1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
We prepared our interim condensed consolidated financial statements that accompany these notes in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
The interim financial information is unaudited, but reflects all normal adjustments that are, in our opinion, necessary to provide a fair statement of results for the interim periods presented. Certain information and note disclosures normally included in the annual financial statements have been omitted pursuant to those instructions. This interim information should be read in conjunction with the consolidated financial statements for the year ended
December 31, 2016
, contained in our Annual Report on Form 10-K and filed with the Securities and Exchange Commission on
March 15, 2017
. Interim results may not be indicative of our full-fiscal year performance.
Corporate Organization
The KeyW Holding Corporation (Holdco or KeyW) was incorporated in Maryland in December 2009. Holdco is a holding company and conducts its operations through The KeyW Corporation (Opco), and its wholly owned subsidiaries. As used herein, the terms “KeyW”, the “Company,” and “we,” “us,” and “our” refer to Holdco and, unless the context requires otherwise, its subsidiaries, including Opco.
As further described in Note 12 - Businesses Held for Sale, Discontinued Operations and Dispositions, during the second quarter of 2016, the Company sold the Hexis Cyber Solutions, Inc. (Hexis) business in its entirety. The Hexis business marketed our HawkEye products and related maintenance and services to the commercial cyber sector and comprised our entire former Commercial Cyber Solutions reportable segment. Our Commercial Cyber Solutions segment is reflected in the accompanying condensed consolidated financial statements as a discontinued operation. References to financial data are to the Company's continuing operations, unless otherwise noted.
KeyW is a highly specialized provider of advanced engineering and technology solutions to support the collection, processing, analysis and dissemination of information across the full spectrum of the Intelligence, Cyber and Counterterrorism Communities’ missions. Our solutions protect our nation and its allies, and are designed to meet the critical needs of agile intelligence and U.S. government national security priorities. Our core capabilities include advanced cyber operations and training; geospatial intelligence; cloud and data analytics; engineering; and intelligence analysis and operations. Other KeyW offerings include a suite of Intelligence Surveillance and Reconnaissance (ISR) solutions deployed from an advanced sensor delivery platform, proprietary products-including electro-optical, hyperspectral and synthetic aperture radar sensors-and other products that we manufacture and integrate with hardware and software to meet unique and evolving intelligence mission requirements.
KeyW's solutions focus on Intelligence Community (IC) customers, including the National Security Agency (NSA), the National Geospatial Intelligence Agency (NGA), the Army Geospatial Center (AGC) and other agencies within the IC and Department of Defense (DoD). In addition, we provide products and services to U.S. federal, state and local law enforcement agencies, foreign governments and other entities in the Cyber and Counterterrorism markets. KeyW's acquisition of Sotera Holdings Inc., a Delaware corporation (Sotera) on April 4, 2017, provides new and enhanced access to agencies within the IC. Sotera will add high-priority new customer agencies to KeyW’s existing IC portfolio, including highly sought-after Federal Bureau of Investigation (FBI) and Department of Homeland Security (DHS) customers, and create additional inroads at new areas of the DoD (e.g., Army Intelligence). We believe the combination of our advanced solutions, understanding of our customers’ mission, longstanding and successful customer relationships, operational capabilities and highly skilled, cleared workforce will help expand our footprint in our core markets.
Principles of Consolidation
The condensed consolidated financial statements include the transactions of KeyW, Opco and their wholly owned subsidiaries from the date of their acquisition. All intercompany accounts and transactions have been eliminated.
Revenue Recognition
We derive the majority of our revenue from time-and-materials, firm-fixed-price, cost-plus-fixed-fee and cost-plus-award-fee contracts.
Revenue from cost reimbursable contracts are recorded as reimbursable costs are incurred, including an estimated share of the applicable contractual fees earned. For performance-based fees under cost reimbursable contracts, we recognize the relevant
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
portion of the expected fee to be awarded by the client at the time such fee can be reasonably estimated, based on factors such as prior award experience and communications with the client regarding performance. For time-and-materials contracts, revenue is recognized based on billable rates times hours delivered plus materials and other reimbursable costs incurred. For firm-fixed-price service contracts, revenue is recognized using the proportional performance based on the estimated total costs of the project or percentage of completion. For fixed-price production contracts, revenue and cost are recognized at a rate per unit as the units are delivered or by other methods to measure services provided. This method of accounting requires estimating the total revenues and total contract costs of the contract. During the performance of contracts, these estimates are periodically reviewed and revisions are made as required. The impact on revenue and contract profit as a result of these revisions is included in the periods in which the revisions are made. This method can result in the deferral of costs or the deferral of profit on these contracts. Because we assume the risk of performing a fixed-price contract at a set price, the failure to accurately estimate ultimate costs or to control costs during performance of the work could result, and in some instances, has resulted in reduced profits or losses on such contracts. Estimated losses on contracts at completion are recognized when probable and reasonably estimable.
Contract revenue recognition inherently involves estimation. Examples of estimates include the contemplated level of effort to accomplish the tasks under the contract, the cost of the effort, and an ongoing assessment of our progress toward completing the contract. From time to time, as part of our management processes, facts develop that require us to revise our estimated total costs or revenue. To the extent that a revised estimate affects contract profit or revenue previously recognized, we record the cumulative effect of the revision in the period in which the facts requiring the revision become known.
In certain circumstances, and based on correspondence with the end customer, management authorizes work to commence or to continue on a contract option, addition or amendment prior to the signing of formal modifications or amendments. We recognize revenue to the extent it is probable that the formal modifications or amendments will be finalized in a timely manner and that it is probable that the revenue recognized will be collected.
Cost of Revenue
Cost of revenue consists primarily of compensation expenses for program personnel, the fringe benefits associated with this compensation and other direct expenses incurred to complete programs, including cost of materials, depreciation and subcontract efforts.
Inventories
Inventories are valued at the lower of cost or net realizable value. Our inventory consists of specialty products that we manufacture on a limited quantity basis for our customers. As of
June 30, 2017
and
December 31, 2016
, we had an inventory reserve balance of
$0.7 million
and
$0.6 million
, respectively, for certain products where the market has not developed as expected.
Accounts Receivable
Accounts receivable are stated at the amount management expects to collect from outstanding balances. Invoice terms range from net
10
days to net
90
days. Management provides for probable uncollectible amounts through a charge to earnings and a credit to an allowance for doubtful accounts based on its assessment of the status of individual accounts. Balances that are still outstanding after management has used reasonable collection efforts are written-off through a charge to the valuation allowance and a credit to accounts receivable. For the
six months ended June 30, 2017
and 2016, there were no charges recorded to the valuation allowance.
Property and Equipment
All property and equipment are stated at acquisition cost or, in the case of self-constructed assets, the cost of labor and a reasonable allocation of overhead costs (no general and administrative costs are included). The cost of maintenance and repairs, which do not significantly improve or extend the life of the respective assets, are charged to operations as incurred.
Provisions for depreciation and amortization are computed on either a straight-line method or accelerated methods acceptable under U.S. GAAP over the estimated useful lives of between
three
and
seven years
. Leasehold improvements are amortized over the lesser of the lives of the underlying leases or the estimated useful lives of the assets.
Lease Incentives
As part of entering into certain building leases, the lessors have provided the Company with tenant improvement allowances. Typically, such allowances represent reimbursements to the Company for tenant improvements made to the leased space. These improvements are capitalized as property and equipment, and the allowances are classified as a deferred lease incentive liability. This incentive is considered a reduction of rental expense by the lessee over the term of the lease and is recognized on a straight-line basis over the same term.
Software Development Costs
Costs of internally developed software for resale are expensed until the technological feasibility of the software product has been
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
established. In accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC), software development costs are capitalized and amortized over the product's estimated useful life. As of
June 30, 2017
and
December 31, 2016
, we had capitalized
$2.1 million
of software development costs. Capitalized software development costs are amortized using the greater of the straight-line method or as a percentage of revenue recognized from the sale of the capitalized software. During the
three months ended June 30, 2017
and
2016
, the Company recorded related amortization of
$0.1 million
and
$0.4 million
, respectively. During the
six months ended June 30, 2017
and
2016
, the Company recorded related amortization of
$0.2 million
and
$0.4 million
, respectively.
Long-Lived Assets (Excluding Goodwill)
The Company follows the provisions of FASB ASC topic 360-10-35,
Impairment or Disposal of Long-Lived Assets,
in accounting for long-lived assets such as property and equipment and intangible assets subject to amortization. The guidance requires that long-lived assets be reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. The possibility of impairment exists if the sum of the long-term undiscounted cash flows is less than the carrying amount of the long-lived asset being evaluated. Impairment losses are measured as the difference between the carrying value of long-lived assets and their fair market value based on discounted cash flows of the related assets. Impairment losses are treated as permanent reductions in the carrying amount of the assets. The Company has not recorded any long-lived asset impairments since inception.
Goodwill
Purchase price in excess of the fair value of tangible assets and identifiable intangible assets acquired and liabilities assumed in a business combination is recorded as goodwill. In accordance with FASB ASC Topic 350-20,
Goodwill
, the Company tests for impairment at least annually or more frequently if impairment indicators arise. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit's carrying amount, including goodwill, to the fair value of the reporting unit. As a result of the adoption of Accounting Standards Update (ASU) 2017-04, Intangibles - Goodwill and Other, we have the option (which may be bypassed at our election) to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, based on our review of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value, we perform a quantitative impairment test to identify goodwill impairment and measure the amount of goodwill impairment loss to be recognized (if any) by comparing the fair value of a reporting unit with its carrying amount, using a combination of income and market approaches. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
Determining the fair value of a reporting unit is a judgment involving significant estimates and assumptions. These estimates and assumptions include revenue growth rates, operating margins and working capital requirements used to calculate projected future cash flows, risk-adjusted discount rates, selected multiples, control premiums and future economic and market conditions. We have based our fair value estimates on assumptions that we believe to be reasonable, but that are unpredictable and inherently uncertain. The Company completed its annual evaluation of goodwill at the beginning of the fourth quarter of fiscal year 2016 and found no impairment to the carrying value of goodwill.
We routinely review goodwill at the reporting unit level for potential impairment as part of our internal control framework. We evaluated our reporting unit to determine if a triggering event has occurred. As of
June 30, 2017
, the Company concluded that there were no indicators of impairment that would cause us to believe that it is more likely than not that the fair value of any such reporting unit is less than the carrying value. Accordingly, a detailed impairment test has not been performed and no goodwill impairment charges were recorded in connection with the interim impairment reviews of any such reporting units.
As further described in Note 2 - Acquisitions, during the second quarter of 2017, the company acquired Sotera. The goodwill related to the Sotera acquisition represents all the 2017 additions to goodwill. A summary of the changes to goodwill, is as follows (in thousands):
|
|
|
|
|
|
|
Goodwill as of January 1, 2017
|
$
|
290,710
|
|
Acquisition
|
201,289
|
|
Goodwill as of June 30, 2017
|
$
|
491,999
|
|
Intangibles
Acquired intangible assets with finite lives consist primarily of the value of customer-related intangibles acquired in various acquisitions. Acquired intangible assets with finite lives are amortized using the method that best reflects how their economic
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
benefits are utilized or, if a pattern of economic benefits cannot be reliably determined, on a straight-line basis over their estimated useful lives. The useful lives of the intangibles range from
one
to
16
years.
Concentrations of Credit Risk
We maintain cash balances that at times exceed the federally insured limit on a per financial institution basis. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk related to cash. In addition, we have credit risk associated with our receivables that arise in the ordinary course of business. In excess of
90%
of our total revenue is derived from contracts where the end customer is the U.S. Government, and any disruption to cash payments from our end customer could put the Company at risk.
Use of Estimates
Management uses estimates and assumptions in preparing these condensed consolidated financial statements in accordance with U.S. GAAP. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Significant estimates include amortization lives, depreciation lives, percentage of completion revenue, inventory obsolescence reserves, medical self-insurance incurred but not reported ("IBNR") claims, income taxes and stock compensation expense. Actual results could vary from the estimates that were used.
Cash and Cash Equivalents
We consider all highly liquid investments purchased with maturities of three months or less, when purchased, to be cash equivalents.
Fair Value of Financial Instruments
The balance sheet includes various financial instruments consisting of cash and cash equivalents, accounts receivable, and accounts payable. The fair values of these instruments approximate the carrying values due to the short maturity of these instruments. The balance sheet also includes our convertible senior notes, the fair value of which is estimated using a market approach with Level 2 inputs (see footnote 3, Fair Value Measurements).
Research and Development
Internally funded research and development costs are expensed as incurred and are included in operating expenses in the accompanying condensed consolidated statement of operations. In accordance with FASB ASC Topic 730,
Research and Development
, such costs consist primarily of payroll, materials, subcontractor and an allocation of overhead costs related to product development. Research and development costs totaled
$1.3 million
and
$1.2 million
for the
three months ended June 30, 2017
and
2016
, respectively. Research and development costs totaled
$2.4 million
and
$2.1 million
for the
six months ended June 30, 2017
and
2016
, respectively.
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 statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. 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 enacted date. In evaluating our ability to realize our deferred tax assets, we consider all available positive and negative evidence, including cumulative historic earnings, reversal of deferred tax liabilities, projected taxable income, and tax planning strategies. The assumptions utilized in evaluating both positive and negative evidence require the use of significant judgment concerning our business plans.
For a tax position that meets the more-likely-than-not recognition threshold, the Company initially and subsequently measures the tax liability or benefit as the largest amount that it judges to have a greater than
50%
likelihood of being realized upon ultimate settlement with a taxing authority. The liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances, such as the progress of tax audits, case law developments and new or emerging legislation. Such adjustments are recognized entirely in the period in which they are identified. The effective tax rate includes the net impact of changes in the liability for unrecognized tax obligations or benefits and subsequent adjustments as considered appropriate by management. The Company's policy is to record interest and penalties as an increase in the liability for uncertain tax obligations or benefits and a corresponding increase to the income tax provision. No such adjustments were recorded during the
six months ended June 30, 2017
or
2016
.
(Loss) Earnings per Share
Basic net (loss) earnings per share is calculated by dividing net (loss) income by the weighted average number of common shares outstanding during the period. Diluted (loss) earnings per share is calculated by dividing net (loss) income by the diluted weighted
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
average common shares, which reflects the potential dilution of stock options, warrants, and contingently issuable shares that could share in our (loss) income if the securities were exercised.
The following table presents the calculation of basic and diluted net loss per share (in thousands except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net (loss) income from continuing operations
|
$
|
(16,672
|
)
|
|
$
|
(436
|
)
|
|
$
|
(20,556
|
)
|
|
$
|
1,474
|
|
Loss on discontinued operations
|
—
|
|
|
(9,136
|
)
|
|
—
|
|
|
(26,455
|
)
|
Net loss
|
$
|
(16,672
|
)
|
|
$
|
(9,572
|
)
|
|
$
|
(20,556
|
)
|
|
$
|
(24,981
|
)
|
Weighted average shares – basic
|
49,546
|
|
|
40,359
|
|
|
48,061
|
|
|
40,087
|
|
Effect of dilutive potential common shares
|
—
|
|
|
—
|
|
|
—
|
|
|
654
|
|
Weighted average shares – diluted
|
49,546
|
|
|
40,359
|
|
|
48,061
|
|
|
40,741
|
|
|
|
|
|
|
|
|
|
Net (loss) income per share from continuing operations – basic
|
$
|
(0.34
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.43
|
)
|
|
$
|
0.04
|
|
Net loss per share from discontinued operations – basic
|
—
|
|
|
(0.23
|
)
|
|
—
|
|
|
(0.66
|
)
|
Net loss per share – basic
|
$
|
(0.34
|
)
|
|
$
|
(0.24
|
)
|
|
$
|
(0.43
|
)
|
|
$
|
(0.62
|
)
|
Net (loss) Income per share from Continuing Operations – diluted
|
$
|
(0.34
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.43
|
)
|
|
$
|
0.04
|
|
Net loss per share from discontinued operations – diluted
|
—
|
|
|
(0.23
|
)
|
|
—
|
|
|
(0.65
|
)
|
Net loss per share – diluted
|
$
|
(0.34
|
)
|
|
$
|
(0.24
|
)
|
|
$
|
(0.43
|
)
|
|
$
|
(0.61
|
)
|
Anti-dilutive share-based awards, excluded
|
2,262
|
|
|
2,321
|
|
|
2,020
|
|
|
2,539
|
|
Employee equity share options, restricted shares and warrants granted by the Company are treated as potential common shares outstanding in computing diluted earnings (loss) per share. Diluted shares outstanding include the dilutive effect of in-the-money options and in-the-money warrants and unvested restricted stock. The dilutive effect of such equity awards is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury-stock method, the amount the employee must pay for exercising stock options and the amount of compensation cost for future service that the Company has not yet recognized are collectively assumed to be used to repurchase shares.
The Company uses the if-converted method for calculating any potential dilutive effect of the conversion spread of our Convertible Senior Notes due 2019 (the Notes) on diluted earnings per share, if applicable. The conversion spread will have a dilutive impact on diluted earnings per share of common stock when the average market price of our common stock for a given period exceeds the Notes' conversion price of
$14.83
. For the three and
six months ended June 30, 2017
,
10.1 million
shares related to the Notes have been excluded from the computation of diluted earnings per share as the effect would be anti-dilutive since the conversion price of the Notes exceeded the average market price of the Company’s common shares for the three and
six months ended June 30, 2017
.
Share-Based Compensation
A
s a result of the adoption of ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting,
and as further discussed in Note 10, Share-Based Compensation, the Company applies the fair value method that requires all share-based payments to employees and non-employee directors be expensed over their requisite service period based on their fair value at the grant date, using a prescribed option-pricing model. The expense recognized is based on the straight-line amortization of each individually vesting piece of a grant. The Company has elected to account for forfeitures related to share-based awards when they occur.
The following assumptions were used for share-based awards granted.
Dividend Yield — The Company has never declared or paid dividends on its common stock and has no plans to do so in the foreseeable future.
Risk-Free Interest Rate — Risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term approximating the expected life of the share-based award term assumed at the date of grant.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
Expected Volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company's expected volatility is based on its historical volatility for a period that approximates the estimated life of the share-based awards.
Expected Term of the Share-based Awards — This is the period of time that the share-based awards granted are expected to remain unexercised. The Company estimates the expected life of the share-based award term based on the expected tenure of employees and historical experience.
Segment Reporting
FASB ASC Section 280,
Segment Reporting
, establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that these enterprises report selected information about operating segments in interim financial reports. The guidance also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company defines its reportable segments based on the way the chief operating decision maker ("CODM"), currently its chief executive officer, manages the operations of the Company for allocating resources and assessing performance. The Company had historically operated two segments, Government Solutions and Commercial Cyber Solutions. The Company disposed of the assets and liabilities of its Commercial Cyber Solutions during the second quarter of 2016, see Note 12 - Businesses Held for Sale, Discontinued Operations and Dispositions. Therefore, we have also reclassified the results of our Hexis business, which comprised our entire Commercial Cyber Solutions reportable segment, as discontinued operations for all periods presented in our consolidated financial statements. As a result of the acquisition of Sotera during the second quarter of 2017, there was no change in our operating or reporting segments. The Company conducts business as
one
operating and reporting segment.
Recently Adopted Accounting Pronouncements
In November 2015, the FASB issued ASU 2015-17,
Income Taxes
, amending the accounting for income taxes and requiring all deferred tax assets and liabilities to be classified as non-current on the condensed consolidated balance sheet. The ASU is effective for reporting periods beginning after December 15, 2016. We adopted ASU 2015-17 as of January 1, 2017 on a retrospective basis and as of December 31, 2016, reclassified
$1.2 million
current deferred tax liability to non-current deferred tax liability on our condensed consolidated balance sheets.
In March 2016, the FASB issued ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
. The amendments in ASU 2016-09 to Topic 718, Compensation - Stock Compensation, simplified several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements as well as classification in the statements of cash flows. The amendments in the new standard are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We adopted ASU 2016-09 in the first quarter of 2017 and it did not impact our condensed consolidated financial statements. The adoption of ASU 2016-09 impacted our accounting policies as follows: (1) Excess tax benefits and tax deficiencies related to share-based payment awards are recognized prospectively as part of the income tax provision in the Condensed Consolidated Statements of Operations. (2) Excess tax benefits related to share-based payment awards are classified in operating activities in the Condensed Consolidated Statements of Cash Flows. We applied this provision on a retrospective basis. (3) We elected to account for forfeitures related to share-based awards when they occur and have applied the accounting policy change on a modified retrospective basis, as required by ASU 2016-09.
There were no impacts on our condensed consolidated financial statements resulting from our early adoption in the first quarter of 2017 of the following accounting pronouncements: (i) ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments and (ii) ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09,
Revenue from Contracts with Customers
, as amended (Topic 606) (the ASU), which may change the way the Company recognizes revenue and significantly expand the disclosure requirements for revenue arrangements. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services.
The new standard is effective for interim and annual periods beginning on or after December 15, 2017. The guidance permits the use of either a full retrospective or modified retrospective transition method. The Company will adopt the requirements of the new standard effective January 1, 2018 and expects to use the modified retrospective transition method with the cumulative effect to the opening balance of retained earnings recognized as of the date of initial adoption.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
The Company has completed an initial assessment of the new standard and believes that, for the majority of its long-term contracts, the Company will continue to recognize revenue over time as the work progresses because of the continuous transfer of control to the customer, generally using an input measure (e.g., cost incurred) to reflect progress. The Company is in the process of quantifying the financial statement impact, revising current accounting policies and determining the appropriate changes to business processes and controls. Based on this initial assessment, the Company does not expect the new standard to have a material effect on its consolidated financial position or results of operations.
In February 2016, the FASB issued ASU 2016-02,
Leases
. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of this pronouncement on our condensed consolidated financial statements.
2. ACQUISITIONS
On April 4, 2017, the Company's wholly-owned operating company, Opco, completed the merger (the “Merger”) of Sandpiper Acquisition Corporation, a wholly-owned subsidiary of Opco, with and into Sotera, with Sotera surviving the Merger as a wholly-owned subsidiary of Opco. The purchase consideration net of cash acquired, for the acquisition of Sotera was
$236.1 million
. The acquisition of Sotera was completed as an all-cash transaction.
We acquired Sotera to diversify our portfolio and provide new and enhanced access to agencies within the IC. Sotera adds high-priority new customer agencies to KeyW’s existing IC portfolio, including highly sought-after FBI and DHS customers, and created additional inroads at new areas of the DoD (e.g., Army Intelligence). Sotera adds significant scale, helping to create a unique, IC focused provider. Sotera adds complementary capabilities to KeyW’s existing suite in agile software and solution development, cyber security and data analytics. In addition, the combined company offers customers advanced emerging technologies focused on machine learning and big data solutions. Sotera adds access to a large portfolio of prime contracts and indefinite delivery indefinite quantity vehicles, which expands KeyW’s overall presence in the IC and DoD. The combined contract portfolio provides the opportunity to sell both KeyW and Sotera capabilities to new and existing customers, serving as a platform intended to drive future growth.
The preliminary fair values of the assets acquired and liabilities assumed at the date of the transaction were as follows (in thousands):
|
|
|
|
|
|
|
Cash
|
$
|
11,583
|
|
Receivables
|
37,795
|
|
Prepaid expenses
|
1,679
|
|
Property and equipment
|
1,499
|
|
Other intangibles
|
23,450
|
|
Goodwill
|
201,289
|
|
Deferred tax assets
|
142
|
|
Other assets
|
1,149
|
|
Total assets acquired
|
278,586
|
|
Accounts payable
|
7,007
|
|
Accrued expenses
|
9,518
|
|
Accrued salaries and wages
|
10,784
|
|
Deferred revenue
|
1,505
|
|
Long-term obligations
|
2,098
|
|
Total liabilities assumed
|
30,912
|
|
Net assets acquired
|
$
|
247,674
|
|
Net cash paid
|
$
|
236,091
|
|
Actual cash paid
|
$
|
247,674
|
|
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
Due to the recent completion and complexity of the acquisition of Sotera, the Company recorded the assets acquired and liabilities assumed at their preliminary estimated fair values. As of
June 30, 2017
, the Company had not finalized the determination of the fair values allocated to various assets and liabilities, including, but not limited to, receivables; deferred revenue; intangible assets and the residual amount allocated to goodwill.
The goodwill primarily represents the acquiring of an assembled workforce of cleared personnel to expand our presence with new and existing customers. The value of having that assembled workforce generated the majority of the goodwill from the acquisition of Sotera and drove much of the purchase price in addition to other identified intangibles. The preliminary goodwill presented above includes
$103.5 million
of tax deductible goodwill.
The Company identified
$23.5 million
of other intangible assets, including backlog and customer relationships. The following table summarizes the preliminary fair value of intangibles assets acquired at the date of acquisition and the related weighted average amortization period:
|
|
|
|
|
|
|
|
|
|
Weighted average amortization period
|
|
Fair Value
|
|
|
(in years)
|
|
(in thousands)
|
Customer relationships
|
|
16.0
|
|
$
|
21,100
|
|
Backlog
|
|
1.0
|
|
2,350
|
|
Total
|
|
|
|
$
|
23,450
|
|
Related to the acquisition of Sotera, during the three and
six months ended June 30, 2017
, the Company incurred
$2.6 million
and
$4.3 million
of acquisition related expenses, respectively. Related to the integration of Sotera, during the three and
six months ended June 30, 2017
, the Company incurred
$10.2 million
of integration related expenses. Acquisition and integration related expenses have been recorded as part of operating expenses.
Unaudited Pro Forma Financial Information
The table below summarizes the unaudited pro forma consolidated results of operations as if the acquisition of Sotera had occurred on January 1, 2016. The unaudited pro forma financial information was prepared based on historical financial information. The unaudited pro forma results below do not include any adjustments that may have resulted from synergies, eliminations of intercompany transactions or from amortization of intangibles (other than during the period following the closing of the Sotera acquisition). The pro forma financial information is not intended to reflect the actual results of operations that would have occurred if the acquisition had been completed on January 1, 2016, nor is it intended to be an indication of future operating results.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
(unaudited and in thousands)
|
Revenues
|
$
|
124,058
|
|
|
$
|
140,784
|
|
|
$
|
254,259
|
|
|
$
|
274,915
|
|
Net (loss) income from continuing operations
|
(16,672
|
)
|
|
93
|
|
|
(26,428
|
)
|
|
1,812
|
|
The Sotera acquisition was accounted for using the acquisition method of accounting. Results of operations were included in the condensed consolidated financial statements from the date of acquisition.
Other Acquisition Related Activity
During the second quarter of 2016, in conjunction with the Milestone Intelligence Group acquisition earnout, the Company issued
129,530
shares of KeyW common stock with an approximate value of
$1 million
.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
3. FAIR-VALUE MEASUREMENTS
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure the fair value of financial assets and liabilities on a recurring basis into three broad levels:
|
|
|
Level 1
|
Inputs are unadjusted quoted prices in active markets for identical assets or liabilities the Company has the ability to access.
|
|
|
|
Level 2
|
Inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
|
|
|
|
Level 3
|
Inputs are unobservable for the asset or liability and rely on management’s own assumptions about what market participants would use in pricing the asset or liability.
|
At
June 30, 2017
, we did not have any assets or liabilities measured at fair value on a recurring basis that would require disclosure based on the fair value hierarchy of valuation techniques.
4. RECEIVABLES
Receivables consist of the following:
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
(In thousands)
|
Receivables
|
|
|
|
|
|
Billed
|
$
|
48,648
|
|
|
$
|
29,861
|
|
Unbilled
|
41,374
|
|
|
13,280
|
|
Total Receivables
|
$
|
90,022
|
|
|
$
|
43,141
|
|
Unbilled amounts represent revenue recognized which could not be billed by the period end based on contract terms. Retainages typically exist at the end of a project and/or if there is a disputed item on an invoice received by a customer. At
June 30, 2017
and
December 31, 2016
, retained amounts are insignificant and are expected to be collected subsequent to the balance sheet date.
Most of the Company's revenues are derived from contracts with the U.S. Government, in which we are either the prime contractor or a subcontractor, depending on the award.
5. INVENTORIES
Inventories at
June 30, 2017
and
December 31, 2016
, consist of work in process at various stages of production and finished goods. This inventory, which consists primarily of mobile communications devices, aeroptic cameras and radars, are valued at the lower of cost (as calculated using the weighted-average method) or net realizable value. The cost of the work in process consists of materials put into production, the cost of labor and an allocation of overhead costs. At
June 30, 2017
and
December 31, 2016
, we had an inventory reserve balance of
$0.7 million
and
$0.6 million
, respectively, for certain products where the market has not developed as expected.
6. PREPAID EXPENSES
Prepaid expenses at
June 30, 2017
and
December 31, 2016
, primarily consist of prepaid insurance and software licenses.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
7. PROPERTY AND EQUIPMENT
Property and equipment, net, including the fair value of those acquired through the acquisition of Sotera are as follows:
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
(In thousands)
|
Property and equipment
|
|
|
|
|
|
Aircraft
|
$
|
27,710
|
|
|
$
|
25,425
|
|
Leasehold improvements
|
25,870
|
|
|
23,289
|
|
Manufacturing equipment
|
6,306
|
|
|
5,887
|
|
Software development costs
|
2,132
|
|
|
2,132
|
|
Office equipment
|
15,198
|
|
|
13,312
|
|
Total
|
77,216
|
|
|
70,045
|
|
Accumulated depreciation
|
(33,086
|
)
|
|
(29,430
|
)
|
Property and equipment, net
|
$
|
44,130
|
|
|
$
|
40,615
|
|
Depreciation expense charged to operations was
$2.2 million
and
$1.9 million
for the
three months ended June 30, 2017
and
2016
, respectively. Depreciation expense charged to operations was
$3.7 million
and
$4.1 million
for the
six months ended
June 30, 2017
and
2016
, respectively.
8. INTANGIBLE ASSETS
Information regarding our purchased intangible assets including the preliminary fair values of those acquired through the acquisition of Sotera was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
Intangible
|
|
Gross Carrying
Value
|
|
Accumulated
Amortization
|
|
Net Carrying
Value
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
Customer relationships and contracts
|
|
$
|
50,287
|
|
|
$
|
(24,899
|
)
|
|
$
|
25,388
|
|
Software technology and other
|
|
2,162
|
|
|
(369
|
)
|
|
1,793
|
|
Total intangible assets
|
|
$
|
52,449
|
|
|
$
|
(25,268
|
)
|
|
$
|
27,181
|
|
The Company recorded amortization expense of
$2.5 million
and
$1.5 million
for the
three months ended June 30, 2017
and
2016
, respectively. The Company recorded amortization expense of
$4.1 million
and
$2.9 million
for the
six months ended June 30, 2017
and
2016
, respectively.
As of
June 30, 2017
, expected amortization expense relating to purchased intangible assets was as follows:
|
|
|
|
|
|
Fiscal Year Ending
|
|
|
|
|
(in thousands)
|
2017 (remainder of year)
|
|
$
|
3,845
|
|
2018
|
|
4,691
|
|
2019
|
|
3,972
|
|
2020
|
|
3,159
|
|
2021
|
|
2,519
|
|
2022 and thereafter
|
|
8,995
|
|
|
|
$
|
27,181
|
|
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
9. DEBT
2017 Credit Facility
On April 4, 2017, Opco entered into (a) a
$135 million
term loan facility (the “2017 Term Loan Facility”) and (b) a
$50 million
revolving credit facility (the “2017 Revolving Loan Facility”) collectively (the “2017 Credit Facility”), the terms of which are set forth in a Credit Agreement (the “2017 Credit Agreement”) dated as of April 4, 2017 (the “Closing Date”), by and among Opco, as borrower, the Company, the several lenders party thereto, Royal Bank of Canada, as administrative agent and collateral agent (the “Agent”), and RBC Capital Markets, as lead arranger and bookrunner. Subject to the terms and conditions of the 2017 Credit Agreement, on April 4, 2017, Opco borrowed an aggregate of
$135 million
under the 2017 Term Loan Facility (the “Term Loan Proceeds”) and an aggregate of
$10 million
under the 2017 Revolving Loan Facility (the “Revolver Proceeds”).
Use of Proceeds
The Term Loan Proceeds were used (i) to pay, directly or indirectly, the purchase price of our previously announced acquisition of Sotera (ii) to refinance, repay or terminate, including discharging and releasing all security and guaranties in respect of, and the termination and unwinding of any interest rate hedging agreements in connection therewith, certain of our and Sotera’s and its subsidiaries’ existing third party indebtedness for borrowed money (the “Refinancing”); and (iii) to pay related transaction fees and expenses.
The Revolver Proceeds were used to fund upfront fees required to be paid on the Closing Date. The proceeds of any borrowings under the Revolving Credit Facility made after the Closing Date will be available for any purpose not prohibited by the terms of the 2017 Credit Agreement.
Interest Rates
Borrowings under the 2017 Credit Agreement were and will be incurred in U.S. Dollars. All borrowings under the Credit Agreement may, at our option, be incurred as either eurodollar loans (“Eurodollar Loans”) or base rate loans (“Base Rate Loans”).
Eurodollar Loans will accrue interest, for any interest period, at (a) the Eurodollar Rate (as defined in the 2017 Credit Agreement) plus (b) an applicable margin of
3.75%
.
Base Rate Loans will accrue interest, for any interest period, at (a) a base rate per annum equal to the highest of (i) the Federal funds rate plus
1/2
of
1%
, (ii) the prime commercial lending rate announced by the Royal Bank of Canada from time to time as its prime lending rate and (iii) the Eurodollar Rate for a one month interest period plus
1.00%
, plus (b) an applicable margin of
2.75%
.
After the completion of our fiscal quarter ending June 30, 2017, the applicable margin for borrowings under the Revolving Credit Facility may be decreased if our consolidated net leverage ratio decreases.
Maturity Dates
The 2017 Credit Facility matures on the earlier of (i) the
five
-year anniversary of the Closing Date, and (ii) the date that is
180
days prior to the scheduled maturity date of the Company’s
2.50%
convertible senior notes due 2019, unless such notes are converted into equity or otherwise repaid or refinanced.
Payments
The Company can voluntarily repay outstanding loans under the 2017 Credit Facility at any time without premium or penalty, other than customary breakage costs with respect to Eurodollar loans. The 2017 Term Loan Facility will require scheduled quarterly payments in an amount equal to:
|
|
•
|
1.25%
for the quarters ending September 30, 2017 through June 30, 2019;
|
|
|
•
|
1.875%
for the quarters ending September 30, 2019 through June 30, 2021; and
|
|
|
•
|
2.50%
for the quarters ending September 30, 2021 through March 31, 2022, with the remaining balance payable on the maturity date.
|
Mandatory Prepayments
Amounts outstanding under the 2017 Credit Agreement will be subject to mandatory prepayments, subject to customary exceptions, from the net cash proceeds to us from certain asset sales or recovery events.
Certain Covenants and Events of Default
The 2017 Credit Agreement contains affirmative and negative covenants that are customary for credit agreements of this nature. The negative covenants include, among other things, limitations on asset sales, mergers and acquisitions, indebtedness, liens, investments and transactions with affiliates. The 2017 Credit Agreement contains two financial covenants: (i) a maximum total
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
leverage ratio of consolidated total indebtedness to consolidated earnings before interest, taxes, depreciation and amortization and other adjustments described in the Credit Agreement (“consolidated EBITDA”) for the trailing four consecutive quarters of (a)
5.50
to
1.00
for any period ending on or prior to June 30, 2017, (b)
5.00
to
1.00
for any period thereafter ending on or prior to December 31, 2019, and (c)
4.50
to
1.00
for each fiscal quarter thereafter; and (ii) a minimum interest coverage ratio of consolidated EBITDA to consolidated interest expense for the trailing four consecutive quarters of
3.00
to
1.00
.
The 2017 Credit Agreement includes customary events of default that include, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, material judgment defaults, ERISA defaults and a change of control default. The occurrence of an event of default could result in the acceleration of the obligations under the 2017 Credit Agreement and cross-default our other indebtedness.
At
June 30, 2017
, we were in compliance with all of our debt covenants under the 2017 Credit Agreement.
Security
Our obligations under the 2017 Credit Agreement are secured by a pledge of substantially all of our and each other guarantors’ assets, including a pledge of the equity interests in certain of Opco’s domestic and first-tier foreign subsidiaries, subject to customary exceptions.
In connection with the issuance of the 2017 Credit Facility the Company incurred approximately
$5.0 million
of debt issuance costs. The Company is amortizing the deferred financing costs over the contractual term of the 2017 Credit Facility using the effective-interest method. During the three and
six months ended June 30, 2017
, the Company recognized
$2.4 million
of interest expense related to the 2017 Credit Facility, which included
$0.2 million
relating to amortization of deferred financing costs.
