TELOS CORP 10-Q

Item 1. Financial Statements TELOS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) For the Three Months Ended March 31, 2023 March 31, 2022 (in thousands, except per share amounts) Revenue – services $ 31,534 $ 48,108 Revenue – products 3,688 2,052 Total revenue 35,222 50,160 Cost of sales – services 19,268 29,731 Cost of sales – products 2,472 1,558 Total cost of sales 21,740 31,289 Gross profit 13,482 18,871 Selling, general and administrative expenses Sales and marketing 1,643 5,252 Research and development 2,833 5,430 General and administrative 21,976 24,556 Total selling, general and administrative expenses 26,452 35,238 Operating loss ( 12,970 ) ( 16,367 ) Other income 2,496 12 Interest expense ( 249 ) ( 190 ) Loss before income taxes ( 10,723 ) ( 16,545 ) Provision for income taxes ( 23 ) ( 71 ) Net loss $ ( 10,746 ) $ ( 16,616 ) Net loss per share: Basic $ ( 0.16 ) $ ( 0.25 ) Diluted $ ( 0.16 ) $ ( 0.25 ) Weighted-average shares outstanding: Basic 68,176 67,559 Diluted 68,176 67,559 See accompanying notes to the unaudited consolidated financial statements. 3 Table of Contents TELOS CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited) For the Three Months Ended March 31, 2023 March 31, 2022 (in thousands) Net loss $ ( 10,746 ) $ ( 16,616 ) Other comprehensive loss, net of tax: Foreign currency translation adjustments 13 29 Comprehensive loss $ ( 10,733 ) $ ( 16,587 ) See accompanying notes to the unaudited consolidated financial statements. 4 Table of Contents TELOS CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) March 31, 2023 December 31, 2022 (in thousands, except per share amount and share data) Assets: Cash and cash equivalents $ 112,462 $ 119,305 Accounts receivable, net 34,702 40,069 Inventories, net 1,629 2,877 Prepaid expenses 5,480 4,819 Other current assets 1,042 893 Total current assets 155,315 167,963 Property and equipment, net 4,406 4,787 Finance lease right-of-use assets, net 7,527 7,832 Operating lease right-of-use assets, net 458 341 Goodwill 17,922 17,922 Intangible assets, net 33,801 37,415 Other assets 1,223 1,137 Total assets $ 220,652 $ 237,397 Liabilities and Stockholders' Equity Liabilities: Accounts payable and other accrued liabilities $ 18,011 $ 22,551 Accrued compensation and benefits 7,665 8,388 Contract liabilities 7,203 6,444 Finance lease obligations – current portion 1,625 1,592 Operating lease obligations – current portion 494 361 Other financing obligations – current portion — 1,247 Other current liabilities 3,856 4,919 Total current liabilities 38,854 45,502 Finance lease obligations – non-current portion 10,832 11,248 Operating lease liabilities – non-current portion — 27 Other financing obligations – non-current portion — 7,211 Deferred income taxes 770 758 Other liabilities 301 297 Total liabilities 50,757 65,043 Commitments and contingencies Stockholders’ equity: Common stock, $ 0.001 par value, 250,000,000 shares authorized, 69,388,256 shares and 67,431,632 shares issued and outstanding as of March 31, 2023 and December 31, 2022, respectively 108 106 Additional paid-in capital 420,980 412,708 Accumulated other comprehensive income ( 42 ) ( 55 ) Accumulated deficit ( 251,151 ) ( 240,405 ) Total stockholders’ equity 169,895 172,354 Total liabilities and stockholders’ equity $ 220,652 $ 237,397 See accompanying notes to the unaudited consolidated financial statements. 5 Table of Contents TELOS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Three Months Ended March 31, 2023 March 31, 2022 (in thousands) Cash flows from operating activities: Net loss $ ( 10,746 ) $ ( 16,616 ) Adjustments to reconcile net loss to cash (used in)/provided by operating activities: Stock-based compensation 9,499 15,931 Depreciation and amortization 1,425 1,405 Deferred income tax provision 12 12 Accretion of discount in acquisition holdback 2 12 Loss on disposal of fixed assets 1 — Provision for doubtful accounts 89 95 Amortization of debt issuance costs 17 — Gain on early extinguishment of other financing obligations ( 1,427 ) — Changes in other operating assets and liabilities: Accounts receivable 5,279 2,014 Inventories 1,248 ( 850 ) Prepaid expenses, other current assets, other assets ( 927 ) ( 3,563 ) Accounts payable and other accrued payables ( 4,489 ) 674 Accrued compensation and benefits ( 364 ) 495 Contract liabilities 758 655 Other current liabilities ( 477 ) ( 15 ) Net cash (used in)/provided by operating activities ( 100 ) 249 Cash flows from investing activities: Capitalized software development costs ( 3,800 ) ( 2,795 ) Purchases of property and equipment ( 223 ) ( 546 ) Payment of DFT holdback amount ( 564 ) — Net cash used in investing activities ( 4,587 ) ( 3,341 ) Cash flows from financing activities: Payments under finance lease obligations ( 383 ) ( 351 ) Payment of tax withholding related to net share settlement of equity awards ( 1,520 ) ( 2,886 ) Repurchase of common stock ( 139 ) — Payments for debt issuance costs ( 114 ) — Net cash used in financing activities ( 2,156 ) ( 3,237 ) Net change in cash, cash equivalents, and restricted cash ( 6,843 ) ( 6,329 ) Cash, cash equivalents, and restricted cash, beginning of period 119,438 126,562 Cash, cash equivalents, and restricted cash, end of period $ 112,595 $ 120,233 See accompanying notes to the 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 Accumulated Deficit Total Stockholders’ Equity Shares Amount (in thousands) Balance at December 31, 2022 67,431 $ 106 $ 412,708 $ ( 55 ) $ ( 240,405 ) $ 172,354 Net loss — — — — ( 10,746 ) ( 10,746 ) Foreign currency translation gain — — — 13 — 13 Restricted stock unit awards vested, net of shares withheld to cover tax withholding 1,180 1 ( 1,585 ) — — ( 1,584 ) Stock-based compensation — 7,916 — — 7,916 Issuance of common stock for 401K match 777 1 1,941 — — 1,942 Balance at March 31, 2023 69,388 $ 108 $ 420,980 $ ( 42 ) $ ( 251,151 ) $ 169,895 Balance at December 31, 2021 66,767 $ 105 $ 367,153 $ ( 27 ) $ ( 186,977 ) $ 180,254 Net loss — — — — ( 16,616 ) ( 16,616 ) Foreign currency translation loss — — — 29 — 29 Restricted stock unit awards vested, net of shares withheld to cover tax withholding 1,100 1 ( 2,887 ) — — ( 2,886 ) Stock-based compensation — — 14,280 — — 14,280 Balance at March 31, 2022 67,867 $ 106 $ 378,546 $ 2 $ ( 203,593 ) $ 175,061 See accompanying notes to the 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 sells 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 Basis of Presentation and Principle of Consolidation The accompanying unaudited consolidated financial statements include the accounts of Telos and its subsidiaries (see Note 1 – Organization ), 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. 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, 2022, 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. Basis of Comparison - Revision of Previously Issued Interim Financial Statements During the course of preparing the Company's consolidated financial statements for the year ended December 31, 2022, we identified that stock-based compensation expense related to performance-based restricted stock unit (“PSU”) awards with market conditions was erroneously reversed when those PSUs were forfeited during the quarter ended March 31, 2022. Although the Company has determined that the error did not have a material impact on its previously issued interim consolidated financial statements, it revised the previously reported interim financial information in conjunction with the issuance of its quarterly filings on Form 10-Q for the quarter ended March 31, 2023. Further information regarding the misstatements and related revisions are included under N ote 20 – Revision of P rior Year Interim Financial Statements to the unaudited consolidated financial statements. 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. Management evaluates these estimates and assumptions on an ongoing basis, including those relating to revenue recognition on cost estimation on certain contracts, allowance for credit losses, inventory obsolescence, valuation allowance for deferred tax assets, income taxes, certain assumptions related to share-based compensation, valuation of intangible assets and goodwill, restructuring expenses accruals, and contingencies. Actual results could differ from those estimates. The impact of changes in estimates is recorded in the period in which they become known. 