Telos Corporation (TLS) Earnings Call Transcript

[Operator Instructions] Please be advised that this conference is being recorded. I would now like to turn the conference over to your speaker today, Allison Phillipp. Please go ahead.

Good morning. Thank you for joining us to discuss Telos Corporation's third quarter 2026 financial results. With me today is Mark Griffin, President and CEO of Telos, and Mark Bendza, Executive Vice President and CFO of Telos. Let me quickly review the format of today's presentation. Mark Griffin will provide opening remarks on our operations and priorities, and Mark Bendza will discuss our third quarter results and full year outlook. We will then open the line for Q&A. The third quarter financial results were issued earlier today and are posted on the Telos Investor Relations website, 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, including all of those relating to 2026 company performance, plans, and operations, 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 financial results summary, in 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 Telos' 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 third quarter results summary 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 on our company website under the Investor Relations link. With that, I'll turn the call over to Mark Griffin.

Thank you, Allison, and good morning, everyone. This is my first earnings call as CEO of Telos, and I'm honored by the Board's confidence. I'm grateful to John Wood for his leadership and for the partnership we have built over the past 35 years. As Executive Chairman, John will continue to provide valuable guidance on our product roadmap, customer relationships, and long-term sales strategy. Telos enters this next chapter with meaningful momentum. Since the beginning of the third quarter, we have announced new and expanded engagements across the Air Force Intelligence Community, the Office of Naval Intelligence, the National Archives and Records Administration, the Department of Health and Human Services, the Department of Commerce Inspector General, and the Department of State. These awards demonstrate that customers increasingly view Telos as a strategic partner managing cybersecurity risk, not simply as a provider of compliance software. Organizations need continuous visibility into their security posture, the ability to integrate data from multiple security tools, and practical automation that helps their teams make faster and better informed risk decisions. Our Xacta platform is well positioned for this environment. Xacta 360 supports the governance and authorization lifecycle. Xacta.io brings together enterprise security data and enables continuous monitoring. And Xacta.ai applies artificial intelligence to automate manual activities and generate actionable insights. Together, these capabilities provide a more complete approach to cyber governance, risk, and compliance. Importantly, we are seeing Xacta adopted across defense, intelligence, and civilian agencies, often through expanded relationships with existing customers. That customer intimacy combined with our deep mission knowledge and FedRAMP High authorization gives Telos a differentiated foundation for growth. We also see an opportunity to sharpen how we bring these capabilities to market. AI is most valuable when it is embedded in solutions that address a clearly defined customer problem. For Telos, that problem is helping security teams understand risk, sustain compliance, and protect mission-critical systems in increasingly complex environments. As CEO, my priorities are straightforward: execute well for our customers, expand our market opportunities, continue improving operational performance, and translate our technology investments into durable, profitable growth. We will remain focused on building a more integrated product portfolio across cyber risk, identity, and related security services. I'm confident in the strength of our people, our customer relationships, and our technology. I look forward to working with our employees and partners to build on Telos' recent return to growth and deliver long-term value for shareholders. With that, I'll turn it over to Mark Bendza to review our third quarter.

