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: SEPTEMBER 30, 1999
[ ] 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 NO
As of November 9, 1999, the registrant had 21,241,980 shares of Class A Common
Stock, no par value, and 4,037,628 shares of Class B Common Stock, no par value;
and 3,185,586 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): 18
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, 1999 and 1998 (unaudited)...................................4
Condensed Consolidated Balance Sheets as of September 30, 1999 (unaudited)
and December 31, 1998 ................................................................................5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 (unaudited) ...........................................6
Notes to Condensed Consolidated Financial Statements (unaudited).......................................7-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................................................11-16
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 17
Item 3. Defaults Upon Senior Securities................................................................17
Item 6. Exhibits and Reports on Form 8-K...............................................................17
SIGNATURES....................................................................................................18
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,
1999 1998 1999 1998
---- ---- ---- ----
Sales
Systems and Support Services $ 26,677 $ 22,347 $ 74,567 $ 75,671
Products 15,432 16,802 62,313 51,148
Enterworks, Inc. 3,403 1,309 7,092 4,142
----- ----- ----- -----
45,512 40,458 143,972 130,961
Costs and expenses
Cost of sales 38,598 37,399 122,479 117,514
Selling, general and
administrative expenses 9,571 6,446 27,081 19,119
Goodwill amortization 133 132 397 457
--- --- --- ---
Operating loss (2,790) (3,519) (5,985) (6,129)
Other income (expenses)
Gain on sale of assets 4,731 -- 4,731 5,683
Other income 7 14 63 40
Interest expense (1,748) (1,662) (5,284) (4,978)
------ ------ ------ ------
Income (loss) before taxes 200 (5,167) (6,475) (5,384)
Income tax (provision) benefit (572) (117) 976 (928)
---- ---- --- ----
Net loss $ (372) $ (5,284) $ (5,499) $ (6,312)
======== ======== ======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
ASSETS
September 30, 1999 December 31, 1998
------------------ -----------------
(unaudited)
Current assets
Cash and cash equivalents (includes
restricted cash of $160 at
September 30, 1999 and December 31, 1998) $ 503 $ 408
Accounts receivable, net 31,550 56,783
Inventories, net 5,194 8,662
Deferred income taxes 4,632 4,164
Other current assets 995 707
------ ------
Total current assets 42,874 70,724
Property and equipment, net of
accumulated depreciation of
24,296 and $24,159, respectively 13,551 14,321
Goodwill, net 4,377 6,896
Other assets 3,004 3,310
----- -----
$ 63,805 $ 95,251
======== ========
LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current liabilities
Accounts payable $12,471 $25,206
Other current liabilities 10,294 4,845
Senior credit facility 16,791 --
Accrued compensation and benefits 8,053 7,400
----- -----
Total current liabilities 47,609 37,451
Senior credit facility -- 36,159
Senior subordinated notes 18,796 18,492
Capital lease obligations 11,457 11,710
------ ------
Total liabilities 77,862 103,812
------ -------
Redeemable preferred stock
Senior redeemable preferred stock 5,948 5,631
Redeemable preferred stock 34,707 31,729
------ ------
Total preferred stock 40,655 37,360
------ ------
Stockholders' investment
Common stock 78 78
Capital in excess of par -- 2,116
Retained deficit (54,790) (48,115)
------- -------
Total stockholders' investment (deficit) (54,712) (45,921)
------- -------
$ 63,805 $ 95,251
======== ========
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,
1999 1998
---- ----
Operating activities:
Net loss $(5,499) $ (6,312)
Adjustments to reconcile net loss to cash
provided by operating activities:
Gain on sale of fixed assets (88) --
Gain on sale of assets (4,731) (5,683)
Depreciation and amortization 3,082 3,169
Goodwill amortization 397 457
Other noncash items 2,096 574
Changes in assets and liabilities 16,119 20,931
------ ------
Cash provided by operating activities 11,376 13,136
Investing activities:
Proceeds from sale of fixed assets 171 --
Proceeds from sale of assets 10,000 14,675
Investment in capitalized software and other assets (762) (1,806)
Purchase of property and equipment (1,047) (970)
------ ----
Cash provided by investing activities 8,362 11,899
Financing activities:
Repayment of borrowings under senior credit facility (19,368) (18,828)
Payments under capital leases (275) (323)
Retirement of Class B redeemable preferred stock -- (6,000)
------ ------
Cash used in financing activities (19,643) (25,151)
Increase (decrease) in cash and cash equivalents 95 (116)
Cash and cash equivalents at beginning of period 408 587
------ ------
Cash and cash equivalents at end of period $ 503 $ 471
====== ======
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, Telos Corporation (California), Telos International
Corporation and its majority owned subsidiary, Enterworks, Inc. (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, including but not limited to 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, 1998.
