KLDISCOVERY INC. We believe that this Quarterly Report on Form 10-Q contains statements that are forward-looking and as such are not historical facts. This includes, without limitation, statements regarding the financial position, business strategy and the plans and objectives of management for future operations. These statements constitute projections, forecasts and forward-looking statements, and are not guarantees of performance. Such statements can be identified by the fact that they do not relate strictly to historical or current facts. When used in this Report, words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "might," "plan," "possible," "potential," "predict," "project," "should," "strive," "would" and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. When we discuss our strategies or plans, we are making projections, forecasts or forward-looking statements. Such statements are based on the beliefs of, as well as assumptions made by and information currently available to, our management. The forward-looking statements contained in this Report are based on current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors described in the section titled "Risk Factors" in Item 1A of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 (our "Annual Report"). These risks and uncertainties may be amplified by the ongoing COVID-19 pandemic and its potential impact on our business and the global economy. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. Throughout this section, unless otherwise noted "we," "us," "our," "Company," "KLDiscovery ," "KLD," "KLDiscovery Inc. " or "LD Topco, Inc. " refer toKLDiscovery Inc. and its consolidated subsidiaries. As a result of the Business Combination, (i)KLDiscovery Inc.'s consolidated financial results for periods prior toDecember 19, 2019 reflect the financial results ofLD Topco, Inc. and its consolidated subsidiaries, as the accounting predecessor toKLDiscovery Inc. , and (ii) for periods from and after this date,KLDiscovery Inc.'s financial results reflect those ofKLDiscovery Inc. and its consolidated subsidiaries (includingLD Topco, Inc. and its subsidiaries) as the successor following the Business Combination. The following overview provides a summary of the sections included in this Management's Discussion and Analysis of Financial Condition and Results of Operations: • Executive Summary - a general description of our business and key highlights for the three and nine months endedSeptember 30, 2020 .
• Results of Operations - an analysis of our results of operations in our
condensed consolidated financial statements.
• Liquidity and Capital Resources - an analysis of our cash flows, sources
and uses of cash, commitments and contingencies and quantitative and
qualitative disclosures about market risk.
• Critical Accounting Policies and Estimates - a discussion of critical
accounting policies requiring judgments and estimates.
Executive Summary
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 34 locations in 19 countries, 8 data centers and 19 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 RESULTS OF OPERATIONS
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
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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 our own end-to-end
proprietary tools as well as third party platforms. 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. However, recently the market has shifted to cloud-based solutions and this shift could result in increased revenue for us as we offer our own proprietary cloud-based solutions.
We classify our legal technology revenue as follows:
• Collections and Processing Services: We have remote and onsite 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 analytics
include predictive coding which allows us to automatically classify
millions of documents in a matter of hours. We offer email threading that
looks at relationships between email messages to identify the most content
inclusive messages to avoid redundant review and we have language
identification that can automatically identify the primary 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 by
gigabyte, page or by file.
• Forensics and Consulting Services: We provide the expertise and tools
needed to extract and analyze digital evidence to support a client's legal
matter. Our forensics 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 multiple information
sources to give our clients the insight and knowledge they need. Our
forensics and consulting services are billed by either hour or unit.
• Professional Services: We manage complex eDiscovery matters and partner
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 to provide clients
with a secure, seamless and cost-effective managed review solution. We
assemble review teams of experienced legal professionals for any type of
case. Each team member is a qualified attorney who has passed a selective
screening process and has received training from a
manager to ensure the most efficient and defensible review of a client's
documents. Document review managers have extensive project management
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 agnostic, possess expert working 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 technology options and platforms to host our
clients' data for the life of the matter. We offer secure data centers
around the globe to support data across jurisdictions and privacy laws.
Hosting is billed by gigabyte.
• Subscription: We offer subscription pricing options to provide cost
predictability over time. Subscriptions cover a range of our services and
are typically a fixed fee billed monthly for contract terms averaging 1 to
3 years.
We classify our data recovery revenue as follows:
• Data Recovery Services: We recover lost data from devices that store
digital information, including data centers, cloud, business servers,
workstations, laptops and mobile devices. Pricing is per device.
