TLS

Business Context and Reporting Period

Company: Telos Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 1999
Business Overview: Telos provides enterprise integration solutions, software development, and systems support, primarily to the U.S. federal government (92.8% of 1999 revenue). The company operates through two main segments: Systems and Support Services and the Products Group. A significant strategic shift occurred in 1999 with the deconsolidation of its e-commerce subsidiary, Enterworks, Inc., following a private placement that reduced Telos's ownership to 34.8%.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenue decreased 17.2% to $171.4 million. Approximately $23.9 million of this decline was due to the expiration of the Products Group's "SMC-II" contract in April 1999. The deconsolidation of Enterworks also removed $11.1 million of revenue that would have been reported in 1999.
• Profitability Improvement: Despite lower revenue, Operating Income improved from a loss of $7.3 million in 1998 to a profit of $2.2 million in 1999. This was driven by a 43.4% reduction in SG&A expenses (from $30.8M to $17.5M) due to the deconsolidation of Enterworks and the sale of the TFE division.
• Asset Reduction: Total assets dropped significantly from $95.3 million to $56.9 million, primarily due to the removal of Enterworks assets and liabilities from the consolidated balance sheet.
• Debt Restructuring: Long-term debt decreased by nearly $30 million. This included the conversion of approximately $7.6 million of subordinated notes into Enterworks stock and the use of $10 million in proceeds from the sale of the TFE division to pay down the Senior Credit Facility.

Guidance, Outlook, and Risks

• Strategic Focus: Management is transitioning toward a larger mix of fixed-price commerce solutions and higher-margin practices (information security, data integration, wireless networking), which saw revenue double to $15.8 million in 1999.
• Backlog: Total backlog decreased to $242.2 million from $923.3 million in 1998. The prior year's figure was inflated by the SMC-II contract which expired in 1999. The new follow-on contract (IS1) has a potential value of up to $380 million over five years.
• Liquidity and Covenants: The company had $7.1 million of unused availability on its $35 million Senior Credit Facility. However, the company was not in compliance with several covenants at year-end, though the bank has waived non-compliance and amended covenants to align with 2000 budget expectations.
• Preferred Stock Obligations: The company carries $43.0 million in redeemable preferred stock with cumulative dividend rates of 12% to 14.125%. Mandatory redemption of Senior Redeemable Preferred Stock is required by December 31, 2001.
• Risks: Significant concentration risk exists with the U.S. Federal Government (92.8% of revenue). Risks include contract termination at the government's convenience and delays in federal budget approvals.

Investor Verification Checklist

• Debt Covenant Compliance: Verify the status of the waivers and amended covenants with the Senior Credit Facility lender to ensure no immediate default risk.
• Preferred Stock Redemption: Assess the company's ability to fund the mandatory redemption of $43 million in preferred stock due in 2001 and 2005-2009, given the current accumulated deficit.
• Contract Renewals: Confirm the conversion of the new IS1 contract backlog into actual revenue, as the expiration of SMC-II caused a significant revenue drop.
• Enterworks Equity Method: Review the "Equity in Net Losses of Enterworks" line item ($18.8 million loss in 1999) to understand the ongoing financial drag from the minority stake.
• Deferred Tax Assets: Evaluate the realizability of the $7.7 million net deferred tax asset, which relies on future taxable income projections.