UPLOAD
View:
Mail Stop 4561
December 14, 2005
John B. Wood
Telos Corporation
19886 Ashburn Road
Ashburn, VA 20147
Re: Telos Corporation
Form 10-K for Fiscal Year Ended December 31, 2004
Forms 10-Q for Fiscal Quarters Ended March 31, 2005, June 30, 2005
and September 30, 2005
File No. 001-08443
Dear Mr. Wood:
We have reviewed your response letter dated July 22, 2005
along
with the above referenced filings and have the following
additional
comments. Where indicated, we think you should revise your
document
in response to these comments. If you disagree, we will consider
your explanation as to why our comments are inapplicable or a
revision is unnecessary. Please be as detailed as necessary in
your
explanation. In some of our comments, we may ask you to provide
us
with supplemental information so we may better understand your
disclosure. After reviewing this information, we may or may not
raise additional comments.
Please understand that the purpose of our review process is
to
assist you in your compliance with the applicable disclosure
requirements and to enhance the overall disclosure in your filing.
We look forward to working with you in these respects. We welcome
any questions you may have about our comments or any other aspect
of
our review. Feel free to call us at the telephone numbers listed
at
the end of this letter.
Form 10-K for the year ended December 31, 2004
Management Discussion and Analysis
Cost of Sales, Page 10
Prior Comment Number 1
1. Your brief response to our prior comment does not provide
sufficient information to explain why you believe the
classification
of litigation settlement is appropriately classified as a credit
in
cost of sales. Tell us more about the underlying basis for the
litigation and the nature of the significant costs you incurred.
Typically, settlements associated with litigation are classified
outside of revenues and cost of sales since they do not meet the
criteria in 5-03(b) of Regulation S-X.
Consolidated Financial Statements
Consolidated Statements of Operations, page 18
Prior Comment Number 3
2. We note in your response that you intend to separately report
product and service revenues in future filings at such time as
comparable information is available for all periods presented.
Please note, however, that if your revenues from products and
services are greater than 10% of total revenues, Rule 5-03(b)
requires this presentation for all periods presented. Refer to
Question 1 of SAB Topic 13B.
Note 1. Summary of Significant Accounting Policies, page 24
Revenue Recognition, page 24
Prior Comment Numbers 4 - 6
3. We have reviewed your responses to prior comment numbers 4, 5
and
6 and have the following additional comments:
* Your response and disclosures in your recent Form 10-Q suggest
that
the application of SOP 81-1 is appropriate as your contracts are
within the scope of the AICPA`s Audit and Accounting Guide for
Audits
of Federal Government Contractors. Please note that it may not be
appropriate to apply SOP 81-1 unless your contracts meet the scope
of
SOP 81-1. Refer to paragraph 13 of SOP 81-1. Also, please note
that
reference to your competitors` arrangements and disclosures should
not be a factor in the determination of the appropriate accounting
literature for your arrangements.
* Your response also suggests that you believe your arrangements
are
within the scope of SOP 81-1, because your contracts involve
"complex
delivery of technology products and services". Clarify whether
your
contracts are similar to those described in paragraph 13 of SOP
81-1.
If so, please further describe the nature of your arrangements and
why you believe your contracts are similar to those set forth in
that
paragraph.
* Clarify what your "managed support services" represent.
Describe
the nature and timing of these services and why you believe these
services are within the scope of SOP 81-1. Similarly clarify the
nature of the services you describe as integration services and
enterprise solutions in the business section of your Form 10-K.
* Your response generally refers to SOP 97-2, SAB 104, EITF 00-21
and
SOP 81-1; however, it does not specifically address how you apply
this literature to your different contracts. For example, tell us
more about the arrangements where you apply EITF 00-21, the nature
of
the elements in that arrangement, how you allocate the arrangement
fee to the elements and the period over which you recognize the
respective revenue for each element. Also, clarify whether your
arrangements under SOP 97-2 require significant production,
modification or customization of software or if your services are
essential to the functionality of any other element. Refer to
paragraphs 7 and 65 of SOP 97-2.
Prior Comment Number 7
4. We note your basis for recognizing gross revenue related to
resold
products. Tell us how you considered all of the criteria in EITF
99-
19 when determining that gross revenue recognition was
appropriate.
Clarify the nature of the `resold products` you are referring to
and
whether your `resold products` include the resale of certain third
party software products, as disclosed on page 4 of your fiscal
year
2004 Form 10-K. Also, tell us more about the contractual
arrangements you recently entered into and how they differ from
your
current arrangements. Explain why it may be appropriate for you
to
apply net revenue reporting for these arrangements.
Financial Instruments, page 26
Prior Comment Number 8
5. Your response indicates that as there are no known comparable
securities with which to estimate fair value for the subordinated
debt or redeemable preferred stock, you believe it is not
practicable
to estimate for those securities. Tell us how you considered
paragraphs 22 - 29 of SFAS 107 when arriving at this
determination.
Furthermore, paragraph 15 of SFAS 107 defines practicable as the
ability to arrive at an estimate of fair value without incurring
excessive costs. Explain how you considered this definition when
arriving at your conclusion to not estimate the fair value of your
subordinated debt or your redeemable preferred stock.
Note 2. Investment in Enterworks, page 27
Prior Comment Numbers 9 and 10
6. We have reviewed your response to prior comments 9 and 10 and
your
disclosures in your recent Form 10-Qs and do not believe you have
provided sufficient information for us to understand your
historical
accounting for your investments in Enterworks and Enterworks
International. Please provide us with sufficient historical
information surrounding your arrangements with Enterworks and
Enterworks International and the corresponding accounting
literature
that supports your accounting. Please ensure your comprehensive
response addresses the following:
* Please clarify how you were accounting for your 50% investment
in
Enterworks International as of December 31, 2003. We understand
that
upon adoption of FIN 46 (in 2004), you consolidated Enterworks
International`s operating results, which suggests that you were
not
consolidating its results prior to that date. Please advise and
clarify your accounting. In your response, tell us how you
considered
your indirect ownership interest in Enterworks International
through
your ownership in Enterworks. Refer to the authoritative
literature
that supports your accounting.
* You indicate that the $500,000 write-down of your investment in
Enterworks International was done in accordance with SFAS 144.
As
previously requested, please explain the reasons for the $500,000
write-down (during Fiscal 2003) of your December 2003 investment
in
Enterworks International. Provide us with the specific facts and
circumstances that lead you to believe that shortly after you made
your investment in Enterworks International your investment was
impaired. Also, clarify why you believe SFAS 144 is the
appropriate
authoritative accounting literature to apply. If you were
applying
the equity method of accounting to your investment in Enterworks
International, please specifically address paragraph 19(h) of APB
18.
Refer to paragraph 5(d) of SFAS 144.
* Your response refers to a $900,000 write-down of the two-year
OEM
SLA, which was comprised of initial consideration of $1 million,
comprised of $100,000 cash and $900,000 services. Your response,
along with disclosures in your June 2005 Form 10-Q indicate that
you
recorded the impairment in accordance with SFAS 144.
Supplementally
tell us why you believe SFAS 144 is the appropriate authoritative
accounting literature for this SLA. In this regard, explain why
you
did not consider SFAS 86 for your accounting. In your response,
also
tell us the specific facts and circumstances that lead you to
believe
your SLA was impaired shortly after you entered into the
agreement.
Also, clarify why you did not impair the $100,000 cash portion of
the
SLA.
* Tell us why you are applying SFAS 142 for the EPX software and
how
you considered either SFAS 86 and/or SOP 98-1.
* Tell us how you have accounted for the 2005 Conversion Agreement
entered into in October 2005 and whether your accounting for
Enterworks has changed as a result of this Agreement. Reconcile
your
disclosure in your September 30, 2005 Form 10-Q that you held a
fully
diluted ownership percentage of 25.1% as of September 30, 2005 and
that ownership interested `increased` to 19%.
7. We have reviewed the calculations you provided us in your
response
to prior comment number 10 and have the following additional
comments:
* Your calculation for Enterworks in Test number 3 indicates that
you
recorded equity in the income from continuing operations before
income taxes for Enterworks during 2002 and 2003. However,
disclosure in MD&A under "Losses from affiliates" indicates that
you
recorded losses of $1.5 million due to the application of the
equity
method of accounting during 2002. Please clarify how you
determined
the numerator in your calculations for Enterworks for all periods
presented. Reconcile your calculation amounts with disclosures in
MD&A and with your statement in Note 2, which states that during
2004
and 2003, the Company`s share of the Enterworks losses exceeded
the
carrying value of the notes.
* Clarify why you have not included the $1.4 million losses
associated with your investment in Enterworks International in
2003.
Note 7. Redeemable Preferred Stock, page 31
12% Cumulative Exchangeable Redeemable Preferred Stock, page 31
Prior Comment Numbers 13 - 17
8. Reconcile your response to us regarding your ability and intent
to
refinance the Public Preferred Stock with the recent disclosures
you
provided in your September 30, 2005 Form 10-Q.
9. We note the recommendations of your Independent Committee which
include the initiation of discussions with the various
stakeholders
to determine if a consensual restructure or purchase of your
Public
Preferred Stock can be negotiated. They further indicate that a
compromise price for the `near term repurchase` of the Public
Preferred Stock would appear to be in the best interest of the
Company. In light of this recommendation, tell us further why you
believe liquidation of the obligation is not reasonably expected
to
require the use of existing resources or the creation of current
liabilities.
10. Since it does not appear that you meet the requirements of
paragraph 10 and 11 of SFAS 6, we do not understand why you have
not
classified the scheduled redemptions according to their
contractual
redemption schedule. While we understand that you believe there
are
certain provisions to existing agreements that preclude you from
redeeming the Public Preferred Stock following the terms of the
redemption schedule, we understand you are required to discharge
the
obligations as soon are you are able to do so and that
recommendations from the Independent Committee include a `near
term
repurchase` of the Public Preferred Stock.
Prior Comment Number 18
11. We note your reference to an independent national investment
firm
in your September 30, 2005 Form 10-Q. If you chose to refer to an
independent firm, you must identify that firm and include the
expert`s consent when the reference is included in a filing in the
1933 Act environment. We believe reference to such expert in a
registration statement requires a consent following Section 436(b)
of
Regulation C.
Note 10. Commitments and Contingencies, page 36
Warranties, page 37
Prior Comment Number 19
12. You indicate in your response that your treatment of warranty
`revenue` is consistent with paragraph 24 of SFAS 5 for the
traditional warranty `revenue`. This particular accounting
literature does not apply to revenue recognition, but rather cost
accruals for obligations related to product warranties and product
defects. In your response, quantify the amount of warranty
revenues
you have recorded and clarify where they are classified in your
statements of operations. If your traditional warranties are not
separately priced, clarify how you determine the amounts of
warranty
`revenue` to recognize. Further explain the nature of your
traditional warranties and the basis for you to recognize revenues
to
the extent they are not separately priced extended warranty
arrangements. Refer to the accounting literature that supports
this
accounting.
Note 13. Summary of Selected Quarterly Financial Data
(Unaudited),
page 39
Prior Comment Number 20
13. You indicate in your response that the "sales increase is due
in
large measure to the seasonality of the government buying
practices."
Tell us how you considered Instruction number 5 to paragraph (b)
of
Item 303 of Regulation S-K which states that a registrant shall
discuss any seasonal aspects of its business which have had a
material effect upon its financial condition or results of
operation.
Also, tell us how you considered Item 303 (a)(3)(ii) of Regulation
S-
K as your response appears to indicate a trend that has a material
impact on net sales.
Form 10-Q for the quarter ended September 30, 2005
Financial Data by Market Segment, page 27
14. Further explain the reasons for the decline in sales of your
higher margin messaging solutions and an increase in lower margin
product revenues. Clarify if this represents a trend that is
expected to continue, and if so, how it is expected to impact
future
operations and liquidity.
Item 4. Controls and Procedures, page 36
15. Management`s conclusion that your disclosure controls and
procedures are effective "in timely alerting them to any material
changes in information required to be included in the Company`s
periodic Securities and Exchange Commission filings" is
significantly
more limited than what is called for under Rule13a-15(e) of the
Exchange Act. The rule requires, among other matters, that the
disclosure controls and procedures be designed "to ensure that
information required to be disclosed by the issuer in the reports
that it files or submits under the Act . . . is recorded,
processed,
summarized and reported, within the time periods specified in the
Commission`s rules and forms" and to ensure that "information
required to be disclosed by an issuer . . . is accumulated and
communicated to the issuer`s management . . . as appropriate to
allow
timely decisions regarding required disclosure." Please confirm,
if
true, that your disclosure controls and procedures for the
relevant
periods met all of the requirements of this section and that you
will
conform your disclosure in future filings.
Please respond to these comments within 10 business days or
tell us when you will provide us with a response. Please submit
all
correspondence and supplemental materials on EDGAR as required by
Rule 101 of Regulation S-T. You may wish to provide us with
marked
copies of any amendment to expedite our review. Please furnish a
cover letter with any amendment that keys your response to our
comments and provides any requested information. Detailed cover
letters greatly facilitate our review. Please understand that we
may
have additional comments after reviewing any amendment and your
response to our comment.
You may contact Jason Niethamer at 202-551-3855, Lisa
Mitrovich
(Assistant Chief Accountant) at 202-551-3453 or me at 202-551-3730
if
you have questions regarding the above comments.
Sincerely,
Stephen Krikorian
Accounting Branch Chief
John B. Wood
Telos Corporation
December 14, 2005
Page 1