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Item 7. Management’s Discussion and Analysis

2023-03-16 compared with 2022-03-28 · 256 added, 244 removed, 136 unchanged (79% of the section changed)

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

Forward-Looking Information

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

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

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

General Overview

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

Management's Discussion and Analysis for the Year Ended December 31, 2020

Management's discussion and analysis of the financial condition and results of operations for the year December 31, 2020, including a comparison of our results for the years ended December 31, 2021 and 2020, is included in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission on March 28, 2022.

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

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

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

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

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

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

Information regarding our segments is presented in Note 21 - Segment Information to the consolidated financial statements at Item 8 of this Form 10-K.

Business Environment

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

move more rapidly to adopt secure cloud services;

adopt multi-factor authentication;

push for increased use of zero trust architecture;

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

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

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

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

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

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

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

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

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

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

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

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 operated for nearly three months under the terms of a continuing resolution ("CR"), which only permitted 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 were generally precluded from moving forward on new contract starts or accelerating current projects while they were funded by a CR.

Congress finally reached an agreement and completed action in late December on an omnibus appropriations package to fund the entire federal government through the remainder of FY 2023.

This final appropriations legislation provided an increase in total defense spending for FY 2023 of $44 billion above the budget proposed last spring by the White House, and represents a $76 billion increase above last year's funding level.

It also included significant increases in federal civilian agency (non-defense) cybersecurity funding, including a 15 percent increase from last year for the Cybersecurity and Infrastructure Security Agency for various program enhancements and new initiatives.

The Office of Management and Budget has already given federal departments and agencies guidance for cybersecurity priorities to include in their FY 2024 proposed budgets, including 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.

We look forward to the President's budget and subsequent congressional action reflecting these priorities, which 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 SLED 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 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.

The Nation's Critical Systems Are Still at Risk

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

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

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

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

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

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

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

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

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

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

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.

The Challenging Complexity of Regulatory Compliance

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.

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

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

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

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

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

COVID-19 Pandemic

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

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

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

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

For example, Xacta supports 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 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 also 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.

Identity Assurance and Privacy Protection are Essential for Today's Enterprises

Identity and access management continues to be a major cybersecurity concern for organizations and individuals that need to ensure their security and protect their privacy.

Trusted identities are essential to confidence in IT and physical security strategies and to the success of Zero Trust security models and architectures.

Telos is a longstanding leader in solutions that assure identity trust, mitigate risk to critical infrastructure, and reduce the threat of sensitive information exposure.

Our IDTrust360® digital identity management platform integrates the full spectrum of identity and access management technologies in a cloud-based system that's quickly scalable to enterprise requirements.

Our ONYX® touchless mobile fingerprinting solution captures fingerprints using the rear-facing camera on most off-the-shelf smartphones, replacing expensive physical hardware infrastructure for capturing fingerprints and streamlining customer identification and background checks in financial services, law enforcement, healthcare, and enterprise identity and authentication.

We also maintain government certifications and designations that distinguish Telos in the identity and access field, including TSA PreCheck enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and Financial Industry Regulatory Authority Electronic Fingerprint Submission provider.

Global Networks and Worldwide Communications Need Baked-in Security

Today's enterprises are also in need of resilient cyber and information security capabilities to protect and defend critical infrastructure to ensure mission success.

Telos Secure Networks offers secure mobility solutions, network architecting, planning and installation, security compliance, and network management expertise to defend against cyber threats and vulnerabilities.

Telos Secure Networks offers these capabilities and more — on-premises, deployed, and in the cloud — to transform and empower military, government, and commercial enterprises to meet their critical and operational needs.

Telos is a certified IT company offering technical expertise, global reach, and strategic partnerships to meet our customers' most challenging issues.

We have also built a culture of innovation focused on digital transformation — taking complex technology solutions and making them actionable and secure with advanced capabilities such as RPA, multi-cloud migration, and risk management.

Telos serves the U.S.

Air Force, U.S.

Army, and other organizations in locations around the globe with base-level network support, deployable communications, modernized voice over IP solutions, infrastructure relocation and realignment, and other capabilities for secure enterprise communications.

Our experience has prepared us for the unique responsibility of ensuring that the government's most critical information systems in the most sensitive locations are protected from threats in both the physical and virtual worlds.

Opportunities, Challenges and Risks

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.

Total backlog consists of the aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or unfunded.

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

government contracts, means that they have been funded by the procuring agency.

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

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

Most of our customers fund contracts on 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.

Table MD&A 1:

Backlog by Segment

As of December 31,

(in thousands)

Security Solutions

Funded backlog $ 33,784 $ 35,382

Unfunded backlog 47,509 54,198

Total Security Solutions backlog 81,292 89,580

Secure Networks

Funded backlog 48,454 88,097

Unfunded backlog 82,296 68,730

Total Secure Networks backlog 130,750 156,827

Funded backlog 82,238 123,479

Unfunded backlog 129,805 122,928

Total backlog $ 212,043 $ 246,407

Financial Overview

A number of factors have affected our current and future financial growth, the most significant of which are described below.

More details on these changes are presented below within our "Results of Operations" section.

• 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 anticipates this launch will occur in calendar year 2023.

• On December 30, 2022, we entered into a new credit agreement with JPMorgan Chase N.A., which provides for a $30.0 million senior secured revolving facility with a maturity date of December 30, 2025, the option of issuing letters of credit and with an uncommitted expansion feature of up to $30.0 million of additional revolver facility.

The revolving credit facility will be used for working capital and general corporate purposes.

While there are no drawn funds from the revolving credit facility as of December 31, 2022, the cost of servicing any debt for a full year, as well as increasing interest rates, may have an impact on future interest expense.

• The winding down of certain projects, completion of several large programs in fiscal years 2021 and 2022, and new business wins below expectations resulted in a decline in current year revenue.

• In the fourth quarter of 2022, we committed to a restructuring plan resulting in a reduction of the Company's workforce, with a majority of the affected employees separating from the business in early 2023.

The costs associated with the restructuring plan include employee severance–related benefit costs (including outplacement services and continuing health insurance coverage).

Key Performance Measures

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

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

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

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

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Results of Operations

Consolidated Overview

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

Years Ended December 31,

2021 2020 2019

(dollar amounts in thousands)

Consolidated Results

Table MD&A 2:

Consolidated Financial Results Comparison

For the Year Ended December 31,

2022 2021 Change ($)

(dollars in thousands)

Revenue $ 216,887 $ 242,433 $ (25,546)

Cost of sales 137,844 156,404 (18,560)

Gross profit 79,043 86,029 (6,986)

Gross margin 36.4 % 35.5 %

Selling, general and administrative expenses 132,893 127,493 5,400

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

Other income (expenses):

Gain on redemption of public preferred stock

— — % 14,012 7.8 % — — %

Non-operating (expense) income

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

Selling, general and administrative expense as percentage of revenue 61.3 % 52.6 %

Operating loss (53,850) (41,464) (12,386)

Other income/(expense) 1,350 (921) 2,271

Interest expense (874) (777) (97)

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

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

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

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

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

Years Ended December 31, 2021, 2020, and 2019

Company Results

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

Revenue, excluding the contract with the U.S.

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

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

The increase in revenue is attributable to new awards and net increase in volume on various projects within the business groups.

Sales may vary from period to period according to the solution mix and timing of deliverables for a particular period.

Cost of sales increased by $38.9 million or 33.1% in 2021 compared to 2020.

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

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

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

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

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

Gross margin increased due to growth in high margin contracts.

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

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

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

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

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

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

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

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

Interest expense decreased by 2.8% to $7.3 million for 2020 from $7.5 million for 2019, primarily due to decreases in public preferred stock interest as a result of such stock redemption, and interest on an equipment purchase arrangement, offset by an increase in interest on the senior term loan with EnCap.

Components of interest expense are as follows:

2021 2020 2019

(amounts in thousands)

Commercial and subordinated note interest incurred $ 777 $ 3,875 $ 3,644

Preferred stock interest accrued — 3,384 3,823

Total $ 777 $ 7,259 $ 7,467

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

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

Loss before income taxes (53,374) (43,162) (10,212)

(Provision for)/benefit from income taxes (54) 28 (82)

Net loss $ (53,428) $ (43,134) $ (10,294)

Our business segments have different factors driving revenue fluctuations and profitability.

The discussion of the changes in our net revenue and profitability are covered in greater detail under the section that follows "Segment Results." We generate revenue from the delivery of products and services to our customers.

Cost of sales, for both products and services, consists of labor, materials, subcontracting costs and an allocation of indirect costs.

Selling, general, and administrative ("SG&A") expenses increased by $5.4 million or 4.2% in 2022 compared to 2021.

This is primarily due to increases in stock-based compensation by $3.6 million and labor costs by $3.0 million, offset by a decrease in outside services of $1.3 million.

In 2022, labor costs include termination benefits related to the restructuring plan aggregating to $2.2 million, with no similar cost in 2021.

Other income/(expense) increased by $2.3 million due to dividend income from money market placements amounting to $1.0 million earned in 2022 without similar income in 2021, and other expenses of $0.9 million for the settlement of outstanding litigation in 2021, with no similar cost in 2022.

There was no significant change in interest expense between comparable periods.

The increase in the income tax provision in 2022 compared to 2021 is primarily due to an increase in state income taxes.

Segment Results

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Management evaluates business segment performance based on gross profit.

Security Solutions Segment:

Years Ended December 31,

2021 2020 2019

(dollar amounts in thousands)

Table MD&A 3:

Security Solutions Segment - Financial Results Comparison

For the Year Ended December 31,

2022 2021 Change ($)

(dollars in thousands)

Revenues $ 120,454 $ 123,534 $ (3,080)

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Gross margin 51.4 % 52.5 % (1.1) %

Revenue increased by 5.3% in 2021 compared to 2020.

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

Revenue, excluding the contract with the U.S.

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

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

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

Revenue increased by 15.1% in 2020 compared to 2019.

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

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

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

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

Secure Networks Segment:

Years Ended December 31,

2021 2020 2019

(dollar amounts in thousands)

Our Security Solutions segment revenue decreased by $3.1 million or 2.5% in fiscal year 2022 compared to fiscal year 2021, primarily as a result of the Census program ending in 2021.

Likewise, the segment gross profit decreased by $3.0 million or 4.6% in 2022 compared to 2021 and segment gross margin also decreased from 52.5% in 2021 to 51.4% in 2022.

The decrease in gross margin is the result of changes in the mix of programs within the portfolio and lower margin of certain projects within the segment.

Table MD&A 4:

Secure Networks Segment - Financial Results Comparison

For the Year Ended December 31,

2022 2021 Change ($)

(dollars in thousands)

Revenues $ 96,433 $ 118,899 $ (22,466)

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Gross margin 17.7 % 17.8 % (0.1) %

Revenue increased by 89.9% in 2021 compared to 2020.

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

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

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

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

Balance Sheet Review

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

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

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

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

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

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

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

Our Secure Networks segment revenue decreased by $22.5 million or 18.9% in 2022 compared to 2021, primarily due to the expected wind-down in 2022 and completion of large programs in the second half of 2022.

Segment gross profit decreased by $4.0 million or 19.1% in 2022 compared to 2021, primarily as a result of the decline in year-to-date segment revenue.

Segment gross margin slightly decreased from 17.8% in 2021 to 17.7% in 2022.

Non-GAAP Measures

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

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

GAAP, we believe the non-GAAP financial measures of 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.

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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 do not represent, and should not be considered as, an alternative to net loss as determined by GAAP.

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

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

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

Years Ended December 31, 2021 2020 2019

(amount in thousands)

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

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

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

EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin

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

We define 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 EBITDA, adjusted for restructuring expenses and stock-based compensation expense.

We define Adjusted EBITDA Margin as Adjusted EBITDA as a percentage of total revenue.