8 Table of Contents Restructuring Expenses In the fourth quarter of 2022, the Company committed to a restructuring plan to streamline its workforce and spending to better align its cost structure with its volume of business. The restructuring plan reduced the Company's workforce, with a majority of the affected employees separating from the business in early 2023. In connection with this restructuring plan, we incurred restructuring-related costs, including employee severance and related benefit costs. Employee severance and related benefit costs may include cash payments, outplacement services and continuing health insurance coverage. Severance costs pursuant to ongoing-benefit arrangements are recognized when probable and reasonably estimated. Other related costs include external consulting and advisory fees related to implementing the restructuring plan. These costs are recognized at fair value in the period in which the costs are incurred. In the Company's recent Annual Report on Form 10-K for the year ended December 31, 2022, the Company estimated that the expected restructuring expenses were $ 2.8 million as of December 31, 2022. As of March 31, 2023, the Company has updated its total expected restructuring plan costs to $ 4.0 million. The Company reviews the restructuring plan and may incur incremental restructuring costs during the remainder of 2023 when determined as probable and estimable. The restructuring expenses are recorded under "Selling, general and administrative expenses" in the Company's unaudited consolidated statements of operations. At each reporting date, the Company evaluates its restructuring expense accrual to determine if the liabilities reported are still appropriate. Any changes in the estimated costs of executing the approved restructuring plan are reflected in the Company's unaudited consolidated statement of operations. Table 2: Summary of Changes in Restructuring Expenses Accrual Severance and related benefit costs (1) Other related costs (1) Total (in thousands) Balance at December 31, 2022 $ 2,763 $ — $ 2,763 Charges/(adjustments) ( 100 ) 1,300 1,200 Cash payments ( 1,673 ) — ( 1,673 ) Balance at March 31, 2023 $ 990 $ 1,300 $ 2,290 (1) Restructuring-related liabilities are reported as part of "Other current liabilities" in the Company's unaudited consolidated balance sheets, see Note 9 - Other Balance Sheet Components for further details. Recent Accounting Pronouncements From time to time, new accounting standards are issued by the Financial Accounting Standard Board or other standard-setting bodies and are adopted by the Company as of the specified accounting date. Unless otherwise discussed, the Company believes that issued standards not yet effective will not have a material effect on its financial statements. 3. 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, 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. Revenue transferred to customers over time accounted for 89 % and 96 % of our revenue for the three months ended March 31, 2023 and 2022, 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. For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at the point in time in which each performance obligation is fully satisfied. This coincides with the point in time the customer obtains control of the product or service, which typically occurs upon customer acceptance or receipt of the product or service, given that we maintain control of the product or service until that point. Revenue transferred to customers at a point in time accounted for 11 % and 4 % of our revenue for the three months ended March 31, 2023 and 2022, respectively. Orders for the sale of software licenses may contain multiple performance obligations, such as maintenance, training, or consulting services, which are typically delivered over time, consistent with the transfer of control disclosed above for the provision of services. When an order contains multiple performance obligations, we allocate the transaction price to the performance obligations based on the standalone selling price of the product or service underlying each performance obligation. The standalone selling price represents the amount we would sell the product or service to a customer on a standalone basis. 