TELOS CORP (TLS)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. Several important factors could cause the Company's actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth in the risk factors section included in the Company's Form 10-K for the year ended December 31, 2025, as filed with the SEC on March 16, 2026.

Overview and Business Environment

Overview

Telos Corporation empowers and protects the world’s most security-conscious organizations with efficient, adaptable, and secure solutions that safeguard people, systems, and information. We deliver advanced capabilities across cyber governance, risk, and compliance ("GRC") with Xacta; identity and biometric solutions; secure networks and communications; and TSA PreCheck® enrollment services. Our primary customers include the U.S. federal government, large commercial organizations, state and local governments, and global enterprises. Telos helps customers stay ahead of evolving threats, accelerate compliance, and achieve mission success. Driven by purpose and guided by our core values, we build trusted partnerships, deliver superior solutions, and help create a more secure, interconnected world.

In the fourth quarter of FY2025, Telos launched Xacta.aiTM, the artificial intelligence ("AI") capability at the core of the Xacta cyber GRC platform, dramatically reducing compliance time and effort. Xacta.ai delivers expert-level guidance and real-time insights, empowering organizations to move from reactive compliance to proactive risk management.

Business Environment

U.S. Federal Government

Our consolidated revenue is largely attributable to prime contracts or to subcontracts with prime contractors engaged in work for the U.S. federal government, with the remaining revenue attributable to state and local governments, and commercial markets. We generated approximately 92% and 90% of our total revenues from contracts with U.S. government agencies in the first half of fiscal year ("FY") 2026 and 2025, respectively.

Our business performance is affected by the overall level of U.S. government spending and the alignment of our offerings and capabilities with the budget priorities of the U.S. government. While certain administration priorities, such as cybersecurity, national security and AI, present greater opportunity for our products and services, turmoil within the federal government, including personnel and leadership turnover and budgetary uncertainty, has had the effect of lengthening our sales cycle in certain cases. We continuously monitor U.S. federal budget, legislative, and contracting trends and activities, and align our capabilities in response to these developments.

Macroeconomic Conditions

During the first half of FY2026, the global economy has continued to experience volatility arising from geopolitical developments and broader economic and financial factors, specifically including the ongoing conflict in the Middle East. This volatility has resulted in, and may be expected to continue to result in, rising energy prices, supply chain disruptions, and inflationary pressures, among other consequences. However, in part due to the importance of our offerings to our customers, the type of solutions we provide, and the nature of our largest customers, to date our business has not been materially impacted by these consequences. If global volatility continues to increase and the conflict in the Middle East is prolonged or intensifies, the economic uncertainty inherent in such global instability may affect our results of operations. Management continues to monitor this evolving geopolitical situation.

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Financial Overview

Several key highlights of our financial performance in the second quarter of 2026 are described below. More details are presented in our "Results of Operations" section.

•Revenue increased 32.7% due to 43.7% growth in Security Solutions, driven primarily by the expansion of multiple large programs in Telos ID.

•Operating expenses decreased by $5.4 million, or 24.9%, year-over-year due to lower stock-based compensation and ongoing disciplined cost management.

•Net income expanded by $10.2 million, from a net loss of $9.5 million in the second quarter of 2025 to a net income of $0.7 million in the current quarter.

•Cash flow from operations improved by $1.9 million year-over-year, increasing from a $6.9 million inflow in the second quarter of 2025 to an $8.8 million inflow in the second quarter of 2026, primarily due to improved revenue and profitability.

•Deployed $4.7 million to repurchase approximately 1.0 million shares of the Company's common stock during the quarter at an average share price of $4.50 per share.

Results of Operations

Consolidated Results

Our business segments have different factors driving revenue fluctuations and profitability. The changes in our revenue and profitability are discussed in greater detail in the following section, "Segment Results." We generate revenue from the delivery of products and services to our customers. Cost of sales, for both products and services, consists of labor, materials, subcontracting costs and an allocation of indirect costs.

Operating Expenses

In the second quarter of 2026, operating expenses decreased by $5.4 million, or 24.9%, compared to the same quarter in 2025. Research and development ("R&D") expenses slightly decreased by $0.2 million, or 11.0%, in the second quarter of 2026, compared to the same period in 2025. Selling, general and administrative ("SG&A") expenses decreased by $5.3 million, or 25.9%, in the second quarter of 2026, compared to the same period in 2025, primarily due to lower stock-based compensation expenses. Reductions in SG&A expenses, other than stock-based compensation, were due to ongoing cost discipline and restructuring. As a percentage of revenue, overall operating expenses were 34.3% and 60.7% for the three months ended June 30, 2026, and 2025, respectively.

For the six months ended June 30, 2026, operating expenses decreased by $10.7 million, or 24.9%, compared with the same period in 2025. R&D expenses slightly declined by $0.4 million, or 12.4%, in the first half of 2026, compared to the same period in 2025. SG&A expenses decreased by $10.3 million, or 25.9%, in the first half of 2026, compared to the same period in 2025, primarily due to lower stock-based compensation expenses. Reductions in SG&A expenses, other than stock-based compensation, were due to ongoing cost discipline and restructuring. As a percentage of revenue, overall operating expenses were 33.8% and 64.6% for the six months ended June 30, 2026, and 2025, respectively.

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Other income

Other income decreased by 9.4% in the second quarter of 2026, compared to the same period in 2025, primarily due to changes in dividend income from money market placements. However, other income for the six months ended June 30, 2026, increased by 7.5%, compared to the same period in 2025, primarily due to the refund in 2026 of a prior-year VAT claim that was previously determined to be uncollectible.

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.

Three Months Ended June 30, 2026, Compared with Three Months Ended June 30, 2025

Security Solutions segment revenue for the second quarter of 2026 increased by 43.7%, compared to the same period in 2025, primarily due to the expansion of multiple large programs in Telos ID.

Security Solutions gross profit for the second quarter of 2026 increased by 46.0%, compared with the same period in 2025, primarily due to higher segment revenues. Likewise, segment gross margin increased from 34.8% to 35.4% for the second quarter of 2026, compared with the same period in 2025.

Six Months Ended June 30, 2026, Compared with Six Months Ended June 30, 2025

Security Solutions segment revenue for the six months ended June 30, 2026, increased by 58.9%, compared to the same period in 2025, primarily due to the expansion of multiple large programs in Telos ID.

Segment gross profit for the six months ended June 30, 2026, increased by 49.2%, compared to the same period in 2025, due to higher segment revenues. By contrast, segment gross margin decreased from 38.4% in 2025 to 36.0% in 2026, primarily due to higher non-cash infrastructure costs.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 contain 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 "Special Note Regarding Forward-Looking Statements" at the beginning of this 10-K.

In this section, we discuss our financial condition, changes in financial condition and results of operations for the year ended December 31, 2025, compared to the year ended December 31, 2024.

Overview

For an overview of our business, including our business segments and a discussion of the services and products we provide, see Item 1, "Business" in Part I and Note 16 – Segment Information of the notes to the consolidated financial statements contained within this 10-K.

As discussed under Item 1A, "Risk Factors," we derive a substantial portion of our revenues from contracts and subcontracts with the U.S. federal government. Our revenues are generated from a number of contract vehicle and task orders. The U.S. federal government has increasingly relied on contracts that are subject to a competitive bidding process (including BPA and IDIQ Task Orders, OTAs, and other GSA schedule solicitations), resulting 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.

Over the past several years we have sought to diversify and improve our operating margins through the evolution of our business from an emphasis on product reselling to an advanced solutions technologies provider. Although we continue to offer resold products through our contract vehicles or our prime partners' contracts, we have focused on the transformation and growth of our software and service solutions offerings, as well as the design and delivery of our manufactured and branded technologies. We emphasize leveraging technology and innovation, specifically in cybersecurity, cloud, and identity solutions, to drive growth and ensure a secure and defendable network. We continue to invest in and develop in AI integration, enhancing automation and improving existing solutions to maintain a competitive edge.

We believe our contract portfolio reflects low to moderate financial risk due to the limited number of long-term fixed-price development contracts, thus minimizing the risk of cost overruns. Our firm-fixed-price activities consist primarily of contracts for products and services at established contract prices that are designed to be repeatable solution offerings. For 2025 and 2024, the Company's revenue derived from firm-fixed-price contracts was 73.3% and 75.3%, respectively; time-and-material contract revenue was 21.8% and 14.6%, respectively; and cost-plus contract revenue was 4.9% and 10.1%, respectively.

Business Environment

U.S. Federal Government Budget

In fiscal year ("FY") 2025, we generated approximately 91.0% of our revenues from the U.S. federal government, either as prime contractor or a subcontractor to other contractors engaged in work for the U.S. federal government, including 58.1% of our revenue from the DoW. Accordingly, our business performance is affected by the overall level of U.S. federal government spending and the alignment of our offerings and capabilities with current and future budget priorities of the U.S. federal government.

While we view the budget environment as constructive and believe there is bipartisan support for continued investment in the areas of defense and national security, it is uncertain when (and if) in any particular government fiscal year appropriations bills will be passed. During those periods of time when appropriations bills have not been passed and signed into law, U.S. federal government agencies operate under a continuing resolution ("CR"), a temporary measure that allows the government to continue operations at prior year funding levels.

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The FY2025 U.S. federal government appropriations, which ran through September 30, 2025, were determined by a full-year CR. While the Administration has submitted its FY2026 budget proposal outlining its priorities, partisan disagreements over federal spending levels, among other things, have stalled progress on the required appropriations bills. Recently, on February 3, 2026, Congress passed another full-year CR for FY2026 to end the partial government shutdown. This enacted bill provides full-year funding for several programs, including defense and national security, through September 30, 2026; and also extended homeland security funding through February 13, 2026. A partial government shutdown began on February 14, 2026 after the lawmakers and the White House failed to reach a deal on legislation to fund DHS through September 2026. The impasse affects agencies such as the Transportation Security Administration, the Federal Emergency Management Agency, U.S. Coast Guard, the Secret Service, U.S. Immigration and Custom Enforcement, and U.S. Customs and Border Protection.

Congress approved a FY2026 Defense Appropriations Bill that provides $838.7 billion in discretionary funding, including $838.5 billion in defense funding and $180 million in nondefense funding. This funding prioritizes restoring military strength, accelerating modernization, and supporting personnel through pay raises. This bill moves in parallel with the National Defense Authorization Act ("NDAA"), signed in December 2025, which authorizes up to approximately $900.6 billion for national defense.

The federal government's cybersecurity and IT spending priorities for fiscal years 2025 and 2026 present both significant opportunities and notable risks for our suite of security solutions. The FY2026 NDAA authorizes approximately $15.1 billion for DoW cyber activities, representing a 4.1% increase. The FY2026 NDAA emphasizes securing the defense industrial base, accelerating artificial intelligence ("AI") integration, and harmonizing cybersecurity requirements. This increase directly aligns with our core offerings in cyber risk management (e.g., Xacta).

Further, the FY2026 budget for AI reflects a massive strategic shift toward implementation and national dominance, particularly within the defense sector. FY26 is viewed as the year federal agencies move from experimenting with AI to adopting "agentic" AI. The FY26 budget request included a record-breaking $13.4 billion for AI and autonomy initiatives within the DoW, the largest single-year investment in the agency's history. Consistent with these initiatives, in October 2025, we launched Xacta.ai, which we believe will reduce cyber compliance timelines through AI-driven automation.

The federal government cybersecurity and AI-related initiatives continue to evolve and may be influenced by changes in Administration policy, legislative action and regulatory developments. These changes may affect funding allocations, procurement strategies and compliance expectations. While management continues to monitor the federal government's initiatives and seeks to align the Company's capabilities accordingly, there can be no assurance that the future government priorities will not impose new compliance obligations, or technological advancements that will require for additional investment or affect the Company's ability to compete for or perform under government contracts.

Other Economic and Regulatory Policies

Aside from the uncertainty in the budgetary environment, the Administration put in place a number of Executive Orders and actions that have affected, and could continue to affect, many businesses. The Administration continuously evaluates federal agencies and existing government contracts, grants, and programs for affordability, efficiency, and alignment with U.S. federal government priorities. Further, the Administration continues ever-changing actions that increase, invoke new and/or rescind tariffs on various goods imported from various countries. Changes in international trade policies, including higher tariffs on imported goods and materials, may increase the procurement costs of certain IT hardware we use internally, on our contracts, or sell to our customers.

The ongoing and potential future reforms to the U.S. federal government processes, including changes to procurement rules and regulations, could transform how contracts are awarded, negotiated, and managed. These initiatives could further delay contract awards and/or result in modifications to the scope or terms of contracts we hold. At the same time, the Administration's focus on efficiency, transparency, consolidation, and accountability could lead to certain traditionally government functions being transferred to private entities. This potential transition of services to the private sector could benefit Telos, given our wide array of capabilities and advanced solutions.

On July 4, 2025, the One Big Beautiful Bill Act (“OBBBA”) was enacted into law. The OBBBA includes significant changes to the Internal Revenue Code, with various provisions changing the U.S. federal income tax regulations and modifications to the Inflation Reduction Act of 2022. Further, the OBBBA significantly impacts the defense sector through substantial funding allocations and strategic investments, including specific investments in areas like AI, and provides the DoW with extended time, until 2029, to make strategic investments in the defense industrial base. Increased funding and improved tax treatment for research and development could boost targeted defense investments, scale commercial technologies for military use, and support related programs.

We continue to monitor and assess the risks and opportunities presented to us, in light of ongoing political tensions and heightened global instability that we expect to persist in the near term. Initiatives to reduce governmental spending, federal budget and debt ceiling action, and U.S. federal government policy positions, including trade policy, tax reform and/or changes to the U.S. federal government priorities, could materially impact federal spending broadly.

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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, cash flow, and Adjusted EBITDA (a non-GAAP financial measure). 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.

Backlog

Backlog is also 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 of U.S. federal government contr

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