Parsons Corporation (PSN) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome back to day 2 of Morgan Stanley's Virtual Laguna Conference. My name is Matt Sharpe. I'm the firm's government services analyst. And with me today is the team from Parsons, including CEO, Carey Smith; CFO, George Ball; and Vice President of Investor Relations, Dave Spille. Now before we begin, I do need to read some disclosures here. For important disclosures, please see the Morgan Stanley Research Disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. With that, Carey, George, Dave, welcome, and thank you so much for joining us this afternoon.

Thank you for having us, Matt.

Our pleasure. Our pleasure. Carey, I wanted to start out sort of high-level thinking about sales here for a moment in the company's trajectory. Much like many of your peers, the last few have been a little bit choppy or experienced some headwinds from COVID-19 and otherwise. Maybe you can just share with us, have you begun to see a rebound in the business in the end markets? And how should we think about growth potential into the back half of 2021 and the exit rate as we transition into 2022?

Sure. Thanks, Matt. We are starting to see a rebound, and we do anticipate seeing growth in the second half of 2021 over the first half of 2021 and then that growth continuing in 2022 and beyond. As far as COVID, we are still seeing a little bit of impact from 2 overseas program, but domestically, our programs have all returned to pre-COVID levels. So we're quite optimistic about that. One area of focus that we will still have going forward is going to continue to be on hiring, both recruiting and retention and particularly in our Federal Solutions segment. But we remain very optimistic about the trajectory. We're in 2 segments that fortunately are growing and they're sustainable. In the Federal Solutions segment, we're focused in the right areas on near-peer threats with solutions that range from cyber to electromagnetic spectrum to information warfare, basically the near-peer fight. And if you look at Critical Infrastructure, we're already seeing some momentum there even without a United States infrastructure bill. And the growth is not just in the United States but worldwide.

Fantastic. When you now think about that context, the demand in your end markets, the levers that you have to pull on, on the things that you have to execute on into the back half, what are maybe the 1 or 2 important things that must happen to hit the higher end of your revised guidance of $3.6 billion to $3.7 billion for fiscal 2021?

The biggest thing that needs to happen is to deliver on the $4 billion of awards that we've received in the last 3 quarters and to make sure that we get those ramped up and then make sure that we get those staffed. That's our #1 area of focus.

To that point, your award, your backlog is up, I think, 9% year-over-year through the second quarter. Your book-to-bill year-to-date is 1.5x. These figures should support some improved top line growth going forward. How should we think about these leading indicators when it comes to the medium term? And what else should we take into consideration to formulate a view of the growth potential here?

Yes. So first, as you noted, our backlog is up 9%. So we're currently at $8.4 billion, which is more than 2x our annual revenue. Our book-to-bill is very solid. We had a 1.3 trailing 12-month book-to-bill, and that was comprised of a 1.5 in Federal and a 1.1 in Critical Infrastructure. And then in the second quarter, we achieved our highest book-to-bill ever for Parsons Corporation at 1.9x, and Federal was at 2.8x with Critical Infrastructure at 1.1x. So to your point, we do have some momentum coming from the new business wins. I would also highlight some of the wins that we've achieved that are greater than $100 million. Since the second quarter and subsequent announcements, we've been awarded 5 contracts that are on or about over $100 million in contract value. Those include the C5ISR exercise operation information support contract valued at $618 million; the Air Base Air Defense contract valued at $953 million; the integrated space situation awareness contract valued at $185 million; satellite prototyping integration contract valued at $139 million; and a large contract in the Middle East for a new industrial city valued at $91 million. So we're quite positive on our recent wins in both of our segments.

Carey, those are definitely some significant wins for Parsons, and it sounds like great opportunities to ramp here over the coming quarters. How should we think about the variability or the rate at which those programs ramp? These aren't necessarily step functions, but what can you tell us about those contracts and where they are today? What inning they're in, in terms of ramping, so that we can think through the remainder of '21? And then getting back to my comments around the exit rate into 2022 because it does sound like there is a decent amount of runway here for you.

Yes. So these contracts are all single-award contracts. Some are task-order-driven while others are not. So for example, the Middle East contract, we're immediately staffing now to full staff, the same with the satellite prototype and integration contract. A couple of the other ones are GSA IDIQ single-award contracts. So those, we're working to drive task orders and drive staffing onboard the contracts. I think a great comparison would be the Combatant Command Mission Support contract that we were awarded in late 2019. We're currently up to a full run rate for that contract, and that was a GSA IDIQ vehicle.

So said another way, these aren't necessarily contracts that you now need to go in, compete for task orders. These are more execution in Parsons' control, the future, the ramp-up and the ultimate performance.

Yes. Again, so it's kind of a mix. So if you look at like the satellite prototype integration, that's when we can go execute. If you look at some of the GSA awards, like the Air Base Air Defense, the C5ISR, we're currently working with the customers to get the task orders onboard to the contracts and get that ramped up at the state base.

Got it, got it. Now maybe just stepping back here a minute and thinking about the bigger picture, the multiyear. Back in March, you guys helped to provide some transparency and provided some targets with respect to where you guys are headed over the course of a few years. Based on how the business has progressed since then in some of these contract awards that you now have in backlog that need to go -- be executed or not, what do you need to do to get to those targets? I think it was $4.5 billion to $4.8 billion in revenue and a margin of mid-9% or so. Do you have line of sight on that? Do you need to go win new work? Do you need to do things internally or externally or otherwise to get to that point?

Well, first, we have a lot of confidence in the business. And again, based on the momentum that we have, we anticipate seeing growth in 2022 and beyond. We're currently in the process of going through our annual operating plan, where we put together a 3-year outlook. And so that will entail both puts and takes. For example, as we mentioned on the second quarter earnings call, we're no longer going to consolidate sales on the Edmonton program. So that would be one that we would pull out of the plan. But on the other hand, we did not plan on a U.S. infrastructure bill. So that will be one that we will be putting into the plan. Likewise, we'll take all the new business wins that we've had in Federal. Those will be added to the plan. And once we have all those puts and takes, Matt, our intent is that we would come back in February and provide a new guidance.

Sure. Fair enough, fair enough. Maybe shifting gears here a moment but certainly related to all of that. The last year, 1.5 years has seen some tremendous change in both Washington as well as the prevailing environment that you're operating in, whether it's who's in the White House or the pandemic or really even the threat environment, quite frankly. So with that, my question is really around your end markets and how they've held up, how they've changed, how demand signals have changed. What can you tell us about both the infrastructure side of the business as well as the Federal Solutions side of the business in terms of end market and market health?

Well, first, to your point, it certainly has been a time of change. We always like to say change equals opportunity. And for us, that's the way we approach it. Our -- both of our market segments have held up. They've been very resilient. And I think what's good is on the Federal side, we've had real clarity from the administration on where they're headed from the interim national security strategy and other information that they've provided. And it's clear that the near-peer threat focus is going to remain in, in particular, China. Likewise, you can look at space now as a war-fighting domain. And then some of the Critical Infrastructure attacks that have recently occurred, such as SolarWinds, there's going to be increased spend on Critical Infrastructure protection. We're very fortunate at Parsons that we have both the Critical Infrastructure domain knowledge but we also have the cybersecurity and physical security resiliency capabilities to be able to protect in those domains. So we feel that we're quite well postured, quite well aligned with the administration on our Federal front. And I can also go into areas like artificial intelligence, hypersonics and directed energy where we also play. So if I shift to Critical Infrastructure, I mentioned earlier we're starting to see momentum even without a critical infrastructure bill. Since 2010, 36 states have passed a gas tax. So what this means, if you just take California alone, they've put in place $54 billion of funding over the next 10 years for infrastructure. And that's without a U.S. infrastructure bill. So if the U.S. infrastructure bill happens, we're looking at $550 billion over the next 5 years of new money. And this is at a time where you have about half the number of providers as you had at the time of the last infrastructure bill due to industry consolidation. At the last infrastructure bill, it was only $244 billion over 4 years. So this is substantially greater with a far reduced industrial base, and we're looking forward to capitalizing on that. If I look around the world also, we're seeing a similar trend. The infrastructure needs not just in the U.S. but it's global, where there's aging infrastructure. In Canada, for example, each of the provinces are putting forward infrastructure plans. Quebec, in March, put forward $8.5 billion of infrastructure funding and then in May added to that with an additional $2.5 billion of infrastructure funding. We're seeing similar in the Middle East. With the rebound of oil prices, there's additional spend there, particularly in Saudi Arabia, where we're involved in, for example, the Riyadh Metro, which is the largest metro system project in the world. But we're seeing a lot of new industrial city buildup as well as transportation modernization. So we're quite excited about the future over the next 12 to 18 months.

With respect to the U.S. government and their ability to have timely defense appropriations, as you sit here today and you think about October 1, it's approaching fast. Will that -- could that impact the business if we end up in a CR? And what is your view in terms of actually getting something across the goal line in a reasonable amount of time even if it isn't October 1?

Yes. So there's a lot, to your point, that has to happen between now and October 1, the surface transportation equity authorization on the Critical Infrastructure side and get a budget passed on the Federal side of the house. We fully anticipate that we will have another continuing resolution, and that the continuing resolution will run at least a quarter or 2. We've operated in this mode, obviously, for decades before. It has not had any material impact on the Parsons business. So we don't expect it, too, this time as well. We are fortunate that we've received all these new recent awards because we have a lot of ceiling value that is sitting there in already awarded contracts. So we're not in a position where we're without new funding. We just need to drive the work to our existing vehicles that we've already won.

Great, great. Let's maybe pivot here from revenue and end markets to profitability of the business. If I take a look at margins and I start to exclude some of the onetime charges, levels have been fairly healthy. And it looks like the back half of the year is implying 9% or so on an EBITDA basis. Is this rate sustainable as an exit rate? And when I think about that 2023 target, you're nearly already there. So structurally speaking, is there anything you need to do to the business to continue to expand and hit those targets that you put out there?

No. Structurally, there's nothing we need to do to the business. And to your point, in the second quarter, without the reserve, particularly in Critical Infrastructure, we were already at a 10% EBITDA margin. This continues to be a very high priority for the business, and we're focused on the drivers that we've been leveraging in the past. One of those has been acquisitions. The companies that we've acquired, we've set pretty high financial criteria. They have to be growing at greater than 10% top line but also have to have greater than 10% margins. We're focused on bidding programs that have greater than 10% margins in both the segments. We also continue to have product sales, which come with higher margins. Those are both software and hardware product sales. And then we've talked in the past about some of the programs in Critical Infrastructure that had pass-through revenue, for example positive train control programs. So as those run off, our margins in Critical Infrastructure will continue to expand. I mentioned the fewer competitors in Critical Infrastructure for the infrastructure bill, and I'd like to come back to that because during the last infrastructure bill, we did see significant margin expansion. Now you're looking about half the number of competitors in this infrastructure bill. So we feel that, that provides a great opportunity for margin expansion as well.

Fantastic. You mentioned one thing that I want to circle around with -- related to margins but really a separate subject, and that's M&A. You guys are coming off the heels of some interesting deals, BlackHorse, Echo Ridge, Braxton, et cetera. I was hoping maybe you could just talk a little bit about each of these, why you did them and how they performed since acquiring.

Certainly. So we're -- we've been really pleased with our acquisition strategy over the last 4 years and have an opportunity to acquire 7 companies. It's really been a very deliberate strategy focused on getting end-to-end solutions in areas such as cyber and in space. So if I take the most recent ones, starting with Braxton, we've carved out niche areas for Parsons in space. So we're involved in space situational awareness. We're involved in small satellite payload development. We're involved in launch and integration activities. The one area we were missing was really that ground system component. So what Braxton brought us was Enterprise Ground Services. And why that's important is previously, you would have a ground system that was for an individual satellite and ground systems weren't enabling multiple satellites. So this is the structure that has a joint command-and-control architecture to be able to control multiple satellites. It's truly disruptive. And that's what we liked about Braxton. It was a great fit with our culture because it has an entrepreneurial mindset and one of agility, where you have to get solutions out to your customers quickly. Similar with BlackHorse, we have a lot of strength in cyber and electromagnetic spectrum. The one piece that we were missing to be able to fight an information warfare battle against near-peer threats was really the information operations. So BlackHorse enhanced our capabilities in cyber, electromagnetic spectrum, but they also brought that information operations, publicly available information, open-source intelligence piece to the table. Then finally, the most recent one, which was a smaller acquisition, is Echo Ridge. We were excited about Echo Ridge for niche reasons. They have a software-defined radio capability. They also do some modeling and simulation of the spectrum. And finally, the big capability that we were anxious about was assured position, navigation and timing to be able to provide the ability to provide those capabilities should you have a GPS go down at any time.

Fantastic. Maybe just thinking now about the future in M&A and reflecting on your portfolio and how it's constructed today, where do you see your M&A program going on a go-forward basis? Does the change in Washington push you more into fed civ targets? Does the shift in the threat landscape push you more into intel? How are you thinking about things right now? And how are you thinking about gaps you might want to fill?

We will continue down a pretty similar trajectory to what we've done. You can expect us to do about 1 to 2 acquisitions a year. Right now, this year, we're going to spend the time absorbing the 2 that we just did, but we will continue to stay on a path of cyber and space. We've expanded our aperture into the federal civilian as well. We have about 20% of our Federal business that is federal civilian, some capabilities that are exciting such as bio-surveillance capabilities, for example. So we are opening the aperture there and also to potential technology acquisitions in the Critical Infrastructure area. Our M&A strategy, we feel, has been very successful. It's really what's enabled us to bid and win these and prime these larger jobs and move up the value chain to a solutions integrator role.

Yes. If I step back here and I look at the health of the balance sheet, you guys are at, I think, 1.1x or thereabouts post your latest transaction. As we've discussed, the environment has changed somewhat. Does the capital deployment program change? Does it remain the same? How are you thinking through that? And then from a cash generation standpoint, maybe how comfortable are you with the trajectory at the moment and supporting that 1 to 2 transactions a year?

Yes. Great question, Matt. As you pointed out, pro forma post BlackHorse, we're at about a 1.1x leverage. We would be comfortable going up to a 2.0 to a 2.5x leverage. Our priority will continue to be focused on M&A and doing 1 to 2 transactions a year. The Board, however, did, in the second quarter, authorize up to $100 million of share repurchase. So that is another lever that we're looking at. And finally, we would not roll out dividends. So that's something that we would consider. But again, our highest priority remains on M&A.

Got it, got it. Let's transition a little bit here to the COVID-19 environment and what that means for Parsons. We've -- I feel like we've talked about it at length, but that said, we're getting to a point where we're 1.5 years into this. We know how to operate, to some extent, in this environment, and we're getting a feel for what might stay and what might go as things normalize. As you look at the business today and you think about that last 18 months and then you overlay that with your future plans, your AOP, your LRSP, what do you see as maybe staying, one? And then two, how does that -- or does that change the economics of the business? Said another way, are there things such as real estate footprint or cost structure or work arrangements that will change? And will they manifest themselves in the P&L?

Yes. So I believe the items that will stay -- first, I think COVID taught us we had to digitally transform and we needed to do so immediately. Our IT department, like most companies, quickly made sure that our 15,000-plus employees worldwide were facilitated to be able to work remotely. We established what we call an engineer work-from-anywhere program where we could develop software, for example, in a virtual DevSecOps environment and any engineer could plug in, in any station. I think the things -- if I look at Parsons particularly going forward, we're allowing our workforce maximum flexibility. If their manager and their customer permits them to work remote and they want to work remote, we're going to permit that going forward. If they want to work hybrid, we're going to do that. Or if they want to be in the office, we will allow that alternative as well. But that -- digital transformation won't go away. I think it's pretty good that we can onboard people remotely and conduct really business virtually. If you had asked any of us about 18 months ago, if we'd be here today, I think we would have said no. The other thing that I see changing, which I think is going to be a terrific opportunity, is the way that we live our lives as people. If you think about cities, cities are going to transform. They're going to have more bike paths. They're going to have more walking paths. So we're going to be thinking about how we redesign the smart cities of the future. And the same can be said in the transportation sector. If you look at an airport, we're so used to going in and just getting our ticket and going on to the plane, throwing our bag down. But there's going to be a lot more sensitivity paid to how do you queue passengers as you go into the airport? What about having instead just an integrated ticketing system, one that's integrated ticketing and health care, whether it's doing temperature testing or uploading your vaccine information or checking it. But those airports of the future are going to be completely remodeled. So we see stepping back and saying, what does a post-COVID world look like? And how can Parsons create the future of that post-COVID world?

But fundamentally, from a sort of a -- let's take a step back here. If I look across the board, the government services space, margins have been very healthy over this period of time. And that's in part because of fewer pass-through, a change in indirect spending. CapEx has maybe shifted but not necessarily outright come down. Should we expect that the uplift in margins that we've experienced over this period of time stay with us as a result of these sort of changes, whether it is derived from work from home or otherwise? Or should we think about the future, the medium term as sort of reverting and resetting and then we start to see that trajectory that we were on prior to this all, where we'd see 10, 20, 30 bps out of the group on average? And I know I'm talking broadly -- in broad strokes, but help us wrap our head around this dynamic because I think it's one that people have been wrestling with for quite some time.

I believe that the margins will stay. I think we've learned how to do work differently. I think we've all realized we were traveling more than we needed to, and we can be effective in some scenarios by doing Zoom meetings. Now we clearly don't want the whole world to be Zoom meetings, and there's times where face-to-face is much more important. But I think the travel budgets will be down to stay. I also believe facilities -- everybody is stepping back and taking a look at their facilities. For us at Parsons, we believe that we can cut out 1/3 of our costs over the next 3 years from a facility perspective. Just by doing that, who wants to work remote and who wants to work hybrid and then we're down to fewer people in the office. So I do believe that the margins can be here to stay, and it's a new way of running the business.

Got it. That's great color, Carey. Let's talk labor for a minute here. We sort of touched on it or skirted the subject throughout the conversation. When we initially talked about the top line, we talked about the hiring dynamic and that being important to drive revenue growth ahead. Based on what you've seen over the last couple of quarters and what you're seeing through the current quarter to date, can you maybe just share with us in some detail what you're seeing in terms of hiring trends, what you're doing to make sure that you're minimizing trend as well -- or minimizing churn, excuse me, and also attracting the right labor? Because at the end of the day, this is largely a services company and it's the people that drive the business.

Certainly. So on the Critical Infrastructure, we clearly have 2 different hiring needs here. On the Critical Infrastructure side of the house, we have not experienced a hiring issue. On the Federal side of the house and particularly in the highly cleared space, that area has always been a challenge. And that's really where we put our focus and our attention. Things that we've put in place. We have a dual career path, for example, a technical and a management career path. There are people in the technical ladder who don't have to go over to management to move and progress in their career. But rather, they can get up to a Chief Technology Officer level or a technical fellow and remain in that technical career path. We've set up spaces outside of the D.C., Maryland and Virginia area. So for example, we're co-located with the Army Cyber Command Augusta, Georgia. We're co-located with the Air Force Cyber Command in San Antonio. Huntsville is another big area for us as well as Colorado Springs in Denver. But really, how do we get outside that D.C., Maryland, Virginia, where hiring is the most difficult. We're also looking at bidding and winning jobs that don't necessarily require those unicorn, elite personnel. So a great example of that would be our recent Air Base Air Defense program, which will not require that full lifestyle [ poly ] type of personnel, but rather, it would be much easier to staff. And then we're just continually focused on culture. Parsons, I think, is really in a unique position that we have a very agile, innovative, disruptive culture. And we have these 2 components of the company that really complement each other quite well in our position in great high-growth markets. And we keep emphasizing that to our employees and our prospective employees. It's a great place to be.

Fantastic, fantastic. We're just about up against our stops here. One more question for you. If you were given 1 incremental dollar of IRAD or 1 incremental dollar of M&A funding, technologically, where would you place your bet?

Yes. I'm going to give you 2. It would be cyber and space. And cyber...

Cyber and space.

Cyber because -- both on the Federal side but also protection of the Critical Infrastructure, which is a big priority. And then space because that is a very strong need right now in the world.

Fair enough. Thank you for that. Thank you. Carey, George, Dave. Really appreciate your time here. It's been great catching up. Hopefully, we can do it a year from now in sunny Laguna Beach instead of virtually. But anyway, thank you so much for your time.

Thank you, Matt.

Thanks, Matt.