Q3 2021 Telos Corp Earnings Call

November 15, 2021

Good day, ladies and gentlemen, and welcome to tell US Corporation third quarter 2021 earnings conference call. At this time all participant lines are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time.

Ask a question you would need to press Star then one on your telephone as a reminder, this call is being recorded if anyone should require operator assistance. Please press Star then zero I would now like to hand, the conference over to Christina Loser Maris. Please go ahead.

Thank you for joining us to discuss tell us corporations third quarter 2021 financial results.

With me today is John <unk>, Chairman and CEO of Telus and Mark than the C. F L. A tell us.

Let me quickly review the format of today's presentation.

John will begin with brief remarks on the third quarter results and tell us is a strategic priority.

And Mark will cover the financials and guidance.

Then we'll open the lines for Q&A for Ed Williams, Executive Vice President and C. O L of pillows and Mark Griffin Executive Vice President of Security solutions will also join us.

The earnings press release was issued earlier today and is posted on the Telos Investor Relations Web site, where this call is being simultaneously webcast.

Additionally, we have provided presentation slides on our investor website.

Before we begin we want to emphasize that some of our statements on this call are forward looking statements and are made under the safe Harbor provisions of the federal Securities laws.

These statements are based on current expectations and assumptions that are subject to risks and uncertainties.

Actual results could materially differ for various reasons.

Including the factors described in today's earnings press release.

And the comments made during this conference call.

And in our SEC filings.

We do not undertake any duty to update any forward looking statements.

In addition, during today's call, we will discuss non-GAAP financial measures, which we believe are useful as supplemental and clarifying measures to help investors understand tell us this financial performance.

These non-GAAP financial measures should be considered in addition to and not as a substitute for or in isolation from GAAP results.

You can find additional disclosures regarding these non-GAAP measures, including reconciliations in comparable GAAP results in our earnings press release and on the Investor Relations page of the Telos website.

The webcast replay of this call will be available for the next year on our company website under the Investor Relations link with that I'll turn the call over to John.

Well. Thank you Kristina welcome to our third quarter 2021 financial results Conference call.

Let's begin today on slide three.

I'm pleased with our performance this quarter, we delivered 48% reported sales growth.

80% adjusted sales growth.

We increased our gross profit, 57% to a record $26 $1 million, we expanded our gross margin by 229 basis points to 37%.

We generated $12 $5 million of positive cash flow from operations and we continue to win meaningful contracts.

Let's turn to slide four.

We are nearing the end of our first year operating as a publicly traded company. It's been a busy year with an exciting new energy and pace.

While we welcome many new people to the team. This year, we have others, who are nearing the end of their careers.

One such retirement is that of Ed Williams, who has served as our chief operating officer since 2003.

Ed joined tell us to 1993 and throughout his tenure has provided nearly three decades of leadership and dedicated service to the company.

Effective today November 15th Ed's responsibilities will transition to two of my senior staff members, Mark Griffin and Brendan Malloy, who will report directly to me.

Mark Griffin will step in as the executive Vice President of Security solutions, where he will oversee all the operations and business development efforts surrounding our security solutions business, which includes exacta tell us coast.

The automated mass message handling system, and IV Trust $3 60.

Mark has been with tell us since 1984 and in 2007, he became the general manager of our identity business and he was instrumental in navigating and ultimately winning the TSA pre check expansion contract.

Brendan Malloy will become the executive Vice President secure networks, overseeing all operations and business development surrounding the secure networks business.

Brandon has been with tell US is 1996 and throughout his tenure. He has provided leadership in support of secure networks opportunities in the D O D intelligence community and federal agencies.

In 2012, Brendan became the general manager responsible for the business development implementation and operations of the secure network solutions area.

To ensure a smooth transition Ed will stay on at Williams will stay on as a senior executive until the end of January of 2022.

I'm confident we have the deep leadership bench needed to take us to the next phase of our growth.

Now, let's turn to slide five to discuss our recent highlights and updates.

Over the last four quarters, we've been a journey to ramp up our sales force and channel partner program.

Which lays the groundwork needed for the expansion of our commercial business in the coming years.

Since the beginning of 2021, we've achieved our objective tripled our sales marketing and channel team and continue to attract top talent.

The build out of the Telos cyber protect partner program is progressing well.

We're actively pursuing partner recruitment and have 20 partners and our partner ecosystem.

Most of our channel partners have both the government and our commercial enterprise practice. This gives tell us solutions more opportunity to expand into new markets.

While we didn't expect the channel to begin driving revenue until 2022, we've seen a few deals go through the channel from the department of housing and urban development and the Alabama, Medicaid agency, which allowed us to pressure test the channel program.

In the third quarter.

We also announced the partnership with AWS, and Splunk and stack armor.

With an initiative called faster.

Which stands for faster Ato.

And a T O stands for authority to operate.

So faster Ato with Splunk, Telos and threat alert for regulated markets.

Faster benefits independent software providers and regulated defense contractors required to cut.

Comply with complex federal state and local government security regulations.

Since our launch Red hat and Wicker had been added as customers of the fast program.

This partnership is a great example of how organizations can embed and leverage our technology.

To our partner driven solution that expands our market reach.

Another example of expanding our reach of our solutions is in the state and local government and education Mark markets are what we call sled.

A critical component of any sled go to market strategy is to have contract in procurement vehicles.

And our third quarter, we successfully added exactly and <unk> solutions to 11 sled purchasing contracts.

Both regional and state specific.

We are very pleased with the performance in our security solutions group, where we have nurtured strong relationships with new and existing customers.

We continue to see accelerated growth.

For example, a customer since 1995, the defense manpower datacenter or D. M. D. C awarded Telos option years, three through mid September of 2022.

Alrighty Trust 360 solutions supports the department of defense within its security and common access programs.

As a part of the D. D. D. M. D. C Award, we received over $22 million in orders in Q3.

We continue to bring on new airlines within our designated aviation channeling business, adding three additional airlines in Q3, and receiving option year extensions from current airport customers, including Chicago O'hare Chicago.

Chicago Midway.

And Phoenix Sky Harbor International.

