Telos Corporation — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. Although the request references 2013 Q4, this is an annual filing; selected fourth-quarter figures are noted below. The financial statements received an unqualified audit opinion from BDO USA, LLP. The auditor was not engaged to audit internal control over financial reporting.
Business context
Telos provides secure IT, communications, cyber-risk and identity-management solutions, primarily to U.S. government customers. Federal revenue was 98.3% of 2013 revenue. The company reports one financial-reporting segment and three business lines: Cyber Operations and Defense, Secure Communications, and Telos ID. Fixed-price contracts generated 84.1% of revenue.
Financial results and condition
- Revenue: $207.4 million, down 8.3% from $226.1 million in 2012. Services revenue fell 19.1% to $143.5 million; product revenue rose 30.9% to $63.9 million.
- Profitability: Gross profit was $38.6 million versus $54.8 million; gross margin declined to 18.6% from 24.2%. Operating income fell to $6.1 million from $17.7 million, with operating margin of 2.9% versus 7.8%. Net loss attributable to Telos was $2.6 million, compared with net income of $7.4 million.
- Cash flow: Operating cash flow was $4.8 million, down from $16.1 million. Investing activities used $0.5 million and financing activities used $4.4 million. Year-end cash was $94,000.
- Liquidity: Working capital was $17.3 million, up from $15.0 million. The $30 million asset-based revolving facility had $19.8 million outstanding and $9.2 million of unused availability at year-end; borrowings are secured by substantially all company assets.
- Debt and preferred obligations: Reported year-end debt and long-term obligations totaled $152.9 million, including $19.1 million of facility debt, $14.9 million of capital lease obligations, and $118.2 million of redeemable preferred stock classified as a liability. Total stockholders’ deficit was $99.4 million. Public preferred stock carried at $116.3 million had an estimated market value of $48.9 million.
- Backlog: Funded backlog was $95.3 million, compared with $99.1 million a year earlier.
Material changes and unusual items
- The sales decline was attributed principally to lower activity under the U.S. Air Force NETCENTS contract. The period for awarding new NETCENTS task orders ended September 30, 2013; existing task orders, including certain option years, were not affected.
- Management increased resale-product sales to help offset sequestration-related effects. It described this as temporary and inconsistent with its longer-term emphasis on solutions and services. The product-heavy mix and lower proprietary software sales contributed to weaker gross margin.
- 2012 results included a $5.2 million gain from early extinguishment of the IT Logistics note; this gain did not recur in 2013.
- For Q4 2013, revenue was $55.3 million and gross profit was $12.9 million. Telos reported pretax income of $3.7 million but a $5.8 million net loss attributable to Telos; the filing attributes a $9.1 million income-tax provision to the quarter.
Outlook, risks and contingencies
- Management said available cash and facility borrowings should be adequate for foreseeable operating, debt-service and capital-expenditure needs, and anticipated approximately $1.2 million of 2014 capital expenditures. No revenue or earnings guidance was provided.
- On March 27, 2014, after year-end, Wells Fargo extended the facility maturity to November 13, 2015 and waived certain existing defaults, including failure to meet required EBITDA covenants. The amendment increased term-loan installments to $250,000 quarterly beginning July 1, 2014; the remaining balance is due at maturity. The company paid a $75,000 fee plus expenses.
- Liquidity depends heavily on the borrowing base and continued access to the revolving facility. Government budget decisions, contract funding and termination rights, customer concentration, competitive bidding, contract mix, vendor performance, cybersecurity threats and retention of cleared personnel are key risks.
- Cumulative preferred dividends and redemption restrictions are significant: public preferred stock accrues at 12% annually and senior preferred stock at 14.125%. Dividends have not been paid on the public preferred stock since 1991; facility restrictions limit redemptions and distributions.
- Two long-running shareholder/director disputes remained unresolved. Management said the likelihood and potential outcome could not be reasonably determined; the Costa Brava matter had a hearing scheduled for April 24, 2014, and a separate directors’ case was awaiting a court decision. Other ordinary-course litigation was not expected by management to have a material adverse effect.
Most important facts for investors to verify
- Current facility availability, covenant compliance, borrowing-base headroom and the effect of the March 2014 waiver and maturity extension.
- Whether NETCENTS-related revenue declines continue, and how replacement awards affect funded backlog, revenue and margins.
- Receivable collection trends: accounts receivable rose to $45.6 million, including $16.5 million unbilled, while 95% of billed receivables were from U.S. government customers.
- The terms, accrued dividends, redemption restrictions and priority of the $118.2 million preferred-stock obligations, as well as the company’s substantial stockholders’ deficit.
- Developments and potential financial effects of the pending litigation; the filing does not provide a clear estimate of possible loss.