The accompanying condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and satisfaction of liabilities in the normal course of business. However, the
Company incurred a net loss of $9.2 million during 1998 and a net loss of $5.5
million for the first nine months of 1999. In addition, the Company was not in
compliance with several covenants of its Senior Credit Facility at December 31,
1998 and September 30, 1999. The lender has provided waivers for the violations
at December 31, 1998, as well as waivers through September 30, 1999. Although
the Company completed an asset sale in the third quarter of 1999, the Company
anticipates an additional need for financing in order to support its investments
in its Enterworks subsidiary and its operations going forward. These factors,
including the uncertainty surrounding whether and when the additional financing
will be secured, and whether the Company will meet its budget expectations and
bank covenants for the rest of 1999, indicate that the Company may be unable to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to obtain the additional financing required, meet its 1999 budgeted
cash flow objectives, and comply with the terms of its Senior Credit Facility.
The Company completed a sale of assets (described in Note 2) during the
third quarter of 1999. After giving consideration to the reduction in borrowing
base from the sale of those assets, the net proceeds were not sufficient enough
to completely alleviate the immediate cash need. Therefore, the Company is
considering such options as the sale of a division or asset that is not critical
to its strategic goals, additional debt financing, debt restructuring, or
additional equity financing at either the parent or the subsidiary level.
Alternatives are currently being pursued under each of these sources; however,
the required additional financing has not yet been secured. The Company believes
the required funding will be arranged in a timely manner that does not have a
significant adverse impact on its operations. However, there can be no assurance
that the Company will be able to secure financing sufficient for its needs and
at terms favorable to the Company. Additionally, there can be no assurance that
the Company will be successful in meeting its budget expectations, or comply
with its bank covenants by the end of 1999. Failure by the Company to obtain
sufficient financing, meet its budget expectations, or meet its bank covenants
may have a material adverse effect on the Company's financial position, results
of operations and cash flows.
Certain reclassifications have been made to prior period financial
statements to conform to the classifications used in the current period.
NOTE 2. SALE OF ASSETS
At the end of the third quarter, 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, an affiliate of Carr & Company,
for $10 million. The sale of TFE, with approximately 250 employees, was
completed on September 29, 1999. As a result of this sale, the Company has
recorded a gain of $4.7 million in its condensed consolidated statement of
operations for the nine months ended September 30, 1999. The Company and TFE
Technology Holdings, LLC ("TFE Holdings") entered into a one year Corporate
Services Agreement on the date of the sale. Under the terms of the agreement
Telos will continue to provide certain administrative support functions to TFE
Technology Holdings, including but not limited to finance and accounting and
human resources, in return for a monthly payment.
On February 28, 1998, Telos sold substantially all of the net assets of
one of its 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 operations for the nine months ended
September 30, 1998.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3. DEBT OBLIGATIONS
SENIOR CREDIT FACILITY
In September 1999 the Company's Senior Credit Facility ("Facility") was
amended to reduce the total amount available under the Facility from $45 million
to $35 million. The Facility's maturity date of July 1, 2000 has remained
unchanged. At September 30, 1999, 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. The amount
of available borrowings fluctuates based on the underlying asset borrowing base.
At September 30, 1999, the Company was not in compliance with several financial
covenants contained within the Facility, including covenants relating to certain
leverage, net worth, and tangible capital goals. The bank has waived this
noncompliance.
