Prepared remarks
Good day, and thank you for standing by. Welcome to the Telos Corporation's second quarter 2026 Earnings Conference Call. At this time, after the speakers' presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press 1-1 on your telephone. You will then hear an automated message advising that your hand is raised. If you would like to remove yourself from the queue, please press 1-1 again. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker for today, Allison Phillipp, Director of Corporate Communications. Please go ahead.
Good morning. Thank you for joining us to discuss Telos Corporation's second quarter 2026 financial results. With me today is John Wood, Chairman and CEO of Telos; Mark Bendza, Executive Vice President and Chief Financial Officer of Telos; and Mark D. Griffin, Executive Vice President of Security Solutions. Let me quickly review the format of today's presentation. Mark Bendza will begin with remarks on our second quarter results and full year outlook. We will then open the line for Q&A. John Wood and Mark D. Griffin 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 2026 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, in the comments made during this conference call and in our SEC filings. We do not undertake any duty to update any forward-looking statement. 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 site under the Investor Relations link. With that, I will turn the call over to Mark Bendza.
Thank you, Allison, and good morning, everyone. We are pleased to report another strong quarter, highlighted by results that exceeded the high end of our guidance range, strong cash flow generation, accelerated share repurchases, and a meaningful increase in our full year profitability outlook. These results reflect the strength of our business and our continued ability to solve complex, mission-critical challenges for our customers. Telos helps the world's most security-conscious organizations solve those challenges by combining proven cybersecurity, digital identity, and secure networking solutions with deep mission expertise and a flexible approach to addressing unique customer requirements. Our solutions strengthen security, improve operational efficiency, accelerate compliance, and help customers adapt to an evolving threat landscape. Let's turn to slide 3. Total company revenue increased 33% year over year to $47.7 million, exceeding our guidance range of $44 million to $46 million, driven by stronger-than-forecast performance in Telos ID. GAAP gross margin was 35% and cash gross margin was 40.6%, both above our expectations, reflecting disciplined execution across large programs in Telos ID. As a reminder, given the diversity of our revenue streams, gross margins will fluctuate from quarter to quarter based on revenue mix. Adjusted operating expenses declined by more than $800 thousand year over year but were approximately $500 thousand above guidance assumptions, primarily reflecting higher TSA PreCheck marketing activity and incentive compensation accruals. Adjusted EBITDA exceeded the high end of our guidance range, reaching $6.9 million compared to guidance of $5 million to $6 million. Adjusted EBITDA margin expanded to 14.4%, up significantly from 1.1% in the prior year period. Let's turn to slide 4 to discuss cash flow. Over the past few years, we have transformed Telos into an increasingly cash-generative business. Strong revenue growth, lower operating expenses, and disciplined working capital management have significantly improved our free cash flow margins while reducing quarter-to-quarter cash flow volatility. Operating cash flow for the second quarter was $8.8 million and free cash flow totaled $6.6 million, representing a 13.9% free cash flow margin. This marks our sixth consecutive quarter with a free cash flow margin above 12%. During the quarter, we deployed $4.7 million to repurchase more than 1 million shares at an average price of $4.50 per share. Let's turn to slide 5 to discuss our third quarter guidance. For the third quarter, we forecast revenue in a range of $49.2 million to $50.6 million, down slightly year over year due to unusually high nonrecurring revenue associated with the startup of a new program in the comparable period last year. Excluding the year-over-year differential in nonrecurring revenue, third quarter revenue guidance implies 6% growth at the midpoint. We expect cash gross margin to be 37.5% to 38.5%, reflecting the anticipated effects of contingency reserves on fixed-price contracts and normal fluctuations in revenue mix. Adjusted operating expenses are expected to be approximately $400 thousand lower than the prior year. Adjusted EBITDA is expected to be between $6 million and $6.8 million, representing a 12.2% to 13.4% margin. Let's turn to slide 6 to discuss our updated full year outlook. Based on our strong first half execution, we are raising our full year profitability outlook. We are increasing our adjusted EBITDA guidance to a range of $23.6 million to $28.6 million, up from our previous guidance of $20.6 million to $28 million. We are also raising our adjusted EBITDA margin outlook to 12.6% to 14.7%, representing an improvement of approximately 70 to 160 basis points versus our prior forecast. In addition, we are raising our full year cash gross margin outlook to 39% to 40%, up from our previous forecast of 38.2% to 39.5%, while lowering our adjusted operating expense forecast by approximately $1.7 million. Our full year revenue outlook is now $187 million to $195 million. Starting in the fourth quarter, we expect the resale of low-margin third-party software to begin phasing out. While this revenue stream contributes meaningful revenue, it carries only a single-digit gross margin and is not consistent with the margin profile we are building across the company. As a result, our revenue outlook is approximately $2.5 million lower at the midpoint than our previous guidance. Beyond 2026, the full run-rate impact will be $33 million of revenue per year with only a modest impact on profit. Because this revenue stream carries a single-digit gross margin, eliminating it is expected to improve total company cash gross margin by over 600 basis points on a run-rate basis, all else being equal. In addition, we expect to realize 400 basis points of additional cash gross margin accretion in the second half of 2027 after we complete the expense recognition of certain prior period investments in our TSA PreCheck program. Accordingly, we expect the combination of these two items to improve our cash gross margins by approximately 10 percentage points during the second half of next year, all else being equal. Before I conclude, I would like to spend a few minutes discussing growth and new business opportunities. On our last earnings call, we mentioned that we had submitted proposals representing nearly $500 million in total contract value and expected the government to make award decisions during the second half of 2026. We continue to expect award decisions in the second half of the year. Consistent with prior quarters, the timing of contract awards is determined by our government customers and may vary based on their priorities and procurement schedules. These opportunities span both our security solutions and secure network segments, with a heavy concentration in security solutions. Beyond these submitted proposals, we continue to build a healthy pipeline while remaining disciplined in pursuing new opportunities that align with our strategic priorities. Let's turn to slide 7 to wrap up. The second quarter reflects the continued execution of our strategy. We are delivering profitable growth, generating consistent free cash flow, and allocating capital in ways that we believe create long-term shareholder value. Looking ahead, we are encouraged by the opportunities in our pipeline as award decisions are made over the coming quarters. Overall, we are pleased with our first half performance, confident in our updated full year outlook, and remain focused on executing our strategy to drive profitable growth, generate steady cash flow, and create long-term value for our shareholders. With that, operator, please open the line for questions.
Questions and answers
Thank you. Please press 1-1 on your telephone. You will hear that automatic message advising that your hand is raised. If you would like to remove yourself from the queue, press 1-1 again. We also ask that you wait for your name and company to be announced before proceeding with your question. One moment while we compile the Q&A roster. The first question will be coming from the line of Erik Suppiger of B. Riley. Please go ahead.
Yes. Thanks for taking the question. First off, on TSA PreCheck, any update on how your work with the post office is progressing? And then secondly, on the September quarter, can you just discuss the nature of fiscal year-end spending? What are your expectations in terms of the health of the fiscal year-end budgets?
Hey, Erik. Good morning. I will start. First, on TSA PreCheck, the program is going really well. We are very pleased with it. First off, market share is up significantly from the same period last year. We are expecting normal seasonality in the second half, generally speaking from what we have seen in the last couple of years. Second-half market tends to be lighter than the first half, so that is reflected in our guidance. But overall, very pleased with how that program is trending and how our market share is trending. I will turn it to Mark D. Griffin to comment on PreCheck.
Hello. Yes. You will see in the near future an additional couple of sites with the post office that we are rolling out as part of the pilot. We are pleased with the progress we are making, and we look forward to additional expansion there. The other question was government fiscal year-end spending, is that right, Erik?
Yep. That is right. Yep.
So why don't I start, and then Mark can supplement. As we mentioned, we have a solid portfolio of proposals outstanding. It is actually up a little bit from the last earnings call. At the last earnings call, we were a little under $500 million total contract value. I would say now we are a little over $500 million total contract value. Indications are still that awards on those opportunities should be decided sometime here in the second half. Of course, that timing is fully under the control of the customer, but we are still expecting award decisions sometime in the second half. Mark, Christina, if you want to add to that.
Yes. The award decision still looks solid for moving forward. We still have quite a few in the pipeline that are expected to be awarded between now and the end of the government fiscal year, which is the end of September. With the progress it looks like Congress is making on extension of a budget, we hope to roll into the October timeframe with no lapse in additional awards for the fourth quarter as well.
Okay. Very good. Thank you.
One moment for the next question. The next question is coming from the line of Matthew Calitri of Needham and Company. Please go ahead.
Hey, guys. This is Matthew Calitri over at Needham. Thank you for taking our questions. I was hoping you could provide a little bit more color on that single-digit gross margin third-party software revenue. So understood on the margin profile and great to see the profitability improvements you guys have been driving. But what exactly is that revenue? Like, is it on the security solutions or on the network side? And how are you thinking about balancing growth and profitability here?
Good morning, Matthew. So that revenue stream is part of a much larger program within Security Solutions. There are multiple revenue streams within that program that were part of the overall RFP when we bid for this program. Clearly, that is not a revenue stream that we would otherwise pursue as a standalone revenue stream; it does not align with the portfolio that we are developing and the margin profile and type of business we pursue. But because it was part of an overall program that aligns very well with our portfolio, that revenue stream came along with it when we won it. That revenue stream will start to phase out in the fourth quarter. As I said, single-digit margin on that revenue stream. We will see a very meaningful cash gross margin accretion as a result of phasing it out, and it will take relatively little additional revenue to fully offset the profit that we would lose with that low-margin stream. Does that answer your question, Matthew?
Yeah. Definitely. That makes a lot of sense. Thank you for that. And then you had called out Telos ID as driving the strength in the quarter. Anything further you can share there on whether it was broad-based strength or specific programs? I know there are confidentiality constraints, but any color to help us get an idea of momentum there?
In the quarter, the beat above the top end of the revenue guide was primarily in our TSA PreCheck program and our program with the Defense Manpower Data Center. Those are two large programs in the portfolio. Both performed well relative to guidance. On gross margins, gross margins outperformed as a result of our program managers doing a terrific job managing fixed-price contracts. Every quarter when we guide, we include some contingency on fixed-price programs. Our program managers continue to do a great job managing the risks we have added contingencies for in our guide, and so we have outperformed gross margins in part as a result of that for the last two quarters.
Thank you. One moment for the next question. The next question is coming from the line of Bradley Clark of B. & Capital Markets. Please go ahead.
Hi. Thanks for the question. I just want to ask about some of the awards that remain to be determined in the later part of the year. What are some considerations or general puts and takes in these awards and how they may impact the overall pipeline growth heading into next year, either on the positive or the negative side?
Thanks for the question, Brad. It is a really solid portfolio of opportunities, both in magnitude as well as how we are positioned on those opportunities. A lot of those opportunities are in a similar scope of work to the confidential IT security work that we have mentioned in the past. We have solid past performance history on that type of work for the federal government, so we feel well positioned. Given the timing of these opportunities, it is less of a P&L driver for this year and much more of an opportunity to drive P&L for next year.
One moment for the next question, please. The next question will be coming from the line of Rudy Kessinger of D.A. Davidson. Please go ahead.
Thanks for taking my questions, guys. On this third-party software revenue, this $33 million — was this part of the DMDC contract, or was this separate? And when did this revenue start? I guess, was it $33 million over the last several years, or how long has it been in the numbers?
Hey, Rudy. So yes, it is one of the revenue streams in that program, and it really kicked in in the second quarter of 2025.
So going forward, with that being out of DMDC, I am just trying to get a sense of revenue concentration between PreCheck and that DMDC contracted business. To your expectation for 2027 on DMDC, is it now more like around $20 million to $30 million a year of revenue versus the prior $50 million to $75 million range? I am just trying to get a sense of how large that contract will be with that third-party software revenue stripped out.
I would rather not get into too much detail deconstructing individual programs. What I can say is there is $33 million of that single-digit-margin software that will come out next year.
Got it. And then lastly, just on PreCheck: I know you called out Telos ID, not specifically PreCheck, but just curious how the PreCheck program has been ramping — how enrollments and renewal volumes that you guys are seeing in market share are tracking versus expectations?
The program's doing great. Market share, as I mentioned earlier, is up significantly in the first half of this year compared to the comparable period last year. Last year, we spent a lot of time and energy and management attention building out our network of enrollment locations. This year, we are spending much more time focused on productivity of those locations. As a function of both the ramp of the locations and the focus on productivity, we are seeing some significant step-ups in market share year over year.
Thank you. One moment for the next question. The next question is coming from the line of Nehal Chokshi of Northland Capital Markets. Please go ahead.
All right. Great. Congrats on a strong quarter. For the full year EBITDA raise, can you parse out the drivers of that? I can think of at least a couple here: ongoing OpEx control, potentially the phasing out of that third-party software, and perhaps any other drivers I have missed.
There are a couple of drivers. First, we have better visibility on OpEx, so we are lowering our OpEx assumption for the year. Cash gross margins are up due to outperformance in the first half, in particular due to more favorable mix and outperformance on fixed-price contracts relative to the contingencies we have in our guidance. Combined with taking out some of the lower-margin revenue in the fourth quarter, the combination of all those things allowed us to raise our cash gross margin guidance and make a modest tweak at the midpoint of the revenue range, primarily driven by the elimination of low-margin software in the fourth quarter.
Great. And just to be clear, the nonrecurring revenue from Q2 2025 has been normalized out and, if we take it out, the Q3 revenue guidance would be up 6% year over year at the midpoint. Is that nonrecurring revenue the same as the third-party software that is being phased out in the fourth quarter?
No. It is different. That was some short-term nonrecurring revenue associated with the startup of a new program. It is a different revenue stream.
Okay. And then you are guiding down EBITDA $500 thousand quarter-over-quarter for Q3 versus a $2 million midpoint increase in revenue. Presumably that is mix. If there is anything else going on, please let us know.
The main driver is we are guiding cash gross margin down in the third quarter. It is a function of a couple of things: one, the contingency we include in fixed-price contracts — we put that in our guide every quarter — and two, seasonal mix impact, in particular from TSA PreCheck. We have been noticing in recent years that the second quarter tends to be lighter than the first quarter, and we have embedded that in our guide. We will see if that seasonality holds this year; maybe it will outperform, but we wanted to reflect that in the guidance.
Great. And as you pointed out, your free cash flow margin has significantly improved over the past six quarters, consistently at or above 12%. From what I understand, I think that premium free cash flow margin relates to your defense contract mix. A couple of questions on that point: One, what are the fundamental drivers of the premium free cash flow margin? Is it simply expense control, or is this a reflection of something else, such as having migrated from cost-plus to fixed-price contracting over time?
There are a few drivers. First, our cash gross margin profile is much better than many companies in the space, which is in part a function of years of investment in IP for some of our businesses. Second, we shifted from a cost-plus model to a much more fixed-price model many years ago, so we take more risk than some other companies and are appropriately compensated for that risk. Third, we have done a lot of work on rightsizing our cost base over the last three to four years. Fourth, we are more of a capital-light business model, carrying less PP&E and CapEx. Lastly, over the last year and a half to two years, we have done significant work around working capital, getting our collections aligned within the quarter with our payments to suppliers and subcontractors. All of these factors contributed to driving free cash flow margins to where they are today, and we are very pleased with the results.
Given this now-proven premium free cash flow margin, one might think Telos becomes an attractive target for larger peers. What is Telos's receptivity to potential strategic transactions or a change of control?
That's a good question and one we have been getting more frequently. We are laser-focused on maximizing value for our shareholders. We have created a lot of value organically over the past couple of years — higher revenues, lower OpEx, excellent cash generation, consistent share repurchases — and we expect those trends to continue. If a change-of-control opportunity clearly represented a superior path to create value for our shareholders, we would seriously consider it.
Thank you. There are no more questions in the queue. We will now turn the call back over to management for closing remarks. Please go ahead.
Thank you, operator, and thanks to everyone for joining us today. We are pleased with our first half performance and believe our results reflect continued progress in building a more profitable, cash-generative, and scalable business. We look forward to updating you next quarter. In addition, we hope to speak with many of you at the D.A. Davidson conference tomorrow, the Vivo Technology and Innovation Leaders Conference on November 12, and the Needham Virtual Tech Week on November 18 through 20.
Thank you. This concludes today's program. Thank you so much for joining. You may now disconnect.