As of
June 30, 2017
, we had
$135 million
and
$10 million
outstanding under the 2017 Term Loan Facility and the 2017 Revolving Credit Facility, respectively. The carrying value of the term loan and the revolver approximate their fair value. Our availability under the revolving portion of the 2017 Credit Facility was
$40 million
as of
June 30, 2017
.
2.5% Convertible Senior Notes
In July 2014, the Company initially issued
$130.0 million
aggregate principal amount of Notes in an underwritten public offering. The Company granted an option to the underwriters to purchase up to an additional
$19.5 million
aggregate principal amount of Notes, which was subsequently exercised in full in August 2014, resulting in a total issuance of
$149.5 million
aggregate principal amount of Notes. The Notes bear interest at a rate of
2.50%
per annum on the principal amount, payable semi-annually in arrears on January 15 and July 15 of each year, beginning on January 15, 2015, to holders of record at the close of business on the preceding January 1 and July 1, respectively. The Notes mature on July 15, 2019, unless earlier repurchased or converted. The Company may not redeem the Notes prior to their stated maturity date.
Holders of the Notes may convert their notes at their option under the following circumstances: (i) during any calendar quarter commencing after the calendar quarter ending September 30, 2014, if the last reported sale price of the Company’s common stock for at least
20
trading days (whether or not consecutive) in the period of
30
consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to
130%
of the conversion price for the Notes on each applicable trading day; (ii) during the five business day period immediately after any five consecutive trading day period in which the trading price per
$1,000
principal amount of Notes for each trading day of that period was less than
98%
of the product of the last reported sale price of Company’s common stock and the conversion rate for the Notes for each such trading day; or (iii) upon the occurrence of specified corporate events. On and after January 15, 2019, holders may convert their Notes at any time, regardless of the foregoing circumstances.
Upon conversion, the Company will settle the Notes in cash, shares of Company common stock or a combination of cash and shares of Company common stock, at the Company’s election. The Notes have an initial conversion rate of
67.41
shares of common shares per
$1,000
principal amount of the Notes, which is equal to an initial conversion price of approximately
$14.83
per common share. The conversion price is subject to adjustments upon the occurrence of certain specified events.
In addition, upon the occurrence of a fundamental change (as defined in the Indenture), holders of the Notes may require the Company to repurchase the Notes at a purchase price of
100%
of the principal amount of the Notes, plus accrued and unpaid interest, if any, to, but excluding, the fundamental change repurchase date.
As of
June 30, 2017
, the outstanding principal of the Notes was
$149.5 million
, the unamortized debt discount was
$11.9 million
, the unamortized deferred financing costs were
$1.9 million
and the carrying amount of the liability component was
$135.7 million
, which was recorded as long-term debt within the Company’s condensed consolidated balance sheet. As of
June 30, 2017
, the fair
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
value of the liability component relating to the Notes, based on a market approach, was approximately
$138.9 million
and represents a Level 2 valuation.
During the
three months ended June 30, 2017
, the Company recognized
$2.6 million
of interest expense related to the Notes, which included
$1.4 million
for non-cash interest expense relating to the debt discount and
$0.2 million
relating to amortization of deferred financing costs. During the
three months ended June 30, 2016
, the Company recognized
$2.5 million
of interest expense related to the Notes, which included
$1.3 million
for non-cash interest expense relating to the debt discount and
$0.2 million
relating to amortization of deferred financing costs. During the
six months ended June 30, 2017
, the Company recognized
$5.1 million
of interest expense related to the Notes, which included
$2.8 million
for non-cash interest expense relating to the debt discount and
$0.5 million
relating to amortization of deferred financing costs. During the
six months ended June 30, 2016
, the Company recognized
$5.0 million
of interest expense relating to the Notes, which included
$2.7 million
for non-cash interest expense relating to the debt discount and
$0.5 million
relating to amortization of deferred financing costs.
Capped Call
During the third quarter of 2014 in conjunction with the issuance of the Notes, the Company paid approximately
$18.4 million
to enter into capped call transactions with respect to its common shares, (the "Capped Call Transactions"), with certain financial institutions. The Capped Call Transactions generally are expected to reduce the potential dilution to the Company's common stock upon conversion of the Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of any converted Notes, as the case may be, in the event that the market price of the common stock is greater than the strike price of the Capped Call Transactions, initially set at
$14.83
, with such reduction of potential dilution subject to a cap based on the cap price, which is initially set at
$19.38
. The strike price and cap price are subject to anti-dilution adjustments under the terms of the Capped Call Transactions.
2014 Revolving Credit Facility
In July 2014, the Company, as a guarantor, entered into a senior credit agreement, (the “2014 Credit Agreement”), by and among itself, the KeyW Corporation, as the borrower (the “Borrower”), the domestic direct and indirect subsidiary guarantors of KeyW (the “Subsidiary Guarantors”) with certain financial institutions. The 2014 Credit Agreement consisted of a
$20.0 million
revolving credit facility, a swing line loan commitment of up to
$10 million
and a letter of credit facility of up to
$15 million
. In February 2016, the Company amended the 2014 Credit Agreement. As a result of the amendment permanently decreasing the amount available under the revolver the Company wrote off
$0.3 million
of unamortized deferred financing costs, which were included as part of interest expense. On April 4, 2017, in connection with the effectiveness of the 2017 Credit Agreement, as described above, the Company terminated its 2014 Credit Agreement. The financial institutions participating in the 2014 Credit Agreement are also included in the 2017 Credit Agreement at increased levels of borrowing capacity. Therefore, the unamortized deferred financing costs remaining in the 2014 Credit Agreement are deferred and amortized over the new term of the 2017 Credit Agreement.
Debt Summary
As of
June 30, 2017
, the composition of our debt was as follows (in thousands):
|
|
|
|
|
|
Convertible notes
|
|
$
|
149,500
|
|
Term loan
|
|
135,000
|
|
Revolver
|
|
10,000
|
|
Total debt
|
|
294,500
|
|
Less: current portion of term loan
|
|
(6,750
|
)
|
Less: current revolver
|
|
(10,000
|
)
|
Less: unamortized original issue discount costs and financing fees
|
|
(18,528
|
)
|
Long-term debt
|
|
259,222
|
|
The KeyW Holding Corporation is a holding company with no independent assets or operations (other than the ownership of its subsidiaries). Holdco contemplates that if it issues any guaranteed debt securities under any registration statement filed by it under the Securities Act of 1933, as amended, all guarantees will be full and unconditional and joint and several, and any subsidiaries of Holdco that are not subsidiary guarantors will be “minor” subsidiaries as such term is defined under the rules and regulations of the Securities and Exchange Commission. The agreements governing the Company's long-term indebtedness do not contain any significant restrictions on the ability of Holdco or any guarantor to obtain funds from its subsidiaries by dividend, loan or otherwise. Accordingly, we do not provide separate financial statements of any guarantor subsidiaries.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
10. SHARE-BASED COMPENSATION
At
June 30, 2017
, KeyW had stock-based compensation awards outstanding under the following plans: The 2008 Stock Incentive Plan ("2008 Plan"), The 2009 Stock Incentive Plan ("2009 Plan") and The Amended and Restated 2013 Stock Incentive Plan ("2013 Plan").
On August 15, 2012, the shareholders approved the 2013 KeyW Holding Corporation Stock Incentive Plan. The 2013 plan, which took effect on
January 1, 2013
, provides for the issuance of additional restricted stock, stock options, and restricted stock units. Pursuant to an amendment approved by the Company’s shareholders on August 12, 2015, the number of shares available for issuance under the 2013 Plan was increased by
700,000
shares to a maximum of
2,700,000
shares.
|
|
|
|
2013 Stock Incentive Plan
|
|
Total equity available to issue
|
2,700,000
|
|
Total equity outstanding or exercised
|
1,834,705
|
|
Total equity remaining for future grants
|
865,295
|
|
The Company has awarded stock options, restricted stock awards, restricted stock units and the rights to receive Long-Term Incentive Shares to attract and retain highly qualified officers, directors, key employees, and other persons, and to motivate such persons to serve the Company and to expend maximum effort to improve the business results and earnings of the Company, by providing to such persons an opportunity to acquire or increase a direct proprietary interest in the operations and future success of the Company and align employee and shareholder interests.
Stock Options
No stock options were granted during the
six months ended June 30, 2017
. Historically the Company has issued stock option awards that vest over varying periods, ranging from
three
to
five years
, and have a
10
-year life. We estimated the fair value of stock options using the Black-Scholes option-pricing model. All stock options were issued with an exercise price at market value or higher based upon our publicly-traded share price on the date of grant. All option awards terminate within
90 days
or sooner after termination of service with the Company, except as provided in certain circumstances under our senior executive employment agreements.
A summary of stock option activity for the period ended
June 30, 2017
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
Option Exercise
Price
|
|
Weighted Average
Exercise Price
|
Options Outstanding January 1, 2017
|
1,236,222
|
|
|
|
|
|
Granted
|
—
|
|
|
—
|
|
|
—
|
|
Exercised
|
(17,487
|
)
|
|
$5.00 - $10.00
|
|
|
$
|
6.23
|
|
Cancelled
|
(237,050
|
)
|
|
$7.41 - $17.11
|
|
|
$
|
13.97
|
|
Options Outstanding June 30, 2017
|
981,685
|
|
|
|
|
|
|
As of
June 30, 2017
, outstanding stock options were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise Price
|
Options
Outstanding
|
|
Intrinsic
Value
|
|
Options
Vested
|
|
Intrinsic
Value
|
|
Weighted Average
Remaining Life
(Years)
|
$5.00 – $5.50
|
246,650
|
|
|
$
|
975,428
|
|
|
246,650
|
|
|
$
|
975,428
|
|
|
2.13
|
$6.90 – $7.66
|
191,511
|
|
|
366,601
|
|
|
191,511
|
|
|
366,601
|
|
|
4.57
|
$7.96 – $9.25
|
146,426
|
|
|
98,712
|
|
|
146,426
|
|
|
98,712
|
|
|
3.63
|
$9.50 - $11.69
|
102,350
|
|
|
—
|
|
|
102,350
|
|
|
—
|
|
|
4.72
|
$11.99 - $12.97
|
124,524
|
|
|
—
|
|
|
124,524
|
|
|
—
|
|
|
4.97
|
$13.00 - $14.57
|
72,974
|
|
|
—
|
|
|
72,974
|
|
|
—
|
|
|
5.25
|
$14.88 - $17.11
|
97,250
|
|
|
—
|
|
|
97,250
|
|
|
—
|
|
|
6.56
|
|
981,685
|
|
|
$
|
1,440,741
|
|
|
981,685
|
|
|
$
|
1,440,741
|
|
|
|
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
Restricted Stock Awards
For the first half of 2017, the Company issued
186,201
shares of restricted common stock as part of employee incentive plans and to new hires. The Company issued
8,518
shares of restricted common stock to a board member,
90,000
shares of restricted common stock to new employees and
87,683
shares of restricted common stock to existing employees as discretionary awards. Of the shares issued to new hires,
20,000
shares were issued as a retention incentive inducement to four Sotera employees. The Company entered into employment agreements with the four Sotera employees. The employment agreements provided for grants of inducement equity awards outside of the 2013 Plan, in accordance with NASDAQ Listing Rule 5635(c)(4) upon commencement of their employment.
The expense for these shares will be recognized over the vesting life of each individual tranche of shares based upon the fair value of a share of stock at the date of grant. All of the above shares cliff vest after
three years
, except for the shares issued to our board member and the four Sotera employees. The shares granted to our board member vest 50% on the first anniversary of the grant date and 50% on the second anniversary of the grant date and the shares granted to the Sotera employees vest on the first anniversary of the grant date.
The following table summarizes the activities for our unvested restricted stock awards for the
six months ended June 30, 2017
:
|
|
|
|
|
Unvested Shares
|
Outstanding January 1, 2017
|
646,378
|
|
Granted
|
186,201
|
|
Vested
|
(163,408
|
)
|
Cancelled
|
(27,825
|
)
|
Outstanding June 30, 2017
|
641,346
|
|
Restricted Stock Units
The following table summarizes the activities for our unvested restricted stock units for the
six months ended June 30, 2017
:
|
|
|
|
|
Unvested Units
|
Outstanding January 1, 2017
|
122,294
|
|
Granted
|
—
|
|
Vested
|
(6,435
|
)
|
Cancelled
|
(3,968
|
)
|
Outstanding June 30, 2017
|
111,891
|
|
Long-Term Incentive Share Rights
During the first half of 2017, the Company granted
500,000
Long-Term Incentive Shares.
300,000
shares were granted outside of the 2013 Plan to new hires, in accordance with NASDAQ Listing Rule 5635(c)(4) upon commencement of their employment. The remaining
200,000
shares were granted to
four
Sotera employees. The Company entered into employment agreements with the
four
Sotera employees. The employment agreements provided for grants of inducement equity awards outside of the 2013 Plan, in accordance with NASDAQ Listing Rule 5635(c)(4) upon commencement of their employment.
The granting and vesting of the Long-Term Incentive Shares will be contingent upon the employees continued employment with KEYW, subject to acceleration upon certain events. We measured the fair value of the Long-Term Incentive Share grants using a Monte Carlo simulation approach with the following assumptions: risk-free interest rate ranging between
1.78%
and
1.89%
, expected volatility ranging between
51.76%
and
51.91%
and dividend yield of
0%
. The grant-date fair value of these long-term incentive shares is
$2.2 million
. The expense for these grants will be recognized over the requisite service period of each individual tranche, which have weighted average requisite service periods ranging from
2.5 years
and
2.6 years
.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
The following table summarizes the activities for our Long-Term Incentive Share rights for the
six months ended June 30, 2017
:
|
|
|
|
|
Unvested Long-Term Incentive Shares
|
Outstanding January 1, 2017
|
1,440,000
|
|
Granted
|
500,000
|
|
Cancelled
|
(130,000
|
)
|
Outstanding June 30, 2017
|
1,810,000
|
|
These rights consist of five vesting tranches, which Long-Term incentive Shares will be awarded at any time prior to the fifth anniversary of the rights' commencement dates if the closing market price of the Company’s common stock over any
30
consecutive trading days is at or greater than the target price set forth in the table below.
|
|
|
Target Price Per Share
|
Long-Term Incentive Shares
|
$13.00
|
226,250
|
$16.00
|
226,250
|
$20.00
|
452,500
|
$25.00
|
452,500
|
$30.00
|
452,500
|
All stock-based compensation has been recorded as part of operating expenses. The Company recorded total stock compensation expense of
$1.1 million
and
$0.7 million
for the
three months ended June 30, 2017
and
2016
, respectively. The Company recorded total stock compensation expense of
$2.1 million
and
$1.1 million
for the
six months ended June 30, 2017
and
2016
, respectively. The total unrecognized stock compensation expense at
June 30, 2017
, is approximately
$9.4 million
, which is expected to be recognized over a weighted average period of
2.2 years
.
11. WARRANTS
During the
six months ended June 30, 2017
, warrant holders exercised
100,000
warrants and
60,000
warrants expired. Under our warrant agreements, warrants may be exercised in a cashless transaction based on the average price of the Company's common stock for the five days prior to exercise. Under this methodology, the warrants exercised were exchanged for
13,773
shares of the Company's common stock.
As of
June 30, 2017
, outstanding warrants were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Exercise Price
|
|
Warrants Outstanding
|
|
Warrants Vested
|
|
Remaining Life (Years)
|
$
|
12.65
|
|
|
158,116
|
|
|
158,116
|
|
|
2.41
|
12. BUSINESSES HELD FOR SALE, DISCONTINUED OPERATIONS AND DISPOSITIONS
Dispositions - Discontinued Operations
During the first quarter of fiscal year 2016, the Company committed to a plan to sell the Hexis business in its entirety. The Hexis business marketed our HawkEye products and related maintenance and services to the commercial cyber sector and comprised our entire former Commercial Cyber Solutions reportable segment. During the second quarter of 2016, the sale of the Hexis Cyber Solutions product lines resulted in a pre-tax loss of approximately
$5.5 million
. This loss reflects the difference between the consideration received for Hexis and the net carrying value of the business less transaction costs.
From inception of the Hexis business through our decision to sell the business, we had been a relatively new participant in the commercial cyber security market. Accordingly, the Hexis business had historically required a significant amount of investment of the Company's resources. The business has historically incurred losses and was expected to continue to incur losses until we gained sufficient traction within the marketplace. Following completion of the sale of the Hexis business, the Company no longer offers or markets any products or services to the commercial cyber security market and does not intend to make similar investments in the development of commercial cyber security products. After consideration of these factors, we concluded that our decision to sell the Hexis business constitutes a strategic shift that is expected to have a major effect on our operations and financial results. Therefore, we also reclassified the results of our Hexis business, which comprised our entire Commercial Cyber Solutions reportable segment, as discontinued operations for all periods presented in our consolidated financial statements. The results of our Commercial
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
Cyber Solutions segment previously included the allocation of certain general corporate costs, which we have reallocated to our remaining continuing operations on a retrospective basis.
The following table summarizes the aggregate carrying amounts of the major classes of Hexis assets and liabilities included in discontinued operations as of
June 30, 2017
and
December 31, 2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
Receivables
|
$
|
—
|
|
|
$
|
3,000
|
|
|
|
|
|
Accounts payable and other accrued expenses
|
$
|
—
|
|
|
$
|
1,185
|
|
The following table provides a summary of the operating results of Hexis, which we have reflected as discontinued operations for the
six months ended June 30, 2017
and
2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue
|
$
|
—
|
|
|
$
|
800
|
|
|
$
|
—
|
|
|
$
|
2,878
|
|
Cost of revenue
|
—
|
|
|
711
|
|
|
—
|
|
|
1,687
|
|
Operating expenses
|
—
|
|
|
5,991
|
|
|
—
|
|
|
15,266
|
|
Impairment of goodwill
|
—
|
|
|
—
|
|
|
—
|
|
|
6,980
|
|
Intangible amortization expense
|
—
|
|
|
—
|
|
|
—
|
|
|
381
|
|
Loss on disposal of Hexis
|
—
|
|
|
3,234
|
|
|
—
|
|
|
5,509
|
|
Loss before income taxes from discontinued operations
|
—
|
|
|
(9,136
|
)
|
|
—
|
|
|
(26,945
|
)
|
Income tax benefit, net on discontinued operations
|
—
|
|
|
—
|
|
|
—
|
|
|
(490
|
)
|
Loss on discontinued operations
|
$
|
—
|
|
|
$
|
(9,136
|
)
|
|
$
|
—
|
|
|
$
|
(26,455
|
)
|
The following table presents the operating and investing cash flows of our discontinued Hexis business for the
six months ended June 30, 2017
and
2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
Non-cash operating items
|
|
|
|
Depreciation and amortization expense
|
$
|
—
|
|
|
$
|
1,016
|
|
Impairment of Commercial Cyber Solutions Goodwill
|
—
|
|
|
6,980
|
|
Loss recognized on classification as held for sale
|
—
|
|
|
3,568
|
|
Cash flows from investing activities
|
|
|
|
Purchases of property and equipment
|
—
|
|
|
(417
|
)
|
Proceeds from Hexis asset divestiture
|
$
|
—
|
|
|
$
|
5,000
|
|
Other Dispositions
In March 2016, we completed the sale of our SETA business to Quantech Services, Inc. for approximately
$11.2 million
in cash. The SETA business was not deemed an individually significant component of our Company. The sale of SETA eliminated KeyW’s organizational conflicts of interest at two key government agencies and will allow our Company to focus 100% on technology development opportunities across the Intelligence Community. However, the sale of SETA did not represent a strategic shift that will have a major effect on our operations and financial results and, accordingly, the business historical results and the gain on sale were classified within continuing operations on our condensed consolidated statements of operations.
In connection with the sale of SETA, we recognized a pre-tax gain of approximately
$3.0 million
. This gain was reported within non-operating expense, net,
on our condensed consolidated statement of operations and reflects the difference between the consideration received for SETA and the net carrying value of the business less transaction costs. The net carrying value of the SETA business included approximately
$7.2 million
of goodwill that, in accordance with ASC 350, was allocated to the business
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES
based upon the relative fair values of SETA and the overall Government Solutions reporting unit within which the SETA business historically had been reported.
13. INCOME TAXES
The Company has historically measured its quarterly provision for income taxes using an estimated annual effective tax rate, subsequently adjusted for discrete items that occur within the quarter. The Company used a discrete effective tax rate method during the second quarter of 2017, as the historical method would not have provided a reliable estimate for the quarter. The provision for income taxes for continuing operations for the
three months ended June 30, 2017
and
2016
, was an expense of
$3.1 million
and
$3.0 million
, respectively. The effective tax rate on income from continuing operations was negative
23.1%
and
117.2%
for the
three months ended June 30, 2017
and
2016
, respectively. The provision for income taxes for continuing operations for the
six months ended June 30, 2017
and
2016
, was an expense of
$3.1 million
and
$4.4 million
, respectively. The effective tax rate on income from continuing operations was negative
17.9%
and
74.8%
for the
six months ended June 30, 2017
and
2016
, respectively.
As a result of the adoption of ASU 2016-09 in the first quarter of 2017, the Company recorded a cumulative effect adjustment to increase deferred tax assets for the federal and state net operating losses attributable to excess tax benefits from stock-based compensation that had not been previously recognized. The impact was an increase to the deferred tax assets associated with net operating losses of approximately
$0.5 million
, which was offset by a corresponding increase to the valuation allowance. All excess tax benefits and deficiencies in the current and future periods will be recognized within the quarterly provision for income taxes during the reporting period in which they occur. This may result in increased volatility in the Company’s effective tax rate.
With the acquisition of Sotera in the second quarter of 2017, the Company determined that the acquired deferred tax assets should have a full valuation allowance established against them. A full valuation allowance was established on KeyW’s deferred tax assets during the second quarter of 2015 due to the uncertainty of the utilization in future periods. In evaluating the Company’s ability to realize the deferred tax assets we considered all available positive and negative evidence, including cumulative historical earnings, reversal of temporary difference, projected taxable income and tax planning strategies. The Company’s negative evidence currently outweighs its positive evidence, therefore it is more likely than not that we will not realize a significant portion of our deferred tax asset. The amount of the deferred tax asset to be realized in the future could however be adjusted if objective negative evidence is no longer present.
THE KEYW HOLDING CORPORATION AND SUBSIDIARIES