Telos Corporation (NASDAQ:TLS) Q4 2022 Earnings Call Transcript
Telos Corporation (NASDAQ:TLS) Q4 2022 Earnings Call Transcript March 16, 2023
Operator: Good day, and thank you for standing by. Welcome to the Telos Corporation Fourth Quarter and Full Year 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation there will be a question and answer session. Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Allison Phillipp. Please go ahead.
Allison Phillipp: Good morning. Thank you for joining us to discuss Telos Corporation's fourth quarter and full year 2022 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 will begin with brief remarks on our 2022 year-end results and recent additions to our senior leadership team. Then Mark will cover the financials and guidance for 2023 before turning it back to John for an overview of our growth strategy and priorities. Then we'll open the line for Q&A or 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 press release, 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 earnings press release and on the Investor Relations portion of the website. Please also note that financial comparisons are year-over-year unless otherwise specified. The webcast replay of this 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.
John Wood: Thank you, Allison, and good morning, everyone. Let's begin today on Slide 3. Before I comment on the fourth quarter, it's important to acknowledge upfront that I'm disappointed with the ongoing core execution of our long-term growth strategy since our IPO. And as CEO of Telos, I take full responsibility for that. During today's earnings call, we will provide an update on our expected revenue contraction in 2023 and the actions I'm taking to rebuild and grow our revenue base. Mark will discuss the details of our financial performance later in the call, but at a high level we delivered $47.3 million for revenue in the fourth quarter. And $216.9 million for the year. Our GAAP gross margin expanded 95 basis points to 38.6% in the fourth quarter and expanded 96 basis points to 36.4% for the year.
We delivered $5.4 million of adjusted EBITDA and 11.4% adjusted EBITDA margin in the fourth quarter and $19.5 million and a 9% margin for the year. Lastly, we delivered $0.05 of adjusted EPS in the fourth quarter and $0.19 for the year. Our fourth quarter results exceeded quarterly expectation for our fifth consecutive quarter. However our longer term trajectory continuous under-perform my aspirations for Telos. As we preview on our third quarter earnings call several factors will weigh heavily on revenues in 2023. Mark will discuss our guidance in detail later on the call, but these factors include the successful completion of large programs, insufficient new business wins in the second half of 2022 to drive revenues in 2023 and significant revenue reductions on some ongoing programs.
2023 will be a transition year for Telos. The Board and I are fully aligned on our immediate priorities including streamlining our operations and rebuilding and growing our revenue base. Now let's turn to Slide 4. A first step to rebuilding and growing our revenue base is the addition of two senior leaders. I'm pleased to announce Josh Salmanson as Senior Vice President of Technology Solutions; and Lee Canterbury as Vice President of Corporate Growth. Josh leads our newly established technology solutions organization. In this newly created role, Josh will leverage our existing technology portfolio, to develop innovative solutions that meet our customers' critical and ever-evolving cybersecurity demands. Josh has over 30 years of experience and brings a successful track record of leading technology, and solutions development for companies serving commercial and government customers.
Also new to the team, Lee Canterbury leads the newly consolidated and centralized corporate growth organization. He will oversee all aspects of new business and revenue generation across the company, serving all our business lines within both security solutions and secure networks. Lee will optimize and continuously improve our business development function to accelerate new business wins and rebuild and grow our revenue base for the future. Lee has over 35 years of experience successfully managing business development operations for companies serving commercial and government customers. Together, Lee and Josh will leverage the company's portfolio to rebuild and grow our revenue base and put Telos back on the path to sustained growth. I'll now turn the call over to Mark, who will discuss the fourth quarter and full year 2022 financial results and guidance for the first quarter and full year 2023.
Mark?
Mark Bendza: Thank you, John, and thank you, everyone, for joining us today. Let's turn to Slide 5. As I walk through the details on the fourth quarter, I will underscore the important dynamics that impact 2023 guidance. Some of these dynamics started taking shape in the fourth quarter of 2022 and further solidified in the first quarter of 2023. We previewed some of these themes on the third quarter earnings call in the context of our preliminary 2023 revenue outlook, namely 6 of the largest programs across the portfolio which combined generated nearly $115 million of revenue in 2022 will face significant revenue headwinds in 2023. Now let's get into the details, starting with revenues. Fourth quarter revenues declined 26% to $47.3 million.
Revenues for our security solutions business declined 11% to $30.3 million, primarily due to the final ramp down of the U.S. census program in the fourth quarter of 2021 and a more than 50% reduction in revenues on the second largest program in security solutions due to a lower volume of customer activity on that program partially offset by higher revenues and information assurance. The 50% reduction in revenues on the second largest program in security solutions reflects the ebbs and flows of customer mission requirements on that program and will persist into 2023 on an annualized basis, creating a large year-over-year headwind. In addition, the largest program in security solutions has descoped by approximately 80% since the end of the year, and the third largest program in security solutions has terminated entirely.
Neither of these two programs had an adverse revenue impact on the fourth quarter, but will create significant revenue headwinds in 2023. In total, the three largest programs in security solutions generated approximately $70 million in revenues in each of 2021 and 2022, and each of them will experience revenue declines of approximately 50% to 100% in 2023. On the third quarter earnings call, we described these programs as large programs that will potentially slow down and/or turn off sometime around the end of 2022 or the first quarter of 2023. Turning to secure networks. Fourth quarter revenues declined 43% to $17.1 million. The decline was driven by 3 of the largest programs in secure networks, all of which are winding down and coming to successful completion.
Photo by Luke van Zyl on Unsplash
Combined, these 3 programs generated $69 million in revenue in 2021 and $44 million in 2022. We expect these 3 programs to generate single-digit revenues in 2023. We started highlighting the wind down of these large programs on our fourth quarter earnings call a year ago and they are ramping up as expected. Now let's discuss profitability. Fourth quarter gross profit declined 24% to $18.3 million due to the decline in revenue partially offset by higher gross margin. Fourth quarter gross margin increased 95 basis points to 38.6%. Gross margin expanded primarily due to a more favorable revenue mix between security solutions and secure networks. Security solutions revenues comprised 53% and of total company revenues in 2021 and 64% in 2022. Security solutions gross margin contracted approximately 650 basis points due to the previously mentioned 50% revenue decline in a large high-margin program.
Secure networks gross margin expanded approximately 250 basis points due to the previously mentioned revenue decline in large lower-margin programs. We delivered $5.4 million of adjusted EBITDA and an 11.4% adjusted EBITDA margin. Adjusted EBITDA excludes the impact of a $2.8 million restructuring charge resulting from severance and other related benefit costs associated with a reduction in force. In anticipation of lower revenues in 2023, we reduced our employee base by approximately 20% and through a series of actions starting in the fourth quarter, including a reduction in force and managed attrition. Personnel counts is lower company-wide including direct staff and indirect staff across all departments as well as among all levels of seniority, including a smaller executive team.
We continue to review our cost base and investments and may take additional actions that could result in various forms of restructuring charges as the year progresses. Now let's turn to free cash flow and liquidity. Free cash flow for the full year increased from a $5.9 million net outflow in 2021 to an $11.2 million net inflow during 2022 and due to strong collections driving lower receivables. We deployed the entirety of our free cash flow to repurchase 1.6 million shares during the year. We ended 2022 with over $119 million of cash on our balance sheet. During the fourth quarter, we also closed on a $30 million senior secured revolving credit facility with an additional $30 million expansion feature. The credit facility remains undrawn, and we currently have no debt.
Our balance sheet is well positioned to support the company through a wide range of operating conditions. Let's turn to Slide 6 to discuss the revenue bridge from 2022 actual results to our 2023 guidance and the evolution of our outlook since we first provided a preliminary view on our last earnings call 4 months ago. The revenue bridge is primarily comprised of 5 components, including large programs that are coming to successful completion, lower revenues on existing programs and the program loss, partially offset by new programs under contract and potential new business wins. Let's take each in turn, starting with the successful completion of large programs. We expect approximately a $45 million headwind, primarily from the 3 large programs and secure networks that are coming to successful completion.
This assumption has not changed since our third quarter earnings call. Turning to lower revenues on existing programs. We expect approximately a $45 million headwind on 2 of the largest programs in security solutions and 1 of the largest programs in secure networks. This assumption is also unchanged since our third quarter earnings call. Turning to program losses. We expect a $10 million revenue headwind from a single program in security solutions that terminated at the end of the year. This assumption is consistent with our preliminary outlook. Next, we expect approximately a $13 million tailwind on new programs that are starting in 2023. This assumption is $10 million lower than previously expected, primarily due to TSA PreCheck. The soft launch of our TSA PreCheck program is well underway but our nationwide launch has not yet begun.
So we have adjusted our revenue assumptions accordingly. Lastly, we're assuming a very modest $2 million tailwind from new business wins. We're only including in our guidance, new programs that we have already won have signed contracts in place and are executing. Our preliminary revenue outlook in November reflected our broader portfolio of pipeline opportunities. But for purposes of setting guidance, we're assuming new business wins in 2023 will primarily occur late in the year with revenue recognition beginning in 2024. There is potential upside to this assumption, but we feel this is an appropriate assumption to start the year. We can pull additional new business wins into our guidance from our funnel of pipeline opportunities as they occur.
Let's turn to Slide 7 for the overall guidance picture. For 2023, we forecast sales in the range of $115 million to $140 million and an adjusted EBITDA loss of $17 million to $27 million. We forecast security solutions revenue to decline low 30% to high 40% due to the previously mentioned headwinds on the segment's three largest programs partially offset by the initial ramp of TSA PreCheck. We forecast secured networks revenue to decline low to high 40% primarily due to the previously mentioned wind down of large programs as expected. Gross margins are likely to be lower as a result of revenue pressure on higher-margin programs partially offset by slightly better mix of revenues between security solutions and secure networks at the top end of the guidance range.
Turning to expenses. Share-based compensation is expected to be lower by approximately $25 million to $30 million, primarily as a result of the final vesting and amortization of substantially all IPO-related grants through the end of 2022. Cash below-the-line expenses, excluding stock-based compensation, restructuring costs and D&A are forecasted to be approximately $4.5 million lower primarily due to $6.5 million of lower labor costs, partially offset by $2 million of higher miscellaneous other costs. This excludes any impact from potential future restructuring costs associated with the ongoing review of our spending and investments as well as our management reserves. For the purposes of setting guidance, we've included an unallocated management reserve in our below-the-line expenses in the event we have opportunities to make further investments in support of the growth initiatives that John will discuss next.
The management reserve ranges from $2 million at the low end of guidance to $7 million at the high end of guidance. Including the management reserve, cash below the line expenses range from $2.5 million lower to $2.5 million higher year-over-year. Layering in the impact of depreciation and amortization, net of capitalization of R&D, would add another $1 million to below-the-line expenses. Potential upside opportunities to our overall guidance includes new business wins that could occur earlier than expected and contribute to 2023 revenue. Potential additional cost actions over the course of the year and non-utilization of the previously mentioned management reserve. Let's turn to Slide 8 to discuss our guidance for the first quarter. For the first quarter, we forecast sales in a range of $30 million to $33 million and an adjusted EBITDA loss of $4.5 million to $6.5 million.
We forecast security solutions revenues to decline mid-20% to mid-30% and secured networks revenues to decline mid-40% to high 40% and both due to the same large program dynamics described for the full year. Gross margin is expected to contract by approximately 300 basis points to 400 basis points, primarily due to revenue pressure on high-margin programs partially offset by a more favorable revenue mix between security solutions and secure networks. Cash below the line expenses, excluding stock-based compensation, restructuring costs and D&A are forecasted to be approximately $1 million to $2 million lower primarily due to lower labor costs. Layering in the impact of depreciation and amortization net of capitalization of R&D would deduct approximately $1 million from the cash numbers due to capitalization of R&D being higher than depreciation and amortization.
With that, I'll pass it back to John, who will discuss 2023 business development priorities and wrap up the presentation. John?
John Wood: Thanks, Mark. Let's move to Slide 9. Our 2023 priorities reflect our sharpened focus on rebuilding and growing our revenue base. We are looking closely at the growth function and implementing performance improvements. To achieve this, in the fourth quarter, we began an internal reorganization that created operations, growth and technology groups to improve our ability to react to the market, and opportunities effectively align our staff and resources for growth and maximize our return on investment across all our teams. Streamlining operations in this way makes the company more agile and able to focus on developing the right technologies for the right markets at the right time. As Mark previously noted, we have implemented a significant personnel reduction through a series of actions beginning in the fourth quarter to better align our staffing levels with our expected revenues.
At the same time, we've been investing in skilled new talent with deep industry experience who will help us meet our growth targets to include Josh Salmanson and Lee Canterbury, as I previously mentioned. We will continue to invest in top talent to bring new technology trials and rigorous execution of our growth strategies. The next top priority for 2023 is to maximize our existing strategic partnerships such as IBM for commercial market expansion impact in ROI. We're also working to increase the overall market awareness and positioning of our solutions. And lastly, we are focused on increasing our opportunity portfolio and the quality of contract vehicles we hold. My team and I are learning from in addressing short-term issues related to the downturn.
We will have renewed discipline around the need for mature account plans and opportunities to drive performance and prioritize quick wins. All of these efforts will help to replenish the pipeline and rebuild and grow our revenue base. Our mission has remained unchanged. Telos empowers and protects the world's most security-conscious enterprises. We entered 2023 committed to that mission with the recognition that to grow, we must rightsize, prioritize and reorganize in ways that enable us to deliver higher levels of new business wins and growth. Now let's turn to Slide 10. In summary, in 2022, we delivered $216.9 million of revenue. We expanded our gross margins by nearly 100 basis points, delivered a 9% adjusted EBITDA margin and generated $11.2 million of free cash flow, which we deployed to share repurchases.
We ended 2022 with over $119 million of cash. We currently have no debt. Our balance sheet is well positioned to support the company through a wide range of operating conditions. Our end markets remain strong. Our customer base is well funded and our solutions address critical and growing customer needs. In 2023, we are focused on generating new business wins that will begin to rebuild and grow our revenue base. We have and are continuing to take immediate action to improve our performance. And with that, we're happy to take questions. Thank you.
Christina Mouzavires: Operator, please open the line for Q&A, and we ask the call participants to please be mindful of others in the queue by asking only one question. Thank you.
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