Business context and reporting period
Telos Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. Telos provides information technology solutions and services to U.S. government and commercial customers, through Cyber Operations and Defense, Identity Management, and IT & Enterprise Solutions. It reports as one operating and reportable segment.
Financial results and position
Amounts below are in millions of dollars unless otherwise noted.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $54.9 | $33.7 | $108.8 | $93.7 |
| Gross profit / margin | $14.5 / 26.4% | $8.7 / 25.8% | $34.6 / 31.8% | $22.6 / 24.1% |
| Operating income (loss) | $2.9 | $0.5 | $4.2 | $(2.4) |
| Interest expense | $1.4 | $1.4 | $4.1 | $4.2 |
| Consolidated net income (loss) | $1.3 | $(0.3) | $(0.2) | $(4.7) |
| Net loss attributable to Telos | $(0.1) | $(1.4) | $(2.9) | $(6.6) |
Q3 revenue rose 63.2%, primarily on higher NETCENTS-2 sales; nine-month revenue rose 16.1%, primarily on NETCENTS sales. Growth was led by services, while nine-month product revenue declined. Q3 gross margin improved modestly overall, with weaker service margin offset by stronger product margin. Nine-month gross margin improved substantially, reflecting the mix of solutions delivered. SG&A increased 42.5% in Q3 and 21.7% for the nine months, including higher bonus accruals and labor costs. The consolidated results include Telos ID, of which half of profits are attributable to the non-controlling investor.
For the nine months, operating cash flow was $14.2 million, versus $4.0 million a year earlier; investing cash use was $0.4 million and financing cash use was $11.6 million. Cash at September 30 was $2.3 million, versus $58,000 at year-end 2015. Management attributed operating cash generation in part to timing of vendor payments and other working-capital movements. Working capital was negative $5.6 million, compared with positive $1.1 million at December 31, 2015.
At September 30, current assets were $36.8 million and current liabilities $42.4 million. Total liabilities were $194.7 million, including $128.9 million of redeemable preferred stock classified as liabilities; total stockholders’ deficit was $125.9 million. Capital lease obligations totaled $20.1 million. The $2.5 million Porter subordinated notes bear 12% interest and are due July 1, 2017; accrued interest was not being paid because of subordination restrictions. The former Wells Fargo revolving facility was repaid and terminated July 15, 2016.
Material changes, outlook, risks and unusual items
- Financing and liquidity: Telos replaced the Wells Fargo facility with an accounts receivable purchase agreement with Republic Capital Access (RCA) and a receivables-backed financing facility with Action Capital. RCA may purchase up to $10 million of receivables outstanding at a time; Telos reported $4.7 million of sold receivables outstanding and $0.7 million of deferred consideration at quarter-end. Telos sold about $25.8 million of receivables during the period and recorded approximately $0.1 million in related loss. Action Capital’s facility limit was raised to $5 million; no borrowings were outstanding at September 30. Management believed available financing was sufficient for the next 12 months, but said loss or replacement of these arrangements could materially harm liquidity and results. The negative working-capital position partly reflected use of current assets to repay the prior facility.
- Business and contract exposure: Contract timing and solution mix can cause material quarter-to-quarter variation. The filing describes prior delays in the NETCENTS-2 procurement, government funding uncertainty, and the loss of a government IT & Enterprise contract that represented about 11% of 2015 revenue. Telos’s appeal concerning that contract award remained pending, with oral arguments scheduled for December 8, 2016. Funded backlog was $62.9 million at September 30, 2016, versus $53.8 million a year earlier.
- Preferred stock and accumulated obligations: Public preferred stock carries a cumulative 12% dividend and senior redeemable preferred stock carries a cumulative 14.125% dividend. The filing reports that dividends and redemptions have been restricted or unpaid; accrued Public Preferred Stock dividends were approximately $94 million, and senior preferred dividends approximately $1.6 million. Public preferred stock is classified as noncurrent and is not stated to be payable on demand. Preferred-stock dividends are included in interest expense despite being noncash accruals.
- Contingencies and other items: Two longstanding investor-related lawsuits remained unresolved; management said outcomes could not reasonably be determined and denied the allegations. No material litigation developments were reported in the quarter. No goodwill impairment was recorded; goodwill was $14.9 million. Other intangible assets became fully amortized by June 30, 2016. Management reported no material change in risk factors from the prior filings, and no material change in internal control over financial reporting.
- Guidance: The filing provides no specific revenue or earnings guidance. Management’s 12-month liquidity assessment is subject to the availability and terms of the RCA and Action Capital arrangements, receivable eligibility and collections, and operating performance.
Important facts for investors to verify
- Whether RCA and Action Capital continue to provide usable liquidity, and the cost, eligibility limits, and recourse terms as receivables are financed or sold.
- Whether operating cash flow and improved margins persist, given the contribution of working-capital timing and changes in contract mix.
- NETCENTS-2 order activity, funded backlog conversion, government funding conditions, and the outcome of the pending contract appeal.
- The company’s capacity to meet near-term obligations, including the Porter Notes’ July 2017 maturity, while carrying negative working capital and substantial preferred-stock liabilities.
- Developments in the investor litigation and the implications of cumulative preferred dividends and redemption restrictions.