TELOS CORPORATION Forward-Looking Information
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and the related notes to consolidated financial statements included
in Part II, Item 8 of this Annual Report on Form 10-K ("10-K"). In addition to
historical financial information, the following discussion and analysis contains
forward-looking statements that involve risks, uncertainties and assumptions.
Our actual results and timing of selected events in future periods may differ
materially from those anticipated or implied in these forward-looking statements
as a result of many factors, including those discussed under Item 1A, " Risk
Factors ," and elsewhere in this 10-K. See also " Spe cial Note
Regarding Forward-Looking Statements " at the beginning of this 10-K.
Management's Discussion and Analysis for the Year Ended
Management's discussion and analysis of the financial condition and results of operations for the yearDecember 31, 2020 , including a comparison of our results for the years endedDecember 31, 2021 and 2020, is included in Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2021 , which was filed with theSecurities and Exchange Commission onMarch 28, 2022 .
Overview
We offer technologically advanced, software-based security solutions that empower and protect the world's most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats. Our portfolio of security products, services and expertise 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' people, information, and digital assets so they can pursue their corporate goals and conduct their global missions with confidence in their security and privacy.
Information regarding our segments is presented in Note 21 - Segment Information to the consolidated financial statements at Item 8 of this Form 10-K.
Business Environment Our business performance continues to be heavily affected by the overall level ofU.S. government spending and the alignment of our solutions with the priorities of theU.S. government.U.S. government spending and contracts continue to be affected by the federal budget, and appropriations process and related legislation.Congress could not agree on fiscal year ("FY") 2023 appropriations legislation before the start of the fiscal year onOctober 1, 2022 . As a result, the entire federal government operated for nearly three months under the terms of a continuing resolution ("CR"), which only permitted 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, federal departments and agencies were generally precluded from moving forward on new contract starts or accelerating current projects while they were funded by a CR.Congress finally reached an agreement and completed action in late December on an omnibus appropriations package to fund the entire federal government through the remainder of FY 2023. This final appropriations legislation provided an increase in total defense spending for FY 2023 of$44 billion above the budget proposed last spring by theWhite House , and represents a$76 billion increase above last year's funding level. It also included significant increases in federal civilian agency (non-defense) cybersecurity funding, including a 15 percent increase from last year for theCybersecurity and Infrastructure Security Agency for various program enhancements and new initiatives.The Office of Management and Budget has already given federal departments and agencies guidance for cybersecurity priorities to include in their FY 2024 proposed budgets, including accelerated 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. We look forward to the President's budget and subsequent congressional action reflecting these priorities, which align with the solutions Telos has been developing and bringing to market for the past several years. For example, Xacta, our flagship offering, continues to set the standard for innovative capabilities 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. 28
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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 have resulted in intensified efforts to better defend against such attacks. The growing demand for these solutions continues to provide Telos with the privilege of offering our expertise to protect these vitally important organizations. 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 the risk of ransomware gaining a foothold in their IT environment. Our Telos ACA offering provides real- and near-real-time intelligence into known and unknown threats to give organizations advance warning 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.
The Nation's Critical Systems Are Still at Risk
Critical infrastructure and industrial 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 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 makesTelos Ghost a robust component in a Secure Access Service Edge or Zero Trust Network Access security architecture.
The Challenging Complexity of Regulatory Compliance
Government mandates and initiatives to assure stronger security in highly regulated industries, as noted above, also lead to opportunities for Telos solutions and services. An update to the research study Telos conducted last year reveals that audit fatigue continues to burden these 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, and automates the security controls and processes that comprise the leading cybersecurity standards and frameworks, in on-premises, cloud, hybrid, and multi-cloud environments.
For example, Xacta supports 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.
TheDoD's emerging 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 byThe Cyber AB to provide consulting services to government contractors and other companies in preparation for their CMMC assessments. Finally, CISOs with today's cost-conscious enterprises are also 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 posture and visualizes progress over time. In addition, customers can also define their own financial loss formula for customer-specific risk analysis in dollar amounts.
