
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q


☒x			Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: ~~September~~June 30, ~~2022~~2023


☐¨			Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number: 001-08443

TELOS CORPORATION

(Exact name of registrant as specified in its charter)


Maryland						52-0880974
(State or other jurisdiction of incorporation or organization)						(I.R.S. Employer Identification No.)

19886 Ashburn Road, Ashburn, Virginia						20147-2358
(Address of principal executive offices)						(Zip Code)

(703) 724-3800

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading symbol	Name of each exchange on which registered
Common stock, $0.001 par value per share	TLS	The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒x No ☐¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒x No ☐¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☒¨

Accelerated filer

☐x

Non-accelerated filer

☐¨

Smaller reporting company

☐¨

Emerging growth company

☐¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐¨ No ☒x

As of ~~November~~August 4, ~~2022,~~2023, the registrant had outstanding ~~67,210,624~~69,582,809 shares of common stock.

Table of Contents

Table of Contents to ~~Third~~Second Quarter ~~2022~~2023 Form 10-Q


		Page
~~Part~~PART I - ~~Financial Information~~FINANCIAL INFORMATION		3
Item 1.	Financial Statements	3
	Consolidated Statements of Operations	3
	Consolidated Statements of Comprehensive Loss	4
	Consolidated Balance Sheets	5
	Consolidated Statements of Cash Flows	6
	Consolidated ~~Statement~~Statements of Changes in ~~Stockholders'~~Stockholders’ Equity	7
	Notes to ~~the~~ Consolidated Financial Statements	8
	1. Organization	8
	2. Significant Accounting Policies	8
	3. Revenue Recognition	10
	4. Accounts Receivable, Net	11
	5. Inventories, Net	1112
	6. Property and Equipment, Net	1112
	7. Goodwill	12
	8. Intangible Assets, Net	12
	9. ~~Acquisition~~	12
	~~10. Purchase of Telos ID Non-controlling Interests~~	12
	~~11. Accounts Payable and~~ Other ~~Accrued Liabilities~~Balance Sheet Components	13
	10. Debt and Other Obligations	13
	11. Acquisition	14
	12. Stock-Based Compensation	1314
	13. Share Repurchases	1416
	14. Accumulated Other Comprehensive Loss	1416
	15. Loss per Share	1416
	16. Related Party Transactions	1516
	17. Segment Information	1517
	18. Commitments and Contingencies	18
	19. Supplemental Cash Flow Information	18
	20. Revision of Prior Year Interim Financial Statements	1619
	~~19. Commitments and Contingencies~~	18
	~~20. Supplemental Cash Flow Information~~	18
Item 2.	~~Management's~~Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
	Forward-Looking Statements	20
	General and Business Overview	20
	Business Environment	2120
	Backlog	2321
	Financial Overview	2322
	Results of Operations	2422
	Non-GAAP Financial Measures	2624
	Liquidity and Capital Resources	2826
	Critical Accounting Policies and Estimates	2926
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	2927
Item 4.	Controls and Procedures	2927
~~Part~~PART II - ~~Other Information~~OTHER INFORMATION		3128
Item 1.	Legal Proceedings	3128
Item 1A.	Risk Factors	3128
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	3128
Item 3.	Defaults ~~Upon~~upon Senior Securities	3129
Item 4.	Mine Safety Disclosures	3129
Item 5.	Other Information	3129
Item 6.	Exhibits	3229
	~~Signatures~~SIGNATURES	3330

Table of Contents

PART I -– FINANCIAL INFORMATION

Item 1. Financial ~~Statements.~~Statements

~~Telos Corporation~~TELOS CORPORATION

~~Consolidated Statements of Operations~~CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


		For the Three Months Ended				For the Nine Months Ended					For the Three Months Ended				For the Six Months Ended
		September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021			June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

		(in thousands, except per share amounts)									(in thousands, except per share amounts)
Revenue – services	Revenue – services	$	55,305	$	62,955	$	153,683	$	164,016	Revenue – services	$	28,947	$	50,270	$	60,481	$	98,378
Revenue – products	Revenue – products	8,288		6,026		15,861		14,367		Revenue – products	3,964		5,521		7,652		$	7,573
Total revenue	Total revenue	63,593		68,981		169,544		178,383		Total revenue	32,911		55,791		68,133		105,951
Cost of sales – services	Cost of sales – services	36,746		40,137		97,913		108,236		Cost of sales – services	19,008		31,436		38,276		61,167
Cost of sales – products	Cost of sales – products	5,902		3,967		10,886		8,266		Cost of sales – products	1,544		3,426		4,016		4,984
Total cost of sales	Total cost of sales	42,648		44,104		108,799		116,502		Total cost of sales	20,552		34,862		42,292		66,151
Gross profit	Gross profit	20,945		24,877		60,745		61,881		Gross profit	12,359		20,929		25,841		39,800
Selling, general and administrative expenses:
Selling, general and administrative expenses										Selling, general and administrative expenses
Sales and marketing	Sales and marketing	3,042		5,363		13,035		14,233		Sales and marketing	1,793		4,741		3,436		9,993
Research and development	Research and development	3,981		4,863		13,900		14,250		Research and development	2,646		4,489		5,479		9,919
General and administrative	General and administrative	21,591		19,739		68,379		69,452		General and administrative	17,387		25,735		39,363		50,291
Total selling, general and administrative expenses	Total selling, general and administrative expenses	28,614		29,965		95,314		97,935		Total selling, general and administrative expenses	21,826		34,965		48,278		70,203
Operating loss	Operating loss	(7,669)		(5,088)		(34,569)		(36,054)		Operating loss	(9,467)		(14,036)		(22,437)		(30,403)
Other income/(expense)		518		20		648		(1,001)
Other income										Other income	1,649		118		4,145		130
Interest expense	Interest expense	(181)		(195)		(558)		(583)		Interest expense	(184)		(187)		(433)		(377)
Loss before income taxes	Loss before income taxes	(7,332)		(5,263)		(34,479)		(37,638)		Loss before income taxes	(8,002)		(14,105)		(18,725)		(30,650)
(Provision for)/benefit from income taxes		(8)		41		(133)		(6)
Provision for income taxes										Provision for income taxes	(22)		(54)		(45)		(125)
Net loss	Net loss	$	(7,340)	$	(5,222)	$	(34,612)	$	(37,644)	Net loss	$	(8,024)	$	(14,159)	$	(18,770)	$	(30,775)

Net loss per share:	Net loss per share:									Net loss per share:
Basic	Basic	$	(0.11)	$	(0.08)	$	(0.51)	$	(0.57)	Basic	$	(0.12)	$	(0.21)	$	(0.27)	$	(0.45)
Diluted	Diluted	$	(0.11)	$	(0.08)	$	(0.51)	$	(0.57)	Diluted	$	(0.12)	$	(0.21)	$	(0.27)	$	(0.45)

Weighted average shares outstanding:
Weighted-average shares outstanding:										Weighted-average shares outstanding:
Basic	Basic	67,493		66,755		67,641		65,999		Basic	69,424		67,876		68,804		67,717
Diluted	Diluted	67,493		66,755		67,641		65,999		Diluted	69,424		67,876		68,804		67,717

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

~~Telos Corporation~~TELOS CORPORATION

~~Consolidated Statements of Comprehensive Loss~~CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)


		For the Three Months Ended				For the Nine Months Ended					For the Three Months Ended				For the Six Months Ended
		September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021			June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

		(in thousands)									(in thousands)
Net loss	Net loss	$	(7,340)	$	(5,222)	$	(34,612)	$	(37,644)	Net loss	$	(8,024)	$	(14,159)	$	(18,770)	$	(30,775)
Other comprehensive loss, net of tax:	Other comprehensive loss, net of tax:									Other comprehensive loss, net of tax:
Foreign currency translation adjustments	Foreign currency translation adjustments	(21)		(13)		(3)		(40)		Foreign currency translation adjustments	(11)		(11)		2		18
Comprehensive loss	Comprehensive loss	$	(7,361)	$	(5,235)	$	(34,615)	$	(37,684)	Comprehensive loss	$	(8,035)	$	(14,170)	$	(18,768)	$	(30,757)

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

~~Telos Corporation~~TELOS CORPORATION

~~Consolidated Balance Sheets~~CONSOLIDATED BALANCE SHEETS

(Unaudited)


		September 30, 2022		December 31, 2021			June 30, 2023		December 31, 2022

		(in thousands, except per share and share data)					(in thousands, except per share amount and share data)
Assets:	Assets:					Assets:
Cash and cash equivalents	Cash and cash equivalents	$	125,332	$	126,562	Cash and cash equivalents	$	103,447	$	119,305
Accounts receivable, net	Accounts receivable, net	50,983		59,844		Accounts receivable, net	34,290		40,069
Inventories, net	Inventories, net	4,676		1,247		Inventories, net	1,767		2,877
Prepaid expenses	Prepaid expenses	6,069		3,329		Prepaid expenses	7,321		4,819
Other current assets	Other current assets	930		732		Other current assets	1,850		893
Total current assets	Total current assets	187,990		191,714		Total current assets	148,675		167,963
Property and equipment, net	Property and equipment, net	5,128		6,088		Property and equipment, net	3,842		4,787
Finance lease right-of-use assets, net	Finance lease right-of-use assets, net	8,137		9,053		Finance lease right-of-use assets, net	7,222		7,832
Operating lease right-of-use assets		456		852
Operating lease right-of-use assets, net						Operating lease right-of-use assets, net	326		341
Goodwill	Goodwill	17,922		17,922		Goodwill	17,922		17,922
Intangible assets, net	Intangible assets, net	26,858		19,199		Intangible assets, net	37,814		37,415
Other assets	Other assets	908		1,253		Other assets	1,059		1,137
Total assets	Total assets	$	247,399	$	246,081	Total assets	$	216,860	$	237,397
Liabilities and Stockholders' Equity:	Liabilities and Stockholders' Equity:					Liabilities and Stockholders' Equity:
Liabilities:	Liabilities:					Liabilities:
Accounts payable and other accrued liabilities	Accounts payable and other accrued liabilities	$	37,583	$	34,548	Accounts payable and other accrued liabilities	$	16,506	$	22,551
Accrued compensation and benefits	Accrued compensation and benefits	8,941		6,557		Accrued compensation and benefits	9,862		8,388
Contract liabilities	Contract liabilities	6,952		6,381		Contract liabilities	6,138		6,444
Finance lease obligations, current portion		1,558		1,461
Operating lease obligations, current portion		408		564
Finance lease obligations – current portion						Finance lease obligations – current portion	1,660		1,592
Operating lease obligations – current portion						Operating lease obligations – current portion	350		361
Other financing obligations – current portion						Other financing obligations – current portion	—		1,247
Other current liabilities	Other current liabilities	1,972		1,430		Other current liabilities	3,317		4,919
Total current liabilities	Total current liabilities	57,414		50,941		Total current liabilities	37,833		45,502
Finance lease obligations, non-current portion		11,660		12,840
Operating lease liabilities, non-current portion		108		388
Finance lease obligations – non-current portion						Finance lease obligations – non-current portion	10,406		11,248
Operating lease liabilities – non-current portion						Operating lease liabilities – non-current portion	—		27
Other financing obligations – non-current portion						Other financing obligations – non-current portion	—		7,211
Deferred income taxes	Deferred income taxes	748		723		Deferred income taxes	782		758
Other liabilities	Other liabilities	436		935		Other liabilities	303		297
Total liabilities	Total liabilities	70,366		65,827		Total liabilities	49,324		65,043
Commitments and contingencies (Note 19)
Stockholders’ equity
Common stock, $0.001 par value, 250,000,000 shares authorized, 67,300,099 shares and 66,767,450 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively		106		105
Commitments and contingencies						Commitments and contingencies
Stockholders’ equity:						Stockholders’ equity:
Common stock, $0.001 par value, 250,000,000 shares authorized, 69,466,777 shares and 67,431,632 shares issued and outstanding as of June 30, 2023 and December 31, 2022, respectively						Common stock, $0.001 par value, 250,000,000 shares authorized, 69,466,777 shares and 67,431,632 shares issued and outstanding as of June 30, 2023 and December 31, 2022, respectively	108		106
Additional paid-in capital	Additional paid-in capital	398,546		367,153		Additional paid-in capital	426,656		412,708
Accumulated other comprehensive loss		(30)		(27)
Accumulated other comprehensive income						Accumulated other comprehensive income	(53)		(55)
Accumulated deficit	Accumulated deficit	(221,589)		(186,977)		Accumulated deficit	(259,175)		(240,405)
Total stockholders’ equity	Total stockholders’ equity	177,033		180,254		Total stockholders’ equity	167,536		172,354
Total liabilities and stockholders’ equity	Total liabilities and stockholders’ equity	$	247,399	$	246,081	Total liabilities and stockholders’ equity	$	216,860	$	237,397

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

~~Telos Corporation~~TELOS CORPORATION

~~Consolidated Statements of Cash Flows~~CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


		For the Nine Months Ended					For the Six Months Ended
		September 30, 2022		September 30, 2021			June 30, 2023		June 30, 2022

		(in thousands)					(in thousands)
Cash flows from operating activities:	Cash flows from operating activities:					Cash flows from operating activities:
Net loss	Net loss	$	(34,612)	$	(37,644)	Net loss	$	(18,770)	$	(30,775)
Adjustments to reconcile net loss to cash flows provided by operating activities:
Adjustments to reconcile net loss to cash (used in)/provided by operating activities:						Adjustments to reconcile net loss to cash (used in)/provided by operating activities:
Stock-based compensation	Stock-based compensation	44,225		47,378		Stock-based compensation	17,244		33,007
Depreciation and amortization	Depreciation and amortization	4,427		4,223		Depreciation and amortization	3,121		2,910
Deferred income tax provision	Deferred income tax provision	25		28		Deferred income tax provision	24		25
Accretion of discount on acquisition holdback		36		7
Accretion of discount in acquisition holdback						Accretion of discount in acquisition holdback	2		23
Loss on disposal of fixed assets	Loss on disposal of fixed assets	2		9		Loss on disposal of fixed assets	1		1
Provision for doubtful accounts	Provision for doubtful accounts	97		7		Provision for doubtful accounts	117		66
Recovery from inventory obsolescence		(108)		(2)
Changes in other operating assets and liabilities
Amortization of debt issuance costs						Amortization of debt issuance costs	35		—
Gain on early extinguishment of other financing obligations						Gain on early extinguishment of other financing obligations	(1,427)		—
Changes in other operating assets and liabilities:						Changes in other operating assets and liabilities:
Accounts receivable	Accounts receivable	8,763		(18,852)		Accounts receivable	5,662		9,102
Inventories	Inventories	(3,321)		1,288		Inventories	1,111		(2,383)
Prepaid expenses, other current assets, and other assets		(2,486)		(3,259)
Prepaid expenses, other current assets, other assets						Prepaid expenses, other current assets, other assets	(3,445)		(3,324)
Accounts payable and other accrued payables	Accounts payable and other accrued payables	2,635		15,742		Accounts payable and other accrued payables	(6,255)		567
Accrued compensation and benefits	Accrued compensation and benefits	371		(519)		Accrued compensation and benefits	(235)		419
Contract liabilities	Contract liabilities	571		1,579		Contract liabilities	(307)		(1,582)
Other current liabilities and other liabilities		(507)		(348)
Net cash provided by operating activities		20,118		9,637
Other current liabilities						Other current liabilities	(1,091)		76
Net cash (used in)/provided by operating activities						Net cash (used in)/provided by operating activities	(4,213)		8,132
Cash flows from investing activities:	Cash flows from investing activities:					Cash flows from investing activities:
Capitalized software development costs	Capitalized software development costs	(8,580)		(6,672)		Capitalized software development costs	(8,198)		(5,134)
Purchases of property and equipment	Purchases of property and equipment	(815)		(1,645)		Purchases of property and equipment	(270)		(641)
Cash paid for acquisition		—		(5,925)
Net cash used in investing activities	Net cash used in investing activities	(9,395)		(14,242)		Net cash used in investing activities	(8,468)		(5,775)
Cash flows from financing activities:	Cash flows from financing activities:					Cash flows from financing activities:
Payments under finance lease obligations	Payments under finance lease obligations	(1,083)		(993)		Payments under finance lease obligations	(775)		(710)
Payment of tax withholding related to net share settlement of equity awards	Payment of tax withholding related to net share settlement of equity awards	(3,135)		—		Payment of tax withholding related to net share settlement of equity awards	(1,584)		(2,886)
Repurchase of common stock	Repurchase of common stock	(7,603)		(1,251)		Repurchase of common stock	(139)		(2,603)
Proceeds from issuance of common stock, net of issuance costs		—		64,269
Repurchase of outstanding warrants		—		(26,894)
Distributions to Telos ID Class B member – non-controlling interest		—		(2,436)
Net cash (used in)/provided by financing activities		(11,821)		32,695
Payment of DFT holdback amount						Payment of DFT holdback amount	(564)		—
Payments for debt issuance costs						Payments for debt issuance costs	(114)		—
Net cash used in financing activities						Net cash used in financing activities	(3,176)		(6,199)
Net change in cash, cash equivalents, and restricted cash	Net change in cash, cash equivalents, and restricted cash	(1,098)		28,090		Net change in cash, cash equivalents, and restricted cash	(15,857)		(3,842)
Cash, cash equivalents and restricted cash, beginning of period		126,562		106,045
Cash, cash equivalents and restricted cash, end of period		$	125,464	$	134,135
Cash, cash equivalents, and restricted cash, beginning of period						Cash, cash equivalents, and restricted cash, beginning of period	119,438		126,562
Cash, cash equivalents, and restricted cash, end of period						Cash, cash equivalents, and restricted cash, end of period	$	103,581	$	122,720

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

~~Telos Corporation~~TELOS CORPORATION

~~Consolidated Statements of Changes in Stockholders' Equity~~CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(Unaudited)


		Common Stock			Additional Paid-in Capital				Accumulated Other Comprehensive Income/(Loss)			Accumulated Deficit				Total Stockholders’ Equity				Common Stock					Additional Paid-in Capital			Accumulated Other Comprehensive Income			Accumulated Deficit			Total Stockholders’ Equity
		Shares	Amount								Shares								Amount

		(in thousands)																		(in thousands)
Balance at June 30, 2022		67,594	$	106			$	388,464						$	(9)			$	(214,249)		$	174,312
Balance at March 31, 2023																			Balance at March 31, 2023	69,388			$	108		$	420,980		$	(42)		$	(251,151)		$	169,895
Net loss																			Net loss	—			—		—			—			(8,024)			(8,024)
Foreign currency translation gain																			Foreign currency translation gain	—			—		—			(11)			—			(11)
Restricted stock unit awards vested, net of shares withheld to cover tax withholding																			Restricted stock unit awards vested, net of shares withheld to cover tax withholding	79			—		—			—			—			—
Stock-based compensation																			Stock-based compensation	—					5,676			—			—			5,676
Balance at June 30, 2023																			Balance at June 30, 2023	69,467			$	108	$	426,656		$	(53)		$	(259,175)		$	167,536

