TELOS CORPORATION — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Telos provides IT solutions and services, primarily to U.S. government, military, intelligence, and commercial customers. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $21.096 | $26.798 | $44.206 | $53.877 |
| Gross profit | $7.391 | $9.452 | $15.834 | $20.035 |
| Gross margin | 35.0% | 35.2% | 35.8% | 37.2% |
| Operating income (loss) | $(1.353) | $0.059 | $(2.554) | $1.296 |
| Interest expense | $1.660 | $1.385 | $3.270 | $2.781 |
| Net loss attributable to Telos | $(3.389) | $(1.912) | $(6.488) | $(2.780) |
Quarterly services revenue was $18.402 million versus $23.509 million; products revenue was $2.694 million versus $3.289 million. SG&A was $8.744 million in Q2 and $18.388 million for the six months, compared with $9.393 million and $18.739 million, respectively. The filing does not provide EBITDA.
- Cash flow: Six-month operating cash flow was $(3.976) million, versus positive $5.929 million a year earlier. Investing cash flow was $(1.173) million versus $(0.220) million; financing cash flow was positive $4.537 million versus $(5.729) million. Cash declined to $0.047 million from $0.659 million at year-end 2016.
- Liquidity: Working capital was negative $4.3 million at June 30, improved from negative $8.6 million at December 31, 2016. Accounts receivable were $13.984 million and inventory was $8.887 million.
- Debt and preferred obligations: The balance sheet reports a senior term loan, net, of $10.697 million; subordinated debt of $2.143 million; and capital lease obligations totaling about $19.464 million. Public preferred stock was recorded as a $129.653 million liability. Total reported liabilities were $194.349 million, and stockholders’ deficit was $137.403 million.
- Backlog: Funded backlog was $77.3 million at June 30, 2017, compared with $75.4 million a year earlier and $59.7 million at December 31, 2016.
Material changes versus the prior comparable period
- Q2 revenue declined 21.3%; six-month revenue declined 18.0%. The main drivers were lower services revenue in Secure Mobility and IT & Enterprise Solutions, largely associated with contracts Telos did not win on recompete. Product revenue was approximately flat for the six-month period.
- Six-month gross margin fell 1.4 percentage points to 35.8%, reflecting program and delivery mix. Operating results shifted from income to loss in both the quarter and first half.
- Six-month net loss attributable to Telos increased to $6.488 million from $2.780 million. Higher interest expense, primarily associated with the EnCap loan, also weighed on results.
- Cash from operations swung from positive to negative, while financing included $9.439 million of proceeds from the new senior term loan. Telos also redeemed all Senior Redeemable Preferred Stock for $2.1 million in April.
Outlook, risks, and unusual items
- Liquidity outlook: Management expected EnCap, RCA receivables-purchase, and Action Capital financing arrangements collectively to meet operating, investing, and financing needs for the next 12 months, but gave no assurance. It noted potential cost reductions or a commercial bank facility as possible responses to funding needs.
- Financing terms: The $11 million EnCap term loan matures January 25, 2022, carries a 13% annual accrual rate (potentially 14.5% under specified conditions), and requires at least 10% annual interest payments in cash. Telos reported covenant compliance at June 30, 2017. The loan is secured and includes an $825,000 exit fee.
- Related-party debt change: Porter subordinated notes were amended in April: the rate was reduced from 12% to 6% and maturity extended to July 25, 2022, with the debt subordinated to EnCap. A roughly $1.0 million extinguishment gain was recorded as a capital transaction in stockholders’ deficit, not as income.
- Preferred stock: Public preferred stock accrues cumulative dividends at 12%; approximately $97.8 million of cash dividends had accrued by June 30, 2017. Dividends have not been declared or paid since 1991, and the filing says debt covenants and legal restrictions limit payments and redemptions.
- Business risks: Results can vary with contract awards, task-order timing, delivery mix, and government appropriations. Management cited uncertainty around fiscal 2018 appropriations and the federal debt ceiling. Funded backlog does not ensure future revenue at the same level or timing.
- Liquidity dependency: RCA purchases eligible receivables at its discretion, subject to a $10 million outstanding limit; Action Capital provides an unused facility of up to $5 million. The filing warns that failure to maintain or replace these arrangements could materially harm liquidity and results. Cash on hand was only $47,000.
- Contingencies: Long-running Costa Brava/Wynnefield preferred-stock litigation and Hamot/Siegel litigation had no material developments during the period; outcomes could not be determined. Management said ordinary-course litigation was not expected to have a material adverse effect.
- Other items: Telos capitalized $0.8 million of software development costs during the first half. It reported no goodwill impairment or material change in risk factors, and stated disclosure controls were effective.
Important facts for investors to verify
- Whether the company can sustain liquidity with minimal cash, negative working capital, operating cash outflow, and reliance on receivables financing and the EnCap loan.
- How the lost recompeted contracts and current funded backlog translate into revenue, margins, and cash collections in subsequent periods.
- The full economic burden and restrictions associated with the $129.653 million Public Preferred Stock liability and its cumulative dividends.
- EnCap loan covenants, cash-interest requirements, security, exit fee, and any future refinancing or repayment needs.
- Progress on replacing or renewing the RCA and Action Capital arrangements, and any changes in receivable eligibility or customer payment timing.
- Developments in the pending litigation, federal budget and debt-ceiling actions, and any contract-award or goodwill-impairment triggers.