Parsons Corporation (PSN) Earnings Call Transcript & Summary

All right. We're going to get going here. Good afternoon, everybody, and welcome back to Laguna. It's nice to be here and not on Zoom. For those of you who don't know me, my name is Matt Sharpe, I'm the firm's government services analyst. And I do have to read a quick disclosure before we get going. For important disclosures, please see Morgan Stanley Research Disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. With that, it's my pleasure to host the Parsons team. With me this afternoon is Carey Smith, President and CEO; and Matt Ofilos, CFO; as well as Dave Spille, Senior Vice President of IR. So welcome all and thanks.

Thanks for inviting us. Glad to be here.

So Carey, Matt, I wanted to start sort of high level with Parsons. Could you maybe speak to us a little bit about its market position, segments and how the business differentiates itself from other government services contractors?

Sure. So we report in 2 business segments: Federal Solutions and Critical Infrastructure, roughly 50-50 with Federal being a little bit larger than Critical Infrastructure. Underneath there, we have several end markets. Within Federal, we have cybersecurity where we're differentiated by doing about 75% offensive cyber, 25% defensive. And we provide capabilities that span platforms, cyber operations and cyber tools. We're also differentiated because we have operational technology and informational technology capability, which I'll talk more about later. Within our space area, we provide space situational awareness, space ground systems, space resiliency, that's everything from the ground systems to the links up to the satellite capability and space situational awareness, another rapidly growing area. Within missile defense, we are the #1 technical adviser to the missile defense agency, a role that we've served in for nearly 40 years, and we're involved in every single aspect of missile defense missions. Right now, the priorities are really on securing the homeland, defense of Guam as well as hypersonic defense capabilities. And then critical infrastructure protection where we provide physical security, electronic security systems. And that spans both areas of our business. On the infrastructure side of the house, we're focused on transportation. We're very differentiated. We've designed and built over 10,000 miles of roads and highways across 6 continents. We're a world leader in long-span bridges, having designed over 4,500 bridges worldwide. We're both in rail and transit projects. We do systems work as well as light rail and transit and communications-based train control. We are the company that brought ultra-wideband, for example, over from Europe and implement those programs in the United States. And we've done over 450 rail and transit programs. And then with airports, we do project management, have over 400 airport clients worldwide. The other area in Critical Infrastructure we're involved in is environmental remediation. So that includes things like PFOS/PFAS emerging contaminant elimination. We do oil well plugging and abandonment and we're involved in mine reclamation including 2 of the biggest abandoned mines up in Canada, Faro mine and Giant mine. And then the final area, the seventh is water and wastewater treatment. We're a little proud of a lot of the programs we've performed. One of our biggest efforts is in Las Vegas, where we improved the quality of drinking water.

Fantastic, fantastic. So you mentioned your Fed Solutions business as well as your Critical Infrastructure business, and Parsons and your team has done a nice job of sort of cross-pollinating both people across both segments as well as sort of capabilities across both the segments. So I was hoping you could talk a little bit about the synergistic nature of the 2 businesses, how they work together and why they make sense under one portfolio.

Well, first, we're really excited that we have both these businesses and particularly when they're both in rising tide end markets at this point in time, they're very synergistic and they're very complementary. And I would break that explanation kind of into 3 areas: markets, people and technology. So if you look at our end market areas, aviation would be a great example. If we're doing an aviation project for the FAA, that would fall under our Federal Solutions business. But if we're doing aviation projects for airports, that would be under our Critical Infrastructure business. I talked earlier about critical infrastructure protection. When you look at the Infrastructure Act that was passed, there's $115 billion of new funds out of the $550 billion of funds that is set aside for cyber and resiliency. We're perhaps the only company that has the domain knowledge of how an airport works or a port works or a rail and transit system works on the critical infrastructure side, but with the technology capacity from the federal side to be able to provide that total integrated solution. Another good example would be PFOS/PFAS emerging contaminants. So on the federal side of the house, our customers would be military installations, for example. But on the critical infrastructure side of the house, it might be industrial customers. So there's a lot of synergies and complementary nature to these 2 businesses. Second would be people. We have a shared software development organization. So a software developer one day might be supporting a defense and intelligence program like join all the main command and control, and the next day be working on a smart city under our Connected Communities organization. We also have a shared design organization, and that design organization spans worldwide. So we have the capacity of having design engineers, again, that can work one day on an exciting project in the Middle East and the next day be working on a project in our Federal area like for the United States Postal Service. And all these engineering tools are designed so that engineers can work from anywhere. Just as well with our software tools, we have a DevSecOps environment where people can work virtually. The third area of synergy is in technologies. So if you have artificial intelligence, you can apply artificial intelligence to improve your cyber performance or you can apply artificial intelligence to improve how you're doing a smart city and driving -- anticipating a route to get through congestion. Cybersecurity is another one. Cybersecurity applies whether it's on the federal side of the house where you can be doing offense or you can be doing defensive and -- for Department of Defense or intel community, but also cyber is absolutely critical for all of our infrastructure sectors. And then cloud computing is a great example. We use cloud computing on the federal side of the house particularly in the secure environment, but we also have taken our cloud computing capabilities to areas like our vehicle inspection program and our traffic management program and been able to put those in the cloud.

