TELOS CORP 10-Q

Item 1. Financial Statements. Telos Corporation Consolidated Statements of Operations (Unaudited) For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands, except per share amounts) Revenue – services $ 50,270 $ 49,003 $ 98,378 $ 101,061 Revenue – products 5,521 4,641 7,573 8,341 Total revenue 55,791 53,644 105,951 109,402 Cost of sales – services 31,436 28,609 61,167 68,099 Cost of sales – products 3,426 2,501 4,984 4,299 Total cost of sales 34,862 31,110 66,151 72,398 Gross profit 20,929 22,534 39,800 37,004 Selling, general and administrative expenses: Sales and marketing 4,741 5,043 9,993 8,869 Research and development 4,489 5,327 9,919 9,388 General and administrative 23,865 29,635 46,788 49,712 Total selling, general and administrative expenses 33,095 40,005 66,700 67,969 Operating loss ( 12,166 ) ( 17,471 ) ( 26,900 ) ( 30,965 ) Other income/(expense) 118 32 130 ( 1,022 ) Interest expense ( 187 ) ( 192 ) ( 377 ) ( 388 ) Loss before income taxes ( 12,235 ) ( 17,631 ) ( 27,147 ) ( 32,375 ) Provision for income taxes ( 54 ) ( 13 ) ( 125 ) ( 47 ) Net loss $ ( 12,289 ) $ ( 17,644 ) $ ( 27,272 ) $ ( 32,422 ) Net loss per share: Basic $ ( 0.18 ) $ ( 0.26 ) $ ( 0.40 ) $ ( 0.49 ) Diluted $ ( 0.18 ) $ ( 0.26 ) $ ( 0.40 ) $ ( 0.49 ) Weighted average shares outstanding: Basic 67,876 66,616 67,717 65,621 Diluted 67,876 66,616 67,717 65,621 See accompanying notes to unaudited consolidated financial statements. 3 Tab l e of Contents Telos Corporation Consolidated Statements of Comprehensive Loss (Unaudited) For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Net loss $ ( 12,289 ) $ ( 17,644 ) $ ( 27,272 ) $ ( 32,422 ) Other comprehensive (loss)/income, net of tax: Foreign currency translation adjustments ( 11 ) 5 18 ( 27 ) Comprehensive loss $ ( 12,300 ) $ ( 17,639 ) $ ( 27,254 ) $ ( 32,449 ) See accompanying notes to unaudited consolidated financial statements. 4 Tab l e of Contents Telos Corporation Consolidated Balance Sheets (Unaudited) June 30, 2022 December 31, 2021 (in thousands, except per share and share data) Assets: Cash and cash equivalents $ 122,588 $ 126,562 Accounts receivable, net 50,676 59,844 Inventories, net 3,630 1,247 Prepaid expenses 6,778 3,329 Other current assets 947 732 Total current assets 184,619 191,714 Property and equipment, net 5,571 6,088 Finance lease right-of-use assets, net 8,442 9,053 Operating lease right-of-use assets 569 852 Goodwill 17,922 17,922 Intangible assets, net 23,783 19,199 Other assets 1,052 1,253 Total assets $ 241,958 $ 246,081 Liabilities and Stockholders' Equity: Liabilities: Accounts payable and other accrued liabilities $ 35,412 $ 34,548 Accrued compensation and benefits 9,280 6,557 Contract liabilities 4,799 6,381 Finance lease obligations, current portion 1,525 1,461 Operating lease obligations, current portion 450 564 Other current liabilities 2,734 1,430 Total current liabilities 54,200 50,941 Finance lease obligations, non-current portion 12,066 12,840 Operating lease liabilities, non-current portion 192 388 Deferred income taxes 748 723 Other liabilities 440 935 Total liabilities 67,646 65,827 Commitments and contingencies ( Note 1 9 ) Stockholders’ equity Common stock, $ 0.001 par value, 250,000,000 shares authorized, 67,594,301 shares and 66,767,450 shares issued and outstanding as of June 30, 2022 and December 31, 2021, respectively 106 105 Additional paid-in capital 388,464 367,153 Accumulated other comprehensive loss ( 9 ) ( 27 ) Accumulated deficit ( 214,249 ) ( 186,977 ) Total stockholders’ equity 174,312 180,254 Total liabilities and stockholders’ equity $ 241,958 $ 246,081 See accompanying notes to unaudited consolidated financial statements. 5 Tab l e of Contents Telos Corporation Consolidated Statements of Cash Flows (Unaudited) For the Six Months Ended June 30, 2022 June 30, 2021 (in thousands) Cash flows from operating activities: Net loss $ ( 27,272 ) $ ( 32,422 ) Adjustments to reconcile net loss to cash flows provided by/(used in) operating activities: Stock-based compensation 29,504 35,006 Depreciation and amortization 2,910 2,764 Deferred income tax provision 25 18 Accretion of discount on acquisition holdback 23 — Loss on disposal of fixed assets 1 5 Provision for doubtful accounts 66 11 (Recovery from)/provision for inventory obsolescence ( 108 ) 14 Changes in other operating assets and liabilities Accounts receivable 9,102 ( 9,595 ) Inventories ( 2,275 ) 1,513 Prepaid expenses, other current assets, and other assets ( 3,324 ) ( 2,417 ) Accounts payable and other accrued payables 567 1,278 Accrued compensation and benefits 419 632 Contract liabilities ( 1,582 ) 271 Other current liabilities and other liabilities 76 ( 432 ) Net cash provided by/(used in) operating activities 8,132 ( 3,354 ) Cash flows from investing activities: Capitalized software development costs ( 5,134 ) ( 3,663 ) Purchases of property and equipment ( 641 ) ( 1,070 ) Net cash used in investing activities ( 5,775 ) ( 4,733 ) Cash flows from financing activities: Payments under finance lease obligations ( 710 ) ( 650 ) Payment of tax withholding related to net share settlement of equity awards ( 2,886 ) — Repurchase of common stock ( 2,603 ) ( 1,251 ) Proceeds from issuance of common stock, net of issuance costs — 64,269 Repurchase of outstanding warrants — ( 26,894 ) Distributions to Telos ID Class B member – non-controlling interest — ( 2,436 ) Net cash (used in)/provided by financing activities ( 6,199 ) 33,038 Net change in cash, cash equivalents, and restricted cash ( 3,842 ) 24,951 Cash, cash equivalents and restricted cash, beginning of period 126,562 106,045 Cash, cash equivalents and restricted cash, end of period $ 122,720 $ 130,996 See accompanying notes to unaudited consolidated financial statements. 