What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-11-12 compared with 2024-08-09 · 160 added, 124 removed, 154 unchanged (65% of the section changed)

16 unchanged sentences

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.

The Company continues to optimize its solution portfolio, expand its business pipeline, strengthen new business proposals and build a healthy culture by engaging employees through improved synergy, performance management, and benefits.

With this foundation established, the Company's current year priorities remain focused on strategically increasing its business development pipeline, effective execution of significant new business wins with our prime partners, and further expansion of TSA PreCheck ® enrollment sites.

Business Environment

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.

The fiscal year ("FY") 2024 budget appropriation was approved in March 2024 and has allowed federal departments and agencies to proceed 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.

The FRA caps total base discretionary spending at $1.6 trillion for FY2024, with base defense spending capped at $886 billion (a three percent increase from FY2023) and base non-defense spending capped at $704 billion (up to a nine percent decrease from FY2023).

In March 2024, the U.S.

President proposed the annual appropriations for FY2025 to fit within the tight caps set as part of last year's debt ceiling agreements.

The Defense Department budget includes $850 billion in discretionary budget authority for 2025, a $34 billion or 4.1% increase from the 2023 enacted level.

This growth is in alignment with levels agreed to in the FRA of 2023 and enables the DoD to make the investments necessary to execute the Administration's 2022 National Security Strategy and 2022 National Defense Strategy.

The President's FY2025 budget also proposed several increases for key cyber programs and initiatives.

For FY2025, the White House had directed agencies to prioritize cyber investments in "secure by design" technologies and the modernization of legacy technology.

The budget provides $13 billion in cybersecurity funding across civilian departments and agencies to advance the Administration's commitment to making cyberspace more resilient and defensible.

The proposed FY2025 budget includes $3 billion for the Cybersecurity and Infrastructure Security Agency ("CISA"), a $103 million increase over the agency's current budget.

CISA's 2025 cyber budget proposal also includes $469.8 million for the Continuous Diagnostics and Mitigation ("CDM") program, wherein the agency would use the CDM funding to complete mobile asset deployments, continued asset deployments, initiate Internet of Things ("IoT") activities in asset management, continue to fill gaps in identity and access management capabilities, and align the agency to Zero Trust use cases.

In the wake of the President's executive order on artificial intelligence last fall, the 2025 budget proposal includes plenty of AI-related spending, much of which intersects with cybersecurity and AI safety.

This includes $470 million to deploy Federal network tools, including endpoint detection and response capabilities;

$394 million for CISA's internal cybersecurity and analytical capabilities;

$41 million for critical infrastructure security coordination;

and $116 million for critical infrastructure cyber event reporting.

Congress was unable to enact any of its annual appropriation bills before the start of FY2025 on October 1, 2024.

Instead, Congress passed and the President has signed into law a Continuing Resolution ("CR") that will extend funding for the federal government until December 20, 2024.

The CR provides minimal needed spending adjustments for certain programs to ensure that the federal government can receive adequate funding to operate for the duration of the CR.

However, in the current political environment in Congress and with the presidential election in November 2024, it is highly questionable whether Congress and the President will reach an agreement on FY2025 appropriations bills within the duration of the CR.

This means the Defense Department and the rest of the federal government will likely be restricted from beginning their planned expenditures in FY2025.

Cybersecurity Landscape

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

The scope of cybersecurity is on the edge of transformative changes.

Cyber threats are not just escalating in frequency but are also becoming more sophisticated, thus challenging traditional security standards.

In this rapidly evolving cybersecurity landscape, the need for vigilant defense is vital, and cybersecurity is a priority for organizations to mitigate their risk and keep safe from threats and exploitation.

Understanding the threat environment and the impending trends (both current and future) is a matter of foresight and is crucial in designing effective security strategies.

The Defense Department's budget continues to invest in cybersecurity programs to protect the nation from malicious cyber actors and cyber campaigns.

These investments strengthen cyber protection standards for the defense industrial base ("DIB") and cybersecurity of DoD networks.

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

Addresses Emerging Cyber and Counterintelligence Threats:

The FY2025 budget expands the Department of Justice’s ("DOJ") ability to pursue threats through investments in the FBI’s cyber and counterintelligence investigative capabilities.

These investments sustain the FBI’s cyber intelligence, counterintelligence, and analysis capabilities and include funding to enhance those cyber response and counterintelligence capabilities.

The budget also includes funding to expand a new section within the DOJ’s National Security Division to focus on cyber threats.

These investments align with the National Cybersecurity Strategy that emphasizes a whole-of-nation approach to addressing ongoing cyber threats.

Finally, the budget also provides for the DOJ to support the implementation of Executive Order 14110, “Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence.”

Rising Threats, Rising Liability:

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

Phishing is one of the top distribution channels for ransomware.

Modern phishing attacks have become adept at bypassing traditional security measures, using more personalized and technically advanced tactics to deceive users.

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.

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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.

The IoT continues its rapid growth, interconnecting an increasing number of devices.

However, this expansion brings with it a host of security challenges.

The widespread range of IoT devices make them attractive targets for cyberattacks, and their interrelated nature can lead to pervasive susceptibilities.

Navigating a Changing Regulatory Landscape and Compliance:

The regulatory landscape governing cybersecurity is developing swiftly.

Over time, the government mandates stronger security in highly regulated industries.

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

Additionally, the SEC adopted new rules on cybersecurity risk management, strategy, governance and incident disclosure by public companies.

The required reporting of this information leads 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.

Identity and access management continue 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.

The shift to a Zero Trust framework represents a fundamental change in approach in cybersecurity, focusing on identity and access management, continuous monitoring and robust authentication mechanisms to establish a secure digital environment.

Enhancing Identity Security:

The shift towards biometric authentication methods is redesigning identity verification in the digital domain.

Integrating biometrics with multi-factor authentication can provide a robust defense against unauthorized access.

Machine Learning :

Artificial Intelligence ("AI") and Machine Learning are set to play a critical role in cybersecurity.

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

AI's advanced data analysis capabilities are increasingly used for defensive measures over time.

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.

The DoD budget provides $455 million to extend the frontiers of AI for science and technology and to increase AI’s safety, security, and resilience.

These investments enhance the DoD’s computing capabilities and support the development of AI testbeds to build foundation models for energy security, national security, and climate resilience as well as tools to evaluate AI capabilities to generate outputs that may represent nuclear, nonproliferation, biological, chemical, critical-infrastructure, and energy security threats or hazards.

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.

A number of factors have contributed to our third quarter ended September 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.

• The decline in our year-over-year revenue was primarily driven by the successful completion and ramp down of programs in Secure Networks without corresponding new business wins to backfill completed programs.

• The growth in TSA PreCheck revenue was driven by the increase in our enrollment locations.

• The reduction in our gross margins was driven by the impact of an impairment loss on intangible assets of $5.3 million and an increase in restructuring expenses of $0.4 million.

• Higher operating expenses were due to an impairment loss on intangible assets of $6.4 million and higher stock-based compensation expense.

Results of Operations

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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

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 Dollar Change September 30, 2024 September 30, 2023 Dollar Change

(dollars in thousands)

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Gross margin 13.2 % 36.0 % 29.1 % 37.2 %

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 expenses 32,007 22,706 9,301 69,757 70,984 (1,227)

Operating expenses as percentage of revenue 134.6 % 62.7 % 85.2 % 68.0 %

Operating loss (28,864) (9,693) (19,171) (45,946) (32,130) (13,816)

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

The discussion of the changes in our revenue and gross margin 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.

Operating expenses

In the third quarter of 2024, operating expenses increased by 41.0%, compared to the same quarter in 2023, primarily due to increases in impairment loss on intangible assets of $6.0 million, restructuring expenses of $1.1 million, and stock-based compensation expenses of $3.6 million.

For the nine months ended September 30, 2024, operating expenses decreased by 1.7%, compared to the same period in 2023, primarily due to a decrease in stock-based compensation expenses of $8.4 million, partially offset by an increase in impairment loss on intangible assets of $6.0 million.

The decrease in other income for the three months ended September 30, 2024, compared to the same quarter in 2023, was primarily due to the change in dividend income from money market placements.

Other income decreased for the nine months ended September 30, 2024, compared to the same period in 2023, 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.

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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

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 Dollar Change September 30, 2024 September 30, 2023 Dollar Change

(dollars in thousands)

Revenue $ 18,332 $ 19,795 $ (1,463) $ 54,839 $ 56,764 $ (1,925)

Cost of sales (excluding depreciation and amortization) 8,565 7,477 17,304 16,806

Cost of sales (excluding impairment loss, depreciation and amortization) 9,201 8,498 703 26,505 25,304 1,201

Impairment loss on intangible assets 5,333 — 5,333 5,333 — 5,333

Depreciation and amortization 1,488 1,943 (455) 4,800 2,281 2,519

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Gross margin 12.6 % 47.3 % 33.2 % 51.4 %

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.

For the quarter ended September 30, 2024, Security Solutions segment revenue decreased by 7.4%, compared to the same quarter in 2023.

This was due to the reduction in revenue from a long-term program and the completion of a short-term program in the prior year, partially offset by the growth in TSA PreCheck.

Further, Security Solutions segment gross profit for the third quarter of 2024 declined by 75.3%, compared to the same quarter in 2023, and segment gross margin for the three months ended September 30, 2024, decreased from 47.3% in 2023 to 12.6% in 2024.

The gross margin decline was primarily due to an increase in costs related to the impairment loss on intangible assets and program mix within the portfolio.

For the nine months ended September 30, 2024, Security Solutions segment revenue decreased by 3.4%, compared to the same period in 2023.

This was due to the reductions in revenue of two long-term programs and completion of a short-term program in the prior year, partially offset by the growth in TSA PreCheck.

In addition, segment gross profit for the nine months ended September 30, 2024 decreased by 37.6%, compared to the same period in 2023, and segment gross margin declined from 51.4% in 2023 to 33.2% in 2024.

The gross margin decline was due to increases in costs related to the impairment loss on intangible assets, higher 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

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 Dollar Change September 30, 2024 September 30, 2023 Dollar Change

(dollars in thousands)

Revenue $ 5,451 $ 16,391 $ (10,940) $ 27,061 $ 47,555 $ (20,494)

Cost of sales (excluding depreciation and amortization) 8,187 12,905 16,828 25,140

Cost of sales (excluding impairment loss, depreciation and amortization) 4,616 12,730 (8,114) 21,444 37,870 (16,426)

Depreciation and amortization 2 2 — 7 10 (3)

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Gross margin 15.3 % 22.3 % 20.7 % 20.3 %

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.

For the quarter ended September 30, 2024, Secure Networks segment revenue decreased by 66.7%, compared to the same period in 2023, primarily due to the successful completion and ramp down of programs, without corresponding new business wins to backfill completed programs.

Further, segment gross profit decreased by 77.2% in the third quarter of 2024, compared to the same quarter in 2023, primarily due to lower revenue.

Gross margin declined from 22.3% in 2023 to 15.3% in 2024, primarily due to restructuring costs and revenue mix within the portfolio.

For the nine months ended September 30, 2024, Secure Networks segment revenue decreased by 43.1%, compared to the same period in 2023, primarily due to the successful completion and ramp down of programs without corresponding new business wins to backfill completed programs.

Segment gross profit for the nine months ended September 30, 2024, decreased by 42.0%, compared to the same period in 2023, primarily due to lower revenue.

By contrast, segment gross margin in the nine months ended September 30, 2024, slightly increased from 20.3% in 2023 to 20.7% in 2024, due to program mix and strong program management.

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.

