Good day, and thank you for standing by. Welcome to the Telos Corporation Second Quarter 2025 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your first speaker, Allison Phillipp. Please begin.

Good morning. Thank you for joining us to discuss Telos Corporation Second Quarter 2025 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. Mark will begin with remarks on our second quarter 2025 results. Next, John will discuss business highlights from the quarter. Then Mark will follow up with third quarter guidance 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 second quarter financial results were issued earlier today and are 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, including all of those relating to 2025 company performance, plans and operations 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 financial results summary 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 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 second quarter results summary 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 on our company website under the Investor Relations link. With that, I'll turn the call over to Mark.

Thank you, Allison, and good morning, everyone. Before we get into the details on the slides, I'd like to provide a brief overview of the good news that you will hear today. Our business has been scaling in a very meaningful way year-to-date. Leading the way are our major long-term programs in security solutions such as the Defense Manpower Data Center or DMDC program and TSA PreCheck, as well as additional confidential IT security work that we are now performing for the federal government. These growth drivers are layered on top of a strong base of recurring revenue streams from sophisticated government and commercial customers throughout our Security Solutions portfolio. Our operational and financial performance inflected in a very positive way in the first quarter of this year, with a return to revenue growth, profitable adjusted EBITDA, and strong cash flow. That trend accelerated in the second quarter, and we're also forecasting a large sequential step-up in revenue and adjusted EBITDA in the second half. In addition, given our confidence in the outlook for the business and our strong cash flow generation in the first half of this year, we have resumed share repurchases. With that introduction, let's get into more detail beginning on Slide 3. I'm pleased to report that Telos has again overdelivered on key financial metrics in the second quarter, exceeding both revenue and profit guidance. Revenue grew 26% in the quarter to $36 million, above our guidance range of $32.5 million to $34.5 million. Security Solutions delivered approximately 90% of total company revenue and drove the outperformance above the top end of the guidance range. GAAP gross margin was 33.2%, and cash gross margin was 38.4%, both within our guidance range. Although gross margins were lower year-over-year due to revenue mix in the quarter, they were representative of typical margins for our portfolio over the past 5 years. Given the breadth of revenue streams in our portfolio, gross margins will naturally fluctuate within our historical range from quarter-to-quarter based on revenue mix. As you'll see in our third quarter guidance, we expect margins to mix higher sequentially next quarter. Adjusted operating expenses in the second quarter were approximately $900,000 better than guidance due to ongoing cost discipline throughout the company. As a result of better than forecasted revenue and operating expenses, adjusted EBITDA also exceeded the top end of our guidance range. Adjusted EBITDA was approximately a $400,000 profit compared to our guidance range of a $2.1 million loss to a $600,000 loss. Lastly, we delivered another quarter of robust cash flow. Operating cash flow in the quarter was $7 million. Free cash flow was $4.6 million or a 12.9% free cash flow margin. Free cash flow in the first half was $8.4 million or a 12.6% margin. As a result of our strong cash generation in the first half and our confidence in the outlook for the business, we resumed share repurchases in the second quarter. We deployed $4 million to repurchase approximately 1.5 million shares at a weighted average price of $2.69 per share. Since our fourth quarter 2024 earnings call, we've been saying that we expect significant year-over-year improvements in revenue, profit, and cash flow for the full year 2025. So let's turn to Slide 4 for a brief review of our year-over-year performance in the second quarter and first half of the year. Year-over-year revenue growth was primarily driven by 82% growth in Security Solutions, partially offset by contraction in secure networks. Growth in Security Solutions was primarily driven by the successful transition of the DMDC program in the fourth quarter of 2024 and the ramp of TSA PreCheck enrollment volume. GAAP gross profit grew 23%, and adjusted EBITDA improved $3.3 million, returning to a profit. It is worth noting that adjusted EBITDA improved by $3.3 million on a $7.5 million increase in revenue. That implies a 44% incremental adjusted EBITDA margin due to a combination of revenue growth and lower operating expenses. Cash flow performance was equally as encouraging. Free cash flow improved by $16 million to a positive $4.6 million. The significant year-over-year improvement in free cash flow was due to higher adjusted EBITDA, lower capitalized software development costs, and an intensive company-wide focus on working capital management. The same year-over-year revenue, profit, and cash flow trends apply to the entire first half. Notably, incremental adjusted EBITDA margin was 71%. Free cash flow improved by over $23 million to a positive $8.4 million. Overall, we expect the trend of year-over-year growth in revenue and adjusted EBITDA to accelerate in the second half, and we expect to generate positive free cash flow for the full year. I will now turn it over to John for an overview of recent business highlights.

Thanks, Mark, and good morning, everyone. Let's turn to Slide 5. First, I'll provide an update on our TSA PreCheck program. We have successfully expanded our nationwide network of enrollment centers to 415 locations across 40 states, including Puerto Rico. This represents a 43% increase in locations since our last earnings call in May. We continue to target achieving 500 enrollment locations in 2025. We are pleased with the progress we have made on this rollout as we strive to provide a convenient solution for travelers across the country and be a trusted partner in this important national security program. In fact, as Mark has previously mentioned, we've made progress in several of the key areas of the Security Solutions portfolio as we're presently seeing several large programs ramp and scale. Additionally, we're very excited about the recent Federal Risk and Authorization Management Program, or FedRAMP High Authorization for our Xacta software solution. This is a formal recognition that Telos' Xacta platform meets the most stringent standards for protecting highly sensitive government data in cloud environments. This milestone reinforces our role as a trusted partner in an increasingly complex and rapidly evolving security environment. We are proud to deliver solutions that help our customers accomplish their missions with the highest level of safety and security. Finally, I will summarize the latest news on other business outcomes since our last earnings call. Our Xacta business has achieved new orders or renewals with several key customers, including the U.S. Department of the Treasury, the U.S. Air Force, the Defense Intelligence Agency, New Zealand Government Agency, the Virginia Department of Education, the National Archives and Records Administration, and several other U.S. federal government customers. We also received a new order for cyber services from a Fortune 100 company in the technology sector, as well as renewals from the U.S. Department of Homeland Security, the General Services Administration, and several other U.S. federal government customers. I'll now turn the call over to Mark, who will discuss third quarter guidance.

Thanks, John. Let's turn to Slide 6. For the third quarter, we forecast revenue to grow 85% to 98% year-over-year to a range of $44 million to $47 million. We forecast adjusted EBITDA of $4 million to $5.7 million or an adjusted EBITDA margin of 9.1% to 12.1%. We expect Security Solutions to generate approximately 90% of total company revenue. We forecast cash gross margin to be approximately 40% to 41%, up sequentially from 38.4% in the second quarter due to normal quarterly fluctuations in revenue mix as described earlier. Adjusted operating expenses are expected to be approximately $14.3 million, representing a $1.6 million reduction year-over-year. Lastly, we expect the fourth quarter to be similar to the third quarter. With that, I'll turn it back to John.

Thanks, Mark. Let's turn to Slide 7. To review, our return to growth plan has taken hold, and we are exhibiting significant gains as large programs within our Security Solutions segment continue to rapidly scale. Our company-wide commitment to expense discipline is driving outstanding operating leverage, and as a result, in the second quarter and first half of 2025, the company delivered substantial year-over-year growth in revenue, adjusted EBITDA, and cash flow. We've achieved free cash flow through the first 2 quarters of the year at 12.6% of revenue. This has enabled us to return cash to shareholders through share repurchases in the second quarter. We also expect the upward trajectory in revenue and adjusted EBITDA to accelerate in the third quarter of the year. With that, we're happy to take questions.

Operator, please open the line for Q&A. Thank you.

Our first question is from Nehal Chokshi with Northland Capital Markets.

Congratulations on spectacular results and guidance. Great to hear is that you're seeing increasing TSA PreCheck enrollments despite what should be declining renewal volume due to the 5-year anniversary of the COVID falloff. So can you talk about how our enrollments per store that are currently open are going relative to the expectations to achieve the 33% targeted market share of TSA PreCheck enrollments?

Yes. Nehal. It's Mark Bendza here. So listen, at the beginning of the year, we said we were targeting 500 locations by the end of the year. We've been ramping really well towards that target. We ended last year with 203 locations. We're at 415 today. So we're on a really good trajectory there. You're right, on renewals, overall market renewals are down this year due to the 5-year anniversary of COVID. However, with the ramp in locations, new enrollments are a big driver of the year-over-year performance you're seeing for the entire company. I won't get into that granular detail on the program around the exact number of transactions per location. But needless to say, enrollments are up along with the ramp in locations.

Enrollments are up consistent with the number of locations or enrollments are up per location? Just wanted to get that clarification.

Enrollment overall are ramping with locations.

Got it. Okay. You mentioned that gross margin will be increasing sequentially. I understand there’s variability from quarter to quarter and it’s likely due to mix. What is driving that mix that will lead to a sequential increase in gross margin?

Yes. As we have discussed previously, we have a diverse range of revenue streams in our portfolio, each with varying margin profiles. The margins can change from quarter to quarter, and I anticipate that variability will continue. Over the past five years, our weighted average cash gross margin has hovered around 38%, which increased significantly last year as our lower-margin revenue streams decreased. We are aiming for margins of 40% and above in the third and fourth quarters. Overall, the full year should look very promising compared to our historical performance. However, there will still be fluctuations each quarter. In the upcoming third quarter, the changes will be driven by various growth factors we currently have in Telos ID, including key programs and their associated revenue streams.

Okay. And is it fair to say that it's largely due to mix shift within the DMDC contract?

That is part of it, but that's not all of it.

Next question is going to come from the line of Rudy Kessinger with D.A. Davidson.

In the prepared remarks, I think you had mentioned additional confidential IT security work with the federal government as contributing to some of the Security Solutions revenue growth. Any additional commentary you could provide on that in regards to size and scale and what kind of revenue generation you're seeing today versus what you could see in the future? And then also any large deals in the pipeline that you're expecting to close in the second half of this year that could contribute meaningful revenue for next year?

Yes. Rudy, it's Mark Bendza here. So on the confidential work, unfortunately, we're not at liberty to say too much about that. In terms of the size, I would say it's a nice additional revenue stream for the portfolio. I can't quantify it for you, unfortunately. But it's relatively meaningful. On the pipeline, I'll pass it over to Mark Griffin.

Rudy, Telos has a strong pipeline with over 200 unique opportunities, representing an estimated contract value of over $4 billion. 69 of these opportunities are new within the last quarter, and we feel award pace will be weighted towards Q4 this year and Q1 of next for many of the more significant opportunities. Our growth opportunities are driven by strategic positioning and well-funded national security priorities, including the ever-changing cybersecurity threat environments, digital enterprise solutions, and modernization of core infrastructure. The majority in total contract value is weighted toward our Security Solutions business, which is exactly where we want our future growth to be centered. We believe we have the right ingredients for success, are very confident in our growth trajectory and are laser-focused on our future profitability and sustainability.

Great. And then maybe just one quick follow-up, if I could. You had some strong positive net working capital changes in the first half, just that led to significant free cash flow outperformance related to EBITDA. How should those dynamics trend in the second half?

Yes. So overall, free capital, I expect to be robust in the second half as well. In terms of net working capital, over the next, I don't know, a number of quarters, I would expect the working capital tailwind to moderate and more of the cash flow coming from higher adjusted EBITDA. But the net effect of all that is I would expect continued robust free cash flow.

Next question is going to come from the line of Zach Cummins with B. Riley Securities.

Congrats on the strong results here. First question is just on TSA PreCheck. With the changes from the DHS allowing just a regular security line to maintain keeping their shoes on throughout the process, do you imagine that having any sort of impact on the appetite for new renewals or anything along that line? Just curious on your insight there.

Zach, Mark Griffin. No, we don't feel as though that will have any negative effect on enrollment at this point. In fact, in some ways, it's increasing visibility of the program. And remember, the speed through the line is still the most critical component, which TSA PreCheck offers.

Understood. That's helpful. And just in terms of DMDC, Mark, I know it can really fluctuate in terms of mix around software products versus hardware products that are being purchased. I mean, now that you've had the program and ramped it for going on a year now, are you starting to get a better sense of visibility into those orders on the third-party side?

Yes. Generally, yes, I'd like to get the full calendar year under our belt to really get a feel for what the mix looks like. Overall, I'd say the mix is more weighted to software than hardware. But overall, this is a really good program for us. And along with a couple of other drivers, one of the really important drivers behind the year-over-year improvement in the financials.

Understood. And final question for me is just given the strong free cash flow in the first half of this year and expect to be that sustained going forward, how should we think about your capital allocation strategy and maybe specifically to M&A?

Yes. So good question. I'd say organically, we're in a great spot right now. Things are going really well. As we've been talking about here on the call and in our materials, top line growth is excellent this year. Cash gross margins are healthy. Our flow-through to adjusted EBITDA is working very well due to OpEx discipline. And we're converting profit to cash at very high rates. And then we're returning that capital to shareholders through buybacks. So I'd say the priority is to use free cash flow to drive additional buybacks over time. That being said, we'll continue to look at say more opportunistic tuck-in acquisitions as they come across our desk, but we'll be very disciplined on that front. And then lastly, if a more transformational M&A opportunity or say a change of control transaction would lock in the most value for our shareholders in a very obvious way, we take a serious look at that as well.

This will conclude today's question-and-answer session. And I would like to hand the conference back over to John Wood for any further remarks.

Well, thank you. I want to thank our shareholders for your ongoing support. And we're going to continue to be intensely focused on executing our plan and are pleased our efforts have enabled positive outcomes for the company and our shareholders during the first half of the year. We look forward to continuing the trend of year-over-year growth throughout the remainder of 2025. And I'll just end with, we have robust and recession-resistant markets, well-funded customers, and decades-long track record of serving the world's most security-conscious organizations. As a result, we believe Telos is a strong foundation for the future. Thank you.

This concludes today's conference call. Thank you for participating, and you may now disconnect. Everyone, have a great day.

Thank you.