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, 2001
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission file number: 1-8443
TELOS CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-0880974
(State of Incorporation) (I.R.S. Employer Identification No.)
19886 Ashburn Road, Ashburn, Virginia 20147-2358
(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 10, 2001, the registrant had 21,171,202 shares of Class A Common
Stock, no par value, and 4,037,628 shares of Class B Common Stock, no par value;
and 3,185,586 shares of 12% Cumulative Exchangeable Redeemable Preferred Stock
par value $.01 per share, outstanding.
No public market exists for the registrant's Common Stock.
Number of pages in this report (excluding exhibits): 19
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, 2001 and 2000 (unaudited)........3
Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited)
and December 31, 2000 .....................................................4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and 2000 (unaudited) ................5
Notes to Condensed Consolidated Financial Statements (unaudited)............6-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................13-17
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........17
PART II. OTHER INFORMATION
------- -----------------
Item 1. Legal Proceedings..............................................17
Item 3. Defaults Upon Senior Securities................................18
Item 4. Submission of Matters to a Vote of Security Holders............18
Item 5. Other Information..............................................18
Item 6. Exhibits and Reports on Form 8-K...............................18
SIGNATURES....................................................................19
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,
---------------- ----------------
2001 2000 2001 2000
------ ------- ------- -------
Sales
Systems and Support Services $ 14,882 $ 13,384 $ 45,582 $ 34,278
Products 18,582 18,709 65,017 50,446
Xacta 3,477 2,781 9,620 6,155
------ ------ ------ ------
36,941 34,874 120,219 90,879
Costs and expenses
Cost of sales 30,357 30,694 99,321 78,631
Selling, general and
administrative expenses 4,832 4,189 17,383 12,636
Goodwill amortization 62 71 187 250
-- -- --- ---
Operating income (loss) 1,690 (80) 3,328 (638)
----- --- ----- ----
Other income (expenses)
Equity in earnings of Telos OK -- 321 -- 2,328
Other income 46 4 68 42
Interest expense (897) (1,151) (3,191) (3,514)
------ ------- ------- -------
Income (loss) before taxes 839 ( 906) 205 (1,782)
Income tax provision (261) (1,355) (112) (1,172)
------ ------- ------- -------
Net income (loss) $ 578 $ (2,261) $ 93 $ (2,954)
====== ======= ====== =======
The accompanying notes are an integral part of these
condensed consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(amounts in thousands)
ASSETS
September 30, 2001 December 31, 2000
------------------ -----------------
Current assets
Cash and cash equivalents (includes restricted
cash of $54 at September 30, 2001 and
December 31, 2000) $ 218 $ 286
Accounts receivable, net 26,837 45,682
Inventories, net 5,201 7,045
Deferred income taxes 2,840 3,256
Other current assets 1,907 404
------ -----
Total current assets 37,003 56,673
Property and equipment, net of
accumulated depreciation of
$10,631 and $9,331, respectively 11,596 12,319
Goodwill, net 2,561 2,749
Investment in Enterworks -- --
Investment in Telos OK -- --
Deferred income taxes, long term 4,719 4,603
Other assets 141 746
------ ------
$ 56,020 $ 77,090
======== ========
LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current liabilities
Accounts payable $ 14,792 $ 19,049
Other current liabilities 3,113 2,438
Unearned revenue 7,360 8,609
Senior subordinated notes 8,179 1,151
Senior credit facility 11,018 --
Accrued compensation and benefits 5,360 7,178
------ ------
Total current liabilities 49,822 38,425
Senior credit facility -- 25,460
Senior subordinated notes -- 7,386
Capital lease obligations 10,817 11,030
------ ------
Total liabilities 60,639 82,301
------ ------
Redeemable preferred stock
Senior redeemable preferred stock 6,796 6,480
Redeemable preferred stock 45,527 42,352
------ ------
Total preferred stock 52,323 48,832
------ ------
Stockholders' investment
Common stock 78 78
Capital in excess of par -- 2,718
Retained deficit (57,020) (56,839)
-------- --------
Total stockholders' investment (deficit) (56,942) (54,043)
-------- --------
$ 56,020 $ 77,090
====== ======
The accompanying notes are an integral part of these condensed
consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts in thousands)
Nine Months
Ended September 30,
-------------------
2001 2000
---- ----
Operating activities:
Net income (loss) $ 93 $(2,954)
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Depreciation and amortization 1,388 1,260
Goodwill amortization 188 250
Other noncash items 476 93
Changes in assets and liabilities 13,351 (3,743)
------ ------
Cash provided by (used in) operating activities 15,496 (5,094)
------ -----
Investing activities:
Proceeds from investment in TelosOK, LLC -- 6,000
Purchases of property and equipment (535) (1,447)
------ ------
Cash (used in) provided by investing activities (535) 4,553
------ ------
Financing activities:
(Repayment of) proceeds from borrowings under senior
credit facility (14,442) 880
Repayment of Series C subordinated note (358) --
Payments under capital leases (229) (255)
------ -----
Cash (used in) provided by financing activities (15,029) 625
------ -----
(Decrease) increase in cash and cash equivalents (68) 84
Cash and cash equivalents at beginning of period 286 315
--- ---
Cash and cash equivalents at end of period $ 218 $ 399
===== =====
The accompanying notes are an integral part of these
condensed consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. General
The accompanying condensed consolidated financial statements are unaudited
and include the accounts of Telos Corporation ("Telos") and its wholly owned
subsidiaries (collectively, the "Company"). Significant intercompany
transactions have been eliminated. In the opinion of management, 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
because of 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, 2000.
