Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following management's discussion and analysis of financial condition and results of operations should be read together with our audited financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses 2021 and 2020 items and year-over-year comparisons between 2021 and 2020. Discussions of 2019 items and year-over-year comparisons between 2020 and 2019 are not included in this Form 10-K, and can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2020.
Certain amounts in this section may not add mathematically due to rounding. The abbreviation "nm" used the the following sections indicates the metric is not meaningful.
For a description and additional information about our three reportable segments, see Note 20, Segment Information , contained in " Item 8 - Financial Statements and Supplementary Data " of this Annual Report on Form 10-K.
Impact of COVID-19 on Results and Trends
The outbreak of COVID-19 in the U.S., which was declared a pandemic by the World Health Organization on March 11, 2020, adversely affected commercial activity and contributed to a significant decline in economic activity in 2020, particularly in the second quarter of 2020.
Starting in mid-March 2020 through April 2020, COVID-19 had a significant negative effect on our results. This impact was evident in a decline in merchant bankcard volume and our revenues particularly during the period of restrictive shelter-in-place requirements instituted across the U.S. toward the end of March 2020 through April 2020. In May 2020, as shelter-in-place restrictions began to be lifted and regional economies started to reopen, our processing volumes began to return, and revenue growth was supplemented by the acceleration of certain specialized product offerings and e-commerce payment transactions. This recovery momentum continued through the second half of 2020 and the year 2021.
While there continues to be uncertainty regarding the future economic impacts of COVID-19 variants, our operating results reflect a significant recovery from the pandemic's negative effects during the first half of 2020. The pandemic's impact on the overall economy and on our comparative historical and future results are beyond our ability to predict or control.
Results of Operations
This section includes certain components of our results of operations for the years ended December 31, 2021 (or "2021"), December 31, 2020 (or "2020") and December 31, 2019 (or "2019"). We have derived this data, except key indicators for merchant bankcard processing dollar values and transaction volumes, from our audited Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Revenue
For the year ended December 31, 2021, our consolidated revenue of $514.9 million increased by $110.6 million, or 27.4%, from $404.3 million for the year ended December 31, 2020. This overall increase was driven by an increase in bankcard volumes fueled by: 1) increased consumer spending resulting from post-pandemic recovery in the economy; and 2) acquisitions made by the Company.
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The following table shows our revenues by type for 2021, 2020 and 2019:
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Revenue Type:
Merchant card fees $ 468,764 $ 377,346 $ 339,450 $ 91,418 24.2 % $ 37,896 11.2 %
Outsourced services and other services 21,033 23,103 28,712 (2,070) (9.0) % (5,609) (19.5) %
Money transmission services revenue 19,415 — — 19,415 nm — nm
Equipment 5,689 3,893 3,692 1,796 46.1 % 201 5.4 %
Total revenues $ 514,901 $ 404,342 $ 371,854 $ 110,559 27.3 % $ 32,488 8.7 %
For the year ended December 31, 2021, our merchant card fees revenue of $468.8 million increased by $91.5 million, or 24.3%, from $377.3 million for the year ended December 31, 2020. This increase was driven by an increase in the merchant bankcard volume processed by the Company.
Outsourced services and other services revenue of $21.0 million for the year ended December 31, 2021 decreased by $2.1 million, or 9.1%, from $23.1 million for the year ended December 31, 2020, primarily due to the wind down of certain customer programs due to the impact of the COVID-19 pandemic.
Money transmission services revenue of $19.4 million for the year ended December 31, 2021 is related to the acquisition of Finxera Holdings, Inc. ("Finxera") in September 2021.
Equipment revenue of $5.7 million for the year ended December 31, 2021 increased by $1.8 million, or 46.2%, from $3.9 million for the year ended December 31, 2020. The increase was primarily due to the sale of equipment to new merchants added during the year.
Operating Expenses
Operating expenses for 2021, 2020 and 2019 were as follows:
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Operating expenses
Costs of services $ 359,885 $ 277,374 $ 252,569 $ 82,511 29.7 % $ 24,805 9.8 %
Salary and employee benefits 43,818 39,507 42,214 4,311 10.9 % (2,707) (6.4) %
Depreciation and amortization 49,697 40,775 39,092 8,922 21.9 % 1,683 4.3 %
Selling, general and administrative 28,408 25,825 30,795 2,583 10.0 % (4,970) (16.1) %
Total operating expenses $ 481,808 $ 383,481 $ 364,670 $ 98,327 25.6 % $ 18,811 5.2 %
Costs of Services
Costs of services of $359.9 million for the year ended December 31, 2021 increased by $82.5 million, or 29.7%, from $277.4 million for the year ended December 31, 2020, primarily due to the corresponding increase in revenues. For the year ended December 31, 2021, costs of services as a percentage of total revenues increased to 69.9% as compared to 68.6% for the year ended December 31, 2020. This increase was primarily due to bankcard volume growth from larger partners with higher commissions.
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Salary and Employee Benefits
Salary and employee benefits expense of $43.8 million for the year ended December 31, 2021 increased by $4.3 million, or 10.9%, from $39.5 million for the year ended December 31, 2020, primarily due to an increase in headcount related to our acquisition of Finxera in September 2021. The Company's employee headcount increased to 790 in 2021 from 479 in 2020.
Depreciation and Amortization Expense
Depreciation and amortization expense of $49.7 million for the year ended December 31, 2021 increased by $8.9 million, or 21.8%, from $40.8 million for the year ended December 31, 2020, primarily due to the recognition of finite lived intangible assets from the business combinations completed during the year, offset by a decrease related to the sale of certain assets from Priority Real Estate Technology, LLC's (" PRET") real estate services business in 2020.
Selling, General and Administrative
Selling, general and administrative expenses of $28.4 million for the year ended December 31, 2021 increased by $2.6 million, or 10.1%, from $25.8 million for the year ended December 31, 2020, primarily due to expenses from acquired businesses as well as one-time transaction expenses.
Other (Expenses) Income, net
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Other (expenses) income
Interest expense $ (36,485) $ (44,839) $ (40,653) $ 8,354 (18.6) % $ (4,186) 10.3 %
Debt extinguishment and modification costs (8,322) (1,899) — (6,423) 338.2 % (1,899) nm
Gain on sale of business and investment 7,643 107,239 — (99,596) (92.9) % 107,239 nm
Other income, net 202 596 710 (394) (66.1) % (114) (16.1) %
Total other (expenses) income, net $ (36,962) $ 61,097 $ (39,943) $ (98,059) (160.5) % $ 101,040 (253.0) %
Interest Expense
Interest expense of $36.5 million for the year ended December 31, 2021 decreased by $8.3 million, or 18.5%, from $44.8 million for the year ended December 31, 2020, primarily due to the lower rate of interest on the new loans secured by the Company in connection with the refinancing of its credit facilities in April 2021. The new term facility and revolving credit facility carry interest rates of 6.75% and 5.75% at December 31, 2021, respectively, as compared to the old term facility and subordinated term loan facility, which carried interest rates of 7.50% and 12.50% at December 31, 2020, respectively. The decrease in interest expense in 2021 was also driven by the timing of additional borrowings. The Company borrowed $320.0 million to fund the acquisition of Finxera in September 2021, which was only outstanding during part of the year.
Debt Extinguishment and Modification Costs
Debt extinguishment and modification costs for the year ended December 31, 2021 were $8.3 million, an increase of $6.4 million, or 336.8%, from $1.9 million for the year ended December 31, 2020. The Company refinanced its credit facilities in April 2021. As a result the Company expensed unamortized deferred costs and discounts of $3.0 million associated with the retirement of its subordinated debt facility and expensed $5.3 million of third-party costs incurred in connection with the refinancing. During 2020, the Company expensed unamortized deferred costs and discounts of $1.5 million associated with the $106.5 million principal prepayment for the term facility under our Senior Credit Facility and expensed $0.4 million of third-party costs incurred in connection with the amendment of its credit facilities.
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Gain on Sale of Business and Investment
Gain on sale of business and investment for the year ended December 31, 2021 was $7.6 million, which resulted from consideration received by the Company in connection with the termination of certain warrants held in the common stock of an entity that was sold during the year. Th e amount of consideration received may be subject to certain adjustments in the future related to a potential earn out that is contingent on 2022 performance. Any remaining payments made or received by the Company will be recorded in the period in which such amounts are finalized. For the year ended December 31, 2020, gain on sale of business and investment was $107.2 million, which was related to the sale of PRET's real estate services business in September 2020, as discussed in Note 6, Disposal of Business .
Income Tax Expense
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
(Loss) income before income taxes $ (3,869) $ 81,958 $ (32,759) $ (85,827) (104.7) % $ 114,717 (350.2) %
Income tax expense $ (5,258) $ 10,899 $ 830 $ (16,157) (148.2) % $ 10,069 1,213.1 %
Effective tax rate 135.9 % 13.3 % (2.5) %
The effective tax rate for 2021 increased primarily due to: 1) an increase in the valuation allowance against certain business interest carryover deferred tax assets; 2) non-deductible transaction costs incurred in the acquisition of Finxera; 3) the finalization of prior estimates on the sale of PRET's real estate services business impacting amounts attributable to noncontrolling partners; and 4) an increase in the tax basis of certain intangible assets resulting from a change in a subsidiary's entity status.
Our consolidated effective income tax rates differ from the statutory rate due to timing and permanent differences between amounts calculated under accounting principles GAAP and the U.S. tax code. The consolidated effective income tax rate for 2021 may not be indicative of our effective tax rate for future periods.
Earnings Attributable to Common Shareholders
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Net income (loss) $ 1,389 $ 71,059 $ (33,589) $ (69,670) (98.0) % $ 104,648 (311.6) %
Less: Dividends and accretion attributable to redeemable senior preferred stockholders (18,009) — — (18,009) nm — nm
Less: Non-controlling interests ("NCI") preferred unit redemptions, net of deferred tax benefit (8,021) — — (8,021) nm — nm
Less: Net income attributable to redeemable and redeemed NCIs — (45,398) — 45,398 (100.0) % (45,398) nm
Net (loss) income attributable to common stockholders $ (24,641) $ 25,661 $ (33,589) $ (50,302) (196.0) % $ 59,250 (176.4) %
Dividends and accretion attributable to redeemable senior preferred stockholders was $18.0 million for the year ended December 31, 2021, and was comprised of $8.7 million of accumulated dividends accrued as part of the carrying value of the redeemable senior preferred stock, $7.5 million of dividends that were paid in cash and $1.8 million related to the accretion of discounts and issuance cost for the redeemable senior preferred stock.
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NCI preferred unit redemptions was $(8.0) million for the year ended December 31, 2021, and was related to the redemption of the PHOT preferred units, as discussed in Note 15, Related Party Transactions .
Net income attributable to redeemable and redeemed NCIs for the year ended December 31, 2020 was $(45.4) million, which was related to the portion of the gain on the sale of PRET's real estate services business in 2020 that was due to the NCIs.
Segment Results
The Company reorganized its business segments as of December 31, 2021, resulting in three segments: Small and medium-sized businesses ("SMB") Payments, business-to-business ("B2B") Payments and Enterprise Payments. Segment results included in the discussion below were restated in accordance with the new segment structure for comparison purposes. The impact of the restatement of the prior period results is as follows:
SMB Payments (1)
B2B Payments (2)
Enterprise Payments (3)
2020 2019 2020 2019 2020 2019
Revenue:
Restated $ 370,521 $ 334,180 $ 20,922 $ 25,980 $ 12,899 $ 11,694
Historically reported 367,816 330,599 20,922 25,980 15,604 15,275
Difference $ 2,705 $ 3,581 $ — $ — $ (2,705) (3,581)
Operating Income:
Restated $ 37,897 $ 30,936 $ 923 $ (891) $ 1,899 $ 2,027
Historically reported 38,392 32,237 923 (891) 1,404 725
Difference $ (495) $ (1,301) $ — $ — $ 495 $ 1,302
Depreciation and Amortization:
Restated $ 35,627 $ 33,194 $ 306 $ 323 $ 3,674 $ 4,046
Historically reported 35,002 32,842 306 323 4,299 4,398
Difference $ 625 $ 352 $ — $ — $ (625) $ (352)
(1) Compared to the Company's legacy Consumer Payments segment.
(2) Compared to the Company's legacy Commercial Payments segment.
(3) Compared to the Company's legacy Integrated Partners segment.
SMB Payments
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Revenue $ 475,630 $ 370,521 $ 334,180 $ 105,109 28.4 % $ 36,341 10.9 %
Operating expenses 422,746 332,624 303,244 90,122 27.1 % 29,380 9.7 %
Operating income $ 52,884 $ 37,897 $ 30,936 $ 14,987 39.5 % $ 6,961 22.5 %
Operating margin 11.1 % 10.2 % 9.3 %
Depreciation and amortization $ 41,144 $ 35,627 $ 33,194 $ 5,517 15.5 % $ 2,433 7.3 %
Key Indicators:
Merchant bankcard processing dollar value $ 53,411,622 $ 42,020,429 $ 42,303,880 $ 11,391,193 27.1 % $ (283,451) (0.7) %
Merchant bankcard transaction volume 578,102 456,066 511,852 122,036 26.8 % (55,786) (10.9) %
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Revenue
Revenue from our SMB Payments segment was $475.6 million for the year ended December 31, 2021, compared to $370.5 million for the year ended December 31, 2020. The increase of $105.1 million, or 28.4%, was primarily driven by increased merchant bankcard volume. The Company's revenue from the SMB Payments segment as a percentage of merchant bankcard processing dollar value during 2021 remained consistent with 2020 at 0.9%.
Operating Income
Operating income from our SMB Payments segment was $52.9 million for the year ended December 31, 2021, compared to $37.9 million for the year ended December 31, 2020. The increase of $15.0 million, or 39.6%, was primarily driven by the increase in sales and the cost benefit tied to purchased residuals from an acquired portfolio.
B2B Payments
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Revenue $ 17,138 $ 20,922 $ 25,980 $ (3,784) (18.1) % $ (5,058) (19.5) %
Operating expenses 17,003 19,999 26,871 (2,996) (15.0) % (6,872) (25.6) %
Operating income $ 135 $ 923 $ (891) $ (788) (85.4) % $ 1,814 (203.6) %
Operating margin 0.8 % 4.4 % (3.4) %
Depreciation and amortization $ 294 $ 306 $ 323 $ (12) (3.9) % $ (17) (5.3) %
Key Indicators:
Merchant bankcard processing dollar value $ 323,502 $ 249,779 $ 312,342 $ 73,723 29.5 % $ (62,563) (20.0) %
Merchant bankcard transaction volume 220 102 109 118 115.7 % (7) (6.4) %
Revenue
Revenue from our B2B Payments segment was $17.1 million for the year ended December 31, 2021, compared to $20.9 million for the year ended December 31, 2020. The decrease of $3.8 million, or 18.2%, was primarily driven by the wind down of certain programs in the Managed Services business due to scaled back operations as a result of the COVID-19 pandemic.
Operating Income
Operating income from our B2B Payments segment was $0.1 million for the year ended December 31, 2021, compared to $0.9 million for the year ended December 31, 2020. The decrease of $0.8 million, or 88.9%, was primarily attributable to the decrease in revenue from the Managed Services business due to scaled back operations as a result of the COVID-19 pandemic.
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Enterprise Payments
(in thousands) Years Ended December 31, 2021 vs 2020 2020 vs 2019
2021 2020 2019 $ Change % Change $ Change % Change
Revenue $ 22,133 $ 12,899 $ 11,694 $ 9,234 71.6 % $ 1,205 10.3 %
Operating expenses 15,370 11,000 9,667 4,370 39.7 % 1,333 13.8 %
Operating income $ 6,763 $ 1,899 $ 2,027 $ 4,864 256.1 % $ (128) (6.3) %
Operating margin 30.6 % 14.7 % 17.3 %
Depreciation and amortization $ 7,158 $ 3,674 $ 4,046 $ 3,484 94.8 % $ (372) (9.2) %
Key Indicators:
Merchant bankcard processing dollar value $ 52,376 $ 46,542 $ 386,101 $ 5,834 12.5 % $ (339,559) (87.9) %
Merchant bankcard transaction volume 549 487 1,380 62 12.7 % (893) (64.7) %
Revenue
Revenue from our Enterprise Payments segment was $22.1 million for the year ended December 31, 2021, compared to $12.9 million for the year ended December 31, 2020. The increase of $9.2 million, or 71.3%, was primarily driven by revenues contributed by the Finxera business since its acquisition in September 2021, offset by decreases due to the sale of PRET's real estate services business in 2020.
Operating Income
Operating income from our Enterprise Payments segment was $6.8 million for the year ended December 31, 2021, compared to $1.9 million for the year ended December 31, 2020. The increase of $4.9 million, or 257.9%, was primarily driven by operating income contributed by the Finxera business since its acquisition in September 2021.
Depreciation and Amortization
Depreciation and amortization expense from our Enterprise Payments segment was $7.2 million for the year ended December 31, 2021, compared to $3.7 million for the year ended December 31, 2020. The increase of $3.5 million, or 94.6%, was primarily driven by the amortization of intangibles resulting from the Finxera acquisition in September 2021.
Liquidity and Capital Resources
Liquidity and capital resource management is a process focused on providing the funding we need to meet our short-term and long-term cash and working capital needs. We have used our funding sources to build our merchant portfolio, technology solutions, and to make acquisitions with the expectation that such investments will generate cash flows sufficient to cover our working capital needs and other anticipated needs, including for our acquisition strategy. We anticipate that cash on hand, funds generated from operations and available borrowings under our revolving credit agreement are sufficient to meet our working capital requirements for at least the next twelve months.
Our principal uses of cash are to fund business operations, administrative costs and debt service.
Our working capital, defined as current assets less current liabilities, was $19.6 million at December 31, 2021 and $(13.0) million at December 31, 2020. As of December 31, 2021, we had cash totaling $20.3 million compared to $9.2 million at December 31, 2020. These cash balances do not include restricted cash of $28.9 million and $78.9 million at December 31, 2021 and December 31, 2020, respectively, which reflects cash accounts holding customer settlement funds and cash reserves
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for potential losses. The current portion of long-term debt included in current liabilities was $6.2 million at December 31, 2021 compared with $19.4 million at December 31, 2020.
At December 31, 2021, we had availability of approximately $25.0 million under our revolving credit arrangement.
The following tables and narrative reflect our changes in cash flows for the comparative annual periods.
Years Ended December 31,
(in thousands) 2021 2020
Net cash provided by (used in):
Operating activities $ 9,377 $ 12,202
Investing activities (451,033) 166,396
Financing activities 871,629 (140,943)
Net increase in cash and restricted cash $ 429,973 $ 37,655
Cash Provided by Operating Activities
Net cash provided by operating activities was $9.4 million and $12.2 million for the years ended December 31, 2021 and December 31, 2020, respectively. The $2.8 million, or 23.0% decrease in 2021 was primarily driven by the payment of payment-in-kind ("PIK") interest upon the refinancing of our credit facilities in April 2021 and changes in operating assets and liabilities offset by cash generated from the operations of the Company.
Cash (Used in) Provided by Investing Activities
Net cash used in investing activities was $451.0 million compared to cash provided by investing activities of $166.4 million for the years ended December 31, 2021 and 2020, respectively. For 2021, net cash used in investing activities included cash purchase consideration of $407.1 million for the acquisition of businesses, additions to property, equipment and software of $9.7 million, and acquisitions of intangible assets of $49.5 million, offset by proceeds from the sale of an investment of $15.3 million. For 2020, net cash provided by investing activities included proceeds from the sale of a business of $179.4 million, offset by additions to property, equipment and software of $7.5 million, and acquisitions of intangible assets of $5.6 million.
Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities was $871.6 million for the year ended December 31, 2021, compared to $140.9 million of cash used in financing activities in the year ended December 31, 2020. The net cash provided by financing activities for 2021 included proceeds from the issuance of new debt of $598.2 million, net borrowings from the revolving credit facility of $15.0 million, proceeds from the issuance of the redeemable senior preferred stock of $211.0 million, proceeds from the exercise of stock options of $1.2 million and changes in the net obligations for funds held on the behalf of customers of $417.6 million. These cash inflows were offset by cash used for the repayment of debt of $361.4 million, cash used for the repurchase of common stock of $1.7 million, dividends paid to redeemable senior preferred stockholders of $7.5 million and distribution to NCIs in subsidiaries of $0.8 million. The net cash used in financing activities for 2020 included changes in the net obligations for funds held on the behalf of customers of $34.9 million. This cash inflow was offset by cash used for the repayment of debt of $113.3 million, net repayment under the revolving credit facility of $11.5 million, redemption of NCI interest in subsidiary of $5.7 million, and distribution to NCIs in subsidiaries of $45.4 million.
Long-Term Debt
On April 27, 2021, the Company entered into a Credit and Guaranty Agreement with Truist Bank ("Truist") (the "Credit Agreement") which provides for: 1) a $300.0 million senior secured term loan facility (the "initial term loan"); 2) a $290.0 million senior secured delayed draw term loan facility (the "delayed draw term loan") (together, the "term facility"); and 3) a $40.0 million senior secured revolving credit facility. The Credit Agreement was amended on September 17, 2021 to
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increase the amount of the delayed draw term loan facility by $30.0 million to $320.0 million. The additional delayed draw term loan is part of the same class of term loans made pursuant to the original commitments under the Credit Agreement.
Outstanding borrowings under the Credit Agreement accrue interest using either a base rate or a LIBOR rate plus an applicable margin per year, subject to a LIBOR rate floor of 1.00% per year. Accrued interest is payable on each interest payment date (as defined in the Credit Agreement). The revolving credit facility incurs an unused commitment fee on any undrawn amount in an amount equal to 0.50% per year of the unused portion. The future applicable interest rate margins may vary based on the Company's Total Net Leverage Ratio in addition to future changes in the underlying market rates for LIBOR and the rate used for base-rate borrowings.
As of December 31, 2021, we had outstanding debt obligations, including the current portion and net of unamortized debt discount of $610.3 million, compared to $377.3 million at December 31, 2020, resulting in an increase of $233.0 million. The debt balance at December 31, 2021 consisted of $616.9 million outstanding under the term facility and $15.0 million outstanding under the revolving credit facility, offset by $21.6 million of unamortized debt discounts and issuance costs. Minimum amortization of the initial term loan are equal quarterly installments in aggregate annual amounts equal to 1.0% of original principal, with the balance paid upon maturity. The term facility matures in April 2027 and the revolving credit facility expires in April 2026.
The Credit Agreement contains representations and warranties, financial and collateral requirements, mandatory payment events, events of default and affirmative and negative covenants, including without limitation, covenants that restrict among other things, the ability to create liens, pay dividends or distribute assets from the loan parties to the Company, merge or consolidate, dispose of assets, incur additional indebtedness, make certain investments or acquisitions, enter into certain transactions (including with affiliates) and to enter into certain leases.
If the aggregate principal amount of outstanding revolving loans and letters of credit under the Credit Agreement exceeds 35% of the total revolving facility thereunder, the loan parties are required to comply with certain restrictions on its Total Net Leverage Ratio, which is defined in the Credit Agreement as the ratio of consolidated total debt to the Consolidated Adjusted EBITDA (as defined in the Credit Agreement). If applicable, the maximum permitted Total Net Leverage Ratio is: 1) 6.50:1.00 at each fiscal quarter ended September 30, 2021 through June 30, 2022; 2) 6.00:1.00 at each fiscal quarter ended September 30, 2022 through June 30, 2023; and 3) 5.50:1.00 at each fiscal quarter ended September 30, 2023 each fiscal quarter thereafter. As of December 31, 2021, the Company was in compliance with our financial covenants.
Critical Accounting Policies and Estimates
Our accounting policies are more fully described in Note 1, Nature of Business and Accounting Policies . The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective, and complex judgments.
Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered or settled. Realization of deferred tax assets is dependent upon future taxable income. A valuation allowance is recognized if it is more likely than not that some portion or all of a deferred tax asset will not be realized based on the weight of available evidence, including expected future earnings.
We recognize an uncertain tax position in our financial statements when we conclude that a tax position is more likely than not to be sustained upon examination based solely on its technical merits. Only after a tax position passes the first step of recognition will measurement be required. Under the measurement step, the tax benefit is measured as the largest amount of
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benefit that is more likely than not to be realized upon effective settlement. This is determined on a cumulative probability basis. The full impact of any change in recognition or measurement is reflected in the period in which such change occurs. Interest and penalties related to income taxes are recognized in the provision for income taxes.
Goodwill and Long-lived Assets
We test goodwill for impairment for each of our reporting units on an annual basis on annual assessment date of October 1 or when events occur, or circumstances indicate the fair value of a reporting unit may be below its carrying value. We may perform a quantitative assessment that uses market data and discounted cash flow analysis, which involve estimates of future revenues and operating cash flows. Where deemed appropriate, we may perform the annual assessment using the optional qualitative method. By using the October 1 annual assessment date, we believe that we will be able to utilize more readily available data from both internal and external sources and have additional time to evaluate the data prior to finalizing our year-end Consolidated Financial Statements and disclosures. This annual impairment assessment for goodwill does not change our requirements to assess goodwill on an interim date between scheduled annual testing dates if triggering events are present.
We review our long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. For long-lived assets, except goodwill, an impairment loss is indicated when the undiscounted future cash flows estimated to be generated by the asset group are not sufficient to recover the unamortized balance of the asset group.
We amortize the cost of our acquired intangible assets over their estimated useful lives using either a straight-line or an accelerated method that most accurately reflects the estimated pattern in which the economic benefit of the respective asset is consumed.
Business Combinations
We allocate the purchase price of an acquired business to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. For acquisitions that include contingent consideration, we estimate the fair value of contingent consideration at the acquisition date. The estimated fair value of contingent consideration is updated in future periods based on information available at that time. Management uses all available information when estimating the fair values of the assets acquired, liabilities assumed and contingent consideration, and must apply judgement and make certain assumptions when making these estimates. The assumptions management uses when determining fair values include estimated future cash flows or income, market rate assumptions, actuarial assumptions and discount rate assumptions. We typically engage third-party valuation advisors to assist in estimating the fair values of acquired assets and assumed liabilities. Our estimates of fair value are based upon assumptions the Company believes to be reasonable, but that are inherently uncertain, and therefore, may not be realized. Accordingly, there can be no assurance that the estimates, assumptions and values reflected in the valuations will be realized, and actual results could differ materially.