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, 2025, as filed with the Securities and Exchange Commission on March 16, 2026. Overview Telos Corporation empowers and protects the world’s most security-conscious organizations with efficient, adaptable, and secure solutions that safeguard people, systems, and information. We deliver advanced capabilities across cyber governance, risk, and compliance ("GRC") with Xacta®; identity and biometric solutions; secure networks and communications; and TSA PreCheck® enrollment services. Our primary customers include the U.S. federal government, large commercial organizations, state and local governments, and global enterprises. Telos helps customers stay ahead of evolving threats, accelerate compliance, and achieve mission success. Driven by purpose and guided by our core values, we build trusted partnerships, deliver superior solutions, and help create a more secure, interconnected world. Recently, Telos launched Xacta.ai TM , the artificial intelligence ("AI") capability at the core of the Xacta cyber GRC platform, dramatically reducing compliance time and effort. 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 Our consolidated revenue is largely attributable to prime contracts or to subcontracts with prime contractors engaged in work for the U.S. federal government, with the remaining revenue attributable to state and local governments, and commercial markets. We generated approximately 93% and 89% of our total revenues from contracts with U.S. government agencies in the first quarter of fiscal year ("FY") 2026 and 2025, respectively. Our business performance is affected by the overall level of U.S. government spending and the alignment of our offerings and capabilities with the budget priorities of the U.S. government. While certain administration priorities, such as cybersecurity, national security and AI, present greater opportunity for our products and services, turmoil within the federal government, including personnel and leadership turnover and budgetary uncertainty, has had the effect of lengthening our sales cycle in certain cases. We continuously monitor U.S. federal budget, legislative, and contracting trends and activities, and align our capabilities in response to these developments. Macroeconomic Conditions During the current quarter, the global economy has continued to experience volatility arising from geopolitical developments and broader economic and financial factors, specifically including the ongoing conflict in Iran and the Middle East. This volatility has resulted in, and may be expected to continue to result in, rising energy prices, supply chain disruptions, and inflationary pressures, among other consequences. However, in part due to the importance of our offerings to our customers, the type of solutions we provide, and the nature of our largest customers, to date our business has not been materially impacted by these consequences. If global volatility continues to increase and the conflict in the Middle East is prolonged or intensifies, the economic uncertainty inherent in such global instability may affect our results of operations. Management continues to monitor this evolving geopolitical situation. 19 Table of Contents Financial Overview Several key highlights of our financial performance in the first quarter of 2026 are described below. More details are presented in our "Results of Operations" section. • Revenue increased 55.9% due to 78.1% growth in Security Solutions, driven primarily by the expansion of multiple large programs in Telos ID. • Operating expenses decreased by $5.3 million, or 24.9%, year-over-year due to lower stock-based compensation and ongoing disciplined cost management. • Net income expanded by $10.6 million, from a net loss of $8.6 million in the first quarter of 2025 to a net income of $2.0 million in the current quarter. • Cash flow from operations improved by $2.6 million year-over-year from a $6.1 million inflow to an $8.7 million inflow, or 18.1% of revenue, primarily due to improved revenue and profitability. • $2.2 million was deployed to repurchase approximately 0.5 million shares of the Company’s common stock at an average share price of $4.25 per share. Results of Operations Table MD&A 1: Consolidated Results of Operations For the Three Months Ended March 31, 2026 March 31, 2025 Dollar Change (dollars in thousands) Revenue $ 47,742 $ 30,616 $ 17,126 Cost of sales 30,367 18,434 11,933 Gross profit 17,375 12,182 5,193 Gross margin 36.4 % 39.8 % Operating expenses 15,920 21,204 (5,284) Operating expenses as percentage of revenue 33.3 % 69.3 % Operating income (loss) 1,455 (9,022) 10,477 Other income 697 561 136 Interest expense (111) (147) 36 Income (loss) before income taxes 2,041 (8,608) 10,649 (Provision for) benefit from income taxes (18) 4 (22) Net income (loss) $ 2,023 $ (8,604) $ 10,627 Consolidated Results Our business segments have different factors driving revenue fluctuations and profitability. The discussion of the changes in our revenue and profitability 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 decreased by $5.3 million, or 24.9%, in the first quarter of 2026, compared to the same period in 2025. Research and development ("R&D") expenses slightly declined by $0.2 million, or 13.6%, in the first quarter of 2026, compared to the same period in 2025. Selling, general and administrative ("SG&A") expenses decreased by $5.1 million, or 25.8%, in the first quarter of 2026, compared to the same period in 2025, primarily due to lower stock-based compensation expenses. Excluding stock-based compensation, reductions in R&D and SG&A expenses were due to ongoing cost discipline and restructuring. As a percentage of revenue, overall operating expenses were 33.3% and 69.3% for the three months ended March 31, 2026, and 2025, respectively. Other income increased by 24.2% in the first quarter of 2026, compared to the same period in 2025, primarily due to the refund in the current quarter of a prior year VAT claim that was previously determined to be uncollectible. 