KLDISCOVERY: Discussion and analysis by management of the financial position and operating results. (form 10-K)
Throughout this section, unless otherwise noted "we," "us," "our," "Company," "
KLDiscovery," "KLD", " KLDiscovery Inc." or " LD Topco, Inc." refer to KLDiscovery Inc.and its consolidated subsidiaries. As a result of the Business Combination, (i) KLDiscovery Inc.'sconsolidated financial results for periods prior to December 19, 2019reflect the financial results of LD Topco, Inc.and its consolidated subsidiaries, as the accounting predecessor to KLDiscovery Inc., and (ii) for periods from and after this date, KLDiscovery Inc.'sfinancial results reflect those of KLDiscovery Inc.and its consolidated subsidiaries (including LD Topco, Inc.and its subsidiaries) as the successor following the Business Combination. The following discussion and analysis of financial condition and results of operations of the Company should be read together with the financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Such discussion and analysis reflects the historical results of operations and financial position of the Company. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors," "Forward-Looking Statements" and elsewhere in this Annual Report on Form 10-K.
We are one of the leading eDiscovery providers and the leading data recovery services provider to corporations, law firms, government agencies and individual consumers. We provide technology-enabled services and software to help law firms, corporations, government agencies and consumers solve complex data challenges. We have broad geographical coverage in the eDiscovery and data recovery industries with more than 32 locations in 18 countries, 9 data centers and 18 data recovery labs around the globe. Our legal technology services cover both eDiscovery and information governance services to support the litigation, regulatory compliance, and internal investigation needs of our clients. We offer data collection and forensic investigation, early case assessment, electronic discovery and data processing, application software, data hosting, and managed review services. In addition, through our global Ontrack Data Recovery name, we deliver world-class data recovery, email extraction and restoration, data destruction and tape management services.
KEY COMPONENTS OF OUR OPERATING RESULTS
Data proliferation is contributing to growth in the eDiscovery and information governance market. Data is growing at an exponential rate due to several factors, including the adoption of mobile devices, accessibility of hosted systems and increased reliance on electronic data storage. We are well positioned to gain market share from the growth of electronically stored information given our prior and continued investment in our infrastructure and proprietary technologies that allows us to efficiently identify, preserve, collect, process, review and host complex data sets. We will continue to develop and enhance our technology which will position us to continue to evolve as the market changes. The eDiscovery and information governance market is highly fragmented and price competitive. While many of our competitors rely on third party software tools to provide their services, we offer our services utilizing third party platforms enhanced with our proprietary tools, as well as our own end-to-end tools. Because we can provide service offerings utilizing proprietary technology, we have more flexibility in pricing, and we are not hindered by third party licensing software expenses. As such, our proprietary tools allow us to be less impacted by significant price compression than our competitors. Historically, on-premise tools have been the dominant deployment solution in the past. However, recently the market has shifted to cloud-based solutions and this shift can result in increased revenue for us as we offer our own proprietary cloud-based solutions.
We classify our legal technology revenue as follows:
• Collection and processing services: we have remote and on-site collection
services. Our proprietary workflows and tools allow us to ingest, extract native file metadata and index in a normalized format. We have near duplication tools to quickly discard duplicative or irrelevant data, significantly minimizing the data that needs to be reviewed. Our
the analyzes include predictive coding that allows us to
file millions of documents in hours. We offer email
thread that examines the relationships between email messages to identify
the most inclusive posts to avoid redundant reviews and we have
language identification which can automatically identify the principal
language in all documents in the data set. The collection of data is billed either by the unit or hour and the data that is processed and produced is billed per gigabyte, page or per file. 35
• Medico-legal and advisory services: we provide the expertise and tools
necessary to extract and analyze digital evidence to support the client
legal matters. Our forensic experts help extract critical evidence,
recover any data that individuals may have sought to erase or hide, retrieve key data buried in documents and organize data contained in
several sources of information to give our client insight and knowledge
they need. Our forensics and consulting services are billed either by hour or unit.
• Professional services: we manage complex eDiscovery issues and work in partnership
with our clients to assist through the lifecycle of a case. Our professional services are billed on an hourly basis. • Managed Review Services: We use our extensive eDiscovery project
management experience, technological excellence and global presence for
provide clients with a secure, transparent and cost-effective managed exam
solution. We bring together review teams of experienced legal professionals to
any kind of case. Each member of the team is a qualified lawyer who has succeeded
a selective selection process and received training from
review manager to ensure the most effective and defensible review of a
client documents. Those responsible for the document review have an extensive project
managed experience to oversee the entire review process and work with the
client's legal team as an integrated partner. Our industry experts have developed advanced managed review processes and tools and deliver services in state of the art facilities, handle subject matter
versatility, are platform independent, have in-depth professional knowledge of
predictive coding and technology assisted review workflows, have multilingual capabilities and focus on quality. Our managed review services are billed on an hourly basis.