Table MD&A 5:

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

For the Year Ended December 31,

Amount Margin Amount Margin

(dollars in thousands)

Net loss $ (53,428) (24.6) % $ (43,134) (17.8) %

Other (income)/expense (1,350) (0.6) % 921 0.4 %

Interest expense 874 0.4 % 777 0.3 %

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

Provision for/(benefit from) income taxes 54 — % (28) — %

Depreciation and amortization 5,890 2.7 % 5,624 2.4 %

Enterprise EBITDA (35,840) 19,387 9,997

Transaction related gains/losses/expenses:

Transaction related legal and accounting — 1,914 —

Transaction related bonus — 3,816 —

Gain on redemption of public preferred stock — (14,012) —

Transaction related non-operating income — (274) —

Loss on extinguishment of senior term loan — 138 —

Loss on extinguishment of subordinated debt — 411 —

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

EBITDA (47,960) (22.1) % (35,840) (14.7) %

Restructuring expenses (1)

2,767 1.3 % — — %

Stock-based compensation expense (2)

64,660 29.8 % 60,231 24.8 %

Adjusted EBITDA $ 19,467 9.0 % $ 24,391 10.1 %

Adjusted Net Income (Loss) and Adjusted EPS

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

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

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

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

Years Ended December 31, 2021 2020 2019

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

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

(1) The restructuring expenses adjustment to EBITDA includes severance and other related benefit costs (including outplacement services and continuing health insurance coverage) associated with a reduction in workforce.

(2) The stock-based compensation adjustment to EBITDA for fiscal year 2022 is made up of $62.5 million of stock-based compensation expenses for the awarded service-based restricted stock units ("RSUs") and performance-based restricted stock units ("PRSUs"), and $2.1 million of other sources of stock-based compensation 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 a change in estimate that would add back to Adjusted EBITDA.

Adjusted Net Income and Adjusted EPS - Non-GAAP

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

We define Adjusted Net Income as net loss, adjusted for non-operating expense/(income), restructuring expenses and stock-based compensation expense.

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

Table MD&A 6:

Reconciliation of Net Loss to Non-GAAP Adjusted Net Income and Adjusted EPS

For the Year Ended December 31,

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

(in thousands, except per share data)

Reported GAAP measure $ (53,428) $ (0.79) $ (43,134) $ (0.65)

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

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

Other (income)/expense (1,350) (0.02) 921 0.01

Restructuring expenses (1)

2,767 0.04 — —

Stock-based compensation expense (2)

64,660 0.96 60,231 0.91

Adjusted non-GAAP measure $ 12,649 $ 0.19 $ 18,018 $ 0.27

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

Weighted-average shares of common stock outstanding, basic 67,559 66,374

(1) The restructuring expenses adjustment to net loss includes severance and other related benefit costs (including outplacement services and continuing health insurance coverage) associated with a reduction in workforce.

(2) The stock-based compensation adjustment to net loss for fiscal year 2022 is made up of $62.5 million of stock-based compensation expenses for the awarded RSUs and PRSUs, and $2.1 million of other sources of stock-based compensation 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 a change in estimate that would add back to Adjusted Net Income/(Loss).

Free Cash Flow

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

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

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

Years Ended December 31, 2021 2020 2019

Table MD&A 7:

Free Cash Flow

For the Year Ended December 31,

(in thousands)

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

Net cash flows provided by operating activities $ 16,508 $ 7,262

Purchases of property and equipment (1,009) (3,201)

Capitalized software development costs (12,708) (9,968)

Net cash proceeds from resale of software 8,457 —

Free cash flow $ 11,248 $ (5,907)

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand, cash flow from operations, and availability under our revolving credit facility.

While a variety of factors related to sources and uses of cash, such as timeliness of accounts receivable collections, vendor credit terms, or significant collateral requirements, ultimately impact our liquidity, such factors may or may not have a direct impact on our liquidity.

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

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

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

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

Upon the closing of the IPO in November 2020, we issued 17.2 million shares of our common stock at a price of $17.00 per share, generating net proceeds of approximately $272.8 million.

We used approximately $108.9 million of the net proceeds in connection with the exchangeable redeemable preferred stock conversion (see Note 8 – Exchangeable Redeemable Preferred Stock Conversion), $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 9 – Non-controlling Interests / Purchase of Telos ID), and $21.0 million to repay our outstanding senior term loan and subordinated debt (see Note 7 – Debt Obligations).

We used approximately $108.9 million of the net proceeds in connection with the exchangeable redeemable preferred stock conversion (see Note 1 3 – Exchangeable Redeemable Preferred Stock Conversio n ), $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 1 1 – Purchase of Telos ID Non-controlling Interests ), and $21.0 million to repay our outstanding senior term loan and subordinated debt (see Note 1 2 – Debt and Other Obligations ).

