Telos Corporation (TLS): Powering Cybersecurity Solutions for the World's Most Security-Conscious Organizations

Business Overview Telos Corporation, founded in 1968 in Maryland, has a rich history spanning over five decades in the technology and security sector. Initially focusing on secure networking and communications solutions for government agencies and the military, Telos has evolved into a comprehensive provider of cybersecurity, cloud security, and enterprise security solutions.

One of Telos' early significant achievements was the development and deployment of its Automated Message Handling System (AMHS), which became a widely adopted organizational messaging solution for the U.S. Department of Defense and its partners. This success laid the foundation for the company's reputation as a trusted provider of secure communication systems.

As the digital landscape evolved, so did Telos' offerings. The company expanded its portfolio to include a range of cybersecurity solutions, with its Xacta platform becoming a widely adopted cyber risk management system used by various government agencies and commercial enterprises. Telos also developed solutions for identity and access management, secure mobility, and network management and defense, solidifying its position as a comprehensive security solutions provider.

Throughout its history, Telos has faced and overcome various challenges. In the early 2000s, increased competition from larger players in the cybersecurity space prompted the company to focus on developing more specialized, differentiated solutions. This strategic pivot allowed Telos to maintain its competitive edge and continue serving its core clientele effectively.

Telos' growth has been significantly influenced by its strong relationship with government agencies, particularly the U.S. Department of Defense. While this relationship has been a key revenue driver, it has also exposed the company to the complexities and uncertainties of the government procurement process, including program award protests and delays. Despite these challenges, Telos has maintained its position as a trusted provider of security solutions to both government and commercial customers, leveraging its track record of innovation and deep understanding of customer needs.

Today, Telos' solutions span three key areas: cybersecurity, cloud security, and enterprise security. The company's cybersecurity solutions help organizations manage IT risk and ensure information security. Its cloud security offerings enable customers to protect cloud-based assets and maintain continuous compliance with industry and government security standards. Telos' enterprise security solutions cover identity and access management, secure mobility, organizational messaging, and network management and defense.

Telos' client base includes commercial enterprises, regulated industries, and government customers around the world. The company has a strong presence in the U.S. federal government, serving agencies such as the Department of Defense, Department of Homeland Security, and various intelligence and law enforcement organizations.

Telos operates its business in two reportable and operating segments: Security Solutions and Secure Networks. The Security Solutions segment focuses on cybersecurity, cloud and identity solutions, and secure messaging through offerings such as Xacta, Telos AMHS, and Telos ID. The Secure Networks segment provides secure networking architectures and solutions to customers through secure mobility solutions, and network management and defense services.

Telos offers technologically advanced, software-based security solutions that empower and protect the world's most security-conscious organizations against rapidly evolving, sophisticated and pervasive threats. The company's portfolio of security products, services, and expertise empowers its customers with capabilities to reach new markets, serve their stakeholders more effectively, and successfully defend the nation or their enterprise.

Financial Performance For the fiscal year 2023, Telos reported revenue of $145.38 million, with a net loss of $34.42 million. The company generated operating cash flow of $1.59 million and free cash flow of -$13.89 million.

For the nine months ended September 30, 2024, Telos reported revenue of $81.90 million, a decline from $104.32 million in the same period of the prior year. The company's net loss for the nine-month period was $43.19 million, compared to a net loss of $27.44 million in the prior-year period.

In the most recent quarter (Q3 2024), Telos reported revenue of $23.78 million, down 34.2% year-over-year. The net loss for the quarter was $28.05 million, with operating cash flow of -$7.08 million and free cash flow of -$0.81 million. The revenue decline was primarily due to the successful completion and ramp down of programs in the Secure Networks segment without corresponding new business wins to backfill the completed programs.

Telos' gross margin for the nine months ended September 30, 2024, was 29.1%, down from 37.2% in the same period of the previous year. The decline in gross margin was primarily due to a $11.70 million non-cash impairment charge related to the company's intangible assets, including $5.30 million recorded in cost of sales.

In the third quarter of 2024, the Security Solutions segment revenue decreased by 7.4% compared to the same quarter in 2023, primarily due to the reduction in revenue from a long-term program and the completion of a short-term program in the prior year, partially offset by the growth in TSA PreCheck. The segment gross profit for the third quarter of 2024 declined by 75.3%, and the segment gross margin decreased from 47.3% in 2023 to 12.6% in 2024.

