Income Tax Receivable Agreement
In connection with the Company’s IPO during the fourth quarter of 2021, the Company entered into the TRA, which provides for the payment by the Company over a period of approximately 12 years to pre-IPO equityholders or their permitted transferees of 85% of the benefits, if any, that the Company and its subsidiaries realize, or are deemed to realize (calculated using certain assumptions) in U.S. federal, state, and local income tax savings as a result of the utilization (or deemed utilization) of certain existing tax attributes. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year. Actual tax benefits realized by the Company may differ from tax benefits calculated under the TRA as a result of the use of certain assumptions in the TRA, including assumptions relating to state and local income taxes, to calculate tax benefits. The Company will record an estimated total liability of approximately $209.9 million and a reduction to Additional paid-in capital of approximately $209.9 million in connection with the TRA during the fourth quarter of 2021 on its condensed consolidated balance sheets.
Employee Stock Purchase Plan
On October 18, 2021, the Company’s stockholders adopted the Company’s Employee Stock Purchase Plan (the “ESPP”), which became effective on October 28, 2021. The Company initially reserved 1,587,810 shares of common stock for future issuance under the ESPP, subject to an annual increase on the first day of each calendar year, beginning on January 1, 2022 and ending on and including January 1, 2031. The annual increase is equal to the least of (i) 1% of the aggregate number of shares of common stock outstanding on the final day of the immediately preceding calendar year, (ii) 1,587,810 shares of common stock, and (iii) such smaller number of shares as determined by the board of directors. No offering periods under the ESPP had been initiated as of September 30, 2021.
Omnibus Incentive plan
On October 18, 2021, the Company’s stockholders adopted the Company’s 2021 Omnibus Incentive Plan (the “Omnibus Incentive Plan”). The Omnibus Incentive Plan was approved by the Company’s stockholders on October 18, 2021 and became effective on October 15, 2021. Upon the adoption of the Omnibus Incentive Plan, the Company will not grant further awards under the Equity Plan. The Omnibus Incentive Plan provides for the grant of awards of non-qualified stock options, incentive (qualified) stock options, stock appreciation rights, restricted stock awards, restricted stock units, other stock-based awards, other cash-based awards or any combination of the foregoing to eligible employees, consultants, directors, and officers. The Omnibus Incentive Plan has a term of 10 years. Pursuant to the Omnibus Incentive Plan, the Company has reserved an aggregate of 7,939,051 shares of the Company’s common stock for issuance of awards to be granted thereunder, subject to an annual increase equal to the lesser of (a) 4% of the aggregate number of shares of common stock outstanding on the final day of the immediately preceding calendar year and (b) such smaller number of shares as is determined by our board of directors. No more than 7,939,051 shares of the Company’s common stock may be issued pursuant to the exercise of incentive stock options granted under the Omnibus Incentive Plan.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
IPO Equity GrantsThe components of the restructuring charges (including professional service fees) are as follows:
| | | | | | | | |
| | Three Months Ended March 31, |
| | 2023 |
| | (in thousands) |
Severance and benefits (1) | | $ | 4,386 | |
Accelerated expense on abandoned right-of-use assets (2) | | 1,482 | |
Professional fees (3) | | 4,006 | |
| Total restructuring charges | | $ | 9,874 | |
In October 2021, the Company's board(2)Charges for accelerated expense on abandoned right-of-use assets recorded in selling, general and administrative expenses.
(3)Professional service fees consist of directors granted 1,035,986 equity awards to certain named executive officers under the Omnibus Incentive Plan. The total dollar amount of equity awards grantedconsulting costs related to the named executive officers was $9,250,000, $4,625,000 of which was granted in the form of options to purchase sharesexecution of the Company’s common stockglobal restructuring plan to improve the Company’s cost structure, operating efficiency, and $4,625,000redesign and right size the organization. These charges are recorded in selling, general and administrative expenses.
The following table provides the components of and changes in the Company’s restructuring and related charges, included in accrued salaries and payroll and accrued expenses and other current liabilities on the condensed consolidated balance sheets:
| | | | | | | | |
| | March 31, 2023 |
| | (in thousands) |
| Balance at December 31, 2022 | | $ | — | |
Charges incurred (1) | | 8,392 | |
| Payments | | (971) | |
| Balance at March 31, 2023 | | $ | 7,421 | |
(1)Includes $4.4 million in charges for employee severance and benefits related to the workforce reduction, all of which was granted in the formremains unpaid as of Restricted Stock Units (“RSUs”) covering shares of the Company’s common stock. The options will vest with respect to 25% of the underlying shares on the first anniversary of their grant date, and with respect to the remaining 75% of the underlying shares in 12 equal quarterly installments thereafter.The RSUs will vest in four installments, each with respect to 25% of the underlying shares, on November 15, 2022, November 15, 2023, November 15, 2024, and November 15, 2025. Each equity award is subject to the terms and conditions of the Omnibus Incentive Plan and an award agreement with the applicable grantee.
In addition to the awards to certain named executive officers, the Company granted equity awards to approximately 106 employees in senior leadership positions.These awards are structured like the executive officer awards, except that some individuals’ awards will be divided 75% RSUs and 25% options. The aggregate equity awards issued consisted of 436,375 RSUs and 1,142,308 options to purchase shares of the Company’s common stock. Further, the Company granted equity awards to the Company’s eight non-employee directors.The aggregate of the non-employee director awards granted was 34,736 equity awards, entirely in the form of RSUs. The equity awards for the Company’s 8 non-employee directors shall, subject to continued service, vest on the first anniversary of the date of their issuance, or if earlier, upon (but effective immediately prior to) the occurrence of a change in control as defined in the governing plan, or the annual meeting of stockholders next following the grant of such annual equity awards.
Revolving Credit Facility
On November 5, 2021, the Company repaid the $10.0 million outstanding principal amount on the Revolving Credit Facility.
Legal Settlement Payment
On November 15, 2021, the Company paid $11.2 million of the $12.1 million legal settlement agreement discussed in Note 13 — Legal Proceedings and expects to pay the balance by the end of 2021.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of theour financial condition and results of operations for HireRight together with our condensed consolidated financial statements and the accompanying notes included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements for the fiscal year ended December 31, 2022, as disclosed in the Company’s prospectus, dated October 28, 2021,Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) in accordance with Rule 424(b) of the Securities Act on November 1, 2021 (the “Prospectus”) in connection with our initial public offeringMarch 9, 2023 (“IPO”Annual Report”). See Initial Public Offering below for additional information.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q and related statements by the Company contain forward-looking statements within the meaning of the federal securities laws that are subject to risks and uncertainties. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business.laws. You can often identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may includefacts, or by their use of words such as “anticipate,” “estimate,” “expect,” “project,” “forecast,” “plan,” “intend,” “believe,” “seek,” “could,” “targets,” “potential,” “may,” “will,” “should,” “can have,” “likely,” “continue,” and other terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. Forward-looking statements may include, but are not limited to, statements concerning our anticipated financial performance, including, without limitation, revenue, profitability, net income (loss), adjusted EBITDA, adjusted EBITDA margin, adjusted net income, earnings per unit,share, adjusted diluted earnings per share, and cash flow; strategic objectives; investments in our business, including development of our technology and introduction of new offerings; sales growth and customer relationships; our competitive differentiation; our market share and leadership position in the industry; market conditions, trends, and opportunities; future operational performance; pending or threatened claims or regulatory proceedings; and factors that could affect these and other aspects of our business. These
Forward-looking statements are not guarantees of future performance; theyguarantees. They reflect our current viewsexpectations and projections with respect to future events and are based on assumptions and estimates and subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from expectations or results projected or implied by forward-looking statements. These risks
Factors that could affect the outcome of the forward-looking statements include, among other things, our vulnerability to adverse economic conditions, including without limitation inflation and recession, which could increase our costs and suppress labor market activity and our revenue; the following, as well as other risksaggressive competition we face; our heavy reliance on information management systems, vendors, and uncertainties not listed hereinformation sources that may be importantnot perform as we expect; the significant risk of liability we face in the services we perform; the fact that data security, data privacy and data protection laws, emerging restrictions on background reporting due to you.
