Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company’s actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth in the risk factors section included in the Company’s Form 10-K for the year ended December 31, 2021, as filed with the SEC.
General and Business 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.
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 information and communications technology introduces new vulnerabilities, as security is still too often overlooked in solution development. 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 give 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, cloud security, and enterprise security.
As a result of the change in our organization and leadership structure in the fourth quarter of 2021, we established and operate in two reportable segments – Security Solutions and Secure Networks.
Security Solutions
Security Solutions focuses on cybersecurity, cloud and identity solutions, which includes Information Assurance, Secure Communications, and Telos ID. Cybersecurity solutions help our customers ensure the ongoing security, integrity, and compliance of their on-premises and related cloud-based systems by reducing threats and vulnerabilities to foil cyber adversaries before they can attack. Our security engineers and subject matter experts assess our customers’ cybersecurity environments and design, engineer, and operate systems needed to strengthen their cybersecurity posture. Our cloud solutions leverage the specialized skills and experience needed to help our customers plan, engineer, execute and accelerate secure cloud migrations while assuring ongoing management and security of enterprise cloud technology environments. Our identity solutions deliver digital identity, biometric, and nationwide enrollment services and address Know Your Customer ("KYC") and identity management challenges for enterprises working within regulated and critical infrastructure environments.
• Information 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. Xacta 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.
◦ Telos Advanced Cyber Analytics ("ACA") : a solution-as-a-service that delivers timely, accurate, actionable intelligence at speed and scale to illuminate threats to enterprise assets. It enables organizations to detect malicious activity earlier and to uncover and identify previously unknown attacks and new malicious behavior. Further, it assists in the attribution of events and provides sophisticated and comprehensive analytics without expensive overhead.
19
Tab l e of Contents
• Secure Communications:
◦ Telos Ghost: 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 cyberattack 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. government. 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 Defense Information System Agency's Organizational Messaging Service and its specialized communications protocols.
• Telos ID: offering identity trust and digital services through IDTrust360 ® – an enterprise-class digital identity risk platform for extending flexible hybrid cloud identity services enabled for mobile and enterprise environments 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. In April 2021, we announced the acquisition of the assets of DFT, whose ONYX ® touchless mobile fingerprint software is being integrated with the IDTrust360 platform. We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck ® enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and Financial Industry Regulatory Authority Electronic Fingerprint Submission provider.
Secure Networks
Secure Networks focuses on enterprise security. Secure Networks provides secure networking architectures and solutions to the DoD, the federal Intelligence Community and other federal government agencies. Our net-centric solutions enable collaboration and connectivity in order to increase efficiency, reduce costs, and improve mission outcomes. We provide an extensive range of wired and wireless, fixed and deployable, classified and unclassified voice, data, and video secure network solutions and services to support defense and civilian missions. Capabilities include network design, operations and sustainment; system integration and engineering; network security and compliance; deployable comms; innovation and digital transformation; service desk; defensive cyber operations; and program management.
• Secure Mobility: solutions for business and government that enable remote work and minimize operational and security concerns 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.
• Network Management and Defense: services for operating, administrating, and defending complex enterprise networks and defensive cyber operations. Our diverse portfolio of capabilities such as defensive cyber operations and robotic process automation addresses common and uncommon requirements in many industries and disciplines, ranging from the military and government agencies to Fortune 500 companies.
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. U.S. government spending and contracts continue to be affected by the federal budget and appropriations process and related legislation.
Congress reached an agreement in March 2022 on fiscal year ("FY") 2022 appropriations legislation, which allows our federal customers to finally operate under more normal conditions and with updated funding levels through the remainder of FY 2022. Of note, the final FY 2022 appropriations bill provided $728.5 billion for the DoD 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 total does not include emergency supplemental appropriations enacted to deal with impacts from the Ukraine conflict, which further increased total defense spending this year.
Given the current political climate in Washington, it is highly questionable whether Congress will be able to enact FY 2023 appropriations legislation prior to the start of the fiscal year. This could again result in the need to fund much, if not all, of the federal government via continuing resolution(s) for an unknown length of time, or else face a government shutdown. Such delays in finalizing FY 2023 appropriations could, in turn, impact future planning by Telos and our government customers.
