Telos Q1 2024 Earnings Call Transcript

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May 10, 2024

There are 9 speakers on the call.

Operator

Please be advised, today's conference is being recorded.

Operator

I would now like to hand the conference over to your speaker today, Allison Phillip. Please go ahead.

Speaker 1

Good morning. Thank you for joining us to discuss TELUS Corporation's Q1 2024 Financial Results. With me today is John Wood, Chairman and CEO of Telos and Mark Benza, Executive Vice President and CFO of Telos. Let me quickly review the format of today's presentation. Mark will begin with remarks on our Q1 2024 results.

Speaker 1

Next, John will discuss business highlights from the Q1. Mark will follow this up with 2nd quarter guidance and insights on the financial outlook for the company before turning back to John to wrap up. We will then open the line for Q and A for 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 TELUS Investor Relations website, where this call is being simultaneously webcast. Additionally, we have provided presentation slides on our Investor Relations website.

Speaker 1

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, 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 TELUS' financial performance.

Speaker 1

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, our earnings press release 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 for the next year on our company website under the Investor Relations link. With that, I'll turn the call over to Mark.

Speaker 2

Thank you, Alison, and good morning, everyone. Let's begin today on Slide 3. I am pleased to report that TELUS has again over delivered on key financial metrics in the Q1, exceeding both revenue and profit guidance. Overall, it was a straightforward quarter with better than guided performance across key financial metrics, leading to a meaningful beat on profit and cash flow. Let's get into some of the details.

Speaker 2

We delivered $29,600,000 of revenue in the Q1 or approximately $600,000 above our guidance range of $28,000,000 to $29,000,000 Security Solutions delivered $18,600,000 of revenue, which was above the top end of our guidance range due to modest outperformance across all lines of business. Secure Networks delivered approximately $11,000,000 of revenue, in line with the top end of our guidance range. GAAP gross margin was 37%, above our guidance due to cost management on fixed price contracts and security solutions, better than expected utilization of direct labor and secure networks and a slightly better overall weighting of revenues to our higher margin Security Solutions business. Security Solutions generated approximately 63% of total company revenues in the Q1 of 2024 versus 56% in the Q1 of 2023, a favorable variance that is expected to widen as the year progresses. Cash gross margin was a notable 42.2 percent, expanding 249 basis points year over year and representing our 2nd highest quarter since our IPO in 2020.

Speaker 2

Revenues and gross margins both above forecast resulted in gross profit above what was incorporated into our adjusted EBITDA guidance range. In addition, R and D and SG and A expenses were better than forecasted due to timing of spending and higher than forecasted capitalization of software development costs. As a result, adjusted EBITDA also exceeded the top end of our guidance range. Adjusted EBITDA was a $2,300,000 loss compared to our guidance range of a $5,500,000 loss to a $5,000,000 loss. Lastly, cash flow from operations was a $350,000 outflow and free cash flow was a $3,600,000 outflow.

Speaker 2

Free cash flow improved from a $4,100,000 outflow in the Q1 of 2023. So overall, it was a clean quarter with solid execution throughout the portfolio. I will now turn it over to John for an overview of business highlights. John?

Speaker 3

Thanks, Mark, and good morning, everyone. Let's turn to Slide 4. As communicated on our last earnings call in March, TELUS has team agreements in place with prime partners who in the Q1 received awards from the federal government worth up to $525,000,000 to TELUS' security solutions business over 5 years. It's not uncommon for award decisions of this magnitude to be protested by incumbents or other bidders as part of a customary post award protest period provided by the government and that's the case here. These awards have been protested and finalization of the awards is subject to resolution of the protests.

Speaker 3

Given the typical protest timetable, resolution is expected in the Q2 and assuming a favorable outcome, revenues are expected to ramp throughout the balance of the year. We look forward to the conclusion of these protests as these awards represent pre existing programs requiring a timely and smooth transition to ensure uninterrupted service to the federal government. Beyond these awards, it's important to highlight since 2023, we have won positions on 5 new federal contract vehicles, including most recently a vehicle through which the United States Marine Corps will procure modernized capabilities for telecommunication and network infrastructure at all required Marine Corps bases, hosts, camps and stations globally. In the aggregate, these 5 new contract vehicles provide Telos with market access to compete for new business opportunities that represent a $12,000,000,000 addressable market. We will continue to pursue additional contract vehicles that will further increase our access to new federal markets over time.

Speaker 3

In addition, I'm pleased to report on several other key outcomes since our last earnings call. Our Exacta business has received new orders with the U. S. Air Force Services Center as well as a major technology company and a federal government customer. Additionally, the Exacta business has achieved renewals with several key customers, including the U.

Speaker 3

S. 16th Air Force, the U. S. National Geospatial Intelligence Agency, the U. S.

Speaker 3

Defense Intelligence Agency, the U. S. Department of Energy, a professional services company and a leading cloud computing company. The company has received services renewals with the U. S.

Speaker 3

Department of Homeland Security, the U. S. Office of Naval Intelligence and a federal executive department. Our automated message handling system business achieved a major contract renewal with a branch of the U. S.

Speaker 3

Armed Forces. And finally, within our TELUS ID business, transaction volumes in our TSA PreCheck program have sequentially ramped every quarter for the last 4 quarters, including the Q1 of 2024. We continue to work closely with TSA to ensure our pre existing enrollment locations are operating at the absolute highest possible standards necessary for a national security program of this magnitude before accelerating our rollout of additional on-site enrollment centers around the country. We opened 2 additional enrollment locations in April with more expected in the coming quarters. I will now turn the call over to Mark, who will discuss Q2 guidance.

Speaker 3

Mark?

Speaker 2

Thanks, John. Let's turn to Slide 5. For the Q2, we expect revenue in a range of $25,000,000 to $28,000,000 and an adjusted EBITDA loss of $8,000,000 to $6,000,000 We forecast Security Solutions revenue to be down high single digits to up mid single digits percent year over year, primarily driven by a non recurring perpetual license sale in the Q2 of 2023, offset by growth in TSA PreCheck in 2024. We forecast Secure Networks revenue to decline low 40% to mid-thirty percent year over year due to the ongoing reductions in backlog that we expect to persist sequentially throughout the year. Our 2nd quarter guidance combined with our 1st quarter reported revenue implies first half revenue of $54,600,000 to $57,600,000 and compares favorably with the approximately $55,000,000 of first half revenue that we outlined in the 2024 modeling inputs provided in the appendix of our Q4 earnings presentation.

Speaker 2

Overall, we expect total company revenue to return to sequential growth in the 3rd or 4th quarter subject to favorable resolution of protests. GAAP gross margin is expected to be down approximately 7.50 basis points to 4.25 basis points year over year, primarily due to higher amortization of capitalized software development costs and security solutions and a non recurring perpetual license sale in the comparable period last year, partially offset by a more favorable revenue contribution from our higher margin Security Solutions business in 2024. Cash gross margin is expected to be down 2 50 basis points to flat year over year. Cash below the line expenses, which adjust for capitalized software development costs, stock based compensation, restructuring costs and D and A are forecast to be approximately $1,900,000 to $2,100,000 higher year over year, primarily due to investment in growth initiatives. Lastly, our full year outlook is substantially unchanged.

Speaker 2

We've made only minor adjustments to the full year modeling inputs provided in the appendix. And with that, I'll turn it back to John.

Speaker 3

Thanks, Mark. Let's turn to Slide 6. In summary, we once again exceeded expectations and delivered results above the high end of the guidance range on key financial metrics in the Q1. We've made substantial progress on new business capture during the Q1 and we expect security solutions and total company revenues to return to sequential growth in the 3rd or 4th quarter subject to favorable resolution of protests. And with that, we're happy to take questions.

Speaker 2

Operator, please open the line for Q and A and we ask the call participants to please be mindful of others in the queue by asking only one question. Thank you.

Operator

Thank you. Our first question comes from Zach Cummins with B. Riley Securities. Your line is

Speaker 4

open. Hi, good morning, John and Mark. Thanks for taking my questions and congrats on solid performance here in Q1. I guess I'll try to make it multipart question. One for John, could you speak to just the protesting process?

Speaker 4

I appreciate the timeline. And just curious if they give you any sort of indications or updates along the way, anything you can share incrementally on the protesting process? And then part 2 is just on the TSA PreCheck program, nice to hear that you've ramped volumes every quarter since its launch. But just curious if we could get more insight into how you're thinking about the rollout timeline for new locations and now that all three vendors are live on the program, if there's been any notable changes in transaction volumes?

Speaker 3

Sure. Thank you for the question, Zach. The protest process is typically 100 days. We would expect the outcome an outcome this quarter on both of the new awards that we announced last quarter. And we're not we don't really have day to day insight into the protest process.

Speaker 3

That's really not our we're not a part of that process. But as we've reported earlier, a very small percentage of these programs are resolved against the winner, if you will. So, we're confident that we're going to be able to move forward with these programs. Now as far as TSA PreCheck goes, I'm just pleased I'm very pleased to say that we will be accelerating the ramp of our Office Depot locations and we expect to accelerate that rollout into Q2 getting to 500 stores within 2025. Yes.

Speaker 2

Zach, I think what I'd add to that with respect to transaction volumes as we've said, they've ramped nicely over the last few quarters. In terms of having all the participants come into the market in terms of the 3 participants, that was already factored into the prior guidance and modeling inputs that we've provided. Does that answer your question Zach?

Speaker 4

Yes, it does. I appreciate answering my questions and best of luck with the rest of the quarter.

Speaker 3

Thank you. Okay. Thanks, Zach.

Operator

Zach. One moment for our next question. Our next question comes from Rudy Kissinger with D. A. Davidson.

Operator

Your line is open.

Speaker 5

Hey, thanks for taking my question. I guess, I'm kind of curious, this $100,000,000 of revenue from existing contracts this year, how much from those existing contracts is going to fall in 2025? So if it's $100,000,000 this year, how much is that going to decline to in 2025? Thank you.

Speaker 2

Yes. So, Rudy, what we've said in the past, and I think it applies here as well, in a typical year, we expect a few tens of 1,000,000 of headwind from prior year revenues. So if you think about the $100,000,000 that's recurring in 2024, I'd say in 2025, that's approximately that $100,000,000 becomes approximately $70,000,000 And then you're adding on from there the additional revenue from these programs that would come on board subject to resolution of the protest. We've given you an indication of what that could be in a typical year. And then we have additional revenue from TSA PreCheck as we make continue to make progress in rolling out our office depot locations.

Speaker 2

And then of course, any other additional new business wins that we realize late this year, early next year. That's the typical seasonality pattern of new business wins. Does that answer your question, Rudi?

Speaker 5

It does. Thank you.

Speaker 3

Okay.

Operator

One moment for our next question. Our next question comes from Bradley Clark with BMO Capital Markets. Your line is open.

Speaker 5

Hi. Thank you for taking my question. On the TSA side, one of the strategies is obviously opening the number of locations. Is there anything else that Telus is doing to sort of differentiate its TSA offering now that sort of the competitive landscape is set? Is there anything from pricing or marketing that could actually fall into the expense line that we should be considering aside from new locations?

Speaker 6

Brad, this is Mark Griffin. I'll answer first. First, I wanted to say how pleased we are with our strategic relationship with Office Depot for the TSA PreCheck program. This direct to consumer opportunity is of great value to TSA and the program. So as we roll out, obviously, from a marketing and an expansion point of view, that's a key partner that will be very critical for us as we do that.

Speaker 6

From an expense line, I'm going to turn it over to Mark. But right now, I'm not anticipating major expenses in that area other than our commitment to our strategic partner, Office Depot and the expansion in those areas.

Speaker 2

I agree with that. I have nothing

Speaker 7

to add to what Chris has already said.

Speaker 5

Thanks. Thank you.

Operator

One moment for our next question. Our next question comes from Alex Henderson with Needham. Your line is open.

Speaker 8

Thanks. I was struck by how many renewals you have announced here. And in that context, you've also maintained the full year numbers. So I assume that these renewals were as expected and not changing the overall trajectory. Is that a fair statement?

Speaker 2

Yes, I think that's a fair statement, Alex. Our track record on renewals is excellent. Our customers tend to be very sticky. And so we had another excellent quarter on renewals and that's what we expected coming into the year.

Speaker 8

And then as you look forward into the back half of the year and

Speaker 6

Alex, on the contract renewal market, the Security Solutions contract renewals renew quite heavily on a renewal percentage basis, Where we see less renewal volume is on the secured network side. So I expect that the majority of the business in security solutions will renew and grow based on the other contract vehicles John mentioned in his script. Those 5 contract vehicles will also come into the portfolio, both for secure networks and secure solutions. So I think you'll see a growth area there, not only on contract renewals, but also new contract vehicles coming into play, which will add to the portfolio.

Speaker 3

Yes. So I'll say it a little more simplistically. So security solutions business by and large is a recurring revenue stream. That's where you can sort of you see the renewals coming in, in a very consistent way, generally speaking. On the secure network side, those programs tend to have a beginning, a middle and an end.

Speaker 3

So that's where you see that few tens of millions that Mark always talks about on these calls. So think about security solutions as being recurring revenue, think about secured networks as being more episodic revenue.

Speaker 8

Yes. I guess what I'm trying to ask and maybe I'll just try it a different way, but it's the same question. Is there more or less than normal renewals in the headlights Or is it just the same level of typical renewals? We're trying to ascertain the potential change in the rate of renewals as opposed to what the closure rates look like.

Speaker 3

Yes. So it's about the same, Alex. And we would anticipate it to continue. There are 4 big points for us in the company. One is to continue our extreme focus on our current customers.

Speaker 3

The second is to very much accelerate the ramp of Office Depot locations so that's going to accelerate the ramp of revenue for TSA PreCheck. And the third is to execute against new business wins that we previously announced. And the 4th is to focus on continuing to deliver new business awards. So our pipeline continues to grow and it continues to be an opportunity for us to see top line.

Speaker 7

Okay. Thanks.

Operator

Thanks, Alex. One moment for our next question. Our next question comes from Nehal Chokshi with Northland Capital Markets. Your line is open.

Speaker 7

Thank you. The 5 new federal contract vehicles that you've won positions in that represent a $12,000,000,000 adjustable market. Can you talk about, A, what is the is that an annualized number or is that over X amount of years? And if it's over X amount of years, how many years is that? And then B, what would you expect the margin profile of this $12,000,000,000 addressable market that you've won the right to compete for

Speaker 3

now? Yes. So 2 of the awards are in the secure networks bucket, if you will. 2 of the awards are in what I'll call our enterprise bucket, which is the entire company. And then one is in security solutions.

Speaker 3

As far as the margin profile goes, the period performance on these can range anywhere from 5 to 10 years. And I'm going to turn to Mark on the margins, if you don't mind.

Speaker 6

Yes. The margin profiles would follow what we have as projected and modeled as far as security solutions and secured networks. So those margin profiles would basically follow that based on what John indicated as the breakout of that total overall market value.

Speaker 3

And keep in mind for the analysts on the call here, each of these awards, there are several other awardees in each case. So what ends up happening is and the reason we call it an addressable market is because on each of these awards, we have to compete at the task order level. So, we're competing against limited competition on the task order level on these on each of these awards versus the previous two awards we chatted about where it's a we're part of a team where it's a single award to 1 player, if you will, the team being 1 player. So that's why those other awards are much more predictable in terms of the way the revenue breakout is, whereas on these other World Wars, these are contract vehicles, which have ceilings, large ceilings. And in each case, we have to compete at the task order level.

Speaker 3

And task orders can be anywhere from like $2,000,000 to $100,000,000 just to be give a little more, if you will, nuance to it.

Speaker 7

Yes, that's definitely helpful. And then in past quarters, you've been talking about your bidding pipeline, size of the bidding pipeline, how that's been growing. Did you give an update? If not, can you do so?

Speaker 3

Sure. So outside of these awards that these vehicles that have been won, there's an additional roughly $3,200,000,000 worth of pipeline, and that's unfactored without renewals.

Speaker 7

Got it. Great. And that's up from what last quarter?

Speaker 3

Truth be told, Ed, I don't want our analysts to fall into the trap of trying to measure it quarter to quarter because it's going to change. It's going to some bids will come in, some bids will go out. We'll no bid certain things, we'll accelerate bids on other things. But in general though, we like to see a pipeline like this because we want to see it be at least 10x what our potential is.

Speaker 7

Got it. Great. Thank you.

Operator

Ladies and gentlemen, this does conclude the Q and A portion of today's conference. I'd like to turn the call back over to John Wood.

Speaker 3

Well, first of all, I just want to thank our shareholders for your ongoing support. And as we said here on the call, I'm very pleased with the progress we've made on our new business capture in the Q1. I'm looking forward to finally getting to sequential revenue growth in the 3rd or Q4 and obviously it's subject to the resolution of the protest we've talked about previously. These contracts will have the potential to significantly and very positively impact our performance along with us opening up Office Depot locations for TSA PreCheck. I think the other thing I want to remain focused on is our pipeline expansion.

Speaker 3

I mentioned several quarters ago that we're going to go back to the markets that we know best. And I think we're seeing the kind of results that we expect to have for a company that knows the U. S. Federal Government and adjacent markets around it. So I remain very excited about the outlook for the company and with robust and recession resistant end markets with well funded customers and a decades long track record of serving the world's most security conscious organizations, TELUS really does have a very strong foundation for the future.

Speaker 3

So I just want to say again on behalf of all of us here at TELUS, thank you.

Operator

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

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Key Takeaways

  • Telos exceeded Q1 guidance with $29.6 M revenue (+$0.6 M), 37% GAAP gross margin, 42.2% cash gross margin and a $2.3 M adjusted EBITDA loss outperforming the forecasted –$5.5 M to –$5 M range.
  • Security Solutions now represents 63% of revenues and Telos secured up to $525 M in contested federal awards (resolution expected in Q2) plus positions on five new federal contract vehicles offering a $12 B addressable market.
  • The company achieved key renewals and new orders across Exacta, Automated Message Handling Systems and TSA PreCheck, with PreCheck volumes ramping sequentially and an accelerated rollout to 500 Office Depot locations by 2025.
  • Q2 guidance calls for $25 M–$28 M revenue and an $8 M–$6 M adjusted EBITDA loss, driven by high single‐digit y/y Security Solutions growth and 30–40% Secure Networks declines, with sequential revenue growth expected in Q3/Q4 pending protest outcomes.
  • Telos’ bidding pipeline stands at ~$3.2 B beyond renewals, and the full‐year outlook remains essentially unchanged with only minor modeling adjustments.
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Earnings Conference Call
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