Balance at March 31, 2022																			Balance at March 31, 2022	67,867			$	106	$	378,546		$	2		$	(203,593)		$	175,061
Net loss	Net loss	—	—		—				—			(7,340)				(7,340)			Net loss	—			—		—			—			(14,159)			(14,159)
Foreign currency translation loss	Foreign currency translation loss	—	—		—				(21)			—				(21)			Foreign currency translation loss	—			—		—			(11)			—			(11)
Stock-based compensation expense, excluding accrued compensation		—	—		15,012				—			—				15,012
Restricted stock unit awards vested, net of shares withheld to cover tax withholding																			Restricted stock unit awards vested, net of shares withheld to cover tax withholding	87			—		—			—			—			—
Stock-based compensation																			Stock-based compensation	—			—		16,423			—			—			16,423
Repurchase of common stock	Repurchase of common stock	(499)	—		(4,681)				—			—				(4,681)			Repurchase of common stock	(360)			—		(3,002)			—			—			(3,002)
RSUs vested, net of shares withheld to cover tax withholding		205	—		(249)				—			—				(249)
Balance at September 30, 2022		67,300	$	106	$	398,546			$	(30)		$	(221,589)			$	177,033

Balance at June 30, 2021		66,635	$	105	$	341,928			$	17		$	(176,265)			$	165,785
Net loss		—	—		—				—			(5,222)				(5,222)

Foreign currency translation loss		—	—		—				(13)			—				(13)
Stock-based compensation expense		—	—		12,372				—			—				12,372

Balance at September 30, 2021		66,635	$	105	$	354,300			$	4		$	(181,487)			$	172,922
Balance at June 30, 2022																			Balance at June 30, 2022	67,594			$	106	$	391,967		$	(9)		$	(217,752)		$	174,312

Common Stock Additional Paid-in
Capital Accumulated
Other Comprehensive Income/(Loss) Accumulated Deficit Total Stockholders’
Equity
Shares Amount
(in thousands)
Balance at December 31, 2021 66,767 $ 105 $ 367,153 $ (27) $ (186,977) $ 180,254
Net loss — — — — (34,612) (34,612)
Foreign currency translation loss — — — (3) — (3)
Stock-based compensation expense, excluding accrued compensation — — 42,212 — — 42,212
Repurchase of common stock (859) — (7,683) — — (7,683)
RSUs vested, net of shares withheld to cover tax withholding 1,392 1 (3,136) — — (3,135)
Balance at September 30, 2022 67,300 $ 106 $ 398,546 $ (30) $ (221,589) $ 177,033
Balance at December 31, 2020 64,625 $ 103 $ 270,800 $ 44 $ (143,843) $ 127,104
Net loss — — — — (37,644) (37,644)
Issuance of common stock 2,050 2 64,267 — — 64,269
Foreign currency translation loss — — — (40) — (40)
Stock-based compensation expense — — 47,378 — — 47,378
Repurchase of outstanding warrants — — (26,894) — — (26,894)
Repurchase of common stock (40) — (1,251) — — (1,251)
Balance at September 30, 2021 66,635 $ 105 $ 354,300 $ 4 $ (181,487) $ 172,922


	Common Stock			Additional Paid-in Capital		Accumulated Other Comprehensive Income		Accumulated Deficit		Total Stockholders’ Equity
	Shares	Amount

	(in thousands)
Balance at December 31, 2022	67,431	$	106	$	412,708	$	(55)	$	(240,405)	$	172,354
Net loss	—	—		—		—		(18,770)		(18,770)
Foreign currency translation gain	—	—		—		2		—		2
Restricted stock unit awards vested, net of shares withheld to cover tax withholding	1,259	1		(1,585)		—		—		(1,584)
Stock-based compensation	—			13,592		—		—		13,592
Issuance of common stock for 401K match	777	1		1,941		—		—		1,942
Balance at June 30, 2023	69,467	$	108	$	426,656	$	(53)	$	(259,175)	$	167,536

Balance at December 31, 2021	66,767	$	105	$	367,153	$	(27)	$	(186,977)	$	180,254
Net loss	—	—		—		—		(30,775)		(30,775)
Foreign currency translation loss	—	—		—		18		—		18
Restricted stock unit awards vested, net of shares withheld to cover tax withholding	1,187	1		(2,887)		—		—		(2,886)
Stock-based compensation	—	—		30,703		—		—		30,703
Repurchase of common stock	(360)	—		(3,002)		—		—		(3,002)
Balance at June 30, 2022	67,594	$	106	$	391,967	$	(9)	$	(217,752)	$	174,312

See accompanying notes to the unaudited consolidated financial statements.

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~~Telos Corporation~~TELOS CORPORATION

~~Notes to the Unaudited Consolidated Financial Statements~~NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

Telos Corporation, together with its subsidiaries (collectively, the "Company," "we," "our" or "Telos"), a Maryland corporation, is a leading provider of cyber, cloud and enterprise security solutions for the world's most security-conscious organizations. We own all of the issued and outstanding shares of Xacta Corporation, a subsidiary that develops, markets and ~~sell~~sells government-validated secure enterprise solutions to government and commercial customers. We own the issued and outstanding share capital of ~~Ubiquity.com, Inc.~~ubIQuity.com, inc., a holding company for Xacta Corporation. We also have a 100% ownership interest in Telos Identity Management Solutions, LLC ("Telos ID"), Teloworks, Inc., and Telos APAC Pte. Ltd.

2. SIGNIFICANT ACCOUNTING POLICIES

~~(a)~~Basis of Presentation and Principle of Consolidation

The accompanying unaudited consolidated financial statements include the accounts of Telos ~~Corporation~~ and its subsidiaries (see Note 1 – ~~Organization~~ Organization), all of whose issued and outstanding share capital is ~~wholly-owned~~wholly owned directly and indirectly by Telos Corporation. All intercompany transactions have been eliminated in consolidation.

~~(b)~~Basis of Presentation for Interim Periods

Certain information and footnote disclosures normally included for the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted for the interim periods presented. We believe that the unaudited interim financial statements include all adjustments (which are normal and recurring) necessary to state fairly our financial position and the results of operations and cash flows for the periods presented.

The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for the year or future periods. The financial statements should be read in conjunction with our audited consolidated financial statements and the notes thereto for the year ended December 31, ~~2021,~~2022, included in our Annual Report on Form 10-K for the fiscal year then ended. We have continued to follow the accounting policies set forth in those financial statements.

~~(c)Segment Reporting~~

Operating segments are defined as components of an enterprise for which separate discrete financial information is available and regularly evaluated by the chief operating decision maker (“CODM”), or decision-making group, in deciding how to allocate resources and assess performance.

During the fourth quarter of 2021, we reorganized our internal management reporting structure and the financial results evaluated by our CODM; therefore, we changed our operating segments to align with how our CODM currently oversees the business, allocates resources, and evaluates operating performance. As a result of the segment reorganization, we reported two reportable and operating segments: Security Solutions and Secure Networks. The segments enable the alignment of our strategies and objectives and provide a framework for the timely and rational allocation of resources within the lines of business. We eliminate any inter-segment revenues and expenses upon consolidation.

~~Prior period segment information has been recast to reflect the change. The segment reorganization had no impact on previously reported unaudited consolidated financial results.~~

~~(d)~~Basis of Comparison – - Revision of Previously Issued Interim Financial Statements

The Company recorded certain revisions related to the previously issued unaudited condensed consolidated financial statements. The Company considered the errors identified in accordance with the SEC's Staff Accounting Bulletin No. 99 and determined the impact was immaterial to the previously issued condensed consolidated interim financial statements. Nonetheless, the Company corrected these errors when identified in 2021.

During the ~~third quarter~~course of ~~2021,~~preparing the Company's consolidated financial statements for the year ended December 31, 2022, we identified that stock-based compensation expense related to performance-based restricted stock unit (“PSU”) awards with market conditions was erroneously reversed when those PSUs were forfeited during the three and six months ended June 30, 2022. Although the Company ~~identified out-of-period adjustments~~has determined that the error did not have a material impact on ~~certain revenue and expense classification. Further, we corrected~~its previously issued interim consolidated financial statements, it revised the ~~cash flow presentation to properly reflect~~previously reported interim financial information in conjunction with the ~~final payment to fully acquire all~~issuance of its quarterly filings on Form 10-Q for the ~~membership interest of Telos ID as financing activities.~~ quarter ended June 30, 2023. Further information regarding the misstatements and related revisions are included inunder Note 18 20 – Revision of Prior Year Interim Financial Statements to the ~~condensed~~unaudited consolidated financial statements.

~~Table of Contents~~

~~(e)~~Use of Estimates

Preparing unaudited consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of revenue, expenses, assets and liabilities, and disclosure of contingent assets and liabilities. The Company regularly assesses these estimates; however, actual results could differ from those estimates. We base our estimates on historical experience, currently available information, and various other assumptions that we believe are reasonable under the circumstances. ~~The most significant items involving management~~

Management evaluates these estimates ~~include estimates of~~and assumptions on an ongoing basis, including those relating to revenue recognition on cost estimation on certain contracts, allowance for credit losses, ~~allowance for~~ inventory obsolescence, ~~the~~ valuation allowance for deferred tax assets, ~~the provision for~~ income taxes, ~~share-based~~certain assumptions related to stock-based compensation, ~~contingencies and litigation, and~~ valuation of ~~intangibles~~intangible assets and ~~goodwill.~~goodwill, restructuring expenses accruals, and contingencies. Actual results could differ from those estimates. The impact of changes in estimates is recorded in the period in which they become known.

~~(f)Software Development Cost (Cloud-computing implementation costs)~~

ASC 350-40 requires hosting arrangements that are service contracts to follow the guidance for internal-use software to determine which implementation costs can be capitalized. As of September 30, 2022, the capitalized implementation costs related to hosting arrangements that were incurred during the application development stage aggregated to $0.3 million. These costs are related primarily to the implementation of a new enterprise resource planning system. The capitalized implementation costs will be amortized over the expected term of the arrangement on a straight-line basis. Amortization begins when the component of the hosting arrangement is ready for its intended use after all substantial testing is complete and classified in the same line item on our consolidated statement of operations as the expense for fees for the associated hosting arrangement.

~~(g)Reclassifications~~

Certain reclassifications have been made to prior years' consolidated financial statements to conform to the current year's presentation. The reclassification had no impact on our total assets or liabilities nor on our net loss or stockholders' equity.

~~(h)Recent Accounting Pronouncements~~

Changes to U.S. GAAP are established by the Financial Accounting Standards Board ("FASB") in the form of Accounting Standards Updates ("ASUs") to the FASB's Accounting Standards Codification ("ASC"). We consider the applicability and impact of all recent ASUs. ASUs not listed below were assessed and determined to be not applicable.

~~Accounting Pronouncements Not Yet Adopted~~

In October 2021, the FASB issued ASU No. 2021-08, “Business Combination (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers,” which requires entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The ASU improves comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. Entities should apply the amendments prospectively to business combinations that occur after the effective date. This standard will be effective for reporting periods beginning after December 15, 2022, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations, and cash flows.

In June 2022, the FASB issued ASU No. 2022-03, "Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions," which clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This standard will be effective for reporting periods beginning December 15, 2023, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations, and cash flows.

In September 2022, the FASB issued ASU No. 2022-04, "Liabilities - Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations," which requires a company that uses a supplier finance program in connection with the purchase of goods or services to disclose sufficient information about the program to allow a user of the financial statements to understand the program's nature, activity during the period, changes from period to period, and potential magnitude. This standard will be effective for reporting periods beginning December 15, 2022, with early adoption permitted. While we are currently assessing the impact of the adoption of this ASU, we do not believe the adoption of this ASU will have a material impact on our unaudited consolidated financial position, results of operations, and cash flows.

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Stock-based Compensation

The Company grants stock-based compensation awards under the 2016 Omnibus Long-Term Incentive Plan, as amended (the "2016 LTIP"). Our 2016 LTIP provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, and dividend equivalent rights to our senior executives, directors, employees, and other eligible service providers. The stock options granted under the 2016 LTIP expire no more than 10 years after the date of grant.

The service-based restricted stock units ("RSUs") granted generally vest in installments over a period of up to three years from the date of grant. The PSUs vest upon the achievement of a defined performance target or at the end of the defined performance period from the date of grant, whichever initially occurs. The fair value of each RSU award is based on the closing stock price on the date of grant, while the fair value of the PSU awards with market condition is based on using a Monte Carlo simulation.

The Company estimates the fair value of stock options on the date of the grant using an option pricing model. The option pricing model takes into consideration the current share price of the underlying common stock, exercise price of the option, expected term, risk-free interest rate and the volatility of share price. These considerations directly affect the amount of compensation expense that will ultimately be recognized.

We recognized these stock-based payment transactions when services from the employees, directors and other eligible service providers are received and recognized a corresponding increase in additional paid-in capital in our unaudited consolidated balances sheets. The measurement objective for these equity awards is the estimated fair value at the date of grant of the equity instruments that we are obligated to issue when the employees, directors and other eligible service providers have rendered the requisite service and satisfied any other conditions necessary to earn the right to benefit from the instruments. The stock-based compensation expense for an award is recognized ratably over the requisite service period, which is generally the vesting period or if it is probable that the performance condition will be satisfied. For the comparative periods, the stock-based payment transactions are recognized in accordance with ASC 718, "Compensation - Stock Compensation" and ASU 2018-07, "Compensation - Stock Compensation (Topic 718): Improvements to Non-employee Share-Based Payment Accounting".

Restructuring Expenses

In the fourth quarter of 2022, the Company committed to a restructuring plan to streamline its workforce and spending to better align its cost structure with its volume of business. The restructuring plan reduced the Company's workforce, with a majority of the affected employees separating from the business in early 2023. In connection with this restructuring plan, we incurred restructuring-related costs, including employee severance and related benefit costs. Employee severance and related benefit costs include cash payments, outplacement services and continuing health insurance coverage. Severance costs pursuant to ongoing-benefit arrangements are recognized when probable and reasonably estimated. Other related costs include external consulting and advisory fees related to implementing the restructuring plan. These costs are recognized at fair value in the period in which the costs are incurred.

In the Company's Annual Report on Form 10-K for the year ended December 31, 2022, the Company estimated that the expected restructuring expenses were $2.8 million as of December 31, 2022. As of June 30, 2023, the Company has updated its total expected restructuring plan costs to $4.0 million, based on the Company's review of the restructuring plan for the remainder of 2023. The restructuring expenses are recorded under "Selling, general and administrative expenses" in the Company's unaudited consolidated statements of operations.

At each reporting date, the Company evaluates its restructuring expense accrual to determine if the liabilities reported are still appropriate. Any changes in the estimated costs of executing the approved restructuring plan are reflected in the Company's unaudited consolidated statement of operations.


Table 2: Summary of Changes in Restructuring Expenses Accrual
	Severance and related benefit costs (1)		Other related costs (1)		Total

	(in thousands)
Balance at December 31, 2022	$	2,763	$	—	$	2,763
(Adjustments)/charges	(103)		1,300		1,197
Cash payments	(1,778)		—		(1,778)
Balance at June 30, 2023	$	882	$	1,300	$	2,182

(1) Restructuring-related liabilities are reported as part of "Other current liabilities" in the Company's unaudited consolidated balance sheets, see Note 9 - Other Balance Sheet Components for further details.

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Recent Accounting Pronouncements

From time to time, new accounting standards are issued by the Financial Accounting Standards Board or other standard-setting bodies and are adopted by the Company as of the specified accounting date. Unless otherwise discussed, the Company believes that issued standards not yet effective will not have a material effect on its financial statements.

3. REVENUE RECOGNITION

We ~~recognize~~account for revenue in accordance with ASC Topic 606, "Revenue from Contracts with Customers." The unit of account in ASC 606 is a performance obligation, which is a promise in a contract with a customer to transfer a good or service to the customer.

The majority of our revenue is recognized over time, as control is transferred continuously to our customers who receive and consume benefits as we ~~perform, and is classified as services revenue.~~perform. Revenue transferred to ~~customer~~customers over time accounted for ~~87%~~88% and ~~91%~~89% of our revenue for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, respectively, and ~~91%~~90% and ~~92%~~93% of our revenue for the three and ~~nine~~six months ended ~~September~~June 30, ~~2021,~~2022, respectively. All of our business groups earn services revenue under a variety of contract types, including time and materials, ~~firm-fixed-price, firm-fixed-price~~firm-fixed price, firm-fixed price level of effort, and cost-plus ~~fixed-fee~~fixed fee contract types, which may include variable consideration.

~~We also~~For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at athe point in time ~~on certain contracts, when our~~in which each performance obligation is fully satisfied. This coincides with the point in time the customer obtains control of the ~~transferred~~ product ~~generally~~or service, which typically occurs upon ~~delivery, and~~customer acceptance or receipt of the ~~revenue is classified as~~ product ~~revenue.~~or service, given that we maintain control of the product or service until that point. Revenue transferred to customers at a point in time accounted for ~~13%~~12% and 9%11% of our revenue for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, respectively, and 9%10% and 8%7% of our revenue for the three and ~~nine~~six months ended ~~September~~June 30, ~~2021,~~2022, respectively.

Orders for the sale of software licenses may contain multiple performance obligations, such as maintenance, training, or consulting services, which are typically delivered over time, consistent with the transfer of control disclosed above for the provision of services. When an order contains multiple performance obligations, we allocate the transaction price to the performance obligations based on the standalone selling price of the product or service underlying each performance obligation. The standalone selling price represents the amount we would sell the product or service to a customer on a standalone basis.

For certain performance obligations where we are not primarily responsible for fulfilling the promise to provide the goods or services to the customer, do not have inventory risk and have limited discretion in establishing the price for the goods or services, we recognize revenue on a net basis.

We provide for anticipated losses on contracts during the period when the loss is determined by recording an expense for the total expected costs that exceed the total estimated revenue for a performance obligation. No contract losses were recorded during the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023 and ~~2021.~~2022.

Disaggregated Revenues

In addition to our segment reporting, as further discussed in Note 17 – Segment Information, we disaggregate our ~~revenue~~revenues by customer and contract types. We treat sales to U.S. customers as sales within the ~~United States,~~U.S. regardless of where the services are performed. Substantially ~~all~~most of our revenues are generated from U.S. ~~customers.~~customers, while international customers are de minimis; as such, the financial information by geographic location is not presented.


Table 3.1: Revenue by Customer Type	Table 3.1: Revenue by Customer Type																	Table 3.1: Revenue by Customer Type
		For the Three Months Ended								For the Nine Months Ended									For the Three Months Ended						For the Six Months Ended
		September 30, 2022				September 30, 2021				September 30, 2022				September 30, 2021					June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022
		Amount		%		Amount		%		Amount		%		Amount		%			Amount		%	Amount		%	Amount		%	Amount		%

		(in thousands)																	(dollars in thousands)
Federal	Federal	$	60,294	95	%	$	66,612	97	%	$	160,351	95	%	$	171,091	96	%	Federal	$	27,512	84 %	$	52,213	94 %	$	60,501	89 %	$	100,056	94 %
State & local, and commercial	State & local, and commercial	3,299		5	%	2,369		3	%	9,193		5	%	7,292		4	%	State & local, and commercial	5,399		16 %	3,578		6 %	7,632		11 %	5,895		6 %
Total revenue	Total revenue	$	63,593			$	68,981			$	169,544			$	178,383			Total revenue	$	32,911	100 %	$	55,791	100 %	$	68,133	100 %	$	105,951	100 %

Table 3.2: Revenue by Contract Type
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
Amount % Amount % Amount % Amount %
(in thousands)
Firm fixed-price $ 54,055 85 % $ 60,349 87 % $ 140,636 83 % $ 155,832 87 %
Time-and-materials 3,457 5 % 3,154 5 % 9,104 5 % 9,243 5 %
Cost plus fixed fee 6,081 10 % 5,478 8 % 19,804 12 % 13,308 8 %
Total revenue $ 63,593 $ 68,981 $ 169,544 $ 178,383

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Table 3.2: Revenue by Contract Type
	For the Three Months Ended						For the Six Months Ended
	June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022
	Amount		%	Amount		%	Amount		%	Amount		%

	(dollars in thousands)
Firm fixed-price	$	25,293	77 %	$	45,305	81 %	$	52,306	77 %	$	86,581	82 %
Time-and-materials	3,548		11 %	2,731		5 %	7,104		10 %	5,646		5 %
Cost plus fixed fee	4,070		12 %	7,755		14 %	8,723		13 %	13,724		13 %
Total revenue	$	32,911	100 %	$	55,791	100 %	$	68,133	100 %	$	105,951	100 %

Table 3.3: Revenue Concentration Greater than 10% of Total Revenue

For the Three Months Ended

For the Six Months Ended

June 30, 2023

June 30, 2022

June 30, 2023

June 30, 2022

U.S. Department of Defense ("DoD")

66%

72 %

67%

71 %


Table 3.4: Contract Balances
	Balance Sheet Presentation	June 30, 2023		December 31, 2022

		(in thousands)
Billed accounts receivables (1)	Accounts receivable, net	$	11,815	$	13,521
Unbilled accounts receivable	Accounts receivable, net	7,214		11,657
Contract assets	Accounts receivable, net	15,261		14,891
Contract liabilities	Contract liabilities	6,138		6,444

(1) Net of allowance for credit losses.

The change in the Company's contract assets and contract liabilities during the current period was primarily the result of the timing differences between the Company's performance, invoicing and customer payments. Revenue recognized for the three and six months ended June 30, 2023, that was included in the contract liabilities balance at the beginning of each reporting period was $1.6 million and $4.1 million, respectively. Revenue recognized for the three and six months ended June 30, 2022, that was included in the contract liabilities balance at the beginning of each reporting period was and $1.6 million and $4.1 million, respectively.

As of June 30, 2023, we had approximately $66.5 million of remaining performance obligations, which we also refer to as funded backlog. We expect to recognize approximately 80% of our remaining performance obligations over the next 12 months, and the balance thereafter.

4. ACCOUNTS RECEIVABLE, NET


Table 4: Details of Accounts Receivable, Net
	June 30, 2023		December 31, 2022

	(in thousands)
Billed accounts receivable	$	12,065	$	13,655
Unbilled accounts receivable	7,214		11,657
Contract assets	15,261		14,891
Allowance for credit losses (1)	(250)		(134)
Accounts receivable, net	$	34,290	$	40,069

(1) Includes provision for credit losses, net of recoveries.

As our primary customer base includes agencies of the U.S. government, we have a concentration of credit risk associated with our accounts receivable, as ~~95%~~91% of our billed and unbilled accounts receivable as of ~~September~~June 30, ~~2022,~~2023, were directly with U.S. government customers. While we acknowledge the potential material and adverse risk of such a significant concentration of credit risk, our past experience collecting substantially all of such receivables provides us with an informed basis that such risk, if any, is manageable. We perform ongoing credit evaluations of all of our customers and generally do not require collateral or other ~~guarantees~~guarantee from our customers. We maintain allowances for potential losses.

~~Table of Contents~~

Table 3.3: Revenue Concentrations Greater than 10% of Total Revenue
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
U.S. Department of Defense ("DoD") 77% 74% 74% 75%
Civilian federal agencies 18% 23% 21% 21%

~~Contract Balances~~

Table 3.4: Contract Balances
September 30, 2022 December 31, 2021
(in thousands)
Contract assets (unbilled receivables) $ 28,290 $ 41,374
Contract liabilities 6,952 6,381

The change in the Company's contract assets and contract liabilities during the period was primarily the result of the timing differences between the Company's performance, invoicing and customer payments. Revenue recognized for the three and nine months ended September 30, 2022, that was included in the contract liabilities balance at the beginning of each reporting period, was $0.9 million and $5.0 million, respectively. Revenue recognized for the three and nine months ended September 30, 2021, that was included in the contract liabilities balance at the beginning of each reporting period, was $0.8 million and $4.1 million, respectively.

As of September 30, 2022, we had $111.4 million of remaining performance obligations, which we also refer to as funded backlog. We expect to recognize approximately 85% of our remaining performance obligations over the next 12 months and the balance thereafter.

~~4. ACCOUNTS RECEIVABLE, NET~~

Table 4: Details of Accounts Receivable, Net
September 30, 2022 December 31, 2021
(in thousands)
Billed accounts receivable $ 22,903 $ 18,586
Unbilled receivables 28,290 41,374
Allowance for credit losses (210) (116)
Accounts receivable, net $ 50,983 $ 59,844

~~5. INVENTORIES, NET~~

Table 5: Details of Inventories, Net
September 30, 2022 December 31, 2021
(in thousands)
Gross inventory $ 5,429 $ 2,108
Allowance for inventory obsolescence (753) (861)
Inventories, net $ 4,676 $ 1,247

~~6. PROPERTY AND EQUIPMENT, NET~~

Table 6: Details of Property and Equipment, Net
September 30, 2022 December 31, 2021
(in thousands)
Furniture and equipment $ 15,765 $ 15,420
Leasehold improvement 3,073 2,994
Property and equipment, at cost 18,838 18,414
Accumulated depreciation (13,710) (12,326)
Property and equipment, net $ 5,128 $ 6,088

Depreciation expense was $0.6 million and $1.8 million for the three and nine months ended September 30, 2022, respectively, compared to $0.6 million and $1.5 million for the three and nine months ended September 30, 2021, respectively.

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5. INVENTORIES, NET


Table 5: Details of Inventories, Net
	June 30, 2023		December 31, 2022

	(in thousands)
Gross inventory	$	2,532	$	3,642
Allowance for inventory obsolescence	(765)		(765)
Inventories, net	$	1,767	$	2,877

6. PROPERTY AND EQUIPMENT, NET


Table 6.1: Details of Property and Equipment, Net
	June 30, 2023		December 31, 2022

	(in thousands)
Furniture and equipment	$	16,063	$	16,033
Leasehold improvement	3,173		3,145
Property and equipment, at cost	19,236		19,178
Accumulated depreciation and amortization	(15,394)		(14,391)
Property and equipment, net	$	3,842	$	4,787


Table 6.2: Depreciation and Amortization Expense
	For the Three Months Ended				For the Six Months Ended
	June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

	(in thousands)
Depreciation & amortization expense	$	579	$	598	$	1,152	$	1,157

7. GOODWILL

The goodwill balance was $17.9 million as of ~~September~~June 30, ~~2022,~~2023, and December 31, ~~2021,~~2022, of which $3.0 million is allocated to the Security Solutions segment and $14.9 million is allocated to the Secure Networks segment. Goodwill is subject to annual impairment tests and if triggering events are present in the interim before the annual tests, we will assess impairment. No impairment charges were ~~taken~~recorded for the three and ~~nine~~six months ended ~~that September~~June 30, ~~2022,~~2023 and ~~2021.~~2022.

8. INTANGIBLE ASSETS, NET


Table 8.1: Details of Intangible Assets, Net
Table 8: Details of Intangible Assets, Net														Table 8: Details of Intangible Assets, Net
		September 30, 2022						December 31, 2021								June 30, 2023						December 31, 2022
		Gross		Accumulated Amortization		Net		Gross		Accumulated Amortization		Net			Estimated Useful Life	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value		Gross Carrying Amount		Accumulated Amortization		Net Carrying Value

		(in thousands)													(in years)	(in thousands)
Acquired technology	Acquired technology	$	3,630	$	(529)	$	3,101	$	3,630	$	(256)	$	3,374	Acquired technology	8	$	3,630	$	(870)	$	2,760	$	3,630	$	(643)	$	2,987
Customer relationships		40		(16)		24		40		(5)		35
Customer relationship														Customer relationship	3	40		(25)		15		40		(19)		21
Software development costs	Software development costs	31,199		(7,466)		23,733		22,222		(6,432)		15,790		Software development costs	2 - 5	43,694		(8,655)		35,039		35,080		(7,793)		27,287
		$	34,869	$	(8,011)	$	26,858	$	25,892	$	(6,693)	$	19,199
Subtotal														Subtotal		47,364		(9,550)		37,814		38,750		(8,455)		30,295
Software held for resale (1)														Software held for resale (1)		—		—		—		7,120		—		7,120
Total														Total		$	47,364	$	(9,550)	$	37,814	$	45,870	$	(8,455)	$	37,415

(1) This amount is net of $0.6 million charged into cost for sales for the period ended December 31, 2022. See Note 10 – Debt and Other Obligations for related details.

Amortization expense related to capitalized software development costs was ~~$0.5~~$0.6 million and ~~$1.3~~$0.9 million for the three and ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, respectively, and ~~$0.4~~$0.3 million and ~~$1.3~~$0.7 million for the three and ~~nine~~six months ended ~~September~~June 30, ~~2021,~~2022, respectively.

Amortization expense related to other intangible assets was $0.1 million and $0.2 million for the three and six months ended June 30, 2023, respectively, and $0.1 million and $0.2 million for the three and six months ended June 30, 2022, respectively.

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9. OTHER BALANCE SHEET COMPONENTS


Table 9.1: Details of Accounts Payable and Other Accrued Liabilities
	June 30, 2023		December 31, 2022

	(in thousands)
Accounts payable	$	11,985	$	12,606
Accrued payables	4,521		9,945
Accounts payable and other accrued liabilities	$	16,506	$	22,551


Table 9.2: Details of Other Current Liabilities
	June 30, 2023		December 31, 2022

	(in thousands)
Other accrued expenses	$	725	$	1,530
Restructuring expenses accrual	2,182		2,763
Other	410		626
Other current liabilities	$	3,317	$	4,919

9.10. DEBT AND OTHER OBLIGATIONS

Revolving Credit Facility

On December 30, 2022 (the "Closing Date"), we entered into a Credit Agreement (the "Credit Agreement"), by and among the Company, as borrower, Xacta Corporation, ubIQuity.com, inc, Teloworks, Inc., and Telos Identity Management Solutions, LLC, as guarantors, the lenders party thereto (the "Lenders"), and JPMorgan Chase Bank N.A., as administrative agent for the Lenders (in such capacity, the "Agent"). The Credit Agreement provides for a $30.0 million senior secured revolving credit facility with a maturity date of December 30, 2025, with the option of issuing letters of credit thereunder with a sub-limit of $5.0 million, and with an uncommitted expansion feature of up to $30.0 million of additional revolver capacity (the "Loan"). The Loan is subject to acceleration in the event of customary events of default. The Company has not drawn any amount under the Loan.

Borrowings under the Credit Agreement will accrue interest, at our option, at one of three variable rates, plus a specified margin. We can elect to borrow at (i) the Alternative Base Rate, plus 0.9%; (ii) Adjusted Daily Simple Secured Overnight Financing Rate ("SOFR"), plus 1.9%; and (iii) Adjusted Term SOFR, plus 1.9%, as such capitalized terms are defined and calculated in the Credit Agreement. The Company may elect to convert borrowings from one type of borrowing to another type per the terms of the Credit Agreement. After the occurrence and during the continuance of any event of default, the interest rate may increase by an additional 2.0%. We are obligated to pay accrued interest (i) with respect to amounts accruing interest based on the Alternative Base Rate, each calendar quarter and on the maturity date, (ii) with respect to amounts accruing interest based on Adjusted Daily Simple SOFR, on each one-month anniversary of the borrowing and on the maturity date, and (iii) with respect to amounts accruing interest based on Adjusted Term SOFR, at the end of the period specified per the Credit Agreement and on the maturity date. Upon five, three, or one day's prior notice, as applicable, we may prepay any portion or the entire amount of the Loan. We also paid costs and customary fees, including a closing fee, commitment fees and letter of credit participation fee, if any, payable to the Agent and Lenders, as applicable, in connection with the Loan.

The Loan under the Credit Agreement is collateralized by substantially all of the Company's assets, including the Company's pledge of its domestic and material foreign subsidiary equity interests.

The Loan has various covenants that may, among other things, affect our ability to create, incur, assume or suffer any indebtedness, merge into or consolidate with another entity, acquire entity interests, sell or transfer certain assets, enter into certain arrangements (such as sale and leaseback and swap agreements) or restrictive agreements, pay dividends and make certain restricted payments, and amend material documents related to any subordinated indebtedness and corporate agreements. The Credit Agreement also requires certain financial covenants to maintain a Senior Leverage Ratio on the last day of any fiscal quarter, no greater than 3 to 1. We were in compliance with all covenants as of June 30, 2023.

The occurrence of an event of default under the Credit Agreement could result in the Loan and other obligations becoming immediately due and payable and allow the Lenders to exercise all rights and remedies available to them under the Credit Agreement.

On April 12, 2023, the Credit Agreement was amended to exclude from collateral the (i) amount collectible from a third party related to an Accounts Receivable Purchase Agreement and (ii) receivables generated by the Company from the sale of goods supplied to this third party in an amount not to exceed $25.0 million.

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Other Financing Obligations

We entered into a Master Purchase Agreement ("MPA") with a third-party buyer ("Buyer") for $9.1 million relating to software licenses under a specific delivery order ("DO") with our customer resulting in proceeds from other financing obligations of $9.1 million in November 2022. Under the MPA, we sold, assigned and transferred all of our rights, title and interest in (i) the DO payments from the customer and (ii) the underlying licenses. The DO covers a base period with an option for the customer to exercise three (3) additional 12-month periods through January 2026. The DO payments assigned to the Buyer are billable to the customer at the beginning of the base period and for each option year exercised. The underlying licenses were acquired for resale, see Note 8 – Intangible Assets, net for further details.

On February 9, 2023, the customer notified us that it would not exercise the first option period under the DO. The MPA provides that, if the customer terminates the DO for non-renewal and the Buyer reasonably concludes that the customer's actions constitute grounds for filing a claim with the customer's contracting officer, Buyer and Telos will cooperate in preparing such a claim, which would be filed in Telos' name. Buyer has notified Telos of its intent to pursue a claim against the customer.

Concurrently, the Company transferred all the rights, title and interest in the underlying licenses in exchange for the extinguishment of the outstanding financing obligations. The Company evaluated the transfer of the underlying licenses as consideration paid for the outstanding financing obligations under ASC 470-10, Debt, and the provisions of the MPA, and concluded that the transaction resulted in an extinguishment of debt. The Company recorded the difference between the carrying value of the Company's debt instrument and the underlying licenses as a gain on early extinguishment of other financing obligations. No gain was reported for the three months ended June 30, 2023. For the six months ended June 30, 2023, the Company reported a gain of $1.4 million, which was recorded as "Other income" in the unaudited consolidated statements of operations.

11. ACQUISITION

On July 30, 2021, the Company acquired the assets of Diamond Fortress Technologies ("DFT") and wholly-owned subsidiaries for a total purchase consideration of $6.7 million, inclusive of $0.3 million related to a pre-existing contractual arrangement with DFT. Upon closing, $5.9 million of cash was paid with an additional $0.6 million payable to DFT 18 months after the close date (the "holdback"). The holdback amount has been discounted to its present value of $0.5 million using a discount rate relevant to the acquisition. ~~The acquisition adds several new patents to the Company’s library of biometric and digital identity intellectual property. The addition of contactless biometrics technology will enable~~On February 2, 2023, the Company ~~to better serve~~paid DFT the ~~needs~~holdback amount of organizations in existing and new markets. The acquisition of the assets of DFT has been accounted for under U.S. GAAP using the acquisition method of accounting. The total purchase consideration of $6.7 million has been allocated among the assets acquired at their fair value at the acquisition date.

The Company recognized $3.7 million of intangible assets and $3.0 million of goodwill, which is housed in the Telos ID reporting unit, part of the Security Solutions operating segment. Goodwill is primarily attributable to an excess of the purchase price over the acquired identifiable net tangible and intangible assets. The acquired intangible assets will be amortized on a straight-line basis over ~~three~~ ~~to eight years. The acquisition was considered an asset purchase for tax purposes, and the recognized goodwill is deductible for tax purposes.~~

~~10. PURCHASE OF TELOS ID NON-CONTROLLING INTERESTS~~

Telos ID was formed as a limited liability company under the Delaware Limited Liability Company Act in 2007. Prior to the IPO, the Company owned a 50% interest in Telos ID, with the remaining interest owned by Hoya ID Fund A, LLC ("Hoya") as the non-controlling interest. Distributions were made to the members only when and to the extent determined by Telos ID’s Board of Directors, in accordance with its Operating Agreement.

On October 5, 2020, we entered into a Membership Interest Purchase Agreement between the Company and Hoya to purchase all of the Class B Units of Telos ID owned by Hoya (the “Telos ID Purchase”). Upon the closing of the Telos ID Purchase, Telos ID became our wholly-owned subsidiary. On November 23, 2020, the Telos ID Purchase was consummated with the Company transferring $30.0 million in cash and issuing 7.3 million shares of our common stock at $20.39 per share (which totals approximately $148.4 million); the total consideration transferred to Hoya was $178.4$0.6 million. As part of the common stock issuance, the Company recognized an increase to additional paid-in capital (“APIC”) of $148.4 million. The Company further recognized a reduction to APIC of $173.9 million as part of eliminating Hoya’s non-controlling interest in Telos ID. The net impact to APIC associated with acquiring the additional 50% interest in Telos ID was a reduction of $25.5 million. Hoya received a final distribution of $2.4 million in January 2021.

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~~11. ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES~~

Table 11: Details of Accounts Payable and Other Accrued Liabilities
September 30, 2022 December 31, 2021
(in thousands)
Accounts payable - trade $ 16,339 $ 7,869
Accrued liabilities 19,870 25,300
Others 1,374 1,379
Accounts payable and other accrued liabilities $ 37,583 $ 34,548

12. STOCK-BASED COMPENSATION

~~Our 2016 Omnibus Long-Term Incentive Plan (the "2016 LTIP") provides~~Stock-based compensation expense recognized for ~~the grant of~~ restricted stock units ~~with time-based vesting ("Service-Based RSU" or "RSU")~~ and ~~restricted~~ stock ~~units with performance-based vesting ("Performance-Based RSU" or "PRSU")~~options granted to ~~our senior executives, directors,~~ employees and ~~other service providers. Awards granted under~~non-employees is included in the ~~2016 LTIP vest over the periods determined by the Board~~consolidated statement of ~~Directors or the Compensation Committee of the Board of Directors, generally~~ ~~one~~ to three years. The Company records stock-based compensation related to accrued compensation in which it intends to settle in shares of the Company’s common stock. However, it is the Company’s discretion whether this compensation will ultimately be paid in stock or cash, as it has the right to dictate the form of these payments up until the date they are paid.