The Company currently does not engage or plan to engage in the use of
hedging or derivative instruments. Therefore, the implementation of SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities" and SFAS 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities"
did not have a material impact on the results of operations, cash flows or
financial position.
On September 29, 2000, FASB Statement No. 140 ("SFAS 140") "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities",
was issued. The new standard replaces FASB Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
and becomes effective for transfers entered into after March 31, 2001. SFAS 140
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. The implementation of SFAS
140 did not have a material impact on the Company's consolidated financial
statements.
In June 2001, the Financial Accounting Standards Board ("FASB") approved
Statements of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141
addresses financial accounting and reporting for business combinations. All
business combinations in the scope of this Statement shall be accounted for
using the purchase method of accounting. The provisions of SFAS No. 141 apply to
all business combinations initiated after June 30, 2001, and business
combinations accounted for by the purchase method for which the date of
acquisition is July 1, 2001, or later. Certain transition provisions of SFAS No.
141 apply to business combinations for which the acquisition date was before
July 1, 2001, that were accounted for using the purchase method, as of the date
SFAS No. 141 is initially applied in its entirety. The adoption of SFAS No. 141
did not have a material effect on the Company's financial position, results of
operations or cash flows.
SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets. Implementation of this Statement will
require the Company to cease amortization of goodwill and goodwill will be
tested for impairment at least annually at the reporting unit level. Goodwill
will be tested for impairment on an interim basis if an 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 provisions of SFAS 142 are required to be applied starting
with fiscal years beginning after December 15, 2001 and will therefore be
applied for the year ending December 31, 2002. The Company is currently
evaluating the impact and materiality thereof, if any, of SFAS No. 142 on its
financial statements and related disclosures.
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 or Disposal of Long-lived Assets" was issued. SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets and this statement supercedes FASB Statement No. 121, "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of".
The Company is currently evaluating the impact and materiality thereof, if any,
of SFAS 144 on its financial statements and related disclosures.
Certain reclassifications have been made to the prior year's financial
statements to conform to the classifications used in the current period.
Note 2. Contribution of Assets
On July 27, 2000, the Company entered into a subscription agreement with
certain investors ("Investors"), which provided for the formation of an Oklahoma
Limited Liability Company named Telos OK, LLC ("TelosOK"). The Company
contributed all of the assets of its Digital Systems Test and Training
Simulators ("DSTATS") business as well as its Government Contract with the
Department of the Army at Ft. Sill (hereafter referred to as the Company's Ft.
Sill operation) to TelosOK. The net assets contributed by the Company totaled
$373,000. The Investors contributed $3.0 million in cash to TelosOK, and at
closing TelosOK borrowed $4.0 million cash from a bank. The Company and the
Investors have each jointly and severally guaranteed the loan of TelosOK. The
Company has guaranteed $2 million and the Investors have guaranteed $1 million
pari passu. This loan has an outstanding balance of approximately $3.0 million
at September 30, 2001. In addition, TelosOK entered into a $500,000 senior
credit facility with the same bank, which was subsequently increased to $750,000
on September 30, 2001, with an expiration date of December 31, 2001. Borrowings
under the facility, if any, will be collateralized by certain assets of TelosOK
(primarily accounts receivable). The Company and the Investors have agreed to
guarantee this credit facility in the amount of $250,000 each of the current
$750,000 when and if drawn.
In compliance with the subscription agreement, on the closing date the
following consideration was given to the Company for its contribution of assets
to TelosOK:
The Company received $6 million in cash, retained $2.5 million in
trade receivables of the Ft. Sill and DSTATS businesses, and received
a $500,000 receivable from TelosOK for a total consideration of $9
million for the contribution of the net assets.
The Company and the Investors each own a 50% voting membership interest in
TelosOK, and have signed an operating agreement which provides for three
subclasses of membership units, Classes A, B and C. The ownership of these
classes is as follows and can change upon Class B redemption:
Class A - owns 20% of TelosOK. The Company and the Investors each own 50%
of the 200,000 units of this class. This class possesses all voting rights
of TelosOK and the sole right to elect the directors of TelosOK. The units
in this class do not have redemption rights.
Class B - owns 40% of TelosOK. The Investors own all 2.9 million units of
this class. This class has no voting rights, but can, subject to certain
restrictions, request the redemption of all or a portion of the Class B
units outstanding one year after the closing date. Class B holders can
redeem no more than 500,000 units per quarter at a price of $1.00 per unit,
and such redemption can only be made from the excess cash flow of TelosOK
as defined in the operating agreement.
Class C- owns 40% of TelosOK. The Company owns all 2.9 million units of
this class. This class has no voting rights, and has the same redemption
rights as Class B, except that no right of redemption will exist until all
Class B units have been redeemed. In addition, when any of the Class B
units are redeemed, the Company will receive a warrant to purchase Class C
units equal to the amount of the Class B units redeemed at a price of $0.01
per unit.
As indicated in the operating agreement, one of the Investors, Bill W.
Burgess, will serve as Chairman of the Board and may designate a Secretary, and
David Aldrich, President and CEO of the Company, and Thomas Ferrara, Treasurer
and CFO of the Company, will serve in those same capacities for TelosOK. The
Company has entered into a corporate services agreement with TelosOK whereby the
Company will provide certain administrative support functions to TelosOK,
including but not limited to finance and accounting and human resources, in
consideration for a monthly cash payment.
As indicated above, the Company owns 50% of TelosOK, sharing control over
TelosOK, and accordingly has changed its method of accounting for the
contributed assets from the consolidation method to the equity method. Pursuant
to this change, the revenues, costs and expenses from the Ft. Sill operation
have been excluded from their respective captions in the Company's Consolidated
Statement of Operations, and the net earnings from the operation have been
reported separately as "Equity in Net Earnings of TelosOK" for the three and
nine months ended September 30, 2000. The results of operations of the Ft. Sill
operation included in the "Equity in Net Earnings of TelosOK" caption are
comprised of the following:
(in thousands)
September 30, 2000
3-mos. ended 9-mos. ended
------------ ------------
Sales $ 1,774 $13,339
Cost of Sales (1,453) (11,011)
------- --------
Gross profit $ 321 $ 2,328
=== =====
From July 27, 2000 through September 30, 2001, the Company was unable to
recognize its pro rata share of the income generated from TelosOK because the
Company's share of TelosOK's capital accounts was negative. Accordingly, under
the equity method of accounting as prescribed by Accounting Principles Board
Opinion 18, the Company's carrying value in TelosOK is $0 at September 30, 2001.
Note 3. Debt Obligations
Senior Credit Facility
The Company has a $25 million Senior Credit Facility ("Facility") with Bank
of America that matures on March 1, 2002. This Facility was $35 million and on
August 31, 2001, was reduced by an agreement with the bank to $25 million. At
September 30, 2001, the Facility was classified as a current liability as the
Facility has a term of less than one year. Borrowings under the Facility are
collateralized by a majority of the Company's assets including accounts
receivable, inventory, and Telos' stock in its subsidiaries and affiliates. The
amount of available borrowings fluctuates based on the underlying
asset-borrowing base, as defined in the Facility agreement. On October 20, 2001,
the Company was notified that Bank of America had assigned 100% participation of
this Facility to Endeavour, LLC.
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 are collateralized by fixed assets of the Company. Series C Notes are
unsecured. In April 2001, the Company retired one of its Series C subordinated
notes with a principal amount of $358,000. Of the remaining $8.2 million in
combined principal of the Series B and Series C Notes at September 30, 2001,
approximately $800,000 of the Notes became currently due and payable as of April
1, 2001, and the remaining $7.4 million becomes payable on April 1, 2002.
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, 2001, the prepayment premium that would be due upon a
triggering event is approximately $9.7 million.
The balance of the Series B Notes was $5.5 million at September 30, 2001
and December 31, 2000. The balances of the Series C Notes were $2.6 million and
$3.0 million, respectively, at September 30, 2001 and December 31, 2000. At
September 30, 2001, the Series B and Series C notes are classified as current
liabilities as they have a term of less than one year.
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 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 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 821.4 of the
outstanding shares of the stock on December 31, 2001, subject to the legal
availability of funds. The remaining 2,178.6 shares and their accrued dividends
are required to be redeemed on April 1, 2002 subject to the legal availability
of funds. Mandatory redemptions are required from excess cash flows, as defined
in the stock agreements. The Series A-1 and A-2 Preferred 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, 2001 and December 31, 2000
cumulative undeclared, unpaid dividends relating to Series A-1 and A-2
redeemable preferred stock totaled $3,796,000 and $3,480,000 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, 2001 was
$1.3 million. The Company declared stock dividends totaling 736,863 shares in
1990 and 1991. No other dividends, in stock or cash, have been declared since
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.
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, 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 $24,412,000.
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.
Note 5. Reportable Business Segments
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", in 1998 which changes the way the Company
reports information about its operating segments.
At September 30, 2001, the Company has three reportable segments:
Systems and Support Services: provides software development and support
services for software and hardware including technology insertion, system
redesign and software re-engineering. The principal market for this segment
is the federal government and its agencies.
Products: delivers networking infrastructure solutions to its customers.
These solutions include providing commercial hardware, software and
services to its customers. The Products group is capable of staging,
installing and deploying large network infrastructures with virtually no
disruption to customer's ongoing operations. In addition, the Products
segment is a value added reseller for Xacta's information security products
into the federal government. The principal market for this segment is the
federal government and its agencies.
Xacta: offers innovative products which leverage its extensive consulting
experience, domain knowledge, and best practices implementation in
enterprise security. Through its core competencies and innovative products,
Xacta helps manage the security of its customers' network environments
through the integration of critical business content and processes.
The Company evaluates the performance of its operating segments based on
revenue, gross profit and income before goodwill amortization, income taxes,
non-recurring items and interest income or expense. Certain businesses within
the Xacta segment in 2000 were transferred to the Products segment beginning
January 2001. The 2000 segment disclosure has been amended to conform to the
2001 change.
Summarized financial information concerning the Company's reportable
segments for the three months ended September 30, 2001 and 2000 is shown in the
following table. The "other" column includes corporate related items.
Systems and
Support Services Products Xacta Other (1) Total
September 30, 2001
External Revenues $14,882 $18,582 $ 3,477 $ -- $36,941
Intersegment Revenues 118 4,875 -- -- 4,993
Gross Profit 1,295 3,908 1,381 -- 6,584
Segment profit(loss)(3) (259) 2,276 (265) -- 1,752
Total assets 9,028 18,881 5,199 22,912 56,020
Capital Expenditures 24 3 31 28 86
Depreciation &
Amortization(2) $ 75 $ 91 $ 64 $ 277 $ 507
Systems and
Support Services Products Xacta Other (1) Total
September 30, 2000
External Revenues $13,384 $18,709 $ 2,781 $ -- $34,874
Intersegment Revenues -- -- -- -- --
Gross Profit 1,175 1,965 1,040 -- 4,180
Segment profit(loss)(3) (359) 19 331 -- (9)
Total assets 9,110 22,171 3,094 22,745 57,120
Capital Expenditures 76 (32) 78 364 486
Depreciation &
Amortization(2) $ 88 $ 86 $ 18 $ 310 $ 502
(1) Corporate assets are principally property and equipment, cash and other
assets.
(2) Depreciation and amortization includes amounts relating to property and
equipment, goodwill, capital leases 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 nine separate
facilities located in four states, Europe and Asia.
Note 6. Investment in Enterworks
During the first quarter of 2001, the Company and Enterworks, Inc.
("Enterworks") entered into an agreement whereby the Company, as a participant
in an additional round of financing for Enterworks, substituted approximately
$530,000 of receivables owed to the Company and in addition funded Enterworks
$470,000 of cash in three equal installments during the quarter. The receivables
included rent owed to the Company, services performed by the Company under a
service agreement between the Company and Enterworks, and expenses advanced by
the Company on behalf of Enterworks for which the Company is reimbursed. In
return, the Company received four separate Demand 10% Convertible Promissory
Notes from Enterworks totaling $1 million, as well as warrants to purchase 2.5
million of underlying shares of Enterworks common stock. The warrants to
purchase 2.5 million underlying shares of Enterworks common stock have an
exercise price of $0.01 per share and an exercise period of five years.
During the second quarter of 2001, the Company and Enterworks entered into
an agreement whereby the Company, as a participant in an additional round of
financing for Enterworks, committed an additional $800,000 which represented the
estimate of amounts owed to the Company for the period May through December 2001
for rent and services performed by the Company under a service agreement. In
return, the Company has received a $300,000 Demand 10% Convertible Promissory
Note from Enterworks, as well as a warrant to purchase 750,000 of underlying
shares of Enterworks common stock. The warrants to purchase the shares of
Enterworks common stock have an exercise price of $0.01 per share and an
exercise period of five years.
During the third quarter of 2001, the Company received two separate Demand
10% Convertible Promissory Notes from Enterworks totaling $200,000, as well as
warrants to purchase 500,000 of underlying shares of Enterworks common stock.
The Company will receive the remaining $300,000 in Demand Notes and warrants to
purchase the remaining 750,000 shares from Enterworks in the fourth quarter of
2001. The warrants to purchase the shares of Enterworks common stock have an
exercise price of $0.01 per share and an exercise period of five years.
During 2001, the Company's ownership interest in Enterworks fell below 20%
and accordingly, the Telos designated voting representation on the Enterworks
Board was relinquished. Consistent with such events, the Company converted to
the cost method of accounting for this investment.
Note 7. Write-off of Investment in Telos International - Filinvest, Inc.
Since 1997, one of the Company's wholly owned subsidiaries, Telos
International Corporation ("TIC"), has been a 50% owner of a joint venture
between TIC and Filivest Capital, Inc., a Philippine company. The Company
accounts for this joint venture under the equity method of accounting as
prescribed by APB No. 18. In the second quarter of 2001, the Company became
uncertain as to whether operations under the joint venture will continue as a
going concern. Therefore, the Company determined that its investment in Telos
International - Filinvest, Inc. was impaired, and reduced its investment balance
in the joint venture to zero. The amount of the write-off totaled approximately
$600,000, and is included in the Selling, general and administrative caption in
the statement of operations for the nine months ended September 30, 2001.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
Sales for the first nine months of 2001 were $120.2 million, an increase of
$29.3 million or 32.3% as compared to the same 2000 period. This increase was
primarily attributable to a $14.6 million increase in sales from the Company's
Products Group, which experienced increased sales from its traditional contracts
with the federal government such as the Infrastructure Solutions 1 ("IS-1")
contract, the Realtime Automated Personnel Identification System contract
("RAPIDS"), and the Data Communication Network Contract servicing the US Courts
("DCN US Courts"). The increase in sales was also attributable to the
pass-through sales from its prime relationship on the Ft. Sill contract. This
contract was contributed to TelosOK in July 2000, however, the Company remains
as the prime contractor until the contract is successfully novated by the
government. The Xacta Group also experienced an increase in revenue, mostly due
to increased sales of its information security products and
solutions.
Operating income through the first nine months of 2001 was $3.3 million as
compared to an operating loss of approximately $600,000 during the same 2000
period. Operating profitability improved principally because of increased sales
volume coupled with improved profits realized under the Company's traditional
businesses.
Total backlog from existing contracts was approximately $124.3 million and
$124.4 million as of September 30, 2001 and December 31, 2000, respectively. As
of September 30, 2001, the funded backlog of the Company totaled $36.8 million,
a decrease of $6.2 million from December 31, 2000. Funded backlog represents
aggregate contract revenues remaining to be earned by the Company at a given
time, but only to the extent, in the case of government contracts, funded by a
procuring government agency and allotted to the contracts.
Results of Operations
The condensed consolidated statements of operations include the results of
operations of Telos Corporation and its wholly owned subsidiaries. The major
elements of the Company's operating expenses as a percentage of sales for the
three and nine month periods ended September 30, 2001 and 2000 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2001 2000 2001 2000
---- ---- ---- ----
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 82.2 88.0 82.6 86.5
SG&A expenses 13.0 12.0 14.4 13.9
Goodwill amortization 0.2 0.2 0.2 0.3
---- ----- ---- ----
Operating income (loss) 4.6 (0.2) 2.8 (0.7)
Other income 0.1 -- 0.1 --
Equity in net earnings of TelosOK -- 0.9 -- 2.6
Interest expense (2.4) (3.3) (2.7) (3.9)
Income tax provision (0.7) (3.9) (0.1) (1.3)
----- ----- ------ -----
Net income (loss) 1.6% (6.5)% 0.1% (3.3)%
=== ===== === ===
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,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----
(amounts in thousands)
Sales:
Systems and Support Services $ 14,882 $13,384 $ 45,582 $ 34,278
Products 18,582 18,709 65,017 50,446
Xacta 3,477 2,781 9,620 6,155
----- ----- ----- -----
Total $ 36,941 $34,874 $120,219 $ 90,879
======== ======= ======== ========
Gross Profit:
Systems and Support Services $ 1,295 $ 1,175 $ 4,212 $ 3,893
Products 3,908 1,965 13,308 6,589
Xacta 1,381 1,040 3,378 1,766
----- ----- ----- -----
Total $ 6,584 $ 4,180 $ 20,898 $ 12,248
======== ======= ======== ========
Gross Margin:
Systems and Support Services 8.7% 8.8% 9.2% 11.4%
Products 21.0% 10.5% 20.5% 13.1%
Xacta 39.7% 37.4% 35.1% 28.7%
Total 17.8% 12.0% 17.4% 13.5%
For the three month period ended September 30, 2001, sales increased by
$2.0 million, or 5.9% to $36.9 million from $34.9 million for the comparable
2000 period. The increase in sales was attributable to the Systems and Support
Services Group, which experienced an increase of $1.5 million in sales for the
three month period ended September 30, 2001 compared to the same period in 2000.
The Xacta Group also experienced an increase in revenue, mostly attributable to
sales from its information security products and solutions.
Sales increased $29.3 million or 32.3% to $120.2 million for the nine
months ended September 30, 2001, from $90.9 million for the comparable 2000
period. The increase for the nine-month period includes a $14.5 million increase
in Products' sales, an increase of $11.3 million in Systems and Support Services
sales, and an increase of $3.5 million in Xacta revenue. This increase in the
nine-month revenue is primarily due to the increases in revenue from the
Products Group traditional businesses as well as the pass-through sales contract
as mentioned above. These increases were enhanced by increased sales under the
Information Security product line of $3.5 million.
Cost of sales was 82.2% of sales for the quarter and 82.6% of sales for the
nine months ended September 30, 2001, as compared to 88.0% and 86.5% for the
same periods in 2000. The reductions in cost of sales as a percentage of sales
are primarily attributable to increased profits realized on Products Group
traditional contracts, such as IS-1, ATWCS and Courts, and from increased orders
under the Company's information security product line.
Gross profit increased approximately $2.4 million in the three-month period
to $6.6 million in 2001, from $4.2 million in the comparable 2000 period. Gross
profit increased $8.7 million in the nine-month period to $20.9 million in 2001
from $12.2 million in 2000. Gross margins were 17.8% and 17.4%, respectively,
for the three and nine month periods of 2001 as compared to 12.0% and 13.5%,
respectively, for the comparable periods of 2000.
Selling, general, and administrative expense ("SG&A") increased by
approximately $600,000 or 15.3%, to $4.8 million in the third quarter of 2001
from $4.2 million in the comparable period of 2000, which is primarily
attributable to the Company's increased investment in Xacta. For the nine month
period of 2001, SG&A increased approximately $4.7 million to $17.4 million from
$12.7 million in 2000, which is primarily due to an approximately $600,000
write-off of an investment made in an international joint venture as well as
increased investment in the product development, sales and marketing effort for
Xacta.
SG&A as a percentage of revenues increased to 13.1% for the third quarter
of 2001 from 12.0% in the comparable 2000 period. SG&A as a percentage of
revenues for the nine-month period ended September 30, 2001 increased to 14.4%
from 13.9% compared to the same period in 2000.
Goodwill amortization expense decreased $9,000 for the comparative
three-month periods of 2001 and 2000, and decreased by $63,000 to $187,000 for
the nine months ended September 30, 2001 compared to the same period in 2000.
The reductions are exclusively due to the goodwill transfer associated with the
TelosOK transaction.
The operating income of the Company increased by $1.8 million to
approximately $1.7 in the three-month period ended September 30, 2001 from an
operating loss of $80,000 in the comparable 2000 period. Operating income
increased $4.0 million to approximately $3.3 million for the nine months ended
September 30, 2001 from a $600,000 operating loss for the nine month period
ended September 30, 2000. The increases in operating profit for the three and
nine month periods are mostly attributable to the increases in gross profit
discussed above.
In order to present the statement of operations in accordance with APB 18,
the revenues and costs of sales for the Ft. Sill operation contributed to
TelosOK were presented in one line item "Equity in Net Earnings of TelosOK" for
the three and nine months ended September 30, 2000 (See Note 2). For 2000, the
three month and nine month Equity in Net Earnings of TelosOK were approximately
$300,000 and $2.3 million, respectively. The Company, under APB 18, is unable to
recognize its pro rata share of the income generated by TelosOk for 2001, as the
Company's capital account for TelosOK is negative.
Interest expense decreased approximately $300,000 to $900,000 in the third
quarter of 2001 from approximately $1.2 million in the comparable 2000 period,
and decreased approximately $300,000 to $3.2 million for the nine months ended
September 30, 2001 from $3.5 million for the comparable 2000 period. These
decreases are primarily due to decreased debt levels and declining interest
rates in the third quarter of 2001 compared to 2000.
The Company recorded an income tax provision for the three and nine months
ended September 30, 2001 of $261,000 and $112,000, respectively. This tax
provision was principally due to the net income generated by the Company. The
Company's net deferred tax assets totaled $7.6 million at September 30, 2001.
Failure to achieve forecasted taxable income may affect the ultimate realization
of the net deferred tax assets. Management believes the Company will generate
taxable income in excess of operating losses sufficient in amounts to realize
the net deferred tax assets. The Company recorded an income tax provision of
$1.4 million and $1.2 million for the three and nine months ended September 30,
2000, respectively. The provision incurred was a result of the taxable gain
generated from proceeds received from the contribution of assets to TelosOK in
July 2000 (see Note 2).
Liquidity and Capital Resources
For the nine months ended September 30, 2001, the Company generated $15.5
million of cash in its operating activities. This cash was provided by a
reduction in the Company's accounts receivable balance of $18.8 million, offset
by decreases in accounts payable of $4.3 million. Investing activities accounted
for approximately $500,000. The Company used cash to reduce borrowings under the
Company's credit facility of $14.4 million, and to repay $358,000 of Series C
Notes.
At September 30, 2001, the Company had outstanding debt and long-term
obligations of $30.2 million, consisting of $11.0 million under the secured
senior credit facility, $8.2 million in subordinated debt, and $11.0 million in
capital lease obligations. The Company believes it will generate enough funds in
the ordinary course of business, or from a debt or equity financing, during the
next twelve months to fund its operations and service its debt and capital lease
obligations.
At September 30, 2001, the Company had an outstanding balance of $11.0
million on its $25 million Senior Credit Facility (the "Facility"). The Facility
matures on March 1, 2002 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, 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. The Facility has
been classified as a current liability at September 30, 2001, as it has a term
of less than one year. On October 20, 2001, the Company was notified that Bank
of America had assigned 100% participation of this Facility to Endeavour, LLC.
New Accounting Pronouncements
The Company currently does not engage or plan to engage in the use of
hedging or derivative instruments. Therefore, the implementation of SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities" and SFAS 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities"
did not have a material impact on the results of operations, cashflows or
financial position.
On September 29, 2000, FASB Statement No. 140 ("SFAS 140") "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities",
was issued. The new standard replaces FASB Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
and becomes effective for transfers entered into after March 31, 2001. SFAS 140
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. The implementation of SFAS
140 did not have a material impact on the Company's consolidated financial
statements.
In June 2001, the Financial Accounting Standards Board ("FASB") approved
Statements of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141
addresses financial accounting and reporting for business combinations. All
business combinations in the scope of this Statement shall be accounted for
using the purchase method of accounting. The provisions of SFAS No. 141 apply to
all business combinations initiated after June 30, 2001, and business
combinations accounted for by the purchase method for which the date of
acquisition is July 1, 2001, or later. Certain transition provisions of SFAS No.
141 apply to business combinations for which the acquisition date was before
July 1, 2001, that were accounted for using the purchase method, as of the date
SFAS No. 142 is initially applied in its entirety. The adoption of SFAS No. 141
did not have a material effect on the Company's financial position, results of
operations or cash flows.
SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets. Implementation of this Statement will
require the Company to cease amortization of goodwill and goodwill will be
tested for impairment at least annually at the reporting unit level. Goodwill
will be tested for impairment on an interim basis if an 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 provisions of SFAS 142 are required to be applied starting
with fiscal years beginning after December 15, 2001 and will therefore be
applied for the year ending December 31, 2002. The Company is currently
evaluating the impact of SFAS No. 142 on its financial statements and related
disclosures.
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 or Disposal of Long-lived Assets" was issued. SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets and this statement supercedes FASB Statement No. 121, "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of".
The Company is currently evaluating the impact and materiality thereof, if any,
of SFAS 144 on its financial statements and related disclosures.
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
the Company's access to ongoing development, product support and viable channel
partner relationships with Enterworks.
The Senior Credit Facility is a current liability as it has a term of less
than one year. The Company is currently exploring opportunities to refinance its
Senior Credit Facility. If the Company is unable to refinance its Senior Credit
Facility with its existing lender or find a replacement lender, the Company's
liquidity position may be adversely impacted.
While in the past 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. The Company's U.S. Army contract at Ft. Monmouth was up for
re-bid, and on October 26, 2001, the Company was awarded one of two contracts.
Since this is a dual award, the Company will now compete for tasks under this
contract versus a sole source contract. The unsuccessful award of competitive
tasks could have an adverse effect on this contract. It should also be noted
that with the change of administration and its key government personnel, related
policy changes and detailed program-by-program review at each agency of the
federal government, especially the Department of Defense, the Company's high
percentage of revenue derived from business with the federal government could be
adversely impacted.
As a high percentage of the Company's revenue is derived from business with
the 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.
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. The weighted average interest rate for the first nine months of 2001 was
9.86%. This facility expires on March 1, 2002 and has an outstanding balance of
$11.0 million at September 30,2001.
The Company's other long-term debt at September 30, 2001 consists of Senior
Subordinated Notes B and C, which bear interest at fixed rates ranging from 14%
to 17%. Of the $8.2 million Senior Subordinated Notes balance at September 30,
2001 approximately $800,000 became currently due and payable as of April 1,
2001, and the remaining $7.4 million in principal becomes payable on April 1,
2002. The Company has no cash flow exposure due to rate changes for its Senior
Subordinated Notes.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is party to various lawsuits arising in the ordinary course of
business. In the opinion of management, 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 $3.8 million for the
Series A-1 and A-2 Preferred Stock at September 30, 2001.
12% Cumulative Exchangeable Redeemable Preferred Stock
Through November 21, 1995, the Company had the option to pay dividends in
additional shares of Preferred Stock in lieu of cash (provided there were no
blocks on payment as further discussed below). Dividends are payable by the
Company, provided the Company has legally available funds under Maryland law and
is able to pay dividends under its charter and other corporate documents, when
and if declared by the Board of Directors, commencing June 1, 1990, and on each
six month anniversary thereof. Dividends in additional shares of the Preferred
Stock were paid at the rate of 6% of a share for each $.60 of such dividends not
paid in cash. Cumulative undeclared dividends as of September 30, 2001 accrued
for financial reporting purposes totaled $28.4 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 $24,412,000.
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 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of common and preferred shareholders was held
on November 6, 2001. The only matter set forth in the meeting was the election
of directors. The shareholders of the common stock necessary to constitute a
quorum were present either in person or represented by proxy or attorney. Dr.
Fred Charles Ikle, John B. Wood, Norman P. Byers, Dr. Stephen D. Bryen, and
David S. Aldrich were elected to a term of approximately one year, a term to
expire at the next annual meeting of shareholders upon the election of their
successors.
With regard to the holders of the 12% Cumulative Exchangeable Redeemable
Preferred Stock, shareholders of such stock necessary to constitute a quorum
were not present and, therefore, the nominations of Malcolm M.B. Sterrett and
Geoffrey B. Baker were not considered. Subsequent to the shareholders meeting,
Malcolm M.B. Sterrett, an incumbent director, appointed Geoffrey B. Baker to
fill the term of John C. Boland, who resigned on October 2, 2001. Such
appointment was consistent with Article Fifth (C)7(b)(vi) of the Company's
Articles of Amendment and Restatement.
Item 5. Other Information
Mr. John C. Boland resigned from the Company's Board of Directors effective
October 2, 2001. His position was filled by Geoffrey B. Baker who was appointed
to the Board of Directors after the Company's annual meeting of shareholders on
November 6, 2001.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None.
Item 2 is not applicable and has 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
November 14, 2001 /s/ Thomas J. Ferrara
----------------------
Thomas J. Ferrara
(Principal Financial Officer &
Principal Accounting Officer)