TELOS CORP 10-Q

Item 1. Financial Statements. Telos Corporation Consolidated Statements of Operations (Unaudited) For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 (in thousands, except per share amounts) Revenue – services $ 55,305 $ 62,955 $ 153,683 $ 164,016 Revenue – products 8,288 6,026 15,861 14,367 Total revenue 63,593 68,981 169,544 178,383 Cost of sales – services 36,746 40,137 97,913 108,236 Cost of sales – products 5,902 3,967 10,886 8,266 Total cost of sales 42,648 44,104 108,799 116,502 Gross profit 20,945 24,877 60,745 61,881 Selling, general and administrative expenses: Sales and marketing 3,042 5,363 13,035 14,233 Research and development 3,981 4,863 13,900 14,250 General and administrative 21,591 19,739 68,379 69,452 Total selling, general and administrative expenses 28,614 29,965 95,314 97,935 Operating loss ( 7,669 ) ( 5,088 ) ( 34,569 ) ( 36,054 ) Other income/(expense) 518 20 648 ( 1,001 ) Interest expense ( 181 ) ( 195 ) ( 558 ) ( 583 ) Loss before income taxes ( 7,332 ) ( 5,263 ) ( 34,479 ) ( 37,638 ) (Provision for)/benefit from income taxes ( 8 ) 41 ( 133 ) ( 6 ) Net loss $ ( 7,340 ) $ ( 5,222 ) $ ( 34,612 ) $ ( 37,644 ) Net loss per share: Basic $ ( 0.11 ) $ ( 0.08 ) $ ( 0.51 ) $ ( 0.57 ) Diluted $ ( 0.11 ) $ ( 0.08 ) $ ( 0.51 ) $ ( 0.57 ) Weighted average shares outstanding: Basic 67,493 66,755 67,641 65,999 Diluted 67,493 66,755 67,641 65,999 See accompanying notes to unaudited consolidated financial statements. 3 Table of Contents Telos Corporation Consolidated Statements of Comprehensive Loss (Unaudited) 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 loss $ ( 7,340 ) $ ( 5,222 ) $ ( 34,612 ) $ ( 37,644 ) Other comprehensive loss, net of tax: Foreign currency translation adjustments ( 21 ) ( 13 ) ( 3 ) ( 40 ) Comprehensive loss $ ( 7,361 ) $ ( 5,235 ) $ ( 34,615 ) $ ( 37,684 ) See accompanying notes to unaudited consolidated financial statements. 4 Table of Contents Telos Corporation Consolidated Balance Sheets (Unaudited) September 30, 2022 December 31, 2021 (in thousands, except per share and share data) Assets: Cash and cash equivalents $ 125,332 $ 126,562 Accounts receivable, net 50,983 59,844 Inventories, net 4,676 1,247 Prepaid expenses 6,069 3,329 Other current assets 930 732 Total current assets 187,990 191,714 Property and equipment, net 5,128 6,088 Finance lease right-of-use assets, net 8,137 9,053 Operating lease right-of-use assets 456 852 Goodwill 17,922 17,922 Intangible assets, net 26,858 19,199 Other assets 908 1,253 Total assets $ 247,399 $ 246,081 Liabilities and Stockholders' Equity: Liabilities: Accounts payable and other accrued liabilities $ 37,583 $ 34,548 Accrued compensation and benefits 8,941 6,557 Contract liabilities 6,952 6,381 Finance lease obligations, current portion 1,558 1,461 Operating lease obligations, current portion 408 564 Other current liabilities 1,972 1,430 Total current liabilities 57,414 50,941 Finance lease obligations, non-current portion 11,660 12,840 Operating lease liabilities, non-current portion 108 388 Deferred income taxes 748 723 Other liabilities 436 935 Total liabilities 70,366 65,827 Commitments and contingencies ( Note 19 ) Stockholders’ equity Common stock, $ 0.001 par value, 250,000,000 shares authorized, 67,300,099 shares and 66,767,450 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively 106 105 Additional paid-in capital 398,546 367,153 Accumulated other comprehensive loss ( 30 ) ( 27 ) Accumulated deficit ( 221,589 ) ( 186,977 ) Total stockholders’ equity 177,033 180,254 Total liabilities and stockholders’ equity $ 247,399 $ 246,081 See accompanying notes to unaudited consolidated financial statements. 5 Table of Contents Telos Corporation Consolidated Statements of Cash Flows (Unaudited) For the Nine Months Ended September 30, 2022 September 30, 2021 (in thousands) Cash flows from operating activities: Net loss $ ( 34,612 ) $ ( 37,644 ) Adjustments to reconcile net loss to cash flows provided by operating activities: Stock-based compensation 44,225 47,378 Depreciation and amortization 4,427 4,223 Deferred income tax provision 25 28 Accretion of discount on acquisition holdback 36 7 Loss on disposal of fixed assets 2 9 Provision for doubtful accounts 97 7 Recovery from inventory obsolescence ( 108 ) ( 2 ) Changes in other operating assets and liabilities Accounts receivable 8,763 ( 18,852 ) Inventories ( 3,321 ) 1,288 Prepaid expenses, other current assets, and other assets ( 2,486 ) ( 3,259 ) Accounts payable and other accrued payables 2,635 15,742 Accrued compensation and benefits 371 ( 519 ) Contract liabilities 571 1,579 Other current liabilities and other liabilities ( 507 ) ( 348 ) Net cash provided by operating activities 20,118 9,637 Cash flows from investing activities: Capitalized software development costs ( 8,580 ) ( 6,672 ) Purchases of property and equipment ( 815 ) ( 1,645 ) Cash paid for acquisition — ( 5,925 ) Net cash used in investing activities ( 9,395 ) ( 14,242 ) Cash flows from financing activities: Payments under finance lease obligations ( 1,083 ) ( 993 ) Payment of tax withholding related to net share settlement of equity awards ( 3,135 ) — Repurchase of common stock ( 7,603 ) ( 1,251 ) Proceeds from issuance of common stock, net of issuance costs — 64,269 Repurchase of outstanding warrants — ( 26,894 ) Distributions to Telos ID Class B member – non-controlling interest — ( 2,436 ) Net cash (used in)/provided by financing activities ( 11,821 ) 32,695 Net change in cash, cash equivalents, and restricted cash ( 1,098 ) 28,090 Cash, cash equivalents and restricted cash, beginning of period 126,562 106,045 Cash, cash equivalents and restricted cash, end of period $ 125,464 $ 134,135 See accompanying notes to unaudited consolidated financial statements. 