Telos Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Telos provides IT solutions and services, primarily to U.S. government customers, across cyber operations and defense, identity management, and IT and enterprise solutions. The company reports one operating segment.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Revenue | $32.4 million | $23.1 million; up 40.2% |
| Services revenue | $28.8 million | $19.7 million |
| Product revenue | $3.6 million | $3.4 million |
| Gross profit and margin | $10.2 million; 31.6% | $8.4 million; 36.5% |
| Operating loss | $22,000 | $1.2 million |
| Net loss attributable to Telos | $2.0 million | $3.1 million |
| Operating cash flow | $0.8 million provided | $6.2 million used |
- Services gross margin declined to 28.7% from 33.9%, mainly due to program mix and timing of Secure Mobility deliverables. Product gross margin rose to 54.4% from 51.8%.
- Cash was $47,000 at quarter-end, down from $600,000 at December 31, 2017. Current assets of $40.4 million were below current liabilities of $42.0 million; working capital was negative $1.6 million, improved from negative $4.1 million at year-end.
- Accounts receivable increased to $30.0 million from $24.5 million; inventory declined to $4.9 million from $13.5 million. Investing activities used $1.1 million, chiefly for property and equipment and capitalized software development. Financing activities used $0.2 million.
- Recorded debt included a senior term loan, net, of $10.8 million; subordinated debt of $2.4 million; and capital lease obligations of $18.8 million, including current obligations. Public preferred stock was recorded as a $132.5 million noncurrent liability. Telos also reported a $100.7 million accrued cash-dividend obligation on that preferred stock.
Changes and notable items
- Revenue rose primarily from higher Secure Mobility, Identity Management, and Cyber Security services and software deliverables. SG&A increased 6.3% to $10.3 million, while interest expense increased 4.0% to $1.7 million.
- Telos adopted ASC 606 on January 1, 2018 using the modified retrospective method. Adoption resulted in a $3.8 million cumulative adjustment to accumulated deficit and contract liabilities for two term-license contracts. Certain resold-product arrangements now receive net rather than gross revenue presentation; prior-period results were not recast.
- On March 30, the EnCap loan amendment waived potential 2017 covenant noncompliance, reset 2018 covenant measurements, added minimum-revenue and net-working-capital covenants, and increased the interest rate by one percentage point. The increase can revert after two consecutive quarters meeting a specified fixed-charge coverage ratio. Telos reported compliance with financial covenants at March 31.
- Funded backlog was $85.5 million, with management expecting to recognize approximately 81.6% as revenue in 2018 and 18.3% by 2020. Total backlog was $284.4 million, including potential future orders and options; timing and customer funding are not assured.
Outlook, risks and contingencies
- No specific company revenue or earnings guidance was provided. Management expected EnCap, receivables-purchase, and Action Capital arrangements collectively to meet operating, investing, and financing needs for the next 12 months, while cautioning that this was not assured.
- Liquidity is sensitive to receivable eligibility and collection timing, vendor terms, collateral needs, and continued access to financing. Loss or nonrenewal of financing arrangements could materially harm liquidity. Management may curtail capital spending or seek commercial-bank financing, with no assurance of acceptable terms. Action Capital had no outstanding borrowings at quarter-end; the receivables-purchase agreement was extended through June 30, 2020.
- Telos cited continued uncertainty over federal spending and the possibility of program changes or cuts. FY2020 and FY2021 defense spending remains subject to statutory limits, creating potential sequestration risk.
- Two longstanding legal matters remain unresolved: the Costa Brava/Wynnefield preferred-stock litigation and Hamot et al. litigation. Management said the probability of outcomes could not be reasonably determined; ordinary-course litigation was not expected to have a material adverse effect based on available information.
- Public preferred dividends have not been paid since 1991 and continue to accrue; redemption and dividend payments are restricted by financing terms and legal limitations. The filing reported no material change to previously disclosed risk factors. Management concluded disclosure controls were effective.
Investor verification points
- Confirm cash conversion and working-capital trends, particularly collections on the increased receivables balance and the sustainability of the sharp inventory reduction.
- Review the amended EnCap covenants, the loan’s effective interest rate and compliance headroom, and continued availability of receivables financing.
- Assess the quality and timing of funded backlog separately from total backlog, which includes unfunded opportunities and options.
- Evaluate the lower services gross margin and whether program mix and delivery timing continue to pressure profitability.
- Track the cumulative preferred-stock obligation, restrictions on redemption and dividends, and developments in the pending litigation.