6 Tab l e of Contents Telos Corporation Consolidated Statements of Changes in Stockholders' Equity (Unaudited) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income/(Loss) Accumulated Deficit Total Stockholders’ Equity Shares Amount (in thousands) Balance at March 31, 2022 67,867 $ 106 $ 376,913 $ 2 $ ( 201,960 ) $ 175,061 Net loss — — — — ( 12,289 ) ( 12,289 ) Foreign currency translation loss — — — ( 11 ) — ( 11 ) Stock-based compensation expense, excluding accrued compensation — — 14,553 — — 14,553 Repurchase of common stock ( 360 ) — ( 3,002 ) — — ( 3,002 ) RSUs vested, net of shares withheld to cover tax withholding 87 — — — — — Balance at June 30, 2022 67,594 $ 106 $ 388,464 $ ( 9 ) $ ( 214,249 ) $ 174,312 Balance at March 31, 2021 64,625 $ 103 $ 284,470 $ 12 $ ( 158,621 ) $ 125,964 Net loss — — — — ( 17,644 ) ( 17,644 ) Issuance of common stock 2,050 2 64,267 — — 64,269 Foreign currency translation gain — — — 5 — 5 Stock-based compensation expense — — 21,336 — — 21,336 Repurchase of outstanding warrants — — ( 26,894 ) — — ( 26,894 ) Repurchase of common stock ( 40 ) — ( 1,251 ) — — ( 1,251 ) Balance at June 30, 2021 66,635 $ 105 $ 341,928 $ 17 $ ( 176,265 ) $ 165,785 Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income/(Loss) Accumulated Deficit Total Stockholders’ Equity Shares Amount (in thousands) Balance at December 31, 2021 66,767 $ 105 $ 367,153 $ ( 27 ) $ ( 186,977 ) $ 180,254 Net loss — — — — ( 27,272 ) ( 27,272 ) Foreign currency translation gain — — — 18 — 18 Stock-based compensation expense, excluding accrued compensation — — 27,200 — — 27,200 Repurchase of common stock ( 360 ) — ( 3,002 ) — — ( 3,002 ) RSUs vested, net of shares withheld to cover tax withholding 1,187 1 ( 2,887 ) — — ( 2,886 ) Balance at June 30, 2022 67,594 $ 106 $ 388,464 $ ( 9 ) $ ( 214,249 ) $ 174,312 Balance at December 31, 2020 64,625 $ 103 $ 270,800 $ 44 $ ( 143,843 ) $ 127,104 Net loss — — — — ( 32,422 ) ( 32,422 ) Issuance of common stock 2,050 2 64,267 — — 64,269 Foreign currency translation loss — — — ( 27 ) — ( 27 ) Stock-based compensation expense — — 35,006 — — 35,006 Repurchase of outstanding warrants — — ( 26,894 ) — — ( 26,894 ) Repurchase of common stock ( 40 ) — ( 1,251 ) — — ( 1,251 ) Balance at June 30, 2021 66,635 $ 105 $ 341,928 $ 17 $ ( 176,265 ) $ 165,785 See accompanying notes to unaudited consolidated financial statements. 7 Tab l e of Contents Telos Corporation Notes to the Unaudited Consolidated Financial Statements 1. ORGANIZATION Telos Corporation, together with its subsidiaries (collectively, the "Company," "we," "our" or "Telos"), a Maryland corporation, is a leading provider of cyber, cloud and enterprise security solutions for the world's most security-conscious organizations. We own all of the issued and outstanding share capital of Xacta Corporation, a subsidiary that develops, markets and sells government-validated secure enterprise solutions to government and commercial customers. We also own all of the issued and outstanding share capital of Ubiquity.com, Inc., a holding company for Xacta Corporation. We also have a 100 % ownership interest in Telos Identity Management Solutions, LLC (“Telos ID”), Teloworks, Inc. (“Teloworks”) and Telos APAC Pte. Ltd. (“Telos APAC”). On November 12, 2020, we amended our charter to effect an approximate 0.794 -for-1 reverse stock split with respect to our common stock. The par value and the authorized shares of the common stock were not adjusted as a result of the reverse stock split. The accompanying consolidated financial statements and notes to the consolidated financial statements give retroactive effect to the reverse stock split for all periods presented. On November 19, 2020, we completed our initial public offering ("IPO") of shares of our common stock. 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 conversion of our outstanding shares of Exchangeable Redeemable Preferred Stock into the right to receive cash and shares of our common stock, $ 30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID, and $ 21.0 million to repay our outstanding senior term loan and subordinated debt. We intend to use the remaining net proceeds for general corporate purposes. 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 held 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 the warrants to purchase 900,970 shares of our common stock owned by certain affiliates of Enlightenment Capital Solutions ("EnCap"). We intend to use the remaining net proceeds for general corporate purposes. 2. SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The accompanying unaudited consolidated financial statements include the accounts of Telos and its subsidiaries, including Ubiquity.com, Inc., Xacta Corporation, Telos ID, Teloworks, and Telos APAC, all of whose issued and outstanding share capital is wholly-owned directly and indirectly by Telos Corporation. All intercompany transactions have been eliminated in consolidation. (b) Basis of Presentation for Interim Periods Certain information and footnote disclosures normally included for the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted for the interim periods presented. We believe that the unaudited interim financial statements include all adjustments (which are normal and recurring in nature) necessary to state fairly our financial position and the results of operations and cash flows for the periods presented. The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for the year or future periods. The financial statements should be read in conjunction with our audited consolidated financial statements and the notes thereto for the year ended December 31, 2021, included in our Annual Report on Form 10-K for the fiscal year then ended (the "2021 10-K"). We have continued to follow the accounting policies set forth in those financial statements. (c) Segment Reporting Operating segments are defined as components of an enterprise for which separate discrete financial information is available and evaluated regularly by the chief operating decision maker (“CODM”), or decision-making group, in deciding how to allocate resources and assess performance. 