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Item 7. Management’s Discussion and Analysis

2021-03-25 compared with 2020-04-13 · 430 added, 602 removed, 124 unchanged (89% of the section changed)

Management's Discussion and Analysis of Financial Condition and Results of

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

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.

Cloud Security – The cloud

as an organizational resource is more than two decades old, yet the needs of cloud users are constantly changing.

Telos offers the specialized skills and experience needed to help our customers plan, engineer, and execute secure cloud

migration strategies and then assure ongoing management and security in keeping with the leading standards for cloud-based systems and workloads.

Enterprise Security –

Securing 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.

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.

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 privacy.

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 ICT introduces new vulnerabilities, as security is still too often overlooked in solution

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 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 in order to foil cyber adversaries before they can attack.

Our consultants assess our

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

Cloud Security – The cloud as

an organizational resource is more than two decades old, yet the needs of cloud users are constantly changing.

We offer the specialized skills and experience needed to help our customers plan, engineer, and execute secure cloud migration

strategies and then ensure ongoing management and security in keeping with the leading standards for cloud-based systems and workloads.

Enterprise Security – Securing

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, and its information and communications.

As ICT and 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).

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

Security Solutions

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.

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:

a virtual 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 DISA Organizational Messaging Service and its specialized communications

Identity Trust and Digital Services through IDTrust360 ® – an enterprise-class digital identity risk platform for extending 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 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.

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.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to

make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses

during the reporting period.

Significant estimates and assumptions used in the preparation of our consolidated financial statements include revenue recognition, allowance for doubtful accounts receivable, allowance for inventory obsolescence, the

valuation allowance for deferred tax assets, income taxes, contingencies and litigation, potential impairments of goodwill and intangible assets, estimated pension-related costs for our foreign subsidiaries and accretion of Public Preferred Stock.

Actual results could differ from those estimates.

The following is a summary of the most critical accounting policies used in the preparation of our consolidated financial statements.

The preparation of consolidated financial statements in conformity with GAAP requires management to make

estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during

the reporting period.

allowance for deferred tax assets, income taxes, contingencies and litigation, potential impairments of goodwill and intangible assets, estimated pension-related costs for our foreign subsidiaries and accretion of public preferred stock.

results could differ from those estimates.

The following is a summary of the most critical accounting policies used in the preparation of our consolidated

financial statements.

Revenue Recognition

We account for revenue in accordance with Accounting Standard Codification (“ASC”) Topic 606, “Revenue from Contracts with

Customers.” The unit of account in ASC 606 is a performance obligation which is a promise in a contract with a customer, to transfer a good or service to the customer.

ASC 606 prescribes a five-step model for recognizing revenue that includes

identifying the contract with the customer, determining the performance obligation(s), determining the transaction price, allocating the transaction price to the performance obligation(s), and recognizing revenue as the performance obligations are

We account for revenue in accordance with Accounting Standards Codification (“ASC”) Topic 606, “Revenue

from Contracts with Customers.” The unit of account in ASC 606 is a performance obligation, which is a promise in a contract with a customer to transfer a good or service to the customer.

ASC 606 prescribes a five-step model for recognizing revenue

that includes identifying the contract with the customer, determining the performance obligation(s), determining the transaction price, allocating the transaction price to the performance obligation(s), and recognizing revenue as the performance

obligations are satisfied.

Timing of the satisfaction of performance obligations varies across our businesses due to our diverse product and service mix, customer base, and contractual terms.

Significant judgment can be required in determining certain performance

obligations, and these determinations could change the amount of revenue and profit recorded in a given period.

Significant judgment can be required in determining

certain performance obligations, and these determinations could change the amount of revenue and profit recorded in a given period.

Our contracts may have a single performance obligation or multiple performance obligations.

When there are multiple performance

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

and consume benefits as we perform, and is classified as services revenue.

All of our business groups earn services revenue under a variety of contract types, including time and materials, firm-fixed price, firm fixed price level of effort, and cost

plus fixed fee contract types, which may include variable consideration as discussed further below.

Revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying our

performance obligations.

When there are multiple

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

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

customers who receive and consume benefits as we perform, and is classified as services revenue.

All of our business groups earn services revenue under a variety of contract types, including time and materials, firm-fixed price, firm-fixed price

level of effort, and cost plus fixed fee contract types, which may include variable consideration as discussed further below.

Revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure

progress toward satisfying our performance obligations.

Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer.

Contract costs include labor, material, subcontractor costs and indirect expenses.

continuous transfer of control to the customer is supported by clauses in our contracts with U.S.

Government customers whereby the customer may terminate a contract for convenience and then pay for costs incurred plus a profit, at which time the

customer would take control of any work in process.

Government contracts where we perform as a subcontractor and our order includes similar Federal Acquisition Regulation (FAR) provisions as the prime contractor’s order from the U.S.

Contract costs include labor, material, subcontractor costs

and indirect expenses.

This continuous transfer of control to the customer is supported by clauses in our contracts with U.S.

Government customers whereby the customer may terminate a contract for convenience and then pay for costs incurred plus a

profit, at which time the customer would take control of any work in process.

Government contracts where we perform as a subcontractor and our order includes similar Federal Acquisition Regulation (FAR) provisions as the prime

contractor’s order from the U.S.

Government, continuous transfer of control is likewise supported by such provisions.

For other non-U.S.

Government customers, continuous transfer of control to such customers is also supported due to general terms in our contracts and rights to

recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit.

Due to the transfer of control over time, revenue is recognized based on progress towards completion of the performance

Government customers, continuous transfer of control to such customers is also supported due to general terms in

our contracts and rights to recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit.

Due to the transfer of control over time, revenue is recognized based on progress towards completion of

the performance obligation.

The selection of the method to measure progress towards completion requires judgment and is based on the nature of the performance obligations.

We generally use the cost-to-cost measure of progress on a proportional performance basis for

our contracts because it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts.

Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of

costs incurred to date to the total estimated costs at completion of the performance obligation.

We generally use the cost-to-cost measure of progress on a proportional

performance basis for our contracts because it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts.

Under the cost-to-cost measure of progress, the extent of progress towards completion is measured

based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation.

Revenues are recorded proportionally as costs are incurred.

Due to the nature of the work required to be performed on certain of our performance

obligations, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment.

Contract estimates are based on various assumptions including labor and subcontractor costs, materials and

other direct costs and the complexity of the work to be performed.

Due to the nature of the work required to be performed on certain of

our performance obligations, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment.

Contract estimates are based on various assumptions including labor and subcontractor costs,

materials and other direct costs and the complexity of the work to be performed.

A significant change in one or more of these estimates could affect the profitability of our contracts.

We review and update our contract-related estimates regularly and recognize

adjustments in estimated profit on contracts on a cumulative catch-up basis, which may result in an adjustment increasing or decreasing revenue to date on a contract in a particular period that the adjustment is identified.

Revenue and profit in

future periods of contract performance are recognized using the adjusted estimate.

Revenue that is recognized at a point in time is for the sale of software licenses in our Secure Mobility and Network

Management/Defense Enterprise Solutions (formerly CO&D’s Secure Mobility Solutions) and Secure Communications Cyber and Enterprise Solutions (formerly IT & Enterprise Solutions) business groups and for the sale of resold products in Telos ID

Enterprise Solutions (formerly Identity Management Solutions) and Cyber & Cloud Solutions (formerly CO&D’s Cyber Security Solutions), and is classified as product revenue.

We review and update our contract-related estimates regularly and

recognize adjustments in estimated profit on contracts on a cumulative catch-up basis, which may result in an adjustment increasing or decreasing revenue to date on a contract in a particular period that the adjustment is identified.

profit in future periods of contract performance are recognized using the adjusted estimate.

Revenue that is recognized at a point in time is for the sale of software licenses in our Information

Assurance / Xacta ® and Secure Communications business groups and for the sale of resold products in Telos ID and Secure Networks, and is classified as product revenue.

Revenue on these contracts is recognized when the customer obtains

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performance obligations, we allocate the transaction price to the performance obligations using our best estimate of standalone selling price.

Contracts are routinely and often modified to account for changes in contract requirements, specifications, quantities, or

Contracts are routinely and often modified to account for changes in contract requirements,

specifications, quantities, or price.

Depending on the nature of the modification, we determine whether to account for the modification as an adjustment to the existing contract or as a new contract.

Generally, modifications are not distinct from the existing contract due to the

significant interrelatedness of the performance obligations and are therefore accounted for as an adjustment to the existing contract, and recognized as a cumulative adjustment to revenue (as either an increase or reduction of revenue) based on the

modification’s effect on progress toward completion of a performance obligation.

Our contracts may include various types of variable consideration, such as claims (for instance, indirect rate or other

equitable adjustments) or incentive fees.

We include estimated amounts in the transaction price based on all of the information available to us, including historical information and future estimations, and to the extent it is probable that a

significant reversal of cumulative revenue recognized will not occur when any uncertainty associated with the variable consideration is resolved.

We have revised and re-submitted several years of incurred cost submissions reflecting certain indirect

rate structure changes as a result of regular Defense Contract Audit Agency (“DCAA”) audits of incurred cost submissions.

