Telos Corporation — FY 2011 Form 10-K
Reporting period: Year ended December 31, 2011; filed March 30, 2012. The filing also provides unaudited fourth-quarter results. Unless stated otherwise, financial amounts below are in USD millions. Telos provides secure IT networks, communications, information-assurance and identity-management solutions, primarily to U.S. government customers.
Financial performance and position
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Revenue | $189.9 | $225.8 |
| Gross profit / gross margin | $47.6 / 25.1% | $47.3 / 20.9% |
| Operating income / operating margin | $12.7 / 6.7% | $15.0 / 6.6% |
| Income before taxes | $6.7 | $9.0 |
| Net income attributable to Telos | $1.5 | $3.0 |
| Cash from operating activities | $14.9 | $3.1 |
| Cash from investing activities | ($8.6) | ($0.7) |
| Cash from financing activities | ($6.2) | ($2.4) |
- FY 2011 revenue comprised $125.0 million of services and $64.9 million of products. Fixed-price contracts generated 88.8% of revenue; time-and-materials contracts generated 11.2%.
- Fourth-quarter revenue was $47.8 million versus $51.2 million in Q4 2010. Gross profit was $12.6 million versus $12.4 million; pretax income was $0.9 million versus $2.8 million. Reported quarterly net loss was $0.5 million, compared with net income of $1.2 million. The filing attributes part of quarterly net income movement to a $1.1 million fourth-quarter tax adjustment.
- At year-end, cash was $0.2 million, working capital was $15.2 million, and unused availability under the revolving facility was $5.3 million. Total assets were $89.8 million; total liabilities were $194.2 million; stockholders’ deficit was $104.4 million.
- Facility borrowings were $17.9 million, including a $6.9 million term loan. The balance-sheet carrying value of ITL-related notes was approximately $15.5 million in total, and capital-lease obligations were approximately $6.0 million. Redeemable preferred stock classified as liabilities totaled $116.9 million. Public preferred stock alone had a $108.6 million carrying value and accrued at a 12% annual rate.
Material changes versus prior period
- Revenue fell 15.9% year over year, principally due to lower Secure Networks sales under NETCENTS and ADMC-2 and lower Secure Communications revenue. Product revenue declined 36.9%; services revenue increased 1.7%.
- Gross margin improved 4.2 percentage points to 25.1%, reflecting contract and product mix and the shift toward solutions and services rather than resold products. SG&A rose 7.9% to $34.9 million, including higher intangible amortization, bonuses, labor and consulting costs.
- Operating income declined 15.5% and net income attributable to Telos declined 52.3%. Operating margin was slightly higher, while lower pretax income drove lower net income.
- Operating cash flow increased substantially, helped by a $17.1 million reduction in accounts receivable; inventory increased $7.2 million. Investing cash use primarily reflected the $8.0 million initial cash payment for the IT Logistics acquisition.
Outlook, risks and unusual items
- Management said available cash and facility borrowings should meet operating, debt-service and projected capital needs for the foreseeable future, while noting continued reliance on a credit facility and the importance of maintaining borrowing availability. Planned 2012 capital expenditures were approximately $1.9 million; this is an estimate, not earnings or revenue guidance.
- Backlog at December 31, 2011 was $609.6 million total, including $124.2 million funded. Total backlog includes potential orders and options and is not assurance of future revenue.
- ITL was acquired on July 1, 2011 for preliminary estimated consideration of $26.7 million, funded partly through cash and notes. The acquisition added secure-network engineering and installation capabilities; management said its pro forma revenue effect was immaterial because Telos had been ITL’s primary revenue source before the acquisition.
- Key exposures include dependence on U.S. government spending and appropriations, contract funding or termination, competition, fixed-price delivery and execution, key suppliers and skilled employees, and concentration of receivables with federal customers. The credit facility is secured by substantially all company assets, has financial covenants, and matures May 17, 2014.
- Preferred dividends and redemptions are restricted by the credit agreement and other conditions. The company had not paid common-stock dividends in the prior two years; no public market existed for its common stock. The large cumulative preferred-stock obligations materially exceed reported assets and carry continuing dividend accruals.
- Litigation remained unresolved, including a preferred-stockholder appeal and disputes involving Class D directors; the filing says outcomes could not be reasonably determined. Management stated ordinary-course litigation was not expected to have a material adverse effect. The company reported compliance with facility financial covenants at year-end and assessed internal controls as effective; the auditor expressed no opinion on internal-control effectiveness.
- BDO USA, LLP gave an unqualified opinion on the consolidated financial statements. Telos reported no off-balance-sheet arrangements with a material effect.
Investor verification priorities
- Verify the drivers and sustainability of the revenue decline, especially NETCENTS and ADMC-2 activity, and whether improved gross margin can persist as product sales contract.
- Assess liquidity against the low cash balance, $5.3 million of facility availability, borrowing-base dependence, covenant requirements and May 2014 facility maturity.
- Reconcile debt and lease balances across the balance sheet and debt disclosures, and evaluate the ITL notes’ repayment terms and their priority relative to senior obligations.
- Review the cumulative preferred-stock obligations, restrictions on payment or redemption, and implications for common-stock value and cash available to investors.
- Test backlog quality: distinguish funded amounts from options and other unfunded potential work, and monitor government appropriations and contract awards.
- Check subsequent court developments and any potential financial or governance consequences of the unresolved litigation.