Business Context and Reporting Period
Company: TELOS CORP
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2003
Business Overview: Telos operates two primary continuing segments: the Products Group (secure wireless networking and messaging solutions for U.S. Government agencies) and Xacta (enterprise risk management and security certification software). The company exited its Systems and Support Services business in 2002, treating it as a discontinued operation.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2003 | Nine Months Ended Sep 30, 2003 |
|---|---|---|
| Total Sales | $30.3 million | $62.6 million |
| Operating Income (Loss) | $2.3 million | ($0.2 million) |
| Net Income (Loss) | ($1.0 million) | $3.4 million |
| Net Income Attributable to Common Equity | ($1.0 million) | $0.3 million |
| Gross Margin | 21.0% | 19.4% |
| Cash and Cash Equivalents | $0.2 million | (Balance Sheet) |
| Total Debt & Obligations | $84.3 million (Includes $65.6M preferred stock reclassified as liability) | |
| Working Capital | ($0.1 million) | (Current Assets $20.7M vs Liabilities $20.9M) |
Material Changes vs. Prior Period
- Revenue: Q3 2003 sales increased 19.9% year-over-year to $30.3 million, driven by a $4.7 million increase in the Products Group and growth in Xacta. However, nine-month sales decreased 2.0% to $62.6 million due to a decline in traditional government contracts.
- Profitability: Operating income improved significantly in Q3 to $2.3 million from a loss of $3.8 million in Q3 2002. This was driven by improved gross margins (21.0% vs 5.7%) and reduced SG&A expenses.
- Unusual Items: The nine-month net income of $3.4 million includes a non-recurring gain of $10.1 million from the sale of the company's 50% interest in TelosOK LLC. Excluding this gain, the company reported a loss from continuing operations.
- Accounting Changes: In accordance with SFAS 150, the company reclassified $65.6 million of redeemable preferred stock from equity to liabilities. Consequently, preferred stock dividends are now recorded as interest expense, increasing reported interest costs.
Guidance, Outlook, and Risks
- Backlog: Total backlog increased to $51.1 million as of September 30, 2003, up from $43.1 million in the prior year. Funded backlog stands at $42.1 million.
- Liquidity: The company maintains a $22.5 million senior revolving credit facility with $3.5 million in unused availability. Management believes current borrowing capacity is sufficient for foreseeable needs.
- Dividend Defaults: The company has not declared or paid dividends on its Senior Redeemable Preferred Stock or Public Preferred Stock since 1991 due to charter restrictions and debt covenants. Accrued unpaid dividends on Senior Preferred Stock totaled $4.6 million.
- Risks:
- Government Dependence: A high percentage of revenue is derived from U.S. Government contracts, subject to budget delays, reprioritization, or termination.
- Debt Covenants: The company must maintain specific tangible net worth and operating earnings covenants under its credit facility.
- Deferred Tax Assets: Realization of $8.3 million in net deferred tax assets depends on generating future taxable income.
Investor Verification Checklist
- Recurring Profitability: Verify if the company can sustain operating profitability without the one-time $10.1 million gain from the TelosOK LLC sale.
- Preferred Stock Liability: Confirm the impact of the $65.6 million preferred stock reclassification on leverage ratios and the feasibility of meeting future redemption obligations.
- Backlog Conversion: Monitor the conversion rate of the $51.1 million backlog into revenue, given the shift from long-term services to shorter-term product contracts.
- Debt Compliance: Review compliance with the Senior Credit Facility covenants, particularly tangible net worth requirements, given the stockholders' deficit of $68.1 million.
- Enterworks Investment: Assess the status of the 21.5% equity investment in Enterworks, Inc., which currently has a carrying value of zero due to prior losses.