Telos Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Telos provides IT solutions and services to U.S. government and commercial customers, including cybersecurity, secure mobility, identity management, and enterprise IT. The company reports one operating segment.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $28.2m | $54.9m | $72.5m | $108.8m |
| Operating income (loss) | $(0.03)m | $2.9m | $(2.6)m | $4.2m |
| Net income (loss), consolidated | $(2.0)m | $1.3m | $(8.1)m | $(0.2)m |
| Net loss attributable to Telos | $(3.0)m | $(0.1)m | $(9.5)m | $(2.9)m |
| Interest expense | $1.7m | $1.4m | $5.0m | $4.1m |
Q3 gross margin increased to 32.8% from 26.4%; nine-month gross margin rose to 34.6% from 31.8%. The filing attributes the margin changes principally to contract and solution mix. SG&A was $9.3m in Q3 and $27.7m for the nine-month period.
For the nine months, operating cash flow was $(2.9)m, versus $14.2m provided in 2016; investing cash use was $1.6m and financing provided $4.1m. Cash was $0.3m at September 30, 2017, down from $0.7m at year-end 2016. Working capital was $(5.4)m, compared with $(8.6)m at year-end.
At September 30, assets totaled $67.1m and liabilities totaled $206.7m; stockholders’ deficit was $139.6m. Debt included a senior term loan with $10.7m net carrying value, subordinated debt of $2.2m, and capital lease obligations of $19.2m. Public preferred stock was recorded at $130.6m, and the company disclosed $98.8m of accrued cash dividends on that stock. The preferred stock accrues dividends at 12% annually; dividends have not been declared or paid since 1991.
Material changes and business developments
- Revenue fell 48.6% in Q3 and 33.4% for the first nine months. Services revenue was the largest driver of the decline, reflecting a prior-year contract delivery that did not recur and contracts Telos did not win on recompetition. Product revenue also declined.
- Funded backlog increased to $92.5m at September 30, 2017, from $75.4m a year earlier and $59.7m at December 31, 2016.
- Telos entered an $11m senior term-loan agreement with Enlightenment Capital in January 2017, maturing in January 2022, with a 13% accrual rate. The company reported $10.7m net carrying value at quarter-end. A revenue-covenant shortfall was waived by lenders; Telos said it was otherwise in compliance with the credit agreement’s financial covenants at September 30.
- In April, Telos redeemed all outstanding senior redeemable preferred stock for $2.1m and amended related-party subordinated notes, reducing the rate from 12% to 6% and extending maturity to July 2022. The amendment produced an approximately $1.0m gain on extinguishment recorded in stockholders’ deficit as a related-party capital transaction.
Outlook, liquidity, and risks
No numerical revenue or earnings guidance is provided. Management expected its EnCap, receivables-purchase, and Action Capital financing arrangements collectively to meet liquidity needs for the next 12 months, but gave no assurance. The company warned that losing or failing to renew comparable financing could materially harm liquidity and results. It also said spending on capital projects and indirect expenses could be curtailed or additional financing sought.
Telos had sold approximately $22.1m of receivables to RCA during the first nine months; the agreement allows up to $10m of purchased receivables outstanding at a time. The company had $5.5m of sold receivables outstanding and a related deferred purchase price of $0.8m at quarter-end. No borrowings were outstanding under the Action Capital facility.
- Federal funding uncertainty: fiscal 2018 appropriations had not been enacted; a continuing resolution funded government activities through December 8, 2017. Procurement delays, budget reductions, sequestration, or a failure to raise the debt ceiling could affect programs and results.
- Contract concentration and recompetes: management cited lost or unrepeated contracts as key revenue pressures. Government IDIQ contract vehicles do not guarantee orders, and orders and delivery timing vary.
- Legal matters: in the Hamot litigation, the court awarded Telos $278,923 on one counterclaim; Telos appealed, and the opposing parties cross-appealed. They separately demanded approximately $1.55m for legal fees and expenses; the board declined advancement or indemnification. The company said outcomes remained uncertain. A separate preferred-stockholder lawsuit also remained unresolved.
- Other notable items: management reported no goodwill impairment trigger during the quarter and no material change in risk factors from its 2016 Form 10-K. Disclosure controls were deemed effective, and no material change in internal control over financial reporting was reported.
Key facts for investors to verify
- Whether the higher funded backlog converts to orders and revenue, and whether replacement contracts offset lost or nonrecurring work.
- Cash availability, operating cash flow, receivables-factoring capacity, and the renewal or replacement of financing arrangements.
- Compliance with EnCap covenants and the status of the waived revenue covenant, given the company’s low cash balance and working-capital deficit.
- The terms, accumulated obligations, and legal restrictions relating to the $130.6m public preferred-stock liability and its accrued dividends.
- Developments in the Hamot appeals and other litigation, as well as federal appropriations and procurement timing.