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EXAMWORKS GROUP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Forward-looking Statements Unless the context indicates otherwise, references in this Quarterly Report on Form 10-Q to "ExamWorks", "the Company," "we," "our," and "us" mean ExamWorks Group, Inc. and its consolidated subsidiaries. The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on 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, that involve risks and uncertainties. Forward-looking statements convey current expectations or forecasts of future events for ExamWorks. All statements contained in this report other than statements of historical fact, including statements regarding our future results of operations and financial position, business strategy and plans, and our objectives for future operations, are forward-looking. You can identify forward-looking statements by terminology such as "project," "believe," "anticipate," "plan," "expect," "estimate," "intend," "should," "would," "could," "will," "can," "continue," or "may," or the negative of these terms or other similar expressions that convey uncertainty of future events or outcomes. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled "Risk Factors," set forth in Part II, Item 1A. of this Quarterly Report on Form 10-Q and elsewhere in this report, and in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this report. Subsequent events and developments may cause our views to change. While we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this report. Our Business We are a leading provider of IMEs, peer and bill reviews, Medicare compliance, case management and other related services, which include legal support services, administrative support services and medical record retrieval services. We were incorporated as a Delaware corporation on April 27, 2007. From July 14, 2008 through the date of this filing, we have acquired 49 IME services businesses, including a leading provider of software solutions to the IME industry. We currently operate out of 65 service centers servicing all 50 U.S. states, Canada, the United Kingdom and Australia. We conduct our business through four geographic segments: the United States, Canada, the United Kingdom and Australia. We provide our services to property and casualty insurance carriers, law firms, third-party claim administrators, government agencies, and state funds that use independent services to confirm the veracity of claims by sick or injured individuals for workers' compensation, automotive, personal injury liability and disability insurance coverage. We help our clients manage costs and enhance their risk management processes by verifying the validity, nature, cause and extent of claims, identifying fraud and providing fast, efficient and quality IME services. We provide our clients with the local presence, expertise and broad geographic coverage they increasingly require. Our size and geographic reach give our clients access to our medical panel of credentialed physicians and other medical providers and our proprietary information technology infrastructure that has been specifically designed to streamline the complex process of coordinating referrals, scheduling appointments, complying with regulations and client reporting. Our primary service is to provide IMEs that give our clients authoritative and accurate answers to questions regarding the nature and permanency of medical conditions or personal injury, their cause and appropriate treatment. Additionally, we provide peer and bill reviews, which consist of medical opinions by members of our medical panel without conducting physical exams, and the review of physician and hospital bills to examine medical care rendered and its conformity to accepted standards of care. With the acquisition of Gould & Lamb in February 2014 and Ability Services Network and MedAllocators in June 2014, we expanded our presence in the Medicare compliance and case management markets. We currently market our IME services under several brands, including but not limited to, ExamWorks, MES, Premex, MedHealth and ExamWorks Clinical Solutions. 31-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES A key feature of our strategy is to grow our business organically by selling additional services to existing clients, cross-selling into additional insurance lines of business and expanding our geographic footprint with existing clients. Because we operate in a highly fragmented industry, and have completed numerous acquisitions, another component of our business strategy has historically been and continues to be growth through acquisitions that expand our geographic coverage, provide new or complementary lines of business, expand our portfolio of services, and increase our market share. For example, our acquisition of MedHealth in August 2012 enabled us to enter the Australian market, expand our range of clients and services, and increase our international market presence. . Similarly, our acquisitions of Gould & Lamb in February 2014 and Ability Services Network and MedAllocators in June 2014 enabled us to expand our presence in the Medicare compliance and case management markets, and offer a wider range of services to new and existing clients. To date, we have completed the following 49 acquisitions: Acquisition Date Name August 22, 2014 ? Expert Medical Opinions June 6, 2014 ? Ability Services Network and MedAllocators May 30, 2014 ? Solomon Associates February 14, 2014 ? Assess Medical February 3, 2014 ? Gould & Lamb January 16, 2014 ? Cheselden January 13, 2014 ? Newton Medical Group December 20, 2013 ? Evaluation Resource Group December 10, 2013 ? AGS Risk Limited December 19, 2012 ? PMG August 31, 2012 ? MedHealth July 12, 2012 ? Makos October 27, 2011 ? Bronshvag October 24, 2011 ? Matrix Health Management October 3, 2011 ? Capital Vocational Specialists ? North York Rehabilitation Centre September 28, 2011 ? MLS Group of Companies ? Medicolegal Services May 10, 2011 ? Premex Group February 28, 2011 ? MES Group February 18, 2011 ? National IME Centres December 20, 2010 ? Royal Medical Consultants October 1, 2010 ? BMEGateway September 7, 2010 ? UK Independent Medical Services September 1, 2010 ? Health Cost Management August 6, 2010 ? Verity Medical ? Exigere June 30, 2010 ? SOMA Medical Assessments ? Direct IME ? Network Medical Review ? Independent Medical Services ? 401 Diagnostics March 26, 2010 ? Metro Medical Services March 15, 2010 ? American Medical Bill Review ? Medical Evaluations December 31, 2009 ? Abeton ? Medical Assurance Group ? MedNet I.M.S. ? Qualmed ? IME Operations of Physicians' Practice August 14, 2009 ? The Evaluation Group August 4, 2009 ? Benchmark Medical Consultants July 7, 2009 ? IME Software Solutions May 21, 2009 ? Florida Medical Specialists ? Marquis Medical Administrators April 17, 2009 ? Ricwel July 14, 2008 ? CFO Medical Services ? Crossland Medical Review Services ? Southwest Medical 32-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Sources of Revenues and Expenses Revenues We derive revenue primarily from fees charged for independent medical examinations, peer and bill reviews, Medicare compliance and other related services, which include litigation support services, administrative support services and medical record retrieval services. Revenues are recognized at the time services have been performed and, if applicable, at the time the report is shipped to the end user. We expect revenue to continue to increase through acquisition and organic growth. Our revenue is derived from services performed in different geographic areas. Certain agreements with customers in the U.K. include provisions whereby collection of the amounts billed are contingent on the favorable outcome of the claim. We have deemed these provisions to preclude revenue recognition at the time of performance, as collectability is not reasonably assured and the cash payments are contingent, and are deferring these revenues, net of estimated costs, until the case has been settled and the contingency has been resolved and the cash has been collected. Costs of revenues Costs of revenues are comprised of fees paid to members of our medical panel; other direct costs including transcription, film and medical record obtainment and transportation; and other indirect costs including labor and overhead related to the generation of revenue. We expect these operationally driven costs to increase to support future revenue growth and as we continue to grow through acquisitions. Selling, general and administrative expenses Selling, general and administrative ("SGA") expenses consist primarily of expenses for administrative, human resource related, corporate information technology support, legal (primarily from transaction costs related to acquisitions), finance and accounting personnel, professional fees (primarily from transaction costs related to acquisitions), insurance and other corporate expenses. We expect that SGA expenses will increase as we continue to add personnel to support the growth of our business and pursue acquisition growth. In addition, we may incur additional personnel expenses, professional service fees, including audit and legal, investor relations, costs of compliance with securities laws and regulations, and higher director and officer insurance costs related to operating as a public company. As a result, we expect that our SGA expenses will continue to increase in the future but decrease as a percentage of revenue over time as our revenue increases. Depreciation and amortization Depreciation and amortization ("D&A") expense consists primarily of amortization of our finite lived intangible assets obtained through acquisitions completed to date and, to a lesser extent, depreciation of property, equipment and leasehold improvements. We expect that depreciation and amortization expense will decrease as a percentage of revenues as our finite lived intangible assets become fully amortized. 33-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Results of Operations The following table sets forth our consolidated statements of operations data for each of the periods indicated (in thousands except share and per share data): For the three months For the nine months ended September 30, ended September 30, 2013 2014 2013 2014 Revenues $ 152,354 $ 204,078 $ 457,205 $ 573,551 Costs and expenses: Costs of revenues 100,831 130,597 300,333 366,483 Selling, general and administrative expenses 31,620 43,534 98,953 126,652 Depreciation and amortization 15,910 15,705 48,058 44,905 Total costs and expenses 148,361 189,836 447,344 538,040 Income from operations 3,993 14,242 9,861 35,511 Interest and other expenses, net 7,316 8,355 22,546 24,027 Income (loss) before income taxes (3,323 ) 5,887 (12,685 ) 11,484 Provision (benefit) for income taxes (1,072 ) 2,472 (4,059 ) 4,826 Net income (loss) $ (2,251 ) $ 3,415 $ (8,626 ) $ 6,658 Per share data: Net income (loss) per share: Basic $ (0.06 ) $ 0.09 $ (0.25 ) $ 0.17 Diluted $ (0.06 ) $ 0.08 $ (0.25 ) $ 0.16 Weighted average number of common shares outstanding: Basic 35,560,227 39,251,221 34,977,335 38,258,941 Diluted 35,560,227 41,647,190 34,977,335 40,896,677 Other Financial Data: Adjusted EBITDA(1) $ 23,885 $ 36,083 $ 71,896 $ 98,672 (1) Adjusted EBITDA is a non-GAAP measure that is described and reconciled to net income (loss) in the next section and is not a substitute for the GAAP equivalent. Adjusted EBITDA In connection with the ongoing operation of our business, our management regularly reviews Adjusted EBITDA, a non-GAAP financial measure, to assess our performance. We define Adjusted EBITDA as earnings before interest, taxes, depreciation, amortization, acquisition-related transaction costs, share-based compensation expenses, and other expenses. We believe that Adjusted EBITDA is an important measure of our operating performance because it allows management, lenders, investors and analysts to evaluate and assess our core operating results from period to period after removing the impact of changes to our capitalization structure, acquisition related costs, income tax status, and other items of a non-operational nature that affect comparability. We believe that various forms of the Adjusted EBITDA metric are often used by analysts, investors and other interested parties to evaluate companies such as ours for the reasons discussed above. Additionally, Adjusted EBITDA is used to measure certain financial covenants in our credit facility. Adjusted EBITDA is also used for planning purposes and in presentations to our Board of Directors as well as in our incentive compensation programs for our employees. Non-GAAP information should not be construed as an alternative to GAAP information, as the items excluded from the non-GAAP measures often have a material impact on our financial results. Management uses, and investors should use, non-GAAP measures in conjunction with our GAAP results. 34-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES The following table presents a reconciliation to Adjusted EBITDA from net income (loss), the most comparable GAAP measure, for each of the periods indicated (in thousands): For the three months For the nine months ended September 30, ended September 30, 2013 2014 2013 2014 Net income (loss) $ (2,251 ) $ 3,415 $ (8,626 ) $ 6,658 Share-based compensation expense (i) 3,820 4,680 12,234 14,660 Depreciation and amortization 15,910 15,705 48,058 44,905 Acquisition-related transaction costs 186 871 1,093 2,825 Other expenses (ii) (24 ) 585 650 771 Interest and other expenses, net 7,316 8,355 22,546 24,027 Provision (benefit) for income taxes (1,072 ) 2,472 (4,059 ) 4,826 Adjusted EBITDA 23,885 36,083 71,896 98,672 (i) Share-based compensation expense of $748,000 and $2.2 million is included in costs of revenues for the three and nine months ended September 30, 2013, respectively, and the remainder is included in SGA expenses. Share-based compensation expense of $444,000 and $1.6 million is included in costs of revenues for the three and nine months ended September 30, 2014, respectively, and the remainder is included in SGA expenses. (ii) Other expenses consist principally of integration related expenses, such as facility termination, severance and relocation costs, associated with our acquisition strategy. Comparison of the Three Months Ended September 30, 2014 and 2013 Revenues. Revenues were $204.1 million for the three months ended September 30, 2014 compared to $152.4 million for the three months ended September 30, 2013, an increase of $51.7 million, or 33.9%. Of the increase in revenues compared to 2013, $24.0 million, or 15.8%, was attributable to acquisitions completed in 2013 and 2014, and $27.7 million, or 18.1%, was due to growth in our existing businesses primarily due to increased IME service volumes. ? U.S. segment revenues were $123.1 million for the three months ended September 30, 2014 compared to $94.0 million for the three months ended September 30, 2013, an increase of $29.1 million, or 31.0%. Of the increase in U.S. revenues compared to 2013, $18.3 million, or 19.4%, was attributable to acquisitions completed in 2013 and 2014, and $10.8 million, or 11.6%, was due to growth in our existing businesses driven by increased IME service volumes. ? Canada segment revenues were $8.1 million for the three months ended September 30, 2014 compared to $7.3 million for the three months ended September 30, 2013, an increase of $786,000, or 10.8%. Excluding the impact of currency, the existing Canada businesses grew 16.0%. The constant currency growth in Canada revenues compared to 2013 was due to increased IME service volumes, offset by an unfavorable change in sales mix. ? U.K. segment revenues were $48.9 million for the three months ended September 30, 2014 compared to $34.6 million for the three months ended September 30, 2013, an increase of $14.3 million, or 41.2%. Of the increase in U.K. revenues compared to 2013, $2.1 million, or 6.1%, was attributable to acquisitions completed in 2013 and 2014, and $12.2 million, or 35.1%, was due to growth in our existing businesses. Excluding the impact of currency, the existing U.K. businesses grew 25.3%. The constant currency growth in the existing businesses was due to increased IME service volumes, offset by an unfavorable change in sales mix. ? Australia segment revenues were $24.0 million for the three months ended September 30, 2014 compared to $16.5 million for the three months ended September 30, 2013, an increase of $7.5 million, or 45.6%. Of the increase in Australia revenues compared to 2013, $3.7 million, or 22.3%, was attributable to an acquisition completed in 2014, and $3.8 million, or 23.3%, was due to growth in our existing businesses. Excluding the impact of currency, the existing Australian businesses grew 22.0% primarily due to increased IME service volumes, and to a lesser extent, a favorable change in sales mix. Costs of revenues. Costs of revenues were $130.6 million for the three months ended September 30, 2014 compared to $100.8 million for the three months ended September 30, 2013, an increase of $29.8 million, or 29.5%. Of the increase in costs of revenues compared to 2013, $11.6 million, or 11.5%, was attributable to acquisitions completed in 2013 and 2014, and $18.2 million, or 18.0%, was related to our existing businesses and was primarily attributable to increased fees paid to members of our medical panel and, to a lesser extent, an increase in other direct costs. Costs of revenues as a percentage of revenues was 64.0% for the three months ended September 30, 2014, a 2.2% improvement over the 66.2% for the three months ended September 30, 2013. 35-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Selling, general and administrative. SGA expenses $43.5 million for the three months ended September 30, 2014 compared to $31.6 million for the three months ended September 30, 2013, an increase of $11.9 million, or 37.7%. Of the increase in SGA expenses compared to 2013, $7.3 million, or 23.2%, was attributable to acquisitions completed in 2013 and 2014, and $4.6 million, or 14.5%, was related to our existing businesses and was primarily attributable to $1.9 million in increased personnel expenses, including share-based compensation, and the remainder resulted primarily from increases in acquisition related transaction costs and referral commissions. Depreciation and amortization. D&A expenses were $15.7 million for the three months ended September 30, 2014 compared to $15.9 million for the three months ended September 30, 2013, a decrease of $205,000, or 1.3%. Of the decrease in D&A expenses compared to 2013, $5.1 million, or 32.2%, was attributable to our existing businesses as historic finite-lived intangible and tangible assets became fully amortized, offset by increases resulting from acquisitions completed in 2013 and 2014. Interest and other expenses, net. Interest and other expenses, net were $8.4 million for the three months ended September 30, 2014 compared to $7.3 million for the three months ended September 30, 2013, an increase of $1.1 million. Interest and other expenses, net, increased primarily due to increased borrowings on the Senior Secured Revolving Credit Facility to fund the 2013 and 2014 acquisitions. Income tax expense (benefit). Income tax expense was $2.5 million for the three months ended September 30, 2014 compared to an income tax benefit of $1.1 million for the three months ended September 30, 2013, a decreased benefit of $3.5 million, or 330.6%. Our effective income tax rate was 42.0% and 32.3% for the three months ended September 30, 2014 and 2013, respectively. The tax rates in the 2014 and 2013 periods were impacted primarily by foreign tax rate differentials and non-deductible items. Net income (loss). For the foregoing reasons, net income was $3.4 million for the three months ended September 30, 2014 compared to our net loss of $2.3 million for the three months ended September 30, 2013. Comparison of the Nine months Ended September 30, 2014 and 2013 Revenues. Revenues were $573.6 million for the nine months ended September 30, 2014 compared to $457.2 million for the nine months ended September 30, 2013, an increase of $116.3 million, or 25.4%. Of the increase in revenues compared to 2013, $49.8 million, or 10.9%, was attributable to acquisitions completed in 2013 and 2014 and $66.5 million, or 14.5%, was due to growth in our existing businesses primarily due to increased IME service volumes. ? U.S. segment revenues were $346.5 million for the nine months ended September 30, 2014 compared to $280.6 million for the nine months ended September 30, 2013, an increase of $65.9 million, or 23.5%. Of the increase in U.S. revenues compared to 2013, $35.9 million, or 12.8%, was attributable to acquisitions completed in 2013 and 2014 and $30.0 million, or 10.7%, was due to growth in our existing businesses, primarily due to increased IME service volumes, and to a lesser extent, a favorable change in sales mix. ? Canada segment revenues were $24.2 million for the nine months ended September 30, 2014 compared to $23.0 million for the nine months ended September 30, 2013, an increase of $1.2 million, or 5.1%. Excluding the impact of currency, the existing Canada businesses grew 12.3%. The constant currency growth in Canada revenues compared to 2013 was attributable to increased IME service volumes, offset by an unfavorable change in sales mix. ? U.K. segment revenues were $139.6 million for the nine months ended September 30, 2014 compared to $103.6 million for the nine months ended September 30, 2013, an increase of $36.0 million, or 34.7%. Of the increase in U.K. revenues compared to 2013, $5.9 million, or 5.7%, was attributable to acquisitions completed in 2013 and 2014 and $30.1 million, or 29.0%, was due to growth in our existing businesses. Excluding the impact of currency, the existing U.K. businesses grew 19.5%. The constant currency growth in the existing businesses was primarily due to increased IME service volumes, and to a lesser extent, a favorable change in sales mix. ? Australia segment revenues were $63.3 million for the nine months ended September 30, 2014 compared to $49.9 million for the nine months ended September 30, 2013, an increase of $13.4 million, or 26.8%. Of the increase in Australia revenues compared to 2013, $8.1 million, or 16.2%, was attributable to an acquisition completed in 2014 and $5.3 million, or 10.6%, was due to growth in our existing businesses. Excluding the impact of currency, the existing Australian businesses grew 17.9%. The constant currency growth in the existing business was primarily due to increased IME service volumes, and to a lesser extent, a favorable change in sales mix. Costs of revenues. Costs of revenues were $366.5 million for the nine months ended September 30, 2014 compared to $300.3 million for the nine months ended September 30, 2013, an increase of $66.2 million, or 22.0%. Of the increase in costs of revenues compared to 2013, $23.3 million, or 7.8%, was attributable to acquisitions completed in 2013 and 2014, and $42.9 million, or 14.3%, was related to our existing businesses and was primarily attributable to increased fees paid to members of our medical panel and, to a lesser extent, an increase in other direct costs. Costs of revenues as a percentage of revenues was 63.9% for the nine months ended September 30, 2014, a 1.8% improvement over the 65.7% for the nine months ended September 30, 2013. 36-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Selling, general and administrative. SGA expenses $126.7 million for the nine months ended September 30, 2014 compared to $99.0 million for the nine months ended September 30, 2013, an increase of $27.7 million, or 28.0%. Of the increase in SGA expenses compared to 2013, $15.3 million, or 15.4%, was attributable to acquisitions completed in 2013 and 2014, and $12.4 million, or 12.6%, was related to our existing businesses and was primarily attributable to $7.0 million in increased personnel expenses, including share-based compensation, and the remainder resulted primarily from increases in acquisition related transaction costs and referral commissions. Depreciation and amortization. D&A expenses were $44.9 million for the nine months ended September 30, 2014 compared to $48.1 million for the nine months ended September 30, 2013, a decrease of $3.2 million, or 6.6%. Of the decrease in D&A expenses compared to 2013, $14.1 million, or 29.3%, was attributable to our existing businesses as historic finite-lived intangible and tangible assets became fully amortized, offset by increases resulting from acquisitions completed in 2013 and 2014. Interest and other expenses, net. Interest and other expenses, net were $24.0 million for the nine months ended September 30, 2014 compared to $22.5 million for the nine months ended September 30, 2013, an increase of $1.5 million. Interest and other expenses, net, increased primarily due to increased borrowings on the Senior Secured Revolving Credit Facility to fund the 2013 and 2014 acquisitions. Income tax expense (benefit). Income tax expense was $4.8 million for the nine months ended September 30, 2014 compared to an income tax benefit of $4.1 million for the nine months ended September 30, 2013, a decreased benefit of $8.9 million, or 218.9%. Our effective income tax rate was 42.0% and 32.0% for the nine months ended September 30, 2014 and 2013, respectively. The tax rates in the 2014 and 2013 periods were impacted primarily by foreign tax rate differentials and non-deductible items. Net income (loss). For the foregoing reasons, net income was $6.7 million for the nine months ended September 30, 2014 compared to our net loss of $8.6 million for the nine months ended September 30, 2013. Liquidity and Capital Resources Our principal capital requirements are to fund operations and acquisitions. We fund our capital needs from cash flow generated from operations, borrowings under the Senior Secured Revolving Credit Facility and working capital facilities. We have also occasionally funded our acquisition program with equity issuances to sellers. We expect that cash and cash equivalents, availability under our existing credit and working capital facilities and cash flow from operations will be sufficient to support our operations, planned capital expenditures and acquisitions for at least the next 12 months. Although we believe that our current cash and cash equivalents and funds available under our Senior Secured Revolving Credit Facility and working capital facilities will be sufficient to meet our working capital and acquisition plans for at least the next 12 months, we may need to raise additional funds through the issuance of equity or convertible debt securities or increase borrowings to fund acquisitions. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our existing stockholders will be reduced and these securities might have rights, preferences and privileges senior to those of our current stockholders. Additional financing may not be available or, if available, such financing may not be obtained on terms favorable to our stockholders and us. Credit Facilities Credit Facility In November 2010, in conjunction with the IPO, we repaid $102.4 million of outstanding debt and terminated a credit facility. This facility was replaced with a new senior secured revolving credit facility with Bank of America, N.A., as administrative agent and the other lenders party thereto (the "Senior Secured Revolving Credit Facility"), which following the exercises of the accordion feature in February 2011 and, subsequently in May 2011, and as amended, provides for borrowings of up to $262.5 million. Up to $15.0 million of the Senior Secured Revolving Credit Facility may be in the form of letters of credit, and up to $15.0 million may be in the form of swingline loans. Loans under the Senior Secured Revolving Credit Facility, which terminates in July 2016, were used to fund our acquisition program and for general corporate purposes, including permitted acquisitions. On May 6, 2011, we increased and fully exercised the accordion features of the Senior Secured Revolving Credit Facility. The increase and exercise of the accordion feature increased the committed capacity of the credit facility by $55.0 million, from a total of $245.0 million to a total of $300.0 million. Concurrently with the foregoing, we amended the Senior Secured Revolving Credit Facility to, among other things, (i) permit its maximum senior leverage ratio to temporarily increase from 3.0 to 1 to 3.50 to 1 for the quarters ending June 30 and September 30, 2011 and 3.25 to 1 for the quarter ending December 31, 2011 and 3.0 to 1 thereafter; and (ii) permit the netting of unrestricted domestic cash in excess of $2.5 million but not exceeding $12.5 million against funded indebtedness for purposes of calculating leverage ratios. 37-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES On July 7, 2011, we entered into a second amendment to our Senior Secured Revolving Credit Facility (the "Second Amendment"), which became effective simultaneously with the consummation of our private offering of $250.0 million aggregate principal senior notes. The Second Amendment amended the Senior Secured Revolving Credit Facility to, among other things, (i) extend the maturity date of the Senior Secured Revolving Credit Facility from November 2013 to July 2016; (ii) permit the issuance and sale of the Senior Unsecured Notes; (iii) replace the consolidated senior leverage ratio with a consolidated senior secured leverage ratio while permitting the maximum consolidated senior secured leverage ratio to be 3.00 to 1; (iv) permit our maximum consolidated leverage ratio to increase from 3.5 to 1 to 4.75 to 1; (v) reduce the borrowing cost; and (vi) allow us to complete acquisitions with a purchase price of up to $75.0 million (previously $50.0 million) without prior lender consent. The Second Amendment also reduced the aggregate revolving commitments under the Senior Secured Revolving Credit Facility by $37.5 million for a maximum commitment of $262.5 million, subject to our right to increase the aggregate revolving commitments by $37.5 million for a maximum commitment of $300.0 million, so long as we are not in default and we satisfy certain other customary conditions. On February 27, 2012, we entered into a third amendment to our Senior Secured Revolving Credit Facility (the "Third Amendment"). The Third Amendment amended the Senior Secured Revolving Credit Facility as to the definitions of consolidated fixed charges and consolidated fixed charge coverage ratio and does not permit the consolidated fixed charge coverage ratio as of the end of any fiscal quarter to be less than (i) for an fiscal quarter ending during the period from December 31, 2011 to and including September 30, 2012, 1.75 to 1.00 and (ii) for an fiscal quarter ending thereafter, 2.00 to 1.00. On August 27, 2012, we entered into a fourth amendment to our Senior Secured Revolving Credit Facility (the "Fourth Amendment"). The Fourth Amendment amended the Senior Secured Revolving Credit Facility to add the Australian dollar as an alternative currency and increased the alternative currency sublimit from USD $60.0 million to USD $100.0 million. On June 27, 2013, we entered into a fifth amendment to our Senior Secured Revolving Credit Facility (the "Fifth Amendment"). Among other changes, the Fifth Amendment modifies the Credit Agreement to permit an implementation of an auto-borrow agreement between the swing line lender and us to facilitate cash management, incorporates new provisions related to swap regulations and updates various provisions related to the LIBOR rate, Foreign Account Tax Compliance Act and the International Financial Reporting Standards. On February 3, 2014, we entered into a sixth amendment to our Senior Secured Revolving Credit Facility (the "Sixth Amendment"). The Sixth Amendment (i) allowed us to consummate the acquisition of Gould & Lamb, and (ii) allows us to acquire a target (a) with negative trailing twelve month adjusted EBITDA (as defined in the Senior Secured Revolving Credit Facility) if the purchase price of such acquisition is less than $5.0 million, (b) with trailing twelve month adjusted EBITDA (as defined in the Senior Secured Revolving Credit Facility) of less than or equal to $3.0 million without delivering to the lenders a quality of earnings report regarding such target and (c) without delivering pro forma projections to our lenders if the purchase price of such acquisition is less than $75.0 million, in each case, without prior lender consent. We financed the $75.0 million purchase price for the Gould & Lamb acquisition in February 2014 with proceeds from the Senior Secured Revolving Credit Facility. Our obligations under the Senior Secured Revolving Credit Facility are guaranteed by each of our existing and future direct and indirect domestic subsidiaries, and such obligations are secured by substantially all of the assets of us and our domestic subsidiaries; however, in the case of our foreign subsidiaries, no more than 65.0% of the capital stock of first-tier subsidiaries shall be pledged, and no assets will be encumbered by liens in favor of our lenders. Borrowings under the Senior Secured Revolving Credit Facility, as amended, bear interest, at either (i) LIBOR plus the applicable margin or (ii) a base rate (equal to the highest of (a) the federal funds rate plus 0.5%, (b) the Bank of America prime rate and (c) LIBOR (using a one-month period) plus 1.0%), plus the applicable margin, as we elect. The applicable margin means a percentage per annum determined in accordance with the following table: Commitment Pricing Fee/Unused Letter of Eurocurrency Base Rate Tier Consolidated Senior Secured Leverage Ratio Line Fee Credit Fee Rate Loans Loans 1 ? 2.50 to 1.0 0.50% 3.75% 3.75% 2.75% 2 ? 2.00 to 1.0 but < 2.50 to 1.0 0.45% 3.50% 3.50% 2.50% 3 ? 1.50 to 1.0 but < 2.00 to 1.0 0.40% 3.25% 3.25% 2.25% 4 ? 1.00 to 1.0 but < 1.50 to 1.0 0.35% 3.00% 3.00% 2.00% 5 < 1.00 to 1.0 0.30% 2.75% 2.75% 1.75% In the event of default, the outstanding indebtedness under the Senior Secured Revolving Credit Facility will bear interest at an additional 2.0%. The Senior Secured Revolving Credit Facility contains restrictive covenants, including among other things financial covenants requiring us to not exceed a maximum consolidated senior secured leverage coverage ratio, a maximum total consolidated leverage ratio and to maintain a minimum consolidated fixed charge coverage ratio. The Senior Secured Revolving Credit Facility also restricts our ability (subject to certain exceptions) to incur indebtedness, prepay or amend other indebtedness, create liens, make certain fundamental changes including mergers or dissolutions, pay dividends and make other payments in respect of capital stock, make certain investments, sell assets, change our lines of business, enter into transactions with affiliates and other corporate actions. As of September 30, 2014, the Company was in compliance with the financial covenants in the Senior Secured Revolving Credit Facility. 38-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES The Senior Secured Revolving Credit Facility also includes events of default typical of these types of credit facilities and transactions, including, but not limited to, the nonpayment of principal, interest, fees or other amounts owing under the new Senior Secured Revolving Credit Facility, the violation of covenants, the inaccuracy of representations and warranties, cross defaults, insolvency, certain ERISA events, material judgments and change of control. The occurrence of an event of default could result in the lenders not being required to lend any additional amounts and the acceleration of obligations under the new senior secured revolving credit facility, causing such obligations to be due and payable immediately, which could materially and adversely affect us. As of September 30, 2014, we had $163.4 million outstanding under the Senior Secured Revolving Credit Facility, bearing interest at a rate of LIBOR plus 3.00%, resulting in $99.1 million of undrawn commitments. Working Capital Facilities On September 29, 2010, our indirect 100% owned subsidiary UKIM entered into a Sales Finance Agreement (the "UKIM SFA") with Barclays Bank PLC ("Barclays"), pursuant to which Barclays provides UKIM a working capital facility of up to £5,000,000, subject to the terms and conditions of the UKIM SFA. The working capital facility bore a discount margin of 2.5% over Base Rate and served to finance UKIM's unpaid account receivables. The working capital facility had a minimum term of 36 months. On June 28, 2013, UKIM entered into an amendment to extend the term of the existing UKIM SFA by 24 months from June 28, 2013, to amend the discount margin to 2.4% over Base Rate (0.5% rate on September 30, 2014) and to provide that payments by UKIM for certain non-working capital purposes are permitted under the UKIM SFA. The working capital facility operates on a co-terminus and cross-default basis with other facilities provided by Barclays and with the Senior Secured Revolving Credit Facility. As of September 30, 2014, UKIM had $7.8 million outstanding under the working capital facility, resulting in $324,000 in availability. On May 12, 2011, our indirect 100% owned subsidiary Premex entered into a Sales Finance Agreement (the "Premex SFA") with Barclays, pursuant to which Barclays provides Premex a working capital facility of up to £26,500,000, subject to the terms and conditions of the Premex SFA. The working capital facility bears a discount margin of 2.4% over Base Rate (0.5% rate on September 30, 2014) and serves to finance Premex's unpaid account receivables. The working capital facility had a minimum term of 36 months. On June 28, 2013, Premex entered into an amendment to extend the term of the existing Premex SFA by 24 months from June 28, 2013, and to provide that payments by Premex for certain non-working capital purposes are permitted under the Premex SFA. The working capital facility operates on a co-terminus and cross-default basis with other facilities provided by Barclays and with the Senior Secured Revolving Credit Facility. As of September 30, 2014, Premex had $36.9 million outstanding under the working capital facility, resulting in approximately $6.2 million in availability. Senior Unsecured Notes On July 19, 2011, we closed a private offering of $250.0 million in aggregate principal amount of 9.0% senior notes due 2019 (the "Initial Notes"). The Initial Notes were issued at a price of 100% of their principal amount. A portion of the gross proceeds of $250.0 million were used to repay borrowings outstanding under our Senior Secured Revolving Credit Facility and pay related fees and expenses, and the remainder was used for general corporate purposes, including acquisitions. In June 2012, in accordance with the registration rights granted to the original purchasers of the Initial Notes, we completed an exchange offer of the privately placed Initial Notes for new 9.0% Senior Notes due 2019 (the "Exchange Notes," and together with the Initial Notes, the "Senior Unsecured Notes") registered with the SEC with substantially identical terms to the Initial Notes. The Senior Unsecured Notes are senior obligations of ExamWorks and are guaranteed by ExamWorks' existing and future U.S. subsidiaries (the "Guarantors"). The Senior Unsecured Notes were issued under an Indenture, dated as of July 19, 2011 (the "Indenture"), among the Company, the Guarantors and U.S. Bank, National Association, as trustee (the "Trustee"). The Senior Unsecured Notes are our general senior unsecured obligations, and rank equally with our existing and future senior unsecured obligations and senior to all of our further subordinated indebtedness. The Senior Unsecured Notes accrue interest at a rate of 9.0% per year, payable semi-annually in cash in arrears on January 15 and July 15 of each year, commencing January 15, 2012. At any time on or after July 15, 2015, we may redeem some or all of the Senior Unsecured Notes at the redemption prices stated in the Indenture, plus accrued and unpaid interest to the date of redemption. Prior to July 15, 2014, we may redeem up to 35% of the aggregate principal amount of the Senior Unsecured Notes with net cash proceeds from certain equity offerings at a redemption price equal to 109% of the aggregate principal amount of the Senior Unsecured Notes, plus accrued and unpaid interest, if any, provided that at least 65% of the original aggregate principal amount of the Senior Unsecured Notes remains outstanding after redemption. Further, we may redeem some or all of the of the Senior Unsecured Notes at any time prior to July 15, 2015 at a redemption price equal to 100% of the principal amount of the Senior Unsecured Notes plus a make whole premium described in the Indenture, plus accrued and unpaid interest. 39-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES The Indenture includes covenants which, subject to certain exceptions, limit the ability of the Company and its restricted subsidiaries (as defined in the Indenture) to, among other things, incur additional indebtedness, make certain types of restricted payments, incur liens on assets of the Company or the restricted subsidiaries, engage in asset sales and enter into transactions with affiliates. Upon a change of control (as defined in the Indenture), we may be required to make an offer to repurchase the Senior Unsecured Notes at 101% of their principal amount, plus accrued and unpaid interest. The Indenture also contains customary events of default. Cash Flow Summary Cash and cash equivalents were $9.1 million at September 30, 2014 as compared with $12.0 million at September 30, 2013. Our cash flows from operating, investing and financing activities, as reported in our consolidated financial statements included elsewhere in this report, are summarized as follows (in thousands): For the nine months ended September 30, 2013 2014 Net cash provided by operating activities $ 22,718 $ 24,961 Net cash used in investing activities (5,159 ) (197,261 ) Net cash provided by (used in) financing activities (13,864 ) 168,932 Exchange rate impact on cash and cash equivalents (277 ) (350 ) Net increase (decrease) in cash and cash equivalents $ 3,418 $ (3,718 ) Operating Activities. Net cash provided by operating activities was $25.0 million for the nine months ended September 30, 2014 compared with net provided by in operating activities of $22.7 million for the nine months ended September 30, 2013. Net cash provided by operating activities for 2014 consisted of our net income of $6.7 million and net non-cash charges of $43.5 million (principally including $44.9 million in depreciation and amortization and $14.7 million in share-based compensation, offset by the excess tax benefit related to share-based compensation of $12.7 million and deferred income taxes of $9.8 million) offset by a net increase in working capital of approximately $25.2 million. The 2014 increase in working capital primarily consisted of increases in accounts receivable in our U.K. business and increased prepaid expenses offset by increased accounts payable and accrued expenses. Net cash provided by operating activities for 2013 consisted of net non-cash charges of $46.1 million (principally including $48.1 million in depreciation and amortization, $12.2 million in share-based compensation and $3.5 million in provisions for bad debts, offset by a net decrease in deferred income taxes of $13.0 million) offset by our net loss of $8.6 million and a net increase in working capital of approximately $14.8 million. The 2013 increase in working capital primarily consisted of increases in accounts receivable in our U.K. businesses and decreased accrued interest expense offset by increased accounts payable and accrued expenses and deferred revenues and customer deposits. Investing Activities. Net cash used in investing activities was $197.3 million for the nine months ended September 30, 2014 as compared to net cash used in investing activities of $5.2 million for the nine months ended September 30, 2013. The 2014 use of cash was due primarily to increased payments associated with acquisitions and related settlement activity, increased purchases of fixed assets and cash payments related to our foreign currency net investment hedges as compared to the comparable prior year period. Financing Activities. Net cash provided by financing activities was $168.9 million for the nine months ended September 30, 2014 as compared to net cash used in financing activities of $13.9 million for the nine months ended September 30, 2013. The 2014 cash provided was primarily attributable to net borrowings under our Senior Secured Revolving Credit Facility of $118.3 million, the proceeds from the exercise of options and warrants of $35.4 million and excess tax benefits related to share-based compensation of $12.7 million. The 2013 use of cash was primarily attributable to net repayments under our Senior Secured Revolving Credit Facility of $32.7 million offset by proceeds from the exercises of options and warrants of $13.1 million and excess tax benefits related to share-based compensation of $6.0 million. 40-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Contingencies We record contingent liabilities resulting from asserted and unasserted claims against us when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. We disclose contingent liabilities when there is a reasonable possibility that the ultimate loss will exceed the recorded liability. Estimating probable losses requires analysis of multiple factors, in some cases including judgments about the potential actions of third-party claimants and courts. Therefore, actual losses in any future period are inherently uncertain. We currently are not involved in any material legal proceedings. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in our assumptions or the effectiveness of our strategies related to any future proceedings. Contingent liabilities are described in Note 9 to the consolidated financial statements included elsewhere in this report. Contractual Obligations and Commitments Our contractual cash payment obligations as of September 30, 2014 are set forth below (in thousands): Payments due by year ending December 31, Period from October 1, 2014 to December Total 31, 2014 2015 2016 2017 2018 ThereafterAmounts outstanding under senior unsecured notes payable $ 250,000 $ - $ - $ - $ - $ - $ 250,000 Amounts outstanding under senior secured revolving credit facility 163,358 - - 163,358 - - - Operating leases 53,991 3,481 13,626 11,491 9,160 7,272 8,961 Amounts outstanding under working capital facilities 44,668 - 44,668 - - - - Totals $ 512,017 $ 3,481 $ 58,294 $ 174,849 $ 9,160 $ 7,272 $ 258,961 As of September 30, 2014, we leased our office spaces for our corporate locations in Atlanta, Georgia and New York, New York and also for our 66 service centers in various cities under non-cancelable lease agreements. We own an office facility in Sarasota, Florida. We have certain contractual obligations including various debt agreements with requirements to make interest payments. Amounts outstanding under the Senior Unsecured Notes are subject to a fixed interest rate of 9.0% and interest is expected to be $22.5 million annually with semi-annual payments that began in January 2012 and end in July 2019. Additionally, certain amounts are subject to the level of borrowings in future periods and the interest rate for the applicable periods, and therefore the amounts of these payments are not determinable. Based upon amounts outstanding at September 30, 2014, and applicable interest rates currently ranging between 2.9% and 5.25%, interest amounts are expected to be approximately $1.7 million for the three months ended December 31, 2014, approximately $6.3 million for the year ended December 31, 2015 and approximately $2.8 million for the year ended December 31, 2016. Off-Balance Sheet Arrangements We engage in no activities, obligations or exposures associated with off-balance sheet arrangements. Critical Accounting Policies and Estimates Overview and Definitions We have identified the policies below as critical to our business operations and understanding of our results of operations. The impact and any associated risks related to these policies on our business operations are discussed throughout this management's discussion and analysis of financial condition and results of operations where such policies affect our reported and expected financial results. Our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, cash flow and related disclosure of contingent assets and liabilities. Our estimates include those related to accounts receivable reserves, goodwill and other intangible assets, share-based compensation other equity instruments, income and other taxes, derivative instruments and contingent obligations. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates, and the impact of changes in key assumptions may not be linear. Our management has reviewed the application of these policies with the audit committee of our Board of Directors. For a detailed discussion on the application of these and other accounting policies, see Note 2 to the consolidated financial statements included elsewhere in this report. We believe that our most critical accounting policies and estimates relate to the following: 41-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Revenue Recognition Revenue related to IMEs, peer reviews, bill reviews, Medicare compliance services and administrative support services is recognized at the time services have been performed and the report is shipped to the end user. We believe that recognizing revenue at the time the report is shipped is appropriate because we meet the following four criteria in accordance with ASC 605-10-S25, Revenue Recognition: Overall, (i) persuasive evidence that arrangement exists, (ii) shipment has occurred, (iii) the price is fixed and determinable and (iv) collectability is reasonably assured. We report revenues net of any sales, use and value added taxes. Revenue related to other IME services, including litigation support services, medical record retrieval services and case management, where no report is generated, is recognized at the time the service is performed. We believe that recognizing revenue at the time the service is performed is appropriate because we meet the following four criteria in accordance with ASC 605-10-S25, (i) persuasive evidence that arrangement exists, (ii) services have been rendered, (iii) the price is fixed and determinable and (iv) collectability is reasonably assured. Certain agreements with customers in the U.K. include provisions whereby collection of the amounts billed are contingent on the favorable outcome of the claim. We have deemed these provisions to preclude revenue recognition at the time of performance, as collectability is not reasonably assured and the cash payments are contingent, and are deferring these revenues, net of estimated costs, until the case has been settled the cash has been collected and the contingency has been resolved. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. Trade Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable balances consist of amounts owed to us for services provided in the normal course of business and are reported net of an allowance for doubtful accounts. Generally, no collateral is received from clients and the collectability of trade receivable balances is regularly evaluated based on a combination of factors such as client credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment patterns and additions to the allowance are made based on these trends. Accounts are reviewed regularly for collectability and those deemed uncollectible are written off. We assume, that on average, all accounts receivable will be collected within one year and thus classify these as current assets; however, there are certain receivables, primarily in the U.K., that have aged longer than one year as of December 31, 2013 and September 30, 2014, and we have recorded an estimate for those receivables that will not be collected within one year as long-term in the Consolidated Balance Sheets contained elsewhere in this report. Goodwill and Other Intangible Assets Goodwill is an asset representing the future economic benefits arising from assets acquired in a business combination that are not individually identified and separately recognized. Based on the provisions of ASC 350, Intangibles-Goodwill and Other ("ASC 350"), goodwill and indefinite lived intangible assets are tested for impairment annually or more frequently if impairment indicators arise. We evaluate the carrying value of goodwill during the fourth quarter of each fiscal year and between annual valuations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting units below their carrying amount. Such circumstances include: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, we compare the fair value of the reporting units to which the goodwill is assigned to the reporting units' carrying amount, including goodwill. The fair value of the reporting units is estimated using primarily the income, or discounted cash flows, approach. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss is calculated by comparing the implied fair value of the reporting unit's goodwill to its carrying amount. In calculating the implied fair value of the reporting unit's goodwill, the fair value of the reporting unit is allocated in a hypothetical analysis to all of the other assets and liabilities, including any unrecognized intangible assets, of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. 42-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Intangible assets, including client relationships, trade names, covenants not to compete and technology that have finite lives are amortized over their useful lives. We performed our annual impairment review of goodwill in October 2013, and reviewed subsequent events through September 30, 2014, and determined that the fair value of our reporting units substantially exceed their carrying value, and goodwill was not impaired as of year end. Further, we believe that there have been no facts or circumstances through the date of this filing that indicate an impairment of goodwill exists. Deferred Income Taxes We provide for deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws. Our deferred and other tax balances are based on management's interpretation of the tax regulations and rulings in numerous taxing jurisdictions. Income tax expense and liabilities recognized by us also reflect our best estimates and assumptions regarding, among other things, the level of future taxable income, the effect of our various tax planning strategies and uncertain tax positions. Future tax authority rulings and changes in tax laws, changes in projected levels of taxable income and future tax planning strategies could affect the actual effective tax rate and tax balances recorded by us. We follow the provisions under FASB ASC Subtopic 740-10, Income Taxes - Overall ("ASC 740") that provides a recognition threshold and measurement criteria for the financial statement recognition of a tax benefit taken or expected to be taken in a tax return. Tax benefits are recognized only when it is more likely than not, based on the technical merits, that the benefits will be sustained on examination. Tax benefits that meet the more-likely-than-not recognition threshold are measured using a probability weighting of the largest amount of tax benefit that has greater than 50% likelihood of being realized upon settlement. Whether the more-likely-than-not recognition threshold is met for a particular tax benefit is a matter of judgment based on the individual facts and circumstances evaluated in light of all available evidence as of the balance sheet date. We are no longer subject to U.S. federal income and state tax return examinations by tax authorities before 2009 and 2008, respectively. We operate in multiple taxing jurisdictions and face audits from various tax authorities. We remain subject