Business context and reporting period
Telos Corporation is an IT solutions and services provider serving U.S. government, military, intelligence-community and commercial customers. This unaudited Form 10-Q covers the three months ended March 31, 2014; comparisons are with the first quarter of 2013. The company reports one operating and reportable segment, with three business lines: Cyber Operations and Defense, Secure Communications, and Telos ID.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $30.1 million | $47.6 million; down 36.6% |
| Gross profit / margin | $6.4 million / 21.4% | $8.0 million / 16.9% |
| SG&A | $9.9 million | $8.7 million |
| Operating loss | $3.4 million | $0.7 million |
| Net loss attributable to Telos | $5.6 million | $1.0 million |
| Cash from operating activities | $8.6 million | $5.8 million |
| Cash used in investing / financing | $0.2 million / $8.4 million | $0.3 million / $5.6 million |
| Cash and cash equivalents, March 31 | $80,000 | $137,000 at March 31, 2013 |
| Working capital | $2.9 million | $17.3 million at December 31, 2013 |
| Facility borrowings / unused availability | $11.2 million / $5.0 million | $19.8 million / $9.2 million at December 31, 2013 |
| Funded backlog | $75.1 million | $121.0 million at March 31, 2013 |
Interest expense was $1.3 million, including approximately $1.0 million of preferred-stock dividends recorded as interest. The balance sheet reported $14.7 million of long-term capital lease obligations, $119.1 million of redeemable preferred stock classified as liabilities, and a total stockholders’ deficit of $105.2 million. Management separately described $144.3 million of debt and long-term obligations; its stated components do not fully reconcile to the balance-sheet figures in the supplied filing text.
Material changes versus the prior comparable period
Revenue fell primarily because sales under the U.S. Air Force NETCENTS contract declined after the period for awarding new task orders ended in September 2013. Services revenue decreased to $27.6 million from $33.8 million; product revenue fell to $2.5 million from $13.8 million. Gross margin improved, partly due to a more favorable solution mix and increased proprietary software sales, but gross profit declined as revenue contracted. SG&A rose 14%, reflecting higher bonuses, labor and other costs, legal costs, audit fees and outside services. The larger operating loss and a change from a tax benefit to a tax provision contributed to the increased net loss.
Operating cash flow increased despite the net loss, mainly reflecting $12.8 million of cash generated by changes in operating assets and liabilities. Cash decreased by $14,000 during the quarter. Funded backlog declined from $95.3 million at December 31, 2013 to $75.1 million at March 31, 2014.
Outlook, risks, contingencies and unusual items
- Credit facility and covenants: A March 27, 2014 amendment extended the $30 million facility maturity to November 13, 2015, waived certain existing defaults, and increased scheduled term-loan installments to $250,000 quarterly beginning July 1, 2014. On May 13, 2014, after quarter-end, Wells Fargo agreed not to measure the EBITDA covenants as of March 31 while the covenants were being revised. The facility is secured by substantially all company assets. Management said available cash and facility borrowings should cover foreseeable needs, but stressed that facility availability is critical to liquidity.
- Government-contract exposure: The company was selected for the NETCENTS-2 replacement contract in March 2014, but had received no delivery orders under it by the filing. The company said sequestration-related uncertainty could delay future contract awards, particularly in Cyber Operations and Defense. Most task orders have performance periods under 12 months, making quarterly results variable.
- Preferred-stock obligations: Redeemable preferred stock carries cumulative annual dividend rates of 12% and 14.125%. Dividends have not been paid on the Public Preferred Stock since 1991, and accrued dividends and redemption obligations are substantial. Facility restrictions limit dividends and redemptions; these instruments are classified as noncurrent liabilities.
- Legal matters: A long-running lawsuit brought by Public Preferred Stock holders remained pending; an April 24, 2014 hearing resulted in no decision. The company said the probability of plaintiffs’ success could not reasonably be determined. It reported no material developments in separate Hamot litigation during the quarter.
- Other: The company reported no goodwill or intangible-asset impairment through March 31, 2014. Management identified variable-rate facility debt as an interest-rate risk. No explicit earnings or revenue guidance was provided.
Important facts for investors to verify
- Whether the revised EBITDA covenants were finalized and whether the company remained compliant with its amended credit facility.
- Current borrowing-base availability, cash position and working-capital needs, given only $80,000 of reported cash and $5.0 million of unused facility availability at quarter-end.
- New task-order awards and funded backlog under NETCENTS-2 and other government contracts.
- The scale, terms and priority of preferred-stock principal, cumulative dividends and redemption obligations, and the reconciliation of management’s $144.3 million obligations figure with balance-sheet amounts.
- Developments in the pending preferred-stock litigation and any resulting financial or liquidity effects.