Telos Corporation (TLS) Earnings Call Transcript

Good day, and thank you for standing by. Welcome to the Telos Corporation's Second Quarter 2026 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker for today, Allison Phillipps, Director of Corporate Communications. Please go ahead.

Good morning. Thank you for joining us to discuss Telos Corporation's Second Quarter 2026 Financial Results. With me today is John Wood, Chairman and CEO of Telos; Mark Bendza, Executive Vice President and CFO of Telos; and Mark Griffin, Executive Vice President of Security Solutions. Let me quickly review the format of today's presentation. Mark Bendza will begin with remarks on our second quarter results and full year outlook. We will then open the line for Q&A, where John Wood and Mark Griffin will also join us. The second 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 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. 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 second 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 Bendza.

Thank you, Allison, and good morning, everyone. We're pleased to report another strong quarter, highlighted by results that exceeded the high end of our guidance range, strong cash flow generation, accelerated share repurchases and a meaningful increase in our full year profitability outlook. These results reflect the strength of our business and our continued ability to solve complex mission-critical challenges for our customers. Telos helps the world's most security-conscious organizations solve those challenges by combining proven cybersecurity, digital identity and secure networking solutions, combined with deep mission expertise and a flexible approach to addressing unique customer requirements. Our solutions strengthen security, improve operational efficiency, accelerate compliance and help customers adapt to an evolving threat landscape. Let's turn to Slide 3. Total company revenue increased 33% year-over-year to $47.7 million, exceeding our guidance range of $44 million to $46 million, driven by stronger-than-forecasted performance in Telos ID. GAAP gross margin was 35%, and cash gross margin was 40.6%, both above our expectations, reflecting disciplined execution across large programs in Telos ID. As a reminder, given the diversity of our revenue streams, gross margins will fluctuate from quarter-to-quarter based on revenue mix. Adjusted operating expenses declined by more than $800,000 year-over-year, but were approximately $500,000 above guidance assumptions, primarily reflecting higher TSA PreCheck marketing activity and incentive compensation accruals. Adjusted EBITDA exceeded the high end of our guidance range, reaching $6.9 million compared to guidance of $5 million to $6 million. Adjusted EBITDA margin expanded to 14.4%, up significantly from 1.1% in the prior year period. Let's turn to Slide 4 to discuss cash flow. Over the past few years, we have transformed Telos into an increasingly cash-generative business. Strong revenue growth, lower operating expenses and disciplined working capital management have significantly improved our free cash flow margins while reducing quarter-to-quarter cash flow volatility. Operating cash flow for the second quarter was $8.8 million, and free cash flow totaled $6.6 million, representing a 13.9% free cash flow margin. This marks our sixth consecutive quarter with a free cash flow margin above 12% -- during the quarter, we deployed $4.7 million to repurchase more than 1 million shares at an average price of $4.50 per share. Let's turn to Slide 5 to discuss our third quarter guidance. For the third quarter, we forecast revenue in a range of $49.2 million to $50.6 million, down slightly year-over-year due to unusually high nonrecurring revenue associated with the start-up of a new program in the comparable period last year. Excluding the year-over-year differential in nonrecurring revenue, third quarter revenue guidance implies 6% growth at the midpoint. We expect cash gross margin to be approximately 37.5% to 38.5% reflecting the anticipated effects of contingency reserves on fixed price contracts and normal fluctuations in revenue mix. Adjusted operating expenses are expected to be approximately $400,000 lower than the prior year. Adjusted EBITDA is expected to be between $6 million and $6.8 million, representing a margin of 12.2% to 13.4%. Let's turn to Slide 6 to discuss our updated full year outlook. Based on our strong first half execution, we are raising our full year profitability outlook. We're increasing our adjusted EBITDA guidance to a range of $23.6 million to $28.6 million, up from our previous guidance of $20.6 million to $28 million. We're also raising our adjusted EBITDA margin outlook to 12.6% to 14.7%, representing an improvement of approximately 70 to 160 basis points versus our prior forecast. In addition, we are raising our full year cash gross margin outlook to 39% to 40%, up from our previous forecast of 38.2% to 39.5%, while lowering our adjusted operating expense forecast by approximately $1.7 million. Our full year revenue outlook is now $187 million to $195 million. 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. As a result, our revenue outlook is approximately $2.5 million lower at the midpoint than our previous guidance. Beyond 2026, the full run rate impact will be approximately $33 million of revenue per year with only a modest impact on profit. Because this revenue stream carries a single-digit gross margin, eliminating it is expected to improve total company cash gross margin by over 600 basis points on a run rate basis, all else being equal. In addition, we expect to realize approximately 400 basis points of additional cash gross margin accretion in the second half of 2027 after we complete the expense recognition of certain prior period investments in our TSA PreCheck program. Accordingly, we expect the combination of these 2 items to improve our cash gross margins by approximately 10 percentage points during the second half of next year, all else being equal. Before I conclude, I'd like to spend a few minutes discussing growth and new business opportunities. On our last earnings call, we mentioned that we had submitted proposals representing nearly $500 million in total contract value and expected the government to make award decisions during the second half of 2026. We continue to expect award decisions in the second half of the year. Consistent with prior quarters, the timing of contract awards is determined by our government customers and may vary based on their priorities and procurement schedules. These opportunities span both our Security Solutions and Secure Networks segments with a heavy concentration in Security Solutions. Beyond these submitted proposals, we continue to build a healthy pipeline while remaining disciplined in pursuing new opportunities that align with our strategic priorities. Let's turn to Slide 7 to wrap up. The second quarter reflects the continued execution of our strategy. We're delivering profitable growth, generating consistent free cash flow and allocating capital in ways that we believe create long-term shareholder value. Looking ahead, we're encouraged by the opportunities in our pipeline as award decisions are made over the coming quarters. Overall, we're pleased with our first half 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.

