Telos Prevails After 3 Years Of Battling Shareholder

Judge Dismisses Final Counts of Shareholder Lawsuit

By Kendra Marr

Monday, April 21, 2008

After three years of litigation and allegations that its directors were abusing millions of dollars of company funds, Telos has prevailed over an investor’s efforts to force it to pay dividends it said it could not afford.

Last week, a Baltimore City Circuit Court judge dismissed the final counts of a lawsuit by activist hedge fund Costa Brava Partnership against Telos, a defense technology contractor in Ashburn. The ruling was the most recent episode in the drawn-out, complicated showdown between the parties.

“We feel vindicated,” said John B. Wood, Telos’s longtime chief executive. “When people attack our integrity and whether or not we’re trustworthy, being a security company, we didn’t have any other choice but to fight. So much of our brand is tied up with whether or not our customers can trust us.”

Wood said his company has spent more than $10 million battling Costa Brava, a Boston-based investment fund managed by Roark, Rearden & Hamot Capital Management in New York.

“The amount of time and energy it took away from our core business was very debilitating,” Wood said.

Costa Brava issued a statement saying it was “disappointed in the judge’s decision.”

The heart of the dispute is Telos’s stock structure. Telos is privately owned. British millionaire John R. C. Porter owns 80 percent of its common stock. The rest is controlled by Telos management and employees.

In a 1989 leveraged buyout, which saddled the company with debt, Telos issued a publicly traded form of preferred stock. It deferred the dividends on that stock in 1995. And when payments came due again in 2005, the company’s charter barred it from redeeming the preferred stock while it was still in the red.

In 2005, Costa Brava began buying the preferred stock, about 16 percent of Telos, at a steep discount to its face value.

In a lawsuit the same year — filed in Maryland, where Telos was then incorporated — Costa Brava asserted that the Telos board paid its executives too much salary given its financial troubles and that it owed the hedge fund at least $79 million in unpaid dividends. Wood was paid $1.06 million in salary and $1.23 million in cash bonuses from 2002 to 2004.

Telos began auditing itself, appointing independent members of the board to investigate the issues in Costa Brava’s suit.

That was only the beginning. In the next two years, a series of motions were filed and ruled upon by the court, including a Costa Brava plan to put Telos into receivership, thereby seizing control from existing management, to protect the hedge fund’s claims. Costa Brava alleged that Porter was siphoning cash from the company in the form of fees and high interest on loans he made to Telos. The motion was denied.

In 2006, the hedge fund sent letters to Telos’s board, alleging the firm had misstated a decade’s worth of financial statements and called for the resignations of Woods and Chief Financial Officer Michele Nakazawa, both of whom are still with the company.

The board then discovered that David Borland, a director and chairman of the audit committee, had used the company-owned golf club membership. Though Borland had paid the expenses himself, it was seen as a conflict with his audit duties.

Borland stepped down as chairman of the committee. Six more directors, or more than half of the board, resigned shortly after.

Through it all, Telos held strong that Costa Brava was too hasty in demanding payment, while Costa Brava continually pressed for the sale of the company or assets to pay for the redemption of its preferred shares.

Last year, in a related case, the hedge fund won a civil suit in Fairfax County against Telos’s accounting firm, Goodman & Co., on charges of aiding and abetting a breach of fiduciary duty.

Seth Hamot and Andrew Siegel, partners at Roark, Reardon & Hamot, joined Telos’s board during an election at a special shareholder meeting.

This year, Telos’s fortunes turned. In January, Baltimore Circuit Court Judge Albert J. Matricciani Jr. dismissed several parts of the lawsuit, clearing the board’s directors and officers of wrongdoing.

And on Tuesday, Matricciani dismissed the hedge fund’s remaining counts, calling it a “third bite at the apple.”

“As a result of the Court’s ruling on the present motion,” Matricciani wrote, “it will come to an end, at least in this forum.”

In recent years, Telos’s business with the Defense Department has been booming. But, assuming Telos continues to make $10 million each year, Woods predicts the company still won’t be able to pay the dividends for an additional 10 years.

Tagged: business, business_news, Telos

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