TLS

TELOS CORP 10-Q Summary: Period Ended June 30, 2009

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2009, and the six months ended June 30, 2009. Telos Corporation is an information technology solutions and services company serving U.S. Government and commercial customers. The company operates four business lines: Secure Networks, Information Assurance, Secure Messaging, and Identity Management. The company is a non-accelerated filer and is not a shell company.

Key Financial Metrics

Note: Debt includes $17.2M Senior Credit Facility, $4.2M Senior Subordinated Notes, $7.3M Capital Leases, and $109.1M Redeemable Preferred Stock classified as liabilities.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 47.6% year-over-year for the quarter to $68.6 million, driven primarily by a $16.4 million increase in Secure Networks solutions and a $3.6 million increase in Identity Management solutions. Product revenue surged 112% to $39.6 million.
• Profitability Decline: Despite revenue growth, Net Income attributable to Telos dropped 39.2% to $0.6 million for the quarter. For the six-month period, the company reported a net loss of $18,000 compared to net income of $3.0 million in the prior year.
• Margin Compression: Gross margin decreased to 17.6% for the quarter (from 19.3% in 2008) and 16.9% for the six months (from 21.0% in 2008). This was attributed to a shift in product mix toward lower-margin resold hardware and a $0.6 million loss on a long-term Secure Networks project.
• Expense Increases: Selling, General, and Administrative (SG&A) expenses rose 35.2% for the quarter, largely due to $1.0 million in litigation-related expenses.
• Cash Flow: Operating cash flow turned negative, using $4.7 million for the six months ended June 30, 2009, compared to providing $2.6 million in the prior year period.

Outlook, Risks, and Contingencies

• Liquidity Dependence: The company relies heavily on a $25 million revolving credit facility with Wells Fargo Foothill. As of June 30, 2009, $17.2 million was outstanding with $6.6 million available. Management believes this is sufficient for foreseeable needs but notes that maintaining availability is critical.
• Preferred Stock Obligations: The company has significant obligations related to Senior Redeemable Preferred Stock ($10.1M carrying value) and Public Preferred Stock ($99.1M carrying value). Due to Maryland law and credit facility covenants, the company is currently precluded from redeeming these securities or paying dividends, though dividends continue to accrue as interest expense.
• Legal Proceedings:
  • Costa Brava Partnership III v. Telos: An appeal regarding the classification of Public Preferred Stock and fiduciary duties remains pending before the Court of Special Appeals of Maryland. The company denies the claims.
  • Hamot et al. v. Telos: Litigation involving Class D Directors regarding access to information and interference with auditors is ongoing. A preliminary injunction against the directors was issued, and an appeal regarding mootness was dismissed.
• Backlog: Total backlog was $636.4 million as of June 30, 2009, with funded backlog at $130.8 million.

Investor Verification Checklist

• Verify the status of the revolving credit facility and compliance with EBITDA covenants, as this is the primary source of liquidity.
• Confirm the outcome of the pending appeal in Costa Brava Partnership III v. Telos, as a ruling could impact the classification of preferred stock liabilities.
• Monitor the resolution of the Hamot et al. litigation regarding director access and auditor interference.
• Assess the sustainability of the revenue mix shift toward lower-margin hardware reselling versus higher-margin services.
• Review the specific details of the $0.6 million loss on the long-term Secure Networks project and its impact on future margins.