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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2021-03-25 compared with 2020-04-13 · 685 added, 939 removed, 597 unchanged (73% of the section changed)

Quantitative and Qualitative Disclosures about Market Risk

Quantitative and Qualitative Disclosures about

Consolidated Financial Statements and Supplementary Data

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Consolidated Statements of Operations for the Years Ended December 31, 2020, 2019 and 2018

Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2019, 2018 and 2017

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2020, 2019 and

Consolidated Balance Sheets as of December 31, 2020 and 2019

Consolidated Statements of Cash Flows for the Years Ended December 31, 2020, 2019, and 2018

Consolidated Statements of Changes in Stockholders' Deficit for the Years Ended December 31, 2019, 2018, and 2017

Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the Years Ended December 31, 2020,

2019, and 2018

Notes to Consolidated Financial Statements

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Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Telos

Corporation (the “Company”) and subsidiaries as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive loss, stockholders’ deficit, and cash flows for each of the three years in the period ended December 31,

2019, and the related notes (collectively referred to as the “consolidated financial statements”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and

subsidiaries at December 31, 2019 and 2018, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2019 ,

in conformity with accounting principles generally accepted in the United States of America.

We have audited the accompanying consolidated balance sheets of Telos Corporation (the “Company”) and subsidiaries as of

December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2020, and the related

notes (collectively referred to as the “consolidated financial statements”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2020

and 2019, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2020 , in conformity

with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s

Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”)

and are required to be independent with respect to the Company in accordance with the U.S.

These consolidated financial statements are the responsibility of the Company’s management.

Our responsibility is to

express an opinion on the Company’s consolidated financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with

respect to the Company in accordance with the U.S.

federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB.

standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were

we engaged to perform, an audit of its internal control over financial reporting.

As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the

effectiveness of the Company’s internal control over financial reporting.

Those standards require that we plan and perform

the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were we engaged to perform, an audit of its

internal control over financial reporting.

As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal

control over financial reporting.

Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material

misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the

consolidated financial statements.

Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

that our audits provide a reasonable basis for our opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial

statements, whether due to error or fraud, and performing procedures that respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements.

also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that our audits provide a reasonable basis for

/s/ BDO USA, LLP

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McLean, Virginia

April 10, 2020

March 25, 2021

TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands)

in thousands , except earnings per share data)

Years Ended December 31,

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Selling, general and administrative expenses

Sales and marketing

Research and development

General and administrative

Operating income

Other income (expenses)

Non-operating income

Gain on redemption of public preferred stock (Note 7)

Non-operating (expense) income

Interest expense

(Loss) income before income taxes

Benefit (provision) for income taxes (Note 9)

Net (loss) income

Income (loss) before income taxes

Benefit from (provision for) income taxes (Note 9)

Net income (loss)

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

Net loss attributable to Telos Corporation

Net income (loss) attributable to Telos Corporation

Net earnings (loss) per share attributable to Telos Corporation, basic

Net earnings (loss) per share attributable to Telos Corporation, diluted

Weighted-average shares of common stock outstanding, basic

Weighted-average shares of common stock outstanding, diluted

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

TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(amounts in thousands)

Years Ended December 31,

Net (loss) income

Other comprehensive (loss) income, net of tax:

Net income (loss)

Other comprehensive income (loss), net of tax:

Foreign currency translation adjustments

Comprehensive income attributable to non-controlling interest

Comprehensive loss attributable to Telos Corporation

Comprehensive income (loss) attributable to Telos Corporation

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

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Cash and cash equivalents

Accounts receivable, net of reserve of $720 and $306, respectively (Note 5)

Inventories, net of obsolescence reserve of $860 and $520, respectively (Note 1)

Accounts receivable, net of reserve

of $308 and $720 , respectively (Note 5)

Inventories, net of obsolescence

reserve of $851 and $860 , respectively (Note 1)

Prepaid expenses

Deferred program expenses

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Property and equipment (Note 1)

Furniture and equipment

Furniture, equipment, and capitalized software development costs

Leasehold improvements

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(amounts in thousands, except share data)

LIABILITIES, REDEEMABLE PREFERRED STOCK,

AND STOCKHOLDERS' DEFICIT

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities

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Accrued compensation and benefits

Contract liabilities

Contract liabilities (Notes 1 and 6)

Finance lease obligations – short-term (Note 10)

Operating lease obligations – short-term (Note 10)

Other current liabilities

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Commitments and contingencies (Notes 10 and 13)

Stockholders’ deficit (Note 8)

Telos stockholders’ deficit

Class A common stock, no par value, 50,000,000 shares authorized, 45,143,460 and 45,158,460 shares issued and

outstanding, respectively

Class B common stock, no par value, 5,000,000 shares authorized, 4,037,628 shares issued and outstanding

Stockholders’ equity (deficit) (Note 8)

Telos stockholders’ equity (deficit)

Common stock, $0.001 par value, 250,000,000 shares authorized, 64,625,071 shares issued and outstanding as of December 31, 2020

Class A common stock, no par value, 50,000,000 shares authorized, 35,826,200 shares issued and outstanding as of December 31, 2019

Class B common stock, no par value, 5,000,000 shares authorized, 3,204,293 shares issued and outstanding as of December 31, 2019

Additional paid-in capital

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Accumulated deficit

Total Telos stockholders’ deficit

Total Telos stockholders’ equity (deficit)

Non-controlling interest in subsidiary (Note 2)

Total stockholders’ deficit

Total liabilities, redeemable preferred stock, and stockholders’ deficit

Total stockholders’ equity (deficit)

Total liabilities and stockholders’ equity (deficit)

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

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Operating activities:

Net (loss) income

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

Net income (loss)

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

Gain on redemption of public preferred stock

Net loss on early extinguishment of

debt and other transactions

Stock-based compensation

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Provision for inventory obsolescence

Provision (benefit) for doubtful accounts receivable

(Benefit) provision for doubtful accounts receivable

Provision for doubtful non-trade receivables

Amortization of debt issuance costs

Deferred income tax (benefit) provision

Loss on disposal of fixed asssets

Deferred income tax provision (benefit)

Loss on disposal of fixed assets

Changes in assets and liabilities:

Decrease (increase) in accounts receivable

Decrease (increase) in inventories

(Increase) decrease in deferred program expenses

(Increase) decrease in other current assets and other assets

(Decrease) increase in accounts payable and other accrued payables

Increase (decrease) in accrued compensation and benefits

Increase (decrease) in contract liabilities

(Increase) decrease in accounts receivable

(Increase) decrease in inventories

Decrease (increase) in deferred program expenses

Increase in prepaid expenses, other current assets and other assets

Increase (decrease) in accounts payable and other accrued payables

(Decrease) increase in accrued compensation and benefits

(Decrease) increase in contract liabilities

Increase in other current liabilities and other liabilities

Cash provided by (used in) operating activities

Cash (used in) provided by operating activities

Investing activities:

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Financing activities:

Proceeds from initial public offering

Redemption of public preferred stock

Purchase of Telos ID membership interest

Payment of senior term loan

Payment of subordinated debt

Proceeds from senior term loan

Redemption of senior preferred stock

Payments under finance lease obligations

Amendment fee paid to lender

Distributions to Telos ID Class B member – non-controlling interest

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Dividends from preferred stock recorded as interest expense

Common stock issued on redemption of public preferred stock (Note 7)

Common stock issued on purchase of Telos ID membership interest (Note 2)

Distributions to Telos ID Class B member – non-controlling interest

Debt issuance costs and prepayment of interest on senior term loan

Gain on extinguishment of subordinated debt

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

TELOS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

(amounts in thousands)

Telos Corporation

Class A Common

Paid–in Capital

Other Comprehensive Income

Comprehensive Income

Non-Controlling Interest

Stockholders’

Balance December 31, 2016

Net (loss) income

Gain on extinguishment of subordinated debt

Stock based compensation

Foreign currency translation gain

Distributions

Stockholders’ Equity

Balance December 31, 2017

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Balance December 31, 2019

Issuance of common stock

Purchase of Telos ID membership interest

Foreign currency translation gain

Stock-based compensation

Distributions

Balance December 31, 2020

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

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We also have a 100% ownership

interest in Telos Identity Management Solutions, LLC (“Telos ID”) and a 100% ownership interest in Teloworks, Inc.

interest in Telos Identity Management Solutions, LLC (“Telos ID”), Teloworks, Inc.

(“Teloworks”) and Telos APAC Pte.

(Telos APAC).

Initial Public Offering of Common Stock

On November 19, 2020, we completed our initial public offering of shares of our common stock.

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 conversion of our outstanding shares of

Exchangeable Redeemable Preferred Stock into the right to receive cash and shares of our common stock, $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID, and $21.0 million to repay our outstanding senior term loan and

subordinated debt.

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.

We do not, however, 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.

Principles of Consolidation and Basis of Presentation

The accompanying consolidated financial statements include the accounts of Telos and its

subsidiaries, including Ubiquity.com, Inc., Xacta Corporation, Teloworks, and Telos APAC, all of whose issued and outstanding share capital is owned by the Company.

We have also consolidated the results of operations of Telos ID (see Note 2 –

Non-controlling Interests).

subsidiaries, including Ubiquity.com, Inc., Xacta Corporation, Telos ID, Teloworks, and Telos APAC, all of whose issued and outstanding share capital is owned by the Company.

Intercompany transactions have been eliminated in consolidation.

In December 2019, an outbreak of COVID-19 was reported in Wuhan, China.

On March 11, 2020, the World Health Organization

declared COVID-19 a global pandemic and on March 13, 2020, President Donald J.

Trump declared the virus a national emergency.

This highly contagious disease has spread to most of the countries in the world and throughout the United States, creating a

serious impact on customers, workforces, and suppliers, disrupting economies and financial markets, and leading to a world-wide economic downturn.

COVID-19, together with subsequently reported variants of this strain, have caused a disruption of the

normal operations of many businesses, including the temporary closure or scale-back of business operations and/or the imposition of either quarantine or remote work or meeting requirements for employees, either by government order or on a voluntary

The pandemic may adversely affect our customers’ ability to perform their missions and is in many cases disrupting their operations.

It may also impact the ability of our subcontractors, partners, and suppliers to operate and fulfill their

contractual obligations, and result in an increase in their costs and cause delays in performance.

These supply chain effects, and the direct effect of the virus and the disruption on our operations, may negatively impact both our ability to meet

customer demand and our revenue and profit margins.

Our employees, in some cases, are working remotely due either to safety concerns or to customer imposed limitations and using various technologies to perform their functions.

We could see delays or

changes in customer demand, particularly if government funding priorities change.

Additionally, the disruption and volatility in the global and domestic capital markets may increase the cost of capital and limit our ability to access capital.

the health and economic aspects of COVID-19 are highly fluid and the future course of each is uncertain.

In preparing these consolidated financial statements, we have evaluated subsequent events through the

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Use of Estimates

The preparation of consolidated financial statements in conformity with Generally Accepted Accounting Principles (“GAAP”)

in the United States of America 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,

The preparation of consolidated financial statements in conformity with U.S.

Generally Accepted

Accounting Principles (“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.

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Revenue Recognition

We account for revenue in accordance with 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.

We account for revenue in accordance with 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.

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.

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 (the 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 (the 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.

Revenue on these contracts is recognized when the customer obtains

control of the transferred product or service, which is generally upon delivery of the product to the customer for their use, due to us maintaining control of the product until that point.

Orders for the sale of software licenses may contain multiple

performance obligations, such as maintenance, training, or consulting services, which are typically delivered over time, consistent with the transfer of control disclosed above for the provision of services.

When an order contains multiple

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

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® (previously referred to as Cyber & Cloud Solutions) and Secure Communications (previously referred to as Secure Communications Cyber and Enterprise Solutions) business groups and for the sale of resold products in Telos ID

(previously referred to as Telos ID Enterprise Solutions) and Secure Networks (previously referred to as Secure Mobility and Network Management/Defense Enterprise Solutions), and is classified as product revenue.

Revenue on these contracts is

recognized when the customer obtains control of the transferred product or service, which is generally upon delivery of the product to the customer for their use, due to us maintaining control of the product until that point.

Orders for the sale of

software licenses may contain multiple performance obligations, such as maintenance, training, or consulting services, which are typically delivered over time, consistent with the transfer of control disclosed above for the provision of services.

When an order contains multiple 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 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.

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

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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

years ended December 31, 2020, 2019, and 2018.

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

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Cost plus fixed fee

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

Billed accounts receivable

Unbilled receivables

Allowance for doubtful accounts

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.

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.

Cash and Cash Equivalents

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Accordingly, all book overdraft balances have been reclassified to accounts payable and other accrued liabilities.

In accordance with ASC 275-10-50-16, in consideration that such a large amount of our working capital

and total assets are held in cash and cash equivalents, we have considered that the balances held in our various treasury accounts may exceed federally insured limits as of the date of the financial statements.

Due to the financial strength of the

financial institution where the accounts are held, we do not believe that this concentration risk makes it reasonably possible that a near-term severe impact risk of loss will occur.

Accounts Receivable

Accounts receivable are stated at the invoiced amount, less an allowance for doubtful accounts.

Collectability of accounts

receivable is regularly reviewed based upon managements’ knowledge of the specific circumstances related to overdue balances.

Collectability of accounts receivable is regularly reviewed based upon managements’ knowledge of the specific circumstances related to overdue balances.

The allowance for doubtful accounts is adjusted based on such evaluation.

Accounts receivable balances are written off

against the allowance when management deems the balances uncollectible.

Accounts receivable

balances are written off against the allowance when management deems the balances uncollectible.

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

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minimum lease payments.

Amortization of property and equipment under finance leases is computed on the straight-line method over the lesser of the term of the related lease and the useful life of the related asset.

Amortization of property and equipment under finance leases is computed using the straight-line method over the lesser of the term of the related lease and the useful life of the related asset.

Upon sale or retirement of property and equipment, the costs and related accumulated depreciation are

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Software Development Costs

Our policy on accounting for development costs of software to be sold is in accordance with ASC

Topic 985-20, “Software – Costs of Software to be Sold, Leased, or Marketed” and ASC Topic 350-40 “Internal Use Software” in so far as our Xacta products being available in various deployment modalities including on premises licenses and

cloud-based Software as a Service (“SaaS”).

Under both standards, software development costs are expensed as incurred until technological feasibility is reached, at which time additional costs are capitalized until the product is available for

general release to customers or is ready for its intended use, as appropriate.

Our policy on accounting for development costs of software to be sold is in accordance with ASC Topic 985-20, “Software –

Costs of Software to be Sold, Leased, or Marketed” and ASC Topic 350-40 “Internal Use Software” in so far as our Xacta products being available in various deployment modalities including on premises licenses and cloud-based Software as a Service

Under both standards, software development costs are expensed as incurred until technological feasibility is reached, at which time additional costs are capitalized until the product is available for general release to customers or is ready

for its intended use, as appropriate.

Technological feasibility is established when all planning, designing, coding and testing activities have been completed, and all risks have been identified.

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

As of December 31, 2019 and 2018, we capitalized $5.6 million and $3.1 million of

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

Amortization expense was $1.8 million and $1.1 million for the year ended December 31, 2019 and 2018, respectively.

Accumulated amortization was

$3.1 million and $1.3 million as of December 31, 2019 and 2018, respectively.

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

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

During 2019, 2018 and 2017, we incurred salary costs for research and development of approximately $4.2 million, $3.5

million and $3.2 million, respectively, which were included as part of the selling, general and administrative expense in the consolidated statements of operations.

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

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

Beginning with the second quarter of 2017, software

development costs are capitalized and amortized over the estimated product life of 2 years on a straight-line basis.

As of December 31, 2020 and 2019, we capitalized $12.3 million and $5.6 million of software development costs, respectively, which

are included as a part of property and equipment.

Amortization expense was $1.7 million, $1.8 million, and $1.1 million for the years ended December 31, 2020, 2019, and 2018, respectively.

Accumulated amortization was $4.8 million and $3.1 million as

of December 31, 2020 and 2019, respectively.

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

development costs as forecasted future sales are adequate to support amortization costs.

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

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.

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.

Based on available evidence, realization of deferred tax assets is dependent upon the generation of future taxable

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.

As such, we 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 remains 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 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 remains on our consolidated

balance sheets 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 2019.

See additional information on tax reform and its impact on our income taxes in Note 9

– Income Taxes.

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

We follow the provisions of ASC 740 related to accounting for uncertainty in income taxes.

The accounting estimates related to liabilities for uncertain tax positions require us to make judgments regarding the

sustainability of each uncertain tax position based on its technical merits.

If we determine it is more likely than not that a tax position will be sustained based on its technical merits, we record the impact of the position in our consolidated

financial statements at the largest amount that is greater than fifty percent likely of being realized upon ultimate settlement.

These estimates are updated at each reporting date based on the facts, circumstances and information available.

are also required to assess at each reporting date whether it is reasonably possible that any significant increases or decreases to our unrecognized tax benefits will occur during the next 12 months.

We evaluate the impairment of goodwill in accordance with ASC 350, 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.

accounting estimates related to liabilities for uncertain tax positions require us to make judgments regarding the sustainability of each uncertain tax position based on its technical merits.

If we determine it is more likely than not that a tax

position will be sustained based on its technical merits, we record the impact of the position in our consolidated financial statements at the largest amount that is greater than fifty percent likely of being realized upon ultimate settlement.

estimates are updated at each reporting date based on the facts, circumstances and information available.

We are also required to assess at each reporting date whether it is reasonably possible that any significant increases or decreases to our

unrecognized tax benefits will occur during the next 12 months.

We evaluate the impairment of goodwill in accordance with ASC 350, 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:

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

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

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

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

expenditures and the selection and use of an appropriate discount rate.

The net assets attributable to the reporting units are determined based upon the estimated assets and liabilities attributable to the reporting units in deriving its free cash

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

The Company’s assessment resulted in a fair value that was greater than the Company’s carrying value, therefore

the second step of the impairment test, as prescribed by the authoritative literature, was not required to be performed and no impairment of goodwill was recorded as of December 31, 2019.

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 and the

selection and use of an appropriate discount rate.

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

The net assets attributable to the reporting units are

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

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

The Company’s assessment resulted in a fair value that was greater than the Company’s carrying value, therefore no impairment of goodwill was recorded as of December 31, 2020.

Subsequent reviews may result in future periodic impairments

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Compensation cost is recognized based on the requirements of ASC 718, “Stock Compensation,” for all share-based awards

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

In May 2017, we granted 5,005,000 shares of restricted stock to our executive officers and employees.

Such stock is

subject to a vesting schedule as follows:

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

of December 31, 2019, there were 1,198,750 shares of restricted stock that remained subject to vesting.

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

2013 Omnibus Long-Term Incentive Plan, or the 2016 Omnibus Long-Term Incentive Plan, all unvested shares shall automatically vest in full.

In accordance with ASC 718, we recorded immaterial compensation expense for any of the issuances as the value

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

company analysis, and comparable transaction analysis.

Since June 2008, we have issued restricted stock to our executive officers, directors and employees.

79,361 shares were granted in 2020.

Such stock is subject to a vesting schedule as follows:

25% of the restricted stock vests

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

As of December 31, 2020, there were 59,521 shares of restricted stock that

remained subject to vesting.

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

Plan, all unvested shares shall automatically vest in full.

In accordance with ASC 718, we recorded immaterial compensation expense for any of the issuances as the value of the common stock was nominal prior to the initial public offering of our

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

comparable transaction analysis.

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

Earnings (Loss) per Share

As we do not have publicly held common stock or potential common stock, no earnings (loss) per share data is reported for

any of the years presented.

Comprehensive Loss

Comprehensive loss includes changes in equity (net assets) during a period from non-owner sources.

Our accumulated other

comprehensive income (loss) was comprised of a loss from foreign currency translation of $101,000 and $90,000 as of December 31, 2019 and 2018, respectively;

and actuarial gain on pension liability adjustments in Teloworks of $107,000 as of December

31, 2019 and 2018.

Basic net earnings (loss) per share is computed by dividing the net loss by the weighted-average

number of common shares outstanding for the period, without consideration for potentially dilutive securities.

Diluted net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of shares of common

stock and dilutive common stock equivalents outstanding for the period determined using the treasury-stock and if-converted methods.

Dilutive common stock equivalents are comprised of unvested restricted common stock and warrants.

For the year ended December 31, 2019, the Class A common basic and diluted net loss per share was

$(0.17), and the Class A common basic and diluted weighted-average shares were 34,525, the Class B common basic and diluted net loss per share was $(0.17), and the Class B common basic and diluted weighted-average shares were 3,204.

For the year ended December 31, 2018, the Class A common basic and diluted net loss per share was

$(0.04), and the Class A common basic and diluted weighted-average shares were 33,558, the Class B common basic and diluted net loss per share was $(0.04), and the Class B common basic and diluted weighted-average shares were 3,204.

Potentially dilutive securities not included in the calculation of diluted net earnings (loss) per

share because to do so would be anti-dilutive are as follows (in common stock equivalent shares):

Year Ended December 31,

Unvested restricted stock

Common stock warrants, exercisable at $1.665/sh.

On November 12, 2020, we amended our Articles of Amendment and Restatement to effect an

approximate 0.794-for-1 reverse stock split with respect to our common stock.

The par value and the authorized shares of the common stock were not adjusted as a result of the reverse stock split.

The accompanying consolidated financial statements

and notes to the consolidated financial statements give retroactive effect to the reverse stock split for all periods presented.

Comprehensive Income (Loss)

Comprehensive income (loss) includes changes in equity (net assets) during a period from non-owner sources.

Our accumulated

other comprehensive income (loss) was comprised of a loss from foreign currency translation of $63,000 and $101,000 as of December 31, 2020 and 2019, respectively;

and actuarial gain on pension liability adjustments in Teloworks of $107,000 as of

December 31, 2020 and 2019.

Financial Instruments

We use various methods and assumptions to estimate the fair value of our financial instruments.

Due to their short-term

nature, the carrying value of cash and cash equivalents, accounts receivable and accounts payable approximates fair value.

The fair value of long-term debt is based on the discounted cash flows for similar term borrowings based on market prices for

the same or similar issues.

their short-term nature, the carrying value of cash and cash equivalents, accounts receivable and accounts payable approximates fair value.

The fair value of long-term debt is based on the discounted cash flows for similar term borrowings based on

market prices for the same or similar issues.

Fair value estimates are made at a specific point in time, based on relevant market information.

These estimates are

subjective in nature and involve matters of judgment and therefore cannot be determined with precision.

estimates are subjective in nature and involve matters of judgment and therefore cannot be determined with precision.

Changes in assumptions could significantly affect the estimates.

Recent Accounting Pronouncements Adopted

In February 2016, the FASB issued ASU 2016-02, “Leases (ASC Topic 842)”, which requires lessees to recognize a right-of-use

asset and lease liability on the balance sheet and expands disclosures about leasing arrangements for both lessees and lessors, among other items, for most lease arrangements.

The new standard is effective for fiscal years beginning after December

15, 2018, which made the new standard effective for us on January 1, 2019.

In July 2018, the FASB issued ASU 2018-11, “Leases (ASC Topic 842):

Targeted Improvements,” which allows for an additional transition method under the modified retrospective

approach for the adoption of ASU 2016-02.

The two permitted transition methods are (a) to apply the new lease requirements at the beginning of the earliest period presented (the Comparative Method) and (b) to apply the new lease requirements at the

effective date (the Effective Date Method).

Under both transition methods there is a cumulative effect adjustment.

We adopted the standard on January 1, 2019 by applying the new lease requirements utilizing the Effective Date Method for all leases

with terms greater than 12 months.

We elected the package of practical expedients permitted under the transition guidance within the new standard, which included carrying forward historical assessments of:

(1) whether contracts are or contain leases,

(2) lease classification and (3) initial direct costs.

The adoption of this standard resulted in the recognition of right-of-use assets of $2.0 million and additional lease liabilities of $2.0 million as of January 1, 2019.

The adoption of the

standard did not have a material impact on our operating results or cash flows.

The comparative periods have not been restated for the adoption of ASU 2016-02.

Recent Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326):

Measurement of Credit Losses

on Financial Instruments,” which introduces new guidance for estimating credit losses on certain types of financial instruments based on expected losses and the timing of the recognition of such losses.

This standard will be effective for interim and

annual reporting periods beginning after December 15, 2019, with early adoption permitted.

While we are currently assessing the impact the adoption of this ASU will have on our consolidated financial position, results of operations and cash flows, we

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

Measurement of Credit Losses on Financial Instruments,” which introduces new guidance for estimating credit losses on certain types of financial instruments based on expected losses and the timing of the recognition of such losses.

This standard is

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

The adoption of this ASU did not have a material impact on our consolidated financial position,

results of operations and cash flows.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350):

Simplifying the Test for

Goodwill Impairment," which eliminates Step 2 of the current goodwill impairment test that requires a hypothetical purchase price allocation to measure goodwill impairment.

A goodwill impairment loss will instead be measured at the amount by which a

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

The provisions of this ASU are effective for years beginning after December 15, 2019, with early adoption permitted for any impairment test

performed on testing dates after January 1, 2017.

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

the Test for Goodwill Impairment," which eliminates Step 2 of the current goodwill impairment test that requires a hypothetical purchase price allocation to measure goodwill impairment.

A goodwill impairment loss instead is measured at the amount by

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

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

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

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

Disclosure Framework – Changes to the

Disclosure Requirements for Fair Value Measurement”, which modifies the disclosure requirement for fair value measurement under ASC 820 to improve the effectiveness of such disclosures.

Those modifications include the removal and addition of

disclosure requirements as well as clarifying specific disclosure requirements.

This standard will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted.

The adoption of this ASU will

not have a material impact on our consolidated financial position, results of operations and cash flows.

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

Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract,” which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract

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

This standard will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption

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

Non-controlling Interests

Disclosure Framework –

Changes to the Disclosure Requirements for Fair Value Measurement”, which modifies the disclosure requirement for fair value measurement under ASC 820 to improve the effectiveness of such disclosures.

Those modifications include the removal and

addition of disclosure requirements as well as clarifying specific disclosure requirements.

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

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

In August 2018, the FASB issued ASU 2018‑15, “Intangibles - Goodwill and Other - Internal-Use Software

(Subtopic 350-40):

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

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

this standard effective for us on January 1, 2020.

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

Recent Accounting Pronouncements Not Yet Adopted

In December 2019, the FASB issued ASU No.

2019-12, “Income Taxes (Topic 740):

Simplifying the Accounting

for Income Taxes,” which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740.

The ASU also clarifies and amends existing guidance to improve consistent application.

This standard will be

effective for reporting periods beginning after December 15, 2020, with early adoption permitted.

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

consolidated financial position, results of operations and cash flows.

Purchase of Telos ID/Non-Controlling

On October 5, 2020, we entered into a Membership Interest Purchase Agreement between the Company and

Hoya ID Fund A, LLC (“Hoya”) to purchase all of the Class B Units of Telos ID (“Telos ID Units”) owned by Hoya (the “Telos ID Purchase”).

Upon the closing of the Telos ID Purchase, Telos ID became our wholly owned subsidiary.

On November 23, 2020,

the Telos ID Purchase was consummated with the Company transferring $30.0 million in cash and issuing 7,278,040 shares of our common stock at $20.39 per share (which totals approximately $148.4 million);

the total consideration transferred to Hoya

was $178.4 million.

As part of the common stock issuance, the Company recognized a credit to APIC of $148.4 million.

The Company further recognized a debit to APIC of $173.9 million as part of the elimination of Hoya’s non-controlling interest in

The net impact to APIC associated with the acquisition of the additional 50% interest in Telos ID was a debit of $25.5 million.

On April 11, 2007, Telos ID was formed as a limited liability company under the Delaware Limited Liability Company Act.

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book value of assets we contributed totaled $17,000.

Until April 19, 2007, we owned 99.999% of the membership interests of Telos ID and certain private equity investors (“Investors”) owned 0.001% of the membership interests of Telos ID.

2007, we sold an additional 39.999% of the membership interests to the Investors in exchange for $6 million in cash consideration.

Until April 19, 2007, we owned 99.999% of the membership interests of Telos ID and Hoya owned 0.001% of the membership interests of Telos ID.

On April 20, 2007, we sold an additional 39.999% of the

membership interests to Hoya in exchange for $6 million in cash consideration.

In accordance with ASC 505, “Equity,” we recognized a gain of $5.8 million.

As a result, we owned 60% of Telos ID, and

therefore continue to account for the investment in Telos ID using the consolidation method.

As a result, we owned 60% of Telos ID, and therefore continued to account for the investment in

Telos ID using the consolidation method.

On December 24, 2014 (the “Closing Date”), we entered into a Membership Interest Purchase Agreement

(the “Purchase Agreement”) between the Company and the Investors, pursuant to which the Investors acquired from the Company an additional ten percent (10%) membership interest in Telos ID in exchange for $5 million (the “Transaction”).

In connection

with the Transaction, the Company and the Investors entered into the Second Amended and Restated Operating Agreement (the “Operating Agreement”) governing the business, allocation of profits and losses and management of Telos ID.

the Operating Agreement, Telos ID is managed by a board of directors comprised of five (5) members (the “Telos ID Board”).

The Operating Agreement provides for two classes of membership units, Class A (owned by the Company) and Class B (owned by the

The Class A member (the Company) owns 50% of Telos ID, is entitled to receive 50% of the profits of Telos ID, and may appoint three (3) members of the Telos ID Board.

The Class B member (the Investors) owns 50% of Telos ID, is entitled to

receive 50% of the profits of Telos ID, and may appoint two (2) members of the Telos ID Board.

Despite the post-Transaction ownership of Telos ID being evenly split at 50% by each member, Telos maintains control of the

subsidiary through its holding of three of the five Telos ID Board seats.

Under the Operating Agreement, the Class A and Class B members each have certain options with regard

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

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

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

Upon the occurrence of the following events:

(i) the involuntary termination of John B.

Wood as CEO and chairman of the Class A

(ii) the bankruptcy of the Class A member;

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

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

provided, however, that

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

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

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

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

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

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

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

purchase or to waive such violation.

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

member’s interest upon the occurrence of any of the foregoing events, the purchase price for the interest will be based on an appraisal of Telos ID prepared by a nationally recognized investment banker.

If the Class A member fails to satisfy its

obligation, subject to the restrictions in the Purchase Agreement, to purchase the interest of the Class B member under the Operating Agreement, the Class B member may require Telos ID to initiate a sales process for the purpose of seeking an offer

from a third party to purchase Telos ID that maximizes the value of Telos ID.

The Telos ID Board must accept any offer from a bona fide third party to purchase Telos ID if that offer is approved by the Class B member, unless the purchase of Telos ID

would violate the terms of any existing line of credit available to the Company and the applicable lender does not consent to that purchase or waive the violation.

The sale process is the sole remedy available to the Class B member if the Class A

member does not purchase its membership interest.

Under such a forced sale scenario, a sales process would result in both members receiving their proportionate membership interest share of the sales proceeds and both members would always be entitled

to receive the same form of consideration.

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

(the “Purchase Agreement”) between the Company and Hoya, pursuant to which Hoya acquired from the Company an additional ten percent (10%) membership interest in Telos ID in exchange for $5 million (the “Transaction”).

In connection with the

Transaction, the Company and Hoya entered into the Second Amended and Restated Operating Agreement (the “Operating Agreement”) governing the business, allocation of profits and losses and management of Telos ID.

Under the Operating Agreement, Telos ID was managed by a board of directors comprised of five (5) members (the “Telos ID Board”).

The Operating Agreement provided for two classes of membership units, Class A (owned by the Company) and Class B (owned

The Class A member (the Company) owned 50% of Telos ID, was entitled to receive 50% of the profits of Telos ID, and could appoint three (3) members of the Telos ID Board.

The Class B member (Hoya) owned 50% of Telos ID, was entitled to

receive 50% of the profits of Telos ID, and could appoint two (2) members of the Telos ID Board.

As a result of the 2014 Transaction, the Class A and Class B members each owned 50% of Telos ID, as

mentioned above, and as such each was allocated 50% of the profits, which was $5.2 million, $4.3 million, and $3.4 million for 2020, 2019, and 2018, respectively.

The Class B member is the non-controlling interest.

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

Directors, in accordance with the Operating Agreement.

The Class B member was the non-controlling interest.

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

Operating Agreement.

During the years ended December 31, 2020, 2019, and 2018, the Class B member received a total of $2.8 million, $2.4 million, and $1.7 million, respectively, of such distributions.

The Class B member also received a final

distribution of $2.4 million in January 2021, which was accrued and presented in accounts payable and other accrued liabilities in the consolidated balance sheets as of December 31, 2020.

The following table details the changes in non-controlling interest for the years ended December 31, 2020, 2019, and 2018

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Distributions

Sale of 50% membership interest

Non-controlling interest, end of period

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Goodwill is subject to

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

As of December 31, 2019 and 2018, no impairment charges were taken.

annual impairment tests and in the interim if triggering events are present before the annual tests, we will assess impairment.

For the years ended December 31, 2020, 2019 and 2018, no impairment charges were taken.

Fair Value Measurements

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

As of December 31, 2019 and 2018, the carrying value of the Company’s 12% Cumulative Exchangeable Redeemable Preferred

Stock, par value $.01 per share (the “Public Preferred Stock”) was $139.2 million and $135.4 million, respectively, and the estimated fair market value was $60.5 million and $41.4 million, respectively, based on quoted market prices.

As of December 31, 2019, the carrying value of the Company’s 12% Cumulative Exchangeable Redeemable Preferred Stock, par

value $.01 per share (the “Public Preferred Stock”) was $139.2 million, and the estimated fair market value was $60.5 million, based on quoted market prices.

For certain of our non-derivative financial instruments, including receivables, accounts payable and other accrued

liabilities, the carrying amount approximates fair value due to the short-term maturities of these instruments.

The estimated fair value of the Credit Agreement (as defined below) and long-term debt is based primarily on borrowing rates currently

available to the Company for similar debt issues.

The fair value approximates the carrying value of long-term debt.

Revenue and Accounts Receivable

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As our primary customer base includes agencies of the U.S.

Government, we have a concentration of credit risk associated with our accounts receivable, as 92.7% of our

billed accounts receivable were directly with U.S.

Government, we have a concentration of credit risk associated with our accounts receivable, as 96.1% of our billed

accounts receivable were directly with U.S.

Government customers.

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On July 15, 2016, the Company entered into an accounts receivable purchase agreement under which the

Company sells certain accounts receivable to a third party, or the “ Factor ” ,

Company could sell certain accounts receivable to a third party, or the “ Factor ” ,

without recourse to the Company.

The Factor initially pays the Company 90% of U.S.

Federal government receivables or 85% of certain commercial prime contractors.

The remaining payment is deferred and based on the amount the Factor receives from our

customer, less a discount fee and a program access fee that is determined by the amount of time the receivable is outstanding before payment.

The structure of the transaction provides for a true sale of the receivables transferred.

Accordingly, upon

transfer of the receivable to the Factor, the receivable is removed from the Company's consolidated balance sheet, a loss on the sale is recorded and the residual amount remains a deferred payment as an accounts receivable until payment is received

from the Factor.

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

During the years ended December 31, 2019 and 2018, the Company sold approximately $12.6 million and $18.1 million of accounts receivable, respectively, and recognized a

related loss of approximately $0.1 million in selling, general and administrative expenses for the same periods.

As of December 31, 2019, there were no outstanding sold accounts receivable.

As of December 31, 2018, the balance of the sold accounts

receivable was approximately $0.9 million, and the related deferred price was approximately $0.1 million.

The components of accounts receivable are as follows (in thousands):

The Factor initially paid the Company 90% of U.S.

Federal government receivables or 85% of certain commercial prime contractors’ receivables that were sold under the agreement.

The remaining payment was deferred and

based on the amount the Factor received from our customer, less a discount fee and a program access fee that was determined by the amount of time the receivable was outstanding before payment.

The structure of the transaction provided for a true sale

of the receivables transferred.

Accordingly, upon transfer of the receivable to the Factor, the receivable was removed from the Company's consolidated balance sheet, a loss on the sale was recorded and the residual amount remains a deferred payment

as an accounts receivable until payment was received from the Factor.

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

There were no accounts receivable sold during 2020.

During the year ended December 31, 2019, the Company sold

approximately $12.6 million of accounts receivable, and recognized a related loss of approximately $0.1 million in selling, general and administrative expenses for the same period.

As of December 31, 2020 and 2019, there were no outstanding sold

accounts receivable.

The components of accounts receivable and contract assets are as follows (in thousands):

Billed accounts receivable

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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

All borrowings under the Credit Agreement accrued interest at the rate of 13.0% per annum (the

“Accrual Rate”).

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

If, at the request of the Company, the Agent executed 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 would

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%

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

The Company was 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.

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payment-in-kind.

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

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

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

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

for transactions of this type.

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

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

any intercreditor agreement.

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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

"Warrant") to the Agent and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms 900,970 shares of the Class A Common Stock of the Company, no par value per share, which was equivalent to

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

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

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

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

The exercise price as $1.665 per share and each Warrant would expire on January 25, 2027.

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

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

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

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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 Amendmend”) to waive certain

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.

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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.

interest rate on the loan was increased by 1%, which would 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 had 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.

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;

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The prepayment price was amended as follows:

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

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

(a) from January 26, 2019 through January 25, 2020, the prepayment price was 102% of the

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

However, the prepayment

price for the additional $5 million loan attributable to the Fourth Amendment will be at par.

price for the additional $5 million loan attributable to the Fourth Amendment would be at par.

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

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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

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

inventory, equipment and accounts receivable.

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costs which were expensed in the current period.

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

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

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

through the maturity of the Credit Agreement to establish that the covenants would 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 15, 2021.

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 Fifth Amendment also provided for the right for the Company to elect to extend the maturity date of the Credit Agreement which was scheduled to mature on January 15, 2021.

Fifth Amendment provided 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.

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

Senior term loan principal, including exit fee

Unamortized discount, debt issuance costs, and lender fees

Senior term loan, net

We incurred interest expense in the amount of $2.7 million, $2.2 million and $1.7 million for the years ended December

31, 2020, 2019 and 2018, 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 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 this date.

On November 24, 2020, upon the closing of the IPO, the Company paid a total of $17.4 million which paid off the Credit

Agreement in full including an exit fee of $1.2 million, accrued interest of $138,000, and legal fees of $13,000.

As a result, we recognized a loss on debt extinguishment of $138,000 presented as a part of the non-operating expense in the

consolidated statements of operations.

Subordinated Debt

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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.

Porter is the sole shareholder, owned 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 bore 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 did not call for

amortization payments and were 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

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.

All other terms remain in full force and effect.

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.

Redeemable Preferred Stock

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 were fully subordinated to the Credit

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

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.

All other terms remained in full force and effect.

We incurred interest expense in the amount of $319,000, $330,000, and $308,000

for 2020, 2019, and 2018, respectively, on the Porter Notes.

On November 23, 2020, upon the closing of the IPO, the Porter Notes were paid in full.

Redeemable Preferred Stock Conversion

Public Preferred Stock

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

Upon the closing of the IPO, which constituted a qualified initial public offering for the purposes of the terms of the

Exchangeable Redeemable Preferred Stock, each issued and outstanding share of Exchangeable Redeemable Preferred Stock automatically was converted (the “ERPS Conversion”) into the right to receive (i) an amount of cash equal to (I) the ERPS

Liquidation Value;

multiplied by (II) 0.90;

multiplied by (III) 0.85 and (ii) that number of shares of common stock (valued at the initial offering price to the public) equal to (I) the ERPS Liquidation Value;

multiplied by (II) 0.90;

multiplied by

No fractional shares of common stock, however, were issued upon an ERPS Conversion Event but, in lieu thereof, the holder was entitled to receive an amount of cash equal to the fair market value of a share of common stock (valued at the

initial offering price to the public) at the time of such ERPS Conversion Event multiplied by such fractional amount (rounded to the nearest cent).

“ERPS Liquidation Value” means, per each share of Exchangeable Redeemable Preferred Stock, $10

together with all accrued and unpaid dividends (whether or not earned or declared) thereon calculated as of the actual date of an ERPS Conversion Event without interest, which, was approximately $142.3 million as of November 19, 2020.

All shares of

common stock issued upon an ERPS Conversion were validly issued, fully paid and non-assessable.

On November 23, 2020, holders of Exchangeable Redeemable Preferred Stock received $108.9 million in cash and 1.1 million shares of our common stock at $17

per share for a total value of $19.2 million in connection with the ERPS Conversion.

The difference in the redemption value of the ERPS and the carrying value has been accounted for as a gain on extinguishment of debt in accordance with ASC 470 and

Approximately $220,000 of costs directly attributable to this redemption were applied against the gain, resulting in a net gain of $14.0 million.

A maximum of 6,000,000 shares of the Public Preferred Stock, par value $0.01 per share, had been

authorized for issuance.

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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.

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

The Public Preferred Stock was 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

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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

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.

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

Moreover, the Public Preferred Stock was 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 classified these securities as

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

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

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

For the cash dividends payable since December 1, 1995, we had accrued $107.4 million as of December 31, 2019.

We accrued dividends on the Public

Preferred Stock of $3.4 million $3.8 million and $3.8 million for the years ended December 31, 2020, 2019, and 2018, respectively, which was recorded as interest expense.

Prior to the effective date of ASC 480 on July 1, 2003, such dividends were

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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 had been extended.

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, “Distinguishing Liabilities from Equity,” on July 1, 2003, such dividends were charged to stockholders’ deficit.

Stockholders' Deficit and Employee Benefit Plan

The relative rights, preferences, and limitations of the Class A common stock and the Class B common

stock are in all respects identical.

The holders of the common stock have one vote for each share of common stock held.

Subject to the priority rights of the Public Preferred Stock, holders of Class A and Class B common stock are entitled to receive

such dividends as may be declared.

Our authorized capital stock consists of 250,000,000 shares of common stock, $0.001 par value per share,

and 10,000,000 shares of preferred stock, $0.01 par value per share.

Prior to our Second Amended and Restated Articles of Incorporation, which were effective November 12, 2020, the relative rights, preferences, and limitations of the Class A common

stock and the Class B common stock were in all respects identical.

The holders of the common stock had one vote for each share of common stock held.

Our Second Amended and Restated Articles of Incorporation authorize our Board of Directors to

classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our stock, and to amend our charter without stockholder approval to increase or decrease the number of shares of stock that we

have authority to issue.

On November 12, 2020, we filed Articles of Amendment (the “Articles”) with the State Department of Assessments and Taxation of the State of Maryland, effective as of the same date (the “Effective Time”).

The Articles amend

the Company’s charter to effect a reverse stock split such that (1) every 1.259446 shares of Class A Common Stock that were issued and outstanding immediately prior to the Effective Time were changed into one issued and outstanding share of Class A

Common Stock, and (2) every 1.259446 shares of Class B Common Stock that were issued and outstanding immediately prior to the Effective Time were changed into one issued and outstanding share of Class B Common Stock.

Also on November 12, 2020, we

filed the Second Articles of Amendment and Restatement (the “Second Amended Articles”) with the State Department of Assessments and Taxation of the State of Maryland, effective as of the same date (the “Effective Time”).

The Second Amended Articles

amend the Company’s charter to effect a conversion of each share of the Class B Common Stock that were issued and outstanding immediately prior to the Effective Time into one fully paid and nonassessable share of Class A Common Stock.

From and after

the Effective Time, certificates representing the Class B Common Stock now represent the number of shares of Class A Common Stock in which such Class B Common Stock was converted.

Also at the Effective Time, the Class A Common Stock was renamed and

redesignated as common stock, par value $0.001 per share, of the Corporation.

As of December 31, 2020, there were 64,625,071 shares of common stock outstanding and no shares of

preferred stock outstanding.

Restricted Stock Grants

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

directors and employees.

In May 2017, we granted shares of restricted stock to our executive officers and employees.

Since June 2008, we have issued restricted stock to our executive officers, directors and employees.

Such stock is subject to a vesting schedule as follows:

25% of the restricted stock vests immediately on the date of grant,

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

As of December 31, 2019, there were 1,198,750 shares of restricted stock that remained subject to vesting.

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

automatically vest in full.

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

preferred stock from an estimated enterprise value, which was estimated based on discounted cash flow analysis, comparable public company analysis, and comparable transaction analysis.

Additionally, we determined that a significant change in the

valuation estimate for common stock would not have a significant effect on the consolidated financial statements.

A summary of restricted stock activities for the years ended December 31, 2019, 2018 and 2017 is as

(number of shares)

Outstanding at beginning of year

Outstanding at end of year

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

shares shall automatically vest in full.

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

Additionally, we determined that a significant

change in the valuation estimate for common stock would not have a significant effect on the consolidated financial statements.

In May 2017, we issued grants of 3,972,007 shares to our executive officers and employees.

shares vest according to the schedule set forth above.

There were 3,948,199 shares outstanding at the beginning of 2018, and 43,649 shares were forfeited during 2018.

There were no new grants in 2018.

There were 3,904,550 shares outstanding at the

beginning of 2019, and 11,904 shares were forfeited during 2019.

There were no new grants in 2019.

At the beginning of 2020 there were 3,892,646 shares outstanding and 47,616 were forfeited prior to May 2020, when the remaining 3,845,030 shares

became fully vested.

Upon vesting there were no remaining restrictions on these shares and they are able to be sold or disposed of, subject to any lock-up agreements subsequently entered into by certain holders of the shares in connection with the

IPO of the Company’s common stock in November 2020.

In May 2020, 79,361 shares were granted.

As of December 31, 2020, there were 59,521 shares of

restricted stock that remained subject to vesting.

Telos Shared Savings Plan

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full-time employees are eligible to participate.

The Plan holds 3,658,536 shares of Telos Class A common stock.

Since no public market exists for Telos Class A common stock, the Trustees of the Plan and their professional advisors undertake an annual

evaluation, based upon the most recent audited financial statements.

To date, the Plan’s trustees have priced the stock at the exact midpoint of the evaluated range of the value of the stock.

We match one-half of employee contributions to the Plan up

to a maximum of 2% of such employee’s eligible annual base salary.

As of December 31, 2020, the Plan held 2,391,552 shares of Telos common stock.

We match one-half of employee contributions to the Plan up to a maximum of 2% of such employee’s eligible annual base

Participant contributions vest immediately, and Company contributions vest at the rate of 20% each year, with full vesting occurring after completion of five years of service.

total contributions to this Plan for 2019, 2018, and 2017 were $861,000, $721,000, and $617,000, respectively.

Our total contributions to the Plan for 2020, 2019, and 2018 were

$998,000, $861,000, and $721,000, respectively.

Additionally, Telos ID sponsors a defined contribution savings plan (the “Telos ID Plan”) under which

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For the Years Ended December 31,

Current provision (benefit)

Current (benefit) provision

Total current

Deferred (benefit) provision

Deferred provision (benefit)

Total deferred

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The provision for income taxes related to operations varies from the amount determined by applying the

federal income tax statutory rate to the income or loss before income taxes, exclusive of net income attributable to non-controlling interest.

federal income tax statutory rate to the income or loss before income taxes.

The reconciliation of these differences is as follows:

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Dividend and accretion on preferred stock

Gain on redemption of preferred stock

Section 162(m) limitation - covered employees

Capitalization of IPO transaction costs

FIN 48 liability

Non-controlling interest

Impact of Tax Act

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December 31, 2018

Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was enacted.

The Tax Act made significant

changes to the U.S.

Internal Revenue Code including a number of changes that impact the Company, most notably a reduction to the U.S.

federal corporate tax rate from 35% to 21%, effective January 1, 2018, and an indefinite carryforward period for net

operating losses generated in taxable years beginning after December 31, 2017.

As a result, we will be able to use our hanging credit deferred tax liability as a source of taxable income to support the indefinite-lived net operating losses created by

the future reversal of our temporary differences.

Accordingly, we re-measured our existing deferred tax assets and liabilities using the enacted tax rate, and adjusted the valuation allowance on our deferred taxes and recorded a decrease in deferred

tax liabilities of $3.0 million, with a corresponding adjustment to deferred tax benefit for the same amount for the year ended December 31, 2017.

On December 22, 2017, Staff Accounting Bulletin No.

118, “Income Tax Accounting Implications of the

Tax Cuts and Jobs Act” was issued to address the application of U.S.

GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the

accounting for certain income tax effects of the Tax Act.

We re-measured our deferred tax assets and liabilities and adjusted the valuation allowance related to the hanging credit deferred tax liability and included these amounts in our consolidated

financial statements for the year ended December 31, 2017.

As of December 31, 2018, we have completed the accounting for all income tax effects of the Tax Act and recorded a SAB 118 adjustment in the current period tax provision related to state

conformity to the indefinite-lived net operating loss provision of the Tax Act.

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

CARES Act, among other things, includes certain changes to U.S.

tax law that impact the Company, including deferment of employer social security payments, modifications to interest deduction limitation rules, a technical correction to tax

depreciation methods for certain qualified improvement property, and alternative minimum tax credit refund.

Beginning January 1, 2018, we are subject to several provisions of the Tax Act including computations under Section 162(m)

executive compensation limitation and Section 163(j) interest limitation rules and we have considered the impact of each of these provisions in our overall tax expense for the years ended December 31, 2019 and 2018.

executive compensation limitation and Section 163(j) interest limitation rules and we have considered the impact of each of these provisions as well as those under the CARES Act in our consolidated financial statements for the years ended December

31, 2020 and 2019.

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

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

a result of a full valuation allowance against our deferred tax assets and liabilities, a deferred tax liability related to goodwill remains on our consolidated balance sheets at December 31, 2019 and 2018.

a result of a full valuation allowance against our deferred tax assets and liabilities, a deferred tax liability related to goodwill remained on our consolidated balance sheets at December 31, 2020 and 2019.

We recorded deferred tax assets and liabilities related to the purchase of an additional 50% interest in

the partnership Telos ID, including a deferred tax asset of $44.9 million for tax-deductible goodwill generated in the transaction.

We also recorded a corresponding valuation allowance against the additional deferred taxes.

At December 31, 2020, for federal income tax purposes there was approximately a $18.2 million net

operating loss available to be carried forward to offset future taxable income.

These net operating loss carryforwards expire in 2037.

In addition, there was approximately $60,000 of alternative minimum tax credit available to be carried forward

indefinitely to reduce future regular tax liabilities until 2020, after which time it will be fully refundable in 2021, in accordance with the Tax Act.

Under the provisions of ASC 740, we determined that there were approximately $673,000 and $648,000 of

unrecognized tax benefits, including $304,000 and $278,000 of related interest and penalties, required to be recorded in other liabilities as of December 31, 2019 and 2018, respectively.

We believe that the total amounts of unrecognized tax benefits

will not significantly increase or decrease within the next 12 months.

Approximately $10.6 million of these net operating loss carryforwards expire between 2035 and 2037, the remaining will be carried forward indefinitely.

As of December 31,

2020, there was approximately $2.5 million of research and development credit carryover which begins to expire in 2033.

Certain tax attributes of the Company, including net operating losses and credits, would be subject to a limitation should an

ownership change as defined under Section 382 of the Internal Revenue Code of 1986, as amended, occur.

The limitations resulting from a change in ownership could affect the Company’s ability to utilize its tax attributes.

A study was completed in

2020 which confirmed that no limitation applies to the Company's tax attributes as of December 31, 2020.

Under the provisions of ASC 740, we determined that there were approximately $763,000, $714,000, and

$649,000 of unrecognized tax benefits as of December 31, 2020, 2019, and 2018, respectively.

Included in the balance of unrecognized tax benefits as of December 31, 2020, 2019, and 2018 were $278,000, $369,000, and $369,000, respectively, of tax

benefits that, if recognized, would impact the effective tax rate.

Also included in the balance of unrecognized tax benefits as of December 31, 2020, 2019, and 2018 were $485,000, $345,000, and $280,000, respectively, of tax benefits that, if

recognized, would not impact the effective tax rate due to the Company’s valuation allowance.

The Company had accrued interest and penalties related to the unrecognized tax benefits of $241,000 and $304,000, which were recorded in other liabilities

as of December 31, 2020 and 2019, respectively.

We believe that the total amounts of unrecognized tax benefits will not significantly increase or

decrease within the next 12 months.

The period for which tax years are open, 2017 to 2020, has not been extended beyond the applicable statute of limitations.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

As of December 31, 2020, the Company is not under examination by any federal or state tax

jurisdiction.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows (in thousands):

Unrecognized tax benefits, beginning of period

Gross decreases — tax positions in prior period

Gross increases — tax positions in current period

(Decrease) increase in prior year tax positions

Increase related to current year tax positions

Decrease related to lapse of statutes

Unrecognized tax benefits, end of period

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Operating Leases

We account for leases in accordance with ASC Topic 842, “Leases,” which requires lessees to recognize

a right-of-use asset and lease liability on the balance sheet and expands disclosures about leasing arrangements for both lessees and lessors, among other items, for most lease arrangements.

In accordance with the adoption of ASC 842 on January 1, 2019, we recorded operating lease

right-of-use (“ROU”) assets, which represent our right to use an underlying asset for the lease term, and operating lease liabilities which represent our obligation to make lease payments.

Generally, we enter into operating lease agreements for

The amount of operating lease liabilities due within 12 months are recorded in other current liabilities, with the remaining operating lease liabilities recorded as non-current liabilities in our consolidated balance sheet based on their

contractual due dates.

We account for leases in accordance with ASC Topic 842, “Leases,” which requires lessees to recognize a

right-of-use (“ROU”) asset and lease liability on the consolidated balance sheets and expands disclosures about leasing arrangements for both lessees and lessors, among other items, for most lease arrangements.

In accordance with the adoption of ASC 842 on January 1, 2019, we recorded operating lease ROU assets,

which represent our right to use an underlying asset for the lease term, and operating lease liabilities which represent our obligation to make lease payments.

Generally, we enter into operating lease agreements for facilities.

The amount of

operating lease liabilities due within 12 months are recorded in other current liabilities, with the remaining operating lease liabilities recorded as non-current liabilities in our consolidated balance sheets based on their contractual due dates.

The operating lease ROU assets and liabilities are recognized as of the lease commencement date at the present value of the lease payments over the lease term.

Most of our leases do not provide an implicit rate that can readily

be determined.

Most of our leases do not provide an implicit rate that can readily be determined.

Therefore, we use a discount rate based on our incremental borrowing rate which was 5.75% for all operating leases.

Our operating lease agreements may include options to extend the lease term or terminate it early.

We have included

options to extend in the operating lease ROU assets and liabilities when we are reasonably certain that we will exercise such options.

The weighted average remaining lease terms and discount rates for our operating leases were approximately 3.5 years

and 5.75% at December 31, 2019.

We have included options to extend

in the operating lease ROU assets and liabilities when we are reasonably certain that we will exercise such options.

The weighted average remaining lease terms for our operating leases were approximately 2.5 years and 3.5 years at December 31, 2020

and 2019, respectively.

The discount rates for our operating leases were 5.75% at December 31, 2020 and 2019.

Operating lease expense is recognized as rent expense on a straight-line basis over the lease term.

Some of our operating leases contain lease and non-lease components, which we account for as a single component.

evaluate ROU assets for impairment consistent with our property and equipment policy disclosure included in Note 1 – Summary of Significant Accounting Policies.

Some of our operating leases contain

lease and non-lease components, which we account for as a single component.

We evaluate ROU assets for impairment consistent with our property and equipment policy disclosure included in Note 1 – Summary of Significant Accounting Policies.

As of December 31, 2020, operating lease ROU assets were $1.5 million and operating lease liabilities

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The 2014 lease was treated as a modification of the prior lease on the property in accordance with ASC 840, and determined to be a capital lease.

As a result of the new lease, the corresponding capital asset increased by $5.7 million,

As a result of the 2014 lease, the corresponding capital asset increased by $5.7 million,

resulting in a net book value of the capital asset of $18.3 million and the liability increased by $6.7 million, resulting in a capital obligation of $22.0 million.

As part of this treatment, the net cash consideration received in connection with the

definitive agreement was treated as a lease incentive that will be amortized over the life of the lease.

The weighted average remaining lease terms and discount rates for finance leases were approximately 9.3 years and 5.04% at December 31, 2019.

The weighted average remaining lease terms for finance leases were approximately 8.3

years and 9.3 years at December 31, 2020 and 2019, respectively.

The discount rates for our finance leases were 5.04% at December 31, 2020 and 2019.

In accordance with the 2014 Lease, the basic rent increases by a fixed 2.5% escalation annually.

Accumulated amortization for property and equipment under finance leases at December 31, 2019 and 2018

was $18.7 million and $17.5 million, respectively.

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

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Cash flows from operating activities - finance leases

Operating lease right-of-use assets obtained in exchange for operating lease liabilities

Cash flows from financing activities - finance leases

Operating lease ROU assets obtained in exchange for operating lease liabilities

Rent expense charged to operations totaled $1.1 million, $1.2 million, and $1.6 million for 2020, 2019, and 2018,

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failure rates or service delivery costs differ from estimates, revisions to the estimated warranty liability may be required.

Accrued warranties are reported as other current liabilities on the consolidated balance sheets.

(amount in thousands)

Year Ended December 31, 2019

Year Ended December 31, 2018

Year Ended December 31, 2017

Accrued warranties were $30,000 as of December 31, 2020 and 2019, and are reported as other current liabilities in the

consolidated balance sheets.

There were no activities in accrued warranties for years ended December 31, 2020, 2019, and 2018.

Certain Relationships and Related Transactions

Information concerning certain relationships and related transactions between us and certain of our

current shareholders and officers is set forth below.

Information concerning certain relationships and related party transactions between us and certain of

our current shareholders and officers is set forth below.

The brother of our Chairman and CEO, Emmett J.

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Additionally, Mr.

Wood owned 810,000 shares of the Company’s Class A Common Stock as of December 31, 2019 and 2018, and

50,000 shares of the Company’s Class B Common Stock as of December 31, 2019 and 2018.

Wood owned 682,502 shares of the Company’s common stock as of December 31, 2020 and 2019.

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

Porter and Toxford Corporation, of

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

Porter is the sole shareholder, owned 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.

According to the 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.

Porter Notes do not call for amortization payments and are unsecured.

principal sum bore 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.

Porter Notes did not call for amortization payments and were 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.

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 (including Action Capital), and payments under the Porter Notes are permitted only if certain conditions are met.

All other terms remain in full force and effect.

We incurred interest expense in the amount of

$330,000, $308,000, and $292,000 for the years ended December 31, 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.

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.

On April 18, 2017, the Company redeemed all outstanding shares of the Senior Redeemable Preferred Stock, including 163

shares and 228 shares of Series A-1 and Series A-2 Redeemable Preferred Stock, respectively, held by Mr.

Porter and Toxford.

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

Agreement and any subsequent senior lenders (including Action Capital), and payments under the Porter Notes were permitted only if certain conditions were met.

All other terms remained in full force and effect.

We incurred interest expense in the

amount of $319,000, $330,000, and $308,000 for the years ended December 31, 2020, 2019, and 2018, respectively, on the Porter Notes.

On November 23, 2020, upon the closing of the IPO, the Porter Notes were paid in full.

Summary of Selected Quarterly Financial Data (Unaudited)

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Net (loss) income attributable to Telos Corporation (1)(2)

Weighted-average common shares outstanding, basic

Weighted-average common shares outstanding, diluted

Basic net (loss) earnings per share

Diluted net (loss) earnings per share

(Loss) income before income taxes and non-controlling interest

Net (loss) income attributable to Telos Corporation (1)(3)

Weighted-average common shares outstanding, basic

Weighted-average common shares outstanding, diluted

Basic net (loss) earnings per share

Diluted net (loss) earnings per share

Changes in net income are the result of several factors, including seasonality of the government year-end buying season, as well as the nature and

timing of other deliverables.

Net income for the third quarter of 2019 is attributable to $2.6 million in proprietary software sales which carry lower cost of sales.

Net income for the third quarter of 2018 included $5.6 million of revenue accruals for multiple contracts as a result of several years of cumulative

indirect rate adjustments which did not include direct costs in Secure Mobility and Network Management/Defense Enterprise deliverables.

Net income for the second quarter of 2020 is attributable to a change in the mix and timing of Telos ID deliverables.

Net income for the third quarter of 2019 is attributable to $2.6

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

Commitments, Contingencies, and Subsequent Events

Financial Condition and Liquidity

As described in Note 6 – Current Liabilities and Debt Obligations, we maintain a Credit Agreement with EnCap

and a Purchase Agreement with RCA.

The 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 operations.

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

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.

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, although no assurance can be given that such a facility could be put in

place under terms acceptable to the Company.

Should management determine that additional capital is required, management would likely look first to the sources of funding discussed above to meet any requirements, although no assurances can be given

that these investors would be able to invest or that the Company and the investors would agree upon terms for such investments.

Our working capital was $2.9 million and $2.1 million as of December 31, 2019 and 2018, respectively.

Although no 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.

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 is 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.

Legal Proceedings

Costa Brava Partnership III, L.P.

and Wynnefield Partners Small Cap Value, L.P.

Telos Corporation, et al.

As previously reported, on October 17, 2005, Costa Brava Partnership III, L.P.

(“Costa Brava”), a holder of Public

Preferred Stock, instituted litigation against the Company and certain past and present directors and officers (the “Telos Defendants”) in the Circuit Court for Baltimore City, Maryland (the “Circuit Court”).

A second holder of the Company’s Public

Preferred Stock, Wynnefield Partners Small Cap Value, L.P.

(“Wynnefield”), subsequently intervened as a co-Plaintiff (Costa Brava and Wynnefield are hereinafter referred to as “Plaintiffs”).

On February 27, 2007, Plaintiffs added, as an additional

defendant, Mr.

Porter, a holder of the Company’s Class A Common Stock.

In the litigation, Plaintiffs alleged, among other things, that the Company and its officers and directors engaged in

tactics to avoid paying dividends on the Public Preferred Stock, that the Company made improper bonus payments or awards to officers and directors, that certain former and present officers and directors breached legal duties or the standard of care

that they owed the Company, that the Company improperly paid consulting fees to and engaged in loan transactions with Mr.

Porter, that the Company failed to improve on the Company’s purported insolvency, that the Company failed to redeem the Public

Preferred Stock as allegedly required by the Company’s charter, and that Mr.

Porter engaged in actions constituting shareholder oppression.

On December 22, 2005, the Company’s Board of Directors established a special litigation committee (“Special Litigation

Committee”), composed of certain independent directors, to review and evaluate the matters raised in the litigation.

On August 30, 2006, Plaintiffs filed a motion with the Circuit Court to place the Company into a receivership following the

resignations of six of the nine members of the Board of Directors on August 16, 2006.

Within a week of the resignations, three new independent board members were added and two more new members were added in October 2006.

Thus, the board and all

board committees, including the Special Litigation Committee, were fully reconstituted.

In an opinion dated November 29, 2006 the Circuit Court denied the motion for receivership.

The Circuit Court concluded that the Plaintiffs’ holdings in the

Public Preferred Stock represented a minority equity interest (and not debt or a fixed liability), and that their equity interests did not provide a guarantee to payment of dividends or redemption of their shares.

The Circuit Court further concluded

that the Plaintiffs’ alleged expectations to a status as debtors of the Company or to rights to current dividends were not objectively reasonable, and that the Plaintiffs in fact had not been denied any rights as defined by the proxy statement and

prospectus forming the terms of the Public Preferred Stock.

On July 20, 2007, the Special Litigation Committee, in its final report, concluded that the available evidence did not

support Plaintiffs’ derivative claims and that it was not in the best interests of the Company to pursue such claims in the litigation.

On August 24, 2007, the Company moved to dismiss Plaintiffs’ derivative claims based upon the report and to

dismiss all remaining claims for failure to state a claim.

Following an evidentiary hearing, the Circuit Court on January 7, 2008 dismissed all derivative claims based upon the recommendation of the Special Litigation Committee.

On February 12, 2008, the Plaintiffs filed a Third Amended Complaint that included both new counts and previously dismissed

The new counts included a breach of contract claim (Count VIII), and claims for preliminary and permanent injunctions against the Company (Count IX) and for an accounting (Count X).

Count VIII alleged there was a contractual obligation to

pay paid-in-kind (or PIK) dividends and the Company’s reversal of position in 2006 to not pay PIK dividends was a breach of contract.

The Company moved to dismiss or strike the Third Amended Complaint and, on April 15, 2008, the Circuit Court issued

an order dismissing with prejudice all counts in the Third Amended Complaint that were not previously disposed of by motion or stipulation.

Regarding Count VIII, the Circuit Court stated that “neither the Registration Statements, nor the company

charter and Articles of Amendment and Restatement can be read to give rise to a contractual obligation to pay PIK dividends” and that “the law is clear that a corporate board may revoke stock dividends, even if they have already been declared, up

until the time they are issued.” On December 2, 2008, the Company filed a motion for voluntary dismissal without prejudice of its counterclaim against Plaintiffs (for their interference with the Company’s relationship with the Company’s then senior

lender, Wells Fargo).

The Circuit Court granted that motion, over Plaintiffs’ opposition, on January 23, 2009.

On February 23, 2009, the Plaintiffs filed a notice of appeal.

In its brief, the Plaintiffs appealed the dismissal of

their derivative claims and the shareholder oppression claim against Mr.

The appeal did not include any challenge to the dismissal of other counts, including Count VIII regarding the alleged contractual obligation to pay PIK dividends.

September 7, 2012, the Court of Special Appeals of Maryland ruled that the Circuit Court applied an incorrect standard of review to evaluate the conclusions of the Special Litigation Committee.

The Court of Special Appeals held that the Circuit

Court’s dismissal of a shareholder oppression claim (asserted against Mr.

Porter) raised an issue of first impression under Maryland law and required further briefing in the Circuit Court.

The Court of Special Appeals vacated the decision of the

Circuit Court that had been appealed, and remanded the case for further consideration and proceedings.

On October 24, 2012, the Company filed a Petition for Writ of Certiorari in the Court of Appeals of Maryland, which was

denied on January 22, 2013.

On remand, the Defendants (excluding Mr.

Porter) filed a Motion to Dismiss the derivative claims under the standard of

review dictated by the opinion of the Court of Special Appeals as a result of the findings of the Special Litigation Committee in its final report of July 20, 2007 (“Defendants’ Motion to Dismiss”).

Following full briefing by the parties, a hearing

on the Defendants’ Motion to Dismiss was held on April 24, 2014 and the matter was taken under advisement by the Court.

On September 17, 2013, the Plaintiffs filed a request for an entry of an order for default as to Mr.

Porter, which was

denied by the Circuit Court on November 8, 2013.

Porter ultimately filed a motion to dismiss the claim against him on May 13, 2014, raising multiple grounds (“Mr.

Porter’s Motion to Dismiss”).

On January 31, 2018, certain former and current officers and directors filed a Motion to Reconsider the Court’s Orders

Denying Motions to Dismiss for Lack of Personal Jurisdiction (“Motion to Reconsider”) with the Circuit Court.

The Court had previously denied the Motions to Dismiss for Lack of Personal Jurisdiction on March 30, 2006.

The Motion to Reconsider was

precipitated by and based upon a newly decided Maryland appellate decision related to personal jurisdiction over directors of a Maryland corporation.

Following full briefing by the parties, a hearing was held on December 19, 2018 on the Motion to

Reconsider and on Mr.

Porter’s Motion to Dismiss, and the matters were taken under advisement by the Court.

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

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

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

a number of the past and present directors and officers.

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

moving defendants.

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

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

The Defendants’ Motion to

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

The Circuit Court found, among other

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

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

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

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

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

Third, the Circuit Court granted Mr.

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

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

Porter for lack of jurisdiction.

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

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

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

judgment which remains pending.

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

As of December 31, 2019, Costa Brava and Wynnefield, directly and through affiliated funds, own 12.7% and 17.4%,

respectively, of the outstanding Public Preferred Stock.

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

Costa Brava’s success in relation to any of the assertions it will make on the pending appeal.

Although there can be no assurance as to the ultimate outcome of the case, the Company and its present and former officers and directors strenuously deny

Plaintiff Costa Brava’s allegations and continue to vigorously defend the matter and oppose all relief sought by Costa Brava.

Telos Corporation

As previously reported, on August 2, 2007, Messrs.

As previously reported, beginning on August 2, 2007, Messrs.

Hamot (“Hamot”) and Andrew R.

Siegel (“Siegel”), principals of

Costa Brava Partnership III, L.P.

(“Costa Brava”), instituted litigation against the Company as Plaintiffs in the Circuit Court for Baltimore City, Maryland (the “Circuit Court”).

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

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

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

Subsequently, Hamot and Siegel further alleged that the Company had failed to follow certain provisions concerning the noticing of Board committee meetings and the recording of Board meeting minutes and, additionally, that Mr.

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

By way of preliminary injunctions entered on August 28, 2007 and September 24, 2007, the Circuit Court

ordered that Hamot and Siegel are entitled to responses and documents, within certain time frames established by the Court, in response to reasonable requests for information pertinent and necessary to perform their duties as members of the Board,

but in light of the Costa Brava shareholder litigation, the Company is entitled to designate certain documents as “confidential” or “highly confidential” and to withhold certain documents from the Plaintiffs based upon the attorney work product

doctrine or attorney-client privilege.

On April 23, 2008, the Company filed a counterclaim against Hamot and Siegel for money damages and preliminary and

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

On June 27, 2008, the Circuit Court granted the

Company’s motion for preliminary injunction and enjoined Hamot and Siegel from contacting the Company’s auditors until the completion of the Company’s Form 10-K for the preceding year.

This preliminary injunction expired by its own terms and an

appeal by Hamot and Siegel from that preliminary injunction order later was held to be moot by the Court of Special Appeals of Maryland.

Trial on both the Plaintiffs’ books and records claims and the Company’s counterclaims related to auditor interference

commenced on July 5, 2013, and continued on several days in July 2013.

The evidentiary portion of the trial concluded on August 1, 2013, and post-trial briefing concluded on September 16, 2013.

On September 11, 2017, the Circuit Court docketed two decisions in this matter.

First, with respect to the Plaintiffs’

complaint related to access to books and records of the Company, the Circuit Court declined to grant permanent injunctive relief to the Plaintiffs but, instead, issued a declaratory order setting forth the pertinent standards the parties should

follow as it relates to the Plaintiffs’ right to books and records.

The Circuit Court found that the Plaintiffs have the right as directors to inspect and copy the records of the Company, subject to the Company’s right to determine that the

materials requested were not reasonably related to the scope of their duties as directors or that their use of the materials may violate the duties they owe to the Company.

The Circuit Court also determined that the scope of the inspection may also

be limited if Telos establishes that the request creates an undue burden or expense.

Second, with respect to the third amended counterclaim, the Circuit Court entered judgment in favor of the Company and

against Hamot and Siegel on the counterclaim for tortious interference with the Company’s contractual relationship with its former auditors, Reznick Group (“Reznick”) (Count Two) and awarded damages against Hamot and Siegel in the amount of $278,923.

The Circuit Court found that Hamot and Siegel’s threat of litigation against Reznick was the precipitating cause of Reznick’s resignation.

In addition, the Circuit Court determined that the threats of litigation were made for an improper purpose –

to influence the accounting treatment that Reznick would use on the Company’s financial statements, specifically as it relates to the 12% Exchangeable Redeemable Preferred Shares – and the resignation was a foreseeable consequence of Hamot and

Siegel’s interference.

The Circuit Court also entered judgment for Hamot and Siegel on the Company’s claims for interference with its relationship

with its former auditor, Goodman and Company, LLP (“Goodman”) and on the Company’s claim seeking declaratory relief in connection with Plaintiffs’ claims for indemnification of attorney’s fees and costs in connection with the litigation.

Court determined that the resignation of Goodman as the Company’s auditor occurred upon the Plaintiffs’ election in 2007 to the Company’s board of directors, which the Circuit Court found itself was not independently wrongful and was the

precipitating cause of the resignation, and not primarily due to the litigation against Goodman maintained by Costa Brava.

The Circuit Court also entered judgment for Hamot and Siegel on the alternative claims for interference with the business

relationships with Goodman and Reznick (Counts Three and Four), finding that it was not necessary to decide issues of liability under these claims since it determined that contracts with each of the audit firms existed.

On September 27, 2017, the Company filed a Motion under Maryland Rule 2-535 to reconsider or revise two specific aspects of

the Circuit Court’s judgment on Count Two of the third amended counterclaim:

(1) to correct the amount of damages awarded on Count Two for audit expenses incurred for the audit year 2007, and (2) to amend or modify the order with respect to Count

Five (the declaratory relief claim related to indemnification) to dismiss the claims instead of entering judgment in favor of Hamot and Siegel on it.

A hearing on the motion was held on October 11, 2017.

At the conclusion of the hearing, the Circuit

Court denied the Company’s motion as to the damages awarded on Count Two, and granted the Company’s motion on the issue related to Count Five and entered a new order accordingly.

The Company filed a notice with the Circuit Court appealing the judgment to the Court of Special Appeals of Maryland on

October 11, 2017, and on October 17, 2017, Hamot and Siegel filed a notice of a cross-appeal, which they later withdrew.

On or about July 6, 2018, the attorneys representing Mr.

Hamot filed a Notice of Substitution of Party in the Circuit Court

and the Court of Special Appeals, providing notice that Mr.

Steven Tannenbaum was appointed and qualified as the Special Personal Representative of the Estate of Seth Hamot to represent the estate in the litigation.

Oral argument on the appeal in the Court of Special Appeals on issues related to the damages awarded to the Company and

against Messrs.

Hamot and Siegel on its Counterclaim for interference with one of its prior auditor relationships was held on October 3, 2018.

On November 28, 2018, the Court of Special Appeals issued an unpublished opinion affirming the judgment of

the Circuit Court on the issues related to damages.

On January 25, 2019, Telos filed a Petition for Writ of Certiorari with Court of Appeals of Maryland seeking review in that Court of issues related to the damage award, and on March 29, 2019, the

Petition for Writ of Certiorari was granted.

Following oral argument, the Court of Appeals issued a per curiam order on September 13, 2019 dismissing the appeal and entered its Mandate on October 11, 2019.

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

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

On April 12, 2010, the Plaintiffs filed a motion for the advancement of legal fees and expenses incurred in defense of the Company’s counterclaim and/or its motion for injunctive

relief on which the Company was successful.

On November 3, 2011, the Circuit Court denied the Plaintiffs’ motion.

On May 21, 2012, the Circuit Court denied Plaintiffs’ motion for reconsideration of these decisions.

Subsequently, on October 19, 2017, Hamot and Siegel submitted a letter to the Company, pursuant to Section 2-418 of the

Maryland General Corporation Law, demanding that the Company advance and/or indemnify them for legal fees and expenses purportedly totaling $1,550,000 and incurred in pursuit of their books and records claim and in defense of the Company’s

counterclaims for auditor interference, and ongoing expenses in the litigation.

The Board addressed Hamot and Siegel’s demand for indemnification and/or advancement at its regularly scheduled meeting on November 13, 2017.

The Board, by a vote of all

members present for this portion of the meeting, and for a number of reasons, determined that the Company will not provide indemnification or advancement to Hamot and Siegel in response to their demand.

On November 20, 2017, Hamot and Siegel filed a Motion for Advancement and Indemnification of Legal Fees and Expenses and

Request for Hearing in the Circuit Court.

Hamot and Siegel alleged that they incurred approximately $1,450,000 of legal fees and expenses in relation to the counterclaim proceedings and approximately $100,000 of legal fees and expenses incurred in

relation to their affirmative claims in the Third Amended Complaint.

Hamot and Siegel claim that, since the Circuit Court ruled in their favor in Counts One and

Three (related to Goodman), they were entitled to the $750,000 for legal fees and expenses incurred in defending those counts, plus legal fees and expenses incurred in the appeal.

In addition, Hamot and Siegel claimed that they were entitled to

approximately $660,000 (91% of the legal fees and expenses incurred in defending Counts Two and Four (related to Reznick)) plus the legal fees and expenses incurred in the appeal from the Circuit Court’s judgment.

Lastly, Hamot and Siegel claimed

that, since they allegedly received a successful ruling in the Third Amended Complaint, they were entitled to approximately $100,000 for legal fees and expenses incurred on this issue.

The Company filed an opposition to Hamot and Siegel’s Motion,

raising a number of reasons why the relief requested by Hamot and Siegel should not be granted.

A hearing on this motion and the Company’s opposition was held on February 28, 2018.

On June 27, 2018, the Circuit Court issued a decision on Hamot and Siegel’s Motion for Advancement and Indemnification of

Legal Fees and Expenses.

The Court, inter alia:

(i) denied Hamot and Siegel’s request for indemnification as premature, given the pendency of the Company's then-appeal and Hamot and Siegel’s then-cross-appeal (subsequently withdrawn) from the

judgment rendered against them after the trial on the merits; (ii) concluded that the evidence established a nexus between the claims against Hamot and Siegel in the Counterclaim and their service as directors; (iii) determined that indemnification

was not available to Hamot and Siegel as a matter of law in connection with their right to inspect claim in their Third Amended Complaint; (iv) determined that Hamot and Siegel were not entitled to advancement of expenses incurred between May 21,

2012 and November 20, 2017, because this request seeks "reimbursement for fees relating to a proceeding that has concluded, and concluded with a ruling that definitively resolves the claims, at least at this juncture", and further determined that

"[a]ccepting the extremely low good faith standard and providing advancement would require the court to ignore the findings that the court has made on the very claims that gave rise to the expenses that are the basis of the request"; and (v)

determined that Hamot and Siegel were entitled to advancement of expenses related to the appeal of the Counterclaim, pending completion of the appellate proceedings, explaining that the "fact that this court found against Hamot and Siegel on the

merits does not compel the conclusion that they could not entertain a good faith belief in the merits of their appeal" and that they met the low bar for showing their good faith belief that they will be successful on the issues related to the

counterclaim on appeal.

On September 21, 2018, Hamot and Siegel filed in the Circuit Court a Motion for Entry of Money Judgment of Advancement Fees

and Expenses, or, in the Alternative, for Order that Telos Corporation Show Cause Why Telos Corporation Should Not be Held in Contempt for Failing to Comply with this Court’s June 27, 2018 Order Directing Telos Corporation to Pay Advancement Fees and

Expenses (Motion for Entry of Monetary Judgment), the Company filed an opposition to the motion, and a hearing was held on the Plaintiffs’ Motion for Entry of Monetary Judgment on November 21, 2018.

Effective on January 4, 2019, the parties entered

into a partial settlement agreement with respect to certain issues related to Plaintiffs’ claim for advancement of fees and expenses on the appeal and certain other matters, and subsequently the Circuit Court issued an order on January 9, 2019

determining that the Motion for Entry of Monetary Judgment was moot.

In connection with the partial settlement agreement, the Company provided advancement of a negotiated and compromised amount of expenses incurred by Hamot and Siegel in connection

with the Company’s appeal of the damages awarded for auditor interference.

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

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

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

intends to vigorously defend the matter and oppose any claim for indemnification if it is pursued.

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

(“Costa Brava”), were involved in litigation against the Company as Plaintiffs and Counter-defendants in the Circuit Court for Baltimore City, Maryland (the “Circuit Court”).

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

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

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

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

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

meeting minutes and, additionally, that Mr.

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

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

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

On June 27, 2008, the

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

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

orders dated September 11, 2017.

Among other rulings, the Court found Hamot and Siegel liable for the intentional tort of tortious interference with the Company’s contractual relationship with one of its auditors and entered a monetary judgment in

favor of the Company and against Hamot and Siegel for approximately $278,000.

The Company’s subsequent appeal of the amount of damages awarded to it for Hamot and Siegel’s intentional interference was ultimately dismissed by way of the Mandate issued

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

Hamot (and later, his Estate) and Siegel on multiple occasions during this litigation have sought to be

indemnified or to be awarded advancement of various attorney’s fees and expenses incurred by them in this litigation.

On October 20, 2020, Hamot’s Estate and Siegel (together the “Plaintiffs”) filed their latest Motion for Indemnification of Legal

Fees and Expenses against the Company in the Circuit Court for Baltimore City and a Request for a Hearing.

The Motion demands that the Company indemnify the Plaintiffs for legal fees and expenses incurred in the sum of $2,540,000.

The Company filed

an Opposition to the Motion on November 4, 2020.

On January 28, 2021, Plaintiffs filed a Motion for Leave to File Amended Motion for Indemnification of Legal Fees and Expenses, which the Company opposed, and which was granted by the Court on February

23, 2021, and briefing of the Amended Motion for Indemnification of Legal Fees and Expenses (“Amended Motion”) continues.

A hearing is scheduled before the Court on Plaintiffs’ Amended Motion for Indemnification of Legal Fees and Expenses for May 18,

The Company denies that it has any liability for indemnification to the Plaintiffs and intends to vigorously defend the matter through its opposition to the Amended Motion and further proceedings.

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

related to the Company’s success in relation to this claim by Hamot’s Estate and Siegel for indemnification for certain attorney’s fees and expenses incurred in this litigation.

The Company intends to vigorously defend the matter.

Other Litigation

In addition, the Company is a party to litigation arising in the ordinary course of business.

In the opinion of

management, while the results of such litigation cannot be predicted with any reasonable degree of certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the Company's

consolidated financial position, results of operations or cash flows.

opinion of management, while the results of such litigation cannot be predicted with any reasonable degree of certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the

Company's condensed consolidated financial position, results of operations or cash flows.

Subsequent Events

Enlightenment Capital Credit Agreement

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

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 15, 2021.

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.

COVID-19 Pandemic

In December 2019, an outbreak of the COVID-19 virus was reported in Wuhan, China.

On March 11, 2020, the World Health

Organization declared the COVID-19 virus a global pandemic and on March 13, 2020, President Donald J.

Trump declared the virus a national emergency.

This highly contagious disease has spread to most of the countries in the world and throughout the

United States, creating a serious impact on customers, workforces, and suppliers, disrupting economies and financial markets, and potentially leading to a world-wide economic downturn.

The full impact of the COVID-19 outbreak continues to evolve as of the date of this report.

As such, it is uncertain as to

the full magnitude that the pandemic will have on the Company’s financial condition, liquidity, and future results of operations.

The Company is dependent on its workforce to deliver its solutions.

Developments such as social distancing and stay-at-home orders from

various jurisdictions may impact the Company’s ability to deploy its workforce effectively.

While expected to be temporary, prolonged workforce disruptions could negatively impact sales in fiscal year 2020 and the Company’s overall liquidity.

the date of this report, the Company’s suppliers and subcontractors have not notified the Company of inability to meet expected orders or of decreased production capacity.

Management is actively monitoring the global situation on its financial condition, liquidity, operations, suppliers,

industry, and workforce.

Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate any adverse effects of the COVID-19 outbreak on its results of operations, financial

condition, or liquidity for fiscal year 2020.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

On January 25, 2021, we filed Form S-8 to register a total of 7,459,913 shares of common stock, par

value $0.001 per share, to be issued under the terms and conditions of the 2016 Omnibus Long-Term Incentive Plan approved by the stockholders at a meeting held on October 26, 2020.

Changes in and Disagreements with Accountants on Accounting and Financial

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 7A. Quantitative and Qualitative Disclosures About Market Risk