TELOS Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Telos provides IT solutions and services, principally to U.S. government customers, and reports one operating segment. Unless otherwise stated, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $45.5 | $34.7 | $112.7 | $102.0 |
| Gross profit / margin | $16.3 / 35.8% | $16.3 / 46.9% | $35.3 / 31.3% | $38.6 / 37.8% |
| Operating income | $5.7 | $6.4 | $3.9 | $8.6 |
| Net income (loss), consolidated | $3.7 | $4.8 | $(1.2) | $3.5 |
| Net income (loss) attributable to Telos | $2.2 | $4.1 | $(2.9) | $2.0 |
| Interest expense | $2.0 | $1.7 | $5.5 | $5.1 |
Q3 revenue grew 31.2%, led by services and product sales; gross profit was essentially flat as cost of sales rose faster than revenue. Nine-month revenue increased 10.5%, but gross profit fell 8.5% and operating income declined 54.8%. The company attributed margin pressure primarily to program mix and timing, including the prior-year recognition of $5.6 million of cumulative indirect-rate adjustments that did not recur in 2019. Higher interest expense also weighed on earnings.
Cash flow, liquidity and capital structure
- Nine-month operating cash flow was $4.4 million, compared with $4.5 million in 2018. Investing used $5.3 million, including $3.1 million for property and equipment and $2.2 million of capitalized software development. Financing provided $2.7 million, including $4.9 million of term-loan proceeds.
- Cash was $1.8 million at September 30, 2019, versus $0.1 million at year-end 2018. Working capital was $3.9 million, up from $2.1 million.
- Senior term-loan carrying value, net of discounts and costs, was $16.1 million; subordinated debt was $2.8 million. Finance lease obligations totaled $17.2 million, current and long-term combined.
- In July 2019, Telos borrowed an additional $5 million under its EnCap facility, increasing principal to $16 million and moving maturity forward to January 15, 2021. The loan bears a high interest rate (13% base accrual rate, subject to specified terms), is secured by substantially all company assets, and has financial covenants. Telos reported compliance at September 30, based on agreed covenant inputs.
- Public preferred stock was recorded as a $138.3 million long-term liability. It accrues cumulative dividends at 12% annually; $106.4 million of cash dividends had accrued as of September 30. The company states it has been unable to meet the preferred-stock redemption schedule and that financing restrictions prevent dividends or redemptions under current circumstances.
Business developments, outlook and risks
- Federal revenue was $42.7 million in Q3 and $105.5 million year to date; substantially all revenue came from U.S. customers. Firm-fixed-price revenue rose substantially year over year, while time-and-materials and cost-plus revenue declined.
- Total backlog was $307.5 million at September 30, 2019, versus $303.9 million a year earlier. Funded backlog was $104.0 million, versus $91.1 million. Management expected to recognize about 52.4% of remaining performance obligations in 2019 and 46.8% in 2020; backlog timing and realization are not assured.
- Management said EnCap and the accounts-receivable purchase arrangement with Republic Capital Access (RCA), together with operating cash generation, were expected to meet liquidity needs for the next 12 months, but gave no assurance. RCA may decline to purchase eligible receivables; failure to renew or replace the arrangement could materially harm liquidity. The arrangement was extended through June 30, 2020.
- Federal fiscal 2020 appropriations had not been enacted; a continuing resolution funded agencies through November 21, 2019. Management warned that a shutdown or funding delays could delay procurement and affect results. The 2019 Bipartisan Budget Act raised defense and non-defense spending limits for fiscal 2020 and 2021, though future program changes and funding debates remain risks.
- Two longstanding matters remain disclosed: preferred-stockholder litigation against Telos and certain directors/officers, with outcome not reasonably estimable; and a dispute involving indemnification costs in Hamot et al. v. Telos. The company reported no material developments in the first matter during the quarter and said the indemnification outcome could not be reasonably determined.
- Telos adopted lease accounting on January 1, 2019, recognizing approximately $2.0 million of right-of-use assets and lease liabilities; management said adoption did not materially affect operating results or cash flows. No material changes to risk factors were reported.
Investor verification priorities
- Review the July 2019 EnCap amendment, including the January 2021 maturity, pricing, exit fee, collateral, covenants and covenant-compliance basis.
- Assess near-term liquidity and reliance on RCA receivables purchases, customer collections, and the company’s low cash balance.
- Track gross-margin recovery and the mix, cost estimates, and timing of firm-fixed-price programs; compare results with the prior-year indirect-rate adjustment benefit.
- Verify funded backlog conversion and federal contract funding, especially after the continuing resolution’s November 21, 2019 expiration.
- Understand the cumulative preferred-stock dividend and redemption obligation, financing restrictions, and potential legal outcomes or indemnification exposure.