Fantastic. Now when you think about the 2 segments, maybe curious to know what your view is on sort of maybe 1 or 2 areas where you're seeing either strong demand signals or increased contracting activities? What are the 1 or 2 things that you're most excited about in each?

Yes. So I would say within the federal, it's definitely a near peer threat. Mostly China, but also Russia. And where we see the opportunity for Parsons is in the area of cyber electromagnetic spectrum and information operations convergence. The near peer threats have been fighting an information war for a long time and the United States is starting to bring those competencies together and under alignment to be able to fight it. So that's really where we focus. A second area within federal would be in the space domain where we see opportunity. Space has become a war-fighting domain. And our capabilities such as space situational awareness, where we can track anything that's going on in the space are going to become important in the future as well as space cyber security as an area. Within infrastructure would be global infrastructure spend. The United States have passed the $1.2 trillion infrastructure bill in November 2021, $550 million of new funding focused on all the areas I discussed earlier, transportation, how do we improve roads and highways, airport, ports, environmental remediation, water and wastewater treatment. Within Canada, they passed their bill back in 2016. It was CAD 188 billion, $96 billion of that being new funding. So that -- those funds are already well underway. But I'd have to say the one that has really accelerated is the Middle East. We get all excited about $550 billion of new funds in the United States, which is very important. But in the Middle East, a single projects such as NEOM being built on the Red Sea is $500 billion alone. A second project such as [indiscernible] is $250 billion. And what we've seen there, Matt, is an acceleration where those programs are moving to the left. So I would say right now, we see a lot of demand signals for the Parsons business.

Fantastic. So with that, I want to transition to some of the revenue growth dynamics we've seen and the look going forward. So obviously, for 2021, you had a down year, but that's inflected nicely into 2022. What drove the reacceleration of growth here? And what are the potential drivers of momentum as we now get into the back half of the year as well as into 2023?

Yes. So the biggest thing is we made a lot of changes last July when I took over in the human resources organization. So we were able to really improve our staffing as well as our retention. So if you look at second half of last year over the first half, our staffing improved by 30%. Then going into this year, first half or the second half of last year, which was already with -- we went up another 20%, having record months in the second quarter in terms of hiring. That was great because I already talked about the demand. If you have the demand and you have the hiring, you're going to see the organic revenue growth. So first quarter, we were 6% organic. In second quarter, we were 9% organic, both our industry-leading type of numbers. What we need to do is continue that momentum as we go forward into the back half. We've been awarded a lot of single-award IDIQ contracts. So what we're doing is driving the task orders to those contracts, getting them staffed. That will be a key driver for the federal side of the house. Then on the critical infrastructure side of the house, I talked about the Middle East programs. We've now been awarded 4 large programs. They are this year, which are on a very steep ramp, and we started to see the infrastructure bill funds roll out within the United States. So a lot of demand drivers, we got to keep doing what we're doing.

Fantastic. So you've already answered a part of this next question, but there's another half to it, I don't want to get at here. And that's this, your revenue guide for the year is $4.05 to $4.15. What needs to occur in order for you to get to the high end of the range? You mentioned performing on task orders, inward facing, outward facing? Is there anything in the environment that needs to occur here in order for that to be achievable?

No, I'd say macro environment conditions are favorable for us. So what we need to continue doing is what we're doing, which is drive task orders to the federal contracts, continue to drive the staffing and continue to execute on our programs.

Great. Great. So I want to talk a little bit about the environment here, the broader environment. Obviously, Q2 industry-wide, we saw light bookings and there are a host of reasons for that, which we can get into. If I look at Parsons specifically, similar to peers, backlog bookings, 10, 12-month book-to-bill were lower. How should we think about the leading indicators of growth? And what else should we consider in that context or within that group to help frame sort of the debate into 2023? Are there any other forward indicators that we need to pay more attention to or scrutinize more closely? And are there any dynamics underlying what I just outlined that are much more transient in nature than maybe people suspect?

Yes. So first, we're very proud of our critical infrastructure book-to-bill. We're going on 7 consecutive quarters of greater than 1.0, and that's without the full Infrastructure bill funding being in FX. So that's been excellent. On the Federal side, it has been light across the industry, but I'd say a couple of dynamics for us that come into play. First is we have a conservative bookings policy. And so for example, when we won our $2.24 billion missile defense contract a year ago, we only booked $618 million out of that booking. And what we do is we kind of booked the base period once we achieve the base period, then we book the option year period. So that conservatism, if we added that in the bookings would be higher. In fact, we have about $6 billion of outstanding work that we have not booked yet on the single-award contracts. I think what's most important for us and what we track is conversion of funded backlog, which was 18% year-over-year. That's an important driver. And then the revenue growth, which, again, organically was 6%, 9% in Q1 and Q2.

Got it. So a level of conservatism baked in. And so when you account for that and you look at some of these headline awards that you've achieved over the last several years, there is fundamental underlying strength here in the business. And so just because of 2Q is a little soft, it doesn't mean that we're entering a new phase of trend, so to speak.

That's correct. And it's revenue that's important. .

Yes, absolutely. So 1 year ago at this conference, albeit in a virtual setting, we said a lot had changed over the past 12 to 18 months. And at risk of sounding like a broken record, I'll say it again. A lot has changed over the last several quarters, variants of COVID, we had a projected CR, Russia innovated Ukraine, et cetera, et cetera. What's your assessment of the end market here given those changes? Do you see any sort of shift in demand on the federal side? And do you yet see any fading headwinds or are the conditions that are in place more permanent at this juncture?

Yes. So I would say, I think the Russian invasion of Ukraine, very unfortunate, but it definitely woke everybody up to the importance to national security. The near peer threat of China is the one that everybody has their attention on. And that's what's going to drive the 2023 budgets, particularly the research and development budget increased by over 9% Because we play on the emerging edge of our customers' missions and federal, that's really where we focus. We're trying to solve their future problems, not the problems of yesterday. And then a global infrastructure need, all over the world, no matter where you go, it's upgrading and it's building new infrastructure. Most of the worlds let that fall behind.

So on the subject of Ukraine and the geopolitics around it and potentially the opportunity for contractors that might come, where is Parsons best suited to provide support to our efforts in both during and after the conflict? Are there opportunities there for you to provide some support?

Yes. So during -- we have an emulator system that is being used currently deployed over in region. I would say post conflict, the biggest areas for us will be things like unexploded ordinance removal, environmental remediation so that people can get back in and live in their homes. And the rebuild ultimately of Ukraine, Parsons was involved in the rebuild of Iraq, and we fully expect to be able to help out with the Ukraine rebuild.

Fantastic, fantastic. Just touching on the federal government spending. Budget numbers have obviously been supportive and into fiscal '23 are going to continue to be supportive. It looks like we'll see some nice growth there. However, awards outlays, as I alluded to earlier, have lagged. So we've seen a dislocation between the 2 forward indicators or leading indicators what's your assessment of this dynamic? And has it affected your planning at all as you look out into the future and where you want to invest?

So I would say the work has to get done, and it will get done. So things will catch up at some point. Because we've had the single awards, we have a lot of ceiling value. And the way our single awards are based, they're focused, for example, on the combatant commander needs, areas like cyber space intelligence. So we've been able to drive work to those critical mission needs without having to wait on new awards to happen. But ultimately, the new awards in the outlays will catch up.

Got it. Got it. So again, getting back to that point earlier about it being more transient and onetime dislocation here and play catch up in future quarters. I want to shift gears here and talk a little bit about profitability of the company. So fiscal '22, if I look at performance to date, and then the guide implies about 9%, 9.2% somewhere in that range EBITDA margins for 3Q, 4Q. This is coming off of 7.7% in the most recent quarter. What can you tell us about the drivers of that step-up? And then as we think about the transition into 2023, is there an opportunity to increase margins here, one in the core business, but 2 in some of those periods in which you have some unevenness, right? 1Q, 4Q at times tend to be a little bit lower than the middle of the year.

Yes. So I'm happy to take that one. I think we'll always have a bit of seasonality. You'll see we have a fair amount of equity and earnings in there. And so second half is typically a step up from the first half on the equity and earnings from the joint ventures. So we will always have some seasonality. I think we had some onetime events in Q2 that Carey talked about, some intelligent investment decisions around the Middle East business. So there could be some -- a little bit more stability going into next year, but we're confident in the second half of this year. If you look at 2021, I think we were 8.6% in Q3 and 9.6% in Q4, 8.8% and 9.6%, so it's definitely within reason, and we feel comfortable that we're going to get there in both businesses should be in that 9% to 9.2% for the second half.

Fantastic. Now on a related note, related to margins that is, inflation has obviously been running hot here for the last several quarters. What's the breakdown in contract structure across the 2 segments? And given that breakdown, what are the opportunities to mitigate some of the -- grown, whether it's wage inflation or material inflation or otherwise, how do you mitigate what's the opportunity to mitigate some of the inflation we're seeing here?

I'll start, and then Matt can jump in. We're about 56% fixed-price T&M versus cost reimbursable. And that varies within the Federal, we're about 2/3, 1/3 cost reimbursable to fixed price T&M and Critical Infrastructure is kind of the opposite. We don't really see inflationary impacts from supply chain in our business because we don't have a lot of things that we're out buying like commodities. And on the wages, we've been able to hold our raises to a moderate level. And because our retention has been very strong ahead of industry, and we've been able to recruit, we feel comfortable.

No, I think you're spot on. We plan raises at a certain amount, and we're kind of coming in, in line with what our expectations were and retention has remained strong. So feel good about where we're at.

Great. Great. Let's talk a little bit about M&A. You guys have done some interesting acquisitions over the last several years. Can you talk about some of the capabilities and some of the customer relations that you've brought into the business and talk a little bit also about how some of the acquisitions have performed since bringing them onboard?

Sure. So we've made 8 acquisitions over the last 5 years, if I focus on -- since 2020. And I'll start with Braxton. Braxton brought us the capabilities of enterprise ground services, common command and control system as well as commercial augmentation services, where they have the capability of buying time on commercial remote antennas and being able to control the Air Force Satellite Control Network for the GPS, which is right. Echo Ridge was a small acquisition for us, but important, it brought us assured position navigation and timing capabilities. And a capability to be able to do that from a mobile backpack, which really helps the Army soldiers. More recently, we acquired BlackHorse Solutions. BlackHorse is focused on the near peer threats. So I talked earlier about that convergence of cyber electromagnetic spectrum and information operations. That's really where BlackHorse plays. And then finally, the most recent one was Xator. Xator brought us capabilities of electronic security systems, but also counter unmanned air systems and biometrics capabilities, a lot of synergies with the Parsons' portfolio. The other good thing about Xator, it crosses both of our segments. So you have the same needs in the critical infrastructure side of the house as you do on the federal side of the house. We have a different integration approach. We like to bring the leaders in, give them more responsibility, that way you're able to keep the teams on board. And we also adopt their best practices. So we'll kind of reshape Parson's culture as we buy these companies because we feel that these companies were successful in their own right. And if we keep their best practices, and change ours, we're going to continue to elevate the Parson's culture as we go forward.

Got it. Now when you look at your pipeline of opportunities, what can you tell us about that or their capabilities, are there customers out there that you'd like to either bolster or expand?

We are going to continue to acquire at least 1 to 2 companies a year. Our focus has tended to be on end-to-end solutions and cybersecurity and space. We would also open aperture to acquisitions on the critical infrastructure side of the house. We do want these to have technology differentiation. Our goal for all is to be a solutions integrator and really drive through software solutions and continue to move up that value chain as we've been able to do the last 5 years.

Got it. Got it. Now I think coming out of your last quarter, you were somewhere around 2x levered net debt-to-EBITDA. How should we think about that level in terms of where you want to be long term? And then what the ability is to flex up? How high would you maybe go, what level would you be comfortable with here in this environment today?

Yes. As you mentioned, the balance sheet is in really good shape. Closed Xator with just under $400 million, leverage remains just around 2 points. So we feel really good about where the balance sheet is. I think Carey mentioned, we're probably targeting companies in the $100 million to $500 million worth of revenue range. So we'd be comfortable up to the 3x, but feel -- don't feel necessary going above that at this point. Really efficient. The free cash flow is pretty strong. So we pay down a turn every 18 months. So feel good about the balance sheet and the cash conversion.

How do you trade M&A versus, say, some of the other capital deployment channels or paths with the framework the company uses to do that? Or it's share repurchase or CapEx or paying down debt, you name it. What's the trade?

Yes, we're pretty consistent when we're going through our strategy, M&A been the top priority from a capital deployment perspective. We have a $100 million share repurchase program in place. I think we're about $30 million into that at this point. So we still got some room there. But without a doubt, M&A has been the focus area for us and we do the trades, what's the make versus buy. Is it cheaper to do it in house? Or is it easier to just go out and purchase and something like that. Echo Ridge is a great example of hey, we could go do this with IRAD, but it's going to take us 2 years and spend just as much money. So just get it in house tomorrow. So I think the trades are pretty consistent and capital deployments in a good place.

Got it. Great. Carey, earlier in the conversation, you mentioned human capital. I want to get into that a little bit here. I think at 2Q, you noted May to June was your best 1-month period for hiring since the IPO, Q-on-Q hiring was up north of 20%. And -- what have you observed quarter-to-date in the labor markets? And how might it impact the business as we think about the future?

Yes. So hiring is still very strong. Retention is very strong. And I feel very confident that because we've got a business that has demand across all of our 7 end market segments, we're going to continue to see business growth in those. One thing I think that attracts people to Parsons, we're sort of a different type of company. First, we have a unique portfolio. The 2 segments are very complementary. But if you're a person coming in as an engineer, you have the opportunity to experience different mission needs. Your passion might be cyber, it might be space. But then tomorrow, you can also go work on a smart city project or go design a water wastewater treatment plant. So it really provides people a lot of flexibility. We're also unique in that. We're not a large business like the Tier 1 companies, but we have the breadth and depth of companies to be able to punch above our rate class and be able to bid and win these bigger programs. And I finally say we have a very entrepreneurial, innovative culture and people that are coming in that really like that type of feel really like Parsons. So I think that dynamic of the labor market is going to continue to attract people to Parsons and expect to see our continued growth.

A lot of the growth areas within the company, EG space or cyber overlap with some commercial spaces. And obviously, in the tech community, there's been a bit of volatility and as a result, either hiring freezes or slowing the pace of hiring. Has that become a tailwind for the hiring at Parsons in your industry in general? Or are the 2 unrelated? What are you seeing when it comes to that dynamic?

We think some people come from tech. But I would say the biggest thing for us is exciting projects and an exciting mission. If you think about the Middle East and you think about the opportunity to go design the city of the future that's as tall as Empire State Building and as long as Long Island and there's no traffic, it's all walking, bicycles. It's all driven by renewable energy, this is kind of our first-of-a-kind program. And it just doesn't get any more exciting than working on something like that. So whether you're from the tech industry or from our current industry, it's a great opportunity to do something that's never been done in the world.

Yes. That's fantastic. So I know that we're getting a little short on time here, but I do have one last question. I think it's an important one, given one additional dollar of IRAD, where would you spend it today? What technology or mission area would you bet on?

Yes, certainly, cyber. And the reason cyber is because it spans everything we do. We're living in a digital world, whether the digital world pertains to cyber and space or whether it pertains to cyber on a sensor on a bridge, everything is connected digitally. And so cybersecurity is going to be increasingly important.

Fantastic, great answer. Carey, Matt, Dave, thank you all for joining us today. It's been a pleasure.

Thank you very much.

Absolutely.