TELOS CORP 10-K

Item 1. Business Overview Telos Corporation, together with its subsidiaries (the “Company” or “Telos” or “We”), offers 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 empower 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 customer base consists of the U.S. federal government, large commercial businesses, state and local governments, as well as international customers. Our federal government customers include the Department of Defense (“DoD”), the Central Intelligence Agency (“CIA”) and multiple other agencies within the Intelligence Community (“IC”), and multiple civilian agencies, including the Department of Homeland Security (“DHS”), the U.S. Department of State (“DoS”), and the Federal Bureau of Investigation (“FBI”). Our commercial customers include Fortune 500 enterprises such as Amazon.com, Inc., Citigroup Inc., Microsoft Corporation, and Salesforce.com, Inc. We have conducted business with over 350 customers in each of the last three years. For the year ended December 31, 2020, approximately 50% of our revenue was derived from sole source contracts or contracts for which we had limited competition. Our customers are highly targeted by cyber attackers and require continuous real-time insights to make informed decisions about how to effectively balance the constraints of security risk with the freedom to act and decide in the best interests of the organization and the greater good of the public. Our advanced security solutions help protect and ensure confidence in the information that is vital to the world’s most important commercial and governmental organizations, national security, and mission success for the warfighter. Our revenue growth trajectory began to accelerate in 2018 as we increased our investment into new products and solutions. Our security solutions are the product of the investment of approximately 3,000 man-years developing our intellectual property and highly sophisticated software technology. These investments helped us expand with commercial customers, as well as win additional contracts within the military and the IC. Revenue grew from $107.7 million in 2017 to $138.0 million in 2018 and to $159.2 million in 2019 and to $179.9 million in 2020, representing annual growth rates of 28.1%, 15.4%, and 13.0%, respectively. Once our security solutions are imbedded in our customers’ technology infrastructure, these customer relationships often expand and lead to us providing additional security solutions. As a consequence, we believe that our customer turnover is low and, based on historical experience, approximately 85% of our revenue is recurring, as discussed further below. We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts. We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers. In the context of our current customer portfolio, we view “recurring revenue” as revenue that occurs often and repeatedly. In each of the last three years, recurring revenue has exceeded 85% of our annual revenue. Our total budgeted revenue is the combination of recurring revenue and a forecast of new business. Total backlog, a component of recurring revenue, consists of the aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or unfunded. Funded backlog consists of the aggregate contract revenues remaining to be earned at a given time, which, in the case of U.S. government contracts, means that they have been funded by the procuring agency. Unfunded backlog is the difference between total backlog and funded backlog and includes potential revenues that may be earned if customers exercise delivery orders and/or renewal options to continue these contracts. Based on historical experience, we generally assume option year renewals to be exercised. Most of our customers fund contracts on a basis of one year or less and, as a result, funded backlog is generally expected to be earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period. 3 Table of Contents On November 19, 2020, we completed our initial public offering of shares of our common stock. We issued 17.2 million shares of our common stock at a price of $17.00 per share, generating net proceeds of approximately $272.7 million. We used approximately $108.9 million of the net proceeds in connection with the conversion of our outstanding shares of Exchangeable Redeemable Preferred Stock into the right to receive cash and shares of our common stock, $30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID, and $21.0 million to repay our outstanding senior term loan and subordinated debt. We intend to use the remaining net proceeds for general corporate purposes. We also may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies. We do not, however, have agreements, commitments, or plans for any specific acquisitions at this time. The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors. Our Mission: Cyber, Cloud, and Enterprise Security Our mission is to protect our customers’ people, systems, and vital information assets with offerings for cybersecurity, cloud security, and enterprise security. In the current global environment, our mission is more critical than ever. The emergence of each new information and communications technology (“ICT”) introduces new vulnerabilities, as security is still too often overlooked in solution development. Networks and applications meant to enhance productivity and profitability often jeopardize an organization due to poor planning, misconfiguration, or an unknown gap in security. Ransomware, insider threats, cybercrime, and advanced persistent threats continue to menace public and private enterprises across all industries. Cybersecurity, cloud security, and enterprise security of the modern organization share much in common, yet also call for a diverse range of skills, capabilities, and experience in order to meet the requirements of security-conscious customers. Decades of experience in developing, orchestrating, and delivering solutions across these three domains gives us the vision and the confidence to provide solutions that empower and protect the enterprise at an integrated, holistic level. Our experience in addressing challenges in one area of an enterprise helps us meet requirements in others. We understand that a range of complementary capabilities may be needed to solve a single challenge, and we also recognize when a single solution might address multiple challenges. Our security solutions span across the following domains: • Cybersecurity – We help our customers ensure the ongoing security, integrity, and compliance of their on-premises and related cloud-based systems, reducing threats and vulnerabilities in order to foil cyber adversaries before they can attack. Our consultants assess our customers’ security environments and design, engineer, and operate the systems they need to strengthen their cybersecurity posture. • Cloud Security – The cloud as an organizational resource is more than two decades old, yet the needs of cloud users are constantly changing. Telos offers the specialized skills and experience needed to help our customers plan, engineer, and execute secure cloud migration strategies and then assure ongoing management and security in keeping with the leading standards for cloud-based systems and workloads. • Enterprise Security – Securing the enterprise means protecting the essential and timeless elements common to every organization: its people and processes, its supply chain and inventories, its finances and facilities, and its information and communications. As ICT and operational technology (“OT”) have become part of the organizational make-up, we have offered solutions that ensure personnel can work securely and productively across and beyond the enterprise. Our