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. Series B
Notes, which total $6.5 million at September 30, 1999 and December 31, 1998, are
collateralized by fixed assets of the Company. Series C Notes, which total $7.9
million at September 30, 1999 and December 31, 1998, are unsecured. Both the
Series B and Series C Notes have a maturity date of October 1, 2000 and 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,
1999 the prepayment premium that would be due upon a triggering event is $9.9
million.
In November 1998, the Company issued additional Senior Subordinated Notes
to certain shareholders which are classified as Series D. The Series D Notes
total $1.8 million and are unsecured. The Series D Notes have a maturity date of
October 1, 2000 and bear interest at 14% per annum. 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. These Notes contain the same payment premium
provisions as the Series B and Series C notes (see above). At September 30,
1999, the prepayment premium that would be due upon a triggering event is
approximately $200,000. In connection with the debt, the Company issued
1,500,000 warrants to purchase shares of the Company's Class A Common Stock. The
warrants have an exercise price of $.01 and an exercise period of 22 months. The
Company has assigned a value to the warrants of $420,000 which has been included
in capital in excess of par. The amount outstanding of the subordinated debt was
approximately $1.5 million at September 30, 1999.
ENTERWORKS SUBORDINATED NOTES
During 1996, the Company completed a private financing whereby $3,277,960
of 8% subordinated debt of Enterworks was issued. Investors included certain
members of the Board of Directors and management and certain shareholders of the
Company. The subordinated debt has a five year maturity. Interest is paid
quarterly, beginning January 1, 1998, on the first of January, April, July and
October each year. In connection with the debt, the Company issued 2,048,725
warrants to purchase shares of Enterworks common stock. The warrants have an
exercise price of one dollar and an exercise period of ten years. The Company
has assigned a value to the warrants of $921,926 which has been included in
capital in excess of par. The amount outstanding of this subordinated debt was
approximately $2,868,000 and $2,723,000 at September 30, 1999 and December 31,
1998, respectively.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 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 30 and
December 31 of each year. The liquidation preference of the senior preferred
stock is the face amount of the Series A-1 and A-2 ($1,000 per share), plus all
accrued and unpaid dividends. The Company is required to redeem all of the
outstanding shares of the stock on December 31, 2001, 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
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,
1999 and December 31, 1998 cumulative undeclared, unpaid dividends relating to
Series A-1 and A-2 redeemable preferred stock totaled $2,948,000 and $2,631,000
respectively.
12% CUMULATIVE EXCHANGEABLE REDEEMABLE PREFERRED STOCK
A maximum of 6,000,000 shares of 12% Cumulative Exchangeable Redeemable
Preferred Stock (the "Public Preferred Stock"), par value $.01 per share, has
been authorized for issuance. The Company initially issued 2,858,723 shares of
the Public Preferred Stock pursuant to the acquisition of the Company during
fiscal year 1990. The Public Preferred Stock was recorded at fair value on the
date of original issue, November 21, 1989, and the Company is making periodic
accretions under the interest method of the excess of the redemption value over
the recorded value. Accretion for the nine months ended September 30, 1999 was
$1,066,000. The Company declared stock dividends totaling 736,863 shares in 1990
and 1991.
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, 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.
The Public Preferred Stock accrues a semi-annual dividend at the annual
rate of 12% ($1.20) per share, based on the liquidation preference of $10 per
share and is fully cumulative. Through November 21, 1995, the Company had the
option to pay dividends in additional shares of Preferred Stock in lieu of cash.
Following November 21, 1995, dividends are only payable in cash. Dividends in
additional shares of the Preferred Stock were paid at the rate of 6% of a share
for each $.60 of such dividends not paid in cash. Dividends 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 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 $16,766,000.
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 5. ENTERWORKS STOCK OPTION PLAN CHANGES
Effective August 1999, Enterworks increased the options authorized
under its employee stock option plan from 5,000,000 to 13,000,000 shares.
During the same period, Telos contributed 1,000,000 shares of
Enterwork's common stock owned by Telos to the Enterworks treasury for issuance
as stock options by Enterworks.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. 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.
The Company has three reportable segments: Systems and Support
Services, Products, and Enterworks, Inc. 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.
Summarized financial information concerning the Company's reportable
segments for the three months ended September 30, 1999 and 1998 is shown in the
following table. The "other" column includes corporate related items.
Systems and
Support Services Products Enterworks Other (1) Total
---------------- -------- ---------- --------- -----
SEPTEMBER 30, 1999
External Revenues $26,677 $15,432 $ 3,403 -- $45,512
Intersegment Revenues 67 -- 221 -- 288
Gross Profit 4,757 539 1,618 -- 6,914
Segment profit(loss)(3) 2,079 (643) (4,093) -- (2,657)
Total assets 12,682 2,343 8,671 $40,109 63,805
Capital Expenditures 84 (3) 185 115 381
Depreciation &
Amortization(2) $ 177 $ 53 $ 528 $ 311 $ 1,069
SEPTEMBER 30, 1998
External Revenues $22,347 $16,802 $ 1,309 -- $40,458
Intersegment Revenues 340 584 1 -- 925
Gross Profit 2,406 808 (155) -- 3,059
Segment profit(loss)(3) 518 (985) (2,920) -- (3,387)
Total assets 22,547 9,359 8,325 $41,238 81,469
Capital Expenditures 55 (44) 87 82 180
Depreciation &
Amortization(2) $ 376 $ 120 $ 772 $ 365 $ 1,633
<FN>
(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 and spare parts inventory.
(3) Segment profit (loss) represents operating income (loss) before goodwill
amortization.
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
7 separate facilities located in 7 states.
</FN>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
Sales for the first nine months of 1999 were $144.0 million, an
increase of $13.0 million or 9.9% as compared to the same 1998 period. This
increase was primarily attributable to an $11.1 million increase in sales from
the Company's Products Group which experienced increased sales from its Joint
Recruitive Information Support Services Blanket Purchase Agreement. The increase
in sales was also attributable to sales from the Company's Enterworks Group,
which increased its sales by $2.9 million or 71.2% over the comparable prior
year period. These increases were partially offset by decreases in sales in the
Systems and Support Services Group of approximately $1.1 million. This decrease
is due to the sale of the Company's Information Systems division ("TIS") in
February 1998, as well as decreased sales under the Artillery Training
Simulation devices product line.
Operating losses through the first nine months of 1999 were $6.0
million as compared to an operating loss of $6.1 million during the same 1998
period. The slight improvement in operating profitability is primarily a result
of increased third quarter revenues and profitability by the Company's
Enterworks subsidiary.
Total backlog from existing contracts was approximately $277.8 million and
$923.3 million as of September 30, 1999 and December 31, 1998, respectively. The
decrease in total backlog is due to the expiration of the Company's SMCII
contract in April of 1999, which was previously disclosed in the Company's Form
10-K for the year ended December 31, 1998. As of September 30, 1999, the funded
backlog of the Company totaled $50.7 million, a decrease of $5.7 million from
December 31, 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 operations include the results
of operations of Telos Corporation and its wholly owned subsidiaries Telos
Corporation (California), Telos International Corporation ("TIC"), and its
majority owned subsidiary Enterworks, Inc. ("Enterworks") ("the Company"). The
major elements of the Company's operating expenses as a percentage of sales for
the three and nine month periods ended September 30, 1999 and 1998 are as
follows:
Three Months Ended Nine months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 84.8 92.4 85.1 89.7
SG&A expenses 21.0 15.9 18.8 14.6
Goodwill amortization 0.3 0.4 0.3 0.4
--- --- --- ---
Operating loss (6.1) (8.7) (4.2) (4.7)
Other income -- -- -- --
Gain on sale of assets 10.4 -- 3.3 4.3
Interest expense (3.8) (4.1) (3.7) (3.8)
Income tax (provision) benefit (1.3) (0.3) 0.7 (0.7)
---- ---- --- ----
Net loss (0.8)% (13.1)% (3.9)% (4.9)%
---- ----- ---- ----
