TELOS CORPORATION (Nasdaq: TLS) — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Telos provides cybersecurity, cloud, identity, and secure-network solutions. Its two reportable segments are Security Solutions and Secure Networks. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $63.6 | $69.0 | $169.5 | $178.4 |
| Gross profit / margin | $20.9 / 32.9% | $24.9 / 36.1% | $60.7 / 35.8% | $61.9 / 34.7% |
| Operating loss | $(7.7) | $(5.1) | $(34.6) | $(36.1) |
| Net loss | $(7.3) | $(5.2) | $(34.6) | $(37.6) |
| Net loss per diluted share | $(0.11) | $(0.08) | $(0.51) | $(0.57) |
- Revenue mix and concentration: Services revenue was $55.3 million in Q3 and $153.7 million year to date; product revenue was $8.3 million and $15.9 million, respectively. Federal customers generated 95% of revenue in both 2022 periods; the DoD accounted for 77% of Q3 revenue and 74% year to date.
- Cash flow: For the first nine months, operating activities provided $20.1 million, versus $9.6 million in the prior year. Investing used $9.4 million, including $8.6 million of capitalized software development. Financing used $11.8 million, including $7.6 million for share repurchases and $3.1 million in tax withholding on equity awards. Management’s non-GAAP free cash flow was $10.7 million, versus $1.3 million.
- Liquidity and obligations: Cash and cash equivalents were $125.3 million at September 30, compared with $126.6 million at year-end 2021; working capital was $130.6 million. Total liabilities were $70.4 million, including $13.2 million of finance lease obligations. The filing reports no conventional borrowings in the presented balance sheet. Management says available funds and expected operating cash generation should meet needs for the next 12 months.
- Non-GAAP results: Adjusted EBITDA was $8.6 million in Q3 and $14.1 million year to date, compared with $8.7 million and $15.5 million, respectively. These company-defined measures exclude, among other items, substantial stock-based compensation; they are not substitutes for GAAP results.
Changes versus prior comparable periods
- Q3 revenue declined 7.8%, primarily because a large Security Solutions program ended and large Secure Networks programs continued to wind down. Nine-month revenue declined 5.0% for similar reasons, partly offset by growth elsewhere.
- Q3 gross margin fell 3.2 percentage points, to 32.9%, mainly due to increased investment in a large Security Solutions program and revenue mix. Nine-month gross margin rose 1.1 points, to 35.8%, reflecting broad-based margin performance and mix.
- Q3 net loss widened by $2.1 million, while the nine-month net loss narrowed by $3.0 million. The year-to-date comparison benefited from lower SG&A and the absence of a $1.0 million litigation-settlement accrual recorded in 2021.
- Security Solutions Q3 revenue fell 6.1% and gross margin declined to 48.0%; year-to-date revenue rose 0.6% and gross margin improved to 52.2%. Secure Networks revenue declined 9.5% in Q3 and 10.6% year to date, reflecting program wind-downs.
Outlook, risks, and notable items
- Backlog: Funded backlog (remaining performance obligations) was $111.4 million at September 30; Telos expected to recognize approximately 85% over the next 12 months.
- TSA PreCheck: TSA issued an authority to operate for Telos ID’s PreCheck system on October 18, 2022. Telos was conducting a limited trial and anticipated a broader public launch in calendar 2022, subject to successful completion and TSA satisfaction.
- Federal budget uncertainty: At filing, the federal government was operating under a continuing resolution through December 16, 2022. Management noted that delayed appropriations could postpone new contract starts or project acceleration and affect planning. Government spending, contract timing, and program wind-downs remain important business dependencies.
- Legal contingency: Telos and certain current and former officers face a securities class action alleging disclosure failures concerning TSA and CMS contract delays and 2021 forecasts. The company is defending the case; it said a loss was reasonably possible but it could not estimate the likelihood or amount, and recorded no material liability.
- Financial reporting controls: Disclosure controls were deemed ineffective at September 30 because previously identified material weaknesses remained unremediated. Weaknesses included entity-level controls, IT access/change controls, and controls over revenue, software capitalization, stock compensation, business-combination valuations, close/reporting, and transaction coding. Remediation was underway but not yet fully tested and completed.
- Share activity: Under a $50 million repurchase authorization, Telos repurchased 859,170 shares for $7.7 million in the first nine months; $42.3 million remained authorized at September 30. It reported an additional 106,623 shares repurchased for $1.0 million through November 4.
- Prior-period revisions: The filing describes corrections to 2021 interim revenue and expense classifications, software capitalization, expense timing, stock compensation, cash-flow presentation, and acquired-asset valuation. The company said the identified errors were immaterial to previously issued interim financial statements; the 2021 comparative figures shown reflect adjustments.
Key facts for investors to verify
- Whether TSA PreCheck completed its trial and achieved a broad public launch, and the timing and financial contribution of that launch.
- Whether funded backlog converts to revenue as expected and whether program wind-downs are offset by new awards and growth.
- How gross margins and cash generation develop, particularly in Security Solutions and Secure Networks.
- Progress in remediating and testing the disclosed material weaknesses in internal control over financial reporting.
- Developments in the securities litigation and any eventual estimate or recognition of exposure.
- Effects of federal appropriations timing and customer concentration on contract starts, funding, and revenue.