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PRGX Global, Inc. (NASDAQ:PRGX)

Q4 2013 Earnings Conference Call

February 25, 2014 8:30 a.m. ET

Executives

Ron Stewart - President and Chief Executive Officer

Bob Lee - Chief Financial Officer

Analysts

Tim McHugh - William Blair

Kevin Liu - B. Riley & Company

Joseph D. Janssen – Barrington Research

Brian Hoffman – Avondale Partners

Gregg Hillman – First Wilshire Securities

Sam Sekine – ALJ Capital

Operator

Good day, ladies and gentlemen, welcome to the PRGX Global Fourth Quarter and Full Year 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, today’s call is being recorded.

I would now like to turn the conference over to your host, Ron Stewart, Chief Executive Officer. Sir, you may begin.

Ron Stewart

Thank you, Shannon. And welcome to today’s earnings conference call. It is indeed my pleasure to speak with you this morning on my first PRGX earnings call as CEO and President. As many of you know, I joined the board of PRGX in November of 2012 where I led the compensation committee and was a member of the nomination and corporate governance committee. Last November I was asked to serve as interim CEO which I was happy to accommodate.

After serving in this role for several weeks, I was asked if I would be interested in assuming the position permanently. Based on my favorable impressions of the people, a deeper understanding of our business and my strong conviction and the future potential for the business, I accepted the job and here I am. It's been a whirlwind but I'm really enjoying the experience thus far.

Prior to joining PRGX, it’s been almost 30 years with Accenture where I retired as a senior partner in 2007. During my tenure with Accenture, I held several senior leadership roles, including head of the firm’s retail and consumer goods practice in the eastern U.S. as well as North America managing partner for the automotive, industrial manufacturing and transportation travel industry group. I also led our global transportation and travel industry practice for a number of years. After leaving Accenture in 2007, I was actively involved in private equity investing in a number of different businesses.

This morning I am joined by our Chief Financial Officer, Bob Lee who will review the company's financial and operating results for the fourth quarter and full year of 2013. Following Bob’s comments, I will give an update of the direction we’re setting for – and some of the resulting changes that you likely saw in our press release last night.

With my introductory comments complete, let me turn the call over to Bob to discuss our results.

Bob Lee

Thank you, Ron. Good day to everyone. I will be reviewing our financial results for the three months and year ended December 31, 2013. Let me note at the outset that certain statements in this conference call 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 10K 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. Reconciliation between these non-GAAP measures and net income or loss, the most directly comparable GAAP measure is available under the investor relations portion of our website at prgx.com.

Now to begin the review of our financial results for the three months ended December 31, 2013. Our revenue was $46.5 million compared to the prior year's fourth quarter revenue of $53.1 million, a decrease of 12.4%. On a constant dollar basis, adjusted for changes in foreign currency exchange rates, 2013 fourth quarter revenue decreased 11.5% compared to the same period in 2012.

Recovery Audit Services Americas revenue was $30.7 million compared the prior year’s fourth quarter revenue of $30.0 million, an increase of 2.2%. On a constant dollar basis, adjusted for changes in foreign exchange rates, Recovery Audit Services Americas fourth quarter revenue increased 3.9% compared to the same period in 2012. We were pleased to see continued stability in this, the largest segment of our business and the capacity for modest growth in the most mature market in which we operate.

Recovery Audit Services Europe, Asia Pacific revenue was $12.6 million compared to the prior year’s fourth quarter revenue of $14.7 million, a decrease of 13.8%. On a constant dollar basis adjusted for changes in foreign exchange rates, recovery audit services Europe, Asia Pacific fourth quarter revenue decreased by 14% compared to the same period in 2012.

Fourth quarter EAP revenue did sequentially increase $0.6 million from the third quarter of 2013, an increase of 5.3% over what was a much improved third quarter. However we were expecting more improvement and it's clear we still have more work to do.

New services revenue was $3.2 million compared to the prior year's fourth quarter revenue of $8.5 million, a decrease of 61.9%. Our New Services segment is comprised of our healthcare claims recovery audit services as well as our profit optimization services. This decline is due primarily to significant and expected lower revenue from our Medicare RAC subcontracts caused by the continued restrictions and scope limitations imposed since the first half of the year.

We announced yesterday that we have withdrawn from the Medicare RAC rebid process. Ron will speak more on this in a moment. listenable revenue

Our cost of revenue, or COR was $29.7 million in the fourth quarter of 2013 compared to $34.4 million in last year's fourth quarter, which was 63.9% of revenue in 2013 and 64.8% of revenue for the same quarter in 2012. The reduction in COR is entirely attributable to cost reductions, primarily compensation, in our European operations and healthcare operations in response to revenue declines. We were able to offset the margin declines attributable to the Medicare RAC program changes with gross margin improvements in both of our core recovery audit segments and we continue to believe there's opportunity to increase these margins further.

