Telos Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Telos provides IT solutions and services to U.S. government and commercial customers through Cyber Operations and Defense, Secure Communications, and Telos ID. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $55.2 | $56.3 | $102.8 | $110.8 |
| Gross profit / margin | $8.9 / 16.1% | $14.6 / 25.9% | $16.9 / 16.4% | $28.7 / 25.9% |
| Operating income (loss) | $0.6 | $5.8 | $(0.02) | $11.3 |
| Net income (loss) attributable to Telos | $0.5 | $2.0 | $(0.5) | $3.8 |
| Operating cash flow | Not separately presented | Not separately presented | $8.3 | $5.8 |
Q2 revenue declined 2.0%; service revenue fell to $35.3 million from $47.3 million, while product revenue rose to $19.9 million from $9.1 million. For the first half, revenue declined 7.2%, reflecting lower services revenue partly offset by higher product resales. Management attributed the shifts mainly to lower and variable sales under the U.S. Air Force NETCENTS contract and changes in solution and delivery mix. Higher-margin services and proprietary software were replaced in part by lower-margin resold products, driving the decline in gross margin and operating income. SG&A was $8.2 million in Q2, down from $8.8 million.
Q2 consolidated net income included a $1.6 million income tax benefit despite a $0.5 million pretax loss; the first-half tax benefit was $3.0 million. The filing attributes the interim tax results partly to the estimated annual effective tax rate and noncash preferred-stock interest. Preferred-stock dividends are reported as interest expense.
Cash, debt, and liquidity
- Cash was $0.094 million at June 30, 2013, versus $0.229 million at year-end 2012. First-half operating cash flow of $8.3 million was more than offset by $8.0 million of financing outflows and $0.4 million of capital spending; cash declined $0.135 million.
- Working capital was $7.3 million, down from $15.0 million at December 31, 2012. Current assets were $43.3 million and current liabilities $36.1 million.
- Borrowings under the Wells Fargo facility totaled $13.6 million, with $7.0 million of unused availability; the facility rate was 4.25% at quarter-end. The facility is secured by substantially all company assets and is a key source of liquidity. Telos reported compliance with its financial covenants at June 30.
- Total debt and long-term obligations were reported as $132.6 million, including $13.2 million under the facility, $3.1 million in capital leases, and $116.2 million of redeemable preferred stock classified as a liability. The company had a stockholders’ deficit of $97.2 million.
- The 12% Public Preferred Stock carries substantial cumulative unpaid dividends; accrued cash dividends were $82.5 million. Dividends and redemptions are restricted by financing terms and other constraints. Senior preferred stock carries a 14.125% cumulative rate; $2.0 million was redeemed in June at a discount, generating an approximately $0.2 million gain.
Outlook, risks, and unusual items
- Management said available cash and facility borrowings should support operating needs, debt service, and projected capital spending for the foreseeable future, while noting continued reliance on a credit facility. This is management’s expectation, not formal earnings guidance.
- Total backlog was $133.6 million at June 30, 2013, compared with $578.0 million a year earlier and $581.3 million at year-end 2012. Funded backlog was $98.1 million, versus $90.1 million a year earlier. The filing does not clearly explain the sharp reduction in reported total backlog.
- On July 31, 2013, after quarter-end, the Wells Fargo facility maturity was extended to November 13, 2014. The facility’s borrowing base, covenant requirements, and dependence on customer collections remain important liquidity considerations.
- Two significant shareholder-related legal matters remained unresolved. The company said outcomes could not be reasonably determined; it denies the allegations and is defending the cases. Management said ordinary-course litigation was not expected to have a material adverse effect based on information available.
- The company reported no material changes to the risk factors in its 2012 Form 10-K. Quarterly results may vary with contract timing and product/service mix. No goodwill or intangible-asset impairment was recorded through June 30.
Most important facts for investors to verify
- Whether NETCENTS and other government-contract activity can recover, and whether the shift toward lower-margin product resales persists.
- What caused the large decline in total backlog, how much of reported backlog is funded, and how quickly funded backlog converts to revenue.
- Facility availability, borrowing-base capacity, covenant compliance, and the implications of the maturity extension through November 2014.
- The terms, accumulated dividends, restrictions, and potential claims associated with the $116.2 million of redeemable preferred stock and the company’s substantial stockholders’ deficit.
- Developments and potential financial consequences in the Costa Brava and Hamot litigation.