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

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

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

Further, on July 30, 2021, we used approximately $5.9 million of the net proceeds to acquire the assets of DFT (see Note 10 – Acquisition ).

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

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

The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors.

Proceeds held by us are invested in short-term investments until needed for the uses described above.

We currently anticipate that we will retain all available funds for use in the operations and expansion of our business, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Our overall financial position and liquidity are strong.

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

Although no assurances can be given, we expect that funds generated from operations are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months.

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

As of December 31, 2022, we had cash and cash equivalents of $119.3 million and our working capital was $122.5 million.

In addition, on December 30, 2022, we entered into a $30.0 million senior secured revolving credit facility, with an expansion feature of up to $30.0 million of additional revolver capacity.

We place a strong emphasis on cash flow generation.

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

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

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

Cash provided by operating activities is primarily driven by our operating income, the timing of receipt of customer payments, the timing of payments to vendors and employees, and the timing of inventory turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities.

Additionally, cash used in operating activities also includes dividends from preferred stock recorded as interest expense of $3.4 million and $3.8 million for 2020 and 2019, respectively.

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

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

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

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

Our overall financial position and liquidity are strong.

Although no assurances can be given, we believe that funds generated from operations, available cash balances and access to our revolving credit facility are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months.

Senior Credit Facility

On December 30, 2022, Telos (as borrower) and its subsidiaries (as guarantors) entered into a Credit Agreement with JPMorgan Chase Bank, N.A.

that provides for a $30.0 million senior secured revolving credit facility, with the option of issuing letters of credits thereunder and with an uncommitted expansion feature of up to $30.0 million of additional revolver capacity (the "Loan").

The Loan will mature on December 30, 2025 and is subject to acceleration in the event of customary events of default.

Borrowings under the Credit Agreement will accrue interest and we may elect to borrow (at our option) at (i) the Alternative Base Rate, plus 0.9%;

(ii) Adjusted Daily Simple Secured Overnight Financing Rate ("SOFR"), plus 1.9%;

and (iii) Adjusted Term SOFR, plus 1.9%.

After the occurrence and during the continuance of any event of default, the interest rate may increase by an additional 2.0%.

We are also paying costs and customary fees, including a closing fee, commitment fees and letter of credit participation fee, if any, payable to the Agent and Lenders, as applicable, in connection with the Loan.

The Credit Agreement contains representations, warranties, covenants, terms and conditions customary for transactions of this type and includes a maximum senior leverage ratio financial covenant.

In connection with the Credit Agreement, the Agent has been granted, for the benefit of the Lenders, a security interest in and general lien upon various property of the Company and the Guarantors, subject to certain permitted liens and encumbrances.

The occurrence of an event of default under the Credit Agreement could result in the Loan and other obligations becoming immediately due and payable and allow the Lenders to exercise all rights and remedies available to them under the Credit Agreement.

As of December 31, 2022, there were no outstanding balances under the revolving credit facility and we were in compliance with all covenants contained in the Credit Agreement.

Other Financing Obligations

Telos entered into a Master Purchase Agreement ("MPA") with a third-party buyer ("Buyer") for $9.1 million ("Assignment Price") relating to software licenses under a specific delivery order ("DO") with our customer resulting in proceeds from other financing obligations of $9.1 million in November 2022.

Under the MPA, we sold, assigned and transferred all of our rights, title and interest in (i) the DO payments from the customer and (ii) the underlying licenses.

The DO covers a base period with an option for the customer to exercise three (3) additional 12-month periods through January 2026.

The DO payments assigned to the Buyer are billable to the customer at the beginning of the base period and for each option year exercised.

The underlying licenses were acquired for resale, see Note 8, Intangible Assets, n et for further details.

On February 9, 2023, the customer notified Telos that it would not exercise the first option period under the DO.

The MPA provides that, if the customer terminates the DO for non-renewal and the Buyer reasonably concludes that the customer's actions constitute grounds for filing a claim with the customer's contracting officer, Buyer and Telos will cooperate in preparing such a claim, which would be filed in Telos' name.