• Hosting: we have flexible technological options and platforms to host our
customer data for the life of the case. We offer secure data centers
around the globe to support data across jurisdictions and privacy laws. Hosting is billed per gigabyte.
• Subscription: we offer subscription pricing options to provide costs
predictability over time. Subscriptions cover a range of our services and
are generally fixed costs billed monthly for contractual terms of an average of one
at three years.
We categorize our data recovery revenue as follows:
• Data recovery services: we recover lost data from devices that store
digital information, including data centers, cloud, corporate servers,
workstations, laptops and mobile devices. The price is per device.
• Power controls and
of data from database files and physically sound devices. Pricing is typically an annual or multi-year agreement at a fixed price. For the years ended
December 31, 2020and December 31, 2019, our legal technology revenue was $247.3 millionand $265.9 million, respectively, and our data recovery revenue was $42.3 millionand $46.2 million, respectively. Additionally, we have longstanding relationships with our clients and for the years ended December 31, 2019and 2020, no single client accounted for more than 5% of our revenues.
We prepare audited financial statements in accordance with
U.S.GAAP. We also disclose and discuss other non- U.S.GAAP financial measures such as EBITDA and adjusted EBITDA. We believe that these measures are relevant and provide useful supplemental information to investors by providing a baseline for evaluation and comparing our operating performance against that of other companies in our industry. The non- U.S.GAAP financial measures that we use may not be comparable to similarly titled measures reported by other companies and, in the future, we may disclose different non- U.S.GAAP financial measures in order to help our investors meaningfully evaluate and compare our results of operations to our previously reported results of operations or to those of other companies in our industry. We believe these non- U.S.GAAP financial measures reflect our ongoing operating performance because the isolation of non-cash charges, such as amortization and depreciation, and other items, such as interest, income taxes, management fees and equity compensation, acquisition and transaction costs, restructuring costs, systems establishment and costs associated with strategic initiatives which are incurred outside the ordinary course of our business, and provide information about our cost structure, that helps track our operating progress. We encourage investors and potential investors to carefully review the U.S.GAAP financial information and compare them with our EBITDA and adjusted EBITDA. 36
We define EBITDA as net income (loss) plus interest (income) expense, income tax expense (benefit), depreciation and amortization. We view adjusted EBITDA as our operating performance measure and as such, we believe that the most directly comparable
U.S.GAAP financial measure is net loss. In calculating adjusted EBITDA, we exclude from net loss certain items that we believe are not reflective of our ongoing business and exclusion of these items allows us to provide additional analysis of the financial components of the day-to-day operation of our business. We have outlined below the type and scope of these exclusions:
• Acquisition, financing and transaction costs generally represented
by changes in the valuation of non-ordinary price supplements, rating agency fees,
letter of credit and revolving facility fees, as well as professional fees
service charges and direct costs related to acquisitions. Because we do
not acquire companies on a predictable cycle, we do not consider
amount of costs related to acquisition and integration
component representative of the daily operational performance of our
• Expenses related to strategic initiatives are related to costs resulting from the pursuit of
strategic business opportunities. We do not consider amounts to be
representative of the daily operational performance of our company.
• Management fees, share-based compensation and others mainly represent
consulting fees and part of the remuneration paid to our employees and
managers through equity-based instruments. Determination of the fair value of
the stock-based instruments involves a high degree of judgment and estimation and the expenses recorded may not align with the actual value realized upon the future exercise or termination of the related stock-based awards. Therefore, we believe it is useful to exclude
stock-based compensation to better understand long-term performance
of our core business. • Restructuring costs generally represent non-ordinary course costs
incurred as part of a change of contract, lease or change of
the makeup of our personnel often related to an acquisition. We do not consider the amount of restructuring costs to be a representative component of the day-to-day operating performance of our business.