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

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

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A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP.

We 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.

We believe these non-GAAP financial measures facilitate comparison of our operating and cash 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.

EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin are supplemental measures of operating and cash flow performance that are not made under GAAP and do not represent, and should not be considered as an alternative to net (loss) income 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 Adjusted EBITDA as EBITDA, adjusted for stock-based compensation expense, impairment loss on intangible assets, and restructuring expenses (adjustments).

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.

We believe that EBITDA, EBITDA Margin, Adjusted EBITDA and Adjusted EBITDA Margin provide the Board of Directors, 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 of Directors 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

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 September 30, 2024 September 30, 2023

Amount Margin Amount Margin Amount Margin Amount Margin

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Depreciation and amortization (3)

2,748 11.6 % 3,215 8.9 % 9,368 11.4 % 6,336 6.0 %

EBITDA (Non-GAAP) (26,116) (109.8 %) (6,478) (17.9 %) (36,578) (44.7) % (25,794) (24.7) %

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8,814 37.1 % 5,218 14.4 % 14,017 17.1 % 22,462 21.5 %

Restructuring (adjustments) expenses (2)

Impairment loss on intangible assets (3)

11,706 49.2 % — — % 11,706 14.3 % — — %

Restructuring expenses (2)

1,447 6.1 % — — % 1,437 1.8 % 1,197 1.2 %

Adjusted EBITDA (Non-GAAP) $ (4,149) (17.4) % $ (1,260) (3.5) % $ (9,418) (11.5) % $ (2,135) (2.0) %

(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.

Stock-based compensation expense for the awarded RSUs, PSUs and stock options was $8.4 million and $12.4 million for the three and nine months ended September 30, 2024, respectively, and $5.2 million and $18.6 million, for the three and nine months ended September 30, 2023, respectively.

Stock-based compensation expense from other sources was $0.5 million and $1.6 million for the three and nine months ended September 30, 2024, 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.

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 (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

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.

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

(3) Due to its immaterial amount, the impairment loss on intangible assets of $0.3 million for the three and nine months ended September 30, 2023 was reported as part of depreciation and amortization expenses in 2023.

Adjusted Net Loss and Adjusted EPS

Adjusted Net Loss and Adjusted EPS are supplemental measures of operating and cash flow performance that are not made under GAAP and do not represent, and should not be considered as an alternatives to net (loss) income and earnings per share as determined by GAAP.

We define Adjusted Net Loss as net (loss) income, adjusted for non-operating (income) expense, stock-based compensation expense, impairment loss on intangible assets, and restructuring expenses (adjustments).

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

Adjusted Net Loss and Adjusted EPS provide the Board of Directors, 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

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 September 30, 2024 September 30, 2023

Net Loss Adjusted Earnings Per Share Adjusted

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8,814 0.12 5,218 0.07 14,017 0.20 22,462 0.33

Restructuring (adjustments) expenses (2)

Impairment loss on intangible assets (3)

11,706 0.16 — — 11,706 0.16 — —

Adjusted net loss (Non-GAAP measure) $ (6,602) $ (0.09) $ (1,931) $ (0.03) $ (12,258) $ (0.17) $ (4,474) $ (0.07)

Restructuring expenses (2)

1,447 0.02 — — 1,437 0.02 1,197 0.02

Adjusted net loss (Non-GAAP) $ (7,071) $ (0.10) $ (4,676) $ (0.07) $ (19,329) $ (0.27) $ (9,150) $ (0.13)

Weighted-average shares of common stock outstanding, basic 72,309 69,571 71,654 69,062

(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 from other sources was $0.5 million and $1.6 million for the three and nine months ended September 30, 2024, 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.

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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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.

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.

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

Adjusted Gross Profit, Cash Gross Profit, Adjusted Gross Margin and Cash Gross Margin

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

We define Adjusted Gross Profit as gross profit, plus stock-based compensation expense, impairment loss on intangible assets, restructuring expenses, as well as non-recurring items charged under cost of sales.

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

We define Cash Gross Profit as Adjusted Gross Profit, plus depreciation and amortization.

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.

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

Table MD&A 6:

Reconciliation of Gross Profit to Cash Gross Profit;

Gross Margin to Cash Gross Margin

For the Three Months Ended For the Six Months Ended

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

Reconciliation of Gross Profit to Adjusted Gross Profit and Cash Gross Profit;

Gross Margin to Adjusted Gross Margin and Cash Gross Margin

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 September 30, 2024 September 30, 2023

Amount Margin Amount Margin Amount Margin Amount Margin

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Stock-based compensation expense – cost of sales 115 0.5% 73 0.2% 600 0.7% 624 0.6%

Impairment loss on intangible assets – cost of sales 5,333 22.4% — —% 5,333 6.5% — —%

Restructuring expenses – cost of sales 393 1.7% — —% 393 0.5% — —%

Adjusted gross profit (Non-GAAP) 8,984 37.8% 13,086 36.2% 30,137 36.8% 39,478 37.8%

Depreciation and amortization – cost of sales 1,490 6.2% 1,945 5.3% 4,807 5.9% 2,291 2.2%

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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.

Free Cash Flow is a supplemental measure of operating and cash flow performance that are not made under GAAP and do not represent, and should not be considered as an alternative to net cash flow (used in) provided by operating activities, as determined by GAAP.

We define Free Cash Flow as net cash (used in) provided by operating activities, less net purchases of property and equipment, and capitalized software development costs.

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.

Further, Free Cash Flow may be useful to management and investors in evaluating the Company's operating and cash flow 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

Reconciliation of Net Cash (Used in) Provided by Operating Activities to Free Cash Flow

For the Three Months Ended For the Nine Months Ended

September 30, 2024 September 30, 2023 September 30, 2024 September 30, 2023

(in thousands)

Net cash used in operating activities $ (7,990) $ (4,113) $ (8,340) $ (4,213)

Purchases of property and equipment (235) (47) (332) (270)

Net cash (used in) provided by operating activities $ (7,080) $ 846 $ (15,420) $ (3,367)

Purchases of property and equipment, net (49) (80) (381) (350)

Capitalized software development costs (2,789) (3,762) (9,104) (11,960)

Free cash flow (Non-GAAP) $ (9,918) $ (2,996) $ (24,905) $ (15,677)

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.

EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net Loss, Adjusted EPS, Adjusted Gross Profit, Adjusted Gross Margin, Cash Gross Profit, Cash Gross Margin and Free Cash Flow each 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, Adjusted EPS, Adjusted Gross Profit, Adjusted Gross Margin, 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, Adjusted EPS, Adjusted Gross Profit, Adjusted Gross Margin, 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, Adjusted EPS, Adjusted Gross Profit, Adjusted Gross Margin, 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 June 30, 2024, we had cash and cash equivalents of $80.1 million and our working capital was $87.0 million.

As of September 30, 2024, we had cash and cash equivalents of $69.8 million and our working capital was $72.0 million.

We place a strong emphasis on liquidity management.

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Net Change in Cash, Cash Equivalents, and Restricted Cash

For the Six Months Ended

June 30, 2024 June 30, 2023

For the Nine Months Ended

September 30, 2024 September 30, 2023

(in thousands)

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Net change in cash, cash equivalents, and restricted cash $ (29,496) $ (19,350)

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.

Net cash used in operating activities for the nine months ended September 30, 2024, was $15.4 million, an increase of $12.1 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.

Net cash used in investing activities for the nine months ended September 30, 2024, slightly increased by $0.2 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 of $2.8 million in capital expenditures in 2024.

Net cash used in financing activities for the nine months ended September 30, 2024, decreased by $2.1 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 $0.5 million in the first half of 2024, compared with $1.7 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.

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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 six months ended June 30, 2024.

Quantitative and Qualitative Disclosures about Market Risk

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis