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Edited Transcript of PRGX earnings conference call or presentation 30-Jul-19 9:00pm GMT

Q2 2019 PRGX Global Inc Earnings Call

ATLANTA Aug 30, 2019 (Thomson StreetEvents) -- Edited Transcript of PRGX Global Inc earnings conference call or presentation Tuesday, July 30, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregory J. Owens

PRGX Global, Inc. - Executive Chairman of the Board

* Kurt J. Abkemeier

PRGX Global, Inc. - CFO & Treasurer

* Ronald E. Stewart

PRGX Global, Inc. - President, CEO & Director

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Conference Call Participants

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* Alexander Peter Paris

Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst

* Andrew E.F. Gordon

E.F. Gordon, L.P. - Portfolio Manager

* Zachary Cummins

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Q2 2019 PRGX Global, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, CFO Mr. Kurt Abkemeier. You may begin.

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [2]

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Thank you, Lara, and good afternoon to all of you on the call. Let us note at the outset that certain statements in this conference call may be considered forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform. These statements include statements relating to management's views with respect to future events and financial performance that are based on management's current expectations and beliefs and are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from historical experience or from future results expressed or implied by such forward-looking statements. For additional information on these factors, please refer to PRGX Global, Inc's. filings with the Securities and Exchange Commission including, but not limited to, its reports on Forms 10-K and 10-Q. PRGX undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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

I will now turn the call over to Ron.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [3]

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Thanks, Kurt. So while we had positive results in a number of areas, overall results of the quarter were lower than our expectations. Q2 revenue grew just 1%, and adjusted EBITDA declined 29% on a currency adjusted basis compared to the same period in 2018. These results are not acceptable and do not reflect the underlying strength of our business and capability of our broader organization. I want to make it very clear that I take these sorts of shortfalls seriously, and you have my full commitment that we have a clear understanding of the reasons for these shortfalls and are taking aggressive actions to address them and improve our profitability and free cash flow generation.

There are 4 underlying reasons for our revenue and adjusted EBITDA shortfalls versus expected. First, overly aggressive revenue targets in our core Recovery Audit business. In Q2, we experienced unexpected audit scope reductions at several significant audits and delays in revenue conversion by a few large clients. Now these situations are typical in our business, but we usually have offsetting positive developments to balance the impact. That was not the case in Q2. And as we've experienced over the last few quarters, we needed more things to go right to hit our numbers, which didn't happen.

We have had consistent growth in our core Recovery Audit, or RA, business over the last few years primarily based on audit acceleration, process improvements and improved audit tools. We expected to continue the growth rate achieved in prior years into 2019, but this has proven unrealistic given stronger comps from prior years and revenue headwinds we described earlier. Our global Recovery Audit business grew 4.3% in the first half of 2019 on a currency adjusted basis compared to 7.9% for the first half of 2018. We will reflect more realistic growth expectations going forward with a wider range to reflect the challenges in predicting timing of revenue in our industry.

Secondly, while our Contract Compliance business grew year-over-year in Q2 and for the first half of 2019, we fell short of our revenue expectations in this business largely due to continued delays in settling outstanding audit findings and greater-than-expected reductions in settlement amounts. Client receptivity to contract compliance as an extension of our services continues to be good, but our traditional pure contingency fee structure is resulting in a number of our client relationships being unprofitable or taking too long to realize revenue. We are actively working to change our fee model to improve profitability, and we'll be exiting unprofitable clients. We have had numerous discussions with our larger Contract Compliance clients regarding changing our fee structure. The feedback thus far is that our clients see meaningful value in our work and are receptive to a revised fee structure. This process is a high priority for the company as we see Contract Compliance as a meaningful growth area for the future in both retail and commercial business segments.

Number three, after 4 straight quarters of growth on a small revenue base, our Adjacent Services business missed our revenue expectations and declined year-over-year as several of our key projects failed to deliver expected revenue. This business segment has consistently delivered negative adjusted EBITDA as we have invested to build our service offerings and develop a base of recurring revenue. Our current offerings in project-based approach have not been successful in generating the scale we expected. And thus, we are making adjustments in our approach and in the level of investment going forward. As we expect, the ultimate value and market attractiveness of the Adjacent Services business will be tied to integrated Source-To-Pay data analysis and visibility coming from our high-performance data infrastructure and embedded analytics. We will be focusing on a few larger clients and building from the data and analytics capabilities as these technologies come online. We have lowered our expectations for Adjacent Services revenue and associated adjusted EBITDA for 2019 as we are managing this business to profitability by the end of the year.

Over the past few years, overhead expenses steadily -- has steadily grown to build capabilities and resources ahead of incremental revenue. With better visibility into operating expenses and associated contribution results along with a more realistic view of expected revenue, we are moving quickly to get expenses in line with revenues. Kurt will take you through the details of our overhead cost reduction efforts during his comments.

While we are disappointed with our Q2 results, there are many positive things happening in our business. I remain 100% confident in our underlying business and our strategy to leverage advanced large data and analytics technologies to increase the strategic value of Recovery Audit and extend our services to create more value from our clients' Source-To-Pay data.

I will address these topics further following Kirk's more detailed review of the quarter and descriptions of our actions to improve adjusted EBITDA and free cash flow going forward. Kurt?

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [4]

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Thank you, Ron. In addition to providing a review of the quarter as is typical for our quarterly earnings call, I'll be discussing our increased focus on profitability, a topic that I introduced on the last call; some of the actions we are undertaking to achieve increased profitability; and a discussion of our revised guidance for 2019 and our preliminary view of 2020.

Moving on to the quarterly results. Consolidated revenue from continuing operations for the second quarter of 2019 were $42.0 million, effectively flat compared to the second quarter of 2018 on a reported basis and an increase of 1.2% on a constant dollar basis, adjusted for changes in foreign currency exchange rates. As for some color on revenue performance in the service lines and regions, Recovery Audit Americas was effectively flat year-over-year on a reported basis and up 0.6% on a constant dollar basis. Growth was adversely impacted by unexpected audit scope changes in 2 of our larger U.S. clients in our Americas retail Recovery Audit business as well as changes in audit approval procedures in 2 clients, which delayed revenue recognition. While we expect to recover revenue from the clients that changed audit approval procedures, we do not expect to recover revenue from clients that reduced audit scope.

Recovery Audit Europe/Asia Pacific growth was 3.4% on a reported basis and 8.1% on a constant dollar basis. Retail Recovery Audit performed well across all regions in Europe/Asia Pacific, while Contract Compliance performance was weaker than expected. As for Adjacent Services, revenue was down about $500,000 year-over-year. As Ron noted, and has discussed in the past, in its current state, this business is very project-based and nonrecurring in nature. While we had landed some large sourcing projects in 2018, the results have not met our expectations.

Moving on from revenue commentary. Gross profit and gross margin from continuing operations continue to improve, with gross margin continuing a multiyear trend of expansion. Gross profit for the second quarter was $15.7 million, an increase of about 7% compared to the second quarter of 2018. And gross margin for the second quarter was 37.3% of revenue, an expansion of about 240 basis points compared to the second quarter of 2018. We expect to continue to focus on and drive continued improvement in our gross margin performance.

As for adjusted EBITDA, adjusted EBITDA for the second quarter of 2019 was $2.9 million, and the adjusted EBITDA margin was 6.8% of revenue. The most notable impact on adjusted EBITDA during the quarter besides the weakness in revenue, which was the largest contributor to the result, was an increase in operating expenses in the second quarter of 2019 compared to 2018, similar to the story of the first quarter of 2019.

Some of the factors impacting operating expenses and, in turn, adjusted EBITDA are recurring and some are generally nonrecurring or unusual. As for the recurring items, as was during the first quarter, we've generally added to staffing in areas that are forward focused in SG&A such as product and innovation and sales and marketing. These additions have generally been ramping since mid-2018, which has contributed to the year-over-year increase. As for the generally nonrecurring or unusually elevated items, in the aggregate, these totaled approximately $1.5 million and fall into 3 categories: one, an elevated level of bad debt, which we ultimately expect to collect on; two, a true-up for variable compensation paid to field auditors and managers; and three, some elevated expenses with recruiting fees. As for Adjacent Services, the adjusted EBITDA loss was approximately $1.6 million.

As I noted in my revenue commentary, revenue has not materialized in this business as planned, so operating costs will need to be reduced to correspond to a more moderated revenue expectation. As you will hear from me in more detail in a few minutes, we are addressing this.

As for net loss, net loss from continuing operations for the second quarter of 2019 was $4.2 million and was largely driven by the same factors impacting revenue and adjusted EBITDA performance, as well as all other expenses and income below adjusted EBITDA were consistent with levels from prior quarters.

Moving on to the balance sheet and cash flow statement. We ended the quarter with $11.5 million in cash and cash equivalents, $33 million in debt and $41.9 million of net accounts receivable.

Turning to capital expenditures. They were $3.2 million for the second quarter of 2019. And there are a few things I would like to note about CapEx. This is down considerably from $4.4 million in the first quarter of 2019. Much of the elevation in cash CapEx over the last few quarters is due to the development and build-out of our next-generation data and audit platform. As this platform becomes more fully implemented, we anticipate CapEx to taper off materially. As for the first half of 2019, we have paid $7.6 million in cash CapEx, which includes paying down approximately $1.3 million of the $1.9 million that was accrued in accounts payable on the balance sheet at the end of 2018 but not yet paid. As for the full year of 2019, we would expect cash CapEx to be around $12 million.

Having covered how we performed during the quarter, I'd now like to discuss what we will be doing differently going forward so as to deliver better operating results and meet or exceed expectations. This can all be distilled down to a sharpened focus on profitability.

On the last earnings call, during the commentary about my initial observations of my first 100 days, I spoke about my 2 primary priorities and objectives. The first of those 2 priorities was to push operational efficiency throughout the entire organization so as to be the most efficient company in our space. And I noted that we would achieve that by automating processes and better leveraging systems and information in order to enable better decision-making with the goal of strengthening the advantages we have compared to our competition and to become more ROI-focused and achieve an improvement of 400 basis points of adjusted EBITDA margin in our business by the end of 2021.

So today, I want to state that not only will we -- will operational efficiency be our intensified focus within the company, but we intend to achieve that on an expedited basis. The more immediate actions have been and will continue to be in the following 2 areas. Our #1 action, rationalizing expenses both at the corporate level and in the field. We have been evaluating expenses group by group and generally making changes where we believe we are not getting the appropriate results. Because we started making these changes during the second quarter and we'll continue them throughout the rest of the year, our results for 2019 will only reflect a partial year benefit, while 2020 will have a full year benefit. I will further elaborate on this during my commentary on guidance. Furthermore, I would expect additional expense improvements beyond 2019 as we improve our systems and processes, which is a multiyear effort.

Our #2 action, rationalizing business lines with subpar results and returns. Two areas that will get particular focus will be Adjacent Services and Contract Compliance. Each has different challenges. But with Adjacent Services, we are committed to getting it to profitability by the end of the year. As for Contract Compliance, we believe we can improve the profitability of the business by changing the economic business model with our customers by introducing a time and materials element into the fee structure instead of having it be skewed so heavily towards a 100% contingency fee-based model. Ron spoke to these in his comments before, but the takeaway here should be that we will be keenly focused on addressing our service lines that have long-standing subpar return on investment.

In addition to these 2 more immediate actions, there are 2 longer-term initiatives that will further enhance margins and returns. The first initiative is evolving our back-office systems and processes to improve visibility and understanding of our business. Coming into the company earlier this year with a set of experiences using a variety of systems and processes, I have challenged the team to take a fresh look at how things can be done very differently behind the scenes at PRGX. I'm optimistic that with better systems and processes in the background, we can significantly improve the profitability of the company. While the full cycle to completely evolve systems, processes, people or culture may likely be measured in quarters or years, I believe that we will be able to achieve some quick hits sooner rather than later. As an example, the 2 actions I just described, expense and business line rationalization, we are able to execute on these already using some of the tools built during the last few months in order to improve insights into our operations.

The second initiative is transforming the systems and process in our operations to increase the efficiency of our audit professionals. You've heard us speak on past calls about innovating our technology and audit platforms, and this continues to be a great importance to us for a few reasons. First, we can automate the aggregation and processing of data. Our next-generation, high-performance data infrastructure automates and accelerates much of the process of ingesting and aggregating the data necessary for us to perform our audits. Over time, this will increasingly enable us to streamline the audit process and save costs. Second, as we develop more audit tools to work with our new data platform, we can further automate and accelerate the audit process. This can not only reduce the amount of time audits are touched by human hands but also, it opens up revenue opportunities as we can go deeper into the audit. And third, it further differentiates us from our competition. This can help with revenue and pricing.

The key takeaway is that as we innovate and push technology into our key operations, we further enable our ability to reduce costs and grow revenue. So what's the end game with these 2 nearer-term actions and 2 longer-term initiatives? And why do I focus on this so much? This is how we take the company from 13% adjusted EBITDA margins, which has been an experience of the company over the last decade, to 20%, taking the same business but simply operating it much better. It doesn't require creating a new market, a new business line, et cetera, it is simply about operating what we have and have had for a long time and operating it much more effectively. This is about a focus on profitability and returns that we will be driving. Of course, we will still work very hard to grow the business and evolve our offerings but so much can be done to squeeze more profitability out of what we already have.

Now I'd like to turn on -- turn to what we expect this to mean for our future results. I'll start by covering our updated view of 2019, but then I want to provide some insights into our preliminary thoughts on 2020, which I believe should provide some comfort to investors. As for guidance for 2019, we are reducing it to a revenue range of $172 million to $178 million and an adjusted EBITDA range of $25 million to $27 million.

There are a few key facets to our change in revenue guidance that I want to touch on, some of which Ron previously noted. First, certain business lines such as Adjacent Services and Contract Compliance have underperformed, and this requires that we make some changes. Also, I noted we're already taking action in these areas. Second, reducing what were, in hindsight, overly aggressive revenue targets in the core Recovery Audit business to more achievable levels. Third, adverse currency changes during the first half of the year have impacted the range by approximately $2 million. And finally, I want to account for the risk of claims recoveries slippering -- slipping from one period to the next, which has been a persistent problem for the last year. These 4 factors have led to our change in guidance, and we expect to deliver results within this guidance range.

Having the benefit of being here for 2 quarters now, I think I can provide some insights to investors and analysts of some of the timing characteristics of our contingency fee-based model that make the predictability of our financial performance on a quarterly or annual basis challenging. In our contingency fee-based model, while the bulk of our costs are generally relatively evenly distributed throughout the quarter as our auditors work on generating claims, the process of turning claims into revenue is highly skewed towards the back of the quarter, even in the last week, which is why significant revenue can be susceptible to slipping into a subsequent quarter. This is why slippage in the resolution of claims can be material to revenue results and even more so to adjusted EBITDA results.

So as a result, we've deemed it is advisable to have a lower end on our guidance ranges to account for this unpredictability of timing. As for how this plays out for the rest of the year, we expect quarterly revenue to follow a similar seasonal trend as it has every year with increasing revenue quarter-over-quarter. As for adjusted EBITDA, it too is expected to follow a similar seasonal upward trend but with the fourth quarter impacted to a larger degree than the third quarter due to expense reductions having more of an impact in the fourth quarter than the third quarter.

So now let's talk about 2020. Because our results in 2019 will include a number of changes to our business, including some partial year benefits from initiatives that we are undertaking, we felt it was prudent to provide a cleaner view of what we think our business will look like on a more annualized basis. For revenue, we expect to achieve low to mid-single-digit growth. This would largely be consistent with what our business has produced for the last few years adjusting for the impact of acquisitions, which is to say, business as usual. Suffice to say, we will be looking to outperform this guidance but plan on taking a more conservative view of expectations of new business generation until we realize more sustained results.

As for adjusted EBITDA, our preliminary view is that we can achieve 17%-plus adjusted EBITDA margins on a consolidated basis, an improvement of over 300 basis points compared to 2019, assuming current business conditions and the moderate revenue growth I just shared. This focus on profitability that we believe will produce adjusted EBITDA margins of 17% or more would be, by far, the highest result that the company will have achieved in over a decade. With an expansion of adjusted EBITDA margins, a moderating of capital expenditures beyond 2019 and reduced nonrecurring and unusually elevated expenses, with even modest revenue growth assumptions, we expect this to result in significantly improved free cash flow, which is largely why we have decided to become much more focused on profitability as we believe that this is ultimately the primary driver of the fundamental valuation of PRGX.

And with that, I'll turn it back over to Ron.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [5]

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Thanks, Kurt. So as you can tell from Kurt's comments, we have a solid and achievable plan underway for improved financial performance. While it's frustrating to bring our revenue and adjusted EBITDA guidance down, I believe it is prudent given the headwinds described earlier in my comments and the difficulty in predicting timing of revenue in this business. Our goal is to provide guidance that we have a high degree of confidence in hitting and work very hard to exceed those targets.

Let's be clear, there are a lot of good things going on in the business, driving positive momentum and improved profitability. First, we have revenue growth in several of our businesses through the first half of the year. Through the first half of the year, we showed strong year-over-year growth in our Europe/Asia Pacific retail Recovery Audit business as well as our United States commercial Recovery Audit and Contract Compliance businesses. We expect to continue positive momentum in these businesses through the second half of the year and beyond. We especially see our commercial Recovery Audit and Contract Compliance businesses as having solid opportunities for future growth.

Next, we continue to create and build sales momentum in our business. We had a very productive first half of the year in new bookings with 50% more contracts signed with new and existing clients compared to the first half of last year. Approximately, 60% of these engagements were signed with retail clients and 40% signed with commercial clients. The expected value of these bookings is also 50% higher than the expected bookings were through the first half of last year. Year-to-date, in our commercial business, we have signed 6 new engagements with Fortune 500 companies and 4 new contracts with Global Fortune 500 companies. We have continued to have strong bookings momentum into Q3 and have a strong pipeline and a growing pipeline of new opportunities and expect to see meaningful acceleration in new business opportunities as our global marketing team, led by Carol O’Kelley, is now fully staffed and kicking off numerous sales campaigns. Jim Madden, our Head of Sales, has also begun to make positive impact. And working closely with Carol, the sales and marketing outlook for the coming quarters is promising.

