TELOS CORP
10-Ks and 10-Qs
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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
For the quarterly period ended: September 30, 2019
◻
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)
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Maryland
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52-0880974
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(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.)
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19886 Ashburn Road, Ashburn, Virginia
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20147-2358
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(Address of principal executive offices)
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(Zip Code)
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(703) 724-3800
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
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
☐
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Accelerated filer
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☐
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Non-accelerated filer
☒
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Smaller reporting company
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☐
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Emerging growth company
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☐
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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 of November 7, 2019, the registrant
had outstanding 45,158,460 shares of Class A Common Stock, no par value; and 4,037,628 shares of Class B Common Stock, no par value.
1
TELOS CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
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||
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Item 1.
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||
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3
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||
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4
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||
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5-6
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||
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7
|
||
|
8
|
||
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9-30
|
||
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Item 2.
|
31-42
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Item 3.
|
42
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|
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Item 4.
|
42
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|
|
PART II - OTHER INFORMATION
|
||
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Item 1.
|
42
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Item 1A.
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42
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Item 2.
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42
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Item 3.
|
43
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Item 4.
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43
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Item 5.
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43
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Item 6.
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44
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45
|
||
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(amounts in thousands)
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
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2019
|
2018
|
2019
|
2018
|
|||||||||||||
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Revenue
|
||||||||||||||||
|
Services
|
$
|
39,221
|
$
|
32,067
|
$
|
101,635
|
$
|
91,739
|
||||||||
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Products
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6,310
|
2,628
|
11,110
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10,300
|
||||||||||||
|
45,531
|
34,695
|
112,745
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102,039
|
|||||||||||||
|
Costs and expenses
|
||||||||||||||||
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Cost of sales - Services
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26,594
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17,143
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71,988
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59,119
|
||||||||||||
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Cost of sales - Products
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2,624
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1,265
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5,453
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4,323
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||||||||||||
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29,218
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18,408
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77,441
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63,442
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|||||||||||||
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Selling, general and administrative expenses
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10,637
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9,851
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31,432
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30,027
|
||||||||||||
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Operating income
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5,676
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6,436
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3,872
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8,570
|
||||||||||||
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Other income (expense)
|
||||||||||||||||
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Other income
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2
|
3
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195
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10
|
||||||||||||
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Interest expense
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(1,970
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)
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(1,717
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)
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(5,470
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)
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(5,101
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)
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||||||||
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Income (loss) before income taxes
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3,708
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4,722
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(1,403
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)
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3,479
|
|||||||||||
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Benefit from income taxes (Note 7)
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10
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106
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187
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41
|
||||||||||||
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Net income (loss)
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3,718
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4,828
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(1,216
|
)
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3,520
|
|||||||||||
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Less: Net income attributable to non-controlling interest (Note 2)
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(1,485
|
)
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(715
|
)
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(1,705
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)
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(1,480
|
)
|
||||||||
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Net income (loss) attributable to Telos Corporation
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$
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2,233
|
$
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4,113
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$
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(2,921
|
)
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$
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2,040
|
|||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(amounts in thousands)
|
Three Months Ended September 30,
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Nine Months Ended September 30,
|
|||||||||||||||
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2019
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2018
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2019
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2018
|
|||||||||||||
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Net income (loss)
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$
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3,718
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$
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4,828
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$
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(1,216
|
)
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$
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3,520
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|||||||
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Other comprehensive loss, net of tax:
|
||||||||||||||||
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Foreign currency translation adjustments
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(2
|
)
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(2
|
)
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--
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(9
|
)
|
|||||||||
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Less: Comprehensive income attributable to non-controlling interest
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(1,485
|
)
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(715
|
)
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(1,705
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)
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(1,480
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)
|
||||||||
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Comprehensive income (loss) attributable to Telos Corporation
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$
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2,231
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$
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4,111
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$
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(2,921
|
)
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$
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2,031
|
|||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
|
September 30, 2019
|
December 31, 2018
|
|||||||
|
(Unaudited)
|
||||||||
|
ASSETS
|
||||||||
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Current assets
|
||||||||
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Cash and cash equivalents
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$
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1,796
|
$
|
72
|
||||
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Accounts receivable, net of reserve of $389 and $306, respectively (Note 1)
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38,319
|
34,542
|
||||||
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Inventories, net of obsolescence reserve of $484 and $520, respectively (Note 1)
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3,322
|
4,389
|
||||||
|
Deferred program expenses
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1,045
|
244
|
||||||
|
Other current assets
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2,151
|
1,985
|
||||||
|
Total current assets
|
46,633
|
41,232
|
||||||
|
Property and equipment, net of accumulated depreciation of $31,546 and $28,665, respectively
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19,568
|
17,426
|
||||||
|
Operating lease right-of-use assets (Note 10)
|
2,089
|
--
|
||||||
|
Goodwill (Note 3)
|
14,916
|
14,916
|
||||||
|
Other assets
|
1,005
|
915
|
||||||
|
Total assets
|
$
|
84,211
|
$
|
74,489
|
||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
TELOS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in
thousands)
|
September 30, 2019
|
December 31, 2018
|
|||||||
|
(Unaudited)
|
||||||||
|
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS’ DEFICIT
|
||||||||
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Current liabilities
|
||||||||
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Accounts payable and other accrued payables (Note 5)
|
$
|
23,166
|
$
|
21,779
|
||||
|
Accrued compensation and benefits
|
10,361
|
9,082
|
||||||
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Contract liabilities (Note 1 and 5)
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4,774
|
5,232
|
||||||
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Finance lease obligations – short-term (Note 10)
|
1,196
|
1,115
|
||||||
|
Other current liabilities (Note 10)
|
3,216
|
1,895
|
||||||
|
Total current liabilities
|
42,713
|
39,103
|
||||||
|
Senior term loan, net of unamortized discount and issuance costs (Note 5)
|
16,149
|
10,984
|
||||||
|
Subordinated debt (Note 5)
|
2,842
|
2,597
|
||||||
|
Finance lease obligations – long-term (Note 10)
|
15,958
|
16,865
|
||||||
|
Operating lease liabilities – long-term (Note 10)
|
1,709
|
--
|
||||||
|
Deferred income taxes (Note 7)
|
612
|
818
|
||||||
|
Public preferred stock (Note 6)
|
138,254
|
135,387
|
||||||
|
Other liabilities (Note 7)
|
696
|
838
|
||||||
|
Total liabilities
|
218,933
|
206,592
|
||||||
|
Commitments and contingencies (Note 8)
|
--
|
--
|
||||||
|
Stockholders’ deficit
|
||||||||
|
Telos stockholders’ deficit
|
||||||||
|
Common stock
|
78
|
78
|
||||||
|
Additional paid-in capital
|
4,310
|
4,310
|
||||||
|
Accumulated other comprehensive income
|
17
|
17
|
||||||
|
Accumulated deficit
|
(142,050
|
)
|
(139,129
|
)
|
||||
|
Total Telos stockholders’ deficit
|
(137,645
|
)
|
(134,724
|
)
|
||||
|
Non-controlling interest in subsidiary (Note 2)
|
2,923
|
2,621
|
||||||
|
Total stockholders’ deficit
|
(134,722
|
)
|
(132,103
|
)
|
||||
|
Total liabilities, redeemable preferred stock, and stockholders’ deficit
|
$
|
84,211
|
$
|
74,489
|
||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts in
thousands)
|
|
Nine Months Ended September 30,
|
|||||||
|
2019
|
2018
|
|||||||
|
Operating activities:
|
||||||||
|
Net loss
|
$
|
(1,216
|
)
|
$
|
3,520
|
|||
|
Adjustments to reconcile net loss to cash provided by operating activities:
|
||||||||
|
Dividends of preferred stock as interest expense
|
2,867
|
2,867
|
||||||
|
Depreciation and amortization
|
3,609
|
2,148
|
||||||
|
Amortization of debt issuance costs
|
275
|
145
|
||||||
|
Deferred income tax (benefit) provision
|
(206
|
)
|
38
|
|||||
|
Other noncash items
|
83
|
216
|
||||||
|
Changes in other operating assets and liabilities
|
(1,028
|
)
|
(4,399
|
)
|
||||
|
Cash provided by operating activities
|
4,384
|
4,535
|
||||||
|
|
||||||||
|
Investing activities:
|
||||||||
|
Capitalized software development costs
|
(2,171
|
)
|
(1,319
|
)
|
||||
|
Purchases of property and equipment
|
(3,141
|
)
|
(1,513
|
)
|
||||
|
Cash used in investing activities
|
(5,312
|
)
|
(2,832
|
)
|
||||
|
|
||||||||
|
Financing activities:
|
||||||||
|
Proceeds from senior term loan
|
4,881
|
--
|
||||||
|
Payments under finance lease obligations
|
(826
|
)
|
(750
|
)
|
||||
|
Distributions to Telos ID Class B member - non-controlling interest
|
(1,403
|
)
|
(1,138
|
)
|
||||
|
Cash used in financing activities
|
2,652
|
(1,888
|
)
|
|||||
|
Increase in cash and cash equivalents
|
1,724
|
(185
|
)
|
|||||
|
Cash and cash equivalents, beginning of period
|
72
|
600
|
||||||
|
Cash and cash equivalents, end of period
|
$
|
1,796
|
$
|
415
|
||||
|
Supplemental disclosures of cash flow information:
|
||||||||
|
Cash paid during the period for:
|
||||||||
|
Interest
|
$
|
2,294
|
$
|
1,860
|
||||
|
Income taxes
|
$
|
39
|
$
|
19
|
||||
|
Noncash:
|
||||||||
|
Dividends of preferred stock as interest expense
|
$
|
2,867
|
$
|
2,867
|
||||
|
Debt issuance costs on senior term loan
|
$
|
110
|
$
|
--
|
||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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, 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 Three Months Ended September 30, 2018
|
||||||||||||||||||||||||
|
Beginning balance
|
$
|
78
|
$
|
4,310
|
$
|
25
|
$
|
(139,562
|
)
|
$
|
773
|
$
|
(134,376
|
)
|
||||||||||
|
Net income
|
--
|
--
|
--
|
4,113
|
715
|
4,828
|
||||||||||||||||||
|
Foreign currency translation loss
|
--
|
--
|
(2
|
)
|
--
|
--
|
(2
|
)
|
||||||||||||||||
|
Distributions
|
--
|
--
|
--
|
--
|
(233
|
)
|
(233
|
)
|
||||||||||||||||
|
Ending balance
|
$
|
78
|
$
|
4,310
|
$
|
23
|
$
|
(135,449
|
)
|
$
|
1,255
|
$
|
(129,783
|
)
|
||||||||||
|
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
|
)
|
||||||||||
|
For the Nine Months Ended September 30, 2018
|
||||||||||||||||||||||||
|
Beginning balance
|
$
|
78
|
$
|
4,310
|
$
|
32
|
$
|
(141,370
|
)
|
$
|
913
|
$
|
(136,037
|
)
|
||||||||||
|
Net income
|
--
|
--
|
--
|
2,040
|
1,480
|
3,520
|
||||||||||||||||||
|
Cumulative effect adjustment due to change in accounting policy
|
--
|
--
|
--
|
3,881
|
--
|
3,881
|
||||||||||||||||||
|
Foreign currency translation loss
|
--
|
--
|
(9
|
)
|
--
|
--
|
(9
|
)
|
||||||||||||||||
|
Distributions
|
--
|
--
|
--
|
--
|
(1,138
|
)
|
(1,138
|
)
|
||||||||||||||||
|
Ending balance
|
$
|
78
|
$
|
4,310
|
$
|
23
|
$
|
(135,449
|
)
|
$
|
1,255
|
$
|
(129,783
|
)
|
||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1
.
General and
Basis of Presentation
Telos Corporation, together with its subsidiaries (the “Company” or “Telos” or “We”), is an
information technology solutions and services company addressing the needs of U.S. Government and commercial customers worldwide. Our principal offices are located at 19886 Ashburn Road, Ashburn, Virginia 20147. The Company was incorporated as a
Maryland corporation in October 1971. Our website is
www.telos.com
.
The accompanying condensed consolidated financial statements include the accounts of Telos and its
subsidiaries, including Ubiquity.com, Inc., Xacta Corporation, and Teloworks, Inc., 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). All intercompany transactions have been eliminated in consolidation.
In our opinion, the accompanying condensed consolidated financial statements reflect all adjustments
(which include normal recurring adjustments) and reclassifications necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to rules and regulations of the
Securities and Exchange Commission (“SEC”). The 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 2018 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, 2018.
In preparing these condensed consolidated financial statements, we have evaluated subsequent events
through the date that these condensed consolidated financial statements were issued.
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 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 Adopted
In February 2016, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02,
“Leases (ASC Topic 842)”, which requires lessees to recognize a right-of-use asset and lease liability on the balance sheet and expands disclosures about leasing arrangements for both lessees and lessors, among other items, for most lease
arrangements. The new standard is effective for fiscal years beginning after December 15, 2018, which made the new standard effective for us on January 1, 2019. In July 2018, the FASB issued ASU 2018-11, “Leases (ASC Topic 842): Targeted
Improvements,” which allows for an additional transition method under the modified retrospective approach for the adoption of ASU 2016-02. The two permitted transition methods are (a) to apply the new lease requirements at the beginning of the
earliest period presented (the Comparative Method) and (b) to apply the new lease requirements at the effective date (the Effective Date Method). Under both transition methods there is a cumulative effect adjustment. We adopted the standard on
January 1, 2019 by applying the new lease requirements utilizing the Effective Date Method for all leases with terms greater than 12 months. We elected the package of practical expedients permitted under the transition guidance within the new
standard, which included carrying forward historical assessments of: (1) whether contracts are or contain leases, (2) lease classification and (3) initial direct costs. The adoption of this standard resulted in the recognition of right-of-use assets
of $2.0 million and additional lease liabilities of $2.0 million as of January 1, 2019. The adoption of the standard did not have a material impact on our operating results or cash flows. The comparative periods have not been restated for the
adoption of ASU 2016-02.
Recent Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments,” which introduces new guidance for estimating credit losses on certain types of financial instruments based on expected losses and the timing of the recognition of such losses. This standard will be effective for interim and
annual reporting periods beginning after December 15, 2019, with early adoption permitted. While we are currently assessing the impact the adoption of this ASU will have on our condensed consolidated financial position, results of operations and cash
flows, we do not believe the adoption of this ASU will have a material impact on our condensed consolidated financial position, results of operations and cash flows.
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for
Goodwill Impairment," which eliminates Step 2 of the current goodwill impairment test, that requires a hypothetical purchase price allocation to measure goodwill impairment. A goodwill impairment loss will instead be measured at the amount by which a
reporting unit's carrying value exceeds its fair value, not to exceed the recorded amount of goodwill. The provisions of this ASU are effective for years beginning after December 15, 2019, with early adoption permitted for any impairment test
performed on testing dates after January 1, 2017. The adoption of this ASU will not have a material impact on our condensed consolidated financial position, results of operations and cash flows.
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the
Disclosure Requirements for Fair Value Measurement”, which modifies the disclosure requirement for fair value measurement under ASC 820 to improve the effectiveness of such disclosures. Those modifications include the removal and addition of
disclosure requirements as well as clarifying specific disclosure requirements. This standard will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The adoption of this ASU will
not have a material impact on our condensed consolidated financial position, results of operations and cash flows.
In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40):
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract,” which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract
with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This standard will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption
permitted. The adoption of this ASU will not have a material impact on our condensed consolidated financial position, results of operations and cash flows.
Revenue Recognition
We account for revenue in accordance with Accounting Standard Codification (“ASC”) Topic 606, “Revenue from Contracts with
Customers.” The unit of account in ASC 606 is a performance obligation, which is a promise, in a contract with a customer, to transfer a good or service to the customer. ASC 606 prescribes a five-step model for recognizing revenue that includes
identifying the contract with the customer, determining the performance obligation(s), determining the transaction price, allocating the transaction price to the performance obligation(s), and recognizing revenue as the performance obligations are
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.
We account for a contract after it has been approved by the parties to the contract, the rights and the payment terms of
the parties are identified, the contract has commercial substance and collectability is probable, which is presumed for our U.S. Government customers and prime contractors for which we perform as subcontractors to U.S. Government end-customers.
The majority of our revenue is recognized over time, as control is transferred continuously to our customers who receive
and consume benefits as we perform, and is classified as services revenue. All of our business groups earn services revenue under a variety of contract types, including time and materials, firm-fixed price, firm fixed price level of effort, and cost
plus fixed fee contract types, which may include variable consideration as discussed further below. Revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying our
performance obligations. 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 transfer of control to the customer is supported by clauses in our contracts with U.S. Government customers whereby the customer may terminate a contract for convenience and then pay for costs incurred plus a profit, at which time the
customer would take control of any work in process. For non-U.S. Government contracts where we perform as a subcontractor and our order includes similar Federal Acquisition Regulation (the FAR) provisions as the prime contractor’s order from the U.S.
Government, continuous transfer of control is likewise supported by such provisions. For other non-U.S. Government customers, continuous transfer of control to such customers is also supported due to general terms in our contracts and rights to
recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit.
Due to the transfer of control over time, revenue is recognized based on progress towards completion of the performance
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 Cyber Operations and Defense
(“CO&D”) and IT & Enterprise Solutions business groups and for the sale of resold products in Telos ID and CO&D and is classified as product revenue. Revenue on these contracts is recognized when the customer obtains control of the
transferred product or service, which is generally upon delivery of the product to the customer for their use, due to us maintaining control of the product until that point. Orders for the sale of software licenses may contain multiple performance
obligations, such as maintenance, training, or consulting services, which are typically delivered over time, consistent with the transfer of control disclosed above for the provision of services. When an order contains multiple performance
obligations, we allocate the transaction price to the performance obligations using our best estimate of standalone selling price.
Contracts are routinely and often modified to account for changes in contract requirements, specifications, quantities, or
price. Depending on the nature of the modification, we determine whether to account for the modification as an adjustment to the existing contract or as a new contract. Generally, modifications are not distinct from the existing contract due to the
significant interrelatedness of the performance obligations and are therefore accounted for as an adjustment to the existing contract, and recognized as a cumulative adjustment to revenue (as either an increase or reduction of revenue) based on the
modification’s effect on progress toward completion of a performance obligation.
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 DCAA audits of incurred cost submissions. This resulted in signed final rate agreement letters for 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 have 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 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.
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 sheet.
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 on a net contract basis at the end of each reporting period.
We have one 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 international customers revenue is de minimus. The following tables
disclose revenue (in thousands) by customer type and contract type for the periods presented. Prior period amounts have not been adjusted under the modified retrospective method.
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
|
2019
|
2018
|
2019
|
2018
|
|||||||||||||
|
Federal
|
$
|
42,702
|
$
|
32,784
|
$
|
105,459
|
$
|
95,354
|
||||||||
|
State & Local, and Commercial
|
2,829
|
1,911
|
7,286
|
6,685
|
||||||||||||
|
Total
|
$
|
45,531
|
$
|
34,695
|
$
|
112,745
|
$
|
102,039
|
||||||||
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
|
2019
|
2018
|
2019
|
2018
|
|||||||||||||
|
Firm fixed-price
|
$
|
38,660
|
$
|
21,154
|
$
|
92,447
|
$
|
74,249
|
||||||||
|
Time-and-materials
|
3,325
|
4,404
|
10,945
|
12,260
|
||||||||||||
|
Cost plus fixed fee
|
3,546
|
9,137
|
9,353
|
15,530
|
||||||||||||
|
Total
|
$
|
45,531
|
$
|
34,695
|
$
|
112,745
|
$
|
102,039
|
||||||||
The following table discloses accounts receivable (in thousands):
|
September 30, 2019
|
December 31, 2018
|
|||||||
|
Billed accounts receivable
|
$
|
17,922
|
$
|
18,848
|
||||
|
Unbilled receivables
|
20,786
|
16,000
|
||||||
|
Allowance for doubtful accounts
|
(389
|
)
|
(306
|
)
|
||||
|
Receivables – net
|
$
|
38,319
|
$
|
34,542
|
||||
The following table discloses contract liabilities (in thousands):
|
September 30, 2019
|
December 31, 2018
|
|||||||
|
Contract liabilities
|
$
|
4,774
|
$
|
5,232
|
||||
As of September 30, 2019, we had $104.0 million of remaining performance obligations, which we also refer to as funded backlog. We expect
to recognize approximately 52.4% of our remaining performance obligations as revenue in 2019, an additional 46.8% in 2020, and the balance thereafter. We recognized revenue of $1.0 million and $4.1 million during the three and nine months ended
September 30, 2019 and 2018, respectively, and $1.2 million and $5.3 million during the three and nine months ended September 30, 2018, 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 allowances 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.
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% 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. 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. During the three and nine months
ended September 30, 2018, the Company sold approximately $6.0 million and $11.1 million of accounts receivable, respectively, and recognized a related loss of approximately $21,000 and $39,000 in selling, general and administrative expenses,
respectively, for the same period. As of September 30, 2019, the balance of the sold accounts receivable was approximately $2.5 million, and the related deferred price was approximately $0.4 million. As of September 30, 2018, the balance of the sold
accounts receivable was approximately $2.9 million, and the related deferred price was approximately $0.4 million. As of December 31, 2018, the balance of the sold accounts receivable was approximately $0.9 million, and the related deferred price was
approximately $0.1 million.
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 commercial 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
$3.8 million
and
$4.9 million
as of September 30, 2019 and December 31, 2018
, respectively. As of September 30, 2019, it is management’s judgment that we have fully provided for any potential inventory obsolescence,
which
was $0.5 million as of September 30, 2019 and December 31, 2018.
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.”
Software development costs for software to be sold, leased or otherwise marketed 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. 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 years on a straight-line basis. As of September 30, 2019 and
December 31, 2018, we capitalized $5.3 million and $3.1 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 the three and nine months
ended September 30, 2019, respectively, and $0.3 million and $0.7 million for the three and nine months ended September 30, 2018, respectively. Accumulated amortization was $2.6 million and $1.3 million as of September 30, 2019 and December 31, 2018,
respectively. The Company analyzes the net realizable value of capitalized software development costs on at least an annual basis and has determined that there is no indication of impairment of the capitalized software development costs as forecasted
future sales are adequate to support amortization costs.
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, 2019 and December 31, 2018. 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, 2019 and December 31, 2018. Due to the tax reform enacted on December 22, 2017, net operating losses generated in taxable years beginning after December 31, 2017 will have an indefinite
carryforward period, which will be available to offset future taxable income created by the reversal of temporary taxable differences related to goodwill. As a result, we have adjusted the valuation allowance on our deferred tax assets and
liabilities at September 30, 2019 and December 31, 2018.
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.
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.
Goodwill
We evaluate the impairment of goodwill and other intangible assets in accordance with ASC 350, “Intangibles - Goodwill and
Other,” which requires goodwill and indefinite-lived intangible assets to be assessed on at least an annual basis for impairment using a fair value basis. Between annual evaluations, if events occur or circumstances change that would more likely than
not reduce the fair value of the reporting unit below its carrying amount, then impairment must be evaluated. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or business climate, or (2) a
loss of key contracts or customers.
As the result of an acquisition, we record any excess purchase price over the net tangible and identifiable intangible
assets acquired as goodwill. An allocation of the purchase price to tangible and intangible net assets acquired is based upon our valuation of the acquired assets. Goodwill is not amortized, but is subject to annual impairment tests. We complete our
goodwill impairment tests as of December 31 each year. Additionally, we make evaluations between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The evaluation is based on the estimation of the fair values of our three reporting units, CO&D, Identity Management, and IT and Enterprise Solutions, of which goodwill is housed in the CO&D reporting unit, in comparison to the reporting
unit’s net asset carrying values. 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, 2018.
There were no triggering events which would require goodwill impairment consideration during the quarter. Subsequent reviews may result in future periodic impairments that could have a material adverse effect on the results of operations in the
period recognized. 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, there have been no grants in 2019. 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, 2019, there were 1,213,750
shares of restricted stock that remained subject to vesting. In the event of death of the employee or a change in control, as defined by the Telos Corporation 2008 Omnibus Long-Term Incentive Plan, the 2013 Omnibus Long-Term Incentive Plan, or the
2016 Omnibus Long-Term Incentive Plan, all unvested shares shall automatically vest in full. In accordance with ASC 718, we recorded immaterial compensation expense for any of the issuances as the value of our common stock was nominal, based on the
deduction of our outstanding debt, capital lease obligations, and preferred stock from an estimated enterprise value, which was estimated based on discounted cash flow analysis, comparable public company analysis, and comparable transaction
analysis. 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.
Other Comprehensive Income
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.
Accumulated other comprehensive income included within stockholders’ deficit consists of the following
(in thousands):
|
September 30, 2019
|
December 31, 2018
|
|||||||
|
Cumulative foreign currency translation loss
|
$
|
(90
|
)
|
$
|
(90
|
)
|
||
|
Cumulative actuarial gain on pension liability adjustment
|
107
|
107
|
||||||
|
Accumulated other comprehensive income
|
$
|
17
|
$
|
17
|
||||
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 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 $17,000. Until April 19, 2007, we owned 99.999% of the membership interests of
Telos ID and
certain private equity investors (“Investors”)
owned 0.001% of the membership interests of Telos ID. On April 20, 2007, we
sold an additional 39.999% of the membership interests to the Investor in exchange for $6 million in cash consideration. In accordance with ASC 505, “Equity,” we recognized a gain of $5.8 million.
As a result, we owned 60% of Telos ID, and
therefore continued to account for the investment in Telos ID using the consolidation method.
On December 24, 2014 (the “Closing Date”), we entered into a Membership Interest Purchase Agreement
(the “Purchase Agreement”) between the Company and the Investors, pursuant to which the Investors acquired from the Company an additional ten percent (10%) membership interest in Telos ID in exchange for $5 million (the “Transaction”). In connection
with the Transaction, the Company and the Investors entered into the Second Amended and Restated Operating Agreement (the “Operating Agreement”) governing the business, allocation of profits and losses and management of Telos ID.
Under the Operating Agreement, Telos ID is managed by a board of directors comprised of five (5) members (the “Telos ID Board”). The Operating Agreement provides for two classes of membership units, Class A
(owned by the Company) and Class B (owned by the Investors). The Class A member (the Company) owns 50% of Telos ID, is entitled to receive 50% of the profits of Telos ID, and may appoint three (3) members of the Telos ID Board. The Class B member
(the Investors) owns 50% of Telos ID, is entitled to receive 50% of the profits of Telos ID, and may appoint two (2) members of the Telos ID Board.
Despite the post-Transaction ownership of Telos ID being evenly split at 50% by each member, Telos
maintains control of the subsidiary through its holding of three of the five Telos ID board of director 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.
|
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.
Pursuant to the Transaction, the Class A and Class B members each own 50% of Telos ID, as mentioned above, and as such each
was allocated 50% of the profits, which was $1.5 million and $1.7 million for the three and nine months ended September 30, 2019, respectively, and $0.7 million and $1.5 million for the three and nine months ended September 30, 2018, respectively.
The Class B member is the non-controlling interest.
Distributions are made to the members only when and to the extent determined by Telos ID’s Board of Directors, in
accordance with the Operating Agreement. The Class B member received a total distribution of $0.4 million and $1.4 million for the three and nine months ended September 30, 2019, respectively, and $0.2 million and $1.1 million for the three and nine
months ended September 30, 2018, respectively.
The following table details the changes in non-controlling
interest for the three and nine months ended September 30, 2019 and 2018 (in thousands):
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
|
2019
|
2018
|
2019
|
2018
|
|||||||||||||
|
Non-controlling interest, beginning of period
|
$
|
1,857
|
$
|
773
|
$
|
2,621
|
$
|
913
|
||||||||
|
Net income
|
1,485
|
715
|
1,705
|
1,480
|
||||||||||||
|
Distributions
|
(419
|
)
|
(233
|
)
|
(1,403
|
)
|
(1,138
|
)
|
||||||||
|
Non-controlling interest, end of period
|
$
|
2,923
|
$
|
1,255
|
$
|
2,923
|
$
|
1,255
|
||||||||
Note 3
.
Goodwill
The goodwill
balance was $14.9 million as of September 30, 2019 and December 31, 2018.
Goodwill is subject to annual impairment tests and if triggering events are present before the annual tests, we will assess impairment. As of September 30, 2019 and
December 31, 2018, no impairment charges were taken.
Note 4
.
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 the 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, 2019 and December 31, 2018, we did not have any financial
instruments with significant Level 3 inputs and we did not have any financial instruments that are measured at fair value on a recurring basis.
As of September 30, 2019 and December 31, 2018, the carrying
value of the Company’s 12% Cumulative Exchangeable Redeemable Preferred Stock, par value $.01 per share (the “Public Preferred Stock”) was $138.3 million and $135.4 million, respectively, and the estimated fair market value was $76.3 million and
$41.4 million, respectively, based on quoted market prices.
For certain of our non-derivative financial instruments, including receivables, accounts payable and other accrued
liabilities, the carrying amount approximates fair value due to the short-term maturities of these instruments. The estimated fair value of the Facility 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 5
.
Current
Liabilities and Debt Obligations
Accounts Payable and Other Accrued Payables
As of September 30, 2019 and December 31, 2018, the accounts payable and other
accrued payables consisted of $20.8 million and $18.5 million, respectively, in trade account payables and $2.4 million and $3.3 million, respectively, in accrued payables.
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, 2019 and
December 31, 2018, the contract liabilities primarily consisted of 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 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 days prior written notice, the Company may prepay any portion or the entire amount of the Loan.
The Credit Agreement contains representations, warranties, covenants, terms and conditions customary
for transactions of this type. In connection with the Credit Agreement, the Agent has been granted, for the benefit of the Lenders, a security interest in and general lien upon various property of the Company, subject to certain permitted liens and
any intercreditor agreement. The occurrence of an event of default under the Credit Agreement could result in the Loan and other obligations becoming immediately due and payable and allow the Lenders to exercise all rights and remedies available to
them under the Credit Agreement or as a secured party under the UCC, in addition to all other rights and remedies available to them.
In connection with the Credit Agreement, on January 25, 2017, the Company issued warrants (each, a
"Warrant") to the Agent and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms 1,135,284.333 shares of the Class A Common Stock of the Company, no par value per share, which is equivalent to
approximately 2.5% of the common equity interests of the Company on a fully diluted basis. The exercise price is $1.321 per share and each Warrant expires on January 25, 2027. The value of the warrants was determined to be de minimis and no value was
allocated to them on a relative fair value basis in accounting for the debt instrument.
The Credit Agreement also includes an $825,000
exit fee, which is payable upon any repayment or prepayment of the loan. This amount has been included in the total principal due and treated as an unamortized discount on the debt, which will be amortized over the term of the loan, using the
effective interest method at a rate of 15.0%
at the time of the original loan
. We incurred fees and transaction costs of approximately $374,000
related to the issuance of the Credit Agreement, which are being amortized over the life of the Credit Agreement.
Effective February 23, 2017, the Credit Agreement was amended
to change the required timing of certain post-closing items to allow for more time to complete the legal and administrative requirements around such items. On April 18, 2017, the Credit Agreement was further amended (the “Second Amendment”) to
incorporate the parties’ agreement to subordinate certain debt owed by the Company to the affiliated entities of Mr. 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, 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.
On July 19, 2019, we entered into the Fourth Amendment to Credit Agreement and Waiver; First Amendment to Fee Letter (“Fourth Amendment”)
to amend the Credit Agreement. As a result of the Fourth Amendment, several terms of the Credit Agreement were amended, including the following:
| ● |
The Company borrowed an additional $5 million from the Lenders, increasing the total amount of the principal to $16 million.
|
| ● |
The maturity date of the Credit Agreement was amended from January 25, 2022 to January 15, 2021.
|
| ● |
The prepayment price was amended as follows: (a) from January 26, 2019 through January 25, 2020, the prepayment price is 102% of the principal amount, (b) from
January 26, 2020 through October 14, 2020, the prepayment price is 101% of the principal amount, and (c) from October 15, 2020 to the maturity date, the prepayment price will be at par. However, the prepayment price for the additional $5
million loan attributable to the Fourth Amendment will be at par.
|
| ● |
The following financial covenants, as defined in the Credit Agreement, were amended and updated: Consolidated Leverage Ratio, Consolidated Senior Leverage Ratio,
Consolidated Capital Expenditures, Minimum Fixed Charge Coverage Ratio, and Minimum Consolidated Net Working Capital.
|
| ● |
Any actual or potential non-compliance with the applicable provisions of the Credit Agreement were waived.
|
| ● |
The borrowing under the Credit Agreement continues to be collateralized by substantially all of the Company’s assets including inventory, equipment and accounts
receivable.
|
| ● |
The Company paid the Agent a fee of $110,000 in connection with the Fourth Amendment. We incurred immaterial third party transation costs which were expensed during
the current period.
|
| ● |
The exit fee was increased from $825,000 to $1,200,000.
|
The exit fee has been included in the total principal due and treated as an unamortized discount on the debt, which will be amortized over
the term of the loan, using the effective interest method at a rate of 17.3% over the remaining term of the loan. For the measurement period ending September 30, 2019 we are 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.
The carrying amount of the Credit Agreement consisted of the following (in thousands):
|
September 30, 2019
|
December 31, 2018
|
|||||||
|
Senior term loan, including exit fee
|
$
|
17,200
|
$
|
11,825
|
||||
|
Less: Unamortized discount, debt issuance costs, and lender fees
|
(1,051
|
)
|
(841
|
)
|
||||
|
Senior term loan, net
|
$
|
16,149
|
$
|
10,984
|
||||
We incurred interest expense in the amount of
$0.7 million and $1.5 million for the three and nine months ended September 30, 2019,
respectively, and $0.4 million and $1.3 million for the three and nine months ended September 30, 2018, respectively,
under the Credit Agreement.
Accounts Receivable Purchase Agreement
On July 15, 2016, we entered into an Accounts Receivable Purchase Agreement (the “Purchase Agreement”) with Republic Capital Access, LLC
(“RCA” or “Buyer”), pursuant to which we may offer for sale, and RCA, in its sole discretion, may purchase, eligible accounts receivable relating to U.S. Government prime contracts or subcontracts of the Company (collectively, the “Purchased
Receivables”). Upon purchase, RCA becomes the absolute owner of any such Purchased Receivables, which are payable directly to RCA, subject to certain repurchase obligations of the Company. The total amount of Purchased Receivables is subject to a
maximum limit of $10 million of outstanding Purchased Receivables (the
“Maximum Amount”) at any given time. The Purchase Agreement had an initial term
expiring on June 30, 2018 and automatically renews for successive 12-month renewal periods unless terminated in writing by either the Company or RCA. On March 2, 2018, the term of the Purchase Agreement was extended to June 30, 2020. No fee or
consideration of any kind was paid in connection with this extension.
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.
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.
Financing and Security Agreement
On July 15, 2016, we entered into a Financing
and Security Agreement (the “Financing Agreement”) with Action Capital Corporation (“Action Capital”), pursuant to which Action Capital agreed to provide the Company with advances of up to 90% of the net amount of certain acceptable customer
accounts of the Company that have been assigned as collateral to Action Capital (the “Acceptable Accounts”). The maximum outstanding principal amount of advances under the Financing Agreement was $5 million. The Financing Agreement had a term of
two years, provided that the Company may terminate it at any time without penalty upon written notice.
On August 13, 2018, the Financing Agreement was extended through January 2, 2019. No fee or consideration of any kind was paid in
connection with this extension. The Financing Agreement was not extended beyond this date.
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 $83,000 and $245,000 for the three and nine months ended September 30, 2019, respectively,
and $78,000 and $229,000 for the three and nine months ended September 30, 2018, respectively,
on the Porter Notes. As of September 30, 2019, approximately $984,000 of accrued interest was payable according to the stated interest rate of the Porter Notes.
Note 6
.
Redeemable
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, 2019 and December 31, 2018 was 3,185,586.
The Public
Preferred Stock is quoted as "TLSRP" on the OTCQB marketplace and the OTC Bulletin Board.
Since 1991,
no dividends were declared or paid on our Public Preferred Stock, based upon our interpretation of restrictions in our Articles of Amendment and Restatement, limitations in the terms of the Public Preferred Stock instrument, specific dividend payment
restrictions in 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, 2019 and December 31, 2018.
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. V
arious 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,
2019. 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 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% of a share for each $.60 of such dividends not paid in cash. For the cash dividends payable since December 1, 1995, we have accrued $106.4 million and $103.5 million as of
September 30, 2019 and December 31, 2018, 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, 2019 and 2018, respectively, which was recorded as
interest expense. Prior to the effective date of ASC 480 on July 1, 2003, such dividends were charged to stockholders’ accumulated deficit.
Note 7
.
Income Taxes
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 in the quarterly period in which they occur. We review and update our estimated annual
effective tax rate each quarter. W
e recorded an approximately $10,000 and $187,000 income tax benefit for the three and nine months ended September 30, 2019, respectively, and a $106,000 and $41,000 income tax benefit for the three and nine
months ended September 30, 2018, respectively. For the three and nine months ended September 30, 2019 and 2018, 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.
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, 2019 and December 31, 2018. 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, 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 a result, a deferred tax liability related to goodwill of
$612,000 and $818,000 remains on our condensed consolidated balance sheets at September 30, 2019 and December 31, 2018, respectively. The income tax benefit recorded for the nine months ended September 30, 2019 is primarily related to this change in
deferred tax liability and is due to the state conformity to the indefinite-lived net operating loss provision of the Tax Act.
As a result of the Tax Act, we are subject to several provisions of the Tax Act including computations under Section 162(m) executive
compensation limitation and Section 163(j) interest limitation rule. We have considered the impact of each of these provisions in our computation of tax expense for the three and nine months ended September 30, 2019 and 2018.
Under the provisions of ASC 740, we determined that
there were approximately $667,000 and $648,000 of unrecognized tax benefits,
including $297,000 and $278,000 of related interest and penalties,
required to be recorded
in other liabilities in the condensed consolidated balance sheets
as of September 30, 2019 and December 31, 2018, respectively.
We believe that the total amounts of unrecognized tax benefits will not significantly increase or decrease within the next 12 months.
Note 8
.
Commitments,
Contingencies and Subsequent Events
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 our availability
under our credit arrangements. For example, a contractual requirement to post collateral for a duration of several months, depending on the materiality of the amount, could have an immediate negative effect on our liquidity, as such a circumstance
would utilize cash resources without a near-term cash inflow back to us. Likewise, the release of such collateral could have a corresponding positive effect on our liquidity, as it would represent an addition to our cash resources without any
corresponding near-term cash outflow. Similarly, a slow-down of payments from a customer, group of customers or government payment office would not have an immediate and direct effect on our availability unless the slowdown was material in amount and
over an extended period of time. Any of these examples would have an impact on our cash resources, our financing arrangements, and therefore our liquidity.
Management may determine that, in order to reduce capital and liquidity requirements, planned spending on capital projects
and indirect expense growth may be curtailed, subject to growth in operating results. Additionally, management may seek to put in place a credit facility with a commercial bank, although no assurance can be given that such a facility could be put in
place under terms acceptable to the Company. Should management determine that additional capital is required, management would likely look first to the sources of funding discussed above to meet any requirements, although no assurances can be given
that these investors would be able to invest or that the Company and the investors would agree upon terms for such investments.
Our working capital was $3.9 million and $2.1 million as of September 30, 2019 and December 31, 2018, respectively.
Although no assurances can be given, we expect that our financing arrangements with EnCap and RCA, collectively, and funds generated from operations are sufficient to maintain the liquidity we require to meet our operating, investing and financing
needs for the next 12 months.
Legal Proceedings
Costa Brava Partnership III, L.P. and Wynnefield Partners Small Cap Value, L.P.v. Telos Corporation, et al.
As previously
disclosed in Note 13 of the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2018, on October 17, 2005, Costa Brava Partnership III, L.P. (“Costa Brava”), a holder of our Public Preferred
Stock,
instituted litigation
against the Company and certain past and present directors and officers ("Telos Defendants") in the
Circuit Court for Baltimore City, Maryland (the “Circuit Court”). A second holder of the Company’s Public Preferred Stock, Wynnefield Small Cap Value, L.P. (“Wynnefield”), subsequently intervened as a co-Plaintiff (Costa Brava and Wynnefield are
hereinafter referred to as “Plaintiffs”). On February 27, 2007, Plaintiffs added, as an additional defendant, Mr. John R.C. Porter, a holder of the Company’s Class A common stock. As of September 30, 2019, Costa Brava and Wynnefield
,
directly and through affiliated funds,
own 12.7% and 17.4%, respectively, of the outstanding Public Preferred Stock.
There have been no
material developments in this litigation during the three months ended September 30, 2019, and the matter remains pending.
At this stage of the litigation, it is impossible to reasonably determine the degree of probability related to Plaintiffs’
success in relation to any of their assertions in the litigation. Although there can be no assurance as to the ultimate outcome of the case, the Company and its present and former officers and directors strenuously deny Plaintiffs’ allegations and
continue to vigorously defend the matter and oppose all relief sought by Plaintiffs.
Hamot et al. v. Telos Corporation
As previously
disclosed in Note 13 of the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2018,
since August 2, 2007, Messrs. Seth W. Hamot (“Hamot”) and Andrew R. Siegel (“Siegel”),
principals of Costa Brava, have been involved in litigation against the Company as Plaintiffs and Counter-defendants in the Circuit Court. Mr. Siegel is a Class D Director of the Company and Mr. Hamot was a Class D Director of the Company until his
resignation on March 9, 2018. On or about July 6, 2018, the attorneys representing Mr. Hamot filed a Notice of Substitution of Party in the Circuit Court and the Court of Special Appeals, providing notice that Mr. Steven Tannenbaum was appointed and
qualified as the Special Personal Representative of the Estate of Seth Hamot to represent the estate in the litigation.
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, the Plaintiffs further alleged that the Company had failed to follow certain provisions concerning the noticing of Board committee meetings and the recording of Board
meeting minutes and, additionally, that Mr. Wood’s service as both CEO and Chairman of the Board was improper and impermissible under the Company’s Bylaws.
Oral argument was held in the Court of Appeals of Maryland on September 10, 2019 on issues related to the damages awarded
to the Company and against Mssrs. Hamot and Siegel on its Counterclaim for interference with one of its prior auditor relationships. On October 11, 2019, the Court of Appeals issued its Mandate with respect to its September 13, 2019 per curiam order
which dismissed the appeal with costs. Counsel for Mr. Hamot’s estate and Mr. Siegel have previously sought indemnification for a portion of their attorney’s fees and costs incurred in this litigation. The parties are currently discussing the
possibility of submitting issues related to indemnification to non-binding alternative dispute resolution before a third party neutral, or mediation, in an attempt to resolve these issues. In the event that disputes pertaining to indemnification
cannot be amicably resolved, these matters would be addressed by the circuit court.
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 the threatened claim for indemnification, and in the event the issue cannot be resolved through mediation the Company intends to vigorously defend the matter and oppose the relief sought.
Other Litigation
In addition, from time to time the Company is a party to litigation arising in the ordinary course of business. In the
opinion of management, while the results of such litigation cannot be predicted with any reasonable degree of certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the
Company's condensed consolidated financial position, results of operations or cash flows.
Note 9
.
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 $110,000 and $344,000 for the three and nine months ended September 30, 2019,
respectively, and $106,000 and $392,000 for the three and nine months ended September 30, 2018, respectively.
Additionally,
as of
September 30, 2019 and December 31, 2018,
Mr. Wood owned 810,000 shares
of the Company’s Class A Common Stock
and 50,000 shares of the Company’s Class B Common Stock.
On March 31, 2015, the Company entered into the Porter Notes. 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. 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 extends 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 $83,000 and $245,000 for the three and nine months ended September 30, 2019, respectively,
and $78,000 and $229,000 for the three and nine months ended September 30, 2018, respectively,
on the Porter Notes. As of September 30, 2019, approximately $984,000 of accrued interest was payable according to the stated interest rate of the Porter Notes.
Note 10 – Leases
We account for leases in accordance with ASC Topic 842, “Leases,” which requires lessees to recognize a right-of-use asset and lease
liability on the balance sheet and expands disclosures about leasing arrangements for both lessees and lessors, among other items, for most lease arrangements.
In accordance with the adoption of ASC 842 on January 1, 2019, we recorded operating lease right-of-use (“ROU”) assets, which represent our
right to use an underlying asset for the lease term, and operating lease liabilities which represent our obligation to make lease payments. Generally, we enter into operating lease agreements for 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 of the lease commencement date at the present value of the lease payments
over the lease term. Most of our leases do not provide an implicit rate that can readily be determined. Therefore, we use a discount rate based on our incremental borrowing rate which was 5.75% for all operating leases. Our operating lease agreements
may include options to extend the lease term or terminate it early. We have included options to extend in the operating lease ROU assets and liabilities when we are reasonably certain that we will exercise such options. The weighted average remaining
lease terms and discount rates for our operating leases were approximately 3.7 years and 5.75% and for our finance leases were approximately 9.6 years and 5.04% at September 30, 2019. Operating lease expense is recognized as rent expense on a
straight-line basis over the lease term. Some of our operating leases contain lease and non-lease components, which we account for as a single component. We evaluate ROU assets for impairment consistent with our property and equipment policy
disclosure included in our 2018 Form 10-K.
As of September 30, 2019, operating lease ROU assets were $2.1 million and operating lease liabilities were $2.3 million, of which
$1.7 million were classified as noncurrent.
Future minimum lease commitments at September 30, 2019 were as follows (in thousands):
|
Year ending December 31,
|
Operating Leases
|
Finance Leases
|
||||||
|
2019 (excluding the nine months ended September 30, 2019)
|
$
|
169
|
$
|
504
|
||||
|
2020
|
710
|
2,045
|
||||||
|
2021
|
714
|
2,096
|
||||||
|
2022
|
564
|
2,149
|
||||||
|
2023
|
368
|
2,203
|
||||||
|
2024 and thereafter
|
28
|
12,917
|
||||||
|
Total lease payments
|
2,553
|
21,914
|
||||||
|
Less imputed interest
|
(262
|
)
|
(4,761
|
)
|
||||
|
Total
|
$
|
2,291
|
$
|
17,153
|
||||
The components of lease expense were as follows (in thousands):
|
Three Months Ended September 30, 2019
|
Nine Months Ended September 30, 2019
|
|||||||
|
Operating lease cost
|
$
|
160
|
$
|
454
|
||||
|
Finance lease cost
|
||||||||
|
Amortization of right-of-use assets
|
$
|
305
|
$
|
915
|
||||
|
Interest on lease liabilities
|
219
|
666
|
||||||
|
Total finance lease cost
|
$
|
524
|
$
|
1,581
|
||||
Supplemental cash flow information related to leases was as follows (in thousands):
|
Nine Months Ended September 30, 2019
|
||||
|
Cash paid for amounts included in the measurement of lease liabilities:
|
||||
|
Cash flows from operating activities - operating leases
|
$
|
435
|
||
|
Cash flows from operating activities - finance leases
|
1,491
|
|||
|
Right-of-use assets obtained in exchange for lease obligations:
|
||||
|
Operating leases
|
$
|
378
|
||
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, 2018, as filed with the SEC.
General
Our goal is to deliver superior IT solutions that meet or exceed our customers’ expectations. We focus on secure enterprise
solutions that address the unique requirements of the federal government, the military, and the intelligence community, as well as commercial enterprises that require secure solutions. Our IT solutions consist of the following:
| ● |
Cyber Operations and Defense (“CO&D”):
|
|
o
|
Cyber Security – Solutions and services that assure the security of our customers’ information, systems, and networks, including the
Xacta suite for IT governance, risk management, and compliance. Our information and cyber security consulting services include security assessments, digital forensics, and continuous compliance monitoring.
|
|
o
|
Secure Mobility – Design, engineering and delivery of secure solutions that empower the mobile and deployed workforce in business
and government. Our solutions protect sensitive communication while delivering voice, data, and video at the point of work in classified and unclassified environments.
|
| ● |
Identity Management – Solutions that establish trusted identities in order to ensure authenticated physical access to offices, workstations, and other facilities;
secure digital access to databases, host systems, and other IT resources; and protect people and organizations against insider threats.
|
| ● |
IT and Enterprise Solutions – We have the experience with solution development and global integration to meet the requirements of business and government
enterprises with secure IT solutions, from organizational messaging and data visualization to network construction and management.
|
Backlog
Many of our contracts with the U.S. Government are funded year to year by the procuring U.S.
Government agency as determined by the fiscal requirements of the U.S. Government and the respective procuring agency. Such a contracting process results in two distinct categories of backlog: funded and unfunded. Total backlog consists of the
aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or not. Funded backlog consists of the aggregate contract revenues remaining to be earned by us at a given time, but only to the
extent, in the case of U.S. Government contracts, when funded by the procuring U.S. Government agency and allotted to the specific contracts. Unfunded backlog is the difference between total backlog and funded backlog. Included in unfunded backlog
are revenues which may be earned only when and if customers exercise delivery orders and/or renewal options to continue such existing contracts.
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, 2019 and 2018, we had total backlog from existing contracts of approximately $307.5
million and $303.9 million, respectively. Such backlog was $290.8 million at December 31, 2018. 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, 2019 and 2018 was $104.0 million and $91.1 million, respectively. Funded backlog was
$79.3 million at December 31, 2018.
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, and Teloworks, Inc., 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 indefinite delivery/indefinite quantity (“IDIQ”) and government-wide acquisition contracts (“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. The period of performance for the original NETCENTS contract ended on September 30, 2013.
Previously awarded task orders that contain periods of performance that extended past September 30, 2013, including exercisable option years under existing task orders, were not affected by the contract expiration. We were selected for an award on
the NETCENTS replacement contract, NETCENTS-2 Network Operations and Infrastructure Solutions Small Business Companion, on March 27, 2014. Although no protest was filed over the Telos contract award, protests filed by other bidders resulted in a
recommendation by the Government Accountability Office (“GAO”) that the U.S. Air Force re-evaluate proposals and make a new source selection decision. Subsequent to the Air Force’s reevaluation of the NETCENTS-2 procurement related to the protests,
we were selected for an award on April 3, 2015 and the contract was opened for issuance of new orders in May 2015. We have also been awarded other IDIQ/GWACs, including the Department of Homeland Security’s EAGLE II, GSA Alliant 2, and blanket
purchase agreements under our GSA schedule. However, we have not been awarded significant delivery orders under EAGLE II, or GSA Alliant 2.
Congress has not yet passed an appropriations bill for fiscal year (“FY”) 2020 (a U.S. Government fiscal year begins
October 1 and ends September 30). On September 27, 2019, however, Congress passed a continuing resolution funding measure to finance all agencies of the U.S. Government through November 21, 2019. Under this continuing resolution, partial-year funding
at amounts consistent with appropriated levels for fiscal year 2019 are available, subject to certain restrictions, but new spending initiatives are not authorized. U.S. Government agencies may be subject to a government shutdown if new
appropriations are not passed prior to the expiration of the current continuing resolution. During periods covered by continuing resolutions or in the event of a government shutdown, we may experience delays in procurement of products and services
due to lack of funding, and those delays may affect our results of operations.
On August 2, 2019, the President signed the Bipartisan Budget Act of 2019 (“BBA-19”), which increased the spending limits
for both defense and non-defense discretionary funding for U.S. Government fiscal years 2020 and 2021 set under the Budget Control Act of 2011 (BCA). The defense spending limits were increased by $90 billion to $667 billion for fiscal year 2020 and
by $81 billion to $672 billion for fiscal year 2021. When combined with approved Overseas Contingency Operations (“OCO”) / emergency funding (OCO and emergency supplemental funding do not count toward discretionary spending caps), the agreement
raises top-line spending for national defense to $738 billion in fiscal year 2020 and $741 billion in fiscal year 2021. The proposed national security spending in both fiscal years 2020 and 2021 are an increase over the fiscal year 2019 enacted
amount of $716 billion, but are lower than the President’s budget request of $750 billion in fiscal year 2020 and $746 billion in fiscal year 2021. By raising the spending limits, the BBA-19 has essentially ended the budgetary constraints implemented
by the BCA. Additionally, the BBA-19 also suspends the debt ceiling through July 31, 2021, at which time the debt limit will be increased to the amount of U.S. Government debt outstanding on that date.
We anticipate there will continue to be a significant amount of debate and negotiations within the U.S. Government over
federal and defense spending. 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.
The principal elements of the Company’s operating expenses as a percentage of sales for the three and nine months ended
September 30, 2019 and 2018 are as follows:
|
Three Months Ended
September 30,
|
Nine Months Ended
September 30,
|
||||||
|
2019
|
2018
|
2019
|
2018
|
||||
|
(unaudited)
|
|||||||
|
Revenue
|
100.0%
|
100.0%
|
100.0%
|
100.0%
|
|||
|
Cost of sales
|
64.2
|
53.1
|
68.7
|
62.2
|
|||
|
Selling, general, and administrative expenses
|
23.4
|
28.4
|
27.9
|
29.4
|
|||
|
Operating income
|
12.4
|
18.5
|
3.4
|
8.4
|
|||
|
Other income
|
----
|
----
|
0.2
|
----
|
|||
|
Interest expense
|
(4.3)
|
(4.9)
|
(4.9)
|
(5.0)
|
|||
|
Income (loss) before income taxes
|
8.1
|
13.6
|
(1.3)
|
3.4
|
|||
|
Benefit from income taxes
|
----
|
0.3
|
0.2
|
----
|
|||
|
Net income (loss)
|
8.1
|
13.9
|
(1.1)
|
3.4
|
|||
|
Less: Net income attributable to non-controlling interest
|
(3.2)
|
(2.1)
|
(1.5)
|
(1.4)
|
|||
|
Net income (loss) attributable to Telos Corporation
|
4.9%
|
11.8%
|
(2.6)%
|
2.0%
|
|||
Three Months Ended September 30, 2019 Compared with Three Months Ended September 30, 2018
Revenue increased by 31.2% to $45.5 million for the third quarter of 2019, from $34.7 million for the same period in 2018.
Services revenue increased to $39.2 million for the third quarter of 2019 from $32.1 million for the same period in 2018, primarily attributable to increases in sales of $3.7 million of Identity Management solutions, $3.4 million of CO&D’s Cyber
Security deliverables, and $2.1 million of IT & Enterprise solutions, offset by a decrease in sales of $2.0 million of CO&D’s Secure Mobility deliverables. The change in product and services revenue varies from period to period depending on
the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables. Product revenue increased to $6.3 million for the third quarter of 2019 from $2.6 million for the same period in 2018, primarily attributable to
increases in resold product sales of $2.0 million of Identity Management solutions and $1.7 million of CO&D’s Cyber Security proprietary software deliverables.
Cost of sales increased to $29.2 million for the third quarter of 2019, from $18.4 million for the same period in 2018,
primarily due to increases in revenue of $10.8 million, coupled with an increased cost of sales as a percentage of revenue of 11.1%. Cost of sales for services increased by $9.5 million, and as a percentage of services revenue increased by 14.3%, due
to a change in the mix of the programs and timing of certain Telos-installed solutions in CO&D’s Secure Mobility deliverables, primarily the comparative effect of the recognition of $5.6 million of revenue accruals in the third quarter of 2018
related to several years of cumulative indirect rate adjustments that were not repeated in 2019. Cost of sales for products increased by $1.4 million, and as a percentage of product revenue decreased by 6.6% due primarily to an increase in
proprietary software sales which carry lower cost of sales. The increase in cost of sales as a percentage of revenue is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary from period to
period, and further can be affected by the timing of deliverables.
Gross profit increased by 0.2% to $16.3 million for the third quarter of 2019 from $16.3 million for the same period in
2018. Gross margin decreased to 35.8% in the second quarter of 2019, from 46.9% for the same period in 2018. Services gross margin decreased to 32.2% in 2019 from 46.5% in 2018 due primarily to the change in program mix related to the indirect rate
adjustments during the period as noted above, and product gross margin increased to 58.4% in 2019 from 51.9% in 2018, due primarily to an increase in proprietary software sales.
Selling, general, and administrative expense (SG&A) increased by 8.0% to $10.6 million for the third quarter of 2019,
from $9.9 million for the same period in 2018, primarily attributable to increases in outside services of $0.4 million, labor costs of $0.2 million and trade shows expenses of $0.1 million.
Operating income decreased by 11.8% to $5.7 million for the third quarter of 2019, compared to $6.4 million for the same
period in 2018, due primarily to an increase in SG&A as noted above.
Interest expense increased by 14.7% to $2.0 million for the third quarter of 2019, from $1.7 million
for the same period in 2018, primarily due to an increase in interest on the EnCap senior term loan.
Income tax benefit was $10,000 for the third quarter of 2019, compared to $106,000 for the same period in 2018, which is
based on the estimated annual effective tax rate applied to the pretax income incurred for the quarter plus discreet tax items, based on our expectation of pretax loss for the fiscal year.
Net income attributable to Telos Corporation was $2.2 million for the third quarter of 2019, compared to $4.1 million for
the same period in 2018, primarily attributable to the operating income for the quarter as discussed above.
Nine Months Ended September 30, 2019 Compared with Nine Months Ended September 30, 2018
Revenue increased by 10.5% to $112.7 million for the nine months ended September 30, 2019, from $102.0 million in the same
period in 2018. Services revenue increased to $101.6 million for the nine months ended September 30, 2019, from $91.7 million for the same period in 2018, primarily attributable to increases in sales of $8.3 million of CO&D’s Cyber Security
deliverables, $5.3 million of Identity Management solutions, and $3.3 million of IT & Enterprise solutions, offset by a decrease in sales of $7.0 million of CO&D’s Secure Mobility deliverables. The change in product and services revenue
varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables. Product revenue increased to $11.1 million for the nine months ended September 30, 2019, from $10.3 million
for the same period in 2018, primarily attributable to increases in resold product sales of $1.7 million of Identity Management solutions and $0.4 million of IT & Enterprise solutions, offset by a decrease in sales of $1.3 million of CO&D’s
Cyber Security proprietary software deliverables.
Cost of sales increased by 22.1% to $77.4 million for the nine months ended September 30, 2019, from $63.4 million for the
same period in 2018, primarily due to increases in services revenue of $10.7 million, coupled with an increased cost of sales as a percentage of revenue of 6.5%. Cost of sales for services increased by $12.9 million, and as a percentage of services
revenue increased by 6.4%, due primarily to a change in the mix of the programs and timing of certain Telos-installed solutions in CO&D’s Secure Mobility deliverables, primarily the comparative effect of the recognition of $5.6 million of revenue
accruals in the third quarter of 2018 related to several years of cumulative indirect rate adjustments that were not repeated in 2019. Cost of sales for products increased by $1.1 million, and as a percentage of product revenue increased by 7.1% due
primarily to a decrease in proprietary software sales which carry lower cost of sales. The increase in cost of sales as a percentage of revenue is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can
vary from period to period, and further can be affected by the timing of deliverables.
Gross profit decreased by 8.5% to $35.3 million for the nine months ended September 30, 2019, from $38.6 million compared
to the same period in 2018, due primarily to the change in the mix of the solutions sold as discussed above. Gross margin decreased to 31.3% for the nine months ended September 30, 2019, from 37.8% in the same period in 2018.
SG&A expense increased by 4.7% to $31.4 million for the nine months ended September 30, 2019, from $30.0 million for
the same period in 2018, primarily attributable to an increase in labor costs of $1.2 million.
Operating income decreased by 54.8% to $3.9 million for the nine months ended September 30, 2019, compared to operating
income of $8.6 million for the same period in 2018, due primarily to a decrease in gross profit and an increase in SG&A as noted above.
Interest expense increased by 7.2% to $5.5 million for the nine months ended September 30, 2019, from $5.1 million for the
same period in 2018, primarily due to an increase in interest on the EnCap senior term loan and an equipment purchase arrangement.
Income tax benefit was $187,000 for the nine months ended September 30, 2019, compared to $41,000 for the same period in
2018, which is based on the estimated annual effective tax rate applied to the pretax loss incurred for the nine month period plus discreet tax items, adjusted for the income tax benefit previously provided, based on our expectation of pretax loss
for the fiscal year.
Net loss attributable to Telos Corporation was $2.9 million for the nine months ended September 30, 2019, compared to net
income of $2.0 million for the same period in 2018, primarily attributable to the decrease in operating income as discussed above.
Liquidity and Capital Resources
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 our availability
under our credit arrangements. For example, a contractual requirement to post collateral for a duration of several months, depending on the materiality of the amount, could have an immediate negative effect on our liquidity, as such a circumstance
would utilize cash resources without a near-term cash inflow back to us. Likewise, the release of such collateral could have a corresponding positive effect on our liquidity, as it would represent an addition to our cash resources without any
corresponding near-term cash outflow. Similarly, a slow-down of payments from a customer, group of customers or government payment office would not have an immediate and direct effect on our availability unless the slowdown was material in amount and
over an extended period of time. Any of these examples would have an impact on our cash resources, our financing arrangements, and therefore our liquidity.
Management may determine that, in order to reduce capital and liquidity requirements, planned spending on capital projects
and indirect expense growth may be curtailed, subject to growth in operating results. Additionally, management may seek to put in place a credit facility with a commercial bank, although no assurance can be given that such a facility could be put in
place under terms acceptable to the Company. Should management determine that additional capital is required, management would likely look first to the sources of funding discussed above to meet any requirements, although no assurances can be given
that these investors would be able to invest or that the Company and the investors would agree upon terms for such investments.
Our working capital was $3.9 million and $2.1 million as of September 30, 2019 and December 31, 2018, respectively.
Although no assurances can be given, we expect that our financing arrangements with EnCap and RCA, collectively, and funds generated from operations are sufficient to maintain the liquidity we require to meet our operating, investing and financing
needs for the next 12 months.
Cash provided by operating activities was $4.4 million for the nine months ended September 30, 2019, compared to $4.5
million for the same period in 2018. 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 loss was $1.2 million for the nine months ended September 30, 2019, compared to $3.5 million net income for
the nine months ended September 30, 2018.
Cash used in investing activities was approximately $5.3 million and $2.8 million for the nine months ended September 30,
2019 and 2018, respectively, due primarily to the purchase of property and equipment of $3.1 million and $1.5 million for the nine months ended September 30, 2019 and 2018, respectively, and the capitalization of software development costs of $2.2
million and $1.3 million for the nine months ended September 30, 2019 and 2018, respectively.
Cash provided by financing activities for the nine months ended September 30, 2019 was $2.7 million, compared to $1.9
million cash used in financing activities for the same period in 2018, primarily attributable to proceeds from the EnCap senior term loan of $4.9 million and distribution of $1.4 million to the Telos ID Class B member for the nine months ended
September 30, 2019, compared to distribution of $1.1 million to the Telos ID Class B member for the nine months ended September 30, 2018.
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 provides 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 will 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.
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 Agent and certain of the Lenders representing in the aggregate the right to purchase in accordance with their terms 1,135,284.333 shares of the Class A Common Stock of the Company, no par value per share, which is equivalent to
approximately 2.5% of the common equity interests of the Company on a fully diluted basis. The exercise price is $1.321 per share and each Warrant expires on January 25, 2027. The value of the warrants were determined to be de minimis and no value
was allocated to them on a relative fair value basis in accounting for the debt instrument.
The Credit Agreement also included an $825,000 exit fee, which is payable upon any repayment or prepayment of the loan.
This amount has been included in the total principal due and treated as an unamortized discount on the debt, which will be amortized over the term of the loan, using the effective interest method at a rate of 15.0% at the time of the original loan.
We incurred fees and transaction costs of approximately $374,000 related to the issuance of the Credit Agreement, which are being amortized over the life of the Credit Agreement.
Effective February 23, 2017, the Credit Agreement was amended to change the required timing of certain
post-closing items to allow for more time to complete the legal and administrative requirements around such items. On April 18, 2017, the Credit Agreement was further amended (the “Second Amendment”) to incorporate the parties’ agreement to
subordinate certain debt owed by the Company to the affiliated entities of Mr. 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, 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. We are 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 July 19, 2019, we entered into the Fourth Amendment to Credit Agreement and Waiver; First Amendment to Fee Letter
(“Fourth Amendment”) to amend the Credit Agreement. As a result of the Fourth Amendment, several terms of the Credit Agreement were amended, including the following:
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The Company borrowed an additional $5 million from the Lenders, increasing the total amount of the principal to $16 million.
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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.
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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.
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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 will be
amortized over the term of the loan, using the effective interest method at a rate of 17.3% over the remaining term of the loan. For the measurement period ending September 30, 2019 we are 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.
We incurred interest expense in the amount of $0.7 million and $1.5 million for the three and nine months ended September
30, 2019, respectively, and $0.4 million and $1.3 million for the three and nine months ended September 30, 2018, respectively, under the Credit Agreement.
Accounts Receivable Purchase Agreement
On July 15, 2016, we entered into an Accounts Receivable Purchase Agreement (the “Purchase Agreement”) with Republic
Capital Access, LLC (“RCA” or “Buyer”), pursuant to which we may offer for sale, and RCA, in its sole discretion, may purchase, eligible accounts receivable relating to U.S. Government prime contracts or subcontracts of the Company (collectively, the
“Purchased Receivables”). Upon purchase, RCA becomes the absolute owner of any such Purchased Receivables, which are payable directly to RCA, subject to certain repurchase obligations of the Company. The total amount of Purchased Receivables is
subject to a maximum limit of $10 million of outstanding Purchased Receivables (the “Maximum Amount”) at any given time. The Purchase Agreement had an initial term expiring on June 30, 2018 and automatically renews for successive 12-month renewal
periods unless terminated in writing by either the Company or RCA. On March 2, 2018, the term of the Purchase Agreement was extended to June 30, 2020. No fee or consideration of any kind was paid in connection with this extension.
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.
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.
Financing and Security Agreement
On July 15, 2016, we entered into a Financing and Security Agreement (the “Financing Agreement”) with Action Capital
Corporation (“Action Capital”), pursuant to which Action Capital agreed to provide the Company with advances of up to 90% of the net amount of certain acceptable customer accounts of the Company that have been assigned as collateral to Action Capital
(the “Acceptable Accounts”). The maximum outstanding principal amount of advances under the Financing Agreement was $5 million. The Financing Agreement had a term of two years, provided that the Company may terminate it at any time without penalty
upon written notice. On August 13, 2018, the Financing Agreement was extended through January 2, 2019. No fee or consideration of any kind was paid in connection with this extension. The Financing Agreement was not extended beyond this date.
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 $83,000 and $245,000 for the three
and nine months ended September 30, 2019, respectively, and $78,000 and $229,000 for the three and nine months ended September 30, 2018, respectively, on the Porter Notes. As of September 30, 2019, approximately $984,000 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, 2019 and December 31, 2018 was 3,185,586. The Public Preferred Stock is quoted as “TLSRP” on the OTCQB marketplace and the OTC Bulletin Board.
Since 1991, no dividends were declared or paid on our Public Preferred Stock, based upon our interpretation of restrictions
in our Articles of Amendment and Restatement, limitations in the terms of the Public Preferred Stock instrument, specific dividend payment restrictions in 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, 2019 and December 31, 2018.
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, 2019. 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 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% of a share for each $.60 of such dividends not paid in cash. For the cash dividends payable since December 1, 1995, we have accrued $106.4 million and $103.5 million as of September 30, 2019 and December 31, 2018,
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, 2019 and 2018, respectively, which was recorded as interest expense. Prior to the effective
date of ASC 480 on July 1, 2003, such dividends were 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
Except as set forth below, during the three months ended September 30, 2019, 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, 2018 as filed with the SEC on April 1, 2019.
Leases
In February 2016, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02,
“Leases (ASC Topic 842)”, which requires lessees to recognize a right-of-use asset and lease liability on the balance sheet and expands disclosures about leasing arrangements for both lessees and lessors, among other items, for most lease
arrangements. The new standard is effective for fiscal years beginning after December 15, 2018, which made the new standard effective for us on January 1, 2019. In July 2018, the FASB issued ASU 2018-11, “Leases (ASC Topic 842): Targeted
Improvements,” which allows for an additional transition method under the modified retrospective approach for the adoption of ASU 2016-02. The two permitted transition methods are (a) to apply the new lease requirements at the beginning of the
earliest period presented (the Comparative Method) and (b) to apply the new lease requirements at the effective date (the Effective Date Method). Under both transition methods there is a cumulative effect adjustment. We adopted the standard on
January 1, 2019 by applying the new lease requirements utilizing the Effective Date Method for all leases with terms greater than 12 months. We elected the package of practical expedients permitted under the transition guidance within the new
standard, which included carrying forward historical assessments of: (1) whether contracts are or contain leases, (2) lease classification and (3) initial direct costs. The adoption of this standard resulted in the recognition of right-of-use assets
of $2.0 million and additional lease liabilities of $2.0 million as of January 1, 2019. The adoption of the standard did not have a material impact on our operating results or cash flows. The comparative periods have not been restated for the
adoption of ASU 2016-02.
None.
Evaluation of Disclosure Controls and Procedures
An evaluation of the
effectiveness of our disclosure controls and procedures as of September 30, 2019 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
.
Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended
September 30, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Information
regarding legal proceedings may be found in Note 8 – Commitments and Contingencies to the condensed consolidated financial statements.
There were no material changes in the period ended September 30, 2019 in our risk factors as disclosed in our Annual Report
on Form 10-K for the year ended December 31, 2018.
None.
12% Cumulative Exchangeable Redeemable Preferred Stock
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 $106.4 million and $103.5 million in cash dividends as of September 30, 2019 and December 31, 2018, 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, 2019 and December 31, 2018.
Not applicable.
None.
|
Exhibit
Number
|
Description of Exhibit
|
|
10.1
|
Fourth Amendment to Credit Agreement and Waiver; First Amendment to Fee Letter between Telos Corporation and Enlightenment Capital Solutions Fund II, L.P.
dated July 19, 2019
(Incorporated by reference to Exhibit 99.1 filed with the Company’s Current Report on Form 8-K on July 23, 2019)
|
|
31.1*
|
|
|
31.2*
|
|
|
32*
|
|
|
101.INS**
|
XBRL Instance Document
|
|
101.SCH**
|
XBRL Taxonomy Extension Schema
|
|
101.CAL**
|
XBRL Taxonomy Extension Calculation Linkbase
|
|
101.DEF**
|
XBRL Taxonomy Extension Definition Linkbase
|
|
101.LAB**
|
XBRL Taxonomy Extension Label Linkbase
|
|
101.PRE**
|
XBRL Taxonomy Extension Presentation Linkbase
|
* filed 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”
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.
|
Date: November 14, 2019
|
TELOS CORPORATION
|
|
|
/s/ John B. Wood
|
||
|
John B. Wood
Chief Executive Officer (Principal Executive Officer)
|
|
/s/ Michele Nakazawa
|
||
|
Michele Nakazawa
Chief Financial Officer (Principal Financial and Accounting Officer)
|
45
TABLE OF CONTENTS
Part I Financial InformationItem 1. Financial StatementsNote 1. General and Basis Of PresentationNote 2. Non-controlling InterestsNote 3. GoodwillNote 4. Fair Value MeasurementsNote 5. Current Liabilities and Debt ObligationsNote 6. Redeemable Preferred StockNote 7. Income TaxesNote 8. Commitments, Contingencies and Subsequent EventsNote 9. Related Party TransactionsNote 10 LeasesItem 2. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPart II Other InformationItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 2. Unregistered Sales Of Equity Securities and Use Of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Mine Safety DisclosuresItem 5. Other InformationItem 6. Exhibits