Telos(TLS) - 2023 Q4 - Annual Report

Special Note Regarding Forward-Looking Statements This section cautions readers about forward-looking statements, which are subject to risks and uncertainties and are not guarantees of future performance - Forward-looking statements are based on management's current views and assumptions, subject to inherent risks and uncertainties, and are not guarantees of future performance[15][16] - Readers are cautioned not to place undue reliance on these statements, as actual results could differ materially from projections, and the company does not intend to update them unless legally required[14][17] PART I Item 1. Business Telos provides advanced software-based security solutions for cybersecurity, cloud, and enterprise, with FY2023 focused on streamlining operations and rebuilding revenue General Overview Telos delivers advanced software-based security solutions across cybersecurity, cloud, and enterprise to protect digital assets - Telos provides technologically advanced, software-based security solutions for cybersecurity, cloud security, and enterprise security[19][21] - The company's mission is to protect customers' people, information, and digital assets against rapidly evolving threats like ransomware, insider threats, and advanced persistent threats[20] Business Segments Telos operates through two reportable segments: Security Solutions and Secure Networks, aligning strategies and resource allocation - Telos conducts business through two reportable and operating segments: Security Solutions and Secure Networks[22] - These segments provide a framework for aligning strategies, objectives, and timely resource allocation[22] Security Solutions Segment This segment focuses on cybersecurity, cloud, and identity solutions, contributing over half of the company's revenue Security Solutions Segment Revenue Contribution | Fiscal Year | Revenue Contribution | | :------------ | :------------------- | | 2023 | 53.3% | | 2022 | 55.5% | - The segment focuses on cybersecurity, cloud, identity solutions, and secure messaging, offering products like Xacta (cyber risk management), Telos AMHS (secure communications), Telos ACA (cyber threat intelligence), Telos Ghost (virtual obfuscation), IDTrust360, and ONYX (digital identity/biometrics)[24][26][27][28][31] Secure Networks Segment This segment provides secure networking architectures and solutions, contributing nearly half of the company's revenue Secure Networks Segment Revenue Contribution | Fiscal Year | Revenue Contribution | | :------------ | :------------------- | | 2023 | 46.7% | | 2022 | 44.5% | - This segment provides secure networking architectures and solutions, including secure mobility solutions and network management and defense services[30][31][32] Our Growth Strategies Growth strategies focus on expanding federal and commercial market reach, replacing legacy products, and pursuing strategic acquisitions - Strategies include broadening reach within the U.S. federal government, leveraging diverse security solutions to expand in commercial markets, targeting and replacing inefficient legacy products, and pursuing strategic acquisition opportunities[33] - Examples include Xacta's inclusion on DHS's Approved Products List and expansion into financial services and airport identity management[33] Customers Primary customers are the U.S. federal government, large commercial businesses, and state/local governments, with most revenue from federal contracts - Primary customers include the U.S. federal government (DoD, IC, civilian agencies), large commercial businesses (e.g., Amazon, Google, Verizon), state and local governments, and international customers[34][36][37] - Consolidated revenues are largely attributable to prime contracts or subcontracts with the U.S. government[34] Sales and Marketing Sales capabilities expanded in key markets, focusing on upsell strategies, supported by marketing efforts with partners - Sales capabilities were expanded in key markets (U.S. government, critical infrastructure, healthcare, financial services) by adding commission-incentivized personnel[39] - The sales strategy focuses on establishing a customer foothold with one solution and then leveraging the relationship to upsell other portfolio items[41] - Marketing efforts include industry analyst briefings, public relations, web seminars, trade show exhibitions, and digital marketing, often in collaboration with partners like AWS, Microsoft Azure, and IBM Security[43][44] Research and Development Telos invests in R&D to innovate new software solutions, enhance existing offerings, and develop features in secure communications and cybersecurity - Telos invests substantial resources in R&D to innovate new software-based solutions, enhance existing offerings, and develop new features, particularly in secure communications and cybersecurity[46] - Leveraging agile innovation and development practices, the company rapidly establishes prototypes for testing and pre-establishing enterprise risk levels[46] Human Capital Resources Telos employs 619 individuals, with a focus on core values, enhanced benefits, and commitment to diversity and inclusion Employee Demographics (as of Dec 31, 2023) | Metric | Value | | :-------------------------------------- | :------ | | Total Employees | 619 | | U.S.-based Employees | 88.7% | | U.S. Employees with Security Clearances | 377 | | U.S. Employees Self-Identifying as Veterans | 26% | - The company's core values include integrity, building trusted relationships, hard work, designing and delivering superior solutions, and having fun[48] - In 2023, Telos improved its employee value proposition through enhanced benefits, increased paid time off and parental leave, accelerated 401(k) stock vesting, a new performance management program, and flexible work arrangements[54][55] - Telos is committed to diversity and inclusion, with approximately 25% female and 38% underrepresented minorities in its global population, aiming for continuous improvement in hiring, development, and retention of diverse talent[56] Seasonality Telos experiences revenue seasonality due to the U.S. government's fiscal year, resulting in higher revenues in the third and fourth fiscal quarters - Telos experiences seasonality in revenue due to the U.S. government's fiscal year ending September 30, which typically results in higher revenues in the third and fourth fiscal quarters[57] Government Contracts and Regulation Business is heavily regulated by U.S. government laws, with contracts subject to funding and termination, utilizing various contracting methods - The business is heavily regulated by U.S. government laws and regulations, including the Federal Acquisition Regulation (FAR), imposing requirements on procurement, security, pricing, and audits[58][63] - Government contracts are subject to annual congressional funding and can be terminated for convenience or default[60] - Telos utilizes various contracting methods, including definitive award contracts, indefinite delivery/indefinite quantity (IDIQ) contracts, GSA schedule contracts, and other transactional agreements (OTA)[59] Environmental, Social, and Governance Matters Telos is committed to environmentally responsible operations and sustainable performance, with ESG oversight and public reporting - Telos is committed to environmentally responsible operations and sustainable long-term financial performance, with oversight from an ESG task force and the Board's Nominating and Corporate Governance Committee[62] - The company publicly reports climate-related information via CDP and provides sustainability disclosures using the SASB Software & IT Service Standard[62] Company Website and Available Information Telos's corporate headquarters are in Ashburn, Virginia, with company and SEC filing information available on its website - Telos's corporate headquarters are in Ashburn, Virginia, and its website (www.telos.com) provides company information and access to SEC filings[64] - SEC filings can also be viewed and downloaded free of charge from the SEC's website (www.sec.gov)[64](index=64&type=chunk)[65] Item 1A. Risk Factors This section outlines significant risks across business operations, industry, legal, regulatory, and financial reporting that could materially impact Telos's performance Business and Operational Risks Telos faces risks from cybersecurity breaches, customer retention, government contract termination, key employee dependence, and third-party reliance - The company faces risks from cybersecurity breaches, including unauthorized access, data loss, reputational damage, and financial liability[68][70] - Revenue could decline if existing customers do not renew or expand their contracts, or if key government contracts are terminated, canceled, or delayed[71][74][76] - Dependence on a few key customer contracts means a significant reduction or delay in these could materially affect future revenue and operating results[77] - Failure to attract, train, retain, and motivate key and skilled employees, including management, would adversely affect strategy execution and operations[78][79][80] - The competitive bidding process for government contracts presents risks of substantial costs, delays from bid protests, and inability to achieve or sustain revenue growth[81][82] - Reliance on third-party computing infrastructure and suppliers exposes the company to risks of errors, disruptions, security issues, or unavailability of services[88][89][92][93] - Catastrophic occurrences, such as natural disasters, wars, or public health crises, could damage systems, disrupt operations, and decrease demand for solutions[94][95][97] - Inaccurate estimation of factors for fixed-price and cost-reimbursable contracts could lead to cost overruns and adversely impact earnings and profitability[100][101] - Public confidence in, and acceptance of, identity platforms and biometrics is a key factor for continued growth, with negative perceptions or breaches posing significant risks[116][117] Industry, Legal and Regulatory Risks The company operates in a highly competitive and regulated market, facing risks from federal budget changes, seasonality, and compliance requirements - Telos operates in a highly competitive market, facing competition from large defense contractors and smaller specialty companies, which could weaken its competitive position and reduce revenue growth[119] - A decline in the federal budget, changes in U.S. government spending priorities, or prolonged government shutdowns may significantly and adversely affect future revenues and financial results[120][121][122][123] - The company is subject to the seasonality of U.S. government spending, typically experiencing higher revenues in its third and fourth fiscal quarters[124] - Compliance with stringent, complex, and evolving laws and regulations related to privacy, data protection, security, and technology protection is critical, with failures potentially leading to significant costs, damages, or liability[125][127][129][130] - As a U.S. government contractor, Telos is subject to substantial oversight, audits, and investigations, with potential for administrative, civil, or criminal liabilities, including suspension or debarment from future contracts[131] - Governmental export and import controls could impair the ability to compete in international markets and subject the company to liability if not in full compliance[132][133] Risks Related to Our Financial Reporting and Common Stock Risks include failure to meet guidance, fluctuating quarterly results, share repurchase program impacts, internal control, and accounting estimate inaccuracies - Failure to meet publicly announced guidance or expectations about business and operating results may cause the stock price to decline[134][136] - Quarterly operating results may fluctuate and fall short of prior periods, projections, or analyst expectations, adversely affecting the trading price of the stock[137] - The share repurchase program may not be fully implemented or enhance long-term stockholder value, potentially affecting stock price, increasing volatility, or diminishing cash reserves[138] - Failure to maintain an effective system of internal control could impair the ability to produce timely and accurate financial statements or comply with applicable regulations, leading to potential restatements or regulatory sanctions[139][141][142] - Judgments or estimates relating to critical accounting policies, if based on incorrect assumptions, could adversely affect results of operations[143] General Risk Factors Weakened global economic conditions, increased ESG scrutiny, changes in accounting principles, and climate-related risks may adversely affect the business - Weakened global economic conditions and geopolitical developments may adversely affect the industry, business, operating results, and financial condition by impacting demand and spending[144] - Increased scrutiny of environmental, social, and governance (ESG) responsibilities may result in additional costs, risks, and adverse impacts on reputation, employee retention, and willingness of customers and suppliers to do business[145] - Changes in accounting principles or their application could result in unfavorable accounting charges or effects, adversely affecting results of operations and growth prospects[146] - Global climate-related risks, including extreme weather events, have the potential to disrupt business, supply chains, or customer operations, leading to higher attrition, losses, and additional costs[147][148][149] Item 1B. Unresolved Staff Comments There are no unresolved staff comments - The company has no unresolved staff comments[151] Item 1C. Cybersecurity Telos manages cybersecurity risks through an ISO/IEC 27001-certified ISMS, a dedicated GRC team, and Board oversight, reporting no material breaches in the last three years Company's processes to assess, identify, and manage material cybersecurity risks Telos uses an ISO/IEC 27001-certified ISMS and GRC team to assess and manage cybersecurity risks, with no material breaches reported - Telos has an ISO/IEC 27001-certified Information Security Management System (ISMS) to enhance corporate security, identify, and mitigate information security risks[152] - A dedicated Governance Risk and Compliance (GRC) team, reporting to the CISO, implements an ISO/IEC 27001-compliant methodology to assess and track cybersecurity risks[154] - The company also assesses itself against NIST Special Publication 800-171, actively monitors known threats, and has a cyber incident response plan and business continuity plan[155] - In the last three years, Telos has not experienced a material information security breach incident or any related penalties or settlements[157] Management's role and expertise in assessing and managing material cybersecurity risks The CISO, with extensive experience and certifications, leads the Information Security team in assessing and managing cybersecurity risks - The Information Security team, led by the CISO, is responsible for assessing and managing material cybersecurity risks[158] - The CISO has over 17 years of experience in IT and Information Security, holding a Master's degree in Cybersecurity and various industry certifications (e.g., CISSP, CEH)[158] - The CISO reports to the Chief Information Technology Officer (CITO), who in turn reports to the CEO, both of whom have extensive cybersecurity experience[158] Board of Director's oversight of cybersecurity risks The Board's Audit Committee oversees cybersecurity risks, receiving regular reports from the CISO on assessment and management - The Board of Directors delegates responsibility for information security and cybersecurity risk oversight to the Audit Committee[160] - The CISO provides regular reports to the Audit Committee on cybersecurity risk assessment, identification, and management, as well as information security incidents[159][160] Item 2. Properties Telos leases approximately 191,700 square feet for its corporate headquarters, integration facility, and primary service depot in Ashburn, Virginia, with the lease expiring in May 2029 - Telos leases approximately 191,700 square feet for its corporate headquarters, integration facility, and primary service depot in Ashburn, Virginia, with the lease expiring in May 2029[161] - Additional office spaces are leased in Maryland, Florida, and Nevada, with various leases expiring through July 2027[161] - The company believes that the current space is substantially adequate to meet its operating requirements[161] Item 3. Legal Proceedings Information regarding legal proceedings is referenced in Note 19 to the Consolidated Financial Statements, with management believing no known matters will have a material adverse effect - Information regarding legal proceedings is found in Note 19 – Commitments and Contingencies to the Consolidated Financial Statements[162] - Management believes that the outcome of known legal matters will not have a material adverse effect on the Company's financial condition and results of operations[439] Item 4. Mine Safety Disclosures This item is not applicable to Telos Corporation - This item is not applicable[163] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Telos common stock trades on the Nasdaq Global Market under "TLS", with approximately 152 holders of record as of March 8, 2024, and a $50.0 million Share Repurchase Program with $38.7 million remaining authorization - Telos common stock is traded on the Nasdaq Global Market under the symbol "TLS"[166] - As of March 8, 2024, there were approximately 152 holders of record of Telos common stock[166] Sales of Equity Securities and Use of Proceeds No sales of unregistered equity securities occurred during the three months ended December 31, 2023 - There were no sales of unregistered equity securities during the three months ended December 31, 2023, that were not previously disclosed[168] Purchases of Equity Securities The Board authorized a $50.0 million Share Repurchase Program, with $38.7 million remaining and no repurchases in FY2023 - The Board of Directors authorized a Share Repurchase Program (SRP) for up to $50.0 million of common stock on May 24, 2022[169] Share Repurchase Program Status | Metric | Value (as of Dec 31, 2023) | | :-------------------------------------- | :------------------------- | | Amount Remaining Under SRP Authorization | $38.7 million | | Repurchases in Fiscal Year 2023 | None | Item 6. [Reserved] This item is reserved and contains no information - This item is reserved[171] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations This section analyzes Telos's financial condition and results for FY2023 vs. FY2022, including business overview, market, backlog, segment results, and key accounting policies Business Overview Telos aims to diversify and improve operating margins by evolving into an advanced solutions technologies provider, focusing on branded technologies - Telos aims to diversify and improve operating margins by evolving from a product reselling model to an advanced solutions technologies provider, focusing on Telos-manufactured and branded technologies[176] - The company's contract portfolio is characterized by low to moderate financial risk due to a limited number of long-term fixed-price development contracts[176] Opportunities, Challenges and Risks A substantial portion of Telos's revenues comes from U.S. government contracts, subject to competitive bidding and spending priorities - A substantial portion of Telos's revenues are derived from U.S. government contracts, which are increasingly subject to competitive bidding and pricing pressure[175] - Business performance is significantly affected by the overall level of U.S. government spending and the alignment of Telos's offerings with budget priorities[177] Business Environment U.S. Budget Congress has not completed FY2024 appropriations, operating under continuing resolutions, delaying federal expenditures and new program starts - Congress has not completed FY2024 appropriations, operating under continuing resolutions at FY2023 levels for over five months, which has delayed planned federal expenditures and new program starts[178][181][183] - The President's proposed FY2024 budget included increased investments for defense and cybersecurity, but these increases remain on hold[179][180] Cybersecurity Landscape The cybersecurity landscape faces rising threats like ransomware and AI-powered attacks, with increasing regulatory compliance complexity - The cybersecurity landscape is characterized by rising threats like ransomware, persistent risks to critical infrastructure, and the emergence of AI-powered cyberattacks[184][185][189] - Regulatory compliance is increasingly complex, with new SEC rules requiring public companies to disclose governance methods, risk management processes, and material cyber incidents[186][187] - Identity assurance and privacy protection are essential for modern enterprises, supporting IT and physical security strategies and Zero Trust security models[188] Backlog Backlog, a measure of aggregate contract revenues, decreased to $118.1 million in 2023, with most expected to be recognized in 2024 - Backlog is a measure of aggregate contract revenues remaining to be earned, including both funded and unfunded portions[190][191] Backlog by Segment (in thousands) | Segment | As of Dec 31, 2023 | As of Dec 31, 2022 | | :----------------- | :----------------- | :----------------- | | Security Solutions | $65,936 | $81,293 | | Secure Networks | $52,166 | $130,750 | | Total Backlog | $118,102 | $212,043 | | Funded Backlog | $52,068 | $82,238 | | Unfunded Backlog | $66,034 | $129,805 | - Approximately 90% of remaining performance obligations are expected to be recognized as revenue in 2024, and 3% by 2025, with the remainder thereafter[371] Financial Highlights Fiscal year 2023 saw a revenue decline due to program completions, offset by lower operating costs from restructuring, improving profitability - Fiscal year 2023 saw a decline in revenue due to program completions, lower revenue on ongoing major programs, and the loss of a program, partially offset by new program wins and the ramp-up of TSA PreCheck[194] - Lower operating costs, resulting from a restructuring plan announced in Q1 2023, led to an improvement in profitability and earnings per share[194] Results of Operations Consolidated Results Consolidated revenue decreased by $71.5 million in FY2023, while operating loss improved by $13.5 million due to lower SG&A expenses Consolidated Financial Results (in thousands) | Metric | FY2023 | FY2022 | Change (YoY) | | :-------------------------------------- | :--------- | :--------- | :----------- | | Revenue | $145,378 | $216,887 | $(71,509) | | Gross profit | $52,942 | $79,043 | $(26,101) | | Gross margin | 36.4% | 36.4% | 0.0 pp | | Selling, general and administrative expenses | $93,257 | $132,893 | $(39,636) | | Operating loss | $(40,315) | $(53,850) | $13,535 | | Other income | $6,715 | $1,350 | $5,365 | | Net loss | $(34,422) | $(53,428) | $19,006 | - Selling, general, and administrative (SG&A) expenses decreased by $39.6 million, or 29.8%, in 2023 compared to 2022, primarily due to lower compensation-related expenses across sales, R&D, and general administration[196] - Other income increased by $5.4 million in 2023, primarily due to an increase in dividend income from money market placements and a gain on early extinguishment of other financing obligations[197] Segment Results Security Solutions revenue decreased by $43.0 million, while Secure Networks revenue decreased by $28.5 million, though its gross margin improved Security Solutions Segment Financial Results (in thousands) | Metric | FY2023 | FY2022 | Change (YoY) | | :----------- | :-------- | :-------- | :----------- | | Revenues | $77,416 | $120,454 | $(43,038) | | Gross profit | $39,614 | $61,948 | $(22,334) | | Gross margin | 51.2% | 51.4% | -0.2 pp | Secure Networks Segment Financial Results (in thousands) | Metric | FY2023 | FY2022 | Change (YoY) | | :----------- | :-------- | :-------- | :----------- | | Revenues | $67,962 | $96,433 | $(28,471) | | Gross profit | $13,328 | $17,095 | $(3,767) | | Gross margin | 19.6% | 17.7% | +1.9 pp | - Security Solutions revenue decreased primarily due to lower revenues on ongoing programs and the loss of a program, partially offset by new program wins and the initial ramp of TSA PreCheck[201] - Secure Networks revenue decreased due to the successful completion of certain programs and lower revenues on ongoing programs, partially offset by new program wins, but its gross margin increased due to strong program and cost management[203][204] Key Performance Measure Primary financial performance measures include revenue, gross profit, and Adjusted EBITDA, with evaluation of contract portfolio and operating cash flows - The primary financial performance measures used to manage the business and monitor results are revenue, gross profit, and Adjusted EBITDA[205] - The company evaluates significant trends and fluctuations in its contract portfolio, changes in costs of revenue, and operating cash flows[205][206] Non-GAAP Financial Measures EBITDA, Adjusted EBITDA, EBITDA Margin and Adjusted EBITDA Margin EBITDA and Adjusted EBITDA are non-GAAP measures representing core operating performance, excluding non-operating and non-cash items - EBITDA and Adjusted EBITDA are non-GAAP measures used to represent core operating performance and trends, excluding non-operating items, interest, taxes, depreciation, amortization, stock-based compensation, and restructuring expenses[209][210] Reconciliation of Net Loss to EBITDA and Adjusted EBITDA (in thousands) | Metric | FY2023 | FY2022 | Change (YoY) | | :------------------------- | :--------- | :--------- | :----------- | | Net loss | $(34,422) | $(53,428) | $19,006 | | Other income | $(6,715) | $(1,350) | $(5,365) | | Interest expense | $786 | $874 | $(88) | | Provision for income taxes | $36 | $54 | $(18) | | Depreciation and amortization | $9,429 | $5,890 | $3,539 | | EBITDA (Non-GAAP) | $(30,886)| $(47,960)| $17,074 | | Stock-based compensation expense | $24,396 | $64,660 | $(40,264) | | Restructuring expenses | $1,132 | $2,767 | $(1,635) | | Adjusted EBITDA (Non-GAAP) | $(5,358) | $19,467 | $(24,825) | | Adjusted EBITDA Margin | (3.7)% | 9.0% | -12.7 pp | Adjusted Net (Loss)/Income and Adjusted EPS These non-GAAP measures provide a clearer view of core operating performance by excluding non-operating income/expense, stock-based compensation, and restructuring - Adjusted Net (Loss)/Income and Adjusted EPS are non-GAAP measures that provide a clearer representation of core operating performance by excluding non-operating income/expense, stock-based compensation, and restructuring expenses[212][213] Reconciliation of Net Loss and GAAP EPS to Non-GAAP Adjusted Net Income and Adjusted EPS (in thousands, except per share data) | Metric | FY2023 Adjusted Net Income/(Loss) (in thousands) | FY2023 Adjusted EPS | FY2022 Adjusted Net Income/(Loss) (in thousands) | FY2022 Adjusted EPS | | :-------------------------------------- | :----------------------------------------------- | :------------------ | :----------------------------------------------- | :------------------ | | Net loss | $(34,422) | $(0.50) | $(53,428) | $(0.79) | | Other income | $(6,715) | $(0.10) | $(1,350) | $(0.02) | | Stock-based compensation expense | $24,396 | $0.35 | $64,660 | $0.96 |\ | Restructuring expenses | $1,132 | $0.02 | $2,767 | $0.04 | | Adjusted net (loss)/income (Non-GAAP) | $(15,609) | $(0.23) | $12,649 | $0.19 | | Weighted-average shares outstanding, basic | 69,256 | | 67,559 | | Cash Gross Profit and Cash Gross Margin These non-GAAP measures provide insight into core gross profit economics by adding back non-cash and non-recurring charges to GAAP gross profit - Cash Gross Profit and Cash Gross Margin are non-GAAP measures that provide insight into the core economics of gross profit by adding back non-cash charges (stock-based compensation, depreciation, amortization) and non-recurring items (restructuring expenses) to GAAP gross profit[215][216] Reconciliation of Gross Profit to Cash Gross Profit (in thousands) | Metric | FY2023 Amount (in thousands) | FY2023 Margin | FY2022 Amount (in thousands) | FY2022 Margin | | :-------------------------------------- | :--------------------------- | :------------ | :--------------------------- | :------------ | | Gross profit | $52,942 | 36.4% | $79,043 | 36.4% | | Stock-based compensation expense — cost of sales | $900 | 0.6% | $3,497 | 1.6% | | Depreciation and amortization — cost of sales | $3,544 | 2.5% | $793 | 0.4% | | Restructuring expenses — cost of sales | $0 | 0.0% | $578 | 0.3% | | Cash gross profit (Non-GAAP) | $57,386 | 39.5% | $83,911 | 38.7% | Free Cash Flow Free Cash Flow, a non-GAAP measure, significantly decreased to $(13.9) million in 2023 due to lower operating cash flows and higher capitalized software costs - Free Cash Flow is a non-GAAP measure defined as net cash provided by/(used in) operating activities, less purchases of property and equipment, and capitalized software development costs[218] Free Cash Flow (in thousands) | Metric | FY2023 (in thousands) | FY2022 (in thousands) | | :-------------------------------------- | :-------------------- | :-------------------- | | Net cash flows provided by operating activities | $1,587 | $16,508 | | Purchases of property and equipment | $(926) | $(1,009) | | Capitalized software development costs | $(14,552) | $(12,708) | | Net cash proceeds from resale of software | $0 | $8,457 | | Free cash flow (Non-GAAP) | $(13,891) | $11,248 | - Free Cash Flow decreased significantly in 2023 to $(13.9) million from $11.2 million in 2022, primarily due to lower operating cash flows and higher capitalized software development costs[220] Liquidity and Capital Resources Telos's liquidity sources include cash on hand, future operating cash flows, and a $30.0 