As a follow-up to my previous article on KEYW Holding (NASDAQ:KEYW), I want to highlight a few recent pieces of troubling information I don't expect you to find in the always-positive sell-side analyst notes. First, from the recently filed 10-K, then some highlights from the analyst day, and finally, a closing comment on the departure of the CFO.
Analyst estimates are once again too high, and our $15 million HawkEye G estimate seems more than fair.
After reading the recently-filed 10-K, we believe that analyst estimates for KEYW are too high for 2014 and could lead to constant downward revisions similar to 2013. The following is from the company's 10-K:
We anticipate that revenue will increase in 2014, but the amount of that increase is linked to the growth of our Commercial Cyber Solutions business. While we expect our Commercial Cyber Solutions revenue to at least double from 2013 levels, we are unable to forecast the amount of any additional 2014 revenue.
This statement indicates that the company expects Hexis' revenue to double from approximately $10 million to at least $20 million. In our prior article, we gave it credit for generating $15 million in HawkEye G, which would result in $25 million of Hexis' revenue, since the company should report approximately $10mln of revenue from the sale of HawkEye AP, the new name of the database product acquired in the 2012 Sensage transaction. If we assume $15 million of cyber growth and a flat government business, we get to roughly $314 million in revenue for the year versus the mean estimate for $317 million. Ok, so that's not a problem if the company achieves that level. It would be less than a 1% miss on revenue. Here is where the analysts appear to be way off (also from the 10-K):
Our overall expectation is that Adjusted EBITDA will be approximately 7 - 8% of our 2014 revenue.
The mid-point of the company's adjusted EBITDA guidance is 7.5% of revenue. 7.5% of $314 million is $23.5 million. The current consensus estimate is for EBITDA of $33.5 million. Just using the company's guidance, they could miss current EBITDA estimates by 30%. KEYW also has $75.5 million of net debt as of December 31st, assuming debt remained at a similar level, the company would have a leverage ratio of 3.2 exiting 2014. This won't be an issue if the business is at a bottom, but if headwinds persist on the government business and Hexis isn't successful, this could become a problem. It's also worth pointing out there is no balance sheet safety net for investors. The company has just over $14 million of net working capital and has a tangible book value per share of NEGATIVE $0.66. The company's recent amendment of its leverage covenants on its credit agreement (filed in an 8-K on 3/19/14) implies that the company agrees with our analysis of its likely 2014 EBITDA, and not the analysts' consensus. It expanded its minimum Consolidated Senior Leverage Ratio to 4.0:1 from January 1 through September 30, 2014 and to 3.75:1 on December 31, 2014, from the prior level of 3.0:1. At least in the near term, the company appears to be preparing for its debt level to increase, not decrease.
Changing the measuring stick for HawkEye G
We listened to the webcast portion of KEYW's Analyst Day, and think the primary takeaway was that the company is changing its definition of success for HawkEye G. Management is now asking us to focus on bookings, rather than revenue for the new product. It has set a target of $30M in Hexis' bookings this year (this includes Hawkeye AP/Sensage), but even when asked directly, declined to give any estimate of what this may mean for revenue. We are not big fans of bookings numbers in general, as they are more subjective and do not have the same standard accounting rules as revenue recognition. Importantly, "bookings" never have to be disclosed in an SEC filing and are not subject to rigorous audit procedures. Management also spent time discussing its sales pipeline and engagements with a nice up and to the right chart. There was also much discussion on pilots for potential customers. What was noticeably absent was talk of closing deals and making sales. We are all still waiting for this to happen.
We would note that we were only able to listen to the 2-hour webcast. There are a total of 7 hours of meetings scheduled, but the other 5 hours are not open to the public. This does not include the hosted breakfasts, lunches and the dinner events held Friday and Saturday night and the Saturday evening sunset cruise. I'm sure the highlights from this time will be available in notes from the invited analysts.
Finally, at the Analyst Day, the company introduced new hire, Todd Weller. Todd was a sell-side analyst at Stifel, who is joining the company, but it wasn't clear in what capacity. KEYW Holding's current investor relations person is also a former sell-side analyst, which makes sense, but we were surprised (and I think many other people will be as well) with Todd popping up and speaking at the Analyst Day, and are curious to understand his role in the company. We can't recall another company whose chief talent pipeline appears to be the financial analysts who cover the sector.
CFO John Krobath resigns to pursue other opportunities.
Thursday night, KEYW announced CFO, John Krobath, was leaving to pursue other opportunities. From the press release:
The KEYW Holding Corporation (KEYW) announced today that John Krobath is stepping down as Chief Financial Officer effective April 25, 2014 to pursue other professional opportunities.
Mr. Moodispaw also addressed the departure on the Analyst Day webcast, basically saying that John's commute was too long. Executives often leave companies. It isn't necessarily a red flag. This just seems like a very inopportune time for John to leave right as the company is making a push to ramp sales of its much-hyped HawkEye G product. We also found the amendment to his employment agreement filed in the 8-K fairly interesting:
In connection with this departure, the Company and Mr. Krobath have entered into an amendment (the "Third Amendment") to Mr. Krobath's Employment Agreement, dated as of June 16, 2009, as amended by Amendment to Employment Agreement dated as of March 12, 2012 and Second Amendment to Employment Agreement dated as of June 29, 2012 (collectively, the "Employment Agreement"). Pursuant to the Third Amendment, Mr. Krobath will receive compensation continuing through December 26, 2014, a lump-sum payment of $330,000 on January 16, 2015, and a potential success fee based on achieving certain corporate milestones no later than August 1, 2014. In addition, all of Mr. Krobath's outstanding equity awards that would have vested before February 28, 2016 will continue to vest on their original vesting schedule, and the performance criteria with respect to Mr. Krobath's 2014 stock option awards made on February 7, 2014 will be removed, and 50% of such options will vest on the first anniversary of the grant date, and 25% will vest on the second anniversary of the grant date.
So even though Mr. Krobath purportedly left on his own volition and KEYW did not therefore owe him anything, they amended his employment agreement to give him more money. By our calculation (using the Black-Scholes valuation model on Bloomberg to value the stock options), KEYW is giving Mr. Korbath $1.58 million in cash and stock compensation for quitting. This does not include the "potential success fee". It just seems odd that Mr. Krobath left to "pursue other professional opportunities" and was rewarded with this type of payout.
Full disclosure: The fund I manage is short KEYW.
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.