Telos(TLS) - 2023 Q3 - Quarterly Report

PART I - FINANCIAL INFORMATION Item 1. Financial Statements The company's financial statements reflect a significant revenue decline and persistent net losses for the third quarter and first nine months of 2023, alongside a reduction in total assets and negative operating cash flow Consolidated Statements of Operations The company experienced a substantial revenue decrease and a slightly wider net loss in Q3 2023 compared to the prior year, with year-to-date figures showing a similar revenue decline but a narrower net loss Consolidated Statements of Operations (Unaudited) | Metric | Q3 2023 (in thousands) | Q3 2022 (in thousands) | YTD 2023 (in thousands) | YTD 2022 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Total Revenue | $36,186 | $63,593 | $104,319 | $169,544 | | Gross Profit | $13,013 | $20,945 | $38,854 | $60,745 | | Operating Loss | $(9,693) | $(8,784) | $(32,130) | $(39,187) | | Net Loss | $(8,672) | $(8,455) | $(27,442) | $(39,230) | | Diluted Loss Per Share | $(0.12) | $(0.13) | $(0.40) | $(0.58) | Consolidated Balance Sheets The balance sheet as of September 30, 2023, shows a contraction in total assets, driven by lower cash and receivables, accompanied by a reduction in total liabilities and a slight decrease in stockholders' equity Consolidated Balance Sheet Highlights (Unaudited) | Metric | Sep 30, 2023 (in thousands) | Dec 31, 2022 (in thousands) | | :--- | :--- | :--- | | Cash and cash equivalents | $99,953 | $119,305 | | Accounts receivable, net | $25,424 | $40,069 | | Total Assets | $204,738 | $237,397 | | Total current liabilities | $29,583 | $45,502 | | Total Liabilities | $40,717 | $65,043 | | Total Stockholders' Equity | $164,021 | $172,354 | Consolidated Statements of Cash Flows For the first nine months of 2023, the company's cash flow from operations turned negative, contrasting sharply with the cash provided in the same period of 2022, while cash used in investing activities increased Consolidated Cash Flow Summary (Unaudited) | Metric | YTD 2023 (in thousands) | YTD 2022 (in thousands) | | :--- | :--- | :--- | | Net cash (used in)/provided by operating activities | $(3,367) | $20,118 | | Net cash used in investing activities | $(12,310) | $(9,395) | | Net cash used in financing activities | $(3,673) | $(11,821) | | Net change in cash, cash equivalents, and restricted cash | $(19,350) | $(1,098) | Notes to Consolidated Financial Statements Notes to the financials detail revenue recognition policies, segment performance, customer concentration, and a significant revision of prior-year statements due to an accounting error in stock-based compensation - The company operates as a provider of cyber, cloud, and enterprise security solutions through its subsidiaries, including Xacta Corporation and Telos Identity Management Solutions, LLC[19] - In Q4 2022, the company initiated a restructuring plan to align its cost structure with business volume, with the total expected cost updated to $4.0 million in early 2023[31][32] - The majority of revenue (89% for YTD 2023) is recognized over time as services are delivered to customers[37] Revenue by Customer Type (YTD 2023 vs YTD 2022) | Customer Type | YTD 2023 Revenue (in thousands) | YTD 2022 Revenue (in thousands) | YTD 2023 % of Total | YTD 2022 % of Total | | :--- | :--- | :--- | :--- | :--- | | Federal | $93,456 | $160,351 | 90% | 95% | | State & local, and commercial | $10,863 | $9,193 | 10% | 5% | | Total Revenue | $104,319 | $169,544 | 100% | 100% | - The U.S. Department of Defense (DoD) is a major customer, accounting for 65% of total revenue for the nine months ended September 30, 2023[45] - As of September 30, 2023, the company had approximately $79.0 million of remaining performance obligations (funded backlog), with 84% expected to be recognized as revenue over the next 12 months[47] - A prior-period error was identified where stock-based compensation expense was erroneously reversed, understating the net loss for the nine months ended September 30, 2022, by $4.6 million[97] Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the significant revenue decline due to program completions, improved gross margins from a favorable revenue mix, and a focus on rebuilding the revenue base amid federal budget uncertainty General and Business Overview Telos provides advanced security solutions primarily to the U.S. federal government and is focused on streamlining operations and growing its revenue base in a transitional 2023 fiscal year - The company's primary customers include the U.S. federal government, large commercial businesses, and state and local governments[104] - 2023 business development priorities include reorganizing resources, adding new talent, maximizing strategic partnerships, and increasing the quality of contract vehicles[107] Business Environment The company's operating environment is shaped by U.S. federal budget uncertainties, though demand is supported by persistent cybersecurity threats and evolving regulatory requirements - Uncertainty in the U.S. federal budget, including the use of Continuing Resolutions (CRs) and the risk of a government shutdown, could impact federal customers' ability to move forward on planned expenditures in FY2024[108] - Key cybersecurity trends driving demand include rising ransomware threats, risks to critical infrastructure, the complexity of regulatory compliance, and the need for identity assurance[109][110][111][113] Results of Operations Third-quarter results show a sharp revenue decline due to program completions, partially offset by an improved consolidated gross margin and lower operating expenses from restructuring efforts - The decline in Q3 revenue was attributed to the completion of certain programs and lower revenue on ongoing major programs[123] - SG&A expenses decreased by $7.0 million (23.6%) in Q3 2023 compared to Q3 2022, primarily driven by lower compensation costs across all departments[120] Security Solutions Segment Results (Q3 2023 vs Q3 2022) | Metric | Q3 2023 (in thousands) | Q3 2022 (in thousands) | % Change | | :--- | :--- | :--- | :--- | | Revenue | $19,795 | $32,440 | -39.0% | | Gross Profit | $9,354 | $15,577 | -39.9% | | Gross Margin | 47.3% | 48.0% | -0.7 p.p. | Secure Networks Segment Results (Q3 2023 vs Q3 2022) | Metric | Q3 2023 (in thousands) | Q3 2022 (in thousands) | % Change | | :--- | :--- | :--- | :--- | | Revenue | $16,391 | $31,153 | -47.4% | | Gross Profit | $3,659 | $5,368 | -31.8% | | Gross Margin | 22.3% | 17.2% | +5.1 p.p. | Non-GAAP Financial Measures Non-GAAP metrics reveal a significant deterioration in profitability, with Adjusted EBITDA turning negative in Q3 and year-to-date 2023 compared to positive results in the prior-year periods Reconciliation of Net Loss to Adjusted EBITDA (Non-GAAP) | Metric | Q3 2023 (in thousands) | Q3 2022 (in thousands) | YTD 2023 (in thousands) | YTD 2022 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net loss | $(8,672) | $(8,455) | $(27,442) | $(39,230) | | EBITDA (Non-GAAP) | $(6,478) | $(7,267) | $(25,794) | $(34,760) | | Adjusted EBITDA (Non-GAAP) | $(1,260) | $8,569 | $(2,135) | $14,083 | Free Cash Flow (Non-GAAP) | Metric | Q3 2023 (in thousands) | Q3 2022 (in thousands) | YTD 2023 (in thousands) | YTD 2022 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net cash provided by/(used in) operating activities | $846 | $11,986 | $(3,367) | $20,118 | | Free cash flow (Non-GAAP) | $(2,996) | $8,366 | $(15,677) | $10,723 | Liquidity and Capital Resources The company maintains a solid liquidity position with substantial cash reserves and working capital, which management deems sufficient for near-term needs despite negative operating cash flow year-to-date - As of September 30, 2023, the company had cash and cash equivalents of $100.0 million and working capital of $106.6 million[151] - Primary sources of liquidity are cash on hand, future operating cash flows, and a $30.0 million revolving credit facility[150] - Net cash used in operating activities for the first nine months of 2023 was $3.4 million, a $23.5 million decrease from the cash provided in the same period of 2022[153] Quantitative and Qualitative Disclosures about Market Risk The company provided no quantitative and qualitative disclosures concerning market risk for the reporting period - No disclosures were made under this item[157] Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective, and no material changes were made to internal controls over financial reporting during the quarter - The CEO and CFO concluded that the Company's disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2023[159] - No changes in internal control over financial reporting occurred during the quarter that have materially affected, or are reasonably likely to materially affect, the company's internal controls[160] PART II - OTHER INFORMATION Legal Proceedings A securities class action lawsuit previously filed against the company was dismissed with prejudice, and the matter is now considered final - A securities lawsuit filed in February 2022 against the company, alleging violations related to disclosures about contracts, was dismissed with prejudice on June 21, 2023[92] - The dismissal of the lawsuit is final as no appeal was taken[92] Risk Factors The company faces risks of a material goodwill impairment charge due to its low stock price and potential adverse impacts on revenue from federal budget uncertainties - A key risk is the potential for a material impairment charge on goodwill ($17.9 million as of Sep 30, 2023) and other intangible assets, as the company's stock price has declined below its net book value per share[165][167] - The company's future revenues are at risk due to potential declines in the federal budget, changes in U.S. government spending priorities, or prolonged government shutdowns[168][169]