Summary of PRG-SCHULTZ INTERNATIONAL, INC.

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
The Company conducts its operations through two reportable operating segments
- Domestic Accounts Payable Services and International Accounts Payable Services. The Company includes the unallocated portion of corporate selling, general and administrative expenses not specifically attributable to the Accounts Payable Services segments in a category referred to as corporate support. The Domestic and International Accounts Payable Services segments principally consist of services that entail the review of client accounts payable disbursements to identify and recover overpayments. These operating segments include accounts payable services provided to retailers and wholesale distributors (the Company's historical client base) and accounts payable and other services provided to various other types of business entities and governmental agencies. The Company conducts business in North America, South America, Europe, Australia and Asia. The Company's revenues are based on specific contracts with its clients. Such contracts generally specify: (a) time periods covered by the audit; (b) the nature and extent of audit services to be provided by the Company; (c) the client's duties in assisting and cooperating with the Company; and (d) fees payable to the Company, generally expressed as a specified percentage of the amounts recovered by the client resulting from overpayment claims identified. Clients generally recover claims by either taking credits against outstanding payables or future purchases from the involved vendors, or receiving refund checks directly from those vendors. The manner in which a claim is recovered by a client is often dictated by industry practice. In addition, many clients establish client-specific procedural guidelines that the Company must satisfy prior to submitting claims for client approval. For some services provided by the Company, client contracts provide for compensation to the Company in the form of a flat fee, a fee per hour, or a fee per other unit of service. The Company's results over the past several years have been affected by its involvement in the demonstration recovery audit contractor ("RAC") program of the Centers for Medicare and Medicaid Services ("CMS"), the federal agency that administers the Medicare program. The demonstration RAC program was designed by CMS to recover Medicare overpayments and identify Medicare underpayments through the use of recovery auditing. CMS awarded the Company the contract to audit Medicare spending in the State of California in 2005 as part of the RAC demonstration program, and the Company began to incur capital expenditures and employee compensation costs related to the RAC demonstration program that year. Such capital expenditures and employee compensation costs continued to be incurred throughout 2006 and 2007 as the Company continued to build this business. Primarily as a result of the expiration of the Company's RAC demonstration program contract in March 2008, revenues from the auditing of Medicare payments in California made only a small contribution to the Company's overall revenues in the year ended December 31, 2008. Pursuant to the Company's agreement with CMS, there will be no additional revenues to the Company or repayments to CMS relating to the RAC demonstration program. In late 2006, legislation was enacted that mandated that recovery auditing of Medicare be extended beyond the March 2008 end of the RAC demonstration program and that CMS enter into additional contracts with recovery audit contractors to expand recovery auditing of Medicare spending to all 50 states by January 1, 2010. In connection with the expansion, the Company submitted its proposal to participate in the expansion on December 14, 2007. On October 3, 2008, the Company was notified by CMS that the Company had not been selected to take part in the national rollout of the Medicare recovery audit program. On November 3, 2008, the Company filed a protest of the CMS contract awards with the Government Accountability Office (the "GAO"). On February 9, 2009, the Company announced that it had entered into subcontracts with three of the four national RAC program contract awardees, and as a result, also announced that it had withdrawn its GAO protest of CMS's contract awards. The Company cannot predict at this time when it will begin receiving revenues from these subcontracts, or the estimated amount of any such revenues.

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Results of Operations
The following table sets forth the percentage of revenues represented by certain items in the Company's Consolidated Statements of Operations for the periods indicated:

                                                                   Years Ended December 31,
                                                            2008             2007             2006
Statements of Operations Data:
Revenues                                                    100.0 %          100.0 %          100.0 %
Cost of revenues                                             64.3             62.0             71.7

Gross margin                                                 35.7             38.0             28.3

Selling, general and administrative expenses                 22.5             29.5             25.0
Operational restructuring expenses                              -              0.7              1.8

Operating income                                             13.2              7.8              1.5

Interest expense, net                                         1.7              6.1              7.2
Loss on debt extinguishment and financial
restructuring                                                   ž              4.1              4.4

Earnings (loss) from continuing operations before
income taxes and discontinued operations                     11.5             (2.4 )          (10.1 )

Income tax expense                                            1.8              0.7              0.5

Earnings (loss) from continuing operations before
discontinued operations                                       9.7             (3.1 )          (10.6 )
Discontinued operations:
Earnings from discontinued operations and
disposals, net of income taxes                                  ž              8.9              1.3


Net earnings (loss)                                           9.7 %            5.8 %           (9.3 )%

Domestic and International Accounts Payable Services Revenues. Accounts Payable Services revenues for the years ended December 31, 2008, 2007 and 2006 were as follows (in millions):

                                                        2008        2007        2006
    Domestic Accounts Payable Services revenues        $ 111.9     $ 140.4     $ 140.4
    International Accounts Payable Services revenues      83.8        87.0        85.5

    Total Accounts Payable Services revenues           $ 195.7     $ 227.4     $ 225.9

Total Accounts Payable Services revenues for the year ended December 31, 2008 decreased by $31.7 million, or 13.9%, compared to the year ended December 31, 2007. Total Accounts Payable Services revenues for the year ended December 31, 2007 increased by $1.5 million, or less than 1.0%, compared to the year ended December 31, 2006.
Domestic Accounts Payable Service revenues decreased by $28.5 million, or 20.3% in 2008 compared to 2007. Domestic Accounts Payable Services revenues include revenues previously generated from the Medicare recovery audit demonstration program. The primary reason for the decrease in the Domestic Accounts Payable Services revenue for the year ended December 31, 2008 compared to the prior year was the end of the Medicare RAC demonstration program in the first quarter of 2008. Excluding Medicare audit revenues, Domestic Accounts Payable Services revenues decreased by less than 10% in 2008 compared to the prior year. For the year ended December 31, 2007 compared to the year ended December 31, 2006, excluding Medicare, the Company experienced a decline of approximately 10% in Domestic Accounts Payable Services revenues.
The year over year decreases in Domestic Accounts Payable Services revenues is consistent with the Company's general declining trend of such revenues over the past several years. It should be noted, however, that a significant portion of the recent historical trend of declining Domestic Accounts Payable Services revenues resulted

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from the Company's recent strategy of exiting smaller, less profitable clients. Additionally, management believes that this historical declining revenue trend is related to several factors, including fewer claims being processed as a result of improved client processes and the impact of the Company's clients developing and strengthening their own internal audit capabilities as a substitute for the Company's services. Furthermore, the Company has observed that with the passage of time, numerous clients make fewer transaction errors as a result of the training and methodologies provided by the Company as part of the Company's accounts payable recovery process. These declines were offset, in part, during 2007 and, to a lesser extent, 2008, by Medicare audit revenues. The Company cannot predict if future revenues, if any, under the national Medicare RAC program subcontracts will be sufficient to offset the expected continued decline in other revenues in the Company's Domestic Accounts Payable segment.
In addition, recent economic conditions which have adversely impacted the U.S. retail industry may at some point negatively impact the Company's revenues. Since the Company audits its clients' purchases on an average of 12-18 months in arrears, the Company may not know the impact, if any, of the current economic downturn on our revenues until late 2009 or 2010. Management expects that if the retail industry economic conditions continue to erode, it could have negative impacts on Company revenues. Specifically, client liquidity and the liquidity of client vendors can significantly impact claim production, the claim approval process, and the ability of clients to offset or otherwise make recoveries from their vendors. Management is also aware of speculation regarding an increase in retailer bankruptcies, which, if correct, could adversely impact future revenues.
Revenues in the International Accounts Payable Services segment for 2008 decreased by $3.2 million, or 3.7%, compared to the prior year. The reported international revenues were adversely impacted by a significant strengthening of the U.S. dollar relative to foreign currencies throughout the world, particularly in the fourth quarter of 2008. On a constant dollar basis adjusted for foreign exchange ("FX") rates, International Accounts Payable Services revenues decreased by 2.1% during 2008 as compared to 2007. Revenues in the International Accounts Payable Services segment for 2007 were $87.0 million compared to $85.5 million in 2006, an increase of $1.5 million, or 1.8%. The international revenues in 2007 were aided by a decline in the U.S. dollar relative to foreign currencies throughout the year, particularly in Europe and Canada. After adjustment for the change in FX rates in Europe and Canada, International Accounts Payable Services revenues declined 5.4% in 2007 versus 2006. The 2008 and 2007 declines in International Accounts Payable Services revenues (on a FX adjusted basis) are attributable to factors comparable to those described for the Domestic Accounts Payable Services segment.
The Company intends to maximize the value it delivers to its historical base of clients by identifying and auditing new categories of potential errors. The Company also intends to increase its emphasis on using its technology and professional experience to assist its clients in achieving objectives that do not directly involve recovery of past overpayments. These objectives are related to such things as transaction accuracy and compliance, managing trade and vendor promotional programs, purchasing effectiveness, M&A due diligence analysis, and processing efficiency in the procure-to-pay value chain.
The Company also expects future revenues from its participation as a subcontractor in three of the Medicare RAC program's four geographic regions; however, the magnitude of such revenues is not predictable and management does not expect any revenues in 2009 from its work under the subcontracts.
Cost of Revenues ("COR"). COR consists principally of commissions and other forms of variable compensation paid or payable to the Company's auditors based primarily upon the level of overpayment recoveries and/or profit margins derived therefrom, fixed auditor salaries, compensation paid to various types of hourly support staff, and salaried operational and client service managers. Also included in COR are other direct and indirect costs incurred by these personnel, including office rent, travel and entertainment, telephone, utilities, maintenance and supplies, clerical assistance, and depreciation. A significant portion of the components comprising COR are variable and will increase or decrease with increases and decreases in revenues.
COR for the years ended December 31, 2008, 2007 and 2006 was as follows (in millions):

                                                     2008        2007        2006
      Domestic Accounts Payable Services COR        $  66.5     $  75.4     $  95.3
      International Accounts Payable Services COR      59.4        65.5        66.5

      Total Accounts Payable Services COR           $ 125.9     $ 140.9     $ 161.8

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COR as a percentage of revenue for Domestic Accounts Payable Services was 59.4%, 53.7% and 67.9% for the years ended December 31, 2008, 2007 and 2006, respectively. This equates to gross margin percentages of 40.6%, 46.3% and 32.1%, respectively, for the Domestic Accounts Payable Services segment.
The total Domestic Accounts Payable Services gross margin percentage decline in 2008 versus 2007 is entirely attributable to the decrease in the Company's Medicare recovery audit activities during 2008. During the year ended December 31, 2008, the Company incurred significant expenses to maintain its Medicare audit capabilities in anticipation of participation in the national rollout of Medicare recovery auditing while revenues from the wrap up of CMS's RAC demonstration program were not significant. Excluding Medicare activities, the gross margin percentage for Domestic Accounts Payable Services for the year ended December 31, 2008 improved by approximately 3% as compared to the year ended December 31, 2007. Such improvement primarily resulted from organizational and operational changes made in late 2007 and early 2008. Management has continued its efforts to monitor and improve profitability on a client-by-client basis since an initiative to address this issue was begun in 2006.
The dollar and percentage of revenue improvement in Domestic Accounts Payable Services COR for 2007 compared to 2006 was partially related to the execution of the Company's strategic initiative to exit smaller less profitable clients. Additionally, a significant reduction in the Medicare claims processing backlog during 2007 significantly contributed to the improvement in the Company's gross margin in 2007. During the Medicare demonstration project, significant costs preceded revenues which caused a large variation in gross margin between 2007 and 2006.
Management expects a similar lag in profitability related to the new Medicare recovery audit subcontracts. Therefore, it is expected that Domestic Accounts Payable Services gross margin in 2009 will be adversely impacted by such lag.
COR as a percentage of revenue for International Accounts Payable Services was 70.9%, 75.3% and 77.8% for the years ended December 31, 2008, 2007 and 2006, respectively. This equates to gross margin percentages of 29.1%, 24.7% and 22.2%, respectively.
The dollar and percentage of revenue improvement for International Accounts Payable Services COR in 2008 and in 2007 primarily resulted from the execution of the strategic initiatives of focusing efforts and resources on larger clients and exiting smaller less profitable clients. The Company also closed offices in many countries during 2006 and 2007, resulting in improved international gross margins in 2007 compared to 2006 and in 2008 compared to 2007.
Selling, General and Administrative Expenses ("SG&A"). SG&A expenses of the Accounts Payable Services segments include the expenses of sales and marketing activities, information technology services and allocated corporate data center costs, human resources, legal, accounting, administration, foreign currency transaction gains and losses, gains and losses on assets disposals, depreciation of property and equipment and amortization of intangibles related to the Accounts Payable Services segments.
Accounts Payable Services SG&A for the years ended December 31, 2008, 2007

and 2006 were as follows (in millions):

                                                       2008       2007       2006
       Domestic Accounts Payable Services SG&A        $ 15.7     $ 18.9     $ 20.7
       International Accounts Payable Services SG&A     11.3       10.0       10.2

       Total Accounts Payable Services SG&A           $ 27.0     $ 28.9     $ 30.9

Domestic Accounts Payable Services SG&A expenses for the year ended December 31, 2008 decreased by $3.2 million, or 16.9%, from the same period in 2007. Domestic Accounts Payable Services SG&A expenses for the year ended December 31, 2007 decreased by $1.8 million, or 8.7%, from the same period in 2006. Domestic Accounts Payable Services SG&A expenses as a percentage of revenues were 14.0%, 13.5% and 14.7% for the years ended December 31, 2008, 2007 and 2006, respectively.
As discussed above with respect to COR ratios, the timing of the Medicare RAC demonstration program revenues dramatically impacted the 2007 ratio of Domestic Accounts Payable Services segment SG&A to segment

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revenues. Excluding the impact of the Medicare recovery audit activities, Domestic Accounts Payable Services SG&A in terms of dollars and as a percentage of revenue decreased in 2008 compared to 2007 and in 2007 compared to 2006. Such decreases resulted primarily from headcount reductions and reductions in facilities costs.
International Accounts Payable Services SG&A includes foreign currency transaction gains and losses, including the gains and losses related to intercompany balances. Gains and losses result from the re-translation of the foreign subsidiaries payable to the U.S. parent from their local currency to their U.S. dollar equivalent and substantial changes from period to period in FX rates can significantly impact the amount of such gains and losses. During the year ended December 31, 2008, the Company recognized $3.3 million of FX losses related to intercompany balances. During the years ended December 31, 2007 and 2006, the Company recognized FX gains related to intercompany balances of $1.2 million and $0.7 million, respectively.
International Accounts Payable Services SG&A excluding the FX gains and losses related to intercompany balances decreased by $3.1 million, or 27.7% for the year ended December 31, 2008 compared to the year ended December 31, 2007. The 2007 amount was $0.3 million more than such amount in 2006. The slight increase in 2007 compared to 2006 is attributable to 2007 severance costs and charges resulting from early lease terminations. The decrease in 2008 International Accounts Payable Services SG&A, excluding the intercompany FX losses, as compared to 2007 and 2006, resulted from headcount reductions and the closing or consolidation of offices in numerous countries.
Corporate Support
SG&A. Corporate Support SG&A represents the unallocated portion of corporate SG&A expenses which are not specifically attributable to Domestic or International Accounts Payable Services and include the expenses of information technology services, the corporate data center, human resources, legal, accounting, treasury, administration, hedging activities and stock-based compensation charges.
Corporate Support SG&A totaled the following for the years ended December 31, 2008, 2007 and 2006 (in millions):

2008 2007 2006 Selling, general and administrative expenses $ 17.0 $ 38.2 $ 25.6

Corporate Support SG&A for the years ended December 31, 2008, 2007 and 2006 includes stock-based compensation charges of $2.2 million, $21.0 million and $6.4 million, respectively. The disproportionate 2007 charge for stock-based compensation resulted primarily from the issuance of additional performance units in accordance with the anti-dilution provisions of the 2006 Management Incentive Plan ("2006 MIP") that was negotiated as part of the Company's financial restructuring completed in March 2006. See "2006 Management Incentive Plan" below for further details regarding the Company's 2006 MIP.
Corporate Support SG&A expenses excluding stock-based compensation charges decreased by $2.4 million, or 14.0%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. Corporate Support SG&A expenses excluding stock-based compensation charges decreased by $2.0 million, or 10.4%, for the year ended December 31, 2007 compared to the year ended December 31, 2006. The decreases in these costs for 2008 compared to 2007 and for 2007 compared to 2006 resulted from reductions in payroll and related taxes and benefits, occupancy costs, insurance, professional fees, and other miscellaneous expenses.
Operational Restructuring Expense
On August 19, 2005, the Company announced that it had taken the initial step in implementing an expense restructuring plan, necessitated by the Company's declining revenue trend over the previous three years. The expense restructuring plan encompassed exit activities, including reducing the number of clients served, reducing the number of countries in which the Company operates, reducing headcount, and terminating operating leases.

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The operational restructuring expense for the years ended December 31, 2008, 2007 and 2006 was as follows (in millions):

2008 2007 2006 Operational restructuring expense $ ž $ 1.6 $ 4.1

The Company initially expected that the implementation of the 2005 operational restructuring plan would result in severance related and other charges of approximately $14.6 million, most or all of which would be recognized prior to the end of 2006. Actual operational restructuring charges related to the 2005 plan recognized by the end of 2006 totaled $15.3 million, including $4.1 million recognized in 2006. As of December 31, 2006 the Company had paid out a total of $11.2 million of severance. In 2006, the Company recorded additional restructuring charges for early termination costs of $1.4 million and leasehold improvement impairment charges of $0.5 million. The 2006 operational restructuring charges also included $2.2 million related to severance pay and related benefits costs.
As of December 31, 2006, the operational restructuring plan as originally contemplated and approved in 2005 had been completed. In 2007, the Company recorded additional restructuring charges for early lease termination costs of $1.3 million and leasehold improvement impairment charges of $0.3 million. Such costs were not included in the original 2005 restructuring plan. For the year ended December 31, 2008, no operational restructuring expenses were recognized.
Interest Expense and Income
Net interest expense for the years ended December 31, 2008, 2007 and 2006 amounted to $3.2 million, $13.8 million and $16.3 million, respectively. The reductions in net interest expense are directly attributable to the Company's reductions in debt obligations. See "Liquidity and Capital Resources - Financing Activities and Interest Expense" below for additional information related to the Company's interest expense and income.
Loss on Debt Extinguishment and Financial Restructuring In 2006, the Company recorded a $10 million charge in connection with the restructuring of its debt obligations. In 2007, the company recorded a $9.4 million charge as a result of debt extinguishments. See "Liquidity and Capital Resources - Financing Activities and Interest Expense" below for additional information related to the Company's 2006 financial restructuring and 2007 debt extinguishments.
Income Tax Expense
The Company's reported effective tax rates on earnings (loss) from continuing operations before income taxes and discontinued operations approximated 15.5%,
(30.6)%, and (5.1)% for the years ended December 31, 2008, 2007 and 2006, respectively. The 2008 effective tax rate is less than the expected tax rate primarily due to a reduction in the Company's deferred tax asset valuation allowance. The reflection of tax expense in 2007 and 2006 in spite of reported losses from continuing operations primarily results from taxes on foreign income and the non-recognition of tax benefits on operating loss carry-forwards through the use of a valuation allowance against deferred tax assets. For the years ended December 31, 2008, 2007 and 2006, management determined that based on all available evidence, a deferred tax asset valuation allowance of $64.3 million, $79.8 million and $79.2 million, respectively, were appropriate as of those dates. The reduction of the allowance during 2008 was partially attributable to a reduction of previously recognized foreign operating loss carry-forwards related to goodwill deductions taken in the United Kingdom ("UK"). During 2008, the Company acceded to a position taken by the taxing authorities in the UK regarding the denial of certain goodwill deductions taken on UK tax returns for 2003 through 2005. As a result, foreign net operating loss carry-forwards were reduced by approximately $17.0 million based on December 31, 2008 FX rates. Accordingly, deferred tax assets of $5.1 million were written off. This reduction in the Company's deferred tax assets was offset by a corresponding reduction in the previously established valuation allowance against these assets. An additional $5.7 million reduction in the December 31, 2008 valuation allowance resulted from a like reduction in deferred tax assets related to 2008 intangible asset amortization deductions for tax purposes related to intangible assets that have been previously written off for financial reporting purposes.

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On March 17, 2006, the Company experienced an ownership change as defined under Section 382 of the IRC. This ownership change resulted in an annual IRC
Section 382 limitation that limits the use of certain tax attribute carry-forwards. Of the $42.8 million of U.S. federal loss carry-forwards that are available to the Company as of December 31, 2008, $23.3 million of the loss carry-forwards are subject to an annual usage limitation of $1.4 million. The ownership change that took place in March 2006, resulted in the write-off of approximately $72.6 million in previously incurred and unexpired federal net operating loss carry-forward amounts and the write-off of approximately $7.4 million in future tax deductions related to certain built-in losses associated with intangible and fixed assets. The following write-offs also took place in . . .