What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2022-11-09 compared with 2022-08-09 · 139 added, 157 removed, 176 unchanged (63% of the section changed)

19 unchanged sentences

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.

Our security solutions span across these three domains.

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.

Security Solutions, which focuses on cybersecurity, cloud and identity solutions, 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.

1 unchanged sentence

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.

Our identity solutions deliver digital identity, biometric, and nationwide enrollment services and address Know Your Customer and identity management challenges for enterprises working within regulated and critical infrastructure environments.

• Information Assurance

3 unchanged sentences

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.

Tab l e of Contents

• Secure Communications:

3 unchanged sentences

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 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.

◦ Telos Automated Message Handling System (“AMHS”):

2 unchanged sentences

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.

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.

offering identity trust and digital services through IDTrust360 ® – an enterprise-class digital identity risk platform for extending flexible hybrid cloud identity services.

This platform is enabled for mobile, 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.

9 unchanged sentences

deployable comms;

innovation and digital transformation;

robotic process automation and other digital transformation capabilities;

service desk;

5 unchanged sentences

• 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.

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

Our diverse portfolio of network management and defense capabilities addresses common and uncommon requirements in many industries and disciplines, ranging from the military and government agencies to Fortune 500 companies.

Business Environment

2 unchanged sentences

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.

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.

Congress could not agree on fiscal year ("FY") 2023 appropriations legislation before the start of the fiscal year on October 1, 2022.

As a result, the entire federal government is currently operating under the terms of a continuing resolution ("CR"), which only permits agencies to spend at FY 2022 appropriations levels without any adjustments for the dramatic increase in inflation we have seen over the past year.

Moreover, federal departments and agencies are generally precluded from moving forward on new contract starts or accelerating current projects while they are funded by a CR.

The current CR runs through December 16, 2022, and it is not clear at this time whether Congress will be able to come to an agreement on appropriations legislation for FY 2023 by then or will have to pass another CR, possibly lasting into January or February 2023.

Such continued delays in finalizing FY 2023 appropriations could, in turn, impact future planning by Telos and our government customers.

The President’s FY 2023 budget request called for approximately 4% more defense spending than was provided for FY 2022.

However, this proposed FY 2023 budget was developed before Russia invaded Ukraine and did not include expenditures related to that ongoing event.

The proposed FY 2023 budget also assumed an inflation rate for DoD of 2.2%, which Pentagon officials subsequently acknowledged would need to be adjusted higher.

There is significant congressional support for boosting defense spending further to account for these factors and other needs, as demonstrated by the House and Senate versions of the FY 2023 National Defense Authorization Act, which call for 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 December, at the earliest.

The proposed FY 2023 budget also called for an increase in federal civilian agency (non-defense) cybersecurity funding of nearly 11%.

An exception to this is the new four-year, $1 billion State and Local Cybersecurity Grant program, which has already been appropriated and the first year’s funding is now available.

Looking ahead to next year, the Office of Management and Budget ("OMB") has already given federal departments and agencies guidance for cybersecurity priorities to include in their FY 2024 proposed budgets.

OMB has directed that agencies prioritize accelerated adoption of the cloud, IT modernization, further private sector collaboration for sector risk management responsibilities and ensuring adequate cyber threat information sharing, and supply chain risk management.

These priorities align with the solutions Telos has been developing and bringing to market for the past several years.

For example, Xacta, our flagship offering, continues to set the standard for innovative capabilities in managing cyber risk and automating continuous compliance in on-premises, cloud, and hybrid environments.

Our cloud practice area includes cloud migration, CloudSecOps, and cloud security compliance to accelerate IT modernization for business and government.

Our Telos ACA platform combines decades of information security experience with an extensive background in cyber intelligence to defend enterprises against advanced cyber threats.

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.

In recent years, continuing and increasingly damaging ransomware and other cyberattacks against federal, state and local governments, K-12 and higher education, 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.

Ransomware remains arguably the most severe cyber threat to enterprises in the commercial, state, and 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.

Our Telos ACA offering provides real- and near-real-time intelligence into known and unknown threats to give organizations advance 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.

Energy, utilities, financial services, and healthcare 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.

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.

These capabilities are increasingly important, as threat actors continue to breach enterprise networks in spite of access management systems such as virtual private networks and multi-factor authentication.

Telos Ghost creates an additional layer of defense against intruders by hiding critical records, information, and applications as well as their users in an anonymous undiscoverable network.

Adversaries cannot see them, so they cannot hack them.

This also makes Telos Ghost a robust component in a Secure Access Service Edge or Zero Trust Network Access security architecture.

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

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.

For example, Xacta supports Federal Risk and Authorization Management Program ("FedRAMP") authorization, allowing all process participants to collaborate within the same Xacta application to attain a FedRAMP Authority to Operate.

Xacta is also a trailblazer in deploying 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 DoD’s emerging Cybersecurity Maturity Model Certification ("CMMC") program is intended to ensure that members of the defense supply chain are applying sound cybersecurity practices in order to protect sensitive unclassified information.

Because CMMC 2.0 is still an evolving standard, the flexible Xacta for CMMC offering enables Defense Industrial Base customers to conduct preliminary CMMC compliance audits that assess the maturity level required today as well as build a roadmap to future maturity level requirements.

Telos is also a Cyber AB Registered Provider Organization ™ , authorized by The Cyber AB to provide consulting services to government contractors and other companies in preparation for their CMMC assessments.

Finally, CISOs with today’s cost-conscious enterprises are under increasing pressure to provide evidence that their security strategies yield a return on investment.

Xacta’s latest cyber risk quantification capabilities meet this need, allowing our customers to calculate inherent risk likelihood, impact, and criticality, shown in a graphic display that illustrates real-time risk posture and visualizes progress over time.

In addition, customers can also define their own financial loss formula for customer-specific risk analysis in dollar amounts.

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.

We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts.

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 is a useful measure in developing 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.

4 unchanged sentences

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.

Most of our customers fund contracts on the 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.

Financial Overview

TSA PreCheck ® Update

On October 18, 2022, TSA issued an authority to operate to Telos ID for Telos’ PreCheck ® System.

With TSA approval, Telos is providing its TSA PreCheck ® enrollment services for a trial period to a limited population of applicants in order to validate systems and processes in advance of its full implementation as an authorized TSA PreCheck ® enrollment provider.

Once Telos successfully completes its trial period to the satisfaction of TSA, Telos will launch its services to the public more widely.

Telos continues to anticipate this launch will occur in calendar year 2022.

Results of Operations

1 unchanged sentence

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

For the Three Months Ended For the Nine Months Ended

September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021

(in thousands)

4 unchanged sentences

Selling, general and administrative expenses 28,614 29,965 95,314 97,935

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 45.0 % 43.4 % 56.2 % 54.9 %

3 unchanged sentences

Loss before income taxes (7,332) (5,263) (34,479) (37,638)

Provision for income taxes (54) (13) (125) (47)

(Provision for)/benefit from income taxes (8) 41 (133) (6)

Net loss $ (7,340) $ (5,222) $ (34,612) $ (37,644)

Company Results

We generate revenue from the delivery of product and services to our customers.

We generate revenue from the delivery of products 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.

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.

Three Months Ended September 30, 2022, Compared with Three Months Ended September 30, 2021

For the three months ended September 30, 2022, revenue decreased by $5.4 million, or 7.8%, compared to the same period in 2021.

The decrease in revenue was primarily due to a large program that ended in 2021 within Security Solutions and the expected wind-down of large programs within Secure Networks.

Cost of sales decreased by $1.5 million, or 3.3%, for the third quarter of 2022 compared to the same period in 2021, primarily as a result of decreased revenue, reduced costs across the Secure Networks portfolio, and revenue mix, offset by increased investment in a single large program in Security Solutions.

Gross profit decreased by $3.9 million, or 15.8%, in the third quarter of 2022 compared to the same period in 2021.

Gross margin decreased from 36.1% to 32.9% for the third quarter of 2022 compared to the same period in 2021.

This is primarily due to higher investment in a single large program in Security Solutions, offset by higher gross margins in Secure Networks due to broad-based margin performance across the portfolio, and a slight shift in revenue mix towards Security Solutions.

Selling, general, and administrative (“SG&A”) expenses decreased by $1.4 million, or 4.5%, in the third quarter of 2022 compared to the same period in 2021, primarily attributable to the cost actions, offset by an increase in stock-based compensation.

Operating loss was $7.7 million for the third quarter of 2022, compared to $5.1 million for the same period in 2021, primarily due to the decrease in gross profit in the third quarter of 2022, as mentioned above, offset by the decrease in SG&A expenses.

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.

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.

The change in the income tax provision for the third 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 $7.3 million for the third quarter of 2022, compared to $5.2 million for the same period in 2021, primarily due to the decrease in gross profit, offset by the decrease in SG&A expenses.

Nine Months Ended September 30, 2022, Compared with Nine Months Ended September 30, 2021

Revenue decreased by $8.8 million, or 5.0%, during the nine months ended September 30, 2022 compared to the same period in 2021.

The decrease is the result of the end of a large program in 2021 in Security Solutions and the expected wind-down of large programs in Secure Networks, offset by other increases across the portfolio.

Cost of sales decreased by $7.7 million, or 6.6%, for the nine months ended September 30, 2022, compared to the same period in 2021, primarily as a result of decreased revenue, reduced costs across the portfolio, and revenue mix.

Gross profit decreased by $1.1 million, or 1.8%, for the nine months ended September 30, 2022, compared to the same period in 2021.

Gross margin increased from 34.7% to 35.8% for the comparable periods due to broad-based margin performance across the portfolio and a shift in revenue mix toward Security Solutions.

SG&A expense decreased by 2.7% to $95.3 million for the nine months ended September 30, 2022, from $97.9 million for the same period in 2021, primarily due to reduced stock-based compensation.

Operating loss was $34.6 million for the nine months ended September 30, 2022, compared to $36.1 million for the same period in 2021, primarily due to the decreases in SG&A expense, offset by the decrease in gross profit described above.

Other expense of $1.0 million for the nine months ended September 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.

The increase in the income tax provision for the nine months ended September 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 nine months plus discrete tax items, based on our expectation of pretax loss for the fiscal year.

Net loss was $34.6 million for the nine months ended September 30, 2022, compared to $37.6 million for the same period in 2021, primarily attributable to the decrease in SG&A expenses coupled by the change in other expenses mentioned above, offset by the decrease in gross profit.

Segment Results

3 unchanged sentences

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

For the Three Months Ended For the Nine Months Ended

September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021

(in thousands)

2 unchanged sentences

Gross margin 48.0 % 56.5 % 52.2 % 51.4 %

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.

For the three months ended September 30, 2022, Security Solutions' revenue decreased by $2.1 million, or 6.1%, compared to the same period in 2021.

The reduction was primarily attributable to a large program that ended in 2021 and a decrease in another large program within the portfolio.

Security Solutions' gross profit for the third quarter of 2022 decreased by $3.9 million, or 20.2%, compared to the same period in 2021.

Gross margin for the quarter decreased from 56.5% in 2021 to 48.0% in 2022 due to higher investment in a single large program and revenue mix shift within the portfolio.

Revenue for the nine months ended September 30, 2022, slightly increased by $0.6 million, or 0.6%, compared to the same period in 2021.

This is due to broad based increases across the segment portfolio, offset by a decrease in revenue from a program that ended in 2021.

Security Solutions' gross profit for the nine months ended September 30, 2022, increased by $1.0 million, or 2.2%, compared to the same period in 2021.

Segment gross margin also increased from 51.4% in 2021 to 52.2% in 2022.

The segment's profitability improvement was primarily due to a revenue mix shift within the business, along with some minor margin improvements in certain portions of the portfolio.

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

For the Three Months Ended For the Nine Months Ended

September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021

(in thousands)

2 unchanged sentences

Gross margin 17.2 % 15.6 % 17.2 % 17.9 %

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.

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.

Secure Networks' revenue for the third quarter of 2022 decreased by $3.3 million, or 9.5%, compared to the same period in 2021.

This was driven by the expected wind-down of large programs within the portfolio.

While revenue decreased in the third quarter of 2022, Secure Networks' gross profit remained at approximately $5.4 million during the comparable periods.

Segment gross margin increased between comparable periods from 15.6% in 2021 to 17.2% in 2022 due to broad-based margin performance across the portfolio.

For the nine months ended September 30, 2022, Secure Networks' revenue decreased by $9.4 million, or 10.6%, compared to the same period in 2021, due to the expected wind-down of large programs.

Gross profit for Secure Networks for the nine months ended September 30, 2022, decreased by $2.2 million, or 13.7%, compared to the same period in 2021, primarily as a result of the decline in year-to-date segment revenue.

Segment gross margin decreased between comparable periods from 17.9% in 2021 to 17.2% in 2022 due to minor margin reductions across the portfolio.

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.

In addition to our results determined in accordance with GAAP, we believe the non-GAAP financial measures of Enterprise EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin, 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.

4 unchanged sentences

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.

Enterprise EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin

Enterprise EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin 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 and net (loss) income margin, 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.

We define Adjusted EBITDA margin as adjusted EBITDA as a percentage of total revenue.

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

Reconciliation of Net Loss to Enterprise EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin

For the Three Months Ended For the Nine Months Ended

September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021

Amount Margin Amount Margin Amount Margin Amount Margin

(in thousands)

2 unchanged sentences

Interest expense 181 0.3 % 195 0.3 % 558 0.3 % 583 0.3 %

Provision for income taxes 54 13 125 47

Provision for/(benefit from) income taxes 8 — % (41) — % 133 0.1 % 6 — %

Depreciation and amortization 1,517 2.4 % 1,459 2.1 % 4,427 2.6 % 4,223 2.4 %

3 unchanged sentences

Adjusted EBITDA $ 8,569 13.5 % $ 8,743 12.7 % $ 14,083 8.3 % $ 15,547 8.7 %

(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.

(1) The stock-based compensation adjustment to EBITDA for the three and nine months ended September 30, 2022, is made up of $15.0 million and $42.2 million, respectively, of stock-based compensation expenses for the awarded RSUs and PRSUs, and $(0.3) million and $2.0 million, respectively, of other sources of stock-based compensation (adjustment)/expense.

The other source of stock-based compensation consists 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.

Tab l e of Contents

Any change to the expected payment form would result in a change of estimate that would add back to Adjusted EBITDA.

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.

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 an alternatives to net income (loss) and earnings (loss) per share, 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.

2 unchanged sentences

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

For the Three Months Ended For the Nine Months Ended

September 30, 2022 September 30, 2021 September 30, 2022 September 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

6 unchanged sentences

Weighted-average shares of common stock outstanding 67,493 66,755 67,641 65,999

(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.

(2) The stock-based compensation adjustment to net loss for the three and nine months ended September 30, 2022, is made up of $15.0 million and $42.2 million, respectively, of stock-based compensation expenses for the awarded RSUs and PRSUs, and $(0.3) million and $2.0 million, respectively, of other sources of stock-based compensation (adjustment)/expense.

The other source of stock-based compensation consists 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).

Any change to the expected payment form would result in a change in estimate that would add back to Adjusted Net Income/(Loss).

Free Cash Flow

3 unchanged sentences

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

For the Three Months Ended For the Nine Months Ended

September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021

(in thousands)

Net cash flows provided by/(used in) operating activities $ 7,883 $ 3,528 $ 8,132 $ (3,354)

Net cash flows provided by operating activities $ 11,986 $ 12,991 $ 20,118 $ 9,637

Purchase of property and equipment (174) (575) (815) (1,645)

1 unchanged sentence

Free cash flow $ 8,366 $ 9,407 $ 10,723 $ 1,320

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.

Enterprise EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow each 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, Enterprise EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net Income (Loss), Adjusted EPS and Free Cash Flow each 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 EBITDA Margin, 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 EBITDA Margin, Adjusted Net Income (Loss), Adjusted EPS nor Free Cash Flow should be considered as a replacement for net income (loss), net income (loss) margin, earnings (loss) 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.

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 .

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 Interests ), 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.

5 unchanged sentences

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.

Our working capital was $130.6 million and $140.8 million as of September 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.

As of September 30, 2022, we had a cash and cash equivalent balance of $125.3 million, compared to $126.6 million on 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.

Cash provided by operating activities was $20.1 million for the nine months ended September 30, 2022, compared to cash used in operating activities of $9.6 million for the same period in 2021.

Cash provided by or used in operating activities is primarily driven by the Company’s operating 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 $9.4 million and $14.2 million for the nine months ended September 30, 2022, and 2021, respectively, primarily due to software development costs of $8.6 million and $6.7 million for the nine months ended September 30, 2022, and 2021, respectively, and the purchase of property and equipment.

In addition, in 2021, $5.9 million was paid in cash for the acquisition completed in July 2021 (see Note 9 – Acquisition ).

Cash used in financing activities was $11.8 million for the nine months ended September 30, 2022, compared to cash provided by financing activities of $32.7 million for the same period in 2021.

This is primarily attributable to payments under finance leases for both periods, payments of tax withholding related to a net share settlement of equity awards of $3.1 million in 2022, and the repurchase of common stock of $7.6 million in 2022 under the share repurchase program (see Note 13 – Share Rep urchases ).

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

3 unchanged sentences

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.

Quantitative and Qualitative Disclosures about Market Risk

Tab l e of Contents

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis