What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-13 compared with 2020-08-13 · 195 added, 181 removed, 362 unchanged (51% of the section changed)

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These factors include, without limitation, those set forth in the risk factors section included in the Company’s Form 10-K for the year ended December 31, 2019, as filed with the SEC.

The solutions we offer secure cyberspace, the cloud environment, and the people and operations of the enterprise.

three facets of the modern organization share much in common, but also require a diverse range of skills, capabilities, and experience to meet the important requirements of security-conscious customers.

Telos’ decades-long resume of providing a broad

spectrum of technology and security solutions uniquely qualifies us to meet our customers’ needs in these three areas.

Our experience in addressing challenges in one operation of the enterprise informs our work in meeting requirements in others.

understand that a range of complementary capabilities may be needed to solve a single challenge, and we also recognize when a single solution might address multiple challenges.

Our substantive expertise in developing, orchestrating, and delivering solutions across these areas gives us the vision and

We offer technologically advanced, software-based security solutions that empower and protect the world’s most

security-conscious organizations against rapidly evolving, sophisticated and pervasive threats.

Our portfolio of security products, services and expertise empower our customers with capabilities to reach new markets, serve their stakeholders more

effectively, and successfully defend the nation or their enterprise.

We protect our customers’ people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in their security and

Our mission is to protect our customers’ people, systems, and vital information assets with offerings for cybersecurity,

cloud security, and enterprise security.

In the current global environment, our mission is more critical than ever.

The emergence of each new information and communications technology (“ICT”) introduces new vulnerabilities, as security is still too

often overlooked in solution development.

Networks and applications meant to enhance productivity and profitability often jeopardize an organization due to poor planning, misconfiguration, or an unknown gap in security.

Ransomware, insider threats,

cybercrime, and advanced persistent threats continue to menace public and private enterprises across all industries.

Cybersecurity, cloud security, and enterprise security of the modern organization share much in common, yet also call for a

diverse range of skills, capabilities, and experience in order to meet the requirements of security-conscious customers.

Decades of experience in developing, orchestrating, and delivering solutions across these three domains gives us the vision and

the confidence to provide solutions that empower and protect the enterprise at an integrated, holistic level.

Our capabilities include:

Cybersecurity – Today’s

enterprises need to understand and manage their cyber risk and reduce their cyber attack surfaces.

Telos helps our customers assure the ongoing security, integrity, and compliance of their on-premises and cloud-based systems and to reduce

threats and vulnerabilities to foil cyber adversaries before they can attack.

Our consultants assess our customers’ security environments and design, engineer, and operate the systems they need to strengthen their cybersecurity posture.

Our experience in addressing challenges in one area of an enterprise helps us meet requirements in others.

We understand that a range of

complementary capabilities may be needed to solve a single challenge, and we also recognize when a single solution might address multiple challenges.

Our security solutions span across the following domains:

Cybersecurity – We help our

customers ensure the ongoing security, integrity, and compliance of their on-premises and related cloud-based systems, reducing threats and vulnerabilities to foil cyber adversaries before they can attack.

Our consultants assess our

customers’ security environments and design, engineer, and operate the systems they need to strengthen their cybersecurity posture.

Cloud Security – The cloud as

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the enterprise means protecting the essential and timeless elements common to every organization:

Its people and processes, its supply chain and inventories, its finances and facilities, its information and communications.

As ICT and OT

systems have become part of the organizational DNA, Telos has led with offerings that ensure personnel can work securely and productively across and beyond the enterprise.

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

national emergency by the U.S.

The pandemic has negatively affected the U.S.

and global economy, disrupted global supply chains and financial markets, and resulted in governments around the world implementing increasingly stringent

measures to help control the spread of the virus, including quarantines, “shelter in place” and “stay at home” orders, travel restrictions, business curtailments, school closures, and other measures.

In addition, governments and central banks in

several parts of the world have enacted fiscal and monetary stimulus measures to counteract the impacts of COVID-19.

We are taking prudent measures to protect the health and safety of our employees, such as practicing social distancing and

enabling our employees to work from home where possible.

As a result of travel restrictions, social distancing guidelines and other efforts that have been adopted by public health officials to mitigate the impact of the COVID-19 pandemic, we have

made changes to our operating schedules and staffing plans to accommodate these restrictions while maintaining the ability of our employees to continue to support and work with our customers to the maximum extent possible.

