TLS

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

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 1998, and the six-month period ended on that date. Telos Corporation provides systems integration, support services, and software solutions, with a significant portion of revenue derived from federal government contracts. The company operates through segments including Systems and Support Services, Systems Integration, and Enterworks.

Key Financial Metrics

Note: Debt figures include Senior Credit Facility ($23.8M), Senior Subordinated Notes ($17.0M), and Capital Leases ($11.9M).

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased by $21.9 million (19.5%) year-over-year. This was driven by an $18.8 million drop in Systems Integration revenue due to the expiration of the Immigration and Naturalization Services (INS) contract in September 1997 and a $4.7 million drop in Systems and Support Services following the sale of the Telos Information Systems (TIS) division.
• Profitability Shift: The company moved from an operating profit of $3.4 million in the prior year to an operating loss of $2.6 million. Gross margins contracted from 15.4% to 11.5% due to a less profitable product mix and under-absorption of fixed infrastructure costs.
• Asset Sale: In February 1998, Telos sold the TIS division for $14.7 million, recording a $5.7 million gain. This transaction significantly impacted cash flow and reduced goodwill amortization expenses.
• Debt Reduction: Net debt levels decreased due to $16.2 million in repayments under the senior credit facility and the retirement of Class B preferred stock.

Guidance, Outlook, and Risks

• Outlook: Management expects future 1998 quarterly revenues and operating profits to decrease compared to 1997 due to the TIS sale. While the company aims to expand its business base to offset this, there is no assurance of success.
• Liquidity: Cash on hand is low ($141,000). The company anticipates that operating cash flows and its $45 million senior credit facility will be adequate to fund operations through 1998.
• Covenant Compliance: As of June 30, 1998, the company was not in compliance with certain financial covenants in its senior credit facility, though the bank has waived this noncompliance.
• Preferred Stock Dividends: The company has not declared or paid dividends on its 12% Cumulative Exchangeable Redeemable Preferred Stock since 1991. Cumulative undeclared dividends accrued to $16.9 million. Holders of this stock elected two Class D directors in July 1998 due to arrears.
• Year 2000 Risk: The company expects to incur costs to ensure Year 2000 compliance. Failure of government agency systems could delay performance or lead to contract terminations.

Investor Verification Checklist

• Covenant Waiver Status: Verify the duration and conditions of the bank's waiver regarding financial covenant noncompliance.
• Backlog Conversion: Assess the risk of converting the $1.01 billion total backlog (of which $818.7 million is under the SMC-II contract expiring Sept 30, 1998) into revenue.
• Preferred Stock Liability: Review the impact of $16.9 million in accrued, unpaid preferred dividends and the potential for forced redemption or further governance changes.
• Cash Runway: Monitor the $141,000 cash balance against monthly burn rates and the availability of the senior credit facility.
• Government Contract Renewals: Evaluate the status of follow-up work for large contracts that expired in late 1997, specifically the INS contract.