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PRGX Global Inc. (NASDAQ:PRGX)

Q1 2013 Earnings Conference Call

April 30, 2013 8:30 a.m. ET

Executives

Romil Bahl – President and CEO

Bob Lee – CFO

Analysts

Joe Janssen – Barrington Research

Kevin Liu – B. Riley & Company

Patrick Wang – Robert W. Baird & Co., Inc.

Tim McHugh – William Blair & Company

Richard Close – Avondale Partners

Gregg Hillman – First Wilshire Securities

Operator

Good day, ladies and gentlemen, and welcome to the PRGX Global, Inc. Q1 2013 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Romil Bahl, Chief Executive Officer. You may begin.

Romil Bahl

Thank you, Latoya. Good morning, good afternoon and good evening to each of you around the world. Thank you for joining PRGX Global Inc.'s first quarter 2012 earnings call. We thank you all for the time that you are taking to be with us today.

Our Chief Financial Officer, Bob Lee, is with me here in our Atlanta headquarters. And after my introductory comments, he will review our financial results for the quarter. I will then update you on our operations and the ongoing execution of our growth strategy. Once we conclude our remarks, we will open the call for your questions.

As many of you saw from our results yesterday and as we announced in our pre-earnings release, our first quarter 2013 financial results were disappointing. The majority of the issues driving these results are explainable, given the lumpy nature of our business. In addition, we received new information over the last few weeks pertaining to our healthcare claims recovery audit or HCRA business, as it relates to the Medicare Act Program Rebate process being conducted by CMS. The most significant new information relates to the plan and transition period from current RAC contracts to the future RAC contracts.

Further, and while we submitted our proposal for the next five year contact with CMS earlier this month, the results of rebid process will have additional implications for our financial performance.

My message today is that while we had hoped our successful smooth transformation and growth trajectory would continue; 2013 and 2014 have become less predictable.

So, what exactly does that mean and what are we doing about it? I want to quickly you PRGX Global have been on a journey to try to double our adjusted EBITDA from 2010 to 2014.

After $21 million plus in adjusted EBITDA in 2010, and $24 million plus in 2011 and a $31 million plus in 2012.

Despite the lumpiness of revenue in our service areas, we have delivered a remarkable smooth and predictable turnaround story to date. In fact, prior to this quarter, we delivered quarter-over-quarter growth in 13 over the last 14 quarters.

Our goal is to hit the mid-30s in adjusted EBITDA in 2013, and then to try to exceed $40 million next year. It is this smooth journey that could mean question as 2013 unfolds.

But do declare, we do not believe our overall transformation journey is in jeopardy. The mid-term and long-term growth prospects of the business remain in fact.

Before turning the call over to Bob, let me make some comments on the quarter.

During the yearend call, I indicated that we experienced some issues with our HCRA business. And while several of the external issues were resolved during the first quarter, similar to the other RAC contractors, some revenue has been delayed in the Q2.

We also have been challenging audit rates that resulted in lower hit rates in Q1, an issue that has already been addressed, as we audit our recent rates, and hit rates are back to where we expect.

While the HCRA weakness has been partially offset by a stronger profit optimization or PO quarter than the same period last year, our new services segment is somewhat bound, compared to Q1 2012.

This brings us to our core accounts payable recovery audit service area, which as most of you know is inherently lumpy, given the dynamics of being a 100% contingent business.

Typically, we rely on a number of the audits across our portfolio to better than expected, which offset other audits were claims may not be as rich or where audit cycles are in transition periods.

It is quite rare that this portfolio does not stabilize our financial performance but such was the case in the first quarter of 2013.

Specifically, we encountered delays in large claim approvals at several clients both in the Americas and in the EAP region. In addition, we had an isolated delivery issue at a significant client in the Americans, which is currently being the addressed. And over in Europe, we continue to experience the weakness caused both by the macroeconomic issues impacting that region, as well as the loss of a few clients, including some of the bankruptcy or as they refer to in Europe administration.

Collectively, these items led to a weak quarter in the in the core business. But for the most part, our claims pipeline looks healthy and we expect to recognize much of this revenue over the remainder of the year.

Shifting the discussions on the individual service lines to the company as a whole, again given the lack (inaudible) of revenue across our service areas, we traditionally count on large (inaudible) of our service line exceeding expectations to make up for temporary weakness and other service lines during any given quarter.

Perhaps perfect storm is too dramatic a term to describe Q1 results but we certainly believe that the combination of weakness in HCRA, coupled with simultaneous weakness in both our core business regions in a rare occurrence. And while PO continues to strengthen – not that we have successfully repositioned that business over the last year or so, its impact on the overall company's results remain small.

I will end my introductory comments by saying that we believe this is a temporary situation that will write itself in both the core business and in PO over the remainder of the year. I will get into the potential full-year scenarios for the HCRA business, as part of my go-forward comments after Bob provide details in our financial results for Q1.

Bob Lee

Thank you, Romil, and good day to everyone. I will be reviewing our financial results for the three months ended March 31, 2013. Let me note at the outset that certain statements in this conference may be considered forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act. These statements include statements relating to management's views, with respect to future events and financial performance that are based on management's current expectations and beliefs and are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from historical experience or from future results expressed or implied by such forward-looking statements.

For additional information on these factors, please refer to PRGX Global Inc.'s filings with the Securities and Exchange Commission, including, but not limited to, its reports on Forms 10-K and 10-Q. PRGX undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

This presentation also contains references to certain non-GAAP financial measures, such as EBIT, EBITDA and adjusted EBITDA; metrics that we use internally to measure our operating performance. A reconciliation between these non-GAAP measures and net earnings are (inaudible) the most directly comparable GAAP measure is available under the Investor Relations portion of our website at www.prgx.com.

