KLDISCOVERY INC. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including information incorporated herein by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act that are not historical facts. This includes, without limitation, statements regarding our financial position, business strategy and management's plans and objectives 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 Quarterly Report on Form 10-Q, 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.
All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expect, including:
•
potential failure to comply with privacy and information security regulations governing the client datasets that we process and store;
•
the outbreak of disease or similar public health threat, such as COVID-19;
•
the ability to operate in highly competitive markets, and potential adverse effects of this competition;
•
risk of decreased revenues if we do not adapt our pricing models;
•
the ability to attract, motivate and retain qualified employees, including members of our senior management team;
•
the ability to maintain a high level of client service and expand operations;
•
potential issues with our product offerings that could cause legal exposure, reputational damage and an inability to deliver services;
•
the ability to develop and successfully grow revenues from new products such as Nebula, improve existing products and adapt our business model to keep pace with industry trends;
•
risk that our products and services fail to interoperate with third-party systems;
•
potential unavailability of third-party technology that we use in our products and services;
•
potential disruption of our products, offerings, website and networks;
•
difficulties resulting from our implementation of new consolidated business systems;
•
the ability to deliver products and services following a disaster or business continuity event;
•
potential unauthorized use of our products and technology by third parties and/or data security breaches and other incidents;
•
potential intellectual property infringement claims;
•
the ability to comply with various trade restrictions, such as sanctions and export controls, resulting from our international operations;
•
consequences of our substantial levels of indebtedness;
•
potential impairment charges related to goodwill, identified intangible assets and fixed assets;
•
impacts of laws and regulations on our business;
•
macroeconomic conditions, including inflationary pressures, rising interest rates, exchange rate volatility, and recessionary fears;
•
potential litigation and regulatory proceedings involving us;
•
expectations regarding the time during which we will be an emerging growth company or smaller reporting company;
•
the potential liquidity and trading of our public securities; and
•
other risks and uncertainties indicated in the section titled "Risk Factors" in this Quarterly Report on Form 10-Q.
18
--------------------------------------------------------------------------------
The forward-looking statements contained in this Quarterly Report on Form 10-Q
are based on current expectations and beliefs, which we believe to be
reasonable, 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 (many 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 "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and in our consolidated financial statements and the
related notes thereto included elsewhere in this Quarterly Report on Form 10-Q
and in our Annual Report on Form 10-K for the year ended December 31, 2021 .
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.
In addition, statements that include phrases such as "we believe" and similar
phrases reflect our beliefs and opinions on the relevant subject. These
statements are based upon information available to us as of the date of this
Quarterly Report on Form 10-Q, and while we believe such information forms a
reasonable basis for these statements, such information may be limited or
incomplete, and our statements should not be read to indicate that we have
conducted an exhaustive inquiry into, or review of, all potentially available
relevant information. These statements are inherently uncertain and investors
are cautioned not to unduly rely upon these statements.
Throughout this section, unless otherwise noted "we," "us," "our," "Company,"
"KLDiscovery ," "KLD," or "KLDiscovery Inc. " refer to KLDiscovery Inc. and its
consolidated subsidiaries. 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 ended September 30, 2022 .
•
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, and commitments and contingencies.
•
Critical Accounting Policies and Estimates - a discussion of critical accounting policies and estimates requiring judgments.
Overview
KLD is a leading global provider of eDiscovery, information governance and data recovery solutions to corporations, law firms, insurance agencies and individuals. We provide technology solutions to help our clients solve complex legal, regulatory and data challenges. We have broad geographical coverage in the eDiscovery and data recovery industries with 25 locations in 16 countries, as well as 9 data centers and 13 data recovery labs globally. Our integrated proprietary technology solutions enable the efficient and accurate collection, processing, transmission, review and/or recovery of complex and large-scale enterprise data. In conjunction with proprietary technology, we provide immediate expert consultation and 24/7/365 support wherever a customer is located worldwide, which empowers us to become a "first-call" partner for mission-critical, time-sensitive, or nuanced eDiscovery and data recovery challenges. We are continuously innovating to provide a more reliable, secure and seamless experience when tackling various "big data" volume, velocity, and veracity challenges. A key example of our purpose-built innovation is Nebula, our flagship, end-to-end artificial intelligence/machine learning, or AI/ML, powered solution that serves as a singular platform of engagement for legal data.
Key factors affecting our performance
Our operating results, financial performance and future growth will depend on a variety of factors, including, among others, maintaining our history of product innovation, increasing adoption of Nebula, maintaining and growing our client base while driving greater penetration, growth in the number of our matters, particularly large matters and establishing our partner channel for Nebula. Some of the more important factors are discussed in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 as filed with theSEC onMarch 17, 2022 (our "Annual Report"), as supplemented by the additional discussion below. In addition, as discussed below, the COVID-19 pandemic has impacted our operating results. Key business metrics
The following are among the key operational and financial metrics we use to measure and evaluate our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.
19
--------------------------------------------------------------------------------Clients
We have a strong track record of growing our client base, and we believe that our ability to increase the number of clients utilizing our Legal Technology solutions, including Nebula, is an important indicator of our market penetration, our business growth, and our future opportunities. We define Legal Technology clients as each primary law firm and corporation to which we provided services in a litigation matter that we billed during the past two years. We define Nebula clients, each of which is included in the number of Legal Technology clients, as the total number of primary law firm, corporation, insurance company and service provider clients to which we provided legal technology solutions for a matter that we billed for use of our Nebula solution during the two years prior to the applicable date.
The following table sets forth the number of Legal Technology clients and Nebula clients as of the dates shown:
September 30,
2022 2021
Legal Technology clients 5,815 5,427
Nebula clients 1,514 1,131
Number and size of matters
We believe our ability to continuously grow the number of matters on our platform over time is an important measure of scale for our business and is indicative of our future growth prospects.
We define Legal Technology matters as the total number of matters on which our Legal Technology solutions were used in the twelve months preceding the applicable date. Matters refer to a range of activities that include collecting, tracking, analyzing, and exchanging relevant data. Legal Technology solutions currently drive the majority of our revenue, and provide the foundation for additional adoption of our proprietary technology solutions and other offerings. We define Nebula matters, which are included in the number of Legal Technology matters, as the total number of matters on which our Nebula solution was used in the twelve months preceding the applicable date. Nebula is our ecosystem of proprietary technology solutions that enables clients to collect, process, store, analyze, and govern their data on a single platform. Nebula comprises a steadily growing component of our revenue and we expect Nebula adoption to increase and the number of Nebula matters to grow in the long term as we continue to introduce new product capabilities and cross-sell Nebula to our existing clients.
The following table sets forth the number of Legal Technology matters and Nebula matters as of the dates shown:
September 30,
2022 2021
Legal Technology matters 7,928 7,951
Nebula matters 1,163 905
Our comprehensive product offerings, technology-enabled service offerings and
reputation as a trusted partner to our clients enable us to capture matters of
large size and complexity. For the three months ended September 30, 2022 and
2021, 27% and 35% of Legal Technology revenue, respectively, was produced by
matters that generated revenues of greater than $500,000 , and 57% and 62% of our
Legal Technology revenue, respectively, was produced by matters that generated
revenues of greater than $100,000 during the relevant period. For the nine
months ended September 30, 2022 and 2021, 41% and 42% of Legal Technology
revenue, respectively, was produced by matters that generated revenues of
greater than $500,000 , and 72% and 73% of our Legal Technology revenue,
respectively, was produced by matters that generated revenues of greater than
$100,000 during the relevant period.
Legal Technology net revenue retention
We calculate our Legal Technology net revenue retention rate by dividing (1)
total Legal Technology revenue in the twelve-month period from accounts that
generated Legal Technology revenue during the corresponding immediately
preceding twelve month period by (2) total Legal Technology revenue in the
immediately preceding twelve month period generated from those same accounts.
Our Legal Technology net revenue retention rate includes revenue from use of
Nebula.
Twelve Months Ended September 30,
2022 2021
Legal Technology net revenue retention 95% 101%
20
--------------------------------------------------------------------------------
For the three months ended September 30, 2022 and 2021, our Legal Technology
revenue was $66.4 million and $70.3 million , respectively, and our data recovery
revenue was $8.1 million and $10.8 million , respectively. For the nine months
ended September 30, 2022 and 2021, our Legal Technology revenue was $205.5
million and $204.8 million , respectively, and our data recovery revenue was
$26.2 million and $33.5 million , respectively.
Our Legal Technology net revenue retention rate is impacted by our usage-based
pricing model, and revenue could fluctuate in any given period due to frequency
of matters, client upsell, cross-sell, and churn. During 2020, 2021 and 2022,
the COVID-19 pandemic impacted our Legal Technology net revenue retention rate,
as it impacted the rest of our business, as certain accounts experienced a
slowdown in the number and frequency of matters. In the long-term, we plan to
increase our net revenue retention rate by increasing the number of solutions
that we sell on a subscription-basis, as well as broadening the scope of our
Nebula offerings, to promote strong product adoption. As we expand our products
beyond eDiscovery to other information governance solutions such as big data
hosting and processing, including through Nebula, we expect clients to leverage
our technology earlier in the data lifecycle, providing further opportunity for
us to increase our product and service penetration and client retention.
Furthermore, we plan to establish and broaden our channel partnerships over time
and leverage these strong relationships to further our awareness of our products
and overall usage within the industry.
KEY COMPONENTS OF OUR RESULTS OF OPERATIONS
Revenue
The Company primarily generates revenue from selling solutions that fall into the following categories:
(1)
Legal Technology, including Nebula and our expansive suite of technology solutions, such as our end-to-end eDiscovery technology solutions, managed review solutions, collections, processing, analytics, hosting, production, and professional services; and
(2)
Data recovery solutions, which provides data restoration, data erasure and data management services.
The Company generates the majority of its revenues by providing Legal Technology
solutions to our clients. Most of the Company's eDiscovery contracts are time
and materials types of arrangements, while others are subscription-based,
fixed-fee arrangements.
Time and materials arrangements are based on units of data stored or processed.
