PAE Incorporated

Good morning and welcome to the PAE conference call. This conference call is being recorded. At this time, I would like to turn the call over to Mark Zindler, PAE's Vice President of Investor Relations.

Good morning and thank you for joining us on rather short notice. Today, we announced that PAE has agreed to acquire Centra Technology in an all-cash transaction. The press release and presentation slides to be utilized in conjunction with today's call can be found at investors.pae.com. Please take a moment to obtain the presentation slides as we intend to utilize them during this call. We have filed a Form 8K regarding this announcement, and I ask that you refer to that filing as well. Joining me today to discuss the announced acquisition are PAE's President and CEO John Heller and CFO Charlie Pifer. Management may make forward-looking statements during the call regarding future events, anticipated future trends, and anticipated future performance of the company as more fully described on slide two. We caution you that such statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors. These factors are described in our SEC filings. Please refer to our transaction announcement press release for PAE's complete forward-looking statement disclosure. We do not undertake any obligation to update forward-looking statements. Management will also discuss non-GAAP financial measures during this call, and we remind you that these non-GAAP financial measures are not a substitute for their comparable GAAP measures. Management will also discuss projections during this call. These projections should not be relied upon as necessarily indicative of future results. As you turn to page three of the presentation slides, it is my pleasure to introduce PAE's President and CEO, John Heller.

Thank you, Mark, and thank you all for joining us this morning on such short notice. Starting on slide four, I am pleased to announce that PAE has entered into agreement to acquire Centra Technology, an independent provider of high-end intelligence support, information analytics, engineering services, and other advanced technology solutions for $208 million net of tax benefits. This deal represents an exciting opportunity for PAE to expand our intelligence analysis portfolio. As I discussed on our first quarterly call in March of this year, our M&A strategy is focused on extending into adjacent business areas, adding complementary capabilities, and expanding our core addressable market while delivering meaningful synergies. Following the onset of the pandemic and the temporary closing of the credit markets, we had to put our M&A initiatives on hold. As the credit markets reopen and we successfully refinanced our debt structure last week, we are now in position and incredibly pleased to enter into this transaction. And as it is well aligned with our growth strategy, we're excited. Recognized as a premier provider of intelligence and national security mission support, we are incredibly pleased to be adding such a successful business to PAE. Centra maintains long and tenured relationships with critical intelligence, defense, and national and homeland security agencies. And this acquisition will create for shareholders, customers, and PAE and Centra employees. Furthermore, this transaction is firmly aligned with PAE's strategy of expanding the business to higher margin market areas. We expect the transaction to close in the fourth quarter of this year. and once finalized, the business combination will expand PAE's portfolio with access to new capabilities, customers, and highly sought-after contract vehicles. The transaction brings new value-added service and technology offerings to the portfolio, including intelligence analysis, communication systems integration, and research and development services. It's highly complementary aligned with our strategy of providing higher-end managed services with virtually no overlap with our existing customers or bid pipeline. Centra will expand PAE's customer reach and add numerous attractive IDIQ contract vehicles to PAE's portfolio. Moreover, the transaction is expected to be accretive to organic revenue growth, adjusted EBITDA margins, and free cash flow per share. Turning to slide five, let me step back and provide an overview of Centra technology. Centra has approximately 760 employees, about 700 of whom hold TSSCI clearances with subject matter expertise across a wide range of critical national security issues. Their strategy is focused on providing mission critical services to the Intel community and other U.S. national security customers. with very little overlap with PAE's existing customer relationships. As you can see on the slide, Centra has developed capabilities in innovative, high-end market areas that will enhance PAE's strategy of moving up the value chain in pursuit of higher-end government contracts. Centra is expected to generate about $255 million in calendar year revenue, approximately $20 million of adjusted EBITDA, equating to a 7.8% margin, and minimal capital expenditures. Turning to slide six, let me hit home the key highlights and rationale for this investment. As I mentioned earlier, Central will increase our addressable market and will bring new value-added service and technology offerings. We'll share the details on the next slide, but through access to new market segments and new customers, Central will increase PAE's addressable market by about $36 billion and attractive mission-critical business areas. Central will further enhance PAE's stability and financial profile via about $1 billion of backlog, equating to a strong ratio of four times revenue. And as I mentioned earlier, they have a highly qualified and skilled workforce with nearly 700 employees with top-secret clearances and a substantial opportunity to grow the highly cleared workforce across PAE. Moving to slide seven, this illustrates the key tenet of the strategic rationale for this transaction. As PAE is executed with prior M&A transactions, the combination with Centra yields significant incremental addressable market expansion. This is the white space opportunity that you've heard Charlie and I comment on numerous occasions. By combining Centra's capabilities with these new customers, It opens up exciting new market segments for PAE that were previously out of reach. These market segments, Intel Analysis, Intel Training, C5ISR, and R&D Services, to name a few, are all adjacent market segments to PAE's existing line of business and are now actionable and in play. Moving to slide eight. As you can see, Accenture has long-standing relationships within the national security community. These customers are highly complementary with PAE's existing customers and will substantially increase our exposure across the intel community. Furthermore, we will add highly sought-after relationships with a variety of Department of Defense and other federal civilian agencies, further enhancing our customer diversification. On slide nine, this really helps visualize how complementary CENTRA will be to PAE in terms of capabilities, customers, and contract vehicles. As we provided here, there is very little overlap between the two organizations, and this is why we are so excited in terms of the resulting increase to the addressable market and potential revenue synergies. Now, let me hand it over to Charlie to discuss the transaction details and key financial metrics.

Thanks, John. Please turn to slide 11. Before I dive into the specifics of the central transaction, allow me to summarize our recently announced debt refinancing to provide greater clarity around the sources and uses of funds. Last week, we announced the closing of a debt refinancing whereby we paid off our existing credit facilities and raised a $740 million term loan B priced at LIBOR floor of 75 basis points plus a spread of 4.5 percent. We also secured a $150 million delayed draw term loan at the same terms as a term loan B in addition to a $175 million credit revolver. Moving to slide 12, I'll summarize the key financial details of the transaction. PAE intends to acquire Centra Technology in an all-cash transaction valued at $208 million. After adjusting for approximately $7 million of estimated tax assets and including an estimated $4 million in expected annualized cost synergies, the transaction represents a multiple of approximately 8.8 times adjusted calendar year 2020 EBITDA. At closing, net leverage will be about 3.6 times with ample liquidity provided by cash on hand, free cash flow generation, and our credit revolver. We plan to fund the transaction and associated fees with cash on hand and borrowings from the delayed draw term loan. In addition to the strategic attributes that John outlined, the financial benefits are attractive. Increased organic revenue growth and accretion to the adjusted EBITDA margins of free cash flow per share. This agreement was unanimously approved by PAE's Board of Directors, and we expect to close by the end of the fourth quarter of this year. As you turn to slide 13, let me provide a summary of the expected deleveraging profile. As I mentioned, the pro forma net leverage at closing is expected to be 3.6 times. Centers business models extremely CapEx light. They have historically spent about $100,000 to $300,000 in an annual CapEx and have net operating loss carry forwards that PA will utilize. Consequently, through free cash flow generation, tax efficiency, and debt pay down, we anticipate reducing net leverage to about 3.1 times by the end of 2021. Please turn to slide 14. In summary, I'd like to reiterate that this transaction is highly aligned with our growth strategy. We are very excited as the addition of Centra yields benefits to all our key stakeholders, shareholders, customers, and PAE and Centra employees. Shareholders will benefit from an acquisition that is aligned with our long-term strategy of driving organic growth through addressable market expansion, and pursuit of innovative higher-end business. Moreover, the transaction will be immediately accretive to organic revenue growth, margins of free cash flow per share. We will also further improve our financial stability through the addition of $1 billion of backlog. Our customers will benefit from enhanced capabilities and an employee base of highly clear professionals with subject matter expertise in a variety of domains. And lastly, the employees of PAE and Central will benefit from an organization that prides itself on executing against our mission of providing safety, security, and stability throughout the world, no matter the challenge. This combination will create exciting career opportunities as part of a larger company with a greater geographical footprint and larger pipeline of business opportunities. Combined, we will share opportunities access to leading technologies, and training opportunities to enhance careers in a dynamic and newly shaped economy. We look forward to welcoming central employees into PAE as we continue to execute and deliver value for our customers and generate growth and profitability for our shareholders. John and I will now take your questions.

Thank you, Azra. Jim, please press star then 1 on your touchtone telephone. To withdraw your question from the queue, please press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Chris Moore with CJS Securities.

Your line is now open. Hey, good morning, guys. Congratulations. Looks interesting. Can you maybe just talk a little bit more about Centra in terms of ownership? Sure. who owned it, and what was the rationale for selling at this point?

Charlie, you want to handle that?

Sure. Ownership, privately held, is a business that has been built over the years with acquisitions. The owner at this point in time felt that in order to move to the next level, there was a need to sell the company to provide the appropriate capital structure and also a combination of additional capabilities from the acquired company to really take it to the next level for growth. So the timing was appropriate for the seller to move forward and it lined up perfectly with our strategy. And quite frankly, the way we were pulling together the refi and the structure to support that, it was with this acquisition in mind.

Got it. And roughly, what has been the organic revenue growth of Centra over the last five years or so?

The organic growth, if you look at over the last five years, I would say you're talking about – high single digits over the last five years.

And is that sustainable in the near future?

As we look out to the next, say, two to three years, we would expect organic growth to be in the low to mid-teens.

Low to mid-teens. Wow. Okay. And is this... Last one for me in terms of, you know, you talked about lower levels of recompete risk here. Maybe could you just expand on that a little bit further?

There's, from a recompete standpoint, there's nothing significant out there for this customer or for this asset. The value we saw here is that there are multiple IDIQ vehicles that now with the combination of our capital resources, our past capabilities, their performance past capabilities, and also customer relationships have really presented an opportunity for the white space that John was talking about. That's why we're very comfortable with the low to mid-teens organic growth over the next two to three years.

Got it. I appreciate it. I'll jump back in line. Thanks, guys.

Thank you. And our next question comes from Josh Sullivan with the Benchmark Company. Your line is now open. Hey, good morning.

Good morning. So we've got an election coming up here. Can you just walk through your confidence in that they're going to bring to the table, it's going to succeed no matter who we have ultimately winning out in early November here?

Well, as we've talked about before, Josh, and we see the importance of a business and success of a business in any type of political environment, we think the number one thing is diversity and having kind of the ability to shift investment to where the government is making investments. I think the central acquisition strengthens that kind of diverse footprint for us. So I can't handicap the election. I don't have a crystal ball. I think we're better off flipping a coin than relying on me or Charlie to predict the political outcome. I think from our perspective, though, it's always been stay focused on our strategy that we've been executing, PAE's footprint, diverse portfolio has enabled us to grow just very steadily, kind of low-risk profile, services-oriented capabilities, mission-critical capabilities, and Centra fits that model to a T for us. And we think we'll provide more kind of stable outlook to the next three years compared to, you know, where we would have been without them.

Got it. And then just with the new capital structure in place with the refi, I imagine you guys have a stable of M&A targets. Can you describe the size after this that you'd still be willing to do or just what the thought process is on M&A going forward after this deal?

I think we'll continue to participate in what's going on in the marketplace. We're very cognizant of our our goal to manage risk and as a new public company, you know, to maintain a lower risk profile, I think Centra, this acquisition enables us to do that, and Charlie explained that in very good detail. I think the refinancing, though, still gives us the ability to be active, but I would expect, you know, in the next six to nine months that our focus will be on you know, smaller tuck-in acquisitions that could even further expand the addressable market reach of PAE into other national security customers, similar to what Centra has done.

Got it. Thank you for the time.

Thank you, and I'm showing no further questions in the queue at this time. I'd like to turn the call back to Mark Zendler for any closing remarks.

Well, thank you very much for joining us this morning, particularly on such short notice. We look forward to providing our third quarter update on Thursday, November 5th. If you have any questions, please don't hesitate to give me a call. Thank you again, and have a great day.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude your program, and you may now disconnect.