The most notable expansion within the practices with the United parcel service or UBS.

Where they announced its full use of our solution for cargo security threat assessments and.

In criminal history record checking beginning later this year.

We continue to work closely with cloud service providers, AWS and Microsoft around our exact solution with.

We recently added a third cloud service provider Oracle to our roster of cloud customers and we continue to engage with Google and IBM.

The commercial cloud enterprise contract with the CIA that was awarded to AWS, Microsoft Google Oracle and IBM continues to be a catalyst for our expanded cloud provider footprint.

As for overall direct sales performance, we received the following notable wins and renewals.

Vmware, a leading cloud computing and virtualization technology company selected exactly to support its fed ramp compliance efforts.

A fortune 50 insurance company renewed an annual license of exact and supporting it.

Its audit automation of security controls validation.

Salesforce, a leading CRM SaaS provider renewed an annualized since of exact in.

In support of its fed ramp requirement.

New federal exactly customers include Idaho National Labs in the U S Department of housing and urban development.

The latter is already moving towards expansion.

New is that the clients will also add in construction and financial services sectors.

And a special customer utilizing telos ghost for an intelligence support solution executed an option year and increased the contract value by 63%.

These wins continue to demonstrate the viability of <unk> solutions in a wide variety of markets.

In addition, we had a solid quarter of exact renewals for added backlog with existing government customers.

These customers include the National Security Agency.

The National Geospatial Intelligence agency.

The Federal Bureau of investigation.

And the social security administration among others.

In our secure networks business, we're pleased to see solid revenue growth associated with recurring large programs that offer solutions to the department of defense.

These large programs continue to provide a solid foundation of business now and into the into the future for the company.

Next I'd like to provide an update on the TSA pre check expansion contract.

In July and then again on September 29th.

TSA confirmed in public notices that they anticipate the additional.

TSA pre check enrollment providers to come online in 2021.

Our team has a near daily communication with TSA program officials, and we stand ready to support TSA is authorization timeline.

The short term delay in granting the new enrollment providers with the authority to operate is related to TSA his own efforts to ensure superior security of the enrollment provider ecosystem and superior quality of the customer experience.

We're encouraged by the commitment TSA has demonstrated to ensure the security of it systems and operating environment.

That's a good thing for all of us.

We want this program to be on a solid footing from the day. It launches so that customers within the program can feel confident that they can transact securely while benefiting from the expedited screening experience.

I'd also like to reiterate that TSA pre check is a multi year contract with multiple option year extensions.

So let me now turn to some comments on the industry.

Congress has been working on an enormous infrastructure package and president guidance build back better lead legislation.

Both of which have potential implications for cyber security and specifically for telos.

The infrastructure Bill recently, given final approval by Congress will provide $1 9 billion in new cyber security money.

Including $1 billion dedicated to a new state local and tribal and territorial cyber Grant program.

The latest version of the build back better build will provide $400 million for cyber security initiatives by DHS is cyber security and infrastructure Security agency for Cisco and.

And $100 million for FEMA to.

To directly support state cyber security efforts.

This new federal funding is above and beyond the money provided for cyber security via the annual congressional appropriations process.

We believe many of these initiatives could ultimately result in an increased need for solutions and services supplied by Telos.

While the government is currently operating under a continuing resolution individual appropriations bills awaiting final negotiations between the house and the Senate would also boost cyber security funding in several areas, including for the department of defense.

Infrastructure, cyber security and risk management operations.

As part of the administration's focus on addressing cyber vulnerabilities in our nation's critical infrastructure.

<unk> recently announced.

That it would require a higher risk rail transit companies and critical.

U S airport and aircraft operators to take certain actions to protect themselves in cyber space.

This action follows TSA is directed in July to require owners and operators of critical pipelines to implement mitigation measures against known threats to it.

And operational technology systems, and established plan to recover from a cyber attack.

These actions by TSA are significant because they represent the first real efforts by the federal government to impose mandatory cyber security requirements for some of the 16 designated critical infrastructure sectors.

We believe that all of these initiatives once finalized we will provide <unk> with a number of additional long term business opportunities and.

And more importantly, these initiatives once enacted will provide organizations and individuals with a higher level of security.

I'll now pass to our CFO, Mark <unk>, who will discuss the third quarter financials.

Mark.

Thank you John.

Thank you everyone for joining us today.

Let's turn to slide six.

I am pleased with our results this quarter highlighted by 48% reported sales growth, 80% adjusted sales growth too.

229 basis points of gross margin expansion, including gross margin expansion across every line of business.

Record gross profit of $26 1 million.

$12 $5 million of cash flow from operations and.

And $9 $4 million of free cash flow, bringing year to date free cash flow to positive $1 3 million.

Now, let's get into the details starting with revenues.

Reported third quarter revenues grew 48% from $47 $4 million in 2020 to $70 $1 million in 2021.

Excluding our contract with the U S census Bureau, which is ramped down as planned since the same period last year total third quarter revenues grew 80%.

In future quarters comparisons with prior year periods will not be meaningfully impacted by our contract with the U S Census Bureau.

Total third quarter revenues for security solutions.

Grew 14% from $31 $2 million.

In 2020 to $35 $7 million in 2021, notwithstanding $7 8 million of lower sales in <unk> on the contract with the U S Census Bureau, as previously mentioned.

Continued strength in security solutions was driven by <unk>.

Exactly solutions and our confidential healthcare program with the federal government.

Excluding the contract with the U S Census Bureau, third quarter revenues and security solutions grew 56%.

Total third quarter revenues for our secured networks business grew 112% from $16 $2 million in 2022 to $34 $4 million in 2021.

This significant increase was mostly driven by the same two large programs mentioned on our last earnings call.

The rollout continued for a contract to provide security modules and kits to support the upgrade of theater Deployable communications for the U S Air Force.

And site work continued on a five year U S army contract to support the migration and modernization of telephone communication systems throughout the Pacific region.

We expect work on these programs to continue into 2022.

Now, let's discuss profitability and cash flow.

Third quarter gross profit increased 57% from $16 $6 million in 2020 to a record $26 $1 million in 2021.