Buyer has notified Telos of its intent to pursue a claim against the customer.

Table MD&A 8:

Cash Flows Information

For the Year Ended December 31,

(in thousands)

Net cash provided by operating activities $ 16,508 $ 7,262

Net cash used in investing activities (13,717) (19,094)

Net cash (used in)/provided by financing activities (9,915) 32,349

Net change in cash, cash equivalents, and restricted cash $ (7,124) $ 20,517

Net cash provided by operating activities for the years ended December 31, 2022 and 2021 was $16.5 million and $7.3 million, respectively.

The cash flow from operating activities is primarily driven by the Company's operating losses, the timing of receipts of customer payments, the timing of payments to vendors and employees, and the timing of inventory turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities.

The $9.2 million increase is due to favorable changes in certain operating assets and liabilities, particularly on receivables.

Net cash used in investing activities for the years ended December 31, 2022 and 2021 was $13.7 million and $19.1 million, respectively.

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

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

Capital expenditures for the year ended December 31, 2022 and 2021, consisted of the capitalization of software development costs of $12.7 million and $10.0 million, respectively, and the purchases of property and equipment of $1.0 million, and $3.2 million, respectively.

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

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

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

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

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

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

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

For the year ended December 31, 2022, net cash used in financing activities was $9.9 million compared to net cash provided by financing activities of $32.3 million in 2021.

This is primarily attributable to payments under finance leases for both periods, payments of tax withholding related to the net share settlement of equity awards of $5.7 million in 2022, and the repurchase of common stock of $11.1 million in 2022 under the Share Repurchase Program, partially offset by the proceeds from the other financing obligations of $9.1 million.

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 to repurchase the outstanding warrants and $1.3 million to repurchase the common stock held by EnCap fund holders.

The Company does not have any other contractual obligations at December 31, 2022, except for the commitments on the existing lease obligations on various office space and equipment under non-cancelable operating and finance leases.

We reported current and long term lease liabilities.

Table MD&A 9:

Contractual Obligations

Payments due by Period

Total 2022 2023 - 2025 2026 - 2028 2029 and later

Total 2023 2024 - 2026 2027 - 2029 Thereafter

(in thousands)

Other financing obligations $ 8,458 $ 1,247 $ 7,211 $ — $ —

Finance lease obligations (1)

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400 373 27 — —

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

Total contract obligations $ 23,976 $ 3,823 $ 14,182 $ 5,971 $ —

(1) Includes interest expense

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

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

We have various lease agreements pursuant to ASC 842, "Leases" that require us to record the present value of the minimum lease payments for such lease properties.

On December 30, 2022, we entered into a revolving credit facility with JPMorgan Chase Bank, N.A.

We had no outstanding balances under the facility as of December 31, 2022 with $30 million of available capacity.

See Note 12 - Debt and Other Obligations , to the Consolidated Financial Statements for information regarding the terms of the facility.

In addition, there were no outstanding commitments that were considered material for capital expenditures on December 31, 2022.

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

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

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

See Note 22 - Commitment and Contingenc ies , to the Consolidated Financial Statements for further discussion of other commitment and contingencies.

Critical Accounting Policies and Estimates

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

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

GAAP requires management to make estimates and assumptions that affect the amounts reported.

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

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

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

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

Typically, the circumstances that make these judgments difficult, subjective and complex have to do with making estimates about the effect of matters that are inherently uncertain;

as a result, actual results could differ from those estimates.

The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements in fiscal year 2022 are described below.

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

Revenue Recognition

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

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

Although most of our revenue is recognized concurrently with billing or with the passage of time, some of our revenue requires us to make estimates.

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

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

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

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

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

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

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

Business Combinations

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

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

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

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

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

During the year ended December 31, 2022, there is no catch-up revenue recognized as a result of changes in contract estimates noted.

Goodwill and Other Long-Lived Assets

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

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

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

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

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

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

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

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We completed the required annual impairment test of goodwill for all reporting units and other long-lived assets as of December 31, 2022, resulting in no impairments.

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

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

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

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Recent Accounting Pronouncements

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

See Note 2 - Significant Accounting Policies of the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

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What changed 10-K

Item 7. Management’s Discussion and Analysis