What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-05-10 compared with 2023-11-09 · 99 added, 131 removed, 156 unchanged (60% of the section changed)

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Several important factors could cause the Company's actual results to differ materially from those indicated by such forward-looking statements.

These factors include, without limitation, those set forth in the risk factors section included in the Company's Form 10-K for the year ended December 31, 2022, as filed with the Securities and Exchange Commission ("SEC") on March 16, 2023.

These factors include, without limitation, those set forth in the risk factors section included in the Company's Form 10-K for the year ended December 31, 2023, as filed with the Securities and Exchange Commission on March 15, 2024.

General and Business Overview

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Information regarding our two reportable segments – Security Solutions and Secure Networks – is presented in Note 1 6 - Segment Information to the unaudited consolidated financial statements at Item 1 of this Form 10-Q.

Fiscal year 2023 continues to be a transition year for Telos, focusing on streamlining our operations and rebuilding and growing the revenue base by generating new business wins.

Our 2023 business development priorities are to:

• Reorganize internally to consolidate and centralize business development resources;

• Add new talent to drive execution of solution development and new business generation;

• Maximize existing strategic partnerships for market expansion;

• Increase our opportunity portfolio and quality of contract vehicles.

The transition efforts carried out by the Company in fiscal year 2023 are exhibiting promising outcomes at the beginning of fiscal year 2024 in the form of new business wins.

The Company will continue these efforts into fiscal year 2024 by focusing on optimizing its solution portfolio, expanding its business pipeline, strengthening proposals for new business and building a healthy culture by engaging employees through synergy, setting performance goals, and improving benefits.

With this foundation established, the Company's priorities for fiscal year 2024 include beginning execution of significant new business wins with our prime partners, pending the favorable outcomes on ongoing protests, ramping TSA PreCheck enrollment sites to achieve program growth, and strategically increasing the Company's business development pipeline.

Business Environment

The President’s proposed FY2024 budget released in March called for a $26 billion increase for the Department of Defense ("DoD") next year, a little more than 3% above the FY2023 enacted level.

The debt ceiling legislation (the "Fiscal Responsibility Act") subsequently enacted into law in early June contains spending caps which reflected that level of defense spending, as have the House and Senate versions of the defense authorization and appropriations bills.

While there are many in Congress who want to boost this increase further to offset current and expected inflation and the continued threats posed by foreign adversaries, final decisions on FY 2024 defense spending are now not likely to be made until December at the very earliest.

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

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

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

However, such increased spending by civilian agencies on cybersecurity could be difficult to achieve, given the caps on non-defense discretionary spending included in the Fiscal Responsibility Act and subsequent efforts by the House majority to seek further reductions in all non-defense discretionary spending.

This could impact future cybersecurity investments by current and potential civilian federal customers.

Congress was unable to enact any of its annual appropriation bills before the start of FY2024 on October 1, 2023 and instead approved a Continuing Resolution (“CR”), which funded the government at FY2023 levels until November 17, 2023 and restricted new contracts and acceleration of current programs.

It is unlikely Congress will enact any individual appropriation bills before the current CR expires, and prospects for approving another CR by then are uncertain.

Failure to enact a new CR by November 17, 2023 would result in a federal government shutdown after that date.

Finally, under the terms of the Fiscal Responsibility Act, if all appropriations legislation is not enacted by January 1, 2024, and the government remains under another CR, appropriations government-wide will revert to the FY2023 level minus an additional one percent.

This uncertainty could impact federal customers' ability to move forward on their planned expenditures in FY2024.

After using continuing resolutions (“CRs”) to fund the government for the first six months of Fiscal Year (“FY”) 2024 at the previous year’s levels, Congress completed action in late March on all appropriations bills for FY2024.

This has allowed federal departments and agencies to begin proceeding with new program starts and acceleration for the final six months of the fiscal year.

Of note, the final FY2024 appropriations bill for the Department of Defense provided a $27 billion (three percent) increase in defense spending.

The White House also submitted to Congress in March its proposed budget for FY2025.

The President’s proposal calls for a one percent increase in funding for the Department of Defense next year, with a total spending level in line with the spending caps Congress imposed on itself in the Fiscal Responsibility Act of 2023.

There will be debate in Congress on whether to adjust the spending caps in order to boost defense spending to meet increased challenges abroad.

The proposed budget also calls for increases in funding for non-defense cybersecurity programs and initiatives, many of which continue to prioritize accelerated cloud adoption, IT modernization, further private sector collaboration for sector risk management responsibilities, ensuring adequate cyber threat information sharing, and supply chain risk management.