Third quarter gross margin increased 229 basis points from 34, 9% in 2020 to 37, 2% in 2021.

Cost of sales included $442000 of stock compensation expense, which did not exist in the same period last year.

Excluding the impact of stock compensation expense gross margins increased 292 basis points to 37, 8%.

Security solutions and secured networks, both drove gross margin expansion, including gross margin expansion across every line of business and.

In fact security solutions gross margins expanded over 12 percentage points from approximately 45% in 2020 to a record 57% in 2021, driven by program performance and favorable sales mix with an exact solutions and.

<unk>.

SG&A and R&D expenses increased by $19 $3 million from $12 million in 2020 to $31 $3 million in 2021.

Of the $19 $3 million increase approximately $12 million was attributable to stock compensation expense that we did not have in the prior year period.

We incorporate restricted stock grants and to our compensation strategy as a retention tool and to ensure direct alignment of our direct alignment of interests between our employees and shareholders.

The remaining increase in R&D and SG&A expense was primarily driven by planned and previously discussed investments in our sales force marketing and channel staff and.

Investments in G&A functions to support our post IPO business model and investments in the development of next generation security capabilities for our customers.

Operating income before stock compensation expense increased 54% from $4 $5 million in 2020 to $6 $9 million in 2021.

Operating income benefited from higher gross profit driven by both sales growth and gross margin expansion.

Partially offset by the previously mentioned investments in R&D and SG&A.

Adjusted net income increased from a loss of $198000 in 2020 to a profit of $6 $8 million in 2021.

The increase in adjusted net income was primarily driven by the same factors as operating income discussed previously, but also benefited from the elimination of $1 $8 million of interest expense and $2 $7 million of minority interest compared to the same period last year as a result of the actions we took to deleverage our balance sheet.

And simplify our capital structure post IPO.

The corresponding adjusted quarterly earnings per share increased from a loss of <unk> <unk> per share in 2020 to a profit of <unk> 10 per share in 2021.

EBITDA adjusted for the impact of stock compensation expense increased 45% from $5 $8 million in $2022 $8 $4 million in 2021, primarily due to the record gross profit generated this quarter.

We generated $12 $5 million of cash flow from operations and $9 $4 million of free cash flow during the quarter.

Year to date free cash flow is now positive $1 3 million.

Before turning to our outlook for the year I'd like to provide insights regarding our sequential performance from the second quarter to the third quarter.

During our second quarter earnings call, we indicated that we expected roughly 40%.

Percent to 50% sequential sales growth from the second quarter to the third quarter.

Based on $52 $6 million of sales in the second quarter that would imply roughly $73 million to $79 million of sales forecasted for the third quarter compared to our actual third quarter sales of $70 1 million.

Our sequential sales growth forecast included a multimillion dollar <unk>.

Chess software license sale to an international government customer within our secure communications business.

Although that program is still scheduled to begin in 2021, our customer has decided to move the software license portion of the program out of the current year.

If the software sale had occurred in the third quarter as originally expected our third quarter sales would have been within the $73 million to $79 million range that we had originally forecasted and our gross margins would have been over 40%.

Turning to slide seven we.

We will discuss our financial outlook for the remainder of the year and provide a high level preview of 2022.

As John previously mentioned, the TSA has reconfirmed and public notices in July and again on September 29.

That it expects the additional pre check enrollment providers will be made available to travelers before the end of 2021.

While we are encouraged by the TSA public confirmation.

At this stage in the fourth quarter, we are not expecting this program to deliver meaningful sales this year.

Accordingly, we are updating our 2021 guidance to reflect our third quarter results as well as our latest view on the pre check expansion program and our secure communications and secured networks businesses.

Our original 2021 guidance reflected sales of $283 million to $295 million year over year growth of 57% to 64%.

And adjusted EBITDA of $33 million to $36 million.

We are updating our 2021 guidance with sales of $240 million to $245 million year over year growth of 33% to 36%.

And adjusted EBITDA of 18 million to $19 million.

Our updated guidance implies fourth quarter sales of $61 6 million to $66 6 million.

Year over year growth of 37% to 48% and.

And adjusted EBITDA of $3 9 million to $4 9 million.

Now, let's recap the buildup to our updated guidance.

On our second quarter earnings call, we lowered our modeling assumptions on two programs due to customer delays beyond our control.

First we eliminated the provider enrollment and oversight program with the centers for Medicare and Medicaid services.

Including $16 million of sales and $6 million of adjusted EBITDA.

Second for the TSA pre check expansion program, we eliminated $13 million of sales and $5 million of adjusted EBITDA.

While maintaining a forecast of $25 million of sales and $10 million of adjusted EBITDA in the fourth quarter.

With our updated guidance. This quarter, we are now eliminating the remaining $25 million of sales and $10 million of adjusted EBITDA from the TSA pre check expansion program in the fourth quarter.

In total we have lowered our sales assumptions on these two programs by $54 million.

And our adjusted EBITDA assumptions by $21 million.

The guidance reductions attributable to the CMS and TSA programs are partially offset by better than expected performance elsewhere in our portfolio. For example, due to a confidential healthcare program with the federal government as well as lower than expected G&A expense.

On our second quarter earnings call, we forecasted $29 million of sales outperformance and $11 million of adjusted EBITDA outperformance. We are now forecasting 4 million to $11 million of sales outperformance and 4 million to $6 million of adjusted EBITDA.

<unk> outperformance.

The changes since our second quarter earnings call reflected the previously mentioned lower than expected sales from our secure communications business.

And lower G&A expense in the second half.

The changes also reflect supply chain disruptions at one of our subcontractors.

And that will delay several large fourth quarter shipments on a major program within our secured networks business.

Lastly, we are very pleased with our free cash flow performance in the third quarter and our positive cumulative free cash flow for the first nine months of the year.

However, as a result of our of our revised guidance, we do not expect to generate positive free cash flow in the fourth quarter.

Full year 2021.

Now, let's discuss our preview for 2022.

Although we will not provide specific guidance for 2022 today, we can provide some high level direction on the year over year sales growth dynamics for our security solutions and secure networks businesses.

Let's start with security solutions.

We're expecting security solutions to have another year of strong growth in 2022, primarily driven by the expected ramp of TSA pre check throughout the course of the year on top of a solid base of recurring revenue as well as potential for higher commercial software sales later in the year.

We believe security solutions has the potential to continue growing approximately in line with the growth rate that we are forecasting for security solutions in 2021, excluding the 2021 year over year headwind from the contract with the U S Census Bureau.

Next we're expecting secured network sales to be flat to down in 2022 due to the completion of a large program.

Keep in mind, we're forecasting secure networks to grow over 85% in 2021.

So the year over year growth comparison is a very high hurdle Nonetheless.

Nonetheless, with large multiyear programs in process, we believe secure networks will hold sales at a high level in 2022.

Our 2022 outlook is based on several key assumptions as follows.

TSA grants the authority to operate in 2021 and sales on that program ramp throughout the course of 2022.

That provider enrollment and oversight program with the centers for Medicare and Medicaid services continues to be delayed, thereby generating no sales in 2022.

We start to see the initial benefits from our initial from our investments in commercial software sales and marketing late in 2022.

The executive order on vaccine mandates does not cause any meaningful disruptions to our ability to recruit and retain employees or to our subcontractor relationships.

And our supply chain normalizes.

To summarize our growth drivers remain intact and our end markets are strong we are well positioned for continued growth and our long term outlook remains unchanged.

Our 2022 preview does reflect some customer delays, which will push a portion of our growth profile to the right.

With that I'll pass it back to John who will wrap up on slide eight.

Thanks Mark.

So we're confident the seasoned leadership team we have in place will Usher the company into this next phase of growth.

We're moving forward on our strategic priorities to increase commercial adoption of our solutions.

Build a robust and productive sales team.

Nurture a strong partner ecosystem.

And drive continued adoption of our solutions through existing customer expansion.

We're very pleased with our performance this quarter.

Which was underscored by substantial revenue growth.

Record gross profit and excellent cash generation.

And we look forward to another year of strong growth in 2022.

With that Mark Benzer, Ed Williams, Mark Griffin and I are available to take your questions.

Operator, please open the line for Q&A.

Thank you to ask a question you will need to press Star then one of your telephone to withdraw your question. Please press the pound key.

These standby, while we compile the Q&A roster.

Our first question comes from the line of Zach Cummins with B Riley Securities. Your line is now open.

Hey, good morning, John and Mark Thanks for all the incremental color and especially kind of around the outlook here going forward, but.

Mark just really dialing down into that one when I'm looking at the full year guidance here for FY 'twenty. One I mean can you give me a little more sense of I guess, the other areas of the business outside of TSA and CMS that that really didn't outperform outperformed your expectations that you were thinking they would when you gave that guidance in Q2.

Yeah, so listen in terms of in terms of the outperformance really.

The change in the outperformance is really driven by by two things first.

The perpetual license that we were expecting in the third quarter on and a chest within our secure coms business.

That program will still launched this year.

We had expected, but the perpetual license portion of it has pushed out of 2021 and the other piece is.

Is the supply chain disruption that we're experiencing on one program within secure networks.

That's a sizable program.

So that is having a meaningful impact on on that outperformance line now what I'll say, even at the low end of our guidance for the fourth quarter.

There is still meaningful.

Supply chain risks in at the low end that we have about $3 million.

<unk>.

Assumed shipments in December even at the bottom end of the guidance range. So so please keep that in mind and there is also another $6 $5 million of shipments that we thought would have gone out by now this quarter, which have not yet gone out, but we feel like we have more more comfort around that around that six and a half run at six five.

Yeah.

And then.

Elsewhere within within the portfolio of the business is performing as expected.

And we feel we feel really good about the other programs within secure networks as well as broad based performance across security solutions and all other aspects of security solutions outside of.

<unk>.

Reference that I made earlier, but strong broad based outperformance strong broad based performance I should say in line with our expectations within security solution and then elsewhere within secured networks outside of that one large program.

Understood that's helpful and looking at your 2022 preview.

Really appreciate just some high level insight into this but.

Maybe I didn't fully understand it in terms of security solutions, you're expecting that growth rate to be in line with what you are going to post this year could you just clarify the expectations for security solutions growth rate this year and I'm, assuming that's excluding the contribution from from the census contract.

Yes, so when you back out.

The headwind from the U S census, contracting our security solutions I think embedded in our guide is going to grow kind of in the high 30%.

Range.

So hi, 30, so sort of probably short of 40%, but in the in the high 30.

Got it and thats, including the headwind from the census contract I'm, just trying to make sure I'm fully clear on that.

That is excluding the impact got it excluding the headwind from sensus. So if you calculated it on a reported basis it would be lower than that.

Understood that's helpful.

And then just finally on the CMS.

Contract it seems like you're already assuming there is not going to be any contribution from that in 2022, I mean can you give us some more insight into what's going on with that program and potentially what could be pushing that further to the right.

Yes. So first let me just give you a kind of a perspective on how I'm thinking about guidance in general So I've always taken over a forecasting and guidance process in recent weeks here.

As I've as I've transitioned to the role what you're starting to see in part with the changes, we're making today to our guidance and our outlook is a little bit around kind of my philosophy on guidance and so we're currently working through our 'twenty two planning process. So of course, we're not can provide 'twenty two guidance today, we'll do that on the <unk> earnings call.

Paul.

But we are assessing a range of scenarios for 'twenty two as we work through our planning process.

And as we've discussed today and throughout the course of 'twenty one.

A couple of our more meaningful short term growth drivers, we originally expected in 'twenty one.

Pushed into 'twenty, two or maybe even beyond in the case of CMS.

In addition to that as I mentioned secured network, yes, we will have a sizable year over year headwind to backfill due to the expected completion of a large program early in 'twenty two.

And so.

Wei.

I think about guidance.

I would like to guide based on what I have a high degree of visibility into at a point in time and then we can pull additional opportunities into our guidance as the year progresses and opportunities to become more visible in certain especially with respect to timing and.

I'll look to to Mark Griffin here to comment briefly on CMS and how we're how we're feeling about that but I think based on what we're seeing right now at this stage.

We're not putting CMS into our 'twenty two outlet, but I'll pass it to mark for more color there.

Hello Zack.

Way, we see CMS is that government agencies have not been reverting back to full in person fingerprinting and the population that this program was anticipated was the lower risk health providers that needed to undergo background checks based on that population and so the.

Anticipated fingerprint volume until that population comes back into the mixed due to both COVID-19 and the vaccine.

And that has come up that expansion and increased opportunity.

This contract was afforded has been delayed and so that's the guidance that Mark and John are both talking about that specific lower risk help providers has not come into the population yet.

Understood and just a final question for me in terms of the Q4 guidance I mean can you give us a rough assumption of the mix between security solutions and secure networks than before.

Yes.

Can you one second here it's about.

At the lower it's going to be a little better than 50 50 that we saw this quarter.

Understood I appreciate you guys, taking my questions.

Looking forward to your progress next year.

Our next question comes from the line of Dan Ives with Wedbush. Your line is now open.

Yes. My question I think a lot of people asking me how could management.

So.

In terms of Miscalculating the timing of deals.

As well as just the complexity.

That's my first question just given.

What we're seeing in terms of just the massive.

Got it.

Yes, So let me take a first.

Shot let.

Let me take a first shot at that Dan.

So listen I think.

One of the strengths of our equity story here is that.

We have some very large needle moving growth opportunities in our portfolio that we're very excited about it and we think our shareholders are excited about now.

The double edge sword, there is that when some of those meaningful growth opportunity shift even a little bit in some cases.

In terms of timing that can have a meaningful impact on on what we are forecasting versus actual results and we saw that.

In the third quarter of.

This year with the movement of that one software license out of the quarter and we thought to the upside in the first quarter of this year when we had a.

A large customer order pull forward into the first quarter and we ended up better than we expected so.

So that's the way that's the way I think about it as I said earlier going forward and I think what you're starting to see in the guide this quarter.

Is that my philosophy on guidance is.

Is.

That.

We'll guide based on what I have a high degree of visibility into at a point in time.

And so youre going to see that and how we guide going forward and Youre seeing that.

For the fourth quarter here as well as our preliminary look on 'twenty, two but I'll pause there and see it.

Hi.

John or anyone else wants it.

Dan It's John the other thing I'd say just in general is that.

When we guided on TSA, our perspective was based on the program office that we could deliver.

But the security office was not able to get to the point, where they could get to an ato.

And as a result as of today at least we don't have that Ato.

So we.

Like Mark said these are large programs are multi year programs.

And unfortunately.

It just didn't happen this particular quarter on the TSA.

Isn't there are $40 million cost cut and only $25 million and Thats TSA.

There is $25 million from TSA.

There are large.

Yes.

Let's take each of the iPhone I just wanted to just just clear numbers. So how much is the guidance cut.

So topline 43, 43% to 43% to $50 million.

So there can have DSA.

Well no the fee component of the of the 43% to $50 million 25 with TSA.

And then the balance is primarily between two other factors first supply chain disruptions that we're getting that are impacting a large program within secure networks. So there are several large shipments on a secured networks program.

Thats our forecast to go out at the end of this quarter.

<unk> supply chain disruptions.

Are impacting <unk>.

One of our subcontractors and thats going to push.

Those shipments out of the end of the fourth quarter into the first quarter and then the other pieces within our secure communications business a large multimillion dollar.

<unk>.

License software license perpetual license that the customer is pushing.

Out of this year.

So.

None of these shifts and I think that's an important point.

None of these changes.

And any way represent a loss of business.

All of this is timing.

<unk>.

And actually in all cases this is timing.

Timing outside of our control Unfortunately.

Okay.

Follow up.

What would give investors any thompson wounds.

We're not back here three six months from now and it just keeps getting pushed out like in terms of your ability to forecast. This.

Well, so then the way out again.

We've only recently taken over the forecast the guidance process here.

<unk>.

How I'm thinking about guidance going forward again is that.

We will guide based on what we have a high degree of visibility into at a point in time.

And then as things become more imminent as things materialize, we'll pull them into the guidance over over the course of the year. So there is going to be a shift in terms of the philosophy of guidance here at least from my perspective.

Thanks.

Our next question comes from the line of Keith Bachman with bank of Montreal.

Your line is open.

Yes, I have a couple.

Similar to the last line of questioning I wanted to go back to CMS for a second.

And.

I think.

Previously, we had thought it might be kind of a $60 million.

Tailwind associated with 22 now.

Now it's zero.

Pretty big bearings there.

What are the conditions that might allow for some of that.

To flow into 'twenty, two and ore.

Is there a risk that that is.

<unk> zero right.

Saying, it's your own 22 is that a zero.

In perpetuity.

And that may be hybrid workforce stays or things along those lines, but put put some context around CMS because I think most people were expecting the TSA to get.

Pushed into next year.

But this is a pretty big change on CMS as well.

Keith before I ask Mark to answer that question.

You might recall on the last discussion we had people were asking me about about CMS and I said that until we had more data I wasn't about to talk about it for 2022.

And we still are down the path of going down the vaccination program process, where HHS has basically said that's our <unk>.

That's where we're pushing a majority of our dollars.

And when the vaccination process is over we'll get back to sort of business as usual, where we moved from doing manual intervention to using automation like like ours. It tell us.

But mark Griffin I'd like you to add any.

Additional points here because.

For those of you on the call here Mark.

And running our identity business also held.

When is the CMS as well as the TSA TSA business, so and today Mark takes over security solutions. So mark.

Keith.

CMS program is a multifaceted program. So the targeted revenue that we had previously given you was on roughly $1 5 million fingerprints annually on that program and as I explained earlier that was primarily an expansion of our lower risk health providers coming into that ecosystem.

Because it's a multifaceted program there are other opportunities that tell us will be looking at both from a security point of view and enhancement of that so we will also be targeting the acquisition that we had earlier in the year, which is the diamond <unk> acquisition, the touchless fingerprinting application to basically bring.

In other capabilities and modalities to collect that population so.

We're confident that the program will expand.

Now we move to guidance out from 2022 on specifically just that $1 5 million fingerprint. So there are other security elements that come into that program that we as a corporate security Corporation will be bidding on and we hope to bring those into the mix I'm just not able to expand on those at this.

Time.

But as the program expands there are other opportunities within that 10 year $2 billion program that we'll be bidding on.

Okay.

My second question is on.

The commercial impact being laid in 'twenty two.

I appreciate given the.

It's very inconsistent performance.

The collective firm.

<unk> been hiring for a while now commercial sales reps and throughout the course of certainly 'twenty one.

And the safety impact doesn't come until late 'twenty two.

Means.

It's <unk>.

Concerning.

And most enterprise sales.

Reps are equal kind of six to 12 months and so if you've been hiring through the course of.

'twenty one even if you took a weighted average you should see some impact.

March or June quarter. So please kind of begs the question.

Why not a greater impact.

Yeah, why don't I start with that key so listen it's not to say there won't be impact earlier.

While I was more signaling in my script.

Degree of impact.

Maybe we'll see something more meaningful earlier than what I'm, indicating in the script, but as I said earlier.

I think about guidance and forecasting more based on.

<unk>.

Yeah.

The level of visibility that I have.

At a point in time so.

We'll see over the course of next year what.

What the ramp curve looks like.

The other thing I'd point out Keith is that we will give.

Actual 'twenty two guidance.

On the heels of Q4 earnings.

Alright.

There are still more things for us to be doing here.

Now and then and so but mark is trying to do is give a if you will a heads up block.

Ahead of time.

And trying to make sure that everybody.

Understand sort of what we're having to deal with these large programs.

Okay, well my last one is just philosophically is there any or.

I'm not expecting specific numbers, but any directional barometers that you want to provide based on at least kind of the top line cadence on how we should be at least.

Philosophically thinking about margins in 'twenty two.

Flat down up any kind of just.

Directional barometer, so folks can at least try to sit there.

Models.

To be in the neighborhood perhaps.

So I think there are a couple of puts and takes there so first.

As pre check phases into the P&L I would describe pre check in the early days as being dilutive to gross margin.

Over time as that program scales and in particular scale again.

<unk> costs running through cost of sales on that program.

Youre going to see gross margins expand and then also over time.

Ancillary revenues get pulled into that program that was going to be at a higher margin, so youre going to mix higher.

But in the short term initially and that program I would consider that program to be dilutive.

Dilutive to gross margin.

I think on the secured network side I think there is opportunity for secure networks to mix slightly higher next year.

And then in terms of the mix between solutions and network.

I would expect solutions to outgrow networks next year.

So youre going to see you should see a tailwind there so headwind in the form of pre check tailwind in the form of potentially higher margins within secure networks, and then tailwind in terms of better mix between solutions and networks.

Okay last one and then I'll cede the floor.

Excuse me.

It's now November 15th.

Is there any.

Whats the status and your mind on the ramp of TSA.

Okay.

And we're lucky even asked since this has been kind of perpetually pushed off but is there any chance of raws in the march quarter or should we be thinking.

Let's just start with June.

Mark.

I'm going to ask Mark Griffin answer that question Keith directly okay.

Okay.

I want to first just touch on a point that.

The TSA modernization act of 2018 as law that that mandated that PSA expand pre check providers. So I just wanted to remind.

Everyone on the phone that there isn't a question of if or when this program. It's mandated by law that it has to expand and so our goal all along was to improve the passenger experience at check point and where we're at right. Now is as we had indicated earlier both by market John.

TSA has still indicating and is working with us daily.

We're here with our facility last week working through.

Fully expect still to get our authority to operate this year and revenue to start ramping as early as January now it probably won't be significant in the first quarter, but we do start seeing revenue in first quarter not June.

Okay, I will cede the floor. Thank you.

Our next question comes from the line of Alex Henderson with Needham. Your line is now open.

So since we were just talking about.

Can you give us a concise and clear explanation of why.

Flip to as much as it has.

Is it just simply because of the.

What happened in the first half.

<unk>, that's causing this voltage.

Alex I'll ask Mark Griffin to answer that again directly for you guys Hello, Alex.

So I believe the increased security heightened.

Policy and procedure has added to some of that delay as you know a government contractor we have to follow the process and procedures at the government mandates us for the authority to operate and so.

Part of the project expansion.

Process is security is a heavy component of that and TSA is very protective of their brand and so they want to make sure that all expansion providers.

Come out of the gate strong with a secure solution that has gone through all the vetted components within their organization, including including their own right, including their own organization and so we are seeing progress I'm very confident.

Moving forward in the right direction. Unfortunately, we are government contractor and we have to follow their process for the authority to operate.

So going back to Q.

The recalibration of the timing.

Is there anything different.

<unk> challenges.

Estimating the timing.

When theyre going to launch this now when there was a three.

Three months ago, when we got to third quarter guidance.

Fourth quarter.

Is there any.

I guess.

I really don't understand is with only a month and a half left what gives you confidence. This is actually going to close this year other than the press release, which.

Cannot be relied upon as we've already seen press releases.

Eric timing Hasnt been materialized.

Sure I can appreciate that we're seeing steps in the process as a security provider within the government. There are steps in the approval process that the government takes.

Review your security documentation, so there's various steps that they take in that process and although we were.

I'm confident that those processes, we're going to begin on the last earnings call.

Were delayed and so now we have seen progress in the right.

Move forward steps and so those security processes and those steps in the process of being taken now by TSA. Obviously, we are following suit in the process.

Under their guidance.

Well it <unk> TSA is there any change in the competitive dynamics associated with the timing of these.

Yeah.

Okay.

<unk>.

That would either help you or hurt you.

As we ramp in 'twenty two.

So as you are aware eligibility that TSA pre check.

Is expanding market due to population growth. So the population continues to grow PSA awarded expansion contracts to three providers. So as such the implied competition Malawi Zig start in this contract and Hasnt changed based on the delay in the launch.

Well the question really goes to the question of how fast can those other companies.

Comparatively get the approvals do they have the same timeline or will you be able to because of the inclusion of exactly and some of the other software gauges, you have be able to get to market sooner than them or are you at risk of them getting compliance.

Before you.

So government does not give us insight into the status of the other providers. However, we feel as though we're leading.

The approval process and making headway as a first out of gate solution provider. So IL currently feel as though we will not be first out of the gate from an expansion provider.

So let me so Keith second subject Paul.

The commentary around the software.

Growth in primarily in the second half inch T y.

Slide 22.

Well it makes little or no sense to me in the context of the fact, we've already said that the salespeople that you've hired in the distribution expansion that you've hired have already resulted in significant benefits to your numbers.

And to growth and that in fact gene felt that there was.

They were running ahead of me.

Budget I don't understand why there would be a sudden launch for six months in the first half of 'twenty two against the already improved performance of those.

Participants.

Alex This is John.

But what I've seen what we've seen is an expansion in the pipeline and that's why I said earlier as it relates to 2022 actual guidance.

We will give that on Q Q4 earnings.

And then we will we'll go from there I think Mark Burns is trying to set expectations in a very conservative way and my hope is that we'll be able to do better than what we're talking about as it relates to on Q4 earnings.

For 2022, and Mark did I think I said that correctly from your point of view.

That's fair.

But while that might be fair with the stock down at 18, 50 year down from 24, and a half mechanics of why the revenue.

Tradition to themselves.

Distribution.

Yes.

All going to be less than the first half than they were in the back half of this year is hard to understand you said in the past that you're already getting contribution from them.

I don't I don't see it.

I don't think.

I don't think that's going to happen Alex I think we're going to see good contribution from our.

Sales and distribution channel.

<unk> ships.

Just again without providing full guidance for 2022, we're just giving you.

Sort of a heads up as where we are today.

Yeah.

Alright.

Let's shift gears and again go over to the secured network side I get it that it was up 85% this year, obviously that.

Is it much lower gross margin product.

Clearly.

As that mix shifts away from that if that's going to be flat to down.

Sequentially or 22, then I would assume that that mix quite significantly improves the gross margin outlook for next year is there any reason why that would not be the case.

Yeah. So there's a few puts and takes there so within solutions itself.

We're going to see.

A gross margin headwind.

Pre check phases into the P&L.

In the early days of pre check I would expect pre check to be dilutive to gross margins.

And over time as that program.

Youre going to see positive operating leverage against some fixed cost that's running through cost of sales on that program and then you'll also see benefit over time from favorable.

Mixed shift some additional ancillary higher margin revenues get attached to.

That get attached to that program.

And then youre going to have.

A verbal mix shift between solutions and networks next year at solutions should outgrow networks and then within networks, we think theres potential for slightly higher margins there as well so those are kind of the.

Puts and takes the headwind from pre check and a tailwind from mix shift between solutions and networks as well as possibly some slightly higher margins within network.

Okay. So the TSA delay of $25 million is that a reasonable baseline quarterly revenues for 2000.

Two given you had expected to do that in the fourth quarter.

I think you had expected at least ramp that.

Quarter forward.

Ignoring that point, assuming it kicked in by the end of the year.

Is it reasonable to think that the $100 million worth of revenue at least from the TSA pre teen.

So.

I would love to be more specific on that as we actually get a couple of months.

<unk> is experiencing that program under our belt, but you can you could see a scenario where perhaps in the second half you could potentially see a run rate around around those levels.

Alright, Thank you I'll cede the floor.

Our next question comes from the line of Niihau Chachi lift Northland capital markets. Your line is now open.

Hi, Noel.

Jeremy.

Yes, I'm here now.

Sorry about that.

Mark when you say that you are changing the way guy to include only items that have high basically into.

When you use the word changing does that.

That means that there is still more.

Although visibility items that you guys that you wanted to scrub out here.

That may have gotten into your initial calendar 'twenty to look through.

No probably not in terms of 'twenty two but in the interest of full transparency to one thing I would like to highlight for the fourth quarter is around the supply chain constraints again, even at the bottom end of that guidance range. There is about $3 million of December shipments assumed within that guide.

<unk> range.

We believe those will go out but again these are yes.

These supply chain constraints are two levels down here. So these are suppliers to our sub contractor in particular around electronics.

Electronic components and plastics.

And so there is.

$3 million of additional risk there at the bottom end of the guidance range and is off to another $6 $5 million of shipments that we thought would have gone out by now which are which are delayed within the quarter.

We feel a little better on those and those will go off this quarter, but.

Phil I'd have to scrub everything out.

Our less $3 million in there at the bottom end of the range and then with respect to 'twenty two.

Yes, I think at this stage based on based on what we know I think the I think the high level year over year direction for solutions and network that I provided.

At this stage.

<unk> reflects.

Our current thinking on 'twenty, two but again bear with US we'll give guidance on the <unk> call. We're working through our 'twenty two planning process and looking at different scenarios.

Right now.

Okay. Thank you.

And then with respect to essentially a high 30% preliminarily look and high 30% growth or preliminary look into calendar 'twenty two security solutions.

Is that going to be even across the three sub segments or it sounds like it probably would be more weighted towards <unk> is that a correct interpretation.

Yes, I think thats, the right way of thinking about it I would say within solutions.

The single largest growth driver.

The rapid and pre check.

Okay.

Got it.

And then within.

The <unk> 'twenty one performance you did say you had 56% year over year growth in Securities solutions adjusting for the census Bureau from the year ago period.

Is that 56% year over year growth relatively even across the three sub segments or how is that ours out there.

Yes, so the single I would say the largest grower there.

Within <unk>.

Followed by.

Information assurance, which is primarily our exact the solution capability.

Alright, Okay, Alright, and then finally.

John in your part of his script. He mentioned a lot of that revenue related exactly wins with industry bellwethers, such as Vmware and Salesforce.

What percent of Federer fed ramp associated opportunity do you think Telus has now captured and pretty other percent whats the typical legacy swisher being utilized.

Yes, I would say, it's a very small percentage right now in the home.

And the way that people do it generally speaking is manually.

I think theres, a great opportunity in front of us to expand that significantly because we're using automation to reduce the time it takes to actually get to fed ramp compliance.

Great Alright, thank you.

Sure.

Thank you welcome.

We will conclude today's question and answer session I will now turn the call back over to John <unk> for closing remarks.

Guys I just wanted to thank our shareholders for.

Their ongoing support we delivered strong results in the third quarter of 'twenty, one and.

And we are well positioned to capitalize on the.

The increased emphasis on cyber security across commercial and government organizations.

<unk> got really really solid outstanding people, we've got leading security solutions and tremendous potential.

While we have had a couple of issues with regard to our larger programs I've actually never been more excited about <unk> future that and today.

So I just wanted to say thank you all for listening and remember this is a long term investment.

One that I am.

Our plan to be a part of for a long time as long as you guys will have me. Thanks, a lot bye bye now.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.

[music].

Good day, ladies and gentlemen, and welcome to tell US Corporation third quarter 2021 earnings Conference call. At this time all participant lines are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time to ask a question you will need to press Star then one on your telephone as a reminder, this call is being.

Record it if anyone should require operator assistance. Please press Star then zero I would now like to hand, the conference over to Christina moves of Erith. Please go ahead.

Thank you for joining us to discuss tell us corporations third quarter 2021 financial results.

With me today is John Wood, Chairman and CEO of Telos, and Mark <unk> CFO of pellets.

Let me quickly review the format of today's presentation.

John will begin with brief remarks on the third quarter results and tell us is a strategic priority and Mark will cover the financials and guidance.

Then we'll open the line for Q&A, where Ed Williams Executive Vice President and C. O L of Telos and Mark Griffin Executive Vice President of Security solutions will also join us.

The earnings press release was issued earlier today and is posted on the Telos Investor Relations Web site, where this call is being simultaneously webcast.

Additionally, we have provided presentation slides on our investor website.

Before we begin we want to emphasize that some of our statements on this call are forward looking statements and are made under the safe Harbor provisions of the federal Securities laws.

These statements are based on current expectations and assumptions that are subject to risks and uncertainties.

Absolute results could materially differ for various reasons.

The factors described in today's earnings press release.

And the comments made during this conference call and in our SEC filings.

We do not undertake any duty to update any forward looking statement.

These non-GAAP financial measures should be considered in addition to and not as a substitute for or in isolation from GAAP results.

The webcast replay of this call will be available for the next year on our company website under the Investor Relations link with that I'll turn the call over to John.

Well. Thank you Kristina welcome to our third quarter 2021 financial results Conference call.

Let's begin today on slide three.

I'm pleased with our performance this quarter, we delivered 48% reported sales growth, 80% adjusted sales growth.

We increased our gross profit 57%.

To a record $26 $1 million, we expanded our gross margin by 229 basis points to 37% we.

We generated $12 $5 million of positive cash flow from operations and we continue to win meaningful contracts.

Let's turn to slide four.

We are nearing the end of our first year operating as a publicly traded company. It's been a busy year with an exciting new energy and pace.

We welcome many new people to the team. This year, we have others, who are nearing the end of their careers.

One such retirement is that of Ed Williams, who has served as our chief operating officer since 2003.

Ed joined tells the 1993 and throughout his tenure has provided nearly three decades of leadership and dedicated service to the company.

Effective today November 15th edge Responsibility's will transition to two of my senior staff members.

Griffin and Brendan Malloy, who will report directly to me.

<unk>, who will tell us since 1984 and in 2007, he became the general manager of our identity business and he was instrumental in navigating and ultimately winning the TSA pre check expansion contract.

Brendan Malloy will become the executive Vice President secure networks, overseeing all operations and business development surrounding the secure networks business.

Brandon has been with tell US is 1996 and throughout his tenure. He has provided leadership in support of secure networks opportunities in the D O D and.

<unk> community and federal agencies.

In 2012, Brandon became the general manager responsible for the business development implementation and operations of the secure network solutions area.

To ensure a smooth transition Ed will stay on at Williams will stay on as.

As a senior executive until the end of January of 2022.

I'm confident we have the deep leadership bench needed to take us to the next phase of our growth.

Now, let's turn to slide five to discuss our recent highlights and updates.

Over the last four quarters, we've got a journey to ramp up our sales force and channel partner program.

Which lays the groundwork needed for the expansion of our commercial business in the coming years.

Since the beginning of 2021, we've achieved our objective tripled our sales marketing and channel team and continue to attract top talent.

The build out of the Telos cyber protect partner program is progressing well.

We're actively pursuing partner recruitment and have 20 partners and our partner ecosystem.

Most of our channel partners have both the government and our commercial enterprise practice. This gives tailored solutions more opportunity to expand into new markets.

In the third quarter, we also announced the partnership with AWS and Splunk and stack armor.

With an initiative called faster.

Which stands for faster Ato.

An ato stands for authority to operate.

So faster Ato with Splunk, Telos and threat alert for regulated markets.

Faster benefits independent software providers and regulated defense contractors required to cut.

Comply with complex.

Federal state and local government security regulations.

Since our launch Red hat and Wicker had been added as customers have the faster program.

This partnership is a great example of how organizations can embed and leverage our technology.

To our partner driven solution that expands our market reach.

Another example of expanding our reach of our solutions is in the state and local government and education Mark markets are what we call sled.

A critical component of any sled go to market strategy is to have contract in procurement vehicles.

And our third quarter, we successfully added exacta and <unk> solutions to 11 sled purchasing contracts.

Both regional and state specific.

We are very pleased with the performance in our security solutions group, where we have nurtured strong relationships with new and existing customers.

We continue to see accelerated growth.

For example, a customer since 1995, the defense manpower datacenter or D. M. D. C awarded Telos option years, three through mid September of 2022.

Alrighty Trust 360 solutions supports the department of defense within its security and common access programs.

As a part of the Dd's D. M. D. C Award, we received over $22 million in orders in Q3.

Chicago, Midway and Phoenix Sky Harbor International.