Total SG&A in the 2013 fourth quarter was $14.5 million compared to $14 million in last year’s fourth quarter, or approximately 31.1% and 26.3% of revenue in each period respectively. The 2013 period includes $2.5 million of charges related to the departure of the company's former president and CEO, including severance charges of $1.1 million and stock compensation charges of $1.4 million. Excluding such charges, SG&A in the fourth quarter of 2013 decreased by $2 million compared to the fourth quarter of 2012, a decrease of 14.3%. A significant portion of that decline is attributable to reduced incentive compensation accruals.

Depreciation expense decreased $0.1 million and amortization expense decreased $0.8 million compared to the fourth quarter of 2012. We expect decreases in periodic depreciation and amortization expenses going forward. As a result of our decision to withdraw from the Medicare RAC rebid process and plan changes to our recovery audit delivery processes, we recorded a fourth quarter 2013 asset impairment charge of $4.2 million related to internally developed software assets. These impairment charges will further reduce our periodic depreciation charges on a go forward basis.

For the three months ended December 31, 2013, our net loss was $6.4 million or $0.22 per basic and diluted share compared to net income of $1.5 million or $0.06 per basic and diluted share in the same period in 2012. The 2013 fourth quarter net loss includes the impairment charges of $4.2 million, the $2.5 million of former CEO separation costs. The 2012 fourth quarter net income includes $1.2 million of credit resulting from the release of a portion of the reserves held for uncertain tax positions. Approximately $0.8 million of this release related to accrued interest on these reserves and is included as a credit to interest expense in the 2012 fourth quarter.

Our adjusted EBITDA for the fourth quarter of 2013 was $6.9 million or 14.9% of revenue compared to $8 million or 15.1% for the same period in 2012. Fourth quarter 2013 adjusted EBITDA excludes the impairment charges of $4.2 million, a $2.5 million charge related to stock-based compensation, $1.8 million of transformation severance and related expenses, $0.4 million of acquisition related charges and less than $0.1 million of foreign-currency losses on short-term intercompany balances.

The comparable adjusted EBITDA for the fourth quarter of 2012 excludes a $1.8 million charge related to stock based compensation, $1.1 million of transformation severance and related expenses, a less than $0.1 million of credit for acquisition related benefits, $0.4 million of wage claim costs, and $0.2 million of foreign currency gains on short term intercompany balances.

Beginning with the third quarter of 2013, we include the fair value adjustments to contingent consideration from acquisitions or earn-out adjustments in our calculation of adjusted EBITDA. Previously we included acquisition obligations classified as compensation and acquisition transaction costs as adjustments to EBITDA. Now we also included these earn-out adjustments and renamed the line in our Schedule 3 to our earnings release as acquisition related charges or benefits. We've made these changes to all periods presented in our earnings release and will also include such changes in the presentation of adjusted EBITDA in our future filings on Forms 10-Q and 10-K. For the full-year this change increased our adjusted EBITDA by $0.4 million.

Now to begin the review of our financial results for the full year ended December 31, 2013. Our revenue was $195.2 million compared to the prior year revenue of $208.5 million, a decrease of 6.4%. On a constant dollar basis, adjusted for changes in foreign currency exchange rates, 2013 revenue decreased 5.6% compared to 2012.

Recovery Audit Services Americas revenue was $118.6 million in the prior year's revenue of $121.6 million, a decrease of 2.5%. On a constant dollar basis, adjusted for changes in foreign exchange rates, Recovery Audit Services Americas revenue decreased 1.4% compared to 2012. Most of this decline dates back to the first quarter of the year with a fairly stable for the rest of the year, including the modest fourth quarter increase previously discussed.

Recovery Audit Services Europe, Asia Pacific revenue was $46.4 million compared to the prior year’s revenue of $53.8 million, a decrease of 13.7%. On a constant dollar basis, adjusted for changes in foreign exchange rates, Recovery Audit Services Europe, Asia Pacific revenue for 2013 decreased by 13.1% compared to 2012. Second half revenue rebounded from the weak first half as we expected. The rebound, however, was not nearly as much as we had hoped and Ron will speak more on this momentarily.

New Services revenue was $30.1 million compared to the prior year’s revenue of $33.1 million, a decrease of 8.9%. The New Services segment revenue for the year ended December 31, 2013 represented 15.4% of total revenue compared to 15.9% in the prior year. With the wind down of auditing under the current Medicare RAC subcontracts and planned rationalization of some of our field [ph] service offerings, we expect New Services revenue will be a smaller portion of our revenue in 2014.

For the year ended December 31, 2013, our cost of revenue was $122.5 million compared to $134.4 million in the prior year, which was 62.8% of revenue in 2013 and 64.5% of revenue in 2012. With margin improving in our core recovery audit business which represents nearly 85% of revenue, the company's total gross margin percentage has improved in spite of the declines in new services.

