Telos Corporation — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; unaudited. Telos provides IT solutions and services to U.S. government and commercial customers through Cyber Operations and Defense, Secure Communications, and Telos ID. It reports one operating and reportable segment.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $49.3m | $66.9m | $152.1m | $177.7m |
| Gross profit / margin | $8.8m / 17.9% | $14.9m / 22.3% | $25.7m / 16.9% | $43.6m / 24.5% |
| SG&A | $7.7m | $11.1m | $24.6m | $28.5m |
| Operating income | $1.1m | $3.8m | $1.1m | $15.1m |
| Income before taxes | $(0.3)m | $2.4m | $(2.9)m | $10.5m |
| Income tax benefit / (provision) | $4.4m | $(1.1)m | $7.4m | $(4.6)m |
| Net income attributable to Telos | $3.7m | $0.5m | $3.2m | $4.3m |
Cash flow: Operating cash flow was $3.5m for the first nine months, versus $19.4m a year earlier. Investing used $0.5m, and financing used $3.0m. Cash declined by $0.1m to $0.1m.
Liquidity and obligations: At September 30, cash was $0.1m, working capital $13.3m, and unused availability on the $30m Wells Fargo facility $10.2m. Facility borrowings were $19.3m, bearing a 4.25% stated rate at quarter-end; the facility matures November 13, 2014 and is secured by substantially all company assets. Capital lease obligations totaled approximately $4.1m. Redeemable preferred stock classified as liabilities totaled $117.2m, including accrued dividends. Total liabilities were $188.8m, and stockholders’ deficit was $93.7m.
Changes versus the prior comparable periods
- Revenue fell 26.4% in Q3 and 14.4% for the nine months. Management primarily attributed the decline to lower sales under the U.S. Air Force NETCENTS contract.
- Nine-month services revenue declined by $37.3m, partly offset by a $11.6m increase in product revenue. Product and service mix contributed to lower gross margins.
- Gross margin declined to 17.9% in Q3 and 16.9% year to date. Nine-month operating income fell 93.0% to $1.1m.
- Lower SG&A and interest expense partly offset the weaker operating results. Nine-month net income attributable to Telos declined despite a $7.4m tax benefit; the company recorded a pretax loss.
- Funded backlog rose to $129.3m from $105.5m at September 30, 2012, and from $99.1m at December 31, 2012.
Outlook, risks, and unusual items
- Management said available cash and facility borrowings should meet operating, debt-service, and projected capital-expenditure needs for the foreseeable future, while noting the continuing need for a similar credit facility. This outlook depends materially on maintaining borrowing availability, which fluctuates with the asset-based borrowing base and can be affected by collections, vendor terms, and collateral requirements.
- The period for awarding new task orders under NETCENTS ended September 30, 2013. Existing task orders, including exercisable options, are not affected. Management also cited sequestration-related uncertainty and potential delays in future government contract awards, particularly in Cyber Operations and Defense.
- The $4.4m quarterly and $7.4m year-to-date income tax benefits were primarily related to applying the estimated annual effective tax rate to year-to-date losses. The filing says this benefit is expected to offset fourth-quarter pretax income; it is not equivalent to operating cash generation.
- Preferred stock creates substantial cumulative obligations: public preferred stock carries a 12% cumulative dividend and senior redeemable preferred stock a 14.125% rate. Dividends and redemptions are restricted by the credit facility and other terms. The public preferred stock has not had dividends declared or paid since 1991, and scheduled redemptions were not met; it is classified as noncurrent.
- Two significant shareholder-related legal matters remain unresolved: Costa Brava litigation, with a motion to dismiss or otherwise dispose of derivative claims under briefing, and Hamot litigation, for which the trial decision was pending. Management said outcomes could not be reasonably determined.
- Management reported compliance with facility financial covenants at quarter-end. Disclosure controls were deemed effective, with no material change in internal control over financial reporting during the quarter. No material risk-factor changes were reported.
Important facts for investors to verify
- Whether post-September 30 NETCENTS work and other contract awards replace expiring task-order opportunities, and how sequestration affects awards and revenue timing.
- Whether lower margins and operating income persist, given the reported program and product mix changes.
- Borrowing-base availability, covenant compliance, and the company’s ability to renew or replace the facility before its November 2014 maturity.
- The timing and potential cash implications of cumulative preferred dividends, redemption obligations, and restrictions on payment.
- Developments and potential exposure in the pending Costa Brava and Hamot litigation.
- The filing contains differing figures for accumulated public preferred cash dividends in its discussion (including $83.5m and $82.5m); verify the correct amount against the company’s underlying disclosures. The reported carrying amount of public preferred stock was $115.3m.