FINANCIAL DATA BY MARKET SEGMENT
Sales, gross profit, and gross margin by market segment for the periods
designated below are as follows:
Three Months Ended Nine months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
(amounts in thousands)
Sales:
Systems and Support Services $26,677 $22,347 $ 74,567 $ 75,671
Products 15,432 16,802 62,313 51,148
Enterworks, Inc. 3,403 1,309 7,092 4,142
----- ----- ----- -----
Total $45,512 $40,458 $143,972 $130,961
======= ======= ======== ========
Gross Profit:
Systems and Support Services $ 4,757 $ 2,406 $ 13,867 $ 10,056
Products 539 808 5,606 2,919
Enterworks, Inc. 1,618 (155) 2,020 472
----- ---- ----- ------
Total $ 6,914 $ 3,059 $ 21,493 $ 13,447
======= ======= ======== ========
Gross Margin:
Systems and Support Services 17.8% 10.8% 18.6% 13.3%
Products 3.5% 4.8% 9.0% 5.7%
Enterworks, Inc. 47.5% (11.8)% 28.5% 11.4%
Total 15.2% 7.6% 14.9% 10.3%
For the three month period ended September 30, 1999, sales increased by
$5.1 million, or 12.5% to $45.5 million from $40.4 million for the comparable
1998 period. Of the $5.1 million increase, $4.3 million was attributable to the
Systems and Support Services Group. The Group experienced increased sales due to
revenue generated from a subcontract to the Consolidated Space Operations
Contract, as well as an increase in sales from the Company's information
security and advanced message handling system solutions business areas. The
overall increase in the revenue was also enhanced by an increase of $2.1 million
in Enterworks revenue for the third quarter of 1999 compared to the third
quarter of 1998. The increase is primarily due to sales of the Group's Virtual
DB product. Offsetting these increases was a decrease in Product Group revenue
of $1.4 million from third quarter 1999 compared to third quarter 1998. This
decrease is primarily due to a decline in revenue under the Small Multi-user
Computer II Contract which expired in April 1999.
Sales increased $13.0 million or 9.9% to $144.0 million for the nine months
ended September 30, 1999, from $131.0 million for the comparable 1998 period.
The increase for the nine month period includes a $11.2 million increase in
Products' sales and a $2.9 million increase in Enterworks sales, partially
offset by a decrease of $1.1 million in Systems and Support Services revenue.
This increase in the nine month revenue is primarily due to the increase in
revenue from the Joint Recruitive Information Support Services Blanket Purchase
Agreement. These increases were slightly offset by decreased sales under the
Artillery Training Simulation Devices product line of $3.5 million, and the sale
of the Company's Information Systems division ("TIS") in February 1998. The TIS
division generated sales of $4.0 million prior to being sold.
Cost of sales was 84.8% of sales for the quarter and 85.1% of sales for
the nine months ended September 30, 1999, as compared to 92.4% and 89.7% for the
same periods in 1998. The decreases in cost of sales as a percentage of sales
are primarily attributable to favorable changes in contract mix within the
Systems and Support Services Group, higher margin sales within the Enterworks
Group, as well as a high margin transaction with one of the Company's partners.
Gross profit increased $3.8 million in the three month period to $6.9
million in 1999, from $3.0 million in the comparable 1998 period. Gross margins
were 15.2% and 14.9%, respectively, for the three and nine month periods of 1999
as compared to 7.6% and 10.3%, respectively, for the comparable periods of 1998.
The increases in gross margin were attributable to the sales increases and cost
of sales decreases explained above.
Selling, general, and administrative expense ("SG&A") increased by
approximately $3.1 million or 48.5%, to $9.6 million in the third quarter of
1999 from $6.4 million in the comparable period of 1998. For the nine month
period of 1999, SG&A increased $8.0 million to $27.1 million from $19.1 million
in 1998. These increases are due primarily to the Company's increased investment
in research and development and sales and marketing for Enterworks. Excluding
the additional expense incurred for Enterworks research and development of $3.7
million and Enterworks sales and marketing costs of $3.8 million, selling
general and administrative expense increased $500,000 for the nine months ended
September 30, 1999 compared to the same period in 1998.
SG&A as a percentage of revenues increased to 21.0% for the third
quarter of 1999 from 15.9% in the comparable 1998 period. SG&A as a percentage
of revenues for the nine month period ended September 30, 1999 increased to
18.8% from 14.6% compared to the same period in 1998.
Goodwill amortization expense remained the same for the comparative
three month periods of 1999 and 1998, and decreased by $60,000 to $397,000 for
the nine months ended September 30, 1999 compared to the same period in 1998.
This reduction is due to a decrease in the goodwill balance associated with the
sale of TIS in early 1998.
The operating loss of the Company decreased by $729,000 to $2.8 million
in the three month period ended September 30, 1999 from $3.5 million of
operating loss in the comparable 1998 period. Operating loss decreased $144,000
to a $6.0 million operating loss for the nine months ended September 30, 1999
from a $6.1 million operating loss for the nine month period ended September 30,
1998. The increases in operating profit for the three and nine month periods are
mostly attributable to the increases in gross profit, net of the increases in
SG&A discussed above.
At the end of the third quarter, 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. The sale of TFE, with approximately 250 employees, was
completed on September 29, 1999. As a result of this sale, The Company has
recorded a gain of $4.7 million in its condensed consolidated statement of
operations for the nine months ended September 30, 1999.
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 was recorded in the nine
months ended September 30, 1998.
Interest expense remained at $1.7 million in the third quarter of 1999
compared to the same 1998 period, and increased approximately $306,000 to $5.3
million for the nine months ended September 30, 1999 from $5.0 million for the
comparable 1998 period.The increase for the nine month period is due to
increased debt levels in 1999.
The income tax provision was $572,000 and a benefit of $976,000 for the
three and nine months ended September 30, 1999, respectively. The provision
incurred 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. 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's tax strategy contemplates the generation of
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
$117,000 and $928,000 for the three and nine months ended September 30, 1998,
respectively. These tax provisions were primarily attributable to provisions for
state income taxes and increases in allowances relating to the recoverability of
deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 1999, the Company provided
$11.4 million of cash in its operating activities. This cash was provided by
reductions of accounts receivable of $20.8 million, offset by decreases in
accounts payable of $11.1 million and $5.5 million in net losses incurred in
operations. Cash provided by investing activities was $8.4 million, mostly due
to the cash generated from the sale of the Company's TFE division. Cash was used
by financing activities during the nine months to pay down approximately $19.4
million of the Senior Credit Facility balance.
At September 30, 1999, the Company had outstanding debt and long term
obligations of $47.0 million, consisting of $16.8 million under the secured
senior credit facility, $18.8 million in subordinated debt, and $11.5 million in
capital lease obligations.
At September 30, 1999, the Company had an outstanding balance of $16.8
million on its $35 million Senior Credit Facility (the "Facility"). The Facility
matures on July 1, 2000 and is collateralized by a majority of the Company's
assets (including inventory, accounts receivable and Telos' stock in
Enterworks). The amount of borrowings fluctuates based on the underlying asset
borrowing base as well as the Company's working capital requirements. At
September 30, 1999, the Company, under its borrowing base formula, had $8.8
million of unused availability. Because the Facility matures on July 1, 2000, at
September 30, 1999 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,
1999, the Company was not in compliance with several covenants contained in the
Facility; however, the bank has waived this non-compliance.
The accompanying condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and satisfaction of liabilities in the normal course of business. However, the
Company incurred a net loss of $9.2 million during 1998 and a net loss of $5.5
million for the first nine months of 1999. In addition, the Company was not in
compliance with several covenants of its Senior Credit Facility at December 31,
1998 and September 30, 1999. The lender has provided waivers for the violations
at December 31, 1998, as well as waivers through September 30, 1999. Although
the Company completed an asset sale in the third quarter of 1999, the Company
anticipates an additional need for financing in order to support its investments
in its Enterworks subsidiary and its operations going forward. These factors,
including the uncertainty surrounding whether and when the additional financing
will be secured, and whether the Company will meet its budget expectations and
bank covenants for the rest of 1999, indicate that the Company may be unable to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to obtain the additional financing required, meet its 1999 budgeted
cash flow objectives, and comply with the terms of its Senior Credit Facility.
The Company completed a sale of assets (described in Note 2) during the
third quarter of 1999. After giving consideration to the reduction in borrowing
base from the sale of those assets, the net proceeds were not sufficient enough
to completely alleviate the immediate cash need. Therefore, the Company is
considering such options as the sale of a division or asset that is not critical
to its strategic goals; additional debt financing, debt restructuring, or
additional equity financing at either the parent or the subsidiary level.
Alternatives are currently being pursued under each of these sources; however,
the required additional financing has not yet been secured. The Company believes
the required funding will be arranged in a timely manner that does not have a
significant adverse impact on its operations. However, there can be no assurance
that the Company will be able to secure financing sufficient for its needs and
at terms favorable to the Company. Additionally, there can be no assurance that
the Company will be successful in meeting its budget expectations, or comply
with its bank covenants by the end of 1999. Failure by the Company to obtain
sufficient financing, meet its budget expectations, or meet its bank covenants
may have a material adverse effect on the Company's financial position, results
of operations and cash flows.
YEAR 2000
Year 2000 issues refer generally to the problems that some software may
have in determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures or the
creation of erroneous results.
The Company, like most owners of computer software, has modified
significant portions of its internal use software so that it will function
properly in the year 2000. Accordingly, the Company has incurred and expects to
continue 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. Total expenditures for such costs were not material
to the Company's consolidated financial statements in 1998 or 1999. The Company
has completed its internal use software compliance efforts as of September 30,
1999. Maintenance, modification costs and software purchased with the express
purpose of fixing the year 2000 problem are expensed as incurred.
The Company has queried its key suppliers and vendors to assess their
Year 2000 readiness and has been informed that software licensed to the Company
for resale will be compliant by the Year 2000. Therefore, the Company is not
aware of any problems that would have a material adverse impact on its financial
position, results of operations or cash flows. However, the Company has no means
of ensuring compliance by its suppliers or vendors. If its suppliers and vendors
are not Year 2000 compliant, there could be a material adverse effect on the
Company.
As is the case with other similarly situated computer companies, if
Telos' current or future customers fail to achieve Year 2000 compliance or if
they divert technology expenditures to address Year 2000 compliance problems,
Telos' business, results of operations or financial condition could be
materially adversely affected. For example, agencies of the United States
Government are principal customers of the Company. If such agencies experience
significant Year 2000 system failures, under terms of typical government
contracts, the Company's performance and/or receipt of payments due would be
delayed or contracts could be terminated for convenience, which could have a
material adverse effect on the Company. If similar failures are experienced by
other customers or potential customers of the Company, this could also have a
material adverse impact on the Company.
Based on its internal review and the compliance information received
from its suppliers, the Company does not believe that there is a need for a
contingency plan for year 2000 system non-compliance. Such a plan will be
developed if the Company becomes aware of any year 2000 non-compliance that
would impact its critical operations. The cost of developing and implementing
such a plan, if required, may in itself be material.
Although the Company does not believe that it will incur any material
unanticipated costs or experience material disruptions in its business
associated with preparing its systems for the Year 2000, there can be no
assurances that the Company will not experience serious unanticipated
consequences and/or material costs caused by undetermined errors or defects in
the technology used in its internal systems, embedded software and the Company's
own software products. Worst case scenarios could include: (i) corruption of
data contained in the Company's internal information systems, (ii)
interruptions, delays or terminations in the Company's business with government
agencies or other customers associated with their own year 2000 problems and
(iii) the failure of infrastructure services provided by government agencies and
other third parties (e.g., electricity, phone service, water transport, internet
services, etc.) Any of these unexpected outcomes could have a material adverse
effect on the Company.
Management believes that software created and sold by the Company is
compliant or will be compliant by the year 2000. However, because the Company is
in the business of selling computer systems, the Company's risk of being
subjected to lawsuits relating to year 2000 issues is likely to be greater than
that of other industries. Computer systems may involve different hardware and
software components from different manufacturers; therefore, it may be difficult
to determine which component in a computer system may cause a year 2000 issue.
As a result, the Company may be subjected to year 2000 related lawsuits
independent of whether its products and services are year 2000 compliant. The
outcomes of such lawsuits and the impact on the Company cannot be determined at
this time.
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 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 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.
The accompanying condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and satisfaction of liabilities in the normal course of business. However, the
Company incurred a net loss of $9.2 million during 1998 and a net loss of $5.5
million for the first nine months of 1999. In addition, the Company was not in
compliance with several covenants of its Senior Credit Facility at December 31,
1998 and September 30, 1999. The lender has provided waivers for the violations
at December 31, 1998, as well as waivers through September 30, 1999. Although
the Company completed an asset sale in the third quarter of 1999, the Company
anticipates an additional need for financing in order to support its investments
in its Enterworks subsidiary and its operations going forward. These factors,
including the uncertainty surrounding whether and when the additional financing
will be secured, and whether the Company will meet its budget expectations and
bank covenants for the rest of 1999, indicate that the Company may be unable to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to obtain the additional financing required, meet its 1999 budgeted
cash flow objectives, and comply with the terms of its Senior Credit Facility.
The Company completed a sale of assets (described in Note 2) during the
third quarter of 1999. After giving consideration to the reduction in borrowing
base from the sale of those assets, the net proceeds were not sufficient enough
to completely alleviate the immediate cash need. Therefore, the Company is
considering such options as the sale of a division or asset that is not critical
to its strategic goals, additional debt financing, debt restructuring, or
additional equity financing at either the parent or the subsidiary level.
Alternatives are currently being pursued under each of these sources; however,
the required additional financing has not yet been secured. The Company believes
the required funding will be arranged in a timely manner that does not have a
significant adverse impact on its operations. However, there can be no assurance
that the Company will be able to secure financing sufficient for its needs and
at terms favorable to the Company. Additionally, there can be no assurance that
the Company will be successful in meeting its budget expectations, or comply
with its bank covenants by the end of 1999. Failure by the Company to obtain
sufficient financing, meet its budget expectations, or meet its bank covenants
may have a material adverse effect on the Company's financial position, results
of operations and cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company'sexposure 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%, subject to
certain adjustments, over the bank's base rate. The weighted average interest
rate for the first nine months of 1999 was 9.56%. This facility expires on July
1, 2000 and has outstanding balance of $16.8 million at September 30, 1999.
The Company's other long-term debt at September 30, 1999 consists of Senior
Subordinated Notes B, C, and D which bear interest at fixed rates ranging from
14% to 17%. The Senior Subordinated Notes mature as to principal in the
aggregate amount of $16,173,000 on October 1, 2000. Additionally, the Company
has subordinated debt issued by their majority owned subsidiary, Enterworks,
which bears interest at a fixed rate of 8%. The Enterworks Notes mature as to
principal in the aggregate amount of $3,277,960 in July 2001. The Company has no
cash flow exposure due to rate changes for its Senior Subordinated or Enterworks
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, while the results of litigation
cannot be predicted with certainty, the final outcome of such matters will not
have a material adverse effect on the Company's consolidated financial position
or results of operations.
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 their issuance. Total undeclared
unpaid dividends accrued for financial reporting purposes are $2,948,000 for the
Series A-1 and A-2 Preferred Stock at September 30, 1999.
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. Cumulative undeclared dividends as of September 30, 1999
accrued for financial reporting purposes totaled $20,716,000. 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
$16,766,000.
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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27 Financial Data Schedule
(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: Telos Corporation
/S/ LORENZO TELLEZ
-------------------
NOVEMBER 15, 1999 Lorenzo Tellez
(Principal Financial Officer &
Principal Accounting Officer)