Now, to begin the review of our financial results for the three months ended March 31, 2013. Our revenues were $45.1 million, compared to the prior year's first quarter revenue of $51.6 million, a decrease of 12.7%. On a constant dollar basis, adjusted for changes in foreign currency exchange rates, 2013 first quarter revenues decreased 11.9%, compared to the same period in 2011.

Recovery Audit Services' Americas revenue was $26.2 million, compared to the prior year's first quarter revenue of $28.8 million, a decrease of 8.9%. On a constant dollar basis, adjusted for changes in foreign exchange rates, Recovery Audit Services' Americas first quarter revenues decreased 8.4%, compared to the same period in 2011.

Recovery Audit Services' Europe Asia/Pacific revenue was $11 million, compared to prior year's first quarter revenue of $14.3 million, a decrease of 23%. On a constant dollar basis, adjusted for changes in foreign exchange rates, Recovery Audit Services' Europe Asia/Pacific first quarter revenue decreased by 21.4%, compared to the same period in 2011.

New Services revenues were $7.8 million, compared to the prior year's first quarter revenue of $8.5 million, a decrease of 8.1%. Our New Services segment is comprised of our Healthcare Claims Recovery Audit business, as well as our Profit Optimization services. Our cost to revenue, our core, was $30.4 million in the first quarter of 2013, compared to $34.2 million in last year's first quarter, which was 67.4% of revenue in 2013 and 66.3% of revenue in the same quarter in 2012.

Total SG&A in the 2013 first quarter was $11.7 million, compared to $12.4 million in last year's first quarter or approximately 26% and 24.5% of revenue in each period respectively.

Depreciation expense increased $0.5 million and amortization decreased $1.1 million, compared to the first quarter of 2012. The increase in depreciation is primarily due to the improvements we made in our IT infrastructure and the depreciation related to software development projects placed on the service in the second half of last year. The decrease in amortization is due to the 2012 period, including greater acquisition-related charges in the 2013 period.

For the three months ended March 31, 2013, our net earnings were $0.5 million or $0.2 per basic and diluted share, compared to net earnings of $0.3 million or $0.1 per basic and diluted share for the same period in 2012. The 2013 first quarter included a $1 million credit, resulting from the release of a portion of the reserves held for uncertain tax positions. Approximately, $0.06 million of this release, related to accrued interest on these reserves and is included as a credit to interest expense, and the remainder is reflected as reduction of income tax expense.

Our adjusted EBITDA for the first quarter 2013 was $4.4 million, compared to $6.8 million of adjusted EBITDA for the same period in 2012. First quarter 2012 adjusted EBITDA excludes a $1.3 million charge related to stock-based compensation, $0.1 million for acquisition obligations classified as compensation, $0.4 million of foreign currency losses on short-term company balances.

The comparable adjusted EBITDA for the first quarter 2012 excludes a $1.4 million charge related to stock-based compensation, $0.1 million for acquisition obligations classified as compensation, $0.2 million of transformation severance and related expenses, and $0.2 million of wage claim cost and $0.3 million of foreign currency gains on short-term intercompany balances.

I will now highlight certain 2013 balance sheet and cash flow information.

As of March 31, 2013 we had unrestricted cash and cash equivalence of $37.8 million and had no borrowings against our revolving credit facility.

(Inaudible) outstanding was $5.3 million, representing the outstanding balance on a variable rate term loan due in quarterly installments through Dec 2013 with a final payment due in Jan 2014.

At March 31 2013, current assets exceeded current liabilities bit $39.2 million.

Net cash provided by operating activities for the three months ended March 31, 2013 amounted to $0.8 million, compared to $2 million in the first quarter of the prior year.

Before working capital changes, cash provided by operating activities amounted to $4.5 million for the three months ended March 31, 2013, compared to $5.2 million for the three months ended March 31, 2012.

Capital expenditures in property equipment for the three months ended March 31, 2013 were $2.2 million.

Net cash provided by financing activities for the three months ended March 31, 2013 amounted to $1.6 million, compared to a $1.6 million net use of cash in the first quarter of the prior year. This change is primarily due to the $4.1 million of net proceeds received from the January 2013 exercise of the over (inaudible) option by the underwriters from our follow-on public offering in December of last year.

With that summary of the financial results, I will now turn it back over to Romil.

Romil Bahl

Thank you, Bob.

Let me first provide quick synopsis of our NGRA or Next Generation Recovery Audit core business and our PO business before spending the bulk of my time up outlining the implications of the CMS RAC program rebate on our HCRA business line.

Let's talk about the EAPA region first in our NGRA business. As you all know, the audit in arrears, so the full (front) of Europe's economic issues have been hitting our numbers over the past three quarters and the first quarter of 2013 was no exception.

It will take a while for the macroeconomic trends in this region to become our friend again. It will happen eventually but it's certainly taking longer than any of us would have expected, given the double-dip and triple-dip recessions in some of our key geographies in the region.

Our corrective actions in the EAP region continue to gain in intensity. We have initiated our service delivery model transformation in this region just as we said we would this year. And while it is the region where centralization and off shoring is much more complicated that is a North America, we are making progress. In fact, we are utilizing not just our (inaudible) England center and, of course our (inaudible) India Shared Services Center quite possible, we are also initiating the use of Montreal, Canada as a French-speaking Shared Services Center, and we have just opened the center in Sachar probably Czech Republic City of (Burno).

Just as a process in the Americas part is slowly and then gained the momentum, we expect that our EAP region clients and our teams will get more comfortable with the process we are implementing. And then we will accelerate our cost to serve production over the coming years.

We are also continuing to drive our global best practices effort, which are expected to result in greater than liberty consistency across the (inaudible) region and the almost 30 countries we serve across EAP.

Our Americas business also under delivered this quarter. This is primarily the result of audit delays and also a few clients delaying claims approvals. Unfortunately, too many of these delays occurred at some of our largest clients that skewed thanks to the downside.

We also have delivery issues at one significant client, which contribute to the situation we find ourselves in for the quarter.

And finally, we have seen an uptake in claims dispute and cancellations, especially with clients who are on weak financial footing. As you might guess, there's a far better likely a little bit time from this situation will cave to vendor pressure on large claims, and there is currently very little we are able to do when this occurs.

Likewise, some deferred client situations also occurred in Europe. Also, one of our big recent wins in Europe continues to be a drain. We will change the situation one way or the other in the very near term. Conversely, our two large Pacific sub region wins are ramping nicely, which bodes well for the remainder of the year.

So, on the quarter was overly lumpy for our core (inaudible). I believe our teams are focused on what they need to do and that largely speaking the NGRA business will do what we expected it to do in 2013, i.e., perform close to last year's levels.

Moving on to our new services segment, let's talk about the key growth level we have in our forward-looking private optimization services. As I said during our last investor call, although these services went through a period of weakness in late 2011 and early 2012, they had stabilized and improved to the point where we believe they can grow in 2013.

Just as predicted, our PO team delivered quarter-over-quarter growth and helped make up part of the ground lost by our healthcare team. Our spend optimization and merchandize optimization services have gained market traction, given our improved analytics capabilities and our improved focus and actionable insights that add value to our funds. Our data confirmation services also continue to gain strength and our obvious core competence in this space makes for instant credibility with our client base.

We have already executed some outstanding engagements in this area and our planned opportunity pipeline continues to grow. In fact we have very high hopes for our data transformation service because of our natural footprint in the information and analytic space. We have spent 40 years developing and perfecting capabilities to gather clean integrate and enrich massive volumes of otherwise dirty and poorly integrated data. Currently we use this claims to integrated data to generate recovery audit claims, as well as to enable certain new services. But we are now starting to focus on providing our clients with direct access to claims data for broader analytics and operations purposes.

As I mentioned on this – on the last call, while these services take us towards a more technical set of capabilities, we believe it is a wholly worthwhile direction given our growing analytics and information technology capabilities including those delivered by our India center and given the sheer volume of dollars that our clients are spending on data and IT services.

All in all, I'm pleased with our field service incubation efforts over the past three plus years, while we spent the vast majority of our investment dollars in fixing the core business in improving our technology and tool kits and of course in launching our HCRA capabilities, we have been able to invest nominally in this area of services that leverage the big datasets our clients entrust us with.

So, that we could learn what works, what solutions are clients are looking for at (center)? We have done this successfully and now we know that with the right focus in the service area, we can grow it handsomely. Certainly, if we are able to pull off some acquisitions in this space, we could really turbocharged our growth and importantly continue to change our mix of services, which in 2012 was still in the range of 84% at GRA and 16% new services.

Finally, let me move to our Healthcare Claims Recovery Audit service, which has been our entree into the overall space known as Healthcare Payment Integrity. You heard me say on the last call that I believe 2013 would be an even better year than 2012 for this service area. This statement was based on the fact that we have continued to improve our capabilities and that we believe that we would audit for most all of this year on the current Medicare RAC program, the other three subcontracts we have in the region A, B and D. You'll recall that our subcontracts were originally expected to end on February 4, 2014 and hence it was fair to assume, we would be auditing until very near the end of this year, i.e., 2013.

However since the last call, we have been provided with more information and it appears that CMS has plan that the current Medicare RAC program will be in a transition phase for the last six months of the current contract, i.e., from August 5, 2013 to February 4, 2014. Our understanding is that there will be no first-time erroneous payment claims accepted after August 5 this year and based on our audit waves and timelines with each prime contractor, PRGX may well have earlier deadlines. Clearly, auditing has to end before (inaudible) submission, we need time for cleanup and that is why we believe that at this transition plan stands, there will be very limited auditing on our current Medicare subcontracts in the second half of the year.

Of course, we believe the precise cutoff for auditing and claims selection on our current subcontracts, depends on CMS's decision timeline for new RAC program contracts. We believe our client is sensitive to keeping the auditing of Medicare claims moving, given how successful the program has been in terms of returning taxpayer dollars to the Medicare trust funds and so as the decision process is delayed for any reason including due to the existing pre-award protest, or due to protest cycles after the initial decision has announced, it is possible that the claim submission deadline under the current contracts may be pushed out to later in the year.

The other labor our client has to ensure there is accountability in the Medicare Part A/B Recovery Audit Program is to allow early movement on ramping up the new program. While the RFQ are request for quote for the contract rebid suggests that any bidding company should be willing to invest for at least six to nine months on the ramp up of the contract, we hope that it will be quicker than that, at least for those of us currently involved. For example, we have audit concepts already approved in the three of the four regions. So, our time to audit should be amongst the quickest of current contractors, especially if we win one of these three regions.

This time is probably a good time to segue into the rebid process itself. As I stated on the last call, we believe that we have a good chance of winning the contract as a prime based on our delivery record, and experience in three of the four current regions and with five of the eight Medicare administrative contractors or MACS.

The RFQ and statement of work, we were provided, did not represent any major surprises for us and with the clarifications we later received when our client answered questions from the bidders, we were able to craft and submit a high quality response.

Given our experience with the demonstration program, and of course the last four plus years of the current contract, we are confident that PRGX is qualified to continue to serve CMS on this key program. Of course, it is also clear in the rebid materials that the ultimate decision will be driven by price, i.e., once qualified to deliver the program technically, the bidding process will come down to the lowest average (inaudible) rate for each of the five contracts.

So, depending on how aggressive the various bidders are, not just the current competitive set of five contractors, but also any new entrants who may be focused on entering this exciting space. The prices could be set to fall by drastically. I am not sure if the percentage drop will as steep as it was last time around, when the contingent rates went from the 27% to 29% range across the three states in the demonstration program to the 9% to 12% range today and even less in reality when you look at the actual effective rates after discounts from various claims types but that said, the price reductions could still be quite dramatic.

On this topic, let me be clear. We have been aggressive on price; we were determined to put our best foot forward just in case there are no reopenings were best in final rounds in the ongoing decision process. If we lose the prices below our current bid range, we really wouldn't want this bid (wins) anyway. Even at the rates we bid, we will be challenged to deliver profitably over the life of this program; especially given the changes that could be coming including those resulting from the pressure of the program is feeling from its critics, notably the provider side logins. There is significant (human cry) over the provider administration burden the program has causing, there are lawsuits and even new builds being tabled in our nation's capital to address these concerns. And we expect the program will continue to be somewhat noisy.

Summarizing the Medicare RAC program rebid (then), we remain cautiously optimistic about our chances of winning a contract. I will spend the last part of my prepared remarks outlining two potential scenarios, (NYSEARCA:IEO) win scenario and a loss scenario for PRGX in the CMS Medicare RAC program. If we win one of the regions, we will more than double the volume of spend we currently audit. Net of the rate reduction impacts, our RAC program revenue will clearly not double and we expect there will be near term RAC program EBITDA losses, first long as it takes us to ramp up on the new program.

To be clear, we had expected the transition impacts would be limited and would occur in 2014. But it now looks like these impacts will start in 2013 and then go into 2014, last thing until we can get the program back to breakeven on a run rate basis. If we don't win a region, the impact on our profitability should be largely limited to 2013. We would take appropriate action to reduce our cost base before turning our focus to the early thinking we have done with respect to the rest of our action plan for this scenario.

As you know, our current RAC subcontracts form the vast majority of our revenue in the HCRA space and while we have initiated our business development efforts to penetrate the private sector, we are still at an early stage. As you might imagine, we are not spending significant time thinking about the scenario because we believe that we can be a player in the RAC program and continue to be a great partner to CMS.

In summary, while our business transformation has been highly successful to-date and the Company's bright future remains intact, 2013 and 2014 have become less predictable than we had anticipated. We are managing through our challenges and remain focused our opportunity. We expect our core business to rebound from the slow lumpy first quarter of 2013, our NGRA cost-to-serve reduction efforts remain in place and are expected to drive EBITDA growth during the coming years. The results of the CMS contract rebid will drive our actions in the near term including influencing our M&A activity.

Finally, the good news is that we have not just one but two sets of new services that target exciting secular growth markets. Depending on how things shake out the remainder of the year, it is possible that going forward, we could focus on one service area more than the other to ensure we take maximum advantage of our growth opportunities overall. As the end of my planned update for today, we look forward to answering your questions. I will now turn it back over to Latoya to help facilitate the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). The first question is from Alex Paris of Barrington Research, your line is open.

Joe Janssen – Barrington Research

Joe Jensen filling for Alex Paris. Real quick just following on some of the comments you made, any thoughts here, as to why CMS expanded this window from August of February? It just seems by having a fifth month window at least a lot of money here on the table that the government can use. I'm just curious as to why CMS is doing this?

Romil Bahl

Yes. Look, I can – let me make a couple of comments. So, first, I think CMS is very sensitive, as I said in my prepared comments, as well to these recoveries and how successful this program has been, so I don't think there's some lack of responsibility issue here at all, number one.

Number two, you know, is the responsibility to ensure a free or completely fair (rebate) process, right? And part of that is ensuring a clean transition and ensuring that the new winners stand set up for success in some of the program is set up for success in the future, right?

So, in my personal opinion, while this sort of worst-case scenario looks really horrendous, right? I mean, six months of no auditing on the current contract, six to nine months is kind of what they say in RFQ as guidance for anybody better prepared for as much as six to nine months of ramp-up period and investment period, I don't think any of us, really reasonable people think that this is going to be up 12 to 15 months type of transition. Not. As far as (inaudible) to tell you, but that's the worst-case and that's what we're seeing. But I don't think any of us believe it, right?

So, my personal belief is that there will be more of an overlap between the transition period of the current contracts and the wrap-up of the future contract. And I believe CMS remains very sensitive to this. And frankly, those of us that aren't primes today are very grateful that we have a fair shot at getting the a new one in the future.

Joe Janssen – Barrington Research

Could those claims be retroactive? Can you go back into that window? Or you're only going to file a claim, as of February 15th on claims that happen within a shorter period of time.

Romil Bahl

Well – and that's the beauty of this whole thing. You have nailed it, right? This is merely a deferral of revenue situation at its worst case because the program had a three-year look back to it. So, any period that is not spent thoroughly will be hard off that year to look back whenever we start. And again we start soon but we will definitely be able to get at those claims when we do start auditing, again, assuming we're going to win it.

Joe Janssen – Barrington Research

And then, in terms of timing of the awards here. And I'm sure you saw it and we're talking about it where the HMS files a complaint with a GAO, which they're going to give 100 days for review process. Some out there were optimistic that the timing of the awards would be given in August. But it sounds – and maybe you can drive more color. It almost sounds like this thing can be pushed maybe in the Q4.

Romil Bahl

Yes, again, in a worst case scenario, is that possible? Yes. It is possible that GAO takes ever bit of the 100 days and decides only on July 15th, which is the deadline they have announced that – again, in that worst case scenario, maybe the protest is actually sustained and GAO makes some recommendations and CMS does not provide or revise solicitation. I mean, yes.

And then, there could be protests even after the decision made after that, right? So, yes, worst case scenario, it could go that far.

We're not necessarily there yet, again. We believe that this protest will not necessarily delay the decision timelines and, again, that's one of the reasons CMS allowed for this audition period is to make sure that they have the time to ensure that the new winners could be transitioned too and the clean-ups could occur. And, again, we remain hopeful that the delays will not be substantial.

Joe Janssen – Barrington Research

Yes. And one last question – do – how many people are actually bidding on this? I think – and you talked about this two or 23 in the last time, this was out for bid, given the three-year experience requirement, which, obviously, offset (inaudible) as well. How many more are out there are actually bidding on this process?

Romil Bahl

Yes. It's impossible for us to know the answer to that question. What we do know is that the schedule that was used, the GFA schedule that was used had, by our accounts, some 66 providers or vendors listed. Only about half of those had the appropriate code that was required to be able to bid on this as that gives you the pool.

Now, a number of those are small companies that would have to partner with much bigger entities, who are interested in coming in here, with the capabilities to attack this space.

So, the total universe, it is the 30s, I don't have any reason to believe that the total number of bidders would be substantially different from what it was last time. I just don't know.

Joe Janssen – Barrington Research

Okay. Great. I'll jump in queue. Thank you.

Romil Bahl

Thank you.

Operator

Thank you. The next question is from Kevin Liu of B. Riley & Company, your line is open.

Kevin Liu - B. Riley & Company

All right. Good morning. Just focusing on the core RIA business, any sense you can provide us with how much of the short fall is more tied to just delayed claims processing, versus the issue set it out one major customer and then any sort of delays on your new programs?

Romil Bahl

Yes, Kevin. I mean I don't know that we can break that out. That's obviously the topic of a lot of scrutiny around here, as we focus in on our bigger opportunities to get back on track.

So, Kevin, what I have really to share with you is that it takes the portfolio effect, right? I mean on par almost (230) that's too easy low retail price globally well over half – over 120 (inaudible) budget over 120 (inaudible) over, right? And it does the same exact dynamic in over 130 commercial clients. And when you make that situation worse, by some of the clients being – that are under budget being some of our larger clients especially in that big retail segment that drives most of our revenue, as you know, you heard that quarter, right? That's what's going on and it will rectify itself going forward.

Kevin Liu – B. Riley & Company

And then, on the large domestic customer, where you saw a few issues, I mean, at which point does those get resolved if they were? And are you able to make out even those – that revenue that you weren't able to audit during Q1 over the course of the year? I guess this – was figured out those with kind of say, permanently, delayed or pushed out, given the time to acquire the time recoveries?

Romil Bahl

Hey, Ken, are you talking about the one specific deliveries that we talked about?

Kevin Liu – B. Riley & Company

Yes. I think you said in the large domestic customer...

Romil Bahl

Right.

Kevin Liu - B. Riley & Company

And, yes.

Romil Bahl

Yes. At that one specific customer, to be honest, the situation remains slow. We do have auditing back up and going. We continue to recover catch up with some of the other data that was lost. We continue to talk to our client. I have low confidence that we will not impact Q2 but I have generally high confidence that we will get back to where we expected to be by the end of the year.

And then, just one last question on the healthcare piece, so talked a little bit about the pricing dynamics for this vacancy. I guess at a high level, maybe you can talk about why it's so important for you guys to even be in the space, if you're not confident that you can generate possibility over the life of the program, given the levels – price that you're bidding.

So, yes, it's a great question, Kevin, and you obviously know our company and our strategy very well, and you know how much we have been focused these past few years on our strategy and the fundamental tenants of which we're – incubate two growth businesses for the future. And, again, one may be forced to focus more on one than the other over time. And this maybe well one of those times.

But in the absence of any strong reasons to change, we remain focused on that strategy, right? And this is our core anchor contract. With this core anchor contract, in fact, we recognize that the prime contract are going forward, which, as you know, has – the optics of being a subcontractor have not been helpful to us, in terms of just respect for our capabilities.

You know we believe we're in great shape to continue to grow outside the government space, certainly to take on more states overtime, on the Medicaid side, but also to attack the private sector. It's a big call.

And, you know – and I'm not saying that this is what it is, Kevin, but even at break-even contract that has a very efficient factory running, provides a great – right – launching block for adding profitable business to it, right? So, that's the gamut here, right?

The flipside of it is, of course, that if we just decided to move it – but first of all what would be the reason to do that?

The biggest reason probably would have been because it would actually given us in a fine kind of way a much better shot of meeting our goal of $40 million makes you – I kind of admit that the truth of the matter is that the biggest thing driving the sort of mechanism or lack of predictability here is this.

So, it was that classic strategy inflection point of how do we call it? The near-term goals define our long-term strategy? No, we're not. We're going to go after long-term strategy, long-term shareholder value creation, and so that's what we've done.

Kevin Liu – B. Riley & Company

Got it. Appreciate it. Thanks.

Operator

Thank you. The next question is from the Dan Levine of Robert W Baird, your line is open.

Patrick Wang – Robert W. Baird & Co., Inc.

Hey, good morning. Patrick Wang for Dan Levine today. Could you elaborate a little bit more on the newer CMS rebid process in terms of – yes, the win-lose situation – in the lose situation, actually, the worst case scenario. Would there still be a subcontractor system available?

Romil Bahl

Yes. I mean – look in a lose scenario, just to kick off the auctions, first of all, I mean – so you mean PRGX lose situation?

So, first of all, we may protest, depending on what the reasoning would be. But, yes, I mean the sort of worst case scenario but you say that's the worst case scenario, let me be crystal clear about that.

I – if we lose because of price – let me say this part of what I said earlier again – then, I assure that losing is not the worst case scenario, right?

Patrick Wang – Robert W. Baird & Co., Inc.

That's true.

Romil Bahl

Because we would be losing so much money on that contract and rates well below where we are today that we wouldn't want it, right? And so, I think, that it would just be a matter of how do we focus for the future? I think it would be a very difficult thing for us to envision, a situation where just absolutely not focused in healthcare.

We – I know healthcare is too exciting, too vibrant in the industry and we have too much investment and time spent in it to complete the (inaudible). But there are series of options of whether we stay focused on the peer side, whether we move over to the provider side, there's series of options that we have looked at and evaluated to some degree.

But, again, we're not spending a ton of time there because we remain optimistic.

Patrick Wang – Robert W. Baird & Co., Inc.

Great. That's helpful. And then, can you give us some update on the business development side in regards to the progress of the private sector? I know we saw some early progress in 2012 but can you give us some update on that front in terms of when we can expect to see any meaningful contributions against that?

Romil Bahl

Yes. You know – so, we have had some progress are existing, private sector client but we have kind a couple of small kind of – we refer to them as sort of pilot help engagements last year. I've actually expanded in a couple of situations – in both situations. And so, that's encouraging. Now, there's still small but they would be encouraging to see that we're able to establish a (inaudible) and expand our scope.

We had two sort of opportunities that were highly focused on this past quarter; one with a very large pair and in which we were, unfortunately, unsuccessful and one with a smaller pair but we are very hopeful; we will actually have a contract soon.

So, you know – so, it's slower and it's going to take a long time to do this kind of organically on our own. We certainly believe that if we win, the CMS RAC Region, the level of confidence everybody will have in our abilities that will drive us to being able to perform some acquisitions to close some of the capability gaps we have in attacking the private sector and hopefully also get an entree into several private sector clients that we can build up, right? I mean because, yes, otherwise, it just is slow progress, its slow hope.

Patrick Wang - Robert W. Baird & Co., Inc.

Okay. Beside they make sense. And then, come back to the core recovery audit, in terms of the Europe business understand that the ongoing impacts, due to the Europe downturn may persist, even beyond European recovery, we realized you mentioned earlier in the call due to the auditing nature in arrears?

Could you help us understand whether you believe the current results already reflect the majority of the economic softness? Or do you think there's still some ways to go before a bottoming out and seeing us and show stability there?

Romil Bahl

Yes. Look, I think we've – I think we're real near the bottom if not bottomed out. We started to feel these impact in Q2 and Q3 of last year. And we also – with these impacts come all these claim delays and cancellations of things that we've talked about, we saw some of that come back and correct itself in Q4 itself because we had a better Q4 in the EAP region.

So, I don't expect sort of much downside, if that's the question from here.

Patrick Wang – Robert W. Baird & Co., Inc.

Okay. So, would you say, sequentially, that there hasn't been any further deterioration? It's more the year-over-year comparisons, where we see that the down take?

Romil Bahl

Yes. Again, just keep in mind, how lumpy we are and things can go against as the times as we've seen classic situation here in Q1. But yes, I mean I think as long as you're looking at as the way we've – Bob and I have asked you for years, and look at us, which is look at us in 12 months should be upwards trajectory. As long as you looking at us in those chunks, we think there will be an upward trajectory in A and B.

Patrick Wang – Robert W. Baird & Co., Inc.

Alright. That's very helpful. That's it from me. Thanks for taking my question.

Romil Bahl

Thank you.

Operator

Thank you. The next question is from Tim McHugh of William Blair & Company. Your line is open.

Tim McHugh – William Blair & Company

Yes. Excuse me. Thank you. Just a few more questions on healthcare, then we've probably deliver this topic. But just to be clear, I mean you're basically signaling that you essentially did to – tell most people must be breakeven on the new contract even at the higher scale. Is that the right way that you're – or right message you're communicating?

Romil Bahl

Yes. I don't know that I said that. I said what I would use that as a bit of an example to say, even if the program was a breakeven program, it provides a real nice foundation and kind of launching block for the – for this business, right?

You know, certainly, we hope to and we'll be – all of our efforts will be focused on making a profitable as well.

Tim McHugh – William Blair & Company

Okay. And I guess just – the other question around the healthcare is if you lost and you had to go to kind of adjusting the cost structure, could you be – could you make it a breakeven or profitable business at the smaller scale while serving kind of the Medicare – Medicaid state contracts? And anything else left in the business at that point?

Romil Bahl

Yes. And I don't see why not. I think one would adjust to the size – scale we were at. Hopefully, we'll continue with the sort of wind I was just talking about, for example, in the private sector and keep that business growing. And, again, I think there are strategic options around that, you know, when one is part a big national program like (inaudible) program is for Medicare, you know, one is very concerned about and we appropriately saw about conflict of interest issues and make sure we're and making sure we're not serving the provider side and so on and so forth.

In a much smaller world where we serve just a few states, I think we would have the opportunity to go serve the provider side in other states. So, there's a different strategic alternative that would emerge. But, yes, specific view of question, there's no real reason that we can't get our fixed cost to a situation where we can be profitable with a smaller book of business.

Tim McHugh – William Blair & Company

Okay. And then, just the last one on the health care year, your press release, specifically said bidding on the parts – Medicare parts A and B contracts and may know reference to the D and E contract or the set of contract that was added this year. Is that a signals – the approach you made? Or am I reading that too finely?

Romil Bahl

I think you might be reading that too finely. I mean, look, the – we use the Medicare part A and B program as our title for the entire program, that's what the program has been called, since we were in the demonstration for three years and then in the current five-year contract, right?

Now, I know that it has become fashionably or late since D and E hold that for cost business and pulled that into its own national contract but the full regions are called kind of part A, B regions that – I mean I'm just not going to say anymore because I'm concerned about (inaudible) to show our hand on our competitive strategy.

Tim McHugh – William Blair & Company

Sure. That's right. Okay. And then, the deliver issue in the US, can you explain more what that was? And, I guess, so we can understand how you might fix that?

Romil Bahl

It was a – you know, literally, without exaggeration, one in a million kind of technology failure. And we spend all this time, effort, money on how your availability systems and, unfortunately, even though they tell you it's 0.001% chance of failure, sometimes it happens and it happens to us. And I can get into the technicalities of it. I think we have a standard. But if any five disarray – two fail, the whole disarray goes into failure, and that's what happened, right?

And so, unfortunately, the scale of the client we're talking about well, it was an isolated issue on technology at that client's site that we view people will maintain and so forth. So, it's isolated for that client. But unfortunately, one of these clients that have enormous amounts of data, and so in a recovery situation it just takes a long time and in fact (inaudible).

Tim McHugh – William Blair & Company

Theoretically, it's just a matter of processing and organizing the data, again, before we can proceed.

Romil Bahl

That's right. That's right. And negotiating with the clients to make sure that we give our (inaudible).

Tim McHugh – William Blair & Company

Is there a sense that impacted that client relationship in a significant way?

Romil Bahl

Yes, I mean, look, any issue at this magnitude will cause concern. But you know we work hard at transparency. And over our client relationships, we have discussed this. We are in active conversations with them. We believe we understand that these one a million things that happened and (inaudible) imagination, it's reflected anyway. But our strength and our ability or capability or anything else.

Tim McHugh – William Blair & Company

Okay. And then, I recognize you're trying not to get into the numbers around how much revenue was lost, was delayed versus some of the other factors but can you tell us, I guess, the revenue front the bankrupt client at least? Because that revenue I believe was coming back.

Romil Bahl

Yes. But we're not really comfortable going to talking about this level of detail. But I think it is significant. I mean, you know, it is significant, Tim, if you look at our miss this quarter versus the same quarter last year, a good chunk of that, maybe as much as half of that, technically, be more than half of that is directionally what you (inaudible).

Tim McHugh – William Blair & Company

It is directionally the bankrupt client?

Romil Bahl

Yes.

Tim McHugh – William Blair & Company

Okay. And then, I guess just – last one, I guess, you said, I think – your comment was , I guess, across the full year, you would still hope that the Next Generation Recovery Audit would be close to what it was this prior year, I mean there were the early year longer-term view of that. Is that from a revenue or a profit perspective that you're referring too?

Romil Bahl

Really both. I mean if we come close to that combined $174 million, $175 million range on revenue, we should do equally well – we should do better on profit because the off shoring in cost reduction programs continue, right?

Tim McHugh – William Blair & Company

That's why I was asking. I was assuming profits would drive better than the revenue?

Romil Bahl

They should.

Tim McHugh – William Blair & Company

Okay. Alright. Thanks.

Romil Bahl

Thanks, Tim.

Operator

Thank you. Next question is from Richard Close of Avondale Partners. Your line is open.

Richard Close – Avondale Partners

Yes, thanks for taking the questions. Just a little bit more on the healthcare. Would your relationships with the MACs, would that change at all? First of all, if you could discuss that a little bit of what exactly those relationships are and what you're doing for them? And then does that change it all those relationships, if you win or become a prime in any of the regions?

Romil Bahl

Sure. So, Richard look, the MAC – so Medicare Administrative Contractors are who other contractors that, basically, administrative process and administrative claims on behalf of CMS, right? They are arrived across the country in what call jurisdictions, MAC jurisdictions, right? And there have been many of them and there's been a long-term multi-year consolidation program that CMS has been driving to get these down to relatively much fewer than they were before? One point they were as many as 15 jurisdictions and narrowed down to eight MACS, and I suspect we'll end up with smaller number over the coming years. And in fact, they may be a point in time, where the number of MACs and number of RACs will be equal, and there will be a one-to-one relationship between MAC and RAC.

If we look back at these prior four plus years on the national roll out program, the majority of the administrative noise and complexity in the CMS RAC program has come from this many-to-many relationship of multiple RACS and multiple MACs, which just creates more confusion, more noise.

Obviously, it would be a much more streamlined operation, if there was one RAC, one MAC type relationship and you just focused on getting that right here. The flow is right, getting the systems to talk to each other and so on and so forth.

I think CMS has made a great step forward in terms of moving, to a more streamlined RAC-MAC relationship even in this new contract. But obviously, there are still eight MACs out there and there will be only kind of five RAC contract winners. So, you can't do one to one but what you can do is at least no MAC will have to deal with more than one RAC and that's one of the reasons why we believe that the regional has been reconfigured and some of the states of the East have been added to this region D, which is really a region and at things that otherwise don't make rational sense, but when you know the program as well as we do and put on to the covers of what's happening, we see exactly where this is going and why.

Hence that's kind of what the MAC-RAC relationship is all about.

In terms of how our relationship changes, depending on the region, we win, we will deal with the MAC or MACs in that region, right? We would create a joint operating agreement with them and go.

Again, we've dealt with many of them before; we don't expect much effort, certainly, again, back to what I said before. If you would want to currently regions we have, it'll be a pretty seamless transition, which is why the six to nine months time kind of guidance that's out there, we cannot really quizzically look at and said, "Well, what are we going to do for that long?"

Richard Close – Avondale Partners

Okay. So, you don't have any necessary contracts with more sub contracts with MACs that if you win a prime that certain business has to go away or you have to (severe) that relationship or anything like that?

Romil Bahl

Our relationship is ultimately with CMS as the client. The MACs do what CMS ask them to do and they will process on behalf of CMS.

Richard Close – Avondale Partners

Okay, great. With respect to the Medicaid recovery audit contracts, can you talk a little bit about your business there? Your presence and the ramp-up period of those contracts for us?

Romil Bahl

Yes. So, we're just – we're starting to ramp up the first of the three states and just how long it's taking us.

We won this thing two years ago, and much like when Medicare was first starting, and we spent two years wrapping up provider outreach and all those sorts of things and didn't drop one in revenue until so much after the February 2009, we first signed this contract.

We saw this coming, right? So, there is no doubt that we started to be emphasized that the first time CAD program states over the past couple of years because we just couldn't afford to kind of bleed into these contracts or help the states learn these things.

And unlike some of our larger competitors who can do this for the step of press release value, we weren't interested, right? So, now, we have competed for a few, we will continue to compete when we think their contract make sense and can make money and we will grow that overtime,

But I think, you will find us competing with five greater intensity for the next round of these contracts. Some of which are started to come up by the way, right? Because some of the contracts were already up. And some say only heard that providers, some of these rebates are going to start coming out and we will compete much harder. All were hoping for is that sort of a training ground stuff can be done on somebody else's day.

Richard Close – Avondale Partners

Okay, and final question on the Medicare RACs. Excluding the price, is there anything structural in the rebid that maybe limits the opportunity for recoveries going forward, as compared to the current contracts?

Romil Bahl

Sure. There are several drivers that we have our eye on and are concerned about, some of which you've heard from our competitors. But certainly the medical necessity claim area, the specific short stays has been the richest ordered category for just about every order across the board these past few years. That area will get less rich going forward because of the new ruling CMS has outlined, which suggest that a part A claim is sort of going to be kind of completely overturned, can be rebuilt as a part B or outpatient claim, that area, in itself, will have significant impact. There are rules changes to the ADR elements, which have the additional documentation request limits. Think about those as constraints to how many medical records we could older? And therefore how much revenue we can recover and we can audit?

The changes to that in our power statistics and analytics across all of our three regions suggest downward movement of ADR limits from where they are today, based on these new rules. And there's going to be additional things. I mean these MAC consolidations that we're talking about are potentially going to hit us with potential blackout times and stuff that we are still finding out more information for and we'll certainly talk about on future calls.

So, they will be all those sorts of things that will continue to happen in the program. And that's before these other outside noise items that I talked about, the new builds and losses and so forth, might have.

So, if there's going to be some of impacts on the contracts, what we will just have to do is stay close to our clients, make sure, you know, our voice is being heard, actually much better than it has been hard, a sub contract in the last periods, which has been a huge disadvantage to us, so we're looking for in that guidance, and making sure that at the of the day, rational minds or are moving towards rational solutions to the challenges that were undoubtedly to come.

Richard Close – Avondale Partners

Alright. Thank you very much.

Romil Bahl

Sure.

Operator

Thank you. The next question is from Gregg Hillman of First Wilshire Securities. Your line is open.

Gregg Hillman – First Wilshire Securities

Yes, hi. Good morning, gentlemen. Say, a couple things. Yes. on the healthcare, how much do you invested to date on that?

Romil Bahl

Hey, good morning, Gregg. I'll let Bob answer the question on the investments to date. We are or we can look back at our...

Bob Lee

Most of these surfaces, EBITDA losses from a ten forward are the vast majority of that clearly relates to the Healthcare ramp up, talking about that the long ramp up that Romil already talked about. So, you can add all those numbers up and you're in that ballpark of $10 million and you throw on top of that, the infrastructure costs, which are – not that much, but definitely addition of millions of dollars.

Gregg Hillman – First Wilshire Securities

Okay. Okay, thanks. And then, also, on the PO business for the quarter descended, was that up quarter-over-quarter and...

Romil Bahl

It was up both quarter-over-quarter and sequentially, Gregg.

Gregg Hillman – First Wilshire Securities

And was that profitable at PO business?

Romil Bahl

Yes, it was. I mean, it's still being managed, as a close to sort of breakeven type business. For example our, sustainability index initiatives that I'm talked about in the last couple of calls that we have launched as being incubated out of there and that's an investment year for that business. So, yes, we're hoping these new service lines can just has help sustain themselves in terms of organic investment anyway going forward.

Gregg Hillman – First Wilshire Securities

Yes. It seems to be got activity for like the data cleansing thing. I think if the market for data cleansing will be in the hundreds and millions.

Romil Bahl

Absolutely, absolutely. And look, I mean, it is indeed unfortunate that in some ways like that the healthcare part of our story gets so much of the air from the room because arguably – and even while we were still caring healthcare in some way, shape or form, acquisitions scaling up talent at the data transformation area as a key priority going forward could have assigned or more exciting growth story. So, anyway, that's something I just have to do better job of communicating.

Gregg Hillman – First Wilshire Securities

Okay, and then I think you did a press release not too long. You highlight it like a contract administrator guy. Is that a news that did you buy a business for contract administration or do you just start that now?

Romil Bahl

Now, let's say, we did not buy a business there, that was actually one specific individual who is one of our key leaders in the contract compliant space, which is really an area that is closer into our Recovery Audit quarter, it takes a look at large expanded contracts of our clients to find whether may have overpaid or not received on the discounting in rates submission have received.

Gregg Hillman – First Wilshire Securities

Okay. And so that like you have like so many different segments within PO, there must be like five or six different businesses to the metric?

Bob Lee

Yes. I mean look there certainly spend optimization as a whole not, you want to get finer in the though level below that. There is our merchandise piece, which is for retail but really takeaway the spent, right? The contract compliance and fraud and that whole area we combine into one area that we call contract and fraud risk management and then the data transformation area, right? Now, I mean, it's not that many. I tend to talk at the next level down a lot, which I'm sure again its bit confusing.

Gregg Hillman – First Wilshire Securities

Okay. Thanks very much. I guess the only other thing is that you are not giving goals on – you are not going to what's your goal is for gross margin for the core? I think you went from 35% to 40% on that? Why you're spent maybe went back down from 40%, but do you have like a goal there or you'd rather used not say..

Romil Bahl

Yes. I mean I'd rather not say we're going to continue to improve gross margins in both sides, both Americas and EAP, for a second there, I thought we are going to talk about future goals of the 2014 goal, getting so close. But just on that point, we have absolutely planned a strategy refresh kind of a PRXG 2.0 initiative for the second-half of this year and we will come out with our next kind of five-year plan and guidance based on that, but for now, pending all of this, instability brought by the contract in CMS, we still remain focused and we still believe there is a chance that we could get real close to 40 next year.

Gregg Hillman – First Wilshire Securities

Okay. Thanks, Romil.

Romil Bahl

Thank you, Gregg.

Operator

Thank.

Romil Bahl

We are out of time. And so, I will just thank everybody for their questions, their interest. Thank you very much. We'll speak to everyone on the next call.

Operator

You're welcome. Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.

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