Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report. In addition to historical data, the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed in our forward-looking statements as a result of various factors, including but not limited to those discussed under “Cautionary Note Regarding Forward-Looking Statements” and disclosed or referenced in Part I, Item 1A “Risk Factors” in this Annual Report. The following discussion and analysis also includes a discussion of certain non-GAAP financial measures. For a description and reconciliation of the non-GAAP measures discussed in this section, see “—Non-GAAP Financial Measures” below.
This Annual Report includes certain historical consolidated financial and other data for TaskUs, Inc. (“we,” “us,” “our” or the “Company”). The following discussion provides a narrative of our financial condition and results of operations for the fiscal year ended December 31, 2022 compared to the fiscal year ended December 31, 2021 . A discussion regarding our financial condition and results of operations for the fiscal year ended December 31, 2021 compared to the fiscal year ended December 31, 2020, other than the comparison of service revenue by delivery geography, can be found in “Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on March 9, 2022, which is incorporated herein by reference. India, which was previously included in Rest of World, is now reported separately within revenue disaggregation by geographical location. As a result, t he comparison of service revenue by delivery geography for the years ended December 31, 2021 and 2020 has been recast, and included in this Annual Report, for comparability.
Overview
We are a provider of outsourced digital services and next-generation customer experience to the world’s most innovative companies, helping our clients represent, protect and grow their respective brands. We serve our clients to support their end customers’ urgent needs, navigate an increasingly-complex compliance landscape, handle sensitive tasks, including online content moderation and enable artificial intelligence technology and automation. As of December 31, 2022, we served over 150 clients spanning established and emerging industry segments, including e-commerce, FinTech, food delivery and ride sharing, gaming, Technology, HealthTech, social media and streaming media.
Our global, omni-channel delivery model is focused on providing our clients three key services – Digital Customer Experience (“Digital CX”), Trust and Safety (formerly known as Content Security) and Artificial Intelligence (“AI”) Services (formerly known as AI Operations). 92% of our revenue for the year ended December 31, 2022 was delivered from non-voice, digital channels or omni-channel services which allow us to utilize resources efficiently, thereby driving higher profitability.
We have designed our platform to enable us to rapidly scale and benefit from our clients’ growth. We believe our ability to deliver “ridiculously good” outsourcing will enable us to continue to grow our client base.
At TaskUs, culture is at the heart of everything we do. Many of the companies operating in the Digital Economy are well-known for their obsession with creating a world-class employee experience. We believe clients choose TaskUs in part because they view our company culture as aligned with their own, which enables us to act as a natural extension of their brands and gives us an advantage in the recruitment of highly engaged frontline teammates who produce better results.
Business Highlights
We continued to grow revenue, despite challenging macroeconomic developments during 2022. As certain of our clients elected to shift work from the United States to the Philippines, India and Rest of World in 2022, we focused on working with clients to deliver service out of their optimal geography, which allows us to serve them better in the long-term, and cost management. We won 40 new clients in 2022, achieving a 43% new client win rate, and 63 current clients signed new statements of work with us.
Recent Financial Highlights
For the year ended December 31, 2022, we recorded service revenue of $960.5 million, a 26.3% increase from $760.7 million for the year ended December 31, 2021.
For the year ended December 31, 2022, we recorded net income of $40.4 million compared to a net loss of $58.7 million for the year ended December 31, 2021. This increase included expenses related to the one-time phantom shares bonuses and non-recurring teammate bonuses associated with the initial public offering ("IPO") of $133.7 million and the impact of our continued revenue growth, partially offset by higher non-cash stock-based compensation expense which we began recognizing upon the IPO, the impact of foreign currency exchange rate forward contracts, depreciation and rising interest rates. Adjusted Net Income for the year ended December 31, 2022 increased 10.4% to $142.8 million from $129.4 million for the year ended
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December 31, 2021. Adjusted EBITDA for the year ended December 31, 2022 increased 18.8% to $223.2 million from $187.9 million for the year ended December 31, 2021.
The operating results in any period are not necessarily indicative of the results that may be expected for any future period.
2022 Developments
Acquisition of heloo
On April 15, 2022, we acquired all of the equity interests of Parsec d.o.o. and Q Experience d.o.o. (collectively, "heloo"), a Croatia-based Digital Customer Experience solutions provider to European technology companies supporting 20 languages across seven additional Eastern European countries, including Bosnia, Serbia, and Slovenia. The results of operations of heloo subsequent to the April 15, 2022 acquisition date are included in the accompanying consolidated financial statements. See Note 3, "Business Combination" in the Notes to Consolidated Financial Statements included in this Annual Report.
Macroeconomic Trends
Macroeconomic factors, including global economic and geopolitical developments, increased inflation rates, interest rate increases, and foreign currency exchange rate changes, have direct and indirect impacts on our results of operations that are difficult to isolate and quantify. Due to market uncertainty and potential recession or other economic challenges, many of our customers are shifting their focus from growth to cost reduction resulting in certain customers electing to shift work from our onshore locations to our offshore delivery centers or reduce vendor spend across the board. This trend has been accelerated by our clients in the cryptocurrency and equity trading spaces. These factors contributed to a deceleration in our revenue growth rate and an increase in our operating costs. We expect some or all of these factors to continue to impact our operations in the near term; however, we believe that the increased cost focus also creates meaningful opportunities with both new and existing clients.
War in Ukraine
The Russian invasion of Ukraine and resulting sanctions and other measures imposed in response thereto have increased the level of economic and political uncertainty in Eastern Europe and worldwide. We do not have employees, facilities or operations in either Russia or Ukraine; however, the continuation of the conflict or its potential expansion into surrounding geographic areas, could directly impact us, our clients, vendors or subcontractors, which could impact our operations and financial performance. We continue to monitor the situation closely to ensure business continuity plans are in place for neighboring countries where we have a presence.
Trends and Factors Affecting our Performance
There are a number of key factors and trends affecting our results of operations.
New client wins and growing with our current clients
We won 40 new clients in 2022, and we achieved a 43% new client win rate for every dollar of new client opportunities we pursued. As of December 31, 2022 , we served over 150 of the world’s leading technology companies. In addition, over 99% of our revenues in 2022 were from recurring revenue contracts. As our clients grow in size and the complexity of their outsourcing needs increases, we believe we have an opportunity to increase the addressable spend available to TaskUs through enhanced penetration of current services as well as cross-selling new services. In 2022, 63 current clients signed new statements of work with us.
Expanded service offerings
We closely watch trends in the start-up and private equity space, working with founders and investors to develop custom service offerings. We also work closely with current and potential clients to develop offerings that we believe align with our core competencies and present an attractive market opportunity. This approach has earned us the opportunity to support some of the most innovative companies in history (often before anyone else) and has enabled significant expansion opportunities with large global enterprises. For example, we leveraged our knowledge of talent management and onboarding to launch our Learning Experience solution to support the onboarding and training of our clients’ employees and we significantly expanded our AI Services capabilities to respond to the needs of our largest clients.
Expanding geographically
We expanded our presence from 23 sites in ten countries as of December 31, 2021 to 27 sites in 13 countries as of December 31, 2022 . During 2022, we nearly doubled our Headcount in the Rest of World from approximately 2,200 employees as of December 31, 2021 to approximately 4,100 as of December 31, 2022. We have seen strong growth in Colombia, Greece and Malaysia, as well as Croatia and Serbia associated with our acquisition of heloo. We plan to continue expanding our geographic footprint to drive growth with both existing and new clients, which may result in one-time costs that may impact profitability.
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As we enter new geographies and make new capabilities available, clients may elect to move current work with TaskUs in one geography to another geography to optimize cost or to provide additional business continuity to their operations. These changes in geographic mix may result in fluctuations in revenue and cost of service which are driven by the geography in which the work is being performed. These fluctuations are in line with our business model, which aims to deliver service out of the optimal geography for our clients. This allows us to serve our clients better in the long-term in most cases and deepens our relationship as we tend to grow and operate over multiple geographies contemporaneously with our larger clients over time as they grow. These fluctuations might be especially noticeable in a particular service line or geography on a period over period basis.
Cost management and financial flexibility
During 2022, we enhanced our focus on cost management and financial flexibility. We conducted a comprehensive review of our cost structure in order to drive efficiencies across functions. We generated net cash flow from operating activities of $147.1 million and Free Cash Flow of $103.3 million, respectively, and refinanced our credit facility which increased our borrowing capacity on our revolving credit facility to $190.0 million. While we incurred certain one-time costs during the year, including severance in some cases, we believe these actions will have long-term benefits to the goal of enabling our future growth and profitability.
Hiring and retention of employees
In order to efficiently and effectively provide services to our clients, we must be able to quickly hire, train and retain employees. We offer our employees competitive wages with annual increases and also invest in their well-being. Our employee benefits and employee engagement costs may vary from period to period based on employee participation. We seek to retain sufficient employees to serve our clients’ increasing business needs and position ourselves for growth. We believe our focus on employee culture leads to lower employee attrition levels. Apart from driving our high client satisfaction and retention metrics, lower employee attrition leads to lower hiring and training costs and higher employee productivity. The voluntary attrition rate for employees who were employed by TaskUs for more than 180 days was 26.0% for the year ended December 31, 2022 .
Foreign currency fluctuations
We are subject to foreign currency exposure, primarily related to costs from the international locations in which we have operations. In order to mitigate this exposure, we enter into foreign currency exchange rate forward contracts for the larger geographies in which we operate to reduce the volatility of forecasted cash flows denominated in foreign currencies.
Key Components of Our Results of Operations
Service Revenue
We derive revenues from the following three service offerings:
• Digital Customer Experience: Principally consists of omni-channel customer care services primarily delivered through digital (non-voice) channels. Other solutions include customer care services for new product or market launches, trust & safety solutions and customer acquisition solutions.
• Trust and Safety: Principally consists of review and disposition of user and advertiser generated visual, text and audio content for purposes which include removal or labeling of policy violating, offensive or misleading content. We are developing and enforcing client designated Trust and Safety policies in several areas including intellectual property, job and commerce postings, objectionable material, political advertising, dating apps and digital marketplaces and gaming platforms. Also included in this area are our offerings for risk management, compliance, identity management and fraud.
• AI Services: Principally consists of high-quality data labeling services, annotation, context relevance and transcription services performed for the purpose of training and tuning machine learning algorithms, enabling them to develop cutting-edge AI systems.
As these services are delivered, we bill our clients on either time-and-materials, cost-plus, unit-priced, fixed-price, or outcome oriented basis. Service revenue from time-and-materials or cost-plus contracts is recognized as the services are performed. Service revenue from unit-priced contracts is recognized monthly as transactions are processed based on objective measures of output. Service revenue from fixed-price contracts is recognized monthly as service revenue is earned and obligations are fulfilled. Service revenue from outcome oriented contracts is recognized when it is reasonably certain that the desired outcome has been achieved.
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Operating Expenses
Cost of Services
Cost of services consists primarily of costs related to delivery of services, and consists primarily of personnel costs like salaries and wages, employee welfare, employee engagement, recruiting, professional development and stock-based compensation expense. Additionally, cost of services includes expenses related to sites and technology costs that can be directly attributed to the delivery of services.
Selling, General, and Administrative
Selling expenses consist of personnel costs, travel expenses, and other expenses for our client services, sales and marketing teams. Additionally, it includes costs of marketing and promotional events, corporate communications, and other brand-building activities.
General and administrative expenses consist of personnel costs and related expenses for technology, human resources, legal, finance, global shared services, and executives including, professional fees, insurance premiums, cloud-based capabilities and other corporate expenses.
Depreciation
Depreciation is computed on the straight-line basis over the estimated useful life of our property and equipment assets, generally three to five years or, for leasehold improvements, over the term of the lease, whichever is shorter.
Amortization of Intangible Assets
Amortization of intangible assets relates primarily to our client relationship and trade name intangibles, which are amortized over their useful lives using the straight-line method, which reflects the pattern of benefit, and assumes no residual value.
Other Expense (Income)
Other expense (income) primarily consists of gains and losses resulting from changes in the fair value of the foreign currency exchange rate forward contracts that we are party to. Our forward contracts are not designated as hedging instruments. Other income also includes gains and losses resulting from the remeasurement of U.S.-denominated accounts to foreign currency and interest income.
Financing Expenses
Financing expenses primarily consist of interest expenses related to our term loan and revolving credit facility in addition to commitment fees related to the undrawn delayed draw loan and revolver borrowings.
Provision for (Benefit From) Income Taxes
Provision for (benefit from) income taxes consists primarily of income taxes related to U.S. federal and state income taxes and income taxes in foreign jurisdictions in which we conduct business.
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Results of Operations
Comparison of the Years Ended December 31, 2022 and 2021
The following table sets forth our consolidated statement of income information for the years ended December 31, 2022 and 2021:
Year ended December 31, Period over Period Change
(in thousands) 2022 2021 ($) (%)
Service revenue $ 960,489 $ 760,703 $ 199,786 26.3 %
Operating expenses:
Cost of services 558,761 431,736 127,025 29.4 %
Selling, general, and administrative expense 260,003 335,312 (75,309) (22.5) %
Depreciation 37,915 29,038 8,877 30.6 %
Amortization of intangible assets 19,882 18,847 1,035 5.5 %
Loss on disposal of assets 31 52 (21) (40.4) %
Total operating expenses 876,592 814,985 61,607 7.6 %
Operating income (loss) 83,897 (54,282) 138,179 NM
Other expense 7,443 177 7,266 NM
Financing expenses 11,921 6,504 5,417 83.3 %
Income (loss) before income taxes 64,533 (60,963) 125,496 NM
Provision for (benefit from) income taxes 24,111 (2,265) 26,376 NM
Net income (loss) $ 40,422 $ (58,698) $ 99,120 NM
NM: not meaningful
Service revenue
Service revenue for the years ended December 31, 2022 and 2021 was $960.5 million and $760.7 million, respectively. Service revenue for the year ended December 31, 2022 increased by $199.8 million or 26.3% when compared to the year ended December 31, 2021.
Service revenue by service offering
The following table presents the breakdown of our service revenue by service offering for each period:
Year ended December 31, Period over Period Change
(in thousands) 2022 2021 ($) (%)
Digital Customer Experience
$ 637,587 $ 486,679 $ 150,908 31.0 %
Trust and Safety
178,409 169,080 9,329 5.5 %
AI Services
144,493 104,944 39,549 37.7 %
Service revenue
$ 960,489 $ 760,703 $ 199,786 26.3 %
The year over year growth in Digital Customer Experience, AI Services and Trust and Safety contributed 19.9%, 5.2% and 1.2%, respectively, of the total increase of 26.3% for the year ended December 31, 2022.
The 31.0% growth in Digital Customer Experience was primarily driven by an increase from existing clients in On Demand Travel + Transportation, FinTech, Entertainment + Gaming and Technology and new clients in On Demand Travel + Transportation, as well as new clients as a result of the acquisition of heloo.
The 37.7% growth in AI Services was driven by an increase from existing clients in Social Media and On Demand Travel + Transportation, partially offset by a decrease from Retail + E-Commerce.
The 5.5% growth in Trust and Safety was primarily driven by an increase from existing clients in Entertainment + Gaming, Retail + E-Commerce and FinTech, partially offset by a decrease from Social Media and On Demand Travel + Transportation.
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Service revenue by delivery geography
The majority of our service revenues are derived from contracts with clients who are either located in the United States, or with clients who are located outside of the United States but whereby the contract specifies payment in United States Dollars. However, we deliver our services from multiple locations around the world.
The following table presents the breakdown of our service revenue by geographical location, based on where the services are provided:
Year ended December 31, Period over Period Change
(in thousands) 2022 2021 ($) (%)
Philippines
$ 504,361 $ 402,340 $ 102,021 25.4 %
United States
252,457 246,642 5,815 2.4 %
India 102,561 56,216 46,345 82.4 %
Rest of World
101,110 55,505 45,605 82.2 %
Service revenue
$ 960,489 $ 760,703 $ 199,786 26.3 %
Revenue generated from services provided from our delivery sites in the Philippines grew primarily from expansion in all three of our service offerings, including the impact of certain clients electing to shift work from the United States. Digital Customer Experience contributed 15.4% of the total increase primarily driven by clients in On Demand Travel + Transportation, FinTech and Entertainment + Gaming. Trust and Safety contributed 7.4% of the total increase primarily driven by clients in Social Media and Retail + E-Commerce. AI Services contributed 2.6% of the total increase primarily driven by clients in Social Media as well as HealthTech, partially offset by clients in On Demand Travel + Transportation.
Revenue generated from services provided from our delivery sites in the United States grew primarily from expansion in two of our service offerings. Digital Customer Experience contributed 9.9% of the total increase primarily driven by clients in Technology, On Demand Travel + Transportation, Entertainment + Gaming and HealthTech, partially offset by clients in FinTech and Social Media. AI Services contributed 4.3% of the total increase primarily driven by clients in On Demand Travel + Transportation, partially offset by clients in Retail + E-Commerce. These increases were partially offset by an 11.8% decrease contributed by Trust and Safety primarily driven by clients in Social Media, partially offset by clients in FinTech. Certain of our clients elected to shift work from the United States to the Philippines and India in 2022. While we expect to see these shifts slow, we expect to grow faster outside of the United States in 2023 as we work to deliver service out of our clients' optimal geography, which allows us to serve them better in the long-term.
Revenue generated from services provided from our delivery sites in India grew primarily from expansion in all three of our service offering s, including the impact of certain clients electing to shift work from the United States. Digital Customer Experience contributed 40.2% of the total increase primarily driven by clients in On Demand Travel + Transportation and FinTech. AI Services contributed 33.1% of the total increase primarily driven by clients in Social Media, as well as HealthTech, On Demand Travel + Transportation and Retail + E-Commerce, partially offset by clients in FinTech. Trust and Safety contributed 9.1% of the total increase primarily driven by clients in Social Media, partially offset by clients in FinTech.
Revenue generated from services provided from our delivery sites in the Rest of World grew primarily from expansion in two of our service offerings. Digital Customer Experience contributed 77.0% of the total increase primarily driven by new clients as a result of the acquisition of heloo, clients in Entertainment + Gaming, FinTech and On Demand Travel + Tran sportation. Trust and Safety contributed 5.2% of the total increase primarily driven by clients in Entertainment + Gaming, partially offset by clients in On Demand Travel + Transportation. Growth in the Rest of World was led by Europe and Latin America.
Operating Expenses
Cost of Services
Cost of services for the years ended December 31, 2022 and 2021 was $558.8 million and $431.7 million, respectively. Cost of services for the year ended December 31, 2022 increased by $127.0 million, or 29.4%, when compared to the year ended December 31, 2021. The increase was primarily driven by higher personnel costs of $108.2 million related to an increase in Headcount to meet the demand in services from our customers. The remaining increase included costs associated with site expansions, returning a portion of employees back to office, and investments in software to support revenue growth.
Selling, general, and administrative expense
Selling, general, and administrative expense for the years ended December 31, 2022 and 2021 was $260.0 million and $335.3 million, respectively. Selling, general, and administrative expense for the year ended December 31, 2022 decreased by
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$75.3 million, or 22.5%, when compared to the year ended December 31, 2021. The decrease was primarily driven by lower personnel costs of $87.2 million due primarily to expenses related to the one-time phantom shares bonuses and non-recurring teammate bonuses associated with the IPO of $133.7 million , partially offset by higher stock-based compensation expense for equity-classified awards and increased headcount across functions in support of our growth, as well as earn-out consideration recognized as compensation expense. The decrease was partially offset by investments in software, as well as costs associated with resuming travel during 2022.
Depreciation
Depreciation for the years ended December 31, 2022 and 2021 was $37.9 million and $29.0 million, respectively. The increase in depreciation is a result of capital expenditures for additional technology and computers, as well as leasehold improvements associated with site expansions to support revenue growth .
Amortization of intangible assets
Amortization of intangible assets for the years ended December 31, 2022 and 2021 was $19.9 million, and $18.8 million, respectively. The increase in amortization is due to the acquisition of heloo on April 15, 2022. See Note 3, "Business Combination" in the Notes to Consolidated Financial Statements included in this Annual Report.
Other expense
Other expense for the years ended December 31, 2022 and 2021 was $7.4 million and $0.2 million, respectively. Changes in other expense are primarily driven by our exposure to foreign currency exchange risk resulting from our operations in foreign geographies, primarily the Philippines, offset by economic hedges using foreign currency exchange rate forward contracts.
Financing expense
Financing expense for the years ended December 31, 2022 and 2021 was $11.9 million and $6.5 million, respectively. Changes in financing expense are primarily driven by the rate of SOFR and LIBOR used to calculate the interest rate of our debt, the additional $32.5 million draw on our Revolving Credit Facility on April 12, 2022 to fund cash payments relating to our acquisition of heloo and the Refinancing. See “—Liquidity and Capital Resources—Indebtedness—2019 Credit Agreement” and “—2022 Credit Agreement” for additional discussion on term loan.
Provision for (benefit from) income taxes
Provision for (benefit from) income taxes for the years ended December 31, 2022 and 2021 was $24.1 million and $(2.3) million, respectively. Our effective tax rate for the years ended December 31, 2022 and 2021 was 37.4% and 3.7%, respectively. There are certain items included within the provision for (benefit from) income taxes calculation which were directly related to the IPO in 2021 and not expected to recur in future periods, including certain phantom shares bonuses and equity awards made to officers which are not deductible under Section 162(m) of the Internal Revenue Code. Additionally, costs related to the issuance of stock-based compensation and costs related to the acquisition of heloo within the provision for (benefit from) income taxes calculation are adjusted for Non-GAAP purposes. If those costs are removed, the provision for income taxes would have been $30.6 million and $23.0 million and the effective tax rate would have been 21.4% and 20.0% for the years ended December 31, 2022 and December 31, 2021, respectively.
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Comparison of the Years Ended December 31, 2021 and 2020
Service revenue
India, which was previously included in Rest of World, is now reported separately within revenue disaggregation by geographical location. As a result, t he comparison of service revenue by delivery geography for the years ended December 31, 2021 and 2020 has been recast, and included in this Annual Report, for comparability.
Service revenue by delivery geography
The majority of our service revenues are derived from contracts with clients who are either located in the United States, or with clients who are located outside of the United States but whereby the contract specifies payment in United States Dollars. However, we deliver our services from multiple locations around the world.
The following table presents the breakdown of our service revenue by geographical location, based on where the services are provided:
Year ended December 31, Period over Period Change
(in thousands) 2021 2020 ($) (%)
Philippines
$ 402,340 $ 267,687 $ 134,653 50.3 %
United States
246,642 171,476 75,166 43.8 %
India 56,216 16,069 40,147 249.8 %
Rest of World
55,505 22,814 32,691 143.3 %
Service revenue
$ 760,703 $ 478,046 $ 282,657 59.1 %
Revenue generated from services provided from our delivery sites in the Philippines grew from expansion in all three of our service offerings, Digital Customer Experience, Trust and Safety and AI Services, which contributed 29.7%, 12.8% and 7.8% of the total increase of 50.3% in the Philippines, respectively.
Revenue generated from services provided from our delivery sites in the United States grew from expansion in two of our service offerings, Digital Customer Experience and AI Services, which contributed 36.7% and 12.7% of the total increase of 43.8% in the United States, respectively, partially offset by a 5.6% decrease contributed by Trust and Safety due to the shift in revenues to the Philippines and Rest of World.
Revenues generated from services provided from our delivery sites in India grew primarily from expansion in all three of our service offerings, Digital Customer Experience, Trust and Safety and AI Services, which contributed 112.9%, 68.6% and 68.3% of the total increase of 249.8% in India, respectively.
Revenues generated from services provided from our delivery sites in the Rest of World grew primarily from expansion in all three of our service offerings, Digital Customer Experience, Trust and Safety and AI Services, which contributed 111.9%, 25.6% and 5.8% of the total increase of 143.3% in the Rest of World, respectively. Growth in the Rest of World was led by Latin America and Europe.
Revenue by Top Clients
The table below sets forth the percentage of our total service revenue derived from our largest clients for the years ended December 31, 2022 and 2021:
Year ended December 31,
2022 2021
Top ten clients
58 % 62 %
Top twenty clients
72 % 76 %
Our clients are part of the rapidly growing Digital Economy and they rely on our suite of digital solutions to drive their continued success. For our existing clients, we benefit from our ability to grow as they grow and to cross sell new solutions, further deepening our entrenchment.
For the years ended December 31, 2022 and 2021, we generated 22% and 27%, respectively, of our service revenue from our largest client, and we generated less than 10% and 11%, respectively, of our service revenue from our second largest client.
We continue to identify and target high growth industry verticals and clients. Our strategy is to win new clients and further grow with our existing ones in order to achieve meaningful client and revenue diversification over time.
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Foreign Currency
As a global company, we face exposure to movements in foreign currency exchange rates. Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts into U.S. Dollars. See Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” for additional information on how foreign currency impacts our financial results.
Key Operational Metrics
We regularly monitor the below operating metrics in order to measure our current performance and estimate our future performance:
Year ended December 31,
2022 2021
Headcount (approx. at period end) (1)
49,500 40,100
Net revenue retention rate (2)
114 % 141 %
(1) “Headcount” refers to the total number of TaskUs teammates globally as of the end of a given measurement period. As of December 31, 2022, our Headcount included approximately 500 contractor and agency teammates who support our heloo operations.
(2) “Net revenue retention rate” is an important metric we calculate annually to measure the retention and growth in the use of our services by our existing clients. Our net revenue retention rate as of a given fiscal year is calculated using a measurement period consisting of the two consecutive fiscal years ending with and including the most recent applicable fiscal year. Next, we define our “base cohort” as the population of clients that were using our services during the entire 12-month period of the first year of the measurement period. Net revenue retention rate is calculated as the quotient obtained by dividing (a) the revenue generated by the base cohort in the second year of measurement by (b) the revenue generated by the base cohort in the first year of measurement.
Non-GAAP Financial Measures
We use Adjusted Net Income, Adjusted Earnings Per Share (“EPS”), EBITDA, Adjusted EBITDA, Free Cash Flow and Conversion of Adjusted EBITDA, as key measures to assess the performance of our business.
Each of the measures are not recognized under accounting principles generally accepted in the United States of America ("GAAP") and do not purport to be an alternative to net income or cash flow as a measure of our performance. Such measures have limitations as analytical tools, and you should not consider any of such measures in isolation or as substitutes for our results as reported under GAAP. Additionally, Adjusted Net Income, Adjusted EPS, EBITDA, and Adjusted EBITDA exclude items that can have a significant effect on our profit or loss and should, therefore, be used in conjunction with profit or loss for the period. Our management compensates for the limitations of using non-GAAP financial measures by using them to supplement GAAP results to provide a more complete understanding of the factors and trends affecting the business than GAAP results alone. Because not all companies use identical calculations, these measures may not be comparable to other similarly titled measures of other companies.
Adjusted Net Income
Adjusted Net Income is a non-GAAP profitability measure that represents net income or loss for the period before the impact of amortization of intangible assets and certain items that are considered to hinder comparison of the performance of our business on a period-over-period basis or with other businesses. During the periods presented, we excluded from Adjusted Net Income amortization of intangible assets, transaction costs, earn-out consideration, the effect of foreign currency gains and losses, gains and losses on disposals of assets, COVID-19 related expenses, severance costs, natural disaster costs, one-time payments associated with the IPO, stock-based compensation expense and employer payroll tax associated with equity-classified awards and the related effect on income taxes of certain pre-tax adjustments, which include costs that are required to be expensed in accordance with GAAP. Our management believes that the inclusion of supplementary adjustments to net income (loss) applied in presenting Adjusted Net Income are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future.
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The following table reconciles net income, the most directly comparable GAAP measure, to Adjusted Net Income for the years ended December 31, 2022 and 2021:
Year ended December 31, Period over Period Change
(in thousands, except %) 2022 2021 ($) (%)
Net Income (loss)
$ 40,422 $ (58,698) $ 99,120 NM
Amortization of intangible assets
19,882 18,847 1,035 5.5 %
Transaction costs (1)
953 6,969 (6,016) (86.3) %
Earn-out consideration (2)
9,729 — 9,729 100.0 %
Foreign currency losses (3)
7,967 809 7,158 NM
Loss on disposal of assets
31 52 (21) (40.4) %
COVID-19 related expenses (4)
— 6,105 (6,105) (100.0) %
Severance costs (5)
821 — 821 100.0 %
Natural disaster costs (6)
— 442 (442) (100.0) %
Phantom shares bonus (7)
— 129,362 (129,362) (100.0) %
Teammate IPO bonus (8)
— 4,361 (4,361) (100.0) %
Stock-based compensation expense (9)
69,452 46,384 23,068 49.7 %
Tax impacts of adjustments (10)
(6,442) (25,244) 18,802 (74.5) %
Adjusted Net Income $ 142,815 $ 129,389 $ 13,426 10.4 %
Net Income (loss) Margin (11)
4.2 % (7.7) %
Adjusted Net Income Margin (11)
14.9 % 17.0 %
NM = not meaningful
(1) Represents non-recurring professional service fees primarily related to the acquisition of heloo in 2022 and the preparation for public offerings that have been expensed during the period in 2021.
(2) Represents earn-out consideration recognized as compensation expense related to the acquisition of heloo.
(3) Realized and unrealized foreign currency losses (gains) include the effect of fair market value changes of forward contracts and remeasurement of U.S. dollar-denominated accounts to foreign currency.
(4) Represents incremental expenses incurred that are directly attributable to the COVID-19 pandemic.
(5) Represents severance payments as a result of certain cost optimization measures we undertook during the period to restructure support roles.
(6) Represents one-time costs associated with emergency housing, transportation costs and bonuses for our employees in connection with the natural disaster related to the severe winter storm in Texas in February 2021.
(7) Represents expense for one-time, non-recurring payments of $127.5 million to vested phantom shareholders in connection with the completion of the IPO, as well as associated payroll tax and 401(k) contributions.
(8) Represents expense for non-recurring bonus payments to certain employees in connection with the completion of the IPO.
(9) Represents stock-based compensation expense associated with equity-classified awards, as well as associated payroll tax.
(10) Represents tax impacts of adjustments to net income (loss) which resulted in a tax benefit during the period, including phantom shares bonus related to the IPO, and stock-based compensation expense and earn-out consideration after the IPO.
(11) Net Income (Loss) Margin represents net income (loss) divided by service revenue and Adjusted Net Income Margin represents Adjusted Net Income divided by service revenue.
Adjusted EPS
Adjusted EPS is a non-GAAP profitability measure that represents earnings available to shareholders excluding the impact of certain items that are considered to hinder comparison of the performance of our business on a period-over-period basis or with other businesses. Adjusted EPS is calculated as Adjusted Net Income divided by our diluted weighted-average number of shares outstanding, including the impact of any potentially dilutive common stock equivalents that are anti-dilutive to GAAP net income (loss) per share – diluted (“GAAP diluted EPS”) but dilutive to Adjusted EPS. Our management believes that the inclusion of supplementary adjustments to earnings per share applied in presenting Adjusted EPS are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future.
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The following table reconciles GAAP diluted EPS, the most directly comparable GAAP measure, to Adjusted EPS for the years ended December 31, 2022 and 2021 :
Year ended December 31,
2022 2021
GAAP diluted EPS $ 0.39 $ (0.62)
Per share adjustments to net income (loss) (1)
1.00 1.98
Per share adjustments for GAAP anti-dilutive shares (2)
— (0.10)
Adjusted EPS $ 1.39 $ 1.26
Weighted-average common stock outstanding – diluted 102,603,179 94,832,137
GAAP anti-dilutive shares (2)
— 7,476,384
Adjusted weighted-average shares outstanding 102,603,179 102,308,521
(1) Reflects the aggregate adjustments made to reconcile net income (loss) to Adjusted Net Income, as noted in the above table, divided by the GAAP diluted weighted-average number of shares outstanding for the relevant period.
(2) Reflects the impact of awards that were anti-dilutive to GAAP diluted EPS since we were in a net loss position, and therefore not included in the calculation, but would be dilutive to Adjusted EPS and are therefore included in the calculation.
EBITDA and Adjusted EBITDA
EBITDA is a non-GAAP profitability measure that represents net income or loss for the period before the impact of the benefit from or provision for income taxes, financing expenses, depreciation, and amortization of intangible assets. EBITDA eliminates potential differences in performance caused by variations in capital structures (affecting financing expenses), tax positions (such as the availability of net operating losses against which to relieve taxable profits), the cost and age of tangible assets (affecting relative depreciation expense) and the extent to which intangible assets are identifiable (affecting relative amortization expense).
Adjusted EBITDA is a non-GAAP profitability measure that represents EBITDA before certain items that are considered to hinder comparison of the performance of our business on a period-over-period basis or with other businesses. During the periods presented, we excluded from Adjusted EBITDA transaction costs, earn-out consideration, the effect of foreign currency gains and losses, gains and losses on disposals of assets, COVID-19 related expenses, severance costs, natural disaster costs, one-time payments associated with the IPO and stock-based compensation expense and employer payroll tax associated with equity-classified awards, which include costs that are required to be expensed in accordance with GAAP. Our management believes that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future.
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The following table reconciles net income, the most directly comparable GAAP measure, to EBITDA and Adjusted EBITDA for the years ended December 31, 2022 and 2021:
Year ended December 31, Period over Period Change
(in thousands, except %) 2022 2021 ($) (%)
Net Income (loss)
$ 40,422 $ (58,698) 99,120 NM
Provision for (benefit from) income taxes 24,111 (2,265) 26,376 NM
Financing expenses 11,921 6,504 5,417 83.3 %
Depreciation 37,915 29,038 8,877 30.6 %
Amortization of intangible assets 19,882 18,847 1,035 5.5 %
EBITDA 134,251 (6,574) 140,825 NM
Transaction costs (1)
953 6,969 (6,016) (86.3) %
Earn-out consideration (2)
9,729 — 9,729 100.0 %
Foreign currency losses (3)
7,967 809 7,158 NM
Loss on disposals of assets 31 52 (21) (40.4) %
COVID-19 related expenses (4)
— 6,105 (6,105) (100.0) %
Severance costs (5)
821 — 821 100.0 %
Natural disaster costs (6)
— 442 (442) (100.0) %
Phantom shares bonus (7)
— 129,362 (129,362) (100.0) %
Teammate IPO bonus (8)
— 4,361 (4,361) (100.0) %
Stock-based compensation expense (9)
69,452 46,384 23,068 49.7 %
Adjusted EBITDA $ 223,204 $ 187,910 $ 35,294 18.8 %
Net Income Margin (10)
4.2 % (7.7) %
Adjusted EBITDA Margin (10)
23.2 % 24.7 %
NM = not meaningful
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(1) Represents non-recurring professional service fees primarily related to the acquisition of heloo in 2022 and the preparation for public offerings that have been expensed during the period in 2021.
(2) Represents earn-out consideration recognized as compensation expense related to the acquisition of heloo.
(3) Realized and unrealized foreign currency losses (gains) include the effect of fair market value changes of forward contracts and remeasurement of U.S. dollar-denominated accounts to foreign currency.
(4) Represents incremental expenses incurred that are directly attributable to the COVID-19 pandemic.
(5) Represents severance payments as a result of certain cost optimization measures we undertook during the period to restructure support roles.
(6) Represents one-time costs associated with emergency housing, transportation costs and bonuses for our employees in connection with the natural disaster related to the severe winter storm in Texas in February 2021.
(7) Represents expense for one-time, non-recurring payments of $127.5 million to vested phantom shareholders in connection with the completion of the IPO, as well as associated payroll tax and 401(k) contributions.
(8) Represents expense for non-recurring bonus payments to certain employees in connection with the completion of the IPO.
(9) Represents stock-based compensation expense associated with equity-classified awards, as well as associated payroll tax.
(10) Net Income (Loss) Margin represents net income (loss) divided by service revenue and Adjusted EBITDA Margin represents Adjusted EBITDA divided by service revenue.
Free Cash Flow
Free Cash Flow is a non-GAAP liquidity measure that represents our ability to generate additional cash from our business operations. Free Cash Flow is calculated as net cash provided by operating activities in the period minus cash used for purchase of property and equipment in the period. Our management believes that the inclusion of this non-GAAP measure, when considered with our GAAP results, provides management and investors with an additional understanding of our ability to generate additional cash for ongoing business operations and other capital deployment.
The following table reconciles net cash provided by (used in) operating activities, the most directly comparable GAAP measure, to Free Cash Flow for the years ended December 31, 2022 and 2021:
Year ended December 31,
2022 2021
Net cash provided by (used in) operating activities $ 147,095 $ (32,674)
Purchase of property and equipment (43,758) (59,363)
Free Cash Flow $ 103,337 $ (92,037)
Conversion of Adjusted EBITDA (1)
46.3 % (49.0) %
(1) Conversion of Adjusted EBITDA represents Free Cash Flow divided by Adjusted EBITDA.
Liquidity and Capital Resources
As of December 31, 2022, our principal sources of liquidity were cash and cash equivalents totaling $134.0 million, which were held for working capital purposes, as well as the available balance of our 2022 Credit Facilities, described further below. Historically, we have made investments in supporting the growth of our business, which were enabled in part by our positive cash flows from operations during these periods. We expect to continue to make similar investments in the future.
We have financed our operations primarily through cash received from operations. We believe our existing cash and cash equivalents and our 2022 Credit Facilities will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements will depend on several factors, including but not limited to our obligation to repay any amounts outstanding under our 2022 Credit Facilities, our revenue growth rate, timing of client billing and collections, the timing of expansion into new geographies, variability in the cost of delivering services in our geographies, the timing and extent of spending on technology innovation, the extent of our sales and marketing activities, and the introduction of new and enhanced service offerings and the continuing market adoption of our platform .
To the extent additional funds are necessary to meet our long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through the incurrence of additional indebtedness, additional equity financings or a combination of these potential sources of funds; however, such financing may not be available on favorable terms, or at all. If we are unable to raise additional funds when desired, our business, financial condition and results of operations could be adversely affected.
Potential investments in, or acquisitions of, complementary businesses, applications or technologies, could reduce our cash and cash equivalents, require us to seek additional equity or debt financing or repatriate cash generated by our international operations that could cause us to incur withholding taxes on any distributions. Additional funds from financing arrangements may not be available on terms favorable to us or at all.
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As market conditions warrant, we and certain of our equity holders, including Blackstone and their respective affiliates, may from time to time seek to purchase our outstanding debt securities or loans, including borrowings under our 2022 Credit Facilities, in privately negotiated or open market transactions, by tender offer or otherwise. Subject to any applicable limitations contained in the agreements governing our indebtedness, any purchases made by us may be funded by the use of cash on our balance sheet or the incurrence of new secured or unsecured debt, including borrowings under our credit facilities. The amounts involved in any such purchase transactions, individually or in the aggregate, may be material. Any such purchases may be with respect to a substantial amount of a particular class or series of debt, with the attendant reduction in the trading liquidity of such class or series. In addition, any such purchases made at prices below the “adjusted issue price” (as defined for U.S. federal income tax purposes) may result in taxable cancellation of indebtedness income to us, which amounts may be material, and in related adverse tax consequences to us .
In September 2022, our board of directors approved a share repurchase program of up to $100.0 million of shares of our Class A common stock. During the year ended December 31, 2022, we repurchased 1,649,931 shares of our Class A common stock under the share repurchase program for $31.0 million, which we funded principally with available cash. As of December 31, 2022, approximately $69.0 million remained available for share repurchases under our share repurchase program.
Indebtedness
As of December 31, 2022, our total indebtedness, net of debt financing fees was $267.6 million .
2019 Credit Agreement
On September 25, 2019, we entered into a credit agreement (the “2019 Credit Agreement”) that included a $210.0 million term loan (the “2019 Term Loan Facility”) and a $40.0 million revolving credit facility (the “2019 Revolving Credit Facility” and, together with the 2019 Term Loan Facility, the “2019 Credit Facilities”) . On April 30, 2021, we entered into Amendment No. 1 to the 2019 Credit Agreement with the existing lenders providing for $50.0 million incremental revolving credit commitments on the same terms as our existing revolving credit facility. On September 7, 2022, we entered into the 2022 Credit Agreement (as defined below) and the total outstanding debt under the 2019 Credit Facilities of $267.2 million was fully repaid.
2022 Credit Agreement
On September 7, 2022, we entered into a credit agreement (the “2022 Credit Agreement”) with both new and existing lenders which amended and restated the 2019 Credit Agreement. The 2022 Credit Agreement includes a $270.0 million term loan (the "2022 Term Loan Facility") and a $190.0 million revolving credit facility (the "2022 Revolving Credit Facility" and, together with the 2022 Term Loan Facility, the “2022 Credit Facilities”). The proceeds of the 2022 Term Loan Facility were used to repay all borrowings under the 2019 Credit Facilities, to pay related fees and expenses and for general corporate purposes. The Revolving Credit Facility includes a letter of credit sub-facility of up to $15.0 million, and the 2022 Credit Facilities include an uncommitted incremental facility, which, subject to certain conditions, would provide for additional term loan facilities, an increase in commitments under the Term Loan Facility and/or an increase in commitments under the Revolving Credit Facility, in an aggregate amount of up to $268.8 million (which may increase based on LTM Consolidated EBITDA (as defined in the 2022 Credit Agreement)) plus additional amounts based on achievement of a certain consolidated total net leverage ratio.
The 2022 Term Loan Facility matures on September 7, 2027, and commencing with the fiscal quarter ending December 31, 2022, requires quarterly principal payments of 0.25% of the original principal amount through September 30, 2023, 0.625% of the original principal amount through September 30, 2024, 1.25% of the original principal amount through September 30, 2025, 1.875% of the original principal amount through September 30, 2026 and 2.50% of the original principal amount thereafter, with the remaining principal due in a lump sum at the maturity date. Voluntary principal prepayments are permitted.
The 2022 Revolving Credit Facility provides us with access to a $15.0 million letter of credit facility and a $15.0 million swing line facility, each of which, to the extent used, reduces borrowing availability under the 2022 Revolving Credit Facility. The 2022 Revolving Credit Facility terminates on September 7, 2027. As of December 31, 2022, we had $190.0 million of borrowing available under the 2022 Revolving Credit Facility.
Borrowings under the 2022 Credit Agreement, with the exception of swing line borrowings, bear interest, at our option, either at (i) an adjusted Term Secured Overnight Financing Rate (“SOFR rate”) plus a margin of 2.25% per annum, subject to a SOFR rate floor of 0.00% or (ii) an alternative base rate plus a margin of 1.25% per annum, subject to an alternative base rate floor of 1.00%, Any borrowings under the swing line will be subject to the base rate. The 2022 Revolving Credit Facility also requires a commitment fee of 0.40% per annum of undrawn commitments to be paid quarterly in arrears. We have elected to pay interest on borrowings under the 2022 Term Loan Facility based on the SOFR rate. The interest rate in effect for the 2022 Term Loan Facility as of December 31, 2022 was 6.667% per annum.
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The 2022 Credit Agreement contains a financial covenant requiring compliance with a maximum total net leverage ratio and certain other covenants, including, among other things, covenants restricting additional borrowings, investments (including acquisitions) and distributions. We were in compliance with all debt covenants as of December 31, 2022. Substantially all assets of our direct wholly owned subsidiary TU MidCo, Inc., its wholly owned subsidiary TU BidCo, Inc. and its material wholly owned domestic subsidiaries are pledged as collateral under the 2022 Credit Agreement, subject to certain customary exceptions.
See Note 8, “Long-Term Debt” in the Notes to Consolidated Financial Statements included in this Annual Report for additional information regarding our debt.
Cash Flows
The following table presents a summary of our consolidated cash flows from operating, investing and financing activities for the periods indicated:
Year ended December 31,
(in thousands) 2022 2021
Net cash provided by (used in) operating activities $ 147,095 $ (32,674)
Net cash used in investing activities (67,993) (59,363)
Net cash provided by (used in) financing activities (4,035) 54,390
Operating Activities
Net cash provided by operating activities for the year ended December 31, 2022 was $147.1 million compared to net cash used in operating activities of $32.7 million for the year ended December 31, 2021. Net cash provided by operating activities for the year ended December 31, 2022 reflects net income of $40.4 million, as well as the add back for non-cash charges totaling $112.8 million, primarily driven by $69.0 million in stock-based compensation expense, $37.9 million of depreciation and $19.9 million of amortization of intangible assets, partially offset by deferred taxes of $11.8 million. These changes were partially offset by changes in operating assets and liabilities of $6.1 million. Net cash used in operating activities for the year ended December 31, 2021 reflects the net loss of $58.7 million, which includes the one-time phantom shares bonuses, as well as changes in operating assets and liabilities of $62.8 million, primarily driven by an increase in accounts receivable of $76.2 million. These changes were partially offset by the add back for non-cash charges totaling $88.8 million, primarily driven by $46.2 million in stock-based compensation expense, $29.0 million of depreciation and $18.8 million of amortization of intangible assets, partially offset by deferred taxes of $11.5 million.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2022 was $68.0 million compared to net cash used in investing activities of $59.4 million for the year ended December 31, 2021. The increase in net cash used from investing activities was primarily driven by the acquisition of heloo, net of cash received .
Financing Activities
Net cash used in financing activities for the year ended December 31, 2022 was $4.0 million compared to net cash provided by financing activities of $54.4 million for the year ended December 31, 2021. Net cash used in financing activities for the year ended December 31, 2022 consisted of payments on long-term debt, including the repayment of all outstanding borrowings under the 2019 Credit Facilities, payments to acquire shares under our share repurchase program, payments for taxes related to net share settlement of equity awards and payments for debt financing fees, mostly offset by proceeds from the 2022 Credit Facilities, borrowings from our 2019 Revolving Credit Facility and proceeds from employee stock plans. Net cash provided by financing activities for the year ended December 31, 2021 consisted of proceeds from the IPO, net of underwriters’ fees, partially offset by distribution of dividends, payments on long-term debt, payments for offering costs and payments for taxes related to net share settlement of equity awards.
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Contractual Obligations
Our principal commitments consist of obligations for outstanding debt and leases for our office space. The following table summarizes our contractual obligations as of December 31, 2022 :
Payments Due by Period
(in thousands) Total Current Noncurrent
Long-term debt obligations
$ 269,325 $ 3,712 $ 265,613
Operating lease obligations
49,560 13,528 36,032
Technology solution obligations
37,954 17,042 20,912
Total
$ 356,839 $ 34,282 $ 322,557
Technology solution obligations relate mainly to third-party cloud infrastructure agreements and subscription arrangements used to facilitate our operations at the enterprise level. If we fail to meet the minimum user or license commitment during any year, we are required to pay the difference.
In addition, in the ordinary course of business, we enter into agreements of varying scope and terms pursuant to which we agree to indemnify clients, vendors and other business partners with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, cybersecurity breach, services to be provided by us or from intellectual property infringement claims made by third parties. We have not included any such indemnification provisions in the contractual obligations table above. Historically, we have not experienced significant losses on these types of indemnification obligations.
JOBS Act Accounting Election
We qualify as an emerging growth company pursuant to the provisions of the JOBS Act. The JOBS Act permits an emerging growth company like us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to use the extended transition period until we are no longer an emerging growth company or until we choose to affirmatively and irrevocably opt out of the extended transition period. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements applicable to public companies.
Critical Accounting Estimates
Our consolidated financial statements and the related notes included elsewhere in this Annual Report are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, provision for income taxes, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Changes in accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.
We believe that the following critical accounting policies involve a greater degree of judgment or complexity than our other accounting policies. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition
We recognize revenue as services are performed and amounts are earned. Determining the method and amount of revenue to recognize requires us, at times, to make judgments and estimates. Specifically, we apply judgments in determining whether performance obligations are satisfied over-time and the method to measure progress towards completion. Additionally, the nature of our contracts gives rise to several types of variable consideration, including estimates on collectability, discounts, and client credits. Some contracts may include incentives or penalties related to costs incurred, benefits produced or adherence to schedules that may increase the variability in service revenues and margins earned on such contracts. Our estimates are monitored over the lives of our contracts and are based on an assessment of our anticipated performance, historical experience and other information available at the time.
Goodwill Impairment
Goodwill is the amount by which the cost of the acquired net assets in a business combination exceeds the fair value of the identifiable net assets on the date of purchase. Goodwill is not amortized.
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We review goodwill for impairment annually on October 1, or more frequently when events or circumstances indicate goodwill may be impaired. We may initially assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not that the estimated fair value of a reporting unit is less than its carrying amount (“Step 0”). If determined that it is more-likely-than-not the estimated fair value of a reporting unit is less than its carrying amount, a quantitative assessment is performe d (“Step 1”). Under FASB Topic ASC 350 Intangibles—Goodwill and Other, entities have an unconditional option to bypass the qualitative assessment described in the preceding sentences for any reporting unit in any period and proceed directly to performing the quantitative goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. We hav e determined that we have a single reporting unit. Historically, the fair value of our reporting unit was estimated using a combination of the income approach, using a discounted cash flow methodology, and a market approach; the determination of discounted cash flows was based on our strategic plans and market conditions. Upon completion of the IPO, a public trading market for our common stock was established and, as a result, we consider our market capitalization (calculated as total common shares outstanding multiplied by the common equity price per share, as adjusted for a control premium factor, as necessary) to represent fair value. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered to be impaired. If the carrying amount of the reporting unit exceeds its fair value, an impairment charge is recorded in an amount equal to that excess, but not more than the carrying value of goodwill.
As of October 1, 2022 and 2021, we opted to bypass the qualitative assessment under Step 0 and proceeded directly to performing a quantitative goodwill impairment test under Step 1. A s a result of the quantitative assessment, we determined that the carrying value of the reporting unit did not exceed its fair value.
Stock-based Compensation
We account for our stock-based awards in accordance with provisions of ASC 718, Compensation—Stock Compensation (“ASC 718”). For equity awards, total compensation cost is based on the grant date fair value. For liability awards, total compensation cost is based on the fair value of the award on the date the award is granted and its remeasured value at each reporting date until its settlement.
Awards granted to employees contain service, performance and market conditions that affect vesting. We use the Black-Scholes model to determine the fair value of stock options with either solely service conditions or with a combination of service and performance conditions. The assumptions used in the Black-Scholes model, other than the fair value of our common stock, are estimated as follows:
• Expected term: Estimated based on the simplified method as we do not have adequate historical data.
• Risk-free interest rate: Based on the U.S. Treasury yield curve in effect at the time of grant.
• Expected volatility: Based on the historical stock price volatility of comparable publicly-traded companies in our peer group and the implied volatility of our assets and current leverage.
• Expected dividend yield: Zero percent, as we do not anticipate paying dividends on our common stock.
Prior to the IPO, we valued our options using a combination of Monte Carlo simulation and Black-Scholes model. A Monte Carlo simulation was first used to determine the number of options eligible for vesting, then a Black-Scholes model was used to estimate the value for the vested options given the simulated scenario, with the assumption that vested options will be exercised at the mid-point from the vesting date to its maturity date. Key assumptions in performing the option valuation include the expected time to liquidity event, total equity value, value per common share, the discount for lack of marketability to be applied to the common shares, and volatility of the common shares.
For unvested awards with performance conditions, we assess the probability of attaining the performance conditions at each reporting period which requires judgment. Awards that are deemed probable of attainment are recognized in expense over the requisite service period of the grant using a graded vesting model.
Prior to the IPO, independent valuations were performed to assist management in determining the fair value of the common stock. Given the absence of an active market for our common stock prior to the IPO, the board of directors was required to estimate the fair value of our common stock at the time of each option grant based on several factors, including consideration of input from management and third-party valuations. Management considered numerous factors to determine the best estimate of the fair value of our common stock, including:
• our operating and financial performance – both historical and projected;
• current business conditions and projections;
• the likelihood of achieving a liquidity event such as an initial public offering or sale of our company;
• the lack of marketability of our shares;
• the market performance of comparable publicly traded companies and guideline transactions; and
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• the overall macroeconomic environment.
The value of the common shares was then used as an input to the option valuation. Upon completion of the IPO, a public trading market for our common stock was established, and as a result, it is no longer necessary for our board of directors or management to estimate the fair value of our common stock in connection with our accounting for stock-based awards, as the fair value of our common stock will be determined based on its trading price on Nasdaq.
See Note 11, “Stock-Based Compensation” in the Notes to Consolidated Financial Statements, for additional information.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
Recent Accounting Pronouncements
For additional information regarding recent accounting pronouncements adopted and under evaluation, refer to Note 2, “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements.