Parsons Corporation (PSN) Earnings Call Transcript & Summary

Good afternoon, and welcome back to Day 2 of Morgan Stanley's Virtual Laguna Industrial Conference Call. My name is Matt Sharpe, and I'm the firm's government services analyst. And with me this afternoon is the team from Parsons, including Chuck Harrington, Chairman and CEO; George Ball, CFO; and Dave Spille, Vice President of Investor Relations. Before we get started here this afternoon, I do have to read some disclosures. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley Research Disclosures website at www.morganstanley.com/researchdisclosures. [Operator Instructions] With that, good afternoon, gentlemen, and thanks so much for joining us.

Matt, thank you for the opportunity, and thank you to Morgan Stanley. Really appreciate the opportunity to participate today.

Absolutely. It's our pleasure to host. And I only wish we could be in sunny California. Hopefully, this time next year, that will be the case.

Yes. We look forward to that.

So maybe just kicking it off here at a high level, Parsons has had an interesting evolution over the course of the last 5 to 10 years. Maybe you can share a little bit about that evolution in the portfolio construct as it stands today. What's the ultimate mix of business as you look forward and contrast that with where you stand today? Just sort of laying the landscape for investors, so they truly appreciate how you're built and where you came from.

Sure. And I guess I'd look at it from a standpoint of an interesting evolution of a company over 75 years, is we've constantly.

Quite well taken.

We've bid in the electronics business. We've been in a lot of businesses. So in the last 5 to 10, George and I took over our current roles in 2008, and started the process of launching a whole new strategy that really can deal in probably 2010, '11 to -- we saw for what we thought were really disruptive technologies that were going to change the way the game was played in both critical infrastructure and our federal markets, and those being artificial intelligence, and that was mainly machine learning. We saw back then, obviously, now we've got deep learning and quantum computing investments taking place. And all the high-speed processing that goes with that, which was really then facilitating the move to autonomous vehicles, which we thought could really be a great game changer for transportation, mobility, modes and also for -- quite frankly, for the way we fight our warfare and putting fewer soldiers at risk. And then cloud computing, really driving the cost of large storage systems, and finally, IoT enabled by 5G. So when we looked at that, we said, "Wow, we've got a couple of opportunities." We -- those are either going to start like eroding our share and -- or we get on that wave and really move into it. So that launched us on a series of acquisitions dating back to SPARTA and Secure Mission Solutions, Polaris Alpha, OGSystems, QRC that really built up -- and we appended that with a lot of hiring and talent, really gave us the IT of software and hardware that was really fitting into our strategy of over the longer-term transformation, becoming a complete solutions provider that brings hardware-software technology solutions wrapped in services and potentially as a service solutions model, much like we see, as I say, Amazon and Microsoft are bringing data centers as a service, we see the same thing happening in intelligence, defense and in critical infrastructure services.

That evolution of the portfolio, I suppose, in part, has created some really interesting opportunities for the company in a very wide range of end markets or domains or you can slice the market as you will, various avenues. Maybe you guys could walk us through what the key drivers for growth are over the near and medium-term? And how that breaks down, say, across your various segments, Critical Infrastructure and Federal Solutions, right? I mean, there's some obvious notable ones, GBSD. There's some wind downs that that are temporary in nature at Critical Infrastructure. How should we think about the growth drivers here over the near and medium-term?

Well, we've got some of our market areas that are just growing exceedingly fast. Things like Cyber and Intelligence are growing greater than 20% annually. And a lot of that is just built on the technology that we have of the platforms we bring to both the offensive and the defensive side of cyber protection as well as our high-speed processing kit, PACKETWOLF that really changes the game of how you do packet analysis on -- for protecting large, large data sets and information flows. Space, obviously, that's on everybody's tip of the tongue, and that's a high-growth market as well. We put space with geospatial. They kind of go hand in glove from our perspective. And then we have our Missile Defense C5ISR and missile -- both of those -- all of those markets I just mentioned are national defense priority markets. And when you strip back -- peel back the onion and look at the underlying technologies, we consider hypersonics or counter hypersonics to be an autonomous system. AI, driving all that, cloud computing, IoT, including the 5G enabling, those are major drivers in both of our markets. And so the growth there near-term and longer-term is strong. We append our organic, and we've set our Federal Solutions unit as we're going through this transformation, probably growing in the upper to high single digits of -- and appended with M&A that will be a double-digit growth item. And in Critical Infrastructure, we've been managing more to a flatter scenario as we roll off some large contracts that had 0 to no margin pass-through costs on it, just driven by local accounting. So net-net, we think the total corporation will be growing high single digits, double digits, depending on the year. And at the same time, we're driving up margins. So that's not always something you have the luxury to do, but in our case, we do. Our bidding is all double-digit margins. Our M&A has all been double-digit companies. The increasing product portfolio is accretive to our margins. So it's just a lot of really positive things going on from both a margin and a growth perspective.

So sort of underpinning that strong market growth that you mentioned, I think you said cyber, for example, was that the 20% annual growth. How should we think about those markets in the current environment? We've got COVID-19. We have an election coming up. And we have a lot of stimulus that just went into the market via the Fed. Is the traditional sort of August-September high-water mark for bookings and demand from a lot of your government customers holding true? Have you seen any slowing or any signs that the pace will add up? Or is this a normal year in that regard? How are you guys thinking about that? And what are you seeing?

That's a great question, Matt. So what our customers are asking are questions like, do you have enough people to meet the ramp that we see coming. Now there were things because of COVID that just took like a year off. And we are told, anticipate restarting those programs after the first of the year. And those are things, the Marshall Islands, where we're doing upgrades there to support the Missile Defense Agency, the Marshallese didn't want outsiders coming in or Antarctica, the National Science Foundation, shutdown a lot of activities on the ice. So those will have a 1-year hiatus, but the impacts of COVID have continued to decline on a weekly basis. So the peak of that was all back around April, May, and then it's been on a steady decline ever since. And what our customers are indicating is, yes, they do have end of year funds. They do have -- of course, it varies across customer set. And heavy emphasis on technology, probably much more than what we've seen in the past.

Does -- so it's interesting. And to some extent, it's not surprising because a lot of what your customers do are mission-critical, and they get -- have to accomplish their mission one way or another. But it's just surprising to many that it held up, but fundamentally, it has to get done. So it makes sense. Now there's another dynamic at play that I think is getting talked about more and more. And that's -- okay. Well, COVID-19 is one thing, a change in political to control in Washington, D.C. and actually having dollars behind these programs is another. So my question to you is, what are your expectations in terms of the DoD budget and meaningful legislation? And how does the election actually play into your growth views? Will you be able to grow regardless of who's in the White House or who's in Congress? Is there any ramification from the sort of CARES Act 2.0 and Section 3610? Just there's a lot of policy moving pieces at the moment. So how are you guys thinking about that and the risk associated with that?

Yes. So I think from a budget perspective, the priorities, as we've talked to representatives of both parties in House and the Senate, they both understand the risk profile we live in today. We have ever-increasing cyber threat from -- and it's not -- you can't point your finger at any one threat actor. Its nation states that are now on par with our abilities. It is terrorist groups. Its criminal activities. So the threats to our nation's critical infrastructure and information are increasing, not decreasing from a cyber perspective. Augment that with the investments being made in China and Russia with hypersonics, with North Korea's launches of missiles, Iran is still a bit of hotspot, and you see that missile defense is an area that -- and an area that's been under-invested in for decades, is in line for a lot of investment, including GBSD, as you mentioned previously. And then space. Space has gone from a domain that the U.S. was almost the sole participant in space. And now it's becoming a very, very crowded neighborhood with China and Russia and India, not to mention all the private kit going up in orbit from SpaceX and everyone else who's launching. Facebook and Google looking for these massive networks of lower orbit satellites to support Internet and other communication needs. So what -- and this all, by the way, has been recently here just reinforced by candidate Biden, saying that it doesn't see a reduction in defense spend, which I think was something we expected. It was nice to see him come out and say that kind of reinforcing it. In fact, even said it could increase in some areas. My guess is it's going to increase in those high-technology areas. It's going to increase in more investment in AI, which everyone sees as critical. It's going to be increasing in autonomous systems, and IoT for sure. And cloud is just a cost saver. So you'd think that, that would get investment as well. So the other side of the equation is Critical Infrastructure. And we've always managed that business as we're a large infrastructure project type of company. So the small projects are the ones that take the heat first. The larger projects, which are bond funded or P3s or other types of funding mechanisms you really can't turn off, they tend to keep going. We saw that in 2008. 2008, '09 and '10 were record years for us in Infrastructure. So longer-term could be issues, but we're pretty agile, and we tend to move to where the work is.

Yes. That's interesting you mentioned that, and I think that's something that a lot of folks forget in terms of that side of your business and actually how it's funded and the stability of the actual funding underneath it, whether it's bond funded or otherwise sort of allows that portion of the business, to some extent, be sheltered from sort of the perturbations in the broader economy. So it's interesting. On one hand, you've got the resiliency from the Fed Solutions. And on the other hand, you have the similar dynamic, but for different reasons on the Critical Infrastructure side of your business. I want to shift gears here. I probably should have touched on this earlier. You did mention margins and expanding your margins overtime for various reasons, but I think you made it in the context of overall M&A. You've got an EBITDA target, as I recall, about 10% overtime, sort of an aspirational goal for the corporation. Maybe you can just talk about what levers you have at your disposal? And sort of when you see the company achieving those types of levels? Is it a near-term goal? Is it a much longer-term goal? Just help us sort of visualize how you get from point A to point B and how long?

Yes. So we believe we'll achieve it next year, towards the end of the year. We've already, at points, exceeded 10% in the quarter on the Federal Solutions side. As Federal Solution gets bigger, it even absorbs more of the overhead from Critical Infrastructure. So it kind of raises both boats, if you will, simultaneously. But the 3 big drivers are: one, running off the work to have large numbers of pass-through, low-margin pass-through dollars. The rest of the portfolio is near or above 10% already. So you move that out, that's a big plus. We're bidding work at double-digit margins. The areas we're investing in with M&A and IR&D and strategic hires are all operating at greater than those margins. And then all of the M&A we do is accretive to that. And then lastly, it's the building of the product portfolio. Our product portfolio is significantly higher than that. And as those dollars continue to grow, and they're growing fast, that just has an incremental impact on our -- an outsized incremental impact on our EBITDA margin.

Sure, sure. Sort of sticking with the P&L and sort of moving to cash here for a moment, 2020, 2021, there are certainly going to be some sort of moving pieces, if you will. How should we think about the company in terms of a generator of cash? What's the right conversion over the long-term? And what are sort of the moving pieces over the near-term that we should be considering, whether it's cash tax dynamic or working capital? Just sort of paint the picture that so we can understand what the puts and takes are over the next, call it, 12 to 18 months.

George, I'm taking too much air time. I'll let you run with this one.

Certainly. Thanks, Chuck. So as a long-term metric, a good benchmark is think of us converting 100% of adjusted net income on an ongoing basis. As we've said since the roadshow, we do have some upside potential, some tailwinds relative to some working capital associated with retention and milestone payments, in many cases, connected to the same projects that have significant pass-through revenue that Chuck referred to previously. . The other thing I mentioned is we're basically an asset-light company. I would envision CapEx this year running at about $50 million, maybe a little bit less. As the moving parts, we are a beneficiary much like probably all the companies you follow of the payroll tax deferral under the CARES Act. For this year, we'll have a benefit of about $30 million to $35 million. And that will be paid back as a decrement, about 50-50, between '21 and '22. But again, a good metric is converting 100% of adjusted net income, but maybe some tailwinds over the next year or 2.