What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-08-09 compared with 2024-05-10 · 78 added, 55 removed, 200 unchanged (40% of the section changed)

15 unchanged sentences

Information regarding our two reportable segments – Security Solutions and Secure Networks – is presented in Note 16 - Segment Information to the unaudited consolidated financial statements at Item 1 of this Form 10-Q.

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.

The restructuring initiatives carried out by the Company in fiscal year 2023 are exhibiting promising outcomes in fiscal year 2024 in the form of new business wins.

The Company will continue to focus on optimizing its solution portfolio, expanding its business pipeline, strengthening proposals for new business and building a healthy culture by engaging employees through improved synergy, performance management, and benefits.

With this foundation established, the Company's priorities for fiscal year 2024 include beginning to execute on significant new business wins with our prime partners (pending 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

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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.

With the enactment of the Fiscal Responsibility Act ("FRA"), appropriations bills were marked up in the House and Senate in June and July.

The FRA caps total base discretionary spending at $1.6 trillion for FY 2024, with base defense spending capped at $886 billion (a three percent increase from FY 2023) and base non-defense spending capped at $704 billion (up to a nine percent decrease from FY 2023, depending on how it is measured).

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.

Of interest, the Senate passed a package of national security-oriented bills passed by the House on April 20, 2024, that provided supplemental appropriations for Israel, Ukraine, and the Indo-Pacific, as well as a fourth bill that addressed sanctions and other economic concerns.

Three of the four bills being considered provide roughly $96 billion in new budget authority.

The proposed budget also calls for new 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;

However, in the current political environment in Congress and with the presidential election looming in November 2024, it is highly questionable whether Congress and the President can reach an 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.

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

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

Specifically, they will have to:

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

Specifically, registrants will have to:

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

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

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

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.

A number of factors have contributed to our second quarter ended June 30, 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.

• 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.

• Decline in year-over-year revenue primarily driven by successful completion and ramp down of programs in Secure Networks.

• Growth in TSA PreCheck revenue driven by the increase in our TSA PreCheck enrollment locations.

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

• Lower operating costs primarily due to lower stock-based compensation expenses.

Results of Operations

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Consolidated Results of Operations

For the Three Months Ended

March 31, 2024 March 31, 2023

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

(dollars in thousands)

17 unchanged sentences

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

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.

R&D expenses .

In the second quarter of 2024, R&D expenses decreased by $1.2 million, or 44.9%, compared to the same quarter in 2023.

Similarly, R&D expenses decreased by $0.9 million, or 15.5%, for the six months ended June 30, 2024, compared to the same period in the prior year.

The decreases in R&D expenses for both periods were primarily due to the completion of certain development projects in 2023 and lower stock-based compensation expenses, partially offset by lower capitalization and higher amortization expense.

SG&A expenses .

SG&A expenses for the three months ended June 30, 2024 decreased by $2.3 million, or 11.9%, compared to the same period in 2023.

Likewise, SG&A expenses decreased by $9.7 million, or 22.6%, for the six months ended June 30, 2024, compared to the same period in the prior year.

The decreases in SG&A expense for both periods were primarily due to the decline in stock-based compensation costs, depreciation and amortization expenses, and outside services, partially offset by an increase in labor costs.

In addition, there were $1.2 million of restructuring expenses for the six months ended June 30, 2023, with no similar charges in 2024.

Other income .

Other income decreased by $0.6 million for the three months ended June 30, 2024, compared to the same period in 2023, due to the change in dividend income from money market placements.

Other income for the six months ended June 30, 2024 was $2.3 million as compared to $4.1 million for the six months ended June 30, 2023.

The decrease was primarily due to the gain on early extinguishment of other financing obligations of $1.4 million in fiscal year 2023, without a similar gain in fiscal year 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.

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

3 unchanged sentences

Security Solutions Segment - Financial Results

For the Three Months Ended

March 31, 2024 March 31, 2023

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

(dollars in thousands)

5 unchanged sentences

Gross margin 40.7 % 55.5 % 43.5 % 53.6 %

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.

For the three months ended June 30, 2024, Security Solutions segment revenue slightly increased by $0.7 million, or 3.9%, compared to the same period in 2023, primarily due to the growth in TSA PreCheck, partially offset by contraction elsewhere in the portfolio.

Security Solutions segment revenue for the six months ended June 30, 2024, slightly decreased by $0.5 million, or 1.2%, compared to the same period in 2023, primarily due to the reductions in two large programs, partially offset by the growth in TSA PreCheck.

Security Solutions gross profit for the second quarter of 2024 decreased by $2.3 million, or 23.9%, compared with the same period in 2023.

Likewise, segment gross profit for the six months ended June 30, 2024, decreased by $3.9 million, or 19.8%, compared to the same period in 2023.

In addition, Security Solution gross margin for the second quarter of 2024 decreased from 55.5% to 40.7%, while year to date segment gross margin decreased from 53.6% to 43.5%.

The decrease in gross profit and gross margin for the three and six months ended June 30, 2024, was primarily due to the increased amortization of software development costs and program mix within the portfolio.

Table MD&A 3:

Secure Networks Segment - Financial Results

For the Three Months Ended

March 31, 2024 March 31, 2023

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

(dollars in thousands)

5 unchanged sentences

Gross margin 23.0 % 17.9 % 22.1 % 19.3 %

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.

Secure Networks segment revenue for the three months ended June 30, 2024, decreased by $5.1 million, or 32.4%, compared to the same period in 2023.

Likewise, Secure Network segment revenue for the six months ended June 30, 2024 decreased by $9.6 million, or 30.7%, compared to the same period in 2023.

The decrease in revenue for the three and six months ended June 30, 2024, is primarily due to the successful completion and ramp down of programs.

Gross profit for Secure Networks slightly decreased by $0.4 million, or 13.0%, for the second quarter of 2024, compared with the same period in 2023.

Segment gross profit for the six months ended June 30, 2024, decreased by $1.2 million, or 20.6%, compared to the same period in 2023.

The change in gross profit for the three and six months ended June 30, 2024, is primarily due to lower revenue, partially offset by improved margin across the portfolio.

Secure Networks gross margin increased to 23.0% for the second quarter of 2024 from 17.9% for the same period in 2023.

Likewise, segment gross margin in the first half of 2024 increased from 19.3% in 2023 to 22.1% in 2024.

The gross margin expansion, for the three and six months ended June 30, 2024, is primarily due to strong program management and favorable program mix.

Non-GAAP Financial Measures

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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

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

Amount Margin Amount Margin Amount Margin Amount Margin

(dollars in thousands)

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Adjusted EBITDA (Non-GAAP) $ (2,934) (10.3) % $ (29) (0.1) % $ (5,269) (9.1) % $ (875) (1.3) %

(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.

(1) The stock-based compensation expense 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 $2.4 million and $4.1 million for the three and six months ended June 30, 2024, respectively, and $5.7 million and $13.6 million, for the three and six months ended June 30, 2023, respectively.

Stock-based compensation (adjustments) expense from other sources was $(0.2) million and $1.1 million for the three and six months ended June 30, 2024, respectively and $2.1 million and $3.7 million for the three and six months ended June 30, 2023, respectively.

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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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

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

Net Loss Adjusted Earnings Per Share Adjusted

Net Loss Adjusted Earnings Per Share

8 unchanged sentences

Weighted-average shares of common stock outstanding, basic 72,017 69,424 71,323 68,804

(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.

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

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.

11 unchanged sentences

Gross Margin to Cash Gross Margin

For the Three Months Ended

March 31, 2024 March 31, 2023

Amount Margin Amount Margin

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

Amount Margin Amount Margin Amount Margin Amount Margin

(dollars in thousands)

10 unchanged sentences

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

For the Three Months Ended

March 31, 2024 March 31, 2023

For the Three Months Ended For the Six Months Ended

June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023

(in thousands)

11 unchanged sentences

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

As of June 30, 2024, we had cash and cash equivalents of $80.1 million and our working capital was $87.0 million.

We place a strong emphasis on liquidity management.

5 unchanged sentences

Net Change in Cash, Cash Equivalents, and Restricted Cash

For the Three Months Ended

March 31, 2024 March 31, 2023

For the Six Months Ended

June 30, 2024 June 30, 2023

(in thousands)

3 unchanged sentences

Net change in cash, cash equivalents, and restricted cash $ (19,155) $ (15,857)

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 operating activities for the six months ended June 30, 2024, was $8.3 million, an increase of $4.1 million compared to the same period in 2023.

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 that do not impact cash flows from operating activities.

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.

Net cash used in investing activities for the six months ended June 30, 2024, increased by $1.2 million, compared to the same period of the prior year, primarily due to the cash outflow from the purchase of an investment of $3.0 million in 2024, with no similar transaction in 2023.

This is partially offset by a decrease in capital expenditures in 2024.

Net cash used in financing activities for the six months ended June 30, 2024, decreased by $2.0 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 half of 2024, compared with $1.6 million in the same period of 2023, and a $0.6 million payment for the Diamond Fortress Technologies ("DFT") holdback in February 2023, with no similar payment in 2024.

Critical Accounting Policies and Estimates

3 unchanged sentences

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 three months ended March 31, 2024.

Quantitative and Qualitative Disclosures about Market Risk

1 unchanged sentence

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