Telos Corporation (TLS) Earnings

Management highlights

- Overall Q2 2026 Performance • Reported results exceeded the high end of prior guidance, with strong cash flow generation and accelerated share repurchases • Maintained consistent profitable growth and free cash flow generation, marking six consecutive quarters of free cash flow margin above 12% • Deployed $4.7 million to repurchase more than 1 million shares at an average price of $4.50 per share - Core Business Progress • TSA PreCheck program: First half 2026 market share is up significantly year-over-year, following 2025 investment in enrollment location expansion and 2026 focus on location productivity; 2 new post office pilot sites will launch in the near term, with plans for further expansion • Telos ID segment outperformance was driven by strong results from both the TSA PreCheck and Defense Manpower Data Center programs; disciplined management of fixed-price contract contingencies led to better-than-expected gross margins • New business pipeline has grown to over $500 million in total contract value of submitted proposals, up from just under $500 million in the prior quarter, with heavy concentration in the Security Solutions segment • Phasing out low-margin third-party software resale to improve overall company margin profile, aligned with the company's strategic focus on higher-margin business - Strategic Priorities • Focus on delivering profitable growth, consistent free cash flow generation, and long-term shareholder value creation through capital allocation including share repurchases • Maintain disciplined pursuit of new opportunities that align with the company's margin and strategic priorities

Guidance

- Third Quarter 2026 Guidance • Revenue is projected between $49.2 million and $50.6 million, down slightly year-over-year due to unusually high non-recurring startup revenue in Q3 2025; excluding this effect, revenue grows 6% year-over-year at the guidance midpoint • Cash gross margin is expected to be 37.5% to 38.5%, reflecting contingency reserves for fixed-price contracts and normal revenue mix fluctuations • Adjusted operating expenses are forecast to be ~$400,000 lower year-over-year • Adjusted EBITDA is projected between $6 million and $6.8 million, for an adjusted EBITDA margin of 12.2% to 13.4% - Full Year 2026 Guidance • Revenue outlook is updated to $187 million to $195 million, ~$2.5 million lower at the midpoint than prior guidance, due to the planned phase-out of low-margin third-party software starting in Q4 • Raised adjusted EBITDA guidance to $23.6 million to $28.6 million, up from the prior range of $20.6 million to $28 million • Raised adjusted EBITDA margin guidance to 12.6% to 14.7%, an improvement of 70 to 160 basis points versus the prior forecast • Raised full year cash gross margin guidance to 39% to 40%, up from 38.2% to 39.5% prior • Lowered adjusted operating expense forecast by ~$1.7 million, reflecting improved cost visibility and expense control - Long-Term Margin Outlook • Phasing out the $33 million annual run rate low-margin third-party software revenue is expected to improve total company cash gross margin by over 600 basis points on a full run rate basis • After completing expense recognition for prior TSA PreCheck investments in H2 2027, an additional 400 basis points of cash gross margin accretion is expected, resulting in a total 10 percentage point cash gross margin improvement in H2 2027 • All $500+ million in submitted proposals are expected to receive government award decisions in H2 2026, with contract awards driving 2027 profitability rather than 2026 results

Segment performance

Total company Q2 2026 revenue increased 33% year-over-year to $47.7 million, exceeding the prior guidance range of $44 million to $46 million. The revenue beat was driven by stronger-than-forecast performance from the Telos ID segment, where two large core programs (TSA PreCheck and the Defense Manpower Data Center contract) both outperformed guidance. GAAP gross margin was 35% and cash gross margin was 40.6%, both above expectations, reflecting disciplined execution on large Telos ID programs. Adjusted operating expenses declined more than $800,000 year-over-year to ~$16.8 million (500,000 above guidance due to higher TSA PreCheck marketing and incentive compensation). Adjusted EBITDA reached $6.9 million (above the guidance range of $5 million to $6 million), with an adjusted EBITDA margin of 14.4% up from 1.1% year-over-year. Operating cash flow was $8.8 million and free cash flow totaled $6.6 million, for a 13.9% free cash flow margin — the sixth consecutive quarter of free cash flow margin above 12%. The low-margin third-party software resale business (single-digit gross margin, $33 million annual run rate revenue) is part of the Security Solutions segment and will be phased out starting Q4 2026.

Risks & headwinds

- Timing of all new government contract awards is controlled fully by government customers, and may shift based on customer priorities, procurement schedules, and federal budget processes - Gross margins fluctuate quarter-to-quarter based on revenue mix, and fixed-price contracts carry inherent performance risk that requires contingency planning - TSA PreCheck has typical seasonality of lower demand in the second half of the year, which is reflected in guidance but may vary from expectations - The planned phase-out of low-margin third-party software will reduce total annual revenue by ~$33 million, requiring offsetting new high-margin revenue to maintain overall profit levels

Analyst Q&A

• Q: What is the progress of the TSA PreCheck USPS pilot, and what are expectations for government fiscal year-end (September) spending? /

  A: The TSA PreCheck program is performing very well, with first half market share up significantly year-over-year. Two additional USPS pilot sites will launch soon, and management is pleased with pilot progress and plans for further expansion. The total value of outstanding proposals is now over $500 million, up from just under $500 million last quarter, and award decisions for these opportunities are still expected by the end of September. A continuing budget resolution is expected to support additional awards in Q4 if decisions slip past September. (231 characters)

• Q: What segment does the low-margin third-party software revenue belong to, and how does Telos balance growth and profitability around this business? /

  A: This low-margin revenue is part of a larger overall program within Security Solutions that aligns well with Telos's strategic portfolio. It was included in the original bid requirements when Telos won the overall contract, but it is not a standalone business that aligns with Telos's target margin profile. Phasing it out starting Q4 2026 will deliver meaningful cash gross margin accretion, and only a small amount of new high-margin revenue is needed to offset the lost profit from this stream. (392 characters)

• Q: What drivers led to the upward full year 2026 profitability guidance revision? /

  A: The upward revision comes from three core factors: better operating expense visibility allowed management to lower full year OpEx assumptions by $1.7 million, first half 2026 cash gross margins outperformed guidance due to more favorable revenue mix and better-than-expected performance on fixed-price contract contingencies, and phasing out low-margin software in Q4 improves overall full year margin profile. Only a small midpoint revenue adjustment was made to reflect the loss of this low-margin revenue. (364 characters)

• Q: What explains Telos's consistently higher free cash flow margin compared to peer defense contractors, and what is the board's position on potential acquisition offers? /

  A: Telos's higher margins stem from multiple factors: a better core gross margin profile driven by years of IP investment, a shift to higher-risk, higher-return fixed-price contracts years ago, successful cost base right-sizing over the past 3-4 years, a capital-light business model with minimal PP&E, and improved working capital management aligned collections and supplier payments. Management is focused on organic shareholder value creation but will seriously consider any change-of-control opportunity that offers superior value for shareholders. (412 characters)