UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-K

 


x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) THE SECURITIES
EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 20022003

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)15 (D) THE SECURITIES
EXCHANGE ACT OF 1934

 

Commission file number: 1-8443

 


 

TELOS CORPORATION

(Exact name of registrant as specified in its charter)

 


Maryland

 

52-0880974

(State of Incorporation)

 

(I.R.S. Employer Identification No.)

19886 Ashburn Road, Ashburn, Virginia

 

20147

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s Telephone Number, including area code: (703) 724-3800

 


Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of the Act:

12% Cumulative Exchangeable Redeemable Preferred Stock, par value $.01 per share

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

No public market exists for the registrant’s Common Stock.

Title of Class


Number of Shares Outstanding

on December 31, 2003


Class A Common Stock, no par value

21,171,202

Class B Common Stock, no par value

4,037,628

Series A-1 Redeemable Preferred Stock, $.01 par value

1,250

Series A-2 Redeemable Preferred Stock, $.01 par value

1,750

12% Cumulative Exchangeable Redeemable Preferred Stock, $.01 par value

3,185,586

 

As of December 31, 2002, the registrant had 21,171,202 shares of Class A Common Stock, no par value; 4,037,628 shares of Class B Common Stock, no par value; and 3,185,586 shares ofThe registrant’s 12% Cumulative Exchangeable Redeemable Preferred Stock par value $.01 per share, outstanding.is traded on the NASDAQ/OTCBB Exchange.

 

INCORPORATION BY REFERENCE: None

None

 

Number of pages in this report (excluding exhibits): 6652

 



TABLE OF CONTENTS

PART I

Item 1.

Business3

Item 2.

Properties6

Item 3.

Legal Proceedings6

Item 4.

Submission of Matters to a Vote of Security Holders6

PART II

Item 5.

Market for the Registrant’s Common Equity and Related Stockholder Matters7

Item 6.

Selected Financial Data7

Item 7.

Management’s Discussion and Analysis of Results of Operations8

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk14

Item 8.

Financial Statements and Supplementary Data15

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure44

Item 9A.

Controls and Procedures44

PART III

Item 10.

Directors and Executive Officers of the Registrant45

Item 11.

Executive Compensation47

Item 12.

Security Ownership of Certain Beneficial Owners and Management50

Item 13.

Certain Relationships and Related Transactions52

Item 14.

Principal Accountant Fees and Services52

PART IV

Item 15.

Exhibits, Financial Statement Schedules, and Reports on Form 8-K53

Signatures

56


PART 1

 

Item 1. Business

 

History and Introduction

 

Founded in 1968, Telos Corporation (“Telos”(the “Company” or the “Company”“Telos”) delivers enterprise security andis a systems integration solutions and services tocompany addressing the U.S. Government worldwide. Telos addresses criticalinformation technology needs of federal government customers through itsworldwide. The Company also owns Xacta Corporation, a wholly-owned subsidiary, that develops, markets, and sells government-validated secure enterprise solutions in the area of secure wireless networking, secure message handling, secure local area networks (“LAN”) data integrationto government and enterprise risk management.commercial customers.

 

Our principle offices are located at 19886 Ashburn Road, Ashburn, Virginia 20147. Our home pageThe Company’s web site is www.telos.com.www.telos.com, and Xacta’s web site is www.xacta.com. You can learn more about the Company by reviewing ourits SEC filings on ourthe Telos web site. The SEC also maintains a web site atwww.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Telos.the Company. We make our website content available for information purposes only. It should not be relied upon for investment purposes, nor is it incorporated by reference into this Form 10-K.

 

Since 1996, Telos has identified and sold a number of business units that were considered as no longer material to its operational objectives and strategic direction. Most recently, in 2002 Telosthe Company sold its wholly owned subsidiary, Telos Corporation-California (TCC) for approximately $20 million dollars. In 2000, Telos contributed the net assets of its Ft Sill operations to a newly created joint venture with Oklahoma investors, resulting in a 50% ownership of TelosOK LLC for consideration of $9 million dollars consisting of cash, accounts receivable and a note receivable. The Company sold the remaining 50% ownership in TelosOK LLC in March 2003. See Note 13 Subsequent Events3 – Sale of TelosOK LLC for more information. In 1999, Enterworks, a2002 the Company sold its wholly-owned subsidiary, Telos Corporation-California (TCC) for approximately $20 million. See Note 4 – Sale of Telos was significantly funded by third parties and deconsolidated from Telos. Telos presentlyCorporation (California).

The Company also owns 21.5% of Enterworks, Stock.Inc. (“Enterworks”). See Note 2 – Investment in Enterworks for more information.

 

Reportable Operating Segments

 

The Company’s operations, as ofFor the year ended December 31, 2002, are comprised2003, Telos generated revenue of two operating segments:$88.4 million. Prior to December 2003, the Products Group and Xacta Corporation (“Xacta”), a wholly owned subsidiary. Prior to July 2002, were the Company had threeCompany’s two operating segments. The third operating segment, Systems and Supports Services consisting primarily of a wholly owned subsidiary, Telos Corporation-California (TCC), was sold on July 19, 2002 and

Xacta is being treatedrecognized as a discontinued operation according to SFAS 144. For additional information related to this transaction referleading provider of secure enterprise solutions to the Consolidated Financial Statements Note 4 – SaleU.S. Government and financial services organizations. In order to take advantage of the Xacta brand strength, Telos Corporation-California. All historical financial informationhas initiated the consolidation of all of its security-related offerings into Xacta. Additionally, such consolidation will simplify the messages and offerings of the respective segments for the Company’s customers, partners, and employees. In particular, the Company’s wireless and messaging solutions have been consolidated into Xacta and accordingly will be reported in such manner. It is the Company’s intention to re-brand the wireless and messaging lines in 2004 from “Telos” to “Xacta” offerings connoting the secure aspects of these solutions. In addition, the Products Group has been reclassified to be consistent with the current segment presentation. Financial information with respect to the Company’s operating segments appear in Note 12, “Reportable Business Segments”, in the Notes to Consolidated Financial Statements.renamed “IT Solutions Group” (see below).

 

ProductsThe IT Solutions Group:The IT Solutions Group: develops, markets and sells integration services and value-added reseller offerings that address a wide range of Government Information Technology (“IT”) requirements. The Company’s ProductsIT Solutions Group delivers solutions that combine information technology products and services to address various customer issues and requirements. Solutions from the Products Groupofferings consist of a combination of commercial-off-the-shelfreselling commercial-off-the-shell (“COTS”) products from major original equipment manufacturers (“OEMs”), which are augmented by Telos proprietary products, Telos and subcontractorwith various value-added support services. The IT Solutions Group also provides professional services and Telos proprietary practices. Product lines include, among others, secure wireless networking and secure messaging solutions. Telos’ secure wireless networking solutions enable customers to securely access databases from non-networked locations thereby permittingthat support various Federal Government integration programs. For 2003, the customer to safely and securely perform its required tasks. Telos’ secure messaging solution, known as the Automated Message Handling System (“AMHS”), is a recognized standard within the Department of Defense. The AMHS solution enables users to securely access, send, search, and profile message traffic. For 2002, the ProductsIT Solutions Group generated revenue of $78.8$41.7 million, down 20.1% from 2001 due in part towhich represents a $8.7 million decrease in revenue from product lines that the company has closed out, a delay in the roll-out of the wireless solution, and lower commodity sales in our IS-1 and U.S. Courts contracts. The Products Groups’ revenue represents 87.1% of the Company’s total reported consolidated revenue for19.9% over 2002. Customers of the Products Group are primarily agencies of the U.S. Government including the military services, various other Defense Agencies, the Treasury Department, the U.S. Courts and various other civilian agencies of the U.S. Government.

 

Xacta CorporationCorporation:: Xacta, while established in February of 2000 to address the growing demand for secure enterprise solutions, is the successor to the Company’s fifteen years of experience in security services with the U.S. Government. Today Xacta develops, enterprise risk management softwaremarkets and relatedsells government-validated secure enterprise solutions to help organizations to proactively manage and monitor the security of their network environments in accordance with internationally recognized industry and security standards. Xacta has developed and sells two products: Xacta Web C&A and Xacta Commerce Trust. Xacta Web C&A automates the rigorous and time-consuming process of security certification and accreditation. Xacta Web C&A simplifies certification and accreditation by guiding users through a step-by-step process which determines the customer’s information security posture and assesses system and network configuration compliance with applicable regulations, standards, and industry best practices and processes. With Xacta Commerce Trust, organizations are able to perform holistic security risk management on a continuous basis in accordance with internationally recognized industry standards and best practices. For 2002, Xacta generated revenue of $11.7 million, down 13.7% from 2001 due to decreased orders for its information security products and solutions, which represents 12.9% of the Company’s total

Page 2 of 69


consolidated revenue for 2002. Xacta currently sells its solutions to agencies of the U.S. Government, state and local agencies,government, and commercial customers. Xacta’s solutions have been validated by leading U.S. government organizations. For example, our Organizational Messaging solution is certified by the Defense Information Systems Agency. Our Wireless Maintenance solution has been approved as part of the Air Force Infrastructure Technology Resource Model and has integrated security enabling it to comply with Federal Information Processing Standards (“FIPS”) and stringent Air Force connection approval requirements, such as Certificate to Operate and NIPRNET accreditation. Additionally, our Security Management solutions are the only products of their type to comply with the U.S. Government’s mandatory certification process (National Information Assurance Partnership (“NIAP”), i.e., NSTISSP 11). Each of these qualifications evidences the fact that Xacta solutions are government-validated and serve as significant competitive differentiators for Xacta.

Xacta products and services include a wide range of security management solutions to include certification and accreditation, vulnerability identification and remediation solutions, perimeter security management, operational security management, as well as federally insured depository institutions.high assurance credentialing solutions. Additionally Xacta, consistent with the consolidation referenced above, provides organizational messaging and wireless maintenance solutions. For 2003, Xacta generated revenue of $46.7 million which represents an increase of 21.6% over 2002.

 

Page 3 of 60


SystemsMajor Markets and Support Services (sold July 2002): This group provides post-deployment and post-production software and systems development and support services including technology insertion, systems redesign and software re-engineering. The Group’s principal operations are located in proximity to its largest customer, the U.S. Army’s Communications and Electronics Command (“CECOM”), located at Fort Monmouth, NJ.Significant Activities

 

This Group consistedTelos operates in a highly competitive marketplace. The Company obtains the majority of its business in response to competitive requests from potential and current customers. Additionally, Telos faces indirect competition from certain government agencies that perform “in-house” services similar to those provided by Telos. The Company knows of no single competitor that is dominant in its relative fields of technology, solutions and services.

The entire range of Telos’ services and solutions are offered to U.S. Government agencies and state and local governments. Accordingly, the Company must maintain expert knowledge of federal, state and local agency policies and operations. The Company’s work for U.S. Government agencies in many instances combine a wide range of skills drawn from each of its major product and service offerings. The Company’s commercial client base consists primarily of federally insured depositories which have purchased Xacta’s solutions and large defense and aerospace organizations.

Decisions regarding contract awards by the Company’s U.S. Government customers typically are based on assessment of the quality of Telos’ past performance, responsiveness to proposal requirements, uniqueness of the offering itself, price, and other competitive factors.

Telos has strategic business relationships with certain companies in the information technology industry. These strategic partners have business objectives compatible with those of the Company, and offer products and services that complement those of the Company’s. The Company intends to continue development of such relationships wherever they support its marketing, growth and service offering objectives.

Marketing and new business development for the Company is undertaken by virtually all officers and managers of the Company, including the chief executive officer, executive officers, vice presidents, and division managers. The Company employs marketing, new business development and sales professionals who identify and qualify contract and sales opportunities, primarily in the U.S. Government marketplace. The Company’s proprietary software systems are sold primarily by full time sales persons. The Company also has established agreements for the resale of certain third party software products.

The majority of the Company’s wholly owned subsidiary, TCC, which was sold on July 19, 2002. The company has excluded this group from its operating revenuesbusiness is awarded through submission of formal competitive bids. Commercial bids are frequently negotiated as to terms and expensesconditions for schedule, specifications, delivery and reported as a discontinued operation accordingpayment. However, with respect to SFAS 144.bids for U.S. Government proposals, in most cases the customer specifies the terms, conditions and form of the contract. In situations where the customer-imposed contract type and/or terms appear to expose the Company to inappropriate risk, the Company may seek alternate arrangements or opt not to bid for such potentially high risk work.

 

Results fromEssentially all contracts with the SystemsUnited States Government, and Support Services Groupmany contracts with state and local government agencies, permit the customers to terminate the contract at Ft. Sill were also included in this groups financial results until its deconsolidation in July 2000. During July 2000any time at their convenience or for default by the Company contributed its Ft. Sill business to TelosOK LLC.contractor. The Company remained asacknowledges the prime contractorrisk that such terminations may occur and therefore have a material, adverse impact on operations. Throughout the Ft. Sill contract until March 2002 when the contract was novated byCompany’s 35 years in business, such terminations have been rare and, generally, have not materially and adversely affected operations. As with other companies that do business with the U.S. Government, to TelosOK LLC. The Company sold its remaining interest in TelosOK LLC March 10, 2003. More information with respect to the sale of the Company’s interest in TelosOK LLC appears in Note 13, “Subsequent Events”business is subject to funding decisions and actions that are beyond its control. The Company’s contracts and subcontracts are generally composed of a wide range of contract vehicles including indefinite delivery/indefinite quantity (“IDIQ”) and government-wide acquisition contracts (known as “GWACS”) which are generally firm fixed-priced or time-and-materials contracts. For 2003, the Company’s revenue derived from fixed price and time and material contracts was 80.7% and 19.3%, in the Notes to Consolidated Financial Statements which note is hereby incorporated by reference.

Revenue by Major Market and Significant Customersrespectively.

 

The Company derived 95.8%, 96.7% and 94.2%substantially all of its revenues from contracts and subcontracts with the U.S. Government in 2002, 2001 and 2000, respectively. Total consolidated revenue derived fromGovernment. Revenue by customer sector for the U.S. Government for includes 31.6%, 36.2% and 43.8% of revenue from contracts with the United States Army for 2002, 2001 and 2000, respectively, 24.2%, 34.1% and 34.3% of revenue with other Department of Defense customers for 2002, 2001 and 2000, respectively, and 32.0%, 29.7% and 21.9% of revenue from Federal Civilian Agencies for 2002, 2001 and 2000, respectively. Revenue from Federal Civilian Agencies includes revenue of 49.4%, 70.8% and 71.6% for 2002, 2001 and 2000, respectively from the U.S. Courts.last three years is as follows:

 

Government Contracts

The U.S. Government is the Company’s primary customer. All U.S. Government contracts and subcontracts may be modified, curtailed or terminated at the convenience of the U.S. Government if program requirements or budgetary constraints change. In the event that a contract is terminated for convenience, the Company is generally reimbursed for its allowable costs through the date of termination and is paid a proportionate amount of the stipulated profit or fee attributable to the work actually performed.

Although in the past contract and program modifications, curtailments or terminations have not had a material adverse effect on the Company, no future assurance can be given that such modifications, curtailments or terminations will not have a material adverse effect on the financial condition or results of operations of the Company.

The Company’s business with the U.S. Government and other customers is generally performed under time-and-materials and fixed-price contracts. Under time-and-materials contracts, the Company is paid for labor hours at negotiated, fixed hourly rates and reimbursed for other allowable direct costs at actual costs plus allocable indirect costs. Under fixed-priced contracts, the Company is required to provide services or stipulated products for a fixed price. Because the Company assumes the risk of performing a firm fixed-price contract at a set price, the failure to accurately estimate ultimate final costs or to control costs during the contract performance could result, and in some instances has resulted, in reduced profits or losses for particular contracts.

During fiscal year 2002 approximately 77.3% and 22.7% of the Company’s revenues were derived from fixed-price and time-and-materials contracts, respectively.

Contract costs for services or products supplied to the U.S. Government, including allocated indirect costs, are subject to audit and possible adjustments to the approved provisional rates. These approved provisional rates are established at the beginning of each calendar year for billing, revenue, and pricing purposes. At the end of each calendar year, actual indirect rates are determined and submitted to DCAA through Incurred Cost Submissions for audit purposes of determining final audited indirect rates. These final audit indirect rates are used to “close-out” contracts for that calendar year and true-up contract billings and possible revenues for the calendar year on contracts that are still active and ongoing. Substantially all the Company’s indirect contract costs and final indirect rates have been agreed upon through calendar year 1995. Proposed actual year-end indirect rates and costs for calendar years 1996 through 1999 are currently under audit. Contract revenues for subsequent years have been recorded based on provisional rates and in some cases trued-up to year-end actual rates when “quick close-outs” are required and expected to be confirmed subject to the above referenced audit process. However, no assurance can be given that audits and adjustments for subsequent years will not result in decreased revenues or profits for such years.

Page 3 of 69


   2003

  2002

  2001

 
   (amount in thousands) 

Department of Defense

   $69,503  78.6% $58,960  65.2% $77,036  68.7%

Federal Civilian

   15,055  17.0%  27,728  30.6%  31,519  28.1%

Commercial

   3,885  4.4%  3,829  4.2%  3,633  3.2%
   

  

 

  

 

  

Total

  $88,443  100.0% $90,517  100.0% $112,188  100.0%
   

  

 

  

 

  

 

Competition

 

The segments of the industry in which the Company operates are highly fragmented with no single company or small group of companies in a dominant position. Some of the large competitors offer capabilities in a number of markets which overlap many of the same areas in which the Company offers services, while certain companies are focused upon only one or a few of thesesuch markets. TheSome of the firms that compete with the Company are computer services firms, applications softwareinclude: EDS, SAIC, and CSC as well as other small and mid-size firms. In addition, Xacta’s business competes with risk and compliance management companies, andorganizational messaging companies, security consulting firms, the computer service arms of computer manufacturingorganizations, as well as companies and defense and aerospace firms.that provide secure wireless offerings.

 

The Company believes that the principal competitive factors in the segmentsPage 4 of the enterprise integration and security solutions market in which it competes include project management capability, technical expertise, reputation for providing quality service, price and contract vehicles. The Company believes its technical competence in computer engineering, systems software, will enable it to compete favorably in the information and network technology market.60


Employees

 

The Company employed 358343 people as of December 31, 2002.2003. The services the Company provides require proficiency in many fields, such as computer science, information security and vulnerability testing, wireless networking technologies, physics, engineering, operations research, economics, and business administration. Of the total Company personnel, 15383 are in the ProductsIT Solutions Group and 111176 in Xacta. An additional 9484 employees provide corporate, sales and administrative services functions.services.

The Company places a high value on its employees and constantly competes for highly skilled professionals in virtually all of its competitive arenas. The success and growth of the Company’s businesses is directly related to its ability to recruit, train, promote and retain high quality people at all levels of the organization. As a result, the Company requires its management to proactively assure themselves that the Company will always remain competitive in terms of salary structures, incentive compensation programs, fringe benefits, opportunities for growth, and individual recognition and award programs.

The Company has published policies and procedures that establish high standards for the conduct of its employees in recognition of its highly regulated U.S. Government contractor responsibility. The Company requires each of its employees, consultants, officers, and directors to annually execute and affirm a code of ethics and other corporate compliance policies and procedures. Each employee must annually reaffirm their specific awareness of, and commitment to complying with the code of ethics and corporate compliance, policies and procedures.

Patents, Trademarks, Trade Secrets and Licenses

Intellectual property is critical to the long-term value and success of the Company. As such the Company has invested heavily in intellectual property, in the form of trademarks, service marks, copyrights, patents and other proprietary assets. The Company is committed to protecting its intellectual property and proprietary information and will use every available resource to protect such investment.

 

Backlog

 

Many of the Company’s contracts with the U.S. Government are funded year to year by the procuring U. S. Government agency as determined by the fiscal requirements of the U.S. Government and the respective procuring agencies’ fiscal requirements.agency. Such a contracting process results in two differentdistinct categories of backlog: funded and unfunded. Total backlog consists of the aggregate contract revenues remaining to be earned by the Company at a given time over the life of its contracts, whether funded or not. Funded backlog consists of the aggregate contract revenues remaining to be earned by the Company at a given time, but only to the extent, in the case of U.S. Government contracts, when funded by the procuring U. S. Government agency and allotted to the specific contracts. Unfunded backlog is the difference between total backlog and funded backlog. Included in unfunded backlog are revenues which may be earned only when and if customers exercise delivery orders and/or renewal options to continue such existing contracts.

 

A number of contracts undertaken by the Company extend beyond one year and accordingly, portions of contracts are carried forward from one year to the next as part of the backlog. Because many factors affect the scheduling and continuation of projects, no assurance can be given as to when revenue will be realized on projects included in the Company’s backlog.

 

At December 31, 20022003 and 2001,2002, the Company had total backlog from existing contracts of approximately $40.2 million and $31.7 million, respectively. Of these amounts, approximately $31.0 million and $830.0$20.3 million, respectively. This isrespectively, were for Xacta’s business with the remaining amount attributed to the IT Solutions Group. Such amounts are the maximum value of additional future orders for systems, products, maintenance and other support services presently allowable under those contracts, including renewal options available on the contracts if exercised by the customer, over periods extending up to seven years. The decrease in total backlog is primarily attributable to the sale of TCC which included a dual award of the US Army CECOM SEC contract to the Company’s 50% owned joint venture, ITel Solutions. The Company was a subcontractor to this joint venture, and estimated upon the successful award of competing task orders total backlog up to approximately $700 million.

 

Approximately $28.9$31.8 million and $28$28.9 million of the total backlog was funded backlog at December 31, 20022003 and 2001,2002, respectively.

 

While backlog remains a measurement consideration, in recent years the Company, as well as other U.S. Government contractors, experienced a material change in the manner in which the U. S. Government procures equipment and services. These procurement changes include the growth in the use of General Services Administration (“GSA”) schedules which allow agencies of the U.S. Government to purchase significant amounts of equipment and services. The use of the GSA schedules results in a significantly shorter and much more flexible procurement cycle, as well as increased competition with many companies holding such schedules. Along with the GSA schedules, the U.S. Government is awarding a large number of omnibus contracts with multiple awardees. Such contracts generally require extensive marketing efforts by the awardees to procure such business. The use of GSA schedules and omnibus contracts, while generally not providing immediate backlog, provide areas of growth thatwhich the Company continues to aggressively pursue.

 

Page 45 of 6960


Item 2. Properties

 

The Company leases 191,700 square feet of space for its corporate headquarters, integration facility, and primary service depot in Ashburn, Virginia. The lease expires in March 2016, with a ten-year extension available at the Company’s option. This facility supports all of the Company’s operating segments.

 

The Company subleases 21,816 rentable square feet of space at itsthe Ashburn, Virginia facility to its affiliate, Enterworks, Inc. for itswhich serves as Enterworks’ corporate headquarters and hosts its operating segments. This sublease will expire on March 31, 2003.2005.

 

The Company leases additional space for regional contract work sites, training and sales offices in 5 separate facilities located in California, New Jersey, the District of Columbia and EuropeGermany under various leases which expire on various datesexpiring through March of 2006.2011.

 

Item 3. Legal Proceedings

 

The Company is a party to various lawsuits arising in the ordinary course of business. In the opinion of management, while the results of litigation cannot be predicted with certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

The Company’s annual meeting of common shareholders was held on November 13, 2002. There were two matters presented for vote2003. The only matter set forth at the meeting. The firstmeeting was the election of directors. The shareholders of the common stock necessary to constitute a quorum were present either in person or represented by proxy or attorney. Norman P. Byers, Dr. Fred Charles Ikle, Ambassador Langhorne (Tony) A. Motley, and John B. Wood Norman P. Byers, Dr. Stephen D. Bryen, and David S. Aldrich were elected to a term of approximately one year, a term to expire at the next annual meeting of shareholders upon the election of their successors. Effective February 24, 2003, Mr. Aldrich resigned as director of the Company.

The second matter presented for vote was the resolution to modify the Long Term Incentive Plan which was adopted, and provided the Company to grant stock options in the Telos DE and Xacta DE subsidiaries, and that such options can be exercised only upon a change of control or other specifically designated events.

 

With regard to the holders of the 12% Cumulative Exchangeable Preferred Stock, shareholders of such stock necessary to constitute a quorum were not present and, therefore, the nominations of Malcolm M.B. Sterrett and Geoffrey B. Baker were not considered. Subsequent to the shareholders meeting, Malcolm M.B. Sterrett appointed Geoffrey B. Baker and himself to fill the term, for a period of one year, to expire at the next annual meeting of shareholders and upon the election of their successors. Such appointment by Mr. Sterrett was consistent with Article Fifth (C)7(b)(vi) of the Company’s Articles of Amendment and Restatement.

 

Page 56 of 6960


PART II

 

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

 

No public market exists for the Company’s Class A or Class B Common Stock. As of December 31, 2002,2003, there were 94 holders of the Company’s Class A Common Stock and 5 holders of the Company’s Class B Common Stock.

No public market exists for the Company’s Series A-1 and Series A-2 Redeemable Preferred Stock (“Senior Redeemable Preferred Stock”). See Note 7 – Redeemable Preferred Stock.

The Company’s 12% Cumulative Exchangeable Redeemable Preferred Stock (“Public Preferred Stock”) is traded on the NASDAQ/OTCBB Exchange. See Note 7 - Redeemable Preferred Stock.

 

Item 6. Selected Financial Data

 

The following should be read in connection with the accompanying information presented in Item 7 and Item 8 of this document.

 

OPERATING RESULTS

 

   

Year Ended December 31,


 
   

2002


   

2001


   

2000


   

1999


   

1998


 
   

(amounts in thousands)

 

Sales (1)

  

$

90,517

 

  

$

112,188

 

  

$

96,881

 

  

$

93,663

 

  

$

114,771

 

(Loss) income from continuing operations

  

 

(7,474

)

  

 

1,507

 

  

 

(925

)

  

 

(20,751

)

  

 

(15,787

)

Discontinued operations:

                         

(Loss) income from discontinued

  

 

(1,078

)

  

 

(2,178

)

  

 

(869

)

  

 

10,772

 

  

 

6,616

 

Gain on sale of TCC

  

 

12,577

 

  

 

—  

 

  

 

—  

 

  

 

—  

 

  

 

—  

 

Income (loss) before extraordinary items

  

 

4,025

 

  

 

(671

)

  

 

(1,794

)

  

 

(9,979

)

  

 

(9,171

)

Extraordinary items (2)

  

 

—  

 

  

 

—  

 

  

 

—  

 

  

 

8,015

 

  

 

—  

 

Net income (loss)

  

 

4,025

 

  

 

(671

)

  

 

(1,794

)

  

 

(1,964

)

  

 

(9,171

)

 

   Year Ended December 31,

 
   2003

  2002

  2001

  2000

  1999

 
   (amounts in thousands) 

Sales (1)

  $88,443  $90,517  $112,188  $96,881  $93,663 

Operating (loss) income

   (1,943)  (7,596)  5,911   1,174   2,200 

Income (loss) before income taxes

   1,802   (10,835)  1,267   (1,177)  (17,832)

Net (loss) income

   (8,685)  4,025   (671)  (1,794)  (1,964)

 

FINANCIAL CONDITION

 

   

As of December 31,


   

2002


  

2001


  

2000


  

1999


  

1998


   

(amounts in thousands)

Total assets (1)

  

$

45,020

  

$

48,760

  

$

71,781

  

$

51,899

  

$

90,902

Long-term debt (3)

  

 

11,797

  

 

20,566

  

 

32,846

  

 

25,045

  

 

54,651

Capital lease obligations, long-term (4)

  

 

10,647

  

 

10,722

  

 

11,030

  

 

11,362

  

 

11,710

Senior redeemable preferred stock (5)

  

 

7,327

  

 

6,903

  

 

6,480

  

 

6,054

  

 

5,631

Class B redeemable preferred stock

  

 

—  

  

 

—  

  

 

—  

  

 

—  

  

 

—  

Redeemable preferred Stock (5)

  

 

53,561

  

 

47,876

  

 

42,352

  

 

36,975

  

 

31,729

   As of December 31,

   2003

  2002

  2001

  2000

  1999

   (amounts in thousands)

Total assets (1)

  $33,611  $45,020  $48,760  $71,781  $51,899

Senior credit facility

   6,497   6,618   12,387   25,460   16,508

Senior subordinated debt

   5,179   5,179   8,179   8,537   8,537

Capital lease obligations, long-term (2)

   10,243   10,647   10,722   11,030   11,362

Senior redeemable preferred stock (3)

   7,751   7,327   6,903   6,480   6,054

Public preferred stock (3)

   59,425   53,561   47,876   42,352   36,975

(1) See Notes 2, 3 & 4 to the Consolidated Financial Statements in Item 8 regarding the sale of TelosOK LLC and Telos Corporation (California), the contribution of Ft. Sill assets and the deconsolidation of Enterworks.

(2)See Note 2 to the Consolidated Financial Statements in Item 8 regarding the extraordinary item relating to the concurrent transactions of the Enterworks private placement.

(3)See Note 6 to the Consolidated Financial Statements in Item 8 regarding long-term debt obligations of the Company. Total long-term debt obligations include amounts due under the Senior Credit Facility and Subordinated Notes.

(4) See Note 10 to the Consolidated Financial Statements in Item 8 regarding the capital lease obligations of the Company.

(5)(3) See Note 7 to the Consolidated Financial Statements in Item 8 regarding redeemable preferred stock of the Company.

 

Page 67 of 6960


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Government oversight

As a U.S. Government contractor, the Company is subject to U.S. Government oversight. The U.S. Government may investigate and make inquiries of the Company’s business practices and conduct audits of contract performance and cost accounting. Depending on the results of these audits and investigations, the U. S. Government may make claims against the Company. Under U.S. Government procurement regulations and practices, an indictment of a U.S. Government contractor could result in that contractor being fined and/or suspended for a period of time from eligibility for bidding on, or for award of, new U.S. Government contracts. A conviction could result in debarment for a specified period of time. Although the outcome of such investigations and inquiries cannot be predicted, in the opinion of management, there are no claims, audits or investigations pending against the Company that are likely to have a material adverse affect on the Company’s business or its consolidated results of operations, cash flows or financial position.

 

General

 

During 2002,2003, the Company continued to focus on its commitment toinvest in creating unique, value added solutions and reducing corporate indebtedness.

The Company created value added solutions through its wholly-owned subsidiary, Xacta,in an effort to address the ever increasing market for reliablesystems integration services and secure communication.enterprise solutions. For example, with the release of Xacta Web C&A 4.0 in March of 2003, Xacta achieved its vision of developing a continuous business process which enables automated and continuous security risk and compliance management. The “Continuous Assessment” functionality provided in the Xacta 4.0 release allows organizations to manage security compliance and risk in an automated and on-going manner. Additionally, Xacta recently introduced Xacta IA Manager which provides solutionscontinuous and automated vulnerability management and remediation, allowing organizations to both U.S. Governmentidentify and commercial customers to handle certainremediate vulnerabilities from a centralized location. Xacta IA Manager when fully deployed will save systems administrators time and effort as well as keep the network “aware” of these critical security requirements. Specifically, Xacta solutions help organizations proactively manage and monitor the security of their network environments in accordance with internationally recognized information security and privacy standards, regulations, guidelines and industry best practices.new vulnerabilities that can appear daily.