• PowerControls and
data from database files and physically sound devices. Pricing is typically
an annual or multi-year agreement at a fixed price.
For the three months endedSeptember 30, 2020 and 2019, our legal technology revenue was$62.0 million and$66.9 million , respectively, and our data recovery revenue was$10.3 million and$11.2 million , respectively. For the nine months endedSeptember 30, 2020 and 2019, our legal technology revenue was$183.9 million and$197.0 million , respectively, and our data recovery revenue was$31.1 million and$34.5 million , respectively. Additionally, we have longstanding relationships with our clients and for the three and nine months endedSeptember 30, 2020 and 2019, no single client accounted for more than 5% of our revenues. 20
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Non-
We prepare audited financial statements in accordance withU.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, provides information about our cost structure and helps us to track our operating progress. We encourage investors and potential investors to carefully review theU.S. GAAP financial information and compare them with our EBITDA and adjusted EBITDA. Adjusted EBITDA 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 comparableU.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 non-ordinary course earn-out valuation changes, rating agency fees,
letter of credit and revolving facility fees, as well as professional
service fees and direct expenses related to acquisitions. Because we do not
acquire businesses on a predictable cycle, we do not consider the amount of
acquisition- and integration-related costs to be a representative component
of the day-to-day operating performance of our business.
• Strategic initiatives expenses relate to costs resulting from pursuing
strategic business opportunities. We do not consider the amounts to be
representative of the day-to-day operating performance of our business.
• Management fees, stock compensation and other primarily represents
consulting fees and portions of compensation paid to our employees and
executives through stock-based instruments. Determining 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 the long-term performance of our core
business.
• Restructuring costs generally represent non-ordinary course costs incurred
in connection with a change in a contract or a change in 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.
• Systems establishment costs relate to non-ordinary course expenses incurred
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 ofU.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 underU.S. GAAP. For example, adjusted EBITDA does not reflect:
• our cash expenditures or future requirements for capital expenditures;
• changes in, or cash requirements for, our working capital needs;
• interest expense, or the 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 requirements for replacements of assets that are depreciated or
amortized over their estimated useful lives and may have to be replaced in
the future; or
• all non-cash income or expense items that are reflected in our statements
of cash flows.
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RESULTS OF OPERATIONS
Impacts of the COVID-19 pandemic on the Company's Business
The potential impacts of the ongoing COVID-19 pandemic on our business are currently not estimable or determinable. We are conducting business as usual with some modifications to employee travel, employee work locations, and cancellation of certain events, among other modifications. We have implemented a salary exchange program pursuant to which certain employees have taken a temporary reduction in salary throughDecember 31, 2020 that ranges from 2% to 20% in exchange for receiving additional stock options and RSUs. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine is in the best interests of our employees, customers, partners, suppliers and stockholders. It is not clear what the potential effects of any such alterations or modifications may have on our business, including the effects on our customers and prospects, or on our financial results for the remainder of fiscal year 2020. OnMarch 27, 2020 , the President signed intoU.S. federal law the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), which is aimed at providing emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally supporting theU.S. economy. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer-side social security payments, NOL carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. In particular, under the CARES Act, (i) for taxable years beginning before 2021, NOL carryforwards and carrybacks may offset 100% of taxable income, (ii) NOLs arising in 2018, 2019, and 2020 taxable years may be carried back to each of the preceding five years to generate a refund and (iii) for taxable years beginning in 2019 and 2020, the base for interest deductibility is increased from 30% to 50% of taxable income. As permitted under the CARES Act, we are deferring payroll taxes due in 2020 to 2021 and 2022. We continue to analyze other aspects of the CARES act as well as similar tax legislation in other countries we operate but do not believe they will have a meaningful impact to our results.