~~The stock-based compensation expense includes an immaterial adjustment of $1.3 million for the nine months ended September 30, 2022, related to the prior year.~~operations. There were no income tax benefits recognized on the ~~share-based~~stock-based compensation expense for both periods.

Table 12.1: Details of Stock Compensation Expense by Department
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
(in thousands)
Cost of sales – services $ 929 $ 718 $ 2,798 $ 1,974
Sales and marketing 611 1,536 3,699 5,316
Research and development 897 970 2,884 2,079
General and administrative 12,284 9,148 34,844 38,009
Total stock-based compensation expense $ 14,721 $ 12,372 $ 44,225 $ 47,378
Restricted Stock

Table 12.2: Service-Based RSU and Performance-Based RSU Award Activity
Service-Based RSU Performance-Based RSU Total Weighted-Average Grant Date Fair Value
Unvested outstanding units as of December 31, 2021 3,030,608 492,727 3,523,335 $ 34.24
Granted 3,897,786 — 3,897,786 10.00
Vested (1,653,308) —�� (1,653,308) 31.21
Forfeited (360,762) (155,942) (516,704) 33.22
Unvested outstanding units as of September 30, 2022 4,914,324 336,785 5,251,109 $ 17.23


Table 12.1: Details of Stock Compensation Expense by Department
	For the Three Months Ended				For the Six Months Ended
	June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

	(in thousands)
Cost of sales – services	$	225	$	862	$	551	$	1,869
Sales and marketing	43		1,420		101		3,088
Research and development	847		692		1,617		1,987
General and administrative	6,630		14,102		14,975		26,063
Total	$	7,745	$	17,076	$	17,244	$	33,007


Table 12.2: Restricted Stock Unit Activity
	Service-Based	Performance-Based	Total Shares	Weighted-Average Grant Date Fair Value
Unvested outstanding units as of December 31, 2022	3,570,082	336,785	3,906,867	$	19.53
Granted	1,604,843	—	1,604,843	1.98
Vested	(1,613,809)	—	(1,613,809)	26.38
Forfeited	(386,694)	(71,177)	(457,871)	14.36
Unvested outstanding units as of June 30, 2023	3,174,422	265,608	3,440,030	$	9.42

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As of ~~September~~June 30, ~~2022,~~2023, the intrinsic value of the RSUs and ~~PRSUs~~PSUs outstanding ~~exercisable,~~ and vested or expected to vest was ~~$46.5~~$8.8 million. There was ~~$42.7~~approximately $12.1 million of total compensation costs related to stock-based awards not yet recognized as of ~~September~~June 30, ~~2022,~~2023, which is expected to be recognized on a straight-line basis over a weighted-average remaining vesting period of ~~approximately~~0.7 years.

Stock Options

The Company uses the Black-Scholes option pricing model to calculate the estimated fair value of stock options on the date of grant. Option awards are generally granted with an exercise price equal to the market price of the Company's stock at the date of grant. The following weighted-average assumptions are used in the Black-Scholes valuation model to estimate the fair value of stock option awards, as granted.

•Expected term of the option – For options granted to employees and directors, the Company estimates the term over which option holders are expected to hold their stock option by using the "simplified method" in accordance with Staff Accounting Bulletin ("SAB") No. 107, Share-Based Payments, and SAB No. 110, Simplified Method for Plain Vanilla Share Options, to calculate the expected term of stock options determined to be "plain vanilla." The Company's stock option exercise history does not provide a reasonable basis to compute the expected term for stock options. Under this approach, the expected term is presumed to be a midpoint between the vesting date and the contractual end of the stock option grant. For options granted to non-employees, the Company elected to use the contractual term as the expected term.

•Risk-free interest rate – Based on the daily yield curve rates for U.S. Treasury obligations with terms that approximate the expected term of the stock options.

•Expected volatility – Due to the absence of the Company's historical price volatility for the expected contractual term of the stock options, the Company utilized the historical price volatility of a peer group.

•Expected dividend yield – The Company has not declared dividends, nor does it expect to in the foreseeable future. Therefore, a zero value was assumed for the expected dividend yield.


Table 12.3: Stock Options Fair Value and Weighted-Average Assumptions
	For the Six Months Ended
	June 30, 2023	June 30, 2022
Weighted-average fair value of underlying stock options	$1.06	$—
Expected term (in years)	5.5 - 10.0	0
Risk-free interest rate	3.5%	—%
Expected volatility	30.7% - 35.1%	—%
Expected dividend yield	—%	—%


Table 12.4: Stock Option Activity
	Stock Options Outstanding	Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding option balance as of December 31, 2022	—	$	—	0.0	$	—
Granted	400,000	1.80
Exercised	—	—
Forfeited, cancelled, or expired	—	—
Outstanding option balance as of June 30, 2023	400,000	$	1.80	9.8	$	304,000
Vested and exercisable stock option as of June 30, 2023	—	$	—	0.0	$	—

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the quoted closing price of the Company's common stock as of June 30, 2023.

The fair value of the stock options is expensed on a straight-line basis over the vesting period of one year, including the stock options granted to directors, as the next annual stockholders meeting is expected to occur at the same approximate time each year.

During the three and six months ended June 30, 2023, the stock-based compensation expense on stock options recorded as part of general and administrative expenses was immaterial, with no similar expense in 2022. As of June 30, 2023, there were approximately $0.4 million of unrecognized compensation costs related to non-vested stock options.

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13. SHARE REPURCHASES

On May 24, 2022, the Company announced that the Board of Directors approved a new share repurchase program ("SRP") authorizing the Company to repurchase up to $50.0 million of its common stock. Pursuant to this authorization, the Company may repurchase shares of its common stock on a discretionary basis from time to time through open market purchases. The repurchase program has no expiration date and may be modified, suspended, or terminated at any time. As of ~~September~~June 30, ~~2022,~~2023, there was ~~$42.3~~approximately $38.7 million of the authorization remaining ~~authorization~~ for future common stock repurchases under the SRP.

Table 13: Shares Repurchase Activity
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
(in thousands, except per share and share data)
Amount paid for shares repurchased (1)
$ 4,681 $ — $ 7,683 $ —
Number of shares repurchased 498,731 — 859,170 —
Average per share price paid (1)
$ 9.38 $ — $ 8.94 $ —

~~(1)Includes commissions paid for repurchases on the open market.~~

~~As of November 4, 2022, the Company has repurchased an additional 106,623 shares of its common stock for $1.0 million since September 30, 2022.~~


Table 13: Share Repurchase Program Activity
	For the Three Months Ended				For the Six Months Ended
	June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

	(in thousands, except per share and share data)
Amount paid for shares repurchased (1)	$	—	$	3,002	$	—	$	3,002
Number of shares repurchased	—		360,439		—		360,439
Average per share price paid (1)	$	—	$	8.33	$	—	$	8.33

14. ACCUMULATED OTHER COMPREHENSIVE LOSS

Our functional currency is the U.S. Dollar. For one of our wholly-owned subsidiaries, the functional currency is the local currency. For this subsidiary, the translation of its foreign currency into U.S. Dollars is performed for assets and liabilities using current foreign currency exchange rates in effect at the balance sheet date and for revenue and expense accounts using average foreign currency exchange rates during the periods presented. Translation gains and losses are included in stockholders’ equity as a component of accumulated other comprehensive ~~loss.~~losses.


Table 14: Details of Accumulated Other Comprehensive Loss	Table 14: Details of Accumulated Other Comprehensive Loss					Table 14: Details of Accumulated Other Comprehensive Loss
		September 30, 2022		December 31, 2021			June 30, 2023		December 31, 2022

		(in thousands)					(in thousands)
Cumulative foreign currency translation loss	Cumulative foreign currency translation loss	$	(137)	$	(134)	Cumulative foreign currency translation loss	$	(160)	$	(162)
Cumulative actuarial gain on pension liability adjustment	Cumulative actuarial gain on pension liability adjustment	107		107		Cumulative actuarial gain on pension liability adjustment	107		107
Accumulated other comprehensive loss	Accumulated other comprehensive loss	$	(30)	$	(27)	Accumulated other comprehensive loss	$	(53)	$	(55)

15. LOSS PER SHARE

Basic net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of common shares outstanding for the period, without consideration for potentially dilutive securities. Diluted net earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted-average number of shares of common stock and dilutive common stock equivalents outstanding for the period determined using the treasury-stock and if-converted methods. Dilutive common stock equivalents are comprised of unvested restricted common stock and warrants.

For the period of net loss, potentially dilutive securities are not included in the calculation of diluted net earnings (loss) per share, because to do so would be anti-dilutive.


Table 15: Potentially Dilutive Securities	Table 15: Potentially Dilutive Securities					Table 15: Potentially Dilutive Securities
		For the Three Months Ended		For the Nine Months Ended			For the Three Months Ended		For the Six Months Ended
		September 30, 2022	September 30, 2021	September 30, 2022	September 30, 2021		June 30, 2023	June 30, 2022	June 30, 2023	June 30, 2022

		(in thousands)					(in thousands)
Unvested restricted stock and restricted stock units	Unvested restricted stock and restricted stock units	833	313	435	394	Unvested restricted stock and restricted stock units	269	57	401	211
Common stock warrants, exercisable at $1.665 per share		—	—	—	405
Total	Total	833	313	435	799	Total	269	57	401	211
Unvested antidilutive stock units excluded from the dilutive effect (stock units)		1,218	—	965	—

For the three and six months ended June 30, 2023 and 2022, the outstanding PSUs aggregating to 265,608 and 379,161, respectively, have been excluded from the calculation of potentially dilutive securities above because the issuance of shares is contingent upon the satisfaction of certain conditions which were not satisfied by the end of the period.

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16. RELATED PARTY TRANSACTIONS

Emmett J. Wood, the brother of our Chairman and CEO, ~~has~~had been an employee of the Company since 1996. In January 2023, he tendered his resignation as an employee effective February 7, 2023. The ~~amounts~~amount paid to ~~this individual~~him as compensation ~~were $91,000 and $696,000~~ for his remaining tenure in 2023 was $249,000. For the three and ~~nine~~six months ended ~~September~~June 30, 2022, ~~respectively,~~the Company paid him $93,000 and ~~$88,000 and $389,000 for the three and nine months ended September 30, 2021,~~$605,000, respectively. Additionally, Mr. ~~Emmett~~ Wood directly owned ~~94,547~~199,785 and ~~73,562~~178,041 shares of the Company’s common stock as of ~~September~~June 30, ~~2022,~~2023 and December 31, ~~2021.~~2022, respectively.

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One of the Company’s directors serves as a consultant to the Company. ~~In February 2022,~~On January 1, 2023, the director and the Company amended the consulting agreement under which he provides services ("2023 consulting agreement"), extending his services through June 30, 2023, with the option to ~~provide that~~further extend for another six months by mutual agreement of the parties. The Company, at its election, would pay the ~~remainder of the director’s consulting~~director's 2023 consultancy fees ~~for 2022~~ in a fixed ~~price~~ amount, in the form of restricted stock units. ~~The~~Consequently, on January 3, 2023, the Company granted the director ~~26,091 restricted stock units~~16,859 RSUs, one-half of which vested on March 3, 2023, and the other half vested on May 18, 2023, as compensation for the first half of his 2023 consulting services. No cash payments were made for his consulting services for the three and six months ended June 30, 2023. In July 2023, the director and the Company amended the 2023 consulting agreement, further extending his services through December 31, 2023. The amended 2023 consulting agreement stipulates a firm-fixed monthly retainer fee, plus additional fees and contingent bonus payments upon achievement of certain contract goals, payable in cash. On February 1, 2022, the Company granted him 26,091 RSUs for his consulting services in 2022, which ~~vest~~RSUs vested quarterly in four equal amounts through the end of the ~~year, subject to the director’s continued performance under the consulting agreement.~~year. No cash payments were made for the three months ended ~~September~~June 30, ~~2022. The~~2022, while the amounts paid in cash for his consulting services were $25,000 for the ~~nine~~six months ended ~~September~~June 30, ~~2022, and $71,000 and $212,000 for the three and nine months ended September 30, 2021, respectively.~~2022.

17. SEGMENT INFORMATION

~~As noted~~We operate our business in ~~Note 2 - Significant Accounting Policies, during the fourth quarter of 2021, as a result of the segment reorganization, our CODM began evaluating, overseeing,~~two reportable and ~~managing the financial performance of our operations through two~~ operating segments: Security Solutions and Secure Networks. ~~The~~These segments enable the alignment of our strategies and objectives and provide a framework for the timely and rational allocation of resources within the ~~lines of business. We eliminate any inter-segment revenues and expenses upon consolidation.~~business lines.

~~The~~Our Security Solutions segment is primarily focused on cybersecurity, cloud and identity solutions, and secure messaging through Xacta®, Telos Ghost®, Telos Advanced Cyber Analytics ("Telos ACA"), Telos AMHS and Telos ID offerings. We recognize revenue on contracts from providing various system platforms in the cloud, on-premises, and in hybrid cloud environments, as well as software sales or software-as-a-service. Revenue associated with the segment's custom solutions is recognized as work progresses or upon delivery of services and products. Fluctuation in revenue from period to period is the result of the volume of software sales, and the progress or completion of cloud ~~and/~~or cybersecurity solutions during the period. The majority of the operating costs relate to labor, material, and overhead costs. Software sales have immaterial ~~operation~~operating costs associated with them, thus yielding higher margins. Gross profit and margin are a function of operational efficiency on security solutions and changes in the volume of software sales.

~~The~~Our Secure Networks segment provides secure networking architectures and solutions to our customers through secure mobility solutions, and network management and defense services. Revenue is recognized over time as the work progresses on contracts related to managing network services and information delivery. Contract costs include labor, material, and overhead costs. Variances in costs recognized from period to period primarily reflect increases and decreases in activity levels on individual contracts.

Table 17: Results of Operations by Business Segment
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
(in thousands)
Revenues:
Security Solutions $ 32,440 $ 34,558 $ 90,178 $ 89,624
Secure Networks 31,153 34,423 79,366 88,759
Total revenue 63,593 68,981 169,544 178,383
Gross profit:
Security Solutions 15,577 19,517 47,062 46,032
Secure Networks 5,368 5,360 13,683 15,849
Total gross profit 20,945 24,877 60,745 61,881
Selling, general and administrative expenses 28,614 29,965 95,314 97,935
Operating loss (7,669) (5,088) (34,569) (36,054)
Other income/(expense) 518 20 648 (1,001)
Interest expense (181) (195) (558) (583)
Loss before income taxes (7,332) (5,263) (34,479) (37,638)
(Provision for)/benefit from income taxes (8) 41 (133) (6)
Net loss $ (7,340) $ (5,222) $ (34,612) $ (37,644)

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Table 17: Results of Operations by Business Segment
	For the Three Months Ended				For the Six Months Ended
	June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

	(in thousands)
Revenue
Security Solutions	$	17,196	$	30,819	$	36,969	$	57,738
Secure Networks	15,715		24,972		31,164		48,213
Total revenue	32,911		55,791		68,133		105,951
Gross profit
Security Solutions	9,551		16,433		19,825		31,485
Secure Networks	2,808		4,496		6,016		8,315
Total gross profit	12,359		20,929		25,841		39,800
Selling, general and administrative expenses	21,826		34,965		48,278		70,203
Operating loss	(9,467)		(14,036)		(22,437)		(30,403)
Other income	1,649		118		4,145		130
Interest expense	(184)		(187)		(433)		(377)
Loss before income taxes	(8,002)		(14,105)		(18,725)		(30,650)
Provision for income taxes	(22)		(54)		(45)		(125)
Net loss	$	(8,024)	$	(14,159)	$	(18,770)	$	(30,775)

We measure each segment's profitability based on gross profit. We account for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Interest income, interest expense, other income and expense items, and income taxes, as reported in the consolidated financial statements, are not part of the segment profitability measure and are primarily recorded at the corporate level.

Management does not utilize total assets by segment to evaluate segment performance or allocate resources. As a result, assets are not tracked by segment, and therefore, total assets by segment are not disclosed.

~~18. REVISION OF PRIOR YEAR INTERIM FINANCIAL STATEMENTS~~

~~(a)Expense Classification~~

During the third quarter of 2021, the Company identified that stock compensation for a single individual was incorrectly charged to "cost of sales - services" instead of "general and administrative expense." The total amount of stock compensation incorrectly charged to the cost of sales was $0.3 million, of which $0.1 million was related to the first quarter of 2021, and $0.2 million related to the second quarter of 2021. The Company corrected the error during the third quarter of 2021.

In addition, the Company identified that the allocation of stock compensation for two of the Company's overhead cost pools was incorrectly charged to "cost of sales" instead of "general and administrative expense" during the second quarter of 2021. The total amount of the allocated stock compensation incorrectly charged to the cost of sales was $0.7 million, which the Company corrected during the third quarter of 2021.

~~(b)Revenue Recognition~~

In the third quarter of 2021, the Company identified $1.1 million in revenue related to the stub period of a newly awarded contract that should have been recognized as income during the second quarter of 2021. The Company initially corrected the error during the third quarter of 2021. Additionally, and related to this contract, in the fourth quarter of 2021, the Company identified $0.3 million of products revenue for the second quarter of 2021 and $0.4 million of products revenue for the third quarter of 2021 that should be classified in the condensed consolidated statements of operations as services revenue.

~~(c)Software Capitalization~~

In the third quarter of 2021, the Company erroneously recorded a $0.5 million expense related to a software project whose development milestones were achieved, and therefore, costs associated with the software should have been capitalized.

~~(d)Recording of Expense~~

In the third quarter of 2021, the Company erroneously recorded a $0.9 million expense related to a contract that had not yet begun. In the fourth quarter of 2021, the Company reversed the expense previously recorded and does not plan to record the expense until the start of the period of performance.

In the fourth quarter of 2021, the Company identified that a third-quarter RSU was awarded to an individual, but that award was erroneously excluded from its calculation of compensation expense, causing compensation expense to be understated by $0.2 million in the third quarter of 2021.

~~(e)Cash Flow~~

The Company erroneously presented the $2.4 million final payment to fully acquire all membership interest of Telos ID as an operating activity on the condensed consolidated statements of cash flows. The Company corrected the presentation to properly reflect the final payment within financing activities on the consolidated statements of cash flows in the fourth quarter of 2021.

~~(f) Valuation of Acquired Assets~~

In the fourth quarter of fiscal year 2021, the Company identified a necessary update to a previously established assumption related to the valuation of its 2021 acquisition. The change in assumption resulted in additional goodwill of $1.3 million and a reduction of the intangible asset for the same amount that should have been reported during the third quarter of 2021.

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Table 18.1: Impact of the Correction to the Condensed Consolidated Statement of Operations
For the Three Months Ended September 30, 2021 For the Nine Months Ended September 30, 2021
Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted
(in thousands, except per share amounts)
Revenue - services $ 63,690 $ (735) $ 62,955 $ 163,366 $ 650 $ 164,016
Revenue - products 6,376 (350) 6,026 15,017 (650) 14,367
Revenue 70,066 (1,085) 68,981 178,383 — 178,383
Cost of sales - services 40,031 106 40,137 109,134 (898) 108,236
Costs and expenses 43,998 106 44,104 117,400 (898) 116,502
Research and development 5,396 (533) 4,863 14,783 (533) 14,250
General and administrative 20,562 (823) 19,739 69,271 181 69,452
Selling, general and administrative expenses 31,321 (1,356) 29,965 98,287 (352) 97,935
Operating loss (5,253) 165 (5,088) (37,304) 1,250 (36,054)
Loss before income taxes (5,428) 165 (5,263) (38,888) 1,250 (37,638)
Net loss (5,387) 165 (5,222) (38,894) 1,250 (37,644)
Net loss attributable to Telos Corporation (5,387) 165 (5,222) (38,894) 1,250 (37,644)
Net loss per share attributable to Telos Corporation
Basic $ (0.08) $ — $ (0.08) $ (0.59) $ 0.02 $ (0.57)
Diluted $ (0.08) $ — $ (0.08) $ (0.59) $ 0.02 $ (0.57)

Table 18.2: Impact of the Correction to the Condensed Consolidated Statement of Comprehensive Loss
For the Three Months Ended September 30, 2021 For the Nine Months Ended September 30, 2021
Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted
(in thousands)
Net loss $ (5,387) $ 165 $ (5,222) $ (38,894) $ 1,250 $ (37,644)
Comprehensive loss attributable to Telos Corporation (5,400) 165 (5,235) (38,934) 1,250 (37,684)

Table 18.3. Impact of the Correction to the Condensed Consolidated Statement of Cash Flows
For the Nine Months Ended September 30, 2021
Previously Reported Error Correction As Adjusted
(in thousands)
Net loss $ (38,894) $ 1,250 (37,644)
Stock-based compensation 47,197 181 47,378
Changes in other operating assets and liabilities (5,900) 1,538 (4,362)
Cash used in operating activities 6,668 2,969 9,637
Capitalized software development costs (6,139) (533) (6,672)
Cash used in investing activities (13,709) (533) (14,242)
Distribution to Telos ID Class B member – non-controlling interest — (2,436) (2,436)
Cash provided by financing activities 35,131 (2,436) 32,695

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Table 18.4. Impact of the Correction to the Condensed Consolidated Statement of Changes in Stockholders' Equity
For the Three Months Ended September 30, 2021 For the Nine Months Ended September 30, 2021
Previously Reported Error Correction As Adjusted Previously Reported Error Correction As Adjusted
(in thousands)
Net loss $ (5,387) $ 165 $ (5,222) $ (38,894) $ 1,250 $ (37,644)
Additional paid-in capital 354,119 181 354,300 354,119 181 354,300
Accumulated deficit - beginning balance (177,350) 1,085 (176,265) (143,843) — (143,843)
Accumulated deficit - ending balance (182,737) 1,250 (181,487) (182,737) 1,250 (181,487)
Total Stockholders' equity 171,491 1,431 172,922 171,491 1,431 172,922

~~19. COMMITMENT~~18. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

~~As previously reported in Note 19 of the Form 10-Q for the quarter ended June 30, 2022, filed on August 9, 2022, on~~On February 7, 2022, Telos and certain of its current and former officers were named as defendants in a lawsuit filed in the United States District Court for the Eastern District of ~~Virginia.~~Virginia ("Court"). In the complaint, the ~~plaintiffs,~~Plaintiffs, who purport to represent a class of purchasers of Telos common stock between November 19, 2020, and March 16, 2022, allege that the defendants violated securities laws by failing to disclose delays relating to the launch of certain contracts between Telos and the Transportation Security Administration ("TSA") and the Centers for Medicare and Medicaid Services and to take into account those delays when providing a financial forecast for the ~~Company’s~~Company's 2021 performance. On June 15, 2022, the Plaintiffs filed a consolidated complaint which added claims (i) concerning Telos' disclosure of revenue projections for these contracts, (ii) against the directors of Telos at the time of its initial public offering, and (iii) pursuant to Sections 11 and 15 of the Securities Act of 1933. On February 1, 2023, the Court dismissed the lawsuit in its entirety for failure to state a claim. The Court's order of dismissal provided the Plaintiffs the opportunity to file a motion for leave to file an amended complaint, should they have a good faith basis to do so. On March 13, 2023, the Court granted the parties' consent motion permitting the filing of a consolidated amended class action complaint and establishing a briefing schedule for Telos' motion to dismiss that amended complaint. On April 14, 2023, Telos moved to dismiss the consolidated amended class action complaint. At the conclusion of a hearing held on June 21, 2023, the Court dismissed the consolidated amended class action complaint with prejudice. No appeal from the order of dismissal was taken, and it is final.

The Company ~~is vigorously defending the case, but given the early stage, although a loss may reasonably be possible, the Company is unable to predict the likelihood of success of plaintiffs'~~does not believe that there are claims or ~~estimate a loss or range of loss. As a result, no material liability has been recorded as of September 30, 2022, and December, 31, 2021, respectively.~~

In addition, the Company is a party to litigation arising in the ordinary course of business. In the opinion of management, while the results of such litigation cannot be predicted with any reasonable degree of certainty, the final outcome of such known matters will not, based upon all available information,proceedings that would have a material adverse effect on the ~~Company's~~business, or the unaudited consolidated financial ~~position, results~~statements of ~~operations or cash flows.~~the Company as of June 30, 2023.

Other - Government Contracts

As a U.S. government contractor, we are subject to various audits and investigations by the U.S. government to determine whether our operations are being conducted in accordance with applicable regulatory requirements. U.S. government investigations of our operations, whether relating to government contracts or conducted for other reasons, could result in administrative, civil, or criminal liabilities, including repayments, fines or penalties being imposed upon us, suspension, proposed debarment, debarment from eligibility for future U.S. government contracting, or suspension of export privileges. Suspension or debarment could have a material adverse effect on us because of our dependence on contracts with the U.S. government. U.S. government investigations often take years to complete and many result in no adverse action against us. We also provide products and services to customers outside of the United States, which are subject to U.S. and foreign laws and regulations and foreign procurement policies and practices. Our compliance with local regulations or applicable U.S. government regulations also may be audited or investigated.

~~20.~~19. SUPPLEMENTAL CASH FLOW INFORMATION


Table 20.1: Details of Cash, Cash Equivalent, and Restricted Cash
Table 19.1: Details of Cash, Cash Equivalents, and Restricted Cash						Table 19.1: Details of Cash, Cash Equivalents, and Restricted Cash
		September 30, 2022		December 31, 2021			June 30, 2023		December 31, 2022

		(in thousands)					(in thousands)
Cash and cash equivalents	Cash and cash equivalents	$	125,332	$	126,562	Cash and cash equivalents	$	103,447	$	119,305
Restricted cash (1)	Restricted cash (1)	132		—		Restricted cash (1)	134		133
Cash, cash equivalents, and restricted cash	Cash, cash equivalents, and restricted cash	$	125,464	$	126,562	Cash, cash equivalents, and restricted cash	$	103,581	$	119,438

(1)Restricted cash consists of a commercial money market account held as a deposit on the Ashburn lease and is recorded under "Other assets" on the ~~Consolidated Balance Sheets~~unaudited consolidated balance sheets.


Table 19.2: Supplemental Cash Flow Information
	For the Six Months Ended
	June 30, 2023		June 30, 2022

	(in thousands)
Cash paid during the period for:
Interest	$	409	$	353
Income taxes	147		188
Non-cash investing and financing activities:
Operating lease ROU assets obtained in exchange for operating lease liabilities	$	15	$	282
Capital expenditure activity in accounts payable and other accrued liabilities	536		296
Issuance of common stock for 401K match	1,943		—
Intangible assets transferred to extinguish other financing obligations	7,089		—
Common stock repurchases under SRP	—		400

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Table 20.2: Supplemental Cash Flow Information
For the Nine Months Ended
September 30, 2022 September 30, 2021
(in thousands)
Cash paid during the period for:
Interest $ 523 $ 583
Income taxes 188 54
Non-cash investing and financing activities:
Operating lease ROU assets obtained in exchange for operating lease liabilities $ 396 $ 486
Capital expenditure activity in accounts payable and other accrued liabilities 400 —
Common stock repurchase under SRP 80 —
Acquisition holdback — 506
20. REVISION OF PRIOR YEAR INTERIM FINANCIAL STATEMENTS

During the course of preparing the Company's consolidated financial statements for the year ended December 31, 2022, we identified that stock-based compensation expense related to the PSU awards with market conditions was erroneously reversed when those PSUs were forfeited. Due to the error, general and administrative expense was understated by $1.9 million and $3.5 million for the three and six months ended June 30, 2022. Although the Company has determined that the error did not have a material impact on its previously issued interim consolidated financial statements, it revised the previously reported interim financial information in conjunction with the issuance of its quarterly filings on Form 10-Q for the quarter ended June 30, 2023. The errors had no net impact on cash flows from operating, investing or financing activities in the consolidated statement of cash flows.

The following tables set forth the effects of the revisions of previously issued unaudited quarterly consolidated financial statements to correct for prior period errors.


Table 20.1: Impact of the Correction to the Unaudited Consolidated Statement of Operations
	Three Months Ended June 30, 2022						Six Months Ended June 30, 2022
	As Previously Reported		Adjustment		As Revised		As Previously Reported		Adjustment		As Revised

	(in thousands, except per share data)
General and administrative	$	23,865	$	1,870	$	25,735	$	46,788	$	3,503	$	50,291
Total selling, general and administrative expenses	33,095		1,870		34,965		66,700		3,503		70,203
Operating loss	(12,166)		(1,870)		(14,036)		(26,900)		(3,503)		(30,403)
Loss before income taxes	(12,235)		(1,870)		(14,105)		(27,147)		(3,503)		(30,650)
Net loss	(12,289)		(1,870)		(14,159)		(27,272)		(3,503)		(30,775)

Net loss per share, basic	$	(0.18)	$	(0.03)	$	(0.21)	$	(0.40)	$	(0.05)	$	(0.45)
Net loss per share, diluted	(0.18)		(0.03)		(0.21)		(0.40)		(0.05)		(0.45)


Table 20.2: Impact of the Correction to the Unaudited Consolidated Statement of Comprehensive Loss
	Three Months Ended June 30, 2022						Six Months Ended June 30, 2022
	As Previously Reported		Adjustment		As Revised		As Previously Reported		Adjustment		As Revised

	(in thousands)
Net loss	$	(12,289)	$	(1,870)	$	(14,159)	$	(27,272)	$	(3,503)	$	(30,775)
Comprehensive loss	(12,300)		(1,870)		(14,170)		(27,254)		(3,503)		(30,757)


Table 20.3: Impact of the Correction to the Unaudited Consolidated Statement of Changes in Stockholders' Equity
	Three Months Ended June 30, 2022						Six Months Ended June 30, 2022
	As Previously Reported		Adjustment		As Revised		As Previously Reported		Adjustment		As Revised

	(in thousands)
Additional paid-in capital, beginning	$	376,913	$	1,633	$	378,546	$	367,153	$	—	$	367,153
Stock-based compensation	14,553		1,870		16,423		27,200		3,503		30,703
Additional paid-in capital, end	388,464		3,503		391,967		388,464		3,503		391,967

Accumulated deficit, beginning	$	(201,960)	$	(1,633)	$	(203,593)	$	(186,977)	$	—	$	(186,977)
Net loss	(12,289)		(1,870)		(14,159)		(27,272)		(3,503)		(30,775)
Accumulated deficit, end	(214,249)		(3,503)		(217,752)		(214,249)		(3,503)		(217,752)

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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. ~~For this purpose, any~~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”~~"believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. ~~There are a number of~~Several important factors ~~that~~ could cause the ~~Company’s~~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~~Company's Form 10-K for the year ended December 31, ~~2021,~~2022, as filed with the ~~SEC.~~Securities and Exchange Commission ("SEC") on March 16, 2023.

General and Business Overview

We offer technologically advanced, software-based security solutions that empower and protect the ~~world’s~~world's most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats. Our portfolio of security products, services and expertise ~~empower~~empowers our customers with capabilities to reach new markets, serve their stakeholders more effectively, and successfully defend the nation or their enterprise. We protect our ~~customers’~~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 ~~mission~~primary customers include the U.S. federal government, large commercial businesses, state and local governments, and international customers. Our consolidated revenue is largely attributable to ~~protect~~prime contracts or to subcontracts with our ~~customers’ people, systems,~~contractors engaged in work for the U.S. government, with the remaining attributable to state, local 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 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 give 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 these three domains.commercial markets.

~~As a result of the change in~~Information regarding our ~~organization and leadership structure in the fourth quarter of 2021, we established and operate in~~ two reportable segments – Security Solutions and Secure ~~Networks.~~Networks – is presented in Note 17 - Segment Information to the unaudited consolidated financial statements at Item 1 of this Form 10-Q.

~~Security Solutions~~

~~Security Solutions, which focuses~~Fiscal year 2023 will continue to be a transition year for Telos, focusing on ~~cybersecurity, cloud~~streamlining our operations and ~~identity solutions, includes Information Assurance, Secure Communications,~~rebuilding and ~~Telos ID. Cybersecurity solutions help our customers ensure~~growing the ~~ongoing security, integrity, and compliance of their on-premises and related cloud-based systems~~revenue base by ~~reducing threats and vulnerabilities to foil cyber adversaries before they can attack.~~generating new business wins. Our security engineers and subject matter experts assess our customers’ cybersecurity environments and design, engineer, and operate systems needed to strengthen their cybersecurity posture. Our cloud solutions leverage the specialized skills and experience needed to help our customers plan, engineer, execute and accelerate secure cloud migrations while assuring ongoing management and security of enterprise cloud technology environments. Our identity solutions deliver digital identity, biometric, and nationwide enrollment services and address Know Your Customer and identity management challenges for enterprises working within regulated and critical infrastructure environments.2023 business development priorities are to:

•~~Information Assurance~~

◦~~Xacta: a premier platform for enterprise cyber risk management~~Reorganize internally to consolidate 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.

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•~~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 cyberattack 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 Advanced Cyber Analytics ("ACA")~~: a solution-as-a-service that delivers timely, accurate, actionable intelligence at speed and scale to illuminate threats to enterprise assets. It enables organizations to detect malicious activity earlier and to uncover and identify previously unknown attacks and new malicious behavior. Further, it assists in the attribution of events and provides sophisticated and comprehensive analytics without expensive overhead.

◦~~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 Organizational Messaging Service and its specialized communications protocols.centralize business development resources;

•~~Telos ID:offering identity trust~~Add new talent to drive execution of solution development and ~~digital services through IDTrust360~~® – an enterprise-class digital identity risk platform for extending flexible hybrid cloud identity services. This platform is enabled for mobile, enterprise environments 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. In April 2021, we announced the acquisition of the assets of DFT, whose ONYX® ~~touchless mobile fingerprint software is being integrated with the IDTrust360 platform. We maintain government certifications and designations that distinguish Telos ID, including TSA PreCheck~~® ~~enrollment provider, Designated Aviation Channeling provider, FBI-approved Channeler, and Financial Industry Regulatory Authority Electronic Fingerprint Submission provider.~~

~~Secure Networks~~

Secure Networks focuses on enterprise security. Secure Networks provides secure networking architectures and solutions to the DoD, the federal Intelligence Community and other federal government agencies. Our net-centric solutions enable collaboration and connectivity in order to increase efficiency, reduce costs, and improve mission outcomes. We provide an extensive range of wired and wireless, fixed and deployable, classified and unclassified voice, data, and video secure network solutions and services to support defense and civilian missions. Capabilities include network design, operations and sustainment; system integration and engineering; network security and compliance; deployable comms; robotic process automation and other digital transformation capabilities; service desk; defensive cyber operations; and program management.

•~~Secure Mobility:~~ ~~solutions for~~new business and government that enable remote work and minimize operational and security concerns 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.generation;

•~~Network Management~~Maximize existing strategic partnerships for market expansion; and ~~Defense:~~

• ~~services for operating, administrating,~~Increase our opportunity portfolio and ~~defending complex enterprise networks and for defensive cyber operations. Our diverse portfolio~~quality of ~~network management and defense capabilities addresses common and uncommon requirements in many industries and disciplines, ranging from the military and government agencies to Fortune 500 companies.~~contract vehicles.

Business Environment

~~Our business performance continues to be heavily affected~~U.S. Budget

In March 2023, the White House released its proposed FY2024 budget, which called for a $26 billion increase for the Department of Defense ("DOD") next year, a little more than 3% above the FY2023 enacted level. The debt ceiling legislation (the "Fiscal Responsibility Act") subsequently approved by ~~the overall~~Congress contains spending caps, which reflect that level of ~~U.S. government~~defense spending, as do the defense authorization and appropriations bills currently under consideration in the House and Senate. There are also many in Congress who want to boost this increase further via a subsequent supplemental appropriations bill to offset current and expected inflationary trends and the ~~alignment of our solutions with~~threats posed by foreign adversaries. Final decisions on defense spending will not be made until this fall, at the ~~priorities of the U.S. government. U.S. government spending and contracts continue to be affected by the~~earliest.

The President's FY2024 budget also proposed increased investments for cybersecurity within numerous federal ~~budget and appropriations process and related legislation.~~

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Congress could not agree on fiscal year ("FY") 2023 appropriations legislation before the start of the fiscal year on October 1, 2022. As a result, the entire federal government is currently operating under the terms of a continuing resolution ("CR"), which only permits agencies to spend at FY 2022 appropriations levels without any adjustments for the dramatic increase in inflation we have seen over the past year. Moreover, federalcivilian departments and agencies, ~~are generally precluded from moving forward on new contract starts or accelerating current projects while they are funded by~~including $3.1 billion in funding for the Cybersecurity and Infrastructure Security Agency, a ~~CR. The current CR runs through December 16, 2022, and it~~5% increase, of which $98 million is ~~not clear at this time whether Congress will be able~~intended to ~~come to an agreement on appropriations legislation~~implement the Cyber Incident Reporting for FY 2023 by then or will have to pass another CR, possibly lasting into January or February 2023. Such continued delays in finalizing FY 2023 appropriations could, in turn, impact future planning by Telos and our government customers.

~~The President’s FY 2023 budget request~~ ~~called for approximately 4% more defense spending than was provided for FY 2022.However, this proposed FY 2023 budget was developed before Russia invaded Ukraine and did not include expenditures related to that ongoing event. The proposed FY 2023~~Critical Infrastructure Act. In general, the President's budget also ~~assumed an inflation rate for DoD~~reflects the prioritization of 2.2%, which Pentagon officials subsequently acknowledged would need to be adjusted higher. There is significant congressional support for boosting defense spending further to account for these factors and other needs, as demonstrated by the House and Senate versions of the FY 2023 National Defense Authorization Act, which call for authorizing appropriations of $37 billion (House) and $45 billion (Senate) more than proposed by the President’s budget. Actual final appropriations levels for national defense will not be determined until December, at the earliest.

The proposed FY 2023 budget also called for an increase in federal civilian agency (non-defense) cybersecurity funding of nearly 11%. The Biden Administration says it is seeking to increase investments across the various civilian federal agencies to help align them to the cybersecurity practices and priorities outlined in the President’s Executive Order 14028, “Improving the Nation’s Cybersecurity.” As with overall defense spending, final appropriations levels for non-defense cybersecurity efforts will not be determined until December, at the earliest. An exception to this is the new four-year, $1 billion State and Local Cybersecurity Grant program, which has already been appropriated and the first year’s funding is now available.

Looking ahead to next year, the Office of Management and Budget ("OMB") has already given federal departments and agencies guidance for cybersecurity priorities to include in their FY 2024 proposed budgets. OMB has directed that agencies prioritize accelerated cloud adoption, ~~of the cloud,~~ IT modernization, further private sector collaboration for sector risk management responsibilities, ~~and~~ ensuring adequate cyber threat information sharing, and supply chain risk management. These priorities align with the solutions Telos has been developing and bringing to market for the past several years.

However, such increased spending by civilian agencies on cybersecurity could be difficult to achieve, given the cap on non-defense discretionary spending included in the Fiscal Responsibility Act and subsequent efforts by the House majority to seek even further reductions in all non-defense discretionary spending. This would impact future cybersecurity investments by potential civilian federal customers.

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For ~~example, Xacta, our flagship offering, continues~~both defense and non-defense spending, it is also doubtful that a divided Congress and the White House can reconcile their differences over fiscal policy before the start of FY2024 on October 1, 2023. Failing to ~~set~~do so would mean the ~~standard for innovative capabilities~~federal government could face a shutdown this fall or, at best, will begin another fiscal year under the constraints of a continuing resolution, with funding frozen at FY2023 levels and restrictions likely on new contracts and acceleration of current programs. Finally, under the terms of the Fiscal Responsibility Act, if all appropriations legislation is not enacted by January 1, appropriations government-wide will revert to the FY2023 level minus an additional one percent. This uncertainty could also impact federal customers' ability to move forward on their planned expenditures in managing cyber risk and automating continuous compliance in on-premises, cloud, and hybrid environments. Our cloud practice area includes cloud migration, CloudSecOps, and cloud security compliance to accelerate IT modernization for business and government. Our Telos ACA platform combines decades of information security experience with an extensive background in cyber intelligence to defend enterprises against advanced cyber threats.FY2024.

Cybersecurity Landscape

In recent years, ~~continuing and increasingly damaging ransomware and other cyberattacks against federal, state and local governments, K-12 and higher education, and private sector enterprises~~we have ~~resulted in intensified efforts~~seen cybersecurity threats become more complex, with threat actors leveraging a wide variety of tactics to ~~better defend against such attacks. The~~exploit their victims. With this growing ~~demand for these solutions continues~~threat, below are some trends to ~~provide Telos with~~consider when looking at the ~~privilege of offering our expertise to protect these vitally important organizations.~~cybersecurity landscape:

Rising Threats, Rising Liability: Ransomware remains arguably the most severe cyber threat to enterprises in the commercial, state, and local government and education sectors. ~~Our Xacta offering empowers these organizations and institutions to maintain a strong cyber risk posture to minimize~~One reason for the ~~risk~~rise of ransomware ~~gaining~~attacks is that it is exceedingly profitable for cybercriminals, and ransomware victims generally settle the ransom than restoring the system from backups or dealing with the fallout from a ~~foothold in their IT environment. Our Telos ACA offering provides real-~~data breach. Aside from the financial costs of paying the ransom and ~~near-real-time intelligence into known~~restoring the system, the consequence of a successful ransomware attack can include damage to the organization's reputation, stolen sensitive data being used for malicious purposes, and ~~unknown threats to give organizations advance warning~~loss of ransomware and other threats. Should ransomware get loose in the enterprise network, Telos Ghost, our virtual obfuscation network offering, can hide vital resources from view to prevent the payload from reaching them.business.

The Nation's Critical Systems Are Still at Risk: Critical infrastructure and industrial ~~internet~~Internet of ~~things~~Things ("IoT") are among the categories at greatest risk of cyberattacks. Energy, utilities, financial services, and healthcare were among the critical infrastructure sectors that experienced high-profile breaches or ransomware attacks over the past year. Telos Ghost can hide critical IoT and industrial control systems from the public internet to keep them from being compromised. Telos Ghost can also cordon off financial data, medical records, intellectual property, and other crown-jewel assets from visibility or accessibility by adversaries.

~~These capabilities are increasingly important, as threat actors continue to breach enterprise networks in spite~~The Challenging Complexity of access management systems such as virtual private networks and multi-factor authentication. Telos Ghost creates an additional layer of defense against intruders by hiding critical records, information, and applications as well as their users in an anonymous undiscoverable network. Adversaries cannot see them, so they cannot hack them. This also makes Telos Ghost a robust component in a Secure Access Service Edge or Zero Trust Network Access security architecture.

Regulatory Compliance~~Table of Contents~~:

Government mandates ~~and initiatives to assure~~ stronger security in highly regulated ~~industries, as noted above, also lead to opportunities for Telos solutions~~industries. These government initiatives and ~~services. An update to the research study Telos conducted last year reveals that~~ audit fatigue ~~continues~~continue to burden ~~these~~highly regulated organizations, with automation solutions being recognized as the most effective remedy for the many repetitive and redundant tasks that security compliance requires. ~~Xacta streamlines, harmonizes,~~

Additionally, the Securities and ~~automates~~Exchange Commission ("SEC") has finalized and adopted new cybersecurity rules for publicly traded companies, which will require registrants to disclose additional cyber-related information in their regulatory filings. Specifically, they will have to: (1) regularly disclose their governance methods, risk analysis and management processes; (2) meet specific disclosure requirements and deadlines for cybersecurity reporting and describing material cyber incidents; and (3) describe the ~~security controls~~board's oversight of risks from cybersecurity threats, and ~~processes~~management's expertise and role in assessing and managing material risks from cybersecurity threats. The required reporting of this information will lead many companies to proactively establish policies that ~~comprise the leading cybersecurity standards and frameworks, in on-premises, cloud, hybrid, and multi-cloud environments.~~

For example, Xacta supports Federal Risk and Authorization Management Program ("FedRAMP") authorization, allowing all process participants to collaborate within the same Xacta application to attain a FedRAMP Authority to Operate. Xacta is also a trailblazer in deploying the Open Security Controls Assessment Language, a multi-format framework adopted by FedRAMP to allow security professionals to automate security assessment, auditing, and continuous monitoring processes.

The DoD’s emerging Cybersecurity Maturity Model Certification ("CMMC") program is intended to ensure that members of the defense supply chain are applying sound cybersecurity practices in order to protect sensitive unclassified information. Because CMMC 2.0 is still an evolving standard, the flexible Xacta for CMMC offering enables Defense Industrial Base customers to conduct preliminary CMMC compliance audits that assess the maturity level required today as well as build a roadmap to future maturity level requirements. Telos is also a Cyber AB Registered Provider Organization™~~, authorized by The Cyber AB to provide consulting services to government contractors and other companies in preparation for~~will improve their ~~CMMC assessments.~~

~~Finally, CISOs with today’s cost-conscious enterprises are under increasing pressure to provide evidence that their security strategies yield a return on investment. Xacta’s latest~~ cyber risk ~~quantification capabilities meet this need, allowing our customers to calculate inherent risk likelihood, impact, and criticality, shown in a graphic display that illustrates real-time risk~~management posture and ~~visualizes progress over time. In addition, customers can also define their own financial loss formula~~enable them to better withstand heightened public and regulatory scrutiny.

Identity Assurance and Privacy Protection are Essential for ~~customer-specific risk analysis in dollar amounts.~~

~~COVID-19 Pandemic~~

~~With much of the business of government still being conducted by federal employees working remotely through the use of information technology systems, we believe there will continue~~Today's Enterprises: Identity and access management continues to be a major cybersecurity concern for organizations and individuals that need onto ensure their security and protect their privacy. Trusted identities are essential to confidence in IT and physical security strategies and to the ~~part~~success of ~~the government for the types of~~Zero Trust security models and architectures.

Artificial Intelligence: Cybercriminals are using Artificial Intelligence ("AI") to launch more sophisticated attacks that can quickly adapt to changing environments, making detection harder. To protect against AI-powered cyberattacks, organizations must stay vigilant and adopt advanced cybersecurity tools and techniques that can detect and respond to these threats timely before they can cause damage.

Global Networks and Worldwide Communications Need Baked-in Security: Enterprises also need resilient cyber and information security capabilities to protect and defend critical infrastructure to ensure mission success.

Telos has several available solutions (Xacta, Telos Ghost, Telos ACA and IDTrust 360®) to help our customers protect and secure their on-premise, cyber, and cloud-based networks, and mitigate risk to critical infrastructure. Further, Secure Networks offers secure mobility solutions and ~~services provided by Telos.~~management expertise to defend against cyber threats and vulnerabilities.

Backlog

Backlog is a useful measure in developing 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.

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Total backlog 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 the 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.

Financial Overview

A number of factors have contributed to the results of our second quarter of fiscal year 2023, the most noteworthy or significant of which are described below. More details on these changes are presented below within our "Results of Operations" section.

~~TSA PreCheck~~•® ~~Update~~The winding down of certain projects and lower revenue on existing major programs resulted in a decline in the current quarter's revenue.

~~On October 18, 2022, TSA issued an authority~~•Actions to ~~operate to Telos ID for Telos’ PreCheck~~® ~~System. With TSA approval, Telos is providing its TSA PreCheck~~® ~~enrollment services for a trial period to a limited population~~cushion the impact of ~~applicants in order to validate systems~~lower revenue on profitability, maintain gross margin level, and ~~processes in advance of its full implementation as an authorized TSA PreCheck~~® enrollment provider. Once Telos successfully completes its trial period to the satisfaction of TSA, Telos will launch its services to the public more widely. Telos continues to anticipate this launch will occur in calendar year 2022.improve net loss position.

•Lower operating costs through a combination of lower stock-based compensation, aggressive cost management and the results of the restructuring plan.

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Results of Operations


Table MD&A 1: Results of Operations
Table MD&A 1: Consolidated Results of Operations														Table MD&A 1: Consolidated Results of Operations
		For the Three Months Ended						For the Nine Months Ended							For the Three Months Ended						For the Six Months Ended
		September 30, 2022			September 30, 2021			September 30, 2022			September 30, 2021				June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022

		(in thousands)													(dollars in thousands)
Revenue	Revenue	$	63,593		68,981			169,544			178,383			Revenue	$	32,911		$	55,791		$	68,133		$	105,951
Cost of sales	Cost of sales	42,648			44,104			108,799			116,502			Cost of sales	20,552			34,862			42,292			66,151
Gross profit	Gross profit	20,945			24,877			60,745			61,881			Gross profit	12,359			20,929			25,841			39,800
Gross margin	Gross margin	32.9		%	36.1		%	35.8		%	34.7		%	Gross margin	37.6		%	37.5		%	37.9		%	37.6		%
Selling, general and administrative expenses	Selling, general and administrative expenses	28,614			29,965			95,314			97,935			Selling, general and administrative expenses	21,826			34,965			48,278			70,203
Selling, general and administrative expenses as percentage of revenue	Selling, general and administrative expenses as percentage of revenue	45.0		%	43.4		%	56.2		%	54.9		%	Selling, general and administrative expenses as percentage of revenue	66.3		%	62.7		%	70.9		%	66.3		%
Operating loss	Operating loss	(7,669)			(5,088)			(34,569)			(36,054)			Operating loss	(9,467)			(14,036)			(22,437)			(30,403)
Other income/(expense)		518			20			648			(1,001)
Other income														Other income	1,649			118			4,145			130
Interest expense	Interest expense	(181)			(195)			(558)			(583)			Interest expense	(184)			(187)			(433)			(377)
Loss before income taxes	Loss before income taxes	(7,332)			(5,263)			(34,479)			(37,638)			Loss before income taxes	(8,002)			(14,105)			(18,725)			(30,650)
(Provision for)/benefit from income taxes		(8)			41			(133)			(6)
Provision for income taxes														Provision for income taxes	(22)			(54)			(45)			(125)
Net loss	Net loss	$	(7,340)		$	(5,222)		$	(34,612)		$	(37,644)		Net loss	$	(8,024)		$	(14,159)		$	(18,770)		$	(30,775)

~~Company~~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 under the section that follows "Segment Results." We generate revenue from the delivery of products and services to our customers. The discussion of material changes in our net revenue should be read in conjunction with the subsequent discussion of changes in our consolidated cost of sales and our business segment results of operations. Cost of sales, for both ~~services~~products and ~~products,~~services, consists of ~~material,~~ labor, materials, subcontracting costs and an allocation of indirect costs.

~~Three Months Ended September 30, 2022, Compared with Three Months Ended September 30, 2021~~

~~For~~Selling, general, and administrative expenses (SG&A). SG&A decreased by $13.1 million, or 37.6%, for the three months ended ~~September~~June 30, ~~2022, revenue decreased by $5.4 million, or 7.8%,~~2023, compared to the same period in ~~2021. The~~2022. This decrease ~~in revenue was~~is primarily due to lower stock-based compensation costs of $8.7 million, reduced labor costs of $2.6 million as a ~~large program that ended~~result of a decrease in ~~2021 within Security Solutions~~personnel, and change in capitalized research and development costs of $2.1 million driven by the ~~expected wind-down of large programs within Secure Networks.~~timing in software projects.

~~Cost of sales~~SG&A decreased by ~~$1.5~~$21.9 million, or ~~3.3%~~31.2%, for the ~~third quarter of 2022~~six months ended June 30, 2023, as compared to the same period in ~~2021,~~the prior year primarily due to lower stock-based compensation costs of $14.4 million, reduced labor costs of $5.3 million as a result of ~~decreased revenue, reduced~~a decrease in personnel, and change in capitalized research and development costs ~~across~~of $3.2 million driven by the ~~Secure Networks portfolio, and revenue mix,~~timing in software projects, partially offset by $1.2 million in restructuring charges.

Other income. Other income increased ~~investment~~by $1.5 million for the three months ended June 30, 2023, due to increases in dividend income from money market placements as a ~~single large program in Security Solutions.~~

~~Gross profit decreased by $3.9 million, or 15.8%, in the third quarter~~result of ~~2022~~increasing interest rates, compared to the same period in ~~2021. Gross margin decreased from 36.1% to 32.9%~~2022.

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Other income increased by $4.0 million for the ~~third quarter of 2022~~six months ended June 30, 2023, as compared to the same period in ~~2021. This is~~the prior year primarily due to ~~higher investment~~an increase in ~~a single large program in Security Solutions, offset by higher gross margins in Secure Networks due to broad-based margin performance across the portfolio,~~dividend income from money market placement of $2.7 million, and a ~~slight shift in revenue mix towards Security Solutions.~~

~~Selling, general, and administrative (“SG&A”) expenses decreased by~~gain on early extinguishment of other financing obligations of $1.4 million ~~or 4.5%,~~ in ~~the third quarter of 2022 compared to~~2023 without a similar gain in the same period in ~~2021, primarily attributable to the cost actions, offset by an increase in stock-based compensation.~~2022.

~~Operating loss~~Interest expenses. There was $7.7 million for the third quarter of 2022, compared to $5.1 million for the same period in 2021, primarily due to the decrease in gross profit in the third quarter of 2022, as mentioned above, offset by the decrease in SG&A expenses.

~~There were~~ no significant ~~changes~~change in interest expense ~~and other~~between comparable periods.

Provision for income ~~and expenses between the comparable periods.~~

taxes. The change in the income tax provision for the ~~third quarter of 2022~~three and six months ended June 30, 2023, compared to the same period in ~~2021~~2022, is based on the estimated annual effective tax rate applied to the pretax loss incurred for the quarter plus discrete tax items, based on our expectation of pretax loss for the fiscal year.

~~Net loss was $7.3 million for the third quarter of 2022, compared to $5.2 million for the same period in 2021, primarily due to the decrease in gross profit, offset by the decrease in SG&A expenses.~~

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~~Nine Months Ended September 30, 2022, Compared with Nine Months Ended September 30, 2021~~

Revenue decreased by $8.8 million, or 5.0%, during the nine months ended September 30, 2022 compared to the same period in 2021. The decrease is the result of the end of a large program in 2021 in Security Solutions and the expected wind-down of large programs in Secure Networks, offset by other increases across the portfolio.

Cost of sales decreased by $7.7 million, or 6.6%, for the nine months ended September 30, 2022, compared to the same period in 2021, primarily as a result of decreased revenue, reduced costs across the portfolio, and revenue mix.

Gross profit decreased by $1.1 million, or 1.8%, for the nine months ended September 30, 2022, compared to the same period in 2021. Gross margin increased from 34.7% to 35.8% for the comparable periods due to broad-based margin performance across the portfolio and a shift in revenue mix toward Security Solutions.

~~SG&A expense decreased by 2.7% to $95.3 million for the nine months ended September 30, 2022, from $97.9 million for the same period in 2021, primarily due to reduced stock-based compensation.~~

Operating loss was $34.6 million for the nine months ended September 30, 2022, compared to $36.1 million for the same period in 2021, primarily due to the decreases in SG&A expense, offset by the decrease in gross profit described above.

Other expense of $1.0 million for the nine months ended September 30, 2021, was attributable to an accrual for a litigation settlement agreement, with no similar cost in 2022. There was no significant change in interest expense between comparable periods.

The increase in the income tax provision for the nine months ended September 30, 2022, compared to the same period in 2021, is based on the estimated annual effective tax rate applied to the pretax loss incurred for the nine months plus discrete tax items, based on our expectation of pretax loss for the fiscal year.

Net loss was $34.6 million for the nine months ended September 30, 2022, compared to $37.6 million for the same period in 2021, primarily attributable to the decrease in SG&A expenses coupled by the change in other expenses mentioned above, offset by the decrease in gross profit.