Total SG&A for the year ended December 31, 2013 was $52.8 million compared to $52.5 million in the prior year. The 2013 period includes the $2.5 million of charges related to the departure of the company’s former President and CEO. Excluding such charges, SG&A in 2013 decreased by $2.2 million compared to 2012, a decrease of 4.2%.

Depreciation expense increased $1.1 million and amortization decreased $2.2 million compared to the year ended December 31, 2012. The increase in depreciation is primarily due to improvements we made in our IT infrastructure and the depreciation relating to software development projects placed into service in the second half of last year. The decrease in amortization is due to the 2012 period, including greater acquisition related charges than the 2013 period. And of course, the full-year 2013 results included the $4.2 million of software impairment charges reflected in the fourth quarter.

For the year ended December 31, 2013 our net loss was $0.2 million or $0.01 per basic and diluted share. For the year ended December 31, 2012, our net income was $5.4 million or $0.21 per basic and diluted share. The 2013 net loss includes the impairment charges of $4.2 million as well as the $2.5 million former CEO separation costs. The 2012 net income included a $1.2 million of credit resulting from the release of a portion of the reserves held for uncertain tax positions. Approximately $0.8 million of this release related to accrued interest on these reserves and is included as a credit to interest expense in 2012.

Our adjusted EBITDA for the year ended December 31, 2013 was $29.4 million compared to $30.8 million of adjusted EBITDA for 2012. 2013 adjusted EBITDA excludes the impairment charges of $4.2 million, a $6.3 million charge related to stock based compensation, $2.5 million of transformation severance and related expenses, $0.6 million of acquisition related charges and less than $0.1 million of foreign currency gains on short-term intercompany balances.

The comparable adjusted EBITDA for the year ended December 31, 2012 excludes a $6.3 million charge related to stock-based compensation, $2.1 million of transformation severance and related expenses, $0.2 million of acquisition related benefits, $1 million of wage claim costs and $0.4 million of foreign currency gains on short-term intercompany balances.

I will now highlight certain 2013 balance sheet and cash flow information. At December 31, 2013 we had unrestricted cash and cash equivalents of $43.7 million, no borrowings against our revolving credit facility and no bank debt outstanding. At December 31, 2013, current assets exceeded current liabilities by $50.5 million.

During 2013 we reduced accounts receivable balances by approximately $6.2 million, most of this being collections on Medicare RAC subcontract balances. Net cash provided by operating activities for the year ended December 31, 2013 amounted to $18.4 million compared to $18.8 million in the prior year.

Capital expenditures on property and equipment for the year ended December 31, 2013 were $6.9 million compared to $7.9 million in 2012. In December we fully paid off the remaining balance of our term loan with SunTrust Bank and currently have no debt outstanding. In January, we extended our credit facility and increased our borrowing capacity to $25 million.

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

Ron Stewart

Thanks, Bob. As a board member I gained a solid understanding of the business. Over the past 90 days I have immersed myself in all aspects of the company. I have met extensively with our business leaders, our staff professionals in the field and in our corporate office. I’ve also met with a number of our clients, investors and analysts.

My key takeaway thus far is that PRGX is fundamentally sound. We have a tremendous foundation grounded in our core recovery audit business which represents 85% of our topline revenue and all of our EBITDA. We have a top-notch and committed workforce serving clients in more than 30 countries around the world. We boast the blue-chip client list, including 16 of the top 20 global retailers as well as an impressive and growing group of commercial clients.

Our brand is broadly recognized in our industry with an excellent reputation for delivering quality results and industry best practices. While we have wonderful foundation for future growth, there are a number of areas we can improve.

Prior to my arrival as CEO, PRGX had initiated a top to bottom review of the strategy, which I’ve referenced throughout my own assessment of the business. While we continue to develop the details of our strategy, there are a number of foundational elements which will ultimately shape the go forward strategy for the company.

First and foremost, we will focus on profitability and growth in our core business. Recovery audit, P2P performance improvement and risk management services primarily focus on the retail industry. We will also continue operations in other industries where we have a presence, can differentiate ourselves from our competition and can achieve an attractive EBITDA and return on our invested capital.

We plan to achieve higher profitability and growth through the following: First, a focus on improved and consistent -- improved and consistent delivery excellence through standard processes, methodologies and tools across the globe. I have lived this model for almost 30 years with Accenture and saw a first hand the power of methodology and consistent delivery.

Second, acceleration of our global low-cost delivery model, leveraging our regional and global shared service centers. We’ve made considerable investments in the past and are positioned to leverage these assets to deliver lower cost and higher quality services to our clients on global scale.

Number three, service offerings that are directly adjacent to our core recovery audit service and are perceived by our clients as logical and differentiated. We will also continue to expand into new geographies and promising industries if they offer opportunities for profitable growth.