8 Tab l e of Contents During the fourth quarter of 2021, we reorganized our internal management reporting structure and the financial results evaluated by our CODM; therefore, we changed our operating segments to align with how our CODM currently oversees the business, allocates resources and evaluates operating performance. As a result of the segment reorganization, we reported two reportable and operating segments: Security Solutions and Secure Networks. The segments enable the alignment of our strategies and objectives and provide a framework for timely and rational allocation of resources within the lines of business. We eliminate any inter-segment revenues and expenses upon consolidation. Prior period segment information has been recast to reflect the change. The segment reorganization had no impact on previously reported unaudited consolidated financial results. (d) Basis of Comparison – Revision of Previously Issued Interim Financial Statements The Company recorded certain revisions related to the previously issued unaudited condensed consolidated financial statements. The Company considered the errors identified in accordance with the SEC's Staff Accounting Bulletin No. 99 and determined the impact was immaterial to the previously issued condensed consolidated interim financial statements. Nonetheless, the Company corrected these errors when identified in 2021. During the third quarter of 2021, the Company identified out-of-period adjustments on certain revenue and expense classification. Further, we corrected the cash flow presentation to properly reflect the final payment to fully acquire all of the membership interest of Telos ID as financing activities. Further information regarding the misstatements and related revisions are included in Note 1 8 – R evision of Prior Year Interim Financial Statements to the condensed consolidated financial statements. (e) Use of Estimates The preparation of unaudited consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of revenue, expenses, assets and liabilities and disclosure of contingent assets and liabilities. The Company regularly assesses these estimates; however, actual results could differ from those estimates. We base our estimates on historical experience, currently available information and various other assumptions that we believe are reasonable under the circumstances. The most significant items involving management estimates include estimates of revenue recognition, allowance for credit losses, allowance for inventory obsolescence, the valuation allowance for deferred tax assets, the provision for income taxes, share-based compensation, contingencies and litigation, and valuation of intangibles and goodwill. The impact of changes in estimates is recorded in the period in which they become known. (f) Recent Accounting Pronouncements Changes to U.S. GAAP are established by the Financial Accounting Standards Board ("FASB") in the form of Accounting Standards Updates ("ASUs") to the FASB's Accounting Standards Codification ("ASC"). We consider the applicability and impact of all recent ASUs. ASUs not listed below were assessed and determined to be not applicable. Accounting Pronouncements Not Yet Adopted In October 2021, the FASB issued ASU No. 2021-08, “Business Combination (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers,” which requires entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The ASU improves comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. Entities should apply the amendments prospectively to business combinations that occur after the effective date. This standard will be effective for reporting periods beginning after December 15, 2022, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations and cash flows. In June 2022, the FASB issued ASU No. 2022-03, "Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions," which clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This standard will be effective for reporting periods beginning December 15, 2023, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations and cash flows. 9 Tab l e of Contents 3. REVENUE RECOGNITION We recognize revenue in accordance with 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. 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. Revenue transferred to customers over time accounted for 90 % and 93 % of our revenue for the three and six months ended June 30, 2022, and 91 % and 92 % of our revenue for the three and six months ended June 30, 2021, respectively. 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 transferred to customers at a point in time accounted for 10 % and 7 % of our revenue for the three and six months ended June 30, 2022, and 9 % and 8 % of our revenue for the three and six months ended June 30, 2021, respectively. 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. For certain performance obligations where we are not primarily responsible for fulfilling the promise to provide the goods or services to the customer, do not have inventory risk and have limited discretion in establishing the price for the goods or services, we recognize revenue on a net basis. We provide for anticipated losses on contracts during the period when the loss is determined by recording an expense for the total expected costs that exceed the total estimated revenue for a performance obligation. No contract losses were recorded during the three and six months ended June 30, 2022 and 2021. Disaggregated Revenues We have identified two reportable segments. 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 generated from U.S. customers. Table 3.1: Revenue by Operating Segments For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Security Solutions: Services $ 25,298 $ 27,595 $ 50,165 $ 46,725 Products 5,521 4,641 7,573 8,341 Total Security Solutions revenue 30,819 32,236 57,738 55,066 Secure Networks: Services 24,972 21,408 48,213 54,336 Products — — — — Total Secure Networks revenue 24,972 21,408 48,213 54,336 Total revenue $ 55,791 $ 53,644 $ 105,951 $ 109,402 Table 3.2: Revenue by Customer Type For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Security Solutions: Federal $ 27,251 $ 29,830 $ 51,853 $ 50,281 State & local, and commercial 3,568 2,406 5,885 4,785 Total Security Solutions revenue 30,819 32,236 57,738 55,066 Secure Networks: Federal 24,962 21,302 48,203 54,198 State & local, and commercial 10 106 10 138 Total Secure Networks revenue 24,972 21,408 48,213 54,336 Total revenue $ 55,791 $ 53,644 $ 105,951 $ 109,402 10 Tab l e of Contents Table 3.3: Revenue by Contract Type For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Security Solutions: Firm fixed-price $ 26,275 $ 27,457 $ 48,742 $ 45,469 Time-and-materials 2,731 3,059 5,646 6,060 Cost plus fixed fee 1,813 1,720 3,350 3,537 Total Security Solutions revenue $ 30,819 $ 32,236 $ 57,738 $ 55,066 Secure Networks: Firm fixed-price 19,030 18,885 37,839 50,014 Time-and-materials — — — 29 Cost plus fixed fee 5,942 2,523 10,374 4,293 Total Secure Networks revenue 24,972 21,408 48,213 54,336 Total revenue $ 55,791 $ 53,644 $ 105,951 $ 109,402 Revenue resulting from contracts and subcontracts with the U.S. government accounted for 94 % and 95 % of our revenue for the three months ended June 30, 2022 and 2021, respectively, and 94 % and 96 % of our revenue for the six months ended June 30, 2022 and 2021, respectively. As our primary customer base includes agencies of the U.S. government, we have a concentration of credit risk associated with our accounts receivable, as 95 % of our billed accounts receivable as of June 30, 2022, were directly with U.S. government customers. We perform ongoing credit evaluations of all our customers and generally do not require collateral or other guarantee from our customers. We maintain allowances for potential losses. Table 3.4: Revenue Concentrations Greater than 10% of Total Revenue For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 U.S. Department of Defense ("DoD") 72 % 67 % 71 % 76 % Civilian 22 % 28 % 23 % 20 % Contract Balances Table 3.5: Contract Balances June 30, 2022 December 31, 2021 (in thousands) Contract assets (unbilled receivables) $ 36,216 $ 41,374 Contract liabilities 4,799 6,381 The change in the Company's contract assets and contract liabilities during the period were primarily the result of the timing differences between the Company's performance, invoicing and customer payments. Revenue recognized for the three and six months ended June 30, 2022, that was included in the contract liabilities balance at the beginning of each reporting period was $ 1.6 million and $ 4.1 million, respectively. Revenue recognized for the three and six months ended June 30, 2021, that was included in the contract liabilities balance at the beginning of each reporting period was $ 1.2 million and $ 3.2 million, respectively. As of June 30, 2022, we had $ 100.5 million of remaining performance obligations, which we also refer to as funded backlog. We expect to recognize approximately 76 % of our remaining performance obligations as revenue in 2022, an additional 20 % in 2023, and the balance thereafter. 4. ACCOUNTS RECEIVABLE, NET Table 4: Details of Accounts Receivable, Net June 30, 2022 December 31, 2021 (in thousands) Billed accounts receivable $ 14,638 $ 18,586 Unbilled receivables 36,216 41,374 Allowance for credit losses ( 178 ) ( 116 ) Accounts receivable, net $ 50,676 $ 59,844 11 Tab l e of Contents 5. INVENTORIES, NET Table 5: Details of Inventories, Net June 30, 2022 December 31, 2021 (in thousands) Gross inventory $ 4,383 $ 2,108 Allowance for inventory obsolescence ( 753 ) ( 861 ) Inventories, net $ 3,630 $ 1,247 6. PROPERTY AND EQUIPMENT, NET Table 6: Details of Property and Equipment, Net June 30, 2022 December 31, 2021 (in thousands) Furniture and equipment $ 15,866 $ 15,420 Leasehold improvement 3,009 2,994 Property and equipment, at cost 18,875 18,414 Accumulated depreciation ( 13,304 ) ( 12,326 ) Property and equipment, net $ 5,571 $ 6,088 Depreciation expense was $ 0.5 million and $ 1.2 million for the three and six months ended June 30, 2022, respectively, compared to $ 0.5 million and $ 0.9 million for the three and six months ended June 30, 2021. 7. GOODWILL The goodwill balance was $ 17.9 million as of June 30, 2022, and December 31, 2021, of which $ 3.0 million is allocated to the Security Solutions segment and $ 14.9 million is allocated to the Secure Networks segment. Goodwill is subject to annual impairment tests and if triggering events are present in the interim before the annual tests, we will assess impairment. For the three and six months ended June 30, 2022 and 2021, no impairment charges were taken. 8. INTANGIBLE ASSETS, NET Table 8.1: Details of Intangible Assets, Net June 30, 2022 December 31, 2021 Gross Accumulated Amortization Net Gross Accumulated Amortization Net (in thousands) Acquired technology $ 3,630 $ ( 416 ) $ 3,214 $ 3,630 $ ( 256 ) $ 3,374 Customer relationships 40 ( 12 ) 28 40 ( 5 ) 35 Software development costs 27,652 ( 7,111 ) 20,541 22,222 ( 6,432 ) 15,790 $ 31,322 $ ( 7,539 ) $ 23,783 $ 25,892 $ ( 6,693 ) $ 19,199 Amortization expense was $ 0.4 million and $ 0.8 million for the three and six months ended June 30, 2022, respectively, and $ 0.5 million and $ 0.9 million for the three and six months ended June 30, 2021, respectively. 9. ACQUISITION On July 30, 2021, the Company acquired the assets of Diamond Fortress Technologies ("DFT") and wholly-owned subsidiaries for a total purchase consideration of $ 6.7 million, inclusive of $ 0.3 million related to a pre-existing contractual arrangement with DFT. Upon closing, $ 5.9 million of cash was paid with an additional $ 0.6 million payable to DFT 18 months after the close date (the "holdback"). The holdback amount has been discounted to its present value of $ 0.5 million using a discount rate relevant to the acquisition. The acquisition adds several new patents to the Company’s library of biometric and digital identity intellectual property. The addition of contactless biometrics technology will enable the Company to better serve the needs of organizations in existing and new markets. The acquisition of the assets of DFT has been accounted for under U.S. GAAP using the acquisition method of accounting. The total purchase consideration of $ 6.7 million has been allocated among the assets acquired at their fair value at the acquisition date. 12 Tab l e of Contents The Company recognized $ 3.7 million of intangible assets and $ 3.0 million of goodwill, which is housed in the Telos ID reporting unit, part of the Security Solutions operating segment. Goodwill is primarily attributable to an excess of the purchase price over the acquired identifiable net tangible and intangible assets. The acquired intangible assets will be amortized on a straight-line basis over 3 - 8 years. The acquisition was considered an asset purchase for tax purposes and the recognized goodwill is deductible for tax purposes. 10. PURCHASE OF TELOS ID NON-CONTROLLING INTERESTS Telos ID was formed as a limited liability company under the Delaware Limited Liability Company Act in 2007. Prior to the IPO, the Company owned a 50 % interest in Telos ID, with the remaining interest owned by Hoya ID Fund A, LLC ("Hoya") as the non-controlling interest. Distributions were made to the members only when and to the extent determined by Telos ID’s Board of Directors, in accordance with its Operating Agreement. On October 5, 2020, we entered into a Membership Interest Purchase Agreement between the Company and Hoya to purchase all of the Class B Units of Telos ID owned by Hoya (the “Telos ID Purchase”). Upon the closing of the Telos ID Purchase, Telos ID became our wholly owned subsidiary. On November 23, 2020, the Telos ID Purchase was consummated with the Company transferring $ 30.0 million in cash and issuing 7.3 million shares of our common stock at $ 20.39 per share (which totals approximately $ 148.4 million); the total consideration transferred to Hoya was $ 178.4 million. As part of the common stock issuance, the Company recognized an increase to additional paid-in capital (“APIC”) of $ 148.4 million. The Company further recognized a reduction to APIC of $ 173.9 million as part of the elimination of Hoya’s non-controlling interest in Telos ID. The net impact to APIC associated with the acquisition of the additional 50 % interest in Telos ID was a reduction of $ 25.5 million. Hoya received a final distribution of $ 2.4 million in January 2021 . 11. ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES Table 11: Details of Accounts Payable and Other Accrued Liabilities June 30, 2022 December 31, 2021 (in thousands) Accounts payable - trade $ 15,929 $ 7,869 Accrued liabilities 18,109 25,300 Others 1,374 1,379 Accounts payable and other accrued liabilities $ 35,412 $ 34,548 12. STOCK-BASED COMPENSATION Our 2016 Omnibus Long-Term Incentive Plan (the "2016 LTIP") provides for the grant of restricted stock units with time-based vesting ("Service-Based RSU" or "RSU") and restricted stock units with performance-based vesting (Performance-Based RSU" or "PRSU") to our senior executives, directors, employees, and other service providers. Awards granted under the 2016 LTIP vest over the periods determined by the Board of Directors or the Compensation Committee of the Board of Directors, generally one to three years . The Company records stock-based compensation related to accrued compensation in which it intends to settle in shares of the Company’s common stock. However, it is the Company’s discretion whether this compensation will ultimately be paid in stock or cash, as it has the right to dictate the form of these payments up until the date at which they are paid. The stock-based compensation expense includes an immaterial adjustment of $ 0.7 million and $ 1.3 million for the three and six months ended June 30, 2022 related to the prior year. There were no income tax benefits recognized on the share-based compensation expense for both periods. Table 12.1: Details of Stock Compensation Expense by Department For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Cost of sales – services $ 862 $ 631 $ 1,869 $ 1,256 Sales and marketing 1,420 2,233 3,088 3,780 Research and development 692 648 1,987 1,109 General and administrative 12,232 17,824 22,560 28,861 Total stock-based compensation expense $ 15,206 $ 21,336 $ 29,504 $ 35,006 13 Tab l e of Contents Table 12.2: Service-Based RSU and Performance-Based RSU Award Activity Service-Based RSU Performance-Based RSU Total Weighted-Average Grant Date Fair Value Unvested outstanding units as of December 31, 2021 3,030,608 492,727 3,523,335 $ 34.24 Granted 3,759,037 — 3,759,037 10.01 Vested ( 1,416,116 ) — ( 1,416,116 ) 32.83 Forfeited ( 260,588 ) ( 113,566 ) ( 374,154 ) 33.15 Unvested outstanding units as of June 30, 2022 5,112,941 379,161 5,492,102 $ 18.04 As of June 30, 2022, the intrinsic value of the RSUs and PRSUs outstanding, exercisable, and vested or expected to vest was $ 44.2 million. There was $ 61.0 million of total compensation costs related to stock-based awards not yet recognized as of June 30, 2022, which is expected to be recognized on a straight-line basis over a weighted-average remaining vesting period of approximately 1.3 years. 