Information Services Group Inc. (III) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this Management’s Discussion and Analysis (“MD&A”) is to facilitate an understanding of significant factors influencing the operating results, financial condition and cash flows of the Company. Additionally, the MD&A conveys our expectations of the potential impact of known trends, events or uncertainties that may impact future results. You should read this discussion in conjunction with our consolidated financial statements and related notes included in this Annual Report on Form 10-K. Historical results and percentage relationships are not necessarily indicative of operating results for future periods. References to “we,” “our” and “us” in this MD&A are to the Company and its consolidated subsidiaries.
This MD&A provides an analysis of our consolidated financial results and cash flows for 2022 and 2021 under the headings “Results of Operations,” “Non-GAAP Financial Presentation and Measures,” and “Liquidity and Capital Resources.” For a similar detailed discussion comparing 2021 and 2020, refer to those headings under Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2021.
BUSINESS OVERVIEW
Information Services Group, Inc. (Nasdaq: III) is a leading global technology research and advisory firm. A trusted business partner to over 900 clients, including more than 75 of the top 100 enterprises in our markets, ISG is committed to helping corporations, public sector organizations and service and technology providers achieve operational excellence and faster growth. The firm specializes in digital transformation services, including automation, cloud and data analytics; sourcing advisory; managed governance and risk services; network carrier services; technology strategy and operations design; change management; market intelligence and technology research and analysis. Founded in 2006, and based in Stamford, Connecticut, ISG employs approximately 1,600 digital-ready professionals operating in more than 20 countries—a global team known for its innovative thinking, market influence, deep industry and technology expertise and world-class research and analytical capabilities based on the industry’s most comprehensive marketplace data. For more information, visit www.isg-one.com.
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Our strategy is to strengthen our existing market position and develop new services and products to support future growth plans. As a result, we are focused on growing our existing service model, expanding geographically, developing new industry sectors, productizing market data assets, expanding our managed services offerings and growing via acquisitions. Although we do not expect any adverse conditions that will impact our ability to execute against our strategy over the next twelve months, the more significant factors that could limit our ability to grow in these areas include global macro-economic conditions and the impact on the overall sourcing market, competition, our ability to retain advisors and reductions in discretionary spending with our top client accounts or other significant client events. Other areas that could impact the business would also include natural disasters, pandemics, such as COVID-19, legislative and regulatory changes and capital market disruptions.
We principally derive revenues from fees for services generated on a project-by-project basis. Prior to the commencement of a project, we reach agreement with the client on rates for services based upon the scope of the project, staffing requirements and the level of client involvement. Revenues for services rendered are recognized on a time and materials basis or on a fixed-fee or capped-fee basis in accordance with accounting and disclosure requirements for revenue recognition.
Revenues for time and materials contracts are recognized based on the number of hours worked by our advisors at an agreed upon rate per hour and are recognized in the period in which services are performed. Revenues for time and materials contracts are billed monthly, semimonthly or in accordance with the specific contractual terms of each project.
We also derive our revenues from certain recurring revenue streams. These include such annuity-based ISG offerings as ISG GovernX, Research, Software as a Subscription (Automation licenses), ISG Inform and the multi-year Public Sector contracts. These offerings are characterized by subscriptions (i.e., renewal centric as opposed to project centric revenue streams) or, in some instances, multi-year contracts. Our digital services now span a volume of offerings and have become embedded as part of even our traditional transaction services. Digital enablement provides capabilities, digital insights and better engagement with clients and partners.
Our results are impacted principally by our full-time consultants’ utilization rate, the number of business days in each quarter and the number of our revenue-generating professionals who are available to work. Our utilization rate can be negatively affected by increased hiring because there is generally a transition period for new professionals that result in a temporary drop in our utilization rate. Our utilization rate can also be affected by seasonal variations in the demand for our services from our clients. The number of business workdays is also affected by the number of vacation days taken by our consultants and holidays in each quarter. We typically have fewer business workdays available in the fourth quarter of the year, which can impact revenues during that period. Time-and-expense engagements do not provide us with a high degree of predictability as to performance in future periods. Unexpected changes in the demand for our services can result in significant variations in utilization and revenues and present a challenge to optimal hiring and staffing. The volume of work performed for any particular client can vary widely from period to period.
CURRENT ENVIRONMENT
Inflation rates and the adverse effect of interest rates have increased significantly in the past year. Inflation has not had a material effect on our business operations, financial performance and results of operations, other than its impact on the general economy. Our exposure from changes to interest rates also has not had a material impact. The Company continuously monitors these changes and evaluates any effect. If our costs, in particular personnel-related costs, were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases in future periods. Our inability or failure to realize these offsets could adversely affect our business operations, financial performance and results of operations.
EXECUTIVE SUMMARY
ISG delivered another record performance in 2022. Coming off our best year ever, we elevated our results to new heights. The Company’s 2022 success was built on our strong portfolio of services and solutions, our proven ISG NEXT operating model and our growing client base. We exceeded 900 clients for the first time, continuing a trend that has seen our client base grow significantly over the past few years.
Nearly every one of our clients today is a digital business. Each is using digital technology to redefine how they operate, how they engage with customers, employees and business partners, and how they create new revenue streams through connected products and services.
Our record revenue and profitability were the result of the operating efficiencies we derive from our ISG NEXT operating model, as well as our more profitable mix of products and services. Our iFlex delivery model, part of ISG NEXT, is generating strong utilization across the firm, allowing us to effectively manage our resources across borders and time zones and deliver greater value to our clients, mostly on a virtual basis.
Our strong financial position and operating results allowed us to return $24 million of capital to our shareholders in the form of dividends and share repurchases in 2022. It also allowed us to amend our existing $140 million credit agreement in early 2023, converting it to an all-revolver facility, with more favorable terms and an extended maturity date.
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Looking ahead, we remain confident about our overall prospects for 2023 and beyond. We are investing now for when the overall market rebounds and demand surges forward again during the next big wave of digitalization.
During 2022, we added more than 250 new professionals to the firm to support our future growth. We also added new and important capabilities with our acquisitions of Change 4 Growth, an award-winning company specializing in transformational change for enterprises, and Agreemint, an automated contracting solution.
Change 4 Growth is a perfect complement to our existing ISG Enterprise Change business and makes ISG a global leader in change management. This acquisition will expand the ISG Enterprise Change business by offering organizational change management (OCM), communications, training development and delivery, leadership development, mentoring, DEI programs, executive coaching and culture change. Agreemint, meanwhile, complements our ISG GovernX business. This AI-powered contract authorizing tool allows clients to negotiate better contracts and accelerate time to completion.
Our clients continue to be the lifeblood of our firm. Our success requires our shared commitment to delivering value to them every day. And by all measures, we are doing a very good job of that.
Environmental, Social and Governance (ESG) has become firmly entrenched in the culture of ISG. We are delighted our people, through individual and group efforts, are helping to lead the charge for better communities, a better environment and better opportunities for all.
Throughout the pandemic years, we reinvented ISG and invested in our future. That has resulted in two back-to-back years of record-breaking financial results and a continuously growing client base. It also has created a solid foundation for the future.
With our ISG NEXT operating model and unmatched portfolio of solutions, advice, research and support, we are ready to take on all challenges and build on our momentum as a stronger, more valuable firm.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2022 COMPARED TO YEAR ENDED DECEMBER 31, 2021
Revenues
Revenues are generally derived from fixed-fee contracts as well as engagements priced on a time and materials basis, which are recorded based on actual time worked as the services are performed. In addition, we also earn revenues which are contingent on the attainment of certain contractual milestones. Revenues related to materials required during an engagement (mainly out-of-pocket expenses such as airfare, lodging and meals) generally do not include a profit mark up and can be charged and reimbursed separately or as part of the overall fee arrangement. Invoices are issued to clients monthly, semimonthly or in accordance with the specific contractual terms of each project.
We operate in one segment, fact-based sourcing advisory services. We operate principally in the Americas, Europe and Asia Pacific. Our foreign operations are subject to local government regulations and to the uncertainties of the economic and political conditions of those areas, and the revenue for our foreign operations is predominantly invoiced and collected in local currency.
