STGGQ STG Group Inc (GM)

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed 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. The Company’s common stock trades over-the-counter on the OTCQB exchange, under the symbol “STGG”.

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.

Basis of presentation: The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For additional information, including the Company’s significant accounting policies, refer to the consolidated financial statements and related footnotes in the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2016.

In the opinion of management, all adjustments considered necessary for a fair statement of financial results have been made. Such adjustments consist of only those of a normal recurring nature. Operating results for the three and six months ended June 30, 2017 and 2016, are not necessarily indicative of the results that may be expected for the entire fiscal year.

Figures are expressed in thousands of dollars unless otherwise indicated .

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. 

Going concern: 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 related to the consolidated EBITDA and the senior secured leverage ratio under the Credit Agreement among the Company, MC Admin Co LLC (the “Lender”) and the other lenders party thereto (the “Credit Agreement”) at September 30, 2016, December 31, 2016, March 31, 2017, and June 30, 2017, and was also not in compliance with its financial covenant related to the fixed charge coverage ratio under the Credit Agreement (collectively with the consolidated EBITDA and senior secured leverage ratio covenants, the “Specified Financial Covenants”) at June 30, 2017. At September 30, 2016, the non-compliance was cured by raising equity from stockholders (“Equity Cure”) as was allowed by the Credit Agreement. At December 31, 2016 the Company received a forbearance which expired on March 31, 2017. The Company then 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 covenants related to the consolidated EBITDA, and the senior secured leverage ratio as of December 31, 2016. Pursuant to the Waiver:

The Company was not in compliance with the covenants related to the consolidated EBITDA and the senior secured leverage ratio for quarter ended March 31, 2017 and was not in compliance with the Specified Financial Covenants for the quarter ended June 30, 2017. The Lender has not granted a waiver for the covenant violations as of March 31, 2017 and June 30, 2017. Without a waiver or other relief under the Credit Agreement, one of the remedies the Lender has available to it, amongst others, is the ability to accelerate repayment of the debt, which the Company would not be able to immediately repay. 

If the business continues to perform at the current level through the next quarter, the Company does not expect to satisfy the Specified Financial Covenants at that time, and it is likely that the Company will be in non-compliance at September 30, 2017. The Company’s inability to meet the required covenant levels could have a material adverse impact to the Company, including the need for the Company 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, or in more than two of any four fiscal quarters. 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 Lender’s not having granted a waiver or other relief from the Lender and the potential acceleration of the debt by the Lender resulted in the reclassification of debt from a long-term liability to a current liability as of March 31, 2017 and June 30, 2017.

Even if the Lender does grant forbearance or an amendment to or waiver under the Credit Agreement, any future covenant non-compliance could give rise to an event of default thereunder.

In addition, on May 18, 2017, the Company received a notice of default (the “Default Notice”) from MC Admin Co LLC (“MC Admin”) that states the Company was in default under the Credit Agreement for failing to deliver an annual budget to the lenders on January 15, 2017 as required by the Credit Agreement (the “Budget Delivery Default”). The Company believes this notice is incorrect, as the Company previously provided the required information to the lenders on February 7, 2017. The Default Notice stated that MC Admin was not taking action to enforce the lenders’ rights under the Credit Agreement at this time, although it also provided that, as a result of the default, the lenders had no obligations under the Credit Agreement to provide any additional loans or letters of credit. The Lender has not granted a waiver or other relief from the Budget Delivery Default.

The potential acceleration of the loan repayment due to the Lender not providing a waiver required the Company 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:

As discussed in our Form 10-Q for the quarter ended March 31, 2017, based on the facts that existed as of December 31, 2016, management determined that it was probable that the condition giving rise to the going concern evaluation had been sufficiently alleviated as of December 31, 2016. However, the Lender has not currently granted a waiver or other relief for the Budget Delivery Default or the financial covenant violations as of March 31, 2017 or June 30, 2017. Consequently, management has changed our assessment regarding the potential acceleration of the loan repayment made as of December 31, 2016. As the Lender has not currently granted a waiver or other form of relief for the financial covenant violations as of March 31, 2017 or June 30, 2017, and as disclosed above, sent us a default letter on May 18, 2017, there exists substantial doubt about our ability to continue as a going concern, in the event the Lender exercises its rights to accelerate the repayment of the loan.

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.

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 six months ended June 30, 2017 and 2016. For the six months ended June 30, 2017 and 2016, there were two customers that each provided revenue in excess of 10% of total revenue. These customers accounted for approximately 82% and 80% respectively, of the Company’s total revenue for the six months ended June 30, 2017 and 2016, respectively. The same customers accounted for approximately 83% and 80% of the Company’s total revenue for the three months ended June 30, 2017 and 2016, respectively.

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.

There was one vendor that comprised approximately 11% of total direct expenses for the three and six months ended June 30, 2017 and approximately 11% and 12% of total direct expenses for the three and six months ended June 30, 2016, respectively.

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 condensed 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 three months ended June 30, 2017, the Company performed an interim impairment test of its intangible assets and concluded that no impairment existed. During the three and six months ended June 30, 2016 there were no adverse changes in long-lived assets which caused a need for an impairment analysis.

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. 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. Prior to the adoption of ASU 2017-04, if the fair value of the reporting unit was less than the carrying value of the reporting unit, the Company was required to perform a goodwill impairment test using a two-step approach, which was performed at the reporting unit level. In the second step, the implied value of the goodwill was 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 exceeded the implied fair value of the goodwill, an impairment charge was 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 was not less than the carrying value of the reporting unit, the two-step goodwill test was not required.

During the second quarter of 2017, the Company early adopted ASU 2017-04, Intangibles-Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment . In accordance with the guidance 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.

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 a 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 a 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, as of the Closing Date of the Business Combination, the Company determined that there was one reporting unit. During the six months ended June 30, 2017, the Company was unable to achieve its targeted revenue and profit forecasts; therefore, the Company recorded an impairment charge on goodwill of $21.1 million. If the Company is unable to achieve revenue growth and increased profitability, future impairment tests may result in an additional goodwill impairment charge, which could be material.

Income taxes: The Company accounts for income taxes under FASB 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 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 six months ended June 30, 2017 and 2016.

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 June 30, 2017 and December 31, 2016, 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 for a comparable market participant 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:

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 condensed 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: The Company applies the provisions of Accounting Standards Update (ASU) 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs . 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 6, the Company recorded amortization of $0.3 million and $0.7 million for the three and six months ended June 30, 2017, respectively, and $0.4 million and $0.7 million for the three and six months ended June 30, 2016, respectively, which is included in interest expense.

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 condensed 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 per share: Basic net loss per share available to common stockholders of the Company is calculated by dividing the net loss by the weighted average number of common shares outstanding during the period. Common shares issuable upon exercise of the stock options and future vesting of the restricted stock awards (see Note 11) 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 condensed consolidated financial position or results of operations.

New Accounting Pronouncements Adopted

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, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For example, the new guidance requires all excess tax benefits and tax deficiencies related to share-based payments to be recognized in income tax expense, and for those excess tax benefits to be recognized regardless of whether it reduces current taxes payable. The ASU also allows an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. These amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Therefore, the effective date was the first quarter of 2017. The adoption of this new standard did not have a material impact on the condensed consolidated financial statements. The Company made a policy election to account for forfeitures as they occur.

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 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 early adopted this ASU during the second quarter of 2017.

New Accounting Pronouncements Not Yet Adopted

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 using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently in the process of evaluating the impact of the adoption of this ASU on our consolidated financial statements and our method of adoption.  The adoption is expected to impact our revenue recognition and related disclosures.

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 impact of the adoption of this standard on the condensed consolidated financial statements. 

In June 2016, the FASB issued ASU No. 2016-13,  Measurement of Credit Losses on Financial Instruments  (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 condensed 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 impact of adoption, if any, to the condensed 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 impact of the adoption of this guidance on its condensed 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. The Company is currently evaluating the impact of the adoption of this guidance on its condensed consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting . ASU 2017-09 provides guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. This ASU is effective for all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The Company has not yet evaluated the impact, if any, that the adoption of ASU 2017-09 will have on the condensed consolidated financial statements.

Billings in excess of revenue recognized as of June 30, 2017 and December 31, 2016, are comprised primarily of billings from firm fixed-price contacts, where revenue is recognized in accordance with the proportional performance method.

Depreciation and amortization expense on property and equipment totaled $0.1 million and $0.2 million, respectively, for the three and six months ended June 30, 2017 and $0.1 million and $0.3 million, respectively, for the three and six months ended June 30, 2016.

Identifiable intangible assets as of December 31, 2016, consist of the following (in thousands): 

Amortization expense amounted to $1.6 million and $3.3 million, respectively, for the three and six months ended June 30, 2017 and $1.8 million and $3.5 million, respectively, for the three and six months ended June 30, 2016. During the three months ended June 30, 2017, the Company performed an interim impairment test of its intangible assets and concluded that no impairment existed. During the three and six months ended June 30, 2016, there were no adverse changes in long-lived assets, which caused a need for an impairment analysis.

Changes in the carrying amount of goodwill are as follows (in thousands):

During the three months ended June 30, 2017, the Company recorded an impairment charge of $21.1 million. The Company determined that a triggering event had occurred since the Company was unable to achieve its targeted revenue and profit forecasts during the six months ended June 30, 2017; therefore, the Company’s third party valuation firm performed an interim goodwill impairment test under the provisions of ASU 2017-04 and determined that the estimated fair value of the Company’s sole reporting unit was lower than the carrying value. The decline in the estimated fair value of the Company was primarily due to significantly lower revenue in 2017 than planned due to losing certain contract proposals and delays in the timing of other anticipated contract awards causing management to revise its 2017 forecast. Projected growth rates in future years remain comparable to the prior planned growth, however, projected future revenue and related profits are less than the previous plan due to significantly lower than expected revenue forecasted for 2017.

Upon completion of the interim goodwill impairment test, the Company recorded a noncash goodwill impairment charge of $21.1 million, or 29% of the total goodwill asset. Additional sensitivity testing was completed using assumptions of only achieving 95% and 90% of the revised 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 $0.7 million and $6.7 million and $4.7 million and $10.4 million, respectively. The Company also has some ability to control indirect costs during the remainder of 2017 that could mitigate any additional shortfalls in our revised 2017 revenue and profit estimates.

The goodwill impairment charges are recorded as goodwill impairment in the consolidated statements of operations. A change in any of our assumptions, including key assumptions regarding revenue growth rate, adjusted EBITDA margins and weighted average cost of capital, 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/or amortizable intangible assets in future periods.

The primary method used to measure the impairment charge was the income method. The significant unobservable inputs used were based on company-specific information and included estimates of revenue, profit margins and discount rates. If the carrying amount of the goodwill exceeds the implied fair value of the goodwill, an impairment charge is recognized in the amount equal to that excess, not to exceed the carrying amount of the goodwill.

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 charge was not required as of June 30, 2017 using this test.

During the three months ended June 30, 2016, the Company did not identify any triggering events related to our goodwill and therefore was not required to test goodwill for impairment.

The Company has investments in mutual funds held in a Rabbi Trust which are classified as trading securities and are included in current assets on the accompanying condensed consolidated balance sheets. 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 8). 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 mark to market adjustments are recorded in other income (expense), net, in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2017 which resulted in investment income of $0.01 million and $0.03 million, respectively, and for the three and six months ended June 30, 2016, for a nominal gain and net investment loss of ($0.4) million. 

Credit Agreement: In connection with the consummation of the Business Combination, the Company entered into a new facility (the Credit Agreement) with a different financial 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 are 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 June 30, 2017 and December 31, 2016 was approximately 9.0% and 10.3%, 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%.

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%.

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 using a provision of the Credit Agreement that allowed the Company to cure (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. 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 meet the 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 the Credit Agreement (the “February Forbearance Agreement”) with MC Admin Co LLC and the other lenders under the Credit Agreement.

The Company then entered into a Limited Waiver (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:

The Waiver does not apply to covenant non-compliance after December 31, 2016 or to covenants other than the Specified Financial Covenants.

As of March 31, 2017 the Company was not in compliance with the covenants related to the consolidated EBITDA and the senior secured leverage ratio. In addition, on May 18, 2017, the Company received a Default Notice from MC Admin that states the Company was in default under the Credit Agreement for the Budget Delivery Default. The Company believes this notice is incorrect, as the Company previously provided the required information to the lenders on February 7, 2017. The Default Notice stated that MC Admin was not taking action to enforce the lenders’ rights under the Credit Agreement at this time, although it also provided that, as a result of the default, the lenders had no obligations under the Credit Agreement to provide any additional loans or letters of credit.

As of June 30, 2017 the Company was not in compliance with the Specified Financial Covenants.

The Lender has not granted a waiver or forbearance for the Budget Delivery Default or the covenant violations as of March 31, 2017 and June 30, 2017. One of the remedies the Lender has available to it, amongst others, is the ability to accelerate repayment of the debt, which the Company would not be able to immediately repay.

The Lender’s not having granted a waiver or other relief and the potential acceleration of the debt by the Lender resulted in the reclassification of the debt from a long-term liability to a current liability as of March 31, 2017 and June 30, 2017.

If the business continues to perform at the current level through the next quarter, the Company does not expect to satisfy the Specified Financial Covenants at that time, and it is likely that the Company will be in non-compliance at September 30, 2017. The Company’s inability to meet the required covenant levels could have a material adverse impact to the Company, including the need for the Company 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, or in more than two of any four fiscal quarters. 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.

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 the Company, and may require the payment of a fee for such forbearance, amendment or waiver. If the Company is unable to renegotiate the financial covenants either through a new credit agreement or through an amendment of the existing financial covenants under the current Credit Agreement, we may not be able to obtain a forbearance, waiver or effect a cure, on acceptable terms.

Even if the Lender does grant forbearance or an amendment to or waiver under the Credit Agreement, any future covenant non-compliance could give rise to an event of default thereunder.

If the Lender does not grant forbearance or a waiver of the covenant non-compliance as of March 31, 2017 and June 30, 2017, the Budget Delivery Default, or any future covenant non-compliance, the indebtedness under the Credit Agreement could be declared immediately due and payable, which could have a material adverse effect on the Company.

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 .

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 June 30, 2017 and December 31, 2016 on the condensed 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. As of June 30, 2017 and December 31, 2016, the amount payable under the Deferred Compensation Plan was equal to the value of the assets owned by the Company. These assets total $0.4 million and $0.3 million as of June 30, 2017 and December 31, 2016, respectively, and are included as part of current assets in the accompanying condensed 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 contributions to the Deferred Compensation Plan of $0.04 million and $0.08 million, respectively, for the three and six months ended June 30, 2017. The Company recorded no contributions to the Deferred Compensation Plan for the three and six months ended June 30, 2016. 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.

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 June 30, 2017 there were no amounts due from this entity and at December 31, 2016, amounts due from this entity totaled $0.01 million. The Company recorded no revenue for the three months ended June 30, 2017 and $0.01 million of revenue for the six months ended June 30, 2017. The Company recorded revenue of $0.03 million and $0.04 million, respectively, for the three and six months ended June 30, 2016.

No amount was due to this entity as of June 30, 2017 and December 31, 2016 for amounts relating to work performed under subcontracts. The Company recorded no direct costs for the three and six months ended June 30, 2017 and 2016 for work performed.

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 three and six months ended June 30, 2017 totaled $0.1 million and $0.3 million, respectively, and totaled $0.1 million and $0.3 million, respectively, for the three and six months ended June 30, 2016.

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 June 30, 2017 and December 31, 2016, the Company had authorized for issuance 100,000,000 shares of $0.0001 par value common stock, of which 16,625,849 and 16,603,449 shares were issued and outstanding, respectively, including 33,600 shares subject to the vesting of restricted stock awards as of December 31, 2016, 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 June 30, 2017 and December 31, 2016.

In connection with the approval of the Business Combination, the 2015 Omnibus Incentive Plan (the Plan) was approved by stockholders 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) 1.6 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 June 30, 2017 and December 31, 2016, there were 0.6 million and 0.9 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.

During the first quarter of 2017, the Company granted non-qualified stock option awards under the Plan to certain employees and senior management 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 4.0 years.

During the six months ended June 30, 2017 and 2016, 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:

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’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 $0.1 million and $0.5 million for the three and six months ended June 30, 2017, respectively, and was $0.2 million and $0.3 million for the three and six months ended June 30, 2016, respectively. The income tax benefit related to share-based compensation expense was approximately $0.04 million and $0.2 million for the three and six months ended June 30, 2017, respectively, and $0.08 million and $0.1 million for the three and six months ended June 30, 2016, respectively. As of June 30, 2017, $0.8 million of total unrecognized compensation expense related to the share-based compensation Plan is expected to be recognized over a weighted-average period of 2.6 years. The total unrecognized share-based compensation expense to be recognized in future periods as of June 30, 2017 does not consider the effect of share-based awards that may be issued in future periods.

Stock option awards as of June 30, 2017, and changes during the six months ended June 30, 2017 were as follows:

There was no aggregate intrinsic value for the options outstanding and exercisable at June 30, 2017, 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 $0.02 million and $0.05 million, respectively, for the three and six months ended June 30, 2017 and was $0.02 million for both the three and six months ended June 30, 2016. The income tax benefit related to the restricted stock awards was approximately $0.01 million and $0.02 million, respectively, for the three and six months ended June 30, 2017 and was $0.01 million for both the three and six months ended June 30, 2016. As of June 30, 2017, there was no unrecognized compensation expense related to the restricted stock awards under the Plan.

There were no outstanding non-vested restricted awards as of June 30, 2017, and there were 22,400 shares of restricted stock that vested during the three months ended June 30, 2017. Outstanding (non-vested) restricted awards as of June 30, 2016 totaled 44,800, and 11,200 shares of restricted stock vested during the six months ended June 30, 2016. The weighted-average grant date fair value of vested and non-vested awards was $1.99 per share.

The effective income tax rate was 12.7% and 16.5%, respectively, for the three and six months ended June 30, 2017 and was 38.9% and 34.8%, respectively, for the three and six months ended June 30, 2016. The Company’s effective tax rate for the three and six months ended June 30, 2017 and 2016, differs from the statutory federal rate as a result of state benefits, net of federal provision, permanent differences primarily due to goodwill impairment and changes in estimates made in the deferred taxes recorded as part of the Business Combination, which were not accounted for as measurement period adjustments.

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.