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Item 7. Management’s Discussion and Analysis

2024-03-15 compared with 2023-03-16 · 200 added, 202 removed, 190 unchanged (68% 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 " 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 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.

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

Our business performance continues to be heavily affected by the overall level of U.S.

government spending and the alignment of our solutions with the priorities of the U.S.

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

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

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, 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, 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.

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.

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.

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

In this section, we discuss our financial condition, changes in financial condition and results of operations for the year ended December 31, 2023, compared to the year ended December 31, 2022.

Business Overview

For an overview of our business, including our business segments and discussion of our products and services we provide, see Item 1, " Business " of this Annual Report on Form 10-K.

Additional information regarding our segments is also presented in Note 1 8 – Segment Information to the consolidated financial statements at Item 8 of this Form 10-K.

Opportunities, Challenges and Risks

We derive a substantial portion of our revenues from contracts and subcontracts with the U.S.

As discussed under Item 1A, " Risk Factor s ", we derive a substantial portion of our revenues from contracts and subcontracts with the U.S.

Our revenues are generated from a number of contract vehicles and task orders.

Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product reselling to that of an advanced solutions technologies provider.

To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and delivering Telos manufactured and branded technologies.

government has increasingly relied on contracts that are subject to a competitive bidding process (including 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.

Over the past several years we sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product reselling to that of an advanced solutions technologies provider.

Although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and delivering Telos manufactured and branded technologies.

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 products and services at established contract prices.

Our firm-fixed-price activities consist primarily 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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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.

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.

Business Environment

Congress has been unable to complete action on all appropriations bills for Fiscal Year ("FY") 2024, which began on October 1, 2023.

Instead, Congress has resorted to approving a series of continuing resolutions (“CRs”), which have funded the government at FY2023 levels for over five months with no new program starts.

Some appropriations bills were finally approved in early March 2024, but most federal spending remains under a CR.

This means the President’s proposed three percent increase in defense spending, which was also provided for by the spending caps contained in the debt ceiling legislation (the "Fiscal Responsibility Act”) signed into law last June 2023, have so far not been approved.

The FY2024 National Defense Authorization Act enacted in December 2023 does not authorize that propose three percent hike in defense spending, but actual appropriated defense spending has remained at FY2023 levels under these CRs, and it will continue to be frozen until a full-year defense appropriations bill can be signed into law.

The President's FY2024 budget also proposed increased investments for cybersecurity within numerous federal civilian departments and agencies.

In general, the President's budget reflected the prioritization of accelerated cloud adoption, IT modernization, further private sector collaboration for sector risk management responsibilities, ensuring adequate cyber threat information sharing, and supply chain risk management.

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

However, as with defense spending, these proposed increases have remained on hold until Congress can agree on full-year FY2024 appropriation legislation for all department and agencies.

Even if Congress finally reaches agreement on the remaining FY2024 appropriations bills in March 2024, that will leave less than seven months for federal agencies to execute any increased spending levels these measures provide.

Finally, submission to Congress of the Biden Administration's proposed FY2025 budget was delayed until March 11, 2024 – a month later than normal – in large part because lawmakers have been unable to complete work on FY2024 appropriations legislation.

Such final bills would normally serve as a detailed baseline from which the White House would develop next year's proposed budget.

This failure to approve the FY2024 appropriations legislation in a timely manner and the resultant uncertainty about actual funding has impacted federal customers' ability to move forward on their planned expenditures in FY2024, and to adequately plan for FY2025.

Cybersecurity Landscape

In recent years, we have seen cybersecurity threats become more complex, with threat actors leveraging a wide variety of tactics to exploit their victims.

With this growing threat, below are some trends to consider when looking at the cybersecurity landscape:

Rising Threats, Rising Liability:

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

One reason for the rise of ransomware attacks is that it is exceedingly profitable for cybercriminals, and ransomware victims generally settle the ransom rather than restoring the system from backups or dealing with the fallout from a data breach.

Aside from the financial costs of paying the ransom and restoring the system, the consequences of a successful ransomware attack can include damage to the organization's reputation, stolen sensitive data being used for malicious purposes, and loss of business.