•We have no assurance of future business from anyalleged discriminatory impacts and adverse social consequences, and other evolving regulations and cross-border data transfer restrictions may increase our costs, limit the use or value of our customers;
•We rely upon third parties for the data we need to deliver our services;
•We rely upon third parties to fulfill our service obligations to our customers;
•We rely upon third parties for integration with many of our customers;
•Third parties are the sole available source for some of the dataservices and services upon which we rely;
•We intend to rely, in part, on acquisitions to help grow our business, and such acquisitions may not produce the benefits we expect or may adversely affect or disrupt our business;
•We must attract, motivate, train, and retain the management, technical, market-facing, and operational personnel we need to enable the success and growth of our business;
•COVID-19 has had, and may continue to have, a materially adverse effect on our business;
•Forecasts of market growth may prove to be inaccurate, and even if the market in which we compete achieves the forecasted growth, our business may not grow at similar rates, if at all;
•Our operating results may fluctuate significantly, be difficult to predict, and fall below analysts' and investors' expectations;
•Significant governmental regulation exposes us to substantial costs and liabilities and can limit our business opportunities;
•Current or potential legal proceedings could subject us to significant monetary damages or restrictions on our ability to do business;
•Credit reporting laws that regulatemaintain our business impose significant operational requirementsprofessional reputation and liability risks;
•Domesticbrand name; social, political, regulatory and international data privacy laws impose significant operational requirementslegal risks in markets where we operate; the impact of foreign currency exchange rate fluctuations; unfavorable tax law changes and liability risks;
•We can incur significant liability for information that we omit in background reports;
•We may be subject to and in violation of state private investigator licensing laws and regulations;
•We are subject to government regulations concerning our employees, including wage-hour laws and taxes;
•We may be subject to intellectual property rights claims by third parties;
•Our contractual indemnities, limitations of liability, and insurance may not adequately protect us;
•Liabilities we incur in the coursetax authority rulings; any impairment of our business may be uninsurable, or insurance may be very expensive and limited in scope;
•Security breaches and improper use of information may negatively impact our business and harm our reputation;
•System failures could delay and disrupt our services, cause harm to our business and reputation and result in a loss of customers;
•If we fail to upgrade, enhance and expand our technology and services to meet customer needs and preferences, the demand for our services may materially diminish;
•Our technology development operations are centered in Estonia, exposing us to risks that may be difficult to manage;
•If we are unable to protect our proprietary technologygoodwill, other intangible assets and other intellectual property rights, it may reducelong-lived assets; our ability to compete for businessexecute and we may experience reduced revenue and incur costly litigation to protect our rights;
•Changes to the availability and permissible uses of consumer data may reduce the demand for our services;
•We operate in an intensely competitive market and we may not be able to develop and maintain competitive advantages necessary to support our growth and profitability;
•Growth will require us to improve our operating capabilities;
•Our business is vulnerable to economic downturns;
•If we do not introduce successful new products, services and analytical capabilities in a timely manner, or if the market does not adopt our new services, our competitiveness and operating results will suffer;
•Our existing indebtedness could adversely affect our business and growth prospects;
•The terms and conditions of our credit agreements restrict our current andintegrate future operations, particularlyacquisitions; our ability to respond to changesaccess additional credit or to take certain actions;
•We may not be able to generate sufficient cash flow to service allother sources of our indebtedness,financing; and may be forced to take other actions to satisfy our obligations under such indebtedness, including refinancing such indebtedness, which may not be successful;
•Inability to obtain financing could limit our ability to conduct necessary operating activitiesthe increased cybersecurity requirements, vulnerabilities, threats and make strategic investments;
•Failure to successfully execute our international plans will adversely affect our growthmore sophisticated and operating results;
•Operating in multiple countries requires us to comply with different legal and regulatory requirements;
•We are subject to governmental export and import controlstargeted cyber-related attacks that could subject uspose a risk to liability or impair our ability to compete in international markets;
•Fluctuations insystems, networks, solutions, services and data. For more information on the exchange rates of foreign currencies could result in currency transaction losses;
•Investment funds managed by General Atlanticbusiness risks we face and investment funds managed by Stone Point (together, the “Principal Stockholders”) control us, and their interests may conflict with ours or yours in the future;
•We are an “emerging growth company,” and we expect to elect to comply with reduced public company reporting requirements, which could make our common stock less attractive to investors;
•The requirements of being a public company strain our resources and distract our management, which could make it difficult to manage our business;
•Failure to maintain effective internal controls over financial reporting could cause our investors to lose confidence in us and adversely affect the market price of our common stock. If our internal control over financial reporting is not effective, we may not be able to accurately report our financial results or prevent fraud;
•We have identified material weaknesses in our internal control over financial reporting and may identify additional material weaknesses in the future or otherwise fail to maintain effective internal control over financial reporting, which may result in material misstatements of our consolidated financial statements or cause us to fail to meet our periodic reporting obligations.
•Provisions of our corporate governance documents could make an acquisition of us more difficult and may prevent attempts by our stockholders to replace or remove our current management;
•Our certificate of incorporation limits the forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees;
•We will be required to pay certain pre-IPO owners or their transferees for certain tax benefits over a period of approximately 12 years pursuant to the income tax receivable agreement (the “TRA”), which amounts to an estimated total liability of approximately $209.9 million. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year;
•We will not be reimbursed for any payments made to certain pre-IPO owners (or their transferees or assignees) under the TRA in the event that any tax benefits are disallowed;
•In certain cases, payments under the TRA to certain pre-IPO owners or their transferees may be accelerated or significantly exceed any actual benefits we realize in respect of the tax attributes subject to the TRA;
•We may have exposure to greater than anticipated tax liabilities and may be affected by changes in tax laws or interpretations;
•The multinational nature of our business can expose us to unexpected tax consequences, which may be adverse;
•We may be subject to examinations of our tax returns by the IRS or other tax authorities, and an adverse outcome could have a material adverse effect on our business;
•An active, liquid trading market for our common stock may not develop, which may constrain the market price of our common stock and limit your ability to sell your shares;
•Our operating results and stock price may be volatile, and the market price of our common stock may drop below the price you pay;
•Future sales of substantial amounts of our common stock, or the possibility that such sales could occur, could adversely affect the market price of our common stock;
•You may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it;
•Our stock price and trading volume could decline due to the action or inaction of securities or industry analysts;
•Our equity-based compensation and acquisition practices expose our stockholders to dilution;
•We could be negatively affected by actions of activist stockholders;
•We may issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of our common stock.
All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are qualified in their entirety by these cautionary statements as well as other cautionary statements that are made from time to time in our other filings with the Securities and Exchange Commission (SEC) and public communications. We discuss many of these risks and additional factors that could cause actual results to differ materially from those anticipated by ouraffect the outcome of forward-looking statements, underrefer to our Annual Report on Form 10-K filed with the headingsSEC on March 9, 2023, in particular the sections of that document entitled "Risk Factors"Factors," "Cautionary Note Regarding Forward-Looking Statements and Risk Factors Summary," and "Management's Discussion and Analysis of Financial Condition and Results of Operations,"” and elsewhere in the Prospectus, this Quarterly Report on Form 10-Q, and in other filings we have made and will make from time to time with the Securities and Exchange Commission. These forward-looking statements represent our estimates and assumptions only as of the date made. Unless required by federal securities laws, we assumeSEC. We undertake no obligation to update publicly any of these forward-looking statements, whether as a result of new information, future events or to update the reasons actual results could differ materially from those anticipated, to reflect circumstances or events that occur after the statements are made. Without limiting the foregoing, any guidance we may provide will generally be given only in connection with quarterly and annual earnings announcements, without interim updates, and we may appear at industry conferences or make other public statements without disclosing material nonpublic information in our possession. Given these uncertainties, investors should not place undue reliance on these forward-looking statements.otherwise.
Investors should read this Quarterly Report on Form 10-Q and the documents that we reference in this report and have filed or will file with the SEC completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.
Business Overview
HireRight Holdings Corporation (“HireRight” or the “Company”) is a leading global provider of technology-driven workforce risk management and compliance solutions. We provide comprehensive background screening, verification, identification, monitoring, and drug and health screening services for more than 40,000approximately 38,000 customers across the globe. We offer our services via a unified global software and data platform that tightly integrates into our customers’ human capital management (“HCM”) systems enabling highly effective and efficient workflows for workforce hiring, onboarding, and monitoring. In 2020,2022, we
delivered reports on screened over 2024 million job applicants, employees and contractors for our customers and processed over 80107 million screens.
HireRight GIS Group Holdings LLC (“HGGH”), was formed in July 2018 through the combination of two groups of companies, the HireRight Group and the GIS Group (“GIS”), each of which includes a number of wholly owned subsidiaries that conduct the Company’s business within the United States of America ( the “U.S.”), as well as countries outside the U.S. Since July 2018, the combined group of companies and their subsidiaries have operated as a unified operating company providing background screens globally, predominantly under the HireRight brand.
On October 15, 2021, HGGH converted into a Delaware corporation and changed its name to HireRight Holdings Corporation (“HireRight” or the “Company”). In conjunction with the conversion, all of HGGH’s outstanding equity interests were converted into shares of common stock of HireRight Holdings Corporation. The foregoing conversion and related transactions are referred to herein as the “Corporate Conversion”. The Corporate Conversion did not affect the assets and liabilities of HGGH, which became the assets and liabilities of HireRight Holdings Corporation.
Initial Public Offering
On November 2, 2021, the Company completed its IPO in which the Company issued and sold 22,222,222 shares of its common stock, $0.001 par value per share at an offering price of $19.00 per share. The Company received net proceeds of $393.5 million, after deducting underwriting discounts and commissions of $23.2 million and other offering costs payable by the Company of approximately $5.5 million. The Company granted the underwriters an option for a period of 30 days to purchase up to an additional 3,333,333 shares of common stock at $19.00 per share less discounts and commissions. The underwriters have until November 27, 2021 to exercise their option to purchase additional shares.
Use of Proceeds
On November 3, 2021, the Company used approximately $215.0 million of the net proceeds from the IPO to repay, in full, indebtedness under the Second Lien Term Loan Facility. In addition, the Company recorded a $3.4 million write off of unamortized deferred financing fees and unamortized original issue discounts related to the repayment of debt under the Second Lien Term Loan Facility. The Company plans to use approximately $100.0 million of proceeds of the IPO to repay, in part, the First Lien Term Loan Facility and no longer expects to incur swap breakage fees of approximately $4.2 million.
Factors Affecting Our Results of Operations
Economic Conditions
Our business is impacted by the overall economic environment and COVID-19
total employment and hiring. The global COVID-19 pandemic has caused significant disruption torapidly changing dynamics of the global economyworkforce are creating increased complexity and regulatory scrutiny for employers, bolstering the importance of the solutions we deliver. We have benefited from key demand drivers, which increase the need for more flexible, comprehensive screening and hiring solutions in particular,the current environment. Our customers are a diverse set of organizations, from large-scale multinational businesses to small and medium businesses across a broad range of industries, including transportation, healthcare, technology, financial services, business and consumer services, manufacturing, education, retail and not-for-profit. Hiring requirements and regulatory considerations can vary significantly across the different types of customers, geographies and industry sectors we serve, creating demand for the extensive institutional knowledge we have developed from our decades of experience.
While we have benefited in the past from the changing dynamics of the labor market. There is considerablemarket, including strength in hiring as the economy recovered from the effects of the COVID pandemic, our business has been adversely affected by recent and continuing uncertainty regarding the extentaround near term macroeconomic conditions. This uncertainty stems from high inflation, declining customer confidence, volatile energy prices, rising interest rates, geopolitical concerns, supply chain disruptions and labor shortages. Each of thethese drivers has its own adverse impact and the durationoutlook for our business in 2023 remains uncertain, with order volumes and revenue anticipated to fall below 2022 levels. In 2022, the annual inflation rate in the United States reached nearly the highest rate in more than three decades, as measured by the Consumer Price Index, and remains elevated. Inflation puts pressure on our suppliers, resulting in increased data costs, and also increases our employment and other expenses. A sustained recession will have an adverse impact on the global hiring market and therefore the demand for our services. Slowing demand for our services will adversely affect our future results. Additionally, rising interest rates will lead directly to higher interest expense. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk” for additional information on the impact of interest rates and inflation on our business. Although the majority of our cost of services is variable in nature and will move in tandem with revenue increases or decreases, there can be no assurance that we can reduce our cost of services in proportion to changes in revenue.
2023 Developments
On November 13, 2022, the Company's Board of Directors authorized a share repurchase program (“Program”). The Program authorizes the Company to repurchase up to $100.0 million of the global COVID-19 pandemic.Company’s common stock, par value $0.001, and will expire on November 14, 2024, or earlier if the repurchases reach $100.0 million before that date. Through March 31, 2023, the Company repurchased 3,791,229 shares of common stock for $42.3 million, including commissions paid and excise taxes, at an average price paid of $11.17 per share. The future impact of COVID-19 on our operational and financial performance will dependrepurchased shares are recorded as “Treasury stock” on the effect on our customers and vendors, allCompany's consolidated balance sheets. As of which continue to be uncertain at this time. Our financial results and prospects are largely dependent onMarch 31, 2023, approximately $57.7 million remained available for future purchases under the number of hires andProgram. Repurchases under the total level of employment. Unemployment in our primary market, the US, reached nearly 15% during the peak of the 2020 pandemic and monthly hiring slowed to less than 4 million in April 2020 according to the Bureau of Labor Statistics.
Our results of operations for the three and nine months ended September 30, 2021 show a significant increase from the prior year period, due to improvement in the global employment market. The peak of the pandemic impact occurred during April and May of 2020, and we began to see a steady recovery in the second half of the year. The weakness experienced in the first half of 2020 and the associated recovery largely impacted all industries we serve. We are a highly diversified business with no industry representing more than 15% of our total revenue. Transportation, healthcare and technology customers represent the largest contributors to revenue. Transportation
Program continued at similar rates through the date of filing of this report, and healthcare annual revenues declined in conjunction with overall revenue declines while technology showed limited growth largely driven by the additionBoard of two larger customers duringDirectors has not yet determined whether to renew the year.Program following its termination.
In the first quarter of 2023, the Company began a global restructuring plan intended to improve the Company’s cost structure, operating efficiency, and profitability in response to ongoing uncertain macroeconomic conditions. The plan, which involves a reduction in force, offshoring of certain functions, and other measures designed to reduce cost and compensate for reduced order volumes, was initiated in the pandemic,first quarter of 2023 and is expected to continue throughout 2023 and early 2024 as the Company implements existing plans and evaluates further opportunities. During the three months ended March 31, 2023, the Company recognized restructuring charges of $5.9 million, primarily for employee severance and benefits in connection with the workforce reduction and accelerated rent expense on abandoned right-of-use assets. In addition, the Company incurred professional service fees of $4.0 million for consulting costs related to the execution of the Company’s global restructuring plan.
The Company expects to recognize additional restructuring charges in 2023 and early 2020,2024 of approximately $15.0 million to $20.0 million, primarily for severance and benefits, professional service fees, and transition costs. Once completed we implementedestimate annualized gross savings of approximately $50.0 million under the global restructuring plan. Additionally, we may not be able to fully realize the cost savings and benefits initially anticipated from the global restructuring plan, and the expected charges may be greater than expected, including charges for additional operational processes to monitor customer salesseverance and collections, taking precautionary measures to ensure sufficient liquidity and adjusting operations to ensure business continuity, including borrowing $50 million against our $100 million revolving credit facility, of which $40 million was repaid by December 31, 2020. Since April 2020, substantially all of our employees have been working from home. To the extent we are operating from our facilities, we have implemented protocols reflecting the recommendations published by the U.S. Centers for Disease Control, the World Health Organization and country, state and local governments.professional service fees.
Key Components of Our Results from Operations
Revenues
The Company generates revenues from background screening and related compliance services delivered in online reports. Our customers place orders for our services and reports either individually or through batch ordering. Each report is accounted for as a single order which is then typically consolidated and billed to our customers on a monthly basis. Approximately 29%27% and 30%29% of revenues for each of the ninethree months ended September 30, 2021March 31, 2023, and 2020,2022, respectively, were generated from the Company’s top 50 customers, which consist of large U.S. and multinational companies across diversified industries such as transportation, healthcare, technology, business and consumer services, financial services, manufacturing, education, retail and not-for-profit. None of the Company’s customers individually accounted for greater than 5% and 6%3% of revenues duringfor each of the ninethree months ended September 30, 2021March 31, 2023, and 2020,2022, respectively. Healthcare, technology, financial services, and transportation customers represent the largest contributors to revenues. Revenues for the three months ended March 31, 2023, from these customers decreased 15% from the prior year period, led by reductions in order volumes from technology companies.
Revenues consist of service revenues and surcharge revenues. Service revenues represent fees charged to customers for performing screening and compliance services. Surcharge revenues consist of fees charged to customers for obtaining data required to fulfill the Company’s performance obligations from federal, state and local jurisdictions as well as fees charged by certain commercial data wholesalers. These fees are predominantly charged to the Company’s customers at cost. Revenue is recognized when the Company satisfies its obligation to complete the service and delivers the screening report to the customer. The Company relies on service revenue to generate cash from operations. Furthermore, only service revenue impacts the operating income or loss as surcharge revenue is predominantly offset by corresponding expenses recognized in costExpenses
Cost of services (excluding depreciation and amortization) consists of data acquisition costs, medical laboratory and collection fees, personnel-related costs for operations, customer service and customer onboarding functions, as well as other direct costs incurred to fulfill our services. Approximately 80% of cost of services is variable in nature.
Selling, general and administrative expenses consist of personnel-related costs for sales, technology, administrative and corporate management functions in addition to costs for third-party technology, professional and consulting services, advertising and facilities expenses. Selling, general and administrative expenses also include amortization of capitalized cloud computing software costs.
Depreciation and amortization expenses consist of depreciation of property and equipment, as well as amortization of purchased and developed software and other intangible assets.
Other expenses consist of interest expense relating to our credit facilities and interest rate swap agreements, gains and losses on theasset disposal, foreign exchange gains and losses, as well as other expenses. On our condensed consolidated statementstatements of operations.
payables are denominated in U.S. dollars, but we also earn revenue, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the Euro, the British pound, the Polish zloty, the Australian dollar, the Canadian dollar, the Singapore dollar, the Mexican peso, the Japanese yen, and the Indian rupee, among others. Therefore, increases or decreases in the value of the U.S. dollar against these currencies could result in realized and unrealized gains and losses in foreign exchange. However, to the extent we earn revenues in currencies other than the U.S. dollar, we generally pay a corresponding amount of expenses in such currency and therefore the cumulative impact of these foreign exchange fluctuations is not generally deemed material to our financial performance.
Income tax expense (benefit) consists of international, U.S. federal, state and local income taxes based on income in multiple jurisdictions for our subsidiaries.
Results of Operations
Comparison of Results of Operations for the three and nine months ended September 30, 2021March 31, 2023 and 20202022
The following table presentstables present operating results for the three and nine months ended September 30, 2021March 31, 2023 and 2020.2022.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2023 | | 2022 |
| (in thousands, except percent of revenues) |
| Revenues | $ | 175,447 | | | 100.0 | % | | $ | 198,711 | | | 100.0 | % |
| | | | | | | |
| Expenses | | | | | | | |
| Cost of services (exclusive of depreciation and amortization below) | 98,451 | | | 56.1 | % | | 112,403 | | | 56.6 | % |
| Selling, general and administrative | 59,726 | | | 34.0 | % | | 48,267 | | | 24.3 | % |
| Depreciation and amortization | 18,417 | | | 10.5 | % | | 18,061 | | | 9.1 | % |
| Total expenses | 176,594 | | | 100.7 | % | | 178,731 | | | 89.9 | % |
| Operating income (loss) | (1,147) | | | (0.7) | % | | 19,980 | | | 10.1 | % |
| | | | | | | |
| Other expenses | | | | | | | |
| Interest expense, net | 12,402 | | | 7.1 | % | | 7,557 | | | 3.8 | % |
| Other expense, net | 306 | | | 0.2 | % | | 41 | | | — | % |
| Total other expenses | 12,708 | | | 7.2 | % | | 7,598 | | | 3.8 | % |
| Income (loss) before income taxes | (13,855) | | | (7.9) | % | | 12,382 | | | 6.2 | % |
| Income tax expense (benefit) | (5,944) | | | (3.4) | % | | 818 | | | 0.4 | % |
| Net income (loss) | $ | (7,911) | | | (4.5) | % | | $ | 11,564 | | | 5.8 | % |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands) |
| Revenues | $ | 204,981 | | | $ | 130,674 | | | $ | 531,522 | | | $ | 390,121 | |
| | | | | | | |
| Expenses | | | | | | | |
| Cost of services (exclusive of depreciation and amortization below) | 111,328 | | | 69,683 | | | 295,832 | | | 215,143 | |
| Selling, general and administrative | 47,652 | | | 48,347 | | | 130,261 | | | 128,583 | |
| Depreciation and amortization | 19,531 | | | 19,808 | | | 56,013 | | | 58,283 | |
| Total expenses | 178,511 | | | 137,838 | | | 482,106 | | | 402,009 | |
| Operating income (loss) | 26,470 | | | (7,164) | | | 49,416 | | | (11,888) | |
| | | | | | | |
| Other expenses | | | | | | | |
| Interest expense | 18,518 | | | 18,597 | | | 54,674 | | | 56,930 | |
| Other expense (income), net | 22 | | | (185) | | | 125 | | | 628 | |
| Total other expense | 18,540 | | | 18,412 | | | 54,799 | | | 57,558 | |
| Income (loss) before income taxes | 7,930 | | | (25,576) | | | (5,383) | | | (69,446) | |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | |
| Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands) |
| Revenues | | | |
| Service revenues | $ | 152,332 | | | $ | 98,587 | | | $ | 395,624 | | | $ | 294,175 | |
| Surcharge revenues | 52,649 | | | 32,087 | | | 135,898 | | | 95,946 | |
| Total revenues | $ | 204,981 | | | $ | 130,674 | | | $ | 531,522 | | | $ | 390,121 | |
Revenues
Three months ended
Total revenues increased by $74.3 million, or 56.9%, to $205.0 million,Revenues for the three months ended September 30, 2021 comparedMarch 31, 2023 decreased to the three months ended September 30, 2020. We continued to see$175.4 million, a recoverydecrease of $23.3 million, or 11.7%, from the impact of COVID-19, with strengthening client volumes surpassing the COVID-impacted prior year period. The increase in total revenues was broad-basedprior-year period, primarily across existing customers, while new business revenue, as defined below, increased from $9.4 million to $10.9 million, driven by saleslower order volume from existing customers. Of the total $23.3 million decrease, $19.0 million was related to avolume reductions associated with our technology and services customers, as both have recently acquired large customer. Service revenuesundertaken efforts to rightsize their workforce in response to macroeconomic
increased $53.7pressures. Revenues from our remaining customer groups represented a net decrease of $4.3 million due to lower volumes.
From a geographical perspective, revenues from international regions decreased by $1.6 million, or 54.5%10.3%, and surcharge revenues increased $20.6from the United States decreased by $21.7 million, or 64.1%11.8%, during the three months ended March 31, 2023, compared to the three months ended September 30, 2020. Revenues from international and domestic regions increased by $8.2 million, or 106.1% and by $66.1 million, or 53.8%, respectively, duringMarch 31, 2022. The strengthening of the U.S. dollar against the British pound in the three months ended September 30, 2021March 31, 2023, compared to the three months ended September 30, 2020. Both service and surchargesame period in 2022 had an unfavorable impact on revenue increases were primarily volume driven. Also contributing to the increasesfrom international regions. On a constant currency basis, United Kingdom revenues would have been $1.1 million higher than actual revenues. Constant currency represents current period results that have been retranslated using exchange rates in surcharge revenues were increases in data supplier costs, which are charged to our customerseffect in the form of increased surcharges.
Nine months ended
Total revenues increased by $141.4 million, or 36.2%, to $531.5 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, primarily due to increases in volume, which surpassed the COVID-impacted prior yearcomparable period. Revenues from international and domestic regions increased $13.8 million, or 52.4% and by $127.6 million, or 35.1%, respectively, during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. Service revenues increased $101.4 million, or 34.5%, and surcharge revenues increased $40.0 million, or 41.6% compared to the prior year period. While growth was primarily volume driven, a portion of the increase in surcharge revenues was due to data supplier cost increases, which are charged to our customers in the form of increased surcharges.
Cost of Services (exclusive of depreciation and amortization below)
Three months ended
Cost of services increased $41.6 million, or 59.8%, to $111.3 million, for the three months ended September 30, 2021 comparedMarch 31, 2023 decreased to $98.5 million, a decrease of $14.0 million, or 12.4%, from the three months ended September 30, 2020prior-year period, primarily due to higher clientlower order volumes, over the COVID- impacted prior year period.decreased use of contract labor, and lower average labor costs per background screen. The decreases in costs of services were partially offset by higher data costs, increases in severance expenses, and increased incentive compensation and fringe benefit programs to keep up with market conditions. Cost of services as a percent of revenue increasedrevenues decreased to 54.3%56.1% for the three months ended September 30, 2021March 31, 2023, compared to 53.3%56.6% for the three months ended September 30, 2020March 31, 2022, primarily driven by increased third-party data costs.
Nine months ended
Cost of services increased $80.7 million, or 37.5%, to $295.8 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to higher volumes and, to a lesser extent, increased data costs. Cost of serviceslower average labor costs per background screen as a percentresult of revenue increased slightly to 55.7% forprocess improvements associated with our technology initiatives as well as a decrease in the nine months ended September 30, 2021 compared to 55.1% for the nine months ended September 30, 2020 primarily driven by increased third-party data costs.use of contract labor.
Selling, General and Administrative
Three months ended
Selling, general and administrative expenses (“SG&A”) decreased $0.7 million, or 1.4% to $47.7 million, for the three months ended September 30, 2021 comparedMarch 31, 2023 increased $11.5 million to $59.7 million primarily due to increases in personnel costs of $4.6 million and increases in professional service fees of $4.6 million primarily due to consulting costs related to our global restructuring plan. Other increases were technology expenses increased by $2.9 million partly due to ongoing operating system improvements and increasing software maintenance costs, as well as increases in facility related expenses of $1.1 million, driven by acceleration of expense associated with cessation of use of certain office facilities. Of the $4.6 million increase in personnel costs, $1.3 million was driven in part by hiring in technology and go to market positions as well as increases in healthcare costs, and $2.7 million was related to employee severance and benefits in connection with the workforce reduction. SG&A as a percent of revenues for the three months ended September 30, 2020. The decrease was driven by reductions in legal settlement fees of $12.1 million and $1.9 million of other merger integration expenses during thethree months ended September 30, 2021 comparedMarch 31, 2023 increased to 34.0% from 24.3% for the three months ended September 30, 2020. These decreases were mostly offset byMarch 31, 2022.
The increases in personnel costs were attributable to employee severance and employee benefits related to our global restructuring plan, increases in market compensation rates, and increased use of stock-based compensation. The increases in SG&A expenses were partially offset by decreases in various other costs, including a reduction of insurance and audit expenses from the prior year period.
Interest Expense, net
Interest expense, net for the three months ended March 31, 2023 increased to $12.4 million, an increase of $4.8 million, or 64.1%, from the prior year period. The increase was primarily due to increased interest expense under our variable rate term loan facility of $8.0 million associated with incentive compensation and fringe benefit programsrising interest rates over the prior year period. The increase in interest expense was partially offset by reclassifications from accumulated other comprehensive income (loss) on the condensed consolidated balance sheet of $5.5 million and investments associated with incremental technology and product resources,unrealized gains related our terminated interest rate swap agreements, which amounted to $3.5 million. In addition, various other and indirect expenses increased $4.3reduced interest expense by $2.5 million during the three months ended September 30, 2021 comparedMarch 31, 2023 and is expected to reduce interest expense by $6.3 million for the three months ended September 30, 2020,remainder of 2023. Additionally, interest income, which included $1.5 million of higher technology costs and $0.9 million associated with marketing programs to support increased business volumes.
Nine months ended
SG&Ais derived primarily from cash and cash equivalent balances held in interest-bearing accounts, increased $1.7$0.9 million or 1.3%, to $130.3 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to increases in personnel costs and other indirect costs, amounting to $19.2 million and $5.8 million, respectively, for the reasons noted above. These increases were partially offset by a reduction in legal settlement fees and merger integration and employee severance expenses of $12.1 million and $8.9 million, respectively. Various other costs accounted for $2.3 million of the offsetting decreases in SG&A for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.
Depreciation and Amortization
Three months ended
Depreciation and amortization expense decreased $0.3 million, or 1.4% to $19.5 million, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The decrease was primarily due to certain computer equipment assets reaching the end of their useful lives inover the prior year.
Nine months ended
Depreciation and amortization expense decreased $2.3 million, or 3.9%, to $56.0 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The decrease was primarily due to certain computer equipment assets reaching the end of their useful lives in the prior year.
Interest Expense
Three months ended
Interest expense, net decreased $0.1 million, or 0.4% to $18.5 million, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The decrease was primarily due to lower outstanding balance due to scheduled principal repayments on the First Lien Term Loan Facility, as defined below, and lower outstanding balance on the Revolving Credit Facility, as defined below. As of September 30, 2021, the balance on the Revolving Credit Facility was $10.0 million compared to $30.0 million as of September 30, 2020.
Nine months ended
Interest expense, net decreased $2.3 million, or 4.0%, to $54.7 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The decrease was primarily due to lower outstanding balance due to scheduled principal repayments on the First Lien Term Loan Facility, and lower outstanding balance on the Revolving Credit Facility.year period.
Income Tax Expense (Benefit)
Three months ended
Income tax expense decreased $0.8 million, or 55.7%, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020 primarily due to revaluation of deferred taxes in the United Kingdom during the third quarter of 2020. Income tax expense for the three months ended September 30, 2021 and 2020 was $0.6 million and $1.5 million, respectively. The effective tax rate for the three months ended September 30, 2021March 31, 2023, was 42.9% compared to 6.6% for the three months ended March 31, 2022. The effective tax rate for the three months ended March 31, 2023, compared to the prior year period, changed primarily due to federal and state valuation allowances and non-deductible stock compensation expense.
The effective tax rate for the three months ended March 31, 2023, differs from the Federalfederal statutory rate of 21% primarily due to state taxes and non-deductible stock-based compensation expense. The effective tax rate for the three months ended March 31, 2022, differs from the federal statutory rate of 21% primarily due to valuation allowances, state taxes, and state taxes. The
rate for the three months ended September 30, 2020 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in the United Kingdom, valuation allowances, and state taxes.
Nine months ended
IncomeU.S. tax expense decreased $0.5 million, or 15.4%, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to revaluation of deferred taxes in the United Kingdom and valuation allowances. Income tax expense for the nine months ended September 30, 2021 and 2020 was $3.0 million and $3.5 million, respectively. The effective tax rate for the nine months ended September 30, 2021 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in the United Kingdom, valuation allowances, and state taxes. The rate for the nine months ended September 30, 2020 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in the United Kingdom, valuation allowances, and state taxes.on foreign operations.
Non-GAAP Financial Measures and Key Metrics
We believe that the presentation of our Non-GAAPnon-GAAP financial measures and key metrics provides information useful to investors in assessing our financial condition and results of operations. These measures should not be considered an alternative to net income (loss) or any other measure of financial performance or liquidity presented in accordance with GAAP.accounting principles generally accepted in the United States (“GAAP”). These measures have important limitations as analytical tools because they exclude some but not all items that affect the most directly comparable GAAP measures. Additionally, because they may be defined differently byto the extent that other companies in our industry our definitionsdefine similar non-GAAP measures differently than we do, the utility of those measures for comparison purposes may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.limited.
Adjusted EBITDA and Adjusted EBITDA Margin
Adjusted EBITDA represents, as applicable for the period, net income (loss) before provision forinterest expense, income taxes, interest expense and depreciation and amortization expense, equity-basedstock-based compensation, realized and unrealized gain (loss) on foreign exchange, merger integration expenses,restructuring charges, amortization of cloud computing software costs, legal settlement costs deemed by management to be outside the normal course of business, and other items management believes are not representative of the Company’s core operations. Adjusted EBITDA Margin is adefined as Adjusted EBITDA divided by revenues for the period. Adjusted EBITDA and Adjusted EBITDA margin are supplemental financial measuremeasures that management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess:assess our:
•our operatingOperating performance as compared to other publicly traded companies without regard to capital structure or historical cost basis;
•our abilityAbility to generate cash flow;
•our abilityAbility to incur and service debt and fund capital expenditures; and
•the viabilityViability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.
Adjusted EBITDA Service Margin
Adjusted EBITDA Service Margin is calculated as Adjusted EBITDA as a percentage of service revenue. Because we are able to charge our customers for direct access to certain data suppliers and we generally do not mark up those charges, we focus on the management of Adjusted EBITDA as a percentage of service revenue, as we believe this non-GAAP measure more accurately reflects the management of our controllable costs and profitability.
