UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

______________

FORM 10-Q

☑ ~~Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934~~


☒			Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: September 30, ~~2020~~2021

◻~~Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934~~


☐			Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number: 001-08443

TELOS CORPORATION

(Exact name of registrant as specified in its charter)

~~Maryland~~	~~52-0880974~~
Maryland		52-0880974
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


19886 Ashburn Road, Ashburn, Virginia						20147-2358
(Address of principal executive offices)						(Zip Code)

(703) 724-3800

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: ~~None~~


Title of each class	Trading symbol	Name of each exchange on which registered
Common stock, $0.001 par value per share	TLS	The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧☒ No ◻☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧☒ No ◻☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer☐

☐

Accelerated filer

☐

Non-accelerated filer☒

☒

Smaller reporting company

☐

Emerging growth company

☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ◻☐ No ⌧☒

As ofNovember ~~12, 2020,~~8, 2021, the registrant had outstanding ~~35,857,945~~ 66,755,230shares of ~~Class A Common Stock, no par value and 3,204,293 shares of Class B Common Stock, no par value.~~

common stock.

Table of Contents

TELOS CORPORATION ~~AND SUBSIDIARIES~~

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

		~~Page~~
				Page
Item 1.			Financial Statements (Unaudited)
			Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, ~~2020~~2021 and ~~2019~~ ~~(unaudited)~~2020	3
			Condensed Consolidated Statements of Comprehensive ~~Income (Loss)~~Loss for the Three and Nine Months Ended September 30, ~~2020~~2021 and ~~2019~~ ~~(unaudited)~~2020	4
			Condensed Consolidated Balance Sheets as of September 30, ~~2020~~ ~~(unaudited)~~2021 and December 31, ~~2019~~2020	~~5-6~~ 5
			Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, ~~2020~~2021 and ~~2019~~ ~~(unaudited)~~2020	7 6
			Condensed Consolidated Statements of Changes in Stockholders’ ~~Deficit~~Equity (Deficit) for the Three and Nine Months Ended September 30, ~~2020~~2021 and ~~2019~~ ~~(unaudited)~~2020	8 7
			Notes to Condensed Consolidated Financial Statements ~~(unaudited)~~	~~9-30~~ 8
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations	~~31-43~~ 24
Item 3.			Quantitative and Qualitative Disclosures about Market Risk	43 33
Item 4.			Controls and Procedures	43 34
			PART II - OTHER INFORMATION
Item 1.			Legal Proceedings	44 35
Item 1A.			Risk Factors	44 35
Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds	48 35
Item 3.			Defaults upon Senior Securities	49 35
Item 4.			Mine Safety Disclosures	49 35
Item 5.			Other Information	49
~~Item 6.~~	~~Exhibits~~35	50
Item 6.			Exhibits	36
SIGNATURES				51 37

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

TELOS CORPORATION ~~AND SUBSIDIARIES~~

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(amounts in thousands, except ~~earnings~~ per share data)

Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Revenue
Services $ 44,166 $ 39,221 $ 124,210 $ 101,635
Products 3,274 6,310 10,819 11,110
47,440 45,531 135,029 112,745
Costs and expenses
Cost of sales - Services 28,619 26,594 82,862 71,988
Cost of sales - Products 2,259 2,624 5,790 5,453
30,878 29,218 88,652 77,441
       Selling, general and administrative expenses 12,049 10,637 36,395 31,432
Operating income 4,513 5,676 9,982 3,872
Other income (expense)
       Other income 2 2 14 195
       Interest expense (2,013 ) (1,970 ) (6,026 ) (5,470 )
Income (loss) before income taxes 2,502 3,708 3,970 (1,403 )
(Provision for) benefit from income taxes (Note 7) (8 ) 10 136 187
Net income (loss) 2,494 3,718 4,106 (1,216 )
Less: Net income attributable to non-controlling interest (Note 2) (2,694 ) (1,485 ) (6,284 ) (1,705 )
Net (loss) income attributable to Telos Corporation $ (200 ) $ 2,233 $ (2,178 ) $ (2,921 )
Net (loss) earnings per share attributable to Telos Corporation, Common A, basic $ (0.01 ) $ 0.06 $ (0.06 ) $ (0.08 )
Net (loss) earnings per share attributable to Telos Corporation, Common B, basic $ (0.01 ) $ 0.06 $ (0.06 ) $ (0.08 )
Net (loss) earnings per share attributable to Telos Corporation, Common A, diluted $ (0.01 ) $ 0.06 $ (0.06 ) $ (0.08 )
Net (loss) earnings per share attributable to Telos Corporation, Common B, diluted $ (0.01 ) $ 0.06 $ (0.06 ) $ (0.08 )
Weighted-average shares of stock outstanding, Common A, basic 35,798 34,869 35,350 34,410
Weighted-avearage shares of stock outstanding, Common B, basic 3,204 3,204 3,204 3,204
Weighted-average shares of stock outstanding, Common A, diluted 35,798 36,727 35,350 34,410
Weighted-average shares of stock outstanding, Common B, diluted 3,204 3,204 3,204 3,204


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Revenue
Services	$	63,690	$	44,166	$	163,366	$	124,210
Products	6,376		3,274		15,017		10,819
	70,066		47,440		178,383		135,029
Costs and expenses
Cost of sales - Services	40,031		28,619		109,134		82,862
Cost of sales - Products	3,967		2,259		8,266		5,790
	43,998		30,878		117,400		88,652
Selling, general and administrative expenses
Sales and marketing	5,363		1,491		14,233		4,556
Research and development	5,396		3,598		14,783		11,070
General and administrative	20,562		6,960		69,271		20,769
	31,321		12,049		98,287		36,395
Operating (loss) income	(5,253)		4,513		(37,304)		9,982
Other income (expense)
Other income (expense)	20		2		(1,001)		14
Interest expense	(195)		(2,013)		(583)		(6,026)
(Loss) income before income taxes	(5,428)		2,502		(38,888)		3,970
Benefit from (provision for) income taxes	41		(8)		(6)		136
Net (loss) income	(5,387)		2,494		(38,894)		4,106
Less: Net income attributable to non-controlling interest	—		(2,694)		—		(6,284)
Net loss attributable to Telos Corporation	$	(5,387)	$	(200)	$	(38,894)	$	(2,178)
Net loss per share attributable to Telos Corporation, basic	$	(0.08)	$	(0.01)	$	(0.59)	$	(0.06)
Net loss per share attributable to Telos Corporation, diluted	$	(0.08)	$	(0.01)	$	(0.59)	$	(0.06)
Weighted-average shares of common stock outstanding, basic	66,755		39,002		65,999		38,554
Weighted-average shares of common stock outstanding, diluted	66,755		39,002		65,999		38,554

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

Table of Contents

TELOS CORPORATION ~~AND SUBSIDIARIES~~

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE ~~INCOME (LOSS)~~LOSS

(Unaudited)

(amounts inthousands)

Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019

Net income (loss) $ 2,494 $ 3,718 $ 4,106 $ (1,216 )
Other comprehensive loss, net of tax:
Foreign currency translation adjustments (2 ) (2 ) (1 ) –
Less: Comprehensive income attributable to non-controlling interest (2,694 ) (1,485 ) (6,284 ) (1,705 )
Comprehensive (loss) income attributable to Telos Corporation $ (202 ) $ 2,231 $ (2,179 ) $ (2,921 )


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net (loss) income	$	(5,387)	$	2,494	$	(38,894)	$	4,106
Other comprehensive loss, net of tax:
Foreign currency translation adjustments	(13)		(2)		(40)		(1)
Less: Comprehensive income attributable to non-controlling interest	—		(2,694)		—		(6,284)
Comprehensive loss attributable to Telos Corporation	$	(5,400)	$	(202)	$	(38,934)	$	(2,179)

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

Table of Contents

TELOS CORPORATION ~~AND SUBSIDIARIES~~

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in ~~thousands)~~thousands, except shares and par value data)


	September 30, 2020		December 31, 2019			September 30, 2021		December 31, 2020
	(Unaudited)					(Unaudited)
ASSETS					ASSETS
Current assets					Current assets
Cash and cash equivalents	$	10,326	$	6,751	Cash and cash equivalents	$	134,135	$	106,045
Accounts receivable, net of reserve of $745 and $720, respectively (Note 1)		29,116		27,942
Inventories, net of obsolescence reserve of $859 and $860, respectively (Note 1)		3,898		1,965
Deferred program expenses		12		673
Accounts receivable, net of reserve of $116 and $308, respectively					Accounts receivable, net of reserve of $116 and $308, respectively	49,759		30,913
Inventories, net of obsolescence reserve of $849 and $851, respectively					Inventories, net of obsolescence reserve of $849 and $851, respectively	2,025		3,311
Prepaid expenses					Prepaid expenses	5,440		3,059
Other current assets		2,717		2,914	Other current assets	941		786
Total current assets		46,069		40,245	Total current assets	192,300		144,114
Property and equipment, net of accumulated depreciation of $35,771 and $32,470, respectively		22,173		19,567
Operating lease right-of-use assets (Note 10)		1,622		1,979
Goodwill (Note 3)		14,916		14,916
Property and equipment, net of accumulated depreciation and amortization of $33,805 and $32,057, respectively					Property and equipment, net of accumulated depreciation and amortization of $33,805 and $32,057, respectively	14,363		14,977
Operating lease right-of-use assets					Operating lease right-of-use assets	1,004		1,464
Goodwill					Goodwill	16,642		14,916
Intangible assets, net					Intangible assets, net	17,102		7,420
Other assets		1,054		985	Other assets	1,256		926
Total assets	$	85,834	$	77,692	Total assets	$	242,667	$	183,817
LIABILITIES AND STOCKHOLDERS’ EQUITY					LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities					Current liabilities
Accounts payable and other accrued liabilities					Accounts payable and other accrued liabilities	$	35,102	$	20,899
Accrued compensation and benefits					Accrued compensation and benefits	7,955		8,474
Contract liabilities					Contract liabilities	7,232		5,654
Finance lease obligations – short-term					Finance lease obligations – short-term	1,430		1,339
Operating lease obligations – short-term					Operating lease obligations – short-term	602		677
Other current liabilities					Other current liabilities	2,089		1,903
Total current liabilities					Total current liabilities	54,410		38,946

Finance lease obligations – long-term					Finance lease obligations – long-term	13,218		14,301
Operating lease obligations – long-term					Operating lease obligations – long-term	516		941
Deferred income taxes					Deferred income taxes	680		652
Other liabilities					Other liabilities	2,352		1,873
Total liabilities					Total liabilities	71,176		56,713

Commitments and contingencies (Note 11)					Commitments and contingencies (Note 11)	0		0

Stockholders’ equity					Stockholders’ equity
Common stock, $0.001 par value, 250,000,000 shares authorized, 66,755,230 shares and 64,625,071 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively					Common stock, $0.001 par value, 250,000,000 shares authorized, 66,755,230 shares and 64,625,071 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively	105		103
Additional paid-in capital					Additional paid-in capital	354,119		270,800
Accumulated other comprehensive income					Accumulated other comprehensive income	4		44
Accumulated deficit					Accumulated deficit	(182,737)		(143,843)
Total stockholders’ equity					Total stockholders’ equity	171,491		127,104
Total liabilities and stockholders’ equity					Total liabilities and stockholders’ equity	$	242,667	$	183,817

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

Table of Contents

TELOS CORPORATION ~~AND SUBSIDIARIES~~

CONDENSED CONSOLIDATED ~~BALANCE SHEETS~~STATEMENTS OF CASH FLOWS

(Unaudited)

(amounts inthousands)

September 30, 2020 December 31, 2019
(Unaudited)
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS’ DEFICIT
Current liabilities
Senior term loan, net of unamortized discount and issuance costs – short-term (Note 5) $ 16,919 $ --
Accounts payable and other accrued liabilities (Note 5) 16,863 15,050
Accrued compensation and benefits 11,231 12,187
Contract liabilities (Notes 1 and 5) 6,353 6,337
Finance lease obligations – short-term (Note 10) 1,310 1,224
Other current liabilities (Note 10) 4,725 2,505
Total current liabilities 57,401 37,303

Senior term loan, net of unamortized discount and issuance costs (Note 5) -- 16,335
Subordinated debt (Note 5) 3,192 2,927
Finance lease obligations – long-term (Note 10) 14,648 15,641
Operating lease liabilities – long-term (Note 10) 1,101 1,553
Deferred income taxes (Note 7) 649 621
Public preferred stock (Note 6) 142,077 139,210
Other liabilities (Note 7) 571 724
Total liabilities 219,639 214,314

Commitments and contingencies (Note 8)

Stockholders’ deficit
Telos stockholders’ deficit
Common stock 78 78
Additional paid-in capital 4,314 4,310
Accumulated other comprehensive income 5 6
Accumulated deficit (147,708 ) (145,530 )
Total Telos stockholders’ deficit (143,311 ) (141,136 )
Non-controlling interest in subsidiary (Note 2) 9,506 4,514
Total stockholders’ deficit (133,805 ) (136,622 )
Total liabilities, redeemable preferred stock, and stockholders’ deficit $ 85,834 $ 77,692


	Nine Months Ended September 30,
	2021		2020
Operating activities:
Net (loss) income	$	(38,894)	$	4,106
Adjustments to reconcile net (loss) income to cash provided by operating activities:
Stock-based compensation	47,197		4
Dividends from preferred stock recorded as interest expense	—		2,867
Depreciation and amortization	4,223		4,018
Amortization of debt issuance costs	—		684
Deferred income tax provision	28		28
Other noncash items	14		(25)
Changes in other operating assets and liabilities	(5,900)		275
Cash provided by operating activities	6,668		11,957

Investing activities:
Cash paid for acquisition	(5,925)		—
Capitalized software development costs	(6,139)		(5,459)
Purchases of property and equipment	(1,645)		(624)
Cash used in investing activities	(13,709)		(6,083)

Financing activities:
Proceeds from issuance of common stock, net of issuance costs	64,269		—
Repurchase of outstanding warrants	(26,894)		—
Repurchase of common stock	(1,251)		—
Payments under finance lease obligations	(993)		(907)
Amendment fee paid to lender	—		(100)
Distributions to Telos ID Class B member - non-controlling interest	—		(1,292)
Cash provided by (used in) financing activities	35,131		(2,299)

Increase in cash and cash equivalents	28,090		3,575
Cash and cash equivalents, beginning of period	106,045		6,751

Cash and cash equivalents, end of period	$	134,135	$	10,326

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	583	$	2,211
Income taxes	$	54	$	50
Noncash:
Dividends from preferred stock recorded as interest expense	$	—	$	2,867

Supplemental disclosure of non-cash investing activity
Acquisition holdback	$	506	$	—

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

Table of Contents

TELOS CORPORATION ~~AND SUBSIDIARIES~~

CONDENSED CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

(Unaudited)

(amounts inthousands)

Nine Months Ended September 30,

2020

2019

Operating activities:
Net income (loss) $ 4,106 $ (1,216 )
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Dividends from preferred stock recorded as interest expense 2,867 2,867
Depreciation and amortization 4,018 3,609
Amortization of debt issuance costs 684 275
Deferred income tax provision (benefit) 28 (206 )
Other noncash items (26 ) 83
Changes in other operating assets and liabilities 280 (1,028 )
Cash provided by operating activities 11,957 4,384

Investing activities:
Capitalized software development costs (5,459 ) (2,171 )
Purchases of property and equipment (624 ) (3,141 )
Cash used in investing activities (6,083 ) (5,312 )

Financing activities:
Proceeds from senior term loan – 4,881
Payments under finance lease obligations (907 ) (826 )
Amendment fee paid to lender (100 ) –
Distributions to Telos ID Class B member - non-controlling interest (1,292 ) (1,403 )
Cash (used in) provided by financing activities (2,299 ) 2,652

Increase in cash and cash equivalents 3,575 1,724
Cash and cash equivalents, beginning of period 6,751 72

Cash and cash equivalents, end of period $ 10,326 $ 1,796

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 2,211 $ 2,294
Income taxes $ 50 $ 39

Noncash:
Dividends from preferred stock recorded as interest expense $ 2,867 $ 2,867
Debt issuance costs on senior term loan $ – $ 110


	Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive Income		Accumulated Deficit		Non-Controlling Interest		Total Stockholders’ Equity (Deficit)
For the Three Months Ended September 30, 2021
Beginning balance	$	105	$	341,928	$	17	$	(177,350)	$	—	$	164,700
Net loss	—		—		—		(5,387)		—		(5,387)

Foreign currency translation loss	—		—		(13)		—		—		(13)
Stock-based compensation	—		12,191		—		—		—		12,191


Ending balance	$	105	$	354,119	$	4	$	(182,737)	$	—	$	171,491
For the Three Months Ended September 30, 2020
Beginning balance	$	78	$	4,310	$	7	$	(147,508)	$	7,104	$	(136,009)
Net (loss) income	—		—		—		(200)		2,694		2,494
Foreign currency translation loss	—		—		(2)		—		—		(2)
Stock-based compensation	—		4		—		—		—		4
Distributions	—		—		—		—		(292)		(292)
Ending balance	$	78	$	4,314	$	5	$	(147,708)	$	9,506	$	(133,805)
For the Nine Months Ended September 30, 2021
Beginning balance	$	103	$	270,800	$	44	$	(143,843)	$	—	$	127,104
Net loss	—		—		—		(38,894)		—		(38,894)
Issuance of common stock	2		64,267		—		—		—		64,269
Foreign currency translation loss	—		—		(40)		—		—		(40)
Stock-based compensation	—		47,197				—		—		47,197
Repurchase of outstanding warrants	—		(26,894)		—		—		—		(26,894)
Repurchase of common stock	—		(1,251)		—		—		—		(1,251)
Ending balance	$	105	$	354,119	$	4	$	(182,737)	$	—	$	171,491
For the Nine Months Ended September 30, 2020
Beginning balance	$	78	$	4,310	$	6	$	(145,530)	$	4,514	$	(136,622)
Net (loss) income	—		—		—		(2,178)		6,284		4,106
Foreign currency translation loss	—		—		(1)		—		—		(1)
Stock-based compensation	—		4		—		—		—		4
Distributions	—		—		—		—		(1,292)		(1,292)
Ending balance	$	78	$	4,314	$	5	$	(147,708)	$	9,506	$	(133,805)

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

Table of Contents

~~TELOS CORPORATION AND SUBSIDIARIES~~

~~CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT~~

~~(Unaudited)~~

~~(amounts in thousands)~~

Telos Corporation

Common
Stock

Additional Paid-in
Capital

Accumulated
Other Comprehensive Income

Accumulated
Deficit

Non-Controlling Interest

Total
Stockholders’
Deficit

For the Three Months Ended September 30, 2020

Beginning balance

$
78
$
4,310
$
7
$
(147,508 ) $ 7,104
$
(136,009 )
Net (loss) income – – – (200 ) 2,694 2,494
Foreign currency translation loss – – (2 ) – – (2 )
Stock-based compensation – 4 – – – 4
Distributions – – – – (292 ) (292 )
Ending balance $ 78 $ 4,314 $ 5 $ (147,708 ) $ 9,506 $ (133,805 )
For the Three Months Ended September 30, 2019

Beginning balance

$
78
$
4,310
$
19
$
(144,283 ) $ 1,857
$
(138,019 )
Net income – – – 2,233 1,485 3,718
Foreign currency translation loss – – (2 ) – – (2 )
Distributions – – – – (419 ) (419 )
Ending balance $ 78 $ 4,310 $ 17 $ (142,050 ) $ 2,923 $ (134,722 )
For the Nine Months Ended September 30, 2020

Beginning balance

$
78
$
4,310
$
6
$
(145,530 )
$
4,514
$
(136,622 )
Net (loss) income – – – (2,178 ) 6,284 4,106
Foreign currency translation loss – – (1 ) – – (1 )
Stock-based compensation – 4 – – – 4
Distributions – – – – (1,292 ) (1,292 )
Ending balance $ 78 $ 4,314 $ 5 $ (147,708 ) $ 9,506 $ (133,805 )
For the Nine Months Ended September 30, 2019

Beginning balance

$
78
$
4,310
$
17
$
(139,129 )
$
2,621
$
(132,103 )
Net (loss) income -- -- -- (2,921 ) 1,705 (1,216 )
Distributions -- -- -- -- (1,403 ) (1,403 )
Ending balance $ 78 $ 4,310 $ 17 $ (142,050 ) $ 2,923 $ (134,722 )

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

~~Table of Contents~~

TELOS CORPORATION ~~AND SUBSIDIARIES~~

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. General and Basis of Presentation

Description of Business

Organization

Telos Corporation, together with its subsidiaries ~~(the “Company”~~(collectively, the "Company", "we", "our" or ~~“Telos” or “We”~~"Telos"), offers technologically advanced, software-based security solutions that empower and protect the world’s most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats. Our portfolio of security products, services and expertise empower our customers with capabilities to reach new markets, serve their stakeholders more effectively, and successfully defend the nation or their enterprise. We protect our customers’ people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in their security and privacy. Our principal offices are located at 19886 Ashburn Road, Ashburn, Virginia 20147. The Company was incorporated as a Maryland corporation, is a leading provider of cyber, cloud and enterprise security solutions for the world's most security-conscious organizations. We own all of the issued and outstanding share capital of Xacta Corporation, a subsidiary that develops, markets and sells government-validated secure enterprise solutions to government and commercial customers. We also own all of the issued and outstanding share capital of Ubiquity.com, Inc., a holding company for Xacta Corporation. We own a 100% ownership interest in ~~October 1971.~~Telos Identity Management Solutions, LLC (“Telos ID”), Teloworks, Inc. (“Teloworks”) and Telos APAC Pte. Ltd. (“Telos APAC”).

On November 12, 2020, we amended our charter 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 condensed consolidated financial statements and notes to the condensed consolidated financial statements give retroactive effect to the reverse stock split for all periods presented.

Public Offerings of Common Stock

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

On April 6, 2021, we completed our follow-on offering of 9.1 million shares of our common stock at a price of $33.00 per share, including 7.0 million shares of common stock held by certain existing stockholders of Telos. The offering generated approximately $64.3 million of net proceeds to Telos. We did not receive any proceeds from the shares of common stock sold by the selling stockholders. On April 19, 2021, we used approximately $1.3 million of the net proceeds to repurchase 39,682 shares of our common stock and $26.9 million to repurchase the warrants to purchase 900,970 shares of our common stock owned by certain affiliates of Enlightenment Capital Solutions ("EnCap").

We have used and intend to continue using the remaining net proceeds for general corporate purposes, including working capital, sales and marketing activities, research and development, general and administrative matters and capital expenditures. We also may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies. The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors.

Principles of Consolidation and Reporting

The accompanying unaudited condensed consolidated financial statements include the accounts of Telos and its subsidiaries, including Ubiquity.com, Inc., Xacta Corporation, Teloworks, Inc. and Telos APAC, Pte. Ltd., all of whose issued and outstanding share capital is owned by the Company. We have also consolidated the results of operations of Telos Identity Management Solutions, LLC (“Telos ID”) (see Note 2 – Non-controlling Interests).wholly-owned subsidiaries. All intercompany transactions have been eliminated in consolidation.

The accompanying condensed consolidated financial statements ~~reflect all adjustments (which include normal recurring adjustments)~~for the three and ~~reclassifications necessary for their fair presentation~~nine months ended September 30, 2021 and 2020 have been prepared in ~~conformity~~accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”). The presented interim results are not necessarily indicative of fiscal year performance for a variety of reasons including, but not limited to, the impact of seasonal and short-term variations. We have continued to follow the accounting policies (including the critical accounting policies) set forth in the consolidated financial statements included in our ~~2019~~2020 Annual Report on Form 10-K filed with the SEC. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, ~~2019~~.

In 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 potentially leading to a world-wide economic downturn. It has 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 basis. 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. Both the health and economic aspects of COVID-19 are highly fluid and the future course of each is uncertain.

2020.

In preparing these condensed consolidated financial statements, we have evaluated subsequent events through the date that these condensed consolidated financial statements were issued.

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Basis of Comparison

Certain prior-period amounts have been reclassified to conform to the current period presentation. In the current period, we have reclassified and presented intangible assets separately from our property and equipment line item. The reclassification had no impact on our total assets or liabilities nor on our net loss or stockholders' equity.

For the three months ended September 30, 2021, the Company recorded an out-of-period adjustment resulting in a $1.1 million increase to 'Services' revenue and a $1.0 million reclassification between 'Cost of Sales - Services' and 'General and Administrative' expenses within the condensed consolidated statements of operations. The Company identified and corrected this error in the current period. This error was not material to any previously filed consolidated financial statements and the impact of correcting this error in the current period is not material to our third quarter 2021 condensed consolidated financial statements.

Segment Reporting

Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker (“CODM”), or decision making group, in deciding how to allocate resources and assess performance. We currently operate in ~~one~~1 operating and reportable business segment for financial reporting purposes. Our Chief Executive Officer is the CODM. The CODM ~~only~~ evaluates profitability based on consolidated results.

Recent Accounting Pronouncements

~~Recent~~ Accounting ~~Pronouncements~~Standards Recently Adopted

In ~~June 2016,~~December 2019, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) ~~2016-13, “Financial Instruments - Credit Losses~~No. 2019-12, “Simplifying the Accounting for Income Taxes (Topic ~~326): Measurement of Credit Losses on Financial Instruments,~~740)”, which ~~introduces new~~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 ~~for estimating credit losses on certain types of financial instruments based on expected losses and the timing of the recognition of such losses.~~to improve consistent application. This standard is effective for ~~interim and annual~~ reporting periods beginning after December 15, ~~2019,~~2020, which made this standard effective for us on January 1, ~~2020.~~2021. The adoption of this ASU did not have a material impact on our condensed consolidated financial position, results of operations and cash flows.

Summary of Significant Accounting Policies

~~In January 2017,~~Inventories

Inventories are stated at the ~~FASB issued ASU 2017-04, "Intangibles - Goodwill~~lower of cost or net realizable value, where cost is determined using the weighted average method. Substantially all inventories consist of purchased off-the-shelf hardware and ~~Other (Topic 350): Simplifying~~software, and component computer parts used in connection with system integration services that we perform. An allowance for obsolete, slow-moving or nonsaleable inventory is provided for all other inventories. This allowance is based on our overall obsolescence experience and our assessment of future inventory requirements. This charge is taken primarily due to the ~~Test for Goodwill Impairment," which eliminates Step 2~~age of the specific inventory and the significant additional costs that would be necessary to upgrade to current ~~goodwill~~standards as well as the lack of forecasted sales for such inventory in the near future. Gross inventory was $2.9 million and $4.2 million as of September 30, 2021 and December 31, 2020, respectively. As of September 30, 2021, it is management’s judgment that we have fully provided for any potential inventory obsolescence, which was $0.8 million and $0.9 million as of September 30, 2021 and December 31, 2020, respectively.

Software Development Costs

We account for development costs of our software to be sold in accordance with ASC Topic 985-20, “Software – Costs of Software to be Sold, Leased, or Marketed” and for internal use software in accordance with ASC Topic 350-40 “Internal Use Software”. 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. Software development costs are capitalized and amortized over the estimated product life of 2 years on a straight-line basis, which are included as a part of intangible assets. 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 ~~test~~of the capitalized software development costs as forecasted future sales are adequate to support the carrying values.

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Income Taxes

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 ~~requires a hypothetical purchase price allocation~~are applicable to ~~measure goodwill impairment. A goodwill impairment loss instead~~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 ~~measured at~~recognized in net income in the ~~amount by~~period in which ~~a reporting unit's carrying value exceeds its fair value, not to exceed~~ the ~~recorded amount of goodwill. The~~tax rate change is enacted.

We follow the provisions of ~~this ASU are effective~~ASC 740 related to accounting for ~~years beginning after December 15, 2019, which made this standard effective~~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 ~~January 1, 2020. The adoption~~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 ~~this ASU did not have a material impact on~~the position in our condensed consolidated financial ~~position, results~~statements at the largest amount that is greater than fifty percent likely of ~~operations~~being realized upon ultimate settlement. These estimates are updated at each reporting date based on the facts, circumstances and ~~cash flows.~~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.

The provision for income taxes in interim periods is computed by applying the estimated annual effective tax rate against earnings before income tax expense for the period. In addition, non-recurring or discrete items are recorded during the period in which they occur.

~~In August 2018,~~Goodwill

Goodwill is recorded as the ~~FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes~~difference between the aggregate consideration paid for an acquisition and the fair value of net tangible and intangible assets acquired and liabilities assumed. Goodwill is not amortized, but rather tested for potential impairment annually during our fourth quarter, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or business climate, or (2) a loss of key contracts or customers.

The goodwill impairment test is performed at the reporting unit level. The Company estimates and compares the fair value of each reporting unit to its respective carrying value including goodwill. If the fair value is less than the carrying value, the amount of impairment expense is equal to the ~~Disclosure Requirements for Fair Value Measurement,” which modifies~~difference between the ~~disclosure requirement for~~reporting unit’s fair value ~~measurement under ASC 820~~and the reporting unit’s carrying value.

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

Stock-Based Compensation

Under our 2016 Omnibus Long-Term Incentive Plan, as amended (the “2016 LTIP”), we have the ability to ~~improve~~award restricted stock units with time-based vesting (“Service-Based RSUs”), and restricted stock units with performance-based vesting (“Performance-Based RSUs”) to senior executives, directors, employees and other eligible service providers. Under the ~~effectiveness~~2016 LTIP, our Board of Directors or, by designation of authority, the Compensation Committee of our Board of Directors has the discretion to establish the terms, conditions and criteria of the various awards, including the weighing and vesting schedule of Service-Based RSUs and the performance conditions applicable to the Performance-Based RSUs, including the achievement of certain financial performance criteria or price targets for our common stock. Upon vesting, Service-Based RSUs and Performance-Based RSUs will be settled in the Company’s common stock.

•Service-Based RSUs granted to eligible employees as an incentive generally vest in equal installments over two to three years from the date of grant. Service-Based RSUs granted to senior executives in 2021 vest in three annual installments from the date of grant, with 30% vesting on the first and second anniversaries and 40% vesting on the third anniversary. The grant date fair value per share is equal to the closing stock price on the date of grant.

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•Performance-Based RSUs may vest upon the achievement of a defined performance target or at the end of the defined performance period from the date of grant, whichever initially occurs. The grant date fair value per share of these Performance-Based RSUs is equal to the closing stock price on the date of the grant or the fair value of the award on the grant date as determined through an independent valuation, for performance-based RSUs with market condition. Performance-Based RSUs may vest upon the achievement of certain price targets for the Company’s common stock anytime over a three-year period from the date of grant. In order to reflect the substantive characteristics of these market condition awards, the Company employs a Monte Carlo simulation valuation model to calculate the grant date fair value and corresponding requisite service period of the award. Monte Carlo approaches are a class of computational algorithms that rely on repeated random sampling to compute their results. This approach allows the calculation of the value of such ~~disclosures. Those modifications include~~awards based on a large number of possible stock price path scenarios.

We recognize these share-based payment transactions when services from the ~~removal~~employees are received 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 1, 2020. The adoption of this ASU did not haverecognize a ~~material impact on~~corresponding increase in additional paid-in capital in our condensed consolidated ~~financial position, results~~balance sheets. The measurement objective for these equity awards is the estimated fair value at the date of ~~operations~~grant of the equity instruments that we are obligated to issue when employees have rendered the requisite service and ~~cash flows.~~

~~In August 2018,~~satisfied any other conditions necessary to earn the ~~FASB issued ASU 2018-15, “Intangibles - Goodwill~~right to benefit from the instruments. The compensation expense for an award is recognized ratably over the requisite service period for the entire award, which is the period during which an employee is required to provide service in exchange for an award. Compensation expense for awards with performance conditions is recognized over the requisite service period if it is probable that the performance condition will be satisfied. If such performance conditions are not or are no longer considered probable, no compensation expense for these awards is recognized, and ~~Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting~~any previously recognized expense is reversed. If the performance condition is achieved prior to the completion of the requisite service period, any unrecognized compensation expense will be recognized in the period the performance condition is achieved. Compensation expense for ~~Implementation Costs Incurred~~awards with market conditions is recognized over the derived service period, or sooner, if the market condition is achieved. Previously recognized expense for awards with market conditions will never be reversed even if the market conditions is never achieved. We recognize forfeitures of share-based compensation awards as they occur. Share-based compensation expense is recognized as part of cost of sales and general and administrative expenses 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 is effective for interim and annual reporting periods beginning after December 15, 2019, which made this standard effective for us on January 1, 2020. The adoption of this ASU did not have a material impact on our condensed consolidated ~~financial position, results~~statements of ~~operations~~operations.

Net Loss per Share

Basic net earnings (loss) per share is computed by dividing the net earnings (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 ~~cash flows.~~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 stock, unvested restricted stock units and common stock warrants.

For the period of net loss, potentially dilutive securities are not included in the calculation of diluted net earnings (loss) per share because to do so would be anti-dilutive. Potentially dilutive securities are as follows (in common stock equivalent shares, in thousands):

~~Recent Accounting Pronouncements Not Yet Adopted~~


	Three Months Ended September 30,		Nine Months Ended September 30,
	2021	2020	2021	2020
Unvested restricted stock and restricted stock units	313	60	394	60
Common stock warrants, exercisable at $1.665/sh.	—	901	405	901
Total	313	961	799	961

~~In December 2019,~~Other Comprehensive Loss

Our functional currency is the ~~FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying~~U.S. Dollar. For one of our wholly owned subsidiaries, the ~~Accounting~~functional currency is the local currency. For this subsidiary, the translation of its foreign currency into U.S. Dollars is performed for ~~Income Taxes,” which simplifies~~assets and liabilities using current foreign currency exchange rates in effect at the ~~accounting~~balance sheet date and for revenue and expense accounts using average foreign currency exchange rates during the periods presented. Translation gains and losses are included in stockholders’ equity (deficit) as a component of accumulated other comprehensive income ~~taxes by removing certain exceptions to the general principles in Topic 740~~(loss). ~~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.

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Accumulated other comprehensive income included within stockholders’ equity (deficit) consists of the following (in thousands):


	September 30, 2021		December 31, 2020
Cumulative foreign currency translation loss	$	(103)	$	(63)
Cumulative actuarial gain on pension liability adjustment	107		107
Accumulated other comprehensive income	$	4	$	44

Note 2. Revenue Recognition

Performance Obligation

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

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.

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. Revenue transferred to customers over time accounted for 91% and 92% of our revenue for the three and nine months ended September 30, 2021, and 93% and 92% of our revenue for the three and nine months ended September 30, 2020. All of our business groups earn services revenue under a variety of contract types, including time and materials, ~~firm-fixed price, firm fixed price~~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. ~~This continuous~~

Revenue that is recognized at a point in time is for the sale of software licenses in our Information Assurance / Xacta® and Secure Communications business groups and for the sale of resold products in Telos ID and Secure Networks, and is classified as product revenue. Revenue transferred to customers at a point in time accounted for 9% and 8% of our revenue for the three and nine months ended September 30, 2021 and 7% and 8% of our revenue for the three and nine months ended September 30, 2020. 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 ~~customer is supported by clauses in~~performance obligations using 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~~best estimate of any work in process. For non-U.S. Government contracts where we perform as a subcontractor and our order includes similar Federal Acquisition Regulation (FAR) provisions as the prime contractor’s order from the U.S. Government, continuous transferstandalone selling price.

Table 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.Contents

Contract Estimates

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. 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. 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 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.

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Our contracts may include various types of variable consideration, such as claims (for instance, indirect rate or other equitable adjustments) or incentive fees. We include estimated amounts in the transaction price based on all of the information available to us, including historical information and future estimations, and to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when any uncertainty associated with the variable consideration is resolved. We have revised and re-submitted several years of incurred cost submissions reflecting certain indirect rate structure changes as a result of regular Defense Contract Audit Agency (“DCAA”) audits of incurred cost submissions. This resulted in signed final rate agreement letters for fiscal years 2011 to 2013 and conformed incurred cost submissions for 2014 to 2015. We evaluated the resulting changes to revenue under the applicable cost plus fixed fee contracts for the years 2011 to 2015 as variable consideration, and determined the most likely amount to which we expect to be entitled, to the extent that no constraint exists that would preclude recognizing this revenue or result in a significant reversal of cumulative revenue recognized. We included these estimated amounts of variable consideration in the transaction price and as performance on these contracts is complete, we have recognized revenue of $~~6.0~~ ~~million during the year ended~~ ~~December 31, 2018~~.

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. 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 the 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. 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 data.

We have 1 reportable segment in accordance with ASC 280, Segment Reporting, as such, the disaggregation of revenue below reconciles directly to its unique reportable segment. We treat sales to U.S. customers as sales within the U.S. regardless of where the services are performed. Substantially all of our revenues are from U.S. customers as revenue derived from international customers is not currently meaningful.

The following tables disclose revenue (in thousands) by customer type and contract type for the three and nine months ended September 30, 2021 and 2020.


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Federal	$	67,697	$	45,788	$	171,091	$	128,756
State & Local, and Commercial	2,369		1,652		7,292		6,273
Total	$	70,066	$	47,440	$	178,383	$	135,029

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	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Firm-fixed-price	$	61,434	$	39,483	$	155,832	$	113,080
Time-and-materials	3,154		3,605		9,243		11,066
Cost plus fixed fee	5,478		4,352		13,308		10,883
Total	$	70,066	$	47,440	$	178,383	$	135,029

Contract Balances

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 condensed consolidated balance sheets.

Billed receivables are amounts billed and due from our customers and are reported within accounts receivable, net of reserve on the condensed 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 condensed consolidated balance ~~sheet~~sheets on a net contract basis at the end of each reporting period.

~~We have~~ ~~one~~ ~~reportable segment.~~ ~~We treat sales~~ As of September 30, 2021 and December 31, 2020, the contract liabilities primarily related to U.S. customers as sales within the U.S. 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 presented.product support services.

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Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Federal $ 45,788 $ 42,702 $ 128,756 $ 105,459
State & Local, and Commercial 1,652 2,829 6,273 7,286
Total $ 47,440 $ 45,531 $ 135,029 $ 112,745

Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Firm fixed-price $ 39,483 $ 38,660 $ 113,080 $ 92,447
Time-and-materials 3,605 3,325 11,066 10,945
Cost plus fixed fee 4,352 3,546 10,883 9,353
Total $ 47,440 $ 45,531 $ 135,029 $ 112,745

The following table ~~discloses~~provides information about accounts receivable, ~~and~~ contract assets ~~(in thousands):~~

September 30, 2020

December 31, 2019

Billed accounts receivable $ 12,315 $ 11,917
Unbilled receivables 17,546 16,745
Allowance for doubtful accounts (745 ) (720 )
Receivables – net $ 29,116 $ 27,942

~~The following table discloses~~and contract liabilities (in thousands):

September 30, 2020

December 31, 2019

Contract liabilities $ 6,353 $ 6,337


	September 30, 2021		December 31, 2020
Billed accounts receivable	$	10,158	$	12,060
Unbilled receivables	39,717		19,161
Allowance for doubtful accounts	(116)		(308)
Accounts receivable – net	$	49,759	$	30,913
Contract liabilities	$	7,232	$	5,654

Significant changes in the contract liabilities balance (in thousands):

~~As of~~ ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019, we had $147.0~~ ~~million and $112.4~~ ~~million of remaining performance obligations, respectively, which we also refer to as funded backlog.~~


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Revenue recognized that was included in the opening contract liability balance	$	823	$	1,690	$	4,065	$	5,208


	September 30, 2021		December 31, 2020
	(in thousands)		(in thousands)
Remaining performance obligations (funded backlog)	$	163,351	$	127,735

We expect to recognize approximately ~~47.1%~~95% of our remaining performance obligations ~~as revenue in 2020, an additional~~ ~~46.6%~~ ~~in 2021,~~over the next 12 months and the balance thereafter. ~~We recognized revenue of $1.7~~ ~~million and $5.2~~ ~~million during the~~ ~~three and nine months ended September 30, 2020, respectively, and $1.0~~ ~~million and $4.1~~ ~~million during the~~ ~~three and nine months ended September 30, 2019, respectively, that was included in the contract liabilities balance at the beginning of each fiscal year.~~

~~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 management’s 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.

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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", without recourse to the Company. The Factor initially pays the Company ~~90%~~Note 3. Non-controlling Interests / Purchase 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 condensed 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. There were~~ no ~~accounts receivable sold during the~~ ~~three and nine months ended September 30, 2020. During the~~ ~~three and nine months ended September 30, 2019, the Company sold approximately $3.2~~ ~~million and $12.6~~ ~~million of accounts receivable, respectively, and recognized a related loss of approximately $12,000~~ ~~and $45,000~~ ~~in selling, general and administrative expenses, respectively, for the same period. As of~~ ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019, there were~~ no ~~outstanding sold accounts receivable.~~

~~Inventories~~

Inventories are stated at the lower of cost or net realizable value, where cost is determined using the weighted average method. Substantially all inventories consist of purchased off-the-shelf hardware and software, and component computer parts used in connection with system integration services that we perform. An allowance for obsolete, slow-moving or nonsalable inventory is provided for all other inventory. This allowance is based on our overall obsolescence experience and our assessment of future inventory requirements. This charge is taken primarily due to the age of the specific inventory and the significant additional costs that would be necessary to upgrade to current standards as well as the lack of forecasted sales for such inventory in the near future. Gross inventory was ~~$4.8 million~~ ~~and~~ ~~$2.8 million~~ ~~as of~~ ~~September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020, it is management’s judgment that we have fully provided for any potential inventory obsolescence,~~ ~~which was $0.9~~ ~~million as of~~ ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019~~.

~~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”) as well as solutions developed within Telos ID. 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. Beginning with the second quarter of 2017, software development costs are capitalized and amortized over the estimated product life of 2-3 ~~years on a straight-line basis. As of~~ ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019, we capitalized $11.0~~ ~~million and $5.6~~ ~~million of software development costs, respectively, which are included as a part of property and equipment. Amortization expense was $0.4~~ ~~million and $1.3~~ ~~million for each of the~~ ~~three and nine months ended September 30, 2020 and 2019, respectively. Accumulated amortization was $4.4~~ ~~million and $3.1~~ ~~million as of~~ ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019~~, respectively. The Company analyzes the net realizable value of capitalized software development costs on at least an annual basis and has determined that there is no indication of impairment of the capitalized software development costs as forecasted future sales are adequate to support amortization costs.

~~Table of Contents~~

~~Income Taxes~~

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 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 ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019. As a result of a full valuation allowance against our deferred tax assets, a deferred tax liability related to goodwill remains on our condensed consolidated balance sheets at~~ ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019~~. Due to the tax reform enacted on December 22, 2017, net operating losses generated in taxable years beginning after December 31, 2017 will have an indefinite carryforward period, which will be available to offset future taxable income created by the reversal of temporary taxable differences related to goodwill. As a result, we have adjusted the valuation allowance on our deferred tax assets and liabilities at ~~September 30, 2020~~ ~~and~~ ~~December 31, 2019~~.

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. 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.

~~Goodwill~~

We evaluate the impairment of goodwill in accordance with ASC 350, “Intangibles - Goodwill and Other,” which requires goodwill and indefinite-lived intangible assets to be assessed on at least an annual basis for impairment using a fair value basis. Between annual evaluations, if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount, then impairment must be evaluated. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or business climate, or (2) a loss of key contracts or customers.

~~Table of Contents~~

As the result of an acquisition, we record any excess purchase price over the net tangible and identifiable intangible assets acquired as goodwill. An allocation of the purchase price to tangible and intangible net assets acquired is based upon our valuation of the acquired assets. Goodwill is not amortized, but is subject to annual impairment tests. We complete our goodwill impairment tests during the quarter. Additionally, we make evaluations between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The evaluation is based on the estimation of the fair values of our ~~three~~ ~~reporting units, CO&D (comprised of Information Assurance / Xacta and Secure Networks),~~ Telos ID and Secure Communications, of which goodwill is housed in the CO&D reporting unit, in comparison to the reporting unit’s net asset carrying values. Our discounted cash flows required management’s judgment with respect to forecasted revenue streams and operating margins, capital expenditures 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 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~~. Subsequent reviews may result in future periodic impairments that could have a material adverse effect on the results of operations in the period recognized. Recent operating results have reduced the projection of future cash flow growth potential, which indicates that certain negative potential events, such as a material loss or losses on contracts, or failure to achieve projected growth could result in impairment in the future. We estimate fair value of our reporting unit and compare the valuation with the respective carrying value for the reporting unit to determine whether any goodwill impairment exists. If we determine through the impairment review process that goodwill is impaired, we will record an impairment charge in our consolidated statements of operations. Goodwill is amortized and deducted over a 15~~-year period for tax purposes.~~

~~Stock-Based Compensation~~

Compensation cost is recognized based on the requirements of ASC 718, “Stock Compensation,” for all share-based awards granted. Since June 2008, we have issued restricted stock (Class A common) to our executive officers, directors and employees. To date, ~~79,361~~ ~~shares have been 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~~ ~~September 30, 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 our common stock was nominal, based on the deduction of our outstanding debt, capital lease obligations, and preferred stock from an estimated enterprise value, which was estimated based on discounted cash flow analysis, comparable public company analysis, and comparable transaction analysis. Additionally, we determined that a significant change in the valuation estimate for common stock would not have a significant effect on the condensed consolidated financial statements.

~~Net Income (Loss) per Share~~

Basic net 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 loss per share is computed by dividing the net 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. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding as inclusion of the potentially dilutive securities would be antidilutive.

~~Potentially dilutive securities not included in the calculation of diluted net loss per share because to do so would be anti-dilutive are as follows (in common stock equivalent shares):~~

Nine Months Ended September 30,
2020 2019
Unvested restricted stock 60 957
Common stock warrants, exercisable at $1.665/sh.
901 901
Total 961 1,858

~~Table of Contents~~

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

~~Other Comprehensive Income (Loss)~~

Our functional currency is the U.S. Dollar. For one of our wholly owned subsidiaries, the functional currency is the local currency. For this subsidiary, the translation of its foreign currency into U.S. Dollars is performed for assets and liabilities using current foreign currency exchange rates in effect at the balance sheet date and for revenue and expense accounts using average foreign currency exchange rates during the period. Translation gains and losses are included in stockholders’ deficit as a component of accumulated other comprehensive income (loss).

~~Accumulated other comprehensive income included within stockholders’ deficit consists of the following (in thousands):~~

September 30, 2020

December 31, 2019

Cumulative foreign currency translation loss $ (102 ) $ (101 )
Cumulative actuarial gain on pension liability adjustment 107 107
Accumulated other comprehensive income $ 5 $ 6

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~~Note 2. Non-controlling Interests~~

On April 11, 2007, Telos ID was formed as a limited liability company under the Delaware Limited Liability Company Act. We contributed substantially all of the assets of our ~~Identity Management~~Telos ID Enterprise business line and assigned our rights to perform under our U.S. Government contract with the Defense Manpower Data Center ~~(“DMDC”)~~ to Telos ID at their stated book ~~values. The net book~~ value, ~~of assets we contributed totaled~~amounting to $17,000. Until April 19, 2007, we owned 99.999% of the membership interests of Telos ID and ~~certain private equity investors (“Investors”~~Hoya ID Funds A, LLC ("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 ~~the Investor in exchange~~Hoya 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~~ consideration, resulting in 60% ownership of Telos ~~ID, and therefore continued to account for the investment in Telos ID using the consolidation method.~~

ID.

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~~Hoya acquired from the Company an additional ten percent (~~10%~~(10%) membership interest in Telos ID in exchange for $5$5 million (the ~~“Transaction”~~“2014 Transaction”). In connection with the 2014 Transaction, the Company and ~~the Investors~~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 iswas 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 Investors). The Class A member (the Company) owns~~ Company owned 50% of Telos ID, iswas entitled to receive 50% of the profits of Telos ID, and ~~may~~could appoint three (3) members of the Telos ID Board. ~~The Class B member (the Investors) owns~~ Hoya owned 50% of Telos ID, iswas entitled to receive 50% of the profits of Telos ID, and ~~may~~could 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 member; (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.

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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 2014 Transaction, each of the ~~Class A and Class B~~ members ~~each own~~ owned 50% of Telos ID, as mentioned above, and as such each was allocated 50% of the profits, which was $~~2.7~~$2.7 million and $~~6.3~~$6.3 million for the three and nine months ended September 30, 2020,~~, respectively,~~ respectively. Hoya held the non-controlling interest.

On October 5, 2020, we entered into a Membership Interest Purchase Agreement between the Company and $~~1.5~~ ~~million and $1.7~~ ~~million for~~Hoya to purchase all of the~~three and nine months ended September 30, 2019, respectively.~~ ~~The~~ Class B ~~member is~~Units of Telos ID 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 an increase to additional paid-in capital (“APIC”) of $148.4 million. The Company further recognized a reduction to APIC of $173.9 million as part of the elimination of Hoya’s non-controlling ~~interest.~~

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

Distributions ~~are~~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. ~~The Class B member~~Hoya 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 condensed consolidated balance sheets as of December 31, 2020. Hoya received a total distribution of $~~0.3~~$0.3 million and $~~1.3~~$1.3 million during the three and nine months ended September 30, 2020,~~, respectively,~~ respectively.

Note 4. Acquisition

On July 30, 2021, the Company acquired the assets of Diamond Fortress Technologies ("DFT") and $~~0.4~~wholly-owned subsidiaries for a total purchase consideration of $6.7 million, inclusive of $0.3 million related to a pre-existing contractual arrangement with DFT. Upon closing, $5.9 million of cash was paid with an additional $0.6 million payable to DFT 18 months after the close date (the "holdback"). The holdback amount has been discounted to its present value of $0.5 million using a discount rate relevant to the acquisition. The acquisition adds several new patents to the Company’s library of biometric and $~~1.4~~digital identity intellectual property. The addition of contactless biometrics technology will enable the Company to better serve the needs of organizations in existing and new markets.

The acquisition of DFT has been accounted for under US GAAP using the acquisition method of accounting. The total purchase consideration of $6.7 million has been allocated among the assets acquired at their acquisition date. We have calculated the fair values of the DFT acquired assets based on our preliminary valuation analysis, using the information available to us. The Company may continue to adjust the preliminary purchase price allocation (including the identified intangible assets) as additional information becomes available during the ~~three~~remainder of the measurement period, which will not exceed 12 months from the closing of the acquisition. Measurement period adjustments will be recognized in the reporting period in which the adjustment amounts are determined. Any such adjustments may be material.

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The Company recognized $5.0 million of intangible assets and ~~nine months ended September 30, 2019, respectively.~~$1.7 million of goodwill, which is housed in the Telos ID reporting unit. Goodwill is primarily attributable to expected synergies between the acquired intangible assets and the Company's digital identify technology and solutions and acquired workforce. The acquired intangible assets will be amortized on a straight-line basis over 3 - 8 years. The acquisition was considered an asset purchase for tax purposes and the recognized goodwill is deductible for tax purposes.

The ~~following table details~~results of DFT operations have been included in our condensed consolidated statements of operations from the ~~changes in non-controlling interest~~acquisition date, and are not material for the three and nine months ended September 30, ~~2020~~2021. Acquisition-related costs were immaterial and ~~2019 (in thousands):~~

Three Months Ended September 30, Nine Months Ended September 30,

2020

2019

2020

2019

Non-controlling interest, beginning of period $ 7,104 $ 1,857 $ 4,514 $ 2,621
Net income 2,694 1,485 6,284 1,705
Distributions (292 ) (419 ) (1,292 ) (1,403 )
Non-controlling interest, end of period $ 9,506 $ 2,923 $ 9,506 $ 2,923

~~On October 5, 2020, we entered into a Membership Interest Purchase Agreement between~~have been expensed as incurred. The pro-forma financial information have not been presented for this acquisition as the ~~Company and the Investors~~impact to ~~purchase all of the Class B Units of Telos ID (“Telos ID Units”) owned by the Investors (the “Telos ID Purchase”). Upon the closing of the Telos ID Purchase, Telos ID will become~~ our wholly owned subsidiary. The successful consummation of an initial public offering of our common stock is a condition to the closing of the Telos ID Purchase. If the initial public offering of our common stockcondensed consolidated financial statements is not ~~consummated, the Telos ID Purchase will not occur.~~material.

Note 35. Goodwill

The goodwill balance was $16.6 million and $14.9 million as of September 30, ~~2020~~2021 and December 31, ~~2019.~~ 2020, respectively. Goodwill is subject to annual impairment tests and if triggering events are present in the interim before the annual tests, we will assess impairment. ~~As of~~ For the three and nine months ended September 30, ~~2020~~2021 and ~~December 31, 2019~~, 2020, no impairment charges were taken.

Note 6. Intangible Assets

Intangible assets, all of which are finite-lived, consists of the following (in thousands):


September 30, 2021	Estimated Useful Life	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value
Acquired technology	8 years	$	4,910	$	(112)	$	4,798
Customer relationships	3 years	40		(2)		38
Software development costs	2 years	18,392		(6,126)		12,266
		$	23,342	$	(6,240)	$	17,102


December 31, 2020	Estimated Useful Life	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value
Acquired technology	0	$	—	$	—	$	—
Customer relationships	0	—		—		—
Software development costs	2 years	12,253		(4,833)		7,420
		$	12,253	$	(4,833)	$	7,420

Amortization expense was $0.5 million and $1.4 million for the three and nine months ended September 30, 2021, respectively; and $0.4 million and $1.3 million for the three and nine months ended September 30, 2020, respectively.

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Note 47. Fair Value Measurements

The accounting standard for fair value measurements provides a framework for measuring fair value and expands disclosures about fair value measurements. The framework requires the valuation of financial instruments using a three-tiered approach. The statement requires fair value measurement to be classified and disclosed in one of the following categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities;

Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; or

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).

As of September 30, ~~2020~~2021 and December 31, ~~2019,~~2020, we did not have any financial instruments with significant Level 3 inputs and we did not have any financial instruments that are measured at fair value on a recurring basis.

Table of September 30, 2020 and December 31, 2019, the carrying value of the Company’s 12% Cumulative Exchangeable Redeemable Preferred Stock, par value $.01 per share (the “Public Preferred Stock”) was $142.1 million and $139.2 million, respectively, and the estimated fair market value was $63.7 million and $60.5 million, respectively, based on quoted market prices.Contents

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.

Note 58. ~~Current Liabilities and~~ Debt Obligations

~~Accounts Payable and Other Accrued Liabilities~~

As of September 30, 2020 and December 31, 2019, the accounts payable and other accrued liabilities consisted of $11.4 million and $13.5 million, respectively, in trade accounts payable and $5.5 million and $1.5 million, respectively, in accrued liabilities.

~~Contract Liabilities~~

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 condensed consolidated balance sheets on a net contract basis at the end of each reporting period. As of ~~September 30, 2020 and December 31, 2019, the contract liabilities primarily related to product support services.~~

Enlightenment Capital Credit Agreement

On January 25, 2017, we entered into a Credit Agreement (the "Credit Agreement") with Enlightenment Capital Solutions Fund II, L.P., as agent (the "Agent") and the lenders party thereto (the "Lenders"), (together referenced as “EnCap”). The Credit Agreement provides for an $11$11 million senior term loan (the "Loan") with a maturity date of January 25, 2022,, subject to acceleration in the event of customary events of default.

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All borrowings under the Credit Agreement ~~accrue~~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 increase to ~~14.5%~~ ~~per~~ annum. ~~After the occurrence and during the continuance of any event of default, the interest rate will increase~~ ~~2.0%. The Company is obligated to pay accrued interest in cash on a monthly basis at a rate of not less than~~ ~~10.0%~~ ~~per annum or, during the continuance of an Alternate Interest Rate Event,~~ ~~11.5%~~ ~~per annum. The Company may elect to pay the remaining interest in cash, by payment-in-kind (by addition to the principal amount of the Loan) or by combination of cash and payment-in-kind. Upon~~ ~~thirty days~~ ~~prior written notice, the Company may prepay any portion or the entire amount of the Loan.~~

The Credit Agreement contains representations, warranties, covenants, terms and conditions customary for transactions of this type. In connection with the Credit Agreement, the Agent has been granted, for the benefit of the Lenders, a security interest in and general lien upon various property of the Company, subject to certain permitted liens and any intercreditor agreement. The occurrence of an event of default under the Credit Agreement could result in the Loan and other obligations becoming immediately due and payable and allow the Lenders to exercise all rights and remedies available to them under the Credit Agreement or as a secured party under the UCC, in addition to all other rights and remedies available to them.

In connection with the Credit Agreement, on January 25, 2017, the Company issued warrants (each, a "Warrant") to the Agent and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms ~~1,135,284.333~~900,970 shares of the Class A Common Stock of the Company, no par value per share, which iswas equivalent to approximately 2.5% of the common equity interests of the Company on a fully diluted ~~basis.~~basis on the date of grant. The exercise price ~~is $1.321~~was $1.665 per ~~share and each Warrant expires on~~ ~~January 25, 2027~~.share. 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 prepayment of the loan. This amount had been included in the total principal due and treated as an unamortized discount on the debt, which would be amortized over the term of the loan, using the effective interest method at a rate of 15.0% at the time of the original ~~loan~~.loan. We incurred fees and transaction costs of approximately $374,000 related to the issuance of the Credit Agreement, which ~~are being~~were 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. John R. C. 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. John R.C. 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. John R. C. 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 amended (the “Third Amendment”) to waive any actual or potential non-compliance with covenants in 2017 and to reset the covenants for 2018 measurement periods to more accurately reflect the Company’s projected performance for the year. The measurement against the covenants for consolidated leverage ratio and consolidated fixed charge coverage ratio were agreed to not be measured as of December 31, 2017 and were reset for 2018 measurement periods. Additionally,add a minimum revenue covenant and a net working capital covenant were added. In consideration of these amendments, the interest rate on the loan was increased by 1%, which will revert back to the original rate upon achievement of ~~two~~2 consecutive quarters of a specified fixed charge coverage ratio as defined in the agreement. ~~The Company may elect to pay the increase in interest expense in cash or by payment-in-kind (by addition to the principal amount of the Loan).~~ The increase in interest expense has been paid in cash. Contemporaneously with the Third Amendment, Mr. John B. Wood agreed to transfer 50,000 shares of the Company’s Class A Common Stock owned by him to EnCap.

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On July 19, 2019, we entered into the Fourth Amendment to Credit Agreement and Waiver; First Amendment to Fee Letter (“Fourth Amendment”) to amend the Credit Agreement. As a result of the Fourth Amendment, several terms of the Credit Agreement were amended, including (but not limited to) the following:

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

●

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

●

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

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~~The prepayment price was amended as follows: (a) from January 26, 2019 through January 25, 2020, the prepayment price is~~ ~~102%~~ ~~of the principal amount, (b) from January 26, 2020 through October 14, 2020, the prepayment price is~~ ~~101%~~ ~~of the principal amount, and (c) from October 15, 2020 to the maturity date, the prepayment price will be at par. However, the prepayment price for the additional $~~5 ~~million loan attributable to the Fourth Amendment will be at par.~~

●

The following financial covenants, as defined in the Credit Agreement, were amended and updated: Consolidated Leverage Ratio, Consolidated Senior Leverage Ratio, Consolidated Capital Expenditures, Minimum Fixed Charge Coverage Ratio, and Minimum Consolidated Net Working Capital.

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

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~~The borrowing under the Credit Agreement continues to be collateralized by substantially all of the Company’s assets including inventory, equipment and accounts receivable.~~

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~~The Company paid the Agent a fee of $110,000~~ ~~in connection with the Fourth Amendment. We incurred immaterial third party transation costs which were expensed during the current period.~~

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

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

•The prepayment price was amended as follows: (a) from January 26, 2019 through January 25, 2020, the prepayment price is 102% of the principal amount, (b) from January 26, 2020 through October 14, 2020, the prepayment price is 101% of the principal amount, and (c) from October 15, 2020 to the maturity date, the prepayment price will be at par. However, the prepayment price for the additional $5 million loan attributable to the Fourth Amendment will be at par.

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

The exit fee ~~has~~had been included in the total principal due and treated as an unamortized discount on the debt, which ~~is being~~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~~ ~~September 30, 2020~~, we were in compliance with the Credit Agreement’s financial covenants, based on an agreement between the Company and EnCap on the definition of certain input factors that determine the measurement against the covenants.

On March 26, 2020, the Credit Agreement was amended (the “Fifth Amendment”) to modify the financial covenants ~~for 2020 through the maturity of the Credit Agreement to establish that the covenants will remain at the~~ ~~December 31, 2019~~ ~~levels~~ and to update the previously agreed-upon definition of certain financial covenants, specifically the amount of Capital Expenditures to be included in the measurement of the covenants. The Fifth Amendment ~~also~~ provides for ~~the right for the Company to elect to extend the maturity date of the Credit Agreement which is currently scheduled to mature on~~ ~~January 15, 2021. The Fifth Amendment provides for~~ ~~four~~4 quarterly maturity date extensions, which would increase the Exit Fee payable under the Credit Agreement by $~~250,000~~$250,000 for each quarterly maturity date extension elected, for a total of $1$1 million increase to the Exit Fee were all ~~four~~4 of the maturity date extensions to be elected. The Company paid EnCap an amendment fee of $~~100,000~~$100,000 and out-of-pocket costs and expenses in consideration for the Fifth Amendment.

As the Company has not exercised the option(s) to extend the maturity of the Credit Agreement, the current maturity date remains January 15, 2021, which is within one year from the balance sheet date. Accordingly, the balance of the EnCap loan has been classified as a current liability. However, the options to extend the maturity provide the Company with the ability by contractual right to extend the maturity of the loan, which the Company will consider exercising at the appropriate time.

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

September 30, 2020 December 31, 2019
Senior term loan principal, including exit fee $ 17,200 $ 17,200
Less: Unamortized discount, debt issuance costs, and lender fees (281 ) (865 )
Senior term loan, net $ 16,919 $ 16,335

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We incurred interest expense in the amount of $0.8 million and $2.3 million for the three and nine months ended September 30, 2020, respectively, ~~and $0.7 million and $1.5 million for the three and nine months ended September 30, 2019,~~ ~~respectively,~~ under the Credit Agreement.

~~Accounts Receivable Purchase Agreement~~

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On ~~July 15, 2016, we~~November 24, 2020, upon the closing of the IPO, the Company paid a total of $17.4 million to satisfy its obligations under the Credit Agreement in full including an exit fee of $1.2 million, accrued interest of $138,000, and legal fees of $13,000.

