Parsons Corp

NYSE:PSN

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, everyone. At this time, I would like to welcome everyone to the 2020 First Quarter Parsons Corporation Earnings Conference Call. [Operator Instructions].

Now I would like to turn the call over to our presenters. Mr.Dave Spille, you may begin your conference.

[David Spille, VP, IR]

Thank you. Good morning, and thank you for joining us today to discuss our first 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; George Ball, CFO; and Carey Smith, President and Chief Operating Officer. Today, Chuck will discuss execution against our corporate strategy, George will provide an overview of our first quarter financial results and then Carey 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 Parsons' 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.

I now will turn the call over to Chuck.

[Charles Harrington, Chairman & CEO]

Thank you, Dave. Welcome to Parson's First Quarter 2020 Earnings Call. First, I want to express our deepest sympathies for everyone that's been impacted by the COVID-19 pandemic. This outbreak has been a tragic event. It has taken the lives of many individuals and further disrupted the health of many more. COVID-19 has had varying impacts to families and businesses around the world. It reminds us that the true measure of humankind is not our responses in times of normalcy but how we rise to the challenges of adversity.

And at Parsons, we've been very fortunate to have had minimal impact to both our financials and staffing as a result of COVID-19. Those impacts that did arise were compensated by offsetting increases in other areas as billable hours have been down by less than 2% and COVID-impacted revenues were down approximately 1%. Where impacts did occur, our customers have been in communications with us on the plans and processes to returning to work in a safe manner, consistent with CDC guidelines.

We recognize we're working in a fluid planning environment. We assume the environment will continue to evolve as we progress through this pandemic, and we're scenario-planning accordingly. As I stated earlier, we are fortunate that we've not experienced any material contract delays or cancellations nor major displacement of our employees. Our customers have been supported during this public health emergency, and they enacted policies to maintain their mission-critical programs.

From a federal government perspective, the CARES Act legislation is an effective tool against lost productivity. It enables agencies to reimburse contractors that have employees who cannot work on a full-time basis due to work site closures or remote work policies or personnel quarantines. And additionally, the Department of Defense identified our industry as mission-critical, and that has helped as well.

These efforts enacted by our customers are beneficial to our nation. First, they allow the federal government's defense industrial base of highly specialized technical and management personnel to remain employed. They've also allowed the defense industrial base employers to remain financially stable. Perhaps most importantly, it's allowed our national security to be maintained in the ongoing competition for cyber, space and missile defense supremacy.

Regarding Critical Infrastructure, given the large and complex nature of our projects, the overwhelming predominance of our programs have been deemed mission-essential to date. These projects improve the safety, security, mobility and healthy lifestyles for residents while contributing to each region's future economic growth.

Internally, we proactively -- we're proactively addressing the realized and potential impacts to our programs from COVID-19. In partnership with our customers, we promoted telework, ensured contractual coverage and redeployed resources. As I stated previously, to date, this has resulted in immaterial impacts to our billable hours and has not impacted ongoing integration of our most recent acquisition. We continue to identify opportunities to further align our overhead investments with our strategy while growing our business development and bid and proposal budgets. We flexed our policies and programs to maximize benefits to our employees.

The president's 2021 defense budget request released in February continues to align with our strategy. Parson's primary core competencies in artificial intelligence and machine learning, cyber, hypersonics, space and missile defense were all prioritized and appear to have bipartisan support for funding. Authorization and appropriations still need to occur, but we're encouraged by current congressional support and our position in these key markets and technologies.

Now I'll move to our first quarter financial results. We reported record first quarter revenue, achieved profitability above our internal Q1 plan, won high-end work in our Federal Solutions market and invested in our people, processes and technologies. In addition, we continue to maintain one of the strongest balance sheets in the industry.

In terms of our first quarter financial results, we delivered total revenue growth of 7%, which includes organic growth of 11% in Federal Solutions and 2.5% in Critical Infrastructure, which were all ahead of our internal plan. We also achieved an adjusted EBITDA margin of 6.2%, which, although below Q4 2019, exceeded our internal plan as the first quarter of each year has historically been our lowest margin quarter; and a book-to-bill ratio of 1.0x, which was driven by 1.3x in Federal Solutions.

Parsons' first quarter is historically our lightest revenue and adjusted EBITDA quarter. This is generally due to lower award fees, seasonality and ramping up of new contracts, combined with the overhead expenditures we invest in to make sure that our teams are aligned both strategically and operationally for the upcoming year. The revenue impact from COVID were approximately 1% of revenue and were offset by strong execution of our contracts and recently won new business.

We reported our second consecutive quarter of double-digit organic revenue growth in our Federal Solutions business, and we're maintaining our guidance issued earlier this year. Our balanced and diversified portfolio has been and will continue to be a strength. Our revenue is now almost evenly split between our 2 businesses, and we have financially stable government customers in both segments.

Our Federal Solutions team continued to execute well by winning key pursuits and posting strong win rates. We won 3 single-award contracts of approximately $100 million each and other classified cyber contracts. Additionally, we had important contract wins in our Critical Infrastructure business in both mobility solutions and connected communities markets.

As we indicated in our conference call last quarter, we're increasing our investments in our people, processes and technologies in 2020. This will ensure we maintain our competitive edge in higher-growth and higher-margin markets that collectively drive our future growth. We're investing in critical areas that drive growth, including business development, research and development and recruiting, retention and training of our talented employees. Additionally, we have recently added key Federal Solutions executives to support and accelerate our growth in strategic markets.

We've strategically maintained our strong balance sheet by being selective in our M&A targets and prudent in our strategic investments. As a result, we've maintained low leverage and over $400 million of undrawn revolver capacity. Our strong financial position, combined with our deep backlog, positions us well to weather COVID-19 uncertainties.