The following table reconciles our non-GAAP financial measure of Adjusted EBITDA and Adjusted EBITDA Service Margin to net income (loss), our most directly comparable financial measures calculated and presented in accordance with GAAP.GAAP, for the periods presented.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands, except percent) |
| Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | |
| Interest expense | 18,518 | | | 18,597 | | | 54,674 | | | 56,930 | |
| Depreciation and amortization | 19,531 | | | 19,808 | | | 56,013 | | | 58,283 | |
| EBITDA | 45,979 | | | 12,829 | | | 105,304 | | | 45,767 | |
| Equity-based compensation | 841 | | | 880 | | | 2,493 | | | 2,570 | |
| Realized and unrealized gain (loss) on foreign exchange | 24 | | | (185) | | | 125 | | | 628 | |
| Merger integration expenses (1) | 193 | | | 2,138 | | | 1,174 | | | 9,255 | |
| | | | | | | |
Technology investments (2) | 1,690 | | | — | | | 1,690 | | | — | |
| Other items (3) | 2,895 | | | 12,380 | | | 6,659 | | | 14,676 | |
| Adjusted EBITDA | $ | 51,622 | | | $ | 28,042 | | | $ | 117,445 | | | $ | 72,896 | |
| Service Revenue | $ | 152,332 | | | $ | 98,587 | | | $ | 395,624 | | | $ | 294,175 | |
Net income (loss) service margin (4) | 4.8 | % | | 27.4 | % | | 2.1 | % | | 24.8 | % |
Adjusted EBITDA service margin (5) | 33.9 | % | | 28.4 | % | | 29.7 | % | | 24.8 | % |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2023 | | 2022 | | | | |
| (in thousands, except percents) |
| Net income (loss) | $ | (7,911) | | | $ | 11,564 | | | | | |
| Income tax (benefit) expense | (5,944) | | | 818 | | | | | |
| Interest expense, net | 12,402 | | | 7,557 | | | | | |
| Depreciation and amortization | 18,417 | | | 18,061 | | | | | |
| EBITDA | 16,964 | | | 38,000 | | | | | |
| Stock-based compensation | 3,828 | | | 2,794 | | | | | |
| Realized and unrealized gain (loss) on foreign exchange | 307 | | | (79) | | | | | |
Restructuring charges (1) | 9,874 | | | — | | | | | |
Amortization of cloud computing software costs (2) | 1,571 | | | 151 | | | | | |
Other items (3) | 497 | | | 860 | | | | | |
| Adjusted EBITDA | $ | 33,041 | | | $ | 41,726 | | | | | |
Net income (loss) margin (4) | (4.5) | % | | 5.8 | % | | | | |
| Adjusted EBITDA margin | 18.8 | % | | 21.0 | % | | | | |
(1)Merger integrationRestructuring charges represent costs incurred in connection with the Company’s global restructuring plan. Costs incurred in connection with the plan include: (i) $4.4 million of severance and benefits related to impacted employees, (ii) $4.0 million of professional service fees related to the execution of our cost savings initiatives, and (iii) $1.4 million related to the abandonment of certain of our leased facilities,
(2)Amortization of cloud computing software costs consists of expense recognized in selling, general and administrative expenses consist primarilyfor capitalized implementation costs for cloud computing IT systems incurred in connection with our platform and fulfillment technology initiatives that are intended to achieve greater operational efficiencies. This expense is not included in depreciation and amortization above.
(3)Other items for the three months ended March 31, 2023 comprise professional services fees not related to core operations. Other items for the three months ended March 31, 2022 include (i) costs of $0.9 million associated with the implementation of a company-wide ERP system, (ii) $0.3 million related to loss on disposal of assets and exit costs associated with one of our short-term leased facilities, (iii) $0.2 million of information technology (“IT”) related costs including personnel expenses and professional and service fees associated with the integration of customers and operations of GIS,an entity with which commencedthe Company merged, and (iv) a partial offset of these costs by a reduction in July 2018 and was substantially completed by the endpreviously accrued legal settlement expense of 2020.
(2)Technology investments represent discovery phase costs associated with the build out and implementation of various technologies that will be used to achieve greater operational efficiencies.
(3)Other items include (i) exit costs associated with one of our facilities$0.6 million during the three months ended September 30, 2021, (ii) costs related to the preparation of the Company’s initial public offering during 2021, (iii) $12.1 million of legal settlement costs in the three and nine months ended September 30, 2020 associated with a single litigation matter relatedMarch 31, 2022 due to a predecessor entity of the Company formore favorable outcome than originally anticipated in a claim dating back to 2009 (for additional information see Note 13 tooutside the accompanying condensed consolidated financial statements for additional information), and (iv) $0.3 million and $2.5 millionordinary course of severance costs incurred in connection with reducing our employee headcount in an effort to right-size our business in response to COVID-19 during the three and nine months ended September 30, 2020, respectively.business.
(4)Net income (loss) service margin is calculated asrepresents net income (loss) as a percentage of service revenue.
(5)Adjusted EBITDA service margin is calculated as Adjusted EBITDA as a percentage of service revenue.
Adjusted Net Income (Loss)and Adjusted Diluted Earnings Per Share
In addition to Adjusted EBITDA, management believes that Adjusted Net Income (Loss) is a strong indicator of our overall operating performance and is useful to our management and investors as a measure of comparative operating performance from period to period. We define Adjusted Net Income (Loss) as net income (loss) adjusted for equity-basedamortization of acquired intangible assets, stock-based compensation, realized and unrealized gain (loss) on foreign exchange, merger integration expenses,restructuring charges, amortization of cloud computing software costs, legal settlement costs deemed by management to be outside the normal course of business, and other items management believes are not representative of the Company’s core operations, to which we apply an adjusted effective tax rate. See the footnotes to the table below for a description of certain of these adjustments. We define Adjusted Diluted Earnings Per Share as Adjusted Net Income divided by the weighted average number of shares outstanding (diluted) for the applicable period. We believe Adjusted Diluted Earnings Per Share is useful to investors and analysts because it enables them
to better evaluate per share operating performance across reporting periods and to compare our performance to that of our peer companies.
The following table reconciles our non-GAAP financial measure of Adjusted Net Income to net income (loss), our most directly comparable financial measure calculated and presented in accordance with GAAP, for the periods presented:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2023 | | 2022 | | | | |
| (in thousands) |
| Net income (loss) | $ | (7,911) | | | $ | 11,564 | | | | | |
| Income tax (benefit) expense | (5,944) | | | 818 | | | | | |
| Income (loss) before income taxes | (13,855) | | | 12,382 | | | | | |
| Amortization of acquired intangible assets | 15,394 | | | 15,505 | | | | | |
| | | | | | | |
Interest expense swap adjustments (1) | (2,527) | | | (2,181) | | | | | |
Interest expense discounts (2) | 803 | | | 821 | | | | | |
| Stock-based compensation | 3,828 | | | 2,794 | | | | | |
| Realized and unrealized gain (loss) on foreign exchange | 307 | | | (79) | | | | | |
Restructuring charges (3) | 9,874 | | | — | | | | | |
Amortization of cloud computing software costs (4) | 1,571 | | | 151 | | | | | |
Other items (5) | 497 | | | 860 | | | | | |
| Adjusted income before income taxes | 15,892 | | | 30,253 | | | | | |
Adjusted income taxes (6) | 2,346 | | | 439 | | | | | |
| Adjusted Net Income | $13,546 | | $29,814 | | | | |
The following table sets forth a reconciliationthe calculation of net income (loss) to Adjusted Net Income (Loss)Diluted Earnings Per Share for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands) |
Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | |
| Income (loss) before income taxes | 7,930 | | | (25,576) | | | (5,383) | | | (69,446) | |
| Equity-based compensation | 841 | | | 880 | | | 2,493 | | | 2,570 | |
| Realized and unrealized gain (loss) on foreign exchange | 24 | | | (185) | | | 125 | | | 628 | |
Merger integration expenses(1) | 193 | | | 2,138 | | | 1,174 | | | 9,255 | |
| | | | | | | |
Technology investments (2) | 1,690 | | | — | | | 1,690 | | | — | |
Other items (3) | 2,895 | | | 12,380 | | | 6,659 | | | 14,676 | |
| Adjusted income (loss) before income taxes | 13,573 | | | (10,363) | | | 6,758 | | | (42,317) | |
Adjusted income taxes (4) | 360 | | | 732 | | | 1,619 | | | 2,063 | |
| Adjusted Net Income (Loss) | $ | 13,213 | | | $ | (11,095) | | | $ | 5,139 | | | $ | (44,380) | |
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2023 | | 2022 | | | | |
| | | | | |
| Diluted net income (loss) per share | $ | (0.10) | | | $ | 0.15 | | | | | |
| Income tax (benefit) expense | (0.08) | | | 0.01 | | | | | |
| Amortization of acquired intangible assets | 0.20 | | | 0.19 | | | | | |
| | | | | | | |
Interest expense swap adjustments (1) | (0.03) | | | (0.03) | | | | | |
Interest expense discounts (2) | 0.01 | | | 0.01 | | | | | |
| Stock-based compensation | 0.05 | | | 0.04 | | | | | |
| Realized and unrealized gain (loss) on foreign exchange | — | | | — | | | | | |
Restructuring charges (3) | 0.13 | | | — | | | | | |
Amortization of cloud computing software costs (4) | 0.02 | | | — | | | | | |
Other items (5) | 0.01 | | | 0.01 | | | | | |
Adjusted income taxes (6) | (0.03) | | | (0.01) | | | | | |
| Adjusted Diluted Earnings Per Share | $ | 0.18 | | | $ | 0.37 | | | | | |
| | | | | | | |
| Weighted average number of shares outstanding - diluted | 77,285,116 | | 79,392,937 | | | | |
| | | | | | | |
| | | | | | | |
(1)Merger integrationInterest expense swap adjustments consist of amortization of unrealized gains on our terminated interest rate swap agreements, which will be recognized through December 2023 as a reduction in interest expense.
(2)Interest expense discounts consist of amortization of original issue discount and debt issuance costs.
(3)Restructuring charges represent costs incurred in connection with the Company’s global restructuring plan. Costs incurred in connection with the plan include: (i) $4.4 million of severance and benefits related to impacted employees, (ii) $4.0 million of professional service fees related to the execution of our cost savings initiatives, and (iii) $1.4 million related to the abandonment of certain of our leased facilities,
(4)Amortization of cloud computing software costs consists of expense recognized in selling, general and administrative expenses consist primarilyfor capitalized implementation costs for cloud computing IT systems incurred in connection with our platform and fulfillment technology initiatives that are intended to achieve greater operational efficiencies. This expense is not included in depreciation and amortization above.
(5)Other items for the three months ended March 31, 2023 comprise professional services fees not related to core operations. Other items for the three months ended March 31, 2022 include (i) costs of IT$0.9 million associated with the implementation of a company-wide ERP system, (ii) $0.3 million related to loss on disposal of assets and exit costs associated with one of our short-term leased facilities, (iii) $0.2 million of information technology related costs including personnel expenses and professional and service fees associated with the integration of GIS, as discussedcustomers and operations of an entity with which the Company merged, and (iv) a partial offset of these costs by a reduction in footnote 1 to the immediately preceding table, which commenced in July 2018 and was substantially completed by the endpreviously accrued legal settlement expense of 2020.
(2)Technology investments represent discovery phase costs associated with the build out and implementation of various technologies that will be used to achieve greater operational efficiencies.
(3)Other items include (i) exit costs associated with one of our facilities$0.6 million during the three months ended September 30, 2021, (ii) costs relatedMarch 31, 2022 due to a more favorable outcome than originally anticipated in a claim outside the preparationordinary course of business.
(6)The tax effect of each adjustment is determined based on the tax laws and valuation allowance status of the Company’s initial public offering during 2021, (iii) $12.1 million of legal settlement costs injurisdiction to which the three and nine months ended September 30, 2020 associated with a single litigation matter related to a predecessor entity of the Company for a claim dating back to 2009 (for additional information see Note 13 to the accompanying condensed consolidated financial statements for additional information), and (iv) $0.3 million and $2.5 million of severance costs incurred in connection with reducing our employee headcount in an effort to right-size our business in response to COVID-19 during the three and nine months ended September 30, 2020, respectively.
(4)adjustment relates. An adjusted effective income tax rate has been determined for each period presented by applying the statutory income tax rate, and the provisionnet of applicable adjustments for deferred income taxes to the pre-tax adjustments,valuation allowances, which was used to compute Adjusted Net Income (Loss) for the periods presented.
Key Metrics
The key metrics used Due to help us evaluate our business, identify trends and formulate business plans and strategy are set forththe existence of a U.S. tax valuation allowance, the tax impact of the pre-tax adjustments for the three months ended March 31, 2022 is immaterial. During the year ended December 31, 2022, the Company determined sufficient positive evidence existed to reverse the Company’s valuation allowance attributable to the deferred tax assets associated with the Company’s operations in the table below and described inU.S. There is no change to the following text:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands, except percent) |
| | | | | | | |
| New business revenue | $ | 10,873 | | | $ | 9,354 | | | $ | 24,117 | | | $ | 23,075 | |
We measure net revenue retention onmanner by which the tax effect of each adjustment is determined as a year-to-date basis. Net revenue retention for the nine months ended September 30, 2021 and 2020 was 133.8% and 75.7%, respectively.
Net Revenue Retention
We generally have long standing relationships with our customers as evidenced by the nine-year average tenure of our enterprise customers. The revenue from these customers is highly reoccurring in nature. In addition, our ability to cross sell and expand our services with our existing customers is an important component of our growth strategy. We measure the success of our customer retention and expansion through net revenue retention particularly among our top 1,250 customers who represent approximately 70% of our total revenue. Net revenue retention is a measure of our ability to retain and grow business from our customer base. It is calculated as the total revenue derived in the current fiscal period by our top 1,250 customers, divided by the total revenue derived in the prior fiscal period from the same 1,250 customers based on the prior fiscal period revenue composition. The 1,250 customers used for this metric may vary from period to period, as defined by the revenue compositionresult of the period immediately preceding the presented fiscal year. Net revenue retention increased in the 2021 periods as general client ordering patterns showed a significant volume and product mix improvement over the COVID impacted prior year quarter and year to date periods.
New Business Revenue
In addition to expanding revenue with our existing customer base, adding new customers to our portfolio is an important driver of growth. New business revenue is a measure of our ability to establish new sources of business from customers outside of our existing base of business. New business represents revenue recognized under a new customer contract during the first yearreversal of the contract term. We have a sales and sales support staff in nine countries focused on expanding our reach and penetration into new markets and regions. Although new contracts are typically three years in duration, new business revenue is determined over the first year of the contract. Continuing to grow this important metric is critical to the success of our business. New business revenue increased in the three and nine months ended September 30, 2021 compared to the prior year period due to valuation allowance.volume and product mix improvement over the COVID impacted prior year quarter and year to date periods.
Liquidity and Capital Resources
General
Our primary sources of liquidity and capital resources are cash generated from our operating activities, cash on hand, and borrowings under our long-term debt arrangements. Income taxes are currentlyhave historically not been a significant use of funds but after the benefits of our net operating loss (“NOL”) carryforwards are fully recognized, could become a material use of funds, depending on our future profitability and future tax rate. Additionally, as a result of the income tax receivable agreement (“TRA”) we entered into in connection with the IPO, we will be required to pay certain pre-IPO ownersequityholders or their transferees 85% of the benefits, if any, that the Company and its subsidiaries realize, or are deemed to realize in income tax savings due to our utilization of the NOLs and other tax attributes, for certain tax benefits over a period of approximately 12 years pursuant towhich the TRA, which amounts toCompany recognized an estimated total liability of approximately $209.9 million.$210.5 million, including a current portion of $27.0 million, as of March 31, 2023. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year.2030. These payments will result in cash outflows of amounts we would otherwise have retained in the form of tax savings from the application of the NOLs and other tax attributes.
Unrestricted cash and cash equivalents as of September 30, 2021 totaled $19.7March 31, 2023 was $127.4 million. As of September 30, 2021,March 31, 2023, cash held in foreign jurisdictions was approximately $4.7$16.1 million and is primarily related to international operations.
Restricted cash of $5.0 million as of September 30, 2021 consists of $1.1 million held in escrow for the benefit of former investors in a subsidiary of the Company pursuant to the terms of its divestiture of a former affiliate in April 2018, and the remainder is related to prior restructurings from predecessor entities.
The Company proactively drew down $50.0 million under its Revolving Credit Facility, during the quarter ended March 31, 2020 in preparation for the impact of the COVID-19 pandemic. The Company repaid $20.0 million on the Revolving Credit Facility during each of the second and third quarters of the year ended December 31, 2020. The Company had $10.0 million outstanding under the Revolving Credit Facility and $88.2 million of availability remained as of September 30, 2021. On November 5, 2021, the Company repaid the $10.0 million outstanding principal amount on the Revolving Credit Facility.
Debt
The Company currently has two long-term debt arrangements:
•The Amended First Lien Term Loan Facility, a first lien senior secured term loan facility, bearing interest payable monthly at a LIBOR variable rate (4.84% at March 31, 2023) + 3.75%, maturing on July 12, 2025. Total principal outstanding balance on our debt was $697.4 million as of March 31, 2023 and $699.5 million as of December 31, 2022.
•The Amended Revolver Credit Facility, a first lien senior secured revolving credit facility in an aggregate principal amount of up to $145.0 million, including a $40.0 million letter of credit sub-facility, bearing interest monthly at a Secured Overnight Financing Rate (“SOFR”) variable rate (4.63% at March 31, 2023) + 2.5% (subject to adjustment pursuant to a leverage-based pricing grid) and maturing on June 3, 2027 or, if earlier, 91 days prior to the maturity of the Company’s term loans under the Amended First Lien Term Loan Facility. The Company had $143.7 million in available borrowing capacity under the Amended Revolving Credit Facility, after utilizing $1.3 million for letters of credit as of March 31, 2023.
The Amended First Lien Term Loan Facility includes a springing financial maintenance covenant for the benefit of the revolving lenders thereunder, which requires us to maintain a maximum first lien leverage ratio as of the last day of any fiscal quarter on which greater than 35% of the revolving commitments are drawn (excluding for this purpose up to $15.0 million of undrawn letters of credit). The Company was not subject to this covenant as of March 31, 2023, as outstanding loans and letters of credit under the Amended Revolving Credit Facility did not exceed 35% of the total commitments under the facility.
The Company’s obligations under the Amended First Lien Facilities are guaranteed, jointly and severally, on a senior secured first-priority basis, by substantially all of the Company’s domestic wholly-owned material subsidiaries, as defined in the agreement, and are secured by first-priority security interests in substantially all of the assets of the Company and its domestic wholly-owned material subsidiaries, subject to certain permitted liens and exceptions. Collateral includes all outstanding equity interests in whatever form of the borrower and each restricted subsidiary that is owned by any credit party.
Operating Commitments
As of September 30, 2021March 31, 2023, the Company had purchase obligations of approximately $27.2 million withto various parties of which approximately $21.7$49.7 million is expected to be paid within one year. These purchase commitments are associated with agreements that are enforceable and legally binding. They arein the aggregate, primarily commitments to purchase data and other screening services in the ordinary course of business withbusiness. These purchase obligations have varying expiration terms through 2023.2023, and approximately $47.9 million of the total is expected to be paid within one year.
In additionOn December 31, 2022 and February 16, 2023, the Company entered into definitive agreements to our regular investment in capital expenditures, we plan to invest $40-$45 millionpurchase 60% of the equity interests in a capital expenditure program through the endprivately held company for a total purchase price of fiscal year 2023approximately $26.5 million, subject to continue to enhance our operating systems and technologies to improve operational efficiency. closing conditions that have not yet been satisfied.
We expect that cash flow from operations and current cash balances, together with available borrowings under the Amended Revolving Credit Facility, will be sufficient to meet operating requirements as well as the obligations under the TRA as discussed below, through the next twelve months. Although we believe we have adequate sources of liquidity over the long term, cash available from operations could be affected by any general economic downturn or any decline or adverse changes in our business such as a loss of customers, market and or competitive pressures, unanticipated liabilities, or other significant changes in business environment. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all.
Debt
Effective with the combination of the HireRight and GIS groups of companies on July 12, 2018, the Company has three long-term debt arrangements as described below. Collateral includes all outstanding equity interests in whatever form of the borrower and each restricted subsidiary that is directly owned by or on behalf of any credit party. The credit agreement has a restrictive covenant for leverage ratios. The Company was in compliance with the covenants under the credit agreement for the three and nine months ended September 30, 2021. Accordingly, the amount payable under the credit agreement is classified as long-term debt in the accompanying condensed consolidated balance sheet.
At September 30, 2021, we had the following long-term debt arrangements:
•a first lien senior secured term loan facility, in an aggregate principal amount of $835.0 million, bearing interest payable monthly at a London Interbank Offered Rate (“LIBOR”) variable rate (0.08% at September 30, 2021) + 3.75%, due July 12, 2025 (the “First Lien Term Loan Facility”).
•a first lien senior secured revolving credit facility, in an aggregate principal amount of up to $100.0 million, including a $40.0 million letter of credit sub-facility, bearing interest monthly at 3.5% and maturing on July 12, 2023 (the “Revolving Credit Facility”).
•a second lien senior secured term loan facility, in an aggregate principal amount of $215.0 million, bearing interest payable monthly at a LIBOR variable rate (0.08% at September 30, 2021) + 7.25%, due July 12, 2026 (the “Second Lien Term Loan Facility”).
The Company used $215.0 million of the proceeds from the IPO to repay, in full, the Second Lien Term Loan Facility. The Company plans to use approximately $100.0 million of proceeds of the IPO to repay, in part, the First Lien Term Loan Facility and no longer expects to incur swap breakage fees of approximately $4.2 million.
Cash Flow
The following table sets forth a summary ofsummarizes our condensed consolidated cash flows for the ninethree months ended September 30, 2021March 31, 2023 and 2020:2022:
| | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2021 | | 2020 |
| (in thousands) |
| Net cash provided by operating activities | $ | 19,043 | | | $ | 7,721 | |
| Net cash used in investing activities | (9,983) | | | (9,276) | |
| Net cash (used in) provided by financing activities | (7,503) | | | 2,335 | |
| Net increase in cash, cash equivalents and restricted cash | $ | 1,557 | | | $ | 780 | |
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2023 | | 2022 |
| (in thousands) |
| Net cash used in operating activities | $ | (5,015) | | | $ | (2,015) | |
| Net cash used in investing activities | (4,611) | | | (4,529) | |
| Net cash used in financing activities | (26,672) | | | (20,533) | |
| Net decrease in cash, cash equivalents and restricted cash | $ | (36,298) | | | $ | (27,077) | |
Operating Activities
Cash provided by operating activities reflects net income (loss) adjusted for certain non-cash items and changes in operating assets and liabilities. Total cash provided byCash used in operating activities was $19.0$5.0 million for the ninethree months ended September 30, 2021March 31, 2023 compared to cash providedused in operating activities of $7.7$2.0 million for the ninethree months ended September 30, 2020.March 31, 2022. The increase in cash flows provided byused in operating activities was due primarily to a lower net loss of $7.9 million for the current period compared to net income of $11.6 million for the prior year period, partly offset by a higherlower use of cash fromfor working capital in the current period compared to the prior year period.
Investing Activities
Cash used in investing activities was approximately $10.0$4.6 million during the ninethree months ended September 30, 2021,March 31, 2023, compared to approximately $9.3$4.5 million during the ninethree months ended September 30, 2020.March 31, 2022. The increase in cash used in investing activities was due primarily to slight increases in other investing and increases in capitalized software development costs under our program to enhance operational efficiencies compared to the prior period, partly offset by a decrease of purchases of property and equipment and capitalized software development costs compared to the prior period.equipment.
Financing Activities
Cash used in financing activities was approximately $7.5$26.7 million for the ninethree months ended September 30, 2021March 31, 2023 compared to cash provided by financing activities of approximately $2.3 million during the nine months ended September 30, 2020. The change in cash used in financing activities isof approximately $20.5 million during the three months ended March 31, 2022. The increase was due primarily to the Company’s draw down$24.6 million of $50.0cash used for repurchases of our common stock made under the Program during the three months ended March 31, 2023, partly offset by $18.4 million onpayment for termination of interest rate swap agreements during the Revolving Credit Facility in the same period last year. We had netprior year period. Mandatory repayments on our debt facilities of $6.3were $2.1 million in in each of the ninethree months ended September 30, 2021 comparedMarch 31, 2023 and 2022.
Share Repurchase Program
On November 13, 2022, the Company's Board of Directors authorized the Program. The Program authorizes the Company to net borrowingsrepurchase up to $100.0 million of $3.7the Company’s common stock and will expire on November 14, 2024, or earlier if repurchases reach $100.0 million before that date. Repurchases under the Program may be made in the nine months ended September 30, 2020.
Financing and Financing Capacity
Total principal outstanding on our debt was $1.0 billion as of September 30, 2021 and $1.0 billion as of December 31, 2020.
Income Tax Receivable Agreement
In connectionopen market, in privately negotiated transactions or otherwise, including through Rule 10b5-1 trading plans, with the amount and timing of repurchases depending on stock price, trading volume, market conditions and other general business considerations. This Program does not obligate the Company to acquire any particular amount of common stock and the Program may be extended, modified, suspended or discontinued at any time at the Company’s IPO during the fourth quarter of 2021, we entered into the TRA with our pre-IPO equityholders or their permitted transferees that will provide for the payment by us over a period of approximately 12 years to our pre-IPO equityholders or their permitted transferees of 85% of the benefits, if any, that we and our subsidiaries realize, or are deemed to realize (calculated using certain assumptions) in U.S. federal,discretion.
state, and local income tax savings as a resultThrough March 31, 2023, the Company repurchased 3,791,229 shares of Common stock for $42.3 million, including commissions paid, at an average price paid of $11.17 per share. As of March 31, 2023, approximately $57.7 million remained available for future purchases under the utilization (or deemed utilization)Program. Repurchases under the Program continued at similar rates through the date of certain existing tax attributes. Based on our current taxable income estimates, we expect to repay the majorityfiling of this obligation byreport, and the endBoard of our 2025 fiscal year. Actual tax benefits realized by us may differ from tax benefits calculated underDirectors has not yet determined whether to renew the TRA as a result of the use of certain assumptions in the TRA, including assumptions relating to state and local income taxes, to calculate tax benefits. The Company will record an estimated total liability of approximately $209.9 million and a reduction to Additional paid-in capital of approximately $209.9 million in connection with the TRA during the fourth quarter of 2021 onProgram following its condensed consolidated balance sheets.termination.
Off-Balance Sheet Arrangements
As of September 30, 2021,March 31, 2023, we did not have anyhad no off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K, other than operating leases, primarilyS-K.
Recently Issued Accounting Pronouncements
See Note 2 — Recently Issued Accounting Pronouncements for our leased facilities.further information on recently adopted accounting pronouncements and those not yet adopted.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impactto our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of exposure due to potential changesinterest rate risk, potential foreign exchange risk and potential increases in inflation. We do not hold financial instruments for trading purposes.
Interest Rate Risk
We are exposed to changes in interest rates as a result of our financing activities used to fund business operations.the outstanding balance under the Amended First Lien Term Loan Facility, as well as any borrowings under the Amended Revolving Credit Facility. Primary exposures include movements in LIBOR.LIBOR and SOFR. The nature and amount of our long-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. To minimize this risk, we have entered intoRising interest rate swap agreementsrates could also limit our ability to hedgerefinance our riskdebt when it matures or cause us to changes in LIBOR.pay higher interest rates upon refinancing and increase interest expense on refinanced indebtedness.
As of September 30, 2021,March 31, 2023, the outstanding balancesprincipal balance of $697.4 million on our credit agreements werethe Amended First Lien Term Loan Facility was subject to variable interest rates. We repaid $215.0 millionBased upon a sensitivity analysis, a hypothetical 1% change in interest rates on our debt outstanding would change our annual interest expense by approximately $7.0 million.
The last publication date of LIBOR rates against various currencies by the amount outstanding under our Second Lien Term Loan Facility using a portion of the proceeds from the IPO.
The Financial Conduct Authority in the United Kingdom intends to phasewas December 31, 2021, with the publication of certain United States dollar rates being phased out LIBOR by the end of 2021.after June 30, 2023. We have negotiated terms in consideration of this discontinuation and do not expect that the discontinuation of the LIBOR rate, including any legal or regulatory changes made in response to its future phase out, will have a material impact on our liquidity or results of operations.
Foreign Currency Exchange Risk
The significant majority of our revenue is denominated in U.S. dollars,dollars; however, we do earn revenue, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including among others,the Euro, the British pound, the Polish zloty, the Australian dollar, the Canadian dollar, the Euro, the Polish Zloty, the Singapore dollar, the Mexican peso, the Japanese yen, and the Indian rupee.rupee, among others. Because our condensed consolidated financial statements are presented in U.S. dollars, we must translate revenue, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against majorother currencies will affect our operating revenues, operating incomestatements of operations and the value of balance sheet items denominated in foreign currencies. We generally do not mitigate the risks associated with fluctuating exchange rates however, because we generallytypically incur expenses and generate revenue in these currencies and the cumulative impact of these foreign exchange fluctuations are not deemed material to our financial performance.
Inflation Risk
Recent growth in inflation has increased and may continue to increase our operating costs. In response to high inflation rates, the Federal Reserve has been raising interest rates and has indicated that a decision on pausing the interest rate increases has not been made but instead the Federal Reserve will continue to monitor economic data. Higher interest rates imposed by the Federal Reserve to address inflation will increase our interest expense. We also expect our labor costs to continue to increase due to the growing competition for labor and the effect of inflation on wage rates. We continue to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions. However, we may not be able to raise our pricing sufficiently to offset our increased costs, for competitive reasons or because some of our customer agreements fix the prices we may charge for some period of time and/or limit permissible price increases. There can be no assurance that future inflation will not have an adverse impact on our operating results and financial condition.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, Act)as amended (the “Exchange Act”)) as of September 30, 2021.March 31, 2023. Based on the evaluation, of the design and operation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of September 30, 2021 due to certain material weaknesses in our internal control over financial reporting as described below. In light of this fact, our management has performed additional analyses, reconciliations, and other post-closing procedures and has concluded that, notwithstanding the material weakness in our internal control over financial reporting, the financial statements for the periods covered by and included in this Quarterly Report fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.
(b) Material weaknesses in internal control over financial reporting
In preparingdesigning and evaluating our financial statements,disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the Company identified material weaknesses in our internaldesired control over financial reporting asobjectives. In addition, the design of December 31, 2020. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting suchdisclosure controls and procedures must reflect the fact that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses we identified were as follows:
•We did not design and maintain an effective control environment commensurate with our financial reporting requirements. Specifically, we lacked a sufficient number of professionals with an appropriate level of accounting knowledge, training and experience to appropriately analyze, record and disclose accounting matters timely and accurately. This material weakness further contributed to the material weaknesses described below.
•We did not design and maintain sufficient formal accounting policies, procedures and controls to achieve complete, accurate and timely financial accounting, reporting and disclosures, including controls over the preparation and review of journal entries and account reconciliations. Additionally, the Company did not design and maintain sufficient controls to assess the reliability of reports and spreadsheets used in controls.
These material weaknesses did not result in a material misstatement to the consolidated financial statements included herein, however, they did result in adjustments to substantially all accounts and disclosures. Additionally, these material weaknesses could result in a misstatement of substantially all of the financial statement accounts and disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
•We did not design and maintain effective controls over certain information technology (“IT”) general controls for information systems that are relevant to the preparation of the financial statements. Specifically, we did not design and maintain: (i) program change management controls for certain financial systems to ensure that information technology program and data changes affecting financial IT applications and underlying accounting records are identified, tested, authorized and implemented appropriately, (ii) user access controls to ensure appropriate segregation of dutiesresource constraints and that adequately restrict user and privileged accessmanagement is required to financial applications, programs, and data to appropriate Company personnel and (iii) computer operations controls to ensure that data backups are authorized and monitored. These IT deficiencies did not resultapply judgment in a material misstatement toevaluating the financial statements, however, the deficiencies, when aggregated, could impact maintaining effective segregationbenefits of duties, as well as the effectiveness of IT-dependent controls (such as automated controls that address the risk of material misstatement to one or more assertions, along with the ITpossible controls and underlying data that support the effectivenessprocedures relative to their costs. The design of system-generated data and reports) that could result in misstatements potentially impacting all financial statement
accounts and disclosures that would not be prevented or detected. Accordingly, management has determined these deficiencies in the aggregate constitute a material weakness.
We have implemented or are in the process of implementing measures designed to improve our internal control over financial reporting and remediate the control deficiencies that led to the material weaknesses. Specifically, we have undertaken the following remedial actions:
•We have hired several additional accounting and finance personnel with the appropriate level of public accounting knowledge and experience.
•We have engaged a nationally recognized public accounting firm to assist us in creating comprehensive process narratives and Company policies and procedures.
•Our Internal Audit team, along with a third party consultant, are assisting us to evaluate our current internal control over financial reporting (ICFRs) and make recommendations for findings noted. We have been enhancing ourany disclosure controls and documentation support as issues are identified.
•We areprocedures also is based in part upon certain assumptions about the processlikelihood of implementing several new systemsfuture events, and there can be no assurance that should assist us to process transactions more efficiently and effectively, ensuring better control and documentation support.
•We are working with our information security and technology and accounting systems teams to develop enhanced procedures around user provisioning and maintenance to ensure access is restricted to appropriate personnel.any design will succeed in achieving its stated goals under all potential future conditions.
(c) Changes in Internal Control over Financial Reporting
Other than theThere have been no changes intended to remediate the material weaknesses noted above, there was no change in our internal controlscontrol over financial reporting during the quarter ended March 31, 2023, as defined under Rule 13a-af(f)13a-15(f) under the Exchange Act, that hashave materially affected, or isare reasonably likely to materially affect, our internal controlscontrol over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to claims, investigations, audits, and enforcement proceedings by private plaintiffs, third parties the Company does business with, and federal, state and foreign authorities charged with overseeing the enforcement of laws and regulations that govern the Company’s business. In the U.S., most of these matters arise under the federal Fair Credit Reporting Act and various state and local laws focused on privacy and the conduct and content of background reports. In addition to claims related to privacy and background checks, the Company is also subject to other claims and proceedings arising in the ordinary course of its business, including without limitation claims for indemnity by customers and vendors, employment-related claims, and claims for alleged taxes owed, infringement of intellectual property rights, and breach of contract. The Company and its subsidiaries are not party to any pending legal proceedings that the Company believes to be material except as set forth below.
In 2009 and 2010, approximately 24 lawsuits were filed against HireRight Solutions, Inc. (“Old HireRight”), which is the predecessor to the Company’s subsidiary HireRight, LLC, by approximately 1,400 individuals alleging violation of the California Investigative Consumer Reporting Agencies Act by Old HireRight and one of its customers (the “Customer”) related to background reports that Old HireRight prepared for the Customer about those individuals (the “Action”). The Customer was also named as a defendant in the Action.
In February of 2015, for unrelated reasons, Old HireRight’s former parent company and certain of its domestic affiliates, including Old HireRight, each filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code, 11 U.S.C. §§ 101-1532, thereby commencing Chapter 11 cases (the “Bankruptcy”). Each plaintiff in the Action filed proofs of claim in the Bankruptcy against Old HireRight asserting an unliquidated general unsecured claim based upon the Action. In August 2015, the Bankruptcy court entered an order confirming the debtors’ Chapter 11 plan of reorganization in the Bankruptcy (the “Plan”).
Plaintiffs’ recovery from HireRight, LLC for claims accrued prior to the filing of the Bankruptcy is limited by the Plan to the Plaintiffs’ pro-rata portion of the Bankruptcy unsecured creditors’ pool. However, the Plan does not limit HireRight, LLC’s liability for claims accrued after the filing of the Bankruptcy, plaintiffs’ recovery from the Customer, or claims against Old HireRight’s insurer.material.
Following a complex procedural history and unsuccessful mediation sessions over an extended period of time, in October 2020, plaintiffs’ counsel made a settlement offer. While the Company believed and continues to believe it has valid defenses, the Company engaged in negotiations with the plaintiffs’ counsel and on November 6, 2020 was able to reach a settlement agreement that the Company viewed as acceptable to avoid the expense and risk of further litigation.
While Old HireRight’s insurer has denied coverage, the Company believes it has valid claims against the carrier and intends to pursue them. Any insurance recovery would offset the cost of the settlement to HireRight, LLC, but at this time the Company is not able to assess the likelihood or amount of any potential insurance recovery.
Item 1A. Risk Factors
InvestingCurrent macroeconomic conditions are volatile and the near-term macroeconomic outlook is uncertain due to high inflation, rising interest rates, geopolitical concerns, supply chain disruptions and labor shortages. These factors have led to reduction in order volumes, and consequently we expect 2023 revenue below 2022 levels. We do not know how long these conditions will persist.
Inflation puts pressure on our suppliers, resulting in increased data costs, and also increases our employment and other expenses. We may not be able to raise our pricing sufficiently to offset increased costs, for competitive reasons or because some of our customer agreements limit price increases. Further, portions of our costs are relatively fixed so it may not be possible for us to cut costs quickly or deeply enough to keep cost increases from adversely affecting our margins.
In response to high inflation, the Federal Reserve has been raising interest rates and has indicated that a decision on pausing the interest rate increases has not been made but instead the Federal Reserve will continue to monitor economic data. Higher interest rates increase our interest expense on variable-rate borrowings under our credit facilities. Further, interest rate hikes or other factors could lead to recessionary conditions, which could adversely affect the global hiring market and therefore the demand for our services.
Customers have been reacting to these uncertainties by reducing hiring, which in turn causes uncertainty in our common stock involves a high degree of risk. We describe risks associated with our business under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in our Prospectus dated October 28, 2021, filed with the SEC in accordance with Rule 424(b) under the Securities Act on November 1, 2021 in connection with our IPO, this report, and in other filings we have made and will make from timenear-term revenue outlook.
In addition to time with the Securities and Exchange Commission (the "Risk Factors"). Each of the risks described in our Risk Factors may be relevant to decisions regarding an investment in or ownership of our stock. The occurrence of any such risks could have a significant adverse effect on our reputation, business, financial condition, revenue, results of operations, growth, or ability to accomplish our strategic objectives, and could cause the trading price of our common stock to decline. You should carefully consider such risks and the other information contained in this report, including our condensed consolidated financial statements and related notes and
Management's Discussion and Analysis of Financial Condition and Results of Operations, before making investment decisions related to our common stock. There are no material changes toQuarterly Report on Form 10-Q, you should carefully consider the risk factors discussed in Part I, Item 1A. Risk Factors set forth in the Prospectus of which we are currently aware. However, our Risk Factors cannot anticipate and fully address all possible risks of investing in our common stock, theAnnual Report. The risks of investingdiscussed in our common stockAnnual Report could materially affect our business, financial condition, and future results. The risks described in our Annual Report may change over time, and additional risks and uncertainties that we are not aware of, or that we do not consider to be material, may emerge. Accordingly, you are advised to consider additional sources of information and exercise your own judgment in addition to the information we provide.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchases of Common Stock
The following table summarizes the Company’s share repurchase program during the three months ended March 31, 2023:
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| Period | Total number of shares purchased | | Average price paid per share | | Total number of shares purchased as part of publicly announced plans or programs (1) | | Approximate dollar value of shares that may yet be purchased under the plans or programs |
| | | | | | | (in millions) |
| January 1 — January 31, 2023 | 577,300 | | $ | 11.79 | | | 577,300 | | $ | 76.4 | |
| February 1 — February 28, 2023 | 463,166 | | 11.65 | | | 463,166 | | 71.0 | |
| March 1 — March 31, 2023 | 1,221,934 | | 10.89 | | | 1,221,934 | | 57.7 | |
| Total | 2,262,400 | | $ | 11.28 | | | 2,262,400 | | $ | 57.7 | |
(1)On November 13, 2022, the Company's Board of Directors authorized a share repurchase program. The share repurchase program authorizes the Company to repurchase up to $100.0 million of the Company’s common stock, par value $0.001 and will expire on November 14, 2024, or earlier if repurchases reach $100.0 million before that date. Repurchases under the program may be made in the open market, in privately negotiated transactions or otherwise, including through Rule 10b5-1 trading plans, with the amount and timing of repurchases depending on stock price, trading volume, market conditions and other general business considerations. Open market repurchases will be structured to occur within the pricing and volume requirements of Rule 10b-18. This program does not obligate the Company to acquire any particular amount of common stock and the program may be extended, modified, suspended or discontinued at any time at the Company’s discretion. Repurchases under the Program continued at similar rates through the date of filing of this report, and the Board of Directors has not yet determined whether to renew the Program following its termination.
Item 6. Exhibits
| | | | | | | | |
| Exhibit Number | | Exhibit Description |
| 31.1 | | |
| 31.2 | | |
| 32.1 | | |
32.2 | | |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HireRight Holdings Corporation
Date: November 18, 2021May 9, 2023
| | | | | |
| By: | /s/ Thomas M. Spaeth |
| Name: | Thomas M. Spaeth |
| Title: | Chief Financial Officer |
| (Principal Financial Officer) |
Date: May 9, 2023
| | | | | |
| By: | /s/ Laurie Blanton |
| Name: | Laurie Blanton |
| Title: | Chief Accounting Officer |
| (Principal Accounting Officer) |