Such changes include the

implementation of telework or other means of remote work for our employees, who support both mission-critical programs and our internal support organization.

For programs that cannot be supported remotely we have accommodated those customers who have

implemented shiftwork or other mitigation protocols by maintaining our workforce in a “mission ready” state.

As a company that is included in the

defense industrial base, we are operating in a critical infrastructure industry, as defined by the U.S.

Department of Homeland Security.

Consistent with federal guidelines and with state and local orders to date, we have been advised that our

operations are considered essential, and we currently continue to operate.

Notwithstanding our continued operations, COVID-19 may have negative impacts on our operations, supply chain, transportation networks and customers, which may compress our

sales and our margins, including as a result of preventative and precautionary measures that we, other businesses and governments are taking.

While we have experienced certain internal disruptions in adapting our operations as described above to the changed and

evolving conditions, the majority of our program operations have not been adversely impacted, and we have implemented alternative means to support requirements.

Due to the essential nature of the majority of our business, the programs that were

adversely impacted did not experience those effects until the final two weeks of the first quarter, and the overall impact of the COVID-19 pandemic on our results of operations and liquidity were immaterial in the first two quarters of 2020.

financial impact of the COVID-19 pandemic cannot be reasonably estimated at this time as its impact depends on future developments, which are highly uncertain and cannot be predicted.

New information may emerge concerning the scope, severity and

duration of the COVID-19 pandemic, actions to contain its spread or treat its impact, and governmental, business and individuals’ actions taken in response to the pandemic (including restrictions and limitations on travel and transportation) among

Additionally, COVID-19 and the mitigation efforts adopted to limit the spread of the disease have had a significant impact on the global economy.

With economic activity curtailing in the United States and other regions, we could experience

delays in our supply chain or challenges when attempting to access financial markets.

its people and processes, its supply chain and inventories, its finances and facilities, and its information and communications.

operational technology (“OT”) have become part of the organizational make-up, we have offered solutions that ensure personnel can work securely and productively across and beyond the enterprise.

We refer to our cyber and cloud applications as Security Solutions, which includes Information Assurance / Xacta®

(previously referred to as Cyber & Cloud Solutions), Secure Communications (previously referred to as Secure Communications Cyber and Enterprise Solutions), and Telos ID (previously referred to as Telos ID Enterprise Solutions).

We refer to our

offerings for enterprise security as Secure Networks (previously referred to as Secure Mobility and Network Management/Defense Enterprise Solutions).

Security Solutions

Information Assurance / Xacta:

a premier platform for enterprise cyber risk management and security compliance automation, delivering security awareness for systems in the cloud, on-premises, and in hybrid and multi-cloud environments.

Xacta delivers automated cyber risk

and compliance management solutions to large commercial and government enterprises.

Across the U.S.

federal government, Xacta is the de facto commercial cyber risk and compliance management solution.

Secure Communications:

obfuscation network-as-a-service with encryption and managed attribution capabilities to ensure the safety and privacy of people, information, and resources on the network.

Telos Ghost seeks to eliminate cyber-attack surfaces by obfuscating

and encrypting data, masking user identity and location, and hiding network resources.

It provides the additional layers of security and privacy needed for intelligence gathering, cyber threat protection, securing critical infrastructure, and

protecting communications and applications when operations, property, and even lives can be jeopardized by a single error in security.

Telos Automated Message Handling

System (“AMHS”):

web-based organizational message distribution and management for mission-critical communications;

the recognized gold standard for organizational messaging in the U.S.

Telos AMHS is used by military field

operatives for critical communications on the battlefield and is the only web-based solution for assured messaging and directory services using the Defense Information System Agency’s (“DISA”) Organizational Messaging Service and its

specialized communications protocols.

offering Identity

Trust and Digital Services through IDTrust360® – an enterprise-class digital identity risk platform for extending software-as-a-service (“SaaS”) and custom digital identity services that mitigate threats through the integration of advanced

technologies that fuse biometrics, credentials, and other identity-centric data used to continuously monitor trust.