Thirdly, I want to point out that our technology development and transition remains on track. We have talked frequently in the past about the importance of our big data infrastructure and next-generation audit platform and associated audit tools. We are on track to have all of our active clients loaded on our new data platform by the end of this year, which we expect will drive both audit efficiency and incremental revenue. We have been investing in building our next-generation audit platform and tools for the last 18 months and have high confidence that these will be strong differentiators in the market and provide for more efficient audit operations. As promised, we are scheduled to complete our new platform in the back half of this year and introduce it into the market in early 2020. Our clients who have seen beta demonstrations of it have reacted very positively, and we continue to view this technology as instrumental in retaining our industry leadership position and enabling our next-generation audit capabilities and services.

As a last point, I want to point out to all of you the underlying profitability of our core Recovery Audit business. This business consistently generates very favorable operating margins, which are improving as we implement more advanced technologies and process innovations. Factoring out the unusually elevated expense items that Kurt referred to earlier and the Adjacent Services negative EBITDA, which we are committed to eliminating by end of the year, we would have easily exceeded analyst expectations for adjusted EBITDA for the quarter. With the cost reduction and business rationalization efforts well underway, we expect to generate strong adjusted EBITDA results for the remainder of the year and even better results into 2020.

I have every faith in our newly coalesced management team's ability to deliver on our objectives and help PRGX return to meeting our performance expectations on a consistent basis. Make no mistake, we have and will take the difficult actions required to deliver on our promise of improved profitability and growth. We will focus on stabilizing adjusted EBITDA and building free cash flow to fund our investments and create value for our shareholders.

Now a number of you on the call have met our Executive Chairman, Greg Owens. Greg has been working very closely with me and the management team along with the Board to assist in a number of important areas. I asked Greg to join the call today to provide his perspective as a tech executive and Board member.

I'll now turn it over to Greg.

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Gregory J. Owens, PRGX Global, Inc. - Executive Chairman of the Board [6]

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Thanks, Ron. When I became Executive Chairman earlier this year, I've set out to assist Ron and his team to, first, recruit and hire new management team members; secondly to better execute on the business strategy; and third, to determine the best path to increase shareholder value. Although these 3 objectives seemed relatively easy, it became clear to me that we had to overcome a number of obstacles that were not readily apparent.

First, it takes approximately 6 months for revenue from a Recovery Audit client that we just closed to materialize. Secondly, bookings reflected an estimate of claims to be uncovered, and we now are more carefully scrutinizing this process. Third, work in process, or WIP, has to be segmented by month than quarterly to get more predictable estimates of revenue timing. Fourth, while Adjacent Services generally results in revenue quicker than Recovery Audit, the services need to be focused on larger, more substantial clients. Fifth, we must differentiate and expand our services within the clients or we'd become commoditized, which hurts our rate. Sixth, existing clients are great, but new client acquisition is key to our growth. And seventh, expenses, particularly product development, must be aligned with those of a value company, not a high-growth company.

We have now embarked on an execution strategy to overcome all of these issues, but it takes a few quarters for these results to materialize into these actions.

In the last 2 quarters, here's what we have accomplished. We focused on hiring new leadership in sales -- with Jim Madden in sales; with Carol O’Kelley in marketing; with Lynn Howard in HR; and with Kurt Abkemeier, our CFO. We have a new mark -- and secondly, we have a new marketing campaign to get our messages into the market as well as a new inside sales group to deliver new leads. Third, we've developed a detailed plan for expense reduction of over $10 million annualized. Fourth, we have a narrow focus in product development and offerings where we get more immediate traction, which also results in more efficient capital allocation. Fifth, we better estimate revenue from sales through the operational and sales teams. Sixth, we've rationalized the target list for Adjacent Services to the larger clients that we can have profitable operations from. And seventh, we've increased our focus on commercial sales, which is our largest growth opportunity. I believe we now have the team to market, sell and deliver in the retail and commercial space.

With these changes, we have clarity in the management team that there are 3 things that we're aligned in order to achieve our highest potential: Recovery Audit as our core business, number one; number two, adjusted EBITDA and free cash flow conversion; and number three, creating shareholder value.

The Board and I are working with Ron and the management team to align our efforts as I've just described. We will now drive execution with this narrowed and more disciplined focus in order to deliver better and more consistent results in the coming quarters.

With that, I'd like to turn it back over to Lara for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Alex Paris with Barrington Research.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [2]

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A lot to digest there, but it sounds like you've got a handle on it and you're heading in the right direction. I have a couple of follow-up questions off the top of my head. First off, while the Adjacent Services EBITDA loss accounted for much of the miss versus my estimate, I wanted to ask a couple of questions about Recovery Audit. First, you noted 2 larger U.S. retail clients reduced the scope of the audit. Can you give us a little color there? And then you mentioned 2 other customers were delaying the claims conversion process for one reason or another. Can you just give a little additional color there? Because it does seem like the miss in Recovery Audit overall was not significant, but I'm interested to hear what's going on there with those specific client examples.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [3]

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Well, thanks, Alex, and good to hear from you. The miss in Recovery Audit was really against expectations -- our expectations and our plan. But in terms of the 2 clients that -- where we had adjusted scope, in both cases, these were clients where we've done the work we've done, the audits, and they had decided to pull those audits and not proceed with those claims because they were doing strategic changes with their client base and didn't want to interfere with that process. So those are both work done, claims generated that didn't -- that were not -- did not proceed to conversion.

In terms of the delays, these are things that you're very used to that happen at the end of the quarter, a client decides not to move forward, and we had one case where we have a client who has recently outsourced their accounts payable process to a third party, and that party was very slow to turn claims and to review our claims to get them converted. So we're working in that situation with the client and with the third party to improve that process going forward. But these are things that happen in our business, but we just didn't have enough of the good surprises or upside to really make up for them.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [4]

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And as you said on the letter, too, there that, that will be -- this revenue postponed. The first 2 though, given the change in scope, those are permanent changes in scope, I guess, and you're not going to recover that.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [5]

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That's correct. Those will not be recovered.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [6]

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Okay. And then second, maybe a little additional color on changing the fee structure within Contract Compliance. I think it was a good idea, but I just would like to learn a little bit more about that.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [7]

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Sure. And we go into Contract Compliance and typically, that is an extension of our normal Recovery Audit services. And obviously, we are a contingent-based firm. That's what our clients are used to engage us around. And what we found is that these claims are -- the business contract compliance and the settlement with suppliers is not as mature as what you would see in the retail business. There's quite a bit of a pushback. There's quite a bit of discussion with suppliers. So the time is very much delayed. And many times, the settlement ends up significantly less than we would have expected that we had planned for.

In terms of changes, what we're really looking for is to have some kind of a hybrid. In certain cases, a fixed fee or a fixed price basis to do these audits; in others, it's a fixed fee plus contingency or a more upfront payment on the work that we do. We're looking to accelerate revenues and to improve the yield from the work that we do.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [8]

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Okay. Good. And then I think Greg mentioned this, nice to hear from you, Greg, an expense reduction program that's going to deliver $10 million in annualized cost reductions. Should we expect $5 million of that this year given you're starting midway through the year and then the full $10 million next year? And then maybe a little bit more detail on where that $10 million comes from at least from business lines, is the majority in one business line or another, that kind of thing?

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [9]

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Yes, this is Kurt answering it. The amount in 2019 is probably in the scale of around $5 million. It might be a little bit less, but it's phasing in. We started during the second quarter, and there will be more that will kick in, in the third quarter and more in the fourth quarter such that it's 2020 where it will be fully annualized. As for the different areas, it does cut across all areas. If you just look at the income statement, some of it is in SG&A, some of it is in cost of revenue. As for business lines, it does cut across all the different business lines, some probably a little bit more than others. We definitely are going to be very hard-nosed to get to the Adjacent Services to be profitable. So proportionately, it would be impacting that kind of business far more than the Recovery Audit part of the business.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [10]

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Makes sense. And then associated with the $10 million in annualized cost reduction, are there costs associated with it? Like, for example, if it is head count, is there severance associated with it? What sort of one-time expenses are associated with achieving that $10 million in savings?

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [11]

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Yes, sure. From -- yes, from kind of an investment perspective, so to speak, it would be anywhere -- I would just imagine it, it's more than $1 million and up to $2 million that would be associated with either severance expenses or termination of leases. But I would note, had we not made those actions, we would have been having those expenses anyway. So it's pretty small in the whole scheme of things. And we'll have a much cleaner cost structure going forward.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [12]

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Great. And then, I guess, the last one for me is, within Adjacent Services, you got some business line rationalization, Greg mentioned focusing on larger customers. What are the changes there? Are you eliminating anything? Or is it really just a refocus on larger customers and taking cost out?

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [13]

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Yes, I would say it's primarily a refocus on larger customers and being a little more cautious before taking on large sourcing deals. I think that that's proven to be a challenge for us, and we want to make sure that we take our time to find the kinds of Adjacent Service offerings that are repeatable.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [14]

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And then, I guess, I lied, one last question. Given the focus internally between cost-cutting and rationalization and so on, I would assume then therefore, you would be growing inorganically or making M&A transactions in the back half of this year? Or would that might be turned off for the time being?

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [15]

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Yes, we're continually -- continuing to stay primarily focused on getting this business on track and getting EBITDA where it needs to be. Yes, we'll continue to evaluate those opportunities as they come up, but we want to stay very focused on what we're doing.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [16]

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All right. Well, again, given the challenges you're faced with, I want to commend you for kind of holding EBITDA together. And there are some reductions and expectations for this year, but they're not drastic. And then the promise of significantly better margins in 2020 is enough to keep me interested.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [17]

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Good to hear it, Alex, and we're very committed to deliver that. So thank you.

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [18]

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Yes. And then just to tack on that, if I'm not mistaken, we probably do get back to your expectation for 2020.

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Operator [19]

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We have your next question coming from Zach Cummins with B. Riley FBR.

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Zachary Cummins, B. Riley FBR, Inc., Research Division - Analyst [20]

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Alex actually asked a lot of the same questions that I was going to ask but just a few incremental follow-ups for me. In terms of changing the fee structure for some of these Contract Compliance offerings, can you talk about some of the initial client feedback? Is this something that's going to be proposed across all of your clients? Or is it just the select few that you view as unprofitable? Just some incremental color there would be helpful.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [21]

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Yes. I think everywhere, we're underperforming relative to our expectations. As we look out and seeing significant delays or reductions in expectations, even if we are making money, we want to get those agreements to move towards a more hybrid balanced model. And then in terms of clients where they're not profitable, obviously, there's a bit more urgency to those. And we have to make a decision if we're not able to move to a different model, we've got to exit the business. And our clients will clearly understand because obviously they see the findings that they're getting as a result of it. And usually, they see the opportunity, they see that we're adding value and they want to be able to obtain those findings earlier as well.

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Zachary Cummins, B. Riley FBR, Inc., Research Division - Analyst [22]

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Understood. And it sounds like from -- in terms of new business opportunities, it sounds like more of this is focused on the commercial side of the business. But in terms of the retail side of the business, have you seen any changes in the competitive landscape that have made this space more challenging? Or is it just kind of the limited opportunity that's available for you at this point?

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [23]

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No. And I don't want to underemphasize the success we're having in retail. About 60% of our year-to-date bookings have been in retail. But we're -- we see that commercial from new space and new client access is a richer environment. So I wanted to point that out. But no, we still are having very good success, and our retail business is still a significant focus for us. We have competitors. We've had competitors. We'll continue to have competitors. But we like how we're playing. We think we have innovation. We have offerings that are very interesting to our clients. And the key thing, especially in retail, is that we have to keep innovating. We have to keep bringing new ideas and new ways of driving value. That's why we've been in business for 50 years in this space, we've continued to innovate and bring new ideas and new ways to add value. And that's what we're doing, especially right now.

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Operator [24]

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(Operator Instructions) Your next question comes from Andrew Gordon with E.F. Gordon Capital.

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Andrew E.F. Gordon, E.F. Gordon, L.P. - Portfolio Manager [25]

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So I think during the past 2 years, you guys have discussed moving more into the Source-To-Pay service offerings. And my understanding is that, that was largely enabled by cumulative investments in building out your technology platform, things like DX3 and automating more of the data collection and aggregation and that -- and harnessing the knowledge from your decades' worth of Recovery Audit work. And so I guess my impression was that there were a lot of accumulated costs that lead to new offerings and that you might consider that cost base fixed.

And today, I'm hearing you guys talk about rationalizing the Adjacent Services business. And there seems to be an implication that you can just kind of ratchet down the cost because if you refocus on larger clients instead of smaller ones, you can make it more profitable. And that seems to imply that it's more of a variable model, it's variable profitability. So I guess I'm just trying to understand. And possibly, this confusion is due to a jumbling of terms. Maybe DX3, when you talk about that, it's not the same thing as Adjacent Services. But I hear that you're trying to pivot towards more of a value-oriented instead of growth-oriented business model. I'm trying to understand what remains after you rationalize things in terms of your service offerings for something like this years-long endeavor to move into Source-To-Pay.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [26]

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Got it. And so let me try to clarify for you because we are absolutely fully in the Source-To-Pay business and definitely see the full scope of Source-To-Pay as our target. This journey we're on towards expanding our service offerings is really built and predicated on this idea of a centralized high-performance data engine that collects very complex, disparate data from clients and maps it in and enriches it so that we can use it not only for audit but also other types of analytics. That platform is what is being converted now, and we're in the process of moving all of our client data into that, and then we are building our analytics tools and our audit tools to integrate with that and draw from that.

But the Adjacent Services business, we have built assets and analytics assets that we have and then that have not been because we haven't implemented all of DX3. They've not been connected to that infrastructure, but that's what the next step of our journey will be. But we've been primarily project-based in Adjacent Services. And that has not scaled at the level that we expected it to. So what we're doing is stepping back, and we're going to build out of our data infrastructure and the analytics that come out of that and then grow to more consistently profitable, repeatable, scalable models there. But I'm going to ask Kurt to respond to your point on fixed cost and variable cost.

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [27]

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Yes. With Adjacent Services, it's really more a cost retrenchment until we can really get that business model to be economic and scalable. So it's not so much about variable versus fixed but just scaling back until we can get the formula right.

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Andrew E.F. Gordon, E.F. Gordon, L.P. - Portfolio Manager [28]

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Maybe -- sorry, maybe a different way to ask a similar question is -- again, maybe this is due to confusion around the definition of terms, but do you still view there being a large optionality in coming years from the cumulative investments you've put into this automation platform? And does that come from the introduction of new services from, as you call it, the data analytics? Or is it more about getting more margin out of your Recovery Audit business by, as you put it, as you described it on the call, having fewer human hands touch an audit project?

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [29]

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Now there -- as we implement this platform -- the data platform and the analytics and audit platforms that will be built with it, that are being built alongside it, value is going to be achieved in several levels. First of all, just the process of getting the data, the process and the data is going to be significantly faster to get it into the audit tools or the analytics tools than we've had in our traditional approaches, and that's from weeks to hours is the way we describe it internally. So that's the first. And what that generates for us is a lot more audit time. It takes cost out of the data aggregation and data management parts of that business. And we expect to start seeing those benefits as we bring those clients into the DX3 platform.

Secondly is this is allowing us to significantly accelerate the analytics and the audit work that we do with our clients, being able to move more accelerated into what we call integrated or real-time audit so that we're actually auditing during the deal or during the contract before it gets paid or the promotional billing occurs. So you're moving from a post Audit Recovery to a prebilling or prepayment prevention, and that is a big part of that. That changes our moment of value and how we access data. The next level of value is how we are integrating data into our analytics. And again, as you got that data much faster then we're able to provide much more valuable analytics at speed and much more efficiently. So those are the levels. And as we move up into more real time, that opens up a lot of areas where we can extend our services not only in Recovery Audit but also in Source-To-Pay analytics and solutions.

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Kurt J. Abkemeier, PRGX Global, Inc. - CFO & Treasurer [30]

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And just to add to Ron's comments, as it would relate to our traditional Recovery Audit business, over time, it should enhance our margins as we can take cost out. It can also add to revenue opportunities and potentially by really providing more value with the analytics, decommoditize what we do more so that it can help with pricing. So it can initially definitely help our existing business. And as we have the platform, it can develop new businesses, which would have been what we were anticipating with Adjacent Services.

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Andrew E.F. Gordon, E.F. Gordon, L.P. - Portfolio Manager [31]

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The new, more conservatively modeled growth guidance longer term for your company does not consider -- you still consider the possibility that there could be meaningful upside to the growth and/or possibly to margins from success that is still to be proven on a broader level from the introduction of this new technology platform. Is that fair? Because that was my impression before, but I'm just trying to make sure that that's still in place now as you're rationalizing Adjacent Services.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [32]

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No, you're correct. And this is coming out. The data platform is being converted now, so it's just coming online. And the audit platform and the analytics platform will be coming online in the first part of 2020. And they're the final stages of development and integration right now, so all these pieces are coming together. And we expect them to have a significant path to 2020. But they have not been there to really accelerate in some of the Adjacent Services, so we've been doing that more on a project-by-project ad hoc that has not been scalable, and that's really what we're cutting back on.

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Andrew E.F. Gordon, E.F. Gordon, L.P. - Portfolio Manager [33]

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Okay. I'd love to follow up with you off-line if you guys have a chance.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [34]

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Thank you for your question and would love to talk to you off-line.

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Operator [35]

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And I am showing no further questions at this time, I would now like to turn the conference back to CEO, Mr. Ron Stewart.

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Ronald E. Stewart, PRGX Global, Inc. - President, CEO & Director [36]

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Thanks, Lara. And I want to thank everyone for joining our call today. And we look forward to our next call when we'll review our Q3 earnings. Thank you.

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Operator [37]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.