Parsons Corporation (PSN) Earnings Call Transcript & Summary

Good morning and good afternoon to those on the webcast. I'm Steve Fisher, UBS Machinery, Engineering and Construction Analyst. Welcome to the UBS Industrial Summit. We're really pleased to have the management of Parsons Corporation with us. We have the CEO, Carey Smith; we have the CFO, Matt Ofilos; and we have Senior Vice President, Investor Relations, Dave Spille. Again, really pleased to have them. A lot of discussion topics to cover here. But just before we get started, one disclosure as a research analyst. I am required to provide certain disclosures relating to the nature of my own relationship and that of UBS with any company on which we express a view on this call today. You can find these disclosures at ubs.com/disclosures or if you can feel free to reach out to me and I can provide them to you after the call. With that, welcome team. Really appreciate you're being here. Carey, for those who aren't as familiar with Parsons, maybe you can just provide us with a bit of a brief background on the company. How you think you're differentiated relative to your peers.

Yes. Thank you very much, Steve, for hosting us today. We appreciate it. So first, the company was founded in 1944. We're very proud that we're going to be celebrating our 80th anniversary as we go into next year. Today, when you look at the company, we've changed quite a bit. First, I would say, starting going public in May of 2019. And we've also shifted our portfolio. If you look at Parsons' kind of legacy, we were more of an architecture and engineering firm. And starting in about the 2011 timeframe, we got into the Federal marketplace. So if you fast forward over the last couple of years, we've made 10 acquisitions over the last 6 years. Today, we have a 55% Federal business and a 45% Critical Infrastructure business. We'd like to look at this in terms of 6 end markets, and those markets include cyber and intelligence that falls under our Federal group. And within cyber and intelligence, we're one of the top providers of offensive cybersecurity that makes up about 75% of our portfolio, and we do about 25% defensive. We're involved in everything with cyber relative to platform development, tool development and as well as performing cyber operations. The next group is space and missile defense. There, we're the #1 technical adviser for the Missile Defense Agency, a customer that we're very proud to have supported over 40 years involved in every aspect of their mission. Right now, very focused on defense of the Homeland, defense of Guam, encountering hypersonic missiles. In our space business, we're involved in several areas, starting with space situational awareness where we track everything going on in space. That's become quite a busy domain these days. We do space resilience of satellites, networks and ground systems. We're a ground system developer where we have some unique offerings such as selling satellite operations as a service. And we provide assured position, navigation and timing. So if you lose your GPS signal, you'll still have location information. In each of those areas, I would say, we've carved out very tough positions in each of those markets. The next market area is critical infrastructure protection. And that's where the predominant amount of our work is for the Department of State and Department of Defense, specifically the Army and Air Force, providing electronic security systems. We're the #1 provider for Department of State, #1 with the Army, #3 with the Air Force. We also do counter unmanned air system. So basically from Level 1 handheld UAVs all the way up to Level 5 UAV systems. We put together a system-of-systems approach to identify, detect, track and we can also return those UAVs or drop them at their point. We also provide biometrics capabilities so that we can capture people that are improperly trying to enter over 280 embassies and consulates around the world, and we're the #1 provider of that system for the Department of State. If I move over to the Critical Infrastructure segment, again, we have 3 end markets there. Starting with transportation, we've designed and built over 10,000 miles of roads and highways across 6 continents worldwide. We are a leader in long span bridges having designed over 4,000 bridges worldwide. We're also involved in intelligent transportation systems. We have the most globally deployed advanced traffic management system, which is called the Intelligent Network. And we're involved in aviation and rail and transit, having performed work for over 400 contracts and customers in those 2 domains, once again worldwide. Moving on to the second market within Critical Infrastructure, that would be environmental remediation, where we're involved in areas such as emerging contaminant elimination, specifically PFOS, PFAS. We hold -- we have 7 patents either 4 are approved and 3 are in process. We've had a water treatment facility established up in New York State since the 1990s. And that's a quite exciting market area for us that's going to continue to evolve. We're involved in mine reclamation. We do 2 of the world's largest abandoned mines up in Canada, Giant Mine and Faro Mine. And we're involved in oil plugging and abandonment where we've developed a methane filter that basically prevents methane leakage from abandoned mines. And then the final area I'll call, urban development, which is largely the work that we do in the Middle East and it's very focused on how we're helping the Middle East diversify away from dependence on oil. And so we're involved in most of the major projects that are going on today in Saudi Arabia, the new builds of the industrial cities, world's largest entertainment center and a lot of mixed use development. And I'll just wrap up that brief summary with one comment. We're particularly proud that within Engineering News-Record, we were ranked #3 for program management, construction management, program and construction management at fee as well as professional services. So 4 categories for a company of our size, again, we're kind of punching above our weight.

That's fantastic. So in terms of, and building on that, a lot of areas of differentiation there, how would you define your competitive set? Who are your biggest competitors? How do you differentiate it? And how is that competitive landscape evolving?

Yes. So our competitors vary by marketplace because we do have a diverse portfolio. So if I look at an area like cyber and intelligence, we tend to run up against mostly companies like ManTech and Northrop Grumman. If I move to missile defense, we've only had one company try to compete against us for the missile defense work in the past and that was KBR. Within the space domain, we run up against companies like Booz Allen Hamilton, General Dynamics and SAIC. Within critical infrastructure protection, it's more of your electronic security companies that would include the firms like MCD and Johnson Controls. If you move over to the infrastructure side of the house within transportation, it would be more companies like AECOM, Jacobs. Urban development, likewise, it would be AECOM and Jacobs, a little bit of WSP. And then areas like environmental remediation, it's more of companies like Stantec, Tetra Tech and WSP. So quite a broad set of competitors. I would say, how we differentiate and what is really key with the company, we stay involved in our customers' emerging problem. So we look to the future and we're trying to find solutions, we call it Imagine Next. How do we look at things with a clean sheet of paper to where they're heading in the future, not where they've been in the past. And in that regard, we try not to go after people's recompete takeaways. So it's really focused on that new, new business where we win and lose on technology differentiation. And very proud of the fact we've had a 70% win rate this year, which shows, I'm going to say, the culmination of all of our acquisitions coming to fruition and our ability to move up the value chain as the solutions integrator.

Great. In terms of growth outlook ahead, you laid out very nicely the different components of the Federal Solutions business. Can you talk maybe about each of those? And what the growth trajectory and opportunities are? How that's developed in 2023 and then for the next few years?

Sure. So starting, first I'll say, we're pleased that all of our markets are growing between 5% to 12% compound annual growth rate. So if I start with cyber and intelligence, that comprises 13% of Parsons' business today. By the way, when I joined the company back in November 2016, we only held one cyber contract for $50 million. So the fact that it's now 13% of our business is terrific. That's growing at a rate of 7% to 9% compound annual growth rate. Space and missile defense comprised 14% of our business. That's growing at a rate of 4% to 5% compound annual growth rate in our markets. Critical infrastructure protection comprises 13% of Parsons' business, and that's growing at a rate of 7% to 9%. If I move over to the Critical Infrastructure side, transportation makes up 30% of our business and it's also the largest compound annual growth rate of 10% to 12%. Within environmental remediation, that makes up about 13% of our business, and that's growing at about a rate of 6%. And then urban development, also about a rate of 6% growth, and that makes up about 11% of our business. So we've been very fortunate over the last couple of years to position our portfolio very thoughtfully in market areas that have high growth, that are sustainable, that are very profitable and where we can be in the top 1, 2 or 3 companies in those different end markets.

Okay. That's super interesting. As we think about maybe on the Critical Infrastructure side, you talked about it a little bit already, but maybe just to dig in a little bit deeper on some of the drivers. And then to the extent that the Infrastructure Bill, IIJA, is relevant in terms of that as a driver, can you talk a little bit about kind of how that is factoring into the growth opportunities? And where you are in terms of those opportunities materializing?

Yes. So first, I'd say, this is unprecedented global infrastructure spend, whether you're talking about United States, Canada or the Middle East, which are the 3 regions that we play in. So starting with the U.S., when the Infrastructure Investment and Jobs Act was approved in November of 2021, that was for $1.2 trillion. Out of that, $550 billion is new. What is really nice is it directly aligns with Parsons' portfolio. With the majority of that new funding, $284 billion of $550 billion going towards transportation. But other market areas that we play in, including utilities, rail and transit, aviation, we're also involved in broadband capabilities, we do electrification and environmental remediation have all received funding. So quite delighted that there's a really good alignment to our portfolio with the IIJA. In the Middle East, that's an even bigger market area. That's a $1.5 trillion market area. And out of the $1.5 trillion, 60% to 70% of that is new funding. And out of that, 50% is in Saudi Arabia. We're very proud that we've been in the GCC countries for 60 years. Within Saudi Arabia, we have a 50-50 joint venture with a Saudi company that's been in place for over 50 years, probably one the best branded, if not the best branded infrastructure company within the region. It makes you really proud when you travel around and you look at some of the projects we've done recently like being involved in the Qatar World Cup, being involved in the World Expo that occurred in the UAE. And some of the projects that we're currently involved in, in Saudi Arabia. We're on all 5 of Saudi Arabia's giga-projects. And those are just amazing programs when you look at a project like Neom, The Line, you're building a brand new city out of the sand off the Red Sea that's going to be as tall as the Empire State building, as long as Long Island, run on 100% renewable energy. And to be involved in a project like that, that's truly a first of a kind and we can take those best practices, transit those back to the United States. And then moving on to Canada where we have 7% of Parsons' business. They passed their Federal Infrastructure Bill back in the 2016 timeframe. So they're already well along on their spend, and that also included quite a bit of new spend. So it's kind of good timing for the company being in the right 3 geographies. I will mention also, Steve, that our geographic split is 83% North America. Out of that, 76% U.S., 7% Canada, 17% is Middle East.

Excellent. So maybe just digging a little bit more into the IIJA piece of that, where do you think we are? And you touched upon some of these different areas. To what extent is that money flowing do you think now versus we still have a lot of it ahead of us to ramp up? And if that does, when do you see that happening?

Yes. So I would say, we're still at early stages. The rollout -- if you look at the Infrastructure Coordination Office, they've said that they've rolled out about $184 billion out of the $1.2 trillion, but that's at various stages because it has to go to Federal government, then get state and local. We saw our first funding in the 2022 timeframe and specifically on our Federal Aviation Administration contract and also some Federal rail work that we do. I'll mention the FAA just a little bit further. The FAA, so we don't just get infrastructure funding on the Critical Infrastructure part of the company, but we also get it on the Federal part of the company. The FAA, for example, got $25 billion in the infrastructure bill. Out of that, $5 billion is going towards facilities work. And we are the facilities contractor for the FAA, a repeat that we secured for the next 7 years. So we see a benefit to the portfolio across the business. I would say, the peak in our estimate was originally we were estimating around '26, but that's probably now moved to the 2027 timeframe due to the rollout timing. 60% to 70% of funds come through formula funds. So it does get a little hard to separate out $1 by IIJA versus $1 of formula funds until how much is coming from where because both projects really have kind of the legacy funding coupled with the new funding. And then you also have states investing quite a bit. As an example, Texas is going to have a total of $30 billion spend between FY '22 and FY '26, a state that we're very well focused on and just made a recent acquisition there. And then if I move to the Middle East in terms of timing too, that's even later because they have Saudi Vision 2030 and they really want to get things in place, both because they're going to be holding the expo in 2030, but they've won also the World Cup for 2034. So they want to make sure everything is established for those. And then if you move to the UAE, they have Projects of the 50 in Abu Dhabi. They have a Vision 2040 for Dubai. And then Qatar also has a National Vision for 2030. So we're again looking at very long-term funding across our infrastructure business.

That's great. Okay. Now maybe turning to a little bit more near-term or recently, you just had your Q3 financial results. So can you just talk a little bit about sort of the revenue drivers there, adjusted EBITDA and your adjusted EPS outperformance and kind of what were the key surprises during the quarter?

Yes, I'm happy to take that one. Carey has been doing a lot of talking. So I'll try -- I'll take my best at these. But yes, I think everybody was really happy with Q3 performance. Obviously, over 20% organic revenue growth is very strong, 9% EBITDA margin. So it was really a great quarter for us. So the biggest drivers for us were continued staffing success through the first half of the year. The first 3 quarters of the year, we've done a great job both hiring and retention. So net hiring is ahead of plan. I think somewhere in the third quarter, we exceeded our total year initial goal for headcount adds. So it's a great position for us to be in with a few months to go. Secondly, Carey talked about the 70% win rates that we've had. So new awards and driving headcount to those new awards and ramping up on those jobs has been a big part of our outperform. And then finally, just execution. We've had really strong backlog, almost $9 billion worth of backlog. We have almost $14 billion worth of work to be awarded, things that were already awarded that they're waiting to -- it's awaiting award. It's awarded 2 parcels, but we're awaiting for them to come on to contract. So the backlog position is really strong for us at the end of the quarter. And so just continuing to drive work to those contracts. On the execution side, the programs continue to perform. We've been tracking the change order for a bit, and it came in. We had a really strong change order on a new job that drove $10 million of additional profit for the quarter. So all in all, just a really great Q3 for us. So really happy with the quarter.

That's fantastic. And you did mention that you had 13 contract wins over $100 million in the first 9 months of the year, which has been, from what I understand, the most in Parsons' history. Anything specifically noteworthy that you want to call out driving that?

Yes. So last year, 2022 for the full year, we had 11 wins greater than $100 million. And this year, to your point, Steve, we've had 13 through Q3 greater than $100 million. I'd say, the biggest drivers are again focusing on where our customers' biggest challenges are and solving those emerging challenges. 9 of the 13 wins were on the Federal side, we tend to see larger jobs on the Federal side with the exception of the Middle East, which also has large jobs on Critical Infrastructure. But I'd go back to highlighting our win rate. Our win rates stood 70% up from 49% last year.

That's great. Now you still have a range for fiscal '23. So anything you could talk about that would get you at sort of the high end or the low end of that range?

Yes, probably a lot of the same things I talked about. If we were to get to the high end, it would be continue to execute, do exactly what we're doing today, sustain the hiring momentum that we've had, continue to win in our fair share of work, driving work to the IDIQs that we have in place. So those will be the things that would drive us to the high end. From a low end, obviously, guidance about a month ago almost. So the uncertainty around the budget environment. Hopefully, you've seen some progress there, but the budget environment and then staffing, if there was some sort of significant change in the staffing. But all in all, we feel really good about that.

I'd probably say, the macro environment factor we always watch is inflation and what's happening there.

Yes. We definitely will come back to that in a little bit. So maybe looking a little bit longer term now, at Investor Day back in March, 3-year growth targets calling for about 4% to 6% annual revenue growth and 20 to 30 basis points of adjusted EBITDA margin expansion annually. How should we think about sort of revenue growth and margin targets given that you've had some really nice outperformance this year? And kind of how to think about that outperformance in general?

Yes, I'll take that one also. Carey and I recently have said that we would use the new midpoint of guide and continue along the mid-single-digit growth rates that we are intending to provide the updated longer term guidance at the February call, the year-end for us. And so all in all, to your point, 4% to 6% was the guidance we provided. We're going to far outperform that for this year on the top-line. Margin expansion is on track. So we're going from [indiscernible] about 20 basis points this year, followed by 20 to 30 basis points for the next few years. If I break it up into the 2 major segments and I think about Federal versus Critical Infrastructure, Federal business is really strong. We're running mid-9 this year given the volume of cost plus work that we do and kind of the front-end R&D type work. We're always going to be structurally limited in terms of margin expansion there just because of the cost plus environment. So we're pretty comfortable with that Federal business continuing to run in the mid-9s, maybe there's 10 or 20 basis points there over time. But a lot of that will come from acquisition and acquiring companies with greater than 10% margin. On the infrastructure side, that's really where we see the opportunity. We expect the infrastructure business will get up into the mid-to-low-9s in the short-term and hopefully target double-digits over time as obviously demand is coming up significantly and a number of suppliers is kind of limited. So we're having some pricing power and obviously efficient growth is a key focus for us. So a great opportunity from a margin expansion perspective.

That's fantastic. And you did have a couple of legacy programs in your Critical Infrastructure segment, can you just give us maybe a little bit of an update there? And I imagine as you move on from those, that would also be a tailwind to your margin opportunity. Maybe just a little bit of an update on those couple of things.

Yes. So the first program is where we're a minority partner in a joint venture, and that program is 98% complete and it's still on track to complete this year. The second program, we are the prime contractor for, and that program is 85% and we expect that to complete at the end of 2024. And just as a reminder, we don't do any kind of hard bid construction anymore as a business. That was a strategy change that we made back in the late 2018 timeframe. So these are legacy projects that were bid back in the 2015 timeframe.

Okay, terrific. So I mentioned, we'd come back to the topic of inflation. And so some of the companies in your broad Critical Infrastructure market have been impacted by wage inflation or supply chain issues. I guess, can you talk a little bit about how -- to what extent you're able to pass through these inflationary pressures? And any of the supply chain costs to your customers?

Yes. So first at the Parsons' level, our portfolio mix is about 56% fixed price time and material, 44% cost reimbursable. If you break that down by segment, Federal is about 2/3 cost reimbursable, 1/3 fixed price time and material, whereas Critical Infrastructure is about 3/4 fixed price time and material, 1 quarter cost reimbursable. So on the Federal side, the majority of the costs are passed through on that Critical Infrastructure side, it would be less. If you look at inflation, we look at 2 things. One is we're largely a labor-based business. So we try and make sure that we keep up with competitive wage increases depending on market demand. We're very pleased with the fact that our hiring has been strong as we've reported across quarters for the last couple of years. And as well, our retention has been improving. We measure our retention against PWC industry benchmarks, and we are better than those benchmarks across our market areas. I will say, on the supply chain side, with the exception of one program, the bulk of our business does not have supply chain constraints. We do have one that we're looking at inflationary pressures and we're currently working through with our customers.

Excellent. One of your peers recently announced plans to merge their government services business with Amentum. How are you thinking about your segment mix and structure as it stands today? Are there opportunities for the 2 segments to work together on projects or are your offerings more typically kind of siloed amongst those different segments?

We love our portfolio the way it is, 55-45 Federal to Critical Infrastructure. We have a lot of synergies across the portfolio. Starting with people, we have a common design engineering group that supports both of the organizations. We move program management talent back and forth between the 2 organizations. In fact, our president that runs our engineered systems group came from the Critical Infrastructure segment. So all the way from bottom to top, we move people around. We have common centers of excellence. So if you look at like artificial intelligence, that supports the entire company. If you look at cybersecurity, that's another area that supports the entire company. Just as important on the Critical Infrastructure side, in fact, becoming increasingly important as on the Federal side of the house. If you look at critical infrastructure protection, specifically physical security, electronic security, that supports both sides. We have a common aviation center of excellence where we sell to airports on the Critical Infrastructure side at the FAA on the Federal side. We do PFOS, PFAS engineering as a common center of excellence. We will sell to industrial customers on the Critical Infrastructure side, but we'll sell to the FAA and defense on the Federal side. And the technologies, the underlying technologies are all the same, whether you're talking about cybersecurity, cloud computing, artificial intelligence, data video analytics. Those are all drivers across the entire business. So I'm really happy that we've been able to capitalize on such a great portfolio and drive the synergies across.

Sounds pretty well integrated. Great. So moving on to another financial question. So given that your leverage stood at about 1.4x exiting Q3 and considering that you've got a 3-year target of 2 acquisitions annually on average, can you talk a little bit about your appetite for M&A over the near to medium-term? Are these acquisitions that you have planned focused on either segment or would it be kind of across the business?

Yes, we're going to continue to focus across the business. Out of the 10 acquisitions we've made, 8 of those have been in the Federal segment. This year, we announced 2 that were in the Critical Infrastructure segment. On the Federal side of the house, we've been doubling down on end-to-end cyber solutions and end-to-end space solutions. And I'd say, the culmination of all of those has led to those significant wins that we've had. 9 of the 13 being greater than $100 million came out of the Federal side of the house, including a win with GSA that was $1.2 billion win where we were fortunate and beat some Tier 1 companies. It really shows how our strategy of moving up the value chain has worked. And then on the Critical Infrastructure side, we're focused on 2 areas. One is digital transformation. We're a pioneer and leading digital transformation of Critical Infrastructure and the acquisition of IPKeys showed that. And that we're doing cyber monitoring, cyber compliance for utility and water companies. And we're also doing distributed energy resources management systems and working with renewable energy sources. And then secondly, we're focused on geography. So our acquisition of I.S. Engineers showed that where we doubled down in Texas, I mentioned they're getting $30 billion from the infrastructure bill between FY '22 and FY '26. So we had our presence in Houston. But neither one of us -- we didn't feel like we were strong enough necessarily to prime some of these major jobs coming up, and together, we're able to do that. Pipeline is good. Pipeline is robust. We have a very high financial bar that we have for acquisitions. We look at companies going -- growing greater than 10% top-line, greater than 10% EBITDA margin. And we have not been factoring in cost of revenue synergies as we bought the targets. And we've been able to get the targets generally at about a 10x to 13x multiple with I.S. Engineers being at 7.7x.

Great. I wanted to just ask you about that sort of 2 acquisitions annually on average target. How do you get to that number? I know it's an average, so it could always be more or less. Is there something like scientific about kind of the -- how many acquisitions like you can integrate as an operational thing?

Yes, there's really not. It's about keeping that high bar on the financial, having companies that have technology differentiation. We passed on 100 companies in the last 12 months. So we're always very active in looking at M&A, but it's got to meet that very high bar. 2 just happens to be an average. We did more than 2 this year. But any -- near could be around that.

Typically, we see really strong free cash flow from the company. So maintaining leverage somewhere in the 1s, it can creep up into the 2 range, but bringing it back down to 1, 4 at the end of Q3 was our goal is to kind of utilize the free cash flow and capital deployment, focus on M&A, but not driving leverage up significantly.

Got it. Makes sense. Carey, you talked a little bit about AI, wanted to just dig in a little bit more about that and ask you if you're experiencing any sort of increased interest in the AI capabilities. And can you talk a little bit about which specific mission problems you're solving with those AI capabilities?

Yes. So first, we've been, I'm going to say again, one of the pioneers in artificial intelligence going back to around the 2000 timeframe. It started on our Federal side of the house, where we were trying to find counter-improvised explosive devices out of video analytics. And we were also one of the first company leaders in how you pull together open source intelligence. Fast forwarding to today, we have 100 contracts that involve artificial intelligence across both sides of the business, almost split 50-50. And we have about 30 internal use cases that we're applying. Some quick examples on the Federal side would be, how do you determine what an adversary's next move is going to be in cybersecurity is one application. We use artificial intelligence for counter unmanned air systems for identifying, tracking and detecting. If I move over to the Critical Infrastructure side, some of the applications there would be for asset management. We're also using it for intelligent transportation. So how do you predict if you have an incident occur, how quickly you can reroute, how you perform the rerouting and do the optimization. Internal use cases are kind of need, I guess, Matt and mine's 2 favorite. Matt likes it for cash flow forecasting, as example. And then the other one that's important for us, we actually predict whether or not we're going to win bids through artificial intelligence. There was a recent LinkedIn notes in May published that said we're in the 3 most overlooked companies in artificial intelligence, and I probably agree with that. We try to embed it throughout.

It's fascinating. Interesting. Okay. Maybe just one a little bit about kind of your capital structure here. Parsons is a little unique and then you have an employee stock ownership program, the ESOP. Can you talk a little bit about this program and how fast those ESOP shares are going to convert into the public float? And is your share liquidity improving? And maybe if you could just talk a little bit about the advantages of having an ESOP and how do you use it today?

Yes, sure. I'll take that one. So when we went public, it was just about 80% of the total float was ESOP-related. And so now we're down to, at the end of Q3, 57%, 58%. So about 23% of the shares have come to market, which is a great position for us to be in. We expect it to be 3% to 5% per year, continues to come to market. Out of the 57% at the end of Q3, 40% almost 2/3 of the shares are current active employees. And so that will kind of remain constant we believe. So it will kind of probably start to stabilize around the 50% range we think, but it's really tough to model. So we're -- but we're really happy with the way it's going. We want to get their shares to the public market and it's an increased drive liquidity up obviously. And I think we're really happy with the ESOP program. From a retention perspective, we're different in the way that we retain folks through the ESOP and have them the owners of the company. And so we're really happy with it.

Terrific. I think we're pretty much coming to the end of the time here. So I want to just ask you, any other last comments you wanted to make or any kind of other message you want to leave? I know we covered a lot, so not necessary, but is there anything you want to cover before we wrap it up?

I'd just say, obviously, we're very excited about the position of the company. Very excited about our 6 end markets, all growing. Pleased with our win rates and our very strong organic growth this year and plan to continue driving that trajectory.

Excellent. Well, best of luck with that. I really want to thank you for being here, and thanks everyone for listening. And if you have any other follow-up questions, feel free to reach out to any of us, and have a great day. Thank you all.