Next, leveraging state of the market technologies to drive faster processing and deeper analytics with the massive amount of data we receive from our clients. Technologies around large data manipulation and unstructured data analysis are evolving at a rapidly rate. We plan to remain at the forefront of these technologies and maintain the most secure and trusted infrastructure environment in our entire industry.

Finally moving from a cultural -- culture based on driving recovery audit and client specific environment to a culture of delivering multiple services from multiple locations, using more standardized processes with a single focus on value creation and client service. Again these elements will form the foundation of our PRGX next-generation strategy which will be fully developed and reviewed with our board.

While we are fully immersed in the strategy process, there are number of key areas requiring attention in the near term. Specifically we are taking action in three important areas of our business. First, as many of you read in last night’s earnings release, we have decided to withdraw from the CMS Medicare RAC rebid process. PRGX entered the healthcare claims recovery audit business almost a decade ago and as many of you know the results have been mixed.

2013 was especially difficult due to changes in audit scope in the Medicare RAC program and significant delays in the rebid process, resulting in disappointing financial results for the year. As previously disclosed, we expect a difficult 2014 in this business due to continued delays in the CMS rebid process and unprofitable changes in the scope of the current subcontracts. Given the uncertain audit scope and challenging business terms as defined in the Medicare RAC rebid RFP and the ongoing pressure from the provider community to limit scope in the future, we simply believe that entering into a new Medicare RAC contract presents unacceptable level of financial risk for PRGX. Thus we have decided to dropout of the CMS rebid process and focus our future growth efforts in other areas.

PRGX is committed to fulfilling our obligations under the current Medicare RAC subcontracts which includes supporting Medicare claims and appeals through 2015. We have other healthcare clients and the Medicaid and prior private payer markets and we will maintain staffing levels appropriate to service all our healthcare clients. To be clear, we're not exiting the healthcare recovery audit business. But we do not see Medicare RAC as a strategic growth area for the company going forward.

The next area requiring near-term attention is our Europe and Asia-Pacific recovery audit operations. While we were encouraged by Q3 results, Q4 proved challenging both in revenue and EBITDA. We remain bullish on growth prospects in EAP overall and see a strong pipeline of new clients and expanded services.

To address our near-term challenges, we're restructuring our organization to provide a greater focus on business development and client profitability. We're also adding some critical skills in our [ph] potential areas and we will increase our focus on moving more business to our low-cost delivery centers.

Finally, let me discuss what we refer to as our profit optimization business. As you know over the past five years we've invested significantly in these initiatives. Our intent was to expand our services beyond our core recovery audit business and leverage our key client relationships to drive incremental revenues. Some of our endeavors have been successful in achieving our objectives while others have not.

We are currently reviewing all of our offerings to assess their alignment with our growth direction and evaluate their ability to generate acceptable financial results in the near to medium term. We expect this business will be profitable by the end of 2014. We believe these actions will improve our long-term profitability. However near-term revenue weakness continues and we expect losses in our healthcare claims, recovery audit business in 2014.

As a result, our financial results in Q1 2014 will likely be weaker than Q1 2013. And EBITDA for the year will be below the level achieved in 2013. To reiterate, while I’ve only been on the job for 90 days, it is clear to me that we have a very strong foundation grounded in world-class clients and strong global team. We’ve begun making changes that I believe will result in a more profitable company and this is my number one goal for PRGX.

With those comments complete, I will now turn the call back over to Shannon to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Tim McHugh of William Blair & Company.

Tim McHugh - William Blair

I guess just a few things on the changes you announced. One I guess on healthcare, was there something that changed in just the last couple of months, that brought you to this conclusion? I think the things you described have been -- uncertainty about that contract, it’s been there for a while I guess. So what changed most recently or is this just been something that’s been coming for a while?

Ron Stewart

Well, thanks, Tim and that’s a very good question. Obviously since the last call we’ve received the RFPs, we’ve had a closer look at the terms and the scope of the contract. At a high level, the unfavourable terms and uncertain scope are the reasons why it’s become too risky financially for us. The uncertainty in scope with a fixed bid contract has been painfully highlighted for us over the last nine months. And with terms that are less favorable and lack of clarity in the scope with the fixed rate make this a highly risky proposition for us. So those were the primary drivers that have occurred since the last call.

Tim McHugh - William Blair

And the comment on restructuring Europe, I heard what you said about making it more focus on business development and accelerating some of the offshore. But what’s restructuring it to be more focused on business development mean? Are you cutting out costs, are you exiting certain areas of the business from a geographic perspective? What’s the plan to re-invigorate revenue and profits there?

Ron Stewart

Sure, well first of all, we are going to focus our leadership directly on this region. So we are going to make sure that we got an intense focus on keeping our eyes and ears on what's going on in the region. Secondly, we’re going to restructure our organization to put more direct focus on clients and developing those clients and broadening a range of services in those clients. There are a number of growth areas in the region that are emerging as very attractive. This is primarily in the area of contract and clients and some of the areas of data services. So we are making some strategic hires in building our teams in those areas so we can take advantage of these increased revenue opportunities.

So we're also looking at our cost and our indirect costs in the area, to serve in our revenue that we currently have and we plan to accelerate the low-cost delivery model which we’re fairly early stage there but we are going to move to accelerate the adoption of that model, which will increase our margins and give us a competitive advantage in that marketplace.

Tim McHugh - William Blair

And then Bob, can you help us at all with -- now that you have decided to exit the Medicare RAC rebid, how, just as we think across this next year and then I guess by the time we are going into 2015 what the financial impact of that is, just as we think about what the impact of new services segment will be now going forward?

Bob Lee

Sure, Tim, I'll speak to the healthcare piece of that. As Ron said, we’re still kind of doing rationalization on the field services. But I think it’s just to the question on healthcare, let’s be clear we are projecting a loss for the healthcare business overall for the year. As we need to serve the existing clients and serve out the remaining terms of the existing RAC contracts and we expect at the present time that the loss for the year from the RAC program will be between $3 million and $4 million.

Tim McHugh - William Blair

And by the time we go into 2015, would you be able to -- can you staff that to a level where it’s no longer -- the healthcare business as a whole I guess is not dragging on profitability?

Bob Lee

It will be minimal. I mean there won’t be any more – at least from the Medicare RAC program there won’t be any more revenues certainly in ’15 and there won’t be any revenues after second quarter of this year. We do expect that costs going forward into 2015 to be quite minimal compared to the current year.

Tim McHugh - William Blair

And from a revenue base, the $3 million or so of new services revenue this quarter, is it fair to assume the majority -- how much of that I guess was PO as we are modeling out without the RAC revenue in there?

Bob Lee

Well, you know we haven't historically gone the granular route on splitting up the new services. I will say that PO was more than half of it.

Operator

Thank you. Our next question is from Kevin Liu of B. Riley & Company.

Kevin Liu - B. Riley & Company

First question just on the Q1 comments about it being weaker than last year. Is that solely attributable to the new service line or is there risk that core recovery audit services business is also down year over year?

Bob Lee

It is mostly attributable to the new services segment, especially healthcare. But as Ron mentioned, we are still facing some revenue challenges, weaknesses particularly in Europe. So it’s going to be little bit of combination of everything, Kevin.

Kevin Liu - B. Riley & Company

And actually maybe you can elaborate on the Europe tone, just a bit. Obviously we saw second consecutive quarter of sequential improvement any way. Is it more so that you are seeing some client churn or are you just not seeing the amount of recoveries with these some of these newer relationship than you would have thought?

Bob Lee

More of the latter, Kevin. Yes, we didn’t see sequential improvement which we were expecting but quite honestly we were expecting more, I mean we did – we were bumping up against a very strong Q4 of ’12, we had a tough comp on a year-over-year comparison. So we were -- and historically Q4 has been very strong in Europe as opposed to the Americas, essentially Q3. So obviously we still got some work to do, which is why Ron spent some time talking about the things we’re doing, and it's been a high focused area for us.

Kevin Liu - B. Riley & Company

And then just one question on the healthcare recovery audit work outside of this Medicare RAC program. I guess how fully ramped are you on the existing Medicaid contracts? Are there any kind of private payer pilots or awards to speak of, and how much of a growth business can this be if you guys don't have a high profile program to work on like the Medicare RAC engagement?

Ron Stewart

Well, first of all we do have private payer clients today and we have – as you know we are in the Medicaid business as well, those Medicaid contracts have not ramped, from what you experienced or what you saw before. That we are in a market on the private payer side and the first decision we needed to make was, what we want to do on the Medicare RAC, which we now have made that decision, we are putting all of our focus on the private payer side and developing our near to mid term strategy of how to accelerate that business. But this is a $2 billion business of broad and recovery in the healthcare industry and Medicare RAC makes up – about 250 million to 300 million of that. So there is absolutely a lot of space for us to get into and we plan on going through that, we are building our team around expanding into those new opportunities that provide a greater economic opportunities for us and give us a little more control of our destiny.

Kevin Liu - B. Riley & Company

And maybe just one last one. I know you are in the process of identifying which cost optimization services might have to be rationalized. But when you look at the business today certainly growth hasn't been quite where you guys would have expected as we move forward without the big Medicare RAC program. Where do you see the growth in the business coming from and what’s kind of the opportunity for shareholders? Does it mostly – does it become more of the return of capital type story given the amount of cash flow coming out of the core business, or how do you envision shareholders realizing upside from here?