• System establishment costs relate to non-standard course expenses
engaged to develop our IT infrastructure, including system automation
and enterprise resource planning system implementation. We do not consider the amount to be representative of a component of the day-to-day operating performance of our business. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by any of these adjustments, or that our projections and estimates will be realized in their entirety or at all. In addition, because of these limitations, adjusted EBITDA should not be considered as a measure of liquidity or discretionary cash available to us to fund our cash needs, including investing in the growth of our business and meeting our obligations. The use of adjusted EBITDA instead of
U.S.GAAP measures has limitations as an analytical tool, and adjusted EBITDA should not be considered in isolation, or as a substitute for analysis of our results of operations and operating cash flows as reported under U.S.GAAP. For example, adjusted EBITDA does not reflect:
• our cash expenses or our future capital expenditure needs;
• changes in, or cash requirements for, our working capital needs;
• interest charges or cash requirements necessary to service interest
or principal payments, on our indebtedness; • any cash income taxes that we may be required to pay;
• any cash flow requirement for the replacement of impaired assets or
amortized over their estimated useful life and may need to be replaced
in the future; or
• all items of non-monetary income or expense that are reflected in our financial statements
of cash flows. 37
The following table provides a reconciliation of net loss to EBITDA and adjusted EBITDA: Year ended Year ended December 31, December 31, (in millions) 2020 2019 Net loss
$ (49.9 ) $ (54.0 )Interest expense 50.7 48.4 Income tax expense 0.9 0.7 Depreciation and amortization expense 47.7
Loss on debt extinguishment -
Acquisition, financing and transaction costs 5.2
Sign-on bonus amortization 0.2
Non-recoverable draw 0.3
Total strategic initiatives 0.5
Management fees, stock compensation and other 3.7 3.5 Restructuring costs 2.5 2.2 Systems establishment 2.0 2.6 Adjusted EBITDA
$ 63.3 $ 68.7RESULTS OF OPERATIONS
For the year ended
The results for the periods shown below should be reviewed in conjunction with our audited consolidated financial statements included in "Item 8 - Financial Statements and Supplementary Data." For The Years Ended December 31, (in millions) 2020 2019 Revenues
$ 289.5 $ 312.1Cost of revenues 147.7 160.9 Gross profit 141.8 151.2 Operating expenses $ 140.0148.6 Income from operations 1.8 2.6 Interest expense 50.7 48.4
Loss on debt extinguishment -
Other expense 0.1
Loss before income taxes (49.0 )
(53.3 ) Income tax provision 0.9 0.7 Net loss (49.9 ) (54.0 ) Total other comprehensive income, net of tax 4.9 0.3 Comprehensive loss
$ (45.0 ) $ (53.7 )Revenues Revenues decreased by $22.6 million, or 7.2%, to $289.5 millionfor the year ended December 31, 2020as compared to $312.1 millionfor the year ended December 31, 2019. This decrease is primarily due to a decrease of $18.6 millionin legal technology revenue and a decrease of $3.9 millionin data recovery revenue. These decreases are primarily due to the impacts of COVID-19, as many clients have delayed the start of new matters and court systems have been slow to reopen. 38
Cost of income
Cost of revenues decreased by
$13.2 million, or 8.2%, to $147.7 millionfor the year ended December 31, 2020as compared to $160.9 millionfor the year ended December 31, 2019. This decrease is primarily due to decreased variable costs of $1.5 millionassociated with decreased revenues, decreased hardware and software expenses of approximately $2.3 million, decreased communications expenses of $0.9 millionand expense reduction measures implemented by management, including decreased (i) personnel expense of approximately $7.4 million, (ii) travel and entertainment expense of $1.3 million, and (iii) other operational expenses of $0.9 million. These decreases were partially offset by $0.6 millionof increased severance expenses due to the integration of operational business units. As a percentage of revenue, our cost of revenues for the year ended December 31, 2020decreased to 51.0% as compared to 51.6% for the year ended December 31, 2019. This decrease was due to the factors noted above.
Gross profit decreased by
$9.4 million, or 6.2%, to $141.8 millionfor the year ended December 31, 2020as compared to $151.2 millionfor the year ended December 31, 2019. Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the year ended December 31, 2020increased to 49.0% as compared to 48.4% for the year ended December 31, 2019. Operating Expenses Operating expenses decreased by $8.6 million, or 5.8%, to $140.0 millionfor the year ended December 31, 2020as compared to $148.6 millionfor the year ended December 31, 2019. This decrease is primarily due to expense reduction measures implemented by management which decreased (i) personnel expenses by $7.3 million, (ii) travel and entertainment expenses by $2.0 million, (iii) marketing expenses by $0.9 million, and (iv) other operational expenses of $0.9 million. In addition, depreciation and amortization decreased by $3.2 million. These decreases were partially offset by increased costs incurred related to lease terminations to optimize our real estate footprint of $4.6 millionand $0.6 millionof increased severance costs due to the integration of operational business units. As a percentage of revenue, our operating expenses for the year ended December 31, 2020increased to 48.4% as compared to 47.6% for the year ended December 31, 2019due to the factors noted above.