[Operator Instructions] One moment while we compile the Q&A roster. First question will be coming from the line of Erik Suppiger of B. Riley.

First off, on the TSA PreCheck, any update on how your work with the post office is working? And then secondly, on the September quarter, the upcoming quarter, can you just discuss the kind of the nature of fiscal year-end spending? What are your expectations in terms of the health of the fiscal year-end budgets here?

Erik, thanks for the question. So this is Mark Bendza. I'll start. So first, on TSA PreCheck, program is going really well. We're very pleased with it. First half market share is up significantly from the same period last year. We're expecting normal seasonality in the second half. Generally speaking, from what we've seen in the last couple of years, second half market tends to be lighter than the first half. So that's reflected in our guidance. But overall, very pleased with how that program is trending and how our market share is trending. I'll turn it to Mark Griffin to comment on postal service.

Yes, you'll see in the very near future an additional couple of sites with the post office that we're rolling out as part of the pilot. We're pleased with the progress we're making, and we look forward to additional expansion there.

September end spending, government spending was the other question. Is that right, Erik?

Yes, that's right. Yes.

Yes. So why don't I start and then Chris can supplement. So as we mentioned, we have a solid portfolio of proposals outstanding. It's actually up a little bit from the last earnings call. Last earnings call, we were a little under $500 million total contract value. I'd say now we're a little over $500 million total contract value. Indications are still that awards on those opportunities should be decided sometime here in the second half. Of course, that's fully under the control of the customer, but we're still expecting award decision sometime here in the second half. I don't know, Mark Griffin, if you want to add to that?

Yes. The award decisions still looks solid for -- and moving forward. So we still have quite a few on the pipeline that are expected to be awarded between now and the end of the government fiscal year, which is the end of September. But with the progress it looks like Congress is making on extension of a budget, we hope to roll into the October time frame with no lapse in additional award for the fourth quarter as well.

Next question is coming from the line of Matthew Calitri of Needham & Company.

This is [ Matt Kocher ] over at Needham. I was hoping you guys could provide a little bit more color on that single-digit gross margin third-party software revenue. So understood on the margin profile, and great to see the profitability improvements you guys have been driving. But what exactly is that revenue like? Is it on the Security Solutions or on the network side? And like, how are you guys thinking about, uh, balancing growth and profitability here?

Yes, good morning Matt. Thanks for the question. Mark Bendza here. So that revenue stream is part of a much larger program within Security Solutions. There are multiple revenue streams within that program that were part of the overall when we bid for this program. Clearly that is not a revenue stream that we would otherwise pursue as a standalone revenue stream. It just doesn't align with the portfolio and the margin profile, the type of business we pursue. But because it was part of an overall program that aligned very well, the overall program aligned very well with our portfolio, that revenue stream came along with it when we won it. So that revenue stream will start to phase out in the fourth quarter. Like I said, single-digit margin on that revenue stream. And we'll see a very meaningful cash gross margin accretion as a result of it. And then it will take, you know, because the revenue stream carries such a low gross margin, it will take relatively little additional revenue to fully offset the profit that would go away with that revenue. Does that answer your question, Matt?

Yes, yes, definitely. That makes a lot of sense. Thank you for that. Bendza, you had called out Telos ID as driving the strength in the quarter. Is there anything further you can share there of like what exactly, um, or was it broad-based strength or whatever? And is there, I know, obviously, by the nature of the name of it, there's not a ton you can share on the confidential IT security, but anything there to, like, kind of help us get an idea of how momentum is there?

Yes, in the quarter, you know, the beat above the top end of the revenue guide was primarily in our TSA PreCheck program and then our program with the Defense Manpower Data Center. Those are 2 large programs in the portfolio, both performed well relative to guidance. And then on gross margins, gross margins outperformed really as a result of just a terrific job our program managers are doing managing fixed-price contracts. Every quarter when we guide, we include in our guide some contingency on fixed-price programs. You have that in our third quarter guide as well. And then we have that in first quarter and second quarter, and then our program managers continue to do a great job managing the risk that we've added contingencies for into our guide, and so we've outperformed gross margins in part as a result of that for the last 2 quarters.

Thank you. One moment for the next question. The next question is coming from the line of Bradley Clark of BMO Capital Markets. Please go ahead.

I just want to ask about some of the awards that, you know, remain to be determined in the later part of the year. What are some considerations or general puts and takes in these awards and how they may impact, you know, the overall pipeline, you know, growth heading into next year, either on the positive or the negative side?

Yes, Brad, thanks for the question, Mark Bend here. So, like we've talked about, it's a really solid portfolio of opportunities, both in magnitude, as well as how we are positioned on those opportunities. A lot of those opportunities are in the similar scope of work to the confidential IT security work that we've mentioned in the past, work performing for the federal government. So we do have some solid past performance history on that type of work. So we feel we're well positioned there. And given the timing of these opportunities, it's less of a P&L driver for this year, much more of an opportunity to drive P&L for next year.

Does that answer your question, Brad?

Yes, thank you.

Okay, great.