Summarized financial information concerning the Company's reportable segments for the three months ended March 31, 2002 and 2001 is shown in the following table. The "other" column includes corporate related items.
The Company does not have material international revenues, profit (loss), assets or capital expenditures. The Company's business is not concentrated in a specific geographical area within the United States, as it has 5 separate facilities located in various states, the District of Columbia and Europe.
Note 6. Subsequent Event
On April 30, 2002, the Company received a Senior Demand Promissory Note from Enterworks totaling $305,945. This Note represents amounts owed to the Company for rent and services performed by the Company under a service agreement during the first quarter 2002. The billings represented in this Note have been fully reserved for at March 31, 2002. This Note contains a maturity date of April 30, 2007, and also includes a provision for repayment of four times principal and accrued interest in the event that Enterworks liquidates, enters into dissolution or seeks the protection of bankruptcy.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
General
Sales for the first three months of 2002 were $33.3 million, a decrease of $10.6 million or 24.1% as compared to the same 2001 period. This decrease was primarily attributable to a $10.9 million decrease in sales from the Company's Products Group, which was impacted by decreased order volume under both its traditional businesses and its wireless product line.
The Company incurred an operating loss of approximately $1.9 million for the three months ended March 31, 2002 as compared to an operating profit of $1.1 million during the same 2001 period. Operating profitability declined principally because of the decreased sales volume discussed above coupled with reduced profit margins on the Company's traditional business contracts and information security product line.
Total backlog from existing contracts was approximately $808.1 million and $830.0 million as of March 31, 2002 and December 31, 2001, respectively. As of March 31, 2002, the funded backlog of the Company totaled $29.4 million, an increase of $1.4 million from December 31, 2001. 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-month periods ended March 31, 2002 and 2001 were as follows:
Three Months Ended
March 31,
--------------------
2002 2001
---- ----
Sales 100.0% 100.0%
Cost of sales (89.8) (84.3)
SG&A expenses (15.8) (13.1)
Goodwill amortization -- (0.1)
------ -----
Operating (loss) income (5.6) 2.5
Other income -- --
Interest expense (2.4) (2.9)
----- -----
Loss before taxes (8.0) (0.4)
Income tax benefit (provision) 3.3 --
----- -----
Net loss (4.7)% (0.4)%
==== ====
Financial Data by Market Segment
Sales, gross profit, and gross margin by market segment for the first quarter
of 2002 and 2001 were as follows:
Three Months Ended
March 31,
---------------------------
2002 2001
---- ----
(amounts in thousands)
Sales:
Systems and Support Services $ 14,355 $13,887
Products 16,581 27,477
Xacta 2,403 2,565
----- ------
Total $ 33,339 $43,929
======== =======
Gross Profit:
Systems and Support Services $ 1,258 $ 1,249
Products 1,891 5,095
Xacta 261 546
----- -----
Total $ 3,410 $ 6,890
======== =======
Gross Margin:
Systems and Support Services 8.8% 9.0%
Products 11.4% 18.5%
Xacta 10.9% 21.3%
Total 10.2% 15.7%
For the three-month period ended March 31, 2002, sales decreased by $10.6 million, or 24.1%, to $33.3 million from $43.9 million for the comparable 2001 period. Of the $10.6 million decrease, $10.9 million was attributable to the Products Group. The Products Group's comparable revenues declined principally due to decreased sales under the Group's traditional contracts such as Infrastructure Solutions-1 and DCN Courts, as well as decreased sales from the Group's wireless product line. The decreases in revenue were partially offset by increases in the revenue of the Systems and Support Services Group, which experienced revenue growth of $468,000. The sales levels in the Xacta Group remained unchanged in the comparable periods.
Cost of sales was 89.8% of sales for the three-month period ended March 31, 2002, as compared to 84.3% in the comparable 2001 period. The increase in cost of sales as a percentage of sales is mainly attributable to decreased profits realized under the Products Group's wireless product line, as well as reduced profits on some of the Xacta Group's firm fixed price contracts.
Gross profit decreased by $3.5 million in the first quarter of 2002 to $3.4 million from $6.9 million in the comparable 2001 period as a result of the decrease in sales and increases in cost of sales discussed above. Total Company gross margins were 10.2% and 15.7% for the three-month periods ended March 31, 2002 and 2001, respectively.
Selling, general and administrative costs decreased for the three-month period by approximately $442,000 to $5.3 million in 2002 from $5.7 million in 2001. This decrease is primarily due to indirect cost control measures implemented in early 2002. SG&A as a percentage of sales was 15.8% and 13.1% for the three-month periods ended March 31, 2002 and 2001, respectively.
Goodwill amortization expense was zero for the three months ended March 31, 2002 compared to $62,000 for the period ended March 2001. The decrease in goodwill amortization was a result of the application of SFAS 142. Under SFAS 142, the Company no longer depreciates its goodwill asset.
Operating profitability declined by $3.0 million during the three months ended March 31, 2002 to approximately $1.9 million in operating loss. The Company had an operating profit of $1.1 million in the comparable period of 2001. The decrease in operating profit resulted primarily from the aforementioned gross profit decreases.
Interest expense decreased by approximately $491,000 to $796,000 during the three-month period ended March 31, 2002, from $1.3 million in the comparable period of 2001. The decrease was attributable to decreased debt levels in 2002.
The Company recorded a tax benefit of approximately $1.1 million and a tax provision of approximately $1,000 for the three-month periods ended March 31, 2002 and 2001, respectively. The tax benefit recorded for the first quarter of 2002 is attributable to the net operating loss generated by the Company.
Liquidity and Capital Resources
For the three months ended March 31, 2002, the Company used $1.8 million of cash for operating activities. This usage of cash was principally due to losses incurred in operations. Cash used in investing activities was approximately $91,000. The Company generated cash during the quarter by drawing on its credit facility in the amount of $2.2 million.
At March 31, 2002, the Company had outstanding debt and long-term obligations of $33.4 million, consisting of $14.6 million under the secured senior credit facility, $8.2 million in subordinated debt, and $10.6 million in capital lease obligations.
At March 31, 2002, the Company had an outstanding balance of $14.6 million on its $20 million Senior Credit Facility (the "Facility"). The Facility matures on January 15, 2003 and is collateralized by a majority of the Company's assets (including inventory, accounts receivable and Telos' stock in its subsidiaries and affiliates). The amount of borrowings fluctuates based on the underlying asset borrowing base as well as the Company's working capital requirements. The Facility has various covenants that may, among other things, restrict the ability of the Company to merge with another entity, to sell or transfer certain assets, the payment of dividends and other distributions beyond certain limitations. The Facility also requires the Company to meet certain fixed coverage and operating goals. The Company is currently in the process of negotiating a replacement for the Facility.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") approved Statement of Financial Accounting Standards ("SFAS") No 142, "Goodwill and Other Intangible Assets". SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Implementation of this Statement requires the Company to cease amortization of goodwill, and goodwill is tested for impairment at least annually at the reporting unit level. Goodwill is tested for impairment on an interim basis if any event occurs or circumstances change that would "more likely than not" reduce the fair value of a reporting unit below its carrying value. Intangible assets that are subject to amortization will be reviewed for impairment in accordance with SFAS 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of". The Company adopted the provisions of SFAS 142 on January 1, 2002. The Company no longer amortizes goodwill to expense, but instead reviews goodwill periodically for impairment. The adoption of SFAS 142 reduced goodwill amortization expense by $250,000 annually. No material changes to the carrying value of goodwill were made as a result of the adoption of SFAS 142.
In September 2001, FASB Statement No. 143 (SFAS 143) "Accounting for Asset Retirement Obligations" was issued. SFAS 143 provides guidance on the initial measurement and subsequent accounting for obligations associated with the sale, abandonment, or other type of disposal of long-lived tangible assets. The Company is currently evaluating the provisions of SFAS 143, but does not anticipate the implementation of SFAS 143 to have a material impact on the results of operations, cash flows or financial position.
In October 2001, FASB Statement No. 144 (SFAS 144) "Accounting for the Impairment of Disposal of Long-Lived Assets" was issued. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and this statement supercedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-lived Assets to be Disposed of". The Company has adopted the provisions of SFAS 144, and the adoption of SFAS 144 did not have a material impact on the Company's financial statements.
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 present period of economic downturn may include, and adversely affect, the cost and continued availability of the Company to secure adequate capital and financing to support its business; the impact of adverse economic conditions on the Company's customers and suppliers; the ability to sell assets or to obtain alternative sources of commercially reasonable refinancing for the Company's debt; or the ability to successfully restructure its debt obligations. Additional uncertainties include the Company's ability to convert contract backlog to revenue, the success of the Company's investment in Enterworks and Xacta and the Company's access to ongoing development, product support and viable channel partner relationships with Enterworks and Xacta.
While in the past the Company has not experienced contract terminations with the U.S. Government, the U.S. Government can terminate at its convenience. Should such a termination occur, the Company's operating results could be adversely impacted. The Company's total backlog (referenced above) includes $700 million attributable to the dual award of the U.S. Army CECOM SEC contract to the Company's 50% owned joint venture, ITel Solutions. The Company will be a subcontractor to this joint venture, and estimates that upon the successful award of each competing task order, its total backlog relating to such contract could be up to $700 million. Conversely, failure to be awarded the majority of the competing task orders for such contract would adversely impact the Company.
It should also be noted that post September 11, 2001, all U.S. Government programs, especially those pertaining to national security, have been subject to review and reprioritization. While the Company believes its products and services are well positioned to benefit from such post September 11 demands, the magnitude of such events certainly serves to emphasize how the Company's high percentage of revenue derived from business with the U.S. Government could alternatively be dramatically, swiftly and adversely impacted.
The Company has many patents and patents pending, trademarks and copyrights and other valuable proprietary information, and the Company has taken reasonable and prudent steps to so protect its intellectual property. With regard to the Company's wholly owned subsidiary, Xacta, whose software products require constant monitoring as it develops future releases and creates additional intellectual property, vigilant oversight of such intellectual property rights is imperative. Similarly, the intellectual property associated with our wireless division and our automated message handling system division require constant oversight with regard to the development and protection of their respective intellectual property. Accordingly, any event that brings into question the Company's ownership of its intellectual property could, therefore, materially and adversely impact the Company.
Item 3. 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 1.5%, subject to certain adjustments, over the bank's base rate. This rate will escalate 25 basis points every other month from April 1, 2002 until expiration. The weighted average interest rate in the first three months of 2002 was 6.5%. This facility expires on January 15, 2003 and had an outstanding balance of $14.6 million at March 31, 2002.
The Company's other debt at March 31, 2002 consists of Senior Subordinated Notes B and C which bear interest at fixed rates ranging from 14% to 17%. The Senior Subordinated Notes principal balance at March 31, 2002 is $8.2 million, and this principal amount matures on May 23, 2003. 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. While the results of litigation cannot be predicted with certainty, based upon the Company'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, results of 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 its issuance. Total undeclared unpaid dividends, accrued for financial reporting purposes, are $4,008,000 for the Series A-1, A-2 Preferred stock at March 31, 2002.
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 March 31, 2002 accrued for financial reporting purposes totaled $30.3 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 $26,323,000.
Based upon the Company's interpretation of charter provisions pertaining to restrictions upon payment of dividends, similar dividend payment restrictions contained in its Senior Credit Facility, and limitations pursuant to Maryland law, the Company has not declared or paid dividends on its public preferred stock since 1991.
Item 5. Other Events
On March 20, 2002, Dr. Stephen Bryen resigned as both a Proxy Holder and Director. On March 26, 2002, Dr. Fred Ikle resigned as Chairman of the Board of Directors, but remains on the Board as a Director and Proxy Holder.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: 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: May 14, 2002 | TELOS CORPORATION
/s/Thomas J. Ferrara
Thomas J. Ferrara
(Principal Financial Officer) |
