UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended: March 31,June 30, 1998
[ ] 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
(Address 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_X NO
----- -----
As of May 15,August 1, 1998, the registrant had 21,238,980 shares of Class A Common
Stock, no par value, and 4,037,628 shares of Class B Common Stock, no par value;
and 3,595,586 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): 1617
-----
TELOS CORPORATION AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
------ ---------------------
Page
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of IncomeOperations for the
Three and Six Months Ended March 31,June 30, 1998 and 1997 (Unaudited)...............................................................31997.....................................................3
Condensed Consolidated Balance Sheets as of March 31,June 30, 1998 (Unaudited)
and December 31, 1997...................................................................................41997 ................................................................................4
Condensed Consolidated Statements of Cash Flows for the
ThreeSix Months Ended March 31,June 30, 1998 and 1997 (Unaudited)...............................................................51997...............................................................5
Notes to Condensed Consolidated Financial Statements (Unaudited)........................................6-8Statements....................................................6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................................9-13Operations..........................................................9-14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..............................................................................15
Item 2. Changes in Securities and Use of Proceeds......................................................15
Item 3. Defaults Upon Senior Securities................................................................14Securities.............................................................15-16
Item 5. Other Events...................................................................................144. Submission of Matters to a Vote of Security Holders............................................16
Item 6. Exhibits and Reports on Form 8-K...............................................................15
SIGNATURES....................................................................................................168-K...............................................................16
SIGNATURES....................................................................................................17
PART I - FINANCIAL INFORMATION
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOMEOPERATIONS
(Unaudited)
(amounts in thousands)
Three Months Ended March 31,
---------------------------------Six Months Ended
June 30, June 30,
------------------------ ------------------------
1998 1997 1998 1997
---- ---- ---- ----
Sales
Systems and Support Services $26,300 $25,836$27,024 $32,189 $53,324 $58,025
Systems Integration 16,193 28,22718,153 24,907 34,346 53,134
Enterworks 1,301 2821,532 993 2,833 1,275
------ ------ ------ -------
------
43,794 54,34546,709 58,089 90,503 112,434
Costs and expenses
Cost of sales 40,481 46,64839,634 48,511 80,115 95,159
Selling, general and
administrative expenses 6,242 6,5256,431 6,869 12,673 13,394
Goodwill amortization 193 225
------132 209 325 434
----- ----- ----- ------
Operating income (loss) income (3,122) 947512 2,500 (2,610) 3,447
Other income (expenses)
Gain on sale of assets -- -- 5,683 --
Other income 20 12(expenses) 6 11 26 23
Interest expense (1,779) (1,760)
------(1,537) (1,883) (3,316) (3,643)
----- Income (loss)----- ----- -----
(Loss) income before taxes 802 (801)(1,019) 628 (217) (173)
Income tax provision (125)(686) -- (811) --
------ ----- ----- -----
Net (loss) income (loss)$(1,705) $ 677628 $(1,028) $ (801)
======(173)
===== ===== ===== =====
The accompanying notes are an integral part of these
condensed consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS(Unaudited)
(amounts in thousands)
March 31,ASSETS
June 30, 1998 December 31, 1997
--------------------------- -----------------
(Unaudited)
Current assets
Cash and cash equivalents $ 412141 $ 587
Accounts receivable, net 35,42741,670 57,972
Inventories, net 9,89910,024 12,390
Deferred income taxes 4,8062,204 4,632
Other current assets 688634 676
------ ------
Total current assets 51,23254,673 76,257
Property and equipment, net of
accumulated depreciation of
$22,715$23,592 and $22,609, respectively 15,50215,146 15,730
Goodwill, 7,316net 7,183 12,466
Other assets 6,0027,546 5,265
------ -------
80,052 109,718$84,548 $109,718
====== =======
LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current liabilities
Accounts payable 10,617 16,912$17,841 $16,912
Other current liabilities 10,949 6,9667,296 6,835
Accrued compensation and benefits 7,608 8,5536,007 8,684
------ ------
Total current liabilities 29,17431,144 32,431
Senior credit facility 12,91423,750 39,945
Senior subordinated notes 16,97017,011 16,930
Capital lease obligations 11,99011,856 12,085
------ -------
Total liabilities 71,04883,761 101,391
------ -------
Redeemable preferred stocksstock
Senior redeemable preferred stock 5,3125,417 5,207
Class B redeemable preferred stock 12,296-- 12,035