Identity Assurance and Privacy Protection are Essential for Today's Enterprises
Identity and access management continues to be a major cybersecurity concern for organizations and individuals that need to ensure their security and protect their privacy. Trusted identities are essential to confidence in IT and physical security strategies and to the success ofZero Trust security models and architectures. Telos is a longstanding leader in solutions that assure identity trust, mitigate risk to critical infrastructure, and reduce the threat of sensitive information exposure. 29
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Our IDTrust360® digital identity management platform integrates the full spectrum of identity and access management technologies in a cloud-based system that's quickly scalable to enterprise requirements. Our ONYX® touchless mobile fingerprinting solution captures fingerprints using the rear-facing camera on most off-the-shelf smartphones, replacing expensive physical hardware infrastructure for capturing fingerprints and streamlining customer identification and background checks in financial services, law enforcement, healthcare, and enterprise identity and authentication. We also maintain government certifications and designations that distinguish Telos in the identity and access field, including TSA PreCheck enrollment provider, Designated Aviation Channeling provider,FBI -approved Channeler, and Financial Industry Regulatory Authority Electronic Fingerprint Submission provider.
Global Networks and Worldwide Communications Need Baked-in Security
Today's enterprises are also in need of resilient cyber and information security capabilities to protect and defend critical infrastructure to ensure mission success. Telos Secure Networks offers secure mobility solutions, network architecting, planning and installation, security compliance, and network management expertise to defend against cyber threats and vulnerabilities. Telos Secure Networks offers these capabilities and more - on-premises, deployed, and in the cloud - to transform and empower military, government, and commercial enterprises to meet their critical and operational needs. Telos is a certified IT company offering technical expertise, global reach, and strategic partnerships to meet our customers' most challenging issues. We have also built a culture of innovation focused on digital transformation - taking complex technology solutions and making them actionable and secure with advanced capabilities such as RPA, multi-cloud migration, and risk management. Telos serves theU.S. Air Force ,U.S. Army , and other organizations in locations around the globe with base-level network support, deployable communications, modernized voice over IP solutions, infrastructure relocation and realignment, and other capabilities for secure enterprise communications. Our experience has prepared us for the unique responsibility of ensuring that the government's most critical information systems in the most sensitive locations are protected from threats in both the physical and virtual worlds.
Opportunities, Challenges and Risks
We derive a substantial portion of our revenues from contracts and subcontracts with theU.S. government. Our revenues are generated from a number of contract vehicles and task orders. Over the past several years we have sought to diversify and improve our operating margins through an evolution of our business from an emphasis on product reselling to that of an advanced solutions technologies provider. To that end, although we continue to offer resold products through our contract vehicles, we have focused on selling solutions and outsourcing product sales, as well as designing and delivering Telos manufactured and branded technologies. We believe our contract portfolio is characterized as having low to moderate financial risk due to the limited number of long-term fixed-price development contracts. Our firm-fixed-price activities consist principally of contracts for products and services at established contract prices. Our time-and-material contracts generally allow the pass-through of allowable costs plus a profit margin. For 2022, 2021, and 2020, the Company's revenue derived from firm-fixed-price contracts was 82.9%, 87.6%, and 84.3%, respectively; cost-plus contracts revenue was 11.1%, 7.3%, and 8.2%, respectively; and time-and-material contracts was 6.0%, 5.1%, and 7.5%, respectively. Our business performance is affected by the overall level ofU.S. government spending and the alignment of our offerings and capabilities with the budget priorities of theU.S. government. Adverse changes in fiscal and economic conditions could materially impact our business. Some changes that could adversely impact our business include the implementation of future spending reductions and government shutdown. Despite the budget and competitive pressure affecting the industry, we believe we are well-positioned to expand existing customer relationships and benefit from opportunities that we have not previously pursued.U.S. government has increasingly relied on contracts that are subject to a competitive bidding process (including indefinite delivery, IDIQ, GSA schedules, OTA, and other multi-award contracts), which has resulted in greater competition and increased pricing pressure. We expect that a majority of the business that we seek in the foreseeable future will be awarded through a competitive bidding process. 30
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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. 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 ofU.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.
Table MD&A 1: Backlog by Segment
As of December 31,
2022 2021
(in thousands)
Security Solutions
Funded backlog $ 33,784 $ 35,382
Unfunded backlog 47,509 54,198
Total Security Solutions backlog 81,292 89,580
Secure Networks
Funded backlog 48,454 88,097
Unfunded backlog 82,296 68,730
Total Secure Networks backlog 130,750 156,827
Total
Funded backlog 82,238 123,479
Unfunded backlog 129,805 122,928
Total backlog $ 212,043 $ 246,407
Financial Overview
A number of factors have affected our current and future financial growth, the
most significant of which are described below. More details on these changes are
presented below within our "Results of Operations" section.
•On October 18, 2022 , TSA issued an authority 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 of applicants in
order to validate systems 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 anticipates this launch will occur in
calendar year 2023.
•On December 30, 2022 , we entered into a new credit agreement with JPMorgan
Chase N.A. , which provides for a $30.0 million senior secured revolving facility
with a maturity date of December 30, 2025 , the option of issuing letters of
credit and with an uncommitted expansion feature of up to $30.0 million of
additional revolver facility. The revolving credit facility will be used for
working capital and general corporate purposes. While there are no drawn funds
from the revolving credit facility as of December 31, 2022 , the cost of
servicing any debt for a full year, as well as increasing interest rates, may
have an impact on future interest expense.
•The winding down of certain projects, completion of several large programs in
fiscal years 2021 and 2022, and new business wins below expectations resulted in
a decline in current year revenue.
•In the fourth quarter of 2022, we committed to a restructuring plan resulting
in a reduction of the Company's workforce, with a majority of the affected
employees separating from the business in early 2023. The costs associated with
the restructuring plan include employee severance-related benefit costs
(including outplacement services and continuing health insurance coverage).
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Key Performance Measures
The primary financial performance measures we use to manage our business and monitor results of operations are revenue, gross profit, and Adjusted EBITDA. We evaluate our results of operations by considering the drivers causing changes in these measures. We evaluate significant trends and fluctuations in our contract portfolio over time due to contract awards and completions, changes in customer requirements and changes in the volume of product and software sales. Changes in costs of revenue as a percentage of revenue other than from revenue volume or cost mix are driven by changes in the compensation expense and other allocated costs and/or cumulative revenue adjustments due to changes in estimates. Changes in operating cash flows are driven by changes in cash generated through delivery of products and services, fluctuations in current assets and liabilities and the impact of changes in the timing of cash receipts or disbursements.
Results of Operations
Consolidated Results
Table MD&A 2: Consolidated Financial Results Comparison
For the
Year Ended
2022 2021 Change ($)
(dollars in thousands)
Revenue $ 216,887 $ 242,433 $ (25,546)
Cost of sales 137,844 156,404 (18,560)
Gross profit 79,043 86,029 (6,986)
Gross margin 36.4 % 35.5 %
Selling, general and administrative expenses 132,893 127,493 5,400
Selling, general and administrative expense as
percentage of revenue 61.3 % 52.6 %
Operating loss (53,850) (41,464) (12,386)
Other income/(expense) 1,350 (921) 2,271
Interest expense (874) (777) (97)
Loss before income taxes (53,374) (43,162) (10,212)
(Provision for)/benefit from income taxes (54) 28 (82)
Net loss $ (53,428) $ (43,134) $ (10,294)
Our business segments have different factors driving revenue fluctuations and
profitability. The discussion of the changes in our net revenue and
profitability are covered in greater detail under the section that follows
"Segment Results." We generate revenue from the delivery of products and
services to our customers. Cost of sales, for both products and services,
consists of labor, materials, subcontracting costs and an allocation of indirect
costs.
Selling, general, and administrative ("SG&A") expenses increased by $5.4 million
or 4.2% in 2022 compared to 2021. This is primarily due to increases in
stock-based compensation by $3.6 million and labor costs by $3.0 million , offset
by a decrease in outside services of $1.3 million . In 2022, labor costs include
termination benefits related to the restructuring plan aggregating to
$2.2 million , with no similar cost in 2021.
Other income/(expense) increased by $2.3 million due to dividend income from
money market placements amounting to $1.0 million earned in 2022 without similar
income in 2021, and other expenses of $0.9 million for the settlement of
outstanding litigation in 2021, with no similar cost in 2022. There was no
significant change in interest expense between comparable periods.
The increase in the income tax provision in 2022 compared to 2021 is primarily due to an increase in state income taxes.
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Segment Results
The accounting policies of each business segment are the same as those followed by the Company as a whole. Management evaluates business segment performance based on gross profit.
Table MD&A 3: Security Solutions Segment - Financial Results Comparison
For the Year
Ended
2022 2021 Change ($)
(dollars in thousands)
Revenues $ 120,454 $ 123,534 $ (3,080)
Gross profit 61,948 64,904 (2,956)
Gross margin 51.4 % 52.5 % (1.1) %
Our Security Solutions segment revenue decreased by
Likewise, the segment gross profit decreased by$3.0 million or 4.6% in 2022 compared to 2021 and segment gross margin also decreased from 52.5% in 2021 to 51.4% in 2022. The decrease in gross margin is the result of changes in the mix of programs within the portfolio and lower margin of certain projects within the segment.
Table MD&A 4: Secure Networks Segment - Financial Results Comparison
For the Year Ended December 31,
2022 2021 Change ($)
(dollars in thousands)
Revenues $ 96,433 $ 118,899 $ (22,466)
Gross profit 17,095 21,125 (4,030)
Gross margin 17.7 % 17.8 % (0.1) %
Our Secure Networks segment revenue decreased by $22.5 million or 18.9% in 2022
compared to 2021, primarily due to the expected wind-down in 2022 and completion
of large programs in the second half of 2022.
Segment gross profit decreased by
Non-GAAP Measures
In addition to our results determined in accordance withU.S. GAAP, we believe the non-GAAP financial measures of EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net 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 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 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 disproportionate 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. 33
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EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin
EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measures of
operating performance that are not made under GAAP and do not represent, and
should not be considered as, an alternative to net loss as determined by GAAP.
We define EBITDA as net (loss)/income, adjusted for non-operating
expense/(income), interest expense, provision for/(benefit from) income taxes,
and depreciation and amortization. We define Adjusted EBITDA as EBITDA, adjusted
for restructuring expenses and stock-based compensation expense. We define
Adjusted EBITDA Margin as Adjusted EBITDA as a percentage of total revenue.
Table MD&A 5: Reconciliation of Net Loss to EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin
For the Year Ended December 31,
2022 2021
Amount Margin Amount Margin
(dollars in thousands)
Net loss $ (53,428) (24.6) % $ (43,134) (17.8) %
Other (income)/expense (1,350) (0.6) % 921 0.4 %
Interest expense 874 0.4 % 777 0.3 %
Provision for/(benefit from) income taxes 54 - % (28) - %
Depreciation and amortization 5,890 2.7 % 5,624 2.4 %
EBITDA (47,960) (22.1) % (35,840) (14.7) %
Restructuring expenses (1) 2,767 1.3 % - - %
Stock-based compensation expense (2) 64,660 29.8 % 60,231 24.8 %
Adjusted EBITDA $ 19,467 9.0 % $ 24,391 10.1 %
(1) The restructuring expenses adjustment to EBITDA includes severance and other
related benefit costs (including outplacement services and continuing health
insurance coverage) associated with a reduction in workforce.
(2) The stock-based compensation adjustment to EBITDA for fiscal year 2022 is
made up of $62.5 million of stock-based compensation expenses for the awarded
service-based restricted stock units ("RSUs") and performance-based restricted
stock units ("PRSUs"), and $2.1 million of other sources of stock-based
compensation expense. The other source of stock-based compensation consists of
accrued compensation, which the Company 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. 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 add back to Adjusted EBITDA.
Adjusted Net Income and Adjusted EPS - Non-GAAP
Adjusted Net Income and Adjusted EPS are supplemental measures of operating performance that are not made under GAAP and do not represent, and should not be considered as, alternatives to net (loss)/income as determined by GAAP. We define Adjusted Net Income as net loss, adjusted for non-operating expense/(income), restructuring expenses and stock-based compensation expense. We define Adjusted EPS as Adjusted Net Income divided by the weighted-average number of common shares outstanding for the period.
Table MD&A 6: Reconciliation of Net Loss to Non-GAAP Adjusted Net Income and Adjusted EPS
For the Year Ended
2022 2021
Adjusted Adjusted
Adjusted Net Earnings Per Adjusted Net Earnings Per
Income/(Loss) Share Income/(Loss) Share
(in thousands, except per share data)
Reported GAAP measure $ (53,428) $ (0.79) $ (43,134) $ (0.65)
Adjustments:
Other (income)/expense (1,350) (0.02) 921 0.01
Restructuring expenses (1) 2,767 0.04 - -
Stock-based compensation expense (2) 64,660 0.96 60,231 0.91
Adjusted non-GAAP measure $ 12,649 $
0.19
67,559 66,374
(1) The restructuring expenses adjustment to net loss includes severance and other related benefit costs (including outplacement services and continuing health insurance coverage) associated with a reduction in workforce.
(2) The stock-based compensation adjustment to net loss for fiscal year 2022 is made up of$62.5 million of stock-based compensation expenses for the awarded RSUs and PRSUs, and$2.1 million of other sources of stock-based compensation expense. The other source of stock-based compensation consists of accrued compensation, which the Company 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. 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 add back to Adjusted Net Income/(Loss). 34
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Free Cash Flow
Free cash flow, as reconciled in the table below, is a non-GAAP financial
measure defined as net cash provided by or used in operating activities less
purchases of property and equipment and capitalized software development costs
plus net cash proceeds from resale of software under other financing
obligations. 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 7: Free Cash Flow
For the Year Ended December 31,
2022 2021
(in thousands)
Net cash flows provided by operating activities $ 16,508 $ 7,262
Adjustments:
Purchases of property and equipment (1,009) (3,201)
Capitalized software development costs (12,708) (9,968)
Net cash proceeds from resale of software 8,457 -
Free cash flow $ 11,248 $ (5,907)
Each of EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net
Income/(Loss), Adjusted EPS and Free Cash Flow has limitations as an analytical
tool, and you should not consider any of them in isolation, or as a substitute
for analysis of our results as reported under GAAP. Among other limitations,
each of EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net
Income/(Loss), Adjusted EPS and Free Cash Flow does not reflect our 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 Adjusted
EBITDA, Adjusted EBITDA Margin, Adjusted Net Income/(Loss), Adjusted EPS and
Free Cash Flow differently than we do, which limits their usefulness as
comparative measures. Because of these limitations, neither EBITDA, Adjusted
EBITDA, Adjusted EBITDA Margin, Adjusted Net Income/(Loss), Adjusted EPS nor
Free Cash Flow should be considered as a replacement for net (loss)/income,
earnings per share or net cash flows provided by operating activities, as
determined by GAAP, or as a measure of our profitability. We compensate for
these limitations by relying primarily on our GAAP results and using non-GAAP
measures only for supplemental purposes.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flow from operations, and availability under our revolving credit 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. Upon the closing of the IPO inNovember 2020 , we issued 17.2 million shares 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 million of the net proceeds in connection with the exchangeable redeemable preferred stock conversion (see Note 1 3 - Exchangeable Redeemable Preferred Stock Conversio n ),$30.0 million to fund our acquisition of the outstanding Class B Units of Telos ID (see Note 1 1 - Purchase of Telos ID
Non-controlling Interests ), and
and
Other Obligations ). 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. OnApril 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 warrants to purchase 900,970 shares of our common stock owned by EnCap (see Note 12 - Debt and Other Obligations ). Further, onJuly 30, 2021 , we used approximately$5.9 million of the net proceeds to acquire the assets of DFT (see Note 10 -
Acquisition ). We intend to use the remaining net proceeds of the IPO and the follow-on offering for general corporate purposes.
As ofDecember 31, 2022 , we had cash and cash equivalents of$119.3 million and our working capital was$122.5 million . In addition, onDecember 30, 2022 , we entered into a$30.0 million senior secured revolving credit facility, with an expansion feature of up to$30.0 million of additional revolver capacity. 35
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We place a strong emphasis on cash flow generation. This focus gives us the flexibility for capital deployment while preserving a strong balance sheet to position us for future opportunities. We believe we have adequate funds on hand to execute our financial and operating strategy. Our overall financial position and liquidity are strong. Although no assurances can be given, we believe that funds generated from operations, 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.
Senior Credit Facility
OnDecember 30, 2022 , Telos (as borrower) and its subsidiaries (as guarantors) entered into a Credit Agreement withJPMorgan Chase Bank, N.A . that provides for a$30.0 million senior secured revolving credit facility, with the option of issuing letters of credits thereunder and with an uncommitted expansion feature of up to$30.0 million of additional revolver capacity (the "Loan"). The Loan will mature onDecember 30, 2025 and is subject to acceleration in the event of customary events of default. Borrowings under the Credit Agreement will accrue interest and we may elect to borrow (at our option) 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%. After the occurrence and during the continuance of any event of default, the interest rate may increase by an additional 2.0%. We are also paying 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 Credit Agreement contains representations, warranties, covenants, terms and conditions customary for transactions of this type and includes a maximum senior leverage ratio financial covenant. In connection with the Credit Agreement, the Agent has been granted, for the benefit of the Lenders, a security interest in and general lien upon various property of the Company and the Guarantors, subject to certain permitted liens and encumbrances. 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. As ofDecember 31, 2022 , there were no outstanding balances under the revolving credit facility and we were in compliance with all covenants contained in the Credit Agreement. Other Financing Obligations Telos entered into a Master Purchase Agreement ("MPA") with a third-party buyer ("Buyer") for$9.1 million ("Assignment Price") relating to software licenses under a specific delivery order ("DO") with our customer resulting in proceeds from other financing obligations of$9.1 million inNovember 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 throughJanuary 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, n et for further details. OnFebruary 9, 2023 , the customer notified Telos 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.
Cash Flow
Table MD&A 8: Cash Flows Information
For the Year Ended December 31,
2022 2021
(in thousands)
Net cash provided by operating activities $ 16,508 $ 7,262
Net cash used in investing activities (13,717) (19,094)
Net cash (used in)/provided by financing activities (9,915) 32,349
Net change in cash, cash equivalents, and restricted cash $ (7,124)
Net cash provided by operating activities for the years endedDecember 31, 2022 and 2021 was$16.5 million and$7.3 million , respectively. The cash flow from operating activities is primarily driven by the Company's operating losses, the timing of receipts of customer payments, the timing of payments to vendors and employees, and the timing of inventory turnover, adjusted for certain non-cash items that do not impact cash flows from operating activities. The$9.2 million increase is due to favorable changes in certain operating assets and liabilities, particularly on receivables. 36
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Net cash used in investing activities for the years endedDecember 31, 2022 and 2021 was$13.7 million and$19.1 million , respectively. Our investing activities include cash paid for capital expenditure and business acquisition. Capital expenditures for the year endedDecember 31, 2022 and 2021, consisted of the capitalization of software development costs of$12.7 million and$10.0 million , respectively, and the purchases of property and equipment of$1.0 million , and$3.2 million , respectively. In 2021, we paid$5.9 million of cash for the acquisition completed inJuly 2021 . For the year endedDecember 31, 2022 , net cash used in financing activities was$9.9 million compared to net cash provided by financing activities of$32.3 million in 2021. This is primarily attributable to payments under finance leases for both periods, payments of tax withholding related to the net share settlement of equity awards of$5.7 million in 2022, and the repurchase of common stock of$11.1 million in 2022 under the Share Repurchase Program, partially offset by the proceeds from the other financing obligations of$9.1 million . By contrast, 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 to repurchase the outstanding warrants and$1.3 million to repurchase the common stock held byEnCap fund holders.
Commitments
The Company does not have any other contractual obligations atDecember 31, 2022 , except for the commitments on the existing lease obligations on various office space and equipment under non-cancelable operating and finance leases. We reported current and long term lease liabilities.
Table MD&A 9: Contractual Obligations
Payments due by Period
Total 2023 2024 - 2026 2027 - 2029 Thereafter
(in thousands)
Other financing obligations $ 8,458 $ 1,247
15,118 2,203 6,944 5,971 -
Operating lease obligations (1) (2) 400 373 27 - -
Total contract obligations $ 23,976 $ 3,823 $ 14,182 $ 5,971 $ -
(1) Includes interest expense $ 2,278 $ 611 $ 1,303 $ 364 $ -
(2) Includes operating lease right-of-use obligations and short-term leases with terms of 12 months or less. We have
various lease agreements pursuant to ASC 842, "Leases" that require us to record the present value of the minimum lease
payments for such lease properties.
On
and Other Obligations , to the Consolidated Financial Statements for information regarding the terms of the facility.
In addition, there were no outstanding commitments that were considered material
for capital expenditures on
See Note 22 - Commitment and Contingenc ies , to the Consolidated Financial Statements for further discussion of other commitment and contingencies.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions that affect the amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. Management evaluates these estimates and assumptions on an ongoing basis. Our estimates and assumptions have been prepared on the basis of the most current reasonably available information, and may change in the future as more current information is available. Management believes that our critical accounting policies are those that are both material to the presentation of our financial condition and results of operations and require management's most difficult, subjective and complex judgments. Typically, the circumstances that make these judgments difficult, subjective and complex have to do with making estimates about the effect of matters that are inherently uncertain; as a result, actual results could differ from those estimates. The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements in fiscal year 2022 are described below. It is not intended to be a comprehensive list of all significant accounting policies that are more fully described in the notes to consolidated financial statements contained within this report. 37
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Revenue Recognition
Although most of our revenue is recognized concurrently with billing or with the passage of time, some of our revenue requires us to make estimates. The timing of the satisfaction of performance obligations varies across our businesses due to our diverse product and service mix, customer base, and contractual terms. Significant judgment can be required in determining certain performance obligations, and these determinations could change the amount of revenue and profit recorded in a given period. Our contracts may have a single performance obligation or multiple performance obligations. When there are multiple performance obligations within a contract, we allocate the transaction price, net of any discounts, to each performance obligation based on the standalone selling price of the product or service underlying each performance obligation. The standalone selling price is either based on estimated or actual costs plus a reasonable profit margin or the observable price of a good or service when Telos sells that good or service separately in similar circumstances and to similar customers. The transaction price for our contracts represents our best estimate of the consideration we will receive and includes assumptions regarding variable consideration, as applicable. The transaction price is allocated to each distinct performance obligation within the contract and recognized as revenue when, or as, the performance obligation is satisfied. Our contracts may also include various types of variable considerations such as claims (i.e., indirect rate or other equitable adjustments) or incentive fees and we include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur. The estimated amounts are based on an assessment of our anticipated performance and all other information that is reasonably available to us. For contracts where revenue is recognized over time, we recognized revenue based on progress towards completion of the performance obligation, using costs incurred to date relative to total estimated cost at completion to measure progress on a proportional performance basis for our contracts. Due to the nature of the work required to be performed on certain contracts, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment. Contract estimates are based on various assumptions, including labor and subcontractor costs, materials and other direct costs and the complexity of the work to be performed. A significant change in one or more of these estimates could affect the profitability of our contracts. We review and update our contract-related estimates regularly and recognize adjustments in estimated profit on contracts on a cumulative catch-up basis, which may result in an adjustment increasing or decreasing revenue to date on a contract in a particular period that the adjustment is identified. Revenue and profit in future periods of contract performance are recognized using the adjusted estimate. During the year endedDecember 31, 2022 , there is no catch-up revenue recognized as a result of changes in contract estimates noted.
We evaluate the impairment of goodwill and other long-lived assets in accordance
with Accounting Standards Codification ("ASC") 350, "Intangibles - Goodwill and
Other." Management annually reviews goodwill and other long-lived assets for
impairment or whenever events or changes in circumstances indicate the carrying
amount may not be recoverable. If we determine that the carrying value of the
goodwill and other long-lived assets may not be recoverable, we will record an
impairment charge for the amount by which the carrying value of the goodwill and
other long-lived assets exceeds its fair value.
Goodwill is not amortized, but rather tested for potential impairment as of
December 31 each year. The goodwill impairment test is performed at the
reporting unit level. Accounting requirements provide that a reporting entity
may perform an optional qualitative assessment on an annual basis to determine
whether events occurred or circumstances changed that would more likely than not
reduce the fair value of a reporting unit below its carrying amount. If an
initial qualitative assessment identifies that it is more likely than not that
the fair value of a reporting unit is less than its carrying amount, or the
optional qualitative assessment is not performed, a quantitative analysis is
performed. The Company performs the quantitative goodwill impairment test by
calculating the fair value of the reporting unit and comparing it to its
respective carrying value including goodwill. If the fair value is less than the
carrying value, the amount of impairment expense is equal to the difference
between the reporting unit's fair value and the reporting unit's carrying value.
We measure fair value based on a discounted cash flow method, which requires
management's judgment with respect to forecasted revenue, operating margins,
capital expenditures, and selection and use of an appropriate discount rate
commensurate with the risk inherent in each of our reporting units' current
business models. We utilize the weighted average cost of capital as derived by
certain assumptions specific to our facts and circumstances as the discount
rate. Our estimate of cash flows and discount rate are subject to change due to
the economic environment. In addition, the estimate of the total fair value of
our reporting units is compared to the market capitalization of the Company.
We amortized intangible assets over their respective estimated useful lives, and
reviewed them for impairment whenever events or changes in business
circumstances indicate the carrying value may not be recoverable. We completed
the required annual impairment test of goodwill for all reporting units and
other long-lived assets as of December 31, 2022 , resulting in no impairments.
Based on our qualitative assessment, we concluded that it was
more-likely-than-not that the estimated fair value of the reporting units
exceeded their carrying value and thus, we did not proceed to the two-step
goodwill impairment test.
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Income Taxes
We account for income taxes in accordance with ASC 740, "Income Taxes." Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid. We record net deferred assets to the extent we believe these assets will more likely than not be realized. The realizability of net deferred tax assets is based on all available evidence, including future taxable income projections, tax planning strategies, and reversal of taxable temporary differences. We regularly review our deferred tax assets for recoverability and establish a valuation allowance when management believes it is more likely than not such asset will not be recovered, taking into consideration historical operating results, expectations of future earnings, tax planning strategies and the expected timing of the reversals of existing temporary differences.
Recent Accounting Pronouncements
See Note 2 - Significant Accounting Policies of the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.
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