TELOS CORPORATION — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Telos provides IT products and services, principally to U.S. government customers. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $53.0 | $57.6 | $142.1 | $174.6 |
| Operating income | $2.7 | $6.6 | $10.1 | $10.7 |
| Net income | $1.2 | $2.1 | $3.7 | $2.6 |
| Net income attributable to Telos | $0.084 | $1.6 | $2.0 | $1.9 |
| Operating margin | 5.0% | 11.4% | 7.1% | 6.2% |
- Q3 gross profit was $11.7 million and gross margin was 22.1%, down from $15.3 million and 26.5%. Nine-month gross profit was $34.9 million in both years, while gross margin improved to 24.6% from 20.0% as product sales declined and the revenue mix shifted.
- Product revenue fell 16.3% in Q3 and 38.7% for the nine months; services revenue was approximately flat in Q3 and declined 2.3% year to date.
- Cash provided by operations was $11.1 million for the nine months, versus $2.1 million. Investing used $8.5 million, principally for the IT Logistics acquisition; financing used $2.5 million. Cash at September 30 was $0.162 million.
- Working capital was $11.3 million, down from $21.3 million at year-end 2010. Revolver availability was $12.2 million; outstanding facility borrowings were approximately $14.7 million. The facility rate was 4.25% at quarter-end, and the company reported covenant compliance.
- Management reported $147.2 million of debt and long-term obligations, including the credit facility, capital leases, IT Logistics notes and redeemable preferred stock classified as liabilities. Redeemable preferred stock represented $115.8 million of that amount. Total assets were $100.9 million and total stockholders’ deficit was $103.2 million.
Changes, transactions and management commentary
- Q3 revenue declined 8.1%; operating income declined 59.4%, mainly due to $3.1 million of direct costs on a Secure Networks contract that was terminated. Services gross margin dropped to 18.4% from 28.3%.
- Nine-month revenue declined 18.6%, primarily reflecting lower Secure Networks product sales as Telos emphasized solutions and services while outsourcing product sales. Operating income fell 6.1%; Telos-attributable net income increased modestly, primarily because of lower tax expense.
- On July 1, Telos acquired selected IT Logistics assets for an $8 million initial cash payment, $7 million in monthly installments and a $15 million subordinated note. The reported preliminary purchase-price allocation included $15.1 million goodwill and $11.3 million intangible assets. IT Logistics results are included from the acquisition date.
- Total backlog was $636.8 million, down from $668.7 million a year earlier; funded backlog increased to $174.7 million from $152.1 million. Management cautioned that quarterly results may vary with contract mix and timing.
- Management said available cash and facility borrowings should meet operating, debt-service and projected capital needs for the foreseeable future, while noting continued dependence on a credit facility and the importance of maintaining borrowing availability. No specific earnings or revenue guidance was provided.
Risks, contingencies and unusual items
- Liquidity depends materially on the asset-based Wells Fargo facility, secured by substantially all company assets. Collections, vendor terms, collateral requirements and borrowing-base availability can affect liquidity. The company expects to need a similar facility beyond the current facility’s May 2014 maturity.
- Preferred obligations remain substantial: the public preferred stock carries a cumulative 12% dividend and the senior redeemable preferred stock 14.125%. Accrued public preferred dividends were $75.8 million; senior preferred unpaid dividends were $5.9 million. Facility restrictions and other limitations prevent ordinary preferred dividends and redemptions.
- The IT Logistics acquisition added notes payable and significant goodwill and intangible assets. The $15 million subordinated note begins accruing cash interest in November 2012 and is payable in 2041, subject to specified change-of-control provisions.
- Ongoing litigation includes an appeal by holders of public preferred stock; management said the appeal’s outcome could not reasonably be predicted. In a separate directors’ dispute, a November 3, 2011 court decision denied advancement of past legal expenses but did not resolve possible advancement of future expenses.
- Telos reported no material third-quarter changes to the risk factors in its 2010 Form 10-K. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the terminated Secure Networks contract creates further costs, and whether services margins recover.
- Facility borrowing-base availability, covenant headroom, refinancing needs and the impact of working-capital movements.
- The terms, payment priority and accretion of IT Logistics notes, and the final purchase-price allocation and performance of acquired operations.
- The enforceability, timing and potential cash implications of preferred-stock dividends and redemptions, including litigation developments.
- Backlog conversion into funded orders, revenue and cash collections; backlog includes unfunded amounts.