TLS

TELOS CORP 10-Q Summary: Period Ended September 30, 1998

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 1998, and the nine-month period ended on that date. Telos Corporation provides systems integration, support services, and software products, with a significant portion of revenue derived from federal government contracts. The company operates in a highly competitive environment and is currently facing revenue declines due to contract expirations and asset divestitures.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenue for the nine months ended September 30, 1998, decreased by 27% ($49.5 million) compared to the same period in 1997. This was driven by a $36.6 million drop in Systems Integration revenue (due to the expiration of the Immigration and Naturalization Services contract) and a $14.7 million drop in Systems and Support Services (due to the sale of the Telos Information Systems division).
• Profitability Shift: The company reported an operating loss of $6.1 million for the nine-month period, a reversal from an operating profit of $5.4 million in the prior year. Gross margins compressed from 14.3% to 10.3% due to unfavorable product mix and under-absorbed infrastructure costs.
• Asset Sale: In February 1998, the company sold the Telos Information Systems (TIS) division for $14.7 million, recording a one-time gain of $5.7 million. Without this gain, the net loss for the nine months would have been significantly higher.
• Debt Reduction: Total debt decreased as the company repaid $18.8 million under its senior credit facility and retired $6.0 million of Class B redeemable preferred stock.

Guidance, Outlook, and Risks

• Outlook: Management expects future quarterly revenues and operating profits to decrease compared to 1997 levels due to the TIS sale. The company anticipates that cash flows from operations and its senior credit facility will be adequate to fund operations through 1998 but is evaluating financing options for 1999.
• Covenant Compliance: As of September 30, 1998, the company was not in compliance with several covenants in its Senior Credit Facility (leverage, net worth, tangible capital, and fixed charge coverage). The bank has waived this noncompliance.
• Dividend Arrears: The company has not declared or paid dividends on its Senior Redeemable Preferred Stock or 12% Cumulative Exchangeable Redeemable Preferred Stock since 1991. Cumulative undeclared dividends totaled approximately $19.4 million as of September 30, 1998.
• Year 2000 Risk: The company faces potential risks related to Year 2000 compliance, including system failures in government agencies (its primary customers) and potential lawsuits regarding system components. Management does not currently believe a contingency plan is required but acknowledges the risk.
• Backlog: Funded backlog decreased to $89.6 million from $104.0 million at year-end 1997, primarily due to the TIS sale. Total backlog remains approximately $994 million, with $799.6 million tied to the SMC-II contract expiring January 31, 1999.

Investor Verification Checklist

• Verify the status of the bank's waiver regarding the Senior Credit Facility covenants and any potential for future non-compliance.
• Confirm the timeline and funding availability for the mandatory redemption of Senior Redeemable Preferred Stock due December 31, 2001.
• Assess the impact of the expiring SMC-II contract ($799.6 million backlog) on future revenue streams post-January 1999.
• Review the company's specific Year 2000 compliance strategy and potential exposure to litigation from government clients.
• Monitor the company's ability to secure additional financing for 1999 given the current cash position of $0.5 million and ongoing operating losses.