HIRERIGHT HOLDINGS CORPORATION You should read the following discussion of the financial condition and results of operations forHireRight together with our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements as disclosed in the Company's prospectus, datedOctober 28, 2021 , filed with theSecurities and Exchange Commission ("SEC") in accordance with Rule 424(b) of the Securities Act onNovember 1, 2021 (the "Prospectus") in connection with our initial public offering ("IPO"). See Initial Public Offering below for additional information.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q, and related statements by the Company
contain forward-looking statements within the meaning of the federal securities
laws that are subject to risks and uncertainties. All statements other than
statements of historical fact are forward-looking statements. Forward-looking
statements give our current expectations and projections relating to our
financial condition, results of operations, plans, objectives, future
performance and business. You can identify forward-looking statements by the
fact that they do not relate strictly to historical or current facts. These
statements may include words such as "anticipate," "estimate," "expect,"
"project," "plan," "intend," "believe," "could," "targets," "potential," "may,"
"will," "should," "can have," "likely," "continue," and other terms of similar
meaning in connection with any discussion of the timing or nature of future
operating or financial performance or other events. Forward-looking statements
may include, but are not limited to, statements concerning our anticipated
financial performance, including, without limitation, revenue, profitability,
net income (loss), adjusted EBITDA, earnings per unit, and cash flow; strategic
objectives; investments in our business, including development of our technology
and introduction of new offerings; sales growth and customer relationships; our
competitive differentiation; our market share and leadership position in the
industry; market conditions, trends, and opportunities; future operational
performance; pending or threatened claims or regulatory proceedings; and factors
that could affect these and other aspects of our business. These statements are
not guarantees of future performance; they reflect our current views with
respect to future events and are based on assumptions and estimates and subject
to known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements to be materially different from
expectations or results projected or implied by forward-looking statements.
These risks include the following, as well as other risks and uncertainties not
listed here that may be important to you.
•We have no assurance of future business from any of our customers;
•We rely upon third parties for the data we need to deliver our services;
•We rely upon third parties to fulfill our service obligations to our customers;
•We rely upon third parties for integration with many of our customers;
•Third parties are the sole available source for some of the data and services
upon which we rely;
•We intend to rely, in part, on acquisitions to help grow our business, and such
acquisitions may not produce the benefits we expect or may adversely affect or
disrupt our business;
•We must attract, motivate, train, and retain the management, technical,
market-facing, and operational personnel we need to enable the success and
growth of our business;
•COVID-19 has had, and may continue to have, a materially adverse effect on our
business;
•Forecasts of market growth may prove to be inaccurate, and even if the market
in which we compete achieves the forecasted growth, our business may not grow at
similar rates, if at all;
•Our operating results may fluctuate significantly, be difficult to predict, and
fall below analysts' and investors' expectations;
25
--------------------------------------------------------------------------------
•Significant governmental regulation exposes us to substantial costs and
liabilities and can limit our business opportunities;
•Current or potential legal proceedings could subject us to significant monetary
damages or restrictions on our ability to do business;
•Credit reporting laws that regulate our business impose significant operational
requirements and liability risks;
•Domestic and international data privacy laws impose significant operational
requirements and liability risks;
•We can incur significant liability for information that we omit in background
reports;
•We may be subject to and in violation of state private investigator licensing
laws and regulations;
•We are subject to government regulations concerning our employees, including
wage-hour laws and taxes;
•We may be subject to intellectual property rights claims by third parties;
•Our contractual indemnities, limitations of liability, and insurance may not
adequately protect us;
•Liabilities we incur in the course of our business may be uninsurable, or
insurance may be very expensive and limited in scope;
•Security breaches and improper use of information may negatively impact our
business and harm our reputation;
•System failures could delay and disrupt our services, cause harm to our
business and reputation and result in a loss of customers;
•If we fail to upgrade, enhance and expand our technology and services to meet
customer needs and preferences, the demand for our services may materially
diminish;
•Our technology development operations are centered in Estonia , exposing us to
risks that may be difficult to manage;
•If we are unable to protect our proprietary technology and other intellectual
property rights, it may reduce our ability to compete for business and we may
experience reduced revenue and incur costly litigation to protect our rights;
•Changes to the availability and permissible uses of consumer data may reduce
the demand for our services;
•We operate in an intensely competitive market and we may not be able to develop
and maintain competitive advantages necessary to support our growth and
profitability;
•Growth will require us to improve our operating capabilities;
•Our business is vulnerable to economic downturns;
•If we do not introduce successful new products, services and analytical
capabilities in a timely manner, or if the market does not adopt our new
services, our competitiveness and operating results will suffer;
•Our existing indebtedness could adversely affect our business and growth
prospects;
•The terms and conditions of our credit agreements restrict our current and
future operations, particularly our ability to respond to changes or to take
certain actions;
26
--------------------------------------------------------------------------------
•We may not be able to generate sufficient cash flow to service all of our
indebtedness, and may be forced to take other actions to satisfy our obligations
under such indebtedness, including refinancing such indebtedness, which may not
be successful;
•Inability to obtain financing could limit our ability to conduct necessary
operating activities and make strategic investments;
•Failure to successfully execute our international plans will adversely affect
our growth and operating results;
•Operating in multiple countries requires us to comply with different legal and
regulatory requirements;
•We are subject to governmental export and import controls that could subject us
to liability or impair our ability to compete in international markets;
•Fluctuations in the exchange rates of foreign currencies could result in
currency transaction losses;
•Investment funds managed by General Atlantic and investment funds managed by
Stone Point (together, the "Principal Stockholders") control us, and their
interests may conflict with ours or yours in the future;
•We are an "emerging growth company," and we expect to elect to comply with
reduced public company reporting requirements, which could make our common stock
less attractive to investors;
•The requirements of being a public company strain our resources and distract
our management, which could make it difficult to manage our business;
•Failure to maintain effective internal controls over financial reporting could
cause our investors to lose confidence in us and adversely affect the market
price of our common stock. If our internal control over financial reporting is
not effective, we may not be able to accurately report our financial results or
prevent fraud;
•We have identified material weaknesses in our internal control over financial
reporting and may identify additional material weaknesses in the future or
otherwise fail to maintain effective internal control over financial reporting,
which may result in material misstatements of our consolidated financial
statements or cause us to fail to meet our periodic reporting obligations.
•Provisions of our corporate governance documents could make an acquisition of
us more difficult and may prevent attempts by our stockholders to replace or
remove our current management;
•Our certificate of incorporation limits the forum for substantially all
disputes between us and our stockholders, which could limit our stockholders'
ability to obtain a favorable judicial forum for disputes with us or our
directors, officers or employees;
•We will be required to pay certain pre-IPO owners or their transferees for
certain tax benefits over a period of approximately 12 years pursuant to the
income tax receivable agreement (the "TRA"), which amounts to an estimated total
liability of approximately $209.9 million . Based on our current taxable income
estimates, we expect to repay the majority of this obligation by the end of our
2025 fiscal year;
•We will not be reimbursed for any payments made to certain pre-IPO owners (or
their transferees or assignees) under the TRA in the event that any tax benefits
are disallowed;
•In certain cases, payments under the TRA to certain pre-IPO owners or their
transferees may be accelerated or significantly exceed any actual benefits we
realize in respect of the tax attributes subject to the TRA;
•We may have exposure to greater than anticipated tax liabilities and may be
affected by changes in tax laws or interpretations;
27
--------------------------------------------------------------------------------
•The multinational nature of our business can expose us to unexpected tax
consequences, which may be adverse;
•We may be subject to examinations of our tax returns by the IRS or other tax
authorities, and an adverse outcome could have a material adverse effect on our
business;
•An active, liquid trading market for our common stock may not develop, which
may constrain the market price of our common stock and limit your ability to
sell your shares;
•Our operating results and stock price may be volatile, and the market price of
our common stock may drop below the price you pay;
•Future sales of substantial amounts of our common stock, or the possibility
that such sales could occur, could adversely affect the market price of our
common stock;
•You may not receive any return on investment unless you sell your common stock
for a price greater than that which you paid for it;
•Our stock price and trading volume could decline due to the action or inaction
of securities or industry analysts;
•Our equity-based compensation and acquisition practices expose our stockholders
to dilution;
•We could be negatively affected by actions of activist stockholders;
•We may issue shares of preferred stock in the future, which could make it
difficult for another company to acquire us or could otherwise adversely affect
holders of our common stock.
All written and oral forward-looking statements attributable to us, or persons
acting on our behalf, are qualified in their entirety by these cautionary
statements as well as other cautionary statements that are made from time to
time in our other filings with the Securities and Exchange Commission (SEC) and
public communications. We discuss many of these risks and additional factors
that could cause actual results to differ materially from those anticipated by
our forward-looking statements under the headings "Risk Factors" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in the Prospectus, this Quarterly Report on Form
10-Q, and in other filings we have made and will make from time to time with the
Securities and Exchange Commission . These forward-looking statements represent
our estimates and assumptions only as of the date made. Unless required by
federal securities laws, we assume no obligation to update any of these
forward-looking statements, or to update the reasons actual results could differ
materially from those anticipated, to reflect circumstances or events that occur
after the statements are made. Without limiting the foregoing, any guidance we
may provide will generally be given only in connection with quarterly and annual
earnings announcements, without interim updates, and we may appear at industry
conferences or make other public statements without disclosing material
nonpublic information in our possession. Given these uncertainties, investors
should not place undue reliance on these forward-looking statements.
Investors should read this Quarterly Report on Form 10-Q and the documents that
we reference in this report and have filed or will file with the SEC completely
and with the understanding that our actual future results may be materially
different from what we expect. We qualify all of our forward-looking statements
by these cautionary statements.