Market Our market includes organizations in business across industry verticals, government, and the military. We believe that digital transformation is a reality for these organizations and that the ICT systems they depend on for their success and security are subject to unprecedented levels of stress, threat, and attack. Market-disrupting technologies, a global pandemic, and economic uncertainty make it difficult for customers to plan for business expansion, develop new programs in service to the public, or prepare military forces for the nation’s defense. Public and private enterprises alike face the following dynamic challenges that threaten their security: • Heavy dependence on information and operational technologies . Organizations are increasingly dependent on technology, including mobile and wireless applications, cloud-based resources, industrial internet of things (“IoT”), industrial control systems (“ICS”), supervisory control and data acquisition (“SCADA”), and others. • Digital transformation and accelerating migration to the cloud . Enterprises and government agencies are accelerating the migration of applications, storage, and ICT/OT infrastructure to hosted and cloud environments. More organizations – including highly security-conscious agencies within the U.S. government and commercial entities – are gaining comfort and confidence in the cloud, taking advantage of the rapid application development, greater flexibility, and strategic agility that the cloud offers. • Ability to work across and beyond the enterprise . Organizations are no longer defined by or confined by real estate, geography, or personnel rosters. Information and applications are now accessible in the cloud. Mobile devices free personnel to work wherever their mission takes them. Employees, contractors, and partners collaborate in the physical and digital domains, trusting that they can rely on the integrity and trustworthiness of their people and their systems. • Turbulent technology environment due to COVID-19. The COVID-19 pandemic has accelerated the growth of the remote workforce and thus, cyber risk. Existing technologies for mobility are being stretched to the limit, and enterprises are facing dramatic growth in cyber-attack risk as a result of personnel and systems that are still adjusting to an increasing number of workers accessing systems remotely. Ransomware, phishing attempts, and inadequate virtual private networks (“VPNs”) all contribute to a significant increase in threats and vulnerabilities. 4 Table of Contents The networked nature of enterprise technologies and the ability to work outside the organizational perimeter result in increased risk and the constant threat of attack. In particular, the cloud adds new complexities due to the shared responsibility of cloud security and the need to manage and maintain the compliance of cloud-based resources. Our solutions across a wide variety of use cases are designed to address our customers’ proliferating need to understand and address cybersecurity risk, reduce the organizational attack surface, enhance enterprise mobility, expand adoption of cloud computing, and manage and protect identities in an increasingly dynamic and intensifying threat landscape. By addressing the breadth of our customers’ complex and evolving needs, we believe that our total addressable market in 2021 for the security services and products that we provide is over $80 billion. Our Offerings We refer to our cyber and cloud applications as Security Solutions, which includes Information Assurance / Xacta®, Secure Communications, and Telos ID. We refer to our offerings for enterprise security as Secure Networks. Security Solutions • Information Assurance / Xacta: a premier platform for enterprise cyber risk management and security compliance automation, delivering security awareness for systems in the cloud, on-premises, and in hybrid and multi-cloud environments. Xacta delivers automated cyber risk and compliance management solutions to large commercial and government enterprises. Across the U.S. federal government, Xacta is the de facto commercial cyber risk and compliance management solution. • Secure Communications: ○ Telos Ghost: a virtual obfuscation network-as-a-service with encryption and managed attribution capabilities to ensure the safety and privacy of people, information, and resources on the network. Telos Ghost seeks to eliminate cyber-attack surfaces by obfuscating and encrypting data, masking user identity and location, and hiding network resources. It provides the additional layers of security and privacy needed for intelligence gathering, cyber threat protection, securing critical infrastructure, and protecting communications and applications when operations, property, and even lives can be jeopardized by a single error in security. ○ Telos Automated Message Handling System (“AMHS”): web-based organizational message distribution and management for mission-critical communications; the recognized gold standard for organizational messaging in the U.S. government. Telos AMHS is used by military field operatives for critical communications on the battlefield and is the only web-based solution for assured messaging and directory services using the Defense Information System Agency’s (“DISA”) Organizational Messaging Service and its specialized communications protocols. • Telos ID: offering Identity Trust and Digital Services through IDTrust360® – an enterprise-class digital identity risk platform for extending software-as-a-service (“SaaS”) and custom digital identity services that mitigate threats through the integration of advanced technologies that fuse biometrics, credentials, and other identity-centric data used to continuously monitor trust. We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck ® enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and the Financial Industry Regulatory Authority (“FINRA”) Electronic Fingerprint Submission provider. We are the only commercial entity in our industry designated as a Secure Flight Services provider for terrorist watchlist checks. Secure Networks • Secure Mobility: solutions for business and government that enable remote work and minimize concern across and beyond the enterprise. Our secure mobility team brings credentials to every engagement, supplying deep expertise and experience as well as highly desirable clearances and industry recognized certifications for network engineering, mobility, and security. • Network Management and Defense: services for operating, administrating, and defending complex enterprise networks and defensive cyber operations. Our diverse portfolio of capabilities addresses common and uncommon requirements in many industries and disciplines, ranging from the military and government agencies to Fortune 500 companies. Xacta Xacta Overview Xacta delivers automated cyber risk and compliance management solutions to large commercial and government enterprises. Xacta is sold as a solution, which includes Xacta technology and Xacta subject matter experts (“SMEs”) to help with deployment, on-going support, and training to ensure rapid and long-term customer success. Our solution-based business model provides predictable, recurring, and growing revenue year-on-year. Xacta disrupted the cyber risk and compliance management industry 20 years ago. When it was first introduced, Xacta represented a new way of doing business that challenged the inefficient labor-intensive business models of traditional consultants and government contractors who charge by the hour. 5 Table of Contents We have developed and evolved Xacta over the past two decades to make security risk and compliance activities more efficient through workflow-based automation. Many cyber risk and compliance management activities can be automated, which greatly reduces the need for inefficient Time and Materials (“T&M”) services. More importantly, we believe that certain critical capabilities like continuous monitoring are effectively impossible without automation. Xacta is the de facto commercial cyber risk and compliance management solution across the U.S. federal government. Noteworthy U.S. government enterprise customers include DoD, multiple agencies within the IC (including the CIA), and civilian agencies such as DHS, DoS and the FBI. Xacta cloud security is also being adopted by very large commercial organizations like Amazon Web Services (“AWS”) and Microsoft Azure. Across these government and commercial customers, we currently have hundreds of Xacta deployments used to manage tens of thousands of mission critical/national security systems that are comprised of millions of critical information technology (“IT”) assets and cloud resources. There are also more than 20,000 cyber security professionals who actively use Xacta to manage cyber risk for a wide range of IT/information systems in warfighting, intelligence, business/financial, and healthcare applications. In 2016, at the request of the CIA, we evolved Xacta from an on-premises cyber risk and compliance management solution, used to manage traditional IT assets, to a solution that also manages cloud resources. As a result, we believe that Xacta is unique in its ability to manage complex hybrid IT environments that span on-premises, cloud, and multi-cloud. Our cloud focus has attracted the attention of the largest cloud and cloud service providers in the world, many of which are now our partners and customers. These partnerships have greatly increased our market opportunity, as many organizations look to migrate to the cloud. Security compliance remains a major inhibitor to cloud adoption. Xacta addresses this issue by automating and accelerating security compliance activities allowing organizations to migrate to the cloud more quickly and securely. Recognizing these advantages, the two largest cloud providers in the world, AWS and Microsoft Azure, have partnered with Telos to use Xacta to accelerate security compliance activities in their air-gapped and global sovereign cloud environments to help hundreds of thousands of regulated organizations address security risk and compliance much more efficiently. Our cloud focus has also resulted in significant partnerships with other cloud organizations, such as Rackspace Technology, Inc., which are helping SaaS vendors address cloud compliance requirements, including the Federal Risk and Authorization Management Program (“FedRAMP”), which is required by the federal government for all SaaS solutions. There are thousands of potential SaaS applications needed by the federal government. These organizations understand that Xacta’s ability to reduce the security compliance burden helps accelerate cloud adoption and generates cloud usage and revenue more quickly. To this end, Xacta’s capabilities are viewed as a strategic advantage by these cloud-centric organizations. Managing cyber risk is top-of-mind for many organizations today. There is an increasing number of security standards and regulations with which global organizations must comply. The National Institute of Standards and Technology (“NIST”) is the source for many security standards that are being adopted globally. Telos, using Xacta, has specialized in supporting NIST-based standards for nearly 20 years. We have been considered by a leading, third-party consultancy to be NIST-based cybersecurity domain experts. Xacta’s Critical Capabilities Xacta offers a number of critical and differentiated capabilities that support a wide range of cyber risk and compliance management use cases, such as: • Automated asset inventory - helps quickly define IT boundary/parameters and establish audit/test plans. • Automated control validation - reduces manual test efforts. • Automated continuous control monitoring - offers ongoing assurance of compliance. • Vulnerability management functionality - understand vulnerabilities that apply to IT environments. • Remediation management - workflow to help organizations prioritize risk, establish remediation plans, and track remediation progress to closure. • Automated regulatory report generation - reduces manual effort needed to create regulatory reports (bi-product of the workflow process). • Cloud integration - allows Xacta to manage cloud-based resources (multi-cloud environments) as well as on-premises assets. • Cloud deployment - allows Xacta to be deployed as a SaaS, Virtual Machine Image (“VMI”), Amazon Machine Image, and Microsoft Azure VMI, as well as on-premises. • Intelligent workflow - Artificial Intelligence (“AI”)-like functionality reduces the need for manual intervention. • Predictive control mapping - AI-like functionality helps reduce redundant control testing and manual control mapping effort to help address audit fatigue. • Automated control inheritance - allows organizations to share common compliance information - cloud providers share common controls with customers as per the shared responsibility model of cloud security - which greatly reduces manual effort and enables rapid cloud adoption. • Visualization and reporting - reduces dependency on third-party business intelligence products. • End-to-end workflow capabilities - support for complex system authorization processes like FedRAMP and the NIST Risk Management Framework, dramatically reducing time, cost, and effort. • Evidence of security posture compliance - designed to provide the body of evidence needed for regulatory or legal proceedings and insurance claims to verify security posture compliance with industry best practices at the time of an event. 6 Table of Contents Xacta Evolution Xacta was launched in August 2000 and was the first automated solution of its kind. Xacta was initially created to help U.S. government organizations satisfy demanding security risk and compliance management requirements. Over the years, commercial and international demand for the Xacta solutions provided by Telos has grown rapidly. In 2004, Xacta was enhanced to provide industry-first automated continuous monitoring functionality. Between 2002 and 2005, Telos was issued five patents in the area of security risk and compliance management, including one patent for what is now known as continuous monitoring. Since then, numerous technical enhancements have been made to Xacta, some of which are described above in “Xacta’s Critical Capabilities.” Xacta supports other NIST frameworks such as the NIST Cybersecurity Framework (“CSF”), which was established in 2014 via Executive Order 13636 to help commercial organizations in the 16 DHS-defined critical infrastructure sectors improve their cyber risk posture. Executive Order 13800, issued in 2017, requires federal agencies to adopt the CSF, and it is also being adopted by many countries as a national cybersecurity standard. Xacta also currently supports various vendor/supply chain risk management standards such as NIST Special Publication 800-161 and NIST Special Publication 800-171. NIST 800-171 is a contractual requirement for approximately 70,000 commercial companies that support the U.S. federal government. Xacta will also support an emerging standard called Cybersecurity Maturity Model Certification, which will soon be required by approximately 300,000 commercial organizations that support DoD. Xacta has highly customizable workflows that can be configured to support most any cybersecurity/risk and compliance management frameworks. To that end, Xacta can support national and international security compliance standards such as HIPAA, PCI-DSS, ISO 27000, and many others. Xacta does not require a customer to abandon (i.e. rip and replace) its existing solutions - rather it works with the customer’s prior software choices and uses those software choices as data feeds so that Xacta can perform automated (and continuous) security compliance validation. Xacta use cases include audit management, compliance management, inventory management, vulnerability management, continuous compliance monitoring, vendor/supply chain risk management, cyber risk management, risk remediation management, and security authorizations. These use cases are broadly applicable across industry verticals globally and help explain the large and expanding market in which Xacta participates. Our goal is to make Xacta the default security risk and compliance management solution of choice for commercial and government entities across the globe that seek continuous compliance with cybersecurity and risk management frameworks and standards. Telos Ghost® Telos Ghost Overview As cyber threats have increased in scope and scale and the consequences of hacks and breaches have grown, we have developed a solution that enables organizations to work on the internet without being detected. In 2018, we introduced Telos Ghost, which allows our customers to shield communications, transactions, and even their very presence on the web from the view of cyber adversaries. Conceived on the notion that “you can’t exploit what you can’t see,” Telos Ghost provides organizations a virtually anonymous way to do business, connect with global resources, and conduct research online. Telos Ghost is a virtual obfuscation network-as-a-service that: • obscures and varies network pathways to prevent adversaries from tracking users and information. • uses multiple layers of encryption to protect information and remove source and destination IP addresses, eliminating network paths back to the source. • enables users to manage their technical and non-technical persona to disguise their identity and location. • hides critical network resources using cloaked capabilities for email, storage, unified communications, and other applications. Telos Ghost seeks to eliminate cyber-attack surfaces by obfuscating and encrypting data, masking user identity and location, and hiding network resources. It provides the additional layers of security and privacy needed for intelligence gathering, cyber threat protection, securing critical infrastructure, and protecting communications and applications when operations, property, and even lives can be jeopardized by a single error in security. 7 Table of Contents Telos Ghost Critical Capabilities • Private Web Access: Secure anonymous Internet access. Telos Ghost disguises the identity and location of personnel when using the public web for cyber threat intelligence and competitive research. It provides users with dynamic access for every session and assures that traffic securely traverses the virtual private lines of Telos Ghost. Scalable and flexible, Telos Ghost Private Web Access allows users multiple points of international or domestic egress to the public internet based on customer requirements. Traffic mixing and misdirection techniques are designed to ensure that activity remains anonymous, obscure and private. • Private Network Access: Leased-line security with VPN flexibility. This capability is designed to allow authorized users to work with mission-critical enterprise information without being seen or discovered. It enables the establishment of sustainable cybersecurity infrastructure, providing multi-layered secure tunnels for data traffic and obscuring the correlation between the entry doorways and the client cloud from external observers. Software and system agnostic and accessible from nearly any device and location, Telos Ghost Private Network Access is designed to provide a full security solution while maintaining existing encryption and software services. • Cloaked Services: Hidden unified mobile communications, storage, and applications. Telos Ghost also provides remote users with the ability to securely talk, text, email, store information, and use video and applications over nearly any mobile device. These abilities include fully encrypted geo-masked hidden mobile communications for device-agnostic voice, video, chat, and data; hidden storage to store, analyze, and collaborate privately and securely within Telos Ghost; and hidden email and applications that cloaks the servers for access only by Telos Ghost users. Telos Ghost Applications • Cyber threat research. Telos Ghost provides members of a U.S. government organization with an isolated networking infrastructure that enables red team members to operate securely and privately without attracting unwanted attention. • Open source intelligence. A U.S. government organization uses Telos Ghost to securely conduct open source cyber threat intelligence analysis. • Supply chain security vulnerability assessment . A security company that vets the vulnerability of supply chains in the Defense Industrial Base uses Telos Ghost to inspect the digital connections of the supply chain online, safe from observation by adversaries that might otherwise evade discovery. • Worldwide investigative and recovery services. A commercial firm uses Telos Ghost for cloaked online research and voice communications over mobile devices to enable secure, privatized communications as they track and recover property from nefarious actors. Telos AMHS Telos AMHS is used by military field operatives for critical communications on the battlefield. Since 1999, it has been one of our signature security solutions and has been one of the most widely used organizational messaging products in DoD and other agencies charged with defending U.S. national security. Telos AMHS is designed to support a range of secure messaging services to a worldwide community of U.S. military, government, and allied customers operating in both strategic and tactical environments. It is used to securely transmit messages that provide direction and establish a formal position, commitment, or response requiring the authority of an organization, rather than an individual, including: • Military command and control; • Cross-border authorizations; • Exchanges between military forces of sovereign nations; • High-level policy, procedure, or directives; and • Response to legal, sensitive, or personnel matters. Because Telos AMHS supports timely and reliable delivery for authoritative communications, its uses include terrorist warnings, “eyes-only” messages, military execution orders, intelligence information, overflight clearances, and Emergency Action Messages for nuclear command and control. Information exchange at this level and for these purposes requires operational requirements for time-sensitive, guaranteed delivery, precedence, high availability, and reliability. Telos AMHS is the only web-based solution for assured messaging and directory services using the DISA’s Organizational Messaging Service and its specialized communications protocols. With Telos AMHS, users are able to send and receive rich-text messages across security domains and in different formats using plain language addressing. Users can search messages, archive messages, and send attachments up to 200MB to accommodate photos and videos, including those of terrorists, most wanted notices, maps, and satellite images. More than fifty organizations around the world depend on Telos AMHS, including the Joint Staff, combatant commands, military services, defense agencies, federal agencies, and the IC. Telos AMHS provides a proven return on investment over alternative organizational messaging offerings and has been implemented on a SaaS basis by an increasing number of organizations. 