Redeemable preferred stock 30,33632,880 29,951
------ -------------
Total preferred stock 47,94438,297 47,193
------ ------
Stockholders' investment
Common stock 7879 78
Capital in excess of par --2,397 --
Retained deficit (39,018)earnings (deficit) (39,986) (38,944)
------ -------------
Total stockholders' investment $80,052(deficit) (37,510) (38,866)
------ ------
$84,548 $109,718
====== =======
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)
ThreeSix Months
Ended March 31,
---------------------------June 30,
----------------------------
1998 1997
---- ----
Operating activities:
Net income (loss)loss $(1,028) $ 677 $ (801)(173)
Adjustments to reconcile net loss to cash
(used in) provided by (used in) operating activities:
Gain on sale of assets (5,683) --
Depreciation and amortization 897 9891,668 1,919
Goodwill amortization 193 225325 434
Other non-cashnoncash items 128 220381 39
Changes in assets and liabilities that
provided (used) cash 17,135 (16,459)12,541 (19,128)
------ ------
Cash provided by (used in) operating activities 13,347 (15,826)8,204 (16,909)
------ ------
Investing activities:
Proceeds from sale of assets 14,675 --
Investment in products (1,111) (1,154)
Purchase of property and equipment (544) (553)
Investment in other assets (527) (563)(790) (1,106)
------ -----
Cash provided by (used in) investing activities 13,604 (1,116)12,774 (2,260)
------ -----
Financing activities:
(Repayment of) Proceedsproceeds from borrowings under
senior credit facility (27,031) 15,900
Repayment of long-term debt -- (675)(16,195) 18,003
Payments under capital leases (95) (85)(229) (183)
Retirement of Class B redeemable preferred stock (5,000) --
Repayment of senior subordinated notes -- (675)
------ ------
Cash (used in) provided by financing activities (27,126) 15,140(21,424) 17,145
------ ------
Decrease in cash and cash equivalents (175) (1,802)(446) (2,024)
Cash and cash equivalents at beginning
of period 587 2,781
----------- -----
Cash and cash equivalents at end
of period $ 412141 $ 979
====== ======757
===== =====
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 of Telos
Corporation ("Telos") and its wholly ownedwholly-owned subsidiaries, Telos Corporation
(California), Telos Field Engineering, Inc., Telos International Corporation,
and its majority ownedmajority-owned subsidiary, Enterworks, Inc. (collectively, the
"Company") have been prepared without audit. Certain information and note
disclosures normally included in the financial statements presented in
accordance with generally accepted accounting principles have been condensed or
omitted. The Company believes the disclosures made are adequate to make the
information presented consistent with past practices. However, these condensed
consolidated 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, 1997.
In the opinion of the Company, the accompanying condensed consolidated
financial statements reflect all adjustments and reclassifications (which
include only normal recurring adjustments) necessary to present fairly the
financial position of the Company as of March 31,June 30, 1998 and December 31, 1997, and
the results of its operations and its cash flows for the three and six month
periods ended March 31,June 30, 1998 and 1997. Interim results are not necessarily
indicative of fiscal year performance because of the impact of seasonal and
short-term variations. DuringThese condensed consolidated financial statements should
be read in conjunction with the first quarter of 1998, the Company modified its view of the
business segments that it operates given the increased activities of its
majority-owned subsidiary, Enterworks, Inc. The Company now analyzes its
businessconsolidated financial statements and notes
thereto included in three distinct market segments: systems and support services which
consists of the Company's hardware services, software systems and solutions
services; systems integration and Enterworks, Inc.
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income" became effectiveannual report on Form 10-K for the Company on January 1, 1998.
Because the Company has no items of other comprehensive income, FAS 130 did not
affect the Company's financial statements presentation or disclosure.fiscal year
ended December 31, 1997.
Certain reclassifications have been made to the prior year's financial
statements to conform to the classifications used in the current period.
Note 2. Sale of Assets
On February 28, 1998, Telos sold substantially all of the net assets of one
of its support services divisions, Telos Information Systems ("TIS"), to NYMA,
Inc., a subsidiary of Federal Data Corporation of Bethesda, Maryland for
approximately $14.7 million in cash. The Company has recorded a gain of $5.7
million in its condensed consolidated statement of incomeoperations for the threesix months
ended March 31,June 30, 1998.
Note 3. Debt Obligations
The Company has a $45 million Senior Credit Facility ("Facility") with a
bank which matures on July 1, 2000. Borrowings under the Facility are
collateralized by certain assets of the Company (primarily accounts receivable
and inventory), and the amount of available borrowings fluctuates based on the
underlying asset borrowing base and the Company's working capital requirements.
At June 30, 1998, the Company was not in compliance with certain financial
covenants contained within the Facility. The bank has waived this noncompliance.
