Telos Corporation (TLS) Q4 2024 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the Telos Corporation Fourth Quarter 2024 Financial Results Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Allison Phillipp – Director of Coporate Communications. Please go ahead.

Good morning. Thank you for joining us to discuss Telos Corporation's fourth quarter and full year 2024 financial results. With me today is John Wood, Chairman and CEO of Telos, and Mark Benza, Executive Vice President and CFO of Telos. Let me quickly review the format of today's presentation. Mark will begin with remarks on our 2024 year-end results. Next, John will discuss business highlights from the quarter. Then, Mark will follow up with first quarter guidance before turning back to John to wrap up. We will then open the line for Q&A where Mark Griffin, Executive Vice President of Security Solutions, will also join us. The fourth quarter and year-end 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 2025 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 an isolation from GAAP results. You can find additional disclosures regarding these non-GAAP measures, including reconciliation with comparable GAAP results in our fourth quarter and year-end financial 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 for the next year on our company website under the Investor Relations link. With that, I'll turn the call over to Mark.

Thank you, Allison, and good morning everyone. Let's begin today on Slide 3. I'm pleased to report that Telos has delivered fourth quarter revenue near the top end of the guidance range and adjusted EBITDA above the top end of the guidance range. Total company revenue grew 11% sequentially to $26.4 million in the quarter compared to guidance of $24.5 million to $26.5 million. Security solutions revenue grew 20% sequentially to $21.9 million or 83% of total company revenue, which was near the top end of our guidance range. During the fourth quarter, our large program with the Defense Manpower Data Center or DMDC successfully transitioned from the incumbent contractor and began to generate significant revenue for security solutions. In addition, revenue from TSA PreCheck enrollments grew over 30% sequentially. Secure Networks delivered $4.5 million of revenue or 17% of total company revenue, representing the top end of the guidance range. Secure networks revenue declined sequentially as expected due to the ramp down of existing programs. Turning to margins, GAAP gross margin expanded nearly 600 basis points year-over-year to 40.3%, and cash gross margin expanded nearly 900 basis points year-over-year to 47%. Fourth quarter cash gross margin of 47% was the company's highest quarter since the IPO in 2020, and full year 2024 cash gross margin of 43.7% was the company's highest since 2000. Gross margin expansion was primarily driven by the favorable mix shifts from our lower margin secure networks business to our higher margin security solutions business. Security solutions revenue grew from 50% of total company revenue in the fourth quarter of 2023 to 83% in 2024, and from 53% for the full year 2023 to 71% in 2024. As discussed on our last earnings call, during the third quarter of 2024, we discontinued the development in sale of selected solutions or parts of solutions that were not generating acceptable returns. These actions reduced our cost base and created new capacity for investment in our highest growth programs in order to maximize our operating leverage, incremental margins, and cash flow as we return to growth in 2025. Largely as a result of our third quarter cost actions, adjusted operating expenses, which include R&D and SG&A expense, excluding stock-based compensation, restructuring, and impairment expenses declined sequentially by $2.4 million. When combined with higher cash gross profit, the reduction in operating expenses drove a sequential improvement in adjusted EBITDA from a $4.2 million loss in the third quarter to a $200,000 loss in the fourth quarter. Lastly, cash flow from operations was a $10.5 million outflow, and the free cash flow was a $14.8 million outflow, reflecting a short-term buildup of working capital associated with high growth programs and one-time CapEx investments in IT infrastructure expansion. We expect these dynamics to reverse and drive positive cash flow from operations and positive free cash flow in the first quarter of 2025. I will now turn it over to John for an overview of recent business highlights, John.

Thanks, Mark, and good morning everyone. Let's turn to Slide 4. First, I'll provide an update on our TSA PreCheck program. We made significant progress expanding our nationwide network of enrollment centers, providing a convenient solution to travelers and gaining market share in this important national security program throughout 2024. We increased our enrollment centers from 26 locations at the beginning of 2024 to 218 locations in key markets across the United States today. As we said in the past, we do not expect a linear monthly pace of opening new enrollment centers. We will have phases when we open a larger number of locations, followed by quarters when we open fewer locations, and during which we, together with the TSA will assess the operations of our enrollment centers before resuming a higher pace of rollouts. We opened a total of 177 new locations in the second, third, and fourth quarters of 2024 before moderating the pace of openings with 15 new locations so far in 2025. We expect to resume a higher pace of rollouts in the coming weeks and months and continue to target 500 locations sometime around the end of the year. PSA PreCheck grew quickly into our single largest program by revenue during 2024, and we expect the program to deliver significant growth again this year. Next, I'll provide an update on the 2 key program wins that we have previously discussed over our last several earnings calls. We have successfully transitioned the Defense Manpower Data Center or DMDC program and are now generating revenue. This program along with TSA PreCheck enrollments was a key source of our sequential growth in the fourth quarter. We look forward to a full year of successful operations on this program in 2025 as we expect it to be a major driver of revenue growth for the company. Additionally, we were pleased to report that the stop work order on the program with the Department of Homeland Security, or DHS was lifted in January. We expect to begin generating revenue in this program later in 2025. We're thrilled with the positive outcomes on both these program awards and look forward to providing high quality services to these critical customers over the next several years. Finally, I'll provide the latest news on other business outcomes since our last earnings call. Our Xacta business has achieved new orders with several customers including the Office of Naval Intelligence, the U.S. Department of Energy, a U.S. federal government agency, as well as a key renewal with the U.S. Federal government customer in the intelligence community. We also received a new order for cyber services from a Fortune 100 company in the technology sector. The automated message handling system or AMHS business achieved key renewals from a UK government department and a US federal government customer in the intelligence community. Regarding our new business pipeline, on our previous call, we indicated we had submitted several bids and we're working on additional opportunities that totaled 9 figures of total contract value to Telos. As a result of the recent change in administration and uncertainty around near-term priorities and objectives, we're experiencing some delays in the timing of awards from the government on single awards. However, we are not seeing similar delays on task orders available via the various active contract vehicles we have won over the last couple of years. Accordingly, we are reprioritizing task orders on our contract vehicles over single awards and are currently vetting and responding to task orders at a rapid pace. We remain optimistic of our positioning and competitiveness on our outstanding and upcoming bids. I'll now turn the call over to Mark, who will discuss first quarter guidance, Mark.

Thanks, John. Let's turn to Slide 5. For the first quarter, we expect revenue to grow 7% to 15% sequentially to a range of $28.2 million to $30.2 million, and we forecast an adjusted EBITDA loss of $1.8 million to $800,000. Sequential revenue growth will be driven by security solutions. We forecast security solutions to grow high single-digit percent to mid-teens percent sequentially driven by our new program with the Defense Manpower Data Center and the ongoing ramp of TSA PreCheck enrollments. Security Solutions is forecasted to contribute approximately 84% of total company revenue. We anticipate secure networks revenue to be comparable to the fourth quarter. GAAP gross margin is expected to expand by 150 basis points to 215 basis points year-over-year, primarily due to the favorable mix shift from our lower margin secure networks business to our higher margin security solutions business. Cash gross margin is forecasted to expand by 260 basis points to 285 basis points year-over-year for the same reason. Cash operating expenses, which include R&D and SG&A adjusted for stock-based compensation, restructuring expenses, depreciation and amortization, impairment and capitalized software development costs are forecasted to be approximately $1 million lower year-over-year due to lower spending as a result of the restructuring plan that we implemented during the third quarter of 2024, partially offset by investments in our highest growth programs. We're pleased to report that we expect to generate positive cash flow during the first quarter. Turning to the full year 2025. The structure of the revenue framework that we outlined on prior earnings calls has not changed. We forecast a return to year-over-year revenue growth. Revenue for the full year will be comprised of several key components. First, we expect our existing business, excluding TSA PreCheck and the DMDC and DHS programs that we won in the first quarter of 2024, to generate approximately $70 million in 2025, representing an increase from the previously estimated $60 million to $65 million. This increase in estimates reflects higher expected revenues on various contracts across the portfolio due to a combination of scope expansion and contract extensions. Second, we estimate the DMDC and DHS programs could recognize approximately $50 million to $75 million of revenue, representing a decrease from the previously estimated $60 million to $85 million. The change in estimates reflects the time phasing of revenue recognition during the first year of the program. Time phasing in the first year will be driven by the ultimate mix of third-party solutions that are recognized as revenue when orders are filled versus solutions that are recognized as revenue over a period of performance. The mix of gross revenue recognition and net revenue recognition will impact the range as well. Third, we are targeting a pro rata share of the TSA PreCheck enrollment market after we complete the rollout of our 500 locations at full capacity for a full calendar year. We believe the entire TSA PreCheck market is approximately a $200 million market on a net revenue basis in a typical year based on our current pricing structure. Although we do not expect to achieve our pro rata market share in 2025, we expect TSA PreCheck revenues to ramp along with our enrollment centers during the year. Enrollment revenue represented approximately 70% of the total $200 million TSA PreCheck market in 2024. Renewal revenue comprised the other 30%. And lastly, John discussed our new business pipeline and business development activities. Any new business wins during 2025 will have the potential to contribute additional revenue during the year. And with that, I'll turn it back to John.

Thanks, Mark. Let's turn to Slide 6. In summary, revenue grew 11% sequentially to $26.4 million and adjusted EBITDA improved sequentially by $4 million to a $200,000 loss. Additionally, we achieved our highest full year cash gross margin since 2000. We successfully assumed full operational control of our scope on the DMDC program and look forward to a full year of operations and the accompanying revenue growth in 2025. We continue to ramp our network of TSA PreCheck enrollment locations and are targeting 500 locations sometime around the end of the year. We expect 7% to 15% sequential revenue growth and positive cash flow in the first quarter of 2025, and we are forecasting significant improvements in revenue, profit, and cash flow for the full year. And with that, we're happy to take questions.

Operator, please open the line for Q&A. Thank you.

[Operator Instructions] Our first question comes from Zach Cummins with B. Riley Securities.

Hi, good morning, Mark and John, congrats on the solid results in Q4. John, I just wanted to ask with the change in administration, it sounds like you've had some impact on single award type of programs, just curious of maybe what you've heard from some of your partners, and just how you're framing the year, just given all the moving parts here in early 2025.

So in general, Zach, and thank you for your question. In general, the company really is focused on delivering solutions that help optimize performance for our customers in terms of automation and so forth and so I would say the new administration in general is positive for Telos; having said that, at the customer level, we are seeing single awards being held back while the administration sort of reviews those opportunities, that's why we're focused on the task orders that we have from existing contract vehicles.

Understood, and my follow up question geared towards Mark, helpful to get a little bit more detail in terms of the 2025 framework, just in terms of the new awards that you outlined with DMDC and DHS. Is it largely just accounting issues as we think about that ramping up in the first year, or can you just go a little bit more into the nuances of that for revenue recognition in the first years of those awards?

Yeah, it's a good question, Zach. So, yes, there is no change in our expectations around the total value of third party content that we would integrate into that program. The difference is the mix of that third party content as we're getting deeper into the program, what we're seeing is that the mix is more weighted to software than it is to hardware. Now hardware content is pretty straightforward in terms of revenue recognition. You recognize essentially the full value of the order at the time the order is filled -- you recognize revenue, the full value of the order at the time the order is filled; with software, it's a mix, some software will be recognized full value at the time the order is filled. Other types of software would be recognized over a period of performance, say over a 1-year period of performance or a 1- year license or maintenance contract. So, in the first year, on some of these orders, we'll see a partial year of revenue recognition rather than a full year. And then in 2026, you'll see the full year of revenue recognition. The other important point is that, it looks like from a cash perspective, for the most part, we'll see the full benefit -- the full cash flow benefit at the time the order is filled. So, that's one of the reasons why we're bullish on cash in the quarter and the year, cash flow -- cash flow should outperform the P&L, so to speak, in 2025.

Understood. That's helpful. Well, thanks for taking my questions and best of luck with the rest of the quarter.

Thanks Zach.

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

Hey guys, thanks for taking my questions. Mark, if I think about TSA PreCheck, 200 million market opportunities, 70% coming from enrollments, you have 218 locations, or I guess you're at about 45% of the roll out if we just do the numbers there, that would imply if you're getting that 1/3 share at this 218 locations you should be running about 21 million in annual revenue from enrollment plus some from renewals understanding it's going to take longer to get those 1/3 share on the renewal side, is that the right way to think ballpark about where TSA revenue is running currently?

So the framework you've laid out, yes, is the right way, to think about it. Of course, over the course of 2024, on an average basis, we have far fewer locations open than we do now, and then over the course of this year those locations will ramp.

Okay and then I'm curious on cash flow. I know it says in slides here, you guys mentioned it should be positive in Q1. Just, how much of that is maybe just driven by strong Q1 collections and then for the full year you just made a comment there, cash should outpace I guess P&L like how should we think about free cash flow potential for the full year?

Yeah, so in the first quarter there is benefit in terms of the fourth quarter working capital buildup that will be liquidating in the first quarter. In terms of the overall year, here's where I would think about it, adjusted EBITDA breakeven for the year is probably somewhere around 155 million, 160 million of revenues somewhere around there depending on mix. [indiscernible] at breakeven adjusted EBITDA this year, I would expect us to be positive free cash flow at a breakeven adjusted EBITDA level. So what that means is you’re going to have -- let's say you have breakeven adjusted EBITDA, you are going to subtract from that about 10 million of capitalized software. Then, you're going to add about 2 million of interest income, that would imply roughly 8 million of negative free cash flow before changes in working capital. I would say the change in working capital should be enough in 2025 to get us to positive free cash flow. So the change in working capital should be better than $8 million at that hypothetical breakeven adjusted EBITDA level. Does that make sense?

It does and that's a very, very helpful breakdown. I appreciate that. Thank you.

And by the way, that's just another way of saying our breakeven level of revenues -- the level of revenues required for breakeven free cash flow should be lower than the level of revenues required to breakeven on adjusted EBITDA basis.

Got it thank you.

This will conclude today's question and answer session. I will now turn the call back to John Wood for closing remarks.

[indiscernible] our shareholders for your ongoing support. With the encouraging news on our DMBC and our TSA PreCheck programs, we look forward to significant improvements in revenue growth, profit, and cash flow in 2025. I look forward to 2025 and I remain excited about the long-term outlook for the company. With robust and recession resistant markets, well-funded customers, and a decades-long track record of serving the world's most security conscious organizations, Telos has a strong foundation for the future. Thank you.

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