Business context and reporting period
Telos Corporation’s Form 10-K covers the fiscal year ended December 31, 2018; it is an annual report, not a standalone fourth-quarter filing. Telos provides cybersecurity, secure mobility, identity management, and IT solutions, primarily to U.S. government customers. The company reports one operating segment and consolidates Telos ID, in which it owns 50% but controls the board.
Key financial metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Revenue | $138.0 million | $107.7 million |
| Gross profit / margin | $53.1 million / 38.4% | $40.6 million / 37.7% |
| Operating income | $9.0 million | $0.4 million |
| Net income (loss), consolidated | $1.7 million | ($3.5 million) |
| Net loss attributable to Telos Corporation | ($1.6 million) | ($5.8 million) |
| Cash from operating activities | $6.3 million | ($0.6 million) |
| Cash and cash equivalents at year-end | $72,000 | $600,000 |
| Working capital | $2.1 million | ($4.1 million) |
Services revenue rose 48.3% to $121.0 million, while product revenue fell 34.8% to $17.0 million. Federal customers represented 93.7% of revenue. Firm fixed-price contracts generated 74.9% of revenue. Year-end accounts receivable, net, was $34.5 million; total assets were $74.5 million.
Debt, obligations, and liquidity
At year-end, the senior term loan had a net carrying amount of $11.0 million and the subordinated debt was $2.6 million. The EnCap loan’s stated annual rate was increased by one percentage point in a 2018 amendment; the original rate was 13%, and the increase had been paid in cash. Capital lease obligations totaled $18.0 million, including current and long-term portions. Total liabilities were $206.6 million, including $135.4 million of cumulative redeemable preferred stock classified as a noncurrent liability; its accrued annual dividend is 12%, and cumulative unpaid dividends were $103.5 million at year-end. Common-stock dividends have not been paid in the last two fiscal years.
Management said EnCap and RCA financing arrangements, together with operating cash generation, were expected to meet operating, investing, and financing needs for the next 12 months, while cautioning that this was not assured. RCA’s receivables purchase facility permits up to $10 million of eligible receivables and was extended through June 30, 2020. A separate Action Capital financing agreement expired January 2, 2019 and was not extended. The company used $4.1 million in investing activities in 2018, including $1.6 million of capitalized software development costs and $2.5 million of property and equipment purchases.
Material changes versus the prior comparable period
- Revenue increased 28.1%, primarily from higher sales under U.S. Air Force NETCENTS-2 delivery orders.
- Gross margin improved 0.7 percentage points; operating income increased to $9.0 million from $0.4 million.
- Despite positive consolidated net income, Telos Corporation reported a parent-attributable net loss, in part because $3.4 million of Telos ID income was attributable to the non-controlling interest.
- Operating cash flow improved to $6.3 million from cash use of $0.6 million. Receivables rose to $34.5 million from $24.5 million, while inventory declined to $4.4 million from $13.5 million.
- Total backlog increased to $290.8 million from $256.3 million, but funded backlog declined to $79.3 million from $98.5 million.
Outlook, commentary, risks, and unusual items
- Management anticipated approximately $6.0 million of 2019 capital expenditures, subject to operating results and financing availability.
- Of the $79.3 million funded backlog at year-end, the company expected to recognize 97.2% as revenue in 2019 and a further 2.6% by 2020. Backlog includes amounts dependent on future orders, options, or appropriations and is not a guarantee of revenue.
- 2018 revenue included a $6.0 million cumulative revenue accrual from indirect-rate adjustments on older cost-plus contracts; quarterly disclosure identifies $5.6 million of related accruals in the third quarter. These adjustments contributed to reported results without associated direct costs on the cited Secure Mobility deliverables.
- Key risks include heavy reliance on U.S. government spending and appropriations, competitive contract bids and recompetes, contract funding delays or termination, fixed-price cost overruns, customer concentration, financing availability, and the ability to retain cleared and specialized staff. The company also cited cybersecurity, supplier, technology, and lengthy sales-cycle risks.
- The EnCap agreement was amended in March 2018 after covenant defaults; covenants were reset and minimum revenue and working-capital covenants added. Telos reported compliance with financial covenants at December 31, 2018.
- Two longstanding shareholder/director-related legal matters remained unresolved. Management said the likelihood of outcomes in the Costa Brava/Wynnefield litigation could not be reasonably determined. In a separate matter, a court had awarded $278,923 against two former/current directors; Telos appealed, and the state appellate court granted review in March 2019. A partial settlement addressed certain advancement-fee issues.
- Telos adopted ASC 606 using the modified retrospective method, recording a $3.9 million cumulative adjustment to accumulated deficit. It reported no goodwill impairment in 2018, but cautioned that contract losses or failure to meet growth projections could trigger future impairment.
- The independent auditor issued an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor was not engaged to provide an opinion on internal control effectiveness.
Most important facts for investors to verify
- Whether revenue growth and margins persist without the $6.0 million indirect-rate catch-up, and how much growth depends on NETCENTS-2 task orders.
- The conversion, timing, and funding quality of backlog, particularly the decline in funded backlog to $79.3 million.
- Liquidity headroom and access to receivables financing, given only $72,000 of year-end cash, the Action Capital facility’s expiration, and the company’s dependence on RCA and EnCap.
- The full economic burden and restrictions associated with the senior loan, leases, subordinated debt, and $135.4 million carrying value of cumulative preferred stock.
- Developments in the pending litigation, government appropriations, contract recompetes, and compliance with EnCap covenants.