Executive Summary / Key Takeaways

• Strategic Pivot Driving Growth: Telos Corporation is executing a successful turnaround, driven by a strategic focus on its high-margin Security Solutions segment, particularly the ramping Defense Manpower Data Center (DMDC) and rapidly expanding TSA PreCheck programs. This shift, coupled with rigorous cost discipline, has led to a significant inflection in financial performance.
• Strong Financial Rebound: The company delivered robust Q2 2025 results, with revenue growing 26% year-over-year to $36.0 million and Adjusted EBITDA returning to a profit of approximately $0.4 million. This momentum is expected to accelerate, with Q3 2025 revenue guided to $44-$47 million and Adjusted EBITDA to $4-$5.7 million.
• Technological Moats in Critical Sectors: Telos's core technologies, including the FedRAMP High-authorized Xacta platform for cyber risk management and Telos ID for identity solutions, provide a crucial competitive edge in highly sensitive government and regulated environments, offering stringent security and compliance automation.
• Robust Cash Flow Generation: Strong operating cash flow of $7.0 million and free cash flow of $4.6 million (12.9% margin) in Q2 2025 highlight efficient working capital management and the favorable economics of key programs. This has enabled the resumption of share repurchases, signaling confidence in future financial health.
• Outlook and Risks: Telos forecasts positive free cash flow for the full year 2025, underpinned by a $4 billion pipeline. However, dependence on U.S. government spending, potential delays in contract awards due to administrative changes, and intense competition from larger cybersecurity players remain key considerations for investors.

A Legacy Forged in Security: Telos's Strategic Reawakening

Telos Corporation, founded in 1968, has built a formidable legacy as a provider of cyber, cloud, and enterprise security solutions for the world's most security-conscious organizations. Its enduring relationship with the Defense Manpower Data Center (DMDC) since 1995 underscores a deep-rooted expertise and trust within the U.S. federal government, a sector that remains the bedrock of its revenue, contributing approximately 90% in the first half of fiscal year 2025. This long history has uniquely positioned Telos to address the evolving and complex cybersecurity threats facing national security and critical infrastructure.

The company operates through two distinct segments: Security Solutions and Secure Networks. Security Solutions, encompassing cybersecurity, cloud, and identity management offerings, has become the primary growth engine, while Secure Networks provides specialized networking architectures. In an industry landscape dominated by larger, more diversified cybersecurity giants like CrowdStrike (CRWD), Palo Alto Networks (PANW), Okta (OKTA), and Fortinet (FTNT), Telos carves out its niche by focusing on high-assurance, compliance-driven solutions tailored for government and regulated sectors. While these larger competitors often boast broader enterprise adoption and faster innovation cycles, Telos's strength lies in its specialized expertise and established trust in mission-critical, high-stakes applications.

The broader industry is experiencing significant tailwinds from escalating cyber threats, the imperative for digital enterprise solutions, and the modernization of core infrastructure. The recently enacted One Big Beautiful Bill Act (OBBBA) further amplifies this, allocating substantial funding and strategic investments to the defense sector, including specific outlays for Artificial Intelligence (AI) and extended timelines for defense industrial base investments. This increased funding, coupled with improved tax treatment for research and development, is poised to boost targeted defense investments and scale commercial technologies for military use, directly aligning with Telos's core competencies and strategic growth opportunities.

Technological Moats and a Focused Evolution

Telos's competitive advantage is deeply embedded in its differentiated technology and specialized solutions. The Xacta platform, a cornerstone of its Security Solutions segment, offers enterprise cyber risk management and security compliance automation. Its recent achievement of FedRAMP High Authorization in July 2025 is a critical milestone, formally recognizing Xacta's adherence to the most stringent standards for protecting highly sensitive government data in cloud environments. This authorization reinforces Telos's role as a trusted partner in a rapidly evolving security landscape, providing a tangible benefit of unparalleled assurance for government agencies.

Another key offering, Telos ID, powers the rapidly expanding TSA PreCheck enrollment program. While precise enrollment figures per location are not disclosed, the program's expansion from 26 locations at the start of 2024 to 415 by June 2025, with a target of 500 by year-end, demonstrates significant operational scaling. The core benefit of TSA PreCheck, as highlighted by management, is the "speed through the line," a critical convenience for travelers that drives adoption. This program is not just a revenue generator but also a significant contributor to cash flow, benefiting from unique expense recognition that allows cash flow to outperform reported earnings.

The Telos Automated Message Handling System (AMHS) further showcases the company's technological prowess in mission-critical communications. A recent $14 million contract with the Defense Information Systems Agency (DISA) for AMHS product sustainment underscores its importance. As CEO John Wood stated, "Ensuring the prompt and secure delivery of messages is crucial for effective military operations," highlighting the system's vital role in secure command and control information exchange for military and intelligence agencies globally.

Recognizing the need to optimize its portfolio, Telos undertook a significant restructuring in Q3 2024. This involved discontinuing less profitable solutions, such as its advanced cyber-analytics and "ghost solution," due to insufficient sales uptake. This strategic pruning freed up resources and capital, creating new capacity for investment in higher-growth, higher-return programs within Security Solutions. This disciplined approach to R&D and resource allocation is crucial for maximizing operating leverage and incremental margins as the company scales.

The Turnaround Takes Hold: Financial Performance and Operational Momentum

Telos's strategic pivot has demonstrably inflected its financial performance. The second quarter of 2025 marked a significant acceleration in its return to growth and profitability. Total revenue surged 26% year-over-year to $35.968 million, exceeding guidance. This robust top-line expansion was primarily fueled by an 81.8% year-over-year revenue increase in the Security Solutions segment, reaching $32.474 million, driven by the successful ramp of the DMDC program and increased TSA PreCheck enrollment volume.

Profitability metrics also showed a strong rebound. GAAP gross profit grew 23% year-over-year to $11.932 million in Q2 2025. While the Security Solutions gross margin saw a slight contraction from 40.7% to 34.8% year-over-year due to revenue mix, this was within the company's historical range. Crucially, adjusted EBITDA returned to a profit of approximately $0.4 million, a substantial improvement from prior losses. The first half of 2025 showcased even stronger operating leverage, with an impressive 71% incremental adjusted EBITDA margin on year-over-year revenue growth. This efficiency was a direct result of revenue expansion combined with stringent operating expense discipline, including lower labor costs from the Q3 2024 restructuring and reduced cash incentive compensation.

The Secure Networks segment, however, continued to contract, with revenue decreasing 67.1% year-over-year to $3.494 million in Q2 2025, primarily due to the ramp-down of several programs. This segment's gross margin also declined from 23.0% to 18.1% year-over-year. Management has acknowledged the risk of goodwill impairment in Secure Networks if its performance remains at current levels, highlighting the ongoing challenge of replenishing backlog in this area despite gaining access to new contract vehicles.

Liquidity and cash flow generation have been particularly strong. Net cash provided by operating activities for the first half of 2025 increased by $21.4 million year-over-year to $13.056 million. Free cash flow for Q2 2025 was a robust $4.6 million, representing a 12.9% margin, and $8.4 million (12.6% margin) for the first half. This strong cash generation, driven by favorable working capital dynamics and the unique expense recognition for TSA PreCheck, has enabled Telos to resume share repurchases, deploying $4 million to buy back approximately 1.5 million shares at an average price of $2.69 per share in Q2 2025. The company maintains a strong balance sheet, with $57.0 million in cash and cash equivalents and $64.0 million in working capital as of June 30, 2025, and remains in compliance with its $30 million revolving credit facility.

Growth Catalysts and a Clear Forward Outlook

Telos's management is confident in its forward trajectory, forecasting an acceleration of year-over-year growth in revenue and adjusted EBITDA in the second half of 2025, with positive free cash flow for the full year. For Q3 2025, the company projects revenue between $44 million and $47 million, representing an impressive 85% to 98% year-over-year growth. Adjusted EBITDA is expected to be a profit of $4 million to $5.7 million, with cash gross margins improving sequentially to 40% to 41%.

This optimistic outlook is underpinned by several key programs. The DMDC contract, valued at up to $485 million over five years, is a major driver. While its blended margin profile is expected to be dilutive to overall company margins as lower-margin revenue streams ramp, it provides a stable base of approximately $25 million in recurring base services revenue, with the remainder coming from third-party hardware and software integration. For 2025, DMDC and the DHS program (worth up to $40 million over five years, with its stop-work order lifted in January 2025) are collectively projected to recognize $50 million to $75 million in revenue. This revised estimate, down from an earlier $60 million-$85 million, reflects the "time phasing of revenue recognition" for software components, which are recognized over a period of performance rather than upfront, though cash flow benefits are largely realized at the time of order fulfillment.

The TSA PreCheck program continues its rapid expansion, targeting 500 enrollment locations by the end of 2025. This program is expected to ramp its enrollment revenue in line with the increasing number of locations. The total TSA PreCheck market is estimated at approximately $200 million on a net revenue basis in a typical year, with enrollment revenue comprising about 70%. While the overall renewal market is expected to contract due to the 5-year anniversary of COVID, new enrollments are offsetting this trend.

Telos also boasts a "strong pipeline with over 200 unique opportunities, representing an estimated contract value of over $4 billion." While the new administration's review of single awards has caused some delays, Telos is strategically prioritizing task orders on existing contract vehicles, such as the $13 billion Air Force infrastructure management contract, to maintain momentum. Management's compensation structure, tied to revenue growth and free cash flow positivity, further aligns their incentives with shareholder value creation.

Risks and the Path Ahead

Despite the compelling turnaround story, Telos faces pertinent risks that investors should monitor. A significant concentration of revenue (approximately 90%) from U.S. government contracts exposes the company to shifts in federal spending priorities, budgetary constraints, and reforms to the acquisition process. The new administration's actions, including potential tariffs on imported IT hardware, could also increase procurement costs and impact financial performance.

Competition remains fierce. While Telos excels in its niche government and compliance-driven markets, larger competitors like CrowdStrike and Palo Alto Networks offer broader, often more agile, cloud-native solutions with superior financial metrics such as higher gross and operating margins (e.g., CRWD's 75% gross margin vs. TLS's 32.44% TTM, or PANW's 75% gross margin). Telos's smaller scale could lead to higher operational costs compared to these rivals, and its dependence on government contracts creates customer concentration risk. The goodwill impairment risk in the Secure Networks segment, if its performance does not improve, also warrants attention.

However, Telos's strategic response to these challenges is clear: leverage its deep government relationships, double down on its technologically differentiated Security Solutions, and maintain rigorous cost and cash flow discipline. The company's ability to secure FedRAMP High Authorization for Xacta and expand the TSA PreCheck program demonstrates its capacity to execute on high-value, high-barrier-to-entry opportunities.

Conclusion

Telos Corporation is in the midst of a compelling resurgence, successfully executing a strategic pivot that is yielding tangible financial results. The company's deep-seated expertise and technologically advanced solutions in cybersecurity and identity management provide a robust foundation, particularly within the well-funded and recession-resistant U.S. federal government sector. The accelerating growth of its Security Solutions segment, driven by the DMDC and TSA PreCheck programs, coupled with a renewed focus on profitability and cash flow, paints a picture of a company regaining its stride.

While competitive pressures from larger industry players and the inherent volatility of government contracting persist, Telos's disciplined approach to capital allocation, including share repurchases, and its clear roadmap for leveraging its unique technological advantages position it for continued value creation. For discerning investors, Telos represents a compelling opportunity to participate in a specialized security provider that has successfully navigated past challenges and is now firmly on a path of renewed growth and financial health, underpinned by critical national security mandates and a commitment to operational excellence.