Docoh
Loading...

KLDI KLDiscovery

Filed: 12 Nov 20, 4:17pm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                       to        

 

Commission File Number 001-38789

 

KLDiscovery Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

61-1898603

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

8201 Greensboro Drive

Suite 300

McLean, VA

22102

(Address of Principal Executive Offices)

 

(Zip Code)

Registrant’s telephone number, including area code: (703) 288-3380

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

N/A

 

N/A

 

N/A

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  NO 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  YES  NO 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES  NO 

As of November 11, 2020, there were 42,529,017 of the registrant’s common stock, par value $0.0001 per share, outstanding.

 

 

 

 


 

Table of Contents

 

 

 

 

Page

 

Part I. Financial Information

  

 

1

 

Item 1. Financial Statements

  

 

1

 

Condensed Consolidated Balance Sheets

  

 

1

 

Condensed Consolidated Statements of Loss

  

 

2

 

Condensed Consolidated Statements of Changes in Stockholders’ Equity

  

 

3

 

Condensed Consolidated Statements of Cash Flows

  

 

4

 

Notes to Unaudited Condensed Consolidated Financial Statements

  

 

5

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

 

19

 

Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk

  

 

28

 

Item 4. Controls and Procedures

  

 

29

 

Part II. Other Information

  

 

29

 

Item 1. Legal Proceedings

 

 

29

 

Item 1A. Risk Factors

 

 

29

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds from Registered Securities

  

 

32

 

Item 3. Exhibits

  

 

32

 

Part III. Signatures

  

 

33

 

 

 

 

 

 


 

PART I – FINANCIAL INFORMATION

 

Item 1.     Financial Statements

 

KLDiscovery Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

 

 

 

September 30, 2020

 

 

December 31, 2019

 

 

 

(unaudited)

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

43,838

 

 

$

43,407

 

Accounts receivable, net of allowance

 

 

 

 

 

 

 

 

for doubtful accounts of $7,805 and $7,486, respectively

 

 

86,095

 

 

 

96,994

 

Prepaid expenses

 

 

10,312

 

 

 

7,296

 

Other current assets

 

 

778

 

 

 

556

 

Total current assets

 

 

141,023

 

 

 

148,253

 

Property and equipment

 

 

 

 

 

 

 

 

Computer software and hardware

 

 

73,343

 

 

 

72,228

 

Leasehold improvements

 

 

27,493

 

 

 

26,963

 

Furniture, fixtures and other equipment

 

 

3,722

 

 

 

3,794

 

Accumulated depreciation

 

 

(76,780

)

 

 

(64,682

)

Property and equipment, net

 

 

27,778

 

 

 

38,303

 

Intangible assets, net

 

 

114,632

 

 

 

130,568

 

Goodwill

 

 

396,310

 

 

 

395,171

 

Other assets

 

 

2,611

 

 

 

2,617

 

Total assets

 

$

682,354

 

 

$

714,912

 

Current liabilities

 

 

 

 

 

 

 

 

Current portion of long-term debt, net

 

$

11,106

 

 

$

11,689

 

Accounts payable and accrued expense

 

 

35,964

 

 

 

31,270

 

Current portion of contingent consideration

 

 

677

 

 

 

340

 

Deferred revenue

 

 

4,018

 

 

 

4,851

 

Total current liabilities

 

 

51,765

 

 

 

48,150

 

Long-term debt, net

 

 

467,163

 

 

 

468,932

 

Contingent consideration

 

 

225

 

 

 

482

 

Deferred tax liabilities

 

 

6,712

 

 

 

6,294

 

Other liabilities

 

 

9,776

 

 

 

7,289

 

Total liabilities

 

 

535,641

 

 

 

531,147

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders' equity

 

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

 

 

 

$0.0001 par value, shares authorized - 200,000,000 shares authorized

as of September 30, 2020 and December 31, 2019; shares issued and

outstanding - 42,529,017 as of September 30, 2020 and December 31, 2019

 

 

4

 

 

 

4

 

Preferred Stock

 

 

 

 

 

 

 

 

$0.0001 par value, 1,000,000 shares authorized, zero issued

and outstanding as of September 30, 2020 and December 31, 2019

 

 

-

 

 

 

-

 

Additional paid-in capital

 

 

384,504

 

 

 

381,952

 

Accumulated deficit

 

 

(245,649

)

 

 

(205,498

)

Accumulated other comprehensive income

 

 

7,854

 

 

 

7,307

 

Total stockholders' equity

 

 

146,713

 

 

 

183,765

 

Total liabilities and stockholders' equity

 

$

682,354

 

 

$

714,912

 

 

See Notes to Consolidated Financial Statements.

1

 


 

KLDiscovery Inc.

Consolidated Statements of Comprehensive Loss (Unaudited)

(in thousands, except share and per share amounts)

 

 

 

Three Months Ended September 30, 2020

 

 

Three Months Ended September 30, 2019

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

Revenues

 

$

72,301

 

 

$

78,169

 

 

$

214,953

 

 

$

231,527

 

Cost of revenues

 

 

37,738

 

 

 

42,018

 

 

 

111,472

 

 

 

118,937

 

Gross profit

 

 

34,563

 

 

 

36,151

 

 

 

103,481

 

 

 

112,590

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

 

14,281

 

 

 

12,223

 

 

 

42,534

 

 

 

41,879

 

Research and development

 

 

1,828

 

 

 

1,533

 

 

 

5,134

 

 

 

4,455

 

Sales and marketing

 

 

9,155

 

 

 

12,043

 

 

 

29,460

 

 

 

36,212

 

Depreciation and amortization

 

 

9,234

 

 

 

9,525

 

 

 

27,135

 

 

 

29,243

 

Total operating expenses

 

 

34,498

 

 

 

35,324

 

 

 

104,263

 

 

 

111,789

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

65

 

 

 

827

 

 

 

(782

)

 

 

801

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense

 

 

11

 

 

 

(9

)

 

 

102

 

 

 

122

 

Interest expense

 

 

12,371

 

 

 

12,034

 

 

 

38,303

 

 

 

36,487

 

Loss before income taxes

 

 

(12,317

)

 

 

(11,198

)

 

 

(39,187

)

 

 

(35,808

)

Income tax provision

 

 

390

 

 

 

62

 

 

 

964

 

 

 

391

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(12,707

)

 

$

(11,260

)

 

$

(40,151

)

 

$

(36,199

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

 

2,242

 

 

 

(2,248

)

 

 

547

 

 

 

(2,293

)

Total other comprehensive income (loss), net of tax

 

 

2,242

 

 

 

(2,248

)

 

 

547

 

 

 

(2,293

)

Comprehensive loss

 

$

(10,465

)

 

$

(13,508

)

 

$

(39,604

)

 

$

(38,492

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share - basic and diluted

 

$

(0.30

)

 

$

(0.26

)

 

$

(0.94

)

 

$

(0.85

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic and diluted

 

 

42,529,017

 

 

 

42,497,078

 

 

 

42,529,017

 

 

 

42,390,717

 

 

 

See Notes to Consolidated Financial Statements.

 

 

2

 


 

KLDiscovery Inc.

Consolidated Statements of Stockholders’ Equity (Unaudited)

(in thousands, except for share amounts)

 

 

 

Common Stock Issued

 

 

Additional

paid-in

 

 

Treasury

 

 

Accumulated

 

 

Accumulated other

comprehensive

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

capital

 

 

Stock

 

 

deficit

 

 

income

 

 

Total

 

Balance as of December 31, 2019

 

 

42,529,017

 

 

$

4

 

 

$

381,952

 

 

$

-

 

 

$

(205,498

)

 

$

7,307

 

 

$

183,765

 

Share-based compensation

 

 

-

 

 

 

-

 

 

 

825

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

825

 

Foreign exchange translation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(4,428

)

 

 

(4,428

)

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(12,526

)

 

 

-

 

 

 

(12,526

)

Balance as of March 31, 2020

 

 

42,529,017

 

 

 

4

 

 

 

382,777

 

 

 

-

 

 

 

(218,024

)

 

 

2,879

 

 

 

167,636

 

Share-based compensation

 

 

-

 

 

 

-

 

 

 

814

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

814

 

Foreign exchange translation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

2,733

 

 

 

2,733

 

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(14,918

)

 

 

-

 

 

 

(14,918

)

Balance as of June 30, 2020

 

 

42,529,017

 

 

 

4

 

 

 

383,591

 

 

 

-

 

 

 

(232,942

)

 

 

5,612

 

 

 

156,265

 

Share-based compensation

 

 

-

 

 

 

-

 

 

 

913

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

913

 

Foreign exchange translation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

2,242

 

 

 

2,242

 

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(12,707

)

 

 

-

 

 

 

(12,707

)

Balance as of September 30, 2020

 

 

42,529,017

 

 

$

4

 

 

$

384,504

 

 

$

-

 

 

$

(245,649

)

 

$

7,854

 

 

$

146,713

 

 

 

 

Common Stock Issued

 

 

Additional

paid-in

 

 

Treasury

 

 

Accumulated

 

 

Accumulated other

comprehensive

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

capital

 

 

Stock

 

 

deficit

 

 

income

 

 

Total

 

Balance as of December 31, 2018

 

 

42,288,870

 

 

$

4

 

 

$

372,316

 

 

$

(2,406

)

 

$

(147,954

)

 

$

6,996

 

 

$

228,956

 

Share-based compensation

 

 

52,150

 

 

 

-

 

 

 

910

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

910

 

Foreign exchange translation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

810

 

 

 

810

 

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(13,491

)

 

 

-

 

 

 

(13,491

)

Balance as of March 31, 2019

 

 

42,341,020

 

 

 

4

 

 

 

373,226

 

 

 

(2,406

)

 

 

(161,445

)

 

 

7,806

 

 

 

217,185

 

Issuance of common stock

 

 

58,534

 

 

 

-

 

 

 

414

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

414

 

Share-based compensation

 

 

-

 

 

 

-

 

 

 

579

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

579

 

Foreign exchange translation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(855

)

 

 

(855

)

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(11,448

)

 

 

-

 

 

 

(11,448

)

Balance as of June 30, 2019

 

 

42,399,554

 

 

 

4

 

 

 

374,219

 

 

 

(2,406

)

 

 

(172,893

)

 

 

6,951

 

 

 

205,875

 

Issuance of common stock

 

 

-

 

 

 

-

 

 

 

1,241

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

1,241

 

Share-based compensation

 

 

-

 

 

 

-

 

 

 

411

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

411

 

Foreign exchange translation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(2,248

)

 

 

(2,248

)

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(11,260

)

 

 

-

 

 

 

(11,260

)

Balance as of September 30, 2019

 

 

42,399,554

 

 

$

4

 

 

$

375,871

 

 

$

(2,406

)

 

$

(184,153

)

 

$

4,703

 

 

$

194,019

 

 

See Notes to Consolidated Financial Statements.

 

 

3

 


 

KLDiscovery Inc.

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

 

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

Operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(40,151

)

 

$

(36,199

)

Adjustments to reconcile net loss to net cash

 

 

 

 

 

 

 

 

used in operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

36,063

 

 

 

37,614

 

Non-cash interest

 

 

14,360

 

 

 

3,597

 

Stock-based compensation

 

 

2,552

 

 

 

1,900

 

Provision for losses on accounts receivable

 

 

3,059

 

 

 

1,846

 

Deferred income taxes (refunds)

 

 

418

 

 

 

(221

)

Change in fair value of contingent consideration

 

 

80

 

 

 

-

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

8,365

 

 

 

(13,780

)

Prepaid expenses and other assets

 

 

(3,338

)

 

 

(3,386

)

Accounts payable and accrued expenses

 

 

4,734

 

 

 

(2,511

)

Deferred revenue

 

 

(835

)

 

 

(820

)

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities

 

 

25,307

 

 

 

(11,960

)

Investing activities

 

 

 

 

 

 

 

 

Acquisitions, net of cash acquired

 

 

(3,124

)

 

 

(650

)

Purchases of property and equipment

 

 

(8,377

)

 

 

(9,288

)

Net cash used in investing activities

 

 

(11,501

)

 

 

(9,938

)

Financing activities

 

 

 

 

 

 

 

 

Revolving credit facility - draws

 

 

29,000

 

 

 

41,500

 

Revolving credit facility - repayments

 

 

(29,000

)

 

 

(24,500

)

Payments for capital lease obligations

 

 

(688

)

 

 

(453

)

Issuance of common stock

 

 

-

 

 

 

414

 

Payments on long-term debt

 

 

(12,750

)

 

 

(12,750

)

Net cash (used in) provided by financing activities

 

 

(13,438

)

 

 

4,211

 

Effect of foreign exchange rates

 

 

63

 

 

 

(142

)

Net increase (decrease) in cash

 

 

431

 

 

 

(17,829

)

Cash at beginning of period

 

 

43,407

 

 

 

23,439

 

Cash at end of period

 

$

43,838

 

 

$

5,610

 

Supplemental disclosure:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

24,857

 

 

$

29,770

 

Income taxes (refunds) paid, net of refunds

 

$

(311

)

 

$

325

 

Significant non-cash investing and financing activities

 

 

 

 

 

 

 

 

Purchases of property and equipment in accounts payable

     and accrued expenses on the consolidated balance sheets

 

$

21

 

 

$

222

 

 

See Notes to Consolidated Financial Statements.

 

 

4

 


 

KLDiscovery Inc.

Notes to Consolidated Financial Statements (Unaudited)

For the Three and Nine Months ended September 30, 2020 and 2019

Note 1 – Organization, business and summary of significant accounting policies

Organization

KLDiscovery Inc. (the “Company”) provides technology-based litigation support solutions and services including computer e-discovery, data hosting, and managed review, predominantly to top law firms, corporations and government agencies. The majority of the Company’s current business is derived from these services. The Company’s headquarters is located in McLean, Virginia and has 34 locations in 19 countries, 8 data centers and 19 data recovery labs around the globe.

The Company was originally incorporated under the name Pivotal Acquisition Corp.  (“Pivotal”) as a blank check company on August 2, 2018 under the laws of the State of Delaware for the purpose of entering into a merger, capital stock exchange, stock purchase, reorganization or similar business combination with one or more businesses or entities.

On December 19, 2019, Pivotal acquired the outstanding shares of LD Topco, Inc. via a reverse capitalization (the “Business Combination”) and was renamed KLDiscovery Inc.

Principles of consolidation

The accompanying consolidated financial statements are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The accompanying consolidated financial statements include the accounts of KLDiscovery and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation.

The Business Combination was accounted for as a reverse recapitalization in accordance with Accounting Standard Codification (“ASC”) 805, Business Combinations. For accounting and financial reporting purposes, LD Topco, Inc. is considered the acquirer based on facts and circumstances, including the following:

 

LD Topco, Inc.’s operations comprise the ongoing operations of the combined entity;

 

The officers of the newly combined company consist of LD Topco, Inc.’s executives, including the Chief Executive Officer, Chief Financial Officer and General Counsel; and

 

The former shareholders of LD Topco, Inc. own a majority voting interest in the combined entity.

As a result of LD Topco, Inc. being the accounting acquirer, the financial reports filed with the Securities and Exchange Commission by the Company subsequent to the Business Combination are prepared “as if” LD Topco, Inc. is the predecessor and legal successor to the Company. The historical operations of LD Topco, Inc. are deemed to be those of the Company. Thus, the financial statements included in this report reflect (i) the historical operating results of LD Topco, Inc. prior to the Business Combination; (ii) the combined results of the Company and LD Topco, Inc. following the Business Combination on December 19, 2019 (the “Closing Date”); (iii) the assets and liabilities of LD Topco, Inc. at their historical cost; and (iv) KLDiscovery Inc.’s equity structure for all periods presented. The recapitalization of the number of shares of common stock attributable to the purchase of LD Topco, Inc. in connection with the Business Combination is reflected retroactively to January 1, 2018 and will be utilized for calculating earnings per share in all prior periods presented. No step-up basis of intangible assets or goodwill was recorded in the Business Combination transaction consistent with the treatment of the transaction as a reverse capitalization of LD Topco, Inc.

 

 

5

 


 

Use of estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. Although actual results could differ from those estimates, management does not believe that such differences would be material.

Significant estimates include, but are not limited to, the allowance for doubtful accounts, determining the fair values of assets acquired and liabilities assumed, the recoverability and useful lives of property and equipment, intangible assets, and other long-lived assets, the impairment of goodwill, the valuation and realization of deferred income taxes, the fair value of the Company’s common stock and stock option awards, and acquisition-related contingent consideration.

Segments, concentration of credit risk and major customers

The Company operates in one business segment, providing technology-based litigation support solutions and services.

Financial instruments, which potentially expose the Company to concentrations of credit risk, consist principally of cash and accounts receivable. The Company places its cash with a banking institution where the balances, at times, exceed federally insured limits. Management believes the risks associated with these deposits are limited.

With respect to accounts receivable, the Company performs ongoing evaluations of its customers, generally grants uncollateralized credit terms to its customers, and maintains an allowance for doubtful accounts based on historical experience and management’s expectations of future losses. As of and for the three and nine months ended September 30, 2020 and 2019, the Company did not have a single customer that represented more than five percent (5%) of its consolidated revenues or accounts receivable. The Company believes that the geographic and industry diversity of the Company’s customer base throughout the U.S. and internationally minimizes the risk of incurring material losses due to concentrations of credit risk.

 

Foreign currency

Results of operations for the Company’s non-U.S. subsidiaries are translated from the designated functional currency to the reporting currency of the U.S. dollar. Revenues and expenses are translated at average exchange rates for each month, while assets and liabilities are translated at balance sheet date exchange rates. Resulting net translation adjustments are recorded as a component of stockholders’ equity in “Accumulated other comprehensive income” in the Company’s Condensed Consolidated Balance Sheets.

Transaction gains and losses arising from currency exchange rate fluctuations on transactions denominated in a currency other than the local functional currency are included in “Other expense” in the Company’s Consolidated Statements of Comprehensive Loss. Such transaction gains and losses may be realized or unrealized depending upon whether the transaction settled during the period or remains outstanding at the balance sheet date.

Cash and cash equivalents

The Company considers all highly liquid financial instruments with an original maturity of three months or less when purchased to be cash equivalents.

Accounts receivable

Accounts receivable are recorded at original invoice amounts less an estimate for doubtful receivables based on a review of outstanding amounts monthly. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition and credit history. Accounts receivable are written off when deemed uncollectible. Recoveries of trade accounts receivable previously written off are recorded when received.

 

Computer software, property and equipment

 

Computer software, property and equipment are recorded at cost. Depreciation is calculated using the straight-line method over the following estimated useful lives of the assets:

 

Computer software and hardware

 

3 to 5 years

Leasehold improvements

 

Shorter of lease term or useful life

Furniture, fixtures and other equipment

 

3 to 5 years

 

6

 


 

Gains or losses on disposals are included in results of operations at amounts equal to the difference between the net book value of the disposed assets and the proceeds received upon disposal. Costs for replacements and betterments are capitalized, while the costs of maintenance and repairs are expensed as incurred. Property under capital leases are depreciated using the straight-line method over the lease term.

Depreciation expense totaled $4.3 million and $4.5 million for the three months ended September 30, 2020 and 2019, respectively, and includes amortization of assets recorded under capital leases. Depreciation expense totaled $12.8 million and $13.8 million for the nine months ended September 30, 2020 and 2019, respectively.

Internal-use software development costs

The Company capitalizes certain internal computer software costs incurred during the application development stage. The application development stage generally includes software design and configuration, coding, testing and installation activities. Training and maintenance costs are expensed as incurred, while upgrades and enhancements are capitalized if it is probable that such expenditure will result in additional functionality. Capitalized software costs are depreciated over the estimated useful life of the underlying project on a straight-line basis. The Company’s estimated useful life of capitalized software costs varies between three and five years, depending on management’s expectation of the economic life of various software. Capitalized software depreciation costs are recorded as a component of cost of revenue.

Capitalized software costs are reflected as part of “Intangible assets, net” in the Company’s Consolidated Balance Sheets and totaled $17.6 million and $13.5 million, net of accumulated amortization, as of September 30, 2020 and December 31, 2019, respectively.

Goodwill

Goodwill represents the excess of the total consideration paid over identified intangible and tangible assets of the Company and its acquisitions. The Company tests its goodwill for impairment at the reporting unit level on an annual basis on October 1, and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. As of the October 1 testing date, the Company determined there is one entity-wide reporting unit.

The Company considered COVID-19 as an indicator of impairment to the value of goodwill and intangible assets and performed a qualitative assessment. Management considered factors that could be affected by COVID-19 such as impact to stock price, consequences of “stay-at-home” orders, impacts to competitors due to COVID-19, changes in demand, and updates to the Company forecasts among other factors.  Management concluded that there was no impairment of goodwill and intangible assets during the nine months ended September 30, 2020.

 

Debt issuance costs

Debt issuance costs are stated at cost, net of accumulated amortization, and are amortized over the term of the debt using both the straight-line and the effective yield methods. U.S. GAAP requires that the effective yield method be used to amortize debt acquisition costs; however, if the effect of using the straight-line method is not materially different from the results that would have been obtained under the effective yield method, the straight-line method may be used. The amortization for funded term debt is calculated according to the effective yield method and revolving and unfunded term debt is calculated according to the straight-line method. Debt issuance costs related to funded term debt is presented in the Consolidated Balance Sheets as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts or premiums. Debt issuance costs related to revolving and unfunded term debt is presented in “Other current assets” in the Company’s Consolidated Balance Sheets.

 

7

 


 

Revenue recognition

The Company adopted Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASC 606”), effective January 1, 2019, utilizing the modified retrospective method. The Company’s adoption of ASC 606 did not result in material changes to the Company’s revenue recognition.

As an Emerging Growth Company, as defined in the Jumpstart Our Business Startups Act of 2012 (“the JOBS Act”), the JOBS Act allowed us to delay adoption of new or revised accounting pronouncements applicable to public companies until December 31, 2019, which is when such pronouncements are made applicable to private companies.  We elected to use this extended transition period and there were no material differences for revenue recognition between the three and nine months ended September 30, 2020 and September 30, 2019.

Revenues are recognized when the Company satisfies a performance obligation by transferring goods or services promised in a contract to a customer, in an amount that reflects the consideration that the Company expects to receive in exchange for those services. Performance obligations in the Company’s contracts represent distinct or separate service streams that are provided to its customers.

The Company evaluates its revenue contracts with customers based on the five-step model under ASC 606: (1) identify the contract with the customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to separate performance obligations; and (5) recognize revenues when (or as) each performance obligation is satisfied.

The following table summarizes revenue from contracts with customers for the three and nine months ended September 30, 2020 and September 30, 2019  (in thousands):

 

 

 

Three months ended September 30, 2020

 

 

Three months ended September 30, 2019

 

 

Nine months ended September 30, 2020

 

 

Nine months ended September 30, 2019

 

eDiscovery services

 

$

48,021

 

 

$

52,910

 

 

$

147,056

 

 

$

161,075

 

Managed review

 

 

14,015

 

 

 

14,025

 

 

 

36,847

 

 

 

35,944

 

Legal technology services

 

 

62,036

 

 

 

66,935

 

 

 

183,903

 

 

 

197,019

 

Data recovery

 

 

10,265

 

 

 

11,234

 

 

 

31,050

 

 

 

34,508

 

Total revenue

 

$

72,301

 

 

$

78,169

 

 

$

214,953

 

 

$

231,527

 

 

 

Performance Obligations and Timing of Revenue Recognition

 

We primarily sell services and products that fall into the categories discussed below. Each category contains one or more performance obligations that are either (1) capable of being distinct (i.e., the customer can benefit from the product or service on its own or together with readily available resources, including those purchased separately from us) and distinct within the context of the contract (i.e., separately identified from other promises in the contract) or (2) a series of distinct products or services that are substantially the same and have the same pattern of transfer to the customer.

 

 

(1)

eDiscovery services, which provides end-to-end eDiscovery services support including collections, processing, analytics, hosting, production and professional services;

 

(2)

Managed review services which provides the staffing necessary to review large complex data sets; and

 

(3)

Data recovery, which offers data restoration, data erasure and data management.

 

We generate the majority of our revenues by providing Legal Technology services to our clients.  All of our eDiscovery service contracts are time and materials types of arrangements.

 

Time and materials arrangements are based on units of data stored or processed. Unit-based revenues are recognized as services are provided, based on either the amount of data stored or processed, the number of concurrent users accessing the information or the number of pages or images processed for a client, at agreed upon per unit rates. We recognize revenues for these arrangements utilizing a right-to-invoice practical expedient because we have a right to consideration for services completed to date.

 

Certain of our eDiscovery contracts are subscription-based, fixed fee arrangements, which have tiered pricing based on the quantity of data hosted. For a fixed monthly fee, our clients receive a variety of optional eDiscovery services, which are included in addition to the data hosting. We recognize revenues for these arrangements based on predetermined monthly fees as determined in our contractual agreements, utilizing a right-to-invoice practical expedient because we have a right to consideration for services completed to date.

 

Managed review services are time and materials types of arrangements. These agreements require the client to pay us based on the number of hours worked at contractually agreed-upon rates. We recognize revenues for these arrangements based on hours

8

 


 

incurred and contracted rates utilizing a right-to-invoice practical expedient because we have a right to consideration for services completed to date.

 

Data recovery services are mainly fixed fee arrangements requiring the client to pay a pre-established fee in exchange for the successful completion of a data recovery on a predetermined device. For the recovery services performed by the Company’s technicians, the revenue is recognized at a point in time, when the recovered data is sent to the customer.

 

Data erasure services are fixed fee arrangements for which revenue is recognized at a point in time, when the certificate of erasure is sent to the customer.

Ontrack PowerControls offers term license subscriptions for customers with on-premises installations of the software pursuant to contracts that are historically one to four years in length. The term license subscriptions include maintenance, support, as well as access to future software upgrades and fixes.  The license and the additional support services are deemed to be one performance obligation, and thus revenue for these arrangements is recognized ratably over the term of the agreement.

 

Net loss per common share

Basic net loss per common share is determined by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is determined by dividing net loss by the weighted average number of common shares outstanding during the period, plus the dilutive effect of common stock equivalents, including stock options and restricted shares. Common stock and common stock equivalents included in the computation represent shares issuable upon assumed exercise of outstanding stock options and release of restricted shares, except when the effect of their inclusion would be antidilutive.

On December 19, 2019, the Company completed a reverse merger with Pivotal Acquisition Corp. whereby the Company received 34,800,000 shares for its outstanding 3,707,564 shares, effecting a 1-to-9.3862 stock exchange. The per share amounts have been updated to show the effect of the exchange on earnings per share as if the exchange occurred at the beginning of both years for the quarterly financial statements of the Company. The impact of the stock exchange is also shown on the Company’s Statements of Stockholders’ Equity.

