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Item 1. Financial Statements

2020-08-13 compared with 2020-05-15 · 195 added, 221 removed, 815 unchanged (34% of the section changed)

Financial Statements

CORPORATION AND SUBSIDIARIES

TELOS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended March 31,

(amounts in thousands)

Three Months Ended June 30,

Six Months Ended June 30,

Costs and expenses

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Interest expense

Loss before income taxes

Benefit from income taxes (Note 7)

Net income attributable to non-controlling interest (Note 2)

Net loss attributable to Telos Corporation

Income (loss) before income taxes

(Provision for) benefit from income taxes (Note 7)

Net income (loss)

Net (income) loss attributable to non-controlling interest (Note 2)

Net income (loss) attributable to Telos Corporation

The accompanying notes are an integral part of these condensed consolidated financial statements.

TELOS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(amounts in thousands)

Three Months Ended March 31,

Other comprehensive (loss) income, net of tax:

Three Months Ended June 30,

Six Months Ended June 30,

Net income (loss)

Other comprehensive income, net of tax:

Foreign currency translation adjustments

Comprehensive income attributable to non-controlling interest

Comprehensive loss attributable to Telos Corporation

Comprehensive (income) loss attributable to non-controlling interest

Comprehensive income (loss) attributable to Telos Corporation

The accompanying notes are an integral part of these condensed consolidated financial statements.

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(amounts in thousands)

March 31, 2020

June 30, 2020

December 31, 2019

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(amounts in thousands)

March 31, 2020

June 30, 2020

December 31, 2019

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(amounts in thousands)

Three Months Ended March 31,

Six Months Ended June 30,

Operating activities:

Adjustments to reconcile net loss to cash provided by operating activities:

Net income (loss)

Adjustments to reconcile net income (loss) to cash provided by operating activities:

Dividends from preferred stock recorded as interest expense

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Telos Corporation

Additional Paid-in

Other Comprehensive Income

Non-Controlling

Non-Controlling Interest

Stockholders’

For the Three Months Ended March 31, 2020

For the Three Months Ended June 30, 2020

Beginning balance

Foreign currency translation gain

Distributions

Ending balance

For the Three Months Ended June 30, 2019

Beginning balance

Distributions

Ending balance

For the Six Months Ended June 30, 2020

Beginning balance

Net (loss) income

Foreign currency translation loss

Foreign currency translation gain

Distributions

Ending balance

For the Three Months Ended March 31, 2019

For the Six Months Ended June 30, 2019

Beginning balance

Net (loss) income

Foreign currency translation loss

Foreign currency translation gain

Distributions

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corporation in October 1971.

Our website is www.telos.com .

The accompanying condensed consolidated financial statements include the accounts of Telos and its subsidiaries, including

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All intercompany transactions have been eliminated in consolidation.

In our opinion, the accompanying condensed consolidated financial statements reflect all adjustments (which include normal

recurring adjustments) and reclassifications necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to rules and regulations of the Securities and

Exchange Commission (“SEC”).

The accompanying condensed consolidated financial statements reflect all adjustments (which include normal recurring

adjustments) and reclassifications necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to rules and regulations of the Securities and Exchange

Commission (“SEC”).

The presented interim results are not necessarily indicative of fiscal year performance for a variety of reasons including, but not limited to, the impact of seasonal and short-term variations.

We have continued to follow

the accounting policies (including the critical accounting policies) set forth in the consolidated financial statements included in our 2019 Annual Report on Form 10-K filed with the SEC.

These condensed consolidated financial statements should be

read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

We have continued to follow the

accounting policies (including the critical accounting policies) set forth in the consolidated financial statements included in our 2019 Annual Report on Form 10-K filed with the SEC.

These condensed consolidated financial statements should be read

in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

In March 2020, the coronavirus disease 2019 ("COVID-19") was declared a pandemic by the World Health Organization and a

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reporting unit's carrying value exceeds its fair value, not to exceed the recorded amount of goodwill.

The provisions of this ASU are effective for years beginning after December 15, 2019.

The adoption of this ASU did not have a material impact on

our condensed consolidated financial position, results of operations and cash flows.

The provisions of this ASU are effective for years beginning after December 15, 2019, which made this standard effective for us on January 1, 2020.

The adoption of this ASU did not have a material impact on our condensed consolidated financial position, results of operations and cash flows.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820):

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disclosure requirements as well as clarifying specific disclosure requirements.

This standard is effective for interim and annual reporting periods beginning after December 15, 2019.

The adoption of this ASU did not have a material impact on our

condensed consolidated financial position, results of operations and cash flows.

This standard is effective for interim and annual reporting periods beginning after December 15, 2019, which made this standard effective for us on January 1, 2020.

adoption of this ASU did not have a material impact on our condensed consolidated financial position, results of operations and cash flows.

In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40):

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with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software.

This standard is effective for interim and annual reporting periods beginning after December 15, 2019.

The adoption of this ASU did not

have a material impact on our condensed consolidated financial position, results of operations and cash flows.

This standard is effective for interim and annual reporting periods beginning after December 15, 2019, which made this standard

effective for us on January 1, 2020.