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

However, in the current political environment in Congress and with the presidential election looming in November, it is highly questionable whether Congress and the President can reach agreement on FY2025 appropriations bills prior to the start of FY2025 on October 1, 2024;

this means the Defense Department along with the rest of the federal government will likely begin the fiscal year funded by a CR at FY2024 spending levels.

Cybersecurity Landscape

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The Nation's Critical Systems Are Still at Risk:

Critical infrastructure and industrial Internet of Things ("IoT") are among the categories at greatest risk of cyberattacks.

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

The Challenging Complexity of Regulatory Compliance:

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

Backlog is a useful measure in developing our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts.

We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers.

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

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

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

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

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

Most of our customers fund contracts on the basis of one year or less, and, as a result, funded backlog is generally expected to be earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period.

Business Highlights

Although a number of factors have contributed to the results of our third quarter of fiscal year 2023, the notable events and significant factors are described below.

Financial Overview

A number of factors have contributed to our first quarter of fiscal year 2024 results of operations, the most significant of which are described below.

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

• The completion of certain programs and lower revenue on ongoing major programs resulted in a decline in the current quarter's revenue compared with 2022 results.

• Gross margin increased significantly primarily due to revenue mix and improved margins due to strong program management within Secure Networks programs.

• Operating costs are lower through a combination of lower stock-based compensation and the results of the restructuring plan announced in the first quarter of 2023.

• Decline in year-over-year revenue primarily driven by the ramp down of programs within Secure Networks.

• Growth in TSA PreCheck revenue.

• Reduction in gross margins driven by the increased impact of amortization of software development costs.

• Lower operating costs through a combination of lower stock-based compensation and restructuring expenses.

Results of Operations

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Consolidated Results of Operations

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

For the Three Months Ended

March 31, 2024 March 31, 2023

(dollars in thousands)

Total revenue $ 36,186 $ 63,593 $ 104,319 $ 169,544

Cost of sales (exclusive of depreciation and amortization shown separately below) 21,228 42,457 63,174 108,197

Depreciation and amortization 1,945 191 2,291 602

Total cost of sales 23,173 42,648 65,465 108,799

Revenue $ 29,619 $ 35,222

Cost of sales 18,658 21,740

Gross profit 10,961 13,482

Gross margin 37.0 % 38.3 %

Selling, general and administrative expenses 22,706 29,729 70,984 99,932

Selling, general and administrative expenses as percentage of revenue 62.7 % 46.7 % 68.0 % 58.9 %

Research and development ("R&D") expenses 3,170 2,833

R&D expenses as percentage of revenue 10.7 % 8.0 %

Selling, general and administrative ("SG&A") expenses 16,229 23,619

SG&A expenses as percentage of revenue 54.8 % 67.1 %

Operating loss (8,438) (12,970)

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

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

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

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

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

SG&A decreased by $7.0 million, or 23.6%, for the three months ended September 30, 2023, compared to the same period in 2022.

Sales and marketing expenses decreased by $1.3 million, research and development expenses decreased by $0.8 million, and general and administrative expenses decreased by $4.9 million.

Lower compensation costs are the primary driver for reductions across all of these areas.

SG&A decreased by $28.9 million, or 29.0%, for the nine months ended September 30, 2023, as compared to the same period in the prior year.

Sales and marketing expenses decreased by $7.9 million primarily due to lower compensation costs.

Research and development expenses decreased by $5.3 million due to lower compensation costs and increased capitalization of software development.

General and administrative expenses also decreased by $15.8 million due to lower compensation costs, partially offset by restructuring expenses.

Other income.

Other income increased by $0.7 million for the three months ended September 30, 2023, due to increases in dividend income from money market placements as a result of increasing interest rates, compared to the same period in 2022.

Other income increased by $4.7 million for the nine months ended September 30, 2023, as compared to the same period in the prior year, primarily due to an increase in dividend income from money market placement of $3.3 million, and a gain on early extinguishment of other financing obligations of $1.4 million in 2023 without a similar gain in the same period in 2022.

Interest expense .

R&D expenses increased by $0.3 million, or 11.9%, in the first quarter of 2024, compared to the same period in 2023, primarily due to increases in amortization costs.

SG&A expenses decreased by $7.4 million, or 31.3%, in the first quarter of 2024 compared to the same period in 2023.

This is primarily due to reduced stock-based compensation costs of $6.1 million and the $1.2 million of restructuring expenses in 2023, with no similar charges in 2024.

Other income decreased by $1.2 million year-over-year due to the gain on early extinguishment of other financing obligations of $1.4 million in the first quarter of 2023, without similar gain in the same period in 2024.

The remaining variance is attributable to the change in dividend income from money market placements.

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

Provision for income taxes .

The change in the income tax provision for the three and nine months ended September 30, 2023, compared to the same period in 2022, is based on the estimated annual effective tax rate applied to the pretax loss incurred for the quarter plus discrete tax items, based on our expectation of pretax loss for the fiscal year.

The change in the income tax provision for the first quarter of 2024 compared to the same period in 2023 is based on the estimated annual effective tax rate applied to the pretax loss incurred for the quarter plus discrete tax items, based on our expectation of pretax loss for the fiscal year.

Segment Results

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Security Solutions Segment - Financial Results

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

For the Three Months Ended

March 31, 2024 March 31, 2023

(dollars in thousands)

Revenue $ 18,640 $ 19,773

Cost of sales (exclusive of depreciation and amortization shown separately below) 8,498 16,680 25,304 42,536

Cost of sales (excluding depreciation and amortization) 8,739 9,329

Depreciation and amortization 1,275 170

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Gross margin 46.3 % 52.0 %

For the three months ended September 30, 2023, Security Solutions segment revenue decreased by $12.6 million, or 39.0%, compared to the same period in 2022, primarily due to lower revenues on ongoing programs.

Security Solutions segment revenue for the nine months ended September 30, 2023, decreased by $33.4 million, or 37.1%, compared to the same period in 2022, primarily due to lower revenues on ongoing programs.

Gross profit for Security Solutions decreased by $6.2 million, or 39.9%, for the third quarter of 2023 compared with the same period in 2022, primarily due to the decrease in revenue and a slight decrease in gross margin.

Segment gross margin decreased to 47.3% for the third quarter of 2023 from 48.0% for the same period in 2022, primarily due to amortization of software development costs partially offset by favorable revenue mix.

For the nine months ended September 30, 2023, Security Solutions segment gross profit decreased by $17.9 million, or 38.0%, compared to the same period in 2022, primarily due to the decrease in revenue and a small decrease in gross margin.

Segment gross margin decreased from 52.2% to 51.4%, primarily due to amortization of software development costs partially offset by favorable revenue mix within the portfolio.

For the three months ended March 31, 2024, Security Solutions segment revenue decreased by $1.1 million, or 5.7%, compared to the same period in 2023, primarily due to lower volume on ongoing programs, partially offset by growth in TSA PreCheck.

Gross profit for Security Solutions decreased by $1.6 million, or 16.0%, for the first quarter of 2024, compared with the same period in 2023, primarily due to the decrease in revenue and a decrease in segment gross margin to 46.3% for the first quarter of 2024 from 52.0% for the same period in 2023.

The gross margin contraction in the first quarter of 2024 was primarily the result of the impact of the increased amortization of software development costs within the segment.

Table MD&A 4:

Secure Networks Segment - Financial Results

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

For the Three Months Ended

March 31, 2024 March 31, 2023

(dollars in thousands)

Revenue $ 10,979 $ 15,449

Cost of sales (exclusive of depreciation and amortization shown separately below) 12,730 25,777 37,870 65,661

Cost of sales (excluding depreciation and amortization) 8,641 12,235

Depreciation and amortization 3 6

Total cost of sales 12,732 25,785 37,880 65,683

Cost of sales 8,644 12,241

Gross profit 2,335 3,208

Gross margin 21.3 % 20.8 %

Secure Networks segment revenue for the three months ended September 30, 2023, decreased by $14.8 million, or 47.4%, compared to the same period in 2022, primarily due to the successful completion of certain programs and lower revenue on ongoing major programs as expected.

For the nine months ended September 30, 2023, Secure Networks segment revenue decreased by $31.8 million, or 40.1%, compared to the same period in 2022, primarily due to the successful completion of certain programs and lower revenue on ongoing major programs as expected.

Gross profit for Secure Networks decreased by $1.7 million, or 31.8%, for the third quarter of 2023, compared with the same period in 2022, primarily due to lower revenue but partially offset by higher gross margins.

Segment gross margin increased to 22.3% for the third quarter of 2023 from 17.2% for the same period in 2022, primarily due to strong program management and the successful wind-down of certain lower-margin programs.

For the nine months ended September 30, 2023, Secure Networks segment gross profit decreased by $4.0 million, or 29.3%, compared to the same period in 2022, primarily due to lower revenue, partially offset by higher gross margins.

Segment gross margin increased from 17.2% in 2022 to 20.3% in 2023 due to strong program management and a shift in the mix across the portfolio driven by the successful wind-down of lower-margin programs.

Secure Networks segment revenue for the three months ended March 31, 2024 decreased by $4.5 million, or 28.9%, compared to the same period in 2023, primarily due to the ramp down of several programs within the portfolio.

Gross profit for Secure Networks decreased by $0.9 million, or 27.2%, for the first quarter of 2024, compared with the same period in 2023, due to the lower revenue, offset by improved margin across the portfolio.

Segment gross margin slightly increased to 21.3% for the first quarter of 2024 from 20.8% for the same period in 2023 primarily due to strong program management and favorable program revenue mix, offset by the higher impact of indirect expenses on lower revenue.

Non-GAAP Financial Measures

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

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

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

We believe that this non-GAAP financial information, when taken collectively with our GAAP results, may be helpful to readers of our financial statements because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results.

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

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

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

Table MD&A 5:

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

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

Amount Margin Amount Margin Amount Margin Amount Margin

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

For the Three Months Ended

March 31, 2024 March 31, 2023

Amount Margin Amount Margin

(dollars in thousands)

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2,984 10.0 % 9,499 27.0 %

Restructuring expenses (2)

Restructuring (adjustments) expenses (2)

(10) — % 1,200 3.4 %

Adjusted EBITDA (Non-GAAP) $ (2,335) (7.9) % $ (846) (2.4) %

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

Stock-based compensation expense for the awarded RSUs, PSUs and stock options was $5.2 million and $18.6 million for the three and nine months ended September 30, 2023, respectively, and $16.1 million and $46.8 million for the three and nine months ended September 30, 2022, respectively.

No stock-based compensation from other sources was recorded for the three months ended September 30, 2023, while $3.8 million was recorded for the nine months ended September 30, 2023.

Stock-based compensation (adjustment)/expense from other sources was $(0.3) million and $2.0 million for the three and nine months ended September 30, 2022, respectively.

(1) The stock-based compensation expense to EBITDA as of March 31, 2024 and 2023 is made up of $1.6 million and $7.9 million, respectively, of stock-based compensation expense for the awarded RSUs, PSUs, and stock options, and $1.3 million and $1.6 million, respectively, of other sources of stock-based compensation expense.

The other sources of stock-based compensation consist of accrued compensation, which the Company intends to settle in shares of the Company's common stock.

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Any change to the expected payment form would result in out of quarter adjustments to this add back to Adjusted EBITDA.

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

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

Adjusted Net (Loss) Income and Adjusted EPS

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Table MD&A 6:

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

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

Amount Earnings Per Share Amount Earnings Per Share Amount Earnings Per Share Amount Earnings Per Share

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

For the Three Months Ended

March 31, 2024 March 31, 2023

Net Loss Adjusted Earnings Per Share Adjusted

Net Loss Adjusted Earnings Per Share

(in thousands, except per share data)

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2,984 0.04 9,499 0.14

Restructuring expenses (2)

Restructuring (adjustments) expenses (2)

(10) — 1,200 0.02

Adjusted net (loss)/income, Adjusted EPS (Non-GAAP) $ (4,676) $ (0.07) $ 6,863 $ 0.10 $ (9,150) $ (0.13) $ 8,965 $ 0.13

Adjusted net loss (Non-GAAP measure) $ (5,656) $ (0.08) $ (2,543) $ (0.04)

Weighted-average shares of common stock outstanding, basic 70,628 68,176

(1) The stock-based compensation adjustment to net (loss)/income is made up of stock-based compensation expense for the awarded RSUs, PSUs and stock options, and other sources.

No stock-based compensation from other sources was recorded for the three months ended September 30, 2023, while $3.8 million was recorded for the nine months ended September 30, 2023.

Stock-based compensation (adjustment)/expense from other sources was $(0.3) million and $2.0 million for the three and nine months ended September 30, 2022, respectively.

(1) The stock-based compensation expense to net loss as of March 31, 2024 and 2023 is made up of $1.6 million and $7.9 million, respectively, of stock-based compensation expense for the awarded RSUs, PSUs and stock options, and $1.3 million and $1.6 million, respectively, of other sources of stock-based compensation expense.

The other sources of stock-based compensation consist of accrued compensation, which the Company intends to settle in shares of the Company's common stock.

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Any change to the expected payment form would result in out of quarter adjustments to this add back to Adjusted Net (Loss) Income.

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

Non-GAAP Gross Profit and Non-GAAP Gross Margin

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

We define Non-GAAP Gross Profit as gross profit, adjusted for stock-based compensation expense, and depreciation and amortization charged under cost of sales.

We define Non-GAAP Gross Margin as Non-GAAP Gross Profit as a percentage of total revenue.

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

Cash Gross Profit and Cash Gross Margin

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

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

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

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

Table MD&A 7:

Reconciliation of Gross Profit to Non-GAAP Gross Profit;

Gross Margin to Non-GAAP Gross Margin

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

Amount Margin Amount Margin Amount Margin Amount Margin

Reconciliation of Gross Profit to Cash Gross Profit;

Gross Margin to Cash Gross Margin

For the Three Months Ended

March 31, 2024 March 31, 2023

Amount Margin Amount Margin

(dollars in thousands)

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Depreciation and amortization — cost of sales 1,278 4.3% 176 0.5%

Non-GAAP gross profit $ 15,031 41.5 % $ 22,065 34.7 % $ 41,769 40.0 % $ 64,145 37.8 %

Cash gross profit (Non-GAAP) $ 12,496 42.2% $ 13,984 39.7 %

Free Cash Flow

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

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

Further, Free Cash Flow may be useful to management and investors in evaluating the Company's operating performance and liquidity, and to evaluate the performance of certain management personnel when determining incentive compensation.

Table MD&A 8:

Free Cash Flow

For the Three Months Ended For the Nine Months Ended

September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022

Reconciliation of Net Cash Used in Operating Activities to Free Cash Flow

For the Three Months Ended

March 31, 2024 March 31, 2023

(in thousands)

Net cash provided by/(used in) operating activities $ 846 $ 11,986 $ (3,367) $ 20,118

Net cash used in operating activities $ (350) $ (100)

Purchases of property and equipment (97) (223)

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Free cash flow (Non-GAAP) $ (3,649) $ (4,123)

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

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

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

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

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

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

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

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

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

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

As of September 30, 2023, we had cash and cash equivalents of $100.0 million and our working capital was $106.6 million.

As of March 31, 2024, we had cash and cash equivalents of $93.9 million and our working capital was $92.7 million.

We place a strong emphasis on liquidity management.

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Net Change in Cash, Cash Equivalents, and Restricted Cash

For the Nine Months Ended

September 30, 2023 September 30, 2022

For the Three Months Ended

March 31, 2024 March 31, 2023

(in thousands)

Net cash (used in)/provided by operating activities $ (3,367) $ 20,118

Net cash used in operating activities $ (350) $ (100)

Net cash used in investing activities (4,149) (4,587)

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Net change in cash, cash equivalents, and restricted cash $ (5,345) $ (6,843)

Net cash used in operating activities for the nine months ended September 30, 2023, was $3.4 million, a decrease in cash inflow of $23.5 million in cash outflow, compared to the same period in 2022.

The change is primarily driven by the Company's operating losses, the timing of receipts of customer payments, the timing of payments to vendors and employees, and the timing of inventory turnover, adjusted for certain non-cash items (i.e.

stock-based compensation costs lower by $26.4 million) that do not impact cash flows from operating activities.

Net cash used in investing activities for the nine months ended September 30, 2023, increased by $2.9 million compared to the same period of the prior year, primarily due to the higher investment in software development costs of $12.0 million and $8.6 million for the nine months ended September 30, 2023 and 2022, respectively, partially offset by the slight decrease in purchases of property and equipment.

Net cash used in financing activities for the nine months ended September 30, 2023, decreased by $8.1 million compared to the same period in 2022.

This is primarily attributable to the decrease in payment of tax withholding related to net share settlement of equity awards of $1.7 million for the nine months ended September 30, 2023, compared with $3.1 million in the same period of 2022, and the cash outflow on repurchases of common stock of $7.6 million in 2022 compared with $0.1 million in 2023 under the share repurchase program (see Note 13 – Share Repurchases ).

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

Net cash used in operating activities for the three months ended March 31, 2024 was $0.4 million, an increase of $0.3 million compared to the same period in 2023.

Net cash used in investing activities for the three months ended March 31, 2024 slightly decreased by $0.4 million, compared to the same period of the prior year, primarily due to the decreases in capital expenditures in 2024 and a $0.6 million payment for the DFT holdback in February 2023, with no similar payment in 2024.

This was partially offset by the purchase of an investment of $0.9 million in 2024, with no similar transaction in 2023.

Net cash used in financing activities for the three months ended March 31, 2024 decreased by $1.3 million, compared to the same period in 2023.

This is primarily attributable to the decreases in payment of tax withholding related to net share settlement of equity awards of $0.4 million in the first quarter of 2024 compared with $1.5 million in the same period of 2023.

Critical Accounting Policies and Estimates

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The 2023 Form 10-K, as filed with the SEC on March 15, 2024, includes a summary of critical accounting policies we believe are the most important to aid in understanding our financial results.

There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of assets, liabilities, revenues, or expenses during the nine months ended September 30, 2023.

Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis