Business Context and Reporting Period
Company: Telos Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: Telos is an information technology leader providing secure solutions (secure networks, information assurance, secure messaging, and identity management) primarily to U.S. Government military, intelligence, and civilian agencies. Approximately 83.5% of revenue is derived from firm fixed-price contracts. The company operates as a single reporting segment following a reorganization in late 2007.
Key Financial Metrics
| Metric | 2008 | 2007 | 2006 |
|---|---|---|---|
| Revenue | $217.1 million | $226.6 million | $140.9 million |
| Operating Income | $14.6 million | $9.4 million | ($9.0 million) |
| Net Income | $10.7 million | $5.5 million | ($29.7 million) |
| Gross Margin | 20.4% | 18.4% | 15.5% |
| Operating Margin | 6.7% | 4.2% | (6.4%) |
| Total Assets | $62.7 million | $67.5 million | $48.5 million |
| Total Liabilities | $172.7 million | $188.5 million | N/A |
| Working Capital | $10.8 million | ($0.4 million) | N/A |
| Debt Obligations | $130.9 million | $135.4 million | N/A |
Note: Debt obligations include $12.2 million in senior revolving credit facility, $4.2 million in senior subordinated notes, $7.6 million in capital lease obligations, and $107.0 million in redeemable preferred stock classified as liabilities.
Material Changes vs. Prior Period
- Revenue Decline: Revenue decreased 4.2% to $217.1 million, driven by a 25.7% drop in product revenue (due to outsourcing of reselling activities) partially offset by a 31.7% increase in services revenue.
- Profitability Improvement: Operating income increased 56.2% to $14.6 million, and Net Income nearly doubled to $10.7 million. This was significantly aided by a $5.7 million income tax benefit resulting from the release of a valuation allowance on deferred tax assets.
- Margin Expansion: Gross margin improved to 20.4% from 18.4% as the company shifted focus from low-margin product reselling to higher-margin services and solutions.
- Backlog Surge: Total backlog increased dramatically to $692.9 million from $118.5 million in 2007, though funded backlog was $177.7 million.
- Cash Flow: Cash used in operating activities was $0.3 million, compared to $0.1 million provided in 2007. Investing activities provided $3.4 million due to the maturity of restricted investments.
Guidance, Outlook, Risks, and Contingencies
- Liquidity and Capital Resources: The company relies heavily on a $25 million revolving credit facility with Wells Fargo Foothill. As of year-end, $12.2 million was outstanding with $3.8 million available. Management believes this is sufficient for 2009 needs.
- Preferred Stock Obligations: The company has $107.0 million in redeemable preferred stock classified as liabilities. Due to covenants in the credit facility and Maryland law restrictions, the company is currently precluded from redeeming these shares or paying dividends, despite scheduled redemption dates.
- Customer Concentration: 98.6% of revenue is derived from the U.S. Government, with 80.3% from the Department of Defense. This creates significant risk regarding budget cycles and contract terminations.
- Legal Proceedings:
- Costa Brava Litigation: Shareholders of Public Preferred Stock sued regarding dividend payments and redemption. The Circuit Court dismissed most claims in 2008, but plaintiffs appealed to the Court of Special Appeals. The company is vigorously defending the appeal.
- Class D Directors Dispute: Two Class D directors (Hamot and Siegel) are involved in litigation regarding access to documents and interference with the company's auditors. A preliminary injunction was granted against them to cease contact with auditors.
- Accountant Changes: The company changed auditors twice recently. Reznick Group resigned in April 2008 citing impaired independence due to communications from Class D directors. BDO Seidman, LLP was engaged in September 2008.
Investor Verification Checklist
- Liquidity Sufficiency: Verify the company's ability to maintain the $25 million credit facility and meet EBITDA covenants given the heavy reliance on this single source of liquidity.
- Preferred Stock Liability: Assess the long-term impact of the $107 million preferred stock liability and the inability to service or redeem it due to legal and contractual restrictions.
- Backlog Realization: Scrutinize the $692.9 million total backlog, noting that only $177.7 million is funded, and evaluate the risk of unfunded portions not being exercised by the government.
- Legal Outcomes: Monitor the status of the Costa Brava appeal and the Class D director litigation, as adverse rulings could impact governance or financial obligations.
- Revenue Mix Sustainability: Confirm the continued shift from product reselling to services and the stability of the Department of Defense contracts driving the backlog increase.