to examination until the statute of limitations expires for the respective tax jurisdiction. We do not anticipate that the amount of the unrecognized benefit will significantly increase or decrease within the next twelve months. We record interest and penalties related to unrecognized tax benefits in income tax expense. Undistributed earnings of our foreign subsidiaries are considered indefinitely reinvested and, accordingly, no provision for U.S. federal income taxes has been recorded. Deferred taxes are provided for earnings outside the United States when those earnings are not considered indefinitely reinvested. Share-Based Compensation and Other Equity Instruments Our stock incentive plan provides for the granting of stock options and other share-based awards including warrants, restricted stock units ("RSUs") and shares of restricted stock, in accordance with ASC Topic 718, Compensation-Stock Compensation ("ASC 718"). ASC 718 requires measurement of compensation cost for all share-based awards at fair value on the grant date (or measurement date, if different) and recognition of compensation expense, net of forfeitures, over the requisite service period for awards expected to vest. We use the straight-line amortization method for recognizing share-based compensation expense. The fair value of stock option grants is determined using the Black-Scholes valuation model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics not present in these stock options. Additionally, option valuation models require the input of highly subjective assumptions, including the expected volatility of the stock price. Because our stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimates, in our opinion, the existing models may not provide a reliable single measure of the fair value of its share-based awards. 43-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES Our expected volatility assumptions are based upon the weighted average of our implied volatility, our mean reversion volatility and the median of our peer group's most recent historical volatilities for 2014 stock option grants. Expected life assumptions are based upon the "simplified" method for those options issued since our IPO which were determined to be issued approximately at-the-money. The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term equal to the expected life of the option being valued. The fair value of shares of restricted stock and RSUs is determined based upon the market price of the underlying common stock as of the date of grant. Additional information regarding our valuation of common stock and equity awards is set forth in Note 2 to our consolidated financial statements included elsewhere in this report. Accounting for Acquisitions Accounting for acquisitions requires us to recognize and measure identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquired entity. Our accounting for acquisitions involves significant judgments and estimates, including the fair value of certain forms of consideration, the fair value of acquired intangible assets, which involve projections of future revenues, cash flows and terminal value, which are then discounted at an estimated discount rate, the fair value of other acquired assets and assumed liabilities, including potential contingencies, and the useful lives of the assets. The projections are developed using internal forecasts, available industry and market data and estimates of long-term rates of growth for our business. The impact of prior or future acquisitions on our financial position or results of operations may be materially impacted by the change in or initial selection of assumptions and estimates. Financial Instruments Our financial assets and (liabilities), which are measured at fair value on a recurring basis, are categorized using the fair value hierarchy at December 31, 2013 and September 30, 2014, and are as follows (in thousands): Level 1 Level 2 Level 3 Total As of December 31, 2013 Financial instruments: Contingent consideration $ - $ - $ (4,834 ) $ (4,834 ) Foreign currency derivative asset - 61 - 61 Foreign currency derivative liability - (683 ) - (683 ) As of September 30, 2014 Financial instruments: Contingent consideration $ - $ - $ (6,854 ) $ (6,854 ) Foreign currency derivative liability - (585 ) - (585 ) The contingent consideration relates to earnout provisions recorded in conjunction with certain acquisitions completed in 2009, 2013 and 2014 (see Note 3 to the consolidated financial statements contained elsewhere in this report). Of the total increase in fair value of the contingent consideration of $2.0 million in 2014, $7.1 million was added as the result of a 2014 acquisition and $310,000 was recorded in interest and other expenses, net in the Consolidated Statements of Comprehensive Income (Loss) due to changes in the fair value of the contingent consideration. These increases were offset by a purchase accounting adjustment to a 2013 acquisition in the amount of $373,000 for the change in the fair value of the contingent consideration, $4.7 million settled as cash consideration to satisfy installments related to 2009 and 2014 acquisitions, and approximately $110,000 of the change in value relates to the release of a restriction associated with shares previously issued related to a 2009 acquisition. The fair value of the foreign currency derivative was determined using observable market inputs such as foreign currency exchange rates and considers our nonperformance risk and that of our counterparties. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements In July 2013, the FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11") which amends accounting guidance on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or tax credit carryforward exists. This new guidance requires entities, if certain criteria are met, to present an unrecognized tax benefit, or portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when such items exist in the same taxing jurisdiction. The provisions of ASU 2013-11 are effective for fiscal years and interim periods beginning after December 15, 2013 and are to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. We adopted these provisions effective January 1, 2014 and the adoption of these provisions did not have a material impact on our financial position, results of operations and cash flows. Accounting Pronouncements Not Yet Adopted In April 2014, the FASB issued ASU No. 2014-08, (Topic 205 and 360), "Reporting Discontinued Operations and Disclosure of Disposals of Components of an Entity" ("ASU 2014-08") which amends the definition for what types of asset disposals are to be considered discontinued operations, and amends the required disclosures for discontinued operations and assets held for sale. ASU 2014-08 also enhances the convergence of the FASB's and the International Accounting Standard Board's reporting requirements for discontinued operations. The amendments in this update are effective for fiscal periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015. We are currently evaluating the impact of this standard on our financial position, results of operations and cash flows. 44-------------------------------------------------------------------------------- EXAMWORKS GROUP, INC. AND SUBSIDIARIES In May 2014, the FASB issued ASU No. 2014-09, (Topic 606): Revenue from Contracts with Customers ("ASU 2014-09") which supersedes the revenue recognition requirements in "Topic 605, Revenue Recognition" and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective retrospectively for annual or interim reporting periods beginning after December 15, 2016, with early application not permitted. We are currently evaluating the impact of this standard on its financial position, results of operations and cash flows. There were various other accounting standards and interpretations issued during 2013 and 2014 we have not yet been required to adopt, none of which are expected to have a material impact on our financial position, results of operations and cash flows. |