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Item 7. Management’s Discussion and Analysis

2022-03-28 compared with 2021-03-25 · 327 added, 501 removed, 53 unchanged (94% of the section changed)

Management's Discussion and Analysis of Financial Condition and Results of

We offer technologically advanced, software-based security solutions that empower and protect the

world’s most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats.

Our portfolio of security products, services and expertise empower our customers with capabilities to reach new markets, serve their

stakeholders more effectively, and successfully defend the nation or their enterprise.

We protect our customers’ people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in

their security and privacy.

Our mission is to protect our customers’ people, systems, and vital information assets with offerings

for cybersecurity, cloud security, and enterprise security.

In the current global environment, our mission is more critical than ever.

The emergence of each new ICT introduces new vulnerabilities, as security is still too often overlooked in solution

Networks and applications meant to enhance productivity and profitability often jeopardize an organization due to poor planning, misconfiguration, or an unknown gap in security.

Ransomware, insider threats, cybercrime, and advanced

persistent threats continue to menace public and private enterprises across all industries.

Cybersecurity, cloud security, and enterprise security of the modern organization share much in common,

yet also call for a diverse range of skills, capabilities, and experience in order to meet the requirements of security-conscious customers.

Decades of experience in developing, orchestrating, and delivering solutions across these three domains gives

us the vision and the confidence to provide solutions that empower and protect the enterprise at an integrated, holistic level.

Our experience in addressing challenges in one area of an enterprise helps us meet requirements in others.

We understand

that a range of complementary capabilities may be needed to solve a single challenge, and we also recognize when a single solution might address multiple challenges.

Our security solutions span across the following domains:

Cybersecurity – We help our

customers ensure the ongoing security, integrity, and compliance of their on-premises and related cloud-based systems, reducing threats and vulnerabilities in order to foil cyber adversaries before they can attack.

Our consultants assess our

customers’ security environments and then design, engineer, and operate the systems they need to strengthen their cybersecurity posture.

Cloud Security – The cloud as

an organizational resource is more than two decades old, yet the needs of cloud users are constantly changing.

We offer the specialized skills and experience needed to help our customers plan, engineer, and execute secure cloud migration

strategies and then ensure ongoing management and security in keeping with the leading standards for cloud-based systems and workloads.

Enterprise Security – Securing

the enterprise means protecting the essential and timeless elements common to every organization:

its people and processes, its supply chain and inventories, its finances and facilities, and its information and communications.

As ICT and OT

have become part of the organizational make-up, we have offered solutions that ensure personnel can work securely and productively across and beyond the enterprise.

We refer to our cyber and cloud applications as Security Solutions, which includes Information Assurance

/ Xacta® (previously referred to as Cyber & Cloud Solutions), Secure Communications (previously referred to as Secure Communications Cyber and Enterprise Solutions), and Telos ID (previously referred to as Telos ID Enterprise Solutions).

refer to our offerings for enterprise security as Secure Networks (previously referred to as Secure Mobility and Network Management/Defense Enterprise Solutions).

Security Solutions

Assurance / Xacta:

a premier platform for enterprise cyber risk management and security compliance automation, delivering security awareness for systems in the cloud, on-premises, and in hybrid and multi-cloud environments.

delivers automated cyber risk and compliance management solutions to large commercial and government enterprises.

Across the U.S.

federal government, Xacta is the de facto commercial cyber risk and compliance management solution.

Secure Communications:

a virtual obfuscation network-as-a-service with encryption and managed attribution capabilities to ensure the safety and privacy of people, information, and resources on the network.

Telos Ghost seeks to eliminate cyber-attack surfaces by

obfuscating and encrypting data, masking user identity and location, and hiding network resources.

It provides the additional layers of security and privacy needed for intelligence gathering, cyber threat protection, securing critical

infrastructure, and protecting communications and applications when operations, property, and even lives can be jeopardized by a single error in security.

Telos Automated

Message Handling System (“AMHS”):

web-based organizational message distribution and management for mission-critical communications;

the recognized gold standard for organizational messaging in the U.S.

Telos AMHS is used

by military field operatives for critical communications on the battlefield and is the only web-based solution for assured messaging and directory services using the DISA Organizational Messaging Service and its specialized communications

Identity Trust and Digital Services through IDTrust360 ® – an enterprise-class digital identity risk platform for extending SaaS and custom digital identity services that mitigate threats through the integration of advanced

technologies that fuse biometrics, credentials, and other identity-centric data used to continuously monitor trust.

We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck ®

enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and FINRA Electronic Fingerprint Submission provider.

We are the only commercial entity in our industry designated as a Secure Flight Services provider for

terrorist watchlist checks.

Secure Networks

Secure Mobility:

solutions for business and government that enable remote work and minimize concern across and beyond the enterprise.

Our secure mobility team brings credentials to every engagement, supplying deep expertise and experience as well as highly

desirable clearances and industry recognized certifications for network engineering, mobility, and security.

Management and Defense:

services for operating, administrating, and defending complex enterprise networks and defensive cyber operations.

Our diverse portfolio of capabilities addresses common and uncommon requirements in many

industries and disciplines, ranging from the military and government agencies to Fortune 500 companies.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make

estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during

the reporting period.

Significant estimates and assumptions used in the preparation of our consolidated financial statements include revenue recognition, allowance for doubtful accounts receivable, allowance for inventory obsolescence, the valuation

allowance for deferred tax assets, income taxes, contingencies and litigation, potential impairments of goodwill and intangible assets, estimated pension-related costs for our foreign subsidiaries and accretion of public preferred stock.

results could differ from those estimates.

The following is a summary of the most critical accounting policies used in the preparation of our consolidated

financial statements.

Revenue Recognition

We account for revenue in accordance with Accounting Standards Codification (“ASC”) Topic 606, “Revenue

from Contracts with Customers.” The unit of account in ASC 606 is a performance obligation, which is a promise in a contract with a customer to transfer a good or service to the customer.

ASC 606 prescribes a five-step model for recognizing revenue

that includes identifying the contract with the customer, determining the performance obligation(s), determining the transaction price, allocating the transaction price to the performance obligation(s), and recognizing revenue as the performance

obligations are satisfied.

Timing of the satisfaction of performance obligations varies across our businesses due to our diverse product and service mix, customer base, and contractual terms.

Significant judgment can be required in determining

certain performance obligations, and these determinations could change the amount of revenue and profit recorded in a given period.

Our contracts may have a single performance obligation or multiple performance obligations.

When there are multiple

performance obligations within a contract, we allocate the transaction price to each performance obligation based on our best estimate of standalone selling price.

The majority of our revenue is recognized over time, as control is transferred continuously to our

customers who receive and consume benefits as we perform, and is classified as services revenue.

All of our business groups earn services revenue under a variety of contract types, including time and materials, firm-fixed price, firm-fixed price

level of effort, and cost plus fixed fee contract types, which may include variable consideration as discussed further below.

Revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure

progress toward satisfying our performance obligations.

Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer.

Contract costs include labor, material, subcontractor costs

and indirect expenses.

This continuous transfer of control to the customer is supported by clauses in our contracts with U.S.

Government customers whereby the customer may terminate a contract for convenience and then pay for costs incurred plus a

profit, at which time the customer would take control of any work in process.

Government contracts where we perform as a subcontractor and our order includes similar Federal Acquisition Regulation (FAR) provisions as the prime

contractor’s order from the U.S.

Government, continuous transfer of control is likewise supported by such provisions.

For other non-U.S.

Government customers, continuous transfer of control to such customers is also supported due to general terms in

our contracts and rights to recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit.

Due to the transfer of control over time, revenue is recognized based on progress towards completion of

the performance obligation.

The selection of the method to measure progress towards completion requires judgment and is based on the nature of the performance obligations.

We generally use the cost-to-cost measure of progress on a proportional

performance basis for our contracts because it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts.

Under the cost-to-cost measure of progress, the extent of progress towards completion is measured

based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation.

Revenues are recorded proportionally as costs are incurred.

Due to the nature of the work required to be performed on certain of

our performance obligations, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment.

Contract estimates are based on various assumptions including labor and subcontractor costs,

materials and other direct costs and the complexity of the work to be performed.

A significant change in one or more of these estimates could affect the profitability of our contracts.

We review and update our contract-related estimates regularly and

recognize adjustments in estimated profit on contracts on a cumulative catch-up basis, which may result in an adjustment increasing or decreasing revenue to date on a contract in a particular period that the adjustment is identified.

profit in future periods of contract performance are recognized using the adjusted estimate.

Revenue that is recognized at a point in time is for the sale of software licenses in our Information

Assurance / Xacta ® and Secure Communications business groups and for the sale of resold products in Telos ID and Secure Networks, and is classified as product revenue.

Revenue on these contracts is recognized when the customer obtains

control of the transferred product or service, which is generally upon delivery of the product to the customer for their use, due to us maintaining control of the product until that point.

Orders for the sale of software licenses may contain multiple

performance obligations, such as maintenance, training, or consulting services, which are typically delivered over time, consistent with the transfer of control disclosed above for the provision of services.

When an order contains multiple

performance obligations, we allocate the transaction price to the performance obligations using our best estimate of standalone selling price.

Contracts are routinely and often modified to account for changes in contract requirements,

specifications, quantities, or price.

Depending on the nature of the modification, we determine whether to account for the modification as an adjustment to the existing contract or as a new contract.

Generally, modifications are not distinct from

the existing contract due to the significant interrelatedness of the performance obligations and are therefore accounted for as an adjustment to the existing contract, and recognized as a cumulative adjustment to revenue (as either an increase or

reduction of revenue) based on the modification’s effect on progress toward completion of a performance obligation.

Our contracts may include various types of variable consideration, such as claims (for instance,

indirect rate or other equitable adjustments) or incentive fees.

We include estimated amounts in the transaction price based on all of the information available to us, including historical information and future estimations, and to the extent it is

probable that a significant reversal of cumulative revenue recognized will not occur when any uncertainty associated with the variable consideration is resolved.

We have revised and re-submitted several years of incurred cost submissions reflecting

certain indirect rate structure changes as a result of regular Defense Contract Audit Agency (“DCAA”) audits of incurred cost submissions.

This resulted in signed final rate agreement letters for fiscal years 2011 to 2013 and conformed incurred cost

submissions for 2014 to 2015.

We evaluated the resulting changes to revenue under the applicable cost plus fixed fee contracts for the years 2011 to 2015 as variable consideration, and determined the most likely amount to which we expect to be

entitled, to the extent that no constraint exists that would preclude recognizing this revenue or result in a significant reversal of cumulative revenue recognized.

We included these estimated amounts of variable consideration in the transaction

price and as performance on these contracts is complete, we have recognized revenue of $6.0 million during the year ended December 31, 2018.

Historically, most of our contracts do not include award or incentive fees.

For incentive fees, we would

include such fees in the transaction price to the extent we could reasonably estimate the amount of the fee.

With limited historical experience, we have not included any revenue related to incentive fees in our estimated transaction prices.

include in our contract estimates additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its

realization is probable.

We consider the contractual/legal basis for the claim (in particular FAR provisions), the facts and circumstances around any additional costs incurred, the reasonableness of those costs and the objective evidence available to

support such claims.

For our contracts that have an original duration of one year or less, we use the practical expedient

applicable to such contracts and do not consider the time value of money.

We capitalize sales commissions related to proprietary software and related services that are directly tied to sales.

We do not elect the practical expedient to expense as

incurred the incremental costs of obtaining a contract if the amortization period would have been one year or less.

For the sales commissions that are capitalized, we amortize the asset over the expected customer life, which is based on recent and

historical data.

Contract assets are amounts that are invoiced as work progresses in accordance with agreed-upon

contractual terms, either at periodic intervals or upon achievement of contractual milestones.

Generally, revenue recognition occurs before billing, resulting in contract assets.

These contract assets are referred to as unbilled receivables and are

reported within accounts receivable, net of reserve on our consolidated balance sheets.

Billed receivables are amounts billed and due from our customers and are reported within accounts

receivable, net of reserve on the consolidated balance sheets.

The portion of the payments retained by the customer until final contract settlement is not considered a significant financing component due to the intent of the retainage being the

customer’s protection with respect to full and final performance under the contract.

Contract liabilities are payments received in advance and milestone payments from our customers on

selected contracts that exceed revenue earned to date, resulting in contract liabilities.

Contract liabilities typically are not considered a significant financing component because they are generally satisfied within one year and are used to meet

working capital demands that can be higher in the early stages of a contract.

Contract liabilities are reported on our consolidated balance sheets on a net contract basis at the end of each reporting period.

We have one reportable segment.

We treat sales to U.S.

customers as sales within the U.S.

regardless of

where the services are performed.

Substantially all of our revenues are from U.S.

customers as revenue derived from international customers is de minimus.

The following tables disclose revenue (in thousands) by customer type and contract type for the

periods presented.

Prior period amounts have not been adjusted under the modified retrospective method.

State & Local, and Commercial

Firm fixed-price

Time-and-materials

Cost plus fixed fee

The following table discloses accounts receivable and contract assets (in thousands):

Billed accounts receivable

Unbilled receivables

Allowance for doubtful accounts

Receivables – net

As of December 31, 2020 and 2019, we had $127.7 million and $112.4 million of remaining performance

obligations, respectively, which we also refer to as funded backlog.

We expect to recognize approximately 92.4% of our remaining performance obligations as revenue in 2021, an additional 2.5% by 2022 and the balance thereafter.

For the years ended

December 31, 2020, 2019, and 2018, the amount of revenue recognized during the year that was included in the opening contract liabilities balance was $5.3 million, $4.2 million, and $5.5 million, respectively.

Contract liabilities were $5.7 million

and $6.3 million as of December 31, 2020 and 2019, respectively.

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

Total backlog, a component of recurring revenue, consists of the aggregate contract revenues remaining

to be earned by us at a given time over the life of our contracts, whether funded or unfunded.

Funded backlog consists of the aggregate contract revenues remaining to be earned at a given time, which, in the case of U.S.

government contracts, means

that they have been funded by the procuring agency.

Unfunded backlog is the difference between total backlog and funded backlog and includes potential revenues that may be earned if customers exercise delivery orders and/or renewal options to

continue these contracts.

Based on historical experience, we generally assume option year renewals to be exercised.

Most of our customers fund contracts on a basis of one year or less and, as a result, funded backlog is generally expected to be

earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period.

Inventories are stated at the lower of cost or net realizable value, where cost is determined primarily

using the weighted average cost method.

Inventories consist primarily of purchased off-the-shelf hardware and software, and component computer parts used in connection with system integration services that we perform.

Inventories also include spare

parts utilized to support certain maintenance contracts.

Spare parts inventory is amortized on a straight-line basis over two to five years, which represents the shorter of the warranty period or estimated useful life of the asset.

An allowance for

obsolete, slow-moving or non-salable inventory is provided for all other inventory.

This allowance is based on our overall obsolescence experience and our assessment of future inventory requirements.

We evaluate the impairment of goodwill in accordance with ASC 350, “Intangibles – Goodwill and Other,”

which requires goodwill and indefinite-lived intangible assets to be assessed on at least an annual basis for impairment using a fair value basis.

Between annual evaluations, if events occur or circumstances change that would more likely than not

reduce the fair value of the reporting unit below its carrying amount, then impairment must be evaluated.

Such circumstances could include, but are not limited to:

(1) a significant adverse change in legal factors or business climate, or (2) a loss

of key contracts or customers.

As the result of an acquisition, we record any excess purchase price over the net tangible and

identifiable intangible assets acquired as goodwill.

An allocation of the purchase price to tangible and intangible net assets acquired is based upon our valuation of the acquired assets.

Goodwill is not amortized, but is subject to annual impairment

We complete our goodwill impairment tests as of December 31st each year.

Additionally, we make evaluations between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit

below its carrying amount.

The evaluation is based on the estimation of the fair values of our three reporting units, CO&D (comprised of Information Assurance / Xacta and Secure Networks), Telos ID, and Secure Communications, of which goodwill is

housed in the CO&D reporting unit, in comparison to the reporting unit’s net asset carrying values.

Our discounted cash flows required management’s judgment with respect to forecasted revenue streams and operating margins, capital expenditures

and the selection and use of an appropriate discount rate.

We utilized the weighted average cost of capital as derived by certain assumptions specific to our facts and circumstances as the discount rate.

The net assets attributable to the reporting

units are determined based upon the estimated assets and liabilities attributable to the reporting units in deriving its free cash flows.

In addition, the estimate of the total fair value of our reporting units is compared to the market

capitalization of the Company.

The Company’s assessment resulted in a fair value that was greater than the Company’s carrying value, therefore the second step of the impairment test, as prescribed by the authoritative literature, was not required to

be performed and no impairment of goodwill was recorded as of December 31, 2020.

Subsequent reviews may result in future periodic impairments that could have a material adverse effect on the results of operations in the period recognized.

operating results have reduced the projection of future cash flow growth potential, which indicates that certain negative potential events, such as a material loss or losses on contracts, or failure to achieve projected growth could result in

impairment in the future.

We estimate the fair value of our reporting unit and compare the valuation with the respective carrying value for the reporting unit to determine whether any goodwill impairment exists.

If we determine through the impairment

review process that goodwill is impaired, we will record an impairment charge in our consolidated statements of operations.

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

We account for income taxes in accordance with ASC 740, “Income Taxes.” Under ASC 740, deferred tax

assets and liabilities are recognized for the estimated future tax consequences of temporary differences and income tax credits.

Deferred tax assets and liabilities are measured by applying enacted statutory tax rates that are applicable to the

future years in which deferred tax assets or liabilities are expected to be settled or realized for differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.

Any change in tax rates on deferred

tax assets and liabilities is recognized in net income in the period in which the tax rate change is enacted.

We record a valuation allowance that reduces deferred tax assets when it is "more likely than not" that deferred tax assets will not be

We are required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

available evidence, realization of deferred tax assets is dependent upon the generation of future taxable income.

We considered projected future taxable income, tax planning strategies, and reversal of taxable temporary differences in making this

As such, we have determined that a full valuation allowance is required as of December 31, 2020 and 2019.

As a result of a full valuation allowance against our deferred tax assets, a deferred tax liability related to goodwill remained on

our consolidated balance sheet at December 31, 2020 and 2019.

Due to the tax reform enacted on December 22, 2017, net operating losses generated in taxable years beginning after December 31, 2017 will have an indefinite carryforward period, which

will be available to offset future taxable income created by the reversal of temporary taxable differences related to goodwill.

As a result, we have adjusted the valuation allowance on our deferred tax assets and liabilities at December 31, 2020 and

See additional information on tax reform and its impact on our income taxes in Note 9 – Income Taxes.

Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, ("10-K").

In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions.

Our actual results and timing of selected events in future periods may differ materially from those anticipated or implied in these forward-looking statements as a result of many factors, including those discussed under Item 1A, " Risk Factors ," and elsewhere in this 10-K.

See also " Cautionary Note Regarding Forward-Looking Statements " at the beginning of this 10-K.

General Overview

We offer technologically advanced, software-based security solutions that empower and protect the world’s most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats.

Our portfolio of security products, services and expertise empower our customers with capabilities to reach new markets, serve their stakeholders more effectively, and successfully defend the nation or their enterprise.

We protect our customers’ people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in their security and privacy.

For an overview of our operating segments, including a discussion of our major products and services and the reorganization of our segments into two operating segments, see our business segment discussion contained in Item 1.

The segment information presented in this management's discussion and analysis for fiscal years 2020 and 2019 has been restated to conform with the changes to our operating structure in fiscal year 2021.

Business Environment

Our business performance continues to be heavily affected by the overall level of U.S.

government spending and the alignment of our solutions with the priorities of the U.S.

government spending and contracts continue to be affected by the federal budget and appropriations process and related legislation.

In fiscal years 2020 and 2021, the COVID-19 pandemic and associated economic dislocation in the United States resulted in an overwhelming federal response, including enactment of multiple significant and comprehensive emergency appropriations and economic stimulus measures.

These were in addition to the annual appropriations legislation for FY 2021, which was not enacted into law until late December 2020.

This was nearly three months after the beginning of the fiscal year, during which time the government operated under a series of Continuing Resolutions ("CRs"), which strictly limited new spending initiatives.

Due to delays again this year in the passage of FY 2022 appropriations legislation, the federal government had been operating since October 1, 2021 under the terms of another series of CRs, which limited spending to the prior year’s funding levels and generally prohibited new spending initiatives and contract starts.

But Congress finally reached agreement in March on FY 2022 appropriations legislation, which will allow our federal customers to finally operate under more normal conditions and with updated funding levels through the remainder of fiscal year 2022.

Of note, the final FY 2022 appropriations bill provides $728.5 billion for the Department of Defense and related activities.

This amount is $32.5 billion more than the FY 2021 enacted level, and is an increase above the level proposed last spring by President Biden for FY 2022.

This delay in enacting final FY 2022 appropriations legislation has postponed submission to Congress of the President’s FY 2023 budget request, and could delay the congressional budget and appropriations process for the next fiscal year.

These delays could, in turn, impact future planning by Telos and its government customers.

In November 2021, Congress gave final approval to and the President signed into law a multi-year, $1.2 trillion infrastructure package, the Infrastructure Investment and Jobs Act, which contains a number of provisions dealing with cybersecurity and provides funding for state and local government cybersecurity grant.

We believe these provisions could ultimately result in an increased need for solutions and services provided by Telos.

At the same time, such large increases in federal spending, following the enormous emergency spending packages during the pandemic and their resulting increases in the budget deficit will necessarily factor into future federal budget planning and spending decisions, affecting to an unknown degree the government contracts that we hold and the federal procurement for which we would otherwise compete.

Despite the pandemic’s resultant massive shift to teleworking by federal employees and contractors, the government has successfully maintained the continuity of services as has Telos.

More recently, as the government has proceeded to develop and implement its reopening process, and to make adjustments based on changing circumstances, officials have said they will seek to continue to maximize the use of teleworking by federal employees.

This stance has continued during the most recent, renewed surge of COVID-19 variant transmission.

As such, with much of the business of government still being conducted by federal employees working remotely through the use of information technology systems, we believe there will continue to be a need on the part of the government for the types of solutions and services provided by Telos.

President Biden’s May 12, 2021 Executive Order on “Improving the Nation’s Cybersecurity” acknowledged the severity and scope of the cybersecurity challenges facing the public and private sectors, the American people and our economy.

It gave the following direction for federal departments and agencies to modernize government cybersecurity:

move more rapidly to adopt secure cloud services;

adopt multi-factor authentication;

push for increased use of zero trust architecture;

and improve the security and integrity of the software supply chain, with a priority on addressing critical software.

The executive order also called for improving communications with cloud service providers through automation and standardization of messages at each stage of the FedRAMP process, and for other changes in an effort to accelerate and improve the process.

Subsequently, federal agencies, including the Cybersecurity & Infrastructure Security Agency ("CISA") and the TSA, which have specific responsibilities for various aspects of government and private sector cybersecurity, have taken steps to enhance public sector and critical infrastructure cybersecurity and to accelerate adoption of zero trust architecture throughout the federal government.

Pursuant to the cybersecurity executive order, the Biden Administration is putting emphasis on greater use of automation in the FedRAMP process, and on supply chain risk management, which are also focus areas for Telos.

NIST is developing a Ransomware profile, based on the NIST Cybersecurity Framework, which is specifically intended to help organizations manage ransomware-related risk, and Telos solutions will support this.

Finally on FedRAMP, this process is now being adopted at the state level, and we believe this StateRAMP effort will expand the market for Telos’ FedRAMP offerings.

Also to carry out that executive order, CISA last fall issued a draft of its Zero Trust Maturity Model to serve as a road map for agencies as they develop and implement zero trust architecture.

Subsequently, the Office of Management and Budget on January 26, 2022 released its final Zero Trust Architecture Strategy for federal agencies, the goals of which are organized using CISA’s Zero Trust Maturity Model.

Agencies will be required to meet specific zero trust security goals by the end of FY 2024, and they must develop, within 60 days of the strategy’s issuance, zero trust migration plans that meet the requirements of this strategy and include budget planning for those efforts.

Further, CISA has indicated it intends to update its draft Zero Trust Maturity Model in order to better align programs and services, including its Continuous Diagnostics and Mitigation ("CDM") program, with government-wide adoption of zero-trust security architectures in 2022.

In addition, a national security memorandum signed by President Biden on January 19, 2022 established guidelines for applying parts of his May 2021 cybersecurity executive order to the national security systems of the Defense Department and Intelligence Community, including pushing for adoption of zero trust architecture and other cybersecurity improvements.

Cybersecurity Landscape

Over the past few years, continued and increasingly damaging ransomware and other cyberattacks against federal, state and local governments, the K-12 and higher education sectors, and private sector enterprises have resulted in intensified efforts to better defend against such attacks.

The growing demand for these solutions continues to provide Telos with the privilege of offering our expertise to protect these vitally important organizations.

Ransomware remains arguably the most severe cyber threat to enterprises in the commercial and SLED sectors.

Our Xacta offering empowers these organizations and institutions to maintain a strong cyber risk posture to minimize the risk of ransomware gaining a foothold in their IT environment.

Should ransomware get loose in the enterprise network, Telos Ghost, our virtual obfuscation network offering, can hide vital resources from view to prevent the payload from reaching them.

Critical infrastructure and industrial IoT are among the categories at greatest risk of cyberattacks.

Energy, utilities, transportation, and food supply were among the critical infrastructure sectors that experienced high-profile breaches or ransomware attacks over the past year.

Telos Ghost can hide critical IoT and ICS from the public internet to keep them from being compromised.

Telos Ghost can also cordon off financial data, medical records, intellectual property, and other crown-jewel assets from visibility or accessibility by adversaries.

Telos Ghost is a complement to zero trust security, creating an additional layer of defense against intruders by hiding critical resources and users in an anonymous undiscoverable network.

As noted above, it protects the crown-jewel assets of critical infrastructure from unauthorized access.

Xacta streamlines and automates the critical processes of the leading cybersecurity standards and frameworks, in particular FedRAMP, allowing all process participants to collaborate within the same Xacta application to attain a FedRAMP Authority to Operate.

Xacta is also a trailblazer in adopting the Open Security Controls Assessment Language, a multi-format framework adopted by FedRAMP to allow security professionals to automate security assessment, auditing, and continuous monitoring processes.

The Cyber Incident Reporting for Critical Infrastructure Act of 2022, which was signed into law March 15, will require critical infrastructure owners and operators as well as federal agencies to report to CISA significant cyber incidents within 72 hours and any ransomware payments made within 24 hours.

Telos believes that such threat of having to make such disclosures will make organizations even more sensitive to boosting their cybersecurity posture, and that our Xacta solution will help illuminate their risk profile so that they can better understand the issues and address those issues proactively.

Government mandates and initiatives to assure stronger security in highly regulated industries, as noted above, also lead to opportunities for Xacta.

An update to the research study Telos conducted last year reveals that audit fatigue continues to burden these organizations, with automation solutions being recognized as the most effective remedy for the many repetitive and redundant tasks that security compliance requires.

Xacta streamlines, harmonizes, and automates the security controls and processes that comprise the leading cybersecurity standards and frameworks, in on-premises, cloud, hybrid, and multi-cloud environments.

The Securities and Exchange Commission has also recently proposed new, mandatory cyber risk management and cybersecurity incident reporting requirements for publicly traded companies.

Telos believes this will make sure companies have in place a sound cyber risk management strategy based on recognized best practices, such as the National Institute of Standards and Technology Cybersecurity Framework (NIST CSF), and Telos solutions will support this.

Finally, as a whole, the COVID-19 pandemic has resulted in the acceleration of digital transformation and cloud adoption within the government and beyond, which could increase demand for Xacta and Telos Ghost.

Xacta is engineered to manage risk and compliance of complex cloud and multi-cloud environments, a key capability for federal agencies and regulated industries that need to gain and maintain compliance with cloud-specific security regulations.

Telos Ghost is a cloud-native, as-as-service offering that delivers network obfuscation and managed attribution capabilities on a global scale to support the cloud-enabled enterprise.

COVID-19 Pandemic

The COVID-19 global pandemic has continued to create significant and unprecedented challenges, and during these highly uncertain times, our top priority remains the health and safety of our employees, customers and suppliers, thereby securing the financial well-being of the Company and supporting business continuity.

We are continuing to monitor the most recent outbreak of COVID-19, to work with our stakeholders to assess further possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate any adverse consequences.

Despite the pandemic's resultant shift to teleworking by federal employees and contractors, the government has successfully maintained continuity of services.

With much of the business of government continuing to be conducted remotely through the use of information technology systems, we believe there will continue to be a need on the part of the government for the types of solutions and services provided by us.

Opportunities, Challenges and Risks

We derive a substantial portion of our revenues from contracts and subcontracts with the U.S.

Our revenues are generated from a number of contract vehicles and task orders.

Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product

reselling to that of an advanced solutions technologies provider.

To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and

delivering Telos manufactured and branded technologies.

Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product reselling to that of an advanced solutions technologies provider.

To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and delivering Telos manufactured and branded technologies.

We believe our contract portfolio is characterized as having low to moderate financial risk due to the limited number of long-term fixed-price development contracts.

Our firm fixed-price

activities consist principally of contracts for the products and services at established contract prices.

Our firm fixed-price activities consist principally of contracts for the products and services at established contract prices.

Our time-and-material contracts generally allow the pass-through of allowable costs plus a profit margin.

For 2020, 2019, and 2018, the

Company’s revenue derived from firm fixed-price contracts was 84.3%, 82.7%, and 74.9%, respectively, cost-plus contracts was 8.2%, 8.2%, and 12.9%, respectively, and time-and-material contracts was 7.5%, 9.1%, and 12.2%, respectively.

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.

NETCENTS and NETCENTS-2 are IDIQ and GWAC, therefore any government customer may utilize the NETCENTS and NETCENTS-2 vehicles to meet its purchasing needs.

Consequently,

revenue earned on the underlying NETCENTS and NETCENTS-2 delivery orders varies from period to period according to the customer and solution mix for the products and services delivered during a particular period, unlike a standalone contract with one

separately identified customer.

For 2021, 2020, and 2019, the Company’s revenue derived from firm fixed-price contracts was 87.6%, 84.3%, and 82.7%, respectively;

cost-plus contracts revenue was 7.3%, 8.2%, and 8.2%, respectively;

and time-and-material contracts was 5.1%, 7.5%, and 9.1%, respectively.

Our business performance is affected by the overall level of U.S.

government spending and the alignment of our offerings and capabilities with the budget priorities of the U.S.

Adverse changes in fiscal and economic conditions could materially impact our business.

Some changes that could have an adverse impact our business include the implementation of future spending reductions and government shutdown.

Currently, the federal government is operating under the terms of the CR, until the individual appropriations bills are enacted.

Despite the budget and competitive pressure affecting the industry, we believe we are well-positioned to expand existing customer relationships and benefit from opportunities that we have not previously pursued.

In fiscal 2021, we reported revenue growth driven by strong demands for our advanced security solutions, and won and retained large-scale and long-term contracts.

Further, we continue to grow our sales channel and partner programs.

government has increasingly relied on contracts that are subject to a competitive bidding process (including indefinite delivery, IDIQ, GSA schedules, and other multi-award contracts), which has resulted in greater competition and increased pricing pressure.

To cite some of our existing contracts, we provide different solutions and are party to contracts of varying revenue types under the Network-Centric Solutions ("NETCENTS")-2 contracts to the U.S.

NETCENTS-2 are IDIQ and GWAC, therefore any government customer may utilize the NETCENTS-2 vehicles to meet its purchasing needs.

Consequently, revenue earned on the underlying NETCENTS-2 delivery orders varies from period to period according to the customer and solution mix for the products and services delivered during a particular period, unlike a standalone contract with one separately identified customer.

The contracts themselves do not fund any orders and they state that the contracts are for an indefinite delivery and indefinite quantity.

The majority of our task/delivery orders have periods of performance of less

than 12 months, which contributes to the variances between interim and annual reporting periods.

We have also been awarded other IDIQ/GWACs, including the Department of Homeland Security’s EAGLE II, GSA Alliant 2, and blanket purchase agreements

under our GSA schedule.

We refer to our cyber and cloud applications as Security Solutions, which includes Information Assurance

/Xacta® (previously referred to as Cyber & Cloud Solutions), Secure Communications (previously referred to as Secure Communications Cyber and Enterprise Solutions), and Telos ID (previously referred to as Telos ID Enterprise Solutions).

to our offerings for enterprise security as Secure Networks (previously referred to as Secure Mobility and Network Management/Defense Enterprise Solutions).

Government appropriations have been and continue to be affected by larger U.S.

Government budgetary

issues and related legislation.

In 2011, Congress enacted the Budget Control Act of 2011 (the “BCA”), which established specific limits on annual appropriations for fiscal years 2012-2021.

These limits were subsequently amended several times.

the expiration of the BCA at the end of FY 2021, there are no statutory limits in place for FY 2022.

According to the non-partisan Congressional Budget 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 overwhelming federal response, including enactment of several 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, during which time the government once again operated under a series of Continuing Resolutions which strictly limited new spending

These enormous emergency spending packages and their resulting increases in the budget deficit will necessarily factor into future spending decisions to an unknown degree.

Further, as the outgoing Trump Administration did not complete

its work on a proposed FY 2022 budget prior to leaving office on January 20, 2021, and the incoming Biden Administration has been delayed in submitting a proposed budget to Congress, the proposed spending levels for FY 2022 cannot be predicted.

Finally, the near- and long-term impacts of the COVID-19 health and associated economic crisis on federal budget planning and the government contracts that we hold, and on the federal procurements that we would otherwise compete for, cannot be known.

Should Congress and the White House be unable to make sufficient progress on the FY 2022 budget and

enact appropriations legislation prior to the beginning of the new fiscal year on October 1, 2021, the Department of Defense and other federal departments and agencies will likely again be funded for an unknown period of time under a Continuing

Resolution, which would restrict new spending initiatives.

Despite the pandemic’s resultant shift to teleworking by federal employees and contractors, the

government has successfully maintained continuity of services as has Telos Corporation.

With much of the business of government continuing to be conducted remotely through use of information technology systems, we believe there will continue to be a

need on the part of the government for the types of solutions and services provided by Telos.

For more information on the risks and uncertainties related to U.S.

Government contracts, see Part I –

Item 1A Risk Factors in this Annual Report on the Form 10-K.

Statement of Operations Data

The following table sets forth certain consolidated financial data and related percentages for the

periods indicated:

The majority of our task/delivery orders have periods of performance of less than 12 months, which contributes to the variances between interim and annual reporting periods.

We have also been awarded other IDIQ/GWACs, including the Department of Homeland Security’s EAGLE II, GSA Alliant 2, and blanket purchase agreements under our GSA schedule.

We expect that a majority of the business that we seek in the foreseeable future will be awarded through a competitive bidding process.

Key Performance Measures

The primary financial performance measures we use to manage our business and monitor results of operations are revenue, gross profit, and Adjusted EBITDA.

We evaluate our results of operations by considering the drivers causing changes in these measures.

We evaluate significant trends and fluctuations on our contract portfolio over time due to contract awards and completions, changes in customer requirements and changes in the volume of product and software sales.

Changes in costs of revenue as a percentage of revenue other than from revenue volume or cost mix are driven by changes in the compensation expense and other allocated costs and or cumulative revenue adjustments due to changes in estimates.

Changes in operating cash flows are driven by changes in cash generated through delivery of products and services, fluctuations in current assets and liabilities and the impact of changes in the timing of cash receipts or disbursements.

Results of Operations

Consolidated Overview

The following table sets forth the results of operations and certain consolidated financial data as a percentage of sales for the periods indicated:

Years Ended December 31,

2021 2020 2019

(dollar amounts in thousands)

Revenue 242,433 100.0 % 179,917 100.0 % 159,218 100.0 %

Cost of sales 156,404 64.5 % 117,497 65.3 % 106,874 67.1 %

Selling, general and administrative expenses 127,493 52.6 % 62,123 34.5 % 47,319 29.7 %

Operating income

Operating (loss) income (41,464) (17.1) % 297 0.2 % 5,025 3.2 %

Other income (expenses):

Gain on redemption of public preferred stock

— — % 14,012 7.8 % — — %

Non-operating (expense) income

(921) (0.4) % (255) (0.1) % 201 0.1 %

Interest expense (777) (0.3) % (7,259) (4.0) % (7,467) (4.7) %

Income (loss) income before income taxes

Benefit from (provision for) income taxes

Net income (loss)

(Loss) income before income taxes (43,162) (17.8) % 6,795 3.8 % (2,241) (1.4) %

Benefit from income taxes 28 — % 46 — % 104 0.1 %

Net (loss) income (43,134) (17.8) % 6,841 3.8 % (2,137) (1.3) %

Net income attributable to non-controlling interest — — % (5,154) (2.9) % (4,264) (2.7) %

Net income (loss) attributable to Telos Corporation

Net (loss) income attributable to Telos Corporation $ (43,134) (17.8) % $ 1,687 0.9 % $ (6,401) (4.0) %

Years Ended December 31, 2021, 2020, and 2019

increased by 13.0% to $179.9 million for 2020 from $159.2 million for 2019.

Security Solutions revenue was $117.3 million and $101.9 million for 2020 and 2019, respectively.

This increase in 2020 of approximately 15% was driven primarily by an

increase of $8.1 million in sales of offerings in Telos ID on the contract with the U.S.

Census Bureau and $7.3 million in sales of offerings related to the contract with a U.S.

government agency for our Telos Ghost managed intelligence support

solution in Secure Communications.

Secure Networks revenue was $62.6 million and $57.3 million for 2020 and 2019, respectively.

This increase in 2020 of approximately 9% resulted from various DoD contracts, in both our Secure Mobility and Network

Management/Defense Enterprise Solutions offerings.

Due to the various solutions offerings and within the business groups, sales may vary from period to period according to the solution mix and timing of deliverables for a particular period.

Revenue increased by 15.4% to $159.2 million for 2019 from $138.0 million for 2018.

Such increase primarily consists of an

increase in sales from the U.S.

Air Force NETCENTS-2 contract.

As discussed above, NETCENTS-2 is an IDIQ contract utilized by multiple government customers and sales under NETCENTS-2 vary from period to period according to the solution mix and timing

of deliverables for a particular period.

Security Solutions revenue was $101.9 million and $86.6 million in 2019 and 2018, respectively.

This increase in 2019 of approximately 18% is primarily attributable to a $10.1 million increase in sales of

offerings in Telos ID on a contract with the U.S.

Census Bureau and a $6.3 million increase in sales of offerings related to a contract with a U.S.

government agency for our Telos Ghost managed intelligence support solution in Secure Communications.

Secure Networks revenue was $57.3 million in 2019 and $51.4 million in 2018.

The sales increase in 2019 is the result of various DoD contracts around our Secure Mobility as well as our Network Management and Defense offerings.

Cost of sales.

of sales increased by 9.9% to $117.5 million for 2020 from $106.9 million for 2019 as a result of increases in revenue.

Cost of sales for Security Solutions increased to $66.9 million in 2020 from $59.9 million in 2019 which translates as a decrease

in the cost of sales as a percentage of revenue to 57.0% from 58.7%.

due to a change in the mix and nature of the programs.

Cost of sales for Secure Networks increased to $50.6 million in 2020 from $47.0 million in 2019 which translates as a decrease

in the cost of sales as a percentage of revenue to 80.9% from 82.0%.

Cost of sales increased by 25.8% to $106.9 million for 2019 from $85.0 million for 2018 as a result of

increases in revenue.

Cost of sales for Security Solutions increased to $59.9 million in 2019 from $48.2 million in 2018 which translates as a increase in the cost of sales as a percentage of revenue to 58.7% from 55.7%.

due to a change in the mix

and nature of the programs.

Cost of sales for Secure Networks increased to $47.0 million in 2019 from $36.7 million in 2018 which translates as an increase in the cost of sales as a percentage of revenue to 82.0% from 71.5% due primarily to the

effect of revenue accruals in 2018 for multiple contracts as a result of several years of cumulative indirect rate adjustments, which did not include direct costs.

Company Results

Revenue increased by $62.5 million or 34.7% in 2021 compared to 2020.

Revenue, excluding the contract with the U.S.

Census Bureau of $5.4 million in 2021 and $31.0 million in 2020, grew 59.2% year-over-year.

Revenue increased by $20.7 million or 13.0% in 2020 compared to 2019.

The increase in revenue is attributable to new awards and net increase in volume on various projects 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 $38.9 million or 33.1% in 2021 compared to 2020.

Cost of sales increased by $10.6 million or 9.9% in 2020 compared to 2019.

The changes in the cost of sales are directly driven by the change in mix and nature of the programs and an increase in stock-based compensation of $2.6 million in 2021 (none in the comparative prior years).

Gross profit increased by 37.8% to $86.0 million for 2021 from $62.4 million for 2020.

Gross profit for Security Solutions increased to $50.5 million in 2020 from $42.1 million in 2019.

Gross profit for Secure Networks increased to

$12.0 million in 2020 from $10.3 million in 2019.

Gross margin increased to 34.7% for 2020 from 32.9% for 2019, due to various changes in the mix of contracts in all business lines as discussed above.

Gross margin for Security Solutions increased to

43.0% in 2020 from 41.3% in 2019.

Gross margin for Secure Networks increased to 19.1% in 2020 from 18% in 2019.

Gross profit decreased by 1.4% to $52.3 million for 2019 from $53.1 million for 2018.

Gross profit for

Security Solutions increased to $42.1 million in 2019 from $38.4 million in 2018.

Gross profit for Secure Networks decreased to $10.3 million in 2019 from $14.6 million in 2018, due primarily to the effect of revenue accruals in 2018 for multiple

contracts as a result of several years of cumulative indirect rate adjustments, which did not include direct costs.

Gross margin decreased to 32.9% for 2019 from 38.4% for 2018, due to various changes in the mix of contracts in all business lines,

primarily decreases in proprietary software sales.

Gross margin for Security Solutions decreased to 41.3% in 2019 from 44.3% in 2018.

Gross margin for Secure Networks decreased to 18% in 2019 from 28.5% in 2018.

general, and administrative expenses .

Selling, general, and administrative expenses increased by 31.3% to $62.1 million for 2020 from $47.3 million for 2019.

Such increase is primarily attributable to increases in bonuses of $6.3 million,

outside services of $5.9 million, labor costs of $5.9 million, and $0.6 million in legal fees, offset by capitalization of research and development costs of $4.2 million.

Selling, general, and administrative expenses increased by 7.4% to $47.3 million for 2019 from $44.0

million for 2018.

Such increase is primarily attributable to increases in labor costs of $1.9 million, bonuses of $0.5 million, bad debt expenses of $0.5 million, and outside services of $0.4 million.

Interest expense decreased by 2.8% to $7.3 million for 2020 from $7.5 million for 2019, primarily due to decreases in public preferred stock interest as a result of such stock redemption, and interest on an equipment purchase

arrangement, offset by an increase in interest on the senior term loan with EnCap (as defined below).

Interest expense increased by 2.9% to $7.5 million for 2019 from $7.3 million for 2018, primarily due to

an increase in interest on the EnCap senior term loan, offset by a decrease in interest on an equipment purchase arrangement.

Gross profit increased by 19.2% to $62.4 million for 2020 from $52.3 million for 2019.

Gross margin increased to 35.5% for 2021 from 34.7% for 2020.

Gross margin increased due to growth in high margin contracts.

Gross margin increased to 34.7% for 2020 from 32.9% for 2019.

The change in the gross margin is due to various mix of contracts in all line of business.

Selling, general, and administrative ("SG&A") expenses increased by 105.2% in 2021 compared to 2020.

This is primarily attributable to an increase in stock-based compensation of $57.6 million, labor cost of $15.0 million, outside services of $4.4 million, insurance cost of $1.1 million and trade show cost of $1.2 million, offset by the decrease in bonus cost of $12.1 million and capitalization of research and development costs of $3.3 million.

SG&A expenses increased by 31.3% in 2020 compared to 2019.

Such increase is primarily attributable to increases in bonuses of $6.3 million, outside services of $5.9 million, labor costs of $5.9 million, and $0.6 million in legal fees, offset by capitalization of research and development costs of $4.2 million.

Other expenses of $0.9 million in 2021 was primarily for the settlement of outstanding litigation compared to other income of $13.8 million in 2020 primarily related to the gain on redemption of the public preferred stock upon the closing of our IPO in November 2020.

Interest expense decreased by 89.3% to $0.8 million for 2021 primarily due to the repayment of a senior term loan held by EnCap (as defined under Note 7 - Debt Obligations), subordinated debt, and redemption of public preferred stock upon the closing of our IPO in November 2020.

Components of interest expense are as follows:

2021 2020 2019

(amounts in thousands)

1 unchanged sentence

Preferred stock interest accrued — 3,384 3,823

for income taxes .

Income tax benefit was $46,000 for 2020, compared to an income tax provision of $104,000 for 2019, primarily attributable to administrative practice release of certain FIN48 liability.

Income tax benefit was $104,000 for 2019, compared to an income tax provision of $31,000 for 2018,

primarily attributable to the decrease in deferred tax liability due to the timing of the state conformity to the indefinite-lived net operating loss provision of the Tax Act (as described below).

Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we believe the non-GAAP financial

measures of Non-GAAP Operating Income, Enterprise EBITDA and Adjusted EBITDA 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

The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled

non-GAAP measures used by other companies.

Total $ 777 $ 7,259 $ 7,467

Income tax benefit was $28,000 for 2021, compared to $46,000 for 2020, primarily due to an increase in state income taxes.

Income tax benefit was $46,000 for 2020, compared to $104,000 for 2019, primarily attributable to administrative practice release of certain FIN48 liability.

Segment Results

The accounting policies of each business segment are the same as those followed by the Company as a whole.

Management evaluates business segment performance based on gross profit.

Security Solutions Segment:

Years Ended December 31,

2021 2020 2019

(dollar amounts in thousands)

Revenues $ 123,534 $ 117,312 $ 101,923

Gross profit $ 64,904 $ 50,458 $ 42,056

Gross margin 52.5 % 43.0 % 41.3 %

Revenue increased by 5.3% in 2021 compared to 2020.

This increase was driven by higher sales of Telos ID and Information Assurance offerings.

Revenue, excluding the contract with the U.S.

Census Bureau of $5.4 million in 2021 and $31.0 million in 2020, grew 36.9% year-over-year.

Gross profit increased by 28.6% to $64.9 million in 2021, with a reported gross margin of 52.5% for 2021.

The increase in profitability in 2021 was due to growth in high margin revenues primarily in Telos ID.

Revenue increased by 15.1% in 2020 compared to 2019.

The increase was driven primarily by $8.1 million in sales of offerings in Telos ID on the contract with the U.S.

Census and $7.3 million in sales of offerings related to the contract with the U.S.

government agency for our Telos Ghost managed intelligence support solution in Secure Communications.

Gross profit increased by 20.0% to $50.5 million in 2020, with a reported gross margin of 43.0% in 2020 from 41.3% in 2019, due to various changes in the mix of various contracts.

Secure Networks Segment:

Years Ended December 31,

2021 2020 2019

(dollar amounts in thousands)

Revenues $ 118,899 $ 62,605 $ 57,295

Gross profit $ 21,125 $ 11,962 $ 10,288

Gross margin 17.8 % 19.1 % 18.0 %

Revenue increased by 89.9% in 2021 compared to 2020.

The increase resulted from various contracts with the DoD, primarily in our Secure Mobility Solution offerings.

Gross profit increased by 76.6% to $21.1 million in 2021, with a reported gross margin of 17.8% in 2021 from 19.1% in 2020, due to various changes in the mix of contracts.

The revenue increased by 9.3% in 2020, compared to 2019, which was the result of various DoD contracts, in both our Secure Mobility and Network Management / Defense Enterprise Solutions offerings.

Gross profit increase by 16.3% to $12.0 million in 2020, with a reported gross margin of 19.1% in 2020 from 18.0% in 2019, due to various changes in the mix of various contracts.

Balance Sheet Review

The Company's total assets as of December 31, 2021 and 2020 were $246.1 million and $183.8 million, respectively.

The increase in total assets was primarily attributable to an increase in cash and cash equivalents provided by the follow-on offering, an increase in accounts receivables due to higher revenue generation, additional capital expenditures and an increase in intangible assets and goodwill as a result of the acquisition of DFT during 2021.

The Company's total liabilities as of December 31, 2021 were $65.8 million compared to $56.7 million in 2020.

The increase in total liabilities was primarily attributable to the increase in accounts payable and other accrued liabilities as a result of the increase in the cost of sales as of December 31, 2021.

As of December 31, 2021, the Company had total equity of $180.3 million compared to $127.1 million in 2020.

The increase in equity is primarily driven by the follow-on offering that raised $64.3 million and stock-based compensation of $60.2 million, offset by the repurchase of the common stock and outstanding warrants held by EnCap for $1.3 million and $26.9 million, respectively.

The Company reported a net loss of $43.1 million for the year ended December 31, 2021.

Non-GAAP Measures

In addition to our results determined in accordance with U.S.

GAAP, we believe the non-GAAP financial measures of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted Earnings Per Share ("EPS") and Free Cash Flow are useful in evaluating our operating performance.

We believe that this non-GAAP financial information, when taken collectively with our GAAP results, may be helpful to readers of our financial statements because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results.

A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP.

We use the following non-GAAP financial measures to understand and evaluate our core operating

performance and trends, to prepare and approve our annual budget, to develop short-term and long-term operating plans, and to evaluate the performance of certain management personnel when determining incentive compensation.

We believe these non-GAAP

financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionate positive or negative impact on our results of operations in any

particular period.

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 income, interest expense, (benefit) provision for income taxes, and depreciation and amortization.

We define Adjusted EBITDA as Enterprise EBITDA, adjusted for stock-based compensation expense,

the gain realized on redemption of the public preferred stock upon the closing of our initial public offering, the losses realized on the extinguishment of senior term loan and subordinated debt upon the closing of our initial public offering,

bonuses paid as a result of the closing of our initial public offering, and other expenses related to our initial public offering.

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:

Both Enterprise EBITDA and Adjusted EBITDA are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, an alternative to net loss as determined by GAAP.

We define Enterprise EBITDA as net (loss) income attributable to Telos Corporation, adjusted for net (loss) income attributable to non-controlling interest, non-operating (income) expense, interest expense, provision for (benefit from) income taxes, and depreciation and amortization.

We define Adjusted EBITDA as Enterprise EBITDA, adjusted for transaction gains/losses/expenses related to our IPO and stock-based compensation expense.

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

Years Ended December 31, 2021 2020 2019

(amount in thousands)

Net income (loss) attributable to Telos Corporation

Net (loss) income attributable to Telos Corporation $ (43,134) $ 1,687 $ (6,401)

Net income attributable to non-controlling interest — 5,154 4,264

Non-operating income

Non-operating expense (income) 921 (20) (201)

Interest expense 777 7,259 7,467

(Benefit) provision for income taxes

Benefit from income taxes (28) (46) (104)

Depreciation and amortization 5,624 5,353 4,972

7 unchanged sentences

Loss on extinguishment of subordinated debt — 411 —

Stock-based compensation expense

Total transaction related gains/losses/expenses — (8,007) —

1 unchanged sentence

Adjusted EBITDA $ 24,391 $ 11,384 $ 9,997

Each of Enterprise EBITDA and Adjusted EBITDA 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 and Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital

expenditures or contractual commitments, does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations, and does not reflect income tax expense or benefit.

Other companies in our

industry may calculate Adjusted EBITDA differently than we do, which limits its usefulness as a comparative measure.

Because of these limitations, neither Enterprise EBITDA nor Adjusted EBITDA should be considered as a replacement for net income

(loss), as determined by GAAP, or as a measure of our profitability.

Adjusted Net Income (Loss) and Adjusted EPS

Adjusted Net Income (Loss) and Adjusted EPS are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, alternatives to net income (loss) as determined by GAAP.

We define Adjusted Net Income (Loss) as net income (loss) attributable to Telos Corporation, adjusted for non-operating expense (income), transaction-related gains/losses/expenses, and stock-based compensation expense.

We define Adjusted EPS as Adjusted Net Income (Loss) divided by the weighted-average number of common shares outstanding for the period.

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

Years Ended December 31, 2021 2020 2019

Adjusted Net Income (Loss) Adjusted Earnings Per Share Adjusted Net Income (Loss) Adjusted Earnings Per Share Adjusted Net Income (Loss) Adjusted Earnings Per Share

(in thousands) (in thousands) (in thousands)

Reported GAAP measure $ (43,134) $ (0.65) $ 1,687 $ 0.04 $ (6,401) $ (0.17)

Non-operating expense (income) 921 0.01 (20) — (201) (0.01)

Transaction related gains/losses/ expenses — — (8,007) (0.19) — —

Stock-based compensation expense 60,231 0.91 4 — — —

Adjusted non-GAAP measure $ 18,018 $ 0.27 $ (6,336) $ (0.15) $ (6,602) $ (0.18)

Weighted-average shares of common stock outstanding, diluted 66,374 42,877 37,729

Free Cash Flow

Free cash flow, as reconciled in the table below, is a non-GAAP financial measure defined as net cash provided by or used in operating activities, less purchases of property and equipment and capitalized software development costs.

This non-GAAP financial measure may be a useful measure for investors and other users of our financial statements as a supplemental measure of our cash performance and to assess the quality of our earnings as a key performance measure in evaluating management.

Years Ended December 31, 2021 2020 2019

(in thousands)

Net cash flows provided by (used in) operating activities $ 7,262 $ (2,104) $ 11,816

Purchases of property and equipment (3,201) (780) (4,090)

Capitalized software development costs (9,968) (6,681) (2,442)

Free cash flow $ (5,907) $ (9,565) $ 5,284

Each of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow has limitations as an analytical tool, and you should not consider any of them in isolation, or as a substitute for analysis of our results as reported under GAAP.

Among other limitations, each of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow does not reflect our future requirements for capital expenditures or contractual commitments, does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations, and does not reflect income tax expense or benefit.

Other companies in our industry may calculate Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow differently than we do, which limits its usefulness as a comparative measure.

Because of these limitations, neither Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS nor Free Cash Flow should be considered as a replacement for net income (loss), earnings per share or net cash flows provided by operating activities, as determined by GAAP, or as a measure of our profitability.

We compensate for these limitations by relying primarily on our GAAP results and using non-GAAP measures only for supplemental purposes.

Liquidity and Capital Resources

Upon the closing of our initial public offering, 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 7 – 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 6 – Debt

Obligations).

We intend to use the remaining net proceeds for general corporate purposes.

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.

For example, a contractual requirement to post collateral for a duration of several months, depending on the materiality of the amount, could have an immediate negative effect on our liquidity, as such a circumstance would utilize cash resources without a near-term cash inflow back to us.

Likewise, the release of such collateral could have a corresponding positive effect on our liquidity, as it would represent an addition to our cash resources without any corresponding near-term cash outflow.

Similarly, a slow-down of payments from a customer, group of customers or government payment office would not have an immediate and direct effect on our availability unless the slowdown was material in amount and over an extended period of time.

Any of these examples would have an impact on our cash resources and therefore our liquidity.

Upon the closing of the IPO in November 2020, 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 exchangeable redeemable preferred stock conversion (see Note 8 – Exchangeable Redeemable Preferred Stock Conversion), $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 9 – Non-controlling Interests / Purchase of Telos ID), and $21.0 million to repay our outstanding senior term loan and subordinated debt (see Note 7 – Debt Obligations).

On April 6, 2021, we completed our follow-on offering of 9.1 million shares of our common stock at a price of $33.00 per share, including 7.0 million shares of common stock by certain existing stockholders of Telos.

The offering generated approximately $64.3 million of net proceeds to Telos.

We did not receive any proceeds from the shares of common stock sold by the selling stockholders.

On April 19, 2021, we used approximately $1.3 million of the net proceeds to repurchase 39,682 shares of our common stock and $26.9 million to repurchase warrants to purchase 900,970 shares of our common stock owned by EnCap (see Note 7 - Debt Obligations).

Further, on July 30, 2021, we used approximately $5.9 million of the net proceeds to acquire the assets of DFT (see Note 4 - Acquisition).

We intend to use the remaining net proceeds of the IPO and the follow-on offering for general corporate purposes.

We also may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies.

However, we do not have agreements,

commitments, or plans for any specific acquisitions at this time.

The amounts and timing of our actual use of the net 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, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.

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 operations and expansion of our business, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Our overall financial position and liquidity are strong.

Our working capital was $140.8 million and $105.2 million as of December 31, 2021 and 2020, respectively.

Although no assurances can be given, we expect that 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 $2.1 million for the year ended December 31, 2020, compared to

cash provided by operating activities of $11.8 million and $6.3 million, for the years ended December 31, 2019 and 2018, respectively.

Cash provided by operating activities is primarily driven by our operating income, the timing of receipt of

customer payments, the timing of 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, cash used in operating activities

also includes dividends from preferred stock recorded as interest expense of $3.4 million, $3.8 million, and $3.8 million for 2020, 2019, and 2018, respectively.

In 2020, net income was $6.8 million, $14.0 million of gain related to the redemption of

public preferred stock, and $5.4 million of depreciation and amortization, $1.7 million of which was amortization of capitalized software development costs.

In 2019, net loss was $2.1 million, which included $5.0 million of depreciation and

amortization, $1.8 million of which was amortization of capitalized software development costs.

In 2018, net income was $1.7 million, which included $3.0 million of depreciation and amortization, $1.1 million of which was amortization of capitalized

software development costs.

Cash used in investing activities for the years ended December 31, 2020, 2019, and

2018 was $7.5 million, $6.5 million, and $4.1 million, respectively, which, for the year ended December 31, 2020, 2019 and 2018, consisted of the capitalization of software development costs of $6.7 million, $2.4 million and $1.6 million,

respectively, and the purchases of property and equipment of $0.8 million, $4.1 million and $2.5 million, respectively.

Cash provided by financing activities for the years ended December 31, 2020 and 2019

was $108.9 million and $1.4 million, respectively, compared to cash used in financing activities $2.7 million for 2018.

The financing activities in 2020 consisted of net proceeds of $272.8 million from the initial public offering, offset by $108.9

million redemption of the public preferred stock, $17.4 million payoff of senior term loan, $30.0 million purchase of Telos ID membership interest, distributions of $2.7 million to the Class B Member of Telos ID, $3.7 million payoff of subordinated

debt, and repayments of $1.2 million under finance leases.

The financing activities in 2019 consisted of net proceeds of $4.9 million from the EnCap senior term loan, distributions of $2.4 million to the Class B Member of Telos ID, and repayments of

$1.1 million under finance leases.

The financing activities in 2018 consisted of distributions of $1.7 million to the Class B Member of Telos ID and repayments of $1.0 million under finance leases.

Contractual Obligations

The following summarizes our contractual obligations and our redeemable preferred stock at December

31, 2020 (in thousands):

We ended fiscal year 2021 with a cash and cash equivalent balance of $126.6 million compared to $106.0 million at the end of 2020.

We place a strong emphasis on cash flow generation.

This focus gives us the flexibility for capital deployment while preserving a strong balance sheet to position us for future opportunities.

We believe we have adequate funds on hand to execute our financial and operating strategy.

The following is a discussion of our major operating, investing and financing activities in fiscal years 2021, 2020 and 2019, as classified on the Consolidated Statements of Cash Flows in Part II, Item 8.

Net cash provided by operating activities was $7.3 million in 2021 compared to cash used in operating activities of $2.1 million in 2020 and cash provided by operating activities of $11.8 million in 2019.

Cash provided by operating activities is primarily driven by our operating income, the timing of receipt of customer payments, the timing of 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, cash used in operating activities also includes dividends from preferred stock recorded as interest expense of $3.4 million and $3.8 million for 2020 and 2019, respectively.

In 2021, net loss was $43.1 million, which included $60.2 million of stock-based compensation, and $5.6 million of depreciation and amortization ($1.9 million of which was amortization of intangible assets).

In 2020, net income was $6.8 million, which included $14.0 million of gain related to the redemption of public preferred stock, and $5.4 million of depreciation and amortization ($1.7 million of which was amortization of intangible assets).

In 2019, net loss was $2.1 million, which included $5.0 million of depreciation and amortization ($1.8 million of which was amortization of intangible assets).

Net cash used in investing activities for the years ended December 31, 2021, 2020, and 2019 was $19.1 million, $7.5 million, and $6.5 million, respectively.

Our investing activities include cash paid for capital expenditure and business acquisition.

Capital expenditures for the year ended December 31, 2021, 2020, and 2019, consisted of the capitalization of software development costs of $10.0 million, $6.7 million, and $2.4 million, respectively, and the purchases of property and equipment of $3.2 million, $0.8 million, and $4.1 million, respectively.

In 2021, we paid $5.9 million of cash for the acquisition completed in July 2021.

Cash provided by financing activities for the years ended December 31, 2021, 2020 and 2019 was $32.3 million, $108.9 million, and $1.4 million, respectively.

The financing activities in 2021 is primarily attributable to the proceeds from the follow-on offering that generated $64.3 million of net proceeds, reduced by $26.9 million used to repurchase the outstanding warrants held by EnCap, $1.3 million to repurchase the common stock held by EnCap, repayments of $1.3 million under finance leases, and $2.4 million final cash distribution to the Class B Member of Telos ID.

The financing activities in 2020 consisted of net proceeds of $272.8 million from the initial public offering, offset by $108.9 million redemption of the public preferred stock, $17.4 million payoff of senior term loan, $30.0 million purchase of Telos ID membership interest, distributions of $2.7 million to the Class B Member of Telos ID, $3.7 million payoff of subordinated debt, and repayments of $1.2 million under finance leases.

The financing activities in 2019 consisted of net proceeds of $4.9 million from the EnCap senior term loan, distributions of $2.4 million to the Class B Member of Telos ID, and repayments of $1.1 million under finance leases.

The Company does not have any other contractual obligations at December 31, 2021, except for the commitments on the existing lease obligations, as described under Note 1 8 - Commitments, Contingencies and Subsequent Events, to the Consolidated Financial Statements.

The following summarizes our obligations at December 31, 2021 (in thousands):

Payments due by Period

2028 and later

Total 2022 2023 - 2025 2026 - 2028 2029 and later

Finance lease obligations (1)

$ 17,267 $ 2,149 $ 6,774 $ 7,295 $ 1,049

Operating lease obligations (2)

1,003 602 401 — —

$ 18,270 $ 2,751 $ 7,175 $ 7,295 $ 1,049

(1) Includes interest expense

$ 2,966 $ 688 $ 1,576 $ 689 $ 13

(2) Includes operating lease right-of-use obligations and short-term leases with terms of 12 months or less.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements (as defined in Item 303, paragraph (a)(4)(ii) of Regulation S-K) that have or are

reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, sales or expenses, results of operations, liquidity, capital expenditures or capital resources.

Capital Expenditures

Capital expenditures for property and equipment were $0.8 million, $4.1 million, and $2.5 million for

2020, 2019, and 2018, respectively.

We have various lease agreements for property and equipment that, pursuant to ASC 842, “Leases,” require us to record the present value of the minimum lease payments for such equipment and property.

In addition, there were no outstanding commitments that were considered material for capital expenditures on December 31, 2021.

We presently anticipate capital expenditures of approximately $11.5 million in 2022;

however, there can be no assurance that this level of capital expenditures will occur.

We believe that available cash and

borrowings under the Purchase Agreement will be sufficient to generate adequate amounts of cash to fund our projected capital expenditures for 2021.

Leases and Related Obligations

We have various lease agreements for property and equipment that, pursuant to ASC 840, “Leases,”

require us to record the present value of the minimum lease payments for such equipment and property as an asset in our consolidated financial statements.

Such assets are amortized on a straight-line basis over the term of the related lease or their

useful life, whichever is shorter.

We adopted ASU 2016-02

effective January 1, 2019 and recorded right-of-use assets and liabilities in our consolidated balance sheets and expanded disclosures about leasing arrangements, among other items, for most lease arrangements.

The rate of inflation has been moderate over the past five years and, accordingly, has not had a

significant impact on the Company.

We have generally been able to pass through any increased costs to customers through higher prices to the extent permitted by competitive pressures.

We believe that the available cash will be sufficient to fund our projected capital expenditures for 2022.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in conformity with U.S.

GAAP requires management to make estimates and assumptions in certain circumstances that affect the amounts reported in the consolidated financial statements.

In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality.

Management evaluates these estimates and assumptions on an ongoing basis.

Our estimates and assumptions have been prepared on the basis of the most current reasonably available information, and may change in the future as more current information is available.

Management believes that our critical accounting policies are those that are both material to the presentation of our financial condition and results of operations and require management's most difficult, subjective and complex judgments.

Typically, the circumstances that make these judgments difficult, subjective and complex have to do with making estimates about the effect of matters that are inherently uncertain, as a result, actual results could differ from those estimates.

The following is a summary of the most critical accounting policies used and the discussion is intended to bring to the attention of readers of those accounting policies that management believes are critical in the preparation of our consolidated financial statements and other financial disclosures.

It is not intended to be a comprehensive list of all significant accounting policies that are more fully described in the notes to consolidated financial statements contained within this report.

Revenue Recognition

We account for revenue in accordance with ASC Topic 606, “Revenue from Contracts with Customers.” The unit of account in ASC 606 is a performance obligation.

Timing of the satisfaction of performance obligations varies across our businesses due to our diverse product and service mix, customer base, and contractual terms.

Significant judgment can be required in determining certain performance obligations, and these determinations could change the amount of revenue and profit recorded in a given period.

Our contracts may have a single performance obligation or multiple performance obligations.

When there are multiple performance obligations within a contract, we allocate the transaction price, net of any discounts, to each performance obligation based on the standalone selling price of the product or service underlying each performance obligation.

The standalone selling price is either based on estimated or actual costs plus a reasonable profit margin or the observable price of a good or service when Telos sells that good or service separately in similar circumstances and to similar customers.

The transaction price for our contracts represents our best estimate of the consideration we will receive and includes assumptions regarding variable consideration, as applicable.

The transaction price is allocated to each distinct performance obligation within the contract and recognized as revenue when, or as, the performance obligation is satisfied.

Our contracts may also include various types of variable considerations such as claims (i.e., indirect rate or other equitable adjustments) or incentive fees and we include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur.

The estimated amounts are based on an assessment of our anticipated performance and all other information that is reasonably available to us.

For contracts where revenue is recognized over time, we recognized revenue based on progress towards completion of the performance obligation, using costs incurred to date relative to total estimated cost at completion to measure progress on a proportional performance basis for our contracts.

Due to the nature of the work required to be performed on certain contracts, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment.

Contract estimates are based on various assumptions, including labor and subcontractor costs, materials and other direct costs and the complexity of the work to be performed.

A significant change in one or more of these estimates could affect the profitability of our contracts.

We review and update our contract-related estimates regularly and recognize adjustments in estimated profit on contracts on a cumulative catch-up basis, which may result in an adjustment increasing or decreasing revenue to date on a contract in a particular period that the adjustment is identified.

Revenue and profit in future periods of contract performance are recognized using the adjusted estimate.

For contracts where revenue is recognized over time, we recognized changes in estimated contract revenues, costs and profits using the cumulative catch-up method of accounting, wherein we recognize the cumulative effect of changes on current and prior periods with the impact of the change from inception-to-date recorded in the current period.

In cases when the total expected costs exceed total estimated revenue for a performance obligation, we recognize the anticipated losses on contracts in full in the period in which the losses become known.

The impact of adjustments in contract estimates on our operating income can be reflected in either revenue or operating costs and expenses.

The aggregate net changes in contract estimates increased our operating income by $0.2 million in 2021.

Business Combinations

We accounted for the acquisition transaction in accordance with ASC 805, "Business Combination".

We recorded all tangible and intangible assets acquired and liabilities assumed at fair value as of the acquisition date, which is determined using the cost, market or income approach.

The excess amount of the aggregate purchase consideration paid over the fair value of the net assets acquired and liabilities assumed is recorded as goodwill.

The preliminary valuations are based on the information that exists as of the acquisition date and available to us.

During the measurement period that shall not exceed one year from the acquisition date, we may adjust the preliminary purchase price allocation to reflect new information that we subsequently obtained regarding facts and circumstances that existed as of the acquisition date.

Goodwill and Other Long-Lived Assets

We evaluate the impairment of goodwill and other long-lived assets in accordance with ASC 350, “Intangibles – Goodwill and Other.” Management annually reviews goodwill and other long-lived assets for impairment or whenever events or changes in circumstances indicate the carrying amount may not be recoverable.

If we determine that the carrying value of the goodwill and other long-lived assets may not be recoverable, we will record an impairment charge for the amount by which the carrying value of the goodwill and other long-lived assets exceeds its fair value.

Goodwill is not amortized, but rather tested for potential impairment as of December 31 each year.

The goodwill impairment test is performed at the reporting unit level.

Accounting requirements provide that a reporting entity may perform an optional qualitative assessment on an annual basis to determine whether events occurred or circumstances changed that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

If an initial qualitative assessment identifies that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or the optional qualitative assessment is not performed, a quantitative analysis is performed.

The Company performs the quantitative goodwill impairment test by calculating the fair value of the reporting unit and comparing it to its respective carrying value including goodwill.

If the fair value is less than the carrying value, the amount of impairment expense is equal to the difference between the reporting unit's fair value and the reporting unit's carrying value.

We measure fair value based on a discounted cash flow method, which requires management's judgment with respect to forecasted revenue, operating margins, capital expenditures, and selection and use of an appropriate discount rate commensurate with the risk inherent in each of our reporting units' current business models.

We utilized the weighted average cost of capital as derived by certain assumptions specific to our facts and circumstances as the discount rate.

Our estimate of cash flows and discount rate are subject to change due to the economic environment.

In addition, the estimate of the total fair value of our reporting units is compared to the market capitalization of the Company.

We amortized intangible assets over their respective estimated useful lives, and reviewed them for impairment whenever events or changes in business circumstances indicate the carrying value may not be recoverable.

We completed the required annual impairment test of goodwill for all reporting units and other long-lived assets as of December 31, 2021, resulting in no impairments.

Based on our qualitative assessment, we concluded that it was more-likely-than-not that the estimated value of the reporting units exceeded its carrying value and thus, we did not proceed to the two-step goodwill impairment test.

We account for income taxes in accordance with ASC 740, “Income Taxes.” Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid.

We record net deferred assets to the extent we believe these assets will more likely than not be realized.

The realizability of net deferred tax assets is based on all available evidence, including future taxable income projections, tax planning strategies, and reversal of taxable temporary differences.

We regularly review our deferred tax assets for recoverability and establish a valuation allowance when management believes it is more likely than not such asset will not be recovered, taking into consideration historical operating results, expectations of future earnings, tax planning strategies and the expected timing of the reversals of existing temporary differences.

Recent Accounting Pronouncements

See Note 1 – Summary of Significant Accounting Policies of the Consolidated Financial Statements for

a discussion of recently issued accounting pronouncements.

See Note 1 - Overview and Summary of Significant Accounting Policies of the consolidated financial statements for a discussion of recently issued accounting pronouncements.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis