TELOS CORP 10-K

Item 7A. Quantitative and Qualitative Disclosures about Market Risk In the normal course of business, we are exposed to a variety of financial risks such as interest rate risk, foreign currency translation risk, and counterparty risk, which can affect our operations and profitability. Our cash and cash equivalents include highly liquid investments that have a maturity of three months or less at the date of purchase, and would not be significantly affected by increases or decreases in interest rates mainly due to the short-term nature of these instruments. The majority of our business is transacted in U.S. dollars, and the impact of the foreign currency fluctuation as we report for our foreign subsidiary upon translation of its financials into U.S. dollars was insignificant. Further, we do not enter into financial instruments for trading purposes. 39 Table of Contents Item 8. Consolidated Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Telos Corporation Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Telos Corporation (the “Company”) as of December 31, 2023 and 2022, and the related consolidated statements of operations, comprehensive (loss)/income, changes in stockholders’ equity/(deficit) and cash flows for each of the two years in the period ended December 31, 2023, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2023 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 40 Table of Contents Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition – Estimated Costs to Complete Long-term Contracts As discussed in Note 3 to the consolidated financial statements, a portion of the Company’s revenues of $145.4 million for the year ended December 31, 2023 were generated from long-term contracts. For the Company’s long-term contracts, due to the transfer of control over time, revenue is recognized based on progress towards completion of the performance obligation. Management generally uses the cost-to-cost measure of progress on a proportional performance basis for its long-term contracts because management believes that measure best depicts the transfer of control to the customer, which occurs as the Company incurs costs on the contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation, which includes both the actual costs already incurred and the estimated costs to complete. Revenues are recorded proportionately as costs are incurred. Due to the nature of the work required to be performed on certain of the performance obligations, management’s estimation of costs at completion is complex, subject to many variables and requires significant judgment. Contract estimates are based on various assumptions, including labor and subcontractor costs, materials and other direct costs, and the complexity of the work to be performed. The principal considerations for our determination that performing procedures relating to revenue recognition - estimated costs to complete long-term contracts is a critical audit matter are (i) the significant judgment by management when estimating costs at completion and (ii) a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating management’s significant assumptions related to labor and subcontractor costs and materials and other direct costs. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the determination of estimated contract revenue and costs. These procedures included, among others, (i) testing management’s process for estimating costs at completion for a sample of contracts (ii) evaluating the appropriateness of the cost-to-cost measure of progress, (iii) testing the completeness and accuracy of data used by management, and (iv) evaluating the reasonableness of management’s significant assumptions related to labor and subcontractor costs and materials and other direct costs. Evaluating management’s significant assumptions involved assessing whether the assumptions were reasonable by (i) performing a comparison of the originally estimated and actual costs incurred on a sample of similar completed contracts; (ii) assessing the reasonableness of estimated costs to complete on a sample of in-process contracts, including the timing of costs incurred and the related impacts on revenue; and (iii) performing retrospective reviews of a sample of contracts to understand and corroborate management’s estimation process and budget-to-actual variances, if any. /s/ PricewaterhouseCoopers LLP Washington, District of Columbia March 15, 2024 We have served as the Company's auditor since 2022. 41 Table of Contents TELOS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS For the Year Ended December 31, 2023 2022 (in thousands, except per share amounts) Revenue – services $ 135,175 $ 192,742 Revenue – products 10,203 24,145 Total revenue 145,378 216,887 Cost of sales – services (excluding depreciation and amortization) 83,159 120,541 Cost of sales – products (excluding depreciation and amortization) 5,733 16,510 Depreciation and amortization 3,544 793 Total cost of sales 92,436 137,844 Gross profit 52,942 79,043 Selling, general and administrative expenses: Sales and marketing 7,122 16,582 Research and development 12,247 16,918 General and administrative 73,888 99,393 Total selling, general and administrative expenses 93,257 132,893 Operating loss ( 40,315 ) ( 53,850 ) Other income 6,715 1,350 Interest expense ( 786 ) ( 874 ) Loss before income taxes ( 34,386 ) ( 53,374 ) Provision for income taxes ( 36 ) ( 54 ) Net loss $ ( 34,422 ) $ ( 53,428 ) Net loss per share: Basic $ ( 0.50 ) $ ( 0.79 ) Diluted $ ( 0.50 ) $ ( 0.79 ) Weighted-average share outstanding: Basic 69,256 67,559 Diluted 69,256 67,559 See accompanying notes to consolidated financial statements. 42 Table of Contents TELOS CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS For the Year Ended December 31, 2023 2022 (in thousands) Net loss $ ( 34,422 ) $ ( 53,428 ) Other comprehensive loss, net of tax: Foreign currency translation adjustments ( 5 ) ( 28 ) Comprehensive loss $ ( 34,427 ) $ ( 53,456 ) See accompanying notes to consolidated financial statements. 43 Table of Contents TELOS CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 2023 2023 2022 (in thousands, except per share and share data) Assets: Cash and cash equivalents $ 99,260 $ 119,305 Accounts receivable, net 30,424 40,069 Inventories, net 1,420 2,877 Prepaid expenses 7,520 4,819 Other current assets 1,367 893 Total current assets 139,991 167,963 Property and equipment, net 3,457 4,787 Finance lease right-of-use assets, net 6,612 7,832 Operating lease right-of-use assets 216 341 Goodwill 17,922 17,922 Intangible assets, net 39,616 37,415 Other assets 885 1,137 Total assets $ 208,699 $ 237,397 Liabilities and Stockholders' Equity: Liabilities: Accounts payable and other accrued liabilities $ 13,750 $ 22,551 Accrued compensation and benefits 14,569 8,388 Contract liabilities 6,728 6,444 Finance lease obligations – current portion 1,730 1,592 Operating lease obligations – current portion 97 361 Other financing obligations – current portion — 1,247 Other current liabilities 2,324 4,919 Total current liabilities 39,198 45,502 Finance lease obligations – non-current portion 9,518 11,248 Operating lease obligations – non-current portion 123 27 Other financing obligations – non-current portion — 7,211 Deferred income taxes 813 758 Other liabilities 44 297 Total liabilities 49,696 65,043 Commitments and contingencies Stockholders' equity: Common stock, $ 0.001 par value, 250,000,000 shares authorized, 70,239,890 shares and 67,431,632 shares issued and outstanding as of December 31, 2023 and 2022, respectively 109 106 Additional paid-in capital 433,781 412,708 Accumulated other comprehensive loss ( 60 ) ( 55 ) Accumulated deficit ( 274,827 ) ( 240,405 ) Total stockholders' equity 159,003 172,354 Total liabilities and stockholders' equity $ 208,699 $ 237,397 See accompanying notes to consolidated financial statements. 44 Table of Contents TELOS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS For the Year Ended December 31, 2023 2022 (in thousands) Cash flows from operating activities: Net loss $ ( 34,422 ) $ ( 53,428 ) Adjustments to reconcile net loss to cash flows from operations: Stock-based compensation 24,396 64,660 Depreciation and amortization 9,429 5,890 Provision for doubtful accounts 152 99 Deferred income tax provision 55 35 Loss on disposal of fixed assets 2 4 Accretion of discount on acquisition holdback 2 48 Amortization of debt issuance costs 69 — Gain on early extinguishment of other financing obligations ( 1,427 ) — Changes in other operating assets and liabilities: Accounts receivable 9,493 19,675 Inventories 1,457 ( 1,630 ) Intangible assets – software held for resale — ( 7,120 ) Prepaid expenses, other current assets and other assets ( 3,058 ) ( 1,249 ) Accounts payable and other accrued payables ( 8,817 ) ( 12,322 ) Accrued compensation and benefits 6,602 ( 317 ) Contract liabilities 283 63 Other current liabilities and other liabilities ( 2,629 ) 2,100 Net cash provided by operating activities 1,587 16,508 Cash flows from investing activities: Capitalized software development costs ( 14,552 ) ( 12,708 ) Purchases of property and equipment ( 926 ) ( 1,009 ) Net cash used in investing activities ( 15,478 ) ( 13,717 ) Cash flows from financing activities: Payments under finance lease obligations ( 1,592 ) ( 1,461 ) Repurchase of common stock ( 139 ) ( 11,145 ) Payment of tax withholding related to net share settlement of equity awards ( 3,742 ) ( 5,671 ) Payments for debt issuance costs ( 114 ) ( 95 ) Payments of DFT holdback amount ( 564 ) — Proceeds from other financing obligations — 9,092 Payments of other financing obligations — ( 635 ) Net cash used in financing activities ( 6,151 ) ( 9,915 ) Net change in cash, cash equivalents, and restricted cash ( 20,042 ) ( 7,124 ) Cash, cash equivalents and restricted cash, beginning of period 119,438 126,562 Cash, cash equivalents and restricted cash, end of period $ 99,396 $ 119,438 See accompanying notes to consolidated financial statements. 45 Table of Contents TELOS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Common Stock Additional Paid–in Capital Accumulated Other Comprehensive Loss Accumulated Deficit Total Stockholders' Equity Shares Amount (in thousands) Balance December 31, 2021 66,767 $ 105 $ 367,153 $ ( 27 ) $ ( 186,977 ) $ 180,254 Net loss — — — ( 53,428 ) ( 53,428 ) Foreign currency translation loss — — — ( 28 ) — ( 28 ) Stock-based compensation — — 62,511 — — 62,511 Restricted stock unit award vested, net of shares withheld to cover tax withholding 2,214 2 ( 5,673 ) — — ( 5,671 ) Repurchase of common stock ( 1,550 ) ( 1 ) ( 11,283 ) — — ( 11,284 ) Balance December 31, 2022 67,431 106 412,708 ( 55 ) ( 240,405 ) 172,354 Net loss — — — — ( 34,422 ) ( 34,422 ) Foreign currency translation loss — — — ( 5 ) — ( 5 ) Stock-based compensation — — 22,874 — — 22,874 Restricted stock unit award vested, net of shares withheld to cover tax withholding 2,032 2 ( 3,743 ) — — ( 3,741 ) Issuance of common stock for 401K match 777 1 1,942 — — 1,943 Balance December 31, 2023 70,240 $ 109 $ 433,781 $ ( 60 ) $ ( 274,827 ) $ 159,003 See accompanying notes to consolidated financial statements. 46 Table of Contents TELOS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Telos Corporation, together with its subsidiaries, (collectively, the "Company" or "Telos" or "We" or "Our"), 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 share capital of Xacta Corporation and ubIQuity.com, inc., (a holding company for Xacta Corporation), and 100 % ownership interest in Telos Identity Management Solutions, LLC ("Telos ID"), Teloworks, Inc. ("Teloworks") and Telos APAC Pte. Ltd. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Principle of Consolidation The accompanying 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 the Telos Corporation. All intercompany transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"), and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Basis of Comparison Certain reclassifications have been made to the prior year's consolidated financial statements to conform to the current year's presentation. In the current period, we reclassified and presented depreciation and amortization separately from the cost of sales line items. The reclassification had no impact on the statement of operations. Segment Reporting Operating segments are defined as components of an enterprise for which separate discrete financial information is available and evaluated regularly by the chief operating decision maker ("CODM"), or decision-making group, in deciding how to allocate resources and assess performance. 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 business lines. We eliminate any inter-segment revenues and expenses upon consolidation. See Note 1 8 – Segment Information for further information. Use of Estimates Preparing 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 stock-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. Concentrations Financial instruments that subject us to concentrations of credit risk consist primarily of cash and cash equivalents, and accounts receivable. In consideration that a large amount of our working capital and total assets are held in cash and cash equivalents, we are exposed to credit risk in the event of default by the financial institutions to the extent of the amounts held in excess of federal insurance limits. Due to the financial strength and high credit quality of the financial institutions where the accounts are held, we do not believe that this credit risk makes it reasonably possible that a near-term severe impact risk of loss will occur. 47 Table of Contents The Company's receivables are primarily due from the U.S. government, or from prime contractors to whom we are subcontractors and the end customer is the U.S. government, and are generally considered collectable from the perspective of the customer's ability to pay. We believe that the credit risk associated with our receivables is limited due to the creditworthiness of our customers. We maintain an allowance for estimated potential credit losses. Cash and Cash Equivalents We consider all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Restricted cash represents funds that are held in our money market account but precluded from use of general business needs through contractual requirements. We report our restricted cash balance within "Other assets" on the consolidated balance sheets. Contract Balances The timing of revenue recognition may differ from the timing of billing and cash receipts from customers. Amounts are invoiced as work progresses, either at periodic intervals or upon achievement of contractual milestones. We record a contract asset when revenue is recognized prior to invoicing, or a contract liability when cash is received in advance or when milestone payments from customers exceed revenue earned to date. A contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract liabilities include deferred revenue, customer advances and billings in excess of revenue. Contract assets and liabilities are recorded net on a contract-by-contract basis and are classified based on the contract's operating cycle at the end of each reporting period. Accounts Receivable Accounts receivable includes the following: Billed Receivables - Billed receivables are balances where an invoice has been prepared and issued and is collectible under standard contract terms. Where we anticipate that an invoice will be issued within a short period of time and where the funds are considered collectible within standard contract terms, we include this balance as billable accounts receivable. Unbilled Receivables - Unbilled receivables are balances which have not yet been billed due to timing, most commonly just a month delayed from the timing of revenue recognition and the actual bill being presented to the customer. The Company has fulfilled all requirements in order to bill the customer and collect the funds. Contract Assets - Contract assets are receivables for which the right to consideration is conditional upon factors other than the passage of time. The timing of these billings is generally driven by contractual terms, which may have billing milestones that are different from revenue recognition milestones. Both billed and unbilled balances are recorded at their face amount less an allowance for credit losses over the contractual payment terms of the receivable. Collectability of these amounts are periodically reviewed based upon management's knowledge and analysis of available information as of the balance sheet date, including any specific circumstances related to overdue balances, length of time that the receivable has been outstanding, historical bad debts and aging trends, and other general and contract specific factors. The allowance for credit losses is adjusted based on such evaluation. Accounts receivable balances are written off against the allowance when management deems the balances uncollectible. Our contract asset balance is recorded at the net amount expected to be billed for services performed once the objective criteria laid out by the contract has been met. Inventories Inventories are valued at the lower of cost or net realizable value, where cost is determined using the weighted-average method. The value of inventory is adjusted for damaged, obsolete, excess and slowing-moving inventory. Net realizable value of inventory is estimated based on the historical obsolescence experience and planned usage. Inventories are substantially comprised of finished goods purchased for customers, such as off-the-shelf hardware and software, and component computer parts used in connection with system integration services that we perform. Property and Equipment Property and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation is recorded over the assets' estimated useful lives using the straight-line method, which is three to five years for furniture and equipment. Leasehold improvements are amortized over the shorter of their useful life or the remaining terms of the lease. 48 Table of Contents Upon sale or retirement of property and equipment, the costs and related accumulated depreciation and amortization are eliminated from the accounts and any gain or loss on such disposition is reflected in the consolidated statements of operations. For the years ended December 31, 2023 and 2022, such amounts are negligible. Repairs and maintenance costs are expensed as incurred. Major renewals and improvements are capitalized and depreciated over their estimated useful lives. Leases We determine if an arrangement is a lease and we account for leases in accordance with ASC Topic 842, "Leases." We entered into contractual arrangements primarily for the use of real estate facilities, and certain other equipment. We determine the classification of the lease under these arrangements, if any, at inception based on: (1) whether the contract involves the use of a distinct identified asset, (2) whether we obtain the right to substantially all the economic benefits from the use of the asset throughout the period, and (3) whether we have a right to direct the use of the asset. Leased property meeting certain criteria is capitalized at the present value of the related minimum lease payments. Amortization of a finance lease ROU asset is computed using the straight-line method over the lesser of the lease term or the useful life of the related asset. In accordance with ASC 842, we recorded operating lease ROU assets, which represent our right to use an underlying asset for the lease term, and operating lease liabilities which represent our obligation to make lease payments. Generally, we enter into operating lease agreements for facilities. The amount of operating lease liabilities due within 12 months are recorded in other current liabilities, with the remaining operating lease liabilities recorded as non-current liabilities in our consolidated balance sheets based on their contractual due dates. The operating lease ROU assets and liabilities are recognized as of the lease commencement date at the present value of the lease payments over the lease term. Most of our leases do not provide an implicit rate that can readily be determined. Therefore, we use a discount rate based on our incremental borrowing rate on all operating leases. Some of our operating leases contain lease and non-lease components, which we account for as a single component. Operating lease expense is recognized as rent expense on a straight-line basis over the lease term, and recorded within our consolidated statement of operations. The related lease payments on short-term lease arrangements (leases of one year or less) are recognized as expense on a straight-line basis over the lease term. ROU assets are assessed for potential impairment whenever there is evidence that events or changes in circumstances indicate that the carrying value of the asset may not be recoverable and the carrying amount of the assets exceeds its estimated fair value. Software Development Costs We account for development costs of software in accordance with ASC Topic 985-20 ("ASC 985-20"), "Software – Costs of Software to be Sold, Leased, or Marketed" and ASC Topic 350-40 ("ASC 350-40") "Internal Use Software", depending on the intended use of the software being developed. Under ASC 985-20, all costs of developing software prior to establishing its technological feasibility are research and development costs and are expensed as incurred. Once technological feasibility has been established, subsequent costs should be capitalized until the software begins to be marketed or is released to customers after which the capitalized costs should be amortized and reviewed for impairment. Under ASC 350-40, we capitalize certain software development costs when the preliminary project stage is completed and the software has entered the application development stage. Once substantial testing is complete and the software is ready to be used, capitalization of costs ceases. Capitalized software development costs are amortized on a straight-line basis over the estimated economic life of the application, ranging from two to five years , beginning when the asset is ready for its intended use. ASC 350-40 also requires hosting arrangements that are service contracts to follow the guidance for internal-use software to determine which implementation costs can be capitalized. In accordance with ASC 350-40, (i) capitalized implementation costs are classified in the same balance sheet line item as the amounts prepaid for the related hosting arrangement, (ii) amortization of capitalized implementation costs is presented in the same income statement line item as the service fees for the related hosting arrangement, and (iii) cash flows related to capitalized implementation costs are presented within the same category of cash flow activity as the cash flow for the related hosting arrangements (i.e. operating activity). As of December 31, 2023 and 2022, the net carrying value of the capitalized implementation costs related to hosting arrangements that were incurred during the application development stage aggregated to $ 0.2 million and $ 0.3 million, respectively. These costs are related primarily to the implementation of a new enterprise resource planning system. The Company begins amortizing the capitalized implementation costs after all substantial testing is complete and ready for its intended use, and amortized over the expected term of the arrangement on a straight-line basis. Software costs classified as held for resale are stated at the lower of cost or net realizable value. Software held for resale is amortized into cost of sales on the consolidated statements of operations. The Company reported the software held for resale as part of the Intangible Assets on the consolidated balance sheets. 49 Table of Contents Goodwill and Intangible Assets Goodwill is recorded for the difference between the aggregate consideration paid for an acquisition and the fair value of net tangible and intangible assets acquired and liabilities assumed. Goodwill is not amortized, but rather tested for potential impairment. We evaluate the impairment of goodwill in accordance with ASC 350, which requires goodwill to be assessed on at least an annual basis, as of December 31 each year, for impairment using a fair value basis. Between annual evaluations, if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount, then impairment must be evaluated. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or business climate, (2) a loss of key contracts or customers, or (3) negative operating performance indicators. The Company performs its goodwill impairment test at the reporting unit level. We may elect to utilize a qualitative assessment to evaluate whether it is "more-likely-than-not" that the fair value of a reporting unit is less than its carrying value. If an impairment indicator exists based on the qualitative assessment, we perform the quantitative goodwill impairment test. When performing a quantitative impairment test, we calculate the estimated fair value of the reporting unit and compare the results with its respective carrying value, including goodwill. If the estimated fair value is determined to be less than the carrying value, we recognize an impairment loss equal to the difference between the reporting unit's fair value and the reporting unit's carrying value, up to the amount of goodwill associated with the reporting unit. The evaluation is based on the estimation of the fair values at the reporting unit level in comparison to the reporting unit's net asset carrying values. The Company uses industry accepted valuation models and set criteria that are reviewed and approved by management. The methodology used to assess impairment is a combination of the income approach (i.e. discounted cash flow ("DCF") method) and the market approach (i.e. Comparable Public Company ("CPC") method) to determine the fair value. In the application of the income approach, the estimated fair value of the reporting unit is determined using a DCF analysis, which requires management's judgment with respect to forecasted revenue streams and operating margins, capital expenditures and the selection and use of an appropriate discount rate commensurate with the risk inherent in each of our reporting unit's current business model. We utilize the weighted average cost of capital ("WACC") as derived by certain assumptions specific to our facts and circumstances as the discount rate. In the application of the market approach, the CPC method uses value multiples or ratio to the reporting accounting data (such as revenue) in measuring the market's perception of the reporting unit's enterprise value. Value multiples or ratio reflect the trends in growth and performance, and the comparable public companies provide a reasonable basis for comparison to the relative investment characteristic of the business being valued. The Company analyzes the relationship between the comparable companies' performance and applies a control premium based on the multiples of comparable companies. The control premium is management's estimate of how much a market participant would be willing to pay over the fair market value in consideration of benefits that flow from control of the entity. The results of the income and market approaches are weighted to determine the estimated fair value of the reporting unit. The weighting is judgmental and is based on the perceived level of appropriateness of the valuation methodology. Estimating the fair value involves the use of assumptions and significant judgments that are based on a number of factors including actual operating results. A relatively small change in the underlying assumptions may cause a change in the results of the impairment assessment in future periods and as such, could result in goodwill impairment. The Company's goodwill is amortized and deducted over a 15 -year period for tax purposes. See Note 7 – Goodwill for additional information. Intangible assets with finite lives are carried at cost, less accumulated amortization. Amortization is computed using the method that best reflects how their economic benefits are utilized or, if a pattern of economic benefits cannot be reliably determined, on a straight-line basis over their estimated useful lives. Impairment of Long-Lived Assets The Company evaluates its long-lived assets, including property and equipment, for potential impairment whenever there is evidence that events or changes in circumstances indicate that the carrying value may not be recoverable. If such evaluation indicates that the carrying amount of the asset exceeds its estimated future undiscounted cash flows or its estimated fair value, an impairment loss is recognized to reduce the asset's carrying amount to its estimated fair value. Considerable management judgment is necessary to estimate its fair value. Accordingly, actual results could differ from such estimates. No events have been identified that caused an evaluation of the recoverability of long-lived assets. 50 Table of Contents In addition to the recoverability assessment, the Company routinely reviews the remaining lives of its long-lived assets. Any reduction in the useful life assumptions will result in increased depreciation or amortization expense in the period when such determinations are made, as well as in subsequent periods. There are no changes in the estimated useful lives of long-lived assets for the periods presented. Fair Value Measurements U.S. GAAP provides a framework for measuring fair value and expands disclosures about fair value measurements. The framework requires the valuation of investments using a three-tiered approach. The statement requires fair value measurement to be classified and disclosed in one of the following categories: • Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities; • Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; or • Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity). As of December 31, 2023 and 2022, we did not have any financial instruments with significant Level 3 inputs and we did not have any financial instruments that are measured at fair value on a recurring basis. For certain of our non-derivative financial instruments, including receivables, accounts payable and other accrued liabilities, the carrying amount approximates fair value due to the short-term maturities of these instruments. Research and Development Research and development expenses consist primarily of employee-related expenses (such as salaries, taxes, benefits and stock-based compensation), allocated overhead costs and outside services costs related to the development and improvement of the Company's software. Research and development costs are generally expensed as incurred, except for costs incurred in connection with the development of software that qualify for the capitalization as described in our software development costs policy. Amortization of capitalized software development costs, not charged under cost of sales, are also reported as part of research and development expenses. Advertising Costs Advertising costs are expensed and included in sales and marketing expense when incurred. Advertising expense was $ 0.8 million and $ 1.3 million for the years ended December 31, 2023 and 2022, respectively. Income Taxes We account for income taxes in accordance with ASC 740, "Income Taxes." Under ASC 740, deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences and income tax credits. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates that are applicable to the future years in which deferred tax assets or liabilities are expected to be settled or realized for differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Any change in tax rates on deferred tax assets and liabilities is recognized in net income in the period in which the tax rate change is enacted. We record a valuation allowance that reduces deferred tax assets when it is "more likely than not" that deferred tax assets will not be realized. We follow the provisions of ASC 740 related to accounting for uncertainty in income taxes. The accounting estimates related to liabilities for uncertain tax positions require us to make judgments regarding the sustainability of each uncertain tax position based on its technical merits. If we determine it is more likely than not that a tax position will be sustained based on its technical merits, we record the impact of the position in our consolidated financial statements at the largest amount that is greater than fifty percent likely of being realized upon ultimate settlement. These estimates are updated at each reporting date based on the facts, circumstances and information available. We are also required to assess at each reporting date whether it is reasonably possible that any significant increases or decreases to our unrecognized tax benefits will occur during the next 12 months. Business Combinations Acquisitions were accounted for under U.S. GAAP using the acquisition method in accordance with ASC 805, Business Combinations . The Company allocates the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities, if any, is recorded as goodwill. 51 Table of Contents The accounting for business combinations requires management to make judgments and estimates of the fair value of assets acquired, including the identification and valuation of intangible assets, as well as liabilities and contingencies assumed. Such judgments and estimates directly impact the amount of goodwill recognized in connection with an acquisition. Estimating the fair value of acquired assets and assumed liabilities, including intangibles, requires judgment about expected future cash flows, weighted-average cost of capital, discount rates and expected long-term growth rates. Stock-Based Compensation The Company grants stock-based compensation awards under the 2016 Omnibus Long-Term Incentive Plan, as amended (the "2016 LTIP"). Our 2016 LTIP provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, unrestricted stock and dividend equivalent rights to our senior executives, directors, employees, and other eligible service providers. The stock options granted under the 2016 LTIP expire no more than 10 years after the date of grant. 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, who has the discretion to establish the terms, conditions and criteria of the various awards, including the weighting and vesting schedule of Service-Based RSUs and the performance conditions applicable to the Performance-Based RSUs, including the achievement of certain financial performance criteria or price targets for our common stock. The restricted stock units granted are time-based ("Service-Based RSU" or "RSU") and performance-based ("Performance-Based RSU" or "PSU"). The Company issues new shares of common stock upon vesting of the restricted stock units under this plan. • Service-Based RSUs granted to eligible employees as an incentive generally vest in installments over a period of up to three years from the date of grant. The grant date fair value per share is equal to the closing stock price on the date of grant. • Performance-Based RSUs vest upon the achievement of a defined performance target during a defined performance period from the date of grant. The fair value per share of these Performance-Based RSUs is equal to the closing stock price on the date of the grant or the fair value of the award on the grant date as determined through an independent valuation for Performance-Based RSUs with market conditions. Performance-Based RSUs vest upon the achievement of certain price targets or market conditions for the Company's common stock anytime or certain operational milestones over a three-year period from the date of grant. In order to reflect the substantive characteristics of these market condition awards, the Company employs a Monte Carlo simulation valuation model to calculate the grant date fair value and corresponding requisite service period of the award. Monte Carlo approaches are a class of computational algorithms that rely on repeated random sampling to compute their results. This approach allows the calculation of the value of such awards based on a large number of possible stock price path scenarios. The Company estimates the fair value of stock options on the date of the grant using an option pricing model. The option pricing model takes into consideration the current share price of the underlying common stock, exercise price of the option, expected term, risk-free interest rate and the volatility of share price. These considerations directly affect the amount of compensation expense that will ultimately be recognized. We recognize these stock-based payment transactions when services from the employees, directors and other eligible service providers are received and recognize a corresponding increase in additional paid-in capital in our consolidated balance sheets. The measurement objective for these equity awards is the estimated fair value at the date of grant of the equity instruments that we are obligated to issue when employees, directors and other eligible service providers have rendered the requisite service and satisfied any other conditions necessary to earn the right to benefit from the instruments. The stock-based compensation expense for an award is recognized ratably over the requisite service period, which is generally the vesting period during which an employee is required to provide service in exchange for an award. Stock-based compensation expense for awards with performance conditions is recognized over the requisite service period if it is probable that the performance condition will be satisfied. If such performance conditions are not or are no longer considered probable, no compensation expense for these awards is recognized, and any previously recognized expense is reversed. If the performance condition is achieved prior to the completion of the requisite service period, any unrecognized compensation expense will be recognized in the period the performance condition is achieved. Compensation expense for awards with market conditions is recognized over the derived service period, or sooner, if the market condition is achieved. Previously recognized expense for awards with market conditions will never be reversed subsequent to completion of the derived service period even if the market conditions are never achieved. We recognize forfeitures of stock-based compensation awards as they occur. Stock-based compensation expense is recognized as part of the cost of sales and selling, general and administrative expenses in our consolidated statements of operations. The stock-based payment transactions are recognized in accordance with ASC 718, "Compensation - Stock Compensation" and ASU 2018-07, "Compensation - Stock Compensation (Topic 718): Improvements to Non-employee Share-Based Payment Accounting." 52 Table of Contents Net (Loss)/Earnings per Share Basic net (loss)/earnings per share is computed by dividing the net (loss)/earnings by the weighted-average number of common shares outstanding for the period, without consideration for potentially dilutive securities. Diluted net (loss)/earnings per share is computed by dividing the net (loss)/earnings by the weighted-average number of shares of common stock and dilutive common stock equivalents outstanding for the period determined using the treasury-stock and if-converted methods. Dilutive common stock equivalents are comprised of unvested restricted common stock and warrants. Other Comprehensive (Loss)/Income 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)/income. Restructuring Expenses The determination of when the Company accrues for involuntary termination benefits under restructuring plans depends on whether the termination benefits are provided under an on-going benefit arrangement or under a one-time benefit arrangement. The Company accounts for on-going benefit arrangements, such as those documented by employment agreements, in accordance with ASC 712 ("ASC 712"), "Compensation – Nonretirement Postemployment Benefits." Under ASC 712, liabilities for postemployment benefits are recorded at the time of obligations are probable of being incurred and can be reasonably estimated. When applicable, the Company records such costs into operating 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, the Company incurred restructuring-related costs, including employees' severance and related benefit costs. Employee severance and related benefit costs 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 fiscal year 2022, the Company estimated that the expected restructuring expenses were $ 2.8 million. In fiscal year 2023, the Company updated its total expected restructuring plan costs to $ 3.9 million, based on the Company's review of the restructuring plan for the remainder of the fiscal year. The restructuring expenses are recorded under "Selling, general and administrative expenses" on the 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 Consolidated Statements of Operations. Table 1: Summary of Changes in Restructuring Expenses Accrual Severance and related benefit costs (1) Other related costs Total (in thousands) Balance at December 31, 2022 $ 2,763 $ — $ 2,763 (Adjustments)/charges ( 168 ) 1,300 1,132 Cash payments ( 2,195 ) ( 1,300 ) ( 3,495 ) Balance at December 31, 2023 $ 400 $ — $ 400 (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. Recently Accounting Pronouncements - Adopted In March 2020, the Financial Accounting Standards Board ("FASB") issued ASU No. 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting," which provides optional expedients and exceptions for a limited period of time to ease the potential burden in accounting for contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. This amendment is effective for all entities as of March 12, 2020 through December 31, 2022. The adoption of this ASU did not have a material impact on our consolidated financial position, results of operations or cash flows. 53 Table of Contents In October 2021, the FASB issued ASU No. 2021-08, "Business Combination (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers," which requires entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The ASU improves comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. Entities should apply the amendments prospectively to business combinations that occur after the effective date. This standard is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. This ASU is applied prospectively to business combinations occurring on or after the effective date of the amendment. The adoption of this ASU did not have a material impact on our consolidated financial position, results of operations or cash flows. In September 2022, the FASB issued ASU No. 2022-04, "Liabilities - Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations," which requires a company that uses a supplier finance program in connection with the purchase of goods or services to disclose sufficient information about the program to allow a user of the financial statements to understand the program's nature, activity during the period, changes from period to period, and potential magnitude. This standard is effective for reporting periods beginning December 15, 2022, with early adoption permitted. The adoption of this ASU does not have a material impact on our consolidated financial position, results of operations, and cash flows. Recent Accounting Pronouncements - Not Yet Adopted In June 2022, the FASB issued ASU No. 2022-03, "Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions," which clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This standard will be effective for reporting periods beginning December 15, 2023, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our consolidated financial position, results of operations, and cash flows. In July 2023, the FASB issued ASU 2023-03, "Presentation of Financial Statements (Topic 205), Income Statement - Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation - Stock Compensation (Topic 718)". This update requires (1) to disclose and present income or loss related to common stock transactions on the face of the income statement, (2) to modify the existing classification and measurement of redeemable preferred shares and redeemable equity-classified shares, and (3) modify accounting treatment for stock-based compensation. The FASB has not set an effective date on this ASU and adoption is permitted. We are currently evaluating the impact of the ASU on our consolidated financial statement disclosures. In August 2023, the FASB issued ASU No. 2023-05, "Business Combinations - Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement," which requires that a joint venture apply a new basis of accounting upon formation and would initially measure its assets and liabilities at fair value. Joint ventures should apply the amendments prospectively with the formation date on or after January 1, 2025, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our consolidated financial position, results of operations, and cash flows. In October 2023, the FASB issued ASU No. 2023-06, "Disclosure Improvements: Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiatives," which modify the disclosure or presentation requirements of a variety of Topics in the Codification, certain of the amendment represent clarifications to or technical corrections of the current requirements. The effective dates for each amendment will be the date on which the SEC's removal of that related disclosure requirement from Regulation S-X or Regulation S-K becomes effective, with early adoption prohibited. For all entities within the scope of the affected Codification subtopics, if by June 30, 2027, the SEC has not removed the applicable requirement from Regulation S-X or Regulation S-K, the pending content of the associated amendment will be removed from the Codification and will not become effective for any entities. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our consolidated financial position, results of operations, and cash flows. In November 2023, the FASB issued ASU No. 2023-07, "Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosure," which requires improvement on reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. The standard will be effective for fiscal year beginning after December 15, 2023 and interim periods within fiscal year beginning after December 15, 2024, with early adoption permitted. We are currently assessing the impact of the adoption of this ASU on our consolidated financial position, results of operations, and cash flows. 54 Table of Contents In December 2023, the FASB issued ASU No. 2023-09, "Income Taxes (Topic 740): Improvements to Income Tax Disclosure," which requires public entities, on an annual basis, (1) disclose specific categories in the rate reconciliation, and (2) provide additional information for reconciling items that meet a quantitative threshold (if the effect of those reconciling items is equal to or greater than 5% of the amount computed by multiplying pretax income/(loss) by the applicable statutory income tax rate). This ASU will be effective, for public entities, for fiscal year beginning after December 15, 2024, with early adoption permitted. We are currently assessing the impact of the adoption of this ASU on our consolidated financial position, results of operations, and cash flows. 3. REVENUE RECOGNITION We recognize revenue in accordance with ASC Topic 606, "Revenue from Contracts with Customers." The unit of account in ASC 606 is a performance obligation, which is a promise in a contract with a customer to transfer a good or service to the customer. The Company follows the five-step model for recognizing revenue that includes identifying the contract with the customer, determining the performance obligation(s), determining the transaction price, allocating the transaction price to the performance obligation(s), and recognizing revenue as the performance obligations are satisfied. Timing of the satisfaction of performance obligations varies across our businesses due to our diverse product and service mix, customer base, and contractual terms. Significant judgment can be required in determining certain performance obligations, and these determinations could change the amount of revenue and profit recorded in a given period. Our contracts may have a single performance obligation or multiple performance obligations. When there are multiple performance obligations within a contract, we allocate the transaction price, net of any discounts, to each performance obligation based on the standalone selling price of the product or service underlying each performance obligation. Our contracts with the U.S. government are generally subject to the Federal Acquisition Regulation ("FAR") and the price is typically based on estimated or actual costs plus a reasonable profit margin. As such, the standalone selling price of products or services in our contracts with the U.S. government are typically equal to the selling price stated in the contract. For non-U.S. government contracts with multiple performance obligations, standalone selling price is the observable price of a good or service when Telos sells that good or service separately in similar circumstances and to similar customers. Contracts are routinely and often modified to account for changes in contract requirements, specifications, quantities, or price. Depending on the nature of the modification, we determine whether to account for the modification as an adjustment to the existing contract or as a new contract. Generally, modifications are not distinct from the existing contract due to the significant interrelatedness of the performance obligations and are therefore accounted for as an adjustment to the existing contract, and recognized as a cumulative adjustment to revenue (as either an increase or reduction of revenue) based on the modification's effect on progress toward completion of a performance obligation. 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 84 % and 89 % of our revenue for the years ended December 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. Revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying our performance obligations. Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer. Contract costs include labor, material, subcontractor costs and indirect expenses. This continuous transfer of control to the customer is supported by clauses in our contracts with U.S. government customers whereby the customer may terminate a contract for convenience and then pay for costs incurred plus a profit, at which time the customer would take control of any work in process. For non-U.S. government contracts where we perform as a subcontractor and our order includes similar FAR provisions as the prime contractor's order from the U.S. government, continuous transfer of control is likewise supported by such provisions. For other non-U.S. government customers, continuous transfer of control to such customers is also supported due to general terms in our contracts and rights to recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit. 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 transferred 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 16 % and 11 % of our revenue for the years ended December 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. 55 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. Contract Estimates Due to the transfer of control over time, revenue is recognized based on progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the performance obligations. We generally use the cost-to-cost measure of progress on a proportional performance basis for our long-term contracts because it best depicts the transfer of control to the customer, which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation, which includes both the actual costs already incurred and the estimated costs to complete. Revenues are recorded proportionally as costs are incurred. Due to the nature of the work required to be performed on certain of our performance obligations, the estimation of costs at completion is complex, subject to many variables and requires significant judgment. Contract estimates are based on various assumptions, including labor and subcontractor costs, materials and other direct costs and the complexity of the work to be performed. A significant change in one or more of these estimates could affect the profitability of our contracts. We review and update our contract-related estimates regularly and recognize adjustments in estimated profit on contracts on a cumulative catch-up basis, which may result in an adjustment increasing or decreasing revenue to date on a contract in a particular period that the adjustment is identified. Revenue and profit in future periods of contract performance are recognized using the adjusted estimate. Our contracts may include various types of variable consideration, such as claims (for instance, indirect rate or other equitable adjustments) or incentive fees. We include estimated amounts in the transaction price based on all of the information available to us, including historical information and future estimations, and to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when any uncertainty associated with the variable consideration is resolved. We have revised and re-submitted several years of incurred cost submissions reflecting certain indirect rate structure changes as a result of regular Defense Contract Audit Agency audits of incurred cost submissions. This resulted in signed final rate agreement letters through fiscal year 2022. We evaluated the resulting changes to revenue under the applicable cost-plus fixed fee contracts, as variable consideration, and determined the most likely amount to which we expect to be entitled, to the extent that no constraint exists that would preclude recognizing this revenue or result in a significant reversal of cumulative revenue recognized. We included these estimated amounts of variable consideration in the transaction price and as performance on these contracts is complete, we adjusted our revenue by $( 0.1 ) million during the year ended December 31, 2023. No revenue adjustment was recorded during fiscal year ended December 31, 2022. 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. We recorded an immaterial contract loss during the year ended December 31, 2023. No contract loss was recorded during the year ended December 31, 2022. Historically, most of our contracts do not include award or incentive fees. For incentive fees, we would include such fees in the transaction price to the extent we could reasonably estimate the amount of the fee. With limited historical experience, we have not included any revenue related to incentive fees in our estimated transaction prices. We may include in our contract estimates additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its realization is probable. We consider the contractual/legal basis for the claim (in particular FAR provisions), the facts and circumstances around any additional costs incurred, the reasonableness of those costs and the objective evidence available to support such claims. For our contracts that have an original duration of one year or less, we use the practical expedient applicable to such contracts and do not consider the time value of money. We capitalize sales commissions related to proprietary software and related services that are directly tied to sales. We do not elect the practical expedient to expense as incurred the incremental costs of obtaining a contract if the amortization period would have been one year or less. For the sales commissions that are capitalized, we amortize the asset over the expected customer life, which is based on recent and historical data. 56 Table of Contents Disaggregated Revenues In addition to our segment reporting, as further discussed in Note 1 8 – Segment Information , we disaggregate our revenue 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 Year Ended December 31, 2023 2022 Amount % Amount % (dollars in thousands) Federal government $ 131,143 90 % $ 205,538 95 % State & local government, and commercial 14,235 10 % 11,349 5 % Total revenue $ 145,378 $ 216,887 Table 3.2: Revenue by Contract Type For the Year Ended December 31, 2023 2022 Amount % Amount % (dollars in thousands) Firm fixed-price $ 114,188 79 % $ 179,803 83 % Time-and-materials 13,535 9 % 12,963 6 % Cost plus fixed-fee 17,655 12 % 24,121 11 % Total revenue $ 145,378 $ 216,887 Table 3.3: Revenue Concentrations Greater than 10% of Total Revenue For the Year Ended December 31, 2023 2022 U.S. Department of Defense ("DoD") 64 % 74 % Table 3.4: Contract Balances As of December 31, Balance Sheet Presentation 2023 2022 (in thousands) Billed account receivables (1) Accounts receivable, net $ 17,818 $ 13,521 Unbilled account receivables Accounts receivable, net 8,022 11,657 Contract assets Accounts receivable, net 4,584 14,891 Contract liabilities - current Contract liabilities 6,728 6,444 (1) Net of allowance for credit losses The changes in the Company's contract assets and contract liabilities during the current period were primarily the result of the timing differences between the Company's performance, invoicing and customer payments. For the years ended December 31, 2023 and 2022, the amount of revenue recognized during the year that was included in the opening contract liabilities balance was $ 5.4 million and $ 5.2 million, respectively. As of December 31, 2023, we had approximately $ 52.1 million of remaining performance obligations, which we also refer to as funded backlog. We expect to recognize approximately 90 % of our remaining performance obligations as revenue in 2024, and approximately 3 % by 2025, with the remainder recognized thereafter. 57 Table of Contents 4. ACCOUNTS RECEIVABLE, NET Table 4.1: Details of Accounts Receivable, Net As of December 31, 2023 2022 (in thousands) Billed accounts receivables $ 18,101 $ 13,655 Unbilled accounts receivable 8,022 11,657 Contract assets 4,584 14,891 Allowance for credit losses ( 283 ) ( 134 ) Accounts receivable, net $ 30,424 $ 40,069 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 91 % of our billed and unbilled accounts receivable, as of December 31, 2023, were directly with U.S. government customers. While we acknowledge the potentially material and adverse risk of such a significant concentration of credit risk, our past experience of 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 guarantees from our customers. We maintain allowances for potential losses. Table 4.2: Allowance for Credit Losses Activities Balance Beginning of Year Bad Debt Expenses (1) Write-Offs / Recoveries (2) Balance End of Year (in thousands) For the Year Ended December 31, 2023 $ 134 $ 152 $ ( 3 ) $ 283 For the Year Ended December 31, 2022 116 99 ( 81 ) 134 (1) Accounts receivable reserves and reversals of allowance for subsequent collection, net (2) Accounts receivable written-off and subsequent recoveries, net On July 15, 2016, the Company entered into an accounts receivable purchase agreement under which the Company could sell certain accounts receivable (balance not to exceed $ 10.0 million) to a third party, or the "Factor", without recourse to the Company, with an availability period through June 30, 2022, and from year to year thereafter unless terminated in writing by the parties. There were no accounts receivable sold during 2023 and 2022, respectively. As of December 31, 2023 and 2022, there were no outstanding sold accounts receivable. 5. INVENTORIES, NET Table 5.1: Details of Inventories, Net As of December 31, 2023 2022 (in thousands) Gross inventory $ 2,179 $ 3,642 Allowance for inventory obsolescence ( 759 ) ( 765 ) Inventories, net $ 1,420 $ 2,877 6. PROPERTY AND EQUIPMENT, NET Table 6.1: Details of Property and Equipment, Net As of December 31, 2023 As of December 31, 2022 Gross Carrying Amount Accumulated Depreciation and Amortization Net Carrying Value Gross Carrying Amount Accumulated Depreciation and Amortization Net Carrying Value (in thousands) Furniture and equipment $ 16,213 $ ( 13,363 ) $ 2,850 $ 16,033 $ ( 11,900 ) $ 4,133 Leasehold improvement 3,211 ( 2,604 ) 607 $ 3,145 ( 2,491 ) 654 Total $ 19,424 $ ( 15,967 ) $ 3,457 $ 19,178 $ ( 14,391 ) $ 4,787 58 Table of Contents Table 6.2: Depreciation and Amortization Expense For the year ended December 31, 2023 2022 (in thousands) Depreciation and amortization $ 2,230 $ 2,367 7. GOODWILL As discussed in Note 2 – Significant Accounting Policies , we reported two operating and reportable segments: Security Solutions and Secure Networks. The two operating and reportable segments represent the reporting units for purposes of testing goodwill. The goodwill balance was $ 17.9 million as of December 31, 2023 and 2022, of which $ 3.0 million is allocated to the Security Solutions segment and $ 14.9 million is allocated to the Secure Networks segment. The net assets attributable to the reporting units are determined based upon the estimated assets and liabilities attributable to the reporting units in deriving its free cash flows. For fiscal year 2023, we performed a qualitative assessment on our reporting units and identified that it is "more-likely-than-not" that the estimated fair value of our Security Solutions reporting unit exceeded its carrying value. In contrast, based on the initial qualitative assessment of our Secure Networks reporting unit, we determined that it is not "more-likely-than-not" that the fair value of this reporting unit exceeds its carrying value, therefore we performed a quantitative impairment test. Based on the quantitative assessment on our Secure Networks reporting unit as of December 31, 2023, the estimated fair value exceeded its carrying value. Based on the results of our annual impairment test of goodwill performed, the estimated fair value of our respective reporting units exceeded their respective carrying value, and no impairment charges were taken during the years ended December 31, 2023 and 2022. 8. INTANGIBLE ASSETS, NET Table 8.1: Details of Intangible Assets, Net Estimated useful life As of December 31, 2023 As of December 31, 2022 Gross Carrying Amount Accumulated Amortization Net Carrying Value Gross Carrying Amount Accumulated Amortization Net Carrying Value (in thousands) Acquired technology 8 years $ 3,630 $ ( 1,097 ) $ 2,533 $ 3,630 $ ( 643 ) $ 2,987 Customer relationships 3 years 40 ( 32 ) 8 40 ( 19 ) 21 Software development costs 2 - 5 years 35,312 ( 12,256 ) 23,056 26,956 ( 7,793 ) 19,163 Subtotal 38,982 ( 13,385 ) 25,597 30,626 ( 8,455 ) 22,171 In-process software development costs (1) (2) 14,019 — 14,019 8,124 — 8,124 Software held for resale (3) — — — 7,120 — 7,120 Total $ 53,001 $ ( 13,385 ) $ 39,616 $ 45,870 $ ( 8,455 ) $ 37,415 (1) In-process software development costs are costs for software that is not yet available for its intended use or general release to customers as of balance sheet date, thus not yet amortized. (2) An impairment charge of $ 0.5 million was recorded against software development costs in fiscal year 2023 related to the write-off of certain software projects. (3) This amount is net of $ 0.7 million charged into cost of sales in fiscal year 2022. In 2023, as a result of the impairment assessment, the Company identified conditions demonstrating impairment of certain software development costs and an impairment charge of $ 0.5 million was recorded under " Research and Development " expenses in the Company's consolidated statements of operations. No similar impairment charge was recorded on software development costs during the fiscal year ended December 31, 2022. The Company did not recognize any impairment charges on other intangible assets for the periods presented. 59 Table of Contents Table 8.2: Amortization Expense For the year ended December 31, 2023 2022 (in thousands) Amortization expense related to: Software development costs - cost of sales (1) $ 2,840 $ — Software development costs - research and development 1,623 1,362 Other intangible assets - general and administrative 467 401 Total $ 4,930 $ 1,763 (1) Amortization expense for software development costs related to assets to be sold, leased, or otherwise marketed are charged under cost of sales on the Consolidated Statements of Operations. Table 8.3: Estimated Future Amortization Expense of Intangible Assets, Net As of December 31, 2023 (in thousands) Year Ending December 31, 2024 $ 8,037 Year Ending December 31, 2025 7,270 Year Ending December 31, 2026 4,864 Year Ending December 31, 2027 3,520 Year Ending December 31, 2028 1,642 Thereafter 264 Total (1) $ 25,597 (1) This does not include amortization of in-process software development costs, as estimation of the timing of future amortization expenses would be impractical. Actual amortization expense in future periods could differ from these estimates as a result of impairments, future releases, future acquisitions, divestitures, and other factors. 9. OTHER BALANCE SHEET COMPONENTS Table 9.1: Details of Accounts Payable and Other Accrued Liabilities As of December 31, 2023 2022 (in thousands) Accounts payable $ 8,307 $ 12,606 Accrued payables 5,443 9,945 Accounts payable and other accrued liabilities $ 13,750 $ 22,551 Table 9.2: Details of Other Current Liabilities As of December 31, 2023 2022 (in thousands) Other accrued liabilities 1,427 1,530 Restructuring expenses accrual 400 2,763 Other 497 626 Other current liabilities $ 2,324 $ 4,919 60 Table of Contents 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. 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 days' prior notice, as applicable, we may prepay any portion or the entire amount of the Loan. We paid and could pay 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 December 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 ("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, 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. 61 Table of Contents 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. The Company reported a gain of $ 1.4 million, which was recorded as "Other income" in the Consolidated Statements of Operations during the year ended December 31, 2023. No gain was reported for the fiscal year ended December 31, 2022. 11. STOCKHOLDERS' EQUITY Capital Stock Our authorized capital stock consists of 250,000,000 shares of common stock, $ 0.001 par value per share, and 10,000,000 shares of preferred stock, $ 0.01 par value per share. As of December 31, 2023 and 2022, there were 70,239,890 and 67,431,632 shares of common stock issued and outstanding, respectively. There were no shares of preferred stock issued and outstanding on either date. Shares Repurchases On May 24, 2022, the Company announced that the Board of Directors approved a new share repurchase program ("SRP") authorizing the Company to repurchase up to $ 50.0 million of its common stock. Pursuant to this authorization, the Company may repurchase shares of its common stock on a discretionary basis from time to time through open market purchases. The repurchase program has no expiration date and may be modified, suspended, or terminated at any time. As of December 31, 2023, there was $ 38.7 million of the remaining authorization for future common stock repurchases under the SRP. Table 11.1: Share Repurchase Program Activity For the Year Ended December 31, 2023 2022 (in thousands, except per share and share data) Amounts paid for shares repurchased (1) (2) $ — $ 11,284 Number of shares repurchased — 1,550,162 Average per share price paid (1) $ — $ 7.28 (1) Includes commission paid for repurchases on the open market. (2) Includes $ 0.1 million of unpaid common stock repurchased paid in fiscal year 2023. Accumulated Other Comprehensive Loss Table 11.2: Details of Changes in Accumulated Other Comprehensive Loss by Category Foreign currency translation adjustment Actuarial gain on pension liability adjustment Total (in thousands) Balance as of December 31, 2021 $ ( 134 ) $ 107 $ ( 27 ) Other comprehensive loss before reclassification ( 28 ) — ( 28 ) Balance as of December 31, 2022 ( 162 ) 107 ( 55 ) Other comprehensive loss before reclassification ( 5 ) — ( 5 ) Balance as of December 31, 2023 $ ( 167 ) $ 107 $ ( 60 ) 12. STOCK-BASED COMPENSATION In October 2020, the Company amended the 2016 LTIP to increase the total number of shares available for issuance from 4,500,000 to 9,400,000 (equivalent to 7,459,913 shares after the stock split in November 2020) and extended the term to September 30, 2030. On May 8, 2023, the Company further amended the 2016 LTIP with an additional 6,000,000 shares available for issuance, increasing the total number of shares available to 13,459,913 . As of December 31, 2023, approximately 4.8 million shares of our common stock were reserved for future grants under the 2016 LTIP, as amended. The Company records stock-based compensation related to accrued compensation in which it intends to settle in shares of the Company's common stock. However, it is the Company's discretion whether this compensation will ultimately be paid in stock or cash, as it has the right to dictate the form of these payments up until the date they are paid. 62 Table of Contents Stock-based compensation expense recognized for restricted stock units and stock options granted to employees and non-employees is included in the Consolidated Statements of Operations. In addition, stock-based compensation expense includes an immaterial increase of $ 1.3 million for the year ended December 31, 2022, to correct a prior period error. There were no income tax benefits recognized on the stock-based compensation expense for these periods. Table 12.1: Details of Stock-based Compensation Expense For the Year Ended December 31, 2023 2022 (in thousands) Cost of sales - services $ 900 $ 3,497 Sales and marketing 188 4,668 Research and development 1,989 3,806 General and administrative (1) 21,319 52,689 Total $ 24,396 $ 64,660 (1) Stock-based compensation expense related to stock options was $ 0.3 million for the year ended December 31, 2023. There was no similar stock-based compensation expense on stock options in fiscal year 2022. Restricted Stock Table 12.2: Restricted Stock Unit Activity Service-Based RSU Performance-Based RSU Total 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 1,888,689 — 1,888,689 2.17 Vested ( 2,910,645 ) — ( 2,910,645 ) 19.04 Forfeited ( 415,513 ) ( 292,985 ) ( 708,498 ) 19.11 Unvested outstanding units as of December 31, 2023 2,132,613 43,800 2,176,413 $ 5.07 Our key assumptions used to calculate the grant date fair value of the PSU awards include a performance period ranging from 2.45 to 2.92 years, expected volatility between 57.4 % - 58.8 %, and a risk-free rate of 0.18 % - 0.29 %. The fair value at the grant date and derived service periods calculated for these market condition PSUs were $ 19.12 - $ 30.84 and between 0.38 - 0.76 years, respectively. As of December 31, 2023, the intrinsic value of the RSUs and PSUs outstanding, exercisable, and vested or expected to vest was $ 7.9 million. There was $ 3.5 million of total compensation costs related to stock-based awards not yet recognized as of December 31, 2023, which is expected to be recognized on a straight-line basis over a weighted-average remaining vesting period of 0.5 years. Stock Options The Company uses the Black-Scholes option pricing model to calculate the estimated fair value of stock options on the date of grant. Option awards are generally granted with an exercise price equal to the market price of the Company's stock at the date of grant. The following weighted-average assumptions are used in the Black-Scholes valuation model to estimate the fair value of stock option awards, as granted. • Expected term of the option – For options granted to employees and directors, the Company estimates the term over which option holders are expected to hold their stock option by using the "simplified method" in accordance with Staff Accounting Bulletin ("SAB") No. 107, Share-Based Payments , and SAB No. 110, Simplified Method for Plain Vanilla Share Options , to calculate the expected term of stock options determined to be "plain vanilla." The Company's stock option exercise history does not provide a reasonable basis to compute the expected term for stock options. Under this approach, the expected term is presumed to be a midpoint between the vesting date and the contractual end of the stock option grant. For options granted to non-employees, the Company elected to use the contractual term as the expected term. • Risk-free interest rate – Based on the daily yield curve rates for U.S. Treasury obligations with terms that approximate the expected term of the stock options. • Expected volatility – Due to the absence of the Company's historical price volatility for the expected contractual term of the stock options, the Company utilized the historical price volatility of a peer group. • Expected dividend yield – The Company has not declared dividends, nor does it expect to in the foreseeable future. Therefore, a zero value was assumed for the expected dividend yield. 63 Table of Contents Table 12.3: Stock Options Fair Value and Weighted-Average Assumptions For the Year Ended December 31, 2023 2022 Weighted-average fair value of underlying stock options $ 1.06 $ — Expected term (in years) 5.5 - 10 0 Risk-free interest rate 3.5 % — % Expected volatility 30.7 % - 35.1 % — % Expected dividend yield — % — % Table 12.4: Stock Option Activity Stock Options Outstanding Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term (in years) Aggregate Intrinsic Value Outstanding option balance as of December 31, 2022 — $ — 0.0 $ — Granted 400,000 1.80 Exercised — — Forfeited, cancelled, or expired — — Outstanding option balance as of December 31, 2023 400,000 $ 1.80 9.4 $ 740,000 Exercisable stock option as of December 31, 2023 — $ — 0.0 $ — The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the quoted closing price of the Company's common stock as of December 31, 2023. The fair value of the stock options is expensed on a straight-line basis over the vesting period of one year , including the stock options granted to directors, as the next annual stockholders meeting is expected to occur at the same approximate time each year. As of December 31, 2023, there were approximately $ 0.1 million of unrecognized compensation costs related to non-vested stock options. 13. LEASES We lease office space facilities and equipment under non-cancelable operating and finance leases with various expiration dates, some of which contain renewal options. The Company's lease portfolio is comprised of two major classes. The lease of the Ashburn facility is accounted for as a finance lease. The other office spaces and equipment leased are accounted for as operating leases. We have included options to extend in the operating lease ROU assets and liabilities when we are reasonably certain that we will exercise such options. In May 2014, the Company entered into a new lease arrangement with the new landlord on the Ashburn facility, which expires on May 28, 2029. In accordance with this lease agreement, the basic rent increases by a fixed 2.5 % escalation annually. Table 13.1: Details of Lease Costs For the Year Ended December 31, 2023 2022 (in thousands) Operating lease cost $ 541 $ 550 Short-term lease cost (1) 55 49 Finance lease cost Amortization of finance lease assets 1,221 1,221 Interest on finance lease liabilities 611 688 Total finance lease cost 1,832 1,909 Total lease costs $ 2,428 $ 2,508 (1) Leases that have terms of 12 months or less. 64 Table of Contents Table 13.2: Future Minimum Lease Payments Operating Leases Finance Leases (in thousands) Year Ending December 31, 2024 $ 105 $ 2,258 Year Ending December 31, 2025 37 2,314 Year Ending December 31, 2026 37 2,371 Year Ending December 31, 2027 37 2,431 Year Ending December 31, 2028 25 2,492 Thereafter — 1,049 Total minimum lease payments 241 12,915 Less: Imputed interest ( 21 ) ( 1,667 ) Total lease obligations 220 11,248 Less: Current portion of lease obligations ( 97 ) ( 1,730 ) Long-term lease obligations $ 123 $ 9,518 Table 13.3: Weighted-Average Remaining Lease Terms and Discount Rates For the Year Ended December 31, 2023 2022 Weighted average remaining lease term (in years): Finance leases 5.3 years 6.3 years Operating leases 3.4 years 1.0 year Weighted average discount rate: Finance leases 5.04 % 5.04 % Operating leases 5.75 % 5.75 % Table 13.4: Supplemental Cash Flow Information Related to Leases For the Year Ended December 31, 2023 2022 (in thousands) Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows related to operating leases $ 585 $ 603 Operating cash flows related to finance leases 611 688 Financing cash flows related to finance leases 1,592 1,461 14. EMPLOYEE BENEFIT PLAN Telos sponsors a defined contribution employee savings plan (the "Plan") under which substantially all full-time employees are eligible to participate. As of December 31, 2023, the Plan held 1,434,464 shares of Telos common stock. Prior to March 2022, we matched one-half of employee contribution to the Plan up to a maximum of 2 % of such employee's eligible annual base salary. In March 2022, we increased the maximum employer match up to 4 % of the employee's eligible annual base salary. Participant contributions are always fully vested immediately at the time of contribution. Telos' contributions vest at the rate of 20 % each year, with full vesting occurring after completion of five years of service. Effective September 1, 2023, we changed our Telos-contributed matching funds to a two -year vesting schedule: 20 % vesting after one year of service, and fully vesting after the completion of two years of service. Telos intends to fund the employer matching contribution in Telos stock, but will have the discretion to fund the match in cash or a combination of stock and cash. The Telos employer matching contribution is funded in the first quarter of the subsequent year. Our total contributions to the Plan for 2023 and 2022 were $ 2.1 million and $ 2.2 million, respectively. 65 Table of Contents 15. INCOME TAXES Table 15.1: Components of Provision for/(Benefit from) Income Taxes For the Year Ended December 31, 2023 2022 (in thousands) Current provision Federal $ — $ — State ( 19 ) 19 Total current ( 19 ) 19 Deferred tax expense Federal 32 37 State 23 ( 2 ) Total deferred 55 35 Provision for income taxes $ 36 $ 54 Table 15.2: Reconciliation of Statutory Tax Rate to Actual Tax Rate For the Year Ended December 31, 2023 2022 Computed expected income tax provision 21.0 % 21.0 % State income taxes, net of federal income tax benefit 3.6 3.6 Change in valuation allowance for deferred tax assets 7.5 ( 3.7 ) Cumulative deferred adjustments — ( 0.9 ) Provision to return adjustments ( 0.1 ) 0.1 Other permanent differences ( 0.2 ) ( 0.1 ) Stock-based compensation ( 41.2 ) ( 20.6 ) Section 162(m) limitation - covered employees 9.5 ( 2.0 ) Uncertain tax positions 0.5 ( 0.5 ) R&D credit ( 0.7 ) 3.0 Effective tax rate ( 0.1 %) ( 0.1 %) 66 Table of Contents Table 15.3: Components of Deferred Tax Assets and Liabilities As of December 31, 2023 2022 (in thousands) Deferred tax assets: Accounts receivable, principally due to allowance for doubtful accounts $ 70 $ 33 Allowance for inventory obsolescence and amortization 203 210 Accrued liabilities not currently deductible 1,133 1,151 Stock-based compensation 1,352 7,943 Accrued compensation 2,457 915 Lease liabilities 2,906 3,349 Goodwill 30,947 34,009 Capitalized research and development costs 2,992 362 Net operating loss carryforwards - federal 8,402 6,034 Net operating loss carryforwards - state 1,522 1,155 R&D tax credit 3,647 3,760 Amortization and depreciation 252 — Total gross deferred tax assets 55,883 58,921 Less valuation allowance ( 54,999 ) ( 57,559 ) Total deferred tax assets, net of valuation allowance 884 1,362 Deferred tax liabilities: Right-of-use assets ( 1,697 ) ( 2,034 ) Amortization and depreciation — ( 86 ) Total deferred tax liabilities ( 1,697 ) ( 2,120 ) Net deferred tax liabilities $ ( 813 ) $ ( 758 ) Table 15.4: Valuation Allowance Activity For the Year Ended December 31, 2023 2022 (in thousands) Balance at beginning of year $ 57,559 $ 55,588 (Reductions)/additions ( 2,560 ) 1,971 Balance at end of year $ 54,999 $ 57,559 We establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income. We considered projected future taxable income, tax planning strategies, and reversal of taxable temporary differences in making this assessment. Based on available evidence, we have determined that a full valuation allowance is required as of December 31, 2023 and 2022. As a result of a full valuation allowance against our deferred tax assets and liabilities, a deferred tax liability related to indefinite-lived goodwill remains on our consolidated balance sheets on December 31, 2023 and 2022. On December 31, 2023, for federal income tax purposes, there was approximately a $ 40.0 million net operating loss available to be carried forward to offset future taxable income. Approximately $ 10.6 million of these net operating loss carryforwards expire in 2037, the remaining will be carried forward indefinitely. As of December 31, 2023, there was approximately $ 4.9 million of R&D credit carryover which begins to expire in 2033. Certain tax attributes of the Company, including net operating losses and credits, would be subject to a limitation should an ownership change as defined under Section 382 of the Internal Revenue Code of 1986, as amended, occur. The limitations resulting from a change in ownership could affect the Company's ability to utilize its tax attributes. A study was completed in 2020 which confirmed that no limitation applies to the Company's tax attributes as of December 31, 2020. We believe that ownership activity since December 31, 2020 would not result in limitation sufficient to result in the expiration of unused attributes. 67 Table of Contents Under the provisions of ASC 740, we determined that there were approximately $ 1.2 million and $ 1.4 million of unrecognized tax benefits as of December 31, 2023 and 2022, respectively. Included in the balance of unrecognized tax benefits as of December 31, 2023 and 2022 were $ 0.01 million and $ 0.10 million, respectively, of tax benefits that, if recognized, would impact the effective tax rate. Also included in the balance of unrecognized tax benefits as of December 31, 2023 and 2022 were $ 1.2 million and $ 1.3 million, respectively, of tax benefits that, if recognized, would not impact the effective tax rate due to the Company's valuation allowance. We report interest and penalties as a component of income tax expense. The Company had accrued interest and penalties related to the unrecognized tax benefits of $ 0.01 million and $ 0.10 million, which were recorded in other liabilities as of December 31, 2023 and 2022, respectively. We believe that the total amounts of unrecognized tax benefits will not significantly increase or decrease within the next 12 months. The period for which tax years are open, 2013 to 2023, has not been extended beyond the applicable statute of limitations. As of December 31, 2023, the Company is not under examination by any federal tax jurisdiction, but is currently under examination by a state tax jurisdiction. Table 15.5: Reconciliation of the Beginning and Ending Amounts of Unrecognized Tax Benefit For the Year Ended December 31, 2023 2022 (in thousands) Balance at beginning of year $ 1,357 $ 1,056 Decrease in prior year tax positions ( 169 ) ( 5 ) Increase related to current year tax positions 131 377 Decrease related to lapse of statutes ( 91 ) ( 71 ) Balance at end of year $ 1,228 $ 1,357 16. (LOSS)/EARNINGS PER SHARE For the period of net loss, potentially dilutive securities are not included in the calculation of diluted net (loss)/earnings per share because to do so would be anti-dilutive. Table 16.1: Potentially Dilutive Securities For the Year Ended December 31, 2023 2022 (in thousands) Unvested restricted stock and restricted stock units 687 529 Total 687 529 As of December 31, 2023 and 2022, performance-based RSUs of 43,800 and 336,785 , respectively, have been excluded in the calculation of the potentially dilutive securities above because issuance of such shares are contingent upon the satisfaction of certain conditions which were not satisfied by the end of the reporting period. 17. RELATED PARTY TRANSACTIONS Emmett J. Wood, the brother of our Chairman and CEO, has been an employee of ours since 1996. In January 2023, he tendered his resignation as an employee effective February 7, 2023. The amounts paid to him as compensation for his remaining tenure in 2023 was $ 0.2 million, while the amount paid for the year ended December 31, 2022, was $ 1.3 million. 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. The Company, at its election, would pay the director's 2023 consultancy fees in a fixed amount, in the form of restricted stock units. Consequently, on January 3, 2023, the Company granted the director 16,859 RSUs, one-half of which vested on March 3, 2023, and the other half vested on May 18, 2023, as compensation for his consultancy services through June 30, 2023. In July 2023, the director and the Company amended the 2023 consulting agreement, extending his services through December 31, 2023. The amended 2023 consulting agreement stipulates a firm-fixed monthly retainer fee, plus additional fees and contingent bonus payments upon achievement of certain contract goals, payable in cash. In February 2022, the director and the Company amended the consulting agreement to provide that the Company would pay the remainder of the director's consulting fees for 2022 in a fixed price amount in the form of restricted stock units. The Company granted the director 26,091 RSUs on February 1, 2022, which vested quarterly in four equal amounts through the end of the fiscal year 2022, subject to the director's continued performance under the consulting agreement. 68 Table of Contents The cash amount paid for his consultancy services were $ 0.09 million and $ 0.03 million for the years ended December 31, 2023, and 2022, respectively. 18. SEGMENT INFORMATION As noted in Note 2 – Significant Accounting Policies , we conduct our operations through two operating segments: Security Solutions and Secure Networks. • 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 Automated Message Handling System ("AMHS") and Telos ID offerings. We recognize revenue on contracts from providing various system platforms in the cloud, on-premises, and in hybrid cloud environments, as well as software sales or software-as-a-service. Revenue associated with the segment's custom solutions is recognized as work progresses or upon delivery of services and products. Fluctuation in revenue from period to period is the result of the volume of software sales, and the progress or completion of cloud and/or cybersecurity solutions during the period. The majority of the operating costs relate to labor, material, and overhead costs. Software sales have immaterial operation costs associated with them, thus yielding higher margins. Gross profit and margin are a function of operational efficiency on security solutions and changes in the volume of software sales. • 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. Table 18.1: Results of Operations by Business Segment For the Year Ended December 31, 2023 2022 (in thousands) Revenues Security Solutions $ 77,416 $ 120,454 Secure Networks 67,962 96,433 Total revenue 145,378 216,887 Gross profit Security Solutions 39,614 61,948 Secure Networks 13,328 17,095 Total gross profit 52,942 79,043 Selling, general and administrative expenses 93,257 132,893 Operating loss ( 40,315 ) ( 53,850 ) Other income 6,715 1,350 Interest expense ( 786 ) ( 874 ) Loss before income taxes ( 34,386 ) ( 53,374 ) Provision for income taxes ( 36 ) ( 54 ) Net loss $ ( 34,422 ) $ ( 53,428 ) 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. 69 Table of Contents 19. COMMITMENT AND CONTINGENCIES Legal Proceedings From time to time, the Company may be a party to litigation or claims arising in the ordinary course of business, including those relating to employment matters, relationship with clients and contractors, intellectual property disputes, and other business matters. These legal proceedings seek various remedies, including claims for monetary damages in varying amounts, none of which are considered material, or are unspecified as to amount. Although the outcome of any such matter is inherently uncertain and may be materially adverse, based on current information, management believes that the outcome of such known matters will not have a material adverse effect on the Company's financial condition and results of operations. Management does not believe that there are any litigation or claims that would have a material adverse effect on the business, or the consolidated financial statements of the Company as of December 31, 2023. Other - Government Contracts As a U.S. government contractor, we are subject to various audits and investigations by the U.S. government to determine whether our operations are being conducted in accordance with applicable regulatory requirements. U.S. government investigations of our operations, whether relating to government contracts or conducted for other reasons, could result in administrative, civil, or criminal liabilities, including repayments, fines or penalties being imposed upon us, suspension, proposed debarment, debarment from eligibility for future U.S. government contracting, or suspension of export privileges. Suspension or debarment could have a material adverse effect on us because of our dependence on contracts with the U.S. government. U.S. government investigations often take years to complete and many result in no adverse action against us. We also provide products and services to customers outside of the United States, which are subject to U.S. and foreign laws and regulations and foreign procurement policies and practices. Our compliance with local regulations or applicable U.S. government regulations also may be audited or investigated. 20. SUPPLEMENTAL CASH FLOW INFORMATION Table 20.1: Details of Cash, Cash Equivalent, and Restricted Cash As of December 31, 2023 2022 (in thousands) Cash and cash equivalents $ 99,260 $ 119,305 Restricted cash (1) 136 133 Cash, cash equivalents, and restricted cash $ 99,396 $ 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 Consolidated Balance Sheets. Table 20.2: Supplemental Cash Flow Information For the Year Ended December 31, 2023 2022 (in thousands) Cash paid during the year for: Interest $ 693 $ 803 Income taxes 147 188 Non-cash investing and financing activities: Operating lease ROU assets obtained in exchange for operating lease liabilities $ 125 $ 511 Capital expenditure activity in accounts payable and other accrued liabilities 341 211 Issuance of common stock for 401K match 1,943 — Intangible assets transferred to extinguish other financing obligations 7,089 — Common stock repurchase under accounts payable and other accrued liabilities — 139 Deferred financing costs in accounts payable and other accrued liabilities — 114 70 Table of Contents Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.