TELOS CORP - 10-Q Summary (Period Ended June 30, 2006)
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2006, and the six months ended June 30, 2006, for Telos Corporation. The Company operates in two primary segments: Managed Solutions (government IT integration and services) and Xacta (secure enterprise solutions for the U.S. Government and financial institutions). The Company derives substantially all of its revenue from U.S. Government contracts, subject to seasonal fluctuations with higher activity typically occurring in the third and fourth fiscal quarters.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2006 |
Six Months Ended June 30, 2006 |
|---|---|---|
| Total Revenue | $35,813 | $60,987 |
| Operating Income (Loss) | $14 | $(5,904) |
| Net Loss | $(13,900) | $(22,019) |
| Interest Expense | $(13,919) | $(16,038) |
| Cash from Operating Activities | N/A | $1,504 |
| Cash and Equivalents (End of Period) | $64 | $64 |
| Working Capital Deficit | $(9,591) | $(9,591) |
| Total Debt & Preferred Stock (Liabilities) | $120,400 | $120,400 |
Note: Working Capital Deficit calculated as Current Assets ($30,799) minus Current Liabilities ($40,390).
Material Changes vs. Prior Period
- Revenue: Revenue increased 45.7% year-over-year for the quarter ($35.8M vs. $24.6M) driven by growth in Xacta's Secure Messaging and IA Services lines and Managed Solutions' NETCENTS contract. For the six-month period, revenue was relatively flat, increasing only 2.3% ($61.0M vs. $59.6M).
- Profitability: The Company reported a net loss of $13.9M for the quarter, compared to a $5.3M loss in the prior year quarter. The six-month net loss widened to $22.0M from $5.9M.
- Interest Expense: Interest expense surged to $13.9M for the quarter (from $2.1M) and $16.0M for the six months (from $4.3M). This increase is primarily due to a $9.9M non-cash charge in Q2 2006 related to a change in accounting estimate for accrued dividends on Public Preferred Stock (shifting from Paid-in-Kind to cash accrual basis).
- Segment Performance: Xacta segment profit improved to $1.1M for the quarter from a $2.3M loss in the prior year. Managed Solutions reported a loss of $1.1M for the quarter, down from a $0.9M loss, with gross margins compressed due to pricing pressure and working capital constraints.
Guidance, Outlook, Risks, and Unusual Items
- Liquidity and Going Concern: The Company reports a working capital deficit of $9.6M. Financial statements are prepared on a going concern basis. Liquidity is constrained by legal expenses ($3.7M net litigation costs in H1 2006) and seasonal revenue patterns. The Company expects liquidity to improve in Q3 and Q4 2006 due to anticipated government orders.
- Strategic Alternatives: The Company has engaged Jefferies Quarterdeck to explore strategic alternatives, including the sale of the Xacta subsidiary or lines of business, to recapitalize the balance sheet. In August 2006, the Board expanded this process to include the potential sale of the entire Company.
- Debt Covenants: The Company is currently in compliance with its Senior Revolving Credit Facility covenants. However, a $3.0M over-advance expired in July 2006, leaving only ~$1.0M in availability. The Company is negotiating to resume the over-advance and increase the credit line.
- Legal Proceedings: A significant derivative lawsuit filed by holders of Public Preferred Stock (Costa Brava and Wynnefield) alleges failure to pay mandatory dividends and seeks the appointment of a receiver. Plaintiffs have sought a preliminary injunction to prevent the sale of Xacta assets. The trial is set for April 2007.
- Preferred Stock: The Company has not paid dividends on its Public Preferred Stock since 1991. Accrued dividends and accretion on preferred stock classified as liabilities totaled $94.1M as of June 30, 2006.
Investor Verification Checklist
- Debt Restructuring Status: Verify the outcome of negotiations with Wells Fargo Foothill regarding the resumption of the $3.0M over-advance and the potential $10M credit line increase.
- Strategic Sale Progress: Monitor the status of the sale process for Xacta or the entire Company, including any definitive agreements or regulatory approvals.
- Litigation Impact: Assess the risk of the preliminary injunction regarding the sale of Xacta assets and the potential financial impact of the derivative lawsuit (receiver appointment or damages).
- Government Contract Backlog: Confirm the conversion of the $129M backlog (of which $72.3M is funded) into revenue, particularly given the seasonal nature of government spending.
- Preferred Stock Obligations: Review the Company's ability to meet future redemption schedules for Senior and Public Preferred Stock, given the current liquidity constraints and Maryland law restrictions.