Business Context and Reporting Period
Company: Telos Corporation (Telos)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: Telos provides information technology solutions and services to U.S. Government and commercial customers. The company operates four business lines: Secure Networks, Information Assurance, Secure Messaging, and Identity Management. As of November 8, 2009, the company had 33,552,968 shares of Class A Common Stock and 4,037,628 shares of Class B Common Stock outstanding.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2009 |
|---|---|---|
| Total Revenue | $71,582 | $190,884 |
| Cost of Sales | $57,844 | $156,968 |
| Gross Profit | $13,738 | $33,916 |
| Operating Income | $4,850 | $8,564 |
| Net Income (Total) | $1,086 | $1,574 |
| Net Income Attributable to Telos | $880 | $863 |
| Cash and Cash Equivalents | $359 | $359 (Ending Balance) |
| Working Capital | $14,700 | $14,700 (Ending Balance) |
| Total Debt & Preferred Stock (Liabilities) | $133,500 (Approx.) | $133,500 (Approx.) |
Note: All figures are in thousands unless otherwise noted. Net income attributable to Telos excludes non-controlling interest.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 26.4% for the quarter and 26.6% for the nine-month period compared to 2008. This was driven primarily by a $22.5 million increase in Secure Networks sales for the quarter and a $42.1 million increase for the nine-month period.
- Margin Compression: Despite revenue growth, gross margins declined. For the nine months ended September 30, 2009, gross margin decreased to 17.8% from 21.6% in the prior year, attributed to a decrease in sales of higher-margin proprietary software and a loss on a long-term Secure Networks project.
- Operating Income: Operating income increased 20.6% for the quarter ($4.9M vs $4.0M) but decreased 23.1% for the nine-month period ($8.6M vs $11.1M) due to higher Selling, General, and Administrative (SG&A) expenses.
- Cash Flow: Cash provided by operating activities improved significantly to $2.1 million for the nine months ended September 30, 2009, compared to a use of $4.3 million in the same period in 2008.
- Backlog: Total backlog decreased to $700.7 million from $742.2 million in the prior year. Funded backlog was $191.1 million.
Guidance, Outlook, Risks, and Contingencies
Liquidity and Capital Resources
Telos relies heavily on a $25 million revolving credit facility with Wells Fargo Foothill, maturing September 30, 2011. As of September 30, 2009, outstanding borrowings were $12.0 million with $5.7 million in unused availability. The company is currently in compliance with financial covenants, including EBITDA requirements.
Debt and Preferred Stock Obligations
The company carries significant long-term obligations classified as liabilities:
- Senior Subordinated Notes: $4.2 million outstanding, maturing December 31, 2011, with interest rates between 14% and 17%.
- Redeemable Preferred Stock: Total carrying value of approximately $110.2 million (including accrued dividends). This includes Senior Redeemable Preferred Stock ($10.2M) and Public Preferred Stock ($100.0M). The company has not declared or paid dividends on the Public Preferred Stock since 1991 due to legal and financial restrictions.
Legal Proceedings
Costa Brava Partnership III, L.P. v. Telos Corporation: An appeal regarding the classification of Public Preferred Stock and alleged breach of fiduciary duties remains pending before the Court of Special Appeals of Maryland. The company vigorously denies the claims.
Hamot et al. v. Telos Corporation: Litigation involving Class D Directors regarding access to information and interference with auditors is ongoing. A preliminary injunction against the directors regarding auditor interference was issued, and an appeal of that injunction was dismissed as moot. A petition for constructive civil contempt remains pending.
Risks
Key risks include the company's dependence on the Wells Fargo credit facility for liquidity, the potential inability to meet redemption schedules for preferred stock, and the impact of ongoing litigation on management focus and potential financial liability.
Investor Verification Checklist
- Credit Facility Compliance: Verify continued compliance with EBITDA covenants under the Wells Fargo facility, as this is the primary source of liquidity.
- Preferred Stock Status: Confirm the legal status and potential redemption triggers for the $110.2 million in redeemable preferred stock liabilities.
- Margin Trends: Monitor the mix of revenue between low-margin product reselling and high-margin proprietary software/services to assess future profitability.
- Legal Outcomes: Track the status of the Costa Brava and Hamot litigation appeals and petitions, as adverse rulings could impact financial position or governance.
- Backlog Funding: Assess the ratio of funded vs. unfunded backlog ($191.1M funded vs. $509.6M unfunded) to gauge revenue certainty.