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Telos Corporation (TLS)

Q4 2022 Earnings Call· Thu, Mar 16, 2023

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Transcript

Operator

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. [Operator Instructions] 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

Analyst

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

Analyst

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…

Mark Bendza

Analyst

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…

John Wood

Analyst

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

Analyst

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.

Operator

Operator

[Operator Instructions] Our first question comes from Zach Cummins with B. Riley. Your line is open.

Zach Cummins

Analyst

John and Mark, I guess I'll just have a 2-part question here. I mean, Mark, I appreciate you giving some insight into the differences between the preliminary outlook and your current guidance. But can you dig a little bit deeper into kind of the final assumption around new business wins, kind of what's driving a lot of that conservatism and the difference between the preliminary outlook? And the second part is, what gives you guys confidence that be able to turn this business back to growth over the longer term, just given some of the challenges you're seeing with some of your core programs and security solutions?

Mark Bendza

Analyst

Sure, Zach. Thanks. I'll take the first question, and then I'll have John respond to the second question. So first, on the $45 million of new business from the preliminary outlook, a couple of comments there. First, we haven't lost any of that business. As a matter of fact, we've won some of that business. We've won approximately $9 million of that business. Given the lead times on that program and when we expect that program to start, we only have about $1 million to $2 million of that $9 million being recognized as revenue in 2023. With respect to the rest of it, that $45 million was actually significantly factored down. It was factored down by about two-thirds or more. But as we think about setting guidance, we want to be cautious about how much new business to put into the guidance for the year. A lot of these opportunities are large and chunky opportunities. And it's unclear exactly when in the year these opportunities could come to fruition. So I don't want to take a lot of risk on timing here. If an opportunity comes through at the end of December versus, say, in September that can have a big difference on revenue. So we decided to just take a blanket assumption with respect to these large opportunities that will happen late in the year as is typical for the customer buying season and primarily contribute to revenues in 2024. So basically, just a blanket assumption there and the large opportunities. I'll turn it to John for the other piece.

John Wood

Analyst

The reason why we feel confident in these business development opportunities is number one, is our past performance, but we've got past performance calls that are very good with these opportunities. Number two, it's sort of around wheelhouse. It's right our wheelhouse. Most of these opportunities are government oriented. And then number three, a lot of it is also the knowledge of the customer and more importantly, the customers' knowledge of us. So that -- those are the 3 reasons why we feel confident in the business development expansion.

Operator

Operator

[Operator Instructions] Our next question comes from Nehal Chokshi with Northland Capital. Your line is open.

Nehal Chokshi

Analyst · Northland Capital. Your line is open.

Yes. On the TSA PreCheck, the soft launch has been underway. And I think at the 3Q call, you had implied that you expected the national launch to start in calendar '22. So why hasn't it launched yet? And what have you learned from the soft launch so far?

John Wood

Analyst · Northland Capital. Your line is open.

Nehal, this is John. One of the things that's happened is I think it's both TSA and Telos working out some of the details of the program, make sure the program will be very smooth for the customer experience. In terms of specific details, I'll turn it over to Mark Griffin, if you want to add anything.

Mark Griffin

Analyst · Northland Capital. Your line is open.

Sure. Nehal, as mentioned, the soft launch is well underway and that involves testing both at Telos and TSA sites. But just to put to -- what this does mean though is that during this testing phase, we are enrolling and renewing staff members during this process, and that continues. So I think we're getting close but we are still in soft watch mode, and we're very confident that we will be launching in 2023.

Operator

Operator

Our next question comes from Nima Rad with D.A. Davidson. Your line is open.

Nima Rad

Analyst · D.A. Davidson. Your line is open.

This is Nima on for Rudy Kessinger. I was just curious about the CMS contract. Anything -- any update there would be great.

John Wood

Analyst · D.A. Davidson. Your line is open.

This is John. There's no update on the CMS contract that I'm right now. Mark Griffin?

Mark Griffin

Analyst · D.A. Davidson. Your line is open.

No, there's been no update at this point. We're still awaiting the future past order release to do the work that was previously described.

Operator

Operator

Our next question comes from Bradley Clark with BMO. Your line is open.

Bradley Clark

Analyst · BMO. Your line is open.

I just want to talk about some of the headcount and expense management move that you have made given the revenue headwinds. How did you -- you mentioned our water of the staff across all departments. What was the strategy in terms of shaping the workforce? Can you just sort of elaborate on how and why you decided to cut where you did and perhaps where you prioritize them, keeping knows that did, what factors what to your decisions on what to keep?

Mark Bendza

Analyst · BMO. Your line is open.

Sure. So it was pretty clear given where the revenue forecast looked for 2023 that they were going to be a number of areas across the company that we're going to experience a lower operational volume between both billable and nonbillable rules, a big chunk of the employee reduction was related to billable roles associated with the six programs that we talked about. And then, of course, naturally, there is a knock-on effect to nonbillable indirect roles as those programs were ramping down or coming to completion or terminating that had a knock-on effect on the operational cadence and volume for all the support functions across the company. So that's really what drove it.

Operator

Operator

Thank you. This concludes today's question-and-answer session. I'd like to turn the call back over to John Wood for any closing remarks.

John Wood

Analyst

Well, first of all, I just want to thank our shareholders for your ongoing support through these times. And we are in robust and recession-resistant end markets. We have well-funded customers. We have a decade-long track record of serving the world's most security-conscious organizations. So Telos does have a strong foundation for the future. I also want to make the point that the Board and I are fully committed to taking the necessary actions to capture the opportunity in front of us and we build and grow our revenue base for the future. Thank you.

Operator

Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.