Q2 2023 Telos Corporation Earnings Call

Okay.

Good day, and thank you for standing by and welcome to the Telos Corporation second quarter 2023 earnings call.

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Please be advised that today's conference is being recorded.

I'd now like to hand, the conference over to your host today Alison Phillips.

Good morning, Thank you for joining us to discuss Telus Corporation second quarter 2023 financial results.

With me today is John Lewis, Chairman, and CEO of Tullow, and Mark <unk> Executive Vice President and CFO of Tullow.

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

John will begin with brief remarks on our second quarter 2023 results entellus and strategic priorities.

Then mark will cover the financials and guidance for the third quarter and full year 2023.

Turning it back to John to wrap up.

Then we'll open the line for Q&A for Mark Griffin Executive Vice President of Security solutions offered by now.

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

Additionally, we have provided presentation slides on our Investor Relations 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 comments made during this conference call and in our SEC filings.

Did 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.

Help investors understand <unk> 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 with comparable GAAP results in our earnings press release and on the Investor Relations portion of our website.

Please also note that financial comparisons are year over year, unless otherwise specified.

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 .

Thanks, Alison and good morning, everyone.

Let's begin today on slide three.

<unk> executed well in the second quarter and over delivered on key financial metrics.

Mark will discuss the details of our financial performance later in the call, but at a high level, we delivered $32 $9 million of revenue in the second quarter above our guidance range of $28 million to $30 million to $32 million.

Gross margin was 37, 6% above our guidance range of 28% to 31, 5%.

And we delivered breakeven adjusted EBITDA above the high end of our guidance range of negative $8 million to negative $6 million.

The sale of a large perpetual software license and security solutions helped drive the over performance.

Additionally, the restructuring plan, we initiated earlier this year strong program management and other cost actions have enabled us to limit the impact of lower year over year revenue on adjusted EBITDA.

Given our first half performance and our outlook for the remainder of the year. We have raised the midpoint of our full year revenue gross margin and adjusted EBITDA guidance ranges.

We continue to view 2023 is a transition year to begin rebuilding our backlog and revenue base for future growth.

We are fully focused on elevating the performance of our business development operation.

With the addition of high caliber senior business development personnel, who have a long and successful record of closing government opportunities and the implementation of business development best practices, we are working to improve substantially our pipeline win rates backlog and revenue over time.

Additionally, we are aligning our investments in our solutions portfolio to the demands of the end markets and customers we know best.

In particular, we are focusing on expanding our already well established and successful managed cyber security services business as well as prioritizing growth in our telos advanced cyber analytics offering.

The board and I are committed to this plan and are confident we are taking the correct actions to position the company for growth over time.

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

Within the security solutions business, we continued to achieve high renewal rates with our exact customer base, including the Central Intelligence Agency U S Department of the Treasury. The U S Department of the interior of the office of Naval Intelligence the National Archives.

<unk> Environmental Protection Agency, Oracle and SAP.

The company was also awarded new contracts with NASA.

The Virginia Department of Education, and the National Endowment for the Arts.

The Telus team secured two new awards are automated message handling service.

One was with a foreign government customer and the other is with our federal government customer.

We ate several major EHS contract renewals, including with the drug enforcement administration in the U S Department of the Treasury.

We also secured a new contract with a federal government customer for our tell us advanced cyber analytics or Telos AUC.

Finally, I had some noteworthy updates on the TSA pre check program.

We recently achieved several operational milestones in close coordination with TSA.

Tell us as official TSA pre check enrollment website is operational.

We are pleased to have reached this milestone and have included the website address in our earnings slides and press release.

Additionally, seven enrollment sites are now open across four states, we look forward to steadily growing this offering in the coming months and years.

I will now turn the call over to Mark Venza, who will discuss the second quarter 2023 financial results and guidance for the third quarter and full year 2023.

Mark.

Thank you John and thank you everyone for joining us today.

Let's turn to slide five.

As John mentioned, we completed the second quarter with revenues gross margin and adjusted EBITDA.

But the high end of our guidance range.

And we are therefore able to raise the midpoint of our full year guidance, while also narrowing our original ranges.

Getting into more detail on the second quarter total revenues were $32 9 million.

Revenues for our security solutions business declined 44% to $17 2 million and were above the top end of our second quarter guidance range due to the sale of a large perpetual software license that was not included in our forecast and drove the entirety of the revenue guide.

<unk> for the company overall.

Security solutions contributed 52% of total company revenues down slightly from 55% in the comparable period last year.

The year over year revenue drivers for security solutions were consistent with our expectations as previously communicated on prior earnings calls.