A key aspect of Parson's culture is our commitment to core values. In recognition of our commitment to integrity and innovation, Parsons was once again recognized for its ethics and IT leadership. For the 11th consecutive year, Ethisphere, a global leader in defending and -- in defining and advancing the standards of ethical business practices, named Parsons as one of 2020 World's Most Ethical Companies. We were also named to the CIO list of the world's 100 most innovative companies.

Building on these core values, I'm truly inspired by the support our employees have provided to our communities and customers during these challenging times. Our President and Chief Operating Officer, Carey Smith, will discuss our focus on the safety and well-being of our employees and the development and deployment of new market solutions that have resulted from COVID-19. These capabilities will help in what we and many others are referring to as the new abnormal operating environment as well as in any future pandemic crisis.

Epitomizing our core values of safety and innovation, I am so proud of the Parsons team employees across the U.S. that initiated an effort to print 3D face masks for both our employees and health care professionals. These masks keep our employees safe while enabling them to perform our customers' critical missions. I'm also grateful for our team working with a municipal client to sanitize public areas to help prevent the spread of COVID-19.

At Parsons, our employees have always been the foundation of our 75-year history of excellence, and we look forward to upholding that legacy during COVID-19 and fulfilling our corporate purpose of delivering a better world.

Finally, I want to highlight the corporate social responsibility report we published on Earth Day, April 22. Our CSR, an integral part of our corporate culture, is closely tied to our core value of sustainability and to our corporate mission to delivering a better world. This report illustrates our commitment to successfully delivering on our customers' missions while reducing our carbon impact, improving society through our charitable support, our inclusion and diversity initiatives and by adhering to the highest level of ethical standards.

In summary, we had a solid first quarter. We reported strong organic revenue growth; achieved profitability results ahead of our internal plan; won significant large and high-end technical contracts; invested in our people, processes and technologies; and maintained our strong balance sheet. I'm also very proud of our employees. It is in times of turbulence when true leaders emerge, and I'm thankful for the way the Parsons team has risen to the challenge and protected our communities while delivering on our customers' missions.

With that, I'll turn the call over to our Chief Financial Officer, George Ball, to discuss our first quarter financial highlights. George?

[George Ball, CFO & EVP]

Thank you, Chuck, and good morning, everyone. Today, I'll organize my remarks into 5 key areas: the income statement, cash flow results, our balance sheet, contract awards and 2020 guidance. I'll also discuss certain financial metrics on an adjusted non-GAAP basis, where doing so provides a meaningful comparison to prior financial results.

As Chuck indicated, we had a solid first quarter and reported revenue and profitability results that exceeded our internal expectations. Total revenue for the first quarter increased 7%, with strong organic revenue growth of 7% as compared to the first quarter of 2019, driven largely by Federal Solutions which achieved organic growth of 11%.

GAAP-based indirect SG&A expenses increased $6 million from the first quarter of 2019. This increase was due primarily to additional costs associated with strategic growth initiatives; the impact of acquisitions, including increased intangible asset amortization expenses; public company costs; as well as various positive overhead adjustments which occurred in the first quarter of 2019 but did not recur in this year's first quarter. These increases were offset by a reversal of approximately $8 million in accrued compensation costs related to legacy equity-based programs linked to changes in the company's share price.

GAAP earnings per share for the quarter increased to $0.13 per share and adjusted EPS decreased to $0.33. Adjusted EBITDA of $60 million represents a $12 million -- represents a decrease of $12 million from last year, and adjusted EBITDA margin decreased to 6.2%.

I'll turn now to our operating segments. Starting first with Federal Solutions, where first quarter revenue grew 13% year-over-year. This increase was due to organic growth of 11% as well as contributions from recent acquisitions. Federal Solutions adjusted EBITDA decreased $9 million from the prior year quarter, and our adjusted EBITDA margin decreased from 9.6% to 6.6%. These decreases were driven primarily by an increase in volume on contracts with higher subcontractor and material costs and an increase in SG&A expenses due in large part to various favorable overhead adjustments which occurred in the first quarter of 2019 but did not recur in the current year quarter.

Now a few words regarding our Critical Infrastructure segment. First quarter organic revenue grew 2.5% year-over-year, driven by on-contract growth. Critical Infrastructure adjusted EBITDA decreased by $3 million and adjusted EBITDA margin decreased from 6.5% to 5.8%. These decreases were driven primarily by lower equity and earnings from unconsolidated joint ventures in the current year quarter. Next, I'll discuss cash flow and balance sheet metrics. Our DSO at March 31, 2020, stands at 64 days compared to 61 days at the end of the first quarter of 2019 and 55 days as of December 31, 2019.

During the first quarter of 2020, we used $119 million in operating cash flow compared to a use of $60 million in the prior year period. The increase in outflows was driven primarily by payment of previously disclosed legacy long-term incentive compensation plans linked to the company's share price. Operating cash flow was also impacted to a lesser degree by slower-than-anticipated collections in our Federal Solutions segment and in the Middle East within our Critical Infrastructure segment. Capital expenditures totaled $13 million in the first quarter of 2020, in line with expectations.

As noted by Chuck in his opening remarks, our balance sheet remains very strong. At the end of the first quarter, gross and net debt were $314 million and $195 million, respectively, as we ended the quarter with a net debt leverage ratio of 0.6x. We closed the quarter with over $400 million of undrawn capacity on our revolver and are in the same position as of today. Regarding awards, we reported contract awards of $966 million in the first quarter, representing a book-to-bill ratio of 1.0x. On a trailing 12-month basis, our book-to-bill ratio is also at 1.0. Our backlog at the end of the first quarter totaled $7.8 billion, representing approximately 2 years revenue at our current run rate.

Now let's turn to our guidance. We are reiterating all of our 2020 guidance ranges provided on March 10, as outlined in our earnings press release issued this morning. We expect to achieve these results on the strength of continued organic growth in our Federal Solutions segment, recognition of higher performance award fees across the entire portfolio and targeted cost reductions centered in our Critical Infrastructure segment.

With that, I'll turn the call over to Carey to discuss some of our first quarter operational highlights. Carey?

[Carey Smith, President & COO]

Thank you, George. As Chuck and George indicated, we had a solid first quarter. I'm impressed by the actions our employees have taken to stay safe, to help our communities and to deliver on our customers' missions. We've been proactively monitoring and managing the COVID-19 situation and holding daily corporate response management team meetings since January. We mobilized quickly to ensure the safety and health of our employees, establish contractual coverage and still accomplish our customers' critical mission requirements.

Today, I will cover 2 areas related to COVID-19: first, how we're handling operations; and second, new business opportunities, both in response to the current pandemic and for preparation of response to future pandemics or bio threats. From an employee perspective, we've been protecting the health and well-being of our employees and enabling them to work productively from remote locations. Across Parsons, we produced and delivered over 1,000 3D-printed face masks to protect our employees and donate to local health care providers.

In addition, we increased the frequency for sanitizing facilities, redeployed staff that were impacted by a lack of customer work and enhanced leave policies. We deployed information technology equipment, and now nearly 90% of our staff is working remotely. And finally, we virtualized our security operations center, enhanced our cybersecurity protections and ensured continuity of operations across the portfolio.

From a business process perspective, our programs have been largely classified as mission-essential, and we've obtained permission for remote work. Working with our customers, we've assured contractual coverage and closely monitor potential program impacts in line with the federal, state and local guidelines. And importantly, we continued to deliver on our customers' critical missions, including our second successful small satellite launch manifested with an Advanced Extremely High Frequency satellite. Many of our customers have recognized our employees' performance for going above and beyond in response to the challenges presented by COVID-19, and I'm very proud of our entire team.

From an opportunity perspective, we were awarded several COVID-19-related projects. We are particularly proud of our work to provide personal protective equipment as a service for N95 mask decontamination and our deployment of virtual transportation management centers. We are also focused on providing solutions to meet our customers' needs in a post COVID-19 crisis world to ensure people can return to a safe living and work environment as soon as possible.

Our offerings are organized into 4 areas: touchless screening solutions and virus testing, biosurveillance, cyber protection and digital transformation. Parsons' mission is to deliver a better world, and our DetectWise suite of offerings will reinvent the entire personal screening experience through system integration of best-of-breed emerging technologies, data analytics and artificial intelligence.

Our solution will help the public feel safe to travel through airports, attend events and enter public buildings. The DetectWise suite of products includes a touchless health screening kiosk, mobile virus testing laboratory and a decontamination facility. With partners, we're developing a scalable nationwide IT architecture for monitoring individuals tested for COVID-19 and a sensing solution to monitor and detect biohazards.

Our cyber protection solutions that have been developed for intelligence and defense customers have synergistic application to a variety of critical infrastructure sectors, such as energy, transportation and health care. This infrastructure must be even more secure in the future given the evolving and increasing cyber threats. Finally, our virtual centers, including traffic management and security and emergency operations are increasingly deployed in our digitally transformed society and will benefit a post-COVID world.

As Chuck indicated, we won 2 single-award contracts worth over $100 million in the first quarter. The first was with a classified customer for physical security work and is valued at approximately $180 million. The second was a General Services Administration Special Programs Division contract for $109 million to provide program, design and construction management services for a wide variety of federal customers. I would also note that we have 6 additional single-award pursuits worth $100 million or more that are awaiting contract award.

Other notable first quarter contract wins include a contract valued at $91 million with the Air Force research laboratory to perform on-site testing, training, enhancements, modifications and technology deployment; classified contracts valued collectively at $60 million to provide cyber operational software development work, security assessment and protection of sophisticated systems and critical infrastructure; and numerous advanced traffic management system contracts throughout North America.

Our strong organic growth is being driven by our alignment to the national defense strategy and growing/enduring markets, including cyber, space, missile defense and C5ISR. These are supported by the president's 2021 budget. In addition, our demonstrated ability to win large new contracts, deliver strong win rates and perform on our programs is also driving organic growth.

And finally, as announced last quarter, we recently realigned our organization into 6 markets to drive business growth and execution in 2020 and beyond. This structure is driving increased collaboration across our 2 business segments as evidenced by the recent introduction of our for COVID-19 One Parsons campaigns that I just discussed. We're fortunate to have a balanced and diversified portfolio as we pursue COVID-19 work and large critical infrastructure contracts within the federal government, such as the Bucholz Army Airfield program, the Antarctica infrastructure modernization program, the Department of Energy Hanford Mission Essential Services joint venture contract and the Ground Based Strategic Deterrent program.

We've also been able to apply our Federal Solutions' cyber, video and data analytics and geospatial technology in the Critical Infrastructure market.

This strong cross-pollinization between our 2 business segments has enabled us to win larger contracts and increase win rates.

In summary, our team continues to execute well, and I'm proud of our many accomplishments. We achieved our revenue and profitability objectives, won large strategic contracts, kept our employees safe and employed during COVID-19, developed new COVID-19 solutions that will help our communities and our customers and optimized our organizational structure to drive additional growth.

With that, I'll turn it back over to Chuck.

[Charles Harrington, Chairman & CEO]

Thank you, Carey. To summarize, we had a successful first quarter with record revenue and significant high-end contract wins. In addition, we have a strong balance sheet that we'll continue to use to further invest in our business and to weather these COVID-19 uncertainties. As I indicated in my opening remarks, I'm extremely proud of the way our team members have stepped up to help our communities and customers during these challenging times and delivered on their financial targets.

Now we'll open up the line for questions.

[Operator]

[Operator Instructions]. First question comes from Ms. Sheila Kahyaoglu.

[Sheila Kahyaoglu, Jefferies]

Chuck or Carey, maybe this one is for you. In terms of FS, just consistent double-digit organic growth for the second quarter in a row. I think book-to-bill was 1.3. How do you view sustainable organic growth? And maybe can you just talk about the recent awards and ramp on newer programs?

[Charles Harrington, Chairman & CEO]

Yes. Thank you, Sheila. We are continuing to see strong proposal activity. Our win rates have been very -- we're blessed with very good win rates. So we continue to see strong growth in that market. I think that's at least partially due to the fact that we're aligned with the national defense priorities of cyber and, obviously, space, with what's going on there, and missile defense, combined with the technologies we're involved in are the technologies that our customers are all looking for, AI and machine learning, autonomous systems, cloud computing and IoT. So we expect that growth to continue. And in terms of the pipeline and wins, I'll let Carey address that. Carey?

[Carey Smith, President & COO]

Thanks, Chuck. Yes, Sheila, I would reiterate what Chuck said. This is our second consecutive quarter of double-digit federal organic growth. We obviously have a strong book-to-bill of 1.2x. And I think that shows our strong competitive market advantage.

So I'll highlight a couple of our recent wins. We were awarded the CUVAS program with the Maryland Procurement Office. It is currently under protest, but we were awarded the contract and we are performing and executing on the contract. That's a critical win for us because we're doing physical security, engineering, design, documentation, software and hardware development across the MPO sites. We also were awarded last year the Combatant Command Mission Support (sic) Combatant Commands Cyber Mission Support contract for $590 million for cyber operations, our largest cyber contract ever. We saw that contract ramp up as we started the first quarter of this year.

Likewise, in our pivot to a Pacific strategy, we were awarded the Kwajalein, Bucholz Army Airfield contract for over $200 million, and that's enabled us to ramp up growth there. Some other cyber wins that we had this quarter are Dark Patriot, which is a multiple-award contract. We were successful in winning the first task order released for cyber and operational software development. We were awarded a classified contract for infested waters, which is security assessment and protection of systems; and a contract that is classified called Lock & Roll, which is cybersecurity capability development. So I think we continue to see our differentiation in these key emerging and growing markets.

[Sheila Kahyaoglu, Jefferies]

That's very helpful. And then on margins, you talked about Q1 being in line with your internal plan and it's always a seasonally weaker quarter. Can you -- it does imply some ramp in the second or the remaining 3 quarters. Can you talk about some of the margin drivers, whether it's indirect or mix, that improves the profitability profile.

[Charles Harrington, Chairman & CEO]

Sure. Yes. It's really a combination of a couple of things. The first quarter of the year is when we do a lot of intensive planning and getting our teams in line and aligned with our strategy and also with our operating plans. So our SG&A or IG&A are generally higher in the first quarter than they are in other quarters. We've seen a lot of growth, a lot of new contracts ramping. So -- and those contracts that are coming onboard are all higher margins.

This particular quarter, we also had a little bump in pass-through revenues, which tended to push down our margins a bit from that perspective. And generally, the first quarter of every year -- this is kind of a repeating occurrence, just like the overhead. We don't generally have higher performance-related revenues or fees. So that tends to come more in Q3, Q4. And so the combination of those factors is what has driven our margin down in Q1 traditionally.

As Carey mentioned, we have quite a few programs that are ramping right now, and those programs, again, are all very strong margin. And we do expect higher award performance fees as we look into downstream quarters. In addition to that, as we mentioned, we continue to integrate our acquisitions and also to align our overhead structure with our strategic focus. So we also made some reductions, which were planned reductions, in this quarter, and those really start to kick in, in Q2 and will be fully deployed in Q3 and Q4. Carey, is there any additional color that you'd like to add to that?

[Carey Smith, President & COO]

Yes. Thanks, Chuck. As Chuck indicated, we have some major programs that are ramping up that have a higher labor component; in particular, two classified higher labor margin contracts, CUVAS and one other that are with the intelligence community. We were also recently awarded the Hanford joint venture for the mission services contract. As we are a minority partner, that is pure profit equity for our company.

And on the combatant command, in the first quarter, as part of the ramp-up, we had additional heavy material, which we will not see. That's converting to a higher labor component as we go into the next quarter. We also expect to see an increase in our equity and earnings -- the profits from our unconsolidated joint ventures as we move forward.

[Operator]

Your next question comes from Mr. Joseph DeNardi.

[Joseph DeNardi, Stifel, Nicolaus & Company]

Chuck, I appreciate you guys maintaining the guidance. I'm wondering if how you're thinking about kind of 2021 or 2022 has changed at all just at least internally because of what's happening, not necessarily that lead spending priorities. But does work that you're expecting to be awarded not get done and so the impact is maybe less than you would expect now and it starts to show up more next year? What are your thoughts there?

[Charles Harrington, Chairman & CEO]

Yes. I think there's -- we've seen things go both ways. We've seen a couple of contracts that have moved out. Some of those contracts that moved out have moved -- come back into this year; in fact, got accelerated. So in terms of trying to see a long-term trend that would indicate negativity, no, I don't see that.

On the Critical Infrastructure side, again, because the contracts we do are generally bond-funded long term, we -- I mean George and I were leading the company through the global financial crisis. We didn't see cancellations there either or with oil price up and down. I think you probably could expect to see some delays of newer contracts in those areas, but given our pivot to more digital solutions, at this point, we're not predicting material changes to 2021 or 2022. George, any color that you'd like to add to that?

[George Ball, CFO & EVP]

Yes, I agree with everything you said. We saw a lot of the same factors in the great financial crisis. The other thing I would add is we've really seen a significant pickup in emergency response work. And from the standpoint of our Critical Infrastructure business, I think as we move through the reopening of the economy, a lot of the things we do relative to that part of the business are technology-based. And I think we'll probably see an upturn in work associated with safe passage of people through airports and just through their communities. So frankly, that's one of the reasons why we're pretty bullish and have maintained guidance, Joe.

[Charles Harrington, Chairman & CEO]

Yes. And I would like to have Carey expand on that a bit. We're obviously doing a lot of work with productization, and we were able to pivot very, very quickly with some of the things we had underway to produce our DetectWise product, which was announced on Monday. And we now have the signed MOU. We're executing for our first deployment of that. And so we're pretty excited. And we really haven't even put the impacts of the four buckets of technologies that Carey discussed into the forecast yet. So Carey, can you kind of talk about that from a perspective of 2021 and 2022?

[Carey Smith, President & COO]

Surely, Chuck. As I mentioned in the remarks, one thing we're very excited about is reinventing the personal screening process, which needs to become touchless. And it can be deployed in any factor of our lives, and it can be scaled up or down. So you might have a simple kiosk solution, for example, at a sports venue, whereas when you go to an airport, you want to feel very secure and go through a kiosk but also have people that have symptoms, as they go through the kiosk, be thoroughly tested for COVID before being permitted to get onto an airplane. This has immediate application pretty much globally across the world, and we're really anxious to roll this out in the next few weeks.

[Joseph DeNardi, Stifel, Nicolaus & Company]

Can you just talk about that a little more, how the kiosk works and whether there are -- I mean, how advanced the plan to deploy it is?

[Charles Harrington, Chairman & CEO]

Carey, do you want to go ahead and take that?

[Carey Smith, President & COO]

Sure. So we're in discussions with various sporting venue companies as well as numerous airports across the globe. And basically, the way the kiosk will work, you go up and you answer a questionnaire that says that you're willing to answer certain information about your symptoms. You will have your temperature taken. And then on a longer-term solution, we'll be adding a sensor for respiratory as well.

And then if you do not pass the questions at the kiosk, for example, if you're at the more complicated airport scenario, you would be sent to our mobile testing lab where you would be tested for COVID. And then depending on the results there, you would either be permitted to board the plane or you'd have to depart the airport. And this really will keep all of our lives safe as we travel.

[Operator]

Next question comes from Cai von Rumohr.

[Cai von Rumohr, Cowen and Company]

Yes. So you touched on COVID a little bit, said it was a 1% revenue hit in the first quarter. Could you talk about how much of a profit hit it was and what sort of impact on the negative side in terms of revenues and profits you see for the year? And maybe what have you baked in for DetectWise and other initiatives you've talked about?

[Charles Harrington, Chairman & CEO]

Thank you, Cai. Great questions. So from a profits perspective, as we said, it is fairly immaterial. We -- other parts of our portfolio overdrove. Part of that is we reassigned people. So it's kind of hard to get down to an exact number because the numbers came in higher than planned. But I would tell you it's in the order of that 2% of -- that I quoted earlier.

In terms of the COVID revenues, obviously, things like the decontamination as a service that we're providing, along with Battelle on decontamination of masks, that's something we've put into our forecast. The work from the airports is not yet into our forecast. We'll be starting our first live launch right around the first of June. So that will be revenue-producing at that point.

And then the others, we're still gathering industry data and looking at -- and incorporating that into the numbers. So all in all, we've been, again, very blessed between being able to -- between CARES Act coverage, redeploying people to other assignments. We've had very few people that were actually on work-from-home status and not gainfully employed.

[Cai von Rumohr, Cowen and Company]

Terrific. And just turning to GBSD. You're one of the members of the Northrop team, and they should be getting a contract here in the next several months. How big is your contract? I mean they've got a very big R&D contract. Do you get proportionately the same amount of that big number? And how do the revenues and profits ramp for you?

[Charles Harrington, Chairman & CEO]

Yes. Thank you, Cai. Well, that's obviously still all being worked out with Northrop, and we don't want to get in front of Northrop's announcements. They're obviously working all that with the Air Force. We're in discussions with them as well, as you would expect.

But our work will tend to be more front end-oriented, given our historic capabilities. And so we're very hopeful and optimistic that, that contract will be signed on time, which would be around August of this year. And Carey, do you have anything else to add to that?

[Carey Smith, President & COO]

No. The only thing I would add is that we're working with both Northrop Grumman and Bechtel. Bechtel is going to be a member of the team as well. And so we're all in the process of finalizing our work scope. The Parsons effort will tend to be on the design effort in the difficult engineering areas like blast and nuclear protection, things that we've uniquely done on other intercontinental ballistic missile programs in the past and where we're uniquely qualified.

[Operator]

Next question comes from Gavin Parsons.

[Gavin Parsons, Goldman Sachs Group]

Chuck, could I just make a quick clarification on the COVID-19 impact? It sounded like you said there was maybe a 1% to as much as 2% impact in the quarter. You do anticipate some impact for the remainder of the year, but that will be offset by benefits on programs like mask, sanitation and maybe the screening devices.

[Charles Harrington, Chairman & CEO]

Yes and just some movement in other programs that got accelerated or additional wins that came earlier than we had anticipated. The 2% was roughly the impact on our billable hours and that -- again, before -- prior to redeployment and then also on the -- roughly to the earnings. On revenue, it's nominally 1%.

So in general, these were things that we were able to take in stride, just like other things that come up on any other year. You have cancellations or protests or -- this kind of all got put into that same mix, just like everything else that comes up as a normal course of business. Obviously, it's not normal business but the impacts were quite normal course of business.

[Gavin Parsons, Goldman Sachs Group]

Okay. Appreciate that clarification. And then on cash flow, maybe, George, if you can just talk about some of the moving pieces of working capital, your confidence in collecting all those. Obviously, there was a little bit of slippage out of 4Q '19 as well, and the collection timing on that was 12-plus months. So maybe just a little bit of color on what happened with collections in the quarter and then your confidence on being able to get those back this year.

[George Ball, CFO & EVP]

Sure. Sure, Gavin. As I indicated in the opening remarks, we had a significant outflow which was about $40 million delta year-over-year associated with the legacy share-based -- share value plan. So that was the big delta as compared to year-over-year. So there's about -- then about a $20 million difference year-over-year in what is truly operating -- normal operating cash flow.

In the federal arena, we actually had some starts which are typically slow in getting billings approved and the like. That was probably frustrated by our government clients' pivot to working from home. We've seen a decided significant improvement in cash flow in federal as we've moved in the second quarter. April in particular was very good. We also suffered in the first quarter some slowness in the Middle East. That too has picked up in the second quarter.

So at this point, frankly, I would say I'm probably more bullish on our ability to meet the guidance than I was 3 months ago in spite of COVID-19. Part of that, and I'm sure you have this with your other companies you follow, has to do with the deferral of payroll tax deposits. And in the year, we'll have a benefit of low $30 million on that. So a lot of moving parts, as you say, but the outlook has actually improved considerably in Q2, and we feel pretty good about our cash flow guidance.

[Gavin Parsons, Goldman Sachs Group]

Got it. And then just kind of considering also that 4Q '19 slippage, is it possible to sort of size the amount of collections that are outstanding above what would be normal?

[George Ball, CFO & EVP]

Relative to COVID-19, it's difficult, as Chuck suggested, to kind of separate the strands. It probably would be some number around the $20 million in shortfall as compared to year-over-year. And also referencing our internal plans, we also fell short by about $20 million. But again, very difficult to determine what would have been with or without COVID. But if I had to put a number on it, that would probably be it.

[Operator]

Next question comes from Tobey Sommer.

[Tobey Sommer, SunTrust Robinson Humphrey]

What internal or external, from a customer perspective, changes at this stage do you think may result from COVID-19 and this experience?

[Charles Harrington, Chairman & CEO]

Thank you, Tobey. Well, I think, one, like most companies that you probably talk to, we had moved to a lot of virtual officing but nowhere near the amount of virtual officing or work from home we're doing now. And it's been amazingly easy to do, and a lot of that brought on by just the incredible technology that's out there today in terms of conferencing technologies, video conferencing technologies or learning how to conduct those more effectively and efficiently. And so productivity hasn't gone down, and in fact, in some ways, productivity may have gone up.

And so I think we'll see more of a pivot to virtual officing on a go-forward basis and leveraging the IT infrastructure that we have in place to continue to do so. And on the longer term, I think we expect to see reductions in real estate costs, facilities costs and probably a reduction in travel cost. I think we're all going to be more comfortable in conducting audio and video teleconferences. And as we're seeing now, a lot more of the trade shows and conferences, there's some great technology out to conduct those. And that also -- if that sticks, and I think it's a little too early to say if that will stick or not, that also could have a resultant reduction in overhead costs associated with those.

I think we're also seeing with some of our customers really scrubbing hard the amount of work that is classified and unclassified and where that line is drawn and allowing more work to be done in an unclassified environment and potentially even in a work-from-home environment. And then the last 15%, 20%, 25% are really critical stuff being done in SCIFs, which then puts reduced load on SCIFs and greater flexibility in how we conduct the work. So I think you're seeing -- we're seeing a lot of flexibility across the platform. And a lot of these changes are, if not permanent, going to be semi-permanent for the foreseeable future.

Carey, you and the team have done a tremendous amount of work looking at facilities and IT and working with our customers in this regard. Perhaps you can add a little additional color to Tobey's question as well.

[Carey Smith, President & COO]

Yes. I would say both internally and externally, there's going to be a lot more focus on teleworking. We've seen our customers starting to make a move to that. The classified customer is looking at how much can be done remotely versus has to be purely on site. There will also be additional focus on cybersecurity.

As we saw during the crisis, the amount of attacks increased across the board. And it's not just going to affect the defense and intelligence sector who have always been focused on it. That's going to have increasing pressure on other sectors, including energy and transportation, to make sure that they're on top of it.

[Tobey Sommer, SunTrust Robinson Humphrey]

And maybe could I get your perspective on how this crisis and resulting recession impact two other things: the company's ability to just source, hire and onboard talent; and the appetite that you have as well as ability to consummate additional acquisitions.

[Charles Harrington, Chairman & CEO]

Yes. So we're very proud of our people team and what they have done. We went back in mid-March to completely virtual onboarding and kitting out of our employees' IT asset needs, how we conduct interviews, and that has done incredibly well. March was, in many ways, a stellar month for us in terms of hiring, and a lot of credit goes to our operations teams and our people team in that regard.

As it relates to acquisitions, I think that we still have an appetite. There's still some great companies out there that we're in discussions with. During this period, I think you'll see a bit of a pause, as we probably have already seen in industries. One can't really do proper due diligence when we can't do -- get into the offices and meet with people one on one, and I think that is an essential thing that has to take place, at least from our perspective. And we need market multiples to settle out a little bit. I think both us and sellers want to make sure that they know that there's some stability around market multiples.

I do imagine that there will be companies who aren't in the same place we are from a balance sheet perspective that may accelerate their thoughts around selling or divesting parts of their business. And I think that will probably result in increased opportunity. So -- and also, I will say that in some markets, what we've seen, where some of our competitors have struggled, hiring has gotten a heck of a lot easier. And that's not just in the U.S., that's internationally as well.

So in the really highly skilled, highly technical markets, I would think, from an employee perspective, you'll see a flight to quality, flight to the companies that you know are going to be around, that can make payments and aren't asking for pay cuts and things like that. And -- but there's still going to be a lot of demand for those employees as well. Carey, anything that you'd like to add to that?

[Carey Smith, President & COO]

Just two additional items. First is our retention is the best that it's ever been. So I think that's terrific. As well as recruiting, like Chuck said, in March, it was our highest month. And we've moved to virtual recruiting, and we found that to be quite effective.

[Operator]

Your next question comes from Mr. Ron Epstein.

[Charles Harrington, Chairman & CEO]

Ron, are you perhaps on mute?

[Ronald Epstein, Bank of America Merrill Lynch]

Oops, yes, I was on mute. Sorry about that, yes. There's a lot of discussion around COVID-19 and the opportunities that might bring along. As we model the company and we think about what that could potentially be as we walk out over the next several years, how should we think about it? I mean how big an opportunity is it? And who's competing with you in that work?

[Charles Harrington, Chairman & CEO]

Well, obviously, it's a rapidly developing market, and it's really kind of hard to tell who the competitors are going to be in the various lines that we're doing. What we've seen at least in these early stages, it's the firms that can be incredibly agile and move quickly and across market lines and industry lines with the talent that's needed have been those that have been very successful. And fortunately, we're one of those companies.

Our teams have been working 7 days a week, getting RFPs on Friday nights and having interviews on Saturdays and awards on Sundays. I mean it's been incredibly inspiring and very motivating. As we model out, I think it's probably a little premature to look at how we model that in. Obviously, these are just kicking off. And I could make all kinds of optimistic or down the middle of the fairway or other projections. I'd personally feel more comfortable when I have a little more data.

[Ronald Epstein, Bank of America Merrill Lynch]

All right. And then maybe just a follow-on, and this -- kind of to take us back to the beginning of the call. Just following up on Sheila's line of questions. You mentioned in the remarks part of the strategy is looking for high-growth, high-margin areas. And we're seeing the growth come through, but I'm still scratching my head on the margins. And the thing I worry about, and maybe you can make me feel more comfortable about this, is that you guys play in an intensely competitive market in that there's concessions being made on price that you might not be able to make up in terms of profitability over time. Why is that wrong?

[Charles Harrington, Chairman & CEO]

Well, I can tell you we're not making concessions on price. We're not seeing that much price competition in the areas we're operating. And I'm not saying that there is excessive margins, but the margins we're bidding are greater than our target margins that we've laid out there. So maybe in parts of the market, you're seeing intense competition.

In the areas we're working, generally, it's all based on the amount of technology we can bid. And that technology is lowering the cost of the total solution to the customer so the customer's cost may be going down but the profit margins that we're seeing are remaining sound. And again, Q1 is always low because of lower performance fees and revenues as well as higher overhead costs that we incur. Carey, anything that you'd like to comment on the -- on contracts we have going forward?

[Carey Smith, President & COO]

I would agree with what you said. We had a shift also. If you look at federal versus Critical Infrastructure, our allocation is shifting because of the bigger mix that federal has, as a result, of the company. We had the new start contracts, combatant commander mission support as well as Kwajalein that had higher-than-normal pass-through costs. On CCMS, in particular, as we go into Q2, we're shifting from a material to a labor. And then, again, relative to last year, there were some onetime overhead adjustments that occurred last year.

[Charles Harrington, Chairman & CEO]

And I think the one other thing I would say, Ron, is in the last 12 years, Q1 has been our lowest margin quarter for 11 out of 12. And it's just -- part of that is just the way we manage the business by increasing cost to make sure everyone is on the same sheet of music. But part of it's just also kind of the nature of the contracts and when these performance fees and revenues kick in.

[Operator]

Next question comes from Mr. Josh Sullivan.

[Joshua Sullivan, The Benchmark Company]

Kind of a related pricing question. The thrust into machine learning and IoT, DetectWise, these appear to be more commercial-like products and services. Can you talk about how the customer is responding or evolving? Are they receptive to commercial pricing such as more service-based models? I think in the prepared remarks you might have mentioned that you had a service model on the COVID masks you were doing.

[Charles Harrington, Chairman & CEO]

As part of our longer-term strategy, we just see that -- in so many of the commercial world that we see as-a-service type models dominating, puts the control of the resources in the hands of the contractor to best apply resources to the opportunities. And also, it generally are faster deployments and brings a total solution to the customer, a combination of hardware, software and services.

And in the federal world, obviously, they've gone to the cloud, which is, in essence, a data center as a service. And we're seeing increased interest. I wouldn't say it's -- flood gates have opened yet, but there's definitely increased interest, and we think that will be a growing trend. And that's why we've been investing in productizing our services and combining them with our hardware and software. And that's been one of the key focus areas that Carey and her team have been working on. Carey, you probably have some additional color you'd like to add on that.

[Carey Smith, President & COO]

Sure. Just a couple of specific examples. We're already selling our iNET product as a service. It can be provided a software as a service or a platform as a service. I mentioned the decontamination as a service that we're currently looking at already. We're also looking in areas of cybersecurity such as hunt as a service, where you go out basically and do a comprehensive threat assessment and you take a look at the supply chain. And we can sell that as a service. And we have a product offering that's called Knowtify, where we sell knowledge as a service. So that's a critical business model for our company.

[Joshua Sullivan, The Benchmark Company]

Got it. And then in the prepared remarks, you mentioned key executives you've brought onboard to accelerate growth. Can you give us any update there? Any contributions so far that we've seen?

[Charles Harrington, Chairman & CEO]

These have all been senior executives that we brought onboard over the last quarter in key federal markets, cyber, intel, space, geospatial and defense, C5ISR. And they're -- they've had big impacts already, obviously helping position us for bid and proposal but also in longer-term strategy of how we further develop and productization. Carey, you probably can -- have a few things you'd like to say about that as well.

[Carey Smith, President & COO]

Certainly. And we've done several press releases on the team that we brought in. We brought in people in the business development side, on the operations side and on the recruiting side. They are folks that are steep with military or intelligence domain expertise as well as deep industry expertise in the federal space.

[Operator]

Next question comes from Louie DiPalma.

[Louie DiPalma, William Blair & Company]

Can you talk about the resiliency of your Critical Infrastructure division during this period that you referred to as the new abnormal? And if state and city budgets become under pressure, how would your business be impacted?

[Charles Harrington, Chairman & CEO]

Okay. Yes. Great question. So very few of our contracts come directly from states. Most of them are from special taxing districts and agencies at the county, city and cross-county levels like airports and transit districts, which tend to cross city lines and county lines, et cetera. And most of the programs that we're on are bond-funded, which you don't really stop. They have dedicated lines of financing.

So what we saw in the global financial crisis, which is fairly similar to this, it tends to be a lagging economic indicator. 2008 for us was a record year, only exceeded by 2009 and only further exceeded by 2010. What we're seeing in the infrastructure business over the last, say, couple of years is a pullback by a lot of companies that did it and a lot of mergers and acquisitions. This resulted in generally fewer competitors going after the work. And so I think that will continue.

The budgets clearly are going to be impacted at the state and local level due to reduced traffic volume. A lot of that is going to depend on how quickly things come back. So we think the focus of those communities will be on how quickly can I build ridership back up in my transit system, at my airport, at the parking decks. And a lot of that is going to go into how confident the public is that they can do that safely. And hence, that's our pivot, which plays into the transformation we were already doing in that marketplace to be able to give not only the physical solutions to help provide physical separation for passengers and people waiting in queues, but also the technology solutions that help identify people are showing the symptoms of COVID, having the rapid testing capability to prove if they have it or not. And we think that will be a growth area because it will be important to get the public confident and back using infrastructure and going to work and going to restaurants, et cetera. Carey, anything you'd like to add to that?

[Carey Smith, President & COO]

Yes. Our Critical Infrastructure proposal volume has gone up. If you look quarter-over-quarter, we submitted 237 last quarter, and this quarter, we submitted 245. So what we're seeing is continued demand for the areas that we're involved in.

The other thing is nearly all of our programs in Critical Infrastructure were deemed mission-critical and are still performing despite COVID. And finally, the COVID offerings that I described, particularly the integrated personal screening system, those are going to be offered through our Critical Infrastructure sector with a significant focus on both rail and transit and aviation market areas.

[Charles Harrington, Chairman & CEO]

I think the other trend that we've seen, which is a good news/bad news story, kind of bad news for us as a society, is that the cyber attacks on infrastructure and citizens and businesses and governments haven't reduced. In fact, in many measures, they've increased. So I think that's going to be another area of increased focus that we're just going to have to protect these assets, both on the IT side, the information technology; as well as in the operational technology, OT side. So those -- for companies like us that provide those services and products and software, I think that could be another growth area.

[Operator]

Next question comes from Justin Donati.

[Justin Donati, Wells Fargo Securities]

You talked about your ability to redirect employees. Can you just talk a little bit more about if that's in one segment more than another?

[Charles Harrington, Chairman & CEO]

Yes. So it all -- obviously, it gets down to each open slot we had and each employee's specific skills and how they matched up skill-wise and, in some cases, geography-wise or time zone-wise. And so when you have folks like with software programming skill sets that are -- have a lot of capabilities in cloud migration or AI algorithm programming or even in areas of design on critical infrastructure or construction management, some of those skills, some -- a lot of those folks were transferable, and we were able to make movements from one unit -- one sector to another or within a sector, from one program to another program. And that's the primary reason. And because we can -- we have such great linkage and synergies between our Critical Infrastructure and our Federal Solutions and within the 6 market areas, these were cross-unit calls that were taking place nearly daily and at the beginning of this. And that's why the team was able to agilely place people so quickly. Carey, you might expand on that a bit.

[Carey Smith, President & COO]

Yes. I agree, Chuck. We have a very robust redeployment system. A couple of times a week, we sit down and we go through program by program, person by person and try and align the skill sets. We've been very successful in redeploying people. So we have extremely few that we have had to furlough. And those few that we did furlough will come back this year, and that was primarily on our vehicle inspection contract just because the inspections are getting deferred to the latter part of the year. But our redeployment program is very successful.

[Justin Donati, Wells Fargo Securities]

Great. And then just as a quick follow-up, what percentage of your federal segment has cleared personnel where they might not be able to be redirected?

[Charles Harrington, Chairman & CEO]

So the specific question is what percent of our personnel are cleared that could not be redirected?

[Justin Donati, Wells Fargo Securities]

Yes. I guess just as -- trying to understand, if those workers would not be able to be repurposed, if they're doing shift work or anything like that.

[Charles Harrington, Chairman & CEO]

Yes. Okay. In some cases, the customer didn't want employees to be redirected because they want to make darn sure when they go back to a full shift that everybody is still available. But some of them have been able to redirect or work 1 week, every other week on another contract. Carey, you can probably give a little more color on that. But those are the kinds of things that we've been doing.

[Carey Smith, President & COO]

Sure. We have about 3,000 folks -- over 3,000 that are cleared. Most of our classified customers have gone to 1 week on, 1 week off. But the recovery will be built through the CARES Act. We're very fortunate only 1.4% of our revenue falls in that category. And it's all going to be recovered through CARES Act from a revenue perspective.

[Operator]

Next question comes from Joseph DeNardi.

[Joseph DeNardi, Stifel, Nicolaus & Company]

Chuck, just a quick follow-up. You mentioned a couple of times the amount of the business that is funded through a bond issuance. Can you actually quantify that? I mean how much of the Critical Infrastructure segment revenues comes from something like that, if you got it handy?

[Charles Harrington, Chairman & CEO]

Yes. I don't have that on the tip of my tongue, Joe, and I'll ask Carey if she does. But what I would tell you is you get over about $100 million in contract size, and basically 100% of those programs are either bond-funded or P3-funded. Those aren't coming out of operating funds at an airport. So any -- or a transit agency or road and highway district.

So capital projects in the infrastructure side are, generally in the U.S., almost exclusively bond-funded. Overseas, you can have a combination of different sources. And that's why it's very important to be on a nation's most critical asset list. Carey, do you have any additional detail?

[Carey Smith, President & COO]

I don't have that number handy, Chuck.

[Charles Harrington, Chairman & CEO]

Yes. We can look that up for you, Joe.

[Operator]

That is all the time we have for questions. Thank you all for joining. Presenters, please stand by.

[David Spille, VP, IR]

Thank you.

[Charles Harrington, Chairman & CEO]

Thank you, everyone.