Note 2. Non-controlling Interests

On April 11, 2007, Telos ID was formed as a limited liability company under the Delaware Limited Liability Company Act. We contributed substantially all of the assets of our Identity Management business line and assigned our rights to perform under our U.S. Government contract with the Defense Manpower Data Center ("DMDC") to Telos ID at their stated book values. The net book value of assets we contributed totaled $17,000. Until April 19, 2007, we owned 99.999% of the membership interests of Telos ID and an entity conrolled by certain private equity investors (the "Investor") owned 0.001% of the membership interests of Telos ID. On April 20, 2007, we sold an additional 39.999% of the membership interests to the Investor in exchange for $6 million in cash consideration. In accordance with ASC 505-10, "Equity-Overall," we recognized a gain of $5.8 million.

On December 24, 2014 (the "Closing Date"), we entered into a Membership Interest Purchase Agreement (the "Purchase Agreement"), by and among the Company and the Investor, pursuant to which the Investor acquired from the Company an additional ten percent (10%) membership interest in Telos ID in exchange for $5 million (the "Transaction"). In connection with the Transaction, the Company and the Investor entered into the Second Amended and Restated Operating Agreement (the "Operating Agreement") governing the business, allocation of profits and losses and management of Telos ID on the Closing Date. Under the Operating Agreement, Telos ID is managed by a board of directors comprised of five (5) members (the "Telos ID Board"). The Operating Agreement provides for two classes of membership units, Class A membership units held by the Company and Class B membership units held by the Investor. The Company, as the "Class A member," owns 50% of Telos ID, is entitled to receive 50% of the profits of Telos ID, and may appoint three (3) members of the Telos ID Board. The Investor, as the "Class B member," owns 50% of Telos ID, is entitled to receive 50% of the profits of Telos ID, and may appoint two (2) members of the Telos ID Board. Notwithstanding the foregoing, the allocations of profits and losses and distributions (including any distributions that relate to the year ending December 31, 2014, that are paid in a subsequent year) from the Closing Date through and including December 31, 2014, will continue to be governed by the operating agreement of Telos ID in effect prior to the Closing Date and allocated based on the percentages of ownership prior to the Closing Date.

In connection with the Transaction, the Company and Wells Fargo Capital Finance, LLC ("Agent"), as agent for certain lenders (the "Lenders") and as a Lender under the Second Amended and Restated Loan and Security Agreement ("Loan Agreement"), entered into the Consent and Ninth Amendment to Second Amended and Restated Loan and Security Agreement (the "Consent") on the Closing Date. Under the Consent, the Agent and the Lenders consented to the consummation of the Transaction and the release of the lien in favor of the Agent on the transferred membership interest; provided that $1 million of the proceeds of the Transaction be applied to the term loan under the Loan Agreement. The parties further agreed to certain amendments to the Loan Agreement.

As of December 31, 2014, we had received $3 million of the $5 million of consideration for the sale. The remaining $2 million was recorded as a receivable and received in January 2015. Despite the post-Transaction ownership of Telos ID being evenly split at 50% by each member, Telos maintains control of the subsidiary through its holding of three of the five Telos ID board of director seats and therefore accounts for the investment in Telos ID using the consolidation method.

Under the Operating Agreement, the Class A and Class B members each have certain options with regard to the ownership interests held by the other party including the following:

●	Upon the occurrence of a change in control of the Class A member (as defined in the Operating Agreement, a "Change in Control"), the Class A member has the option to purchase the entire membership interest of the Class B member.

●

Upon the occurrence of the following events: (i) the involuntary termination of John B. Wood as CEO and chairman of the Class A member; (ii) the bankruptcy of the Class A member; or (iii) unless the Class A member exercises its option to acquire the entire membership interest of the Class B member upon a Change in Control of the Class A member, the transfer or issuance of more than fifty-one percent (51%) of the outstanding voting securities of the Class A member to a third party, the Class B member has the option to purchase the membership interest of the Class A member; provided, however, that in the event that the Class B member exercises the foregoing option, the Class A Member may then choose to purchase the entire interest of the Class B member.

●

In the event that more than fifty percent (50%) of the ownership interests in the Class B member are transferred to persons or individuals (other than members of the immediate family of the initial owners of the Class B member) without the consent of Telos ID, the Class A member has the option to purchase the entire membership interest of the Class B member.

●

The Class B member has the option to sell its interest to the Class A member at any time if there is not a letter of intent to sell Telos ID, a binding contract to sell all of the assets or membership interests in Telos ID, or a standstill for due diligence with respect to a sale of Telos ID. Notwithstanding the foregoing, the Class A member will not be obligated to purchase the interest of the Class B member if that purchase would constitute a violation of the Loan Agreement (as defined below) or if a Default or Event of Default (as each is defined in the Loan Agreement) would occur immediately after giving effect to that purchase and the Agent (as defined below) refuses to consent to that purchase or to waive such violation, Default, or Event of Default.

If either the Class A member or the Class B member elects to sells its interest or buy the other member's interest upon the occurrence of any of the foregoing events, the purchase price for the interest will be based on an appraisal of Telos ID prepared by a nationally recognized investment banker. If the Class A member fails to satisfy its obligation, subject to the restrictions in the Purchase Agreement, to purchase the interest of the Class B member under the Operating Agreement, the Class B member may require Telos ID to initiate a sales process for the purpose of seeking an offer from a third party to purchase Telos ID that maximizes the value of Telos ID. The Telos ID Board must accept any offer from a bona fide third party to purchase Telos ID if that offer is approved by the Class B member, unless the purchase of Telos ID would violate the terms of the Loan Agreement or result in the occurrence of a Default or Event of Default and the Agent does not consent to that purchase or waive the violation, Default, or Event of Default. The sale process is the sole remedy available to the Class B member if the Class A member does not purchase its membership interest. Under such a forced sale scenario, a sales process would result in both members receiving their proportionate membership interest shares of the sales proceeds and both members would always be entitled to receive the same form of consideration.

Pursuant to the Transaction, the Class A and Class B members each owns 50% of Telos ID, as mentioned above, and as such was allocated 50% of the profits, which was $362,000 and $747,000 for the three and six months ended June 30, 2015, respectively. Prior to the Transaction, the Class A member owns 60% of Telos ID, as mentioned above, and as such is allocated 60% of the profits, which was $0.5 million and $0.9 million for the three and six months ended June 30, 2014, respectively. The Class B member owns 40% of Telos ID, and as such is allocated 40% of the profits, which was $343,000 and $601,000 for the three and six months ended June 30, 2014, respectively. The Class B member is the non-controlling interest.

Distributions are made to the members only when and to the extent determined by the Telos ID's Board of Directors, in accordance with the Operating Agreement. The Class B member received a total of $961,000 for the three and six months ended June 30, 2015, and $257,000 and $705,000 for the three and six months ended June 30, 2014, respectively, of such distributions.

The following table details the changes in non-controlling interest for the three and six months ended June 30, 2015 and 2014 (in thousands):

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Non-controlling interest, beginning of period	$	969		$	264		$	584		$	454
Net income		362			343			747			601
Distributions		(961	)		(257	)		(961	)		(705	)
Non-controlling interest, end of period	$	370		$	350		$	370		$	350