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, 2024, as filed with the Securities and Exchange Commission on March 10, 2025. Overview At Telos, we deliver efficient, adaptable, and secure solutions that protect people, organizations, and information across government and industry. From cyber governance, risk and compliance ("GRC") with Xacta ® , to identity and biometric solutions, secure networks, and TSA PreCheck ® enrollment, we help customers stay ahead of evolving threats. Our primary customers include the U.S. federal government, large commercial organizations, state and local governments, and international customers. Our deep domain expertise, cleared workforce, and proven technologies give us a unique position at the intersection of cybersecurity, identity, and network security. Driven by purpose and guided by our core values, we build lasting partnerships, deliver superior solutions, and help create a more secure, interconnected world. Recently, Telos launched Xacta.ai ™ , the artificial intelligence ("AI") capability at the core of the Xacta cyber GRC platform, dramatically reducing compliance time and effort. Leveraging AI and rules-based logic, Xacta.ai delivers expert-level guidance and real-time insights, empowering organizations to move from reactive compliance to proactive risk management. Business Environment U.S. Federal Government Budget Our consolidated revenue is largely attributable to prime contracts or to subcontracts with a prime contractor engaged in work for the U.S. federal government, with the remaining attributable to state and local governments, and commercial markets. For the nine months ended September 30, 2025, we generated approximately 91% of our total revenue from contracts with U.S. federal government agencies. Our business performance is affected by the overall level of U.S. federal government spending and the alignment of our offerings and capabilities with the budget priorities of the U.S. federal government. The U.S. federal government appropriations for fiscal year ("FY") 2025, which ran through September 30, 2025, were determined by a full-year continuing resolution. While the Administration has submitted its FY2026 budget proposal outlining its priorities, partisan disagreements over federal spending levels, among other things, have stalled progress on the required appropriations bills. On October 1, 2025, the federal government began to shut down as a result of congressional inaction on passing appropriations legislation for FY2026. In a government shutdown, non-essential federal employees and contractors are furloughed until the impasse ends. It is unclear when the impasse between congressional parties over the funding bill to reopen the government will end. Although the impact on our operations has been modest to date, the shutdown presents practical challenges that can disrupt performance, including on fully funded agreements. Many federal facilities are closed and, with furloughed government personnel, it can be difficult to deliver contract items, obtain required government reviews and approval, or receive timely direction. In some cases, tasks cannot proceed if federal personnel are not available to supervise, inspect, or accept deliverables. Where performance depends on access to government facilities, networks, systems, or personnel, the risk of significant delays increases regardless of funding availability. In addition, many agencies are experiencing heightened administrative burdens and workforce actions, with ripple effects that can slow procurement, approvals, and program execution across the government, particularly at agencies operating without full‑year appropriations. Delayed awards and contract starts, together with performance slowdowns, may shift revenue and cash collections to future periods, affect backlog burn rates, and increase days sales outstanding where customer acceptances or invoicing are delayed. The duration and ultimate impact of the shutdown remain uncertain, and the magnitude and timing of any effects will depend on the length of the shutdown, agency-specific operating status, and the cadence at which procurements and approvals resume. When funding and operations normalize, compressed procurement calendars and pent‑up demand may intensify competition and pricing pressure, and agencies may continue to favor incumbent extensions, which could affect our growth trajectory and margins. We continue to monitor these developments and to manage labor deployment, program schedules, and discretionary spending to mitigate potential impacts on operations and cash flows. 21 Table of Contents Other Economic and Regulatory Policies Aside from the uncertainty in the budgetary environment, the Administration put in place a number of Executive Orders and actions that have affected, and could continue to affect, many businesses. The Administration continuously evaluates federal agencies and existing government contracts, grants, and programs for affordability, efficiency, and alignment with U.S. federal government objectives. Further, the Administration has increased existing tariffs, imposed additional tariffs, and expanded tariffs on various goods imported from various countries. Changes in international trade policies, including higher tariffs on imported goods and materials, may increase the procurement costs of certain IT hardware we use internally, on our contracts, or sell to our customers. The ongoing and potential future reforms to the U.S. federal government processes, including changes to procurement rules and regulations, could transform how contracts are awarded, negotiated, and managed. These initiatives could further delay contract awards and/or result in modifications to the scope or terms of contracts we hold. At the same time, the Administration's focus on efficiency, transparency, consolidation, and accountability could lead to certain traditionally government functions being transferred to private entities. This potential transition of services to the private sector could benefit Telos, given our wide array of capabilities and advanced solutions. On July 4, 2025, the One Big Beautiful Bill Act (“OBBBA”) was enacted into law. The OBBBA includes significant changes to the Internal Revenue Code, with various provisions changing the U.S. federal income tax regulations and modifications to the Inflation Reduction Act of 2022. Further, the OBBBA significantly impacts the defense sector through substantial funding allocations and strategic investments, including specific investments in areas like AI, and provides the Department of Defense with extended time, until 2029, to make strategic investments in the defense industrial base. Increased funding and improved tax treatment for research and development could boost targeted defense investments, scale commercial technologies for military use, and support related programs. See Note 2 – Significant Accounting Policies on Income Taxes for additional information on key income tax provisions of the OBBBA. We continue to monitor and assess the risk and opportunities presented to the Company, in light of ongoing political tensions and heightened global instability that we expect to persist in the near term. Initiatives to reduce governmental spending, federal budget and debt ceiling action, and U.S. federal government policy positions, including trade policy, tax reform and/or changes to the U.S. government priorities, could materially impact federal spending broadly. Financial Overview Several key highlights of our financial performance in the third quarter ended September 30, 2025 are described below. More details are presented in our "Results of Operations" section below. • Revenue increased 116.3% year-over-year due to 153.5% growth in Security Solutions primarily due to the ongoing expansion of large programs in Telos ID. Gross margin expanded 2,672 bps year-over-year primarily due to the impairment and restructuring charges taken in the third quarter of 2024. • Operating expenses decreased due to the impairment loss on intangible assets of $6.4 million recorded in the third quarter of 2024, and the reduction in expenses as a result of the restructuring efforts taken in the third quarter of FY2024. • Net loss improved by $25.9 million year-over-year to a $2.1 million loss. • Cash flow from operations improved by $16.2 million year-over-year to $9.1 million, or 17.8% of revenue. 22 Table of Contents Results of Operations Table MD&A 1: Consolidated Results of Operations For the Three Months Ended For the Nine Months Ended September 30, 2025 September 30, 2024 Dollar Change September 30, 2025 September 30, 2024 Dollar Change (dollars in thousands) Revenue $ 51,444 $ 23,783 $ 27,661 $ 118,028 $ 81,900 $ 36,128 Cost of sales 30,898 20,640 10,258 73,368 58,089 15,279 Gross profit 20,546 3,143 17,403 44,660 23,811 20,849 Gross margin 39.9 % 13.2 % 37.8 % 29.1 % Operating expenses 23,014 32,007 (8,993) 66,033 69,757 (3,724) Operating expenses as percentage of revenue 44.7 % 134.6 % 55.9 % 85.2 % Operating loss (2,468) (28,864) 26,396 (21,373) (45,946) 24,573 Other income 511 983 (472) 1,625 3,299 (1,674) Interest expense (136) (157) 21 (424) (492) 68 Loss before income taxes (2,093) (28,038) 25,945 (20,172) (43,139) 22,967 Provision for income taxes (21) (17) (4) (63) (51) (12) Net loss $ (2,114) $ (28,055) $ 25,941 $ (20,235) $ (43,190) $ 22,955 Consolidated Results Our business segments are driven by different factors, leading to revenue fluctuations and varying profitability. The discussion of the changes in our revenue and gross margin is 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. Operating expenses In the third quarter of 2025, operating expenses decreased by $9.0 million, or 28.1%, compared to the same quarter in 2024. This was primarily due to the impairment loss on intangible assets of $6.4 million recorded in the third quarter of 2024, whereas there was none for the same quarter of this current year. Research and development ("R&D") expenses decreased by $0.5 million, or 21.2%, in the third quarter of 2025, compared to the same period in 2024, primarily due to the lower amortization costs associated with the discontinued development of selected solutions in the third quarter of 2024. Selling, general and administrative ("SG&A") expenses decreased by $2.1 million, or 9.1%, in the third quarter of 2025, compared to the same period in 2024. These decreases were largely the result of lower labor costs due to the restructuring efforts taken in the third quarter of 2024. For the nine months ended September 30, 2025, operating expenses decreased by $3.7 million, or 5.3%, compared