We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck™ enrollment provider,

Designated Aviation Channeling provider, FBI-approved Channeler, and the Financial Industry Regulatory Authority (“FINRA”) Electronic Fingerprint Submission provider.

We are the only commercial entity in our industry designated as a Secure

Flight Services provider for terrorist watchlist checks.

Secure Networks

Secure Mobility:

solutions for

business and government that enable remote work and minimize concern across and beyond the enterprise.

Our secure mobility team brings credentials to every engagement, supplying deep expertise and experience as well as highly desirable

clearances and industry recognized certifications for network engineering, mobility, and security.

Network Management and Defense:

services for operating, administrating, and defending complex enterprise networks and defensive cyber operations.

Our diverse portfolio of capabilities addresses common and uncommon requirements in many industries and disciplines, ranging

from the military and government agencies to Fortune 500 companies.

Many of our contracts with the U.S.

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Government and the respective procuring agency.

Such a contracting process results in two distinct categories of backlog:

funded and unfunded.

Total backlog consists of the

aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or not.

Funded backlog consists of the aggregate contract revenues remaining to be earned by us at a given time, but only to the

extent, in the case of U.S.

Government contracts, when funded by the procuring U.S.

Government agency and allotted to the specific contracts.

Unfunded backlog is the difference between total backlog and funded backlog.

Included in unfunded backlog

are revenues which may be earned only when and if customers exercise delivery orders and/or renewal options to continue such existing contracts.

Total backlog, a component of recurring revenue, consists of the aggregate contract revenues remaining to be earned by us

at a given time over the life of our contracts, whether funded or unfunded.

Funded backlog consists of the aggregate contract revenues remaining to be earned at a given time, which, in the case of U.S.

government contracts, means that they have been

funded by the procuring agency.

Unfunded backlog is the difference between total backlog and funded backlog and includes potential revenues that may be earned if customers exercise delivery orders and/or renewal options to continue these contracts.

Based on historical experience, we generally assume option year renewals to be exercised.

Most of our customers fund contracts on a basis of one year or less and, as a result, funded backlog is

generally expected to be earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period.

A number of contracts that we undertake extend beyond one year and, accordingly, portions of contracts

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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 our backlog.

At June 30, 2020 and 2019, we had total backlog from existing contracts of approximately $308.6

At September 30, 2020 and 2019, we had total backlog from existing contracts of approximately $374.6

million and $307.5 million, respectively.

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under those contracts, including renewal options available on the contracts if fully exercised by the customers.

Funded backlog as of June 30, 2020 and 2019 was $84.8 million and $74.1 million, respectively.

Funded backlog as of September 30, 2020 and 2019 was $147.0 million and $104.0 million, respectively.

Funded backlog was

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In addition to the ongoing need to respond to the crisis in the current fiscal year, Congress and the President must agree

on FY 2021 appropriations legislation prior to October 1, 2020;

on FY 2021 appropriations legislation prior to December 11, 2020;

failing to do so by then would likely mean DoD and other departments will again be funded for an unknown period of time under another Continuing Resolution, which would again restrict

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year ended December 31, 2019.

The principal elements of the Company’s operating expenses as a percentage of sales for the three and six months ended June

30, 2020 and 2019 are as follows:

Three Months Ended June 30,

Six Months Ended June 30,

The principal elements of the Company’s operating expenses as a percentage of sales for the three and nine months ended

September 30, 2020 and 2019 are as follows:

Three Months Ended September 30,

Nine Months Ended September 30,

Cost of sales

Selling, general, and administrative expenses

Operating income (loss)

Operating income

Interest expense

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Net income (loss)

Net (income) loss attributable to non-controlling interest

Net income (loss) attributable to Telos Corporation

Three Months Ended June 30, 2020 Compared with Three Months Ended June 30, 2019

Revenue increased by 34.8% to $48.6 million for the second quarter of 2020, from $36.0 million for the same period in 2019.

Services revenue increased to $45.5 million for the second quarter of 2019 from $34.4 million for the same period in 2019, primarily attributable to increases in sales of $9.6 million of Telos ID Enterprise Solutions and $2.8 million of Secure

Communications Cyber and Enterprise Solutions, offset by decreases in sales of $1.2 million of Secure Mobility and Network Management/Defense Enterprise Solutions and $0.1 million of Cyber & Cloud Solutions.