Interest expense increased by
$2.3 million, or 4.8%, to $50.7 millionfor the year ended December 31, 2020as compared to $48.4 millionfor the year ended December 31, 2019. This increase is primarily due to the increase in outstanding debenture related debt, partially offset by lower interest rates during the year ended December 31, 2020compared to the year ended December 31, 2019.
Income tax provision
A valuation allowance has been made on our
deferred taxes for tax-deductible goodwill and other liabilities with indefinite useful lives.
During the years ended
December 31, 2020and 2019, we recorded an income tax provision of $0.9 millionand $0.7 million, respectively, resulting in an effective tax rate of (1.8) % and (1.3) %, respectively. These effective tax rates differ from the U.S.federal statutory rate primarily due to the effects of foreign tax rate differences and the valuation allowance against our domestic deferred tax assets. The effective rate for the year ended December 31, 2020did not meaningfully change from the year ended December 31, 2019. We reported pre-tax loss of $49.0 millionduring the year ended December 31, 2020with an effective tax rate of (1.8) %, resulting in a $0.9 millionincome tax provision. The effective tax rate was primarily impacted by our valuation allowance, which caused a decrease in the tax benefit of $9.6 million. Without this item, our effective tax rate would have been 21.4%, which is higher than the statutory tax rate of 21.0%, primarily due to the effects of foreign tax rate differences, U.S.state taxes and certain permanent items. 39 -------------------------------------------------------------------------------- We reported pre-tax loss of $53.3 millionduring the year ended December 31, 2019with an effective tax rate of (1.3) %, resulting in a $0.7 millionincome tax provision. The effective tax rate was primarily impacted by our valuation allowance, which caused a decrease in the tax benefit of $12.7 million. Without this item, our effective tax rate would have been 25.1%, which is higher than the statutory tax rate of 21.0%, primarily due to the effects of foreign tax rate differences, U.S.state taxes and certain permanent items.
Net loss for the year ended
December 31, 2020was $49.9 millioncompared to $54.0 millionfor year ended December 31, 2019. Net loss decreased for the year ended December 31, 2020as compared to the year ended December 31, 2019due to the factors noted above.
Liquidity and capital resources
Our primary cash needs have been to meet debt service requirements and to fund working capital and capital expenditures. We fund these requirements from cash generated by our operations, as well as funds available under our 2021 Credit Agreement (as defined below). See "2021 Credit Agreement". Although our eDiscovery solutions and information archiving services are billed on a monthly basis in arrears with amounts typically due within 30 to 45 days, the eDiscovery industry tends towards longer collectability trends. As a result, we have typically collected on the majority of our eDiscovery accounts receivables within 90 to 120 days, which is consistent within the industry. With respect to our data recovery services, they are billed as the services are provided, with payments due within 30 days of billing. We typically collect on our data recovery services accounts receivables within 30 to 45 days. Lastly, the majority of our data recovery software is billed monthly in advance with amounts typically due within 30 to 45 days; however, depending on the client contract, billing can occur annually, quarterly or monthly. Long outstanding receivables are not uncommon due to the nature of our legal technology services as litigation cases can go on for years, and in certain instances, our collections are delayed until the customer has received payment for their services in connection with a legal matter or the case has been settled. These long-outstanding invoices are a function of the industry in which we operate, rather than indicative of an inability to collect. We have experienced no material seasonality trends as it relates to collection on our accounts receivable. As of
December 31, 2020, we had $51.2 millionin cash compared to $43.4 millionas of December 31, 2019. As of December 31, 2020, we had $503.5 millionof outstanding borrowings compared to $506.0 millionas of December 31, 2019. We expect to finance our operations over the next 12 months primarily through existing cash balances and cash flow, supplemented as necessary by funds available through our 2021 Credit Agreement.
