Morning, everyone. This is Gavin Parsons with Goldman Sachs, and I'm pleased to introduce Chuck Harrington, CEO, and George Ball, CFO of Parsons Corporation. They're going to do some prepared remarks, and then we'll do Q&A after. If you would like to send in any questions, my email is gavin.parsons@gs.com. I'll turn it over to Chuck and George.
Thank you, Gavin. Before I start, I'll make my obligatory declaration that I may be making forward-looking statements. The standard forward-looking statement disclosure applies. I thought I'd just take a couple of minutes and overview Parsons. We're a $4 billion technology company. We have a strong balance sheet, low leverage, about 0.6 turns, so plenty of dry powder. Strong backlog at about two years, 16,000 employees, 3,200 cleared. The majority of those are highly cleared. We operate in two segments, Federal Solutions and Critical Infrastructure. Our Federal Solutions business is focused on four markets: cyber intelligence, defense, predominantly missile defense and C5ISR, space and geospatial solutions, and engineered systems. Our Critical Infrastructure business is in two markets, what we call connected communities, think of all the advanced systems that operate communities, and mobility solutions.
Secondly, cutting across all of those, and part of the synergy we get across these markets, are our four core technologies. We're focused on artificial intelligence. We're one of the government leaders in machine learning, and the associated data analytics. Autonomous systems, think land, sea, air, space, and we include hypersonics in that technology base. Cloud computing, predominantly mission software replatforming, active equivalent server management for our customers, as well as new software platform development, and IoT. This is the hardware and software sensors and the associated communications and high-speed processors that we create. Just looking back a bit on Q1 performance, good solid quarter. We exceeded our internal plan. We reaffirmed our 2020 guidance. I think the thing I'm proudest of is the agility. We immediately took a defensive posture, and this was the first 72 hours, take care of our employees, customers, our suppliers.
We quickly got up out of the foxhole, put the field glasses on, and started looking at the battlefield of how we can help deliver our mission of delivering a better world. Where do we focus in helping our customers? Parsons immediately went into 3D printing face masks. Redirected our 3D printers around the globe. That went to frontline workers and our own employees who needed decontamination. We're working with Battelle on face mask decontamination for the frontline workers, as well as infrastructure for some of our customers. Touchless biometrics. You may have seen some of the press recently about DetectWise kiosks in our mobile laboratories. Digitalization virtualization. We virtualized our SOCs within 72 hours. That's our secure operating centers for our global network that protects them from cyberattack. We brought in some of the technology we developed for our customers.
It's also traffic management centers into cyber. A little bit about where we go and what's our strategy that we've publicly declared. One, we're looking to tie more of our revenues to our four key technologies. It's currently a little over a third, and looking to drive that to a half. More of our revenues to what we call transactional revenues. That's direct software sales, hardware sales, solutions of software, hardware, and services wrapped together, either in a lump sum contract or a SaaS model, or a combination of the two. There's just the potential for continued agile development and rapid prototyping of our COVID response technologies, all around health and safety and restoring public trust to get out into high occupancy areas like airports and transit systems and sporting arenas.
That's primarily our touchless biometrics, physical mods for physical distancing in a lot of these places. The digitalization and virtualization I talked about, going from on-prem to virtual, reducing people in these IT networks and SaaS. Let me just ask George real quick. George, anything that you'd like to add to that?
No, that's very complete.
Well, Gavin, that's our overview. Thanks for the opportunity.
That's great. Thanks a lot. I guess we'll start on COVID-19, obviously most top of mind, given you noted that you reiterated guidance with earnings last week. Is it your sense that the government customer is increasingly adapting to this work environment and that we're kind of past the most significant disruptions that are there and your workflow?
It certainly feels that way, Gavin. Our customers have been incredibly agile on their own part, leveraging video and audio conferencing. Meetings are continuing to take place now in a virtual format, which actually, it makes it a lot easier to have or conduct a meeting this way, quite frankly. You're not taking all the time to get into a government facility and back out again. RFPs are continuing to be issued, awards are continuing to be made, and I think it's been a wake-up call for the entire defense industrial complex, comprised of private companies and governments, that we can't allow things like this to disrupt the important missions that are taking place to protect our nation from cyber attack, missile attack, space interruption on GPS networks, and the like. Yeah, I think that's a fair characterization you made.
