TLS

TELOS CORP 10-Q Summary: Period Ended June 30, 1999

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 1999, and the six-month period ended on that date. Telos Corporation operates in three reportable segments: Systems and Support Services, Products, and Enterworks, Inc. The company primarily serves the federal government. As of August 9, 1999, the company had 21.2 million shares of Class A Common Stock and 4.0 million shares of Class B Common Stock outstanding, with no public market for the common stock.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 8.8% year-over-year, driven by a $12.5 million increase in the Products segment (due to the Joint Recruitive Information Support Services Blanket Purchase Agreement) and growth in Enterworks. This was partially offset by a $5.4 million decline in Systems and Support Services due to the 1998 sale of the Information Systems division and lower sales in Artillery Training Simulation devices.
• Profitability: While gross margins improved to 14.8% from 11.5%, operating losses widened to $3.2 million from $2.6 million. This deterioration was caused by a $4.8 million increase in Selling, General, and Administrative (SG&A) expenses, primarily due to increased R&D and marketing investments in the Enterworks subsidiary.
• Cash Flow: Operating cash flow improved significantly to $12.5 million, aided by a $17.7 million reduction in accounts receivable. However, the company used $10.7 million in financing activities to repay debt under its Senior Credit Facility.
• Backlog: Total backlog decreased to $712.8 million from $923.3 million due to the expiration of the SMCI Icontract. However, funded backlog increased to $86.1 million.

Outlook, Risks, and Contingencies

Going Concern Warning: Management has explicitly stated that the company may be unable to continue as a going concern. The company incurred net losses of $9.2 million in 1998 and $5.1 million in the first half of 1999. It anticipates a need for approximately $10 million in additional financing for the second half of 1999.

Debt Covenants: The company was not in compliance with several financial covenants of its Senior Credit Facility as of June 30, 1999. While the lender has provided waivers, future compliance is uncertain. The Senior Credit Facility ($25.5 million outstanding) matures on July 1, 2000, and will be classified as a current liability.

Preferred Stock Dividends: The company has not declared or paid dividends on its Senior Redeemable Preferred Stock or 12% Cumulative Exchangeable Redeemable Preferred Stock since 1991 due to legal and contractual restrictions. Cumulative undeclared dividends totaled approximately $23.6 million as of June 30, 1999.

Year 2000 Compliance: The company is working on internal software compliance but faces risks if government customers or suppliers fail to comply, which could delay payments or terminate contracts.

Investor Verification Checklist

• Financing Status: Verify if the anticipated $10 million in additional financing has been secured to sustain operations through 1999.
• Covenant Compliance: Confirm the status of waivers for the Senior Credit Facility and the likelihood of meeting amended covenants in the second half of 1999.
• Debt Maturity: Assess the refinancing plan for the $25.5 million Senior Credit Facility maturing July 1, 2000, and the $18.7 million in Senior Subordinated Notes maturing October 1, 2000.
• Dividend Arrears: Review the impact of $23.6 million in accrued, unpaid preferred dividends on future capital structure and liquidity.
• Backlog Conversion: Monitor the conversion of the $86.1 million funded backlog into revenue, given the recent expiration of the SMCI Icontract.