million revolving credit facility - Telos's primary sources of liquidity are cash on hand, future operating cash flows, and a $30.0 million senior secured revolving credit facility[221] Liquidity Metrics (in thousands) | Metric | As of Dec 31, 2023 (in thousands) | As of Dec 31, 2022 (in thousands) | | :---------------------- | :-------------------------------- | :-------------------------------- | | Cash and cash equivalents | $99,260 | $119,305 | | Working capital | $100,800 | N/A | Cash Flows Information (in thousands) | Metric | FY2023 (in thousands) | FY2022 (in thousands) | | :-------------------------------------- | :-------------------- | :-------------------- | | Net cash provided by operating activities | $1,587 | $16,508 | | Net cash used in investing activities | $(15,478) | $(13,717) | | Net cash used in financing activities | $(6,151) | $(9,915) | | Net change in cash, cash equivalents, and restricted cash | $(20,042) | $(7,124) | Commitments from Contractual Obligations Material cash requirements as of December 31, 2023, primarily consist of lease obligations for office space and equipment - Telos's material cash requirements from contractual obligations as of December 31, 2023, primarily consist of lease obligations for office space and equipment[227] Contractual Obligations (in thousands) | Obligation Type | Total (in thousands) | 2024 (in thousands) | 2025 - 2027 (in thousands) | 2028 - 2030 (in thousands) | Thereafter (in thousands) | | :---------------------- | :------------------- | :------------------ | :------------------------- | :------------------------- | :------------------------ | | Finance lease obligations | $12,915 | $2,258 | $7,116 | $3,541 | $0 | | Operating lease obligations | $241 | $105 | $111 | $25 | $0 | | Total | $13,156 | $2,363 | $7,227 | $3,566 | $0 | Revolving Credit Facility Telos has a $30.0 million senior secured revolving credit facility, maturing in December 2025, with no outstanding balances as of December 31, 2023 - Telos entered into a $30.0 million senior secured revolving credit facility with JPMorgan Chase Bank, N.A. on December 30, 2022, maturing on December 30, 2025, with an uncommitted expansion feature of up to $30.0 million[230] - As of December 31, 2023, there were no outstanding balances under the revolving credit facility, and the company was in compliance with all covenants[231] Other Financing Obligations The extinguishment of other financing obligations related to software licenses resulted in a $1.4 million gain in February 2023 - In November 2022, Telos entered a Master Purchase Agreement for $9.1 million relating to software licenses, resulting in proceeds from other financing obligations[232] - In February 2023, the customer's non-renewal of an option period led to the transfer of underlying licenses and extinguishment of outstanding financing obligations, resulting in a $1.4 million gain recorded as "Other income"[232][395] Critical Accounting Policies and Estimates Preparation of financial statements requires significant judgments and estimates, particularly for revenue recognition, goodwill, and income taxes - The preparation of consolidated financial statements requires management to make significant judgments, estimates, and assumptions, particularly concerning revenue recognition, goodwill and other long-lived assets, and income taxes[233][235] - These estimates are based on historical experience and available information, but actual results could differ, potentially impacting the company's results of operations[234][143] Revenue Recognition Telos recognizes revenue using a five-step model, with significant judgment in determining performance obligations and allocating transaction prices - Telos recognizes revenue in accordance with ASC Topic 606, using a five-step model, with significant judgment required in determining performance obligations and allocating transaction prices[236] - For contracts where revenue is recognized over time, progress is measured using costs incurred to date relative to total estimated cost at completion, which is complex and subject to many variables[238] - The transaction price includes assumptions regarding variable consideration (e.g., claims, incentive fees) to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur[237] Goodwill and Other Long-Lived Assets Goodwill is tested annually for impairment, with no impairment found in 2023, but a $0.5 million impairment charge was recorded for software development costs - Goodwill is tested annually for impairment as of December 31, with a qualitative assessment performed first, followed by a quantitative analysis if impairment is likely[239][240][241] - For fiscal year 2023, the Security Solutions reporting unit exceeded its carrying value qualitatively, while the Secure Networks reporting unit required a quantitative analysis, which also concluded no impairment[244] - An impairment charge of $0.5 million was recorded in 2023 for certain software development costs, identified through an assessment of intangible assets[247] Income Taxes Telos accounts for income taxes under ASC 740, recognizing deferred tax assets and liabilities, with a valuation allowance for unrealized assets - Telos accounts for income taxes in accordance with ASC 740, recognizing deferred tax assets and liabilities for temporary differences[249] - A valuation allowance is established when it is more likely than not that deferred tax assets will not be realized, based on future taxable income projections and tax planning strategies[249] Recent Accounting Pronouncements Telos adopted several ASUs with no material impact and is assessing the impact of other recently issued pronouncements - Telos has adopted several ASUs (2020-04, 2021-08, 2022-04) related to reference rate reform, business combinations, and supplier finance programs, none of which had a material impact[342][343][344] - The company is currently assessing the impact of recently issued ASUs (2022-03, 2023-03, 2023-05, 2023-06, 2023-07, 2023-09) on fair value measurement, financial statement presentation, joint venture formations, disclosure improvements, segment reporting, and income tax disclosures[345][346][347][348][349][350] Item 7A. Quantitative and Qualitative Disclosures about Market Risk Telos is exposed to interest rate, foreign currency, and counterparty risks, but these are not significant due to short-term, U.S. dollar-denominated operations - Telos is exposed to financial risks including interest rate risk, foreign currency translation risk, and counterparty risk[251] - These risks are not considered significant due to the short-term nature of highly liquid investments (cash and cash equivalents) and the majority of business being transacted in U.S. dollars[252] Item 8. Consolidated Financial Statements and Supplementary Data This item presents Telos's audited consolidated financial statements for FY2023 and FY2022, including the independent auditor's report, critical audit matters, and comprehensive notes Report of Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP issued an unqualified opinion on Telos's consolidated financial statements and effective internal control over financial reporting - PricewaterhouseCoopers LLP audited Telos Corporation's consolidated financial statements and internal control over financial reporting for the period ended December 31, 2023[254] - The firm issued an unqualified opinion, stating that the consolidated financial statements present fairly in all material respects and that the company maintained effective internal control over financial reporting[255] Critical Audit Matters The critical audit matter identified is 'Revenue Recognition – Estimated Costs to Complete Long-term Contracts' due to significant judgment and auditor effort - The critical audit matter identified is "Revenue Recognition – Estimated Costs to Complete Long-term Contracts"[261][262] - This matter is critical due to the significant judgment required by management in estimating costs at completion and the high degree of auditor judgment and effort in evaluating related assumptions (labor, subcontractor costs, materials, and other direct costs)[263] Consolidated Statements of Operations This statement details Telos's revenues, costs, and expenses, resulting in a net loss of $(34.4) million for FY2023 Consolidated Statements of Operations (in thousands, except per share amounts) | Metric | FY2023 (in thousands) | FY2022 (in thousands) | | :-------------------------------------- | :-------------------- | :-------------------- | | Revenue – services | $135,175 | $192,742 | | Revenue – products | $10,203 | $24,145 | | Total revenue | $145,378 | $216,887 | | Total cost of sales | $92,436 | $137,844 | | Gross profit | $52,942 | $79,043 | | Total selling, general and administrative expenses | $93,257 | $132,893 | | Operating loss | $(40,315) | $(53,850) | | Other income | $6,715 | $1,350 | | Interest expense | $(786) | $(874) | | Loss before income taxes | $(34,386) | $(53,374) | | Provision for income taxes | $(36) | $(54) | | Net loss | $(34,422) | $(53,428) | | Basic net loss per share | $(0.50) | $(0.79) | | Diluted net loss per share | $(0.50) | $(0.79) | | Weighted-average share outstanding, basic | 69,256 | 67,559 | | Weighted-average share outstanding, diluted | 69,256 | 67,559 | Consolidated Statements of Comprehensive Loss This statement presents Telos's net loss and other comprehensive loss components, totaling a comprehensive loss of $(34.4) million for FY2023 Consolidated Statements of Comprehensive Loss (in thousands) | Metric | FY2023 (in thousands) | FY2022 (in thousands) | | :-------------------------------------- | :-------------------- | :-------------------- | | Net loss | $(34,422) | $(53,428) | | Other comprehensive loss, net of tax: | | | | Foreign currency translation adjustments | $(5) | $(28) | | Comprehensive loss | $(34,427) | $(53,456) | Consolidated Balance Sheets This statement provides a snapshot of Telos's assets, liabilities, and equity, with total assets at $208.7 million as of December 31, 2023 Consolidated Balance Sheets (in thousands) | Metric | As of Dec 31, 2023 (in thousands) | As of Dec 31, 2022 (in thousands) | | :-------------------------------------- | :-------------------------------- | :-------------------------------- | | Cash and cash equivalents | $99,260 | $119,305 | | Accounts receivable, net | $30,424 | $40,069 | | Inventories, net | $1,420 | $2,877 | | Total current assets | $139,991 | $167,963 | | Property and equipment, net | $3,457 | $4,787 | | Goodwill | $17,922 | $17,922 | | Intangible assets, net | $39,616 | $37,415 | | Total assets | $208,699 | $237,397 | | Accounts payable and other accrued liabilities | $13,750 | $22,551 | | Accrued compensation and benefits | $14,569 | $8,388 | | Total current liabilities | $39,198 | $45,502 | | Total liabilities | $49,696 | $65,043 | | Total stockholders' equity | $159,003 | $172,354 | | Total liabilities and stockholders' equity | $208,699 | $237,397 | Consolidated Statements of Cash Flows This statement details Telos's cash flows from operating, investing, and financing activities, showing a net decrease in cash of $(20.0) million in FY2023 Consolidated Statements of Cash Flows (in thousands) | Metric | FY2023 (in thousands) | FY2022 (in thousands) | | :-------------------------------------- | :-------------------- | :-------------------- | | Net cash provided by operating activities | $1,587 | $16,508 | | Net cash used in investing activities | $(15,478) | $(13,717) | | Net cash used in financing activities | $(6,151) | $(9,915) | | Net change in cash, cash equivalents, and restricted cash | $(20,042) | $(7,124) | | Cash, cash equivalents and restricted cash, beginning of period | $119,438 | $126,562 | | Cash, cash equivalents and restricted cash, end of period | $99,396 | $119,438 | Consolidated Statements of Changes in Stockholders' Equity This statement shows changes in equity, with total stockholders' equity decreasing to $159.0 million in 2023, primarily due to net loss Consolidated Statements of Changes in Stockholders' Equity (in thousands) | Metric | As of Dec 31, 2023 (in thousands) | As of Dec 31, 2022 (in thousands) | | :-------------------------------------- | :-------------------------------- | :-------------------------------- | | Common Stock | $109 | $106 | | Additional Paid–in Capital | $433,781 | $412,708 | | Accumulated Other Comprehensive Loss | $(60) | $(55) | | Accumulated Deficit | $(274,827) | $(240,405) | | Total Stockholders' Equity | $159,003 | $172,354 | - Total stockholders' equity decreased from $172.4 million in 2022 to $159.0 million in 2023, primarily due to the net loss of $(34.4) million, partially offset by $22.9 million in stock-based compensation and $1.9 million from the issuance of common stock for 401K match[278] Notes to the Consolidated Financial Statements 1. Organization Telos Corporation, a Maryland corporation, is a leading provider of cyber, cloud, and enterprise security solutions, with several wholly-owned subsidiaries - Telos Corporation is a Maryland corporation and a leading provider of cyber, cloud, and enterprise security solutions[281] - The company wholly owns several subsidiaries, including Xacta Corporation, ubIQuity.com, inc., Telos Identity Management Solutions, LLC, Teloworks, Inc., and Telos APAC Pte. Ltd[281] 2. Significant Accounting Policies Consolidated financial statements adhere to U.S. GAAP, requiring key estimates for revenue, credit losses, inventory, deferred taxes, and stock-based compensation - The consolidated financial statements are prepared in accordance with U.S. GAAP and SEC rules, with all intercompany transactions eliminated[283] - Key estimates and assumptions are made for revenue recognition, allowance for credit losses, inventory obsolescence, deferred tax assets, stock-based compensation, valuation of intangible assets and goodwill, restructuring expenses, and contingencies[287] - Goodwill is tested annually for impairment, and software development costs are capitalized once technological feasibility is established or during the application development stage, then amortized over 2-5 years[307][308][312] - Restructuring expenses for involuntary termination benefits are accrued when probable and reasonably estimated, and other related costs are recognized at fair value when incurred[337][338] 3. Revenue Recognition Telos follows ASC Topic 606's five-step model, recognizing most revenue over time for services and at a point in time for products - Telos follows the five-step model for recognizing revenue under ASC Topic 606, with the majority (84% in 2023) recognized over time for services, using a cost-to-cost measure of progress[351][355][356] - Revenue for products (16% in 2023) is recognized at a point in time when the customer obtains control, typically upon acceptance or receipt[357] - Contract estimates are complex and subject to significant judgment, with adjustments recognized on a cumulative catch-up basis[361] Disaggregated Revenue by Customer Type (in thousands) | Customer Type | 2023 Amount (in thousands) | 2023 % | 2022 Amount (in thousands) | 2022 % | | :---------------------------- | :------------------------- | :----- | :------------------------- | :----- | | Federal government | $131,143 | 90% | $205,538 | 95% | | State & local government, and commercial | $14,235 | 10% | $11,349 | 5% | | Total revenue | $145,378 | 100% | $216,887 | 100% | Disaggregated Revenue by Contract Type (in thousands) | Contract Type | 2023 Amount (in thousands) | 2023 % | 2022 Amount (in thousands) | 2022 % | | :---------------- | :------------------------- | :----- | :------------------------- | :----- | | Firm fixed-price | $114,188 | 79% | $179,803 | 83% | | Time-and-materials| $13,535 | 9% | $12,963 | 6% | | Cost plus fixed-fee | $17,655 | 12% | $24,121 | 11% | | Total revenue | $145,378 | 100% | $216,887 | 100% | Revenue Concentrations Greater than 10% of Total Revenue | Customer | 2023 % | 2022 % | | :------------------------ | :----- | :----- | | U.S. Department of Defense | 64% | 74% | 4. Accounts Receivable, Net Accounts receivable, net, totaled $30.4 million as of December 31, 2023, with 91% directly from creditworthy U.S. government customers Details of Accounts Receivable, Net (in thousands) | Metric | As of Dec 31, 2023 (in thousands) | As of Dec 31, 2022 (in thousands) | | :-------------------------- | :-------------------------------- | :-------------------------------- | | Billed accounts receivables | $18,101 | $13,655 | | Unbilled accounts receivable| $8,022 | $11,657 | | Contract assets | $4,584 | $14,891 | | Allowance for credit losses | $(283) | $(134) | | Accounts receivable, net| $30,424 | $40,069 | - 91% of billed and unbilled accounts receivable as of December 31, 2023, were directly with U.S. government customers, limiting credit risk due to their creditworthiness[372] 5. Inventories, Net Net inventories, primarily finished goods and component parts, totaled $1.4 million as of December 31, 2023 Details of Inventories, Net (in thousands) | Metric | As of Dec 31, 2023 (in thousands) | As of Dec 31, 2022 (in thousands) | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Gross inventory | $2,179 | $3,642 | | Allowance for inventory obsolescence | $(759) | $(765) | | Inventories, net | $1,420 | $2,877 | - Inventories are substantially comprised of finished goods (off-the-shelf hardware and software) and component computer parts used in system integration services[300] 6. Property and Equipment, Net Net property and equipment totaled $3.5 million as of December 31, 2023, with depreciation and amortization expense of $2.2 million in FY2023 Details of Property and Equipment, Net (in thousands) | Metric | As of Dec 31, 2023 (in thousands) | As of Dec 31, 2022 (in thousands) | | :---------------------- | :-------------------------------- | :-------------------------------- | | Furniture and equipment | $2,850 | $4,133 | | Leasehold improvement | $607 | $654 | | Total | $3,457