For the three months ended
The following table sets forth statements of operations data for each of the periods indicated:
For the Three Months Ended September 30,
(in millions) 2020 2019
Revenues $ 72.3 $ 78.2
Cost of revenues 37.7 42.1
Gross profit 34.6 36.1
Operating expenses 34.5 35.3
Income from operations 0.1 0.8
Interest expense 12.4 12.0
Other expense - -
Loss before income taxes (12.3 ) (11.2 )
Income tax provision 0.4 0.1
Net loss (12.7 ) (11.3 )
Total other comprehensive (loss) income, net of tax 2.2 (2.2 )
Comprehensive loss (10.5 ) (13.5 )
Revenues
Revenues decreased by $5.9 million , or 7.5%, to $72.3 million for the three
months ended September 30, 2020 as compared to $78.2 million for the three
months ended September 30, 2019 . This is primarily due to decreases in hosting
services of $2.6 million , collections and processing of $1.1 million and data
recovery of $1.0 million . 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.
Cost of Revenues
Cost of revenues decreased by$4.4 million , or 10.5%, to$37.7 million for the three months endedSeptember 30, 2020 as compared to$42.1 million for the three months endedSeptember 30, 2019 . This decrease is due to expense reduction measures implemented by management, which decreased personnel expense by$2.6 million and travel and entertainment expense by$0.4 million , as well as other smaller expense decreases. In addition, hardware and software expenses decreased by$1.1 million and communications expenses decreased by$0.4 million . These decreases were partially offset by$0.7 million of increased severance expenses due to the integration of operational business units. As a percentage of revenue, our cost of revenues for the three months endedSeptember 30, 2020 decreased to 52.1% as compared to 53.8% for the three months endedSeptember 30, 2019 . This decrease was due to the factors noted above. 22 --------------------------------------------------------------------------------
Gross Profit
Gross profit decreased by$1.5 million , or 4.2%, to$34.6 million for the three months endedSeptember 30, 2020 as compared to$36.1 million for the three months endedSeptember 30, 2019 . Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the three months endedSeptember 30, 2020 increased to 47.9% as compared to 46.2% for the three months endedSeptember 30, 2019 primarily due to the factors noted above.
Operating Expenses
Operating expenses decreased by$0.8 million , or 2.3%, to$34.5 million for the three months endedSeptember 30, 2020 as compared to$35.3 million for the three months endedSeptember 30, 2019 . This decrease is due to expense reduction measures implemented by management which decreased personnel expenses by$2.3 million , decreased travel and entertainment expenses by$0.7 million and decreased marketing expenses by$0.4 million . These decreases were partially offset by increased costs incurred related to lease terminations to optimize our real estate footprint of$1.2 million and$0.8 million of increased severance costs due to the integration of operational business units. As a percentage of revenue, our operating expenses for the three months endedSeptember 30, 2020 increased to 47.7% as compared to 45.1% for three months endedSeptember 30, 2019 due to the factors noted above.
Interest Expense
Interest expense increased by$0.4 million , or 3.3%, to$12.4 million for the three months endedSeptember 30, 2020 as compared to$12.0 million for the three months endedSeptember 30, 2019 . This increase is primarily due to the increase in outstanding debt, partially offset by lower interest rates during the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 .
Income Tax Provision (Benefit)
During the three months endedSeptember 30, 2020 and 2019, we recorded an income tax provision of$0.4 million and$0.1 million , respectively, resulting in an effective tax rate of (3.3)% and (0.6)%, respectively. These effective tax rates differ from theU.S. federal statutory rate primarily due to the effects of foreign tax rate differences,U.S. state and local income taxes and the valuation allowance against our domestic deferred tax assets. The effective rate for the three months endedSeptember 30, 2020 increased from the three months endedSeptember 30, 2019 primarily due to a change in the allocation of our pre-tax earnings and losses among countries with differing statutory tax rates.
Net Loss
Net loss for the three months endedSeptember 30, 2020 was$12.7 million compared to$11.3 million for the three months endedSeptember 30, 2019 . Net loss increased for the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 due to the factors noted above.
Adjusted EBITDA
For the Three Months Ended September 30,
(in millions) 2020 2019
Net Loss $ (12.7 ) $ (11.3 )
Interest expense 12.4 12.0
Income tax expense 0.4 0.1
Depreciation and amortization expense 12.2 12.6
EBITDA $ 12.3 $ 13.4
Acquisition, financing and transaction costs 1.3 0.7
Strategic Initiatives:
Sign-on bonus amortization - 0.1
Non-recoverable draw - 0.9
Total strategic initiatives - 1.0
Management fees, stock compensation and other 1.0 0.7
Restructuring costs 1.6 0.3
Systems establishment 0.5 0.7
Adjusted EBITDA $ 16.7 $ 16.8
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For the nine months ended
The following table sets forth statements of operations data for each of the
periods indicated:
For the Nine Months Ended September 30,
(in millions) 2020 2019
Revenues $ 215.0 $ 231.5
Cost of revenues 111.5 118.9
Gross profit 103.5 112.6
Operating expenses 104.3 111.8
(Loss) income from operations (0.8 ) 0.8
Interest expense 38.3 36.5
Other expense 0.1 0.1
Loss before income taxes (39.2 ) (35.8 )
Income tax provision 1.0 0.4
Net loss (40.2 ) (36.2 )
Total other comprehensive income (loss), net of tax 0.6 (2.3 )
Comprehensive loss (39.6 ) (38.5 )
Revenues
Revenues decreased by $16.5 million , or 7.1%, to $215.0 million for the nine
months ended September 30, 2020 as compared to $231.5 million for the nine
months ended September 30, 2019 . This is primarily due to decreases in hosting
services of $5.5 million , collections and processing of $4.8 million ,
subscriptions of $3.1 million and data recovery of $2.9 million , partially
offset by an increase in managed review services of $0.9 million during the
first quarter of 2020. The decreases are primarily due to the impacts of
COVID-19 as many clients have delayed the start of new matters and court systems
were widely closed for a period of time and subsequently slow to reopen.
Cost of Revenues
Cost of revenues decreased by$7.4 million , or 6.2%, to$111.5 million for the nine months endedSeptember 30, 2020 as compared to$118.9 million for the nine months endedSeptember 30, 2019 . This decrease is due to expense reduction measures implemented by management, which decreased personnel expense by$4.3 million and travel and entertainment expense by$1.2 million , as well as other smaller expense decreases. In addition, hardware and software expenses decreased by$1.2 million , communications expenses decreased by$0.8 million and professional services expenses decreased by$0.3 million . These decreases were partially offset by$0.7 million of increased severance expenses due to the integration of operational business units and higher amortization of intangibles of approximately$0.6 million due to new assets being placed in service. As a percentage of revenue, our cost of revenues for the nine months endedSeptember 30, 2020 increased to 51.9% as compared to 51.4% for the nine months endedSeptember 30, 2019 . This increase was driven by decreased revenues due to COVID-19 without a corresponding decrease related to fixed costs.
Gross Profit
Gross profit decreased by$9.1 million , or 8.1%, to$103.5 million for the nine months endedSeptember 30, 2020 as compared to$112.6 million for the nine months endedSeptember 30, 2019 . Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the nine months endedSeptember 30, 2020 decreased to 48.1% as compared to 48.6% for the nine months endedSeptember 30, 2019 primarily due to the factors noted above.
Operating Expenses
Operating expenses decreased by$7.5 million , or 6.7%, to$104.3 million for the nine months endedSeptember 30, 2020 as compared to$111.8 million for the nine months endedSeptember 30, 2019 . This decrease is due to expense reduction measures implemented by management which decreased personnel expenses by$5.5 million , decreased travel and entertainment expenses by$1.5 million and decreased marketing expenses by$1.7 million . In addition, depreciation and amortization expenses decreased by$2.1 million . These decreases were partially offset by increased costs incurred related to lease terminations to optimize our real estate footprint of$1.2 million ,$1.2 million in increased bad debt expenses and$0.7 million of increased severance costs due to the integration of operational business units. As a percentage of revenue, our operating expenses for the nine months endedSeptember 30, 2020 increased to 48.5% as compared to 48.3% for the nine months endedSeptember 30, 2019 due to the factors noted above. 24
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Interest Expense
Interest expense increased by$1.8 million , or 4.9%, to$38.3 million for the nine months endedSeptember 30, 2020 as compared to$36.5 million for nine months endedSeptember 30, 2019 . This increase is primarily due to the increase in outstanding debt, partially offset by lower interest rates during the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 .
Income Tax Provision (Benefit)
During the nine months endedSeptember 30, 2020 and 2019, we recorded an income tax provision of$1.0 million and$0.4 million , respectively, resulting in an effective tax rate of (2.6)% and (1.1)%, respectively. These effective tax rates differ from theU.S. federal statutory rate primarily due to the effects of foreign tax rate differences,U.S. state and local income taxes and the valuation allowance against our domestic deferred tax assets. The effective rate for the nine months endedSeptember 30, 2020 increased from the nine months endedSeptember 30, 2019 primarily due to a change in the allocation of our pre-tax earnings and losses among countries with differing statutory tax rates.
Net Loss
Net loss for the nine months endedSeptember 30, 2020 was$40.2 million compared to$36.2 million for the nine months endedSeptember 30, 2019 . Net loss increased for the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 due to the factors noted above. Adjusted EBITDA For the Nine Months Ended September 30, (in millions) 2020 2019 Net Loss $ (40.2 ) $ (36.2 ) Interest expense 38.3 36.5 Income tax expense 1.0 0.4 Depreciation and amortization expense 36.1 37.6 EBITDA $ 35.2 $ 38.3 Acquisition, financing and transaction costs 1.6 3.5 Strategic Initiatives: Sign-on bonus amortization 0.2 0.4 Non-recoverable draw 0.3 2.9 Total strategic initiatives 0.5 3.3 Management fees, stock compensation and other 2.7 2.8 Restructuring costs 2.3 1.6 Systems establishment 1.6 2.0 Adjusted EBITDA $ 43.8 $ 51.5
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 revolving credit facility (our "Revolving Credit Facility"). 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 receivables. As ofSeptember 30, 2020 , we had$43.8 million in cash compared to$43.4 million as ofDecember 31, 2019 . As ofSeptember 30, 2020 , we had$478.3 million of outstanding borrowings compared to$480.6 million as ofDecember 31, 2019 . We expect to finance our operations over the next 12 months primarily through existing cash balances and cash flow. 25
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2016 Credit Agreement The Facilities OnDecember 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 byLD Intermediate, Inc. andLD 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 onDecember 9, 2022 andDecember 9, 2023 , respectively. The Second Lien Facility was repaid onDecember 19, 2019 in connection with the consummation of the Business Combination. The First Lien Facility established a term loan principal payment schedule with payments due on the last day of each calendar quarter, beginning onMarch 31, 2017 with a payment of$2.1 million . Quarterly principal payments increased to$4.3 million beginning onMarch 31, 2019 with a balloon payment of$259.3 million due at maturity. The interest rate for the First Lien Facility adjusts 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 include the last day of each interest period and any maturity dates of the First Lien Facility; however, if any interest period exceeds three months, the respective dates that fall every three months after the beginning of an interest period is also an interest payment date. For each interest period, the interest rate per annum is 5.875% plus the Adjusted Eurocurrency Rate which is 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 ofSeptember 30, 2020 , the balance due was$293.3 million , with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 1.000%. As ofDecember 31, 2019 , the balance due was$306.0 million , with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 2.61463%.
The Facilities are secured by substantially all of our assets and contain
certain covenants. As of
The 2016 Credit Agreement includes a mandatory excess cash flow prepayment within ten days after delivery of the annual audited financial statements commencing with the year endedDecember 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 is reduced if the FirstLien 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 FirstLien 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 payments under the Excess Cash Flow covenant for the three or nine months endedSeptember 30, 2020 and 2019 and do not anticipate making any additional principal payments under the Excess Cash Flow covenant for the year endedDecember 31, 2020 .