The Secure Networks segment revenue decreased by 66.7% in the third quarter of 2024 compared to the same period in 2023, primarily due to the successful completion and ramp down of programs, without corresponding new business wins to backfill completed programs. The segment gross profit decreased by 77.2%, and gross margin declined from 22.3% in 2023 to 15.3% in 2024.

Liquidity The company's cash and cash equivalents stood at $69.76 million as of September 30, 2024, compared to $99.26 million as of December 31, 2023. Telos reported a net cash outflow from operating activities of $15.42 million for the nine-month period, compared to a net cash inflow of $3.37 million in the prior-year period.

Telos' debt-to-equity ratio is 0.066, and its current ratio and quick ratio are 3.64 and 3.59, respectively. The company has a $30 million senior secured revolving credit facility with an uncommitted expansion feature of up to $30 million of additional revolver capacity. As of the latest reporting, Telos has not drawn any amount under this credit facility.

Ongoing Challenges and Initiatives Telos has faced several challenges in recent quarters, including the impact of program award protests and the discontinuation of certain solutions that were not generating acceptable returns.

In the third quarter of 2024, the company resolved a protest on a program award worth up to $485 million over five years with the U.S. Department of Defense's Defense Manpower Data Center (DMDC). This program is now generating revenue for Telos as it ramps up operations. However, a separate program award worth up to $40 million over five years with the Department of Homeland Security (DHS) remains under protest.

To address the underperforming aspects of its business, Telos discontinued the development and sale of its advanced cyber-analytics and Ghost solutions in the third quarter of 2024. This restructuring, along with the impairment of related intangible assets, resulted in a $13.1 million charge, which impacted the company's GAAP gross margin.

Despite these challenges, Telos remains focused on optimizing its cost structure and reallocating resources to support its larger, higher-return programs, such as the DMDC contract and the growing TSA PreCheck enrollment business. The company is also actively pursuing new business opportunities, particularly in its Secure Networks segment, where it has access to several new contract vehicles and a sizable pipeline of potential awards.

Outlook and Growth Opportunities For the fourth quarter of 2024, Telos expects revenue to grow 3% to 11% sequentially to a range of $24.5 million to $26.5 million, driven by the accelerating ramp-up of its TSA PreCheck enrollment program and the DMDC contract. The company forecasts an adjusted EBITDA loss of $4.5 million to $3.5 million for the quarter.

Telos expects sequential revenue growth to be driven by their Security Solutions segment, which they forecast to grow low teens to low 20% sequentially. The Secure Networks segment is expected to decline sequentially in Q4 2024 due to declining backlog. The company anticipates GAAP gross margin to expand 170 to 230 basis points year-over-year, and cash gross margin to expand 465 to 580 basis points year-over-year, due to a favorable mix shift from lower-margin Secure Networks to higher-margin Security Solutions.

Looking ahead to 2025, Telos sees several drivers for potential revenue growth. The company expects its existing business, excluding the TSA PreCheck and DMDC/DHS programs, to generate approximately $60 million to $65 million in revenue. Assuming the DHS protest is resolved in Telos' favor, the DMDC and DHS programs could contribute $60 million to $85 million in revenue in a typical year at full run rate, with the potential to generate over $100 million in some years.

Additionally, Telos is targeting a pro-rata market share of the TSA PreCheck market, which it believes is a $200 million opportunity, as it completes the rollout of 500 enrollment locations by the end of 2025. The company also has a large pipeline of new business opportunities, particularly in its Secure Networks segment, that it plans to pursue during the fourth quarter of 2024 and the first quarter of 2025.

The cybersecurity market is expected to grow at a CAGR of 15.6% from 2023 to 2030, driven by the increasing adoption of cloud computing, the proliferation of IoT devices, and the rising frequency of cyber-attacks. This industry trend bodes well for Telos' future growth prospects.

Conclusion Telos Corporation is a veteran in the cybersecurity industry, leveraging its decades of experience to provide mission-critical solutions to its diverse client base. While the company has faced some challenges in recent quarters, it remains focused on optimizing its operations, capitalizing on its larger program awards, and pursuing new growth opportunities. With a strong market position, a comprehensive suite of security offerings, and a promising outlook for 2025, Telos is well-positioned to continue empowering the world's most security-conscious organizations.