Business Overview
HireRight is a leading global provider of technology-driven workforce risk management and compliance solutions. We provide comprehensive background screening, verification, identification, monitoring, and drug and health screening services for more than 40,000 customers across the globe. We offer our services via a unified global software and data platform that tightly integrates into our customers' human capital management ("HCM") systems enabling highly effective and efficient workflows for workforce hiring, onboarding, and monitoring. In 2020, we 28 --------------------------------------------------------------------------------
delivered reports on over 20 million job applicants, employees and contractors for our customers and processed over 80 million screens.
HireRight GIS Group Holdings LLC ("HGGH"), was formed inJuly 2018 through the combination of two groups of companies, theHireRight Group and theGIS Group ("GIS"), each of which includes a number of wholly owned subsidiaries that conduct the Company's business withinthe United States of America ( the "U.S."), as well as countries outside theU.S. SinceJuly 2018 , the combined group of companies and their subsidiaries have operated as a unified operating company providing background screens globally, predominantly under the HireRight brand. OnOctober 15, 2021 , HGGH converted into aDelaware corporation and changed its name toHireRight Holdings Corporation ("HireRight" or the "Company"). In conjunction with the conversion, all of HGGH's outstanding equity interests were converted into shares of common stock ofHireRight Holdings Corporation . The foregoing conversion and related transactions are referred to herein as the "Corporate Conversion". The Corporate Conversion did not affect the assets and liabilities of HGGH, which became the assets and liabilities ofHireRight Holdings Corporation .
Initial Public Offering
OnNovember 2, 2021 , the Company completed its IPO in which the Company issued and sold 22,222,222 shares of its common stock,$0.001 par value per share at an offering price of$19.00 per share. The Company received net proceeds of$393.5 million , after deducting underwriting discounts and commissions of$23.2 million and other offering costs payable by the Company of approximately$5.5 million . The Company granted the underwriters an option for a period of 30 days to purchase up to an additional 3,333,333 shares of common stock at$19.00 per share less discounts and commissions. The underwriters have untilNovember 27, 2021 to exercise their option to purchase additional shares. Use of Proceeds OnNovember 3, 2021 , the Company used approximately$215.0 million of the net proceeds from the IPO to repay, in full, indebtedness under the Second Lien Term Loan Facility. In addition, the Company recorded a$3.4 million write off of unamortized deferred financing fees and unamortized original issue discounts related to the repayment of debt under the Second Lien Term Loan Facility. The Company plans to use approximately$100.0 million of proceeds of the IPO to repay, in part, the First Lien Term Loan Facility and no longer expects to incur swap breakage fees of approximately$4.2 million .
Factors Affecting Our Results of Operations
Economic Conditions and COVID-19
The global COVID-19 pandemic has caused significant disruption to the global economy and, in particular, the labor market. There is considerable uncertainty regarding the extent of the impact and the duration of the global COVID-19 pandemic. The future impact of COVID-19 on our operational and financial performance will depend on the effect on our customers and vendors, all of which continue to be uncertain at this time. Our financial results and prospects are largely dependent on the number of hires and the total level of employment. Unemployment in our primary market, the US, reached nearly 15% during the peak of the 2020 pandemic and monthly hiring slowed to less than 4 million inApril 2020 according to theBureau of Labor Statistics . Our results of operations for the three and nine months endedSeptember 30, 2021 show a significant increase from the prior year period, due to improvement in the global employment market. The peak of the pandemic impact occurred during April and May of 2020, and we began to see a steady recovery in the second half of the year. The weakness experienced in the first half of 2020 and the associated recovery largely impacted all industries we serve. We are a highly diversified business with no industry representing more than 15% of our total revenue. Transportation, healthcare and technology customers represent the largest contributors to revenue. Transportation 29 -------------------------------------------------------------------------------- and healthcare annual revenues declined in conjunction with overall revenue declines while technology showed limited growth largely driven by the addition of two larger customers during the year. In response to the pandemic, in early 2020, we implemented additional operational processes to monitor customer sales and collections, taking precautionary measures to ensure sufficient liquidity and adjusting operations to ensure business continuity, including borrowing$50 million against our$100 million revolving credit facility, of which$40 million was repaid byDecember 31, 2020 . SinceApril 2020 , substantially all of our employees have been working from home. To the extent we are operating from our facilities, we have implemented protocols reflecting the recommendations published by theU.S. Centers for Disease Control , theWorld Health Organization and country, state and local governments. Key Components of Our Results from Operations Revenues The Company generates revenues from background screening and compliance services delivered in online reports. Our customers place orders for our services and reports either individually or through batch ordering. Each report is accounted for as a single order which is then typically consolidated and billed to our customers on a monthly basis. Approximately 29% and 30% of revenues for the nine months endedSeptember 30, 2021 and 2020, respectively, were generated from the Company's top 50 customers, which consist of largeU.S. and multinational companies across diversified industries such as transportation, healthcare, technology, business and consumer services, financial services, manufacturing, education, retail and not-for-profit. None of the Company's customers individually accounted for greater than 5% and 6% of revenues during the nine months endedSeptember 30, 2021 and 2020, respectively. Revenues consist of service revenues and surcharge revenues. Service revenues represent fees charged to customers for performing screening and compliance services. Surcharge revenues consist of fees charged to customers for obtaining data required to fulfill the Company's performance obligations from federal, state and local jurisdictions as well as fees charged by certain commercial data wholesalers. These fees are predominantly charged to the Company's customers at cost. Revenue is recognized when the Company satisfies its obligation to complete the service and delivers the screening report to the customer. The Company relies on service revenue to generate cash from operations. Furthermore, only service revenue impacts the operating income or loss as surcharge revenue is predominantly offset by corresponding expenses recognized in cost of services (excluding depreciation and amortization) on the condensed consolidated statement of operations. 30
