Telos Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Telos provides IT solutions and services, primarily to U.S. Government customers; it reports one operating segment. Amounts below are in U.S. dollars. Financial statement amounts are unaudited.
Financial performance and position
| Metric | Q2 2019 | Six months 2019 |
|---|---|---|
| Revenue | $36.0 million, up 3.2% year over year | $67.2 million, down 0.2% |
| Gross profit / margin | $10.0 million / 27.8% | $19.0 million / 28.2% |
| Operating income (loss) | $(0.4) million | $(1.8) million |
| Net income (loss), consolidated | $(2.0) million | $(4.9) million |
| Net income (loss) attributable to Telos | $(1.7) million | $(5.2) million |
| Interest expense | $1.7 million | $3.5 million |
Services revenue was $34.4 million in Q2 and $62.4 million for the first half; product revenue was $1.7 million and $4.8 million, respectively. Federal customers generated $33.8 million of Q2 revenue and $62.8 million for the first half.
For the six months, operating cash flow was $5.9 million, investing cash use was $3.7 million, and financing cash use was $1.5 million. Cash increased by $0.7 million to $0.8 million. Investing outlays included $2.4 million of property and equipment purchases and $1.3 million of capitalized software development costs.
At June 30, cash was $0.8 million, current assets were $35.9 million, and current liabilities were $40.4 million; reported working capital was negative $4.5 million. Total assets were $72.6 million and stockholders’ deficit was $138.0 million. The senior term loan’s carrying value was $11.1 million, subordinated debt was $2.8 million, and finance lease obligations totaled $17.4 million. Public preferred stock was recorded as a $137.3 million liability. It accrues a 12% cumulative dividend; the company reported $105.4 million in accumulated cash dividends payable.
Changes versus the prior comparable period
- Q2 revenue rose, but gross profit fell 17.1% and gross margin declined from 34.6% to 27.8%; the quarter shifted from $2.2 million operating income to a $0.4 million operating loss.
- First-half revenue was nearly unchanged, while gross profit declined 14.9% and gross margin fell from 33.1% to 28.2%. Operating results shifted from $2.1 million income to a $1.8 million loss; Telos-attributable net loss widened from $2.1 million to $5.2 million.
- Management attributed weaker margins primarily to program and delivery mix, including lower Secure Mobility margins and lower proprietary software sales. Q2 SG&A increased 5.2%, partly due to labor and legal costs.
- First-half operating cash flow increased from $3.5 million to $5.9 million, while capital investment and software development outlays also increased.
Outlook, risks and unusual items
- Backlog: Total backlog was $255.0 million at June 30, 2019, versus $261.4 million a year earlier; funded backlog was $74.1 million versus $70.2 million. The company expected to recognize about 85.4% of remaining performance obligations in 2019 and 14.2% in 2020. Backlog conversion and timing are not assured.
- Liquidity outlook: Management said EnCap and RCA financing arrangements together with operating cash generation were expected to meet needs for the next 12 months, while noting there could be no assurance. The company warned that losing or replacing its receivables-purchase arrangement could materially harm liquidity. RCA may purchase eligible receivables up to a $10 million outstanding limit.
- Subsequent financing: On July 19, 2019, Telos borrowed an additional $5 million from EnCap, increasing principal to $16 million. The maturity was accelerated from January 2022 to January 15, 2021; the amendment also revised covenants, waived actual or potential noncompliance, increased the exit fee to $1.2 million, and required a $110,000 fee. The loan remains secured by substantially all company assets. At June 30, the company reported covenant compliance based on agreed definitions; the later amendment waived noncompliance.
- Debt and preferred-stock burden: The EnCap loan accrues interest at a high rate (13% under the disclosed terms, subject to amendment provisions). Public preferred stock redemption and dividends remain restricted by financing documents and legal conditions; scheduled historical redemptions were not met, and the stock is classified as a noncurrent liability.
- Government exposure: The company cited possible federal funding delays, continuing-resolution effects, shutdowns, or program changes. The August 2, 2019 budget agreement raised defense spending limits, but FY2020 appropriations still required enactment.
- Legal matters: Long-running litigation involving preferred-stock holders remained pending, with management unable to assess the probability of success. A separate appeal concerning damages on the company’s counterclaim had oral argument scheduled for September 10, 2019. Management said other ordinary-course litigation was not expected to have a material adverse effect.
- Accounting and controls: Adoption of the lease standard on January 1, 2019 added approximately $2.0 million of right-of-use assets and lease liabilities, with no material operating-results or cash-flow effect. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the deterioration in gross margin and operating profitability reverses, particularly as contract and product mix changes.
- Cash conversion, receivable collections, and continued availability and economics of RCA receivables purchases.
- Compliance with the amended EnCap covenants, the impact of the shorter maturity, and the company’s ability to refinance or repay the $16 million loan.
- How the preferred-stock liability, cumulative unpaid dividends, and restrictions on redemption affect the capital structure and potential distributions.
- Whether funded backlog converts to revenue on the stated schedule and whether government procurement, appropriations, or shutdown risks affect orders.
- Developments and potential financial consequences in the pending litigation; the filing does not provide a clear estimate of exposure.