Unit-based revenues are recognized as services are provided, based on either the
amount of data stored or processed, the number of concurrent users accessing the
information or the number of pages or images processed for a client, at agreed
upon per unit rates. The Company recognizes revenues for these arrangements
utilizing a right-to-invoice practical expedient because it has a contractual
right to consideration for services completed to date.
Certain of the Company's eDiscovery contracts are subscription-based, fixed fee
arrangements, which have tiered pricing based on the quantity of data hosted.
For a fixed monthly fee, the Company's clients receive a variety of optional
eDiscovery solutions, which are included in addition to the data hosting. The
Company recognizes revenues for these arrangements based on predetermined
monthly fees as determined in its contractual agreements, utilizing a
right-to-invoice practical expedient because the Company has a contractual right
to consideration for services completed to date.
Other eDiscovery agreements are time and material arrangements that require the
client to pay us based on the number of hours worked at contractually
agreed-upon rates. The Company recognizes revenues for these arrangements based
on hours incurred and contracted rates utilizing a right-to-invoice practical
expedient because it has a contractual right to consideration for services
completed to date.
Data recovery engagements are mainly fixed fee arrangements requiring the client
to pay a pre-established fee in exchange for the successful completion of such
engagement on a predetermined device. For the recovery performed by the
Company's technicians, the revenue is recognized at a point in time, when the
recovered data is sent to the customer.
Data erasure engagements are also fixed fee arrangements for which revenue is
recognized at a point in time when the certificate of erasure is sent to the
customer.
The Company offers term license subscriptions to Ontrack PowerControls software
to customers with on-premises installations of the software pursuant to
contracts that are historically one to four years in length. The term license
subscriptions include maintenance and support, as well as access to future
software upgrades and patches. The license and the additional support services
are deemed to be one performance obligation, and thus revenue for these
arrangements is recognized ratably over the term of the agreement.
21
--------------------------------------------------------------------------------
For the three months ended September 30, 2022 and 2021, our Legal Technology
revenue was $66.4 million and 70.3 million, respectively, and our data recovery
revenue was $8.1 million and $10.8 million , respectively. For the three months
ended September 30, 2022 and 2021, Legal Technology revenue from our technology
solutions other than Nebula was $60.0 million and $63.3 million respectively,
and revenue from Nebula was $6.5 million and $7.1 million , respectively. For the
nine months ended September 30, 2022 and 2021, our Legal Technology revenue was
$205.5 million and $204.8 million , respectively, and our data recovery revenue
was $26.2 million and $33.5 million , respectively. For the nine months ended
September 30, 2022 and 2021, Legal Technology revenue from our technology
solutions other than Nebula was $185.1 million and $185.5 million respectively,
and revenue from Nebula was $20.3 million and $19.3 million , respectively.
Additionally, we generally have longstanding relationships with our clients and
for the three and nine months ended September 30, 2022 and 2021, no single
client accounted for more than five percent of our revenues.
We currently expect non-Nebula Legal Technology revenues to remain relatively
consistent over time and that Nebula revenue will continue to accelerate, with
Nebula growing as a larger percentage of the mix of total revenue over time.
Cost of Revenues
Cost of revenue consists primarily of technology infrastructure costs, personnel
costs and amortization of capitalized developed technology costs. Infrastructure
costs include hardware, software, occupancy and cloud costs to support our legal
technology and data recovery solutions. Personnel costs include salaries,
benefits, bonuses, and stock-based compensation as well as costs associated with
document reviewers which are variable based on managed review revenue. We intend
to continue to invest additional resources in our infrastructure to expand the
capability of solutions and enable our customers to realize the full benefit of
our solutions. The level, timing and relative investment in our cloud
infrastructure could affect our cost of revenue in the future. Additionally,
cost of revenue in future periods could be impacted by fluctuations in document
reviewer costs associated with managed review revenue.
Operating expenses
Our operating expenses consist of research and development, sales and marketing, general and administrative and depreciation and amortization expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, share-based compensation and sales commissions. Operating expenses also include occupancy, software expense and professional services. During the remainder of 2022, we intend to continue to invest in research and development to further develop our proprietary technology and support further penetration and adoption of our offering, including our end-to-end Nebula platform, together with hiring additional personnel. We expect these investments to cause research and development expense to continue to increase in 2022 versus 2021, and thereafter anticipate research and development expense normalizing as a percentage of revenues. We also intend to significantly increase our investment in sales and marketing through the end of 2022 in connection with an expected increase in headcount. The anticipated long-term benefits from these investments are expected to increase revenues, which is also expected to slightly decrease sales and marketing expense as a percentage of revenue over time. We also expect general and administrative expense to decrease slightly as a percentage of revenue over time due to our ability to scale as revenues increase and as a result of historical cost-cutting measures.
Interest Expense
Interest expense consists primarily of interest payments and accruals relating to outstanding borrowings. We expect interest expense to vary each reporting period depending on the amount of outstanding borrowings and prevailing interest rates.
Income Tax (Benefit) Provision
Income tax (benefit) provision is primarily related to foreign tax activity andU.S. deferred taxes for tax deductible goodwill and other indefinite-lived liabilities. We maintain a valuation allowance on our federal and state deferred tax assets as we have concluded that it is not more likely than not that the deferred assets will be utilized.
