TELOS Corporation — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Telos provides IT solutions and services to U.S. government and commercial customers through Cyber Operations and Defense, Secure Communications, and Telos ID. Results are consolidated, including Telos ID, which Telos controls despite 50% ownership.
Financial results
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $33.7M | $38.5M | $93.7M | $97.7M |
| Gross profit / margin | $8.7M / 25.8% | $7.5M / 19.5% | $22.6M / 24.1% | $19.3M / 19.8% |
| Operating income (loss) | $0.5M | $(2.2)M | $(2.4)M | $(10.1)M |
| Net loss attributable to Telos | $(1.4)M | $(0.8)M | $(6.6)M | $(10.7)M |
| Operating cash flow | Not separately presented for the quarter | $4.0M | $8.3M |
Q3 services revenue fell to $23.9M from $29.2M, while product revenue rose to $9.8M from $9.3M. For the first nine months, services revenue was $74.2M and product revenue $19.5M. SG&A was $8.2M in Q3 and $25.0M year to date, down from $9.7M and $29.4M, respectively. Interest expense was $1.4M for Q3 and $4.2M for nine months. Income tax benefits were $0.6M and $1.8M, respectively.
The Q3 consolidated net loss was $0.3M, but $1.1M of net income was attributable to the Telos ID noncontrolling owner, producing a $1.4M loss attributable to Telos. The comparable Q3 amounts were a $0.3M consolidated loss, $0.5M attributable to the noncontrolling owner, and a $0.8M Telos loss.
Liquidity, debt and financial position
- At September 30, cash was only $34,000; working capital was $3.3M, versus $4.2M at December 31, 2014. Operating cash flow of $4.0M was down from $8.3M year over year. Investing used $0.3M and financing used $3.7M. Cash increased by just $2,000 over the nine-month period.
- Wells Fargo facility borrowings were $8.5M, including $3.6M of term debt; unused availability was $6.2M. The facility was secured by substantially all company assets, had a 4.25% stated rate at quarter-end, and was subject to EBITDA, recurring-revenue, capital-expenditure and minimum-availability covenants.
- Telos borrowed $2.5M through unsecured, subordinated related-party Porter Notes at 12% interest, due July 1, 2017. Capital lease obligations totaled $20.9M.
- Redeemable preferred stock carried at $125.0M is classified as noncurrent liabilities: approximately $123.0M of public preferred stock and $2.0M of senior preferred stock. The public preferred stock accrues cumulative dividends at 12%; senior preferred accrues at 14.125%. Dividends and redemptions are restricted, and the public preferred stock’s scheduled redemptions have not been met.
- Total liabilities were $185.2M, total assets $70.6M, and total stockholders’ deficit $114.6M. The public preferred stock’s estimated fair value was $35.0M, compared with its $123.0M carrying value.
Changes, outlook and key risks
- Revenue declined 12.6% in Q3 and 4.0% for the first nine months. Gross margin improved in both periods, principally from contract and solution mix; lower SG&A also narrowed the operating loss. Nine-month Telos-attributable loss improved, while Q3 attributable loss worsened, partly because Telos ID’s noncontrolling owner received a larger share of subsidiary earnings.
- Funded backlog was $65.6M, down from $84.8M a year earlier and $68.3M at year-end 2014. Management cautioned that contract timing and solution mix make interim results variable.
- Telos said delays in the NETCENTS-2 procurement and government funding issues had shifted orders to other contract vehicles and pressured revenue and margins. Telos was selected for NETCENTS-2 in April 2015 after reevaluation, but the filing does not quantify the timing or value of future orders.
- On August 31, Telos was notified it had not won a Secure Communications contract with more than $45M in funded value over the prior three years; the contract represented approximately 11% of 2015 revenue. Telos protested the award and continued to perform under the existing contract, then scheduled to end November 22, 2015, with an option through January 22, 2016. The company warned that losing the work could materially affect future results.
- Management said existing borrowing capacity, together with the 2014 Telos ID interest sale and 2015 Porter Notes, should fund foreseeable needs, and expected covenant compliance. However, liquidity depends heavily on the asset-based credit facility and its availability, collections, covenants and renewal. On November 17, 2015, after quarter-end, Wells Fargo extended facility maturity to October 1, 2016 and reset the September 30 EBITDA covenant to reflect revised operating estimates.
- Two longstanding preferred-stockholder-related legal proceedings had no material developments during Q3; the company said outcomes could not be reasonably determined. Management reported effective disclosure controls and no material change in internal control over financial reporting. No material Q3 changes to previously disclosed risk factors were reported.
Most important facts to verify
- Facility covenant compliance, the effect of the post-quarter covenant reset, maturity extension, and actual borrowing availability.
- Outcome of the Secure Communications contract protest, any extension of existing performance, and resulting revenue or backlog impact.
- Backlog conversion and timing of NETCENTS-2 orders amid government funding and procurement uncertainty.
- Cash generation and working-capital needs, given $34,000 of cash and reliance on the secured credit facility.
- Accumulation and payment restrictions on preferred dividends and the large preferred-stock liability, as well as potential outcomes of the pending litigation.