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EX-31.1 - CERTIFICATION OF CEO - PRGX GLOBAL, INC.ex3112015q3.htm
EX-31.2 - CERTIFICATION OF CFO - PRGX GLOBAL, INC.ex3122015q3.htm
EX-32.1 - CERTIFICATION OF THE CEO AND CFO - PRGX GLOBAL, INC.ex3212015q3.htm
EX-10.1 - SEPERATION AGREEMENT C. LEE - PRGX GLOBAL, INC.ex101clee_separationagreem.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
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
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 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     (Do not check if a smaller reporting company)
¨
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
Common shares of the registrant outstanding at November 6, 2015 were 22,859,734.




PRGX GLOBAL, INC.
FORM 10-Q
For the Quarter Ended September 30, 2015
INDEX
 
 
Page No.
Part I. Financial Information
 
Part II. Other Information
 



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PRGX GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue
 
$
33,923

 
$
42,988

 
$
104,344

 
$
122,870

Operating expenses:
 
 
 
 
 
 
 
 
Cost of revenue
 
24,387

 
28,681

 
73,085

 
87,457

Selling, general and administrative expenses
 
8,487

 
10,492

 
26,043

 
31,505

Depreciation of property and equipment
 
1,262

 
1,428

 
3,858

 
4,696

Amortization of intangible assets
 
517

 
895

 
2,017

 
2,700

Total operating expenses
 
34,653

 
41,496

 
105,003

 
126,358

Operating (loss) income
 
(730
)
 
1,492

 
(659
)
 
(3,488
)
Foreign currency transaction losses on short-term intercompany balances
 
654

 
1,221

 
1,930

 
1,073

Interest (income), net
 
(8
)
 
(44
)
 
(103
)
 
(33
)
Other loss
 
1,612

 

 
1,612

 

(Loss) income before income taxes
 
(2,988
)
 
315

 
(4,098
)
 
(4,528
)
Income tax expense
 
421

 
554

 
1,172

 
853

Net loss
 
$
(3,409
)
 
$
(239
)
 
$
(5,270
)
 
$
(5,381
)
 
 
 
 
 
 
 
 
 
Basic loss per common share (Note B)
 
$
(0.14
)
 
$
(0.01
)
 
$
(0.20
)
 
$
(0.18
)
 
 
 
 
 
 
 
 
 
Diluted loss per common share (Note B)
 
$
(0.14
)
 
$
(0.01
)
 
$
(0.20
)
 
$
(0.18
)
Weighted-average common shares outstanding (Note B):
 
 
 
 
 
 
 
 
Basic
 
25,167

 
27,744

 
26,015

 
29,203

Diluted
 
25,167

 
27,744

 
26,015

 
29,203




CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(In thousands)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Net loss
 
$
(3,409
)
 
$
(239
)
 
$
(5,270
)
 
$
(5,381
)
Foreign currency translation adjustments
 
(844
)
 
(619
)
 
(692
)
 
(112
)
Comprehensive loss
 
$
(4,253
)
 
$
(858
)
 
$
(5,962
)
 
$
(5,493
)

See accompanying Notes to Condensed Consolidated Financial Statements.

1


PRGX GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
 
 
September 30,
2015
 
December 31,
2014
ASSETS
Current assets:
 
 
 
 
Cash and cash equivalents (Note E)
 
$
15,673

 
$
25,735

Restricted cash
 
98

 
53

Receivables:
 
 
 
 
Contract receivables, less allowances of $1,752 in 2015 and $2,243 in 2014:
 
 
 
 
Billed
 
24,255

 
32,373

Unbilled
 
1,288

 
2,809

 
 
25,543

 
35,182

Employee advances and miscellaneous receivables, less allowances of $834 in 2015 and $692 in 2014
 
1,781

 
1,993

Total receivables
 
27,324

 
37,175

Prepaid expenses and other current assets
 
3,141

 
3,421

Total current assets
 
46,236

 
66,384

Property and equipment
 
58,333

 
56,174

Less accumulated depreciation and amortization
 
(46,993
)
 
(43,954
)
Property and equipment, net
 
11,340

 
12,220

Goodwill
 
11,589

 
13,036

Intangible assets, less accumulated amortization of $35,163 in 2015 and $33,973 in 2014
 
7,131

 
9,439

Noncurrent portion of unbilled receivables
 
825

 
1,196

Other assets
 
828

 
507

Total assets
 
$
77,949

 
$
102,782

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
 
 
 
 
Accounts payable and accrued expenses
 
$
6,437

 
$
7,397

Accrued payroll and related expenses
 
12,103

 
15,415

Refund liabilities
 
4,953

 
5,393

Deferred revenue
 
1,094

 
2,173

Other current liabilities
 
254

 

Total current liabilities
 
24,841

 
30,378

Noncurrent refund liabilities
 
716

 
857

Other long-term liabilities
 
1,218

 
561

Total liabilities
 
26,775

 
31,796

Commitments and contingencies (Note H)
 


 


Shareholders’ equity (Note B):
 
 
 
 
Common stock, no par value; $.01 stated value per share. Authorized 50,000,000 shares; 22,872,100 shares issued and outstanding at September 30, 2015 and 26,762,861 shares issued and outstanding at December 31, 2014
 
229

 
268

Additional paid-in capital
 
576,256

 
590,067

Accumulated deficit
 
(526,182
)
 
(520,912
)
Accumulated other comprehensive income
 
871

 
1,563

Total shareholders’ equity
 
51,174

 
70,986

Total liabilities and shareholders’ equity
 
$
77,949

 
$
102,782


See accompanying Notes to Condensed Consolidated Financial Statements.

2


PRGX GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(5,270
)
 
$
(5,381
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
5,875

 
7,396

Amortization of deferred loan costs
 
(100
)
 
67

Stock-based compensation expense
 
4,530

 
3,409

Loss/gain on sale of assets/investments
 
1,561

 

Deferred income taxes
 
61

 
(933
)
Foreign currency transaction (gains) losses on short-term intercompany balances
 
1,930

 
1,073

Changes in operating assets and liabilities:
 
 
 
 
Restricted cash
 
(45
)
 
(64
)
Billed receivables
 
6,843

 
(2,762
)
Unbilled receivables
 
1,815

 
7,921

Prepaid expenses and other current assets
 
211

 
541

Other assets
 
(40
)
 
15

Accounts payable and accrued expenses
 
(822
)
 
(2,871
)
Accrued payroll and related expenses
 
(2,861
)
 
(445
)
Refund liabilities
 
(581
)
 
(1,058
)
Deferred revenue
 
(645
)
 
(265
)
Noncurrent compensation obligations
 

 
414

Other long-term liabilities
 
(99
)
 
73

Net cash provided by operating activities
 
12,363

 
7,130

Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment, net of disposal proceeds
 
(3,169
)
 
(3,574
)
Net cash used in investing activities
 
(3,169
)
 
(3,574
)
Cash flows from financing activities:
 
 
 
 
Payment of deferred loan costs
 

 
(104
)
Restricted stock repurchased from employees for withholding taxes
 
(311
)
 
(568
)
Proceeds from option exercises
 
45

 
2,790

Payments of deferred acquisition consideration
 

 
(2,208
)
Repurchase of common stock
 
(17,261
)
 
(20,000
)
Net cash used in financing activities
 
(17,527
)
 
(20,090
)
 
 
 
 
 
Effect of exchange rates on cash and cash equivalents
 
(1,729
)
 
(873
)
Net decrease in cash and cash equivalents
 
(10,062
)
 
(17,407
)
 
 
 
 
 
Cash and cash equivalents at beginning of period
 
25,735

 
43,700

Cash and cash equivalents at end of period
 
$
15,673

 
$
26,293

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for interest
 
$
51

 
$
80

Cash paid during the period for income taxes, net of refunds received
 
$
734

 
$
2,405


See accompanying Notes to Condensed Consolidated Financial Statements.

3

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note A – Basis of Presentation
The accompanying Condensed Consolidated Financial Statements (Unaudited) of PRGX Global, Inc. and its wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.
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. For further information, refer to the Consolidated Financial Statements and Footnotes thereto included in the Company’s Form 10-K for the year ended December 31, 2014.
New Accounting Standards
A summary of the new accounting standards issued by the Financial Accounting Standards Board (“FASB”) and included in the Accounting Standards Codification (“ASC”) that apply to PRGX is set forth below:

    FASB ASC Update No. 2015-15. In August 2015, the FASB issued Accounting Standards Update No. 2015-15, Interest - Imputations of Interest (Subtopic 835-30). The amendments in this update clarify the stance by the SEC allowing an entity to defer and present debt issuance costs for a line-of-credit arrangement as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. We are currently evaluating the impact of ASU 2015-15 on our consolidated financial statements.

FASB ASC Update No. 2015-05. In April 2015, the FASB issued Accounting Standards Update 2015-05, Goodwill and Other - Internal - Use Software (Subtopic 350-40). The amendments in this update provide guidance about whether a cloud computing arrangement includes a software license. Specifically the amendment states that if a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments in this update are effective for those annual periods beginning after December 15, 2015. We are currently evaluating the impact of ASU 2015-05 on our consolidated financial statements.

FASB ASC Update No. 2015-03. In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30) (“ASU 2015-03”). ASU 2015-03 simplifies presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for annual periods beginning after December 15, 2015 with early adoption permitted. The guidance also requires retrospective application to all prior periods presented. We are currently evaluating the impact of ASU 2015-03 on our consolidated financial statements.

FASB ASC Update No. 2015-02. In February 2015, the FASB issued Accounting Standards Update 2015-02, Consolidation (Topic 810). The amendments in this update revise the consolidation model for all entities. Specifically the amendments:

1.
Modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities.
2.
Eliminate the presumption that a general partner should consolidate a limited partnership.
3.
Affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships.

4



4.
Provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.

The amendments in this update are effective for fiscal years beginning after December 15, 2015. We are currently evaluating the impact of ASU 2015-02 on our consolidated financial statements.

FASB ASC Update No. 2015-01. In January 2015, the FASB issued Accounting Standards Update 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20). This update eliminates the concept of extraordinary items and their use in financial statements and corresponding disclosure. The amendments in this update are effective for fiscal years beginning after December 15, 2015. We are currently evaluating the impact of ASU 2015-01 on our consolidated financial statements.

FASB ASC Update No. 2014-15. In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40) (“ASU 2014-15”). ASU 2014-15 provides guidance on management's responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and related disclosure requirements. ASU 2014-15 is effective for annual periods beginning after December 15, 2016 with early adoption permitted. We do not expect the adoption of ASU 2014-15 to have a material impact on our consolidated financial statements.

FASB ASC Update No. 2014-09. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in Revenue Recognition (Topic 605), and requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the transferring entity expects to be entitled in exchange for those goods or services. ASU 2014-09 allows for adoption using either of two methods; retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of application recognized at the date of initial adoption. In August 2015, the FASB issued ASU 2015-14 to defer the effective date by one year. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. We are currently evaluating the impact of ASU 2014-09 on our consolidated financial statements.

5

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note B – Earnings (Loss) Per Common Share
The following tables set forth the computations of basic and diluted loss per common share for the three and nine months ended September 30, 2015 and 2014 (in thousands, except per share data):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Basic loss per common share:
 
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
 
Net loss
 
$
(3,409
)
 
$
(239
)
 
$
(5,270
)
 
$
(5,381
)
 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
 
25,167

 
27,744

 
26,015

 
29,203

 
 
 
 
 
 
 
 
 
Basic loss per common share
 
$
(0.14
)
 
$
(0.01
)
 
$
(0.20
)
 
$
(0.18
)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Diluted loss per common share:
 
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
 
Net loss
 
$
(3,409
)
 
$
(239
)
 
$
(5,270
)
 
$
(5,381
)
 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
 
25,167

 
27,744

 
26,015

 
29,203

 Incremental shares from stock-based compensation plans
 

 

 

 

Denominator for diluted loss per common share
 
25,167

 
27,744

 
26,015

 
29,203

 
 
 
 
 
 
 
 
 
Diluted loss per common share
 
$
(0.14
)
 
$
(0.01
)
 
$
(0.20
)
 
$
(0.18
)
For the three and nine months ended September 30, 2015, weighted-average common shares outstanding excludes from the computation of diluted earnings (loss) per common share antidilutive shares underlying options that totaled 3.6 million shares. For the three and nine months ended September 30, 2014, weighted-average common shares outstanding excludes from the computation of diluted earnings (loss) per common share antidilutive shares underlying options that totaled 3.8 million shares and antidilutive Performance Units related to the Company's 2006 Management Incentive Plan that totaled less than 0.1 million shares. As a result of the net loss for the three months ended September 30, 2015 and September 30, 2014 and the nine months ended September 30, 2015 and September 30, 2014, all shares underlying stock options and Performance Units were considered antidilutive for such periods. The number of common shares used in the basic and diluted earnings (loss) per common share computations include nonvested restricted shares of 0.4 million and 0.6 million for the three and nine months ended September 30, 2015 and 2014, respectively, and nonvested restricted share units that we consider to be participating securities of 2.6 million and 0.1 million for the three and nine months ended September 30, 2015 and 2014, respectively.
We repurchased 1,735,277 shares of our common stock during the three months ended September 30, 2015 for $6.9 million, and 3,912,037 shares of our common stock during the nine months ended September 30, 2015 for $17.3 million. We repurchased 1,413,017 shares of our common stock during the three months ended September 30, 2014 for $9.0 million, and 3,117,277 shares of our common stock during the nine months ended September 30, 2014 for $20.0 million.
Pursuant to exercises of outstanding stock options, we issued no shares of our common stock in the three months ended September 30, 2015 and 12,863 shares of our common stock having a value of less than $0.1 million in the nine months ended September 30, 2015. We issued 105,478 shares of our common stock having a value of less than $0.5 million in the three months ended September 30, 2014 and 710,063 shares of our common stock having a value of $2.8 million in the nine months ended September 30, 2014. Stock option exercises during the nine-month period ended September 30, 2014 primarily consisted of exercises by a former executive officer of the Company.
In partial satisfaction of a business acquisition obligation, we issued 187,620 shares of our common stock having a value of $1.3 million in the nine months ended September 30, 2014. There were no shares issued to satisfy business acquisition obligations in the nine months ended September 30, 2015.

6

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note C – Stock-Based Compensation
The Company currently has two stock-based compensation plans: (1) the 2006 Management Incentive Plan (“2006 MIP”) and (2) the 2008 Equity Incentive Plan (“2008 EIP”) (collectively, the “Plans”). We describe the Plans in the Company’s Annual Report on Form 10–K for the fiscal year ended December 31, 2014. For all periods presented herein, awards outside the Plans are referred to as inducement awards.
2008 EIP Awards and Inducement Awards
Stock options granted under the 2008 EIP generally have a term of seven years and vest in equal annual increments over the vesting period, which typically is three years for employees and one year for directors. The following table summarizes stock option grants during the nine months ended September 30, 2015 and 2014:
Grantee
Type
 
# of
Options
Granted
 
Vesting Period
 
Weighted
Average
Exercise Price
 
Weighted
Average Grant
Date Fair Value
2015
 
 
 
 
 
 
 
 
Director
 
249,273

 
1 year or less
 
$
4.49

 
$
2.44

Director
 
17,092

 
3 years
 
$
3.99

 
$
1.33

Employee inducements (1)
 
135,000

 
3 years
 
$
5.51

 
$
1.42

 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
Director
 
51,276

 
1 year or less
 
$
6.45

 
$
1.89

Employee group (2)
 
1,480,000

 
3 years
 
$
6.99

 
$
1.81

Employee inducements (3)
 
270,000

 
3 years
 
$
6.64

 
$
1.71

 
(1)
The Company granted non-qualified stock options outside its existing stock-based compensation plans in the first nine months of 2015 to three employees in connection with the employees joining the Company.
(2)
The exercise price for these options is $6.36 for the options that vested on June 27, 2015, $6.99 for the options that vest on June 27, 2016 and $7.63 for the options that vest on June 27, 2017.
(3)
The Company granted non-qualified stock options outside its existing stock-based compensation plans in the third quarter of 2014 to two executive officers in connection with the employees joining the Company. The weighted average exercise price for these options is calculated based on an exercise price of $6.04 for the options that vested on September 11, 2015, $6.64 for the options that vest on September 11, 2016 and $7.24 for the options that vest on September 11, 2017.
Nonvested stock awards, including both restricted stock and restricted stock units, granted under the 2008 EIP generally are nontransferable until vesting and the holders are entitled to receive dividends with respect to the nonvested shares. Prior to vesting, the grantees of restricted stock are entitled to vote the shares, but the grantees of restricted stock units are not entitled to vote the shares. Generally, nonvested stock awards with time-based vesting criteria vest in equal annual increments over the vesting period, which typically is three years for employees and one year for directors. Nonvested stock awards with performance-based vesting criteria vest in accordance with specific performance criteria associated with the awards.











7

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The following table summarizes nonvested stock awards granted during the nine months ended September 30, 2015 and 2014:
Grantee
Type
 
# of Shares
Granted
 
Vesting Period
 
Weighted
Average Grant
Date Fair Value
2015
 
 
 
 
 
 
Director
 
4,273

 
1 year or less
 
$
4.02

Director
 
17,092

 
3 years
 
$
3.99

Employee group (1)
 
2,533,333

 
2 years
 
$
3.99

Employee inducements (2)
 
10,000

 
3 years
 
$
5.29

 
 
 
 
 
 
 
2014
 
 
 
 
 
 
Director group
 
51,276

 
1 year or less
 
$
6.45

Employee group
 
120,000

 
3 years
 
$
6.36

Employee inducements (3)
 
70,000

 
3 years
 
$
6.04

 
(1)
The Company granted nonvested performance-based stock awards (restricted stock units) in the first quarter of 2015 to eight executive officers totaling 1,325,000 units. During the third quarter of 2015, the Company issued 1,208,333 units to key employees.
(2)
The Company granted nonvested stock awards (restricted stock) outside its existing stock-based compensation plans in the first quarter of 2015 to two employees in connection with the employees joining the Company.
(3)
The Company granted nonvested stock awards (restricted stock) outside its existing stock-based compensation plans in the third quarter of 2014 to two executive officers in connection with the employees joining the Company.
2006 MIP Performance Units
On June 19, 2012, seven executive officers of the Company were granted 154,264 Performance Units under the 2006 MIP, comprising all of the then remaining available awards under the 2006 MIP. The awards had an aggregate grant date fair value of $1.2 million and vest ratably over three years. Upon vesting, the Performance Units were settled by the issuance of Company common stock equal to 60% of the number of Performance Units being settled and the payment of cash in 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. During the nine months ended September 30, 2015, an aggregate of 16,530 Performance Units were settled, which resulted in the issuance of 9,918 shares of common stock and cash payments of less than $0.1 million. There were no shares issued during the third quarter of 2015 in settlement of Performance Units and 16,526 shares issued during the third quarter of 2014 in settlement of Performance Units. Since the June 19, 2012 grant date to September 30, 2015, an aggregate of 137,740 Performance Units were settled by two current executive officers and four former executive officers, and 16,524 Performance Units were forfeited by one former executive officer and currently are available to be granted. Such settlements resulted in the issuance of 79,356 shares of common stock and cash payments totaling $0.3 million. As of September 30, 2015, no Performance Units were outstanding.
Performance-Based Restricted Stock Units
On March 30, 2015, eight executive officers of the Company were granted 1,325,000 performance-based restricted stock units (“PBUs”) under the 2008 EIP. Upon vesting, the PBUs will be settled by the issuance of Company common stock equal to 50% of the number of PBUs being settled and the payment of cash in an amount equal to 50% of the fair market value of that number of shares of common stock equal to the number of PBUs being settled. The PBUs vest and become payable based on the cumulative adjusted EBITDA that the Company (excluding the Healthcare Claims Recovery Audit business) achieves for the two-year performance period ending December 31, 2016. At the threshold performance level, 35% of the PBUs will become vested and payable; at the target performance level, 100% of the PBUs will become vested and payable; and at the maximum performance level, 200% of the PBUs will become vested and payable. If performance falls between the stated performance levels, the percentage of PBUs that shall become vested and payable will be based on straight line interpolation between such stated performance levels (although the PBUs may not become vested and payable for more than 200% of the PBUs and no PBUs shall become vested and payable if performance does not equal or exceed the threshold performance level).
On September 28, 2015, certain employees of the Company were granted 1,208,333 PBUs under the 2008 EIP. Upon vesting, the PBUs will be settled by the issuance of Company common stock equal to 25% of the number of PBUs being settled and the payment of cash in an amount equal to 75% of the fair market value of that number of shares of common stock equal to the number of PBUs being settled. The PBUs vest and become payable based on the cumulative adjusted EBITDA that the Company (excluding the Healthcare Claims Recovery Audit business) achieves for the two-year performance period ending

8

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

December 31, 2016. At the threshold performance level, 35% of the PBUs will become vested and payable and at the target performance level, 100% of the PBUs will become vested and payable. If performance falls between the stated performance levels, the percentage of PBUs that shall become vested and payable will be based on straight line interpolation between such stated performance levels (although the PBUs may not become vested and payable for more than 100% of the PBUs and no PBUs shall become vested and payable if performance does not equal or exceed the threshold performance level).
Selling, general and administrative expenses for the three months ended September 30, 2015 and 2014 include $1.4 million related to stock-based compensation charges. Selling, general and administrative expenses for the nine months ended September 30, 2015 and 2014 include $4.5 million and $3.4 million, respectively, related to stock-based compensation charges. At September 30, 2015, there was $11.2 million of unrecognized stock-based compensation expense related to stock options, restricted stock awards and restricted stock unit awards, which we expect to recognize over a weighted-average period of 1.17 years. The unrecognized stock-based compensation expense related to restricted stock unit awards with performance vesting criteria is based on our estimate of both the number of shares of the Company's common stock that will ultimately be issued and cash payments that will be made when the restricted stock units are settled.

9

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note D – Operating Segments and Related Information
We conduct our operations through the following four reportable segments:
Recovery Audit Services – Americas represents recovery audit services (other than Healthcare Claims Recovery Audit services) provided in the United States of America (“U.S.”), Canada and Latin America.
Recovery Audit Services – Europe/Asia-Pacific represents recovery audit services (other than Healthcare Claims Recovery Audit services) provided in Europe, Asia and the Pacific region.
Adjacent Services represents data transformation, data analytics and associated advisory services.
Healthcare Claims Recovery Audit Services represents recovery audit services for healthcare claims, which consist primarily of services provided under subcontracts related to the Medicare Recovery Audit Contractor program.
Additionally, Corporate Support includes the unallocated portion of corporate selling, general and administrative expenses not specifically attributable to the four reportable segments.
We evaluate the performance of our reportable 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 further 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, certain severance charges and foreign currency transaction gains and losses on short-term intercompany balances viewed by management as individually or collectively significant. We do not have any inter-segment revenue.

10

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Segment information for the three and nine months ended September 30, 2015 and 2014 (in thousands) is as follows:
 


Recovery
Audit
Services –
Americas

Recovery Audit
Services –
Europe/Asia-
Pacific

Adjacent
Services

Healthcare Claims Recovery Audit Services

Corporate
Support

Total
Three Months Ended September 30, 2015












Revenue

$
23,981


$
8,052


$
1,332


$
558


$


$
33,923















Net loss











$
(3,409
)
Income tax expense











421

Interest income, net











(8
)
EBIT

$
5,255


$
365


$
(2,373
)

$
(532
)

$
(5,711
)

$
(2,996
)
Depreciation of property and equipment

947


148


160


7




1,262

Amortization of intangible assets

437


47


33






517

EBITDA

$
6,639


$
560


$
(2,180
)

$
(525
)

$
(5,711
)

$
(1,217
)
Foreign currency transaction (gains) losses on short-term intercompany balances

393


287


(714
)



688


654

Transformation severance and related expenses

101






472


272


845

Loss on sale/disposal of assets
 

 

 
1,612

 

 

 
1,612

Stock-based compensation









1,381


1,381

Adjusted EBITDA

$
7,133


$
847


$
(1,282
)

$
(53
)

$
(3,370
)

$
3,275


 
 
Recovery
Audit
Services –
Americas
 
Recovery Audit
Services –
Europe/Asia-
Pacific
 
Adjacent
Services
 
Healthcare Claims Recovery Audit Services
 
Corporate
Support
 
Total
Three Months Ended September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
28,550

 
$
10,708

 
$
3,586

 
$
144

 
$

 
$
42,988

 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
 
 
 
 
 
 
 
 
 
 
$
(239
)
Income tax expense
 
 
 
 
 
 
 
 
 
 
 
554

Interest income, net
 
 
 
 
 
 
 
 
 
 
 
(44
)
EBIT
 
$
7,155

 
$
(151
)
 
$
(265
)
 
$
(1,133
)
 
$
(5,335
)
 
$
271

Depreciation of property and equipment
 
1,111

 
150

 
145

 
22

 

 
1,428

Amortization of intangible assets
 
500

 
299

 
96

 

 

 
895

EBITDA
 
$
8,766

 
$
298

 
$
(24
)
 
$
(1,111
)
 
$
(5,335
)
 
$
2,594

Foreign currency transaction (gains) losses on short-term intercompany balances
 
208

 
1,192

 

 

 
(179
)
 
1,221

Transformation severance and related expenses
 
44

 
7

 
18

 
26

 
318

 
413

Stock-based compensation
 

 

 

 

 
1,405

 
1,405

Adjusted EBITDA
 
$
9,018

 
$
1,497

 
$
(6
)
 
$
(1,085
)
 
$
(3,791
)
 
$
5,633




11

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 
 
Recovery
Audit
Services –
Americas
 
Recovery Audit
Services –
Europe/Asia-
Pacific
 
Adjacent
Services
 
Healthcare Claims Recovery Audit Services
 
Corporate
Support
 
Total
Nine Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
71,748

 
$
27,307

 
$
4,290

 
$
999

 
$

 
$
104,344

 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
 
 
 
 
 
 
 
 
 
 
$
(5,270
)
Income tax expense
 
 
 
 
 
 
 
 
 
 
 
1,172

Interest income, net
 
 
 
 
 
 
 
 
 
 
 
(103
)
EBIT
 
$
15,838

 
$
1,719

 
$
(5,019
)
 
$
(1,961
)
 
$
(14,778
)
 
$
(4,201
)
Depreciation of property and equipment
 
2,895

 
454

 
479

 
30

 

 
3,858

Amortization of intangible assets
 
1,319

 
600

 
98

 

 

 
2,017

EBITDA
 
$
20,052

 
$
2,773

 
$
(4,442
)
 
$
(1,931
)
 
$
(14,778
)
 
$
1,674

Foreign currency transaction (gains) losses on short-term intercompany balances
 
651

 
1,359

 
7

 

 
(87
)
 
1,930

Transformation severance and related expenses
 
265

 
268

 
30

 
683

 
308

 
1,554

Loss on sale/disposal of assets
 

 

 
1,612

 

 

 
1,612

Stock-based compensation
 

 

 

 

 
4,530

 
4,530

Adjusted EBITDA
 
$
20,968

 
$
4,400

 
$
(2,793
)
 
$
(1,248
)
 
$
(10,027
)
 
$
11,300




 
 
Recovery
Audit
Services –
Americas
 
Recovery Audit
Services –
Europe/Asia-
Pacific
 
Adjacent
Services
 
Healthcare Claims Recovery Audit Services
 
Corporate
Support
 
Total
Nine Months Ended September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
80,377

 
$
32,792

 
$
8,150

 
$
1,551

 
$

 
$
122,870

 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
 
 
 
 
 
 
 
 
 
 
$
(5,381
)
Income tax expense
 
 
 
 
 
 
 
 
 
 
 
853

Interest income, net
 
 
 
 
 
 
 
 
 
 
 
(33
)
EBIT
 
$
16,632

 
$
1,309

 
$
(3,607
)
 
$
(4,785
)
 
$
(14,110
)
 
$
(4,561
)
Depreciation of property and equipment
 
3,612

 
445

 
463

 
176

 

 
4,696

Amortization of intangible assets
 
1,501

 
911

 
288

 

 

 
2,700

EBITDA
 
$
21,745

 
$
2,665

 
$
(2,856
)
 
$
(4,609
)
 
$
(14,110
)
 
$
2,835

Foreign currency transaction (gains) losses on short-term intercompany balances
 
164

 
1,079

 

 

 
(170
)
 
1,073

Acquisition-related charges
 

 

 
249

 

 

 
249

Transformation severance and related expenses
 
510

 
569

 
396

 
431

 
446

 
2,352

Stock-based compensation
 

 

 

 

 
3,409

 
3,409

Adjusted EBITDA
 
$
22,419

 
$
4,313

 
$
(2,211
)
 
$
(4,178
)
 
$
(10,425
)
 
$
9,918



12

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note E – Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and highly liquid investments with an initial maturity of three months or less from date of purchase. We place our temporary cash investments with high credit quality financial institutions. At times, certain investments may be in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limit or otherwise may not be covered by FDIC insurance. Some of our cash and cash equivalents are held at banks in jurisdictions outside the U.S. that have restrictions on transferring such assets outside of these countries on a temporary or permanent basis. Such restricted net assets are not significant in comparison to our consolidated net assets.
Our cash and cash equivalents included short-term investments of approximately $3.7 million as of September 30, 2015 and $12.2 million as of December 31, 2014, of which approximately $2.4 million and $2.5 million, respectively, were held at banks outside of the United States, primarily in Brazil and Canada.
Note F – Debt
On January 19, 2010, we entered into a four-year revolving credit and term loan agreement (the “2010 Credit Agreement”) with SunTrust Bank (“SunTrust”). Subsequent modifications of the 2010 Credit Agreement were entered into with SunTrust. Most recently, on December 23, 2014, we entered into an amended and restated revolving credit agreement (the “Credit Facility”) with SunTrust. The Credit Facility, and provisions of the 2010 Credit Agreement where applicable, is guaranteed by the Company and all of its material domestic subsidiaries and secured by substantially all of the assets of the Company.
The amount available for borrowing under the Credit Facility is $20.0 million, and as of September 30, 2015 we had no outstanding borrowings. With the Credit Facility provision of a fixed applicable margin of 1.75% plus a specified index rate based on one-month LIBOR, the interest rate that would have applied at September 30, 2015 had any borrowings been outstanding was approximately 1.95%. We also must pay a commitment fee of 0.25% per annum, payable quarterly, on the unused portion of the Credit Facility.
The 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 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 Credit Facility includes customary events of default. The Company was in compliance with the covenants in its Credit Facility as of September 30, 2015.
Note G – Fair Value of Financial Instruments
We state cash equivalents at cost, which approximates fair market value. The carrying values for receivables from clients, unbilled services, accounts payable, deferred revenue and other accrued liabilities reasonably approximate fair market value due to the nature of the financial instrument and the short term maturity of these items.
We had no debt outstanding as of September 30, 2015 and December 31, 2014. Should we have debt outstanding in the future, we would consider the factors used in determining the fair value of debt to be Level 3 inputs (significant unobservable inputs).
Note H – Commitments and Contingencies
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.

13

PRGX GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note I – Income Taxes
Reported income tax expense in each period primarily results from taxes on the income of foreign subsidiaries. The effective tax rates generally differ from the expected tax rate due primarily to the Company’s deferred tax asset valuation allowance on the domestic earnings and taxes on income of foreign subsidiaries.
Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service in the U.S. and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.
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 GAAP for guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. In accordance with FASB ASC 740, 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 when a tax assessment is raised. The number of years subject to tax assessments also varies by tax jurisdiction.

Note J - Business Acquisitions and Divestitures
We completed several acquisitions and divestitures in recent years (see Note 12 in our Annual Report on Form 10-K for the year ended December 31, 2014). Generally, we acquire businesses that we believe advance our business strategy and we divest assets or businesses that we no longer find strategically aligned with our service offerings.
In August 2015, we divested certain assets from a document service offering purchased as part of the Business Strategy, Inc. acquisition in 2011.
We did not receive any initial cash payments at closing of the transaction and recognized a loss on the sale of $1.6 million, which we recognized in Other loss in the Consolidated Statements of Operations. We may receive a portion of revenue recognized by the buyer for the period from January 1, 2016 to December 31, 2016 that is based on a percentage of revenue from the clients transferred in connection with the disposition. The revenue sharing percentage ranges from 10% to 30% based on the type of solution or service to be performed.
Note K – Subsequent Events
None.

14


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
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 (other than Healthcare Claims Recovery Audit Services) we provide in Europe, Asia and the Pacific region. The Adjacent Services segment 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

15


effectively serve our clients. Further, we continue to pursue our ongoing growth strategy to expand our business beyond our core recovery 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. 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. 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. On April 28, 2015, the Company announced its decision to exit its Healthcare Claims Recovery Audit Services business due to the continued challenges in the Medicare RAC business and our lack of a diversified client base in that segment. The Company has incurred and will likely continue to incur employee termination and other exit costs as a result of this strategic decision. In connection with certain Medicare RAC program overpayment findings under appeal, CMS has proposed to settle with hospitals willing to withdraw such appeals by offering to pay the hospitals 68% of the original inpatient claim paid amount for all eligible claims that they have billed to Medicare. Although we have accrued an estimated liability for our fee repayment obligations under the Medicare RAC program subcontracts, such accrual is based on our historical experience with appeals. As a subcontractor, we are not a party to communications with CMS regarding the settlement; however, we have been in communication with the prime contractors regarding the proposal and its financial impact remains uncertain at this time. Our financial condition and results of operations could be adversely affected if we are required to return Medicare RAC program fees substantially in excess of our accrued liability.
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. We include a reconciliation of net loss to each of EBIT, EBITDA and Adjusted EBITDA and a calculation of Adjusted EBITDA by segment below in “–Adjusted EBITDA”.

16


Results of Operations
The following table sets forth the percentage of revenue represented by certain items in the Company’s Condensed Consolidated Statements of Operations (Unaudited) for the periods indicated:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue
 
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Operating expenses:
 
 
 
 
 
 
 
 
Cost of revenue
 
71.9

 
66.7

 
70.0

 
71.2

Selling, general and administrative expenses
 
25.0

 
24.4

 
25.0

 
25.6

Depreciation of property and equipment
 
3.7

 
3.3

 
3.7

 
3.8

Amortization of intangible assets
 
1.5

 
2.1

 
1.9

 
2.2

Total operating expenses
 
102.1

 
96.5

 
100.6

 
102.8

Operating income (loss)
 
(2.1
)
 
3.5

 
(0.6
)
 
(2.8
)
 
 
 
 
 
 
 
 
 
Foreign currency transaction losses on short-term intercompany balances
 
1.9

 
2.8

 
1.8

 
0.9

Interest income, net
 

 

 
(0.1
)
 

Other loss
 
4.2

 

 
1.4

 

Income (loss) before income taxes
 
(8.2
)
 
0.7

 
(3.7
)
 
(3.7
)
Income tax expense
 
1.2

 
1.3

 
1.1

 
0.7

 
 
 
 
 
 
 
 
 
Net income (loss)
 
(9.4
)%
 
(0.6
)%
 
(4.8
)%
 
(4.4
)%
Three and Nine Months Ended September 30, 2015 Compared to the Corresponding Period of the Prior Year
Revenue. Revenue was as follows (in thousands):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Recovery Audit Services – Americas
 
$
23,981

 
$
28,550

 
$
71,748

 
$
80,377

Recovery Audit Services – Europe/Asia-Pacific
 
8,052

 
10,708

 
27,307

 
32,792

Adjacent Services
 
1,332

 
3,586

 
4,290

 
8,150

Healthcare Claims Recovery Audit Services
 
558

 
144

 
999

 
1,551

Total
 
$
33,923

 
$
42,988

 
$
104,344

 
$
122,870

Total revenue decreased for the three months ended September 30, 2015 by $9.1 million, or 21.1%, compared to the same period in 2014. Total revenue decreased for the nine months ended September 30, 2015 by $18.5 million, or 15.1%, compared to the same period in 2014.
Below is a discussion of our revenue for our four reportable segments.
Recovery Audit Services – Americas revenue decreased by $4.6 million, or 16.0%, for the third quarter of 2015 compared to the third quarter of 2014. For the nine months ended September 30, 2015, revenue decreased by $8.6 million, or 10.7%, compared to the same period in the prior year. One of the factors contributing to changes in our reported revenue is the strength of the U.S. dollar relative to foreign currencies. Changes in the average value of the U.S. dollar during the periods relative to foreign currencies negatively impacted our revenue for the reported periods. On a constant dollar basis, adjusted for changes in foreign exchange (“FX”) rates, revenue for the third quarter of 2015 decreased by 11.5% compared to a decrease of 16.0% as reported and decreased by 7.1% during the first nine months of 2015 compared to a decrease of 10.7% as reported.
In addition to the impact of the change in FX rates, the year over year net decrease in our Recovery Audit Services – Americas revenue in the three and nine months ended September 30, 2015 was due to a number of factors. Revenue at our existing clients declined 8.5% in the three-month period and 8.1% in the nine-month period primarily due to lower contingency

17


fee rates at several clients, delays in claims conversion at key clients and a change in position from primary auditor to secondary auditor at a large client. Additionally, the 2014 third quarter included revenue of approximately $0.9 million from a large contract compliance claim and revenue from a large client who filed bankruptcy in the third quarter of this year, which together combined for approximately $1.4 million of revenue in the prior year. Partially offsetting these declines, revenue increased 4.1% and 3.5% in the three and nine-month periods, respectively, due to new clients.
Recovery Audit Services – Europe/Asia-Pacific revenue decreased by $2.7 million, or 24.8%, for the three months ended September 30, 2015 compared to the same period in 2014. For the nine months ended September 30, 2015, revenue decreased by $5.5 million, or 16.7%, compared to the same period in the prior year. The changes in the value of the U.S. dollar relative to foreign currencies in Europe, Asia and the Pacific region negatively impacted reported revenue for the third quarter and first nine months of 2015 compared to the same periods in 2014. On a constant dollar basis, adjusted for changes in FX rates, revenue decreased by 15.2% for the third quarter of 2015 and decreased by 4.9% during the first nine months of 2015 compared to the same periods in 2014. The 15.2% net decrease on a constant dollar basis for the three-month period included net decreases in revenue of 13.3% attributable to existing clients and 2.0% attributable to lost clients. The 4.9% net decrease in revenue on a constant dollar basis for the nine-month period included decreases in revenue of 4.6% attributable to lost clients and 1.6% attributable to cyclical clients, which were partially offset by an increase in revenue of 2.0% for new clients.
Adjacent Services revenue decreased by $2.3 million, or 62.9%, for the three months ended September 30, 2015 and decreased $3.9 million, or 47.4%, for the nine months ended September 30, 2015 compared to the same periods in 2014 primarily due to the sale of our Chicago, Illinois-based consulting practice on October 1, 2014 and reduced revenue from delays associated with the transition between phases of a few large engagements.
Healthcare Claims Recovery Audit Services revenue increased $0.4 million for the three months ended September 30, 2015 when compared to the same period in 2014 and decreased $0.6 million for the nine months ended September 30, 2015 when compared to the same period in 2014. On April 28, 2015, the Company announced its decision to exit its Healthcare Claims Recovery Audit Services business.
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):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Recovery Audit Services – Americas
 
$
15,139

 
$
17,074

 
$
45,272

 
$
50,148

Recovery Audit Services – Europe/Asia-Pacific
 
5,883

 
7,608

 
18,927

 
23,698

Adjacent Services
 
2,485

 
3,284

 
6,586

 
9,168

Healthcare Claims Recovery Audit Services
 
880

 
715

 
2,300

 
4,443

Total
 
$
24,387

 
$
28,681

 
$
73,085

 
$
87,457

COR as a percentage of revenue for Recovery Audit Services – Americas was 63.1% and 59.8% for the three months ended September 30, 2015 and 2014, respectively, and 63.1% and 62.4% for the nine months ended September 30, 2015 and 2014, respectively. The increase in COR as a percentage of revenue for the three and nine months ended September 30, 2015 compared to the same periods in 2014 is primarily due to the declines in revenue for the the 2015 periods and our continued investment in our contract compliance service offering.
COR as a percentage of revenue for Recovery Audit Services – Europe/Asia-Pacific was 73.1% and 71.0% for the three months ended September 30, 2015 and 2014, respectively, and 69.3% and 72.3% for the nine months ended September 30, 2015 and 2014, respectively. The increase in COR as a percentage of revenue for the three months ended September 30, 2015 compared to the same period in 2014 is primarily due to the decline in revenue for the third quarter of 2015.
COR as a percentage of revenue for Recovery Audit Services – Europe/Asia-Pacific is generally higher than COR as a percentage of revenue for Recovery Audit Services – Americas primarily due to differences in service delivery models, scale

18


and geographic fragmentation. The Recovery Audit Services – Europe/Asia-Pacific segment generally serves fewer clients in each geographic market and on average generates lower revenue per client than those served by the Company’s Recovery Audit Services – Americas segment.
COR as a percentage of revenue for Adjacent Services was 186.6% and 91.6% for the three months ended September 30, 2015 and 2014, respectively, and 153.5% and 112.5% for the nine months ended September 30, 2015 and 2014, respectively. The increase in COR as a percentage of revenue for the three and nine months ended September 30, 2015 compared to the same periods in 2014 is primarily due to carrying costs associated with the delays in transitioning between phases of a few large engagements while continuing to focus on closing new client sales.
Healthcare Claims Recovery Audit Services COR relates primarily to costs associated with the Medicare RAC program subcontracts. COR increased $0.2 million for the three months ended September 30, 2015 and decreased $2.1 million for the nine months ended September 30, 2015 compared to the same periods in 2014. The decrease for the nine months ended September 30, 2015 was primarily due to personnel reductions and reduced direct costs associated with the Medicare RAC program such as costs for medical records and other costs associated with the generation of claims. These reductions were not sufficient to enable us to achieve revenue in excess of COR for our services under the Medicare RAC program, resulting in COR exceeding revenue in the 2015 periods.
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):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015

2014
Recovery Audit Services – Americas
 
$
1,810

 
$
2,502

 
$
5,773

 
$
8,320

Recovery Audit Services – Europe/Asia-Pacific
 
1,322

 
1,610

 
4,248

 
5,350

Adjacent Services
 
129

 
326

 
527

 
1,838

Healthcare Claims Recovery Audit Services
 
203

 
540

 
630

 
1,717

Subtotal for reportable segments
 
3,464

 
4,978

 
11,178

 
17,225

Corporate Support
 
5,023

 
5,514

 
14,865

 
14,280

Total
 
$
8,487

 
$
10,492

 
$
26,043

 
$
31,505

Recovery Audit Services – Americas SG&A decreased by $0.7 million, or 27.7%, for the three months ended September 30, 2015 and decreased by $2.5 million, or 30.6%, for the nine months ended September 30, 2015 compared to the same periods in 2014 due primarily to lower compensation expense that resulted from our transformation efforts and reductions in bad debt expense.
Recovery Audit Services – Europe/Asia-Pacific SG&A decreased $0.3 million, or 17.9%, in the three months ended September 30, 2015 and decreased $1.1 million, or 20.6%, in the nine months ended September 30, 2015 compared to the same periods in 2014. These decreases are primarily due to an increase in the value of the U.S. dollar relative to foreign currencies in Europe, Asia and the Pacific region between the 2015 and 2014 periods.
Adjacent Services SG&A decreased $0.2 million, or 60.4%, in the three months ended September 30, 2015 and decreased $1.3 million, or 71.3%, in the nine months ended September 30, 2015 compared to the same periods in 2014. These decreases are primarily due to lower compensation, travel and office-related expenses that declined as a result of personnel reductions that were made as we rationalized our service offerings in this segment.
Healthcare Claims Recovery Audit Services SG&A decreased $0.3 million, or 62.4%, in the three months ended September 30, 2015 and decreased $1.1 million, or 63.3%, in the nine months ended September 30, 2015 compared to the same periods in 2014. These decreases are primarily due to reductions in overhead charges and occupancy costs that resulted from staff reductions in this segment necessitated by the decline in Healthcare Claims Recovery Audit Services revenue.

19


Corporate Support SG&A decreased $0.5 million, or 8.9%, for the three months ended September 30, 2015 and increased $0.6 million, or 4.1%, for the nine months ended September 30, 2015 compared to the same periods in 2014. The decrease for the three-month period is primarily due to a decrease in incentive compensation expenses. The increase for the nine-month period is primarily due to an increase in equity compensation expenses which were partially offset by reductions in legal and accounting costs.
Depreciation of property and equipment. Depreciation of property and equipment was as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015

2014
Recovery Audit Services – Americas
 
$
947

 
$
1,111

 
$
2,895

 
$
3,612

Recovery Audit Services – Europe/Asia-Pacific
 
148

 
150

 
454

 
445

Adjacent Services
 
160

 
145

 
479

 
463

Healthcare Claims Recovery Audit Services
 
7

 
22

 
30

 
176

Total
 
$
1,262

 
$
1,428

 
$
3,858

 
$
4,696

The overall decrease in depreciation relates primarily to the mix and timing of our capital expenditures and the associated useful lives for such purchases.
Amortization of intangible assets. Amortization of intangible assets was as follows (in thousands):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015

2014
Recovery Audit Services – Americas
 
$
437

 
$
500

 
$
1,319

 
$
1,501

Recovery Audit Services – Europe/Asia-Pacific
 
47

 
299

 
600

 
911

Adjacent Services
 
33

 
96

 
98

 
288

Total
 
$
517

 
$
895

 
$
2,017

 
$
2,700

The decreases in amortization expense for the three and nine months ended September 30, 2015 compared to the same periods in 2014 are primarily due to the end of the finite lives of certain intangible assets, added no new intangible assets since 2013, the disposition of intangible assets as a result of the sale of our Chicago, Illinois-based consulting practice on October 1, 2014 and the August 2015 disposal of certain non-core assets related to a document service offering purchased as part of the Business Strategy, Inc. acquisition in 2011. 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. Unless we complete an acquisition in any of our reportable segments in 2015, we anticipate that amortization expense will continue to decrease in 2015 compared to 2014.
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 for 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. In the three months ended September 30, 2015 and 2014, we recorded foreign currency transaction losses of $0.7 million and $1.2 million, respectively, on short-term intercompany balances. In the nine months ended September 30, 2015 and 2014 we recorded foreign currency transaction losses of $1.9 million and $1.1 million, respectively, on short-term intercompany balances.
Income Tax Expense. Our income tax expense amounts as reported in the accompanying Condensed Consolidated Financial Statements (Unaudited) do not reflect amounts that normally would be expected due to several factors. The most significant of these factors is that for U.S. tax reporting purposes we have net operating loss carryforwards and other tax attributes which created deferred tax assets on our balance sheet. 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. Generally, these factors result in our recording no net income tax expense or benefit relating to our operations in the United States. Reported income tax expense for the three and nine months ended September 30, 2015 and 2014 primarily resulted from taxes on the income of certain of our foreign subsidiaries.

20


Adjusted EBITDA. We evaluate the performance of our reportable 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 further 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, certain severance charges and foreign currency transaction gains and losses on short-term intercompany balances viewed by management as individually or collectively significant.
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):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015

2014
Net loss
 
$
(3,409
)
 
$
(239
)
 
$
(5,270
)
 
$
(5,381
)
Income tax expense
 
421

 
554

 
1,172

 
853

Interest (income), net
 
(8
)
 
(44
)
 
(103
)
 
(33
)
EBIT
 
$
(2,996
)
 
$
271

 
$
(4,201
)
 
$
(4,561
)
Depreciation of property and equipment
 
1,262

 
1,428

 
3,858

 
4,696

Amortization of intangible assets
 
517

 
895

 
2,017

 
2,700

EBITDA
 
$
(1,217
)
 
$
2,594

 
$
1,674

 
$
2,835

Foreign currency transaction (gains) losses on short-term intercompany balances
 
654

 
1,221

 
1,930

 
1,073

Acquisition-related charges
 

 

 

 
249

Transformation severance and related expenses
 
845

 
413

 
1,554

 
2,352

Loss on sale/disposal of assets
 
1,612

 

 
1,612

 

Stock-based compensation
 
1,381

 
1,405

 
4,530

 
3,409

Adjusted EBITDA
 
$
3,275

 
$
5,633

 
$
11,300

 
$
9,918

Transformation severance and related expenses increased $0.4 million for the three months ended September 30, 2015 and $0.8 million for the nine months ended September 30, 2015 compared to the same periods in 2014. Transformation severance and related expenses fluctuate with staff reductions and lease expenses associated with vacating office space across all segments in order to reduce our cost structure.
Stock-based compensation was essentially unchanged for the three months ended September 30, 2015 compared to the prior year and increased $1.1 million, or 32.9% for the nine months ended September 30, 2015 compared to the same period in 2014. The year over year increase for the nine-month period is due to higher expenses associated with equity awards granted during the 2015 fiscal year.
We include a detailed calculation of Adjusted EBITDA by segment in Note D of “Notes to Consolidated Financial Statements” in Item 1 of this Form 10-Q. A summary of Adjusted EBITDA by segment for the three and nine months ended September 30, 2015 and 2014 is as follows (in thousands):

21


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Recovery Audit Services – Americas
 
$
7,133

 
$
9,018

 
$
20,968

 
$
22,419

Recovery Audit Services – Europe/Asia-Pacific
 
847

 
1,497

 
4,400

 
4,313

Adjacent Services
 
(1,282
)
 
(6
)
 
(2,793
)
 
(2,211
)
Healthcare Claims Recovery Audit Services
 
(53
)
 
(1,085
)
 
(1,248
)
 
(4,178
)
Subtotal for reportable segments
 
6,645

 
9,424

 
21,327

 
20,343

Corporate Support