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PRGX GLOBAL, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Overview We conduct our operations through three reportable operating segments: Recovery Audit Services - Americas, Recovery Audit Services - Europe/Asia-Pacific and New Services. The Recovery Audit Services - Americas segment represents recovery audit services (other than healthcare claims recovery audit services) we provide in the U.S., Canada and Latin America. The Recovery Audit Services - Europe/Asia-Pacific segment represents recovery audit services (other than healthcare claims recovery audit services) we provide in Europe, Asia and the Pacific region. The New Services segment includes business analytics and advisory services as well as healthcare claims recovery audit services. We include the unallocated portion of corporate selling, general and administrative expenses not specifically attributable to the three operating segments in Corporate Support. Recovery auditing is a business service focused on finding overpayments created by errors in payment transactions, such as missed or inaccurate discounts, allowances and rebates, vendor pricing errors, erroneous coding and duplicate payments. Generally, we earn our recovery audit revenues by identifying overpayments made by our clients, assisting our clients in recovering the overpayments from their vendors, and collecting a specified percentage of the recoveries from our clients as our fee. The fee percentage we earn is based on specific contracts with our clients that generally also specify: (a) time periods covered by the audit; (b) the nature and extent of services we are to provide; and (c) the client's duties in assisting and cooperating with us. Clients generally recover claims by either taking credits against outstanding payables or future purchases from the relevant vendors, or receiving refund checks directly from those vendors. The manner in which a claim is recovered by a client is often dictated by industry practice. In addition, many clients establish client-specific procedural guidelines that we must satisfy prior to submitting claims for client approval. For some services we provide, such as advisory services, we earn our compensation in the form of a flat fee, a fee per hour, or a fee per other unit of service. We earn the vast majority of our recovery audit revenues from clients in the retail industry due to the high volume of purchases and the complicated discount programs typical in this industry. Changes in consumer spending associated with economic fluctuations such as the recent global downturn generally impact our revenues to a lesser degree than they affect individual retailers due to several factors, including: • Diverse client base - our clients include a diverse mix of discounters, grocery, pharmacy, department and other stores that tend to be impacted to varying degrees by general economic fluctuations, and even in opposite directions from each other depending on their position in the market and their market segment; • Motivation - when our clients experience a downturn, they frequently are more motivated to use our services to recover prior overpayments to make up for relatively weaker financial performance in their own business operations; • Nature of claims - the relationship between the dollar amount of recovery audit claims identified and client purchases is non-linear. Claim volumes are generally impacted by purchase volumes, but a number of other factors may have an even more significant impact on claim volumes, including new items being purchased, changes in discount programs offered by vendors and changes in a client's or a vendor's information processing systems; and • Timing - the client purchase data on which we perform our recovery audit services is historical data that typically reflects transactions between our clients and their vendors that took place 3 to 15 months prior to the data being provided to us for audit. As a result, we generally experience a delayed impact from economic changes that varies by client and the impact may be positive or negative depending on the individual clients' circumstances. While the net impact of changes in the current economic environment on our recovery audit revenues is difficult to determine or predict, we believe that for the foreseeable future, our revenues will remain at a level that will not have a significant adverse impact on our liquidity, and we have taken steps to mitigate any adverse impact of an economic downturn on our revenues and overall financial health. These steps include devoting substantial efforts to the development of a lower cost service delivery model to enable us to more cost effectively serve our clients. Further, we are working diligently to expand our business beyond our core recovery audit services to retailers by growing the portion of our business that provides recovery audit services to enterprises other than retailers and growing our New Services segment which includes our healthcare claims recovery audit services and our business 12-------------------------------------------------------------------------------- Table of Contents analytics and advisory services. Our healthcare claims recovery audit services include services we provide as a participant in the Medicare Recovery Audit Contractor program (the "Medicare RAC program"). The investments we are making in connection with our growth initiatives have had a significant negative impact on our recent reported financial results. While we generated $9.6 million of incremental revenues in our New Services segment in the first six months of 2011 compared to the first six months of 2010, we continue to generate operating losses in this segment. These operating losses primarily relate to our healthcare claims recovery audit services, which generated improved revenues in the first six months of 2011 and which we believe will continue to generate increasing revenues through the remainder of 2011. We will continue to monitor the performance of the New Services segment, and will focus on achieving profitability and reducing and/or reversing the negative impact that these efforts have had on our financial position and results of operations. Results of Operations The following table sets forth the percentage of revenues represented by certain items in the Company's Condensed Consolidated Statements of Operations (Unaudited) for the periods indicated: Three Months Six Months Ended Ended June 30, June 30, 2011 2010 2011 2010 Revenues 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenues 68.1 68.0 68.1 70.0 Gross margin 31.9 32.0 31.9 30.0 Selling, general and administrative expenses 24.3 22.7 24.4 23.4 Depreciation and amortization 4.6 4.8 4.6 5.0 Operating income 3.0 4.5 2.9 1.6 Foreign currency transaction (gains) losses on intercompany balances (0.8 ) 2.4 (0.9 ) 2.0 Interest expense, net 0.9 0.6 0.8 0.7 Loss on debt extinguishment 0.0 0.0 0.0 1.6 Earnings (loss) before income taxes 2.9 1.5 3.0 (2.7 ) Income tax expense 1.5 1.4 1.9 1.2 Net earnings (loss) 1.4 % 0.1 % 1.1 % (3.9 %) Three and Six Months Ended June 30, 2011 Compared to the Corresponding Periods of the Prior Year Revenues. Revenues were as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Recovery Audit Services - Americas $ 27,901 $ 29,870 $ 57,014 $ 54,844 Recovery Audit Services - Europe/Asia-Pacific 15,753 12,957 30,505 27,695 New Services 7,050 2,680 13,903 4,297 Total $ 50,704 $ 45,507 $ 101,422 $ 86,836 Total revenues increased for the three months ended June 30, 2011 by $5.2 million, or 11.4%, compared to the same period in 2010. Total revenues increased for the six months ended June 30, 2011 by $14.6 million, or 16.8%, compared to the same period in 2010. Recovery Audit Services - Americas revenues decreased by 6.6% for the second quarter of 2011 compared to the second quarter of 2010. For the six months ended June 30, 2011, revenues increased by 4.0% compared to the same period in the prior year. We experience changes in our reported revenues based on the strength of the U.S. dollar relative to foreign currencies. Changes in the value of the U.S. dollar relative to currencies in Canada and Latin America positively impacted reported revenues in both the second quarter of 2011 and six months ended June 30, 13 -------------------------------------------------------------------------------- Table of Contents 2011. On a constant dollar basis, adjusted for changes in foreign exchange ("FX") rates, revenues for the second quarter of 2011 decreased by 8.8% compared to a decrease of 6.6% as reported and increased by 1.9% during the first six months of 2011 compared to an increase of 4.0% as reported. The decrease in our Recovery Audit Services - Americas revenues in the second quarter of 2011 is due to a number of factors. A portion of this decrease was attributable to some atypical revenues at several clients during the first quarter of 2011, including revenues from client-driven audit accelerations, which impacted revenues in the second quarter of 2011. Additionally, revenues in this segment may vary significantly from period to period due to numerous recurring factors, including the timing of individually significant claims, audit scope changes, variances in audit start dates and receipt of client approval of claims. While these factors led to significant variances in the year over year quarterly comparisons, they had a lesser impact on revenues for the six months ended June 30, 2011 compared to the same period in 2010. Although we generated year over year increases in revenues in this segment for the first six months of 2011, we have experienced declining revenues in this segment in recent years due to reduced liquidity of our clients' vendors, competitive rate pressures, client attrition, and the impact of our clients developing and strengthening their own internal audit capabilities as a substitute for our services. To address these issues, offset their impact and generate growth in this segment, we began implementing several growth strategies in late 2009. We reinstituted a sales function in 2010, resulting in a significant increase in our client count in recent quarters. We continue to implement our service delivery model transformation designed to make our recovery audit process more cost efficient and effective. We concluded successful pilots of our new service delivery platform in the first half of 2011, and expect to continue to expand its use. We also are providing greater value to our existing and potential clients by offering adjacent services in the procure-to-pay value chain and to the CFO suite, and by capitalizing on our existing data mining and related competencies. While we are encouraged by some of our recent successes, we can provide no assurances that we will be able to build on them in the future or that we will be able to sustain our current revenue levels in this segment. We are near completion of our