Revolving Credit Facility
The 2016 Credit Agreement also provides for a Revolving Credit Facility of up to$30.0 million that maturesDecember 9, 2021 . Borrowings under the Revolving Credit Facility may be subject to meeting certain financial covenants set forth in the 2016 Credit Agreement, including the First Lien Net Leverage Ratio. We may draw up to$30.0 million under 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 defined in the 2016 Credit Agreement). As ofSeptember 30, 2020 andDecember 31, 2019 , we had no amounts outstanding under our Revolving Credit Facility, and$0.8 million and$0.9 million , respectively, in letters of credit issued as ofSeptember 30, 2020 andDecember 31, 2019 with$29.2 million available borrowing capacity under the Revolving Credit Facility as ofSeptember 30, 2020 . The Initial Term Loan borrowings pursuant to the 2016 Credit Agreement were issued at an original issue discount of$11.9 million and$6.3 million for the First Lien Facility and Second Lien Facility, respectively. The original issue discount is amortized using the effective yield method over the respective term of each Facility. We wrote off the OID related to the Second Lien Facility when it was repaid in 2019. 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 onDecember 9, 2016 , along with fees of$0.6 million related 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. We are always evaluating opportunities for a more advantageous indebtedness structure, which may include a refinancing or replacement of our Facilities and/or our Revolving Credit Facility. 26 --------------------------------------------------------------------------------
Convertible Debenture Notes
In connection with the Business Combination onDecember 19, 2019 , we issued$200 million aggregate principal amount of convertible debentures due 2024 (the "Debentures") 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 stock to the Debenture holders related to the Debenture issuance. The proceeds of the Debentures were used in part to repay our outstanding Second Lien Facility and amounts outstanding under the Revolving Credit Facility. AtSeptember 30, 2020 , the balance due under the Debentures was$206.4 million . The Debentures mature onDecember 19, 2024 unless 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. At any time, upon notice as set forth in the Debentures, the Debentures are 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 are 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$18 per share, subject to certain adjustments. However, in the event we elect to redeem any Debentures, the holders 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 flows from operating, investing and financing activities for the
nine months ended
Nine Months Ended Nine Months Ended
September 30, 2020 September 30, 2019
Net cash provided by (used in):
Operating activities $ 25,307 $ (11,960 )
Investing activities $ (11,501 ) $ (9,938 )
Financing activities $ (13,438 ) $ 4,211
Effect of foreign exchange rates $ 63 $ (142 )
Net increase (decrease) in cash $ 431 $ (17,829 )
Cash Flows Provided By (Used in) Operating Activities
Net cash provided by operating activities was$25.3 million for the nine months endedSeptember 30, 2020 as compared to net cash used in operating activities of$(12.0) million for the nine months endedSeptember 30, 2019 . The increase in net cash provided is due to a$7.9 million increase in cash provided by net loss plus non-cash items and an increase in cash provided by working capital of$29.4 million . The period over period increase in non-cash items is primarily due to a$10.8 million increase in paid-in-kind interest, a$0.6 million increase in deferred income taxes, a$0.7 million increase in stock-based compensation and a$1.2 million increase in the allowance provision, offset by a$1.6 million decrease in depreciation and amortization. The increase in cash provided by working capital for the period is primarily due to a$22.1 million decrease in accounts receivable and a$7.2 million increase in accounts payable and accrued expenses. 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$11.5 million for the nine months endedSeptember 30, 2020 as compared to net cash used in investing activities of$9.9 million for the nine months endedSeptember 30, 2019 . The increase in cash used is due to a 27
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Cash Flows (Used In) Provided by Financing Activities
For the nine months endedSeptember 30, 2020 , net cash used for financing activities was$13.4 million and related to the payments of long-term debt of$12.8 million and capital lease obligations of$0.7 million . For the nine months endedSeptember 30, 2019 , net cash provided by financing activities was$4.2 million and related to the net borrowings under our Revolving Credit Facility of$17.0 million and$0.4 million for common stock issuances, partially offset by payments of long-term debt of$12.8 million and payments on capital lease obligations of$0.5 million .
Contractual Obligations
Our operating lease obligations are disclosed in Note 4 to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Rent expense for the three months endedSeptember 30, 2020 and 2019 was$3.4 million and$3.7 million , respectively. Rent expense for the nine months endedSeptember 30, 2020 and 2019 was$11.0 million and$11.2 million , respectively.
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 Pronouncements
See Note 1 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for a summary of accounting standards not yet adopted.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance withU.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. There were no changes to our critical accounting policies from those described in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , as filed with theSecurities and Exchange Commission (the "SEC") onMarch 26, 2020 .
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