13. SHARE REPURCHASES On May 24, 2022, the Company announced that the Board of Directors approved a new share repurchase program ("SRP") authorizing the Company to repurchase up to $ 50.0 million of its common stock. Pursuant to this authorization, the Company may repurchase shares of its common stock on a discretionary basis from time to time through open market purchases. The repurchase program has no expiration date and may be modified, suspended, or terminated at any time. As of June 30, 2022, there was $ 47.0 million of the remaining authorization for future common stock repurchases under the SRP. Table 13: Shares Repurchase Activity For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands, except per share and share data) Amount paid for shares repurchased (1) $ 3,002 $ — $ 3,002 $ — Number of shares repurchased 360,439 — 360,439 — Average per share price paid (1) $ 8.33 $ — $ 8.33 $ — (1) Includes commissions paid for repurchases on the open market. As of August 5, 2022, the Company repurchased an additional 142,536 shares of its common stock, for $ 1.1 million since June 30, 2022. 14. ACCUMULATED OTHER COMPREHENSIVE LOSS Our functional currency is the U.S. Dollar. For one of our wholly-owned subsidiaries, the functional currency is the local currency. For this subsidiary, the translation of its foreign currency into U.S. Dollars is performed for assets and liabilities using current foreign currency exchange rates in effect at the balance sheet date and for revenue and expense accounts using average foreign currency exchange rates during the periods presented. Translation gains and losses are included in stockholders’ equity as a component of accumulated other comprehensive loss. Table 14: Details of Accumulated Other Comprehensive Loss June 30, 2022 December 31, 2021 (in thousands) Cumulative foreign currency translation loss $ ( 116 ) $ ( 134 ) Cumulative actuarial gain on pension liability adjustment 107 107 Accumulated other comprehensive loss $ ( 9 ) $ ( 27 ) 15. LOSS PER SHARE Basic net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of common shares outstanding for the period, without consideration for potentially dilutive securities. Diluted net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of shares of common stock and dilutive common stock equivalents outstanding for the period determined using the treasury-stock and if-converted methods. Dilutive common stock equivalents are comprised of unvested restricted common stock and warrants. For the period of net loss, potentially dilutive securities are not included in the calculation of diluted net earnings (loss) per share, because to do so would be anti-dilutive. 14 Tab l e of Contents Table 15: Potentially Dilutive Securities For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Unvested restricted stock and restricted stock units 57 1,030 211 239 Common stock warrants, exercisable at $ 1.665 per share — 856 — 857 Total 57 1,886 211 1,096 Unvested antidilutive stock units excluded from the dilutive effect (stock units) 3,056 — 1,348 — 16. RELATED PARTY TRANSACTIONS Emmett J. Wood, the brother of our Chairman and CEO, has been an employee of the Company since 1996. The amounts paid to this individual as compensation were $ 93,000 and $ 605,000 for the three and six months ended June 30, 2022, respectively, and $ 83,000 and $ 301,000 for the three and six months ended June 30, 2021, respectively. Additionally, Mr. Wood owned 94,547 and 73,562 shares of the Company’s common stock as of June 30, 2022, and December 31, 2021. One of the Company’s directors serves as a consultant to the Company. In February 2022, the director and the Company amended the consulting agreement to provide that the Company would pay the remainder of the director’s consulting fees for 2022 in a fixed price amount in the form of restricted stock units. The Company granted the director 26,091 restricted stock units on February 1, 2022, which vest quarterly in four equal amounts through the end of the year, subject to the director’s continued performance under the consulting agreement. The amounts paid for his consulting services were $ 25,000 for the three and six months ended June 30, 2022, and $ 70,500 and $ 141,000 for the three and six months ended June 30, 2021, respectively. 17. SEGMENT INFORMATION As noted in Note 2 - Significant Accounting Policies , during the fourth quarter of 2021, as a result of the segment reorganization, our CODM began evaluating, overseeing and managing the financial performance of our operations through two operating segments: Security Solutions and Secure Networks. The segments enable the alignment of our strategies and objectives and provide a framework for timely and rational allocation of resources within the lines of business. We eliminate any inter-segment revenues and expenses upon consolidation. The Security Solutions segment is primarily focused on cybersecurity, cloud and identity solutions, and secure messaging through Xacta ® , Telos Ghost ® , Telos ® Advanced Cyber Analytics, Telos ® AMHS and Telos ® ID offerings. We recognize revenue on contracts from providing various system platforms in the cloud, on-premises and in hybrid cloud environments, as well as software sales or software-as-a-service. Revenue associated with the segment's custom solutions is recognized as work progresses or upon delivery of services and products. Fluctuation in revenue from period to period is the result of the volume of software sales, and progress or completion of cloud and/or cybersecurity solutions during the period. The majority of the operating costs relates to labor, material, and overhead costs. Software sales have immaterial operation costs associated with them, thus yielding higher margins. Gross profit and margin are a function of operational efficiency on security solutions and changes in the volume of software sales. The Secure Networks segment provides secure networking architectures and solutions to our customers through secure mobility solutions and network management and defense services. Revenue is recognized over time as the work progresses on contracts related to managing network services and information delivery. Contract costs include labor, material and overhead costs. Variances in costs recognized from period to period primarily reflect increases and decreases in activity level on individual contracts. 15 Tab l e of Contents Table 17: Results of Operations by Business Segment For the Three Months Ended For the Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (in thousands) Revenues: Security Solutions $ 30,819 $ 32,236 $ 57,738 $ 55,066 Secure Networks 24,972 21,408 48,213 54,336 Total revenue 55,791 53,644 105,951 109,402 Gross profit: Security Solutions 16,433 17,188 31,485 26,515 Secure Networks 4,496 5,346 8,315 10,489 Total gross profit 20,929 22,534 39,800 37,004 Selling, general and administrative expenses 33,095 40,005 66,700 67,969 Operating loss ( 12,166 ) ( 17,471 ) ( 26,900 ) ( 30,965 ) Other income/(expense) 118 32 130 ( 1,022 ) Interest expense ( 187 ) ( 192 ) ( 377 ) ( 388 ) Loss before income taxes ( 12,235 ) ( 17,631 ) ( 27,147 ) ( 32,375 ) Provision for income taxes ( 54 ) ( 13 ) ( 125 ) ( 47 ) Net loss $ ( 12,289 ) $ ( 17,644 ) $ ( 27,272 ) $ ( 32,422 ) We measure each segment's profitability based on gross profit. We account for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Interest income, interest expense, other income and expense items and income taxes, as reported in the consolidated financial statements, are not part of the segment profitability measure, and are primarily recorded at the corporate level. Under U.S. government Cost Accounting Standards, indirect costs including depreciation and amortization expense, are collected in numerous indirect cost pools, which are then collectively allocated out to the Company’s reportable segments based on a representative causal or beneficial relationship of the costs in the pool to the costs in the base. While depreciation and amortization expense is a component of the allocated costs, the allocation process precludes depreciation and amortization expense from being specifically identified by the Company’s individual reportable and operating segments. For this reason, the non-cash items by a reportable and operating segment have not been reported above. Management does not utilize total assets by segment to evaluate segment performance or allocate resources. As a result, assets are not tracked by segment and therefore, total assets by segment are not disclosed. 18. REVISION OF PRIOR YEAR INTERIM FINANCIAL STATEMENTS During the third quarter of 2021, the Company identified that stock compensation for a single individual was incorrectly charged to "cost of sales - services" instead of "general and administrative expense." The total amount of stock compensation incorrectly charged to cost of sales was $ 0.3 million, of which $ 0.1 million was related to the first quarter of 2021, and $ 0.2 million related to the second quarter of 2021. The Company corrected the error during the third quarter of 2021. During the third quarter of 2021, the Company identified that the allocation of stock compensation for two of the Company's overhead cost pools was incorrectly charged to "cost of sales" instead of "general and administrative expense" during the second quarter of 2021. The total amount of the allocated stock compensation incorrectly charged to cost of sales was $ 0.7 million, which the Company corrected during the third quarter of 2021. In the third quarter of 2021, the Company identified $ 1.1 million in revenue related to the stub period of a newly awarded contract that should have been recognized as income during the second quarter of 2021. The Company initially corrected the error during the third quarter of 2021. Additionally, and related to this contract, in the fourth quarter of 2021 the Company identified $ 0.3 million of products revenue for the second quarter of 2021 that should be classified in the condensed consolidated statements of operations as services revenue. The Company erroneously presented the $ 2.4 million final payment to fully acquire all membership interest of Telos ID as an operating activity on the condensed consolidated statements of cash flows. The Company corrected the presentation to properly reflect the final payment within financing activities on the consolidated statements of cash flows in the fourth quarter of 2021. 16 Tab l e of Contents Table 18.1: Impact of the Correction to the Condensed Consolidated Statement of Operations For the Three Months Ended June 30, 2021 For the Six Months Ended June 30, 2021 Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted (in thousands, except per share amounts) Revenue - services $ 47,618 $ 1,385 $ 49,003 $ 99,676 $ 1,385 $ 101,061 Revenue - products 4,941 ( 300 ) 4,641 8,641 ( 300 ) 8,341 Revenue 52,559 1,085 53,644 108,317 1,085 109,402 Cost of sales - services 29,501 ( 892 ) 28,609 69,103 ( 1,004 ) 68,099 Costs and expenses 32,002 ( 892 ) 31,110 73,402 ( 1,004 ) 72,398 General and administrative 28,743 892 29,635 48,708 1,004 49,712 Selling, general and administrative expenses 39,113 892 40,005 66,965 1,004 67,969 Operating loss ( 18,556 ) 1,085 ( 17,471 ) ( 32,050 ) 1,085 ( 30,965 ) Loss before income taxes ( 18,716 ) 1,085 ( 17,631 ) ( 33,460 ) 1,085 ( 32,375 ) Net loss ( 18,729 ) 1,085 ( 17,644 ) ( 33,507 ) 1,085 ( 32,422 ) Net loss attributable to Telos Corporation ( 18,729 ) 1,085 ( 17,644 ) ( 33,507 ) 1,085 ( 32,422 ) Net loss per share attributable to Telos Corporation Basic $ ( 0.28 ) $ 0.02 $ ( 0.26 ) $ ( 0.51 ) $ 0.02 $ ( 0.49 ) Diluted $ ( 0.28 ) $ 0.02 $ ( 0.26 ) $ ( 0.51 ) $ 0.02 $ ( 0.49 ) Table 18.2: Impact of the Correction to the Condensed Consolidated Statement of Comprehensive Loss For the Three Months Ended June 30, 2021 For the Six Months Ended June 30, 2021 Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted (in thousands) Net loss $ ( 18,729 ) $ 1,085 $ ( 17,644 ) $ ( 33,507 ) $ 1,085 $ ( 32,422 ) Comprehensive loss attributable to Telos Corporation ( 18,724 ) 1,085 ( 17,639 ) ( 33,534 ) 1,085 ( 32,449 ) Table 18.3. Impact of the Correction to the Condensed Consolidated Statement of Cash Flows For the Six Months Ended June 30, 2021 Previously Reported Error Correction As Adjusted (in thousands) Net loss $ ( 33,507 ) $ 1,085 ( 32,422 ) Changes in other operating assets and liabilities ( 10,074 ) 1,351 ( 8,723 ) Cash used in operating activities ( 5,790 ) 2,436 ( 3,354 ) Distribution to Telos ID Class B member – non-controlling interest — ( 2,436 ) ( 2,436 ) Cash provided by financing activities 35,474 ( 2,436 ) 33,038 Table 18.4. Impact of the Correction to the Condensed Consolidated Statement of Changes in Stockholders' Equity For the Three Months Ended June 30, 2021 For the Six Months Ended June 30, 2021 Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted (in thousands) Net loss $ ( 18,729 ) $ 1,085 $ ( 17,644 ) $ ( 33,507 ) $ 1,085 $ ( 32,422 ) Accumulated deficit ( 177,350 ) 1,085 ( 176,265 ) ( 177,350 ) 1,085 ( 176,265 ) Total Stockholders' equity 164,700 1,085 165,785 164,700 1,085 165,785 17 Tab l e of Contents 19. COMMITMENT AND CONTINGENCIES Legal Proceedings On February 7, 2022, Telos and certain of its current and former officers were named as defendants in a lawsuit filed in the United States District Court for the Eastern District of Virginia. In the complaint, the plaintiffs, who purport to represent a class of purchasers of Telos common stock between November 19, 2020, and March 16, 2022, allege that the defendants violated securities laws by failing to disclose delays relating to the launch of certain contracts between Telos and the Transportation Security Administration ("TSA") and the Centers for Medicare and Medicaid Services and to take into account those delays when providing a financial forecast for the Company’s 2021 performance. On June 15, 2022, the Plaintiffs filed a consolidated complaint which added claims (i) concerning Telos' disclosure of revenue projections for these contracts, (ii) against the directors of Telos at the time of its initial public offering, and (iii) pursuant to Sections 11 and 15 of the Securities Act of 1933. The Company is vigorously defending the case, but given the early stage, although a loss may reasonably be possible, the Company is unable to predict the likelihood of success of plaintiffs' claims or estimate a loss or range of loss. As a result, no material liability has been recorded as of June 30, 2022 and December, 31, 2021, respectively. In addition, the Company is a party to litigation arising in the ordinary course of business. In the opinion of management, while the results of such litigation cannot be predicted with any reasonable degree of certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the Company's unaudited consolidated financial position, results of operations or cash flows. Other - Government Contracts As a U.S. government contractor, we are subject to various audits and investigations by the U.S. government to determine whether our operations are being conducted in accordance with applicable regulatory requirements. U.S. government investigations of our operations, whether relating to government contracts or conducted for other reasons, could result in administrative, civil, or criminal liabilities, including repayments, fines or penalties being imposed upon us, suspension, proposed debarment, debarment from eligibility for future U.S. government contracting, or suspension of export privileges. Suspension or debarment could have a material adverse effect on us because of our dependence on contracts with the U.S. government. U.S. government investigations often take years to complete, and many result in no adverse action against us. We also provide products and services to customers outside of the United States, which are subject to U.S. and foreign laws and regulations and foreign procurement policies and practices. Our compliance with local regulations or applicable U.S. government regulations also may be audited or investigated. 20. SUPPLEMENTAL CASH FLOW INFORMATION Table 20.1: Details of Cash, Cash Equivalent, and Restricted Cash June 30, 2022 December 31, 2021 (in thousands) Cash and cash equivalents $ 122,588 $ 126,562 Restricted cash (1) 132 — Cash, cash equivalents, and restricted cash $ 122,720 $ 126,562 (1) Restricted cash consists of a commercial money market account held as a deposit on the Ashburn lease and is recorded under "Other assets" on the Consolidated Balance Sheets Table 20.2: Supplemental Cash Flow Information For the Six Months Ended June 30, 2022 June 30, 2021 (in thousands) Cash paid during the period for: Interest $ 353 $ 388 Income taxes 188 54 Non-cash investing and financing activities: Operating lease ROU assets obtained in exchange for operating lease liabilities 282 322 Capital expenditure activity in accounts payable and other accrued liabilities 296 — Common stock repurchase under SRP 400 — 18 Tab l e of Contents