2023-08-15 10:33:43 ET
Summary
- Telos Corporation provides IT cybersecurity software and travel identity services for government agencies and commercial enterprises.
- The company's TSA PreCheck segment offers potential for higher-margin revenue growth opportunities.
- Telos is worth monitoring for future progress, although I remain Neutral [Hold] in the near term.
A Quick Take On Telos Corporation
Telos Corporation (TLS) provides IT cybersecurity software and travel identity services for government agencies and commercial enterprises.
I previously wrote about Telos with a Hold outlook.
The firm’s TSA PreCheck segment looks to provide higher-margin revenue growth opportunities as Telos Corporation progresses into 2024 and beyond.
Although I remain Neutral [Hold] on Telos for the near term, it is worth putting on a watchlist to follow the company's progress.
Telos Overview And Market
Ashburn, Virginia-based Telos was founded to develop cybersecurity and information systems for federal and state government entities as well as for large enterprises.
Management is headed by President and Chief Executive Officer John B. Wood, who has been with the firm since 1992 and previously worked on Wall Street for Dean Witter Reynolds and UBS Securities.
The company’s primary offerings include:
Security Solutions:
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Information Assurance / Xacta
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Secure Communications
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TSA PreCheck system.
Secure Networks:
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Secure Mobility
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Network Management and Defense.
According to a 2023 market research report by Grand View Research, the global market for cybersecurity products and services was an estimated $203 billion in 202 and is expected to reach $513 billion by 2030.
This represents a forecast CAGR of 12.3% from 2023 to 2030.
The main drivers for this expected growth are an increasing proliferation of online threats pursuing greater potential payoff in the form of stolen information.
Also, the continued transition of enterprises and agencies from legacy on-premises systems to the cloud presents new security challenges that must be addressed by the industry.
Additionally, the COVID-19 pandemic exposed firms to greater security threats, not least due to the greater dispersion of company personnel in 'work from home' environments.
Below is a chart indicating the historical and projected future North American cyber security market growth forecast through 2030 by component:
N. American Cybersecurity Market (Grand View Research)
Major competitive or other industry participants include:
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CLEAR
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Cutting Edge
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IDEMIA
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MetricStream
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Palantir Technologies
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RSA Archer
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ServiceNow
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Unisys
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Booz Allen Hamilton
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General Dynamics
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Lockheed Martin
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Northrop Grumman
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Science Applications International.
Telos’ Recent Financial Trends
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Total revenue by quarter has continued to decline; Operating income by quarter has remained substantially negative.
Total Revenue and Operating Income (Seeking Alpha)
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Gross profit margin by quarter has fluctuated within a narrow range; Selling, G&A expenses as a percentage of total revenue by quarter have risen markedly in recent quarters:
Gross Profit Margin and Selling, G&A % Of Revenue (Seeking Alpha)
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Earnings per share (Diluted) have varied well within negative territory, as the chart shows here:
Earnings Per Share (Seeking Alpha)
(All data in the above charts is GAAP.)
In the past 12 months, TLS’ stock price has fallen 73.82% vs. that of the iShares Expanded Tech-Software Sector ETF’s (IGV) rise of 10.21%, as the chart indicates below:
52-Week Stock Price Comparison (TradingView)
For the balance sheet , the firm ended the quarter with $103.4 million in cash and equivalents and no debt. It has a $30 million undrawn credit facility.
Over the trailing twelve months, free cash flow was $3.6 million, during which capital expenditures were $0.6 million. The company paid a hefty $48.9 million in stock-based compensation in the last four quarters.
Valuation And Other Metrics For Telos
Below is a table of relevant capitalization and valuation figures for the company:
Measure [TTM] | Amount |
Enterprise Value / Sales | 0.4 |
Enterprise Value / EBITDA | NM |
Price / Sales | 0.9 |
Revenue Growth Rate | -25.1% |
Net Income Margin | -23.1% |
EBITDA % | -23.1% |
Net Debt To Annual EBITDA | 2.5 |
Market Capitalization | $162,130,000 |
Enterprise Value | $71,100,000 |
Operating Cash Flow | $4,160,000 |
Earnings Per Share (Fully Diluted) | -$0.67 |
(Source - Seeking Alpha.)
The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.
TLS’ most recent unadjusted Rule of 40 calculation was negative (48.2%) as of Q2 2023’s results, so the firm has performed even worse than in Q4 2022, per the table below:
Rule of 40 Performance (Unadjusted) | Q4 2022 | Q2 2023 |
Revenue Growth % | -10.5% | -25.1% |
EBITDA % | -22.8% | -23.1% |
Total | -33.3% | -48.2% |
(Source - Seeking Alpha.)
Commentary On Telos
In its last earnings call ( Source - Seeking Alpha ), covering Q2 2023’s results , management highlighted quarterly revenue of $32.9 million, above the previous guidance range of $28 million to $32 million.
This beat was driven by the sale of a large perpetual software license but represented a 41% revenue drop year-over-year from $55.8 million in June 2022.
Gross margin was 37.6%, also above the previous guidance of 28% to 31.5%. This was due to higher software sales, lower indirect costs, and expense management. This figure rose 0.2% YoY.
Adjusted EBITDA was approximately breakeven, exceeding guidance of negative $8 million to negative $6 million, from higher gross profit and reduced expenses.
However, adjusted EBITDA usually excludes stock-based compensation, which was $7.7 million during the quarter.
Management raised full-year 2023 revenue guidance to a midpoint of $129.5 million vs prior $127.5 million.
If this raised revenue guidance is achieved, it would still represent a year-over-year revenue decline of 40.3% versus 2022’s increase of 16.18% over 2021.
This revenue decline is due to the completion of large programs in late 2022. Management is focused on new business development to rebuild the backlog.
The company is still in the early stages of ramping up its TSA PreCheck business with a website launched and seven enrollment sites opened to-date so far. Leadership expects only a modest revenue contribution in the second half of 2023.
Analysts questioned company leadership about its Secure Networks segment renewals and headwinds. Management said the firm typically has some roll-off of business but that it wasn’t atypical and is in the 'few tens of millions of dollars' annually, though that sum is significant.
For its PreCheck segment, management expects more revenue contribution to come from renewals since they can be done online and less from new enrollments since the firm has to set up additional enrollment sites.
Once the PreCheck system is fully ramped, the firm expects to see 50%+ gross margins and 30%+ adjusted EBITDA margins, which, if achieved, would be materially higher than its current gross margin mix of around 38%.
Regarding valuation, in the past twelve months, the firm's EV/Sales valuation multiple appears to have bottomed in recent quarters, as the chart from Seeking Alpha shows below:
EV/Sales Multiple History (Seeking Alpha)
A potential upside catalyst to the stock could include a continued ramp from higher margin PreCheck business, but this catalyst will be more incremental over time and into 2024.
Although I remain Neutral [Hold] on Telos Corporation for the near term, it is worth putting on a watchlist for following the company's progress.
For further details see:
Telos Raises Forward Guidance And Looks To PreCheck Revenue Ramp