UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X][X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended: September 30, 2000March 31, 2001
[ ] Transition Report Pursuant to Section 13 or 15(d)
of 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 20147-2358
(AddressAddress of principal executive offices) (Zip Code)
Registrant's Telephone Number,
including area code: (703) 724-3800
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
------------------- -----------
As of November 10, 2000,May 1, 2001 the registrant had 21,241,98021,171,202 shares of Class A Common Stock,
no par value, and 4,037,628 shares of Class B Common Stock, no par value; and
3,185,586 shares of 12% Cumulative Exchangeable Redeemable Preferred Stock, par
value $.01 per share, outstanding.
No public market exists for the registrant's Common Stock.
Number of pages in this report (excluding exhibits): 20
--16
TELOS CORPORATION AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
------ ---------------------
Item 1. Financial Statements:
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2000 and 1999 (unaudited)...................................5
Condensed Consolidated Balance Sheets as of September 30, 2000 (unaudited)
and December 31, 1999 ................................................................................6
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and 1999 (unaudited) ...........................................7
Notes to Condensed Consolidated Financial Statements (unaudited).......................................8-13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................................................14-18
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................18
PART II. OTHER INFORMATION
------- -----------------
Item 1. Legal Proceedings............................................................................. 19
Item 3. Defaults Upon Senior Securities................................................................19
Item 4. Submission of Matters to a Vote of Security Holders............................................19
Item 6. Exhibits and Reports on Form 8-K...............................................................19
SIGNATURES....................................................................................................20
Item 1. Financial Statements:
Condensed Consolidated Statements of Operations for the Three Months
Ended March 31, 2001 and 2000 (Unaudited)...................................3
Condensed Consolidated Balance Sheets as of March 31, 2001 (Unaudited)
and December 31, 2000.......................................................4
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2001 and 2000 (Unaudited)...................................5
Notes to Condensed Consolidated Financial Statements (Unaudited)...........6-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................11-14
PART II. OTHER INFORMATION
------- -----------------
Item 1. Legal Proceedings..............................................15
Item 3. Defaults Upon Senior Securities................................15
Item 6. Exhibits and Reports on Form 8-K...............................15
SIGNATURES....................................................................16
PART I - FINANCIAL INFORMATION
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(amounts in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------- ----------------
2000 1999 2000 1999
---- ---- ---- ----
Sales
Systems and Support Services $13,384 $ 22,012 $34,278 $ 65,414
Products 17,829 18,893 47,126 66,872
Xacta 3,661 1,204 9,475 4,594
------ ------ ------ ---------
34,874 42,109 90,879 136,880
Costs and expenses
Cost of sales 30,694 36,813 78,631 117,407
Selling, general and
administrative expenses 4,189 3,857 12,636 12,311
Goodwill amortization 71 133 250 397
------ ------ ------ -------
Operating (loss) income (80) 1,306 (638) 6,765
Other income (expenses)
Gain on sale of assets -- 4,731 -- 4,731
Equity in net losses of Enterworks -- (4,407) -- (13,575)
Equity in earnings of Telos OK 321 -- 2,328 --
Other income 4 7 42 60
Interest expense (1,151) (1,437) (3,514) (4,456)
------- ------- ------- --------
(Loss)income before taxes ( 906) 200 (1,782) (6,475)
Income tax (provision) benefit (1,355) (572) (1,172) 976
------- ------ ------- ------
Net loss $ (2,261) $ (372) $ (2,954) $ (5,499)
======= ====== ======= =======
PART I - FINANCIAL INFORMATION
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(amounts in thousands)
Three Months Ended
March 31,
-----------------------------
2001 2000
---- ----
Sales
Systems and Support Services $13,887 $10,346
Products 27,477 14,872
Xacta 2,565 1,522
------ ------
43,929 26,740
Costs and expenses
Cost of sales 37,039 23,579
Selling, general and administrative expenses 5,713 4,210
Goodwill amortization 62 89
------ ------
Operating income (loss) 1,115 (1,138)
Other income (expenses)
Equity in net earnings of Telos OK -- 840
Other income -- 20
Interest expense (1,287) (1,137)
------- -------
Loss before taxes (172) (1,415)
Income tax (provision) benefit (1) 487
------ ------
Net loss $ (173) $ ( 928)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(amounts in thousands)
ASSETS
September 30, 2000 December 31, 1999
------------------ -----------------
Current assets
Cash and cash equivalents (includes restricted
cash of $54 at September 30, 2000 and
December 31, 1999) $ 399 $ 315
Accounts receivable, net 28,527 27,030
Inventories, net 5,483 4,779
Deferred income taxes 2,537 4,802
Other current assets 199 83
----- -----
Total current assets 37,145 37,009
Property and equipment, net of
accumulated depreciation of
$8,934 and $23,093, respectively 12,416 12,236
Deferred income taxes, long term 4,210 2,930
Goodwill, net 2,811 4,284
Investment in Enterworks -- --
Investment in Telos OK -- --
Other assets 538 427
------ ------
$ 57,120 $ 56,886
====== ======
LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current liabilities
Accounts payable $ 12,354 $13,792
Other current liabilities 2,632 3,421
Unearned revenue 6,035 5,183
Senior credit facility 17,388 --
Senior subordinated notes 8,537 --
Accrued compensation and benefits 5,437 7,645
------ ------
Total current liabilities 52,383 30,041
Senior credit facility -- 16,508
Senior subordinated notes -- 8,537
Capital lease obligations 11,108 11,362
------ -------
Total liabilities 63,491 66,448
------ ------
Redeemable preferred stock
Senior redeemable preferred stock 6,373 6,054
Redeemable preferred stock 40,041 36,975
------ ------
Total preferred stock 46,414 43,029
------ ------
Stockholders' investment
Common stock 78 78
Capital in excess of par 5,135 --
Retained deficit (57,998) (52,669)
-------- ------
Total stockholders' investment (deficit) (52,785) (52,591)
-------- ------
$ 57,120 $ 56,886
====== ======
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
(unaudited)
ASSETS
March 31, 2001 December 31, 2000
-------------- -----------------
Current assets
Cash and cash equivalents
(includes restricted cash of
$54 at March 31, 2001 and
December 31, 2000) $ 114 $ 286
Accounts receivable, net 38,041 45,682
Inventories, net 6,404 7,045
Deferred income taxes, current 3,363 3,256
Other current assets 1,685 404
------ ------
Total current assets 49,607 56,673
------ ------
Property and equipment, net of
accumulated depreciation of
$9,838 and $9,331, respectively 12,177 12,319
Goodwill 2,686 2,749
Investment in Enterworks -- --