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	Table MD&A 2: Security Solutions Segment - Financial Results									Table MD&A 2: Security Solutions Segment - Financial Results
		For the Three Months Ended				For the Nine Months Ended					For the Three Months Ended						For the Six Months Ended
		September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021			June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022

		(in thousands)									(dollars in thousands)
Revenue	Revenue	$	32,440	$	34,558	$	90,178	$	89,624	Revenue	$	17,196		$	30,819		$	36,969		$	57,738
Gross profit	Gross profit	$	15,577	$	19,517	$	47,062	$	46,032	Gross profit	9,551			16,433			19,825			31,485
Gross margin	Gross margin	48.0 %		56.5 %		52.2 %		51.4 %		Gross margin	55.5		%	53.3		%	53.6		%	54.5		%

For the three months ended ~~September~~June 30, ~~2022,~~2023, Security ~~Solutions'~~Solutions segment revenue decreased by ~~$2.1~~$13.6 million, or ~~6.1%~~44.2%, compared to the same period in ~~2021. The reduction was~~2022, primarily ~~attributable~~due to ~~a large program that ended in 2021 and a decrease in another large program within the portfolio.~~lower volume on certain major programs.

Security ~~Solutions' gross profit~~Solutions segment revenue for the ~~third quarter of 2022~~six months ended June 30, 2023, decreased by ~~$3.9~~$20.8 million, or ~~20.2%~~36.0%, compared to the same period in ~~2021.~~ 2022, primarily due to lower revenues on major programs.

Gross ~~margin~~profit for Security Solutions decreased by $6.9 million, or 41.9%, for the second quarter ~~decreased from 56.5% in 2021 to 48.0%~~of 2023 compared with the same period in 2022, primarily due to ~~higher investment~~the decrease in ~~a single large program~~revenue, partially offset by lower indirect expenses due to restructuring and ~~revenue mix shift within the portfolio.~~

~~Revenue~~other cost actions. Segment gross margin increased to 55.5% for the ~~nine~~second quarter of 2023 from 53.3% for the same period in 2022, primarily due to revenue mix.

For the six months ended ~~September~~June 30, ~~2022, slightly increased~~2023, Security Solutions segment gross profit decreased by ~~$0.6~~$11.7 million, or ~~0.6%~~37.0%, compared to the same period in ~~2021. This is~~2022, primarily due to ~~broad based increases across~~ the ~~segment portfolio, offset by a~~ decrease in revenue but partially offset by significantly lower indirect expenses. Segment gross margin decreased from 54.5% to 53.6% as a ~~program that ended in 2021.~~result of a lower revenue base for indirect expenses.

~~Security Solutions' gross profit~~


Table MD&A 3: Secure Networks Segment - Financial Results
	For the Three Months Ended						For the Six Months Ended
	June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022

	(dollars in thousands)
Revenue	$	15,715		$	24,972		$	31,164		$	48,213
Gross profit	2,808			4,496			6,016			8,315
Gross margin	17.9		%	18.0		%	19.3		%	17.2		%

Secure Networks segment revenue for the ~~nine~~three months ended ~~September~~June 30, ~~2022, increased~~2023, decreased by ~~$1.0~~$9.3 million, or ~~2.2%~~37.1%, compared to the same period in ~~2021.~~2022, primarily due to the successful wind-down of large programs as expected.

For the six months ended June 30, 2023, Secure Networks segment revenue decreased by $17.0 million, or 35.4%, compared to the same period in 2022, primarily due to the successful wind-down of large programs as expected.

Gross profit for Secure Networks decreased by $1.7 million, or 37.5%, for the second quarter of 2023, compared with the same period in 2022, primarily due to lower revenue, partially offset by lower indirect expenses. Segment gross margin ~~also increased~~slightly decreased to 17.9% for the second quarter of 2023 from ~~51.4%~~18.0% for the same period in ~~2021~~2022.

For the six months ended June 30, 2023, Secure Networks segment gross profit decreased by $2.3 million, or 27.6% compared to ~~52.2%~~the same period in ~~2022. The segment's profitability improvement was~~2022, primarily due to lower revenue, partially offset by lower indirect expenses. Segment gross margin increased from 17.2% in 2022 to 19.3% in 2023 due to improved performance on several programs and a ~~revenue~~shift in the mix ~~shift within~~across the ~~business, along with some minor margin improvements in certain portions~~portfolio driven by the wind-down of ~~the portfolio.~~lower-margin programs.

2523

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Table MD&A 3: Secure Networks Segment - Financial Results
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
(in thousands)
Revenue $ 31,153 $ 34,423 $ 79,366 $ 88,759
Gross profit $ 5,368 $ 5,360 $ 13,683 $ 15,849
Gross margin 17.2 % 15.6 % 17.2 % 17.9 %

Secure Networks' revenue for the third quarter of 2022 decreased by $3.3 million, or 9.5%, compared to the same period in 2021. This was driven by the expected wind-down of large programs within the portfolio.

While revenue decreased in the third quarter of 2022, Secure Networks' gross profit remained at approximately $5.4 million during the comparable periods. Segment gross margin increased between comparable periods from 15.6% in 2021 to 17.2% in 2022 due to broad-based margin performance across the portfolio.

~~For the nine months ended September 30, 2022, Secure Networks' revenue decreased by $9.4 million, or 10.6%, compared to the same period in 2021, due to the expected wind-down of large programs.~~

Gross profit for Secure Networks for the nine months ended September 30, 2022, decreased by $2.2 million, or 13.7%, compared to the same period in 2021, primarily as a result of the decline in year-to-date segment revenue. Segment gross margin decreased between comparable periods from 17.9% in 2021 to 17.2% in 2022 due to minor margin reductions across the portfolio.

Non-GAAP Financial Measures

In addition to our results determined in accordance with U.S. GAAP, we believe the non-GAAP financial measures of ~~Enterprise~~ EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net ~~Income~~ Income/(Loss), Adjusted Earnings Per Share ("EPS") and Free Cash Flow are useful in evaluating our operating performance. We believe that this non-GAAP financial information, when taken collectively with our GAAP results, may be helpful to readers of our financial statements because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results. The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from ~~similarly titled~~similarly-titled non-GAAP measures used by other companies. A reconciliation is provided below for each of these non-GAAP financial measures to the most directly comparable financial measure stated in accordance with GAAP.

We use ~~the following~~these non-GAAP financial measures to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, to develop short-term and long-term operating plans, and to evaluate the performance of certain management personnel when determining incentive compensation. We believe these non-GAAP financial measures facilitate comparison of our operating performance on a consistent basis between periods by excluding certain items that may, or could, have a disproportionately positive or negative impact on our results of operations in any particular period. When viewed in combination with our results prepared in accordance with GAAP, these non-GAAP financial measures help provide a broader picture of factors and trends affecting our results of operations.

~~Enterprise~~ EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin

~~Enterprise~~ EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin are supplemental measures of operating performance that are not made under GAAP and ~~that~~ do not represent, and should not be considered as, an alternative to net ~~(loss) income and net (loss) income margin,~~loss as determined by GAAP. We define ~~Enterprise~~ EBITDA as net (loss)/income, adjusted for non-operating (income)/expense, ~~(income),~~ interest expense, (benefit from)/provision for ~~(benefit from)~~ income taxes, and depreciation and amortization. We define Adjusted EBITDA as ~~Enterprise~~ EBITDA, adjusted for stock-based compensation ~~expense.~~expense and restructuring expenses/(adjustments). We define EBITDA Margin as EBITDA as a percentage of total revenue. We define Adjusted EBITDA ~~margin~~Margin as ~~adjusted~~Adjusted EBITDA as a percentage of total revenue.

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Table MD&A 4: Reconciliation of Net Loss to Enterprise EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
Amount Margin Amount Margin Amount Margin Amount Margin
(in thousands)
Net loss $ (7,340) (11.5) % $ (5,222) (7.6) % $ (34,612) (20.4) % $ (37,644) (21.1) %
Adjustments:
Non-operating (income)/expense (518) (0.8) % (20) — % (648) (0.4) % 1,001 0.6 %
Interest expense 181 0.3 % 195 0.3 % 558 0.3 % 583 0.3 %
Provision for/(benefit from) income taxes 8 — % (41) — % 133 0.1 % 6 — %
Depreciation and amortization 1,517 2.4 % 1,459 2.1 % 4,427 2.6 % 4,223 2.4 %
Enterprise EBITDA (6,152) (9.6) % (3,629) (5.2) % (30,142) (17.8) % (31,831) (17.8) %
Stock-based compensation expense (1)
14,721 23.1 % 12,372 17.9 % 44,225 26.1 % 47,378 26.5 %
Adjusted EBITDA $ 8,569 13.5 % $ 8,743 12.7 % $ 14,083 8.3 % $ 15,547 8.7 %


Table MD&A 4: Reconciliation of Net Loss to EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin
	For the Three Months Ended						For the Six Months Ended
	June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022
	Amount		Margin	Amount		Margin	Amount		Margin	Amount		Margin

	(dollars in thousands)
Net loss	$	(8,024)	(24.4 %)	$	(14,159)	(25.4 %)	$	(18,770)	(27.5) %	$	(30,775)	(29.0) %
Other income	(1,649)		(5.0 %)	(118)		(0.2 %)	(4,145)		(6.1) %	(130)		(0.1) %
Interest expense	184		0.5 %	187		0.3 %	433		0.6 %	377		0.4 %
Provision for income taxes	22		0.1 %	54		0.1 %	45		0.1 %	125		0.1 %
Depreciation and amortization	1,696		5.2 %	1,505		2.7 %	3,121		4.5 %	2,910		2.7 %
EBITDA (Non-GAAP)	(7,771)		(23.6 %)	(12,531)		(22.5 %)	(19,316)		(28.4) %	(27,493)		(25.9) %
Stock-based compensation expense (1)	7,745		23.5 %	17,076		30.6 %	17,244		25.3 %	33,007		31.1 %
Restructuring expenses/(adjustments) (2)	(3)		— %	—		— %	1,197		1.8 %	—		— %
Adjusted EBITDA (Non-GAAP)	$	(29)	(0.1 %)	$	4,545	8.1 %	$	(875)	(1.3 %)	$	5,514	5.2	%

(1)The stock-based compensation adjustment to EBITDA is made up of stock-based compensation expense for the awarded RSUs, PSUs and stock options, and of other sources. Stock-based compensation expense for the awarded RSUs, PSUs and stock options was $5.7 million and $13.6 million for the three and ~~nine~~six months ended ~~September~~June 30, 2023, respectively, and $16.4 million and $30.7 million for the three and six months ended June 30, 2022, ~~is made up of $15.0~~respectively. Stock-based compensation from other sources was $2.1 million and ~~$42.2~~$3.7 million ~~respectively, of stock-based compensation expenses~~ for the ~~awarded RSUs~~three and ~~PRSUs,~~six months ended June 30, 2023, respectively, and ~~$(0.3)~~$0.7 million and ~~$2.0~~$2.3 million ~~respectively, of~~for the three and six months ended June 30, 2022, respectively. The other sources of stock-based compensation ~~(adjustment)/expense. The other source of stock-based compensation consists~~consist of accrued compensation, which the Company intends to settle in shares of the Company's common stock. However, it is the ~~Company's~~Company’s discretion whether this compensation will ultimately be paid in stock or cash. The Company has the right to dictate the form of these payments up until the date at which they are paid. Any change to the expected payment form would result in ~~a change of estimate that would~~out-of-quarter adjustments to this add back to Adjusted EBITDA.

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

Table of Contents

Adjusted Net (Loss)/Income ~~(Loss)~~ and Adjusted EPS

Adjusted Net (Loss)/Income ~~(Loss)~~ and Adjusted EPS are supplemental measures of operating performance that are not made under GAAP and ~~that~~ do not represent, and should not be considered as, an alternatives to net ~~income~~ income/(loss) ~~and earnings (loss) per share,~~ as determined by GAAP. We define Adjusted Net (Loss)/Income ~~(Loss)~~ as net ~~income (loss),~~loss, adjusted for non-operating (income)/expense, ~~(income) and~~ stock-based compensation ~~expense.~~expense and restructuring expense/(adjustments). We define Adjusted EPS as Adjusted Net ~~Income (Loss)~~Loss divided by the weighted-average number of common shares outstanding for the period.

Table MD&A 5: Reconciliation of Net Loss to Adjusted Net Income and Adjusted EPS
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
Adjusted Net Income/(Loss) Adjusted Per Share Adjusted Net Income/(Loss) Adjusted Per Share Adjusted Net Income/(Loss) Adjusted Per Share Adjusted Net Income/(Loss) Adjusted Per Share
(in thousands, except per share data)
Reported GAAP measure $ (7,340) $ (0.11) $ (5,222) $ (0.08) $ (34,612) $ (0.51) $ (37,644) $ (0.57)
Adjustments:
Non-operating (income)/ expense (518) (0.01) (20) — (648) (0.01) 1,001 0.01
Stock-based compensation expense (2)
14,721 0.22 12,372 0.19 44,225 0.65 47,378 0.72
Adjusted non-GAAP measure $ 6,863 $ 0.10 $ 7,130 $ 0.11 $ 8,965 $ 0.13 $ 10,735 $ 0.16
Weighted-average shares of common stock outstanding 67,493 66,755 67,641 65,999


Table MD&A 5: Reconciliation of Net Loss to Non-GAAP Adjusted Net (Loss)/Income and Adjusted EPS
	For the Three Months Ended								For the Six Months Ended
	June 30, 2023				June 30, 2022				June 30, 2023				June 30, 2022
	Adjusted Net (Loss)/Income		Adjusted Earnings Per Share		Adjusted Net (Loss)/Income		Adjusted Earnings Per Share		Adjusted Net (Loss)/Income		Adjusted Earnings Per Share		Adjusted Net (Loss)/Income		Adjusted Earnings Per Share

	(in thousands, except per share data)
Net loss	$	(8,024)	$	(0.12)	$	(14,159)	$	(0.21)	$	(18,770)	$	(0.27)	$	(30,775)	$	(0.45)
Adjustments:
Other income	(1,649)		(0.02)		(118)		—		(4,145)		(0.06)		(130)		—
Stock-based compensation expense (1)	7,745		0.11		17,076		0.25		17,244		0.25		33,007		0.48
Restructuring expenses/(adjustments) (2)	(3)		—		—		—		1,197		0.01		—		—
Adjusted net (loss)/income (Non-GAAP)	$	(1,931)	$	(0.03)	$	2,799	$	0.04	$	(4,474)	$	(0.07)	$	2,102	$	0.03
Weighted-average shares of common stock outstanding, basic	69,424				67,876				68,804				67,717

~~(2)~~(1)The stock-based compensation adjustment to ~~net loss~~Net (Loss)/Income is made up of stock-based compensation expense for the awarded RSUs, PSUs and stock options, and of other sources. Stock-based compensation expense for the awarded RSUs, PSUs and stock options was $5.7 million and $13.6 million for the three and ~~nine~~six months ended ~~September~~June 30, 2023, respectively, and $16.4 million and $30.7 million for the three and six months ended June 30, 2022, ~~is made up of $15.0~~respectively. Stock-based compensation from other sources was $2.1 million and ~~$42.2~~$3.7 million ~~respectively, of stock-based compensation expenses~~ for the ~~awarded RSUs~~three and ~~PRSUs,~~six months ended June 30, 2023, respectively, and ~~$(0.3)~~$0.7 million and ~~$2.0~~$2.3 million ~~respectively, of~~for the three and six months ended June 30, 2022, respectively. The other sources of stock-based compensation ~~(adjustment)/expense. The other source of stock-based compensation consists~~consist of accrued compensation, which the Company intends to settle in shares of the Company's common stock. However, it is the ~~Company's~~Company’s discretion whether this compensation will ultimately be paid in stock or cash. The Company has the right to dictate the form of these payments up until the date at which they are paid. Any change to the expected payment form would result in ~~a change in estimate that would~~out-of-quarter adjustments to this add back to Adjusted Net ~~Income/~~(Loss)./Income.

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

Free Cash Flow

Free cash flow, as reconciled in the table below, is a non-GAAP financial measure defined as net cash provided ~~by or~~ by/(used inin) operating activities, less purchases of property and equipment, and capitalized software development costs. This non-GAAP financial measure may be a useful measure for investors and other users of our financial statements as a supplemental measure of our cash performance and to assess the quality of our earnings as a key performance measure in evaluating management.


Table MD&A 6: Free Cash Flow
	For the Three Months Ended				For the Six Months Ended
	June 30, 2023		June 30, 2022		June 30, 2023		June 30, 2022

	(in thousands)
Net cash (used in)/provided by operating activities	$	(4,113)	$	7,883	$	(4,213)	$	8,132
Adjustments:
Purchases of property and equipment	(47)		(95)		(270)		(641)
Capitalized software development costs	(4,398)		(2,339)		(8,198)		(5,134)
Free cash flow (Non-GAAP)	$	(8,558)	$	5,449	$	(12,681)	$	2,357

Table of Contents

Table MD&A 6: Free Cash Flow
For the Three Months Ended For the Nine Months Ended
September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021
(in thousands)
Net cash flows provided by operating activities $ 11,986 $ 12,991 $ 20,118 $ 9,637
Adjustments:
Purchase of property and equipment (174) (575) (815) (1,645)
Capitalized software development costs (3,446) (3,009) (8,580) (6,672)
Free cash flow $ 8,366 $ 9,407 $ 10,723 $ 1,320

~~Enterprise~~Each of EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net ~~Income~~ Income/(Loss), Adjusted EPS and Free Cash Flow ~~each~~ has limitations as an analytical tool, and you should not consider any of them in isolation, or as a substitute for analysis of our results as reported under GAAP. Among other limitations, ~~Enterprise~~each of EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net ~~Income~~ Income/(Loss), Adjusted EPS and Free Cash Flow ~~each~~ does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments, does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations, and does not reflect income tax expense or benefit. Other companies in our industry may calculate ~~Enterprise EBITDA,~~ Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net ~~Income~~ Income/(Loss), Adjusted EPS and Free Cash Flow differently than we do, which limits their usefulness as a comparative ~~measure.~~measures. Because of these limitations, neither ~~Enterprise~~ EBITDA, Adjusted EBITDA, EBITDA Margin, Adjusted EBITDA Margin, Adjusted Net ~~Income~~ Income/(Loss), Adjusted EPS nor Free Cash Flow should be considered as a replacement for net (loss)/income, ~~(loss), net income (loss) margin,~~ earnings ~~(loss)~~ per share or net cash flows provided by/ ~~(used~~(used in) operating activities, as determined by GAAP, or as a measure of our profitability. We compensate for these limitations by relying primarily on our GAAP results and using non-GAAP measures only for supplemental purposes.

Liquidity and Capital Resources

~~Upon the closing~~Our primary sources of ~~the IPO in November 2020, we issued 17.2~~liquidity are cash on hand, future operating cash flows, and, if needed, borrowings under our $30.0 million ~~shares~~revolving credit facility, with an available expansion feature of ~~our common stock at a price of $17.00 per share, generating net proceeds of approximately $272.8 million. We used approximately $108.9~~up to $30.0 million of ~~the net proceeds in connection with the exchangeable redeemable preferred stock conversion, $30.0~~additional revolver facility. While a variety of factors related to sources and uses of cash, such as timeliness of accounts receivable collections, vendor credit terms, or significant collateral requirements, ultimately impact our liquidity, such factors may or may not have a direct impact on our liquidity.