20
Tab l e of Contents
The President’s FY 2023 budget request, which was released on March 25, 2022, calls for approximately 4% more in defense spending than was provided for FY 2022. However, this proposed FY 2023 budget was developed prior to Russia’s invasion of Ukraine and did not include expenditures related to that ongoing event. The proposed FY 2023 budget also assumes an inflation rate for DoD of 2.2%, which Pentagon officials subsequently acknowledged will need to be adjusted higher. As such, there is significant congressional support for boosting defense spending further to account for these factors and other needs. The House and Senate versions of the FY 2023 National Defense Authorization Act reflect this, authorizing appropriations of $37 billion (House) and $45 billion (Senate) more than proposed by the President’s budget. Actual final appropriations levels for national defense will not be determined until this fall, at the earliest.
The proposed FY 2023 budget also calls for an increase in federal civilian agency (non-defense) cybersecurity funding of nearly 10.7%. The Biden Administration says it is seeking to increase investments across the various civilian federal agencies to help align them to the cybersecurity practices and priorities outlined in the President’s Executive Order 14028, “Improving the Nation’s Cybersecurity.” The proposed budget says this specifically includes providing funding to facilitate the ongoing transition to a Zero Trust approach to cybersecurity, per the direction of President Biden's May 12, 2021 Executive Order on "Improving the Nation's Cybersecurity." Also in accordance with that order, various federal departments and agencies have been taking steps to enhance public sector and critical infrastructure cybersecurity and to accelerate the adoption of Zero Trust architecture throughout government, and the proposed budget would further support those efforts. Congress has just begun work on the FY 2023 appropriations bills for civilian agencies, so it is unknown what the final funding levels will be for civilian agency cybersecurity.
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 state, local government and education 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. Our Telos ACA offering provides real- and near-real-time intelligence into known and unknown threats to give organizations advanced warning of ransomware and other threats. 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 internet of things ("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 industrial control systems 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 complements 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, particularly the Federal Risk and Authorization Management Program ("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 on March 15, 2022, will require critical infrastructure owners and operators as well as federal agencies to report to the Cybersecurity & Infrastructure Security Agency significant cyber incidents within 72 hours and any ransomware payments made within 24 hours. Telos believes that having to make such disclosures will make organizations even more sensitive to boosting their cybersecurity posture; our Xacta solution will help illuminate their risk profile and our Telos ACA solution will illuminate threats so that they can better understand the issues and address them proactively.
The Securities and Exchange Commission has also proposed new, mandatory cyber risk management and cybersecurity incident reporting requirements for publicly traded companies. Telos believes this will ensure companies take steps to employ a sound cyber risk management strategy based on recognized best practices, such as the National Institute of Standards and Technology Cybersecurity Framework, and Telos solutions will support this.
21
Tab l e of Contents
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.
COVID-19 Pandemic
Despite the pandemic’s resultant shift to teleworking by federal employees and contractors, the government successfully maintained the continuity of services, as did Telos. As the government has developed and implemented its reopening process, and made 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 subsequent surges of COVID-19 variants. 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.
Backlog
We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts. We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers.
Total backlog 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.
Results of Operations
Table MD&A 1: Results of Operations
For the Three Months Ended For the Six Months Ended
June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021
(in thousands)
Revenue $ 55,791 53,644 105,951 109,402
Cost of sales 34,862 31,110 66,151 72,398
Gross profit 20,929 22,534 39,800 37,004
Gross margin 37.5 % 42.0 % 37.6 % 33.8 %
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
Selling, general and administrative expenses as percentage of revenue 59.3 % 74.6 % 63.0 % 62.1 %
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)
Company Results
We generate revenue from the delivery of product and services to our customers. The discussion of material changes in our net revenue should be read in conjunction with the subsequent discussion of changes in our consolidated cost of sales and our business segment results of operations. Cost of sales, for both services and products, consists of material, labor, subcontracting costs and an allocation of indirect costs.
22
Tab l e of Contents
Three Months Ended June 30, 2022 Compared with Three Months Ended June 30, 2021
Revenue increased by 4.0% to $55.8 million for the second quarter of 2022, from $53.6 million for the same period in 2021. Services revenue increased by $1.3 million, or 2.6%, during the second quarter of 2022 compared to the same period in 2021. The increase in services revenue was primarily due to sales offerings within Secure Networks. Product revenue increased $0.9 million, or 19.0%, during the second quarter of 2022 compared to the same period in 2021. The increase in product revenue was primarily due to various product delivery within Security Solutions. Due to the various solution offerings within the business groups, sales may vary from period to period according to the solution mix and timing of deliverables for a particular period.
Cost of sales increased by 12.1% to $34.9 million for the second quarter of 2022, from $31.1 million for the same period in 2021, as a result of increased revenue. The change in cost of sales is directly driven by the change in mix and nature of the programs. Cost of sales for Security Solutions decreased to $14.4 million for the second quarter of 2022 from $15.0 million for the same period in 2021. While the cost of sales decreased between periods, the cost of sales as a percentage of revenue remained at 46.7%. Cost of sales for Secure Networks increased to $20.5 million for the second quarter of 2022 from $16.1 million for the same period in 2021. Likewise, cost of sales as a percentage of revenue increased to 82.0% from 75.0%.
Gross profit decreased by 7.1% to $20.9 million for the second quarter of 2022 from $22.5 million for the same period in 2021. Gross margin decreased to 37.5% for the second quarter of 2022 from 42.0% for the same period in 2021, due to various changes in the mix of contracts within each of Security Solutions and Secure Networks, as well as the relative weighting of revenue between these segments.
Selling, general, and administrative (“SG&A”) expense decreased by 17.3% to $33.1 million for the second quarter of 2022, from $40.0 million for the same period in 2021, primarily attributable to a decrease in stock-based compensation by $6.6 million, offset by an increase in labor costs by $0.5 million.
Operating loss was $12.2 million for the second quarter of 2022, compared to $17.5 million for the same period in 2021, primarily due to a decrease in SG&A expenses partially offset by a decrease in gross profit in the second quarter of 2022 as mentioned above.
There were no significant changes in interest expense, and other income and expenses between the comparable periods.
The slight increase in the income tax provision for the second quarter of 2022 compared to the same period in 2021 is based on the estimated annual effective tax rate applied to the pretax loss incurred for the quarter plus discrete tax items, based on our expectation of pretax loss for the fiscal year.
Net loss was $12.3 million for the second quarter of 2022, compared to $17.6 million for the same period in 2021, primarily due to a decrease in SG&A expenses partially offset by a decrease in gross profit in the second quarter of 2022 as mentioned above.
Six Months Ended June 30, 2022 Compared with Six Months Ended June 30, 2021
Revenue decreased by 3.2% to $106.0 million during the six months ended June 30, 2022, from $109.4 million for the same period in 2021. Services revenue decreased by $2.7 million, or 2.7%, during the six months ended June 30, 2022 compared to the same period in 2021. Product revenue also decreased by $0.8 million, or 9.2%, during the six months ended June 30, 2022 compared to the same period in 2021. The decrease in revenue was attributable to the impact of certain projects nearing their completion within Secure Networks.
Cost of sales decreased by 8.6% to $66.2 million for the six months ended June 30, 2022, from $72.4 million for the same period in 2021. Cost of sales for Security Solutions decreased to $26.3 million for the six months ended June 30, 2022, from $28.6 million for the same period in 2021. In addition, cost of sales as a percentage of revenue decreased to 45.5% from 51.8%. Cost of sales for Secure Networks decreased to $39.9 million for the six months ended June 30, 2022 from $43.8 million for the same period in 2021. While the costs of sales decreased between periods, the cost of sales as a percentage of revenue increased to 82.8% from 80.7%. The overall decrease in cost of sales was due to various changes in the mix of contracts within each of Security Solutions and Secure Networks, and winding down of lower-margin projects.
Gross profit increased by 7.6% to $39.8 million for the six months ended June 30, 2022, from $37.0 million for the same period in 2021. Gross margin increased to 37.6% for the six months ended June 30, 2022 from 33.8% for the same period in 2021, due to a change in the mix of contracts within each of Security Solutions and Secure Networks, as well as the relative weighting of revenue between Security Solutions and Secure Networks.
SG&A expense decreased by 1.9% to $66.7 million for the six months ended June 30, 2022, from $68.0 million for the same period in 2021, primarily attributable to a decrease in stock-based compensation by $7.0 million, offset by the increases in labor costs by $4.8 million and outside services by $0.9 million.
23
Tab l e of Contents
Operating loss was $26.9 million for the six months ended June 30, 2022, compared to $31.0 million for the same period in 2021, primarily due to the increase in gross profit and decrease in SG&A expenses in 2022 compared with the same period in the prior year as mentioned above.
Other expense of $1.0 million for the six months ended June 30, 2021, was attributable to an accrual for a litigation settlement agreement, with no similar cost in 2022. There was no significant change in interest expense between comparable periods.
The slight increase in the income tax provision for the six months ended June 30, 2022 compared to the same period in 2021 is based on the estimated annual effective tax rate applied to the pretax loss incurred for the six months period plus discrete tax items, based on our expectation of pretax loss for the fiscal year.
Net loss was $27.3 million for the six months ended June 30, 2022, compared to $32.4 million for the same period in 2021, primarily attributable to the increase in gross profit and decreases in certain SG&A and other expenses as mentioned above.
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.
Table MD&A 2: Security Solutions Segment - Financial Results
For the Three Months Ended For the Six Months Ended
June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021
(in thousands)
Revenue $ 30,819 $ 32,236 $ 57,738 $ 55,066
Gross profit $ 16,433 $ 17,188 $ 31,485 $ 26,515
Gross margin 53 % 53 % 55 % 48 %
For the three months ended June 30, 2022, Security Solutions' revenue decreased by approximately 4% compared to the same period in 2021. This was driven primarily by a decrease of $2.3 million in services revenue, offset by an increase of $0.9 million in product revenue compared to the same period in 2021. This is primarily due to the decrease in sales offerings for certain projects winding down within the segment's business lines.
Revenue for the six months ended June 30, 2022 increased by approximately 5%, which was primarily driven by an increase of $3.4 million in services revenue compared to the same period in 2021, due to an increase in sales offerings within the segment.
Security Solutions' gross profit for the second quarter of 2022 decreased by $0.8 million or 4% compared to the same period in 2021. With revenue decreased, segment gross margin remained at 53% between comparable periods.
Security Solutions' gross profit for the six months ended June 30, 2022 increased by $5.0 million or 19% compared to the same period in 2021. Likewise, segment gross margin increased to 55% for the six months ended June 30, 2022 from 48% for the same period in 2021. The increase in profitability was due to growth in high margin projects under this segment.
Table MD&A 3: Secure Networks Segment - Financial Results
For the Three Months Ended For the Six Months Ended
June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021
(in thousands)
Revenue $ 24,972 $ 21,408 $ 48,213 $ 54,336
Gross profit $ 4,496 $ 5,346 $ 8,315 $ 10,489
Gross margin 18 % 25 % 17 % 19 %
Secure Networks' revenue for the second quarter of 2022 increased by approximately 17% compared to the same period in 2021. This was driven by an increase of $3.6 million in service revenue due to new awards, timing of significant orders and higher segment offerings on several existing projects.
For the six months ended June 30, 2022, Secure Networks' revenue decreased by 11% compared to the same period in 2021. This was primarily due to the ramping down of certain large projects under our Secure Networks offerings.
Secure Networks' gross profit for the second quarter of 2022, decreased by $0.9 million or 16% compared to the same period in 2021. Segment gross margin decreased to 18% for the second quarter of 2022 from 25% for the same period in 2021. This is due to the various changes in the mix of contracts within the segment and timing of order delivery.
24
Tab l e of Contents
Gross profit for Secure Networks for the six months ended June 30, 2022 decreased by $2.2 million or 21% compared to the same period in 2021, as a result of the decline in year-to-date segment revenue. Secure Networks' gross margin also decreased to 17% for the for the six months ended 2022 from 19% compared to the same period in 2021 due to the sale mix.
Non-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we believe the non-GAAP financial measures of Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), 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. 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. 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 disproportionately 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 do not represent, and should not be considered as, an alternative to net (loss) income as determined by GAAP. We define Enterprise EBITDA as net (loss) income, adjusted for non-operating expense (income), interest expense, provision for (benefit from) income taxes, and depreciation and amortization. We define Adjusted EBITDA as Enterprise EBITDA, adjusted for stock-based compensation expense.
Table MD&A 4: Reconciliation of Net Loss to Enterprise EBITDA and Adjusted EBITDA
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)
Adjustments:
Non-operating (income)/expense (118) (32) (130) 1,022
Interest expense 187 192 377 388
Provision for income taxes 54 13 125 47
Depreciation and amortization 1,505 1,404 2,910 2,764
Enterprise EBITDA (10,661) (16,067) (23,990) (28,201)
Stock-based compensation expense (1)
15,206 21,336 29,504 35,006
Adjusted EBITDA $ 4,545 $ 5,269 $ 5,514 $ 6,805
(1) The stock-based compensation adjustment to EBITDA for the three and six months ended June 30, 2022, is made up of $14.6 million and $27.2 million of stock-based compensation expenses for the awarded RSUs and PRSUs, respectively, and $0.7 million and $2.3 million of other sources of stock-based compensation expense, respectively. The other source of stock-based compensation consist of accrued compensation, which the Company 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. The Company has the right to dictate the form of these payments up until the date at which they are paid. Any change to the expected payment form would result in out of quarter adjustments to this add back to Adjusted EBITDA.
25
Tab l e of Contents
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 that 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), adjusted for non-operating expense (income) and stock-based compensation expense. We define Adjusted EPS as Adjusted Net Income (Loss) divided by the weighted-average number of common shares outstanding for the period.
Table MD&A 5: Reconciliation of Net Loss to Adjusted Net Income and Adjusted EPS
For the Three Months Ended For the Six Months Ended
June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021
Adjusted Net Income/(Loss) Adjusted Per Share Adjusted Net Income/(Loss) Adjusted Per Share Adjusted Net Income/(Loss) Adjusted Per Share Adjusted Net Income/(Loss) Adjusted Per Share
(in thousands, except per share data)
Reported GAAP measure $ (12,289) $ (0.18) $ (17,644) $ (0.26) $ (27,272) $ (0.40) $ (32,422) $ (0.49)
Adjustments:
Non-operating (income)/ expense (118) — (32) — (130) — 1,022 0.02
Stock-based compensation expense (2)
15,206 0.22 21,336 0.32 29,504 0.43 35,006 0.53
Adjusted non-GAAP measure $ 2,799 $ 0.04 $ 3,660 $ 0.06 $ 2,102 $ 0.03 $ 3,606 $ 0.06
Weighted-average shares of common stock outstanding 67,876 66,616 67,717 65,621
(2) The stock-based compensation adjustment to net loss for the three and six months ended June 30, 2022, is made up of $14.6 million and $27.2 million of stock-based compensation expense for the awarded RSUs and PRSUs, respectively, and $0.7 million and $2.3 million of other sources of stock-based compensation expense, respectively. The other source of stock-based compensation consist of accrued compensation, which the Company 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. The Company has the right to dictate the form of these payments up until the date at which they are paid. Any change to the expected payment form would result in out-of-quarter adjustments to this add back to Adjusted Net Income/(Loss).
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.
Table MD&A 6: Free Cash Flow
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 cash flows provided by/(used in) operating activities $ 7,883 $ 3,528 $ 8,132 $ (3,354)
Adjustments:
Purchase of property and equipment (95) (590) (641) (1,070)
Capitalized software development costs (2,339) (1,498) (5,134) (3,663)
Free cash flow $ 5,449 $ 1,440 $ 2,357 $ (8,087)
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 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 Enterprise EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow differently than we do, which limits their 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/ (used in) 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.
26
Tab l e of Contents
Liquidity and Capital Resources
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, $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 10 – Purchase of Telos ID Non- controlling I nteres ts ), and $21.0 million to repay our outstanding senior term loan and subordinated debt .
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 900,970 outstanding warrants for our common stock held by EnCap fund holders. Further, on July 30, 2021, we used approximately $5.9 million of the net proceeds to acquire the assets of DFT (see Note 9 – Acquisition ). We intend to use the remaining net proceeds of the IPO and the follow-on offering for general corporate purposes.
Our overall financial position and liquidity are strong. Our working capital was $130.4 million and $140.8 million as of June 30, 2022, and December 31, 2021, 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.
As of June 30, 2022, we had a cash and cash equivalent balance of $122.6 million, compared to $126.6 million at December 31, 2021. This balance gives us the flexibility for capital deployment while maintaining our focus on 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.
Cash provided by operating activities was $8.1 million for the six months ended June 30, 2022, compared to cash used in operating activities of $3.4 million for the same period in 2021. Cash provided by or used in operating activities is primarily driven by the Company’s operating income (loss), the timing of receipt of customer payments, the timing of our 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.
Cash used in investing activities was approximately $5.8 million and $4.7 million for the six months ended June 30, 2022 and 2021, respectively, primarily due to software development costs of $5.1 million and $3.7 million for the six months ended June 30, 2022 and 2021, respectively, and the purchase of property and equipment.
Cash used in financing activities was $6.2 million for the six months ended June 30, 2022, compared to cash provided by financing activities of $33.0 million for the same period in 2021. This is primarily attributable to payments under finance leases for both periods, payment of tax withholding related to a net share settlement of an equity awards of $2.9 million in the first quarter of 2022 and the repurchase of common stock of $2.6 million under the share repurchase program described below in the second quarter of 2022. By contrast, in 2021 there was a cash inflow from the follow-on offering that generated $64.3 million of net proceeds, reduced by $2.4 million of final distributions to the Class B Members of Telos ID in the first quarter, $26.9 million used to repurchase the outstanding warrants and $1.3 million to repurchase the common stock held by EnCap fund holders.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates, judgments, and assumptions that affect the amounts reported. Actual results could differ from those estimates. The 2021 Form 10-K, as filed with the SEC on March 28, 2022, includes a summary of critical accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of assets, liabilities, revenues, or expenses during the six months ended June 30, 2022.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
None.
27
Tab l e of Contents
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.