Non-
We prepare 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. Our management believes that these measures are relevant and provide useful supplemental information to investors by providing a baseline for evaluating and comparing our operating performance against that of other companies in our industry. 22 -------------------------------------------------------------------------------- Our management believes EBITDA and Adjusted EBITDA 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, equity compensation, acquisition and transaction costs, restructuring costs, and systems establishment costs 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 ourU.S. GAAP financial measures and compare them with our EBITDA and adjusted EBITDA. 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. EBITDA and Adjusted EBITDA We define EBITDA as net income (loss) plus interest (income) expense, income tax expense (benefit), extinguishment of debt, impairment losses, and depreciation and amortization. We view adjusted EBITDA as an 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 as the 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 represent earn-out payments, rating agency fees and letter of credit and revolving facility fees, as well as professional service fees and direct expenses related to acquisitions and public offerings. Because we do not acquire businesses or effect financings on a regular or predictable cycle, we do not consider the amount of these costs to be a representative component of the day-to-day operating performance of our business.
•
Stock compensation and other primarily represent 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. Additionally, stock compensation is a non-cash expense. Therefore, we believe it is useful to exclude stock-based compensation to better understand the long-term performance of our core business.
•
Change in fair value of Private Warrants relates to changes in the fair market value of the Private Warrants issued in conjunction with the Business Combination. We do not consider the amount to be representative of a component of the day-to-day operating performance of our 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, such as severance payments, recruiting fees and retention charges. 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.
23
--------------------------------------------------------------------------------
The use of EBITDA and adjusted EBITDA instead of U.S. GAAP measures has
limitations as an analytical tool, and adjusted EBITDA should not be considered
in isolation, or as a substitute for analysis of our results of operations and
operating cash flows as reported under U.S. GAAP. For example, EBITDA and
adjusted EBITDA do 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.
See "-Results of Operations" below for reconciliations of adjusted EBITDA to net loss.
RESULTS OF OPERATIONS
Impacts of the COVID-19 pandemic on the Company's Business
The COVID-19 pandemic continues to impact the global economy and cause significant macroeconomic uncertainty. The future impacts of the pandemic on the Company's business are currently not estimable or determinable. As new variants of the virus emerge, infection rates vary across the countries in which we operate, and governmental authorities have continued to implement numerous and evolving measures to try to contain the spread of the virus, including travel bans and restrictions, masking recommendations and mandates, vaccine recommendations and mandates, limits on gatherings, quarantines, shelter-in-place orders and business shutdowns. We have taken proactive measures to protect the health and safety of our employees, customers, partners and suppliers, consistent with governmental guidelines. The Company modified employee travel and work locations, including the closure of several offices as the Company transitioned to a primarily work from home model, and cancelled certain events, among other actions taken in response to the COVID-19 pandemic. During 2020, the Company implemented a salary exchange program pursuant to which certain employees took a temporary reduction in salary throughDecember 31, 2020 ranging from 2% to 20% in exchange for grants of an aggregate of 417,673 stock options and 211,207 RSUs. InDecember 2020 , the Company extended the salary exchange program for the Company's named executive officers and for the position of Vice-President and higher but did not issue any additional stock options or RSUs in connection with the salary exchange program. As ofJune 2021 , the Company ended the salary exchange program. The Company will continue to actively monitor the situation and may reinstate certain of the measures described above or take further actions that alter its business operations, including actions as required by federal, state or local authorities or that it determines are in the best interests of its employees, customers, partners, suppliers and stockholders. Due to the evolving situation and the uncertainties as to the scope and duration of the COVID-19 pandemic, our business may be impacted in ways that we cannot predict. OnMarch 27, 2020 , the President signed intoU.S. federal law the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, to provide emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally support 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 was increased from 30% to 50% of taxable income. As permitted under the CARES Act, the Company deferred$4.0 million of payroll taxes due in 2020, of which$2.0 million was paid inDecember 2021 and$2.0 is expected to be paid inDecember 2022 . 24 -------------------------------------------------------------------------------- For the three months endedSeptember 30, 2022 compared with the three months endedSeptember 30, 2021 The results for the periods shown below should be reviewed in conjunction with our unaudited condensed consolidated financial statements included in "Item 1. Financial Statements." The following table sets forth statements of operations data for each of the periods indicated: For the Three Months Ended September 30, (in millions) 2022 2021 Revenues $ 74.5 $ 81.1 Cost of revenues 40.8 41.9 Gross profit 33.7 39.2
Operating expenses, including impairment of
36.6 56.9
Loss from operations (2.9 ) (17.7 )
Interest expense 14.0 12.8
Change in fair value of Private Warrants (0.1 ) 0.1
Loss before income taxes (16.8 ) (30.5 )
Income tax provision (benefit) 0.6 (1.0 )
Net loss (17.4 ) (29.5 )
Total other comprehensive loss, net of tax (4.7 ) (1.8 )
Comprehensive loss (22.1 ) (31.3 )
Adjusted EBITDA
For the Three Months Ended September 30,
(in millions) 2022 2021
Net Loss $ (17.4 ) $ (29.5 )
Interest expense 14.0 12.8
Income tax provision (benefit) 0.6 (1.0 )
Impairment of intangible asset - 22.5
Depreciation and amortization expense 7.9 10.0
EBITDA (1) $ 5.1 $ 14.8
Acquisition, financing and transaction costs 2.6 0.5
Stock compensation and other 1.3 1.0
Change in fair value of Private Warrants (0.1 ) 0.1
Restructuring costs 2.2 -
Systems establishment 0.2 0.5
Adjusted EBITDA (1) $ 11.3 $ 16.9
(1)
EBITDA and adjusted EBITDA are non-GAAP measures. See "-Non-
Revenues
Revenues decreased by
Cost of Revenues
Cost of revenues decreased by$1.1 million , or 2.6%, to$40.8 million for the three months endedSeptember 30, 2022 as compared to$41.9 million for the three months endedSeptember 30, 2021 . This decrease is primarily due to decreased wages of approximately$2.4 million for document reviewers due to decreased managed review revenue, partially offset by increased payroll benefits of$1.0 million , due to increased health care costs and increased severance of$0.7 million , associated with the optimization of data recovery personnel as we unify our inbound and business development teams. As a percentage of revenue, our cost of revenues for the three months endedSeptember 30, 2022 increased to 54.8% as compared to 51.7% for the three months endedSeptember 30, 2021 , and was due to the lower revenue and increased payroll benefits noted above. 25 --------------------------------------------------------------------------------
Gross Profit
Gross profit decreased by$5.5 million , or 14.0%, to$33.7 million for the three months endedSeptember 30, 2022 as compared to$39.2 million for the three months endedSeptember 30, 2021 . Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the three months endedSeptember 30, 2022 decreased to 45.2% as compared to 48.3% for the three months endedSeptember 30, 2021 , and was due to the decline in revenue noted above that was greater in percentage than the comparable decrease in cost of revenues. Operating Expenses Operating expenses decreased by$20.3 million , or 35.7%, to$36.6 million for the three months endedSeptember 30, 2022 as compared to$56.9 million for the three months endedSeptember 30, 2021 . This decrease is a result of the impairment of the intangible asset for the Kroll tradename of$22.5 million in the 2021 period, decreased depreciation and amortization expense of$2.6 million , decreased bad debt expense of$0.4 million , decreased impaired intangible write-off of$0.3 million , and decreased professional fees of$0.6 million . This decrease is partially offset by increased vacated lease costs of$2.3 million associated with the consolidation of our real estate footprint, increased sales and marketing severance of$1.3 million associated with the optimization of our data recovery personnel as we unify our inbound and business development teams, increased research and development wages, taxes and benefits of$0.9 million and increased research and development contract labor of$0.2 million . As a percentage of revenue, our operating expenses for the three months endedSeptember 30, 2022 decreased to 49.1% as compared to 70.2% for three months endedSeptember 30, 2021 .
Interest Expense
Interest expense increased by$1.2 million , or 9.4%, to$14.0 million for the three months endedSeptember 30, 2022 as compared to$12.8 million for the three months endedSeptember 30, 2021 . The increase is due to an increase in the variable interest rate on borrowings under the 2021 Credit Agreement, which resulted in a$0.4 million increase in expense, and an increase in the debt balance due to the quarterly accruals of Paid in Kind ("PIK") interest which resulted in a$0.8 million increase in interest expense.
Change in Fair Value of Private Warrants
During the first quarter of 2021, the Company determined that the Private Warrants, which had historically been accounted for as a component of equity, should be reclassified and recorded as a liability at fair value during each reporting period. For the three months endedSeptember 30, 2022 the Company recorded a gain to the Private Warrants liability of$0.1 million and for the three months endedSeptember 30, 2021 the Company recorded a loss of$0.1 million .
Income Tax Provision
During the three months endedSeptember 30, 2022 and 2021, the Company recorded an income tax provision of$0.6 million and benefit of$1.0 million , respectively, resulting in an effective tax rate of (3.6)% and 3.3%, respectively. These effective tax rates differ from theU.S. federal statutory rate primarily due to the effects of foreign tax rate differences,U.S. state and local income taxes and the valuation allowance against our domestic deferred tax assets. The effective rate for the three months endedSeptember 30, 2022 decreased from the three months endedSeptember 30, 2021 primarily due to the impairment of intangible assets that occurred during the period endedSeptember 30, 2021 . Net Loss Net loss for the three months endedSeptember 30, 2022 was$(17.4) million compared to$(29.5) million for the three months endedSeptember 30, 2021 . Net loss decreased for the three months endedSeptember 30, 2022 as compared to the three months endedSeptember 30, 2021 due to the factors noted above. 26 -------------------------------------------------------------------------------- For the nine months endedSeptember 30, 2022 compared with the nine months endedSeptember 30, 2021 The results for the periods shown below should be reviewed in conjunction with our unaudited condensed consolidated financial statements included in "Item 1. Financial Statements." The following table sets forth statements of operations data for each of the periods indicated: For the Nine Months Ended September 30, (in millions) 2022 2021 Revenues $ 231.6 $ 238.2 Cost of revenues 123.7 120.1 Gross profit 107.9 118.1
Operating expenses, including impairment of
106.2 128.2
Income (loss) from operations 1.7 (10.1 )
Interest expense 39.5 37.6
Change in fair value of Private Warrants (0.8 ) (1.7 )
Loss on debt extinguishment - 7.3
Loss before income taxes (37.0 ) (53.3 )
Income tax provision (benefit) 1.2 (0.1 )
Net loss (38.2 ) (53.2 )
Total other comprehensive loss, net of tax (12.5 ) (3.6 )
Comprehensive loss (50.7 ) (56.8 )
Adjusted EBITDA
For the Nine Months Ended September 30,
(in millions) 2022 2021
Net Loss $ (38.2 ) $ (53.3 )
Interest expense 39.5 37.6
Income tax provision 1.2 (0.1 )
Extinguishment of debt - 7.3
Impairment of intangible asset - 22.5
Depreciation and amortization expense 23.6 29.4
EBITDA (1) $ 26.1 $ 43.4
Acquisition, financing and transaction costs 5.6 2.5
Stock compensation and other 3.8 3.2
Change in fair value of Private Warrants (0.8 ) (1.7 )
Restructuring costs 2.3 1.0
Systems establishment 0.8 1.4
Adjusted EBITDA (1) $ 37.8 $ 49.9
(1)
EBITDA and adjusted EBITDA are non-GAAP measures. See "-Non-
Revenues Revenues decreased$6.6 million , or 2.8%, to $$231.6 million for the nine months endedSeptember 30, 2022 as compared to$238.2 million for the nine months endedSeptember 30, 2021 . Data recovery revenue decreased by$7.3 million , partially offset by an increase in Legal Technology revenue of$0.7 million , which includes an increase of$1.0 million from Nebula. The decline in data recovery revenue is due to a lower volume of large jobs. The increase in Legal Technology revenue is due to a higher volume of litigation, partially offset by a decrease in managed review revenue. 27
--------------------------------------------------------------------------------
Cost of Revenues
Cost of revenues increased by$3.6 million , or 3.0%, to$123.7 million for the nine months endedSeptember 30, 2022 as compared to$120.1 million for the nine months endedSeptember 30, 2021 . This increase is primarily due to increased payroll benefits of approximately$1.9 million due to increased health care costs and increased severance of$0.7 million , associated with the optimization of data recovery personnel as we unify our inbound and business development teams. In addition, amortization expense increased by$0.9 million as internally developed software intangible assets were placed into service. As a percentage of revenue, our cost of revenues for the nine months endedSeptember 30, 2022 increased to 53.4% as compared to 50.4% for the nine months endedSeptember 30, 2021 , and was due to the lower revenue and factors noted above.
Gross Profit
Gross profit decreased by$10.2 million , or 8.6%, to$107.9 million for the nine months endedSeptember 30, 2022 as compared to$118.1 million for the nine months endedSeptember 30, 2021 . Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the nine months endedSeptember 30, 2022 decreased to 46.6% as compared to 49.6% for the nine months endedSeptember 30, 2021 , and was due to decreased revenues and increased cost of revenues as noted above.
Operating Expenses
Operating expenses decreased by$22.0 million , or 17.2%, to$106.2 million the nine months endedSeptember 30, 2022 as compared to$128.2 million for nine months endedSeptember 30, 2021 . This decrease is the result of the impairment on intangible asset for the Kroll tradename of$22.5 million in the 2021 period, decreased depreciation and amortization of$7.9 million due to more assets becoming fully depreciated versus the planned purchases of new assets, decreased bad debt expense of$0.9 million , partially offset by increased vacated lease costs of$2.3 million associated with the consolidation of our real estate footprint, the write-off of$1.1 million of previously deferred costs incurred in 2021 related to a public offering planned for 2022 which the Company believed was not probable in the near term due to changes in market conditions, increased personnel expense in research and development of approximately$2.5 million and in sales of$2.3 million due to planned investment in headcount and increased marketing expenses of$0.7 million . As a percentage of revenue, our operating expenses for the nine months endedSeptember 30, 2022 decreased to 45.9% as compared to 53.8% for nine months endedSeptember 30, 2021 .
Interest Expense
Interest expense increased by$1.9 million , or 5.1%, to$39.5 million for the nine months endedSeptember 30, 2022 as compared to$37.6 million for nine months endedSeptember 30, 2021 . The increase is due to an increase in the variable interest rate on borrowings under the 2021 Credit Agreement, which resulted in a$0.4 million increase in expense, and an increase in the debt balance due to the quarterly accruals of PIK interest which resulted in a$1.5 million increase in interest expense.
Loss on Debt Extinguishment
For the nine months ended
Change in Fair Value of Private Warrants
During the first quarter of 2021, the Company determined that the Private Warrants, which had historically been accounted for as a component of equity, should be reclassified and recorded as a liability at fair value during each reporting period. For the nine months endedSeptember 30, 2022 and 2021, we recorded an adjustment to the Private Warrants liability of$0.8 million and$1.7 million , respectively.
Income Tax Provision
During the nine months endedSeptember 30, 2022 and 2021, the Company recorded an income tax provision of$1.2 million and an income tax benefit of$0.1 million , respectively, resulting in an effective tax rate of (3.2)% and 0.2%, 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, 2022 decreased from the nine months endedSeptember 30, 2021 primarily due to the impairment of intangible assets that occurred during the period endedSeptember 30, 2021 . 28 --------------------------------------------------------------------------------
Net Loss
Net loss for the nine months endedSeptember 30, 2022 was$38.2 million compared to$53.2 million for the nine months endedSeptember 30, 2021 . Net loss decreased for the nine months endedSeptember 30, 2022 as compared to the nine months endedSeptember 30, 2021 due to the factors noted above.
Liquidity and Capital Resources
Our primary cash needs are and 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 discussed below. We may also seek to access the capital markets opportunistically from time-to-time depending on, among other things, financial market conditions. 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 the majority of our eDiscovery accounts receivable 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 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 continue 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 of our accounts receivable. As ofSeptember 30, 2022 , we had$32.9 million in cash compared to$46.5 million as ofDecember 31, 2021 . As ofSeptember 30, 2022 , we had$518.7 million of outstanding borrowings compared to$510.7 million as ofDecember 31, 2021 . We expect to finance our operations in the short- and long-term primarily through existing cash balances and cash flow from operating activities. 2021 Credit Agreement
On
The 2021 Credit Agreement provides for (i) initial term loans in an aggregate principal amount of$300 million (the "Initial Term Loans"), (ii) delayed draw term loans in an aggregate principal amount of$50 million (the "Delayed Draw Term Loans"), and (iii) revolving credit loans in an aggregate principal amount of$40 million , with a letter of credit sublimit of$10 million (the "Revolving Credit Loans"). The Delayed Draw Term Loans are available to the Loan Parties at any time prior toFebruary 8, 2023 , subject to certain conditions. The Initial Term Loans and Delayed Draw Term Loans bear interest, at the Loan Parties' option, at the rate of (x) with respect to Eurocurrency Rate Loans (as defined in the 2021 Credit Agreement), the Adjusted Eurocurrency Rate (as defined in the 2021 Credit Agreement) with a 1.0% floor, plus 6.50% per annum, or (y) with respect to Base Rate Loans (as defined in the 2021 Credit Agreement), the Base Rate (as defined in the 2021 Credit Agreement) plus 5.50% per annum. The Revolving Credit Loans bear interest, at our option, at the rate of (x) with respect to Eurocurrency Rate Loans, the Adjusted Eurocurrency Rate plus 4.00% per annum, or (y) with respect to Base Rate Loans, the Base Rate plus 3.00% per annum. The Initial Term Loans and Delayed Draw Term Loans amortize at a rate of 1.00% of the aggregate principal amount of Initial Term Loans and Delayed Draw Term Loans outstanding, payable in consecutive quarterly installments of$0.8 million , beginning onJune 30, 2021 . OnSeptember 30, 2022 , the balance due was$295.5 million with an interest rate of 6.50% plus an Adjusted Eurocurrency Rate of 3.67414%. OnDecember 31, 2021 , the balance due was$297.8 million with an interest rate of 6.50% plus an Adjusted Eurocurrency Rate of 1.00%. The Initial Term Loans, Delayed Draw Term Loans and Revolving Credit Loans are each scheduled to mature on the earlier ofFebruary 8, 2026 or six months prior to maturity of our Debentures due inDecember 2024 . The Initial Term Loans and Delayed Draw Term Loans may be voluntarily repaid at any time, but may be subject to a prepayment premium. The Initial Term Loans and Delayed Draw Term Loans are required to be repaid under certain circumstances, including with Excess Cash Flow (as defined in the 2021 Credit Agreement), the proceeds of an Asset Sale or Casualty Event (each as defined in the 2021 Credit Agreement) and the proceeds of certain refinancing indebtedness. The obligations under the 2021 Credit Agreement are secured by substantially all of the Loan Parties' assets. The 2021 Credit Agreement contains customary affirmative and negative covenants as well as a financial maintenance covenant that requires the Loan Parties to maintain a First Lien Net Leverage Ratio (as defined in the 2021 Credit Agreement) of less than or equal to 7.00 to 1.00, tested at the end of each fiscal quarter. The Company was in compliance with all Credit Agreement covenants as ofSeptember 30, 2022 . 29 --------------------------------------------------------------------------------
Revolving Credit Loans
The 2021 Credit Agreement also provides for the Revolving Credit Loans pursuant to an unfunded revolver commitment for borrowing up to$40.0 million . As ofSeptember 30, 2022 , there was$39.4 million available capacity for borrowing under the revolving loan commitment due to the$0.6 million of letters of credit outstanding (See Note 9 - Commitments and Contingencies).
2016 Credit Agreement and Revolving Credit Facility
OnDecember 9, 2016 , certain subsidiaries of the Company entered into a credit agreement, or 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 loan borrowings of$340.0 million and the second lien facility of$125.0 million were to mature onDecember 9, 2022 andDecember 9, 2023 , respectively. The 2016 Credit Agreement also provided for an unfunded revolver commitment for borrowing up to$30.0 million , maturing onJune 9, 2022 . The initial term loan and the revolving credit facility were repaid and retired onFebruary 8, 2021 and the second lien facility was repaid onDecember 19, 2019 . The Company incurred a loss on debt extinguishment of$7.3 million during the three months endedMarch 31, 2021 in connection with the retirement of the first lien facility and the revolving credit facility.
Convertible Debentures
OnDecember 19, 2019 , the Company issued Debentures in an aggregate principal amount of$200 million . AtSeptember 30, 2022 andDecember 31, 2021 , the balance due under the Convertible Debentures was$236.4 million and$229.4 million , respectively. This increase is due to the quarterly accruals of PIK interest. The Debentures mature onDecember 19, 2024 unless earlier converted, redeemed or repurchased, and bear interest at an annual rate of 4.00% in cash, payable quarterly, and 4.00% in kind, accrued quarterly, on the last business day of March, June, September and December. In addition, on each anniversary of the Closing Date, the Company will increase the principal amount of the Debentures by an amount equal to 3.00% of the original aggregate principal amount of the Debentures outstanding (subject to reduction for any principal amount repaid). The additional payment will accrue from the last payment date for the additional payment (or the Closing Date if no prior payment has been made), and will also be payable at maturity, upon conversion and upon an optional redemption. At any time, upon notice as set forth in the Debentures, the Debentures are redeemable at the Company's 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. The Debentures are convertible into shares of 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. OnJune 16, 2022 , pursuant to the contractual requirement with the holders of the Debentures, at the 2022 Annual Meeting of Stockholders, the Company's stockholders approved a proposal to approve the issuance of shares of Common Stock in connection with the conversion of the Debentures into shares of Common Stock. In the event the Company elects to redeem any Debentures, the holders have a right to purchase Common Stock from the Company in an amount equal to the amount redeemed at the conversion price. The Debentures contain covenants that limit the Company's ability to, among other things: (i) incur additional debt; (ii) create liens on assets; (iii) engage in certain transactions with affiliates; or (iv) designate the Company's 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. As ofSeptember 30, 2022 , the Company was in compliance with all Debenture covenants.
Our net cash flows from operating, investing and financing activities for the
nine months ended
Nine Months Ended Nine Months Ended
(in thousands) September 30, 2022 September 30, 2021
Net cash (used in) provided by:
Operating activities $ 2,049 $ 7
Investing activities $ (10,498 ) $ (9,708 )
Financing activities $ (3,842 ) $ 661
Effect of foreign exchange rates $ (1,304 ) $ (375 )
Net decrease in cash $ (13,595 ) $ (9,415 )
30--------------------------------------------------------------------------------
Cash Flows Provided by Operating Activities
Net cash provided by operating activities was$2.0 million compared to net cash used in operating activities of$0.0 million for the nine months endedSeptember 30, 2022 and 2021, respectively. The increase in net cash provided by operating activities is due to increase in cash provided by working capital of$20.1 million and decreased net loss of$15.1 million , partially offset by decreased non-cash items of$33.1 million . The increase of$20.1 million in cash provided by working capital is primarily due to a$12.6 million decrease in accounts receivables and a$7.5 increase in accounts payable and accrued expenses, a$1.0 million decrease in prepaid expenses and other assets partially offset by a$1.0 million decrease in deferred revenue. Accounts Receivable and Accounts Payable fluctuate from period-to-period depending on the timing of purchases and payments. Net cash provided by operating activities for the nine months endedSeptember 30, 2022 includes$1.5 million of capitalized implementation costs used for cloud computing agreements reflecting the implementation of ASU 2018-15. Prior to the implementation of ASU 2018-15 capitalized implementation costs related to cloud computing agreements were included in investing activities.
Cash Flows Used in Investing Activities
Net cash used in investing activities was$10.5 million for the nine months endedSeptember 30, 2022 as compared to net cash used in investing activities of$9.7 million for the nine months endedSeptember 30, 2021 . The increase in cash used is due to a$2.7 million increase in purchases of property and equipment, partially offset by$1.9 million of capitalized implementation costs related to cloud computing agreements for the nine months that endedSeptember 30, 2021 that are classified in operating cash flows in the current year as a result of the implementation of ASU 2018-15.
Cash Flows Used in/Provided by Financing Activities
For the nine months endedSeptember 30, 2022 , net cash used in financing activities was$3.8 million related to the payments of long-term debt of$2.3 million and capital lease obligations of$1.6 million . For the nine months endedSeptember 30, 2021 , net cash provided by financing activities was$0.7 million and included the proceeds of long-term debt, net of original discount of$294.0 million , partially offset by the retirement of long-term debt of$289.0 million , debt acquisition costs of$2.0 million , payments of long-term debt and capital lease obligations of$0.8 million and$1.5 million , respectively.
Capital Resources and Material Cash Requirements
A summary of our capital resources and material cash requirements is presented
in Part II, Item 7 of our Annual Report . Other than as described above,
there were no material changes to our capital resources and material cash
requirements during the nine months ended
Recent Accounting Pronouncements
There were no changes to our recent accounting pronouncements from those described in our Annual Report.
Critical Accounting Policies and Estimates
We prepare our condensed 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.
© Edgar Online, source