Note 4. Preferred Stock
Senior Redeemable Preferred Stock
- ---------------------------------
The components of the senior redeemable preferred stock are Series A-1 and
Series A-2 redeemable preferred stock 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 June 30 and December 31 of each year. The liquidation
preference of the 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 Series A-1 and
A-2 Preferred Stock is senior to all other present and future equity of the
Company. The Company is required to redeem all of the outstanding shares of the
Series A-1 and A-2 on December 31, 2001, subject to the legal availability of
funds. At March 31,June 30, 1998 and December 31, 1997 cumulative undeclared, unpaid
dividends relating to Series A-1 and A-2 Preferred Stock were accrued for
financial reporting purposes in the amount of $2,312,000$2,417,000 and $2,207,000
respectively.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Class B Redeemable Preferred Stock
- ----------------------------------
TheOn May 8, 1998 the Company entered into an agreement with one of its
shareholders, Union de Banques Suisses (Luxembourg) S.A. ("UBS"), to retire all
of UBS's equity holdings in the Company. These equity holdings included all of
the 7,500 shares of the Company's Class B Redeemable Preferred Stock haswith a $.01 par value, with 7,500
shares authorized, issuedliquidation
preference of $1,000 per share, and outstanding. The Class B Redeemable Preferred
Stock has athe cumulative dividend payable semi-annually at June 30 and December
31. The dividend is calculated at a rate equal to 14.125% per annum of its
liquidation value. The Class B Redeemable Preferred Stock may be redeemed at its
liquidation value together with all accrued and unpaid dividends at any time at
the optionof
approximately $4.8 million, 1,837,773 shares of the Company.Company's Class A Common
Stock, and 1,312,695 of the Company's Class A Common Stock warrants. The
liquidation preferencepurchase price to retire these interests was $6.5 million, of which $5 million
was paid in cash, and the remaining $1.5 million was funded by two separate
letters of credit secured by the Company's lender. These will mature in 120 and
180 days from the date of the transaction.
The $5.9 million excess of the carrying amount of the Class B Redeemable
Preferred Stock isover the face amount, $1,000 per share, plus all accrued and
unpaid dividends. The Company is required to redeem allredemption price was recorded as an increase in capital
in excess of the outstanding
shares of the stockpar; there was no impact on December 31, 2001, subject to the legal availability of
funds. At March 31, 1998 and December 31, 1997, cumulative undeclared and unpaid
dividends relating to the Class B redeemable preferred stock were accrued for
financial reporting purposes in the amount of $4,796,000 and $4,535,000,
respectively. The Class B Redeemable Preferred Stock was retired in May 1998.
See Note 4. - Subsequent Event.income from this transaction.
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, have
been authorized for issuance. The Company has issued 3,595,586 shares of the
Public Preferred Stock. 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.
The Public Preferred Stock has a 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, 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.
Through November 21, 1995, the Company had the option to pay dividends in
additional shares of Preferred Stock in lieu of 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. Dividends in additional shares of the
Preferred Stock were paid at the rate of $.066% of a share for each $.60 of such
dividends not paid in cash. No dividends have been declared or paid during
fiscal years 1992 through 1997. Cumulative undeclared dividends as of March 31,June 30,
1998 accrued for financial reporting purposes totaled $14,735,000.$16,892,000. 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.
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 4. Subsequent Event
On May 8, 1998 the Company entered into an agreement with one of its
shareholders, Union de Banques Suisses (Luxembourg) S.A. ("UBS"), to retire all
of UBS's equity holdings in the Company. These equity holdings included all of
the 7,500 shares of the Company's Class B Preferred Stock and the cumulative
unpaid dividends of approximately $4.8 million, 1,837,773 shares of the
Company's Class A Common Stock, and 1,312,695 of the Company's Class A Common
Stock warrants. The purchase price to retire these interests was $5.5 million.
In addition, the Company agreed to pay UBS $1.0 million for the termination
of a letter agreement between UBS and the Company, as well as a negotiation fee
for certain expenses UBS incurred in connection with past services performed on
behalf of the Company.
The total price of $6.5 million was funded by borrowings under the
Company's term facility as well as two separate letters of credit secured by the
Company's lender. These will mature in 120 and 180 days from the date of the
transaction.
The $5.9 million excess of the carrying amount of the Class B Redeemable
Preferred Stock over the redemption price will be recorded as an increase in
stockholders' investment; there is no impact on income from this transaction.
Item 2. Management's Discussion and Analysis of Financial Condition -----------------------------------------------------------
and
Results of Operations.