Ron Stewart

All right, well that’s a big question, so let me take a minute – give you our thoughts on this. First of all, we plan to refocus our efforts on our core recovery business and adjacent services. We believe we are in a very strong position to lead, including our low-cost delivery model which gives us a great opportunity to gain market share and broaden our footprint in existing audits. While we are pursuing several other areas of expansion in the business we want to focus primarily on geographical expansion in emerging markets where we have new clients that are evolving in their – outside their interest, to focus on recovery audit as well as some of our traditional clients as they expand globally.

We’re also moving into other industries outside of retail where recovery audit is perhaps less mature but robust opportunity exists. And there are some specific industries that have some characteristics that are very interesting to us and we are seeing some solid growth in some of those areas. In the area of services, we want to expand into – with our term, adjacent services such as contract compliance and focused data services that allow us to leverage our very strong client relationships and our key data and IT capabilities into new revenue areas. But these adjacent services have got to be logical to our clients, in other words, they see us has confident in those areas and pick up [ph[ there and they also have to be profitable in the near to medium term. And like I said, healthcare while we’re taking a step back relative to the Medicare, it is still a very large market. And while we are – we can’t give you the details of exactly our plans in that area. There is clearly an area of opportunity that we’re going to focus on and expect to see growth in the medium to longer term.

And finally, we are – we have a very, very strong balance sheet with capital available and we are pursuing M&A opportunities, leveraging our global delivery model and technology platform to broaden our client base primarily in our core recovery audit business or closely related businesses which can achieve higher margins on additional revenues. So those are some of the areas we plan to focus on and grow.

Kevin Liu - B. Riley & Company

All right, thanks for taking the question.

Operator

Thank you. Our next question is from Alex Paris of Barrington Research. You may begin.

Joseph D. Janssen – Barrington Research

Yeah, this is Joe filling in for Alex. Ron, you kind of just led me to my next question. You talked about M&A opportunities that you’re seeing out there. Maybe can you just frame the context of what an M&A would look like? Are we talking like low risk, small, I know this is a highly fragmented market. Would we expect kind of 5 to maybe call it above $10 million acquisition in terms of revenue potential or are there any out there that are appealing in the pipe right now that could be bigger?

Ron Stewart

I would say that first of all we’re looking for primarily at businesses that are going to be add-ons to our core business because with our low cost delivery model, our global delivery capabilities, the investment we’ve made and continue to make in our infrastructure, we feel like that adding some businesses in the small to medium range in the core business can be immediately accretive and position us very nicely with these key clients so we can build our relationships and expand our reach. So I would say you look for small to medium in the -- around a core business or closely related adjacent services.

Joseph D. Janssen – Barrington Research

Okay. And just curious on the -- you talk about accelerating the offshoring to India. Kind of where you are at now and then and how much do you think can be sourced in India?

Ron Stewart

Well first of all, we have India as well as regional centers. So there is significant efficiency coming out of these regional centers as we’ve seen in the past and we're continuing to expand and grow these regional centers. So and India is clearly part of the solution. We’ve got a I’ll say a more significant portion of our U.S. business being fulfilled in India and a smaller portion in Europe. So we feel confident that we can increase that fairly significantly. The key is getting processes and tools for standardized, methodology standardized and a focused effort on quality deliver -- delivery in the global model. But the company has laid the groundwork very nicely for this expansion and I’m confident that we can move it quicker and achieve some strong results. So there will be more work moving to our centers both regionally and in India.

Joseph D. Janssen – Barrington Research

Okay. And one unless question kind of high level, given where you see the business now, focusing on the core, if you had to look, what do you think a realistic long-term growth rate for this business is given adjacencies, focusing on core clients, focusing on maybe some M&A possibility. Are you comfortable to give maybe a two to three year long-term growth rate within the core?

Ron Stewart

I think, like we said, we’re working hard to piece together the strategy which we plan to review at the Board. But I would tell you directionally that there is still going to be long-term challenges and top line revenue that I expect us to achieve mid to high low digit growth on top line, a double growth in the EBITDA. That’s where we’re pushing.

Joseph D. Janssen – Barrington Research

Fair enough. Thank you.

Ron Stewart

Thank you. Appreciate it Joe.

Operator

Thank you. Our next question is from Richard Close of Avondale Partners. You may begin.

Brian Hoffman – Avondale Partners

Great. Thank you, this is Brian Hoffman for Richard this morning. First question just to clarify, at the end of your prepared remarks, you stated that Q1 2014 will be weaker than Q1 2013 and that EBITDA for the year will be below the level in 2013. Were you referencing profit optimization there or the business as a whole?

Ron Stewart

The business as a whole.

Brian Hoffman – Avondale Partners

Okay.

Ron Stewart

Influenced by what we see happening in healthcare as well as some of the PL results, but it’s the whole business.

Brian Hoffman – Avondale Partners

Okay. Great, and then my next question I understand that you going forward you don't view the new RAC contract as a profitable opportunity. But since you began the current contract a few years ago, has there been a year where as a subcontractor the business has been profitable overall?

Ron Stewart

Bob, can you address that?