--------------------------------------------------------------------------------
Results of Operations
Comparison of Results of Operations for the three and nine months ended
The following table presents operating results for the three and nine months
ended
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
(in thousands)
Revenues $ 204,981 $ 130,674 $ 531,522 $ 390,121
Expenses
Cost of services (exclusive of
depreciation and amortization below) 111,328 69,683 295,832 215,143
Selling, general and administrative 47,652 48,347 130,261 128,583
Depreciation and amortization 19,531 19,808 56,013 58,283
Total expenses 178,511 137,838 482,106 402,009
Operating income (loss) 26,470 (7,164) 49,416 (11,888)
Other expenses
Interest expense 18,518 18,597 54,674 56,930
Other expense (income), net 22 (185) 125 628
Total other expense 18,540 18,412 54,799 57,558
Income (loss) before income taxes 7,930 (25,576) (5,383) (69,446)
Income tax expense 649 1,466 2,954 3,490
Net income (loss) $ 7,281 $ (27,042) $ (8,337) $ (72,936)
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
(in thousands)
Revenues
Service revenues $ 152,332 $ 98,587 $ 395,624 $ 294,175
Surcharge revenues 52,649 32,087 135,898 95,946
Total revenues $ 204,981 $ 130,674 $ 531,522 $ 390,121
Revenues
Three months ended
Total revenues increased by $74.3 million , or 56.9%, to $205.0 million , for the
three months ended September 30, 2021 compared to the three months ended
September 30, 2020 . We continued to see a recovery from the impact of COVID-19,
with strengthening client volumes surpassing the COVID-impacted prior year
period. The increase in total revenues was broad-based primarily across existing
customers, while new business revenue, as defined below, increased from $9.4
million to $10.9 million , driven by sales to a recently acquired large customer.
Service revenues
31
--------------------------------------------------------------------------------
increased $53.7 million , or 54.5%, and surcharge revenues increased
$20.6 million , or 64.1%, compared to the three months ended September 30, 2020 .
Revenues from international and domestic regions increased by $8.2 million , or
106.1% and by $66.1 million , or 53.8%, respectively, during the three months
ended September 30, 2021 compared to the three months ended September 30, 2020 .
Both service and surcharge revenue increases were primarily volume driven. Also
contributing to the increases in surcharge revenues were increases in data
supplier costs, which are charged to our customers in the form of increased
surcharges.
Nine months ended
Total revenues increased by$141.4 million , or 36.2%, to$531.5 million , for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 , primarily due to increases in volume, which surpassed the COVID-impacted prior year period. Revenues from international and domestic regions increased$13.8 million , or 52.4% and by$127.6 million , or 35.1%, respectively, during the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . Service revenues increased$101.4 million , or 34.5%, and surcharge revenues increased$40.0 million , or 41.6% compared to the prior year period. While growth was primarily volume driven, a portion of the increase in surcharge revenues was due to data supplier cost increases, which are charged to our customers in the form of increased surcharges.
Cost of Services (exclusive of depreciation and amortization below)
Three months ended
Cost of services increased$41.6 million , or 59.8%, to$111.3 million , for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 primarily due to higher client order volumes over the COVID- impacted prior year period. Cost of services as a percent of revenue increased to 54.3% for the three months endedSeptember 30, 2021 compared to 53.3% for the three months endedSeptember 30, 2020 primarily driven by increased third-party data costs. Nine months ended Cost of services increased$80.7 million , or 37.5%, to$295.8 million , for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 primarily due to higher volumes and, to a lesser extent, increased data costs. Cost of services as a percent of revenue increased slightly to 55.7% for the nine months endedSeptember 30, 2021 compared to 55.1% for the nine months endedSeptember 30, 2020 primarily driven by increased third-party data costs. Selling, General and Administrative Three months ended Selling, general and administrative expenses ("SG&A") decreased$0.7 million , or 1.4% to$47.7 million , for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . The decrease was driven by reductions in legal settlement fees of$12.1 million and$1.9 million of other merger integration expenses during the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . These decreases were mostly offset by increases in personnel costs associated with incentive compensation and fringe benefit programs of$5.5 million and investments associated with incremental technology and product resources, which amounted to$3.5 million . In addition, various other and indirect expenses increased$4.3 million during the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 , which included$1.5 million of higher technology costs and$0.9 million associated with marketing programs to support increased business volumes. 32 --------------------------------------------------------------------------------
Nine months ended
SG&A increased$1.7 million , or 1.3%, to$130.3 million , for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 primarily due to increases in personnel costs and other indirect costs, amounting to$19.2 million and$5.8 million , respectively, for the reasons noted above. These increases were partially offset by a reduction in legal settlement fees and merger integration and employee severance expenses of$12.1 million and$8.9 million , respectively. Various other costs accounted for$2.3 million of the offsetting decreases in SG&A for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . Depreciation and Amortization
Three months ended
Depreciation and amortization expense decreased$0.3 million , or 1.4% to$19.5 million , for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . The decrease was primarily due to certain computer equipment assets reaching the end of their useful lives in the prior year. Nine months ended Depreciation and amortization expense decreased$2.3 million , or 3.9%, to$56.0 million , for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The decrease was primarily due to certain computer equipment assets reaching the end of their useful lives in the prior year. Interest Expense Three months ended Interest expense, net decreased$0.1 million , or 0.4% to$18.5 million , for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . The decrease was primarily due to lower outstanding balance due to scheduled principal repayments on the First Lien Term Loan Facility, as defined below, and lower outstanding balance on the Revolving Credit Facility, as defined below. As ofSeptember 30, 2021 , the balance on the Revolving Credit Facility was$10.0 million compared to$30.0 million as ofSeptember 30, 2020 . Nine months ended Interest expense, net decreased$2.3 million , or 4.0%, to$54.7 million , for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The decrease was primarily due to lower outstanding balance due to scheduled principal repayments on the First Lien Term Loan Facility, and lower outstanding balance on the Revolving Credit Facility. Income Tax Expense
Three months ended
Income tax expense decreased$0.8 million , or 55.7%, for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 primarily due to revaluation of deferred taxes in theUnited Kingdom during the third quarter of 2020. Income tax expense for the three months endedSeptember 30, 2021 and 2020 was$0.6 million and$1.5 million , respectively. The effective tax rate for the three months endedSeptember 30, 2021 differs from the Federal statutory rate of 21% primarily due to valuation allowances and state taxes. The 33 --------------------------------------------------------------------------------
rate for the three months ended
Nine months ended Income tax expense decreased$0.5 million , or 15.4%, for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 primarily due to revaluation of deferred taxes in theUnited Kingdom and valuation allowances. Income tax expense for the nine months endedSeptember 30, 2021 and 2020 was$3.0 million and$3.5 million , respectively. The effective tax rate for the nine months endedSeptember 30, 2021 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in theUnited Kingdom , valuation allowances, and state taxes. The rate for the nine months endedSeptember 30, 2020 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in theUnited Kingdom , valuation allowances, and state taxes. Non-GAAP Financial Measures and Key Metrics We believe that the presentation of our Non-GAAP financial measures and key metrics provides information useful to investors in assessing our financial condition and results of operations. These measures should not be considered an alternative to net income or any other measure of financial performance or liquidity presented in accordance with GAAP. These measures have important limitations as analytical tools because they exclude some but not all items that affect the most directly comparable GAAP measures. Additionally, because they may be defined differently by other companies in our industry, our definitions may not be comparable to similarly titled measures of other companies, thereby diminishing their utility. Adjusted EBITDA Adjusted EBITDA represents, as applicable for the period, net income (loss) before provision for income taxes, interest expense and depreciation and amortization expense, equity-based compensation, realized and unrealized gain (loss) on foreign exchange, merger integration expenses, legal settlement costs outside the normal course of business, and other items management believes are not representative of the Company's core operations. Adjusted EBITDA is a supplemental financial measure that management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess: •our operating performance as compared to other publicly traded companies without regard to capital structure or historical cost basis; •our ability to generate cash flow; •our ability to incur and service debt and fund capital expenditures; and •the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.
Adjusted EBITDA Service Margin
Adjusted EBITDA Service Margin is calculated as Adjusted EBITDA as a percentage
of service revenue. Because we are able to charge our customers for direct
access to certain data suppliers and we generally do not mark up those charges,
we focus on the management of Adjusted EBITDA as a percentage of service
revenue, as we believe this non-GAAP measure more accurately reflects the
management of our controllable costs and profitability.
34
--------------------------------------------------------------------------------
The following table reconciles our non-GAAP financial measure of Adjusted EBITDA
and Adjusted EBITDA Service Margin to our most directly comparable financial
measures calculated and presented in accordance with GAAP.
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(in thousands, except percent)
Net income (loss) $ 7,281 $ (27,042) $ (8,337) $ (72,936)
Income tax expense 649 1,466 2,954 3,490
Interest expense 18,518 18,597 54,674 56,930
Depreciation and amortization 19,531 19,808 56,013 58,283
EBITDA 45,979 12,829 105,304 45,767
Equity-based compensation 841 880 2,493 2,570
Realized and unrealized gain (loss) on
foreign exchange 24 (185) 125 628
Merger integration expenses (1) 193 2,138 1,174 9,255
Technology investments (2) 1,690 - 1,690 -
Other items (3) 2,895 12,380 6,659 14,676
Adjusted EBITDA $ 51,622 $ 28,042 $ 117,445 $ 72,896
Service Revenue $ 152,332 $ 98,587 $ 395,624 $ 294,175
Net income (loss) service margin (4) 4.8 % 27.4 % 2.1 % 24.8 %
Adjusted EBITDA service margin (5) 33.9 % 28.4 % 29.7 % 24.8 %
(1)Merger integration expenses consist primarily of information technology
("IT") related costs including personnel expenses, professional and service fees
associated with the integration of customers and operations of GIS, which
commenced in July 2018 and was substantially completed by the end of 2020.
(2)Technology investments represent discovery phase costs associated with the
build out and implementation of various technologies that will be used to
achieve greater operational efficiencies.
(3)Other items include (i) exit costs associated with one of our facilities
during the three months ended September 30, 2021 , (ii) costs related to the
preparation of the Company's initial public offering during 2021, (iii) $12.1
million of legal settlement costs in the three and nine months ended September
30, 2020 associated with a single litigation matter related to a predecessor
entity of the Company for a claim dating back to 2009 (for additional
information see Note 13 to the accompanying condensed consolidated financial
statements for additional information), and (iv) $0.3 million and $2.5 million
of severance costs incurred in connection with reducing our employee headcount
in an effort to right-size our business in response to COVID-19 during the three
and nine months ended September 30, 2020 , respectively.
(4)Net income (loss) service margin is calculated as net income (loss) as a
percentage of service revenue.
(5)Adjusted EBITDA service margin is calculated as Adjusted EBITDA as a
percentage of service revenue.
Adjusted Net Income (Loss)
In addition to Adjusted EBITDA, management believes that Adjusted Net Income
(Loss) is a strong indicator of our overall operating performance and is useful
to our management and investors as a measure of comparative operating
performance from period to period. We define Adjusted Net Income (Loss) as net
income (loss) adjusted for equity-based compensation, realized and unrealized
gain (loss) on foreign exchange, merger integration expenses, legal settlement
costs outside the normal course of business, and other items, to which we apply
an adjusted effective tax rate. See the footnotes to the table below for a
description of certain of these adjustments.
35
--------------------------------------------------------------------------------The following table sets forth a reconciliation of net income (loss) to Adjusted Net Income (Loss) for the periods presented:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(in thousands)
Net income (loss) $ 7,281 $ (27,042) $ (8,337) $ (72,936)
Income tax expense 649 1,466 2,954 3,490
Income (loss) before income taxes 7,930 (25,576) (5,383) (69,446)
Equity-based compensation 841 880 2,493 2,570
Realized and unrealized gain (loss) on
foreign exchange 24 (185) 125 628
Merger integration expenses(1) 193 2,138 1,174 9,255
Technology investments (2) 1,690 - 1,690 -
Other items (3) 2,895 12,380 6,659 14,676
Adjusted income (loss) before income
taxes 13,573 (10,363) 6,758 (42,317)
Adjusted income taxes (4) 360 732 1,619 2,063
Adjusted Net Income (Loss) $ 13,213 $ (11,095) (1)Merger integration expenses consist primarily of IT related costs including personnel expenses, professional and service fees associated with the integration of GIS, as discussed in footnote 1 to the immediately preceding table, which commenced inJuly 2018 and was substantially completed by the end of 2020. (2)Technology investments represent discovery phase costs associated with the build out and implementation of various technologies that will be used to achieve greater operational efficiencies. (3)Other items include (i) exit costs associated with one of our facilities during the three months endedSeptember 30, 2021 , (ii) costs related to the preparation of the Company's initial public offering during 2021, (iii)$12.1 million of legal settlement costs in the three and nine months endedSeptember 30, 2020 associated with a single litigation matter related to a predecessor entity of the Company for a claim dating back to 2009 (for additional information see Note 13 to the accompanying condensed consolidated financial statements for additional information), and (iv)$0.3 million and$2.5 million of severance costs incurred in connection with reducing our employee headcount in an effort to right-size our business in response to COVID-19 during the three and nine months endedSeptember 30, 2020 , respectively. (4)An adjusted effective income tax rate has been determined for each period presented by applying the statutory income tax rate and the provision for deferred income taxes to the pre-tax adjustments, which was used to compute Adjusted Net Income (Loss) for the periods presented. Key Metrics
The key metrics used to help us evaluate our business, identify trends and formulate business plans and strategy are set forth in the table below and described in the following text:
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
(in thousands, except percent)
New business revenue $ 10,873 $ 9,354 $ 24,117 $ 23,075 We measure net revenue retention on a year-to-date basis. Net revenue retention
for the nine months ended
36
--------------------------------------------------------------------------------Net Revenue Retention
We generally have long standing relationships with our customers as evidenced by the nine-year average tenure of our enterprise customers. The revenue from these customers is highly reoccurring in nature. In addition, our ability to cross sell and expand our services with our existing customers is an important component of our growth strategy. We measure the success of our customer retention and expansion through net revenue retention particularly among our top 1,250 customerswho represent approximately 70% of our total revenue. Net revenue retention is a measure of our ability to retain and grow business from our customer base. It is calculated as the total revenue derived in the current fiscal period by our top 1,250 customers, divided by the total revenue derived in the prior fiscal period from the same 1,250 customers based on the prior fiscal period revenue composition. The 1,250 customers used for this metric may vary from period to period, as defined by the revenue composition of the period immediately preceding the presented fiscal year. Net revenue retention increased in the 2021 periods as general client ordering patterns showed a significant volume and product mix improvement over the COVID