to the same period in 2024. An impairment loss on intangible assets of $6.4 million was recorded for the nine months ended September 30, 2024, whereas there was none for the same period of this current year. R&D expenses decreased by $2.1 million, or 29.2%, for the nine months ended September 30, 2025, compared to the same period in 2024. This was primarily due to lower amortization costs associated with the discontinued development of select solutions in the third quarter of 2024. SG&A expenses increased by $4.7 million, or 8.4%, for the nine months ended September 30, 2025, compared to the same period in 2024. This was due to higher stock-based compensation costs, partially offset by lower labor costs due to the restructuring efforts taken in the third quarter of 2024 and lower cash incentive compensation expense. Other income Other income decreased by $0.5 million, or 48.0%, for the third quarter of 2025, compared to the same period in 2024. Similarly, other income decreased by $1.7 million, or 50.7%, for the nine months ended September 30, 2025, compared to the same period in 2024. The decreases in other income for the three and nine months ended September 30, 2025, were primarily due to the change in dividend income from money market placements. 23 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 Nine Months Ended September 30, 2025 September 30, 2024 Dollar Change September 30, 2025 September 30, 2024 Dollar Change (dollars in thousands) Revenue $ 46,478 $ 18,332 $ 28,146 $ 104,770 $ 54,839 $ 49,931 Cost of sales (excluding impairment loss, depreciation and amortization) 24,838 9,201 15,637 57,557 26,505 31,052 Impairment loss on intangible assets — 5,333 (5,333) — 5,333 (5,333) Depreciation and amortization 2,354 1,488 866 5,569 4,800 769 Total cost of sales 27,192 16,022 11,170 63,126 36,638 26,488 Gross profit $ 19,286 $ 2,310 $ 16,976 $ 41,644 $ 18,201 $ 23,443 Gross margin 41.5 % 12.6 % 39.7 % 33.2 % Three Months Ended September 30, 2025, Compared with Three Months Ended September 30, 2024 Security Solutions segment revenue for the third quarter of 2025 increased by $28.1 million, or 153.5%, compared to the same quarter in 2024, primarily due to the ongoing expansion of multiple large programs in Telos ID. Security Solutions segment gross profit for the third quarter of 2025 increased by $17.0 million, or 734.9%, compared to the same quarter in 2024, due to higher segment revenue and higher segment gross margin. Segment gross margin for the quarter increased from 12.6% in 2024 to 41.5% in 2025, due to the decrease in cost of sales related to the impairment loss on intangible assets taken in the third quarter of 2024, whereas there was none for this current quarter. Nine Months Ended September 30, 2025, Compared with Nine Months Ended September 30, 2024 For the nine months ended September 30, 2025, Security Solutions segment revenue increased by $49.9 million, or 91.1%, compared to the same period in 2024, primarily due to the ongoing expansion of multiple large programs in Telos ID. Segment gross profit for the nine months ended September 30, 2025 increased by $23.4 million, or 128.8%, compared to the same period in 2024, due to higher segment revenues and higher segment gross margin. Year-to-date segment gross margin increased from 33.2% in 2024 to 39.7% in 2025, due to the decrease in cost of sales related to the impairment loss on intangible assets taken in 2024, whereas there was none in the current year, partially offset by unfavorable program mix. Table MD&A 3: Secure Networks Segment - Financial Results For the Three Months Ended For the Nine Months Ended September 30, 2025 September 30, 2024 Dollar Change September 30, 2025 September 30, 2024 Dollar Change (dollars in thousands) Revenue $ 4,966 $ 5,451 $ (485) $ 13,258 $ 27,061 $ (13,803) Cost of sales (excluding impairment loss, depreciation and amortization) 3,704 4,616 (912) 10,237 21,444 (11,207) Depreciation and amortization 2 2 — 5 7 (2) Cost of sales 3,706 4,618 (912) 10,242 21,451 (11,209) Gross profit $ 1,260 $ 833 427 $ 3,016 $ 5,610 (2,594) Gross margin 25.4 % 15.3 % 22.7 % 20.7 % 24 Table of Contents Three Months Ended September 30, 2025, Compared with Three Months Ended September 30, 2024 Secure Networks segment revenue for the third quarter of 2025 decreased by $0.5 million, or 8.9%, compared to the same period in 2024, primarily due to the ramp down of several programs within the portfolio. Segment gross profit for Secure Networks for the third quarter of 2025 increased by $0.4 million, or 51.3%, compared with the same period in 2024. Likewise, segment gross margin for the quarter increased from 15.3% in 2024 to 25.4% in 2025 primarily due to revenue mix. Nine Months Ended September 30, 2025, Compared with Nine Months Ended September 30, 2024 Secure Network segment revenue for the nine months ended September 30, 2025, decreased by $13.8 million, or 51.0%, compared to the same period in 2024, primarily due to the ramp down of several programs within the portfolio without corresponding new business wins to backfill completed programs. Segment gross profit for the nine months ended September 30, 2025, decreased by $2.6 million, or 46.2%, compared to the same period in 2024, due to lower segment revenue. Year-to-date segment gross margin increased from 20.7% in 2024 to 22.7% in 2025, primarily due to the results of revenue mix. 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 September 30, 2025, we had cash and cash equivalents of $59.1 million and our working capital was $65.6 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 4: Net Change in Cash, Cash Equivalents, and Restricted Cash For the Nine Months Ended September 30, 2025 September 30, 2024 (in thousands) Net cash provided by (used in) operating activities $ 22,202 $ (15,420) Net cash used in investing activities (7,205) (12,485) Net cash used in financing activities (10,524) (1,591) Net change in cash, cash equivalents, and restricted cash $ 4,473 $ (29,496) Net cash provided by operating activities for the nine months ended September 30, 2025, was $22.2 million, an increase of $37.6 million compared to the same period in 2024. The increase is attributable to favorable changes in working capital, primarily driven by timing of receipts from customers and the timing of payments to vendors, coupled with higher cash earnings (i.e., net loss, excluding non-cash items that do not impact cash flows from operating activities). Net cash used in investing activities for the nine months ended September 30, 2025, decreased by $5.3 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 2025, coupled by a decrease of $2.3 million in capital expenditures in 2025. Net cash used in financing activities for the nine months ended September 30, 2025, increased by $8.9 million, compared to the same period in 2024. This is primarily attributable to the repurchase of common stock for $7.6 million in 2025 under the share repurchase program (See Note 12 – Share Repurchases ), with no similar activity in 2024, and an increase in payment of tax withholding related to net share settlement of equity awards by $1.1 million in fiscal year 2025. 25 Table of Contents Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates, judgments, and assumptions that affect the amounts reported. Actual results could differ from those estimates. Our 2024 Form 10-K, as filed with the SEC on March 10, 2025, includes a summary of critical accounting policies and estimates we believe are the most important to aid in understanding our financial results. Stock-Based Compensation The stock-based compensation expense related to the stock options, RSUs and PSUs awarded under the Amended and Restated 2016 Omnibus Long-Term Incentive Plan (the “2016 LTIP”) is recognized ratably over the requisite service period. For awards with performance conditions, stock-based compensation expense is estimated at each reporting date using management’s expectation of the probable achievement of the specific performance targets and recognized over the requisite service period for each tranche on a graded-vesting basis. Stock-based compensation expense for PSUs with market conditions is recognized based on the grant-date fair value calculated using the Monte Carlo model, as described below, or sooner if the market conditions are achieved. The fair value of the PSUs is equal to the closing stock price on the date of the grant or the fair value of the award on the grant date, as determined through an independent valuation for PSUs with market conditions. Estimating the fair value of PSUs with market condition, using the Monte Carlo simulation valuation model, requires assumptions as to the fair value of the underlying common stock, the estimated performance period, expected volatility, risk-free rate, and derived service period. See Note 11 – Stock-Based Compensation for additional information. Goodwill We test for goodwill impairment at the reporting unit level. Between annual evaluations, if events occur or circumstances change that would more-likely-than-not reduce the fair value of the reporting units below its carrying amount, then impairment must be evaluated. When evaluating goodwill for impairment, we first assess qualitative factors which could include, but are not limited to, macroeconomic conditions, industry and market conditions, overall company financial performance and events affecting the reporting units or the Company as a whole. If the financial performance of our Secure Networks reporting segment remains at the current level for a sustained period of time, and after considering other qualitative factors, there may be a triggering event indicating goodwill may be impaired in our Secure Networks reporting unit. Accordingly, management may need to perform a quantitative impairment test over the Secure Networks reporting unit to determine if an impairment loss should be recorded, which may have an adverse impact on our results of operations. Based on the result of our interim qualitative assessment, we determined that it is more-likely-than-not that the estimated fair value of the reporting units exceeds their carrying value and thus, no impairment charges were taken during the three and nine months ended September 30, 2025. Other critical accounting policies and estimates include revenue recognition, goodwill and long-lived assets, and income taxes, as discussed in our 2024 Form 10-K. There have been no changes to these critical accounting policies and estimates that have had a material impact on our reported amounts of assets, liabilities, revenues, or expenses during the nine months ended September 30, 2025.