previously disclosed investment program; however, we believe that a certain level of ongoing investments will be necessary for us to continue to grow our revenues in the Recovery Audit Services - Americas segment. Recovery Audit Services - Europe/Asia-Pacific revenues increased by 21.6% for the three months ended June 30, 2011 compared to the same period in 2010. For the six months ended June 30, 2011, revenues increased by 10.1% compared to the six months ended June 30, 2010. The weakening of the U.S. dollar relative to foreign currencies in Europe, Asia and Australia positively impacted reported revenues in both the second quarter and first half of 2011. On a constant dollar basis, adjusted for changes in FX rates, revenues for the second quarter of 2011 increased by 7.7% compared to an increase of 21.6% as reported and increased by 1.5% during the first six months of 2011 compared to an increase of 10.1% as reported. These increases on a constant dollar basis primarily are attributable to additional audit areas at existing clients and new audit clients in the 2011 periods, partially offset by audit delays experienced in the first half of 2011 at key clients for which we expect to record the related revenues in the third and fourth quarters of 2011. As in our Recovery Audit Services - Americas segment, we experience competitive and other pressures in this segment, but to a lesser degree due to the smaller number of competitors with global capabilities. We are implementing many of the same strategic initiatives for this segment as we are in the Recovery Audit Services - Americas segment. Also, as in the Recovery Audit Services - Americas segment, revenues in this segment may vary significantly from period to period due to numerous recurring factors as discussed above. New Services revenues increased by $4.4 million, or 163.1%, for the three months ended June 30, 2011 compared to the same period in 2010. For the six months ended June 30, 2011, revenues increased by $9.6 million, or 223.6%, compared to the corresponding prior year period. New Services revenues have grown from less than 5% of consolidated revenues in the first half of 2010 to almost 14% of consolidated revenues in the first half of 2011. We generate New Services revenues from our advisory services, business analytics services and from our participation in the Medicare RAC program. We generated increases in our first half of 2011 revenues in each of these areas, particularly in our advisory services due in part to our November 2010 acquisition of The Johnsson Group. We expect New Services revenues to continue to increase in 2011 in the aggregate. We were awarded our first state Medicaid RAC contract early in the first quarter of 2011 and are continuing to evaluate and bid for additional state Medicaid RAC opportunities and healthcare claims recovery auditing opportunities in the private sector. While the magnitude and timing of additional healthcare claims recovery audit revenues are difficult to predict, we expect those revenues to increase in the third and fourth quarters of 2011 compared to the first half of the year. 14-------------------------------------------------------------------------------- Table of Contents Cost of Revenues ("COR"). COR consists principally of commissions and other forms of variable compensation we pay to our auditors based primarily upon the level of overpayment recoveries and/or profit margins derived therefrom, fixed auditor salaries, compensation paid to various types of hourly support staff and salaries for operational and client service managers for our recovery audit, business analytics and advisory services businesses. COR also includes other direct and indirect costs incurred by these personnel, including office rent, travel and entertainment, telephone, utilities, maintenance and supplies and clerical assistance. A significant portion of the components comprising COR is variable and will increase or decrease with increases or decreases in revenues. COR was as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Recovery Audit Services - Americas $ 15,597 $ 17,146 $ 32,240 $ 33,301 Recovery Audit Services - Europe/Asia-Pacific 12,068 10,170 23,658 21,413 New Services 6,858 3,620 13,219 6,055 Total $ 34,523 $ 30,936 $ 69,117 $ 60,769 COR as a percentage of revenues for Recovery Audit Services - Americas was 55.9% and 57.4% for the three months ended June 30, 2011 and 2010, respectively. This equates to gross margin percentages of 44.1% and 42.6% in the 2011 and 2010 periods, respectively. For the six months ended June 30, 2011 and 2010, COR as a percentage of revenues for Recovery Audit Services - Americas was 56.5% and 60.7%, respectively. This equates to gross margin percentages of 43.5% and 39.3% in the 2011 and 2010 periods, respectively. The increase in gross margins for the three and six months ended June 30, 2011 compared to the same periods in 2010 is attributable primarily to decreases in auditor compensation relative to revenues. Gross margins in the Recovery Audit Services - Americas segment in both 2011 and 2010 were negatively impacted by the inclusion in COR of significant portions of the non-capitalized amounts of the costs of the previously disclosed recovery audit service delivery model transformation. This transformation involves the centralization of audit functions and other process improvements that we believe will improve the efficiency and lower the costs of delivering our recovery audit services. COR as a percentage of revenues for Recovery Audit Services - Europe/Asia-Pacific was 76.6% and 78.5% for the three months ended June 30, 2011 and 2010, respectively. This equates to gross margin percentages of 23.4% and 21.5% in the 2011 and 2010 periods, respectively. For the six months ended June 30, 2011 and 2010, COR as a percentage of revenues for Recovery Audit Services - Europe/Asia-Pacific was 77.6% and 77.3%, respectively. This equates to gross margin percentages of 22.4% and 22.7% in the 2011 and 2010 periods, respectively. The slight changes in the gross margins in these periods primarily resulted from changes in the mix of audit revenues and from changes in our methods of providing audit services in Europe. We subcontract a significant portion of our audit services in Europe to third-party audit firms. We currently are migrating several of the larger audits to an employee model. Although we incur some increased costs during this migration process, we expect that the migrations ultimately will result in higher gross margins for this segment and for the Company as a whole. The higher COR as a percentage of revenues for Recovery Audit Services - Europe/Asia-Pacific (76.6% for the second quarter of 2011 and 77.6% for the six months ended June 30, 2011) compared to Recovery Audit Services - Americas (55.9% for the second quarter of 2011 and 56.5% for the six months ended June 30, 2011) is due primarily to differences in service delivery models, scale and geographic fragmentation. The Recovery Audit Services - Europe/Asia-Pacific segment generally serves fewer clients in each geographic market and on average generates lower revenues per client than those served by the Company's Recovery Audit Services - Americas segment. New Services COR relates primarily to costs of advisory services and costs associated with our participation in the Medicare RAC program. COR as a percentage of revenues for New Services was 97.3% and 95.1% for the three and six months ended June 30, 2011, reflecting New Services gross profits of $0.2 million and $0.7 million for these periods, respectively. New Services COR exceeded revenues by $0.9 million and $1.8 million for the three and six months ended June 30, 2010, respectively. The increases in New Services gross margins are due to revenue growth in all of the Company's newly incubated Client Value Propositions, including spend optimization and profit performance. However, COR exceeded revenues for the healthcare claims recovery audit unit by $1.0 million and $1.2 million for the three and six months ended June 30, 2011, respectively. Despite significant growth in revenues in this unit during 2011, we continued to incur losses as we expanded our service capacity in anticipation of greater healthcare claims recovery audit activity. We expect to increase these revenues and adjust our cost structure in the second half of 2011 in order to improve our operating performance in our healthcare claims recovery audit unit. 15-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses ("SG&A"). SG&A expenses of the Recovery Audit and New Services segments include the expenses of sales and marketing activities, information technology services and allocated corporate data center costs, human resources, legal, accounting, administration, foreign currency transaction gains and losses on other than intercompany balances and gains and losses on asset disposals related to the Recovery Audit and New Services segments. Corporate Support SG&A represents the unallocated portion of SG&A expenses which are not specifically attributable to our segment activities and include the expenses of information technology services, the corporate data center, human resources, legal, accounting, treasury, administration and stock-based compensation charges. SG&A expenses were as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Recovery Audit Services - Americas $ 4,652 $ 4,435 $ 10,028 $ 7,944 Recovery Audit Services - Europe/Asia-Pacific 1,398 948 2,561 2,297 New Services 1,338 690 2,566 1,107 Corporate support 4,909 4,271 9,572 8,995 Total $ 12,297 $ 10,344 $ 24,727 $ 20,343 Recovery Audit Services - Americas SG&A increased 4.9% for the three months ended June 30, 2011 and 26.2% for the six months ended June 30, 2011 from the comparable periods in 2010. These increases resulted primarily from severance costs related to the transformation of our recovery audit service delivery model and incentive compensation accruals, combined with higher selling and marketing costs we incurred in connection with our efforts to increase revenues in this segment. In addition, the first quarter of 2010 included a reversal of a portion of our provision for bad debts that resulted in lower reported SG&A expenses in the six months ended June 30, 2010. Recovery Audit Services - Europe/Asia-Pacific SG&A increased 47.5% and 11.5% for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. These increases are due to increased sales efforts in the segment coupled with increased provisions for bad debts in the 2011 periods compared to reversals of provisions for bad debts and a reduction of a business acquisition earn-out estimate in the 2010 periods. New Services SG&A increased 93.9% and 131.8% in the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. These increases are related to our growth in New Services revenues and are attributable to several factors, including: the additional operating costs of our 2010 acquisitions, including Etesius Limited in February 2010 and The Johnsson Group in November 2010; higher costs relating to our participation in the Medicare RAC program subcontracts; and the hiring of additional sales and business development personnel. Corporate Support SG&A increased 14.9% and 6.4% for the three and six months ended June 30, 2011, respectively, when compared to the same periods in 2010. These increases are due primarily to higher stock-based compensation charges, incentive compensation accruals and marketing costs. Depreciation and Amortization. Depreciation and amortization was as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Recovery Audit Services - Americas $ 1,340 $ 1,477 $ 2,687 $ 2,957 Recovery Audit Services - Europe/Asia-Pacific 435 399 855 804 New Services 568 326 1,103 551 Total $ 2,343 $ 2,202 $ 4,645 $ 4,312 During the second quarter of 2010, we revised our estimate of the useful lives of certain fixed assets for the purpose of calculating depreciation expense based on a review of our planned fixed asset replacement cycle. The effects of these changes reduced depreciation expense in the three and six months ended June 30, 2011 but was not significant in the three and six months ended June 30, 2010. The increase in depreciation and amortization expense in the New Services segment is primarily due to amortization of intangible assets recorded in connection with our 16-------------------------------------------------------------------------------- Table of Contents acquisitions of Etesius Limited and The Johnsson Group, as well as an increase in the depreciation of capitalized software development costs. Foreign Currency Transaction (Gains) Losses on Intercompany Balances. Foreign currency transaction gains and losses on intercompany balances result from the remeasurement of the foreign subsidiaries' balances payable to the U.S. parent from their local currency to their U.S. dollar equivalent. Substantial changes from period to period in foreign currency exchange rates may significantly impact the amount of such gains and losses. The strengthening of the U.S. dollar relative to other currencies results in recorded losses on intercompany balances receivable from our foreign subsidiaries while the weakening of the U.S. dollar results in recorded gains. In the three months ended June 30, 2011, we recorded foreign currency gains of $0.4 million on intercompany balances, while we recorded foreign currency losses of $1.1 million on intercompany balances in the three months ended June 30, 2010, a change of $1.5 million between periods. For the first six months of 2011, we recorded foreign currency gains of $0.9 million on intercompany balances, while we recorded foreign currency losses of $1.7 million on intercompany balances for the first six months of 2010, a change of $2.6 million between periods. Net Interest Expense and Loss on Debt Extinguishment. Net interest expense was $0.5 million and $0.3 million for the three months ended June 30, 2011 and 2010, respectively. Net interest expense was $0.8 million and $0.7 million for the six months ended June 30, 2011 and 2010, respectively. We entered into a new credit facility with SunTrust Bank in the first quarter of 2010 (see "Secured Credit Facility" below for additional information regarding this transaction) and repaid our prior term loan from Ableco LLC. In connection with our repayment of the Ableco term loan we recorded a $1.4 million loss on extinguishment of debt representing the write-off of the unamortized deferred loan costs. The increase in net interest expense in the 2011 periods is primarily due to interest expense associated with business acquisition obligations. Income Tax Expense. Our income tax expense amounts as reported in the accompanying Condensed Consolidated Financial Statements (Unaudited) do not reflect amounts that normally would be expected due to several factors. The most significant of these factors is that for U.S. tax reporting purposes we have net operating loss carryforwards and other tax attributes which created deferred tax assets on our balance sheet. We reduce our deferred tax assets by a valuation allowance if it is more likely than not that some portion or all of a deferred tax asset will not be realized. Generally, these factors result in our recording no net income tax expense or benefit relating to our operations in the United States. Reported income tax expense for the three and six months ended June 30, 2011 and 2010 primarily results from taxes on the income of our foreign subsidiaries. 17-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of June 30, 2011, we had $22.9 million in cash and cash equivalents and no borrowings under the revolver portion of our credit facility. The revolver had approximately $8.1 million of calculated availability for borrowings. The Company was in compliance with the covenants in its SunTrust credit facility as of June 30, 2011. Operating Activities. Net cash provided by (used in) operating activities was $10.2 million and $(0.3 million) during the six months ended June 30, 2011 and 2010, respectively. These amounts consist of two components, specifically, net earnings (loss) adjusted for certain non-cash items (such as depreciation, amortization and stock-based compensation expense) and changes in assets and liabilities, primarily working capital, as follows: Six Months Ended June 30, 2011 2010 Net earnings (loss) $ 1,082 $ (3,400 ) Adjustments for certain non-cash items 5,792 8,813 6,874 5,413 Changes in assets and liabilities 3,309 (5,747 ) Net cash provided by (used in) operating activities $ 10,183 $ (334 ) The $10.5 million improvement in cash provided by operating activities in the first half of 2011 compared to the first half of 2010 was due to a $1.5 million increase in net earnings (loss) adjusted for non-cash items and a $9.0 million improvement from changes in assets and liabilities, primarily working capital. 2011 working capital improvements resulted primarily from $7.1 million of increases in accounts payable and compensation accruals offset by $3.5 million in increases in receivables and prepaid expenses. 2010 working capital deterioration resulted primarily from $7.2 million of decreases in accounts payable and compensation accruals offset by $2.4 million of decreases in receivables. We include an itemization of these changes in our Consolidated Statements of Cash Flows included in Item 1 of this Form 10-Q. We incurred operating losses in our healthcare claims recovery audit unit within our New Services segment of approximately $2.8 million and $2.3 million during the first six months of 2011 and 2010, respectively, primarily related to the Medicare RAC program. As of June 30, 2011, we had contract receivables of $1.0 million, deferred costs (included in other current assets) of $1.0 million, as well as capitalized software development costs and other fixed assets associated with this program. These losses and investments have had a significant negative impact on our liquidity and cash flows. We expect to continue to incur losses, increase receivables and other current assets, and incur capital expenditures relating to this program in the second half of 2011. Investing Activities and Depreciation and Amortization. Depreciation and amortization for the six months ended June 30, 2011 and 2010 amounted to $4.6 million and $4.3 million, respectively. Net cash used for property and equipment capital expenditures was $4.2 million and $4.0 million during the six months ended June 30, 2011 and 2010, respectively. These capital expenditures primarily related to investments we made to upgrade our information technology infrastructure, redesign our recovery audit services delivery model to reduce our cost to serve, and improve our processes to generate efficiencies in the performance of our healthcare claims recovery audit procedures. Capital expenditures are discretionary and we currently expect future capital expenditures to continue at slightly reduced levels over the next several quarters as we continue to enhance our service delivery capabilities. We may alter our capital expenditure plans should we experience changes in our operating results which cause us to adjust our operating plans. In February 2010, the Company acquired all of the issued and outstanding capital stock of Etesius Limited for a purchase price valued at $3.1 million. The purchase price included an initial cash payment of $2.8 million and payment of obligations on behalf of Etesius shareholders of $0.3 million that we paid in February 2010. Financing Activities and Interest Expense. Net cash used in financing activities was $2.2 million and $2.3 million for the six months ended June 30, 2011 and 2010, respectively. During the first six months of 2011, we made mandatory payments totaling $1.5 million on our new term loan, received $0.3 million in proceeds from stock option exercises and paid $1.0 million for restricted stock remitted by employees as payment for taxes they incurred upon vesting of their restricted stock. As described in more detail below, in January 2010, we entered into a new $15.0 million term loan, the proceeds of which were used to repay the remaining $14.1 million of outstanding 18-------------------------------------------------------------------------------- Table of Contents principal from the Ableco LLC term loan and to pay $0.5 million of the loan costs we incurred in connection with the new SunTrust credit facility. In January 2010, the Company made the first of two deferred payments required as part of the acquisition of First Audit Partners LLP in the amount of £0.5 million ($0.8 million). The second payment of £0.8 million ($1.3 million) was made in July 2010. Secured Credit Facility On January 19, 2010, we entered into a four-year revolving credit and term loan agreement with SunTrust Bank ("SunTrust"). We used substantially all the funds from the SunTrust term loan to repay in full the $14.1 million outstanding under our then-existing Ableco LLC term loan. The SunTrust credit facility consists of a $15.0 million committed revolving credit facility and a $15.0 million term loan. The SunTrust credit facility is guaranteed by the Company and its domestic subsidiaries and is secured by substantially all of our assets. Amounts available for borrowing under the SunTrust revolver are based on our eligible accounts receivable and other factors. Borrowing availability under the SunTrust revolver at June 30, 2011 was $8.1 million. We had no borrowings outstanding under the SunTrust revolver as of June 30, 2011. The SunTrust term loan requires quarterly principal payments of $0.8 million from March 2010 through December 2013, and a final payment of $3.0 million in January 2014. The loan agreement requires mandatory prepayments with the net cash proceeds from certain asset sales, equity offerings and insurance claims. The loan agreement also requires an additional annual prepayment based on excess cash flow ("ECF") if our leverage ratio, as defined in the agreement, exceeds a certain threshold. The first of any such ECF payments would have been payable in April 2011, but our leverage ratio did not exceed the threshold and we were not required to make an ECF payment in April 2011. Interest on both the revolver and term loan is payable monthly and accrues at an index rate based on the one-month LIBOR rate, plus an applicable margin as determined by the loan agreement. The applicable interest rate margin varies from 2.25% per annum to 3.5% per annum, depending on our consolidated leverage ratio, and is determined in accordance with a pricing grid under the SunTrust loan agreement. The applicable margin was 2.5% and the interest rate was approximately 2.69% at June 30, 2011. We also must pay a commitment fee of 0.5% per annum, payable quarterly, on the unused portion of the $15.0 million SunTrust revolving credit facility. The SunTrust credit facility includes customary affirmative, negative, and financial covenants binding on the Company, including delivery of financial statements and other reports, maintenance of existence, and transactions with affiliates. The negative covenants limit the ability of the Company, among other things, to incur debt, incur liens, make investments, sell assets, repurchase shares of its capital stock or declare or pay dividends on its capital stock. The financial covenants included in the SunTrust credit facility, among other things, limit the amount of capital expenditures the Company can make, set forth maximum leverage and net funded debt ratios for the Company and a minimum fixed charge coverage ratio, and also require the Company to maintain minimum consolidated earnings before interest, taxes, depreciation and amortization. In addition, the SunTrust credit facility includes customary events of default. We believe that we will have sufficient borrowing capacity and cash generated from operations to fund our capital and operating needs for at least the next twelve months. Off Balance Sheet Arrangements As of June 30, 2011, the Company did not have any material off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of the SEC's Regulation S-K. 19-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies We describe the Company's significant accounting policies in Note 1 of Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the year ended December 31, 2010. We consider certain of these accounting policies to be "critical" to the portrayal of the Company's financial position and results of operations, as they require the application of significant judgment by management. As a result, they are subject to an inherent degree of uncertainty. We identify and discuss these "critical" accounting policies in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the Company's Annual Report on Form 10-K for the year ended December 31, 2010. Management bases its estimates and judgments on historical experience and on various other factors that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. On an ongoing basis, management evaluates its estimates and judgments, including those considered "critical". Management has discussed the development, selection and evaluation of accounting estimates, including those deemed "critical," and the associated disclosures in this Form 10-Q with the Audit Committee of the Board of Directors. Forward-Looking Statements Some of the information in this Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which statements involve substantial risks and uncertainties including, without limitation, (1) statements that contain projections of the Company's future results of operations or of the Company's financial condition, (2) statements regarding the adequacy of the Company's current working capital and other available sources of funds, (3) statements regarding goals and plans for the future, including the Company's strategic initiatives and growth opportunities, (4) expectations regarding future accounts payable services revenue trends, and (5) the anticipated impact of the Company's participation in the Medicare RAC program. All statements that cannot be assessed until the occurrence of a future event or events should be considered forward-looking. These statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and can be identified by the use of forward-looking words such as "may," "will," "expect," "anticipate," "believe," "estimate" and "continue" or similar words. Risks and uncertainties that may potentially impact these forward-looking statements include, without limitation, those set forth under Part I, Item 1A "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2010 and its other periodic reports filed with the Securities and Exchange Commission. The Company disclaims any obligation or duty to update or modify these forward-looking statements. There may be events in the future, however, that the Company cannot accurately predict or over which the Company has no control. The risks and uncertainties listed in this section, as well as any cautionary language in this Form 10-Q, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should be aware that the occurrence of any of the events denoted above as risks and uncertainties and elsewhere in this Form 10-Q could have a material adverse effect on our business, financial condition and results of operations. 20 -------------------------------------------------------------------------------- Table of Contents |