Telos Corporation

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. John will begin with brief remarks on our second quarter 2023 results and Telos' strategic priorities. Then, Mark will cover the financials and guidance for the third quarter and full year 2023 before turning it back to John to wrap up. Then, we'll open the line for Q&A where 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 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 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 can 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 filing. 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 TELUS's 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, Allison, and good morning, everyone. Let's begin today on slide three. Telus 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 $32 million. Gross margin was 37.6%, above our guidance range of 28% to 31.5%. And we delivered break-even 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 in security solutions helped drive the overperformance. 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 as 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 operations. 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 cybersecurity 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 continue 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, the Office of Naval Intelligence, the National Archives, the U.S. 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 TELOS team secured two new awards of our automated message handling service. One was with a foreign government customer and the other was with a federal government customer. We inked several major AMHS contract renewals, including with the Drug Enforcement Administration and the U.S. Department of the Treasury. We also secured a new contract with a federal government customer for our TELOS Advanced Cyber Analytics, or TELOS ACA. Finally, I have some noteworthy updates on the TSA PreCheck program. We recently achieved several operational milestones in close coordination with TSA. TELOS's official TSA PreCheck 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 Benza, 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 all above 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 guidance beat 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 in our information assurance business were offset by revenue contraction and secure communications and Telos ID as a result of a program loss in secure communications at the end of 2022 and lower revenues on two ongoing programs in Telos ID. 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 in secure 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 in 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 in 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, a more favorable mix of labor and materials on select programs, 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 break-even 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 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 a $4.1 million outflow in the quarter. Free cash flow was 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 headwind 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 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 reserve, primarily due to planned growth investments in the second half focused on business development, information assurance, TELOS ACA, and TSA PreCheck. 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 original ranges. Our revised guidance includes revenues in a range of $122 million to $137 million, and we're raising the midpoint slightly from $127.5 million in our prior guidance to $129.5 million in 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 in AMHS, and TELOS ACA, lower revenues on pre-existing programs in TELOS ID, higher revenues on pre-existing programs in secure networks, higher gross margins, higher capitalization of R&D, and second half growth investments focused on business development, information assurance, TELOS ACA, and TSA PreCheck. With that, I'll pass it back to John, who will wrap up on slide eight. John?