8 Table of Contents Telos ID Identity Offerings Telos ID Overview Telos ID provides trusted identity and digital services that are critical for the delivery of vital citizen services that millions of Americans rely on each year. Access to these vital services requires a robust and reliable infrastructure comprised of advanced technologies, facilities, and professional staff members that can effectively deliver these services around the world. We have transformed the Telos ID business model by leveraging a SaaS approach. We utilize our partnerships with AWS and ServiceNow, and we have fully integrated a robust suite of customer service, cybersecurity, and performance monitoring tools that align with DHS’s Continuous Diagnostics and Mitigation (“CDM”) Program that are designed to enable us to quickly deliver SaaS or turn-key solutions to our federal customers. Our digital platform extends web, mobile, and client applications that also drive professional services and product licensing opportunities. Our services are differentiated because our back-end system is intended to interface with critical homeland security and law enforcement systems and are tightly coupled with a mature, modern cloud-based platform that can scale to support large federal, state, local, and commercial programs. We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck ® enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and the FINRA Electronic Fingerprint Submission provider. We are the only commercial entity in our industry designated as a Secure Flight Services provider for terrorist watchlist checks. Our strategic partners offer retail and on-demand service channels that further differentiate our offerings. Our established global logistics infrastructure provides responsive supply chain support. We operate a full-service call center with chat-bots, AI, and virtual agent support, all of which contribute to scalability. Our network and security operations centers align with U.S. Computer Emergency Readiness Team and CDM best practices. Telos ID Applications and Use Cases • U.S. Military ID . For more than 25 years, Telos ID’s identity trust services have provided access to health care, commissary services, and critical defense resources for more than 2,000,000 military members, their dependents, and civilian employees through use of the Common Access Card (“CAC”). We operate more than 250,000 components that comprise 7,000 end-user systems deployed around the world to nearly 2,000 military installations. We provide near real-time data collection support on personnel movement and location information for operating forces, government civil servants, and government contractors in specified operational theaters. This system has captured over 636,000,000 scans of government, U.S. military, and contractor personnel since its inception. Our logistics infrastructure provides responsive 24-hour delivery of components to our warfighters deployed across the globe, and we custom-build our identity, credentialing, and access management solutions to function effectively in austere environments that demand reliability and performance at all times. • TSA Airport Employee Vetting . Historically, more than 300,000,000 airline passengers’ travel experiences have been handled by more than 1,500,000 aviation workers who are screened through Telos ID’s aviation channeling service. As one of only two authorized aviation channeling providers in the market, we offer our aviation partners innovative biometric, identity trust, and customer service technologies that are critical to the operation of more than half of the largest airports in the nation. We actively support nearly 100 commercial airports, airlines, and general aviation customers, and our Independent Secure Flight Vetting technology provides a secure vetting service for non-travelers who need to access secure areas of an airport. We were the first commercial company in the United States to implement the FBI’s Rap Back service, enabling our aviation partners to perform continuous monitoring for insider threat detection. • U.S. Census Bureau Enumerator Screening . For the 2020 U.S. Census, we have processed more than 1,000,000 enumerators through our 1,100 identity service centers. Telos ID extends digital identity verification, fingerprinting, and photo services across the nation in support of 2020 Census hiring initiatives. We custom designed and deployed more than 1,300 desktop, kiosk, and mobile workstations that are operated by thousands of Census-cleared staff members. At the peak, Telos ID’s managed service supported more than 30,000 appointments per day, and our customer call center handled more than 35,000 daily calls at the peak. • TSA PreCheck ® Enrollment Screening . Telos ID’s recent award of a 10-year contract to provide enrollment services in support of the TSA PreCheck ® Enrollment Program presents a large, high-profile opportunity for us, and we are preparing to launch services under this program in early 2021. The TSA PreCheck ® contract is an important example of a government-sponsored, consumer facing opportunity, in which we provide PreCheck ® enrollment services to individual, fee-paying applicants. Telos ID’s service will engage with the world’s leading airline, hospitality, credit card, ride share, and other Fortune 500 businesses to provide consumer marketing and loyalty program tie-ins to promote the PreCheck ® program. In addition, this program is expected to feature an omni-channel market approach that leverages advanced digital services to reach our customers across several market segments. 9 Table of Contents • CMS Healthcare Provider Screening . Telos ID was recently awarded a 10-year contract to provide technology and service solutions that detect, prevent, and proactively deter fraud, waste and abuse in the Medicare and Medicaid programs. Telos ID’s digital identity trust platform and digital services is expected to offer critical technology necessary to identify and mitigate fraud across the United States. Each year, approximately 1,500,000 health care providers are required to undergo FBI-based non-criminal history checks requiring identity trust services, including identity verification, fingerprinting, and continuous monitoring. Telos ID's digital trusted identity platform -- IDTrust360® -- is a leading, fully integrated suite containing IoT, Machine Learning (ML), AI, and other advanced cloud-hosted products and services that deliver identity trust, multi-modal biometric capture and matching, identity assurance, identity vetting, document validation, credentialing, personnel security, case management, call center support, cyber security, network and security operations, service management, integrated logistics, and numerous other features and functions. Its open architecture is supported by a flexible API gateway and a robust workflow engine that can efficiently extend individual services or offer the entire platform as a SaaS or turn-key solution for our customers. IDTrust360® is the only commercially owned and operated platform on the market with direct interfaces to the FBI's criminal records, DHS's terrorist watch list service, Treasury's pay.gov, other government identity risk management systems, and numerous commercial identity, intelligence, and risk-based data sources. We are actively engaged with federal customers to integrate vital event records, government identification document records, and other fingerprint-based biometric records hosted across multiple agencies. This enables Telos ID exclusively to offer NIST-compliant digital identity services aligned with federal security mandates. IDTrust360 ® extends web, mobile, and client applications within a fully integrated low-code development environment for rapid application development. The environment meets FISMA High certification standards and is NIST SP 800-53 certified within multiple federal agencies, while boasting 99.998% availability performance and enterprise-level scalability. IDTrust360 ® leverages leading cyber security and network monitoring tools aligned with DHS Continuous Diagnostics & Mitigation and industry best practices for strengthening network defense and enhancing the resiliency of our infrastructure necessary for managing and protecting millions of identity records, sensitive information, and end-point hardware components deployed across thousands of sites around the world for customers operating within defense, homeland security and law enforcement, financial, health, commerce, transportation, retail, and other market segments. Secure Mobility Nearly 20 years ago, we were the first non-government solutions provider to receive approval to design and deliver secure wireless solutions to DoD. That authorization to operate enabled us to build a very large footprint within DoD and the U.S. Air Force. As a result, we have a long track record of enabling our customers to work remotely and securely. Given the depth of our relationships, when one of our customers elects to modernize its remote mobility infrastructure, it frequently chooses to work with us. Within the U.S. Air Force and supporting DoD communities, we have designed and delivered enterprise-level secure mobile networks on every active duty, Air National Guard, and Air Force Reserve site worldwide. Our secure mobility team brings credentials to every engagement, supplying deep expertise and experience as well as highly desirable clearances and industry recognized certifications for network engineering, mobility, and security. We also foster and maintain key industry partnerships, offering insight into technology advances and early access to new secure mobility solutions. Network Management and Defense On a managed basis, we offer a broad suite of services needed to operate, administer, and defend complex enterprise networks, giving our customers the benefit of these capabilities without having to commit to the cost and burden of providing the services for themselves. We have the expertise to manage and defend large-scale enterprises and have been successful at hiring and retaining personnel with the necessary key skills and security clearances. Our Competitive Strengths • Leading cybersecurity company with a long history of providing security solutions to the most sophisticated customers . We have been providing security solutions, specializing in the area of cybersecurity, since 1995. Our customers include some of the most security-conscious organizations in the world, including the IC. For example, we believe that our award-winning Xacta offering is the dominant commercial risk management solution in the federal government space and is increasingly being adopted in the commercial sphere, notably by leading cloud providers such as AWS and Microsoft Azure. Additionally, Telos Ghost gives organizations and individuals the ability to hide in plain sight, eliminating attack vectors from hackers through obfuscation and mis-attribution. And, we believe our Telos ID identity offerings are market disruptors that present large opportunities for growth. • Superior security solutions and capabilities . Our solutions are designed for both government and commercial industries and are configured to operate in highly sensitive, highly classified environments, serving some of the most demanding, secure organizations in the world. Our solutions are flexible, and can be deployed in various ways, including on premises, in the cloud, or in hybrid or multi-cloud environments. 10 Table of Contents • Proven ability to win and retain large contracts and enterprise-level deals, providing clear visibility into future revenue and profitability . We have over 20 active acquisition contracts and vehicles, thousands of active contracts and purchase orders, and more than 350 customers in each of the last three years. These contracts, vehicles and customers present a solid platform for growth. As but one example, we have provided IT security support to the Defense Manpower Data Center (“DMDC”) under a variety of contract vehicles since 1995, and this program accounts for annual revenue at a historical average of approximately $28 million over the last five years. We also have proven repeatedly our ability to deploy our security solutions at the enterprise level for both federal and commercial organizations. These long-term contract relationships provide predictable, recurring revenue at attractive margins. • Our substantial investments into technology and automation can be expanded beyond our core market . Our solutions are built to help our customers be more secure, more efficient, and more effective. We have made investments across the company to take advantage of efficiencies and automation through scalable security solutions that are market driven and market proven. In contrast to traditional cybersecurity businesses with a focus on government customers, we own the intellectual property developed through our R&D initiatives and can deploy our technology solutions across our entire public and private sector customer set. The ability to offer our solutions beyond the U.S. federal government sphere is a key enabler of our strategy to grow and expand our relationships with commercial customers. • Strong relationships with our customers . We are a customer-centric organization and pride ourselves on our close customer relationships. We have longstanding relationships with DoD, civilian agencies of the federal government, and the IC that date back more than two decades. Since 1995, our security solutions have been adopted by many defense, intelligence, civilian agency, and commercial customers, and we believe that the Telos brand has become synonymous with trust. • Respected, experienced management team . Our executive officers have an average tenure at Telos of approximately 21 years. The team is comprised of personnel with extensive military, federal government, and commercial backgrounds who are directly familiar with customer needs. Our management team also includes senior professionals who are experienced in developing commercial software solutions and leading technical teams throughout the development process. • COVID-resistant business . We support mission critical operations. Because of this and the growth of remote workforces as a result of the COVID-19 pandemic, we believe, based upon our 2020 financial performance to date, that our business is relatively COVID resistant. Additionally, the automation provided by our solutions can help customers do more with less as they are forced to downsize their staffs because of the pandemic. Automation is now even more critical to efficiently manage a business, including with respect to cyber risk and regulatory compliance, which should result in additional demand for our security solutions. Our Growth Strategies We are pursuing multiple strategies in order to grow the company, in both our commercial and government business end markets in the United States and abroad. Our key strategies are: • Leverage our diverse security solutions to expand our presence in commercial markets . Our offerings are designed to have broad application and include security risk and compliance, secure messaging, identity vetting, and managed attribution and obfuscation. We believe that we are well-positioned to sell our capabilities into a dynamic and growing commercial opportunity