 

The Company’s Products Group continues to better serve its customers with innovative product offerings, including the Products Group’s secure wireless networking and secure messaging solutions. Telos’ secure wireless networking solutions allow customers to securely and safely access databases from non-networked locations. Telos’ secure messaging solution is known ascalled the Automated Message Handling System (“AMHS”). AMHS version 2003 was approved by Defense Information Systems Agency and released in July of 2003 after extensive evaluation and testing. AMHS 2003 is recognized as a standard within the Department of Defense.U.S. Government’s exclusive certified stand-alone messaging application. The AMHS solution allows2003 stand-alone architecture is more efficient and cost effective than competitive client/server architectures as it enables users to access their messages securely access, send,from a single server using a simple web browser. In addition to its more intuitive user interface, AMHS 2003 provides outbound message processing and numerous advanced message management capabilities such as retrospective search and profilesimplified user profiling, which functionality is essential to large organizations with time sensitive formal message traffic.

The Company made significant strides in reducing corporate indebtedness in 2002. The Company’s term facility balance has been reduced by approximately 47% from the December 31, 2001 balance, primarily duerequirements. Such retrospective search and user profiling capabilities facilitate message distribution to cash received from the saleimportant staff elements, as well as research and coordination of TCC. The Company was also able to retire $3 million of its Series C Subordinated Notes in 2002. For more information on the sale of TCC, see Note 4 to the Consolidated Financial Statements on the Sale of Telos Corporation (California).formal message origination and response.

 

Critical Accounting Policies and Estimates

 

The preparation of consolidated financial statements requires management to make judgments based upon estimates and assumptions that are inherently uncertain. Such judgments affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management continuously evaluates its estimates and assumptions including those related to contract percentage of completion methodology for revenue recognition purposes, inventories, long-lived assets, warranty obligations, income taxes, contingencies and litigation and the carrying values of assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

The following is a summary of the most critical accounting policies used in the preparation of our consolidated financial statements.

 

In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatory redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. On November 7, 2003, the FASB issued FSP FAS 150-3 which deferred certain areas of FAS 150 including the measurement provisions of mandatory redeemable preferred stock. Accordingly, the Company has continued to accrue dividends on the preferred stock, but was required to reclassify its preferred stock as a liability in accordance with the standard. Also, dividends are now required to be reported as a component of interest expense.

For the year ended December 31, 2003, the Company concluded that a full valuation allowance is required for the deferred tax assets, as required under SFAS 109, “Accounting for Income Taxes”. Accordingly, a valuation allowance totaling $9.7 million was provided at December 31, 2003.

In accordance with APB 18 and EITF 98-13 “Accounting by an Equity Method Investor for Investee Losses when the Investor has Loans to and Investments in Other Securities of the Investee”, the Company has reduced the carrying amounts of Enterworks notes receivable and investment account in Enterworks and Enterworks International to zero, as the Company’s share of the Enterworks losses exceeded the carrying value of the notes receivable and Enterworks investment account. See Note 2 – Investment in Enterworks for more information. Other transactions with Enterworks also have been evaluated, based on the investee relationship and resulted in additional losses being recorded in 2003.

The Company recognizes revenue from time and materials contracts as services are performed and costs are incurred. Revenue from fixed price services contracts is generally recognized over the contract term using the percentage of completion method. Such revenues are recorded based on the percentage that costs incurred to date bear to the most recent estimates of total costs to complete each contract.

 

Page 7 of 69


contract. Estimating future costs and, therefore, revenues and profits, is a process requiring a high degree of management judgment. In the event of a change in total estimated contract cost or profit, the cumulative effect of a change is recorded in the period the change in estimate occurs. In the event cost estimates indicate a loss on a contract, the total amount of such loss, excluding general and administrative expense, is recorded in the period in which the loss is first estimated. The Company generally recognizes product revenue as products are shipped,delivered, although certain revenue recognition practices are dependent upon contract terms. Revenue for maintenance contracts is recognized as such services are performed.over the term of the maintenance contracts.

 

Page 8 of 60


Inventories are stated at the lower of cost or market, where cost is determined primarily on the first-in, first-out method. Inventories consist primarily of purchased customer off-the-shelf hardware and software, and component computer parts used in connection with system integration services performed by the Company. Inventories also include spare parts utilized to support certain maintenance contracts. Spare parts inventory is amortized on a straight-line basis over five years. An allowance for obsolete, slow-moving or non-salable inventory is provided for all other inventory. This allowance is based on the Company’s overall obsolescence experience and its assessment of future inventory requirements.

 

We recordThe Company records a liability in connection with various warranty obligations. OurSuch warranty obligations are affected by product failure rates and material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required, resulting in additional income statement charges.

 

We record a valuation allowance to adjust our deferred tax asset that is more likely than not to be realized. In the event that we can no longer substantiate future liabilities based on projected earnings, the adjustment to the deferred tax asset would decrease income in the period such determination is made.

Exit Fromfrom the Systems and Support Services Business

 

The Company haseffectively completed its exit from the Systems and Support Services business with the sale of TCC in July 2002. The SolutionsSystems and Support Services Group was characterized primarily by large, long-term time-and-material services contracts with consistent and predictable revenue and cash flow streams. With the exit from such business, the Company is now more reliant on short term, less predictable revenue and cash flow streams, although with projected higher margins from its realigned business opportunities. Such a possibleIt is anticipated that any potential negative impact to the Company’s liquidity however, is projected tofrom such business realignment will be offset by other higher margin offerings such as its focus on Xactas’ product subscription offering, which, as a subscription, is paid for by the customer upon sale.Xacta security management, organizational messaging, and wireless maintenance solutions.

 

The Company sold its 50% share of TelosOK LLC, on March 10, 2003 which is reported in Note 13 “Subsequent Events”3—Sale of TelosOK LLC of the Consolidated Financial Statements. The primary business of TelosOK LLC was to provide post-deployment and post-production software and systems development and support services including technology insertion, system redesign and software re-engineering. The largest customer of TelosOK LLC was the U.S. Army’s Communications and Electronics Command (“CECOM”) with significant operations at Ft. Sill in Lawton, Oklahoma. TelosOK LLCLLC’s tasks were performed on a time and materials basis and on a firm fixed price basis.

 

Results of Operations

 

The Company did not receivederived substantially all of its anticipated volume of orders by September 30, 2002, the end of the U.S. Government fiscal year. In addition, the 2003 U.S. Government budget approval process was delayed by several months. Such negative factors caused the Company to experience a decline in salesrevenues from the fourth quarter of 2002 as compared to the comparable period in 2001.

Approximately 95.8% of the Company’s total revenues in 2002 were attributable to contracts and subcontracts with the U.S. Government. The Company’s revenues are generated from a number of contract vehicles.vehicles and task orders. In general, the Company believes its contract portfolio is characterized as having low to moderate financial risk asdue to the Company has limited number of long-term fixed price development contracts. The Company’s firm fixed price contracts consist principally of contracts for the purchase of computer equipment at established contract prices or contracts for certification and accreditation services offerings. The company’s time and

Page 8 of 69


material contracts generally allow the pass-through of allowable costs plus a profit margin. For 2002,2003, revenue by contract type was as follows: time and materials, 22.7%19.3% and firm fixed price 77.3%80.7%. While the Company has not experienced any significant recent terminations or contract renegotiations, U.S. Government contracts may be terminated or renegotiated at any time at the convenience of the U.S. Government.

 

Statement of Operations Data

 

The following table sets forth certain consolidated financial data and related percentages for the periods indicated. The financial data has been reclassified to present all years reported consistent with current operating segments:indicated:

 

   

Year Ended December 31,


 
   

2002


   

2001


   

2000


 
   

(dollar amounts in thousands)

 

Sales

  

$

90,517

 

  

100.0

%

  

$

112,188

 

  

100.0

%

  

$

96,881

 

  

100.0

%

Cost of sales

  

 

79,457

 

  

87.8

 

  

 

89,258

 

  

79.6

 

  

 

80,952

 

  

83.6

 

Selling, general and administrative expenses

  

 

19,557

 

  

21.6

 

  

 

18,535

 

  

16.5

 

  

 

13,247

 

  

13.7

 

   


  

  


  

  


  

Operating (loss) income from continuing operations

  

 

(8,497

)

  

(9.4

)

  

 

4,395

 

  

3.9

 

  

 

2,682

 

  

2.8

 

Interest expense

  

 

(2,348

)

  

(2.6

)

  

 

(3,195

)

  

(2.8

)

  

 

(3,491

)

  

(3.6

)

Other income

  

 

10

 

  

—  

 

  

 

67

 

  

0.1

 

  

 

92

 

  

0.1

 

   


  

  


  

  


  

(Loss) income from continuing operations before taxes

  

 

(10,835

)

  

(12.0

)

  

 

1,267

 

  

1.1

 

  

 

(717

)

  

(0.7

)

Income tax benefit (provision)

  

 

3,361

 

  

3.7

 

  

 

240

 

  

0.2

 

  

 

(208

)

  

(0.2

)

   


  

  


  

  


  

(Loss) income from continuing operations

  

 

(7,474

)

  

(8.3

)

  

 

1,507

 

  

1.3

 

  

 

(925

)

  

(1.0

)

Loss from discontinued operations

  

 

(1,078

)

  

(1.2

)

  

 

(2,178

)

  

(1.9

)

  

 

(869

)

  

(0.9

)

Gain on sale of TCC

  

 

12,577

 

  

13.9

 

  

 

—  

 

  

—  

 

  

 

—  

 

  

—  

 

   


  

  


  

  


  

Net income (loss)

  

$

4,025

 

  

4.4

%

  

$

(671

)

  

(0.6

)%

  

$

(1,794

)

  

(1.9

)%

   


  

  


  

  


  

   Year Ended December 31,

 
   2003

  2002

  2001

 
   (dollar amounts in thousands)    

Sales

  $88,443  100.0% $90,517  100.0% $112,188  100.0%

Cost of sales

   71,359  80.7   79,457  87.8   89,258  79.6 

Selling, general and administrative expenses

   19,027  21.5   18,656  20.6   17,019  15.2 
   


 

 


 

 


 

Operating (loss) income

   (1,943) (2.2)  (7,596) (8.4)  5,911  5.2 

Gain from sale of 50% interest in TelosOK LLC

   10,121  11.4   —    —     —    —   

Losses from affiliates

   (848) (0.9)  (901) (1.0)  (1,516) (1.4)

Other income

   14  —     10  —     67  0.1 

Interest expense

   (5,542) (6.3)  (2,348) (2.6)  (3,195) (2.8)
   


 

 


 

 


 

Income (loss) before income taxes

   1,802  2.0   (10,835) (12.0)  1,267  1.1 

Income tax (provision) benefit

   (11,487) (12.9)  3,361  3.7   240  0.2 
   


 

 


 

 


 

Income (loss) from continuing operations

   (9,685) (10.9)  (7,474) (8.3)  1,507  1.3 

Loss from discontinued operations

   —    —     (1,078) (1.2)  (2,178) (1.9)

Gain on sale of TCC

   1,000  1.1   12,577  13.9   —    —   
   


 

 


 

 


 

Net income (loss)

  $(8,685) (9.8)% $4,025  4.4% $(671) (0.6)%
   


 

 


 

 


 

 

Page 9 of 6960


Financial Data by Operating Segment

 

The Company has two reportable operating segments: ProductsIT Solutions Group and Xacta. Prior to December 2003, the Company had two operating segments, the Product Group and the Xacta Group. Sales, gross profit and gross margin by market segment for the periods designated below are as follows:

 

  

Year Ended December 31,


   Year Ended December 31,

 
  

2002


   

2001


   

2000


   2003

 2002

 2001

 
  

(dollar amounts in thousands)

   (dollar amounts in thousands) 

Sales:

            

Products

  

$

78,819

 

  

$

98,630

 

  

$

87,799

 

IT Solutions and other services

  $41,722  $52,090  $67,538 

Xacta

  

 

11,698

 

  

 

13,558

 

  

 

9,082

 

   46,721   38,427   44,650 
  


  


  


  


 


 


Total

  

$

90,517

 

  

$

112,188

 

  

$

96,881

 

  $88,443  $90,517  $112,188 
  


  


  


  


 


 


Gross Profit:

            

Products

  

$

7,943

 

  

$

17,998

 

  

$

13,399

 

IT Solutions and other services

  $954  $(272) $7,359 

Xacta

  

 

3,117

 

  

 

4,932

 

  

 

2,530

 

   16,130   11,332   15,571 
  


  


  


  


 


 


Total

  

$

11,060

 

  

$

22,930

 

  

$

15,929

 

  $17,084  $11,060  $22,930 
  


  


  


  


 


 


Gross Profit Percentage:

            

Products

  

 

10.1

%

  

 

18.2

%

  

 

15.3

%

IT Solutions and other services

   2.3%  (0.5)%  10.9%

Xacta

  

 

26.6

%

  

 

36.4

%

  

 

27.9

%

   34.5%  29.5%  34.9%

Total

  

 

12.2

%

  

 

20.4

%

  

 

16.4

%

   19.3%  12.2%  20.4%

 

Results of Continuing Operations

 

Years ended December 31, 2003 and 2002

Sales from continuing operations decreased $21.7by $2.1 million or 19.3%2.3% to $90.5$88.4 million for the year ended December 31, 2002,2003, from $112.2$90.5 million for the comparable 20012002 period. The decrease for the period includes an $19.8a $10.4 million decrease in Product’sthe IT Solutions Group’s sales, and a decreasean increase of $1.9$8.3 million in Xacta revenue.Xacta. Included in the IT Solutions Group’s sales is a $900,000 services fee from TelosOK LLC since March of 2003. See Note 3 – Sale of TelosOK LLC. The Company’s Products GroupIT Solutions Group’s decrease in revenues declined $19.8 million in 2002 from 2001 due in part to $8.7 million from product lines that the Company closed out after 2001. The remaining $11.1 million decrease is due primarily to a delayits decline in the roll-out of the wireless solutionreselling sales and lower commodity sales in our IS-1 and courts contracts. The Xacta Group decreaseinformation technology services. Xacta’s increase in revenue was primarily due to decreasedan increase in sales of its organizational messaging and deployable maintenance solutions, as well as increased orders offor its information security products and solutions.

 

Cost of sales was 87.8%80.7% of sales for the year ended December 31, 2002,2003, a decrease of 7.1% as compared to 79.6%87.8% for the same period in 2001.2002. The increasedecrease in cost of sales as a percentage of sales werewas primarily attributable to decreased profits realized on Product Group contracts such as the Company’s subcontracts to the Bureau of Census, and from reduced profits under the Company’s wireless products business. Theincrease in higher margin business lines, combined with a reduction in overhead expenses. In addition, the wireless products business profits were caused primarily by delays2003 cost of sales included a credit of $1.1 million settlement received in projected orders while maintaining personnel and infrastructure costs necessary to fulfill such orders. Xacta also experienced lower marginsJuly 2003 as a result of litigation against a decrease in sales volume. Theformer business partner. During 2002, the Company recognized inventory obsolescence charges of $2.2 million during 2002 cosistingconsisting primarily of $1.7 million to adjust certain software inventory to market value. This charge was taken due to the age of the inventory and the significant additional costs that would be necessary to upgrade to current standards as well as the lack of forecasted sales for such inventoryinventory. Such obsolescence charge was included in cost of goods sold during the month of September 2002.

Gross profit increased by $6.0 million or 54.5% from 2002 to 2003. The increase is primarily attributable to the above-referenced favorable change in revenue mix from lower margin sales to higher margin business.

Selling, general, and administrative expenses (“SG&A”) increased by $371,000 to $19.0 million in 2003 compared to $18.7 million in 2002. As a percentage of revenue, SG&A increased by 0.9% from 20.6% in 2002 to 21.5% in 2003. Such increase was primarily due to a $2.0 million increase in bonus accruals, off-set by various cost reduction measures and a decrease in severance costs of $1.0 million.

For the year ended December 31, 2003, the Company recorded $848,000 of losses from affiliates, which included the write-down of the $500,000 investment in Enterworks International, and expenses of $900,000 related to rent and services provided to Enterworks pursuant to an earn-out provision of a two-year Original Equipment Manufacturer (OEM) software license agreement with Enterworks, see Note 2 – Investment in Enterworks. Such losses were partially off-set by a $556,000 cash distribution received from TelosOK. For the comparable period in 2002, the Company recorded $901,000 of losses from affiliates, principally consisting of reserves of $1.5 million on Enterworks notes due to the application of the equity method of accounting in accordance with APB 18 and EITF 98-13 “Accounting by an Equity Method Investor for Investee Losses when the Investor has Loans to and Investments in Other Securities of the Investee”, whereby the Company reduced the carrying amounts of Enterworks notes receivable and investment account to zero during 2001 and 2002, as the Company’s share of the Enterworks losses exceeded the carrying value of the notes receivable and the Enterworks investment account. See Note 2 – Investment in Enterworks for more information.

Page 10 of 60


Interest expense increased by approximately $3.2 million to $5.5 million for the year ended December 31, 2003 from approximately $2.3 million in the near future.comparable 2002 period. Such increase is primarily due to the reclassification of preferred stock dividends and accretion as interest in accordance with FAS 150. Components of interest expense are as follows:

   December 31,

 
   2003

  2002

  2001

 
   (amounts in thousands) 

Commercial interest incurred

  $2,386  $2,955  $4,073 

Preferred stock interest accrued

   3,156   —     —   

Interest reclassified to discontinued operations

   —     (607)  (878)
   

  


 


Total

  $5,542   $2,348  $3,195 
   

  


 


Income before income taxes increased by $12.6 million to $1.8 million for the year ended December 31, 2003 from that of a loss of $10.8 million for the same period in 2002. Such increase is primarily due to an increase in the sales of the Company’s higher margin offerings, and a gain of $10.1 million from the sale of TelosOK LLC. See Note 3 – Sale of TelosOK LLC.

The Company recorded an income tax provision from continuing operations for the year ended December 31, 2003 of approximately $11.5 million, primarily as a result of the full valuation allowance provided in accordance with FAS 109. For a comparable 2002 period, an income tax benefit of $3.4 million was recorded, primarily due to the net operating loss carryforwards associated with the losses generated by the Company.

Years ended December 31, 2002 and 2001

Sales decreased $21.7 million or 19.3% to $90.5 million for the year ended December 31, 2002, from $112.2 million for the comparable 2001 period. The decrease for the period includes a $15.4 million decrease in the IT Solutions Group’s sales, and a decrease of $6.2 million in Xacta sales. The Company’s IT Solutions Group sales declined due in part to the fact that the Company closed out certain product lines after 2001. The remaining decrease was due to lower reselling sales. Xacta’s sales decreased primarily due to decreased orders of information security products and solutions as well as a delay in the rollout of its wireless maintenance solutions.

Cost of sales was 87.8% of sales for the year ended December 31, 2002, as compared to 79.6% for the same period in 2001. The increase in cost of sales was primarily attributable to decreased profits realized on the IT Solutions Group contracts and from reduced profits under the Company’s deployable wireless solutions. The reduction in the deployable wireless solutions profits was caused primarily by delays in projected orders while maintaining personnel and infrastructure costs necessary to fulfill such orders. The Company also recognized inventory obsolescence charges of $2.2 million during 2002 consisting primarily of $1.7 million to adjust certain software inventory to market value. This charge was taken due to the age of the inventory and the significant additional costs that would be necessary to upgrade to current standards as well as the lack of forecasted sales for such inventory. Such obsolescence charge was included in cost of goods sold during the month of September 2002. The Company also recognized a reserveprovision for bad debt of $470,000 to during the year 2002 as an estimate of uncollectableuncollectible accounts receivable at December 31, 2002.

 

Gross profit decreased $11.9 million in the twelve-month period to $11.1 million in 2002, from $22.9 million in the comparable 2001 period. The decrease is attributable to the decreases in overall sales volume discussed above with a relatively higher percentage of sales concentrated in lower margin products.offerings.

 

Selling, general, and administrative expense (“SG&A”) remained flat on a fixed dollar basisincreased by $1.6 million to $18.7 million in 2002 compared toover 2001. SG&A however, increased as a percentage of revenue from 16.5%15.2% in 2001 to 21.6%20.6% in 20022002. The increase in SG&A was primarily due to the sale of TCC and the resulting reclassification of revenues and expenses as discontinued operations. The Company also recorded employee costs related to certain severance agreements resulting in a $960,000 charge to SG&A in fiscal 2002. Also included in SG&A is a reserve inagreements.

For the amountyear ended December 31, 2002, the Company recorded $901,000 of losses from affiliates, principally consisting of reserves of $1.5 million to reduce the carrying amount of Notes Receivable fromon Enterworks to $0. See Note 2 “Investment in Enterworks” in the Notesnotes due to the Consolidated Financial Statements for more information. In accordance with APB 18 and EITF 98-13 “Accounting by an Equity Method Investor for Investee Losses when the Investor has Loans to and Investments in Other Securitiesapplication of the Investee”,equity method of accounting, as previously discussed, offset by a $556,000 distribution from TelosOK. For the comparable period in 2001, the Company has reduced the

Page 10recorded $1.5 million of 69


carrying amountslosses from affiliates, primarily consisting of reserves of $1.8 million on Enterworks notes, receivable and investment account to zero during 2001 and 2002, as the Company’s share of the Enterworks losses exceeded the carrying value of the notes receivable and Enterworks investment account. The Company has therefore, recognizedoffset by a reserve in the amount of $397,000 in December 2002 to accrue costs related to an agreement with Enterworks to provide certain administrative and support services and sub-leased office space for a period of six months ending June 30, 2003.$284,000 cash distribution received from TelosOK.

 

Goodwill amortization expense for 2001 has been reported separately under operating income (loss) from discontinued operations to account for the sale of “TCC”. Beginning January 2002 the Company no longer amortizes its goodwill asset according to SFAS 142. The Company no longer carries a Goodwillgoodwill asset as a result of the sale of TCC in 2002. (seeSee Note 4 Sale of Telos Corporation (California)).

 

Page 11 of 60


Interest expense from continuing operations decreased approximately $847,000 to $2.3 million for the year ended December 31, 2002 from approximately $3.2 million in the comparable 2001 period. These decreases are primarily due to decreased debt levels in 2002 as compared to 2001.

 

In orderIncome before income taxes decreased by $12.1 million to present the statement of operations in accordance with APB 18, the revenues and costs of sales for the Ft. Sill operation contributed to TelosOK LLC were presented in one line item “Equity in Net Earnings of TelosOK LLCa $10.8 million loss for the year ended December 31, 2000 (See Note 3). Consistent with prior years,2002 from a $1.3 million in income for the Company, under APB 18,comparable period in 2001. Such a decrease in income is unablesubstantially attributable to recognize its pro rata share of the income generated by TelosOK LLC for 2002, as the Company’s capital account for TelosOK LLC is negative.changes referenced above.

 

The Company recorded an income tax benefit from continuing operations for the year ended December 31, 2002 and 2001 of approximately $3.4 million and $240,000, respectively. The tax benefit at December 31, 2002 is primarily due to net operating loss carry forwardscarryforwards associated with the losses generated by the Company. The Company’s net deferred tax assets totaled $11.5 million at December 31, 2002. Failure to achieve forecasted taxable income may affect the ultimate realization of the net deferred tax assets. Management believes the Company will generate taxable income in excess of operating losses in amounts sufficient to realize the net deferred tax assets.

Profit from continuing operations decreased $9.0 million to a $7.5 million loss from continuing operations for the year ended December 31, 2002 from a $1.5 million profit from continuing operations for the same period in 2001. Such a decrease in profit from continuing operations is mostly attributable to the decrease in gross profit discussed above.

 

Discontinued Operations

 

Telos Corporation-CaliforniaCorporation-California:

 

The Company reported a gain of $1.0 million, which represents a release of $1.0 million held in escrow, and $12.6 million for the sale of TCC in 2003 and 2002, respectively. An additional $0.8 million is to be released from escrow during 2004, and another $0.8 million during 2007. Additionally, the Company reported a loss from discontinued operations of $1.1 million and $2.2 million and $869,000 in 2002 and 2001, and 2000, respectively. In addition to the 2002 loss from discontinued operations, the Company reported a one-time gainSee Note 4 – Sale of $12.6 million for the sale of TCC.

Years ended December 31, 2001 and 2000

Sales increased $15.3 million or 15.8% to $112.2 million for the year ended December 31, 2001, from $96.9 million for the comparable 2000 period. The increase includes a $10.8 million increase in Products’ sales and an increase of $4.5 million in Xacta revenue. This increase in revenue is primarily due to increased sales in Xacta’s information security product line of $4.5 million and an increase in the Product’s Group Rapids contract of $4.7 million.

Cost of sales was 79.6% of sales for the year ended December 31, 2001, as compared to 83.6% for the same period in 2000. The decrease in cost of sales as a percentage of sales is primarily attributable to increased profits realized under certain Products contracts including, but not limited to, increased profits realized on Products Group traditional contracts, such as IS-1 and US Courts, and from increased profits from sales of the Company’s information security product line.

Gross profit increased approximately $7.0 million to $22.9 million in 2001 from $15.9 million in 2000. Gross margin was 20.4% for 2001 as compared to 16.4% for the same period of 2000. The increase in gross margin was attributable to the cost of sales decreases explained above.

Selling, general, and administrative expense (“SG&A”) increased by approximately $5.3 million or 39.9%, to $18.5 million for the year ended

Page 11 of 69


December 31, 2001 from $13.2 million in the comparable period of 2000. This increase is due primarily to the Company’s increased investment in the product development, sales and marketing effort for Xacta and two one-time charges of approximately $600,000 to write-off of an investment made in an international joint venture, and a $1.8 million reserve recorded against the Enterworks notes receivable held by the Company (See Note 2 to the Financial Statements)Telos Corporation (California). SG&A as a percentage of revenues for the twelve-month period ended December 31, 2001 increased to 16.5% from 13.7% compared to the same period in 2000.

Income from continuing operations for 2001 was $1.5 million, as compared to a loss from continuing operations of $925,000 in 2000. Profitability increased principally as a result of increased sales volume from both Groups, coupled with improved profits under the Company’s traditional businesses and its information security channel business in its Products Group as well as increased margins in its Xacta subsidiary.

 

Liquidity and Capital Resources

 

The Company’s capital structure consists of a revolving credit facility, subordinated notes, redeemable preferred stock, and common stock.

 

Revolving Credit Facility

On October 21, 2002, the Company entered into a $22.5 million Senior Credit Facility agreementAgreement (“Facility”) with a financial institutionWells Fargo Foothill, Inc. (formerly known as Foothill Capital Corporation) that matures on October 21, 2005 and is2005. Borrowings under the Facility are collateralized by substantially all of the Company’s assets including inventory, equipment and accounts receivable. The amount of anyavailable borrowings fluctuates based upon the eligible underlying asset borrowing base, as well asdefined in the Company’s working capital requirements.Facility agreement. The Facility has various covenants that may, among other things, restrictaffect the ability of the Company to merge with another entity, sell or transfer certain assets, pay dividends and make other distributions beyond certain limitations. The Facility also requires the Company to meet certain financial covenants, including tangible net worth and operating goals.earnings. Certain financial covenants were amended and restated to more accurately reflect the Company’s future performance based upon revised projections. At December 31, 2002,2003 the Company was in compliance with its covenants pursuant to the Facility. However, due to the 15-day extension to file Form 10-K, the Company has not provided annual financial statements to the bank within the required 90-day period. In addition, it was probable that certain 2004 cash flow covenants would not be achieved. Accordingly, the Company has obtained a waiver for any such covenant violations and the Company and Wells Fargo Foothill have agreed upon modified cash flow covenants through October 21, 2005. The amended negative covenants require the Company to meet cash flow targets based on EBITDA as defined in the Facility. At December 31, 2003, the Company had outstanding borrowings of $6.6$6.5 million and available creditunused borrowing availability of $4.9$2.0 million on the facility.Facility. As of December 31, 2002,2003, the interest rate on the facilityFacility was 5.75%.

Cash used by operating activities was $4.3 million in 2003, due primarily to the operating losses the Company incurred during the year. Cash provided by investing activities was $4.7 million in 2003. This is primarily due to $4.0 million proceeds from the sale of TelosOK LLC in March 2003 and a release of a $1.0 million escrow payment received in October 2003 in connection with the sale of TCC, offset by the purchase of property and equipment. The Company used cash for financing activities in the amount of $654,000 in 2003, primarily due to payments made to reduce capital lease obligations and the Facility.

Management believes that the borrowing capacity under its Facility is sufficient to fund its capital and liquidity needs for the foreseeable future.

Senior Subordinated Notes

 

The Company’s subordinated notes (“Subordinated Notes”) are held principally by common shareholders and totaled $5.2 million at December 31, 2002.2003. These subordinated notes bear interest at rates between 14% and 17%, due and payable on October 31, 2004. During 2002,2003, the Company paid $1.1 million$757,000 in interest to subordinated note holders. In addition, these notes have a cumulative prepayment premium of 13.5% per annum payable only upon certain circumstances, which if in effect, would be approximately $10.0 million at December 31, 2003. See Note 6 – Debt Obligations.

Redeemable Preferred Stock

 

The Company currently has two primary classes of redeemable preferred stock - Senior Redeemable Preferred Stock and Public Preferred Stock. Each class carries cumulative dividend rates of 12% to 14.125%. At December 31, 20022003 the total carrying amount of redeemable preferred stock, including accumulated and unpaid dividends was $60.9$67.2 million. The Company accrues dividends and provides for accretion related to the redeemable preferred stock. During 2002,2003, the Company recorded $4.2 million of dividends on the two classes of redeemable preferred stock. Mandatory redemption for all shares of the Senior Redeemable Preferred Stock plus all accrued dividends on those shares is due on October 31, 2004, and2004. In accordance with certain requirements in the Facility, on or before August 15, 2004, to the extent the redemption date of the Senior Redeemable Preferred Stock has not been extended to a date later than October 31, 2005,2004, Senior Redeemable Preferred Stockholders agreehave agreed to extend the redemption date to a date no earlier than October 31, 2005, subject to the legal availability of funds. Mandatory redemption for the Public Preferred Stock is requiredcontractually scheduled from 2005 through 2009, subject to the legal availability of funds.2009.

 

Cash used by operating activities was $9.3 million in 2002, due primarily to the operating lossesSince 1991, the Company incurredhas not declared or paid any dividends on its Public Preferred Stock, based upon its interpretation of restrictions in its corporate charter, limitations in the terms of the Public Preferred Stock, specific dividend payment restrictions in the $22.5 million Facility entered into with Wells Fargo Foothill, and other senior obligations and limitations pursuant to Maryland law. Pursuant to their terms, the Company is required to redeem the Public Preferred Stock in five annual tranches during the year. Cash provided by investing activities was $18.2 millionperiod 2005 through 2009. Due to its substantial senior obligations, limitations set forth in 2002. Thisthe covenants in the Facility, foreseeable capital and operational requirements, corporate charter restrictions and prohibitions, and provisions of Maryland law, and assuming sufficient liquidity to undertake any stock redemption (which is primarily duepresently unquantifiable), the Company believes that the likelihood is that it will not be able to proceedsmeet the redemption schedule set forth in the terms of the sale of Telos Corporation (California) during July 2002 partially offset by $338,000 in capital expenditures. The Company used cash for financing activities in the amount of $8.7 million in 2002, consisting primarily of $3 million in payments made to reduce the Subordinated Debt and $5.8 million in payments to reduce the Facility.

In July 2000, the Company entered into a subscription agreement with certain investors that provided for the formation of an Oklahoma limited liability company, TelosOK, LLC (See Note 3 to the Consolidated Financial Statements). The Company owns 50% of this joint venture and has guaranteed 50% of the outstanding balance of a term loan TelosOK LLC has with a bank. The balance of this loan was $1.5 million at December 31, 2002. In March 2003, the Company disposed of the remaining 50% ownership interest in TelosOK LLC and was released from the loan guarantee (See discussion in Note 13 – Subsequent Events).Public Preferred Stock.

 

Page 12 of 6960


The Company has noted in previous filings (see Form 10-Q for the period ending September 30, 2003 – Reclassifications) that its ability to successfully restructure its debt obligations could affect the Company’s future operating results and that for a variety of reasons, the Company believes it will more likely than not be unable to meet the redemption schedule set forth in the terms of the Company’s Public Preferred Stock.

On March 26, 2004, the Company’s Board of Directors authorized the Company’s management to commence the process of planning for and, if appropriate, implementing the activities set forth below. Before any definitive action is undertaken in connection with such authorization (including without limitation any issuance, redemption or exchange of any equity securities of the Company), further review and approval by the Board is required.

In an effort to address its capital structure and the adverse impact of SFAS150 (Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity), which reclassified the redeemable preferred stock from equity to liability (see Note 7 – Redeemable Preferred Stock), the Company intends to immediately engage such professional service providers it deems reasonable and appropriate to advise management with regard to such recapitalization and any other transaction. The Company contemplates that such engagement will include, but may not be limited to, consideration of a swap of all debt instruments into common shares, the filing of an S-8 or other appropriate filings in order to issue the remaining authorized, but un-issued shares of Public Preferred Stock or to take such other steps as may be recommended to facilitate such recapitalization. The company will use its best efforts to reach a decision on such recapitalization within 60 days. There is no assurance that any such transaction can or will be effected, or if effected what the form of such transactions would be or when they might occur.

None of the Company’s present directors has any material financial interest in any holder of the Senior Redeemable Preferred Stock or the Subordinated Notes. Also, other than directors fees received for their service as members of the Board of Directors of the Company or fees for service as members of the Company’s Proxy Board, none of the non-executive directors receive any consulting or advisory fees or other compensation from the Company or any of its subsidiaries. Subject to further review, the full Board will continue to address the Company’s capital structure and any recommendations of the professional service providers pertaining thereto.

Aggregate Contractual Obligations and Off-Balance Sheet Arrangements

The following summarizes the Company’s contractual obligations at December 31, 2003, both on and off balance sheet, and their anticipated impact upon the Company’s liquidity and cash flow in future periods (in millions):

      Payments due by Period

   Total

  

Less than
1 Year


  1 - 3
Years


  3 - 5
Years


  More than
5 Years


Long term debt

  $11,676  $—    $11,676  $—    $—  

Capital lease obligations

  20,808   1,777   3,554   3,404   12,073

Operating lease obligations

  2,967   449   933   829   756

Preferred stock redemption (1)

  59,425   —     23,770   23,770   11,885
   
  

  

  

  

Total

  $94,876  $2,226  $39,933  $28,003  $24,714
   
  

  

  

  


(1)excludes dividends and accretion accrual

 

Capital Expenditures

 

The Company believes that its business is generally not capital intensive. Capital expenditures for property and equipment were $335,000 in 2003, $338,000 in 2002 $656,000and $626,000 in 2001 and $1.7 million in 2000.2001. The Company anticipates capital expenditures of approximately $900,000$1.6 million in 2003;2004; however, there can be no assurance that this level of capital expenditures will occur.

 

Capital Leases and Related Obligations

 

The Company has various lease agreements for property and equipment that, have met one or more of the tests, as defined inpursuant to FAS 13 “Accounting for Leases”, that require recordingthe Company to record the present value of the minimum lease payments for such equipment and property as an asset in the CompanysCompany’s consolidated financial statements. Such assets are amortized on a straight-line basis over the term of the related lease.

 

Inflation

 

The rate of inflation has been moderate over the past five years and, accordingly, has not had a significant impact on the Company. The Company has generally been able to pass through any increased costs to customers through higher prices to the extent permitted by competitive pressures. The Company’s cost reduction efforts have generally offset the effects of any inflation on the Company’s performance.

 

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) approved Statement of Financial Accounting Standards (“SFAS”) No 142, “Goodwill and Other Intangible Assets”. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Implementation of this Statement requires the Company to cease amortization of goodwill, and goodwill is tested for impairment at least annually at the reporting unit level. Goodwill is tested for impairment on an interim basis if any event occurs or circumstances change that would “more likely than not” reduce the fair value of a reporting unit below its carrying value. Intangible assets that are subject to amortization will be reviewed for impairment in accordance with SFAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of”. The Company adopted the provisions of SFAS 142 on January 1, 2002. The Company no longer amortizes goodwill to expense, but instead reviews goodwill periodically for impairment. The adoption of SFAS 142 reduced goodwill amortization expense by $250,000 annually. No material changes to the carrying value of goodwill were made as a result of the adoption of SFAS 142. As of December 31, 2002, the Company did not have any goodwill balances due to the sale of TCC in July 2002.

In October 2001, FASB Statement No. 144 (SFAS 144) “Accounting for the Impairment or Disposal of Long-lived Assets” was issued. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and this statement supercedes FASB Statement No. 121, “Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of”. The Company has restated the Consolidated Financial Statements to account for the sale of TCC as a discontinued operation in accordance with SFAS 144. For more information, refer to Note 4 – Sale of Telos Corporation-CA in the Notes to the Consolidated Financial Statements.

In July 2002, SFAS No. 146 (SFAS 146) “Accounting for Costs Associated with Exit or Disposal Activities” was issued. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 replaces EITF Issue. No. 94-3, “Liability recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company is currently evaluating the provisions of SFAS 146 to determine the Statements impact on the Company’s financial statements.

In November 2002, the FASB issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others.” The interpretation requires disclosure about the nature and terms of obligations under certain guarantees that

Page 13 of 69


the Company has issued. The interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing a guarantee. The initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements in this interpretation are effective immediately. The Company, in response to this interpretation, has provided further disclosure as it relates to product warranties and can be found in Note 10 “Commitments and Contigencies”.

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation and Disclosure – an amendment of FASB Statement No. 123” (FAS 148). This statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative transition methods for a voluntary change to fair value accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Management does not expect to adopt fair value accounting for stock-based employee compensation.

 

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 isresulting in multiple effective dates in 2003 and 2004 based on the nature as well as the creation date of the variable interest entity. The revised FIN 46 will be effective for all newnon-SPE variable interest entities created prior to February 1, 2003 no later than the first quarter of 2004. For variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be appliedapplied. The Company is the process of assessing the impact of this pronouncement for the first interim or annual period beginning after June 15, 2003.2004. The company believes that the adoption of this standard willFIN 46 applicable to 2003 did not have noa material impact on its financial statements.position or results of operations.

 

Page 13 of 60


Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company’s actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth below under the caption “Certain Factors That May Affect Future Results.”

 

Certain Factors That May Affect Future Results

 

The following important factors among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by management from time to time.

 

A number of uncertainties exist that could affect the Company’s future operating results, including, without limitation, general economic conditions which in the present period of economic downturn may include, and adversely affect, the cost and continued availability of the Company to secure adequate capital and financing to support its business; the impact of adverse economic conditions on the Company’s customers and suppliers; the ability to sell assets or to obtain alternative sources of commercially reasonable refinancing for the Company’s debt; or the ability to successfully restructure its debt obligations. Additional uncertainties include the Company’s ability to convert contract backlog to revenue, the success of the Company’s investment in Enterworks and Xacta and the Company’s access to ongoing development, product support and viable channel partner relationships with Enterworksits partners and Xacta.suppliers.

 

While in the past the Company has not experienced contract terminations with the U.S. Government, the U.S. Government can terminate at its convenience. Should such a termination occur, the Company’s operating results could be adversely impacted.

 

Due to heightened security awareness and the ongoing warmilitary and peacekeeping actions in Iraq and Afghanistan, all U.S. Government programs, especially those pertaining to national security, have been subject to review and reprioritization as evidenced by the Homeland Defense Act, and the pendingcontinued funding requirements of the warU.S. activities in Iraq.Iraq and Afghanistan. While the Company believes its products and services are well positioned to benefit from such reprioritization of demands, the magnitude of recent and prospective events pertaining to national security certainly serves to emphasize how the Company’s high percentage of revenue derived from business with the U.S. Government could alternatively be dramatically, swiftly and adversely impacted.

Page 14 of 69


 

In addition, as a high percentage of the Company’s revenue is derived from business with the U.S. Government, the Company’s operating results could also be adversely impacted should the U.S. Government’s annual budget not be approved in a timely fashion.

 

The Company has many patents and patents pending, trademarks and copyrights and other valuable proprietary information, and the Company has taken reasonable and prudent steps to protect its intellectual property. With regard to the Company’s wholly owned subsidiary, Xacta, whose software products require constant monitoring as it develops future releases and creates additional intellectual property, vigilant oversight of such intellectual property rights is imperative. Similarly,All of the intellectual property associated with our wireless division and our automated message handling system divisionCompany’s propriety solutions require constant oversight with regard to the development and protection of their respective intellectual property. Accordingly, any event that brings into question the Company’s ownership of its intellectual property could, therefore, materially and adversely impact the Company.

Page 15 of 69


 

Item 7a.7A. Quantitative and Qualitative Disclosures Aboutabout Market Risk

The Company’s exposure to market risk for changes in interest rates relates primarily to the Company’s long-term debt obligations.

 

The Company is exposed to interest rate volatility with regard to its variable rate debt obligations under its Senior Credit Facility. This facility bears interestInterest on the Facility is charged at 1.25%, subject to certain adjustments, over the bank’s base rate.rate, which was 5.75% upon initial funding. The weighted average interest rate of the facilityFacility in 20022003 was 6.89%6.66%. As of December 31, 2002, the interest rate of this facility was 5.75%. This facility expires on October 21, 2005 and hasThe Facility had an outstanding balance of $6.6$6.5 million at December 31, 2002.

The Company’s other long-term debt at December 31, 2002 consists of Senior Subordinated Notes B and C which bear interest at fixed rates ranging from 14% to 17%. The Senior Subordinated Notes principal balance at December 31, 2002 is $5.2 million, and this principal amount matures on October 31, 2004. The Company has no cash flow exposure due to rate changes for its Senior Subordinated Notes.2003.

 

Page 1614 of 6960


Item 8. Financial Statements and Supplementary Data

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

Page



Report of Independent AccountantsAuditors

  

18

16

Consolidated Statements of Operations for the Years Ended December 31, 2002,2003, December 31, 2001,2002, and December 31, 20002001

  

19

17

Consolidated Balance Sheets as of December 31, 20022003 and December 31, 20012002

  

20-21

18-19

Consolidated Statements of Cash Flows for the Years Ended December 31, 2002,2003, December 31, 2001,2002, and December 31, 20002001

  

22-23

20-21

Consolidated Statements of Changes Inin Stockholders’ Deficit for the Years Ended December 31, 2002,2003, December 31, 2001,2002, and December 31, 20002001

  

24

22

Notes to Consolidated Financial Statements

  

25-51

23-43

 

INDEX TO SCHEDULES

 

All schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.

 

Page 1715 of 6960


Report of Independent AccountantsAuditors

 

To the Board of Directors and Stockholders

of Telos Corporation:

 

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of changes in stockholders’ deficitinvestment (deficit) present fairly, in all material respects, the financial position of Telos Corporation and its subsidiaries (“the Company”) at December 31, 20022003 and 2001,2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002,2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Notes 1 and 7, effective July 1, 2003, the Company adopted Statement of Financial “Accounting Standard No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” Accordingly, the Company changed its method of accounting for its Senior Redeemable Preferred Stock and Public Preferred Stock.

/s/ PRICEWATERHOUSECOOPERSPricewaterhouseCoopers LLP

 

McLean, VAVirginia

March 28, 2003April 14, 2004

 

Page 1816 of 6960


TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands)

 

   

Year Ended December 31,


 
   

2002


   

2001


   

2000


 

Sales

               

Products

  

$

78,819

 

  

$

98,630

 

  

$

87,799

 

Xacta

  

 

11,698

 

  

 

13,558

 

  

 

9,082

 

   


  


  


   

 

90,517

 

  

 

112,188

 

  

 

96,881

 

   


  


  


Costs and expenses

               

Cost of Products

  

 

70,876

 

  

 

80,632

 

  

 

74,400

 

Cost of Xacta

  

 

8,581

 

  

 

8,626

 

  

 

6,552

 

Selling, general and administrative expenses

  

 

19,557

 

  

 

18,535

 

  

 

13,247

 

   


  


  


   

 

99,014

 

  

 

107,793

 

  

 

94,199

 

   


  


  


Operating (loss) income from continuing Operations

  

 

(8,497

)

  

 

4,395

 

  

 

2,682

 

Other income (expenses)

               

Non-operating income

  

 

10

 

  

 

67

 

  

 

92

 

Interest expense

  

 

(2,348

)

  

 

(3,195

)

  

 

(3,491

)

   


  


  


(Loss) income before continuing operations before income taxes

  

 

(10,835

)

  

 

1,267

 

  

 

(717

)

Benefit (provision) for income taxes

  

 

3,361

 

  

 

240

 

  

 

(208

)

   


  


  


(Loss) income from continuing operations

  

 

(7,474

)

  

 

1,507

 

  

 

(925

)

Discontinued operations: (Note 4)

               

Loss from discontinued operations (net of tax)

  

 

(1,078

)

  

 

(2,178

)

  

 

(869

)

Gain on sale of TCC (net of tax)

  

 

12,577

 

  

 

—  

 

  

 

—  

 

   


  


  


Net income (loss)

  

$

4,025

 

  

$

(671

)

  

$

(1,794

)

   


  


  


   Year Ended December 31,

 
   2003

  2002

  2001

 

Revenue

   88,443   90,517   112,188 

Costs and expenses

             

Cost of sales

   71,359   79,457   89,258 

Selling, general and administrative expenses

   19,027   18,656   17,019 
   


 


 


    90,386   98,113   106,277 
   


 


 


Operating (loss) income

   (1,943)  (7,596)  5,911 

Other income (expenses)

             

Non-operating income

   14   10   67 

Losses from affiliates

   (848)  (901)  (1,516)

Gain from sale of 50% interest in TelosOK LLC

   10,121   —     —   

Interest expense

   (5,542)  (2,348)  (3,195)
   


 


 


Income (loss) before income taxes

   1,802   (10,835)  1,267 

(Provision) benefit for income taxes

   (11,487)  3,361   240 
   


 


 


(Loss) income from continuing operations

   (9,685)  (7,474)  1,507 

Discontinued operations: (Note 4)

             

Loss from discontinued operations (net of tax)

   —     (1,078)  (2,178)

Gain on sale of TCC

   1,000   12,577   —   
   


 


 


Net (loss) income

   (8,685)  4,025   (671)

Accretion and dividends of redeemable preferred stock

   (3,133)  (6,109)  (5,947)
   


 


 


Net loss attributable to common equity

  $(11,818) $(2,084) $(6,618)
   


 


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 1917 of 6960


TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(amounts in thousands)

 

ASSETS

 

   

December 31,


 
   

2002


   

2001


 

Current assets

          

Cash and cash equivalents (includes restricted cash of $54 at December 31, 2002 and 2001)

  

$

358

 

  

$

115

 

Accounts receivable, net

  

 

18,820

 

  

 

19,022

 

Inventories, net

  

 

1,531

 

  

 

4,227

 

Deferred income taxes

  

 

3,477

 

  

 

2,817

 

Other current assets

  

 

496

 

  

 

540

 

Net assets of discontinued operations

  

 

—  

 

  

 

5,995

 

   


  


Total current assets

  

 

24,682

 

  

 

32,716

 

   


  


Property and equipment

          

Furniture and equipment

  

 

7,053

 

  

 

7,107

 

Leasehold improvements

  

 

412

 

  

 

352

 

Property and equipment under capital leases

  

 

14,163

 

  

 

13,774

 

   


  


   

 

21,628

 

  

 

21,233

 

Accumulated depreciation and amortization

  

 

(11,285

)

  

 

(10,090

)

   


  


   

 

10,343

 

  

 

11,143

 

Deferred income taxes, long term

  

 

8,000

 

  

 

4,748

 

Other assets

  

 

1,995

 

  

 

153

 

   


  


Total assets

  

$

45,020

 

  

$

48,760

 

   


  


   December 31,

 
   2003

  2002

 

Current assets

         

Cash and cash equivalents (includes restricted cash of $54 at December 31, 2003 and 2002)

  $64  $358 

Accounts receivable, net of reserve of $487 and $381, respectively

   17,232   18,820 

Inventories, net of obsolescence reserve of $546 and $2,291, respectively

   3,967   1,531 

Deferred income taxes

   —     3,477 

Other current assets

   2,068   496 
   


 


Total current assets

   23,331   24,682 
   


 


Property and equipment

         

Furniture and equipment

   7,025   7,053 

Leasehold improvements

   441   412 

Property and equipment under capital leases

   14,377   14,163 
   


 


    21,843   21,628 

Accumulated depreciation and amortization

   (12,475)  (11,285)
   


 


    9,368   10,343 
   


 


Deferred income taxes, long term

   —     8,000 

Other assets

   912   1,995 
   


 


Total assets

  $33,611  $45,020 
   


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 2018 of 6960


TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

 

LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK,

AND STOCKHOLDERS’ DEFICIT

 

   

December 31,


 
   

2002


   

2001


 

Current liabilities

          

Accounts payable

  

$

8,021

 

  

$

7,879

 

Accrued compensation and benefits

  

 

5,558

 

  

 

5,230

 

Deferred revenue

  

 

8,074

 

  

 

8,710

 

Current portion, capital lease obligations

  

 

408

 

  

 

337

 

Other current liabilities

  

 

1,872

 

  

 

698

 

   


  


Total current liabilities

  

 

23,933

 

  

 

22,854

 

Senior credit facility

  

 

6,618

 

  

 

12,387

 

Senior subordinated notes

  

 

5,179

 

  

 

8,179

 

Capital lease obligations

  

 

10,647

 

  

 

10,722

 

   


  


Total liabilities

  

 

46,377

 

  

 

54,142

 

   


  


Commitments and contingencies (Note 10)

          

Senior mandatorily redeemable preferred stock

  

 

7,327

 

  

 

6,903

 

Mandatorily redeemable exchangeable preferred stock

  

 

53,561

 

  

 

47,876

 

   


  


   

 

60,888

 

  

 

54,779

 

   


  


Stockholders’ deficit

          

Class A common stock, no par value, 50,000,000 shares authorized, 21,171,202 shares issued and outstanding, respectively

  

 

65

 

  

 

65

 

Class B common stock, no par value, 50,000,000 shares authorized, 4,037,628 shares issued and outstanding

  

 

13

 

  

 

13

 

Capital in excess of par

  

 

6,127

 

  

 

6,127

 

Accumulated deficit

  

 

(68,450

)

  

 

(66,366

)

   


  


Total stockholders’ deficit

  

 

(62,245

)

  

 

(60,161

)

   


  


   

$

45,020

 

  

$

48,760

 

   


  


The accompanying notes are an integral part of these consolidated financial statements

Page 21 of 69


TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

   

Year Ended December 31,


 
   

2002


   

2001


   

2000


 

Operating activities:

               

(Loss) income from continuing operations

  

$

(7,474

)

  

$

1,507

 

  

$

(925

)

Adjustments to reconcile (loss) income from continuing operations to cash provided by (used in) operating activities:

               

Depreciation and amortization

  

 

1,784

 

  

 

1,779

 

  

 

1,662

 

Amortization of debt issuance costs

  

 

—  

 

  

 

—  

 

  

 

182

 

Telos OK LLC note receivable

  

 

—  

 

  

 

500

 

  

 

—  

 

Provision for inventory obsolescence

  

 

2,236

 

  

 

514

 

  

 

50

 

Provision for doubtful accounts receivable

  

 

470

 

  

 

—  

 

  

 

1,213

 

Incentive bonus accrual

  

 

—  

 

  

 

320

 

  

 

—  

 

Reserve for termination agreements

  

 

920

 

  

 

—  

 

  

 

1,186

 

Write off of international joint venture

  

 

—  

 

  

 

654

 

  

 

—  

 

Deferred income tax benefit

  

 

(3,912

)

  

 

(571

)

  

 

(9

)

Changes in assets and liabilities

               

(Increase) decrease in accounts receivable

  

 

(268

)

  

 

17,290

 

  

 

(20,482

)

Decrease (increase) in inventories

  

 

204

 

  

 

2,082

 

  

 

(2,481

)

Increase in other assets

  

 

(1,798

)

  

 

(206

)

  

 

(304

)

(Decrease) increase in accounts payable and other liabilities

  

 

(413

)

  

 

(9,702

)

  

 

6,205

 

   


  


  


Cash (used in) provided by continuing operating activities

  

 

(8,251

)

  

 

14,167

 

  

 

(13,703

)

Cash used in discontinued operating activities

  

 

(1,092

)

  

 

(406

)

  

 

(1,018

)

   


  


  


Net cash (used in) provided by operating activities

  

 

(9,343

)

  

 

13,761

 

  

 

(14,721

)

Investing activities:

               

Proceeds from contribution of assets

  

 

—  

 

  

 

—  

 

  

 

6,000

 

Net proceeds from sale of TCC

  

 

18,586

 

  

 

—  

 

  

 

—  

 

Purchase of property and equipment

  

 

(338

)

  

 

(626

)

  

 

(1,578

)

   


  


  


Cash provided by (used in) continuing operations investing activities

  

 

18,248

 

  

 

(626

)

  

 

4,422

 

Cash used in discontinued investing activities

  

 

—  

 

  

 

(30

)

  

 

(113

)

   


  


  


Net cash provided by (used in) investing activities

  

 

18,248

 

  

 

(656

)

  

 

4,309

 

Financing activities:

               

(Payments of) proceeds from Senior Credit Facility

  

 

(5,769

)

  

 

(13,073

)

  

 

8,952

 

Repayment of Series C Subordinated Note

  

 

(3,000

)

  

 

(358

)

  

 

—  

 

Increase in book overdrafts

  

 

501

 

  

 

470

 

  

 

1,789

 

Payments under capital lease obligations

  

 

(394

)

  

 

(315

)

  

 

(358

)

   


  


  


Cash (used in) provided by financing activities

  

 

(8,662

)

  

 

(13,276

)

  

 

10,383

 

   


  


  


Increase (decrease) in cash and cash equivalent

  

 

243

 

  

 

(171

)

  

 

(29

)

Cash and cash equivalents at beginning of the year

  

 

115

 

  

 

286

 

  

 

315

 

   


  


  


Cash and cash equivalents at end of year

  

$

358

 

  

$

115

 

  

$

286

 

   


  


  


Page 22 of 69


   

Year Ended December 31,


   

2002


  

2001


  

2000


Supplemental disclosures of cash flow information:

            

Cash paid during the year for:

            

Interest

  

$

1,784

  

$

2,605

  

$

3,396

   

  

  

Income taxes

  

$

28

  

$

522

  

$

529

   

  

  

Supplemental disclosure of non cash investing:

            

Equipment acquired under capital lease obligations

  

$

390

  

$

  

$

   

  

  

   December 31,

 
   2003

  2002

 

Current liabilities

         

Accounts payable

  $8,392  $8,021 

Accrued compensation and benefits

   5,520   5,558 

Deferred revenue

   8,296   8,074 

Current portion, capital lease obligations

   457   408 

Other current liabilities

   2,042   1,872 
   


 


Total current liabilities

   24,707   23,933 

Senior credit facility

   6,497   6,618 

Senior subordinated notes

   5,179   5,179 

Capital lease obligations

   10,243   10,647 

Senior redeemable preferred stock (Note 7)

   7,751   —   

Public preferred stock (Note 7)

   59,425   —   
   


 


Total liabilities

   113,802   46,377 
   


 


Senior redeemable preferred stock (Note 7)

   —     7,327 

Public preferred stock (Note 7)

   —     53,561 
   


 


    —     60,888 
   


 


Stockholders’ deficit

         

Class A common stock, no par value, 50,000,000 shares authorized, 21,171,202 shares issued and outstanding, respectively

   65   65 

Class B common stock, no par value, 5,000,000 shares authorized, 4,037,628 shares issued and outstanding

   13   13 

Capital in excess of par

   —     6,127 

Accumulated deficit

   (80,269)  (68,450)
   


 


Total stockholders’ deficit

   (80,191)  (62,245)
   


 


   $33,611  $45,020 
   


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 2319 of 6960


TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICITCASH FLOWS

(amounts in thousands)

 

   

Class A

Common

Stock


  

Class B

Common

Stock


  

Capital

In Excess of Par


  

Stockholders’

Accumulated

Deficit


   

Total

Deficit


 

Balance December 31, 1999

  

$

65

  

$

13

  

$

—  

  

$

(52,669

)

  

$

(52,591

)

   

  

  

  


  


Senior redeemable preferred stock dividend

  

 

—  

  

 

—  

  

 

—  

  

 

(424

)

  

 

(424

)

Deconsolidation of accounts

  

 

—  

  

 

—  

  

 

—  

  

 

517

 

  

 

517

 

Redeemable preferred stock dividend

  

 

—  

  

 

—  

  

 

—  

  

 

(3,823

)

  

 

(3,823

)

Redeemable preferred stock accretion

  

 

—  

  

 

—  

  

 

—  

  

 

(1,555

)

  

 

(1,555

)

Contribution of assets to TelosOK LLC

  

 

—  

  

 

—  

  

 

5,627

  

 

—  

 

  

 

5,627

 

Net loss for the year

  

 

—  

  

 

—  

  

 

—  

  

 

(1,794

)

  

 

(1,794

)

   

  

  

  


  


Balance December 31, 2000

  

$

65

  

$

13

  

$

5,627

  

$

(59,748

)

  

$

(54,043

)

   

  

  

  


  


Senior redeemable preferred stock dividend

  

 

—  

  

 

—  

  

 

—  

  

 

(423

)

  

 

(423

)

Redeemable preferred stock dividend

  

 

—  

  

 

—  

  

 

—  

  

 

(3,822

)

  

 

(3,822

)

Redeemable preferred stock accretion

  

 

—  

  

 

—  

  

 

—  

  

 

(1,702

)

  

 

(1,702

)

Contribution of assets to TelosOK LLC

  

 

—  

  

 

—  

  

 

500

  

 

—  

 

  

 

500

 

Net loss for the year

  

 

—  

  

 

—  

  

 

—  

  

 

(671

)

  

 

(671

)

   

  

  

  


  


Balance December 31, 2001

  

$

65

  

$

13

  

$

6,127

  

$

(66,366

)

  

$

(60,161

)

   

  

  

  


  


Senior redeemable preferred stock dividend

  

 

—  

  

 

—  

  

 

—  

  

 

(424

)

  

 

(424

)

Redeemable preferred stock dividend

  

 

—  

  

 

—  

  

 

—  

  

 

(3,823

)

  

 

(3,823

)

Redeemable preferred stock accretion

  

 

—  

  

 

—  

  

 

—  

  

 

(1,862

)

  

 

(1,862

)

Net income for the year

  

 

—  

  

 

—  

  

 

—  

  

 

4,025

 

  

 

4,025

 

   

  

  

  


  


Balance December 31, 2002

  

$

65

  

$

13

  

$

6,127

  

$

(68,450

)

  

$

(62,245

)

   

  

  

  


  


   Year Ended December 31,

 
   2003

  2002

  2001

 

Operating activities:

             

(Loss) income from continuing operations

  $(9,685) $(7,474) $1,507 

Adjustments to reconcile (loss) income from continuing operations to cash provided by (used in) operating activities:

             

Gain from on sale of 50% interest in TelosOK LLC

   (10,121)  —     —   

Dividends and accretion of preferred stock as interest expense

   3,155   —     —   

Depreciation and amortization

   1,587   1,784   1,779 

Telos OK LLC note receivable

   —     —     500 

Provision for inventory obsolescence

   664   2,236   514 

Provision for doubtful accounts receivable

   (173)  470   —   

Deferred income tax provision (benefit)

   11,477   (3,912)  (571)

Changes in assets and liabilities

             

Decrease (increase) in accounts receivable

   1,761   (268)  17,290 

(Increase) decrease in inventories

   (3,379)  204   2,082 

(Increase) decrease in other assets

   (489)  (1,798)  (206)

Increase (decrease) in accounts payable and other liabilities

   904   507   (8,728)
   


 


 


Cash (used in) provided by continuing operating activities

   (4,299)  (8,251)  14,167 

Cash used in discontinued operating activities

   —     (1,092)  (406)
   


 


 


Net cash (used in) provided by operating activities

   (4,299)  (9,343)  13,761 
   


 


 


Investing activities:

             

Net proceeds from sale of TelosOK LLC

   3,994   —     —   

Net proceeds from sale of TCC

   1,000   18,586   —   

Purchase of property and equipment

   (335)  (338)  (626)
   


 


 


Cash provided by (used in) continuing operations investing activities

   4,659   18,248   (626)

Cash used in discontinued investing activities

   —     —     (30)
   


 


 


Net cash provided by (used in) investing activities

   4,659   18,248   (656)
   


 


 


Financing activities:

             

Payments of Senior Credit Facility

   (121)  (5,769)  (13,073)

Repayment of Series C Subordinated Note

   —     (3,000)  (358)

(Decrease) increase in book overdrafts

   (178)  501   470 

Payments under capital lease obligations

   (355)  (394)  (315)
   


 


 


Cash (used in) financing activities

   (654)  (8,662)  (13,276)
   


 


 


Increase (decrease) in cash and cash equivalent

   (294)  243   (171)

Cash and cash equivalents at beginning of the year

   358   115   286 
   


 


 


Cash and cash equivalents at end of year

  $64  $358  $115 
   


 


 


Page 20 of 60


   Year Ended December 31,

   2003

  2002

  2001

Supplemental disclosures of cash flow information:

            

Cash paid during the year for:

            

Interest

  $2,413  $3,094  $4,001
   

  

  

Income taxes

  $18  $28  $522
   

  

  

Supplemental disclosure of non cash investing:

            

Equipment acquired under capital lease obligations

  $—    $390  $—  
   

  

  

Non-cash:

            

Interest on redeemable preferred stock

  $3,155  $—    $—  
   

  

  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 2421 of 6960


TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT

(amounts in thousands)

   

Class A

Common

Stock


  

Class B

Common

Stock


  

Capital

In Excess

of Par


  

Stockholders

Accumulated

Deficit


  

Total

Deficit


 

Balance December 31, 2000

  $65  $13  $5,627  $(59,748) $(54,043)
   

  

  


 


 


Senior redeemable preferred stock dividend

   —     —     —     (423)  (423)

Public preferred stock dividend

   —     —     —     (3,822)  (3,822)

Public preferred stock accretion

   —     —     —     (1,702)  (1,702)

Contribution of assets to TelosOK LLC

   —     —     500   —     500 

Net loss for the year

   —     —     —     (671)  (671)
   

  

  


 


 


Balance December 31, 2001

  $65  $13  $6,127  $(66,366) $(60,161)
   

  

  


 


 


Senior redeemable preferred stock dividend

   —     —     —     (424)  (424)

Public preferred stock dividend

   —     —     —     (3,823)  (3,823)

Public preferred stock accretion

   —     —     —     (1,862)  (1,862)

Net loss for the year

   —     —     —     4,025   4,025 
   

  

  


 


 


Balance December 31, 2002

  $65  $13  $6,127  $(68,450) $(62,245)
   

  

  


 


 


Senior redeemable preferred stock dividend

   —     —     —     (211)  (211)

Public preferred stock dividend

   —     —     —     (1,912)  (1,912)

Public preferred stock accretion

   —     —     —     (1,011)  (1,011)

Sale of Telos OK LLC

   —     —     (6,127)  —     (6,127)

Net loss for the year

   —     —     —     (8,685)  (8,685)
   

  

  


 


 


Balance December 31, 2003

  $65  $13  $—    $(80,269) $(80,191)
   

  

  


 


 


The accompanying notes are an integral part of these consolidated financial statements.

Page 22 of 60


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1. Summary of Significant Accounting Policies

 

Business and Organization

 

Founded in 1968, Telos Corporation (“Telos”(the “Company” or the “Company”“Telos”) delivers enterprise security andis a systems integration solutions and services to customers incompany addressing the U. S. Government and industry. Since September 11, 2001, the United States and Telos’ largest customer, theinformation technology needs of U.S. Government changed forever in terms of their respective requirements for increased reliablecustomers worldwide. The Company also owns Xacta Corporation, a wholly-owned subsidiary, that develops, markets and sells U.S. Government-validated secure informationenterprise solutions to federal, state and communication. Telos solutions address critical needs in the areas of secure wireless networking, secure messaging, secure local area networks (“LAN”) data integrationgovernment agencies and enterprise risk management.to financial institutions.

 

Since 1996, Telos has identified and sold a number of business units that were no longer a part of its strategic plan. These businesses were: Telos Consulting Services, Telos Information Systems, Telos Field Engineering and most recently, Telos Corporation (California). In 2000, Telos contributed2003, the net assets ofCompany sold its Ft. Sill operation to a newly created joint venture with outside investors, resulting in a 50% ownershipinterest in TelosOK LLC. The Company has subsequently sold such interest to TelosOK LLC in March 2003 for consideration of $4.5$4.0 million. Refer to Note 13 “Subsequent Events”3—Sale of TelosOK LLC for more information. These business dispositions and ventures as well as operating cashflows, have enabled Telos to reduce corporate indebtedness from a high of $56.9 million in 1997 to $11.8$11.7 million at December 31, 2002.

During 2002 the Company provided its business solutions through two operating segments: the Products Group and it’s a wholly owned subsidiary, Xacta . A third reportable segment, Systems and Support Services, provided through a wholly owned subsidiary, Telos Corporation (California) (“TCC”), was sold on July 19, 2002 (See Note 4 – Sale of Telos Corporation (California)) and is being treated as a discontinued operation.2003.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of Telos Corporation and its wholly owned subsidiaries including ubIQuity.com, Inc., Telos International Corporation, Xacta Corporation Telos.com, Inc., and Telos Delaware, Inc. (collectively, the “Company”). The accounts of the Company’s investment in Enterworks, Inc. (“Enterworks”) have been deconsolidated as of December 30, 1999, and therefore have been removed from the consolidated balance sheet and statement of changes in stockholders equity. The Company had a 50% interest in TelosOK LLC, (“TelosOK”) as of December 31, 2002 which was accounted for underhas applied the equity method of accounting. The Company soldaccounting for the remaining interest in TelosOK LLC on March 10, 2003. Details of the transaction can be found in Note 13 “Subsequent Events”.Enterworks investment. Significant intercompany transactions have been eliminated.

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions used in the preparation of the Company’s consolidated financial statements include contract percentage-of-completion methodology, allowance for doubtful accounts receivable, allowance for inventory obsolescence, valuation of goodwill, the valuation allowance for deferred tax assets, employee benefits, and estimated useful lives of goodwill, property and equipment and other non-current assets, including software development costs. Actual results could differ from those estimates.

 

Revenue Recognition

 

The majority of the Company’s sales are made directly or indirectly to the U.S. Government. A substantial portion of the Company’s revenues is derived fromFor time and materials contracts, under which revenue is recognized as services are performed and costs are incurred. Revenue from fixed price services contracts is generally recognized over the contract term using the percentage of completion method. The CompanyProduct reselling revenue is generally recognizes product revenuerecognized as products are shipped,delivered to customers, although certain revenue recognition practices are dependent upon contract terms. Revenue for maintenance contracts is recognized as such services are performed. The Company records anyover the term of the maintenance contracts. Any required loss provisions for its contracts are recorded at the time such losses are identified.

Page 25 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenue from the licensing of software is recognized in accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position (“SOP”)97-2 and SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions”. Revenue generated from software subscription contracts is recognized ratably over the subscription period.period, generally up to 3 years.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. The Company’s cash management program utilizes zero balance accounts. Accordingly, all book overdraft balances have been reclassified to accounts payable.

 

Page 23 of 60


Inventories

 

Inventories are stated at the lower of cost or market, where cost is determined on the first-in, first-out method. Substantially all inventories consist of purchased customer off-the-shelf hardware and software, and component computer parts used in connection with system integration services performed by the Company. Inventories also include spare parts of $685,000$788,000 and $794,000$685,000 at December 31, 20022003 and 2001,2002, respectively, which are utilized to support maintenance contracts. Spare parts inventory is amortized on a straight-line basis over four to five years. An allowance for obsolete, slow-moving or non-salable inventory is provided for all other inventory. This allowance is based on the Company’s overall obsolescence experience and its assessment of future inventory requirements. The Company’s cost of sales includes charges for inventory obsolescence of $2.2 million during 2002 consisting primarily of a $1.7 million charge taken in September 2002 included in the ProductsIT Solutions Group cost of goods sold. This charge was taken primarily due to the age of the specific inventory and the significant additional costs that would be necessary to upgrade to current standards as well as the lack of forecasted sales for such inventory in the near future. Gross inventory is $5.1$5.6 million and $6.1$5.1 million at December 31, 2003 and 2002, and 2001, respectively. As of December 31, 2003, it is management’s judgment that the Company is fully reserved for any potential inventory obsolescence.

 

The components of the allowance for inventory obsolescence are set forth below (in thousands):

 

   

Balance,

Beginning

of Year


  

Additions Charge to Costs and

Expense


  

Deductions(1)


   

Balance,

End

Of Year


Year Ended December 31, 2002

  

$

884

  

$

2,236

  

$

(829

)

  

$

2,291

Year Ended December 31, 2001

  

$

1,777

  

$

514

  

$

(1,407

)

  

$

884

Year Ended December 31, 2000

  

$

1,992

  

$

50

  

$

(265

)

  

$

1,777

(1)Inventories written off or transferred to fixed assets.
   

Balance,
Beginning
of

Year


  

Additions
Charge to
Costs and
Expense


  Deductions

  

Balance,

End

Of

Year


Year Ended December 31, 2003

  $2,291  $664  $(2,409) $546

Year Ended December 31, 2002

  $884  $2,236  $(829) $2,291

Year Ended December 31, 2001

  $1,777  $514  $(1,407) $884

 

Property and Equipment

 

Property and equipment is recorded at cost. Depreciation is provided on the straight-line method at rates based on the estimated useful lives of the individual assets or classes of assets as follows:

 

Buildings

  

20

Years

Machinery and equipment

  

3-7

3-5 Years

Office furniture and fixtures

  

5-7

5 Years

Leasehold improvements

  

Life of Lease

 

Leased property meeting certain criteria is capitalized at the present value of the related minimum lease payments. Amortization of property and equipment under capital leases is computed on the straight-line method over the term of the related lease.

 

Upon sale or retirement of property and equipment, the costs and related accumulated depreciation are eliminated from the accounts, and any gain or loss on such disposition is reflected in the statement of operations. ExpenditureExpenditures for repairs and maintenance are charged to operations as incurred.

Page 26 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company’s policy on internal use software is in accordance with Statement of Position 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” This standard requires companies to capitalize qualifying computer software costs which are incurred during the application development stage and amortize them over the software’s estimated useful life.

 

Depreciation and amortization expense related to property and equipment, including property and equipment under capital leases, was $1,549,000,$1,307,000, $1,526,000 and $1,598,000 and $1,541,000 for the years ended December 31, 2003, 2002 2001 and 2000,2001, respectively.

 

Goodwill

 

Goodwill arose principally from the acquisition of Telos Corporation (California) (“TCC”) in 1992 and was initially assigned a useful life of twenty years. The useful life considered a number of factors including the Company’s maintenance of long-term significant customer relationships for periods of up to twenty-seven years and its strong positions in the marketplace.

 

Goodwill amortization expense for 2000 and 2001 has been reported separately under operating income (loss) from discontinued operations due to the sale of TCC. Beginning January 2002 the Company no longer amortizesamortized its goodwill asset according to SFAS 142. The Company does not have any goodwill assets recorded on the balance sheet as of December 31, 20022003 due to the sale of TCC. (seeSee Note 4 - Sale of Telos Corporation (California)).

 

  

For the year ended December 31,


 
  

2002


  

2001


   

2000


   

For the year ended December 31,

(amount in thousands)


 
  

(amounts in thousands)

   2003

 2002

  2001

 

Reported net income (loss)

  

$

4,025

  

$

(671

)

  

$

(1,794

)

  $(8,685) $4,025  $(671)

Add back: Goodwill amortization

  

 

—  

  

 

250

 

  

 

312

 

   —     —     250 
  

  


  


  


 

  


Adjusted net income (loss)

  

$

4,025

  

$

(421

)

  

$

(1,482

)

  $(8,685) $4,025  $(421)
  

  


  


  


 

  


 

Page 24 of 60


Other Assets

 

The balance as of December 31, 20022003 consists mostlyprimarily of prepaid expenses with vendors providing credit against future purchases.

Since 1997, onecertain escrow deposits related to the sale of the Company’s wholly owned subsidiaries, Telos International Corporation (“TIC”), has been a 50% owner of a joint venture between TIC and Filinvest Capital, Inc., a Philippine company. The Company accounted for this joint venture under the equity method of accounting as prescribed by APB No. 18. The investment in this joint venture was included in the other asset balance prior to 2001. In the second quarter of 2001, the Company became uncertain as to whether operations under the joint venture would continue as a going concern. Therefore, the Company determined that its investment in Telos International-Filinvest, Inc. was impaired, and reduced its investment balance in the joint venture to zero. The amount of the write-off totaled $654,000, and is included in the Selling, General and Administrative caption in the statement of operations for the year ended December 31, 2001.

The Company accounts for its investment balance TelosOK LLC under the equity method.TCC. See Note 3 for a discussion4 – Sale of the TelosOK LLC investment accounted for under the equity method.Telos Corporation (California).

 

Income Taxes

 

The Company accounts for income taxes under Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”. Under this asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences and income tax credits. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates that are applicable to the future years in which deferred tax assets or liabilities are expected to be settled or realized to the differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Any change in tax rates on deferred tax assets and liabilities is recognized in net income in the period in which the tax rate change is enacted. The Company provides a valuation allowance that reduces deferred tax assets when it is “more likely than not” that deferred tax assets will not be realized.

 

Accounting for Stock Based Compensation

 

The Company accounts for stock-based compensation using the intrinsic value method provided byconsistent with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Under APB 25, compensation cost is measured as the excess, if any, of the fair market value of the Company’s common stock at the date of grant over the exercise price of the option granted.

Page 27 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Compensation cost for stock options, if any, is recognized over the vesting period. The Company has provided additional pro forma disclosures as if the fair value measurement provisions of SFAS No. 123 had been used in determining compensation expense (See Note 8).

 

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation and Disclosure - an amendment of FASB Statement No. 123” (FAS 148). This statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative transition methods for a voluntary change to fair value accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Management does not expect to adopt fair value accounting for stock-based employee compensation.

 

There were no options granted from any plan during 2003. There were no options granted in the 1990 or 1993 Stock Option Plan in 2002 or 2001. The weighted-average fair value of options granted under the 1990 Stock Option Plan, the 1993 Stock Option Plan, the 1996 Stock Option Plan, the 2000 Telos Delaware Stock Option Plan, and the 2000 Xacta Stock Option Plan was $0, $0, $0.20, $0.41, and $0.08, respectively, in 2002, and $0, $0, $0.30, $0.50, and $0.10, respectively, in 2001. Had the Company determinedrecorded compensation cost consistent with SFAS No. 148123 methodology, net income/income (loss) would have been:

 

Adjusted net income/(loss) consistent with SFAS No. 148 methodology:

   

December 31,


 
   

2002


   

2001


   

2000


 
   

(amounts in thousands)

 

Net income/(loss)

  

$

4,025

 

  

$

(671

)

  

$

(1,794

)

SFAS 123 compensation expense Using fair value method

  

 

(724

)

  

 

(588

)

  

 

(297

)

   


  


  


Adjusted net income/(loss)

  

$

3,301

 

  

$

(1,259

)

  

$

(2,091

)

   


  


  


   December 31,

 
   2003

  2002

  2001

 
   (amounts in thousands) 

Net (loss) income

  $(8,685) $4,025  $(671)

SFAS 123 compensation expense using fair value method

   (271)  (724)  (588)
   


 


 


Adjusted net (loss) income

  $(8,956) $3,301  $(1,259)
   


 


 


 

Significant assumptions used in determining the fair value of each option grant at the date of grant were as follows:

 

  

1990 Stock Option Plan


   

1993 Stock Option Plan


   1990 Stock Option Plan

 1993 Stock Option Plan

 
  

2002


   

2001


   

2000


   

2002


   

2001


   

2000


   2003

 2002

 2001

 2003

 2002

 2001

 

Expected dividend yield

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Expected stock price volatility

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Risk free interest rate

  

—  

 

  

—  

 

  

5.91

%

  

—  

 

  

—  

 

  

—  

 

  —    —    —    —    —    —   

Expected life of options

  

—  

 

  

—  

 

  

2.09

yrs

  

—  

 

  

—  

 

  

—  

 

  —    —    —    —    —    —   

 

   

1996 Stock Option Plan


   

2000 Telos Delaware Stock Option Plan


 
   

2002


   

2001


   

2000


   

2002


   

2001


   

2000


 

Expected dividend yield

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

Expected stock price volatility

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

  

0.0

%

Risk free interest rate

  

3.13

%

  

4.96

%

  

6.59

%

  

3.56

%

  

4.70

%

  

6.01

%

Expected life of options

  

6.6

yrs

  

6.6

yrs

  

4.0

yrs

  

3.1

yrs

  

3.0

yrs

  

3.3

yrs

   1996 Stock Option Plan

  

2000 Telos Delaware

Stock Option Plan


   2003

  2002

  2001

  2003

  2002

  2001

Expected dividend yield

  0.0%  0.0%  0.0%  0.0%  0.0%  0.0%

Expected stock price volatility

  0.0%  0.0%  0.0%  0.0%  0.0%  0.0%

Risk free interest rate

  —    3.13%  4.96%  —    3.56%  4.70%

Expected life of options

  —    6.6 yrs  6.6 yrs  —    3.1 yrs  3.0 yrs

 

Page 2825 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   

2000 Xacta Stock Option Plan


 
   

2002


   

2001


   

2000


 

Expected dividend yield

  

0.0

%

  

0.0

%

  

0.0

%

Expected stock price volatility

  

0.0

%

  

0.0

%

  

0.0

%

Risk free interest rate

  

3.53

%

  

4.70

%

  

6.52

%

Expected life of options

  

3.1

yrs

  

3.0

yrs

  

3.3

yrs

Because the pro forma disclosures under SFAS No. 123 only apply to stock options granted in or after 1995, pro forma net income for 2000, 2001, and 2002 is not necessarily indicative of future periods.

   

2000 Xacta

Stock Option Plan


   2003

  2002

  2001

Expected dividend yield

  0.0%  0.0%  0.0%

Expected stock price volatility

  0.0%  0.0%  0.0%

Risk free interest rate

  —    3.53%  4.70%

Expected life of options

  —    3.1 yrs  3.0 yrs

 

Research and Development

 

The Company charges all research and development costs to expense as incurred. For software research and development expenses, such costs are capitalized once technological feasibility is reached. During 2003, 2002 2001 and 2000,2001, the Company incurred approximately $577,000, $925,000,$0.9 million, $1.4 million and $200,000$1.3 million in research and development salary costs, respectively.

 

Earnings per Share

 

In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, “Earnings per Share.” This Statement establishes standards for computing and presenting earnings per share (EPS). As the Company does not have publicly held common stock or potential common stock, this Statement is not applicable and, accordingly, no EPSearnings per share data is reported for any of the years presented.

 

Comprehensive Income

 

Comprehensive income includes changes in equity (net assets) during a period from non-owner sources. The Company has no comprehensive income/income (loss) components other than its net income/income (loss).

 

Financial Instruments

 

The Company uses various methods and assumptions to estimate the fair value of its financial instruments. Due to their short-term nature, the carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximates fair value. The fair value of long-term debt is based on the discounted cash flows for similar term borrowings based on market prices for the same or similar issues. The Company has not estimated the fair value of its subordinated debt or its redeemable preferred stock. The Company does not deem such estimation practicable due to the unique features of these instruments.

 

Fair value estimates are made at a specific point in time, based on relevant market information. These estimates are subjective in nature and involve matters of judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

Reclassifications

 

Certain reclassifications have been made to the 20012003, 2002 and 20002001 financial statements to conform to the current period presentation. Additional material reclassifications had been required in order to conform to the recent accounting pronouncements of FAS 150 (as discussed below and in Note 7 – Redeemable Preferred Stock).

 

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) approved Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Implementation of this Statement requires the Company to cease amortization of goodwill, and goodwill is tested for

Page 29 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

impairment at least annually at the reporting unit level. Goodwill is tested for impairment on an interim basis if any event occurs or circumstances change that would “more likely than not” reduce the fair value of a reporting unit below its carrying value. Intangible assets that are subject to amortization will be reviewed for impairment in accordance with SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of”. The Company adopted the provisions of SFAS No. 142 on January 1, 2002. The Company no longer amortizes goodwill to expense, but instead reviews goodwill periodically for impairment. The adoption of SFAS No. 142 reduced goodwill amortization expense by $250,000 annually. No material changes to the carrying value of goodwill were made as a result of the adoption of SFAS No. 142. As discussed in Note 4 – Sale of Telos Corporation (CA), the goodwill balance of $2.5 million related to TCC was netted against the gain on the sale of that subsidiary. As of December 31, 2002, the goodwill balance was zero.

In October 2001, FASB Statement No. 144 (SFAS 144) “Accounting for the Impairment or Disposal of Long-lived Assets” was issued. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and this statement supercedes FASB Statement No. 121, “Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of”. The Company has restated the Consolidated Financial Statements to account for the sale of TCC as a discontinued operation in accordance with SFAS 144. For more information, refer to Note 4 – Sale of Telos Corporation-CA in the Notes to the Consolidated Financial Statements.

In July 2002, SFAS No. 146 (SFAS 146) “Accounting for Costs Associated with Exit or Disposal Activities” was issued. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 replaces EITF Issue. No. 94-3, “Liability recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company has evaluated the affects of implementing SFAS 146 and has determined there is no material affect to the financial statements and related disclosures.

In November 2002, the FASB issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others.” The interpretation requires disclosure about the nature and terms of obligations under certain guarantees that the Company has issued. The interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing a guarantee. The initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements in this interpretation are effective immediately. The Company, in response to this interpretation, has provided further disclosure as it relates to product warranties and can be found in Note 10 “Commitments and Contigencies”.

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation and Disclosure – an amendment of FASB Statement No. 123” (FAS 148). This statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative transition methods for a voluntary change to fair value accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Management does not expect to adopt fair value accounting for stock-based employee compensation.

 

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 isresulting in multiple effective dates in 2003 and 2004 based on the nature as well as the creation date of the variable interest entity. The revised FIN 46 will be effective for all newnon-SPE variable interest entities created prior to February 1, 2003 no later than the first quarter of 2004. For variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be appliedapplied. The Company is the process of assessing the impact of this pronouncement for 2004. The adoption of FIN 46 applicable to 2003 did not have a material impact on its financial position or results of operations.

Preferred Stock

In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatory redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim or annual period beginning after June 15, 2003. The company believes thatOn November 7, 2003, the adoptionFASB issued FSP FAS 150-3 which deferred certain areas of this standard will have no material impactFAS 150 including the measurement provisions of mandatory redeemable preferred stock. Accordingly, the Company has continued to accrue dividends on the preferred stock, but was required to reclassify its financial statements.preferred stock as a liability in accordance with the standard. Also, dividends are now required to be reported as a component of interest expense.

 

Page 3026 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2. Investment in Enterworks

 

History and Deconsolidation:

On December 30, 1999, Enterworks, Inc. (“Enterworks”), a majority-owned subsidiaryAs of the Company, completed a private placement of 21,739,127 shares of Series A Convertible Preferred Stock (“Preferred Stock”) at a price of $1.15 per share. The sale generated gross proceeds of $25,000,000. In addition, the Company entered into a series of concurrent transactions pursuant to which the Company’s voting interest in Enterworks was reduced to approximately 34.8%. The concurrent transactions were as follows:

1. The Company converted approximately $7.6 million of its Senior Subordinated Notes, Series B, C and D held by investors, plus the accrued interest and the waiver of a prepayment premium associated with these notes, into shares of Enterworks’ Common Stock currently owned by the Company at an exchange ratio of one share of Enterworks’ Common Stock for each $1.00 principal amount of notes payable. These subordinated notes had a maturity date of October 1, 2000.

2. Enterworks purchased 5,000,000 shares of Enterworks’ Common Stock owned by the Company at a price of $1.00 per share. This amount was reduced by 20% of the Agent’s fee, the Company’s pro rata share of the proceeds from the transaction. The net amount received was $4.7 million. This transaction, together with the one described above, resulted in an extraordinary gain, net of tax of $5.3 million, of $8.0 million, which is included in the Company’s statement of operations for the year ended December 31, 1999.

3. Enterworks’ payable to the Company, which was approximately $24.4 million at December 30, 1999, was cancelled in its entirety before the issuance of Series A Preferred Stock. The forgiveness of the payable increased the Company’s investment in Enterworks. Funding required to cover Enterworks’ working capital needs from November 30, 1999 to the date of closing was funded by the Company and will be repaid through collections from Enterworks’ trade accounts receivable. This funding approximated $2.0 million. This forgiveness of intercompany debt is deemed by management to be a normal occurrence of a capital raising transaction.

4. Enterworks issued 4,000,000 shares of Enterworks’ Common Stock to Telos concurrent with the issuance of Series A Preferred Stock. This issuance increased the Company’s investment in Enterworks as it increased the number of shares the Company owned in Enterworks.

5. Enterworks issued a warrant to acquire 350,000 shares of Enterworks’ Common Stock to Telos’ primary lender, Bank of America, in connection with obtaining the necessary approvals for this offering. The exercise price of the warrant equaled $1.15 per share, the same per share price of the Series A Preferred Stock. This warrant was recorded at its fair market value as a charge to interest expense and a reduction to the Company’s investment in Enterworks.

6. Telos contributed 210,912 shares of Enterworks’ Common Stock owned by Telos to the Enterworks Treasury for the subsequent grant of warrants to the Agent, Deutsche Bank Alex. Brown. This issuance of warrants was also part of the Agent’s fee. This contribution of shares was also a charge to interest expense and a reduction to the Company’s investment in Enterworks.

As a result of the reduction of the Company’s ownership percentage in Enterworks, in 2000 the Company has changed its method of accounting for its Enterworks subsidiary from the consolidation method to the equity method. Pursuant to this change the revenues, costs and expenses of Enterworks have been excluded from their respective captions in the Company’s consolidated statement of operations, and the Company’s interest in the losses of Enterworks have been reported separately as “Equity in Net Losses of Enterworks.” Additionally, the assets, liabilities, and equity of Enterworks have been excluded from their respective consolidated balance sheet captions and the Company will establish an “Investment in Enterworks” account in accordance with APB 18. The recognition of this net loss by the Company reduced the carrying value of its investment in Enterworks to $0 in 1999. Enterworks continued to recognize losses during fiscal 2000, and in accordance with APB18 the Company has not recognized these losses since the investment balance was $0.

Enterworks has completed rounds of private financing in 2000 and 2001 which have further diluted the Company’s interest in Enterworks. At December 31, 2001, the Company accounts for this investment under the equity method as prescribed by APB Opinon 18.

Page 31 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Additional Enterworks Agreements:

During the first quarter of 2001, the Company and Enterworks, Inc. (“Enterworks”) entered into an agreement whereby the Company, as a participant in an additional round of financing for Enterworks, substituted approximately $530,000 of receivables owed to the Company and in addition funded Enterworks $470,000 of cash in three equal installments during the quarter. The receivables included rent owed to the Company, services performed by the Company under a service agreement between the Company and Enterworks, and expenses advanced by the Company on behalf of Enterworks for which the Company is reimbursed. In return, the Company received four separate Demand 10% Convertible Promissory Notes from Enterworks totaling $1 million, as well as warrants to purchase 2.5 million of underlying shares of Enterworks common stock. The warrants to purchase 2.5 million underlying shares of Enterworks common stock have an exercise price of $0.01 per share and an exercise period of five years.

During the second quarter of 2001, the Company and Enterworks entered into an agreement whereby the Company, as a participant in an additional round of financing for Enterworks, committed an additional $800,000 which represented the estimate of amounts owed to the Company for the period May through December 2001 for rent and services performed by the Company under a service agreement. In return, the Company received a $300,000 Demand 10% Convertible Promissory Note from Enterworks, as well as a warrant to purchase 750,000 of underlying shares of Enterworks common stock. The warrants to purchase the shares of Enterworks common stock have an exercise price of $0.01 per share and an exercise period of five years.

During the third and fourth quarters of 2001, the Company received five separate Demand 10% Convertible Promissory Notes from Enterworks totaling $500,000, as well as warrants to purchase 1,250,000 of underlying shares of Enterworks common stock. The warrants to purchase the shares of Enterworks common stock have an exercise price of $0.01 per share and an exercise period of five years.

During 2001, the Company’s ownership interest in Enterworks fell below 20% and accordingly, the Telos designated voting representation on the Enterworks Board was relinquished. However, due to the receipt of the warrants referenced above, at December 31, 2001 the Company’s ownership interest became 23.1%, and therefore the Company now accounts for its investment in Enterworks under the equity method of accounting as prescribed by APB 18. Under this method, and in accordance with EITF 98-13 “Accounting by an Equity Method Investor for Investee Losses when the Investor has Loans to and Investments in Other Securities of the Investee”, the Company reduced the carrying amounts of the Notes to $-0- at December 31, 2001, as the Company’s share of the Enterworks losses exceeded the carrying value of the Notes.

At December 31, 2002,2003, the Company owns 17,153,059 shares of Enterwork’sEnterworks, Inc. (“Enterworks”)’s common stock and holds warrants to purchase 4,499,997 underlying common stock shares which equates to a fully diluted ownership percentage of 21.5%. The Company accounts for its investment in Enterworks under the equity method of accounting as prescribed by APB18.

 

All of the EnterworksThe Company also owns notes issued to the Company in 2001 include provisions for repayment of two times principal and accrued interest in the event that Enterworks liquidates, enters into dissolution or seeks the protection of bankruptcy. The fair value of all warrants receivedreceivable from Enterworks is zero.

On April 30, 2002, the Companya lease and totaling $3,260,000. Such notes were received a Senior Demand Promissory Note from Enterworks totaling $305,945. This Note represents amounts owed to the Company for rent and professional services performed by the Company during the first quarter 2002 pursuant to a service agreement. This Note contains a maturity date of April 30, 2007. The receivables represented in this Note were fully reserved during the second quarter of 2002.

On June 5 and 26, 2002, the Company received two Senior Demand Promissory Notes from Enterworks totaling $92,588 and $64,006, respectively. The June 5, 2002 Note matures on June 5, 2007 and the June 26, 2002 Note matures on June 26, 2007. These Notes represent amounts owed to the Company by Enterworksexchange for rent and professional services performed by the Company pursuant to a service agreement during April, May,lease and June of 2002. The receivables represented in these Notes have been fully reserved for at the time of receipt.

Page 32 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On July 16, 2002, the Company received a Senior Demand Promissory Note from Enterworks totalling $37,461. This Note represents amounts owed to the Company for rent and professionalan inter-company services performed by the Company under a service agreement during the first quarter 2002. This Note contains a maturity date of July 16, 2007. The receivables represented in this Note were fully reserved during the third quarter of 2002.

On December 16, 18 and 31, 2002, the Company received three Senior Demand Promissory Notes from Enterworks in the amounts of $100,000, $250,000 and $250,000, respectively. The December 16, 2002 Note matures on December 16, 2007, the December 18,2002 Note matures on December 18, 2007 and the December 31, 2002 Note matures on December 31, 2007. These Notes represent amounts owed to the Company by Enterworks for rent and professional services performed by the Company pursuant to a service agreement during the period July through December of 2002. The receivables represented in these Notes have been fully reserved for at the time of receipt.

All of the Enterworks notes issued to the Company in 2002 include a provision for repayment of four times principal and accrued interest in the event that Enterworks liquidates, enters into dissolution or seeks the protection of bankruptcy.

agreement. In accordance with APB 18 and EITF 98-13 “Accounting by an Equity Method Investor for Investee Losses when the Investor has Loans to and Investments in Other Securities of the Investee”, the Company has reduced the carrying amounts of the Notesnotes to zero during 20012003 and 2002, as the Company’s share of the Enterworks losses exceeded the carrying value of the Notes.notes. All of such notes issued to the Company in 2003 and 2002 include a provision for repayment of four times principal and accrued interest in the event that Enterworks liquidates, enters into dissolution or seeks bankruptcy protection.

In December 2003, the Company purchased a 50% interest in Enterworks International, which at the time of the transaction was a wholly-owned subsidiary of Enterworks, for $500,000. Pursuant to the terms of the stock purchase agreement and the stockholder agreement setting forth the transaction, the Company agreed to fund up to 50% of Enterworks International’s 2004 operating costs for an amount not to exceed $300,000 in the year 2004, and 50% of such operating costs thereafter.

Separately, in December 2003, the Company entered into a two-year Original Equipment Manufacturer (OEM) software license agreement (“SLA”) with Enterworks, which, pursuant to an earn-out provision is comprised of cumulative license fees and/or Company services to Enterworks equal to at least $2.0 million. The Company provided initial consideration of $1.0 million, comprised of a $100,000 cash payment and Company services in the amount of $900,000, including $300,000 for rent and services from July 2003 to December 2003, and an additional $600,000 for rent and services for 2004. In addition to the above-described exchange, the Company has agreed to pay royalties of $1.0 million over the course of the next two years and, upon payment of cumulative license fees and/or company services to Enterworks equal to at least $2.0 million, will own a worldwide, non-exclusive, perpetual, irrevocable, royalty-free, fully paid-up license for the Enterworks Process Exchange (EPX) software.

 

The Company has recognizedcapitalized the $100,000 license cash payment to Enterworks as a reservefixed asset. In accordance with APB18 and EITF 98-13, the Company has accounted for both the investment in Enterworks International and the amount of $397,000 in December 2002 to accrue costs related to an agreement with Enterworks to provide certain administrativeSLA as losses from affiliates and support services and sub-leased office space for a period of six months ending June 30, 2003.accordingly written off $1.4 million.

 

Note 3. ContributionSale of AssetsTelosOK LLC

 

The Company’sOn March 10, 2003 the Company and other TelosOK LLC investors (“Purchaser”) entered into a unit purchase agreement whereby the Company sold all of its 50% interest in TelosOK LLC as described herein has subsequently been sold tofor a total cash consideration of $4.0 million. The Company had accounted for its investment in TelosOK LLC on March 10, 2003. For more information onunder the sale of TelosOK LLC see Note 13 “Subsequent Events”.

On July 27, 2000, the Company entered into a subscription agreement with certain investors (“Investors”), which provided for the formation of an Oklahoma Limited Liability Company named TelosOK LLC. The Company contributed all of the assets of its Digital Systems Test and Training Simulators (“DSTATS”) business as well as its U.S. Government contracts with the Department of the Army at Ft. Sill (hereafter referred to as the Company’s Ft. Sill operation) to TelosOK LLC. The net assets contributed by the Company totaled $373,000. The third party Investors contributed $3.0 million in cash to TelosOK LLC,equity method and, at closing TelosOK LLC borrowed $4.0 million cash from a bank.the time of this transaction, had negative basis for its investment. The Company and the Investors have each jointly and severally guaranteed the loan of TelosOK LLC. The Company has guaranteed 50% of the outstanding loan balance and the Investors have guaranteed 25% of the outstanding loan balance. This loan has an outstanding balance of approximately $1.5 million at December 31, 2002. In addition, TelosOK LLC entered into a $500,000 senior credit facility with the same bank, which was subsequently increased to $750,000 on September 30, 2001, with an expiration date of July 1, 2003. Borrowings under the facility, if any, were collateralized by certain assets of TelosOK LLC (primarily accounts receivable). The Company and the Investors haveparties also agreed to guarantee this credit facility12 monthly payments to the Company in the amount of $250,000 each$45,000 per month, expiring on March 10, 2004, or a total of $540,000, to recover its fixed infrastructure costs associated with providing certain accounting and support services, and the current $750,000 when and if drawn.Company has recorded these payments as other service revenue.

 

In compliance with the subscriptiona separate agreement, on the closing date the following consideration was given to the Company for its contribution of assetswould continue to TelosOK LLC:

The Company received $6 million in cash, retained $2.5 million in trade receivables from the Ft. Sillprovide certain accounting and DSTATS businesses, and received a $500,000 receivable fromsupport services to TelosOK LLC for a period of 12 months, expiring on March 10, 2004, in the additional amount of $45,000 per month, or an additional total consideration of $9 million in exchange$540,000. These payments have been recorded as other service revenue.

As additional consideration for the contributionsale of the net assets. In accordance withmembership units, the Company and TelosOK LLC committed to certain “non-compete” and “non-solicitation” agreements between the two parties. The “non-solicitation” commitment provided for a sole exception relating to the employment by TelosOK LLC of the former President, CEO and Director of the Company. At the effective date of closing, all Telos Corporation employees serving as officers of TelosOK LLC resigned said positions in TelosOK LLC.

Upon the sale of its interest in TelosOK LLC, the Company recognized a gain of approximately $10.1 million, comprised of $6.1 million of deferred gain and $4.0 million of gain from the proceeds received in March 2003. The deferred gain was recorded in July 2000 as a result of Staff Accounting Bulletin No. 81 which required the gain be deferred until the Company has deferred approximately $6.1 milliondisposed of the gain on the TelosOK LLC transaction. This gain will be recognized by the Company in the first quarter of 2003 as a result of the sale of the remaining 50%its interest in TelosOK LLC. (See Note 13 “Subsequent Events”)

The Company and the Investors each own a 50% voting membership interest in TelosOK LLC, and have signed an operating agreement which provides for three subclasses of membership units, Classes A, B and C. The ownership of these classes is as follows and can change upon Class B redemption:

 

Page 3327 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Class A – owns 20% of TelosOK LLC. The Company and the Investors each own 50% of the 200,000 units of this class. This class possesses all voting rights of TelosOK LLC and the sole right to elect the directors of TelosOK LLC. The units in this class do not have redemption rights.

Class B – owns 40% of TelosOK LLC. The Investors own all 2.9 million units of this class. This class has no voting rights, but can, subject to certain restrictions, request the redemption of all or a portion of the Class B units outstanding one year after the closing date. Class B holders can redeem no more than 500,000 units per quarter at a price of $1.00 per unit, and such redemption can only be made from the excess cash flow of TelosOK LLC as defined in the operating agreement.

Class C – owns 40% of TelosOK LLC. The Company owns all 2.9 million units of this class. This class has no voting rights, and has the same redemption rights as Class B, except that no right of redemption will exist until all Class B units have been redeemed. In addition, when any of the Class B units are redeemed, the Company will receive a warrant to purchase Class C units equal to the amount of the Class B units redeemed at a price of $0.01 per unit.

As provided for in the operating agreement, one of the Investors, Bill W. Burgess, serves as Chairman of the Board and John R. Braught serves as Secretary, and David Aldrich, President and CEO of the Company, and Thomas Ferrara, Treasurer and CFO of the Company, serves in those same capacities for TelosOK LLC. The Company has entered into a corporate services agreement with TelosOK LLC whereby the Company has contracted to provide certain administrative support functions including, but not limited to, finance and accounting and human resources, in consideration for a fixed monthly cash payment.

As indicated above, the Company owns 50% of TelosOK LLC, sharing control over TelosOK LLC, and accordingly has changed its method of accounting for the contributed assets from the consolidation method to the equity method. Pursuant to this change, the revenues, costs and expenses from the Ft. Sill operation have been excluded from their respective captions in the Company’s Consolidated Statement of Operations, and the net earnings from the operation have been reported separately as “Equity in Net Earnings of TelosOK” for the year ended December 31, 2000. The results of operations of the Ft. Sill operation included in the “Equity in Net Earnings of TelosOK” caption are comprised of the following:

     

Year ended

December 31, 2000


 
     

(in thousands)

 

Sales

    

$

13,339

 

Cost of Sales

    

 

(11,011

)

     


Gross profit

    

$

2,328

 

     


From July 27, 2000 through December 31, 2002, the Company was unable to recognize its pro rata share of the income generated from TelosOK LLC because the Company’s share of TelosOK LLC’s capital accounts was negative. Accordingly, under the equity method of accounting as prescribed by Accounting Principles Board Opinion 18, the Company’s carrying value in TelosOK LLC was $0 at December 31, 2002, 2001 and 2000.

The Company received member distributions for estimated tax liabilities created by its interest in the TelosOK LLC of $556,000 and $284,000 during the fiscal years 2002 and 2001, respectively and recorded as a credit to selling, general and administrative expense.

Note 4. Sale of Telos Corporation (California)

 

On July 19, 2002, the Company and L-3 Communications Corporation (“L-3”) entered into a purchase agreementStock Purchase Agreement whereby the Company sold all of the issued and outstanding shares of its wholly owned subsidiary, Telos Corporation-CaliforniaCorporation (California) (“TCC”) to L-3 for a purchase price of approximately $20 million which includes:included: 1) approximately $15.3 million to the Company at closing; 2) $2.0 million held in an escrow account, $1.0 million of which willwas released and paid in October 2003 with the remaining $1.0 million to be paid to the Company over the next 30 months. (DuringJanuary 2005. During the 30 month period after July 19, 2002 the escrow amount may be subject to a reduction if any claims for indemnification by L-3 arise that are finally determined in favor of L-3 per the terms and conditions of the mutually agreed upon dispute resolution process);process; and 3) approximately $2.7 million held back as deposits for liabilities relating to leased properties in which at the time of

Page 34 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

closing TCC was a lessee or guarantor. Approximately $1 million of such hold-back was released and paid in August 2002 with the remaining $1.7$0.8 million beingscheduled to be released upon certain events, termsin 2004, and conditions over the course of the next five years.another $0.8 million in 2007. The resulting gain of $12.7$10.9 million included the write-off of $2.5 million of goodwill previously recorded for TCC.

 

According to the Stock Purchase Agreement, the purchase price shallwas to be increased or decreased on a dollar for dollar basis by the amount by which the closing date net assets deviatedeviated from $2.3 million. The closing date net assets were $4.6 million, an increase of an additional $2.3 million. ThisSuch amount has beenwas invoiced by the Company and collected in October 2002 from L-3. Accordingly, as a result of the increase in purchase price during the fourth quarter 2002, the Company adjusted the gain by $2.3 million to $13.2 million. The Company recognized a bonus accrual for certain key employees considered critical to the sale in the amount of $560,000. Therefore,$560,000 and accordingly the gain has beenwas adjusted to $12.6 million. In accordance with the Company’s Senior Credit Facility, proceeds from the sale were used to pay down the Company’s Senior Credit Facility.

 

As additional consideration for the sale of the shares of TCC, the Company and its affiliates committed to certain “Non-Compete” and “No Solicitation”“Non-Solicitation” provisions relating primarily to the business and employees associated with its TCC/Ft. Monmouth operations.

 

The sale of TCC has been treated as a discontinued operation in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Pursuant to SFAS 144, the revenue, costs and expenses of TCC have been excluded from their respective captions in the Company’s consolidated statements of incomeoperations and the net results of these operations have been reported separately as “Income (loss) from discontinued operations”. Results from discontinued operations isare reported net of tax benefit of $761,000 $756,000 and $409,000$756,000 for the years 2002 2001 and 2000,2001, respectively. Also included in the discontinued results from operations is allocated interest expense of $608,000 $878,000 and $1.3 million$878,000 for the years 2002 2001 and 2000,2001, respectively. Interest has been allocated based on the net assets of the discontinued operation in relation to the Company’s consolidated net assets plus non-specific debt. TCC had revenue of $24.7 million $58.1 million and $48.4 million$58.1million for the years 2002 2001 and 2000,2001, respectively.

 

The assets and liabilities of discontinued operations and the related results of operations have been reclassified for all periods presented. The carrying values of assets and liabilities of discontinued operations at December 31, 2001 were as follows (in thousands):

   

Solutions


Current assets

    

(liabilities), net

  

$

3,024

   

Non-current assets,

    

Net:

    

Property, plant and Equipment, net

  

 

71

Goodwill, net

  

 

2,499

Deferred Taxes And other, net

  

 

401

   

Net non-current assets

  

 

2,971

   

Net assets of discontinued operations

  

$

5,995

   

 

The following summarizes the operating results of discontinued operations (in thousands):

 

   

For the Years Ended December 31,


 
   

2002


   

2001


   

2000


 

Sales

  

$

24,715

 

  

$

58,073

 

  

$

48,429

 

Loss from discontinued Operations

  

 

(1,078

)

  

 

(2,178

)

  

 

(869

)

   For the Years Ended December 31,

 
   2003

  2002

  2001

 

Sales

  $—    $24,715  $58,073 

Loss from discontinued operations

   —     (1,078)  (2,178)

Gain on sale of TCC

   1,000   12,577   —   

 

Page 3528 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5. Revenue and Accounts Receivable

 

Revenue resulting from contracts and subcontracts with the U.S. Government, and state and local governments accounted for 95.8%95.6%, 97.7%,95.8% and 96.2%96.8% of consolidated revenue in 2003, 2002 2001 and 2000,2001, respectively. Total consolidated revenue derived from the U.S. Government for 20022003 includes 31.6%78.6% of revenue from contracts with the United States Army, 36.1% of revenue with other Department of Defense customers,agencies, and 32.0%17.0% or revenue from Federal Civilian Agencies including 49.4% of revenue from the Federal Judicial branch.Agencies. As the Company’s primary customer base is agencies of the federal government,U.S. Government, the Company has a concentration of credit risk associated with its accounts receivable. However,While the Company does not believeacknowledges the likelihoodpotentially material and adverse risk of loss arising from such a significant concentration of credit risk, the Company’s past experience of collecting substantially all of such receivables provide it with an informed basis that any such risk is significant.manageable. The Company performs ongoing credit evaluations of all of its customers and generally does not require collateral or other guarantee from its customers. The Company maintains allowances for potential losses.

 

The components of accounts receivable are for continuing operations are as follows (in thousands):

 

  

December 31,


   December 31,

 
  

2002


   

2001


   2003

 2002

 

Billed accounts receivable

  

$

17,552

 

  

$

16,407

 

  $13,718  $17,552 

Amounts currently billable and other

  

 

1,649

 

  

 

3,836

 

   4,001   1,649 

Allowance for doubtful accounts

  

 

(381

)

  

 

(1,221

)

   (487)  (381)
  


  


  


 


  

$

18,820

 

  

$

19,022

 

  $17,232  $18,820 
  


  


  


 


 

The components ofactivities in the allowance for doubtful accounts are for continuing operations set forth below (in thousands):

 

  

Balance Beginning

Of Year


  

Bad Debt

Expenses


  

Deductions(1)


   

Balance

End of Year


  Balance
Beginning
Of Year


  

Bad Debt

Expenses


  Deductions (1)

 

Balance

End of Year


Year ended December 31, 2003

  $381  $173  $(67) $487

Year ended December 31, 2002

  

$

1,221

  

$

470

  

$

(1,310

)

  

$

381

  $1,221  $470  $(1,310) $381

Year ended December 31, 2001

  

$

1,810

  

$

—  

  

$

(589

)

  

$

1,221

  $1,810   —    $(589) $1,221

Year ended December 31, 2000

  

$

765

  

$

1,213

  

$

(168

)

  

$

1,810


(1)Accounts receivable written-off or reserve reversals

 

1. Accounts receivable written-off or reserve reversals.Page 29 of 60


Note 6. Debt Obligations

 

Senior Revolving Credit Facility

 

TheOn October 21, 2002 the Company entered into a $22.5 million Senior Revolving Credit Facility (“Facility”) with a financial institution on October 21, 2002Wells Fargo Foothill, Inc. (“closing date”Wells Fargo Foothill”) (formerly known as Foothill Capital Corporation) that matures on October 21, 2005. Borrowings under the Facility are collateralized by substantially all of the Company’s assets including accounts receivable,inventory, equipment, and inventory.accounts receivable. The amount of available borrowings fluctuates based on the underlying asset-borrowing base, as defined in the Facility agreement.

The Company paid an origination fee of $225,000 at the date of closing. Unused availability on the facilityFacility was $4.9$2.0 million at December 31, 2002.2003; however, such availability fluctuates on a daily basis based on the amount of underlying assets in the borrowing base. Interest on the Facility is charged at 1.25%, subject to certain adjustments, over the bank’s base rate, which was 5.75% per annum upon initial funding. The Company paid an origination fee of $225,000 upon entering the agreement. The weighted average interest rate on the outstanding borrowings under the Facility was 6.66% for 2003 compared with 6.89% for 2002 compared with 9.13% for 2001.2002.

 

The Facility has various covenants, that may,which among other things, restrictaffect the ability of the Company to merge with another entity, sell or transfer certain assets, pay dividends and make other distributions beyond certain limitations. The Facility also requires the Company to meet certain financial covenants, including tangible net worth and operating earnings. At December 31, 2002 the Company is in compliance with allCertain financial covenants contained in the Facility.

Financial covenants were amended and restated with Amendment 1 to the Facility received in March 2003. Such covenantsduring 2003 were amended and restated to more accurately reflect the Company’s future performance based upon revised projections. At December 31, 2003 the Company was in compliance with its covenants pursuant to the Facility. However, due to a 15 day extension to file Form 10-K, the Company has not provided annual financial statements to the bank within the required 90-day period. In addition, it was probable that certain 2004 cash flow covenants would not be achieved. Accordingly, the Company has obtained a waiver for any such covenant violations and the Company and Wells Fargo Foothill have agreed upon modified cash flow covenants through October 21, 2005. The amended negative covenants require the Company to meet cash flow targets based on recent projections.

Page 36 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTSEBITDA as defined in the Facility.

 

A separate facility with a different bank was paid in full from the proceeds of the sale of TCC in July 2002 and subsequently terminated prior to the current Facility.

 

Senior Subordinated Notes

 

In 1995, the Company issued Senior Subordinated Notes (“Notes”) to certain shareholders. TheSuch Notes are classified as either Series B or Series C. The Series B Notes are collaterlizedsecured by the fixed assets of the Company.Company’s property and equipment. The Series C Notes are unsecured. The maturity date of thesuch Notes is October 31, 2004 and havewith interest rates ranging from 14% to 17%. Interest on the Notes is, and paid quarterly on January 1, April 1, July 1, and October 1 of each year. The senior subordinated note holders have extended the maturity date of the Notes to a date no earlier than October 31, 2004. The Notes can be prepaid at the Company’s option. The Notes have a cumulative paymentprepayment premium of 13.5% per annum payable only upon certain circumstances, which include, but are not limited to, an initial public offering of the Company’s common stock or a significant refinancing (“qualifying triggering event”), to the extent that net proceeds from either of the above events are received and are sufficient to pay thesuch cumulative prepayment premium. Due to the contingent nature of the Notecumulative premium payment, theany associated premium expense willcan only be quantified and recorded subsequent to the occurrence of such a qualifying triggering event. At December 31, 2002,2003, if such a qualifying triggering event were to occur, the cumulative prepayment premium that would be due upon a triggering event is approximately $12.9$10.0 million.

 

In April 2001, the Company retired one of its Series C Subordinated Notes with a principal amount of $358,000.

In October 2002, upon funding of the Facility, theThe Company retired $3 million of the Series B Notes in October 2002 upon the initial funding of the Facility. In consideration for whichsuch requested payment, the noteholdersnote holders waived the prepayment penalty on such Notes.Notes, which were due May 2003.

 

The balances of the Series B and C Notes were $2.5 million and $5.5$2.7 million, respectively, each at December 31, 20022003 and 2001. The balances of the Series C Notes were $2.6 million at December 31, 2002 and 2001.2002.

 

The following are maturities of obligations presented by year:

 

   

Year


  

Obligation Due


 

Senior Credit Facility

  

2003

  

—  

 

Senior Subordinated Debt

  

2003

  

—  

 

Senior Credit Facility

  

2004

  

—  

 

Senior Subordinated Debt

  

2004

  

5,179,000

 

Senior Credit Facility

  

2005

  

6,618,000

1

Senior Subordinated Debt

  

2005

  

—  

 

Year

Obligation Due

Senior Subordinated Debt

20045,179,0001

Senior Credit Facility

20056,497,0002


1 Pursuant to Section 17 of a Subordination Agreement entered into in conjunction with the Facility, the senior subordinated note holders and the Company have agreed to extend the maturity date of the Notes, on or before August 15, 2004, to a date no earlier than October 31, 2005.
2Balance due represents balance as of December 31, 2002,2003, however, the Senior Credit Facility is a revolving credit facility with fluctuating balances based on working capital requirements of the Company.

 

Page 3730 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 7. Redeemable Preferred Stock

 

Senior Redeemable Preferred Stock

 

The components of the authorized, issued and outstanding senior redeemable preferred stock (“Senior Redeemable Preferred Stock”) are 1,250 Series A-1 and 1,750 Series A-2 senior redeemable preferred shares, respectively, each with $.01 par value and 1,250 and 1,750 shares authorized, issued and outstanding, respectively.value. The Series A-1 and Series A-2 carrySenior Redeemable Preferred Stock carries a cumulative per annum dividend rate of 14.125% of theirits liquidation value of $1,000 per share. The dividends are payable semi-annually on June 30 and December 31 of each year. The liquidation preference of the senior preferred stockSenior Redeemable Preferred Stock is the face amount of the Series A-1 and A-2 ($1,000 per share), plus all accrued and unpaid dividends. The Company is required to redeem all shares and accrued dividends outstanding on October 31, 2004,2004. The Senior Redeemable Preferred Stockholders and the Company have agreed to extend the redemption date, on or before August 15, 2004, to the extent the redemption date of the Senior Preferred Stock has not been extended to a date later than October 31, 2005, Senior Preferred Stockholders agree to extend the redemption date to a date no earlier than October 31, 2005. Mandatory redemptions are subject to legal availability of funds and required to be paid from excess cash flows, as defined in the stock agreements.Corporate Charter. The Series A-1 and A-2Senior Redeemable Preferred Stock is senior to all other present and future equity of the Company. The Series A-1 is senior to the Series A-2. The Company has not declared dividends on its senior redeemable preferred stockSenior Redeemable Preferred Stock since its issuance. At December 31, 20022003 and 20012002 cumulative undeclared, unpaid dividends relating to Series A-1 and A-2 redeemable preferred stockRedeemable Preferred Stock totaled $4,327,000$4,751,000 and $3,903,000$4,327,000 respectively.

 

During 2003, 2002, 2001 and 20002001 the Company recorded senior redeemable preferred stock dividends of $424,000, $423,000$424,000 and $424,000,$423,000, respectively.

 

12% Cumulative Exchangeable Redeemable Preferred Stock

 

A maximum of 6,000,000 shares of 12% Cumulative Exchangeable Redeemable Preferred Stock (the “Public Preferred Stock”), par value $.01 per share, has been authorized for issuance. The Company initially issued 2,858,723 shares of the Public Preferred Stock pursuant to the acquisition of the Company during fiscal year 1990. The Public Preferred Stock was recorded at fair value on the date of original issue, November 21, 1989, and the Company is makingmakes periodic accretions under the interest method of the excess of the redemption value over the recorded value. Accretion for the years ended December 31, 2003 and 2002 was $2,042,000 and 2001 was $1,862,000, and $1,701,000, respectively. The Company declared stock dividends totaling 736,863 shares in 1990 and 1991. NoSince 1991, no other dividends, in stock or cash, have been declared since 1991.declared. In November 1998, the Company retired 410,000 shares of the Public Preferred Stock held by certain shareholders.Stock. The total number of shares issued and outstanding at December 31, 2003 was 3,185,586. The stock trades over the NASDAQ/ OTCBB Exchange.

 

TheSince 1991, the Company has not declared or paid any dividends on its Public Preferred Stock, has a 20 year maturity, however,based upon its interpretation of restrictions in its corporate charter, limitations in the Company must redeem, out of funds legally available, 20%terms of the Public Preferred Stock, onspecific dividend payment restrictions in the 16th, 17th, 18th$22.5 million Facility entered into with Wells Fargo Foothill, and 19th anniversariesother senior obligations and limitations pursuant to Maryland law. Pursuant to their terms, the Company is required to redeem the Public Preferred Stock in five annual tranches during the period 2005 through 2009. Due to its substantial senior obligations, limitations set forth in the covenants in the Facility, foreseeable capital and operational requirements, corporate charter restrictions and prohibitions, and provisions of November 12, 1989, leaving 20%Maryland law, and assuming sufficient liquidity to undertake any stock redemption (which is presently unquantifiable), the Company believes that the likelihood is that it will not be redeemed at maturity. able to meet the redemption schedule set forth in the terms of the Public Preferred Stock.

On any dividend payment date after November 21, 1991, the Company may exchange the Public Preferred Stock, in whole or in part, for 12% Junior Subordinated Debentures that are redeemable upon terms substantially similar to the Public Preferred Stock and subordinated to all indebtedness for borrowed money and like obligations of the Company.

 

The Public Preferred Stock accrues a semi-annual dividend at the annual rate of 12% ($1.20) per share, based on the liquidation preference of $10 per share and is fully cumulative. Through November 21, 1995, the Company had the option to pay dividends in additional shares of Preferred Stock in lieu of cash. Dividends in additional shares of the Preferred Stock were paid at the rate of 6% of a share for each $.60 of such dividends not paid in cash. Dividends areAny such dividends payable by the Company, provided the Company has legally available funds under Maryland law, when and if declared by the Board of Directors, commencing June 1, 1990, and on each six month anniversary thereof.thereafter were paid out of legally available funds in accordance with Maryland law. For the years 1992 through 1994 and for the dividend payable June 1, 1995, the Company has accrued undeclared dividends in additional shares of preferred stock. ThesePublic Preferred Stock. Such accrued dividends arewere valued at $3,950,000. Had the Company accrued thesesuch dividends on a cash basis, the total amount accrued would have been $15,101,000. For the cash dividends payable since December 1, 1995, the Company has accrued $30,145,000$33,968,000 as of December 31, 2002.2003. During 2003, 2002 2001 and 20002001 the Company recorded cumulative exchangeable redeemable preferred stock dividends of $3.8 million each year.

 

The Company has not declared or paid dividends on itsIn accordance with SFAS 150, both the Senior Redeemable Preferred Stock and the Public Preferred Stock since 1991, based uponhave been reclassified from equity to liability. Consequently, the Company’s interpretationpreferred dividend accrued from July 1, 2003 to December 31, 2003 in the amount of charter provisions pertaining to restrictions upon payment$3.1 million was recorded as interest expense. The aggregate fair value of dividends, similar dividend payment restrictions contained in its Senior Credit Facility, and limitations pursuant to Maryland law.the public preferred stock at December 31, 2003 was $4.7 million.

 

Page 3831 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 8. Stockholders’ InvestmentEquity, Warrants, Option Plan, and Employee Benefit PlansPlan

 

Common Stock

 

The relative rights, preferences, and limitations of the Class A common stock and the Class B common stock are in all respects identical. The holders of the common stock have one vote for each share of common stock held. Subject to the prior rights of the Public Preferred Stock orand any series of the Series A redeemable preferred stock,Senior Preferred Stock, holders of Class A and the Class B common stock are entitled to receive such dividends as may be declared.

 

Stock Warrants

 

In 1994, Toxford Corporation contributed $3 million to the Company to increase the borrowing capacity under the CompanysCompany’s prior Facility. In exchange, Toxford Corporation was issued 500,000 shares of Class A common stock for which the Company recorded additional interest expense of $410,000. The Company also granted Toxford Corporation warrants to acquire 7,228,916 shares of the Company’s Class A common stock at a purchase price of $.83 per share which approximated the estimated market value of the Company’s common stock at the issuance date. In November 1998, 840,000 of these warrants were transferred to certain other shareholders of the Company. The warrant is fully exercisable and has a term of ten years from the date of issue.

 

Stock Options

 

The Company has granted stock options to certain employees of the Company under five plans. The Long-Term Incentive Compensation Plan was adopted in 1990 (“1990 Stock Option Plan”) and had option grants under it through 2000. In 1993, stock option plan agreements were reached with certain employees.employees (“1993 Stock Option Plan”). In 1996, the Board of Directors approved and the shareholders ratified the 1996 Stock Option Plan (“1996 Stock Option Plan”).

 

In 2000, the Board of Directors of the Company approved two new stock option plans, one for Telos Delaware, Inc. (“Telos Delaware Stock Incentive Plan”) and one for Xacta Corporation (“Xacta Stock Incentive Plan”), both wholly owned subsidiaries of the Company.

 

TheAs determined by the members of the Compensation Committee, the Company generally grants options under its respective plans at the estimated fair value at the date of grant. Fair value is determined by the members of the option committeegrant, based upon all information available to it.

Page 39 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1990 Stock Option Plan

 

Under the terms of the 1990 Stock Option Plan, 2,168,215 shares of the Company’s Class A common stock are available for issuance under options to key employees, including officers and directors. TheseThe options have a life of 10 years from the date of grant. The option price determined by the Board of Directors was not less than the fair market value at the date of the grant and the options are generally exercisablevest over a four-year period. Additional information as to these options is as follows:

 

    

Stock Option Activity


    

Numbers of Shares

(000’s)


     

Weighted Average

Exercise Price


  Stock Option Activity

Outstanding at December 31, 1999

    

1,718

 

    

$

1.22

    

    

Granted

    

632

 

    

 

1.37

Exercised

    

—  

 

    

 

—  

Canceled

    

(328

)

    

 

1.42

    

    

  

Number of Shares

(000’s)


 Weighted Average
Exercise Price


Outstanding at December 31, 2000

    

2,022

 

    

$

1.23

  2,022  $1.23
    

    

Granted

    

—  

 

    

 

—  

  —     —  

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(377

)

    

 

1.19

  (377)  1.19
    

    

  

 

Outstanding at December 31, 2001

    

1,645

 

    

$

1.24

  1,645  $1.24
    

    

  

 

Granted

    

—  

 

    

 

—  

  —     —  

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(221

)

    

 

1.22

  (221)  1.22
    

    

  

 

Outstanding at December 31, 2002

    

1,424

 

    

$

1.25

  1,424  $1.25
    

    

  

 

Granted

  —     —  

Exercised

  —     —  

Canceled

  (427)  1.29
  

 

Outstanding at December 31, 2003

  997  $1.22
  

 

 

Page 32 of 60


1993 Option Plan

 

In 1993, stock option plan agreements were reached to provide Mr. John Wood, Executive Chairman, and Mr. Joseph Beninati, former Chairman, with options to each purchase up to 700,459 shares of the Company’s Class A common stock from the Company at $0.50 per share. Under the terms of the agreements, 350,230 shares vested immediately and the remainder vested ratably over the next twelve months. The Company recorded compensation expense related to these options based upon the difference between the exercise price and the estimated fair value of $0.82 per share at the measurement date of the stock option. Mr. Beninati’s agreement was canceled in 1996 and the shares now available will be administered under the same terms as the 1996 Stock Option Plan. These options have a life of 10 years from the date of grant. Additional information as to these options follows:

 

    

Stock Option Activity


    

Number of Shares

(000’s)


     

Weighted Average

Exercise Price


  Stock Option Activity

Outstanding at December 31, 1999

    

1,251

 

    

$

0.72

    

    

Granted

    

—  

 

    

 

—  

Exercised

    

—  

 

    

 

—  

Canceled

    

(168

)

    

 

1.01

    

    

  

Number of Shares

(000’s)


 

Weighted Average

Exercise Price


Outstanding at December 31, 2000

    

1,083

 

    

$

0.68

  1,083  $0.68
    

    

Granted

    

—  

 

    

 

—  

  —     —  

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(60

)

    

 

1.01

  (60)  1.01
    

    

  

 

Outstanding at December 31, 2001

    

1,023

 

    

$

0.66

  1,023  $0.66
    

    

  

 

Granted

    

—  

 

    

 

—  

  —     —  

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(8

)

    

 

1.01

  (8)  1.01
    

    

  

 

Outstanding at December 31, 2002

    

1,015

 

    

$

0.66

  1,015  $0.66
    

    

  

 

Granted

  —     —  

Exercised

  —     —  

Canceled

  (1,000)(1)  .65
  

 

Outstanding at December 31, 2003

  15  $1.01
  

 


(1)Mr. Wood’s 700,459 options granted in October 1993 have expired in October 2003.

 

Page 4033 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Mr. Wood has the option to cancel the 1993 stock options discussed above and receive an equal number of options under the 1996 plan at an exercise price of $0.95 per share. Additionally, the effect on the 1996 stock option plan as of December 31, 2002 would be to increase the number of shares outstanding to 4,530,240 with a weighted average exercise price of $1.00 per share.