Thank you, Griff, and good morning, everyone. We're pleased to report another strong quarter, highlighted by results that exceeded the high end of our guidance range, continued strong cash flow generation to fund share repurchases, and an increase in our full year guidance. Let's turn to slide 3. Total company revenue grew 7% year-over-year to $55.2 million, exceeding our guidance range of $49.2 million to $50.6 million, driven by stronger-than-forecasted performance in Telos ID. GAAP gross margin was 37.9% and cash gross margin was 43.1%, both above our expectations, reflecting disciplined execution on fixed-price programs and revenue outperformance on higher-margin programs. Adjusted EBITDA exceeded the high end of our guidance range, reaching $10.6 million compared to guidance of $6 million to $6.8 million and representing the highest quarterly adjusted EBITDA since our IPO in 2020. Adjusted EBITDA margin was 19.2%. Cash flow from operations was $9.4 million, or a 17.1% margin. Free cash flow was $7.4 million, or a 13.4% margin, and represented the seventh consecutive quarter above 12%. During the quarter, we deployed $5.7 million to repurchase over 1.2 million shares at an average price of $4.59 per share. Let's turn to slide 4 to discuss fourth quarter guidance. For the fourth quarter, we forecast revenue in a range of $47.5 million to $50 million, up 2% to 7% year-over-year. We expect cash gross margin to be approximately 43% to 44.5%, up year-over-year due to favorable revenue mix. Adjusted EBITDA is expected to be between $7 million and $8.8 million, representing a margin of 14.7% to 17.6%. Let's turn to slide 5 to discuss our updated full year outlook. Based on our third quarter outperformance and fourth quarter guidance, we are raising our full year revenue guidance to a range of $198.2 million to $200.7 million, which brackets the top end of our original revenue guidance range of $187 million to $200 million. Our strong revenue performance compared to our original guidance is primarily the result of significant new business wins in our information assurance business and outperformance on TSA PreCheck transaction volumes. We are also raising our adjusted EBITDA guidance to a range of $32.3 million to $34.1 million, significantly above our original guidance of $20.6 million to $28 million. The significant increase in adjusted EBITDA guidance is primarily the result of revenues at the top end of the range, higher cash gross margins on fixed-price programs, and better-than-expected revenue mix, partially offset by higher operating expenses. Turning to 2027, as previously discussed on our second quarter earnings call, starting in the fourth quarter, we expect the resale of low-margin third-party software to begin phasing out. While this revenue stream contributes meaningful revenue, it carries only a single-digit gross margin and is not consistent with the margin profile we're building across the company. The phase-out of this revenue stream is forecasted to create a $32 million year-over-year revenue headwind in 2027 with only a modest profit impact. The new business wins in our information assurance business that Griff discussed in his opening remarks represent $58 million of net new Xacta and professional services bookings in that business. We forecast those bookings will generate approximately $6 million of revenue in 2026 and $20 million of revenue in 2027 with normalized margins. And lastly, together with our prime partners, we continue to make progress on the pending proposals that we've discussed on prior earnings calls. We still expect to hear award decisions in the coming months, which could contribute meaningfully to 2027 revenue and profits. Let's turn to slide 6 to wrap up. The third quarter reflects the continued execution of our strategy. We're pleased with our year-to-date performance, confident in our updated full-year outlook, and remain focused on executing our strategy to drive profitable growth, generate steady cash flow, and create long-term value for our shareholders. With that, operator, please open the line for questions. Thank you.

Mark, this is Mark Griffin. And before we open up the line for questions, I wanted to have John Wood, Telos Executive Chairman, who has joined us by phone, say a few words. John?

Hey, Mark, thanks a lot. Hey, everybody. I just wanted to say thank you to all the shareholders for your participation today. I also wanted to spend just a couple of minutes to reflect on the decision that was made by Telos and me to move to an executive chairman function. You know, Mark and I have worked together for over 35 years. I've gotten to see him work in very difficult situations, very interesting situations, and really, really big opportunities. I personally believe we're at that stage where we have great big opportunities in front of us. And I asked Mark whether he'd be willing to take on the role of CEO because I was that sure he could do it for me. As many of you know, I've been CEO for many, many years. And I unfortunately made this decision with a little bit of heartburn because it meant that I had to go deal with some personal issues. And one of those personal issues was my health. I've had to go to the hospital and deal with my heart and some other things. It's been a really big deal for me. So again, I'm not going anywhere. I plan on being a shareholder and continue to be a shareholder of size over the coming years. So again, thank you so much. And what Mark is doing around identity as a service with TSA PreCheck and what we're doing around our AI activity with Xacta.ai is nothing short of a miracle in terms of the time it takes to get these jobs done. So anyway, best of luck, guys. I have complete faith in Mark, Mark Bendza, and the rest of the team, because I think they're really capable and they're really good and they've gotten us through the hard part. Now comes the fun part. Thanks, everybody. And I'll look forward to hearing from you in the future, and feel free to reach out anytime. But as it relates to day-to-day activities and getting to those hills that we need to take, Mark's the man. See you, guys. Thank you.

[Operator Instructions] Our first question comes from Rudy Kessinger with D.A. Davidson.

Hey, guys. I wanted to dive into these new business wins, $58 million in new business wins. Could you share a bit more color on these wins, just with respect to how recurring they are in nature versus more one-time, project-oriented wins? Just trying to get a sense of that $20 million in revenue you expect for '27. Is that a recurring $20 million we should expect well into the future? Or is there any one-time kind of contract stuff in there?

Hey, Rudy, Mark Griffin. These are definitely recurring-type awards. So we put out press releases, as you know, and you saw the size and number of these. So these are customers who have Xacta, whether it be the base core product of Xacta 360 or the IO, and in many cases, they're adding the AI component to it. So they see the value and the efficiency that they're getting for these products. So you'll see these recurring or renewals coming up for the foreseeable future. So we're very proud of where the direction Xacta is going, but these aren't one-time deals.

Great. That's great to hear, and congrats on that. Is there any—Mark, is there any, I know you didn't give any preliminary outlook for '27, but just as we think about '27, we update our models here, you've got about a $30 million headwind from the wind down of the third-party software. You've got $20 million at least from new business wins. You have other potential new business wins you could win this quarter. How should we be thinking about 2027 revenue versus '26? Is it possible we could still see you grow the top line even with that $30 million headwind?

Yes. Yes, Rudy, I do think we have a really good shot of seeing growth even with that headwind. And the information assurance wins helped to offset a good chunk of that headwind. And those new wins are coming in at, as you can imagine, significantly better margins than the $30 million of revenue that's going away. And then, as you referenced, we have significant additional opportunities to add revenue through ongoing strength in information assurance new wins next year, as well as the other submitted proposals that we've talked about on prior earnings calls.

Okay. And then last one for me, just any updated color on maybe gross margins in the next year and what those might look like on a full-year basis, and particularly in the second half, once you renew the TSA PreCheck contract?

Yes. Yes, so we'll dive into more detail on the March earnings call, but just to reiterate a couple of things that I said on the last earnings call. The elimination of the IDEM's third-party software, that should give us about 600 basis points of gross margin lift on a full-year run-rate basis. And then in addition, TSA PreCheck in the second half of 2027, we're expecting about 400 basis points of sequential margin improvement from the first half of '27 to the second half of '27. So by the time we get to the second half, it could be as much as 10 percentage points of margin lift from those two items. Now, between now and then, of course, there's going to be a bunch of other puts and takes, but those are two notable items from a margin accretion perspective.

Okay. Thanks for taking my questions, guys. Congrats on the quarter, and Mark, congrats on the new CEO role as well.

Thanks, Rudy.

Our next question comes from Erik Suppiger with B. Riley Securities.

Yes. And to John, we wish you the very best, and congratulations, Mark, and congrats on a great quarter for getting out of the box. First off, on the $33 million, how much of that is falling into Q4 and then the rest all hit? Can you talk about how the trajectory is in '27?

Yes, so in terms of the year-over-year headwind, in each of the first and second quarters, there's about $7.5 million to $8.5 million of revenue headwind. And then in the third quarter next year, that steps up to closer to $10 million. And then in the fourth quarter, it's a little under $6 million.

Okay. Okay. And Mark, are there particular changes that you anticipate making in light of your position? Are there strengths that you bring or are there any strategic changes in strategy that you plan to implement any different than what had already been underway?

Hello, Eric. The current strategy and vision that we have in place is working for us currently. You've seen significant growth this year, the expansion as we continue to roll out sites and perform on TSA PreCheck. So the identity business is performing well. With the Xacta and the Xacta.ai component and the adoption we're now seeing from multiple agencies in the GRC market, things are working well. So no, no immediate changes. What John and I have worked together for 35 years putting in place is showing progress. We'll continue to refine and continue to look at additional AI adoption throughout the company. But right now, the cornerstones are the Telos ID business area and the Xacta areas where we're seeing great pickup right now. So we expect that growth momentum to continue into '27.

Very good. Thank you.