TELOS CORP quarterly report, Q1 FY2021

Telos Corporation — Q1 2021 Form 10-Q

Reporting period: Three months ended March 31, 2021; interim financial statements are unaudited. Telos provides cybersecurity, cloud security, identity, communications and secure-network solutions. Substantially all revenue came from U.S. customers, primarily federal customers.

Financial performance and liquidity

Cash and cash equivalents were $93.8 million at quarter-end, down from $106.0 million at December 31, 2020. Working capital was $102.2 million, versus $105.2 million at year-end. Investing activities used $2.6 million, including $2.2 million of capitalized software development; financing activities used $0.3 million.

Telos reported $15.3 million of finance lease obligations and $1.4 million of operating lease liabilities. Its EnCap senior term loan and subordinated debt had been repaid in 2020; the filing reports no outstanding conventional borrowings at March 31, 2021. Management said it expected available funds and operating cash generation to meet liquidity needs for the next 12 months, while noting there could be no assurance.

Changes versus prior-year quarter

• Revenue rose 43.0%. Secure Networks revenue increased to $32.9 million from $11.7 million, largely on DoD contracts; Security Solutions revenue fell to $22.9 million from $27.3 million, primarily as the U.S. Census Bureau Telos ID contract ramped down.
• Gross margin declined to 25.7% from 31.4%, reflecting stock-based compensation and contract mix. Security Solutions margin improved to 40.6% from 37.0%; Secure Networks margin declined to 15.5% from 18.8%.
• SG&A rose 135.2% to $27.9 million. Stock-based compensation was $13.7 million, including $6.0 million for performance-based RSUs and $7.7 million for service-based RSUs; this was the principal driver of the GAAP operating loss and higher net loss.
• Interest expense decreased to $0.2 million from $2.0 million, mainly following repayment of debt and preferred stock in connection with the November 2020 IPO. Operating cash flow shifted from $1.7 million provided to $9.3 million used; changes in operating assets and liabilities used $9.6 million in Q1 2021.

Outlook, risks and unusual items

• Funded backlog was $126.8 million at March 31, 2021, compared with $127.7 million at December 31, 2020. Telos expected to recognize approximately 84.2% in 2021 and 10.3% in 2022. Backlog is not a guarantee of future revenue.
• Federal customers accounted for $53.3 million of Q1 revenue, about 95.7% of the total. Management cited uncertainty around federal appropriations, continuing resolutions and future defense spending. It also identified potential COVID-19 effects on customers, suppliers, contract performance, demand and margins.
• A settlement of a longstanding dispute with former directors and Costa Brava was agreed in May 2021. Telos accrued $1.0 million in other expense; the settlement resolved the indemnification claim and related open disputes.
• After quarter-end, Telos received approximately $64.5 million of net proceeds from an April follow-on offering. On April 19, it used approximately $28.1 million to repurchase EnCap-held shares and warrants. These subsequent events were not reflected in March 31 cash.
• The filing reported a full valuation allowance against deferred tax assets. Management reported no material change to the risk factors disclosed in its 2020 Form 10-K and no material adverse effect expected from other ordinary-course litigation, based on information available.

Important facts for investors to verify

1. How much of revenue growth and funded backlog converts to revenue and cash, particularly as the Census Bureau contract ramps down and government orders fluctuate.
2. Whether margins and operating cash flow improve as stock-based compensation and working-capital timing affect results; assess GAAP results alongside, not replaced by, non-GAAP measures.
3. Cash needs and liquidity after the follow-on offering and EnCap repurchase, including finance lease payments and investment in software development.
4. Federal budget and contract-funding developments, customer concentration, and any continuing effects of COVID-19 or supplier delays.
5. Potential dilution and future compensation expense from outstanding RSUs and the expanded equity plan; the filing disclosed $89.9 million of unrecognized service-based RSU expense.