TELOS CORP 10-Q Summary: Period Ended September 30, 2008
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2008, and the nine-month period ended on the same date. Telos Corporation is an information technology solutions and services company serving U.S. Government and commercial customers. The company focuses on secure enterprise solutions, including Secure Networks, Information Assurance, Secure Messaging, and Identity Management. As of January 1, 2008, the company ceased reporting multiple operating segments, consolidating its Managed Solutions segment under the Secure Networks business line to focus on higher-margin offerings.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended Sep 30, 2008 | 9 Months Ended Sep 30, 2008 |
|---|---|---|
| Total Revenue | $56,638 | $150,729 |
| Operating Income | $4,023 | $11,139 |
| Net Income | $796 | $3,838 |
| Gross Margin | 22.5% | 21.6% |
| Cash and Equivalents | $22 | N/A (Balance Sheet Item) |
| Working Capital | $8,000 | N/A (Balance Sheet Item) |
| Total Debt & Preferred Stock (Liabilities) | $132,100 | N/A (Balance Sheet Item) |
Note: Cash flow from operating activities was negative $4.3 million for the nine months ended September 30, 2008.
Material Changes vs. Prior Period
- Revenue: Total revenue decreased 7.1% in the third quarter and 7.3% for the nine months compared to 2007. This was driven by a significant decline in product reselling revenue (down 23.9% QoQ and 32.2% YoY) as the company shifted focus to higher-margin services. Conversely, services revenue increased 24.2% in the quarter and 31.1% for the nine months.
- Profitability: Operating income increased 38.3% in the quarter and 2.9% for the nine months. Gross margin improved to 22.5% in the quarter (from 14.8% in 2007) due to the shift toward services and a $1.1 million warranty liability adjustment in Q1 2008.
- Net Income: Net income for the quarter rose 136.3% to $0.8 million. However, net income for the nine months dropped 61.1% to $3.8 million, primarily due to a one-time $5.8 million gain on the sale of TIMS LLC membership interest recorded in the prior year (2007) which was not present in 2008.
- Expenses: Selling, general, and administrative (SG&A) expenses increased 43.8% in the quarter due to litigation-related costs, though they decreased 4.8% for the nine-month period.
Guidance, Outlook, Risks, and Contingencies
- Liquidity and Capital Resources: The company relies heavily on a $25 million senior revolving credit facility with Wells Fargo Foothill. As of September 30, 2008, outstanding borrowings were $14.3 million with $10.7 million in unused availability. Management believes this facility is sufficient to meet needs through 2009.
- Debt Obligations: The company carries significant long-term liabilities, including $105.9 million in redeemable preferred stock (classified as liabilities under SFAS 150) and $4.2 million in senior subordinated notes. The company has not declared dividends on preferred stock since 1991 due to legal and covenant restrictions.
- Legal Proceedings:
- Costa Brava Partnership III v. Telos: A lawsuit filed by holders of Public Preferred Stock alleging failure to pay mandatory dividends and redeem stock. While many counts were dismissed, the plaintiffs filed a Notice of Appeal in February 2009. The company denies the claims.
- Hamot et al. v. Telos: Litigation involving Class D Directors regarding access to documents and interference with the company's auditors. A preliminary injunction was granted against the directors in June 2008, prohibiting contact with auditors. An appeal regarding this injunction was pending before the Court of Special Appeals of Maryland as of the filing date.
- Going Concern: The financial statements are prepared assuming the company will continue as a going concern. However, the company notes that an unfavorable outcome in its legal matters could have a material adverse effect on its financial position.
Investor Verification Checklist
- Credit Facility Covenants: Verify continued compliance with EBITDA covenants under the Wells Fargo Foothill facility, as this is the primary source of liquidity.
- Legal Outcomes: Monitor the status of the appeals in the Costa Brava and Hamot litigation, as adverse rulings could impact capital structure or operations.
- Preferred Stock Liability: Confirm the classification and accrued dividend obligations of the $105.9 million in redeemable preferred stock, which significantly impacts the balance sheet and interest expense.
- Revenue Mix: Assess the sustainability of the shift from low-margin product reselling to higher-margin services and government contracts (e.g., DMDC, NETCENTS).
- Cash Flow: Review the negative operating cash flow of $4.3 million for the nine-month period and the company's ability to fund operations without further dilution or debt restructuring.