--------------------------
General
In the first threesix months of 1998, the Company had decreasedexperienced a decrease in
revenue and
profitabilityof $21.9 million as compared to the same period in 1997. This decrease
was largely attributable to a decrease of $18.8 million of revenue from the
Company's Systems Integration Group. The decreased revenue and profitability
resulted primarily fromSystems Integration Group was impacted
by the expiration of the Systems Integration Group's Immigration and Naturalization Services Contract in
September 1997 and a lack of follow-up work from certain large contracts which
were in place in 1997. Overall,In addition, Systems Integrationand Support Services revenues for
the first six months of 1998 were $4.7 million less than the same 1997 period
principally due to the sale of TIS in February 1998.
Operating profitability decreased by $12 millionduring the first six months of 1998 as
compared to the same 1997 period, principally due to the effect of the revenue
decreases summarized above, a less profitable product mix in 1998 compared to 1997.
As a result,on certain
System Integration Group contracts, and under absorption of infrastructure and
the fixed nature of facility and infrastructure costs was
disproportionate with associated revenues. A change in product mix also
contributed to a decrease in profitability from 1997 to 1998. Accordingly,
product margins were significantly impacted in the first quarter of 1998.costs.
Total backlog from existing contracts was approximately $1.01 billion and
$1.07 billion as of March 31,June 30, 1998 and December 31, 1997, respectively. Of the
$1.01 billion in total backlog, $818.7 million is backlog under the Company's
SMC-II contract. The SMC-II contract expires on September 30, 1998. As of March 31,June
30, 1998, the funded backlog of the Company totaled $70.4$61.7 million, a decrease
from $104.3 million from December 31, 1997. This decrease is primarily due to
the sale of TIS which decreased funded backlog by $24.9 million in the first
quarter of 1998. 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 incomeoperations include the results of
operations of Telos Corporation and its wholly owned subsidiaries Telos
Corporation (California), Telos Field Engineering Inc. ("TFE"), Telos
International Corporation ("TIC"), and itsit majority owned subsidiary Enterworks,
Inc. ("Enterworks") (collectively, "the("the Company"). The major elements of the Company's
operating expenses as a percentage of sales for the three and six month periods
ended March 31,June 30, 1998 and 1997 wereare as follows:
Three Months Ended March 31,
-------------------------Six Months Ended
June 30, June 30,
---------------------- ----------------------
1998 1997 1998 1997
---- ---- ---- ----
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales (92.4) (85.8)84.8 83.5 88.5 84.6
SG&A expenses (14.2) (12.0)13.8 11.8 14.1 11.9
Goodwill amortization (0.4) (0.4)
----- -----0.3 0.4 0.3 0.4
--- ---- --- ----
Operating income (loss) 1.1 4.3 (2.9) 3.1
Other income (7.0) 1.8(expense) -- -- -- --
Gain on sale of Assets 13.0assets -- Other income -- 6.3 --
Interest expense (4.1)(3.3) (3.2) ---- ----
Income (loss) before taxes 1.9 (1.4)(3.6) (3.2)
Income tax provision (0.3)(1.5) -- ----(0.9) --
--- --- --- ---
Net (loss) income (loss) $ 1.6% $(1.4)(3.7)% ====1.1% (1.1)% (0.1)%
=== === === ===
Financial Data by Market Segment
During the first quarter of 1998, the Company modified its view of the
business segments that it operates given the increased activities of its
majority-owned subsidiary, Enterworks, Inc. The Company now analyzes its
business in three distinct market segments: systems and support services which
consists of the Company's hardware services and software systems and solutions
services; systems integration and Enterworks, Inc.
