TELOS CORPORATION — Q3 2014 Form 10-Q
Business context and period. Telos provides IT solutions and services to U.S. government and commercial customers through Cyber Operations and Defense, Secure Communications, and Telos ID. This unaudited report covers the three and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods. The company reports one operating segment.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $38.5 million | $49.3 million | $97.7 million | $152.1 million |
| Gross profit / margin | $7.5 million / 19.5% | $8.8 million / 17.9% | $19.4 million / 19.8% | $25.7 million / 16.9% |
| Operating income (loss) | $(2.2) million | $1.1 million | $(10.1) million | $1.1 million |
| Net income (loss), consolidated | $(0.3) million | $4.1 million | $(9.6) million | $4.5 million |
| Net income (loss) attributable to Telos | $(0.8) million | $3.7 million | $(10.7) million | $3.2 million |
| Interest expense | $1.4 million | $1.4 million | $4.0 million | $4.2 million |
Cash flow. Operating activities provided $8.3 million in the first nine months, compared with $3.5 million in 2013. The filing attributes the result partly to changes in operating assets and liabilities; it should not be read as a direct reflection of operating profitability. Investing activities used $0.5 million, and financing activities used $7.9 million. Cash declined $49,000 to $45,000.
Liquidity and obligations. At September 30, cash was $45,000, working capital was $2.9 million (down from $17.3 million at December 31, 2013), and unused availability under the asset-based Wells Fargo facility was $4.8 million. Facility borrowings totaled approximately $13.0 million; the facility rate was 4.25%. Capital lease obligations were $21.7 million. Redeemable preferred stock classified as liabilities totaled $121.1 million, bringing reported debt and long-term obligations to $154.1 million. Stockholders’ deficit was $110.0 million.
Changes versus the prior period
- Revenue fell 21.8% in Q3 and 35.8% year to date. The main driver was lower sales under the U.S. Air Force NETCENTS contract, especially secure-network services and resold products.
- Q3 SG&A rose 26.3% to $9.7 million; nine-month SG&A rose 19.4% to $29.4 million. Higher accrued bonuses, labor and other costs contributed. The resulting operating loss compared with operating income in 2013.
- Gross margin improved year to date despite lower gross profit, reflecting changes in solution mix. In Q3, product margin improved while services margin declined.
- Funded backlog was $84.8 million, down from $129.3 million a year earlier and $95.3 million at year-end 2013.
Outlook, risks, contingencies and unusual items
- Contracts and government spending: Telos was selected for the NETCENTS-2 replacement contract, but protests by other bidders led the Government Accountability Office to recommend that the Air Force reevaluate proposals. No delivery orders had been issued under Telos’s award as of the filing. The company said delays had shifted some government orders to contract vehicles where it was not a prime awardee. Sequestration and federal award timing remain uncertainties.
- Credit facility: The facility maturity was extended to November 13, 2015. The lender had waived or suspended EBITDA covenant testing for earlier 2014 quarters. A November 13, 2014 amendment also waived testing for the September quarter and adjusted the recurring-revenue covenant; the company stated it was in compliance as of September 30. Management believed available cash and facility borrowings would meet foreseeable needs, but said continued access to a similar facility is important.
- Preferred stock: Public preferred stock carries a cumulative 12% dividend and senior redeemable preferred stock a cumulative 14.125% dividend. Dividends remain unpaid and accrue; redemption and dividend payments are constrained by the credit facility and other restrictions. The company reported $87.3 million of accrued cash dividends on the public preferred stock and $1.5 million of unpaid senior preferred dividends.
- Taxes and unusual noncash expense: Income-tax benefits were $3.3 million for Q3 and $4.2 million year to date, materially offsetting pretax losses. Management said the estimated effective tax rate was affected primarily by noncash preferred-stock interest.
- Lease: The Ashburn headquarters arrangement became a capital lease in May 2014, adding a recorded asset and lease obligation. The company received $1.7 million for assigning the purchase option.
- Litigation: The filing reports ongoing Costa Brava/Wynnefield and Hamot litigation, with no material quarterly developments. Management said the probability of plaintiffs’ success in the former case could not be reasonably determined; ordinary-course litigation was not expected to have a material adverse effect.
- Management outlook: No specific revenue or earnings guidance is provided. Management cautioned that contract mix and timing make interim results potentially unrepresentative of full-year performance.
Important facts for investors to verify
- Current NETCENTS-2 protest and award status, and whether new delivery orders are being issued.
- Backlog conversion, customer collections, and the amount of borrowing availability under the receivables-based facility.
- Compliance with facility covenants and the status of the November 2014 amendment and 2015 maturity.
- Accumulation and potential payment or redemption obligations for preferred dividends and preferred stock.
- Whether operating cash generation is sustainable given the large contribution from changes in operating assets and liabilities.
- Developments in the disclosed litigation and any related financial exposure.