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"“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'sCompany’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'sCompany’s Form 10-K for the year ended December 31, 2016,2020, as filed with the SEC.
Network Management and Defense: services for operating, administrating, and defending complex enterprise networks and defensive cyber operations. Our diverse portfolio of capabilities addresses common and uncommon requirements of the federal government,in many industries and disciplines, ranging from the military and the intelligence community, as well as commercial enterprises that require secure solutions. Our IT solutions consist of the following:government agencies to Fortune 500 companies.
● | Cyber Operations and Defense: |
o | Cyber Security – Solutions and services that assure the security of our customers' information, systems, and networks, including the Xacta IA Manager 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
We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts. We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers. In the context of our current customer portfolio, we view “recurring revenue” as revenue that occurs often and repeatedly. In each of the last three years, recurring revenue has exceeded 85% of our annual revenue. Our total budgeted revenue is the combination of recurring revenue and a forecast of new business.
Total backlog, a component of recurring revenue, consists of the aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or unfunded. Funded backlog consists of the aggregate contract revenues remaining to be earned at a given time, which, in the case of U.S. government contracts, means that they have been funded by the procuring agency. Unfunded backlog is the difference between total backlog and funded backlog and includes potential revenues that may be earned if customers exercise delivery orders and/or renewal options to continue these contracts. Based on historical experience, we generally assume option year renewals to be exercised. Most of our customers fund contracts on a basis of one year or less and, as of September 30, 2017 and 2016 was $92.5 million and $75.4 million, respectively. Fundeda result, funded backlog was $59.7 million at December 31, 2016.is generally expected to be earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period.
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, andTelos Identity Management Solutions, LLC, Teloworks, Inc., and Telos APAC Pte. Ltd., all of whose issued and outstanding share capital is owned directly or indirectly by Telos Corporation (collectively, the "Company"“Company” or "Telos"“Telos” or "We"“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 solution, 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.
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")IDIQ and government-wide acquisition contracts ("GWAC"),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'sSecurity’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.
On August 31, 2015, we were notified that we were not awarded the re-compete of a contract withinWe refer to our ITcyber and cloud applications as Security Solutions, which includes Information Assurance /Xacta® (previously referred to as Cyber & Cloud Solutions), Secure Communications (previously referred to as Secure Communications Cyber and Enterprise Solutions (formerlySolutions), and Telos ID (previously referred to as Telos ID Enterprise Solutions). We refer to our offerings for enterprise security as Secure Communications) area for a government agency. The contract had a total funded value of over $45 million over the prior three yearsNetworks (previously referred to as Secure Mobility and accounted for approximately 11% of revenue for 2015. We filed a protest of the award with the Court of Federal Claims, which entered a final order denying the protest on February 29, 2016. On March 4, 2016, we filed an appeal with the United States Court of Appeals for the Federal Circuit, appealing the decision of the Court of Federal Claims, and the appellate court affirmed the judgement of the lower court on December 13, 2016. We continued to perform under the contract through the period of performance, which ended on May 22, 2016.Network Management/Defense Enterprise Solutions).
On October 13, 2016, we were notified that we were not awarded the re-compete of a contract within our Cyber Operations & Defense area for a government agency that we had bid as part of a joint venture. The contract had a total funded value of over $22 million over the prior three years and accounted for approximately 6% of revenue for 2016. The joint venture filed a protest of the award to another bidder with the GAO on October 24, 2016, which denied the protest on February 2, 2017. The joint venture then filed a claim with United States Court of Federal Claims ("COFC") on February 10, 2017, together with a motion seeking to stay and enjoin the transition of the contract. The COFC denied the requests for injunctive relief on February 14, 2017, but initiated a one-month extension on the current contract so as to allow the Court to address the joint venture's protest, hold a hearing and issue a decision in advance of any final contract transition. On April 27, 2017, the COFC issued a final decision in favor of the government. The period of performance on the contract ended on May 2, 2017.
The U.S. Government has not yet passed an appropriations bill for fiscal year 2018 (the U.S. Government's fiscal year begins on October 1have been and ends on September 30). On September 8, 2017, however, the U.S. Government passed a continuing resolution funding measure to finance all U.S. Government activities through December 8, 2017. Under this continuing resolution, partial-year funding at amounts consistent with appropriated levels for fiscal year 2017 are available, subject to certain restrictions, but new spending initiatives are not authorized. Our key programs continue to be supportedaffected by larger U.S. Government budgetary issues and funded despite the continuing resolution financing mechanism. During periods covered by continuing resolutions or until the regular appropriation bills are passed, however, we may experience delays in procurement of products and services due to lack of funding, and those delays may affect our results of operations.
related legislation. In May 2017, the President submitted a budget proposal for fiscal year 2018 to2011, Congress which includes a base budget for the Department of Defense ("DoD") of $575 billion, approximately $52 billion above the spending limits established underenacted the Budget Control Act of 2011 (the “BCA”), which established specific limits on annual appropriations for fiscal years 2012-2021. These limits were subsequently amended several times. With the expiration of the BCA at the end of FY 2021, there are no statutory limits in place for FY 2022 to guide federal spending negotiations and decisions.
According to the non-partisan Congressional Budget Control Act) (described below)Office (CBO), since enactment of the BCA, federal outlays devoted to defense programs fell from 4.5 percent as a share of Gross Domestic Product (GDP) to as low as 3.1 percent of GDP in each of FYs 2016-18, before rising slightly the past two years to a level of 3.4 percent in FY 2020. Moreover, CBO reports that, as a result of the spending caps imposed by the BCA, non-adjusted defense outlays subsequently shrank from $699.4 billion in FY 2011 to as low as $583.4 billion in FY 2016, and did not again exceed their FY 2011 level until FY 2020, when outlays were $713.8 billion, two percent above the FY 2011 level.
In fiscal years 2020 and 2021, the COVID-19 pandemic and associated economic dislocation in the United States has resulted in an increaseoverwhelming federal response, including enactment of $32 billion overmultiple massive and comprehensive emergency appropriations and economic stimulus measures. These were in addition to annual appropriations legislation for FY 2021, which was not enacted into law until late December 2020, nearly three months after the beginning of the fiscal year, 2017 funding level.during which time the government once again operated under a series of Continuing Resolutions which strictly limited new spending initiatives. These enormous emergency spending packages and their resulting increases in the budget deficit will necessarily factor into future federal budget planning and spending decisions, which will affect to an unknown degree the government contracts that we hold and the federal procurements that we would otherwise compete for.
While a detailed FY 2022 budget proposal has not been released, on April 9, 2021, the White House released an outline of President Biden’s discretionary budget request, with topline numbers to help Congress begin the annual appropriations process. The President'sPresident’s budget requestsproposes $715 billion in base spending for the Department of Defense (“DoD”) in FY 2022, which the Office of Management and Budget described as an $11.3 billion (1.6 percent) increase above the FY 2021 enacted level of $703.7 billion. However, this requested base defense budget also include funding of $65 billionnow includes wartime spending which was formerly provided in a separate account for Overseas Contingency Operations (OCO) / Global War on Terror (GWOT), whichOperations. Moreover, congressional support for the President’s proposed level of defense spending is not subjectuncertain, as there are some in Congress who are advocating large cuts to the Budget Control Act spending limits. Congress must approve or revise the President's 2018defense budget, proposals through enactment of appropriations bills and other policy legislation, which would then require final Presidential approval.as well as others who are calling for much greater increases in military spending.
BothShould Congress and the
White House
be unable to make sufficient progress on the FY 2022 budget and
Senate have passed versionsenact appropriations legislation prior to the beginning of the
2018 National Defense Authorization bills,new fiscal year on October 1, 2021, the DoD and other federal departments and agencies will likely again be funded for an unknown period of time under a Continuing Resolution, which
establish funding levels forwould restrict new spending initiatives.
Despite the agencies responsible for defensepandemic’s resultant massive shift to teleworking by federal employees and set forth howcontractors, the funds willgovernment has successfully maintained continuity of services as has Telos. With much of the business of government continuing to be used. Eachconducted remotely through use of these proposals reflects significant increases over the President's $575 billion request. These two positions mustinformation technology systems, now be reconciled in conference. It remains uncertain which measures will be adoptedand in the final National Defense Authorization Act and when an appropriations bill for fiscal year 2018 will be enacted or at what levels.
Currently, U.S. defense spending through fiscal year 2021 remains subject to statutory spending limits established by the Budget Control Act. The spending limits were modified for fiscal years 2013 through 2017 by the American Taxpayer Relief Act of 2012, the Bipartisan Budget Act of 2013 and the Bipartisan Budget Act of 2015. These acts, however, did not provide relief to the spending limits beyond fiscal year 2017. If Congress approves the President's budget proposal or other appropriation legislation with funding levels that exceed the spending limits, automatic across-the-board spending reductions, known as sequestration, would be triggered to reduce funding back to the spending limits. As currently enacted, the Budget Control Act limits defense spending to $522 billion for fiscal year 2018 with modest increases of about 2.5% per year through 2021. The President's budget proposal as well as defense budget estimates for fiscal year 2018 and beyond exceeds the spending limits established by the Budget Control Act. As a result, continued budget uncertainty and the risk of future, sequestration cuts remain unless the Budget Control Act is repealed or significantly modified. Our programs could be materially reduced, extended, or terminated as a result of the U.S. Government's continuing assessment of priorities, changes in government priorities, the implementation of sequestration (particularly in those circumstances where sequestration is implemented across-the-board without regard to national priorities), or other budget cuts in lieu of sequestration.
In March 2017, the outstanding debt of the U.S. reached the debt borrowing limit, known as the debt ceiling. To avoid exceeding the debt ceiling, the U.S. Department of Treasury began employing measures to finance the U.S. Government. On September 8, 2017, Congress passed legislation suspending the debt ceiling through December 8, 2017. Effective on December 9, 2017, the debt limit will be increased to the amount of debt the government holds outstanding on that date. Despite using cash on hand and measures employed by the Department of Treasury, however, the debt ceiling is expected to be reached again in early 2018. Congress will need to raise the debt limit in order for the U.S. Government to continue borrowing money before these measures are exhausted. If the debt ceiling is not raised, the U.S. Government may not be able to pay for expenditures or fulfill its funding obligations and there could be significant disruption to all discretionary programs. Although we believe that key defense, intelligence and homeland security programs would receive priority, the effect on individual programs or Telos cannot be predicted at this time.
We anticipate there will continue to be a significant amountneed on the part of debatethe government for the types of solutions and negotiations within the U.S. Government over defense spending and the debt ceiling. In the context of these negotiations, it is possible that existing cuts to government programs could be kept in place, replaced with different spending cuts, and/or replaced with a package of broader reforms to reduce the federal deficit.services provided by Telos.
The principal elementelements of the Company'sCompany’s operating expenses as a percentage of sales for the three and nine months ended September 30, 2017March 31, 2021 and 20162020 are as follows:
| | (unaudited) | Three Months Ended March 31, |
| | Three Months Ended September 30, | | Nine Months Ended September 30, | 2021 | | 2020 |
| | 2017 | | 2016 | | 2017 | | 2016 | (unaudited) |
| | | | | | | | | | | |
| Revenue | 100.0% | | 100.0% | | 100.0% | | 100.0% | 100.0% | | 100.0% |
| Cost of sales | 67.2 | | 73.6 | | 65.4 | | 68.2 | 74.3 | | 68.6 |
| Selling, general, and administrative expenses | 32.9 | | 21.2 | | 38.2 | | 28.0 | |
| | | | | | | | | |
| Selling, general and administrative expenses | | 49.9 | | 30.4 |
| Operating (loss) income | (0.1) | | 5.2 | | (3.6) | | 3.8 | (24.2) | | 1.0 |
| | | | | | | | | |
| Other income | ---- | | ---- | | ---- | | ---- | |
| Other expense | | (1.9) | | ---- |
| Interest expense | (6.1) | | (2.5) | | (6.9) | | (3.8) | (0.4) | | (5.1) |
| | | | | | | | | |
| (Loss) income before income taxes | (6.2) | | 2.7 | | (10.5) | | -- | |
| Provision for income taxes | (0.7) | | (0.3) | | (0.7) | | (0.2) | |
| Net (loss) income | (6.9) | | 2.4 | | (11.2) | | (0.2) | |
| Loss before income taxes | | (26.5) | | (4.1) |
| Benefit from income taxes | | ---- | | 0.4 |
| Net loss | | (26.5) | | (3.7) |
| Less: Net income attributable to non-controlling interest | (3.8) | | (2.6) | | (2.0) | | (2.5) | ---- | | (2.0) |
| Net loss attributable to Telos Corporation | (10.7)% | | (0.2)% | | (13.2)% | | (2.7)% | (26.5)% | | (5.7)% |
Three Months Ended September 30, 2017 Compared with Three Months Ended September 30, 2016
Revenue decreasedincreased by 48.6%43.0% to $28.3$55.8 million for the thirdfirst quarter of 2017,2021, from $54.9$39.0 million for the same period in 2016. Services2020. Security Solutions revenue decreased to $19.1was $22.9 million and $27.3 million for the thirdfirst quarter of 20172021 and 2020, respectively. This decrease of approximately 16.1% was driven primarily by a decrease of $5.3 million in sales of offerings in Telos ID on the contract with the U.S. Census Bureau as the contract ramps down, offset by various increases in Information Assurance and Secure Communications offerings. Secure Networks revenue was $32.9 million and $11.7 million for the first quarter of 2021 and 2020, respectively. This increase of approximately 181.2% resulted from $43.5various contracts with the DoD, primarily in our Secure Mobility Solutions offerings. Due to the various solutions offerings within the business groups, sales may vary from period to period according to the solution mix and timing of deliverables for a particular period.
Cost of sales increased by 54.8% to $41.4 million for the first quarter of 2021, from $26.7 million for the same period in 2016, primarily attributable to decreases2020 as a result of increases in revenue. Cost of sales of $22.8 million of Cyber Operations and Defense in Secure Mobility deliverables due primarily to a significant contract delivery in the prior year that was not repeated in the current year and to us not being awarded a re-competed contract with a government agency as discussed above, $2.4 million of Cyber Operations and Defense in Cyberfor Security deliverables, offset by an increase in sales of $0.7 million of Identity Management solutions and $0.1 million of IT & Enterprise solutions. The change in product and services revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables. Product revenueSolutions decreased to $9.1$13.6 million (inclusive of $660,000 of stock-based compensation) for the thirdfirst quarter of 20172021 from $11.5$17.2 million for the same period in 2016, primarily attributable to decreases2020 (which had no stock-based compensation), which translates as a decrease in resold product sales of $1.9 million of Identity Management solutions, $1.5 million of Cyber Operations and Defense in Cyber Security proprietary software deliverables, offset by an increase in sales of $1.1 million of Cyber Operations and Defense in Secure Mobility resold product sales.
Cost of sales decreased to $19.0 million for the third quarter of 2017 from $40.4 million for the same period in 2016, primarily due to decreases in revenue of $26.7 million, coupled with a decreased cost of sales as a percentage of revenue of 6.3%. Cost of sales for services decreased by $21.2 million, and as a percentage of services revenue decreased by 13.2%to 59.4% from 63.0%, due to a change in the mix and nature of the programs and timing of certain Telos-installed solutions in Cyber Operations and Defense in Secure Mobility deliverables.programs. Cost of sales for products decreased by $0.2Secure Networks increased to $27.8 million and(inclusive of $77,000 of stock-based compensation) for the first quarter of 2021 from $9.5 million for the same period in 2020 (which had no stock-based compensation), which translates as an increase in the cost of sales as a percentage of product revenue increased by 13.9% due primarily to a decrease in proprietary software sales which carry lower cost of sales and an increase in lower margin resold product sales. The decrease in cost of sales is not necessarily indicative of a trend as the mix of solutions sold and the nature of such solutions can vary84.5% from period to period, and further can be affected by the timing of deliverables.81.2%.
Gross profit increased by 17.3% to $14.4 million for the first quarter of 2021 from $12.3 million for the same period in 2020. Gross profit for Security Solutions decreased to $9.3 million for the thirdfirst quarter of 20172021 from $14.5$10.1 million for the same period in 2016.2020. Gross marginprofit for Secure Networks increased to 32.8% in the third quarter of 2017, from 26.4% for the same period in 2016. Services gross margin increased to 36.3% from 23.0% in 2016, and product gross margin decreased to 25.5% in 2017 from 39.4% in 2016, due primarily to a change in program mix during the period as noted above.
Selling, general, and administrative expense (SG&A) decreased by 20.3% to $9.3$5.1 million for the thirdfirst quarter of 2017,2021 from $11.7$2.2 million for the same period in 2016,2020. Gross margin decreased to 25.7% for the first quarter of 2021 from 31.4% for the same period in 2020, due to stock-based compensation and various changes in the mix of contracts in all business lines as discussed above. Gross margin for Security Solutions increased to 40.6% for the first quarter of 2021 from 37.0% for the same period in 2020. Gross margin for Secure Networks decreased to 15.5% for the first quarter of 2021 from 18.8% for the same period in 2020.
Selling, general, and administrative (“SG&A”) expense increased by 135.2% to $27.9 million for the first quarter of 2021, from $11.8 million for the same period in 2020, primarily attributable to decreasesincreases in accrued bonusesstock-based compensation of $2.1$12.9 million, labor costs of $0.1$2.2 million, outside services of $0.8 million, insurance costs of $0.3 million, legal costs of $0.2 million, and trade shows costs of $0.2 million, offset by the capitalization of software development costs of $0.3 million, offset by an increase in outside services of $0.2$0.7 million.
Operating loss was $34,000$13.5 million for the thirdfirst quarter of 2017,2021, compared to $0.4 million operating income for the same period in 2020, due primarily to the stock-based compensation related to the RSUs granted in the first quarter of $2.92021.
Other expense of $1.1 million for the first quarter of 2021 was attributable to an accrual for a litigation settlement agreement.
Interest expense decreased by 90.3% to $0.2 million for the first quarter of 2021, from $2.0 million for the same period in 2016, due primarily to a decrease in gross profit as noted above.
Interest expense increased by 26.1% to $1.7 million for the third quarter of 2017, from $1.4 million for the same period in 2016,2020, primarily due to an increase in interest onthe payoff of the EnCap senior term loan.loan, subordinated debt, and redemption of public preferred stock upon the closing of our initial public offering (“IPO”) in November 2020.
Income tax provision was $211,000$34,000 for the thirdfirst quarter of 2017,2021, compared to $158,000$146,000 income tax benefit for the same period in 2016,2020, which is based on the estimated annual effective tax rate applied to the pretax lossincome incurred for the quarter plus discreet tax items, based on our expectation of pretax lossincome for the fiscal year.
Net loss attributable to Telos Corporation was $3.0$14.8 million for the thirdfirst quarter of 2017,2021, compared to $0.1$2.2 million for the same period in 2016,2020, primarily attributable to the increasestock-based compensation recorded in operating loss for the first quarter of 2021 as discussedmentioned above.
Nine Months Ended September 30, 2017 Compared with Nine Months Ended September 30, 2016
Revenue decreased by 33.4% to $72.5 million for the nine months ended September 30, 2017 from $108.8 million in the same period in 2016. Services revenue decreased to $57.2 million for the nine months ended September 30, 2017 from $91.3 million for the same period in 2016, primarily attributable to decreases in sales of $29.3 million of Cyber Operations and Defense in Secure Mobility deliverables, including a significant contract delivery in the prior year that was not repeated in the current year and a decline related to us not being awarded a re-competed contract with a government agency as discussed above, $4.6 million of IT & Enterprise solutions due primarily to us not being awarded a re-competed contract with a government agency as discussed above, and $0.8 million of Cyber Operations and Defense in Cyber Security deliverables, offset by an increase in sales of $0.8 million of Identity Management solutions. The change in product and services revenue varies from period to period depending on the mix of solutions sold and the nature of such solutions, as well as the timing of deliverables. Product revenue decreased to $15.2 million for the nine months ended September 30, 2017 from $17.5 million for the same period in 2016, primarily attributable to decreases in resold product sales of $3.0 million of Identity Management solutions and $1.6 million of Cyber Operations and Defense in Cyber Security proprietary software deliverables, offset by increases in sales of $1.3 million of Cyber Operations and Defense in Secure Mobility resold product sales, and $1.0 million of IT & Enterprise solutions.
Cost of sales decreased to $47.4 million for the nine months ended September 30, 2017 from $74.2 million for the same period in 2016, primarily due to decreases in revenue of $36.4 million, coupled with a decreased cost of sales as a percentage of revenue of 2.9%. Cost of sales for services decreased by $26.5 million, and as a percentage of services revenue decreased by 4.8%, due to a change in the mix of the programs and timing of certain Telos-installed solutions in Cyber Operations and Defense in Secure Mobility deliverables. Cost of sales for products decreased by $0.4 million, and as a percentage of product revenue increased by 6.7% due primarily to a decrease in proprietary software sales which carry lower cost of sales and an increase in lower margin resold product sales. The decrease in cost of sales 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 to $25.1 million for the nine months ended September 30, 2017 from $34.6 million compared to the same period in 2016, due primarily to the change in the mix of the solutions sold as discussed above. Gross margin increased to 34.6% for the nine months ended September 30, 2017, from 31.8% in the same period in 2016.
SG&A expense decreased by 9.0% to $27.7 million for the nine months ended September 30, 2017 from $30.4 million for the same period in 2016, primarily attributable to decreases in accrued bonuses of $2.3 million, amortization of intangible assets of $1.1 million, and the capitalization of software development costs of $1.1 million, offset by an increase in outside services of $1.5 million and labor costs of $0.2 million.
Operating loss was $2.6 million for the nine months ended September 30, 2017, compared to operating income of $4.2 million for the same period in 2016, due primarily to a decrease in gross profit as noted above.
Interest expense increasedNon-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we believe the non-GAAP financial measures of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss) and Adjusted EPS are useful in evaluating our operating performance. We believe that this non-GAAP financial information, when taken collectively with our GAAP results, may be helpful to readers of our financial statements because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results. The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled non-GAAP measures used by 20.4%other companies. A reconciliation is provided below for each of these non-GAAP financial measures to $5.0 million for the nine months ended September 30, 2017, from $4.1 million for the same periodmost directly comparable financial measure stated in 2016, primarily due to an increase in interest on the EnCap senior term loan.accordance with GAAP.
We use the following non-GAAP financial measures to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, to develop short-term and long-term operating plans, and to evaluate the performance of certain management personnel when determining incentive compensation. We believe these non-GAAP financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionate positive or negative impact on our results of operations in any particular period. When viewed in combination with our results prepared in accordance with GAAP, these non-GAAP financial measures help provide a broader picture of factors and trends affecting our results of operations.
Enterprise EBITDA and Adjusted EBITDA
Both Enterprise EBITDA and Adjusted EBITDA are supplemental measures of operating performance that are not made under GAAP and that does not represent, and should not be considered as, an alternative to net income (loss) as determined by GAAP. We define Enterprise EBITDA as net income (loss) attributable to Telos Corporation, adjusted for net income attributable to non-controlling interest, non-operating expense (income), interest expense, provision for (benefit from) income taxes, and depreciation and amortization. We define Adjusted EBITDA as Enterprise EBITDA, adjusted for transaction gains/losses/expenses related to our IPO and stock-based compensation expense.
A reconciliation of Enterprise EBITDA and Adjusted EBITDA to net income (loss) attributable to Telos Corporation, the most directly comparable GAAP measure, is as follows:
| | | Three Months Ended March 31, | |
| | | 2021 | | | 2020 | |
| Net loss attributable to Telos Corporation | | $ | (14,778 | ) | | $ | (2,244 | ) |
| Adjustments: | | | | | | | | |
| Net income attributable to non-controlling interest | | | ---- | | | | 784 | |
| Non-operating expense (income) | | | 1,054 | | | | (8 | ) |
| Interest expense | | | 196 | | | | 2,017 | |
| Provision for (benefit from) income taxes | | | 34 | | | | (146 | ) |
| Depreciation and amortization | | | 1,360 | | | | 1,389 | |
| Enterprise EBITDA | | | (12,134 | ) | | | 1,792 | |
| Stock-based compensation expense | | | 13,670 | | | | ---- | |
| Adjusted EBITDA | | $ | 1,536 | | | $ | 1,792 | |
Adjusted Net Income tax provision was $529,000(Loss) and Adjusted EPS
The adjusted measures of Net Income (Loss) and Diluted EPS, (defined as “Adjusted Net Income (Loss)” and “Adjusted EPS”, respectively) are supplemental measures of operating performance that are not made under GAAP and that does not represent, and should not be considered as, an alternative to net income (loss) as determined by GAAP. We define Adjusted Net Income (Loss) as net income (loss) attributable to Telos Corporation, adjusted for non-operating expense (income) and stock-based compensation expense. We define Adjusted EPS as Adjusted Net Income (Loss) divided by the weighted-average number of common shares outstanding for the nine months ended September 30, 2017, compared to $181,000 for the same period in 2016, which is based on the estimated annual effective tax rate applied to the pretax loss for the nine month period, adjusted for the income tax provision previously provided, based on our expectation of pretax loss for the fiscal year.period.
A reconciliation of Adjusted Net Loss and Adjusted EPS to net loss attributable to Telos Corporation, was $9.5 millionthe most directly comparable GAAP measure, is as follows:
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| | | Net Loss Attributable to Telos Corporation | | | Diluted Earnings Per Share | | | Net Loss Attributable to Telos Corporation | | | Diluted Earnings Per Share | |
| | | (in thousands) | | | | | | (in thousands) | | | | |
| Reported GAAP measure | | $ | (14,778 | ) | | $ | (0.23 | ) | | $ | (2,244 | ) | | $ | (0.06 | ) |
| Adjustments: | | | | | | | | | | | | | | | | |
| Non-operating expense (income) | | | 1,054 | | | | 0.02 | | | | (8 | ) | | | ---- | |
| Stock-based compensation expense | | | 13,670 | | | | 0.21 | | | | ---- | | | | ---- | |
| Adjusted non-GAAP measure | | $ | (54 | ) | | $ | 0.00 | | | $ | (2,252 | ) | | $ | (0.06 | ) |
| Weighted-average shares of common stock outstanding | | | 64,625 | | | | | | | | 38,073 | | | | | |
Each of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss) and Adjusted EPS has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under GAAP. Among other limitations, each of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss) and Adjusted EPS does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments, does not reflect the nine months ended September 30, 2017, comparedimpact of certain cash charges resulting from matters we consider not to $2.9 millionbe indicative of our ongoing operations, and does not reflect income tax expense or benefit. Other companies in our industry may calculate Adjusted EBITDA, Adjusted Net Income (Loss) and Adjusted EPS differently than we do, which limits its usefulness as a comparative measure. Because of these limitations, neither Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss) nor Adjusted EPS should be considered as a replacement for the same period in 2016,net income (loss) or earnings per share, as determined by GAAP, or as a measure of our profitability. We compensate for these limitations by relying primarily attributable to the increase in operating loss as discussed above.on our GAAP results and using non-GAAP measures only for supplemental purposes.
Liquidity and Capital Resources
As describedUpon the closing of our IPO, we issued 17.2 million shares of our common stock at a price of $17.00 per share, generating net proceeds of approximately $272.8 million. We used approximately $108.9 million of the net proceeds in connection with the ERPS Conversion (see Note 6 – Exchangeable Redeemable Preferred Stock Conversion), $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 2 – Purchase of Telos ID/Non-controlling Interests), $21.0 million to repay our outstanding senior term loan and subordinated debt (see Note 5 – Current Liabilities and Debt Obligations, we maintainObligations). We intend to use the remaining net proceeds for general corporate purposes. We also may use a Credit Agreement with EnCap, a Purchase Agreement with RCAportion of the net proceeds to acquire complementary businesses, products, services, or technologies. The amounts and a Financing Agreement with Action Capital. The willingness of RCA to purchase our accounts receivable under the Purchase Agreement and of Action Capital to make advances under the Financing Agreement, and our ability to obtain additional financing, may be limited due to various factors, including the eligibilitytiming of our receivables,actual use of the statusnet proceeds will vary depending on numerous factors. Proceeds held by us are invested in short-term investments until needed for the uses described above. We currently anticipate that we will retain all available funds for use in the operation and expansion of our business, global credit market conditions, and perceptionswe do not anticipate paying any cash dividends on our common stock in the foreseeable future.
On April 6, 2021, we completed our follow-on offering of 9.1 million shares of our business or industrycommon stock at a price of $33.00 per share, including a secondary public offering of 7.0 million shares of common stock by EnCap, RCA, Action Capital, or other potential sourcescertain existing stockholders of financing. IfTelos. The offering generated approximately $64.5 million of net proceeds to Telos. We did not receive any proceeds from the shares of common stock sold by the selling stockholders. On April 19, 2021, we are unable to maintain the Purchase Agreement and the Financing 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 and the Financing 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 materialityused approximately $28.1 million 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 backnet proceeds to us. Likewise,repurchase all 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 immediateshares 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.warrants owned by EnCap.
Our working capital was $(5.4)$102.2 million and $(8.6)$105.2 million as of September 30, 2017March 31, 2021 and December 31, 2016,2020, respectively. Although no assurances can be given, we expect that our financing arrangements with EnCap, RCA and Action Capital, collectively,funds generated from operations are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months.
Cash used in operating activities was $2.9$9.3 million for the ninethree months ended September 30, 2017,March 31, 2021, compared to $14.2 million cash provided inby operating activities of $1.7 million for the same period in 2016.2020. Cash provided by or used in operating activities is primarily driven by the Company'sCompany’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 $8.1$14.8 million for the ninethree months ended September 30, 2017,March 31, 2021, compared to $0.2$1.5 million for the ninethree months ended September 30, 2016.March 31, 2020.
Cash used in investing activities was approximately $1.6$2.6 million and $0.4$1.7 million for the ninethree months ended September 30, 2017March 31, 2021 and 2016,2020, respectively, due primarily to the capitalization of software development costs of $1.1$2.2 million and $1.5 million for the ninethree months ended September 30, 2017,March 31, 2021 and 2020, respectively, and the purchase of property and equipment.
Cash provided by financing activities for the nine months ended September 30, 2017 was $4.1 million, compared to $11.6 million cash used in financing activities for the same period in 2016, primarily attributable to the proceeds of $9.4 million from the EnCap senior term loan, offset by distribution of $2.6 million to the Telos ID Class B member, and the redemption of $2.1 million senior preferred stock for the nine months ended September 30, 2017, compared to net repayments of $8.5 million to the Facility (as defined below) and distribution of $1.3 million to Telos ID Class B member for the nine months ended September 30, 2016.
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 on the Company's and the Guarantor's collateral (an "Alternative Interest Rate Event"), the interest rate will increase to 14.5% per annum. After the occurrence and during the continuance of any event of default, the interest rate will increase 2.0%. The Company is obligated to pay accrued interest in cash on a monthly basis at a rate of not less than 10.0% per annum or, during the continuance of an Alternate Interest Rate Event, 11.5% per annum. The Company may elect to pay the remaining interest in cash, by payment-in-kind (by addition to the principal amount of the Loan) or by combination of cash and payment-in-kind. Upon thirty days prior written notice, the Company may prepay any portion or the entire amount of the Loan.
An amount of approximately $1.1 million was netted from the proceeds on the Loan as a prepayment of all interest due and payable at the Accrual Rate during the period from January 25, 2017 to October 31, 2017. A separate fee letter executed by the Company and the Agent, dated January 25, 2017, sets forth the fees payable to the Agent in connection with the Credit Agreement.
The Credit Agreement contains representations, warranties, covenants, terms and conditions customary for transactions of 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 and the Guarantors, 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. While we did not earn sufficient revenue to meet the revenue covenant in Section 7.15(d) of the Credit Agreement, the Lenders agreed to waive our compliance with the covenant and consequently, as of September 30, 2017, we were in compliance with the Credit Agreement's financial covenants.
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.
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.
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%. 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.
We incurred interest expense in the amount of $0.4$0.3 million and $1.1$0.4 million for the three and nine months ended September 30, 2017,March 31, 2021 and 2020, respectively, on the Credit Agreement.
Accounts Receivable Purchase Agreement
On July 15, 2016, we entered intoprimarily attributable to payments under finance leases for both periods and an Accounts Receivable Purchase Agreement (the "Purchase Agreement") with Republic Capital Access, LLC ("RCA" or "Buyer"), pursuantamendment fee paid 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 has 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.
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 Receivable are outstanding; (iii) a commitment fee equal to 1% per annum of 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. At the time the Purchase Agreement was signed, the Company received proceeds in an amount equal to $6.3 million, net of an initial enrollment fee equal to $25,000. Those proceeds were used to repay the outstanding amount under the Facility to Wells Fargo as described below.
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 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 has a term of two years, provided that the Company may terminate it at any time without penalty upon written notice. At the time the Financing Agreement was signed, the Company did not borrow any amounts under the Financing Agreement.
The Company shall pay Action Capital interest on the advances outstanding under the Financing Agreement at a rate equal to the prime rate of Wells Fargo Bank, N.A. in effect on the last business day of the prior month plus 2%, and a monthly fee equal to 0.50%. All interest calculations are based on a year of 360 days. The Company's obligations under the Financing Agreement are secured by certain assets of the Company pertaining to the Acceptable Accounts, including all accounts, accounts receivable, earned and unbilled revenue, contract rights, chattel paper, documents, instruments, general intangibles, reserves, reserve accounts, rebates, books and records, and all proceeds of the foregoing.
Pursuant to the terms of the Financing Agreement, Action Capital shall have full recourse against the Company when an Acceptable Account is not paid in full by the respective customer within 90 days of the date of purchase or if for any reason it ceases to be an Acceptable Account, including the right to charge-back any such Acceptable Account. It is considered an event of default if the Company breaches any covenant or warranty, knowingly provides false or incorrect material information to Action Capital, or otherwise defaults on any of its material obligations under the Financing Agreement or any other material agreements with Action Capital (subject to a cure period). If any such events of default occur, then Action Capital may take certain actions, including declaring any indebtedness immediately due and payable, requiring any customers with Acceptable Accounts to make payments directly to Action Capital, exercising its power of attorney from the Company to take actions in the Company's stead with respect to any of Company's Acceptable Accounts, or terminating the Financing Agreement.
As of September 30, 2017, there were no outstanding borrowings under the Financing Agreement.
In connection with the Purchase Agreement and the Financing Agreement, we terminated our revolving credit facility (the "Facility") with Wells Fargo Capital Finance, LLC ("Wells Fargo"), effective as of July 15, 2016, prior to its maturity date of April 1, 2017, and repaid all amounts outstanding under the Facility; other than (1) the obligations of the Company under the Facility and related loan documents with respect to letters of credits and fees, charges, costs and expenses related thereto, (2) the obligations of the Company under the Facility and related loan documents to reimburse Wells Fargo for costs and expenses that may become due and payable after the date of the termination of the Facility, and (3) any customary contingent indemnification obligations. The Company paid an early termination fee of $100,000, and no other early termination fees or prepayment penalties were incurred by the Company in connection with the termination of the Facility.
Senior Revolving Credit Facility
On March 30, 2016, we amended our Facility with Wells Fargo ("the Seventeenth Amendment") to reduce the total credit available from $20 million to $10 million effective as of the date of the amendment, which more appropriately reflected the Company's projected utilization of the Facility. The Seventeenth Amendment fixed the interest rate at the higher of the Wells Fargo Bank "prime rate" plus 2.25%, the Federal Funds rate plus 2.75%, or the 3-month LIBOR rate plus 3.25%. We incurred interest expense in the amount of $14,000 and $220,000lender for the three and nine months ended September 30, 2016, respectively, on the Facility. In consideration for the closing of the Seventeenth Amendment, we paid Wells Fargo a fee of $100,000, plus expenses related to the closing.
On July 15, 2016, the outstanding balance under the Facility was paid in full.
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 34.9% 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 Wells Fargo, in which the Porter Notes are fully subordinated to the Facility and any subsequent senior lenders (including Action Capital), and payments under the Porter Notes are permitted only if certain conditions are met. According to the terms of the Porter Notes, the outstanding principal sum bears interest at the fixed rate of twelve percent (12%) per annum which would be payable in arrears in cash on the 20th day of each May, August, November and February, with the first interest payment date due on August 20, 2015. 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 the Intercreditor Agreements with Porter and EnCap, in which the Porter Notes are fully subordinated to the Credit Agreement and any subsequent senior lenders (including Action Capital), and payments under the Porter Notes are permitted only if certain conditions are met. All other terms remain in full force and effect. We incurred interest expense in the amount of $99,000 and $218,000 for the three and nine months ended September 30, 2017, respectively, and $75,000 and $225,000 for the three and nine months ended September 30, 2016, respectively, on the Porter Notes. As a result of the amendment and restatement of the Porter Notes, we recorded a gain on extinguishment of debt of approximately $1 million, which consisted of the remeasurement of the debt at fair value. As the extinguishment was with a related party, the transaction was deemed to be a capital transaction and the gain was recorded in the Company's stockholders' deficit as of September 30, 2017.
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, 2017 and December 31, 2016 was 3,185,586. The Public Preferred Stock is quoted as TLSRP on the OTCQB marketplace and the OTC Bulletin Board.2020.
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 Credit Agreement and the Porter Notes to which the Public Preferred Stock is subject, other senior obligations currently or previously in existence, and Maryland law limitations in existence prior to October 1, 2009. Subsequent to the 2009 Maryland law change, dividend payments continue to be prohibited except under certain specific circumstances as set forth in Maryland Code Section 2-311, which the Company did not satisfy as of the measurement dates. Pursuant to the terms of the Articles of Amendment and Restatement, we were scheduled, but not required, to redeem the Public Preferred Stock in five annual tranches during the period 2005 through 2009. However, due to our substantial senior obligations currently or previously in existence, limitations set forth in the covenants in the Credit Agreement and the Porter Notes, foreseeable capital and operational requirements, and restrictions and prohibitions of our Articles of Amendment and Restatement, we were and remain unable to meet the redemption schedule set forth in the terms of the Public Preferred Stock as of the measurement 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, 2017 and December 31, 2016.
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. The Credit Agreement and the Porter Notes prohibit, among other things, the redemption of any stock, common or preferred, other than as described above. The Public Preferred Stock by its terms also cannot be redeemed if doing so would violate the terms of an agreement regarding the borrowing of funds or the extension of credit which is binding upon us or any of our subsidiaries, and it does not include any other provisions that would otherwise require any acceleration of the redemption of or amortization 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, 2017. This classification is consistent with ASC 210-10, "Balance Sheet" and 470-10, "Debt" and the FASB ASC Master Glossary definition of "Current Liabilities."
ASC 210-10 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 470-10 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 $98.8 million and $95.9 million as of September 30, 2017 and December 31, 2016, 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, 2017 and 2016, respectively, which was recorded as interest expense. Prior to the effective date of ASC 480-10 on July 1, 2003, such dividends were charged to stockholders' accumulated deficit.
Senior Redeemable Preferred Stock
The Senior Redeemable Preferred Stock was senior to all other outstanding equity of the Company, including the Public Preferred Stock. The Series A-1 ranked on a parity with the Series A-2. The components of the authorized Senior Redeemable Preferred Stock were 1,250 shares of Series A-1 and 1,750 shares of Series A-2 Senior Redeemable Preferred Stock, each with $.01 par value. The Senior Redeemable Preferred Stock carried a cumulative per annum dividend rate of 14.125% of its liquidation value of $1,000 per share. The dividends were payable semiannually on June 30 and December 31 of each year. We had not declared dividends on our Senior Redeemable Preferred Stock since its issuance, other than in connection with the redemptions from 2010 to 2013. The liquidation preference of the Senior Redeemable Preferred Stock was the face amount of the Series A-1 and A-2 ($1,000 per share), plus all accrued and unpaid dividends.
Due to the terms of the Credit Agreement, the Porter Notes, other senior obligations currently or previously in existence, the Senior Redeemable Preferred Stock and applicable provisions of Maryland law governing the payment of distributions, we had been precluded from redeeming the Senior Redeemable Preferred Stock and paying any accrued and unpaid dividends on the Senior Redeemable Preferred Stock, other than the redemptions that occurred from 2010 to 2013. In addition, certain holders of the Senior Redeemable Preferred Stock had entered into standby agreements whereby, among other things, those holders would not demand any payments in respect of dividends or redemptions of their instruments and the maturity dates of the instruments had been extended. As a result of such standby agreements, as of December 31, 2016, instruments held by Toxford Corporation ("Toxford"), the holder of 76.4% of the Senior Redeemable Preferred Stock, would mature on May 31, 2018.
At December 31, 2016, the total number of shares of the Senior Redeemable Preferred Stock issued and outstanding was 197 shares and 276 shares for Series A-1 and Series A-2, respectively. At December 31, 2016, cumulative undeclared, unpaid dividends relating to the Senior Redeemable Preferred stock totaled $1.6 million.
We accrued dividends on the Senior Redeemable Preferred Stock of $20,000 for the nine months ended September 30, 2017, and $17,000 and $50,000 for the three and nine months ended September 30, 2016, respectively, which were reported as interest expense. Prior to the effective date of ASC 480-10, "Distinguishing Liabilities from Equity," on July 1, 2003, such dividends were charged to stockholders' deficit.
In accordance with the requirements of the Second Amendment to the EnCap Credit Agreement, we redeemed all outstanding shares of the Senior Redeemable Preferred Stock on April 18, 2017 for $2.1 million.
Recent Accounting Pronouncements
See Note 1 of the Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.
Critical Accounting Policies
There have beenDuring the three months ended March 31, 2021, there were no material changes to our critical accounting policies as disclosedreported in our Annual Report on Form 10-K for the year ended December 31, 20162020 as filed with the SEC on March 30, 2017.25, 2021.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Until July 15, 2016, we were exposed to interest rate volatility with regard to our variable rate debt obligations under the Facility. The effective weighted average interest rate on the outstanding borrowings under the Facility was 6.7% for the nine months ended September 30, 2016.None.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2017,March 31, 2021 was performed under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in its reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that information required to be disclosed by the Company in the reports the Company files or submits under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended September 30, 2017March 31, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
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, 2017March 31, 2021 in our risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.2020.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
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 $98.8 million and $95.9 million in cash dividends as of September 30, 2017 and December 31, 2016, 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 Credit Agreement and the Porter Notes to which the Public Preferred Stock is subject, other senior obligations currently or previously in existence, and Maryland law limitations in existence prior to October 1, 2009. Subsequent to the 2009 Maryland law change, dividend payments continue to be prohibited except under certain specific circumstances as set forth in Maryland Code Section 2-311, which the Company did not satisfy as of the measurement dates. Pursuant to the terms of the Articles of Amendment and Restatement, we were scheduled, but not required, to redeem the Public Preferred Stock in five annual tranches during the period 2005 through 2009. However, due to our substantial senior obligations currently or previously in existence, limitations set forth in the covenants in the Credit Agreement and the Porter Notes, foreseeable capital and operational requirements, and restrictions and prohibitions of our Articles of Amendment and Restatement, we were and remain unable to meet the redemption schedule set forth in the terms of the Public Preferred Stock as of the measurement 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, 2017 and December 31, 2016.
Senior Redeemable Preferred Stock
We had not declared dividends on our Senior Redeemable Preferred Stock, Series A-1 and A-2, since issuance. At December 31, 2016, total undeclared unpaid dividends accrued for financial reporting purposes were $1.6 million for the Senior Redeemable Preferred Stock. We were required to redeem all shares and accrued dividends outstanding on October 31, 2005. However, certain holders of the Senior Redeemable Preferred Stock had entered into standby agreements whereby, among other things, those holders would not demand any payments in respect of dividends or redemptions of their instruments and the maturity dates of the instruments have been extended. As a result of such standby agreements, as of December 31, 2016, instruments held by Toxford Corporation ("Toxford"), the holder of 76.4% of the Senior Redeemable Preferred Stock, would mature on May 31, 2018. As of December 31, 2016, Mr. Porter held 6.3% of the Senior Redeemable Preferred Stock. In the aggregate, as of December 31, 2016, Mr. Porter and Toxford held a total of 163 shares and 228 shares of Series A-1 and Series A-2 Redeemable Preferred Stock, respectively, or 82.7% of the Senior Redeemable Preferred Stock. Mr. Porter is the sole stockholder of Toxford. Subject to limitations set forth below, we were scheduled to redeem 14.7% and 8.9% of the outstanding shares and accrued dividends outstanding on October 31, 2005 and December 31, 2011, respectively. Due to the terms of the Credit Agreement, the Porter Notes, other senior obligations currently or previously in existence, the Senior Redeemable Preferred Stock and applicable provisions of Maryland law governing the payment of distributions, we had been precluded from redeeming the Senior Redeemable Preferred Stock and paying any accrued and unpaid dividends on the Senior Redeemable Preferred Stock, other than the redemptions that occurred from 2010 to 2013. On April 18, 2017, in accordance with the requirements of the Second Amendment to the EnCap Credit Agreement, we redeemed all outstanding shares of the Senior Redeemable Preferred Stock for $2.1 million.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.On May 14, 2021, our Board of Directors terminated the Telos ID Sale Bonus Plan (“Telos ID Plan”). The purpose of the Telos ID Plan was to provide a long-term incentive program to motivate key executives of Telos ID to participate in the value creation of Telos ID and enjoy the benefits of participation in future increases in the value of Telos ID and its underlying assets.
Prior to the IPO, we had a 50% ownership interest in Telos ID. Participants in the Telos ID Plan were entitled to a payment upon the transfer for value of all of the Company’s ownership interest in Telos ID or upon the occurrence of a “Sale” (as defined in the Telos ID Plan) of Telos ID if the value of Telos ID at the time of such transaction was at least $50 million. Upon a transfer of our ownership interest, the bonuses payable under the Telos ID Plan would have equaled 2.5% of the value of Telos ID (as defined by the Telos ID Plan) up to $85 million, plus 4% of the of the value of Telos ID in excess of $85 million. Upon a Sale, the bonuses payable would have amounted to 5% of the proceeds up to $85 million, plus 8% of the proceeds in excess of $85 million. If the Sale occurred after the transfer of ownership, the bonuses payable would have been 5% of the proceeds up to $85 million, plus 8% of the proceeds in excess of $85 million, less any bonuses already paid as part of any prior transfer of Telos’ ownership interests. The total bonuses payable upon a transfer of interest or Sale would have been allocated as follows: (i) 50% of the total to the President of Telos ID; and (ii) 50% to other participants as determined by the President of Telos ID. Both of these allocations would have been subject to approval by the Chairman of our Board of Directors.
In connection with the IPO, we purchased the 50% ownership interest in Telos ID that we did not already own. As a result of our ownership of 100% of Telos ID, the Board of Directors decided to terminate the Telos ID Plan. Employees of Telos ID who would have been eligible to participate in the Telos ID Plan, including the President of Telos ID, participate in the Telos Corporation 2016 Omnibus Long-Term Incentive Plan.
| |
Exhibit Number | Description of Exhibit |
| Forms of Indemnification Agreement between the Company and 16 of its directors and executive officers |
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"“furnished” and not "filed"“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, 2017May 17, 2021 | | TELOS CORPORATION |
| | | |
| | |
/s/ John B. Wood |
| | | John B. Wood Chief Executive Officer (Principal Executive Officer) |
| | | |
| | |
| | | Michele Nakazawa Chief Financial Officer (Principal Financial and Accounting Officer) |