Accounting standards not yet adopted

In connection with the transaction with Pivotal, as discussed in more detail in “Note 2, Acquisitions,” the Company elected to be an Emerging Growth Company under the JOBS Act and take advantage of the extended transition period of delaying the adoption of new or revised accounting standards until such time as those standards apply to private companies. This may make the comparison of the Company’s consolidated financial statements to other public companies not meaningful due to the differences in accounting standards being applied.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize on the balance sheet a right-of-use asset, representing their right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. This standard is effective for the Company for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022, and the Company is currently evaluating the impact that Topic 842 will have on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This guidance is intended to introduce a revised approach to the recognition and measurement of credit losses, emphasizing an updated model based on expected losses rather than incurred losses. The Company is required to adopt Topic 326 effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years, and the Company is currently evaluating the impact that Topic 326 will have on its consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to the general principles for income taxes. The new standard is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption, including the adoption in any interim period, is permitted for all entities. The Company is currently evaluating the potential impact of adoption of the pronouncement on its consolidated financial statements but does not expect the impact to be material.

9

 


 

Note 2 – Acquisitions

 

Pivotal Acquisition Corp.

 

On December 19, 2019, Pivotal, the legal predecessor company, consummated the Business Combination with LD Topco, Inc. The stockholders of LD Topco, Inc. received an aggregate of 34,800,000 shares of Pivotal common stock. The former stockholders of LD Topco, Inc. also have the right to receive up to 2,200,000 shares of the Company’s common stock if (i) a change in control occurs or (ii) the reported closing sale price of the Company’s common stock exceeds $13.50 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations or other similar actions) for any 20 consecutive trading days during the five-year period following the closing of the Business Combination.  The Company also assumed 29,350,000 warrants, each of which entitles the holder to purchase shares of the Company’s common stock beginning on February 4, 2020 at an exercise price of $11.50 per share as part of the Business Combination.

As part of the Business Combination, on December 19, 2019, the Company issued $200 million aggregate principal amount of 8% convertible debentures (“Debentures”) due in 2024. The proceeds of the Debentures were used in part to repay LD Topco, Inc.’s outstanding Second Lien Facility (as defined below) and amounts outstanding under its Revolving Credit Facility (as defined below).

 

Note 3 – Fair value measurements

The Company accounts for recurring and non-recurring fair value measurements in accordance with ASC 820, Fair Value Measurements (“ASC 820”). ASC 820 defines fair value, establishes a fair value hierarchy for assets and liabilities measured at fair value, and requires expanded disclosures about fair value measurements. The ASC 820 hierarchy ranks the quality of reliability of inputs, or assumptions, used in the determination of fair value, and requires assets and liabilities carried at fair value to be classified and disclosed in one of the following three categories:

Level 1 – Fair value is determined by using unadjusted quoted prices that are available in active markets for identical assets and liabilities.

Level 2 – Fair value is determined by using inputs other than Level 1 quoted prices that are directly or indirectly observable. Inputs can include quoted prices for similar assets and liabilities in active markets or quoted prices for identical assets and liabilities in inactive markets. Related inputs can also include those used in valuation or other pricing models, such as interest rates and yield curves that can be corroborated by observable market data.

Level 3 – Fair value is determined by inputs that are unobservable and not corroborated by market data. Use of these inputs involves significant and subjective judgments to be made by a reporting entity – e.g., determining an appropriate adjustment to a discount factor for illiquidity associated with a given security.

The Company evaluates financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level at which to classify them each reporting period. This determination requires significant judgments to be made by the Company.

The Company believes that the fair values of its current assets and current liabilities (cash, accounts receivable, accounts payable, and other current liabilities) approximate their reported carrying amounts.

The Company estimates the fair value of contingent purchase consideration based on the present value of the consideration expected to be paid during the remainder of the earn-out period, based on management’s assessment of the acquired operations’ forecasted earnings. This fair value measure is based on significant inputs not observed in the market and thus represents a Level 3 measurement.  During 2019, the Company acquired three companies for total consideration of $5.5 million, of which $2.0 million was in cash, $1.5 million was in deferred payments which were subsequently paid, $1.2 million was in stock and contingent consideration ($1.0 million which was recorded at its estimated fair value of $0.8 million).  The fair value of future expected acquisition-related contingent consideration obligations was $0.9 million and $0.8 million at September 30, 2020 and December 31, 2019, respectively.

The significant unobservable inputs used in the fair value measurements of the Company’s contingent purchase consideration include its measures of the future profitability and related cash flows of the acquired business or assets, impacted by appropriate discount rates. Significant increases (decreases) in any of these individual inputs would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumptions used for the discount rates is indirectly proportional to the fair value of contingent purchase consideration and a change in the assumptions used for the future cash flows is directly proportional to the fair value of contingent purchase consideration. The Company, using additional information as it becomes available, reassesses the fair value of the contingent purchase consideration on a quarterly basis.

10

 


 

Any change in the fair value of contingent consideration liability results in a remeasurement gain or loss that is recorded as income or expense in the Company’s Consolidated Statements of Comprehensive Loss.

The following table provides a reconciliation of liabilities measured at fair value using significant unobservable inputs (Level 3) for the periods ended September 30, 2020 and December 31, 2019 (in thousands):

 

Balance at December 31, 2018

 

$

-

 

Contingent consideration

 

 

774

 

Change in fair value of contingent consideration

 

 

48

 

Balance at December 31, 2019

 

$

822

 

 

 

 

 

 

Payment of contingent consideration

 

 

-

 

Change in fair value of contingent consideration

 

 

80

 

Balance at September 30, 2020

 

$

902

 

 

Management estimates that the carrying amount of the Company’s long-term debt approximates its fair value because the interest rates on these instruments are subject to changes in market interest rates or are consistent with prevailing interest rates.

Note 4 – Leasing arrangements

The Company leases office space and certain equipment under operating and capital lease agreements, expiring in various years through 2027. Certain leases contain annual rent escalation clauses.

Rent expense totaled $3.4 million and $3.7 million for the three months ended September 30, 2020 and 2019, respectively. Rent expense totaled $11.0 million and $11.2 million for the nine months ended September 30, 2020 and 2019, respectively.

As part of an effort to optimize the Company’s real estate footprint, during the three months ended September 30, 2020 the Company recorded $1.2 million in lease termination related expenses which were included in cost of goods sold and operating expenses in our consolidated statements of comprehensive loss.

For years subsequent to September 30, 2020, future minimum payments for all operating and capital lease obligations that have initial non-cancelable lease terms exceeding one year, net of rental income from subleases are as follows (in thousands):

 

December 31,

 

Capital Leases

 

 

Operating Leases

 

2020 (3 months)

 

$

886

 

 

$

2,384

 

2021

 

 

1,586

 

 

 

9,209

 

2022

 

 

1,346

 

 

 

8,277

 

2023

 

 

721

 

 

 

7,736

 

2024

 

 

-

 

 

 

6,597

 

Thereafter

 

 

-

 

 

 

13,103

 

Total

 

$

4,539

 

 

$

47,306

 

Less interest on lease obligations

 

 

(464

)

 

 

 

 

 

 

 

4,075

 

 

 

 

 

Less current portion

 

 

(886

)

 

 

 

 

Non-current portion

 

$

3,189

 

 

 

 

 

 

11

 


 

Note 5 – Long term debt

The table below summarizes the components of the Company’s long-term debt (in thousands):

 

 

 

September 30, 2020

 

 

December 31, 2019

 

First lien facility due 2022

 

$

293,250

 

 

$

306,000

 

Convertible debenture notes due 2024

 

 

206,423

 

 

 

200,000

 

Total debt

 

 

499,673

 

 

 

506,000

 

Less: unamortized original issue discount

 

 

(17,109

)

 

 

(19,806

)

Less: unamortized debt issuance costs

 

 

(4,295

)

 

 

(5,573

)

Total debt, net

 

 

478,269

 

 

 

480,621

 

 

 

 

 

 

 

 

 

 

Current portion of debt

 

 

17,000

 

 

 

17,000

 

Less: current portion of unamortized original issue discount

 

 

(4,170

)

 

 

(3,687

)

Less: current portion of unamortized debt issuance costs

 

 

(1,724

)

 

 

(1,624

)

Total current portion of debt, net

 

 

11,106

 

 

 

11,689

 

Total long term debt, net

 

$

467,163

 

 

$

468,932

 

 

2016 Credit Agreement

On December 9, 2016, certain subsidiaries of the Company entered into a credit agreement (as amended or supplemented to date, the “2016 Credit Agreement”) with a group of lenders to establish term loan facilities and a revolving line of credit for borrowings by LD Intermediate, Inc. and LD Lower Holdings, Inc. (the “Initial Term Loans”). The Initial Term Loan borrowings of $340.0 million (“First Lien Facility”) and $125.0 million (“Second Lien Facility”) were to mature on December 9, 2022 and December 9, 2023, respectively. The Second Lien Facility was repaid on December 19, 2019 in connection with the consummation of the Business Combination.

The First Lien Facility established a term loan principal payment schedule with payments due on the last day of each calendar quarter beginning on March 31, 2017 of $2.1 million. Quarterly principal payments increased to $4.3 million beginning on March 31, 2019 with a balloon payment of $259.3 million due at maturity. The interest rate for the First Lien Facility adjusts every interest rate period, which can be one, two, three or six months in duration and is decided by the Company, or to the extent consented to by all Appropriate Lenders (as defined in the 2016 Credit Agreement), 12 months thereafter. Interest payment dates include the last day of each interest period and any maturity dates of the First Lien Facility; however, if any interest period exceeds three months, the respective dates that fall every three months after the beginning of an interest period is also an interest payment date. For each interest period, the interest rate per annum is 5.875% plus the Adjusted Eurocurrency Rate which is defined as an amount equal to the Statutory Reserve Rate (as defined in the 2016 Credit Agreement) multiplied by the greatest of a) LIBOR, b) 0.00% per annum and c) solely with respect to the Initial Term Loans, 1.00% per annum. At September 30, 2020, the balance due was $293.3 million with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 1.000%.  At December 31, 2019, the balance due was $306.0 million with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 2.61463%.

The First Lien Facility is secured by substantially all the Company’s assets and contains financial covenants. As of September 30, 2020 and December 31, 2019, the Company was in compliance with all covenants.

The 2016 Credit Agreement includes a mandatory prepayment within 10 days after delivery of the annual audited financial statements commencing with the year ending December 31, 2016, in an amount equal to the Excess Cash Flow Percentage of Excess Cash Flow for such Fiscal Year, as defined in the 2016 Credit Agreement. There were no mandatory prepayments with respect to the nine months ended September 30, 2020 and 2019.

Revolving Credit Facility

The 2016 Credit Agreement also provides for an unfunded revolver commitment for borrowing up to $30.0 million, maturing December 9, 2021 (the “Revolving Credit Facility”). Borrowings under the Revolving Credit Facility may be limited by certain financial covenants of the 2016 Credit Agreement including the First Lien Net Leverage Ratio. The Company may draw up to $30.0 million, on a term loan basis, with an adjustable interest rate of 5.375%, 5.625%, or 5.875% based on the First Lien Net Leverage Ratio plus an amount equal to the LIBOR. As of September 30, 2020 and December 31, 2019, the balance was zero under the Revolving Credit Facility.  

As of September 30, 2020, there was $29.2 million available capacity for borrowing under the revolving loan commitment due to the $0.8 million of letters of credit outstanding (See Note 9 – Commitments and contingencies).

 

12

 


 

Convertible Debentures

On December 19, 2019, the Company issued the Debentures in an aggregate principal amount of $200 million. The proceeds of the Debentures were used in part to repay the Company’s outstanding Second Lien Facility and amounts then outstanding under the Revolving Credit Facility. At September 30, 2020, the balance due under the Convertible Debentures was $206.4 million. At December 31, 2019, the balance due under the Convertible Debentures was $200.0 million.

The Debentures mature on December 19, 2024 unless earlier converted, redeemed or repurchased, and bear interest at an annual rate of 4.00% in cash, payable quarterly, and 4.00% in kind, accrued quarterly, on the last business day of March, June, September and December. In addition, on each anniversary of the Closing Date, the Company will add to the principal amount (subject to reduction for any principal amount repaid) of the Debentures an amount equal to 3.00% of the original aggregate principal amount of the Debentures outstanding. The additional payment will accrue from the last payment date for the additional payment (or the Closing Date if no prior payment has been made), and will also be payable at maturity, upon conversion and upon an optional redemption.

At any time, upon notice as set forth in the Debentures, the Debentures are redeemable at the Company’s option, in whole or in part, at a price equal to 100% of the principal amount of the Debentures redeemed, plus accrued and unpaid interest thereon.

Subject to approval to allow for the full conversion of the Debentures into common stock, the Debentures are convertible into shares of the Company’s common stock at the option of the Debenture holders at any time and from time to time at a price of $18 per share, subject to certain adjustments. However, in the event the Company elects to redeem any Debentures, the holders have a right to purchase common stock from the Company in an amount equal to the amount redeemed at the conversion price.

The Debentures contain covenants that limit the Company’s ability to, among other things: (i) incur additional debt; (ii) create liens on assets; (iii) engage in certain transactions with affiliates; or (iv) designate the Company’s subsidiaries as unrestricted subsidiaries. The Debentures provide for customary events of default, including non-payment, failure to comply with covenants or other agreements in the Debentures and certain events of bankruptcy or insolvency. If an event of default occurs and continues, the holders of at least 25% in aggregate principal amount of the outstanding Debentures may declare the entire principal amount of all the Debentures to be due and payable immediately. As of September 30, 2020, the Company was in compliance with all covenants.

Note 6 – Equity incentive plan

On December 19, 2019, the Company adopted the 2019 Incentive Award Plan (the “2019 Plan”) under which eligible employees, officers, directors and consultants of the Company may be granted incentive or non-qualified stock options, restricted stock, restricted stock units, or other stock-based awards, including shares of common stock. The Compensation Committee did not increase the share reserve under the 2019 Plan in 2020. As of September 30, 2020, 7,500,000 shares of common stock, $0.0001 par value per share (the “Common Stock”) were reserved under the 2019 Plan, of which 1,767,156 shares of Common Stock remained available for issuance.

On March 29, 2016, the Company adopted the 2016 Equity Incentive Plan (as amended, the “2016 Plan”) under which eligible employees, officers, directors and consultants of the Company may be granted incentive or non-qualified stock options, restricted stock, restricted stock units, or other stock-based awards, including shares of common stock. The 2016 Plan was terminated on December 19, 2019 and all outstanding awards were cancelled for no consideration.

Stock option activity

The following table summarizes the Company’s stock option activity under the 2019 Plan:

 

Description

 

Options

Outstanding

 

 

Weighted

Average

Exercise

Price

 

 

Weighted

Average

Remaining

Contractual

Term (Years)

 

 

Aggregate

Intrinsic

Value (1)

 

Options Outstanding, December 31, 2019

 

 

514,710

 

 

$

9.90

 

 

 

10.0

 

 

$

-

 

Granted

 

 

4,137,750

 

 

 

8.49

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(248,101

)

 

 

9.08

 

 

 

 

 

 

 

 

 

Expired

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

Options Outstanding, September 30, 2020

 

 

4,404,359

 

 

$

8.46

 

 

 

9.3

 

 

$

-

 

Options Exercisable, September 30, 2020

 

 

-

 

 

$

-

 

 

 

-

 

 

$

-

 

 

 

13

 


 

(1)

Aggregate intrinsic value represents the difference between the estimated fair value of the underlying Common Stock (as defined below) and the exercise price of outstanding, in-the-money options. There were no in-the-money options as of September 30, 2020 or December 31, 2019.

No stock options were exercised during the nine months ended September 30, 2020 and 2019 under the 2019 Plan or the 2016 Plan.

The following table summarizes additional information on stock option grants and vesting (in thousands):

 

 

 

2016 Plan

 

 

2019 Plan

 

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

Total fair value of stock options granted

 

$

-

 

 

$

2,492

 

 

$

9,241

 

 

$

-

 

Total fair value of options vested

 

 

-

 

 

 

1,439

 

 

 

-

 

 

 

-

 

 

Time-based vesting stock options

Under the 2016 Plan, time-based vesting stock options vested over a five-year period, subject to graded vesting schedules, and expired 10 years from the date of grant or within 90 days of termination. The weighted-average fair value per share of time-based vesting stock options granted by us was $37.16 during the nine months ended September 30, 2019.

Under the 2016 Plan, for the three months ended September 30, 2020 and 2019, the Company recognized $0.0 million and $0.4 million of stock-based compensation expense in connection with time-based stock options, respectively. Under the 2016 Plan, for the nine months ended September 30, 2020 and 2019, the Company recognized $0.0 million and $1.9 million of stock-based compensation expense in connection with time-based stock options, respectively. As of September 30, 2020, there was no unrecognized stock-based compensation expense as the 2016 Plan was terminated during 2019 and all options were forfeited.

Under the 2019 Plan, time-based vesting stock options generally vest over a three-year period and expire not more than 10 years from the date of grant. The weighted-average fair value per share of time-based vesting stock options granted by us was $2.19, during the nine months ended September 30, 2020.

Under the 2019 Plan, for the three months ended September 30, 2020, the Company recognized $0.9 million of stock-based compensation expense in connection with time-based stock options. Under the 2019 Plan, for the nine months ended September 30, 2020, the Company recognized $2.5 million of stock-based compensation expense in connection with time-based stock options. As of September 30, 2020, there was $7.2 million of unrecognized stock-based compensation expense related to unvested time-based stock options that is expected to be recognized over a weighted-average period of 2.3 years.

Performance-based vesting stock options

Performance-based vesting stock options generally vested upon the satisfaction of performance- and market-based criteria, based on the Principal Stockholders’ (as defined in the 2016 Plan) internal rate of return on their investment in the Company as measured following their sale of at least 70% of the Principal Stockholders total holdings in the Company, and expired 10 years from the date of grant. The weighted-average fair value per share of performance-based vesting stock options granted by us was $0 and $37.16 during the nine months ended September 30, 2020 and 2019, respectively. As of September 30, 2020, there were no stock options with performance-based vesting outstanding, as the 2016 Plan was terminated and all options were forfeited.

Award Valuation

The Company used valuation models to value both time and performance-based vesting stock options granted during the nine months ended September 30, 2020 and 2019. The following table summarizes the assumptions used in the valuation models to determine the fair value of awards granted to employees and non-employees under both the 2019 Plan and the 2016 Plan:

 

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

Expected volatility

 

37.63% - 41.24%

 

 

36.92%

 

Expected term (in years)

 

6.0

 

 

6.5

 

Dividend yield

 

0.00%

 

 

0.00%

 

Risk free interest rate

 

1.43% - 0.30%

 

 

2.42%

 

 

14

 


 

A discussion of management’s methodology for developing each of the assumptions used in the valuation model follows

 

Expected volatility – Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company uses an estimated volatility based on the historical and implied volatilities of comparable companies.

 

Expected term – This is the period that the options granted are expected to remain unexercised. For options granted during the three and nine months ended September 30, 2020 and 2019, the Company derived the expected life of the option based on the average midpoint between vesting and the contractual term as there is little exercise history.

 

Dividend yield – The Company has never declared or paid dividends and has no plans to do so in the foreseeable future.

 

Risk-free interest rate – This is the U.S. Treasury rate for securities with similar terms that most closely resembles the expected life of the option.

Stock-based award activity

During the nine months ended September 30, 2020, the Company granted to certain non-employee directors 136,956 restricted stock units (“RSUs”) for their initial appointment to the Company’s board of directors (the “Board”) and for continued service, which awards are subject to a three or one-year vesting period. Accordingly, the Company will recognize the grant-date fair value of the stock awards, ratably over the vesting period. During the three and nine months ended September 30, 2020, the Company recognized $0.2 million as stock-based compensation expense related to this grant.

During the nine months ended September 30, 2019, the Company granted to certain non-employee directors 7,223 stock awards. These stock awards were issued to non-employee directors in satisfaction of their annual retainer payments and are not subject to any vesting conditions, and thus became issued and outstanding shares on the grant date. Accordingly, the Company recognized the grant-date fair value of the stock awards of $0.7 million as stock-based compensation expense concurrent with the grant date of the awards during the three and nine months ended September 30, 2019.

Stock-based compensation expense

Stock-based compensation expense is included in the Company’s Consolidated Statements of Comprehensive Loss within the following line items (in thousands):

 

  

 

Three Months Ended September 30, 2020

 

 

Three Months Ended September 30, 2019

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

Cost of revenues

 

$

339

 

 

$

144

 

 

$

1,020

 

 

$

442

 

General and administrative

 

 

350

 

 

 

127

 

 

 

841

 

 

 

1,045

 

Research and development

 

 

65

 

 

 

24

 

 

 

205

 

 

 

67

 

Sales and marketing

 

 

159

 

 

 

116

 

 

 

486

 

 

 

346

 

Total

 

$

913

 

 

$

411

 

 

$

2,552

 

 

$

1,900

 

 

Restricted stock units

The Company granted RSUs to certain employees which are subject to certain vesting criteria.  The RSUs become eligible to begin vesting upon a liquidity event (as defined in the award agreements governing the RSUs). The amount and timing of the vesting of the RSUs is dependent on the type and timing of the liquidity event as it relates to the Business Combination date of December 19, 2019.  Generally, a portion of the RSUs will first vest upon the occurrence of the liquidity event and the remainder will vest in installments thereafter, provided that if the liquidity event occurs after the third anniversary of the Business Combination, all RSUs will vest immediately upon the liquidity event. The vesting of the RSUs is generally subject to continued employment.

15

 


 

RSU activity

The following table summarizes the Company’s RSU activity under the 2019 Plan:

 

Description

 

RSUs

Outstanding

 

 

 

 

 

 

Balance at December 31, 2019

 

 

-

 

Granted

 

 

1,402,312

 

Forfeited

 

 

(73,827

)

Expired

 

 

-

 

Balance at September 30, 2020

 

 

1,328,485

 

 

The Company determined that the achievement of the liquidity event was not probable and therefore no expense was recorded during the three or nine months ended September 30, 2020.

Note 7 – Equity

The Company is authorized to issue up to 200,000,000 shares of Common Stock and 1,000,000 shares of preferred stock, $0.0001 par value per share. Each holder of Common Stock is entitled to one vote for each share of Common Stock held on all matters submitted to a vote of stockholders. The holders of the Common Stock are entitled to receive dividends out of assets legally available at the time and in the amounts as the Board may from time to time determine. In the event of any liquidation, dissolution or winding up of the Company, the assets of the Company shall be distributed ratably among the holders of the then outstanding Common Stock.

Warrants

On December 19, 2019, in connection with the consummation of the Business Combination, the Company assumed (i) 23,000,000 warrants (the “Public Warrants”), (ii) 4,585,281 warrants (the “Private Warrants”) and (iii) 1,764,719 warrants (the “Debenture Holder Warrants” and together with the Public Warrants and the Private Warrants, the “Warrants”). These Warrants qualified for equity accounting as the Warrants did not fall within the scope of ASC Topic 480, Distinguishing Liabilities from Equity. The Warrants were measured at fair value at the time of issuance and classified as equity.

Each Warrant entitles the holder to purchase one share of Common Stock for $11.50 per share. If held by the initial purchaser of the Private Warrant or certain permitted transferees, the purchase can occur on a cashless basis. The Warrants will expire on December 19, 2024 or earlier upon redemption or liquidation.

If the reported last sale price of the Company’s Common Stock equals or exceeds $18.00 per share for any 20 trading days within a 30-trading day period ending three business days before the Company sends the notice of redemption to the Warrant holders, the Company may redeem all the Public Warrants at a price of $0.01 per Warrant upon not less than 30 days’ prior written notice.

If the Company calls the Public Warrants for redemption, management will have the option to require all holders that wish to exercise the Public Warrants to do so on a cashless basis. The exercise price and number of shares of Common Stock issuable upon exercise of the Warrants may be adjusted in certain circumstances including in the event of a stock dividend, or recapitalization, reorganization, merger or consolidation. The Warrants will not be adjusted for issuance of Common Stock at a price below its exercise price. The Company will not be required to net cash settle the Warrants.

The Private Warrants are identical to the Public Warrants except that the Private Warrants will be exercisable on a cashless basis and be non-redeemable so long as they are held by the initial purchasers or their permitted transferees. If the Private Warrants are held by someone other than the initial purchasers or their permitted transferees, the Private Warrants will be redeemable by the Company and exercisable by such holders on the same basis as the Public Warrants.

16

 


 

Shares Subject to Forfeiture

On December 19, 2019, in connection with the consummation of the Business Combination, 550,000 shares of Common Stock held by Pivotal Acquisition Holdings LLC were subjected to an additional lockup that will be released only if the last reported sale price of the Common Stock equals or exceeds $15.00 for a period of 20 consecutive trading days during the five-year period following the Closing Date. If the last reported sale price of Common Stock does not equal or exceed $15.00 within five years from the Closing Date, such shares of Common Stock will be forfeited to the Company for no consideration. These shares are reported as outstanding in our financial statements.

 

Note 8 – Income taxes

A valuation allowance has been established against our net U.S. federal and state deferred tax assets, including net operating loss (“NOL”) carryforwards. As a result, our income tax position is primarily related to foreign tax activity and U.S. deferred taxes for tax deductible goodwill and other indefinite-lived liabilities. During the three months ended September 30, 2020 and 2019, the Company recorded an income tax provision of $0.4 million and $0.1 million, respectively, resulting in an effective tax rate of (3.3)% and (0.6)%, respectively. During the nine months ended September 30, 2020 and 2019, the Company recorded an income tax provision of $1.0 million and $0.4 million, respectively, resulting in an effective tax rate of (2.6)% and (1.1)%, respectively. These effective tax rates differ from the U.S. federal statutory rate primarily due to the effects of foreign tax rate differences and the valuation allowance against our domestic deferred tax assets.

 

Note 9 – Commitments and contingencies

The Company is involved in various legal proceedings, which may arise occasionally in the normal course of business. While the ultimate results of such matters generally cannot be predicted with certainty, management does not expect such matters to have a material effect on the financial position and results of operations as of September 30, 2020.

The Company has four letters of credit totaling $0.8 million as additional security for lease guarantees related to four leased properties.

Risks and Uncertainties

 

Impacts of COVID-19 pandemic on KLDiscovery’s Business

The potential impacts of the ongoing COVID-19 pandemic on the Company’s business are currently not estimable or determinable.  The Company has made modifications to employee travel, employee work locations, and cancellation of certain events, among other modifications. During 2020, the Company implemented a salary exchange program pursuant to which certain employees have taken a temporary reduction in salary through December 31, 2020 that ranges from 2% to 20% in exchange for receiving 417,673 stock options and 211,207 RSUs to purchase shares of Common Stock in future periods. The Company also initiated limited furloughs for certain employees. The Company will continue to actively monitor the situation and may take further actions that alter its business operations as may be required by federal, state or local authorities or that it determines is in the best interests of its employees, customers, partners, suppliers and stockholders.  It is not clear what the potential effects any such alterations or modifications may have on the Company’s business, including the effects on its customers and prospects, or on its financial results for the remainder of fiscal year 2020.

On March 27, 2020, the President signed into U.S. federal law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which is aimed at providing emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally supporting the U.S. economy. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer-side social security payments, NOL carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. In particular, under the CARES Act, (i) for taxable years beginning before 2021, NOL carryforwards and carrybacks may offset 100% of taxable income, (ii) NOLs arising in 2018, 2019, and 2020 taxable years may be carried back to each of the preceding five years to generate a refund and (iii) for taxable years beginning in 2019 and 2020, the base for interest deductibility is increased from 30% to 50% of taxable income. As permitted under the CARES Act, we are deferring payroll taxes due in 2020 to 2021 and 2022. We continue to analyze other aspects of the CARES act as well as similar tax legislation in other countries we operate but do not believe they will have a meaningful impact to our results.

17

 


 

Note 10 – Related parties

On December 22, 2015, the Company entered into a consulting agreement with Carlyle Investment Management, LLC, an affiliate of The Carlyle Group, Inc., for advisory, consulting and other services in relation to the strategic and financial management of the Company. For the nine months ended September 30, 2019, the Company recognized $0.8 million in management consulting fees, reflected within “General and administrative expenses” in the accompanying consolidated Statements of Comprehensive Loss. The consulting agreement was terminated on December 19, 2019.

In connection with the Business Combination, the Company assumed Debentures of which $103.2 million are owed to affiliates of MGG Investment Group, an affiliate of Kevin Griffin, a director of the Company as of September 30, 2020. For the three months ended September 30, 2020 and 2019, the Company recognized $3.1 million and $0 million in interest expense, respectively, related to the Debentures. For the nine months ended September 30, 2020 and 2019, the Company recognized $9.0 million and $0 million in interest expense, respectively, related to the Debentures.

Note 11 – Subsequent events

The Company has evaluated subsequent events through the dates on which this Quarterly Report on Form 10-Q was filed, the date on which these financial statements were issued, and identified no additional items for disclosure.

 


18

 


 

 

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

We believe that this Quarterly Report on Form 10-Q contains statements that are forward-looking and as such are not historical facts. This includes, without limitation, statements regarding the financial position, business strategy and the plans and objectives of management for future operations. These statements constitute projections, forecasts and forward-looking statements, and are not guarantees of performance. Such statements can be identified by the fact that they do not relate strictly to historical or current facts. When used in this Report, words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” “strive,” “would” and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. When we discuss our strategies or plans, we are making projections, forecasts or forward-looking statements. Such statements are based on the beliefs of, as well as assumptions made by and information currently available to, our management. The forward-looking statements contained in this Report are based on current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors described in the section titled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (our “Annual Report”). These risks and uncertainties may be amplified by the ongoing COVID-19 pandemic and its potential impact on our business and the global economy. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.

Throughout this section, unless otherwise noted “we,” “us,” “our,” “Company,” “KLDiscovery,” “KLD,” “KLDiscovery Inc.” or “LD Topco, Inc.” refer to KLDiscovery Inc. and its consolidated subsidiaries. As a result of the Business Combination, (i) KLDiscovery Inc.’s consolidated financial results for periods prior to December 19, 2019 reflect the financial results of LD Topco, Inc. and its consolidated subsidiaries, as the accounting predecessor to KLDiscovery Inc., and (ii) for periods from and after this date, KLDiscovery Inc.’s financial results reflect those of KLDiscovery Inc. and its consolidated subsidiaries (including LD Topco, Inc. and its subsidiaries) as the successor following the Business Combination. The following overview provides a summary of the sections included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations:

 

Executive Summary — a general description of our business and key highlights for the three and nine months ended September 30, 2020.

 

Results of Operations — an analysis of our results of operations in our condensed consolidated financial statements.

 

Liquidity and Capital Resources — an analysis of our cash flows, sources and uses of cash, commitments and contingencies and quantitative and qualitative disclosures about market risk.

 

 

Critical Accounting Policies and Estimates — a discussion of critical accounting policies requiring judgments and estimates.

Executive Summary

We are one of the leading eDiscovery providers and the leading data recovery services provider to corporations, law firms, government agencies and individual consumers. We provide technology-enabled services and software to help law firms, corporations, government agencies and consumers solve complex data challenges. We have broad geographical coverage in the eDiscovery and data recovery industries with 34 locations in 19 countries, 8 data centers and 19 data recovery labs around the globe. Our legal technology services cover both eDiscovery and information governance services to support the litigation, regulatory compliance, and internal investigation needs of our clients. We offer data collection and forensic investigation, early case assessment, electronic discovery and data processing, application software, data hosting, and managed review services. In addition, through our global Ontrack Data Recovery name, we deliver world-class data recovery, email extraction and restoration, data destruction and tape management services.

KEY COMPONENTS OF OUR RESULTS OF OPERATIONS

Data proliferation is contributing to growth in the eDiscovery and information governance market. Data is growing at an exponential rate due to several factors, including the adoption of mobile devices, accessibility of hosted systems and increased reliance on electronic data storage. We are well positioned to gain market share from the growth of electronically stored information given our prior and continued investment in our infrastructure and proprietary technologies that allows us to

19

 


 

efficiently identify, preserve, collect, process, review and host complex data sets. We will continue to develop and enhance our technology which will position us to continue to evolve as the market changes.

The eDiscovery and information governance market is highly fragmented and price competitive. While many of our competitors rely on third party software tools to provide their services, we offer our services utilizing our own end-to-end proprietary tools as well as third party platforms. Because we can provide service offerings utilizing proprietary technology, we have more flexibility in pricing, and we are not hindered by third party licensing software expenses. As such, our proprietary tools allow us to be less impacted by significant price compression than our competitors.

Historically, on-premise tools have been the dominant deployment solution. However, recently the market has shifted to cloud-based solutions and this shift could result in increased revenue for us as we offer our own proprietary cloud-based solutions.

We classify our legal technology revenue as follows:

 

Collections and Processing Services: We have remote and onsite collection services. Our proprietary workflows and tools allow us to ingest, extract native file metadata and index in a normalized format. We have near duplication tools to quickly discard duplicative or irrelevant data, significantly minimizing the data that needs to be reviewed. Our analytics include predictive coding which allows us to automatically classify millions of documents in a matter of hours. We offer email threading that looks at relationships between email messages to identify the most content inclusive messages to avoid redundant review and we have language identification that can automatically identify the primary language in all documents in the data set. The collection of data is billed either by the unit or hour and the data that is processed and produced is billed by gigabyte, page or by file.

 

Forensics and Consulting Services: We provide the expertise and tools needed to extract and analyze digital evidence to support a client’s legal matter. Our forensics experts help extract critical evidence, recover any data that individuals may have sought to erase or hide, retrieve key data buried in documents and organize data contained in multiple information sources to give our clients the insight and knowledge they need. Our forensics and consulting services are billed by either hour or unit.

 

Professional Services: We manage complex eDiscovery matters and partner with our clients to assist through the lifecycle of a case. Our professional services are billed on an hourly basis.

 

Managed Review Services: We use our extensive eDiscovery project management experience, technological excellence and global presence to provide clients with a secure, seamless and cost-effective managed review solution. We assemble review teams of experienced legal professionals for any type of case. Each team member is a qualified attorney who has passed a selective screening process and has received training from a KLDiscovery review manager to ensure the most efficient and defensible review of a client’s documents. Document review managers have extensive project management experience to oversee the entire review process and work with the client’s legal team as an integrated partner. Our industry experts have developed advanced managed review processes and tools and deliver services in state-of-the-art facilities, handle subject matter versatility, are platform agnostic, possess expert working knowledge of predictive coding and technology assisted review workflows, have multilingual capabilities and focus on quality. Our managed review services are billed on an hourly basis.

 

Hosting: We have flexible technology options and platforms to host our clients’ data for the life of the matter. We offer secure data centers around the globe to support data across jurisdictions and privacy laws. Hosting is billed by gigabyte.

 

Subscription: We offer subscription pricing options to provide cost predictability over time. Subscriptions cover a range of our services and are typically a fixed fee billed monthly for contract terms averaging 1 to 3 years.

We classify our data recovery revenue as follows:

 

Data Recovery Services: We recover lost data from devices that store digital information, including data centers, cloud, business servers, workstations, laptops and mobile devices. Pricing is per device.

 

PowerControls and Data Recovery Software: We enable search and recovery of data from database files and physically sound devices. Pricing is typically an annual or multi-year agreement at a fixed price.

For the three months ended September 30, 2020 and 2019, our legal technology revenue was $62.0 million and $66.9 million, respectively, and our data recovery revenue was $10.3 million and $11.2 million, respectively. For the nine months ended September 30, 2020 and 2019, our legal technology revenue was $183.9 million and $197.0 million, respectively, and our data recovery revenue was $31.1 million and $34.5 million, respectively. Additionally, we have longstanding relationships with our clients and for the three and nine months ended September 30, 2020 and 2019, no single client accounted for more than 5% of our revenues.

20

 


 

Non-U.S. GAAP Financial Measures

We prepare audited financial statements in accordance with U.S. GAAP. We also disclose and discuss other non-U.S. GAAP financial measures such as EBITDA and adjusted EBITDA. We believe that these measures are relevant and provide useful supplemental information to investors by providing a baseline for evaluation and comparing our operating performance against that of other companies in our industry.

The non-U.S. GAAP financial measures that we use may not be comparable to similarly titled measures reported by other companies and in the future, we may disclose different non-U.S. GAAP financial measures in order to help our investors meaningfully evaluate and compare our results of operations to our previously reported results of operations or to those of other companies in our industry. We believe these non-U.S. GAAP financial measures reflect our ongoing operating performance because the isolation of non-cash charges, such as amortization and depreciation, and other items, such as interest, income taxes, management fees and equity compensation, acquisition and transaction costs, restructuring costs, systems establishment and costs associated with strategic initiatives which are incurred outside the ordinary course of our business, provides information about our cost structure and helps us to track our operating progress. We encourage investors and potential investors to carefully review the U.S. GAAP financial information and compare them with our EBITDA and adjusted EBITDA.

Adjusted EBITDA

We define EBITDA as net income (loss) plus interest (income) expense, income tax expense (benefit), depreciation and amortization. We view adjusted EBITDA as our operating performance measure and as such, we believe that the most directly comparable U.S. GAAP financial measure is net loss. In calculating adjusted EBITDA, we exclude from net loss certain items that we believe are not reflective of our ongoing business and exclusion of these items allows us to provide additional analysis of the financial components of the day-to-day operation of our business. We have outlined below the type and scope of these exclusions:

 

Acquisition, financing and transaction costs generally represented by non-ordinary course earn-out valuation changes, rating agency fees, letter of credit and revolving facility fees, as well as professional service fees and direct expenses related to acquisitions. Because we do not acquire businesses on a predictable cycle, we do not consider the amount of acquisition- and integration-related costs to be a representative component of the day-to-day operating performance of our business.

 

Strategic initiatives expenses relate to costs resulting from pursuing strategic business opportunities. We do not consider the amounts to be representative of the day-to-day operating performance of our business.

 

Management fees, stock compensation and other primarily represents consulting fees and portions of compensation paid to our employees and executives through stock-based instruments. Determining the fair value of the stock-based instruments involves a high degree of judgment and estimation and the expenses recorded may not align with the actual value realized upon the future exercise or termination of the related stock-based awards. Therefore, we believe it is useful to exclude stock-based compensation to better understand the long-term performance of our core business.

 

Restructuring costs generally represent non-ordinary course costs incurred in connection with a change in a contract or a change in the makeup of our personnel often related to an acquisition. We do not consider the amount of restructuring costs to be a representative component of the day-to-day operating performance of our business.

 

Systems establishment costs relate to non-ordinary course expenses incurred to develop our IT infrastructure, including system automation and enterprise resource planning system implementation. We do not consider the amount to be representative of a component of the day-to-day operating performance of our business.

Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by any of these adjustments, or that our projections and estimates will be realized in their entirety or at all. In addition, because of these limitations, adjusted EBITDA should not be considered as a measure of liquidity or discretionary cash available to us to fund our cash needs, including investing in the growth of our business and meeting our obligations.

The use of adjusted EBITDA instead of U.S. GAAP measures has limitations as an analytical tool, and adjusted EBITDA should not be considered in isolation, or as a substitute for analysis of our results of operations and operating cash flows as reported under U.S. GAAP. For example, adjusted EBITDA does not reflect:

 

our cash expenditures or future requirements for capital expenditures;

 

changes in, or cash requirements for, our working capital needs;

 

interest expense, or the cash requirements necessary to service interest or principal payments, on our indebtedness;

 

any cash income taxes that we may be required to pay;

 

any cash requirements for replacements of assets that are depreciated or amortized over their estimated useful lives and may have to be replaced in the future; or

 

all non-cash income or expense items that are reflected in our statements of cash flows.

21

 


 

RESULTS OF OPERATIONS

 

Impacts of the COVID-19 pandemic on the Company’s Business

The potential impacts of the ongoing COVID-19 pandemic on our business are currently not estimable or determinable.  We are conducting business as usual with some modifications to employee travel, employee work locations, and cancellation of certain events, among other modifications. We have implemented a salary exchange program pursuant to which certain employees have taken a temporary reduction in salary through December 31, 2020 that ranges from 2% to 20% in exchange for receiving additional stock options and RSUs. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine is in the best interests of our employees, customers, partners, suppliers and stockholders.  It is not clear what the potential effects of any such alterations or modifications may have on our business, including the effects on our customers and prospects, or on our financial results for the remainder of fiscal year 2020.

On March 27, 2020, the President signed into U.S. federal law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which is aimed at providing emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally supporting the U.S. economy. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer-side social security payments, NOL carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. In particular, under the CARES Act, (i) for taxable years beginning before 2021, NOL carryforwards and carrybacks may offset 100% of taxable income, (ii) NOLs arising in 2018, 2019, and 2020 taxable years may be carried back to each of the preceding five years to generate a refund and (iii) for taxable years beginning in 2019 and 2020, the base for interest deductibility is increased from 30% to 50% of taxable income. As permitted under the CARES Act, we are deferring payroll taxes due in 2020 to 2021 and 2022. We continue to analyze other aspects of the CARES act as well as similar tax legislation in other countries we operate but do not believe they will have a meaningful impact to our results.

For the three months ended September 30, 2020 compared with the three months ended September 30, 2019

The following table sets forth statements of operations data for each of the periods indicated:

 

 

For the Three Months Ended September 30,

 

(in millions)

 

2020

 

 

2019

 

Revenues

 

$

72.3

 

 

$

78.2

 

Cost of revenues

 

 

37.7

 

 

 

42.1

 

Gross profit

 

 

34.6

 

 

 

36.1

 

Operating expenses

 

 

34.5

 

 

 

35.3

 

Income from operations

 

 

0.1

 

 

 

0.8

 

Interest expense

 

 

12.4

 

 

 

12.0

 

Other expense

 

 

-

 

 

 

-

 

Loss before income taxes

 

 

(12.3

)

 

 

(11.2

)

Income tax provision

 

 

0.4

 

 

 

0.1

 

Net loss

 

 

(12.7

)

 

 

(11.3

)

Total other comprehensive (loss) income, net of tax

 

 

2.2

 

 

 

(2.2

)

Comprehensive loss

 

 

(10.5

)

 

 

(13.5

)

Revenues

Revenues decreased by $5.9 million, or 7.5%, to $72.3 million for the three months ended September 30, 2020 as compared to $78.2 million for the three months ended September 30, 2019. This is primarily due to decreases in hosting services of $2.6 million, collections and processing of $1.1 million and data recovery of $1.0 million. These decreases are primarily due to the impacts of COVID-19, as many clients have delayed the start of new matters and court systems have been slow to reopen.

Cost of Revenues

Cost of revenues decreased by $4.4 million, or 10.5%, to $37.7 million for the three months ended September 30, 2020 as compared to $42.1 million for the three months ended September 30, 2019.  This decrease is due to expense reduction measures implemented by management, which decreased personnel expense by $2.6 million and travel and entertainment expense by $0.4 million, as well as other smaller expense decreases. In addition, hardware and software expenses decreased by $1.1 million and communications expenses decreased by $0.4 million.  These decreases were partially offset by $0.7 million of increased severance expenses due to the integration of operational business units.  As a percentage of revenue, our cost of revenues for the three months ended September 30, 2020 decreased to 52.1% as compared to 53.8% for the three months ended September 30, 2019. This decrease was due to the factors noted above.

22

 


 

Gross Profit

Gross profit decreased by $1.5 million, or 4.2%, to $34.6 million for the three months ended September 30, 2020 as compared to $36.1 million for the three months ended September 30, 2019. Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the three months ended September 30, 2020 increased to 47.9% as compared to 46.2% for the three months ended September 30, 2019 primarily due to the factors noted above.

Operating Expenses

Operating expenses decreased by $0.8 million, or 2.3%, to $34.5 million for the three months ended September 30, 2020 as compared to $35.3 million for the three months ended September 30, 2019. This decrease is due to expense reduction measures implemented by management which decreased personnel expenses by $2.3 million, decreased travel and entertainment expenses by $0.7 million and decreased marketing expenses by $0.4 million. These decreases were partially offset by increased costs incurred related to lease terminations to optimize our real estate footprint of $1.2 million and $0.8 million of increased severance costs due to the integration of operational business units. As a percentage of revenue, our operating expenses for the three months ended September 30, 2020 increased to 47.7% as compared to 45.1% for three months ended September 30, 2019 due to the factors noted above.

Interest Expense

Interest expense increased by $0.4 million, or 3.3%, to $12.4 million for the three months ended September 30, 2020 as compared to $12.0 million for the three months ended September 30, 2019. This increase is primarily due to the increase in outstanding debt, partially offset by lower interest rates during the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

Income Tax Provision (Benefit)

During the three months ended September 30, 2020 and 2019, we recorded an income tax provision of $0.4 million and $0.1 million, respectively, resulting in an effective tax rate of (3.3)% and (0.6)%, respectively. These effective tax rates differ from the U.S. federal statutory rate primarily due to the effects of foreign tax rate differences, U.S. state and local income taxes and the valuation allowance against our domestic deferred tax assets. The effective rate for the three months ended September 30, 2020 increased from the three months ended September 30, 2019 primarily due to a change in the allocation of our pre-tax earnings and losses among countries with differing statutory tax rates.  

Net Loss

Net loss for the three months ended September 30, 2020 was $12.7 million compared to $11.3 million for the three months ended September 30, 2019. Net loss increased for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 due to the factors noted above.

Adjusted EBITDA

 

 

For the Three Months Ended September 30,

 

(in millions)

 

2020

 

 

2019

 

Net Loss

 

$

(12.7

)

 

$

(11.3

)

Interest expense

 

 

12.4

 

 

 

12.0

 

Income tax expense

 

 

0.4

 

 

 

0.1

 

Depreciation and amortization expense

 

 

12.2

 

 

 

12.6

 

EBITDA

 

$

12.3

 

 

$

13.4

 

Acquisition, financing and transaction costs

 

 

1.3

 

 

 

0.7

 

Strategic Initiatives:

 

 

 

 

 

 

 

 

Sign-on bonus amortization

 

 

-

 

 

 

0.1

 

Non-recoverable draw

 

 

-

 

 

 

0.9

 

Total strategic initiatives

 

 

-

 

 

 

1.0

 

Management fees, stock compensation and other

 

 

1.0

 

 

 

0.7

 

Restructuring costs

 

 

1.6

 

 

 

0.3

 

Systems establishment

 

 

0.5

 

 

 

0.7

 

Adjusted EBITDA

 

$

16.7

 

 

$

16.8

 

 

23

 


 

For the nine months ended September 30, 2020 compared with the nine months ended September 30, 2019

The following table sets forth statements of operations data for each of the periods indicated:

 

 

 

For the Nine Months Ended September 30,

 

(in millions)

 

2020

 

 

2019

 

Revenues

 

$

215.0

 

 

$

231.5

 

Cost of revenues

 

 

111.5

 

 

 

118.9

 

Gross profit

 

 

103.5

 

 

 

112.6

 

Operating expenses

 

 

104.3

 

 

 

111.8

 

(Loss) income from operations

 

 

(0.8

)

 

 

0.8

 

Interest expense

 

 

38.3

 

 

 

36.5

 

Other expense

 

 

0.1

 

 

 

0.1

 

Loss before income taxes

 

 

(39.2

)

 

 

(35.8

)

Income tax provision

 

 

1.0

 

 

 

0.4

 

Net loss

 

 

(40.2

)

 

 

(36.2

)

Total other comprehensive income (loss), net of tax

 

 

0.6

 

 

 

(2.3

)

Comprehensive loss

 

 

(39.6

)

 

 

(38.5

)

Revenues

Revenues decreased by $16.5 million, or 7.1%, to $215.0 million for the nine months ended September 30, 2020 as compared to $231.5 million for the nine months ended September 30, 2019. This is primarily due to decreases in hosting services of $5.5 million, collections and processing of $4.8 million, subscriptions of $3.1 million and data recovery of $2.9 million, partially offset by an increase in managed review services of $0.9 million during the first quarter of 2020. The decreases are primarily due to the impacts of COVID-19 as many clients have delayed the start of new matters and court systems were widely closed for a period of time and subsequently slow to reopen.

Cost of Revenues

Cost of revenues decreased by $7.4 million, or 6.2%, to $111.5 million for the nine months ended September 30, 2020 as compared to $118.9 million for the nine months ended September 30, 2019.  This decrease is due to expense reduction measures implemented by management, which decreased personnel expense by $4.3 million and travel and entertainment expense by $1.2 million, as well as other smaller expense decreases. In addition, hardware and software expenses decreased by $1.2 million, communications expenses decreased by $0.8 million and professional services expenses decreased by $0.3 million.  These decreases were partially offset by $0.7 million of increased severance expenses due to the integration of operational business units and higher amortization of intangibles of approximately $0.6 million due to new assets being placed in service.  As a percentage of revenue, our cost of revenues for the nine months ended September 30, 2020 increased to 51.9% as compared to 51.4% for the nine months ended September 30, 2019. This increase was driven by decreased revenues due to COVID-19 without a corresponding decrease related to fixed costs.

Gross Profit

Gross profit decreased by $9.1 million, or 8.1%, to $103.5 million for the nine months ended September 30, 2020 as compared to $112.6 million for the nine months ended September 30, 2019. Gross profit decreased primarily due to the factors noted above. As a percentage of revenue, our gross profit for the nine months ended September 30, 2020 decreased to 48.1% as compared to 48.6% for the nine months ended September 30, 2019 primarily due to the factors noted above.

Operating Expenses

Operating expenses decreased by $7.5 million, or 6.7%, to $104.3 million for the nine months ended September 30, 2020 as compared to $111.8 million for the nine months ended September 30, 2019. This decrease is due to expense reduction measures implemented by management which decreased personnel expenses by $5.5 million, decreased travel and entertainment expenses by $1.5 million and decreased marketing expenses by $1.7 million. In addition, depreciation and amortization expenses decreased by $2.1 million.  These decreases were partially offset by increased costs incurred related to lease terminations to optimize our real estate footprint of $1.2 million, $1.2 million in increased bad debt expenses and $0.7 million of increased severance costs due to the integration of operational business units. As a percentage of revenue, our operating expenses for the nine months ended September 30, 2020 increased to 48.5% as compared to 48.3% for the nine months ended September 30, 2019 due to the factors noted above.

24

 


 

Interest Expense

Interest expense increased by $1.8 million, or 4.9%, to $38.3 million for the nine months ended September 30, 2020 as compared to $36.5 million for nine months ended September 30, 2019. This increase is primarily due to the increase in outstanding debt, partially offset by lower interest rates during the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

Income Tax Provision (Benefit)

During the nine months ended September 30, 2020 and 2019, we recorded an income tax provision of $1.0 million and $0.4 million, respectively, resulting in an effective tax rate of (2.6)% and (1.1)%, respectively. These effective tax rates differ from the U.S. federal statutory rate primarily due to the effects of foreign tax rate differences, U.S. state and local income taxes and the valuation allowance against our domestic deferred tax assets. The effective rate for the nine months ended September 30, 2020 increased from the nine months ended September 30, 2019 primarily due to a change in the allocation of our pre-tax earnings and losses among countries with differing statutory tax rates.  

Net Loss

Net loss for the nine months ended September 30, 2020 was $40.2 million compared to $36.2 million for the nine months ended September 30, 2019. Net loss increased for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 due to the factors noted above.

Adjusted EBITDA

 

 

 

For the Nine Months Ended September 30,

 

(in millions)

 

2020

 

 

2019

 

Net Loss

 

$

(40.2

)

 

$

(36.2

)

Interest expense

 

 

38.3

 

 

 

36.5

 

Income tax expense

 

 

1.0

 

 

 

0.4

 

Depreciation and amortization expense

 

 

36.1

 

 

 

37.6

 

EBITDA

 

$

35.2

 

 

$

38.3

 

Acquisition, financing and transaction costs

 

 

1.6

 

 

 

3.5

 

Strategic Initiatives:

 

 

 

 

 

 

 

 

Sign-on bonus amortization

 

 

0.2

 

 

 

0.4

 

Non-recoverable draw

 

 

0.3

 

 

 

2.9

 

Total strategic initiatives

 

 

0.5

 

 

 

3.3

 

Management fees, stock compensation and other

 

 

2.7

 

 

 

2.8

 

Restructuring costs

 

 

2.3

 

 

 

1.6

 

Systems establishment

 

 

1.6

 

 

 

2.0

 

Adjusted EBITDA

 

$

43.8

 

 

$

51.5

 

 

Liquidity and Capital Resources

Our primary cash needs have been to meet debt service requirements and to fund working capital and capital expenditures. We fund these requirements from cash generated by our operations, as well as funds available under our revolving credit facility (our “Revolving Credit Facility”). Although our eDiscovery solutions and information archiving services are billed on a monthly basis in arrears with amounts typically due within 30 to 45 days, the eDiscovery industry tends towards longer collectability trends. As a result, we have typically collected on the majority of our eDiscovery accounts receivables within 90 to 120 days, which is consistent within the industry. With respect to our data recovery services, they are billed as the services are provided, with payments due within 30 days of billing. We typically collect on our data recovery services accounts receivables within 30 to 45 days. Lastly, the majority of our data recovery software is billed monthly in advance with amounts typically due within 30 to 45 days; however, depending on the client contract, billing can occur annually, quarterly or monthly. Long outstanding receivables are not uncommon due to the nature of our legal technology services as litigation cases can go on for years, and in certain instances, our collections are delayed until the customer has received payment for their services in connection with a legal matter or the case has been settled. These long-outstanding invoices are a function of the industry in which we operate, rather than indicative of an inability to collect. We have experienced no material seasonality trends as it relates to collection on our accounts receivables. As of September 30, 2020, we had $43.8 million in cash compared to $43.4 million as of December 31, 2019. As of September 30, 2020, we had $478.3 million of outstanding borrowings compared to $480.6 million as of December 31, 2019. We expect to finance our operations over the next 12 months primarily through existing cash balances and cash flow.

25

 


 

2016 Credit Agreement

The Facilities

On December 9, 2016, we entered into a credit agreement (as amended or supplemented to date, the “2016 Credit Agreement”) with a group of lenders to establish term loan facilities and a revolving line of credit for borrowings by LD Intermediate, Inc. and LD Lower Holdings, Inc. (the “Initial Term Loans”). The Initial Term Loan borrowings of $340.0 million (the “First Lien Facility”) and $125.0 million (the “Second Lien Facility” and, together with the First Lien Facility, the “Facilities”) were to mature on December 9, 2022 and December 9, 2023, respectively.  The Second Lien Facility was repaid on December 19, 2019 in connection with the consummation of the Business Combination.

The First Lien Facility established a term loan principal payment schedule with payments due on the last day of each calendar quarter, beginning on March 31, 2017 with a payment of $2.1 million. Quarterly principal payments increased to $4.3 million beginning on March 31, 2019 with a balloon payment of $259.3 million due at maturity. The interest rate for the First Lien Facility adjusts every interest rate period, which can be one, two, three or six months in duration and is decided by us, or to the extent consented to by all Appropriate Lenders (as defined in the 2016 Credit Agreement), 12 months thereafter. Interest payment dates include the last day of each interest period and any maturity dates of the First Lien Facility; however, if any interest period exceeds three months, the respective dates that fall every three months after the beginning of an interest period is also an interest payment date. For each interest period, the interest rate per annum is 5.875% plus the Adjusted Eurocurrency Rate which is defined as an amount equal to the Statutory Reserve Rate (as defined in the 2016 Credit Agreement) multiplied by the greatest of (a) LIBOR, (b) 0.00% per annum and (c) solely with respect to the Initial Term Loans, 1.00% per annum. As of September 30, 2020, the balance due was $293.3 million, with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 1.000%. As of December 31, 2019, the balance due was $306.0 million, with an interest rate of 5.875% plus an Adjusted Eurocurrency Rate of 2.61463%.

The Facilities are secured by substantially all of our assets and contain certain covenants. As of September 30, 2020 and December 31, 2019, we were in compliance with all covenants.

The 2016 Credit Agreement includes a mandatory excess cash flow prepayment within ten days after delivery of the annual audited financial statements commencing with the year ended December 31, 2017. The Excess Cash Flow amount is specifically defined in Section 1.01 of the 2016 Credit Agreement. The Excess Cash Flow calculation starts with net income and then adds back a series of non-cash expenses, capital expenditures, M&A, and debt related amounts to arrive at a final amount due.

The amount of the Excess Cash Flow payment is reduced if the First Lien Net Leverage Ratio falls below certain thresholds. Such percentage in respect of any Excess Cash Flow Period shall be reduced to 50%, 25% or 0% if the First Lien Net Leverage Ratio as of the last day of the year to which such Excess Cash Flow Period relates was equal to or less than 3.75 to 1.00, 3.25 to 1.00 or 2.75 to 1.00, respectively.

We were not required to make any additional principal payments under the Excess Cash Flow covenant for the three or nine months ended September 30, 2020 and 2019 and do not anticipate making any additional principal payments under the Excess Cash Flow covenant for the year ended December 31, 2020.

Revolving Credit Facility

The 2016 Credit Agreement also provides for a Revolving Credit Facility of up to $30.0 million that matures December 9, 2021. Borrowings under the Revolving Credit Facility may be subject to meeting certain financial covenants set forth in the 2016 Credit Agreement, including the First Lien Net Leverage Ratio. We may draw up to $30.0 million under the Revolving Credit Facility, on a term loan basis, with either an adjustable eurocurrency loan interest rate of 5.375%, 5.625%, or 5.875% with interest rates based on the First Lien Net Leverage Ratio plus an amount equal to the LIBOR, or a base rate loan interest rate of 4.375%, 4.635%, or 4.875% plus the Base Rate (as defined in the 2016 Credit Agreement). As of September 30, 2020 and December 31, 2019, we had no amounts outstanding under our Revolving Credit Facility, and $0.8 million and $0.9 million, respectively, in letters of credit issued as of September 30, 2020 and December 31, 2019 with $29.2 million available borrowing capacity under the Revolving Credit Facility as of September 30, 2020.

The Initial Term Loan borrowings pursuant to the 2016 Credit Agreement were issued at an original issue discount of $11.9 million and $6.3 million for the First Lien Facility and Second Lien Facility, respectively. The original issue discount is amortized using the effective yield method over the respective term of each Facility. We wrote off the OID related to the Second Lien Facility when it was repaid in 2019.

We incurred closing fees in connection with the entry into the Facilities and the Revolving Credit Facility pursuant to the 2016 Credit Agreement of $13.6 million. These closing fees were deferred on December 9, 2016, along with fees of $0.6 million related to our prior term loan facility that we refinanced in connection with our entry into the 2016 Credit Agreement and are amortized over their respective terms. We are always evaluating opportunities for a more advantageous indebtedness structure, which may include a refinancing or replacement of our Facilities and/or our Revolving Credit Facility.

26

 


 

Convertible Debenture Notes

In connection with the Business Combination on December 19, 2019, we issued $200 million aggregate principal amount of convertible debentures due 2024 (the “Debentures”) in a private placement to certain “accredited investors” pursuant to an exemption from registration under Section 4(a)(2) of the Securities Act. The equity structure as of the date of the Business Combination included 2,097,974 shares of common stock and 1,764,719 warrants for the issuance of common stock to the Debenture holders related to the Debenture issuance. The proceeds of the Debentures were used in part to repay our outstanding Second Lien Facility and amounts outstanding under the Revolving Credit Facility. At September 30, 2020, the balance due under the Debentures was $206.4 million.

The Debentures mature on December 19, 2024 unless earlier converted, redeemed, or repurchased. The Debentures bear interest at an annual rate of 4.00% in cash and 4.00% in kind, payable quarterly on the last business day of March, June, September and December. In addition, on each anniversary of the Closing Date, we will add to the principal amount (subject to reduction for any principal amount repaid) of the Debentures an amount equal to 3.00% of the original aggregate principal amount of the Debentures outstanding, which will accrue from the last payment and will be payable at maturity, upon conversion or upon an optional redemption, if no prior payment was made.

At any time, upon notice as set forth in the Debentures, the Debentures are redeemable at our option, in whole or in part, at a price equal to 100% of the principal amount of the Debentures redeemed, plus accrued and unpaid interest thereon.

Subject to approval to allow for the full conversion of the Debentures into common stock, the Debentures are convertible into shares of our common stock at the option of the Debenture holders at any time and from time to time at a price of $18 per share, subject to certain adjustments. However, in the event we elect to redeem any Debentures, the holders have a right to purchase common stock from us in an amount equal to the amount redeemed at the conversion price.

The Debentures contain covenants that limit our ability to, among other things: (i) incur additional debt; (ii) create liens on assets; (iii) engage in certain transactions with affiliates; or (iv) designate our subsidiaries as unrestricted subsidiaries. The Debentures provide for customary events of default, including non-payment, failure to comply with covenants or other agreements in the Debentures and certain events of bankruptcy or insolvency. If an event of default occurs and continues, the holders of at least 25% in aggregate principal amount of the outstanding Debentures may declare the entire principal amount of all the Debentures to be due and payable immediately.

Our net cash flows from operating, investing and financing activities for the nine months ended September 30, 2020 and 2019 were as follows:

 

 

 

Nine Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2019

 

Net cash provided by (used in):

 

 

 

 

 

 

 

 

Operating activities

 

$

25,307

 

 

$

(11,960

)

Investing activities

 

$

(11,501

)

 

$

(9,938

)

Financing activities

 

$

(13,438

)

 

$

4,211

 

Effect of foreign exchange rates

 

$

63

 

 

$

(142

)

Net increase (decrease) in cash

 

$

431

 

 

$

(17,829

)

 

Cash Flows Provided By (Used in) Operating Activities

Net cash provided by operating activities was $25.3 million for the nine months ended September 30, 2020 as compared to net cash used in operating activities of $(12.0) million for the nine months ended September 30, 2019. The increase in net cash provided is due to a $7.9 million increase in cash provided by net loss plus non-cash items and an increase in cash provided by working capital of $29.4 million. The period over period increase in non-cash items is primarily due to a $10.8 million increase in paid-in-kind interest, a $0.6 million increase in deferred income taxes, a $0.7 million increase in stock-based compensation and a $1.2 million increase in the allowance provision, offset by a $1.6 million decrease in depreciation and amortization. The increase in cash provided by working capital for the period is primarily due to a $22.1 million decrease in accounts receivable and a $7.2 million increase in accounts payable and accrued expenses. Trade accounts receivable fluctuate from period to period depending on the period to period change in revenue and the timing of collections. Accounts payable fluctuate from period to period depending on the timing of purchases and payments.

Cash Flows Used in Investing Activities

Net cash used in investing activities was $11.5 million for the nine months ended September 30, 2020 as compared to net cash used in investing activities of $9.9 million for the nine months ended September 30, 2019. The increase in cash used is due to a

27

 


 

$2.5 million increase in cash payments related to acquisitions, partially offset by a $0.9 million decrease in purchases of property and equipment.

Cash Flows (Used In) Provided by Financing Activities

For the nine months ended September 30, 2020, net cash used for financing activities was $13.4 million and related to the payments of long-term debt of $12.8 million and capital lease obligations of $0.7 million. For the nine months ended September 30, 2019, net cash provided by financing activities was $4.2 million and related to the net borrowings under our Revolving Credit Facility of $17.0 million and $0.4 million for common stock issuances, partially offset by payments of long-term debt of $12.8 million and payments on capital lease obligations of $0.5 million.

Contractual Obligations

Our operating lease obligations are disclosed in Note 4 to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Rent expense for the three months ended September 30, 2020 and 2019 was $3.4 million and $3.7 million, respectively. Rent expense for the nine months ended September 30, 2020 and 2019 was $11.0 million and $11.2 million, respectively.

Off-Balance Sheet Financing Arrangements

We have no obligations, assets or liabilities which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. We have not entered into any off-balance sheet financing arrangements, established any special purpose entities, guaranteed any debt or commitments of other entities or purchased any nonfinancial assets.

Recent Accounting Pronouncements

See Note 1 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for a summary of accounting standards not yet adopted.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with U.S. GAAP. In applying accounting principles, it is often required to use estimates. These estimates consider the facts, circumstances and information available, and may be based on subjective inputs, assumptions and information known and unknown to us. Material changes in certain of the estimates that we use could potentially affect, by a material amount, our consolidated financial position and results of operations. Although results may vary, we believe our estimates are reasonable and appropriate. There were no changes to our critical accounting policies from those described in our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission (the “SEC”) on March 26, 2020.

Item 3.      Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

We are subject to interest rate market risk in connection with our long-term indebtedness. Our principal interest rate exposure relates to outstanding amounts under the $340 million First Lien Facility as well as the Revolving Credit Facility of $30 million. Interest rate changes generally impact the amount of our interest payments and, therefore, our future net income and cash flows, assuming other factors are held constant. Assuming the amounts outstanding at September 30, 2020 are fully drawn, each one-eighth percentage point increase or decrease in the applicable interest rates would correspondingly change our annualized interest expense by approximately $0.1 million. We do not currently hedge our interest rate exposure.

Exchange Rate Risk

Results of operations for our non-U.S. subsidiaries are translated from the designated functional currency to the reporting currency of the U.S. dollar. Revenues and expenses are translated at average exchange rates for each month, while assets and liabilities are translated at balance sheet date exchange rates. Resulting net translation adjustments are recorded as a component of stockholders’ equity in “Accumulated other comprehensive (loss) income” in our consolidated balance sheets included elsewhere in this Quarterly Report on Form 10-Q.

Transaction gains and losses arising from currency exchange rate fluctuations on transactions denominated in a currency other than the local functional currency are included in “Other expense” in our consolidated statements of comprehensive loss included

28

 


 

elsewhere in this Quarterly Report on Form 10-Q. Such transaction gains and losses may be realized or unrealized depending upon whether the transaction settled during the period or remains outstanding at the balance sheet date.