set and to innovate to address emerging and unique requirements. For example, we have leveraged core Xacta functionality to meet the needs of large financial services and CRM firms. We have also leveraged our U.S. federal government identity management qualifications to improve the speed and accuracy of vetting results for nearly 100 airports, air carriers, and general aviation across the country. We intend to continue to innovate and are developing additional offerings for cloud, mobile, and IoT devices. • Grow our revenue and expand margins by building robust sales channels . In recent years, we have formed an inside sales organization that serves as both the direct channel to a wider account universe and an effective and efficient training program to grow our field sales organization. We plan to expand our partner program to include a variety of channels, including resellers, integrators, and contract partners to help us more quickly gain access to new markets, particularly commercial and international. For example, both Telos Ghost and Xacta are now available through various AWS and Microsoft Azure marketplaces, serving regions around the world and markets requiring varying levels of security. We plan to grow our direct sales team and to accelerate the expansion of these channel partner initiatives, which we anticipate will drive revenue growth and material gross margin expansion. • Target and replace inefficient legacy products . Recognizing the limitations of their legacy systems, organizations are replacing existing systems and processes with our solutions. For example, Telos AMHS is a web-centric system that replaced legacy capabilities like communications centers for the purpose of executing operational orders (through organizational messaging) across the U.S. federal government and around the world. Xacta has disrupted the cyber risk and compliance management business across the U.S. federal government, replacing tedious manual activity with automation and delivering that automation to meet our customer’s needs flexibly on premises, in hybrid environments, in the cloud, and across multi-cloud infrastructures. 11 Table of Contents • Broaden reach within the U.S. federal government . We have historically focused on the U.S. federal government and believe that we are an established leader in providing security solutions to federal agencies, including DoD and the IC. Nonetheless, we believe the U.S. federal government represents a significant growth opportunity, and we expect to continue to invest in products to serve additional customers in this vertical. For example, Xacta is included on DHS’s CDM Approved Products List to provide federal agencies with innovative security tools, which we believe presents us with an excellent opportunity to pursue contracts with additional federal agencies. In addition, our platform is available for use in the AWS GovCloud (US) and Azure Government. • Expand our international footprint . We are expanding our international operations and intend to invest globally to broaden our international footprint. We are currently working with countries such as Canada, Singapore, Australia, and Bahrain to offer Xacta to address cyber risk and compliance management capabilities. We are also working to expand AMHS to all NATO countries and to offer Telos Ghost internationally. We intend to grow our international customer base by increasing our investments in overseas operations, establishing channel partners, and adding personnel in Europe, the Middle East, and Asia-Pacific. • Pursue strategic acquisition opportunities . We believe that our markets remain fragmented, with many niche players providing limited product solutions targeting narrow customer segments. Given the breadth of our solution set and our customer end markets, we believe that we are well-positioned to opportunistically acquire smaller companies and incorporate their technology or deploy their solutions across a larger customer set. We believe that a targeted and opportunistic acquisition strategy will complement our significant organic growth opportunity. Sales and Marketing We typically focus on large government and commercial organizations that have demanding security requirements and/or complex cyber security risk and compliance management objectives. Customer acquisition often involves extensive interaction at all levels of the organizations from users to executives and decision makers. We seek to forge relationships throughout an organization in an effort to obtain broad consensus as part of the sales process. Currently, the customer acquisition process is largely driven by direct sales activity. As a result of the long tenure of many of our employees, many of our sales and business development executives have trusted relationships that have developed over many years. We augment these trusted relationships with senior leaders who have retired from the military, civil service, and various related industries. Many of these individuals are our employees. These leaders provide our sales team with access to high level contacts that would be difficult to achieve otherwise. Our sales executives are supported by an inside sales team that works with the Telos marketing team on various awareness campaigns where sales leads are obtained, vetted, and pursued via proactive outreach (calls, email, etc.). Metrics are tracked using a formal CRM process and used to equip the sales executives with useful sales data. Our sales team works hand in hand with our marketing team and various subject matter experts to develop target awareness campaigns for our various solutions that generate valuable leads and contacts. Our sales strategy is to establish a customer foothold with one of our solutions and work to achieve rapid success. We then leverage this customer relationship to expand usage of other Telos solutions. We have a variety of upsell opportunities that allow us to expand our presence within a customer account. For example, there are various complementary Xacta features that build on each other and are sold separately. Additionally, our sales team is responsible for selling all Telos solutions. This allows a sales executive to quickly identify demand for other Telos solutions in existing accounts. Our sales team also works with partner organizations like AWS, Microsoft Azure, and Rackspace Technology, Inc. to pursue mutual customers. These relationships represent our current channel sales strategy that we are in the process of expanding. We are also actively working with Singapore Technologies Engineering, Limited, which is helping us gain access to the Asian market for cyber security solutions. We plan to expand our direct sales capability for markets in which we are well-known, such as the U.S. government, certain critical infrastructure sectors, and certain commercial verticals like healthcare and financial services. We also plan to expand our channel sales capability to gain rapid access to other commercial verticals and international markets. We will be increasing our investment in sales and marketing with the goal of increasing sales of our security solutions and acquiring customers in a variety of verticals. In 2021, we are planning on implementing an approximate 300% increase from our 2020 sales and marketing investment. We currently have less than 10 salespeople at Telos who carry quotas that they are expected to meet. We plan on adding direct, quota-driven, in-house sales assets to focus on commercial accounts. We will focus Xacta and Telos Ghost sales efforts in the banking/financial services and insurance sector, healthcare, energy, and other critical infrastructure protection markets. We will also be investing in additional lead generation tools, financial incentives and marketing programs. 