2021 credit agreement
February 8, 2021, the Company entered into a new secured credit agreement (the "2021 Credit Agreement"). Proceeds were used to pay in full all outstanding loans and terminate all lending commitments under the 2016 Credit Agreement. The 2021 Credit Agreement provides for (i) initial term loans in an aggregate principal amount of $300 million(the "Initial Term Loans"), (ii) delayed draw term loans in an aggregate principal amount of $50 million(the "Delayed Draw Term Loans"), and (iii) revolving credit loans in an aggregate principal amount of $40 million(the "Revolving Credit Loans"). The Delayed Draw Term Loans will be available to the Company at any time prior to February 8, 2023, subject to certain conditions. The Initial Term Loans and Delayed Draw Term Loans will bear interest, at the Company's option, at the rate of (x) with respect to Eurocurrency Rate Loans (as defined in the 2021 Credit Agreement), the Adjusted Eurocurrency Rate (as defined in the 2021 Credit Agreement) with a 1.0% floor, plus 6.50% per annum, or (y) with respect to Base Rate Loans (as defined in the 2021 Credit Agreement), the Base Rate (as defined in the 2021 Credit Agreement) plus 5.50% per annum. The Revolving Credit Loans will bear interest, at our option, at the rate of (x) with respect to Eurocurrency Rate Loans, the Adjusted Eurocurrency Rate plus 4.00% per annum, or (y) with respect to Base Rate Loans, the Base Rate plus 3.00% per annum. The Initial Term Loans and Delayed Draw Term Loans amortize at a rate of 1.00% of the aggregate principal amount of Initial Term Loans and Delayed Draw Term Loans outstanding, payable in consecutive quarterly installments, beginning on June 30, 2021. 40 -------------------------------------------------------------------------------- The Initial Term Loans, Delayed Draw Term Loans and Revolving Credit Loans are each scheduled to mature on the earlier of February 16, 2026and or six months prior to maturity of our Debentures due in December 2024. The Initial Term Loans and Delayed Draw Term Loans may be voluntarily repaid at any time, but may be subject to a prepayment premium. The Initial Term Loans and Delayed Draw Term Loans are required to be repaid under certain circumstances, including with Excess Cash Flow (as defined in the 2021 Credit Agreement), the proceeds of an Asset Sale or Casualty Event (each as defined in the 2021 Credit Agreement) and the proceeds of certain refinancing indebtedness. The obligations under the 2021 Credit Agreement are secured by substantially all of the Company's assets. The 2021 Credit Agreement contains customary affirmative and negative covenants as well as a financial maintenance covenant that requires the Loan Parties to maintain a First Lien Net Leverage Ratio of less than or equal to 7.00 to 1.00, tested at the end of each fiscal quarter. The Company closing fees of $8.0 millionin connection with the entry into the 2021 Credit Agreement. These fees will be amortized over the full term of the 2021 Credit Agreement.
Credit agreement 2016
December 9, 2016, we entered into a Credit Agreement (as amended or supplemented to date, the "2016 Credit Agreement") with a group of lenders to establish term loan facilities and a revolving line of credit for borrowings by LD Intermediate, Inc.and LD Lower Holdings, Inc.(the "Initial Term Loans"). The Initial Term Loan borrowings of $340.0 million(the "First Lien Facility") and $125.0 million(the "Second Lien Facility" and, together with the First Lien Facility, the "Facilities") were to mature on December 9, 2022and December 9, 2023, respectively. The First Lien Facility was repaid on February 8, 2021and the Second Lien Facility was repaid on December 19, 2019. The First Lien Facility established a term loan principal payment schedule with payments due on the last day of each calendar quarter, beginning on March 31, 2017with a payment of $2.1 million. Quarterly principal payments increased to $4.3 millionbeginning on March 31, 2019with a balloon payment of $259.3 milliondue at maturity. The interest rate for the First Lien Facility adjusted every interest rate period, which can be one, two, three or six months in duration and is decided by us, or to the extent consented to by all Appropriate Lenders (as defined in the 2016 Credit Agreement), 12 months thereafter. Interest payment dates included the last day of each interest period and any maturity dates of the facility; however, if any interest period exceeded three months, the respective dates that fall every three months after the beginning of an interest period was also an interest payment date. For each interest period, the interest rate per annum was 5.875% plus the Adjusted Eurocurrency Rate which was defined as an amount equal to the Statutory Reserve Rate (as defined in the 2016 Credit Agreement) multiplied by the greatest of (a) LIBOR, (b) 0.00% per annum and (c) solely with respect to the Initial Term Loans, 1.00% per annum. As of December 31, 2020, the net balance due was $289.0 million, with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 1.00%. As of December 31, 2019, the net balance due was $306.0 million, with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 2.596%. The Second Lien Facility required a balloon payment of $125.0 milliondue at maturity. The interest rate for the Second Lien Facility adjusted every interest rate period, which could be one, two, three or six months in duration and is decided by the Company, or to the extent consented to by all Appropriate Lenders (as defined in the 2016 Credit Agreement), 12 months thereafter. Interest payment dates included the last day of each interest period and any maturity dates of the facility; however, if any interest period exceeded three months, the respective dates that fall every three months after the beginning of an interest period was also an interest payment date. For each interest period, the interest rate per annum is 10.0% plus the Adjusted Eurocurrency Rate which was defined as an amount equal to the Statutory Reserve Rate multiplied by the greatest of (a) LIBOR, (b) 0.00% per annum and (c) solely with respect to the Initial Term Loans, 1.00% per annum. The Second Lien Facility was repaid upon consummation of the Business Combination on December 19, 2019. 41
The facilities were secured by substantially all of our assets and contain certain restrictive covenants. From
The 2016 Credit Agreement included a mandatory prepayment within ten days after delivery of the annual audited financial statements commencing with the year ended
December 31, 2017. The Excess Cash Flow amount is specifically defined in section 1.01 of the 2016 Credit Agreement. The Excess Cash Flow calculation starts with net income and then adds back a series of non-cash expenses, capital expenditures, M&A, and debt related amounts to arrive at a final amount due. The amount of the Excess Cash Flow payment would have been reduced if the First Lien Net Leverage Ratio falls below certain thresholds. Such percentage in respect of any Excess Cash Flow Period shall be reduced to 50%, 25% or 0% if the First Lien Net Leverage Ratio as of the last day of the year to which such Excess Cash Flow Period relates was equal to or less than 3.75 to 1.00, 3.25 to 1.00 or 2.75 to 1.00, respectively.
We were not required to make any additional principal payment under the excess cash flow clause for the year ended
Revolving credit facility
The 2016 Credit Agreement also provided for a Revolving Credit Facility of up to
$30.0 millionthat was scheduled to mature on June 9, 2022. Borrowings under the Revolving Credit Facility were subject to meeting certain financial covenants set forth in the 2016 Credit Agreement, including the First Lien Net Leverage Ratio. We were able to draw up to $30.0 millionunder the Revolving Credit Facility, on a term loan basis, with either an adjustable eurocurrency loan interest rate of 5.375%, 5.625%, or 5.875% with interest rates based on the First Lien Net Leverage Ratio plus an amount equal to the LIBOR, or a base rate loan interest rate of 4.375%, 4.635%, or 4.875% plus the Base Rate. As of December 31, 2020and 2019, we had no amounts outstanding under our Revolving Credit Facility and $0.7 millionin letters of credit were issued with approximately $29.3 millionof available borrowing capacity under the Revolving Credit Facility. As discussed above, the Revolving Credit Facility was repaid on February 8, 2021and was terminated. The Initial Term Loan borrowings pursuant to the 2016 Credit Agreement were issued at an original issue discount of $11.9 millionand $6.3 millionfor the First Lien Facility and Second Lien Facility, respectively. The original issue discount was amortized using the effective yield method over the respective term of each Facility. We incurred closing fees in connection with the entry into the Facilities and the Revolving Credit Facility pursuant to the 2016 Credit Agreement of $13.6 million. These closing fees were deferred on December 9, 2016, along with fees of $0.6 millionrelated to our prior term loan facility that we refinanced in connection with our entry into the 2016 Credit Agreement and are amortized over their respective terms. Debentures In connection with the Business Combination on December 19, 2019, we issued $200 millionaggregate principal amount of Debentures due 2024 in a private placement to certain "accredited investors" pursuant to an exemption from registration under Section 4(a)(2) of the Securities Act. The equity structure as of the date of the Business Combination included 2,097,974 shares of common stock and 1,764,719 warrants for the issuance of common stocks to the debenture holders related to the Debenture issuance. The proceeds of the Debentures were in part to repay our outstanding Second Lien Facility and amounts outstanding under the Revolving Credit Facility. The Debentures mature on December 19, 2024unless earlier converted, redeemed or repurchased. The Debentures bear interest at an annual rate of 4.00% in cash and 4.00% in kind, payable quarterly on the last business day of March, June, September and December. In addition, on each anniversary of the Closing Date, we will add to the principal amount (subject to reduction for any principal amount repaid) of the Debentures an amount equal to 3.00% of the original aggregate principal amount of the Debentures outstanding, which will accrue from the last payment and will be payable at maturity, upon conversion or upon an optional redemption, if no prior payment was made. 42 -------------------------------------------------------------------------------- At any time, upon notice as set forth in the Debentures, the Debentures will be redeemable at our option, in whole or in part, at a price equal to 100% of the principal amount of the Debentures redeemed, plus accrued and unpaid interest thereon. Subject to approval to allow for the full conversion of the Debentures into common stock, the Debentures will be convertible into shares of our common stock at the option of the debenture holders at any time and from time to time at a price of $18per share, subject to certain adjustments. However, in the event we elect to redeem any Debentures, the holders will have a right to purchase common stock from us in an amount equal to the amount redeemed at the conversion price. The Debentures contain covenants that limit our ability to, among other things: (i) incur additional debt; (ii) create liens on assets; (iii) engage in certain transactions with affiliates; or (iv) designate our subsidiaries as unrestricted subsidiaries. The Debentures provide for customary events of default, including non-payment, failure to comply with covenants or other agreements in the Debentures and certain events of bankruptcy or insolvency. If an event of default occurs and continues, the holders of at least 25% in aggregate principal amount of the outstanding Debentures may declare the entire principal amount of all the Debentures to be due and payable immediately.
