PRGX Global's (PRGX) CEO Ronald Stewart on Q4 2017 Results - Earnings Call Transcript

PRGX Global, Inc. (NASDAQ:PRGX) Q4 2017 Earnings Conference Call March 1, 2018 5:00 PM ET

Executives

Ronald Stewart - President & CEO

Peter Limeri - CFO

Analysts

Alex Paris - Barrington Research

Kevin Liu - B. Riley

Operator

Good day, ladies and gentlemen and welcome to the Q4 2017 PRGX Global Inc. 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 be given at that time. [Operator Instructions] As a remainder this conference is being recorded.

I'd now like to introduce your host for today's conference Ron Stewart, President and CEO and Pete Limeri, CFO. I'll now turn the conference over to Pete Limeri. Sir, you may begin.

Peter Limeri

Thank you, Ashley and good morning, afternoon or evening, to each of you around the world. Let us 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 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 income loss to most directly comparable GAAP measure is available under the Investor Relations portion of our website at prgx.com.

I will now turn the call over to Ron.

Ronald Stewart

Thanks, Pete and welcome everyone, to the fourth quarter 2017 earnings conference call. We had a strong finish to the year with our fourth quarter revenue and adjusted EBITDA from continuing operations growing at 17% and 41% respectively, on a year-over-year constant dollar basis. These results marked our sixth consecutive quarter of revenue and adjusted EBITDA growth.

Our results for the year were also impressive, with revenue and adjusted EBITDA from continuing operations growing 14% and 25% respectively on a year-over-year constant dollar basis. We're very pleased with this year's performance and importantly we believe the underlying fundamentals are in place to continue to drive growth in 2018 and beyond.

A few highlights to put this into perspective. First our core Recovery Audit business is showing consistent growth and increasing profitability. Our global retail Recovery Audit business grew in each region for the second year in a row and we expect continued growth going forward.

These revenue increases are primarily incremental revenues at existing clients driven by our continued focus on acceleration, auditing closer to the payment transaction and introducing innovative new audit claim types.

Our commercial Recovery Audit business, which includes all industry verticals outside of retail, grew significantly, not only from our acquisition of Cost & Compliance Associates, but also organically, led by strong performance in the U.S. Europe and Asia-Pacific.

Our superior audit performance combined with our expanded service offerings and increased investment in technology are translating to increased market share for our core business. We added 31 new logos in our Recovery Audit business in 2017, nearly all taken from incumbents and competitive bidding situations.

Our largest retail recovery auditor in the U.K. recently announced they are exiting the market after we were awarded the primary audit position at one of their major retail clients. We have secured the primary audit position in several major U.K. and European retailers during 2017 and thus far early in 2018 and expect to see revenue expansion from these clients starting in late 2018 as these new audits come online.

Contract Compliance was a major area of focus in 2017, starting with the acquisition and integration of Cost & Compliance Associates, which had a solid practice in this important area. We made meaningful progress in 2017 adding 17 new Contract Compliance clients, most of which are expansions at existing recovery audit clients. We are also investing in additional talent and technology to grow this business further in 2018.

While our Adjacent Services revenue declined in Q4 of 2017 compared to the prior year, revenue for the year 2017 grew by 12.9% compared to 2016. As we discussed in our Q3 earnings call, we have moved our focus in Adjacent Services from being primarily project-based and advisory led to becoming technology and SaaS services led.

The ramp-up of service offerings, client bookings and associated SaaS-based revenues is coming along, but the pace is slower than we would like. While we did not meet my revenue expectations for 2017, we made substantial progress towards moving this business segment forward and positioning for future growth.

During the year, we launched our PRGX OPTIX toolset. We integrated Lavante SaaS offerings and client base into our broad organization and we extended the Lavante SIM platform to include a robust deduction management solution.

Our deduction management offering gives our clients the ability to provide their suppliers with easier access to billing details, thereby enabling resolution of billing and claims inquiries in a more timely, effective and efficient manner.

We announced a multiyear deduction management SaaS and Services Agreement with Kroger in October of 2017, which went live in late December. Thus far the client and their suppliers appear to be very pleased with their solution.

In the U.K. as part of our PRGX OPTIX suite, we recently announced a solution designed for the U.K. legislative requirement for payment, processing, reporting, also known as Duty to Report. Our Payment Processing Reporting Solution significantly reduces the time required to prepare data for submission and eliminates the need to undertake a costly IT project in order to comply.

In addition, to reporting for compliance, our solution uncovers critical information to help companies benchmark, monitor and improve their payment practices, ultimately maximizing cash flow. We've completed our first contract in this area and have a growing pipeline of new SaaS-based opportunities for existing and new clients.

So, looking at our business overall, we finished 2017 with a strong pipeline of new client prospects and expansion opportunities at existing clients across all of our service and technology offerings. Obviously, converting this pipeline is critical to achieving continued growth and we believe that we have a winning strategy, a strong leadership team and a highly motivated and experienced resource pool to achieve success.

As a final point, we generated $13.5 million in cash flow from operations in 2017 an increase of over 30% compared to 2016. We believe our ability to generate meaningful operating cash flow, coupled with our increasing financial strength and flexibility, positions us to continue growing in 2018 and beyond.

I would now like to turn the call over to Pete to provide greater financial and operational detail on the quarter and year.

Peter Limeri

Thank you, Ron. I will begin by reviewing our financial results from continuing operations for the quarter ended December 31, 2017, compared to the same period in 2016.

Consolidated revenue from continuing operations for the three months ended December 31, 2017 was $47.1 million, an increase of $7.9 million or 20.1% compared to the fourth quarter of 2016. On a constant dollar basis, adjusted for changes in foreign currency exchange rates, consolidated revenue for the fourth quarter of 2017 increased $6.9 million or 17% compared to the same quarter in 2016.

These amounts include revenue from the CMCA acquired businesses, which was not in the prior year amounts. Excluding CMCA, our revenues from continuing operations increased 12.3% and on a constant dollar basis, increased 9.3%.

Some additional constant dollar revenue highlights for the quarter include, this is our sixth consecutive quarter of year-over-year organic growth. We had year-over-year revenue growth in every region -- each region.

Our global Recovery Audit business had year-over-year growth of 18.7% including CMCA and excluding CMCA, our year-over-year revenue growth was 10.8%. Within the global RA business, our global retail business grew 10.5% and our global Commercial Recovery Audit business had year-over-year growth of 68.8%. Excluding CMCA, our global commercial RA business posted growth of 12.8%.

In December we recognized our first revenue from the previously announced multiyear deduction management program with Kroger.

Total operating expenses from continuing operations for the quarter ended December 31, 2017, excluding depreciation, amortization, transformation and stock-based compensation expenses was $37.8 million or 80.2% of revenue compared to $32.8 million or 83.8% of revenue for the fourth quarter of 2016 an increase of $4.9 million compared to the prior year, but an improvement of approximately 3.6% as a percentage of revenue.

Adjusted EBITDA from continuing operations for the three months ended December 31, 2017 was $9.3 million or 19.8% of revenue, which was $3 million or a 46.9% increase compared to the same period in the prior year.

Excluding the CMCA acquired businesses, which was not part of our prior year financials, adjusted EBITDA from our continuing operations in the fourth quarter increased 32.9% on a constant dollar basis, compared to the same period in the prior year.

Now I will review our financial results from continuing operations for the three months ended December 31, 2017 at a more detailed level. Revenue from each of our reporting segments was as follows. Recovery Audit Services Americas' revenue was $31.5 million compared to revenue of $27.5 million in Q4 2016, an increase of $4 million or 14.7%.

On a constant dollar basis Q4 2017 Americas' RA revenue grew by 13.8% compared to the 2016 fourth quarter. Our retail RA Americas business grew by 8.9% and our commercial RA Americas business posted year-over-year growth of over 40%.

Recovery Audit Services Europe, Asia-Pacific revenue was $14.9 million compared to revenue of $10.7 million in the fourth quarter of 2016, representing growth of $4.3 million or 40.2%. On a constant dollar basis Q4 2017 revenue for this segment grew by 30.4% compared to the same quarter of the prior year.

The growth was led by our Asia-Pacific retail RA business, which grew 14.1% and our commercial RA business posted year-over-year constant dollar growth of over 164%. Excluding revenue from the CMCA acquisition, our Europe, Asia-Pacific commercial RA revenue grew over 71% on a year-over-year constant dollar basis.

Adjacent Services revenue for the quarter ended December 31, 2017 was $654,000 compared to $1.1 million in the same period in 2016. The reduction was due to our completing a large advisory project in 2016 that was not repeated in Q4 2017.

As discussed in our last earnings call, while we are pleased with the pipeline momentum for our SaaS-based solutions and the signing of the Kroger contract, the sales cycle for these deals is proving to be significantly longer than the sales cycle for our traditional project-based Advisory Services.

So, while momentum for our technology centered solutions continues to grow and we expect to convert additional opportunities to contracts in the coming months, revenue growth from these solutions is not expected until the second half of 2018.

We expect to continue investing in our emerging businesses, particularly in our sales team and developing our service offerings. Our gross margin from continuing operations excluding transformation was $20.4 million or 43.3% of revenue in the fourth quarter of 2017 compared to $15.5 million or 39.5% of revenue in the same period in the prior year, which is an improvement of approximately 4% on a percentage of revenue basis.

Excluding the revenue and expenses associated with the CMCA acquired business, our gross margin as a percentage of revenue improved by 5.5% on a year-over-year basis. The year-over-year organic improvements were primarily related to the flow-through of the higher revenue and our continued operational process improvements, partially offset by the cost associated with new regional senior operation leaders and other recovery audit staff that were not in place in the prior year.

Total SG&A expenses from continuing operations excluding transformation and stock-based compensation expenses were $11.1 million or 23.5% of revenue in the fourth quarter of 2017 compared to $9.1 million or 23.3% of revenue in the same period of the prior year.

The increase is primarily a result of operating expenses associated with the CMCA acquired businesses that were not in the prior year amounts and incentive-based compensation expense. These increases were partially offset by cost reductions in other areas across the company.

Depreciation and amortization expenses from continuing operations for the fourth quarter of 2017 were $2.6 million compared to $1.9 million in the prior year. In our discontinued operations, for the quarter ended December 31, 2017, we incurred a loss of $341,000 compared to a $407,000 loss for the same period in 2016.

For the quarter ended December 31, 2017, we had net income of $5.3 million or $0.24 per basic and diluted share, compared to a net loss of $233,000 or negative $0.01 per basic and diluted share for the same period in 2016.

The year-over-year improvement was primarily driven by the increase in revenue, the improvement in gross margin and also included a $2.3 million acquisition-related earn-out adjustment that is recorded as income for the quarter.

With regard to the results for the full year of 2017, I would note the following constant dollar basis highlights. First, revenue from continuing operations grew $20.8 million or 14.8% compared to 2016. On an organic basis, our revenue grew 6% on a year-over-year basis. This is our second consecutive year of as-reported and organic growth.

We had year-over-year revenue growth in each service line. We are year-over-year revenue growth in each region. With regard to gross margin, it increased by $9.9 million or 1.7% as a percentage of revenue.

On an organic basis, our gross margin increased 2.7% as a percent of revenue. Since December 31, 2015, our gross margins from continuing operation has increased over 430 basis points.

Last, adjusted EBITDA, we had a year-over-year increase of $4.5 million or 26.4% improvement compared to the prior year. I will now highlight certain balance sheet and cash flow information.

As of December 31, 2017, we had net unrestricted cash and cash equivalent of $18.8 million and had $13.6 million of borrowings against our revolving credit facility. $5.4 million of our December 31, cash was in U.S. bank accounts with the remainder held outside the U.S.

Cash flow from operations for the fourth quarter of 2017 was $10 million compared to $3.9 million in the same period in 2016. On a full year basis, cash flow from operations in 2017 was $13.5 million compared to $10.1 million for the full year of 2016.

Capital expenditures on property and equipment for the quarter ended December 31, 2017 were $2.9 million compared to $1.2 million in Q4 2016. On a full year basis, our capital expenditures were $9.3 million compared to $5.9 million in 2016.

With the completion of the financial review, I will now turn it back over to Ron.

Ronald Stewart

Thanks Pete. So, December of 2017 marked my four-year anniversary as CEO and President of PRGX. At the beginning of my tenure, we laid out a strategy to refocus on our core recovery audit business and invest in people, processes and technology to drive growth and extend our client value proposition.

We have remained on track with this strategy and we believe our 2017 performance confirms that we were making significant progress in our transformation journey, delivering meaningful sustainable and more predictable growth.

So, looking ahead in 2018 and beyond, as we grow our core business and expand our service and technology offerings, we recognize that we will be operating in a challenging environment. Our direct competitors in the recovery audit industry are constantly improving and evolving their service offerings.

Our clients are constantly upgrading their internal processes and controls and in certain cases building internal teams to perform specific types of recovery audits. As we extend our offerings into broader Source-To-Pay SaaS solutions and capabilities, we frequently compete against larger ERP and specialized Source-To-Pay technology providers as well as global consulting and professional services companies.

We must constantly challenge our status quo and continue to innovate and invest in our future to be successful and we plan to do just that. For 2018, we will focus on three primary imperatives, all targeted at building a solid foundation for continued growth.

First, building on our 2017 progress in our Source-To-Pay SaaS solutions, we must continue to evolve our product development organization to create a highly capable and properly structured SaaS, product management, development and operations delivery team. To that end, we recently announced that Mark Morel has joint PRGX as Vice President and Chief Product Officer, charged with establishing PRGX as a global leader in Source-To-Pay technology solutions.

Mark comes to us with a rich background in leading successful Source-To-Pay SaaS technology companies and will be focused on building a highly capable SaaS product organization and further developing our SaaS Digital Solutions business. Mark will be adding skilled resources to his team as well as integrating existing and knowledgeable PRGX SaaS product team members into his organization.

In addition to Mark, we recently introduced Scott McClellan as our Chief Technology Officer and Chief Architect. Scott is a highly respected large data and advanced technology veteran, who spent many years in the senior technology position with Hewlett Packard and Red Hat with deep expertise in big data, cloud computing, distributed computing and artificial intelligence.

He will be instrumental in us moving forward designing and delivering advanced technology into all aspects of our business. Our second imperative is focused on expanding the use of advanced technologies and tools into our core service offerings in addition to new SaaS product offerings while we are confident that we are performing at a very high level relative to the competition, we know that we must continue to evolve our capabilities and apply leading edge technologies in all aspects of our business.

We expect to accelerate our investments in artificial intelligence and machine learning in 2018, focusing on our primary service offerings, including core recovery audit, contract compliance and our spend analytics and SaaS based solutions.

We believe our investment in AI capabilities will not only drive improved audit efficiencies, but also will expand revenues by allowing us to go deeper in our traditional audit services at existing clients and to move into smaller clients previously deemed too costly to serve using traditional Audit Techniques.

Blockchain is another exciting area of innovation that we believe will be highly relevant to our business, our clients and to their suppliers. We are undertaking research and proof of concept projects in this area and have every intention of leading our industry in this important domain.

As a third imperative we are continuing to invest in our global go to market team. Last May, we announced the addition of Daryl Rolley, as our Senior Vice President and Chief Commercial Officer. Daryl has done an outstanding job building a highly qualified global go to market team, focused on brand development and marketing, new business generation, client service and growth on existing client service expansion.

We expect to significantly increase our investment and our global sales and marketing team building around our existing team and adding qualified resources as strategic growth areas of our business. We expect that these incremental investments will translate into increased brand awareness, lead generation volume, increased bookings and ultimately revenue.

A final point I would make regarding our commitment to growth. We feel we have flexibility to fund our investments toward growth through our improving cash from operations and expanded capacity. We expect to continue to invest in our internal growth initiatives as well as we'll consider strategic acquisitions to accelerate our growth.

As you can tell from my comments I am very bullish about the future prospects for PRGX. 2017 was an excellent year on many fronts and as already mentioned, we fully expect 2018 to be another growth year for 2017. For 2018 we are projecting year-over-year revenue growth in the range of 8% to 10% and adjusted EBITDA growth in the range of 17% to 22%.

With my comments complete, I will now turn it over to Ashley for any questions.

Question-and-Answer Session

Operator

[Operator Instruction] Our first question comes from our Alex Paris of Barrington Research. Your line is open.

Alex Paris

Hi guys. Congratulations on a strong finish to the year and Ron, happy anniversary.

Ronald Stewart

Thanks Alex. You heard well.

Alex Paris

Yeah. I have a couple of questions. First off for Pete, I'm just trying to get a handle on what will be the impact of tax reform on PRGX in 2018, with the first question being, you had a tax credit I believe, no, no, you had a tax expense in the fourth quarter, but obviously at a very low rate.

Was there anything in there associated with tax reform that forced it to be such a low rate?

Peter Limeri

No Alex, that amount that you see is primarily from before as you know in the U.S. we've got NOKs and we've got valuation allowances on our balance sheet. So, there's not a lot from -- a book perspective there is not a lot of U.S. tax expense that was through our P&L until we released those valuation allowance in the future.

Overall when you look at the tax reform, the lowering of the tax rate to 21%, that as we'll go back and look at our valuation allowances and revalue those, we expect the impact of the not material at this point.

The other big point of tax reform is the ability to repatriate cash from the foreign jurisdictions, but based on historical losses, there's no immediate benefit for us to be able to bring those -- bring the cash back through the new legislation.

So, we'll continue to analyze it and understand it over the next year, but in the near term, it doesn't appear to be any material impact to us one way or the other.

Alex Paris

Okay. And then that just gives me another question, what's the NOL balance as of the end of the year?

Peter Limeri

That is about $45 million.

Alex Paris

Okay. Thank you. With regard to Adjacent Services, congratulations on that fourth quarter Kroger win, as you said in the prepared comments, that only started to come into revenue in December. I'm sure it's a immaterial amount.

My question is and I think Ron might've alluded to this, when would we expect, I know you haven't released nor are you going to release the expected annual revenue from this contract, but when will it be at that run rate? It sounds like the second half, and then should it be steady over the course of the year given the SaaS component.

Peter Limeri

Yeah Alex, starting in January, really December was a partial month, but starting with January it will be in the time of the contract where it's SaaS based and fixed and determinant volume and divide by the rise of the contract. So, it will be at full scale, starting with January.

Alex Paris

I got you. Okay. That's sooner than I had expected. Given all these investments that you're going to make in growth, you're going to continue to make in growth. CapEx was $9.3 million in '17 up from $5.9 million in '16, what will it be in '18, '19 '20. So, I assume it's good to continue at a relatively high rate.

Peter Limeri

I think that we got it last year $87 million. I think we're still in that same range for '18. Again, depending on the momentum, we get on the SaaS solutions or some of the technology, that number could increase in '19 and '20. So, $9 million to $12 million.

I think some of that will depend on the momentum we get in the progress we're making in those areas, but it depends for this year again.

Alex Paris

Okay. Good. And then I think the organic growth was well described in the prepared comments, I have a question about M&A, how would you characterize the M&A pipeline, both in terms of activity and character of the targets that you're looking at? Should we expect more acquisition activity in 2018?

Ronald Stewart

So, Alex, I think first of all, our approach and our philosophy on acquisitions really hasn’t changed. There are really two types of acquisitions we're interested in. One would be appropriate tuck-in acquisitions in our recovery audit business or related businesses that would be either provide additional services or additional clients to our mix and so we'll continue to look at opportunistically at companies in that space.

From a technology standpoint, we're clearly building a platform and building additional services that we want to extend into the future. So, we are actively and will continue to actually look at good technology companies that fit our model in the sourced paid space that make sense.

So, I'd say that we are active in that endeavor and would expect to see some level of acquisition activity in 2018, we would like to.

Alex Paris

Great. That's really helpful. Okay. I think does it for me right now. Thanks again guys and if I have any other questions, I'll let you know.

Ronald Stewart

Thanks Alex.

Operator

[Operator instructions] Our next question comes from Kevin Liu of B. Riley. Your line is now open.

Kevin Liu

Hi. Good afternoon. First question, just wanted to start on the Europe-Asia PAC segment for the RA business, and obviously very strong growth within the fourth quarter. Was that driven more so by kind of bring in some well claims or did you just see fairly broad-based strength or maybe some of those new client adds that you referenced contribute more meaningfully?

Ronald Stewart

As you may recall, Kevin, Europe has been, Europe, Asia-Pacific has been a project for us for the last few years and we first started seeing some substantial growth in Asia-Pacific. In the last couple years, we've really seen a significant turnaround in Europe and that's continued and that's really around good fundamentals, tool improvement, process improvement, focus activity from our very skilled team there and that's continued through 2017, which I think in terms of picking up new clients and adding to market share there, it's really attributed to the great work that those team members have done in improving those audits and delivering great value to the clients. So, I wouldn't call a lot of claim well claims that really wasn’t a big factor.

Kevin Liu

Got it. And just as you think about visibility and potential growth in Europe going into 2018, to what extent has a lot of these new customers you signed up in 2017 already ramped and how are you feeling about pricing as it relates to either pursuing new customers and any sort of renewals that are coming up?

Ronald Stewart

So first of all, the clients that I referred to that we had picked up and have been selected in late '17 and 2018, those will be ramped up during 2018 and I wouldn't expect a substantial impact on revenues to the latter part of 2018, but we do expect that to pick up later this year and then obviously into 2019.

Renewals have been strong and I think just having great position with great results over the last couple of years I expect to be very competitive and retain the clients we have at attractive rates.

Kevin Liu

Okay. And just looking at Adjacent Services side, with north of $600,000 in revenues for the quarter, any sense you can give us in terms of how much of that is just remaining project work that needs to be run off versus more SaaS like revenues that we can build off of going forward?

Peter Limeri

It is primarily SaaS. So, we are focused on being technology led and bringing those SaaS and it will include SaaS and managed services around the SaaS platforms, but that's -- and we expect that to continue to evolve and grow on that base. As you know, we're just introducing some of these capabilities into the market.

So yeah, you get those signed up and up and running and SaaS revenue recognition is a bit of a slower process. So, it will ramp over time.

Kevin Liu

Okay. And just lastly, regarding your investments on the SaaS side as well here, given that you don't have some of that project revenue in order to help offset the overhead cost of investments, just curious how you're thinking about the timeframe for when you like to get the Adjacent Services segment profitable?

Is it still within the next couple years or do you think it's much further off given that there is a big opportunity to try to scale up that business.

Peter Limeri

No, we expect to see improvement this year and I think we'll see as that ramps up throughout the year, but we definitely expect to see improvement this year, but we expect to still be negative EBITDA this year, but I would look to '19 to start seeing that turnaround and seeing better days ahead there.

Kevin Liu

All right, great. Thanks for taking the questions and congrats on a very strong quarter.

Peter Limeri

Thanks Kevin.

Ronald Stewart

Thanks Kevin.

Operator

I am showing no further questions at the time. I'd like to turn the call back to Ron Stewart for closing remarks.

Ronald Stewart

Okay. Well, thank you very much actually and thank you all for attending our earnings call and we look forward to getting with you soon as we cover the first quarter earnings call later in the year.

Peter Limeri

Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.