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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d)
The Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998
[ ]Transition Report Pursuant to Section 13 or 15(d)
The Securities Exchange Act of 1934
Commission file number: 1-8443
TELOS CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-0880974
(State of Incorporation) (I.R.S. Employer Identification No.)
19886 Ashburn Road, Ashburn, Virginia 20147
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number,
including area code: (703) 724-3800
Securities registered pursuant to Section 12(b)of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
12% Cumulative Exchangeable Redeemable Preferred Stock, par value $.01 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
No public market exists for the registrant's Common Stock.
As of March 28, 1999, the registrant had 21,238,980 shares of Class A
Common Stock, no par value; 4,037,628 shares of Class B Common Stock, no par
value; and 3,185,586 shares of 12% Cumulative Exchangeable Redeemable Preferred
Stock, par value $.01 per share, outstanding.
Incorporation by Reference: None
Number of pages in this report (excluding exhibits): 57
PART 1
Item 1. Business
History and Introduction
Founded in 1968, Telos Corporation ("Telos" or the "Company") delivers
enterprise integration solutions and services to customers in the U.S. federal
government and industry. Telos' product and service offerings span the entire
systems life cycle, including network and systems design, software development,
systems integration, hardware and software maintenance, and solutions for
emerging needs for enterprise network infrastructure management, data
integration, and information security. The Company headquarters is in Ashburn,
Virginia, part of Northern Virginia's growing Netplex region of high technology
companies. There are approximately 60 other offices throughout the United States
and around the world.
In today's dynamic business environment, timely and accurate information
flow is critical for success. Telos' specialized approach to this information
challenge is based on leveraging customers' IT infrastructure, delivering user
centric information, and enabling customers to achieve a fast return on
investment. Many customers are turning to the virtual enterprise as a model for
improving business performance through enhanced communications and business
processes. The virtual enterprise is a demand driven partnership of customers,
employees, partners and suppliers to deliver solutions. Telos' solutions are
aimed at overcoming the critical barriers that face the virtual enterprise: (1)
the difficulty in accessing disparate data without extensive programming, (2)
the inability to quickly integrate data to ensure customer responsiveness,
manufacturing and distribution efficiency and overall competitive strength, (3)
the problem of effectively distributing information quickly and securely and (4)
the challenge of making the organizational and technological complexity
invisible to end users.
Over each of the past three years, Telos has made significant investments
in the development of software and service solutions to facilitate the
transition of its business toward a larger mix of fixed price commerce
solutions. As part of this strategy, the Company has discontinued or divested
itself of those elements of its traditional business which were not consistent
with this strategy. In December 1996, Telos sold Telos Consulting Services
("TCS"), one of its contract labor divisions, for $31.6 million. In February
1998, Telos sold Telos Information Systems ("TIS"), another contract labor
division, for $14.7 million.
Reportable Operating Segments
During 1998, the Company provided its business solutions through three
operating segments: Systems and Support Services, its Products Group, and its
Enterworks subsidiary.
Systems and Support Services
The Company's Systems and Support Services Group provides software
development and support services for software and hardware including technology
insertion, system redesign, software re-engineering, Help Desk, and third party
maintenance. Key customers of this segment include: The U.S. Army at Ft. Sill in
Lawton, Oklahoma; the U.S. Army at Ft. Monmouth in Red Bank, New Jersey; and the
U.S. Army's Redstone Arsenal in Huntsville, Alabama. Telos is the largest
provider of software engineering services to the U.S. Army, maintaining over 50
million lines of software code for fire support systems. In addition, the
Company has supported seventy-nine tactical land and satellite communications
systems for the Communications-Electronics Command's Research, Development, and
Engineering Center. The Company's largest hardware services contract is for the
Redstone Arsenal where the Telos Call Center responds to support the Army's
Aviation and Missile Command. In addition to these traditional Telos customers
and services, the Company has information assurance, data integration and
enterprise management practices which generate higher margins and represent a
growing component of this segment.
For 1998, the Systems and Support Services Group generated revenue of $98.3
million, or 47.5%, of the Company's consolidated revenue. Both the TIS and TCS
divisions were part of the Systems and Support Services Group prior to their
respective sales in 1998 and 1996, respectively.
Products Group
The Products Group delivers product-based solutions for networking
environments. This group sells commercial products from most major original
equipment manufacturers. The Company is capable of staging, installing, and
deploying large network infrastructures with little disruption to the customer's
ongoing operations.
This operating segment also holds the largest network integration contract
ever awarded by the U.S. federal government. The Small Multi-user Computer
("SMC-II") contract has a three-year term that commenced with award in September
1995, and was extended through April 1999. The Products Group was awarded the
follow-on to the SMC II Contract, Infrastructure Solutions 1, in February 1999.
For 1998, the Products Group had revenues of $101.7 million, or 49.1%, of the
Company's consolidated revenues.
Enterworks, Inc.
Enterworks, Inc. ("Enterworks") develops, markets, licenses and supports
Web-enabled software products that integrate data, applications and business
processes throughout an enterprise. The Company's primary product is Virtual
DB(TM), which delivers single, integrated views of data across multiple,
disparate databases and platforms. These real-time views can easily be tailored
to a company's business model, and the cleansed, integrated data can be stored
in a data warehouse or forwarded to an enterprise software application. At the
end of 1998, the Company released Enterworks(TM) Process Manager ("EPM") for
Deployment, an innovative solution for reducing the cost, time and complexity of
implementing enterprise software packages. The technology underlying EPM for
Deployment uses intelligent agents that interact with existing databases and
business applications to automate data exchange and coordinate the execution of
tasks across any system using proven "best practices" models.
Enterworks' advanced solutions are targeted at companies with complex data
environments and a strong need to build competitive strengths by increasing
their speed, agility, and business intelligence. The Company focuses primarily
in government markets, manufacturing, and healthcare, offering specialized
consulting, training and support services as part of a total solution for its
customers.
For 1998, Enterworks had revenues of $7.1 million, or 3.4%, of the
Company's consolidated revenues.
Revenue by Major Market and Significant Customers
Revenue by major market for the Company are as follows:
Percentage of total consolidated revenue for
-------------------------------------------------
1998 1997 1996(1)
---- ---- -------
Federal government 92.9% 94.6% 84.8%
Commercial 5.1 3.9 13.6
State and local governments 2.0 1.5 1.6
---- ---- ----
Total 100.0% 100.0% 100.0%
====== ===== =====
(1) 1996 major market revenue percentages exclude TCS revenues. TCS was sold in 1996.
Total consolidated revenue derived from the federal government for 1998
includes 68.9% of revenue from contracts with the Department of Defense, 21.7%
of revenue from contracts with other Departments of the federal government, and
2.3% of revenue from subcontracts with U.S. government prime contractors.
Competition
The segments of the information services industry in which the Company
operates are highly fragmented with no single company or small group of
companies in a dominant position. Some of the Company's competitors also operate
in international markets, along with other entities, which operate exclusively
or primarily outside the United States. Some of the large competitors offer
services in a number of markets which overlap many of the same areas in which
the Company offers services, while certain companies are focused on only one or
a few of these markets. The firms which compete with the Company are computer
services firms, applications software companies and accounting firms, as well as
the computer service arms of computer manufacturing companies and defense and
aerospace firms. Thousands of firms fall into these categories. As the Company
becomes more focused on network-enabled enterprise computing, the competition
shifts to include companies that perform enterprise integration for large and
complex information technology environments. In addition, the internal staffs of
client organizations, non-profit federal contract research centers and
universities are competitors of the Company.
The Company believes that the principal competitive factors in the segments
of the information and network technology market in which it competes include
project management capability, technical expertise, reputation for providing
quality service, and price. The Company believes its technical competence in
computer engineering, systems software, engineering, system and network
integration, and hardware maintenance will enable it to compete favorably in the
information and network technology market.
Employees
The Company employed 1,155 persons as of December 31, 1998. The services
the Company provides require proficiency in many fields, such as computer
science, mathematics, physics, engineering, operations research, economics, and
business administration.
Of the total Company personnel, 807 provide Systems and Support Services,
105 are employed by Enterworks and 105 provide System Integration (Products)
Services. An additional 138 employees provide corporate and business services
functions.
Backlog
Many of the Company's contracts with the U.S. Government are funded by the
procuring government agency from year to year, primarily based upon the
government's fiscal requirements. This results in two different categories of
backlog: funded and unfunded. Total backlog consists of the aggregate contract
revenues remaining to be earned by the Company at a given time over the life of
its contracts, whether or not funded. Funded backlog consists of the aggregate
contract revenues remaining to be earned by the Company at a given time, but
only to the extent, in the case of government contracts, funded by a procuring
government agency and allotted to the contracts. Unfunded backlog is the
difference between total backlog and funded backlog. Included in unfunded
backlog are revenues which may be earned only if customers exercise delivery
orders and/or renewal options to continue existing contracts.
A number of contracts undertaken by the Company extend beyond one year, and
accordingly, portions of contracts are carried forward from one year to the next
as part of the backlog. Because many factors affect the scheduling and
continuation of projects, no assurance can be given as to when revenue will be
realized on projects included in the Company's backlog.
At December 31, 1998 and 1997, the Company had total backlog from existing
contracts of approximately $923.3 million and $1.0 billion, respectively. This
is the maximum value of additional future orders for systems, products,
maintenance and other support services presently allowable under those
contracts, including renewal options available on the contracts if exercised by
the client, over periods extending up to seven years. Included in the backlog at
December 31, 1998 is $786 million from the Company's SMC-II contract, which is
due to expire in April 1999 and is therefore unlikely to be converted to orders
and revenue of this magnitude in 1999. The Company has been awarded the
follow-on contract to SMC II, Infrastructure Solutions-1 ("IS1"), in the first
quarter of 1999. This contract has a five year term with an award amount not to
exceed $380 million. The backlog totals at December 31, 1998 do not include this
award. Approximately $56 million and $104 million of the total was funded
backlog at December 31, 1998 and 1997, respectively.
While backlog remains a useful measurement consideration, in recent years
the Company, as well as other federal contractors, experienced a change in the
manner in which the federal government procures equipment and services. These
procurement changes include the growth in the use of General Services
Administration ("GSA") schedules which allow agencies of the federal government
to purchase significant amounts of equipment and services. The use of the GSA
schedules results in a significantly shorter and much more flexible procurement
cycle, as well as increased competition as many companies hold such schedules.
Along with the GSA schedules, the federal government is awarding a large number
of omnibus contracts with multiple awardees. These contracts generally require
extensive marketing efforts by the awardees to procure business. The use of GSA
schedules and omnibus contracts, while generally not providing immediate
backlog, provide areas of potential growth that the Company continues to
aggressively pursue.
Overview of 1998
During 1998, Telos continued to make investments in order to execute its
strategy of transitioning its business toward a larger mix of fixed price
commerce solutions.
These investments included the continued development of Enterworks'
enterprise application integration software solutions, Virtual Database
("Virtual DB") and Enterworks Process Manager ("EPM"). Virtual DB 3.0 was
released in March 1999, and EPM 1.0 was released in December 1998. Enterworks'
revenue grew to $7.1 million in 1998, more than double 1997 revenue. The Company
expects Enterworks revenue to continue to increase in 1999 based on the status
of its products and its continuing investment in its sales and marketing
infrastructure to support those products. However, the Company does not expect
the Enterworks business to be profitable until after 1999, consistent with the
experience of comparable software companies at this stage of development.
The Company's 1998 investments were also focused on its higher margin
information assurance, data integration, advanced messaging and wireless
networking practices. Revenue for these practices approximated $7.0 million for
1998, which also represents a more than doubling of 1997 revenue. In December
1998, Telos announced a strategic partnership with Tivoli Systems, a subsidiary
of IBM, whereby Telos plans to provide professional services to support Tivoli
Products. This enterprise management practice will be an additional area of
emphasis for Telos in 1999 and beyond. As with Enterworks, the Company expects
total revenue for these practices will continue to grow in 1999 based in part on
its continuing investments in sales and marketing to support these practices.
The Company's 1998 activities also focused on reducing or eliminating
certain of its least profitable contracts. These reductions or eliminations were
principally within the Products Group, although there were also some targeted
reductions in the Systems and Support Services Group. With these business
reductions came decreases in related corporate infrastructure costs, including
sales, general and administrative ("SG&A") expenses. However, on a total company
basis, these cost reductions were more than offset by increases in SG&A costs to
support Enterworks and the other higher margin businesses noted above.
In February 1998, Telos sold substantially all of the net assets of its TIS
division for $14.7 million in cash. In connection with this sale, the Company
recorded a gain of $5.7 million in its consolidated statement of operations for
1998.
In May 1998, the Company entered into an agreement with one of its
shareholders, Union de Banques Suisses (Luxembourg) S.A. ("UBS"), to retire all
of UBS's equity holdings in the Company. These equity holdings included all of
the 7,500 shares of the Company's Class B Preferred Stock, 1,837,773 shares of
the Company's Class A Common Stock, and 1,312,695 of the Company's Class A
Common Stock warrants. The $5.9 million excess of the carrying amount of the
Class B Redeemable Preferred Stock over the redemption price was recorded as an
increase in capital in excess of par; there was no impact on income from this
transaction.
In November 1998, the Company retired 410,000 shares of the Public
Preferred Stock held by certain shareholders. The Company repurchased the stock
at $4.00 per share. The carrying value of these shares was determined to be $3.8
million, and the $2.2 million excess of the carrying amount of these shares of
Public Preferred Stock over the redemption price of $1.6 million was recorded as
an increase in capital in excess of par; there was no impact on income from this
transaction.
Item 2. Properties
The Company leases 191,700 square feet of space in Ashburn, Virginia for
its corporate headquarters, integration facility, and primary service depot.
This lease expires in March 2016, with a ten year extension available at the
Company's option. This facility supports all three of the Company's operating
segments.
The Company leases additional space for regional field engineering,
contract work sites, training, and sales offices in 56 separate facilities
located in 19 states and Europe under various leases, which expire on various
dates through February 2006. At December 31, 1998, the Company also owned two
buildings in Amery, Wisconsin. One of these buildings was sold in early 1999.
These facilities principally support the Company's Systems and Support Services
operating segment.
Item 3. Legal Proceedings
The Company is a party to various lawsuits arising in the ordinary course
of business. In the opinion of management, while the results of litigation
cannot be predicted with certainty, the final outcome of such matters will not
have a material adverse effect on the Company's consolidated financial position,
results of operations or of cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 1998, no matters were submitted to a vote of
security holders.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
No public market exists for the Company's Class A or Class B Common Stock.
As of March 1, 1999, there were 85 holders of the Company's Class A Common Stock
and 3 holders of the Company's Class B Common Stock.
Item 6. Selected Financial Data
The following should be read in connection with the accompanying
information presented in Item 7 and Item 8 of this document.
OPERATING RESULTS
Year Ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------
(amounts in thousands)
Sales (5) $207,086 $253,787 $188,895 $175,759 $150,676
(Loss) income from
continuing operations (9,171) 1,412 (9,816) 592 (11,838)
Discontinued Operations: (1)
Income (loss) from
discontinued operations -- -- 500 423 (583)
Gain on sale of
Consulting Services -- -- 11,524 -- --
(Loss) income before
extraordinary items (9,171) 1,412 2,208 1,015 (12,421)
Extraordinary items -- -- -- -- (196)
Net (loss) income (9,171) 1,412 2,208 1,015 (12,617)
FINANCIAL CONDITION
As of December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------
(amounts in thousands)
Total assets(5) $ 95,251 $109,718 $110,064 $94,492 $86,872
Long-term debt (2) 54,651 56,875 32,857 47,316 40,414
Capital lease obligations,
long-term (3) 11,710 12,085 12,537 -- --
Senior redeemable
preferred stock (4) 5,631 5,207 4,828 4,494 4,192
Class B redeemable
preferred stock (4) -- 12,035 11,087 10,252 9,497
Redeemable preferred
Stock (4) 31,729 29,951 24,230 18,647 14,263
(1) See Note 3 to the Consolidated Financial Statements in Item 8 regarding
the sale of TCS.
(2) See Note 5 to the Consolidated Financial Statements in Item 8 regarding
long-term debt obligations of the Company. Total long-term debt
obligations include amounts due under the Senior Credit Facility and
subordinated notes.
(3) See Note 9 to the Consolidated Financial Statements in Item 8 regarding
the capital lease obligations of the Company.
(4) See Note 6 to the Consolidated Financial Statements in Item 8 regarding
redeemable preferred stock of the Company.
(5) See Note 2 to the Consolidated Financial Statements in Item 8 regarding
the sale of TIS.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
Over the last three years, the Company has made significant investments in
the development of software and hardware products, operational infrastructure to
support contracts awarded to the Company, and sales and marketing. The Company's
investments in new software products provide the Company with an expanded
product line that, the Company believes, offers its customers unique value added
solutions for their computing and information gathering analysis problems. The
investment in software products is primarily through Enterworks and is focused
on the enterprise application integration market, through data integration and
information processing products. Additionally, the Company has established a
comprehensive offering of products and services on its GSA schedule. These
investments have enabled the Company to win most of its significant contract
rebids, and continue to provide significant new business opportunities.
During 1998, the Company experienced decreases in revenue and
profitability. Revenue decreased $46.7 million, or 18.4%, as compared to 1997.
Approximately $39.5 million of this decrease was attributable to the expiration
of two large contracts in 1997, which are discussed further below, and
approximately $20.7 million of the decrease was due to the sale of the TIS
division in February 1998. The operating loss for 1998 was $7.3 million, as
compared to operating income of $7.4 million in 1997. Operating profitability
declined principally as a result of the decreases in revenue and the Company's
continued investment in its majority-owned subsidiary, Enterworks, Inc.
Exclusive of Enterworks, the Company's earnings before interest and taxes for
1998 was $4.2 million. Profitability was also impacted by unfavorable changes in
the product mix of the Products Group and the under absorption of certain
infrastructure costs. These operating losses were partially offset by a $5.7
million gain on the sale of the TIS division in February 1998.
During 1997, the Company's revenue and profitability increased as compared
to 1996. Revenue increased $64.9 million, or 34.4%, primarily due to three large
projects awarded in 1997 which are discussed further below. Operating income for
1997 was $7.4 million, as compared to an operating loss of $9.4 million in 1996.
Operating profitability improved principally as a result of the increases in
revenue, as well as cost cutting measures initiated in 1996 and continued into
1997, which included staff reductions and branch consolidation.
The year ended December 31, 1996 was difficult from an operational
perspective due to the federal government budget impasse early in the year.
However, during 1996 the Company continued to invest in its contract and support
services infrastructure to accommodate a number of contracts awarded in late
1995. The Company also moved to a larger headquarters and systems integration
facility in 1996, which resulted in increased costs associated with the
relocation.
Revenue by Contract Type
Approximately 95% of the Company's total revenues in 1998 were attributable
to contracts with federal, state, and local governments, including 93%
attributable to the federal government. This represents a decrease of 2% from
1997 and relates primarily to the increase in commercial revenue generated from
Enterworks, Inc. in 1998. The Company's revenues are generated from a number of
contract vehicles. In general, the Company believes its contract portfolio is
characterized as having low to moderate financial risk as the Company has
limited long-term fixed price development contracts. The Company's firm fixed
price contracts consist principally of contracts for the purchase of computer
equipment at established contract prices or contracts for maintenance of
computer hardware. A significant portion of the Company's revenue is from time
and material and cost reimbursable contracts, which generally allow the
pass-through of allowable costs plus a profit margin. For 1998, revenue by
contract type was as follows: time and materials, 24.6%; firm fixed price,
56.8%; cost reimbursable, 13.7%; fixed monthly rate, 4.7%; and other, 0.2%.
While the Company has not experienced any significant recent terminations or
renegotiations, government contracts may be terminated or renegotiated at any
time at the convenience of the government.
Statement of Operations Data
The following table sets forth certain consolidated financial data and
related percentages for the periods indicated:
Year Ended December 31,
-----------------------------------------------------------------------
1998 1997 1996
------------------ ------------------- ---------------------
(dollar amounts in thousands)
Sales $207,086 100.0% $253,787 100.0% $188,895 100.0%
Cost of sales 182,915 88.3 218,430 86.1 168,281 89.1
Selling, general and
administrative expenses 30,842 14.9 27,054 10.7 29,055 15.4
Goodwill amortization 589 0.3 892 0.3 1,001 0.5
------- ---- ------- ----- ----- ----
Operating (loss) income (7,260) (3.5) 7,411 2.9 (9,442) (5.0)
Interest expense (6,555) (3.1) (7,455) (2.9) (5,668) (3.0)
Gain on Sale of Assets 5,683 2.7 -- -- -- --
Other income (expense) 64 -- 124 -- ( 445) (0.2)
------ ---- ------ ----- ------- ----
(Loss) income before taxes (8,068) (3.9) 80 -- (15,555) (8.2)
Income tax (provision) benefit (1,103) (0.5) 1,332 0.6 5,739 3.0
------- ----- ----- ---- ------ ---
(Loss) income from
continuing operations (9,171) (4.4) 1,412 0.6 (9,816) (5.2)
Discontinued Operations:
Income from discontinued
operations, net of tax -- -- -- -- 500 0.2
Gain on sale of TCS, net of tax -- -- -- -- 11,524 6.1
---- ---- ----- ---- ------ ---
Net (loss) income $ (9,171) (4.4)% $1,412 0.6% $ 2,208 1.1%
======= ====== ===== === ====== ===
Financial Data by Operating Segment
The Company has three reportable operating segments: Enterworks, Inc.,
Systems and Support Services, and Products.
Sales, gross profit and gross margin by market segment for the periods
designated below are as follows:
Year Ended December 31,
-----------------------------------------------------
1998 1997 1996
-----------------------------------------------------
(dollar amounts in thousands)
Revenue:
Enterworks, Inc. $ 7,073 $ 3,398 $ 2,140
Systems and Support Services 98,277 121,052 101,535
Products 101,736 129,337 85,220
------- ------- -------
Total $207,086 $253,787 $188,895
======= ======= =======
Gross Profit:
Enterworks, Inc. $ 1,542 $ (132) $ 955
Systems and Support Services 14,046 20,614 11,237
Products 8,583 14,875 8,422
------ ------ ------
Total $ 24,171 $ 35,357 $ 20,614
======= ====== =======
Gross Margin:
Enterworks, Inc. 21.8 % (3.9)% 44.6 %
Systems and Support Services 14.3 % 17.0 % 11.1 %
Products 8.4 % 11.5 % 9.9 %
Total 11.7 % 13.9 % 10.9 %
Results of Operations
Years ended December 31, 1998 and 1997
Revenue for 1998 was $207.1 million, a $46.7 million or 18.4% decrease from
1997. Approximately $27.6 million of this decrease was attributable to the
Products Group, which experienced lower revenue primarily due to the completion
of the Immigration and Naturalization Services Contract ("INS Contract") in the
third quarter of 1997. The INS contract contributed revenue of $27.8 million in
1997. In addition, the Systems and Support Services Group experienced a $22.8
million decrease in revenue for the year ended December 31, 1998 compared to the
same period of 1997. This decrease was primarily due to the sale of TIS in
February 1998 and the expiration of its Immigration and Naturalization Services
Blanket Purchase Agreement for Field Operation Support Contract ("INS BPA") in
the fourth quarter of 1997. TIS and INS BPA contributed revenue of $24.7 million
and $12.2 million, respectively, during 1997 with corresponding 1998 revenues of
$4.0 million and $100,000, respectively. The declines in Products and Systems
and Support Services revenue were partially offset by an increase of $3.7
million, or 108%, in Enterworks revenue for the year ended December 31, 1998
compared to the same period of 1997.
Cost of revenue was 88.3% of revenue for 1998, as compared to 86.1% for
1997. The increase in cost of revenue as a percentage of revenue is primarily
attributable to unfavorable changes in product mix and the under absorption of
infrastructure costs. On a dollar basis, the decrease in cost of revenue for the
year is primarily attributable to the decreases in revenue.
Gross profit decreased by $11.2 million or 31.6% from 1997 to 1998. The
decrease is primarily attributable to the revenue declines discussed above, as
well as the unfavorable changes in product mix and under absorption of
infrastructure costs.
Selling, general and administrative expenses ("SG&A") were $30.8 million in
1998 and $27.1 million in 1997. During 1998, the Company increased expenditures
for Enterworks research and development and sales and marketing by $5.1 million
and $1.2 million, respectively, as compared to the same 1997 period. Research
and development expense for 1998 included a net realizable value adjustment of
$1.7 million to capitalized software costs. However, these increases were
partially offset by reductions in other SG&A expenditures, relating principally
to the consolidation of certain administrative support functions.
Goodwill amortization expense decreased $303,000 to $589,000 for 1998, as
compared to $892,000 in 1997. This reduction is primarily due to a decrease in
the goodwill balance associated with the sale of the TIS division in early 1998.
Telos sold substantially all of the net assets of TIS in the first quarter
of 1998. The transaction generated $14.7 million in cash proceeds and a gain of
$5.7 million.
Interest expense decreased $900,000 to $6.6 million in 1998, from $7.5
million in 1997. This decrease is due principally to a decrease in the average
balance of the Senior Credit Facility for most of 1998 compared to 1997, as well
as a reduction in the bank's base rate due to changing economic conditions.
The income tax provision was $1.1 million for 1998. The tax provision was
primarily attributable to state income taxes, and increases in allowances
relating to the recoverability of deferred tax assets. An income tax benefit of
$1.3 million was recorded for 1997, principally because the Company reduced its
valuation allowance relating to net operating loss carryforwards expected to be
utilized as a result of the gain on the TIS sale.
Years ended December 31, 1997 and 1996
Revenue increased $64.9 million, or 34.4%, from $188.9 million in 1996 to
$253.8 million in 1997. This increase was attributable both to the Products
Group which reported an increase in sales of $44.1 million and the Systems and
Support Services Group with an increase in sales of $19.5 million.
The increase in the Systems Integration Group's revenue was primarily due
to orders under its Joint Recruiting Information Support System ("JRISS")
Blanket Purchase Agreement ($15.1 million) as well as its U.S. Courts Systems
Data Communication Network contract ($10.6 million) which were both awarded in
1997. In general, those 1996 contracts that continued into 1997 experienced
reduced order volume, except for the Small Multi-User Computer II ("SMC-II")
contract which had an increase in order volume of $25.7 million from 1996 to
1997.
The increase in the Systems and Support Services Group's revenue is
primarily attributable to the effect of a Blanket Purchase Agreement won and
completed in 1997 for the Immigration and Naturalization Service ($12.2
million). The TIS division, which held Jet Propulsion Laboratory contracts,
experienced an increase in revenue of $6.1 million in 1997, compared to 1996.
Hardware support revenues remained consistent between 1997 and 1996.
Cost of sales increased by $50.1 million, or 29.8%, to $218.4 million in
1997 from $168.3 million in 1996. This increase is the result of increased sales
during the year, and changes in the revenue product mix. The Systems and Support
Services Group benefited significantly as a result of new contract revenues
described above. The cost of labor required to support these new contracts, as a
percentage of revenue, was much less than to support traditional services
contracts, on a per hour basis. Additionally, the Systems and Support Services
Group implemented a cost reduction program to reduce labor and material costs in
the hardware support area. The Products Group benefited from the insertion of
new technology with lower cost components as part of the solutions provided in
its larger contracts. However, in the second half of 1997, certain additional
reserves for the write-off of inventory of approximately $1.8 million were
recorded.
Gross profit increased by $14.8 million for the year to $35.4 million in
1997, from $20.6 million in 1996. The increase is primarily attributable to the
changes in cost of sales discussed above and reflects the result of cost cutting
measures initiated in 1996 and continued in 1997, including staff reductions and
branch consolidation.
Selling, general and administrative (SG&A) expenses decreased for the year
by approximately $2.0 million, from $29.1 million in 1996 to $27.1 million in
1997. A reduction in SG&A costs in 1997 resulted from the Company's relocation
to a new headquarters facility. The lease for the new facility is considered a
capital lease rather than the previous operating lease. The Company also
realized a reduction in facility and operating costs as a result of the sale of
TCS in late 1996. Additionally, aggressive cost reduction programs implemented
in late 1996, reduced bid and proposal and sales and marketing expenses as well
as other discretionary expenses contributed to the decrease in SG&A expenses.
SG&A as a percentage of sales decreased to 10.7% for 1997 from 15.4% in 1996.
Goodwill amortization expense was $892,000 for 1997 compared to $1.0
million for 1996. The reduction in goodwill amortization is attributable to
reductions in the goodwill balance as a result of the sale of TCS which reduced
goodwill by approximately $6.9 million in 1996.
The change from an operating loss of $9.4 million in 1996 to operating
income of $7.4 million in 1997 is a result of the increases in gross profit and
the decreases in SG&A discussed above.
Other non-operating income of $124,000 for 1997 is compared to an expense
of $445,000 in 1996. The income in 1997 is attributable to non-operating refunds
and other miscellaneous charges. The expense in 1996 was attributable to costs
required to settle a previous non-operating related lawsuit.
Interest expense increased approximately $1.8 million to $7.5 million for
1997, as compared to $5.7 million in 1996. The increase is a result of the
significant increase in the average outstanding balance of the Senior Credit
Facility for most of 1997, as well as an increase in interest recorded for
capital lease obligations associated with the mid-1996 move by the Company to
its new manufacturing and support facility in Ashburn, Virginia.
The deferred tax benefit recognized for 1997 of $1.3 million represents the
reduction of the valuation allowance related to net operating loss carryforwards
which are expected to be utilized to offset the taxable gain of approximately
$11 million were recognized related to the sale of TIS in February 1998.
Liquidity and Capital Resources
The Company's capital structure consists of a revolving credit facility,
subordinated notes, and redeemable preferred stock and common stock.
At December 31, 1998, the Company had an outstanding balance of $36.2
million on its $45 million Senior Credit Facility (the "Facility"). The Facility
matures on July 1, 2000 and is collateralized by certain assets of the Company
(primarily inventory and accounts receivable). The amount of borrowings
fluctuates based on the underlying asset borrowing base as well as the Company's
working capital requirements. At December 31, 1998, the Company, under its
borrowing base formula, had $6.7 million of unused availability. The Facility
has various covenants which may, among other things, restrict the ability of the
Company to merge with another entity, sell or transfer certain assets, pay
dividends and make other distributions beyond certain limitations. The Facility
also requires the Company to meet certain leverage, net worth interest coverage
and operating goals. At December 31, 1998, the Company was not in compliance
with several covenants contained in the Facility; however, the bank has waived
this non-compliance. In addition, the bank has amended the covenants to conform
to the Company's 1999 budget expectations.
The Company's subordinated notes are held principally by shareholders and
management, and totaled $18.5 million at December 31, 1998. These notes bear
interest at rates between 8% and 17% and become payable in 2000 through 2001.
The Company currently has two primary classes of redeemable preferred stock
- - Senior Redeemable Preferred Stock and Public Preferred Stock. Each class
carries cumulative dividend rates of 12% to 14.125%. At December 31, 1998 the
total carrying value of redeemable preferred stock, including accumulated and
unpaid dividends, was $37.4 million. The Company accrues dividends and provides
for accretion related to the redeemable preferred stock. Mandatory redemption
for the Senior Redeemable Preferred Stock including all dividends payable, is
required on December 31, 2001, subject to the legal availability of funds.
Mandatory redemption for the Public Preferred Stock is required from 2005
through 2009, subject to the legal availability of funds.
Cash used by operating activities was $2.7 million in 1998, due primarily
to the year's net loss and an increase in accounts receivable as a result of
sales growth in the fourth quarter compared to the prior year's fourth quarter.
Cash provided by investing activities was $11.4 million in 1998, reflecting
capital expenditures of $1.3 million and $2.0 million in continued investments
in software development costs related to Enterworks, offset by the proceeds from
the sale of TIS of $14.7 million. The Company used cash from financing
activities of $8.9 million in 1998, reflecting principally the payment of $6.5
million for the retirement of the UBS equity holdings, the repurchase of 410,000
shares of Redeemable Preferred Stock for $1.6 million, and net payments on the
Facility.
In February 1998, the Company sold its TIS division for approximately $15
million. The net proceeds from the sale were used to pay down amounts
outstanding under the Facility.
In May 1998, the Company retired all of the equity holdings of Union de
Banques Suisses (Luxembourg) S.A. for $6.5 million, of which $5 million was paid
in cash in May 1998, and the remaining $1.5 million was funded by two separate
letters of credit. UBS was paid $1.0 million in September 1998 using the first
letter of credit secured by the Company's lender and $500,000 in November 1998
using the second letter of credit.
In November 1998, the Company retired 410,000 shares of the Public
Preferred Stock held by certain shareholders. The Company repurchased the stock
at $4.00 per share. The carrying value of these shares was $3.8 million, and the
$2.2 million excess of the carrying amount of these shares of Public Preferred
Stock over the redemption price of $1.6 million was recorded as an increase in
capital in excess of par; there was no impact on income from this transaction.
In November 1998, the Company issued additional Senior Subordinated Notes
to certain shareholders which are classified as Series D. The Series D Notes
total $1.8 million and are unsecured. The Series D Notes have a maturity date of
October 1, 2000 and bear interest at 14% per annum. Interest is paid quarterly
on January 1, April 1, July 1, and October 1 of each year. The notes can be
prepaid at the Company's option. These Notes contain the same payment premium
provisions as the Series B and Series C Notes (see above). In connection with
the debt, the Company issued 1,500,000 warrants to purchase shares of the
Company's Class A Common Stock. The warrants have an exercise price of $.01 and
an exercise period of 22 months. The Company has assigned a value to the
warrants of $420,000 which has been included in capital in excess of par. The
amount outstanding of the subordinated debt was approximately $1,396,000 at
December 31, 1998.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. However, as
reflected in the accompanying financial statements, the Company incurred a net
loss of $9.2 million in 1998. This loss included the effect of a $5.7 million
non-recurring gain from the sale of its TIS division. In addition, the Company
was not in compliance with several covenants of its Senior Credit Facility,
although the lender has provided waivers for the violations and has amended the
covenants to conform to the Company's 1999 budget expectations. Based on its
budget, the Company anticipates a need for approximately $10 million of
additional financing for 1999. These factors, including the uncertainty
surrounding whether and when the additional financing will be secured and
whether the Company will meet its budget expectations and bank covenants in
1999, indicate that the Company may be unable to continue as a going concern for
a reasonable period of time. The financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to obtain the additional financing required, meet its 1999 budgeted
cash flow objectives, and comply with the terms of its Senior Credit Facility.
The Company believes that the necessary additional financing will be
secured through one or more of the following sources: the sale of a division or
asset which is not critical to its strategic goals; additional financing from
its lender; or additional equity financing. Alternatives are currently being
pursued under each of these sources; however, the required financing has not yet
been secured. The Company believes the required funding will be arranged in a
timely manner that does not have a significant adverse impact on its operations.
However, there can be no assurance that the Company will be able to secure
financing sufficient for its needs and at terms favorable to the Company.
Additionally, there can be no assurance that the Company will be successful in
meeting budget expectations and bank covenants in 1999. Failure by the Company
to obtain sufficient financing, meet its budget expectations, or meet its bank
covenants may have a material adverse effect on the Company's financial
position, results of operations or cash flows. See also Note 1 to the
Consolidated Financial Statements.
Capital Expenditures
The Company believes that its business is generally not capital intensive.
Capital expenditures for property and equipment were $1.2 million in 1998 and
$2.6 million in each of 1997 and 1996. The Company incurred capital expenditures
in 1996 as a result of moving to a new headquarters and integration facility. In
1996, the Company entered into a twenty year lease for a building that provides
significantly more integration and warehouse space. The Company anticipates
capital expenditures of approximately $2.6 million in 1999, however, there can
be no assurance that this level of capital expenditures will occur.
Inflation
The rate of inflation has been moderate over the past five years and,
accordingly, has not had a significant impact on the Company. The Company has
generally been able to pass through increased costs to customers through higher
prices to the extent permitted by competitive pressures. The Company's cost
reduction efforts have offset the effects of inflation, if any, on the Company's
performance.
Year 2000
Year 2000 issues refer generally to the problems that some software may
have in determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures or the
creation of erroneous results.
The Company, like most owners of computer software, is modifying
significant portions of its internal use software so that it will function
properly in the Year 2000. Accordingly, the Company has incurred and expects to
continue to incur internal staff costs as well as consulting and other expenses
related to software and infrastructure enhancements necessary to prepare the
systems for the Year 2000. Total expenditures for such costs were not material
to the Company's consolidated financial statement in 1998 or 1999. The Company
expects to complete its internal use software compliance efforts during 1999.
Maintenance, modification costs and software purchased with the express purpose
of fixing the Year 2000 problem are expensed as incurred.
The Company has queried its key suppliers and vendors to assess their Year
2000 readiness and has been informed that software licensed to the Company for
resale will be compliant by the Year 2000. Therefore, the Company is not aware
of any problems that would have a material adverse impact on its financial
position, results of operations or cash flows. However, the Company has no means
of ensuring compliance by its suppliers or vendors. If its suppliers and vendors
are not Year 2000 compliant, there could be a material adverse effect on the
Company.
As is the case with other similarly situated computer companies, if Telos'
current or future customers fail to achieve Year 2000 compliance or if they
divert technology expenditures to address Year 2000 compliance problems, Telos'
business, results of operations or financial condition could be materially
adversely affected. For example, agencies of the United States Government are
principal customers of the Company. If such agencies experience significant Year
2000 system failures, under terms of typical government contracts, the Company's
performance and/or receipt of payments due could be delayed or contracts could
be terminated for convenience, which could have a material adverse effect on the
Company. If similar failures are experienced by other customers or potential
customers of the Company, this could also have a material adverse impact on the
Company.
Based on its internal review and the compliance information received from
its suppliers and vendors, the Company does not believe that there is a need for
a contingency plan for Year 2000 system non-compliance. Such a plan will be
developed if the Company becomes aware of any Year 2000 non-compliance that
would impact its critical operations. The cost of developing and implementing
such a plan, if required, may in itself be material.
Although the Company does not believe that it will incur any material
unanticipated costs or experience material disruptions in its business
associated with preparing its internal systems for the Year 2000, there can be
no assurances that the Company will not experience serious unanticipated
consequences and/or material costs caused by undetermined errors or defects in
the technology used in its systems, which are composed of third party software,
third party hardware that contains embedded software and the Company's own
software products. A worst case scenario could include: (i) corruption of data
contained in the Company's internal information systems, (ii) interruptions,
delays or terminations in the Company's business with government agencies or
other customers associated with their own Year 2000 problems, and (iii) the
failure of infrastructure services provided by government agencies and other
third parties (e.g., electricity, phone service, water transport, internet
services, etc.). Any of these unexpected outcomes could have a material adverse
effect on the Company.
Management believes that computer systems and software created and sold by
the Company is compliant or will be compliant by the Year 2000. However, because
the Company is in the business of selling computer systems, the Company's risk
of being subjected to lawsuits relating to Year 2000 issues is likely to be
greater than that of other industries. Computer systems may involve different
hardware and software components from different manufacturers; therefore, it may
be difficult to determine which component in a computer system may cause a Year
2000 issue. As a result, the Company may be subjected to Year 2000 related
lawsuits independent of whether its products and services are Year 2000
compliant. The outcomes of such lawsuits and the impact on the Company cannot be
determined at this time.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This standard
requires companies to capitalize qualifying computer software costs which are
incurred during the application development stage and amortize them over the
software's estimated useful life. SOP 98-1 is effective for fiscal years
beginning after December 15, 1998. The Company is currently evaluating the
impact of SOP 98-1 on its financial statements and related disclosures.
In November 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-9 ("SOP 98-9"), "Modification of SOP 97-2,
"Software Revenue Recognition", with Respect to Certain Transactions". The
Company is currently evaluating the impact of SOP 98-9 on its financial
statements and related disclosures.
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects" and
similar expressions are intended to identify forward-looking statements. There
are a number of important factors that could cause the Company's actual results
to differ materially from those indicated by such forwarding-looking statements.
These factors include, without limitation, those set forth below under the
caption "Certain Factors That May Affect Future Results."
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results
to differ materially from those indicated by forward-looking statements made in
this Annual Report on Form 10-K and presented elsewhere by management from time
to time.
A number of uncertainties exist that could affect the Company's future
operating results, including, without limitation, general economic conditions,
the timing and approval of the federal government's fiscal year budget, business
growth through obtaining new business and, once obtained, the Company's ability
to successfully perform at a profit, the Company's ability to convert contract
backlog to revenue, the Company's ability to secure adequate capital and
financing to support its business, the success of the Company's investments in
Enterworks, and the risk of the federal government terminating contracts with
the Company. While the Company has not experienced contract terminations with
the federal government, the federal government can terminate at its convenience.
Should this occur, the Company's operating results could be adversely impacted.
As a high percentage of the Company's revenue is derived from business with
the federal government, the Company's operating results could be adversely
impacted should the federal government not approve and implement its annual
budget in a timely fashion.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. However, as
reflected in the accompanying financial statements, the Company incurred a net
loss of $9.2 million in 1998. This loss included the effect of a $5.7 million
non-recurring gain from the sale of its TIS division. In addition, the Company
was not in compliance with several covenants of its Senior Credit Facility,
although the lender has provided waivers for the violations and has amended the
covenants to conform to the Company's 1999 budget expectations. Based on its
budget, the Company anticipates a need for approximately $10 million of
additional financing for 1999. These factors, including the uncertainty
surrounding whether and when the additional financing will be secured and
whether the Company will meet its budget expectations and bank covenants in
1999, indicate that the Company may be unable to continue as a going concern for
a reasonable period of time. The financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to obtain the additional financing required, meet its 1999 budgeted
cash flow objectives, and comply with the terms of its Senior Credit Facility.
The Company believes that the necessary additional financing will be
secured through one or more of the following sources: the sale of a division or
asset which is not critical to its strategic goals; additional financing from
its lender; or additional equity financing. Alternatives are currently being
pursued under each of these sources; however, the required financing has not yet
been secured. The Company believes the required funding will be arranged in a
timely manner that does not have a significant adverse impact on its operations.
However, there can be no assurance that the Company will be able to secure
financing sufficient for its needs and at terms favorable to the Company.
Additionally, there can be no assurance that the Company will be successful in
meeting budget expectations and bank covenants in 1999. Failure by the Company
to obtain sufficient financing, meet its budget expectations, or meet its bank
covenants may have a material adverse effect on the Company's financial
position, results of operations or cash flows.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's long-term debt obligations.
The Company is exposed to interest rate volatility with regard to its
variable rate debt obligations under its Senior Credit Facility. This facility
bears interest at 1.00%, subject to certain adjustments, over the bank's base
rate. The weighted average interest rate in 1998 was 9.95%. This facility
expires on July 1, 2000 and has outstanding balance of $36.2 million at December
31, 1998.
The Company's other long-term debt at December 31, 1998 consists of Senior
Subordinated Notes B, C, and D which bear interest at fixed rates ranging from
14% to 17%. The Senior Subordinated Notes mature as to principal in the
aggregate amount of $16,173,000 on October 1, 2000. Additionally, the Company
has subordinated debt issued by their majority owned subsidiary, Enterworks,
which bears interest at a fixed rate of 8%. The Enterworks Notes mature as to
principal in the aggregate amount of $3,277,960 on January 1, 2000. The Company
has no cash flow exposure due to rate changes for its Senior Subordinated or
Enterworks Notes.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Accountants - PricewaterhouseCoopers LLP..............................................19
Consolidated Statements of Operations for the Years Ended
December 31, 1998, December 31, 1997, and December 31, 1996.............................................20
Consolidated Balance Sheets as of December 31, 1998 and
December 31, 1997.......................................................................................21-22
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, December 31, 1997, and December 31, 1996.............................................23
Consolidated Statements of Changes In Stockholders' Investment (Deficit)
for the Years Ended December 31, 1998, December 31, 1997,
and December 31, 1996...................................................................................24
Notes to Consolidated Financial Statements..................................................................25-43
INDEX TO SCHEDULES
All schedules are omitted because they are not applicable or the required
information is included in the consolidated financial statements or notes
thereto.
Report of Independent Accountants
To the Board of Directors and Stockholders
of Telos Corporation
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of cash flows and of changes in
stockholders' investment (deficit) present fairly, in all material respects, the
financial position of Telos Corporation and its subsidiaries at December 31,
1998 and 1997, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company has suffered losses from
operations and has not yet been able to obtain sufficient financing for 1999
working capital purposes. These conditions raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
PRICEWATERHOUSECOOPERS LLP
McLean, VA
April 1, 1999
TELOS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands)
Year Ended December 31,
-------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------
Sales
Enterworks, Inc. $ 7,073 $ 3,398 $ 2,140
Systems and Support Services 98,277 121,052 101,535
Products 101,736 129,337 85,220
------- ------- -------
207,086 253,787 188,895
------- ------- -------
Costs and expenses
Cost of Enterworks, Inc. 5,531 3,530 1,185
Cost of Systems and
Support Services 84,231 100,438 90,298
Cost of Products 93,153 114,462 76,798
Selling, general and
administrative expenses 30,842 27,054 29,055
Goodwill amortization 589 892 1,001
------ ------- -------
214,346 246,376 198,337
------- ------- -------
Operating (loss) income (7,260) 7,411 (9,442)
Other income (expenses)
Non-operating income (expense) 64 124 (445)
Gain on sale of assets 5,683 -- --
Interest expense (6,555) (7,455) (5,668)
------- ------ -----
(Loss) income before income taxes (8,068) 80 (15,555)
(Provision) benefit for income taxes (1,103) 1,332 5,739
--------- ------ ------
(Loss) income from continuing
operations (9,171) 1,412 (9,816)
Discontinued operations:
Income from discontinued
operations (net of income tax
provision of $566) -- -- 500
Gain on sale of Consulting
Services, (net of income tax
provision of $6,327) -- -- 11,524
------ ------ ------
Net (loss) income $ (9,171) $ 1,412 $ 2,208
========= ====== ======
The accompanying notes are an integral part of these consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
ASSETS
December 31,
---------------------------------
1998 1997
---------------------------------
Current assets
Cash and cash equivalents
(includes restricted cash of
$160 at December 31, 1998) $ 408 $ 587
Accounts receivable, net 56,783 57,972
Inventories, net 8,662 12,390
Deferred income taxes 4,164 4,632
Prepaid income taxes 220 268
Other current assets 487 408
------- ------
Total current assets 70,724 76,257
------- ------
Property and equipment
Land and building 346 346
Furniture and equipment 21,677 21,469
Leasehold improvements 2,683 2,750
Property and equipment
under capital leases 13,774 13,774
------ ------
38,480 38,339
Accumulated depreciation
and amortization (24,159) (22,609)
-------- ------
14,321 15,730
------ ------
Goodwill, net 6,896 12,466
Deferred income taxes 442 385
Other assets 2,868 4,880
------- -------
$ 95,251 $109,718
======= =======
The accompanying notes are an integral part of these consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share data)
LIABILITIES AND STOCKHOLDERS' INVESTMENT (DEFICIT)
December 31,
---------------------------
1998 1997
---------------------------
Current liabilities
Accounts payable $ 25,206 $16,912
Accrued compensation and benefits 7,400 8,553
Unearned warranty revenue 1,349 1,135
Current portion, capital lease obligations 379 430
Other current liabilities 3,117 5,401
------ -----
Total current liabilities 37,451 32,431
Senior credit facility 36,159 39,945
Senior subordinated notes 18,492 16,930
Capital lease obligations 11,710 12,085
------- -------
Total liabilities 103,812 101,391
------- -------
Commitments and contingencies (Note 9)
Redeemable preferred stock
Senior redeemable preferred stock 5,631 5,207
Class B redeemable preferred stock -- 12,035
Redeemable preferred stock 31,729 29,951
------ ------
37,360 47,193
------ ------
Stockholders' investment
Class A common stock, no par value,
50,000,000 shares authorized, 21,238,980 and
23,076,753 shares issued and outstanding at
1998 and 1997, respectively 65 65
Class B common stock, no par value, 50,000,000 shares
authorized, 4,037,628 shares issued and outstanding 13 13
Capital in excess of par 2,116 --
Accumulated deficit (48,115) (38,944)
--------- ------
Total stockholders' investment (deficit) (45,921) (38,866)
--------- ------
$ 95,251 $109,718
======== =======
The accompanying notes are an integral part of these consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
Year Ended December 31,
---------------------------------
1998 1997 1996
---------------------------------
Operating activities:
Net (loss) income $(9,171) $ 1,412 $ 2,208
Adjustments to reconcile net income
to cash used in operating activities:
Depreciation and amortization 4,266 4,098 3,058
Gain on sale of TCS -- -- (17,176)
Loss on disposal of fixed assets -- 715 --
Goodwill amortization 589 892 1,418
Amortization of debt issuance costs 243 243 243
Accretion of subordinated notes 181 143 78
Provision for inventory obsolescence 1,254 2,150 1,008
Provision for doubtful accounts receivable 39 490 647
Gain on sale of assets (5,683) -- --
Provision for net realizable value of other assets 1,743 887 --
Deferred income tax provision (benefit) 434 (1,719) 900
Changes in assets and liabilities
Increase in accounts receivable (2,329) (6,913) (14,487)
Decrease (increase) in inventories 2,826 2,186 (2,364)
Decrease (increase) decrease in other assets (76) 795 (2,319)
Increase (decrease) in accounts payable and
other liabilities 3,031 (20,559) 11,283
------ -------- ------
Cash used in operating activities (2,653) (15,180) (15,503)
------- ------- ------
Investing activities:
Proceeds from sale of assets 14,675 -- --
Proceeds from sale of discontinued operations -- -- 31,579
Purchase of property and equipment (1,250) (2,589) (2,558)
Investment in other assets (2,040) (3,083) (1,422)
------- ------- -------
Cash provided by (used in) investing activities 11,385 (5,672) 27,599
------ ------- ------
Financing activities:
(Payments) proceeds from Senior Credit Facility (3,786) 24,526 (16,894)
Proceeds from debt issuance 1,800 -- 3,278
Increase (decrease) in book overdrafts 1,641 (4,838) 3,833
Repayment of long-term debt -- (651) --
Retirement of Class B redeemable preferred stock (6,500) -- --
Repurchase of 410,000 shares of redeemable
preferred stock (1,640) -- --
Payments under capital lease obligations (426) (379) (267)
------- ------- -------
Cash (used in) provided by financing
activities ( 8,911) 18,658 (10,050)
-------- ------ ------
(Decrease) increase in cash and cash equivalents (179) (2,194) 2,046
Cash and cash equivalents at beginning of the year 587 2,781 735
------ ----- -----
Cash and cash equivalents at end of year $ 408 $ 587 $ 2,781
====== ===== ======
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 5,228 $6,872 $ 5,760
======= ====== ======
Income taxes 1,088 $ 92 $ 187
======= ====== ======
Supplemental schedule of non-cash investing activities:
Assets under capital lease $ -- $ --- $13,154
======= ====== ======
The accompanying notes are an integral part of these consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT (DEFICIT)
(amounts in thousands)
Total
Class A Class B Capital Stockholders'
Common Common In Excess Accumulated Investment
Stock Stock of Par Deficit (Deficit)
----- ----- ------ --------- ---------
Balance December 31, 1995 $65 $13 $7,669 $(37,356) $(29,609)
Senior redeemable preferred stock dividend -- -- -- (334) (334)
Class B redeemable preferred stock dividend -- -- -- (835) (835)
Redeemable preferred stock dividend -- -- (3,272) (1,039) (4,311)
Redeemable preferred stock accretion -- -- (1,270) -- (1,270)
Issuance of Enterworks common stock warrants -- -- 921 -- 921
Net income for the year -- -- -- 2,208 2,208
-- -- ----- ------ ------
Balance December 31, 1996 65 13 4,048 (37,356) (33,230)
Senior redeemable preferred stock dividend -- -- (379) -- (379)
Class B redeemable preferred stock dividend -- -- (948) -- (948)
Redeemable preferred stock dividend -- -- (2,721) (1,594) (4,315)
Redeemable preferred stock accretion -- -- -- (1,406) (1,406)
Issuance of Net income for the year -- -- -- 1,412 1,412
-- -- ------ ------ ------
Balance December 31, 1997 65 13 -- (38,944) (38,866)
Senior redeemable preferred stock dividend -- -- (423) -- (423)
Class B redeemable preferred stock dividend -- -- (347) -- (347)
Redeemable preferred stock dividend -- -- (4,068) -- (4,068)
Redeemable preferred stock accretion -- -- (1,527) -- (1,527)
Gain on retirement of Class B redeemable
preferred stock -- -- 5,883 -- 5,883
Repurchase of 410,000 shares of redeemable
preferred stock -- -- 2,178 -- 2,178
Issuance of Telos common stock warrants -- -- 420 -- 420
Net loss for the year -- -- -- (9,171) (9,171)
-- -- ------ --------- ---------
Balance December 31, 1998 $65 $13 $ 2,116 $(48,115) $ (45,921)
== == ====== ======== =========
The accompanying notes are an integral part of these consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Business and Organization
Telos Corporation ("Telos" or "the Company") provides enterprise
integration services and solutions primarily to the U.S. federal government and
industry. In addition to its core competency of software development and systems
support services, Telos delivers information security, enterprise integration
and networking infrastructure solutions to its customers. The Company, founded
in 1968, is incorporated under the laws of the State of Maryland.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. However, as
reflected in the accompanying financial statements, the Company incurred a net
loss of $9.2 million in 1998. This loss included the effect of a $5.7 million
non-recurring gain from the sale of its TIS division. In addition, the Company
was not in compliance with several covenants of its Senior Credit Facility,
although the lender has provided waivers for the violations and has amended the
covenants to conform to the Company's 1999 budget expectations. Based on its
budget, the Company anticipates a need for approximately $10 million of
additional financing for 1999. These factors, including the uncertainty
surrounding whether and when the additional financing will be secured and
whether the Company will meet its budget expectations and bank covenants in
1999, indicate that the Company may be unable to continue as a going concern for
a reasonable period of time. The financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to obtain the additional financing required, meet its 1999 budgeted
cash flow objectives, and comply with the terms of its Senior Credit Facility.
The Company believes that the necessary additional financing will be
secured through one or more of the following sources: the sale of a division or
asset which is not critical to its strategic goals; additional financing from
its lender; or additional equity financing. Alternatives are currently being
pursued under each of these sources; however, the required financing has not yet
been secured. The Company believes the required funding will be arranged in a
timely manner that does not have a significant adverse impact on its operations.
However, there can be no assurance that the Company will be able to secure
financing sufficient for its needs and at terms favorable to the Company.
Additionally, there can be no assurance that the Company will be successful in
meeting budget expectations and bank covenants in 1999. Failure by the Company
to obtain sufficient financing, meet its budget expectations, or meet its bank
covenants may have a material adverse effect on the Company's financial
position, results of operations or cash flows.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Telos Corporation and its wholly-owned subsidiaries, Telos Corporation
(California), Telos Field Engineering, Inc., and Telos International
Corporation, and its substantially owned subsidiary Enterworks, Inc., formerly,
enterWorks.com ("Enterworks") (collectively, the "Company"). Significant
intercompany transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Significant estimates and assumptions used in the preparation
of the Company's consolidated financial statements include contract percentage
of completion methodology, allowance for accounts receivable, allowance for
inventory obsolescence, valuation of goodwill, the valuation allowance for
deferred tax assets, employee benefits and estimated useful lives of goodwill,
property and equipment and other noncurrent assets, including software
development costs. Actual results could differ from those estimates.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
The majority of the Company's sales are made directly or indirectly to the
federal government. A substantial portion of the Company's revenues are derived
from time and materials and cost reimbursement contracts, under which revenue is
recognized as services are performed and costs are incurred. The Company
generally recognizes equipment revenue as products are shipped, although certain
revenue recognition practices are dependent upon contract terms. Revenue for
maintenance contracts is recognized as such services are performed. The Company
records loss provisions for its contracts, if required, at the time such losses
are identified.
Revenue from the licensing of software is recognized in accordance with
American Institute of Certified Public Accountants (AICPA) Statement of Position
97-2 (SOP 97-2),"Software Revenue Recognition", whereby revenue is recognized
when a noncancelable revenue agreement is in force, the product has been shipped
and no significant obligations remain. Revenue generated from warranty service
contracts is recognized ratably over the warranty service period.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less at the date of purchase to be cash equivalents.
The Company's cash management program utilizes zero balance accounts.
Accordingly, all book overdraft balances have been reclassified to accounts
payable.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventories
Inventories are stated at the lower of cost or market, cost being
determined primarily on the first-in, first-out method. Substantially all
inventories consist of purchased hardware and component computer parts used in
connection with system integration services performed by the Company.
Inventories also include spare parts of $729,000 and $1,329,000 at December 31,
1998 and 1997, respectively, which are utilized to support maintenance
contracts. Spare parts inventory is amortized on a straight line basis over five
years. An allowance for obsolete, slow-moving or non-salable inventory is
provided for all other inventory. This allowance is based on the Company's
overall obsolescence experience and its assessment of future inventory
requirements. In addition to the product inventory obsolescence stated below,
the Company provided for $50,000 in spares inventory obsolescence and $114,000
in software inventory obsolescence.
At December 31, 1998 and 1997, the Company's allowance for product
inventory obsolescence was $3,074,000 and $3,915,000, respectively. The
components of the allowance for inventory obsolescence are set forth below (in
thousands):
Additions
Balance, Charged to Balance,
Beginning Costs and End
of Year Expense Deductions(1) of Year
------- ------- ------------- -------
Year Ended December 31, 1998 $ 3,915 $ 1,090 $ 1,931 $ 3,074
Year Ended December 31, 1997 $ 2,357 $ 2,150 $ 592 $ 3,915
Year Ended December 31, 1996 $ 1,385 $ 1,008 $ 36 $ 2,357
(1) Inventories written off.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is provided on the
straight-line method at rates based on the estimated useful lives of the
individual assets or classes of assets as follows:
Buildings 20 Years
Machinery and equipment 3-7 Years
Office furniture and fixtures 5-7 Years
Leasehold improvements Life of Lease
Leased property meeting certain criteria is capitalized at the present
value of the related minimum lease payments. Amortization of property and
equipment under capital leases is computed on the straight-line method over the
term of the related lease.
Upon sale or retirement of property and equipment, the costs and related
accumulated depreciation are eliminated from the accounts, and any gain or loss
on such disposition is reflected in the statement of operations. Expenditures
for repairs and maintenance are charged to operations as incurred.
Depreciation and amortization expense related to property and equipment,
including property and equipment under capital leases, was $2,460,000,
$2,630,000 and $2,255,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
Goodwill
Goodwill arose principally from the acquisition of Telos Corporation
(California) in 1992 and has been assigned a useful life of twenty years. The
useful life considered a number of factors including the Company's maintenance
of long-term significant customer relationships for periods of up to
twenty-seven years and its strong positions in the marketplace.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company assesses the potential impairment and recoverability of
goodwill on an annual basis and more frequently if factors dictate. Management
forecasts are used to evaluate the recovery of goodwill through determining
whether amortization of goodwill can be recovered through projected undiscounted
future cash flows. If an impairment of goodwill is indicated, the impairment is
measured based on projected discounted cash flows using a discount rate
reflecting the Company's cost of funds. In addition, the Company may assess the
net carrying amount of goodwill using internal and/or independent valuations of
the Company.
Accumulated amortization of goodwill at December 31, 1998 and 1997 was
$8,955,000 and $8,366,000, respectively.
Other Assets
Other noncurrent assets consist principally of deferred software
development costs and debt issuance costs. The Company expenses all research and
development costs incurred in connection with software development projects
until such software achieves technological feasibility, determined based on the
achievement of a working model. All costs thereafter are capitalized. The
Company amortizes such capitalized costs on a product-by-product basis over the
greater of the amount computed using an estimated product life of two years or
the ratio that current gross revenues bears to the total of current and
anticipated future gross revenues. The Company periodically evaluates the
realizability of these capitalized costs through evaluation of anticipated
revenue and gross margin as compared to current revenue and gross margin. At the
time a determination is made that capitalized amounts are not recoverable based
on the estimated cash flows to be generated from the applicable software
product, a loss is recognized.
Unamortized software and product costs at December 31, 1998 and 1997 were
$1.9 million and $3.6 million, respectively. Amortization expense associated
with these capitalized software and product costs was $2,044,000, $1,128,000 and
$689,000 in 1998, 1997 and 1996, respectively. Additionally, $1,743,000 and
$887,000 were written off as net realizable value adjustments in the fourth
quarter of 1998 and in the fourth quarter of 1997, respectively.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Debt issuance costs are amortized over the term of the underlying financial
instrument, which amortization method does not differ significantly from the
effective interest method. Unamortized costs amounted to $425,000 and $668,000
at December 31, 1998 and 1997, respectively.
Income Taxes
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". Under this
asset and liability method, deferred tax assets and liabilities are recognized
for the estimated future tax consequences of temporary differences and income
tax credits. Deferred tax assets and liabilities are measured by applying
enacted statutory tax rates that are applicable to the future years in which
deferred tax assets or liabilities are expected to be settled or realized to the
differences between the financial statement carrying amounts and the tax bases
of existing assets and liabilities. Any change in tax rates on deferred tax
assets and liabilities is recognized in net income in the period in which the
tax rate change is enacted. The Company provides a valuation allowance that
reduces deferred tax assets when it is "more likely than not" that deferred tax
assets will not be realized.
Accounting for Stock Based Compensation
The Company accounts for stock-based compensation using the intrinsic value
method provided by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Pro forma disclosures are made as if
the fair value measurement provisions of SFAS No. 123 had been used in
determining compensation expense (See Note 7).
Research and Development
The Company charges all research and development costs to expense as
incurred, until, as in the case of software, technological feasibility is
reached after which time such costs are capitalized. During 1998, 1997 and 1996,
the Company incurred $6.1 million, $1.0 million and $1.2 million in research and
development costs, respectively.
Earnings per Share
In February 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, "Earnings per Share." This Statement establishes standards for
computing and presenting earnings per share (EPS). As the Company does not have
publicly held common stock or potential common stock, this Statement is not
applicable and, accordingly, no EPS data is reported for any of the years
presented.
Financial Instruments
The Company uses various methods and assumptions to estimate the fair value
of its financial instruments. Due to their short-term nature, the carrying value
of cash and cash equivalents, accounts receivable, accounts payable and accrued
expenses approximates fair value. The fair value of long-term debt is based on
the discounted cash flows for similar term borrowings based on market prices for
the same or similar issues. The Company has not estimated the fair value of its
subordinated debt or its redeemable preferred stock. The Company does not deem
such estimation practicable due to the unique features of these instruments.
Fair value estimates are made at a specific point in time, based on
relevant market information. These estimates are subjective in nature and
involve matters of judgment and therefore cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
Reclassifications
Certain reclassifications have been made to the 1997 and 1996 financial
statements to conform to the current period presentation.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This standard
requires companies to capitalize qualifying computer software costs which are
incurred during the application development stage and amortize them over the
software's estimated useful life. SOP 98-1 is effective for fiscal years
beginning after December 15, 1998. The Company is currently evaluating the
impact of SOP 98-1 on its financial statements and related disclosures.
In November 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-9 ("SOP 98-9"), "Modification of SOP 97-2,
"Software Revenue Recognition", with Respect to Certain Transactions". The
Company is currently evaluating the impact of SOP 98-9 on its financial
statements and related disclosures.
Note 2. Sale of Assets
In February 1998, Telos sold substantially all of the net assets of one of
its support services divisions, Telos Information Systems ("TIS"), to NYMA,
Inc., a subsidiary of Federal Data Corporation of Bethesda, Maryland, for
approximately $14.7 million in cash. In connection with this sale, the Company
has recorded a gain of $5.7 million in its consolidated statement of income for
the year ended December 31, 1998, which included a write-off of $4.9 million of
goodwill allocated to TIS operations.
Note 3. Discontinued Operations
On December 27, 1996, the Company sold substantially all of the assets of
its consulting division, Telos Consulting Services (TCS), to COMSYS Technical
Services, Inc., a subsidiary of COREStaff, Inc. for approximately $31.6 million.
The resulting gain from the sale of TCS of $11.5 million included a write-off of
$6.9 million of goodwill allocated to the TCS operations.
The sale of TCS has been treated as a discontinued operation in accordance
with APB Opinion Number 30 ("APB 30"). Pursuant to APB 30, the revenue, costs
and expenses of TCS have been excluded from their respective captions in the
Company's consolidated statements of operations and the net results of these
operations have been reported separately as "Income (loss) from discontinued
operations." Included in the results of the discontinued operations is allocated
interest expense of $1.5 million for 1996. Interest has been allocated based on
the net assets of the discontinued operations in relation to the Company's
consolidated net assets plus non-specific debt. Additionally, goodwill
amortization of $418,000 for 1996 has been included in the results of the
discontinued operations. TCS had revenue of $33.1 million for 1996.
Note 4. Revenue and Accounts Receivable
Revenue resulting from contracts and subcontracts with federal, state, and
local governments accounted for 94.9%, 96.1% and 86.4% of consolidated revenue
in 1998, 1997 and 1996, respectively. As the Company's primary customer is the
federal government, the Company has a concentration of credit risk associated
with its accounts receivable. However, the Company does not believe the
likelihood of loss arising from such concentration is significant. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral from its customers. The Company maintains allowances for
potential losses.
The components of accounts receivable are as follows (in thousands):
December 31,
------------
1998 1997
---- ----
Billed accounts receivable $48,222 $ 48,207
------ ------
Amounts billable upon acceptance by customer 1,422 4,485
Amounts currently billable 7,878 6,244
------ ------
Total unbilled accounts receivable 9,300 10,729
------ ------
Allowance for doubtful accounts (739) (964)
------ ------
$56,783 $ 57,972
====== ======
The provision for doubtful accounts receivable was $39,000, $490,000 and
$647,000 for 1998, 1997 and 1996, respectively. Reductions to the allowance were
primarily due to write-offs of accounts receivable and other adjustments.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5. Debt Obligations
Senior Revolving Credit Facility
At December 31, 1998, the Company has a $45 million Senior Revolving Credit
Facility (the "Facility") with a bank which expires on July 1, 2000 and has an
outstanding balance of $36.2 million. Borrowings under the facility are
collateralized by certain assets of the Company (primarily accounts receivable
and inventory), and the amount of the available borrowings fluctuates based on
the underlying asset borrowing base and the Company's working capital
requirements. The agreement requires payment of a fee of .25% of the unused
portion of the Facility. The Facility bears interest at 1.00%, subject to
certain adjustments, over the bank's base rate, which was 9.00% at December 31,
1998. The weighted average interest rate on the outstanding borrowings under the
Facility was 9.95% for 1998 compared with 9.44% for 1997. At December 31, 1998,
the Company had approximately $6.7 million available under the Facility.
The Facility has various covenants which may, among other things, restrict
the ability of the Company to merge with another entity, sell or transfer
certain assets, pay dividends and make other distributions beyond certain
limitations. The Facility also requires the Company to meet certain leverage,
net worth, interest coverage and operating goals. At December 31, 1998, the
Company was not in compliance with several covenants contained in the Facility;
however, the bank has waived this non-compliance. In addition, the bank has
amended the covenants to conform to the Company's 1999 budget expectations.
The carrying value of the Facility at December 31, 1998 and 1997
approximates fair value.
Senior Subordinated Notes
In 1995 the Company issued Senior Subordinated Notes ("Notes") to certain
shareholders. The Notes are classified as either Series B or Series C. Series B
Notes, which total $6.5 million at December 31, 1998 and 1997, are
collateralized by fixed assets of the Company. Series C Notes, which total $7.9
million at December 31, 1998 and 1997, are unsecured. Both the Series B and
Series C Notes have a maturity date of October 1, 2000 and have interest rates
ranging from 14% to 17%. Interest is paid quarterly on January 1, April 1, July
1, and October 1 of each year. The Notes can be prepaid at the Company's option.
Additionally, these Notes have a cumulative payment premium of 13.5% per annum
payable only upon certain circumstances. These circumstances include an initial
public offering of the Company's common stock or a significant refinancing, to
the extent that net proceeds from either of the above events are received and
are sufficient to pay the premium. Due to the contingent nature of the premium
payment, the associated premium expense will only be recorded after the
occurrence of a triggering event. At December 31, 1998, the prepayment premium
that would be due upon a triggering event is $7,620,000.
In November 1998, the Company issued additional Senior Subordinated Notes
to certain shareholders which are classified as Series D. The Series D Notes
total $1.8 million and are unsecured. The Series D Notes have a maturity date of
October 1, 2000 and bear interest at 14% per annum. Interest is paid quarterly
on January 1, April 1, July 1, and October 1 of each year. The notes can be
prepaid at the Company's option. These Notes contain the same payment premium
provisions as the Series B and Series C Notes (see above). In connection with
the debt, the Company issued 1,500,000 warrants to purchase shares of the
Company's Class A Common Stock. The warrants have an exercise price of $.01 and
an exercise period of 22 months. The Company has assigned a value to the
warrants of $420,000 which has been included in capital in excess of par. The
amount outstanding of the subordinated debt was approximately $1,396,000 at
December 31, 1998.
Enterworks Subordinated Notes
During 1996, the Company completed a private financing whereby $3,277,960
of 8% subordinated debt of Enterworks was issued. Investors included certain
members of the Board of Directors and management and certain shareholders of the
Company. The subordinated debt has a five year maturity. Interest is paid
quarterly, beginning January 1 1998, on the first of January, April, July and
October each year. In connection with the debt, the Company issued 2,048,725
warrants to purchase shares of Enterworks common stock. The warrants have an
exercise price of one dollar and an exercise period of ten years. The Company
has assigned a value to the warrants of $921,926 which has been included in
capital in excess of par. The amount outstanding of this subordinated debt was
approximately $2,723,000 and $2,557,000 at December 31, 1998 and 1997,
respectively.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Redeemable Preferred Stock
Senior Redeemable Preferred Stock
The components of the senior redeemable preferred stock are Series A-1 and
Series A-2, each with $.01 par value and 1,250 and 1,750 shares authorized,
issued and outstanding, respectively. The Series A-1 and Series A-2 carry a
cumulative per annum dividend rate of 14.125% per annum of their liquidation
value of $1,000 per share. The dividends are payable semi-annually on June 30
and December 31 of each year. The liquidation preference of the preferred stock
is the face amount of the Series A-1 and A-2 Stock ($1,000 per share), plus all
accrued and unpaid dividends. The Company is required to redeem all of the
outstanding shares of the stock on December 31, 2001, subject to the legal
availability of funds. Mandatory redemptions are required from excess cash
flows, as defined in the stock agreements. The Series A-1 and A-2 redeemable
preferred stock is senior to all other present and future equity of the Company.
The Series A-1 is senior to the Series A-2. The Company has not declared
dividends on its senior redeemable preferred stock since its issuance. At
December 31, 1998 and 1997 undeclared, unpaid dividends relating to Series A-1
and A-2 redeemable preferred stock totaled $2,631,000 and $2,207,000,
respectively, and have been accrued and are included in the Series A-1 and A-2
redeemable preferred stock balances.
Class B Redeemable Preferred Stock
In May 1998 the Company entered into an agreement, with one of its
shareholders, Union de Banques Suisses (Luxemborg) S.A. ("UBS"), to retire all
of UBS's equity holdings in the Company. These equity holdings included all of
the 7,500 shares of the Company's Class B Preferred Stock with a liquidation
preference of $1,000 per share, and the cumulative unpaid dividends of
approximately $4.8 million, 1,837,773 shares of the Company's Class A Common
Stock, and 1,312,695 of the Company's Class A Common Stock warrants. The
purchase price to retire these interests was $6.5 million, of which $5 million
was paid in cash, and the remaining $1.5 million was funded by two separate
letters of credit secured by the Company's lender. UBS was paid these letters of
credit in the amount of $1.0 million in September 1998 and in the amount of
$500,000 in November 1998.
The $5.9 million excess of the carrying amount of the Class B Redeemable
Preferred Stock over the redemption price was recorded as an increase in capital
in excess of par; there was no impact on income from this transaction.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12% Cumulative Exchangeable Redeemable Preferred Stock
A maximum of 6,000,000 shares of 12% Cumulative Exchangeable Redeemable
Preferred Stock, par value $.01 per share, has been authorized for issuance.
The Company initially issued 2,858,723 shares of 12% Cumulative
Exchangeable Redeemable Preferred Stock (the "Public Preferred Stock") pursuant
to the acquisition of the Company during fiscal year 1990. The Public Preferred
Stock was recorded at fair value on the date of original issue, November 21,
1989, and the Company is making periodic accretions under the interest method of
the excess of the redemption value over the recorded value. Accretion for the
years ended December 31, 1998 and 1997 was $1,528,000 and $1,406,000,
respectively. The Company declared stock dividends totaling 736,863 shares in
1990 and 1991.
The Public Preferred Stock has a 20 year maturity, however, the Company
must redeem, out of funds legally available, 20% of the Public Preferred Stock
on the 16th, 17th, 18th and 19th anniversaries of November 21, 1989, leaving 20%
to be redeemed at maturity. On any dividend payment date after November 21,
1991, the Company may exchange the Public Preferred Stock, in whole or in part,
for 12% Junior Subordinated Debentures that are redeemable upon terms
substantially similar to the Public Preferred Stock and subordinated to all
indebtedness for borrowed money and like obligations of the Company.
The Public Preferred Stock accrues a semi-annual dividend at an annual rate
of 12% ($1.20) per share, based on the liquidation preference of $10 per share,
and is fully cumulative. Through November 21, 1995, the Company had the option
to pay dividends in additional shares of Preferred Stock in lieu of cash.
Dividends in additional shares of the Preferred Stock are paid at the rate of
0.06 of a share of the Preferred Stock for each $.60 of such dividends not paid
in cash. Dividends are payable by the Company, provided the Company has legally
available funds under Maryland law, when and if declared by the Board of
Directors, commencing June 1, 1990, and on each six month anniversary thereof.
For the years 1992 through 1994 and for the dividend payable June 1, 1995, the
Company has accrued undeclared dividends in additional shares of preferred
stock. These accrued dividends are valued at $3,950,000. Had the Company accrued
such dividends on a cash basis, the total amount accrued would have been
$15,101,000.For the cash dividends payable since December 1, 1995, the Company
has accrued $14,855,000.
The Company has not declared or paid dividends since 1991, due to
restrictions and ambiguities relating to the payment of dividends contained
within its charter, its working capital facility agreement, and under Maryland
law.
In November 1998, the Company retired 410,000 shares of the Public
Preferred Stock held by certain shareholders. The Company repurchased the stock
at $4.00 per share. The carrying value of these shares was $3.8 million, and the
$2.2 million excess of the carrying amount of these shares of Public Preferred
Stock over the redemption price of $1.6 million was recorded as an increase in
capital in excess of par; there was no impact on income from this transaction.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7. Stockholders' Investment and Employee Benefit Plans
Common Stock
The relative rights, preferences, and limitations of the Class A common
stock and the Class B common stock are in all respects identical. The holders of
the common stock have one vote for each share of common stock held. Subject to
the prior rights of the Public Preferred Stock or any series of the Series A
redeemable preferred stock, holders of Class A and the Class B common stock are
entitled to receive such dividends as may be declared.
Stock Warrants
In 1992, the Company issued to the holder of the Class B Redeemable
Preferred Stock a common stock warrant to purchase up to 3,150,468 shares of
Class A common stock of the Company. The stock warrant was valued at $1,109,000
and such amount was shown as an increase in capital in excess of par. The
warrant was initially exercisable to purchase up to 1,181,425 shares at any
time. The warrant increased by 656,348 shares on June 30, 1993 and July 1, 1994
and by 656,347 shares on July 1, 1995. Through December 31, 1997, 1,837,773
shares of Class A Common Stock has been purchased under the warrant. The price
per share at which shares have been purchased and are purchasable upon the
exercise of the warrant is $.0025. In May 1998, the Company retired the
remaining 1,312,695 Class A common stock warrants held by the holder of the
Class B Redeemable preferred stock (See Note 6).
In 1994, Toxford Corporation deposited $3 million with the Company's bank
to provide the Company with increased borrowing capability under its Facility
(see Note 5). In exchange, Toxford Corporation was issued 500,000 shares of
Class A common stock for which the Company recorded additional interest expense
of $410,000. The Company also granted Toxford Corporation warrants to acquire
7,228,916 shares of the Company's Class A common stock at a purchase price of
$.83 per share which approximated the estimated market value of the Company's
common stock at the issuance date. In November 1998, 840,000 of these warrants
were transferred to certain other shareholders of the Company. The warrant is
fully exercisable and has a term of ten years from the date of issue.
Stock Options
The Company has granted stock options to certain employees of the Company
under four plans. The Long-Term Incentive Compensation Plan was adopted in 1990
("1990 Stock Option Plan") and had option grants under it through 1993. In 1993,
stock option plan agreements were reached with certain employees. In 1996, the
Board of Directors approved and the shareholders ratified the 1996 Stock Option
Plan ("1996 Stock Option Plan"). The Company also approved an Enterworks stock
option plan ("1996 Enterworks Option Plan") during 1996.
The Company generally grants options under its respective plans at the
estimated fair value at the date of grant. Fair value is determined by the
Trustees of the Plan or management based on third party appraisals and
information with respect to the business operations.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1990 Stock Option Plan
Under the terms of the 1990 Stock Option Plan, 2,168,215 shares of the
Company's Class A common stock are available for issuance under options to key
employees, including officers and directors. The option price of $1.42 and $1.07
per share, determined by the Board of Directors, was not less than the fair
market value at the date of the grant and the options are generally exercisable
over a four year period. Additional information as to these options is as
follows:
Stock Option Activity
---------------------------------------------
Number of Shares Weighted Average
(000's) Exercise Price
------- --------------
Outstanding at December 31, 1995 598 $1.42
Granted -- --
Exercised -- --
Canceled (13) 1.42
------ -----
Outstanding at December 31, 1996 585 $1.42
Granted -- --
Exercised -- --
Canceled (55) 1.42
------ -----
Outstanding at December 31, 1997 530 $1.42
Granted 1,495 1.07
Exercised -- --
Canceled (85) 1.42
------ -----
Outstanding at December 31, 1998 1,940 $1.27
====== =====
1996 Stock Option Plan
The 1996 Stock Option Plan allows for the award of up to 6,644,974 shares
of Class A common stock at an exercise price of not lower than fair market value
at the date of grant. Vesting of the stock options for key employees is based
both upon the passage of time and certain key events occurring including an
initial public offering or a change in control. Vesting for options granted to
employees is based upon the passage of time, generally four years. The stock
options may be exercised over a ten year period subject to the vesting
requirements. Additional information as to these options follows:
Stock Option Activity
---------------------------------------------
Number of Shares Weighted Average
(000's) Exercise Price
------- --------------
Outstanding at December 31, 1995 -- --
Granted 3,767 0.95
Exercised -- --
Canceled ( 29) 0.97
------ ----
Outstanding at December 31, 1996 3,738 $0.95
Granted 772 1.01
Exercised -- --
Canceled (259) 0.97
------ ----
Outstanding at December 31, 1997 4,251 $0.96
Granted 1,447 1.07
Exercised -- --
Canceled (143) 0.98
------ ----
Outstanding at December 31, 1998 5,555 $0.99
====== =====
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Option Plans
In 1993, stock option plan agreements were reached to provide Mr. John
Wood, CEO and President, and Mr. Joseph Beninati, former Chairman, with options
to each purchase up to 700,459 shares of the Company's Class A common stock from
the Company at $0.50 per share. Under the terms of the agreements, 350,230
shares vested immediately and the remainder vested ratably over the next twelve
months. The Company recorded compensation expense related to these options based
upon the difference between the exercise price and the estimated fair value of
$0.82 per share at the measurement date of the stock option. Mr. Beninati's
agreement was canceled in 1996 and the shares now available will be administered
under the same terms as the 1996 Stock Option Plan. Additional information as to
these options follows:
Stock Option Activity
---------------------------------------------
Number of Shares Weighted Average
(000's) Exercise Price
------- --------------
Outstanding at December 31, 1995 1,401 $0.50
Granted -- --
Exercised -- --
Canceled -- --
----- -----
Outstanding at December 31, 1996 1,401 $0.50
Granted 653 1.01
Exercised -- --
Canceled (700) 0.50
----- -----
Outstanding at December 31, 1997 1,354 $0.75
Granted -- --
Exercised -- --
Canceled -- --
----- -----
Outstanding at December 31, 1998 1,354 $0.75
===== =====
John Wood has the option to cancel the 1993 stock options discussed above
or receive an equal number of options under the 1996 plan at an exercise price
of $0.95 per share. Additionally, the effect on the 1996 stock option plan as of
December 31, 1998 would be to increase the number of shares outstanding to
6,255,000 with a weighted average exercise price of $.98 per share.
1996 Enterworks Option Plan
In 1996, Enterworks implemented a stock option plan that allows for the
award of up to 5,000,000 shares of common stock at an exercise price of not
lower than fair market value at the date of grant. Vesting of the stock options
for key employees is based both upon the passage of time and certain key events
occurring including an initial public offering or a change in control. Vesting
for options granted to employees is based upon the passage of time, generally
four years. The stock options may be exercised over a ten year period subject to
the vesting requirements.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Additional information as to these options follows:
Stock Option Activity
---------------------------------------------
Number of Shares Weighted Average
(000's) Exercise Price
---------------- ----------------
Outstanding at December 31, 1995 -- --
Granted 2,744 $0.22
Exercised -- --
Canceled (15) 0.12
----- ----
Outstanding at December 31, 1996 2,729 0.22
Granted 998 0.77
Exercised (163) 0.12
Canceled (462) 0.39
----- ----
Outstanding at December 31, 1997 3,102 $0.38
Granted 1,814 0.77
Exercised (16) 0.12
Canceled (1,150) 0.46
----- -----
Outstanding at December 31, 1998 3,750 $0.55
====== =====
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1998:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices (000's) Life in Years Price (000's) Price
------ ------- ------------- ----- ------- -----
1990 Stock $1.07 1,495 9.4 years $1.07 299 $1.07
Option Plan $1.42 445 2.0 years 1.42 445 $1.42
---- ----- --------- ---- --- -----
$1.07 - $1.42 1,940 7.7 years $1.27 744 $1.28
============= ===== ========= ==== === =====
Other Stock
Option Plan $0.50 701 5.0 years $0.50 700 $0.50
$1.07 653 8.1 years $1.07 261 $1.07
----- --- --------- ----- --- -----
$0.50 -$1.07 1,354 6.5 years $0.75 961 $0.65
============ ===== ========= ===== === =====
1996 Stock
Option Plan $.95 3,320 7.4 years $0.95 1,712 $0.95
0.97 113 7.6 years 0.97 68 0.97
1.01 645 8.2 years 1.01 258 1.01
1.07 1,477 9.4 years 1.07 295 1.07
---- ----- --------- ---- ----- ----
$0.95 - $1.07 5,555 8.0 years $0.99 2,333 $0.97
============= ===== ========= ===== ===== =====
1996 Enterworks
Option Plan $0.12 1,309 7.5 years $0.12 621 $0.12
0.77 2,441 9.1 years 0.77 300 0.77
---- ----- --------- ---- --- ----
$0.12 - $0.77 3,750 8.6 years $0.55 921 $0.33
============= ===== ========= ===== === =====
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The weighted-average fair value of options granted under the 1990 Stock
Option Plan, the Other Stock Option Plan, the 1996 Stock Option Plan, and the
1996 Enterworks Option Plan was $0.26, $0, $0.25 and $0.19 per share,
respectively, in 1998 and $0, $0.23, $0.28 and $0.22 per share, respectively, in
1997. Had the Company determined compensation cost consistent with SFAS No. 123
methodology, net (loss) income would have been ($9,666,000), $1,073,000 and
$2,100,000 in 1998, 1997 and 1996, respectively. Significant assumptions used in
determining the fair value of each option grant at the date of grant were as
follows:
1990 Stock Other Stock
Option Plan Option Plan
------------------------- --------------------------------
1998 1997 1996 1998 1997 1996
-------------------------- --------------------------------
Expected dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Expected stock price volatility 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Risk free interest rate 5.54% -- -- -- 6.28% --
Expected life of options 5.3 yrs -- -- -- 4.0 yrs --
1996 Stock 1996 Enterworks
Option Plan Option Plan
-------------------------- --------------------------------
1998 1997 1996 1998 1997 1996
-------------------------- --------------------------------
Expected dividend yield 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Expected stock price volatility 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Risk free interest rate 5.54% 6.28% 6.66% 5.18% 6.00% 6.73%
Expected life of options 4.8 yrs 5.5 yrs 6.0 yrs 5.2 yrs 5.5 yrs 6.0 yrs
Because the pro forma disclosures under SFAS No. 123 only apply to stock
options granted in or after 1995, pro forma net income for 1996, 1997 and 1998
is not necessarily indicative of future periods.
Telos Shared Savings Plan
The Company sponsors a defined contribution employee savings plan (the
"Plan") under which substantially all full-time employees are eligible to
participate. The Company matches one-half of voluntary participant contributions
to the Plan up to a maximum Company contribution of 3% of a participant's
salary. Total Company contributions to this Plan for 1998, 1997 and 1996 were
$835,000, $1,335,000, and $1,679,000, respectively.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8. Income Taxes
The provision (benefit)for income taxes includes the following (in
thousands):
For The Year Ended December 31,
------------------------------------------
1998 1997 1996
------- ------- --------
Current provision (benefit)
Federal $ -- $ -- $ (421)
State 669 387 --
---- --- ----
Total current 669 387 (421)
---- --- -----
Deferred provision (benefit)
Federal 568 (1,464) (4,527)
State ( 134) (255) (791)
------ ----- ------
Total deferred 434 (1,719) (5,318)
------ ------- -------
Total provision (benefit) $ 1,103 $(1,332) $ (5,739)
====== ====== ======
The provision (benefit)for income taxes varies from the amount determined
by applying the federal income tax statutory rate to the income or loss before
income taxes. The reconciliation of these differences is as follows:
For the Year Ended December 31,
--------------------------------------------
1998 1997 1996
----- --------- -------
Computed expected income tax
provision (benefit) (34.0)% 34.0 % (34.0)%
Goodwill amortization 2.4 379.6 2.2
State income taxes, net of
federal income tax benefit (1.8) 5.9 (5.9)
Change in valuation allowance
for deferred tax assets 24.9 (2,214.0) 0.2
Meals and entertainment 1.1 111.8 --
Sale of division/other 20.9 17.2 0.6
---- ----- ---
13.5 % (1,665.5)% (36.9)%
===== ======= ====
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997 are as follows (in thousands):
December 31,
------------------------
1998 1997
----- ------
Deferred tax assets:
Accounts receivable, principally due
to allowance for doubtful accounts $ 153 $ 201
Allowance for inventory obsolescence and
amortization 1,377 1,728
Accrued liabilities not currently
deductible 794 999
Accrued compensation 1,562 2,190
Deferred office rent and accrued
sublease liabilities -- 25
Property and equipment, principally due
to differences in depreciation methods 396 1,165
Net operating loss carryforwards 5,660 3,140
Alternative minimum tax credit carryforward 703 703
----- ------
Total gross deferred tax assets 10,645 10,151
Less valuation allowance (4,987) (2,974)
------ ------
Net deferred tax assets 5,658 7,177
------ ------
Deferred tax liabilities:
Unbilled accounts receivable, deferred for tax purposes (317) (800)
Software development costs (735) (1,360)
------ -----
Total deferred tax liabilities (1,052) (2,160)
------- -----
Net deferred tax assets $4,606 $5,017
======= =====
The net change in the valuation allowance was an increase of $2,013,000 for
1998 and a decrease of $1,728,000 for 1997. Included in the change in the
valuation allowance were decreases of approximately $23,000 and $187,000 for
1998 and 1997, respectively, related to the reversal of temporary differences
acquired from Telos Corporation (California). The total tax benefits of future
deductible temporary differences acquired in connection with the Telos
Corporation acquisition were $6,097,000 at January 14, 1992. As of December 31,
1998, all of the tax benefits acquired have reversed.
At December 31, 1998, for federal income tax purposes the Company had net
operating loss carryforwards of $12,741,000 available to offset future regular
taxable income. These net operating loss carryforwards expire in 2011 through
2014. Additionally, $10,943,000 of alternative minimum tax net operating loss
carryforwards are available to offset future alternative minimum taxable income.
These alternative minimum tax net operating loss carryforwards also expire from
2011 to 2014. In addition, the Company has $703,000 of alternative minimum tax
credits available to be carried forward indefinitely to reduce future regular
tax liabilities.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9. Commitments and Contingencies
Leases
The Company leases office space and equipment under non-cancelable
operating and capital leases with various expiration dates, some of which
contain renewal options.
On March 1, 1996, the Company entered into a twenty year capital lease for
a building that serves as its corporate headquarters. The Company has accounted
for this transaction as a capital lease and has accordingly recorded assets and
a corresponding liability of approximately $12.3 million. Under the terms of the
lease, the landlord furnished the Company with $1.3 million to fund tenant
improvements and other building costs. The Company's former headquarters
facility was leased with a lease expiration date of March 31, 1997. In 1996, the
Company recorded $781,000 of additional expense for the remaining lease
obligation of its former headquarters facility.
The following is a schedule by years of future minimum payments under
capital leases together with the present value of the net minimum lease payments
as of December 31, 1998 (in thousands):
Property Equipment Total
-------- --------- ------
1999 $ 1,447 $ 140 $ 1,587
2000 1,447 103 1,550
2001 1,447 54 1,501
2002 1,447 -- 1,447
2003 1,447 -- 1,447
Remainder 17,655 -- 17,655
------ --- ------
Total minimum obligations 24,890 297 25,187
Less amounts representing
interest (13,033) (65) (13,098)
-------- ------ --------
Net present value of
minimum obligations 11,857 232 12,089
Less current portion (274) ( 105) (379)
------- ----- --------
Long term capital lease
obligations at
December 31, 1998 $11,583 $127 $11,710
====== === ======
Accumulated amortization for property and equipment under capital leases at
December 31, 1998 and 1997 is $2,019,000 and $1,196,000, respectively.
Future minimum lease payments for all non-cancelable operating leases at
December 31, 1998 are as follows (in thousands):
1999 $2,369
2000 1,543
2001 590
2002 304
2003 248
Remainder 677
------
Total minimum lease payments $5,731
======
Net rent expense charged to operations for 1998, 1997, and 1996 totaled
$2,001,000, $2,545,000, and $4,556,000, respectively.
Legal
The Company is a party to various other lawsuits arising in the ordinary
course of business. In the opinion of management, while the results of
litigation cannot be predicted with certainty, the final outcome of such matters
will not have a material adverse effect on the Company's consolidated financial
position or results of operations.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10. Related Parties
In 1996, the Company paid previously accrued advisory fees of $525,000 to
the firm Beninati and Wood, Inc. Mr. John B. Wood became an employee of the
Company in 1992 and serves as President and Chief Executive Officer and a
Director of the Company. Mr. Joseph P. Beninati served as Chairman of the Board
for the majority of 1994 before resigning January 5, 1995. The Company paid Mr.
Beninati $165,000 annually subject to a three year employment agreement that
began in 1995. Mr. Beninati resigned from the Board in 1996 and received his
final payment in 1998.
Mr. John R. Porter, a major shareholder, has a consulting agreement with
the Company whereby he is compensated for specific services. Expense recorded
pursuant to this agreement was $200,000 in both 1998 and 1997.
Mr. Byers, a Director of the Company, has a consulting agreement with the
Company to help the Company expand its business operations into the
international marketplace. Under this agreement Mr. Byers receives $10,500 a
month for his services. Mr. Byers was compensated $125,000, $130,000 and
$128,000 for 1998, 1997 and 1996, respectively. This consulting agreement was
terminated in the fourth quarter of 1998.
Note 11. Reportable Business Segments
The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", in 1998 which changes the way the Company
reports information about its operating segments. The information for 1997 and
1996 has been restated from the prior year's presentation in order to conform to
the 1998 presentation.
The Company has three reportable segments:
Systems and Support Services - provides software development and support
services for software and hardware including technology insertion, system
redesign and software re-engineering. This segment consists of four divisions -
solutions, services, international, and systems (systems was sold in February
1998 as discussed in Note 2). The principal market for this segment is the
Federal government and its agencies.
Products - delivers information security, enterprise integration and
networking infrastructure solutions to its customers. These solutions include
providing commercial hardware, software and services to its customers. The
Products group is capable of staging, installing and deploying large network
infrastructures with virtually no disruption to customer's ongoing operations.
The principal market for this segment is the Federal government and its
agencies.
Enterworks - this group helps companies build the fast and flexible
information infrastructure they need to compete in a global economy. Though
web-enabled integration of disparate data and intelligent business process
flows, their software links employees, customers and partners in ways that make
the virtual enterprise a reality. Their products include Virtual DB and
Enterworks Process Manager. Enterworks' advanced solutions serve healthcare,
financial services, manufacturing and government customers worldwide.
The accounting policies of the reportable segments are the same as those
described in Note 1. The Company evaluates the performance of its operating
segments based on revenue, gross profit and income before goodwill amortization,
income taxes, non-recurring items and interest income or expense.
TELOS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summarized financial information concerning the Company's reportable
segments is shown in the following table. The "other" column includes corporate
related items.
The Company has excluded TCS amounts from external and internal revenues,
and segment profit (loss) disclosures as this business was sold in December 1996
and has been treated as a disposal of a segment of a business under APB 30 (Note
3).
Systems and
Support Services Products Enterworks Other (1) Total
---------------- -------- ---------- --------- -----
1998
External Revenues $ 98,277 $101,736 $ 7,073 $ -- $ 207,086
Intersegment Revenues $ 970 $ 2,622 $ 1 $ -- $ 3,593
Gross profit $ 14,046 $ 8,583 $ 1,542 $ -- $ 24,171
Segment profit (loss)(4) $ 4,849 $ 14 $ (11,534) $ -- $ (6,671)
Total assets $ 45,340 $ 24,206 $ 6,119 $19,586 $ 95,251
Capital Expenditures $ 179 $ 49 $ 587 $ 435 $ 1,250
Depreciation & Amortization(2) $ 557 $ 479 $ 2,332 $ 1,487 $ 4,855
1997
External Revenues $121,052 $129,337 $ 3,398 $ -- $ 253,787
Intersegment Revenues $ 667 $ 1,387 $ 4 $ -- $ 2,058
Gross profit $ 20,614 $ 14,875 $ ( 132) $ -- $ 35,357
Segment profit (loss)(4) $ 10,229 $ 3,977 $ (5,903) $ -- $ 8,303
Total assets $ 55,834 $ 24,323 $ 6,374 $23,187 $ 109,718
Capital Expenditures $ 330 $ 688 $ 480 $ 1,091 $ 2,589
Depreciation & Amortization(2) $ 716 $ 929 $ 1,075 $ 2,270 $ 4,990
1996
External Revenues $101,535 $ 85,220 $ 2,140 $ -- $ 188,895
Intersegment Revenues $ 946 $ 968 $ 69 $ -- $ 1,983
Gross profit $ 11,237 $ 8,422 $ 955 $ -- $ 20,614
Segment profit (loss)(4) $ 593 $ (5,362) $ (3,672) $ -- $ (8,441)
Total assets $ 54,975 $ 27,885 $ 3,284 $23,920 $ 110,064
Capital Expenditures(3) $ 150 $ 1,087 $ 554 $ 656 $ 2,447
Depreciation & Amortization(2) $ 1,417 $ 949 $ 502 $ 1,126 $ 3,994
(1) Corporate assets are principally property and equipment, cash and other
assets.
(2) Depreciation and amortization includes amounts relating to property and
equipment, goodwill, deferred software costs and spare parts inventory.
The depreciation and amortization disclosure above is net of TCS
depreciation and amortization of $482 for 1996.
(3) The 1996 capital expenditure disclosure is net of TCS capital expenditures
of $111.
(4) Segment profit (loss) represents operating income (loss) before goodwill
amortization.
The Company does not have material international revenues, profit (loss),
assets or capital expenditures. The Company's business is not concentrated in a
specific geographical area within the United States, as it has 56 separate
facilities located in 19 states.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
PART III
Item 10. Directors and Executive Officers of the Registrant
Dr. Fred Charles Ikle, Chairman of the Board
- --------------------------------------------
Dr. Ikle (age 74) was elected to the Company's Board of Directors on
January 31, 1994 and was elected Chairman of the Board in January 1995. He is
Chairman of Conservation Management Corporation and Director of the
Zurich-American Insurance Companies. Dr. Ikle is also a Director of the National
Endowment for Democracy and a Distinguished Scholar at the Center for Strategic
& International Studies. From 1981 to 1988, Dr. Ikle served as Under Secretary
of Defense for Policy.
Julio E. Heurtematte, Jr., Director
- -----------------------------------
Mr. Heurtematte (age 62) was elected to the Company's Board of Directors on
July 31, 1998. He has been a private consultant since 1989, specializing in
international projects, trade and investments. From 1963 to 1989, he held
various positions at the InterAmerican Development Bank ("IAD"), most recently
as the deputy Manager for Project Analysis. From 1979 to 1989, Mr. Heurtematte
was also a member of IAD Bank's Pension Fund Investment Committee. Mr.
Heurtematte is also a member of the Board of Directors of Trans World Gaming
Corporation.
Malcolm M.B. Sterrett, Director
- -------------------------------
Mr. Sterrett (age 55) is a private investor and was elected to the
Company's Board of Directors on July 31, 1998. From 1989 to 1993, he was a
partner at the law firm of Pepper Hamilton & Scheetz in Washington, D.C. From
1988 to 1989, he served as General Counsel to the U.S. Department of Health and
Human Services and from 1982 to 1988 he was a Commissioner on the U.S.
Interstate Commerce Commission. Prior thereto, he was Vice President and General
Counsel to the United States Railway Association and served as Staff Director
and Counsel to the U.S. Senate Committee on Commerce, Science and
Transportation. Mr. Sterrett is also a member of the Board of Directors of Trans
World Gaming Corporation.
John B. Wood, Director, President and Chief Executive Officer
- -------------------------------------------------------------
Mr. Wood (age 35) was elected President and Chief Executive Officer on
February 16, 1994. Mr. Wood was appointed Chief Operating Officer on October 8,
1993 after serving as Executive Vice President from May of 1992. He was elected
to the Board of Directors on May 13, 1992. Mr. Wood joined the Company on
February 13, 1992. Prior to joining the Company, Mr. Wood was a founder of
Beninati & Wood, Inc., an investment banking firm which had provided services to
the Company.
Dr. Stephen D. Bryen, Director
- ------------------------------
Dr. Stephen Bryen (56) was elected to the Company's Board of Directors on
January 31, 1994. He currently serves as a Director in Jefferson Partners,
L.L.C., a strategic management consulting and merchant banking firm with offices
in Washington, D.C. and New York and as Senior Vice President of L-3 Network
Security, LLC, in Denver, Colorado. Dr. Bryen currently serves on the board of
C-MAC Industries in Mechanicsburgh, Pennsylvania and is the senior technical
advisor to Hollinger Digital Corporation in New York. From 1981 to 1988 Dr.
Bryen served as the Deputy Under Secretary of Defense for Trade Security Policy
and as the Director of the Defense Technology Security Administration, which he
founded.
Norman P. Byers, Director
- -------------------------
Mr. Byers (age 52) was elected to the Board of Directors on January 31,
1994. He has been president of Byers Consulting, a Fairfax County, Virginia
international business consulting firm since July 1996. Before that appointment,
he had served as the President of International Strategies Limited, another
local international business consulting firm. From 1968 until his retirement in
1989, Mr. Byers served in a variety of operational and staff positions in the
United States Air Force.
David S. Aldrich, Vice President, Chief Operating Officer
- ---------------------------------------------------------
Mr. Aldrich (age 39) joined the Company in September 1996 as Vice
President, Corporate Development and Strategy. Prior to joining the Company, he
was a partner in the Financial Advisory Services Group - Corporate Finance at
Coopers & Lybrand L.L.P. Prior to joining Coopers & Lybrand L.L.P. in 1991, Mr.
Aldrich was Senior Vice President at Dean Witter Capital Corp., the merchant
banking arm of Dean Witter Reynolds, Inc. Mr. Aldrich was appointed to the
position of Chief Operating Officer of the Company in January 1999.
William L. Prieur Brownley, Vice President and General Counsel
- --------------------------------------------------------------
Mr. Brownley (age 42) joined the Company in April 1991 and is responsible
for the management of the Company's legal affairs. For the five years prior to
joining the Company, he served as Assistant General Counsel and then as General
Counsel at Infotechnology Inc., an investment company whose holdings included
various companies in the communications industry.
Gerald D. Calhoun, Vice President, Human Resources, and Corporate
Secretary, Telos Corporation and Enterworks, Inc.
- --------------------------------------------------------------------------------
Mr. Calhoun (age 49) joined the Company as Vice President, Human Resources,
in August 1989. Prior to joining the Company he served as Corporate Director,
Risk and Financial Management of BDM International Corp., an information
technology consulting services company, Vice President, Human Resources of
Halifax Corp. a technical services company, and as Director for the U.S.
Department of Labor, Employment Standards Administration.
Mark W. Hester, former Executive Vice President and Chief Operating
Officer, Telos Corporation
- --------------------------------------------------------------------------------
Mr. Hester (age 46) joined Telos in 1979 and was appointed as Executive
Vice President and Chief Operating Officer in 1998. He was responsible for all
business activities at Telos. Previously, he has held progressive positions with
Telos as President of Telos Systems Solutions, President of Telos Field
Engineering, Regional Manager of Operations, and Vice President of Marketing.
Mr. Hester resigned from the position of Chief Operating Officer in 1999.
Robert W. Lewis, President, Enterworks, Inc.
- --------------------------------------------
Mr. Lewis (age 37) has served as the President of Enterworks, Inc. since
its inception in 1996. Mr. Lewis' prior experience has been with Telos
Corporation. From 1991 to 1995, he was Director, Business Development with
responsibility for major customer development and technology integration.
Robert J. Marino, Chief Sales and Marketing Officer and Executive Vice
President
- --------------------------------------------------------------------------------
Mr. Marino (age 62) joined the Company in 1988 as Senior Vice President of
Sales and Marketing. In 1990, his responsibilities were expanded to include
Program Management in addition to Sales and Marketing. On January 1, 1994, Mr.
Marino was promoted to President of Telos Systems Integration. With the
amalgamation of all Telos divisions, Mr. Marino was selected on January 1, 1998,
as Chief Sales & Marketing Officer reporting directly to the CEO and is part of
the Office of the President.
Lorenzo Tellez, Chief Financial Officer, Treasurer, and Vice President
- ----------------------------------------------------------------------
Mr. Tellez (age 41) was appointed Chief Financial Officer of the Company in
1993 and Treasurer in 1994. He joined Telos Corporation (California) in 1989
where he was responsible for all financial and regulatory functions. Prior to
joining Telos Corporation, Mr. Tellez served as a Senior Manager with Arthur
Andersen & Company.
Each of the directors and executive officers of the Company is a United
States citizen.
Item. 12. Executive Compensation
Information is set forth in the Summary Compensation Table included on the
following page with respect to all forms of compensation for service rendered in
all capacities to the Company during the fiscal years ended December 31, 1998,
1997, and 1996, of the Chief Executive Officer and four other most highly paid
executive officers during 1998.
SUMMARY COMPENSATION TABLE
Long-Term Compensation (3)
Annual Compensation Awards Payouts
------------------- ------ -------
Name Other All
and Annual Other
Principal Compen- Options/ Compen-
Position Year Salary Bonus(1) sation(2) SARs(#)(4) sation (5)
- --------------------------------------------------------------------------------------------------------------------
John B. Wood 1998 $334,198 $ -- $ 8,500 -- $5,000
(President, Chief 1997 $299,998 $382,000 $32,000 -- $4,750
Executive Officer) 1996 $291,921 $ -- $23,000 2,017,531 $4,750
Mark W. Hester 1998 $202,425 $ -- $ 500 250,000 $5,000
(Former Executive V. P. and 1997 $174,990 $200,000 $ 6,000 150,000 $3,525
Former Chief Operating Officer) 1996 $184,607 80,000 $ 6,000 185,000 $2,850
Lorenzo Tellez 1998 $218,080 $ -- $ 500 200,000 $5,000
(V.P., Treasurer, Chief 1997 195,000 $150,000 $24,000 150,000 $4,750
Financial Officer) 1996 188,269 $145,000 $15,000 465,000 $4,750
David Aldrich 1998 $173,850 $ -- $ 1,250 210,000 $1,083
(V.P., Chief Operating Officer) 1997 $150,010 $150,000 $ 6,000 300,000 --
1996 $ 45,580 -- $ -- 200,000 --
Robert J. Marino 1998 $204,734 $ -- $ 500 362,000 $5,000
(Chief Sales and Marketing 1997 $195,000 $ 76,000 $ 6,000 -- $4,750
Officer and Executive V.P.) 1996 $182,310 $ 90,000 $ 6,000 212,500 $4,750
(1) 1997 amounts include bonuses relating to the TIS sale completed in 1998.
(2) Other annual compensation represents automobile and living allowances
provided to executives. Additionally, compensation for John B. Wood
includes directors fees.
(3) There are no restricted stock awards or payouts pursuant to long-term
investment plans.
(4) Options granted are in both the Company's common stock as well as in
Enterworks, Inc., common stock.
(5) All other compensation represents Company contributions made on behalf of
the executive officers to the Telos Shared Savings Plan.
Stock Option Grants
The Summary Table of Options/SAR Grants in the Last Fiscal Year is set
forth below for the stock option grants in 1998.
Number of % of Potential Realizable
Securities Total Value at Assumed
Underlying Options/ Exercise Rates of Stock Price
Name and Principal Options/SARS SARS or Base Expiration Appreciation for
Position Granted Granted Price Date Option Term
- ----------------------------------------------------------------------------------------------------------------
5% 10%
-------- -------
John B. Wood
(President, Chief Executive
Officer) -- -- -- -- -- --
Mark W. Hester
(Former Executive V.P. and
Former Chief Operating
Officer) 250,000 8.5% $1.07 May 2008 $168,229 $426,326
Lorenzo Tellez
(V.P., Treasurer, Chief
Financial Officer) 200,000 6.8% $1.07 May 2008 $134,583 $341,061
David Aldrich
(V.P., Chief Operating Officer) 210,000 7.1% $1.07 May 2008 $141,313 $358,114
Robert J. Marino
(Chief Sales and Marketing
Officer and Executive V.P.) 362,000 12.3% $1.07 May 2008 $243,596 $617,320
Management Stock Options
The following table shows, as to the individuals named in the Summary
Compensation table, the number of shares acquired during such period through the
exercise of options, and the number of shares subject to and value of all
unexercised options held as of December 31, 1998.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
at FY-End at FY-End (1)(2)
Shares Acquired Value Exercisable/ Exercisable/
Name on Exercise Realized Unexercisable Unexercisable
- ---- ----------- -------- ------------- -------------
John B. Wood -- -- 1,507,471/1,210,519 $924,615/494,887
(President, Chief Executive
Officer)
Mark W. Hester -- -- 169,000/416,000 62,400/141,350
(Former Executive V.P.
and Former Chief
Operating Officer)
Lorenzo Tellez -- -- 271,000/544,000 107,400/201,850
(V.P., Treasurer,
Chief Financial Officer)
David Aldrich -- -- 212,000/498,000 94,360/196,440
(V.P., Chief Operating
Officer)
Robert J. Marino -- -- 372,550/534,350 75,857/178,703
(Chief Sales and Marketing
Officer and Executive V.P.)
(1) Based on an estimated fair market value of the Company's Class A common
stock of $1.35 per share at December 31, 1998.
(2) Based on an estimated fair market value of Enterworks common stock of $0.77
per share at December 31, 1998.
Compensation of Directors
During the fiscal year ended December 31, 1998, employee directors were
paid a fee of $2,000 for each Board meeting attended. Outside directors Mr.
Byers and Dr. Bryen were paid an annual fee of $25,000, and- further compensated
at a rate of $750 for each meeting in excess of four meetings a year. Chairman
of the Board, Dr. Ikle, is paid $25,000 quarterly for his service on the Board.
In addition, Mr. Byers receives $5,000 per annum for his service as Proxy
Chairman. The compensation paid to the outside directors is paid pursuant to a
proxy agreement between the Company, the Defense Security Service and certain of
the Company shareholders. During the fiscal year ended December 31, 1998, other
than Mr. Wood, no directors of the Company were awarded options.
Employment Contracts
The Company is a party to agreements with certain of its executive
officers. Mr. David Aldrich, Vice President and Chief Operating Officer, Mr.
William Brownley, General Counsel, Mr. Gerald Calhoun, Vice President Human
Resources and Corporate Secretary Telos Corporation and Enterworks, Mr. Robert
Marino, Chief Sales and Marketing Officer and Executive Vice President, Mr.
Lorenzo Tellez, Chief Financial Officer, and Mr. John Wood, Chief Executive
Officer, have agreements with the Company which provide for a payment of two
year's base salary then in effect if involuntarily terminated. At December 31,
1998, Mr. Aldrich, Brownley, Calhoun, Marino, Tellez and Wood had base salary
levels of $181,000, $171,000, $169,000, $206,000, $206,000, $219,000, and
$350,000, respectively. In addition, these executive officers' agreements
provide for bonus payments should certain operating results be attained.
Item 12. Security Ownership of Certain Beneficial Owners and Management
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(1) (2) (3) (4)
Amount and Nature
Name and Address of Beneficial Ownership Percent of
Title of Class of Beneficial Owner as of March 1, 1999 Class
-------------------------------------------------------------------------------------------------------------
Class A Common Stock John Porter 22,190,718 shares (A) 80.32%
15 Berners St.
London SW1W 9EA England
Class A Common Stock C3, Inc. 401(k) Plan and 3,658,536 shares 17.23%
Telos Corporation Savings Plan
c/o C3, Inc.
19886 Ashburn Road
Ashburn, Virginia 20147
Class B Common Stock F&C Nominees Limited 3,143,358 shares 77.85%
11 Devonshire Square
London EC 2M 4YR England
Class B Common Stock Hare & Company 815,700 shares 20.20%
C/o Bank of New York
P.O. Box 11203
New York, NY 10249
Class A Common Stock David Aldrich 170,392 shares (B) 0.80%
Class A Common Stock Robert J. Marino 493,352 shares (B) 2.28%
Class A Common Stock Mark W. Hester 240,778 shares (B) 1.12%
Class A Common Stock Lorenzo Tellez 412,440 shares (B) 1.92%
Class A Common Stock John B. Wood 1,491,863 shares (C) 6.57%
Class A Common Stock All Officers and
Directors As A Group
(9 persons) 3,124,616 shares (D) 13.03%
12% Cumulative Exchangeable Value Partners, Ltd. 714,317 shares (E) 22.42%
Redeemable Preferred Stock 2200 Ross Avenue, Ste 4660
Dallas, TX 75201
12% Cumulative Exchangeable Fisher Ewing Partners 714,317 shares (E) 22.42%
Redeemable Preferred Stock 2200 Ross Avenue, Ste 4660
Dallas, TX 75201
12% Cumulative Exchangeable Wynnefield Partners Small 228,500 shares (F) 7.17%
Redeemable Preferred Stock Cap Value L.P.
Channel Partnership II, L.P.
Wynnefield Small Cap Value
Offshore Fund, Ltd.
One Penn Plaza, Suite 4720
New York, NY 10119
12% Cumulative Exchangeable Magten Asset Management Corp. 221,200 shares 6.94%
Redeemable Preferred Stock 35 East 21st Street
New York, NY 10010
(A) Mr. Porter's holdings include 6,388,916 shares of Class A Common Stock
purchasable upon exercise of a warrant.
(B) Messrs. Aldrich, Marino,Hester,and Tellez hold options to acquire 162,000,
371,300, 170,000, and 260,000 shares of the Company's Class A Common Stock,
respectively, in addition to their current common stock holdings. These
shares are purchasable upon exercise of warrant and are exercisable within
60 days of March 1, 1999.
(C) Mr. Wood owns 8,392 shares of Common Stock and he holds an option to
acquire 1,483,471 shares of the Company's Class A Common Stock purchasable
upon exercise of options 60 days from March 1, 1999.
(D) Under the Company's stock option plan and certain stock option agreements,
all officers and directors as a group hold options to acquire 2,737,971
shares of Class A Common Stock exercisable within 60 days after March 1,
1999.
(E) Value Partners Ltd. and Fisher Ewing Partners have filed jointly a
Schedule 13D under which they disclosed that they may act as a "group"
within the meaning of Section 13(d) of the Securities Exchange Act. Each
of the reporting persons disclosed that it may be deemed to beneficially
own the aggregate of 714,317 shares of the Public Preferred Stock held of
record by the reporting persons collectively.
(F) Wynnefield Partners Small Cap Value L.P., Channel Partnership II, L.P. and
Wynnefield Small Cap Value Offshore Fund, Ltd. Have filed jointly a
Schedule 13D under which they disclosed that they may act as a "group"
within the meaning of Section 13 (d) of the Securities Exchange Act.
Item 13. Certain Relationships and Related Transactions
Mr. Joseph P. Beninati served as Chairman of the Board for the majority of
1994 before resigning January 5, 1995. The Company paid $165,000 annually
subject to a three year employment agreement that began in 1995 and terminated
January 8, 1998. Mr. Beninati resigned from the Board in 1996 and received his
final payment in 1998.
Mr. John R. Porter has a consulting agreement with the Company whereby he
will be compensated for specific services. Expense recorded pursuant to this
agreement was $200,000 for both 1998 and 1997.
Mr. Byers, a Director of the Company, has a consulting agreement with the
Company to help the Company expand its business operations into the
international marketplace. Under this agreement Mr. Byers receives $10,500 a
month for his services. Mr. Byers was compensated $125,000, $130,000, and
$128,000 for 1998, 1997 and 1996, respectively. The consulting agreement was
terminated in the fourth quarter of 1998.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements
All financial statements of the registrant as set forth under
Item 8 of this report on Form 10-K.
(a) 2. Financial Statement Schedules
All schedules are omitted because they are not applicable or the
required information is included in the consolidated financial
statements or notes thereto.
(a) 3. Exhibits:
Exhibits marked with (1*) are incorporated by reference to the Company's
Registration Statement No. 2-84171 filed June 2, 1983. Exhibits marked with (3*)
are incorporated by reference to the Company's Form 10-K report for the fiscal
year ended March 31, 1987. Exhibits marked with (4*) are incorporated by
reference to the Company's Form 10-K report for the fiscal year ended March 31,
1989. The registrant will furnish to stockholders a copy of other exhibits upon
payment of $.20 per page to cover the expense of furnishing such copies.
Requests should be directed to the attention of Investor Relations at Telos
Corporation, 19886 Ashburn Road, Ashburn, Virginia 20147-2358.
2.6 Stock Purchase Agreement dated as of January 14, 1992, by
and among C3, Inc., Telos Corporation and Contel Federal
Systems, Inc.(Incorporated by reference to C3, Inc. Form 8-K
filed January 29, 1992)
3.1 (1*) Articles of Amendment and Restatement of C3, Inc.
3.2 (1*) Articles of Amendment of C3, Inc. dated August 31,
1981.
3.3 (3*) Articles supplementary of C3, Inc. dated May 31, 1984.
3.4 (4*) Articles of Amendment of C3, Inc.dated August 18, 1988.
3.5 Articles of Amendment and Restatement Supplementary to the
Articles of Incorporation dated August 3, 1990.
(Incorporated by reference to C3, Inc. 10-Q for the quarter
ended June 30, 1990)
3.6 Restated Bylaws of C3, Inc. (Incorporated by reference to
C3, Inc.10-Q for the quarter ended December 31,1990)
3.7 Articles of Amendment of C3, Inc. dated April 13, 1995
4.1 Form of Indenture between the Registrant and Bankers Trust
Company, as Trustee, relating to the 12% Junior Subordinated
Debentures Due 2009. (Incorporated herein by reference to
C3's Registration Statement on Form S-4 filed October 20,
1989)
4.3 Form of the terms of the 12% Cumulative Exchangeable
Redeemable Preferred Stock of the Registrant. (Incorporated
herein by reference to C3's Registration Statement on Form
S-4 filed October 20, 1989)
4.4 Shareholders Agreement dated as of August 3, 1990 by and
among C3, Inc.; Union de Banques Suisses Luxembourg), S.A.;
C3 Investors, L.P.; Anthony Craig, together with the
investors; the Class A holders; MIM Limited; Knoll and
Associates, Inc.; Murray Enterprises PLC; Electra
Development Holdings; and Hartley Limited. (Incorporated by
reference to C3, Inc. 10-Q for the quarter ended June 30,
1990)
4.5 Articles of Amendment and Restatement of the Company, filed
with the Secretary of State of the State of Maryland on
January 14, 1992. (Incorporated by reference to C3, Inc.
Form 8-K filed January 29, 1992)
10.20 Revolving and Reducing Senior Facility Credit Agreement
dated as of January 14, 1992, among C3, Inc., Telos
Corporation and NationsBank, N.A. (Incorporated by
reference to C3, Inc. Form 8-K filed January 29, 1992)
10.31 September 27, 1993 Settlement Agreement among John R.C.
Porter, Toxford Corporation, Cantrade Nominees Ltd.,
Cantrade Trust Company (Cayman) Ltd., Cantrade Trustee,
AG, Fred Knoll, Cottonwood Holdings, C3 Investors
L.P., C3, Inc., Telos Corporation, Joseph P. Beninati,
John B. Wood and Beninati & Wood, Inc. (Incorporated by
reference to C3, Inc. Form 8-K filed October 18, 1993)
10.32 September 27, 1993 Stock Purchase and Sale Agreement
between Mr. John R.C. Porter and C3 Investors, L.P.
(Incorporated by reference to C3, Inc. Form 8-K filed
October 18, 1993)
10.33 September 27, 1993 Stock Purchase and Sale Agreement
between Mr. John R.C. Porter and Cottonwood Holdings,
Inc. (Incorporated by reference to C3, Inc. Form 8-K
filed October 18, 1993)
10.34 September 27, 1993 Note Interest Purchase and Sale Agreement
among Mr.John R.C. Porter, Cottonwood and C3,Inc.
(Incorporated by reference to C3, Inc.Form 8-K filed October
18, 1993)
10.35 October 8, 1993 Promissory Note in the amount of $8,438,000
issued by Mr.John R.C.Porter in favor of C3 Investors, L.P.
(Incorporated by reference to C3, Inc.Form 8-K filed October
18, 1993)
10.36 October 8, 1993 Promissory Note in the amount of
$1,562,000 issued by Mr. John R.C. Porter in favor of
Cottonwood Holdings, Inc. (Incorporated by reference to C3,
Inc. Form 8-K filed October 18, 1993)
10.37 September 27, 1993 Collateral Agency, Security and
Pledge Agreement among Mr. John R.C. Porter, Mr. Fred
Knoll, Cottonwood Holdings, C3 Investors, L.P., C3, Inc.,
Telos Corporation, Toxford Corporation, Cantrade Nominees
Limited, Mr. Robert M. Ercole and Mr.Frank S.Jones, Jr.
(Incorporated by reference to C3, Inc. Form 8-K filed
October 18, 1993)
10.38 September 27, 1993 Standstill Agreement among Mr.John R.C.
Porter, Mr. Fred Knoll, Mr. Alfredo Frohlich and C3, Inc.
(Incorporated by reference to C3, Inc. Form 8-K filed
October 18, 1993)
10.39 September 27, 1993 Mutual Release among Mr. John R.C.
Porter, Mr.Fred Knoll,Cottonwood Holdings, C3 Investors,
L.P.,C3, Inc., Telos Corporation, Mr.Joseph P. Beninati,
Mr. John B. Wood, and Beninati & Wood, Inc.(Incorporated
by reference to C3,Inc. Form 8-K filed October 18, 1993)
10.40 September 27, 1993 Consulting Agreement among Mr. Fred
Knoll, C3, Inc. and Telos Corporation. (Incorporated by
reference to C3, Inc. Form 8-K filed October 18, 1993)
10.43 Amendment to Revolving and Reducing Senior Credit Facility
dated as of December 31, 1993 among C3, Inc., Telos
Corporation and NationsBank, N.A.
10.44 Amendment to Revolving and Reducing Senior Credit Facility
dated as of April 11, 1994 among C3, Inc., Telos Corporation
and NationsBank, N.A.
10.45 Amendment to Revolving and Reducing Senior Credit Facility
dated as of June 8, 1994 among C3, Inc., Telos Corporation
and NationsBank, N.A.
10.46 Amendment to Revolving and Reducing Senior Credit Facility
dated as of October 7, 1994 among C3,Inc., Telos Corporation
and NationsBank, N.A.
10.47 October 7, 1994 Letter Agreement among C3,Inc., Toxford
Corporation, and NationsBank, N.A.regarding cash collateral
held on behalf of the Company.
10.48 October 25, 1994 General Release and Settlement memorandum
among Sapiens International Corporation N.V., Sapiens
International Corporation B.V., Sapiens U.S.A., Inc., C3,
Inc. and Telos Corporation.
10.49 Amendment to Revolving and Reducing Senior Credit Facility
dated as of January 5, 1995 among C3, Inc.,Telos Corporation
and NationsBank, N.A.
10.50 Amendment to Revolving and Reducing Senior Credit Facility
dated as of January 12, 1995 among C3, Inc., Telos
Corporation and NationsBank, N.A.
10.51 Waiver and Amendment to Revolving and Reducing Senior
Credit Facility dated as of April 17,1995 among C3,Inc.,
Telos Corporation and NationsBank, N.A.
10.58 Series B Senior Subordinated Secured Note due October 1,
2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Drayton English and International Investment
Trust.
10.59 Series B Senior Subordinated Secured Note due October 1,2000
as of October 13, 1995 between Telos Corporation (Maryland)
and J.O.Hambro Investment Management, Ltd.
10.60 Series B Senior Subordinated Secured Note due October
1, 2000 as of October 13, 1995 between Telos Corporation
(Maryland) and North Atlantic Smaller Companies Investment
Trust, PLC.
10.61 Series B Senior Subordinated Secured Note due October 1,2000
as of October 13, 1995 between Telos Corporation (Maryland)
and Mr. John R.C. Porter.
10.62 Series B Senior Subordinated Secured Note due October 1,
2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Sir Leslie Porter.
10.63 Series B Senior Subordinated Secured Note due October
1, 2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Second Consolidated Trust, PLC
10.64 Series B Senior Subordinated Secured Note due October 1,2000
as of October 13, 1995 between Telos Corporation (Maryland)
and Toxford Corp.
10.65 Series C Senior Subordinated Unsecured Note due October
1, 2000 as of October 13, 1995 between Telos Corporation
(Maryland)and Drayton English and International Investment
Trust
10.66 Series C Senior Subordinated Unsecured Note due October 1,
2000 as of October 13, 1995 between Telos Corporation
(Maryland) and J.O. Hambro Investment Management, Ltd.
10.67 Series C Senior Subordinated Unsecured Note due October 1,
2000 as of October 13, 1995 between Telos Corporation
(Maryland) and North Atlantic Smaller Companies Investment
Trust, PLC.
10.68 Series C Senior Subordinated Unsecured Note due October
1, 2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Mr. John R.C. Porter.
10.69 Series C Senior Subordinated Unsecured Note due October
1, 2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Sir Leslie Porter.
10.70 Series C Senior Subordinated Unsecured Note due October
1, 2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Second Consolidated Trust, PLC.
10.71 Series C Senior Subordinated Unsecured Note due October 1,
2000 as of October 13, 1995 between Telos Corporation
(Maryland) and Toxford Corp.
10.72 Amendment to Revolving and Reducing Senior Credit Facility
dated as of August 4, 1995 Telos Corporation (Maryland),
Telos Corporation (California) and NationsBank N.A.
10.73 Amendment to Revolving and Reducing Senior Credit Facility
dated as of October 13, 1995 Telos Corporation (Maryland),
Telos Corporation (California) and NationsBank N.A.
10.74 1996 Stock Option Plan
10.76 Sixteenth Amendment to Credit Facility and Tenth Amended and
Restated Promissory Note
10.77 Enterworks, Inc. 1996 Stock Option Plan
10.78 Form of Series A Senior Subordinated Unsecured Note
10.79 Form of Enterworks, Inc., Capital Stock Purchase Series A
Warrant
10.80 Asset Purchase Agreement
10.81 Amendment No. 1 to Asset Purchase Agreement
10.82 Amended and Restated Credit Agreement between Telos
Corporation, a Maryland corporation; Telos Corporation, a
California corporation; and NationsBank, N.A. dated as of
July 1, 1997
10.83 Asset Purchase Agreement
10.84 Interim Agreement
10.85 Share Purchase Agreement between Telos Corporation, a
Maryland corporation, formerly named and known as C3,
Inc. and Union Bank of Switzerland, dated May 7, 1998
10.86 Series D Senior Subordinated Unsecured Note due October
1, 2000 as of November 20,1998 between Telos Corporation
(Maryland) and Foreign and Colonial Enterprise Trust PLC
10.87 Series D Senior Subordinated Unsecured Note due October
1, 2000 as of November 20, 1998 between Telos Corporation
(Maryland)and Foreign and Colonial Enterprise Trust LP
10.88 Common Stock Purchase Series D Warrant between Telos
Corporation (Maryland) and Foreign and Colonial Enterprise
Trust PLC
10.89 Common Stock Purchase Series D Warrant between Telos
Corporation (Maryland) and Foreign and Colonial Enterprise
Trust LP
10.90 Form of Stock Purchase Agreement
21 Schedule of Subsidiaries.
27 Financial Data Schedule
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Telos Corporation has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
TELOS CORPORATION
By: John B. Wood
----------------------------
President and
Chief Executive Officer
Date: April 1, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of Telos Corporation and in
the capacities and on the date indicated.
Signature Title Date
- ---------------------- ---------------------- ----------------
/s/ Fred Charles Ikle Chairman of the April 1, 1999
- ---------------------- Board of Directors
Fred Charles Ikle
/s/ John B. Wood President, Chief Executive
- ---------------------- Officer & Director
John B. Wood (Principal Executive Officer) April 1, 1999
/s/ Stephen D. Bryen Director April 1, 1999
- ------------------------
Stephen D. Bryen
/s/ Norman P. Byers Director April 1, 1999
- ------------------------
Norman P. Byers
/s/ Lorenzo Tellez Chief Financial Officer April 1, 1999
- ------------------------ (Principal Financial Officer)
Lorenzo Tellez & Principal Accounting Officer)
Director April 1, 1999
- ------------------------------
Julio E. Heurtematte, Jr.
Director April 1, 1999
- --------------------------
Malcolm M.B. Sterrett
Telos Corporation
Exhibit Index
Exhibit
Number Exhibit Name Page
------ ------------ ----
10.86 Series D Senior Subordinated Unsecured Note
due October 1, 2000 as of November 20, 1998
between Telos Corporation (Maryland) and
Foreign and Colonial Enterprise Trust PLC
10.87 Series D Senior Subordinated Unsecured Note
due October 1, 2000 as of November 20, 1998
between Telos Corporation (Maryland) and
Foreign and Colonial Enterprise Trust LP
10.88 Common Stock Purchase Series D Warrant
between Telos Corporation (Maryland) and
Foreign and Colonial Enterprise Trust PLC
10.89 Common Stock Purchase Series D Warrant
between Telos Corporation (Maryland) and
Foreign and Colonial Enterprise Trust LP
10.90 Form of Stock Purchase Agreement