Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We operate in a very competitive and rapidly changing environment that involves numerous known and unknown risks and uncertainties, some of which are beyond our control. Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed in any of our forward-looking statements. Our future quarterly and annual revenues, operating income, results of operations and cash flows, as well as any forward-looking statement, are subject to change and to inherent risks and uncertainties, such as those disclosed or incorporated by reference in our filings with the Securities and Exchange Commission. Important factors that could cause our actual results, performance and achievements, or industry results to differ materially from estimates or projections contained in our forward-looking statements include, among others, the following: uncertainty of the magnitude, duration, geographic reach and impact on the global economy of the COVID-19 pandemic; our ability to pay our debt; compliance with our credit agreements; risks associated with acquisitions or investments; integration of businesses we have acquired; worldwide economic conditions and credit tightening which could impact our operating results; less than anticipated growth rates in broadly defined business information services & advisory sector; the termination, delay, or reduction in scope to engagements with our clients; fluctuating operating results from factors outside of our control; a decrease in revenues from failure to secure new project-based advisory engagements; the inability to achieve or maintain adequate utilization for our consultants; the loss of money on our fixed-fee or capped fee contracts; contracts with contingent-based revenue may cause unusual variations in our operating results; our ability to maintain our existing services and products; the profitability from expanding our service offering; our ability to develop and offer the new services and products that we need to remain competitive; our potential failure to anticipate and respond to market trends; our ability to protect important intellectual property rights; our ability to face and compete with competition; a loss of key executives could adversely affect our business; our reliance on key members of our management team; the ability to attract, retain and train skilled advisory and other professionals; agreements with certain clients that limit the ability of particular advisors to work on some engagements for a period of time; the financial impact of losing one or more of our large clients; the exposure to international operations could negatively impact our future revenue and growth; the uncertainty surrounding the effect of Brexit; data protection laws and self-regulatory codes may restrict our activities and increase our costs; our exposure to risks related to cybersecurity; our international operations expose us to foreign currency exchange rate risk; we may be subject to claims for substantial damages by our clients arising out of disruptions to their businesses or inadequate
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service and our insurance coverage may be inadequate; we could be liable to our clients for damages and subject to liability and our reputation could be damaged if our confidential information or client data is compromised; failure to maintain effective internal control over financial reporting could adversely affect our business and the market price of our Common Stock; client restrictions on the use of client data could adversely affect our activities; we may not be able to maintain the equity in our brand name; our actual operating results may differ significantly from our guidance; and other risks and uncertainties. The potential fluctuations in our operating income could cause period-to-period comparisons of operating results not to be meaningful and could provide an unreliable indication of future operating results. A description of the risk factors associated with our business is included under “Risk Factors” in Item 1A. of this Annual Report on Form 10-K, which is incorporated herein by reference.
BUSINESS OVERVIEW
ISG (Information Services Group) (Nasdaq: III) is a leading global technology research and advisory firm. A trusted business partner to over 700 clients, including more than 75 of the top 100 enterprises in our markets, ISG is committed to helping corporations, public sector organizations, and service and technology providers achieve operational excellence and faster growth. The firm specializes in digital transformation services, including automation, cloud and data analytics; sourcing advisory; managed governance and risk services; network carrier services; technology strategy and operations design; change management; market intelligence and technology research and analysis. Founded in 2006, and based in Stamford, Conn., ISG employs approximately 1,300 digital-ready professionals operating in more than 20 countries—a global team known for its innovative thinking, market influence, deep industry and technology expertise, and world-class research and analytical capabilities based on the industry’s most comprehensive marketplace data. For more information, visit www.isg-one.com.
Our strategy is to strengthen our existing market position and develop new services and products to support future growth plans. As a result, we are focused on growing our existing service model, expanding geographically, developing new industry sectors, productizing market data assets, expanding our managed services offerings and growing via acquisitions. Although we do not expect any adverse conditions that will impact our ability to execute against our strategy over the next twelve months, the more significant factors that could limit our ability to grow in these areas include global macro-economic conditions and the impact on the overall sourcing market, competition, our ability to retain advisors and reductions in discretionary spending with our top client accounts or other significant client events. Other areas that could impact the business would also include natural disasters, pandemics, such as COVID-19, legislative and regulatory changes and capital market disruptions.