If things are relatively back to normal by the end of this year, is 2021 unimpacted, or is there some potential catch-up work as customers try to make up slippage from this year or try to take delivery of products that you couldn't get to them this year?
Yeah, I think the potential for that exists. I think right now what we'd say is steady as she goes as we look next year. No major ups or downs as a result of COVID in what we're anticipating, given what we're hearing from our customers, and what we're seeing in the marketplace. Obviously, as months and quarters roll on, we'll have greater and greater visibility, but that's how I'd characterize it today.
Yeah, certainly. You mentioned the Battelle mask decontamination, the DetectWise solution, kind of some of the opportunities that you have to help, I guess, mitigate the impact of COVID-19. What's the potential sizing of some of those, and then have you gotten orders for either of those two or some others yet?
Yes, we have orders. We're out decontaminating masks now. Been doing that for a couple of weeks, and that's going well. The great side of that is that decontaminated mask, and this is a patented process approved by everyone. Battelle developed it. It's at a much lower price point than going out and buying a new mask. Even if there are rebounds of COVID, say, in the fall or next spring like we saw in the 1918, 1919 pandemic, that's there ready to meet those initial surge needs. Not only is it continuing now, but I think it helps build a stockpile later on, potentially. DetectWise, we hope to be announcing our first contract on that either tomorrow or Monday, or first part of next week. That's the remote, or touchless biometric scanning. We've developed an app to work with our kiosk.
You can answer questions on the app, and then it will scan, take your temperature, and we're also adding the ability to do respiratory rate and pulse rates on that, so you get a full, much richer biometric scanning data. If you pass the test, then you're off into the airport. Right now, we're going to start off testing employees before they go in. That's a pretty high load count. Prove it out, get any feedback or tweaks we need to make to it. That is a paid installation, by the way. Then it's to take it to the front side of the airports. Transit centers, we see this potentially having application to sports arenas, large parking lots associated with large office buildings and government complexes, potentially government installations, borders. It has pretty wide application in that regard.
As well as being able to do the heavier lift we're doing on that is the software programming to be able to link that data right to the ticket so the TSA agent can see if you've taken the test and whether you passed or failed, as can the desk agent and the gate agent.
Yeah, that's great. Sounds like a pretty big opportunity on that one. In as far as how much the government's spending right now and the growing fiscal deficit, what's your view on the multi-year budget outlook? Call it three, five years. Do you think that the government's going to have to cut budgets in the out years?
Yeah. That's an interesting question. We've obviously been spending a lot of scenario-planning efforts on that, and I wouldn't say that we have perfect insight, but 75%+ of the federal budget is going to mandated payments and interest debt processing. You only got 25% or 30% of the budget that's theoretically discretionary in some form or fashion. I can imagine there will be some belt-tightening at the federal level. I think that's inevitable. We've seen that in the past. However, even in past scenarios when that's happened, certain subparts of that federal growth has been forced to grow for one reason or another. As we looked at it and did our long-term strategic planning, because we've been through these cycles before, since the early 1980s when George and I came into the business.
We think, one, the enemies aren't going to reduce their attack vectors on our companies and our national networks. That's going to continue. We don't see the space race slowing down. Part of that is obviously private money, but the other part that we're more concerned about is the investments being made by foreign governments like Russia and China and even India. Space has gone from a very lonely place with kind of one nation controlling more of it. Now we've got a lot of neighbors in space, and things are getting a little more crowded and therefore a little more dangerous. Lastly, missile defense. That tends to be an episodic business. We've been in it since the '50s, and there are eras of missile defense investment, then it kind of goes quiet for a while as those systems are deployed.
We're now in an era where that's got to be amped up for, one, we've got aging infrastructure, but two, there's now the potential for some of our adversaries having hypersonics. That's a whole new game. That's the way we see it, Gavin.
Right. Well, you make a great point, too, in that, does this change the way the government thinks about national security, whether it be in terms of IT infrastructure or, to your point, digital security, if we can't necessarily just rely on hardware, things like that.
Well, in a complex warfare, and I'm not insinuating that this has happened or will happen, but you've got to think about it. You've got to have resiliency, and you have to have sustainability. The last thing you can do is have some sort of disease vector or anthrax or anything else come in and say, "Oh, we can't go to the office. We've got to be able to conduct this. We're going to shut down for a few months while this comes back." If you're playing a basketball game or a football game and the defense decides to go off the field, you score a lot of points during that time out that the other side decided to take. I think we've got to figure out a whole new way of delivering these with or without these kinds of conditions.
Whether it's looking at our highly classified work and saying, "70% to 80% of that really doesn't have to be done in a SCIF, and arguably doesn't even need the highest level of clearance, potentially." You're bringing in off-the-shelf or prepackaged software and integrating it. Maybe the last 20%, 30% of that really has got to be done in a SCIF. Where you can do that really reduces the SCIF load, frees up the amount of available talent you can deploy rapidly. I think these are times of the creative solutions. We are very blessed to have our own Fed DevOps network, which is a highly classified network that we can do DevOps, software DevOps, in our own space, leveraging our own laboratories like one of our flagship software labs is our PUMA Labs and our PALADIN Lab. PUMA Labs supports missile defense.
PALADIN Lab supports cyber. That's in Maryland. We have these scattered around the country so that we have more geographic diversity. Ditto with our high bay laboratories, where we're either integrating satellites. We do that out in a high bay facility out in California, or where we're working on our ZEUS laser systems that can neutralize unexploded ordnance. That we do out of Huntsville. Drones. We have a lot of 3D manufacturing capability that we use for rapid prototyping and these high bay facilities, and we geographically disperse them. Part of that's better cost environments, and part of it is more resiliency. I think you'll see the government looking to do things that way as well.
Got it. Yeah, you talked a lot about your positioning there in some of the other more critical areas of spend. How should we think about, maybe if I take that from a different angle, the size that you are today in federal solutions relative to a couple of years ago, maybe post Polaris Alpha and OG Systems, and how that's both expanded your capability set and your scale in being able to bid more and larger work?
Yeah. There's no question that we've gone from a predominantly subcontract role where we probably weren't one of the names on the top of everyone's tongue to now being at a prime role, especially on some very large mission-oriented contracts. Just to clarify, we're very mission-oriented. We are not necessarily a player on the enterprise IT side of things, and that's by choice. Not that we don't like them both. We think they're phenomenal. Our expertise and kind of the passion of the company is to be really close to the pointy edge of the spear. On those contracts, we've really carved out a great position in our mind and continuing to invest. We've almost doubled our R&D spend this year in our plans, and continuing to create great software and hardware products to deliver the solutions our customers need.
If I wrap all that up, where do you see Federal Solutions growing at over the next few years?
We think the markets that we're involved in can support higher, say, upper single-digit growth in that business. In some years, it may be a bit higher than that. We think that's long-term sustainable. We augment that with the M&A program that we have in place, which was the driver to go public in the first place. Via combined organic and inorganic, we should be able to achieve double-digit growth in that market.
If we look at some of those specific opportunities, obviously GBSD is a really big one. Any idea you can give us on sizing for that and when that could start to contribute?
No. Obviously, the focus right there is really Northrop Grumman is the prime, and they've done just a fantastic job of bringing together a national team of many companies to help deliver on the vision of GBSD and restore the resiliency of our strategic missile defense system. They're in negotiations, discussions right now with the Air Force. The stated contract signing date as originally published was in August of this year. If you assume that that happens, then I could see the team being mobilized and starting work pretty much immediately thereafter and ramping up over the next couple of years. That whole program is probably a 20-year program to deliver the whole vision. Firms that do the engineering, like ourselves, will probably be more engaged in the earlier years of that than in the later years.
As is our practice, we don't typically include things like GBSD in our forecast until contracts are signed and executed. Right now, that's upside to our plans.
Got it. That's helpful. Maybe one more on cyber or the CCMS contract. Can you just give us a little bit more color on what you're doing there? I think that's maybe, was it $500 million-$600 million in total? If we can expect to see more contracts of that sort of size in your pipeline and potential wins.
Yeah. That was a $590 million ceiling contract, Combatant Commands Cyber Mission Support, CCMS. Our scope is cyber and what we call RD T&E, research development, testing, and the ongoing operations, maintenance, training, and exercise. We're continuously managing existing and emerging technology on that contract while developing and delivering and maintaining cyber platforms, the IT infrastructures, the tools and the systems to allow them to conduct their operations. At the end of Q1, I think we had six $100 million contracts awaiting award. One of those was announced. It's in protest. In the pipeline, we have 15 more contracts greater than $100 million with a few of those approximately $1 billion in value. We've had two or three other wins here recently, task orders with Air Force Research Laboratory.
We've got a large win we announced with GSA Special Programs Division, which was mainly for U.S. Customs and Border Protection on ports of entry and non-intrusive inspection and others with Maryland Procurement Office. As we look out, we see more of those in the pipeline and more of those, including the proprietary software and hardware we have through either our acquisition of QRC with the radio frequency kit we have, or OGSystems and the geospatial hardware and software solutions we have there, plus those that we internally developed and showed during the pre-road show technology day. We'll be playing another one of those soon and maybe conduct that in a virtual environment since that seems to be a pretty effective way of conducting these.
Yeah, that'll be great. Following on that, the hardware and software comment, I think earlier you referred to that as transactional revenue. Do you have a rough approximation of what percentage of the business that is today and where you think you could take that or hope to take that over the next few years?
Yeah, that's sub 10% today. I mean, we've been doing this for a while, especially in things like our vehicle inspection business, where we came up with a model that is based on cars. Years ago, we did it in the telecom industry with customers like BellSouth, where we conducted our services on a per installed line basis. We like that model. We are controlling the resources, we are controlling the application, we're delivering a solution in accordance with KPIs, and it really serves us well. Obviously with OGSystems and QRC and products like our DFUSE kit, which we sell out of the U.K. to global police departments, those are all either hardware sales or software sales.
What we've been working on is the productization of that by combining that hardware and software with our corresponding services in a model that gives us one contract with 2 phases, kind of an install contract. It's more of a lump sum contract up front with a tail that gives us those monthly subscription services to keep that updated, maintained, operational, cloud-based for our customers. We see that as a way that we take technology we've developed for one part of the federal government to other parts, as well as the pull that we're receiving to bring that to our critical infrastructure customers as well on a global basis.
Yeah, it sounds like that could have a lot of scalability going forward.
I guess to answer the last part of that, Gavin, what we'd said during our roadshow is our target we're driving to is to get that transactional revenues up to nominally a third of our revenue base.
Got it. Maybe that's the natural interlude to margins. George, feel free to weigh in here as well. On the roadshow, you talked about the aspirational 10% EBITDA margin. What do you need to get there from today? Is that critical infrastructure? Is that federal solutions? Is that accretive M&A? Can you walk that bridge for us? When do you think that is possible?
Yeah. Grace said we' ll take that at a summary level and turn it over to George. The ship's driving that direction. We took actions starting two years ago that put us on this course. We see both segments getting to those margins. We see federal getting there sooner, critical infrastructure following up in 9-12 months. It's a combination of just the underlying work we're bidding and booking. It's the large pass-through costs with low revenues we're letting run out. It's the M&A is all accretive to that as well. George, is there any additional color that you'd like to provide on that?
No, totally agree with that.
George.
Sorry about that. I was on mute. I totally agree with that we're on track. I would say the bigger impact is really the inflow, the intake of new work, which is at higher margins than the work off, and that's true both in federal and critical infrastructure. M&A will play a role to some degree, but I think we'll achieve that predominantly just through reworking the portfolio and bidding and winning work at higher margins.
Presumably, there's a good amount of that in your backlog today, so that's just a steady transition that you have high visibility into.
That's correct. Our backlog today has appreciably higher margins than the day we went public, and we anticipate that that will continue to move up.
Okay. Maybe specifically on critical infrastructure, on margins and growth, are those a trade-off there? Obviously you've got some of the low-margin pass-through work that you're intentionally rolling off, but is there kind of a lever that you can pull that you kind of have to decide between one of the two, margins or growth?
Certainly if you are taking on prime contracts with a lot of pass-through costs, be they equipment material or even labor subcontracts on some of these large program management contracts. Our focus has been driving the bottom line and driving the margins. Yes, there are certain prime contracts, starting about two years ago, we started migrating away from, because there wasn't a way of getting those types of contracts to the margin profile we want. That tends to play very well with the digitalization transformation we're going through as well, which is into augmenting our deep domain knowledge that we've developed on the services side. Not exiting the services side, but staying on that high-end services side and augmenting it with further hardware and software applications, which just add to the incremental revenue on those contracts that also help drive the margins even further.
We also think that long term, on the infrastructure side, on a global basis, there's got to be more higher-end digital tools to, one, drive the cost of infrastructure down, and two, increase throughput on the infrastructure that's there. In the areas that have the greatest congestion, there just isn't room for more lanes or more tracks. We've got to get more people through. Now it's kind of like an added level of complexity. We've got to get more people through at a lower cost while maintaining vastly improved health standards. There has to be a bit more physical separation, which seems like an oxymoron, but maybe it's some sort of enclosures that just keep everyone kind of in their own airspace, so to speak, combined with testing before you enter.
Whether it's on transit systems, what they call the headspace, which is the distance between trains, which things like Positive Train Control that we help roll out facilitate. We got to get the trains running closer together, and we've got to get people through airports more efficiently, as well as roads, and with the ever-increasing progress being made by the autonomous systems. It's inevitable we'll have autonomous transportation, lighter-weight vehicles operating closer together, putting less wear and tear and strain on the roadways. I think all of these things together point to a more digitized electronic future for infrastructure.
Makes a lot of sense. Maybe that's not the highest budget areas of priority for some of those districts funding them. What do you think that end market growth rate kind of ramps up to over the next few years?
Generally, over the longer term, if you look at infrastructure, it's pretty much in line with GDP. Maybe not on an instantaneous basis, because large programs come out in one particular area, drives it above GDP for a short period of time. Other times, you're coming off capital programs might be lower. Over the longer term, it's pretty close to GDP on the physical side. Having said that, a lot of these networks are really outdated and old, and therefore are requiring greater maintenance spend, higher levels of staffing by the government teams to maintain this older hardware and older software. I think to lower their cost of operations and improve their efficiency, that's where the creativity can come in from the private industry. Maybe it's P3-type models, where that electronic infrastructure gets replaced with privately funded longer-term contracts to operate that infrastructure.
That's a change that's just going to have to happen. Otherwise, as we all know, with IT infrastructure, it just gets ever more increasingly difficult to maintain as it gets more outdated and aged.
Yeah. I think in both New York City and D.C., we'd love to sit in a lot less traffic.
Yes.
On the Middle East side of the critical infrastructure business, any slowdown in bookings or activity in the region just reflecting the decline in the oil price?
That's another area we've been pleasantly surprised. George and I took over in our current roles, it was right during the beginning of the global financial crisis. A couple of our competitors who had larger portfolios of smaller contracts started putting out warning signals they were seeing a slowdown. 2008 was a record year for us, only exceeded by 2009, only exceeded by 2010 in our infrastructure business. We tend to be a lagging economic indicator in that regard because of the large nature and generally the critical priority of the things we're working on. In the Middle East, we've continuing to get awards. In fact, we've got a very large looming extension of one of our largest contracts over there that has moved ahead. Staffing has gotten a lot easier as some of the companies have decided to pull out or whatever.
Our perspective that we've seen historically is that those countries tend to take a longer-term view of things like oil pricing. When oil is at $140 a barrel, they don't raise their estimates to $140. When it drops to $20 or below, they don't drop their estimates to $20. They have more of a longer-term stable view. That's looking backward. We're not seeing any material change to that as of this date.
Great. That's helpful. Pivoting to M&A for a minute here. Polaris Alpha and OGSystems and great margins, fast growers, really well-positioned. Is that the type of deal or the type of company that you still see out there in the pipeline, or are those two fairly special assets, and you still should be able to hit your 10% growth and 10% margin hurdle or are there still some gems out there like Polaris and OG?
Yeah, there's no question those were real gems, and we were very fortunate to have had the opportunity to talk to and make sure our cultures were aligned and close on those two acquisitions. Fortunately, we have a very robust pipeline, and we've not seen that pipeline materially increase or decrease, quite frankly, as a result of COVID. We're in discussions with companies now. We obviously aren't conducting any due diligence at this point. Given that we're a very culture-oriented company, and it's a culture of inclusion and a culture of collaboration to really drive innovative solutions like you saw with our rapid development of COVID. That wasn't like a small group of five or six people coming together.
That was 16,000 people in a very orchestrated manner we've done before, submitting their ideas from around the globe, sifting through those very quick, finding synergies, finding areas where marketing and sales teams are saying, "Hey, there's real interest here from the customers." Contracts teams involved, pricing teams involved, all coming together to formulate four buckets of very defined solutions. That culture is so important to us. We have to have companies that share that agility and rapid response and no excuses, let's get her done, and complete transparency. It's a lot to say that face-to-face due diligence is very important to our model, and we are not planning to change that as a result of COVID.
That is obviously going to slow down to, I'll call it more of a pause on due diligence activities until we can get more free access and have really good responses of how we conduct this with the proper PPE and proper social distancing to be able to do it. Having said that, a lot of good opportunities out there that are in the range of and type of QRC that are 100% transactional revenues and high in hardware, software IP. There's good opportunity suites like the OGSystems and Polaris that have IP, that also have a lot of services. There's a few companies out there that are even a bit larger, a bit more specialized. We're pretty pleased with our pipeline right now. Obviously a lot of dry powder.
Yeah, I appreciate all that color. Coming up on time here, so maybe I'll just ask just another couple questions related to free cash flow. George, what should we think of as a normal annual free cash flow conversion ratio and just kind of excluding any one-time items, whether it be working capital slippage, things like that. What's the right free cash conversion?
Best measure, Gavin, would be on the basis of adjusted net income. We would anticipate that on a running basis, we should be at 100% or slightly above each year. 2021, I think, will be a special year. We have an opportunity to liquidate a lot of legacy working capital in connection with mostly critical infrastructure projects and one federal solutions project associated with late cycle milestone payments and retention. Long term, a good conversion metric is 100% slightly above of adjusted net income.
Got it. That working capital, do you have any opportunity to improve the timing of collection, or obviously you've had a couple slippages over the last few quarters, or is that just customers are unpredictable and then that's out of your hands?
The ones I referenced relative to 2021, the answer would be no. They're very contractually driven. Many of them have been extended based upon extensions of time under contractual amendments and the like. We are relatively confident that we will recover the slippage that we experienced in Q1 and referenced on our earnings call. Q2 is actually off to a very good start. We think we'll recover a good chunk of that in Q2 and the balance over the rest of the year.
Great. Maybe final one on days of sales outstanding, do you have a target or a number you think you can work that down to over the next few years?
Our target over the short term on a net DSO basis is 50 days. We were 55 at the end of 2019. As the portfolio becomes more transaction-oriented and product-oriented as we move ahead, in keeping with Chuck's earlier comments, we think 40 days net is achievable. As a short-term target, I would have in mind 50 days.
Okay, great. I think we've come up with time. Do you guys want to give any kind of final closing remarks?
Gavin, we just really appreciate the opportunity to talk today. We just passed our one-year anniversary, which was May 8th, of being public for the second time, and really appreciate the support that the investors and our analysts have shown in the company. Thank you.
Thank you very much.
Very well. Thank you both so much for attending. Thanks, George. Thanks, Chuck. Appreciate it. Take care.
Thank you.
Thanks, everyone.
Take care. Bye