Sales, gross profit, and gross margin by market segment for the first
quarter of 1998 and 1997 wereperiods
designated below are as follows:
Three Months Ended March 31,
---------------------------------Six Months Ended
June 30, June 30,
------------------- ----------------------
1998 1997 1998 1997
---- ---- ---- ----
(amounts in thousands)
Sales:
Revenues:
Systems and Support Services $26,300 $25,836$27,024 $32,189 $53,324 $ 58,025
Systems Integration 16,193 28,22718,153 24,907 34,346 53,134
Enterworks 1,301 2821,532 993 2,833 1,275
------ ------ ------ -------
Total $43,794 $54,345$46,709 $58,089 $90,503 $112,434
====== ====== ====== =======
Gross Profit:
Systems and Support Services $ 4,184 $3,919$4,228 $6,126 $8,412 $10,045
Systems Integration 164 3,9301,947 3,692 2,111 7,622
Enterworks (1,035) (152)900 (240) (135) (392)
----- ----- ----- ------
-----
Total $ 3,313 $7,697$7,075 $9,578 $10,388 $17,275
===== ===== ====== ===========
Gross Margin:
Systems and Support Services 15.9% 15.2%15.6% 19.0% 15.8% 17.3%
Systems Integration 1.0% 13.9%10.7% 14.8% 6.1% 14.3%
Enterworks (79.6)58.7% (24.2)% (53.9)(4.8)% (30.7)%
Total 7.6% 14.2%15.1% 16.5% 11.5% 15.4%
For the three month period ended March 31,June 30, 1998, salesrevenue decreased by approximately $10.5$11.4
million, or 19.4%,19.6% to $43.8$46.7 million from $54.3$58.1 million for the comparable 1997
period. ThisOf the $11.4 million decrease, for the three month period is due$6.7 million was attributable to the
Systems Integration Group, which reported decreased salesexperienced this loss of $12.0 million.
Offsetting this decrease was increased sales duringrevenue primarily
because of the period byexpiration of its Immigration and Naturalization Services
contract ("INS contract") in September 1997. The INS contract contributed
revenues of $7.6 million in the second quarter of 1997. The Systems and Support
Services Group and Enterworks of approximately $500,000 and $1.0also experienced a $5.2 million respectively.
Systems Integration Group sales decreased by $12.0 million during the firstdecrease in revenue from second
quarter of 1998 as compared to the firstsecond quarter of 1997. TheThis decrease wasis primarily due to
a $6.3 million decrease in revenue resulting from the Immigrationsale of the TIS division
in February 1998. This loss of revenue was partially offset by an increase in
software solutions sales related to an order under the Artillery Training
Simulation Devices product line. The declines in System Integration and Naturalization Services Contract, which
ended on September 30, 1997.
Within the Systems
and Support Services Group, software services sales
increased approximately $500,000 duerevenue were also partially offset by an increase of
$539,000 in Enterworks revenue for the second quarter of 1998 compared to the
start upsecond quarter of MIS Services-II contract
supporting Air Force Material Command Sites.
Enterworks sales for the three months ended March 31, 1998 of $1.3 million
increased approximately 361% or $1.0 million from $282,000 for the comparable
period ended 1997. The increase is primarily due to Enterworks sales to the
Army Logistics market segment.
Revenue decreased $21.9 million or 19.5% to $90.5 million for the six
months ended June 30, 1998, from $112.4 million for the comparable 1997 period.
The decrease for the six month period includes an $18.8 million decrease in
Systems Integration revenue and healthcarea $4.7 million decrease in Systems and Support
Services revenue, partially offset by an increase of $1.6 million in Enterworks
revenue. This decrease in the six month revenue is primarily due to the lack of
revenue from the INS contract, which expired in September 1997 and had revenue
of $17.3 million in the first six months of 1997, the sale of TIS in February
1998, and the lack of follow-up work from large contracts which were in place in
1997. These decreases were slightly offset by sales under the Artillery Training
Simulation Devices product line of $3.0 million, and Enterworks sales to the
Army Logistics and health care market segments.
Cost of sales decreased by $6.2$8.9 million or 13.2%18.3%, to $40.5$39.6 million duringin the
three month period ended March 31,June 30, 1998, from $46.6$48.5 million in the comparable
1997 period. The decrease in cost of sales for the three month period includes a
$5.0 million decrease in systems integration cost of sales, a $3.3 million
decrease in systems and support services cost of sales, and a $600,000 decrease
in Enterworks cost of sales. Except for Enterworks, the decrease in cost of
sales resulted from the decreasedecreases in sales for the period. Additionally, cost of
sales increased due to unfavorable changes in product mix and by an under
absorption of infrastructure and the fixed nature of facilities costs.
For the six months ended June 30, 1998, cost of sales decreased $15.0
million, or 15.8%, to $80.1 million from $95.1 million for the same period offset by ain
1997. The change in product mix.cost of sales includes a $13.3 million decrease in systems
integration cost of sales and a $3.0 million decrease in systems and support
services cost of sales, and a $1.3 million increase in Enterworks cost of sales.
The reasons for these cost of sales decreases are consistent with those
summarized in the preceding paragraph.
Gross profit decreased by $4.4$2.5 million in the first quarter ofthree month period to $7.1
million in 1998, to $3.3
million from $7.7$9.6 million in the comparable 1997 period. The decrease
in gross profit includes a $1.7 million decrease in systems integration gross
profit, and a $1.9 million decrease in systems and support services gross
profit, partially offset by an increase in Enterworks gross profit of $1.1
million. For the six month period, asgross profit decreased by $6.9 million to
$10.4 million from $17.3 million. This decrease includes a result of$5.5 million decrease
in systems integration gross profit and a $1.6 million decrease in systems and
support services gross profit, offset by a $257,000 decline in Enterworks gross
loss. The reasons for the matters discussed above. Thegross profit decrease for the periods ended June 30,
1998 compared to June 30, 1997 related to the reduced revenue base in both the
Systems Integration and Systems and Support Services Group improved gross
margin was attributed to the MIS Services-II contract. The Systems Integration
Group reduced revenue base resulted in increased costs of sales due to
disproportionate absorption of its facility and infrastructure costs.Groups. In addition, the
Systems Integration Group experienced shifts in product mix which significantly
impacted gross margin.
The result was a decrease in gross margins
of 12.9% percent for the Systems Integration Group. Accordingly, gross margin
decreased significantly from 1997 to 1998. The decrease in the Enterworks gross
margin is directly attributed to increased product amortization costs and
increased staff in anticipation of future growth. Total Company grossGross margins were 7.6%15.1% and 14.2%11.5%, respectively, for the three and six
month periods ended March 31,of 1998 as compared to 16.5% and 1997,
respectively.
15.4%, respectively, for the
comparable periods of 1997.
Selling, general, and administrative costsexpense ("SG&A") decreased forby
approximately $438,000 or 6.4%, to $6.4 million in the threesecond quarter of 1998
from $6.9 million in the comparable period of 1997. For the six month period by approximately $300,000of
1998, SG&A decreased $721,000 to $6.2$12.7 million in 1998 from $6.5$13.4 million in 1997. This decrease isThese
decreases are due primarily to the Company's consolidation of its administrative
support functions. This decrease was slightlyfunctions and were partially offset by an increased investment in
research and development and sales and marketing for itsEnterworks. Excluding the
additional expense incurred for Enterworks division.research and development of $545,000
and Enterworks sales and marketing costs of $824,000, selling general and
administrative expense decreased $2.1 million for the six months ended June 30,
1998 compared to the same period in 1997.
SG&A as a percentage of sales was 14.2% and 12.0%revenues increased to 13.8% for the threesecond quarter
of 1998 from 11.8% in the comparable 1997 period. SG&A as a percentage of
revenues for the six month periodsperiod ended March 31,June 30, 1998 and 1997, respectively.increased to 14.1% from
11.9% compared to the same period in 1997.
Goodwill amortization expense was $193,000decreased $77,000 to $132,000 for the three
months ended March
31, 1998 comparedand decreased by $109,000 to $225,000$325,000 for the periodsix months ended March 1997. TheJune 30,
1998. These reductions are due to a decrease in Goodwill amortization was a result of the Goodwill writedowngoodwill balance associated
with the sale of TIS.TIS in early 1998.
Operating income decreased by $4.1$2.0 million duringto $512,000 in the three monthsmonth
period ended March 31,June 30, 1998 to $3.1from $2.5 million inof operating loss. The Company had an operating
income of $947,000profit in the
comparable period of 1997. The decrease in1997 period. Operating income decreased $6.1 million to a $2.6
million operating loss for the six months ended June 30, 1998 from a $3.4
million operating profit for the six month period ended June 30, 1997. These
decreases resulted primarily from the aforementioned sales anddecreases in gross profit
decreases.profit.
Telos sold substantially all of the net assets of one of its divisions,
TIS, in the first quarter of 1998. The transaction generated approximately $14.7
million in cash proceeds and a gain of $5.7 million. The sale had no material impact
on the operating results for the first quarter of 1998 as compared to 1997. The Company expects that
future 1998 quarterly revenues and operating profits will decrease, when
compared to 1997, as a result of the TIS sale. Although the Company expects to
offset effects of the TIS sale by expanding its business base, there is no
assurance that such expansion will occur.
Interest expense increased bydecreased approximately $19,000$346,000 to $1.8$1.5 million duringin the
three month period ended March 31,second quarter of 1998 from $1.8$1.9 million in the comparable 1997 period, of 1997.and
decreased approximately $327,000 to $3.3 million for the six months ended June
30, 1998 from $3.6 million for the comparable 1997 period. These decreases are
due to decreased debt levels in 1998.
The Company had aincome tax provision of $125,000was $686,000 and $811,000 for the three month periodand six
months ended June 30, 1998, respectively. The tax provisions were primarily
attributable to provisions for state income taxes and increases and allowances
relating to the Company did not have arecoverability of deferred tax assets. An income tax provision
inwas not recorded for the three or six month periodperiods ended March 31, 1997.June 30, 1997,
principally because federal and state net operating loss carryforwards were
sufficient to offset taxes due for those periods.
Liquidity and Capital Resources
For the threesix months ended March 31,June 30, 1998, the Company provided $13.3generated $8.2 million
of cash infrom its operating activities. Excluding the effect of the TIS
transaction, thisThis cash was provided by reductions of
accounts receivable of $22.5$16.3 million, offset by decreases in accounts payable of $6.3 million and increased losses incurred in
operations. Cash provided by investing activities was $13.6$12.8 million, which is
a result ofprimarily attributable to the proceeds from the sale of TIS of $14.7 million.
Cash was used by financing activities during the quarterfirst half of the year was
principally due to pay
down approximately $27.0$16.2 million in debt.of net repayment of debt and $5.0 million
relating to the retirement of preferred stock.
At March 31,June 30, 1998, the Company had outstanding debt and long term
obligations of $41.9$52.6 million, consisting of $12.9$23.7 million under the secured
senior credit facility, $17.0 million in subordinated debt, and $12.0$11.9 million in
capital lease obligations.
The Company continuallyregularly evaluates its financing requirements to support its
business base. Company revenues are seasonal primarily due toand are significantly influenced by
the federal government's fiscal year ending inend, which is September 30, of each year.30. The Company
anticipates that its current securedprojected cash flows from operations together with amounts
available under its senior credit facility will be adequate forto fund operations
at least through 1998. TheIn addition, the Company has and continues, from time to
time, to evaluate various financing options for additional capital infusion and
long-term growth.
OnIn May 8, 1998, the Company entered into an agreement with oneretired all of its
shareholders,the equity holdings of Union de
Banques Suisses (Luxembourg) S.A. ("UBS"), to retire allfor $6.5 million, of UBS's equity holdingswhich $5 million was paid
in the Company for approximately $5.5 million. In
addition, the Company agreed to pay UBS $1.0 million for the termination of a
letter agreement between UBScash in May 1998, and the Company, as well as a negotiation fee for
certain expenses UBS incurred in connection with past services performed on
behalf of the Company. The total price of $6.5remaining $1.5 million was funded by borrowings
under the Company's term facility as well as two separate
letters of credit secured by the Company's lender. These will mature in 120 and
180 days from the date of transaction.
At June 30, 1998, the Company was noncompliant with certain financial
covenants contained in its senior credit facility. The Company's bank has waived
this noncompliance.
Year 2000
- ---------
The Company, like most owners of computer software, will be required to
modify significant portions of its software so that it will function properly in
the year 2000. Systems that do not properly recognize date-sensitive information
could generate erroneous data or cause a system to fail. The Company expects to
incur internal staff costs as well as consulting and other expenses related to
software and infrastructure enhancements necessary to prepare the systems for
the year 2000. Maintenance, or modification costs and software purchased with the
express purpose of fixing the year 2000 problem will be expensed as incurred,
while the costs of new software will be capitalized and amortized over the
software's useful life.incurred.
Management believes that on the basis of its review of its own computer based
systems, the Company is or will be year 2000 compliant without incurring
additional material costs. All software created and sold by the Company is
believed to be compliant or will be compliant by the year 2000. The Company has
been informed by its suppliers that all software licensed to the Company for
resale will be compliant by the year 2000. Agencies of the United States
Government are principal customers of the Company. If such agencies experience
significant year 2000 compliance
expense will notsystem failures, under terms of typical government
contracts, the Company's performance could be delayed or contracts could be
terminated for convenience. If similar failures are experienced by customers or
potential customers of the Company, this would also have a material effectan impact on the
Company.Company's financial performance.
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,
the timing and approval of the federal government's fiscal year budget, business
growth through obtaining new business and, once obtained, the Company's ability
to perform successfully perform at a profit, the Company's ability to convert contract
backlog to revenue, the Company's ability to secure adequate capital and
financing to support continued business growth, and the risk of the federal
government terminating contracts with the Company. While the Company has not
experienced significant contract terminations with the federal government, the
federal government can terminate at its convenience. Should this occur, the
Company's operating results could be adversely impacted.
As a high percentage of the Company's revenue is derived from business with
the federal government, the Company's operating results could be adversely
impacted should the federal government not approve and implement its annual
budget in a timely fashion.
