TELOS CORP 10-Q Summary: Period Ended June 30, 2011
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2011, and the six months ended June 30, 2011. Telos Corporation is an information technology solutions and services company serving U.S. Government and commercial customers. The company operates through four primary solution areas: Secure Networks, Information Assurance, Secure Communications, and Identity Management. The company is a non-accelerated filer and is not a shell company.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended 6/30/11 | 6 Months Ended 6/30/11 | 6 Months Ended 6/30/10 |
|---|---|---|---|
| Revenue | $41,145 | $89,122 | $117,005 |
| Operating Income | $3,345 | $7,414 | $4,183 |
| Net Income | $1,185 | $2,468 | $507 |
| Net Income Attributable to Telos | $780 | $1,896 | $218 |
| Cash from Operating Activities | N/A | $6,629 | $4,616 |
| Cash and Equivalents (End of Period) | $283 | $283 | $379 |
| Total Debt & Preferred Stock (Liabilities) | $166,204 | $166,204 | $180,600 |
| Working Capital | $21,410 | $21,410 | $21,261 |
Margins (6 Months Ended 6/30/11): Gross Margin was 26.0% (up from 16.8% in 2010). Operating Margin was 8.3% (up from 3.6% in 2010). Net Income Margin attributable to Telos was 2.1% (up from 0.2% in 2010).
Material Changes vs. Prior Period
- Revenue Decline: Revenue decreased 23.8% year-over-year for the six months ended June 30, 2011. This was driven primarily by a $25.8 million decrease in Secure Networks product sales due to a strategic shift away from resold products (specifically under the U.S. Army ADMC-2 contract) toward higher-margin services.
- Profitability Improvement: Despite lower revenue, Operating Income increased 77.2% to $7.4 million. Gross profit increased 18.1% due to improved margins from the shift in product mix.
- Debt Reduction: The company redeemed $2.1 million of Senior Redeemable Preferred Stock in April 2011 at a discount, recording a gain of approximately $0.2 million. Senior Subordinated Notes were fully repaid in May 2010, reducing interest expense.
- Backlog: Total backlog was $594.2 million at June 30, 2011, compared to $591.8 million at June 30, 2010. Funded backlog was $114.0 million.
Guidance, Outlook, Risks, and Unusual Items
Outlook and Liquidity: Management believes available cash and borrowings under the Wells Fargo revolving credit facility (the "Facility") are sufficient to meet operating and debt service needs. The Facility has a $30 million limit, with $12.7 million unused availability as of June 30, 2011. The company anticipates a continued need for this credit facility.
Unusual Items:
- Preferred Stock Dividends: The company has not declared cash dividends on Senior Redeemable Preferred Stock or Public Preferred Stock since 1991 due to debt covenants. However, dividends are accrued as interest expense ($2.1 million for the six months ended June 30, 2011). Cumulative unpaid dividends on Public Preferred Stock totaled $74.9 million.
- Acquisition: On July 1, 2011 (subsequent event), Telos acquired assets from IT Logistics Inc. for $30 million ($8M cash, $7M installments, $15M note).
Risks and Contingencies:
- Liquidity Dependence: Liquidity is heavily dependent on the Wells Fargo Facility, which is collateralized by substantially all assets. Availability fluctuates based on accounts receivable collections.
- Legal Proceedings: Ongoing litigation with holders of Public Preferred Stock (Costa Brava Partnership III, et al.) regarding dividend payments and redemption obligations. The case is currently on appeal in the Maryland Court of Special Appeals. Additionally, there is litigation with Class D Directors regarding interference with auditors and indemnification requests.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with the Wells Fargo Facility covenants (EBITDA, recurring revenue, capital expenditure limits), as a breach could restrict operations or trigger default.
- Preferred Stock Liability: Confirm the classification and valuation of the $114.8 million in redeemable preferred stock liabilities and the impact of accrued but unpaid dividends on future cash flow requirements.
- Revenue Mix: Assess the sustainability of the shift from low-margin product reselling to higher-margin services, and the risk of further revenue declines if government contracts are not renewed.
- Legal Exposure: Monitor the status of the Costa Brava appeal and the Class D Director litigation, as adverse rulings could result in significant financial liabilities or operational restrictions.
- Working Capital: Review the aging of accounts receivable, as the borrowing base for the credit facility is tied to 85% of trade receivables.