This resulted in signed final rate agreement letters for fiscal years 2011 to 2013 and conformed incurred cost submissions for

2014 to 2015.

We evaluated the resulting changes to revenue under the applicable cost plus fixed fee contracts for the years 2011 to 2015 as variable consideration, and determined the most likely amount to which we expect to be entitled, to the

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

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.

Generally, modifications are not distinct from

the existing contract due to the significant interrelatedness of the performance obligations and are therefore accounted for as an adjustment to the existing contract, and recognized as a cumulative adjustment to revenue (as either an increase or

reduction of revenue) based on the modification’s effect on progress toward completion of a performance obligation.

Our contracts may include various types of variable consideration, such as claims (for instance,

indirect rate or other equitable adjustments) or incentive fees.

We include estimated amounts in the transaction price based on all of the information available to us, including historical information and future estimations, and to the extent it is

probable that a significant reversal of cumulative revenue recognized will not occur when any uncertainty associated with the variable consideration is resolved.

We have revised and re-submitted several years of incurred cost submissions reflecting

certain indirect rate structure changes as a result of regular Defense Contract Audit Agency (“DCAA”) audits of incurred cost submissions.

This resulted in signed final rate agreement letters for fiscal years 2011 to 2013 and conformed incurred cost

submissions for 2014 to 2015.

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

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.

Historically, most of our contracts do not include award or incentive fees.

For incentive fees, we would include such fees

in the transaction price to the extent we could reasonably estimate the amount of the fee.

For incentive fees, we would

include such fees in the transaction price to the extent we could reasonably estimate the amount of the fee.

With limited historical experience, we have not included any revenue related to incentive fees in our estimated transaction prices.

We may include in our

contract estimates additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its realization is probable.

We consider the contractual/legal basis for the claim (in particular FAR provisions), the facts and circumstances around any additional costs incurred, the reasonableness of those costs and the objective evidence available to support such claims.

For our contracts that have an original duration of one year or less, we use the practical expedient applicable to such

contracts and do not consider the time value of money.

include in our contract estimates additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its

realization is probable.

support such claims.

For our contracts that have an original duration of one year or less, we use the practical expedient

applicable to such contracts and do not consider the time value of money.

We capitalize sales commissions related to proprietary software and related services that are directly tied to sales.

We do not elect the practical expedient to expense as incurred the

incremental costs of obtaining a contract if the amortization period would have been one year or less.

For the sales commissions that are capitalized, we amortize the asset over the expected customer life, which is based on recent and historical

Contract assets are amounts that are invoiced as work progresses in accordance with agreed-upon contractual terms, either

at periodic intervals or upon achievement of contractual milestones.

We do not elect the practical expedient to expense as

incurred the incremental costs of obtaining a contract if the amortization period would have been one year or less.

For the sales commissions that are capitalized, we amortize the asset over the expected customer life, which is based on recent and

historical data.

Contract assets are amounts that are invoiced as work progresses in accordance with agreed-upon

contractual terms, either at periodic intervals or upon achievement of contractual milestones.

Generally, revenue recognition occurs before billing, resulting in contract assets.

These contract assets are referred to as unbilled receivables and are reported within accounts

receivable, net of reserve on our consolidated balance sheets.

Billed receivables are amounts billed and due from our customers and are reported within accounts receivable, net of

reserve on the consolidated balance sheets.

The portion of the payments retained by the customer until final contract settlement is not considered a significant financing component due to the intent of the retainage being the customer’s protection

with respect to full and final performance under the contract.

Contract liabilities are payments received in advance and milestone payments from our customers on selected contracts that

exceed revenue earned to date, resulting in contract liabilities.

Contract liabilities typically are not considered a significant financing component because they are generally satisfied within one year and are used to meet working capital demands

that can be higher in the early stages of a contract.

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

These contract assets are referred to as unbilled receivables and are

reported within accounts receivable, net of reserve on our consolidated balance sheets.

Billed receivables are amounts billed and due from our customers and are reported within accounts

receivable, net of reserve on the consolidated balance sheets.

The portion of the payments retained by the customer until final contract settlement is not considered a significant financing component due to the intent of the retainage being the

customer’s protection with respect to full and final performance under the contract.

Contract liabilities are payments received in advance and milestone payments from our customers on

selected contracts that exceed revenue earned to date, resulting in contract liabilities.

Contract liabilities typically are not considered a significant financing component because they are generally satisfied within one year and are used to meet

working capital demands that can be higher in the early stages of a contract.

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

We have one reportable segment.

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customers as sales within the U.S.

regardless of where the services

are performed.

regardless of

where the services are performed.

Substantially all of our revenues are from U.S.

customers as revenue derived from international customers is de minimus.

The following tables disclose revenue (in thousands) by customer type and contract type for the periods

The following tables disclose revenue (in thousands) by customer type and contract type for the

periods presented.

Prior period amounts have not been adjusted under the modified retrospective method.

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Receivables – net

The following table discloses contract liabilities (in thousands):

Contract liabilities

As of December 31, 2019 and 2018, we had $112.4 million and $79.3 million of remaining performance obligations,

respectively, which we also refer to as funded backlog.

As of December 31, 2020 and 2019, we had $127.7 million and $112.4 million of remaining performance

obligations, respectively, which we also refer to as funded backlog.

We expect to recognize approximately 92.4% of our remaining performance obligations as revenue in 2021, an additional 2.5% by 2022 and the balance thereafter.

For the years ended December 31,

2019 and 2018, the amount of revenue recognized during the year that was included in the opening contract liabilities balance was $4.2 million and $5.5 million, respectively.

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

average cost method.

For the years ended

December 31, 2020, 2019, and 2018, the amount of revenue recognized during the year that was included in the opening contract liabilities balance was $5.3 million, $4.2 million, and $5.5 million, respectively.

Contract liabilities were $5.7 million

and $6.3 million as of December 31, 2020 and 2019, respectively.

We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from

existing customers and active contracts.

We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers.

In the context of our current customer portfolio, we view

“recurring revenue” as revenue that occurs often and repeatedly.

In each of the last three years, recurring revenue has exceeded 85% of our annual revenue.

Our total budgeted revenue is the combination of recurring revenue and a forecast of new

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.

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

using the weighted average cost method.

Inventories consist primarily of purchased off-the-shelf hardware and software, and component computer parts used in connection with system integration services that we perform.

Inventories also include spare parts utilized to

support certain maintenance contracts.

Inventories also include spare

parts utilized to support certain maintenance contracts.

Spare parts inventory is amortized on a straight-line basis over two to five years, which represents the shorter of the warranty period or estimated useful life of the asset.

An allowance for obsolete,

slow-moving or non-salable inventory is provided for all other inventory.

An allowance for

obsolete, slow-moving or non-salable inventory is provided for all other inventory.

This allowance is based on our overall obsolescence experience and our assessment of future inventory requirements.

We evaluate the impairment of goodwill in accordance with ASC 350, “Intangibles – Goodwill and Other,” which requires

goodwill and indefinite-lived intangible assets to be assessed on at least an annual basis for impairment using a fair value basis.

Between annual evaluations, if events occur or circumstances change that would more likely than not reduce the fair

value of the reporting unit below its carrying amount, then impairment must be evaluated.

We evaluate the impairment of goodwill in accordance with ASC 350, “Intangibles – Goodwill and Other,”

which requires goodwill and indefinite-lived intangible assets to be assessed on at least an annual basis for impairment using a fair value basis.

Between annual evaluations, if events occur or circumstances change that would more likely than not

reduce the fair value of the reporting unit below its carrying amount, then impairment must be evaluated.

Such circumstances could include, but are not limited to:

(1) a significant adverse change in legal factors or business climate, or (2) a loss of key contracts

or customers.

As the result of an acquisition, we record any excess purchase price over the net tangible and identifiable intangible

assets acquired as goodwill.

(1) a significant adverse change in legal factors or business climate, or (2) a loss

of key contracts or customers.

As the result of an acquisition, we record any excess purchase price over the net tangible and

identifiable intangible assets acquired as goodwill.

An allocation of the purchase price to tangible and intangible net assets acquired is based upon our valuation of the acquired assets.

Goodwill is not amortized, but is subject to annual impairment tests.

We complete our

goodwill impairment tests as of December 31st each year.

Additionally, we make evaluations between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying

The evaluation is based on the estimation of the fair values of our three reporting units, Cyber Operations and Defense (“CO&D”), Telos ID Enterprise Solutions, and Secure Communications Cyber and Enterprise Solutions, of which goodwill

is housed in the CO&D reporting unit, in comparison to the reporting unit’s net asset carrying values.

Goodwill is not amortized, but is subject to annual impairment

We complete our goodwill impairment tests as of December 31st each year.

Additionally, we make evaluations between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit

below its carrying amount.

The evaluation is based on the estimation of the fair values of our three reporting units, CO&D (comprised of Information Assurance / Xacta and Secure Networks), Telos ID, and Secure Communications, of which goodwill is

housed in the CO&D 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

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Goodwill is amortized and deducted over a 15-year period for tax purposes.

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

are recognized for the estimated future tax consequences of temporary differences and income tax credits.

Deferred tax assets and liabilities are measured by applying enacted statutory tax rates that are applicable to the future years in which

deferred tax assets or liabilities are expected to be settled or realized for differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.

Any change in tax rates on deferred tax assets and

liabilities is recognized in net income in the period in which the tax rate change is enacted.

We record a valuation allowance that reduces deferred tax assets when it is "more likely than not" that deferred tax assets will not be realized.

required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Based on available evidence,

realization of deferred tax assets is dependent upon the generation of future taxable income.

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

have determined that a full valuation allowance is required as of December 31, 2019 and 2018.

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

sheet at December 31, 2019 and 2018.

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.

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

assets and liabilities are recognized for the estimated future tax consequences of temporary differences and income tax credits.

Deferred tax assets and liabilities are measured by applying enacted statutory tax rates that are applicable to the

future years in which deferred tax assets or liabilities are expected to be settled or realized for differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.

Any change in tax rates on deferred

tax assets and liabilities is recognized in net income in the period in which the tax rate change is enacted.

We record a valuation allowance that reduces deferred tax assets when it is "more likely than not" that deferred tax assets will not be

We are required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

available evidence, realization of deferred tax assets is dependent upon the generation of future taxable income.

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

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

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

our consolidated balance sheet at December 31, 2020 and 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 December 31, 2020 and

See additional

information on tax reform and its impact on our income taxes in Note 9 – Income Taxes.

See additional information on tax reform and its impact on our income taxes in Note 9 – Income Taxes.

Results of Operations

We derive a substantial portion of our revenues from contracts and subcontracts with the U.S.

revenues are generated from a number of contract vehicles and task orders.

Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product reselling to that of

an advanced solutions technologies provider.

To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and delivering Telos

manufactured and branded technologies.

Our revenues are generated from a number of contract vehicles and task orders.

Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product

reselling to that of an advanced solutions technologies provider.

To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and

delivering Telos manufactured and branded technologies.

We believe our contract portfolio is characterized as having low to moderate financial risk due to the limited number of long-term fixed price development contracts.

Our firm fixed-price activities consist

principally of contracts for the products and services at established contract prices.

Our firm fixed-price

activities consist principally of contracts for the products and services at established contract prices.

Our time-and-material contracts generally allow the pass-through of allowable costs plus a profit margin.

For 2019, 2018, and 2017, the Company’s revenue derived

from firm fixed-price contracts was 82.7%, 74.9%, and 83.1%, respectively, cost-plus contracts was 8.2%, 12.9%, and 7.4%, respectively, and time-and-material contracts was 9.1%, 12.2%, and 9.5%, respectively.

We provide different solutions and are party to contracts of varying revenue types under the NETCENTS (Network-Centric

Solutions) and NETCENTS-2 contracts to the U.S.

For 2020, 2019, and 2018, the

Company’s revenue derived from firm fixed-price contracts was 84.3%, 82.7%, and 74.9%, respectively, cost-plus contracts was 8.2%, 8.2%, and 12.9%, respectively, and time-and-material contracts was 7.5%, 9.1%, and 12.2%, respectively.

We provide different solutions and are party to contracts of varying revenue types under the NETCENTS

(Network-Centric Solutions) and NETCENTS-2 contracts to the U.S.

NETCENTS and NETCENTS-2 are IDIQ and GWAC, therefore any government customer may utilize the NETCENTS and NETCENTS-2 vehicles to meet its purchasing needs.

Consequently, revenue earned on the

underlying NETCENTS and NETCENTS-2 delivery orders varies from period to period according to the customer and solution mix for the products and services delivered during a particular period, unlike a standalone contract with one separately identified

Consequently,

revenue earned on the underlying NETCENTS and NETCENTS-2 delivery orders varies from period to period according to the customer and solution mix for the products and services delivered during a particular period, unlike a standalone contract with one

separately identified customer.

The contracts themselves do not fund any orders and they state that the contracts are for an indefinite delivery and indefinite quantity.

The majority of our task/delivery orders have periods of performance of less than 12 months, which

contributes to the variances between interim and annual reporting periods.

The period of performance for the original NETCENTS contract ended on September 30, 2013.

Previously awarded task orders that contain periods of performance that extended past

September 30, 2013, including exercisable option years under existing task orders, were not affected by the contract expiration.

We were selected for an award on the NETCENTS replacement contract, NETCENTS-2 Network Operations and Infrastructure

Solutions Small Business Companion, on March 27, 2014, and upon re-evaluation by the customer, we were again selected for an award on April 3, 2015 and the contract was opened for issuance of new orders in May 2015.

We have also been awarded other

IDIQ/GWACs, including the Department of Homeland Security’s EAGLE II, GSA Alliant 2, and blanket purchase agreements under our GSA schedule.

However, we have not been awarded significant delivery orders under EAGLE II, or GSA Alliant 2 as it was not

ready for agencies to use until July 1, 2018.

The majority of our task/delivery orders have periods of performance of less

than 12 months, which contributes to the variances between interim and annual reporting periods.

We have also been awarded other IDIQ/GWACs, including the Department of Homeland Security’s EAGLE II, GSA Alliant 2, and blanket purchase agreements

under our GSA schedule.

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).

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

Government appropriations have been and continue to be affected by larger U.S.

budgetary issues and related legislation.

Government budgetary

issues and related legislation.

In 2011, Congress enacted the Budget Control Act of 2011 (the “BCA”), which established specific limits on annual appropriations for fiscal years 2012-2021.

The BCA has been amended a number of times, most

recently by the Bipartisan Budget Act of 2019 (the “BBA”), which was enacted on August 2, 2019.

As a result, DoD funding levels have fluctuated over this period and have been difficult to predict.

Most recently, while the two-year BBA allowed for

modestly increased defense spending in FY 2020, unless and until it is again modified, the BBA also essentially will maintain defense spending in FY 2021 with only a minor increase (less than one percent) permitted above the current FY 2020

appropriated funding level.

According to the Office of Management and Budget, federal outlays devoted to defense programs have fallen from 4.5 percent

to 3.2 percent as a share of Gross Domestic Product (GDP) since enactment of the BCA.

Moreover, as a result of the spending caps imposed by the BCA, annual DoD budget authority in FY 2020 is only 3.7 percent higher (in unadjusted dollars) than it was

a decade ago in FY 2010.

Since final enactment in December 2019 of appropriations legislation for FY 2020, and the February 10,

2020 submission of the President’s proposed FY 2021 budget, the Coronavirus pandemic and associated economic dislocation in the United States has resulted in the need for an overwhelming federal response.

This has led to the enactment of several

comprehensive appropriations and economic stimulus measures, as well as negotiations between Congress and the White House for additional massive initiatives for the current year and into the next fiscal year, the details of which are not yet

These substantial alterations to FY 2020 spending baselines are also likely to further impact FY 2021 spending in ways that cannot now be predicted.

The impact of the health and economic crisis, and the resulting large increase in

federal spending, on the government contracts that we hold and the federal procurements that we would otherwise compete for cannot now be known.

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;

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 new spending initiatives.

This is consistent with the practice for a number of years where the U.S.

Government has been unable to complete its appropriations process prior to the beginning of the next fiscal year, resulting in

actual or threatened governmental shut-downs and repeated use for extended time periods each year of Continuing Resolutions to fund part of all of the government.

The impact of the substantial additional spending on the Coronavirus pandemic on the

appropriations for FY 2021, and the appropriations process itself, is not now known.

The current health and economic crisis is highly fluid, and it is likely to continue to affect multiple federal departments

and agencies for an unknown period of time and in ways that are difficult to predict.

Nonetheless, we believe that the federal government will very likely endeavor to maintain continuity of services and, with much of the business of government now

being conducted through use of information technology systems and in many cases during the crisis remotely, we believe there will still be a need on the part of the government for the types of solutions and services provided by Telos.

We anticipate there will continue to be a significant amount of debate and negotiations within the

Government over federal and defense spending, and these deliberations may be impacted by the health and economic impacts of the COVID-19 pandemic in ways that are at this time difficult to foresee.

In the context of these negotiations, it is

possible that the U.S.

Government, or portions of the U.S.

Government, could be shut down or disrupted for periods of time, and that government programs could be modified, cut or replaced as part of broader reforms to reduce the federal deficit or

efforts to redirect federal spending, whether related or unrelated to the COVID-19 crisis.

These limits were subsequently amended several times.

the expiration of the BCA at the end of FY 2021, there are no statutory limits in place for FY 2022.

According to the non-partisan Congressional Budget Office (CBO), since enactment of the BCA, federal

outlays devoted to defense programs fell from 4.5 percent as a share of Gross Domestic Product (GDP) to as low as 3.1 percent of GDP in each of FYs 2016-18, before rising slightly the past two years to a level of 3.4 percent in FY 2020.

Moreover, CBO

reports that, as a result of the spending caps imposed by the BCA, non-adjusted defense outlays subsequently shrank from $699.4 billion in FY 2011 to as low as $583.4 billion in FY 2016, and did not again exceed their FY 2011 level until FY 2020,

when outlays were $713.8 billion, two percent above the FY 2011 level.