While the Company believes it has adequate financing to support its revenue
base anticipated for 1998, the Company's growth depends upon its ability to
obtain additional capital and financing sources. The Company continuallyregularly reviews
the requirements for additional financing. However, no assurance can be made on
whether such financing, if necessary, can be obtained or if available, that it
will be available on acceptable terms.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On May 1, 1998, the U.S. District Court for the Eastern District of
Virginia entered its final order in Telos Corporation v. Cede & Co., Case No.
1:97CVO439. In its final order, the court held that dividends payable on Telos'
12% Cumulative Exchangeable Redeemable Preferred Stock (the "Preferred Stock")
had been in arrears and unpaid for more than three consecutive full semi-annual
periods and that the holders of the Preferred Stock were entitled to elect two
Class D directors on or before July 31, 1998. Said election was held on July 31,
1998, and the Preferred Stock shareholders elected two Class D directors.
Item 2. Changes in Securities and Use of Proceeds
On May 8, 1998 the Company entered into an agreement with one of its
shareholders, Union de Banques Suisses (Luxembourg) S.A. ("UBS"), to retire all
of UBS's equity holdings in the Company. These equity holdings included all of
the 7,500 shares of the Company's Class B Preferred Stock with a liquidation
preference of $1,000 per share, and the cumulative unpaid dividends of
approximately $4.8 million, 1,837,773 shares of the Company's Class A Common
Stock, and 1,312,695 of the Company's Class A Common Stock warrants. The
purchase price to retire these interests was $6.5 million, of which $5 million
was paid in cash, and the remaining $1.5 million was funded by two separate
letters of credit secured by the Company's lender. These will mature in 120 and
180 days from the date of the transaction.
Item 3. Defaults Upon Senior Securities
-------------------------------
Senior and Class B Redeemable Preferred Stocks
- ----------------------------------------------
The Company has not declared dividends on its Senior Redeemable Preferred
Stock, Series A-1 and A-2, and its Class B Redeemable Preferred Stock since their issuance. Total undeclared unpaid
dividends accrued for financial reporting purposes are $2,312,000$2,417,000 for the Series
A-1 A-2 Preferred stock and $4,796,000 for the Class BA-2 Preferred Stock at March 31, 1998. The Class B
Redeemable Preferred stock was retired in May 1998. See Subsequent Event
discussed in Note 4 to financial statements for quarter ended March 31,June 30, 1998.
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 0.06 of a share for each $.60 of such dividends
not paid in cash. No dividends have been declared or paid during fiscal years
1992 through 1997. Cumulative undeclared dividends as of March 31,June 30, 1998 accrued
for financial reporting purposes totaled $14,735,000.$16,892,000. 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 $10,795,000.$12,942,000.
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 5. Other Events
------------
Sale4. Submission of Assets
- --------------Matters to a Vote of Security Holders
On February 28,May 11, 1998 Telos Corporation sold substantially allat the annual meeting of common shareholders a vote was
taken to elect the following directors: Dr. Fred Charles Ikle, John B. Wood,
Norman P. Byers and Dr. Stephen Bryen. The persons nominated were approved to be
directors of the net
assetsCorporation by unanimous vote of oneall shareholders present at
the meeting which represented a majority of its divisions, Telos Information Systemsthe Company's common shares
outstanding.
On July 31, 1998, at a special meeting of the holders of the 12% Cumulative
Exchangeable Redeemable Preferred Stock ("TIS"12% Preferred Stock"), to NYMA,
Inc., a subsidiaryvote was
taken to elect two new Class D directors. Mr. Julio E. Heurtematte, Jr. and
Malcolm M.B. Sterrett were elected by plurality vote of Federal Data Corporationall shareholders present
at the meeting, in person or by proxy, which represented a majority of Bethesda, Maryland for
approximately $14.7 million in cash. The Company has recorded a gain of $5.7
million on its condensed consolidated statement of income for the
three months
ended March 31, 1998.Company's 12% Preferred Stock outstanding.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits:
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.
27 Financial Data Schedule
(b) Reports on Form 8-K:
Registrant filed a Current Report on Form
8-K/A, dated March 18, 1998, in respect of
the Registrant's selling its software
support division, Telos Information Systems,
on February 28, 1998.None.
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
May 15,August 14, 1998 /s/ Lorenzo Tellez
--------------------------------------------------
Lorenzo Tellez
(Principal Financial Officer &
Principal Accounting Officer)
Telos Corporation
Exhibit Index
Exhibit
Number Exhibit Name Page
------ ------------ ----
10.85 Share Purchase Agreement between Telos Corporation, a Maryland 19
Corporation, formerly named and known as C3, Inc. and Union
Bank of Switzerland dated May 7, 1998.
27 Financial Data Schedule 27