Parsons Corporation (PSN) Earnings Call Transcript & Summary

Thank you, everyone. My name is Sheila Kahyaoglu, the Jefferies aerospace, defense and airlines equity research team. Thanks for joining us for the Parsons story. We have Carey Smith here, who's Chairwoman, the President and CEO; Matt Ofilos, who's CFO. And we have Sebastian Mitchell here, who is my son, who was part of the fireside chat questions practice session at home. So he had some answers for profitability, Carey, that you might not appreciate or Matt might not appreciate.

We look forward to the help.

He wants to hear the real answers. But he's super fascinated by your business, and I think investors are as well, given the interest in the stock and the performance has been quite spectacular. So if folks don't know the Parsons story yet, they're getting to know it really well pretty soon. So if you could kind of talk about what helps Parsons succeed, that could be a great starting point.

Yes. Well, thanks, Sheila, and thanks for Jefferies for hosting this conference. It's great as always. So just a little bit of background on the company today and what helps us to succeed. We're currently reporting in 2 segments. We have 58% in our Federal Solutions segment, 42%, our Critical Infrastructure segment. We have 18,500 employees that are based worldwide in over 25 countries around the world, all 50 states. Within our federal business, we are focused on outpacing near peer threats. So we specifically focus on areas like cyber, intelligence, space, missile defense and electronic warfare. Within our critical infrastructure business, we're focused in markets such as transportation, environmental remediation and urban development. I would say what I'm most excited about is our last 5 quarters of greater than 20% organic growth. This has really been driven by all 4 of our business units hitting on all cylinders. So every single business unit has been double-digit growth. In addition, we're in terrific end markets. When I talk about the 6 end markets that we're in, those all have between 5% to 12% compound annual growth over the next 3 years. Finally, if you look at our long-term visibility, it's very strong. So this year, we have less than 3% of our business. That's up for recompete. Next year, we have less than 10% of our business that's up for recompete. Our backlog is $8.8 billion, and all of that 62% is funded backlog, which is very strong among the peers. Also, we have a $57 billion pipeline. This is one of the largest pipelines in Parsons history. And within that pipeline, we have over 121 jobs that are greater than $100 million. So I would say bottom line, what's made us successful, it's having the right team leading the business. It's having the right strategy being executed at the right time where demand is high in both our federal market as well as our critical infrastructure market.

And if you can't keep up with Carey's numbers, Connor is going to have a note right after this presentation, so don't worry. But organic growth has been 25% plus over the last 4 quarters. And I think the question to ask is not is it going to go down, but how much can it continue at this pace right after you set the 4% to 6% growth target. So maybe if you could talk about the underlying growth in your business and what you think Parsons could go from here?

Yes. So first, I'd say we're very pleased again with the strong organic growth, and it's really a tribute to the team delivering on the strategy and being in the right end markets at the right time. As we look forward, we're going to continue to execute. And as I talk about some of the markets that we're in, again, strong compound annual growth rates and our goal is really to continue to outpace those market CAGRs. I'd say we have the right business development team. We've put the right investment in both organic investment into critical market areas such as artificial intelligence, as well as our M&A strategy, which has made us successful. As we do more acquisitions, and we've been on a pace to do 2 to 3 per year, we continue to move up that solutions integration value chain bid and win more jobs. And so looking forward, I'd say win rates were very high. We're at 76% win rate. Perhaps when we gave the initial long-term guidance, we were planning more around a 40% win rate. And I would say our hiring and retention has been very strong to be able to enable that type of organic growth.

Great. And maybe we'll delve into those 6 end markets, if you don't mind. So first, starting with cyber and intelligence. It's a $13.5 billion market, growing 5% to 6%. A lot of this is classified. But maybe if you could talk about your strategy here on the defensive cyber capabilities and how Parsons thinks about the growth in cyber?

Sure. So I would say in cyber, our addressable market is 8% to 10% compound annual growth rate. What we've achieved through the first half of the year is 27% growth. This is now approaching a $1 billion business as we go into this year. I'm personally very excited about that. When I joined the company back in November 2016, we only had one cyber contract too. So now to be able to say we're approaching $1 billion, we're very pleased with that. It's quite a fascinating market. As everybody knows, we're involved in areas like platforms. A good example is there is we produce a platform that's called the enhanced network visualization environment. It's an enabling capability to basically perform reconnaissance on any network for a Department of Defense and the Intel community. We also developed tools. A good example there is our high-speed packet processing tool that we deliver for the intelligence community. Another thing that I would highlight in the cyber market that's very recent is our acquisition of BlackSignal. BlackSignal is very complementary with Parsons capability in cyber. They bring research and development, whereas we're heavier on the operation. So when you look at the capability, you now have end-to-end full-spectrum cyber capabilities. In addition, BlackSignal plays with different customers than what Parsons does. They are heavier with the Air Force as they're #1. They have a lot of work with the Navy as well as DARPA and parts of the intelligence community. Whereas with Parsons our #1 is Army. We also have work with the Air Force and parts of the intelligence community. So it basically fits together very well and exciting capability that will enhance and continue to help us grow in cyber. I look at cyber in 3 areas. Offensive is your toughest problem to do. 75% of our business is there. Defensive is your middle layer, 25% of our business is there. And then the bottom layer is infrastructure and services, and we really don't play in that area.

Moving on to critical infrastructure protection. I think it's a $27 billion market, 7% to 9% CAGR. These numbers might be wrong because you're blowing through these growth rates. So another hot topic is grid security and investment being made along border security. What role does Parsons play in critical infrastructure protection?

Yes, your numbers are accurate. So it is 27% of Parsons revenue, and we expect around a 6% to 7% growth rate in the critical infrastructure area. So within critical infrastructure protection, our largest customer would be the Department of State, where we're servicing 285 embassies and consulates all over the world. Some of the products that we provide are electronic security systems. We're #1 with the Department of State. We're also #1 with the Army, and we're #3 with the Air Force. So you can think about physical protection, physical security, access control type of capabilities. We also do counter unmanned air systems, where we provide system to system capability to identify, detect, track and defeat an unmanned air vehicle. And that could be everything from a group 1, which is a small handheld vehicle up to a group 5 predator type of system. We're providing that capability for the Department of State as well as the Air Force and some intelligence community customers as well. So this is an area that's been -- had robust growth. We anticipate additional growth. And one of the areas that I would say we're pleased to be top of the market. Untapped potential within critical infrastructure protection is kind of where the synergies come in between our federal and our critical infrastructure business. If you think about water systems getting attacked or utility systems getting attacked or a transportation system, these all have sensors, they all have data. They're all threats for cybersecurity. So Parsons has domain knowledge from our critical infrastructure side of our house in those market areas, but we're also the only company that can come in and protect those markets from a cyber and a physical security perspective.

Got it. And then maybe if we could talk about transportation market, pretty self-explanatory there. What's your growth rate? How do you think about your TAM? And obviously, we've seen infrastructure bills in North America across the U.S. and Canada. How much of that money has been allocated out?

Yes. So with transportation, that represents about 19% of Parsons revenue. We're involved in several areas. We're a world leader in bridges. We've designed and built over 4,500 bridges. We're involved in airport projects. We've done over 400 airport projects. Rail and transit, over 450 projects around the world. And design and build over 17,000 miles of road and highway across 6 continents. So it's a big focus area for us. The compound annual growth rate for the transportation market is 10% to 12%. I would like to highlight in this area some excitement that we've had since the end of second quarter, which we've publicly announced which are 3 terrific wins, the biggest in Parsons history now is a design subcontractor. We were just awarded in Hawaii, the rail and transit extension. It's going to be a 1.6 mile segment. that will be added, and it will connect to the Civic Center from the downtown area. We were awarded in California, the Inglewood Connector program. That's what's needed for the Olympics because it's basically going to connect the Inglewood to many of these stadiums such as the SoFi and the Kia Stadium, a very important project. And then finally, we were just awarded the State Route 400 project in Atlanta, Georgia, where we're going to be putting in some express lines. So this follows 3 significant wins that we had prior year. But again, these are some of the biggest projects we've seen in Parsons history. I would also mention that we don't just do transportation within the U.S., we also do transportation systems in Canada. We were recently awarded the Metrolinx's project around the Greater Toronto region and we're involved in transportation within Saudi Arabia. Some of the jobs we've performed there was the Dubai Metro system, which was the world's largest metro system at the time it was built. Also, we were involved in all the traffic management for the World Cup in Qatar, and we were involved in the Dubai Expo. So these capabilities that we're looking forward to applying in the United States as the United States starts to host in Mexico and Canada, the upcoming World Cup events and for Saudi Arabia.

So we have to look to Parsons for stadium tickets, concert tickets at SoFi and the World Cup.

I'm going to get your son Sebastian some.

There you go. So in terms of just those 3 contracts you mentioned, quite big values. How do we think about the revenue trajectory of those if you're allowed to disclose them?

Yes. So generally, I would say, because we are a design subcontractor, most of our work is upfront. So it will range over about a 3- to 5-year period.

Okay. Next up is environmental remediation, and we've been bothering Dave Spille about your PFAS opportunities and such. So maybe if you could talk -- I'm pretty fascinated by it. You have a large mine reclamation projects there. Can you talk about how you think about the environmental remediation market.

Yes. So environmental remediation, we are involved in mine reclamation, 2 of the world's largest abandoned mines up in Canada, Faro and Giant mine, and we've won those recompetes for the next 12 to 20 years. We also are involved in oil plugging and abandonment. So if you have an abandoned oil well, we've developed a filter that basically prevents methane leakage from those oil wells. And then PFOS, PFAS, perhaps the most exciting part of that market where we're looking at a total market of about $220 billion, about $40 billion of that being addressable for Parsons. We've had a research and development laboratory for over 3 decades up in Syracuse, New York, where we've developed some exciting advanced destructive technologies. Most recent one is called our hot ESCO technology. So it basically has the capability to destroy on the spot PFAS. Whereas other technologies will take your PFAS molecule and they break it up into smaller molecules. Our technology actually destroys in on the spot. We've done 2,000 investigations for PFAS. We've done 7,000 point-of-use treatment systems. We've designed, built and operated 4 large PFAS treatment plants for industrial clients. So again, very exciting area where Parsons plans to address the full life cycle of PFAS.

And how do we think about your current revenues from that market today?

Yes. So today, it's less than $100 million. So we see significant opportunity there for the future. That market is expected to peak in about the 2032 time frame.

And I'm saving all the Middle East commentary for your urban development business. I think it's about $1 billion business in the Middle East today. Maybe if you could talk about the major growth drivers. It's been in the news in terms of the projects, whether it's NEOM or Oxigon. If you could talk about the progress on those programs?

Yes. So we've been in the Middle East for 6 decades. We've been in Saudi Arabia 5 decades. We have a 50-50 joint venture partner with the Saudi firm. So we're really seeing a Saudi company. I would say we're probably the best branded program manager within the Middle East today, have extremely high win rates based on our reputation of being able to deliver. So nearly every large project going on in Saudi Arabia Parsons has a footprint and we're one of the integrated delivery partners for NEOM on the line. We are the program manager for NEOM, Oxigon. We're one of the integrated delivery partners for Qiddiya, which is going to be the world's largest entertain city being built outside Riyadh. We were just awarded also a brand-new resort that's going to be in the southern part of Saudi Arabia. We won the Riyadh rings and roads contract that's focused around Riyadh. We're also involved in Diriyah gate, helping to restore Saudi Arabia's history. So as we look forward to Saudi Vision 2030 and in the Middle East, $1.5 trillion of spend, half of that going into Saudi Arabia, very well positioned, also well positioned in the UAE and Qatar.

Maybe the last of your end market space and missile defense. This was also, in addition to cyber, one of the markets that was nonexistent when you first joined, I believe. Can you size how much of your revenues are from space and missile defense. And I think it's actually your slowest grower, still growing steadily. How you think about that growth and where you've invested, whether it's satellite as a service or missile defense.

Yes. So within space and missile defense, comprised about 11% of Parsons revenue. And what we do there, first, I'll start on the missile defense side, so that's a contract that we've had for over 4 decades. We support the Missile Defense Agency as system engineer and integrator involved in every aspect of what goes on MDA's mission. If I move over to the space side of the house, this was a business, as you mentioned, that did not exist in November 2016. We got in very selective areas there. And we got into space domain awareness where we were providing space domain awareness for Department of Defense and the Intel community. And then we just were awarded the TraCSS contract, which is going to be the Civil mission that's under Department of Commerce. That also has some international potential as we start to look at roles of the road with our allies across the world. We do space launch, and so we got involved very early on in launching small satellite systems as we try and put a disaggregated architecture up in the space to prevent any single-point failures. We've been involved in over 170 ground system contracts supporting customers from commercial to civil to the Intel community. So satellite, service, I'll hit on for a minute. We've come up with some disruptive business models. Great example of satellite service where we buy the infrastructure, we buy the antennas, and we have the government coming in and buying time from us. It's a win-win model. They don't have to spend to purchase the infrastructure. And for us, we only purchased at once, and so that helps to be margin accretive.

What are the main budget areas where you look at for growth for space and missile defense?

Yes, I would say across our whole company within federal, it's really the RDT area. We play on our customers' emerging missions. So we're always focused on how do we solve their problems of tomorrow. We're not a company that goes after other companies recompetes, but it's rather knowing where our customers are ahead of? What are their most critical, most complex problems that we can help to resolve?

We talked about what's driven your growth rates above expectations. How do you think about -- maybe can you talk about your win rate again? Was it above 70% or 40%. I forgot which one you mentioned.

Yes. Our win rate in the first half of this year is 76%. That's comprised of 70% on new business and close to 100% on recompete through the second quarter.

And what do you think drives such above industry growth rates? Is it your pricing? Is it your bid strategy? Is it work on prior programs?

Yes. So on both federal and critical infrastructure, it's really driven by technical capabilities. We do not -- try not to get into cost competition. So it's really how are we the #1 technical provider. Because we're solving emerging problems on both federal and critical infrastructure, it's always leaning forward where customers are looking for something that has never been done before and solutions kind of with a clean sheet of paper approach. I think we have a very strong team. I think we're in very strong markets. We've increased our business development capacity. And then I would say with customers, I call it a land-and-expand strategy. So when we get with the customer, we have the ability to land, we win the work. We show that we can deliver, we show that we can execute. We drive on contract growth, then we're able to expand into other areas.

And we don't often like to look at backlog as a lead indicator, which I know sounds ironic, but with Parsons, we do because I think your booking protocol is very strict. So when we think about your $13 billion of unbooked value, $6 billion of awards awaiting notice in the pipeline of [ 57 ], how do we think about that conversion over the next few years?

Yes, I'm look at Matt talking here.

Yes. There we go.

Yes. So to Sheila's point, we have just under $9 billion worth of backlog, which is your traditional bookings and what drove book-to-bill. And then we have a $13 billion awarded to Parsons, but that has not flowed into our backlog yet. The reason is that future contracts, whether it's -- it is Parsons -- it's sole sourced to Parsons. But in some cases, it's option years. So as we get to whether you meet a scheduled time line or you meet the ceiling. So it's really an opportunity for us to drive work to the vehicles and achieve the option period. So that work is from a period's perspective, that's 100% probability that, that will come to Parsons. That makes up about 50% of the $13 billion, and then the rest is on us to bring work to the vehicles, but we have 80-plus percent success on bringing work to those vehicles on the ones that we've won in the past. So over the next 5 years, Sheila, I think, 50% will flow through over the next 3. So we're feeling really good about this.

So 50% of that $13 billion will flow through?

Yes.

And the change from the $14 billion you had prior was that it moved into actual backlog.

Yes. So you heard Carey talk about the team's contract. That's the MDA job that we had. So we've met an option year period, so $400-plus million flowed into backlog. And so kind of just rounding were down. It looks like $1 billion but came down about $600 million.

And as we think about your revenue growth, what's the recompete risk? This year, you only have 3% left. How do we think about '25 and '26 again?

Yes, I'd say in a normal year, you see about 10% of revenue from recompetes. That's kind of a normal run rate for us and most of our peers, I would say. When we look at next year, we were at 10%. Last quarter, we expect by the end of the year, it will be below that. So we can probably think 6% to 7% by the end of the year for 2025.

So very little deduction, but that $7 billion kind of converts...

Work out for recompete, yes.

Yes, I would add to that. We were very fortunate. We have 4 programs that were over $2 billion, and we secured each of those recompetes and those are secured for the next 7 to 20 years.

And I think one of the things that's a distinction with Parsons, whether it's your revenue growth or your LinkedIn page is the way you treat your employees and clearly, that manifests itself in the growth that you have. How do you think about investing in your employees, whether it's hiring, recruiting and the attrition you're seeing in the market?

Yes. So we've been very successful in both hiring as well as retention. Obviously, that's what's driven our greater than 20% organic growth over the last 5 quarters. I think we're a different type of company, which we're very proud of. We are -- we have capabilities like a large business, but we operate with agility and innovation of a small business. So what that enables us to do is get operationally relevant solutions to our customers very quickly. Employees come to Parsons because of the mission and the opportunities as well as the culture of Parsons. And once they come there, we like to call them destination employees because they stay. We've put in place some great initiatives such as a Chief Technology Officer organization, where the CTO sits at the executive leadership team, and we have one in each of the 4 business units. We have a dual technical career path. As a master's in electrical engineering, the one thing I don't want to do is lose great engineers that feel like they have to go in management to be able to move up the career ladder. So we put in place a mechanism where these great technical people can stay. We also put in place a technical fellows program, which are kind of the best of the best across the company. So I would say also success breeds success. We have been winning a lot of work. We're winning these exciting projects in both federal and critical infrastructure and people are really anxious to come to Parsons and have the opportunity to deliver on these opportunities.

Yes, Sheila, I'd probably add to that, Carey, was in Hawaii last week. But we have so many employees that are attached to the mission. So winning some of these early on programs, research and development type programs folks want to be involved in the next mission, I would say.

Great. And in terms of maybe just to talk about profitability. Starting on profitability from a total company level, you target 20 to 30 bps of annual margin expansion. Help us understand the operating leverage dynamics, any contract mix that you'd call out over this year or next year, especially with the win rates you see?

Yes. So I'll take that one, Sheila and Carey can add in. But I would say really in great shape this year. Year-to-date, we're north of 9%. We're at 8.9% midpoint on guide. Company has been performing quite well. Our federal business specifically, Carey and I, a year ago, would have told you that kind of low to mid-9s was a good position for us to be. . If you think about the structure of the federal work that we do, a lot of it is kind of front end and kind of new work, so you want to be in a cost type. And then with cost type you're kind of structurally limited from a margin expansion perspective. But what we're seeing is a little bit of a mix shift, a little bit more on the fixed price side. So through the first 2 quarters, federal was over 10% both quarters. Carey and I are still thinking kind of high 9s is a good place. We've talked a little bit about that. GSA-FedSIM wins. So there's a couple of hundred million dollars' worth of growth that will come from cost type over the next 12 to 18 months. But I'd say federal is in a great place. We really see opportunities within the infrastructure business. Infrastructure is kind of low to mid 7s right now. If you think about -- if we normalize for -- we've talked about some challenge programs that we had. And so when you normalize for the headwind from those programs from a margin perspective, the infrastructure business is also running kind of high 9s, low 10s through Q1 and Q2. So the underlying performance is there. The contracts that we've won are accretive to the company and infrastructure is trending toward that double digit. So as an overall company, 20 to 30 basis points per year, with the majority of it coming from critical infrastructure. So I think 40 to 60 basis points per year from the low 7s will get us -- trend us towards double digits over the next few years.

Just a couple of events there. I would say. So at the Parsons level, we have about 63% fixed price, time and material and 37% that is reimbursable. To Matt's point, the opportunity, we have 71% fixed price, time, material within the infrastructure business. So that's where we expect the delivery. Federal has about 58% fixed price, time and material. A lot of levers that we're pulling. One is demand is greater than supply. So I already mentioned that we really compete on technical capabilities. So the work that we're bidding, we're able to get higher margins. We've held our SG&A as our revenues increase. So we were at 13.4% SG&A as a percent of revenue, and that's down from over 16% just a year ago and 18% the year before that. And then our acquisitions are accretive. So we're buying companies at greater than 10% EBITDA margin.

And maybe just on that point in terms of fixed price. You've disclosed better profitability this year mostly due to better fixed price mix. And I think you've talked about fixed price having 400 basis points of better profitability, but I might be putting numbers in your mouth, Matt. So let me know if I'm wrong. Does that normalize? Or do we kind of continue that trajectory? And there's no dilution from the new work?

Yes, I would say, again, the mix -- I think the mix shift is probably about appropriate right now given the amount of fixed price work that we've won within the federal business. As I mentioned, a fair amount of growth is going to come from cost type given the kind of demands on the customer set. So I think the current mix is a reasonable number. And you're right, Sheila, the fixed price is about a couple of points ahead. So -- yes.

So we could reach double-digit margins as we think about the next few years, but no stated deadline on that?

Yes. Carey has long-term goal is to get to double digits. It's kind of the slope at which we get there. We're coming out from, I think Carey's talked about legacy programs, wrapped one up in late Q1. We've got the second one wrapping up in late Q3, call into September, early October, so before our next earnings call. So hopefully, we'll have those 2 behind us. And then we've got another contract that we've worked through some supply chain challenges. Hopefully, we'll have that kind of behind us by the end of the year as well. So again, the underlying normalized business is running kind of towards double digits. So that's carrying as a long-term goal.

And I want to leave a few minutes on your M&A strategy because it's been really critical. It seems like Carey has friends that have great businesses that you continue to buy. So maybe if you could talk about your M&A strategy, what are the hurdles to acquiring an asset?

Yes, when we look at M&A, we're looking at greater than 10% top line growth companies and greater than 10% EBITDA. We are buying in both segments, federal as well as critical infrastructure. On the federal side, we're going to stay laser-focused on outpacing near peer threats. Where is that matter that includes cyber, space, intelligence, missile defense and electronic warfare. BlackSignal being a great example of that. Within critical infrastructure, we're focused on digital transformation. We believe we're one of the companies leading the digital transformation of critical infrastructure. So continuing to acquire there, as well as looking at our top Tier 1 states, which we would call Texas, Florida, California, New York and New Jersey. You can expect to see us do 2 to 3 acquisitions this year. We've obviously played a BlackSignal so far. And likewise, as we head into next year. We have bought over the last 5 years, 11 companies. And for almost every year, we've bought one company that's greater than $200 million.

Maybe in terms of the specific deals, Xator, BlackSignal, Sealing Technologies, each of them have brought an end market capability. Can you touch upon like how you think about the revenues of these businesses and how they performed over the last year since you've acquired them?

Yes. So I would say all of them are very happy with. And it goes back to our thesis cyber has been a key focus area for us BlackSignal, as well Sealing Tech brought cyber. Sealing Tech also brought defensive cyber operations, whereas BlackSignal helped us double down in offensive cyberations. BlackSignal also brought the electronic warfare capability, signals intelligence, very counter space capability, very complementary to the capabilities we have within Parsons. Xator, I'd say, was also a game changer. Xator has really delivered for us. It gave us an entree into the Department of State where we now have a customer that we cannot just sell Xator capabilities, but we can sell all the Parsons capabilities. And one thing we did when we acquired Xator, we took our like markets such as we both did electronics systems security systems. We also both had counter unmanned air systems, and we both have biometrics. We actually took the Parsons portfolio. We put it under the Xator leadership. We felt that they were stronger. That did 2 things. They retain their founder, it retain the people, and it also helped us faster grow.

Last one on M&A. How do you think about capital deployment priorities from here, given your leverage is that 1x or lower depending on how much cash you have today on the balance sheet, but -- and how active is the market.

Yes. So our current leverage is at 1.3 pro forma with BlackSignal would be around 1.6 to 1.7. So we're going to continue to focus. That has really driven Parsons growth. When you look at our ability to move up the value chain, differentiate us a solutions integrator through software and advanced technology, be able to bid and win larger jobs, 15 greater than $100 million last year, over 11 greater than $100 million in the year prior. M&A has really been a differentiator for the company, putting together those full spectrum capabilities. We do have $100 million authorized for share repurchase. Within the last quarter, we used $10 million of that. So there is $90 million available, but we are sensitive that because we have an ESOP, there also isn't that much float. So you can still look to see us do more M&A.

Well, thank you, Carey. Thank you, Matt, for being here. And thank you, everyone, for listening in.