As of June 30, 2023, we had cash and cash equivalents of $103.4 million ~~to fund~~and our ~~acquisition of the outstanding Class B Units of Telos ID (see~~ ~~Note 10~~ – ~~Purchase of Telos ID Non-controlling Interests~~), and $21.0 million to repay our outstanding senior term loan and subordinated debt. On April 6, 2021, we completed our follow-on offering of 9.1 million shares of our common stock at a price of $33.00 per share, including 7.0 million shares of common stock by certain existing stockholders of Telos. The offering generated approximately $64.3 million of net proceeds to Telos. We did not receive any proceeds from the shares of common stock sold by the selling stockholders. On April 19, 2021, we used approximately $1.3 million of the net proceeds to repurchase 39,682 shares of our common stock and $26.9 million to repurchase 900,970 outstanding warrants for our common stock held by EnCap fund holders. Further, on July 30, 2021, we used approximately $5.9 million of the net proceeds to acquire the assets of DFT (see ~~Note 9~~ – ~~Acquisition). We intend to use the remaining net proceeds of the IPO and the follow-on offering for general corporate purposes.~~

~~Our overall financial position and liquidity are strong. Our~~ working capital was $130.6 million and $140.8 million as of September 30, 2022, and December 31, 2021, respectively. Although no assurances can be given, we expect that funds generated from operations are sufficient to maintain the$110.8 million.

We place a strong emphasis on liquidity ~~we require to meet our operating, investing and financing needs for the next 12 months.~~

~~As of September 30, 2022, we had a cash and cash equivalent balance of $125.3 million, compared to $126.6 million on December 31, 2021.~~management. This ~~balance~~focus gives us the flexibility for capital deployment while ~~maintaining our focus on~~ 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 ~~provided by operating activities was $20.1 million for the nine months ended September 30, 2022, compared to~~Flow


Table MD&A 7: Net Change in Cash, Cash Equivalents, and Restricted Cash
	For the Six Months Ended
	June 30, 2023		June 30, 2022

	(in thousands)
Net cash (used in)/provided by operating activities	$	(4,213)	$	8,132
Net cash used in investing activities	(8,468)		(5,775)
Net cash used in financing activities	(3,176)		(6,199)
Net change in cash, cash equivalents, and restricted cash	$	(15,857)	$	(3,842)

Net cash used in operating activities for the six months ended June 30, 2023, was $4.2 million, an increase of ~~$9.6~~$12.3 million ~~for~~in cash outflow, compared to the same period in ~~2021. Cash provided by or used in operating activities~~2022. The change is primarily driven by the ~~Company’s~~Company's operating ~~loss,~~losses, the timing of ~~receipt~~receipts of customer payments, the timing of ~~our~~ payments to vendors and employees, and the timing of inventory turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities.

~~Cash~~Net cash used in investing activities ~~was approximately $9.4 million and $14.2 million~~ for the ~~nine~~six months ended ~~September~~June 30, ~~2022, and 2021, respectively,~~2023, increased by $2.7 million compared to the same period of the prior year, primarily due to the higher investment in software development costs of ~~$8.6~~$8.2 million and ~~$6.7~~$5.1 million for the ~~nine~~six months ended ~~September~~June 30, 2023 and 2022, ~~and 2021,~~ respectively, ~~and~~partially offset by the ~~purchase~~slight decrease in purchases of property and equipment. ~~In addition, in 2021, $5.9 million was paid in cash for the acquisition completed in July 2021 (see~~ ~~Note 9~~ – ~~Acquisition~~).

~~Cash~~Net cash used in financing activities ~~was $11.8 million~~ for the ~~nine~~six months ended ~~September~~June 30, ~~2022,~~2023, decreased by $3.0 million compared to ~~cash provided by financing activities of $32.7 million for~~ the same period in ~~2021.~~2022. This is primarily attributable to ~~payments under finance leases for both periods, payments~~the decrease in payment of tax withholding related to a net share settlement of equity awards of ~~$3.1~~$1.6 million for the six months ended June 30, 2023, compared with $2.9 million in the same period of 2022, and the ~~repurchase~~cash outflow on repurchases of common stock of ~~$7.6~~$2.6 million in 2022 compared with $0.1 million in 2023 under the share repurchase program (see Note 13 – Share ~~Repurchases~~Repurchases). By

~~Table~~This is partially offset by the payment of ~~Contents~~

~~contrast,~~the DFT holdback amount of $0.6 million in 2021, there was a cash inflow from the follow-on offering that generated $64.3 million of net proceeds, reduced by $2.4 million of final distributions to the Class B Members of Telos ID in the first quarter, $26.9 million used to repurchase the outstanding warrants and $1.3 million to repurchase the common stock held by EnCap fund holders.February 2023.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates, judgments, and assumptions that affect the amounts reported. Actual results could differ from those estimates. The ~~2021~~2022 Form 10-K, as filed with the SEC on March ~~28, 2022,~~16, 2023, includes a summary of critical accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of assets, liabilities, revenues, or expenses during the ~~nine~~six months ended ~~September~~June 30, ~~2022.~~2023.

Table of Contents

Item 3. Quantitative and Qualitative Disclosures about Market Risk

None.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company ~~has established~~maintains disclosure controls and procedures ~~to ensure that information required to be disclosed~~(as defined in ~~this quarterly report on Form 10-Q was properly recorded, processed, summarized~~Rules 13a-15(e) and ~~reported within~~15d-15(e) under the ~~time periods specified in the Commission's rules and forms. The Company's controls and procedures~~Securities Exchange Act of 1934, as amended (the "Exchange Act")), which are designed to ensure that information required to be disclosed by the Company in ~~the~~ reports that it files or submits under the ~~Securities~~ Exchange Act, ~~of 1934, as amended (the "Exchange Act")~~including this Report, are recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Company under the Exchange Act is accumulated and communicated to the Company's management, including its principal executive officer ("CEO") and principal financial officer ("CFO") as appropriate to allow timely decisions regarding required disclosure.

~~We carried out~~The Company's management, including the Company's CEO and CFO, conducted an evaluation of the effectiveness of the ~~design and operation of our~~Company's disclosure controls and procedures ~~(as defined in Exchange Act Rules 13a-15(e)~~as of the end of the period covered by this Report and, ~~15d-15(e)) at September 30, 2022,~~ based on that evaluation, the ~~evaluation of these controls~~CEO and procedures required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Exchange Act. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer. Based upon the evaluation, our Chief Executive Officer and Chief Financial OfficerCFO concluded that ~~on September 30, 2022, our~~the Company’s disclosure controls and procedures were ~~not~~ effective ~~as a result of~~at the ~~previously identified material weaknesses disclosed below.~~

~~Internal Control over Financial Reporting~~

In connection with its evaluation of the internal control over financial reporting for the year ended December 31, 2021, management identified the following material weaknesses in our internal control over financial reporting:

a.Management did not maintain appropriately designed entity-level controls impacting the control environment and monitoring activities to prevent or detect material misstatements to the consolidated financial statements. Specifically, the Company did not have sufficient qualified resources to effectively design, operate and oversee internal control over financial reporting, which contributed to the failure in the effectiveness of certain controls.

b.Management did not maintain appropriately designed information technology general controls in the areas of user access, change management, and segregation of duties, including controls over the recording of journal entries and safeguarding of assets, related to certain information technology systems that support the Company’s financial reporting process.

c.~~Management did not maintain appropriately designed and implemented controls over the following:~~

i.~~Recording of revenue in accordance with ASC Topic 606, "Revenue from Contracts with Customers.”~~

~~ii.Accounting for software development costs in accordance with ASC Topic 985-20, “Software – Costs of Software to be Sold, Leased, or Marketed,” and ASC Topic 350-40, “Internal Use Software.”~~

~~iii.Review of completeness and accuracy of award stock-based compensation expense, and review of the key inputs and assumptions utilized in third-party valuations.~~

~~iv.Preparation and review of projected financial information utilized in the valuation of the business combination.~~

v.~~Financial statement close process to ensure the consistent execution, accuracy, and timely review of account reconciliations, as well as review of the statement of cash flows.~~

~~vi.Coding of transactions within the purchase to disbursement cycle.~~

~~Table of Contents~~

~~These material weaknesses were partially related to employee turnover, resulting in a temporary shortage of qualified personnel to effectively perform the internal controls referenced above.~~

The Company is working to remediate the material weaknesses in internal control over financial reporting and is taking steps to improve the internal control environment. The Company hired additional accounting personnel and implemented training of new and existing personnel on the proper execution of designed control procedures. Further, the Company is:

a.Enhancing processes and designing and implementing internal controls around revenue recognition, software development costs, stock-based compensation, business combination, and financial close and reporting; and,

b.~~Enhancing user access provisioning and monitoring controls to enforce appropriate system access and segregation of duties.~~

~~The material weaknesses will be considered remediated when management concludes that, through testing, the applicable remedial controls are designed and implemented effectively.~~

~~We are still assessing the design and operating effectiveness of these measures and, as such, the identified material weaknesses have not been fully remediated~~reasonable assurance level as of ~~September~~June 30, ~~2022. We will continue to monitor the effectiveness of these remediation measures and will make any changes and take other actions that we deem appropriate.~~2023.

Changes in Internal Control over Financial Reporting

~~Other than the ongoing remediation activities listed above, there has been~~There was no change in ~~our~~the Company's internal control over financial reporting during the quarter ended ~~September~~June 30, ~~2022,~~2023, identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that ~~has~~have materially affected, or isare reasonably likely to materially affect, ~~our~~the Company’s internal control over financial reporting.

3027

Table of Contents

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

Information regarding legal proceedings ~~may be found in~~is included under Note 19 18 – Commitments and Contingencies to the unaudited consolidated financial statements.

Item 1A. Risk Factors

~~There were no material changes in the period ended September 30, 2022, in our risk factors as~~We have disclosed under "Item 1A – Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022, the risk factors which may materially affect our business, financial conditions or results of operations. Except as set forth below, there have been no material changes from the risk factors previously disclosed. You should carefully consider the risk factors set forth below and in the Annual Report on Form 10-K, and other information set forth elsewhere in this Quarterly Report on Form 10-Q. You should be aware that these risk factors and other information may not describe every risk facing the Company. In addition, risks and uncertainties not currently known to us or that we currently do not believe are material could also materially and adversely affect our business, financial condition or results of operations.

An impairment charge of goodwill or other intangibles could have a material adverse impact on our results of operations.

Goodwill was $17.9 million as of June 30, 2023, and December 31, 2022, of which $3.0 million is allocated to the Security Solutions segment and $14.9 million is allocated to the Secure Networks segment. Intangible assets were $37.8 million and $37.4 million as of June 30, 2023, and December 31, 2022, respectively. Under generally accepted accounting principles ("GAAP"), we are required to test the carrying value of goodwill and intangible assets at least annually or sooner if events occur that indicate impairment could exist. These events or circumstances could include a significant change in the business climate, including a sustained decline in a reporting unit’s fair value, legal and regulatory factors, operating performance indicators, competition and other factors. GAAP requires us to assign and then test goodwill at the reporting unit level.

If over a sustained period of time we experience a decrease in our stock price and market capitalization, which may serve as an estimate of the fair value of our reporting unit, an indication of impairment may have occurred. If the fair value of our reporting unit is less than its net book value, we may be required to record goodwill impairment charges in the future. In addition, if the revenue and cash flows generated from any of our other intangible assets is not sufficient to support its net book value, we may be required to record an impairment charge.

During the first half of 2023, the price per share of our common stock as traded on the NASDAQ Global Market declined below net book value per share. If our stock price remains below net book value per share or other negative business factors described above exist, we may be required to perform a goodwill impairment analysis before the end of the year. That analysis or the annual analysis may result in an impairment charge that could be significant and could have a material adverse impact on our results of operations for the period in which the charge is taken.

A decline in the federal budget, changes in spending or budgetary priorities of the U.S. government, a prolonged U.S. government shutdown or delays in contract awards may significantly and adversely affect our future revenues, cash flow and financial results.

In recent years, U.S. government appropriations have been affected by larger U.S. government budgetary issues and related legislation. As a result, DoD funding levels have fluctuated and have been difficult to predict. Future spending levels are subject to a wide range of factors, including Congressional action. In addition, in recent years, the U.S. government has been unable to complete its budget process before the end of its fiscal year, resulting in both a government shutdown and continuing resolutions to extend sufficient funds only for U.S. government agencies to continue operating. Most recently, the federal government was shut down due to a lack of funding for over one month between late 2018 and early 2019. Additionally, the national debt has recently threatened to reach the statutory debt ceiling in 2023, and such an event in future years could result in the U.S. government defaulting on its debts.

As a result, government spending levels are difficult to predict beyond the near term due to numerous factors, including the external threat environment, future government priorities and the state of government finances. Significant changes in government spending or changes in U.S. government priorities, policies and requirements could have a material adverse effect on our results of operations, financial condition or liquidity.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) None.

(b) None.

~~(a)Unregistered Sales~~Table of ~~Securities~~Contents

~~None.~~

~~(b)Use of Proceeds~~

~~None.~~

~~(c)Issuer Purchases of Equity Securities~~

Common Stock Purchase Activity During the Three Months Ended September 30, 2022
Period
Total Number of Shares Purchased (1) (2)
Average Price Paid per Share (1)
Total Number of Shares Purchased as Part of Publicly Announced Repurchases Plans (1)
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans (1)
July 1, 2022 - July 31, 2022 151,675 $ 7.73 119,012 $ 46,077,038
August 1, 2022 - August 31, 2022 230,183 9.64 230,183 $ 43,856,971
September 1, 2022 - September 30, 2022 149,536 10.30 149,536 $ 42,316,996
Total 531,394 $ 9.38 498,731

~~(1)~~ On May 24, 2022, the Board of Directors authorized a Share Repurchase Program, pursuant to which the Company can repurchase up to $50.0 million of issued and outstanding common stock. The repurchase program has no expiration date and may be modified, suspended, or terminated at any time. For the third quarter of 2022, the Company repurchased 498,731 shares of common stock under the program for an aggregate price of $4.7 million in open market.

~~(2)~~ The Total Number of Shares Purchased includes shares withheld by the Company upon the vesting of restricted stock units to satisfy tax withholding obligations of the holders of those restricted stock units.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

~~Table of Contents~~

Item 6. Exhibits


Exhibit ~~No.~~ Number		Description
10.1	* +	Form of ~~Exhibit~~Telos Corporation Notice of Grant of Option
10.2	* +	Form of Telos Corporation Notice of Grant of Restricted Shares and/or Restricted Share Units (Time-Based)
31.1	v+	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2	v+	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32	z^	Certification ~~of Chief Executive Officer and Chief Financial Officer~~pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS	v+	XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

101.SCH	v+	XBRL Taxonomy Extension Schema Document

101.CAL	v+	XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF	v+	XBRL Taxonomy Extension Definition Linkbase Document

101.LAB	v+	XBRL Taxonomy Extension Label Linkbase Document

101.PRE	v+	XBRL Taxonomy Extension Presentation Linkbase Document

104	v+	Cover Page Interactive Data ~~File. (formatted as~~File - the cover page iXBRL tags are embedded within the Inline XBRL ~~tags and~~document contained in Exhibit ~~101)~~101



v*			~~Filed herewith.~~constitutes a management contract or compensatory plan or arrangement
z+			~~Furnished herewith.~~filed herewith
^			furnished herewith

3229

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the ~~Registrant~~registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


TELOS CORPORATION


	/s/ John B. Wood	~~November~~August 9, ~~2022~~2023
By:	John B. Wood
	Chief Executive Officer
	~~(Principal~~ (Principal Executive Officer)


	/s/ Mark Bendza	~~November~~August 9, ~~2022~~2023
By:	Mark Bendza
	Chief Financial Officer
	~~(Principal~~ (Principal Financial Officer)


	/s/ Victoria Harding	~~November~~August 9, ~~2022~~2023
By:	Victoria Harding
	Controller and Chief Accounting Officer
	~~(Principal~~ (Principal Accounting Officer)

3330


Table 12.2: Service-Based RSU and Performance-Based RSU Award Activity
	Service-Based RSU	Performance-Based RSU	Total	Weighted-Average Grant Date Fair Value
Unvested outstanding units as of December 31, 2021	3,030,608	492,727	3,523,335	$	34.24
Granted	3,897,786	—	3,897,786	10.00
Vested	(1,653,308)	—��	(1,653,308)	31.21
Forfeited	(360,762)	(155,942)	(516,704)	33.22
Unvested outstanding units as of September 30, 2022	4,914,324	336,785	5,251,109	$	17.23


Table 13: Shares Repurchase Activity
	For the Three Months Ended				For the Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021

	(in thousands, except per share and share data)
Amount paid for shares repurchased (1)	$	4,681	$	—	$	7,683	$	—
Number of shares repurchased	498,731		—		859,170		—
Average per share price paid (1)	$	9.38	$	—	$	8.94	$	—


Table 18.1: Impact of the Correction to the Condensed Consolidated Statement of Operations
	For the Three Months Ended September 30, 2021						For the Nine Months Ended September 30, 2021
	Previously Reported		Error Correction		As Adjusted		Previously Reported		Error Correction		As Adjusted

	(in thousands, except per share amounts)
Revenue - services	$	63,690	$	(735)	$	62,955	$	163,366	$	650	$	164,016
Revenue - products	6,376		(350)		6,026		15,017		(650)		14,367
Revenue	70,066		(1,085)		68,981		178,383		—		178,383
Cost of sales - services	40,031		106		40,137		109,134		(898)		108,236
Costs and expenses	43,998		106		44,104		117,400		(898)		116,502
Research and development	5,396		(533)		4,863		14,783		(533)		14,250
General and administrative	20,562		(823)		19,739		69,271		181		69,452
Selling, general and administrative expenses	31,321		(1,356)		29,965		98,287		(352)		97,935
Operating loss	(5,253)		165		(5,088)		(37,304)		1,250		(36,054)
Loss before income taxes	(5,428)		165		(5,263)		(38,888)		1,250		(37,638)
Net loss	(5,387)		165		(5,222)		(38,894)		1,250		(37,644)
Net loss attributable to Telos Corporation	(5,387)		165		(5,222)		(38,894)		1,250		(37,644)
Net loss per share attributable to Telos Corporation
Basic	$	(0.08)	$	—	$	(0.08)	$	(0.59)	$	0.02	$	(0.57)
Diluted	$	(0.08)	$	—	$	(0.08)	$	(0.59)	$	0.02	$	(0.57)


Common Stock Purchase Activity During the Three Months Ended September 30, 2022
Period	Total Number of Shares Purchased (1) (2)	Average Price Paid per Share (1)		Total Number of Shares Purchased as Part of Publicly Announced Repurchases Plans (1)	Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans (1)
July 1, 2022 - July 31, 2022	151,675	$	7.73	119,012	$	46,077,038
August 1, 2022 - August 31, 2022	230,183	9.64		230,183	$	43,856,971
September 1, 2022 - September 30, 2022	149,536	10.30		149,536	$	42,316,996
Total	531,394	$	9.38	498,731