TLS

Business Context and Reporting Period

Company: Telos Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2009
Business Overview: Telos is an information technology leader providing secure solutions (networks, messaging, identity management, and information assurance) primarily to U.S. federal government, military, and intelligence agencies. The company operates through subsidiaries including Xacta Corporation, Teloworks, Inc., and a 60% interest in Telos Identity Management Solutions, LLC.

Key Financial Metrics

Debt and Liquidity:

• Senior Revolving Credit Facility: $9.2 million outstanding; $10.6 million unused availability. Matures September 30, 2011.
• Senior Subordinated Notes: $4.2 million outstanding. Interest rates 14%-17%.
• Capital Lease Obligations: $7.7 million total ($0.8 million current).
• Redeemable Preferred Stock: $111.3 million total carrying value (classified as liability). Includes $10.3 million Senior and $101.0 million Public Preferred Stock. No dividends paid since 1991 on Public Preferred Stock due to contractual restrictions.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 27.0% to $275.7 million, driven by a 54.8% increase in product revenue ($162.9 million) due to sales of Telos-manufactured technology solutions under U.S. Air Force NETCENTS and U.S. Army ADMC-2 contracts. This was partially offset by a decrease in Identity Management sales.
• Margin Compression: Gross margin decreased from 20.4% to 16.6%. Management attributed this to a mix of contracts, an estimated loss on a contract recognized in 2009, and increased product reselling activities which have lower margins than manufactured solutions.
• Net Income Decline: Net income attributable to Telos Corporation dropped significantly from $10.7 million to $1.3 million. This was primarily due to a $4.3 million income tax provision in 2009 (utilization of net operating loss carryforwards) compared to a $5.7 million tax benefit in 2008 (release of valuation allowance on deferred tax assets).
• Balance Sheet Expansion: Total assets increased 67% to $104.9 million, largely due to a significant increase in inventory ($32.6 million vs. $7.1 million) caused by drop-shipped products in transit at year-end.

Guidance, Outlook, and Risks

Outlook and Guidance:
The filing does not provide specific numerical guidance for 2010 revenue or earnings. Management anticipates capital expenditures of approximately $2.2 million in 2010. They believe available cash and borrowings under the credit facility will be sufficient to meet operating and debt service needs.

Key Risks and Contingencies:

• Liquidity Dependence: The company relies almost entirely on a $25 million revolving credit facility with Wells Fargo Foothill for liquidity. Availability is tied to accounts receivable. Failure to maintain covenants or access to this facility would severely impact operations.
• Customer Concentration: 98.6% of revenue is derived from the U.S. Government. Changes in defense spending, budget delays, or contract terminations pose significant risks.
• Preferred Stock Obligations: The company has $111.3 million in redeemable preferred stock classified as liabilities. While not currently due on demand, the inability to redeem these instruments and the associated accrued dividends (recorded as interest expense) create a substantial long-term financial burden.
• Legal Proceedings: Ongoing litigation with holders of Public Preferred Stock (Costa Brava Partnership III, L.P. et al.) regarding dividend payments and corporate governance. The company is vigorously defending against claims, but outcomes remain uncertain.

Investor Verification Checklist

• Credit Facility Status: Verify current compliance with EBITDA covenants and the status of the Wells Fargo Foothill revolving credit facility, as it is the primary source of liquidity.
• Preferred Stock Redemption: Review the terms and potential triggers for the $111.3 million redeemable preferred stock liability and the impact of accrued dividends on future cash flows.
• Government Contract Backlog: Assess the funded vs. unfunded backlog ($156.8 million funded vs. $665.6 million total) and the risk of funding delays given the heavy reliance on U.S. Government appropriations.
• Inventory Levels: Investigate the composition of the $32.6 million inventory balance to ensure it is not obsolete, given the sharp increase from the prior year.
• Legal Litigation: Monitor the status of the Costa Brava and Class D Director lawsuits, as adverse rulings could impact governance or financial obligations.