Stable recurring revenues and our information assurance business were offset by revenue contraction and secure communications and telecom.

As a result of a program loss and secure communications at the end of 2022.

And lower revenues on two ongoing programs in Telos IV <unk>.

Combined these three programs represented a $15 $3 million year over year headwind in the quarter.

Turning to secure networks as expected revenues declined 37% to $15 7 million.

Near the top end of our second quarter guidance range due to continued strong supply chain management.

The year over year revenue headwinds and secured networks were also consistent with our expectations as previously communicated on prior earnings calls.

Three large programs that primarily came to a successful completion in 2022 and lower revenues on an ongoing program drove a $10 million headwind in the quarter.

Turning to profitability.

Gross margin expanded slightly to 37, 6% due to 222 basis points of margin expansion and security solutions.

Partially offset by a slightly less favorable weighting of revenues to our higher margin security solutions business.

And 13 basis points of margin contraction and secure networks.

Gross profit exceeded the high end of our guidance range by approximately $2 3 million and gross margin exceeded the high end of our guidance range by over 600 basis points.

Gross margin for our security solutions business expanded to 55, 5%, primarily due to higher software sales.

Lower indirect costs from ongoing expense management actions.

And lower stock based compensation and cost of sales.

And significantly exceeded the high end of our guidance range, primarily due to the previously mentioned sale of a large perpetual software license.

More favorable mix of labor and materials on select programs and.

And expense management on fixed price contracts.

Gross margin for our secure networks business at 17, 9% was comparable to last year, but exceeded the high end of our guidance range due to ongoing expense management actions driving lower indirect costs.

Adjusted EBITDA was approximately breakeven and exceeded the top end of our guidance range by $6 million due to the previously mentioned $2 $3 million of better than expected gross profit as.

As well as $3 7 million of lower than previously forecasted below the line expenses, excluding depreciation and amortization.

Below the line expenses were lower due to ongoing expense management initiatives and higher capitalization of R&D.

Now, let's turn to free cash flow and liquidity.

Cash flow from operations was $4 1 million outflow in the quarter.

Free cash flow with an $8 $6 million outflow down from a $5 4 million inflow during the comparable period last year due to lower earnings higher capitalized development costs.

And less favorable working capital dynamics.

As expected and mentioned on our prior earnings call discrete vendor payments created a sequential headwinds for cash flow from the first quarter to the second quarter.

We ended the quarter with over $103 million of cash no debt and an undrawn $30 million senior secured revolving credit facility with an additional $30 million expansion feature.

Our balance sheet continues to be a competitive advantage and remains well positioned to support the company through a wide range of operating conditions and strategic opportunities.

Let's turn to slide six to discuss our guidance for the third quarter.

For the third quarter, we forecast sales in a range of $30 million to $34 million.

And an adjusted EBITDA loss of 8 million to $6 million.

We forecast security solutions revenues to decline mid 50% to mid 40% year over year and.

And secure networks revenues to decline low 50% to mid 40% year over year.

Both due to the same large program dynamics that will persist throughout 2023.

Gross margin is expected to be down approximately 250 basis points to up 125 basis points year over year.

With the range driven by mix and timing of revenue recognition on programs of varying margin profiles within the quarter.

Gross margin is also expected to be down sequentially, primarily due to the previously mentioned sale of a large perpetual software license in the second quarter.

Cash below the line expenses, which adjusts for capitalized software development costs.

Stock based compensation restructuring costs, and DNA are forecasted to be approximately $2 million higher year over year, excluding management reserves.

Primarily due to planned growth investments in the second half focused on business development information assurance.

<unk> HCA and TSA pre check.

Including management reserve cash below the line expenses are projected to be approximately $3 5 million to $4 million higher year over year.

Let's turn to slide seven to discuss our updated guidance for the full year.

We're raising the midpoint of our full year guidance and also narrowing our our original ranges.

Our revised guidance includes revenues in a range of $122 million to $137 million and we are raising the midpoint slightly from $127 $5 million in our prior guidance to $129 $5 million and our updated guidance.

Revised guidance also includes adjusted EBITDA, ranging from a $19 million loss to a $14 million loss and we're raising the midpoint from a $22 million loss in our prior guidance to a $16 $5 million loss in our updated guidance.

The improved full year guidance reflects new business wins, and Ami Hs and Telos HCA.

Lower revenues on pre existing programs in Telos I'd.

Higher revenues on pre existing programs and secure networks high.

Higher gross margins higher capitalization of R&D and second half growth investments focused on business development information assurance Tullow for HCA and TSA pre check.

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

Thanks, Mark let's move to slide eight.

To summarize we exceeded quarterly expectations and delivered results above the high end of our guidance range on key financial metrics.

We continue to actively manage expenses and have seen that focus drive an improved profit outlook.

Based on our first half performance and outlook for the second half, we're raising the midpoint of our full year guidance and also narrowing our original ranges.

We continue to focus on elevating the performance of our business development operation by investing in new and existing personnel and implementing standardized best practices, which will enable us to improve our pipeline win rates backlogs and revenue over time.

Additionally, we are aligning investments in our solution portfolio to the demands of customers and end markets that we know best.

The board and I remain fully committed to this plan and are confident we are taking the correct actions to position the company for growth over time.

And with that we're happy to take questions. Operator, Please open the line for Q&A.

We asked the call participants to please be mindful of others in the queue by asking only one question. Thank you.

Alright. Thank you we will now conduct the question and answer session.

<unk> to ask a question. Please press star one on one on your telephone and wait for your name to be announced to withdraw your question. Please press star one again.

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

Okay.

Thank you for standing by our first question comes from Zach Cummins with B Riley Securities.

Yes.

Yes, hi, good morning, John and Mark Congrats on solid results here in Q2.

I guess I'll just ask because as a two part question, but first John can you just talk about some of the new business activity and nice to see some incremental wins.

Within MHS NACA and then can you talk about the progress that you've seen with with your new business development initiatives and then part two is just really.

Expectations around TSA pre check it seems relatively early but still encouraging that the website is now up and live.

Sure. Thanks, Thanks for your questions.

So with regard to our advanced cyber analytics activity. There are basically two sites, where we provided the service the first as you know.

Looking for zero day, <unk> zero day activities and the second is really a surveillance kind of a capability and customers buying both of those kind of very interesting. So are there.

The first real customer of size.

As seen that as a real positive for them and that's going to be something that we're going to stay focused on delivering as we could go down this path of providing much more active sort of related active cyber security activities. If you will.

The second thing I'll say about the automated message handling system is that it really is the standard of secure messaging in our government, but as our government does business with other governments around the world and particularly as we as we plan operations government to government around.

The World I think there is an opportunity for EHS to be sold to those other governments that our allies.

The United States. So I think that's something that we'll see more of as we head down the path.

Now as it relates to as.

As it relates to our business development activity.

I would say in general is that we're really raising up the focus on that activity and I'm going to ask Mark Griffin to address that as well as the where we are with TSA pre checks I think mark really is the person who asked to take over that and take on that responsibility for the company.

Hello, Zack Marc Griffin.

Ed.

We have previously indicated some of our objectives. This year was the restructuring of the business and growth practice.

With that we added as we indicated senior professionals to increase the high caliber of talent, we had to increase that we also.

<unk> seeing and wanted to add contracts to our portfolio. So that we could then bid on additional vehicles and expand our pipeline in that space. One of the other objectives was not only partnering but adding additional companies that we could team with both on these.

<unk> pipeline opportunities, but also on strategic growth objectives.

The pipeline in general from a 'twenty two to 'twenty three has increased.

X multiple so we are seeing significant improvement in the factored pipeline to date. So we're confident that we're going in the right direction a lot of the opportunities.

Close or get awarded this quarter and into the end of the year. So that's really when we start seeing results of some of this at all honestly.

Continue into 'twenty four as we continue to grow that organization.

On the TSA pre tax side, yes, we are happy the official website that was in the slide deck has been launched and we also indicated seven enrollment sites are now open and we look forward to.

Spanning that nationwide presence.

In the coming months.

So.

On the volume that we've seen primarily on the renewal side has been decent.

Since we launched and so.

We expect that to continue to grow so the next steps are expansion nationwide. So that we can service the customers in.

In locations in areas that are more convenient and Zach just to remind you and the rest of the people on the call here.

This contract way back win was awarded because we had several proof points that were important one was we had won the census contract and just to remind everybody over a course of four months during the height of Covid, we're able to take in a $1 million of numerator is to do the census process itself that was a big Pat.

Performance qualification for us.

Second was around our ability to win at airports across America. So I think but that first point is important once we build out that network there'll be other activities that we can push through that network that was our plan and that continues to be our plan.

Okay. Thank you one moment for our next question.

Our next question comes from Rudy Kessinger, Dave.

Davidson and company.

Great. Thank you for taking my questions.

I wanted to ask another question on TSA.

Just how much revenue are you expecting in the second half of this year and then could you.

And remind us of the fixed cost structure.

The potential margin flow through.

At scale and just at this point.

You have any timeline to when you expect to get material share of sign ups and renewals.

So really if you don't mind I'll ask Bryan tended to handle the first part of your question and then as it relates to the scaling question I will ask Mark what's enabled that later and after Mark Penza addresses. Your first question, Okay, Hey, everybody. Good morning, so on on pre check.

Listen we are in the early stages.

Ramping pre check so in.

In the second half here in the guide we have a pretty modest level of revenue.

<unk> of it as.

Okay.

Very low single digit.

To start.

Regarding.

The ramp over time.

Yes, I think.

We're probably looking at.

It's split between renewals and new enrollments right. So renewals I would say, we'll ramp much more quickly.

That's an online process as opposed to an on site to process, new enrollments will ramp over a longer period of time think of it more like a one year ramp.

Because that will involve.

The rollout of a nationwide network of physical locations, which will which will take which will take more time.

And then in terms of once the program is fully ramped.

Yes, I think we could see gross margins in the fifties.

And adjusted EBITDA margins in the thirties, when you get to a full run rate program.

Mark Griffin as far as market share.

Obviously there.

There are three contract award.

At this stage all of which.

Ourselves and the current provider.

Provider or have websites that are operational so I'm not able to draw conclusions yet on what ultimately we can take market share, but the conclusion. Currently is there are two players with light websites to do both enrollment and renewals.

Okay. Thank you one moment for our next question.

Our next question comes from Alex Henderson of Needham.

Thanks.

Just wanted to clarify upfront.

The contract that you signed.

That.

It was on the software side I assume that was.

<unk>.

To the extent that that was perpetual I guess it doesn't recur so could you give us some sense of.

Hey, what kind of customer that was it.

Government agency was at a partner was it.

And enterprise.

What the scale of that was so that we can anticipate that falling out of the numbers next year.

As a large contract in the comp.

Sure.

Alex that was.

Foreign government.

What made that purchase.

It was a purchase of the automated message handling system.

That has a tail of about 20% per year as it was a perpetual license.

And it was.

I don't think we sit with exactly what the number was.

It was low single digit millions, yes, Alex.

Okay.

For next question.

Yeah.

Our next question comes from Brian Clark of BMO capital markets.

Alright. Thank you for taking my question on the security network business clearly aggravated in growth are being impacted by.

Contract completion from 'twenty to 'twenty, two you mentioned probably in particular, how should we be thinking about sort of the go forward run rate of contract completion.

Nope.

<unk> you know that had been awarded and then.

We anticipate.

<unk> growth for control.

In particular network might be over the next few years. Thank you.

Yes.

Yes, Brad I think your question was on networks there.

And the outlook for network. So as you referenced we have we've had a meaningful step down in networks. This year as a result of a couple of very large contracts coming to a successful completion.

At the end of last year those were contracts that grew that drove 89% growth for networks on the top line in 2021, and then ramp down have been ramping down since then.

As we as we look forward into 2024 and beyond.

I think not just for <unk> for the company overall, it's still too early to provide detailed visibility into 2024.

But keep in mind at this point in any given year, we typically have somewhere around call. It a few tens of millions of dollars of revenue headwinds embedded in our backlog across the portfolio for the upcoming year, which then needs to be back filled with new business, especially unsecured networks. So so.

Par for the course, and new business tends to be seasonally weighted to late in the calendar year or early the following calendar year.

Now the headwinds youre, referring to that we have coming into 2023.

It was unusually large and we werent able to backfill the revenue as we've previously discussed.

But I'd say at this point the revenue we need to backfill not only in secured networks, but just in general across the company for 2024 is much more typical roughly in the range of a few tens of millions of dollars. So the conversation we were having with Zack earlier.

Around.

The investments in R.

Our growth and business development organization.

As an important one.

Because in order to grow next year will need to backfill that unusual.

Revenue headwinds in the in the <unk>.

Backlog, let me to convert our pipeline and win additional business later this year and early next year as we do every year.

Thanks.

Alright, Thank you for your questions.

Im showing no further questions at this time I would now like to turn the conference back to John Wood.

Closing remarks.

Thank you operator.

I just want to thank our shareholders.

For your ongoing support.

Our first half results reflect our team's diligence and focus on delivering results that exceed our original outlook for 2023.

And I just want to assure you that the board and I remain fully committed to taking the necessary actions to improve.

Performance and return to growth.

So we are in a robust and recession resistant end markets. We are very well funded customers and we do have a decades long track record of serving the world's most security conscious organizations. So as a result, we feel that tell us as a strong foundation for the future.

We hope you share that point of view as well thanks, a lot everybody.

This concludes today's conference call. Thank you for participating you may now disconnect.

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