impacted prior year quarter and year to date periods. New Business Revenue In addition to expanding revenue with our existing customer base, adding new customers to our portfolio is an important driver of growth. New business revenue is a measure of our ability to establish new sources of business from customers outside of our existing base of business. New business represents revenue recognized under a new customer contract during the first year of the contract term. We have a sales and sales support staff in nine countries focused on expanding our reach and penetration into new markets and regions. Although new contracts are typically three years in duration, new business revenue is determined over the first year of the contract. Continuing to grow this important metric is critical to the success of our business. New business revenue increased in the three and nine months endedSeptember 30, 2021 compared to the prior year period due to volume and product mix improvement over the COVID impacted prior year quarter and year to date periods. Liquidity and Capital Resources
General
Our primary sources of liquidity and capital resources are cash generated from our operating activities, cash on hand, and borrowings under our long-term debt arrangements. Income taxes are currently not a significant use of funds but after the benefits of our net operating loss carryforwards are fully recognized, could become a material use of funds, depending on our future profitability and future tax rate. Additionally, we will be required to pay certain pre-IPO owners or their transferees for certain tax benefits over a period of approximately 12 years pursuant to the TRA, which amounts to an estimated total liability of approximately$209.9 million . Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year. Unrestricted cash and cash equivalents as ofSeptember 30, 2021 totaled$19.7 million . As ofSeptember 30, 2021 , cash held in foreign jurisdictions was approximately$4.7 million and is primarily related to international operations. Restricted cash of$5.0 million as ofSeptember 30, 2021 consists of$1.1 million held in escrow for the benefit of former investors in a subsidiary of the Company pursuant to the terms of its divestiture of a former affiliate inApril 2018 , and the remainder is related to prior restructurings from predecessor entities. The Company proactively drew down$50.0 million under its Revolving Credit Facility, during the quarter endedMarch 31, 2020 in preparation for the impact of the COVID-19 pandemic. The Company repaid$20.0 million on the Revolving Credit Facility during each of the second and third quarters of the year endedDecember 31, 2020 . The Company had$10.0 million outstanding under the Revolving Credit Facility and$88.2 million of availability remained as ofSeptember 30, 2021 . OnNovember 5, 2021 , the Company repaid the$10.0 million outstanding principal amount on the Revolving Credit Facility. 37 -------------------------------------------------------------------------------- As ofSeptember 30, 2021 the Company had purchase obligations of approximately$27.2 million with various parties, of which approximately$21.7 million is expected to be paid within one year. These purchase commitments are associated with agreements that are enforceable and legally binding. They are primarily commitments to purchase data and other screening services in the ordinary course of business with varying expiration terms through 2023. In addition to our regular investment in capital expenditures, we plan to invest$40-$45 million in a capital expenditure program through the end of fiscal year 2023 to continue to enhance our operating systems and technologies to improve operational efficiency. We expect that cash flow from operations and current cash balances, together with available borrowings under the Revolving Credit Facility, will be sufficient to meet operating requirements as well as the obligations under the TRA, as discussed below, through the next twelve months. Although we believe we have adequate sources of liquidity over the long term, cash available from operations could be affected by any general economic downturn or any decline or adverse changes in our business such as a loss of customers, market and or competitive pressures, or other significant changes in business environment. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Debt Effective with the combination of theHireRight and GIS groups of companies onJuly 12, 2018 , the Company has three long-term debt arrangements as described below. Collateral includes all outstanding equity interests in whatever form of the borrower and each restricted subsidiary that is directly owned by or on behalf of any credit party. The credit agreement has a restrictive covenant for leverage ratios. The Company was in compliance with the covenants under the credit agreement for the three and nine months endedSeptember 30, 2021 . Accordingly, the amount payable under the credit agreement is classified as long-term debt in the accompanying condensed consolidated balance sheet. AtSeptember 30, 2021 , we had the following long-term debt arrangements: •a first lien senior secured term loan facility, in an aggregate principal amount of$835.0 million , bearing interest payable monthly at a London Interbank Offered Rate ("LIBOR") variable rate (0.08% atSeptember 30, 2021 ) + 3.75%, dueJuly 12, 2025 (the "First Lien Term Loan Facility"). •a first lien senior secured revolving credit facility, in an aggregate principal amount of up to$100.0 million , including a$40.0 million letter of credit sub-facility, bearing interest monthly at 3.5% and maturing onJuly 12, 2023 (the "Revolving Credit Facility"). •a second lien senior secured term loan facility, in an aggregate principal amount of$215.0 million , bearing interest payable monthly at a LIBOR variable rate (0.08% atSeptember 30, 2021 ) + 7.25%, dueJuly 12, 2026 (the "Second Lien Term Loan Facility"). The Company used$215.0 million of the proceeds from the IPO to repay, in full, the Second Lien Term Loan Facility. The Company plans to use approximately$100.0 million of proceeds of the IPO to repay, in part, the First Lien Term Loan Facility and no longer expects to incur swap breakage fees of approximately$4.2 million . 38 --------------------------------------------------------------------------------
