Telos Corporation — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Telos provides cybersecurity, cloud security, and enterprise security products and services, with substantial exposure to U.S. federal customers.
Financial performance and liquidity
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $70.1M | $47.4M | $178.4M | $135.0M |
| Gross margin | 37.2% | 34.9% | 34.2% | 34.3% |
| Operating income (loss) | $(5.3)M | $4.5M | $(37.3)M | $10.0M |
| Net income (loss) attributable to Telos | $(5.4)M | $(0.2)M | $(38.9)M | $(2.2)M |
| Adjusted EBITDA (non-GAAP) | $8.4M | $5.8M | $14.1M | $14.0M |
Amounts are in U.S. dollars. Revenue increased 47.7% in Q3 and 32.1% for the nine-month period. Excluding the U.S. Census Bureau contract, which was winding down, management reported growth of 79.9% and 65.8%, respectively. Q3 gross margin improved, while nine-month gross margin was broadly flat.
- Revenue mix: Q3 Security Solutions revenue was $35.7M, up about 14.4%; Secure Networks was $34.4M, up about 112.3%, primarily from Department of Defense contracts. For nine months, Security Solutions declined about 3.0% to $89.7M, while Secure Networks rose about 108.7% to $88.7M.
- Expenses and earnings: SG&A rose to $31.3M in Q3 and $98.3M year to date. Management attributed much of the increase to stock-based compensation, which was $12.2M in Q3 and $47.2M year to date, compared with immaterial expense in the prior-year periods. This expense was a principal driver of the GAAP operating and net losses.
- Cash flow: Nine-month operating cash flow was $6.7M, down from $12.0M. Investing used $13.7M, including $5.9M for the DFT acquisition and $6.1M for capitalized software development. Financing provided $35.1M, mainly from the $64.3M follow-on offering, partly offset by $26.9M of warrant repurchases and $1.3M of share repurchases. Non-GAAP free cash flow was $1.3M versus $5.9M.
- Balance sheet: Cash was $134.1M at September 30, 2021, versus $106.0M at year-end 2020; working capital was $137.9M. Total assets were $242.7M and total liabilities $71.2M. The filing reports no outstanding term or subordinated borrowings; finance lease obligations totaled $14.6M, including current and long-term portions.
- Backlog: Funded remaining performance obligations were $163.4M, up from $127.7M at year-end. The company expected to recognize approximately 95% over the following 12 months.
Material changes, outlook, and risks
- The April 2021 follow-on offering raised $64.3M net for Telos. The company used proceeds, among other purposes, to repurchase EnCap warrants and shares. Weighted-average shares outstanding rose to 66.0M for the first nine months from 38.6M in the comparable 2020 period.
- In July, Telos acquired Diamond Fortress Technologies’ assets for $6.7M, including a $0.6M holdback payable after 18 months. The preliminary allocation included $5.0M of intangible assets and $1.7M of goodwill; purchase accounting may be adjusted during the measurement period.
- Management stated that available liquidity was expected to support operating, investing, and financing needs for the next 12 months. No numerical revenue or earnings guidance was provided.
- Management cited delayed FY2022 federal appropriations and the continuing resolution, then due to expire December 3, 2021, as potential constraints on new spending and contract starts. Federal contract concentration, contract timing and estimates, and the wind-down of the Census contract are relevant business risks.
- The filing discusses possible COVID-19 effects on customers, suppliers, performance, costs, and margins. Federal contractor vaccination requirements could also affect hiring, retention, subcontractors, and vendors.
- A $1.0M settlement payment in May resolved the disclosed Hamot/Siegel indemnification dispute. Management said other known litigation and government contract audits, investigations, modifications, and claims were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
- The company recorded a Q3 out-of-period correction that increased services revenue by $1.1M and reclassified $1.0M between services cost of sales and G&A. It said the error and current-period effect were not material.
Important facts for investors to verify
- Whether federal contract awards, funding, and delivery timing sustain the reported growth and funded backlog, particularly amid the continuing-resolution environment.
- How much of the GAAP loss reflects stock-based compensation and whether compensation expense, award vesting, and potential dilution evolve as expected.
- Whether operating cash flow and free cash flow improve, given working-capital movements and investment in software development.
- The final purchase-price allocation for DFT and the realization of expected benefits from the acquisition.
- Any material developments in contract claims, government audits, litigation, or workforce and supply-chain effects related to COVID-19 and federal contractor requirements.