6 Table of Contents Telos Corporation Consolidated Statements of Changes in Stockholders' Equity (Unaudited) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income/(Loss) Accumulated Deficit Total Stockholders’ Equity Shares Amount (in thousands) Balance at June 30, 2022 67,594 $ 106 $ 388,464 $ ( 9 ) $ ( 214,249 ) $ 174,312 Net loss — — — — ( 7,340 ) ( 7,340 ) Foreign currency translation loss — — — ( 21 ) — ( 21 ) Stock-based compensation expense, excluding accrued compensation — — 15,012 — — 15,012 Repurchase of common stock ( 499 ) — ( 4,681 ) — — ( 4,681 ) RSUs vested, net of shares withheld to cover tax withholding 205 — ( 249 ) — — ( 249 ) Balance at September 30, 2022 67,300 $ 106 $ 398,546 $ ( 30 ) $ ( 221,589 ) $ 177,033 Balance at June 30, 2021 66,635 $ 105 $ 341,928 $ 17 $ ( 176,265 ) $ 165,785 Net loss — — — — ( 5,222 ) ( 5,222 ) Foreign currency translation loss — — — ( 13 ) — ( 13 ) Stock-based compensation expense — — 12,372 — — 12,372 Balance at September 30, 2021 66,635 $ 105 $ 354,300 $ 4 $ ( 181,487 ) $ 172,922 Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income/(Loss) Accumulated Deficit Total Stockholders’ Equity Shares Amount (in thousands) Balance at December 31, 2021 66,767 $ 105 $ 367,153 $ ( 27 ) $ ( 186,977 ) $ 180,254 Net loss — — — — ( 34,612 ) ( 34,612 ) Foreign currency translation loss — — — ( 3 ) — ( 3 ) Stock-based compensation expense, excluding accrued compensation — — 42,212 — — 42,212 Repurchase of common stock ( 859 ) — ( 7,683 ) — — ( 7,683 ) RSUs vested, net of shares withheld to cover tax withholding 1,392 1 ( 3,136 ) — — ( 3,135 ) Balance at September 30, 2022 67,300 $ 106 $ 398,546 $ ( 30 ) $ ( 221,589 ) $ 177,033 Balance at December 31, 2020 64,625 $ 103 $ 270,800 $ 44 $ ( 143,843 ) $ 127,104 Net loss — — — — ( 37,644 ) ( 37,644 ) Issuance of common stock 2,050 2 64,267 — — 64,269 Foreign currency translation loss — — — ( 40 ) — ( 40 ) Stock-based compensation expense — — 47,378 — — 47,378 Repurchase of outstanding warrants — — ( 26,894 ) — — ( 26,894 ) Repurchase of common stock ( 40 ) — ( 1,251 ) — — ( 1,251 ) Balance at September 30, 2021 66,635 $ 105 $ 354,300 $ 4 $ ( 181,487 ) $ 172,922 See accompanying notes to unaudited consolidated financial statements. 7 Table of Contents Telos Corporation Notes to the Unaudited Consolidated Financial Statements 1. ORGANIZATION Telos Corporation, together with its subsidiaries (collectively, the "Company," "we," "our" or "Telos"), a Maryland corporation, is a leading provider of cyber, cloud and enterprise security solutions for the world's most security-conscious organizations. We own all of the issued and outstanding shares of Xacta Corporation, a subsidiary that develops, markets and sell government-validated secure enterprise solutions to government and commercial customers. We own the issued and outstanding share capital of Ubiquity.com, Inc., a holding company for Xacta Corporation. We also have a 100% ownership interest in Telos Identity Management Solutions, LLC ("Telos ID"), Teloworks, Inc., and Telos APAC Pte. Ltd. 2. SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The accompanying unaudited consolidated financial statements include the accounts of Telos Corporation and its subsidiaries (see Note 1 – Organ ization ), all of whose issued and outstanding share capital is wholly-owned directly and indirectly by Telos Corporation. All intercompany transactions have been eliminated in consolidation. (b) Basis of Presentation for Interim Periods Certain information and footnote disclosures normally included for the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted for the interim periods presented. We believe that the unaudited interim financial statements include all adjustments (which are normal and recurring) necessary to state fairly our financial position and the results of operations and cash flows for the periods presented. The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for the year or future periods. The financial statements should be read in conjunction with our audited consolidated financial statements and the notes thereto for the year ended December 31, 2021, included in our Annual Report on Form 10-K for the fiscal year then ended. We have continued to follow the accounting policies set forth in those financial statements. (c) Segment Reporting Operating segments are defined as components of an enterprise for which separate discrete financial information is available and regularly evaluated by the chief operating decision maker (“CODM”), or decision-making group, in deciding how to allocate resources and assess performance. During the fourth quarter of 2021, we reorganized our internal management reporting structure and the financial results evaluated by our CODM; therefore, we changed our operating segments to align with how our CODM currently oversees the business, allocates resources, and evaluates operating performance. As a result of the segment reorganization, we reported two reportable and operating segments: Security Solutions and Secure Networks. The segments enable the alignment of our strategies and objectives and provide a framework for the timely and rational allocation of resources within the lines of business. We eliminate any inter-segment revenues and expenses upon consolidation. Prior period segment information has been recast to reflect the change. The segment reorganization had no impact on previously reported unaudited consolidated financial results. (d) Basis of Comparison – Revision of Previously Issued Interim Financial Statements The Company recorded certain revisions related to the previously issued unaudited condensed consolidated financial statements. The Company considered the errors identified in accordance with the SEC's Staff Accounting Bulletin No. 99 and determined the impact was immaterial to the previously issued condensed consolidated interim financial statements. Nonetheless, the Company corrected these errors when identified in 2021. During the third quarter of 2021, the Company identified out-of-period adjustments on certain revenue and expense classification. Further, we corrected the cash flow presentation to properly reflect the final payment to fully acquire all of the membership interest of Telos ID as financing activities. Further information regarding the misstatements and related revisions are included in Note 18 – Revision of Prior Year Interim Financial Statements to the condensed consolidated financial statements. 8 Table of Contents (e) Use of Estimates Preparing unaudited consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of revenue, expenses, assets, and liabilities and disclosure of contingent assets and liabilities. The Company regularly assesses these estimates; however, actual results could differ from those estimates. We base our estimates on historical experience, currently available information, and various other assumptions that we believe are reasonable under the circumstances. The most significant items involving management estimates include estimates of revenue recognition, allowance for credit losses, allowance for inventory obsolescence, the valuation allowance for deferred tax assets, the provision for income taxes, share-based compensation, contingencies and litigation, and valuation of intangibles and goodwill. The impact of changes in estimates is recorded in the period in which they become known. (f) Software Development Cost (Cloud-computing implementation costs) ASC 350-40 requires hosting arrangements that are service contracts to follow the guidance for internal-use software to determine which implementation costs can be capitalized. As of September 30, 2022, the capitalized implementation costs related to hosting arrangements that were incurred during the application development stage aggregated to $ 0.3 million. These costs are related primarily to the implementation of a new enterprise resource planning system. The capitalized implementation costs will be amortized over the expected term of the arrangement on a straight-line basis. Amortization begins when the component of the hosting arrangement is ready for its intended use after all substantial testing is complete and classified in the same line item on our consolidated statement of operations as the expense for fees for the associated hosting arrangement. (g) Reclassifications Certain reclassifications have been made to prior years' consolidated financial statements to conform to the current year's presentation. The reclassification had no impact on our total assets or liabilities nor on our net loss or stockholders' equity. (h) Recent Accounting Pronouncements Changes to U.S. GAAP are established by the Financial Accounting Standards Board ("FASB") in the form of Accounting Standards Updates ("ASUs") to the FASB's Accounting Standards Codification ("ASC"). We consider the applicability and impact of all recent ASUs. ASUs not listed below were assessed and determined to be not applicable. Accounting Pronouncements Not Yet Adopted In October 2021, the FASB issued ASU No. 2021-08, “Business Combination (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers,” which requires entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The ASU improves comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. Entities should apply the amendments prospectively to business combinations that occur after the effective date. This standard will be effective for reporting periods beginning after December 15, 2022, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations, and cash flows. In June 2022, the FASB issued ASU No. 2022-03, "Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions," which clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This standard will be effective for reporting periods beginning December 15, 2023, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations, and cash flows. In September 2022, the FASB issued ASU No. 2022-04, "Liabilities - Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations," which requires a company that uses a supplier finance program in connection with the purchase of goods or services to disclose sufficient information about the program to allow a user of the financial statements to understand the program's nature, activity during the period, changes from period to period, and potential magnitude. This standard will be effective for reporting periods beginning December 15, 2022, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations, and cash flows. 9 Table of Contents 3. REVENUE RECOGNITION We recognize revenue in accordance with ASC Topic 606, "Revenue from Contracts with Customers." The unit of account in ASC 606 is a performance obligation, which is a promise in a contract with a customer to transfer a good or service to the customer. The majority of our revenue is recognized over time, as control is transferred continuously to our customers who receive and consume benefits as we perform, and is classified as services revenue. Revenue transferred to customer over time accounted for 87 % and 91 % of our revenue for the three and nine months ended September 30, 2022, respectively, and 91 % and 92 % of our revenue for the three and nine months ended September 30, 2021, respectively. All of our business groups earn services revenue under a variety of contract types, including time and materials, firm-fixed-price, firm-fixed-price level of effort, and cost-plus fixed-fee contract types, which may include variable consideration. We also recognize revenue at a point in time on certain contracts, when our customer obtains control of the transferred product, generally upon delivery, and the revenue is classified as product revenue. Revenue transferred to customers at a point in time accounted for 13 % and 9 % of our revenue for the three and nine months ended September 30, 2022, respectively, and 9 % and 8 % of our revenue for the three and nine months ended September 30, 2021, respectively. For certain performance obligations where we are not primarily responsible for fulfilling the promise to provide the goods or services to the customer, do not have inventory risk, and have limited discretion in establishing the price for the goods or services, we recognize revenue on a net basis. We provide for anticipated losses on contracts during the period when the loss is determined by recording an expense for the total expected costs that exceed the total estimated revenue for a performance obligation. No contract losses were recorded during the three and nine months ended September 30, 2022, and 2021. Disaggregated Revenues In addition to our segment reporting, as further discussed in Note 17 – Segment Information , we disaggregate our revenue by customer and contract types. We treat sales to U.S. customers as sales within the United States, regardless of where the services are performed. Substantially all of our revenues are generated from U.S. customers. Table 3.1: Revenue by Customer Type For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Amount % Amount % Amount % Amount % (in thousands) Federal $ 60,294 95 % $ 66,612 97 % $ 160,351 95 % $ 171,091 96 % State & local, and commercial 3,299 5 % 2,369 3 % 9,193 5 % 7,292 4 % Total revenue $ 63,593 $ 68,981 $ 169,544 $ 178,383 Table 3.2: Revenue by Contract Type For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Amount % Amount % Amount % Amount % (in thousands) Firm fixed-price $ 54,055 85 % $ 60,349 87 % $ 140,636 83 % $ 155,832 87 % Time-and-materials 3,457 5 % 3,154 5 % 9,104 5 % 9,243 5 % Cost plus fixed fee 6,081 10 % 5,478 8 % 19,804 12 % 13,308 8 % Total revenue $ 63,593 $ 68,981 $ 169,544 $ 178,383 As our primary customer base includes agencies of the U.S. government, we have a concentration of credit risk associated with our accounts receivable, as 95 % of our billed accounts receivable, as of September 30, 2022, were directly with U.S. government customers. We perform ongoing credit evaluations of all our customers and generally do not require collateral or other guarantees from our customers. We maintain allowances for potential losses. 10 Table of Contents Table 3.3: Revenue Concentrations Greater than 10% of Total Revenue For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 U.S. Department of Defense ("DoD") 77 % 74 % 74 % 75 % Civilian federal agencies 18 % 23 % 21 % 21 % Contract Balances Table 3.4: Contract Balances September 30, 2022 December 31, 2021 (in thousands) Contract assets (unbilled receivables) $ 28,290 $ 41,374 Contract liabilities 6,952 6,381 The change in the Company's contract assets and contract liabilities during the period was primarily the result of the timing differences between the Company's performance, invoicing and customer payments. Revenue recognized for the three and nine months ended September 30, 2022, that was included in the contract liabilities balance at the beginning of each reporting period, was $ 0.9 million and $ 5.0 million, respectively. Revenue recognized for the three and nine months ended September 30, 2021, that was included in the contract liabilities balance at the beginning of each reporting period, was $ 0.8 million and $ 4.1 million, respectively. As of September 30, 2022, we had $ 111.4 million of remaining performance obligations, which we also refer to as funded backlog. We expect to recognize approximately 85 % of our remaining performance obligations over the next 12 months and the balance thereafter. 4. ACCOUNTS RECEIVABLE, NET Table 4: Details of Accounts Receivable, Net September 30, 2022 December 31, 2021 (in thousands) Billed accounts receivable $ 22,903 $ 18,586 Unbilled receivables 28,290 41,374 Allowance for credit losses ( 210 ) ( 116 ) Accounts receivable, net $ 50,983 $ 59,844 5. INVENTORIES, NET Table 5: Details of Inventories, Net September 30, 2022 December 31, 2021 (in thousands) Gross inventory $ 5,429 $ 2,108 Allowance for inventory obsolescence ( 753 ) ( 861 ) Inventories, net $ 4,676 $ 1,247 6. PROPERTY AND EQUIPMENT, NET Table 6: Details of Property and Equipment, Net September 30, 2022 December 31, 2021 (in thousands) Furniture and equipment $ 15,765 $ 15,420 Leasehold improvement 3,073 2,994 Property and equipment, at cost 18,838 18,414 Accumulated depreciation ( 13,710 ) ( 12,326 ) Property and equipment, net $ 5,128 $ 6,088 Depreciation expense was $ 0.6 million and $ 1.8 million for the three and nine months ended September 30, 2022, respectively, compared to $ 0.6 million and $ 1.5 million for the three and nine months ended September 30, 2021, respectively. 11 Table of Contents 7. GOODWILL The goodwill balance was $ 17.9 million as of September 30, 2022, and December 31, 2021, of which $ 3.0 million is allocated to the Security Solutions segment and $ 14.9 million is allocated to the Secure Networks segment. Goodwill is subject to annual impairment tests and if triggering events are present in the interim before the annual tests, we will assess impairment. No impairment charges were taken for the three and nine months ended that September 30, 2022, and 2021. 8. INTANGIBLE ASSETS, NET Table 8.1: Details of Intangible Assets, Net September 30, 2022 December 31, 2021 Gross Accumulated Amortization Net Gross Accumulated Amortization Net (in thousands) Acquired technology $ 3,630 $ ( 529 ) $ 3,101 $ 3,630 $ ( 256 ) $ 3,374 Customer relationships 40 ( 16 ) 24 40 ( 5 ) 35 Software development costs 31,199 ( 7,466 ) 23,733 22,222 ( 6,432 ) 15,790 $ 34,869 $ ( 8,011 ) $ 26,858 $ 25,892 $ ( 6,693 ) $ 19,199 Amortization expense was $ 0.5 million and $ 1.3 million for the three and nine months ended September 30, 2022, respectively, and $ 0.4 million and $ 1.3 million for the three and nine months ended September 30, 2021, respectively. 