Our net cash flow from operating, investing and financing activities for the years ended
2020 2019 Net cash provided by (used in): Operating activities
$ 39,776 $ (8,297 )Investing activities $ (14,059 ) $ (15,218 )Financing activities $ (18,595 ) $ 43,490Effect of foreign exchange rates $ 672 $ (7 )Net increase in cash $ 7,794 $ 19,968
Cash flows generated by (used in) operating activities
Net cash provided by operating activities was
$39.8 millionfor the year ended December 31, 2020as compared to net cash used in operating activities of $(8.3) millionfor the year ended December 31, 2019. The increase in net cash provided is due to a $4.1 millionreduction in net loss, a $7.3 millionincrease in non-cash expenses and a $36.7 millionincrease in working capital. The period over period decrease in non-cash items is primarily due to a $14.1 millionincrease in non-cash interest, a $1.2 millionincrease in stock-based compensation, an increase in the provision for losses on accounts receivable of $1.0 millionand a $0.8 milliondecrease in deferred tax benefit, offset by a $7.2 milliondecrease on the loss on debt extinguishment and a $2.7 milliondecrease in depreciation and amortization. The increase in working capital for the period is primarily due to a $26.8 milliondecrease in accounts receivable and a $13.6 millionincrease in accounts payable and accrued expenses, offset by a $2.3 millionincrease in prepaid expense and other current assets and a $1.4 milliondecrease in deferred revenue. Trade accounts receivable fluctuate from period to period depending on the period to period change in revenue and the timing of collections. Accounts payable fluctuate from period to period depending on the timing of purchases and payments.
Cash flows used in investing activities
Net cash used in investing activities was
$14.1 millionfor the year ended December 31, 2020as compared to net cash used in investing activities of $15.2 millionfor the year ended December 31, 2019. The decrease in cash used in investing activities is due to decreased purchases of property and equipment of $2.3 million, offset by increased cash payments related to acquisitions in 2020 of $1.2 million.
Cash flow (used) provided by financing activities
For the year ended
December 31, 2020, net cash used in financing activities of $18.6 millionrelated to the payments of long-term debt of $17.0 millionand capital lease obligations of $1.6 million. For the year ended December 31, 2019, net cash provided by financing activities of $43.5 millionrelated to the net cash received in the Business 43
Contractual Obligations Our operating lease obligations are disclosed below and in Note 5 to our audited consolidated financial statements included in "Item 8 - Financial Statements and Supplementary Data." Rent expense for the years ended
December 31, 2020and 2019 was $14.1 millionand $14.7 million, respectively. The following table summarizes our contractual obligations as of December 31, 2020: Payments due by period 1 to less 3 to less More Less than than 3 than 5 than (in thousands) Total 1 year years years 5 years
Contractual obligations Debt: Principal (1)
$ 566,287 $ 17,000 $ 272,000 $ 277,287$ - Interest on debt (2) 154,530 47,694 76,517 30,318 - Purchase obligations 40,922 15,264 21,594 4,064 - Capital leases 4,966 1,313 2,932 721 - Operating leases 40,680 9,437
17,504 11,187 2,552 Total contractual obligations
(1) Includes in kind interest in the Debentures. (2) Assumed effective interest rates on our First Lien Facility and
The debentures were 8.325% and 11.78% respectively at the
Off-balance sheet financing arrangements
We have no obligations, assets or liabilities which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. We have not entered into any off-balance sheet financing arrangements, established any special purpose entities, guaranteed any debt or commitments of other entities or purchased any nonfinancial assets.
Recent accounting positions
See note 1 of our consolidated financial statements included in “Section 8 – Financial statements and supplementary data” for a summary of accounting standards not yet adopted.
Critical accounting conventions and estimates
We prepare our consolidated financial statements in accordance with
U.S.GAAP. In applying accounting principles, it is often required to use estimates. These estimates consider the facts, circumstances and information available, and may be based on subjective inputs, assumptions and information known and unknown to us. Material changes in certain of the estimates that we use could potentially affect, by a material amount, our consolidated financial position and results of operations. Although results may vary, we believe our estimates are reasonable and appropriate. See Note 1 to our consolidated financial statements included in "Item 8 - Financial Statements and Supplementary Data" for a summary of our significant accounting policies. The following describes certain of our significant accounting policies that involve more subjective and complex judgments where the effect on our consolidated financial position and operating performance could be material. 44
We recognize all of the assets acquired, liabilities assumed, contractual contingencies and contingent consideration at their fair value on the acquisition date. Acquisition-related costs are recognized separately from the acquisition and expensed as incurred. Restructuring costs incurred in periods subsequent to the acquisition date are expensed when incurred. Subsequent changes to the purchase price, such as working capital adjustments, or other fair value adjustments determined during the measurement period are recorded as an adjustment to goodwill, with the exception of contingent consideration, which is recognized in the statement of operations in the period it is modified. All subsequent changes to a valuation allowance or uncertain tax position that relate to the acquired company and existed at the acquisition date that occur both within the measurement period and as a result of facts and circumstances that existed at the acquisition date are recognized as an adjustment to goodwill. All other changes in valuation allowances are recognized as a reduction or increase to income tax expense or as a direct adjustment to additional paid-in capital as required.