We principally derive revenues from fees for services generated on a project by project basis. Prior to the commencement of a project, we reach agreement with the client on rates for services based upon the scope of the project, staffing requirements and the level of client involvement. Revenues for services rendered are recognized on a time and materials basis or on a fixed fee or capped fee basis in accordance with accounting and disclosure requirements for revenue recognition.
Revenues for time and materials contracts are recognized based on the number of hours worked by our advisors at an agreed upon rate per hour and are recognized in the period in which services are performed. Revenues for time and materials contracts are billed monthly, semimonthly or in accordance with the specific contractual terms of each project.
We also derive our revenues from certain recurring revenue streams. These include such annuity-based ISG offerings as ISG GovernX®, Research, Software as a Subscription (Automation licenses), ISG Inform™ and the multi-year Public Sector contracts. These offerings are characterized by subscriptions (i.e., renewal centric as opposed to project centric revenue streams) or, in some instances, multi-year contracts. Our digital services now span a volume of offerings and have become embedded as part of even our traditional transaction services. Digital enablement provides capabilities, digital insights and better engagement with clients and partners.
Our results are impacted principally by our full-time consultants’ utilization rate, the number of business days in each quarter and the number of our revenue-generating professionals who are available to work. Our utilization rate can be negatively affected by increased hiring because there is generally a transition period for new professionals that result in a temporary drop in our utilization rate. Our utilization rate can also be affected by seasonal variations in the demand for our services from our clients. The number of business work days is also affected by the number of vacation days taken by our consultants and holidays in each quarter. We typically have fewer business work days available in the fourth quarter of the year, which can impact revenues during that period. Time-and-expense engagements do not provide us with a high degree of predictability as to performance in future periods. Unexpected changes in the demand for our services can result in significant variations in utilization and revenues and present a challenge to optimal hiring and staffing. The volume of work performed for any particular client can vary widely from period to period.
CURRENT ENVIRONMENT
On March 11, 2020, the World Health Organization categorized the novel coronavirus (COVID-19) as a pandemic, and COVID-19 has spread throughout the United States and the rest of the world with different geographical locations impacted more than others. The outbreak of COVID-19 and public and private sector measures to reduce its transmission, such as the imposition of social distancing and orders to work-from-home, stay-at-home and shelter-in-place, have, to some degree, adversely impacted our business and demand for our
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services. Businesses have adjusted, reduced or suspended operating activities, which has negatively impacted the markets and some of the clients we serve. We continue to believe our focus on our strategic strengths, including technology expertise, digital transformation, data management capabilities, and the relevance of our service offerings will continue to serve our Firm well as we navigate a rapidly changing marketplace.
New vaccines are coming to market and the pandemic shows early signs of receding. This is the first indication that life may begin to return to normal in 2021 and release the pent-up demand for our advice, data, and support. If there is a silver lining to the pandemic for ISG, it is this: it is accelerating digital adoption and transformation.
Every company now sees, clearer than ever, the need for digital—to get closer to their customers, enhance customer experience and analyze customer data for new growth opportunities; to digitize the workplace to make work more efficient and collaborative, improve employee engagement and attract the best talent; to become more agile and flexible to address rapid-fire changes in the market, and to make operations smarter and leaner, streamline the entire supply chain and generally reduce the friction of business.
ISG is ideally positioned to be our clients’ partner in digital transformation. Our full range of digital, network and research solutions, and subscription software platforms, are here to help clients see, plan for and realize what’s next.
We have taken steps to strengthen our financial position, which will serve us well during this period of heightened uncertainty. On March 10, 2020, we refinanced our credit facility and expanded our borrowing capacity under our revolving credit agreement, and extended the maturity date, lowered the interest rate, and secured less restrictive debt covenants. During 2020, we lowered our cost base as well as introduced a new operating model, ISG NEXT, that we believe will enhance our growth opportunities and drive significant value for all stakeholders.
EXECUTIVE SUMMARY
2020 was a year like no other. We began the year with a solid growth plan and strong momentum coming off a successful second half of 2019. Then, the bottom fell out as the pandemic spread. We immediately adjusted our business plan. We pivoted quickly to a work-from-home model, made tough but necessary decisions to lower our cost base to match anticipated client demand, and reset our financial expectations. In parallel, we began the process of creating a business model that would allow us to meet the challenge of the pandemic head on—not only to survive a difficult year, but to emerge from the pandemic a stronger, more energized and vital firm for our clients. Thanks to our swift and decisive actions, and the collective contributions of our professionals around the world, ISG bounced back from the initial economic shock of the pandemic and turned a challenging year into a successful one. Before the pandemic hit, our clients were focused on large-scale digital transformation programs. Then, facing business disruption, they quickly turned to us for help with immediate needs, such as cost takeout, captive monetization and supply chain management, as well as digital workplace, cloud and network modernization initiatives to support remote work and digital customer experience.
As with most businesses, the pandemic had an immediate negative impact on our revenues. But that impact was short-lived. After a difficult first half, ISG turned the corner, delivering quarter-over-quarter revenue and adjusted EBITDA growth in the second half. Client demand rose, as companies realized they needed to continue investing in digital to recover faster and emerge stronger from this crisis. Our renewed revenue momentum, coupled with our disciplined operating approach, enabled ISG to generate a record $44 million of cash flow from operations in 2020. We used $8 million of that cash to pay down debt, lowering our balance by 9 percent.
Our Go Digital investments over the last few years helped ISG pivot quickly to new ways of working, collaborating and engaging with clients. Importantly, we did not allow the pandemic to impact our long-term vision for the firm. We continued to invest in the ISG Platform, our suite of subscription-based, on-demand software solutions. That included expanding the capabilities of ISG GovernX®, to meet rising demand from clients looking to manage their supply chains and mitigate risk. We also created an internal platform, the ISG Workbench, that reimagines how we collaborate and access the tools, information, and IP we need to make our delivery more efficient and more valuable for our clients. Considering our current work-from-home model, the timing could not have been better. As it has for many of our clients, the pandemic has opened our eyes to the art of the possible and allowed us to think differently about our business. The result is ISG NEXT, an entirely new operating model for ISG.
Under ISG NEXT, we are pivoting from services to solutions, building our capabilities around two major consulting practices, ISG Digital and ISG Enterprise, complemented by ISG Research and Events and our SaaS platforms. Every client engagement now passes through our dedicated Solution Hubs, to bring the best thinking, tools and capabilities to bear to solve every client challenge. A key part of ISG NEXT is our new ISG iFlex™ virtual delivery model, which enables us to rapidly deploy our global resources to support clients, regardless of geography or time zone. We also are building more industry-specific capabilities, particularly in the Americas and Europe.
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RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2020 COMPARED TO YEAR ENDED DECEMBER 31, 2019
Revenues
Revenues are generally derived from fixed fee contracts as well as engagements priced on a time and materials basis, which are recorded based on actual time worked as the services are performed. In addition, we also earn revenues which are contingent on the attainment of certain contractual milestones. Revenues related to materials (mainly out-of-pocket expenses such as airfare, lodging and meals) required during an engagement generally do not include a profit mark up and can be charged and reimbursed separately or as part of the overall fee arrangement. Invoices are issued to clients monthly, semimonthly or in accordance with the specific contractual terms of each project.
We operate in one segment, fact-based sourcing advisory services. We operate principally in the Americas, Europe, and Asia Pacific. Our foreign operations are subject to local government regulations and to the uncertainties of the economic and political conditions of those areas, and the revenue for our foreign operations is predominantly invoiced and collected in local currency.
Geographical revenue information for the segment is as follows:
Years Ended December 31,
Percent
Geographic Area
2020
2019
Change
Change
(in thousands)
Americas
$
141,227
$
156,075
$
(14,848)
(10)
%
Europe
87,131
90,739
(3,608)
(4)
%
Asia Pacific
20,770
18,949
1,821
10
%
Total revenues
$
249,128
$
265,763
$
(16,635)
(6)
%
Revenues decreased by $16.6 million or approximately 6% in 2020. The decrease in revenues in the Americas and Europe was primarily attributable to a decline in our Advisory service line, related to the COVID-19 pandemic and its impact on certain of our clients’ operations, and was partially offset by an increase in our Research service line. The increase in revenues in Asia Pacific was primarily attributable to an increase in our public sector service line in Australia. Revenues also declined by $7.9 million due to lower travel and expense reimbursement resulting from pandemic related travel restrictions. The translation of foreign currency revenues into U.S. dollars positively impacted performance compared to the prior year in Europe and Asia Pacific.
Operating Expenses
The following table presents a breakdown of our operating expenses by functional category:
Years Ended December 31,
Percent
Operating Expenses
2020
2019
Change
Change
(in thousands)
Direct costs and expenses for advisors
$
149,878
$
153,179
$
(3,301)
(2)
%
Selling, general and administrative
83,785
92,518
(8,733)
(9)
%
Depreciation and amortization
6,196
6,708
(512)
(8)
%
Total operating expenses
$
239,859
$
252,405
$
(12,546)
(5)
%
Total operating expenses decreased by $12.5 million for 2020 with decreases in direct costs and expenses for advisors, selling, general and administrative (“SG&A”) expenses, and depreciation and amortization. The decrease in SG&A and direct costs and expenses for advisors were due primarily to lower travel expenses of $16.9 million. The cost decreases were partially offset by higher RPA license fees of $2.8 million, severance, integration, and other expense of $1.0 million, and bad debt expense of $0.7 million.
Compensation costs consist of a mix of fixed and variable salaries, annual bonuses, benefits and retirement plan contributions. Statutory and 401(k) plans are offered to employees as appropriate. Direct costs also include employee taxes, health insurance, workers compensation and disability insurance.
A portion of compensation expenses for certain billable employees are allocated between direct costs and selling, general and administrative costs based on relative time spent between billable and non-billable activities.
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Selling costs consist principally of compensation expense related to business development, proposal preparation and delivery, and negotiation of new client contracts. Selling costs also include travel expenses relating to the pursuit of sales opportunities, expenses for hosting periodic client conferences, public relations activities, participation in industry conferences, industry relations, website maintenance and business intelligence activities. Additionally, we maintain a dedicated global marketing function responsible for developing and managing sales campaigns, brand promotion, the ISG Index and assembling client proposals.
We maintain a comprehensive program for training and professional development with the related costs included in SG&A. Related expenses include product training, updates on new service offerings or methodologies and development of client project management skills. Also included in training and professional development are expenses associated with the development, enhancement and maintenance of our proprietary methodologies and tools and the systems that support them.
Selling, general and administrative expenses consist principally of executive management compensation, allocations of billable employee compensation related to general management activities, IT infrastructure, and costs for the finance, accounting, information technology and human resource functions. General and administrative costs also reflect continued investment associated with implementing and operating client and employee management systems. Because our billable personnel operate primarily on client premises, all occupancy expenses are recorded as general and administrative.
Depreciation and amortization expense in 2020 and 2019 were $6.2 million and $6.7 million, respectively. The decrease of $0.5 million in depreciation and amortization expense was primarily due to intangible assets that were fully amortized in the prior year. Depreciation expense is generally computed by applying the straight-line method over the estimated useful lives of assets. We also capitalize some costs associated with the purchase and development of internal-use software, system conversions and website development costs. These costs are amortized over the estimated useful life of the software or system.
We amortize our intangible assets (e.g., client relationships and databases) over their estimated useful lives. Goodwill related to acquisitions is not amortized but is subject to annual impairment testing.
Other Expense, Net
The following table presents a breakdown of other expense, net:
Years Ended December 31,
Percent
Other income (expense), Net
2020
2019
Change
Change
(in thousands)
Interest income
$
260
$
194
$
66
34
%
Interest expense
(3,563)
(6,267)
2,704
43
%
Foreign currency loss
(98)
(146)
48
33
%
Total other income (expense), net
$
(3,401)
$
(6,219)
$
2,818
45
%
The total decrease of $2.8 million was primarily the result of lower interest expense attributable to our lower debt balance and lower interest rates.
Income Tax Expense
Our effective tax rate varies from period to period based on the mix of earnings among the various state and foreign tax jurisdictions in which business is conducted and the level of non‑deductible expenses incurred in any given period. Our effective tax rate for the year ended December 31, 2020 was 53.1% compared to 53.2% for the year ended December 31, 2019. The variance between the US statutory rate of 21.0% for the year ended December 31, 2020 was primarily caused by the impact of higher tax rates applicable on company earnings in foreign jurisdictions and non-deductible expenses for tax purposes in the U.S.
NON-GAAP FINANCIAL PRESENTATION
This management’s discussion and analysis presents supplemental measures of our performance that are derived from our consolidated financial information but are not presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We refer to these financial measures, which are considered “non-GAAP financial measures” under SEC rules, as adjusted EBITDA, adjusted net income, and adjusted earnings per diluted share, each as defined below. See “Non-GAAP Financial Measures” below for information about our use of these non-GAAP financial measures, including our reasons for including these measures and reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
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NON-GAAP FINANCIAL MEASURES
We use non-GAAP financial measures to supplement the financial information presented on a GAAP basis. We provide adjusted EBITDA (defined as net income, plus interest, taxes, depreciation and amortization, foreign currency transaction gains/losses, non-cash stock compensation, change in contingent consideration, acquisition-related costs, severance, integration and other expense, tax indemnity receivable, and financing-related costs), adjusted net income (defined as net income, plus amortization of intangible assets, non-cash stock compensation, foreign currency transaction gains/losses, change in contingent consideration, acquisition-related costs, severance, integration and other expense, financing-related costs, and write-off of deferred financing costs on a tax-adjusted basis) and adjusted net income as earnings per diluted share, excluding the net of tax effect of the items set forth in the table below. These are non-GAAP measures that the Company believes provide useful information to both management and investors by excluding certain expenses and financial implications of foreign currency translations that management believes are not indicative of ISG’s core operations. These non-GAAP measures are used by the Company to evaluate the Company’s business strategies and management’s performance. These non-GAAP financial measures exclude non-cash and certain other special charges that many investors believe may obscure the user’s overall understanding of the Company’s current financial performance and the Company’s prospects for the future. We believe that these non-GAAP measures provide useful information to investors because they improve the comparability of the financial results between periods and provide for greater transparency of key measures used to evaluate the Company’s performance.
Years Ended December 31,
2020
2019
Net income
$
2,755
$
3,341
Interest expense (net of interest income)
3,303
6,073
Income taxes
3,113
3,798
Depreciation and amortization
6,196
6,708
Change in contingent consideration
419
30
Acquisition-related costs (1)
756
58
Severance, integration and other expense
2,717
1,740
Tax indemnity receivable
—
31
Financing-related costs
92
—
Foreign currency transaction loss
98
146
Non-cash stock compensation
8,891
9,589
Adjusted EBITDA
$
28,340
$
31,514
Years Ended December 31,
2020
2019
Net income
$
2,755
$
3,341
Non-cash stock compensation
8,891
9,589
Intangible amortization
3,532
4,011
Change in contingent consideration
419
30
Acquisition-related costs (1)
756
58
Severance, integration and other expense
2,717
1,740
Financing-related costs
92
—
Write-off of deferred financing costs
167
—
Foreign currency transaction loss
98
146
Tax effect (2)
(5,335)
(4,984)
Adjusted net income
$
14,092
$
13,931
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Years Ended December 31,
2020
2019
Net income per diluted share
$
0.06
$
0.07
Non-cash stock compensation
0.18
0.20
Intangible amortization
0.07
0.08
Change in contingent consideration
0.01
0.00
Acquisition-related costs (1)
0.02
0.00
Severance, integration and other expense
0.05
0.04
Financing-related costs
0.00
—
Write-off of deferred financing costs
0.00
—
Foreign currency transaction loss
0.00
0.00
Tax effect (2)
(0.11)
(0.10)
Adjusted net income per diluted share
$
0.28
$
0.29
________________________________________
(1)
Consists of expenses from acquisition-related costs and non-cash fair value adjustments on pre-acquisition contract liabilities.
(2)
Marginal tax rate of 32%, reflecting U.S. federal income tax rate of 21% plus 11% attributable to U.S. states and foreign jurisdictions.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our primary sources of liquidity are cash flows from operations, existing cash and cash equivalents and borrowings under our revolving line of credit. Operating assets and liabilities consist primarily of receivables from billed and unbilled services, accounts payable, accrued expenses, and accrued payroll and related benefits. The volume of billings and timing of collections and payments affect these account balances.
The following table summarizes our cash flows for the years ended December 31, 2020 and 2019:
Years Ended December 31,
2020
2019
(in thousands)
Net cash provided by (used in):
Operating activities
$
43,971
$
20,437
Investing activities
(3,498)
(1,922)
Financing activities
(15,695)
(18,934)
Effect of exchange rate changes on cash
806
(65)
Net increase (decrease) in cash, cash equivalents, and restricted cash
$
25,584
$
(484)
As of December 31, 2020, our liquidity and capital resources included cash, cash equivalents, and restricted cash of $43.8 million compared to $18.2 million as of December 31, 2019, a net increase of $25.6 million, which was primarily attributable to the following:
● our operating activities provided net cash of $44.0 million for the year ended December 31, 2020. Net cash provided from operations was primarily attributable to $23.5 million provided by working capital and our net income after adjustments for non-cash charges of approximately $20.5 million. The change in working capital was primarily attributable to a $13.1 million increase in accrued expenses, $10.1 million decline in accounts receivable and contract assets, and $2.1 increase in accounts payable partially offset by a $1.7 million increase in prepaid expense and other assets;
● net principal payments on borrowings of $8.1 million;
● treasury share repurchases of $5.2 million;
● Neuralify acquisition of $2.3 million;
● payments of $2.0 million related to tax withholding for stock-based compensation;
● capital expenditures for property, plant and equipment of $1.2 million; and
● debt financing costs of $0.9 million.
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Capital Resources
The Company’s current outstanding debt, may limit our ability to fund general corporate requirements and obtain additional financing, impact our flexibility in responding to business opportunities and competitive developments and increase our vulnerability to adverse economic and industry conditions.
On March 10, 2020, the Company amended and restated its senior secured credit facility to include a $86.0 million term facility and to increase the revolving commitments per the revolving facility (the “2020 Credit Agreement”) from $30.0 million to $54.0 million. The material terms under the 2020 Credit Agreement are as follows:
● Each of the term loan facility and revolving credit facility has a maturity date of March 10, 2025 (the “Maturity Date”).
● The credit facility is secured by all of the equity interests owned by the Company, and its direct and indirect domestic subsidiaries and, subject to agreed exceptions, the Company’s direct and indirect “first-tier” foreign subsidiaries and a perfected first priority security interest in all of the Company’s and its direct and indirect domestic subsidiaries’ tangible and intangible assets.
● The Company’s direct and indirect existing and future wholly owned domestic subsidiaries serve as guarantors to the Company’s obligations under the senior secured facility.
● At the Company’s option, the credit facility bears interest at a rate per annum equal to either (i) the “Base Rate” (which is the highest of (a) the rate publicly announced from time to time by the administrative agent as its “prime rate”, (b) the Federal Funds Rate plus 0.5% per annum and (c) the Eurodollar Rate, plus 1.0%), plus the applicable margin (as defined below) or (ii) Eurodollar Rate (adjusted for maximum reserves) as determined by the Administrative Agent, plus the applicable margin. The applicable margin is adjusted quarterly based upon the Company’s quarterly leverage ratio.
● The term loan is repayable in nineteen consecutive quarterly installments of $1,075,000 each that commenced on June 30, 2020 and a final payment of the outstanding principal amount of the term loan on the Maturity Date.
● Mandatory repayments of term loans shall be required from (subject to agreed exceptions) (i) 100% of the proceeds from asset sales by the Company and its subsidiaries, (ii) 100% of the net proceeds from issuances of debt and equity by the Company and its subsidiaries and (iii) 100% of the net proceeds from insurance recovery and condemnation events of the Company and its subsidiaries.
● The senior secured credit facility contains a number of covenants that, among other things, place restrictions on matters customarily restricted in senior secured credit facilities, including restrictions on indebtedness (including guarantee obligations), liens, fundamental changes, sales or disposition of property or assets, investments (including loans, advances, guarantees and acquisitions), transactions with affiliates, dividends and other payments in respect of capital stock, optional payments and modifications of other material debt instruments, negative pledges and agreements restricting subsidiary distributions and changes in line of business. In addition, the Company is required to comply with a total leverage ratio and fixed charge coverage ratio.
● The senior secured credit facility contains customary events of default, including cross-default to other material agreements, judgment default and change of control.
The Company’s financial statements include outstanding borrowings of $78.8 million and $86.9 million at December 31, 2020 and December 31, 2019, respectively, which are carried at amortized cost. The fair value of debt is classified within Level 3 of the fair value hierarchy. The fair value of the Company's outstanding borrowings is approximately $77.7 million and $86.7 million at December 31, 2020 and December 31, 2019, respectively. The fair values of debt have been estimated using a discounted cash flow analysis based on the Company's incremental borrowing rate for similar borrowing arrangements. The incremental borrowing rate used to discount future cash flows is 2.49%. The Company also considered recent transactions of peer group companies for similar instruments with comparable terms and maturities as well as an analysis of current market conditions.
We anticipate that our current cash and the ongoing cash flows from our operations will be adequate to meet our working capital, capital expenditure, and debt financing needs for at least the next twelve months. The anticipated cash needs of our business could change significantly if we pursue and complete additional business acquisitions, if our business plans change, if economic conditions change from those currently prevailing or from those now anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flow or profitability of our business, including the potential impacts of the COVID-19 pandemic and the severity of the related economic downturn and length of time of an economic recovery. If we require additional capital resources to grow our business, either internally or through acquisition, or maintain liquidity, we may seek to sell additional equity securities or to secure additional debt financing. The sale of additional equity securities or certain forms of debt financing could result in additional dilution to our stockholders. We may not be able to obtain financing arrangements in amounts or on terms acceptable to us in the future.
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The Company has financial covenants underlying its debt which require an adjusted Debt to EBITDA ratio of 3.25. In light of the pandemic, there is uncertainty regarding the marketplace demand for the Company’s services and thus the Company’s future revenue generation. Accordingly, in light of this uncertainty, the Company has developed plans to further reduce operating expenses to the extent more prolonged revenue shortfalls are experienced which would prevent the Company from complying with its financial covenants. We believe that cash flows generated from operations, existing cash and cash equivalents and borrowing capacity under our senior secured credit facility are sufficient to finance the requirements of our business for 12 months from the date of issuance of these financial statements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets or any obligation arising out of a material variable interest in an unconsolidated entity.
Employee Retirement Plans
For the fiscal years ended December 31, 2020 and 2019, we contributed $0.9 million and $0.1 million, respectively, to the 401(k) plan (the “Savings Plan”) on a fully discretionary basis. These amounts were invested by the participants in a variety of investment options under an arrangement with a third party asset manager. All current and future financial risks associated with the gains and losses on investments are borne by Savings Plan participants.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, many of which require management to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results may differ from estimates. Such differences may be material to the consolidated financial statements.
We believe the application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found the application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.
Our accounting policies are more fully described in Note 2 “Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements.” We have identified revenue recognition as a critical accounting estimate:
Revenue Recognition
We recognize our revenues by applying the following five steps: (1) identify the contract with the customer; (2) identify the performance obligation(s) in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligation(s); and (5) recognize revenue when (or as) the company satisfies the performance obligation(s).
We principally derive revenues from fees for services generated on a project-by-project basis. Prior to the commencement of a project, we reach agreement with the client on rates for services based upon the scope of the project, staffing requirements and the level of client involvement. It is our policy to obtain written agreements from clients prior to performing services or when evidence of enforceable rights and obligations is obtained. In these agreements, the clients acknowledge that they will pay based upon the amount of time spent on the project or an agreed upon fee structure.
Revenues for time and materials contracts, which may include capped fees or “not-to-exceed” clauses, are recognized based on the number of hours worked by our advisors at an agreed upon rate per hour and are recognized in the period in which services are performed. Revenues for time and materials contracts are billed monthly, semimonthly or in accordance with the specific contractual terms of each project. For contracts with capped fees or not-to-exceed clauses, we monitor our performance and fees billed to ensure that revenue is not recognized in excess of the contractually capped fee.
Revenues related to fixed fee contracts are recognized as value is delivered to the customer, consistent with the transfer of control to the customer over time. Revenue for these contracts is recognized proportionally over the term of the contract using an input method based on the proportion of labor hours incurred as compared to the total estimated labor hours for the fixed fee contract performance obligations, which we consider the best available indicator of the pattern and timing in which contract performance obligations are fulfilled and control transfers to the customer. This percentage is multiplied by the contracted dollar amount of the project to determine the amount of revenue to recognize in an accounting period. The contracted amount used in this calculation typically excludes the amount the client pays for reimbursable expenses. There are situations where the number of hours to complete projects may exceed our original estimate as a result of an increase in project scope or unforeseen events. The results of any revisions in these estimates are reflected in the period in which they become known.
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For managed service implementation contracts, revenue is recognized over time as a percentage of hours incurred to date as compared to the total expected hours of the implementation, consistent with the transfer of control to the customer. For ongoing managed services contract, revenue is recognized over time, consistent with the weekly or monthly fee specified within such arrangements.
We also derive revenues based on negotiating reductions in network costs of companies with the entity’s related service providers and providing other services such as audits of network and communication expenses, and consultation for network architecture. These contracts can be fixed in fees or can be based on the level of savings achieved related to its communications costs. Additionally, these contracts can also have a fixed component and a contingent component that is based on the savings generated by the Company. For network contingency contracts with termination for convenience clauses, revenue is recognized over time due to the existence of provisions for payment for progress incurred to date plus a reasonable profit margin. The contract periods range from a few months to in excess of a year.
We also enter into arrangements for the sale of robotics software licenses and related delivery of consulting or implementation services at the same time or within close proximity to one another. Such software-related performance obligations include the sale of software licenses and other software-related services. For software and implementation contracts, revenue associated with the software performance obligation is recognized at the point at which the software is installed, while revenue associated with the implementation service performance obligation is recognized over the software implementation period as a percentage of hours incurred to date as compared to the total expected hours.
Revenue associated with events is recognized at the point of time at which the event occurs. Conversely, revenue associated with research subscriptions is recognized over time, as the customer accesses our data or related platforms.
The agreements entered into in connection with a project typically allow our clients to terminate early due to breach or for convenience with 30 days’ notice. In the event of termination, the client is contractually required to pay for all time, materials and expenses incurred by us through the effective date of the termination. In addition, from time to time, we enter into agreements with clients that limit our right to enter into business relationships with specific competitors of that client for a specific time period. These provisions typically prohibit us from performing a defined range of services that we might otherwise be willing to perform for potential clients. These provisions are generally limited to six to twelve months and usually apply only to specific employees or the specific project team.
When we recognize revenues in advance of billing, those revenues are recorded as contract assets. When we receive cash in advance of completing services or earning revenues, those amounts are recorded as contract liabilities.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements included elsewhere in this report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
As a smaller reporting company, we are not required to provide the information required by this item.
Item 8. Financial Statements and Supplementary Data
Reference is made to our financial statements beginning on page F-1 of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None