TELOS Corporation — Q2 2016 Form 10-Q
Business context and reporting period. Telos provides secure IT solutions and services to U.S. government and commercial customers through Cyber Operations and Defense, Identity Management, and IT & Enterprise Solutions. This unaudited filing covers the quarter and six months ended June 30, 2016; dollar amounts below are in millions unless stated otherwise. Telos reports as one operating segment.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $26.8 | $32.0 | $53.9 | $60.0 |
| Gross profit / margin | $9.5 / 35.2% | $7.2 / 22.4% | $20.0 / 37.2% | $13.9 / 23.3% |
| SG&A | $9.4 | $8.3 | $18.7 | $16.8 |
| Operating income (loss) | $0.1 | $(1.1) | $1.3 | $(2.8) |
| Net loss attributable to Telos | $(1.9) | $(2.4) | $(2.8) | $(5.2) |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $5.9 | $2.6 |
Q2 revenue fell 16.3%; first-half revenue fell 10.3%. Gross margin improved substantially, primarily from program and product mix, including improved product-reselling margins and a settlement on a prior-period loss contract. SG&A rose 13.2% in Q2 and 11.6% for the first half, largely due to labor and bonus costs. Interest expense was $1.4 million in Q2 and $2.8 million for the first half. Consolidated net loss was $1.3 million in Q2 and $1.5 million in the first half; Telos-attributable losses were higher because Telos ID income was allocated to its non-controlling investor.
For the six months, investing activities used $0.2 million and financing activities used $5.7 million. Cash declined $20,000 to $38,000. Operating cash flow benefited in part from changes in operating assets and liabilities and includes $1.9 million of noncash preferred-stock dividends recorded as interest expense.
Balance sheet, debt, and liquidity
At June 30, cash was $38,000, current assets were $28.7 million, and current liabilities were $33.5 million; reported working capital was negative $4.8 million, versus positive $1.1 million at year-end 2015. Accounts receivable were $17.9 million and inventory was $8.0 million. Total assets were $61.0 million, total liabilities $187.5 million, and total stockholders’ deficit $126.5 million.
Telos had $4.8 million outstanding on its Wells Fargo facility, including a $2.5 million term loan, and $2.5 million in subordinated Porter Notes bearing 12% interest and due July 1, 2017. Capital lease obligations totaled approximately $20.3 million. The facility had $6.0 million of unused availability at June 30; Telos reported compliance with its financial covenants. The facility was secured by substantially all assets. Cash on hand was minimal and liquidity depended heavily on financing and receivables collection.
Redeemable preferred stock carried a balance of $127.9 million, including accrued amounts, and bears cumulative dividends of 12% on the public preferred stock and 14.125% on senior preferred stock. Dividends and redemptions are restricted; $94.0 million of public preferred cash dividends and $1.6 million of senior preferred dividends were accrued. Telos has a full valuation allowance against deferred tax assets.
Changes, outlook, and risks
- Revenue drivers: Lower NETCENTS sales and the loss of a government-agency contract reduced revenue. The lost contract, which had generated more than $45 million in funded value over the prior three years and about 11% of 2015 revenue, ended May 22, 2016. Telos appealed the denial of its protest; the filing reports no ruling on its request for an injunction pending appeal.
- Backlog: Funded backlog was $75.4 million at June 30, 2016, up from $53.8 million a year earlier and $59.2 million at December 31, 2015. Backlog is not a guarantee of future revenue.
- Financing after quarter-end: On July 15, 2016, Telos repaid and terminated the Wells Fargo facility before maturity. RCA purchased eligible receivables under an agreement allowing up to $10 million outstanding, with initial purchase prices generally 90% for U.S. government receivables and 85% for other receivables, subject to fees and discounts. Action Capital agreed to provide advances of up to $2.5 million against acceptable accounts; the company said it began using that facility shortly after closing. These arrangements depend on receivable eligibility and lender discretion, and Action Capital advances are full recourse. Management expected available financing to meet needs for the next 12 months, but cautioned that loss of comparable financing could materially harm liquidity and results.
- Operating and funding risks: Management cited government budget and procurement delays, NETCENTS order variability, customer-payment timing, and dependence on continued financing. Telos may curtail capital spending and indirect expense growth if needed. No specific earnings or revenue guidance was provided.
- Contingencies and other items: Long-running Costa Brava/Wynnefield preferred-stock litigation and Hamot litigation continued, with no material quarterly developments; outcomes could not be reasonably predicted. The company said ordinary-course litigation was not expected to have a material adverse effect based on available information. On August 12, 2016, the board adopted a long-term incentive plan with 4.5 million shares available for issuance, creating potential dilution.
Important facts for investors to verify
- Whether RCA and Action Capital financing remains available on workable terms, and its actual cost, utilization, and effect on working capital.
- Receivables eligibility, collections, and any recourse or repurchase exposure under the financing agreements.
- Progress on the lost-contract appeal, replacement contract awards, NETCENTS-related activity, and conversion of funded backlog into revenue.
- The company’s ability to manage near-term liquidity alongside $2.5 million of Porter Notes due in 2017, lease obligations, and large cumulative preferred-stock claims.
- Developments in the preferred-stock litigation and potential dilution or compensation expense under the 2016 incentive plan.