1996 Stock Option Plan

 

The 1996 Stock Option Plan allows for the award of up to 6,644,974 shares of Class A common stock at an exercise price of not lower than fair market value at the date of grant. Vesting of the stock options for key employees is based both upon the passage of time and certain key events occurring including an initial public offering or a change in control. Vesting for options granted to employees is based upon the passage of time, generally four years. The stock options may be exercised over a ten-year period subject to the vesting requirements. Additional information as to these options follows:

 

    

Stock Option Activity


    

Number of Shares (000’s)


     

Weighted Average Exercise Price


  Stock Option Activity

Outstanding at December 31, 1999

    

5,004

 

    

$

1.01

Granted

    

148

 

    

 

1.35

Exercised

    

—  

 

    

 

—  

Canceled

    

(666

)

    

 

1.03

    

    

  

Number of Shares

(000’s)


 

Weighted Average

Exercise Price


Outstanding at December 31, 2000

    

4,486

 

    

$

1.02

  5,186  $1.02
    

    

Granted

    

150

 

    

 

1.07

  150   1.07

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(611

)

    

 

1.04

  (611)  1.13
    

    

  

 

Outstanding at December 31, 2001

    

4,025

 

    

$

1.02

  4,725  $1.02
    

    

  

 

Granted

    

50

 

    

 

1.07

  50   1.07

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(245

)

    

 

1.13

  (245)  1.13
    

    

  

 

Outstanding at December 31, 2002

    

3,830

 

    

$

1.01

  4,530  $1.01
    

    

  

 

Granted

  —     —  

Exercised

  —     —  

Canceled

  (179)  1.07
  

 

Outstanding at December 31, 2003

  4,351  $1.01
  

 

 

Page 41 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn 1996, Mr. Wood was granted 700,459 shares that were exercisable only to the extent that certain options in the 1993 Plan were not exercised.

 

Telos Delaware Stock Incentive Plan

 

During the third quarter of 2000, the Board of Directors of the Company approved a new stock option plan for Telos Delaware, Inc., a wholly owned subsidiary of the Company. Certain key executives and employees of the Company are eligible to receive stock options under the plan. Under the plan, the Company may award up to 3,500,000 shares of common stock as either incentive or non-qualified stock options. An incentive option must have an exercise price of not lower than fair market value on the date of grant. A non-qualified option will not have an exercise price any lower than 85% of the fair market value on the date of grant. All options have a term of ten years and vest no less rapidly than the rate of 20% per year for each of the first five years unless changed by the option committee of the Board of Directors. Additional information as to these options follows:

 

    

Stock Option Activity


    

Number of Shares (000’s)


     

Weighted Average Exercise Price


  Stock Option Activity

Outstanding at December 31, 1999

    

—  

 

    

 

—  

Granted

    

1,826

 

    

$

3.85

Exercised

    

—  

 

    

 

—  

Canceled

    

(88

)

    

 

3.85

    

    

  

Number of Shares

(000’s)


 

Weighted Average

Exercise Price


Outstanding at December 31, 2000

    

1,738

 

    

$

3.85

  1,738  $3.85
    

    

Granted

    

811

 

    

 

3.85

  811   3.85

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(360

)

    

 

3.85

  (360)  3.85
    

    

  

 

Outstanding at December 31, 2001

    

2,189

 

    

$

3.85

  2,189  $3.85
    

    

  

 

Granted

    

108

 

    

 

3.85

  108   3.85

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(518

)

    

 

3.85

  (518)  3.85
    

    

  

 

Outstanding at December 31, 2002

    

1,779

 

    

$

3.85

  1,779  $3.85
    

    

  

 

Granted

  —     —  

Exercised

  —     —  

Canceled

  (497)  3.85
  

 

Outstanding at December 31, 2003

  1,282  $3.85
  

 

 

Page 34 of 60


Xacta Stock Incentive Plan

 

In the third quarter of 2000, Xacta Corporation, a wholly owned subsidiary of the Company, initiated a stock option plan under which up to 3,500,000 shares of Xacta common stock may be awarded to key employees and associates. The options may be awarded as incentive or non-qualified, have a term of ten years, and vest no less rapidly than the rate of 20% per year for each of the first five years unless changed by the option committee of the Board of Directors. The exercise price may not be less than the fair market value on the date of grant for an incentive option, or less than 85% of the fair market value on the date of grant for a non-qualified stock option. Additional information as to these options follows:

 

    

Stock Option Activity


    

Number of Shares (000’s)


     

Weighted Average Exercise Price


  Stock Option Activity

Outstanding at December 31, 1999

    

—  

 

    

 

—  

Granted

    

1,287

 

    

$

0.75

Exercised

    

—  

 

    

 

—  

Canceled

    

(79

)

    

 

0.75

    

    

  

Number of Shares

(000’s)


 

Weighted Average

Exercise Price


Outstanding at December 31, 2000

    

1,208

 

    

$

0.75

  1,208  $0.75
    

    

Granted

    

930

 

    

 

0.75

  930   0.75

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(291

)

    

 

0.75

  (291)  0.75
    

    

  

 

Outstanding at December 31, 2001

    

1,847

 

    

$

0.75

  1,847  $0.75
    

    

  

 

Granted

    

97

 

    

 

0.75

  97   0.75

Exercised

    

—  

 

    

 

—  

  —     —  

Canceled

    

(280

)

    

 

0.75

  (280)  0.75
    

    

  

 

Outstanding at December 31, 2002

    

1,664

 

    

$

0.75

  1,664  $0.75
    

    

  

 

Granted

  —     —  

Exercised

  —     —  

Canceled

  (598)  0.75
  

 

Outstanding at December 31, 2003

  1,066  $0.75
  

 

 

Page 4235 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes information about stock options outstanding and exercisable at December 31, 2002:2003:

 

   

Options Outstanding


  

Options Exercisable


   

Range of
Exercise
Prices


    

Average Number Outstanding (000’s)


  

Weighted Remaining Contractual Life in Years


  

Weighted Average Exercise Price


  

Number Exercisable (000’s)


  

Weighted Average Exercise Price


1990 Stock Option Plan

  

 

$1.07

    

594

  

5.4 years

  

$

1.07

  

594

  

$

1.07

   

 

$1.35

    

249

  

6.7 years

  

$

1.35

  

199

  

$

1.35

   

 

$1.37

    

572

  

7.8 years

  

$

1.37

  

560

  

$

1.37

   

 

$1.40

    

9

  

5.7 years

  

$

1.07

  

9

  

$

1.07

   

    
  
  

  
  

   

 

$1.07—$1.40

    

1,424

  

6.6 years

  

$

1.24

  

1,362

  

$

1.24

   

    
  
  

  
  

                        

1993 Stock Option Plan

  

 

$0.50

    

700

  

1.0 years

  

$

0.50

  

700

  

$

0.50

   

 

$1.01

    

315

  

4.1 years

  

$

1.01

  

315

  

$

1.01

   

    
  
  

  
  

   

$

0.50—$1.01

    

1,015

  

2.0 years

  

$

0.66

  

1,015

  

$

0.66

   

    
  
  

  
  

                        

1996 Stock Option Plan

  

 

$0.95

    

2,301

  

3.4 years

  

$

0.95

  

1,239

  

$

0.95

   

 

$0.97

    

49

  

3.6 years

  

$

0.97

  

49

  

$

0.97

   

 

$1.00

    

50

  

9.8 years

  

$

1.00

  

10

  

$

1.00

   

 

$1.01

    

413

  

4.2 years

  

$

1.01

  

329

  

$

1.01

   

 

$1.07

    

692

  

6.9 years

  

$

1.07

  

462

  

$

1.07

   

 

$1.35

    

255

  

6.9 years

  

$

1.35

  

202

  

$

1.35

   

 

$1.40

    

70

  

5.7 years

  

$

1.40

  

70

  

$

1.40

   

    
  
  

  
  

   

 

$0.95—$1.40

    

3,830

  

3.7 years

  

$

1.01

  

2,361

  

$

1.03

   

    
  
  

  
  

                        
                        

2000 Telos Delaware Option Plan

  

 

$3.85

    

1,779

  

7.5 years

  

$

3.85

  

853

  

$

3.85

   

    
  
  

  
  

                        
                        

2000 Xacta Option Plan

  

 

$0.75

    

1,664

  

7.5 years

  

$

0.75

  

774

  

$

0.75

   

    
  
  

  
  

Page 43 of 69


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      Options Outstanding

  Options Exercisable

   

Range of

Exercise Prices


  

Average

Number

Outstanding

(000’s)


  

Weighted

Remaining

Contractual

Life in Years


  

Weighted

Average

Exercise
Price


  

Number

Exercisable

(000’s)


  

Weighted

Average

Exercise

Price


1990 Stock Option

  $1.07  483  4.4 years  $1.07  483  $1.07
   $1.35  189  5.7 years  $1.35  189  $1.35
   $1.37  322  6.8 years  $1.37  316  $1.37
   $1.40  3  4.6 years  $1.40  3  $1.40
   

  
  
  

  
  

   $1.07 -$1.40  997  5.4 years  $1.22  991  $1.22
   

  
  
  

  
  

1993 Stock Options

  $1.01  15  3.1 years  $1.01  15  $1.01
   

  
  
  

  
  

   $1.01  15  3.1 years  $1.01  15  $1.01
   

  
  
  

  
  

1996 Stock Option Plan

  $0.95  3,001  2.4 years ��$0.95  1,939  $0.95
   $0.97  41  2.6 years  $0.97  41  $0.97
   $1.00  40  8.8 years  $1.00  12  $1.00
   $1.01  413  3.2 years  $1.01  329  $1.01
   $1.07  571  5.9 years  $1.07  413  $1.07
   $1.35  215  5.9 years  $1.35  202  $1.35
   $1.40  70  4.7 years  $1.40  70  $1.40
   

  
  
  

  
  

   $0.95 -$1.40  4,351  2.7 years  $1.00  3,006  $1.00
   

  
  
  

  
  

2000 Telos Delaware Option Plan

  $3.85  1,282  6.5 years  $3.85  958  $3.85
   

  
  
  

  
  

2000 Xacta Option Plan

  $0.75  1,066  6.5 years  $0.75  757  $0.75
   

  
  
  

  
  

 

Telos Shared Savings Plan

 

The Company sponsors a defined contribution employee savings plan (the “Plan”) under which substantially all full-time employees are eligible to participate. The Company has 3,658,536 shares of Telos Class A common stock in the plan representing 17% of the class. Since no public market exists for Telos Class A common stock, the Trustees of the plan engage annually an outside investment firm to evaluate the stock. The Company’sPlan’s trustees price the stock at the exact midpoint of the range defined by the outside investment firm. The Company matches one-half of voluntary participant contributions to the Plan up to a maximum Company contribution of 3% of a participant’s salary. Total Company contributions to this Plan for 2003, 2002, and 2001 were $516,000, $654,000 and 2000 were $654,000, $707,000 and $784,000 respectively.

 

Page 36 of 60


Note 9. Income Taxes

 

The provision (benefit) for income taxes attributable to income (loss) from continuing operations includes the following (in thousands):

 

  

For The Year Ended December 31,


 
  

2002


   

2001


   

2000


   For the Years Ended
December 31,


 

Current (benefit) provision

         
  2003

  2002

 2001

 

Current provision (benefit)

      

Federal

  

$

(257

)

  

$

162

 

  

$

285

 

  $—    $(257) $162 

State

  

 

7

 

  

 

28

 

  

 

50

 

   10   7   28 
  


  


  


  

  


 


Total current

  

 

(250

)

  

 

190

 

  

 

335

 

   10   (250)  190 
  


  


  


  

  


 


Deferred benefit

         

Deferred provision (benefit)

      

Federal

  

 

(3,396

)

  

 

(366

)

  

 

(108

)

   11,091   (3,396)  (366)

State

  

 

285

 

  

 

(64

)

  

 

(19

)

   386   285   (64)
  


  


  


  

  


 


Total deferred

  

 

(3,111

)

  

 

(430

)

  

 

(127

)

   11,477   (3,111)  (430)
  


  


  


  

  


 


Total (benefit) provision

  

$

(3,361

)

  

$

(240

)

  

$

208

 

Total provision (benefit)

  $11,487  $(3,361) $(240)
  


  


  


  

  


 


 

The provision (benefit) for income taxes related to continuing operations varies from the amount determined by applying the federal income tax statutory rate to the income or loss before income taxes. The reconciliation of these differences is as follows:

 

  

For the Year Ended December 31,


   For the Years Ended
December 31,


 
  

2002


   

2001


   

2000


   2003

 2002

 2001

 

Computed expected income tax provision (benefit)

  

(34.0

)%

  

34.0

%

  

(34.0

)%

  34.0% (34.0)% 34.0%

State income taxes, net of federal income tax benefit

  

0.4

 

  

(42.8

)

  

107.1

 

  14.0  0.4  (42.8)

Change in valuation allowance for deferred tax assets

  

1.4

 

  

(15.0

)

  

(47.1

)

  529.3  1.4  (15.0)

Meals and entertainment

  

0.5

 

  

4.8

 

  

3.0

 

  2.6  0.5  4.8 

Dividend and accretion on preferred stock

  59.5  —    —   

Other

  

0.7

 

  

0.1

%

  

—  

 

  (2.0) 0.7  0.1%
  

  

  

  

 

 

  

(31.0

)%

  

(18.9

)%

  

29.0

%

  637.4% (31.0)% (18.9)%
  

  

  

  

 

 

 

Page 4437 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 20022003 and 20012002 are as follows (in thousands):

 

  

December 31,


   December 31,

 
  

2002


   

2001


   2003

 2002

 

Deferred tax assets:

         

Accounts receivable, principally due to allowance for doubtful accounts

  

$

155

 

  

$

461

 

  $185  $155 

Allowance for inventory obsolescence and amortization

  

 

892

 

  

 

377

 

   293   892 

Accrued liabilities not currently deductible

  

 

2,746

 

  

 

2,231

 

   3,059   2,746 

Accrued compensation

  

 

917

 

  

 

1,108

 

   1,578   917 

Property and equipment, principally due to differences in depreciation methods

  

 

805

 

  

 

790

 

   736   805 

Basis difference in TelosOK LLC interest

  

 

2,504

 

  

 

2,216

 

   —     2,504 

Net operating loss carryforwards—state

  

 

3,609

 

  

 

233

 

Alternative minimum tax credit carryforward

  

 

386

 

  

 

457

 

Net operating loss carryforwards

   3,753   3,609 

Alternative minimum tax credit carry forward

   386   386 
  


  


  


 


Total gross deferred tax assets

  

 

12,014

 

  

 

7,873

 

   9,990   12,014 

Less valuation allowance—State

  

 

(193

)

  

 

(44

)

Less valuation allowance

   (9,730)  (193)
  


  


  


 


Net deferred tax assets

  

 

11,821

 

  

 

7,829

 

   260   11,821 
  


  


  


 


Deferred tax liabilities:

         

Unbilled accounts receivable, deferred for tax purposes

  

 

(344

)

  

 

(264

)

   (260)  (344)
  


  


  


 


Total deferred tax liabilities

  

 

(344

)

  

 

(264

)

   (260)  (344)
  


  


  


 


Net deferred tax assets

  

$

11,477

 

  

$

7,565

 

  $—    $11,477 
  


  


  


 


 

The components of the valuation allowance are as follows (in thousands):

 

  

Balance at Beginning of Period


  

Additions Charged to Expenses


  

Deductions


   

Balance At End of Period


  

Balance at

Beginning

of Period


  

Additions

Charged to

Expenses


  Deductions

 

Balance At

End of

Period


December 31, 2003

  $193  $9,537  $—    $9,730

December 31, 2002

  

$

44

  

$

149

  

$

—  

 

  

$

193

  $44  $149  $—    $193

December 31, 2001

  

 

234

  

 

—  

  

 

(190

)

  

 

44

  $234  $—    $(190) $44

December 31, 2000

  

 

572

  

 

—  

  

 

(338

)

  

 

234

 

The net change in theIn accordance with FAS 109, a full valuation allowance was an increase of $149,000 for 2002 and a decrease of $190,000 for 2001. The increase inhas been provided at December 31, 2003, due principally to the valuation allowance in 2002 is attributable to an increase in the state net operating loss in certain jurisdictions in which separate returns are filed. The Company provides a valuation allowance whenevidence that it is more likely than not that the deferred tax assets will not be realized.realized in the future.

 

At December 31, 2002,2003, for federal income tax purposes there were approximately $9,365,000$9,863,000 net operating loss carryforwards to offset future regular taxable income. These net operating loss carryforwards expire in 2022.2023. Additionally, approximately $8,359,000$7,753,000 of alternative minimum tax net operating loss carryforwards areis available to offset future alternative minimum taxable income. These alternative minimum tax net operating loss carryforwards also expire in 2022.2023. In addition, the Company has $386,000 of alternative minimum tax credits available to be carried forward indefinitely to reduce future regular tax liabilities.

 

Page 4538 of 6960


Note 10. Commitments and Contingencies

 

Leases

 

The Company leases office space and equipment under non-cancelable operating and capital leases with various expiration dates, some of which contain renewal options.

 

On March 1, 1996, the Company entered into a twenty-year capital lease for a building in Ashburn, Virginia, that serves as its corporate headquarters. The Company has accounted for this transaction as a capital lease and has accordingly recorded assets and a corresponding liability of approximately $12.3 million. Under the terms of the lease, the landlord furnished the Company with $1.3 million to fund tenant improvements and other building costs.

 

TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following is a schedule by years of future minimum payments under capital leases together with the present value of the net minimum lease payments as of December 31, 20022003 (in thousands):

 

  

Property


   

Equipment


   

Total


 

2003

  

 

1,666

 

  

 

112

 

  

 

1,778

 

  Property

 Equipment

 Total

 

2004

  

 

1,666

 

  

 

106

 

  

 

1,772

 

   1,666   111   1,777 

2005

  

 

1,666

 

  

 

106

 

  

 

1,772

 

   1,666   111   1,777 

2006

  

 

1,666

 

  

 

96

 

  

 

1,762

 

   1,666   111   1,777 

2007

  

 

1,666

 

  

 

72

 

  

 

1,738

 

   1,666   72   1,738 

2008

   1,666   —     1,666 

Remainder

  

 

13,738

 

  

 

—  

 

  

 

13,738

 

   12,073   —     12,073 
  


  


  


  


 


 


Total minimum obligations

  

 

22,068

 

  

 

492

 

  

 

22,560

 

   20,403   405   20,808 

Less amounts representing interest

  

 

(11,392

)

  

 

(113

)

  

 

(11,505

)

   (10,017)  (91)  (10,108)
  


  


  


  


 


 


Net present value of minimum obligations

  

 

10,676

 

  

 

379

 

  

 

11,055

 

   10,386   314   10,700 

Less current portion

  

 

(336

)

  

 

(72

)

  

 

(408

)

   (381)  (76)  (457)
  


  


  


  


 


 


Long-term capital lease obligations at December 31, 2002

  

$

10,340

 

  

$

307

 

  

$

10,647

 

Long-term capital lease obligations at December 31, 2003

  $10,005  $238  $10,243 
  


  


  


  


 


 


 

Accumulated amortization for property and equipment under capital leases at December 31, 2003 and 2002 and 2001 is $4.3$5.0 million and $4.2$4.3 million respectively. Future minimum lease payments for all non-cancelable operating leases at December 31, 20022003 are as follows (in thousands):

 

2003

  

 

457

2004

  

 

278

  $449

2005

  

 

284

   458

2006

  

 

72

   475

2007

   423

2008

   406

Remainder

  

 

—  

   756
  

  

Total minimum lease payments

  

$

1,091

  $2,967
  

  

 

Net rent expense charged to operations for 2003, 2002 and 2001, 2000, totaled $516,000, $492,000, $613,000, and $403,000,$613,000, respectively.

 

Page 4639 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Legal

 

The Company is a party to various lawsuits arising in the ordinary course of business. In the opinion of management, while the results of litigation cannot be predicted with certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the Company’s consolidated financial position, results of operations or of cash flows.

 

Warranties

 

The Company provides product warranties for products sold through certain U.S. Government contract vehicles and is reported as deferred revenues on the Company’s Consolidated Balance Sheet. Warranties are valued using historical warranty usage trends and recorded as a liability on the Company’s books when items are sold and amortized over the contractual warranty period, currently three or five years depending on the contract.

 

  

Balance, Beginning of Year


  

Accruals


  

Warranty Expenses


   

Balance, End Of Year


  

Balance,

Beginning

Of Year


  Accruals

  

Warranty

Expenses


 

Balance,

End of

Year


Year Ended December 31, 2003

  $1,985  $1,211  $(1,078) $2,118

Year Ended December 31, 2002

  

$

2,519

  

$

863

  

$

(1,397

)

  

$

1,985

  $2,519  $863  $(1,397) $1,985

Year Ended December 31, 2001

  

 

3,609

  

 

1,715

  

 

(2,805

)

  

 

2,519

  $3,609  $1,715  $(2,805) $2,519

Year Ended December 31, 2000

  

 

3,325

  

 

2,607

  

 

(2,323

)

  

 

3,609

 

Note 11. Certain Relationships and Related Transactions

 

Information concerning certain relationships and related transactions between the Company and certain of its current and former officers and directors is set forth below.

 

Mr. John R. C. Porter, the owner of a majority of the Company’s Class A Common Stock, has a consulting agreement with the Company whereby he is compensated for consulting services provided to the Company in the areas of marketing, product development, strategic planning and finance as requested by the Company. Mr. John R. C. Porter was paid $260,000 by the Company in 2003, 2002, 2001, and 20002001 pursuant to this agreement, which amounts were determined by negotiation between the Company and Mr. John R.C. Porter.

 

Mr. Mark Hester,David S. Aldrich, former Executive Vice President and former Chief OperatingExecutive Officer of the Company, had a consultingentered into an agreement with the Company whereby Mr. Aldrich will serve as an advisor to the Company from December 31, 2002 through March 31, 2005. In return, Mr. Aldrich will be paid $350,000 per annum from January 1, 2003 through March 31, 2005. The Company will also continue to provide strategic advice concerning the Company’s hardware services division. Under this agreement, Mr. Hester received $206,000 for his servicesAldrich with medical and insurance benefits during 1999 and 2000, and was eligible for a bonus under certain circumstances, at the Company’s discretion. Under this agreement Mr. Hester received a bonus of $135,000 payable in installments during 2000. The Company completed payment to Mr. Hester in 2000.that same period.

 

Mr. Gerald Calhoun, former Vice President of Human Resources and Corporate Secretary, entered into a settlement agreement with the Company to resolve a dispute over Mr. Calhoun’s employment contract with the Company. The Company paid Mr. Calhoun 24 months of severance in installments from 2000 until April 19, 2002. Mr. Calhoun also received medical and insurance benefits through the Company for the same two-year period. Mr. Calhoun’s payment of salary and fringe benefits amountsamounted to approximately $189,000 per annum. Under the agreement, the Company extended the option term of Mr. Calhoun’s vested options until September 2001. These options have now expired.

 

Mr. William L.P. Brownley, former Vice President and General Counsel of the Company, entered into an agreement with the Company whereby Mr. Brownley will serveserved as an of counsel attorney to the Company from December 31, 2000 through March 31, 2003. In return, Mr. Brownley will bewas paid $220,000 per annum from January 1, 2001 through March 31, 2003. The Company will also continue to provideprovided Mr. Brownley with medical and insurance benefits during that same period.

 

Mr. Lorenzo Tellez, former Vice President, Treasurer, and Chief Financial Officer of the Company, entered into a settlement agreement with the Company to resolve a dispute on Mr. Tellez’s employment contract with the Company. With regard to the salary component of the contract, theThe Company paid Mr. Tellez the equivalent of 24 months of severance in installments during 2001. Mr. Tellez also received medical and insurance benefits through the Company for the same two-year period. Mr. Tellez’s payment of salary and fringe benefits amountsamounted to approximately $243,000 per annum. The Company completed its payments of the salary portion of the contract to Mr. Tellez on December 7, 2001. TheIn March 2003, pursuant to the final settlement of arbitration proceedings, the Company has recorded a charge to earnings of $200,000 under SG&A to recognize a claim bypaid Mr. Tellez to a discretionary bonus of $96,000 and estimated legal expenses during 2002.fees in the amount of $53,000.

 

Page 4740 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12. Reportable Business Segments

 

At December 31, 2002,2003, the Company’s operations are comprised of two operating segments, the IT Solutions Group and Xacta. The segment information below has been reclassified to conform with management’s new internal operating structure. Principally, the Company has two continuing reportable segments, Productsincluded the results of its wireless and Xacta. A third reportable segment, Systems and Support Services, a wholly owned subsidiary, Telos Corporation (California) (“TCC”),messaging solutions product line in the Xacta Segment, which was sold on July 19, 2002 (See Note 4 – Sale of Telos Corporation (California)) and is being treatedpreviously included as a discontinued operation according to SFAS 144. The information for 2000 and 2001 has been restated from the prior year’s presentation in order to conform to the 2002 presentation.

The Products Group: delivers solutions that combine information technology products and services to solve customer problems. Customerspart of the Products Group include agencies ofSegment. Prior to December 2003, the U.S. Government such as: military services, Defense Agencies, Treasury Department, U.S. Courts and others. Solutions fromCompany had two operating segments: the Products Group and the Xacta Group.

The IT Solutions Group: markets and sells integration services and value-added reseller solutions that address a wide range Government Information Technology (IT) requirements. Telos solutions consist of a combination ofreselling commercial-off-the-shelf (“COTS”) products from major original equipment manufacturers (“OEMs”), which are augmented with various value added support service. Telos proprietary products, Telos and subcontractoralso provides professional services and Telos proprietary practices.that support various U.S. Government integration programs. For example, Telos currently has a significant VAR partnership with Hewlett Packard (HP) Public Sector for the Products Group sells secure wireless networking and secure messaging solutions. Telos’ secure wireless networkingpurpose of reselling HP-centric solutions, allow customersprincipally to securely access databases from non-networked locations so that they can perform a variety of tasks safely. Telos’ secure messaging solution is known as the Automated Message Handling System (“AMHS”) and is a standard within the Department of Defense. The AMHS allows users to securely access, send, search, and profile message traffic. Significant U.S. Government procurement vehicles for customers of the Products Group include: Infrastructure Solutions – 1 (government-wide); GSA schedule (government-wide); Data Communications Network Equipment/Software (US Courts); and Treasury Distributed Processing Infrastructure (Treasury).

 

In addition toFor 2003, the above, the ProductsIT Solutions Group includesgenerated revenue of $41.7million, which represents 47.2% of the Company’s wireless networking, secure messaging solutionstotal consolidated revenue. Customers of Telos are primarily agencies of the U.S. Government including the military services, various other Defense Agencies, U.S. Courts, and is a value added reseller for Xacta’s information security products intovarious other civilian agencies of the U.S. Government.

 

Xacta:: develops markets and sells Government-validated enterprise risk managementsecurity solutions to help organizations proactively manage and monitor the security of their network environments in accordance with internationally recognized industry and security standards. Xacta currently provides its solutions to agencies of the U.S. Government as well as credit unions.

and financial institutions. Xacta, has developed and is selling two products: Xacta Web C&A and Xacta Commerce Trust. Xacta Web C&A automatesa wholly-owned subsidiary of Telos, was established in February 2000 to address the rigorous and time-consuming process of security certification and accreditation. Xacta Web C&A simplifies certification and accreditation by guiding users through a step-by-step process which determines the customer’sgrowing demand for information security posture and assesses system and network configuration compliance with applicable regulations, standards, and industry best practices and processes. Withsolutions. Over the last few years, Xacta Commerce Trust, organizations are able to perform holistic security risk management on a continuous basis in accordance with internationally recognized industry standards and best practices.

Systems and Support Services Group:provides post-deployment and post-production software and systems development and support services including technology insertion, systems redesign and software re-engineering. The Group’s largest customer isbrand name within the U.S. Army’s CommunicationsGovernment and Electronics Command (“CECOM”). The System and Support Services Group’s principal operationsthe financial services vertical is one which connotes to its customers that its solutions are located at Fort Monmouth, NJ.

This Group was the Company’s wholly owned subsidiary, TCC,secure. In order to capitalize on Xacta’s brand strength, Telos has consolidated its security-oriented solutions which was sold on July 19, 2002. The company has excluded this group from its operating revenues and expenses and reported as a discontinued operation according to SFAS 144 (see Note 4 – Sale of Telos Corporation (California)).

Results from the Systems and Support Services Group at Ft. Sill were alsopreviously included in the Company’s financial results until its deconsolidation in July 2000. During July 2000 the Company contributed its Ft. Sill business to TelosOK LLC. The Company has since sold it’s remaining interest in TelosOK LLC in March 2003. More information with respect to the sale ofProducts Group into Xacta. As a result, the Company’s interest inDeployable Wireless and Organizational Messaging solutions have moved into Xacta, and it is the Company’s intention to market and sell these as Xacta solutions. This change also serves to simplify the respective messages of Telos OK appears in Note 13, “Subsequent Events”.and Xacta for our customers and our employees. Moving forward, all security-related offerings will be marketed and sold as Xacta solutions.

 

The accounting policies of the reportable segments are the same as those described in Note 1.1 – Summary of Significant Accounting Policies. The Company evaluates the performance of its operating segments based on revenue, gross profit, and incomesegment profit (loss) before goodwill amortization, income taxes non-recurring items and interestother income or expense.expenses.

 

Summarized financial information concerning the Company’s reportable segments is shown in the following table. The “other” column includes corporate related items.

 

Page 4841 of 6960


TELOS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   

Products


   

Xacta


   

Other(1)


  

Total


 

2002

                   

External revenues

  

$

78,819

 

  

$

11,698

 

  

$

—  

  

$

90,517

 

Intersegment revenues

  

 

10,212

 

  

 

—  

 

  

 

—  

  

 

10,212

 

Gross profit

  

 

7,943

 

  

 

3,117

 

  

 

—  

  

 

11,060

 

Interest (4)

  

 

1,902

 

  

 

436

 

  

 

10

  

 

2,348

 

Segment loss (3)

  

 

(3,247

)

  

 

(5,250

)

  

 

—  

  

 

(8,497

)

Total assets

  

 

20,564

 

  

 

408

 

  

 

24,048

  

 

45,020

 

Capital expenditures

  

 

108

 

  

 

61

 

  

 

169

  

 

338

 

Depreciation & amortization (2)

  

 

404

 

  

 

268

 

  

 

1,112

  

 

1,784

 

2001

                   

External revenues

  

$

98,630

 

  

$

13,558

 

  

$

—  

  

$

112,188

 

Intersegment revenues

  

 

11,860

 

  

 

—  

 

  

 

—  

  

 

11,860

 

Gross profit

  

 

17,998

 

  

 

4,932

 

  

 

—  

  

 

22,930

 

Interest (4)

  

 

2,808

 

  

 

283

 

  

 

104

  

 

3,195

 

Segment profit (loss) (3)

  

 

7,659

 

  

 

(2,162

)

  

 

—  

  

 

5,497

 

Total assets

  

 

22,974

 

  

 

1,010

 

  

 

18,779

  

 

42,763

 

Capital expenditures

  

 

63

 

  

 

242

 

  

 

321

  

 

626

 

Depreciation & amortization (2)

  

 

390

 

  

 

242

 

  

 

1,147

  

 

1,779

 

2000

                   

External revenues

  

$

87,799

 

  

$

9,082

 

  

$

—  

  

$

96,881

 

Intersegment revenues

  

 

669

 

  

 

—  

 

  

 

—  

  

 

669

 

Gross Profit

  

 

13,399

 

  

 

2,530

 

  

 

—  

  

 

15,929

 

Interest (4)

  

 

3,117

 

  

 

307

 

  

 

67

  

 

3,491

 

Segment profit (loss) (3)

  

 

3,488

 

  

 

(425

)

  

 

—  

  

 

3,063

 

Total assets

  

 

41,313

 

  

 

2,725

 

  

 

20,388

  

 

64,426

 

Capital expenditures

  

 

354

 

  

 

360

 

  

 

864

  

 

1,578

 

Depreciation & amortization (2)

  

 

348

 

  

 

66

 

  

 

1,248

  

 

1,662

 

   IT Solutions
and Other
Services


  Xacta

  Other (1)

  Total

 

2003

                 

External revenues

  $41,722  $46,721      $88,443 

Gross margin

   954   16,130       17,084 

Segment (loss) income (3)

   (3,414)  1,471       (1,943)

Total assets

   10,121   12,431   11,059   33,611 

Capital expenditures

   32   89   114   235 

Depreciation & amortization (2)

   329   254   1,004   1,587 

2002

                 

External revenues

  $52,090  $38,427  $—    $90,517 

Gross margin

   (272)  11,332   —     11,060 

Segment loss (3)

   (5,053)  (2,543)  —     (7,596)

Total assets

   2,998   17,887   24,135   45,020 

Capital expenditures

   12   157   169   338 

Depreciation & amortization (2)

   328   344   1,112   1,784 

2001

                 

External revenues

  $67,538  $44,650  $—    $112,188 

Gross margin

   7,359   15,571   —     22,930 

Segment income (3)

   2,894   3,017   —     5,911 

Total assets

   14,567   9,417   18,779   42,763 

Capital expenditures

   55   250   321   626 

Depreciation & amortization (2)

   315   317   1,147   1,779 

(1) Corporate assets are principally property and equipment, cash and other assets.
(2) Depreciation and amortization includes amounts relating to property and equipment, capital leases and spare parts inventory.
(3) Segment profit (loss) represents operating income (loss) before goodwill amortization.
(4)Interest has been allocated based on the net assets of the segment in relation to the Company’s consolidated net assets plus non-specific debt.

 

The Company does not have material international revenues, profit (loss), assets or capital expenditures. The Company’s business is not concentrated in a specific geographical area within the United States, as it has 5 separate facilities located in various states, the District of Columbia and Europe.

 

Revenue by Major Market and Significant Customers

 

The Company derived 95.8%, 96.7% and 94.2%substantially all of its revenues from contracts and subcontracts with the U.S. Government in 2002, 2001 and 2000, respectively. Total consolidated revenue derived fromGovernment. Revenue by customer sector for the U.S. Government for includes 31.6%, 36.2% and 43.8% of revenue from contracts with the United States Army for 2002, 2001 and 2000, respectively, 36.1%, 34.1% and 34.3% of revenue with other Department of Defense customers for 2002, 2001 and 2000, respectively, and 32.0%, 29.7% and 21.9% of revenue from Federal Civilian Agencies for 2002, 2001 and 2000, respectively. Revenue from Federal Civilian Agencies includes revenue of 49.4%, 70.8% and 71.6% for 2002, 2001 and 2000, respectively from the U.S. Courts.

Page 49 of 69


Note 13. Subsequent Events

On March 10, 2003 the Company and TelosOK LLC entered into a purchase agreement whereby the Company sold all of the issued and outstanding membership units of TelosOK LLC for a total consideration of $4.5 million. The Company had accounted for its investment in TelosOK LLC under the equity method and, at the time of this transaction, the Company had a zero basis recorded for this investment. The parties agreed to allocate the proceeds of the salelast three years is as follows:

 

$4.0 million to the Company at close

A minimum of 12 monthly payments to the Company in the amount of $45,000 per month, or a total of $540,000, to recover its fixed infrastructure costs associated with providing the inter-company support services

The parties also agreed that the Company would provide certain inter-company support services to TelosOK LLC for a period of 12 months in the amount of $45,000 per month, or a total of $540,000.

As additional consideration for the sale of the membership units, the Company and TelosOK LLC committed to certain “non-compete” and “no solicitation” agreements between the two parties. The “no solicitation” commitment provides a specific exception for the employment by TelosOK LLC of David S. Aldrich, former President, CEO and Director of the Company.

All Telos Corporation employees serving as officers of TelosOK LLC resigned said positions in TelosOK LLC in conjunction with the sale effective the date of the sale. The Company expects to recognize a gain on the disposal of the remaining 50% ownership of TelosOK LLC of approximately $10.1 million comprised of $6.1 million of deferred gain (see Note 3) and $4 million of gain associated with the cash received in March 2003.

   2003

  2002

  2001

 
   (amount in thousands) 

Department of Defense

  $69,503  78.6% $58,960  65.2% $77,036  68.7%

Federal Civilian

   15,055  17.0%  27,728  30.6%  31,519  28.1%

Commercial

   3,885  4.4%  3,829  4.2%  3,633  3.2%
   

  

 

  

 

  

Total

  $88,443  100.0% $90,517  100.0% $112,188  100.0%
   

  

 

  

 

  

 

Page 5042 of 6960


Note 14.13. Summary of Selected Quarterly Financial Data (Unaudited)

 

The following is a summary of selected quarterly financial data for the previous two years (in thousands). Certain reclassifications have been made to prior quarter financial data to conform to the presentation used in the December 31, 20022003 consolidated financial statements.

 

  

Quarters Ended


 
  Quarters Ended

 
  March 31

 June 30

 Sept. 30

 Dec. 31

 

2003

   

Sales

  $16,823  $15,412  $30,329  $25,879 

Gross profit

   3,072   2,680   6,365   4,967 

Income (loss) from continuing operations

   5,300   (865)  (1,011)  (13,109)

Loss from discontinued operations

   —     —     —     —   

Gain on sale of TCC

   —     —     —     1,000 

Net income (loss)

   5,300   (865)  (1,011)  (12,109)
  

March

31


   

June

30


   

Sept.

30


   

Dec.

31


 

2002

               

Sales

  

$

18,984

 

  

$

19,562

 

  

$

25,293

 

  

$

26,678

 

  $18,984  $19,562  $25,293  $26,678 

Gross Profit

  

 

2,024

 

  

 

3,151

 

  

 

1,452

 

  

 

4,433

 

Loss from continuing Operations

  

 

(1,194

)

  

 

(1,591

)

  

 

(2,011

)

  

 

(2,678

)

Loss from discontinued Operations

  

 

(373

)

  

 

(378

)

  

 

(105

)

  

 

(222

)

Gross profit

   2,024   3,151   1,452   4,433 

Loss from continuing operations

   (1,194)  (1,591)  (2,011)  (2,678)

Loss from discontinued operations

   (373)  (378)  (105)  (222)

Gain on sale of TCC

  

 

—  

 

  

 

—  

 

  

 

10,879

 

  

 

1,698

 

   —     —     10,879   1,698 

Net (loss) income

  

 

(1,567

)

  

 

(1,969

)

  

 

8,763

 

  

 

(1,202

)

   (1,567)  (1,969)  8,763   (1,202)

2001

            

Sales

  

$

30,401

 

  

$

23,153

 

  

$

22,692

 

  

$

35,942

 

Gross profit

  

 

5,898

 

  

 

6,155

 

  

 

5,546

 

  

 

5,331

 

Income (loss) from continuing Operations

  

 

151

 

  

 

(62

)

  

 

1,012

 

  

 

406

 

Loss from discontinued Operations

  

 

(324

)

  

 

(249

)

  

 

(434

)

  

 

(1,171

)

Net (loss) income

  

 

(173

)

  

 

(311

)

  

 

578

 

  

 

(765

)

Note 14. Recent Significant Company Filing

On April 9, 2004, the Company filed a Form 8-K report, which, due to its recent nature, is included herein in its entirety as follows:

Item 5, Other Events

The Board of Directors (the “Board”) of Telos Corporation (“Telos” or “the Company”) has authorized management of the Company to commence the process of planning for and, if appropriate, implementing the activities set forth below. Before any definitive action is undertaken in connection with such authorization (including without limitation any issuance, redemption or exchange of any equity securities of the Company), further review and approval by the Board is required.

The Company has noted in previous filings [see Form 10-Q for the period ending September 30, 2003 – “Reclassifications”] that its ability to successfully restructure its debt obligations could affect the Company’s future operating results and that for a variety of reasons, the Company believes it will more likely than not be unable to meet the redemption schedule set forth in the terms of the Company’s 12% Cumulative Exchangeable Redeemable Preferred Stock (“Public Preferred Stock”).

In an effort to address its capital structure and the adverse impact of FAS150 (“Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”), the Company intends to immediately engage such professional service providers it deems reasonable and appropriate to advise with regard to such recapitalization. The Company contemplates that such engagement will include, but may not be limited to, consideration of a swap of all debt instruments into common shares, the filing of an S-8 or other appropriate filings in order to issue the remaining authorized, but un-issued shares of Public Preferred Stock or to take such other steps as may be recommended to facilitate such recapitalization. The Company will use its best efforts to reach a decision on such recapitalization within 60 days. There is no assurance that any such transaction can or will be effected, or if effected what the form of such transactions would be or when they might occur.

None of the Company’s present directors has any material financial interest in any holder of the Senior Redeemable Preferred Stock or the Senior Subordinated Notes. Also, other than directors fees received for their service as members of the Board of Directors of the Company or fees for service as members of the Company’s Proxy Board, none of the non-executive directors receive any consulting or advisory fees or other compensation from the Company or any of its subsidiaries. Subject to further review, the full Board will continue to address the Company’s capital structure and any recommendations of the professional service providers pertaining thereto.

 

Page 5143 of 6960


Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None

Page 52 of 69


PART III

Item 9A. Control and Procedures

The Company’s chief executive officer and chief financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange Act), within 90 days prior to the filing of this annual report, and concluded that those disclosure controls and procedures are effective in timely alerting them to material changes in information required to be included in the Company’s periodic Securities and Exchange Commission filings.

Since such evaluation, such officers are unaware of any significant subsequent changes in the Company’s internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

The Company intends to continue its diligent review and evaluation of the design and effectiveness of the controls with the intention of making continuous improvements to such controls, and to correct in a timely manner any significant deficiencies and material weaknesses that may be discovered. The Company’s goal is to provide senior management with detailed information and timely access to all material information concerning the business. While the Company believes the present design of its disclosure controls and procedures effectively achieve its objectives, future unforeseen events may cause the Company to significantly modify such disclosure controls and procedures.

Page 44 of 60


PART III

 

Item 10. Directors and Executive Officers of the Registrant

 

Directors and Executive Officers

 

The following is certain biographical information concerning the directors and executive officers of the Company. The term of each of the directors to be elected at the Annual Meeting continues until the next annual meeting of shareholders and until his successor is elected and qualified, except that the directorships held by the Class D Directors will terminate whenever all accumulated dividends on the ExchangeablePublic Preferred Stock have been paid.

 

John B. Wood, Chairman andPresident, Chief Executive Officer, Chairman of the Board and Director

 

Mr. Wood (age 39) has served40) joined Telos Corporation in 1992 as ChairmanExecutive Vice President and Chief Operating Officer and in 1994 was named President and Chief Executive Officer. In March 2000 he was appointed to the newly created position of the Board since March 26, 2002 and as Executive Chairman of the Board since March 8, 2000.which he held until he became Chairman of the Board subsequent to a restructuring of the Board of Directors in 2002. In January of 2003, Mr. Wood was elected asresumed the positions of President and Chief Executive Officer on December 31, 2002 . From January 1994 until March 8, 2000, Mr. Wood served as President and Chief Executive Officer of the Company.Officer. Mr. Wood has also served as Chairman and CEO of Enterworks since January 1996. Between 1992 and 1994, Mr. Wood served as Chief Operating Officer and as an Executive Vice President of the Company. Prior to joining the Company,Telos Corporation, Mr. Wood founded a boutique investment-banking firmworked on Wall Street.Street for Dean Witter Reynolds, UBS Securities, and his own boutique investment bank. Mr. Wood has a BSBA in Finance and Computer Sciencegraduated from Georgetown University.University where he earned a Bachelor of Science in Business Administration in finance and computer science. Mr. Wood also serves on the Board of Directors of two privately held companies.private company boards and two foundation boards.

 

Dr. Fred Charles Ikle, Former Chairman of the Board,David Borland, Director

 

Dr. IkleMr. Borland (age 78) was elected to the Company’s Board of Directors on January 31, 1994 and was elected Chairman of the Board in January 1995. He is Chairman of Conservation Management Corporation and a Governor of the Smith Richardson Foundation. Dr. Ikle is a Distinguished Scholar at the Center for Strategic & International Studies and a member of the Defense Policy Board that advises the Secretary of Defense. He served as Under Secretary of Defense for Policy from 1981-1988, and as Director of the US Arms Control and Disarmament Agency from 1973-1976. Dr. Ikle resigned from the Chairmanship of the Board on March 26, 2002. He remains a proxy holder and director.

David S. Aldrich, Former President, Former Chief Executive Officer and Director

Mr. Aldrich (age 43) was elected to the positions of President and Chief Executive Officer on March 8, 2000. He56) was elected to the Board of Directors on February 8, 2000. He was appointed to the position of Chief Operating OfficerMarch 26, 2004 after retiring as Deputy CIO of the CompanyU.S. Army with more than 30 years of experience in January 1999. He joined the Company in September 1996Federal government. Mr. Borland’s career Army experience also includes serving as Vice President, Corporate DevelopmentDirector of Information Systems for Command, Control, Communications, and Strategy. Prior to joining the Company, he was a partner in the Financial Advisory Services Group – Corporate Finance at Coopers & Lybrand L.L.P. Prior to joining Coopers & Lybrand L.L.P. in 1991, Mr. Aldrich was Senior Vice President at Dean Witter Capital Corp., the merchant banking arm of Dean Witter Reynolds, Inc. Mr. Aldrich resigned as President and Chief Executive Officer on December 31, 2002 and as a director on February 24, 2003.

Dr. Stephen D. Bryen, Former Director

Dr. Stephen Bryen (age 59) was elected to the Company’s Board of Directors on January 31, 1994. He currently serves as a Director in Jefferson Partners, L.L.C., a strategic management consulting and merchant-banking firm with offices in Washington, D.C. and New York, and as Senior Vice President of L-3 Network Security, LLC in Denver, Colorado. Dr. Bryen currently serves on the board of C-MAC Industries in Mechanicsburgh, Pennsylvania and is the senior technical advisor to Hollinger Digital Corporation in New York. From 1981 to 1988 Dr. Bryen served as the Deputy Under Secretary of Defense for Trade Security Policy and as theComputers (DISC4); Director of the Information Systems Selection and Acquisition Agency (ISSAA); and numerous other positions. From 1966 through 1970, Mr. Borland served in the U.S. Air Force. Mr. Borland has received numerous awards, including the Meritorious Presidential Rank Award for Senior Executive Service Members (1996) and the Distinguished Presidential Rank Award (2000). He has been namedFederal Computer Week Fed 100 four times andGovernment Computer News Department of Defense Technology Security Administration, which he founded. Dr. Bryen resigned as a proxy holder and Director on March 20, 2002.Executive of the Year in November 2000.

 

Norman P. Byers, Director

 

Mr. Byers (56)(age 57) was elected to the Board of Directors on January 31, 1994. He is the chiefVice President and General Manager of staff toFoxhunt Incorporated, a Fairfax County Supervisorprovider of contract and directs all activities of a political staff serving 110,000 constituents. In addition,long-term technical staffing and executive recruiting services in McLean, Virginia. Previously, Mr. Byers iswas President and CEO of Virginia-based Classwise, Incorporated, a principal in Byers Consulting, a firm specializing in management and corporate governance consultingdistance learning ISP. Prior to information technology firms.his work at Classwise, Mr. Byers is also a Directorwas COO of ETI Engineering Incorporated, Chantilly, VirginiaThe Carpe Diem Group, President of Telos International Corporation, and

Page 53 managing partner of 69


Panalpina FMS Incorporated, Sterling, Virginia.International Strategies Limited. From 1968 until his retirement in 1989, Mr. Byers served in a variety of operational and staff positions in the United States Air Force. Mr. Byers is also a proxy holder.

 

Dr. Fred Charles Iklé, Director

Dr. Iklé (age 79) was elected to the Company’s Board of Directors on January 31, 1994 and Chairman of the Board in January 1995. He resigned from his position as Chairman of the Board on March 26, 2002. He is Chairman of Conservation Management Corporation and a member of the Defense Policy Board of the Secretary of Defense. Dr. Iklé is on the Board of Governors of the Smith Richardson Foundation and is a Distinguished Scholar at the Center for Strategic & International Studies. From 1981 to 1988, Dr. Iklé served as Under Secretary of Defense for Policy.

Ambassador Longhorne (Tony) A. Motley, Director

Ambassador L. Anthony Motley (age 66) was elected to the Company’s Board of Directors on January 13, 2003. Since 1985, Ambassador Motley has headed two successive international trade consulting firms that serve US companies in pursuing their international business goals. Additionally, Ambassador Motley has co-chaired the Department of State’s ambassadorial seminars and is a frequent lecturer for programs in the Department of State, Department of Defense, and other foreign affairs agencies. Ambassador Motley was previously the United States Ambassador to Brazil from 1981 until 1983 and the Assistant Secretary of State for Inter-American Affairs from 1983 to July of 1985. Ambassador Motley, in addition to his Board service for Telos Corporation, serves on the Board of Directors of the US-Brazil Business Council, Junior Achievement International, and the American Academy of Diplomacy.

Geoffrey B. Baker, Class D Director

Mr. Baker (age 54) was appointed as a Class D Director on November 6, 2001. Mr. Baker is a private investor and since 1983 has been a partner in Baker & Donaldson, a private investment firm, having served on various corporate and civic boards. A graduate of Stanford University and Georgetown University Law Center, he previously served as Legislative Director to U.S. Senator Lowell P. Weicker, Jr., and as Professional Staff Member on the U.S. Senate Committee on Commerce, Science and Transportation.

Page 45 of 60


Malcolm M. B. Sterrett, Class D Director

 

Mr. Sterrett (age 60)61) is a private investor and was elected to the Company’s Board of Directors as a Class D Director on July 31, 1998 as part of the preferred stockholder class.Class D Director. From 1989 to 1993, he was a partner at the law firm of Pepper Hamilton & Scheetz in Washington, D.C. From 1988 to 1989, he served as General Counsel to the U.S. Department of Health and Human Services and from 1982 to 1988 he was a Commissioner on the U.S. Interstate Commerce Commission. Prior thereto, he was Vice President and General Counsel to the United States Railway Association and served as Staff Director and Counsel to the U.S. Senate Committee on Commerce, Science and Transportation. Mr. Sterrett is also a member of the Board of Directors of Trans World Corporation.

 

Geoffrey Baker, Class D Director

Mr. Baker (age 54) was appointed as a Class D Director on November 6, 2001. Mr. Baker is a private investor and since 1983 has been a partner in Baker & Donaldson, a private investment firm. Previously, he served as Legislative Director to U.S. Senator Lowell P. Weicker, Jr., and as counsel to the U.S. Senate Committee on Commerce, Science and Transportation. A graduate of Stanford University and of the Georgetown University Law Center, he has served on public and private corporate boards and currently serves as Chairman of the Governing Board of St. Albans School, Washington, D.C.

Ambassador Langhorne A. Motley, New Director and Proxy Holder, 2003

Ambassador L. Anthony Motley (age 65) was elected to the Company’s Board of Directors on January 13, 2003. Since 1985, Ambassador Motley has headed two successive international trade consulting firms that serve US companies in pursuing their international business goals. Additionally, Ambassador Motley has co-chaired the Department of State’s ambassadorial seminars and is a frequent lecturer for programs in the Department of State, Department of Defense and other foreign affairs agencies. Ambassador Motley was previously the United States Ambassador to Brazil from 1981 until 1983 and the Assistant Secretary of State for Inter-American Affairs from 1983 to July of 1985. Ambassador Motley, in addition to his Board Service for Telos Corporation, serves on the Board of Directors of the US Brazil Business Council, Junior Achievement International and the American Academy of Diplomacy.

Michael P. Flaherty, Executive Vice President, General Counsel and Chief Administrative Officer

 

Mr. Flaherty (age 57)58) was appointed Executive Vice President, General Counsel and Chief Administrative Officer on January 3, 2001. Prior to joining Telos Corporation, Mr. Flaherty was of Counsel withcounsel in the law firm of O’Donnell & Shaeffer, LLC and principal shareholder and Chief Executive Officer of First Continental Financial Group, Inc. Mr. Flaherty has extensive experience in all aspects of civil litigation, and is experienced in comprehensive legislative and regulatory representation of national organizations and corporations before the U.S. Congress and federal, state and local governmental agencies.serving as lead trial counsel for major corporations. Mr. Flaherty has also served as General Counsel of the U.S. House of Representatives Committee on Banking, Finance and Urban Affairs atand Counsel to the U.S.Speaker of the House of Representatives from 1972 to 1982. He earned his J.D. degree from Columbus SchoolRepresentatives. Additionally, Mr. Flaherty is the past chairman of the Executive Committee of the Federal Bar Association’s Banking Law the Catholic University of America, and his B.A. degree from Boston University.Committee.

 

Robert J. Marino, Executive Vice President ofand Chief Sales and Marketing Officer

 

Mr. Marino (age 66)67) joined the Company in 1988 as Senior Vice President of Sales and Marketing. In 1990, his responsibilities were expanded to include Program Management in addition to Sales and Marketing. On January 1, 1994, Mr. Marino was appointed to President of Telos Systems Integration, and on January 1, 1998, he was appointed to his current position. Prior to joining the Company in February 1988, Mr. Marino held the position of Senior Vice President of Sales and Marketing with Centel Federal Systems and M/A-COMA.com Information Systems, both of which are U.S. Government contractors.

Edward L. Williams, Executive Vice President and Chief Operating Officer

Mr. Williams (age 43) joined the company in 1993 as a Senior Vice President responsible for finance, pricing, purchasing, and DCAA compliance. In 1994, his responsibilities were expanded to include accounting and business development. In 1996, Mr. Williams was appointed to manage the Company’s networking business unit. In 2000, his responsibilities were expanded to include management of Telos operations. Mr. Williams was named Executive Vice President and Chief Operating Officer in 2003. Prior to joining Telos Corporation, Mr. Williams was the Chief Financial Officer for Centel Federal Systems and M/A.com Information Systems, both of which are U.S. Government contractors. Mr. MarinoWilliams has a B.S. in Finance from the University of Maryland. On October 15, 2003, Mr. Williams was recognized in 1999 by Federal Computer Weekappointed to serve as one of the top 100 Executives from U.S. Government, industry and academia.interim Chief Financial Officer.

 

Thomas J. Ferrara,Richard P. Tracy, Senior Vice President and Chief FinancialSecurity Officer and Treasurer

 

Mr. FerraraTracy (age 45)42) was appointed Chief FinancialSecurity Officer in February 2004. He joined Telos in October 1986 where he held a number of management positions within the CompanyTelos NJ operation. In February 1996, Mr. Tracy started the Telos information security consulting practice. In February of 2000, Mr. Tracy was selected to manage Xacta operations. Mr. Tracy is identified as the chief inventor on September 14, 2000. He was electedall of Xacta’s patent applications.

Therese K. Hathaway, Vice President, of FinanceCorporate Secretary and Accounting and Treasurer on February 8, 2000. HeCorporate Counsel

Ms. Hathaway (age 49) joined the Company in 19942001 as Director of Pricinga Legal Consultant. In January 2002 she was appointed Corporate Counsel and in May 2003 Corporate Secretary. In January 2004 she was responsible for all pricing of major contracts and Company forecasts.named Vice President. Prior to joining Telos Mr. Ferrara wasCorporation, Ms. Hathaway funded and managed Hathaway Communications, specializing in legal translation services for law firms and government agencies, including the Accounting Manager for Cordant,Justice Department. Ms. Hathaway has also served as Management Consultant to IDS Corporation, a privately held U.S. Government contractor.

Michelle Wertz, Vice Presidentprivate firm, and as Law Clerk to the International Trade Policy Counsel of Human ResourcesGeneral Electric Company. Ms. Hathaway holds a law degree from the University of Berne/Switzerland and Corporate Secretary

Ms. Wertz (age 39) was appointed Vice President, Human Resources for Telos Corporation in Julya Master of 2000 and Corporate Secretary in September 2000. Ms. Wertz joined Telos in May 1998 to revamp the Recruiting and Retention activities for the company leading to her position as Vice President, Resource Management in December of 1999. Ms. Wertz’ previous Human Resources experienceComparative Law from 1995 – 1998 includes working for America Online, IPR Staffnet and Total Systems Solutions to provide technical and professional staffing solutions and best practice recruiting strategies.George Washington University.

 

Each of the proxy holders, directors and executive officers of the Company is a United States citizen.

 

Page 5446 of 6960


Item.Item 11. Executive Compensation

 

The following table shows for the years ended December 31, 2003, 2002 2001 and 2000,2001, the cash compensation paid by the Company as well as certain other compensation paid or accrued for those years, to the chief executive officer and the four other most highly compensated executive officers of the Company in fiscal year 2002.2003.

 

SUMMARY COMPENSATION TABLE
Annual Compensation

Long-Term

      

Annual Compensation


  

Long-Term Compensation

Securities


       

Name and Principal Position


  

Year


  

Salary


   

Bonus


  

underlying

Options(1)


     

All Other

Compensation(5)


 

John B. Wood

  

2002

  

$

335,873

(7)

  

$

100,000

  

10,000

(2)

    

$

12,182

(5)

(Chairman, Chief Executive Officer)

  

2001

  

$

350,002

(7)

  

$

125,000

  

510,000

(3)

    

$

28,859

(5)

   

2000

  

$

350,002

(7)

  

$

—    

  

—  

 

    

$

18,100

(5)

David S. Aldrich

  

2002

  

$

350,002

 

  

$

50,000

  

10,000

(2)

    

$

63,346

(5)(6)

(Former President and Chief Executive Officer)

  

2001

  

$

350,002

 

  

$

125,000

  

510,000

(3)

    

$

34,784

(5)

   

2000

  

$

332,894

 

  

$

—  

  

250,000

(3)

    

$

18,100

(5)

Michael P. Flaherty

  

2002

  

$

300,019

 

  

$

200,000

  

—  

 

    

$

12,715

 

(Exec. V.P., General Counsel and Chief Administrative Officer)

  

2001

  

$

300,018

 

  

$

132,692

  

300,000

(3)

    

$

6,229

 

   

2000

  

 

—  

 

  

 

—  

  

30,000

(3)

    

$

—  

 

Robert J. Marino

  

2002

  

$

227,094

 

  

$

15,000

  

—  

 

    

$

110,039

(6)

(Executive Vice President of Sales and Marketing)

  

2001

  

$

222,390

 

  

$

70,000

  

—  

 

    

$

23,517

 

   

2000

  

$

211,706

 

  

$

—  

  

292,900

(3)

    

$

5,100

 

Thomas J. Ferrara

  

2002

  

$

184,233

 

  

$

135,000

  

—  

 

    

$

7,318

 

(Chief Financial Officer, Treasurer)

  

2001

  

$

160,205

 

  

$

80,000

  

—  

 

    

$

6,771

 

   

2000

  

$

133,561

 

  

$

—  

  

128,000

(3)

    

$

5,100

 

Compensation
Awards
Securities
Underlying
Options (1)


All Other
Compensation (4)


Name and Principal Position


Year

Salary

Bonus

John B. Wood

(Chairman, President and Chief Executive Officer)

2003
2002
2001
$
$
$
345,969
335,873
350,002
(7)
(7)
(7)
$
$
$
380,000
100,000
125,000
—  
10,000
510,000

(2)
(3)
$
$
$
10,201
12,182
28,859

(5)
(5)

Michael P. Flaherty

(Exec. V.P., General Counsel and Chief Administrative Officer)

2003
2002
2001
$
$
$
300,019
300,019
300,018


$
$
$
250,000
200,000
132,692
—  
—  
300,000


(3)
$
$
$
12,715
12,715
6,229


Robert J. Marino

(Executive V. P. and Chief Sales and Marketing Officer)

2003
2002
2001
$
$
$
227,094
227,094
222,390


$
$
$
239,659
15,000
70,000
—  
—  
—  


$
$
$
13,635
110,039
23,517

(6)

Edward L. Williams

(Exec. V. P., Chief Operating Officer, Chief Financial Officer)

2003
2002
2001
$
$
$
227,136
226,200
198,600


$
$
$
250,000
136,000
100,000
—  
—  
—  


$
$
$
6,938
6,445
5,888


Richard P. Tracy

(Senior V. P., Chief Security Officer)

2003
2002
2001
$
$
$
160,514
160,110
145,285


$

$
125,000
—  
41,500
—  
—  
—  


$
$
$
4,142
4,146
3,938



(1) There are no restricted stock awards or payouts pursuant to long-term investment plans.
(2) Options granted in 2002 are in the Company’s Class A common stock.
(3) Options granted in 2001 and 2000 are in Telos, Telos Delaware, and Xacta common stock.
(4) All other compensation represents Company contributions made on behalf of the executive officers to the Telos Shared Savings Plan, and life insurance premiums paid by the Company for the benefit of the executives.
(5) Included in these amounts are $2,500 in 2002, $10,000 in 2001, and $13,000$10,000 in 2001 for director’s fees paid.
(6) Included in these amounts arethis amount is cash surrender value paymentspayment from life insurance policies.policy.
(7) The Company and its affiliate, Enterworks, Inc., have an agreement whereby Enterworks, Inc. reimbursesreimbursed the Company for $108,000 for 2003, $250,000 for 2002 and 2001, of Mr. Wood’s annual salary.

 

Page 5547 of 6960


Stock Option Grants

The Summary Table of Options/SAR Grants in the Last Fiscal Year is set forth below for the stock option grants in 2002.

Name and Principal Position


    

Number of Securities Underlying Options/SARS Granted(1)


  

% of

Total

Options/ SARS Granted


   

Exercise

or Base

Price


  

Expiration Date


  

Potential Realizable Value at Assumed Rates of Stock Price Appreciation for

Option Term


                  

5%


  

10%


John B. Wood

    

10,000

  

3.9

%

  

$

1.00

  

Oct. 2012

  

$

6,300

  

$

16,100

(Chairman and Chief Executive Officer)

                        

David S. Aldrich

    

10,000

  

3.9

%

  

$

1.00

  

Oct. 2012

  

$

6,300

  

$

16,100

(Former President, Chief Executive Officer)

                        

Thomas J. Ferrara

    

—  

  

—  

 

  

 

—  

  

—  

  

 

—  

  

 

—  

(Chief Financial Officer, Treasurer)

                        

Robert J. Marino

    

—  

  

—  

 

  

 

—  

  

—  

  

 

—  

  

 

—  

(Executive Vice President of Sales and Marketing)

                        

Michael P. Flaherty

                        

(Exec.VP, General Counsel and Chief Administrative Officer)

                        

(1)Options granted in 2002 were in the common stock of Telos.

Page 56 of 69


Management Stock Options

 

The following table shows, as to the individuals named in the Summary Compensation table, the number of shares acquired during such period through the exercise of options, and the number of shares subject to and value of all unexercised options held as of December 31, 2002.2003.

 

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR

AND FY-END OPTION/SAR VALUES

 

Name


  

Shares Acquired
on

On Exercise


  

Value

Realized


  

Number of

Securities

Underlying

Unexercised

Options/SARs

at FY-End(1)At FY-End

Exercisable/


Unexercisable


  

Value of


Unexercised


In-the-Money


Options/SARs

at
At FY-End (2)(1)
Exercisable/
Unexercisable

Exercisable/

Unexercisable



John B. Wood (Chairman, President and Chief Executive Officer)

  

—  

  

—  

  

3,962,975/1,275,016

1,679,745/ 1,498,245
  

$

399,168/$48,938

0 /$0

David S. Aldrich (Former President, Chief Executive Officer)

—  

—  

1,331,250/ 450,125

$

0/$0

Thomas J. Ferrara (V.P., Treasurer, Chief Financial Officer)

—  

—  

120,500/60,000

$

225/$0

Robert J. Marino (Executive Vice President of Sales and Marketing)

—  

—  

886,400/ 303,500

$

4,188/$4,188

Michael P. Flaherty

—  

—  

252,167/ 194,500

$

0/$0

(Exec. (Exec. V.P., General Counsel and Chief Administrative Officer)

          301,500 / 128,500  $0 /$0

(1)

Robert J. Marino (Exec. V. P., Chief Sales and Marketing Officer)

  These aggregate amounts include exercisable options to purchase the common stock of Enterworks, Inc. for 2,060,000 shares held by Mr. Wood, 400,000 shares held by Mr. Aldrich, 7,500 shares held by Mr. Ferrara, 200,000 shares held by Mr. Marino and 16,667 shares held by Mr. Flaherty, respectively.—  —  718,400 / 271,500$0 /$0

Edward L. Williams (Exec. V. P., Chief Operating Officer, Chief Financial Officer)

—  —  504,000 / 24,000$0 /$0

Richard P. Tracy (Senior V.P., Chief Security Officer)

—  —  151,000 / 24,000$0 /$0


(2)(1) These aggregate values include values for exercisable options to purchase the Class A Common Stock of the Company. These values are based upon an estimated fair market value at December 31, 20022003 of $1.00$.62 per share for the Company’s Class A Common Stock. These values were derived from valuations performed by an independent third party for the trustees of the Telos Shared Savings Plan, a defined contribution employee savings plan in which substantially all full-time employees are eligible to participate.

 

 

Pager 57Page 48 of 6960


Compensation of Directors

 

During the fiscal year ended December 31, 2002,2003, outside directors and proxy holders Mr. Byers, and Dr. Ikle were paid $40,000 and 46,250, respectively. Outside Class D directors Mr. Sterrett and Mr. Baker were paid $26,500 and $25,000, respectively. Dr. Ikle resigned as Chairman on March 26, 2002 and will remain as a proxy holder and director. Dr. Ikle, and Dr. Bryen areAmbassador Motley were paid $42,000, $32,000, and $34,000, respectively for their services as directors and proxy holders. Proxy holder services were paid pursuant to athe 1994 proxy agreement amongbetween the Company, the Defense Security Service, and Mr. John R.C. Porter. Dr. Bryen resigned as a proxy holderThe outside Class D directors, Mr. Sterrett and Director on March 20, 2002. He wasMr. Baker, were paid $8,750 for 2002.$34,000 and $32,000, respectively.

 

Effective March 27, 2002, the Board of Directors adopted a new compensation structure for the annual compensation of the Board annuallymembers which provides for the following: $25,000 annually for Proxy holder directors; $25,000 annually for Class D Directors; $0 for employee directors and committee participation; $5,000 for the Chairman of the Board’s annual retainer; $5,000 for the Proxy Board Chairman’s annual retainer; $5,000 annually for the Chairmen of the Audit Committee; $2,000 annually for the Chairmen of the Management Development and Compensation Committee; and $2,000 annually for membership in the Audit, Management Development and Compensation Committee, or Nominating/Corporate Governance Committee; and eachCommittee. Each director other thanwho is not an employee directorsdirector is entitled to receive $1,250 for each meeting attended, up tofor a maximum of four meetings per year.

 

Employment Contracts

 

As of December 31, 2002,2003, the Company was a party to agreements with certain of its executive officers. Mr. John Wood, President, Chief Executive Officer, Chairman and Director; Mr. Michael Flaherty, Executive Vice President, General Counsel and Chief Administrative Officer; Mr. Edward Williams, Executive Vice President, Chief Operating Officer and Chief Financial Officer; and Mr. Robert Marino, Executive Vice President and Chief Sales and Marketing Officer, and Mr. John Wood, Director and Executive Chairman, currently have employment contracts with the Company. The agreements are for one-year terms and provide, respectively, for a payment to Mr. Wood and Mr. Marino of two years’the equivalent of 24 months base salary then in effect, and for payment to Mr. Flaherty and Mr. Williams of the equivalent of 18 months base salary then in effect, if involuntarily terminated or if the agreements are not extended.

 

Accordingly, Messrs. MarinoWood and WoodMarino would receive annually $227,000$350,000 and $350,000$227,000, respectively, for a two-year period.period, and Messrs. Flaherty and Williams would receive 18 months of their annual salaries of $300,000 and $227,000, respectively.

 

In addition to base salary, the executives are eligible for a discretionary bonus and for the grant of stock options under the agreements. The amount of theany such discretionary bonus and the grant of any such stock options is determined atsubject to, depending on the individual, the review and/or approval of the Compensation Committee and its report to and approval by the Board of Directors and Chief Executive Officers discretion. Directors.

Each year, the Company renegotiates such employment contracts as part of the yearly review process. Accordingly in 2003,2004, the Company expects to review the contracts described above. In addition, strategic hires or promotions may increase the number of Executivesexecutives who have Employment Contracts.employment contracts.

 

Page 5849 of 6960


Item 12. Security Ownership of Certain Beneficial Owners and Management

 

Title of Class


  

Name and Address of

Beneficial Owner


  

Amount and Nature of

Beneficial Ownership as of


December 31, 20022003


  

Percent of
Class

Class



 

Class A Common Stock

  

John R. C.R.C. Porter

34 Rue Concorde

1050 Brussels Belgium

  

22,190,718 shares(A)

shares (A)
  

80.52

%

227 Marsh Wall

London E14 9SD England

Class A Common Stock

  

Telos Corporation Shared

  3,658,536 shares

17.28

%

Savings Plan

19886 Ashburn Road

Ashburn, VA 20147

  3,658,536 shares  17.28%

Class B Common Stock

  

Graphite Enterprise Trust PLC

  1,681,960 shares(B)

41.66

%

BerkeleyBerkley Square House, 4th Floor

London W1J 6BQ England

  1,681,960 shares (B)  41.66%

Class B Common Stock

  

Graphite Enterprise Trust LP

     420,490 shares(B)

10.41

%

Berkley Square House, 4th Floor

London W1J 6BQ England

  420,490 shares (B)  10.41%

Class B Common Stock

  

Hare & Company

  1,186,720 shares

29.39

%

c/o Bank of New York

P.O. Box 11203

New York, NY 10249

  1,186,720 shares  29.39%

Class B Common Stock

  

Cudd & Company

     669,888 shares

16.59

%

c/o Chase Manhattan Bank

Corporate Actions Department Four

Four New York Plaza, 11th11th Floor

New York, NY 10004

  669,888 shares  16.59%

Class A Common Stock

  

John B. Wood

  

  1,731,861 shares(C)

1,383,631 shares (C)
  

7.58

6.15

%

Class A Common Stock

  

David S. Aldrich

Robert J. Marino
  

     722,781 shares(C)

649,535 shares (C)
  

3.30

2.98

%

Class A Common Stock

  

Robert J. Marino

Michael P. Flaherty
  

     648,575 shares(C)

167,233 shares (C)
  

2.98

0.78

%

Class A Common Stock

  

Michael P. Flaherty

Edward L. Williams
  

     149,558 shares(C)

501,575 shares (C)
  

0.70

2.33

%

Class A Common Stock

  

Thomas J. Ferrara

Richard P. Tracy
  

       51,862 shares(C)

80,151 shares (C)
  

0.24

0.38

%

Class A Common Stock

  

Norman P. Byers

  

         5,0007,000 shares

  

0.02

0.03

%

Class A Common Stock

  

Stephen D. Bryen

Fred C. Ikle
  

         3,0007,000 shares

  

0.01

0.03

%

Class A Common Stock

  

Fred C. Ikle

Malcom M.B. Sterrett
  

         5,0003,000 shares

  

0.02

0.01

%

Class A Common Stock

Malcolm Sterrett

         2,000 shares

0.01

%

Class A Common Stock

  

All Officers and Directors

  3,320,912 shares(D)

13.62

%

As a Group (10(9 persons)

  2,800,130 shares (D)  11.79%

12% Cumulative

Exchangeable Redeemable

Preferred Stock

  

Value Partners, Ltd.

     714,317 shares(E)Ewing & Partners

4514 Cole Avenue, Suite 808

Dallas, TX 75205

  

22.42

%

Exchangeable Redeemable

714,317 shares (E)
  

2200 Ross Avenue, Suite 4660

22.42
%

Preferred Stock

Dallas, TX 75201

Fisher Ewing Partners

2200 Ross Avenue, Suite 4660

Dallas, TX 75201

12% Cumulative

Exchangeable Redeemable

Preferred Stock

  

Wynnefield Partners Small Cap Value, L.P.

Wynnefield Partners Small Cap Value, L.P. I

Channel Partnership II, L.P. Wynnefield Small Cap Value Offshore Fund, Ltd.

450 Seventh Avenue, Suite

509 New York, NY 10123

  

     228,500 shares(F)

466,200 shares (F)
  

7.17

14.63

%

12% Cumulative

Exchangeable Redeemable

Value, L.P.

Preferred Stock

  

One Penn Plaza, Suite 4720Athena Capital Management, Inc. Minerva Group, LP

David P. Cohen

4 Tower Bridge #222

200 Barr Harbor Drive

West Conshohocken, PA 19428

  162,362 shares (G)  5.10

New York, NY 10119

Channel Partnership II, L.P.

One Penn Plaza, Suite 4720

New York, NY 10119

Wynnefield SmallCap Value

Offshore Fund, Ltd.

One Penn Plaza, Suite 4720

New York, NY 10119

%

 

Page 50 of 60


(A) Mr. John R. C. Porter’s holdings include 6,388,916 shares of P Class A Common Stock purchasable upon exercise of a warrant.

 

(B) Graphite Enterprise Trust PLC and Graphite Enterprise Trust LP did not provide the Company with the addresses of the respective beneficial owners.

 

(C) The common stock holdings of Messrs. Aldrich, Flaherty, Marino, FerraraTracy, Williams and Wood include 1,889; 1,558; 22,123; 10,8623,233; 23,083; 33,151; 30,599; and 39,244 shares of the Company’s Class A Common Stock, respectively, held for their beneficial interest by the Telos Corporation Savings Plan. Messrs. Aldrich,

Page 59 of 69


Flaherty, Marino, FerraraTracy, Williams and Wood hold options to acquire 712,500; 148,000;164,000; 614,400; 41,000;47,000; 400,000; and 1,684,2251,335,995 shares of the Company’s Class A Common Stock, respectively, in addition to their current common stock holdings. These shares are purchasable upon exercise of the options and are exercisable within 60 days of March 1, 2003.2004.

 

(D) The common stock holdings of the Company’s officers and directors as a group include 76,951130,315 shares of the Company’s Class A Common Stock held for their beneficial interest by the Telos Corporation Savings Plan. Under the Company’s stock option plan and certain stock option agreements, all officers and directors as a group hold options to acquire 3,215,1252,578,395 shares of Class A Common Stock exercisable within 60 days of March 1, 2003.2004.

 

(E) Value Partners Ltd. (“VP”) and Fisher Ewing & Partners (“FEP”E&P”) have filed jointly a joint Schedule 13D under which they disclosed that they may act as a “group” within the meaning of Section 13(d) of the Securities Exchange Act. Each of the reporting persons disclosed that it might be deemed to beneficially own the aggregate of 714,317 shares of the Exchangeable Preferred Stock held of record by the reporting persons collectively.

 

According to the Schedule 13D, each of FEPVP, E&P and Timothy G. Ewing and Richard W. Fisher may be deemed to have the sole power to vote and to dispose of the shares of the Exchangeable Preferred Stock held of record by the reporting persons collectively.

 

(F) Wynnefield Partners SmallCapSmall Cap Value, L.P., (“WPSCV”), Wynnefield Partners Small Cap Value L.P. I (“WPSCVI”), Channel Partnership II, L.P. (“CP”), and Wynnefield SmallCapSmall Cap Value Offshore Fund, Ltd. (“WSCVOF”), Wynnefield Capital Management, LLC (“WCM”), Wynnefield Capital, Inc. (“WCI”) and Mr. Nelson Obus have jointly filed a joint Schedule 13D under which they disclosed that they may act as a “group” within the meaning of Section 13(d) of the Securities Exchange Act. Each of the reporting persons disclosed that it might be deemed to beneficially own the aggregate of 228,500466,200 shares of the Exchangeable Preferred Stock held of record by the reporting persons collectively. According to the Schedule 13D, WCM is the sole general partner of WPSCV and WPSCVI, Messrs. Nelson Obus and Joshua Landes by virtueare the co-managing members of their status as general partnersWCM. WCI is the sole investment manager of WPSCV,WSCVOF, Messrs. Obus and Landes are the principal executive officers of WCI. Mr. Obus as general partner of CP and Messrs. Obus and Landes, as co-managing members of WCM and principal executive officers of WSCVOF’s investment manager,WCI, have the power to vote or to direct the vote and the power to dispose and to direct the disposition of the shares of Exchangeable Preferred Stock owned by WPSCV, WPSCVI, CP and WSCVOF, respectively.

 

(G)Athena Capital Management, Inc. (“ACM”), Minerva Group, LP (“MG”), and Mr. David Cohen have filed a joint Schedule 13G in which ACM has the shared power to vote or to direct the vote and the shared power to dispose or to direct the disposition of 111,429 shares; MG and Mr. Cohen have the sole power to vote or to direct the vote and the sole power to dispose or to direct the disposition of 43,500 and 7,433 shares, respectively.

Page 6051 of 6960


Item 13. Certain Relationships and Related Transactions

 

Information concerning certain relationships and related transactions between the Company and certain of its current and former officers and directors is set forth below.

 

Mr. John R.C. Porter, the owner of a majority of the Company’s Class A Common Stock, has a consulting agreement with the Company whereby he is compensated for consulting services provided to the Company in the areas of marketing, product development, strategic planning and finance as requested by the Company. Mr. John R.C. Porter was paid $260,000 by the Company in 2002, 2001, and 2000 pursuant to this agreement, which amounts were determined by negotiation between the Company and Mr. John R.C. Porter.

 

Mr. David S. Aldrich, former President and Chief Executive Officer of the Company, entered into an agreement with the Company whereby Mr. Aldrich will serve as an advisor to the Company from December 31, 2002 through March 31, 2005. In return, Mr. Aldrich will be paid $350,000 per annum from January 1, 2003 through March 31, 2005. The Company will also continue to provide Mr. Aldrich with medical and insurance benefits during that same period.

 

Mr. Mark Hester, former Executive Vice President and former Chief Operating Officer of the Company, had a consulting agreement with the Company to provide strategic advice concerning the Company’s hardware services division. Under this agreement, Mr. Hester received $206,000 for his services during 1999 and 2000, and was eligible for a bonus under certain circumstances, at the Company’s discretion. Under this agreement Mr. Hester received a bonus of $135,000 payable in installments during 2000. The Company competed payment to Mr. Hester in 2000.

Mr. Gerald Calhoun, former Vice President of Human Resources and Corporate Secretary, entered into a settlement agreement with the Company to resolve a dispute over Mr. Calhoun’s employment contract with the Company. The Company paid Mr. Calhoun 24 months of severance in installments from 2000 until April 19, 2002. Mr. Calhoun also received medical and insurance benefits through the Company for the same two-year period. Mr. Calhoun’s payment of salary and fringe benefits amounted to approximately $189,000 per annum. Under the agreement, the Company extended the option term of Mr. Calhouns vested options until September 2001. These options have now expired.

 

Mr. William L.P. Brownley, former Vice President and General Counsel of the Company, entered into an agreement with the Company whereby Mr. Brownley will serveserved as an of counsel attorney to the Company from December 31, 2000 through March 31, 2003. In return, Mr. Brownley will bewas paid $220,000 per annum from January 1, 2001 through March 31, 2003. The Company will also continue to provideprovided Mr. Brownley with medical and insurance benefits during that same period.

 

Mr. Lorenzo Tellez, former Vice President, Treasurer, and Chief Financial Officer of the Company, entered into a settlement agreement with the Company to resolve a dispute on Mr. Tellez’s employment contract with the Company. With regard to the salary component of the contract,theThe Company paid Mr. Tellez the equivalent of 24 months of severance in installments during 2001. Mr. Tellez also received medical and insurance benefits through the Company for the same two-year period. Mr. Tellez’s payment of salary and fringe benefits amounts to approximately $243,000 per annum. The Company completed its payments of the salary portion of the contract to Mr. Tellez on December 7, 2001. TheIn March 2003, pursuant to the final settlement of arbitration proceedings, the Company as recorded a charge to earnings of $200,000 under SG&A to recognize a claim bypaid Mr. Tellez a bonus of $96,000 and legal fees in the amount of $53,000.

Item 14. Principal Accountant Fees and Services

PricewaterhouseCoopers LLP has served as the principal accountant for the Company since the fiscal year ended December 31, 1997. Aggregate fees for professional services rendered to a discretionary bonusthe Company by PricewaterhouseCoopers LLP for the year ended December 31, 2003 and estimated legal expenses during 2002.2002 are summarized as follows:

   2003

  2002

Audit fees

  $198,300  $183,400

All other fees

   48,431   63,380
   

  

Total

  $246,731  $246,780
   

  

 

Page 6152 of 6960


PART IV

Item 14. Controls and Procedures

The Company’s chief executive officer and chief financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange Act), within 90 days prior to the filing of this annual report, and concluded that those disclosure controls and procedures are effective in timely alerting them to material changes in information required to be included in the Company’s periodic Securities and Exchange Commission filings.

There have been no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

The Company intends to review and evaluate the design and effectiveness of the controls on an ongoing basis with the intention of improving such controls and to correct in a timely manner any deficiencies that may be discovered. The Company’s goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the business. While the Company believes the present design of the disclosure controls and procedures is effective to achieve our goals, future events affecting the business may cause us to significantly modify disclosure controls and procedures.

Page 62 of 69


PART IV

 

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

(a) 1. Financial Statements

(a)1. Financial Statements

 

All financial statements of the registrant as set forth under Item 8 of this report on Form 10-K.

 

(a) 2. Financial Statement Schedules

(a)2. Financial Statement Schedules

 

All schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.

 

(a) 3. Exhibits:

(a)3. Exhibits:

 

Exhibits marked with (1*) are incorporated by reference to the Company’s Registration Statement No. 2-84171 filed June 2, 1983. Exhibits marked with (3*) are incorporated by reference to the Company’s Form 10-K report for the fiscal year ended March 31, 1987. Exhibits marked with (4*) are incorporated by reference to the Company’s Form 10-K report for the fiscal year ended March 31, 1989. The registrant will furnish to stockholders a copy of other exhibits upon payment of $.20 per page to cover the expense of furnishing such copies. Requests should be directed to the attention of Investor Relations at Telos Corporation, 19886 Ashburn Road, Ashburn, Virginia 20147-2358.

 

2.6

 

Stock Purchase Agreement dated as of January 14, 1992, by and among C3, Inc., Telos Corporation and Contel Federal Systems, Inc. (Incorporated by reference to C3, Inc.

Form 8-K filed January 29, 1992)

3.1

(1*)

 

Articles of Amendment and Restatement of C3, Inc.

3.2

(1*)

 

Articles of Amendment of C3, Inc. dated August 31, 1981.

3.3

(3*)

 

Articles supplementary of C3, Inc. dated May 31, 1984.

3.4

(4*)

 

Articles of Amendment of C3, Inc. dated August 18, 1988.

3.5

 

Articles of Amendment and Restatement Supplementary to the Articles of Incorporation dated August 3, 1990. (Incorporated by reference to C3, Inc. 10-Q for the quarter ended June 30, 1990)

3.6

 

Restated Bylaws of C3, Inc. (Incorporated by reference to C3, Inc. 10-Q for the quarter ended December 31, 1990)

3.7

 

Articles of Amendment of C3, Inc. dated April 13, 1995

4.1

 

Form of Indenture between the Registrant and Bankers Trust Company, as Trustee, relating to the 12% Junior Subordinated Debentures Due 2009. (Incorporated herein by reference to C3’s Registration Statement on Form S-4 filed October 20, 1989)

1989

4.2

4.3
 

Form of the terms of the 12% Cumulative Exchangeable Redeemable Preferred Stock of the Registrant. (Incorporated herein by reference to C3’s Registration Statement on Form S-4 filed October 20, 1989)

4.3

4.4
 

Shareholders Agreement dated as of August 3, 1990 by and among C3, Inc.; Union de Banques Suisses (Luxembourg)Suisses(Luxembourg), S.A.; C3 Investors, L.P.; Anthony Craig, together with the investors; the Class A holders; MIM Limited; Knoll and Associates, Inc.; Murray Enterprises PLC; Electra Development Holdings; and Hartley Limited. (Incorporated by reference to C3, Inc. 10-Q for the quarter ended June 30, 1990)

Page 63 of 69


  4.4

4.5
 

Articles of Amendment and Restatement of the Company, filed with the Secretary of State of the State of Maryland on January 14, 1992. (Incorporated by reference to C3, Inc. Form 8-K filed January 29, 1992)

10.20

 

Revolving and Reducing Senior Facility Credit Agreement dated as of January 14, 1992, among C3, Inc., Telos Corporation and NationsBank, N.A. (Incorporated by reference to C3, Inc. Form 8-K filed January 29, 1992)

10.31

 

September 27, 1993 Settlement Agreement among John R.C. Porter, Toxford Corporation, Cantrade Nominees Ltd., Cantrade Trust Company (Cayman) Ltd., Cantrade Trustee, AG, Fred Knoll, Cottonwood Holdings, C3 Investors L.P., C3, Inc., Telos Corporation,

Joseph P. Beninati, John B. Wood and Beninati & Wood, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.32

 

September 27, 1993 Stock Purchase and Sale Agreement between Mr. John R.C. Porter and C3 Investors, L.P. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.33

 

September 27, 1993 Stock Purchase and Sale Agreement between Mr. John R.C. Porter and Cottonwood Holdings, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.34

 

September 27, 1993 Note Interest Purchase and Sale Agreement among Mr. John R.C. Porter, Cottonwood and C3, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.35

 

October 8, 1993 Promissory Note in the amount of $8,438,000 issued by Mr. John R.C. Porter in favor of C3 Investors, L.P. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.36

 

October 8, 1993 Promissory Note in the amount of $1,562,000 issued by Mr. John R.C. Porter in favor of Cottonwood Holdings, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

Page 53 of 60


10.37

  

September 27, 1993 Collateral Agency, Security and Pledge Agreement among Mr. John R.C. Porter, Mr. Fred Knoll, Cottonwood Holdings, C3 Investors, L.P., C3, Inc., Telos Corporation, Toxford Corporation, Cantrade Nominees Limited, Mr. Robert M. Ercole and Mr. Frank S. Jones, Jr. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.38

  

September 27, 1993 Standstill Agreement among Mr. John R.C. Porter, Mr. Fred Knoll, Mr. Alfredo Frohlich and C3, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.39

  

September 27, 1993 Mutual Release among Mr. John R.C. Porter, Mr. Fred Knoll, Cottonwood Holdings, C3 Investors, L.P., C3, Inc., Telos Corporation, Mr. Joseph P. Beninati, Mr. John B. Wood, and Beninati & Wood, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.40

  

September 27, 1993 Consulting Agreement among Mr. Fred Knoll, C3, Inc. and Telos Corporation. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)

10.43

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of December 31, 1993 among C3, Inc., Telos Corporation and NationsBank, N.A.

10.44

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of April 11, 1994 among C3, Inc., Telos Corporation and NationsBank, N.A.

Page 64 of 69


10.45

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of June 8, 1994 among C3, Inc., Telos Corporation and NationsBank, N.A.

10.46

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of October 7, 1994 among C3, Inc., Telos Corporation and NationsBank, N.A.

10.47

  

October 7, 1994 Letter Agreement among C3, Inc., Toxford Corporation, and NationsBank, N.A. regarding cash collateral held on behalf of the Company.

10.48

  

October 25, 1994 General Release and Settlement memorandum among Sapiens International Corporation N.V., Sapiens International Corporation B.V., Sapiens U.S.A., Inc., C3, Inc. and Telos Corporation.

Corporation

10.49

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of January 5, 1995 among C3, Inc., Telos Corporation and NationsBank, N.A.

10.50

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of January 12, 1995 among C3, Inc., Telos Corporation and NationsBank, N.A.

10.51

  

Waiver and Amendment to Revolving and Reducing Senior Credit Facility dated as of April 17, 1995 among C3, Inc., Telos Corporation and NationsBank, N.A.

10.58

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Drayton English and International Investment Trust

10.59

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and J. O. Hambro Investment Management, Ltd.

10.60

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and North Atlantic Smaller Companies Investment Trust, PLC

10.61

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Mr. John R.C. Porter

10.62

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Sir Leslie Porter

10.63

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Second Consolidated Trust, PLC

10.64

  

Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Toxford Corp.

10.65

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Drayton English and International Investment Trust

10.66

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and J.O. Hambro Investment Management, Ltd.

10.67

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and North Atlantic Smaller Companies Investment Trust, PLC

10.68

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Mr. John R.C. Porter

10.69

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Sir Leslie Porter

10.70

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Second Consolidated Trust, PLC

10.71

  

Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Toxford Corp.

10.72

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of August 4, 1995 Telos Corporation(Maryland), Telos Corporation (California) and NationsBank N.A.

10.73

  

Amendment to Revolving and Reducing Senior Credit Facility dated as of October 13, 1995 Telos Corporation (Maryland), Telos Corporation (California) and NationsBank N.A.

10.74

  

1996 Stock Option Plan

10.76

  

Sixteenth Amendment to Credit Facility and Tenth Amended and Restated Promissory Note

Page 65 of 69


10.77

  

Enterworks, Inc. 1996 Stock Option Plan

10.78

  

Form of Series A Senior Subordinated Unsecured Note

10.79

  

Form of Enterworks, Inc., inc. Capital Stock Purchase Series A Warrant

10.80

  

Asset Purchase Agreement

10.81

  

Amendment No. 1 to Asset Purchase Agreement

10.82

  

Amended and Restated Credit Agreement between Telos Corporation, a Maryland corporation; Telos Corporation, a California corporation; and NationsBank, N.A. dated as of July 1, 1997

Page 54 of 60


10.83Asset Purchase Agreement

10.83

10.84
  

Asset PurchaseInterim Agreement

10.84

10.85
  

Interim Agreement

10.85

Share Purchase Agreement between Telos Corporation, a Maryland corporation, formerly named and known as C3, Inc. and Union Bank of Switzerland, dated May 7, 1998

10.86

  

Series D Senior Subordinated Unsecured Note due October 1, 2000 as of November 20, 1998 between Telos Corporation (Maryland)Corporation(Maryland) and Foreign and Colonial Enterprise Trust PLC

10.87

  

Series D Senior Subordinated Unsecured Note due October 1, 2000 as of November 20, 1998 between Telos Corporation (Maryland)Corporation(Maryland) and Foreign and Colonial Enterprise Trust LP

10.88

  

Common Stock Purchase Series D Warrant between Telos Corporation (Maryland) and Foreign and Colonial Enterprise Trust PLC

10.89

  

Common Stock Purchase Series D Warrant between Telos Corporation (Maryland and Foreign and Colonial Enterprise Trust LP

10.90

  

Form of Stock Purchase Agreement

10.90

10.91
  

Asset Purchase Agreement, dated as of September 29, 1999 between Telos Corporation (Maryland), Telos Corporation (California), Telos Field Engineering, Inc. and TFE Technology Holdings, Inc.

10.92

  

Letter to Bank of America concerning Enterworks private placement

10.93

  

Form of Enterworks Subdebt conversion letter

10.94

  

Form of Telos Subdebt conversion letter

10.95

  

Listing of Subdebt conversion parties

10.96

  

Transaction agreement between Telos and Enterworks

21

  

Schedule of Subsidiaries.

Subsidiaries
31.1Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32Certification pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b) Reports filed on 8K:Form 8-K:

 

1. 8-K filed August 5, 2002. Item 2. Sale of Telos Corporation (California) to L-3 Communications Corporation.

 

2. 8-K filed November 1, 2002. Item 5. Disclosing Loan and Security Agreement with Foothill Capital Corporation.

 

3. 8-K filed January 14, 2003. Item 5. Announcing the resignation of David S. Aldrich as CEO of Telos Corporation and the appointment of John B. Wood.

 

4. 8-K filed March 10, 2003. Item 5. Announcing the resignation of David S. Aldrich as Telos Corporation Director.

 

5. 8-K filed March 24, 2003. Item 5. Announcing the sale of TelosOK LLC.

 

6. 8-K filed May 14, 2003. Item 5. Announcing the resignation of Thomas J. Ferrara as CFO of Telos Corporation and the appointment of David E. Pearson.

7. 8-K filed October 23, 2003. Item 5. Announcing the resignation of David E. Pearson as CFO of Telos Corporation and the appointment of Edward L. Williams.

8. 8-K filed April 9, 2004. Item 5. Intent to obtain professional advice concerning potential recapitalization of Telos Corporation.

Page 6655 of 6960


SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Telos Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

TELOS CORPORATION

By:

 

/s/ THOMAS J. FERRARAEdward L. Williams


  

Interim Chief Financial Officer

Date:

 

Date:        March 31, 2003

April 14, 2004

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following personsperson on behalf of Telos Corporation and in the capacities and on the datedated indicated.

 

Signature


  

Title


 

Date


/s/ JOHNJohn B. WOODWood


John B. Wood

  

Chairman and Chief Executive Officer

 

March 31, 2003

April 14, 2004

/s/ Fred Charles Ikle


Fred Charles Ikle

  

Director

 

March 31, 2003

April 14, 2004

/s/ NORMANNorman P. BYERSByers


Norman P. Byers

  

Director

 

March 31, 2003

April 14, 2004

/s/ MALCOLMMalcom M.B. STERRETTSterrett


Malcolm M.B. Sterrett

  

Director

 

March 31, 2003

April 14, 2004

/s/ GEOFFREY BAKERGeoffrey B. Baker


Geoffrey B. Baker

  

Director

 

March 31, 2003

April 14, 2004

/s/ L. ANTHONY MOTLEYAnthony Motley


Ambassador L. Anthony Motley

  

Director

 

March 31, 2003

April 14, 2004

/s/ THOMAS J. FERRARAEdward L. Williams


Thomas J. FerraraEdward L. Williams

  

Interim Chief Financial Officer (Principal Financial Officer & Principal Accounting Officer)

 

March 31, 2003

April 14, 2004

 

Page 6756 of 6960


CERTIFICATIONS

I, John B. Wood, Chief Executive Officer of Telos Corporation, certify that:

1. I have reviewed this annual report on Form 10-K of Telos Corporation;

2. Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly represent in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

/s/    JOHN B. WOOD


Chief Executive Officer

Page 68 of 69


CERTIFICATIONS

I, Thomas J. Ferrara, Chief Financial Officer of Telos Corporation, certify that:

1. I have reviewed this annual report on Form 10-K of Telos Corporation;

2. Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

/s/    THOMAS J. FERRARA


Chief Financial Officer

Page 69 of 69