TELOS CORPORATION — Q2 2014 Form 10-Q
Business context and reporting period. Telos provides information technology solutions and services to U.S. government and commercial customers, through Cyber Operations and Defense, Secure Communications, and Telos ID. This filing covers the quarter and six months ended June 30, 2014; amounts below are in millions unless stated otherwise. The company reports one operating segment.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $29.0 | $55.2 | $59.2 | $102.8 |
| Gross profit | $5.4 | $8.9 | $11.8 | $16.9 |
| Gross margin | 18.6% | 16.1% | 20.0% | 16.4% |
| SG&A | $9.8 | $8.2 | $19.7 | $16.9 |
| Operating income (loss) | $(4.4) | $0.6 | $(7.8) | $(0.02) |
| Net income (loss) attributable to Telos | $(4.3) | $0.5 | $(9.9) | $(0.5) |
For the six months, cash provided by operating activities was $6.9 million, compared with $8.3 million in 2013; changes in operating assets and liabilities contributed $14.5 million. Investing activities used $0.3 million, and financing activities used $6.6 million. Cash at June 30 was just $83,000, versus $94,000 at year-end 2013.
Working capital fell to $1.5 million from $17.3 million at December 31, 2013. Current assets were $29.0 million and current liabilities $27.5 million. Facility borrowings totaled $13.2 million, with $3.7 million of unused availability, down from $9.2 million at year-end. Facility interest was 4.25% at quarter-end; the six-month effective weighted-average rate was 5.6%.
At June 30, total debt and long-term obligations were reported in MD&A as $153.5 million: $12.2 million under the credit facility, $21.1 million in capital lease obligations, $120.1 million of redeemable preferred stock classified as liabilities, and $0.1 million in other liabilities. The balance sheet also showed a $109.4 million stockholders’ deficit.
Material changes versus comparable periods
- Q2 revenue fell 47.5% year over year; six-month revenue fell 42.5%. The principal cause was lower sales under the U.S. Air Force NETCENTS contract, particularly secure-network services and resold products.
- NETCENTS’ period for awarding new task orders ended in September 2013. Telos was selected for NETCENTS-2 in March 2014, but no delivery orders had been issued by the filing date while the government evaluated award protests. The filing says no protest was filed against Telos’s award.
- Despite higher gross-margin percentages, lower gross profit and increased SG&A drove the company from near breakeven operating results in the prior-year periods to operating losses. Q2 SG&A increased 18.7%; six-month SG&A increased 16.2%.
- Funded backlog declined to $64.4 million from $98.1 million a year earlier and $95.3 million at December 31, 2013.
Outlook, risks, contingencies, and unusual items
- Management stated that available cash and borrowing capacity under the amended facility should be sufficient for operating expenses, debt service, and projected capital expenditures for the foreseeable future, while anticipating a continuing need for a similar credit facility. Liquidity is highly dependent on facility availability, which fluctuates with eligible receivables and other borrowing-base factors.
- The lender waived EBITDA covenant testing for the quarters ended March 31 and June 30, 2014, pending covenant revisions. The June amendment also reduced the recurring-revenue covenant from $5.0 million to $4.5 million. The facility maturity was extended to November 13, 2015; quarterly term-loan installments increased to $250,000 beginning July 1, 2014. The company stated it expected covenant compliance, but provided no assurance.
- Management cited uncertainty from government funding and sequestration, delays in contract awards, the NETCENTS-2 order delay, and variability in the timing and mix of contract deliveries. Interim results may not indicate full-year performance.
- Redeemable preferred stock carries cumulative dividend rates of 14.125% and 12%. Telos accrued $1.9 million of preferred dividends during the first half as interest expense. Public preferred stock had $118.2 million carrying value, including accrued amounts; the filing says dividends and redemptions are restricted and classifies it as noncurrent. The preferred obligations materially burden the capital structure.
- The headquarters lease changed in May 2014: Telos assigned its purchase option for $1.7 million and entered a new 15-year lease treated as a capital lease. The transaction increased the recorded capital asset and lease liability; the filing reports the liability at $22.0 million after the transaction.
- A longstanding lawsuit brought by holders of public preferred stock remained pending after an April 2014 hearing. The company said the probability of plaintiffs’ success could not reasonably be determined and is vigorously defending the matter. No material developments were reported in separate litigation; management said other ordinary-course litigation was not expected to have a material adverse effect.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material changes to the previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether NETCENTS-2 protests are resolved and delivery orders begin, and how continued contract delays affect revenue, margins, and backlog.
- Current borrowing-base availability, cash collections, and compliance with revised facility covenants, particularly given $83,000 of cash and $3.7 million of unused availability at quarter-end.
- Facility refinancing or renewal plans before its November 2015 maturity, and the impact of higher scheduled term-loan installments.
- The cumulative preferred-stock obligations, dividend accruals, and restrictions on payment or redemption; reconcile the reported $120.1 million preferred liability with the applicable instrument terms.
- Updates and potential financial consequences of the preferred-stockholder litigation and the headquarters capital lease.