During the three months ended September 30, 2020 and 2019, we generated the equivalent of $13.3 million and $17.5 million, respectively, of U.S. dollar-denominated revenues in non-U.S. subsidiaries. Each 100 basis point increase or decrease in the average foreign currency rate to U.S. dollar exchange rate for the three-month period would have correspondingly changed our revenues by approximately $0.1 million and $0.2 million for each of the three months ended September 30, 2020 and 2019. During the nine months ended September 30, 2020 and 2019, we generated the equivalent of $41.9 million and $50.8 million, respectively, of U.S. dollar-denominated revenues in non-U.S. subsidiaries. Each 100 basis point increase or decrease in the average foreign currency rate to U.S. dollar exchange rate for the nine-month period would have correspondingly changed our revenues by approximately $0.4 million and $0.5 million for the nine months ended September 30, 2020 and 2019, respectively. We do not currently hedge our exchange rate exposure.

 

Item 4.     Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Management’s Report on Internal Controls over Financial Reporting

This Quarterly Report on Form 10-Q does not include a report of management’s assessment regarding our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) due to a transition period established by rules of the SEC.

 

Changes to Internal Control over Financial Reporting

 

There have been no changes in our internal controls over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

Inherent Limitation on the Effectiveness of Internal Control

 

The effectiveness of any system of internal control over financial reporting, including ours, is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over financial reporting, including ours, no matter how well designed and operated, can only provide reasonable, not absolute assurances. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business but cannot assure you that such improvements will be sufficient to provide us with effective internal control over financial reporting.

Part II. Other Information

 

Item 1.     Legal Proceedings.

 

In the ordinary conduct of our business, we are subject to lawsuits, arbitrations and administrative proceedings from time to time. We vigorously defend these claims; however, no assurances can be given as to the outcome of any pending legal proceedings. We believe, based on currently available information, that the outcome of any existing or known threatened proceedings, even if determined adversely, should not have a material adverse effect on our business, financial condition, liquidity or results of operations.

 

Item 1A.  Risk Factors.

 

Except as noted below, there have been no material changes to the risk factors disclosed in “Risk Factors” in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 as filed with the SEC on March 26, 2020.

 

29

 


 

An outbreak of disease or similar public health threat, such as a novel strain of coronavirus, could have an ongoing material adverse impact on the Company’s business, operating results and financial condition.

We are vulnerable to the general economic effects of disease outbreaks and similar public health threats. COVID-19 began to spread globally in late 2019 and has been declared a pandemic by the World Health Organization and is impacting worldwide economic activity. A public health pandemic, including COVID-19, poses the risk that we or our employees, contractors, suppliers, customers and other business partners may be prevented from conducting business activities for an indefinite period of time, including due to shutdowns that may be requested or mandated by governmental authorities. We have offices in 19 countries, including regions significantly impacted by COVID-19.  In March 2020, we transitioned the majority of our workforce to a remote working model, whereby employees execute their job functions from home leveraging a two-factor authenticated and secure VPN. A majority of our workforce continues to work remotely for the near term. Additionally, our document review business, which has always been conducted entirely at our facilities, has transitioned to a remote model to ensure continuity of operations. In April and May 2020, the Company implemented a salary exchange program pursuant to which certain employees took a temporary reduction in salary that ranged from 2% to 20% in exchange for receiving stock options to purchase Common Stock of the Company and restricted stock units of Common Stock.  In July 2020, the Company extended the salary reduction program through December 31, 2020 and initiated limited furloughs for certain employees. Revenues decreased by $16.5 million, or 7.1%, to $215.0 million for the nine months ended September 30, 2020 as compared to $231.5 million for the nine months ended September 30, 2019, primarily due to the impacts of COVID-19 as many clients have delayed the start of new matters and court systems were widely closed for a period of time and subsequently slow to reopen. With the ongoing pandemic and possible additional shutdowns, our sales force and in-person services may continually be impacted, which could impact our sales and operating results.  The extent to which COVID-19 will impact our results, including the ability of our customers to continue to pay in a timely manner, is dependent on future developments, which are uncertain and unpredictable, including new information which may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact.  While it is not possible at this time to estimate the full impact that COVID-19 could have on our business, the ongoing COVID-19 pandemic and the measures taken by the governments of countries affected could adversely impact our business, financial condition or results of operations.

We process, store and use personal and other special datasets on behalf of some of our clients, which subjects us to governmental regulation and other legal obligations related to privacy and information security, and our actual or perceived failure to comply with such obligations could harm our business and reputation.

 

We collect, store, transmit, use, disclose and process data that was collected from or about natural persons or their devices (“personally identifiable information” or “PII”) and other sensitive client data. In addition to terms in our contractual arrangements with our clients, there are numerous federal, state, local and foreign laws, regulations and directives regarding privacy and the collection, storage, transmission, use, processing, disclosure and protection of such PII and other personal or client data, the scope of which is continually evolving and subject to differing interpretations. We and our clients must comply with such laws, regulations and directives and we and our clients may be subject to significant consequences, including penalties and fines, for our failure to comply.

For example, on May 25, 2018, the General Data Protection Regulation 679/2016 (“GDPR”) replaced the Data Protection Directive 95/46/EC with respect to the processing of PII in the European Union. The GDPR imposes several stringent requirements for controllers and processors of PII (including non-E.U. processors who process personal data on behalf of E.U. controllers), including, for example, more robust internal accountability controls, a strengthened individual data rights regime, shortened timelines for mandatory data breach notifications, limitations on retention and secondary use of information and additional obligations when we contract with third parties in connection with the processing of PII. Failure to comply with the requirements of the GDPR and the applicable national data protection laws of the E.U. member states may result in fines of up to €20 million or up to 4% of the total worldwide annual turnover of the preceding financial year, whichever is higher, and other administrative penalties. Complying with the GDPR has required us to implement additional internal processes to ensure that we collect and process PII in a compliant way and re-draft of all our standard contracts to meet specific articles within the GDPR. As we continue to operate under the GDPR, compliance may become onerous and adversely affect our business, financial condition, results of operations and prospects.

In addition, recent legal developments in Europe have created complexity and compliance uncertainty regarding certain transfers of information from the EEA to the United States. For example, on July 16, 2020, the E.U.-U.S. Privacy Shield Framework, which allows for the transfer of personal data from the US to the EU, was invalidated by the European Court of Justice (“CJEU”). Three of our group companies are accredited under the Privacy Shield program to legitimize the transfer of personal data from the EEA to the US. Although the CJEU upheld the adequacy of the standard contractual clauses (a standard form of contract approved by the European Commission as an adequate PII transfer mechanism) upon which we rely for intra group transfers of PII (and is the most widely used transfer mechanism by our clients), it made clear that use of the standard contractual clauses must now be assessed on a case-by-case basis taking into account the legal regime applicable in the destination country, in particular applicable surveillance laws and rights of individuals. The future of the standard contractual clauses remains uncertain and may be

30

 


 

invalidated in future by European courts or supervisory authorities. We could be impacted by changes in law as a result of a future review of transfer mechanisms by European supervisory authorities under the GDPR.  If further legal bases for transferring PII from Europe to the United States are invalidated, or if we are unable to transfer PII between and among countries and regions in which we operate, it could affect the manner in which we provide our services or could adversely affect our financial results.

Furthermore, any failure, or perceived failure, by us to comply with or make effective modifications to our policies, or to comply with any federal, state or international privacy, data-retention or data-protection-related laws, regulations, orders or industry self-regulatory principles could result in proceedings or actions against us by governmental entities or others (including clients), a loss of client confidence, damage to our brand and reputation or a loss of clients, any of which could have an adverse effect on our business. In addition, various federal, state and foreign legislative or regulatory bodies may enact new or additional laws and regulations concerning privacy, data-retention and data-protection issues, including laws or regulations mandating disclosure to domestic or international law enforcement bodies, which could adversely impact our business, our brand or our reputation with clients. For example, some countries have adopted laws mandating that PII regarding clients in their country be maintained solely in their country. Having to maintain local data centers and redesign product, service and business operations to limit PII processing to within individual countries could increase our operating costs significantly.

Additionally, in connection with some of our product initiatives, we expect that our clients may increasingly use our cloud services to store and process PII and other regulated data. We post on our websites and, where appropriate, within our products, our privacy policies and practices concerning the treatment of PII that we hold as a “controller.” While we include minimum privacy or information security commitments in our contracts, E.U. requirements may make it so that we will be unable to do business without such commitments. Any failure by us to timely amend client contracts to conform to changing data protection laws, or to comply with our posted privacy policies, other federal, state or international privacy-related or data protection laws and regulations, or the privacy or information security commitments contained in our contracts could result in proceedings against us by governmental entities or others, including individual rights of action, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the increased attention focused upon any liability we may have as a result of lawsuits or regulatory actions could also harm our reputation or otherwise impact the growth of our business. Furthermore, although we market and sell products to our clients to help them comply with federal, state, local and foreign laws, regulations and directives, including the GDPR, our clients are responsible for ensuring they are in compliance with such laws, regulations and directives. Any failure by our clients to comply could result in significant consequences to them, including penalties and fines, and despite the existence of contractual exclusions and marketing disclaimers which make their responsibility for their own compliance clear, our clients may file claims or seek indemnification from us, which may result in reputational harm and require us to expend time, effort and costs to defend such claims or respond to indemnification requests.

In addition to government regulation, privacy advocacy and industry groups or other third parties may propose new and different self-regulatory standards that either legally or contractually apply to our clients or us. Any significant change to applicable laws, regulations, directives or industry practices regarding the collection, storage, transmission, processing, use or disclosure of our clients’ data, or regarding the manner in which the express or implied consent of clients for the collection, storage, transmission, processing, use and disclosure of such data is obtained, could require us to modify our solutions and features, possibly in a material manner, and may limit our ability to develop new services and features that make use of the data that our clients voluntarily share with us. Any failure or perceived failure by us to comply with our privacy policies, our privacy-related obligations to clients or other third parties, our privacy-related legal obligations or any compromise of security that results in the unauthorized access to, use, release or transfer of PII or other client data, may result in governmental enforcement actions, litigation, negative media attention or public statements against us by consumer advocacy groups or others and could cause our clients to lose trust in us, which would have an adverse effect on our reputation and business. Our clients may also accidentally disclose their passwords or store them on a mobile device that may be lost or stolen, resulting in unauthorized access to their data and creating the perception that our systems are not secure against third-party access. Additionally, if employees or third parties that we work with, such as contractors, vendors or developers, violate applicable laws or our policies, such violations may also put our clients’ information at risk and could in turn have an adverse effect on our business.

We have expanded our involvement in the delivery and provision of cloud computing through business alliances with various providers of cloud computing services and software and expect to continue to do so in the future. The application of U.S. and international data privacy laws to cloud computing vendors is uncertain, and our existing contractual provisions may prove to be inadequate to protect us from claims for data loss or regulatory noncompliance made against us resulting from the failures of cloud computing providers which we may partner with. While we do limit this in our contractual agreements with clients, the failure to comply with data protection laws and regulations by our clients and business partners who provide cloud computing services could have a material adverse effect on our business. Some cloud computing providers have been reluctant to provide us with information which we need in order to comply with E.U. privacy laws, and some providers refuse to offer legally compliant terms or offer terms that are commercially reasonable. We will need to modify our procurement processes in response to changing client and regulatory demands. If we fail to do so correctly, or in a timely manner, we may experience disruptions in client relationships, or receive regulatory inquiries or be the subject of government enforcement actions, which may in turn cause a material loss in revenues or damage our brand and reputation.

 

31

 


 

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

Item 3.     Exhibits and Financial Statement Schedules.

 

a)

Exhibits

Exhibit Index

 

Exhibit

Number

 

Description

3.1

 

Second Amended and Restated Certificate of Incorporation of KLDiscovery Inc. (incorporated by reference to
Exhibit 3.1 to the Current Report on Form 8-K filed December 26, 2019)

3.2

 

Amended and Restated Bylaws of KLDiscovery Inc. (incorporated by reference to Exhibit 3.2 to the Current
Report on Form 8-K filed December 26, 2019)

10.1 *+

 

Pay Change Letter, dated July 31, 2020, by and between KLDiscovery Inc. and Christopher Weiler.

10.2 *+

 

Pay Change Letter, dated July 31, 2020, by and between KLDiscovery Inc. and Dawn Wilson.

10.3 *+

 

Pay Change Letter, dated July 31, 2020, by and between KLDiscovery Inc. and Krystina Jones.

10.4 *+

 

Forfeiture of Options Letter, dated August 6, 2020, by and between KLDiscovery Inc. and Christopher Weiler.

10.5 *+

 

Executive Severance and Novation Agreement, dated September 30, 2020, by and between KLDiscovery Inc. and Christopher Weiler.  

10.6*+#

 

KrolLDiscovery, 2018 Legal Technology Sales Commission Plan, by and between the Company and Krystina Jones.

10.7*+#

 

KLDiscovery (January – December 2018) Sales Commission Plan Sales Performance Addendum, by and between the Company and Krystina Jones.

10.8*+#

 

KLDiscovery 2020 Americas Legal Technology Sales Commission Plan, by and between the Company and Krystina Jones.

10.9*+#

 

KLDiscovery 2020 Sales Commission Plan, Sales Performance Addendum, by and between the Company and Krystina Jones.

31.1*

 

Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*

 

Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*

 

Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*

 

Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

*

Filed herewith.

+

Management contract and compensatory plan and arrangement

#    

Certain confidential information contained in this agreement has been omitted because it (i) is not material and (ii)             would be competitively harmful if publicly disclosed.

 

 

32

 


 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

KLDiscovery Inc.

 

 

 

 

 

 

By:

/s/ Christopher J. Weiler

 

 

 

Christopher J. Weiler

 

 

 

Chief Executive Officer

 

Date: November 12, 2020

 

33