Intangible assets and other long-term assets
We evaluate the recoverability of our long-lived assets, including finite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of any asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the difference between the fair value of the asset compared to its carrying amount.
Goodwillrepresents the excess of the total consideration paid over our identified intangible and tangible assets and our acquisitions. We test our goodwill for impairment at the reporting unit level on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. As of the testing date ( October 1), we have determined there is one reporting unit.
We annually test the goodwill resulting from acquisitions for impairment
Goodwillimpairment exists when the estimated fair value of the reporting unit is less than its carrying value. If impairment exists, the carrying value of the goodwill is reduced by the excess through an impairment charge recorded in our statements of operations. The process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at many points during the analysis. The fair value of each reporting unit is estimated using a combination of a discounted cash flow ("DCF") analysis and market-based valuation methodologies such as comparable public company trading values and values observed in recent business combinations. Determining fair value requires the exercise of significant judgments, including the amount and timing of expected future cash flows, long-term growth rates, discount rates and relevant comparable public company earnings multiples and relevant transaction multiples. The cash flows employed in the DCF analyses are based on our best estimate of future sales, earnings and cash flows after considering factors such as general market conditions, changes in working capital, long term business plans and recent operating performance. Accordingly, we have not identified any indicators of impairment, nor have any impairment charges been recorded related to goodwill as a result of the annual impairment test. 45
Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax burden and in evaluating our tax positions.
Tax law requires certain items to be included in our tax returns at different times than when the items are reflected in the financial statements. The annual tax expense reflected in the Consolidated Statements of Income is different than that reported in our tax returns. Some of these differences are permanent (for example, expenses recorded for accounting purposes that are not deductible in the returns such as certain entertainment expenses) and some differences are temporary and reverse over time, such as depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred, or expense for which a deduction has been taken already in the tax return, but the expense has not yet been recognized in the financial statements. Deferred tax assets generally represent items that can be used as a tax deduction or credit in tax returns in future years for which a benefit has already been recorded in the financial statements, as well as tax losses that can be carried over and used in future years. Valuation allowances are established when necessary to reduce deferred income tax assets to the amounts we believe are more likely than not to be recovered. In evaluating the amount of any such valuation allowance, we consider the existence of cumulative income or losses in recent years, the reversal of existing temporary differences, the existence of taxable income in prior carry back years, available tax planning strategies and estimates of future taxable income for each of our taxable jurisdictions. The latter two factors involve the exercise of significant judgment. As of
December 31, 2020, deferred tax asset valuation allowances totaled $65.2 million, primarily related to federal and state net operating losses available to carry forward to future years and, interest expense disallowance carryovers. Although realization is not assured, we believe it is more likely than not that all other deferred tax assets for which no valuation allowances have been established will be realized. This conclusion is based on our expectation that the reversal of existing taxable temporary differences will provide a source of taxable income to realize these deferred tax assets. We determine whether it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit is recorded in our financial statements. A tax position is measured as the portion of the tax benefit that is greater than 50% likely to be realized upon settlement with a taxing authority (that has full knowledge of all relevant information). We may be required to change our provision for income taxes when the ultimate treatment of certain items is challenged or agreed to by taxing authorities, when estimates used in determining valuation allowances on deferred tax assets significantly change, or when receipt of new information indicates the need for adjustment in valuation allowances. Future events, such as changes in tax laws, tax regulations, or interpretations of such laws or regulations, could have an impact on the provision for income tax and the effective tax rate. Any such changes could significantly affect the amounts reported in the consolidated financial statements in the year these changes occur. As of December 31, 2020, unrecognized tax benefits totaled $1.0 million, related to U.S.federal and state net operating losses available to carry forward to future years. However, due to the Company's determination that the U.S.federal and state net operating losses for the unrecognized tax benefit would likely be realized, a valuation allowance offset was recorded against the unrecognized tax benefit, resulting in no effective tax rate impact.
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