9 Table of Contents 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 exceeds the total estimated revenue for a performance obligation. No contract losses were recorded during the three months ended March 31, 2023 and 2022. Disaggregated Revenues In addition to our segment reporting, as further discussed in Note 1 7 – Segment Information , we disaggregate our revenues by customer and contract types. We treat sales to U.S. customers as sales within the U.S. regardless of where the services are performed. Substantially most of our revenues are generated from U.S. customers, while international customers are de minimis; as such, the financial information by geographic location is not presented. Table 3.1: Revenue by Customer Type For the Three Months Ended March 31, 2023 March 31, 2022 Amount % Amount % (dollars in thousands) Federal $ 32,989 94 % $ 47,843 95 % State & local, and commercial 2,233 6 % 2,317 5 % Total revenue $ 35,222 100 % $ 50,160 100 % Table 3.2: Revenue by Contract Type For the Three Months Ended March 31, 2023 March 31, 2022 Amount % Amount % (dollars in thousands) Firm fixed-price $ 27,013 77 % $ 41,277 82 % Time-and-materials 3,556 10 % 2,916 6 % Cost plus fixed fee 4,653 13 % 5,967 12 % Total revenue $ 35,222 100 % $ 50,160 100 % Table 3.3: Revenue Concentration Greater than 10% of Total Revenue For the Three Months Ended March 31, 2023 March 31, 2022 U.S. Department of Defense ("DoD") 68 % 71 % Civilian 26 % 24 % Table 3.4: Contract Balances Balance Sheet Presentation March 31, 2023 December 31, 2022 (in thousands) Billed accounts receivables (1) Accounts receivable, net $ 18,297 $ 13,521 Unbilled accounts receivable Accounts receivable, net 4,658 11,657 Contract assets Accounts receivable, net 11,747 14,891 Contract liabilities Contract liabilities 7,203 6,444 (1) Net of allowance for credit losses. The significant change in the Company's contract assets and contract liabilities during the current period was primarily the result of the timing differences between the Company's performance, invoicing and customer payments. Revenue recognized for the three months ended March 31, 2023 and 2022, that was included in the contract liabilities balance at the beginning of each reporting period was $ 2.5 million and $ 2.5 million, respectively. As of March 31, 2023, we had approximately $ 77.4 million of remaining performance obligations, which we also refer to as funded backlog. We expect to recognize approximately 70 % of our remaining performance obligations as revenue in 2023, an additional 29 % in 2024, and the balance thereafter. 10 Table of Contents 4. ACCOUNTS RECEIVABLE, NET Table 4: Details of Accounts Receivable, Net March 31, 2023 December 31, 2022 (in thousands) Billed accounts receivable $ 18,520 $ 13,655 Unbilled accounts receivable 4,658 11,657 Contract assets 11,747 14,891 Allowance for credit losses (1) ( 223 ) ( 134 ) Accounts receivable, net $ 34,702 $ 40,069 (1) Includes provision for credit losses, net of recoveries. 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 and unbilled accounts receivable as of March 31, 2023 were directly with U.S. government customers. While we acknowledge the potential material and adverse risk of such a significant concentration of credit risk, our past experience collecting substantially all of such receivables provides us with an informed basis that such risk, if any, is manageable. We perform ongoing credit evaluations of all of our customers and generally do not require collateral or other guarantee from our customers. We maintain allowances for potential losses. 5. INVENTORIES, NET Table 5: Details of Inventories, Net March 31, 2023 December 31, 2022 (in thousands) Gross inventory $ 2,394 $ 3,642 Allowance for inventory obsolescence ( 765 ) ( 765 ) Inventories, net $ 1,629 $ 2,877 6. PROPERTY AND EQUIPMENT, NET Table 6: Details of Property and Equipment, Net March 31, 2023 December 31, 2022 (in thousands) Furniture and equipment $ 16,104 $ 16,033 Leasehold improvement 3,171 3,145 Property and equipment, at cost 19,275 19,178 Accumulated depreciation and amortization ( 14,869 ) ( 14,391 ) Property and equipment, net $ 4,406 $ 4,787 Depreciation and amortization expense was $ 0.6 million for both three months ended March 31, 2023 and 2022, respectively. 7. GOODWILL The goodwill balance was $ 17.9 million as of March 31, 2023, and December 31, 2022, 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 recorded for the three months ended March 31, 2023 and 2022 . 11 Table of Contents 8. INTANGIBLE ASSETS, NET Table 8: Details of Intangible Assets, Net March 31, 2023 December 31, 2022 Estimated Useful Life Gross Carrying Amount Accumulated Amortization Net Carrying Value Gross Carrying Amount Accumulated Amortization Net Carrying Value (in years) (in thousands) Acquired technology 8 $ 3,630 $ ( 756 ) $ 2,874 $ 3,630 $ ( 643 ) $ 2,987 Customer relationship 3 40 ( 22 ) 18 40 ( 19 ) 21 Software development costs 2 - 5 39,005 ( 8,096 ) 30,909 35,080 ( 7,793 ) 27,287 Subtotal 42,675 ( 8,874 ) 33,801 38,750 ( 8,455 ) 30,295 Software held for resale (1) — — $ — 7,120 — $ 7,120 Total $ 42,675 $ ( 8,874 ) $ 33,801 $ 45,870 $ ( 8,455 ) $ 37,415 (1) This amount is net of $ 0.6 million charged into cost for sales for the period ended December 31, 2022. See Note 10 – Debt and Other Obligations for related details. Amortization expense related to capitalized software development costs was $ 0.3 million for both three months ended March 31, 2023 and 2022. Amortization expense related to other intangible assets was $ 0.1 million for both three months ended March 31, 2023 and 2022. 9. OTHER BALANCE SHEET COMPONENTS Table 9.1: Details of Accounts Payable and Other Accrued Liabilities March 31, 2023 December 31, 2022 (in thousands) Accounts payable $ 11,683 $ 12,606 Accrued payables 6,328 9,945 Accounts payable and other accrued liabilities $ 18,011 $ 22,551 Table 9.2: Details of Other Current Liabilities March 31, 2023 December 31, 2022 (in thousands) Other accrued expenses $ 874 $ 1,530 Restructuring expenses accrual 2,290 2,763 Other 692 626 Other current liabilities $ 3,856 $ 4,919 10. DEBT AND OTHER OBLIGATIONS Revolving Credit Facility On December 30, 2022 (the "Closing Date"), we entered into a Credit Agreement (the "Credit Agreement"), by and among the Company, as borrower, Xacta Corporation, ubIQuity.com. inc, Teloworks, Inc., and Telos Identity Management Solutions, LLC, as guarantors, the lenders' party thereto (the "Lenders"), and JPMorgan Chase Bank N.A., as administrative agent for the Lenders (in such capacity, the "Agent"). The Credit Agreement provides for a $ 30.0 million senior secured revolving credit facility with a maturity date of December 30, 2025, with the option of issuing letters of credit thereunder with a sub-limit of $ 5.0 million, and with an uncommitted expansion feature of up to $ 30.0 million of additional revolver capacity (the "Loan"). The Loan is subject to acceleration in the event of customary events of default. The Company has not drawn any amount under the Loan. 12 Table of Contents Borrowings under the Credit Agreement will accrue interest, at our option, at one of three variable rates, plus a specified margin. We can elect to borrow 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 %, as such capitalized terms are defined and calculated in the Credit Agreement. The Company may elect to convert borrowings from one type of borrowing to another type per the terms of the Credit Agreement. After the occurrence and during the continuance of any event of default, the interest rate may increase by an additional 2.0 %. We are obligated to pay accrued interest (i) with respect to amounts accruing interest based on the Alternative Base Rate, each calendar quarter and on the maturity date, (ii) with respect to amounts accruing interest based on Adjusted Daily Simple SOFR, on each one-month anniversary of the borrowing and on the maturity date, and (iii) with respect to amounts accruing interest based on Adjusted Term SOFR, at the end of the period specified per the Credit Agreement and on the maturity date. Upon five, three, or one day's prior notice, as applicable, we may prepay any portion or the entire amount of the Loan. We also paid 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 Loan under the Credit Agreement is collateralized by substantially all of the Company's assets, including the Company's pledge of its domestic and material foreign subsidiary equity interests. The Loan has various covenants that may, among other things, affect our ability to create, incur, assume or suffer any indebtedness, merge into or consolidate with another entity, acquire entity interests, sell or transfer certain assets, enter into certain arrangements (such as sale and leaseback and swap agreements) or restrictive agreements, pay dividends and make certain restricted payments, and amend material documents related to any subordinated indebtedness and corporate agreements. The Credit Agreement also requires certain financial covenants to maintain a Senior Leverage Ratio on the last day of any fiscal quarter, no greater than 3 to 1. We were in compliance with all covenants as of March 31, 2023. 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. On April 12, 2023, the Credit Agreement was amended to exclude from collateral the (i) amount collectible from a third party related to an Accounts Receivable Purchase Agreement and (ii) receivables generated by the Company from the sale of goods supplied to this third party in an amount not to exceed $ 25.0 million. Other Financing Obligations We entered into a Master Purchase Agreement ("MPA") with a third-party buyer ("Buyer") for $ 9.1 million 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 , net for further details. On February 9, 2023, the customer notified us 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. Concurrently, the Company transferred all the rights, title and interest in the underlying licenses in exchange for the extinguishment of the outstanding financing obligations. The Company evaluated the transfer of the underlying licenses as consideration paid for the outstanding financing obligations under ASC 470-10, Debt , and the provisions of the MPA, and concluded that the transaction resulted in an extinguishment of debt. The Company recorded the difference between the carrying value of the Company's debt instrument and the underlying licenses as a gain on early extinguishment of other financing obligations. During the three months ended March 31, 2023, the Company reported a gain of $ 1.4 million, which was recorded as "Other income" in the unaudited consolidated statements of operations. 11. 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. On February 2, 2023, the Company paid DFT the holdback amount of $ 0.6 million. 13 Table of Contents 12. STOCK-BASED COMPENSATION The Company grants stock-based compensation awards under the 2016 Omnibus Long-Term Incentive Plan, as amended (the "2016 LTIP"). We may grant restricted stock awards ("RSA"), restricted stock units with time-based vesting ("RSUs") and PSUs. 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, which has the discretion to establish the terms, conditions and criteria of the various awards. The RSUs granted to eligible employees generally vest in installments over a period of up to three years. PSUs will vest upon the achievement of a defined performance target or market conditions for the Company's common stock, certain operational milestones over prescribed period, or at the end of the defined performance period from the date of grant. 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 March 31, 2023 March 31, 2022 (in thousands) Cost of sales – services $ 326 $ 1,007 Sales and marketing 58 1,668 Research and development 770 1,295 General and administrative 8,345 11,961 Total $ 9,499 $ 15,931 Table 12.2: Restricted Stock Activity Service-Based Performance-Based Total Shares Weighted-Average Grant Date Fair Value Unvested outstanding units as of December 31, 2022 3,570,082 336,785 3,906,867 $ 19.53 Granted 205,540 — 205,540 3.87 Vested ( 1,535,288 ) — ( 1,535,288 ) 26.71 Forfeited ( 370,807 ) ( 71,177 ) ( 441,984 ) 14.66 Unvested outstanding units as of March 31, 2023 1,869,527 265,608 2,135,135 $ 14.67 As of March 31, 2023, the intrinsic value of the RSUs and PSUs outstanding, exercisable, and vested or expected to vest was $ 5.4 million. There was approximately $ 15.2 million of total compensation costs related to stock-based awards not yet recognized as of March 31, 2023, which is expected to be recognized on a straight-line basis over a weighted-average remaining vesting period of 0.9 years. 13. SHARE REPURCHASES On May 24, 2022, the Company announced that the Board of Directors approved a new share repurchase program ("SRP") authorizing the Company to repurchase up to $ 50.0 million of its common stock. Pursuant to this authorization, the Company may repurchase shares of its common stock on a discretionary basis from time to time through open market purchases. The repurchase program has no expiration date and may be modified, suspended, or terminated at any time. There were no share purchases during the first quarter of 2023 and 2022. As of March 31, 2023, there was approximately $ 38.7 million of the authorization remaining for future common stock repurchases under the SRP. 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. 14 Table of Contents Table 14: Details of Accumulated Other Comprehensive Loss March 31, 2023 December 31, 2022 (in thousands) Cumulative foreign currency translation loss $ ( 149 ) $ ( 162 ) Cumulative actuarial gain on pension liability adjustment 107 107 Accumulated other comprehensive loss $ ( 42 ) $ ( 55 ) 15. LOSS PER SHARE 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 March 31, 2023 March 31, 2022 (in thousands) Unvested restricted stock and restricted stock units 410 — Total 410 — For the three months ended March 31, 2023 and 2022, PSUs in the amount of 265,608 and 439,786 , respectively, have been excluded from the calculation of potentially dilutive securities above because the issuance of shares is contingent upon the satisfaction of certain conditions which were not satisfied by the end of the period. 16. RELATED PARTY TRANSACTIONS Emmett J. Wood, the brother of our Chairman and CEO, had been an employee of the Company since 1996. The amounts paid to him as compensation were $ 249,000 and $ 512,000 for the three months ended March 31, 2023 and 2022, respectively. Additionally, Mr. Wood owned 199,785 and 178,041 shares of the Company’s common stock as of March 31, 2023 and December 31, 2022, respectively. In January 2023, he tendered his resignation as an employee effective February 7, 2023. One of the Company’s directors serves as a consultant to the Company. On January 1, 2023, the director and the Company amended the consulting agreement under which he provides services ("2023 consulting agreement"), extending his services through June 30, 2023, with the option to further extend for another six months by mutual agreement of the parties. The Company, at its election, would pay the director's 2023 consultancy fees in a fixed amount, in the form of restricted stock units. On January 3, 2023, the Company granted the director 16,859 RSUs for his consulting services, one-half of which vested on March 3, 2023, and the other half vesting on or about May 18, 2023, subject to the director's continued performance under the 2023 consulting agreement. During the three months ended March 31, 2022, the Company paid $ 25,000 , and granted him 26,091 RSUs on February 1, 2022, for his consulting services in 2022, which RSUs vested quarterly in four equal amounts through the end of the year. 17. SEGMENT INFORMATION We operate our business in two reportable and operating segments: Security Solutions and Secure Networks. These segments enable the alignment of our strategies and objectives and provide a framework for the timely and rational allocation of resources within the business lines. Our Security Solutions segment is primarily focused on cybersecurity, cloud and identity solutions, and secure messaging through Xacta ® , Telos Ghost ® , Telos Advanced Cyber Analytics ("Telos ACA"), 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 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. Our 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. 15 Table of Contents Table 17: Results of Operations by Business Segment For the Three Months Ended March 31, 2023 March 31, 2022 (in thousands) Revenues Security Solutions $ 19,773 $ 26,919 Secure Networks 15,449 23,241 Total revenue 35,222 50,160 Gross profit Security Solutions 10,274 15,051 Secure Networks 3,208 3,820 Total gross profit 13,482 18,871 Selling, general and administrative expenses 26,452 35,238 Operating loss ( 12,970 ) ( 16,367 ) Other income 2,496 12 Interest expense ( 249 ) ( 190 ) Loss before income taxes ( 10,723 ) ( 16,545 ) Provision for income taxes ( 23 ) ( 71 ) Net loss $ ( 10,746 ) $ ( 16,616 ) 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. COMMITMENTS AND CONTINGENCIES Legal Proceedings On February 7, 2022, Telos and certain of its current and former officers were named as defendants in a lawsuit filed in the United States District Court for the Eastern District of Virginia ("Court"). 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. On February 1, 2023, the Court dismissed the lawsuit in its entirety for failure to state a claim. The Court's order of dismissal provided the Plaintiffs twenty-one days within which to file a motion for leave to file an amended complaint, should they have a good faith basis to do so. On March 1, 2023, the Plaintiffs filed a motion for leave to file an amended complaint, and on March 13, 2023, the Court granted the parties' consent motion permitting the filing of a consolidated amended class action complaint and establishing a briefing schedule for Telos' forthcoming motion to dismiss that amended complaint. On April 14, 2023, Telos moved to dismiss the consolidated amended class action complaint. The Company does not believe that there are claims or proceedings that would have a material adverse effect on the business, or the unaudited consolidated financial statements of the Company as of March 31, 2023. 16 Table of Contents 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. 19. SUPPLEMENTAL CASH FLOW INFORMATION Table 19.1: Details of Cash, Cash Equivalents, and Restricted Cash March 31, 2023 December 31, 2022 (in thousands) Cash and cash equivalents $ 112,462 $ 119,305 Restricted cash (1) 133 133 Cash, cash equivalents, and restricted cash $ 112,595 $ 119,438 (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 unaudited consolidated balance sheets. Table 19.2: Supplemental Cash Flow Information For the Three Months Ended March 31, 2023 March 31, 2022 (in thousands) Cash paid during the period for: Interest $ 219 $ 179 Non-cash investing and financing activities: Operating lease ROU assets obtained in exchange for operating lease liabilities $ 117 $ 147 Capital expenditure activity in accounts payable and other accrued liabilities 273 — Withholding tax on net share settlement under other current liabilities 65 — Issuance of common stock for 401K match 1,942 — Intangible assets transferred to extinguish the other financing obligations 7,089 — 20. REVISION OF PRIOR YEAR INTERIM FINANCIAL STATEMENTS During the course of preparing the Company's consolidated financial statements for the year ended December 31, 2022, we identified that stock-based compensation expense related to the PSU awards with market conditions was erroneously reversed when those PSUs were forfeited during the quarter ended March 31, 2022. Due to the error, general and administrative expense was understated by $ 1.6 million in the first quarter of 2022. Although the Company has determined that the error did not have a material impact on its previously issued interim consolidated financial statements, it revised the previously reported interim financial information in conjunction with the issuance of its quarterly filings on Form 10-Q for the quarter ended March 31, 2023. The errors had no net impact on cash flows from operating, investing or financing activities in the consolidated statement of cash flows. 17 Table of Contents The following tables set forth the effects of the revisions of previously issued unaudited quarterly consolidated financial statements to correct for prior period error. Table 20.1: Impact of the Correction to the Unaudited Consolidated Statement of Operations For the Three Months Ended March 31, 2022 As Previously Reported Adjustment As Revised (in thousands, except per share data) General and administrative $ 22,923 $ 1,633 $ 24,556 Total selling, general and administrative expenses 33,605 1,633 35,238 Operating loss ( 14,734 ) ( 1,633 ) ( 16,367 ) Loss before income taxes ( 14,912 ) ( 1,633 ) ( 16,545 ) Net loss ( 14,983 ) ( 1,633 ) ( 16,616 ) Net loss per share, basic $ ( 0.22 ) $ ( 0.03 ) $ ( 0.25 ) Net loss per share, diluted $ ( 0.22 ) $ ( 0.03 ) $ ( 0.25 ) Table 20.2: Impact of the Correction to the Unaudited Consolidated Statement of Comprehensive Loss For the Three Months Ended March 31, 2022 As Previously Reported Adjustment As Revised (in thousands) Net loss $ ( 14,983 ) $ ( 1,633 ) $ ( 16,616 ) Comprehensive loss ( 14,954 ) ( 1,633 ) ( 16,587 ) Table 20.3: Impact of the Correction to the Unaudited Consolidated Statement of Changes in Stockholders' Equity For the Three Months Ended March 31, 2022 As Previously Reported Adjustment As Revised (in thousands) Stock-based compensation $ 12,647 $ 1,633 $ 14,280 Additional paid-in capital, end 376,913 1,633 378,546 Net loss $ ( 14,983 ) $ ( 1,633 ) $ ( 16,616 ) Accumulated deficit, end ( 201,960 ) ( 1,633 ) ( 203,593 ) 18 Table of Contents