KEYW: Infecting Investors With A False Sense Of Security?

| About: KEYW Holding (KEYW)

* Editor's Note: The following story is the second installment in a detailed investigative report on KEYW. Simply click here for immediate access to the earlier article.

The more cash that KEYW (Nasdaq: KEYW) blows on acquisitions to pursue its capital-intensive growth strategy - without unlocking the fabulous potential that management sure liked to trumpet whenever it tried to justify those expensive deals - the more the bleeding rollup company seems to conveniently relax its standards for success.

Go back and look at the compelling story that KEYW presented to the press a couple of years ago, when it first arrived on the scene as a young public company bursting with fresh promise, and compare the glorious visions that management shared back then with the stark results that the swaggering upstart actually went on to deliver instead. In a bold (if misplaced) show of confidence ahead of an embarrassing setback, KEYW predicted that it would capitalize on its relentless shopping spree by not only enhancing its role as a prime contractor on big-budget government projects but also by maximizing the future performance of all the obscure firms that it kept on swallowing - casually boasting that "30 percent organic growth is achievable" right off the bat - once it fully digested those acquisitions into its own system and transformed them into a fresh layer of muscle.

Eager to showcase its early progress a few months after debuting on the Nasdaq exchange, KEYW bragged that it already generated two-thirds of its revenue from coveted prime contracts and practically assumed that its share of that high-margin business would further expand along with its escalating size. Unable to land a prominent $700 million government contract or even maintain some of the lucrative projects that it already supervised, however, KEYW wound up playing a secondary role on so many of the accounts that it inherited - with prime contracts accounting for barely one-quarter of its revenue by 2012 - that the company emerged from its costly shopping binge looking more like a lowly subcontractor than ever.

Since KEYW has largely manufactured its top-line growth by simply purchasing other firms and then booking their revenue as its own, the ravenous defense contractor still looks like a typical rollup company, too. To be sure, KEYW has yet to approach the impressive levels of organic growth that management supposedly regarded as "achievable" back when its young stock staged its first remarkable (if temporary) rally. Even based on the generous formula that KEYW prefers to calculate its organic growth - selectively including any new business that it has added while conveniently excluding any prior business that it has lost - the company has fallen well short of the incredible productivity gains that it originally promised and, two years later, now seem hopelessly beyond its reach.

Take the financial results that KEYW ultimately reported for 2011, the year that began with management prematurely suggesting that the company would grow its existing business by 30% before the firm had even flipped past the first page of its new 12-month calendar. By the time that KEYW actually closed its books on that disappointing year, losing its bid for one gigantic contract and its grip on a major Air Force account rapidly shrinking to a fraction of its original size, the company needed to lean on its most liberal measure of organic growth just to reach the midpoint of its faraway target.

Once KEYW properly adjusted that figure to reflect the withered contribution that it actually realized from that dwindling Air Force contract, however, the company netted such a modest bump in sales from its core business - up a mere 8% overall - that its legitimate organic growth rate technically fell into the single digits instead.

Although KEYW dutifully pledged to reaccelerate its organic growth rate after it posted that glaring shortfall, the company actually went on to net even smaller gains the following year. When 2012 ended with yet another slide in its own contributions to the top-line growth that it had otherwise acquired, in fact, KEYW seemed a little panicked by those lackluster results itself. After all, KEYW resorted to some rather curious moves - repeatedly contradicting itself in the process - by providing investors with all sorts of figures for its organic growth rate while restricting their access to the underlying financial data required to simply calculate (or at least verify) that vital measure on their own.

KEYW offered up its first set of vague numbers back in early February, when the company hosted a conference call to review its year-end results ahead of the official 10-K filing that would finally surface - with a fresh supply of figures -- more than a full month down the road. Pressed for a routine metric that it nevertheless seemed reluctant to disclose, KEYW evasively pegged its organic rate somewhere "in the low double digits (but) over 10%" and then minimized the probing that followed by simply ending the conference call. Even when KEYW issued its formal 10-K five weeks later (just two days ahead of the final deadline), the company still hesitated to settle on a concrete figure for that crucial measure of its performance and elected to provide a wide assortment of possibilities instead.

KEYW started by claiming an organic growth rate of 10%-even, at least slightly lower than the double-digit increase that its CFO had twice suggested in response to direct questions about the matter when the company verbally previewed its official financial results. By once again ignoring the gutted Air Force contract that had continued to hamper its performance for another year, however, KEYW managed to push that figure up to 12% and arrive at the range that its top financial officer (the former CFO of a puny defense contractor tarnished by a notorious stock promotion) had previously led investors to expect. Indeed, just a few pages after completing that elaborate math assignment, KEYW decided to try out yet another formula that - by retaining credit for several cancelled orders this time - shoved its organic growth rate all the way up to 16% and therefore served its purposes even better still.

At that point, however, KEYW had already taken the obligatory step of subtracting all of the revenue that it never collected to expose the humble nature of its legitimate progress. Without any help from those illusory sales, KEYW revealed a meager 5% boost to its core business that literally ranked as the weakest gain ever documented by the glorified rollup company.

Secret Formula

Still undeterred in spite of its latest shortfall, KEYW proceeded to recite the same familiar vow that it had by then broken for years. This time, management decided to shoot for an organic growth rate of "at least 20%" that - even when measured according to its most liberal standards - KEYW has yet achieve since it originally impressed investors as a brand-new public company.

By the time that KEYW closed the books on its dismal first quarter to reveal its widest miss in a year, however, the company had already run into at least one thorny problem that threatened to poke a gaping hole in its rosy forecast. Notably, back when KEYW issued that lofty guidance and tried to justify its bullish view, the company pointed directly at "Project G" - an elusive cyber-security platform for the commercial market -- as one of three primary drivers behind its projected gains. Although KEYW somehow managed to develop that groundbreaking system from scratch within the span of four short months, however, the company has by now spent almost a full year simply conducting beta tests on its new platform - originally slated for widespread release in "early 2013" - so that it can supposedly perfect its mysterious breakthrough before it officially hits the marketplace.

Since KEYW initially began testing its new security platform last summer, when a handful of "early adopters" began trying out the service at little or no cost, the company has already missed two deadlines for the launch of that overdue product and recently hinted at potential delays to a third. Now that KEYW has postponed the release of its new system from early 2013 to the third (or even the fourth) quarter of the year, the company itself readily admits that it no longer expects to generate any meaningful revenue from the celebrated platform that had ranked as such a promising source of organic growth a few months earlier.

KEYW cannot exactly count on outsized gains from the two acquisition targets that rounded out its short list of growth drivers, either. Stung by rejection when it tried to score a big-budget government project as a young public company, KEYW spent a fortune last fall to acquire Poole & Associates - paying even more than it had commanded when it first began trading on the public stock exchange -- so that it could gain control of a juicy government contract that it would have otherwise serviced as a mere subcontractor instead. KEYW proceeded to miss Wall Street estimates for both of the quarters that followed that expensive deal (ironically financed by growth-hungry investors who footed much of the bill), however, with the company blaming Poole for the major downturn in its margins and the recent slowdown in its growth that have since pressured its financial results.

In essence, by deliberately pursuing a big-ticket acquisition that both diminished its status as a prime contractor and limited its prospects for organic growth, KEYW arguably sacrificed the very benefits that the company has long used to rationalize its costly (and inherently risky) rollup strategy.

No wonder KEYW seems reluctant to provide investors with the details necessary to measure its true performance on their own. By rushing to combine its financial results with those of the firms that it keeps on acquiring, KEYW alone maintains full control over the telling information required to determine whether the company achieves (or even approaches) the solid organic growth that it inevitably promises year after year.

When KEYW came under pressure to quantify that crucial metric a few months ago, prompting management to grudgingly substitute a ballpark figure instead, the company itself literally claimed some measure of ignorance about the exact contributions that it had made.

"For example, with Poole, we immediately integrate the operations," KEYW Chief Executive Officer Leonard Moodispaw rushed to explain at the time. "So it's very difficult then to figure out precisely how much came from the acquisition and how much was work that we already had, now that one plus one equaled three …

"The good news is we merge them together very quickly," he further insisted. "So we're not being coy about it."

Lax Security

Still, KEYW apparently sees little reason to operate under the same restrictions that typically apply to most companies that trade on any sort of respectable stock exchange.

Granted the freedom to withhold material details about its business due to the secretive nature of its government contracts, KEYW looks even stingier than a typical rollup company that buys most of the growth reflected in its complicated financial statements. Despite the potential for abuse created by that situation, however, KEYW has adopted a downright cavalier attitude toward corporate oversight.

Just look at the potential conflict that KEYW casually risked when the company established its compliance department, for example. By appointing none other than the daughter of its CEO to serve as its chief compliance officer, KEYW has effectively placed her in charge of policing her own father (who, in turn, happens to double as chairman of the ethics committee) and preventing the sort of reckless actions that have already backfired at other rollup companies. While Moodispaw never bothered to mention that relationship when discussing his compliance department with The Washington Post a couple of years ago, he clearly revealed his open disdain for pesky restrictions that might inhibit the rapid expansion that KEYW has pursued under its aggressive growth strategy.

"To help us manage," Moodispaw volunteered at the time, "we have a director of corporate compliance (who's) responsible for looking at any new policy/procedure that comes along and saying, 'Do we have to have that? If we've got to have it, does it have to be 20 pages? Can it be two pages" instead?

KEYW must have breezed right through the paperwork for its $125 million buyout of Poole last fall, despite the paltry $235,000 listed on its balance sheet when it struck that record-breaking deal, since it managed to extend a $35 million offer for Sensage - the partner behind its overdue commercial platform - just a few days later.

As its own leaders emphasized from the start, KEYW primarily acquired Sensage so that it could secure full control of Project G and largely regarded the existing services offered by that firm as a minor bonus at best. Nevertheless, KEYW has effectively doubled down on Sensage, anyway. When KEYW placed its hopeful (if premature) bet on Project G as a major driver of organic growth this year, the company also assumed that Sensage would enjoy surging demand for its older services, too, providing the company with the extra boost that it would need to finally hit its impressive targets for a change.

By the time that KEYW presented that healthy forecast, however, the company had arguably owned Sensage long enough to at least shake its remarkable confidence in that bleeding firm. Within a few short months of taking full control of Sensage, in fact, KEYW had not only given up on its original schedule for the widespread release of Project G but also recognized that its new partner had overestimated potential orders for its existing services by a significant margin.

Since then, KEYW has gone on to further postpone the launch of its new commercial platform - abandoning a deadline regarded as crucial until management cancelled it - and report an even wider loss than the market had previously expected due to the swelling cost of that extended project. Although KEYW has now pledged to burst onto the commercial market with its long-awaited breakthrough sometime in the third quarter (set to begin mere weeks from now), the company has yet to even announce a formal name for that celebrated platform, let alone provide an official price list - still under review itself - for its overhyped services.

Indeed, by the time that KEYW confirmed that third-quarter deadline with TheStreetSweeper last month, its own CEO had already backed away from that schedule and hinted at further delays.

"I expect to open the doors, making it more broadly available later in the year -- perhaps in the fourth quarter, late third quarter," Moodispaw conceded this spring, with the earlier date (still two months away at that point) already sounding a bit like an afterthought. But "we don't expect significant revenue for G in 2013 … Nothing's changed in that regard."

In reality, KEYW has changed its tune so many times by now (revising the launch date for Project G two or three times since it began testing that supposed breakthrough less than a year ago) that even the company itself may have easily forgotten all of the outdated versions of its original story. Of course, with KEYW currently sporting a generous $500 million market valuation that effectively rewards the company for promises that it keeps on breaking, its trusting investors also look remarkably forgetful themselves. Given the high stakes for all parties involved, TheStreetSweeper felt compelled to close by providing a detailed chronology of noteworthy revisions for those who might need some more jarring reminders to refresh their stale memories.

History Lesson

"I don't intend to be prolific with announcements touting some tactical or incremental event or news not meaningful to KEYW. I do intend to communicate, as clearly and openly as possible, about matters that really impact our strategy and risks associated with achieving it. … The Aura contract opportunity, with one of our major customers, has grown to be a seven-year, $700 million program to deliver next-generation intelligence community capabilities using agile systems integration methods. We delivered our proposal during December 2010 and expect a decision in mid-2011. (But) we expect to continue high organic growth regardless of specific contracts."

-- KEYW Chief Executive Officer, Letter to Shareholders (Jan. 5, 2011)

"We don't … worry about having a contract in hand or a new task (order). If we see something that needs to be done, we just go do it and the contract catches up. And we have never failed to get the contract."

-- KEYW Chief Executive Officer, Article in The Washington Post (Jan. 24, 2011)

"We believe we're going to continue to grow 20% to 30% organically a year, without considering the Aura contract. Demand for what we do is very strong. We have over 100 contracts. We're the prime contractor in about 40% of those and the subcontractor in the rest. Part of our strategy is growing the prime contractor relationship in which we are closest to the customer."

-- KEYW Chief Strategy Officer, Article in Reuters (June 3, 2011)

"While the award of the Aura contract to a competitor is disappointing, we continue to see abundant opportunities for continued high growth … Our strategy and success are not dependant on any single contract or opportunity."

-- KEYW Chief Executive Officer, Press Release (Sept. 26, 2011)

"We don't go out looking for companies. I don't know of a single company we've acquired that hasn't in effect knocked on our door and said, 'We want to join up with you.'"

-- KEYW Chief Executive Officer, Article in the Baltimore Business Journal (Oct. 26, 2011)

"We have known each other for years and worked together for years. But most recently, after the contract was awarded (to Poole), we began chit-chatting about how it might be useful to be together. So I would say, back in the spring, we started talking about how to do it and when to do it and so on … Obviously, they are prime on the very large contract; we are a subcontractor to them … Mike (Poole) and I would have gotten it done in a day, but for lawyers and bankers and accountants making it much more difficult."

-- KEYW Chief Executive Officer, Conference Call (Sept. 11, 2012)

"The acquisition price of $126 million is a significant premium to the $60 million and $90 million in expected revenue that the press release states for 2012 and 2013, respectively. Given that high valuation, I would assume there is visibility of significant growth beyond 2013. Could you talk about what you see (that) gives you the sense of visibility that this should be so highly valued relative to near-term revenues?"

-- Noble Financial Group Analyst, KEYW Conference Call (Sept. 11, 2012)

"Visibility implies that I have data - or that I have good, solid facts - so I don't want to dignify it by saying that … I can't give you specifics, (but) we are quite comfortable with the growth that will follow on this."

-- KEYW Chief Executive Officer, Conference Call (September 2012)

"The acquisition of Sensage accelerates our pace and our ability to respond to (commercial) demand. Picture giving some steroids to the parrot in his food and seeing how fast it can go; that's what Sensage helps us do. So we're going to get further - and faster - than we would have without Sensage … We believe, with their contribution, it will enhance the profitability and speed with which we could roll out G, which at the end of the day makes G more profitable for us. (The) early adopter phase is going to take us through the fall, so to the end of the year … You won't see much in terms of announcements related to G until the end of the year or early spring, when we say it's now generally available."

-- KEYW Senior Management Team, Conference Call (Sept. 13, 2012)

"In July 2012, we announced the installation of our new cyber-awareness and response platform, code named 'Project G,' in its first operational network … We expect to continue working with Project G early adopters through the end of 2012, with general release of the Project G platform in early 2013."

-- KEYW Prospectus for Secondary Offering (Sept. 26, 2012)

"The commercial phase of what we call 'Project G' is already starting … The software will be generally available in the second quarter, as we have planned, and we're on pace for that. We are finishing up two of the three early adopters, (NYSEARCA:AND) we are picking up the pace … So, in a sense, I believe we're ahead when it comes to the commercial phase of G … We fully expect to have it out - those core capabilities - in the second quarter."

-- KEYW Chief Executive Officer, Conference Call (Feb. 7, 2013)

"We don't make it easy for people who write about us, because we don't give guidance. And I know that some folks were, I'll say, wildly optimistic about our results, and they may be disappointed. But we're very pleased, and we think we did a good job … We expect to continue growing double-digits this year. (Right now), we're in the low double-digits in terms of organic growth … Obviously, we have the impact of Sensage and Poole in (overall) numbers. But if you strip that out, we're still over 10%."

-- KEYW Senior Management Team, Conference Call (Feb. 7, 2013)

"Getting (Project) G generally available in the second quarter is so important to us because RSA cost us a lot of money and because we want to keep - and must keep - our development team focused on G. (But) we have taken our time to do it right. We don't want to go out and fail. We'd rather take time and be one month late and have it right than be one month early and have to go 'Oops.' So we're going through that."

-- KEYW Senior Management Team, Analyst Day (March 1, 2013)

"We've been working with the commercial side for quite some time. For example, everybody's heard, I think, about Project G … But Project G just happens to be there because Projects A through F are things that we didn't talk a whole lot about."

-- KEYW Chief Executive Officer, Analyst Day (March 1, 2013)

"In 2012 and 2011, we recorded inventory reserves of $963,000 and $471,000, respectively, for certain products where the market has not developed as expected."

-- KEYW Annual Report (March 12, 2013)

"Organic revenue, addressed in more detail in the segment discussion below, increased $10 million - or 5% -- on a net basis, including the reduction in our services segment related to the Air Force services, a contract reassignment of $14 million and the absence of the Integrated Solutions production contract of $6 million from 2011. Absent these three items, our organic growth was $30 million or 16% … While we are unable to predict revenue in 2013 including acquisitions, we do expect revenue to grow at least 20% from 2012 levels without acquisitions."

-- KEYW Annual Report (March 12, 2013)

"Their stock is up a bit. So it wouldn't surprise me if they continue to be acquisitive, just because they tend to use their stock as currency, and that's a lot easier to do when you've got a healthy stock price."

-- McLean Group Investment Banker, Article in (March 25, 2013)

"The company determined that it had achieved technological feasibility during the third quarter of 2012 on certain software being developed. (However), as of March 31, 2013, (Project G) was not yet available for sale."

-- KEYW First-Quarter 2013 Report (April 30, 2013)

"Our gross margin's … down from where we were, due to the reliance we have on subcontracted labor, predominantly from the Poole acquisition. our cash from operations was basically zero for the quarter - which was significantly better than it was last year … We're still growing, as you can tell - 14% above where we were last year - but not in terms of the numbers that we were hoping for."

-- KEYW Chief Financial Officer, Conference Call (May 1, 2013)

"G's functional, and it's being deployed. What we learned, however, is the necessity for very thorough upfront analysis could be more extensive than we anticipated. (NYSE:SO) we're not planning to install and deliver more G platforms until we're satisfied that these initial deliveries are working smoothly. Thus, as I said before, we don't expect significant revenue for G in 2013 … Perhaps next year, at the end of this year, we will extend and expand our marketing efforts to bring on more customers, but we've got more than what we're ready to deal with right now … The early adopters, we had three. One, we were able to talk about, which is AT&T, which is going through reorganization … So we really haven't gone far with them … The first installations, we are less concerned about pricing. the way we're working these first ones is to get those systems installed and to make sure they're working before we beat the customer up for the cost therefore … It is less important to us right now to have that paid upfront before we open the doors … I want to try and clarify a terminology because I think, between us all, we may have confused things. So for some time, we've been talking about G being generally available in the second quarter. And when I said we're on track - we're ahead of the game - it's because my definition of that has been, and I think we've said this, when the platform is ready to go out to customers … I don't want to get hung up on the terminology of 'what's an early adopter?' (or) 'when is it generally available?' The product is ready to go, is gone, is out being installed. It might be ahead of pace. We could be installing more. If that meets somebody's definition of general availability, so be it. (Meanwhile), we don't need another thing in terms of acquisitions … If we don't make an acquisition in either side (of the business), we're going to continue to grow and be successful."

-- KEYW Chief Executive Officer, Conference Call (May 1, 2013)

* Important Disclosure: The owners of TheStreetSweeper hold a short position in KEYW and stand to profit on any future declines in the stock price.

* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Melissa Davis, the senior editor of this website and the author of this story, please send an email to

Disclosure: I am short KEYW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.