UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| | | | | |
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 20212022
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 001-04321001-40982
HireRight Holdings Corporation
(Exact name of registrant as specified in its charter)
| | | | | | | | | | | |
| Delaware | | 82-1092072 |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | | | | | | | | | | |
| 100 Centerview Drive, Suite 300 | Nashville | Tennessee | 37214 |
| (Address of Principal Executive Offices) | | | (Zip Code) |
(615) 320-9800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| | | | | | | | | | | | | | |
| Title of each class | | Trading Symbol(s) | | Name of each exchange on which registered |
| Common stock, par value $0.001 per share | | HRT | | New York Stock Exchange |
Indicate by check mark whether the registrant: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 Act). ☐ Yes ☒ No
The registrant had outstanding 79,390,51379,484,907 shares of common stock as of November 18, 2021.October 27, 2022.
EXPLANATORY NOTE
As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires, references to “we,” “us,” “our,” the “Company,” and similar references refer: (1) following the consummation of our conversion to a Delaware corporation on October 15, 2021 in connection with our initial public offering, to HireRight Holdings Corporation, and (2) prior to the completion of such conversion, to HireRight GIS Group Holdings, LLC. See “Part I, Item 1. Financial Statements (Unaudited) - Note 1 “Organization,— Organization, Basis of Presentation and Consolidation, and Use of Estimates—Organization” toSignificant Accounting Policies” in this Quarterly Report on Form 10-Q for further information.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
HireRight Holdings Corporation
Condensed Consolidated Balance Sheets (Unaudited)
| | | September 30,
2021 | | December 31,
2020 | | September 30,
2022 | | December 31,
2021 |
| | (in thousands, except unit amounts) | | (in thousands, except share and per share data) |
| Assets | Assets | | Assets | |
| Current assets | Current assets | | Current assets | |
| Cash and cash equivalents | Cash and cash equivalents | $ | 19,656 | | | $ | 19,077 | | Cash and cash equivalents | $ | 146,508 | | | $ | 111,032 | |
| Restricted cash | Restricted cash | 4,982 | | | 4,982 | | Restricted cash | 1,306 | | | 5,182 | |
| Accounts receivable, net of allowance for doubtful accounts of $4,277 and $3,919 at September 30, 2021 and December 31, 2020, respectively | 151,801 | | | 107,800 | | |
| Accounts receivable, net of allowance for doubtful accounts of $5,170 and $4,284 at September 30, 2022 and December 31, 2021, respectively | | Accounts receivable, net of allowance for doubtful accounts of $5,170 and $4,284 at September 30, 2022 and December 31, 2021, respectively | 165,944 | | | 142,473 | |
| Prepaid expenses and other current assets | Prepaid expenses and other current assets | 21,992 | | | 18,221 | | Prepaid expenses and other current assets | 17,067 | | | 18,583 | |
| Total current assets | Total current assets | 198,431 | | | 150,080 | | Total current assets | 330,825 | | | 277,270 | |
| Property and equipment, net | Property and equipment, net | 14,457 | | | 17,486 | | Property and equipment, net | 9,492 | | | 11,127 | |
| Right-of-use assets, net | | Right-of-use assets, net | 8,802 | | | — | |
| Intangible assets, net | Intangible assets, net | 403,862 | | | 448,816 | | Intangible assets, net | 343,025 | | | 389,483 | |
| Goodwill | Goodwill | 819,639 | | | 820,032 | | Goodwill | 801,674 | | | 819,538 | |
| Cloud computing software, net | | Cloud computing software, net | 29,844 | | | 8,133 | |
| Deferred tax assets | | Deferred tax assets | 63,167 | | | — | |
| Other non-current assets | Other non-current assets | 18,258 | | | 17,238 | | Other non-current assets | 18,811 | | | 18,211 | |
| Total assets | Total assets | $ | 1,454,647 | | | $ | 1,453,652 | | Total assets | $ | 1,605,640 | | | $ | 1,523,762 | |
| Liabilities and Members' Equity | | | | |
| Liabilities and Stockholders’ Equity | | Liabilities and Stockholders’ Equity | | | |
| Current liabilities | Current liabilities | | Current liabilities | |
| Accounts payable | Accounts payable | $ | 10,053 | | | $ | 24,608 | | Accounts payable | $ | 11,355 | | | $ | 13,688 | |
| Accrued expenses and other current liabilities | Accrued expenses and other current liabilities | 76,488 | | | 56,809 | | Accrued expenses and other current liabilities | 79,867 | | | 75,294 | |
| Accrued salaries and payroll | Accrued salaries and payroll | 29,319 | | | 23,125 | | Accrued salaries and payroll | 33,158 | | | 29,280 | |
| Derivative instruments, current | 18,772 | | | 18,258 | | |
| Derivative instruments, short-term | | Derivative instruments, short-term | — | | | 16,662 | |
| Debt, current portion | Debt, current portion | 8,350 | | | 8,350 | | Debt, current portion | 8,350 | | | 8,350 | |
| Total current liabilities | Total current liabilities | 142,982 | | | 131,150 | | Total current liabilities | 132,730 | | | 143,274 | |
| Debt, long-term portion | Debt, long-term portion | 1,009,936 | | | 1,013,397 | | Debt, long-term portion | 684,565 | | | 688,683 | |
| Derivative instruments, long-term | Derivative instruments, long-term | 19,097 | | | 35,317 | | Derivative instruments, long-term | — | | | 11,444 | |
| Deferred taxes | 15,164 | | | 13,567 | | |
| Tax receivable agreement liability | | Tax receivable agreement liability | 211,438 | | | 210,639 | |
| Deferred tax liabilities | | Deferred tax liabilities | 5,760 | | | 14,765 | |
| Operating lease liabilities, long-term | | Operating lease liabilities, long-term | 11,051 | | | — | |
| Other non-current liabilities | Other non-current liabilities | 3,052 | | | 3,334 | | Other non-current liabilities | 2,394 | | | 9,240 | |
| Total liabilities | Total liabilities | 1,190,231 | | | 1,196,765 | | Total liabilities | 1,047,938 | | | 1,078,045 | |
| Commitments and contingencies (Note 12) | 0 | | 0 | |
| Class A Units - 57,168,291 units issued and outstanding at September 30, 2021 and December 31, 2020 | 590,711 | | | 590,711 | | |
| Commitments and contingent liabilities (Note 12) | | Commitments and contingent liabilities (Note 12) | | | |
| Preferred stock, $0.001 par value, authorized 100,000,000 shares; none issued and outstanding as of September 30, 2022 and December 31, 2021 | | Preferred stock, $0.001 par value, authorized 100,000,000 shares; none issued and outstanding as of September 30, 2022 and December 31, 2021 | — | | | — | |
| Common stock, $0.001 par value, authorized 1,000,000,000 shares; 79,482,612 and 79,392,937 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively | | Common stock, $0.001 par value, authorized 1,000,000,000 shares; 79,482,612 and 79,392,937 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively | 79 | | | 79 | |
| Additional paid-in capital | Additional paid-in capital | 17,853 | | | 15,360 | | Additional paid-in capital | 802,484 | | | 793,382 | |
| Accumulated deficit | Accumulated deficit | (347,398) | | | (339,061) | | Accumulated deficit | (231,065) | | | (360,364) | |
| Accumulated other comprehensive income (loss) | Accumulated other comprehensive income (loss) | 3,250 | | | (10,123) | | Accumulated other comprehensive income (loss) | (13,796) | | | 12,620 | |
| Total members’ equity | 264,416 | | | 256,887 | | |
| Total liabilities and members’ equity | $ | 1,454,647 | | | $ | 1,453,652 | | |
| Total stockholders’ equity | | Total stockholders’ equity | 557,702 | | | 445,717 | |
| Total liabilities and stockholders’ equity | | Total liabilities and stockholders’ equity | $ | 1,605,640 | | | $ | 1,523,762 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
HireRight Holdings Corporation
Condensed Consolidated Statements of Operations (Unaudited)
| | | Three Months Ended
September 30, | | Nine Months Ended
September 30, | | Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 | | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands, except units and per unit amounts) | | (in thousands, except share and per share data) |
| Revenues | Revenues | $ | 204,981 | | | $ | 130,674 | | | $ | 531,522 | | | $ | 390,121 | | Revenues | $ | 210,303 | | | $ | 204,981 | | | $ | 631,306 | | | $ | 531,522 | |
| | Expenses | Expenses | | Expenses | |
| Cost of services (exclusive of depreciation and amortization below) | Cost of services (exclusive of depreciation and amortization below) | 111,328 | | | 69,683 | | | 295,832 | | | 215,143 | | Cost of services (exclusive of depreciation and amortization below) | 110,848 | | | 111,328 | | | 343,241 | | | 295,832 | |
| Selling, general and administrative | Selling, general and administrative | 47,652 | | | 48,347 | | | 130,261 | | | 128,583 | | Selling, general and administrative | 49,378 | | | 47,652 | | | 152,032 | | | 130,261 | |
| Depreciation and amortization | Depreciation and amortization | 19,531 | | | 19,808 | | | 56,013 | | | 58,283 | | Depreciation and amortization | 17,946 | | | 19,531 | | | 54,056 | | | 56,013 | |
| Total expenses | Total expenses | 178,511 | | | 137,838 | | | 482,106 | | | 402,009 | | Total expenses | 178,172 | | | 178,511 | | | 549,329 | | | 482,106 | |
| Operating income (loss) | 26,470 | | | (7,164) | | | 49,416 | | | (11,888) | | |
| Operating income | | Operating income | 32,131 | | | 26,470 | | | 81,977 | | | 49,416 | |
| | Other expenses | Other expenses | | Other expenses | |
| Interest expense | Interest expense | 18,518 | | | 18,597 | | | 54,674 | | | 56,930 | | Interest expense | 8,457 | | | 18,518 | | | 20,971 | | | 54,674 | |
| Other expense (income), net | 22 | | | (185) | | | 125 | | | 628 | | |
| Total other expense | 18,540 | | | 18,412 | | | 54,799 | | | 57,558 | | |
| Other expense, net | | Other expense, net | 89 | | | 22 | | | 163 | | | 125 | |
| Total other expenses, net | | Total other expenses, net | 8,546 | | | 18,540 | | | 21,134 | | | 54,799 | |
| Income (loss) before income taxes | Income (loss) before income taxes | 7,930 | | | (25,576) | | | (5,383) | | | (69,446) | | Income (loss) before income taxes | 23,585 | | | 7,930 | | | 60,843 | | | (5,383) | |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | | |
| Income tax (benefit) expense | | Income tax (benefit) expense | (69,704) | | | 649 | | | (68,456) | | | 2,954 | |
| Net income (loss) | Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | | Net income (loss) | $ | 93,289 | | | $ | 7,281 | | | $ | 129,299 | | | $ | (8,337) | |
| | Net income (loss) per unit: | | |
| Net income (loss) per share: | | Net income (loss) per share: | |
| Basic | Basic | $ | 0.13 | | | $ | (0.47) | | | $ | (0.15) | | | $ | (1.28) | | Basic | $ | 1.17 | | | $ | 0.13 | | | $ | 1.63 | | | $ | (0.15) | |
| Diluted | Diluted | $ | 0.13 | | | $ | (0.47) | | | $ | (0.15) | | | $ | (1.28) | | Diluted | $ | 1.17 | | | $ | 0.13 | | | $ | 1.63 | | | $ | (0.15) | |
| Weighted average units outstanding: | | |
| Weighted average shares outstanding: | | Weighted average shares outstanding: | |
| Basic | Basic | 57,168,291 | | 57,168,291 | | 57,168,291 | | 57,168,291 | Basic | 79,459,633 | | 57,168,291 | | 79,419,725 | | 57,168,291 |
| Diluted | Diluted | 57,199,204 | | 57,168,291 | | 57,168,291 | | 57,168,291 | Diluted | 79,542,715 | | 57,199,204 | | 79,476,574 | | 57,168,291 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
HireRight Holdings Corporation
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
| | | Three Months Ended
September 30, | | Nine Months Ended
September 30, | | Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 | | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands) | | (in thousands) |
| Net income (loss) | Net income (loss) | | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | | Net income (loss) | $ | 93,289 | | | $ | 7,281 | | | $ | 129,299 | | | $ | (8,337) | |
| | Other comprehensive income (loss), net of tax | Other comprehensive income (loss), net of tax | | Other comprehensive income (loss), net of tax | |
| Unrealized gain (loss) on derivatives qualified for hedge accounting: | Unrealized gain (loss) on derivatives qualified for hedge accounting: | | Unrealized gain (loss) on derivatives qualified for hedge accounting: | |
| Unrealized gain (loss) on interest rate swaps | Unrealized gain (loss) on interest rate swaps | | (991) | | | (1,426) | | | 973 | | | (35,137) | | Unrealized gain (loss) on interest rate swaps | — | | | (991) | | | 7,981 | | | 973 | |
Reclassification adjustments included in earnings (1) | Reclassification adjustments included in earnings (1) | | 5,018 | | | 4,854 | | | 14,733 | | | 11,136 | | Reclassification adjustments included in earnings (1) | (3,413) | | | 5,018 | | | (7,997) | | | 14,733 | |
| Total unrealized gain (loss) | Total unrealized gain (loss) | | 4,027 | | | 3,428 | | | 15,706 | | | (24,001) | | Total unrealized gain (loss) | (3,413) | | | 4,027 | | | (16) | | | 15,706 | |
| Currency translation adjustment, net of taxes of $16 and $0 for the three months ended September 30, 2021 and 2020, respectively, and $1 and $0 for the nine months ended September 30, 2021 and 2020, respectively. | | (3,595) | | | 4,616 | | | (2,333) | | | (2,011) | | |
| Currency translation adjustment, net of tax benefit (expense) of ($64) and ($16) for the three months ended September 30, 2022 and 2021, respectively, and ($210) and ($1) for the nine months ended September 30, 2022, and 2021, respectively | | Currency translation adjustment, net of tax benefit (expense) of ($64) and ($16) for the three months ended September 30, 2022 and 2021, respectively, and ($210) and ($1) for the nine months ended September 30, 2022, and 2021, respectively | (12,565) | | | (3,595) | | | (26,400) | | | (2,333) | |
| | Other comprehensive income (loss) | Other comprehensive income (loss) | | 432 | | | 8,044 | | | 13,373 | | | (26,012) | | Other comprehensive income (loss) | (15,978) | | | 432 | | | (26,416) | | | 13,373 | |
| Comprehensive income (loss) | | $ | 7,713 | | | $ | (18,998) | | | $ | 5,036 | | | $ | (98,948) | | |
| Comprehensive income | | Comprehensive income | $ | 77,311 | | | $ | 7,713 | | | $ | 102,883 | | | $ | 5,036 | |
(1) Represents the reclassification of the effective portion of the gain on the Company's interest rate swaps into interest expense. Includes reclassification to earnings as a reduction to interest expense of unrealized gains included in accumulated other comprehensive income (loss) on the condensed consolidated balance sheet related to the interest rate swap agreements terminated on February 18, 2022. See Note 9 for additional information.
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
HireRight Holdings Corporation
Condensed Consolidated Statements of Members'Stockholders’ Equity (Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2021 |
| Class A Member Units Outstanding | | Class A Member Unit Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income | | Total Members’ Equity |
| (in thousands, except unit amounts) |
| Balances at June 30, 2021 | 57,168,291 | | | $ | 590,711 | | | $ | 17,012 | | | $ | (354,679) | | | $ | 2,818 | | | $ | 255,862 | |
| Net income | — | | | — | | | — | | | 7,281 | | | — | | | 7,281 | |
| Equity-based compensation | — | | | — | | | 841 | | | — | | | — | | | 841 | |
| Other comprehensive income | — | | | — | | | — | | | — | | | 432 | | | 432 | |
| Balances at September 30, 2021 | 57,168,291 | | | $ | 590,711 | | | $ | 17,853 | | | $ | (347,398) | | | $ | 3,250 | | | $ | 264,416 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2022 |
| Common Stock | | | | | | | | |
| Shares | | Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income (Loss) | | Total Stockholders’ Equity |
| (in thousands, except share data) |
| Balances at June 30, 2022 | 79,432,321 | | | $ | 79 | | | $ | 800,566 | | | $ | (324,354) | | | $ | 2,182 | | | $ | 478,473 | |
| Common stock issuance for vesting of restricted stock units and exercise of stock options | 50,291 | | | — | | | 803 | | | — | | | — | | | 803 | |
| Net income | — | | | — | | | — | | | 93,289 | | | — | | | 93,289 | |
| Stock-based compensation | — | | | — | | | 1,115 | | | — | | | — | | | 1,115 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | (15,978) | | | (15,978) | |
| Balances at September 30, 2022 | 79,482,612 | | | $ | 79 | | | $ | 802,484 | | | $ | (231,065) | | | $ | (13,796) | | | $ | 557,702 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2020 |
| Class A Member Units Outstanding | | Class A Member Unit Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income (Loss) | | Total Members’ Equity |
| (in thousands, except unit amounts) |
| Balances at June 30, 2020 | 57,168,291 | | | $ | 590,711 | | | $ | 13,832 | | | $ | (292,878) | | | $ | (28,817) | | | $ | 282,848 | |
| Net loss | — | | | — | | | — | | | (27,042) | | | — | | | (27,042) | |
| Equity-based compensation | — | | | — | | | 880 | | | — | | | — | | | 880 | |
| Other comprehensive income | — | | | — | | | — | | | — | | | 8,044 | | | 8,044 | |
| Balances at September 30, 2020 | 57,168,291 | | | $ | 590,711 | | | $ | 14,712 | | | $ | (319,920) | | | $ | (20,773) | | | $ | 264,730 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2021 |
| Class A Member Units | | | | | | | | |
| Units | | Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income | | Total Stockholders’ Equity |
| (in thousands, except unit data) |
| Balances at June 30, 2021 | 57,168,291 | | | $ | 590,711 | | | $ | 17,012 | | | $ | (354,679) | | | $ | 2,818 | | | $ | 255,862 | |
| Net income | — | | | — | | | — | | | 7,281 | | | — | | | 7,281 | |
| Stock-based compensation | — | | | — | | | 841 | | | — | | | — | | | 841 | |
| Other comprehensive income | — | | | — | | | — | | | — | | | 432 | | | 432 | |
| Balances at September 30, 2021 | 57,168,291 | | | $ | 590,711 | | | $ | 17,853 | | | $ | (347,398) | | | $ | 3,250 | | | $ | 264,416 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
HireRight Holdings Corporation
Condensed Consolidated Statements of Members'Stockholders’ Equity (Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2021 |
| Class A Member Units Outstanding | | Class A Member Unit Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income (Loss) | | Total Members’ Equity |
| (in thousands, except unit amounts) |
| Balances at December 31, 2020 | 57,168,291 | | | $ | 590,711 | | | $ | 15,360 | | | $ | (339,061) | | | $ | (10,123) | | | $ | 256,887 | |
| Net loss | — | | | — | | | — | | | (8,337) | | | — | | | (8,337) | |
| Equity-based compensation | — | | | — | | | 2,493 | | | — | | | — | | | 2,493 | |
| Other comprehensive income | — | | | — | | | — | | | — | | | 13,373 | | | 13,373 | |
| Balances at September 30, 2021 | 57,168,291 | | | $ | 590,711 | | | $ | 17,853 | | | $ | (347,398) | | | $ | 3,250 | | | $ | 264,416 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2022 |
| Common Stock | | | | | | | | |
| Shares | | Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income (Loss) | | Total Stockholders’ Equity |
| (in thousands, except share data) |
| Balances at December 31, 2021 | 79,392,937 | | | $ | 79 | | | $ | 793,382 | | | $ | (360,364) | | | $ | 12,620 | | | $ | 445,717 | |
| Common stock issuance for vesting of restricted stock units and exercise of stock options | 89,675 | | | — | | | 803 | | | — | | | — | | | 803 | |
| Net income | — | | | — | | | — | | | 129,299 | | | — | | | 129,299 | |
| Stock-based compensation | — | | | — | | | 8,299 | | | — | | | — | | | 8,299 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | (26,416) | | | (26,416) | |
| Balances at September 30, 2022 | 79,482,612 | | | $ | 79 | | | $ | 802,484 | | | $ | (231,065) | | | $ | (13,796) | | | $ | 557,702 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2020 |
| Class A Member Units Outstanding | | Class A Member Unit Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income (Loss) | | Total Members’ Equity |
| (in thousands, except unit amounts) |
| Balances at December 31, 2019 | 57,168,291 | | | $ | 590,711 | | | $ | 12,142 | | | $ | (246,984) | | | $ | 5,239 | | | $ | 361,108 | |
| Net loss | — | | | — | | | — | | | (72,936) | | | — | | | (72,936) | |
| Equity-based compensation | — | | | — | | | 2,570 | | | — | | | — | | | 2,570 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | (26,012) | | | (26,012) | |
| Balances at September 30, 2020 | 57,168,291 | | | $ | 590,711 | | | $ | 14,712 | | | $ | (319,920) | | | $ | (20,773) | | | $ | 264,730 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2021 |
| Class A Member Units | | | | | | | | |
| Units | | Amount | | Additional Paid in Capital | | Accumulated Deficit | | Accumulated Other Comprehensive Income (Loss) | | Total Stockholders’ Equity |
| (in thousands, except unit data) |
| Balances at December 31, 2020 | 57,168,291 | | | $ | 590,711 | | | $ | 15,360 | | | $ | (339,061) | | | $ | (10,123) | | | $ | 256,887 | |
| Net loss | — | | | — | | | — | | | (8,337) | | | — | | | (8,337) | |
| Stock-based compensation | — | | | — | | | 2,493 | | | — | | | — | | | 2,493 | |
| Other comprehensive income | — | | | — | | | — | | | — | | | 13,373 | | | 13,373 | |
| Balances at September 30, 2021 | 57,168,291 | | | $ | 590,711 | | | $ | 17,853 | | | $ | (347,398) | | | $ | 3,250 | | | $ | 264,416 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
HireRight Holdings Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
| | | Nine Months Ended September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2022 | | 2021 |
| | (in thousands) | | (in thousands) |
| Cash flows from operating activities | Cash flows from operating activities | | Cash flows from operating activities | |
| Net loss | $ | (8,337) | | | $ | (72,936) | | |
| Adjustments to reconcile net loss to net cash provided by operating activities: | | |
| Net income (loss) | | Net income (loss) | $ | 129,299 | | | $ | (8,337) | |
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |
| Depreciation and amortization | Depreciation and amortization | 56,013 | | | 58,283 | | Depreciation and amortization | 54,056 | | | 56,013 | |
| Deferred income taxes | Deferred income taxes | 1,933 | | | 2,601 | | Deferred income taxes | (70,954) | | | 1,933 | |
| Amortization of debt issuance costs | Amortization of debt issuance costs | 3,139 | | | 3,012 | | Amortization of debt issuance costs | 2,549 | | | 3,139 | |
| Amortization of contract assets | Amortization of contract assets | 2,782 | | | 2,159 | | Amortization of contract assets | 3,312 | | | 2,782 | |
| Equity-based compensation | 2,493 | | | 2,570 | | |
| Amortization of right-of-use assets | | Amortization of right-of-use assets | 2,094 | | | — | |
| Amortization of unrealized gains on terminated interest rate swap agreements | | Amortization of unrealized gains on terminated interest rate swap agreements | (9,676) | | | — | |
| Amortization of cloud computing software costs | | Amortization of cloud computing software costs | 1,446 | | | — | |
| Stock-based compensation | | Stock-based compensation | 8,587 | | | 2,493 | |
| Increase in tax receivable agreement liability | | Increase in tax receivable agreement liability | 800 | | | — | |
| Other non-cash charges, net | Other non-cash charges, net | (541) | | | 1,457 | | Other non-cash charges, net | 524 | | | (541) | |
| Changes in operating assets and liabilities: | Changes in operating assets and liabilities: | | Changes in operating assets and liabilities: | |
| Accounts receivable | Accounts receivable | (44,715) | | | 3,229 | | Accounts receivable | (24,521) | | | (44,715) | |
| Prepaid expenses and other current assets | Prepaid expenses and other current assets | (2,327) | | | 2,471 | | Prepaid expenses and other current assets | 1,516 | | | (2,327) | |
| Cloud computing software | | Cloud computing software | (23,158) | | | — | |
| Other non-current assets | Other non-current assets | (4,157) | | | (3,275) | | Other non-current assets | (3,934) | | | (4,157) | |
| Accounts payable | Accounts payable | (13,736) | | | (7,932) | | Accounts payable | (5,212) | | | (13,736) | |
| Accrued expenses and other current liabilities | Accrued expenses and other current liabilities | 19,676 | | | 14,241 | | Accrued expenses and other current liabilities | 5,498 | | | 19,676 | |
| Accrued salaries and payroll | Accrued salaries and payroll | 6,194 | | | 1,504 | | Accrued salaries and payroll | 3,631 | | | 6,194 | |
| Operating lease liabilities, net | | Operating lease liabilities, net | (4,125) | | | — | |
| Other non-current liabilities | Other non-current liabilities | 626 | | | 337 | | Other non-current liabilities | (805) | | | 626 | |
| Net cash provided by operating activities | Net cash provided by operating activities | 19,043 | | | 7,721 | | Net cash provided by operating activities | 70,927 | | | 19,043 | |
| Cash flows from investing activities | Cash flows from investing activities | | | | Cash flows from investing activities | | | |
| Purchases of property and equipment | Purchases of property and equipment | (5,092) | | | (4,156) | | Purchases of property and equipment | (3,973) | | | (5,092) | |
| Capitalized software development | Capitalized software development | (4,891) | | | (5,024) | | Capitalized software development | (9,149) | | | (4,891) | |
| Cash paid for acquisitions, net of cash acquired | — | | | (96) | | |
| | Net cash used in investing activities | Net cash used in investing activities | (9,983) | | | (9,276) | | Net cash used in investing activities | (13,122) | | | (9,983) | |
| Cash flows from financing activities | Cash flows from financing activities | | | | Cash flows from financing activities | | | |
| Repayments of debt | Repayments of debt | (6,263) | | | (6,263) | | Repayments of debt | (6,263) | | | (6,263) | |
| Borrowings on line of credit | Borrowings on line of credit | 30,000 | | | 50,000 | | Borrowings on line of credit | — | | | 30,000 | |
| Repayments on line of credit | Repayments on line of credit | (30,000) | | | (40,000) | | Repayments on line of credit | — | | | (30,000) | |
| Payment of holdbacks | — | | | (1,000) | | |
| Payment of capital lease obligations | — | | | (402) | | |
| Payments for termination of interest rate swap agreements | | Payments for termination of interest rate swap agreements | (18,445) | | | — | |
| Payment of issuance costs - revolving credit facility | | Payment of issuance costs - revolving credit facility | (342) | | | — | |
| Other financing | Other financing | (1,240) | | | — | | Other financing | — | | | (1,240) | |
| Net cash (used in) provided by financing activities | (7,503) | | | 2,335 | | |
| Net cash used in financing activities | | Net cash used in financing activities | (25,050) | | | (7,503) | |
| Net increase in cash, cash equivalents and restricted cash | Net increase in cash, cash equivalents and restricted cash | 1,557 | | | 780 | | Net increase in cash, cash equivalents and restricted cash | 32,755 | | | 1,557 | |
| Effect of exchange rates | Effect of exchange rates | (978) | | | (642) | | Effect of exchange rates | (1,155) | | | (978) | |
| Cash, cash equivalents and restricted cash | Cash, cash equivalents and restricted cash | | Cash, cash equivalents and restricted cash | |
| Beginning of period | Beginning of period | 24,059 | | | 21,180 | | Beginning of period | 116,214 | | | 24,059 | |
| End of period | End of period | $ | 24,638 | | | $ | 21,318 | | End of period | $ | 147,814 | | | $ | 24,638 | |
| Cash paid for | Cash paid for | | | | Cash paid for | | | |
| Interest | Interest | $ | 51,355 | | | $ | 36,279 | | Interest | $ | 27,890 | | | $ | 51,355 | |
| Income taxes | 787 | | | (21) | | |
| Supplemental schedule of non-cash operating activities | | |
| Income taxes paid | | Income taxes paid | 2,718 | | | 787 | |
| Supplemental schedule of non-cash activities | | Supplemental schedule of non-cash activities | |
| Unpaid deferred offering costs | Unpaid deferred offering costs | $ | 2,975 | | | $ | — | | Unpaid deferred offering costs | $ | — | | | $ | 2,975 | |
| Supplemental schedule of non-cash investing and financing activities | | |
| Unpaid property and equipment and capitalized software purchases | Unpaid property and equipment and capitalized software purchases | $ | 468 | | | $ | 433 | | Unpaid property and equipment and capitalized software purchases | 1,102 | | | 468 | |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Organization, Basis of Presentation and Consolidation, and Use of EstimatesSignificant Accounting Policies
Organization
Description of Business
HireRight GIS Group Holdings LLC (“HGGH”), was formed in July 2018 throughin connection with the combination of two groups of companies: the HireRight Group and the GISGeneral Information Services (“GIS”) Group, each of which includeincludes a number of wholly-owned subsidiaries that conduct the Company’s business withinin the United States, of America (the “U.S.”), as well as countries outside the U.S.other countries. Since July 2018, the combined group of companies and their subsidiaries have operated as a unified operating company providing screening and compliance services, predominantly under the HireRight brand.
Corporate Conversion and Stock Split
On October 15, 2021, HGGH converted into a Delaware corporation and changed its name to HireRight Holdings Corporation (“HireRight” or the “Company”). In conjunction with the conversion, all of HGGH’s outstanding equity interests were converted into shares of common stock of HireRight Holdings Corporation. The foregoing conversion and related transactions are referred to herein as the “Corporate Conversion”.Conversion.” The Corporate Conversion did not affect the assets and liabilities of HGGH, which became the assets and liabilities of HireRight Holdings Corporation.
On October 18, 2021, HireRight Holdings Corporation effected a one-for-15.969236 reverse stock split (the “Stock(“Stock Split”). The accompanyingAll shares of the Company’s common stock, stock-based instruments, and per-share data included in the condensed consolidated financial statements give retroactive effect to the Stock Split for all periods presented.Split.
Initial Public Offering
On November 2, 2021, the Company completed its initial public offering (“IPO”), in which the Company soldissued 22,222,222 shares of its common stock, $0.001 par value per sharestock. The shares began trading on the New York Stock Exchange on October 29, 2021 under the symbol “HRT.” The shares were sold at an offeringIPO price of $19.00 per share. The Company receivedshare for net proceeds of $393.5 million, after deducting underwriting discounts and commissions of $23.2 million and other offering costs payable by the Company of approximately $5.5 million. TheOn November 30, 2021, the Company granted the underwriters an option for a period of 30 days to purchase up toissued an additional 3,333,3332,424 shares pursuant to the partial exercise of common stock at $19.00 per share less discounts and commissions. The underwriters have until November 27, 2021 to exercise theirthe underwriters’ option to purchase additional shares.shares for net proceeds of an immaterial amount.
Income Tax Receivable Agreement
In connection with the Company’s IPO, the Company entered into an income tax receivable agreement (“TRA”), which provides for the payment by the Company over a period of approximately 12 years to pre-IPO equityholders or their permitted transferees of 85% of the benefits, if any, that the Company and its subsidiaries realize, or are deemed to realize (calculated using certain assumptions) in U.S. federal, state, and local income tax savings as a result of the utilization (or deemed utilization) of certain existing tax attributes. During the three months ended September 30, 2022, the Company recognized an expense of $0.8 million related to an increase in the estimated liability pertaining to the TRA as a result of federal return-to-provision adjustments. The expense is included in Other expense, net in the Company’s condensed consolidated statements of operations. As of September 30, 2022 and December 31, 2021, the Company had a total liability of $211.4 million and $210.6 million, respectively, in connection with the projected obligations under the TRA on its condensed consolidated balance sheets.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements include the Company’s accounts and those of its wholly-owned subsidiaries. The unaudited condensed consolidated financial statements are presented in accordance with generally accepted accounting principles in the United States of America ("GAAP") and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting.
Certain information and note disclosures normally included in the consolidated financial statements prepared in accordance with GAAP have been condensed or omitted. Therefore, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s audited consolidated financial statementsAnnual Report on Form 10-K for the year ended December 31, 2020, included in the Company’s prospectus, dated October 28, 2021, as filed with the SEC in accordance with Rule 424(b) of the Securities Act on November 1, 2021 (the “Prospectus”March 21, 2022 (“Annual Report”). The year-endDecember 31, 2021 condensed consolidated balance sheet data included herein was derived from audited financial statements but does not include all disclosures required by GAAP.
In the opinion of management, all adjustments, consisting of normal recurring items, necessary for the fair statement of the condensed consolidated financial statements have been included. All intercompany balances and transactions have been eliminated in consolidation. These unaudited condensed consolidated financial statements have been prepared on a consistent basis with the accounting policies described in Note 1 of the notes to the audited consolidated financial statements for the year ended December 31, 2020,2021, included in the Prospectus.Annual Report. Certain reclassifications have been made to prior year presentation to conform to current year presentation.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Significant Accounting Policies
The Company’s significant accounting policies are discussed in Note“Note 1— Organization, Basis of Presentation and Consolidation, and Significant Accounting Policies” of the notes to the audited consolidated financial statements for the year ended December 31, 2020,2021, included in the Prospectus. ThereAnnual Report. Except as noted below and in Note 2 — Recently Issued Accounting Pronouncements regarding leases, there have been no significant changes to these policies which have had a material impact on the Company’s unaudited condensed consolidated financial statements during the three and nine months ended September 30, 2021, except as noted below.2022.
Implementation Costs Incurred in Cloud Computing Arrangements
Deferred Offering Costs
Deferred offering costs consist ofFor cloud computing arrangements that are a service contract, the Company capitalizes certain implementation costs incurred, in connection withincluding employee costs and third-party costs, during the sale ofapplication development stage, and expenses costs as incurred during the Company’s common stock in its IPO, including certain legal, accounting,preliminary project and other IPO-related costs. Atpost-implementation stages. Capitalized implementation costs are expensed on a straight-line basis over the completion of the IPO, the deferred offering costs will be recorded as a reduction from the proceeds of the offering. As of September 30, 2021 and December 31, 2020, $4.2 million and zero, respectively, of deferred offering costs had beenestimated useful life. Capitalized amounts related to such arrangements are recorded within prepaid expenses and other current assets onand within cloud computing software in the Company’s condensed consolidated balance sheets.
Use of Estimates
Preparation of the Company’s unaudited condensed consolidated financial statements in conformity with GAAP requires the Company to make estimates, judgments, and assumptions that affect the amounts reported and disclosed in the financial statements. The Company believes that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable based upon information available at the time they are made. The Company uses such estimates, judgments, and assumptions when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, lease accounting, uncertain tax positions, income tax expense, liabilities under the TRA, derivative instruments, fair value of debt, equity-basedstock-based compensation expense, useful lives assigned to long-lived assets, and the stand-alone selling price of performance obligations for revenue recognition purposes. Results and outcomes could differ materially from these estimates, judgments, and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to the potential impact of the coronavirus (“COVID-19”).
Correction of Immaterial Misstatement
In connection with the preparation of its condensed consolidated financial statements for the quarter ended September 30, 2021, the Company identified immaterial errors in its historical financial statements. The errors resulted in understatement of goodwill, provision for income taxes, and deferred tax liability and overstatement of prepaid expenses and other current assets, accrued expenses and other current liabilities, and selling, general and administrative expenses. The Company evaluated the effect of these errors on prior periods under the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 99 - Materiality, and determined the amounts were not material to any previously-issued financial statements. The Company also evaluated the effect of correcting these errors through a cumulative adjustment to the condensed consolidated financial statements and concluded, based on the guidance within SAB No. 108 - Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, it was appropriate to correct these errors out of period during the quarter ended September 30, 2021.
COVID-19
In March 2020, the World Health Organization declared COVID-19 a pandemic. The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains, and created significant volatility and disruption in the financial and capital markets, which could continue to negatively impact the Company’s customers’ access to working capital necessary to fund their operations, resulting in lower revenue for the Company. The COVID-19 pandemic and the resulting economic conditions and government shut down orders resulted in a decrease in total employment and hiring on a global level.uncertainties.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company’s financial results and prospects are impacted by the number of hires and the total level of employment. The Company’s results for the year ended December 31, 2020 were negatively impacted by the temporary dropchange in hiring and the associated pre-employment background screen demand, which peakedgoodwill during the second quarter of 2020. The temporary drop in order volume negatively impacted total revenues, net incomenine months ended September 30, 2022 was driven by foreign currency translation, as the U.S. dollar strengthened against the British pound and cash flows from operations during 2020. While the peak of the pandemic impact on the Company occurred during April and May of 2020, the Company began to see a steady recovery beginning in June 2020, which continued throughout the year and into 2021.
2. Recently Issued Accounting Pronouncements
Recently Issued Accounting Pronouncements Adopted
Accounting Pronouncements Adopted in 20212022
In August 2018,February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-15,2016-02, “Intangibles-GoodwillLeases (Topic 842)” (“Topic 842”) to increase transparency and Other-Internal Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurredcomparability among organizations related to their leasing arrangements. The update requires lessees to recognize most leases, with the exception of short-term leases if a policy election is made, on their balance sheets as a right-of-use (“ROU”) asset representing the right to use an underlying asset and a lease liability representing the obligation to make lease payments over the lease term, measured on a discounted basis, while recognizing lease expense on their income statements in a Cloud Computing Arrangement That Is a Service Contract” (“ASU 2018-15”), which clarifies the accounting for implementation costs in cloud computing arrangements.manner similar to current GAAP. The guidance is effectivealso requires an entity to disclose key quantitative and qualitative information about its leasing arrangements.
The Company leases office facilities under operating lease agreements. All of the Company’s leases are operating leases. The Company adopted Topic 842 on January 1, 2022 using the modified retrospective transition approach. Under this transition provision, results for the reporting period beginning on January 1, 2022 are presented under Topic 842 while prior period amounts continue to be reported and disclosed in accordance with the Company’s historical accounting treatment under ASC Topic 840, Leases.
The Company elected the “package of practical expedients” permitted under the transition guidance, which among other things, does not require reassessment of whether contracts entered into prior to adoption are or contain leases, and allows carryforward of the historical lease classification for annual periods beginning after December 15, 2020.existing leases. The Company did not elect the “hindsight” practical expedient, and therefore measured the ROU asset and lease liability using the remaining portion of the lease term at adoption on January 1, 2022.
The Company made an accounting policy election not to recognize ROU assets and lease liabilities for leases with a term of twelve months or less. For all other leases, the Company recognizes ROU assets and lease liabilities based on the present value of lease payments over the lease term at the commencement date of the lease (or January 1, 2022 for existing leases upon the adoption of Topic 842). Lease payments may include fixed rent escalation clauses or payments that depend on an index (such as the consumer price index). Subsequent changes to an index and any other periodic market-rate adjustments to base rent are recorded in variable lease expense in the period incurred. The ROU assets also include any initial direct costs incurred and lease payments made at or before the commencement date and are reduced by any lease incentives.
The Company has made an accounting policy election to account for lease and non-lease components in its contracts as a single lease component. The non-lease components typically represent additional services transferred to the Company, such as common area maintenance for real estate, which are variable in nature and recorded in variable lease expense in the period incurred.
The Company uses its incremental borrowing rate which is the rate of interest the Company would have to pay to borrow on a collateralized basis over a similar term and amount in a similar economic environment to determine the present value of lease payments as the Company’s leases do not have a readily determinable implicit discount rate. Judgment is applied in assessing factors such as Company specific credit risk, lease term, nature and quality of the underlying collateral, currency, and economic environment in determining the incremental borrowing rate to apply to each lease.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Upon adoption, the Company recorded ROU assets and operating lease liabilities of $9.9 million and $18.9 million, respectively, related to the Company’s operating leases. The adoption of the new lease standard did not materially impact the Company’s condensed consolidated statements of operations for the three and nine months ended September 30, 2022, or the condensed consolidated statements of cash flows for the nine months ended September 30, 2022.
In November 2021, the FASB issued ASU 2021-10, “Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance.” The ASU requires additional disclosures for transactions with a government accounted for by applying a grant or contribution accounting model by analogy, including: (i) information about the nature of the transactions and related accounting policy used to account for the transactions; (ii) the line items on the balance sheet and income statement affected by these transactions including amounts applicable to each line; and (iii) significant terms and conditions of the transactions, including commitments and contingencies. The Company adopted this ASU effective January 1, 2021.2022. The Company adoptedadoption of this ASU prospectively, and the adoption did not have a material impact on the condensed consolidated financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
In October 2021, the FASB issued ASU 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers”Customers,”, which aims to improve the accounting for acquired revenue contracts with customers in a business combination. The ASU requires an entity (acquirer) to recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. The new guidance is effective for the Company for annual periods beginning after December 15, 2023 and interim periods within those fiscal years. The CompanyEarly adoption is currently evaluating the impact and applicability of this new standard on the condensed consolidated financial statements.
In January 2021, the FASB issued ASU 2021-01, “Reference Rate Reform (Topic 848): Scope,” which clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The amendments in this update are elective and apply to all entities that have derivative instruments that use various reference rates, including the London Interbank Offered Rate (“LIBOR”) and other reference rates expected to be discontinued. The new guidance is effective immediately for all entities and amendments may be applied on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020.permitted. The Company is currently evaluating the impact of this standard on the condensed consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848),”, which provides temporary, optional practical expedients and exceptions to enable a smoother transition to the new reference rates which will replace LIBORthe London Interbank Offered Rate (“LIBOR”) and other reference rates expected to be discontinued. The newIn January 2021, the FASB issued ASU No. 2021-01, “Reference Rate Reform (Topic 848): Scope,” which expanded the scope of Topic 848 to include derivative instruments impacted by the discounting transition. This collective guidance is effective at any time after March 12, 2020 but no later than December 31, 2022. The Company is currently evaluatingdoes not expect the impactadoption of this standardguidance to have a material impact on the condensed consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” ", to provide financial statement users with more decision-usefuluseful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The guidance is effective for the Company for annual periods beginning after December 15, 2020 and interim periods within those fiscal years. ASU 2019-10 delayed the effective
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
date for this guidance until the fiscal year beginning after December 15, 2022. Early adoption is permitted. The Company is currently evaluating the impact of this standard on the condensed consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,“Leases (Topic 842)” (“ASU 2016-02”) related to the reporting of leases. The guidance requires recognition of most leases on the balance sheet as a right-of-use asset and a lease liability. In November 2019, the FASB issued ASU 2019-10, “Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842),” which deferred adoption until periods after December 15, 2020. In June 2020, the FASB issued ASU 2020-05,“Topic 606 and Topic 842: Effective Dates for Certain Entities”, which defersdelayed the effective date of ASU 2016-02 for onethis guidance until the fiscal year for entities in the “all other” category. Therefore, the standard is now effective for the Company for annual periods beginning after December 15, 2021, and2022 including interim periods within those fiscal years beginning after December 15, 2022.years. Early adoption is permitted.
In March 2021, the Company established an implementation team and engaged external advisers and solution providers to develop a multi-phase plan to assess the Company’s leasing arrangements, as well as any changes to accounting policies, processes, or necessary systems. The Company has entered into agreementsexpects there to procure software and services to facilitate adoption of the guidance. The Company is performing a detailed review of its leases and other contractual arrangements, system implementation requirements, and practical expedient alternatives available.
While the Company continues to assess all of the effects of the new standard, the Company expects the adoption of ASU 2016-02 to result in recognition of right-of-use assets and lease liabilities in the Company’s condensed consolidated balance sheet, and new disclosures in the footnotes to the Company’s condensed consolidated financial statements. The Company is unable to quantify thebe no material impact on the condensed consolidated financial statements atfrom the adoption of this time but expects the new standard to have a material effect on its condensed consolidated balance sheet.ASU.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
3. Prepaid Expenses and Other Current Assets, and Other Non-Current Assets
The components of prepaid expenses and other current assets were as follows:
| | | | | | | | | | | |
| September 30,
2021 | | December 31,
2020 |
| (in thousands) |
| Prepaid software licenses, maintenance, and insurance | $ | 12,882 | | | $ | 13,105 | |
| Other prepaid expenses and current assets | 9,110 | | | 5,116 | |
| Total prepaid expenses and other current assets | $ | 21,992 | | | $ | 18,221 | |
| | | | | | | | | | | |
| September 30,
2022 | | December 31,
2021 |
| (in thousands) |
| Prepaid software licenses, maintenance, and insurance | $ | 10,433 | | | $ | 11,668 | |
| Other prepaid expenses and current assets | 6,634 | | | 6,915 | |
| Total prepaid expenses and other current assets | $ | 17,067 | | | $ | 18,583 | |
The components of other non-current assets were as follows:
| | | | | | | | | | | |
| September 30,
2021 | | December 31,
2020 |
| (in thousands) |
| Contract implementation costs | $ | 17,041 | | | $ | 15,768 | |
| Other non-current assets | 1,217 | | | 1,470 | |
| Total other non-current assets | $ | 18,258 | | | $ | 17,238 | |
Interest expense includes the amortization of $0.1 million of debt issuance costs for the Company’s revolving credit agreement for both the three months ended September 30, 2021 and 2020 and $0.3 million for both the nine months ended September 30, 2021 and 2020. Amortization of debt issuance costs for the Company’s revolving credit agreement is recorded in other non-current assets on the Company’s condensed consolidated balance sheets.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
| | | | | | | | | | | |
| September 30,
2022 | | December 31,
2021 |
| (in thousands) |
| Contract implementation costs | $ | 17,680 | | | $ | 17,242 | |
| Other non-current assets | 1,131 | | | 969 | |
| Total other non-current assets | $ | 18,811 | | | $ | 18,211 | |
Please seeSee Note 14 — Revenues for further discussion on contract implementation assetscosts and related amortization included in cost of services in the Company’s accompanying condensed consolidated statements of operations.
4. GoodwillRight-of-Use Assets and Lease Liabilities
The changesCompany determines if an arrangement is or contains a lease at inception, which is the date on which the terms of the contract are agreed, and if the arrangement creates enforceable rights and obligations. Under Topic 842, a contract is or contains a lease when (i) explicitly or implicitly identified assets have been deployed in the carrying amountcontract and (ii) the customer obtains substantially all of goodwillthe economic benefits from December 31, 2020the use of that underlying asset and directs how and for what purpose the asset is used during the term of the contract. See Note 2 — Recently Issued Accounting Pronouncements for more information on the Company’s accounting policies for leases.
The Company leases office facilities under operating lease agreements that have initial terms ranging from 1 to September 30, 202112 years. Some leases include one or more options to extend the term of the lease, generally at the Company’s sole discretion, with renewal terms that can extend the lease term up to 5 years. In addition, certain leases give the Company, the lessor, or both parties the right to terminate. Options to extend a lease are included in the lease term when it is reasonably certain that the Company will exercise the option. Options to terminate a lease are excluded from the lease term when it is reasonably certain that the Company will not exercise the option. The Company’s leases generally do not contain any material restrictive covenants or residual value guarantees.
The Company’s operating leases were as follows:
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
| | | | | |
| September 30, 2022 |
| (in thousands) |
| Right-of-use assets, net | $ | 8,802 | |
| |
Current operating lease liabilities (1) | $ | 5,207 | |
| Operating lease liabilities, long-term | 11,051 | |
| Total operating lease liabilities | $ | 16,258 | |
(1) Current lease liabilities are recorded in other current liabilities on the Company’s condensed consolidated balance sheets.
The components of lease cost are recorded in selling, general, and administrative expenses for the three and nine months ended September 30, 2022 and were as follows:
| | | | | | | | | | | |
| Three Months Ended September 30, 2022 | | Nine Months Ended September 30, 2022 |
| (in thousands) |
| Operating lease cost | $ | 981 | | | $ | 2,764 | |
| Short-term lease cost | 137 | | | 470 | |
| Variable lease cost | 12 | | | 36 | |
| Total lease cost | $ | 1,130 | | | $ | 3,270 | |
Operating lease cost is recognized on a straight-line basis over the lease term.
Supplemental cash flow information related to leases was as follows:
| | | | | |
| Nine Months Ended September 30, 2022 |
| (in thousands) |
| Cash paid for amounts included in measurement of operating lease liabilities | $ | 4,193 | |
| ROU assets obtained in exchange for operating lease liabilities | $ | 10,896 | |
The weighted-average remaining lease term and weighted-average discount rate for the Company’s operating leases were as follows:
| | | | | |
| September 30, 2022 |
| Weighted-average remaining lease term (in years) | 4.22 |
| Weighted-average discount rate | 4.6 | % |
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Maturities of the Company’s operating lease liabilities were as follows: | | | | | |
| September 30, 2022 |
| (in thousands) |
| 2022 (excluding the nine months ended September 30, 2022) | $ | 1,499 | |
| 2023 | 5,958 | |
| 2024 | 3,636 | |
| 2025 | 2,166 | |
| 2026 | 1,357 | |
| Thereafter | 3,392 | |
| Total lease payments | 18,008 | |
| Less amount representing interest | (1,750) | |
| Total present value of lease liabilities | $ | 16,258 | |
Cease-use Liabilities
The Company periodically identifies opportunities for cost savings through office consolidations or by exit from certain underutilized facilities. Cease-use costs represent lease obligation charges and executory costs for exited facilities. The Company accounts for cease-use costs pursuant to guidance under ASC 420, Costs Related to Exit or Disposal Activities. Charges related to these cease-use costs are estimated based on the discounted future cash flows of rent expense and executory costs that the Company is obligated to pay under the lease agreements, partially offset by projected sublease income, which is calculated based on certain sublease assumptions.
As a result of the exit from certain facilities, the Company recorded a cease-use liability in 2021. The cease-use liability of $9.0 million was reclassified and treated as a reduction to the beginning ROU asset recorded upon adoption of ASC 842, Leases, on January 1, 2022. Cease-use costs were $0.2 million during the nine months ended September 30, 2022, and are included as a component of selling, general and administrative expenses in the condensed consolidated statements of operations. No cease-use costs were incurred during the three months ended September 30, 2022. Cease-use costs were $1.5 million during the three and nine months ended September 30, 2021.
Cease-use costs are included in other non-current liabilities and accrued expenses and other current liabilities on the condensed consolidated balance sheets as of September 30, 2022 and December 31, 2021. The following table summarizes the activity for the liability for cease-use costs for the periods presented:
| | | | | | | | |
| | Cease-use Liability |
| | (in thousands) |
Balance at December 31, 20202021 | | $ | 820,032 11,588 | |
| Cease-use costs | | 160 | |
| Reclassified as a reduction to the beginning ROU asset upon adoption of ASC 842 | | (9,001) | |
| Accretion of liability | | (146) | |
| Payments | | (874) | |
| Foreign currency translation | (1,083) | |
Other (1)
| 690 (390) | |
Balance at September 30, 20212022 | | $ | 819,6391,337 | |
(1)
Includes $0.7 million related to the out-of-period adjustment discussed in Note 1.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
5. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities were as follows:
| | | September 30,
2021 | | December 31,
2020 | | September 30,
2022 | | December 31,
2021 |
| | (in thousands) | | (in thousands) |
| Accrued data and direct labor costs | $ | 31,966 | | | $ | 20,064 | | |
| Accrued data costs | | Accrued data costs | $ | 39,017 | | | $ | 34,632 | |
| Litigation settlements (Note 13) | Litigation settlements (Note 13) | 13,424 | | | 12,916 | | Litigation settlements (Note 13) | 607 | | | 3,310 | |
Other (1) | Other (1) | 31,098 | | | 23,829 | | Other (1) | 40,243 | | | 37,352 | |
| Total accrued expenses and other current liabilities | Total accrued expenses and other current liabilities | $ | 76,488 | | | $ | 56,809 | | Total accrued expenses and other current liabilities | $ | 79,867 | | | $ | 75,294 | |
________________
(1)As of bothDuring the nine months ended September 30, 2021 and December 31, 2020,2022, the Company had $1.1 million held in escrow for the benefit of former investors in a subsidiary of the Company pursuant to the terms of its divestiture of a former affiliate in April 2018. A total ofpaid $3.9 million, which was previously held in escrow as of both September 30, 2021 and December 31, 2020 related2021, as unsecured creditors’ funds pursuant to priorplans of liquidation and restructurings fromof predecessor entities.
6. Accrued Salaries and Payroll
The components of accrued salaries and payroll were as follows:
| | | September 30,
2021 | | December 31,
2020 | | September 30,
2022 | | December 31,
2021 |
| | (in thousands) | | (in thousands) |
| Wages, benefits and taxes | Wages, benefits and taxes | $ | 17,158 | | | $ | 14,719 | | Wages, benefits and taxes | $ | 18,258 | | | $ | 12,017 | |
| Accrued bonus | Accrued bonus | 12,161 | | | 8,406 | | Accrued bonus | 14,900 | | | 17,263 | |
| Total accrued salaries and payroll | Total accrued salaries and payroll | $ | 29,319 | | | $ | 23,125 | | Total accrued salaries and payroll | $ | 33,158 | | | $ | 29,280 | |
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
7. Debt
The components of debt were as follows:
| | | September 30,
2021 | | December 31,
2020 | | September 30,
2022 | | December 31,
2021 |
| | (in thousands) | | (in thousands) |
| First Lien Term Loan Facility | $ | 809,951 | | | $ | 816,213 | | |
| Second Lien Term Loan Facility | 215,000 | | | 215,000 | | |
| Revolving Credit Facility | 10,000 | | | 10,000 | | |
| Amended First Lien Term Loan Facility | | Amended First Lien Term Loan Facility | $ | 701,600 | | | $ | 707,863 | |
| Amended Revolving Credit Facility | | Amended Revolving Credit Facility | — | | | — | |
| Total debt | Total debt | 1,034,951 | | | 1,041,213 | | Total debt | 701,600 | | | 707,863 | |
| Less: Original issue discount | Less: Original issue discount | (3,892) | | | (4,499) | | Less: Original issue discount | (1,598) | | | (1,993) | |
| Less: Unamortized debt issuance costs | Less: Unamortized debt issuance costs | (12,773) | | | (14,967) | | Less: Unamortized debt issuance costs | (7,087) | | | (8,837) | |
| Less: Current portion of long-term debt | Less: Current portion of long-term debt | (8,350) | | | (8,350) | | Less: Current portion of long-term debt | (8,350) | | | (8,350) | |
| Long-term debt, less current portion | Long-term debt, less current portion | $ | 1,009,936 | | | $ | 1,013,397 | | Long-term debt, less current portion | $ | 684,565 | | | $ | 688,683 | |
|
On July 12, 2018, the Company entered into the following credit arrangements:
•a first lien senior secured term loan facility, in an aggregate principal amount of $835.0 million, maturing on July 12, 2025 (the “First(“First Lien Term Loan Facility”);
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
•a first lien senior secured revolving credit facility, in an aggregate principal amount of up to $100.0 million, including a $40.0 million letter of credit sub-facility, maturing on July 12, 2023 (the “Revolving(“Revolving Credit Facility” and, together with the First Lien Term Loan Facility, the “First Lien Facilities”); and
•a second lien senior secured term loan facility, in an aggregate principal amount of $215.0 million, maturing on July 12, 2026 (the “Second Lien Term Loan Facility” and, together with the First Lien Facilities, the “Senior Facilities”).
On June 3, 2022, the Company entered into an amendment to the First Lien Term Loan Facility (“Amended First Lien Term Loan Facility”) with the lenders party thereto and Bank of America, N.A. as administrative agent. The Amended First Lien Term Loan Facility amends the Company’s First Lien Facilities, by and among the Company, the lending institutions from time to time party thereto and Bank of America, N.A. as administrative agent, collateral agent and a letter of credit issuer (as amended through the Amended First Lien Term Loan Facility, the “Amended First Lien Facilities”).
Under the Amended First Lien Facilities, (i) the aggregate commitments under the Company’s Revolving Credit Facility were increased from $100.0 million to $145.0 million; (ii) the maturity date of the Revolving Credit Facility was extended from July 12, 2023 to June 3, 2027 or, if earlier, 91 days prior to the maturity of the Company’s term loans under the Amended First Lien Facilities, as may be extended or refinanced; and (iii) the interest rate benchmark applicable to the Revolving Credit Facility was converted from LIBOR to term Secured Overnight Financing Rate (“SOFR”). The Revolving Credit Facility as amended is herein after referred to as the “Amended Revolving Credit Facility.” The Company’s existing term loans under the Amended First Lien Facilities remained in effect. Upon the effectiveness of the Amended First Lien Term Loan Facilities, the Company did not have any outstanding principal balance on the Revolving Credit Facility. The Amended First Lien Term Loan Facilities did not modify the financial covenants, negative covenants, mandatory prepayment events or security provisions or arrangements under the Amended First Lien Facilities.
The Amended First Lien Term Loan Facility was accounted for as a modification for certain lenders and an extinguishment for other lenders and debt issuance costs and lender fees were accounted for in proportion to whether the related borrowing commitment was considered modified or extinguished. Accordingly, newly incurred and existing deferred debt issuance costs of $0.4 million and $0.4 million, respectively, will be amortized to interest expense over the new remaining term of the Amended Revolving Credit Facility. Additionally, the Company wrote off unamortized debt issuance costs of $0.1 million related to the modification of the Revolving Credit Facility, which is recorded in interest expense in the condensed consolidated statements of operations.
Amended First Lien Facilities
The Company is required to make scheduled quarterly payments equal to 0.25% of the aggregate initial outstanding principal amount of the Amended First Lien Term Loan Facility, or approximately $2.1 million per quarter, with the remaining balance payable at maturity.
The Company may make voluntary prepayments on the Amended First Lien Term Loan Facility at any time prior to maturity at par.
The Company is required to make prepayments on the Amended First Lien Term Loan Facility with the net cash proceeds of certain asset sales, debt incurrences, casualty events and sale-leaseback transactions, subject to certain specified limitations, thresholds and reinvestment rights. Additionally, the Company is required to make annual prepayments on the outstandingAmended First Lien Term Loan Facility with a percentage (subject to leverage-based reductions) of the Company’s excess cash flow, as defined therein, if the excess cash flow exceeds a certain specified threshold. For the three and nine months ended September 30, 20212022 and 2020,2021, the Company was not required to make a prepayment under the Amended First Lien Term Loan Facility based on the Company’s excess cash flow.
The Amended First Lien Term Loan Facility has an interest rate calculated as, at the Company’s option, either (a) LIBOR determined by reference to the costs of funds for Eurodollar deposits for the interest period relevant to such borrowing, adjusted for certain additional costs (“LIBOR Reference Rate”) with a floor of 0.00% or (b) a base rate determined by reference to the highest of (i) the federal funds effective rate plus 0.50% per annum, (ii) the rate the Administrative Agent announces from time to time as its prime lending rate in New York City, and (iii) one-month adjusted LIBOR plus 1.00% per annum (“ABR”), in each case, plus the applicable margin of 3.75% for
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
LIBOR loans and 2.75% for ABR loans, and is payable on each interest payment date, at least quarterly, in arrears. The applicable margin for
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
borrowings under the First Lien Revolving Credit Facility is 3.00% for LIBORSOFR loans and 2.00% for ABR loans, in each case, subject to adjustment pursuant to a leverage-based pricing grid. As of September 30, 2021,2022, the Amended First Lien Term Loan Facility accrued interest at one-month LIBOR plus 3.75%, and the Amended Revolving Credit Facility accrued interest at one-month SOFR plus 2.50% based upon the current pricing grid.
Unlike the Amended Revolving Credit Facility, the interest rates for the Amended First Lien Term Loan Facility are calculated using LIBOR, plus 3.00%.which is scheduled to become unavailable in June 2023. The credit agreement underlying the Amended First Lien Term Loan Facility contemplates that, if the administrative agent determines that LIBOR is unavailable or is replaced by a new benchmark interest rate to replace LIBOR for syndicated loans, then, the administrative agent and the Borrower may amend the Amended First Lien Term Loan Facility to replace LIBOR with an alternate benchmark rate (“LIBOR Successor Rate”) unless lenders holding more than 50% in value of the loans or commitments under the credit agreement do not accept such amendment. If no LIBOR Successor Rate has been determined, the obligation of lenders to make or maintain LIBOR loans will be suspended (to the extent of the affected LIBOR rate loans or interest periods), and the LIBOR component will no longer be utilized in determining an alternative benchmark rate. Under such circumstances, the Borrower can revoke any pending request for a new borrowing, conversion to, or continuation of LIBOR loans or such loans will be deemed to be ABR loans of the same amount. The Borrower also has the ability to convert all or a portion equal to at least $2.5 million of LIBOR loans to ABR loans under the credit agreement.
The Company’s obligations under the Amended First Lien Facilities are guaranteed, jointly and severally, on a senior secured first-priority basis, by substantially all of the Company’s domestic wholly-owned material subsidiaries, as defined in the agreement, and are secured by first-priority security interests in substantially all of the assets of the Company and its domestic wholly-owned material subsidiaries, subject to certain permitted liens and exceptions. Collateral includes all outstanding equity interests in whatever form of the borrower and each restricted subsidiary that is owned by any credit party.
As of September 30, 2021,2022, the Company had approximately $88.2$143.7 million in available borrowing under the Amended Revolving Credit Facility, after utilizing approximately $1.8$1.3 million for letters of credit. The Company is required to pay a quarterly fee of 0.50% on unutilized commitments under the Amended Revolving Credit Facility, subject to adjustment pursuant to a leverage-based pricing grid. As of September 30, 20212022 and December 31, 2020,2021, the quarterly fee on unutilized commitments under the Amended Revolving Credit Facility was 0.50%.
Second Lien Term Loan Facility
The Company may make voluntary prepayments on the Second Lien Term Loan Facility at any time prior to maturity at par.
The Company is required to make prepayments on the Second Lien Term Loan Facility with the net cash proceeds of certain asset sales, debt incurrences, casualty events0.38% and sale-leaseback transactions, subject to certain specified limitations, thresholds and reinvestment rights, in each case to the extent permitted under the First Lien Facilities prior to the repayment in full and discharge thereof. Additionally, the Company is required to make annual prepayments on the outstanding Second Lien Term Loan Facility with a percentage (subject to leverage-based reductions) of the Company’s excess cash flow, as defined therein, if the excess cash flow exceeds a certain specified threshold, to the extent permitted under the First Lien Facilities prior to the repayment in full and discharge thereof. For the three and nine months ended September 30, 2021 and 2020, the Company was not required to make an annual prepayment under the Second Lien Term Loan Facility based on the Company’s excess cash flow.
The Second Lien Term Loan Facility has an interest rate calculated as, at the Company’s option, either (a) LIBOR with a floor of 0.00% or (b) ABR, in each case, plus the applicable margin of 7.25% for LIBOR loans and 6.25% for ABR loans, and is payable on each interest payment date, at least quarterly, in arrears. As of September 30, 2021 and December 31, 2020 the Second Lien Term Loan Facility accrued interest at one-month LIBOR plus 7.25%.
The Company’s obligations under the Second Lien Term Loan Facility are guaranteed, jointly and severally, on a senior secured second-priority basis, by substantially all of the Company’s domestic wholly-owned material subsidiaries and are secured by second-priority security interests in substantially all of the assets of the Company and its domestic wholly-owned material subsidiaries, subject to certain permitted liens and exceptions.0.50%, respectively.
Debt Covenants
The SeniorAmended First Lien Facilities contain certain covenants and restrictions that limit the Company’s ability to, among other things: (a) incur additional debt or issue certain preferred equity interests; (b) create or permit the existence of certain liens; (c) make certain loans or investments (including acquisitions); (d) pay dividends on or make distributions in respect of the capital stock or make other restricted payments; (e) consolidate, merge, sell, or otherwise dispose of all or substantially all of the Company’s assets; (f) sell assets; (g) enter into certain transactions with affiliates; (h) enter into sale-leaseback transactions; (i) restrict dividends from the Company’s subsidiaries or restrict liens; (j) change the Company’s fiscal year; and (k) modify the terms of certain debt agreements. In addition, the SeniorAmended First Lien Facilities also provide for customary events of default. The Company was in compliance with the covenants under the SeniorAmended First Lien Facilities for the three and nine months ended September 30, 2021.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
2022.
The Company is also subject to a springing financial maintenance covenant under the Amended Revolving Credit Facility, which requires the Company to not exceed a specified first lien leverage ratio at the end of each fiscal quarter if the outstanding loans and letters of credit under the Amended Revolving Credit Facility, subject to certain exceptions, exceed 35% of the total commitments under the Amended Revolving Credit Facility at the end of such fiscal quarter. The Company was not subject to this covenant as of September 30, 20212022 and December 31, 2020,2021, as outstanding loans and letters of credit under the Amended Revolving Credit Facility did not exceed 35% of the total commitments under the facility.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Other
Interest expense includes the amortizationAmortization of debt discount and debt issuance costs related to the Amended First Lien Term Loan Facility are included in interest expense in the condensed consolidated statements of operations and the Second Lien Term Loan Facility of $0.2 million and $0.7 million, respectively, for both of the three months ended September 30, 2021 and 2020. The amortization of debt discount and debt issuance costs for the nine months ended September 30, 2021 amounted to $0.6 million and $2.2 million, respectively, and $0.6 million and $2.1 million, respectively, for the nine months ended September 30, 2020. were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands) |
| Debt discount amortization | $ | 133 | | | $ | 146 | | | $ | 395 | | | $ | 431 | |
| Debt issuance costs amortization | 588 | | | 658 | | | 1,750 | | | 1,955 | |
| Total debt discount and issuance cost amortization | $ | 721 | | | $ | 804 | | | $ | 2,145 | | | $ | 2,386 | |
In addition, interest expense includes the amortization of debt issuance costs for the Amended Revolving Credit Facility of $0.1 million for botheach of the three months ended September 30, 2022 and 2021, and 2020$0.4 million and $0.3 million, for both of the nine months ended September 30, 2022 and 2021, and 2020.respectively. Unamortized debt issuance costs for the Amended Revolving Credit Facility are recorded in other non-current assets on the Company’s condensed consolidated balance sheets.
Interest expense for the three and nine months ended September 30, 2021 includes $4.2 million and $12.4 million, respectively, related to a second lien senior secured term loan facility which was repaid in full on November 3, 2021 using proceeds from the IPO.
The weighted average interest rate on outstanding borrowings as of September 30, 20212022 and December 31, 20202021 was 4.57%4.8% and 5.06%4.5%, respectively.
See Note 19 — Subsequent Events included in these condensed consolidated financial statements for a description of the repayment of certain of the outstanding debt with proceeds from the IPO.
8. Fair Value Measurements
The accounting standard for fair value measurements defines fair value, establishes a market-based framework or hierarchy for measuring fair value, and requires disclosures about fair value measurements. The standard is applicable whenever assets and liabilities are measured at fair value.
The fair value hierarchy established in the standard prioritizes the inputs used in valuation techniques into three levels as follows:
Level 1 Quoted prices in active markets for identical assets and liabilities;
| | | | | |
| Level 1 | Quoted prices in active markets for identical assets and liabilities; |
| |
| Level 2 | Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data; or |
| |
| Level 3 |
Level 2 Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data; or
Level 3 Amounts derived from valuation models in which unobservable inputs reflect the reporting entity’s own assumptions about the assumptions of market participants that would be used in pricing the asset or liability, such as discounted cash flow models or valuations.
|
Recurring Fair Value Measurements
The carrying amounts of the Company’s cash, cash equivalents, and restricted cash accounts receivable, and accounts payable approximate their fair value due to the short-term maturity of these instruments.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company’s outstanding debt instruments are recorded at their carrying values in the condensed consolidated balance sheets, which may differ from their respective fair values. The estimated fair value of the Company’s debt, which is Level 2 of the fair value hierarchy, is based on quoted prices for similar instruments in active markets or identical instruments in markets that are not active.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company’s derivative instruments, consistall of which the Company terminated during the quarter ended March 31, 2022, consisted of interest rate swap contracts which arewere Level 2 of the fair value hierarchy and reported in the condensed consolidated balance sheetssheet as of September 30, 2021 and December 31, 20202021 as derivative liabilities current and derivative liabilities long-term. Please seeSee Note 9 — Derivative Instruments for more information.
The fair value of the Company’s Amended First Lien Term Loan Facility and Second Lien Term Loan Facility is calculated based upon market price quotes obtained for the Company’s debt agreements (Level 2 fair value inputs). The fair value of the Amended Revolving Credit Facility approximates carrying value, based upon the short-term duration of the interest rate periods currently available to the Company. The estimated fair values were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2021 | | December 31, 2020 |
| Carrying Value | | Fair Value | | Carrying Value | | Fair Value |
| (in thousands) |
| First Lien Term Loan Facility | $ | 807,529 | | | $ | 800,972 | | | $ | 813,361 | | | $ | 784,894 | |
| Second Lien Term Loan Facility | 213,528 | | | 202,453 | | | 213,353 | | | 160,014 | |
| Revolving Credit Facility | 10,000 | | | 10,000 | | | 10,000 | | | 10,000 | |
| Total | $ | 1,031,057 | | | $ | 1,013,425 | | | $ | 1,036,714 | | | $ | 954,908 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
| Carrying Value | | Fair Value | | Carrying Value | | Fair Value |
| (in thousands) |
| Amended First Lien Term Loan Facility | $ | 700,002 | | | $ | 684,693 | | | $ | 705,870 | | | $ | 704,550 | |
| Amended Revolving Credit Facility | — | | | — | | | — | | | — | |
| Total | $ | 700,002 | | | $ | 684,693 | | | $ | 705,870 | | | $ | 704,550 | |
9. Derivative Instruments
The Company is exposed to changes in interest rates as a result of the Company’s financing activities used to fund business operations. Primary exposures include movements in LIBOR. The nature and amount of the Company’s long-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. To minimize this risk, the Company entered into interest rate swap agreements effective September 26, 2019 forwith a total notional amount of $700 million (the “Interestwith an effective date of December 31, 2018 (“Interest Rate Swap Agreements”). The Interest Rate Swap Agreements arewere designed to provide predictability against changes in the interest rates on the Company’s debt, as the Interest Rate Swap Agreements convertconverted a portion of the variable interest rate on the Company’s debt to a fixed rate. The Interest Rate Swap Agreements were originally scheduled to expire on December 31, 2023.
On September 26, 2019, the Company modified the terms of the Interest Rate Swap Agreements with the then existing counterparties to change the LIBOR reference period to one month. The notional amount and maturities of the Interest Rate Swap Agreements remained unchanged. The Company has elected hedge accounting treatment for the Interest Rate Swap Agreements.at that time. To ensure the effectiveness of the Interest Rate Swap Agreements, the Company elected the one-month LIBOR rate option for its variable rate interest payments on term balances equal to or in excess of the applicable notional amount of the interest rate swap agreementInterest Rate Swap Agreements as of each reset date. The reset dates and other critical terms on the term loans perfectly matchmatched with the interest rate cap reset dates and other critical terms through February 18, 2022, the date the Interest Rate Swap Agreements were terminated, and during the three and nine months ended September 30, 2021 and 2020.2021. At September 30, 20212022 and December 31, 2020,2021, the effective portion of the Interest Rate Swap Agreements was included on the condensed consolidated balance sheetsheets in accumulated other comprehensive income (loss).
During the three and nine months ended September 30, 2021 and 2020, the Company reclassified interest expense related to hedges of these transactions into earnings in the following amounts:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 |
| | (in thousands) |
| Interest expense reclassified into earnings | | $ | 5,018 | | | $ | 4,854 | | | $ | 14,733 | | | $ | 11,136 | |
For derivative instruments that qualify for hedge accounting treatment, the fair value is recognized on the Company’s condensed consolidated balance sheets as derivative assets or liabilities with offsetting changes in fair
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
value, to the extent effective, recognized in accumulated other comprehensive income (loss) until reclassified into earnings when the related transaction occurs. The portion of a cash flow hedge that does not offset the change in the fair value of the transaction being hedged, which is commonly referred to as the ineffective portion, is immediately recognized in earnings. No portionPrior to termination discussed below, the Interest Rate Swap Agreements were determined to be effective hedging agreements.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Effective February 18, 2022, the Company terminated the Interest Rate Swap Agreements. In connection with the termination of the cash flow hedge was ineffective duringInterest Rate Swap Agreements, the three and nine months ended September 30, 2021 and 2020.Company made a payment of $18.4 million to the swap counterparties. Following these terminations, $21.5 million of unrealized gains related to the terminated Interest Rate Swap Agreements included in accumulated other comprehensive income (loss) will be reclassified to earnings as reductions to interest expense through December 31, 2023.
The Company reclassified interest expense related to hedges of these transactions into earnings as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands) |
Reclassification of the effective portion of the gain on the Interest Rate Swap Agreements into interest expense | $ | — | | | $ | 5,018 | | | $ | 1,679 | | | $ | 14,733 | |
| Reclassification of unrealized gains related to terminated Interest Rate Swap Agreements into interest expense | (3,413) | | | — | | | (9,676) | | | — | |
| Total reclassification adjustments included in earnings | $ | (3,413) | | | $ | 5,018 | | | $ | (7,997) | | | $ | 14,733 | |
The fair value of the Interest Rate Swap Agreements was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2021 |
| Markets for Identical
Assets
(Level 1) | | Observable Inputs
(Level 2) | | Unobservable Inputs
(Level 3) | | Total |
| (in thousands) |
| Derivative instruments, current | $ | — | | | $ | 18,772 | | | $ | — | | | $ | 18,772 | |
| Derivative instruments, long-term | — | | | 19,097 | | | — | | | 19,097 | |
| Total liabilities measured at fair value | $ | — | | | $ | 37,869 | | | $ | — | | | $ | 37,869 | |
| | | December 31, 2020 | | December 31, 2021 |
| | Markets for Identical
Assets
(Level 1) | | Observable Inputs
(Level 2) | | Unobservable Inputs
(Level 3) | | Total | | Markets for Identical
Assets
(Level 1) | | Observable Inputs
(Level 2) | | Unobservable Inputs
(Level 3) | | Total |
| | (in thousands) | | (in thousands) |
| Derivative instruments, current | Derivative instruments, current | $ | — | | | $ | 18,258 | | | $ | — | | | $ | 18,258 | | Derivative instruments, current | $ | — | | | $ | 16,662 | | | $ | — | | | $ | 16,662 | |
| Derivative instruments, long-term | Derivative instruments, long-term | — | | | 35,317 | | | — | | | 35,317 | | Derivative instruments, long-term | — | | | 11,444 | | | — | | | 11,444 | |
| Total liabilities measured at fair value | Total liabilities measured at fair value | $ | — | | | $ | 53,575 | | | $ | — | | | $ | 53,575 | | Total liabilities measured at fair value | $ | — | | | $ | 28,106 | | | $ | — | | | $ | 28,106 | |
There were no amounts excluded from the measurement of hedge effectiveness at September 30, 2021February 18, 2022, the date of termination, and December 31, 2020. Please see2021. See Note 10 — Accumulated Other Comprehensive Income (Loss) for further information. Also see Note 7 — Fair Value Measurements for further information on the Company’s derivative instruments.
The results of derivative activities are recorded in cash flows from operating activities on the condensed consolidated statements of cash flows.
10. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) consists primarily of unrealized changes in fair value of derivative instruments that qualifyqualified for hedge accounting prior to termination and cumulative foreign currency translation adjustments.
The components of accumulated other comprehensive income (loss) as of September 30, 20212022 and December 31, 20202021 were as follows:
| | | | | | | | | | | | | | | | | |
| Derivative
Instruments | | Currency
Translation
Adjustment | | Total |
| (in thousands) |
| Balance at December 31, 2020 | $ | (13,646) | | | $ | 3,523 | | | $ | (10,123) | |
| Other comprehensive income (loss) | 15,706 | | | (2,333) | | | 13,373 | |
| Balance at September 30, 2021 | $ | 2,060 | | | $ | 1,190 | | | $ | 3,250 | |
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
| | | | | | | | | | | | | | | | | |
| Derivative
Instruments | | Currency
Translation
Adjustment | | Total |
| (in thousands) |
| Balance at December 31, 2021 | $ | 11,823 | | | $ | 797 | | | $ | 12,620 | |
| Other comprehensive income (loss) | (16) | | | (26,400) | | | (26,416) | |
| Balance at September 30, 2022 | $ | 11,807 | | | $ | (25,603) | | | $ | (13,796) | |
The maximum period over whichaccumulated net loss in foreign currency translation adjustment primarily reflects the strengthening of the U.S. dollar against the British pound and the Japanese yen.
The Company terminated the Interest Rate Swap Agreements are designated is December 31, 2023. Assuming interest rates ateffective February 18, 2022. As of September 30, 2021 remain constant, approximately $18.82022, $9.8 million of interest expensethe remaining accumulated other comprehensive income related to hedges of these transactionshedge accounting is expected to be reclassified into earnings over the next 12 months. Actual amounts ultimately reclassified into earnings over the next 12 months could vary materially from this estimated amount as a result of changes in interest rates.
11. Segments and Geographic Information
The Company determines its operating segments based on how the chief operating decision maker (“CODM”) manages the business, allocates resources, makes operating decisions and evaluates operating performance. The Company’s President and Chief Executive Officer is the Company’s CODM. The Company’s operating segments may not be comparable to similar companies in similar industries. The Company has determined it operates in one reportable segment.
Revenues are attributed to each geographic region based on the location of the HireRight entity that has contracted for which the Company’s services and revenue originate.that result in the revenues. The following tables summarizetable summarizes the Company’s revenues by region:
| | | Three Months Ended September 30, | | Nine Months Ended September 30, | | Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 | | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands, except percent) | | (in thousands, except percent) |
| Revenues | Revenues | | Revenues | |
| United States | United States | $ | 189,097 | | | 92.3 | % | | $ | 122,966 | | | 94.1 | % | | $ | 491,490 | | | 92.5 | % | | $ | 363,846 | | | 93.3 | % | United States | $ | 194,081 | | | 92.3 | % | | $ | 189,097 | | | 92.3 | % | | $ | 582,817 | | | 92.3 | % | | $ | 491,490 | | | 92.5 | % |
| International | International | 15,884 | | | 7.7 | % | | 7,708 | | | 5.9 | % | | 40,032 | | | 7.5 | % | | 26,275 | | | 6.7 | % | International | 16,222 | | | 7.7 | % | | 15,884 | | | 7.7 | % | | 48,489 | | | 7.7 | % | | 40,032 | | | 7.5 | % |
| Total revenues | Total revenues | $ | 204,981 | | | 100.0 | % | | $ | 130,674 | | | 100.0 | % | | $ | 531,522 | | | 100.0 | % | | $ | 390,121 | | | 100.0 | % | Total revenues | $ | 210,303 | | | 100.0 | % | | $ | 204,981 | | | 100.0 | % | | $ | 631,306 | | | 100.0 | % | | $ | 531,522 | | | 100.0 | % |
The following table summarizes the Company’s long-lived assets, which consist of property and equipment, net, and operating lease ROU assets, net, by geographic region:
| | | September 30,
2021 | | December 31,
2020 | | September 30,
2022 | | December 31,
2021 |
| | (in thousands) | | (in thousands) |
| Property and equipment, net | | |
| Long-lived assets: | | Long-lived assets: | |
| United States | United States | $ | 8,897 | | | $ | 12,613 | | United States | $ | 12,047 | | | $ | 7,154 | |
| International | International | 5,560 | | | 4,873 | | International | 6,247 | | | 3,973 | |
| Total property and equipment, net | $ | 14,457 | | | $ | 17,486 | | |
| Total long-lived assets | | Total long-lived assets | $ | 18,294 | | | $ | 11,127 | |
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
12. Commitments and ContingenciesContingent Liabilities
Indemnification
In the ordinary course of business, the Company enters into agreements with customers, providers of services and data that the Company uses in its business operations, and other third parties pursuant to which the Company agrees to indemnify and defend them and their affiliates for losses resulting from claims of intellectual property infringement, damages to property or persons, business losses, and other costs and liabilities. Generally, these indemnity and defense obligations relate to claims and losses that result from the Company’s acts or omissions, including actual or alleged process errors, inclusion of erroneous or impermissible information, or omission of includable information in background screening reports that the Company prepares. In addition, under some circumstances, the Company agrees to indemnify and defend contract counterparties against losses resulting from their own business operations, obligations, and acts or omissions, or the business operations, obligations, and acts or omissions of third
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
parties. For example, its business interposes the Company between suppliers of information that the Company includes in its background screening reports and customers that use those reports; the Company generally agrees to indemnify and defend its customers against claims and losses that result from erroneous information provided by its suppliers, and also to indemnify and defend its suppliers against claims and losses that result from misuse of their information by its customers.
The Company’s agreements with customers, suppliers, and other third parties typically include provisions limiting its liability to the counterparty, and the counterparty’s liability to the Company. However, these limits often do not apply to indemnity obligations. The Company’s rights to recover from one party for its acts or omissions may be capped below its obligation to another party for those same acts or omissions, and its obligation to provide indemnity and defense for its own acts or omissions in any particular situation may be uncapped.
The Company has also entered into indemnification agreements with the members of its board of managersdirectors and executive officers that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service. In addition, customers of the Company may seek indemnity for negligent hiring claims that result from the Company’s alleged failure to identify or report adverse background information about an individual.
As of December 31, 2021, the Company included $1.4 million in accrued expenses and other current liabilities in the condensed consolidated balance sheets as a result of the Company agreeing to indemnify a customer from a negligent hiring claim. While the Company did not believe it had legal responsibility, the Company chose to indemnify the customer against the negligent hiring claim in the interests of customer relations and to limit risk. On January 11, 2022, the Company paid the $1.4 million to the customer. The Company is not aware of any other pending demands to provide indemnity or defense under such agreements that would reasonably be expected to have a material adverse effect on its condensed consolidated financial statements, financial condition or results of operations.statements.
13. Legal Proceedings
The Company is subject to claims, investigations, audits, and enforcement proceedings by private plaintiffs, third parties the Company does business with, and federal, stategovernmental and foreignregulatory authorities charged with overseeing the enforcement of laws and regulations that govern the Company’s business. In the U.S., most of these matters arise under the federal Fair Credit Reporting Act and various state and local laws focused on privacy and the conduct and content of background reports. These claims are typically brought by individuals alleging process errors, inclusion of erroneous or impermissible information, or failure to include appropriate information in background reports prepared about them by the Company. Proceedings related to the Company’s U.S. operations may also be brought under the same laws by the Consumer Financial Protection Bureau or Federal Trade Commission, or by state authorities. Claims or proceedings may also arise under the European Union (“E.U.”) and U.K. General Data Protection RegulationRegulations and other laws around the world addressing privacy and the use of background information
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
such as criminal and credit histories, and may be brought by individuals about whom the Company has prepared background reports or by the Data Protection Authorities of E.U. member states and other governmental authorities. In addition, customers of the Company may seek indemnity for negligent hiring claims that result from the Company’s alleged failure to identify or report adverse background information about an individual.
In addition to claims related to privacy and background checks, the Company is also subject to other claims and proceedings arising in the ordinary course of its business, including without limitation claims for indemnity by customers and vendors, employment-related claims, and claims for alleged taxes owed, infringement of intellectual property rights, and breach of contract.
The Company accrues for contingent liabilities if it is probable that a liability has been incurred and the amount iscan be reasonably estimable.estimated. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. The Company does not record liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated or when the liability is believed to be only reasonably possible or remote.
Although the Company and its subsidiaries are subject to various claims and proceedings from time to time in the ordinary course of business, the Company and its subsidiaries are not party to any pending legal proceedings that the Company believes to be material except as set forth below.material.
HireRight Holdings Corporation
NotesOn November 6, 2020, the Company entered into a settlement agreement related to Condensed Consolidated Financial Statements (Unaudited)
In24 lawsuits that had been filed in 2009 and 2010 approximately 24 lawsuits were filed against HireRight Solutions, Inc. (“Old HireRight”), which is the predecessor to the Company’s subsidiary HireRight, LLC, by approximately 1,400 individuals alleging violation of the California Investigative Consumer Reporting Agencies Act by Old HireRight and one of its customers (the “Customer”(“Customer”) related to background reports that Old HireRight prepared for the Customer about those individuals (the “Action”). The Customer was also named as a defendant in the Action.individuals.
In February of 2015, for unrelated reasons, Old HireRight’s former parent company and certain of its domestic affiliates, including Old HireRight, each filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code, 11 U.S.C. §§ 101-1532, thereby commencing Chapter 11 cases (the “Bankruptcy”). Each plaintiff in the Action filed proofs of claim in the Bankruptcy against Old HireRight asserting an unliquidated general unsecured claim based upon the Action. In August 2015, the Bankruptcy court entered an order confirming the debtors’ Chapter 11 plan of reorganization in the Bankruptcy (the “Plan”).
Plaintiffs’ recovery from HireRight, LLC for claims accrued prior to the filing of the Bankruptcy is limited by the Plan to the Plaintiffs’ pro-rata portion of the Bankruptcy unsecured creditors’ pool. However, the Plan does not limit HireRight, LLC’s liability for claims accrued after the filing of the Bankruptcy, plaintiffs’ recovery from the Customer, or claims against Old HireRight’s insurer.
Following a complex procedural history and unsuccessful mediation sessions over an extended period of time, in October 2020, plaintiffs’ counsel made a settlement offer. While the Company believed and continues to believe it has valid defenses, the Company engaged in negotiations with the plaintiffs’ counsel and on November 6, 2020 was able to reach a settlement agreement that the Company viewed as acceptable to avoid the expense and risk of further litigation.
Based upon the foregoing, the Company accrued $12.1 million pursuantPursuant to the settlement agreement the Company paid $11.2 million on November 15, 2021, and potential separate individual settlements with plaintiffs who did not subscribethe remaining balance of $0.3 million on March 31, 2022. No amounts related to the settlement agreement. See Note 19 — Subsequent Events included in these condensed consolidated financial statements for more information regarding payment of this legal settlement liability.agreement are accrued at September 30, 2022.
While Old HireRight’s insurer has denied coverage, the Company believes it has valid claims against the carrier and intends to pursue them.is pursuing those claims. Any insurance recovery would offsetdefray the cost of the settlement to HireRight, LLC, but at this time the Company is not able to assess the likelihood or amount of any potential insurance recovery.
14. Revenues
Revenues consist of service revenue and surcharge revenue. Service revenue representsconsists of fees charged to customers for performing screening and compliance services.services provided by the Company. Surcharge revenue consists of fees charged to customers for obtaining data from federal, state and local jurisdictions, and certain commercial data wholesalers,which areproviders required to fulfill the Company’s screening and compliance serviceperformance obligations. These fees are predominantlygenerally charged to the Company’s customers at cost. Revenue is recognized when the Company satisfies its obligation to complete the service and delivers the screening report to the customer.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Disaggregated revenues were as follows:
| | | Three Months Ended September 30, | | Nine Months Ended
September 30, | | Three Months Ended September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 | | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands) | | (in thousands) |
| Revenues | Revenues | | | Revenues | |
| Service revenues | Service revenues | | $ | 152,332 | | | $ | 98,587 | | | $ | 395,624 | | | $ | 294,175 | | Service revenues | | $ | 151,256 | | | $ | 152,332 | | | $ | 451,184 | | | $ | 395,624 | |
| Surcharge revenues | Surcharge revenues | | 52,649 | | | 32,087 | | | 135,898 | | | 95,946 | | Surcharge revenues | | 59,047 | | | 52,649 | | | 180,122 | | | 135,898 | |
| Total revenues | Total revenues | | $ | 204,981 | | | $ | 130,674 | | | $ | 531,522 | | | $ | 390,121 | | Total revenues | | $ | 210,303 | | | $ | 204,981 | | | $ | 631,306 | | | $ | 531,522 | |
Contract Implementation Costs
Contract implementation costs represent incremental set up costs to fulfill contracts with customers, including, for example, salaries and wages incurred to onboard the customer oncustomers onto the Company’s platform to enable the customer's abilitycustomers to request and access completed background screening reports. Contract implementation costs and the related amortization are recorded in other non-current assets on the Company’s condensed consolidated balance sheets. Includedsheets and in cost of services is $1.0 million(exclusive of depreciation and $2.8 million related toamortization) in the Company’s condensed consolidated statements of operations, respectively. Amortization of contract implementation costs for the threeincluded in cost of services (exclusive of depreciation and nine months ended September 30, 2021, respectively, and $0.8amortization) was $1.1 million and $2.2$3.3 million for the three and nine months ended September 30, 2020,2022, respectively, and $1.0 million and $2.8 million for the three and nine months ended September 30, 2021, respectively. See Note 3 — Prepaid Expenses and Other Current Assets, and Other Non-Current Assets for contract implementation costs included in the Company’s condensed consolidated balance sheets.
15. Income Taxes
Income tax expense and effective tax rates were:were as follows:
| | | Three Months Ended September 30, | | Nine Months Ended
September 30, | | Three Months Ended September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 | | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands, except effective tax rate) | | (in thousands, except effective tax rate) |
| Income (loss) before income taxes | Income (loss) before income taxes | | $ | 7,930 | | | $ | (25,576) | | | $ | (5,383) | | | $ | (69,446) | | Income (loss) before income taxes | | $ | 23,585 | | | $ | 7,930 | | | $ | 60,843 | | | $ | (5,383) | |
| Income tax expense | | 649 | | | 1,466 | | | 2,954 | | | 3,490 | | |
| Income tax (benefit) expense | | Income tax (benefit) expense | | (69,704) | | | 649 | | | (68,456) | | | 2,954 | |
| Effective tax rate | Effective tax rate | | 8.2 | % | | 5.7 | % | | 54.9 | % | | 5.0 | % | Effective tax rate | | (295.5) | % | | 8.2 | % | | (112.5) | % | | 54.9 | % |
In general, with certain exceptions, ASC 740-270, Income Taxes, requires the use of an estimated annual effective tax rate to compute the tax provision during an interim period.The For the three and nine months ended September 30, 2022, the Company has net income before income taxes and used a discrete-periodan estimated annual effective tax rate to compute the income tax provision. However, due to operating losses for the nine months ended September 30, 2021, the Company determined that it was unable to reliably estimate its annual effective tax rate. As such, for the three and nine months ended September 30, 2021, the Company used a discrete method, which reflectsreflected the actual tax attributable to year-to-date earnings and losses for the threeperiod.
The Company recorded income tax benefit of $69.7 million and nineincome tax expense of $0.6 million for the three months ended September 30, 2022 and 2021, and 2020.respectively. Due to operating losses, the Company has determined that it is unable to reliably estimate its annualThe effective tax rate. A small change in the Company’s estimated marginal pretax resultsrate for the year ending December 31, 2021 may result in a material change in the expected annual effective tax rate.
On July 22, 2020, the United Kingdom enacted a law that increased the corporate income tax rate from 17% to 19% beginning in April 2021.As a result of the tax rate change, the Company re-valued its deferred taxes in the United Kingdom and recognized tax expense of $0.7 million for the three and nine months ended September 30, 2020.
On June 10, 2021, the United Kingdom enacted a law that increased the corporate income tax rate from 19%2022 was negative 295.5% compared to 25% beginning in April 2023.As of result of the tax rate change, the Company re-valued its deferred taxes in the United Kingdom and recognized tax expense of $1.5 million8.2% for the ninethree months ended September 30, 2021. The effective tax rate for the three months ended September 30, 2022, differs from the Federal statutory rate of 21%
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Incomeprimarily due to the release of federal and state valuation allowances during the quarter as discussed below, state taxes, and U.S. tax expense for the three months ended September 30, 2021 and 2020 was $0.6 million and $1.5 million, respectively.on foreign operations. The effective tax rate for the three months ended September 30, 2021 differs from the Federal statutory rate of 21% primarily due to valuation allowances and state taxes.
The rateCompany recorded income tax benefit of $68.5 million and income tax expense of $3.0 million for the threenine months ended September 30, 20202022 and 2021, respectively. The effective tax rate for the nine months ended September 30, 2022 was negative 112.5% compared to 54.9% for the nine months ended September 30, 2021. The effective tax rate for the nine months ended September 30, 2022, differs from the Federal statutory rate of 21% primarily due to the revaluationrelease of deferred taxes in the United Kingdom,federal and state valuation allowances during the quarter as discussed below, state taxes, and state taxes.
IncomeU.S. tax expense for the nine months ended September 30, 2021 and 2020 was $3.0 million and $3.5 million, respectively.on foreign operations. The effective tax rate for the nine months ended September 30, 2021 differs from the Federal statutory rate of 21% primarily due to the revaluation of deferred taxes in the United Kingdom, valuation allowances and state taxes. The rate for the nine months ended September 30, 2020 differs from the Federal statutory rate of 21% primarily due to the revaluation of deferred taxes in the United Kingdom, valuation allowances and state taxes.
Realization of theThe Company’s net U.S. federal and state deferred tax assets is dependent upon future earnings, if any. The timing and amount of future earnings are uncertain. Because of the Company’s lack of U.S. earnings history, the Company’s net U.S. deferred tax assets have beenwere previously fully offset by a valuation allowance, excluding a portion of its deferred tax liabilities for tax deductible goodwill.goodwill, primarily as a result of the Company’s lack of U.S. earnings history and cumulative loss position. The Company prepares a quarterly analysis of its deferred tax assets which considers positive and negative evidence, including its cumulative income (loss) position, revenue growth, continuing and improved profitability, and expectations regarding future profitability. Although the Company believes its estimates are reasonable, the ultimate determination of the appropriate amount of valuation allowance involves significant judgment.
In connectionThe Company determined sufficient positive evidence existed to conclude that the U.S. deferred tax assets are more likely than not realizable. As a result, the Company released the valuation allowance attributed to the deferred tax assets associated with the IPO,Company’s operations in the U.S. during the three months ended September 30, 2022. In making the determination to release the valuation allowance, the Company executed anconsidered its movement into a cumulative income position for the most recent three-year period, the significant decrease in interest expense from the paydown of debt in the fourth quarter of 2021 using IPO proceeds, its seventh consecutive quarter of operating income, forecasts for future earnings for its U.S. operations, and other factors. The release of the valuation allowance resulted in a non-cash deferred tax benefit of $70.2 million, which materially decreased the Company’s income tax receivable agreement (the “TRA”) with certain pre-IPO owners. See Note 19 — expense during the three months ended September 30, 2022.
Subsequent Events included
On August 16, 2022, the "Inflation Reduction Act" (H.R. 5376) was signed into law in thesethe United States. Among other things, the Act imposes a 15% corporate alternative minimum tax for tax years beginning after December 31, 2022, levies a 1% excise tax on net stock repurchases after December 31, 2022, and provides tax incentives to promote clean energy. The Company is still in the process of analyzing the provisions of the Act. The Company does not currently expect the Inflation Reduction Act to have a material impact on the condensed consolidated financial statements for more information regarding the TRA.statements.
16. Equity-BasedStock-Based Compensation
Equity Incentive Plans
On October 22, 2018, the Company implemented the HireRight GIS Group Holdings LLC Equity Incentive Plan (“Equity Plan”). The Equity Plan provides providing for the issuance of up to 4,573,463 of its Class A Units of the Company (“Units”) pursuant to awards made under the Equity Plan to members of the board of managers, officers and employees as determined by the Company’s compensation committee. Outstanding UnitFollowing the adoption of the Omnibus Incentive Plan (as defined below), the Company did not grant further awards under the Equity Plan. However, any outstanding awards granted under the Equity Plan remain subject to the Equity Plan and applicable award agreement. In connection with the Corporate Conversion, each option to purchase units of HireRight GIS Group Holdings LLC was converted into an option to purchase shares of common stock of HireRight Holdings Corporation.
On October 18, 2021, the Company’s stockholders adopted the Company’s 2021 Omnibus Incentive Plan (“Omnibus Incentive Plan”), which became effective on October 28, 2021. The Omnibus Incentive Plan provides for the grant of awards of non-qualified stock options, vestincentive (qualified) stock options, stock appreciation rights,
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
restricted stock awards, restricted stock units (“RSU”), other stock-based awards, other cash-based awards or any combination of the foregoing to eligible employees, consultants, directors, and officers. At September 30, 2022, 6,332,851 shares were available for issuance under the Omnibus Incentive Plan.
Modification of Certain Pre-IPO Equity Awards
The stock option awards issued prior to the Company’s IPO pursuant to the Equity Plan had vesting schedules based either upon continued service (“Time-Vesting Options”), or upon attainment of specified levels of cash-on-cash return to the Company’s pre-IPO investors as a multiple of invested capital (“MOIC”) on their investments in the Company (“Performance-Vesting Options”). Outstanding Unit option awardsOn March 19, 2022, the compensation committee of the Company’s Board of Directors approved a modification of outstanding Performance-Vesting Options to vest based solely on continued service rather than MOIC attainment. Under the modified vesting terms, the amended Performance-Vesting Options vest quarterly starting March 31, 2022 and ending December 31, 2024 based solely on continued service.
Stock-Based Compensation Expense
Stock-based compensation expense recognized in the condensed consolidated statements of operations was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended
September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands) |
| Selling, general and administrative | | $ | 1,089 | | | $ | 841 | | | $ | 8,083 | | | $ | 2,493 | |
| Cost of services (exclusive of depreciation and amortization) | | 193 | | | — | | | 504 | | | — | |
| Total stock-based compensation expense | | $ | 1,282 | | | $ | 841 | | | $ | 8,587 | | | $ | 2,493 | |
Equity Plan Awards (Pre-IPO)
For stock options issued to officers and employees consist of half Time-Vesting Options and half Performance-Vesting Options.
The Company did not grant any options during the three months ended September 30, 2021. During the nine months ended September 30, 2021, the Company granted option awards covering 229,195 units, of which 53,858 units are Time-Vesting Options and the remaining option awards covering 175,337 units are half Time-Vesting Options and half Performance-Vesting Options. The Time-Vesting Options and Performance Vesting Options granted during 2021 under the Equity Plan had a weighted-average grant date fair value of $7.98 and $5.12, respectively, calculated using the Monte Carlo simulation.
Included in selling, general and administrative expenses is equity-based compensation expense of $0.8 million and $0.9 million for the three months ended September 30, 2021 and 2020, respectively, and $2.5 million and $2.6 million for the nine months ended September 30, 2021 and 2020, respectively. For Time-Vesting Options and Performance-Vesting Optionsthat were outstanding and unvested as of September 30, 2021,2022, the Company willexpects to recognize future compensation expense of approximately $5.1$6.0 million and $13.1 million, respectively, over a weighted average remaining vesting period of 1.4 years and 1.3 years, respectively.2.19 years.
In connection withDuring the IPO,three months ended September 30, 2022, the Company entered into new compensation plans. See Note 19 — Subsequent Events included in these condensed consolidated financial statementsdetermined that it is no longer probable that the target performance conditions will be achieved for more information regarding the adoption ofcertain awards granted under the Omnibus Incentive Plan during the three months ended March 31, 2022. Accordingly, the Company reversed $1.8 million of previously recognized stock-based compensation expense and no stock-based compensation expense was recognized in the Employee Stock Purchasecurrent period for these awards.
The Company granted 1,167,199 options during the nine months ended September 30, 2022 under the Omnibus Incentive Plan, in connection with a weighted-average grant date fair value of $5.14 calculated using the IPO.Black-Scholes option valuation model. For options under the Omnibus Incentive Plan outstanding and unvested as of September 30, 2022, the Company expects to recognize future compensation expense of $14.2 million over a weighted average remaining vesting period of 2.70 years.
The Company granted 1,134,464 RSUs with a weighted-average grant date fair value of $15.30 per share during the nine months ended September 30, 2022 under the Omnibus Incentive Plan. For RSUs outstanding and unvested
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
17. Members' Equityas of September 30, 2022, the Company expects to recognize future compensation expense of $11.5 million over a weighted average remaining vesting period of 2.99 years.
For the three and nine months ended September 30, 2022, compensation expense associated with these awards totaled $0.3 million and $0.4 million, respectively.
Employee Stock Purchase Plan
The first offering period for the Company’s Employee Stock Purchase Plan (“ESPP”) began on May 20, 2022 and will continue for six months until the purchase date on November 19, 2022. Thereafter, offerings will begin on November 20 and May 20 and will end on the following May 19 and November 19, respectively. Such shares will be purchased at an amount equal to 85% of the fair market value of a share on (i) the purchase date or (ii) the offering date, whichever amount is lower; provided, that the purchase price will in no event be less than the par value of a share.
The Company recognized $0.1 million and $0.2 million of stock-based compensation expense related to the ESPP during the three and nine months ended September 30, 2022, respectively. As of September 30, 2021 and prior2022, total unrecognized compensation expense related to the Corporate Conversion, outstanding equity interests in the Company consisted onlyESPP was $0.1 million, which will be recognized on a straight-line basis over a weighted-average remaining period of Class A Units, as defined in the operating agreement of the Company (“Operating Agreement”), and outstanding equity-based compensation awards consisted only of options exercisable for Class A Units. The rights, powers, duties, obligations, and liabilities of the Company’s members as holders of the Company’s Class A Units (“Members”) are set forth in the Operating Agreement. Under the Operating Agreement, distributions, if any, were to be made to Members, at such times as the Company’s board of managers determined, pro rata in accordance with their respective ownership of Class A Units. In conjunction with the Corporate Conversion in October 2021, all of the Company’s outstanding equity interests were converted into shares of common stock. See Note 19 — Subsequent Events included in these condensed consolidated financial statements for more information about the Corporate Conversion.0.14 years.
18.17. Earnings Per UnitShare
Basic net income (loss) per unitshare (“EPU”EPS”) is computed by dividing net income (loss) by the weighted-average number of outstanding Class A units.shares during the period.
The weighted average outstanding Class A unitsshares may include potentially dilutive units. Atoptions. Diluted net income (loss) per share includes the effects of potentially dilutive awards. For the three and nine months ended September 30, 2020, 3,927,3592022, there were 6,630,588, and 6,799,424 potentially dilutive optionsawards, respectively, which were excluded from the calculations of diluted EPUEPS because including them would have had an anti-dilutive effect. For the three and nine months ended September 30, 2021, there were 3,927,359 potentially dilutive awards, which were excluded from the calculation of diluted EPS because including them would have had an anti-dilutive effect.
Basic and diluted EPU for the three and nine months ended September 30, 2021 and 2020 were:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended
September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands, except unit and per unit data) |
| Numerator: | | | | | | | |
| Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | |
| Denominator: | | | | | | | |
| Weighted average units outstanding - basic | 57,168,291 | | 57,168,291 | | 57,168,291 | | 57,168,291 |
| Effect of dilutive options | 30,913 | | | — | | | — | | | — | |
| Weighted average units outstanding - diluted | 57,199,204 | | 57,168,291 | | 57,168,291 | | 57,168,291 |
| | | | | | | |
| Net income (loss) per unit: | | | | | | | |
| Basic | $ | 0.13 | | | $ | (0.47) | | | $ | (0.15) | | | $ | (1.28) | |
| Diluted | $ | 0.13 | | | $ | (0.47) | | | $ | (0.15) | | | $ | (1.28) | |
19. Subsequent Events
The following material events occurred subsequent to September 30, 2021.
Initial Public Offering
On November 2, 2021, the Company completed the initial public offering of its common stock. See Note 1 — Organization, Basis of Presentation and Consolidation, and Significant Accounting Policies included in these condensed consolidated financial statements for more information about the IPO.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Corporate Conversion
Basic and Stock Split
In preparationdiluted EPS for its IPO, on October 15,the three and nine months ended September 30, 2022 and 2021 the Company converted into a Delaware corporation and changed its name to HireRight Holdings Corporation, and on October 18, 2021, HireRight Holdings Corporation effected a one-for-15.969236 reverse stock split.were:
Use of Proceeds
On November 3, 2021, the Company used approximately $215.0 million of the net proceeds from the IPO to repay, in full, indebtedness under the Second Lien Term Loan Facility. In addition, the Company recorded a $3.4 million write off of unamortized deferred financing fees and unamortized original issue discounts related to the repayment of debt under the Second Lien Term Loan Facility.
Income Tax Receivable Agreement
In connection with the Company’s IPO during the fourth quarter of 2021, the Company entered into the TRA, which provides for the payment by the Company over a period of approximately 12 years to pre-IPO equityholders or their permitted transferees of 85% of the benefits, if any, that the Company and its subsidiaries realize, or are deemed to realize (calculated using certain assumptions) in U.S. federal, state, and local income tax savings as a result of the utilization (or deemed utilization) of certain existing tax attributes. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year. Actual tax benefits realized by the Company may differ from tax benefits calculated under the TRA as a result of the use of certain assumptions in the TRA, including assumptions relating to state and local income taxes, to calculate tax benefits. The Company will record an estimated total liability of approximately $209.9 million and a reduction to Additional paid-in capital of approximately $209.9 million in connection with the TRA during the fourth quarter of 2021 on its condensed consolidated balance sheets.
Employee Stock Purchase Plan
On October 18, 2021, the Company’s stockholders adopted the Company’s Employee Stock Purchase Plan (the “ESPP”), which became effective on October 28, 2021. The Company initially reserved 1,587,810 shares of common stock for future issuance under the ESPP, subject to an annual increase on the first day of each calendar year, beginning on January 1, 2022 and ending on and including January 1, 2031. The annual increase is equal to the least of (i) 1% of the aggregate number of shares of common stock outstanding on the final day of the immediately preceding calendar year, (ii) 1,587,810 shares of common stock, and (iii) such smaller number of shares as determined by the board of directors. No offering periods under the ESPP had been initiated as of September 30, 2021.
Omnibus Incentive plan
On October 18, 2021, the Company’s stockholders adopted the Company’s 2021 Omnibus Incentive Plan (the “Omnibus Incentive Plan”). The Omnibus Incentive Plan was approved by the Company’s stockholders on October 18, 2021 and became effective on October 15, 2021. Upon the adoption of the Omnibus Incentive Plan, the Company will not grant further awards under the Equity Plan. The Omnibus Incentive Plan provides for the grant of awards of non-qualified stock options, incentive (qualified) stock options, stock appreciation rights, restricted stock awards, restricted stock units, other stock-based awards, other cash-based awards or any combination of the foregoing to eligible employees, consultants, directors, and officers. The Omnibus Incentive Plan has a term of 10 years. Pursuant to the Omnibus Incentive Plan, the Company has reserved an aggregate of 7,939,051 shares of the Company’s common stock for issuance of awards to be granted thereunder, subject to an annual increase equal to the lesser of (a) 4% of the aggregate number of shares of common stock outstanding on the final day of the immediately preceding calendar year and (b) such smaller number of shares as is determined by our board of directors. No more than 7,939,051 shares of the Company’s common stock may be issued pursuant to the exercise of incentive stock options granted under the Omnibus Incentive Plan.
HireRight Holdings Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
IPO Equity Grants
In October 2021, the Company's board of directors granted 1,035,986 equity awards to certain named executive officers under the Omnibus Incentive Plan. The total dollar amount of equity awards granted to the named executive officers was $9,250,000, $4,625,000 of which was granted in the form of options to purchase shares of the Company’s common stock and $4,625,000 of which was granted in the form of Restricted Stock Units (“RSUs”) covering shares of the Company’s common stock. The options will vest with respect to 25% of the underlying shares on the first anniversary of their grant date, and with respect to the remaining 75% of the underlying shares in 12 equal quarterly installments thereafter.The RSUs will vest in four installments, each with respect to 25% of the underlying shares, on November 15, 2022, November 15, 2023, November 15, 2024, and November 15, 2025. Each equity award is subject to the terms and conditions of the Omnibus Incentive Plan and an award agreement with the applicable grantee.
In addition to the awards to certain named executive officers, the Company granted equity awards to approximately 106 employees in senior leadership positions.These awards are structured like the executive officer awards, except that some individuals’ awards will be divided 75% RSUs and 25% options. The aggregate equity awards issued consisted of 436,375 RSUs and 1,142,308 options to purchase shares of the Company’s common stock. Further, the Company granted equity awards to the Company’s eight non-employee directors.The aggregate of the non-employee director awards granted was 34,736 equity awards, entirely in the form of RSUs. The equity awards for the Company’s 8 non-employee directors shall, subject to continued service, vest on the first anniversary of the date of their issuance, or if earlier, upon (but effective immediately prior to) the occurrence of a change in control as defined in the governing plan, or the annual meeting of stockholders next following the grant of such annual equity awards.
Revolving Credit Facility
On November 5, 2021, the Company repaid the $10.0 million outstanding principal amount on the Revolving Credit Facility.
Legal Settlement Payment
On November 15, 2021, the Company paid $11.2 million of the $12.1 million legal settlement agreement discussed in Note 13 — Legal Proceedings and expects to pay the balance by the end of 2021. | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands, except share and per share data) |
| Numerator: | | | | | | | |
| Net income (loss) | $ | 93,289 | | | $ | 7,281 | | | $ | 129,299 | | | $ | (8,337) | |
| Denominator: | | | | | | | |
| Weighted average shares outstanding - basic | 79,459,633 | | 57,168,291 | | 79,419,725 | | 57,168,291 |
| Effect of dilutive options | 83,082 | | | 30,913 | | | 56,849 | | | — | |
| Weighted average shares outstanding - diluted | 79,542,715 | | 57,199,204 | | 79,476,574 | | 57,168,291 |
| | | | | | | |
| Net income (loss) per share: | | | | | | | |
| Basic | $ | 1.17 | | | $ | 0.13 | | | $ | 1.63 | | | $ | (0.15) | |
| Diluted | $ | 1.17 | | | $ | 0.13 | | | $ | 1.63 | | | $ | (0.15) | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of the financial condition and results of operations for HireRight together with our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements for the fiscal year ended December 31, 2021, as disclosed in the Company’s prospectus, dated October 28, 2021,Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) in accordance with Rule 424(b) of the Securities Act on November 1, 2021 (the “Prospectus”) in connection with our initial public offeringMarch 21, 2022 (“IPO”Annual Report”). See Initial Public Offering below for additional information.The statements in the following discussion and analysis regarding expectations about our future performance, liquidity and capital resources and any other non-historical statements in this discussion and analysis are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those described immediately below.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q and related statements by the Company contain forward-looking statements within the meaning of the federal securities laws that are subject to risks and uncertainties. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business.laws. You can often identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may includefacts, or by their use of words such as “anticipate,” “estimate,” “expect,” “project,” “forecast,” “plan,” “intend,” “believe,” “seek,” “could,” “targets,” “potential,” “may,” “will,” “should,” “can have,” “likely,” “continue,” and other terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. Forward-looking statements may include, but are not limited to, statements concerning our anticipated financial performance, including, without limitation, revenue, profitability, net income (loss), adjusted EBITDA, adjusted EBITDA margin, adjusted net income, earnings per unit,share, adjusted diluted earnings per share, and cash flow; strategic objectives; investments in our business, including development of our technology and introduction of new offerings; sales growth and customer relationships; our competitive differentiation; our market share and leadership position in the industry; market conditions, trends, and opportunities; future operational performance; pending or threatened claims or regulatory proceedings; and factors that could affect these and other aspects of our business. These
Forward-looking statements are not guarantees of future performance; theyguarantees. They reflect our current viewsexpectations and projections with respect to future events and are based on assumptions and estimates and subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from expectations or results projected or implied by forward-looking statements. These risks include the following, as well as other risks and uncertainties not listed here that may be important to you.
•We have no assuranceFactors that could affect the outcome of future business from anythe forward-looking statements include, among other things, our vulnerability to adverse economic conditions, including without limitation inflation and recession, which could increase our costs and suppress labor market activity and our revenue; the aggressive competition we face; our heavy reliance on information management systems, vendors, and information sources that may not perform as we expect; the significant risk of liability we face in the services we perform; the fact that data security, data privacy and data protection laws, emerging restrictions on background reporting due to alleged discriminatory impacts and adverse social consequences, and other evolving regulations and cross-border data transfer restrictions may increase our costs, limit the use or value of our customers;
•We rely upon third parties for the data we need to deliver our services;
•We rely upon third parties to fulfill our service obligations to our customers;
•We rely upon third parties for integration with many of our customers;
•Third parties are the sole available source for some of the dataservices and services upon which we rely;
•We intend to rely, in part, on acquisitions to help grow our business, and such acquisitions may not produce the benefits we expect or may adversely affect or disrupt our business;
•We must attract, motivate, train, and retain the management, technical, market-facing, and operational personnel we need to enable the success and growth of our business;
•COVID-19 has had, and may continue to have, a materially adverse effect on our business;
•Forecasts of market growth may prove to be inaccurate, and even if the market in which we compete achieves the forecasted growth, our business may not grow at similar rates, if at all;
•Our operating results may fluctuate significantly, be difficult to predict, and fall below analysts' and investors' expectations;
•Significant governmental regulation exposes us to substantial costs and liabilities and can limit our business opportunities;
•Current or potential legal proceedings could subject us to significant monetary damages or restrictions on our ability to do business;
•Credit reporting laws that regulatemaintain our professional reputation and brand name; the impacts, direct and indirect, of the COVID‐19 pandemic on our business, impose significant operational requirementsour personnel and liability risks;
•Domesticvendors, and international data privacy laws impose significant operational requirementsthe overall economy; social, political, regulatory and liability risks;
•We can incur significant liability for information thatlegal risks in markets where we omit in background reports;
•We may be subject tooperate; the impact of foreign currency exchange rate fluctuations; unfavorable tax law changes and in violation of state private investigator licensing laws and regulations;
•We are subject to government regulations concerning our employees, including wage-hour laws and taxes;
•We may be subject to intellectual property rights claims by third parties;
•Our contractual indemnities, limitations of liability, and insurance may not adequately protect us;
•Liabilities we incur in the coursetax authority rulings; any impairment of our business may be uninsurable, or insurance may be very expensive and limited in scope;
•Security breaches and improper use of information may negatively impact our business and harm our reputation;
•System failures could delay and disrupt our services, cause harm to our business and reputation and result in a loss of customers;
•If we fail to upgrade, enhance and expand our technology and services to meet customer needs and preferences, the demand for our services may materially diminish;
•Our technology development operations are centered in Estonia, exposing us to risks that may be difficult to manage;
•If we are unable to protect our proprietary technologygoodwill, other intangible assets and other intellectual property rights, it may reducelong-lived assets; our ability to compete for businessexecute and we may experience reduced revenue and incur costly litigation to protect our rights;
•Changes to the availability and permissible uses of consumer data may reduce the demand for our services;
•We operate in an intensely competitive market and we may not be able to develop and maintain competitive advantages necessary to support our growth and profitability;
•Growth will require us to improve our operating capabilities;
•Our business is vulnerable to economic downturns;
•If we do not introduce successful new products, services and analytical capabilities in a timely manner, or if the market does not adopt our new services, our competitiveness and operating results will suffer;
•Our existing indebtedness could adversely affect our business and growth prospects;
•The terms and conditions of our credit agreements restrict our current andintegrate future operations, particularlyacquisitions; our ability to respond to changesaccess additional credit or to take certain actions;
•We may not be able to generate sufficient cash flow to service allother sources of our indebtedness,financing; and may be forced to take other actions to satisfy our obligations under such indebtedness, including refinancing such indebtedness, which may not be successful;
•Inability to obtain financing could limit our ability to conduct necessary operating activitiesthe increased cybersecurity requirements, vulnerabilities, threats and make strategic investments;
•Failure to successfully execute our international plans will adversely affect our growthmore sophisticated and operating results;
•Operating in multiple countries requires us to comply with different legal and regulatory requirements;
•We are subject to governmental export and import controlstargeted cyber-related attacks that could subject uspose a risk to liability or impair our ability to compete in international markets;
•Fluctuations insystems, networks, solutions, services and data. For more information on the exchange rates of foreign currencies could result in currency transaction losses;
•Investment funds managed by General Atlanticbusiness risks we face and investment funds managed by Stone Point (together, the “Principal Stockholders”) control us, and their interests may conflict with ours or yours in the future;
•We are an “emerging growth company,” and we expect to elect to comply with reduced public company reporting requirements, which could make our common stock less attractive to investors;
•The requirements of being a public company strain our resources and distract our management, which could make it difficult to manage our business;
•Failure to maintain effective internal controls over financial reporting could cause our investors to lose confidence in us and adversely affect the market price of our common stock. If our internal control over financial reporting is not effective, we may not be able to accurately report our financial results or prevent fraud;
•We have identified material weaknesses in our internal control over financial reporting and may identify additional material weaknesses in the future or otherwise fail to maintain effective internal control over financial reporting, which may result in material misstatements of our consolidated financial statements or cause us to fail to meet our periodic reporting obligations.
•Provisions of our corporate governance documents could make an acquisition of us more difficult and may prevent attempts by our stockholders to replace or remove our current management;
•Our certificate of incorporation limits the forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees;
•We will be required to pay certain pre-IPO owners or their transferees for certain tax benefits over a period of approximately 12 years pursuant to the income tax receivable agreement (the “TRA”), which amounts to an estimated total liability of approximately $209.9 million. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year;
•We will not be reimbursed for any payments made to certain pre-IPO owners (or their transferees or assignees) under the TRA in the event that any tax benefits are disallowed;
•In certain cases, payments under the TRA to certain pre-IPO owners or their transferees may be accelerated or significantly exceed any actual benefits we realize in respect of the tax attributes subject to the TRA;
•We may have exposure to greater than anticipated tax liabilities and may be affected by changes in tax laws or interpretations;
•The multinational nature of our business can expose us to unexpected tax consequences, which may be adverse;
•We may be subject to examinations of our tax returns by the IRS or other tax authorities, and an adverse outcome could have a material adverse effect on our business;
•An active, liquid trading market for our common stock may not develop, which may constrain the market price of our common stock and limit your ability to sell your shares;
•Our operating results and stock price may be volatile, and the market price of our common stock may drop below the price you pay;
•Future sales of substantial amounts of our common stock, or the possibility that such sales could occur, could adversely affect the market price of our common stock;
•You may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it;
•Our stock price and trading volume could decline due to the action or inaction of securities or industry analysts;
•Our equity-based compensation and acquisition practices expose our stockholders to dilution;
•We could be negatively affected by actions of activist stockholders;
•We may issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of our common stock.
All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are qualified in their entirety by these cautionary statements as well as other cautionary statements that are made from time to time in our other filings with the Securities and Exchange Commission (SEC) and public communications. We discuss many of these risks and additional factors that could cause actual results to differ materially from those anticipated by ouraffect the outcome of forward-looking statements, underrefer to our Annual Report on Form 10-K filed with the headingsSEC on March 21, 2022, in particular the sections of that document entitled "Risk Factors"Factors," "Forward-Looking Statements," and "Management's Discussion and Analysis of Financial Condition and Results of Operations,"” and elsewhere in the Prospectus, this Quarterly Report on Form 10-Q, and in other filings we have made and will make from time to time with the Securities and Exchange Commission. These forward-looking statements represent our estimates and assumptions only as of the date made. Unless required by federal securities laws, we assumeSEC. We undertake no obligation to update publicly any of these forward-looking statements, whether as a result of new information, future events or to update the reasons actual results could differ materially from those anticipated, to reflect circumstances or events that occur after the statements are made. Without limiting the foregoing, any guidance we may provide will generally be given only in connection with quarterly and annual earnings announcements, without interim updates, and we may appear at industry conferences or make other public statements without disclosing material nonpublic information in our possession. Given these uncertainties, investors should not place undue reliance on these forward-looking statements.otherwise.
Investors should read this Quarterly Report on Form 10-Q and the documents that we reference in this report and have filed or will file with the SEC completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.
Business Overview
HireRight is a leading global provider of technology-driven workforce risk management and compliance solutions. We provide comprehensive background screening, verification, identification, monitoring, and drug and health screening services for more than 40,000approximately 39,000 customers across the globe. We offer our services via a unified global software and data platform that tightly integrates into our customers’ human capital management (“HCM”) systems enabling highly effective and efficient workflows for workforce hiring, onboarding, and monitoring. In 2020,2021, we
delivered reports on screened over 2029 million job applicants, employees and contractors for our customers and processed over 80110 million screens.
HireRight GIS Group Holdings LLC (“HGGH”), was formed in July 2018 throughin connection with the combination of two groups of companies,companies: the HireRight Group and the GIS GroupGeneral Information Services (“GIS”), Group, each of which includes a number of wholly ownedwholly-owned subsidiaries that conduct the Company’s business withinin the United States, of America ( the “U.S.”), as well as countries outside the U.S.other countries. Since July 2018, the combined group of companies and their subsidiaries have operated as a unified operating company providing background screens globally,screening and compliance services, predominantly under the HireRight brand.
On October 15, 2021, HGGH converted into a Delaware corporation and changed its name to HireRight Holdings Corporation (“HireRight” or the “Company”). In conjunction with the conversion, all of HGGH’s outstanding equity interests were converted into shares of common stock of HireRight Holdings Corporation. The foregoing conversion and related transactions are referred to herein as the “Corporate Conversion”.Conversion.” The Corporate Conversion did not affect the assets and liabilities of HGGH, which became the assets and liabilities of HireRight Holdings Corporation.
Initial Public Offering
On November 2, 2021, the Company completed its IPO in which the Company issued and sold 22,222,222 shares of its common stock, $0.001 par value per share at an offering price of $19.00 per share. The Company received net proceeds of $393.5 million, after deducting underwriting discounts and commissions of $23.2 million and other offering costs payable by the Company of approximately $5.5 million. The Company granted the underwriters an option for a period of 30 days to purchase up to an additional 3,333,333 shares of common stock at $19.00 per share less discounts and commissions. The underwriters have until November 27, 2021 to exercise their option to purchase additional shares.
Use of Proceeds
On November 3, 2021, the Company used approximately $215.0 million of the net proceeds from the IPO to repay, in full, indebtedness under the Second Lien Term Loan Facility. In addition, the Company recorded a $3.4 million write off of unamortized deferred financing fees and unamortized original issue discounts related to the repayment of debt under the Second Lien Term Loan Facility. The Company plans to use approximately $100.0 million of proceeds of the IPO to repay, in part, the First Lien Term Loan Facility and no longer expects to incur swap breakage fees of approximately $4.2 million.
Factors Affecting Our Results of Operations
Economic Conditions
Our business is impacted by the overall economic environment and COVID-19total employment and hiring. The rapidly changing dynamics of the global workforce are creating increased complexity and regulatory scrutiny for employers, bolstering the importance of the solutions we deliver. We have benefited from key demand drivers, which increase the need for more flexible, comprehensive screening and hiring solutions in the current environment. Our customers are a diverse set of organizations, from large-scale multinational businesses to small and medium businesses across a broad range of industries, including transportation, healthcare, technology, financial services, business and consumer services, manufacturing, education, retail and not-for-profit. Hiring requirements and regulatory considerations can vary significantly across the different types of customers, geographies and industry sectors we serve, creating demand for the extensive institutional knowledge we have developed from our decades of experience.
The global COVID-19 pandemic has caused significant disruption toWhile we have benefited from the global economy and, in particular,changing dynamics of the labor market. There is considerablemarket as well as a strong hiring environment, there continues to be uncertainty regardingaround the extentnear term macroeconomic environment. This uncertainty stems from high inflation, volatile energy prices, rising interest rates, geopolitical concerns, supply chain disruptions and labor shortages. Each of thethese drivers has its own adverse impact and the duration ofoutlook for our business remains uncertain. Inflation puts pressure on our suppliers, resulting in increased data costs, and also increases our employment and other expenses. A sustained recession will have an adverse impact on the global COVID-19 pandemic. Thehiring market and therefore the demand for our services. Slowing demand for our services will adversely affect our future results. Additionally rising interest rates will lead directly to higher interest expense. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk — Inflation Risk” for additional information on the impact of COVID-19inflation on our operational and financial performance will depend onbusiness. Although the effect on our customers and vendors, all of which continue to be uncertain at this time. Our financial results and prospects are largely dependent on the number of hires and the total level of employment. Unemployment in our primary market, the US, reached nearly 15% during the peak of the 2020 pandemic and monthly hiring slowed to less than 4 million in April 2020 according to the Bureau of Labor Statistics.
Our results of operations for the three and nine months ended September 30, 2021 show a significant increase from the prior year period, due to improvement in the global employment market. The peak of the pandemic impact occurred during April and May of 2020, and we began to see a steady recovery in the second half of the year. The weakness experienced in the first half of 2020 and the associated recovery largely impacted all industries we serve. We are a highly diversified business with no industry representing more than 15%majority of our total revenue. Transportation, healthcarecost of services are variable in nature and technology customers represent the largest contributorswill move in tandem with revenue increases or decreases, there can be no assurance that we can reduce our cost of services in proportion to revenue. Transportation
changes in revenue. The Company has taken steps to continue to improve its profitability, including the impact of lowering interest expense through the voluntary repayment of debt.
The Company’s net U.S. federal and healthcare annual revenues declinedstate deferred tax assets were previously fully offset by a valuation allowance, excluding a portion of its deferred tax liabilities for tax deductible goodwill, primarily as a result of the Company’s lack of U.S. earnings history and cumulative loss position. The Company prepares a quarterly analysis of its deferred tax assets which considers positive and negative evidence, including its cumulative income (loss) position, revenue growth, continuing and improved profitability, and expectations regarding future profitability. Although the Company believes its estimates are reasonable, the ultimate determination of the appropriate amount of valuation allowance involves significant judgment.
Even though there are factors creating uncertainty in conjunctionthe future financial results of the business as described above, the Company determined sufficient positive evidence existed to conclude that the U.S. deferred tax assets are more likely than not realizable. As a result, the Company released the valuation allowance attributed to the deferred tax assets associated with overall revenue declines while technology showed limited growth largely driven by the addition of two larger customersCompany’s operations in the U.S. during the year.three months ended September 30, 2022. In making the determination to release the valuation allowance, the Company considered its movement into a cumulative income position for the most recent three-year period, the significant decrease in its interest expense from the paydown of debt in the fourth quarter of 2021 using IPO proceeds, its seventh consecutive quarter of operating income, forecasts of future earnings for its U.S. operations, and other factors. The release of the valuation allowance resulted in a non-cash deferred tax benefit of $70.2 million, which materially decreased the Company’s income tax expense during the three months ended September 30, 2022.
In response
2022 Developments
On June 3, 2022, the Company entered into an amendment to its First Lien Term Loan Facility, as defined below under “Liquidity and Capital Resources”, (“Amended First Lien Term Loan Facility”) with the pandemic, in early 2020, we implemented additional operational processes to monitor customer saleslenders party thereto and collections, taking precautionary measures to ensure sufficient liquidity and adjusting operations to ensure business continuity, including borrowing $50 million against our $100 millionBank of America, N.A. as administrative agent. The Amended First Lien Term Loan Facility amended the Company’s revolving credit facility (“Amended Revolving Credit Facility”) to increase the aggregate commitments under the facility from $100.0 million to $145.0 million and extend the maturity date from July 12, 2023 to the earlier of which $40June 3, 2027 or 91 days prior to the maturity of the First Lien Term Loan Facility. The interest rate benchmark applicable to the Amended Revolving Credit Facility was converted from the London Interbank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”).
Effective February 18, 2022, the Company terminated the Interest Rate Swap Agreements, as defined below, prior to their stated termination dates. In connection with the termination of the Interest Rate Swap Agreements, the Company made a payment of $18.4 million was repaid byto the swap counterparties. Following these terminations, $21.5 million of unrealized gains related to the terminated Interest Rate Swap Agreements included in accumulated other comprehensive income (loss) on the condensed consolidated balance sheet will be reclassified to earnings as reductions to interest expense through December 31, 2020. Since April 2020, substantially all of our employees have been working from home. To the extent we are operating from our facilities, we have implemented protocols reflecting the recommendations published by the U.S. Centers2023. See “Liquidity and Capital Resources — Interest Rate Swaps” below for Disease Control, the World Health Organization and country, state and local governments.additional information.
Key Components of Our Results from Operations
Revenues
The Company generates revenues from background screening and compliance services delivered in online reports. Our customers place orders for our services and reports either individually or through batch ordering. Each report is accounted for as a single order which is then typically consolidated and billed to our customers on a monthly basis. Approximately 29% and 30%28% of revenues for each of the three and nine months ended September 30, 20212022 and 2020,32% and 29% of revenues for the three and nine months ended September 30, 2021, respectively, were generated from the Company’s top 50 customers, which consist of large U.S. and multinational companies across diversified industries such as transportation, healthcare, technology, financial services, business and consumer services, financial services, manufacturing, education, retail and not-for-profit. None of the Company’s customers individually accounted for greater than 5% and 6%3% of revenues during each of the three and nine months ended September 30, 20212022, and 2020, respectively.
Revenues consist of service revenues and surcharge revenues. Service revenues represent fees charged to customers for performing screening and compliance services. Surcharge revenues consist of fees charged to customers for obtaining data required to fulfill the Company’s performance obligations from federal, state and local jurisdictions as well as fees charged by certain commercial data wholesalers. These fees are predominantly charged to the Company’s customers at cost. Revenue is recognized when the Company satisfies its obligation to complete the service and delivers the screening report to the customer. The Company relies on service revenue to generate cash from operations. Furthermore, only service revenue impacts the operating income or loss as surcharge revenue is predominantly offset by corresponding expenses recognized in cost of services (excluding depreciation and amortization) on the condensed consolidated statement of operations.
5% of revenues during each of the three and nine months ended September 30, 2021. Technology, healthcare, financial services, and transportation customers represent the largest contributors to revenues. Revenues for the three and nine months ended September 30, 2022, from these customers increased 5% and 24%, respectively, over the prior year periods.
Expenses
Cost of services (excluding depreciation and amortization) consists of data acquisition costs, medical laboratory and collection fees, personnel-related costs for operations, customer service and customer onboarding functions, as well as other direct costs incurred to fulfill our services. Approximately 80% of cost of services is variable in nature.
Selling, general and administrative expenses consist of personnel-related costs for sales, technology, administrative and corporate management functions in addition to costs for third-party technology, professional and consulting services, advertising and facilities expenses. Selling, general and administrative expenses also include amortization of capitalized cloud computing software costs.
Depreciation and amortization expenses consist of depreciation of property and equipment, as well as amortization of purchased and developed software and other intangible assets, principally resulting from the acquisition of GIS in 2018.
Other expenses consist of interest expense relating to our credit facilities and interest rate swap agreements, gains and losses on asset disposal, foreign exchange gains and losses, as well as other expenses. The majority of our receivables and payables are denominated in U.S. dollars, but we also earn revenue, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the Euro, the British pound, the Polish zloty, the Australian dollar, the Canadian dollar, the Singapore dollar, the Mexican peso, the Japanese yen, and the Indian rupee, among others. Therefore, increases or decreases in the value of the U.S. dollar against other currencies could result in realized and unrealized gains and losses in foreign exchange. However, to the extent we earn revenue in currencies other than the U.S. dollar, we generally pay a corresponding amount of expenses in such currency and therefore the cumulative impact of these foreign exchange fluctuations is not generally deemed material to our financial performance.
Income tax expense consists of international, U.S. federal, state and local income taxes based on income in multiple jurisdictions for our subsidiaries.
Results of Operations
Comparison of Results of Operations for the three and nine months ended September 30, 20212022 and 20202021
The following table presentstables present operating results for the three and nine months ended September 30, 20212022 and 2020.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands) |
| Revenues | $ | 204,981 | | | $ | 130,674 | | | $ | 531,522 | | | $ | 390,121 | |
| | | | | | | |
| Expenses | | | | | | | |
| Cost of services (exclusive of depreciation and amortization below) | 111,328 | | | 69,683 | | | 295,832 | | | 215,143 | |
| Selling, general and administrative | 47,652 | | | 48,347 | | | 130,261 | | | 128,583 | |
| Depreciation and amortization | 19,531 | | | 19,808 | | | 56,013 | | | 58,283 | |
| Total expenses | 178,511 | | | 137,838 | | | 482,106 | | | 402,009 | |
| Operating income (loss) | 26,470 | | | (7,164) | | | 49,416 | | | (11,888) | |
| | | | | | | |
| Other expenses | | | | | | | |
| Interest expense | 18,518 | | | 18,597 | | | 54,674 | | | 56,930 | |
| Other expense (income), net | 22 | | | (185) | | | 125 | | | 628 | |
| Total other expense | 18,540 | | | 18,412 | | | 54,799 | | | 57,558 | |
| Income (loss) before income taxes | 7,930 | | | (25,576) | | | (5,383) | | | (69,446) | |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | |
| Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands) |
| Revenues | | | |
| Service revenues | $ | 152,332 | | | $ | 98,587 | | | $ | 395,624 | | | $ | 294,175 | |
| Surcharge revenues | 52,649 | | | 32,087 | | | 135,898 | | | 95,946 | |
| Total revenues | $ | 204,981 | | | $ | 130,674 | | | $ | 531,522 | | | $ | 390,121 | |
Revenues
Three months ended
Total revenues increased by $74.3 million, or 56.9%, to $205.0 million, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. We continued to see a recovery from the impact of COVID-19, with strengthening client volumes surpassing the COVID-impacted prior year period. The increase in total revenues was broad-based primarily across existing customers, while new business revenue, as defined below, increased from $9.4 million to $10.9 million, driven by sales to a recently acquired large customer. Service revenues2021.
increased $53.7 million, or 54.5%, and surcharge revenues increased $20.6 million, or 64.1%, compared to the three months ended September 30, 2020. Revenues from international and domestic regions increased by $8.2 million, or 106.1% and by $66.1 million, or 53.8%, respectively, during the three months ended September 30, 2021 compared to the three months ended September 30, 2020. Both service and surcharge revenue increases were primarily volume driven. Also contributing to the increases in surcharge revenues were increases in data supplier costs, which are charged to our customers in the form of increased surcharges. | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, |
| 2022 | | 2021 |
| (in thousands, except percent of revenues) |
| Revenues | $ | 210,303 | | | 100.0 | % | | $ | 204,981 | | | 100.0 | % |
| | | | | | | |
| Expenses | | | | | | | |
| Cost of services (exclusive of depreciation and amortization below) | 110,848 | | | 52.7 | % | | 111,328 | | | 54.3 | % |
| Selling, general and administrative | 49,378 | | | 23.5 | % | | 47,652 | | | 23.2 | % |
| Depreciation and amortization | 17,946 | | | 8.5 | % | | 19,531 | | | 9.5 | % |
| Total expenses | 178,172 | | | 84.7 | % | | 178,511 | | | 87.1 | % |
| Operating income | 32,131 | | | 15.3 | % | | 26,470 | | | 12.9 | % |
| | | | | | | |
| Other expenses | | | | | | | |
| Interest expense | 8,457 | | | 4.0 | % | | 18,518 | | | 9.0 | % |
| Other expense, net | 89 | | | — | % | | 22 | | | — | % |
| Total other expenses, net | 8,546 | | | 4.1 | % | | 18,540 | | | 9.0 | % |
| Income before income taxes | 23,585 | | | 11.2 | % | | 7,930 | | | 3.9 | % |
| Income tax (benefit) expense | (69,704) | | | (33.1) | % | | 649 | | | 0.3 | % |
| Net income | $ | 93,289 | | | 44.4 | % | | $ | 7,281 | | | 3.6 | % |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Nine months ended | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2022 | | 2021 |
| (in thousands, except percent of revenues) |
| Revenues | $ | 631,306 | | | 100.0 | % | | $ | 531,522 | | | 100.0 | % |
| | | | | | | |
| Expenses | | | | | | | |
| Cost of services (exclusive of depreciation and amortization below) | 343,241 | | | 54.4 | % | | 295,832 | | | 55.7 | % |
| Selling, general and administrative | 152,032 | | | 24.1 | % | | 130,261 | | | 24.5 | % |
| Depreciation and amortization | 54,056 | | | 8.6 | % | | 56,013 | | | 10.5 | % |
| Total expenses | 549,329 | | | 87.0 | % | | 482,106 | | | 90.7 | % |
| Operating income | 81,977 | | | 13.0 | % | | 49,416 | | | 9.3 | % |
| | | | | | | |
| Other expenses | | | | | | | |
| Interest expense | 20,971 | | | 3.3 | % | | 54,674 | | | 10.3 | % |
| Other expense, net | 163 | | | — | % | | 125 | | | — | % |
| Total other expenses, net | 21,134 | | | 3.3 | % | | 54,799 | | | 10.3 | % |
| Income (loss) before income taxes | 60,843 | | | 9.6 | % | | (5,383) | | | (1.0) | % |
| Income tax (benefit) expense | (68,456) | | | (10.8) | % | | 2,954 | | | 0.6 | % |
| Net income (loss) | $ | 129,299 | | | 20.5 | % | | $ | (8,337) | | | (1.6) | % |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Total revenues increased by $141.4 million, or 36.2%, to $531.5 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, primarily due to increases in volume, which surpassed the COVID-impacted prior year period. Revenues from international and domestic regions increased $13.8 million, or 52.4% and by $127.6 million, or 35.1%, respectively, during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. Service revenues increased $101.4 million, or 34.5%, and surcharge revenues increased $40.0 million, or 41.6% compared to the prior year period. While growth was primarily volume driven, a portion of the increase in surcharge revenues was due to data supplier cost increases, which are charged to our customers in the form of increased surcharges.
Cost of Services (exclusive of depreciation and amortization below)
Three months ended
Cost of services increased $41.6 million, or 59.8%, to $111.3 million,Revenues for the three months ended September 30, 2021 compared to the three months ended September 30, 2020 primarily due to higher client order volumes over the COVID- impacted prior year period. Cost of services as a percent of revenue2022 increased to 54.3% for$210.3 million, an increase of $5.3 million, or 2.6%, from the three months ended September 30, 2021 compared to 53.3% for the three months ended September 30, 2020prior-year period, primarily driven by increased third-party data costs.
Nine months ended
Cost of services increased $80.7 million, or 37.5%, to $295.8 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to higher volumes and, to a lesser extent, increased data costs. Cost of services as a percent of revenue increased slightly to 55.7% for the nine months ended September 30, 2021 compared to 55.1% for the nine months ended September 30, 2020 primarily driven by increased third-party data costs.
Selling, General and Administrative
Three months ended
Selling, general and administrative expenses (“SG&A”) decreased $0.7 million, or 1.4% to $47.7 million, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The decrease was driven by reductions in legal settlement fees of $12.1 million and $1.9 million of other merger integration expenses during thethree months ended September 30, 2021 compared to the three months ended September 30, 2020. These decreases were mostly offset by increases in personnel costs associated with incentive compensation and fringe benefit programs of $5.5 million and investments associated with incremental technology and product resources, which amounted to $3.5 million. In addition, various other and indirect expenses increased $4.3 million during the three months ended September 30, 2021 compared to the three months ended September 30, 2020, which included $1.5 million of higher technology costs and $0.9 million associated with marketing programs to support increased business volumes.
Ninerevenues increased due to price increases. Revenues from international and United States regions increased by $0.3 million, or 2.1%, and by $5.0 million, or 2.6%, respectively, during the three months ended September 30, 2022, compared to the three months ended September 30, 2021. The strengthening of the U.S. dollar against the British pound in the three months ended September 30, 2022, compared to the same period in 2021 had an unfavorable impact on revenue from international regions. On a constant currency basis, United Kingdom revenues would have been $2.0 million higher than actual revenues. Constant currency represents current period results that have been retranslated using exchange rates in effect in the prior comparable period.
Revenues for the nine months ended September 30, 2022 increased to $631.3 million, an increase of $99.8 million, or 18.8%, from prior-year period, primarily driven by higher order volume and higher average order values associated with existing customers and sales to new customers. Revenues from international and United States regions increased by $8.5 million, or 21.1%, and by $91.3 million, or 18.6%, respectively, during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. For the same reasons noted in the preceding paragraph, on a constant currency basis, United Kingdom revenues would have been $3.5 million higher than actual revenues for the nine months ended September 30, 2022.
Cost of Services (exclusive of depreciation and amortization)
Cost of services for the three months ended September 30, 2022 decreased to $110.8 million, a decrease of $0.5 million, or 0.4%, from the prior-year period, primarily due to lower average labor costs per background screen partially offset by increased data supplier costs and increased fringe benefit programs to keep up with market conditions. Cost of services as a percent of revenues decreased to 52.7% for the three months ended September 30, 2022, compared to 54.3% for the three months ended September 30, 2021, primarily driven by lower average labor costs per background screen as a result of process improvements associated with our ongoing technology initiatives as well as an increase in the use of offshore labor.
Cost of services for the nine months ended September 30, 2022 increased to $343.2 million, an increase of $47.4 million, or 16.0%, from the prior-year period, primarily due to higher volumes and increased incentive compensation and fringe benefit programs to keep up with market conditions. For the same reasons noted in the preceding paragraph, cost of services as a percent of revenues decreased to 54.4% for the nine months ended September 30, 2022, compared to 55.7% for the nine months ended September 30, 2021.
Selling, General and Administrative
Selling, general and administrative expenses (“SG&A”) for the three months ended September 30, 2022 increased $1.7 million to $49.4 million primarily due to increases in personnel costs of $3.4 million and increases in professional service fees of $1.3 million, partially offset by a decrease in facility related expenses of $2.7 million. Of the $3.4 million increase in personnel costs, $3.2 million was related to increased salary expenses, incentive compensation and fringe benefit programs. SG&A as a percent of revenues for the three months ended September 30, 2022 increased to 23.5% from 23.2% for the three months ended September 30, 2021.
SG&A expenses for the nine months ended September 30, 2022 increased $21.8 million to $152.0 million primarily due to increases in personnel costs of $19.1 million, investments in technology of $3.3 million, and the addition of public company costs of $3.2 million. Of the $19.1 million increase in personnel costs, $5.6 million was related to stock-based compensation and $13.5 million was related to increased salary expenses, incentive compensation and fringe benefit programs. The increases were partially offset by a decrease in facility related expenses of $4.9 million. SG&A as a percent of revenues for the nine months ended September 30, 2022 decreased slightly to 24.1% from 24.5% for the nine months ended September 30, 2021.
The increases in personnel costs in both periods were attributable to responses to increases in market compensation rates, the increased use of stock-based compensation following our initial public offering in November 2021, and staffing to support growth. Our initial public offering also drove the addition of public company costs including incremental audit, accounting and legal fees as well as premiums for increased insurance coverage, which were not present in the 2021 periods but which will continue. The increases in SG&A expenses
were partially offset in each period by decreases in various other costs, including a reduction of facility expenses resulting from exiting unused office space during 2021.
Interest Expense
Interest expense decreased by $10.1 million or 1.3%, to $130.3$8.5 million for the three months ended September 30, 2022, and by $33.7 million to $21.0 million for the nine months ended September 30, 2022. The decreases in both periods were primarily due to a reduction in outstanding indebtedness under our credit facilities as a result of voluntary principal prepayments using IPO proceeds during the fourth quarter of 2021, compared toand scheduled principal repayments. Interest expense for the three and nine months ended September 30, 2020 primarily due to increases in personnel costs and other indirect costs, amounting to $19.22021 includes $4.2 million and $5.8$12.4 million, respectively, related to a second lien senior secured term loan facility which was repaid on November 3, 2021. Additionally, reclassifications from accumulated other comprehensive income (loss) on the condensed consolidated balance sheet of unrealized gains related to the terminated Interest Rate Swap Agreements, reduced interest expense by $3.4 million and $9.7 million during the three and nine months ended September 30, 2022, respectively. The decreases for the reasons noted above. These increasesthree and nine months ended September 30, 2022 were partially offset by a reduction in legal settlement fees and merger integration and employee severance expensesincreased interest expense of $12.1$3.7 million and $8.9$4.9 million, respectively. Various other costs accountedrespectively, associated with rising interest rates during those periods.
Income Tax (Benefit) Expense
The effective tax rate for $2.3 million of the offsetting decreases in SG&Athree months ended September 30, 2022, was negative 295.5% compared to 8.2% for the three months ended September 30, 2021. The effective tax rate for the nine months ended September 30, 20212022, was negative 112.5% compared to the nine months ended September 30, 2020.
Depreciation and Amortization
Three months ended
Depreciation and amortization expense decreased $0.3 million, or 1.4% to $19.5 million, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The decrease was primarily due to certain computer equipment assets reaching the end of their useful lives in the prior year.
Nine months ended
Depreciation and amortization expense decreased $2.3 million, or 3.9%, to $56.0 million,54.9% for the nine months ended September 30, 20212021. The effective tax rate for the three and nine month periods ended September 30, 2022, compared to the nine months ended September 30, 2020. The decrease wasprior year periods, changed primarily due to certain computer equipment assets reaching the endrelease of their useful livesthe federal and state valuation allowances in the prior year.
Interest Expense
Three months ended
Interest expense, net decreased $0.1 million, or 0.4% to $18.5 million, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The decrease was primarily due to lower outstanding balance due to scheduled principal repayments on the First Lien Term Loan Facility, as defined below,2022 and lower outstanding balance on the Revolving Credit Facility, as defined below. As of September 30, 2021, the balance on the Revolving Credit Facility was $10.0 million compared to $30.0 million as of September 30, 2020.
Nine months ended
Interest expense, net decreased $2.3 million, or 4.0%, to $54.7 million, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The decrease was primarily due to lower outstanding balance due to scheduled principal repayments on the First Lien Term Loan Facility, and lower outstanding balance on the Revolving Credit Facility.
Income Tax Expense
Three months ended
Income tax expense decreased $0.8 million, or 55.7%, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020 primarily due to revaluation of deferred taxes in the United Kingdom during the third quarter of 2020. Incomein 2021.
The effective tax expenserate for the three and nine months ended September 30, 20212022, differs from the Federal statutory rate of 21% primarily due to the release of federal and 2020 was $0.6 millionstate valuation allowances, state taxes, and $1.5 million, respectively.U.S. tax on foreign operations. The effective tax rate for the three months ended September 30, 2021, differs from the Federal statutory rate of 21% primarily due to valuation allowances, state taxes, and state taxes. The
rate for the three months ended September 30, 2020 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in the United Kingdom, valuation allowances, and state taxes.
Nine months ended
IncomeU.S. tax expense decreased $0.5 million, or 15.4%, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to revaluation of deferred taxes in the United Kingdom and valuation allowances. Income tax expense for the nine months ended September 30, 2021 and 2020 was $3.0 million and $3.5 million, respectively.on foreign operations. The effective tax rate for the nine months ended September 30, 2021, differs from the Federal statutory rate of 21% primarily due to the revaluation of deferred taxes in the United Kingdom, valuation allowances, and state taxes. The rate for the nine months ended September 30, 2020 differs from the Federal statutory rate of 21% primarily due to revaluation of deferred taxes in the United Kingdom, valuation allowances, and state taxes.Kingdom.
Non-GAAP Financial Measures and Key Metrics
We believe that the presentation of our Non-GAAPnon-GAAP financial measures and key metrics provides information useful to investors in assessing our financial condition and results of operations. These measures should not be considered an alternative to net income (loss) or any other measure of financial performance or liquidity presented in accordance with GAAP.accounting principles generally accepted in the United States (“GAAP”). These measures have important limitations as analytical tools because they exclude some but not all items that affect the most directly comparable GAAP measures. Additionally, because they may be defined differently by other companies in our industry, our definitions may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.
Adjusted EBITDA and Adjusted EBITDA Margin
Adjusted EBITDA represents, as applicable for the period, net income (loss) before provision forinterest expense, income taxes, interest expense and depreciation and amortization expense, equity-basedstock-based compensation, realized and unrealized gain (loss) on foreign exchange, merger integration expenses, amortization of cloud computing software costs, legal settlement costs deemed by management to be outside the normal course of business, and other items management believes are not representative of the Company’s core operations. Adjusted EBITDA Margin is adefined as Adjusted EBITDA divided by revenues for the period. Adjusted EBITDA and Adjusted EBITDA margin are supplemental financial measure
measures that management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess:assess our:
•our operatingOperating performance as compared to other publicly traded companies without regard to capital structure or historical cost basis;
•our abilityAbility to generate cash flow;
•our abilityAbility to incur and service debt and fund capital expenditures; and
•the viabilityViability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.
Adjusted EBITDA Service Margin
Adjusted EBITDA Service Margin is calculated as Adjusted EBITDA as a percentage of service revenue. Because we are able to charge our customers for direct access to certain data suppliers and we generally do not mark up those charges, we focus on the management of Adjusted EBITDA as a percentage of service revenue, as we believe this non-GAAP measure more accurately reflects the management of our controllable costs and profitability.
The following table reconciles our non-GAAP financial measure of Adjusted EBITDA and Adjusted EBITDA Service Margin to net income (loss), our most directly comparable financial measures calculated and presented in accordance with GAAP.GAAP, for the periods presented.
| | | Three Months Ended
September 30, | | Nine Months Ended
September 30, | | Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| | 2021 | | 2020 | | 2021 | | 2020 | | 2022 | | 2021 | | 2022 | | 2021 |
| | (in thousands, except percent) | | (in thousands) |
| Net income (loss) | Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | | Net income (loss) | $93,289 | | $7,281 | | $129,299 | | $(8,337) |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | | |
Income tax (benefit) expense (1) | | Income tax (benefit) expense (1) | (69,704) | | 649 | | (68,456) | | 2,954 |
| Interest expense | Interest expense | 18,518 | | | 18,597 | | | 54,674 | | | 56,930 | | Interest expense | 8,457 | | 18,518 | | 20,971 | | 54,674 |
| Depreciation and amortization | Depreciation and amortization | 19,531 | | | 19,808 | | | 56,013 | | | 58,283 | | Depreciation and amortization | 17,946 | | 19,531 | | 54,056 | | 56,013 |
| EBITDA | EBITDA | 45,979 | | | 12,829 | | | 105,304 | | | 45,767 | | EBITDA | 49,988 | | | 45,979 | | | 135,870 | | | 105,304 | |
| Equity-based compensation | 841 | | | 880 | | | 2,493 | | | 2,570 | | |
| Realized and unrealized gain (loss) on foreign exchange | 24 | | | (185) | | | 125 | | | 628 | | |
| Stock-based compensation | | Stock-based compensation | 1,282 | | 841 | | 8,587 | | 2,493 |
| Realized and unrealized (gain) loss on foreign exchange | | Realized and unrealized (gain) loss on foreign exchange | (780) | | 24 | | (795) | | 125 |
Merger integration expenses (1)(2) | Merger integration expenses (1)(2) | 193 | | | 2,138 | | | 1,174 | | | 9,255 | | Merger integration expenses (1)(2) | — | | 193 | | 205 | | 1,174 |
| Technology investments (2) | 1,690 | | | — | | | 1,690 | | | — | | |
Technology investments (3) | | Technology investments (3) | 559 | | 1,690 | | 559 | | 1,690 |
Amortization of cloud computing software costs (4) | | Amortization of cloud computing software costs (4) | 980 | | — | | 1,446 | | — |
Other items (3)(5) | Other items (3)(5) | 2,895 | | | 12,380 | | | 6,659 | | | 14,676 | | Other items (3)(5) | 1,943 | | 2,895 | | 3,501 | | 6,659 |
| Adjusted EBITDA | Adjusted EBITDA | $ | 51,622 | | | $ | 28,042 | | | $ | 117,445 | | | $ | 72,896 | | Adjusted EBITDA | $53,972 | | $51,622 | | $149,373 | | $117,445 |
| Service Revenue | $ | 152,332 | | | $ | 98,587 | | | $ | 395,624 | | | $ | 294,175 | | |
Net income (loss) service margin (4) | 4.8 | % | | 27.4 | % | | 2.1 | % | | 24.8 | % | |
Adjusted EBITDA service margin (5) | 33.9 | % | | 28.4 | % | | 29.7 | % | | 24.8 | % | |
| Net income (loss) margin (6) | | Net income (loss) margin (6) | 44% | | 4% | | 20% | | 2% |
| Adjusted EBITDA margin | | Adjusted EBITDA margin | 26% | | 25% | | 24% | | 22% |
(1)During the three months ended September 30, 2022, the Company determined sufficient positive evidence existed to reverse the Company’s valuation allowance attributable to the deferred tax assets associated with the Company’s operations in the U.S. This reversal resulted in a non-cash deferred tax benefit of $70.2 million, which materially decreased the Company’s income tax expense during the three and nine months ended September 30, 2022.
(2)Merger integration expenses consist primarily of information technology (“IT”) related costs including personnel expenses, professional and service fees associated with the integration of customers and operations of GIS, which commenced in July 2018 and was substantially completed by the end of 2020.
(2)(3)Technology investments represent discovery phase costs associated with the build outvarious platform and implementation of various technologiesfulfillment technology initiatives that will be usedare intended to achieve greater operational efficiencies.
(3)(4)Amortization of cloud computing software costs consists of expense recognized in selling, general and administrative expenses for capitalized implementation costs for cloud computing IT systems incurred in connection with our platform and
fulfillment technology initiatives that are intended to achieve greater operational efficiencies. This expense is not included in depreciation and amortization above.
(5)Other items include (i) costs of $0.4 million and $1.7 million associated with the implementation of a company-wide enterprise resource planning (“ERP”) system during the three and nine months ended September 30, 2022, respectively, (ii) $1.0 million and $1.6 million of severance costs during the three and nine months ended September 30, 2022, respectively, and (iii) $0.4 million related to professional services fees not related to core operations for the three and nine months ended September 30, 2022, and (iv) $0.2 million related to loss on disposal of assets and exit costs associated with one of our short-term leased facilities during the nine months ended September 30, 2022. These costs were partially offset by a reduction in previously accrued legal settlement expense of $0.6 million during the nine months ended September 30, 2022 due to a more favorable outcome than originally anticipated in a claim outside the ordinary course of business. Other items for the three and nine months ended September 30, 2021 (ii) costsinclude (i) $1.1 million and $4.3 million, respectively, related to the preparation of the Company’s initial public offering during 2021, (iii) $12.1(ii) $1.5 million related to loss on disposal of legal settlementassets and exit costs in the three and nine months ended September 30, 2020 associated with a single litigation matter related to a predecessor entityone of the Company for a claim dating back to 2009 (for additional information see Note 13 to the accompanying condensed consolidated financial statements for additional information), and (iv) $0.3 million and $2.5 million of severance costs incurred in connection with reducing our employee headcount in an effort to right-size our business in response to COVID-19short-term leased facilities during the three and nine months ended September 30, 2020, respectively.2021, and (iii) costs of $0.3 million and $0.8 million associated with the implementation of an ERP system during the three and nine months ended September 30, 2021.
(4)(6)Net income (loss) service margin is calculated asrepresents net income (loss) as a percentage of service revenue.
(5)Adjusted EBITDA service margin is calculated as Adjusted EBITDA as a percentage of service revenue.divided by revenues for the period.
Adjusted Net Income (Loss)and Adjusted Diluted Earnings Per Share
In addition to Adjusted EBITDA, management believes that Adjusted Net Income (Loss) is a strong indicator of our overall operating performance and is useful to our management and investors as a measure of comparative operating performance from period to period. We define Adjusted Net Income (Loss) as net income (loss) adjusted for equity-basedamortization of acquired intangible assets, stock-based compensation, realized and unrealized gain (loss) on foreign exchange, merger integration expenses, amortization of cloud computing software costs, legal settlement costs deemed by management to be outside the normal course of business, and other items management believes are not representative of the Company’s core operations, to which we apply an adjusted effective tax rate. See the footnotes to the table below for a description of certain of these adjustments. We define Adjusted Diluted Earnings Per Share as Adjusted Net Income divided by the adjusted weighted average number of shares outstanding (diluted) for the applicable period. We believe Adjusted Diluted Earnings Per Share is useful to investors and analysts because it enables them to better evaluate per share operating performance across reporting periods and to compare our performance to that of our peer companies.
The following table sets forth a reconciliationreconciles our non-GAAP financial measure of Adjusted Net Income to net income (loss) to Adjusted Net Income (Loss), our most directly comparable financial measure calculated and presented in accordance with GAAP, for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands) |
Net income (loss) | $ | 7,281 | | | $ | (27,042) | | | $ | (8,337) | | | $ | (72,936) | |
| Income tax expense | 649 | | | 1,466 | | | 2,954 | | | 3,490 | |
| Income (loss) before income taxes | 7,930 | | | (25,576) | | | (5,383) | | | (69,446) | |
| Equity-based compensation | 841 | | | 880 | | | 2,493 | | | 2,570 | |
| Realized and unrealized gain (loss) on foreign exchange | 24 | | | (185) | | | 125 | | | 628 | |
Merger integration expenses(1) | 193 | | | 2,138 | | | 1,174 | | | 9,255 | |
| | | | | | | |
Technology investments (2) | 1,690 | | | — | | | 1,690 | | | — | |
Other items (3) | 2,895 | | | 12,380 | | | 6,659 | | | 14,676 | |
| Adjusted income (loss) before income taxes | 13,573 | | | (10,363) | | | 6,758 | | | (42,317) | |
Adjusted income taxes (4) | 360 | | | 732 | | | 1,619 | | | 2,063 | |
| Adjusted Net Income (Loss) | $ | 13,213 | | | $ | (11,095) | | | $ | 5,139 | | | $ | (44,380) | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (in thousands) |
Net income (loss) | $ | 93,289 | | | $ | 7,281 | | | $ | 129,299 | | | $ | (8,337) | |
Income tax (benefit) expense (1) | (69,704) | | | 649 | | | (68,456) | | | 2,954 | |
| Income (loss) before income taxes | 23,585 | | | 7,930 | | | 60,843 | | | (5,383) | |
| Amortization of acquired intangible assets | 15,353 | | | 16,226 | | | 46,335 | | | 47,518 | |
Interest expense swap adjustments (2) | (3,413) | | | — | | | (9,676) | | | — | |
Interest expense discounts (3) | 790 | | | 1,057 | | | 2,549 | | | 3,139 | |
| Stock-based compensation | 1,282 | | | 841 | | | 8,587 | | | 2,493 | |
| Realized and unrealized (gain) loss on foreign exchange | (780) | | | 24 | | | (795) | | | 125 | |
Merger integration expenses (4) | — | | | 193 | | | 205 | | | 1,174 | |
Technology investments (5) | 559 | | | 1,690 | | | 559 | | | 1,690 | |
Amortization of cloud computing software costs (6) | 980 | | | — | | | 1,446 | | | — | |
Other items (7) | 1,943 | | | 2,895 | | | 3,501 | | | 6,659 | |
| Adjusted income before income taxes | 40,299 | | | 30,856 | | | 113,554 | | | 57,415 | |
Adjusted income taxes (8) | (71,216) | | | 662 | | | (70,951) | | | 2,533 | |
| Adjusted Net Income | $111,515 | | $30,194 | | $184,505 | | $54,882 |
The following table sets forth the calculation of Adjusted Diluted Earnings Per Share for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| | | | | |
| Diluted net income (loss) per share | $ | 1.17 | | | $ | 0.13 | | | $ | 1.63 | | | $ | (0.15) | |
Income tax (benefit) expense (1) | (0.88) | | | 0.01 | | | (0.86) | | | 0.05 | |
| Amortization of acquired intangible assets | 0.19 | | | 0.29 | | | 0.58 | | | 0.83 | |
Interest expense swap adjustments (2) | (0.04) | | | — | | | (0.12) | | | — | |
Interest expense discounts (3) | 0.01 | | | 0.02 | | | 0.03 | | | 0.06 | |
| Stock-based compensation | 0.02 | | | 0.01 | | | 0.11 | | | 0.04 | |
| Realized and unrealized loss on foreign exchange | (0.01) | | | — | | | (0.01) | | | — | |
Merger integration expenses (4) | — | | | — | | | — | | | 0.02 | |
Technology investments (5) | 0.01 | | | 0.03 | | | 0.01 | | | 0.03 | |
Amortization of cloud computing software costs (6) | 0.01 | | | — | | | 0.02 | | | — | |
Other items (7) | 0.02 | | | 0.05 | | | 0.04 | | | 0.12 | |
Adjusted income taxes (8) | 0.90 | | | (0.01) | | | 0.89 | | | (0.04) | |
| Adjusted Diluted Earnings Per Share | $ | 1.40 | | | $ | 0.53 | | | $ | 2.32 | | | $ | 0.96 | |
| | | | | | | |
| Weighted average number of shares outstanding - diluted | 79,542,715 | | 57,199,204 | | 79,476,574 | | 57,168,291 |
| | | | | | | |
| | | | | | | |
(1)During the three months ended September 30, 2022, the Company determined sufficient positive evidence existed to reverse the Company’s valuation allowance attributable to the deferred tax assets associated with the Company’s operations in the U.S. This reversal resulted in a non-cash deferred tax benefit of $70.2 million, which materially decreased the Company’s income tax expense during the three and nine months ended September 30, 2022.
(2)Interest expense swap adjustments consist of amortization of unrealized gains on the terminated Interest Rate Swap Agreements, which will be recognized through December 2023 as a reduction in interest expense.
(3)Interest expense discounts consist of amortization of original issue discount and debt issuance costs.
(4)Merger integration expenses consist primarily of ITinformation technology (“IT”) related costs including personnel expenses, professional and service fees associated with the integration of customers and operations of GIS, as discussed in footnote 1 to the immediately preceding table, which commenced in July 2018 and was substantially completed by the end of 2020.
(2)(5)Technology investments represent discovery phase costs associated with the build outvarious platform and implementation of various technologiesfulfillment technology initiatives that will be usedare intended to achieve greater operational efficiencies.
(3)(6)Amortization of cloud computing software costs consists of expense recognized in selling, general and administrative expenses for capitalized implementation costs for cloud computing IT systems incurred in connection with our platform and fulfillment technology initiatives that are intended to achieve greater operational efficiencies. This expense is not included in depreciation and amortization above.
(7)Other items include (i) costs of $0.4 million and $1.7 million associated with the implementation of a company-wide enterprise resource planning (“ERP”) system during the three and nine months ended September 30, 2022, respectively, (ii) $1.0 million and $1.6 million of severance costs during the three and nine months ended September 30, 2022, respectively, and (iii) $0.4 million related to professional services fees not related to core operations for the three and nine months ended September 30, 2022, and (iv) $0.2 million related to loss on disposal of assets and exit costs associated with one of our short-term leased facilities during the nine months ended September 30, 2022. These costs
were partially offset by a reduction in previously accrued legal settlement expense of $0.6 million during the nine months ended September 30, 2022 due to a more favorable outcome than originally anticipated in a claim outside the ordinary course of business. Other items for the three and nine months ended September 30, 2021 (ii) costsinclude (i) $1.1 million and $4.3 million, respectively, related to the preparation of the Company’s initial public offering during 2021, (iii) $12.1(ii) $1.5 million related to loss on disposal of legal settlementassets and exit costs in the three and nine months ended September 30, 2020 associated with a single litigation matter related to a predecessor entityone of the Company for a claim dating back to 2009 (for additional information see Note 13 to the accompanying condensed consolidated financial statements for additional information), and (iv) $0.3 million and $2.5 million of severance costs incurred in connection with reducing our employee headcount in an effort to right-size our business in response to COVID-19short-term leased facilities during the three and nine months ended September 30, 2020, respectively.2021, and (iii) costs of $0.3 million and $0.8 million associated with the implementation of an ERP system during the three and nine months ended September 30, 2021.
(4)(8)The tax effect of each adjustment is determined based on the tax laws and valuation allowance status of the jurisdiction to which the adjustment relates. An adjusted effective income tax rate has been determined for each period presented by applying the statutory income tax rate, and the provisionnet of applicable adjustments for deferred income taxes to the pre-tax adjustments,valuation allowances, which was used to compute Adjusted Net Income (Loss) for the periods presented.
Key Metrics
The key metrics used Due to help us evaluate our business, identify trends and formulate business plans and strategy are set forth in the table below and described inexistence of a U.S. tax valuation allowance, the following text:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2021 | | 2020 | | 2021 | | 2020 |
| (in thousands, except percent) |
| | | | | | | |
| New business revenue | $ | 10,873 | | | $ | 9,354 | | | $ | 24,117 | | | $ | 23,075 | |
We measure net revenue retention on a year-to-date basis. Net revenue retention for the nine months ended September 30, 2021 and 2020 was 133.8% and 75.7%, respectively.
Net Revenue Retention
We generally have long standing relationships with our customers as evidenced by the nine-year average tenure of our enterprise customers. The revenue from these customers is highly reoccurring in nature. In addition, our ability to cross sell and expand our services with our existing customers is an important component of our growth strategy. We measure the success of our customer retention and expansion through net revenue retention particularly among our top 1,250 customers who represent approximately 70% of our total revenue. Net revenue retention is a measure of our ability to retain and grow business from our customer base. It is calculated as the total revenue derived in the current fiscal period by our top 1,250 customers, divided by the total revenue derived in the prior fiscal period from the same 1,250 customers based on the prior fiscal period revenue composition. The 1,250 customers used for this metric may vary from period to period, as defined by the revenue compositiontax impact of the period immediately preceding the presented fiscal year. Net revenue retention increased in the 2021 periods as general client ordering patterns showed a significant volume and product mix improvement over the COVID impacted prior year quarter and year to date periods.
New Business Revenue
In addition to expanding revenue with our existing customer base, adding new customers to our portfolio is an important driver of growth. New business revenue is a measure of our ability to establish new sources of business from customers outside of our existing base of business. New business represents revenue recognized under a new customer contract during the first year of the contract term. We have a sales and sales support staff in nine countries focused on expanding our reach and penetration into new markets and regions. Although new contracts are typically three years in duration, new business revenue is determined over the first year of the contract. Continuing to grow this important metric is critical to the success of our business. New business revenue increased inpre-tax adjustments for the three and nine months ended September 30, 2021 comparedis immaterial. During the three months ended September 30, 2022, the Company determined sufficient positive evidence existed to reverse the Company’s valuation allowance attributable to the priordeferred tax assets associated with the Company’s operations in the U.S. This reversal resulted in a non-cash deferred tax benefit of $70.2 million, which materially decreased the Company’s income tax expense during the three and nine months ended September 30, 2022. As a result of the reversal of the valuation allowance, the U.S. tax provision for the remainder of the year period dueis expected to be immaterial.
volume and product mix improvement over the COVID impacted prior year quarter and year to date periods.
Liquidity and Capital Resources
General
Our primary sources of liquidity and capital resources are cash generated from our operating activities, cash on hand, and borrowings under our long-term debt arrangements. Income taxes are currentlyhave historically not been a significant use of funds but after the benefits of our net operating loss (“NOL”) carryforwards are fully recognized, could become a material use of funds, depending on our future profitability and future tax rate. Additionally, as a result of the income tax receivable agreement (“TRA”) we entered into in connection with the IPO, we will be required to pay certain pre-IPO ownersequityholders or their transferees 85% of the benefits, if any, that the Company and its subsidiaries realize, or are deemed to realize in income tax savings due to our utilization of the NOLs and other tax attributes, for certain tax benefits over a period of approximately 12 years pursuant towhich the TRA, which amounts toCompany recognized an estimated total liability of approximately $209.9 million.$211.4 million as of September 30, 2022. Based on our current taxable income estimates, we expect to repay the majority of this obligation by the end of our 2025 fiscal year.2030. These payments will result in cash outflows of amounts we would otherwise have retained in the form of tax savings from the application of the NOLs and other tax attributes.
Unrestricted cash and cash equivalents as of September 30, 2021 totaled $19.72022 was $146.5 million. As of September 30, 2021,2022, cash held in foreign jurisdictions was approximately $4.7$17.1 million and is primarily related to international operations.
Restricted cash of $5.0$1.3 million as of September 30, 20212022 consists primarily of $1.1 million held in escrow for the benefit of former investors in a subsidiary of the Company pursuant to the terms of its divestiture of a former affiliate in April 2018, and the remainder is related to prior restructurings from predecessor entities.2018.
Debt
The Company proactively drew down $50.0currently has two long-term debt arrangements:
•The Amended First Lien Term Loan Facility, a first lien senior secured term loan facility, bearing interest payable monthly at a LIBOR variable rate (3.12% at September 30, 2022) + 3.75%, maturing on July 12, 2025. Total principal outstanding on our debt was $701.6 million under its Revolving Credit Facility, during the quarter ended March 31, 2020 in preparation for the impact of the COVID-19 pandemic. The Company repaid $20.0 million on the Revolving Credit Facility during each of the second and third quarters of the year ended December 31, 2020. The Company had $10.0 million outstanding under the Revolving Credit Facility and $88.2 million of availability remained as of September 30, 2021. On November 5, 2021, the Company repaid the $10.02022 and $707.9 million outstandingas of December 31, 2021.
•The Amended Revolver Credit Facility, a first lien senior secured revolving credit facility in an aggregate principal amount on the Revolving Credit Facility.of up to $145.0 million, including a $40.0 million letter of credit sub-facility, bearing
interest monthly at a SOFR variable rate (2.47% at September 30, 2022) + 2.5% (subject to adjustment pursuant to a leverage-based pricing grid) and maturing on June 3, 2027 or, if earlier, 91 days prior to the maturity of the Company’s term loans under the Amended First Lien Term Loan Facility. The Company had $143.7 million in available borrowing capacity under the Amended Revolving Credit Facility, after utilizing $1.3 million for letters of credit as of September 30, 2022.
The Amended First Lien Term Loan Facility includes a financial maintenance covenant for the benefit of the revolving lenders thereunder, which requires us to maintain a maximum first lien leverage ratio as of the last day of any fiscal quarter on which greater than 35% of the revolving commitments are drawn (excluding for this purpose up to $15.0 million of undrawn letters of credit). The Company was in compliance with the covenants under the Amended First Lien Facilities for the three and nine months ended September 30, 2022.
The Company’s obligations under the Amended First Lien Facilities are guaranteed, jointly and severally, on a senior secured first-priority basis, by substantially all of the Company’s domestic wholly-owned material subsidiaries, as defined in the agreement, and are secured by first-priority security interests in substantially all of the assets of the Company and its domestic wholly-owned material subsidiaries, subject to certain permitted liens and exceptions. Collateral includes all outstanding equity interests in whatever form of the borrower and each restricted subsidiary that is owned by any credit party.
Operating Commitments
As of September 30, 20212022, the Company had purchase obligations of approximately $27.2 million withto various parties of which approximately $21.7$28.9 million is expected to be paid within one year. These purchase commitments are associated with agreements that are enforceable and legally binding. They arein the aggregate, primarily commitments to purchase data and other screening services in the ordinary course of business withbusiness. These purchase obligations have varying expiration terms through 2023.2023, and approximately $25.8 million of the total is expected to be paid within one year. Our obligations as of September 30, 2022, have increased from $21.7 million as of December 31, 2021, due to the extension of a service agreement with one of the Company’s current vendors.
In addition to our regular investment in capital expenditures, we planexpect to invest $40-$45approximately $45 to $50 million in a capital expenditure program, expected to extend through the end of fiscal year 2023 to continue to enhance our operating systems and technologies to improve operational efficiency. We expect that cash flow from operations and current cash balances, together with available borrowings under the Amended Revolving Credit Facility, will be sufficient to meet operating requirements as well as the obligations under the TRA as discussed below, through the next twelve months. Although we believe we have adequate sources of liquidity over the long term, cash available from operations could be affected by any general economic downturn or any decline or adverse changes in our business such as a loss of customers, market and or competitive pressures, unanticipated liabilities, or other significant changes in business environment. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all.
DebtCash Flow Analysis
Effective with the combinationComparison of the HireRight and GIS groups of companies on July 12, 2018, the Company has three long-term debt arrangements as described below. Collateral includes all outstanding equity interests in whatever form of the borrower and each restricted subsidiary that is directly owned by or on behalf of any credit party. The credit agreement has a restrictive covenant for leverage ratios. The Company was in compliance with the covenants under the credit agreementCash Flows for the three and nine months ended September 30, 2021. Accordingly,2022 versus the amount payable under the credit agreement is classified as long-term debt in the accompanying condensed consolidated balance sheet.
Atnine months ended September 30, 2021, we had the following long-term debt arrangements:
•a first lien senior secured term loan facility, in an aggregate principal amount of $835.0 million, bearing interest payable monthly at a London Interbank Offered Rate (“LIBOR”) variable rate (0.08% at September 30, 2021) + 3.75%, due July 12, 2025 (the “First Lien Term Loan Facility”).
•a first lien senior secured revolving credit facility, in an aggregate principal amount of up to $100.0 million, including a $40.0 million letter of credit sub-facility, bearing interest monthly at 3.5% and maturing on July 12, 2023 (the “Revolving Credit Facility”).
•a second lien senior secured term loan facility, in an aggregate principal amount of $215.0 million, bearing interest payable monthly at a LIBOR variable rate (0.08% at September 30, 2021) + 7.25%, due July 12, 2026 (the “Second Lien Term Loan Facility”).
The Company used $215.0 million of the proceeds from the IPO to repay, in full, the Second Lien Term Loan Facility. The Company plans to use approximately $100.0 million of proceeds of the IPO to repay, in part, the First Lien Term Loan Facility and no longer expects to incur swap breakage fees of approximately $4.2 million.
Cash Flow
The following table sets forth a summary of our condensed consolidated cash flows for the nine months ended September 30, 20212022 and 2020:2021:
| | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2021 | | 2020 |
| (in thousands) |
| Net cash provided by operating activities | $ | 19,043 | | | $ | 7,721 | |
| Net cash used in investing activities | (9,983) | | | (9,276) | |
| Net cash (used in) provided by financing activities | (7,503) | | | 2,335 | |
| Net increase in cash, cash equivalents and restricted cash | $ | 1,557 | | | $ | 780 | |
| | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2022 | | 2021 |
| (in thousands) |
| Net cash provided by operating activities | $ | 70,927 | | | $ | 19,043 | |
| Net cash used in investing activities | (13,122) | | | (9,983) | |
| Net cash used in financing activities | (25,050) | | | (7,503) | |
| Net increase in cash, cash equivalents and restricted cash | $ | 32,755 | | | $ | 1,557 | |
Operating Activities
Cash provided by operating activities reflects net income (loss) adjusted for certain non-cash items and changes in operating assets and liabilities. TotalCash provided by operating activities was $70.9 million for the nine months ended September 30, 2022 compared to cash provided by operating activities wasof $19.0 million for the nine months ended September 30, 2021 compared to cash provided of $7.7 million for the nine months ended September 30, 2020.2021. The increase in cash flows provided by operating activities was due primarily to a lowerhigher net lossincome for the current period compared to the prior year period, partly offset by athe tax benefit from the release of the valuation allowance and higher use of cash fromfor working capital comparedwhich includes our expenditures related to the prior period.our cloud computing platform modernization and automation efforts.
Investing Activities
Cash used in investing activities was approximately $13.1 million during the nine months ended September 30, 2022, compared to approximately $10.0 million during the nine months ended September 30, 2021,2021. The increase was due primarily to increases in capitalized software development costs under our program to enhance operational efficiencies compared to the prior period, partly offset by a decrease of purchases of property and equipment.
Financing Activities
Cash used in financing activities was approximately $9.3$25.1 million for the nine months ended September 30, 2022 compared to cash used in financing activities of approximately $7.5 million during the nine months ended September 30, 2020.2021. The increase in cash used in investing activities was due primarily to slight increases in purchases of property and equipment and capitalized software development costs comparedthe $18.4 million payment related to the prior period.
Financing Activities
Cash usedtermination of the Interest Rate Swap Agreements, as defined below. Mandatory repayments on our debt facilities were $6.3 million in financing activities was approximately $7.5 million forin each of the nine months ended September 30, 2021 compared2022 and 2021.
Interest Rate Swaps
Effective December 31, 2018, the Company had entered into interest rate swap agreements with a total notional amount of $700.0 million (“Interest Rate Swap Agreements”). The Interest Rate Swap Agreements were designed to cash provided by financing activitiesprovide predictability against changes in the interest rates on the Company’s debt, as the Interest Rate Swap Agreements converted a portion of approximately $2.3 millionthe variable interest rate on the Company’s debt to a fixed rate. The Interest Rate Swap Agreements were originally scheduled to expire on December 31, 2023.
On September 26, 2019, the Company modified the terms of the Interest Rate Swap Agreements with the then existing counterparties to change the LIBOR reference period to one month. The notional amount and maturities of the Interest Rate Swap Agreements remained unchanged. The Company elected hedge accounting treatment at that time. To ensure the effectiveness of the Interest Rate Swap Agreements, the Company elected the one-month LIBOR rate option for its variable rate interest payments on term balances equal to or in excess of the applicable notional amount of the Interest Rate Swap Agreement as of each reset date. The reset dates and other critical terms on the term loans perfectly matched with the interest rate cap reset dates and other critical terms through February 18, 2022, the date the Interest Rate Swap Agreements were terminated, and during the three and nine months ended September 30, 2020. The change in cash used in financing activities is due primarily to the Company’s draw down of $50.0 million on the Revolving Credit Facility in the same period last year. We had net repayments on our debt facilities of $6.3 million in the nine months ended2021. At September 30, 2021 compared to net borrowings of $3.7 million in the nine months ended September 30, 2020.
Financing2022 and Financing Capacity
Total principal outstanding on our debt was $1.0 billion as of September 30, 2021 and $1.0 billion as of December 31, 2020.
Income Tax Receivable Agreement
In connection with2021, the Company’s IPO during the fourth quarter of 2021, we entered into the TRA with our pre-IPO equityholders or their permitted transferees that will provide for the payment by us over a period of approximately 12 years to our pre-IPO equityholders or their permitted transferees of 85%effective portion of the benefits, if any, that we and our subsidiaries realize, or are deemed to realize (calculated using certain assumptions) in U.S. federal,Interest Rate Swap
state, and localAgreements was included on the condensed consolidated balance sheets in accumulated other comprehensive income tax savings as a result of(loss).
Effective February 18, 2022, the utilization (or deemed utilization) of certain existing tax attributes. Based on our current taxable income estimates, we expect to repayCompany terminated the majority of this obligation by the end of our 2025 fiscal year. Actual tax benefits realized by us may differ from tax benefits calculated under the TRA as a result of the use of certain assumptions in the TRA, including assumptions relating to state and local income taxes, to calculate tax benefits. The Company will record an estimated total liability of approximately $209.9 million and a reduction to Additional paid-in capital of approximately $209.9 million inInterest Rate Swap Agreements. In connection with the TRA duringtermination of the fourth quarterInterest Rate Swap Agreements, the Company made a payment of 2021 on its condensed consolidated balance sheets.$18.4 million to the swap counterparties. Following these terminations, $21.5 million of unrealized gains related to the terminated Interest Rate Swap Agreements included in accumulated other comprehensive income (loss) will be reclassified to earnings as reductions to interest expense through December 31, 2023.
Off-Balance Sheet Arrangements
As of September 30, 2021,2022, we did not have anyhad no off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K, other than operating leases, primarilyS-K.
Recently Issued Accounting Pronouncements
See Note 2 — Recently Issued Accounting Pronouncements for our leased facilities.further information on recently adopted accounting pronouncements and those not yet adopted.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of exposure due to potential changesinterest rate risk, potential foreign exchange risk and potential increases in inflation. We do not hold financial instruments for trading purposes.
Interest Rate Risk
We are exposed to changes in interest rates as a result of our financing activities used to fund business operations.the outstanding balance under the Amended First Lien Term Loan Facility, as well as any borrowings under the Amended Revolving Credit Facility. Primary exposures include movements in LIBOR.LIBOR and SOFR. The nature and amount of our long-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. To minimize this risk, we have entered intoRising interest rate swap agreementsrates could also limit our ability to hedgerefinance our riskdebt when it matures or cause us to changes in LIBOR.pay higher interest rates upon refinancing and increase interest expense on refinanced indebtedness.
As of September 30, 2021,2022, the outstanding balancesprincipal balance of $701.6 million on our credit agreements werethe Amended First Lien Term Loan Facility was subject to variable interest rates. We repaid $215.0 millionBased upon a sensitivity analysis, a hypothetical 1% change in interest rates on our debt outstanding would change our annual interest expense by approximately $7.0 million.
The last publication date of LIBOR rates against various currencies by the amount outstanding under our Second Lien Term Loan Facility using a portion of the proceeds from the IPO.
The Financial Conduct Authority in the United Kingdom intends to phasewas December 31, 2021, with the publication of certain United States dollar rates being phased out LIBOR by the end of 2021.after June 30, 2023. We have negotiated terms in consideration of this discontinuation and do not expect that the discontinuation of the LIBOR rate, including any legal or regulatory changes made in response to its future phase out, will have a material impact on our liquidity or results of operations.
Foreign Currency Exchange Risk
The significant majority of our revenue is denominated in U.S. dollars,dollars; however, we do earn revenue, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including among others,the Euro, the British pound, the Polish zloty, the Australian dollar, the Canadian dollar, the Euro, the Polish Zloty, the Singapore dollar, the Mexican peso, the Japanese yen, and the Indian rupee.rupee, among others. Because our condensed consolidated financial statements are presented in U.S. dollars, we must translate revenue, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against majorother currencies will affect our operating revenues, operating incomestatements of operations and the value of balance sheet items denominated in foreign currencies. We generally do not mitigate the risks associated with fluctuating
exchange rates however, because we generallytypically incur expenses and generate revenue in these currencies and the cumulative impact of these foreign exchange fluctuations are not deemed material to our financial performance.
Inflation Risk
Based on our analysis of the periods presented, we believe that inflation has not had a material effect on our operating results. However, recent growth in inflation may increase our operating costs. In response to high inflation rates, the Federal Reserve has been raising interest rates and has indicated that it foresees further interest rate increases throughout the year and into next year. Higher interest rates imposed by the Federal Reserve to address inflation will increase our interest expense. We also expect our labor costs to continue to increase as the growing competition for labor has a greater impact on our business. We continue to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions. However, we may not be able to raise our pricing sufficiently to offset our increased costs, for competitive reasons or because some of our customer agreements fix the prices we may charge for some period of time and/or limit permissible price increases. There can be no assurance that future inflation will not have an adverse impact on our operating results and financial condition.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, Act)as amended) as of September 30, 2021.2022. Based on the evaluation of the design and operation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of September 30, 20212022 due to certainthe material weaknesses in our internal control over financial reporting as described below. In light of this fact, our management has performed additional analyses, reconciliations, and other post-closing procedures and has concluded that, notwithstanding the material weakness in our internal control over financial reporting, the financial statements for the periods covered by and included in this Quarterly Report fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.
(b) Material weaknesses in internal control over financial reporting
In preparing our financial statements, management of the Company identified material weaknesses in our internal control over financial reporting as of December 31, 2020. These material weaknesses continued to exist as of September 30, 2022. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses we identified were as follows:
•We did not design and maintain an effective control environment commensurate with our financial reporting requirements. Specifically, we lacked a sufficient number of professionals with an appropriate level of accounting knowledge, training and experience to appropriately analyze, record and disclose accounting matters timely and accurately. This material weakness further contributed to the material weaknesses described below.
•We did not design and maintain sufficient formal accounting policies, procedures and controls to achieve complete, accurate and timely financial accounting, reporting and disclosures, including controls over the preparation and review of journal entries and account reconciliations. Additionally, the Company did not design and maintain sufficient controls to assess the reliability of reports and spreadsheets used in controls.
These material weaknesses did not result in a material misstatement to the consolidated financial statements included herein, however, they did result in adjustments to substantially all accounts and disclosures.disclosures for the year ended December 31, 2020 and prior. Additionally, these material weaknesses resulted in immaterial adjustments to goodwill, prepaid expenses, accrued expenses and other current liabilities, and selling, general and administrative expenses for the quarters ended March 31, 2021, June 30, 2021 and September 30, 2021. Furthermore, these
material weaknesses could result in a misstatement of substantially all of theour financial statement accounts and disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
•We did not design and maintain effective controls over certain information technology (“IT”) general controls for information systems that are relevant to the preparation of the financial statements. Specifically, we did not design and maintain: (i) program change management controls for certain financial systems to ensure that information technology program and data changes affecting financial IT applications and underlying accounting records are identified, tested, authorized and implemented appropriately, (ii) user access controls to ensure appropriate segregation of duties and that adequately restrict user and privileged access to financial applications, programs, and data to appropriate Company personnel and (iii) computer operations controls to ensure that data backups are authorized and monitored. These IT deficiencies did not result in a material misstatement to the financial statements, however, the deficiencies, when aggregated, could impact maintaining effective segregation of duties, as well as the effectiveness of IT-dependent controls (such as automated controls that address the risk of material misstatement to one or more assertions, along with the IT controls and underlying data that support the effectiveness of system-generated data and reports) that could result in misstatements potentially impacting all financial statement
accounts and disclosures that would not be prevented or detected. Accordingly, management has determined these deficiencies in the aggregate constitute a material weakness.
(c) Remediation plan for the previously identified material weaknesses
We have implemented or are in the process of implementing measures designed to improve our internal control over financial reporting and remediate the control deficiencies that led to the material weaknesses. Specifically, we have undertaken the following remedial actions:
•We have hired several additional accounting and finance personnel with the appropriate level of public accounting knowledge and experience.
•We have engaged a nationally recognized public accounting firm to assistthat assisted us in creating comprehensive process narratives and Company policies and procedures.
•Our Internal Audit team, along with a third partythird-party consultant, are assistingassisted us to evaluatein evaluating our current internal control over financial reporting (ICFRs)(“ICFR”) and makemade several recommendations for findings noted. We have been enhancingenhanced our controls and documentation support as issues are identified.based on these recommendations.
•We are in the process of implementing severalimplemented a new systems that shouldERP system to assist us to processin processing transactions more efficiently and effectively, ensuring bettereffectively. The new ERP system provides significant enhancements to our internal control and documentation support.reporting environment.
•We are working with our information securityhave designed and technology and accounting systems teamsimplemented controls related to develop enhanced procedures around user provisioning and maintenance to ensure access is restricted to appropriate personnel. In addition, we have strengthened procedures and controls around program change management and computer operations.
(c)While we believe that these efforts have improved and will continue to improve our internal control over financial reporting, the newly implemented controls have not been in place and operating for a sufficient period to evaluate if the material weakness has been remediated. Therefore, these material weaknesses have not been remediated as of September 30, 2022.
(d) Changes in Internal Control over Financial Reporting
Other than theThere have been no changes intended to remediate the material weaknesses noted above, there was no change in our internal controlscontrol over financial reporting during the quarter ended September 30, 2022, as defined under Rule 13a-af(f)13a-15(f) under the Exchange Act, that hashave materially affected, or isare reasonably likely to materially affect, our internal controlscontrol over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to claims, investigations, audits, and enforcement proceedings by private plaintiffs, third parties the Company does business with, and federal, state and foreign authorities charged with overseeing the enforcement of laws and regulations that govern the Company’s business. In the U.S., most of these matters arise under the federal Fair Credit Reporting Act and various state and local laws focused on privacy and the conduct and content of background reports. In addition to claims related to privacy and background checks, the Company is also subject to other claims and proceedings arising in the ordinary course of its business, including without limitation claims for indemnity by customers and vendors, employment-related claims, and claims for alleged taxes owed, infringement of intellectual property rights, and breach of contract. The Company and its subsidiaries are not party to any pending legal proceedings that the Company believes to be material except as set forth below.
In 2009 and 2010, approximately 24 lawsuits were filed against HireRight Solutions, Inc. (“Old HireRight”), which is the predecessor to the Company’s subsidiary HireRight, LLC, by approximately 1,400 individuals alleging violation of the California Investigative Consumer Reporting Agencies Act by Old HireRight and one of its customers (the “Customer”) related to background reports that Old HireRight prepared for the Customer about those individuals (the “Action”). The Customer was also named as a defendant in the Action.
In February of 2015, for unrelated reasons, Old HireRight’s former parent company and certain of its domestic affiliates, including Old HireRight, each filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code, 11 U.S.C. §§ 101-1532, thereby commencing Chapter 11 cases (the “Bankruptcy”). Each plaintiff in the Action filed proofs of claim in the Bankruptcy against Old HireRight asserting an unliquidated general unsecured claim based upon the Action. In August 2015, the Bankruptcy court entered an order confirming the debtors’ Chapter 11 plan of reorganization in the Bankruptcy (the “Plan”).
Plaintiffs’ recovery from HireRight, LLC for claims accrued prior to the filing of the Bankruptcy is limited by the Plan to the Plaintiffs’ pro-rata portion of the Bankruptcy unsecured creditors’ pool. However, the Plan does not limit HireRight, LLC’s liability for claims accrued after the filing of the Bankruptcy, plaintiffs’ recovery from the Customer, or claims against Old HireRight’s insurer.material.
Following a complex procedural history and unsuccessful mediation sessions over an extended period of time, in October 2020, plaintiffs’ counsel made a settlement offer. While the Company believed and continues to believe it has valid defenses, the Company engaged in negotiations with the plaintiffs’ counsel and on November 6, 2020 was able to reach a settlement agreement that the Company viewed as acceptable to avoid the expense and risk of further litigation.
While Old HireRight’s insurer has denied coverage, the Company believes it has valid claims against the carrier and intends to pursue them. Any insurance recovery would offset the cost of the settlement to HireRight, LLC, but at this time the Company is not able to assess the likelihood or amount of any potential insurance recovery.
Item 1A. Risk Factors
InvestingCurrent macroeconomic conditions are volatile and the near-term macroeconomic outlook is uncertain due to high inflation, rising interest rates, geopolitical concerns, supply chain disruptions and labor shortages.
Inflation puts pressure on our suppliers, resulting in increased data costs, and also increases our employment and other expenses. We may not be able to raise our pricing sufficiently to offset increased costs, for competitive reasons or because some of our customer agreements limit price increases. Further, portions of our costs are relatively fixed so it may not be possible for us to cut costs quickly or deeply enough to keep cost increases from adversely affecting our margins.
In response to high inflation, the Federal Reserve has been raising interest rates and has indicated that it foresees further interest rate increases. Higher interest rates increase our interest expense on variable-rate borrowings under our credit facilities. Further, interest rate hikes or other factors could lead to recessionary conditions, which could adversely affect the global hiring market and therefore the demand for our services.
Customers have begun to react to these uncertainties by reducing hiring, which in turn causes uncertainty in our common stock involves a high degree of risk. We describe risks associated with our business under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in our Prospectus dated October 28, 2021, filed with the SEC in accordance with Rule 424(b) under the Securities Act on November 1, 2021 in connection with our IPO, this report, and in other filings we have made and will make from timenear-term revenue outlook.
In addition to time with the Securities and Exchange Commission (the "Risk Factors"). Each of the risks described in our Risk Factors may be relevant to decisions regarding an investment in or ownership of our stock. The occurrence of any such risks could have a significant adverse effect on our reputation, business, financial condition, revenue, results of operations, growth, or ability to accomplish our strategic objectives, and could cause the trading price of our common stock to decline. You should carefully consider such risks and the other information contained in this report, including our condensed consolidated financial statements and related notes and
Management's Discussion and Analysis of Financial Condition and Results of Operations, before making investment decisions related to our common stock. There are no material changes toQuarterly Report on Form 10-Q, you should carefully consider the risk factors discussed in Part I, Item 1A. Risk Factors set forth in the Prospectus of which we are currently aware. However, our Risk Factors cannot anticipate and fully address all possible risks of investing in our common stock,Annual Report on Form 10-K for the year ended December 31, 2021. The risks of investingdiscussed in our common stockAnnual Report on Form 10-K could materially affect our business, financial condition, and future results. The risks described in our Annual Report on Form 10-K may change over time, and additional risks and uncertainties that we are not aware of, or that we do not consider to be material, may emerge. Accordingly, you are advised to consider additional sources of information and exercise your own judgment in addition to the information we provide.
Item 6. Exhibits
| | | | | | | | |
| Exhibit Number | | Exhibit Description |
| 31.1 | | |
| 31.2 | | |
| 32.1 | | |
32.2 | | |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HireRight Holdings Corporation
Date: November 18, 20213, 2022
| | | | | |
| By: | /s/ Thomas M. Spaeth |
| Name: | Thomas M. Spaeth |
| Title: | Chief Financial Officer |
| (Principal Financial Officer) |
Date: November 3, 2022
| | | | | |
| By: | /s/ Laurie Blanton |
| Name: | Laurie Blanton |
| Title: | Chief Accounting Officer |
| (Principal Accounting Officer) |