Geographical revenue information for the segment is as follows:
| | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | Years Ended December 31, | ||||||||||
| | | | | | | | | | | | | Percent | |
| Geographic Area | | 2022 | 2021 | Change | Change | ||||||||
| | | | (in thousands) | ||||||||||
| Americas | | | $ | 166,661 | $ | 160,181 | $ | 6,480 | 4 | % | |||
| Europe | | | 89,908 | | 90,256 | | (348) | (0) | % | ||||
| Asia Pacific | | | 29,698 | | 27,395 | | 2,303 | 8 | % | ||||
| Total revenues | | | $ | 286,267 | | $ | 277,832 | | $ | 8,435 | 3 | % |
Revenues increased by $8.4 million or approximately 3% in 2022. The increase in revenue in the Americas was primarily attributable to an increase in our Advisory, Research, NaSa and GovernX service lines, partially offset by a decrease in our Automation service line. The revenue in Europe was flat with an increase in our Automation and GovernX service lines, being offset by a decrease in our Advisory, Research and NaSa service lines. The increase in revenue in Asia Pacific was primarily attributable to an increase in our NaSa, Advisory and GovernX service lines, partially offset by a decrease in our Research service line. The translation of foreign currency revenues into U.S. dollars negatively impacted performance in Europe and Asia Pacific compared to the prior year by $12.7 million.
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Operating Expenses
The following table presents a breakdown of our operating expenses by functional category:
| | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | Years Ended December 31, | ||||||||||
| | | | | | | | | | | | | Percent | |
| Operating Expenses | 2022 | 2021 | Change | Change | |||||||||
| | | | (in thousands) | ||||||||||
| Direct costs and expenses for advisors | | $ | 169,650 | $ | 168,475 | $ | 1,175 | 1 | % | ||||
| Selling, general and administrative | | | 81,769 | | 78,759 | | 3,010 | 4 | % | ||||
| Depreciation and amortization | | | 5,368 | | 5,331 | | 37 | 1 | % | ||||
| Total operating expenses | | | $ | 256,787 | | $ | 252,565 | | $ | 4,222 | 2 | % |
Total operating expenses increased by $4.2 million, or approximately 2%, for 2022. The increase in operating expenses was due primarily to higher travel and entertainment expenses of $3.3 million, compensation expenses of $3.0 million, event-related expenses of $1.5 million, non-cash stock compensation of $1.0 million, professional fees of $0.6 million, bad debt expenses of $0.5 million, occupancy expenses of $0.4 million, subscriptions fees of $0.3 million and computer expenses of $0.3 million. The cost increases were partially offset by lower contract labor of $4.2 million, changes in fair value of contingent consideration of $1.5 million, lower restructuring costs of $0.8 million and communication expenses of $0.4 million.
Compensation costs consist of a mix of fixed and variable salaries, annual bonuses, benefits and retirement plan contributions. Statutory and 401(k) plans are offered to employees as appropriate. Direct costs also include employee taxes, health insurance, workers compensation and disability insurance.
A portion of compensation expenses for certain billable employees are allocated between direct costs and selling, general and administrative costs based on relative time spent between billable and non-billable activities.
Selling costs consist principally of compensation expense related to business development, proposal preparation and delivery and negotiation of new client contracts. Selling costs also include travel expenses relating to the pursuit of sales opportunities, expenses for hosting periodic client conferences, public relations activities, participation in industry conferences, industry relations, website maintenance and business intelligence activities. Additionally, we maintain a dedicated global marketing function responsible for developing and managing sales campaigns, brand promotion, the ISG Index and assembling client proposals.
We maintain a comprehensive program for training and professional development with the related costs included in SG&A. Related expenses include product training, updates on new service offerings or methodologies and development of client project management skills. Also included in training and professional development are expenses associated with the development, enhancement and maintenance of our proprietary methodologies and tools and the systems that support them.
Selling, general and administrative expenses consist principally of executive management compensation, allocations of billable employee compensation related to general management activities, IT infrastructure and costs for finance, accounting, information technology and human resource functions. General and administrative costs also reflect continued investment associated with implementing and operating client and employee management systems. Because our billable personnel operate remotely or on client premises, all occupancy expenses are recorded as general and administrative.
Depreciation and amortization expenses in 2022 and 2021 were $5.4 million and $5.3 million, respectively. Our fixed assets consist of furniture, fixtures, equipment (mainly personal computers) and leasehold improvements. Depreciation expenses are generally computed by applying the straight-line method over the estimated useful lives of assets. We also capitalize some costs associated with the purchase and development of internal-use software, system conversions and website development costs. These costs are amortized over the estimated useful life of the software or system.
We amortize our intangible assets (e.g., client relationships and databases) over their estimated useful lives. Goodwill related to acquisitions is not amortized but is subject to annual impairment testing.
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Other Income (Expense), Net
The following table presents a breakdown of other expense, net:
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | Years Ended December 31, | ||||||||||
| | | | | | | | | | | | | Percent | |
| Other income (expense), net | | 2022 | 2021 | Change | Change | ||||||||
| | | | (in thousands) | ||||||||||
| Interest income | | $ | 189 | $ | 142 | $ | 47 | 33 | % | ||||
| Interest expense | | | (3,157) | | (2,342) | | (815) | (35) | % | ||||
| Foreign currency transaction gain | | | 170 | | 44 | | 126 | 286 | % | ||||
| Total other income (expense), net | | | $ | (2,798) | | $ | (2,156) | | $ | (642) | (30) | % |
The total increase of $0.6 million was primarily the result of higher interest expense attributable to higher interest rates and higher borrowings outstanding.
Income Tax Expense
Our effective tax rate varies from period to period based on the mix of earnings among the various state and foreign tax jurisdictions in which business is conducted and the level of non‑deductible expenses incurred in any given period. Our effective tax rate for the year ended December 31, 2022 was 26.1% compared to 32.8% for the year ended December 31, 2021. The variance from the U.S. statutory rate of 21.0% for the year ended December 31, 2022 was primarily caused by the impact of higher tax rates applicable on company earnings in foreign jurisdictions and non-deductible expenses for tax purposes in the United States.
NON-GAAP FINANCIAL PRESENTATION
This management’s discussion and analysis presents supplemental measures of our performance that are derived from our consolidated financial information but are not presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We refer to these financial measures, which are considered “non-GAAP financial measures” under SEC rules, as adjusted EBITDA, adjusted net income and adjusted earnings per diluted share, each as defined below. See “Non-GAAP Financial Measures” below for information about our use of these non-GAAP financial measures, including our reasons for including these measures and reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
NON-GAAP FINANCIAL MEASURES
We use non-GAAP financial measures to supplement the financial information presented on a GAAP basis. We provide adjusted EBITDA (defined as net income, plus interest, taxes, depreciation and amortization, foreign currency transaction gains/losses, non-cash stock compensation, interest accretion associated with contingent consideration, acquisition-related costs, and severance, integration and other expense), adjusted net income (defined as net income, plus amortization of intangible assets, non-cash stock compensation, foreign currency transaction gains/losses, interest accretion associated with contingent consideration, acquisition-related costs, and severance, integration and other expense on a tax-adjusted basis) and adjusted net income per diluted share, excluding the net of tax effect of the items set forth in the table below. These are non-GAAP measures that the Company believes provide useful information to both management and investors by excluding certain expenses and financial implications of foreign currency translations that management believes are not indicative of ISG’s core operations. These non-GAAP measures are used by the Company to evaluate the Company’s business strategies and management’s performance. These non-GAAP financial measures exclude non-cash and certain other special charges that many investors believe may obscure the user’s overall understanding of the Company’s current financial performance and the Company’s prospects for the future. We
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believe that these non-GAAP measures provide useful information to investors because they improve the comparability of the financial results between periods and provide for greater transparency of key measures used to evaluate the Company’s performance.
| | | | | | | |
|---|---|---|---|---|---|---|
| | | Years Ended December 31, | ||||
| | 2022 | 2021 | ||||
| | | (in thousands) | ||||
| Net income | $ | 19,726 | $ | 15,529 | ||
| Interest expense (net of interest income) | | 2,968 | | 2,200 | ||
| Income taxes | | 6,956 | | 7,582 | ||
| Depreciation and amortization | | 5,368 | | 5,331 | ||
| Interest accretion associated with contingent consideration | | 33 | | 101 | ||
| Acquisition-related costs (1) | | 282 | | 240 | ||
| Severance, integration and other expense | | 633 | | 1,406 | ||
| Foreign currency transaction gain | | (170) | | (44) | ||
| Non-cash stock compensation | | 7,460 | | 6,467 | ||
| Adjusted EBITDA | | $ | 43,256 | | $ | 38,812 |
| | | | | | | |
|---|---|---|---|---|---|---|
| | | Years Ended December 31, | ||||
| | | 2022 | 2021 | |||
| | | (in thousands) | ||||
| Net income | $ | 19,726 | $ | 15,529 | ||
| Non-cash stock compensation | | 7,460 | | 6,467 | ||
| Intangible amortization | | | 2,323 | | | 2,643 |
| Interest accretion associated with contingent consideration | | 33 | | 101 | ||
| Acquisition-related costs (1) | | 282 | | 240 | ||
| Severance, integration and other expense | | 633 | | 1,406 | ||
| Foreign currency transaction gain | | (170) | | (44) | ||
| Tax effect (2) | | (3,379) | | (3,460) | ||
| Adjusted net income | | $ | 26,908 | | $ | 22,882 |
| | | | | | | |
|---|---|---|---|---|---|---|
| | | Years Ended December 31, | ||||
| | 2022 | 2021 | ||||
| Net income per diluted share | | $ | 0.39 | $ | 0.30 | |
| Non-cash stock compensation | | 0.15 | | 0.12 | ||
| Intangible amortization | | 0.05 | | 0.05 | ||
| Interest accretion associated with contingent consideration | | 0.00 | | 0.00 | ||
| Acquisition-related costs (1) | | 0.00 | | 0.01 | ||
| Severance, integration and other expense | | 0.01 | | 0.03 | ||
| Foreign currency transaction gain | | 0.00 | | 0.00 | ||
| Tax effect (2) | | (0.07) | | (0.07) | ||
| Adjusted net income per diluted share | | $ | 0.53 | | $ | 0.44 |
________________________________________
| Column 1 | Column 2 |
|---|---|
| (1) | Consists of expenses from acquisition-related costs and non-cash fair value adjustments on pre-acquisition contract liabilities. |
| Column 1 | Column 2 |
|---|---|
| (2) | Marginal tax rate of 32%, reflecting U.S. federal income tax rate of 21% plus 11% attributable to U.S. states and foreign jurisdictions. |
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our primary sources of liquidity are cash flows from operations, existing cash and cash equivalents and borrowings under our revolving line of credit. Operating assets and liabilities consist primarily of accounts receivable and contract assets, prepaid expense and other assets, accounts payable, contract liabilities, accrued expenses and other liabilities. The volume of billings and timing of collections and payments affect these account balances.
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The following table summarizes our cash flows for the years ended December 31, 2022 and 2021:
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|---|---|---|---|---|---|---|---|
| | | Years Ended December 31, | | ||||
| | 2022 | 2021 | |||||
| | | (in thousands) | | ||||
| Net cash provided by (used in): | | | | | | | |
| Operating activities | $ | 11,146 | $ | 41,942 | | ||
| Investing activities | | (6,873) | | (2,320) | | ||
| Financing activities | | (18,941) | | (34,125) | | ||
| Effect of exchange rate changes on cash | | (2,271) | | (1,713) | | ||
| Net (decrease) increase in cash, cash equivalents, and restricted cash | | $ | (16,939) | | $ | 3,784 | |
As of December 31, 2022, our liquidity and capital resources included cash, cash equivalents and restricted cash of $30.7 million compared to $47.6 million as of December 31, 2021, a net decrease of $16.9 million, which was primarily attributable to the following:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | our operating activities provided net cash of $11.1 million for the year ended December 31, 2022. Net cash provided from operations was primarily attributable to our net income after adjustments for non-cash charges of approximately $34.1 million partially offset by $23.0 million use of working capital primarily attributable to a $14.0 million change in accounts receivables and contract assets, a $7.2 million change in accrued expenses and other liabilities, a $1.0 million change in prepaid expense and other assets, a $0.7 million change in accounts payables; and $0.1 million change in contract liabilities; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | treasury share repurchases of $12.1 million; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | payments related to tax withholding for stock-based compensation of $4.1 million; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | cash dividends paid to shareholders of $7.5 million; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | proceeds from revolving facility of $9.0 million; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | principal payments on borrowings of $4.3 million; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | payment of contingent consideration of $1.0 million; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | payment for Change 4 Growth acquisition of $3.5 million: |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | capital expenditures for property, plant and equipment of $3.4 million; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | proceeds from issuance of employee stock purchase plan shares of $0.9 million. |
Capital Resources
The Company’s current outstanding debt may limit our ability to fund general corporate requirements and obtain additional financing, impact our flexibility in responding to business opportunities and competitive developments and increase our vulnerability to adverse economic and industry conditions.
On March 10, 2020, the Company amended and restated the 2020 Credit Agreement to include a $86.0 million term facility and to increase the revolving commitments per the revolving facility from $30.0 million to $54.0 million. The material terms under the 2020 Credit Agreement are as follows:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Each of the term loan facility and revolving credit facility has a maturity date of March 10, 2025 (the “Maturity Date”). |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The credit facility is secured by all of the equity interests owned by the Company and its direct and indirect domestic subsidiaries and subject to agreed exceptions, the Company’s direct and indirect “first-tier” foreign subsidiaries and a perfected first priority security interest in all of the Company’s and its direct and indirect domestic subsidiaries’ tangible and intangible assets. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The Company’s direct and indirect existing and future wholly owned domestic subsidiaries serve as guarantors to the Company’s obligations under the senior secured facility. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | At the Company’s option, the credit facility bears interest at a rate per annum equal to either (i) the “Base Rate” (which is the highest of (a) the rate publicly announced from time to time by the administrative agent as its “prime rate”, (b) the Federal Funds Rate plus 0.5% per annum and (c) the Eurodollar Rate, plus 1.0%), plus the applicable margin or (ii) Eurodollar Rate (adjusted for maximum reserves) as determined by the Administrative Agent (as defined in the 2020 Credit Agreement), plus the applicable margin. The applicable margin is adjusted quarterly based upon the Company’s quarterly leverage ratio. |
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| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The term loan is repayable in nineteen consecutive quarterly installments of $1,075,000 that commenced on June 30, 2020 and a final payment of the outstanding principal amount of the term loan on the Maturity Date. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Mandatory repayments of term loans shall be required from (subject to agreed exceptions) (i) 100% of the proceeds from asset sales by the Company and its subsidiaries, (ii) 100% of the net proceeds from issuances of debt and equity by the Company and its subsidiaries and (iii) 100% of the net proceeds from insurance recovery and condemnation events of the Company and its subsidiaries. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The senior secured credit facility contains a number of covenants that, among other things, place restrictions on matters customarily restricted in senior secured credit facilities, including restrictions on indebtedness (including guarantee obligations), liens, fundamental changes, sales or disposition of property or assets, investments (including loans, advances, guarantees and acquisitions), transactions with affiliates, dividends and other payments in respect of capital stock, optional payments and modifications of other material debt instruments, negative pledges and agreements restricting subsidiary distributions and changes in line of business. In addition, the Company is required to comply with a total leverage ratio and fixed charge coverage ratio. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The senior secured credit facility contains customary events of default, including cross-default to other material agreements, judgment default and change of control. |
The Company’s financial statements include outstanding borrowings of $79.2 million and $74.5 million as of December 31, 2022 and December 31, 2021, respectively, which are carried at amortized cost. The fair value of debt is classified within Level 3 of the fair value hierarchy. The fair value of the Company's outstanding borrowings is approximately $76.5 million and $73.6 million as of December 31, 2022 and December 31, 2021, respectively. The fair values of debt have been estimated using a discounted cash flow analysis based on the Company's incremental borrowing rate for similar borrowing arrangements. The incremental borrowing rate used to discount future cash flows was 6.3% and 2.0% for December 31, 2022 and December 31, 2021, respectively. The Company also considered recent transactions of peer group companies for similar instruments with comparable terms and maturities as well as an analysis of current market conditions and interest rates. As of December 31, 2022 and December 31, 2021, there were $9.0 million and $0.0 million borrowings, respectively, under the revolver. The Company is currently in compliance with its financial covenants.
We anticipate that our current cash and the ongoing cash flows from our operations will be adequate to meet our working capital, capital expenditure and debt financing needs for at least the next twelve months. The anticipated cash needs of our business could change significantly if we pursue and complete additional business acquisitions, if our business plans change, if economic conditions change from those currently prevailing or from those now anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flow or profitability of our business. If we require additional capital resources to grow our business, either internally or through acquisition, or maintain liquidity, we may seek to sell additional equity securities or to secure additional debt financing. The sale of additional equity securities or certain forms of debt financing could result in additional dilution to our stockholders. We may not be able to obtain financing arrangements in amounts or on terms acceptable to us in the future.
The Company has financial covenants underlying its debt which require a Debt to adjusted EBITDA ratio of 3.25. The Company was in compliance with its financial covenants under the 2020 Credit Agreement as of December 31, 2022.
On February 22, 2023, the Company entered into a third amended and restated senior secured credit facility comprising a $140.0 million revolving credit facility, amending and restating the 2020 Credit Agreement.
Employee Retirement Plans
For both fiscal years ended December 31, 2022 and 2021, we contributed $2.1 million, respectively, to our 401(k) plan (the “Savings Plan”) on a fully discretionary basis. These amounts were invested by the participants in a variety of investment options under an arrangement with a third-party asset manager. All current and future financial risks associated with the gains and losses on investments are borne by Savings Plan participants.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, many of which require management to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results may differ from estimates. Such differences may be material to the consolidated financial statements.
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We believe the application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found the application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.
Our accounting policies are more fully described in “Note 2—Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements.” We have identified revenue recognition as a critical accounting estimate:
Revenue Recognition
We recognize our revenues by applying the following five steps: (1) identifying the contract with the customer; (2) identifying the performance obligation(s) in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligation(s); and (5) recognizing revenue when (or as) the Company satisfies the performance obligation(s).
We principally derive revenues from fees for services generated on a project-by-project basis. Prior to the commencement of a project, we reach agreement with the client on rates for services based upon the scope of the project, staffing requirements and the level of client involvement. It is our policy to obtain written agreements from clients prior to performing services or when evidence of enforceable rights and obligations is obtained. In these agreements, the clients acknowledge that they will pay based upon the amount of time spent on the project or an agreed upon fee structure.
Revenues for time and materials contracts, which may include capped-fees or “not-to-exceed” clauses, are recognized based on the number of hours worked by our advisors at an agreed-upon rate per hour and are recognized in the period in which services are performed. Revenues for time and materials contracts are billed monthly, semimonthly or in accordance with the specific contractual terms of each project. For contracts with capped fees or not-to-exceed clauses, we monitor our performance and fees billed to ensure that revenue is not recognized in excess of the contractually capped fee.
Revenues related to fixed-fee contracts are recognized as value is delivered to the customer, consistent with the transfer of control to the customer over time. Revenue for these contracts is recognized proportionally over the term of the contract using an input method based on the proportion of labor hours incurred as compared to the total estimated labor hours for the fixed-fee contract performance obligations, which we consider the best available indicator of the pattern and timing in which contract performance obligations are fulfilled and control transfers to the customer. This percentage is multiplied by the contracted dollar amount of the project to determine the amount of revenue to recognize in an accounting period. The contracted amount used in this calculation typically excludes the amount the client pays for reimbursable expenses. There are situations where the number of hours to complete projects may exceed our original estimate as a result of an increase in project scope or unforeseen events. The results of any revisions in these estimates are reflected in the period in which they become known.
For managed service implementation contracts, revenue is recognized over time as a percentage of hours incurred to date as compared to the total expected hours of the implementation, consistent with the transfer of control to the customer. For ongoing managed services contract, revenue is recognized over time, consistent with the weekly or monthly fee specified within such arrangements.
We also derive revenues based on negotiating reductions in network and software costs of companies with the entities’ related service providers and providing other services such as audits of network and communication expenses and consultation for network architecture. These contracts can be fixed in fees or can be based on the level of savings achieved related to its communications costs. Additionally, these contracts can also have a fixed component and a contingent component that is based on the savings generated by the Company. For network and software contingency contracts with termination for convenience clauses, revenue is recognized over time due to the existence of provisions for payment for progress incurred to date plus a reasonable profit margin. The contract periods range from a few months to in excess of a year.
We also enter into arrangements for the sale of automation software licenses and related delivery of consulting or implementation services at the same time or within close proximity to one another. Such software-related performance obligations include the sale of on-premise software, hybrid and software-as-a-service licenses, as well as other software-related services. Revenue associated with the software performance obligation is primarily recognized at the point at which the software is installed or access is granted.
Revenue associated with events is recognized at the point of time at which the event occurs and is primarily comprised of sponsorships. Conversely, revenue associated with research subscriptions is recognized over time, as the customer accesses our data or related platforms. In addition, we sell research products for which the revenue is recognized at a point in time upon delivery to the client.
The agreements entered into in connection with a project typically allow our clients to terminate early due to breach or for convenience with 30 days’ notice. In the event of termination, the client is contractually required to pay for all time, materials and expenses incurred by us through the effective date of the termination. In addition, from time to time, we enter into agreements with clients that limit our right to enter into business relationships with specific competitors of that client for a specific time period. These provisions typically
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prohibit us from performing a defined range of services that we might otherwise be willing to perform for potential clients. These provisions are generally limited to six to twelve months and usually apply only to specific employees or the specific project team.
When we recognize revenues in advance of billing, those revenues are recorded as contract assets. When we invoice in advance of earning revenues, those amounts are recorded as contract liabilities.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements included elsewhere in this report.