The adoption of this ASU did not have a material impact on our condensed consolidated financial position, results of operations and cash flows.

Recent Accounting Pronouncements Not Yet Adopted

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This standard will be effective for reporting periods beginning after December 15, 2020, with early adoption permitted.

The adoption of this ASU will not have a material impact on our consolidated financial position, results of operations and cash flows.

While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our

consolidated financial position, results of operations and cash flows.

Revenue Recognition

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obligations within a contract, we allocate the transaction price to each performance obligation based on our best estimate of standalone selling price.

We account for a contract after it has been approved by the parties to the contract, the rights and the payment terms of

the parties are identified, the contract has commercial substance and collectability is probable, which is presumed for our U.S.

Government customers and prime contractors for which we perform as subcontractors to U.S.

Government end-customers.

The majority of our revenue is recognized over time, as control is transferred continuously to our customers who receive

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extent that no constraint exists that would preclude recognizing this revenue or result in a significant reversal of cumulative revenue recognized.

We have included these estimated amounts of variable consideration in the transaction price and as

We included these estimated amounts of variable consideration in the transaction price and as

performance on these contracts is complete, we have recognized revenue of $6.0 million during the year ended December 31, 2018.

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revenue (in thousands) by customer type and contract type for the periods presented.

Three Months Ended March 31,

Three Months Ended June 30,

Six Months Ended June 30,

State & Local, and Commercial

Three Months Ended March 31,

Three Months Ended June 30,

Six Months Ended June 30,

Firm fixed-price

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The following table discloses accounts receivable and contract assets (in thousands):

March 31, 2020

June 30, 2020

December 31, 2019

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The following table discloses contract liabilities (in thousands):

March 31, 2020

June 30, 2020

December 31, 2019

Contract liabilities

As of March 31, 2020 and December 31, 2019, we had $102.5 million and $112.4 million of remaining performance obligations, respectively,

As of June 30, 2020 and December 31, 2019, we had $84.8 million and $112.4 million of remaining performance obligations, respectively,

which we also refer to as funded backlog.

We expect to recognize approximately 87.6% of our remaining performance obligations as revenue in 2020, an additional 11.4% in 2021, and the balance thereafter.

Revenue recognized for the three months ended

March 31, 2020 and 2019 that was included in the contract liabilities balance at the beginning of each reporting period was $2.4 million and $1.8 million, respectively.

We recognized revenue of $1.1 million and $3.5

million during the three and six months ended June 30, 2020, respectively, and $1.2 million and $3.1 million during the three and six months ended June 30, 2019, respectively, that was included in the contract liabilities balance at the beginning of

each fiscal year.

Accounts Receivable

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The balance of the sold receivables may not exceed $10 million.

There were no accounts receivable sold during the three months ended March 31, 2020.

three months ended March 31, 2019, the Company sold approximately $5.0 million of accounts receivable, and recognized a related loss of approximately $18,000 in selling, general and administrative expenses.

As of March 31, 2020 and December 31,

2019, there were no outstanding sold accounts receivable.

There were no accounts receivable sold during the three and six months ended June 30, 2020.

the three and six months ended June 30, 2019, the Company sold approximately $4.4 million and $9.4 million of accounts receivable, respectively, and recognized a related loss of approximately $15,000 and $32,000 in selling, general and administrative

expenses, respectively, for the same period.

As of June 30, 2020 and December 31, 2019, there were no outstanding sold accounts receivable.

Inventories are stated at the lower of cost or net realizable value, where cost is determined using the weighted average

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significant additional costs that would be necessary to upgrade to current standards as well as the lack of forecasted sales for such inventory in the near future.

Gross inventory was $3.6 million and $2.8 million as of March 31, 2020 and December 31, 2019 , respectively.

As of March 31, 2020, it is management’s judgment that we have fully provided for any potential inventory obsolescence, which

was $0.9 million as of March 31, 2020 and December 31, 2019.

Gross inventory was $4.2 million and $2.8 million as of June 30, 2020 and December 31, 2019 , respectively.

As of June 30, 2020, it is management’s judgment that we have fully provided for any potential inventory obsolescence, which

was $0.9 million as of June 30, 2020 and December 31, 2019.

Software Development Costs

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second quarter of 2017, software development costs are capitalized and amortized over the estimated product life of 2-3 years on a straight-line basis.

As of March 31, 2020 and December 31, 2019, we capitalized $7.1 million and $5.6 million of

As of June 30, 2020 and December 31, 2019, we capitalized $8.7 million and $5.6 million of

software development costs, respectively, which are included as a part of property and equipment.

Amortization expense was $0.5 million and $0.4 million for the three months ended March 31, 2020 and 2019, respectively.

Accumulated amortization was

$3.6 million and $3.1 million as of March 31, 2020 and December 31, 2019, respectively.

The Company analyzes the net realizable value of capitalized software development costs on at least an annual basis and has determined that there is no indication

of impairment of the capitalized software development costs as forecasted future sales are adequate to support amortization costs.

Amortization expense was $0.4 million and $0.9 million for the three and six months ended June 30, 2020, respectively, and $0.5 million and $0.9 million

for the three and six months ended June 30, 2019, respectively.

Accumulated amortization was $4.0 million and $3.1 million as of June 30, 2020 and December 31, 2019, respectively.

The Company analyzes the net realizable value of capitalized software

development costs on at least an annual basis and has determined that there is no indication of impairment of the capitalized software development costs as forecasted future sales are adequate to support amortization costs.

We account for income taxes in accordance with ASC 740, “Income Taxes.” Under ASC 740, deferred tax assets and liabilities

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We considered projected future taxable income, tax planning strategies, and reversal of taxable temporary differences in making this assessment.

we have determined that a full valuation allowance is required as of March 31, 2020 and December 31, 2019.

As a result of a full valuation allowance against our deferred tax assets, a deferred tax liability related to goodwill remains on our

condensed consolidated balance sheets at March 31, 2020 and December 31, 2019.

Due to the tax reform enacted on December 22, 2017, net operating losses generated in taxable years beginning after December 31, 2017 will have an indefinite carryforward

period, which will be available to offset future taxable income created by the reversal of temporary taxable differences related to goodwill.

As a result, we have adjusted the valuation allowance on our deferred tax assets and liabilities at March

we have determined that a full valuation allowance is required as of June 30, 2020 and December 31, 2019.

As a result of a full valuation allowance against our deferred tax assets, a deferred tax liability related to goodwill remains on our condensed

consolidated balance sheets at June 30, 2020 and December 31, 2019.

Due to the tax reform enacted on December 22, 2017, net operating losses generated in taxable years beginning after December 31, 2017 will have an indefinite carryforward period,

which will be available to offset future taxable income created by the reversal of temporary taxable differences related to goodwill.

As a result, we have adjusted the valuation allowance on our deferred tax assets and liabilities at June 30, 2020

and December 31, 2019.

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The evaluation is based on the estimation of the fair values of our three reporting units, CO&D, Telos ID Enterprise Solutions, and Secure Communications Cyber and Enterprise Solutions, of which goodwill is housed in the CO&D

reporting units, in comparison to the reporting unit’s net asset carrying values.

Our discounted cash flows required management’s judgment with respect to forecasted revenue streams and operating margins, capital expenditures and the selection and

use of an appropriate discount rate.

reporting unit, in comparison to the reporting unit’s net asset carrying values.

Our discounted cash flows required management’s judgment with respect to forecasted revenue streams and operating margins, capital expenditures and the selection and use

of an appropriate discount rate.

We utilized the weighted average cost of capital as derived by certain assumptions specific to our facts and circumstances as the discount rate.

The net assets attributable to the reporting units are determined

based upon the estimated assets and liabilities attributable to the reporting units in deriving its free cash flows.

The net assets attributable to the reporting units are determined based

upon the estimated assets and liabilities attributable to the reporting units in deriving its free cash flows.

In addition, the estimate of the total fair value of our reporting units is compared to the market capitalization of the Company.

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Since June 2008, we have issued restricted stock (Class A common) to our executive officers, directors and employees.

To date, there have been no grants in 2020.

Such stock is subject to a vesting schedule as follows:

To date, 100,000 shares have been granted in 2020.

Such stock is subject to a vesting schedule as

25% of the restricted stock vests immediately on the date of grant, thereafter, an additional 25% will vest annually on the anniversary of the date of grant subject to continued employment or services.

As of March 31, 2020, there were 1,153,750 shares of

restricted stock that remained subject to vesting.

In the event of death of the employee or a change in control, as defined by the Telos Corporation 2008 Omnibus Long-Term Incentive Plan, the 2013 Omnibus Long-Term Incentive Plan, or the 2016 Omnibus

Long-Term Incentive Plan, all unvested shares shall automatically vest in full.

In accordance with ASC 718, we recorded immaterial compensation expense for any of the issuances as the value of our common stock was nominal, based on the deduction of

our outstanding debt, capital lease obligations, and preferred stock from an estimated enterprise value, which was estimated based on discounted cash flow analysis, comparable public company analysis, and comparable transaction analysis.

As of June 30, 2020, there were 75,000

shares of restricted stock that remained subject to vesting.

In the event of death of the employee or a change in control, as defined by the Telos Corporation 2008 Omnibus Long-Term Incentive Plan, the 2013 Omnibus Long-Term Incentive Plan, or the

2016 Omnibus Long-Term Incentive Plan, all unvested shares shall automatically vest in full.

In accordance with ASC 718, we recorded immaterial compensation expense for any of the issuances as the value of our common stock was nominal, based on the

deduction of our outstanding debt, capital lease obligations, and preferred stock from an estimated enterprise value, which was estimated based on discounted cash flow analysis, comparable public company analysis, and comparable transaction

Additionally, we determined that a significant change in the valuation estimate for common stock would not have a significant effect on the condensed consolidated financial statements.

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(in thousands):

March 31, 2020

June 30, 2020

December 31, 2019

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to the ownership interests held by the other party including the following:

Upon the occurrence of a change in control of the Class A member (as defined in the Operating Agreement, a “Change in Control”), the Class A member

has the option to purchase the entire membership interest of the Class B member.

Upon the occurrence of a change in control of the Class A member (as defined in the Operating Agreement, a “Change in Control”), the Class A member has

the option to purchase the entire membership interest of the Class B member.

Upon the occurrence of the following events:

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bankruptcy of the Class A member;

or (iii) unless the Class A member exercises its option to acquire the entire membership interest of the Class B member upon a Change in Control of the Class A member, the transfer or issuance of more

than fifty-one percent (51%) of the outstanding voting securities of the Class A member to a third party, the Class B member has the option to purchase the membership interest of the Class A member;

provided, however, that in the event

that the Class B member exercises the foregoing option, the Class A Member may then choose to purchase the entire interest of the Class B member.

In the event that more than fifty percent (50%) of the ownership interests in the Class B member are transferred to persons or individuals (other

than members of the immediate family of the initial owners of the Class B member) without the consent of Telos ID, the Class A member has the option to purchase the entire membership interest of the Class B member.

The Class B member has the option to sell its interest to the Class A member at any time if there is not a letter of intent to sell Telos ID, a

binding contract to sell all of the assets or membership interests in Telos ID, or a standstill for due diligence with respect to a sale of Telos ID.

Notwithstanding the foregoing, the Class A member will not be obligated to purchase the

interest of the Class B member if that purchase would constitute a violation of any existing line of credit available to the Company after giving effect to that purchase and the applicable lender refuses to consent to that purchase or to

waive such violation.

fifty-one percent (51%) of the outstanding voting securities of the Class A member to a third party, the Class B member has the option to purchase the membership interest of the Class A member;

provided, however, that in the event that the

Class B member exercises the foregoing option, the Class A Member may then choose to purchase the entire interest of the Class B member.

In the event that more than fifty percent (50%) of the ownership interests in the Class B member are transferred to persons or individuals (other than

members of the immediate family of the initial owners of the Class B member) without the consent of Telos ID, the Class A member has the option to purchase the entire membership interest of the Class B member.

The Class B member has the option to sell its interest to the Class A member at any time if there is not a letter of intent to sell Telos ID, a binding

contract to sell all of the assets or membership interests in Telos ID, or a standstill for due diligence with respect to a sale of Telos ID.

Notwithstanding the foregoing, the Class A member will not be obligated to purchase the interest of

the Class B member if that purchase would constitute a violation of any existing line of credit available to the Company after giving effect to that purchase and the applicable lender refuses to consent to that purchase or to waive such

If either the Class A member or the Class B member elects to sell its interest or buy the other

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As a result of the Transaction, the Class A and Class B members each own 50% of Telos ID, as mentioned above, and as such

each was allocated 50% of the profits, which was $784,000 and $473,000 for the three months ended March 31, 2020 and 2019, respectively.

Class B member is the non-controlling interest.

each was allocated 50% of the profits (loss), which was $2.8 million and $3.6 million for the three and six months ended June 30, 2020, respectively, and $(0.3) million and $0.2 million for the three and six months ended June 30, 2019, respectively.

The Class B member is the non-controlling interest.

Distributions are made to the members only when and to the extent determined by Telos ID’s Board of Directors, in

accordance with the Operating Agreement.

No distribution was made during the three months ended March 31, 2020.

The Class B member received a total distribution of $716,000 for the three months ended March 31, 2019.

The following table details the changes in non-controlling

interest for the three months ended March 31, 2020 and 2019 (in thousands):

Three Months Ended March 31,

The Class B member received a total distribution of $1.0 million during the three and six months ended June 30, 2020, and $0.3 million and $1.0 million during the three and six months ended June 30, 2019,

respectively.

The following table details the changes in non-controlling interest for the

three and six months ended June 30, 2020 and 2019 (in thousands):

Three Months Ended June 30,

Six Months Ended June 30,

Non-controlling interest, beginning of period

Net income (loss)

Distributions

Non-controlling interest, end of period

balance was $14.9 million as of March 31, 2020 and December 31, 2019.

balance was $14.9 million as of June 30, 2020 and December 31, 2019.

Goodwill is subject to annual impairment tests and if triggering events are present before the annual tests, we will assess impairment.

As of March 31, 2020 and December

As of June 30, 2020 and December

31, 2019, no impairment charges were taken.

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supported by little or no market activity).

As of March 31, 2020 and December 31, 2019, we did not have any financial

As of June 30, 2020 and December 31, 2019, we did not have any financial

instruments with significant Level 3 inputs and we did not have any financial instruments that are measured at fair value on a recurring basis.

As of March 31, 2020 and December 31, 2019, the carrying value

As of June 30, 2020 and December 31, 2019, the carrying value

of the Company’s 12% Cumulative Exchangeable Redeemable Preferred Stock, par value $.01 per share (the “Public Preferred Stock”) was $141.1 million and $139.2 million, respectively, and the estimated fair market value was $68.5 million and $60.5

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Accounts Payable and Other Accrued Liabilities

As of March 31, 2020 and December 31, 2019, the accounts payable and other accrued

liabilities consisted of $13.7 million and $13.5 million, respectively, in trade account payables and $1.5 million in accrued liabilities.

As of June 30, 2020 and December 31, 2019, the accounts payable and other accrued

liabilities consisted of $14.8 million and $13.5 million, respectively, in trade accounts payable and $4.8 million and $1.5 million, respectively, in accrued liabilities.

Contract Liabilities

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Contract liabilities are reported on our condensed consolidated balance sheets on a net contract basis at the end of each reporting period.

As of March 31, 2020 and

December 31, 2019, the contract liabilities primarily related to product support services.

As of June 30, 2020 and December

31, 2019, the contract liabilities primarily related to product support services.

Enlightenment Capital Credit Agreement

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payment-in-kind.

Upon thirty days days prior written notice, the Company may prepay any portion or the entire amount of the Loan.

Upon thirty days prior written notice, the Company may prepay any portion or the entire amount of the Loan.

The Credit Agreement contains representations, warranties, covenants, terms and conditions customary

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The prepayment price was amended as follows:

(a) from January 26, 2019 through January 25, 2020, the prepayment price is 102% of the principal amount, (b) from

January 26, 2020 through October 14, 2020, the prepayment price is 101% of the principal amount, and (c) from October 15, 2020 to the maturity date, the prepayment price will be at par.

However, the prepayment price for the additional $5

million loan attributable to the Fourth Amendment will be at par.

(a) from January 26, 2019 through January 25, 2020, the prepayment price is 102% of the principal amount, (b) from January

26, 2020 through October 14, 2020, the prepayment price is 101% of the principal amount, and (c) from October 15, 2020 to the maturity date, the prepayment price will be at par.

However, the prepayment price for the additional $5 million

loan attributable to the Fourth Amendment will be at par.

The following financial covenants, as defined in the Credit Agreement, were amended and updated:

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The Company paid the Agent a fee of $110,000 in connection with the Fourth Amendment.

We incurred immaterial third party transation costs which were expensed during

the current period.

We incurred immaterial third party transation costs which were expensed during the

current period.

The exit fee was increased from $825,000 to $1,200,000.

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the term of the loan using the effective interest method at a rate of 17.3% over the remaining term of the loan.

For the measurement period ended March 31, 2020 we were in compliance with the Credit Agreement’s financial covenants, based on an

For the measurement period ended June 30, 2020, we were in compliance with the Credit Agreement’s financial covenants, based on an

agreement between the Company and EnCap on the definition of certain input factors that determine the measurement against the covenants.

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The carrying amount of the Credit Agreement consisted of the following (in thousands):

March 31, 2020

June 30, 2020

December 31, 2019

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We incurred interest expense in the amount of

$0.8 million and $0.4 million for the three months ended March 31, 2020 and 2019, respectively, under the Credit Agreement.

$0.7 million and $1.5 million for the three and six months ended June 30, 2020, respectively, and $0.4 million and $0.8 million for the three and six months ended June 30, 2019, respectively, under the Credit Agreement.

Accounts Receivable Purchase Agreement

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All other terms remain in full force and

We incurred interest expense in the amount of $87,000 and $80,000 for the three months ended March 31, 2020 and 2019, respectively, on the Porter Notes.

As of March 31, 2020, approximately $1.1 million of accrued interest was

payable according to the stated interest rate of the Porter Notes.

We incurred interest expense in the amount of $88,000 and $175,000 for the three and six months ended June 30, 2020, respectively, and $82,000 and $162,000 for the three and six months ended June 30, 2019, respectively, on the

Porter Notes.

As of June 30, 2020, approximately $1.2 million of accrued interest was payable according to the stated interest rate of the Porter Notes.

Preferred Stock

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In November 1998, we retired 410,000 shares of the Public Preferred Stock.

The total number of shares issued and outstanding at March 31, 2020 and December 31, 2019 was 3,185,586.

The total number of shares issued and outstanding at June 30, 2020 and December 31, 2019 was 3,185,586.

The Public Preferred

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Therefore, we classify these securities as

noncurrent liabilities in the condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019.

noncurrent liabilities in the condensed consolidated balance sheets as of June 30, 2020 and December 31, 2019.

On January 25, 2017, we became parties with certain of our subsidiaries to the Credit Agreement with EnCap.

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otherwise require any acceleration of the redemption of or amortization of payments with respect to the Public Preferred Stock.

Thus, the Public Preferred Stock is not and will not be due on demand, nor callable, within 12 months from March 31,

Thus, the Public Preferred Stock is not and will not be due on demand, nor callable, within 12 months from June 30,

This classification is consistent with ASC 210, “Balance Sheet” and 470, “Debt” and the FASB ASC Master Glossary definition of “Current Liabilities.”

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For the cash dividends payable since December 1, 1995, we have accrued $109.3 million and $107.4 million as of

March 31, 2020 and December 31, 2019, respectively.

We accrued dividends on the Public Preferred Stock of $1.0 million for each of the three months ended March 31, 2020 and 2019, which was recorded as interest expense.

Prior to the effective date

of ASC 480 on July 1, 2003, such dividends were charged to stockholders’ accumulated deficit.

June 30, 2020 and December 31, 2019, respectively.

We accrued dividends on the Public Preferred Stock of $1.0 million and $1.9 million for each of the three and six months ended June 30, 2020 and 2019, respectively, which was recorded as interest

Prior to the effective date of ASC 480 on July 1, 2003, such dividends were charged to stockholders’ accumulated deficit.

The income tax

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effective tax rate each quarter.

W e recorded an approximately $146,000 and $197,000 income tax benefit for the three months ended March 31, 2020 and 2019, respectively.

For the three months ended March 31, 2020 and 2019, our estimated

annual effective tax rate was primarily impacted by the overall valuation allowance position which reduced the net tax impact from taxable loss for both periods.

W e recorded an approximately $2,000 income tax provision and $144,000 income tax benefit for the three and six months ended June 30, 2020, respectively, and a $20,000 income tax provision and $177,000 income

tax benefit for the three and six months ended June 30, 2019, respectively.

For the three and six months ended June 30, 2020 and 2019, our estimated annual effective tax rate was primarily impacted by the overall valuation allowance position which

reduced the net tax impact from taxable loss for all periods.

In March 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted.

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qualified improvement property, and alternative minimum tax credit refund.

We will continue to assess the impact of the CARES Act as well as any ongoing government guidance related to COVID-19 that may be issued.

We are required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence,

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future taxable income, tax planning strategies, and reversal of taxable temporary differences in making this assessment.

As such, we have determined that a full valuation allowance is required as of March 31, 2020 and December 31, 2019.

As such, we have determined that a full valuation allowance is required as of June 30, 2020 and December 31, 2019.

Under the Tax

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As a result, a deferred tax liability related to goodwill of $640,000 and

$621,000 remains on our condensed consolidated balance sheets at March 31, 2020 and December 31, 2019, respectively.

The income tax benefit recorded for the three months ended March 31, 2020 is primarily related to this change in deferred tax

liability and is due to the release of FIN 48 liability on state nexus.

$621,000 remains on our condensed consolidated balance sheets at June 30, 2020 and December 31, 2019, respectively.

The income tax benefit recorded for the six months ended June 30, 2020 is primarily related to this change in deferred tax liability

and is due to the release of FIN 48 liability on state nexus.

As a result of the Tax Act, we are subject to several provisions of the Tax Act including computations under Section 162(m) executive

compensation limitation and Section 163(j) interest limitation rule.

We have considered the impact of each of these provisions in our computation of tax expense for the three months ended March 31, 2020 and 2019.

Under the provisions of ASC 740, we determined that there were approximately $502,000 and $673,000 of unrecognized tax benefits, including $224,000 and $304,000 of related interest and penalties, required to be recorded in other liabilities in the condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019, respectively.

We have considered the impact of each of these provisions in our computation of income tax expense for the three and six months ended June 30, 2020 and 2019.

Under the provisions of ASC 740, we determined that there were approximately $508,000 and $673,000 of unrecognized tax benefits, including $229,000 and $304,000 of related interest and penalties, required to be recorded in other liabilities in the condensed consolidated balance sheets as of June 30, 2020 and December 31, 2019, respectively.

We believe that the total amounts of unrecognized tax benefits will not significantly increase or decrease within the next 12 months.

Contingencies and Subsequent Events

Commitments and

Contingencies

Financial Condition and Liquidity

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capital by selling equity, although no assurances can be given that these investors would be able to invest or that the Company and the investors would agree upon terms for such investments.

Our working capital was $(14.8) million and $2.9 million as of March 31, 2020 and December 31, 2019, respectively.

Our working capital was $(12.8) million and $2.9 million as of June 30, 2020 and December 31, 2019, respectively.

current working capital deficit is due to the classification of the EnCap Credit Agreement as a current liability as discussed in Note 5 to the financial statements, although the Fifth Amendment to the Credit Agreement provides us the option to

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Legal Proceedings

Costa Brava Partnership III, L.P.

and Wynnefield Partners Small Cap Value, L.P.v.

Telos Corporation, et al.

As previously disclosed in Note 13 of the Consolidated Financial Statements contained in our Annual Report on Form 10-K for

the year ended December 31, 2019, on October 17, 2005, Costa Brava Partnership III, L.P.

(“Costa Brava”), a holder of our Public Preferred Stock, instituted litigation against the Company and certain past and present directors and officers (“Telos

Defendants”) in the Circuit Court for Baltimore City, Maryland (the “Circuit Court”).

A second holder of the Company’s Public Preferred Stock, Wynnefield Small Cap Value, L.P.

(“Wynnefield”), subsequently intervened as a co-Plaintiff (Costa Brava

and Wynnefield are hereinafter referred to as “Plaintiffs”).

On February 27, 2007, Plaintiffs added, as an additional defendant, Mr.

Porter, a holder of the Company’s Class A common stock.

As of March 31, 2020, Costa Brava and Wynnefield , directly and through affiliated funds, own 12.7% and 17.4%, respectively, of the outstanding Public Preferred Stock.

On December 18, 2019, the Circuit Court filed three (3) Memorandum Opinions and entered four (4) Orders addressing all of

the pending motions and open claims in the litigation and closing the case.

First, the Circuit Court granted the Motion to Reconsider the Circuit Court’s March 30, 2006 order denying the Motions to Dismiss for Lack of Personal Jurisdiction filed by

a number of the past and present directors and officers.

The Circuit Court determined that the intervening appellate decision was binding legal precedent on a pertinent legal issue, and concluded that the Court lacked personal jurisdiction over the

moving defendants.

The Circuit Court entered an order dismissing the derivative claims against these defendants for lack of personal jurisdiction.

Second, the Circuit Court granted the Defendants’ Motions to Dismiss the derivative claims.

The Defendants’ Motion to

Dismiss relied on the conclusions in the final report of the Special Litigation Committee (SLC) that the derivative claims lacked merit and that it was not in the best interests of the Company to pursue them.

The Circuit Court found, among other

things, that the Telos Defendants had sustained their burden of proof to show that (i) the SLC was independent, (ii) the legal counsel for the SLC was independent, (iii) the SLC acted in good faith in conducting its investigation and reaching its

conclusions, and (iv) the SLC conducted a reasonable investigation with factually supported conclusions.

The Circuit Court also determined that the procedural mechanism the Telos Defendants had utilized to present the issue to the Circuit Court —

proceedings under Maryland Rule 2-502 — was an appropriate procedural vehicle to use for this issue.

The Circuit Court entered an order granting the Defendants’ Motion to Dismiss and ordering the dismissal of the derivative claims on the merits.

Third, the Circuit Court granted Mr.

Porter’s Motion to Dismiss based on a lack of minimum contacts with the State of

Maryland, and entered an order dismissing the claim for shareholder oppression against Mr.

Porter for lack of jurisdiction.

Finally, the Circuit Court entered a separate order concluding that all claims in the Third Amended Complaint had been

dismissed by various orders of the Court dated June 6, 2007, January 7, 2008, April 15, 2008, and December 18, 2019, and further ordering the Clerk of the Court to close the case with costs to be paid by Plaintiffs.

Costa Brava noted an appeal to the Court of Special Appeals of Maryland on January 17, 2020 from the Circuit Court’s

final judgment.

Co-plaintiff Wynnefield elected not to note or pursue an appeal.

Prior to any briefing by the parties, Costa Brava voluntarily filed a notice dismissing its appeal on May 12, 2020.

The dismissal of the appeal by Costa Brava fully

concludes this long-pending litigation.

Telos Corporation

As previously disclosed in Note 13 of the Consolidated Financial Statements contained in our Annual Report on Form 10-K for

the year ended December 31, 2019, since August 2, 2007, Messrs.

the year ended December 31, 2019, beginning on August 2, 2007, Messrs.

Hamot (“Hamot”) and Andrew R.

Siegel (“Siegel”), principals of Costa Brava, have been involved in litigation against the Company as Plaintiffs and Counter-defendants in the

Circuit Court.

Siegel (“Siegel”), principals of Costa Brava Partnership III, L.P.

(“Costa Brava”), were involved in litigation against the Company as

Plaintiffs and Counter-defendants in the Circuit Court for Baltimore City, Maryland (the “Circuit Court”).

Siegel is a Class D Director of the Company and Mr.

Hamot was a Class D Director of the Company until his resignation on March 9, 2018.

The Plaintiffs initially alleged that certain documents and records had not been provided to

them promptly and were necessary to fulfill their duties as directors of the Company.

Subsequently, Hamot and Siegel further alleged that the Company had failed to follow certain provisions concerning the noticing of Board committee meetings and the

recording of Board meeting minutes and, additionally, that Mr.

Wood’s service as both CEO and Chairman of the Board was improper and impermissible under the Company’s Bylaws.

On April 23, 2008, the Company filed a counterclaim against Hamot and

Siegel for money damages and preliminary and injunctive relief based upon Hamot and Siegel’s interference with, and improper influence of, the Company’s independent auditors regarding, among other things, a specific accounting treatment.

2008, the Circuit Court granted the Company’s motion for preliminary injunction and enjoined Hamot and Siegel from contacting the Company’s auditors until the completion of the Company’s Form 10-K for the preceding year, which injunction later

expired by its own terms.

As previously disclosed, trial on Hamot and Siegel’s claims and the Company’s counterclaims took place in July through September, 2013, and the Court subsequently issued decisions on the various claims by way of memorandum

opinions and orders dated September 11, 2017.

The Company’s subsequent appeal of the amount of damages awarded to it for Hamot and Siegel’s intentional interference with the relationships with its former auditor was ultimately dismissed by way of the

Mandate issued by the Court of Appeals of Maryland on October 11, 2019.

Hamot and Siegel at various times in this litigation have sought to be indemnified or to be awarded advancement of various

attorney’s fees and expenses incurred by them in this litigation.

Plaintiffs initially alleged that certain documents and records had not been provided to them promptly and were necessary to fulfill their duties as directors of the Company.

Subsequently, Hamot and Siegel further alleged that the Company had failed

to follow certain provisions concerning the noticing of Board committee meetings and the recording of Board meeting minutes and, additionally, that Mr.

John Wood’s service as both CEO and Chairman of the Board was improper and impermissible under the

Company’s Bylaws.

On April 23, 2008, the Company filed a counterclaim against Hamot and Siegel for money damages and preliminary and injunctive relief based upon Hamot and Siegel’s interference with, and improper influence of, the Company’s

independent auditors regarding, among other things, a specific accounting treatment.

On June 27, 2008, the Circuit Court granted the Company’s motion for preliminary injunction and enjoined Hamot and Siegel from contacting the Company’s auditors

until the completion of the Company’s Form 10-K for the preceding year, which injunction later expired by its own terms.

As previously disclosed, trial on Hamot and Siegel’s claims and the Company’s counterclaims took place in July through September

2013, and the Court subsequently issued decisions on the various claims by way of memorandum opinions and orders dated September 11, 2017.

The Company’s subsequent appeal of the amount of damages awarded to it for Hamot and Siegel’s intentional

interference with the relationships with its former auditor was ultimately dismissed by way of the Mandate issued by the Court of Appeals of Maryland on October 11, 2019.

Hamot (and later, his Estate) and Siegel at various times in this litigation have sought to be indemnified or to be awarded

advancement of various attorney’s fees and expenses incurred by them in this litigation.

No claim for indemnification is pending as of the reporting date.

There have been no material developments in connection with this litigation during the three months ended March 31, 2020.

At this stage of the litigation, it is impossible to reasonably determine the degree of probability related to the

Company’s success in relation to any possible further claim by Hamot and Siegel for indemnification for certain attorney’s fees and expenses incurred in this litigation.

The Company intends to vigorously defend the matter and oppose any claim for

indemnification if it is pursued.

There have been no material developments in connection with this litigation during the three months ended June 30, 2020.

At this stage of the litigation, it is

impossible to reasonably determine the degree of probability related to the Company’s success in relation to any possible further claim by Hamot’s Estate and Siegel for indemnification for certain attorney’s fees and expenses incurred in this

The Company intends to vigorously defend the matter and oppose any claim for indemnification were it to be pursued.

Other Litigation

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Wood, the brother of our Chairman and CEO, has been an employee of the Company since 1996.

The amounts paid to this individual as compensation were $173,000 and $158,000 for the three months ended March 31, 2020 and 2019, respectively.

Additionally, as of March 31, 2020 and December 31, 2019, Mr.

Wood owned 810,000 shares of the Company’s Class A Common Stock and 50,000 shares of the Company’s Class B

Common Stock.

The amounts paid to this individual as compensation were $151,000 and $324,000 for the three and six months ended June 30, 2020, respectively, and

$76,000 and $234,000 for the three and six months ended June 30, 2019, respectively.

Additionally, as of June 30, 2020 and December 31,

Wood owned 810,000 shares of the Company’s Class A Common Stock and 50,000 shares of the Company’s Class B Common Stock.

On March 31, 2015, the Company entered into the Porter Notes.

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On April 18, 2017, we amended and restated the

Porter Notes to reduce the interest rate from twelve percent (12%) to six percent (6%) per annum, to be accrued, and extends the maturity date from July 1, 2017 to July 25, 2022.

Porter Notes to reduce the interest rate from twelve percent (12%) to six percent (6%) per annum, to be accrued, and extended the maturity date from July 1, 2017 to July 25, 2022.

Telos also entered into Intercreditor Agreements with Porter and

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All other terms remain in full force and

We incurred interest expense in the amount of $87,000 and $80,000 for the three months ended March 31, 2020, respectively , on the Porter Notes.

As of March 31, 2020, approximately $1.1 million of accrued interest was payable

according to the stated interest rate of the Porter Notes.

We incurred interest expense in the amount of $88,000 and $175,000 for the three and six months ended June 30, 2020, respectively , and $82,000 and $162,000 for the three and six months ended June 30, 2019, respectively, on the Porter

As of June 30, 2020, approximately $1.2 million of accrued interest was payable according to the stated interest rate of the Porter Notes.

Note 10 – Leases

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The weighted average remaining

lease terms and discount rates for our operating leases were approximately 3.3 years and 5.75% and for our finance leases were approximately 9.1 years and 5.04% at March 31, 2020.

lease terms and discount rates for our operating leases were approximately 3.0 years and 5.75% and for our finance leases were approximately 8.8 years and 5.04% at June 30, 2020.

Operating lease expense is recognized as rent expense on a

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disclosure included in our 2019 Form 10-K.

As of March 31, 2020, operating lease ROU assets were $1.9 million and operating lease liabilities were $2.1 million, of which $1.4 million

As of June 30, 2020, operating lease ROU assets were $1.8 million and operating lease liabilities were $1.9 million, of which $1.3 million

were classified as noncurrent.

Future minimum lease commitments at March 31, 2020 were as follows (in thousands):

Future minimum lease commitments at June 30, 2020 were as follows (in thousands):

Year ending December 31,

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Finance Leases

2020 (excluding the three months ended March 31, 2020)

2020 (excluding the six months ended June 30, 2020)

Total lease payments

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The components of lease expense were as follows (in thousands):

Three Months Ended March 31,

Three Months Ended June 30,

Six Months Ended June 30,

Operating lease cost

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Supplemental cash flow information related to leases was as follows (in thousands):

Three Months Ended March 31,

Six Months Ended June 30,

Cash paid for amounts included in the measurement of lease liabilities:

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1. Financial Statements