Telos Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Telos provides IT and cybersecurity solutions, services, and products, primarily to U.S. government customers. Financial amounts below are in millions unless otherwise stated.
Financial performance
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $23.1 | $27.1 |
| Gross profit / gross margin | $8.4 / 36.5% | $10.6 / 39.1% |
| Operating income (loss) | $(1.2) | $1.2 |
| Interest expense | $1.6 | $1.4 |
| Net loss, consolidated | $(3.0) | $(0.2) |
| Net loss attributable to Telos | $(3.1) | $(0.9) |
| Cash from (used in) operations | $(6.2) | $4.3 |
| Cash and cash equivalents, quarter-end | $2.1 | $0.1 |
- Services revenue declined to $19.7 million from $24.3 million; product revenue increased to $3.4 million from $2.8 million.
- Services gross margin fell to 33.9% from 38.6%, while product gross margin rose to 51.8% from 43.6%.
- SG&A increased to $9.6 million from $9.3 million. The tax provision was $179,000 versus $8,000.
- Operating cash use reflected a $4.8 million adverse change in operating assets and liabilities, alongside the larger net loss. Investing cash use was $0.1 million; financing provided $7.8 million, principally from the new term loan, partly offset by a $1.4 million distribution to Telos ID’s non-controlling member.
Balance sheet, debt, and liquidity
- At March 31, 2017, current assets were $28.7 million and current liabilities were $28.9 million; working capital was negative $0.2 million, improved from negative $8.6 million at December 31, 2016.
- Debt included a senior term loan with a net carrying value of $10.7 million, subordinated debt of $3.1 million, and capital lease obligations totaling $19.7 million. The term loan carries a 13% annual accrual rate, with at least 10% payable in cash monthly, and an $825,000 exit fee.
- Public preferred stock was recorded as a $128.7 million noncurrent liability. It carries a cumulative 12% dividend; accrued cash dividends were $96.8 million. Total stockholders’ deficit was $134.4 million.
- Management said the EnCap term loan, receivables-purchase arrangement, and Action Capital financing arrangement were expected, collectively, to meet liquidity needs for the next 12 months, but gave no assurance. There were no borrowings under the Action Capital facility at quarter-end.
Changes, outlook, and notable items
- Revenue fell 14.7%, mainly due to lower sales under the U.S. Air Force NETCENTS-2 contract and weaker Secure Mobility and IT and Enterprise services deliverables. Cybersecurity services and IT product sales partly offset the decline.
- Funded backlog was $82.3 million, compared with $58.3 million a year earlier and $59.7 million at December 31, 2016. Management cautioned that contract timing, customer mix, and short performance periods make quarterly results variable.
- On January 25, 2017, Telos entered an $11 million EnCap senior term loan maturing in 2022. In connection with the loan, it issued warrants for approximately 2.5% of common equity on a fully diluted basis.
- After quarter-end, on April 18, Telos redeemed all Senior Redeemable Preferred Stock for $2.112 million and amended the $2.5 million Porter subordinated notes: the rate was reduced from 12% to 6% and maturity extended from July 1, 2017 to July 25, 2022. The notes were subordinated to EnCap debt. These transactions are subsequent events, not March 31 cash or balance-sheet activity.
- Telos’ joint venture lost a contract recompete protest; the Court of Federal Claims ruled for the government on April 27, and contract performance ended May 2, 2017. Separately, a previously lost IT and Enterprise contract had generated over $45 million of funded value during the prior three years; its appeal was affirmed against Telos in December 2016.
- Management identified potential liquidity pressure if financing arrangements cannot be maintained or replaced, or if receivable collections slow or collateral needs rise. Government funding uncertainty, contract awards and renewals, and possible future goodwill impairment were also noted. No goodwill impairment was recorded in Q1.
- Two longstanding preferred-stock-related lawsuits had no material developments during the quarter; management said the outcome could not be reasonably determined. Management reported disclosure controls effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether funded backlog converts to revenue and cash, particularly after the adverse contract protest outcome and the May 2 contract end.
- Cash conversion and working-capital requirements, including the drivers of the $6.2 million operating cash outflow.
- Availability, terms, and ongoing compliance with the EnCap, RCA, and Action Capital financing arrangements, including the senior loan’s effective cost and exit fee.
- The scope and long-term implications of the $128.7 million public preferred liability and its cumulative unpaid dividends.
- Whether the April 18 preferred-stock redemption and Porter debt amendments improve liquidity without creating additional financing or covenant constraints.
- Developments in the pending litigation and government contract funding, award, and renewal environment.