Business context and reporting period
Telos Corporation filed this unaudited Form 10-Q for the quarter ended March 31, 2012. The company provides IT solutions and services, primarily to U.S. government customers, across Cyber Operations and Defense, Secure Communications, and Identity Management. It reported one operating segment. In Q1 2012, it merged its Secure Networks and Information Assurance solution areas.
Key financial metrics
Amounts are in millions of dollars unless noted. Comparisons are with the three months ended March 31, 2011.
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Revenue | $54.4 | $48.0 |
| Services revenue | $47.4 | $32.2 |
| Products revenue | $7.0 | $15.8 |
| Gross profit / margin | $14.1 / 25.8% | $11.9 / 24.8% |
| Operating income / margin | $5.5 / 10.1% | $4.1 / 8.5% |
| Interest expense | $1.8 | $1.5 |
| Income before taxes | $3.7 | $2.6 |
| Net income | $2.0 | $1.3 |
| Net income attributable to Telos | $1.8 | $1.1 |
| Operating cash flow | $2.1 | $7.6 |
At March 31, 2012, cash was $0.4 million, working capital was $17.9 million, total assets were $96.2 million, and stockholders’ deficit was $102.8 million. The filing reports debt and long-term obligations of $151.6 million, including $16.7 million under the Wells Fargo facility, $12.2 million in ITL notes, $4.7 million in capital leases, and $117.9 million in redeemable preferred stock classified as a liability. Facility borrowings were $17.1 million, with $12.2 million of unused availability. The facility interest rate was 4.25% at quarter-end.
Material changes versus the prior comparable period
- Revenue rose 13.4%, principally from a $6.9 million increase in U.S. Air Force NETCENTS sales. Services revenue increased substantially, while product revenue fell $8.8 million, primarily reflecting lower sales of Telos-manufactured technology solutions under NETCENTS.
- Gross margin improved by 1.0 percentage point, and operating income increased 35.4%, aided by a more favorable services and program mix. Product gross margin declined to 17.2% from 21.3%.
- SG&A rose 9.1% to $8.5 million, including higher intangible-asset amortization and legal fees. Interest expense increased 23.9%, primarily due to accretion of ITL notes and higher facility interest expense.
- Operating cash flow fell to $2.1 million from $7.6 million, largely reflecting changes in operating assets and liabilities. Cash increased by $0.2 million during the quarter, to $0.4 million.
- Total backlog declined to $604.1 million from $629.3 million a year earlier and $609.6 million at year-end 2011. Funded backlog was $111.7 million, down from $121.0 million a year earlier and $124.2 million at year-end.
Outlook, risks, contingencies, and unusual items
- Management said available cash and facility borrowings should be sufficient for operating expenses, debt service, and projected capital expenditures for the foreseeable future, while noting continued reliance on a credit facility. No numerical earnings or revenue guidance was provided.
- Liquidity depends materially on availability under the asset-based revolving facility, which is secured by substantially all company assets and subject to borrowing-base limits and financial covenants. Telos reported compliance with covenants at March 31, 2012.
- Both preferred-stock classes carry cumulative dividends—14.125% on senior redeemable preferred and 12% on public preferred. Dividends and redemptions are restricted; accrued preferred dividends were included in interest expense. The public preferred liability was $109.6 million, with $77.7 million in accrued cash dividends. The company reported a substantial stockholders’ deficit.
- On May 11, 2012, the facility was amended to permit, subject to conditions, up to $4.0 million of senior preferred-stock redemptions at a discount. As of the filing, Telos said it intended to redeem shares for $2.0 million on or about May 18, 2012; this was a stated intention, not a completed quarter-end transaction.
- The IT Logistics acquisition included a $15 million subordinated note, carried at $12.2 million at quarter-end, with 6% interest beginning November 1, 2012 and payment scheduled for 2041, subject to change-of-control provisions.
- Two previously disclosed lawsuits—Costa Brava Partnership III v. Telos and Hamot et al. v. Telos—had no material developments during the quarter. Management said ordinary-course litigation was not expected to have a material adverse effect, while acknowledging outcomes cannot be predicted with certainty.
- Federal contract timing and customer/solution mix can make quarterly results variable. The filing also identifies interest-rate exposure on variable-rate facility debt. Management reported no material first-quarter changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether the May 2012 preferred-stock redemption was completed, on what terms, and how it affected cash, accrued dividends, and facility availability.
- Whether operating cash conversion improves and receivables, vendor payments, and inventory remain manageable, given low cash and the company’s reliance on its borrowing base.
- Trends in NETCENTS orders, funded backlog, and the shift between services and product revenue, including the resulting margin mix.
- The full economics and repayment assumptions for ITL acquisition notes, alongside the sizeable cumulative preferred dividends and other senior obligations.
- The status and potential financial impact of the Costa Brava and Hamot litigation, and continued compliance with facility covenants.
- The filing says Telos-attributable net income increased 67.3%; the displayed figures of $1.803 million and $1.116 million imply approximately 61.6%. Verify the growth rate against the underlying unrounded amounts.