Q4 2023 Telos Corp Earnings Call
Participants
Allison Phillipp; Director of Corporate Communications; Telos Corp
Mark Bendza; Chief Financial Officer, Executive Vice President; Telos Corp
John Wood; CEO & Chairman; Telos Corp
Mark Griffin; EVP of Security Solutions; Telos Corp
Zach Cummins; Analyst; B. Riley Securities, Inc.
Rudy Kessinger; Analyst; D.A. Davidson & Co.
Alex Henderson; Analyst; Needham & Company, LLC
Nehal Chokshi; Analyst; Northland Securities, Inc.
Presentation
Operator
Good day, and thank you for standing by. Welcome to Telos Corporation Fourth Quarter and Full Year 2023 Financial Results Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded.
I would now like to hand the conference over to your first speaker today, Allison Phillipp, Director of Corporate Communications. Please go ahead.
Allison Phillipp
Good morning. Thank you for joining us to discuss Telos Corporation's fourth quarter and full year 2023 financial results. With me today is John Wood, Chairman and CEO of Telos; and Mark Bendza, Executive Vice President and CFO of Telos.
Let me quickly review the format of today's presentation. John and Mark will begin with remarks on our 2023 year end results. Next, John will provide an update on the large portfolio of new business proposals that had been submitted and were pending as of our last earnings call. And lastly, Mark will follow this up with first quarter guidance and insights on the financial outlook for the company 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 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 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. 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 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 will turn the call over to Mark.
Mark Bendza
Thank you, Allison, and good morning, everyone. Let's begin today on slide 3. I'm pleased to report that Telos has again over delivered on key financial metrics in the fourth quarter and exceeded expectations for revenue, profit and cash flow. We delivered $41.1 million of revenue in the fourth quarter or $7.1 million above our guidance range of $30 million to $34 million.
Security Solutions delivered $20.7 million of revenue, which represents approximately the top end of our guidance range, primarily driven by TSA PreCheck. Secure Networks delivered $20.4 million of revenue and significantly exceeded the top end of our guidance range due to strong program management and favorable supply chain performance, which accelerated a $7.8 million delivery to a customer in the fourth quarter of 2023 instead of the first quarter of 2024, thereby bringing the program to a successful completion several weeks earlier than forecasted. This $7.8 million accelerated delivery drove the entirety of the $7.1 million revenue beat in the quarter.
GAAP gross margin was 34.3%, below our guidance range of 35.1% to 36.4% due to significant revenue outperformance in our lower-margin Secure Networks business. Excluding the accelerated product delivery in Secure Networks, GAAP gross margin was 40%, well above our guidance range due to margin outperformance in both reporting segments.
Revenues well above forecast, combined with gross margins only slightly below forecast, resulted in gross profit well above what was incorporated into our adjusted EBITDA guidance range. As a result, adjusted EBITDA also exceeded the top end of our guidance range. Adjusted EBITDA was a $3.2 million loss compared to our guidance range of a $6.5 million loss to a $4.5 million loss.
Lastly, we returned to positive free cash flow in the fourth quarter and delivered positive cash flow from operations for the full year. Fourth quarter cash flow from operations was a $5 million inflow and free cash flow was a $1.8 million inflow. Full year cash flow from operations was a $1.6 million inflow, and free cash flow was a $13.9 million outflow.
I'll now turn it over to John for a recap on 2023. John?
John Wood
Thanks, Mark and good morning, everyone. Let's turn to slide 4. We started 2023 facing a challenging outlook. More than 45% or $100 million of our 2022 revenues would not reoccur in 2023 due to the successful completion of large programs, lower revenues on existing programs and one program loss. We had just completed the government buying season with insufficient business wins to backfill the large revenue headwinds in 2023, and we were overstaffed relative to our lower revenue outlook.
We indicated that 2023 would be a transition year, focused on streamlining our operations, and rebuilding and growing our revenue base, especially in our core end markets in the Federal government, where we have a long history of success. In anticipation of lower revenues in 2023, we reduced our employee base by approximately 20% company-wide including indirect and direct staff across all departments as well as among all levels of seniority, including a smaller executive team. But we didn't stop there. We assessed our spending month-to-month and quarter-to-quarter throughout the year to find ways to reallocate resources to focus on winning new business and returning to growth.
On the business development side, we hired new executives for our growth organization and we consolidated and centralized growth-oriented resources under their leadership. In part, as a result of these actions, our 2023 outlook and guidance improved as we progress throughout the year.
I'll turn it back to Mark to provide a recap on the evolution of our guidance throughout 2023. Mark?
Mark Bendza
Thanks, John. To recap on our 2023 full-year guidance, we set our original guidance on our fourth quarter earnings call. We reaffirmed guidance on our first quarter earnings call. We raised guidance on our second and third quarter earnings calls, and we completed the year with revenue and adjusted EBITDA both above the top end of our original and final guidance ranges.
Within Security Solutions, strong renewal rates within our information assurance and secure communications businesses, new high margin contract wins in secure communications, and better-than-expected performance on our TSA PreCheck program drove revenue above the midpoint of our original guidance range and gross margin above the top end of our original guidance range.
Within Secure Networks, favorable supply chain performance, expanded revenues on a large program, and disciplined program and cost management also drove revenue and gross margin above the top end of our original guidance range. Overall, nearly $12 million of better-than-expected cash gross profit, combined with $5 million of lower-than-forecasted below-the-line expenses drove adjusted EBITDA approximately $17 million above the original midpoint of guidance.
Now, I'll turn it back to John, who will discuss our substantial progress on new business capture. John?
John Wood
Thanks, Mark. Let's turn to slide 5. First and foremost, we are absolutely thrilled with the progress we have made on new business capture in recent months. I'm pleased to announce that Telos has teaming agreements in place with prime partners who have received awards from the federal government worth up to $525 million to Telos' Security Solutions business over five years. That is over 85% of the $610 million of pending proposals that we mentioned on our last earnings call, a truly terrific outcome for our company and our shareholders.
It's not uncommon for award decisions of this magnitude to be protested by incumbents or other bidders as part of a customary post-award protest period provided by the government, and that's the case here. These awards have been protested and finalization of the awards is subject to the resolution of protests that are currently in process.
Although we are not able to opine on the merits of any specific protest, for context and as an example, according to data from the Government Accountability Office, or the GAO, over the past five fiscal years, nearly 10,000 protests have been filed with the GAO and approximately only 5% of those protests were ultimately sustained. These statistics are publicly available on the Government Accountability Office's website.
We eagerly await resolution of these protests and stand ready to begin executing on these new awards and delivering value to customers alongside our prime partners. These are pre-existing long-term programs. Resolution of the protests and the smooth transition of the work will be important to ensure continuity of service for our customers. These new awards represent substantial, high-quality, and recurring revenue streams. Assuming favorable resolution of the protest, they should ultimately drive sequential revenue growth later this year and annualize into significant revenue tailwinds in 2025.
Beyond this exciting news, I'm pleased to report on several other key outcomes since our last earnings call. Our Xacta business has achieved critical renewals with the Department of Energy and a large intelligence agency, as well as new orders and incremental scope on existing contracts from the US Department of the Interior, the US government publishing office, multiple other federal government agencies, the Australian government and a large commercial customer in the technology sector.
Additionally, our automated message handling system business achieved several major contact renewals, including with the US Special Operations Command, the Defense Information Systems Agency and several other federal government customers. Within our Telos ID business, transaction volumes in our TSA PreCheck program have sequentially ramped every quarter for the last three quarters of 2023 and into the first quarter of 2024. We continue to work closely with the TSA to ensure our preexisting enrollment locations are operating in the absolute highest possible standards necessary for a national security program of this magnitude, before accelerating our rollout of additional on-site enrollment centers around the country. And lastly, the Secure Networks team completed and successfully delivered a global satellite communication solution for the US Air Force.
I'll now turn the call over to Mark, who will discuss first quarter guidance and the outlook for '24. Mark?
Mark Bendza
Thanks, John. Let's turn to slide 6 to discuss our guidance for the first quarter. For the first quarter, we forecast revenue in a range of $28 million to $29 million and an adjusted EBITDA loss of $5.5 million to $5 million. We forecast Security Solutions revenue to decline low teens to high single-digit percent year-over-year, primarily driven by the expected timing of revenue in Telos ID, partially offset by significant growth in TSA PreCheck. We forecast secured networks revenue to decline low 30% to high 20% year-over-year, due to lower backlog and the $7.8 million delivery that accelerated into the fourth quarter of 2023.
GAAP gross margin is expected to be down approximately 400 basis points year-over-year, primarily due to higher amortization of capitalized software development costs in security solutions. Cash gross margin is expected to be approximately flat year-over-year. Cash below-the-line expenses, which adjust for capitalized software development costs, stock-based compensation, restructuring costs and depreciation and amortization, are forecast to be slightly higher year-over-year primarily due to increased expenses associated with our TSA PreCheck program.
Turning to the full-year outlook, we're absolutely thrilled with the progress we've made on new business capture in recent months. As John mentioned, we have teaming agreements in place with prime partners, who have received awards worth up to $525 million to Telos' Security Solutions business over five years. Assuming favorable resolution of protests, these new programs should drive large incremental revenue streams starting later this year.
Given the magnitude of the programs, combined with the potential variability and pace of resolving the protest and transitioning the work from incumbents, the revenue contribution is difficult to forecast at this point. So we're going to guide quarter-to-quarter for the time being, but we can provide insights into the high-level revenue headwinds and tailwinds for the year.
Let's start with an update on the revenue headwinds embedded in our preexisting programs that we previewed on our last earnings call. We said in our last earnings call that we would have a few tens of millions of dollars of revenue headwind in 2024, compared to our 2023 revenue guidance at the time. Since then, we had approximately $8 million of revenue pull into 2023 from 2024. So that adds an additional $16 million of headwind compared to our final 2023 results. The quarterly year-over-year headwinds in our pre-existing programs will increase sequentially throughout the year and are inclusive of or net of gross from the full year annualization of our TSA PreCheck program based on our pre-existing network of enrollment locations and our online renewal platform.
Turning to revenue tailwinds from new business, we estimate the new program awards currently under protest could generate over $100 million of revenue in some years. But for modeling purposes, we're assuming a more modest $60 million to $85 million of revenue contribution in a typical year. Provided the protests are resolved in our favor, we should capture some portion of that revenue starting in the second half of 2024 and a full year of that revenue in 2025.
In addition, any expansion of our TSA PreCheck enrollment centers would drive additional revenue growth beyond the quite meaningful revenue growth we are already expecting from the simple annualization of the revenue we generated for a partial year in 2023. We believe a fully ramped network of new enrollment locations will ultimately generate several tens of millions of dollars of revenue. And lastly, we continue to invest in growing and maturing our pipeline into new business proposals. If we're able to win new contracts over the course of 2024 as we did in 2023, we may be able to capture additional revenue upside during this calendar year.
And with that, I'll turn it back to John.
John Wood
Thanks, Mark. Let's move to slide 7. So in summary, we exceeded expectations and delivered results above the high end of the guidance range on key financial metrics for both the quarter and the full year. We're very pleased with the progress we've made on new business capture in recent months. These new opportunities represent high-quality, recurring business that would provide meaningful tailwinds later this year and beyond.
With that, we're happy to take questions.
Allison Phillipp
Operator, please.
Question and Answer Session
Operator
(Operator Instructions) Zach Cummins, B. Riley Securities.
Zach Cummins
Thanks for taking my questions and congrats on the strong results in 2023. John, I just wanted to focus on the new award wins. I mean, can you talk about the typical protest process? I mean, any sense of how long this typically lasts, and understanding that it's hard to have any forecast around this, but just curious on any happenings you've had in the past and your assumptions that are baked in?
John Wood
Sure. So protests have been -- they can last as long as 100 days or so. It can also be much shorter, and sometimes it can be a little longer, but on average, I'd say about 100 days.
Operator
Rudy Kessinger, D.A. Davidson.
Rudy Kessinger
Any more color you can provide around TSA PreCheck, just revenue in Q4 expected in Q1? And just do you still feel like you're going to get to the full rollout of all enrollment centers by this year? I know on slide 12, I think it says still just 26 enrollment centers. So when do you think that rollout will be complete?
Mark Bendza
Yeah, Rudy, I'll take the first part of the question, it's Mark Bendza, and then I'll pass it on to Mark Griffin. So first of all, we're very pleased with how transaction volumes have ramped over the last three quarters in 2023. And so far into the first two-plus months the first quarter of 2024, both transaction volumes and revenues have ramped quite significantly. And in the first quarter, that program, I'm not going to give program-level revenue or margin detail. But I can say that program is contributing a very meaningful portion of our first quarter revenue guide. So we feel very good about that at this point.
And as you may know, the lion's share of the revenue opportunity within that program is on the new enrollment side. So as we ultimately roll out those 500 locations, there's several tens of millions of dollars of potential revenue upside from where we are today. So with that segue, I'll pass it on to Mark Griffin to answer the other part of your question.
Mark Griffin
Hello, Rudy. As the first TSA expansion enrollment provider, we have worked tirelessly along TSAs since launch to address current and anticipated security and operational needs on the program. This quality-driven approach, while measured has been extremely systematic and will ultimately allow us to scale faster. Our goal is still 500 sites. And currently and in the future, the throughput through those sites are meeting expectations. So we're pleased with the progress to date, and we obviously intend to expand.
Operator
Alex Henderson, Needham.
Alex Henderson
Yeah, so three-part question all around the same subject, i.e., the contract awards. First off, when did the clock start ticking on these contracts, you're aggregating them in conversation with this call, but I don't think it's 100 days starting today. So when does the 100-day start ticking? Second, can you talk a little bit about the gross margin structure of these contracts give us some sense of what the implication is for gross margins as these deals kick-in?
And then third, obviously, a big part of the conversation here relative to these contracts is that it will kick in at some point and then there's a step-up into 2025. So as you look out to 2025, the analysts could easily be adding significant revenues to 2025. But my assumption is that there's also offsets against that. Can you talk a little bit about what kind of contract offsets so we should typically expect annually that might be an offset to this step-up that you just kicked in here? Thanks.
John Wood
So Alex, it's John. The clock started within the last month and so that's why I would capture that. I'll turn the rest of the question over to Mark Bendza, who will cover margins as well as the tailwinds heading into 2025 and whatever headwinds we might have in 2025 as well.
Mark Bendza
Hey Alex, it's Mark Bendza here. So good question. On the margins, I'll give you some color there, while at the same time, we try not to comment directly on program-level margins. But we added a slide to the appendix, slide 12, that basically gives you all of the key components to model 2024. And in there, one of the things we point out is overall cash gross margins are similar to 2023.
So in that slide, there's various assumptions embedded in there around a range of potential revenue capture in 2024 on those new programs. And you'll see that overall cash gross margins are similar to 2023.
And lastly, on 2025, to think of the walk as what we've said historically is that in a typical year, we have a few tens of millions of dollars of revenue headwinds that we then have to backfill with new business wins. I'd say 2025 would be a typical year of a few tens of millions of headwinds. So I say a few tens of millions, call it, roughly $30 million, let's say.
Then you're adding to that, as you pointed out, the full-year annualization of these new programs. Peak years, we think these programs could potentially contribute $100 million or more. But for the time being, until we have some experience under our belt on these programs and see how revenues are trending for modeling purposes, we're assuming a more modest $60 million to $85 million a year. So you'll get the full year annualization of that in 2025.
And then of course, we still have the upside potential from the rollout of our PreCheck locations, which, as I mentioned earlier, once those are fully up and running the full 500 location network, that's several tens of millions of additional upside compared to the revenues we're generating today. And then lastly, we have our new business win seasonality that we go through every year, late this calendar year, early next calendar year is usually around the time that we'll see the results from the government buying season. So any additional new business wins that come in late this year, early next year will benefit 2025 as well. So those are some of the high-level headwinds and tailwinds.
John Wood
And I think Mark said this, but I just want to mention again that these are pre-existing programs that would be rolling over to us from an incumbent.
Operator
Nehal Chokshi, Northland Capital Markets.
Nehal Chokshi
Thank you and congrats on the $100 million ACV in tier that will roll out throughout the end of 2024 and into 2025, that's awesome. What about the rest of that $3.5 billion pipeline? Has that further grown? And what's the progression on the rest of that pipeline and confidence level on that rest of that pipeline?
John Wood
So Nehal, the pipeline continues to grow. Think it's going to be an ongoing flywheel, if you will. And we really only go after business that we think we have a very good chance of winning. So I'm confident that the pipeline is going to be something that it's going to yield results for the company.
Mark, do you have anything you want to say?
Mark Griffin
No.
John Wood
Okay, good. Okay. But it continues to grow, Nehal, just to answer your question.
Operator
(Operator Instructions) Alex Henderson, Needham.
Alex Henderson
Yes. So just to paraphrase what I think you said on the margin. So we should be using the same gross margin in 2024 as we saw in 2023. And that sounds like if these programs are kicking in, in the back half that the gross margin is pretty much the same as we go into 2025 as well, so kind of steady gross margin trajectory. Is that a fair statement? And the second piece of this is, is there any of these contracts that are actually coming from existing business, in other words, offsetting something that you'd already had in your revenue stream?
Mark Bendza
So Alex, yes, overall cash gross margins in 2024, we expect to be approximately comparable to 2023, and I'll let John answer the other part.
John Wood
Yes, these contracts, from the Telos point of view, would be considered to be incremental revenue.
Alex Henderson
All incremental. Okay.
John Wood
Yes.
Alex Henderson
Since this is a secondary question, and there probably isn't a whole lot of people in the pipeline behind it. I don't want to miss the opportunity. Can you talk a little bit about the split of the business between the segments as it kicks in, is it all in one segment or split between the two segments?
John Wood
So all of the business, all of the large contract awards that we've announced today, those are all Security Solutions business. And probably somewhere around 80% of the pipeline is in the Security Solutions area. So we would see more of a movement towards Security Solutions over time.
Operator
Thank you. And this will conclude today's Q&A session. I will now turn the call back over to Mr. John Wood for closing remarks.
John Wood
Well, first of all, I just want to thank our shareholders for your ongoing support. I'm very proud of my team's ability to manage through a challenging '23 and deliver better-than-expected results across the board. These results demonstrate our focus on execution, and they are a testament to our team's unwavering commitment to delivering for our customers and our shareholders.
We're also absolutely thrilled with the progress we've made on new business capture in recent months. These outcomes have the potential to significantly and positively impact our financial performance with the addition of high-quality, predictable revenues to the Telos portfolio, beginning later this year and into 2025.
And really, we're just getting started. I'm very excited about the future outlook for the company with robust and recession-resistant markets, well-funded customers and really a decades-long track record of serving the world's most security-conscious organizations, Telos is a strong foundation for the future. So I just want to say, thank you.
Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
