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TELOS CORP 10-Q Summary: Period Ended June 30, 2010

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2010, for Telos Corporation, an information technology solutions and services company serving U.S. Government and commercial customers. The company operates through four primary business lines: Secure Networks, Information Assurance, Secure Messaging, and Identity Management. The filing includes unaudited condensed consolidated financial statements.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline (Q2): Revenue decreased 29.8% to $48.2 million in Q2 2010 compared to $68.6 million in Q2 2009. This was driven by a $20.9 million drop in Secure Networks product sales and a $1.2 million drop in Identity Management solutions.
• Revenue Stability (YTD): For the six months ended June 30, revenue decreased only 2.0% to $117.0 million, as service revenue growth offset product declines.
• Margin Improvement: Gross margin improved to 21.6% in Q2 2010 from 17.6% in Q2 2009, primarily due to a change in program mix and the absence of a $0.6 million loss on a Secure Networks project that occurred in the prior year.
• Debt Restructuring: On May 17, 2010, the company amended its credit facility, extending the maturity to 2014, increasing the limit to $30 million, and adding a $7.5 million term loan. Proceeds were used to fully repay $4.2 million in Senior Subordinated Notes.
• Profitability: Net income attributable to Telos Corporation decreased 35.6% in Q2 to $0.4 million but improved year-to-date from a net loss of $18,000 in 2009 to net income of $0.2 million in 2010.

Guidance, Outlook, and Risks

• Liquidity: The company relies heavily on its revolving credit facility with Wells Fargo for liquidity. As of June 30, 2010, there was $11.7 million in unused borrowing availability. Management believes this is sufficient to meet needs through the second quarter of 2011.
• Backlog: Total backlog decreased to $588.1 million from $636.4 million in the prior year. Funded backlog was $86.8 million.
• Preferred Stock Obligations: The company has significant obligations related to Senior Redeemable Preferred Stock ($10.5 million carrying value) and Public Preferred Stock ($102.9 million carrying value). Dividends on these instruments are accrued as interest expense. The company is currently precluded from redeeming these securities due to covenants in its credit facility.
• Legal Proceedings: Significant ongoing litigation includes Costa Brava Partnership III v. Telos Corporation, involving claims regarding the classification of Public Preferred Stock and dividend payments. An appeal is pending before the Maryland Court of Special Appeals. Additionally, there is litigation involving Class D Directors regarding interference with auditors and indemnification requests.
• Outlook: Management anticipates a continued need for a credit facility similar to the current one to meet long-term operational and debt service requirements.

Investor Verification Checklist

• Credit Facility Covenants: Verify continued compliance with EBITDA and recurring revenue covenants under the Wells Fargo facility, as default could trigger immediate repayment obligations.
• Preferred Stock Redemption: Confirm the status of the $113.4 million in redeemable preferred stock liabilities and the feasibility of future redemption given current cash flow and covenant restrictions.
• Legal Outcomes: Monitor the resolution of the Costa Brava appeal and the Class D Director litigation, as adverse rulings could impact capital structure or result in significant financial penalties.
• Revenue Mix: Assess the sustainability of the shift from product sales to service revenue, which drove margin improvements but may face different growth dynamics.
• Working Capital: Review the trend in accounts receivable and inventory levels to ensure the borrowing base for the credit facility remains stable.