Telos Corporation — Q3 2018 Form 10-Q
Business context and period. Telos provides IT solutions and services, primarily to U.S. government customers. This unaudited report covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. The company reports one operating segment.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $34.7 million | $28.2 million | $102.0 million | $72.5 million |
| Gross profit / margin | $16.3 million / 46.9% | $9.3 million / 32.8% | $38.6 million / 37.8% | $25.1 million / 34.6% |
| Operating income (loss) | $6.4 million | $(0.03) million | $8.6 million | $(2.6) million |
| Net income (loss), consolidated | $4.8 million | $(2.0) million | $3.5 million | $(8.1) million |
| Net income (loss) attributable to Telos | $4.1 million | $(3.0) million | $2.0 million | $(9.5) million |
For Q3, services revenue was $32.1 million and product revenue $2.6 million; for the nine months, services revenue was $91.7 million and product revenue $10.3 million. Federal customers accounted for $95.4 million, or most, of nine-month revenue. Operating margin was 18.5% in Q3 and 8.4% for the nine months, versus a loss in both 2017 comparison periods.
- Cash flow: Nine-month operating cash flow was $4.5 million, compared with cash used of $2.9 million in 2017. Investing used $2.8 million, including $1.3 million of capitalized software development and $1.5 million of property and equipment purchases. Financing used $1.9 million. Cash declined $0.2 million to $0.4 million.
- Liquidity: At September 30, current assets were $38.1 million and current liabilities $34.1 million; reported working capital was $4.0 million, versus a $4.1 million deficit at year-end 2017. Accounts receivable was $26.3 million, including $16.1 million unbilled.
- Debt and obligations: Balance-sheet carrying amounts included a $10.9 million senior term loan, $2.5 million subordinated debt and $18.2 million of capital lease obligations. Public preferred stock was classified as a $134.4 million noncurrent liability; accrued cumulative cash dividends were $102.6 million. The preferred stock accrues dividends at 12% annually. Interest expense was $5.1 million for the nine months.
Material changes versus prior period
- Nine-month revenue increased 40.8%; Q3 revenue increased 22.8%. Growth was driven primarily by services, while product revenue declined in both comparisons.
- Profitability improved substantially, with higher gross profit and lower cost of sales as a share of revenue. Management cited a more favorable solution mix and increased proprietary software sales.
- Revenue included a $5.6 million cumulative catch-up from indirect-rate adjustments on completed government contracts, following DCAA rate agreements and contract submissions covering 2011–2015. Management said these accruals had no related direct costs in the cited Secure Mobility deliverables.
- On adopting ASC 606, Telos recorded a $3.9 million cumulative adjustment reducing accumulated deficit and contract liabilities. Some resold-product arrangements are now reported net rather than gross; prior periods were not recast.
Outlook, commentary and risks
- Management said financing arrangements with EnCap, RCA and Action Capital, together with operating cash generation, were expected to meet operating, investing and financing needs for the next 12 months, while cautioning that there was no assurance. The company depends on continued availability of receivables-purchase and financing arrangements; loss of comparable facilities could materially harm liquidity.
- Funded backlog was $91.1 million at September 30, 2018, versus $92.5 million a year earlier. Total backlog was approximately $303.9 million, but includes potential future orders and renewal options that may not be exercised. Remaining performance obligations were $91.1 million; Telos expected to recognize about 41.8% in 2018 and a further 56.4% by 2020.
- Telos reported compliance with EnCap financial covenants at quarter-end. A March 2018 amendment reset covenants, added minimum-revenue and net-working-capital covenants, and increased the loan rate by 1% until specified performance is achieved.
- Management cited uncertainty in future federal spending: FY2019 appropriations were enacted, but a continuing resolution funded other government agencies through December 7, 2018, and statutory spending limits could constrain FY2020–2021 defense budgets.
- Two longstanding matters remain pending: Costa Brava/Wynnefield litigation involving preferred-stock holders, and Hamot litigation, including an appeal and a pending request concerning advancement fees and expenses. Management said outcomes could not be reasonably determined. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether the $5.6 million indirect-rate revenue adjustment is collectible, and how much it contributed to reported margins and earnings.
- Cash conversion and working-capital needs, particularly unbilled receivables, customer-payment timing and reliance on receivables financing.
- Availability and renewal terms of the RCA and Action Capital facilities; Action Capital had no borrowings outstanding at quarter-end, and its extension ran through January 2, 2019.
- The full economic burden and restrictions associated with the 12% cumulative public preferred stock, including accrued dividends, missed scheduled redemptions and limits on payment or redemption.
- Backlog quality and conversion: total backlog includes unfunded work and optional orders, while funded backlog was lower than a year earlier.
- Developments in the pending litigation and any effects on cash needs or operations.