Investment in TelosOK -- --
Deferred income taxes, long term 4,558 4,603
Other assets 745 746
----- -----
$69,773 $77,090
======= =======
LIABILITIES AND STOCKHOLDERS' INVESTMENT (DEFICIT)
Current liabilities
Accounts payable $16,234 $19,049
Other current liabilities 2,615 2,438
Unearned revenue 7,398 8,609
Senior subordinated notes, current 1,151 1,151
Senior credit facility 23,101 --
Accrued compensation and benefits 6,324 7,178
------ ------
Total current liabilities 56,823 38,425
Senior credit facility -- 25,460
Senior subordinated notes 7,386 7,386
Capital lease obligations 10,949 11,030
------ ------
Total liabilities 75,158 82,301
Redeemable preferred stock
Senior redeemable preferred stock 6,584 6,480
Redeemable preferred stock 42,773 42,352
------ ------
Total preferred stock 49,357 48,832
Stockholders' (deficit) investment
Common stock 78 78
Capital in excess of par 2,192 2,718
Retained deficit (57,012) (56,839)
-------- --------
Total stockholders' investment
(deficit) (54,742) (54,043)
-------- --------
$69,773 $77,090
======= =======
The accompanying notes are an integral part of these condensed
consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts in thousands)
Nine Months
Ended September 30,
-------------------
2000 1999
---- ----
Operating activities:
Net loss $(2,954) $(5,499)
Adjustments to reconcile net loss to cash
(used in) provided by operating activities:
Gain on sale of fixed assets -- (88)
Gain on sale of assets -- (4,731)
Depreciation and amortization 1,260 3,082
Goodwill amortization 250 397
Other noncash items 93 2,096
Changes in assets and liabilities (3,743) 16,119
------- ------
Cash (used in) provided by operating activities (5,094) 11,376
----- ------
Investing activities:
Proceeds from sale of fixed assets -- 171
Proceeds from sale of assets -- 10,000
Investment in capitalized software and other assets -- (762)
Cash distributions from Telos OK, LLC 6,000 --
Purchases of property and equipment (1,447) (1,047)
------ ------
Cash provided by investing activities 4,553 8,362
----- -----
Financing activities:
Proceeds (repayment of) borrowings under senior
credit facility 880 (19,368)
Payments under capital leases (255) (275)
--- -------
Cash provided by (used in) financing activities 625 (19,643)
----- ------
Increase in cash and cash equivalents 84 95
Cash and cash equivalents at beginning of period 315 408
----- -------
Cash and equivalents at end of period 399 $ 503
===== ======
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts in thousands)
Three Months
Ended March 31,
---------------
2001 2000
---- ----
Operating activities:
Net loss $ (173) $ (928)
Adjustments to reconcile net loss to
cash provided by (used in) operating activities:
Depreciation and amortization 490 415
Goodwill amortization 62 89
Other non-cash items 308 124
Changes in assets and liabilities, net 1,904 (6,119)
----- -------
Cash provided by (used in) operating
activities 2,591 (6,419)
----- -------
Investing activities:
Purchase of property and equipment (308) (392)
---- ----
Cash used in investing activities (308) (392)
---- ----
Financing activities:
(Repayments of) proceeds from senior credit
facility, net (2,359) 6,733
Payments under capital leases (96) (87)
----- -----
Cash (used in) provided by financing activities (2,455) 6,646
------- ------
Decrease in cash and cash equivalents (172) (165)
Cash and cash equivalents at beginning of period 286 315
------ -----
Cash and cash equivalents at end of period $ 114 $ 150
======= ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. General
The accompanying condensed consolidated financial statements are unaudited
and include the accounts of Telos Corporation ("Telos") and its wholly owned
subsidiaries (collectively, the "Company"). Significant intercompany
transactions have been eliminated. In the opinion of the Company, the
accompanying financial statements reflect all adjustments and reclassifications
(which include only normal recurring adjustments) necessary for their fair
presentation in conformity with generally accepted accounting principles.
Interim results are not necessarily indicative of fiscal year performance becausefor a
variety of reasons including the impact of seasonal and short-term variations.
These financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's annual report
on Form 10-K for the fiscal year ended December 31, 1999.2000.
In June 1998, the FASB issued SFAS No. 133, "Accounting orFor Derivative
Instruments and Hedging Activities." SFAS 133 establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging activities. SFAS 133, as amended by
SFAS 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the effective date of SFASFASB Statement No. 133, an amendment of FASB
Statement No. 133", is effective for all quarters of the Company's year ending
December 31, 2001. The Company currently does not engage or plan to engage in
the use of derivative instruments, and does not expectthe implementation of SFAS 133 todid not
have a material impact on the results of operations.operations, cash flows or financial
position.
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities" which amends SFAS 133.
SFAS 138 amends SFAS 133 to 1)expand the scope of the "normal sales and normal
purchases" exception; 2)introduce the benchmark rate as an interest rate that
may be hedged; 3)permit a recognized foreign currency denominated asset to be
hedged and; 4)allow certain intercompany derivatives that are offset net to be
designated as hedging instruments. The Company doesdid not anticipate SFAS 138 to
have a material impact on its financial statements.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin 101 "Revenue Recognition in Financial Statements" ("SAB 101") to
provide guidance regarding the recognition, presentation and disclosure of
revenue in the financial statements. The Company expects to adopt the provisions
of SAB 101 (as amended by SAB 101B which deferred the implementation date by
three quarters) on October 1, 2000. Management does not anticipate the adoption
of SAB 101 to have a material impact on
its results of operations, cash flows or financial condition.
In April 2000, the FASB issued FASB Interpretation No. 44 "Accounting
for Certain Transactions Involving Stock Compensation; Interpretation of APB
Opinion No.25" ("FIN 44"). FIN 44 clarifies the application of APB 25 regarding
certain key issues. It addresses various interpretive guidelines including: 1)
stock compensation granted to non-employees or to employees who have changed
their employment status; 2) modifications made to a fixed stock option or award;
3) share repurchase features and tax withholding features; 4) and exchanges due
to business combinations. The Company has applied FIN 44 to its stock option
plans as of July 1, 2000 and there has been no material impact to its
consolidated financial statementsposition from the adoption of
this interpretation.SFAS 138.
On September 29, 2000, FASB Statement No. 140 ("SFAS 140"), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities",
was issued. The new standard replaces FASB Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
and becomes effective for transfers entered into after March 31, 2001. SFAS 140
significantly changes the collateral recognition guidance for secured borrowings
and related collateral disclosure requirements. The Company does not anticipate
SFAS 140 will have a material impact on the Company's consolidated financial
statements.
Certain reclassifications have been made to the prior periodyear's financial
statements to conform to the classifications used in the current period.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 2. Contribution of Assets
On July 28,27, 2000, the Company entered into a Subscription Agreement with
certain investors ("Investors"), which provided for the formation of an Oklahoma
Limited Liability Company named Telos OK, L.L.C.LLC ("Telos OK"TelosOK"). The Company
contributed all of the assets of its Digital Systems Test and Training
Simulators ("DSTATS") business as well as its Government Contract with the
Department of the Army at Ft. Sill (hereafter referred to as the Company's Ft.
Sill business)operation) to Telos OK.TelosOK. The net assets contributed by the Company totaled
$353,000.$373,000. The Investors contributed $3.0 million in cash to Telos OK,TelosOK, and at
closing Telos OKTelosOK borrowed $4.0 million cash from a bank. The Company and the
Investors each have guaranteed a portion of the loan of Telos OK.TelosOK. The Company has
guaranteed $2 million and the Investors have guaranteed $1 million. In addition,
Telos OK entered into a $500,000 senior credit facility with the same bank,
which expires August 1, 2001. Borrowings under the facility, should there be
any, will be collateralized by certain assets of Telos OKTelosOK (primarily accounts
receivable). The Company and the Investors have agreed to guarantee this credit
facility in the amount of $250,000 each when and if drawn.
In compliance with the subscription agreement, on the closing date the
following consideration was given to the Company for its contribution of assets
to Telos OK:TelosOK:
The Company received $6 million in cash, retained $2.5 million in trade
receivables of the Ft. Sill and DSTATS businesses, and received a $500,000
receivable from Telos OKTelosOK for a total consideration of $9 million for the
contribution of the net assets.
The Company and the Investors each own a 50% voting membership interest in
Telos OK,TelosOK, 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:
Class A - owns 20% of Telos OK.TelosOK. The Company and the Investors each own 50% of the
200,000 units of this class. This class has all voting rights of Telos OKTelosOK and has
the sole right to elect the directors of Telos OK.TelosOK. The units in this class do not
have redemptiveredemption rights.
Class B - owns 40% of Telos OK.TelosOK. The Investors own all 2.9 million units of this
class. This class does not have voting rights, to elect directors, but can request the redemption of
all or a portion of the Class B units outstanding beginning one year after the
closing date, subject to certain restrictions. 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 Telos OKTelosOK as defined in
the agreement.
Class C- owns 40% of Telos OK.TelosOK. The Company owns all 2.9 million units of this
class. This class does not have voting rights, to elect directors, and has the same redemptiveredemption
rights as class B above, 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
have been redeemed, the Company will receive a warrant to purchase a number of
Class C units equal to the amount of the Class B units redeemed at a price of
$0.01 per unit.
As indicated in the operating agreement, one of the Investors, Bill W.
Burgess, will
initially serve as Chairman of the Board and may designate a Secretary, and
David Aldrich, President and CEO of the Company, and Thomas Ferrara, Treasurer
and CFO of the Company, will initially serve in those same capacities for Telos OK.TelosOK. The
Company has entered into a corporate services agreement with Telos OKTelosOK whereby the
Company will provide certain administrative support functions to Telos OK,TelosOK,
including but not limited to finance and accounting and human resources, in
return for a monthly cash payment.
As indicated above, the Company owns 50% of Telos OK LLC,TelosOK, and shares control
over Telos OK, LLC,TelosOK, and therefore 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 and DSTATS
businesses have been excluded from their respective captions in the Company's
Consolidated Statement of Operations, and the net earnings from these businesses
have been reported separately as "Equity in Net Earnings of Telos OK" for the
three and nine months ended September 30,March 31, 2000. The results of operations of the Ft. Sill and
DSTATS businesses included in the "Equity in Net Earnings of Telos OK"TelosOK" caption
are comprised of the following:
(in thousands)
September 30, 2000
------------------------
3-months 9-months
ended ended
----- ------
Sales 1,774 13,339
Cost of Sales (1,453) (11,011)
------- --------
Gross Profit 321 2,328
======= ======
(in thousands)
Three months ended
March 31, 2000
--------------
Sales $ 5,354
Cost of Sales (4,514)
-----
Gross Profit $ 840
===
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 3. Deconsolidation of Enterworks
On December 30, 1999, Enterworks, Inc. ("Enterworks"), a majority-owned
subsidiary 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 which generated gross proceeds of $25,000,000. In addition, the Company
entered into a series of concurrent transactions pursuant to whichFrom July 27, 2000 through March 31, 2001, 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 prepayment premium associated with these notes, into shares
of Enterworks' Common Stock 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 $8 million
extraordinary gain, net of tax of $5.3 million, which is included in the
Company's statementcumulative equity of operations forTelosOk was still negative. Accordingly, under 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 was 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 the Enterworks' 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 the Company changed itsequity
method of accounting for its investment in
Enterworks from the consolidation method to the equity method. Pursuant to this
change the Company's interest in the losses of Enterworks have been reported
separately as "Equity in Net Losses of Enterworks" in the Company's consolidated
statement of operations for the three and nine months ended September 30, 1999.
Additionally, the Company established an "Investment in Enterworks" account in
accordance withprescribed by Accounting Principles Board 18. As of September 30, 2000 and
December 31, 1999, respectively, the balance is zero in the Investment in
Enterworks account due to the fact thatOpinion 18,
the Company's share of cumulative losses
exceeds its investment basis.carrying value in TelosOK is $0 at March 31, 2001.
Note 4. Sale of Assets
On September 29, 1999, the Company sold substantially all of the assets
of its computer maintenance and service business, Telos Field Engineering Inc.
("TFE"), to TFE Technology Holdings LLC ("TFE Holdings"), an affiliate of Carr &
Company, for $10 million. As a result of this sale, the Company recorded a gain
of $4.7 million in its consolidated statement of operations for the year ended
December 31, 1999. This gain included a write-off of $2.1 million of goodwill
allocated to TFE operations. The Company and TFE Holdings entered into a
one-year corporate services agreement on the date of the sale. Under the terms
of the Agreement, Telos continued to provide certain administrative support
functions to TFE Holdings, including but not limited to finance and accounting
and human resources, in return for a monthly payment. This agreement was
terminated on August 31, 2000.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 5.3. Debt Obligations
Senior Credit Facility
The Company has a $35 million Senior Credit Facility ("the Facility") with
a bank which matures on JulyMarch 1, 2001.2002. At September 30, 2000,March 31, 2001, the Facility was
classified as a current liability as the Facility has a term of less than one
year. Borrowings under the Facility are collateralized by a majority of the
Company's assets including accounts receivable, inventory, and Telos' stock in
Enterworks, Inc.its subsidiaries. The amount of available borrowings fluctuates based on the
underlying asset borrowing base. At September 30, 2000, the Company was notbase, as defined in
compliance with several financial covenants contained within the Facility including covenants relating to certain fixed charge coverage and leverage
goals. The bank has waived this noncompliance.agreement.
Senior Subordinated Notes
In 1995 the Company issued Senior Subordinated Notes ("Notes") to certain
shareholders. The Notes are classified as either Series B or Series C. FixedSeries B
Notes are collateralized by fixed assets of the Company collateralize Series B Notes.Company. Series C Notes are
unsecured. BothOf the $8.5 million in combined principal of the Series B and Series
C Notes have a maturity dateat March 31, 2001, approximately $1.2 million of Notes mature on April
1, 2001, and the remaining $7.3 million become payable on April 1, 2002. The
Notes have interest rates ranging from 14% to 17%. Interest is paid quarterly on
January 1, April 1, July 1, and October 1 of each year. The Notes can be prepaid
at the Company's option. Additionally, these Notes have a cumulative payment
premium of 13.5% per annum payable only upon certain circumstances. These
circumstances include an initial public offering of the Company's common stock
or a significant refinancing, to the extent that net proceeds from either of the
above events are received and are sufficient to pay the premium. Due to the
contingent nature of the premium payment, the associated premium expense will
only be recorded after the occurrence of a triggering event. At September
30, 2000March 31, 2001,
the prepayment premium that would be due upon a triggering event is
$7.9approximately $9.0 million.
In conjunction with the Enterworks private placement offering (Note 3),of 1999, the
Company retired approximately $1.0 million of Series B Notes, and $4.8 million of
Series C Notes, and $1.8 million of Series D Notes in exchange for shares of
Enterworks' common stock owned by the Company at an exchange ratio of one share
of Enterworks' common stock for each $1.00 principal amount of notes payable. In
addition to the retirement of these notes, accrued interest of approximately
$300,000 was forgiven and the holders of these notes waived their rights to the
prepayment premium associated with these notes.
The balances of the Series B and Series C Notes were $5.5 million and $3.0
million, respectively, at September 30, 2000March 31, 2001 and December 31, 1999. At
September 30, 2000, the Series B and Series C notes are classified as current
liabilities as they have a term of less than one year.2000.
Note 6.4. Preferred Stock
Senior Redeemable Preferred Stock
The components of the senior redeemable preferred stock are Series A-1 and
Series A-2, each with $.01 par value and 1,250 and 1,750 shares authorized,
issued and outstanding, respectively. The Series A-1 and Series A-2 each carry a
cumulative per annum dividend rate of 14.125% of their liquidation value of
$1,000 per share. The dividends are payable semi-annually on September 30June 30th and
December 3131st of each year. The liquidation preference of the senior preferred stock is
the face amount of the Series A-1 and A-2 Stock ($1,000 per share), plus all
accrued and unpaid dividends. The Company is required to redeem all821.4 of the
outstanding shares of the stock on December 31, 2001, subject to the legal
availability of funds. The remaining 2,178.6 shares and their accrued dividends
are required to be redeemed on April 1, 2002 subject to the legal availability
of funds. Mandatory redemptions are required from excess cash flows, as defined
in the stock agreements. The Series A-1 and A-2 Preferred
Stockredeemable 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 stock since its issuance. At September 30,
2000March 31, 2001 and December
31, 1999 cumulative2000 undeclared, unpaid dividends relating to Series A-1 and A-2 redeemable
preferred stock totaled $3,373,000$3,584,000 and $3,054,000$3,480,000, respectively.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 Public12% Cumulative Exchangeable Redeemable Preferred Stock (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 making periodic accretions under the
interest method of the excess of the redemption value over the recorded value.
Accretion for the ninethree months ended September 30, 2000March 31, 2001 was $1,155,000.$421,000. The Company
declared stock dividends totaling 736,863 shares in 1990 and 1991. No other
stock dividends have been declared since 1991.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In November 1998, the Company retired 410,000 shares of the Public
Preferred Stock held by certain shareholders. The Company repurchased the stock
at $4.00 per share. The carrying value of these shares was determined to be $3.8
million, and the $2.2 million excess of the carrying amount of these shares of
Public Preferred Stock over the redemption price of $1.6 million was recorded as
an increase in capital in excess of par; there was no impact on income from this
transaction.
The Public Preferred Stock has a 20 year maturity,20-year maturity; however, the Company
must redeem, out of funds legally available, 20% of the Public Preferred Stock
on the 16th, 17th, 18th and 19th anniversaries of November 12,21, 1989, leaving 20%
to be redeemed at maturity. 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 thean 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. Following November 21, 1995, dividends are only payable in cash. Dividends in
additional shares of the Preferred Stock wereare paid at the rate of 6% of a share
of the Preferred Stock for each $.60 of such dividends not paid in cash.
Dividends are payable by the Company, provided the Company has legally available
funds under Maryland law, and
is able to pay dividends under its charter and other corporate documents, when and if declared by the Board of Directors,
commencing June 1, 1990, and on each six month anniversary thereof. 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. These
accrued dividends are 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
$20,588,000.$22,500,000.
The Company has not declared or paid dividends since 1991, due to
restrictions and ambiguities relating to the payment of dividends contained
within its charter, its working capital facility agreement, and under Maryland
law.
Note 7.5. Reportable Business Segments
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", in 1998 which changes the way the Company
reports information about its operating segments.
TheAt March 31, 2001, the Company has three reportable segments:
Systems and Support Services:Services - provides software development and support
services for software and hardware including technology insertion, system
redesign and software re-engineering. ThisThe principal market for this segment consists of two divisionsis
the federal government and its agencies.
Products - solutions and
international.
Products: delivers enterprise integration and networking infrastructure solutions to its customers.
These solutions include providing commercial hardware, software and services to
its customers. ThisThe Products group is capable of staging, installing and
deploying large network infrastructures with virtually no disruption to
customer's ongoing operations. Xacta:The principal market for this segment is the
federal government and its agencies.
Xacta - offers innovative products which leverage its extensive consulting
experience, domain knowledge, and best practices implementation in enterprise
integration, enterprise management, and enterprise security. Through theseits core competencies and innovative products, Xacta helps
manage the security of its customers' network environments through the
integration of critical business content and processes.
The Company evaluates the performance of its operating segments based on
revenue, gross profit and income before goodwill amortization, income taxes,
non-recurring items and interest income or expense. Certain businesses within
the Xacta segment in 2000 were transferred to the Products segment beginning
January 2001. The 2000 segment disclosure has been amended to conform to this
2001 change.
Summarized financial information concerning the Company's reportable
segments for the three months ended September 30,March 31, 2001 and 2000 and 1999 is shown in the
following table. The "other" column includes corporate related items.
Enterworks, Inc. (Note 3) was disclosed as a segment in 1999 filed reports
and therefore it is still identified as a segment in the 1999 captions below.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(amounts in thousands)
Systems and
Support Services Products Xacta Enterworks Other (1) Total
----------------------------------------------------------------------------------------------------------------------------------------------
September 30,March 31, 2001
External Revenues ............................... $ 13,887 $ 27,477 $ 2,565 -- $ 43,929
Intersegment Revenues ........................... $ 569 $ 1,963 $ -- -- $ 2,532
Gross Profit .................................... $ 1,249 $ 5,095 $ 546 -- $ 6,890
Segment profit (loss) ........................... $ (434) $ 2,651 $ (1,040) -- $ 1,177
Total assets .................................... $ 8,521 $ 32,830 $ 5,149 $ 23,273 $ 69,773
Capital Expenditures ............................ $ 136 $ 10 $ 95 $ 67 $ 308
Depreciation & Amortization ..................... $ 90 $ 93 $ 52 $ 317 $ 552
March 31, 2000
External Revenues $13,384 $17,829............................... $ 3,66110,346 $ 14,872 $ 1,522 $ -- $ -- $34,87426,740
Intersegment Revenues ........................... -- -- -- --$ -- --
Gross Profit 1,175 1,973 1,032.................................... $ 1,195 $ 1,450 $ 516 $ -- $ 3,161
Segment profit (loss) ........................... $ (533) $ (294) $ (222) $ -- 4,180
Segment (loss) profit(3) (359) 415 (65) -- -- (9)$ (1,049)
Total assets 9,110 19,816 5,449 -- 22,745 57,120.................................... $ 11,631 $ 19,774 $ 2,673 $ 23,929 $ 58,007
Capital Expenditures 76 (42) 88 -- 364 486............................ $ 80 $ 2 $ 112 $ 198 $ 392
Depreciation & Amortization (2) 88 75 29 -- 310 502
Systems and
Support Services Products Xacta Enterworks Other (1) Total
---------------------------------------------------------------------------------------
September 30, 1999
External Revenues $22,012..................... $ 18,893111 $ 1,20479 $ --10 $ -- $42,109
Intersegment Revenues 40 -- 27 -- -- 67
Gross Profit 3,639 1,906 (249) -- -- 5,296
Segment profit (loss)(3) 2,200 (197) (564) -- -- 1,439
Total assets 7,483 21,570 3,293 8,671 22,788 63,805
Capital Expenditures 24 (3) 60 185 115 381
Depreciation &
Amortization (2)304 $ 82 $ 120 $ 28 $ 528 $ 311 $ 1,069
(1) Corporate assets are principally property and equipment, cash and other
assets.
(2) Depreciation and amortization includes amounts relating to property and
equipment, goodwill, deferred software costs (1999) and spare parts
inventory.
(3) Segment profit (loss) represents operating income (loss) before
goodwill amortization.
504
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 129 separate
facilities located in 4 states and Europe and Asia.Europe.
Note 8. Stock Incentive Plans
Telos Stock Incentive Plan6. Investment in Enterworks
During the thirdfirst quarter of 2000, the Board of Directors of2001, the Company approved a new stock option plan for Telos Delaware,and Enterworks, Inc., a wholly owned
subsidiary of the Company. Certain key executives and employees of
("Enterworks") entered into an agreement whereby the Company are eligible, as a participant
in an additional round of financing for Enterworks, substituted approximately
$530,000 of receivables owed to receive stock options under the plan. Under the plan, the Company, may award upand in addition funded Enterworks
$470,000 of cash in three equal installments during the quarter. The receivables
substituted included rent owed to 3,500,000the Company, services performed by the Company
under a service agreement between the Company and Enterworks, and expenses paid
for by the Company on behalf of Enterworks. In return, the Company received four
separate Demand 10% Convertible Promissory Notes from Enterworks totaling $1
million, as well as warrants to purchase approximately 2.5 million of underlying
shares of Enterworks common stock. The warrants to purchase 2.5 million
underlying shares of Enterworks 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$0.01 per
share and an exercise price any lower than 85%period of five years. There was no impact to income for
the fair market value on
the datequarter as a result of grant. All options have a term of ten years and vest no more than
20% each year over a five-year period unless changed by the option committee of
the Board of Directors. Through September 30, 2000, the Company has awarded
1,796,813 options for shares of common stock at an exercise price of $1.37 per
share.
Xacta Stock Incentive Plan
In the third quarter 2000, Xacta, Inc., a wholly owned subsidiary of the
Company, initiated a stock option plan under which up to 3,500,000 shares of
Xacta common stock maybe awarded to key employees and associates. The options
may be awarded as incentive or non-qualified, have a term of 10 years, and vest
ratably over a 5 year period unless otherwise directed by a committee of the
Company's 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 85% of the fair
market value on the date of grant for a non-qualified stock option. As of
September 30, 2000, the Company has granted 1,316,531 options for shares of
Xacta common stock at an exercise price of $0.75 per share.this transaction.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
- --------------------------------------------------------------------------------
General
Sales for the first ninethree months of 20002001 were $90.9$43.9 million, a decreasean increase of
$46.0$17.2 million or 33.6%64.3% as compared to the same 19992000 period. This decreaseincrease was
partiallyprimarily attributable to a $19.7$12.6 million decreaseincrease in sales from the Company's
Products Group, which experienced decreasedwas impacted by increased sales due toorders under both its
completion of the
Joint Recruitive Information Support Services Blanket Purchase Agreement in
1999.traditional businesses and its newer wireless product line. The declineincrease in
sales was also attributable to sales froman increase in the Company's Systems &and Support
Services Group sales of $3.5 million which decreased its sales by $31.1 million
compared to 1999. This decline in this Group's sales is mostlywas primarily due to the sale
of the Company's field engineering division ("TFE") in September 1999 and the
presentation of the Ft. Sill business under the equity method of accounting for
the year 2000. These decreases were partially offset by increases in sales in
therevenue
generated from long-term labor contracts. The Xacta Group of approximately $4.9 million. These increases are attributablealso experienced an
increase in revenue, mostly due to increased sales of its Certification and Accreditation product.
The operating lossinformation security
products.
Operating profit through the first ninethree months of 20002001 was approximately
$600,000$1.1 million as compared to an operating profitloss of $6.8$1.1 million during the same
19992000 period. The decline in operatingOperating profitability is primarily a
resultimproved principally because of decreased third quarter revenues,increased
sales volume coupled with improved profits realized under the sale of TFE in 1999, as well as
the deconsolidation of the Ft. Sill profits.Company's new
businesses.
Total backlog from existing contracts was approximately $275.2$135.1 million and
$242.2$124.4 million as of September 30, 2000March 31, 2001 and December 31, 1999,2000, respectively. As of
September 30, 2000,March 31, 2001, the funded backlog of the Company totaled $61.3$45.4 million, an
increase of approximately $16$2.4 million from December 31, 1999.2000. Funded backlog represents
aggregate contract revenues remaining to be earned by the Company at a given
time, but only to the extent, in the case of government contracts, funded by a
procuring government agency and allotted to the contracts.
Results of Operations
The condensed consolidated statements of operations include the results of
operations of Telos Corporation and its wholly owned subsidiaries. The major
elements of the Company's operating expenses as a percentage of sales for the
three and nine monththree-month periods ended September 30,March 31, 2001 and 2000 and 1999 arewere as follows:
Three Months Ended Nine months Ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 88.0 87.4 86.5 85.8
SG&A expenses 12.0 9.2 13.9 9.0
Goodwill amortization 0.2 0.3 0.3 0.3
---- ---- ---- ----
Operating income (0.2) 3.1 (0.7) 4.9
Other income -- -- -- --
Gain on sale of assets -- 11.2 -- 3.5
Equity in net losses of Enterworks -- (10.5) -- (9.9)
Equity in earnings of Telos OK 0.9 -- 2.6 --
Interest expense (3.3) (3.4) (3.9) (3.2)
Income tax (provision) benefit (3.9) (1.3) (1.3) 0.7
----- ----- ------ ---
Net loss (6.5)% (0.9)% (3.3)% (4.0)%
==== ==== ==== ====
Three Months Ended
March 31,
-----------------------
2001 2000
---- ----
Sales 100.0% 100.0%
Cost of sales (84.3) (88.2)
SG&A expenses (13.1) (15.7)
Goodwill amortization (0.1) (0.3)
---- ----
Operating income (loss) 2.5 (4.2)
Other income -- 0.1
Equity in net earnings of TelosOK -- 3.1
Interest expense (2.9) (4.3)
----- -----
Loss before taxes (0.4) (5.3)
Income tax (provision) benefit -- 1.8
--- ----
Net loss (0.4)% (3.5)%
====== ======
Financial Data by Market Segment
Sales, gross profit, and gross margin by market segment for the periods
designated below arefirst
quarter of 2001 and 2000 were as follows:
Three Months Ended Nine months Ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
(amounts in thousands)
Sales:
Systems and Support Services $13,384 $22,012 $ 34,278 $ 65,414
Products 17,829 18,893 47,126 66,872
Xacta 3,661 1,204 9,475 4,594
------ ------ ------ ------
Total $34,874 $42,109 $ 90,879 $136,880
====== ====== ======= =======
Gross Profit:
Systems and Support Services $ 1,175 $ 3,639 $ 3,893 $ 11,202
Products 1,973 1,906 5,396 7,040
Xacta 1,032 ( 249) 2,959 1,231
------ ------ ------- ------
Total $ 4,180 $ 5,296 $ 12,248 $ 19,473
======= ======= ======== ========
Gross Margin:
Systems and Support Services 8.8% 16.5% 11.4% 17.1%
Products 11.1% 10.1% 11.5% 10.5%
Xacta 28.2% (20.7)% 31.2% 26.8%
Total 12.0% 12.6% 13.5% 14.2%
Three Months Ended
March 31,
---------------------------
2001 2000
---- ----
(amounts in thousands)
Sales:
Systems and Support Services $13,887 $10,346
Products 27,477 14,872
Xacta 2,565 1,522
------ ------
Total $43,929 $26,740
====== ======
Gross Profit:
Systems and Support Services $ 1,249 $ 1,195
Products 5,095 1,450
Xacta 546 516
----- -----
Total $ 6,890 $ 3,161
===== =====
Gross Margin:
Systems and Support Services 9.0% 11.6%
Products 18.5% 9.7%
Xacta 21.3% 33.9%
Total 15.7% 11.8%
For the three monththree-month period ended September 30, 2000,March 31, 2001, sales decreasedincreased by $7.2$17.2
million, or 17.2%64.3%, to $34.9$43.9 million from $42.1$26.7 million for the comparable 19992000
period. Of the $7.2$17.2 million decrease, $8.6increase, $12.6 million was attributable to the
Products Group. The Group's comparable revenues were enhanced by increased sales
under the Group's traditional contracts such as IS-1, ATWCS and Courts, as well
as increased sales under new businesses such as the Group's wireless product
line. The increases in revenue were also attributable to the Systems and Support
Services Group.Group, which experienced revenue growth of $3.5 million. The increase
was further enhanced by increases in Xacta Group experienced decreased sales of $7.5$1.1 million, due to
increased orders under its information security product line.
Cost of sales was 84.3% of sales the salethree-month period ended March 31,
2001, as compared to 88.2% in the comparable 2000 period. The reduction in cost
of TFE atsales is attributable to increased profits realized on the end of the third quarter of 1999Products Group's
Courts contracts as well as increased profits under the Group's wireless product
line.
Gross profit increased by $3.7 million in the first quarter of 2001 to
$6.9 million from $3.2 million in the comparable 2000 period as a decrease due to the presentationresult of the Ft. Sill businesses under the
equity method for the year 2000. This decrease was enhanced by a decrease in
Products' Group revenue of $1.1 million from third quarter 2000 compared to
third quarter 1999. This decrease is primarily due to a decline in revenue from
the Group's racks products. Offsetting these decreases was a $2.5 million
increase in sales and decreases in cost of sales discussed above. Total Company
gross margins were 15.7% and 11.8% for the three-month periods ended March 31,
2001 and 2000, respectively.
Selling, general and administrative costs increased for the three-month
period by approximately $1.5 million to $5.7 million in 2001 from the Company's Xacta segment.$4.2 million
in 2000. This increase is mostly
attributable to sales from the Company's information security business line.
Sales decreased $46.0 million or 33.6% to $90.9 million for the nine
months ended September 30, 2000, from $136.9 million for the comparable 1999
period. The decrease for the nine month period includes a $19.7 million decrease
in Products' sales and a $31.1 million decrease in Systems and Support Services
sales, partially offset by an increase of $4.9 million in Xacta revenue. This
decrease in the nine-month revenue is primarily due to the decreaseincreased investment in revenue
from the Joint Recruitive Information Support Services Blanket Purchase
Agreement of $19.0 million, the deconsolidation of Ft. Sill revenue,sales
and the
sale of TFE. The TFE division generated sales of $24.3 millionmarketing effort for the Company
prior to being sold. These decreases were slightly offset by increased sales
under the Company's information security product line of $4.2 million.
Cost of sales was 88.0% of sales for the quarter and 86.5% of sales for
the nine months ended September 30, 2000, as compared to 87.4% and 85.8% for the
same periods in 1999. The increases in cost of salesXacta subsidiary. SG&A as a percentage of
sales are primarily attributablewere 13.1% and 15.7% for the three-month periods ended March 31, 2001 and
2000, respectively.
Goodwill amortization expense was $62,000 for the three months ended March
31, 2001 compared to loss of profits realized under$89,000 for the TFE contracts
soldperiod ended March 2000. The decrease in
September 1999 and the deconsolidationgoodwill amortization was a result of the profitable Ft. Sill
contract for all of 2000.
Gross profit decreasedgoodwill transfer associated with the
TelosOK transaction.
Operating profitability improved by $2.3 million during the three months
ended March 31, 2001 to approximately $1.1 million in the three-month
period to $4.2 million in 2000, from $5.3 million in the comparable 1999 period.
Gross profit decreased $7.3 million in the nine-month period to $12.2 million in
2000 from $19.5 million in 1999. Gross margins were 12.0% and 13.5%,
respectively, for the three and nine month periodsoperating profit. The
Company had an operating loss of 2000 as compared to 12.6%
and 14.2%, respectively, for the comparable periods of 1999. The decreases in
gross margin were attributable to the sales decreases and cost of sales
increases explained above.
Selling, general, and administrative expense ("SG&A") increased by
approximately $300,000 or 8.6%, to $4.2 million in the third quarter of 2000
from $3.9$1.1 million in the comparable period of 1999. For the nine month period of
2000, SG&A increased approximately $300,000 or 2.6% to $12.6 million from $12.3
million2000.
The increase in 1999. These increases are dueoperating profit resulted primarily to the Company's increased
investment in its Xacta group.
SG&A as a percentage of revenues increased to 12.0% for the third quarter
of 2000 from 9.2% in the comparable 1999 period. SG&A as a percentage of
revenues for the nine-month period ended September 30, 2000 increased to 13.9%
from 9.0% compared to the same period in 1999.
Goodwill amortization expense decreased for the comparative three and nine
month periods of 2000 from 1999. This reduction is due to a decrease in the
goodwill balance associated with the sale of TFE in the third quarter 1999 and
the asset transfer from the Ft. Sill transaction.
The operating income of the Company decreasedaforementioned
gross profit increases.
Interest expense increased by $1.4approximately $150,000 to $1.3 million to an
operating loss of $80,000 induring
the three-month period ended September 30, 2000March 31, 2001, from a $1.3$1.1 million operating profit in the comparable
1999 period. Operating
income decreased $7.4 million to a $600,000 loss for the nine months ended
September 30, 2000 from a $6.8 million operating income for the nine month
period ended September 30, 1999.of 2000. The decreases in operating profit for the three
and nine month periods are mostlyincrease was attributable to the decreasesincreased debt levels in gross profit
and increases in S,G & A discussed above.
At the end of the third quarter 1999, the Company sold substantially all of
the assets of its computer maintenance and service business, Telos Field
Engineering Inc. ("TFE"), to TFE Technology Holdings, an affiliate of Carr &
Company, for $10 million. As a result of this sale,2001.
The Company recorded a gain
of $4.7 million in its condensed consolidated statement of operations for the
nine months ended September 30, 1999.
In order to present the statement of operations in accordance with APB
18, the revenues and cost of sales for the Ft. Sill and DSTATS businesses
contributed to Telos OK, LLC were presented in one line item "Equity in net
earnings of Telos OK" due to the joint venture agreement signed July 28, 2000
(See Note 2). The equity in net earnings of Telos OK was approximately $300,000
for the three-month period and $2.3 million for the nine-month period ended
September 30, 2000.
Interest expense decreased to $1.1 million in the third quarter of 2000
compared to $1.4 million in the same 1999 period, and decreased approximately
$1.0 to $3.5 million for the nine months ended September 30, 2000 from $4.5
million for the comparable 1999 period. The decreases for the three and
nine-month periods are due to decreased debt levels in 2000.
The income tax provision was $1.4 million and $1.2 million for the
three and nine months ended September 30, 2000, respectively. The provision
incurred was a result of the taxable gain generated from proceeds received from
the contribution of assets to Telos OK in July 2000 (see Note 2). The Company's
net deferred tax asset includes substantial amounts of net operating loss
carryforwards. 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 sufficient in
amounts to realize the net deferred tax assets. The Company recorded an income
tax provision of approximately $600,000$1,000 and a tax
benefit of $1.0 millionapproximately $500,000 for the threethree-month periods ended March 31,
2001 and nine months ended September 30, 1999,2000, respectively. The tax provision
was a result of the gain generated from the sale of TFE. The tax benefit was
principally due to the net operating loss carryforwards generated during the
first quarter 1999.
Liquidity and Capital Resources
For the ninethree months ended September 30, 2000, the Company used $5.1March 31, 2001, operating activities provided
$2.6 million of cash in its operating activities.flow to the Company. This cash was usedprovided by increases ofa decrease
in the Company's accounts receivable balance of $2.9$7.6 million, and inventory of $1.0 million, enhancedoffset by
increasesdecreases in accounts payable of $1.0$2.8 million and $3.0 million in net losses incurred in operations.
Cash provided byused in investing activities was $4.6 million,
mostly dueapproximately $300,000. The Company used
cash during the quarter to the cash received from the contribution ofpay down the Company's Ft. Sill
and DSTATS assets (See Note 2). Cash was providedcredit facility balance by
financing activities during
the nine months due to increased borrowings under the Senior Credit Facility of
approximately $900,000.$2.4 million.
At September 30, 2000,March 31, 2001, the Company had outstanding debt and long-term
obligations of $37.0$42.5 million, consisting of $17.4$23.1 million under the secured
senior credit facility, $8.5 million in subordinated debt, and $11.1$10.9 million in
capital lease obligations.
The Company believes it will generate enough funds in
the ordinary course of business, or from a debt or equity financing, during the
next twelve months to fund its operations and service its debt and capital lease
obligations.
At September 30, 2000,March 31, 2001, the Company had an outstanding balance of $17.4$23.1 million
on its $35 million Senior Credit Facility (the "Facility"). The Facility matures
on JulyMarch 1, 20012002 and is collateralized by a majority of the Company's assets
(including inventory, accounts receivable and Telos' stock in Enterworks)its subsidiaries).
The amount of borrowings fluctuates based on the underlying asset borrowing base
as well as the Company's working capital requirements. Because
the Facility matures on July 1, 2001, at September 30, 2000 the Facility has a
term of less than one year, and therefore is classified as a current liability
on the Company's condensed consolidated balance sheet. The Facility has various
covenants that may, among other things, restrict 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 leverage, net worth, interest coverage and operating
goals.
At September 30, 2000, the Company was not in compliance with several
covenants contained in the Facility; however, the bank has waived this
non-compliance.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting or Derivative Instruments and Hedging Activities."
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including derivative instruments embedded in other contracts, and
for hedging activities. SFAS 133, as amended by SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the effective date
of FASB Statement No. 133, an amendment of FASB Statement No. 133" is effective
for all quarters of the Company's year ending December 31, 2001. The Company
currently does not engage or plan to engage in the use of derivative
instruments, and does not expect SFAS 133 to have a material impact on the
results of operations.
In June 2000, the FASB issued SFAS 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" which amends SFAS 133. SFAS 138
amends SFAS 133 to 1) expand the scope of the "normal sales and normal
purchases" exception; 2) introduce the benchmark rate as an interest rate that
may be hedged; 3) permit a recognized foreign currency denominated asset to be
hedged and; 4) allow certain intercompany derivatives that are offset net to be
designated as hedging instruments. The Company does not anticipate SFAS 138 to
have a material impact on its financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101 "Revenue Recognition in Financial Statements" ("SAB
101") to provide guidance regarding the recognition, presentation and disclosure
of revenue in the financial statements. The Company expects to adopt the
provisions of SAB 101 (as amended by SAB 101B which deferred the implementation
date by three quarters) on October 1, 2000. Management does not anticipate the
adoption of SAB 101 to have a material impact on its results of operations or
financial condition.
In April 2000, the FASB issued FASB Interpretation No. 44 "Accounting for
Certain Transactions Involving Stock Compensation; Interpretation of APB Opinion
No.25" ("FIN 44"). FIN 44 clarifies the application of APB 25 regarding certain
key issues. It addresses various interpretive guidelines including: 1) stock
compensation granted to non-employees or to employees who have changed their
employment status; 2) modifications made to a fixed stock option or award; 3)
share repurchase features and tax withholding features; 4) and exchanges due to
business combinations. The Company has applied FIN 44 to its stock option plans
as of July 1, 2000 and there has been no material impact to its consolidated
financial statements from the adoption of this interpretation.
Forward-Looking Statements
This Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q 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 timingpresent period of economic downturn may include, and approvaladversely
affect, the cost and continued availability of the Federal government's fiscal year budget, business
growth through obtaining new businessCompany to secure adequate
capital and once obtained,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 perform at a profit,restructure its debt obligations.
Additional uncertainties include the Company's ability to convert contract
backlog to revenue, the success of the Company's ability to secure adequate capital and
financing to support continued business growth,investment in Enterworks and
the risk ofCompany's access to ongoing development, product support and viable channel
partner relationships with Enterworks.
While in the Federal
government terminating contracts with the Company. Whilepast the Company has not experienced contract terminations
with the Federalfederal government, the Federalfederal government can terminate at its
convenience. Should this occur, the Company's operating results could be
adversely impacted. The Company's U.S. Army contract at Ft. Monmouth is up for
re-bid, which, if unsuccessful, could adversely impact the Company's revenue. It
should also be noted that with the change of administration and its key
government personnel, related policy changes and detailed program-by-program
review at each agency of the federal government, especially the Department of
Defense, the Company's high percentage of revenue derived from business with the
federal government could be adversely impacted.
As a high percentage of the Company's revenue is derived from business with
the Federalfederal government, the Company's operating results could be adversely
impacted should the Federalfederal government not approve and implement its annual
budget in a timely fashion.
Item 3.7a. Quantitative and Qualitative Disclosures About 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 interest at 1.00%1.5%, subject to certain adjustments, over the bank's base
rate. The weighted average interest rate forin the first ninethree months of 20002001 was
10.14%10.9%. This facility expires on JulyMarch 1, 20012002 and has an outstanding balance of
$17.4$23.1 million at September 30,2000.March 31, 2001.
The Company's other long-term debt at September 30, 2000March 31, 2001 consists of Senior Subordinated
Notes B and C which bear interest at fixed rates ranging from 14% to 17%. TheOf the
$8.5 million Senior Subordinated Notes mature as tobalance at March 31, 2001, $1.2 million
of this principal in the aggregate
amount of $8,537,000matures on April 1, 2001.2001, and the remaining $7.3
million in principal becomes payable on April 1, 2002. The Company has no cash
flow exposure due to rate changes for its Senior Subordinated Notes.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is party to various lawsuits arising in the ordinary course of
business. In the opinion of management, whileWhile the results of litigation cannot be predicted with certainty,
based upon the final outcomeCompany's present understanding of its pending legal matters, it
is of the opinion such matters for this quarter will not have a material adverse
effect on the Company's consolidated financial position, or results of operations.operations,
or of cash flows.
Item 3. Defaults Upon Senior Securities
Senior Redeemable Preferred Stock
The Company has not declared dividends on its Senior Redeemable Preferred
Stock, Series A-1 and A-2, since theirits issuance. Total undeclared unpaid
dividends, accrued for financial reporting purposes, are $3,373,000$3,584,000 for the
Series A-1, and A-2 Preferred Stockstock at September 30, 2000.March 31, 2001.
12% Cumulative Exchangeable Redeemable Preferred Stock
Through November 21, 1995, the Company had the option to pay dividends in
additional shares of Preferred Stock in lieu of cash, (provided there were no
blocks on payment as further discussed below). Dividends are payable by the
Company, provided the Company has legally available funds under Maryland law and
is able to pay dividends under its charter and other corporate documents, when
and if declared by the Board of Directors, commencing June 1, 1990, and on each
six month anniversary thereof. 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. Cumulative undeclared dividends as of September 30, 2000March 31, 2001 accrued for
financial reporting purposes totaled $24.5$26.5 million. Dividends for the years 1992
through 1994 and for the dividend payable June 1, 1995 were accrued under the
assumption that the dividend will be paid in additional shares of preferred
stock and are valued at $3,950,000. Had the Company accrued these 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 $20,588,000.$22,500,000.
The Company has not declared or paid dividends since 1991, due to
restrictions and ambiguities relating to the payment of dividends contained
within its charter, its working capital facility agreement, and under Maryland
law.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of common shareholders was held on September
14, 2000. The only matter set forth in the meeting 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. Dr. Fred
Charles Ikle, John B. Wood, Norman P. Byers, Dr. Stephen 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.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
27 Financial Data ScheduleNone
(b) Reports on Form 8-K: None.None
Items 2, 4, and 5 are not applicable and have been omitted.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATE: Telos Corporation
NovemberMay 14, 20002001 TELOS CORPORATION
/s/ Thomas J. Ferrara
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Thomas J. Ferrara
(Principal Financial Officer &
Principal Accounting Officer)