The change in product and services

revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables.

Product revenue increased to $3.1 million for the second quarter of 2020 from $1.7 million for the

same period in 2019, primarily attributable to increases in sales of $1.5 million of Telos ID Enterprise Solutions and $0.3 million of Cyber & Cloud Solutions, offset by a decrease in sales of $0.4 million of Secure Communications Cyber and

Enterprise Solutions.

Cost of sales increased to $31.0 million for the second quarter of 2020, from $26.0 million for the same period in 2019,

primarily due to an increase in revenue of $12.6 million, however cost of sales as a percentage of revenue decreased by 8.4%.

Cost of sales for services increased by $4.2 million, and as a percentage of services revenue decreased by 8.7%, due to a

change in the mix of the programs and timing of certain Telos ID Enterprise Solutions deliverables.

Cost of sales for products increased by $0.8 million, and as a percentage of product revenue increased by 3.4% due primarily to an increase in product

reselling, which carries a greater cost of sales.

The increase in cost of sales as a percentage of revenue is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary from period to period, and

further can be affected by the timing of deliverables.

Gross profit increased by 75.5% to $17.6 million for the second quarter of 2020 from $10.0 million for the same period in

Gross margin increased to 36.2% in the second quarter of 2020, from 27.8% for the same period in 2019.

Services gross margin increased to 35.4% in 2020 from 26.7% in 2019 due to the change in program mix during the period as noted above,

primarily in Telos ID Enterprise Solutions, and product gross margin decreased to 46.9% in 2020 from 50.3% in 2019, due primarily to an increase in product reselling.

Selling, general, and administrative expense (SG&A) increased by 19.8% to $12.5 million for the second quarter of 2020,

from $10.4 million for the same period in 2019, primarily attributable to increases in outside services of $1.4 million, labor costs of $1.3 million, and accrued bonuses of $0.9 million, offset by an increase in capitalized software development costs

of $1.0 million, and decreases in trade shows costs of $0.3 million and travel costs of $0.2 million.

Operating income was $5.1 million for the second quarter of 2020, compared to an operating loss of $0.4 million for the

same period in 2019, due primarily to an increase in gross profit as noted above.

Interest expense increased by 14.7% to $2.0 million for the second quarter of 2020, from $1.7 million

for the same period in 2019, primarily due to an increase in interest on the EnCap senior term loan.

Income tax provision was $2,000 for the second quarter of 2020, compared to $20,000 for the same period in 2019, which is

based on the estimated annual effective tax rate applied to the pretax income incurred for the quarter plus discreet tax items, based on our expectation of pretax loss for the fiscal year.

Net income attributable to Telos Corporation was $0.3 million for the second quarter of 2020, compared to a net loss of

$1.7 million for the same period in 2019, primarily attributable to the operating income for the quarter as discussed above.

Six Months Ended June 30, 2020 Compared with Six Months Ended June 30, 2019

Revenue increased by 30.3% to $87.6 million for the six months ended June 30, 2020, from $67.2 million in the same period

Services revenue increased to $80.0 million for the six months ended June 30, 2020, from $62.4 million for the same period in 2019, primarily attributable to increases in sales of $13.2 million of Telos ID Enterprise Solutions and $5.1

million of Secure Communications Cyber and Enterprise Solutions, offset by decreases in sales of $0.6 million of Cyber & Cloud Solutions and $0.1 million of Secure Mobility and Network Management/Defense Enterprise Solutions.

The change in

product and services revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables.

Product revenue increased to $7.5 million for the six months ended June 30,

2020, from $4.8 million for the same period in 2019, primarily attributable to increases in sales of $1.7 million of Cyber & Cloud Solutions proprietary software deliverables and $1.3 million of Telos ID Enterprise Solutions, offset by a decrease

in sales of $0.3 million of Secure Communications Cyber and Enterprise Solutions.

Cost of sales increased by 19.8% to $57.8 million for the six months ended June 30, 2020, from $48.2 million for the same

period in 2019, primarily due to an increase in revenue of $20.4 million, however cost of sales as a percentage of revenue decreased by 5.8%.

Cost of sales for services increased by $8.8 million, and as a percentage of services revenue decreased by

5.0%, due primarily to a change in the mix of the programs and timing of certain Telos ID Enterprise Solutions deliverables.

Cost of sales for products increased by $0.7 million, and as a percentage of product revenue decreased by 12.1% due primarily

to an increase in proprietary software sales which carry lower cost of sales.

The increase in cost of sales as a percentage of revenue is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary

from period to period, and further can be affected by the timing of deliverables.

Gross profit increased by 57.0% to $29.8 million for the six months ended June 30, 2020, from $19.0 million compared to the

same period in 2019, due primarily to the change in the mix of the solutions sold as discussed above, primarily in Telos ID Enterprise Solutions.

Gross margin increased to 34.0% for the six months ended June 30, 2020, from 28.2% in the same period in

SG&A expense increased by 17.1% to $24.3 million for the six months ended June 30, 2020, from $20.8 million for the

same period in 2019, primarily attributable to increases in outside services of $2.6 million, labor costs of $2.1 million, and accrued bonuses of $0.9 million, offset by an increase in capitalized software development costs of $1.9 million, and a

decrease in legal costs of $0.3 million.

Operating income was $5.5 million for the six months ended June 30, 2020, compared to an operating loss of $1.8 million for

Net income attributable to non-controlling interest

Net (loss) income attributable to Telos Corporation

Three Months Ended September 30, 2020 Compared with Three Months Ended September 30, 2019

Revenue increased by 4.2% to $47.4 million for the third quarter of 2020, from $45.5 million for the same period in 2019.

Services revenue increased to $44.2 million for the third quarter of 2020 from $39.2 million for the same period in 2019, primarily attributable to increases in sales of $2.5 million by Telos ID, $2.1 million by Assurance / Xacta, and $1.7 million by

Secure Communications, offset by a decrease in sales of $1.3 million by Secure Networks.

The change in product and services revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the

timing of deliverables.

Product revenue decreased to $3.3 million for the third quarter of 2020 from $6.3 million for the same period in 2019, primarily attributable to decreases in sales of $2.5 million by Assurance / Xacta and $0.6 million by Telos

ID, offset by an increase in sales of $0.1 million by Secure Communications.

Cost of sales increased to $30.9 million for the third quarter of 2020, from $29.2 million for the same period in 2019,

primarily due to an increase in revenue of $1.9 million, coupled with an increased cost of sales as a percentage of revenue of 0.9%.

Cost of sales for services increased by $2.0 million, and as a percentage of services revenue decreased by 3.0%, due

to a change in the mix of the programs and timing of certain deliverables.

Cost of sales for products decreased by $0.4 million, and as a percentage of product revenue increased by 27.4% due primarily to a decrease in proprietary software sales which

carry lower cost of sales.

The increase in cost of sales as a percentage of revenue is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary from period to period, and further can be affected by

the timing of deliverables.

Gross profit increased by 1.5% to $16.6 million for the third quarter of 2020 from $16.3 million for the same period in

Gross margin decreased to 34.9% in the third quarter of 2020, from 35.8% for the same period in 2019.

Services gross margin increased to 35.2% in 2020 from 32.2% in 2019 due to the change in program mix during the period as noted above, and

product gross margin decreased to 31.0% in 2020 from 58.4% in 2019, due primarily to a decrease in proprietary software sales.

Selling, general, and administrative expense (SG&A) increased by 13.3% to $12.0 million for the third quarter of 2020,

from $10.6 million for the same period in 2019, primarily attributable to increases in labor costs of $1.6 million, outside services of $1.6 million, legal costs of $0.4 million, and trade shows of $0.1 million, offset by a increase in capitalized

software development costs of $1.4 million, and decreases in accrued bonuses of $0.7 million and travel costs of $0.2 million.

Operating income decreased by 20.5% to $4.5 million for the third quarter of 2020, from $5.7 million for the same period in

2019, due primarily to an increase in SG&A as noted above.

Interest expense increased by 2.2% to $2.0 million for the third quarter of 2020, from $2.0 million for

the same period in 2019, primarily due to an increase in interest on the EnCap senior term loan.

Income tax provision was $8,000 for the third quarter of 2020, compared to income tax benefit of $10,000 for the same

period in 2019, which is based on the estimated annual effective tax rate applied to the pretax income incurred for the quarter plus discreet tax items, based on our expectation of pretax loss for the fiscal year.

Net loss attributable to Telos Corporation was $0.2 million for the third quarter of 2020, compared to a net income of $2.2

million for the same period in 2019, primarily attributable to the decrease in operating income for the quarter as discussed above.

Nine Months Ended September 30, 2020 Compared with Nine Months Ended September 30, 2019

Revenue increased by 19.8% to $135.0 million for the nine months ended September 30, 2020, from $112.7 million in the same

period in 2019.

Services revenue increased to $124.2 million for the nine months ended September 30, 2020, from $101.6 million for the same period in 2019, primarily attributable to increases in sales of $15.7 million by Telos ID, $6.8 million by

Secure Communications, and $1.5 million by Assurance / Xacta, offset by a decrease in sales of $1.4 million by Secure Networks.

The change in product and services revenue varies from period to period depending on the mix of solutions sold and the

nature of such solutions, as well as the timing of deliverables.

Product revenue decreased to $10.8 million for the nine months ended September 30, 2020, from $11.1 million for the same period in 2019, primarily attributable to decreases in sales of

$0.7 million by Assurance / Xacta and $0.3 million by Secure Communications, offset by an increase in sales of $0.7 million by Telos ID.

Cost of sales increased by 14.5% to $88.7 million for the nine months ended September 30, 2020, from $77.4 million for the

same period in 2019, primarily due to an increase in revenue of $22.3 million, however cost of sales as a percentage of revenue decreased by 3.0%.

Cost of sales for services increased by $10.9 million, and as a percentage of services revenue

decreased by 4.1%, due primarily to a change in the mix of the programs and timing of certain Telos ID deliverables.

Cost of sales for products increased by $0.3 million, and as a percentage of product revenue increased by 4.4% due primarily to a

decrease in proprietary software sales which carry lower cost of sales.

The decrease in cost of sales as a percentage of revenue is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary from

period to period, and further can be affected by the timing of deliverables.

Gross profit increased by 31.4% to $46.4 million for the nine months ended September 30, 2020, from $35.3 million compared

to the same period in 2019, due primarily to the change in the mix of the solutions sold as discussed above, primarily in Telos ID.

Gross margin increased to 34.3% for the nine months ended September 30, 2020, from 31.3% in the same period in 2019.

SG&A expense increased by 15.8% to $36.4 million for the nine months ended September 30, 2020, from $31.4 million for

the same period in 2019, primarily attributable to increases in outside services of $4.2 million, labor costs of $3.6 million, software maintenance costs of $0.2 million, accrued bonuses of $0.2 million, recruiting fees of $0.2 million, and legal

costs of $0.1 million, offset by an increase in capitalized software development costs of $3.3 million, and a decrease in travel costs of $0.4 million.

Operating income increased by 157.8% to $10.0 million for the nine months ended September 30, 2020, from $3.9 million for

the same period in 2019, due primarily to an increase in gross profit as noted above.

Interest expense increased by 14.7% to $4.0 million for the six months ended June 30, 2020, from $3.5 million for the same

period in 2019, primarily due to an increase in interest on the EnCap senior term loan.

Income tax benefit was $144,000 for the six months ended June 30, 2019, compared to $177,000 for the same period in 2019,

which is based on the estimated annual effective tax rate applied to the pretax loss incurred for the six month period plus discreet tax items, adjusted for the income tax benefit previously provided, based on our expectation of pretax loss for the

Net loss attributable to Telos Corporation was $2.0 million for the six months ended June 30, 2020, compared to $5.2

million for the same period in 2019, primarily attributable to the operating income as discussed above.

Interest expense increased by 10.2% to $6.0 million for the nine months ended September 30, 2020, from $5.5 million for the

same period in 2019, primarily due to an increase in interest on the EnCap senior term loan.

Income tax benefit was $136,000 for the nine months ended September 30, 2019, compared to $187,000 for the same period in

2019, which is based on the estimated annual effective tax rate applied to the pretax loss incurred for the nine month period plus discreet tax items, adjusted for the income tax benefit previously provided, based on our expectation of pretax loss

for the fiscal year.

Net loss attributable to Telos Corporation was $2.2 million for the nine months ended September 30, 2020, compared to $2.9

million for the same period in 2019, primarily attributable to the increase in operating income as discussed above, offset by an increase to income attributable to noncontrolling interest.

Liquidity and Capital Resources

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

Our working capital was $(11.3) million and $2.9 million as of September 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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operations are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months.

Cash provided by operating activities was $0.8 million for the six months ended June 30, 2020, compared to $5.9 million for

the same period in 2019.

Cash provided by or used in operating activities is primarily driven by the Company’s operating income, the timing of receipt of customer payments, the timing of its payments to vendors and employees, and the timing of

inventory turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities.

Additionally, net income was $1.6 million for the six months ended June 30, 2020, compared to a net loss of $4.9 million for the six

months ended June 30, 2019.

Cash used in investing activities was approximately $3.5 million and $3.7 million for the six months ended June 30, 2020

and 2019, respectively, due primarily to the capitalization of software development costs of $3.2 million and $1.3 million for the six months ended June 30, 2020 and 2019, respectively, and the purchase of property and equipment $0.3 million and $2.4

million for the six months ended June 30, 2020 and 2019, respectively.

Cash used in financing activities for the six months ended June 30, 2020 was $1.7 million, compared to $1.5 million for the

same period in 2019, primarily attributable to payments under finance leases and distribution to the Telos ID Class B member for both periods.

Cash provided by operating activities was $12.0 million for the nine months ended September 30, 2020, compared to $4.4

million for the same period in 2019.

timing of inventory turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities.

Additionally, net income was $4.1 million for the nine months ended September 30, 2020, compared to a net loss of $1.2 million

for the nine months ended September 30, 2019.

Cash used in investing activities was approximately $6.1 million and $5.3 million for the nine months ended September 30,

2020 and 2019, respectively, due primarily to the capitalization of software development costs of $5.5 million and $2.2 million for the nine months ended September 30, 2020 and 2019, respectively, and the purchase of property and equipment $0.6

million and $3.1 million for the nine months ended September 30, 2020 and 2019, respectively.

Cash used in financing activities for the nine months ended September 30, 2020 was $2.3 million, compared to cash provided

by financing activities of $2.7 million for the same period in 2019, primarily attributable to proceeds from the EnCap senior term loan for the nine months ended September 30, 2019, and payments under finance leases and distribution to the Telos ID

Class B member for both periods.

Additionally, our capital structure consists of redeemable preferred stock and common stock.

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Enlightenment Capital Credit Agreement

On January 25, 2017, we entered into a Credit Agreement (the "Credit Agreement") with Enlightenment

Capital Solutions Fund II, L.P., as agent (the "Agent") and the lenders party thereto (the "Lenders") (together referenced as “EnCap”).

The Credit Agreement provided for an $11 million senior term loan (the "Loan") with a maturity date of January 25,

2022, subject to acceleration in the event of customary events of default.

All borrowings under the Credit Agreement accrue interest at the rate of 13.0% per annum (the “Accrual

If, at the request of the Company, the Agent executes an intercreditor agreement with another senior lender under which the Agent and the Lenders subordinate their liens (an "Alternative Interest Rate Event"), the interest rate will increase

to 14.5% per annum.

On January 25, 2017, we entered into a Credit Agreement (the "Credit Agreement") with Enlightenment Capital Solutions Fund

II, L.P., as agent (the "Agent") and the lenders party thereto (the "Lenders") (together referenced as “EnCap”).

The Credit Agreement provided for an $11 million senior term loan (the "Loan") with a maturity date of January 25, 2022, subject to

acceleration in the event of customary events of default.

All borrowings under the Credit Agreement accrue interest at the rate of 13.0% per annum (the “Accrual Rate”).

request of the Company, the Agent executes an intercreditor agreement with another senior lender under which the Agent and the Lenders subordinate their liens (an "Alternative Interest Rate Event"), the interest rate will increase to 14.5% per annum.

After the occurrence and during the continuance of any event of default, the interest rate will increase 2.0%.

The Company is obligated to pay accrued interest in cash on a monthly basis at a rate of not less than 10.0% per annum

or, during the continuance of an Alternate Interest Rate Event, 11.5% per annum.

The Company may elect to pay the remaining interest in cash, by payment-in-kind (by addition to the principal amount of the Loan) or by combination of cash and

payment-in-kind.

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

for transactions of this type.

In connection with the Credit Agreement, the Agent has been granted, for the benefit of the Lenders, a security interest in and general lien upon various property of the Company, subject to certain permitted liens and

any intercreditor agreement.

The occurrence of an event of default under the Credit Agreement could result in the Loan and other obligations becoming immediately due and payable and allow the Lenders to exercise all rights and remedies available to

them under the Credit Agreement or as a secured party under the UCC, in addition to all other rights and remedies available to them.

In connection with the Credit Agreement, on January 25, 2017, the Company issued warrants (each, a

"Warrant") to the Agent and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms 1,135,284.333 shares of the Class A Common Stock of the Company, no par value per share, which is equivalent to

approximately 2.5% of the common equity interests of the Company on a fully diluted basis.

The Company is obligated to pay accrued interest in cash on a monthly basis at a rate of not less than 10.0% per annum or, during the

continuance of an Alternate Interest Rate Event, 11.5% per annum.

The Company may elect to pay the remaining interest in cash, by payment-in-kind (by addition to the principal amount of the Loan) or by combination of cash and payment-in-kind.

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 for transactions of

Credit Agreement or as a secured party under the UCC, in addition to all other rights and remedies available to them.

In connection with the Credit Agreement, on January 25, 2017, the Company issued warrants (each, a "Warrant") to the Agent

and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms 1,135,284.333 shares of the Class A Common Stock of the Company, no par value per share, which is equivalent to approximately 2.5% of the

common equity interests of the Company on a fully diluted basis.

The exercise price is $1.321 per share and each Warrant expires on January 25, 2027.

The value of the warrants was determined to be de minimis and no value was

allocated to them on a relative fair value basis in accounting for the debt instrument.

The value of the warrants was determined to be de minimis and no value was allocated to them on a

relative fair value basis in accounting for the debt instrument.

The Credit Agreement also included an $825,000 exit fee, which was payable upon any repayment or

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being amortized over 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 June 30, 2020, we were in compliance with the Credit Agreement’s financial

For the measurement period ended September 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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by contractual right to extend the maturity of the loan, which the Company intends to consider exercising at the appropriate time.

We incurred interest expense in the amount of $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.

We incurred interest expense in the amount of $0.8 million and $2.3 million for the three and nine months ended September

30, 2020, respectively, and $0.7 million and $1.5 million for the three and nine months ended September 30, 2019, respectively, under the Credit Agreement.

Accounts Receivable Purchase Agreement

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We incurred interest expense in the amount of $90,000 and $265,000 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, 2020, 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.

and nine months ended September 30, 2020, respectively, and $83,000 and $245,000 for the three and nine months ended September 30, 2019, respectively, on the Porter Notes.

As of September 30, 2020, approximately $1.2 million of accrued interest was

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

Public Preferred Stock

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shares of the Public Preferred Stock.

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

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

The Public Preferred Stock is quoted as “TLSRP” on the OTCQB marketplace and the OTC Bulletin Board.

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Therefore, we classify these securities as

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

noncurrent liabilities in the condensed consolidated balance sheets as of September 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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would 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 June 30,

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

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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and 1991 were paid at the rate of 6% per share for each $.60 of such dividends not paid in cash.

For the cash dividends payable since December 1, 1995, we have accrued $109.3 million and $107.4 million as of June 30, 2020 and December 31, 2019,

For the cash dividends payable since December 1, 1995, we have accrued $110.2 million and $107.4 million as of September 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 expense.

Prior to the effective date of

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

We accrued dividends on the Public Preferred Stock of $1.0 million and $2.9 million for each of the three and nine months ended September 30, 2020 and 2019, respectively, 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.

Recent Accounting Pronouncements

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Critical Accounting Policies

During the three months ended June 30, 2020, there were no material changes to our critical accounting policies as reported

in our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the SEC on April 13, 2020.

During the three months ended September 30, 2020, there were no material changes to our critical accounting policies as

reported in our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the SEC on April 13, 2020.

Quantitative and Qualitative Disclosures about Market Risk

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 2. Management’s Discussion and Analysis