In Fiscal Years 2020 and 2021, the COVID-19 pandemic and associated economic dislocation in the United

States has resulted in an overwhelming federal response, including enactment of several massive and comprehensive emergency appropriations and economic stimulus measures.

These were in addition to annual appropriations legislation for FY 2021, which

was not enacted into law until late December, 2020, nearly three months after the beginning of the fiscal year, during which time the government once again operated under a series of Continuing Resolutions which strictly limited new spending

These enormous emergency spending packages and their resulting increases in the budget deficit will necessarily factor into future spending decisions to an unknown degree.

Further, as the outgoing Trump Administration did not complete

its work on a proposed FY 2022 budget prior to leaving office on January 20, 2021, and the incoming Biden Administration has been delayed in submitting a proposed budget to Congress, the proposed spending levels for FY 2022 cannot be predicted.

Finally, the near- and long-term impacts of the COVID-19 health and associated economic crisis on federal budget planning and the government contracts that we hold, and on the federal procurements that we would otherwise compete for, cannot be known.

Should Congress and the White House be unable to make sufficient progress on the FY 2022 budget and

enact appropriations legislation prior to the beginning of the new fiscal year on October 1, 2021, the Department of Defense and other federal departments and agencies will likely again be funded for an unknown period of time under a Continuing

Resolution, which would restrict new spending initiatives.

Despite the pandemic’s resultant shift to teleworking by federal employees and contractors, the

government has successfully maintained continuity of services as has Telos Corporation.

With much of the business of government continuing to be conducted remotely through use of information technology systems, we believe there will continue to be a

need on the part of the government for the types of solutions and services provided by Telos.

For more information on the risks and uncertainties related to U.S.

Government contracts, see Part I – Item 1A Risk Factors in this Annual Report on the Form

Government contracts, see Part I –

Item 1A Risk Factors in this Annual Report on the Form 10-K.

Statement of Operations Data

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Other income (expenses):

Non-operating income

Gain on redemption of public preferred stock

Non-operating (expense) income

Interest expense

(Loss) income before income taxes

Benefit (provision) for income taxes

Net (loss) income

Income (loss) income before income taxes

Benefit from (provision for) income taxes

Net income (loss)

Net income attributable to non-controlling interest

Net loss attributable to Telos Corporation

Net income (loss) attributable to Telos Corporation

Years ended December 31, 2020, 2019, and 2018

increased by 13.0% to $179.9 million for 2020 from $159.2 million for 2019.

Such increase primarily consists of an increase in sales from the U.S.

Air Force NETCENTS-2 contract.

As discussed above, NETCENTS-2 is an IDIQ contract utilized by multiple

government customers and sales under NETCENTS-2 vary from period to period according to the solution mix and timing of deliverables for a particular period.

Services revenue increased by 18.7% to $143.6 million for 2019 from $121.0 million for 2018,

primarily attributable to increases in sales of $10.8 million of Telos ID Enterprise Solutions, $9.2 million of Cyber & Cloud Solutions, $5.9 million of Secure Communications Cyber and Enterprise Solutions, offset by a decrease in sales of $3.4

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 decreased by 8.2% to $15.6 million for 2019 from $17.0 million for 2018, primarily attributable to decreases in sales of $0.9 million of Cyber & Cloud Solutions in proprietary software, and $0.8 million of Telos ID

Enterprise Solutions, offset by an increase in sales of $0.4 million of proprietary software in Secure Communications Cyber and Enterprise Solutions.

Security Solutions revenue was $117.3 million and $101.9 million for 2020 and 2019, respectively.

This increase in 2020 of approximately 15% was driven primarily by an

increase of $8.1 million in sales of offerings in Telos ID on the contract with the U.S.

Census Bureau and $7.3 million in sales of offerings related to the contract with a U.S.

government agency for our Telos Ghost managed intelligence support

solution in Secure Communications.

Secure Networks revenue was $62.6 million and $57.3 million for 2020 and 2019, respectively.

This increase in 2020 of approximately 9% resulted from various DoD contracts, in both our Secure Mobility and Network

Management/Defense Enterprise Solutions offerings.

Due to the various solutions offerings and within the business groups, sales may vary from period to period according to the solution mix and timing of deliverables for a particular period.

Revenue increased by 15.4% to $159.2 million for 2019 from $138.0 million for 2018.

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Air Force NETCENTS-2 contract.

Services revenue increased by 48.3% to $121.0 million for 2018 from $81.6 million for 2017, primarily attributable to increases in sales of $22.7 million of Secure Mobility and Network

Management/Defense Enterprise Solutions under several NETCENTS delivery orders for Telos-installed solutions which included $6.0 million of revenue accruals for multiple contracts as a result of several years of cumulative indirect rate adjustments,

$10.6 million of Telos ID Enterprise solutions, $5.7 million of Cyber & Cloud Solutions, and $0.4 million of Secure Communications Cyber and Enterprise Solutions.

Product revenue decreased by 34.8% to $17.0 million for 2018 from $26.1 million for

2017, primarily attributable to decreases in sales of $9.2 million of Telos ID Enterprise solutions, $2.0 million of resold products in Secure Mobility and Network Management/Defense Enterprise Solutions, and $1.0 million of proprietary software in

Secure Communications Cyber and Enterprise Solutions, offset by an increase in sales of $3.1 million of Cyber & Cloud Solutions in proprietary software.

Cost of sales increased by 25.8% to $106.9 million for 2019 from $85.0 million for 2018 as a result of increases in revenue.

Cost of sales for services increased by $21.9 million, and as a percentage of services revenue increased

by 5.3%, due to a change in the mix and nature of the programs including increases in sales of certain Telos-installed solutions in Secure Mobility and Network Management/Defense Enterprise Solutions under NETCENTS-2.

Cost of sales for product

increased by 0.1%, and as a percentage of product revenue increased by 4.3%, primarily due to declines in proprietary software sales.

Cost of sales increased by 26.5% to $85.0 million for 2018 from $67.2 million for 2017 as a result of increases in revenue.

Cost of sales for services increased by $26.9 million, and as a percentage of services revenue increased by 2.3%, due to a change in the mix and nature of the programs including an increase in sales of certain Telos-installed solutions in Secure

Mobility and Network Management/Defense Enterprise Solutions under NETCENTS-2 and due to other contracts in Cyber & Cloud Solutions, offset by the revenue accruals related to indirect rate adjustments discussed above which did not include direct

costs in Secure Mobility and Network Management/Defense Enterprise Solutions deliverables.

Cost of sales for product decreased by $9.1 million, primarily due to decreases in product revenue for resold products, and as a percentage of product revenue

decreased by 18.3%, primarily due to declines in resold products, as well as increases in proprietary software sales.

Gross profit .

Gross profit decreased by 1.4% to $52.3 million for 2019 from $53.1 million for 2018.

Gross margin decreased to 32.9% for 2019 from 38.4% for 2018, due to various changes in the mix of contracts in all business lines, primarily decreases in

proprietary software sales.

As discussed above, NETCENTS-2 is an IDIQ contract utilized by multiple government customers and sales under NETCENTS-2 vary from period to period according to the solution mix and timing

of deliverables for a particular period.

Security Solutions revenue was $101.9 million and $86.6 million in 2019 and 2018, respectively.

This increase in 2019 of approximately 18% is primarily attributable to a $10.1 million increase in sales of

offerings in Telos ID on a contract with the U.S.

Census Bureau and a $6.3 million increase in sales of offerings related to a contract with a U.S.

government agency for our Telos Ghost managed intelligence support solution in Secure Communications.

Secure Networks revenue was $57.3 million in 2019 and $51.4 million in 2018.

The sales increase in 2019 is the result of various DoD contracts around our Secure Mobility as well as our Network Management and Defense offerings.

Cost of sales.

of sales increased by 9.9% to $117.5 million for 2020 from $106.9 million for 2019 as a result of increases in revenue.

Cost of sales for Security Solutions increased to $66.9 million in 2020 from $59.9 million in 2019 which translates as a decrease

in the cost of sales as a percentage of revenue to 57.0% from 58.7%.

due to a change in the mix and nature of the programs.

Cost of sales for Secure Networks increased to $50.6 million in 2020 from $47.0 million in 2019 which translates as a decrease

in the cost of sales as a percentage of revenue to 80.9% from 82.0%.

Cost of sales increased by 25.8% to $106.9 million for 2019 from $85.0 million for 2018 as a result of

increases in revenue.

Cost of sales for Security Solutions increased to $59.9 million in 2019 from $48.2 million in 2018 which translates as a increase in the cost of sales as a percentage of revenue to 58.7% from 55.7%.

due to a change in the mix

and nature of the programs.

Cost of sales for Secure Networks increased to $47.0 million in 2019 from $36.7 million in 2018 which translates as an increase in the cost of sales as a percentage of revenue to 82.0% from 71.5% due primarily to the

effect of revenue accruals in 2018 for multiple contracts as a result of several years of cumulative indirect rate adjustments, which did not include direct costs.

Gross profit increased by 19.2% to $62.4 million for 2020 from $52.3 million for 2019.

Gross margin increased to 38.4% for

2018 from 37.7% for 2017, due to various changes in the mix of contracts in all business lines, primarily increases in sales of Cyber & Cloud Security solutions in proprietary software, as well as the revenue accruals related to indirect rate

adjustments discussed above.

Selling, general, and

administrative expenses .

Selling, general, and administrative expenses increased by 7.4% to $47.3 million for 2019 from $44.0 million for 2018.

Such increase is primarily attributable to increases in labor costs of $1.9 million, bonuses of

$0.5 million, bad debt expenses of $0.5 million, and outside services of $0.4 million.

Gross profit for Security Solutions increased to $50.5 million in 2020 from $42.1 million in 2019.

Gross profit for Secure Networks increased to

$12.0 million in 2020 from $10.3 million in 2019.

Gross margin increased to 34.7% for 2020 from 32.9% for 2019, due to various changes in the mix of contracts in all business lines as discussed above.

Gross margin for Security Solutions increased to

43.0% in 2020 from 41.3% in 2019.

Gross margin for Secure Networks increased to 19.1% in 2020 from 18% in 2019.

Gross profit decreased by 1.4% to $52.3 million for 2019 from $53.1 million for 2018.

Gross profit for

Security Solutions increased to $42.1 million in 2019 from $38.4 million in 2018.

Gross profit for Secure Networks decreased to $10.3 million in 2019 from $14.6 million in 2018, due primarily to the effect of revenue accruals in 2018 for multiple

contracts as a result of several years of cumulative indirect rate adjustments, which did not include direct costs.

Gross margin decreased to 32.9% for 2019 from 38.4% for 2018, due to various changes in the mix of contracts in all business lines,

primarily decreases in proprietary software sales.

Gross margin for Security Solutions decreased to 41.3% in 2019 from 44.3% in 2018.

Gross margin for Secure Networks decreased to 18% in 2019 from 28.5% in 2018.

general, and administrative expenses .

Selling, general, and administrative expenses increased by 31.3% to $62.1 million for 2020 from $47.3 million for 2019.

increase is primarily attributable to increases in labor costs of $1.7 million, bonuses of $1.5 million, and capitalization and related amortization of software development costs of $0.6 million.

Interest expense.

Interest expense increased by 2.9% to $7.5 million for 2019 from $7.3 million for 2018, primarily due to an increase in interest on the EnCap senior term loan, offset by a decrease in interest on an equipment purchase arrangement.

Interest expense increased by 8.5% to $7.3 million for 2018 from $6.7 million for 2017, primarily due to an increase in

interest on the EnCap senior term loan and an equipment purchase arrangement.

Such increase is primarily attributable to increases in bonuses of $6.3 million,

outside services of $5.9 million, labor costs of $5.9 million, and $0.6 million in legal fees, offset by capitalization of research and development costs of $4.2 million.

Selling, general, and administrative expenses increased by 7.4% to $47.3 million for 2019 from $44.0

million for 2018.

Such increase is primarily attributable to increases in labor costs of $1.9 million, bonuses of $0.5 million, bad debt expenses of $0.5 million, and outside services of $0.4 million.

Interest expense decreased by 2.8% to $7.3 million for 2020 from $7.5 million for 2019, primarily due to decreases in public preferred stock interest as a result of such stock redemption, and interest on an equipment purchase

arrangement, offset by an increase in interest on the senior term loan with EnCap (as defined below).

Interest expense increased by 2.9% to $7.5 million for 2019 from $7.3 million for 2018, primarily due to

an increase in interest on the EnCap senior term loan, offset by a decrease in interest on an equipment purchase arrangement.

Components of interest expense are as follows:

2 unchanged sentences

Preferred stock interest accrued

Provision for income taxes .

Income tax benefit was $104,000 for 2019, compared to an income tax provision of $31,000 for 2018, primarily attributable to the decrease in deferred tax liability due to the timing of the state conformity to the indefinite-lived net operating loss

provision of the Tax Act (as described below).

Income tax provision was $31,000 for 2018, compared to an income tax benefit of $2.8 million for 2017, primarily due to the decrease in the hanging credit deferred tax liability offset by the adjustment

to the provisional estimate recorded for the hanging credit deferred tax liability under SAB 118.

for income taxes .

Income tax benefit was $46,000 for 2020, compared to an income tax provision of $104,000 for 2019, primarily attributable to administrative practice release of certain FIN48 liability.

Income tax benefit was $104,000 for 2019, compared to an income tax provision of $31,000 for 2018,

primarily attributable to the decrease in deferred tax liability due to the timing of the state conformity to the indefinite-lived net operating loss provision of the Tax Act (as described below).

Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we believe the non-GAAP financial

measures of Non-GAAP Operating Income, Enterprise EBITDA and Adjusted EBITDA are useful in evaluating our operating performance.

We believe that this non-GAAP financial information, when taken collectively with our GAAP results, may be helpful to

readers of our financial statements because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP

The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled

non-GAAP measures used by other companies.

A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP.

We use the following non-GAAP financial measures to understand and evaluate our core operating

performance and trends, to prepare and approve our annual budget, to develop short-term and long-term operating plans, and to evaluate the performance of certain management personnel when determining incentive compensation.

We believe these non-GAAP

financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionate positive or negative impact on our results of operations in any

particular period.

When viewed in combination with our results prepared in accordance with GAAP, these non-GAAP financial measures help provide a broader picture of factors and trends affecting our results of operations.

Enterprise EBITDA and Adjusted EBITDA

Both Enterprise EBITDA and Adjusted EBITDA are supplemental measures of operating performance that are

not made under GAAP and that does not represent, and should not be considered as, an alternative to net income (loss) as determined by GAAP.

We define Enterprise EBITDA as net income (loss) attributable to Telos Corporation, adjusted for net income

attributable to non-controlling interest, non-operating income, interest expense, (benefit) provision for income taxes, and depreciation and amortization.

We define Adjusted EBITDA as Enterprise EBITDA, adjusted for stock-based compensation expense,

the gain realized on redemption of the public preferred stock upon the closing of our initial public offering, the losses realized on the extinguishment of senior term loan and subordinated debt upon the closing of our initial public offering,

bonuses paid as a result of the closing of our initial public offering, and other expenses related to our initial public offering.

A reconciliation of Enterprise EBITDA and Adjusted EBITDA to net income (loss) attributable to Telos

Corporation, the most directly comparable GAAP measure, is as follows:

Years Ended December 31,

(amount in thousands)

Net income (loss) attributable to Telos Corporation

Net income attributable to non-controlling interest

Non-operating income

Interest expense

(Benefit) provision for income taxes

Depreciation and amortization

Enterprise EBITDA

Transaction related gains/losses/expenses:

Transaction related legal and accounting

Transaction related bonus

Gain on redemption of public preferred stock

Transaction related non-operating income

Loss on extinguishment of senior term loan

Loss on extinguishment of subordinated debt

Stock-based compensation expense

Total transaction related gains/losses/expenses

Stock-based compensation expense

Adjusted EBITDA

Each of Enterprise EBITDA and Adjusted EBITDA has limitations as an analytical tool, and you should not

consider it in isolation, or as a substitute for analysis of our results as reported under GAAP.

Among other limitations, each of Enterprise EBITDA and Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital

expenditures or contractual commitments, does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations, and does not reflect income tax expense or benefit.

Other companies in our

industry may calculate Adjusted EBITDA differently than we do, which limits its usefulness as a comparative measure.

Because of these limitations, neither Enterprise EBITDA nor Adjusted EBITDA should be considered as a replacement for net income

(loss), as determined by GAAP, or as a measure of our profitability.

We compensate for these limitations by relying primarily on our GAAP results and using non-GAAP measures only for supplemental purposes.

Liquidity and Capital Resources

As described in more detail below, we maintain a Credit Agreement with EnCap and a Purchase Agreement with RCA.

willingness of RCA to purchase our accounts receivable under the Purchase Agreement and our ability to obtain additional financing may be limited due to various factors, including the eligibility of our receivables, the status of our business, global

credit market conditions, and perceptions of our business or industry by EnCap, RCA, or other potential sources of financing.

If we are unable to maintain the Purchase Agreement, we would need to obtain additional credit to fund our future

If credit is available in that event, lenders may impose more restrictive terms and higher interest rates that may reduce our borrowing capacity, increase our costs, or reduce our operating flexibility.

The failure to maintain, extend,

renew or replace the Purchase Agreement with a comparable arrangement or arrangements that provide similar amounts of liquidity for the Company would have a material negative impact on our overall liquidity, financial and operating results.

While a variety of factors related to sources and uses of cash, such as timeliness of accounts receivable collections,

vendor credit terms, or significant collateral requirements, ultimately impact our liquidity, such factors may or may not have a direct impact on our liquidity based on how the transactions associated with such circumstances impact our availability

under our credit arrangements.

For example, a contractual requirement to post collateral for a duration of several months, depending on the materiality of the amount, could have an immediate negative effect on our liquidity, as such a circumstance

would utilize cash resources without a near-term cash inflow back to us.

Likewise, the release of such collateral could have a corresponding positive effect on our liquidity, as it would represent an addition to our cash resources without any

corresponding near-term cash outflow.

Similarly, a slow-down of payments from a customer, group of customers or government payment office would not have an immediate and direct effect on our availability unless the slowdown was material in amount and

over an extended period of time.

Any of these examples would have an impact on our cash resources, our financing arrangements, and therefore our liquidity.

Management may determine that, in order to reduce capital and liquidity requirements, planned spending on capital projects

and indirect expense growth may be curtailed, subject to growth in operating results.

Additionally, management may seek to put in place a credit facility with a commercial bank or other potential lenders, although no assurance can be given that such

a facility could be put in place under terms acceptable to the Company.

Upon the closing of our initial public offering, we issued 17.2 million shares of our common stock at a

price of $17.00 per share, generating net proceeds of approximately $272.8 million.

We used approximately $108.9 million of the net proceeds in connection with the ERPS Conversion (see Note 7 – Exchangeable Redeemable Preferred Stock Conversion),

$30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 2 – Purchase of Telos ID/Non-controlling Interests), $21.0 million to repay our outstanding senior term loan and subordinated debt (see Note 6 – Debt

Obligations).

We intend to use the remaining net proceeds for general corporate purposes.

We also may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies.

However, we do not have agreements,

commitments, or plans for any specific acquisitions at this time.

The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors.

Proceeds held by us are invested in short-term investments until needed for the

uses described above.

We currently anticipate that we will retain all available funds for use in the operation and expansion of our business, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Our working capital was $105.2 million and $2.9 million as of December 31, 2020 and 2019, respectively.

assurances can be given, we expect that our financing arrangements with EnCap and RCA, collectively, and funds generated from 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 of $11.8 million for the year ended December 31, 2019, compared to cash provided by

operating activities of $6.3 million for 2018, and cash used in operating activities of $0.6 million for 2017.

Cash provided by operating activities is primarily driven by our operating income, the timing of receipt of customer payments, the timing

of 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, cash provided by operating activities also includes approximately

$3.8 million annually of dividends from preferred stock recorded as interest expense.

In 2019, net loss was $2.1 million, which included $5.0 million of depreciation and amortization, $1.8 million of which amortization of capitalized software

development costs.

In 2018, net income was $1.7 million, which included $3.0 million of depreciation and amortization, $1.1 million of which amortization of capitalized software development costs.

In 2017, net loss was $3.5 million, which included

$2.0 million of depreciation and amortization and $2.8 million of income tax benefit.

Cash used in investing activities for the year ended December 31, 2019, 2018, and 2017 was $6.5

million, $4.1 million, and $2.2 million, respectively, which, for the year ended December 31, 2019, 2018 and 2017, consisted of the capitalization of software development costs of $2.4 million, $1.6 million and $1.5 million, respectively, and the

purchases of property and equipment of $4.1 million, $2.5 million and $0.7 million, respectively.

Cash provided by financing activities for the year ended December 31, 2019 was $1.4 million, compared

to cash used in financing activities of $2.7 million for 2018, and cash provided by financing activities $2.8 million for 2017.

The financing activities in 2019 consisted of net proceeds of $4.9 million from the EnCap senior term loan, distributions

of $2.4 million to the Class B Member of Telos ID, and repayments of $1.1 million under finance leases.

The financing activities in 2018 consisted of distributions of $1.7 million to the Class B Member of Telos ID and repayments of $1.0 million under

finance leases.

The financing activities in 2017 consisted of net proceeds of $9.4 million from the EnCap senior term loan, distributions of $3.7 million to the Class B Member of Telos ID, redemption of $2.1 million of senior preferred stock, and

repayments of $0.9 million under finance leases.

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

capital structure is complex and requires an understanding of the terms of the instruments, certain restrictions on scheduled payments and redemptions of the various instruments, and the interrelationship of the instruments especially as it relates

to the subordination hierarchy.

Therefore, a thorough understanding of how our capital structure impacts our liquidity is necessary and, accordingly, we have disclosed the relevant information about each instrument as follows:

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.

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.

An amount of approximately $1.1 million was netted from the proceeds of the Loan as a prepayment of

all interest due and payable at the Accrual Rate during the period from January 25, 2017 to October 31, 2017.

A separate fee letter executed by the Company and the Agent, dated January 25, 2017, sets forth the fees payable to the Agent in connection

with the Credit Agreement.

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

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

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

The value of the warrants were 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 prepayment of the loan.

This amount had been included in the total principal due and treated as an unamortized discount on the debt, which would be amortized over the term of the loan, using the effective interest method at a rate of 15.0%.

We incurred fees and transaction

costs of approximately $374,000 related to the issuance of the Credit Agreement, which are being amortized over the life of the Credit Agreement.

Effective February 23, 2017, the Credit Agreement was amended to change the required timing of certain

post-closing items to allow for more time to complete the legal and administrative requirements around such items.

On April 18, 2017, the Credit Agreement was further amended (the “Second Amendment”) to incorporate the parties’ agreement to

subordinate certain debt owed by the Company to the affiliated entities of Mr.

Porter (the “Subordinated Debt”) and to redeem all outstanding shares of the Series A-1 Redeemable Preferred Stock and the Series A-2 Redeemable Preferred

Stock, including those owned by Mr.

Porter and his affiliates, for an aggregate redemption price of $2.1 million.

In connection with the Second Amendment and that subordination of debt, on April 18, 2017, we also entered into

Subordination and Intercreditor Agreements (the “Intercreditor Agreements”) with affiliated entities of Mr.

Porter (together referenced as “Porter”), in which Porter agreed that the Subordinated Debt is fully subordinated to the amended

Credit Agreement and related documents, and that required payments, if any, under the Subordinated Debt are permitted only if certain conditions are met.

On March 30, 2018, the Credit Agreement was further amended (the “Third Amendment”) to waive certain

covenant defaults and to reset the covenants for 2018 measurement periods to more accurately reflect the Company’s projected performance for the year.

The measurement against the covenants for consolidated leverage ratio and consolidated fixed charge

coverage ratio were agreed to not be measured as of December 31, 2017 and were reset for 2018 measurement periods.

Additionally, a minimum revenue covenant and a net working capital covenant were added.

In consideration of these amendments, the

interest rate on the loan was increased by 1%, which will revert back to the original rate upon achievement of two consecutive quarters of a specified fixed charge coverage ratio as defined in the agreement.

The Company may elect to pay the increase

in interest expense in cash or by payment-in-kind (by addition to the principal amount of the Loan).

The increase in interest expense has been paid in cash.

Contemporaneously with the Third Amendment, Mr.

Wood agreed to transfer 50,000

shares of the Company’s Class A Common Stock owned by him to EnCap.

On July 19, 2019, we entered into the Fourth Amendment to Credit Agreement and Waiver;

First Amendment to Fee Letter

(“Fourth Amendment”) to amend the Credit Agreement.

As a result of the Fourth Amendment, several terms of the Credit Agreement were amended, including the following:

The Company borrowed an additional $5 million from the Lenders, increasing the total amount of the principal to $16 million.

The maturity date of the Credit Agreement was amended from January 25, 2022 to January 15, 2021.

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.

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

Consolidated Leverage Ratio,

Consolidated Senior Leverage Ratio, Consolidated Capital Expenditures, Minimum Fixed Charge Coverage Ratio, and Minimum Consolidated Net Working Capital.

Any actual or potential non-compliance with the applicable provisions of the Credit Agreement were waived.

The borrowing under the Credit Agreement continues to be collateralized by substantially all of the Company’s assets including

inventory, equipment and accounts receivable.

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

We incurred immaterial third party transaction

costs which were expensed in the current period.

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

The exit fee has been included in the total principal due and treated as an unamortized discount on the debt, which will be

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 December 31, 2019 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.

On March 26, 2020, the Credit Agreement was amended (the “Fifth Amendment”) to modify the financial

covenants for 2020 through the maturity of the Credit Agreement to establish that the covenants will remain at the December 31, 2019 levels and to update the previously agreed-upon definition of certain financial covenants, specifically the amount of

Capital Expenditures to be included in the measurement of the covenants.

The Fifth Amendment also provides for the right for the Company to elect to extend the maturity date of the Credit Agreement which is currently scheduled to mature on January

The Fifth Amendment provides for four quarterly maturity date extensions, which would increase the Exit Fee payable under the Credit Agreement by $250,000 for each quarterly maturity date extension elected, for a total of $1 million

increase to the Exit Fee were all four of the maturity date extensions to be elected.

The Company paid EnCap an amendment fee of $100,000 and out-of-pocket costs and expenses in consideration for the Fifth Amendment.

We incurred interest expense in the amount of $2.2 million, $1.7 million and $1.5 million for the year ended December 31,

2019, 2018 and 2017, respectively, under the Credit Agreement.

Accounts Receivable Purchase Agreement

On July 15, 2016, we entered into an Accounts Receivable Purchase Agreement (the “Purchase Agreement”) with Republic

Capital Access, LLC (“RCA” or “Buyer”), pursuant to which we may offer for sale, and RCA, in its sole discretion, may purchase, eligible accounts receivable relating to U.S.

Government prime contracts or subcontracts of the Company (collectively, the

“Purchased Receivables”).

Upon purchase, RCA becomes the absolute owner of any such Purchased Receivables, which are payable directly to RCA, subject to certain repurchase obligations of the Company.

The total amount of Purchased Receivables is

subject to a maximum limit of $10 million of outstanding Purchased Receivables (the “Maximum Amount”) at any given time.

The Purchase Agreement had an initial term expiring on June 30, 2018 and automatically renews for successive 12-month renewal

periods unless terminated in writing by either the Company or RCA.

On March 2, 2018, the term of the Purchase Agreement was extended to June 30, 2020.

On November 15, 2019, the term of the Purchase Agreement was extended to June 30, 2022.

consideration of any kind was paid in connection with these extensions.

The initial purchase price of a Purchased Receivable is equal to 90% of the face value of the receivable if the account

debtor is an agency of the U.S.

Government, and 85% if the account debtor is not an agency of the U.S.

provided, however, that RCA has the right to adjust these initial purchase price rates in its sole discretion.

After collection by RCA

of the portion of a Purchased Receivable in excess of the initial purchase price, RCA shall pay the Company the residual 10% or 15% of such Purchased Receivable, as appropriate, less (i) a discount factor equal to 0.30%, for federal government prime

contracts (or 0.56% for non-federal government investment grade account obligors or 0.62% for non-federal government non-investment grade account obligors) of the face amounts of Purchased Receivables;

(ii) a program access fee equal to 0.008% of the

daily ending account balance for each day that the Purchased Receivables are outstanding;

(iii) a commitment fee equal to 1% per annum of the Maximum Amount minus the amount of Purchased Receivables outstanding;

and (iv) fees, costs and expenses

relating to the preparation, administration and enforcement of the Purchase Agreement and any other related agreements.

The Purchase Agreement provides that in the event, but only to the extent, that the conveyance of Purchased Receivables by

the Company is characterized by a court or other governmental authority as a loan rather than a sale, the Company shall be deemed to have granted RCA, effective as of the date of the first purchase under the Purchase Agreement, a security interest in

all of the Company’s right, title and interest in, to and under all of the Purchased Receivables, whether now or hereafter owned, existing or arising.

The Company provides a power of attorney to RCA to take certain actions in the Company’s stead, including (a) to sell,

assign or transfer in whole or in part any of the Purchased Receivables;

(b) to demand, receive and give releases to any account debtor with respect to amounts due under any Purchased Receivables;

Purchased Receivables;

and (d) to take any actions necessary to perfect RCA’s interests in the Purchased Receivables.

The Company is liable to the Buyer for any fraudulent statements and all representations, warranties, covenants, and

indemnities made by the Company pursuant to the terms of the Purchase Agreement.

It is considered an event of default if (a) the Company fails to pay any amounts it owes to RCA when due (subject to a cure period);

(b) the Company has voluntary or

involuntary bankruptcy proceedings commenced by or against it;

(d) any voluntary liens, garnishments, attachments, or the like are issued against or attach

to the Purchased Receivables;

(e) the Company breaches any warranty, representation, or covenant (subject to a cure period);

(f) the Company is not in compliance or has otherwise defaulted under any document or obligation in favor of RCA or an RCA

or (g) the Purchase Agreement or any material provision terminates (other than in accordance with the terms of the Purchase Agreement) or ceases to be effective or to be a binding obligation of the Company.

If any such event of default

occurs, then RCA may take certain actions, including ceasing to buy any eligible receivables, declaring any indebtedness or other obligations immediately due and payable, or terminating the Purchase Agreement.

Financing and Security Agreement

On July 15, 2016, we entered into a Financing and Security Agreement (the “Financing Agreement”) with

Action Capital Corporation (“Action Capital”), pursuant to which Action Capital agreed to provide the Company with advances of up to 90% of the net amount of certain acceptable customer accounts of the Company that have been assigned as collateral to

Action Capital (the “Acceptable Accounts”).

The maximum outstanding principal amount of advances under the Financing Agreement was $5 million.

The Financing Agreement had a term of two years, provided that the Company may terminate it at any time

without penalty upon written notice.

On August 13, 2018, the Financing Agreement was extended through January 2, 2019.

No fee or consideration of any kind was paid in connection with this extension.

The Financing Agreement was not extended beyond

Subordinated Debt

On March 31, 2015, the Company entered into Subordinated Loan Agreements and Subordinated Promissory

Notes (“Porter Notes”) with affiliated entities of Mr.

Porter (together referenced as “Porter”).

Porter and Toxford Corporation, of which Mr.

Porter is the sole shareholder, own 35.0% of our Class A Common Stock.

Under the terms of the

Porter Notes, Porter lent the Company $2.5 million on or about March 31, 2015.

Telos also entered into Subordination and Intercreditor Agreements (the “Subordination Agreements”) with Porter and a prior senior lender, in which the Porter Notes were

fully subordinated to the financing provided by that senior lender, and payments under the Porter Notes were permitted only if certain conditions are met.

According to the original terms of the Porter Notes, the outstanding principal sum bears

interest at the fixed rate of twelve percent (12%) per annum which would be payable in arrears in cash on the 20th day of each May, August, November and February, with the first interest payment date due on August 20, 2015.

The Porter Notes do not

call for amortization payments and are unsecured.

The Porter Notes, in whole or in part, may be repaid at any time without premium or penalty.

The unpaid principal, together with interest, was originally due and payable in full on July 1, 2017.

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 extended the maturity date from July 1, 2017 to July 25, 2022.

Telos also entered into Intercreditor Agreements with Porter and EnCap, in which the Porter Notes are fully subordinated to the Credit Agreement

and any subsequent senior lenders, and payments under the Porter Notes are permitted only if certain conditions are met.

All other terms remain in full force and effect.

As a result of the amendment and restatement of the Porter Notes, we recorded a

gain on extinguishment of debt of approximately $1 million, which consisted of the remeasurement of the debt at fair value.

As the extinguishment was with a related party, the transaction was deemed to be a capital transaction and the gain was

recorded in the Company’s stockholders’ deficit as of December 31, 2017.

We incurred interest expense in the amount of $330,000, $308,000, and $292,000 for 2019, 2018, and 2017, respectively, on the Porter Notes.

As of December 31, 2019,

approximately $1.1 million of accrued interest was payable according to the stated interest rate of the Porter Notes.

Public Preferred Stock

A maximum of 6,000,000 shares of the Public Preferred Stock, par value $.01 per share, has been

authorized for issuance.

We initially issued 2,858,723 shares of the Public Preferred Stock pursuant to the acquisition of the Company during fiscal year 1990.

The Public Preferred Stock was recorded at fair value on the date of original issue,

November 21, 1989, and we made periodic accretions under the interest method of the excess of the redemption value over the recorded value.

We adjusted our estimate of accrued accretion in the amount of $1.5 million in the second quarter of 2006.

The Public Preferred Stock was fully accreted as of December 2008.

We declared stock dividends totaling 736,863 shares in 1990 and 1991.

Since 1991, no other dividends, in stock or cash, have been declared.

In November 1998, we retired 410,000

shares of the Public Preferred Stock.

The total number of shares issued and outstanding at December 31, 2019 and 2018, was 3,185,586.

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

Since 1991, no dividends were declared or paid on our Public Preferred Stock, based upon our interpretation of restrictions

in our Articles of Amendment and Restatement, limitations in the terms of the Public Preferred Stock instrument, specific dividend payment restrictions in various financing agreements to which the Public Preferred Stock is subject, other senior

obligations currently or previously in existence, and Maryland law limitations in existence prior to October 1, 2009.

Subsequent to the 2009 Maryland law change, dividend payments continue to be prohibited except under certain specific circumstances

as set forth in Maryland Code Section 2-311, which the Company did not satisfy as of the measurement dates.

Pursuant to the terms of the Articles of Amendment and Restatement, we were scheduled, but not required, to redeem the Public Preferred Stock

in five annual tranches during the years 2005 through 2009.

However, due to our substantial senior obligations currently or previously in existence, limitations set forth in the covenants in the Credit Agreement and the Porter Notes, foreseeable

capital and operational requirements, and restrictions and prohibitions of our Articles of Amendment and Restatement, we were and remain unable to meet the redemption schedule set forth in the terms of the Public Preferred Stock as of the measurement

Moreover, the Public Preferred Stock is not payable on demand, nor callable, for failure to redeem the Public Preferred Stock in accordance with the redemption schedule set forth in the instrument.

Therefore, we classify these securities as

noncurrent liabilities in the consolidated balance sheets as of December 31, 2019 and 2018.

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

Credit Agreement, we agreed that, until full and final payment of the obligations under the Credit Agreement, we would not make any distribution or declare or pay any dividends (other than common stock) on our stock, or purchase, acquire, or redeem

any stock, or exchange any stock for indebtedness, or retire any stock.

Additionally, the Porter Notes contain similar prohibitions on dividend payments or stock redemptions.

Accordingly, as stated above, we will continue to classify the entirety of our obligation to redeem the Public Preferred

Stock as a long-term obligation.

The Credit Agreement and the Porter Notes prohibit, among other things, the redemption of any stock, common or preferred, other than as described above.

The Public Preferred Stock by its terms also cannot be redeemed

if doing so would violate the terms of an agreement regarding the borrowing of funds or the extension of credit which is binding upon us or any of our subsidiaries, and it does not include any other provisions that 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 December 31, 2019.

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

ASC 210 and the FASB ASC Master Glossary define current liabilities as follows:

The term current liabilities is used

principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities.

As a balance sheet category, the

classification is intended to include obligations for items which have entered into the operating cycle, such as payables incurred in the acquisition of materials and supplies to be used in the production of goods or in providing services to be

offered for sale;

collections received in advance of the delivery of goods or performance of services;

and debts that arise from operations directly related to the operating cycle, such as accruals for wages, salaries, commissions, rentals,

royalties, and income and other taxes.

Other liabilities whose regular and ordinary liquidation is expected to occur within a relatively short period of time, usually twelve months, are also intended for inclusion, such as short-term debts arising

from the acquisition of capital assets, serial maturities of long-term obligations, amounts required to be expended within one year under sinking fund provisions, and agency obligations arising from the collection or acceptance of cash or other

assets for the account of third persons.

ASC 470 provides the following:

The current liability classification is also intended to include obligations that, by their

terms, are due on demand or will be due on demand within one year (or operating cycle, if longer) from the balance sheet date, even though liquidation may not be expected within that period.

It is also intended to include long-term obligations that

are or will be callable by the creditor either because the debtor’s violation of a provision of the debt agreement at the balance sheet date makes the obligation callable or because the violation, if not cured within a specified grace period, will

make the obligation callable.

If, pursuant to the terms of the Public Preferred Stock, we do not redeem the Public Preferred Stock

in accordance with the scheduled redemptions described above, the terms of the Public Preferred Stock require us to discharge our obligation to redeem the Public Preferred Stock as soon as we are financially capable and legally permitted to do so.

Therefore, by its very terms, the Public Preferred Stock is not due on demand or callable for failure to make a scheduled payment pursuant to its redemption provisions and is properly classified as a noncurrent liability.

We pay dividends on the Public Preferred Stock when and if declared by the Board of Directors.

Public Preferred Stock accrues a semi-annual dividend at the annual rate of 12% ($1.20) per share, based on the liquidation preference of $10 per share, and is fully cumulative.

Dividends in additional shares of the Public Preferred Stock for 1990

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 $107.4 million and $103.5 million as of December 31, 2019 and 2018, respectively.

We accrued dividends on the Public Preferred Stock of $3.8 million for each of the years ended December 31, 2019, 2018, and 2017, 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.

Senior Redeemable Preferred Stock

The Senior Redeemable Preferred Stock was senior to all other outstanding equity of the Company, including the Public

Preferred Stock.

The Series A-1 ranked on a parity with the Series A-2.

The components of the authorized Senior Redeemable Preferred Stock were 1,250 shares of Series A-1 and 1,750 shares of Series A-2 Senior Redeemable Preferred Stock, each with

$.01 par value.

The Senior Redeemable Preferred Stock carried a cumulative per annum dividend rate of 14.125% of its liquidation value of $1,000 per share.

The dividends were payable semiannually on June 30 and December 31 of each year.

declared dividends on our Senior Redeemable Preferred Stock since its issuance, other than in connection with the redemptions from 2010 to 2013.

The liquidation preference of the Senior Redeemable Preferred Stock was the face amount of the Series A-1

and A-2 ($1,000 per share), plus all accrued and unpaid dividends.

Due to the terms of the Credit Agreement, the Porter Notes, other senior obligations currently or previously in existence,

the Senior Redeemable Preferred Stock and applicable provisions of Maryland law governing the payment of distributions, we had been precluded from redeeming the Senior Redeemable Preferred Stock and paying any accrued and unpaid dividends on the

Senior Redeemable Preferred Stock, other than the redemptions that occurred from 2010 to 2013.

In addition, certain holders of the Senior Redeemable Preferred Stock had entered into standby agreements whereby, among other things, those holders would

not demand any payments in respect of dividends or redemptions of their instruments and the maturity dates of the instruments have been extended.

In accordance with the requirements of the Second Amendment to the EnCap Credit Agreement, we redeemed all outstanding

shares of the Senior Redeemable Preferred Stock on April 18, 2017 for $2.1 million.

We accrued dividends on the Senior Redeemable Preferred Stock of $0, $0, and $20,000 for the years ended December 31, 2019,

2018, and 2017, respectively, which were reported as interest expense.

Prior to the effective date of ASC 480-10, “Distinguishing Liabilities from Equity,” on July 1, 2003, such dividends were charged to stockholders’ deficit.

Although no assurances can be given, we expect that funds generated from operations are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months.

Cash used in operating activities was $2.1 million for the year ended December 31, 2020, compared to

cash provided by operating activities of $11.8 million and $6.3 million, for the years ended December 31, 2019 and 2018, respectively.

Cash provided by operating activities is primarily driven by our operating income, the timing of receipt of

customer payments, the timing of 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, cash used in operating activities

also includes dividends from preferred stock recorded as interest expense of $3.4 million, $3.8 million, and $3.8 million for 2020, 2019, and 2018, respectively.

In 2020, net income was $6.8 million, $14.0 million of gain related to the redemption of

public preferred stock, and $5.4 million of depreciation and amortization, $1.7 million of which was amortization of capitalized software development costs.

In 2019, net loss was $2.1 million, which included $5.0 million of depreciation and

amortization, $1.8 million of which was amortization of capitalized software development costs.

In 2018, net income was $1.7 million, which included $3.0 million of depreciation and amortization, $1.1 million of which was amortization of capitalized

software development costs.

Cash used in investing activities for the years ended December 31, 2020, 2019, and

2018 was $7.5 million, $6.5 million, and $4.1 million, respectively, which, for the year ended December 31, 2020, 2019 and 2018, consisted of the capitalization of software development costs of $6.7 million, $2.4 million and $1.6 million,

respectively, and the purchases of property and equipment of $0.8 million, $4.1 million and $2.5 million, respectively.

Cash provided by financing activities for the years ended December 31, 2020 and 2019

was $108.9 million and $1.4 million, respectively, compared to cash used in financing activities $2.7 million for 2018.

The financing activities in 2020 consisted of net proceeds of $272.8 million from the initial public offering, offset by $108.9

million redemption of the public preferred stock, $17.4 million payoff of senior term loan, $30.0 million purchase of Telos ID membership interest, distributions of $2.7 million to the Class B Member of Telos ID, $3.7 million payoff of subordinated

debt, and repayments of $1.2 million under finance leases.

The financing activities in 2019 consisted of net proceeds of $4.9 million from the EnCap senior term loan, distributions of $2.4 million to the Class B Member of Telos ID, and repayments of

$1.1 million under finance leases.

The financing activities in 2018 consisted of distributions of $1.7 million to the Class B Member of Telos ID and repayments of $1.0 million under finance leases.

Contractual Obligations

4 unchanged sentences

Finance lease obligations (1)

Senior term loan (2)

Subordinated debt (3)

Operating lease obligations (2)

Public preferred stock (5)

(1) Includes interest expense:

(2) Amount represents the carrying value as of December 31, 2019, plus interest and fee accrual of $3.1 million, is due

and payable in full on January 15, 2021.

(3) Amount represents the carrying value as of December 31, 2019 plus interest accrual of $1.0million, is due and

payable in full on July 25, 2022.

operating lease right-of-use obligations and short-term leases with terms of 12 months or less.

accordance with ASC 480, the public preferred stock was reclassified from equity to liability in July 2003.

Amount represents the carrying value as of December 31, 2019, and includes accrual of accumulated dividends and accretion of $132.8

Payment of such amount presumes conditions precedent being satisfied (See Note 7 – Redeemable Preferred Stock) and as such, redemption date is unknown and accordingly payment is not reflected in a particular period.

Amount does not reflect

additional dividends and accretion through the redemption date as such date is unknown.

Such additional dividends accrue annually in the amount of $3.8 million.

Such accretion has been fully accreted as of December 31, 2008.

(2) Includes operating lease right-of-use obligations and short-term leases with terms of 12 months or less.

Off-Balance Sheet Arrangements

14 unchanged sentences

We adopted ASU 2016-02

effective January 1, 2019 and recorded right-of-use assets and liabilities in our consolidated balance sheet and expanded disclosures about leasing arrangements, among other items, for most lease arrangements.

effective January 1, 2019 and recorded right-of-use assets and liabilities in our consolidated balance sheets and expanded disclosures about leasing arrangements, among other items, for most lease arrangements.

The rate of inflation has been moderate over the past five years and, accordingly, has not had a

5 unchanged sentences

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-K

Item 7. Management’s Discussion and Analysis