Bob Lee

Yeah, absolutely. I mean through the first nine months of this year it was extremely profitable. It wasn’t until the scope changes hit that it did start to impact us a bit in the third quarter although the third quarter was still quite profitable and then turned to a loss in the fourth quarter.

Brian Hoffman – Avondale Partners

Okay, thank you.

Ron Stewart

Thanks Brian.

Operator

Thank you. Our next question is from Gregg Hillman of First Wilshire Securities. You may begin.

Gregg Hillman – First Wilshire Securities

Yeah good morning gentlemen. First of all, the charge off of the 4.2, I wonder why it wasn’t higher because didn’t you invest like $10 million in Medicare RAC, development of the business over the last many years? And should we expect a further writedown in the future because you under charged off so to speak in this quarter?

Bob Lee

No, no, I think the $10 million investment in healthcare wasn’t all just necessarily in software and of course there is infrastructure that can be used for other parts of the business. And I think you might be including some of the early years’ operating losses in that number. No, you should not expect additional impairment charges related to health care. This pretty much clears the deck on what we have as far as capitalized costs related to healthcare.

Gregg Hillman – First Wilshire Securities

Okay. And well maybe you could talk about on the human resource side what you plan on doing to improve this recruitment, retention, training and management development?

Ron Stewart

Yeah, that’s a great question Gregg. In regards to the human resources, first of all there has been quite a bit of work done in the past around culture and values that have really gone a long way in terms of getting people on board and communicating on broader topics. I think when you step back and you look, this is a company with tremendous tenure. I was on a call a few weeks ago where we were doing a quarterly update and we celebrated 10 people just in that three month period that had been with the company over 20 years. So the experience and knowledge is pretty remarkable. And so really from -- we plan on building on those now and focusing very firmly on best practices and methodologies that especially as we look at a global delivery model.

And I had the great experiences seeing this first generation of the shared service centers and globalization in my time with Accenture and the importance of standard processes and methodologies and really thinking through each of our recovery audit concepts on how they were going to be delivered globally and supporting those with tools and technologies. That has got to be fully understood and we’ve got to do a lot of training and we’ve got to get in these very, very large and important clients and start to work through some of the changes. And we won't be 100% adapted in every single client, but our objective is to get as far as we can because there is significant benefit to our clients and to us when we do that. So we’ve got to have some clear understanding of strategies. We’ve got to have training around processes and methodologies and then I think the continued communication and sense of street décor is something that’s been started that we’re going to doubledown on and do more of. So there is a lot to build on that we’ve got to be viewed as a single company with people focused on first around the success of the client and then success of the overall enterprise. So those are some of the things we’re focused on.

Gregg Hillman – First Wilshire Securities

Okay. And then just finally, in terms of just positioning yourself for you are differentiated for commercial recovery audit, could you speak to that, the non-retail portion, how you think you think you’re differentiated now relative to the competitor and how you think you'll be differentiated in future?

Ron Stewart

Sure. Well we’ve – in the commercial sector this is something that we’ve really made a focus on the last few years to build with our acquisitions of BSI, that gave us a real jumpstart. I think of the adoption of the shared service model and how we approach that work, there has been a lot of benefit from the BSI acquisition. We’re mirroring that with the broader capabilities and technology capabilities of PRGX. So I think that does give us a significant advantage and then as we expand into other areas, being able to have a integrated process between how we serve more the traditional core recovery audit with extended services and contract compliance and vendor compliance that I think how we go to market and how we deliver those will be seen as different. And it appears, early days, but we’re seeing some great take up in the market. I’m really impressed with the scale of clients that we’re dealing with and the messages seem to be come along very well.

Gregg Hillman – First Wilshire Securities

Okay, thanks very much.

Ron Stewart

Yeah, and let me just add one other point on that is that a lot of these commercial clients do act globally and in many cases more globally than you traditionally see in retail. We are in 30 countries and we can deliver on a global footprint; that gives us a unique position relative to a number of our competitors.

Gregg Hillman – First Wilshire Securities

Okay, great thank you.

Ron Stewart

Thanks Gregg.

Operator

Thank you. Our next question comes from Sam Sekine of ALJ Capital. You may begin. Sam Sekine, your line is open. Please check your mute button.

Sam Sekine – ALJ Capital

Yeah, sorry, just a couple of questions on the CMS the bid withdrawal. So I mean I know there were a couple of protests from the other bidders and CMS comes and makes some changes. I mean do you guys see yourself ever coming back in or is it the final that you guys are out?

Ron Stewart

No, at this point, we’ve submitted our withdrawal notification and so we’re out.

Sam Sekine – ALJ Capital

Got it. And just maybe if you can help me understand the, you made the comment about with the uncertainty of scope and you had a fixed bid, but I mean why not just raise your bid to a point where you’d be comfortable regardless of whatever scope changes that you can foresee?

Ron Stewart

Well, first of all, the bids are -- you don’t really have an opportunity to elect to adjust your bid as you learn more and more things. You have one shot at the bid unless the CMS comes back. So it’s not a straightforward process of adjusting it. And at the end of the day you’ve got to be competitive and you’ve got to believe that you can provide value to CMS at a rate and given that the amount of the – the number of unknowns and some of the difficult terms that makes it very challenging to have a competitive price and a winning price that we’re sure we can make money in. There is just a lot of unknowns that we prefer to focus on other areas where the risks are not so high and that we can differentiate ourselves and enjoy higher profitability than we would expect out of the Medicare program.

Sam Sekine – ALJ Capital

Okay. And then with the timing of the existing contracts, I believe the document, additional document request period is over and can you just maybe help me understand how long it will take you guys to I guess ramp down or just kind of reduce costs in this segment and how long that period will take?

Ron Stewart

Bob, why don’t you address that?

Bob Lee

Well, the – we did send out a wave in accordance with the last extension of the – and we’re talking about the existing contracts of course. We did send out our last wave a week or so ago and we will audit those records when they come in. We can submit claim adjustments until June under the current extension of the contract and then auditing is over that time of course. I’m not saying what they will or won’t do, that could get extended, it's been extended twice already. We’re not expecting this to be extended, it could be. Following that, there is a two year clean out period, we’re now going to be a 18 month clean out period that extends to December of 2015 to collect the -- on the adjustments address appeals as they come up and just do the general wrap up under the existing contracts for the work that's been done. And again, the bulk of that work will occur in 2014. We do expect most of that type of work will be completed before the end of this year. But of course again, CMS has extended that clean up period to December 15 and as I said earlier we don't expect a tremendous amount of costs. There will be some costs in 2015 related to that, but most of it’s going to occur this year.

Sam Sekine – ALJ Capital

Got it. So if I looked at the new services, EBITDA that you had put out was around negative 3 million this quarter. I mean is that kind of expected in Q1? And also I guess through Q2, I mean if it’s through June or would you guys be able to reduce staffing in the next six months or next four months I guess?

Ron Stewart

Well, as said earlier, we're looking at the year to be about a $3 million to $4 million from the RAC for the year. And obviously I mean there will be some revenue in the first half of the year that will offset some costs and then we’re already reducing costs and we’ll continue to reduce costs throughout the period.

Sam Sekine – ALJ Capital

Okay. And just one last one. So with the appeals that will go through 2015, I mean those – I guess the money that would come in through an appeal that wouldn’t be revenue but is that just I guess working capital gain or how should I look at that?

Ron Stewart

No, that would be as we handle appeals successfully we would increase collections, the revenue would have been recognized subject to -- we do carry reserves for potential appeal losses. But once the claim has been originally asserted and collected, the revenue is recognized at that point in time. So again, as we handle appeals in the future, it will bring cash in the door.

Sam Sekine – ALJ Capital

And I mean I know you guys haven’t shared that number before, but is that reserve, it that going to be a meaningful amount, if anything comes back in through that?

Ron Stewart

We have not shared that amount specifically. We feel like we have an adequate reserve.

Sam Sekine – ALJ Capital

Okay, thank you.

Operator

Thank you. Our last question is a follow up from Tim McHugh of William Blair & Company. You may begin.

Tim McHugh – William Blair & Company

Hey, just two quick ones. One, tying on that last question is from a working capital perspective, I guess how much cash flow can I guess get freed up as you unwind the Medicare RAC program? I believe that you’ve had kind of longer collections cycle there and that’s tied up some AR balance.

Bob Lee

Yeah, I mean we haven't given too many specifics separating the working capital into the healthcare piece versus the rest of the business. I did mention in my opening remarks that we did bring down receivables during about $6 million. Most of that is attributable to collections from the RAC subcontracts because during the fourth quarter, we weren’t really putting up new receivables to replace the collections and that will of course occur throughout this year. We do still have a significant number of dollar amount of receivables remaining. So from a cash flow standpoint, the healthcare program will be closer to a breakeven for the ’14.

Tim McHugh – William Blair & Company

Okay and then just the comment about EBITDA being down for the year. I guess if we -- I guess you kind of give us a rough sense of healthcare but just to tell you I guess directly, for the core recovery audit business would you expect EBITDA still to be improving this year?

Ron Stewart

Year-over-year?

Tim McHugh – William Blair & Company

Yes.

Ron Stewart

Yes we do and we’re seeing that improving through driving the costs to serve down through the low cost delivery model and more efficiency in our indirect costs associated with that revenue as well.

Tim McHugh – William Blair & Company

Okay. Great. Thank you.

Ron Stewart

Good. Well thanks to all of you for your interest and your questions. We appreciate your attendance this morning and look forward to speaking to you next quarter. Good bye.

Operator

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation. Have a wonderful day.

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