Cash Flow
The following table sets forth a summary of our condensed consolidated cash
flows for the nine months ended
Nine Months Ended September 30,
2021 2020
(in thousands)
Net cash provided by operating activities $ 19,043 $ 7,721
Net cash used in investing activities (9,983) (9,276)
Net cash (used in) provided by financing activities (7,503) 2,335
Net increase in cash, cash equivalents and restricted cash
Operating Activities Cash provided by operating activities reflects net income (loss) adjusted for certain non-cash items and changes in operating assets and liabilities. Total cash provided by operating activities was$19.0 million for the nine months endedSeptember 30, 2021 compared to cash provided of$7.7 million for the nine months endedSeptember 30, 2020 . The increase in cash flows provided by operating activities was due primarily to a lower net loss partly offset by a higher use of cash from working capital compared to the prior period. Investing Activities Cash used in investing activities was approximately$10.0 million during the nine months endedSeptember 30, 2021 , compared to approximately$9.3 million during the nine months endedSeptember 30, 2020 . The increase in cash used in investing activities was due primarily to slight increases in purchases of property and equipment and capitalized software development costs compared to the prior period. Financing Activities Cash used in financing activities was approximately$7.5 million for the nine months endedSeptember 30, 2021 compared to cash provided by financing activities of approximately$2.3 million during the nine months endedSeptember 30, 2020 . The change in cash used in financing activities is due primarily to the Company's draw down of$50.0 million on the Revolving Credit Facility in the same period last year. We had net repayments on our debt facilities of$6.3 million in the nine months endedSeptember 30, 2021 compared to net borrowings of$3.7 million in the nine months endedSeptember 30, 2020 . Financing and Financing Capacity Total principal outstanding on our debt was$1.0 billion as ofSeptember 30, 2021 and$1.0 billion as ofDecember 31, 2020 . Income Tax Receivable Agreement In connection with the Company's IPO during the fourth quarter of 2021, we entered into the TRA with our pre-IPO equityholders or their permitted transferees that will provide for the payment by us over a period of approximately 12 years to our pre-IPO equityholders or their permitted transferees of 85% of the benefits, if any, that we and our subsidiaries realize, or are deemed to realize (calculated using certain assumptions) inU.S. federal, 39 -------------------------------------------------------------------------------- state, and local income tax savings as a result of the utilization (or deemed utilization) of certain existing tax attributes. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year. Actual tax benefits realized by us may differ from tax benefits calculated under the TRA as a result of the use of certain assumptions in the TRA, including assumptions relating to state and local income taxes, to calculate tax benefits. The Company will record an estimated total liability of approximately$209.9 million and a reduction to Additional paid-in capital of approximately$209.9 million in connection with the TRA during the fourth quarter of 2021 on its condensed consolidated balance sheets. Off-Balance Sheet Arrangements As ofSeptember 30, 2021 , we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K, other than operating leases, primarily for our leased facilities. Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of exposure due to potential changes in inflation. We do not hold financial instruments for trading purposes. Interest Rate Risk We are exposed to changes in interest rates as a result of our financing activities used to fund business operations. Primary exposures include movements in LIBOR. The nature and amount of our long-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. To minimize this risk, we have entered into interest rate swap agreements to hedge our risk to changes in LIBOR. As ofSeptember 30, 2021 , the outstanding balances on our credit agreements were subject to variable interest rates. We repaid$215.0 million of the amount outstanding under our Second Lien Term Loan Facility using a portion of the proceeds from the IPO.The Financial Conduct Authority in theUnited Kingdom intends to phase out LIBOR by the end of 2021. We have negotiated terms in consideration of this discontinuation and do not expect that the discontinuation of the LIBOR rate, including any legal or regulatory changes made in response to its future phase out, will have a material impact on our liquidity or results of operations. Foreign Currency Exchange Risk The significant majority of our revenue is denominated inU.S. dollars, however, we do earn revenue, pay expenses, own assets and incur liabilities in countries using currencies other than theU.S. dollar, including among others, the British pound, the Australian dollar, the Canadian dollar, the Euro, the Polish Zloty, theSingapore dollar, the Mexican peso, the Japanese yen and the Indian rupee. Because our condensed consolidated financial statements are presented inU.S. dollars, we must translate revenue, income and expenses, as well as assets and liabilities, intoU.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of theU.S. dollar against major currencies will affect our operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. We generally do not mitigate the risks associated with fluctuating exchange rates, however, because we generally incur expenses and revenue in these currencies the cumulative impact of these foreign exchange fluctuations are not deemed material to our financial performance. 40
--------------------------------------------------------------------------------
© Edgar Online, source
