ITEM 7
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of financial
condition and results of operations of the Company should be read in conjunction with the consolidated financial statements for
the year ended December 31, 2016, the periods November 24, 2015 through December 31, 2015 and January 1, 2015 through November
23, 2015, and the years ended December 31, 2014, including the notes thereto, included elsewhere in this Annual Report on Form
10-K. The Company’s actual results may not be indicative of future performance. This discussion and analysis contains forward-looking
statements and involves numerous risk and uncertainties, including, but not limited to, those discussed in “Cautionary Note
Regarding Forward-Looking Statements” and “Risk Factors” included in Part I, Item 1A, or in other parts of this
Annual Report on Form 10-K. Actual results may differ materially from those contained in any forward-looking statements.
Management’s Discussion and Analysis of
Financial Condition and Results of Operations (“MD&A”) contains certain financial measures, in particular EBITDA
and Adjusted EBITDA, which are not presented in accordance with GAAP. These non-GAAP financial measures are being presented because
management believes that they provide readers with additional insight into the Company’s operational performance relative
to earlier period and relative to its competitors. EBITDA and Adjusted EBITDA are key measures used by the Company to evaluate
its performance. The Company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information.
Readers of this MD&A should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.
Reconciliations of EBITDA and Adjusted EBITDA to net income, the most comparable GAAP measure, are provided in this MD&A.
On November 23, 2015, the Company (formerly
known as Global Defense and National Security Systems, Inc.) and STG Group Holdings, Inc. (“STG Group Holdings”) completed
a transaction in which the Company acquired 100 percent of the capital stock of STG Group Holdings, Inc. from its then owners (the
“Business Combination”). In connection with the closing of the Business Combination, the Company changed its name to
STG Group, Inc., and commenced trading of its common stock under the symbol “STGG” on the OTC Pink Current Information
tier of the over-the-counter market. The Company’s common stock trades over the counter on the OTCQB. This transaction is
further described in Note 2 to the Company’s consolidated financial statements included herein.
Fiscal Year
The Company’s fiscal year ends on
December 31. Throughout the year, the Company reports its results using a fiscal calendar whereby each three month calendar end
represents the end of a quarter. As a result, the number of work days may fluctuate between the various quarterly periods. For
comparison purposes we have combined our contract revenue and Adjusted EBITDA in the period November 24, 2015 to December 31, 2015
(Successor) with STG Group’s contract revenue and Adjusted EBITDA in the period January 1, 2015 through November 23, 2015
(Predecessor). Net sales and Adjusted EBITDA were not affected by acquisition accounting. Refer to Note 2 to the consolidated financial
statements for additional information on acquisition accounting for the Business Combination.
Overview
The Company provides specialist cyber, software
and intelligence solutions to U.S. government organizations with a national security mandate. Our solutions are integral to national
security-related programs run by more than 50 U.S. government agencies, including the Department of Defense, the Intelligence Community,
the Department of Homeland Security, the Department of State and other government departments with national security responsibilities.
Our programs are predominantly funded from base budgets and essential to the effective day-to-day operations of our customers.
Our operational strength and track record has
been established in securing highly sensitive, mission-critical national security networks, solving complex technology problems
in mission-critical contexts and providing decision makers with actionable intelligence from multiple data sources.
The Company specializes in three core areas
of capability:
|
•
|
Cyber Security and Secure
Information Systems
— securing highly sensitive, mission-critical national security networks
|
|
•
|
Software Development, Systems and Services
— solving complex problems in mission-critical contexts
|
|
•
|
Intelligence and Analytics
— gathering and analyzing data from multiple sources to provide high quality, actionable intelligence across multiple contexts
|
Key Events
Business Combination
. On November 23,
2015, the Company and STG Group Holdings completed the Business Combination in which the Company acquired 100% of the capital stock
of STG Group Holdings from its then-current owners. In connection with the closing of the Business Combination, the Company changed
its name to STG Group, Inc., and commenced trading of its common stock on the OTC Pink Current Information tier of the over-the-counter
market. The Company’s common stock now trades over the counter on the OTCQB. This transaction is further described in Note
2 to the Company’s consolidated financial statements included herein.
The Company’s 2015 results for the
period January 1, 2015 through November 23, 2015 and the period November 24, 2015 through December 31, 2015, were impacted by approximately
$1 million and $2 million in transaction expenses directly related to the Business Combination. The Company also incurred $1.0
million and $0.8 million in increased amortization and interest expense, respectively, during the period November 24, 2015 to December
31, 2015 resulting from the identification of intangibles at fair value in acquisition accounting for the Business Combination
and the Term Note issued to finance the combination. See Notes 2 and 7 to the Company’s consolidated financial statements
included herein for further discussion of the Business Combination.
During the period ended December 31, 2016,
the Company recognized an annual goodwill impairment charge of $41 million. For a discussion of the methodology used for our goodwill
impairment testing, see “
—Goodwill, Other Intangible Assets and Other Long-Lived Assets
.”
On February 18, 2017, the Company entered into
an Agreement and Plan of Merger (the “Merger Agreement”) to acquire PSS Holdings, Inc. (“PSS”) for approximately
$119.5 million in cash, subject to certain adjustments based upon closing working capital, plus a portion of the value of certain
tax benefits as they are realized after the closing. The purchase price will also be increased by an additional $20,000 per day
if the merger is consummated after March 31, 2017 and certain conditions to the obligations of the Company to close are otherwise
satisfied, such increase applicable for each day after March 31, 2017 that such conditions are so satisfied.
PSS is a privately-held government services
business that provides products and services in information technology, engineering, and program management, and is a leading provider
of advanced computing, analytics, program and acquisition management, cyber and software solutions to key defense, intelligence
and federal civilian customers, working with over 25 government agency partners. Upon consummation of the merger contemplated by
the Merger Agreement (the “merger”), PSS will become a wholly-owned subsidiary of the Company.
The consummation of the merger is subject
to the satisfaction of certain conditions, including receipt of certain required third party consents. If any condition to the
merger is not satisfied or waived, the merger will not be completed. In addition, the Company intends to fund the merger consideration
through a combination of equity and debt financing. We do not presently have commitments for such financing. To the extent the
merger is not completed for any reason with respect to our ability to obtain financing for the merger, we may be required to pay
a termination fee of $625,000 to PSS.
On April 13, 2017, the Company received
a letter from PSS purporting to terminate the Merger Agreement, unless we notify PSS that we are prepared to close and schedule
the closing of the merger for no later than April 23, 2017. The Company does not believe the purported termination of the Merger
Agreement is valid, and the Company is evaluating its alternatives and rights under the Merger Agreement.
Key Financial Definitions
Contract Revenue
. Contract Revenue reflects
the Company’s sales of its services, software or material purchases. Several factors affect revenue in any period, including
the contractual funding and timing of acquisitions and the purchasing habits of its customers.
Cost of Revenue
. Cost of revenue includes
all direct costs of providing services and products to the government. Such costs include direct labor, subcontract labor, software,
hardware, materials, and travel. The largest component of cost of goods sold is labor.
Indirect and Selling Expenses
. Indirect
and selling expenses include all fringe related expenses, all management cost, sales and marketing, finance and administration,
and quality expenses.
Impairment of Goodwill and Intangible
Assets
. As required by GAAP, when certain conditions or events occur, the Company recognizes impairment losses to reduce the
carrying value of goodwill, other intangible assets, and property, plant and equipment. During the period ended December 31, 2016,
the Company recognized an impairment charge of $41 million related to goodwill in the Company’s only reporting unit. For
a discussion of the methodology used for our goodwill impairment testing, see “
—Goodwill, Other Intangible Assets
and Other Long-Lived Assets
.”
Transaction-related expenses
. Transaction-related
expenses primarily consist of professional service fees related to the Business Combination.
Interest expense
. Interest expense consists
of interest paid to the Company’s lenders under its line of credit revolving facilities and its term debt and amortization
of deferred financing costs.
Other (expense) income
. Other (expense)
income is principally comprised of investment activity generated from the Rabbi Trust for the Company’s deferred compensation
plan. As a result of the transaction, the deferred compensation plan had a triggering event under which participant balances on
deposit were liquidated in January 2016.
Tax (benefit) provision
. The Company’s
tax provision is impacted by a number of factors, including the amount of taxable earnings derived in foreign jurisdictions with
tax rates that are different than U.S. federal statutory rate, state tax rates in the jurisdictions where the Company does business,
tax minimization planning and its ability to utilize various tax credits and net operating loss carry-forwards. Income tax expense
also includes the impact of provision to return adjustments, changes in valuation allowances and changes in reserve requirements
for unrecognized tax benefits.
Consolidated Results of Operations
|
|
Successor
|
|
|
Successor
|
|
|
Predecessor
|
|
|
Predecessor
|
|
|
|
(In thousands)
|
|
|
|
Year Ended
December 31,
2016
|
|
|
November 24, 2015
Through
December 31, 2015
|
|
|
January 1, 2015
Through
November 23, 2015
|
|
|
Year Ended
December 31,
2014
|
|
Contract Revenue
|
|
$
|
164,055
|
|
|
$
|
17,300
|
|
|
$
|
176,345
|
|
|
$
|
209,727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenue
|
|
|
111,263
|
|
|
|
11,702
|
|
|
|
120,989
|
|
|
|
141,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
52,792
|
|
|
|
5,598
|
|
|
|
55,356
|
|
|
|
67,802
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect and Selling Expenses
|
|
|
54,538
|
|
|
|
6,407
|
|
|
|
47,837
|
|
|
|
61,286
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of goodwill and intangible assets
|
|
|
41,276
|
|
|
|
0
|
|
|
|
2,970
|
|
|
|
6,928
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
|
(43,022
|
)
|
|
|
(809
|
)
|
|
|
4,549
|
|
|
|
(412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
|
(8,725
|
)
|
|
|
(898
|
)
|
|
|
(57
|
)
|
|
|
(70
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
|
(354
|
)
|
|
|
(132
|
)
|
|
|
37
|
|
|
|
313
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income taxes
|
|
|
(52,101
|
)
|
|
|
(1,839
|
)
|
|
|
4,529
|
|
|
|
(169
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax (benefit) provision
|
|
|
(3,902
|
)
|
|
|
(1,585
|
)
|
|
|
644
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
|
(48,199
|
)
|
|
|
(254
|
)
|
|
|
3,885
|
|
|
|
(169
|
)
|
Year ended December, 31 2016 and the periods November 24,
2015 through December 31, 2015 (Successor) and January 1, 2015 through November 23, 2015 (Predecessor). For the discussion below,
the Successor and Predecessor periods have been combined to discuss results for the year ended December 31, 2015 as a whole.
Contract Revenue
Contract revenue was $164.1 million for the
year ended December 31, 2016, a decrease of $29.5 million, or 15.3% compared to $193.6 million for the year ended December 31,
2015. The decrease in revenue is primarily due to seven contracts. Three Department of Defense (DOD) contracts, two of which ended
in 2015 and one early in 2016, an Intelligence Community contract which was completed and ended in September 2015, a Department
of Homeland Security contract which ended in 2016 and contracts with Department of State and DEA which both ended in 2015.
The table below summarizes our revenue by customer
for the year ended December 31, 2016 and 2015 (Combined Successor and Predecessor Periods).
|
|
Year ended December 31,
|
|
Revenue by customer
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except percentages)
|
|
|
|
|
|
|
|
|
Department of Defense
|
|
$
|
70,639
|
|
|
|
43
|
%
|
|
$
|
83,855
|
|
|
|
43
|
%
|
Department of State
|
|
|
57,334
|
|
|
|
35
|
%
|
|
|
62,038
|
|
|
|
32
|
%
|
Department of Homeland Security
|
|
|
10,532
|
|
|
|
7
|
%
|
|
|
18,195
|
|
|
|
9
|
%
|
Intelligence Community
|
|
|
3,810
|
|
|
|
2
|
%
|
|
|
9,007
|
|
|
|
5
|
%
|
Drug Enforcement Administration
|
|
|
-
|
|
|
|
0
|
%
|
|
|
3,974
|
|
|
|
2
|
%
|
Other Federal Civilian
|
|
|
21,740
|
|
|
|
13
|
%
|
|
|
16,576
|
|
|
|
9
|
%
|
|
|
$
|
164,055
|
|
|
|
|
|
|
$
|
193,645
|
|
|
|
|
|
The Department of Defense continues to be our
largest customer with 43% of total revenue generated from this customer in the year ended December 31, 2016 compared to 43%
of total revenue in the year ended December 31, 2015. Revenue generally decreased across the customer base for the year ended December
31, 2016 compared to the same period in 2015, although there was an increase in revenue from the Federal Civilian agencies.
The table below summarizes our revenue by contract
billing type for the years ended December 31, 2016 and 2015 (Combined Successor and Predecessor Periods).
|
|
Year ended December 31,
|
|
Revenue by Contract Type
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except percentages)
|
|
T&M
|
|
$
|
56,323
|
|
|
|
34
|
%
|
|
$
|
64,523
|
|
|
|
33
|
%
|
Fixed price
|
|
|
47,615
|
|
|
|
29
|
%
|
|
|
58,858
|
|
|
|
30
|
%
|
Cost Plus
|
|
|
60,117
|
|
|
|
37
|
%
|
|
|
70,264
|
|
|
|
37
|
%
|
|
|
$
|
164,055
|
|
|
|
|
|
|
$
|
193,645
|
|
|
|
|
|
Time-and-materials contract revenue decreased
by $8.2 million in the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease in time-and-materials
contract revenue was driven by the end of the DEA contract in the second quarter, the end of the Army/DOD contract in the third
quarter of 2015 and the expiration of a Department of State contract in 2015. Fixed price contract revenue decreased by $11.3 million.
Reductions in Department of Defense and Department of Homeland Security customers’ activities are responsible for these decreases.
Cost Plus revenue was down $10.1 million due primarily to a reduction of Intelligence Community and Department of Defense tasking.
Our prime contract revenue decreased by $26.7 million in the year ended December, 2016 compared to the
year ended December 31, 2015. The decrease was attributable to the expiration of the Department of Defense Intelligence Community,
Department of Homeland Security, Department of State and DEA contracts.
The table below summarizes our revenue by prime
and subcontract type for the years ended December 31, 2016 and 2015 (Combined Successor and Predecessor Periods).
|
|
Year ended December 31,
|
|
Revenue – Prime and Subcontract
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands, except percentages)
|
|
Prime
|
|
$
|
143,305
|
|
|
|
87
|
%
|
|
$
|
170,070
|
|
|
|
88
|
%
|
Subcontract
|
|
|
20,750
|
|
|
|
13
|
%
|
|
|
23,575
|
|
|
|
12
|
%
|
|
|
$
|
164,055
|
|
|
|
|
|
|
$
|
193,645
|
|
|
|
|
|
STG continues to concentrate on to increasing
its presence as a prime contractor on larger, more complex programs where it delivers services to customers by deploying its own
staff and expertise.
Direct Expenses and Gross Profit
Direct expenses consist of direct labor, subcontractors
and consultants, and other direct costs. For the year ended December 31, 2016, direct expenses were $111.3 million and $132.7 million
for the year ended December 31, 2015. The decrease of $21.4 million, or 16.1%, was primarily a result of the Department of Defense,
Intelligence Community, Department of Homeland Security, Department of State and DEA contracts that expired in 2015 and 2016.
Gross profit was $52.8 million for the year ended December 31,
2016, compared to $61 million for the year ended December 31, 2015. The decrease of in gross profit during the year ended December
31, 2016 of $8.2 million or 13.4% is primarily a result of the Department of Defense, Department of Homeland Security, Department
of State and DEA contracts that ended during 2015 and 2016.
Indirect and Selling Expenses
Indirect and selling expenses were $54.5 million
for the year ended December 31, 2016 compared to $6.4 million for the period November 24, 2015 to December 31, 2015 and $47.8 million
for the period January 1, 2015 through November 23, 2015 or $54.2 million for the full year ended December 31, 2015. This represents
a small increase of $0.3 million in overall indirect and selling expenses in 2016 compared to 2015.
During the year ended December 31, 2016, the
Company incurred $0.7 million in expense for share-based compensation related to the new equity awards granted upon consummation
of the Business Combination and subsequent awards compared to $0.03 million recognized in the period November 24, 2015 to December
31, 2015. No share based compensation expense was incurred in prior periods. Selling and administrative expenses for the year
ended December 31, 2016 include $0.5 million and $7.0 million of depreciation and amortization expense, respectively, compared
to $0.9 million and $1.6 million of depreciation and amortization expense, respectively in the combined periods November 24, 2015
to December 31, 2015 and January 1, 2015 to November 23, 2015.
The increase in intangible amortization of $5.4 million is due
to an increase in intangible assets from the Business Combination. Selling and administrative expenses in 2016 also include a
decrease in personnel and benefits costs of ($5.6) million due to savings realized in 2016 from the Company restructuring efforts
implemented during 2015 and 2016. These savings were partially offset by increases in board of director compensation and expenses,
third party professional fees and public filing related expenses, which approximated $1.4 million for the year ended December
31, 2016 and $0.3 million
for the period
November 24 to December 31, 2015. Selling and administrative expenses during the period January 1, 2015 to November 23, 2015,
included an expense of $0.7 million recognizing a loss on the sublease of space once the Company renegotiated its lease agreement
and moved its Corporate Headquarters.
Additionally, for the period January 1, 2015
to November 23, 2015, the selling and administrative expenses included a charge of $1.1 million related to the disposal of fixed
assets. This was primarily associated with moving its Corporate Headquarters and writing off undepreciated leasehold improvements.
For the period November 24, 2015 to December 31, 2015, and for the year ended December 31, 2014, no losses on disposal of fixed
assets were material.
Impairment of Goodwill and Other Intangible Assets
In 2002, STG Group acquired DSTI and Seamast
Incorporated (“Seamast”) as wholly-owned subsidiaries, which resulted in STG Group recording goodwill. Effective December
31, 2012, STG Group acquired Access Systems, which also resulted in STG Group recording additional amounts of goodwill. The Company’s
goodwill balance consists of the following (in thousands):
|
|
DSTI
|
|
|
Seamast
|
|
|
Access
|
|
|
STG
successor
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2014, Predecessor
|
|
$
|
440
|
|
|
$
|
1,898
|
|
|
$
|
2,361
|
|
|
|
|
|
|
$
|
4,699
|
|
Impairment loss
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,064
|
)
|
|
|
|
|
|
|
(2,064
|
)
|
Balance, November 23, 2015, Predecessor
|
|
|
440
|
|
|
|
1,898
|
|
|
|
297
|
|
|
|
|
|
|
|
2,635
|
|
Elimination of predecessor goodwill
|
|
|
(440
|
)
|
|
|
(1,898
|
)
|
|
|
(297
|
)
|
|
|
|
|
|
|
(2,635
|
)
|
Acquisition of business, Successor
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
113,589
|
|
|
|
113,589
|
|
Balance, December 31, 2015, Successor
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
113,589
|
|
|
|
113,589
|
|
Impairment loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(41,276
|
)
|
|
|
(41,276
|
)
|
Balance, December 31, 2016, Successor
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
72,313
|
|
|
$
|
72,313
|
|
For the period from January 1, 2015 to November
23, 2015 and for the year ended December 31, 2014, the Company recorded impairment losses on Access Systems goodwill of $2.1 million
and $3.5 million and impairment losses on Access Systems customer relationships of $0.9 million and $1.8 million, respectively.
Additionally, for the year ended December 31, 2014, the Company recorded an impairment loss related to its previous acquisition
of Decision Systems Technologies, Inc. (DSTI) of $1.7 million. The primary methods used to measure the impairment losses for DSTI
and Access Systems were the income method and the market approach. The impairment loss is primarily due to declining revenues
and future cash flows generated for the DSTI and Access Systems reporting units.
For the year ended December 31, 2016, the Company recorded an impairment loss of $41.3 million. For the
year ended December 31, 2016, the Company’s third party valuation firm performed the first step of the annual goodwill impairment
test in the fourth quarter of 2016 and determined that the estimated fair value of the Company’s sole reporting unit was
lower than the carrying value, requiring further analysis under the second step of the impairment test. The decline in the estimated
fair value of the Company was primarily due to significantly lower revenue in 2016 than planned. Growth rates in future years remain
comparable to the prior planned growth; however future revenue and related profits are less than the previous plan due to significantly
lower 2016 revenue.
Operating Income (Loss)
There was an operating loss of ($43.0) million
for the year ended December 31, 2016 compared to operating income of $3.7 million for the year ended December 31, 2015.
The decrease in operating income of ($46.7)
million is primarily due to the impairment charge related to goodwill of ($41.2) million and additional depreciation and amortization
expense of ($6.4) million recognized during the year ended December 31, 2016 versus the year ended December 31, 2015. These losses
were partially offset by cost savings realized in the Company’s indirect and selling expenses during 2016.
For a discussion of the methodology used for our goodwill impairment testing, see “
—Goodwill,
Other Intangible Assets and Other Long-Lived Assets
.”
Other Income (Expense)
Other (expense) income was ($0.3) million for
the year ended December 31, 2016 and ($0.1) for the combined periods November 24, 2015 to December 31, 2015 and January 1, 2015
to November 23, 2015. Other income (expense) is primarily generated by market performance of the investments of the assets held
in trust securing the Company’s deferred compensation plan.
Interest Expense
Interest expense was $8.7 million for the year
ended December 31, 2016 compared to $1.0 million for the combined periods November 24, 2015 to December 31, 2015 and January 1,
2015 to November 23, 2015. Interest expense for the year ended December 31, 2016 reflects the Company’s new level of debt
following the consummation of the Business Combination. See “Secured Credit Facilities” in the Liquidity and Capital
Resources section of this MD&A for further discussion.
(Loss) Income before Income Taxes
(Loss) income before income taxes was ($52.1)
million for the year ended December 31, 2016 and $2.7 million for the combined periods November 24, 2015 to December 31, 2015 and
January 1, 2015 to November 23, 2015. The decrease in income before income taxes is primarily due to recognition of the non-cash
impairment of Goodwill and additional amortization of intangible assets resulting from the Business Combination.
Tax Provision (Benefit)
The tax provision (benefit) was ($3.9) million
for the year ended December 31, 2016 and ($0.9) million for the combined periods November 24, 2015 to December 31, 2015 and period
January 1, 2015 to November 23, 2015. The post-acquisition net deferred tax liability is primarily due to the future tax expense
related to the intangible assets recognized as a result of the Business Combination. Amortization of intangible assets recognized
in the Business Combination is not deductible for tax purposes. The predecessor company was an S Corporation for Federal and most
State related tax filings and as a result the tax liabilities flowed directly to its stockholders. Due to a change from a cash
basis to accrual basis in the S Corporation period the predecessor company incurred higher state taxes in jurisdictions that tax
S Corporations. As a result, pre and post-acquisition income tax related expenses will not be comparable.
Deferred income taxes are accounted for under
the asset and liability method and reported on the Company’s Balance Sheet as a net asset or net liability. Deferred tax
assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities
are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets
and liabilities and their income tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management,
it is more-likely-than-not that some portion or all of the deferred tax assets may not be realized. Deferred tax assets and liabilities
are adjusted for effects of changes in tax laws and rates on the date of enactment.
In connection with the Business Combination,
STG Group (Predecessor) converted from a Subchapter S-Corporation to a C-Corporation. Prior to this, for the period from January
1, 2015 through November 23, 2015 and the year ended December 31, 2014, STG Group generally did not incur corporate level income
taxes, exclusive of certain state level jurisdictions. In lieu of corporate income taxes, the Predecessor's stockholders separately
accounted for their pro-rata share of STG Group’s income, deductions, losses and credits. Therefore, the Company recognized
corporate level deferred tax assets and liabilities for solely the Successor period. In addition, the Company released a valuation
allowance against its deferred tax assets in the amount of $1.05 million following the Business Combination due to an assessment
that it was more likely than not that these deferred tax assets would be realized.
The consolidated entity was able to recognize
a deferred tax asset of $1.7 million in 2015 due to the tax amortization treatment of the start-up costs and the payout of the
deferred compensation balances on January 25, 2016. Further, upon change to a C-Corporation on November 23, 2015, our taxable income
generated from our operational activities is subject to an effective tax rate in excess of 35% for both Federal and State taxes.
Net (Loss) Income
For the reasons described above, net (loss)
income was ($48.2) million for the year ended December 31, 2016 compared to $3.6 million for the combined periods November 24,
2015 to December 31, 2015 and January 1, 2015 to November 23, 2015.
Periods
November 24, 2015 through December
31, 2015 (Successor), January 1, 2015 through November 23, 2015 (Predecessor), and the year ended December 31, 2014. For the discussion
below, the Successor and Predecessor periods have been combined to discuss results for the year ended December 31, 2015 as a whole.
Contract Revenue
Contract revenues was $193.6 million for the
combined year ended December 31, 2015, a decrease of $16.1 million, or 7.6% compared to $209.7 million for the year ended December
31, 2014. The decrease in revenue is primarily due to three contracts, a Drug Enforcement Administration (DEA) contract which ended
in June 2015, an Army contract which ended in August 2015, and an Intelligence Community contract which was completed and ended
in September 2015.
The table below summarizes our revenue by customer
for the year ended December 31, 2015 (Combined Successor and Predecessor Periods) and 2014.
|
|
Year ended December 31,
|
|
Revenue by customer
|
|
2015
|
|
|
2014
|
|
|
|
(in thousands, except percentages)
|
|
|
|
|
|
|
|
|
Department of Defense
|
|
$
|
83,855
|
|
|
|
43
|
%
|
|
$
|
87,057
|
|
|
|
41
|
%
|
Department of State
|
|
|
62,038
|
|
|
|
32
|
%
|
|
|
65,591
|
|
|
|
31
|
%
|
Department of Homeland Security
|
|
|
18,195
|
|
|
|
9
|
%
|
|
|
15,902
|
|
|
|
8
|
%
|
Intelligence Community
|
|
|
9,007
|
|
|
|
5
|
%
|
|
|
13,132
|
|
|
|
6
|
%
|
Drug Enforcement Administration
|
|
|
3,974
|
|
|
|
2
|
%
|
|
|
9,971
|
|
|
|
5
|
%
|
Other Federal Civilian
|
|
|
16,576
|
|
|
|
9
|
%
|
|
|
18,074
|
|
|
|
9
|
%
|
|
|
$
|
193,645
|
|
|
|
|
|
|
$
|
209,727
|
|
|
|
|
|
The Department of Defense continues to be
our largest customer with 43% of total revenue generated from this customer in the year ended December 31, 2015 compared to 41%
of total revenue in the year ended December 31, 2014. Revenue by customer remained relatively consistent in the year ended December
31, 2015 compared to the year ended December 31, 2014, except for the loss of the Drug Enforcement Administration contract, the
Army contract, and the loss of an Intelligence Community contract.
The table below summarizes our revenue by contract
billing type for the years ended December 31, 2015 (Combined Successor and Predecessor Periods) and 2014.
|
|
Year ended December 31,
|
|
Revenue by Contract Type
|
|
2015
|
|
|
2014
|
|
|
|
(in thousands, except percentages)
|
|
T&M
|
|
$
|
64,523
|
|
|
|
33
|
%
|
|
$
|
76,532
|
|
|
|
37
|
%
|
Fixed price
|
|
|
58,858
|
|
|
|
30
|
%
|
|
|
59,388
|
|
|
|
28
|
%
|
CPFF
|
|
|
70,264
|
|
|
|
37
|
%
|
|
|
73,807
|
|
|
|
35
|
%
|
|
|
$
|
193,645
|
|
|
|
|
|
|
$
|
209,727
|
|
|
|
|
|
Time-and-materials contract revenue decreased
by $12 million in the year ended December 31, 2015 compared to the year ended December 31, 2014. The decrease in time-and-materials
contract revenue was driven by loss of the DEA contract ending in the second quarter and the loss of the Army contract in the third
quarter of 2015.
The table below summarizes our revenue by prime
and subcontract type for the years ended December 31, 2015 (Combined Successor and Predecessor Periods) and 2014.
|
|
Year ended December 31,
|
|
Revenue – Prime and Subcontract
|
|
2015
|
|
|
2014
|
|
|
|
(in thousands, except percentages)
|
|
Prime
|
|
$
|
170,070
|
|
|
|
88
|
%
|
|
$
|
181,008
|
|
|
|
86
|
%
|
Subcontract
|
|
|
23,575
|
|
|
|
12
|
%
|
|
|
28,719
|
|
|
|
14
|
%
|
|
|
$
|
193,645
|
|
|
|
|
|
|
$
|
209,727
|
|
|
|
|
|
Our prime contract revenue percentage increased by 2% in the year ended December, 2015 compared to the
year ended December 31, 2014. STG continues to concentrate on increasing its presence as a prime contractor on larger, more complex
programs where it delivers services to customers by deploying its own staff and expertise.
Direct Expenses and Gross Profit
Direct expenses consist of direct labor, subcontractors
and consultants, and other direct costs. In the year ended December 31, 2015, direct expenses were $11.7 million for the period
November 24, 2015 through December 31, 2015 and was $121 million for the period January 1, 2015 through November 23, 2015 compared
to $141.9 million for the year ended December 31, 2014. The decrease of $9.2 million, or 6.4% was primarily a result of the Drug
Enforcement Administration contract ending, the loss of an Army contract, and the ending of an Intelligence Community contract.
Gross profit was $5.6 million for the period
November 24, 2015 through December 31, 2015 and $55.4 million for the period January 1, 2015 through November 23, 2015, compared
to $68 million for the year ended December 31, 2014. The decrease in gross profit during the year ended December 31, 2015 of $7.0
million or 10.3% is primarily due to the loss of the DEA contract, the Army contract, and the Intelligence Community contract during
2015.
Indirect and Selling Expenses
Indirect and selling expenses were $6.4 million
for the period November 24, 2015 to December 31, 2015 and $47.8 million for the period January 1, 2015 through November 23, 2015,
compared to $61.3 million during the year ended December 31, 2014. The decrease of $7.1 million or 12% was due to management’s
cost reduction efforts which included the relocation of the Corporate headquarters as well as personnel reductions.
During the period November 24, 2015 to December
31, 2015, the Company incurred $0.03 million in expense for share-based compensation related to new equity awards granted upon
consummation of the Business Combination, for which no expense was incurred in prior periods. Selling and administrative expenses
for the period November 24, 2015 to December 31, 2015, include $0.1 million and $0.9 million of incremental depreciation and amortization
expense, respectively, and the period January 1, 2015 to November 23, 2015, which includes $0.8 million and $0.7 million respectively,
compared to $1.2 million and $0.6 million of depreciation and amortization expense for the year ended December 31, 2014. The increase
in intangible amortization is due to an increase in intangible assets from the business combination. Selling and administrative
expenses also increased in the period November 24, 2015 to December 31, 2015, due to the incurrence of additional expense in personnel
costs, board of director compensation and expenses, third party professional fees and public filing related expenses, which approximated
$0.3 million for the period. Selling and administrative expenses during the period January 1, 2015 to November 23, 2015, included
an expense of $0.7 million recognizing a loss on the sublease of space once the Company renegotiated its lease agreement and moved
its Corporate Headquarters.
Additionally, for the period January 1, 2015
to November 23, 2015, the selling and administrative expenses included a charge of $1.1 million related to the disposal of fixed
assets. This was primarily associated with moving its Corporate Headquarters and writing off undepreciated leasehold improvements.
For the period November 24, 2015 to December 31, 2015, and for the year ended December 31, 2014, no losses on disposal of fixed
assets were material.
Impairment of Goodwill and Other Intangible Assets
In 2002, STG Group acquired DSTI and Seamast
Incorporated (“Seamast”) as wholly-owned subsidiaries, which resulted in STG Group recording goodwill. Effective December
31, 2012, STG Group acquired Access Systems, which also resulted in STG Group recording additional amounts of goodwill. The Company’s
goodwill balance consists of the following (in thousands):
|
|
Predecessor
DSTI
|
|
|
Predecessor
Seamast
|
|
|
Predecessor
Access
|
|
|
Successor
STG Group
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2014, Predecessor
|
|
$
|
440
|
|
|
$
|
1,898
|
|
|
$
|
2,361
|
|
|
|
-
|
|
|
$
|
4,699
|
|
Impairment loss
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,064
|
)
|
|
|
-
|
|
|
|
(2,064
|
)
|
Balance, November 23, 2015, Predecessor
|
|
|
440
|
|
|
|
1,898
|
|
|
|
297
|
|
|
|
-
|
|
|
|
2,635
|
|
Elimination of predecessor goodwill
|
|
|
(440
|
)
|
|
|
(1,898
|
)
|
|
|
(297
|
)
|
|
|
-
|
|
|
|
(2,635
|
)
|
Acquisition of business
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
113,589
|
|
|
|
113,589
|
|
Balance, December 31, 2015, Successor
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
113,589
|
|
|
|
113,589
|
|
Impairment loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(41,276
|
)
|
|
|
(41,276
|
)
|
Balance, December 31, 2016, Successor
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
72,313
|
|
|
$
|
72,313
|
|
For the period from January 1, 2015 to November
23, 2015 and for the year ended December 31, 2014, the Company recorded impairment losses on Access Systems goodwill of $2.1 million
and $3.5 million and impairment losses on Access Systems customer relationships of $0.9 million and $1.8 million, respectively.
Additionally, for the year ended December 31, 2014, the Company recorded an impairment loss related to its previous acquisition
of Decision Systems Technologies, Inc. (DSTI) of $1.7 million. The primary methods used to measure the impairment losses for DSTI
and Access Systems were the income method and the market approach. The impairment loss is primarily due to declining revenues and
future cash flows generated for the DSTI and Access Systems reporting units.
Operating Income (Loss)
Operating income was $3.7 million for the year
ended December 31, 2015 compared to ($0.4) million in the year ended December 31, 2014.
The decrease in indirect and selling expenses
was partially offset by a decrease in revenue and gross profit in the year ended December 31, 2015 compared to the year ended December
31, 2014. The impairment loss of goodwill and other intangible assets decreased the operating income in the Predecessor’s
third quarter by $3.0 million.
Other Income (Expense)
Other (expense) income was ($0.1) million for
the period November 24, 2015 to December 31, 2015 and $.03 for the period January 1, 2015 to November 23, 2015, and was $0.3 million
for the year ended December 31, 2014. Other income (expense) is primarily generated by market performance of the investments of
the assets held in trust securing the Company’s deferred compensation plan.
Interest Expense
Interest expense was $0.9 million for the period
November 24, 2015 to December 31, 2015 and was $0.1 million for the period January 1, 2015 to November 23, 2015. Interest expense
was $0.1 million in 2014. Interest expense for the period November 24, 2015 to December 31, 2015 reflects the Company’s new
level of debt following the consummation of the Business Combination. See “Secured Credit Facilities” in the Liquidity
and Capital Resources section of this MD&A for further discussion.
(Loss) Income before Income Taxes
(Loss) income before income taxes was ($1.8)
million for the period November 24, 2015 to December 31, 2015 and $4.5 million for the period January 1, 2015 to November 23, 2015,
compared to a loss of ($0.2) million in 2014. The decrease in income before income taxes is primarily due to transaction-related
expenses as well as increases in selling and administrative expenses from being a public company as a result of the transaction.
The loss in 2014 was primarily due to impairment related charges around the Company’s goodwill and intangible asset balances
from previous acquisitions.
Tax Provision (Benefit)
The tax provision (benefit) was
($1.6) million for the period November 24, 2015 to December 31, 2015 and $0.6 million for the period January 1, 2015 to
November 23, 2015. The post-acquisition deferred tax benefit was primarily due to the future benefit related to the
capitalization and amortization (for tax purposes) of start-up costs. The predecessor company was an S Corporation for
Federal and most State related tax filings and as a result the tax liabilities flowed directly to its stockholders. Due to a
change from a cash basis to accrual basis in the S Corporation period ending November 23, 2015 the predecessor company
incurred higher state taxes in jurisdictions that tax S Corporations. As a result, pre and post-acquisition income tax
related expenses will not be comparable.
STG Group, excluding operations in the Netherlands
and Qatar conducted through STG Netherlands, B.V. (“STG Netherlands”) and STG Doha, LLC (“STG Doha”), respectively,
elected previous to the Business Combination to be treated as an S corporation under Subchapter S of the Internal Revenue Code,
which provides that, in lieu of corporate income taxes, the stockholders separately accounted for their pro-rata share of STG Group’s
items of income, deductions, losses and credits.
STG Netherlands and STG Doha are in jurisdictions
that do not recognize S corporations. Deferred income taxes are accounted for under the asset and liability method. Deferred tax
assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities
are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets
and liabilities and their income tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management,
it is more-likely-than-not that some portion or all of the deferred tax assets may not be realized. Deferred tax assets and liabilities
are adjusted for effects of changes in tax laws and rates on the date of enactment.
In connection with the Business Combination,
STG Group (Predecessor) converted from a Subchapter S-Corporation to a C-Corporation. Prior to this, for the period from January
1, 2015 through November 23, 2015 and the years ended December 31, 2014. STG Group, generally did not incur corporate level income
taxes, exclusive of certain state level jurisdictions. In lieu of corporate income taxes, the Predecessor's stockholders separately
accounted for their pro-rata share of STG Group’s income, deductions, losses and credits. Therefore, the Company recognized
corporate level deferred tax assets and liabilities for solely the Successor period. In addition, the Company released a valuation
allowance against its deferred tax assets in the amount of $1.05 million following the Business Combination due to an assessment
that it was more likely than not that these deferred tax assets would be realized.
The consolidated entity was able to recognize
a deferred tax asset of $1.7 million due to the tax amortization treatment of the start-up costs and the payout of the deferred
compensation balances on January 25, 2016. Further, upon change to a C-Corporation, our taxable income generated from our operational
activities is subject to an effective tax rate in excess of 35% for both Federal and State taxes.
Net (Loss) Income
For the reasons described above, net (loss)
income was ($0.3) million for the period November 24, 2015 to December 31, 2015 and $3.9 million for the period January 1, 2015
to November 23, 2015, compared to ($0.2) million for the year ended December 31, 2014.
Key Measures the Company Uses to Evaluate Its Performance
EBITDA and Adjusted EBITDA
The Company defines EBITDA as net income (loss)
before interest expense, provision (benefit) for income taxes, depreciation and amortization and (gain)/loss on disposal of property,
plant and equipment.
The Company defines Adjusted EBITDA as EBITDA,
excluding the impact of operational restructuring charges and non-cash or non-operational losses or gains, including long-lived
asset impairment charges, formal cost reduction plans, excess and unutilized accruals, transactional legal fees, other professional
fees and retention employee bonuses.
Management believes that Adjusted EBITDA provides
a clear picture of our operating results by eliminating expenses and income that are not reflective of the underlying business
performance. We use this metric to facilitate a comparison of operating performance on a consistent basis from period to period
and to analyze the factors and trends affecting its core business areas. Our internal plans, budgets and forecasts use Adjusted
EBITDA as a key metric and the Company uses this measure to evaluate its operating performance and core business operating performance
and to determine the level of incentive compensation paid to its employees. Adjusted EBITDA is not an item recognized by the generally
accepted accounting principles in the United States of America, or U.S. GAAP, and should not be considered as an alternative to
net income, operating income, or any other indicator of a company’s operating performance required by U.S. GAAP. Our definition
of Adjusted EBITDA used here may not be comparable to the definition of Adjusted EBITDA used by other companies. A reconciliation
of income from net income to Adjusted EBITDA is as follows:
Set forth below is a reconciliation of Adjusted
EBITDA to net income (loss) (unaudited)
|
|
Successor
|
|
|
Predecessor
|
|
|
|
|
|
|
|
|
|
Year Ended
December 31,
2016
|
|
|
November 24, 2015
Through
December 31, 2015
|
|
|
January 1, 2015
Through
November 23, 2015
|
|
|
Year Ended
December 31,
2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(48,199
|
)
|
|
$
|
(254
|
)
|
|
$
|
3,885
|
|
|
$
|
(169
|
)
|
Income tax (benefit) expense*
|
|
|
(3,902
|
)
|
|
|
(1,585
|
)
|
|
|
644
|
|
|
|
346
|
|
Interest Expense
|
|
|
7,316
|
|
|
|
898
|
|
|
|
57
|
|
|
|
70
|
|
Amortization of loan issuance cost
|
|
|
1,409
|
|
|
|
119
|
|
|
|
0
|
|
|
|
0
|
|
Depreciation and Amortization
|
|
|
549
|
|
|
|
57
|
|
|
|
842
|
|
|
|
1,179
|
|
Amortization of intangibles
|
|
|
7,004
|
|
|
|
852
|
|
|
|
710
|
|
|
|
625
|
|
Impairment of Goodwill
|
|
|
41,276
|
|
|
|
0
|
|
|
|
2,064
|
|
|
|
5,117
|
|
Impairment of other intangible assets
|
|
|
0
|
|
|
|
0
|
|
|
|
906
|
|
|
|
1,811
|
|
EBITDA
|
|
$
|
5,453
|
|
|
$
|
87
|
|
|
$
|
9,108
|
|
|
$
|
8,979
|
|
Adjustments to EBITDA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Integration and other restructuring costs (1)
|
|
$
|
3,656
|
|
|
$
|
468
|
|
|
$
|
5,207
|
|
|
$
|
6,678
|
|
Nonrecurring expenses – advisory, legal, and professional fees (2)
|
|
|
3,069
|
|
|
|
13
|
|
|
|
1,805
|
|
|
|
2,765
|
|
Transaction related expenses (3)
|
|
|
243
|
|
|
|
1,194
|
|
|
|
1,394
|
|
|
|
0
|
|
Share-based compensation (4)
|
|
|
707
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
$
|
13,128
|
|
|
$
|
1,762
|
|
|
$
|
17,514
|
|
|
$
|
18,422
|
|
|
(1)
|
Integration and other restructuring costs including development of incentive compensation plans, branding, communication plans, and severance related to reductions in force.
|
|
(2)
|
Expenses incurred by the Company as a result of transitioning from a privately owned entity to a public company. These expenses include increased legal and accounting costs, investor relations, and marketing expenses.
|
|
(3)
|
Transaction-related expenses primarily consist of professional service fees related to the Business Combination.
|
|
(4)
|
Represents non-cash share based compensation expense for awards made under the Company’s 2015 Omnibus Incentive Plan.
|
*Income tax expense in 2014 relates to tax payments made in jurisdictions where the Company filed as if
it were a C Corporation for tax purposes (i.e. the District of Columbia). These expenses were included in indirect and selling
expenses in those years.
Backlog
Backlog, both funded and unfunded at, December
31, 2016, 2015 and 2014, is as follows:
|
|
December 31,
|
|
Backlog
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Funded
|
|
$
|
75
|
|
|
$
|
107
|
|
|
$
|
90
|
|
Unfunded
|
|
|
215
|
|
|
|
212
|
|
|
|
288
|
|
Funded and Unfunded
|
|
$
|
290
|
|
|
$
|
319
|
|
|
$
|
378
|
|
All of our existing contracts may have funded
and unfunded backlog, each of which is described below. The contract values and management’s estimated revenues do not include
any task orders or ceiling value under ID/IQ contracts, except to the extent that task orders have been awarded to the Company
under those contracts.
The amount of the Company’s backlog as
of December 31, 2015 increased from the amount previously disclosed in our Annual Report on Form 10-K for the year ended December
31, 2015 to include amounts inadvertently excluded. This increased backlog at December 31, 2015 by $66.3 million.
The Company defines total backlog as the amount of revenue it expects to realize (i) over the remaining
base contract performance period and (ii) from the exercise of option periods that management reasonably believes will be exercised,
in each case from signed contracts in existence as of the measurement date. The Company also includes in backlog its estimates
of revenue from future delivery orders on requirements and ID/IQ contracts for which we have an established pattern of revenues.
At times, our estimates of future revenue on such contracts are less than the contract ceiling. Our estimates are based on our
experience using such vehicles and similar contracts.
The Company defines funded backlog as the portion
of its total backlog for which funding is currently appropriated and obligated to it under a signed contract or task order by the
purchasing agency, or otherwise authorized for payment to the Company by a customer upon completion of a specified portion of work.
Our funded backlog does not include the full potential value of our contracts, because Congress often appropriates funds to be
used by an agency for a particular program or contract only on a yearly or quarterly basis, even though the contract may call for
performance over a number of years. As a result, contracts typically are only partially funded at any point during their term,
and all or some of the work to be performed under the contracts may remain unfunded unless and until Congress makes subsequent
appropriations and the procuring agency allocates funding to the contract. Unfunded backlog is primarily unfilled firm and expected
follow-on orders that have not yet met our established funding criteria. Our established funding criteria require both authorizations
by the customer as well as our management’s determination that there is little or no risk of the authorized funding being
rescinded. For example, option years on an existing contract are within the customer’s budgetary and procurement plans and
represent their plans to continue work on the contract. Those option years are not constituted as “funded backlog”
until the customer provides written authorization for work within that period of performance, which is usually expressed in one
year terms.
Our funded and unfunded backlog estimates are
determined by analyzing a number of key factors and attributes for executed contracts, task orders or delivery orders. Based upon
the result of our analysis we establish the expected revenue value for each of those contracts, task orders or delivery orders
and report those results on a consolidated basis. We may not realize the full amount of our backlog, which could lower future revenue.
See “Risk
Factors — Risks Related to the Business, Operations and Industry
.”
The $29 million or 9% decrease in backlog
from December 31, 2015 to December 31, 2016 was primarily due to not replacing contracts that expired in 2015 and 2016. The decrease
of $59 million or 16% in backlog from December 31, 2014 to December 31, 2015 was primarily the result of contracts expiring in
2015 that were not replaced by new contracts.
There can be no assurance that our existing
contracts will result in actual revenue in any particular period, or at all, or that any contract included in backlog will be profitable.
There is a higher degree of risk in this regard with respect to unfunded backlog. The actual receipt and timing of any revenue
is subject to various contingencies, many of which are beyond our control. The actual recognition of revenue on contracts included
in our backlog may never occur or may change because a program schedule could change, the program could be cancelled, a contract
could be reduced, modified, or terminated early, whether for the convenience of the government or otherwise; or an option that
we had assumed would be exercised could not be exercised.
The primary risks that could affect timing
and recognition of backlog-related contract revenue include: schedule changes, contract modifications, and our ability to assimilate
and deploy new staff against funded backlog; U.S. government cost cutting initiatives and other efforts to reduce spending, which
could reduce or delay funding for orders for services; and delayed funding of our contracts due to delays in the completion of
the U.S. government’s budgeting process and the use of continuing resolutions by the U.S. government to fund its operations,
as described under “
Risk Factors — Risks Related to the Business, Operations and Industry
.”
We depend on U.S. government contracts for substantially all of our revenue. Changes in the contracting or fiscal policies of
the U.S. government could adversely affect our business, financial condition, results of operations and ability to satisfy our
financial obligations and grow our business and we may not realize the full amount of our backlog, which could lower future revenue.
Liquidity and Capital Resources
Background
On November 23, 2015, the Company, together
with STG Group Holdings, STG, Inc., and Access Systems entered into a Credit Agreement (the “Credit Agreement”) with
the lenders party thereto from time to time, MC Admin Co LLC (the "Lender"), as administrative agent, PNC Bank, National
Association, as collateral agent (the “Collateral Agent”), and MC Admin Co LLC, as lead arranger. The Company served
as the initial borrower of the term loans under the Credit Agreement, and STG, Inc. and Access Systems (collectively, the “Borrowers”)
each immediately assumed all obligations of the Company under the Credit Agreement as if they had originally incurred them as borrowers.
The Company and STG Group Holdings have each guaranteed Borrowers’ obligations under the Credit Agreement. Our debt agreement
requires payment of administrative fees, interest, and for the Company to be in compliance with certain financial covenants, including
Quarterly EBITDA, Fixed Charge Coverage Ratio, Senior Secured Leverage Ratio, as well as restrictions on the amount of outstanding
liens, sale of assets, payment of dividends, other indebtedness, and investments.
Each of the Revolving Loan and the Term Loan
matures on November 23, 2020.
As of December 31, 2016, the Company had
$7.8 million of available cash. Because the Company did not meet the required consolidated senior secured leverage ratio and minimum
consolidated EBITDA required in the Credit Agreement as of December 31, 2016, the $15 million of borrowings under the revolving
credit facility are only available subject to lender consent, and the $90 million uncommitted accordion facility is not available.
In addition, on February 18, 2017, we entered
into the Merger Agreement to acquire PSS for approximately $119.5 million in cash, subject to certain adjustments based upon closing
working capital, plus a portion of the value of certain tax benefits as they are realized after the closing. The purchase price
will also be increased by an additional $20,000 per day if the merger is consummated after March 31, 2017 and certain conditions
to the obligations of the Company to close are otherwise satisfied, such increase applicable for each day after March 31, 2017
that such conditions are so satisfied.
The Company intends to fund the merger consideration
through a combination of equity and debt financing. We do not presently have commitments for such financing. To the extent the
merger is not completed for any reason with respect to our ability to obtain financing for the merger, we may be required to pay
a termination fee of $625,000 to PSS.
Going Concern Consideration:
The consolidated financial
statements included in this Form 10-K have been prepared using the going concern basis of accounting, which contemplates
the realization of assets and the satisfaction of liabilities in the normal course of business.
The Company was
not in compliance with its financial covenants at September 30, 2016 or at December 31, 2016. At September 30, 2016, the non-compliance
was cured by raising equity from stockholders’ (“Equity Cure”) as was allowed by the Lending Agreement. At December
31, 2016 the Company received a forbearance which expired on March 31, 2017. The Company entered into a Limited Waiver (“the
Waiver”) from MC Admin Co LLC and other lenders under the Credit Agreement as of March 31, 2017, pursuant to which the lenders
waived the Company’s noncompliance with the Specified Financial Covenants as of December 31, 2016. Based upon the preliminary
results of operations through the first quarter of 2017, the Company anticipates that it will not be in compliance with the same
financial covenants at March 31, 2017. One of the remedies the Lender has available to it, amongst others is the ability to accelerate
repayment of the loan which the Company would not be able to immediately repay.
The potential inability to meet financial covenants under the
Company’s existing Credit Agreement and the potential acceleration of the debt by the Lender resulting in the reclassification
of our debt from a long-term liability to a current liability due to the potential of future covenant defaults required us to evaluate
whether there is substantial doubt regarding the Company’s ability to continue as a going concern.
Management’s Plan to alleviate this condition is as follows:
|
1.
|
Identify, qualify, and win new business to increase revenue and
profits;
|
|
2.
|
Complete the PSS transaction, including the raising of equity and
refinancing of our current Credit Agreement; or
|
|
3.
|
Renegotiate the current Credit Agreement to obtain relief from the
existing financial covenants and other terms.
|
We considered the likelihood of refinancing the current Credit
Agreement in connection with the PSS acquisition financing which contemplates new financial covenants and the renegotiation of
the financial covenants in the event the acquisition of PSS is not completed. Based upon the executed term sheet for financing
of the planned acquisition of the PSS which contemplates new financial covenants and discussions with our Lender regarding the
need to renegotiate the existing financial covenants in the Credit Agreement in the event the acquisition is not completed, management
determined that it was probable that the condition giving rise to the going concern evaluation has been sufficiently alleviated.
Indebtedness
In connection with the consummation of the Business
Combination, all indebtedness under STG Group’s prior credit facility was repaid in full and the agreement was terminated.
The Company replaced the prior credit facility and entered into a new facility (the Credit Agreement) with the Lender.
The Credit Agreement provides for:
(a) a term loan in an aggregate principal amount
of $81.75 million
(b) a $15 million asset-based revolving line-of-credit
(c) an uncommitted accordion facility to be
used to fund acquisitions of up to $90 million.
Concurrent with the consummation of the
Business Combination, the full amount of the term loan was drawn and there were no amounts drawn on the other two facilities. Each
facility matures on November 23, 2020. The Company recorded $6.4 million of debt issuance costs in connection with the new facility
as a reduction to the carrying amount of the new term loan. These costs are being amortized using the effective interest method
over the life of the term loan.
The principal amount of the term loan amortizes
in quarterly installments which increase after each annual period. The quarterly installments range from 0.625% to 2.500% of the
original principal amount and are paid through the quarter ending September 30, 2019. The remaining unpaid principal is due on
the maturity date of November 23, 2020.
At the Company’s election, the interest rate per annum applicable to all the facilities is based
on a fluctuating rate of interest. The interest rate in effect as of December 31, 2016 was 10.55%. The Borrowers may elect to use
either a Base Rate or a Eurodollar Rate. The interest rate per annum for electing the Base Rate is equal to the sum of 6.80% plus
the Base Rate, which is equal to the highest of: (a) the base commercial lending rate of the Collateral Agent as publicly announced
to be in effect from time to time, as adjusted by the Collateral Agent; (b) the sum of 0.50% per annum and the Federal Funds Rate
(as defined in the Credit Agreement); (c) the daily one month LIBOR rate as published each business day in the Wall Street Journal
for a one month period divided by a number equal to 1.00 minus the Reserve Percentage (as defined in the Credit Agreement) plus
100 basis points, as of such day and; (d) 2.00%.
The interest rate per annum for electing the
Eurodollar Rate will be equal to the sum of 7.80% plus the Eurodollar Rate, which is equal to the highest of: (a) the amount calculated
by dividing (x) the rate which appears on the Bloomberg Page BBAM1, or the rate which is quoted by another authorized source, two
business days prior to the commencement of any interest period as the LIBOR for such an amount by (y) a number equal to 1.00 minus
the Reserve Percentage (as defined in the Credit Agreement) and; (b) 1.00%.
Advances under the revolving line-of-credit
are limited by a borrowing base which may not exceed the lesser of (x) the difference between $15,000,000 and amounts outstanding
under letters of credit issued pursuant to the Credit Agreement; and (y) an amount equal to the sum of: (i) up to 85% of certain
accounts receivable of the Company plus (ii) up to 100% of unrestricted cash on deposit in the Company’s accounts with the
Collateral Agent, minus (iii) amounts outstanding under letters of credit issued pursuant to the Credit Agreement, minus (iv) reserves
established by the Collateral Agent from time to time in its reasonable credit judgment exercised in good faith.
The Company is also subject to certain provisions
which will require mandatory prepayments of its term loan and has agreed to certain minimums for its fixed charge coverage ratio
and consolidated EBITDA and certain maximums for its senior secured leverage ratio, as defined in the Credit Agreement.
Future annual maturities of long-term debt
outstanding at December 31, 2016 are as follows (in millions):
Year Ending December 31,
|
|
|
|
|
|
|
|
2017
|
|
|
4.50
|
|
2018
|
|
|
6.34
|
|
2019
|
|
|
6.13
|
|
2020
|
|
|
60.05
|
|
|
|
$
|
77.02
|
|
Debt and Covenant Compliance
As of September 30, 2016, the Company did not
meet the required consolidated senior secured leverage ratio and minimum consolidated EBITDA under the Credit Agreement. The Company
remained in compliance with the Credit Agreement using a provision of the Credit Agreement that allowed us to cure (the "Cure
Right") certain covenant non-compliance by issuances of Common Stock for cash and use of the proceeds to reduce the principal
balance of the term loan.
On November 14, 2016, we entered into Common
Stock Purchase Agreements with Simon S. Lee Management Trust, for which Simon Lee, our Chairman, is Trustee, and Phillip E. Lacombe,
our President and Chief Operating Officer (collectively, the “Investors”) that provided for the sale to the Investors
of 462,778 shares of Common Stock at a purchase price of $3.60 per share, an aggregate of approximately $1.7 million. We used the
proceeds to reduce the principal balance of the term loan as required to effect the Cure Right.
The Credit Agreement does not allow the Company
to exercise the Cure Right in consecutive fiscal quarters, more than three fiscal quarters in the aggregate, or in no more than
two of any four fiscal quarters. The amount allowed under the Cure Right may not exceed $2.5 million and 20% of consolidated EBITDA.
The aggregate Cure Rights may not exceed $5 million.
As of December 31, 2016, the Company did not
meet the required consolidated senior secured leverage ratio and minimum consolidated EBITDA required in the Credit Agreement.
The Company was in compliance with all other financial covenants.
On February 24, 2017, we entered into a Limited
Forbearance to Credit Agreement (the “Forbearance Agreement”) with MC Admin Co LLC and other lenders relating to the
Credit Agreement.
In the Forbearance Agreement, the lenders
agreed to forbear from exercising rights and remedies (including enforcement and collection actions), for which we agreed to pay
a fee of up to $750,000, related to our failure to comply with the Specified Financial Covenants. The Forbearance Agreement requires
us to obtain lender consent prior to use of our revolving credit facility during the period of forbearance. The forbearance expired
on March 31, 2017. On or after the termination of forbearance, the lenders may proceed to enforce any or all of their rights and
remedies. The Company also agreed to pay an additional two percent (2%) per annum in interest on the amount outstanding under
the loans under the Credit Agreement from January 1, 2017, until the earlier of (1) the date on which all loans under the Credit
Agreement are repaid and (2) the date on which the non-compliance with the Specified Financial Covenants is waived by the lenders.
The Company entered into a Limited Waiver
(“the Waiver”) from MC Admin Co LLC and other lenders under the Credit Agreement as of March 31, 2017, pursuant to
which the lenders waived the Company’s noncompliance with the specified Financial Covenants as of December 31, 2016. Pursuant
to the Waiver:
|
·
|
Loans under the Credit Agreement are subject to additional interest at a rate of 2% per annum until the earliest of (x) the date on which all loans are repaid and all commitments under the Credit Agreement are terminated, (y) the date we deliver the financial statements and certificates for the quarter ending March 31, 2017 showing that we are not in default under the Credit Agreement or (z) the date on which default interest is otherwise due under the Credit Agreement;
|
|
|
|
|
·
|
We must obtain lender consent prior to use of our revolving credit facility; and
|
|
|
|
|
·
|
We cannot effect a Cure Right in respect of the quarter ending March 31, 2017.
|
The Credit Agreement also provides that
the minimum consolidated EBITDA requirement will be increased on June 30, 2017. If our business continues to perform at the current
level through that period, we do not expect to satisfy that covenant or the senior secured leverage ratio at that time, and it
is likely that we will be in non-compliance at March 31, 2017. An inability to meet the required covenant levels could have a material
adverse impact on us, including the need for us to effect an additional Cure Right or obtain additional forbearance or an amendment,
waiver, or other changes in the Credit Agreement. The Credit Agreement does not allow the Company to exercise the Cure Right in
consecutive fiscal quarters, more than three fiscal quarters in the aggregate, in more than two of any four fiscal quarters or
for the quarter ending March 31, 2017. The amount allowed under the Cure Right may not exceed the lesser of $2.5 million and 20%
of consolidated EBITDA. The aggregate of Cure Rights may not exceed $5 million. The Waiver does not apply to covenant non-compliance
after December 31, 2016 or to covenants other than the Specified Financial Covenants. Any additional forbearance, amendment or
waiver under the Credit Agreement may result in increased interest rates or premiums and more restrictive covenants and other terms
less advantageous to us, and may require the payment of a fee for such forbearance, amendment or waiver. Although we anticipate
that we will be able to renegotiate the financial covenants either through a new credit agreement in connection with the anticipated
financing of our planned acquisition of PSS or in the event the acquisition of PSS is not completed, through an amendment of the
existing financial covenants under our current Credit Agreement, if we are unsuccessful in executing an amendment to the existing
financial covenants, we may not be able to obtain a forbearance, waiver or effect a cure, on terms acceptable to us.
If we are not able to effect an amendment
to the Credit Agreement, any future covenant non-compliance will give rise to an event of default thereunder if we are unable to
effect a Cure Right or otherwise obtain forbearance or a waiver in which case the indebtedness under the Credit Agreement could
be declared immediately due and payable, which could have a material adverse effect on the Company.
Consolidated Condensed Statements of
Cash Flows for the Year Ended December 31, 2016, the Periods November 24, 2015 to December 31, 2015 (Successor), January 1, 2015
to November 23, 2015 (Predecessor), and Year Ended December 31, 2014 (Predecessor)
|
|
Successor
Year Ended,
|
|
|
Successor
November 24,
2015
to
|
|
|
Predecessor
January 1, 2015
to
|
|
|
Predecessor
Year Ended,
|
|
(in millions)
|
|
December 31,
2016
|
|
|
December 31,
2015
|
|
|
November 23,
2015
|
|
|
December 31,
2014
|
|
Cash (used in) provided by operating activities
|
|
$
|
(1.91
|
)
|
|
$
|
(9.60
|
)
|
|
$
|
34.42
|
|
|
$
|
13.99
|
|
Cash provided (used in) by investing activities
|
|
|
3.80
|
|
|
|
(69.23
|
)
|
|
|
(1.38
|
)
|
|
|
(1.28
|
)
|
Cash used in financing activities
|
|
|
(2.56
|
)
|
|
|
78.95
|
|
|
|
(31.20
|
)
|
|
|
(12.53
|
)
|
Net (decrease) increase in cash and cash equivalents
|
|
|
(0.66
|
)
|
|
|
0.12
|
|
|
|
1.84
|
|
|
|
0.18
|
|
Cash and cash equivalents at beginning of period
|
|
|
8.50
|
|
|
|
8.38
|
|
|
|
0.34
|
|
|
|
0.16
|
|
Cash and cash equivalents at end of period
|
|
$
|
7.84
|
|
|
$
|
8.50
|
|
|
$
|
2.18
|
|
|
$
|
0.34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
8.96
|
|
|
|
1.03
|
|
|
|
1.55
|
|
|
|
1.8
|
|
Capital expenditures
|
|
|
(0.01
|
)
|
|
|
(0.1
|
)
|
|
|
(1.38
|
)
|
|
|
(1.28
|
)
|
Year Ended December 31, 2016 compared to Periods November 24,
2015 through December 31, 2015 (Successor) and the period January 1, 2015 to November 23, 2015 (Predecessor)
Cash used in operating activities
Operating cash flows are primarily affected
by the Company’s ability to invoice and collect from its clients in a timely manner, its ability to manage its vendor payments,
the overall profitability of its contracts and its cash interest expense. Customers are mostly billed monthly after services are
rendered.
For the year ended December 31, 2016 (Successor),
cash flows used in operating activities were ($1.9) million. The cash flows used in operating activities were significantly impacted
by a net loss of ($48.2) million and a distribution of ($3.8) million triggered by the Business Combination offset by adding back
the non-cash impairment of goodwill in the amount of $41.3 million, and a net increase in cash due to changes in accounts receivable
of $4.2 million.
In the period November 24, 2015 to December
31, 2015, cash flows used in operating activities were ($9.6) million. The cash flows used in operating activities were significantly
impacted by (a) a net loss of ($0.3) million, (ii) payments for accrued payroll and payroll related liabilities of ($4.3) million,
and (iii) payments of accounts payable and accrued expenses of ($6.4) million, which included $2.8 million of accrued transaction
costs and professional service fees, and (iiv) partially offset by a net increase in cash due to changes in accounts receivable
of $1.5 million.
In the period January 1, 2015 to November 23,
2015, cash flows provided by operating activities were $34.4 million. The cash flows provided by operating activities were significantly
impacted by the (i) net income of $3.9 million and (ii) improved accounts receivable collections for $13.2 million, (iii) increases
in accounts payable and accrued expenses of $9.3 million which included accrued transaction costs and professional fees incurred
by the Company related to the Business Combination and paid upon consummation of the Business Combination. (iii) operating income
included $3.0 million in non-cash impairment loss charges related to goodwill and intangible assets, (iv) a $1.1 million one-time
non-cash loss incurred on capitalized leasehold improvements written off due to the Company moving premises in the period ended
November 23, 2015, and (v) a, $0.7 million one-time lease termination cost associated with subletting two floors on a previous
premises at a loss to maturity of the agreement There was an increase of $20.4 million over the prior year. Interest per annum
remained consistent with that for the same period in 2014.
The Company had cash collections of $168.7 million
or 103% of revenue for the year ended December 31, 2016, $160.9 million, or 83.1% of revenue for the year ended December 31, 2015
and $162.2 million. Collections have improved as a percent of revenue year over year as a result of efforts to maximize cash realization.
The Company computes accounts receivable
days sales outstanding ("DSO") based on trailing three-month revenue. Days sales outstanding decreased by 1 day from
66 days as of December 31, 2015, to 65 days as of December 31, 2016. Total receivables for purposes of the DSO calculation includes
both billed and unbilled receivables.
Cash used in investing activities
For the year ended December 31, 2016, cash flows
provided by investing activities of $3.8 million is primarily proceeds from the sale of the investments held in the Rabbi Trust
for distribution to the plan participants.
In the period November 24, 2015 to December
31, 2015, cash flows used in investing activities were ($69.2) million. The cash flows used in investing activities were primarily
the result of the acquisition of the Company for $69.2 million, net of $2.2 million of cash acquired.
In the period January 1, 2015 to November 23,
2015, cash flows used in investing activities were ($1.4) million. The cash flows used in investing activities were primarily the
result of investing in equipment and software, and leasehold improvements of $1.4 million primarily the result of the Company’s
headquarters relocation.
Cash used in financing activities
For the year ended December 31, 2016, cash flows
used in financing activities was ($2.6) million, the net of payments due on the Company’s term debt of ($4.2) million offset
by the proceeds of the issuance of Company stock of $1.7 million as a result of the exercise of the Cure Right on November 14,
2016.
In the period November 24, 2015 through December
31, 2015, cash flows provided by financing activities were $78.9 million. The cash flows provided by financing activities were
primarily the result of (i) net proceeds from the Term Loan on our Credit Facility of $81.8 million, partially offset by debt issuance
costs of ($6.4) million,(ii) redemption of redeemable common stock of ($21.6) million, (ii) net proceeds from the issuance of common
stock of $11.0 million, partially offset by payments of deferred underwriters fees of ($1.9) million (iv) repayment of notes to
the Sponsor of ($5.0) million and (v) repayment of the first installment of principal under the Term Loan of ($0.5) million.
In the period January 1, 2015 to November 23,
2015, cash flows used in financing activities were ($31.2) million. The cash flows provided by financing activities were primarily
the result of (i) repayment of the prior revolving credit facility at November 23, 2015 of ($13.5) million, (ii) decrease of outstanding
checks in excess of the bank balance of ($6.1) million, (iii) distributions to the Predecessor’s stockholders of ($9.0) million,
and the issuance of a note receivable of ($2.5) million.
Depreciation and Amortization
Depreciation and amortization totaled $9.0 million
for the year ended December 31, 2016, compared to $1.0 million and $1.6 million for the period November 24, 2015 through December
31, 2015 and the period January 1, 2015 through November 23, 2015, respectively. The $6.4 million increase was primarily due to
the amortization of the intangible assets recorded as a result of the Business Combination.
Capital Expenditures
Capital expenditures for property, plant, and
equipment totaled $0.01 million for the year ended December 31, 2016 compared to $0.01 million and $1.4 million for the period
November 24, 2015 to December 31, 2015 and January 1, 2015 to November 23, 2015, respectively. Capital expenditures were lower
in 2016 due to expenditures in 2015 related to the build out for the Company’s new headquarters.
Cash Paid for Income Taxes
Cash paid for income taxes, net of refunds totaled
$0.6 million, $0 million, $0.2 million and $0.3 million for the year ended December 31, 2016, periods November 24, 2015 to December
31, 2015 and January 1, 2015 to November 23, 2015 and the year ended December 31, 2014, respectively.
The Combined Periods for the Year Ended December 31, 2015 Compared
to Year Ended December 31, 2014
Cash used in operating activities
Operating cash flows are primarily affected
by the Company’s ability to invoice and collect from its clients in a timely manner, its ability to manage its vendor payments,
the overall profitability of its contracts and its cash interest expense. Customers are mostly billed monthly after services are
rendered.
In the year ended December 31, 2015, cash flows
used in operating activities were $24.8 million. The cash flows used in operating activities were significantly impacted by (a)
the consolidated net income of $3.6 million, (ii) payments for accrued payroll and payroll related liabilities of ($2.7) million,
and (iii) payments of accounts payable and accrued expenses of $2.9 million, (iv) partially offset by a net increase in cash due
to changes in accounts receivable of $14.7 million.(v) operating income included $3.0 million in non-cash impairment loss charges
related to goodwill and intangible assets, (vi) a $1.1 million one-time non-cash loss incurred on capitalized leasehold improvements
written off due to the Company moving premises during 2015, and (vii) a, $0.7 million one-time lease termination cost associated
with subletting two floors on a previous premises at a loss to maturity of the agreement There was an increase of $24.8 million
over the prior year.
For the year ended December 31, 2015 (predecessor
and successor periods), the Company had cash collections of $160.9 million or 83% of revenue in 2015. For the year ended December
31, 2014, the Company collected cash of $162.2 million which was 77% of revenue recognized in 2014. The Company improved its cash
collections as a percent of revenue recognized in 2015 versus 2014. The Company continues to develop efficiencies in an effort
to maximize cash realization.
The Company computes accounts receivable
days sales outstanding ("DSO") based on trailing three-month revenue. Days sales outstanding decreased by 17 days from
83 days as of December 31, 2014, to 66 days as of December 31, 2015. Total receivables for purposes of the DSO calculation includes
both billed and unbilled receivables.
Cash used in investing activities
In the combined year ended December 31,
2015, cash flows used in investing activities were ($70.6) million. The cash flows used in investing activities were primarily
the result of the acquisition of the Company for $71.7 million, net of $2.2 million of cash acquired. The cash flows used
in investing activities were primarily the result of investing in equipment and software, and leasehold improvements for $1.4
million primarily the result of the Company’s headquarters relocation compared to cash flows used in investing activities
in 2014 of ($1.3) million which was mainly a result of leasehold build out cost of the Company’s old headquarters during
2014.
Cash used in financing activities
For the combined period ending December
31, 2015, cash flows provided by financing activities were $47.8 million. The cash flows provided by financing activities were
primarily the result of (i) net proceeds from the Term Loan on our Credit Facility of $81.8 million, partially offset by debt issuance
costs of ($6.4) million, (ii) redemption of redeemable common stock of ($21.6) million, (iii) net proceeds from the issuance of
common stock of $11.0 million, partially offset by payments of deferred underwriters fees of ($1.9) million (iv) repayment of notes
to the sponsor of ($5.0) million (v) repayment of the first installment of principal under the Term Loan of ($0.5) million, (vi)
repayment of the previous revolving credit facility of ($13.5) million, (vii) decrease of outstanding checks in excess of the bank
balance of ($6.1) million, and (viii) distributions to the Predecessor’s stockholders of ($9.0) million.
Depreciation and Amortization
Depreciation and amortization totaled $2.6 million
for the year ended December 31, 2015 compared with $1.8 million for the year ended 2014. The $0.8 million increase in 2015 was
primarily caused recording property, plant, and equipment and identifiable intangible assets at fair value in acquisition accounting
for the Business Combination.
Capital Expenditures
Capital expenditures for property, plant, and
equipment totaled $1.4 million for the year ended December 31, 2015. Capital Expenditures totaled $1.3 million for year ended December
31, 2014. Capital expenditures were higher in 2015 due to the build out for the Company’s new headquarters. In 2014, the
capital expenditures related to leasehold improvements to renovate the Company’s old headquarters to be able to sublease
the facility.
Cash Paid for Income Taxes
Cash paid for income taxes, net of refunds totaled
$0.2 million and $0.3 million for the combined year ended December 31, 2015 and the year ended December 31, 2014, respectively.
Off-Balance Sheet Arrangements
Company accounts for operating leases entered
into in the routine course of business in accordance with ASC 840 Leases. At December 31, 2016, the Company has no off-balance
sheet financing arrangements other than operating leases. During the predecessor period of January 1, 2015 through November 23,
2015, the Company had a letter of credit related to an operating lease previously issued under STG Group’s terminated credit
facility. At December 31, 2015, the lease was secured by a cash security deposit of $0.4 million. At December 31, 2014, a letter
of credit had been issued and was outstanding for $0.8 million. The Company has no relationship with any unconsolidated or special
purpose entity and has not issued any guarantees.
Short-term borrowings
The following table summarizes the activity
under STG Group’s prior revolving credit facility for the years ended December 31, 2016, 2015 and 2014, not including issued
and outstanding letters of credit:
|
|
|
|
|
Year Ended December 31,
|
|
Short term borrowings
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
(in millions)
|
|
Balance – beginning of period
|
|
$
|
0
|
|
|
$
|
13.5
|
|
|
$
|
20.0
|
|
Net revolving credit facility repayments
|
|
|
-
|
|
|
|
(13.5
|
)
|
|
|
(6.5
|
)
|
Net change in revolving credit facility balance payable
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
13.5
|
|
Because the Company did not meet the required
consolidated senior secured leverage ratio and minimum consolidated EBITDA required in the Credit Agreement as of December 31,
2016, the $15 million of borrowings under the revolving credit facility are only available subject to lender consent
Contingent obligations
From time to time we may be involved in litigation
in the normal course of our business. Our management does not expect that the resolution of these matters would have a material
adverse effect on our business, operations, financial condition or cash flows.
We have no other contingent obligations.
Related Party Transactions
On November 14, 2016, we entered into Common
Stock Purchase Agreements with the Investors that provided for the sale to the Investors of 462,778 shares of Common Stock at a
purchase price of $3.60 per share, an aggregate of approximately $1.7 million. We used the proceeds to reduce the principal balance
of the term loan under the Credit Agreement as required to effect the Cure Right.
A company owned by a party related to the
majority stockholder of the Company is both a subcontractor to and customer of the Company on various contracts. As of December
31, 2016 and 2015, amounts due from this entity totaled $0.01 million and $0.02 million respectively. The Company recorded revenue
of $0.01 million for the year ended December 31, 2016, $0.01 million and $0.11 million, respectively, for the periods from November
24, 2015 through December 31, 2015 and January 1, 2015 through November 23, 2015.
There was no work performed under subcontracts with this entity during the year ended December 31, 2016,
however the Company recorded direct costs of $0.02 million for the period from January 1, 2015 through November 23, 2015 and $0.14
million for the year ended December 31, 2014 relating to such work performed.
On September 15, 2015, the Company issued a
note receivable to the Predecessor’s stockholder for $2.5 million. The note bore interest at 2.35%. The principal and accrued
interest was payable in full on the earlier of December 31, 2015 or the closing of the Business Combination which is described
previously in Note 2. This note was satisfied with the closing of the Business Combination that took effect on November 23, 2015
On November 23, 2015, Global Strategies
Group (North America) Inc., an affiliate of Holdings, and the Company entered into a services agreement, pursuant to which the
Company may retain Global Strategies Group (North America) Inc. from time to time to perform certain services: corporate development
services such as assisting the Company in post-integration matters, regulatory compliance support services, financial services
and financial reporting, business development and strategic services, marketing and public relations services, and human resources
services. Global Strategies Group (North America) Inc. is an affiliate of both the Company and a Board member. Amounts paid and
expensed under this agreement during the year ended December 31, 2016 totaled $0.6 million.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity
with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company
evaluates its estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed
to be reasonable under the circumstances. The following policies and procedures are considered by management to be the most critical
in understanding the judgments that are involved in the preparation of our consolidated financial statements and the uncertainties
that could impact our results of operations, financial position, and cash flows. Application of these accounting policies involves
the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these
estimates. Although the Company has listed a number of accounting policies below which it believes to be the most critical, the
Company also believes that all of its accounting policies are important to the reader. Therefore, please see Note 1 “Summary
of Significant Accounting Policies”, of the accompanying consolidated financial statements of the Company appearing elsewhere
in this Annual report.
Goodwill, Other Intangible Assets and Other Long-Lived Assets:
The Company’s goodwill, other intangible
assets and tangible fixed assets are held at historical cost, net of depreciation and amortization, less any provision for impairment.
Tangible assets with determinable lives are amortized or depreciated on a straight line basis over their estimated useful lives.
Other intangible assets are comprised of customer relationships and trade name acquired as a result of the Business Combination.
The Company has determined that the customer relationships and trade name represent finite-lived intangible assets with useful
lives ranging from 8 to 15 years, respectively. The assets are being amortized proportionately over the term of their useful lives
based on the estimated economic benefit derived over the course of the asset life.
Intangible Assets
|
|
Goodwill
|
No Amortization
|
Customer Relationships
|
Amortized over 8 years
|
Trade Name
|
Amortized over 15 years
|
|
|
Tangible Asset
|
|
Leasehold Improvements
|
Life of lease
|
Furniture and Fixtures
|
1-7 years
|
Computer Equipment and Software
|
1-3 years
|
On an annual basis, or more frequently if triggering
events occur, the Company compares the estimated fair value of its reporting unit to the carrying value to determine if a potential
goodwill impairment exists. If the fair value of the reporting unit is less than the carrying value, an impairment loss, if any,
is recorded for the difference between the implied fair value and the carrying value of the unit’s goodwill. The estimated
fair value represents the amount at which a reporting unit could be bought or sold in a current transaction between willing parties
on an arms-length basis. In estimating the fair value, the Company uses several models, which are dependent on a number of assumptions
including estimated future revenues and expenses, weighted average cost of capital, capital expenditures and other variables. The
Company also reviews other intangible assets and tangible fixed assets for impairment when events or changes in business circumstances
indicate that the carrying amount of assets may not be fully recoverable. If such indicators are present, the Company performs
undiscounted cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any impairment loss
is calculated based on fair value.
As a result of the Business Combination, the
carrying value of the Company’s reporting unit was equal to its fair value on the acquisition date. The stock consideration
was valued at the estimated fair value per share using the three day average closing prices of Company, shares traded preceding
the Business Combination or $10.63 per share and then was discounted by approximately 20% for a lack of marketability or a share
price of $8.50 a share.
In performing the annual goodwill impairment
assessment in the fourth quarter of 2015, the fair value exceeded the carrying value in the reporting unit. As the carrying values
of tangible assets and other intangible assets with the reporting unit decrease due to depreciation and amortization and the fair
value of the reporting unit increases through value creation, we expect the estimated fair value to increase in the future. The
Company is subject to financial risk in the event that business or economic conditions unexpectedly decline and goodwill becomes
impaired.
For impairment testing for the year ended December 31, 2016, the Company engaged a third party valuation
firm to assist management with determining fair value estimates for the Company’s only reporting unit in the first step of
the goodwill impairment test, and in estimating fair values of tangible and intangible assets used in the second step of the goodwill
impairment test. In connection with obtaining an independent third party valuation, management provided certain information and
assumptions that were utilized in the fair value calculation. Significant assumptions used in determining reporting unit fair value
include forecasted cash flows, revenue growth rates, adjusted EBITDA margins, weighted average cost of capital (discount rate),
assumed tax treatment of a future sale of the reporting unit, terminal growth rates, capital expenditures, sales and EBITDA multiples
used in the market approach, and the weighting of the income and market approaches. The fair value of the Company’s only
reporting unit is determined using the discounted cash flow valuation methodology primarily based on the Company’s five year
plan. Two market based approaches were performed as well to gain additional comfort that the guideline public company analysis
resulted in a similar range of value.
For the year ended December 31, 2016, the
Company’s third party valuation firm performed the first step of the annual goodwill impairment test in the fourth quarter
of 2016 and determined that the estimated fair value of the Company’s sole reporting unit was lower than the carrying value,
requiring further analysis under the second step of the impairment test. The decline in the estimated fair value of the Company
was primarily due to significantly lower revenue in 2016 than planned. Growth rates in future years remain comparable to the prior
planned growth however future revenue and related profits are less than the previous plan due to significantly lower 2016 revenue.
In performing the second step of the impairment
testing, the Company’s third party valuation firm performed a theoretical purchase price allocation for the Company to determine
the implied fair values of goodwill which were compared to the recorded amounts of goodwill for the Company’s sole reporting
unit.
Upon completion of the second step of the
goodwill impairment test, the Company recorded a noncash goodwill impairment charge of $41 million, or 36% of the total goodwill
asset. Additional sensitivity testing was completed using assumptions of only achieving 90% and 85% of the 2017 forecasted plan
with other major assumptions including growth rates, profit margins, and discount factors remaining the same. The result of this
analysis was an estimated additional goodwill impairment of between $5 million and $8 million and $11 million and $14 million respectively.
The Company also has some flexibility in its ability to control indirect costs during 2017 that could mitigate any shortfalls in
our 2017 revenue and profit estimates.
The goodwill impairment charges are recorded as impairment charges
in the consolidated statements of operations. The assumptions that have the most significant impact on determination of the reporting
unit fair value are the growth rate of estimated free cash flows, including 3 percent in the terminal year, maintaining adjusted
EBITDA margins of 10% throughout the forecast period, and the weighted average cost of capital (discount rate), of 15.08%. A change
in any of these assumptions, individually or in the aggregate, or future financial performance that is below management expectations
may result in the carrying value of this reporting unit exceeding its fair value and could result in additional impairment to goodwill
and amortizable intangible assets in future periods.
In connection with the evaluation of the
goodwill impairment, the Company assessed intangible assets for impairment prior to performing the first step of the goodwill impairment
test. As a result of this analysis, the undiscounted future cash flows of each asset group within the Company’s sole reporting
unit exceeded the recorded carrying values of the net assets within each asset group, and as such, no noncash impairment charges
resulted from such assessment.
A considerable amount of management judgments
and assumptions is required in performing the impairment tests, principally in determining the fair value of the reporting unit
and specifically identifiable intangible and tangible assets. While the Company believes its judgments and assumptions are reasonable,
different assumptions could change the estimated fair values and, therefore, additional impairment charges could be required in
future periods.
Income Taxes
The Company is subject to income taxes in the
United States. Significant judgment is required in determining our provision for income taxes and recording the related deferred
tax assets and liabilities. The Company assesses its income tax positions and records tax liabilities for all years subject to
examination based upon management’s evaluation of the facts and circumstances and information available at the reporting
dates. For those income tax positions where it is more-likely-than-not that a tax benefit will be sustained upon the conclusion
of an examination, the Company has recorded the largest amount of tax benefit having a cumulatively greater than 50% likelihood
of being realized upon ultimate settlement with the application taxing authority assuming that it has full knowledge of all relevant
information. For those income tax positions that do not meet the more-likely-than-not threshold regarding the ultimate realization
of the related tax benefit, no tax benefit has been recorded in the financial statements.
The Company recognizes deferred tax assets
and liabilities for the future tax consequences attributable to differences between financial statement carrying amounts of existing
assets and liabilities and their respective tax bases, net operating losses, tax credit and other 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 Company regularly reviews its deferred tax assets for recoverability
and establishes a valuation allowance based on historical losses, projected future taxable income and the expected timing of the
reversals of existing temporary differences. As a result of this review, the Company has not established any reserves at this time.
Future tax authority rulings and changes in tax laws, changes in projected levels of taxable income and future tax planning strategies
could affect the actual effective tax rate and tax balances recorded. See Note 13 “Income Taxes”, of the accompanying
consolidated financial statements for further discussion.
Use of Estimates
The Company records reserves or allowances for
doubtful accounts, incurred by not reported claims, litigation, and incentive compensation. These reserves require the use of estimates
and judgment. The Company bases its estimates on historical experience and on various other assumptions that are believed to be
reasonable under the circumstances. The Company believes that such estimates are made on a consistent basis and with appropriate
assumptions and methods. However, actual results may differ from these estimates.
Revenue Recognition
Revenue is recognized when persuasive evidence
of an arrangement exists, services have been rendered or goods delivered, the contract price is fixed or determinable and collectability
is reasonably assured. Revenue associated with work performed prior to the completion and signing of contract documents is recognized
only when it can be reliably estimated and realization is probable. The Company bases its estimates on previous experiences with
the customer, communications with the customer regarding funding status and its knowledge of available funding for the contract.
Revenue on cost-plus-fee contracts is recognized
to the extent of costs incurred plus a proportionate amount of the fee earned. The Company considers fixed fees under cost-plus-fee
contracts to be earned in proportion to the allowable costs incurred in performance of the contract. The Company considers performance-based
fees, including award fees, under any contract type to be earned when it can demonstrate satisfaction of performance goals, based
upon historical experience, or when the Company receives contractual notification from the customer that the fee has been earned.
Revenue on time-and-materials contracts is recognized based on the hours incurred at the negotiated contract billing rates, plus
the cost of any allowable material costs and out-of-pocket expenses. Revenue on fixed-price contracts is primarily recognized using
proportional performance method of contract accounting. Unless it is determined as part of the Company’s regular contract
performance review that overall progress on a contract is not consistent with costs expended to date, the Company determines the
percentage completed based on the percentage of costs incurred to date in relation to total estimated costs expected upon completion
of the contract. Revenue on fixed-price services contracts is primarily recognized on a straight-line basis over the contractual
service period, unless the revenue is earned, or obligations fulfilled, in a different manner.
Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are determined and are recorded as forward loss liabilities in the consolidated
financial statements. Changes in job performance, job conditions and estimated profitability may result in revisions to costs and
revenue and are recognized in the period in which the revisions are determined.
Contract Receivables
Contract receivables are generated primarily
from prime and subcontracting arrangements with federal government agencies. Billed contract receivables represent invoices
that have been prepared based on contract terms and sent to the customer. Billed accounts receivable are considered past due if
the invoice has been outstanding more than 30 days. The Company does not charge interest on accounts receivable; however, federal
governmental agencies are required under certain circumstances to pay interest on invoices outstanding more than 30 days. The Company
records interest income from federal governmental agencies when received. All contract receivables are on an unsecured basis.
Unbilled amounts represent costs and anticipated
profits awaiting milestones to bill, contract retainages, award fees and fee withholdings, as well as amounts currently waiting
to be invoiced.
In accordance with industry practice, contract
receivables relating to long-term contracts are classified as current, even though portions of these amounts may not be realized
within one year.
Management determines the allowance for doubtful
accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit
history, and current economic conditions. Management has recorded an allowance for contract receivables that are considered to
be uncollectible. Both billed and unbilled receivables are written off when deemed uncollectible. Recoveries of receivables previously
written off are recorded when received.
New Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (Topic 606)
, which establishes a comprehensive revenue recognition standard for virtually
all industries under GAAP, including those that previously followed industry-specific guidance. Under the guidance, all entities
should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those goods or services. Additionally, various updates have been issued
during 2015 and 2016 to clarify the guidance in Topic 606. The guidance is effective for the Company in the first
quarter of 2018. Early adoption is permitted. Management has not yet assessed the potential impact of this guidance on the
consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15,
Presentation
of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue
as a Going Concern
. ASU 2014-15 explicitly requires management to evaluate, at each annual or interim reporting period, whether
there are conditions or events that exist which raise substantial doubt about an entity's ability to continue as a going concern
and to provide related disclosures. The guidance is effective for annual periods ending after 15 December 2016 and for annual periods
and interim periods thereafter. See Note 1 of the Financial Statements.
In September 2015, the FASB issued ASU 2015-16,
Business Combinations
(Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
. This ASU eliminates the requirement to retrospectively
account for changes to provisional amounts initially recorded in a business combination. ASU 2015-16 requires that an acquirer
recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which
the adjustments are determined, including the effect of the change in provisional amount as if the accounting had been completed
at the acquisition date. The provisions of this ASU are effective for fiscal years beginning after December 15, 2015, including
interim periods within those fiscal years and should be applied prospectively to adjustments to provisional amounts that occur
after the effective date. The adoption of this standard has not had a significant impact on the consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17,
Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.
This ASU simplifies the presentation of
deferred income taxes by eliminating the requirement for entities to separate deferred tax liabilities and assets into current
and noncurrent amounts in classified balance sheets. Instead it requires deferred tax assets and liabilities be classified as
noncurrent in the balance sheet. This ASU is effective for financial statements issued for annual periods beginning after December
15, 2016, and interim periods within those annual periods. Early adoption is permitted, and this ASU may be applied either prospectively
to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company has adopted this standard
prospectively during the quarter ended June 30, 2016. The adoption of ASU 2015-17 resulted in the aggregation of a $4.5 million
deferred tax asset and a $10.9 million deferred tax liability to a single line reported on the balance sheet as a non-current
deferred tax liability in the amount of $6.4 million.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842
). The standard impacts both lessors and lessees. The most significant change for lessees is that the requirement
to recognize right-to-use assets and lease liabilities for all leases not considered short term. The guidance is effective for
fiscal years beginning after December 15, 2018, and will be applied on a modified retrospective basis. The Company is currently
evaluating the expected impact of the adoption of this standard on the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation –
Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting (ASU 2016-09)
. ASU 2016-09 is intended
to simplify several aspects of accounting for share-based payment awards. The effective date will be the first quarter of fiscal
year 2017, with early adoption permitted. The Company is evaluating the expected impact that adoption of this new standard will
have on the consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash
Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
. The amendments in this update clarify the guidance
regarding the classification of operating, investing, and financing activities for certain types of cash receipts and payments.
The amendments in this update are effective for the annual periods, and the interim periods within those years, beginning after
December 15, 2017, and should be applied using a retrospective transition method to each period presented. Early adoption is permitted.
The Company is evaluating the expected impact of adoption, if any, to the consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18,
Statement of Cash
Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force),
which provides guidance on the presentation
of restricted cash or restricted cash equivalents in the statement of cash flows. These amendments are effective for fiscal years,
and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently evaluating the expected
impact of the adoption of this guidance on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01,
"
Business Combinations (Topic 805) Clarifying the Definition of a Business",
which amends the guidance
of FASB Accounting Standards Codification (ASC) Topic 805, "
Business Combinations
", adding guidance to assist
entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The
definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. This
guidance is effective for annual and interim periods beginning after December 15, 2017, and early adoption is permitted under
certain circumstances. We intend to evaluate the impact of this guidance on our consolidated financial statements and related
disclosures in connection with the potential business combination as disclosed in note 15 to the consolidated financial statements.
In January 2017, the FASB
issued ASU No. 2017-04 “Intangibles-Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment” (“ASU
2017-04”). ASU 2017-04 provides guidance to simplify the subsequent measurement of goodwill by eliminating the Step 2 procedure
from the goodwill impairment test. Under the updates in ASU 2017-04, an entity should perform its annual or interim, goodwill impairment
test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge
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. The amendments of this ASU are effective for annual or
any interim goodwill impairment tests beginning after December 15, 2019. The Company has not yet evaluated the impact, if any,
that the adoption of ASU 2017-04 will have on our Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
STG Group, Inc
.
Financial Report
December 31, 2016
Contents
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
STG Group, Inc.
Reston, VA
We have audited the accompanying consolidated balance sheet
of STG Group, Inc. (“Successor” or the “Company”) as of December 31, 2016 and 2015 and the related
consolidated statements of operations, stockholders’ equity, and cash flows for the period from November 24, 2015 through
December 31, 2015 and the year ended December 31, 2016. These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe
that our audits provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of STG Group, Inc. at December 31, 2016 and 2015, and
the results of its operations and its cash flows for the period from November 24, 2015 through December 31, 2015 and year ended
December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
McLean, Virginia
April 17, 2017
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
STG Group, Inc.
Reston, VA
We have audited the accompanying consolidated balance sheet
of STG Group Holdings, Inc. (“Predecessor”) as of December 31, 2014 and the related consolidated statements of operations,
stockholders’ equity, and cash flows for the period from January 1, 2015 through November 23, 2015 and the year ended December
31, 2014. These consolidated financial statements are the responsibility of the Predecessor management. Our responsibility is to
express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of STG Group Holdings, Inc. at December 31, 2014, and
the results of its operations and its cash flows for the period from January 1, 2015 through November 23, 2015 and the year ended
December 31, 2014 in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
McLean, Virginia
April 17, 2017
STG Group, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Amounts)
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Assets
|
|
|
|
|
|
|
|
|
Current Assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
7,841
|
|
|
$
|
8,503
|
|
Contract receivables, net
|
|
|
28,784
|
|
|
|
32,824
|
|
Investments held in Rabbi Trust
|
|
|
332
|
|
|
|
4,517
|
|
Prepaid expenses and other current assets
|
|
|
2,294
|
|
|
|
1,357
|
|
Deferred income taxes
|
|
|
-
|
|
|
|
2,415
|
|
Total current assets
|
|
|
39,251
|
|
|
|
49,616
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
1,157
|
|
|
|
1,698
|
|
Goodwill
|
|
|
72,313
|
|
|
|
113,589
|
|
Intangible assets, net
|
|
|
31,984
|
|
|
|
38,988
|
|
Other assets
|
|
|
423
|
|
|
|
432
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
145,128
|
|
|
$
|
204,323
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
Current Liabilities
|
|
|
|
|
|
|
|
|
Long-term debt, current portion
|
|
$
|
4,496
|
|
|
$
|
2,555
|
|
Accounts payable and accrued expenses
|
|
|
11,683
|
|
|
|
9,605
|
|
Accrued payroll and related liabilities
|
|
|
6,391
|
|
|
|
8,441
|
|
Income taxes payable
|
|
|
-
|
|
|
|
561
|
|
Billings in excess of revenue recognized
|
|
|
688
|
|
|
|
304
|
|
Deferred compensation plan
|
|
|
332
|
|
|
|
4,517
|
|
Deferred rent
|
|
|
228
|
|
|
|
81
|
|
Total current liabilities
|
|
|
23,818
|
|
|
|
26,064
|
|
|
|
|
|
|
|
|
|
|
Long-term debt, net of current portion and discount
|
|
|
72,522
|
|
|
|
72,447
|
|
Deferred income taxes
|
|
|
6,354
|
|
|
|
12,630
|
|
Deferred rent
|
|
|
743
|
|
|
|
837
|
|
Total liabilities
|
|
|
98,609
|
|
|
|
111,978
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ Equity
|
|
|
|
|
|
|
|
|
Preferred stock; $0.0001 par value; 10,000,000 shares
authorized; none issued and outstanding at December 31, 2016 and 2015
|
|
|
-
|
|
|
|
-
|
|
STG Group, Inc. (Successor) common stock; $0.0001 par value; 100,000,000 shares authorized; 16,603,449 shares issued and outstanding at December 31, 2016 and 16,107,071 shares issued and outstanding at December 31, 2015
|
|
|
2
|
|
|
|
2
|
|
Additional paid-in capital
|
|
|
102,920
|
|
|
|
100,547
|
|
Accumulated deficit
|
|
|
(56,403
|
)
|
|
|
(8,204
|
)
|
Total stockholders’ equity
|
|
|
46,519
|
|
|
|
92,345
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholdersʼ equity
|
|
$
|
145,128
|
|
|
$
|
204,323
|
|
See accompanying notes to the consolidated financial statements.
STG Group, Inc.
Consolidated Statements of Operations
(In Thousands, Except Share and Per Share Amounts)
|
|
Successor
|
|
|
Successor
|
|
|
Predecessor
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31, 2016
|
|
|
November 24, 2015
Through
December 31, 2015
|
|
|
January 1, 2015
Through
November 23, 2015
|
|
|
Year
Ended
December 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract revenue
|
|
$
|
164,055
|
|
|
$
|
17,300
|
|
|
$
|
176,345
|
|
|
$
|
209,727
|
|
Direct expenses
|
|
|
111,263
|
|
|
|
11,702
|
|
|
|
120,989
|
|
|
|
141,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
52,792
|
|
|
|
5,598
|
|
|
|
55,356
|
|
|
|
67,802
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect and selling expenses
|
|
|
54,538
|
|
|
|
6,407
|
|
|
|
47,837
|
|
|
|
61,286
|
|
Impairment of goodwill
|
|
|
41,276
|
|
|
|
-
|
|
|
|
2,064
|
|
|
|
5,117
|
|
Impairment of other intangible assets
|
|
|
-
|
|
|
|
-
|
|
|
|
906
|
|
|
|
1,811
|
|
|
|
|
95,814
|
|
|
|
6,407
|
|
|
|
50,807
|
|
|
|
68,214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
|
(43,022
|
)
|
|
|
(809
|
)
|
|
|
4,549
|
|
|
|
(412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
|
(354
|
)
|
|
|
(132
|
)
|
|
|
37
|
|
|
|
313
|
|
Interest expense
|
|
|
(8,725
|
)
|
|
|
(898
|
)
|
|
|
(57
|
)
|
|
|
(70
|
)
|
|
|
|
(9,079
|
)
|
|
|
(1,030
|
)
|
|
|
(20
|
)
|
|
|
243
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income taxes
|
|
|
(52,101
|
)
|
|
|
(1,839
|
)
|
|
|
4,529
|
|
|
|
(169
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax (benefit) expense
|
|
|
(3,902
|
)
|
|
|
(1,585
|
)
|
|
|
644
|
|
|
|
-
|
|
Net (loss) income
|
|
$
|
(48,199
|
)
|
|
$
|
(254
|
)
|
|
$
|
3,885
|
|
|
$
|
(169
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (Loss) income per share available to common stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(2.98
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
3,497
|
|
|
$
|
(152
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
16,172,040
|
|
|
|
16,107,071
|
|
|
|
1,111
|
|
|
|
1,111
|
|
See accompanying notes to the consolidated financial statements.
STG Group, Inc.
Consolidated Statements of Stockholders’ Equity
(In Thousands, Except Share Amounts)
|
|
|
|
|
|
|
|
Additional
|
|
|
Stockholder
|
|
|
(Accumulated
|
|
|
Total
|
|
|
|
Common Stock
|
|
|
Paid-In
|
|
|
Note
|
|
|
Deficit)
|
|
|
Stockholders'
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Receivable
|
|
|
Retained Earnings
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, January 1, 2014, Predecessor
|
|
|
1,111
|
|
|
|
-
|
|
|
|
12,891
|
|
|
|
-
|
|
|
|
18,416
|
|
|
|
31,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions to stockholders
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(8,181
|
)
|
|
|
(8,181
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(169
|
)
|
|
|
(169
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2014, Predecessor
|
|
|
1,111
|
|
|
|
-
|
|
|
|
12,891
|
|
|
|
-
|
|
|
|
10,066
|
|
|
|
22,957
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholder note receivable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,500
|
)
|
|
|
|
|
|
|
(2,500
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions to stockholders
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(9,148
|
)
|
|
|
(9,148
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,885
|
|
|
|
3,885
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, November 23, 2015, Predecessor
|
|
|
1,111
|
|
|
|
-
|
|
|
|
12,891
|
|
|
|
(2,500
|
)
|
|
|
4,803
|
|
|
|
15,194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Elimination of Predecessor common stock, additional
paid-in capital, and retained earnings
|
|
|
(1,111
|
)
|
|
|
-
|
|
|
|
(12,891
|
)
|
|
|
2,500
|
|
|
|
(4,803
|
)
|
|
|
(15,194
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to reflect STG Group, Inc. common
stock, additional paid-in capital, and accumulated deficit (Note 1)
|
|
|
3,027,986
|
|
|
|
-
|
|
|
|
6,939
|
|
|
|
-
|
|
|
|
(7,950
|
)
|
|
|
(1,011
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock to Predecessor stockholders
in conjunction with the Business Combination (Note 2)
|
|
|
9,716,873
|
|
|
|
1
|
|
|
|
82,631
|
|
|
|
-
|
|
|
|
-
|
|
|
|
82,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
to Sponsor (Note 11)
|
|
|
1,030,103
|
|
|
|
-
|
|
|
|
10,950
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,950
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, November 24, 2015, Successor
|
|
|
13,774,962
|
|
|
|
1
|
|
|
|
100,520
|
|
|
|
-
|
|
|
|
(7,950
|
)
|
|
|
92,571
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock dividends declared (2)
|
|
|
2,332,109
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
28
|
|
|
|
-
|
|
|
|
-
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(254
|
)
|
|
|
(254
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2015, Successor
|
|
|
16,107,071
|
|
|
|
2
|
|
|
|
100,547
|
|
|
|
-
|
|
|
|
(8,204
|
)
|
|
|
92,345
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
|
462,778
|
|
|
|
-
|
|
|
|
1,666
|
|
|
|
|
|
|
|
|
|
|
|
1,666
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock awards
|
|
|
33,600
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
707
|
|
|
|
-
|
|
|
|
-
|
|
|
|
707
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(48,199
|
)
|
|
|
(48,199
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2016, Successor
|
|
|
16,603,449
|
|
|
|
|
|
|
|
102,920
|
|
|
$
|
-
|
|
|
|
(56,403
|
)
|
|
|
46,519
|
|
(1) Adjustment to reflect STG Group, Inc. common stock, additional
paid-in capital, and accumulated deficit is net of 2,031,383 shares of common stock redeemed, which reduced common stock and additional
paid-in capital by $21,594 (Note 11).
(2) The Company declared a dividend of one share of common stock
for every 1.06 shares of common stock payable to stockholders of record immediately following the consummation of the Business
Combination. Certain stockholders forfeited this right to receive the dividends as described further in Note 11.
See accompanying notes to the consolidated financial statements.
STG Group, Inc.
Consolidated Statements of Cash Flows
(In Thousands, Except Share Amounts)
|
|
Successor
|
|
|
Successor
|
|
|
Predecessor
|
|
|
Predecessor
|
|
|
|
|
|
|
November 24 ,
2015
Through
|
|
|
January 1,
2015
Through
|
|
|
|
|
|
|
Year
Ended
December
31, 2016
|
|
|
December 31,
2015
|
|
|
November
23, 2015
|
|
|
Year Ended
December
31, 2014
|
|
Cash Flows From Operating Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(48,199
|
)
|
|
$
|
(254
|
)
|
|
$
|
3,885
|
|
|
$
|
(169
|
)
|
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bad debt expense (recoveries)
|
|
|
(210
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
200
|
|
Lease termination costs
|
|
|
-
|
|
|
|
-
|
|
|
|
703
|
|
|
|
-
|
|
Deferred rent
|
|
|
53
|
|
|
|
66
|
|
|
|
(40
|
)
|
|
|
(1,009
|
)
|
Deferred taxes
|
|
|
(3,861
|
)
|
|
|
(1,598
|
)
|
|
|
(90
|
)
|
|
|
-
|
|
Amortization of deferred financing costs
|
|
|
1,409
|
|
|
|
119
|
|
|
|
-
|
|
|
|
-
|
|
Depreciation and amortization of property and equipment
|
|
|
549
|
|
|
|
57
|
|
|
|
842
|
|
|
|
1,179
|
|
Amortization of intangible assets
|
|
|
7,004
|
|
|
|
852
|
|
|
|
710
|
|
|
|
625
|
|
Impairment of goodwill
|
|
|
41,276
|
|
|
|
-
|
|
|
|
2,064
|
|
|
|
5,117
|
|
Impairment of other intangible assets
|
|
|
-
|
|
|
|
-
|
|
|
|
906
|
|
|
|
1,811
|
|
Net loss on disposal of property and equipment
|
|
|
-
|
|
|
|
-
|
|
|
|
1,113
|
|
|
|
40
|
|
Stock-based compensation
|
|
|
707
|
|
|
|
28
|
|
|
|
-
|
|
|
|
-
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Increase) decrease in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract receivables
|
|
|
4,250
|
|
|
|
1,530
|
|
|
|
13,163
|
|
|
|
7,049
|
|
Prepaid expenses and other current assets
|
|
|
(937
|
)
|
|
|
527
|
|
|
|
425
|
|
|
|
1,695
|
|
Other assets
|
|
|
9
|
|
|
|
(356
|
)
|
|
|
24
|
|
|
|
80
|
|
Increase (decrease) in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
|
2,078
|
|
|
|
(6,395
|
)
|
|
|
9,254
|
|
|
|
(2,306
|
)
|
Accrued payroll and related liabilities
|
|
|
(2,050
|
)
|
|
|
(4,321
|
)
|
|
|
1,589
|
|
|
|
(413
|
)
|
Income taxes payable
|
|
|
(561
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Deferred compensation plan
|
|
|
(3,808
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Billings in excess of revenue recognized
|
|
|
384
|
|
|
|
142
|
|
|
|
(125
|
)
|
|
|
92
|
|
Net cash (used in) provided by operating activities
|
|
|
(1,907
|
)
|
|
|
(9,603
|
)
|
|
|
34,423
|
|
|
|
13,991
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition of Predecessor business, net of cash acquired of $2,184
|
|
|
-
|
|
|
|
(69,216
|
)
|
|
|
-
|
|
|
|
-
|
|
Proceeds from the sale of property and equipment
|
|
|
-
|
|
|
|
-
|
|
|
|
16
|
|
|
|
-
|
|
Proceeds from sales of investments held in Rabbi Trust
|
|
|
3,808
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Purchases of property and equipment
|
|
|
(8
|
)
|
|
|
(10
|
)
|
|
|
(1,397
|
)
|
|
|
(1,280
|
)
|
Net cash
provided by (used in) investing activities
|
|
|
3,800
|
|
|
|
(69,226
|
)
|
|
|
(1,381
|
)
|
|
|
(1,280
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net repayments of line-of-credit
|
|
|
-
|
|
|
|
-
|
|
|
|
(13,520
|
)
|
|
|
(6,517
|
)
|
Increase (decrease) in outstanding checks in excess of bank balance
|
|
|
-
|
|
|
|
-
|
|
|
|
(6,141
|
)
|
|
|
2,172
|
|
Proceeds from long-term debt
|
|
|
-
|
|
|
|
81,750
|
|
|
|
-
|
|
|
|
-
|
|
Payments on long-term debt
|
|
|
(4,221
|
)
|
|
|
(512
|
)
|
|
|
-
|
|
|
|
-
|
|
Payments on note to Sponsor
|
|
|
-
|
|
|
|
(4,986
|
)
|
|
|
-
|
|
|
|
-
|
|
Deferred financing costs
|
|
|
-
|
|
|
|
(6,357
|
)
|
|
|
-
|
|
|
|
-
|
|
Deferred underwriters' fees
|
|
|
-
|
|
|
|
(1,898
|
)
|
|
|
-
|
|
|
|
-
|
|
Proceeds from issuance of common stock to Shareholders
|
|
|
1,666
|
|
|
|
10,950
|
|
|
|
-
|
|
|
|
-
|
|
Note receivable issued to Predecessor stockholder
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,500
|
)
|
|
|
-
|
|
Distributions to stockholders
|
|
|
-
|
|
|
|
-
|
|
|
|
(9,037
|
)
|
|
|
(8,181
|
)
|
Net
cash (used in) provided by financing activities
|
|
|
(2,555
|
)
|
|
|
78,947
|
|
|
|
(31,198
|
)
|
|
|
(12,526
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in cash and cash equivalents
|
|
|
(662
|
)
|
|
|
118
|
|
|
|
1,844
|
|
|
|
185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and Cash Equivalents
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
|
|
|
8,503
|
|
|
|
8,385
|
|
|
|
340
|
|
|
|
155
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending
|
|
$
|
7,841
|
|
|
$
|
8,503
|
|
|
$
|
2,184
|
|
|
$
|
340
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
7,316
|
|
|
$
|
779
|
|
|
$
|
16
|
|
|
$
|
70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
615
|
|
|
$
|
-
|
|
|
$
|
184
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosures of Non-Cash Investing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in investments held in Rabbi Trust
|
|
$
|
377
|
|
|
$
|
113
|
|
|
$
|
320
|
|
|
$
|
615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in deferred compensation plan
|
|
$
|
(377
|
)
|
|
$
|
(113
|
)
|
|
$
|
(320
|
)
|
|
$
|
(615
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment distributed to Predecessor stockholder
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
111
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of 9,681,873 shares of common stock to Predecessor stockholder
|
|
$
|
-
|
|
|
$
|
82,632
|
|
|
$
|
-
|
|
|
$
|
-
|
|
See accompanying notes to the consolidated financial statements.
STG Group, Inc.
|
|
Notes to Consolidated Financial Statements
|
|
Note 1.
|
Nature
of Business and Significant Accounting Policies
|
Nature of business:
STG Group, Inc. (formerly, Global Defense
& National Security Systems, Inc. or GDEF) and its subsidiaries (collectively, the Company) was originally incorporated in
Delaware on July 3, 2013 as a blank check company, with Global Defense & National Security Holdings LLC (“Global Defense
LLC” or the “Sponsor”) as Sponsor, formed for the purpose of effecting a merger, capital stock exchange, asset
acquisition, stock purchase, reorganization, exchangeable share transaction or other similar business combination. On November
23, 2015, the Company consummated its business combination with STG Group Holdings, Inc. (formerly, STG Group, Inc. or “STG
Group”) pursuant to the stock purchase agreement, dated as of June 8, 2015, which provided for the purchase of all the capital
stock of STG Group by the Company (the “Business Combination”). In connection with the closing of the Business Combination,
the Company ceased to be a shell company in accordance with its Amended and Restated Certificate of Incorporation. The Company
also changed its name from Global Defense & National Security Systems, Inc. to STG Group, Inc., and the Company’s securities
were delisted from The NASDAQ Capital Market. The Company recommenced trading of its common stock under the symbol “STGG”
on the OTC Pink Current Information tier of the over-the-counter market. The Company’s common stock now trades over-the-counter
on the OTCQB. See Note 2 for a further discussion of the Business Combination.
The Company provides enterprise engineering, telecommunications,
information management and security products and services to the federal government and commercial businesses. Segment information
is not presented since all of the Company’s revenue is attributed to a single reportable segment.
STG Group was incorporated in the State of Delaware on July
12, 2012, for the purpose of holding shares of STG, Inc. (STG) and the ownership interests of other entities in the future. Concurrent
with the incorporation of STG Group, STG became a wholly-owned subsidiary of STG Group. Effective July 27, 2012, STG Ventures,
LLC (STG Ventures) was created and its sole member was STG Group. On October 24, 2012, STG Netherlands, B.V. (STG Netherlands)
was created as a cooperative in Amsterdam, and is 99% owned by STG Group and 1% owned by STG Ventures. Effective November 28, 2012,
STG Doha, LLC (STG Doha) was incorporated in Doha, Qatar, and is 49% owned by STG Netherlands and 51% owned by Pro-Partnership,
a local Qatar Company. STG Group holds full control over STG Doha due to an arrangement with the other partner, whereby the partner
gives up ownership rights in lieu of a management fee paid to them by STG Group.
STG Ventures, STG Netherlands and STG Doha did not have significant
activity from the dates of inception through the year ended December 31, 2016, periods from November 24, 2015 through December
31, 2015 and January 1, 2015 through November 23, 2015, and year ended December 31, 2014, since any activity would be eliminated
entirely upon consolidation with STG Group or with the Company.
At the close of business on December 31, 2012, STG Group entered
into a Reorganization and Acquisition Agreement with the stockholders of Access Systems, Incorporated (Access), a company incorporated
under the laws of the Commonwealth of Virginia on June 15, 1992, to acquire all of the outstanding common stock of Access. Access
provides software development and facilities management under contractual relationships, primarily with various agencies of the
federal government. On January 2, 2013, STG Group contributed all of the outstanding common stock of Access to STG, Inc. As a result
of the transfer, Access became STG, Inc.’s wholly owned subsidiary.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
During the year ended December 31, 2013, STG Group formed STG
Sentinel, LLC (Sentinel). During the year ended December 31, 2014, Sentinel formed STG Sentinel AFG, LLC (Sentinel AFG). STG Group
is the sole member of Sentinel, which is the sole member of Sentinel AFG. There was no significant activity related to any of these
subsidiaries formed during the year ended December 31, 2016, periods from November 24, 2015 through December 31, 2015 and January
1, 2015 through November 23, 2015, and year ended December 31, 2014.
A summary of the Company’s significant accounting policies
follows:
Basis of presentation and principles of consolidation:
As a result of the Business Combination, the Company was identified as the acquirer for accounting purposes, and STG Group is the
acquiree and accounting predecessor. This determination was based upon an evaluation of facts which included, but was not limited
to, consideration of the following: 1) the relative voting rights of the stockholders in the combined entity after the Business
Combination; 2) the composition of the board of directors of the combined entity; 3) the composition of the senior management team
of the combined entity; 4) and the cash consideration that was transferred by the Company to the acquiree’s shareholders.
Based upon this evaluation, the preponderance of facts supported the conclusion that the Company was the accounting acquirer. The
Company’s consolidated financial statement presentation distinguishes a “Predecessor” for STG Group for the periods
up to and prior to the Closing Date. The Company was subsequently re-named as STG Group, Inc. and is the “Successor”
for periods after the Closing Date, which includes the consolidation of STG Group subsequent to the Business Combination. The acquisition
was accounted for as a business combination using the acquisition method of accounting, and Successor financial statements reflect
a new basis of accounting that is based on the fair value of the net assets acquired. See Note 2 for further discussion of the
Business Combination. As a result of the application of the acquisition method of accounting as of the effective date of the acquisition,
the financial statements for the Predecessor period and for the Successor period are presented on a different basis and, therefore,
are not comparable.
The accompanying consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The consolidated financial
statements include the accounts of STG Group, Inc. (Successor) and STG Group (Predecessor) and their wholly owned subsidiaries,
including STG Doha, which is consolidated under the variable interest entity model. Activity under STG Doha is immaterial to these
consolidated financial statements. These entities are collectively referred to as the Company. All intercompany accounts and transactions
have been eliminated in the accompanying consolidated financial statements.
Figures are expressed in thousands of dollars unless otherwise
indicated.
Going Concern Consideration:
The accompanying consolidated
financial statements have been prepared using the going concern basis of accounting, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business.
The Company was not in compliance with its financial covenants
at September 30, 2016 or at December 31, 2016. At September 30, 2016, the non-compliance was cured by raising equity from stockholders’
(“Equity Cure”) as was allowed by the Lending Agreement. At December 31, 2016 the Company received a forbearance which
expired on March 31, 2017. The Company entered into a Limited Waiver (“the Waiver”) from MC Admin Co LLC and other
lenders under the Credit Agreement as of March 31, 2017, pursuant to which the lenders waived the Company’s non-compliance
with the Specified Financial Covenants as of December 31, 2016. Based upon the preliminary results of operations through the
first quarter of 2017, the Company anticipates that it will not be in compliance with the same financial covenants at March 31,
2017. One of the remedies the Lender has available to it, amongst others is the ability to accelerate repayment of the loan which
the Company would not be able to immediately repay. The potential inability to meet financial covenants under the Company’s
existing Credit Agreement and the potential acceleration of the debt by the Lender resulting in the reclassification of our debt
from a long-term liability to a current liability due to the potential of future covenant defaults required us to evaluate whether
there is substantial doubt regarding the Company’s ability to continue as a going concern.
Management’s Plan to alleviate this condition is as follows:
|
1.
|
Identify, qualify, and win new business to increase revenue and profits.
|
|
2.
|
Complete the PSS transaction including the raising of equity and
refinancing of our current Credit Agreement; or
|
|
3.
|
Renegotiate the current Credit Agreement to obtain relief from the
existing financial covenants and other terms.
|
We considered the likelihood of refinancing the current Credit
Agreement in connection with the PSS acquisition financing which contemplates new financial covenants and the renegotiation of
the financial covenants in the event the acquisition of PSS is not completed. Based upon the executed term sheet for financing
of the planned acquisition of the PSS which contemplates new financial covenants and discussions with our Lender regarding the
need to renegotiate the existing financial covenants in the Credit Agreement in the event the acquisition is not completed, management
determined that it was probable that the condition giving rise to the going concern evaluation has been sufficiently alleviated.
These consolidated financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and classification of assets and liabilities that may result in the
Company not being able to continue as a going concern.
Use of estimates:
The preparation of financial statements
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the consolidated financial statements. Actual results could differ from those
estimates.
Significant estimates embedded in the consolidated financial
statements for the periods presented include revenue recognition on fixed-price contracts, the allowance for doubtful accounts,
the valuation and useful lives of intangible assets, the length of certain customer relationships, useful lives of property, plant
and equipment, valuation of a Rabbi Trust and related deferred compensation liability. Estimates and assumptions are also used
when determining the allocation of the purchase price in a business combination to the fair value of assets and liabilities and
determining related useful lives.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
Revenue recognition:
Revenue is recognized when persuasive
evidence of an arrangement exists, services have been rendered or goods delivered, the contract price is fixed or determinable
and collectability is reasonably assured. Revenue associated with work performed prior to the completion and signing of contract
documents is recognized only when it can be reliably estimated and realization is probable. The Company bases its estimates on
previous experiences with the customer, communications with the customer regarding funding status and its knowledge of available
funding for the contract.
Revenue on cost-plus-fee contracts is recognized to the extent of
costs incurred plus a proportionate amount of the fee earned. The Company considers fixed fees under cost-plus-fee contracts to
be earned in proportion to the allowable costs incurred in performance of the contract. The Company considers performance-based
fees, including award fees, under any contract type to be earned when it can demonstrate satisfaction of performance goals, based
upon historical experience, or when the Company receives contractual notification from the customer that the fee has been earned.
Revenue on time-and-materials contracts is recognized based on the hours incurred at the negotiated contract billing rates, plus
the cost of any allowable material costs and out-of-pocket expenses. Revenue on fixed-price contracts is primarily recognized using
the proportional performance method of contract accounting. Unless it is determined as part of the Company’s regular contract
performance review that overall progress on a contract is not consistent with costs expended to date, the Company determines the
percentage completed based on the percentage of costs incurred to date in relation to total estimated costs expected upon completion
of the contract. Revenue on other fixed-price service contracts is generally recognized on a straight-line basis over the contractual
service period, unless the revenue is earned, or obligations fulfilled, in a different manner.
Provisions for estimated losses on uncompleted contracts are made
in the period in which such losses are determined and are recorded as forward loss liabilities in the consolidated financial statements.
Changes in job performance, job conditions and estimated profitability may result in revisions to costs and revenue and are recognized
in the period in which the revisions are determined.
Multiple agencies of the federal government directly or indirectly
provided the majority of the Company’s contract revenue during the year ended December 31, 2016 and periods from November
24, 2015 through December 31, 2015 and from January 1, 2015 through November 23, 2015, and the year ended December 31, 2014. For
the year ended December 31, 2016 and periods from November 24, 2015 through December 31, 2015 and from January 1, 2015 through
November 23, 2015, and the year ended December 31, 2014, there were two, three, two, and three customers, respectively, that each
provided revenue in excess of 10% of total revenue. These customers accounted for approximately 78%, 89%, 75%, and 84%, respectively,
of the Company’s total revenue for the year ended December 31, 2016, periods from November 24, 2015 through December 31,
2015 and from January 1, 2015 through November 23, 2015, and the year ended December 31, 2014.
Federal government contract costs, including indirect costs, are
subject to audit and adjustment by the Defense Contract Audit Agency. Contract revenue has been recorded in amounts that are expected
to be realized upon final settlement.
Costs of revenue:
Costs of revenue include all direct contract
costs, as well as indirect overhead costs and selling, general and administrative expenses that are allowable and allocable to
contracts under federal procurement standards. Costs of revenue also include costs and expenses that are unallowable under applicable
procurement standards and are not allocable to contracts for billing purposes. Such costs and expenses do not directly generate
revenue, but are necessary for business operations.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
For the year ended December 31, 2016, periods from November 24,
2015 through December 31, 2015 and from January 1, 2015 through November 23, 2015, and the year ended December 31, 2014, there
was one vendor that comprised approximately 16%, 10%, 11%, and 10%, of total direct expenses, respectively.
Cash and cash equivalents:
The Company considers all highly
liquid investments purchased with an original maturity of three months or less at the date of purchase to be cash equivalents.
Investments held in Rabbi Trust:
The Company has investments
in mutual funds held in a Rabbi Trust that are classified as trading securities. Management determines the appropriate classification
of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet
date. The securities are classified as trading securities because they are held for resale in anticipation of short-term (generally
90 days or less) fluctuations in market prices. The trading securities are stated at fair value. Realized and unrealized gains
and losses and other investment income are included in other income (expense) in the accompanying consolidated statements of operations.
Contract receivables:
Contract receivables are generated
primarily from prime and subcontracting arrangements with federal governmental agencies. Billed contract receivables represent
invoices that have been prepared based on contract terms and sent to the customer. Billed accounts receivable are considered past
due if the invoice has been outstanding more than 30 days. The Company does not charge interest on accounts receivable; however,
federal governmental agencies may pay interest on invoices outstanding more than 30 days. The Company records interest income from
federal governmental agencies when received. All contract receivables are on an unsecured basis.
Unbilled amounts represent costs and anticipated profits awaiting
milestones to bill, contract retainages, award fees and fee withholdings, as well as amounts currently billable.
In accordance with industry practice, contract receivables relating
to long-term contracts are classified as current, even though portions of these amounts may not be realized within one year.
Management determines the allowance for doubtful accounts by regularly
evaluating individual customer receivables and considering a customer’s financial condition, credit history and current economic
conditions. Management has recorded an allowance for contract receivables that are considered to be uncollectible. Both billed
and unbilled receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded
when received.
Valuation of long-lived assets:
The Company accounts
for the valuation of long-lived assets, including amortizable intangible assets, under authoritative guidance issued by the Financial
Accounting Standards Board (FASB), which requires that long-lived assets and certain intangible assets be reviewed for impairment
whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the long-lived
assets is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated
by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the estimated fair value of the assets. During the period from January 1, 2015 through
November 23, 2015 and for the year ended December 31, 2014, the Company recorded an impairment loss on its customer relationships
of $0.9 million and $1.8 million, respectively. No indicators of impairment were identified for the year ended December 31, 2016
and for the period from November 24, 2015 through December 31, 2015.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
Identifiable intangible assets:
Intangible assets of the
Company are comprised of customer relationships and a trade name acquired as a result of the Business Combination described further
in Note 2. The Company determined that the customer relationships and trade name represent finite-lived intangible assets with
useful lives of eight and fifteen years, respectively. The assets are being amortized proportionately over the term of their useful
lives based on the estimated economic benefit derived over the course of the asset life.
Goodwill:
The Company records the excess of the purchase
price of an acquired company over the fair value of the identifiable net assets acquired as goodwill. In accordance with authoritative
guidance issued by the FASB, entities can elect to use a qualitative approach to test goodwill for impairment. Under this approach,
the Company performs a qualitative assessment (Step Zero) to determine whether it is more-likely-than-not that the fair value of
the reporting unit is less than the carrying value. If the fair value of the reporting unit is less than the carrying value of
the reporting unit, the Company is required to perform a goodwill impairment test using a two-step approach, which is performed
at the reporting unit level. In the second step, the implied value of the goodwill is estimated at the fair value of the reporting
unit, less the fair value of all other tangible and identifiable intangible assets of the reporting unit. If the carrying amount
of the goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in the amount equal to that excess,
not to exceed the carrying amount of the goodwill. If the fair value of the reporting unit is not less than the carrying value
of the reporting unit, the two-step goodwill test is not required.
Application of the goodwill impairment test requires judgment,
including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill
to reporting units and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated
using a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows,
which is dependent on internal forecasts, estimation of the long-term rate of growth for the business, estimation of the useful
life over which cash flows will occur and determination of the weighted-average cost of capital. This discounted cash flow analysis
is corroborated by top-down analysis, including a market assessment of enterprise value.
The Company has elected to perform its annual analysis on December
31 each year at the reporting unit level and, during the Predecessor periods, had identified three reporting units with goodwill:
DSTI, Seamast, and Access Systems. During the period from January 1, 2015 through November 23, 2015 and the year ended December
31, 2014, the Company recorded an impairment loss for goodwill of $2.1 million and $5.1 million, respectively. As of the Closing
Date of the Business Combination, the Company determined that there was one reporting unit and as a result of acquisition accounting
for the Business Combination, the carrying value of the reporting unit was equal to its fair value on the Closing Date. After performing
a step zero analysis, no indicators of impairment were identified for the period from November 24, 2015 through December 31,
2015. For the year ended December 31, 2016, the Company has been unable to achieve its targeted revenue and profit forecasts; therefore,
the Company recorded an impairment loss for goodwill of $41.3 million.
Income taxes:
In connection with the Business Combination,
STG Group (Predecessor) converted from a Subchapter S Corporation to a C Corporation. Prior to this, STG Group, excluding STG Netherlands
and STG Doha, was treated as an S corporation under Subchapter S of the Internal Revenue Code. Therefore, in lieu of corporate
income taxes, the Predecessor stockholder separately accounted for his pro-rata share of STG Group’s income, deductions,
losses and credits.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
The Company accounts for income
taxes under FASB Accounting Standards Codification (ASC) Topic 740, Income Taxes
(ASC 740). At the end of each interim period,
the Company estimates an annualized effective tax rate expected for the full year based on the most recent forecast of pre-tax
income, permanent book and tax differences, and global tax planning strategies. The Company uses this effective rate to provide
for income taxes on a year-to-date basis, excluding the effect of significant
, unusual, discrete or extraordinary items,
and items that are reported net of their related tax effects. The Company records the tax effect of significant, unusual, discrete
or extraordinary items, and items that are reported net of their tax effects in the period in which they occur.
In accordance with authoritative guidance on accounting for uncertainty
in income taxes issued by the FASB, management has evaluated the Company’s tax positions and has concluded that the Company
has taken no uncertain tax positions that require adjustment to the quarterly condensed consolidated financial statements to comply
with the provisions of this guidance.
Interest and penalties related to tax matters are recognized in
expense. There was no accrued interest or penalties recorded during the year ended December 31, 2016, for the periods from November
24, 2015 through December 31, 2015 and from January 1, 2015 through November 23, 2015, and the year ended December 31, 2014. STG
Group (Predecessor) is generally no longer subject to income tax examinations by the U.S. federal, state or local tax authorities
for the years ended December 31, 2013, and prior.
Fair value of financial instruments
The carrying value of
the Company’s cash and cash equivalents, contract receivables, line-of-credit, accounts payable and other short-term liabilities
are believed to approximate fair value as of December 31, 2016 and 2015, respectively, because of the relatively short duration
of these instruments. The Company also assessed long-term debt and determined that such amounts approximated fair value primarily
since its terms and interest approximate current market terms and was negotiated with an unrelated third party lender. The Company
considers the inputs related to these estimates to be Level 2 fair value measurements.
Certain assets and liabilities are recorded at fair value. Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability between market participants
in an orderly transaction on the measurement date. The market in which the reporting entity would sell the asset or transfer the
liability with the greatest volume and level of activity for the asset or liability is known as the principal market. When no principal
market exists, the most advantageous market is used. This is the market in which the reporting entity would sell the asset or transfer
the liability with the price that maximizes the amount that would be received or minimizes the amount that would be paid. Fair
value is based on assumptions market participants would make in pricing the asset or liability. Generally, fair value is based
on observable quoted market prices or derived from observable market data when such market prices or data are available. When such
prices or inputs are not available, the reporting entity should use valuation models.
The Company’s assets recorded at fair value on a recurring
basis are categorized based on the priority of the inputs used to measure fair value. Fair value measurement standards require
an entity to maximize the use of observable inputs (such as quoted prices in active markets) and minimize the use of unobservable
inputs (such as appraisals or other valuation techniques) to determine fair value. The inputs used in measuring fair value are
categorized into three levels, as follows:
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
|
Level 1:
|
Inputs that are based upon quoted prices for identical instruments traded in active markets.
|
|
|
|
|
Level 2:
|
Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar investments in markets that are not active, or models based on valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the investment.
|
|
|
|
|
Level 3:
|
Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models and similar techniques. As of December 31, 2016 and 2015, the Company has no financial assets or liabilities that are categorized as Level 3.
|
The Company has investments carried at fair value in mutual funds
held in a Rabbi Trust, which is included in investments held in Rabbi Trust on the accompanying consolidated balance sheets. The
Company does not measure non-financial assets and liabilities at fair value unless there is an event which requires this measurement.
Financial credit risk:
The Company’s assets that are
exposed to credit risk consist primarily of cash and cash equivalents, investments held in Rabbi Trust and contract receivables.
Cash and cash equivalents are deposited with high-credit, quality financial institutions whose balances may, at times, exceed
federally insured limits. The Company has not experienced any losses in such amounts and believes that it is not exposed to any
significant credit risk on cash and cash equivalents. Investments held in Rabbi Trust are stated at fair value at each reporting
period and are subject to market fluctuations. Contract receivables consist primarily of amounts due from various agencies of
the federal government or prime contractors doing business with the federal government. Historically, the Company has not experienced
significant losses related to contract receivables and, therefore, believes that the credit risk related to contract receivables
is minimal.
Debt issuance costs:
In April 2015, the FASB issued
Accounting Standards Update (ASU) 2015-03,
Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation
of Debt Issuance Costs
. This ASU requires that debt issuance costs related to a recognized debt liability be presented in
the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03
is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those
fiscal years. Early adoption is permitted, and retrospective application is required. The Company decided to early adopt this
ASU as of December 31, 2015. Therefore, financing costs incurred for fees paid to lenders and other parties in connection with
debt issuances are recorded as a deduction against the related debt agreement and amortized by the effective interest method over
the terms of the related financing arrangements. In connection with the term loan described further in Note 7, the Company originally
recorded $6.4 million in debt issuance costs as a discount against the carrying amount of the loan. Amortization of $1.4 million
and $0.1 million for the year ended December 31, 2016, and the period from November 24, 2015 through December 31, 2015, is included
in interest expense.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
Transaction-related
expenses:
The Company incurs transaction-related expenses primarily consisting of professional
service fees and costs related to business acquisition activities. The Company recognized transaction-related expenses of approximately
$2.6 million, $0.6 million, and $0.89 million, respectively, during the year ended December 31, 2016, the period from November
24, 2015 through December 31, 2015, and the period from January 1, 2015 through November 23, 2015, which primarily includes fees
related to the Business Combination and related transactions, and the pending transaction disclosed further in Note 15. The transaction-related
expenses were recognized as incurred within the respective Successor or Predecessor periods in accordance with the applicable
accounting guidance on business combinations and classified with indirect and selling expenses on the consolidated statements
of operations.
Stock based compensation:
The Company measures compensation
expense for stock based equity awards based on the fair value of the awards on the grant date. Compensation is recognized as expense
in the accompanying consolidated statements of operations ratably over the required service period or, for performance based awards,
when the achievement of the performance targets become probable.
Net (loss) income per share:
Basic net (loss) income per
share available to common shareholders of the Company is calculated by dividing the net (loss) income by the weighted average number
of common shares outstanding during the year. Common shares issuable upon exercise of the stock options and future vesting of the
restricted stock awards (see Note 12) have not been included in the computation because their inclusion would have had an antidilutive
effect for all periods presented.
Recent accounting pronouncements:
We consider the applicability
and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have
minimal impact on our consolidated financial position or results of operations.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts
with Customers (Topic 606)
, which establishes a comprehensive revenue recognition standard for virtually all industries under
GAAP, including those that previously followed industry-specific guidance. Under the guidance, all entities should recognize revenue
to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services. Additionally, various updates have been issued during 2015 and
2016 to clarify the guidance in Topic 606. The guidance is effective for the Company in the first quarter of 2018. Early adoption
is permitted. Management has not yet assessed the potential impact of this guidance on the consolidated financial statements.
In August 2014, the FASB issued Accounting Standards Update
(“ASU”) 2014-15,
Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties
about an Entity's Ability to Continue as a Going Concern
. ASU 2014-15 explicitly requires management to evaluate, at each
annual or interim reporting period, whether there are conditions or events that exist which raise substantial doubt about an entity's
ability to continue as a going concern and to provide related disclosures. The guidance is effective for annual periods ending
after 15 December 2016 and for annual periods and interim periods thereafter. The adoption of ASU 2014-15 did not have a material
effect on the Company’s consolidated financial statements, however the standard does require additional disclosure of management’s
evaluation of potential conditions or events that exist that raise substantial doubt about an entity’s ability to continue
as a going concern. Such disclosure has been made in note 1 of the Company’s financial statements.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 1.
|
Nature of Business and Significant Accounting Policies
(Continued)
|
In September 2015, the FASB issued ASU 2015-16,
Business Combinations
(Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
. This ASU eliminates the requirement to retrospectively
account for changes to provisional amounts initially recorded in a business combination. ASU 2015-16 requires that an acquirer
recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which
the adjustments are determined, including the effect of the change in provisional amount as if the accounting had been completed
at the acquisition date. The provisions of this ASU are effective for fiscal years beginning after December 15, 2015, including
interim periods within those fiscal years and should be applied prospectively to adjustments to provisional amounts that occur
after the effective date. The adoption of this standard has not had a significant impact on the consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17,
Income Taxes
(Topic 740): Balance Sheet Classification of Deferred Taxes.
This ASU simplifies the presentation of deferred income taxes
by eliminating the requirement for entities to separate deferred tax liabilities and assets into current and noncurrent amounts
in classified balance sheets. Instead it requires deferred tax assets and liabilities be classified as noncurrent in the balance
sheet. This ASU is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim
periods within those annual periods. Early adoption is permitted, and this ASU may be applied either prospectively to all deferred
tax liabilities and assets or retrospectively to all periods presented. The Company has adopted this standard prospectively during
the quarter ended June 30, 2016. The adoption of ASU 2015-17 resulted in the aggregation of a $4.5 million deferred tax asset
and a $10.9 million deferred tax liability to a single line reported on the balance sheet as a non-current deferred tax liability
in the amount of $6.4 million.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic
842
). The standard impacts both lessors and lessees. The most significant change for lessees is that the requirement to recognize
right-to-use assets and lease liabilities for all leases not considered short term. The guidance is effective for fiscal years
beginning after December 15, 2018, and will be applied on a modified retrospective basis. The Company is currently evaluating the
expected impact of the adoption of this standard on the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation
– Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting (ASU 2016-09)
. ASU 2016-09
is intended to simplify several aspects of accounting for share-based payment awards. The effective date will be the first quarter
of fiscal year 2017, with early adoption permitted. The Company is evaluating the expected impact that adoption of this new standard
will have on the consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13,
Financial
Instruments-Credit Losses
(“ASU 2016-13”). ASU 2016-13 will replace the incurred loss impairment methodology
in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable
and supportable information to inform credit loss estimates. The amendments affect loans, debt securities, trade receivables, net
investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded
from the scope that have the contractual right to receive cash. ASU 2016-13 will be effective for the Company beginning in the
first quarter of fiscal year 2020, and early adoption is permitted but not earlier than fiscal year 2019. The Company does not
expect the adoption of ASU 2016-13 to have a material impact on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash
Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
. The amendments in this update clarify the guidance
regarding the classification of operating, investing, and financing activities for certain types of cash receipts and payments.
The amendments in this update are effective for the annual periods, and the interim periods within those years, beginning after
December 15, 2017, and should be applied using a retrospective transition method to each period presented. Early adoption is permitted.
The Company is evaluating the expected impact of adoption, if any, to the consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18,
Statement of
Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force),
which provides guidance on the
presentation of restricted cash or restricted cash equivalents in the statement of cash flows. These amendments are effective
for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently evaluating
the expected impact of the adoption of this guidance on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, "
Business
Combinations (Topic 805) Clarifying the Definition of a Business",
which amends the guidance of FASB Accounting
Standards Codification (ASC) Topic 805, "
Business Combinations
", adding guidance to assist entities with
evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The definition of
a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. This guidance is effective
for annual and interim periods beginning after December 15, 2017, and early adoption is permitted under certain circumstances.
We intend to evaluate the impact of this guidance on our consolidated financial statements and related disclosures in connection
with the potential business combination as disclosed in note 15 to the consolidated financial statements.
In January 2017, the FASB
issued ASU No. 2017-04 “Intangibles-Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment” (“ASU
2017-04”). ASU 2017-04 provides guidance to simplify the subsequent measurement of goodwill by eliminating the Step 2 procedure
from the goodwill impairment test. Under the updates in ASU 2017-04, an entity should perform its annual or interim, goodwill impairment
test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge
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. The amendments of this ASU are effective for annual or
any interim goodwill impairment tests beginning after December 15, 2019. The Company has not yet evaluated the impact, if any,
that the adoption of ASU 2017-04 will have on our Consolidated Financial Statements.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 2.
|
Business Combination
|
After the close of business on November 23, 2015, the Company and
STG Group completed the Business Combination in which the Company acquired STG Group from its current owner. The purchase price
consisted of: (a) $68 million paid in cash and $3.4 million of an estimated net working capital adjustment and other purchase price
adjustments paid in cash (“Cash Consideration”); (b) 8,578,199 new shares of Company common stock, 445,161 shares that
were forfeited by the Sponsor and reissued to the STG Stockholders, and an additional 35,000 shares that were transferred by the
Sponsor to the STG Stockholders, valued at a price of approximately $8.50 per share (“Stock Consideration”); and (c)
$5.6 million worth of stock at approximately $8.50 per share (658,513 “Conversion Shares”) in a private placement.
The Company funded a majority of the purchase price through new debt financing as described further in Note 7. On the date of the
Business Combination, the Company also collected $2.5 million from the Predecessor’s stockholder pursuant to a note
receivable agreement outstanding. This is netted against the purchase price adjustments that were settled in cash.
Upon consummation of the Business Combination, the Predecessor changed
its name to STG Group Holdings, Inc. and the Company changed its name from Global Defense & National Security Systems, Inc.
to STG Group, Inc.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 2.
|
Business Combination (Continued)
|
The Company has recorded an allocation of the purchase price to
the Predecessor’s tangible and identifiable intangible assets acquired and liabilities assumed based on their fair values
as of the Business Combination date. The calculation of purchase price and purchase price allocation is as follows (in thousands):
Cash consideration:
|
|
|
|
|
Cash consideration per Stock Purchase Agreement
|
|
$
|
68,000
|
|
Net working capital and other cash consideration adjustments
|
|
|
3,400
|
|
Total cash consideration
|
|
|
71,400
|
|
Stock consideration, including Conversion Shares
|
|
|
82,632
|
|
Total purchase price
|
|
$
|
154,032
|
|
|
|
|
|
|
Current assets
|
|
$
|
42,716
|
|
Property and equipment
|
|
|
1,745
|
|
Goodwill
|
|
|
113,589
|
|
Identifiable intangible assets
|
|
|
39,840
|
|
Other assets
|
|
|
166
|
|
Total assets acquired
|
|
|
198,056
|
|
|
|
|
|
|
Current liabilities
|
|
|
26,639
|
|
Deferred income taxes
|
|
|
11,903
|
|
Other long-term liabilities
|
|
|
5,482
|
|
Total liabilities assumed
|
|
|
44,024
|
|
|
|
|
|
|
Total purchase price
|
|
|
154,032
|
|
Less cash acquired
|
|
|
2,184
|
|
Total purchase price, net of cash acquired
|
|
$
|
151,848
|
|
Separately identifiable intangible assets are considered to be Level 3 fair value measurements and were
valued by a third party valuation specialist. Intangible assets comprised of customer relationships for $26.4 million and a trade
name for $13.5 million were valued using a discounted cash flow method and a relief from royalty method, respectively. The stock
consideration was valued at the estimated fair value per share using other stock based transactions and the actively traded share
price around the time prior to and immediately after the Closing Date for the Business Combination, as discounted by approximately
20% for a lack of marketability discount. Goodwill is not deductible for tax purposes.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 2.
|
Business Combination (Continued)
|
The following unaudited pro forma financial information for the
years ended December 31, 2015 and 2014, assumes the Business Combination occurred on January 1, 2014, after giving effect to certain
adjustments for amortization, interest, and transaction-related expenses and income tax effects. There was also an adjustment to
reverse the impairment charges taken on goodwill and other intangibles during these periods. The pro forma information is presented
for illustrative purposes only and is not indicative of what actual results would have been if the acquisition had taken place
on January 1, 2014, or of future results. The table below summarizes pro forma results for the years ended December 31, 2015 and
2014, (in thousands, except for per share information):
|
|
(unaudited)
|
|
|
|
2015
|
|
|
2014
|
|
Contract revenue
|
|
$
|
193,645
|
|
|
$
|
209,727
|
|
Operating income
|
|
|
3,134
|
|
|
|
(680
|
)
|
Net loss
|
|
|
(3,134
|
)
|
|
|
(5,414
|
)
|
Net loss per share, basic and diluted
|
|
|
(0.19
|
)
|
|
|
(0.34
|
)
|
The pro forma adjustments increased amortization and interest
expense by $5.0 million and $7.2 million, respectively, reversed transaction-related expenses of $1.4 million, reversed goodwill
and other intangible asset impairment charges of $3.0 million, and decreased the income tax benefit by $1.1 million for the year
ended December 31, 2015.
The pro forma adjustments increased amortization and interest expense by $6.7 million and $8.4 million,
respectively, increased transaction-related expenses of $0.6 million for solely the buyer related costs, reversed goodwill and
other intangible asset impairment charges of $7.0 million, and increased the income tax benefit by $3.5 million for the year ended
December 31, 2014.
There were no adjustments made to purchase price allocation
during the year ended December 31, 2016.
|
Note 3.
|
Contract Receivables and
Billings in Excess of Revenue Recognized
|
At December 31, 2016 and 2015, contract receivables consist of the
following (in thousands):
|
|
Successor
|
|
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
Billed accounts receivable
|
|
$
|
21,588
|
|
|
$
|
27,875
|
|
Unbilled accounts receivable
|
|
|
7,262
|
|
|
|
5,225
|
|
|
|
|
28,850
|
|
|
|
33,100
|
|
Less allowance for doubtful accounts
|
|
|
(66
|
)
|
|
|
(276
|
)
|
|
|
$
|
28,784
|
|
|
$
|
32,824
|
|
Billing in excess of revenue recognized as of December 31, 2016 and 2015, is comprised primarily of billings
from firm fixed-price contacts, where revenue is recognized in accordance with the proportional performance method.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 4.
|
Property and Equipment
|
At December 31, 2016 and 2015, property and equipment consists of
the following (in thousands):
|
|
Estimated
|
|
Successor
|
|
|
|
Life
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
Leasehold improvements
|
|
Life of lease
|
|
$
|
1,324
|
|
|
$
|
1,316
|
|
Computer hardware and software
|
|
1 - 3 years
|
|
|
329
|
|
|
|
329
|
|
Office furniture and equipment
|
|
1 - 7 years
|
|
|
110
|
|
|
|
110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,763
|
|
|
|
1,755
|
|
Less accumulated depreciation and amortization
|
|
|
|
|
(606
|
)
|
|
|
(57
|
)
|
|
|
|
|
$
|
1,157
|
|
|
$
|
1,698
|
|
Depreciation and amortization expense on property and equipment totaled $0.6 million, $0.06 million, $0.8
million, and $1.2 million for the year ended December 31, 2016, the periods from November 24, 2015 through December 31, 2015 and
January 1, 2015 through November 23, 2015, and the year ended December 31, 2014, respectively.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 5.
|
Intangible Assets and
Goodwill
|
Identifiable intangible assets as of December 31, 2016, consist
of the following (in thousands):
|
|
Successor
|
|
|
December 31, 2016
|
|
|
Estimated
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Life
|
|
Cost
|
|
|
Amortization
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
8 years
|
|
$
|
26,380
|
|
|
$
|
6,136
|
|
|
$
|
20,244
|
|
Trade name
|
|
15 years
|
|
|
13,460
|
|
|
|
1,720
|
|
|
|
11,740
|
|
|
|
|
|
$
|
39,840
|
|
|
$
|
7,856
|
|
|
$
|
31,984
|
|
Identifiable intangible assets as of December 31, 2015, consist
of the following (in thousands):
|
|
Successor
|
|
|
December 31, 2015
|
|
|
Estimated
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Life
|
|
Cost
|
|
|
Amortization
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
8 years
|
|
$
|
26,380
|
|
|
$
|
698
|
|
|
$
|
25,682
|
|
Trade name
|
|
15 years
|
|
|
13,460
|
|
|
|
154
|
|
|
|
13,306
|
|
|
|
|
|
$
|
39,840
|
|
|
$
|
852
|
|
|
$
|
38,988
|
|
Amortization expense amounted to $7.0 million, $0.9 million, $0.7 million, and $0.6 million for the year
ended December 31, 2016, the periods from November 24, 2015 through December 31, 2015 and January 1, 2015 through November 23,
2015, and the year ended December 31, 2014, respectively.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 5.
|
Intangible Assets and
Goodwill (Continued)
|
Estimated amortization of the intangible assets for subsequent years
is as follows (in thousands):
Year Ending December 31,
|
|
|
|
|
2017
|
|
$
|
6,535
|
|
2018
|
|
|
5,600
|
|
2019
|
|
|
5,111
|
|
2020
|
|
|
4,537
|
|
2021
|
|
|
3,191
|
|
Thereafter
|
|
|
7,010
|
|
|
|
$
|
31,984
|
|
The Company’s goodwill balance by reporting unit, consists
of the following as of December 31 (in thousands):
|
|
Predecessor
DSTI
|
|
|
Predecessor
Seamast
|
|
|
Predecessor
Access
|
|
|
Successor
STG Group
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, January
1, 2015, Predecessor
|
|
$
|
440
|
|
|
$
|
1,898
|
|
|
$
|
2,361
|
|
|
$
|
-
|
|
|
$
|
4,699
|
|
Impairment loss
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,064
|
)
|
|
|
-
|
|
|
|
(2,064
|
)
|
Balance, November 23, 2015, Predecessor
|
|
|
440
|
|
|
|
1,898
|
|
|
|
297
|
|
|
|
-
|
|
|
|
2,635
|
|
Elimination of Predecessor goodwill
|
|
|
(440
|
)
|
|
|
(1,898
|
)
|
|
|
(297
|
)
|
|
|
-
|
|
|
|
(2,635
|
)
|
Acquisition of business
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
113,589
|
|
|
|
113,589
|
|
Balance, December 31, 2015, Successor
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
113,589
|
|
|
|
113,589
|
|
Impairment loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(41,276
|
)
|
|
|
(41,276
|
)
|
Balance, December 31, 2016, Successor
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
72,313
|
|
|
$
|
72,313
|
|
During the Predecessor periods, the Company completed three acquisitions
resulting in goodwill: DSTI, Seamast, and Access Systems. Subsequent to the Business Combination, the Company determined that
there was one reporting unit and determined that the carrying value of the reporting unit was equal to its fair value on the Closing
Date.
For the year ended December 31, 2016, the Company recorded an impairment loss of $41.3 million. For the
year ended December 31, 2016, the Company’s third party valuation firm performed the first step of the annual goodwill impairment
test in the fourth quarter of 2016 and determined that the estimated fair value of the Company’s sole reporting unit was
lower than the carrying value, requiring further analysis under the second step of the impairment test. The decline in the estimated
fair value of the Company was primarily due to significantly lower revenue in 2016 than planned. Growth rates in future years remain
comparable to the prior planned growth however future revenue and related profits are less than the previous plan due to significantly
lower 2016 revenue.
In performing the second step of the impairment testing, the
Company’s third party valuation firm performed a theoretical purchase price allocation for the Company to determine the implied
fair values of goodwill which were compared to the recorded amounts of goodwill for the Company’s sole reporting unit.
Upon completion of the second step of the goodwill impairment
test, the Company recorded a noncash goodwill impairment charge of $41.3 million, or 36% of the total goodwill asset. Additional
sensitivity testing was completed using assumptions of only achieving 90% and 85% of the 2017 forecasted plan with other major
assumptions including growth rates, profit margins, and discount factors remaining the same. The result of this analysis was an
estimated additional goodwill impairment of between $5 million and $8 million and $11 million and $14 million respectively. The
Company also has some flexibility in its ability to control indirect costs during 2017 that could mitigate any shortfalls in our
2017 revenue and profit estimates.
The goodwill impairment charges are recorded as impairment charges
in the consolidated statements of operations. The assumptions that have the most significant impact on determination of the reporting
unit fair value are the revenue growth rate, including 3 percent in the terminal year, maintaining adjusted EBITDA margins of 10%
throughout the forecast period, and the weighted average cost of capital (discount rate), of 15.08%. A change in any of these assumptions,
individually or in the aggregate, or future financial performance that is below management expectations may result in the carrying
value of this reporting unit exceeding its fair value, could result in additional impairment to goodwill and amortizable intangible
assets in future periods.
For the period from January 1, 2015 through November 23, 2015, the Company recorded an impairment loss
on Access Systems’ goodwill of $2.0 million. For the year ended December 31, 2014, the Company recorded an impairment loss
on Access Systems’ goodwill of $3.5 million, and an impairment loss on DSTI’s goodwill of $1.7 million. The Company
also recorded an impairment loss on the Access Systems customer relationships of $0.91 million during the period from January 1,
2015 through November 23, 2015 and $1.8 million for the year ended December 31, 2014, primarily due to declining profits on contracts.
The primary methods used to measure the impairment losses were
the income method and the market approach. The significant unobservable inputs used were based on Company-specific information
and included estimates of revenue, profit margins and discount rates. The Company used the two-step approach in measuring the impairment
loss. In the second step, the implied value of the goodwill is estimated at the fair value of the reporting unit less the fair
value of all other tangible and identifiable intangible assets of the reporting unit. If the carrying amount of the goodwill exceeds
the implied fair value of the goodwill, an impairment loss is recognized in the amount equal to that excess, not to exceed the
carrying amount of the goodwill. Following an assessment of revenue, profit, and cash flow projections and the relevant discount
rates, the Company did not record any impairment charges for the Successor period during the period from November 24, 2015 through
December 31, 2015.
Additionally, the Company performed an impairment test on its
long-lived intangible assets. The first step of the impairment test is to compare the undiscounted cash flows of the asset group
to the carrying amount. If the results of the test determine that the undiscounted cash flows of the asset group are less than
the carrying amount, then an impairment exists and further testing is required. An impairment was not required as of December 31,
2016.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 6.
|
Fair Value Measurements
|
The Company has investments in mutual funds held in a Rabbi Trust
which are classified as trading securities. The Rabbi Trust assets are used to fund amounts the Company owes to key managerial
employees under the Company’s non-qualified deferred compensation plan (See Note 9). Based on the nature of the assets held,
the Company uses quoted market prices in active markets for identical assets to determine fair values, which apply to Level 1 investments.
The following tables set forth the fair values of financial assets that are measured at fair value on a recurring basis as of December
31, 2016 and 2015, (in thousands):
|
|
Successor
|
|
|
|
As of December 31, 2016
|
|
|
|
|
|
|
Fair Value Hierarchy Level
|
|
Description
|
|
Assets
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mutual Funds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
US Equity – Large Cap Growth
|
|
$
|
67
|
|
|
$
|
67
|
|
|
$
|
-
|
|
|
$
|
-
|
|
US Equity – Large Cap Value
|
|
|
2
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Large Cap Blend
|
|
|
84
|
|
|
|
84
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Mid Cap Growth
|
|
|
2
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Mid Cap Value
|
|
|
94
|
|
|
|
94
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Small Cap Growth
|
|
|
73
|
|
|
|
73
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
International Equity
|
|
|
7
|
|
|
|
7
|
|
|
|
-
|
|
|
|
-
|
|
Fixed Income
|
|
|
1
|
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
Money Market Funds
|
|
|
2
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
332
|
|
|
$
|
332
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
Successor
|
|
|
|
As of December 31, 2015
|
|
|
|
|
|
|
Fair Value Hierarchy Level
|
|
Description
|
|
Assets
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mutual Funds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
US Equity – Large Cap Growth
|
|
$
|
374
|
|
|
$
|
374
|
|
|
$
|
-
|
|
|
$
|
-
|
|
US Equity – Large Cap Value
|
|
|
48
|
|
|
|
48
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Large Cap Blend
|
|
|
1,038
|
|
|
|
1,038
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Mid Cap Growth
|
|
|
28
|
|
|
|
28
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Mid Cap Value
|
|
|
1,795
|
|
|
|
1,795
|
|
|
|
-
|
|
|
|
-
|
|
US Equity – Small Cap Growth
|
|
|
833
|
|
|
|
833
|
|
|
|
-
|
|
|
|
-
|
|
Growth Real Estate
|
|
|
25
|
|
|
|
25
|
|
|
|
-
|
|
|
|
-
|
|
International Equity
|
|
|
37
|
|
|
|
37
|
|
|
|
-
|
|
|
|
-
|
|
Fixed Income
|
|
|
158
|
|
|
|
158
|
|
|
|
-
|
|
|
|
-
|
|
Money Market Funds
|
|
|
181
|
|
|
|
181
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
4,517
|
|
|
$
|
4,517
|
|
|
$
|
-
|
|
|
$
|
-
|
|
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 6.
|
Fair Value Measurements
(Continued)
|
The mark to market adjustments are recorded in other income (expense), net, in the accompanying consolidated
statements of operations for the year ended December 31, 2016, the periods from November 24, 2015 through December 31, 2015 and
January 1, 2015 through November 23, 2015, and the year ended December 31, 2014, for a net investment (loss) income of $0.4 million,
($0.14) million, $0.03 million, $0.4 million, respectively.
The Company’s debt as of December 31, 2016
and 2015, consists of the following:
|
|
Successor
|
|
|
Successor
|
|
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
Term loan
|
|
|
77,018
|
|
|
|
81,239
|
|
Less: debt discount on term loan
|
|
|
(4,828
|
)
|
|
|
(6,237
|
)
|
Less: current portion
|
|
|
(4,496
|
)
|
|
|
(2,555
|
)
|
|
|
$
|
67,694
|
|
|
$
|
72,447
|
|
Credit Agreement (Successor):
In connection with the
consummation of the Business Combination, all indebtedness under STG Group’s prior credit facility was repaid in full and
the agreement was terminated. The Company replaced the prior credit facility and entered into a new facility (the Credit Agreement)
with a different lending Group. The Credit Agreement provides for (a) a term loan in an aggregate principal amount of $81.8 million;
(b) a $15 million asset-based revolving line-of-credit; and (c) an uncommitted accordion facility to be used to fund acquisitions
of up to $90 million. Concurrent with the consummation of the Business Combination, the full amount of the term loan was drawn
and there were no amounts drawn on the other two facilities. Each facility matures on November 23, 2020. The Company recorded
$6.4 million of debt issuance costs in connection with the new facility as a reduction to the carrying amount of the new term
loan. These costs will be amortized using the effective interest method over the life of the term loan.
The principal amount of the term loan amortizes in quarterly installments
which increase after each annual period. The quarterly installments range from 0.625% to 2.500% of the original principal amount
and are paid through the quarter ending September 30, 2019. The remaining unpaid principal is due on the maturity date of November
23, 2020.
At the Company’s election, the interest
rate per annum applicable to all the facilities is based on a fluctuating rate of interest. The interest rate in effect as of December
31, 2016 and 2015 was 10.30% and 8.80%, respectively. The Borrowers may elect to use either a Base Rate or a Eurodollar Rate. The
interest rate per annum for electing the Base Rate will be equal to the sum of 6.80% plus the Base Rate, which is equal to the
highest of: (a) the base commercial lending rate of the Collateral Agent as publicly announced to be in effect from time to time,
as adjusted by the Collateral Agent; (b) the sum of 0.50% per annum and the Federal Funds Rate (as defined in the Credit Agreement);
(c) the daily one month LIBOR as published each business day in
The Wall Street Journal
for a one month period divided by
a number equal to 1.00 minus the Reserve Percentage (as defined in the Credit Agreement) plus 100 basis points, as of such day
and; (d) 2.00%.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
The interest rate per annum for electing the Eurodollar Rate will
be equal to the sum of 7.80% plus the Eurodollar Rate, which is equal to the highest of: (a) the amount calculated by dividing
(x) the rate which appears on the Bloomberg Page BBAM1, or the rate which is quoted by another authorized source, two business
days prior to the commencement of any interest period as the LIBOR for such an amount by (y) a number equal to 1.00 minus the Reserve
Percentage (as defined in the Credit Agreement) and; (b) 1.00%.
Advances under the revolving line-of-credit are limited by a borrowing
base which may not exceed the lesser of (x) the difference between $15 million and amounts outstanding under letters of credit
issued pursuant to the Credit Agreement; and (y) an amount equal to the sum of: (i) up to 85% of certain accounts receivable of
the Company plus (ii) up to 100% of unrestricted cash on deposit in the Company’s accounts with the Collateral Agent, minus
(iii) amounts outstanding under letters of credit issued pursuant to the Credit Agreement, minus (iv) reserves established by
the Collateral Agent from time to time in its reasonable credit judgment exercised in good faith. The amount available under the
line-of-credit was $15 million at December 31, 2016 (subject to lender consent) and 2015.
The Company is also subject to certain
provisions which will require mandatory prepayments of its term loan and has agreed to certain minimums for its fixed charge coverage
ratio and consolidated EBITDA and certain maximums for its senior secured leverage ratio, as defined in the Credit Agreement.
As of September 30, 2016, the Company did not meet the required consolidated senior secured leverage ratio and minimum consolidated
EBITDA. The Company remained in compliance with the Credit Agreement as of September 30, 2016 by using a provision of the Credit
Agreement that allowed the Company to cure (the "Cure Right") certain covenant non-compliance by issuances of common
stock for cash and use of the proceeds to reduce the principal balance of the term loan.
On November 14, 2016, the Company entered into Common Stock Purchase Agreements with Simon S. Lee Management
Trust, for which Simon Lee, Chairman, is Trustee, and Phillip E. Lacombe, President and Chief Operating Officer (collectively,
the “Investors”), that provided for the sale to the Investors of 462,778 shares of Common Stock at a purchase price
of $3.60 per share, for an aggregate purchase price of approximately $1.7 million. The Company used the proceeds to reduce the
principal balance of the term loan as required to effect the Cure Right.
As of December 31, 2016, the Company did not satisfy the covenants
related to its required consolidated senior secured leverage ratio and minimum consolidated EBITDA. The Credit Agreement does
not allow the Company to exercise the Cure Right in consecutive fiscal quarters; therefore, on February 24, 2017, the Company
entered into a limited forbearance to credit agreement (the “Forbearance Agreement”) with MC Admin Co LLC and the
other lenders under the Credit Agreement. In the Forbearance Agreement, the lenders agreed to forbear from exercising rights and
remedies (including enforcement and collection actions), for which we agreed to pay a fee of up to $750,000, related to our failure
to comply with covenants related to the fixed charge coverage ratio, consolidated EBITDA and the senior secured leverage ratio,
for the fiscal quarter ended December 31, 2016 (the “Specified Financial Covenants”). The Forbearance Agreement requires
us to obtain lender consent prior to use of our revolving credit facility during the period of forbearance. The forbearance period
expired on March 31, 2017. The Company has also agreed to pay an additional two percent (2%) per annum in interest on the amount
outstanding under the loan sunder the Credit Agreement from January 1, 2017 until the earlier of (1) the date on which all loans
under the Credit Agreement are repaid and (2) the date on which the non-compliance with the Specified Financial Covenants is are
waived by the lenders.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
The Company entered into a Limited Waiver
(“the Waiver”) from MC Admin Co LLC and other lenders under the Credit Agreement as of March 31, 2017, pursuant to
which the lenders waived the Company’s noncompliance with the Specified Financial Covenants as of December 31, 2016. Pursuant
to the Waiver:
|
·
|
Loans under the Credit Agreement are subject to additional interest at a rate of 2% per annum until the earliest of (x) the date on which all loans are repaid and all commitments under the Credit Agreement are terminated, (y) the date we deliver the financial statements and certificates for the quarter ending March 31, 2017 showing that we are not in default under the Credit Agreement or (z) the date on which default interest is otherwise due under the Credit Agreement;
|
|
|
|
|
·
|
We must obtain lender consent prior to use of our revolving credit facility; and
|
|
|
|
|
·
|
We cannot effect a Cure Right in respect of the quarter ending March 31, 2017.
|
The Credit Agreement also provides that
the minimum consolidated EBITDA requirement will be increased on June 30, 2017. If our business continues to perform at the current
level through that period, we do not expect to satisfy that covenant or the senior secured leverage ratio at that time, and it
is likely that we will be in non-compliance at March 31, 2017. An inability to meet the required covenant levels could have a material
adverse impact on us, including the need for us to effect an additional Cure Right or obtain additional forbearance or an amendment,
waiver, or other changes in the Credit Agreement. The Credit Agreement does not allow the Company to exercise the Cure Right in
consecutive fiscal quarters, more than three fiscal quarters in the aggregate, in more than two of any four fiscal quarters or
for the quarter ending March 31, 2017. The amount allowed under the Cure Right may not exceed the lesser of $2.5 million and 20%
of consolidated EBITDA. The aggregate of Cure Rights may not exceed $5 million. The Waiver does not apply to covenant non-compliance
after December 31, 2016 or to covenants other than the Specified Financial Covenants. Any additional forbearance, amendment or
waiver under the Credit Agreement may result in increased interest rates or premiums and more restrictive covenants and other terms
less advantageous to us, and may require the payment of a fee for such forbearance, amendment or waiver. Although we anticipate
that we will be able to renegotiate the financial covenants either through a new credit agreement in connection with the anticipated
financing of our planned acquisition of PSS or in the event the acquisition of PSS is not completed, through an amendment of the
existing financial covenants under our current Credit Agreement, if we are unsuccessful in executing an amendment to the existing
financial covenants, we may not be able to obtain a forbearance, waiver or effect a cure, on terms acceptable to us.
If we are not able to effect an amendment
to the Credit Agreement, any future covenant non-compliance will give rise to an event of default thereunder if we are unable to
effect a Cure Right or otherwise obtain forbearance or a waiver in which case the indebtedness under the Credit Agreement could
be declared immediately due and payable, which could have a material adverse effect on the Company.
In accordance with the terms of the Credit Agreement, and withstanding
no acceleration of repayment of the debt, future annual maturities of long-term debt outstanding at December 31, 2016, are as follows
(in thousands):
Year Ending December 31,
|
|
|
|
|
2017
|
|
$
|
4,496
|
|
2018
|
|
|
6,336
|
|
2019
|
|
|
6,131
|
|
2020
|
|
|
60,055
|
|
|
|
$
|
77,018
|
|
Line-of-credit (Predecessor):
Until consummation
of the Business Combination, the Company maintained a bank line-of-credit agreement, whereby the Company could borrow up to the
lesser of either (1) the sum of its billed accounts receivable and unbilled accounts receivable, less the balance in its doubtful
accounts; or (2) $15 million up through the date of the Business Combination. Borrowings under this facility were secured by all
assets of the Company. This facility bore interest at London Interbank Offered Rate (LIBOR) plus 1.75%. This facility was closed
on November 23, 2015 as a result of the Business Combination described further in Note 2.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 8.
|
Commitments and Contingencies
|
Operating leases:
The Company leases office space and equipment
under the terms of non-cancellable operating leases that expire at various dates through 2021.
On March 25, 2015, the Company terminated
a portion of an office lease agreement. The Company agreed to vacate the space no later than August 31, 2015. The remaining space
is still under a lease agreement that expires on December 31, 2021, and has been subleased under the terms of a sublease agreement.
Because the Company vacated the space where its principal office was located, the Company disposed of the related leasehold improvements.
There was a tenant improvement liability associated with the disposed assets. The Company recorded a loss on property and equipment
of $1.1 million from the disposal of the assets and related liability. The Company also expects to incur a loss of approximately
$0.7 million in lease termination costs related to the sublease agreements that are in effect on the remaining space. The related
unfavorable lease liability was adjusted to its fair value as part of the Business Combination. This liability totaled approximately
$0.8 million and $0.9 million as of December 31, 2016 and 2015, respectively.
On April 8, 2015, the Company entered into a new lease agreement
to lease space under an agreement which expires on September 30, 2020. The new lease agreement includes rent abatement and an escalation
clause which has increased the existing deferred rent liability related to the new lease. Similarly, the Company recognizes landlord
incentive payments received as a reduction of rent expense over the lease term. The unrecognized portion of landlord incentive
payments is reflected as deferred rent in the accompanying consolidated balance sheets. In connection with the Business Combination,
any existing deferred rent liabilities were removed as a result.
The future minimum lease payments have not been reduced by minimum required rental income under sublease
agreements totaling approximately $7.6 million as of December 31, 2016. The following is a schedule of the approximate future minimum
lease payments required under non-cancelable operating leases that have initial or remaining terms in excess of one year at December
31, 2016 (in thousands):
Year Ending December 31,
|
|
|
|
|
2017
|
|
$
|
3,343
|
|
2018
|
|
|
2,591
|
|
2019
|
|
|
2,579
|
|
2020
|
|
|
2,350
|
|
2021
|
|
|
1,754
|
|
|
|
$
|
12,617
|
|
In conjunction with the principal office lease agreement, the Company
was required to issue a letter-of-credit to the landlord as security for the new facility in the amount of $0.8 million. The letter-of-credit
can be reduced to $0.4 million in conjunction with the termination agreement. This letter-of-credit was cancelled due to the termination
of the prior credit facility described further in Note 7. As a result, the Company was required to increase its security deposit.
The security deposit shall be the security for the performance of the Company’s obligations, covenants and agreements under
the deed of the lease.
Rent expense, net of sublease income, aggregated to $1.9 million,
$0.2 million, $2.3 million, and $3.3 million for the year ended December 31, 2016, the period from November 24, 2015 through December
31, 2015 and January 1, 2015 through November 23, 2015, and the year ended December 31, 2014, respectively.
Underwriters’ Agreement:
In
2013, pursuant to their public offering, the Company entered into an agreement with their underwriters which entitled them to
an underwriting discount of 3.0%. This fee was paid in cash at the closing of the public offering, including any amounts raised
pursuant to the over-allotment option. In addition, the underwriters were entitled to a deferred fee of 2.75% of the public offering,
including any amounts raised pursuant to the over-allotment option, payable in cash upon the closing of a business combination.
This amount, totaling approximately $1.9 million, was paid upon closing of the Business Combination with STG Group. The Company
also paid $0.6 million in additional fees and other expenses to the underwriters upon close of the Business Combination. These
costs are included as part of the buyer related transaction costs which are recorded during the period from November 24, 2015
through December 31, 2015.
Legal matters:
From time to time the Company may be involved
in litigation in the normal course of its business. Management does not expect that the resolution of these matters would have
a material adverse effect on the Company’s business, operations, financial condition or cash flows.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
The
Deferred Compensation Plan:
The Company maintains a deferred compensation
plan (the Deferred Compensation Plan) in the form of a Rabbi Trust, covering key managerial employees of the Company as determined
by the Board of Directors. The Deferred Compensation Plan gives certain senior employees the ability to defer all, or a portion,
of their salaries and bonuses on a pre-tax basis and invest the funds in marketable securities that can be bought and sold at
the employee’s discretion. The future compensation is payable upon either termination of employment or change of control.
The liabilities are classified within current liabilities as of December 31, 2016 and 2015 on the consolidated balance sheets.
The assets held in the Rabbi Trust are comprised of mutual funds and are carried at fair value based on the quoted market prices
(see Note 6). As of December 31, 2016 and 2015, the amount payable under the Deferred Compensation Plan was equal to the value
of the assets owned by the Company. These assets total $0.3 million and $4.5 million as of December 31, 2016 and 2015, respectively,
and are included as part of current assets in the accompanying consolidated balance sheets. Additionally, the Company may make
discretionary matching contributions to the Deferred Compensation Plan, which vest ratably over three years. The Company recorded
no contributions to the Deferred Compensation Plan for the year ended December 31, 2016, and $0.01 million, $0.05 million, and
$0.1 million for the periods from November 24, 2015 through December 31, 2015 and January 1, 2015 through November 23, 2015, and
the year ended December 31, 2014, respectively. The assets are available to satisfy the claims of the Company’s creditors
in the event of bankruptcy or insolvency of the Company. The participants in the Deferred Compensation Plan were paid a distribution
of their earnings to date through the consummation of the Business Combination. This distribution totaled $4.1 million and was
paid on January 25, 2016.
401(k) profit sharing plan:
The Company maintains a
defined contribution 401(k) plan (the Plan) with respect to all full time employees. Participants may make voluntary contributions
to the Plan up to the maximum amount allowable by law, but not to exceed 50% of their annual compensation. The Company makes matching
contributions to the Plan for all participants, which vest ratably over three years, equal to 50% of employee contributions, up
to a maximum of 3% for those employees contributing 6% or more of their annual compensation. The Company recorded contributions
to the Plan of $1.4 million, $0.3 million, $1.6 million, and $2.1 million for the year ended December 31, 2016, the periods from
November 24, 2015 through December 31, 2015 and January 1, 2015 through November 23, 2015, and the year ended December 31, 2014,
respectively.
Self-funded insurance plan:
The Company has a self-funded
medical insurance plan available to all employees, which includes coinsurance to minimize the Company’s annual financial
risk. The maximum amount of claims that will be paid during the plan year is $0.1 million per employee per annum, up to
an aggregate amount of $7.5 million for the year ended December 31, 2016, and the periods from November 24, 2015 through
December 31, 2015 and January 1, 2015 through November 23, 2015 and $10.6 million for the year ended December 31, 2014. As of
December 31, 2016 and 2015, the Company has accrued $0.9 million and $0.9 million, respectively, for unpaid liabilities related
to claims, premiums and administrative fees.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 9.
|
Benefit Plans (Continued)
|
Predecessor Management Incentive Plan:
The Predecessor had
the STG, Inc. Management Incentive Plan (the MIP Plan) in place prior to the consummation of the Business Combination. The MIP
Plan was created effective November 1, 2011. The purpose of the MIP Plan was to enable STG Group to retain and recruit employees
by providing them with the incentive of participating in the appreciation of the value of the STG Group’s common stock. The
value of STG Group’s common stock represented the equity value determined by the Plan Committee based on a valuation performed
by an external appraisal, which was performed as of the effective date of the MIP Plan (baseline valuation). The appreciation in
value of the common stock, if any, was determined based on the appreciation between the baseline valuation and an internal appraisal
performed by STG Group or external appraisal annually. STG Group would record annual compensation expense based on the proportion
of this appreciation allocated to designated individuals. Only designated individuals had been identified to participate in the
MIP Plan, as determined by the MIP Plan Committee. Awards (units under the MIP Plan) could be granted by the MIP Plan Committee
at any time. Participants vested daily in their awards over a three year measurement period. If a participant remained employed
with STG Group through the fifth anniversary of the grant date of an award, the participant’s plan account would be paid
in three annual installments, commencing immediately following the fifth anniversary. If an employee separated from STG Group for
other than cause, the participant’s vested portion would be paid in three annual installments, the first of which being due
on the anniversary date of the first year of separation. If a change of control event were to occur (change in over 50% ownership),
then all vested amounts under the grant were to be payable within five business days of such change of control. Select individuals
were designated to participate in the MIP Plan. Upon consummation of the Business Combination, the MIP Plan was terminated with
no resulting payouts to the participants.
|
Note 10.
|
Related Party Transactions
|
On November 14, 2016, the Company entered into Common
Stock Purchase Agreements with Simon S. Lee Management Trust, for which Simon Lee, the Company’s Chairman, is Trustee,
and Phillip E. Lacombe, President and Chief Operating Officer (collectively, the “Investors”) that provided for
the sale to the Investors of 462,778 shares of Common Stock at a purchase price of $3.60 per share, an aggregate of
approximately $1.7 million. We used the proceeds to reduce the principal balance of the term loan under the Credit Agreement
as required to effect the Cure Right.
A company owned by a party related to the majority stockholder of
the Company is both a subcontractor to and customer of the Company on various contracts. As of December 31, 2016 and 2015, amounts
due from this entity totaled $0.01 million and $0.02 million, respectively. The Company recorded revenue of $0.07 million, $0.01
million, $0.11 million, and $0.08 million, respectively, for the year ended December 31, 2016, the periods from November 24,
2015 through December 31, 2015 and January 1, 2015 through November 23, 2015 and for the year ended December 31, 2014.
No amount was due to this entity as of December 31, 2016 and 2015
for amounts relating to work performed under subcontracts. The Company also recorded no direct costs for the year ended December 31,
2016 and $0.02 million and $0.14 million, for the period from January 1, 2015 through November 23, 2015, and for the year ended
December 31, 2014, respectively, relating to such work performed.
On September 15, 2015, the Company issued a note receivable to the
Predecessor stockholder for $2.5 million. The note bore interest at 2.35%. The principal and accrued interest was payable in full
on the earlier of December 31, 2015 or the closing of the Business Combination which is described previously in Note 2. This note
was satisfied with the closing of the Business Combination that took effect on November 23, 2015.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 10.
|
Related Party Transactions
(Continued)
|
On November 23, 2015, Global Strategies Group (North America) Inc. and the Company entered into a services
agreement, pursuant to which the Company may retain Global Strategies Group (North America) Inc. from time to time to perform certain
services: corporate development services such as assisting the Company in post-integration matters, regulatory compliance support
services, financial services and financial reporting, business development and strategic services, marketing and public relations
services, and human resources services. Global Strategies Group (North America) Inc. is an affiliate of both the Company and a
Board member. Amounts paid and expensed under this agreement during the year ended December 31, 2016 and the period from November
24, 2015 through December 31, 2015 totaled $0.6 million and $0.04 million, respectively.
|
Note 11.
|
Stockholders’ Equity
|
On November 13, 2015, the Company held a special meeting in lieu of the 2015 Annual Meeting of the Stockholders
where the Business Combination was approved by the Company’s stockholders. At the special meeting, 4,598,665 shares of common
stock were voted in favor of the proposal to approve the Business Combination and 676,350 shares of common stock were voted against
that proposal. In connection with the closing, the Company redeemed a total of 2,031,383 shares of its common stock, pursuant to
the terms of the Company’s amended and restated certificate of incorporation, at $10.63 per share, for a total payment to
redeeming stockholders of $21.6 million.
On November 23, 2015, the Company’s amended and restated certificate
of incorporation authorized 110,000,000 shares of capital stock, consisting of (i) 100,000,000 shares of common stock, par value
$0.0001 per share, and (ii) 10,000,000 shares of preferred stock, par value $0.0001 per share.
At December 31, 2016 and 2015, the Company had authorized for
issuance 100,000,000 shares of $0.0001 par value common stock, of which 16,603,449 shares were issued and outstanding, including
33,600 shares subject to the vesting of restricted stock awards, and 16,107,071 shares issued and outstanding at December 31, 2015,
and had authorized for issuance 10,000,000 shares of $0.0001 par value preferred stock, of which no shares were issued and outstanding
as of December 31, 2016 and 2015.
Preferred Stock
The Board of Directors of the Company is authorized to provide for
the issuance of all or any shares of the Preferred Stock in one or more classes or series, and to fix for each such class or series
such voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional
or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated and expressed in the resolution
or resolutions adopted by the Board of Directors providing for the issuance of such class or series, including, without limitation,
the authority to provide that any such class or series may be: (i) subject to redemption at such time or times and at such price
or prices; (ii) entitled to receive dividends (which may be cumulative or noncumulative) at such rates, on such conditions, and
at such times, and payable in preference to, or in such relation to, the dividends payable on any other class or classes or any
other series; (iii) entitled to such rights upon the dissolution of, or upon any distribution of the assets of, the Company; or
(iv) convertible into, or exchangeable for, shares of any other class or classes of stock, or of any other series of the same or
any other class or classes of stock, of the Company at such price or prices or at such rates of exchange and with such adjustments;
all as may be stated in such resolution or resolutions.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 11.
|
Stockholders’ Equity
(Continued)
|
Backstop Purchase Agreement
On November 23, 2015, the Company entered into a Second Amended
and Restated Backstop Common Stock Purchase Agreement (“Backstop Purchase Agreement”) with the Sponsor of GDEF. The
Backstop Purchase Agreement granted the Sponsor the right to purchase shares of common stock, at a price of $10.63 per share (the
“Backstop Purchase”). The purchase right was exercisable only in the event, and to the extent, that the Company did
not meet the Threshold Cash Amount ($20,000,000 in cash available to the Company from (1) the trust account at the closing of
the Business Combination following the payment in full to stockholders who had requested to be redeemed in connection with the
closing of the Business Combination, and (2) the payment of any aggregate purchase price for the Backstop Purchase). In connection
with the closing of the Business Combination, the Sponsor purchased 1,030,103 shares for approximately $11 million.
Common Stock Dividends
The Company declared a dividend of one share of common stock for
every 1.06 shares of common stock payable to stockholders of record immediately following the consummation of the Business Combination.
The Sponsor and the Predecessor’s stockholder, with respect to the shares of common stock currently held by the Sponsor,
have agreed to forfeit this dividend. The Sponsor did not forfeit the right to receive dividends with respect to any shares it
acquired pursuant to the Backstop Purchase and the Predecessor’s stockholder did not forfeit the right to receive dividends
with respect to the Conversion Shares described further in Note 2. Payment of the dividend was contingent upon the closing of the
Business Combination and made in connection with the close of the Business Combination.
Common Stock Purchase Agreements
As further described in Note 7, on November 14, 2016, the Company
entered into two Common Stock Purchase Agreements that provided for the sale of 462,778 shares of common stock at a purchase price
of $3.60 per share, for an aggregate purchase price of approximately $1.7 million.
|
Note 12.
|
Stock Based Compensation
|
In connection with the approval of the Business Combination, the
2015 Omnibus Incentive Plan (the Plan) was approved by shareholders to provide incentives to key employees, directors, and consultants
of the Company and its subsidiaries. Awards under the Plan are generally not restricted for any specific form or structure and
could include, without limitation, stock options, stock appreciation rights, dividend equivalent rights, restricted stock awards,
cash-based awards, or other right or benefit under the Plan. The Plan allowed for the lesser of: (i) 1.60 million shares of common
stock; or (ii) 8% of the outstanding common shares immediately following the consummation of the Business Combination as reserved
and authorized for issuance under the Plan. At December 31, 2016 and 2015, there were 0.94 million and 1.57 million shares, respectively,
of common stock authorized and available for issuance under the Plan.
Stock Options
Upon completion of the Business Combination, the Company approved
initial grants of non-qualified stock option awards under the Plan to the current independent members of the Board of Directors.
The stock option awards expire in ten years from the date of grant and vest over a period of one year – 20% of the options
will vest 30 days following the grant date, 40% of the options will vest six months following the grant date subject to the Director’s
continued service and the remaining 40% of the options will vest 12 months following the grant date subject to the director’s
continued service. The exercise price is required to be set at not less than 100% of the fair market value of the Company’s
common stock on the date of grant.
In June 2016, the Company granted non-qualified stock option awards
under the Plan to certain key employees of the Company. The stock option awards expire in ten years from the date of grant and
vest in 20% increments over a period that ranges from the grant date to approximately 4.5 years.
In September 2016, the Company granted non-qualified stock option
awards under the Plan to a key employee of the Company. The stock option awards expire in ten years from the date of grant and
vest at 25% on the grant date and in 25% increments thereafter over approximately 1.5 years.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 12.
|
Stock Based Compensation
(Continued)
|
During the year ended December 31, 2016, and the period from November
24, 2015 through December 31, 2015, the fair value of each option was estimated on the date of grant using the Black-Scholes
model that uses the following weighted average assumptions:
|
|
2016
|
|
|
2015
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Risk-free interest rate
|
|
|
1.5
|
%
|
|
|
1.7
|
%
|
Expected option term
|
|
|
6 years
|
|
|
|
5.5 years
|
|
Volatility
|
|
|
88.3
|
%
|
|
|
75.4
|
%
|
Weighted-average fair value
|
|
$
|
2.66
|
|
|
$
|
3.46
|
|
The Company calculated the expected term of the stock option awards
using the “simplified method” in accordance with the
Securities and Exchange Commission Staff Accounting Bulletins
No. 107 and 110
because the Company lacks historical data and is unable to make reasonable assumptions regarding the future.
The Company also estimates forfeitures of share-based awards at the time of grant and revises such estimates in subsequent periods
if actual forfeitures differ from original projections. The Company’s assumptions with respect to stock price volatility
are based on the average historical volatility of peers with similar attributes. The Company determines the risk-free interest
rate by selecting the U.S. Treasury constant maturity rate.
The total compensation expense related to stock option awards under the Plan was $0.6 million and $0.03
million for the year ended December 31, 2016, and the period from November 24, 2015 through December 31, 2015, respectively. The
income tax benefit related to share-based compensation expense was approximately $0.3 million and nominal for the year ended December
31, 2016, and the period from November 24, 2015 through December 31, 2015, respectively. As of December 31, 2016, $1.0 million
of total unrecognized compensation expense related to the share-based compensation Plan is expected to be recognized over a weighted-average
period of 2.50 years. The total unrecognized share-based compensation expense to be recognized in future periods as of December
31, 2016 does not consider the effect of share-based awards that may be issued in future periods.
Stock option awards as of December 31, 2016, and changes during
the year ended December 31, 2016 were as follows:
|
|
Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted Average
Remaining
Contractual Term
(Years)
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, beginning of period
|
|
|
33,336
|
|
|
$
|
5.40
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
567,972
|
|
|
|
4.12
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding, end of period
|
|
|
601,308
|
|
|
$
|
4.19
|
|
|
|
9.51
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, end of period
|
|
|
210,485
|
|
|
$
|
4.47
|
|
|
|
9.43
|
|
|
$
|
-
|
|
There was no aggregate intrinsic value for the options outstanding
and exercisable at December 31, 2016 because the exercise price exceeds the underlying share price.
Restricted Stock Awards
In June 2016, the Company granted restricted stock awards under
the Plan to members of the Board of Directors. The awards vest at 20% on the date of the award and in two 40% increments during
the remaining annual period.
The total compensation expense related to restricted stock
awards granted under the Plan was $0.1 million for the year ended December 31, 2016. The income tax benefit related to the restricted
stock awards was approximately $0.03 million for the year ended December 31, 2016. As of December 31, 2016, $0.05 million of total
unrecognized compensation expense related to the restricted stock awards under the Plan is expected to be recognized over a weighted-average
period of 0.5 years. The total unrecognized share-based compensation expense to be recognized in future periods as of December
31, 2016 does not consider the effect of share-based awards that may be issued in future periods.
Outstanding (non-vested) and vested restricted awards as of December
31, 2016 totaled 22,400 and 33,600, respectively, and 33,600 that vested during the year ended December 31, 2016. The fair value
grant date fair value of vested and non-vested awards was $1.99 per share.
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
The consolidated provision for income taxes included within the
consolidated statements of operations consisted of the following:
|
|
Successor
|
|
|
Predecessor
|
|
|
|
Year Ended
December 31, 2016
|
|
|
November 24,
2015
Through
December 31,
2015
|
|
|
January 1,
2015
Through
November 23,
2015
|
|
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
(42
|
)
|
|
|
13
|
|
|
|
734
|
|
|
|
|
(42
|
)
|
|
|
13
|
|
|
|
734
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(3,415
|
)
|
|
|
(1,337
|
)
|
|
|
-
|
|
State
|
|
|
(445
|
)
|
|
|
(261
|
)
|
|
|
(90
|
)
|
|
|
|
(3,860
|
)
|
|
|
(1,598
|
)
|
|
|
(90
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax (benefit) provision
|
|
$
|
(3,902
|
)
|
|
$
|
(1,585
|
)
|
|
$
|
644
|
|
Income tax (benefit) expense recognized in the accompanying consolidated
statements of operations differs from the amounts computed by applying the Federal income tax rate to earnings before income tax
(benefit) expense. A reconciliation of income taxes at the Federal statutory rate to the effective tax rate is summarized as follows:
|
|
Successor
|
|
|
Successor
|
|
|
Predecessor
|
|
|
|
Year Ended
December 31, 2016
|
|
|
November 24,
2015
Through
December 31
31, 2015
|
|
|
January 1,
2015
Through
November
23, 2015
|
|
|
|
|
|
|
|
|
|
|
|
Tax at Federal statutory rate of 35%
|
|
|
35.0
|
%
|
|
|
35.0
|
%
|
|
|
35.0
|
%
|
State taxes – net of Federal benefit
|
|
|
0.9
|
|
|
|
8.8
|
|
|
|
9.3
|
|
Benefit from S corporation election
|
|
|
-
|
|
|
|
-
|
|
|
|
(30.0
|
)
|
Non-deductible transaction costs
|
|
|
(1.1
|
)
|
|
|
(10.4
|
)
|
|
|
-
|
|
Release of valuation allowance
|
|
|
-
|
|
|
|
51.4
|
|
|
|
-
|
|
Goodwill impairment
|
|
|
(27.7
|
)
|
|
|
-
|
|
|
|
-
|
|
Permanent differences
|
|
|
-
|
|
|
|
(0.1
|
)
|
|
|
-
|
|
Other
|
|
|
0.4
|
|
|
|
1.4
|
|
|
|
-
|
|
|
|
|
7.5
|
%
|
|
|
86.1
|
%
|
|
|
14.3
|
%
|
STG Group, Inc.
|
|
Notes to the Consolidated Financial Statements
|
|
Note 13.
|
Income Taxes (Continued)
|
The Company’s temporary differences which gave rise to deferred
tax assets and liabilities as of December 31, 2016 and 2015 were as follows:
|
|
Successor
|
|
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
Deferred Compensation
|
|
$
|
101
|
|
|
$
|
1,445
|
|
Accrued expenses and reserves
|
|
|
1,045
|
|
|
|
929
|
|
Deferred rent
|
|
|
381
|
|
|
|
521
|
|
Share-based compensation
|
|
|
262
|
|
|
|
-
|
|
Net operating losses
|
|
|
2,726
|
|
|
|
476
|
|
|
|
|
4,515
|
|
|
|
3,371
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(270
|
)
|
|
|
(11
|
)
|
Intangible assets
|
|
|
(10,599
|
)
|
|
|
(13,575
|
)
|
|
|
|
(10,869
|
)
|
|
|
(13,586
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$
|
(6,354
|
)
|
|
$
|
(10,215
|
)
|
In connection with the Business Combination, STG Group (Predecessor)
converted from a Subchapter S Corporation to a C Corporation. Prior to this, for the period from January 1, 2015 through November
23, 2015, and the year ended December 31, 2014, STG Group, generally did not incur corporate level income taxes, exclusive of
certain state level jurisdictions. In lieu of corporate income taxes, the Predecessor stockholder separately accounted for his
pro-rata share of STG Group’s income, deductions, losses and credits. Therefore, the Company presented corporate level deferred
tax assets and liabilities for solely the Successor period. In addition, the Company released a valuation allowance against GDEF’s
deferred tax assets in the amount of $1.1 million. The Company’s gross net operating losses totaling approximately $6.8
million and $8.2 million for federal and state income taxes, respectively, as of December 31, 2016 will expire in 2033 through
2036. The net deferred tax liability is presented on the consolidated balance sheets as a long-term liability totaling $6.4 million
as of December 31, 2016, and a current asset totaling $2.4 million and as a long-term liability totaling $12.6 million as of December
31, 2015. The Company adopted ASU 2015-17 prospectively during the quarter ended June 30, 2016. The adoption of ASU 2015-17 resulted
in the aggregation of a current deferred tax asset and a long-term deferred tax liability to a single line reported on the consolidated
balance sheets as a non-current deferred tax liability.
|
Note 14.
|
Segment Information
|
Segment information is not presented since all of the Company’s
revenue and operations are attributed to a single reportable segment. In accordance with authoritative guidance on segment reporting
under the FASB, the chief operating decision maker has been identified as the President. The President reviews operating results
to make decisions about allocating resources and assessing performance for the entire company.
|
Note 15.
|
Subsequent Events
|
Merger Agreement to Acquire PSS Holdings Inc. (“PSS”).
On February 18, 2017, the Company entered into the Merger Agreement
to acquire PSS. Under the terms of the Merger Agreement, the aggregate purchase price to be paid for PSS at closing is $119.5 million
in cash, subject to certain adjustments based upon closing working capital plus a portion of the value of certain tax benefits
as they are realized after the closing. The purchase price will also be increased by an additional $20,000 per day if the
merger is consummated after March 31, 2017 and certain conditions to the obligations of the Company to close are otherwise satisfied,
such increase applicable for each day after March 31, 2017 that such conditions are so satisfied.
The consummation of the merger is subject
to the satisfaction of certain conditions, including receipt of certain required third party consents. If any condition to the
merger is not satisfied or waived, the merger will not be completed. In addition, the Company intends to fund the merger consideration
through a combination of equity and debt financing. The Company does not presently have commitments for such financing. To the
extent the merger is not completed for any reason with respect to our ability to obtain financing for the merger, we may be required
to pay a termination fee of $625,000 to PSS.
On April 13, 2017, the Company received a letter from PSS purporting
to terminate the Merger Agreement, unless we notify PSS that we are prepared to close and schedule the closing of the merger for
no later than April 23, 2017. The Company does not believe the purported termination of the Merger Agreement is valid, and the
Company is evaluating its alternatives and rights under the Merger Agreement.
Forbearance Agreement and Waiver
On February 24, 2017, we entered into a forbearance agreement
with MC Admin Co LLC and the other lenders under our Credit Agreement. Under the forbearance agreement, the lenders agreed to forbear
from exercising rights and remedies (including enforcement and collection actions) related to our failure to comply with the covenants
related to the fixed charge coverage ratio, consolidated EBITDA and the senior secured leverage ratio, for the fiscal quarter ended
December 31, 2016. The forbearance will expire no later than March 31, 2017.
The Company entered into a Limited Waiver
(“the Waiver”) from MC Admin Co LLC and other lenders under the Credit Agreement as of March 31, 2017, pursuant to
which the lenders waived the Company’s noncompliance with the Specified Financial Covenants as of December 31, 2016. Pursuant
to the Waiver:
|
·
|
Loans under the Credit Agreement are subject to additional interest at a rate of 2% per annum until the earliest of (x) the date on which all loans are repaid and all commitments under the Credit Agreement are terminated, (y) the date we deliver the financial statements and certificates for the quarter ending March 31, 2017 showing that we are not in default under the Credit Agreement or (z) the date on which default interest is otherwise due under the Credit Agreement;
|
|
|
|
|
·
|
We must obtain lender consent prior to use of our revolving credit facility; and
|
|
|
|
|
·
|
We cannot effect a Cure Right in respect of the quarter ending March 31, 2017.
|