TELOS CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. 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, 2023, as filed with the Securities and Exchange Commission on March 15, 2024. General and Business Overview We offer technologically advanced, software-based security solutions that empower and protect the world's most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats. Our portfolio of security products, services and expertise empowers our customers with capabilities to reach new markets, serve their stakeholders more effectively, and successfully defend the nation or their enterprise. We protect our customers' people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in their security and privacy. Our primary customers include the U.S. federal government, large commercial businesses, state and local governments, and international customers. Our consolidated revenue is largely attributable to prime contracts or to subcontracts with our contractors engaged in work for the U.S. government, with the remaining attributable to state, local, and commercial markets. 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 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 U.S. Budget 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. 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. 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 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. 19 Table of Contents Cybersecurity Landscape In recent years, we have seen cybersecurity threats become more complex, with threat actors leveraging a wide variety of tactics to exploit their victims. With this growing threat, below are some trends to consider when looking at the cybersecurity landscape: Rising Threats, Rising Liability: Ransomware remains arguably the most severe cyber threat to enterprises in the commercial, state, and local government and education sectors. One reason for the rise of ransomware attacks is that it is exceedingly profitable for cybercriminals, and ransomware victims generally settle the ransom rather than restoring the system from backups or dealing with the fallout from a data breach. Aside from the financial costs of paying the ransom and restoring the system, the consequences of a successful ransomware attack can include damage to the organization's reputation, stolen sensitive data being used for malicious purposes, and loss of business. The Nation's Critical Systems Are Still at Risk: Critical infrastructure and industrial IoT are among the categories at greatest risk of cyberattacks. The Challenging Complexity of Regulatory Compliance: Government mandates stronger security in highly regulated industries. These government initiatives and audit fatigue continue to burden highly regulated organizations, with automation solutions being recognized as the most effective remedy for the many repetitive and redundant tasks that security compliance requires. Additionally, the SEC has finalized and adopted new cybersecurity rules for publicly traded companies, which (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; (2) meet specific disclosure requirements and deadlines for reporting and describing material cyber incidents; and (3) describe the board's oversight of risks from cybersecurity threats, and management's expertise and role in assessing and managing material risks from cybersecurity threats. The required reporting of this information will lead many companies to proactively establish policies that will improve their cyber risk management posture and enable them to better withstand heightened public and regulatory scrutiny. Identity Assurance and Privacy Protection are Essential for Today's Enterprises: Identity and access management continues to be a major cybersecurity concern for organizations and individuals that need to ensure their security and protect their privacy. Trusted identities are essential to confidence in IT and physical security strategies and to the success of Zero Trust security models and architectures. Artificial Intelligence : Cybercriminals are using Artificial Intelligence ("AI") to launch more sophisticated attacks that can quickly adapt to changing environments, making detection harder. To protect against AI-powered cyberattacks, organizations must stay vigilant and adopt advanced cybersecurity tools and techniques that can detect and respond to these threats in a timely manner before they cause damage. Financial Overview 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 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. 20 Table of Contents Results of Operations Table MD&A 1: Consolidated Results of Operations 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) Revenue $ 28,498 $ 32,911 $ 58,117 $ 68,133 Cost of sales 18,791 20,552 37,449 42,292 Gross profit 9,707 12,359 20,668 25,841 Gross margin 34.1 % 37.6 % 35.6 % 37.9 % Research and development ("R&D") expenses 1,459 2,646 4,629 5,479 R&D expenses as percentage of revenue 5.1 % 8.0 % 8.0 % 8.0 % Selling, general and administrative ("SG&A") expenses 16,892 19,180 33,121 42,799 SG&A expenses as percentage of revenue 59.3 % 58.3 % 57.0 % 62.8 % Operating loss (8,644) (9,467) (17,082) (22,437) Other income 1,064 1,649 2,316 4,145 Interest expense (160) (184) (335) (433) Loss before income taxes (7,740) (8,002) (15,101) (18,725) Provision for income taxes (17) (22) (34) (45) Net loss $ (7,757) $ (8,024) $ (15,135) $ (18,770) Consolidated Results Our business segments have different factors driving revenue fluctuations and profitability. 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. 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. 21 Table of Contents Segment Results The accounting policies of each business segment are the same as those followed by the Company as a whole. Management evaluates business segment performance based on gross profit. Table MD&A 2: Security Solutions Segment - Financial Results 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) Revenue $ 17,867 $ 17,196 $ 36,507 $ 36,969 Cost of sales (excluding depreciation and amortization) 8,565 7,477 17,304 16,806 Depreciation and amortization 2,037 168 3,312 338 Total cost of sales 10,602 7,645 20,616 17,144 Gross profit $ 7,265 $ 9,551 $ 15,891 $ 19,825 Gross margin 40.7 % 55.5 % 43.5 % 53.6 % 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 For the Six Months Ended June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023 (dollars in thousands) Revenue $ 10,631 $ 15,715 $ 21,610 $ 31,164 Cost of sales (excluding depreciation and amortization) 8,187 12,905 16,828 25,140 Depreciation and amortization 2 2 5 8 Cost of sales 8,189 12,907 16,833 25,148 Gross profit $ 2,442 $ 2,808 $ 4,777 $ 6,016 Gross margin 23.0 % 17.9 % 22.1 % 19.3 % 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. 22 Table of Contents 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"), 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. The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled non-GAAP measures used by other companies. A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP. We believe these non-GAAP financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionately positive or negative impact on our results of operations in any particular period. When viewed in combination with our results prepared in accordance with GAAP, these non-GAAP financial measures help provide a broader picture of factors and trends affecting our results of operations. EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, an alternative to net loss as determined by GAAP. We define EBITDA as net (loss) income, adjusted for non-operating (income) expense, interest expense, provision for (benefit from) income taxes, and depreciation and amortization. We define Adjusted EBITDA as EBITDA, adjusted for stock-based compensation expense and restructuring expenses. We define EBITDA Margin as EBITDA as a percentage of total revenue. We define Adjusted EBITDA Margin as Adjusted EBITDA as a percentage of total revenue. We believe that EBITDA, EBITDA Margin, Adjusted EBITDA and Adjusted EBITDA Margin provide the Board, management and investors with clear representation of our core operating performance and trends, provide greater visibility into the long-term financial performance of the Company, and eliminate the impact of items that do not relate to the ongoing operating performance of the business. Further, Adjusted EBITDA is used by the Board and management to prepare and approve our annual budget, and to evaluate the performance of certain management personnel when determining incentive compensation. Table MD&A 4: Reconciliation of Net Loss to EBITDA, Adjusted EBITDA and Adjusted EBITDA 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) Net loss $ (7,757) (27.2 %) $ (8,024) (24.4 %) $ (15,135) (26.0) % $ (18,770) (27.5) % Other income (1,064) (3.7 %) (1,649) (5.0 %) (2,316) (4.0) % (4,145) (6.1) % Interest expense 160 0.5 % 184 0.5 % 335 0.5 % 433 0.6 % Provision for income taxes 17 0.1 % 22 0.1 % 34 0.1 % 45 0.1 % Depreciation and amortization 3,491 12.2 % 1,696 5.2 % 6,620 11.4 % 3,121 4.5 % EBITDA (Non-GAAP) (5,153) (18.1 %) (7,771) (23.6 %) (10,462) (18.0) % (19,316) (28.4) % Stock-based compensation expense (1) 2,219 7.8 % 7,745 23.5 % 5,203 8.9 % 17,244 25.3 % Restructuring (adjustments) expenses (2) — — % (3) — % (10) — % 1,197 1.8 % 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 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. However, it is the Company’s discretion whether this compensation will ultimately be paid in stock or cash. The Company has the right to dictate the form of these payments up until the date at which they are paid. Any change to the expected payment form would result in out of quarter adjustments to this add back to Adjusted EBITDA. (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. 23 Table of Contents Adjusted Net (Loss) Income and Adjusted EPS Adjusted Net (Loss) Income and Adjusted EPS are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, alternatives to net (loss) income as determined by GAAP. We define Adjusted Net (Loss) Income as net loss, adjusted for non-operating (income) expense, stock-based compensation expense and restructuring expense. We define Adjusted EPS as Adjusted Net (Loss) Income divided by the weighted-average number of common shares outstanding for the period. Adjusted Net (Loss) Income and Adjusted EPS provide the Board, management and investors with clear representation of our core operating performance and trends, provide greater visibility into the long-term financial performance of the Company, and eliminate the impact of items that do not relate to the ongoing operating performance of the business. Table MD&A 5: Reconciliation of Net Loss and GAAP EPS to Non-GAAP Adjusted Net Loss and Adjusted EPS For the Three Months Ended For the Six Months Ended June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023 Adjusted Net Loss Adjusted Earnings Per Share Adjusted Net Loss Adjusted Earnings Per Share Adjusted Net Loss Adjusted Earnings Per Share Adjusted Net Loss Adjusted Earnings Per Share (in thousands, except per share data) Net loss $ (7,757) $ (0.11) $ (8,024) $ (0.12) $ (15,135) $ (0.21) $ (18,770) $ (0.27) Adjustments: Other income (1,064) (0.01) (1,649) (0.02) (2,316) (0.03) (4,145) (0.06) Stock-based compensation expense (1) 2,219 0.03 7,745 0.11 5,203 0.07 17,244 0.25 Restructuring (adjustments) expenses (2) — — (3) — (10) — 1,197 0.01 Adjusted net loss (Non-GAAP measure) $ (6,602) $ (0.09) $ (1,931) $ (0.03) $ (12,258) $ (0.17) $ (4,474) $ (0.07) 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 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. However, it is the Company’s discretion whether this compensation will ultimately be paid in stock or cash. The Company has the right to dictate the form of these payments up until the date at which they are paid. Any change to the expected payment form would result in out of quarter adjustments to this add back to Adjusted Net (Loss) Income. (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. 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. 24 Table of Contents Table MD&A 6: Reconciliation of Gross Profit to Cash Gross Profit; Gross Margin to Cash Gross 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) Gross profit $ 9,707 34.1% $ 12,359 37.6% $ 20,668 35.6% $ 25,841 37.9% Adjustments: Stock-based compensation expense — cost of sales 228 0.8% 225 0.7% 485 0.8% 551 0.8% Depreciation and amortization — cost of sales 2,039 7.1% 170 0.5% 3,317 5.7% 346 0.5% Cash gross profit (Non-GAAP) $ 11,974 42.0% $ 12,754 38.8 % $ 24,470 42.1% $ 26,738 39.2 % Free Cash Flow Free cash flow, as reconciled in the table below, is a non-GAAP financial measure defined as net cash provided by (used in) operating activities, less purchases of property and equipment, and capitalized software development costs. This non-GAAP financial measure may be a useful measure for investors and other users of our financial statements as a supplemental measure of our cash performance and to assess the quality of our earnings as a key performance measure in evaluating management. We use Free Cash Flow to understand the cash flows that directly correspond with our operations and the investments we must make in those operations, using a methodology that combines operating cash flows and capital expenditures. Further, Free Cash Flow may be useful to management and investors in evaluating the Company's operating performance and liquidity, and to evaluate the performance of certain management personnel when determining incentive compensation. Table MD&A 7: Reconciliation of Net Cash Used in Operating Activities to Free Cash Flow For the Three Months Ended For the Six Months Ended June 30, 2024 June 30, 2023 June 30, 2024 June 30, 2023 (in thousands) Net cash used in operating activities $ (7,990) $ (4,113) $ (8,340) $ (4,213) Adjustments: Purchases of property and equipment (235) (47) (332) (270) Capitalized software development costs (3,113) (4,398) (6,315) (8,198) Free cash flow (Non-GAAP) $ (11,338) $ (8,558) $ (14,987) $ (12,681) 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. 25 Table of Contents Liquidity and Capital Resources Our primary sources of liquidity are cash on hand, future operating cash flows, and, if needed, borrowings under our $30.0 million revolving credit facility, with an available expansion feature of up to $30.0 million of additional revolver facility. 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 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. This focus gives us the flexibility for capital deployment while preserving a strong balance sheet to position us for future opportunities. We believe we have adequate funds on hand to execute our financial and operating strategy. Our overall financial position and liquidity are strong. Although no assurances can be given, we believe the available cash balances and access to our revolving credit facility are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months. Cash Flow Table MD&A 8: Net Change in Cash, Cash Equivalents, and Restricted Cash For the Six Months Ended June 30, 2024 June 30, 2023 (in thousands) Net cash used in operating activities $ (8,340) $ (4,213) Net cash used in investing activities (9,647) (8,468) Net cash used in financing activities (1,168) (3,176) Net change in cash, cash equivalents, and restricted cash $ (19,155) $ (15,857) 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 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 The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates, judgments, and assumptions that affect the amounts reported. Actual results could differ from those estimates. 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 six months ended June 30, 2024. Item 3. Quantitative and Qualitative Disclosures about Market Risk Not applicable. 26 Table of Contents