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TELOS CORP 10-Q Summary: Quarter Ended March 31, 2007

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007, for Telos Corporation, a provider of government information technology (IT) solutions. The company operates through two primary segments: Managed Solutions (IT integration and support services) and Xacta (secure enterprise solutions including wireless LAN, messaging, and identity management). The financial statements are prepared on a going concern basis, though the company faces significant working capital constraints due to unreimbursed litigation expenses.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 59.7% year-over-year, driven by a $12.4 million increase in Xacta sales (primarily NETCENTS contract) and a $3.0 million increase in Managed Solutions.
• Profitability Turnaround: The company returned to profitability with $1.7 million in net income, reversing an $8.1 million loss in the prior year. This was driven by a gross margin expansion to 32.0% and a $1.3 million reduction in SG&A expenses.
• Segment Performance: Xacta gross margin improved significantly to 46.9% from 27.0%. Conversely, Managed Solutions reported a gross margin loss of (2.9%) due to pricing pressure and working capital constraints limiting supplier options.
• Liquidity: Cash and cash equivalents declined to $15,000 from $235,000 at year-end 2006. Operating cash flow was negative ($962,000) compared to positive ($3.0 million) in the prior year, largely due to changes in operating assets and liabilities.

Outlook, Risks, and Contingencies

• Going Concern & Liquidity: The company reports a $9.5 million working capital deficit, exacerbated by $3.0 million in unreimbursed litigation costs for the quarter. Management expects to meet obligations through existing cash and a $15 million revolving credit facility (with $2.0 million availability as of March 31).
• Legal Proceedings: A significant lawsuit filed by Costa Brava Partnership III and Wynnefield Small Cap Value L.P. challenges the company's failure to pay mandatory dividends on Public Preferred Stock and alleges insolvency. Plaintiffs have sought preliminary injunctions and receivership, which have been denied thus far, but the outcome remains uncertain.
• Preferred Stock Obligations: The company has accrued $58.6 million in unpaid cash dividends on Public Preferred Stock and $6.1 million on Senior Redeemable Preferred Stock. Due to Maryland law and credit facility covenants, the company is currently precluded from making these payments or redemptions.
• Delisting Risk: The company was notified of potential removal from the OTCBB due to late filings. An appeal and waiver request have been submitted, but no determination has been made.
• Subsequent Event: In April 2007, the company sold a 40% interest in its Identity Management business (TIMS LLC) to private equity investors for $6 million to address working capital needs.

Investor Verification Checklist

• Verify the status of the pending lawsuit regarding Public Preferred Stock dividends and the potential for receivership or asset freezes.
• Confirm the company's ability to maintain compliance with EBITDA covenants under the Wells Fargo Foothill credit facility given the working capital deficit.
• Monitor the outcome of the NASD delisting proceedings and the SEC waiver request.
• Assess the sustainability of the Xacta segment's margin expansion versus the continued losses in the Managed Solutions segment.
• Review the utilization of the $6 million proceeds from the TIMS LLC sale and its impact on the $8.9 million in unpaid legal expenses.