20 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 March 31, 2026 March 31, 2025 Dollar Change (dollars in thousands) Revenue $ 45,970 $ 25,818 $ 20,152 Cost of sales (excluding depreciation and amortization) 26,514 13,257 13,257 Depreciation and amortization 2,593 1,501 1,092 Total cost of sales 29,107 14,758 14,349 Gross profit $ 16,863 $ 11,060 $ 5,803 Gross margin 36.7 % 42.8 % For the quarter ended March 31, 2026, the Security Solutions segment revenue increased by 78.1%, compared to the same period in 2025, due to the expansion of multiple large programs in Telos ID. For the quarter ended March 31, 2026, the Security Solutions segment gross profit increased by 52.5%, compared with the same period in 2025, due to higher segment revenues. Segment gross margin decreased from 42.8% in 2025 to 36.7% in 2026, primarily due to revenue mix and higher non-cash infrastructure costs. Table MD&A 3: Secure Networks Segment - Financial Results For the Three Months Ended March 31, 2026 March 31, 2025 Dollar Change (dollars in thousands) Revenue $ 1,772 $ 4,798 $ (3,026) Cost of sales (excluding depreciation and amortization) 1,257 3,674 (2,417) Depreciation and amortization 3 2 1 Cost of sales 1,260 3,676 (2,416) Gross profit $ 512 $ 1,122 $ (610) Gross margin 28.9 % 23.4 % For the quarter ended March 31, 2026, the Secure Networks segment revenue decreased by 63.1%, compared to the same period in 2025, primarily due to the continued ramp down of several programs within the portfolio without corresponding new business wins to backfill completed programs. For the quarter ended March 31, 2026, the Secure Networks segment gross profit decreased by 54.4%, compared with the same period in 2025, due to lower revenue. By contrast, segment gross margin expanded from 23.4% in the first quarter of 2025 to 28.9% in the first quarter of 2026, primarily due to program mix. Liquidity and Capital Resources Our primary sources of liquidity are cash on hand, future operating cash flows, and, if needed, sale of receivables under the Factoring Agreement and/or borrowings under our $15.0 million revolving credit facility with a maturity date of December 30, 2026, and with an available expansion feature of up to $15.0 million of additional revolver facility. 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. As of March 31, 2026, we had cash and cash equivalents of $50.2 million and our working capital was $58.6 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 available cash balances and access to our revolving credit facility and Factoring Agreement are sufficient to maintain the liquidity we require to meet our operating, investing and financing needs for the next 12 months. 21 Table of Contents Cash Flow Table MD&A 4: Net Change in Cash, Cash Equivalents, and Restricted Cash For the Three Months Ended March 31, 2026 March 31, 2025 (in thousands) Net cash provided by operating activities $ 8,656 $ 6,106 Net cash used in investing activities (2,277) (2,337) Net cash used in financing activities (9,329) (556) Net change in cash, cash equivalents, and restricted cash $ (2,950) $ 3,213 Net cash provided by operating activities for the three months ended March 31, 2026, was $8.7 million, an increase of $2.6 million compared to the same period in 2025. The change is attributable to favorable changes in working capital, primarily driven by the timing of receipts from customers, and the timing of payments to vendors, coupled with higher cash earnings (i.e., net income (loss), excluding non-cash items that do not impact cash flows from operating activities). Net cash used in investing activities for the three months ended March 31, 2026, slightly decreased by $0.1 million, compared to the same period of the prior year, primarily due to decreases in capital expenditures. Net cash used in financing activities for the three months ended March 31, 2026, increased by $8.8 million, compared to the same period in 2025. This is primarily attributable to the repurchases of common stock under the share repurchase program (see Note 11 – Share Repurchases ) amounting to $2.2 million in the first quarter of 2026 , with no similar activity in 2025, and an increase in payment of tax withholding related to net share settlement of equity awards by $6.5 million in fiscal year 2026. 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. The 2025 Form 10-K, as filed with the SEC on March 16, 2026, includes a summary of the critical accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of assets, liabilities, revenues, or expenses during the three months ended March 31, 2026.