Telos Corporation — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Telos provides software-based cybersecurity, cloud-security and enterprise-security products and services, with substantially all revenue from U.S. customers. It reports one operating segment.
Financial performance and position
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $47.4 | $45.5 | $135.0 | $112.7 |
| Gross profit / margin | $16.6 / 34.9% | $16.3 / 35.8% | $46.4 / 34.3% | $35.3 / 31.3% |
| Operating income / margin | $4.5 / 9.5% | $5.7 / 12.4% | $10.0 / 7.4% | $3.9 / 3.4% |
| Consolidated net income (loss) | $2.5 | $3.7 | $4.1 | $(1.2) |
| Net income (loss) attributable to Telos | $(0.2) | $2.2 | $(2.2) | $(2.9) |
| Telos basic and diluted EPS | $(0.01) | $0.06 | $(0.06) | $(0.08) |
- Revenue mix and drivers: Q3 services revenue rose to $44.2 million from $39.2 million, while product revenue declined to $3.3 million from $6.3 million. For the first nine months, services increased to $124.2 million from $101.6 million; products decreased to $10.8 million from $11.1 million.
- Profitability: Q3 operating income declined 20.5% as SG&A rose 13.3% to $12.0 million. Nine-month operating income increased 157.8%, primarily reflecting higher gross profit and improved gross margin. Interest expense was $2.0 million in Q3 and $6.0 million for nine months.
- Cash flow: Nine-month operating cash flow was $12.0 million, versus $4.4 million in 2019. Investing used $6.1 million, including $5.5 million of capitalized software development and $0.6 million of property and equipment purchases. Financing used $2.3 million, compared with $2.7 million provided in 2019. Cash increased to $10.3 million from $6.8 million at year-end 2019.
- Liquidity: Current assets were $46.1 million and current liabilities $57.4 million; reported working capital was negative $11.3 million, versus positive $2.9 million at year-end. Management attributed the deficit principally to classifying the EnCap loan as current because its then-current maturity was January 15, 2021.
- Debt and capital structure: The EnCap senior loan had $17.2 million principal including exit fee and a $16.9 million net carrying amount; it bears 13% annual interest and is secured by substantially all company assets. The company had $3.2 million subordinated debt and $16.0 million in finance lease obligations. Public preferred stock was recorded as a $142.1 million noncurrent liability; it carries a cumulative 12% annual dividend, with $110.2 million of cash dividends accrued since December 1995. Dividends and scheduled redemptions have not been paid as required, and financing restrictions limit payment.
Material changes and outlook
- Nine-month revenue grew 19.8%, led by services, particularly Telos ID. Q3 revenue grew 4.2%, but product sales and product gross margin fell; management cited lower proprietary software sales and changing program and delivery mix.
- Funded backlog was $147.0 million at September 30, 2020, up from $112.4 million at December 31, 2019. Total backlog was $374.6 million, versus $354.5 million at year-end. Management expected to recognize approximately 47.1% of remaining performance obligations in 2020 and 46.6% in 2021; backlog is not assurance of future revenue.
- No quantified full-year revenue or earnings guidance is provided. Management said EnCap financing, the receivables purchase arrangement and cash generated from operations were expected to meet operating, investing and financing needs for the next 12 months, while noting this expectation was not assured. The company had not yet exercised the loan-extension options; each quarterly extension increases the exit fee by $250,000.
- The company reported compliance with EnCap financial covenants at September 30, 2020. It said failure to extend, refinance or replace financing, or to maintain the RCA receivables arrangement, could materially harm liquidity and results.
- COVID-19 could disrupt customer demand, government funding priorities, suppliers, contract performance and margins, and limit access to capital. Federal budget uncertainty, continuing resolutions, government shutdowns, contract timing and government-spending seasonality are also risks.
- On October 5, 2020, Telos agreed to buy the remaining 50% of Telos ID, subject to successful completion of an initial public offering; absent the IPO, the purchase will not occur. On November 12, the company effected an approximately 0.794-for-1 reverse stock split, reflected retroactively in the reported share and per-share data.
- A pending claim by the Hamot estate and Andrew Siegel seeks $2.54 million in legal-fee indemnification. Telos disputes liability and intends to defend the claim; management said the outcome could not then be reasonably assessed. No goodwill impairment was recorded.
Investor verification priorities
- Confirm the status and terms of the EnCap maturity extensions, any refinancing, covenant compliance and the RCA receivables facility.
- Assess the quality and conversion of funded backlog, including renewal options and government funding, and whether service growth and margins persist.
- Reconcile consolidated earnings with the losses attributable to Telos, given Telos ID’s 50% non-controlling interest and its share of profits.
- Review the preferred stock’s cumulative dividend accrual, redemption restrictions and effect on the capital structure, alongside senior debt and lease obligations.
- Track the IPO-dependent Telos ID acquisition and the pending indemnification claim, including any material changes after the reporting date.