The Nation's Critical Systems Are Still at Risk:

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

The Challenging Complexity of Regulatory Compliance:

Government mandates stronger security in highly regulated industries.

These government initiatives and audit fatigue continue to burden highly regulated organizations, with automation solutions being recognized as the most effective remedy for the many repetitive and redundant tasks that security compliance requires.

Additionally, the SEC has finalized and adopted new cybersecurity rules for publicly traded companies, which will require registrants to disclose additional cyber-related information in their regulatory filings.

Specifically, they will have to:

(1) regularly disclose their governance methods, risk analysis and management processes;

(2) meet specific disclosure requirements and deadlines for reporting and describing material cyber incidents;

and (3) describe the board's oversight of risks from cybersecurity threats, and management's expertise and role in assessing and managing material risks from cybersecurity threats.

The required reporting of this information will lead many companies to proactively establish policies that will improve their cyber risk management posture and enable them to better withstand heightened public and regulatory scrutiny.

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.

Artificial Intelligence :

Cybercriminals are using Artificial Intelligence ("AI") to launch more sophisticated attacks that can quickly adapt to changing environments, making detection harder.

To protect against AI-powered cyberattacks, organizations must stay vigilant and adopt advanced cybersecurity tools and techniques that can detect and respond to these threats timely before they can cause damage.

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.

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Total backlog $ 118,102 $ 212,043

Financial Overview

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

Increases in backlog is a result from the award of new contracts and the renewal or extension of existing contracts.

Reductions in backlog arises from the completion or the early termination of contracts.

See the relevant industry, legal and regulatory risks under Item 1A, "Risk Factors", of this Annual Report on Form 10-K.

We believe that comparisons of backlog period-to-period are difficult.

We also believe that it is difficult to predict future revenue solely based on analysis of backlog.

The actual timing of revenue from projects included in backlog will vary.

Financial Highlights

A number of factors have affected our fiscal year 2023 results, the most significant of which we have listed 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

The primary financial performance measures we use to manage our business and monitor results of operations are revenue, gross profit, and Adjusted EBITDA.

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

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.

Changes in operating cash flows are driven by changes in cash generated through delivery of products and services, fluctuations in current assets and liabilities and the impact of changes in the timing of cash receipts or disbursements.

• The successful completion of certain programs, lower revenue on ongoing major programs and the loss of a program resulted in a decline in fiscal year 2023 compared with 2022 results, partially offset by some new program wins across the portfolio and the ramp of TSA PreCheck.

• TSA announced Telos Corporation as TSA's second official TSA PreCheck enrollment and renewal provider in August 2023.

• Operating costs were lower, in part, as a result of the restructuring plan announced in the first quarter of 2023.

• Lower operating costs resulted in an improvement in profitability and earnings per share.

Results of Operations

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For the Year Ended December 31,

2022 2021 Change ($)

(dollars in thousands)

Revenue $ 145,378 $ 216,887

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

Cost of sales (excluding depreciation and amortization) 88,892 137,051

Depreciation and amortization 3,544 793

Total cost of sales 92,436 137,844

Gross profit 52,942 79,043

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Operating loss (40,315) (53,850)

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

Other income 6,715 1,350

Interest expense (786) (874)

Loss before income taxes (34,386) (53,374)

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

Provision for income taxes (36) (54)

Net loss $ (34,422) $ (53,428)

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.

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.

Selling, general, and administrative ("SG&A") .

SG&A expenses decreased by $39.6 million, or 29.8%, in 2023 compared to 2022.

Sales and marketing expenses decreased by $9.5 million primarily due to lower compensation-related expenses.

Research and development expenses decreased by $4.7 million primarily due to lower compensation-related expenses and increased capitalization of software development by $1.9 million.

General and administrative expenses also decreased by $25.5 million mostly due to lower compensation-related expenses.

Other income .

Other income increased by $5.4 million in 2023, compared to 2022, primarily due to an increase in dividend income from money market placements of $3.9 million, and a gain on early extinguishment of other financing obligation of $1.4 million in 2023, without a similar gain in 2022.

Interest expense .

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.

Provision for income taxes.

There was no significant change in the provision for income taxes in 2023, compared to 2022.

Segment Results

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For the Year Ended December 31,

2022 2021 Change ($)

(dollars in thousands)

Revenues $ 77,416 $ 120,454

Cost of sales (excluding depreciation and amortization) 34,270 57,743

Depreciation and amortization 3,532 763

Total cost of sales 37,802 58,506

Gross profit $ 39,614 $ 61,948

Gross margin 51.2 % 51.4 %

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.

Our Security Solutions segment revenue decreased by $43.0 million or 35.7% in fiscal year 2023, compared to fiscal year 2022, primarily due to lower revenues on ongoing programs and the loss of a program, partially offset by some new program wins and the initial ramp of the TSA PreCheck program.

Likewise, the segment gross profit decreased by $22.3 million or 36.1% in 2023, compared to 2022, primarily due to the decrease in revenue.

Segment gross margin slightly decreased from 51.4% in 2022 to 51.2% in 2023 primarily due to higher amortization of software development costs, offset by high margin new program wins, mix within the portfolio and lower stock-based compensation.

Table MD&A 4:

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For the Year Ended December 31,

2022 2021 Change ($)

(dollars in thousands)

Revenues $ 67,962 $ 96,433

Cost of sales (excluding depreciation and amortization) 54,622 79,308

Depreciation and amortization 12 30

Total cost of sales 54,634 79,338

Gross profit $ 13,328 $ 17,095

Gross margin 19.6 % 17.7 %

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.

Our Secure Networks segment revenue decreased by $28.5 million, or 29.5%, in 2023, compared to 2022, primarily due to the successful completion of certain programs and lower revenues on ongoing programs as expected, partially offset by new program wins.

Segment gross profit decreased by $3.8 million or 22.0% in 2023, compared to 2022, primarily due to lower revenue, partially offset by higher gross margins.

Segment gross margin increased from 17.7% in 2022 to 19.6% in 2023 primarily due to strong program and cost management across several key programs.

Key Performance Measures

The primary financial performance measures we use to manage our business and monitor results of operations are revenue, gross profit, and Adjusted EBITDA.

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

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

Non-GAAP Measures

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

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.

GAAP, we believe the non-GAAP financial measures of EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net (Loss)/Income, Adjusted Earnings Per Share ("EPS"), Cash Gross Profit, Cash Gross Margin 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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A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP.

We use the following non-GAAP financial measures to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, to develop short-term and long-term operating plans, and to evaluate the performance of certain management personnel when determining incentive compensation.

We believe these non-GAAP financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionate positive or negative impact on our results of operations in any particular period.

We believe these non-GAAP financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionately positive or negative impact on our results of operations in any particular period.

When viewed in combination with our results prepared in accordance with GAAP, these non-GAAP financial measures help provide a broader picture of factors and trends affecting our results of operations.

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.

EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin

EBITDA, Adjusted EBITDA, EBITDA Margin 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 (income)/expense, interest expense, provision for/(benefit from) income taxes, and depreciation and amortization.

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

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

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

We believe that EBITDA, EBITDA Margin, Adjusted EBITDA and Adjusted EBITDA Margin provide the Board, management and investors with clear representation of our core operating performance and trends, provide greater visibility into the long-term financial performance of the Company, and eliminate the impact of items that do not relate to the ongoing operating performance of the business.

Further, Adjusted EBITDA is used by the Board and management to prepare and approve our annual budget, and to evaluate the performance of certain management personnel when determining incentive compensation.

Table MD&A 5:

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Net loss $ (34,422) (23.7) % $ (53,428) (24.6) %

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

Other income (6,715) (4.6) % (1,350) (0.6) %

Interest expense 786 0.5 % 874 0.4 %

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

Provision for income taxes 36 — % 54 — %

Depreciation and amortization 9,429 6.5 % 5,890 2.7 %

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

Restructuring expenses (1)

2,767 1.3 % — — %

EBITDA (Non-GAAP) (30,886) (21.3) % (47,960) (22.1) %

Stock-based compensation expense (1)

24,396 16.8 % 64,660 29.8 %

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

(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.

Restructuring expenses (2)

1,132 0.8 % 2,767 1.3 %

Adjusted EBITDA (Non-GAAP) $ (5,358) (3.7) % $ 19,467 9.0 %

(1) The stock-based compensation adjustment to EBITDA is made up of stock-based compensation expense for the awarded service-based restricted stock units ("RSUs"), performance-based restricted stock units ("PSUs"), stock options, and other sources.

Stock-based compensation expense for the awarded RSUs, PSUs and stock options was $22.9 million and $62.5 million for fiscal year 2023 and 2022, respectively.

Stock-based compensation expense from other sources was $1.5 million and $2.1 million for the fiscal year 2023 and 2022, respectively.

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.

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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.

(2) The restructuring expenses include severance and other related benefit costs (including outplacement services and continuing health insurance coverage), external consulting and advisory fees related to implementing the restructuring plan.

Adjusted Net (Loss)/Income and Adjusted EPS

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

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

Adjusted Net (Loss)/Income and Adjusted EPS provide the Board, management and investors with clear representation of our core operating performance and trends, provide greater visibility into the long-term financial performance of the Company, and eliminate the impact of items that do not relate to the ongoing operating performance of the business.

Table MD&A 6:

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

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

For the Year Ended December 31,

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(in thousands, except per share data)

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

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

Restructuring expenses (1)

2,767 0.04 — —

Net loss $ (34,422) $ (0.50) $ (53,428) $ (0.79)

Other income (6,715) (0.10) (1,350) (0.02)

Stock-based compensation expense (1)

24,396 0.35 64,660 0.96

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

Restructuring expenses (2)

1,132 0.02 2,767 0.04

Adjusted net (loss)/income (Non-GAAP) $ (15,609) $ (0.23) $ 12,649 $ 0.19

Weighted-average shares of common stock outstanding, basic 69,256 67,559

(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.

Stock-based compensation expense for the awarded RSUs, PSUs and stock options was $22.9 million and $62.5 million for fiscal year 2023 and 2022, respectively.

Stock-based compensation expense from other sources was $1.5 million and $2.1 million for the fiscal year 2023 and 2022, respectively.

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.

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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).

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

Cash Gross Profit and Cash Gross Margin

Cash Gross Profit and Cash Gross Margin are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, alternatives to gross profit and gross margin as determined by GAAP.

We define Cash Gross Profit as gross profit, plus noncash charges for stock-based compensation expense, depreciation and amortization, as well as non-recurring items (such as restructuring expenses) charged under cost of sales.

We define Cash Gross Margin as Cash Gross Profit as a percentage of total revenue.

Cash Gross Profit and Cash Gross Margin provide management and investors a clear representation of the core economics of gross profit and gross margin without the impact of non-cash expenses and sunk costs expended.

Table MD&A 6:

Reconciliation of Gross Profit to Cash Gross Profit;

Gross Margin to Cash Gross Margin

For the Year Ended December 31,

Amount Margin Amount Margin

(dollars in thousands)

Gross profit $ 52,942 36.4 % $ 79,043 36.4 %

Stock-based compensation expense — cost of sales 900 0.6 % 3,497 1.6 %

Depreciation and amortization — cost of sales 3,544 2.5 % 793 0.4 %

Restructuring expenses — cost of sales — —% 578 0.3%

Cash gross profit (Non-GAAP) $ 57,386 39.5% $ 83,911 38.7 %

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 plus net cash proceeds from resale of software under other financing obligations.

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

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

We use Free Cash Flow to understand the cash flows that directly correspond with our operations and the investments we must make in those operations, using a methodology that combines operating cash flows and capital expenditures.

Further, Free Cash Flow may be useful to management and investors in evaluating the Company's operating performance and liquidity.

Table MD&A 7:

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Net cash proceeds from resale of software — 8,457

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

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.

Free cash flow (Non-GAAP) $ (13,891) $ 11,248

Each of EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net (Loss)/Income, Adjusted EPS, Cash Gross Profit, Cash Gross Margin 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, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net (Loss)/Income, Adjusted EPS, Cash Gross Profit, Cash Gross Margin and Free Cash Flow does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments, does not reflect the impact of certain cash and non-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 (Loss)/Income, Adjusted EPS, Cash Gross Profit, Cash Gross Margin and Free Cash Flow differently than we do, which limits their usefulness as comparative measures.

Because of these limitations, neither EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net (Loss)/Income, Adjusted EPS, Cash Gross Profit, Cash Gross Margin nor Free Cash Flow should be considered as a replacement for gross profit, gross margin, net (loss)/income, earnings per share or net cash flows (used in)/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.

Our primary sources of liquidity are cash on hand, future operating cash flows, and if needed, borrowings under our $30.0 million senior secured revolving credit facility, with an expansion feature of up to $30.0 million of additional revolver capacity.

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.

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 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.

The offering generated approximately $64.3 million of net proceeds to Telos.

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

On April 19, 2021, we used approximately $1.3 million of the net proceeds to repurchase 39,682 shares of our common stock and $26.9 million to repurchase warrants to purchase 900,970 shares of our common stock owned by EnCap (see Note 12 - Debt and Other 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.

As of December 31, 2023, we had cash and cash equivalents of $99.3 million and our working capital was $100.8 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.

We place a strong emphasis on liquidity management.

This focus gives us the flexibility for capital deployment while preserving a strong balance sheet to position us for future opportunities.

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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.

Although no assurances can be given, we believe the 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.

Table MD&A 8:

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Net cash used in investing activities (15,478) (13,717)

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

Net cash used in financing activities (6,151) (9,915)

Net change in cash, cash equivalents, and restricted cash $ (20,042) $ (7,124)

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

Net cash provided by operating activities for the years ended December 31, 2023 and 2022 was $1.6 million and $16.5 million, respectively, a decrease in cash inflow of $14.9 million compared with prior year.

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, 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.

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.

Net cash used in investing activities for the years ended December 31, 2023, increased by $1.8 million in cash outflow compared to the same period in 2022, primarily due to higher investments in software development costs of $14.6 million and $12.7 million for the years ended December 31, 2023 and 2022, respectively.

For the year ended December 31, 2023, net cash used in financing activities was $6.2 million compared to $9.9 million in 2022.

The decrease in cash outflow from financing activities is primarily attributable to decreases in payments of tax withholding related to the net share settlement of equity awards of $3.7 million in 2023, compared with $5.7 million in 2022.

In addition, the 2023 cash outflow related to the repurchase of common stock under the Share Repurchase Program is comprised only of unpaid purchases in 2022 paid-off in 2023, amounting to $0.1 million, compared with $11.1 million in 2022.

This is partially offset by the payments of the DFT holdback of $0.6 million in February 2023.

By contrast, in 2022, there was a cash inflow from the other financing obligations of $9.1 million.

Commitments from Contractual Obligations

The Company does not have any other material cash requirements from contractual obligations at December 31, 2023, 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.

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(in thousands)

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

Finance lease obligations (1)

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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, 2023.

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

See Note 19 - Commitment and Contingencies , to the consolidated financial statements within this Annual Report for further discussion of other commitment and contingencies.

Revolving Credit Facility

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

("Credit Agreement") 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, maturing on December 30, 2025.

On April 12, 2023, we amended our Credit Agreement and revised certain provision on the terms of the covered collateral.

See Note 1 0 - Debt and Other Obligatio ns to the consolidated financial statements contained within this Annual Report for additional information.

The Credit Agreement contains customary terms and conditions, including certain covenant requirements.

As of December 31, 2023, 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

In November 2022, we entered into a Master Purchase Agreement with a third-party for $9.1 million relating to software licenses under a specific delivery order with a customer resulting in proceeds from other financing obligation.

On February 9, 2023, when the third-party buyer notified us that it would not exercise the option period, we transferred all the rights, title and interest in the underlying licenses in exchange for the extinguishment of the outstanding financing obligations.

The extinguishment of the other financing obligations resulted to a gain of $1.4 million.

See Not e 1 0 – Debt and Other Ob ligations to the consolidated financial statements for a detailed discussion of our debt financing arrangements.

Critical Accounting Policies and Estimates

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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 2023 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.

This 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

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The estimated amounts are based on an assessment of our anticipated performance and all other information that is reasonably available to us.

For contracts where revenue is recognized over time, we recognized revenue based on progress towards completion of the performance obligation, using costs incurred to date relative to total estimated cost at completion to measure progress on a proportional performance basis for our contracts.

For contracts where revenue is recognized over time, we recognize revenue based on progress towards completion of the performance obligation, using costs incurred to date relative to total estimated cost at completion to measure progress on a proportional performance basis for our contracts.

Due to the nature of the work required to be performed on certain contracts, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment.

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

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

During the year ended December 31, 2023, there is an immaterial catch-up revenue adjustment as a result of the changes in contract estimates noted.

Goodwill and Other Long-Lived Assets

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If an initial qualitative assessment identifies that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or the optional qualitative assessment is not performed, a quantitative analysis is performed.

In testing goodwill for impairment, we first assess the qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value.

If after the assessment, we determine that an impairment indicator exists, we perform the quantitative goodwill impairment test.

The Company performs the quantitative goodwill impairment test by calculating the fair value of the reporting unit and comparing it to its respective carrying value including goodwill.

If the fair value is less than the carrying value, the amount of impairment expense is equal to the difference between the reporting unit's fair value and the reporting unit's carrying value.

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.

Determining the fair value of a reporting unit requires management's judgment and involves the use of significant estimates and assumptions, including 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 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.

In addition, the estimate of the total fair value of our reporting units is compared to the market capitalization of the Company.

We amortized intangible assets over their respective estimated useful lives, and reviewed them for impairment whenever events or changes in business circumstances indicate the carrying value may not be recoverable.

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 fair value of the reporting units exceeded their carrying value and thus, we did not proceed to the two-step goodwill impairment test.

A relatively small change in the underlying assumptions, including if the financial performance of the reporting unit does not meet expectations in future years, may cause a change in the results of the impairment assessment in future periods and, as such, could result in goodwill impairment.

For fiscal year 2023, we performed a qualitative assessment on our reporting units and determined that it is "more-likely-than-not" that the estimated fair value of our Security Solutions reporting unit exceeded its carrying value.

On the other hand, based on the initial qualitative assessment of our Secure Networks reporting unit, we concluded that it is not "more-likely-than-not" that the fair value of this reporting unit exceeds its carrying value;

as such, we performed a quantitative analysis.

Based on the quantitative analysis on our Secure Networks reporting unit, its estimated fair value exceeded its carrying value and we concluded that there was no impairment.

Due to the nature of our business and other factors described in Item 1A , " R isk Factors ", of this Annual Report on Form 10-K, the profitability of our individual reporting units may periodically be affected by downturns in customer demand, operational challenges, and other factors.

If material adverse conditions occur that impact one or all of our reporting units, our determination of future fair value might not support the carrying amount of our reporting units, and the related goodwill may be impaired.

We will continue to monitor any changes to our assumptions and will evaluate goodwill as deemed warranted during future periods.

We amortize intangible assets over their respective estimated useful lives, and review them for impairment whenever events or changes in business circumstances indicate the carrying value may not be recoverable.

Likewise, we evaluated our intangible assets for potential impairment.

As a result of the assessment, we identified conditions demonstrating an impairment of certain software development costs.

An impairment charge of $0.5 million was recorded in the consolidated statements of operations for the year ended December 31, 2023.

For further discussion of the methods used and factors considered in our estimates as part of the impairment testing for goodwill and intangible assets, see Note 2 - Significant Accounting Policies on Goodwill and Intangible Assets, Note 7 - Goodwill and Note 8 - Intangible Assets, Net to the consolidated financial statements.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis