TLS

Business Context and Reporting Period

Company: Telos Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 1998
Business Overview: Telos provides enterprise integration solutions, software development, and systems support services, primarily to the U.S. federal government (92.9% of 1998 revenue). The company operates through three segments: Systems and Support Services, Products Group, and Enterworks, Inc. (a software subsidiary).
Strategic Shift: The company is transitioning from traditional contract labor to fixed-price commercial solutions and software products, evidenced by the sale of two contract labor divisions (TCS in 1996 and TIS in 1998) and increased investment in Enterworks.

Key Financial Metrics (Year Ended Dec 31, 1998)

Note: 1998 Net Loss includes a one-time gain of $5.7 million from the sale of the TIS division. Without this gain, the loss would have been significantly larger.

Material Changes vs. Prior Period

• Revenue Decline: Revenue dropped $46.7 million (18.4%) primarily due to the expiration of large contracts (INS Contract and INS BPA) and the sale of the TIS division in February 1998.
• Profitability Reversal: The company swung from an operating income of $7.4 million in 1997 to an operating loss of $7.3 million in 1998. This was driven by revenue declines, unfavorable product mix changes, and increased SG&A expenses to support new software ventures.
• Segment Performance:
  • Systems & Support Services: Revenue fell $22.8 million due to the TIS sale and contract expirations.
  • Products Group: Revenue fell $27.6 million due to the completion of the INS Contract.
  • Enterworks: Revenue doubled to $7.1 million (108% increase), though the segment remained unprofitable with a loss of $11.5 million.
• Asset Sales: Sold TIS division for $14.7 million cash, recording a $5.7 million gain.
• Debt & Equity: Retired $6.5 million of Class B Preferred Stock held by UBS and repurchased $1.6 million of Public Preferred Stock. Issued $1.8 million in new Series D Subordinated Notes.

Outlook, Risks, and Contingencies

• Going Concern Warning: The independent auditors (PricewaterhouseCoopers) and management have raised substantial doubt about the company's ability to continue as a going concern. The company incurred a net loss of $9.2 million and anticipates a need for approximately $10 million in additional financing for 1999.
• Covenant Violations: The company was not in compliance with several covenants of its Senior Credit Facility at year-end, though the lender has granted waivers and amended covenants to align with 1999 budget expectations.
• Financing Needs: Management plans to secure necessary funding through asset sales, additional lender financing, or equity financing. No assurance is given that this will be secured on favorable terms.
• Backlog: Total backlog was $923.3 million, but $786 million of this relates to the SMC-II contract expiring in April 1999. A follow-on contract (Infrastructure Solutions-1) was awarded in Q1 1999 with a potential value of $380 million.
• Year 2000 Compliance: The company is modifying internal software for Y2K compliance. While costs are not currently material, failure of government customers to achieve compliance could delay payments or terminate contracts.

Investor Verification Checklist

• Financing Status: Verify if the anticipated $10 million in additional financing for 1999 has been secured and under what terms.
• Covenant Compliance: Confirm current compliance status with the Senior Credit Facility covenants and the terms of the waivers granted by the lender.
• Contract Renewals: Assess the likelihood of converting the expiring SMC-II backlog into revenue under the new Infrastructure Solutions-1 contract.
• Enterworks Viability: Evaluate the timeline for Enterworks to reach profitability, as management does not expect this until after 1999.
• Preferred Stock Obligations: Review the mandatory redemption schedules and accrued dividend obligations for the Senior and Public Preferred Stock classes.