Parsons Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the third quarter 2020 Parsons Corporation earnings conference call. At this time, all participant lines are in listen-only mode, so if you require operator assistance, please press star, then zero. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star, then one. Please be advised today's conference may be recorded. I'd now like to hand the conference over to your host today, Mr. Dave Spilly, Vice President of Investor Relations. Please go ahead, sir.

Thank you. Good morning, and thank you for joining us today to discuss our third quarter 2020 financial results. Please note that we provided presentation slides on the Investor Relations section of our website. On the call with me today are Chuck Harrington, Chairman and CEO of George Ball, CFO, and Carrie Smith, President and Chief Operating Officer. Today, Chuck will discuss execution against our corporate strategy, George will provide an overview of our third quarter financial results, and then Carrie will review our operational highlights. We then will close with a question and answer session. Management may also make forward-looking statements during the call regarding future events, anticipated future trends, and the anticipated future performance of the company. 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 risk factors are described in our Form 10-K for fiscal year ended December 31, 2019 and other SEC filings. Please refer to our earnings press release for Parson's complete forward-looking statement disclosure. We do not undertake any obligation to update forward-looking statements. Management will also make reference to non-GAAP financial measures during this call. We remind you that these non-GAAP financial measures are not a substitute for their comparable GAAP measures. And now we'll turn the call over to Chuck.

Thank you, Dave. Good morning to everyone on the call, and welcome to Parson's third quarter 2020 earnings call on this eventful morning of continued vote counting. We had a great third quarter, and this was against a backdrop of challenging global macroeconomic conditions. We delivered record-adjusted EBITDA while also delivering outstanding cash flow. These accomplishments once again reflect the resiliency of our combined portfolio of federal solutions and critical infrastructure. After the end of the quarter, we announced the pending $300 million acquisition of Braxton Science and Technology Group, Braxton reinforces our strong position in a rapidly expanding space market. We're very excited about joining forces with Braxton. It further expands our cutting-edge space capabilities, our strong government space customer base, and expands our addressable market to include critical ground-based technology systems. This acquisition exceeds all of our quantitative and qualitative M&A thresholds. Now, I'll review a few of our third quarter financial highlights. We reported adjusted EBITDA of $101 million. This is an adjusted EBITDA margin of 10%, achieving on an interim basis one of our long-term financial targets announced during our IPO last year. We also generated $145 million of operational cash flow and ended the quarter with a 1.2 times book-to-bill ratio, driven by 1.5 times in federal solutions. We continue to execute on our goals of winning larger programs and additional OTA awards. We are also simultaneously delivering strong program performance for our customers. Exemplifying these points during the quarter, we won a $300 million contract with a classified customer, doubled our year-to-date OTA awards over last year, and continued to receive high customer satisfaction scores. The above reflects our strong contract performance, which drives margin expansion. We continue our disciplined balance sheet management and execution of our M&A strategy. We recently closed a $400 million convertible note, taking advantage of historically low pricing. Additionally, we protected shareholders by purchasing a hedging instrument that precludes potential dilution below a stock price of $66 per share. The incremental capital we raised in this transaction was very timely. It will enable us to fully fund our Braxton acquisition while leaving the financial flexibility for additional future M&A transactions. The acquisition of Braxton underscores our disciplined approach to M&A. We strive to acquire companies that operate in specific high priority and high growth markets. Our market strengths are aligned with national defense priorities of cyber security, geospatial and radio frequency intelligence, space, C5ISR and missile defense. These markets are enduring and expected to be insulated from budget cuts. Our core technologies of artificial intelligence, autonomous systems including counter hypersonics, cloud computing and IOT are also aligned with the nation's technology priorities. So Braxton is well aligned with Parsons and the nation's top investment priorities. We also like to acquire companies we've worked with in the past and have a strong reputation in the market and that benefit from our scale and broader set of capabilities. Braxton perfectly aligns with this aspect of our M&A strategy. We ensure M&A candidate companies have great technology, exceptional management teams, and are a strong fit with our agile, innovative, and disruptive culture. Braxton meets all of these objectives as well. Braxton also exceeds all of our major financial criteria with revenue growth and adjusted EBITDA margins above 10% respectively, and transaction is accretive. Braxton enhances our margin revenue growth profile and further strengthens our strategy to win large prime contracts within the DoD and intelligence communities. Braxton builds on our strong track record of successfully acquiring and integrating companies. It is consistent with our recent acquisitions of Polaris Alpha, OG Systems, and QRC Technologies. We look forward to welcoming their employees into Team Parsons. Carrie will elaborate further on the Braxton acquisition in a few minutes. In summary, we delivered on another strong and successful quarter. We reported record adjusted EBITDA and record EBITDA margins, delivering outstanding cash flow and achieved a strong book-to-bill ratio. Our operations team continues to be successful in winning large new contracts and OTA awards. Perhaps most importantly, we continue to deliver on our commitments to our customers. We started the fourth quarter by announcing a strategic space acquisition, and this acquisition will further enhance our position in this important and fast-growing market. With that, I'll turn the call over to our Chief Financial Officer, George Ball, to discuss our third quarter financial highlights. George? Thank you, Chuck, and good morning, everyone.

Today I'll organize my remarks into the following five key areas, the income statement, cash flow results, the balance sheet, the contract awards, and 2020 guidance. As Chuck indicated, we had an outstanding third quarter. Strong program execution and our continued focus on cost management resulted in record adjusted EBITDA and margin, and excellent cash collections drove operating cash flow of $145 million. We also opportunistically raised $400 million of additional capital to fund our Braxton acquisition and enable investment in additional strategic growth opportunities. Regarding the details of our financial results, total revenue for the third quarter decreased by $19 million or 2% in the prior year period. This was driven by growth in our federal solution segment, offset by an expected decline in critical infrastructure revenue, consistent with our ongoing strategy to roll off low margin pass-through work. Indirect IGA expenses decreased $13 million from the third quarter of 2019, driven by lower transaction-related expenses and insurance costs. Adjusted EBITDA of $101 million represents an increase of $12 million from last year, and adjusted EBITDA margin increased 130 basis points to 10%. These increases were primarily driven by higher earnings, from unconsolidated joint ventures and lower indirect G&A expenses. I'll turn now to our operating segments, starting first with federal solutions, where third quarter revenue grew by $12 million, or 2%, year over year. This increase was driven by higher business volume on new and existing contracts. Federal solutions adjusted EBITDA decreased $5 million, or 9%, from the prior year quarter, and our adjusted EBITDA margin decreased from 10.4%, to 9.2%. These decreases result from a significant contract milestone incentive fee recognized in the third quarter of 2019, which was not repeated in the current year, and higher pass-through revenue in the current quarter. And now a few words regarding our critical infrastructure segment. Third quarter revenue decreased $31 million, or 6%, from the prior year period. This decrease was driven primarily by lower volume on contracts with significant pass-through revenue. Critical infrastructure adjusted EBITDA increased by $16 million, or 42% year-over-year, and our adjusted EBITDA margin increased 360 basis points, 10.8%. These increases result primarily from higher earnings on unconsolidated joint ventures and lower IG&A costs. Next, I'll discuss cash flow and balance sheet metrics. Net DSO of September 30th, 2020 stands at 69 days, compared to 58 days at the end of Q3 2019. Our third quarter operating cash flow totaled $145 million, driven primarily by strong collections in our federal solution segment. Capital expenditures totaled $6 million in the third quarter of 2020. As noted by Chuck, our balance sheet remains very strong. we ended the quarter with a positive net cash position of $27 million. Taking into account the impact of the $300 million all-cash Braxton acquisition, our pro forma net debt as of September 30, 2020, would total $273 million. This would equate to a pro forma net debt leverage ratio of approximately 0.8 times. Regarding awards, We reported contract rewards of $1.2 billion in the third quarter, representing a book-to-vote ratio of 1.2 times. On a trailing 12-month basis, our book-to-vote ratio is 1.0. Our backlog at the end of the third quarter totals $7.8 billion and continues to represent approximately two years' revenue at our current run rate. Now let's turn to our guidance. Given our strong third quarter performance and outlook for the balance of the year, We are narrowing our fiscal year 2020 adjusted EBITDA guidance range and reiterating the revenue and cash flow ranges initially established on March the 10th. With that, I'll turn the call over to our President and Chief Operating Officer, Carrie Smith, to discuss our third quarter operational highlights. Carrie?

Thank you, George. As Chuck and George indicated, we had a strong quarter from an operations perspective and completed a significant acquisition that bolsters our space presence. I'm proud of our team's accomplishments, given the challenging conditions we're facing on a few of our contracts due to the COVID-19 pandemic. Despite these challenges, we delivered strong cash flow results and a 10% adjusted EBITDA margin for the first time in our history. The third quarter was our strongest year to date for our federal solutions team with a 1.5 times book to bill, and we won large single award contracts, strategic space and cyber contracts, and other transaction agreements. Seventy percent of our total awards in the third quarter were for new business. We also achieved a historical milestone on our salt waste processing facility contract by moving into the operations phase. and QRC Technologies reported the best quarter in its entire history. As you can imagine, I'm very excited about our Braxton acquisition, which positions us well with Keyspace customers. Notable contract wins in the third quarter include a $307 million contract win with a classified customer, $115 million option year on our Combatant Command Cyber Mission Support Contract, where we provide offensive cyber operations, defensive cyber operations, and open source intelligence in support of joint all domain operations. We expanded our rail systems footprint with over $100 million in wins, including a $45 million contract by the Bay Area Rapid Transit District to support the implementation of a communications-based train control system. Once complete, this will be the largest communication-based train-controlled installed system in North America. We've also awarded the TransLink Broadway line of British Columbia, Canada for over $44 million, where persons will design the system elements for the fully driverless rapid transit system, as well as provide system assurance. And after the third quarter, We were selected as the preferred proponent for the Edmonton Light Rail Transit Contract in Western Canada as a 50-50 joint venture partner. This $2 billion program is the second stage of the Valley Line and applies the latest light rail technology. Finally, we were awarded a $51 million Recovery of Air Base Denied by Ordinance, or RADBO, win where we employ the Parsons Developed Zeus Directed Energy System. The Zeus laser can hit targets more than 300 meters away, and it's powerful enough to detonate cluster bombs, landmines, and general purpose bombs. This program is also the first Department of Defense ground-based laser system placed into production. Our momentum of winning other transaction agreements or OTA contracts continues. During the third quarter, we won strategic new OTA contracts, bring our total award value to more than $200 million year-to-date, which is double the amount we had in 2019. Our program execution on the salt waste processing facility contract has also been strong. During the third quarter, we were thrilled to celebrate the start of operations at this facility. Eighteen years ago, the Department of Energy and Parsons embarked on a mission to revolutionize the treatment of radioactive waste produced during the Cold War and contained in the underground liquid waste storage tanks at the Savannah River site. We're now able to process radioactive waste eight times faster than historical treatment rates. The startup of the salt waste processing facility is a testament to the commitment and dedication of the person's workforce at this first-of-a-kind facility. We also continue to be pleased with QRC technology's performance. as we book large orders with the United States Marine Corps and the United States Special Operations Command in the third quarter. These sales demonstrate the continued reliance upon QRC signals intelligence and integrated network survey products by our critical Department of Defense customers. The successful integration of QRC has enabled us to increase high margin product sales and also enhanced our ability to win larger awards. As Chuck indicated, we're very excited to welcome the Braxton employees into the Parsons family. Braxton complements our existing space portfolio, increases our product offerings, and adds critical intellectual property that expands capabilities for the United States Air Force, Space Force, the Department of Defense research laboratories, and the intelligence community. Braxton's broad portfolio of greater than 50 proprietary commercial off-the-shelf products along with the development and sustainment of key government off-the-shelf products, provides mission-critical solutions for spacecraft ground control and spacecraft integration. Braxton's unique mix of products and services solve complex engineering problems, including command control and communications, cybersecurity, and data processing. As the prime contractor for the Satellite Prototyping and Integration Contract, Parsons supports the United States Space Force Enterprise Ground Services Program, or EGS. EGS is a next generation architecture that will unify spacecraft ground control operations across multiple major government agencies. With this acquisition, Parsons is better positioned to capitalize on the rapid space market growth driven by the proliferation of low Earth orbit constellations small satellite expansion, and space cyber resiliency. Braxton has a strong reputation in the industry, a history of technology disruptiveness, and we look forward to leveraging both their technology and their expertise. Parsons is fortunate to have known and worked with Braxton and the space community, and we're collaborating already in areas including space situational awareness and NOAA space weather systems. Our portfolios are extremely complementary and will enable end-to-end space solutions for the warfighter. With synergy spanning space situational awareness, satellite operations, space protection and resiliency, cybersecurity, and space modeling and simulation, Parsons and Braxton together will accelerate growth in the global space market. With that, I'll turn it back over to Chuck.

Thank you, Carrie. In summary... Our team's third quarter execution was very strong. We delivered strong financial results and exceptional program performance for our customers. We also further strengthened our balance sheet with a $400 million convertible note offering. And we quickly put this capital to work with a strategic acquisition that will drive additional growth in our space market. Before we begin the Q&A session, I'm pleased to announce that we will be conducting our first Virtual Investor Day on March 11th of next year. This will be a great opportunity to learn more about our strategic vision, hear from market line leaders, and participate in various Q&A sessions. We look forward to the event and your participation. Now, we'll open the line for questions.

Ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number one key on your touchtone telephone. To withdraw your question, press the pound key. Our first question comes from the line of Sheila Kailogu. With Jeffries, your line is now open.

Thank you so much. Good morning, Chuck, George, and Carrie. First question, maybe, George, for you, looking at the implied cash flow ramp in Q4, it's over 50% of the total, and I know you guys are Q4 heavy, but can you give us some of the major moving pieces around working capital and if any one-off items there?

Certainly, Sheila. As you indicated, we had a nice quarter in the third quarter, building on momentum of the second quarter. Traditionally, the fourth quarter is a very strong quarter for us. As I indicated in my prepared remarks, Federal Solutions was a major contributor in the third quarter. We anticipate significant strength from critical infrastructure in the fourth, including in the Middle East.

Okay. Thank you. And then, You know, maybe another question on the business, just parsing out space and geospatial and cyber and intel, those two businesses were up 37% and 20% in the quarter, so pretty significant numbers, and definitely areas that are more insulated from broader budget trends. Are there any ways to maybe quantify the success that you're seeing in these two businesses, whether win rates, book to bill, sorry if I missed it and if you said it, and just trying to get a sense of the runway for growth?

Thank you, Sheila, and thank you for your questions. We're very bullish on our cyber and intel and space and geospatial markets. Those were obviously both helped and appended greatly by the acquisitions of Polaris Alpha and OG Systems. And our win rates have been very strong, also appended by the larger contracts that we're winning than we had historically won without the acquisitions that we garnered. and our win rates have been very strong. Carrie mentioned a couple of the wins that we had this last quarter, and we continue to be very bullish on the strong growth of those two units and our missile defense C-5ISR unit going forward. Carrie, any additional color you'd like to add to that?

Yes, Sheila. Under cyber and intelligence, we had growth on our combatant command mission support contract And as I mentioned during the remarks, QRC's organic growth was the best it's been in the history of the company. We also had strong organic growth across the whole portfolio of CNI contracts, and our very strong win rates continue there. Within space and geospatial, there were two primary areas. One was our launch manifest system integration contract, and the second one was the T-REX special operations contract.

Okay. Thank you so much.

Thank you, Sheila.

Our next question comes from Gavin Parsons with Goldman Sachs. Your line is now open.

Hey, good morning. Good morning, Gavin. Guys, the pipeline has grown pretty significantly over this year and over the last few years, and we haven't seen that convert to backlog yet. And I know you've discussed the dynamic of awarded but unbooked value with contracts like CCMS. So I guess my question is, one, when would you expect to see that increase in the pipeline actually start to drive backlog growth? And two, is there any way to quantify that unbooked value?

Well, as we've mentioned in the past, Gavin, our approach on IDIQ contracts, be they single award or multiple award, is to book those very conservatively. So although we may have won a billion-dollar contract, or in the case of, say, CCMS, a contract north of $500 million, we're only booking it in pieces per year, whereas I think some of our other companies in the space would book the whole item. So what that gives us is, one, we're never getting too far out in front of our headlights, but two, the confidence that our backlog will continue to build on contracts we've already won but just haven't booked the entire backlog yet. given our booking policies. So we expect our backlog to continue to grow in the next two years at least, but that's where we've got some pretty good visibility. Carrie, anything you'd like to add on that regarding any of the specifics?

I agree with what you said, Chuck, and the two that I would point to in cyber and intelligence that we're currently getting work on would be Combatant Command's mission support contract, and we very conservatively only booked the base and the option year one there. And the other one was a contract called Minotaur, a classified contract we booked last year, and we did receive the Aslan task order in the last quarter on that contract.

Great. That makes sense. Quick clarification, what is the COVID revenue headwind in dollar terms this quarter?

You know, if we look at – And it gets tougher to estimate, Gavin, because one, we're kind of comparing, you know, actual numbers to plan numbers. But you kind of spread it apart. You'd look at federal solutions, for example, and they'd be growing in the high single digits sans COVID. And that's, you know, nominally $50 million of headwinds that we're facing in that market, probably, you know, close to 75 across the portfolio. Yeah.