12 Table of Contents Our partner program will include a variety of channels, including resellers, technical/integrators, and consulting partners to help us accelerate access and implementations in new markets, particularly commercial and international. Currently, we participate in Microsoft and AWS partner programs, which incentivize their respective sellers to promote Telos security solutions (e.g., Xacta and Telos Ghost). As part of the sales and channel program investment, we are also making corporate investments in functional areas such as contracts, solution architects and operations. Much of our business is awarded through submission of formal competitive bids, though about 50% is awarded through limited competition or sole source contracts. We build market awareness of Telos and our solutions through a variety of marketing programs, including regular briefings with industry analysts, public relations activities, government relations initiatives, web seminars, trade show exhibitions, speaking engagements and web site marketing. We will be making additional investments in these types of activities and targeting additional vertical specific content creation, targeted advertising and brand awareness campaigns, social media campaigns, and search engine marketing. When appropriate, we will engage in joint marketing activities with our channel, technology and consulting partners. Competition We operate in a highly competitive marketplace. There are other companies that provide solutions similar to ours. Although these companies provide offerings that overlap with some of our solutions, we are not aware of any single company that provides competitive solutions in all of the areas where we compete. The primary companies with which our solutions compete range from security solutions and software organizations such as CLEAR (operated by Alclear, LLC), Cutting Edge, IDEMIA, MetricStream Inc., Palantir Technologies Inc., RSA Archer, ServiceNow, Inc., and Unisys Corporation, to more traditional government services integrators that provide products and services such as Booz Allen Hamilton Inc., General Dynamics Corporation, Lockheed Martin Corporation, Northrop Grumman Corporation, and Science Applications International Corporation. The majority of our business is in response to competitive requests from potential and current customers. Decisions regarding contract awards by our customers typically are based upon an assessment of the quality of our past performance, responsiveness to proposal requirements, uniqueness of the offering itself, price, and other competitive factors. Aside from other companies that compete in our space, we sometimes face indirect competition from solutions that are developed “in-house” by some of our customers. Our People and Culture As of December 31, 2020, we had 785 employees, of which approximately 60% held security clearances. Our people are proficient in many fields such as computer science, information security and vulnerability testing, networking technologies, physics, engineering, operations research, mathematics, economics, and business administration. We place a high value on our people. As a result, we seek to remain competitive in terms of salary structures, incentive compensation programs, fringe benefits, opportunities for growth, and individual recognition and award programs. Our management team is committed to maintaining a corporate culture that fosters mutual respect and job satisfaction for our people, while delivering innovation and value to customers and shareholders. This commitment is reflected in our core values. Always with integrity, at Telos we: Build trusted relationships, Work hard together, Design and deliver superior solutions, and Have fun doing it. These values are woven throughout the fabric of Telos. They are reflected in our hiring practices, reinforced regularly, and reviewed during appraisals. They are written into annual and quarterly objectives for staff and managers alike, as well as department and company business goals. Employees are encouraged to challenge themselves and each other to exhibit the core values in everyday activities. Our employees also are given avenues of communication and interaction should they observe activities that are inconsistent with our core values. Encouraged first to speak openly about any issues, a hotline provides an opportunity to express concerns anonymously. We consider the foundational value of integrity to be a non-negotiable requirement of employment, and an expectation of suppliers, partners, and our customers. We guard our reputation and will take aggressive action to protect it. An essential part of our brand promise is that we always engage employees, customers, partners, suppliers, and investors with integrity. 13 Table of Contents Government Contracts and Regulation Our business is heavily regulated. We must comply with and are affected by laws and regulations relating to the formation, administration and performance of U.S. Government and other contracts. These laws and regulations, among other things: • impose specific and unique cost accounting practices that may differ from Generally Accepted Accounting Principles (“GAAP”) in the United States of America and therefore require reconciliation; • impose acquisition regulations that define reimbursable and non-reimbursable costs; and • restrict the use and dissemination of information classified for national security purposes and the export of certain products and technical data. Government contracts are subject to congressional funding. Consequently, at the outset of a program, a contract is usually partially funded, and Congress annually determines if additional funds are to be appropriated to the contract. All of our government customers have the right to terminate their contract with us at their convenience or in the event that we default. A portion of our business is classified by the U.S. Government and cannot be specifically described. The operating results of these classified programs are included in our consolidated financial statements. Backlog We develop our annual budgeted revenue by estimating for the upcoming year our continuing business from existing customers and active contracts. We consider backlog, both funded and unfunded (as explained below), other expected annual renewals, and expansion planned by our current customers. In the context of our current customer portfolio, we view “recurring revenue” as revenue that occurs often and repeatedly. In each of the last three years, recurring revenue has exceeded 85% of our annual revenue. Our total budgeted revenue is the combination of recurring revenue and a forecast of new business. Total backlog, a component of recurring revenue, consists of the aggregate contract revenues remaining to be earned by us at a given time over the life of our contracts, whether funded or unfunded. Funded backlog consists of the aggregate contract revenues remaining to be earned at a given time, which, in the case of U.S. government contracts, means that they have been funded by the procuring agency. Unfunded backlog is the difference between total backlog and funded backlog and includes potential revenues that may be earned if customers exercise delivery orders and/or renewal options to continue these contracts. Based on historical experience, we generally assume option year renewals to be exercised. Most of our customers fund contracts on a basis of one year or less and, as a result, funded backlog is generally expected to be earned within one year from any point in time, whereas unfunded backlog is expected to be earned over a longer period. 14 Table of Contents