asia-Pacific
 
6,829

 
5,884

 
7,155

Adjacent Services
 
2,124

 
3,312

 
2,532

Healthcare Claims Recovery Audit Services
 
2,207

 
3,057

 
2,965

Subtotal for reportable segments
 
21,371

 
26,393

 
27,398

Corporate Support
 
19,417

 
22,807

 
22,168

Total
 
$
40,788

 
$
49,200

 
$
49,566

Recovery Audit Services – Americas SG&A decreased 27.8% in 2014 compared to 2013 and decreased 4.1% in 2013 compared to 2012. The decrease in 2014 is due to lower personnel costs and contingent consideration recorded in 2013 for the Business Strategy, Inc. acquisition that did not reoccur during 2014. The decrease in 2013 is due to lower incentive-compensation accruals and lower legal expenses as 2012 included expenses for an overtime wages claim, partially offset by higher sales commissions and incremental contingent consideration relating to our December 2011 acquisition of Business Strategy, Inc. ("BSI").
Recovery Audit Services – Europe/Asia-Pacific SG&A increased 16.1% in 2014 compared to 2013 after decreasing 17.8% in 2013 compared to 2012. The 2014 increase resulted primarily from increased transformation costs in 2014, the reversal of bad debt provisions in 2013 and fair value adjustments recorded in 2013 to reduce the acquisition-related contingent consideration for a prior year business acquisition. The 2013 decrease resulted primarily from the reversal of provisions for bad debts recorded in 2012 due to our collecting the past due accounts and a reduction in a business acquisition obligation resulting from decreased revenue and profitability generated by the acquired business.
Adjacent Services SG&A decreased 35.9% in 2014 compared to 2013 after increasing 30.8% in 2013 compared to 2012. The 2014 decrease resulted primarily from personnel reductions that were made in response to the decline in revenue and the strate

23


gic decision to dispose of our Chicago, Illinois-based consulting business during the fourth quarter of 2014. The increase in 2013 primarily resulted from additional personnel and related costs we incurred in our efforts to generate additional revenue in this segment.
Healthcare Claims Recovery Audit Services SG&A decreased 27.8% in 2014 compared to 2013 after increasing 3.1% in 2013 compared to 2012. The 2014 decrease resulted primarily from personnel reductions that were made in response to the decline in revenue that resulted from the restrictions placed on all Medicare RAC program auditors by CMS. The increase in 2013 primarily resulted from additional personnel and related costs we incurred in our efforts to generate additional revenue in this segment.
Corporate Support SG&A includes stock-based compensation charges of $4.5 million in 2014 and $6.3 million in both 2013 and 2012. Excluding stock-based compensation charges, Corporate Support SG&A decreased 9.9% in 2014 compared to 2013 after increasing 4.2% in 2013 from 2012. The decrease in 2014 relates primarily to severance costs recorded in 2013 that were associated with the departure of the Company's former President and CEO. The increase in 2013 compared to 2012 relates primarily to the severance costs associated with the departure of the Company’s former President and CEO, partially offset by lower incentive compensation accruals.
Depreciation of Property and Equipment. Depreciation of property and equipment was as follows (in thousands):
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$
4,711

 
$
5,617

 
$
4,651

Recovery Audit Services – Europe/Asia-Pacific
 
592

 
514

 
322

Adjacent Services
 
722

 
723

 
770

Healthcare Claims Recovery Audit Services
 
191

 
1,377

 
1,341

Total
 
$
6,216


$
8,231

 
$
7,084

Depreciation expense declined in 2014 compared to 2013 primarily as a result of the impairment charges recorded in the fourth quarter of 2013, which reduced the future depreciation to be recorded. The increase in depreciation in 2013 compared to 2012 relates primarily to improvements we made to our information technology infrastructure and to an increase in the depreciation of capitalized software development costs during 2013.
Amortization of Intangible Assets. Amortization of intangible assets was as follows (in thousands): 
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$
2,002

 
$
2,792

 
$
4,355

Recovery Audit Services – Europe/Asia-Pacific
 
1,195

 
1,508

 
2,062

Adjacent Services
 
334

 
697

 
807

Healthcare Claims Recovery Audit Services
 

 

 

Total
 
$
3,531

 
$
4,997

 
$
7,224

Generally, we amortize the customer relationship and trademark intangible assets we record in connection with an acquisition on an accelerated basis over six years or longer, and we amortize non-compete agreements and trade names on a straight-line basis over five years or less. This methodology results in higher amortization immediately following an acquisition, and declining expense in subsequent periods. Our most recent acquisitions include BSI in Recovery Audit Services – Americas in December 2011, the associate migrations in Recovery Audit Services – Europe / Asia-Pacific in 2011 and 2012, and Etesius Limited and TJG Holdings LLC in Adjacent Services in 2010. Amortization expense declined in our recovery audit segments in both 2014 and 2013 compared to the prior year as we did not complete an acquisition in either year. Similarly, Adjacent Services amortization declined in both 2014 and 2013 compared to the prior year as we have not completed an acquisition in this segment since 2010. We have not recorded any amortization of intangible assets in our Healthcare Claims Recovery Audit Services segment because there have been no business acquisitions in this segment. We anticipate that, absent our completing additional acquisitions in any of our reportable segments in 2015, amortization expense will continue to decrease in 2015.

24


Impairment Charges. Impairment charges were as follows (in thousands):
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$

 
$
2,702

 
$

Recovery Audit Services – Europe/Asia-Pacific
 

 

 

Adjacent Services
 

 
71

 

Healthcare Claims Recovery Audit Services
 

 
1,434

 

Total
 
$

 
$
4,207

 
$


The impairment charges in the Recovery Audit Services - Americas segment in 2013 relate to certain capitalized software development costs associated with our improved service delivery model. Much of the development efforts in this area were beneficial, but certain aspects of the development did not yield the benefits anticipated. We continue to develop this service delivery model, but have changed our focus in certain areas and no longer expect to receive future economic benefit from certain costs and recorded an impairment charge in the fourth quarter of 2013.

The impairment charges in the Healthcare Claims Recovery Audit Services segment in 2013 relate primarily to the capitalized software development costs for the systems we use to deliver our services under the Medicare RAC program. With our decision to withdraw our bids for a new contract under this program, we no longer anticipate generating meaningful revenue in this area and recorded an impairment charge in the fourth quarter of 2013.
Foreign Currency Transaction (Gains) Losses on Short-Term Intercompany Balances. Foreign currency transaction gains and losses on short-term intercompany balances result from fluctuations in the exchange rates between foreign currencies and the U.S. dollar and the impact of these fluctuations, primarily on balances payable by our foreign subsidiaries to their U.S. parent. Substantial changes from period to period in foreign currency exchange rates may significantly impact the amount of such gains and losses. The strengthening of the U.S. dollar relative to other currencies results in recorded losses on short-term intercompany balances receivable from our foreign subsidiaries while the relative weakening of the U.S. dollar results in recorded gains.
The U.S. dollar generally strengthened relative to the local currencies of certain of our foreign subsidiaries in 2014 resulting in our recording net foreign currency losses on short-term intercompany balances of $2.0 million. We recorded gains on short-term intercompany balances of less than $0.1 million in 2013 and $0.4 million in 2012.
Net Interest Expense (Income). Net interest income was $0.1 million in 2014 and 2013 due to interest accruals on uncertain tax positions. Net interest expense was $1.0 million in 2012. The net interest expense in 2012 was due primarily to interest expense associated with business acquisition obligations and borrowings outstanding under our credit facility which was partially offset by net reversals of $0.8 million of interest on accruals made in previous years for interest on uncertain tax positions as described in more detail under Income Tax Expense below.
Income Tax Expense. Our reported effective tax rates on earnings approximated (75.6%) in 2014, 107.2% in 2013 and 19.4% in 2012. Reported income tax expense in each year primarily results from taxes on the income of foreign subsidiaries. We have recorded a deferred tax asset valuation allowance that effectively eliminates income tax expense or benefit relating to our U.S. operations. The tax rate for 2014 reflects the impact of the recording of a valuation allowance against certain deferred tax assets in the United Kingdom. The high effective tax rate in 2013 is due to the Company's U.S. operations incurring a loss due in part to the impairment charges noted above, while certain foreign subsidiaries generated greater taxable income in 2013. Income tax expense reflects the net reversal of $0.5 million in each of 2013 and 2012 of the accruals made in previous years for uncertain tax positions.
Together with the reversal of interest expense accruals described above, the total net reduction to our reserves for uncertain tax positions based on changes in accruals was $1.4 million in 2013 and $1.2 million in 2012. These reserves decreased in 2013 by an additional $1.3 million due to payments we made to various taxing authorities. We initially established these reserves based on estimates we made in prior years of the potential liability we may incur should certain domestic and foreign tax jurisdictions perform audits of our books and records and determine that we owe additional taxes, for which they may also assess penalty and interest amounts. We increased the reserves for additional estimated interest in subsequent years to reflect the additional time from when the estimated potential taxes may have been due. In 2012, we adjusted our estimates for several reasons, including the expiration of the statute of limitations for certain of these taxes in several states and in two foreign jurisdictions, completion of an audit by a foreign jurisdiction that resulted in a lower tax assessment than we had estimated, and the imposition of limitations on our potential liability resulting from our beginning the voluntary disclosure

25


agreement process with one state. In 2013, we further adjusted our estimates based primarily on completing voluntary disclosure processes with additional states. Under these voluntary disclosure agreements, we agreed to file required returns for specified periods, and received waivers of the requirement to file other returns as well as limitations on the taxes and other amounts required to be paid in connection with such filings.
As of the end of the past three years, management determined that based on all available evidence, deferred tax asset valuation allowances of $52.0 million in 2014 and $48.5 million in both 2013 and 2012 were appropriate. We recorded an increase in the valuation allowance of $2.3 million in 2014 as a result of placing a valuation allowance against deferred tax assets in the United Kingdom. We expensed or impaired a significant amount of acquisition-related intangible assets in previous years for financial reporting purposes. For income tax reporting purposes, we continue to deduct the amortization of these intangible assets over their tax lives, generally 15 years. The excess of tax amortization over amortization for financial reporting purposes is reducing the related deferred tax asset each year, resulting in lower deferred tax assets and a lower related valuation allowance, although increases in our net operating losses have partially offset this impact in recent years. This reduction in deferred tax assets related to intangible assets was $0.9 million in 2014, $5.3 million in 2013 and $5.7 million in 2012.
As of December 31, 2014, we had approximately $87.6 million of U.S. federal loss carry-forwards available to reduce future U.S. federal taxable income. The U.S. federal loss carry-forwards expire through 2033. As of December 31, 2014, we had approximately $92.1 million of state loss carry-forwards available to reduce future state taxable income. The state loss carry-forwards expire to varying degrees between 2019 and 2033 and are subject to certain limitations.
On March 17, 2006, the Company experienced an ownership change as defined under Section 382 of the Internal Revenue Code (“IRC”). This ownership change resulted in an annual IRC Section 382 limitation that limits the use of certain tax attribute carry-forwards and also resulted in the write-off of certain deferred tax assets and the related valuation allowances that the Company recorded in 2006. Of the $87.6 million of U.S. federal loss carry-forwards available to the Company, $15.2 million of the loss carry-forwards are subject to an annual usage limitation of $1.4 million. The Company has reviewed subsequent potential ownership changes as defined under Section 382 and has determined that on August 4, 2008, the Company experienced an additional ownership change. This subsequent ownership change did not decrease the original limitation nor did it impact the Company’s financial position, results of operations, or cash flows.
Adjusted EBITDA. We evaluate the performance of our operating segments based upon revenue and measures of profit or loss we refer to as EBITDA and Adjusted EBITDA. We define Adjusted EBITDA as earnings from continuing operations before interest and taxes (“EBIT”), adjusted for depreciation and amortization (“EBITDA”), and then adjusted for unusual and other significant items that management views as distorting the operating results of the various segments from period to period. Such adjustments include restructuring charges, stock-based compensation, bargain purchase gains, acquisition-related charges and benefits (acquisition transaction costs, acquisition obligations classified as compensation, and fair value adjustments to acquisition-related contingent consideration), tangible and intangible asset impairment charges, certain litigation costs and litigation settlements, severance charges and foreign currency transaction gains and losses on short-term intercompany balances viewed by management as individually or collectively significant.

26


Reconciliations of net income (loss) to each of EBIT, EBITDA and Adjusted EBITDA for the periods included in this report are as follows (in thousands):
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Net income (loss)
 
$
(7,526
)
 
$
(186
)
 
$
5,392

Income tax expense
 
3,241

 
2,755

 
1,297

Interest expense (income), net
 
(77
)
 
(77
)
 
966

EBIT
 
(4,362
)
 
2,492

 
7,655

Depreciation of property and equipment
 
6,216

 
8,231

 
7,084

Amortization of intangible assets
 
3,531

 
4,997

 
7,224

EBITDA
 
5,385

 
15,720

 
21,963

Impairment charges
 

 
4,207

 

Foreign currency transaction (gains) losses on short-term intercompany balances
 
2,003

 
(13
)
 
(377
)
Acquisition-related charges (benefits)
 
249

 
602

 
(231
)
Transformation severance and related expenses
 
4,050

 
2,544

 
2,107

Other (income) loss
 
57

 

 

Wage claim costs
 

 

 
984

Stock-based compensation
 
4,532

 
6,294

 
6,321

Adjusted EBITDA
 
$
16,276

 
$
29,354

 
$
30,767

Acquisition-related charges (benefits) included: acquisition obligations classified as compensation of $0.2 million in both 2014 and 2013, and $0.4 million in 2012; and fair value adjustments to acquisition-related contingent consideration of $0.4 million in 2013 and $(0.6) million in 2012. We made the final payments for the related acquisitions in the third quarter of 2014.
Transformation severance and related expenses increased $1.5 million, or 59.2%, in 2014 compared to 2013 due to severance and related costs associated with reductions in staff and lease expense across all segments in order to reduce our cost structure. Transformation severance and related expenses increased $0.4 million, or 20.7%, in 2013 compared to 2012 due to costs associated with the departure of the Company's former President and CEO.
Wage claim costs in 2012 relate to specific legal issues that were resolved in 2012. We did not incur any similar costs in 2014 or 2013.
Stock-based compensation decreased by $1.8 million, or 28.0%, in 2014 compared to 2013 and decreased less than $0.1 million, or 0.4%, in 2013 compared to 2012. The reduced expenses in 2014 compared to 2013 were due primarily to the acceleration of vesting of outstanding awards for certain executives in connection with their separation from the Company in the prior periods as well as the relatively lower fair value of options and stock awards granted as part of the annual equity grant to employees in 2014.
We include a detailed calculation of Adjusted EBITDA by segment in Note 2 of “Notes to Consolidated Financial Statements” included in Item 8 of this Form 10-K. A summary of Adjusted EBITDA by segment for the years ended December 31, 2014, 2013, and 2012 was as follows (in thousands):
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Recovery Audit Services – Americas
 
$
29,507

 
$
39,954

 
$
38,620

Recovery Audit Services – Europe/Asia-Pacific
 
7,672

 
5,842

 
7,632

Adjacent Services
 
(2,381
)
 
(1,792
)
 
(1,072
)
Healthcare Claims Recovery Audit Services
 
(4,226
)
 
729

 
1,370

Subtotal for reportable segments
 
30,572

 
44,733

 
46,550

Corporate Support
 
(14,296
)
 
(15,379
)
 
(15,783
)
Total
 
$
16,276

 
$
29,354

 
$
30,767


27


Recovery Audit Services – Americas Adjusted EBITDA decreased by $10.4 million, or 26.1%, in 2014 compared to 2013 and increased $1.3 million, or 3.5%, in 2013 compared to 2012. The 2014 decrease resulted from reductions in revenue that exceeded the reductions in COR and SG&A expenses for the year. The 2013 increase resulted from reductions in COR and SG&A expenses that exceeded the decrease in revenue for the year.
Recovery Audit Services – Europe/Asia-Pacific Adjusted EBITDA increased by $1.8 million, or 31.3%, in 2014 compared to 2013 and decreased $1.8 million, or 23.5%, in 2013 compared to 2012. The increase in 2014 is due to reductions in COR and SG&A that exceeded the revenue reductions for the year. The decrease in 2013 is due to lower revenue partially offset by lower COR and SG&A expenses.
Adjacent Services Adjusted EBITDA declined 32.8% to a loss of $(2.4) million in 2014 compared to 2013, and declined 67.2% to a loss of $(1.8) million in 2013 compared to 2012. These declines are due to revenue in each period declining at a faster rate than COR and SG&A expenses.
Healthcare Claims Recovery Audit Services Adjusted EBITDA was a loss of $(4.2) million for 2014 and a profit of $0.7 million for 2013. The profit generated in 2013 was 46.8% less than the prior year due to revenue declines that exceeded our cost reductions. The loss generated in 2014 was due to the costs required to continue fulfillment of obligations for contracts associated with the Medicare RAC program and the reduced levels of revenue generated by that business. As the existing Medicare RAC program is winding down, we anticipate generating additional Adjusted EBITDA losses in this segment in 2015.
Corporate Support Adjusted EBITDA improved by $1.1 million, or 7.0%, in 2014 compared to 2013 and improved by $0.4 million, or 2.6%, in 2013 compared to 2012. The improvement in 2014 is due mainly to a reduction in transformation-related expense. The improvement in 2013 is due primarily to lower incentive compensation accruals, partially offset by higher non-incentive payroll expenses.
Liquidity and Capital Resources
As of December 31, 2014, we had $25.7 million in cash and cash equivalents and no borrowings under the revolver portion of our credit facility. As of December 31, 2014, the revolver had $20.0 million of availability for borrowings and the Company was in compliance with the covenants in its SunTrust credit facility. We amended the SunTrust credit facility in January 2014 and again in December 2014 as further described in Secured Credit Facility below.
The $25.7 million in cash and cash equivalents includes $10.2 million held in the U.S., $4.9 million held in Canada, and $10.6 million held in other foreign jurisdictions, primarily in the United Kingdom, Australia, India, and Brazil. Certain foreign jurisdictions restrict the amount of cash that can be transferred to the U.S. or impose taxes and penalties on such transfers of cash. To the extent we have excess cash in foreign locations that could be used in, or is needed by, our operations in the U.S., we may incur significant penalties and/or taxes to repatriate these funds. Generally, we have not provided deferred taxes on the undistributed earnings of international subsidiaries as we consider these earnings to be permanently reinvested. However, we do not consider the earnings of our Canadian subsidiary to be permanently invested, and have provided deferred taxes relating to the potential repatriation of the funds held in Canada.
Operating Activities. Net cash provided by operating activities was $10.0 million in 2014, $18.4 million in 2013 and $18.8 million in 2012. These amounts consist of two components, specifically, net income (loss) adjusted for certain non-cash items (such as depreciation, amortization, stock-based compensation expense, impairment charges, and deferred income taxes) and changes in assets and liabilities, primarily working capital, as follows (in thousands):
 
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Net income (loss)
 
$
(7,526
)
 
$
(186
)
 
$
5,392

Adjustments for certain non-cash items
 
18,009

 
23,886

 
19,667

 
 
10,483

 
23,700

 
25,059

Changes in operating assets and liabilities
 
(436
)
 
(5,276
)
 
(6,216
)
Net cash provided by operating activities
 
$
10,047

 
$
18,424

 
$
18,843

The decrease in net cash provided by operating activities in 2014 compared to 2013 is primarily attributable to the decrease in operating income excluding non-cash expenses. Operating income excluding non-cash expenses (depreciation, amortization and impairment charges) was $10.5 million in 2014 compared to 2013 which is mainly attributable to the $31.0 million decrease in revenue offset by an $18.6 million decrease in COR and SG&A expenses and $2.0 million of foreign

28


currency losses. This use of cash from operations was partially offset by a $0.4 million reduction in our working capital. Receivables and current asset balances were reduced $2.5 million in 2014 compared to 2013 primarily due to lower revenue and the collection of Medicare RAC program receivables. In addition, our accrued liabilities decreased by approximately $2.9 million in 2014 compared to 2013. The reduced receivable collections in 2014 compared to 2013 were more than offset by smaller reductions in accrued liability balances, particularly compensation related accruals.
The change in net cash provided by operating activities from 2012 to 2013 primarily resulted from lower net income adjusted for non-cash items in 2013, partially offset by changes in operating assets and liabilities. These changes included higher payments made in 2013 for incentive compensation earned in 2012 than were made in 2012 for incentive compensation earned in 2011, lower incentive compensation accruals in 2013, and higher payments in 2013 for settlement of liabilities for accounts payable and accrued expenses in 2012, which were partially offset by net collections of receivables in 2013 compared to a net increase in receivables in 2012.
We include an itemization of these changes in our Consolidated Statements of Cash Flows included in Part II, Item 8 of this Form 10-K.
No client accounted for 10% or more of our annual revenue in 2012, 2013 or 2014. The loss of any one of our major clients would negatively impact our operating cash flows and would potentially have a material adverse impact on the Company’s liquidity.
Investing Activities. Net cash used for capital expenditures was $4.7 million in 2014, $6.9 million in 2013 and $7.9 million in 2012. These capital expenditures primarily related to investments we made to upgrade our information technology infrastructure, develop our proprietary audit tools and develop software relating to Adjacent Services and Healthcare Claims Recovery Audit Services.
Capital expenditures are discretionary and we currently expect to continue to make capital expenditures to enhance our information technology infrastructure and proprietary audit tools in 2015. Should we experience changes in our operating results, we may alter our capital expenditure plans.
Business Acquisitions and Divestitures
We made several business acquisitions over the past few years, each of which is discussed more fully in Note 12 – Business Acquisitions and Divestitures in “Notes to Consolidated Financial Statements” in Part II, Item 8 of this Form 10-K. Following is a summary of recent business acquisition and divestiture activities impacting our liquidity and capital resources in the past three years.
In July 2009, we acquired the business and certain assets of First Audit Partners LLP (“FAP”), a privately-held European provider of recovery audit services based in Cambridge, United Kingdom, for a purchase price valued at $5.8 million. The purchase price included an initial cash payment of $1.6 million that we paid in July 2009. We made the first of two deferred payments required as part of the FAP acquisition in January 2010 in the amount of £0.5 million ($0.8 million) and the second payment of £0.8 million ($1.3 million) in July 2010. Additional variable consideration potentially was due based on the operating results generated by the acquired business over a four year period from the date of acquisition. From the acquisition date to December 31, 2013, we paid £1.1 million ($1.7 million) of the earn-out and recorded accretion and other adjustments of the liability that resulted in a net decrease of $0.4 million. There were no remaining amounts payable relating to this acquisition as of December 31, 2013.
In February 2010, we acquired all of the issued and outstanding capital stock of Etesius Limited, a privately-held European provider of purchasing and payables technologies and spend analytics based in Chelmsford, United Kingdom for a purchase price valued at $3.1 million. The purchase price included an initial cash payment of $2.8 million and a $0.3 million payment for obligations on behalf of Etesius shareholders that we paid in February 2010 as well as deferred payments of $1.2 million over four years from the date of the acquisition. We also were potentially required to make additional payments of up to $3.8 million over a four-year period if the financial performance of this service line met certain targets. These payments would be to Etesius employees that we hired in connection with the acquisition. We were not obligated to make the deferred and earn-out payments to these employees if they resigned or were terminated under certain circumstances. We therefore recognized the accrual of the deferred payments as compensation expense. From the acquisition date to December 31, 2014, we paid $1.4 million of deferred payments and variable consideration. This amount included the final $0.7 million of deferred payments paid in February 2014 and the final payment of $0.2 million of variable consideration paid in August 2014.
In November 2010, we acquired the business and certain assets of TJG Holdings LLC (“TJG”), a privately-held provider of finance and procurement operations improvement services based in Chicago, Illinois for a purchase price valued at $3.7 million. The purchase price included an initial cash payment of $2.3 million that we paid in November 2010. Additional

29


payments of up to a maximum of $1.9 million potentially were due to the sellers in four semi-annual payments if certain performance targets were met. We recorded $1.4 million as the estimated fair value of these payments at the acquisition date. From the acquisition date to December 31, 2013, we paid $1.9 million of the earn-out and recorded accretion and other adjustments of the liability of $0.5 million. There were no remaining amounts payable relating to this acquisition as of December 31, 2013.
In December 2011, we acquired Business Strategy, Inc. and substantially all of the assets of an affiliated company (collectively “BSI”), both based in Grand Rapids, Michigan, for a purchase price valued at $11.9 million. BSI was a provider of recovery audit and related procure-to-pay process improvement services for commercial clients, and a provider of customized software solutions and outsourcing solutions to improve back office payment processes. The purchase price included an initial cash payment of $2.8 million and 640,614 shares of our common stock having a value of $3.7 million. An additional payment of approximately $0.7 million was made in the first half of 2012 for working capital received in excess of a specified minimum level. Additional variable consideration of up to $5.5 million, payable via a combination of cash and shares of our common stock, potentially was due based on the performance of the acquired businesses over a two year period from the date of acquisition. We also could have been required to pay additional consideration of up to $8.0 million, payable in cash over a period of two years, based on certain net cash fee receipts from a particular recovery audit claim at a specific client. We recorded an additional $4.9 million payable at the acquisition date based on management’s estimate of the fair value of the variable consideration payable. From the acquisition date to December 31, 2014, we paid $6.3 million of the earn-out liability consisting of cash payments of $3.6 million and 404,775 shares of our common stock having a value of $2.7 million. We also recorded accretion and other adjustments of the earn-out liability of $1.4 million. There was no remaining earn-out payable as of December 31, 2014.
We also acquired the assets of several third-party audit firms to which we had subcontracted a portion of our audit services in our Recovery Audit Services – Europe/Asia-Pacific segment. These 2012 associate migrations included CRC Management Consultants LLP (“CRC”) in January 2012 for a purchase price valued at $1.0 million; QFS Ltd (“QFS”) in June 2012 for a purchase price valued at $0.4 million; and Nordic Profit Provider AB (“NPP”) in November 2012 for a purchase price valued at $0.1 million.
We did not complete a business acquisition in the years ended December 31, 2014 and 2013.
In October 2014, we divested certain assets within our Adjacent Services segment that were related to our Chicago, Illinois-based consulting business. These assets, related to the assets previously acquired in November 2010 from TJG Holdings LLC, were sold to Salo, LLC, a Minnesota limited liability company. We received an initial cash payment of $1.1 million in connection with the closing of the transaction and recognized a loss on the sale of less than $0.1 million, which we recognized in Other (income) loss in the Consolidated Statements of Operations. We have also received payment for working capital transferred to the buyer. In addition, we may receive up to $0.9 million in earn-out payments based on certain revenue recognized by the buyer in relation to the acquired business during the year following the closing date of the divestiture.
Financing Activities. Net cash used in financing activities was $22.7 million in 2014 and $4.6 million in 2013 and net cash provided by financing activities was $7.8 million in 2012. The net cash used in financing activities in 2014 included $22.7 million for the repurchase of common stock (see Stock Repurchase Program below). We made mandatory payments of $3.0 million on our term loan in 2012 and 2013 and an additional final payment of $3.0 million in December 2013 that was not due until January 2014. The net cash provided by financing activities in 2012 included net proceeds of $14.7 million from our follow-on public offering in December 2012. The net cash used in financing activities in 2013 included $4.1 million of net proceeds we received from the exercise of the overallotment option for an additional 685,375 shares by the underwriters of our December 2012 public offering (see Common Stock Offering below).
Secured Credit Facility
On January 19, 2010, we entered into a four-year revolving credit and term loan agreement with SunTrust Bank (“SunTrust”). The SunTrust credit facility initially consisted of a $15.0 million committed revolving credit facility and a $15.0 million term loan. The SunTrust credit facility is guaranteed by the Company and its domestic subsidiaries and is secured by substantially all of our assets. Borrowing availability under the SunTrust revolver at December 31, 2014 was $20.0 million. We had no borrowings outstanding under the SunTrust revolver as of December 31, 2014. The SunTrust term loan required quarterly principal payments of $0.8 million from March 2010 through December 2013, and a final principal payment of $3.0 million in January 2014 that we paid in December 2013.
On January 17, 2014, we entered into an amendment of the SunTrust credit facility that increased the committed credit facility from $15.0 million to $25.0 million, lowered the applicable margin to a fixed rate of 1.75%, eliminated the provision limiting availability under the credit facility based on eligible accounts receivable, increased our stock repurchase program limit, and extended the scheduled maturity of the credit facility to January 16, 2015 (subject to earlier termination as provided

30


therein). We must pay a commitment fee of 0.5% per annum, payable quarterly, on the unused portion of the $25.0 million credit facility.
On December 23, 2014, we entered into an amendment of the SunTrust credit facility that reduced the committed revolving credit facility from $25.0 million to $20.0 million. The credit facility bears interest at a rate per annum comprised of a specified index rate based on one-month LIBOR, plus an applicable margin (1.75% per annum). The index rate is determined as of the first business day of each calendar month. With the provision of a fixed applicable margin of 1.75% per the amendment of the SunTrust credit facility, the interest rate that would have applied at December 31, 2014 had any borrowings been outstanding was approximately 1.92%. The credit facility includes two financial covenants (a maximum leverage ratio and a minimum fixed charge coverage ratio) that apply only if we have borrowings under the credit facility that arise or remain outstanding during the final 30 calendar days of any fiscal quarter. These financial covenants also will be tested, on a modified pro forma basis, in connection with each new borrowing under the credit facility. This amendment also extends the scheduled maturity of the revolving credit facility to December 23, 2017 and lowered the commitment fee to 0.25% per annum, payable quarterly, on the unused portion of the revolving credit facility. Unless we change our debt arrangements, we anticipate lower accruals for commitment fees for 2015 given the December 23, 2014 amendment that lowered the commitment fee rate.
The SunTrust credit facility includes customary affirmative, negative, and financial covenants binding on the Company, including delivery of financial statements and other reports, maintenance of existence, and transactions with affiliates. The negative covenants limit the ability of the Company, among other things, to incur debt, incur liens, make investments, sell assets or declare or pay dividends on its capital stock. The financial covenants included in the SunTrust credit facility, among other things, limit the amount of capital expenditures the Company can make, set forth maximum leverage and net funded debt ratios for the Company and a minimum fixed charge coverage ratio, and also require the Company to maintain minimum consolidated earnings before interest, taxes, depreciation and amortization. In addition, the SunTrust credit facility includes customary events of default.
We believe that we will have sufficient borrowing capacity and cash generated from operations to fund our capital and operational needs for at least the next twelve months.
Common Stock Offering
On December 11, 2012, we closed our public offering of 6,249,234 shares of our common stock, which consisted of 2,500,000 shares sold by us and 3,749,234 shares sold by certain selling shareholders, at a price to the public of $6.39 per share. The net proceeds to us from the public offering, after deducting underwriting discounts and commissions and offering expenses, were $14.7 million. We intend to use the net proceeds from the public offering for working capital and general corporate purposes, including potential acquisitions. We did not receive any proceeds from the sale of shares by the selling shareholders. In addition, the underwriters elected to exercise an overallotment option for an additional 687,385 shares, and we completed the sale of these additional shares on January 8, 2013. The net proceeds to us from the exercise of the overallotment option, after deducting underwriting discounts and commission and offering expenses, were $4.1 million.
Stock Repurchase Program
On February 21, 2014, our Board of Directors authorized a stock repurchase program under which we may repurchase up to $10.0 million of our common stock from time to time through March 31, 2015. On March 25, 2014, our Board of Directors authorized a $10.0 million increase to the stock repurchase program. On October 24, 2014, our Board of Directors authorized a $20.0 million increase to the stock repurchase program, increasing the total stock repurchase program since its inception to $40.0 million, and extended the duration of the program to December 31, 2015. From the February 2014 announcement of the Company’s current stock repurchase program through December 31, 2014, the Company has repurchased 3.6 million shares, or 12.0%, of its common stock outstanding on the date of the announcement, for an aggregate cost of $22.7 million. These shares were retired and accounted for as a reduction to Shareholders' equity in the Consolidated Balance Sheet. Direct costs incurred to acquire the shares are included in the total cost of the shares.
The timing and amount of future repurchases, if any, will depend upon the Company’s stock price, the amount of the Company’s available cash, regulatory requirements, and other corporate considerations. The Company may initiate, suspend or discontinue purchases under the stock repurchase program at any time.

31


Contractual Obligations and Other Commitments
As discussed in “Notes to Consolidated Financial Statements” included in Item 8 of this Form 10-K, the Company has certain contractual obligations and other commitments. A summary of those commitments as of December 31, 2014 is as follows:
 
 
Payments Due by Period (in thousands)
Contractual obligations
 
Total
 
Less
Than
1 Year
 
1-3 Years
 
3-5
Years
 
More
Than
5 Years
Interest and commitment fee on Secured Credit Facility (1)
 
$
149

 
$
50

 
$
99

 
$

 
$

Operating lease obligations
 
16,477

 
4,186

 
5,799

 
3,221

 
3,271

Payments to Messrs. Cook and Toma (2)
 
780

 
62

 
129

 
137

 
452

Severance
 
2,161

 
2,139

 
22

 

 

Total
 
$
19,567

 
$
6,437

 
$
6,049

 
$
3,358

 
$
3,723


(1)
Represents the estimated commitment fee and interest due on the Secured Credit Facility using the interest rate as of December 31, 2014 and assuming no borrowings on the revolver. See Note 5 of the Notes to Consolidated Financial Statements for additional information regarding the Secured Credit Facility.
(2)
Represents estimated reimbursements payable for healthcare costs incurred by these former executives.
2006 Management Incentive Plan
At the annual meeting of shareholders held on August 11, 2006, the shareholders of the Company approved a proposal granting authorization to issue up to 2.1 million shares of our common stock under the 2006 Management Incentive Plan (“2006 MIP”). At Performance Unit settlement dates, participants are issued that number of shares of Company common stock equal to 60% of the number of Performance Units being settled, and are paid in cash an amount equal to 40% of the fair market value of that number of shares of common stock equal to the number of Performance Units being settled. Prior to 2012, Performance Units were only granted in 2006 and 2007, and the last of such units were settled in May 2011.
On June 19, 2012, seven senior officers of the Company were granted 154,264 Performance Units under the 2006 MIP, comprising all remaining available awards under the plan. The awards had an aggregate grant date fair value of $1.2 million and vest ratably over three years.
All Performance Units must be settled before April 30, 2016. We recognized compensation expense of $0.2 million in 2014, $0.5 million in 2013 and $0.2 million in 2012 related to these 2006 MIP Performance Unit awards. We determined the amount of compensation expense recognized on the assumption that none of the Performance Unit awards will be forfeited and recorded actual forfeitures as incurred.
Cash payments relating to these MIP awards were $0.1 million in 2014 and $0.2 million in 2013. There was no cash payment in 2012 for the MIP awards.
Off-Balance Sheet Arrangements
As of December 31, 2014, the Company did not have any material off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of the SEC’s Regulation S-K.
Critical Accounting Policies
We describe our significant accounting policies in Note 1 of “Notes to Consolidated Financial Statements” included in Item 8 of this Form 10-K. Certain of our accounting policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by management. As a result, they are subject to an inherent degree of uncertainty. We consider accounting policies that involve the use of estimates that meet both of the following criteria to be “critical” accounting policies. First, the accounting estimate requires us to make assumptions about matters that are highly uncertain at the time that the accounting estimate is made. Second, alternative estimates in the current period, or changes in the estimate that are reasonably likely in future periods, would have a material impact on the presentation of our financial condition, changes in financial condition or results of operations.

32


In addition to estimates that meet the “critical” estimate criteria, we also make many other accounting estimates in preparing our consolidated financial statements and related disclosures. All estimates, whether or not deemed critical, affect reported amounts of assets, liabilities, revenue and expenses, as well as disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, refund liabilities, accounts receivable allowance for doubtful accounts, goodwill and other intangible assets and income taxes. We base our estimates and judgments on historical experience, information available prior to the issuance of the consolidated financial statements and on various other factors that we believe to be reasonable under the circumstances. This information forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Materially different results can occur as circumstances change and additional information becomes known, including changes in those estimates not deemed “critical”.
We believe the following critical accounting policies, among others, involve our more significant estimates and judgments we used in the preparation of our consolidated financial statements. We have discussed the development and selection of accounting estimates, including those deemed “critical,” and the associated disclosures in this Form 10-K with the audit committee of the Board of Directors.
Revenue Recognition. We generally recognize revenue for a contractually specified percentage of amounts recovered when we have determined that our clients have received economic value (generally through credits taken against existing accounts payable due to the involved vendors or refund checks received from those vendors), and when we have met the following criteria: (a) persuasive evidence of an arrangement exists; (b) services have been rendered; (c) the fee billed to the client is fixed or determinable; and (d) collectability is reasonably assured.
Additionally, for purposes of determining appropriate timing of recognition and for internal control purposes, we rely on customary business practices and processes for documenting that the criteria described in (a) through (d) above have been met. Such customary business practices and processes may vary significantly by client. On occasion, it is possible that a transaction has met all of the revenue recognition criteria described above but we do not recognize revenue, unless we can otherwise determine that criteria (a) through (d) above have been met, because our customary business practices and processes specific to that client have not been completed. The determination that we have met each of the aforementioned criteria, particularly the determination of the timing of economic benefit received by the client and the determination that collectability is reasonably assured, requires the application of significant judgment by management and a misapplication of this judgment could result in inappropriate recognition of revenue.
Unbilled Receivables & Refund Liabilities. Unbilled receivables relate to claims for which our clients have received economic value but for which we contractually have agreed not to invoice the clients. These unbilled receivables arise when a portion of our fee is deferred at the time of the initial invoice. At a later date (which can be up to a year after the original invoice, or a year after completion of the audit period), we invoice the unbilled receivable amount. Notwithstanding the deferred due date, our clients acknowledge that we have earned this unbilled receivable at the time of the original invoice, but have agreed to defer billing the client for the related services. Unbilled receivables also arise in our Healthcare Claims Recovery Audit services as we generally cannot invoice the prime contractors for whom we operate as a subcontractor under the Medicare RAC program until cash is collected by the prime contractors.
Refund liabilities result from reductions in the economic value previously received by our clients with respect to vendor claims identified by us and for which we previously have recognized revenue. We satisfy such refund liabilities either by offsets to amounts otherwise due from clients or by cash refunds to clients. We compute the estimate of our refund liabilities at any given time based on actual historical refund data.
We record periodic changes in unbilled receivables and refund liabilities as adjustments to revenue.

Goodwill, Other Intangible Assets, Long-lived Assets, and Impairment Charges. Goodwill represents the excess of the purchase price over the estimated fair market value of net identifiable assets of acquired businesses. Intangible assets are assets that lack physical substance. We evaluate the recoverability of goodwill and other intangible assets in accordance with ASC 350, Intangibles—Goodwill and Other, in the fourth quarter of each year or sooner if events or changes in circumstances indicate that the carrying amount may exceed its fair value. This evaluation includes a preliminary assessment of qualitative factors to determine if it is necessary to perform a two-step impairment testing process. The first step identifies potential impairments by comparing the fair value of the reporting unit with its carrying value, including goodwill. If the calculated fair value of a reporting unit exceeds the carrying value, goodwill is not impaired, and the second step is not necessary. If the carrying value of a reporting unit exceeds the fair value, the second step calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying value. If the fair value is less than the carrying value, we would record an impairment charge.
We are not required to calculate the fair value of our reporting units that hold goodwill unless we determine that it is more likely than not that the fair value of these reporting units is less than their carrying values. In this analysis, we

33


consider a number of factors, including changes in our legal, business and regulatory climates, changes in competition or key personnel, macroeconomic factors impacting our company or our clients, our recent financial performance and expectations of future performance and other pertinent factors. Based on these analyses, we determined that it was not necessary for us to perform the two-step process. We last used independent business valuation professionals to estimate fair value in the fourth quarter of 2010 and determined that fair value exceeded carrying value for all relevant reporting units. No impairment charges were necessary based on our internal calculations in the three years ended December 31, 2014.
We review the carrying value of long-lived assets such as property and equipment for impairment when events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, we will recognize an impairment loss equal to the amount by which the carrying value exceeds the fair value of the asset. No impairment charges were necessary in the three years ended December 31, 2014 with the exception of impairment charges in 2013 for software development costs. In 2013, we recorded impairment charges of $4.2 million related to certain internally developed software assets. These charges primarily resulted from our decision to withdraw from the Medicare RAC program rebid process and from planned changes to the Company's recovery audit delivery processes.
Income Taxes. Our effective tax rate is based on historical and anticipated future taxable income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining the effective tax rate and in evaluating our tax positions. Tax regulations require items to be included in the tax returns at different times than the items are reflected in the financial statements. As a result, our effective tax rate reflected in our Consolidated Financial Statements included in Item 8 of this Form 10-K is different than that reported in our tax returns. Some of these differences are permanent, such as expenses that are not deductible on our tax returns, and some are temporary differences, such as depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our Consolidated Statements of Operations. We establish valuation allowances to reduce net deferred tax assets to the amounts that we believe are more likely than not to be realized. We adjust these valuation allowances in light of changing facts and circumstances. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which a deduction has already been taken on our tax returns but has not yet been recognized as an expense in our consolidated financial statements.
We reduce our deferred tax assets by a valuation allowance if it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are deductible. In determining the amount of valuation allowance to record, we consider all available positive and negative evidence affecting specific deferred tax assets, including our past and anticipated future performance, the reversal of deferred tax liabilities, the length of carry-back and carry-forward periods, and the implementation of tax planning strategies. Objective positive evidence is necessary to support a conclusion that a valuation allowance is not needed for all or a portion of deferred tax assets when significant negative evidence exists. Cumulative tax losses in recent years are the most compelling form of negative evidence we considered in this determination.
We apply a “more-likely-than-not” recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We refer to U.S. generally accepted accounting principles (“GAAP”) for guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Our policy for recording interest and penalties associated with tax positions is to record such items as a component of income before income taxes. A number of years may elapse before a particular tax position is audited and finally resolved or before a tax assessment is raised. The number of years subject to tax assessments varies by tax jurisdictions.
Stock-Based Compensation. We account for awards of equity instruments issued to employees and directors under the fair value method of accounting and recognize such amounts in our Consolidated Statements of Operations. We measure compensation cost for all stock-based awards at fair value on the date of grant and recognize compensation expense using the straight-line method over the service period over which we expect the awards to vest. We recognize compensation costs for awards with performance conditions based on the probable outcome of the performance conditions. We accrue compensation cost if we believe it is probable that the performance condition(s) will be achieved and do not accrue compensation cost if we believe it is not probable that the performance condition(s) will be achieved. In the event that it becomes probable that performance condition(s) will no longer be achieved, we reverse all of the previously recognized compensation expense in the period such a determination is made.

34


We estimate the fair value of all time-vested options as of the date of grant using the Black-Scholes option valuation model, which was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions, including the expected stock price volatility, which we calculate based on the historical volatility of our common stock. We use a risk-free interest rate, based on the U.S. Treasury instruments in effect at the time of the grant, for the period comparable to the expected term of the option. Given our limited history with stock option grants and exercises, we use the “simplified” method in estimating the expected term, the period of time that options granted are expected to be outstanding, for our grants.
We estimate the fair value of awards of restricted shares and nonvested shares as being equal to the market value of the common stock on the date of the award. We classify our share-based payments as either liability-classified awards or as equity-classified awards. We remeasure liability-classified awards to fair value at each balance sheet date until the award is settled. We measure equity-classified awards at their grant date fair value and do not subsequently remeasure them. We have classified our share-based payments which are settled in our common stock as equity-classified awards and our share-based payments that are settled in cash as liability-classified awards. Compensation costs related to equity-classified awards generally are equal to the grant-date fair value of the award amortized over the vesting period of the award. The liability for liability-classified awards generally is equal to the fair value of the award as of the balance sheet date multiplied by the percentage vested at the time. We charge (or credit) the change in the liability amount from one balance sheet date to another to compensation expense.
New Accounting Standards
For information related to new and recently adopted accounting standards, see Note 1 – Summary of Significant Accounting Policies and Basis of Presentation, in “Notes to Consolidated Financial Statements” in Item 8 of this Form 10-K.


35


Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Market Risk. Our reporting currency is the U.S. dollar, although we transact business in various foreign locations and currencies. As a result, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we provide our services. Our operating results are exposed to changes in exchange rates between the U.S. dollar and the currencies of the other countries in which we operate. When the U.S. dollar strengthens against other currencies, the value of foreign functional currency revenue decreases. When the U.S. dollar weakens, the value of the foreign functional currency revenue increases. Overall, we are a net receiver of currencies other than the U.S. dollar and, as such, benefit from a weaker dollar. We therefore are adversely affected by a stronger dollar relative to major currencies worldwide. In 2014, we recognized $9.8 million of operating income from operations located outside the U.S., virtually all of which was originally accounted for in currencies other than the U.S. dollar. Upon translation into U.S. dollars, such operating income would increase or decrease, assuming a hypothetical 10% change in weighted-average foreign currency exchange rates against the U.S. dollar, by approximately $1.0 million. We currently do not have any arrangements in place to hedge our foreign currency risk.
Interest Rate Risk. Our interest income and expense are sensitive to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on our cash equivalents as well as interest paid on amounts outstanding under our revolving credit facility, if any. We had $20.0 million of borrowing availability under our revolving credit facility as of December 31, 2014, but had no amounts drawn under the revolving credit facility as of that date. Interest on the amended credit facility is payable monthly and accrues at an index rate using the one-month LIBOR rate plus an applicable margin of 1.75%. Assuming full utilization of the credit facility, a hypothetical 100 basis point change in interest rates would result in an approximate $0.2 million change in annual pre-tax income.


36


ITEM 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS




37


Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders
PRGX Global, Inc.
Atlanta, Georgia
We have audited the accompanying consolidated balance sheets of PRGX Global, Inc. and subsidiaries (the Company) as of December 31, 2014 and 2013 and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. 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 PRGX Global, Inc. and subsidiaries at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 13, 2015 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Atlanta, Georgia
March 13, 2015


38


PRGX GLOBAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
Revenue
 
$
164,192

 
$
195,216

 
$
208,503

Operating expenses:
 
 
 
 
 
 
Cost of revenue
 
115,959

 
126,102

 
137,351

Selling, general and administrative expenses
 
40,788

 
49,200

 
49,566

Depreciation of property and equipment
 
6,216

 
8,231

 
7,084

Amortization of intangible assets
 
3,531

 
4,997

 
7,224

Impairment charges
 

 
4,207

 

Total operating expenses
 
166,494

 
192,737

 
201,225

Operating income (loss)
 
(2,302
)
 
2,479

 
7,278

Foreign currency transaction (gains) losses on short-term intercompany balances
 
2,003

 
(13
)
 
(377
)
Interest expense
 
(351
)
 
(138
)
 
(1,116
)
Interest income
 
428

 
215

 
150

Other (income) loss
 
57

 

 

Income (loss) before income taxes
 
(4,285
)
 
2,569

 
6,689

Income tax expense (Note 7)
 
3,241

 
2,755

 
1,297

Net income (loss)
 
$
(7,526
)
 
$
(186
)
 
$
5,392

 
 
 
 
 
 
 
Basic earnings (loss) per common share (Note 3)
 
$
(0.26
)
 
$
(0.01
)
 
$
0.21

 
 
 
 
 
 
 
Diluted earnings (loss) per common share (Note 3)
 
$
(0.26
)
 
$
(0.01
)
 
$
0.21

Weighted-average common shares outstanding (Note 3):
 
 
 
 
 
 
Basic
 
28,707

 
29,169

 
25,566

Diluted
 
28,707

 
29,169

 
26,137



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)

 
 
Years Ended December 31,
 
 
2014
 
2013
 
2011
Net income (loss)
 
$
(7,526
)
 
$
(186
)
 
$
5,392

Foreign currency translation adjustments
 
(551
)
 
(1,414
)
 
363

Comprehensive income (loss)
 
$
(8,077
)
 
$
(1,600
)
 
$
5,755





See accompanying Notes to Consolidated Financial Statements.

39


PRGX GLOBAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
 
 
December 31,
 
 
2014
 
2013
ASSETS
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
25,735

 
$
43,700

Restricted cash
 
53

 
57

Receivables:
 
 
 
 
Contract receivables, less allowances of $2,243 in 2014 and $1,996 in 2013:
 
 
 
 
Billed
 
32,373

 
28,175

Unbilled
 
2,809

 
9,904

 
 
35,182

 
38,079

 Employee advances and miscellaneous receivables, less allowances of $692 in 2014 and $402 in 2013
 
1,993

 
2,242

Total receivables
 
37,175

 
40,321

Prepaid expenses and other current assets
 
3,416

 
3,910

Deferred income taxes (Note 7)
 
5

 
7

Total current assets
 
66,384

 
87,995

 
 
 
 
 
Property and equipment:
 
 
 
 
Computer and other equipment
 
28,864

 
28,810

Furniture and fixtures
 
2,926

 
3,050

Leasehold improvements
 
3,450

 
3,401

Software
 
20,934

 
23,535

 
 
56,174

 
58,796

Less accumulated depreciation and amortization
 
(43,954
)
 
(44,802
)
Property and equipment, net
 
12,220

 
13,994

 
 
 
 
 
Goodwill (Note 4)
 
13,036

 
13,686

Intangible assets, less accumulated amortization of $33,973 in 2014 and $32,717 in 2013
 
9,439

 
13,582

Unbilled receivables
 
1,196

 
1,379

Deferred income taxes (Note 7)
 
36

 
1,701

Other assets
 
471

 
492

Total assets
 
$
102,782

 
$
132,829

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
 
 
 
 
Accounts payable and accrued expenses
 
$
7,397

 
$
10,809

Accrued payroll and related expenses
 
15,415

 
15,415

Refund liabilities
 
5,393

 
6,597

Deferred revenue
 
2,173

 
1,512

Business acquisition obligations (Note 12)
 

 
3,156

Total current liabilities
 
30,378

 
37,489

 
 
 
 
 
Refund liabilities
 
857

 
950

Other long-term liabilities
 
561

 
562

Total liabilities
 
31,796

 
39,001

 
 
 
 
 
Commitments and contingencies (Notes 5, 6, 9 and 10)
 


 


 
 
 
 
 
Shareholders’ equity (Notes 9 and 11):
 
 
 
 
Common stock, no par value; $.01 stated value per share. Authorized 50,000,000 shares; 26,762,861 shares issued and outstanding at December 31, 2014 and 29,367,439 shares issued and outstanding at December 31, 2013
 
268

 
294

Additional paid-in capital
 
590,067

 
604,806

Accumulated deficit
 
(520,912
)
 
(513,386
)
Accumulated other comprehensive income
 
1,563

 
2,114

Total shareholders’ equity
 
70,986

 
93,828

Total liabilities and shareholders’ equity
 
$
102,782

 
$
132,829

See accompanying Notes to Consolidated Financial Statements.

40


PRGX GLOBAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2014, 2013 and 2012
(In thousands, except share data)
 
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
Total Shareholders' Equity
 
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2011
 
25,108,754

 
$
251

 
$
574,266

 
$
(518,592
)
 
$
3,165

 
$
59,090

Net income
 

 

 

 
5,392

 

 
5,392

Foreign currency translation adjustments
 

 

 

 

 
363

 
363

Issuances of common stock:
 
 
 
 
 
 
 
 
 
 
 
 
Restricted share awards
 
500,128

 
5

 
(5
)
 

 

 

Shares issued for stock offering
 
2,500,000

 
25

 
14,657

 

 

 
14,682

Restricted shares remitted by employees for taxes
 
(161,514
)
 
(2
)
 
(1,603
)
 

 

 
(1,605
)
Stock option exercises
 
141,849

 
2

 
557

 

 

 
559

Forfeited restricted share awards
 
(196,085
)
 
(2
)
 
2

 

 

 

Stock-based compensation expense
 

 

 
6,171

 

 

 
6,171

Balance at December 31, 2012
 
27,893,132

 
279

 
594,045

 
(513,200
)
 
3,528

 
84,652

Net loss
 

 

 

 
(186
)
 

 
(186
)
Foreign currency translation adjustments
 

 

 

 

 
(1,414
)
 
(1,414
)
Issuances of common stock:
 
 
 
 
 
 
 
 
 
 
 
 
Restricted share awards
 
665,629

 
7

 
(7
)
 

 

 

Shares issued for acquisition
 
217,155

 
2

 
1,470

 

 

 
1,472

Shares issued for stock offering
 
687,385

 
7

 
4,111

 

 

 
4,118

Restricted shares remitted by employees for taxes
 
(259,116
)
 
(3
)
 
(1,754
)
 

 

 
(1,757
)
Stock option exercises
 
202,159

 
2

 
914

 

 

 
916

2006 MIP Performance Unit settlements
 
52,912

 
1

 
(1
)
 

 

 

Forfeited restricted share awards
 
(91,817
)
 
(1
)
 
1

 

 

 

Stock-based compensation expense