9. ACQUISITION On July 30, 2021, the Company acquired the assets of Diamond Fortress Technologies ("DFT") and wholly-owned subsidiaries for a total purchase consideration of $ 6.7 million, inclusive of $ 0.3 million related to a pre-existing contractual arrangement with DFT. Upon closing, $ 5.9 million of cash was paid with an additional $ 0.6 million payable to DFT 18 months after the close date (the "holdback"). The holdback amount has been discounted to its present value of $ 0.5 million using a discount rate relevant to the acquisition. The acquisition adds several new patents to the Company’s library of biometric and digital identity intellectual property. The addition of contactless biometrics technology will enable the Company to better serve the needs of organizations in existing and new markets. The acquisition of the assets of DFT has been accounted for under U.S. GAAP using the acquisition method of accounting. The total purchase consideration of $ 6.7 million has been allocated among the assets acquired at their fair value at the acquisition date. The Company recognized $ 3.7 million of intangible assets and $ 3.0 million of goodwill, which is housed in the Telos ID reporting unit, part of the Security Solutions operating segment. Goodwill is primarily attributable to an excess of the purchase price over the acquired identifiable net tangible and intangible assets. The acquired intangible assets will be amortized on a straight-line basis over three to eight years . The acquisition was considered an asset purchase for tax purposes, and the recognized goodwill is deductible for tax purposes. 10. PURCHASE OF TELOS ID NON-CONTROLLING INTERESTS Telos ID was formed as a limited liability company under the Delaware Limited Liability Company Act in 2007. Prior to the IPO, the Company owned a 50 % interest in Telos ID, with the remaining interest owned by Hoya ID Fund A, LLC ("Hoya") as the non-controlling interest. Distributions were made to the members only when and to the extent determined by Telos ID’s Board of Directors, in accordance with its Operating Agreement. On October 5, 2020, we entered into a Membership Interest Purchase Agreement between the Company and Hoya to purchase all of the Class B Units of Telos ID owned by Hoya (the “Telos ID Purchase”). Upon the closing of the Telos ID Purchase, Telos ID became our wholly-owned subsidiary. On November 23, 2020, the Telos ID Purchase was consummated with the Company transferring $ 30.0 million in cash and issuing 7.3 million shares of our common stock at $ 20.39 per share (which totals approximately $ 148.4 million); the total consideration transferred to Hoya was $ 178.4 million. As part of the common stock issuance, the Company recognized an increase to additional paid-in capital (“APIC”) of $ 148.4 million. The Company further recognized a reduction to APIC of $ 173.9 million as part of eliminating Hoya’s non-controlling interest in Telos ID. The net impact to APIC associated with acquiring the additional 50 % interest in Telos ID was a reduction of $ 25.5 million. Hoya received a final distribution of $ 2.4 million in January 2021. 12 Table of Contents 11. ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES Table 11: Details of Accounts Payable and Other Accrued Liabilities September 30, 2022 December 31, 2021 (in thousands) Accounts payable - trade $ 16,339 $ 7,869 Accrued liabilities 19,870 25,300 Others 1,374 1,379 Accounts payable and other accrued liabilities $ 37,583 $ 34,548 12. STOCK-BASED COMPENSATION Our 2016 Omnibus Long-Term Incentive Plan (the "2016 LTIP") provides for the grant of restricted stock units with time-based vesting ("Service-Based RSU" or "RSU") and restricted stock units with performance-based vesting ("Performance-Based RSU" or "PRSU") to our senior executives, directors, employees, and other service providers. Awards granted under the 2016 LTIP vest over the periods determined by the Board of Directors or the Compensation Committee of the Board of Directors, generally one to three years . The Company records stock-based compensation related to accrued compensation in which it intends to settle in shares of the Company’s common stock. However, it is the Company’s discretion whether this compensation will ultimately be paid in stock or cash, as it has the right to dictate the form of these payments up until the date they are paid. The stock-based compensation expense includes an immaterial adjustment of $ 1.3 million for the nine months ended September 30, 2022, related to the prior year. There were no income tax benefits recognized on the share-based compensation expense for both periods. Table 12.1: Details of Stock Compensation Expense by Department For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 (in thousands) Cost of sales – services $ 929 $ 718 $ 2,798 $ 1,974 Sales and marketing 611 1,536 3,699 5,316 Research and development 897 970 2,884 2,079 General and administrative 12,284 9,148 34,844 38,009 Total stock-based compensation expense $ 14,721 $ 12,372 $ 44,225 $ 47,378 Table 12.2: Service-Based RSU and Performance-Based RSU Award Activity Service-Based RSU Performance-Based RSU Total Weighted-Average Grant Date Fair Value Unvested outstanding units as of December 31, 2021 3,030,608 492,727 3,523,335 $ 34.24 Granted 3,897,786 — 3,897,786 10.00 Vested ( 1,653,308 ) — ( 1,653,308 ) 31.21 Forfeited ( 360,762 ) ( 155,942 ) ( 516,704 ) 33.22 Unvested outstanding units as of September 30, 2022 4,914,324 336,785 5,251,109 $ 17.23 As of September 30, 2022, the intrinsic value of the RSUs and PRSUs outstanding, exercisable, and vested or expected to vest was $ 46.5 million. There was $ 42.7 million of total compensation costs related to stock-based awards not yet recognized as of September 30, 2022, which is expected to be recognized on a straight-line basis over a weighted-average remaining vesting period of approximately one year . 13 Table of Contents 13. SHARE REPURCHASES On May 24, 2022, the Company announced that the Board of Directors approved a new share repurchase program ("SRP") authorizing the Company to repurchase up to $ 50.0 million of its common stock. Pursuant to this authorization, the Company may repurchase shares of its common stock on a discretionary basis from time to time through open market purchases. The repurchase program has no expiration date and may be modified, suspended, or terminated at any time. As of September 30, 2022, there was $ 42.3 million of the remaining authorization for future common stock repurchases under the SRP. Table 13: Shares Repurchase Activity For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 (in thousands, except per share and share data) Amount paid for shares repurchased (1) $ 4,681 $ — $ 7,683 $ — Number of shares repurchased 498,731 — 859,170 — Average per share price paid (1) $ 9.38 $ — $ 8.94 $ — (1) Includes commissions paid for repurchases on the open market. As of November 4, 2022, the Company has repurchased an additional 106,623 shares of its common stock for $ 1.0 million since September 30, 2022. 14. ACCUMULATED OTHER COMPREHENSIVE LOSS Our functional currency is the U.S. Dollar. For one of our wholly-owned subsidiaries, the functional currency is the local currency. For this subsidiary, the translation of its foreign currency into U.S. Dollars is performed for assets and liabilities using current foreign currency exchange rates in effect at the balance sheet date and for revenue and expense accounts using average foreign currency exchange rates during the periods presented. Translation gains and losses are included in stockholders’ equity as a component of accumulated other comprehensive loss. Table 14: Details of Accumulated Other Comprehensive Loss September 30, 2022 December 31, 2021 (in thousands) Cumulative foreign currency translation loss $ ( 137 ) $ ( 134 ) Cumulative actuarial gain on pension liability adjustment 107 107 Accumulated other comprehensive loss $ ( 30 ) $ ( 27 ) 15. LOSS PER SHARE Basic net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of common shares outstanding for the period, without consideration for potentially dilutive securities. Diluted net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of shares of common stock and dilutive common stock equivalents outstanding for the period determined using the treasury-stock and if-converted methods. Dilutive common stock equivalents are comprised of unvested restricted common stock and warrants. For the period of net loss, potentially dilutive securities are not included in the calculation of diluted net earnings (loss) per share, because to do so would be anti-dilutive. Table 15: Potentially Dilutive Securities For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 (in thousands) Unvested restricted stock and restricted stock units 833 313 435 394 Common stock warrants, exercisable at $ 1.665 per share — — — 405 Total 833 313 435 799 Unvested antidilutive stock units excluded from the dilutive effect (stock units) 1,218 — 965 — 14 Table of Contents 16. RELATED PARTY TRANSACTIONS Emmett J. Wood, the brother of our Chairman and CEO, has been an employee of the Company since 1996. The amounts paid to this individual as compensation were $ 91,000 and $ 696,000 for the three and nine months ended September 30, 2022, respectively, and $ 88,000 and $ 389,000 for the three and nine months ended September 30, 2021, respectively. Additionally, Mr. Emmett Wood owned 94,547 and 73,562 shares of the Company’s common stock as of September 30, 2022, and December 31, 2021. One of the Company’s directors serves as a consultant to the Company. In February 2022, the director and the Company amended the consulting agreement to provide that the Company would pay the remainder of the director’s consulting fees for 2022 in a fixed price amount in the form of restricted stock units. The Company granted the director 26,091 restricted stock units on February 1, 2022, which vest quarterly in four equal amounts through the end of the year, subject to the director’s continued performance under the consulting agreement. No cash payments were made for the three months ended September 30, 2022. The amounts paid for his consulting services were $ 25,000 for the nine months ended September 30, 2022, and $ 71,000 and $ 212,000 for the three and nine months ended September 30, 2021, respectively. 17. SEGMENT INFORMATION As noted in Note 2 - Significant Accounting Policies , during the fourth quarter of 2021, as a result of the segment reorganization, our CODM began evaluating, overseeing, and managing the financial performance of our operations through two operating segments: Security Solutions and Secure Networks. The segments enable the alignment of our strategies and objectives and provide a framework for the timely and rational allocation of resources within the lines of business. We eliminate any inter-segment revenues and expenses upon consolidation. The Security Solutions segment is primarily focused on cybersecurity, cloud and identity solutions, and secure messaging through Xacta ® , Telos Ghost ® , Telos Advanced Cyber Analytics, Telos AMHS and Telos ID offerings. We recognize revenue on contracts from providing various system platforms in the cloud, on-premises, and in hybrid cloud environments, as well as software sales or software-as-a-service. Revenue associated with the segment's custom solutions is recognized as work progresses or upon delivery of services and products. Fluctuation in revenue from period to period is the result of the volume of software sales, and the progress or completion of cloud and/or cybersecurity solutions during the period. The majority of the operating costs relate to labor, material, and overhead costs. Software sales have immaterial operation costs associated with them, thus yielding higher margins. Gross profit and margin are a function of operational efficiency on security solutions and changes in the volume of software sales. The Secure Networks segment provides secure networking architectures and solutions to our customers through secure mobility solutions, and network management and defense services. Revenue is recognized over time as the work progresses on contracts related to managing network services and information delivery. Contract costs include labor, material, and overhead costs. Variances in costs recognized from period to period primarily reflect increases and decreases in activity levels on individual contracts. Table 17: Results of Operations by Business Segment For the Three Months Ended For the Nine Months Ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 (in thousands) Revenues: Security Solutions $ 32,440 $ 34,558 $ 90,178 $ 89,624 Secure Networks 31,153 34,423 79,366 88,759 Total revenue 63,593 68,981 169,544 178,383 Gross profit: Security Solutions 15,577 19,517 47,062 46,032 Secure Networks 5,368 5,360 13,683 15,849 Total gross profit 20,945 24,877 60,745 61,881 Selling, general and administrative expenses 28,614 29,965 95,314 97,935 Operating loss ( 7,669 ) ( 5,088 ) ( 34,569 ) ( 36,054 ) Other income/(expense) 518 20 648 ( 1,001 ) Interest expense ( 181 ) ( 195 ) ( 558 ) ( 583 ) Loss before income taxes ( 7,332 ) ( 5,263 ) ( 34,479 ) ( 37,638 ) (Provision for)/benefit from income taxes ( 8 ) 41 ( 133 ) ( 6 ) Net loss $ ( 7,340 ) $ ( 5,222 ) $ ( 34,612 ) $ ( 37,644 ) 15 Table of Contents We measure each segment's profitability based on gross profit. We account for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Interest income, interest expense, other income and expense items, and income taxes, as reported in the consolidated financial statements, are not part of the segment profitability measure and are primarily recorded at the corporate level. Management does not utilize total assets by segment to evaluate segment performance or allocate resources. As a result, assets are not tracked by segment, and therefore, total assets by segment are not disclosed. 18. REVISION OF PRIOR YEAR INTERIM FINANCIAL STATEMENTS (a) Expense Classification During the third quarter of 2021, the Company identified that stock compensation for a single individual was incorrectly charged to "cost of sales - services" instead of "general and administrative expense." The total amount of stock compensation incorrectly charged to the cost of sales was $ 0.3 million, of which $ 0.1 million was related to the first quarter of 2021, and $ 0.2 million related to the second quarter of 2021. The Company corrected the error during the third quarter of 2021. In addition, the Company identified that the allocation of stock compensation for two of the Company's overhead cost pools was incorrectly charged to "cost of sales" instead of "general and administrative expense" during the second quarter of 2021. The total amount of the allocated stock compensation incorrectly charged to the cost of sales was $ 0.7 million, which the Company corrected during the third quarter of 2021. (b) Revenue Recognition In the third quarter of 2021, the Company identified $ 1.1 million in revenue related to the stub period of a newly awarded contract that should have been recognized as income during the second quarter of 2021. The Company initially corrected the error during the third quarter of 2021. Additionally, and related to this contract, in the fourth quarter of 2021, the Company identified $ 0.3 million of products revenue for the second quarter of 2021 and $ 0.4 million of products revenue for the third quarter of 2021 that should be classified in the condensed consolidated statements of operations as services revenue. (c) Software Capitalization In the third quarter of 2021, the Company erroneously recorded a $ 0.5 million expense related to a software project whose development milestones were achieved, and therefore, costs associated with the software should have been capitalized. (d) Recording of Expense In the third quarter of 2021, the Company erroneously recorded a $ 0.9 million expense related to a contract that had not yet begun. In the fourth quarter of 2021, the Company reversed the expense previously recorded and does not plan to record the expense until the start of the period of performance. In the fourth quarter of 2021, the Company identified that a third-quarter RSU was awarded to an individual, but that award was erroneously excluded from its calculation of compensation expense, causing compensation expense to be understated by $ 0.2 million in the third quarter of 2021. (e) Cash Flow The Company erroneously presented the $ 2.4 million final payment to fully acquire all membership interest of Telos ID as an operating activity on the condensed consolidated statements of cash flows. The Company corrected the presentation to properly reflect the final payment within financing activities on the consolidated statements of cash flows in the fourth quarter of 2021. (f) Valuation of Acquired Assets In the fourth quarter of fiscal year 2021, the Company identified a necessary update to a previously established assumption related to the valuation of its 2021 acquisition. The change in assumption resulted in additional goodwill of $ 1.3 million and a reduction of the intangible asset for the same amount that should have been reported during the third quarter of 2021. 16 Table of Contents Table 18.1: Impact of the Correction to the Condensed Consolidated Statement of Operations For the Three Months Ended September 30, 2021 For the Nine Months Ended September 30, 2021 Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted (in thousands, except per share amounts) Revenue - services $ 63,690 $ ( 735 ) $ 62,955 $ 163,366 $ 650 $ 164,016 Revenue - products 6,376 ( 350 ) 6,026 15,017 ( 650 ) 14,367 Revenue 70,066 ( 1,085 ) 68,981 178,383 — 178,383 Cost of sales - services 40,031 106 40,137 109,134 ( 898 ) 108,236 Costs and expenses 43,998 106 44,104 117,400 ( 898 ) 116,502 Research and development 5,396 ( 533 ) 4,863 14,783 ( 533 ) 14,250 General and administrative 20,562 ( 823 ) 19,739 69,271 181 69,452 Selling, general and administrative expenses 31,321 ( 1,356 ) 29,965 98,287 ( 352 ) 97,935 Operating loss ( 5,253 ) 165 ( 5,088 ) ( 37,304 ) 1,250 ( 36,054 ) Loss before income taxes ( 5,428 ) 165 ( 5,263 ) ( 38,888 ) 1,250 ( 37,638 ) Net loss ( 5,387 ) 165 ( 5,222 ) ( 38,894 ) 1,250 ( 37,644 ) Net loss attributable to Telos Corporation ( 5,387 ) 165 ( 5,222 ) ( 38,894 ) 1,250 ( 37,644 ) Net loss per share attributable to Telos Corporation Basic $ ( 0.08 ) $ — $ ( 0.08 ) $ ( 0.59 ) $ 0.02 $ ( 0.57 ) Diluted $ ( 0.08 ) $ — $ ( 0.08 ) $ ( 0.59 ) $ 0.02 $ ( 0.57 ) Table 18.2: Impact of the Correction to the Condensed Consolidated Statement of Comprehensive Loss For the Three Months Ended September 30, 2021 For the Nine Months Ended September 30, 2021 Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted (in thousands) Net loss $ ( 5,387 ) $ 165 $ ( 5,222 ) $ ( 38,894 ) $ 1,250 $ ( 37,644 ) Comprehensive loss attributable to Telos Corporation ( 5,400 ) 165 ( 5,235 ) ( 38,934 ) 1,250 ( 37,684 ) Table 18.3. Impact of the Correction to the Condensed Consolidated Statement of Cash Flows For the Nine Months Ended September 30, 2021 Previously Reported Error Correction As Adjusted (in thousands) Net loss $ ( 38,894 ) $ 1,250 ( 37,644 ) Stock-based compensation 47,197 181 47,378 Changes in other operating assets and liabilities ( 5,900 ) 1,538 ( 4,362 ) Cash used in operating activities 6,668 2,969 9,637 Capitalized software development costs ( 6,139 ) ( 533 ) ( 6,672 ) Cash used in investing activities ( 13,709 ) ( 533 ) ( 14,242 ) Distribution to Telos ID Class B member – non-controlling interest — ( 2,436 ) ( 2,436 ) Cash provided by financing activities 35,131 ( 2,436 ) 32,695 17 Table of Contents Table 18.4. Impact of the Correction to the Condensed Consolidated Statement of Changes in Stockholders' Equity For the Three Months Ended September 30, 2021 For the Nine Months Ended September 30, 2021 Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted (in thousands) Net loss $ ( 5,387 ) $ 165 $ ( 5,222 ) $ ( 38,894 ) $ 1,250 $ ( 37,644 ) Additional paid-in capital 354,119 181 354,300 354,119 181 354,300 Accumulated deficit - beginning balance ( 177,350 ) 1,085 ( 176,265 ) ( 143,843 ) — ( 143,843 ) Accumulated deficit - ending balance ( 182,737 ) 1,250 ( 181,487 ) ( 182,737 ) 1,250 ( 181,487 ) Total Stockholders' equity 171,491 1,431 172,922 171,491 1,431 172,922 19. COMMITMENT AND CONTINGENCIES Legal Proceedings As previously reported in Note 19 of the Form 10-Q for the quarter ended June 30, 2022, filed on August 9, 2022, on February 7, 2022, Telos and certain of its current and former officers were named as defendants in a lawsuit filed in the United States District Court for the Eastern District of Virginia. In the complaint, the plaintiffs, who purport to represent a class of purchasers of Telos common stock between November 19, 2020, and March 16, 2022, allege that the defendants violated securities laws by failing to disclose delays relating to the launch of certain contracts between Telos and the Transportation Security Administration ("TSA") and the Centers for Medicare and Medicaid Services and to take into account those delays when providing a financial forecast for the Company’s 2021 performance. On June 15, 2022, the Plaintiffs filed a consolidated complaint which added claims (i) concerning Telos' disclosure of revenue projections for these contracts, (ii) against the directors of Telos at the time of its initial public offering, and (iii) pursuant to Sections 11 and 15 of the Securities Act of 1933. The Company is vigorously defending the case, but given the early stage, although a loss may reasonably be possible, the Company is unable to predict the likelihood of success of plaintiffs' claims or estimate a loss or range of loss. As a result, no material liability has been recorded as of September 30, 2022, and December, 31, 2021, respectively. In addition, the Company is a party to litigation arising in the ordinary course of business. In the opinion of management, while the results of such litigation cannot be predicted with any reasonable degree of certainty, the final outcome of such known matters will not, based upon all available information, have a material adverse effect on the Company's unaudited consolidated financial position, results of operations or cash flows. Other - Government Contracts As a U.S. government contractor, we are subject to various audits and investigations by the U.S. government to determine whether our operations are being conducted in accordance with applicable regulatory requirements. U.S. government investigations of our operations, whether relating to government contracts or conducted for other reasons, could result in administrative, civil, or criminal liabilities, including repayments, fines or penalties being imposed upon us, suspension, proposed debarment, debarment from eligibility for future U.S. government contracting, or suspension of export privileges. Suspension or debarment could have a material adverse effect on us because of our dependence on contracts with the U.S. government. U.S. government investigations often take years to complete, and many result in no adverse action against us. We also provide products and services to customers outside of the United States, which are subject to U.S. and foreign laws and regulations and foreign procurement policies and practices. Our compliance with local regulations or applicable U.S. government regulations also may be audited or investigated. 20. SUPPLEMENTAL CASH FLOW INFORMATION Table 20.1: Details of Cash, Cash Equivalent, and Restricted Cash September 30, 2022 December 31, 2021 (in thousands) Cash and cash equivalents $ 125,332 $ 126,562 Restricted cash (1) 132 — Cash, cash equivalents, and restricted cash $ 125,464 $ 126,562 (1) Restricted cash consists of a commercial money market account held as a deposit on the Ashburn lease and is recorded under "Other assets" on the Consolidated Balance Sheets 18 Table of Contents Table 20.2: Supplemental Cash Flow Information For the Nine Months Ended September 30, 2022 September 30, 2021 (in thousands) Cash paid during the period for: Interest $ 523 $ 583 Income taxes 188 54 Non-cash investing and financing activities: Operating lease ROU assets obtained in exchange for operating lease liabilities $ 396 $ 486 Capital expenditure activity in accounts payable and other accrued liabilities 400 — Common stock repurchase under SRP 80 — Acquisition holdback — 506 19 Table of Contents