Good day and thank you for standing by. Welcome to the Telos Corporation Second Quarter 2022 Earnings 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, today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Christina Mouzavires. Please go ahead.

Good morning. Thank you for joining us to discuss Telos Corporation’s second quarter 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 second quarter results and Telos’ strategic priority, and Mark will cover the financials and guidance for the third quarter and full year 2022. Then we will open the line for questions-and-answers 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 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 that help investors understand Telos’ financial performance. These non-GAAP financial measures should be considered in addition to and not as assessed to 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 at 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 page. With that, I will turn the call over to John.

Thank you, Christina, and good morning, everyone. Let’s begin today on slide three. I am pleased to report that Telos over delivered again on key financial metrics in the second quarter of 2022. Mark will discuss our financial performance later in this call, but at a high level, we delivered $55.8 million of revenue in the second quarter, above our guidance range of $50 million to $54 million, up 4% year-over-year and 11%, sequentially. Gross margin was 37.5%, above our guidance range of 33% to 35%. Finally, we delivered $4.5 million of adjusted EBITDA, above the high end of our guidance range of negative $2 million to positive $2 million and $0.04 of adjusted EPS. Now, let’s turn to slide four to discuss our recent business highlights and updates. This quarter we announced a new strategic partnership with IBM. Telos is the launch partner for the new active governance service or AGS offering with IBM Security. Telos and IBM are teaming to provide capabilities to address the significant challenges organizations are facing with cybersecurity and risk compliance. AGS is a unique and comprehensive offering, coupling the Xacta suite of tools with IBM’s services and security expertise to significantly improve the efficiency of clients’ approach to cyber security risk management in today’s increasingly challenging cyber environment. Target customers include large enterprise organizations in global markets such as financial services, healthcare, telecommunications and energy. We are very excited about this opportunity to partner with IBM, a leading global organization that brings recognized thought leadership and leading capability in the cybersecurity management space. This relationship also enables us to effectively broaden our reach in the global marketplace for sales of our Xacta suite of tools to drive future growth for Telos. Beyond the IBM partnership, we have continued to maintain momentum in the…

Thank you, John, and thank you everyone for joining us today. Let’s turn to slide five. As John mentioned, we delivered a strong second quarter, with results that exceeded our guidance on key financial metrics. We reported revenue, gross margin and adjusted EBITDA above the high end of our guidance range. We also delivered $5.4 million of free cash flow, representing a nearly four-fold increase in free cash flow year-over-year. Before I turn the year-over-year comparison, I just wanted to remind everyone again, as I did in our last earnings call, that we had a large delivery on a lower margin program in our Secure Networks business last year that’s pulled forward from the second quarter of 2021 to the first quarter of 2021 per the request of our customer. The accelerated delivery caused with Secure Networks contribution to total revenue to shift from 60% in the first quarter of 2021 to 40% in the second quarter of 2021 and gross margin to shift from 25.9% in the first quarter of 2021 to 42% in the second quarter of 2021, thereby skewing some of the second quarter year-over-year comparisons this year. So I will provide year-over-year comparisons for the second quarter as usual and also for the first half overall to normalize for the accelerated shipment from the second quarter to the first quarter of last year. Okay, with that backdrop, I will go into details. For the second quarter, total sales were $55.8 million, up 11% sequentially and up 4% year-over-year. Performance about the high end of the guidance range of $50 million to $54 million was driven by favorable timing variances and pre-existing higher margin programs in Security Solutions and strong supply chain management in Secure Networks. Security Solutions sales were $30.8 million, up 15% sequentially and down…

Thanks, Mark. In summary, we delivered a solid second quarter during which we formed a new strategic partnership with IBM and outpaced guidance on our key financial metrics. We also delivered gross margin expansion and strong free cash flow in the first half of the year and have begun to return free cash flow to shareholders through share repurchases. Our core business and pre-existing programs are performing well and we expect that to continue for the balance of the year. We are taking a slightly more cautious approach to new business in the second half of the year and are managing our forecasting expenses accordingly. With that, we are happy to take questions.

Thank you. [Operator Instructions] Our first question comes from the line of that Zach Cummins with D.A. Davidson, oh, I am sorry with B. Riley. Your line is open. Please go ahead.

Yeah. Thanks. Good morning. Hi, John. Hi, Mark. Thanks for taking my questions. Mark, I -- my question is really geared towards the updated guidance for the year. I mean can you give a little more granularity around the assumptions you are making for TSA PreCheck and maybe why you are taking a slightly more cautious approach to new business wins here in the second half of the year?

Yeah. Sure, Zach. Thanks for your question. So why don’t I dissect that a little bit for you? So, at the high end of the guidance range, we are taking sales down by $15 million, $11 million of the $15 million is PreCheck net revenue. So we previously assumed $12 million of net revenues for PreCheck at the high end of the guidance, now we are assuming $1 million. The PreCheck process is progressing well. Obviously, we don’t have the ATO yet and so we felt it appropriate to take that guide down, but certainly, wanted to leave revenue in there as a recognition that we still expect the ATO this year. The balance of the $4 million, the other $4 million, is really net reductions across the rest of the portfolio, primarily driven by lower assumptions on new business in the second half. The thought there is, even though we are not seeing impact from the more complicated macro environment right now in our core business, our core business is performing very well, it’s not being impacted by the macro environment and you are seeing that in the second quarter results. But we wanted to acknowledge at least as we scrub the forecast for PreCheck, we wanted to take a broader look at some of the higher risk items in the forecast. For example, anywhere where we are selling new solutions for pre-existing solution to new customers in new end markets, we wanted to take a slightly more cautious approach there. So that’s the $4 million of additional net reduction. To put that in perspective, at the midpoint of the range that would represent about 80 basis points of year-over-year growth, so a very modest reduction as a nod, in part to the macro environment, but very modest nonetheless. On adjusted EBITDA at the high end of the guidance, we are taking by $4 million. That is the reduction in the gross profit corresponding to the revenue reduction, partially offset by reduction in below the line expense. And then at the low end, no change to sales, but what you are seeing in the $3 million of lower adjusted EBITDA is lower gross margin on Secure Networks, primarily in new business in the second half.

Understood. That’s helpful. Much appreciated and best of luck in the coming quarter.

Thanks a lot.

Thanks, Zach.

Our next question comes from the line of Rudy Kessinger with D.A. Davidson. Your line is open. Please go ahead.

Hey, guys. So just following up on that question there, I guess, the $4 million reduction at the top end, I am just more conservative ex-TSA and the rest of the portfolio. I guess, I would just ask, the channel and the direct sales reps, are they meeting your expectations from, say, the start this year on pipeline build in sales production as we get into the second half year? And then, secondly, on IBM, do you have anything incremental baked into the guide this year for IBM? And I guess just bigger picture, how big of a driver or growth -- how much can IBM be, say, in maybe 2023?

Hey, Rudy. This is John. I will take first -- I will take the second question and I will ask Mark Griffin to answer the first one. As it relates to IBM, we have a couple of hundred thousand dollars in our model for purposes of this year. As it relates to the -- how big it can be, we think it could be quite sizable and that’s not a good number -- that’s not me able to give you -- I am not able to give you a modeling perspective as yet. What I can say however is that the their pipeline is filling up quite rapidly with what I would consider to be Tier 1 names, large car manufacturers, large banks, large pharmaceutical companies, countries, et cetera, places that I think would be very difficult for us to get into on our own and really what’s happened is that they have embedded Xacta as their launch partner in their advanced -- its governance solutions. So I think it’s got a lot of potential in front of us. As we put out our guide for 2023, I am sure we will give you much greater detail. But I am quite happy with how the -- how that relationship is really coming out in a fully blossoming way, much like I had hoped it was going to be with the cloud service providers, but they have been quite, as you are well aware slower. So here IBM is completely embraced it. They are also looking at using it internally. So I think there is a great opportunity for us with IBM in over the next five years to 10 years. And Mark, if you have a mic, can you answer the first question on the sales force?

Sure. Hello, Rudy. Mark Griffin. Commercial adoption is happening, but obviously, we took a more cautious and slower approach than initially planned. We are ongoing and continuing to fine-tune the staff, not only in the sales area, but also increase the capture and business development areas to achieve operational efficiencies and maximize our potential. So, yes, we are seeing progress. The pipeline is increasing. We are seeing some opportunities that will close in late Q3 and in Q4. But we continue to fine-tune that staff and look for additional opportunities and growth from additional -- look across operations in the sales and Capture BD areas.

Go ahead.

Thank you. And our next question comes from the line of Alex Henderson with Needham & Company. Your line is open. Please go ahead.

Thanks. I am going to break little bit, just ask two questions, one just why you think there’s any improvement in TSA. The primary question is on the Xacta. It’s very difficult looking at the numbers to cut through the noise and understand exactly what’s going on with the product. Can you give us some sense of what the growth rate, based on your current guidance for Xacta on a full year basis? Is it actually producing double-digit growth, is it flat, is it up 20%? What -- can you just give us some parameters around what the true underlying growth rate is, because it’s kind of lost in the numbers?

Yeah. Hey, Alex. It’s Mark. So on our Information Assurance business for 2022, I mean, as you know, we don’t guide at that level. But I would say, we are probably going to end somewhere in the -- we are probably going to be somewhere in the, call it, low-to-mid single digits on the year, say, mid single-digit on year, higher at the high end of the range but, call it, midpoint -- kind of mid-single digits.

And the reason for the TSA optimism that it actually was going to close, I mean, you thought it was going to close in September, then you thought it was going to close at the end of the year, now we are still thinking it’s somehow going to close and that it’s improved. What makes you think that?

Sure, Alex. This is Mark Griffin. So ultimately we follow TSA guidelines and schedule for launch. We are engaged with them extensively on a daily basis going through their launch plan and their security approvals. We are getting to the end of that schedule and we are in this process now deploying to our enrollment sites and gearing up training and operational enrollment capabilities for those site. So every indication is we are following TSA schedule. They are positive on our results at this point and we fully expect to launch this year.

So just so I understand, when you say gearing up training, they have been instructed you to train your employees and they are -- they understand that that’s an expense you are carrying and therefore they wouldn’t stretch that…

Look…

…ask you do that it would if it wasn’t imminent. Is that the right way we should be reading that?

Yeah. Would you explain a little more about...

Sure.

…if you could.

Alex, yeah, the entire program is under guidance and policy and procedures from TSA. So every aspect of the program is reviewed and approved by TSA. And so everything we do from approval of sites, to training of personnel, to our soft launch, to our security process and procedures are all controlled by TSA. So, yes, TSA reviews every document. There are contractual delivery -- deliverables that we have to adhere to on every aspect of this launch. So, yes, TSA is the ultimate approval of when we launch, but we are meeting their schedules and we are doing everything that they are asking in the time frame they are asking for a launch this year.

Great. Thanks.

Thank you. And our next question comes from the line of Nehal Chokski with Northland Capital Markets. Your line is open. Please go ahead.

Yeah. Thank you and congrats on the solid results and commend you, Mark, on especially a clear guidance deck. Thank you very much for that. Where are you guys in terms of percent of software billing sold on a term basis versus perpetual basis now and relative to the one, two and four quarters ago?

That’s a good question. I would say, the majority of what we are selling now, Nehal, is subscription or term versus perpetual and that’s true in our pipeline as well that the vast majority of our pipeline are subscription oriented. There are a couple of exceptions. There are a couple of government examples that are exceptions, but the vast majority of the remaining pipeline, whether you are talking about ACA or Ghost or you are talking about Xacta, there are going to be subscription based or term based licenses versus perpetual.

Okay. Great. And how much of an impact does that transition have on the projection of low-to-mid single-digit growth for Xacta?

It has a -- it definitely has an impact. I don’t know the number off the top my head. But in the past, when we would do, say, we did $6.5 million in revenue. That was all perpetual. My guess right now is we are at about 60% or 50% perpetual currently and I think going forward it’s going to be -- the vast majority is going to be term or subscription.

And then to be clear, what is -- for every dollar of perpetual that’s capitalized into term, what the...

Basically -- what that basically means is, if I am delivering on a $6 million number for the year and it’s all term, I have got to deliver $12 million of orders by no later than June 30th.

Got it. Great. Thank you. And then my last question is that, Mark you alluded to in terms of a more cautious outlook on the macro being part out for the $15 million take down on the high end of the guidance, but that you are not seeing any impact yet. Why do you think you are not seeing any impact yet?

Correct. So what I am distinguishing between there is our core business. Our core business has been very strong through the first half of the year and including in the second quarter as the macro became choppier. So we are not seeing any impact there. I think it’s really just the nature of our portfolio and the customers and markets that we serve. And then, for the second half, again, slightly outside of our core business where we are selling either new solutions or pre-existing to new end markets and customers, we just wanted to take a finer point on that forecast. And again, the net effect is only 80 basis points of year-over-year growth.

Thank you.

Thank you. And our next question comes from the line of Brad Clark with BMO. Your line is open. Please go ahead.

Hi. Thanks for taking my question. I want to ask a question about the sort of new business slowdown and how it’s in the guide and so much more of a clarification. And what I am trying to understand is, the deals out there that are sort of being pushed back either by the customers or from Telos’ perspective given the sort of proposed margin profile and it’s more not so good business at this or is it, yeah, it basically trying to understand between those two, more from the customer side or from Telos’ side to sort of push back and delay the new business? That’s it from me. Thank you.

So, it depends on the customer’s side, Brad. The government’s side is always -- it takes longer than people think and that we have mainly built into our guide. On the commercial side, I think, we are actually having success. But what’s happening is they are starting small and building out over time. So we landed another commercial customer in this quarter. It started out being a six-digit, if you will starting place for it, but we expect it to be more like a seven-digit plus opportunity for us per year as they rollout Xacta throughout their offerings. So I would say that on the commercial side, there is more of a try it and buy it, they are going to buy it small and then build out over time whereas in the markets that were more well known as in the Federal Government, there is some level of doing a pilot, but it’s a much more controlled pilot and it typically has a very, very specific beginning, middle and an end. And there the customers will go to an enterprise-wide license more quickly just based on the reputation that we have.

Thank you. And we do have a follow-up question from the line of Alex Henderson with Needham & Company. Your line is open. Please go ahead.

Great. Thank you very much. So I was hoping you could talk a little bit about what’s going on with the voice-over-AWS and is your big chunk of the story when you guys came out was that those guys were going to be reselling it starting kind of in the beginning of this year and that they thought it was a big driver of acceleration of the -- their services business, yet that doesn’t seem to be materializing. Can you talk about what the environment is there and why it’s taking so long or not metastasizing?

Metastasizing. That’s a good word. Thank you, Alex. I think it is taking longer. It is frustrating. They continue to use it internally. There are pockets of the organization that still want to build their own capabilities and it is moving but slowly, whereas on the other hand IBM made that -- made the decision not to build, but buy using Xacta as a -- as their launch partner. And so, there we have a situation that a service provider is using us in the way that I was hoping the cloud providers are going to use us. It doesn’t mean the cloud providers aren’t going to get there. It’s just that they have not got there yet. They do continue to use us. They continue to use us more and more. On the recent -- one of the recent awards we had that we haven’t announced the name on, it started out in the intelligence community. They see the value of the intelligence community. Now they are bringing us into their Department of Defense side of the business. And then, ultimately, we want to be in a commercial world. So each of the cloud providers has looked at it and gone about it in a little bit of a different way. In the case of Azure, there has been quite a bit of turnover on the security and compliance side of their house. So we have had to sort of start-over in the case of Azure. And so, each cloud provider has a little bit of a story associated with it, but it is frustrating.

Similarly, can you talk a bit about the Ghost product and the progress or what’s going on there in terms of commercializing it into a product that’s used outside of the government security infrastructure play?

Sure. And actually you made a comment that I’d like to extend a little bit. One of the things that we have learned about our Xacta is that, it’s in the language of the government. And one of the things that we have to do is we have had to really change verbiage, how we describe things that we do inside of Xacta and I will give you an example. There is something called a poem in the government world. Poem doesn’t mean anything to the commercial guys. Remediation is the commercial equivalent of a poem. So we had to make changes in the product itself that more reflected what it is that the commercial world want it, which was also something that we had to build in. As it relates to the -- as it relates to Ghost, we have continued to -- we have got continued progress with JCI offering Ghost as an embedded option with their cameras. Those cameras will -- if you will be hidden on the internet and their security product sales continue to be a very healthy growing business. We expect a small level of sales out of that to happen late this year with this offering. And again, you have had some -- not turnover but promotions over there. So getting it off the ground has just taken longer than we would have liked. Having said that, there are other organizations that are looking to do very similar things with JCI and we are in the midst of negotiating those -- with those other players and our hope is that we will be able to roll out some other announcements about how we are building that capability inside of these other players. Now just to remind you, what we do with advanced cyber analytics is, all of that activity is hidden behind Ghost as well. So there is a -- there are opportunities for us with Ghost, both within our existing customer set, as well as selling through other players.

Since we are going around into the second round of questions, I am going to ask one more, if it’s okay. If not then just let me know. But I was hoping you could talk a little bit about the security networking business. It sounds like some projects were pulled forward in that business into the first half and just the favorable timing comment. Does that mean that you are expecting little less in the back half of the year from Security Networks?

So not in Secure Networks, the dynamic within Secure Networks, the team there is doing a really terrific job of managing their supply chain risk. And so when we set guidance we account for their supply chain risk in guidance and they have been outperforming that risk. So the program management teams there are doing a terrific job and outperforming guidance. The pull-forward I think that you are referencing is more or less Security Solutions side. We did have some higher margin order on one program in particular within that business that came into the second quarter that we were otherwise expecting to more so come in the second half. So that’s the favorable…

Mark, but….

…there.

But if you pulled forward the availability of supply then you deployed products sooner than expected. Doesn’t that come out of your pipeline?

I am not sure I understand the question.

You have got an order from a government agency to deploy a, I don’t know, choose a location…

Oh! I think that lapped….

… and you told you can’t deploy because you don’t have the product…

Alex I think you are ….

[Inaudible]

…referring to last year. You are talking about the pull-forward last year in 2021, the pull-forward on the Secure...

No. I am not. Mark, I am talking about the current environment. You used that as an example because they could not know specifically which projects we are involved. But you have a pipeline of business that you need to deploy gear for in order to get the revenue. If you get the parts sooner than expected…

Yeah.

… then that do reduces your pipeline into the forward period, correct?

That assumes that the pipeline is static, Alex. So the pipeline is not static.

Okay. So there’s no erosion in the outlook for the back half of the year within that because of the pull-forward of parts?

Not the revenue line.

Correct.

Thank you. That’s what I was looking for.

Yeah. Thanks, Alex.

Thank you. And I am showing no further questions and I would like to turn the conference back over to John Wood for any further remarks.

Oh! Thank you very much, Operator. Well, first, I really well thank our shareholders for your ongoing support. And despite the current environment, I am pleased with our recent performance. And well, our year-to-date has progressed as we have expected. We are taking a balanced approach to the second half and we remain very focused on delivering for our customers and our shareholders. And again, I just want to say thank you to all of you for listening and to the analysts for asking questions and covering our stock. Thanks a lot everybody.

This concludes today’s conference call. Thank you for participating -- this concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.