Telos Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Telos provides IT solutions and services, primarily to U.S. government customers, and reports one operating segment. Figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Financial performance and condition
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $34.9m | $21.1m | $67.3m | $44.2m |
| Gross profit / margin | $12.1m / 34.6% | $7.4m / 35.0% | $22.3m / 33.1% | $15.8m / 35.8% |
| Operating income (loss) | $2.2m | $(1.4)m | $2.1m | $(2.6)m |
| Net income (loss), consolidated | $0.4m | $(3.2)m | $(1.3)m | $(6.1)m |
| Net loss attributable to Telos | $(0.1)m | $(3.4)m | $(2.1)m | $(6.5)m |
- Revenue and mix: Q2 revenue rose 65.6%; first-half revenue rose 52.3%. Services revenue was $30.9m in Q2 and $59.7m for the half; product revenue was $4.1m and $7.7m, respectively. Federal customers generated $62.6m, or the substantial majority, of first-half revenue.
- Margins and expenses: Q2 gross margin edged down 0.4 percentage points; first-half gross margin fell 2.7 points, reflecting program and delivery mix, including Secure Mobility work. SG&A rose 13.5% in Q2 and 9.7% for the half, slower than revenue growth.
- Interest and taxes: Interest expense was $1.7m in Q2 and $3.4m for the half. It includes accrued dividends on the 12% cumulative Public Preferred Stock. Income tax provisions were $0.006m and $0.065m, respectively; a full valuation allowance remains against deferred tax assets.
- Cash flow: First-half operating cash flow was $3.5m, versus $4.0m used in the prior-year period. Investing used $1.8m, principally software development and equipment; financing used $1.4m, including a $0.9m distribution to Telos ID’s non-controlling member. Cash increased to $0.9m from $0.6m at year-end.
- Liquidity: Current assets were $26.0m and current liabilities $27.1m, for negative working capital of approximately $1.2m, improved from negative $4.1m at year-end. Accounts receivable were $18.8m, down from $24.5m; inventories were $3.1m, down from $13.5m.
- Debt and preferred obligations: At June 30, the balance sheet showed $10.9m net senior term debt, $2.4m subordinated debt, and $18.5m capital lease obligations. Public Preferred Stock was reported as a $133.5m noncurrent liability; accumulated unpaid cash dividends were $101.6m. The preferred stock accrues dividends at 12% annually, and the company says contractual and legal restrictions prevent redemption and dividend payments under current conditions.
Material changes and business indicators
- Operating results improved substantially from 2017, moving from operating losses to operating income in both the quarter and first half; Telos nevertheless recorded a parent-attributable net loss in both 2018 periods.
- Growth was led by Secure Mobility, Identity Management, and Cyber Security deliverables. Management attributed weaker services margin to program mix and timing; stronger product margin reflected higher proprietary software sales.
- Total backlog was approximately $261.4m at June 30, up from $118.5m a year earlier and $256.3m at December 31, 2017. Funded backlog was $70.2m, down from $77.3m a year earlier and $98.5m at year-end. The filing says it expects to recognize approximately 62.1% of remaining performance obligations in 2018 and an additional 37.9% by 2020.
- Telos adopted ASC 606 on January 1, 2018 using the modified retrospective method. Adoption included a $3.8m cumulative adjustment to accumulated deficit for two term-license contracts and changed certain resold IT product arrangements from gross to net revenue presentation.
Outlook, risks, and unusual items
- Outlook: The filing provides backlog conversion expectations but no specific full-year revenue or earnings guidance. Management expected its EnCap, receivables-purchase, and Action Capital arrangements collectively to cover liquidity needs for the next 12 months, while stating this was not assured.
- Financing and covenants: The EnCap term loan matures January 2022 and carries a stated 13% annual accrual rate, subject to specified adjustments. A March 2018 amendment waived potential 2017 covenant non-compliance, reset 2018 covenant tests, added minimum-revenue and net-working-capital covenants, and increased the interest rate by one percentage point. Telos reported compliance at June 30. Action Capital borrowings were zero at that date; the agreement was extended through January 2, 2019 in August 2018.
- Liquidity exposure: Telos depends on continued availability of receivables financing and credit arrangements. It cautioned that failure to renew or replace these facilities could materially harm liquidity and operating results. Customer payment timing, receivable eligibility, collateral requirements, and access to additional financing are also risks.
- Government-market risks: Most revenue comes from federal customers. Management noted uncertainty about future federal spending and the possibility that programs could be modified, cut, or replaced; statutory defense spending limits remain relevant after FY 2019. Government contract awards, funding, renewals, and order timing may affect results and backlog conversion.
- Legal matters: The Costa Brava/Wynnefield preferred-stock litigation and Hamot/Siegel litigation remained pending; management said outcomes could not be reasonably determined. The filing states ordinary-course litigation was not expected, based on available information, to have a material adverse effect.
- Other accounting and operating risks: Contract profitability depends on estimates of costs to complete and may be revised through cumulative revenue adjustments. Management reported no goodwill impairment trigger during the quarter. It identified no material risk-factor changes from the 2017 Form 10-K.
Important facts for investors to verify
- Whether revenue growth and funded-backlog conversion continue, and how much of total backlog becomes funded, awarded, and recognized.
- Whether services gross margin stabilizes as Secure Mobility program mix and delivery timing change.
- Cash availability and working-capital trends, including continued access to EnCap, RCA, and Action Capital facilities and compliance with revised loan covenants.
- The full economic burden and restrictions associated with the $133.5m preferred-stock liability and $101.6m accrued preferred dividends.
- Progress and potential financial consequences of the pending litigation, and any changes in federal budgets, customer orders, or contract awards.