On April 19, 2021, the Company entered into ~~an Accounts Receivable Purchase Agreement (the “Purchase Agreement”~~multiple Redemption Agreements and Warrant Redemption and Cancellation Agreements (collectively the "Repurchase Agreement") with ~~Republic Capital Access, LLC (“RCA” or “Buyer”), pursuant~~EnCap and certain related funds that held the warrants 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~~900,970 shares of the ~~Company (collectively, the “Purchased Receivables”). Upon purchase, RCA becomes the absolute owner of any such Purchased Receivables, which are payable directly~~Company's common stock in addition to ~~RCA, subject to certain repurchase obligations~~39,682 shares of the ~~Company.~~Company's common stock. Under the Repurchase Agreement, the Company agreed to repurchase the outstanding warrants for $26.9 million and common stock for $1.3 million. 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. On November 15, 2019, the term~~average price of the ~~Purchase Agreement was extended to June 30, 2022.~~

warrants and common stock repurchased were $29.85 per share and $31.51 per share, respectively. Upon settlement, the repurchased warrants were retired. The ~~initial purchase price of a Purchased Receivable is equal to~~ ~~90%~~ ofCompany reduced common stock for the ~~face~~$0.001 par value of the ~~receivable if~~shares repurchased, with the ~~account debtor is an agency~~excess purchase price over par value recorded as a reduction of additional paid-in-capital ("APIC"). As a result of the ~~U.S. Government, and~~ ~~85%~~ if the account debtor is not an agency of the U.S. Government; 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 payrepurchases, 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~~recognized these 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~~reduction 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.APIC.

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; (c) to notify all account debtors with respect to the 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; (c) the Company is no longer solvent or is generally not paying its debts as they become due; (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 affiliate; 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.

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Subordinated Debt

On March 31, 2015, the Company entered into Subordinated Loan Agreements and Subordinated Promissory Notes (“Porter Notes”) with affiliated entities of Mr. John R. C. Porter (together referenced as “Porter”). At the time, Mr. Porter and Toxford Corporation, of which Mr. Porter controls as the co-trustee of the trust that is the sole ~~shareholder, own~~ stockholder of Toxford, owned 35.0% of our Class A Common Stock. Under the terms of the Porter Notes, Porter lent the Company $~~2.5~~$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~~were met. According to the original terms of the Porter Notes, the outstanding principal sum ~~bears~~bore interest at the fixed rate of twelve percent (~~12%~~(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~~.2015. The Porter Notes dodid not call for amortization payments and ~~are~~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~~. 2017.

We incurred interest expense in the amount of $90,000 and $265,000 for the three and nine months ended September 30, 2020, respectively, ~~and $83,000 and $245,000 for the three and nine months ended September 30, 2019, respectively,~~ on the Porter Notes. ~~As of~~ ~~September 30,~~

On November 23, 2020,~~, approximately $1.2~~ ~~million of accrued interest was payable according to~~ upon the ~~stated interest rate~~closing of the IPO, the Porter ~~Notes.~~

Notes were paid in full.

Note 69. Exchangeable Redeemable Preferred Stock Conversion

Public Preferred Stock

A maximum of 6,000,000 shares of ~~the Public~~Exchangeable Redeemable Preferred Stock (the "Public Preferred Stock"), par value $.01 per share, has been authorized for issuance. We initially issued 2,858,723 shares of the Public Preferred Stock pursuant to the acquisition of the Company during fiscal year 1990. The Public Preferred Stock was recorded at fair value on the date of original issue, November 21, 1989, and we made periodic accretions under the interest method of the excess of the redemption value over the recorded value. We adjusted our estimate of accrued accretion in the amount of $1.5 million in the second quarter of 2006. The Public Preferred Stock was fully accreted as of December 2008. We declared stock dividends totaling 736,863 shares in 1990 and 1991. Since 1991, no other dividends, in stock or cash, ~~have~~had been declared. In November 1998, we retired 410,000 shares of the Public Preferred Stock. ~~The total number of shares issued and outstanding at September 30, 2020 and December 31, 2019 was 3,185,586.~~ ~~The Public Preferred Stock is quoted as "TLSRP" on the OTCQB marketplace and the OTC Bulletin Board.~~

Since 1991, no dividends were declared or paid on our Public Preferred Stock, based upon our interpretation of restrictions in our Articles of Amendment and Restatement, limitations in the terms of the Public Preferred Stock instrument, specific dividend payment restrictions in the various financing documents to which the Public Preferred Stock is subject, other senior obligations currently or previously in existence, and Maryland law limitations in existence prior to October 1, 2009. Subsequent to the 2009 Maryland law change, dividend payments have continued to be prohibited except under certain specific circumstances as set forth in Maryland Code Section 2-311. Pursuant to the terms of the Articles of Amendment and Restatement, we were scheduled, but not required, to redeem the Public Preferred Stock in ~~five~~ annual tranches during the years 2005 through 2009. However, due to our substantial senior obligations currently or previously in existence, limitations set forth in the covenants in the various financing documents to which the Public Preferred Stock is subject, 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 dates. 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 condensed consolidated balance sheets as of ~~September 30, 2020 and December 31, 2019~~.

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On January 25, 2017, we became parties with certain of our subsidiaries to the Credit Agreement with EnCap. Under the 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. Various financing documents to which the Public Preferred Stock is subject~~ prohibit, among other things, the redemption of any stock, common or preferred, other than as described above. The Public Preferred Stock by its terms also cannot be redeemed if doing so would violate the terms of an agreement regarding the borrowing of funds or the extension of credit which is binding upon us or any of our subsidiaries, and it does not include any other provisions that would otherwise require any acceleration of the redemption of or amortization of payments with respect to the Public Preferred Stock. Thus, the Public Preferred Stock is not and will not be due on demand, nor callable, within 12 months from September 30, 2020. This 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~~paid dividends on the Public Preferred Stock when and if declared by the Board of Directors. The Public Preferred Stock ~~accrues~~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 iswas 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 $110.2 million and $107.4 million as of September 30, 2020 and December 31, 2019, respectively.~~ We accrued dividends on the Public Preferred Stock of $1.0 million and $2.9 million for ~~each of~~ the three and nine months ended September 30, 2020, ~~and 2019,~~ respectively, which was recorded as interest expense. Prior to the effective date of ASC 480 on July 1, 2003, such dividends were charged to stockholders’ accumulated deficit.

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~~Note 7~~Upon the closing of the IPO, which constituted a qualified initial public offering for the purposes of the terms of the Public Preferred Stock, each issued and outstanding share of Public 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 (III) 0.15. No fractional shares of common stock, however, were issued upon the ERPS Conversion 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 the ERPS Conversion multiplied by such fractional amount (rounded to the nearest cent). ~~Income Taxes~~“ERPS Liquidation Value” means, per each share of Public Preferred Stock, $10 together with all accrued and unpaid dividends (whether or not earned or declared) thereon calculated as of the actual date of the ERPS Conversion 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 the Public 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 ~~income tax provision for interim periods is determined using an estimated annual effective tax rate adjusted for discrete items, if any, which are taken into account~~difference in the ~~quarterly period~~redemption value of the ERPS and the carrying value has been accounted for as a gain on extinguishment of debt in ~~which they occur. We review~~accordance with ASC 470 and ~~update our estimated annual effective tax rate each quarter. We recorded an approximately $8,000~~ ~~income tax provision and $136,000~~ ~~income tax benefit for~~ASC 480. Approximately $0.2 million of costs directly attributable to this redemption were applied against the ~~three and nine months ended September 30, 2020, respectively, and~~gain, resulting in a $~~10,000~~ ~~and $187,000~~ ~~income tax benefit for the~~ ~~three and nine months ended September 30, 2019, respectively. For the~~ ~~three and nine months ended September 30, 2020 and 2019, our estimated annual effective tax rate was primarily impacted by the overall valuation allowance position which reduced the~~ net ~~tax impact from taxable income for all periods.~~gain of $14.0 million.

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

Note 10. Income Taxes

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 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~~There has been no change in the established valuation allowance ~~is required~~ as of September 30, ~~2020~~2021. As of September 30, 2021 and December 31, ~~2019~~. Under the Tax Cuts and Jobs Act of 2017 (“Tax Act”), we will be able to use our hanging credit deferred tax liabilities as a source of taxable income to support the indefinite-lived net operating losses created by the future reversal of our temporary differences. Accordingly,2020, we have ~~re-measured our existing deferred tax assets and liabilities using the enacted tax rate, and adjusted the valuation allowance on our deferred taxes. As~~recorded a ~~result, a~~net deferred tax liability ~~related to goodwill~~ of $~~649,000~~approximately $680,000 and $~~621,000~~ ~~remains on~~$652,000, respectively.

We review and update our ~~condensed consolidated balance sheets at~~ estimated annual effective tax rate each quarter. For the three months ended September 30, 2021 and 2020, ~~and December 31, 2019, respectively. The~~we recorded an income tax benefit ~~recorded for~~of $41,000 and income tax provision of $8,000 respectively. For the nine months ended September 30, ~~2020~~ ~~is primarily related to this change in deferred tax liability~~2021 and ~~is due to the release of FIN 48 liability on state nexus.~~

~~As a result of the Tax Act,~~2020, we are subject to several provisions of the Tax Act including computations under Section 162(m) executive compensation limitation and Section 163(j) interest limitation rule. We have considered the impact of each of these provisions in our computation ofrecorded an income tax ~~expense for~~provision of $6,000 and income tax benefit of $136,000, respectively. For the three and nine months ended September 30, 2021 and 2020, ~~and 2019~~.

our estimated effective rate was primarily impacted by the overall valuation allowance position which reduced the net tax impact from taxable income or loss for all periods.

Under the provisions of ASC 740, we determined that there were approximately ~~$514,000~~$961,000 and ~~$673,000~~$763,000 of gross unrecognized tax benefits as of September 30, 2021 and December 31, 2020, respectively. Included in the balance of unrecognized tax benefits ~~including $235,000~~ ~~and $304,000~~ ~~of related interest and penalties,~~ ~~required to be recorded~~ ~~in other liabilities in the condensed consolidated balance sheets~~ as of September 30, ~~2020~~2021 and December 31, ~~2019,~~2020 were $241,000 and $278,000, respectively, of tax benefits that, if recognized, would impact the effective tax rate. Also included in the balance of unrecognized tax benefits as of September 30, 2021 and December 31, 2020 were $720,000 and $485,000, 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 $238,000 and $241,000, which were recorded in other liabilities as of September 30, 2021 and December 31, 2020, respectively. We believe that the total amounts of unrecognized tax benefits will not significantly increase or decrease within the next 12 months.

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Note 811. Commitments and Contingencies

~~Financial Condition and Liquidity~~

As described in Note 5 – 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 flexibility. The failure to maintain, extend, renew or replace the Purchase Agreement with a comparable arrangement or arrangements that provide similar amounts of liquidity for the Company would have a material negative impact on our overall liquidity, financial and operating results.

While a variety of factors related to sources and uses of cash, such as timeliness of accounts receivable collections, vendor credit terms, or significant collateral requirements, ultimately impact our liquidity, such factors may or may not have a direct impact on our liquidity, based on how the transactions associated with such circumstances impact the 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: The Credit Agreement currently matures in January 2021, but we may extend the maturity to January 2022 at our election in accordance with the Fifth Amendment. Our ability to renew or refinance the Credit Agreement after January 2022 or to enter into a new credit facility to replace or supplement the Credit Agreement may be limited due to various factors, including the status of our business, global credit market conditions, and perceptions of our business or industry by sources of financing. In addition, if credit is available, lenders may seek more restrictive covenants and higher interest rates that may reduce our borrowing capacity, increase our costs, or reduce our operating flexibility. The failure to extend, renew or replace the Credit Agreement beyond the current or ultimate maturity date of January 2022 (assuming we exercise all options to extend as provided by the Fifth Amendment) with a comparable credit facility that provides similar amounts of liquidity for the Company would have a material negative impact on our overall liquidity, financial and operating results.

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

~~Our working capital was $(11.3)~~ ~~million and $2.9~~ ~~million as of~~ ~~September 30, 2020 and December 31, 2019~~, respectively. Our current working capital deficit is due to the classification of the EnCap Credit Agreement as a current liability as discussed in Note 5 to the financial statements, although the Fifth Amendment to the Credit Agreement provides us the option to extend the maturity of the agreement. We intend to consider exercising the option at the appropriate time. 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.

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Legal Proceedings

Hamot et al. v. Telos Corporation

As previously ~~disclosed~~reported in Note 138 of the ~~Consolidated Financial Statements contained in our Annual Report on~~ Form ~~10-K~~10-Q for the ~~year~~quarter ended ~~December 31, 2019~~,June 30, 2021 filed on August 16, 2021, beginning on August 2, 2007, Messrs. Seth W. Hamot (“Hamot”) and Andrew R. 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”). Mr. Siegel iswas a Class D Director of the Company until the closing of the IPO on November 23, 2020, 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 own terms. As previously disclosed, trialTrial 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~~Siegel.

Table 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.~~Contents

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”)~~January 28, 2021, Plaintiffs filed ~~their latest~~a Motion for Leave to File Amended Motion for Indemnification of Legal Fees and Expenses ~~against the Company in the Circuit Court for Baltimore City and a Request for a Hearing.~~(“Amended Motion”). The Amended Motion ~~demands~~demanded that the Company indemnify the Plaintiffs for legal fees and expenses incurred in the sum of $~~2,540,000. The~~$2,540,000 plus the costs incurred in obtaining indemnification, and the Company ~~filed an Opposition to~~opposed the ~~Motion on November 4, 2020. The~~motions. On May 5, 2021, the Company, ~~denies that it has any liability for indemnification to the~~ Plaintiffs and ~~intends to vigorously defend~~Costa Brava entered into a settlement agreement, which included a mutual general release, fully and finally settling the ~~matter through an opposition to~~indemnification claim in exchange for a $1.0 million payment, which sum was paid on May 12, 2021 as reported under other income (expense) in our condensed consolidated statements of operations. This settlement concluded all open matters or disputes between the ~~Motion~~Company 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~~Messrs. Hamot (or his estate) and Siegel, ~~for indemnification for certain attorney’s fees and expenses incurred in this litigation. The Company intends to vigorously defend~~as well as the ~~matter.~~

previously disposed of claims of Costa Brava.

Other Litigation

~~In addition, the~~The Company ismay be a party to litigation from time to time 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 condensed consolidated financial position, results of operations or cash flows.

Other - Government Contracts

As a government contractor, we are subject to U.S. government audits and investigations relating to our operations, including claims for fines, penalties, and compensatory and damages. We believe the outcome of such ongoing government audits and investigations will not have a material impact on our results of operations, financial condition or cash flows.

In the performance of our contracts, we routinely request contract modifications that require additional funding from the customer. Most often, these requests are due to customer-directed changes in the scope of work. While we are entitle to recovery of these costs under our contracts, the administrative process with our customer may be protracted. Based on the circumstances, we periodically file requests for equitable adjustments ("REAs") that are sometimes converted into claims. In some cases, these requests are disputed by our customers. We believe our outstanding modifications, REAs and other claims will be resolved without material impact to our result of operations, financial conditions or cash flows.

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Note 912. Related Party Transactions

Emmett J. Wood, the brother of our Chairman and CEO, has been an employee of the Company since 1996. The amounts paid to this individual as compensation were $~~193,000~~$88,000 and $~~517,000~~$389,000 for the three and nine months ended September 30, 2021, respectively, and $193,000 and $517,000 for the three and nine months ended September 30, 2020,~~, respectively, and $110,000~~ ~~and $344,000~~ ~~for the~~ ~~three and nine months ended September 30, 2019~~, respectively. Additionally, ~~as of~~ ~~September 30, 2020 and December 31, 2019~~, Mr. Wood owned ~~810,000 shares~~ ~~of the Company’s Class A Common Stock~~ 73,562 and ~~50,000~~682,502 shares of the Company’s ~~Class B Common Stock.~~

common stock as of September 30, 2021 and December 31, 2020, respectively.

On March 31, 2015, the Company entered into the Porter Notes. At that time, Mr. Porter and Toxford Corporation, of which Mr. Porter controls as the co-trustee of the trust that is the sole ~~shareholder, own~~ stockholder of Toxford, owned 35.0% of our Class A Common Stock. Under the terms of the Porter Notes, Porter lent the Company $~~2.5~~$2.5 million on or about March 31, 2015. According to the original terms of the Porter Notes, the outstanding principal sum ~~bears~~bore interest at the fixed rate of twelve percent (~~12%~~(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~~.2015. The Porter Notes dodid not call for amortization payments and ~~are~~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~~. 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~~were fully subordinated to the Credit Agreement and any subsequent senior lenders, and payments under the Porter Notes ~~are~~were permitted only if certain conditions ~~are~~were met. All other terms ~~remain~~remained in full force and effect. We incurred interest expense in the amount of $90,000 and $265,000 for the three and nine months ended September 30, 2020, respectively,~~, and $83,000~~ ~~and $245,000~~ ~~for the~~ ~~three and nine months ended September 30, 2019, respectively,~~ on the Porter Notes. ~~As of~~ ~~September 30,~~On November 23, 2020,~~, approximately $1.2~~ ~~million of accrued interest was payable according to~~ upon the ~~stated interest rate~~closing of the IPO, the Porter ~~Notes.~~Notes were paid in full.

~~Note 10. Leases~~

~~We account for leases in accordance with ASC Topic 842, “Leases,” which requires lessees~~On February 8, 2021, we hired Ms. Donna Hill, as Director, Human Resources, reporting directly 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 facilities. Finance lease assets are recorded within property and equipment, net of accumulated depreciation. 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. Finance lease liabilities are classified according to contractual due dates.

~~The operating lease ROU assets and liabilities are recognized as~~Ms. Nakazawa, EVP of the ~~lease commencement date at~~Company. Ms. Hill is the ~~present value~~sister of Mr. Edward Williams, COO of the lease payments over the lease term. 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 ~~2.8~~ ~~years and~~ ~~5.75%~~ ~~and for our finance leases were approximately~~ ~~8.6~~ ~~years and~~ ~~5.04%~~ at ~~September 30, 2020~~. 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. We evaluate ROU assets for impairment consistent with our property and equipment policy disclosure included in our 2019 Form 10-K.

~~As of~~ ~~September 30, 2020, operating lease ROU assets were $1.6~~ ~~million and operating lease liabilities were $1.8~~ ~~million, of which $1.1~~ ~~million were classified as noncurrent.~~

Company.

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~~Future minimum lease commitments at~~ ~~September 30, 2020~~ ~~were as follows (in thousands):~~Note 13. Leases

Year ending December 31,

Operating Leases

Finance Leases

2020 (excluding the nine months ended September 30, 2020) $ 194 $ 517
2021 752 2,097
2022 592 2,149
2023 373 2,203
2024 27 2,258
After 2024 -- 10,658
Total lease payments 1,938 19,882
Less imputed interest (151 ) (3,924 )
Total $ 1,787 $ 15,958

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Operating lease cost	$	182	$	182	$	546	$	542
Short-term lease cost(1)	4		26		13		83
Finance lease cost
Amortization of right-of-use assets	305		305		915		915
Interest on lease liabilities	187		205		574		622
Total finance lease cost	492		510		1,489		1,537
Total lease costs	$	678	$	718	$	2,048	$	2,162

Three Months Ended September 30, Nine Months Ended September 30,

2020

2019

2020

2019

Operating lease cost $ 182 $ 160 $ 542 $ 454
Short-term lease cost (1) 26 42 83 126
Finance lease cost
Amortization of right-of-use assets 305 305 915 915
Interest on lease liabilities 205 219 622 666
Total finance lease cost 510 524 1,537 1,581
Total lease costs $ 718 $ 726 $ 2,162 $ 2,161

(1) Leases that have terms of 12 months or less

The weighted average remaining lease terms and discount rates were as follows:


	September 30,
	2021		2020
Weighted average remaining lease term (in years):
Finance leases	7.6 years		8.6 years
Operating leases	1.9 years		2.8 years
Weighted average discount rate:
Finance leases	5.04	%	5.04	%
Operating leases	5.75	%	5.75	%

Future minimum lease commitments at September 30, 2021 were as follows (in thousands):


Year Ending December 31,	Operating Leases		Finance Leases
2021 (excluding the nine months ended September 30, 2021)	$	181	$	530
2022	603		2,149
2023	373		2,202
2024	27		2,258
2025	—		2,314
After 2025	—		8,344
Total lease payments	1,184		17,797
Less imputed interest	(66)		(3,149)
Total	1,118		14,648
Less Short-term portion	602		1,430
Total, net of short-term portion	$	516	$	13,218

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


	Nine Months Ended September 30,					Nine Months Ended September 30,
	2020		2019			2021		2020
Cash paid for amounts included in the measurement of lease liabilities:					Cash paid for amounts included in the measurement of lease liabilities:
Cash flows from operating activities - operating leases	$	552	$	435	Cash flows from operating activities - operating leases	$	586	$	552
Cash flows from operating activities - finance leases		622		665	Cash flows from operating activities - finance leases	574		622
Cash flows from financing activities - finance leases		907		826	Cash flows from financing activities - finance leases	993		907
Operating lease right-of-use assets obtained in exchange for lease obligations		455		378	Operating lease right-of-use assets obtained in exchange for lease obligations	486		455

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Note 14 – Stock-Based Compensation

During October 2020, the Company amended the 2016 LTIP to increase the total number of shares available for issuance to 9,400,000 from 4,500,000 and extend the term to September 30, 2030. Our 2016 LTIP provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, unrestricted stock and dividend equivalent rights to our senior executives, directors, employees, and other service providers. Awards granted under the 2016 LTIP vest over the periods determined by the Board of Directors or the Compensation Committee of the Board of Directors, generally two to three years and stock options granted under the 2016 LTIP expire no more than ten years after the date of grant. Approximately 5.7 million shares of our common stock were reserved for future grants as of September 30, 2021 under the 2016 LTIP.

The following are the stock-based compensation expense incurred for the three and nine months ended September 30, 2021 (in thousands). We recorded immaterial share-based compensation expense for the comparative periods ended September 30, 2020.


	Three Months Ended September 30, 2021		Nine Months Ended September 30, 2021
Cost of sales - services	$	442	$	1,974
Sales and marketing	1,536		5,316
Research and development	970		2,079
General and administrative	9,243		37,828
Total	$	12,191	$	47,197

Restricted Stock Awards and Restricted Stock Unit (collectively “RSU”) Activity

The Company grants RSUs to our senior executives, directors and employees.

Service-Based RSU Awards

A summary of the awards of Service-Based RSUs that vest upon the completion of a service requirement are presented below:


	Number of Shares	Weighted- Average Grant Date Fair Value (per share)		Weighted- Average Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Unvested Balance - December 31, 2020	59,521	$	0.18	2.4	$	2,000
Granted	3,036,563	35.69		—	—
Vested	(119,800)	36.17		—	—
Forfeited	(79,476)	36.63		—	—
Unvested Balance - September 30, 2021	2,896,808	$	35.04	1.5	$	82,300

We recognized an expense of $12.0 million and $34.0 million related to share-based compensation expense for Service-Based RSUs capable of being earned for completing a service requirement during the three and nine months ended September 30, 2021, respectively. As of September 30, 2021, there was approximately $71.5 million of unrecognized stock-based compensation expense related to Service-Based RSUs, and this unrecognized expense is expected to be recognized over a weighted-average period of 1.5 years on a straight-line basis.

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Performance-Based RSU Awards

A summary of the awards of Performance-Based RSUs that vest upon the attainment of certain price targets of the Company’s common stock are presented below:


	Number of Shares	Weighted- Average Grant Date Fair Value (per share)		Weighted- Average Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Unvested Balance - December 31, 2020	—	$	—	—	$	—
Granted	508,903	30.09		—	—
Vested	—	—		—	—
Forfeited	(16,176)	30.84		—	—
Unvested Balance - September 30, 2021	492,727	$	30.07	2.5	$	14,000

During 2021 the Company granted certain senior executives awards of Performance-Based RSUs that could settle in 458,903 shares of our common stock. The awards will vest only if, during the three-year period from the date of grant, (a) the Company’s common stock, as listed on the Nasdaq Global Market, trades at or above $42.40 per share (the “Target Price”) for 20 of 30 consecutive trading days or (b) the weighted average of the per share price of the Company’s common stock over any 30 consecutive trading days is at least equal to the Target Price. Further, the Company granted 50,000 shares of Performance-Based RSUs to certain employees that will fully vest upon the achievement of certain operational milestones during a three-year period from the grant date.

For these Performance-Based RSUs containing market conditions, the conditions are required to be considered when calculating the grant date fair value. In order to reflect the substantive characteristics of these awards, a Monte Carlo simulation valuation model was used to calculate the grant date fair value of such awards. Monte Carlo approaches are a class of computational algorithms that rely on repeated random sampling to compute their results. This approach allows the calculation of the value of such Performance-Based RSUs based on a large number of possible stock price path scenarios. As the Company recently completed its IPO in November 2020, expected volatility was based on the average historical stock price volatility of comparable publicly-traded companies over the performance period. The risk-free rate is based on the U.S. treasury zero-coupon issues in effect at the time of grant over the performance period. Expense for these awards is recognized over the derived service period as determined through the Monte Carlo simulation model.

Our key assumptions include a performance period ranging from 2.45 to 2.92 years, expected volatility between 57.4% - 58.81%, and a risk-free rate of 0.18%-0.29%. The fair value at grant date and derived service periods calculated for these market condition Performance-Based RSUs were $19.12 - $30.84 and between 0.38 - 0.76 years, respectively.

We recognized an expense of $0.2 million and $13.2 million related to share-based compensation expense for these awards of Performance-Based RSUs during the three and nine months ended September 30, 2021, respectively. As of September 30, 2021, there was approximately $1.6 million of unrecognized stock-based compensation expense related to these Performance-Based RSUs, and this unrecognized expense is expected to be recognized over a weighted-average period of 0.3 years on a straight-line basis.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company’s actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth in the risk factors section included in the Company’s Form 10-K for the year ended December 31, ~~2019,~~2020, as filed with the SEC.

General and Business Overview

We offer technologically advanced, software-based security solutions that empower and protect the world’s most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats. Our portfolio of security products, services and expertise empower our customers with capabilities to reach new markets, serve their stakeholders more effectively, and successfully defend the nation or their enterprise. We protect our customers’ people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in their security and privacy.

Our mission is to protect our customers’ people, systems, and vital information assets with offerings for cybersecurity, cloud security, and enterprise security. In the current global environment, our mission is more critical than ever. The emergence of each new information and communications technology ~~(“ICT”~~("ICT") introduces new vulnerabilities, as security is still too often overlooked in solution development. Networks and applications meant to enhance productivity and profitability often jeopardize an organization due to poor planning, misconfiguration, or an unknown gap in security. Ransomware, insider threats, cybercrime, and advanced persistent threats continue to menace public and private enterprises across all industries.

Cybersecurity, cloud security, and enterprise security of the modern organization share much in common, yet also call for a diverse range of skills, capabilities, and experience in order to meet the requirements of security-conscious customers. Decades of experience in developing, orchestrating, and delivering solutions across these three domains gives us the vision and the confidence to provide solutions that empower and protect the enterprise at an integrated, holistic level. Our experience in addressing challenges in one area of an enterprise helps us meet requirements in others. We understand that a range of complementary capabilities may be needed to solve a single challenge, and we also recognize when a single solution might address multiple challenges.

Our security solutions span across the following domains:

•Cybersecurity – We help our customers ensure the ongoing security, integrity, and compliance of their on-premises and related cloud-based systems, reducing threats and vulnerabilities to foil cyber adversaries before they can attack. Our consultants assess our customers’ security environments and design, engineer, and operate the systems they need to strengthen their cybersecurity posture.

•Cloud Security – The cloud as an organizational resource is more than two decades old, yet the needs of cloud users are constantly changing. Telos offers the specialized skills and experience needed to help our customers plan, engineer, and execute secure cloud migration strategies and then assure ongoing management and security in keeping with the leading standards for cloud-based systems and workloads.

•Enterprise Security – Securing the enterprise means protecting the essential and timeless elements common to every organization: its people and processes, its supply chain and inventories, its finances and facilities, and its information and communications. As ICT and operational technology (“OT”) have become part of the organizational make-up, we have offered solutions that ensure personnel can work securely and productively across and beyond the enterprise.

We refer to our cyber and cloud applications as Security Solutions, which includes Information Assurance / Xacta® (previously referred to as Cyber & Cloud Solutions), Secure Communications (previously referred to as Secure Communications Cyber and Enterprise Solutions), and Telos ID (previously referred to as Telos ID Enterprise Solutions). We refer to our offerings for enterprise security as Secure Networks (previously referred to as Secure Mobility and Network Management/Defense Enterprise Solutions).

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Security Solutions

•	~~Information Assurance / Xacta:~~ a premier platform for enterprise cyber risk management and security compliance automation, delivering security awareness for systems in the cloud, on-premises, and in hybrid and multi-cloud environments. Xacta delivers automated cyber risk and compliance management solutions to large commercial and government enterprises. Across the U.S. federal government, Xacta is the de facto commercial cyber risk and compliance management solution.
•	~~Secure Communications:~~
	○	~~Telos Ghost:~~ a virtual obfuscation network-as-a-service with encryption and managed attribution capabilities to ensure the safety and privacy of people, information, and resources on the network. Telos Ghost seeks to eliminate cyber-attack surfaces by obfuscating and encrypting data, masking user identity and location, and hiding network resources. It provides the additional layers of security and privacy needed for intelligence gathering, cyber threat protection, securing critical infrastructure, and protecting communications and applications when operations, property, and even lives can be jeopardized by a single error in security.
	○	~~Telos Automated Message Handling System (“AMHS”):~~ web-based organizational message distribution and management for mission-critical communications; the recognized gold standard for organizational messaging in the U.S. government. Telos AMHS is used by military field operatives for critical communications on the battlefield and is the only web-based solution for assured messaging and directory services using the Defense Information System Agency’s (“DISA”) Organizational Messaging Service and its specialized communications protocols.
•	~~Telos ID:~~ offering Identity Trust and Digital Services through IDTrust360® – an enterprise-class digital identity risk platform for extending software-as-a-service (“SaaS”) and custom digital identity services that mitigate threats through the integration of advanced technologies that fuse biometrics, credentials, and other identity-centric data used to continuously monitor trust. We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck™ enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and the Financial Industry Regulatory Authority (“FINRA”) Electronic Fingerprint Submission provider. We are the only commercial entity in our industry designated as a Secure Flight Services provider for terrorist watchlist checks.

•Information Assurance / Xacta: a premier platform for enterprise cyber risk management and security compliance automation, delivering security awareness for systems in the cloud, on-premises, and in hybrid and multi-cloud environments. Xacta delivers automated cyber risk and compliance management solutions to large commercial and government enterprises. Across the U.S. federal government, Xacta is the de facto commercial cyber risk and compliance management solution.

•Secure Communications:

◦Telos Ghost: a virtual obfuscation network-as-a-service with encryption and managed attribution capabilities to ensure the safety and privacy of people, information, and resources on the network. Telos Ghost seeks to eliminate cyber-attack surfaces by obfuscating and encrypting data, masking user identity and location, and hiding network resources. It provides the additional layers of security and privacy needed for intelligence gathering, cyber threat protection, securing critical infrastructure, and protecting communications and applications when operations, property, and even lives can be jeopardized by a single error in security.

◦Telos Automated Message Handling System (“AMHS”): web-based organizational message distribution and management for mission-critical communications; the recognized gold standard for organizational messaging in the U.S. government. Telos AMHS is used by military field operatives for critical communications on the battlefield and is the only web-based solution for assured messaging and directory services using the DISA Organizational Messaging Service and its specialized communications protocols.

•Telos ID: offering Identity Trust and Digital Services through IDTrust360® – an enterprise-class digital identity risk platform for extending SaaS and custom digital identity services that mitigate threats through the integration of advanced technologies that fuse biometrics, credentials, and other identity-centric data used to continuously monitor trust. We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck® enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and FINRA Electronic Fingerprint Submission provider.

Secure Networks

•	~~Secure Mobility:~~ solutions for business and government that enable remote work and minimize concern across and beyond the enterprise. Our secure mobility team brings credentials to every engagement, supplying deep expertise and experience as well as highly desirable clearances and industry recognized certifications for network engineering, mobility, and security.
•	~~Network Management and Defense:~~ services for operating, administrating, and defending complex enterprise networks and defensive cyber operations. Our diverse portfolio of capabilities addresses common and uncommon requirements in many industries and disciplines, ranging from the military and government agencies to Fortune 500 companies.

•Secure Mobility: solutions for business and government that enable remote work and minimize concern across and beyond the enterprise. Our secure mobility team brings credentials to every engagement, supplying deep expertise and experience as well as highly desirable clearances and industry recognized certifications for network engineering, mobility, and security.

~~Backlog~~•Network Management and Defense: services for operating, administrating, and defending complex enterprise networks and defensive cyber operations. Our diverse portfolio of capabilities addresses common and uncommon requirements in many industries and disciplines, ranging from the military and government agencies to Fortune 500 companies.

~~Many~~

Business Environment

Our business performance continues to be heavily affected by the overall level of U.S. Government spending and the alignment of our ~~contracts~~solutions with the ~~U.S. Government are funded year to year by the procuring U.S. Government agency as determined by the fiscal requirements~~priorities of the U.S. Government. U.S. Government spending and contracts continue to be affected by the federal budget and appropriations process and related legislation. Due to delays in the passage of FY 2022 appropriations legislation, the federal government is operating under the terms of a Continuing Resolution ("CR"), which limits spending to the prior year’s funding levels and generally prohibits new spending initiatives and contract starts. The current CR will expire December 3, and unless the individual appropriations bills are enacted by then, another CR will be needed to avert a government shutdown.

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Cybersecurity Landscape

Despite the massive shift to teleworking by federal employees and contractors as a result of the pandemic, the government has successfully maintained continuity of services. More recently, as the government has proceeded to develop and implement its reopening process, officials have said they will seek to continue to maximize use of teleworking by federal employees. As such, with much of the business of government still being conducted by federal employees working remotely using information technology systems, we believe there will continue to be a need on the part of the government for the types of solutions and services provided by Telos.

Over the past year, continued and increasingly damaging ransomware and other cyberattacks against federal, state and local government and K-12 education (SLED), and higher education, and private sector enterprises have resulted in intensified efforts to better defend against such attacks. The growing demand for these solutions continues to provide Telos with the privilege of offering our expertise to protect these vitally important organizations.

Ransomware remains arguably the most severe cyber threat to enterprises in the commercial and SLED sectors. Our Xacta offering empowers these organizations and institutions to maintain a strong cyber risk posture to minimize the risk of ransomware gaining a foothold in their IT environment. Should ransomware get loose in the enterprise network, Telos Ghost, our virtual obfuscation network offering, can hide vital resources from view to prevent the payload from reaching them.

Critical infrastructure and industrial Internet of things are among the categories at greatest risk of cyberattacks. Energy, utilities, transportation, and food supply were among the critical infrastructure sectors that experienced high-profile breaches or ransomware attacks over the past year. Telos Ghost can hide critical OT and industrial control systems (ICS) from the public internet to keep them from being compromised. It can also cordon off financial data, medical records, intellectual property, and other crown-jewel assets from visibility or accessibility by adversaries.

Government mandates and initiatives to assure stronger security in highly regulated industries also lead to opportunities for Xacta. A pending update to the research study Telos conducted last year reveals that audit fatigue continues to burden these organizations, with automation solutions being recognized as the most effective remedy for the many repetitive and redundant tasks that security compliance requires. Xacta streamlines, harmonizes, and automates the security controls and processes that comprise the leading cybersecurity standards and frameworks, in on-premises, cloud, hybrid, and multi-cloud environments.

President Biden’s May 12 Executive Order on “Improving the Nation’s Cybersecurity” acknowledged the severity and scope of the cybersecurity challenges facing the public and private sectors, the American people and our economy. It gave direction for federal departments and agencies to modernize government cybersecurity by: moving more rapidly to adopt secure cloud services; adopting multifactor authentication; pushing for increased use in government of such practices as zero trust architecture; and improving the security and integrity of the software supply chain, with a priority on addressing critical software. The executive order also called for improving communications with cloud service providers through automation and standardization of messages at each stage of the Federal Risk and Authorization Management Program ("FedRAMP") process, and for other changes in an effort to accelerate and improve the process.

Subsequently, federal agencies, including the Cybersecurity & Infrastructure Security Agency and the ~~respective procuring agency.~~Transportation Security Administration, which have specific responsibilities for various aspects of government and private sector cybersecurity, have taken steps to enhance public sector and critical infrastructure cybersecurity.

Congress has given final approval to a $1.2 trillion infrastructure package which contains a number of provisions dealing with cybersecurity and would provide considerable funding for infrastructure-related cybersecurity. We believe many of these actions could ultimately result in increased need for solutions and services provided by Telos. Congress is also considering a potentially $2 trillion budget reconciliation measure that could, among other things, also boost federal support for cybersecurity and provide additional opportunities for Telos.

For example, Telos Ghost is a perfect complement to zero trust security, creating an additional layer of defense against intruders by hiding critical resources and users in an anonymous undiscoverable network. As noted earlier, it is also ideal for protecting the crown-jewel assets of critical infrastructure from unauthorized access. Xacta streamlines and automates the critical processes of the leading cybersecurity standards and frameworks, in particular FedRAMP, allowing all process participants to collaborate within the same Xacta application to attain a FedRAMP Authority to Operate. Xacta is also a trailblazer in adopting the Open Security Controls Assessment Language, a multi-format framework adopted by FedRAMP to allow security professionals to automate security assessment, auditing, and continuous monitoring processes.

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Finally, as a whole, the COVID-19 pandemic has resulted in acceleration of digital transformation and cloud adoption within the government and beyond, which will likely increase demand for Xacta and Telos Ghost. Xacta is engineered to manage risk and compliance of complex cloud and multi-cloud environments, a key capability for federal agencies and regulated industries that need to gain and maintain compliance with cloud-specific security regulations. Telos Ghost is a cloud-native, as-as-service offering that delivers network obfuscation and managed attribution capabilities on a global scale to support the cloud-enabled enterprise.

COVID-19 Pandemic

The coronavirus disease 2019 ("COVID-19") pandemic has 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 basis.

The ongoing 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. On September 24, 2021, Executive Order 14042 on Ensuring Adequate COVID Safety Protocols for Federal Contractors was issued requiring, amongst other things, all employees, sub-contractors and vendors working on certain federal contracts or who do work related to these federal contracts be fully vaccinated by December 8, 2021. While that deadline to be fully vaccinated has been pushed back to January 18, 2022, this new requirement may negatively impact our ability to hire and retain talent, and to utilize certain sub-contractors and/or vendors to meet our customer demands and/or contractual requirements.

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

Backlog

We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts. We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers. In the context of our current customer portfolio, we view “recurring revenue” as revenue that occurs often and repeatedly. In each of the last three years, recurring revenue has exceeded 85% of our annual revenue.

Total backlog, a component of recurring revenue, consists of the aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or unfunded. Funded backlog consists of the aggregate contract revenues remaining to be earned at a given time, which, in the case of U.S. government contracts, means that they have been funded by the procuring agency. Unfunded backlog is the difference between total backlog and funded backlog and includes potential revenues that may be earned if customers exercise delivery orders and/or renewal options to continue these contracts. Based on historical experience, we generally assume option year renewals to be exercised. Most of our customers fund contracts on a basis of one year or less and, as a result, funded backlog is generally expected to be earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period.

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A number of contracts that we undertake extend beyond one year and, accordingly, portions of contracts are carried forward from one year to the next as part of the backlog. Because many factors affect the scheduling and continuation of projects, no assurance can be given as to when revenue will be realized on projects included in our backlog.

At September 30, 2020 and 2019, we had total backlog from existing contracts of approximately $374.6 million and $307.5 million, respectively. Such backlog was $354.5 million at December 31, 2019. Such amounts are the maximum possible value of additional future orders for systems, products, maintenance and other support services presently allowable under those contracts, including renewal options available on the contracts if fully exercised by the customers.

~~Funded backlog as of September 30, 2020 and 2019 was $147.0 million and $104.0 million, respectively. Funded backlog was $112.4 million at December 31, 2019.~~

While backlog remains a measurement consideration, in recent years we, as well as other U.S. Government contractors, experienced a material change in the manner in which the U.S. Government procures equipment and services. These procurement changes include the growth in the use of General Services Administration ("GSA") schedules which authorize agencies of the U.S. Government to purchase significant amounts of equipment and services. The use of the GSA schedules results in a significantly shorter and much more flexible procurement cycle, as well as increased competition with many companies holding such schedules. Along with the GSA schedules, the U.S. Government is awarding a large number of omnibus contracts with multiple awardees. Such contracts generally require extensive marketing efforts by the multiple awardees to procure business under the omnibus contract through separate task or delivery orders. The use of GSA schedules and omnibus contracts, while generally not providing immediate backlog, provide areas of growth that we continue to aggressively pursue.

Consolidated Results of Operations (Unaudited)

The accompanying condensed consolidated financial statements include the accounts of Telos Corporation and its subsidiaries including Ubiquity.com, Inc., Xacta Corporation, Teloworks, Inc., and Telos APAC Pte. Ltd., all of whose issued and outstanding share capital is owned by Telos Corporation (collectively, the “Company” or “Telos” or “We”). We have also consolidated the results of operations of Telos ID (see Note 2 – Non-controlling Interests). All intercompany transactions have been eliminated in consolidation.

Our operating cycle involves many types of solutions, product and service contracts with varying delivery schedules. Accordingly, results of a particular quarter, or quarter-to-quarter comparisons of recorded sales and operating profits may not be indicative of future operating results and the following ~~comparative analysis should therefore be viewed in such context.~~

Our revenues are generated from a number of contract vehicles and task orders. Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product reselling to that of an advanced solutions technologies provider. To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and delivering Telos manufactured and branded technologies. We believe our contract portfolio is characterized as having low to moderate financial risk due to the limited number of long-term fixed price development contracts. Our firm fixed-price activities consist principally of contracts for the products and services at established contract prices. Our time-and-material contracts generally allow the pass-through of allowable costs plus a profit margin.

We provide different solutions and are party to contracts of varying revenue types under the NETCENTS (Network-Centric Solutions) and NETCENTS-2 contracts to the U.S. Air Force. NETCENTS and NETCENTS-2 are IDIQ and GWAC, therefore any government customer may utilize the NETCENTS and NETCENTS-2 vehicles to meet its purchasing needs. Consequently, revenue earned on the underlying NETCENTS and NETCENTS-2 delivery orders varies from period to period according to the customer and solution mix for the products and services delivered during a particular period, unlike a standalone contract with one separately identified customer. The contracts themselves do not fund any orders and they state that the contracts are for an indefinite delivery and indefinite quantity. The majority of our task/delivery orders have periods of performance of less than 12 months, which contributes to the variances between interim and annual reporting periods. We have also been awarded other IDIQ/GWACs, including the Department of Homeland Security’s EAGLE II, GSA Alliant 2, and blanket purchase agreements under our GSA schedule.

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U.S. Government appropriations have been and continue to be affected by larger U.S. Government budgetary issues and related legislation. In 2011, Congress enacted the Budget Control Act of 2011 (the “BCA”), which established specific limits on annual appropriations for fiscal years 2012-2021. The BCA has been amended a number of times, most recently by the Bipartisan Budget Act of 2019 (the “BBA”), which was enacted on August 2, 2019. As a result, DoD funding levels have fluctuated over this period and have been difficult to predict. Most recently, while the two-year BBA allowed for modestly increased defense spending in FY 2020, unless and until it is again modified, the BBA also essentially will maintain defense spending in FY 2021 with only a minor increase (less than one percent) permitted above the current FY 2020 appropriated funding level.

According to the Office of Management and Budget, federal outlays devoted to defense programs have fallen from 4.5 percent to 3.2 percent as a share of Gross Domestic Product (GDP) since enactment of the BCA. Moreover, as a result of the spending caps imposed by the BCA, annual DoD budget authority in FY 2020 is only 3.7 percent higher (in unadjusted dollars) than it was a decade ago in FY 2010.

Since final enactment in December 2019 of appropriations legislation for FY 2020, and the February 10, 2020 submission of the President’s proposed FY 2021 budget, the Coronavirus pandemic and associated economic dislocation in the United States has resulted in the need for an overwhelming federal response. This has led to the enactment of several comprehensive appropriations and economic stimulus measures, as well as negotiations between Congress and the White House for additional massive initiatives for the current year and into the next fiscal year, the details of which are not yet finalized. These substantial alterations to FY 2020 spending baselines are also likely to further impact FY 2021 spending in ways that cannot be predicted. The impact of the health and economic crisis, and the resulting large increase in federal spending, on the government contracts that we hold and the federal procurements that we would otherwise compete for cannot be known.

In addition to the ongoing need to respond to the crisis in the current fiscal year, Congress and the President must agree on FY 2021 appropriations legislation prior to December 11, 2020; failing to do so by then would likely mean DoD and other departments will again be funded for an unknown period of time under another Continuing Resolution, which would again restrict new spending initiatives. This is consistent with the practice for a number of years where the U.S. Government has been unable to complete its appropriations process prior to the beginning of the next fiscal year, resulting in actual or threatened governmental shut-downs and repeated use for extended time periods each year of Continuing Resolutions to fund part or all of the government. The impact of the substantial additional spending on the Coronavirus pandemic on the appropriations for FY 2021, and the appropriations process itself, is not known.

The current health and economic crisis is highly fluid, and it is likely to continue to affect multiple federal departments and agencies for an unknown period of time and in ways that are difficult to predict. Nonetheless, we believe that the federal government will very likely endeavor to maintain continuity of services and, with much of the business of government now being conducted through use of information technology systems and in many cases during the crisis remotely, we believe there will still be a need on the part of the government for the types of solutions and services provided by Telos.

We anticipate there will continue to be a significant amount of debate and negotiations within the U.S. Government over federal and defense spending, and these deliberations may be impacted by the health and economic impacts of the COVID-19 pandemic in ways that are at this time difficult to foresee. In the context of these negotiations, it is possible that the U.S. Government, or portions of the U.S. Government, could be shut down or disrupted for periods of time, and that government programs could be modified, cut or replaced as part of broader reforms to reduce the federal deficit or efforts to redirect federal spending, whether related or unrelated to the COVID-19 crisis. For more information on the risks and uncertainties related to U.S. Government contracts, see Part I – Item 1A Risk Factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019.

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~~The principal elements of the Company’s operating expenses~~table sets forth selected data as a percentage of sales for the three and nine months ended September 30, ~~2020~~2021 and ~~2019~~2020 are as follows:

Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
(unaudited)

Revenue 100.0% 100.0% 100.0% 100.0%
Cost of sales 65.1 64.2 65.7 68.7
Selling, general, and administrative expenses 25.4 23.4 26.9 27.9
Operating income 9.5 12.4 7.4 3.4
Other income ---- ---- ---- 0.2
Interest expense (4.2) (4.3) (4.5) (4.9)
Income (loss) before income taxes 5.3 8.1 2.9 (1.3)
Benefit from income taxes ---- ---- 0.1 0.2
Net income (loss) 5.3 8.1 3.0 (1.1)
Less: Net income attributable to non-controlling interest (5.7) (3.2) (4.6) (1.5)
Net (loss) income attributable to Telos Corporation (0.4)% 4.9% (1.6)% (2.6)%


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(unaudited)				(unaudited)

Revenue	100.0	%	100.0%		100.0%		100.0%
Cost of sales	62.8		65.1		65.8		65.7
Selling, general and administrative expenses	44.7		25.4		55.1		26.9
Operating (loss) income	(7.5)		9.5		(20.9)		7.4
Other income (expense)	—		—		(0.6)		—
Interest expense	(0.2)		(4.2)		(0.3)		(4.5)
(Loss) income before income taxes	(7.7)		5.3		(21.8)		2.9
Benefit from (provision for) income taxes	—		—		—		0.1
Net (loss) income	(7.7)		5.3		(21.8)		3.0
Less: Net income attributable to non-controlling interest	—		(5.7)		—		(4.6)
Net loss attributable to Telos Corporation	(7.7)	%	(0.4)	%	(21.8)	%	(1.6)	%

Three Months Ended September 30, ~~2020~~2021 Compared with Three Months Ended September 30, ~~2019~~2020

Revenue increased by ~~4.2%~~47.7% to ~~$47.4~~$70.1 million for the third quarter of ~~2020,~~2021, from ~~$45.5~~$47.4 million for the same period in ~~2019. Services~~2020. Revenue for the third quarter, excluding the contract with the U.S. Census Bureau of $1.6 million in 2021 and $9.4 million in 2020, would have grown by 79.9% in the current quarter compared with prior year same period. Security Solutions revenue ~~increased to $44.2~~was $35.7 million and $31.2 million for the third quarter of 2021 and 2020, respectively. This increase of approximately 14.4% was driven primarily by the increases in sales of Telos ID and Information Assurance offerings, offset by the decrease in Secure Communications offerings. Secure Networks revenue was $34.4 million and $16.2 million for the third quarter of 2021 and 2020, respectively. This increase of approximately 112.3% resulted from ~~$39.2~~various contracts with the DoD, primarily in our Secure Mobility Solutions offerings. Due to the various solutions offerings within the business groups, sales may vary from period to period according to the solution mix and timing of deliverables for a particular period.

Cost of sales increased by 42.5% to $44.0 million for the third quarter of 2021, from $30.9 million for the same period in ~~2019, primarily attributable to~~2020 as a result of increases in revenue. Cost of sales of $2.5 million by Telos ID, $2.1 million by Assurance / Xacta, and $1.7 million by Secure Communications, offset by a decrease in sales of $1.3 million by Secure Networks. The change in product and services revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables. Product revenuefor Security Solutions decreased to ~~$3.3~~$15.3 million (inclusive of $0.4 million of stock-based compensation) for the third quarter of ~~2020~~2021 from ~~$6.3~~$17.2 million for the same period in ~~2019, primarily attributable to decreases~~2020 (which had no stock-based compensation), which translates as a decrease in ~~sales of $2.5 million by Assurance / Xacta and $0.6 million by Telos ID, offset by an increase in sales of $0.1 million by Secure Communications.~~

~~Cost of sales increased to $30.9 million for~~ the ~~third quarter of 2020, from $29.2 million for the same period in 2019, primarily due to an increase in revenue of $1.9 million, coupled with an increased~~ cost of sales as a percentage of revenue ~~of 0.9%. Cost of sales for services increased by $2.0 million, and as a percentage of services revenue decreased by 3.0%~~to 42.9% from 55.1%, due to a change in the mix and nature of the ~~programs and timing of certain deliverables.~~programs. Cost of sales for ~~products decreased by $0.4~~Secure Networks increased to $28.7 million ~~and as a percentage~~(inclusive of ~~product revenue~~$0.1 million stock-based compensation) for the third quarter of 2021 from $13.7 million for the same period in 2020 (which had no stock-based compensation). While the cost of sales increased ~~by 27.4% due primarily~~between periods, the sales mix improved, which translates to a decrease in ~~proprietary software sales which carry lower cost of sales. The increase in~~the cost of sales as a percentage of revenue ~~is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary~~to 83.4% from ~~period to period, and further can be affected by the timing of deliverables.~~

84.6%.

Gross profit increased by ~~1.5%~~57.4% to ~~$16.6~~$26.1 million for the third quarter of ~~2020~~2021 from ~~$16.3~~$16.6 million for the same period in ~~2019.~~2020. Gross ~~margin decreased to 34.9% in the third quarter of 2020, from 35.8%~~profit for ~~the same period in 2019. Services gross margin~~Security Solutions increased to 35.2% in 2020 from 32.2% in 2019 due to the change in program mix during the period as noted above, and product gross margin decreased to 31.0% in 2020 from 58.4% in 2019, due primarily to a decrease in proprietary software sales.

~~Selling, general, and administrative expense (SG&A) increased by 13.3% to $12.0~~$20.4 million for the third quarter of ~~2020,~~2021 from ~~$10.6~~$14.0 million for the same period in ~~2019, primarily attributable~~2020. Gross profit for Secure Networks increased to increases in labor costs of $1.6 million, outside services of $1.6 million, legal costs of $0.4 million, and trade shows of $0.1 million, offset by a increase in capitalized software development costs of $1.4 million, and decreases in accrued bonuses of $0.7 million and travel costs of $0.2 million.

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~~Operating income decreased by 20.5% to $4.5~~$5.7 million for the third quarter of ~~2020,~~2021 from ~~$5.7~~$2.6 million for the same period in ~~2019,~~2020. Gross margin increased to 37.2% for the third quarter of 2021 from 34.9% for the same period in 2020, due ~~primarily~~ to ~~an increase~~various changes in ~~SG&A~~the mix of higher profit margin contracts in all business lines as ~~noted~~discussed above. Gross margin for Security Solutions increased to 57.1% for the third quarter of 2021 from 44.9% for the same period in 2020. Gross margin for Secure Networks increased to 16.6% for the third quarter of 2021 from 15.8% for the same period in 2020.

~~Interest~~Selling, general, and administrative (“SG&A”) expense increased by ~~2.2%~~160.0% to ~~$2.0~~$31.3 million for the third quarter of 2021, from $12.0 million for the same period in 2020, primarily attributable to increases in stock-based compensation of $11.8 million, labor costs of $5.5 million, and outside services of $1.2 million.

Operating loss was $5.3 million for the third quarter of 2021, compared to $4.5 million operating income for the same period in 2020, primarily due to the stock-based compensation expense related to the RSUs granted in fiscal year 2021.

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Interest expense decreased by 90.3% to $0.2 million for the third quarter of 2021, from $2.0 million for the same period in ~~2019,~~2020, primarily due to ~~an increase in interest on~~the repayment of the EnCap ~~senior term loan.~~

loan, subordinated debt, and redemption of public preferred stock upon the closing of our IPO in November 2020.

Income tax ~~provision~~benefit was ~~$8,000~~$41,000 for the third quarter of ~~2020,~~2021, compared to $8,000 income tax ~~benefit of $10,000~~provision for the same period in ~~2019,~~2020, which is based on the estimated annual effective tax rate applied to the pretax ~~income~~loss incurred for the quarter plus discreet tax items, based on our expectation of pretax loss for the fiscal year.

Net loss attributable to Telos Corporation was ~~$0.2~~$5.4 million for the third quarter of ~~2020,~~2021, compared to ~~a net income of $2.2~~$0.2 million for the same period in ~~2019,~~2020, primarily ~~attributable~~due to the ~~decrease~~stock-based compensation recorded in ~~operating income for~~ the third quarter of 2021 as ~~discussed~~mentioned above.

Nine Months Ended September 30, ~~2020~~2021 Compared with Nine Months Ended September 30, ~~2019~~2020

Revenue increased by ~~19.8%~~32.1% to ~~$135.0~~$178.4 million for the nine months ended September 30, ~~2020,~~2021, from ~~$112.7~~$135.0 million infor the same period in ~~2019. Services~~2020. Revenue, excluding the contract with the U.S. Census Bureau of $4.2 million in 2021 and $29.9 million in 2020, would have grown by 65.8% year-over-year. Security Solutions revenue ~~increased to $124.2~~was $89.7 million and $92.5 million for the nine months ended September 30, 2021 and 2020, ~~from $101.6 million for the same period in 2019,~~respectively. This decrease of approximately 3.0% was driven primarily ~~attributable to increases~~by decreases in sales of ~~$15.7 million by~~offerings in Telos ID, ~~$6.8 million by~~as the Census contract ramps down, and Secure ~~Communications, and $1.5 million by Assurance / Xacta,~~Communication offerings, offset by ~~a decrease~~an increase in ~~sales of $1.4~~Information Assurance offerings. Secure Networks revenue was $88.7 million ~~by Secure Networks. The change in product~~ and ~~services revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables. Product revenue decreased to $10.8~~$42.5 million for the nine months ended September 30, 2021 and 2020, respectively. This increase of approximately 108.7% resulted from ~~$11.1 million~~various contracts with the DoD, primarily in our Secure Mobility Solutions offerings. Due to the various solutions offerings within the business groups, sales may vary from period to period according to the solution mix and timing of deliverables for the same period in 2019, primarily attributable to decreases in sales of $0.7 million by Assurance / Xacta and $0.3 million by Secure Communications, offset by an increase in sales of $0.7 million by Telos ID.

a particular period.

Cost of sales increased by ~~14.5%~~32.4% to ~~$88.7~~$117.4 million for the nine months ended September 30, ~~2020,~~2021, from ~~$77.4~~$88.7 million for the same period in ~~2019, primarily due~~2020 as a result of increases in revenue. Cost of sales for Security Solutions decreased to ~~an increase~~$44.5 million (inclusive of $1.7 million of stock-based compensation) for the nine months ended September 30, 2021 from $53.8 million for the same period in ~~revenue of $22.3 million, however~~2020 (which had no stock-based compensation), which translates as a decrease in the cost of sales as a percentage of revenue ~~decreased by 3.0%. Cost of sales for services increased by $10.9 million, and as a percentage of services revenue decreased by 4.1%~~to 49.6% from 58.2%, due ~~primarily~~ to a change in the mix and nature of the ~~programs and timing of certain Telos ID deliverables.~~programs. Cost of sales for ~~products~~Secure Networks increased byto $72.9 million (inclusive of $0.3 million ~~and~~of stock-based compensation) for the nine months ended September 30, 2021 from $34.9 million for the same period in 2020 (which had no stock-based compensation), which translates as ~~a percentage of product revenue increased by 4.4% due primarily to a decrease~~an increase in ~~proprietary software sales which carry lower cost of sales. The decrease in~~the cost of sales as a percentage of revenue ~~is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary~~to 82.2% from ~~period to period, and further can be affected by the timing of deliverables.~~

82.1%.

Gross profit increased by ~~31.4%~~31.5% to ~~$46.4~~$61.0 million for the nine months ended September 30, ~~2020,~~2021 from ~~$35.3~~$46.4 million ~~compared to~~for the same period in ~~2019,~~2020. Gross profit for Security Solutions increased to $45.2 million for the nine months ended September 30, 2021 from $38.7 million for the nine months ended September 30, 2020. Gross profit for Secure Networks increased to $15.8 million for the nine months ended September 30, 2021 from $7.6 million for the nine months ended September 30, 2020. Gross margin decreased to 34.2% as of the third quarter of 2021 from 34.3% for the same period in 2020, due ~~primarily~~ to ~~the change~~various changes in the mix of ~~the solutions sold~~contracts in all business lines as discussed ~~above, primarily in Telos ID.~~above. Gross margin for Security Solutions increased to ~~34.3%~~50.4% as of the third quarter of 2021 from 41.8% for the same period in 2020. Gross margin for Secure Networks decreased to 17.8% as of the third quarter of 2021 from 17.9% for the same period in 2020.

SG&A expense increased by 170.1% to $98.3 million for the nine months ended September 30, 2021, from $36.4 million for the same period in 2020, primarily attributable to increases in stock-based compensation of $45.2 million, labor costs of $11.9 million, outside services of $3.2 million, insurance costs of $1.0 million, and trade show costs of $1.1 million, offset by the decrease in bonus costs of $1.6 million.

Operating loss was $37.3 million for the nine months ended September 30, 2021, compared to $10.0 million of operating income for the same period in 2020, primarily due to the stock-based compensation recorded as of the third quarter of 2021 as mentioned above.

Other expense for the nine months ended September 30, 2021 was $1.0 million compared to $14,000 of other income for the nine months ended September 30, 2020 ~~from 31.3% in~~was as a result of the ~~same period in 2019.~~settlement of outstanding litigation.

~~SG&A~~Interest expense ~~increased~~decreased by ~~15.8%~~90.3% to ~~$36.4~~$0.6 million for the nine months ended September 30, ~~2020,~~2021, from ~~$31.4~~$6.0 million for the same period in ~~2019,~~2020, primarily ~~attributable~~due to ~~increases~~the repayment of the EnCap loan, subordinated debt, and redemption of public preferred stock upon the closing of our IPO in ~~outside services~~November 2020.

Table of $4.2 million, labor costs of $3.6 million, software maintenance costs of $0.2 million, accrued bonuses of $0.2 million, recruiting fees of $0.2 million, and legal costs of $0.1 million, offset by an increase in capitalized software development costs of $3.3 million, and a decrease in travel costs of $0.4 million.Contents

~~Operating income increased by 157.8% to $10.0 million~~Income tax provision was $6,000 for the nine months ended September 30, ~~2020, from $3.9 million~~2021, compared to $136,000 income tax benefit for the same period in ~~2019, due primarily to an increase in gross profit as noted above.~~

~~Interest expense increased by 10.2% to $6.0 million for the nine months ended September 30,~~ 2020, ~~from $5.5 million for the same period in 2019, primarily due to an increase in interest on the EnCap senior term loan.~~

~~Income tax benefit was $136,000 for the nine months ended September 30, 2019, compared to $187,000 for the same period in 2019,~~ which is based on the estimated annual effective tax rate applied to the pretax loss incurred for the nine ~~month~~months period plus discreet tax items, ~~adjusted for the income tax benefit previously provided,~~ based on our expectation of pretax loss for the fiscal year.

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Net loss attributable to Telos Corporation was ~~$2.2~~$38.9 million for the nine months ended September 30, ~~2020,~~2021, compared to ~~$2.9~~$2.2 million for the same period in ~~2019,~~2020, primarily attributable to the stock-based compensation recorded in 2021 as mentioned above.

Balance Sheet Review

Assets

The Company's total assets as of September 30, 2021 were $242.7 million compared to $183.8 million as of December 31, 2020. The increase in total assets was primarily attributable to an increase in cash and cash equivalents provided by the follow-on offering, an increase in accounts receivables due to higher revenue generation and increase in intangible assets and goodwill as a result of the acquisition during the nine months ended September 30, 2021.

Liabilities

The Company's total liabilities as of September 30, 2021 were $71.2 million compared to $56.7 million as of December 31, 2020. The increase in total liabilities was primarily attributable to the increase in ~~operating income~~accounts payable and other accrued liabilities as ~~discussed above,~~a result of the increase in cost of sales as of September 30, 2021.

Equity

As of September 30, 2021, the Company had a total equity of $171.5 million compared to $127.1 million as of December 31, 2020. The increase in equity is primarily driven by the follow-on offering that raised $64.3 million and stock-based compensation of $47.2 million; offset by the repurchase of the common stock and outstanding warrants held by EnCap for $1.3 million and $26.9 million, respectively. The Company reported a net loss of $38.9 million for the nine months ended September 30, 2021.

Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we believe the non-GAAP financial measures of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow are useful in evaluating our operating performance. We believe that this non-GAAP financial information, when taken collectively with our GAAP results, may be helpful to readers of our financial statements because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results. The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled non-GAAP measures used by other companies. A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP.

We use the following non-GAAP financial measures to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, to develop short-term and long-term operating plans, and to evaluate the performance of certain management personnel when determining incentive compensation. We believe these non-GAAP financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionate positive or negative impact on our results of operations in any particular period. When viewed in combination with our results prepared in accordance with GAAP, these non-GAAP financial measures help provide a broader picture of factors and trends affecting our results of operations.

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Enterprise EBITDA and Adjusted EBITDA

Both Enterprise EBITDA and Adjusted EBITDA are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, an ~~increase~~alternative to net loss as determined by GAAP. We define Enterprise EBITDA as net loss attributable to Telos Corporation, adjusted for net income attributable to ~~noncontrolling interest.~~non-controlling interest, non-operating (income) expense, interest expense, provision for (benefit from) income taxes, and depreciation and amortization. We define Adjusted EBITDA as Enterprise EBITDA, adjusted for transaction gains/losses/expenses related to our IPO and stock-based compensation expense.

A reconciliation of net loss attributable to Telos Corporation to Enterprise EBITDA and Adjusted EBITDA, the most directly comparable GAAP measure, is as follows (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net loss attributable to Telos Corporation	$	(5,387)	$	(200)	$	(38,894)	$	(2,178)
Adjustments:
Net income attributable to non-controlling interest	—		2,694		—		6,284
Non-operating (income) expense	(20)		(2)		1,001		(14)
Interest expense	195		2,013		583		6,026
(Benefit from) provision for income taxes	(41)		8		6		(136)
Depreciation and amortization	1,459		1,284		4,223		4,018
Enterprise EBITDA	(3,794)		5,797		(33,081)		14,000
Stock-based compensation expense	12,191		4		47,197		4
Adjusted EBITDA	$	8,397	$	5,801	$	14,116	$	14,004

Adjusted Net Income (Loss) and Adjusted EPS

Adjusted Net Income (Loss) and Adjusted EPS are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, alternatives to net income (loss) as determined by GAAP. We define Adjusted Net Income (Loss) as net income (loss) attributable to Telos Corporation, adjusted for non-operating expense (income) and stock-based compensation expense. We define Adjusted EPS as Adjusted Net Income (Loss) divided by the weighted-average number of common shares outstanding for the period.

A reconciliation of net loss attributable to Telos Corporation to Adjusted Net Income (Loss) and Adjusted EPS, the most directly comparable GAAP measure, is as follows:


Three Months Ended September 30,	2021				2020
	Adjusted Net Income (Loss)		Adjusted Earnings Per Share		Adjusted Net Income (Loss)		Adjusted Earnings Per Share
	(in thousands)				(in thousands)
Reported GAAP measure	$	(5,387)	$	(0.08)	$	(200)	$	(0.01)
Adjustments:
Non-operating income	(20)		—		(2)		—
Stock-based compensation expense	12,191		0.18		4		—
Adjusted non-GAAP measure	$	6,784	$	0.10	$	(198)	$	(0.01)
Weighted-average shares of common stock outstanding	66,755				39,002

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Nine Months Ended September 30,	2021				2020
	Adjusted Net Income (Loss)		Adjusted Earnings Per Share		Adjusted Net Income (Loss)		Adjusted Earnings Per Share
	(in thousands)				(in thousands)
Reported GAAP measure	$	(38,894)	$	(0.59)	$	(2,178)	$	(0.06)
Adjustments:
Non-operating expense (income)	1,001		0.01		(14)		—
Stock-based compensation expense	47,197		0.72		4		—
Adjusted non-GAAP measure	$	9,304	$	0.14	$	(2,188)	$	(0.06)
Weighted-average shares of common stock outstanding	65,999				38,554

Free Cash Flow

Free cash flow, as reconciled in the table below, is a non-GAAP financial measure defined as net cash provided by or used in operating activities, less capital expenditure and adjusted for the final distribution to Telos ID Class B members included in cash from operating activities. This non-GAAP financial measure may be a useful measure for investors and other users of our financial statements as a supplemental measure of our cash performance and assess the quality of our earnings as a key performance measure in evaluating management.


Nine Months Ended September 30,	2021		2020
	(in thousands)		(in thousands)
Net cash flows provided by operating activities	$	6,668	$	11,957
Adjustments:
Capital expenditure	(7,784)		(6,083)
Final distribution to Telos ID Class B member - included in cash from operating activities	2,436		—
Free cash flow	$	1,320	$	5,874

Each of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow has limitations as an analytical tool, and you should not consider any of them in isolation, or as a substitute for analysis of our results as reported under GAAP. Among other limitations, each of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow does not reflect our future requirements for capital expenditures or contractual commitments, does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations, and does not reflect income tax expense or benefit. Other companies in our industry may calculate Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow differently than we do, which limits its usefulness as a comparative measure. Because of these limitations, neither Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS nor Free Cash Flow should be considered as a replacement for net income (loss), earnings per share or net cash flows provided by operating activities, as determined by GAAP, or as a measure of our profitability. We compensate for these limitations by relying primarily on our GAAP results and using non-GAAP measures only for supplemental purposes.

Liquidity and Capital Resources

~~As described~~Upon the closing of the IPO in ~~Note 5 – Current Liabilities and Debt Obligations,~~November 2020, 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 eligibilityissued 17.2 million shares of our ~~receivables,~~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 ~~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~~net proceeds in connection with the ~~Purchase Agreement, we would need to obtain additional credit~~ERPS Conversion (see Note 9 – Exchangeable Redeemable Preferred Stock Conversion), $30.0 million to fund our ~~future operations. If credit~~acquisition of the outstanding Class B Units of Telos ID (see Note 3 – Non-controlling Interests / Purchase of Telos ID), and $21.0 million to repay our outstanding senior term loan and subordinated debt (see Note 8 – Debt Obligations).

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On April 6, 2021, we completed our follow-on offering of 9.1 million shares of our common stock at a price of $33.00 per share, including 7.0 million shares of common stock by certain existing stockholders of Telos. The offering generated approximately $64.3 million of net proceeds to Telos. We did not receive any proceeds from the shares of common stock sold by the selling stockholders. On April 19, 2021, we used approximately $1.3 million of the net proceeds to repurchase 39,682 shares of our common stock and $26.9 million to repurchase warrants to purchase 900,970 shares our common stock owned by EnCap (see Note 8 - Debt Obligations). Further, on July 30, 2021, we used approximately $5.9 million of the net proceeds to acquire the assets of DFT (see Note 4 - Acquisition).

We intend to use the remaining net proceeds of the IPO and the follow-on offering for general corporate purposes. We also may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies. The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors. Proceeds held by us is ~~available~~invested in that event, lenders may impose more restrictive terms and higher interest rates that may reduce our borrowing capacity, increase our costs, or reduce our operating flexibility. The failure to maintain, extend, renew or replace the Purchase Agreement with a comparable arrangement or arrangements that provide similar amounts of liquidityshort-term investments until needed 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 the 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: The Credit Agreement currently matures in January 2021, but we may extend the maturity to January 2022 at our election in accordance with the Fifth Amendment. Our ability to renew or refinance the Credit Agreement after January 2022 or to enter into a new credit facility to replace or supplement the Credit Agreement may be limited due to various factors, including the status of our business, global credit market conditions, and perceptions of our business or industry by sources of financing. In addition, if credit is available, lenders may seek more restrictive covenants and higher interest rates that may reduce our borrowing capacity, increase our costs, or reduce our operating flexibility. The failure to extend, renew or replace the Credit Agreement beyond the current or ultimate maturity date of January 2022 (assuming we exercise all options to extend as provided by the Fifth Amendment) with a comparable credit facility that provides similar amounts of liquidity for the Company would have a material negative impact on our overall liquidity, financial and operating results.

described above.

Our working capital was ~~$(11.3)~~$137.9 million and ~~$2.9~~$105.2 million as of September 30, ~~2020~~2021 and December 31, ~~2019,~~2020, respectively. Our current working capital deficit is due to the classification of the EnCap Credit Agreement as a current liability as discussed in Note 5 to the financial statements, although the Fifth Amendment to the Credit Agreement provides us the option to extend the maturity of the agreement. We intend to consider exercising the option at the appropriate time. Although no assurances can be given, we expect ~~that~~ our ~~financing arrangements with EnCap and RCA, collectively, and funds generated from operations~~current sources of liquidity are sufficient to ~~maintain the liquidity we require to meet~~support our operating, investing and financing needs for the next 12 months.

~~Table~~We ended the third quarter of ~~Contents~~

2021 with a cash and cash equivalent balance of $134.1 million compared to $106.0 million at the end of 2020. We believe we have adequate funds on hand to execute our financial and operating strategy. The following is a discussion of our major operating, investing and financing activities in the first nine months of 2021 and 2020, as classified on the Condensed Statements of Cash Flows in Part I, Item 1.

Cash provided by operating activities was ~~$12.0~~$6.7 million for the nine months ended September 30, ~~2020,~~2021, compared to ~~$4.4~~cash provided by operating activities of $12.0 million for the same period in ~~2019.~~2020. Cash provided by or used in operating activities is primarily driven by the ~~Company’s operating income, the~~ timing of receipt of customer payments, the timing of ~~its~~ payments to vendors and employees, and the timing of inventory ~~turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities. Additionally, net income~~turnover.

Cash used in investing activities was ~~$4.1~~approximately $13.7 million and $6.1 million for the nine months ended September 30, 2021 and 2020, ~~compared to a net loss~~respectively, primarily driven by the $5.9 million of ~~$1.2~~cash paid for the acquisition completed in July 2021 (see Note 4 - Acquisition).

Cash provided by financing activities was $35.1 million for the nine months ended September 30, ~~2019.~~

~~Cash used in investing activities was approximately $6.1 million and $5.3 million for the nine months ended September 30, 2020 and 2019, respectively, due primarily~~2021 compared to the capitalization of software development costs of $5.5 million and $2.2 million for the nine months ended September 30, 2020 and 2019, respectively, and the purchase of property and equipment $0.6 million and $3.1 million for the nine months ended September 30, 2020 and 2019, respectively.

~~Cash~~cash used in financing activities ~~for the nine months ended September 30, 2020 was~~of $2.3 ~~million, compared to cash provided by financing activities of $2.7~~ million for the same period in ~~2019,~~2020, primarily attributable to the proceeds from the ~~EnCap senior term loan for~~follow-on offering that generated $64.3 million of net proceeds, reduced by $26.9 million used to repurchase the ~~nine months ended September 30, 2019,~~outstanding warrants and ~~payments under finance leases and distribution~~$1.3 million to ~~the Telos ID Class B member for both periods.~~

Additionally, our capital structure consists of redeemable preferred stock and common stock. The capital structure is complex and requires an understanding of the terms of the instruments, certain restrictions on scheduled payments and redemptions of the various instruments, and the interrelationship of the instruments especially as it relates to the subordination hierarchy. Therefore, a thorough understanding of how our capital structure impacts our liquidity is necessary and, accordingly, we have disclosed the relevant information about each instrument as follows:

~~Enlightenment Capital Credit Agreement~~

On January 25, 2017, we entered into a Credit Agreement (the "Credit Agreement") with Enlightenment Capital Solutions Fund II, L.P., as agent (the "Agent") and the lenders party thereto (the "Lenders") (together referenced as “EnCap”). The Credit Agreement provided for an $11 million senior term loan (the "Loan") with a maturity date of January 25, 2022, subject to acceleration in the event of customary events of default.

All borrowings under the Credit Agreement accrue interest at the rate of 13.0% per annum (the “Accrual 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 increase to 14.5% per annum. After the occurrence and during the continuance of any event of default, the interest rate will increase 2.0%. The Company is obligated to pay accrued interest in cash on a monthly basis at a rate of not less than 10.0% per annum or, during the continuance of an Alternate Interest Rate Event, 11.5% per annum. The Company may elect to pay the remaining interest in cash, by payment-in-kind (by addition to the principal amount of the Loan) or by combination of cash and payment-in-kind. Upon thirty days prior written notice, the Company may prepay any portion or the entire amount of the Loan.

In connection with the Credit Agreement, on January 25, 2017, the Company issued warrants (each, a "Warrant") to the Agent and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms 1,135,284.333 shares of the Class A Common Stock of the Company, no par value per share, which is equivalent to approximately 2.5% ofrepurchase 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.

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The Credit Agreement also included an $825,000 exit fee, which was payable upon any repayment or prepayment of the loan. This amount had been included in the total principal due and treated as an unamortized discount on the debt, which would be amortized over the term of the loan, using the effective interest method at a rate of 15.0%. We incurred fees and transaction costs of approximately $374,000 related to the issuance of the Credit Agreement, which are being amortized over the life of the Credit Agreement.

Effective February 23, 2017, the Credit Agreement was amended to change the required timing of certain post-closing items, to allow for more time to complete the legal and administrative requirements around such items. On April 18, 2017, the Credit Agreement was further amended (the “Second Amendment”) to incorporate the parties’ agreement to subordinate certain debt owedstock held by the Company to the affiliated entities of Mr. John R. C. 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. John R.C. Porter and his affiliates, for an aggregate redemption price of $2.1 million.

On March 30, 2018, the Credit Agreement was further amended (the “Third Amendment”) to waive certain covenant defaults and to reset the covenants for 2018 measurement periods to more accurately reflect the Company’s projected performance for the year. The measurement against the covenants for consolidated leverage ratio and consolidated fixed charge coverage ratio were agreed to not be measured as of December 31, 2017 and were reset for 2018 measurement periods. Additionally, a minimum revenue covenant and a net working capital covenant were added. In consideration of these amendments, the interest rate on the loan was increased by 1%, which will revert back to the original rate upon achievement of two consecutive quarters of a specified fixed charge coverage ratio as defined in the agreement. The Company may elect to pay the increase in interest expense in cash or by payment-in-kind (by addition to the principal amount of the Loan). The increase in interest expense has been paid in cash. Contemporaneously with the Third Amendment, Mr. John B. Wood agreed to transfer 50,000 shares of the Company’s Class A Common Stock owned by him to EnCap.

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

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

The prepayment price was amended as follows: (a) from January 26, 2019 through January 25, 2020, the prepayment price is 102% of the principal amount, (b) from January 26, 2020 through October 14, 2020, the prepayment price is 101% of the principal amount, and (c) from October 15, 2020 to the maturity date, the prepayment price will be at par. However, the prepayment price for the additional $5 million loan attributable to the Fourth Amendment will be at par.

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

~~The borrowing under the Credit Agreement continues to be collateralized by substantially all of the Company’s assets including inventory, equipment and accounts receivable.~~

~~The Company paid the Agent a fee of $110,000 in connection with the Fourth Amendment. We incurred immaterial third party transaction costs which were expensed in the current period.~~

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

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The exit fee has been included in the total principal due and treated as an unamortized discount on the debt, which is being amortized over the term of the loan using the effective interest method at a rate of 17.3% over the remaining term of the loan. For the measurement period ended September 30, 2020, we were in compliance with the Credit Agreement’s financial covenants, based on an agreement between the Company and EnCap on the definition of certain input factors that determine the measurement against the covenants.

On March 26, 2020, the Credit Agreement was amended (the “Fifth Amendment”) to modify the financial covenants for 2020 through the maturity of the Credit Agreement to establish that the covenants will remain at the December 31, 2019 levels and to update the previously agreed-upon definition of certain financial covenants, specifically the amount of Capital Expenditures to be included in the measurement of the covenants. The Fifth Amendment also provides for the right for the Company to elect to extend the maturity date of the Credit Agreement which is currently scheduled to mature on January 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 Company paid EnCap an amendment fee of $100,000 and out-of-pocket costs and expenses in consideration for the Fifth Amendment.

We incurred interest expense in the amount of $0.8 million and $2.3 million for the three and nine months ended September 30, 2020, respectively, and $0.7 million and $1.5 million for the three and nine months ended September 30, 2019, respectively, under the Credit Agreement.

~~Accounts Receivable Purchase Agreement~~

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

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. Government; 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.

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~~Subordinated Debt~~

On March 31, 2015, the Company entered into Subordinated Loan Agreements and Subordinated Promissory Notes (“Porter Notes”) with affiliated entities of Mr. John R. C. Porter (together referenced as “Porter”). Mr. Porter and Toxford Corporation, of which Mr. Porter is the sole shareholder, own 35.0% of our Class A Common Stock. Under the terms of the Porter Notes, Porter lent the Company $2.5 million on or about March 31, 2015. Telos also entered into Subordination and Intercreditor Agreements (the “Subordination Agreements”) with Porter and a prior senior lender, in which the Porter Notes were fully subordinated to the financing provided by that senior lender, and payments under the Porter Notes were permitted only if certain conditions are met. According to the original terms of the Porter Notes, the outstanding principal sum bears interest at the fixed rate of twelve percent (12%) per annum which would be payable in arrears in cash on the 20th day of each May, August, November and February, with the first interest payment date due on August 20, 2015. The Porter Notes do not call for amortization payments and are unsecured. The Porter Notes, in whole or in part, may be repaid at any time without premium or penalty. The unpaid principal, together with interest, was originally due and payable in full on July 1, 2017.

On April 18, 2017, we amended and restated the Porter Notes to reduce the interest rate from twelve percent (12%) to six percent (6%) per annum, to be accrued, and extended the maturity date from July 1, 2017 to July 25, 2022. Telos also entered into Intercreditor Agreements with Porter and EnCap, in which the Porter Notes are fully subordinated to the Credit Agreement and any subsequent senior lenders, and payments under the Porter Notes are permitted only if certain conditions are met. All other terms remain in full force and effect. We incurred interest expense in the amount of $90,000 and $265,000 for the three and nine months ended September 30, 2020, respectively, and $83,000 and $245,000 for the three and nine months ended September 30, 2019, respectively, on the Porter Notes. As of September 30, 2020, approximately $1.2 million of accrued interest was payable according to the stated interest rate of the Porter Notes.

~~Public Preferred Stock~~

A maximum of 6,000,000 shares of the Public Preferred Stock, par value $.01 per share, has been authorized for issuance. We initially issued 2,858,723 shares of the Public Preferred Stock pursuant to the acquisition of the Company during fiscal year 1990. The Public Preferred Stock was recorded at fair value on the date of original issue, November 21, 1989, and we made periodic accretions under the interest method of the excess of the redemption value over the recorded value. We adjusted our estimate of accrued accretion in the amount of $1.5 million in the second quarter of 2006. The Public Preferred Stock was fully accreted as of December 2008. We declared stock dividends totaling 736,863 shares in 1990 and 1991. Since 1991, no other dividends, in stock or cash, have been declared. In November 1998, we retired 410,000 shares of the Public Preferred Stock. The total number of shares issued and outstanding at September 30, 2020 and December 31, 2019 was 3,185,586. The Public Preferred Stock is quoted as “TLSRP” on the OTCQB marketplace and the OTC Bulletin Board.

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Since 1991, no dividends were declared or paid on our Public Preferred Stock, based upon our interpretation of restrictions in our Articles of Amendment and Restatement, limitations in the terms of the Public Preferred Stock instrument, specific dividend payment restrictions in the various financing documents to which the Public Preferred Stock is subject, other senior obligations currently or previously in existence, and Maryland law limitations in existence prior to October 1, 2009. Subsequent to the 2009 Maryland law change, dividend payments have continued to be prohibited except under certain specific circumstances as set forth in Maryland Code Section 2-311. Pursuant to the terms of the Articles of Amendment and Restatement, we were scheduled, but not required, to redeem the Public Preferred Stock in five annual tranches during the years 2005 through 2009. However, due to our substantial senior obligations currently or previously in existence, limitations set forth in the covenants in the various financing documents to which the Public Preferred Stock is subject, 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 dates. 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 condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019.

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. Various financing documents to which the Public Preferred Stock is subject prohibit, among other things, the redemption of any stock, common or preferred, other than as described above. The Public Preferred Stock by its terms also cannot be redeemed if doing so would violate the terms of an agreement regarding the borrowing of funds or the extension of credit which is binding upon us or any of our subsidiaries, and it does not include any other provisions that would otherwise require any acceleration of the redemption of or amortization of payments with respect to the Public Preferred Stock. Thus, the Public Preferred Stock is not and will not be due on demand, nor callable, within 12 months from September 30, 2020. This classification is consistent with ASC 210, “Balance Sheet” and 470, “Debt” and the FASB ASC Master Glossary definition of “Current Liabilities.”

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We pay dividends on the Public Preferred Stock when and if declared by the Board of Directors. The Public Preferred Stock accrues a semi-annual dividend at the annual rate of 12% ($1.20) per share, based on the liquidation preference of $10 per share, and is fully cumulative. Dividends in additional shares of the Public Preferred Stock for 1990 and 1991 were paid at the rate of 6% per share for each $.60 of such dividends not paid in cash. For the cash dividends payable since December 1, 1995, we have accrued $110.2 million and $107.4 million as of September 30, 2020 and December 31, 2019, respectively. We accrued dividends on the Public Preferred Stock of $1.0 million and $2.9 million for each of the three and nine months ended September 30, 2020 and 2019, respectively, which was recorded as interest expense. Prior to the effective date of ASC 480 on July 1, 2003, such dividends were charged to stockholders’ accumulated deficit.

Recent Accounting Pronouncements

See Note 1 of the Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

Critical Accounting Policies

During the three months ended September 30, ~~2020,~~2021, there were no material changes to our critical accounting policies as reported in our Annual Report on Form 10-K for the year ended December 31, ~~2019~~2020 as filed with the SEC on ~~April 13, 2020.~~March 25, 2021.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

None.

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation of the effectiveness of our disclosure controls and procedures as of September 30, ~~2020~~2021 was performed under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in its reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that information required to be disclosed by the Company in the reports the Company files or submits under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required ~~disclosure~~.

disclosure.

Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting during the quarter ended September 30, ~~2020~~2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

Information regarding legal proceedings may be found in Note 811 – Commitments and Contingencies to the condensed consolidated financial statements.

Item 1A. Risk Factors

~~The following~~There were no material changes in the period ended September 30, 2021 in our risk factors ~~are in addition to those risk factors~~as disclosed in our Annual Report on Form 10-K ~~filed with~~for the ~~SEC on April 13, 2020, which are incorporated by reference herein.~~

~~We are subject to the seasonality of the U.S. government spending.~~

We derive a substantial portion of our revenues from U.S. government contracting, and as a result, we are subject to the annual seasonality of the U.S. government purchasing. Because the U.S. government fiscal year ends on September 30, it is not uncommon for U.S. government agencies to award extra tasks in the weeks immediately prior to the end of its fiscal year in order to avoid the loss of unexpended fiscal year funds. As a result of this seasonality, we have historically experienced higher revenues in the third and fourth fiscal quarters, ending September 30 andended December 31, ~~respectively, with the pace of orders typically substantially reduced during the first and second fiscal quarters ending March 31 and June 30, respectively.~~2020.

~~Our pricing structures for our solutions and services may change from time to time.~~

We expect that we may change our pricing model from time to time, including as a result of competition, global economic conditions, and general reductions in our customers’ spending levels, pricing studies, or changes in how our solutions are broadly consumed. Similarly, as we introduce new products and services, or as a result of the evolution of our existing solutions and services, we may have difficulty determining the appropriate price structure for our products and services. In addition, as new and existing competitors introduce new products or services that compete with ours, or revise their pricing structures, we may be unable to attract new customers at the same price or based on the same pricing model as we have used historically. Moreover, as we continue to target selling our solutions and services to larger organizations, these larger organizations may demand substantial price concessions. In addition, we may need to change pricing policies to accommodate government pricing guidelines for our contracts with federal, state, local, and foreign governments and government agencies. If we are unable to modify or develop pricing models and strategies that are attractive to existing and prospective customers, while enabling us to significantly grow our sales and revenue relative to our associated costs and expenses in a reasonable period of time, our business, financial condition, and results of operations may be adversely impacted.

We depend on computing infrastructure operated by Amazon Web Services (“AWS”), Microsoft, and other third parties to support some of our solutions and customers, and any errors, disruption, performance problems, or failure in their or our operational infrastructure could adversely affect our business, financial condition, and results of operations.

We rely on the technology, infrastructure, and software applications, of certain third parties, such as AWS and Microsoft Azure, in order to host or operate some of certain key platform features or functions of our business. Additionally, we rely on computer hardware and cloud capabilities purchased in order to deliver our solutions and services. We do not have control over the operations of the facilities of the third parties that we use. If any of these third-party services experience errors, disruptions, security issues, or other performance deficiencies, if they are updated such that our solutions become incompatible, if these services, software, or hardware fail or become unavailable due to extended outages, interruptions, defects, or otherwise, or if they are no longer available on commercially reasonable terms or prices (or at all), these issues could result in errors or defects in our solutions, cause our solutions to fail, our revenue and margins could decline, or our reputation and brand to be damaged, we could be exposed to legal or contractual liability, our expenses could increase, our ability to manage our operations could be interrupted, and our processes for managing our sales and servicing our customers could be impaired until equivalent services or technology, if available, are identified, procured, and implemented, all of which may take significant time and resources, increase our costs, and could adversely affect our business. Many of these third-party providers attempt to impose limitations on their liability for such errors, disruptions, defects, performance deficiencies, or failures, and if enforceable, we may have additional liability to our customers or third-party providers.

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We have experienced, and may in the future experience, disruptions, failures, data loss, outages, and other performance problems with our infrastructure and cloud-based offerings due to a variety of factors, including infrastructure changes, introductions of new functionality, human or software errors, employee misconduct, capacity constraints, denial of service attacks, phishing attacks, computer viruses, malicious or destructive code, or other security-related incidents, and our disaster recovery planning may not be sufficient for all situations. If we experience disruptions, failures, data loss, outages, or other performance problems, our business, financial condition, and results of operations could be adversely affected.

Our systems and the third-party systems upon which we and our customers rely are also vulnerable to damage or interruption from catastrophic occurrences such as earthquakes, floods, fires, power loss, telecommunication failures, cybersecurity threats, terrorist attacks, natural disasters, public health crises such as the COVID-19 pandemic, geopolitical and similar events, or acts of misconduct. Despite any precautions we may take, the occurrence of a catastrophic disaster or other unanticipated problems at our or our third-party vendors’ hosting facilities, or within our systems or the systems of third parties upon which we rely, could result in interruptions, performance problems, or failure of our infrastructure, technology, or solutions, which may adversely impact our business. In addition, our ability to conduct normal business operations could be severely affected. In the event of significant physical damage to one of these facilities, it may take a significant period of time to achieve full resumption of our services, and our disaster recovery planning may not account for all eventualities. In addition, any negative publicity arising from these disruptions could harm our reputation and brand and adversely affect our business.

Furthermore, our solutions are in many cases important or essential to our customers’ operations, including in some cases, their cybersecurity or oversight and compliance programs, and subject to service level agreements (“SLAs”). Any interruption in our service, whether as a result of an internal or third-party issue, could damage our brand and reputation, cause our customers to terminate or not renew their contracts with us or decrease use of our solutions and services, require us to indemnify our customers against certain losses, result in our issuing credit or paying penalties or fines, subject us to other losses or liabilities, cause our solutions to be perceived as unreliable or unsecure, and prevent us from gaining new or additional business from current or future customers, any of which could harm our business, financial condition, and results of operations.

Moreover, to the extent that we do not effectively address capacity constraints, upgrade our systems as needed, and continually develop our technology and network architecture to accommodate actual and anticipated changes in technology, our business, financial condition, and results of operations could be adversely affected. The provisioning of additional cloud hosting capacity requires lead time. AWS, Microsoft Azure, and other third parties have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If AWS, Microsoft Azure, or other third parties increase pricing terms, terminate or seek to terminate our contractual relationship, establish more favorable relationships with our competitors, or change or interpret their terms of service or policies in a manner that is unfavorable with respect to us, we may be required to transfer to other cloud providers or invest in a private cloud. If we are required to transfer to other cloud providers or invest in a private cloud, we could incur significant costs and experience possible service interruption in connection with doing so, or risk loss of customer contracts if they are unwilling to accept such a change.

A failure to maintain our relationships with our third-party providers (or obtain adequate replacements), and to receive services from such providers that do not contain any material errors or defects, could adversely affect our ability to deliver effective products and solutions to our customers and adversely affect our business and results of operations.

We will face risks associated with the growth of our business in new commercial markets and with new customer verticals, and we may neither be able to continue our organic growth nor have the necessary resources to dedicate to the overall growth of our business.

We plan to expand our operations in new commercial markets, including those where we may have limited operating experience, and may be subject to increased business, technology and economic risks that could affect our financial results. In recent periods, we have increased our focus on commercial customers. In the future, we may increasingly focus on such customers, including in the banking, financial services, healthcare, pharmaceutical, manufacturing, telecommunication, airlines and aerospace, insurance, retail, transportation, shipping and logistics, and energy industries, as well as other critical infrastructure industries. Entering new verticals and expanding in the verticals in which we are already operating will continue to require significant resources and there is no guarantee that such efforts will be successful or beneficial to us. Historically, sales to a new customer have often led to additional sales to the same customer or similarly situated customers. As we expand into and within new and emerging markets and heavily regulated industry verticals, we will likely face additional regulatory scrutiny, risks, and burdens from the governments and agencies which regulate those markets and industries. While this approach to expansion within new commercial markets and verticals has proven successful in the past, it is uncertain we will achieve the same penetration and organic growth in the future and our reputation, business, financial condition, and results of operations could be negatively impacted.

~~Table of Contents~~

In the future, we may seek to enter into other credit facilities to help fund our working capital needs. These credit facilities may expose us to additional risks associated with leverage and may inhibit our operating flexibility.

We may seek to enter into other credit facilities with third-party lenders to help fund our business. Such credit facilities will likely require us to pay a commitment fee on the undrawn amount and will likely contain a number of affirmative and restrictive covenants.

If we violate any such covenants, our lenders could accelerate the maturity of any debt outstanding and we may be prohibited from making any distributions to our stockholders. Such debt may be secured by our assets, including the stock we may own in subsidiaries and the rights we have under intercompany loan agreements that we may enter into in the future with our businesses. Our ability to meet our debt service obligations may be affected by events beyond our control and will depend primarily upon cash produced by our business. Any failure to comply with the terms of our indebtedness may have a material adverse effect on our financial condition.

In addition, we expect that such credit facilities will bear interest at floating rates which will generally change as interest rates change. We will bear the risk that the rates that we are charged by our lenders will increase faster than we can grow the cash flow from our businesses, which could reduce profitability, materially adversely affect our ability to service our debt and cause us to breach covenants contained in our third-party credit facilities.

Our business is subject to complex and evolving U.S. and non-U.S. laws and regulations regarding privacy, data protection and security, technology protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or otherwise harm our business.

We are subject to a variety of local, state, national, and international laws and directives and regulations in the United States and abroad that involve matters central to our business, including privacy and data protection, data security, data storage, retention, transfer and deletion, technology protection, and personal information. Foreign data protection, data security, privacy, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which, depending on the regime, may be enforced by private parties or government entities, are constantly evolving and can be subject to significant change, and they are likely to remain uncertain for the foreseeable future. In addition, the application, interpretation, and enforcement of these laws and regulations are often uncertain, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. A number of proposals are pending before U.S. federal, state, and foreign legislative and regulatory bodies that could significantly affect our business.

The overarching complexity of privacy and data protection laws and regulations around the world pose a compliance challenge that could manifest in costs, damages, or liability in other forms as a result of failure to implement proper programmatic controls, failure to adhere to those controls, or the malicious or inadvertent breach of applicable privacy and data protection requirements by us, our employees, our business partners, or our customers.

In addition to government regulation, self-regulatory standards and other industry standards may legally or contractually apply to us, be argued to apply to us, or we may elect to comply with such standards or to facilitate our customers’ compliance with such standards. Because privacy, data protection, and information security are critical competitive factors in our industry, we may make statements on our website, in marketing materials, or in other settings about our data security measures and our compliance with, or our ability to facilitate our customers’ compliance with, these standards. We also expect that there will continue to be new proposed laws and regulations concerning privacy, data protection, and information security, and we cannot yet determine the impact such future laws, regulations and standards, or amendments to or re-interpretations of existing laws and regulations, industry standards, or other obligations may have on our business. New laws, amendments to or re-interpretations of existing laws and regulations, industry standards, and contractual and other obligations may require us to incur additional costs and restrict our business operations. As these legal regimes relating to privacy, data protection, and information security continue to evolve, they may result in ever-increasing public scrutiny and escalating levels of enforcement and sanctions. Furthermore, because the interpretation and application of laws, standards, contractual obligations and other obligations relating to privacy, data protection, and information security are uncertain, these laws, standards, and contractual and other obligations may be interpreted and applied in a manner that is, or is alleged to be, inconsistent with our data management practices, our policies or procedures, or the features of our solutions. If so, in addition to the possibility of fines, lawsuits, and other claims, we could be required to fundamentally change our business activities and practices or modify our solutions, which could have an adverse effect on our business. We may be unable to make such changes and modifications in a commercially reasonable manner or at all, and our ability to fulfill existing obligations, make enhancements, or develop new solutions and features could be limited. Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations, and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our solutions.

~~Table of Contents~~

These existing and proposed laws and regulations can be costly to comply with and can make our solutions and services less effective or valuable, delay or impede the development of new products, result in negative publicity, increase our operating costs, require us to modify our data handling practices, limit our operations, impose substantial fines and penalties, require significant management time and attention, or put our data or technology at risk. Any failure or perceived failure by us or our solutions to comply with U.S., or applicable foreign laws, regulations, directives, policies, industry standards, or legal obligations relating to privacy, data protection, or information security, or any security incident that results in loss of or the unauthorized access to, or acquisition, use, release, or transfer of, personal information, personal data, or other customer or sensitive data sensitive data or information may result in governmental investigations, inquiries, enforcement actions and prosecutions, private claims and litigation, indemnification or other contractual obligations, other remedies, including fines or demands that we modify or cease existing business practices, or adverse publicity, and related costs and liabilities, which could significantly and adversely affect our business and results of operations.

~~Changes in accounting principles or their application to us could result in unfavorable accounting charges or effects, which could adversely affect our results of operations and growth prospects.~~

We prepare consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”). In particular, we make certain estimates and assumptions related to the adoption and interpretation of these principles including the recognition of our revenue and the accounting of our stock-based compensation expense with respect to our consolidated financial statements. If these assumptions turn out to be incorrect, our revenue or our stock-based compensation expense could materially differ from our expectations, which could have a material adverse effect on our financial results. A change in any of these principles or guidance, or in their interpretations or application to us, may have a significant effect on our reported results, as well as our processes and related controls, and may retroactively affect previously reported results or our forecasts, which may negatively impact our financial statements. For example, recent new standards issued by the Financial Accounting Standards Board could materially impact our consolidated financial statements. The adoption of these new standards may potentially require enhancements or changes in our processes or systems and may require significant time and cost on behalf of our financial management. This may in turn adversely affect our results of operations and growth prospects.

If our judgments or estimates relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our results of operations could fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

The preparation of our consolidated financial statements in conformity with GAAP requires management to make judgments, estimates, and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets, liabilities, and equity, and the amount of revenue and expenses that are not readily apparent from other sources. Our results of operations may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our results of operations to fall below the expectations of securities analysts and investors, resulting in a decline in the trading price of our common stock. Significant judgments, estimates, and assumptions used in preparing our consolidated financial statements include, or may in the future include, those related to revenue recognition, stock-based compensation, common stock valuations, and income taxes.

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~~A novel strain of coronavirus, COVID-19, may adversely affect our future business operations, financial condition and our ability to execute on business or contract opportunities.~~

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a)Unregistered Sales of Securities

None.

(b)Use of Proceeds

None.

(c)Issuer Purchases of Equity Securities

None.

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Item 3. Defaults upon Senior Securities

~~12% Cumulative Exchangeable Redeemable Preferred Stock~~None.

Through November 21, 1995, we had the option to pay dividends in additional shares of Public Preferred Stock in lieu of cash (provided there were no restrictions on payment as further discussed below). As more fully explained in the next paragraph, dividends are payable by us, when and if declared by the Board of Directors, commencing June 1, 1990, and on each six-month anniversary thereof. Dividends in additional shares of the Preferred Stock for 1990 and 1991 were paid at the rate of 6% of a share for each $.60 of such dividends not paid in cash. Dividends for the years 1992 through 1994, and for the dividend payable June 1, 1995, were accrued under the assumption that such dividends would be paid in additional shares of preferred stock and were valued at $4.0 million. Had we accrued these dividends on a cash basis, the total amount accrued would have been $15.1 million. However, as a result of the redemption of the 410,000 shares of the Public Preferred Stock in November 1998, such amounts were reduced and adjusted to $3.5 million and $13.4 million, respectively. As more fully disclosed in Note 6 – Redeemable Preferred Stock, in the second quarter of 2006, we accrued an additional $9.9 million in interest expense to reflect our intent to pay cash dividends in lieu of stock dividends, for the years 1992 through 1994, and for the dividend payable June 1, 1995. We have accrued $110.2 million and $107.4 million in cash dividends as of September 30, 2020 and December 31, 2019, respectively.

Since 1991, no dividends were declared or paid on our Public Preferred Stock, based upon our interpretation of restrictions in our Articles of Amendment and Restatement, limitations in the terms of the Public Preferred Stock instrument, specific dividend payment restrictions in the various financing documents to which the Public Preferred Stock is subject, other senior obligations currently or previously in existence, and Maryland law limitations in existence prior to October 1, 2009. Subsequent to the 2009 Maryland law change, dividend payments have continued to be prohibited except under certain specific circumstances as set forth in Maryland Code Section 2-311. Pursuant to the terms of the Articles of Amendment and Restatement, we were scheduled, but not required, to redeem the Public Preferred Stock in five annual tranches during the period 2005 through 2009. However, due to our substantial senior obligations currently or previously in existence, limitations set forth in the covenants in the various financing documents to which the Public Preferred Stock is subject, 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 dates. 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 condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits


Exhibit Number		Description of Exhibit

~~10.1~~ 31.1 *	~~Membership Interest Purchase Agreement, dated October 5, 2020 (Incorporated by reference to Exhibit 99.1 filed with the Company’s Current Report on Form 8-K on October 6, 2020)~~
10.2*	~~Amended Voting and Support Agreement, dated October 19, 2020~~
31.1*	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2* 31.2 *		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32* 32 *		Certification pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS**101.INS		XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH**101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL**101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document
104		Cover Page Interactive Data File - the cover page iXBRL tags are embedded within the Inline XBRL document contained in Exhibit 101

* filed ~~herewith~~or furnished herewith.

** in accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed”

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		~~/s/ Michele Nakazawa~~

			~~Michele Nakazawa~~
			/s/ Mark Bendza
			Mark Bendza Chief Financial Officer (Principal Financial and Accounting Officer)

	Telos Corporation
	Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive Income			Accumulated Deficit			Non-Controlling Interest			Total Stockholders’ Deficit
For the Three Months Ended September 30, 2020
Beginning balance	$	78	$	4,310	$	7		$	(147,508	)	$	7,104		$	(136,009	)
Net (loss) income		–		–		–			(200	)		2,694			2,494
Foreign currency translation loss		–		–		(2	)		–			–			(2	)
Stock-based compensation		–		4		–			–			–			4
Distributions		–		–		–			–			(292	)		(292	)
Ending balance	$	78	$	4,314	$	5		$	(147,708	)	$	9,506		$	(133,805	)
For the Three Months Ended September 30, 2019
Beginning balance	$	78	$	4,310	$	19		$	(144,283	)	$	1,857		$	(138,019	)
Net income		–		–		–			2,233			1,485			3,718
Foreign currency translation loss		–		–		(2	)		–			–			(2	)
Distributions		–		–		–			–			(419	)		(419	)
Ending balance	$	78	$	4,310	$	17		$	(142,050	)	$	2,923		$	(134,722	)
For the Nine Months Ended September 30, 2020
Beginning balance	$	78	$	4,310	$	6		$	(145,530	)	$	4,514		$	(136,622	)
Net (loss) income		–		–		–			(2,178	)		6,284			4,106
Foreign currency translation loss		–		–		(1	)		–			–			(1	)
Stock-based compensation		–		4		–			–			–			4
Distributions		–		–		–			–			(1,292	)		(1,292	)
Ending balance	$	78	$	4,314	$	5		$	(147,708	)	$	9,506		$	(133,805	)
For the Nine Months Ended September 30, 2019
Beginning balance	$	78	$	4,310	$	17		$	(139,129	)	$	2,621		$	(132,103	)
Net (loss) income		--		--		--			(2,921	)		1,705			(1,216	)
Distributions		--		--		--			--			(1,403	)		(1,403	)
Ending balance	$	78	$	4,310	$	17		$	(142,050	)	$	2,923		$	(134,722	)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
Federal	$	45,788	$	42,702	$	128,756	$	105,459
State & Local, and Commercial		1,652		2,829		6,273		7,286
Total	$	47,440	$	45,531	$	135,029	$	112,745

	September 30, 2020			December 31, 2019
Senior term loan principal, including exit fee	$	17,200		$	17,200
Less: Unamortized discount, debt issuance costs, and lender fees		(281	)		(865	)
Senior term loan, net	$	16,919		$	16,335

Date: November ~~13, 2020~~15, 2021

TELOS CORPORATION

/s/ John B. Wood

John B. Wood

Chief Executive Officer (Principal Executive Officer)