PAE Incorporated
Q2 2021 Earnings Call Transcript

Published: 7 Aug 2021

[Mark Zindler:]

Good morning, and thank you for participating in PAE's Second Quarter 2021 Earnings Announcement. We hope you've had an opportunity to read the release we issued earlier this morning. We've also provided presentation slides on the Investor Relations section of our website. Joining me today to discuss our business and financial results is Charlie Peiffer, Interim President and Chief Executive Officer. Following our prepared remarks, we will close with a question-and-answer session. Management may 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 factors are described in our SEC filings. Please refer to our earnings press release for PAE's complete forward-looking statement disclosure. We do not undertake any obligation to update or statements. Management will also discuss non-GAAP financial measures during this call, and we remind you that these non-GAAP financial measures are not a substitute for their comparable GAAP measures. Reconciliations of these non-GAAP financial measures to the comparable GAAP measures are contained in the press release and investor presentation issued earlier today. And now I will turn the call over to Charlie Peiffer.

[Charlie Peiffer:]

Thank you all for joining us this morning for our second quarter earnings conference call. I'm pleased with our results for the second quarter. We generated significant margin expansion and saw a strong improvement in our net bookings. The positive momentum has continued in the first month of the third quarter, and I'm encouraged for the second half of the year. For today's call, I'll start with an overview of the key fundamentals of the business and the highlights of the second quarter. In addition, I'll address our perspectives on the macro trends in our industry and PAE's competitive positioning. Beginning with the second quarter results, we performed well, delivering 2% organic revenue growth and strong margin expansion compared to the first quarter of 2021. Revenue was slightly below our internal expectations due to timing on several IDIQ vehicles. However, these task orders have now been awarded, and we have line of sight to delivering the revenue growth in the second half of the year. We continue to plan to submit at least $10 billion in bids this year and more than $7 billion is new business. With regards to COVID-19, we've continued to see a measured return to normal operating levels with increased staffing on our training and immigration-related programs, increases in travel and fewer disruptions to logistics efforts. We are monitoring the impacts of the Delta variant, but to date, we have not seen new disruptions to our business. Moving on to our more detailed financial results. The core business grew approximately 2% year-over-year, and the CENTRA and Metis business grew approximately 25% over last year driven by several sizable contract wins by both companies in the second half of 2020. We were also pleased to see legacy NSS return to growth. We achieved 5% organic growth driven by on-contract growth on a variety of programs and COVID-19 recovery in our training and immigration-related business areas. Our GMS segment grew more -- grew about 1% year-over-year driven primarily by new business wins. I'm really proud of our teams for driving such strong adjusted EBITDA and margins this quarter. It's further validation of our ability to execute our margin expansion strategy. Our margins contracted about 40 basis points over last year. This was primarily driven by the acceleration of bid and proposals cost this year, and the COVID-19 reduction of nonlabor revenue in the prior year period. You will note in our earnings release that cash flow was negative for the quarter. This was a timing issue and is so isolated to a handful of programs. During the last 3 days of June, which falls in our fiscal third quarter, we collected approximately $31 million in receivables that were planned for our fiscal second quarter. As I discussed earlier, we experienced a solid improvement in award activity for the quarter, and we've seen continued progress to start the third quarter. As you will note in our earnings release, the awards we highlighted demonstrated our diverse portfolio across intelligent analytics, mission readiness business solutions, test and training solutions, and infrastructure management. The second quarter awards also demonstrated our broad geographic reach, including several notable awards in the Asia Pacific region, which will continue to be a region that we emphasized strategically. Next, regarding the $1.3 billion CBP award, the Government Accountability Office denied our protest on June 8 and we subsequently filed a protest with the Court of Federal Claims. We believe a decision should be rendered by late third quarter. Now I'll provide a summary of the bid pipeline at the end of the quarter. We had about $7.5 billion in awards under evaluation, of which about $4.9 billion is new business and approximately $2.6 billion are recompete awards. We also had an incremental $1.2 billion in the proposal writing process, almost all of which is new business. In addition, following the end of the second quarter, GMS was awarded approximately $402 million NASA recompete contract at Johnson Space Center in Houston, Texas. The Johnson Space Center award was subsequently protested by a competitor, and that -- and the protest is currently pending at the Government Accountability Office. Assuming PAE's award is upheld, we will take it into backlog at that point in time. Within GMS and including both CBP and Johnson Space Center, we're waiting approximately $5.3 billion in awards. More than $3 billion are new business awards and about $2.2 billion are recompete opportunities. At NSS, we're awaiting more than $2.2 billion in awards, of which $1.9 billion is new business and close to $0.4 billion of recompete awards. I'm pleased to report that during the second quarter, we were successful in winning all our recompete task orders submitted under the Department of Justice MEGA 5 litigation support services program, a great accomplishment by our team. As I mentioned earlier, we expect to bid at least $10 billion this year with more than $7 billion being new business opportunities. We're forecasting GMS to bid about 55% and NSS to bid 45% of this total. I'll take a moment to step back and provide additional commentary about the general themes we are pursuing. Across PAE, we continue to benefit from our diversified set of customers, capabilities and our global reach to address an attractive demand environment. From a customer perspective, our strategic focus areas are closely aligned with defense, intelligence and federal civilian key priorities. Within the Department of State, we had several key wins with USAID, including infrastructure management in Bangladesh, and we are awarded a seat on the USAID Global Architect Engineering Services IDIQ. In terms of capability, we see continued prioritization from the administration in areas such as international development, foreign policy initiatives, immigration services, DoD readiness and intelligence analytics. And geographically, we're well positioned given our presence on all 7 continents, which is a unique competitive advantage. As we noted previously, we are particularly focused on the PACOM region, which we believe will be a region of intense focus for the foreseeable future. Our recent contract awards with the Defense Logistics Agency in Korea and for base operating support services at Marine Corps Air Station in Japan further solidify our strong growing position in the PACOM region. We are also well positioned in terms of contract vehicles. We will continue to pursue attractive IDIQs to further enhance our portfolio. In addition, I believe we can execute our near-term financial objectives based on the IDIQs we have already won positions on over the past several years. This is a tremendous accomplishment by our business development teams, and we look forward to successful execution moving forward. Next, I'll spend a few minutes discussing Afghanistan, and its impact on our business. As I discussed in our prior call, our revenue in Afghanistan is comprised of Department of State and Department of Defense programs. As we enter 2021, the Department of State exposure was roughly 4% of revenue, and DoD was approximately 7% of revenue and driven primarily by the Maintenance -- the National Maintenance Strategy, or NMS program, which provided vehicle maintenance and logistics support for Afghan forces. Based on the Biden administration's decision to withdraw both U.S. troops and DoD contractors, our NMS program was effectively concluded at the end of June, with revenue ceasing in the third quarter. I'm extremely proud of the quick-turn demobilization effort by the team. The demobilization process was very efficient and successful and demonstrate the leadership and professionalism of our team on the ground in Afghanistan. With regard to our ongoing state department programs, we are seeing significant support from the U.S. government on keeping the U.S. Embassy in Kabul open. Our expectation is that the Department of State will explore a variety of scenarios to address security concerns, and our current understanding is that we will not see reductions to revenue or profitability. Mark will elaborate further in his remarks. But based on the financial results to date and our outlook for the remainder of the year, we are reiterating guidance despite the financial impact from concluding the NMS program in Afghanistan. With regard to the federal government budget discussions, we are currently monitoring the ongoing negotiations. Thus far, we're pleased with the direction of discussions are headed regarding the 2022 defense, intelligence and federal civilian budgets. Even if we start government fiscal year 2022 under a continuing resolution, PAE and our industry have grown accustomed to operating in a CR environment, and we do not anticipate any changes to business operations. Lastly, before Mark addresses our financial results, I'll provide an update on the CEO recruitment search process. As we previously communicated, our expectation was that this process will take about 4 to 6 months, and we see no reason to revise this estimate. The search committee has interviewed numerous highly qualified candidates, and we believe we are on track to name the CEO within the estimated time frame. In the meantime, we are continuing to execute against our strategic plan and building momentum for 2022. With that, I'll hand the call over to Mark for an overview of our second quarter 2021 financial results.

[Mark Zindler:]

Thanks, Charlie. Good morning, and thanks to everyone for joining us on the call. I'll provide an overview of our second quarter 2021 results, followed by a discussion of 2021 guidance. I'll start with key takeaways. As Charlie discussed, we delivered a solid quarter in which we generated strong adjusted EBITDA and margins, and experienced a strong improvement in contract award activity. Revenue was slightly lower than our internal plan, but based on our bid submissions, we remain confident in our revenue guidance for the year. Operating cash flow was below our expectations due to timing considerations. As Charlie discussed, we collected $31 million of receivables that we had planned on collecting at the end of our fiscal second quarter ending June 27. That was collected over the last 3 days of June. Consequently, based on this activity and our anticipated results for the remainder of the year, we are reiterating our operating cash flow guidance for the full year. Moving to the detailed results. I'll start first with revenue. We delivered $747 million of second quarter revenue, representing about 2% organic growth over the prior year quarter. The CENTRA and Metis acquisitions delivered approximately $93 million in revenue, which represented about top line growth over the prior year quarter. Legacy GMS and NSS grew about 1% and 5%, respectively, over the prior year. Revenue benefited from new business awards, increases in contract volume on existing programs and higher nonlabor revenue. Second quarter adjusted EBITDA margin was 7.1%, modestly higher than our internal plan, and the 40 basis point contraction margins relative to last year was primarily due to an acceleration of bid and proposal costs in the quarter and the reduction of nonlabor revenue in the prior year quarter. Second quarter adjusted net income grew to $21 million, an approximate 8% increase over the prior year. Cash used in operating activities was about $12 million for the quarter. As I discussed, this was driven by customer payment delays, which were collected the first 3 days of the fiscal third quarter. In addition, cash used in investing activities was approximately $14 million for the quarter, driven primarily by approximately $10 million in CapEx, supporting a customer program. We'll recover these costs through customer charges over the life of the contract. Moving next to our segment results. GMS second quarter revenue grew 1% over the prior period due to new business wins, partially offset by reductions in revenue volume due to program timing. GMS second quarter adjusted operating income about $35 million for the quarter at a margin of 6.8%. Margins declined relative to last year, primarily due to higher SG&A expenses, including an increase in bid and proposal costs this quarter and the reduction nonlabor revenue in the prior year quarter. Turning to the NSS segment. We generated $236 million of revenue, of which about $93 million was attributable to the recent acquisitions. NSS delivered 5% organic revenue growth this quarter,, driven by increased volume on our training and immigration programs due primarily to COVID-19 recovery. Moreover, the former headwinds caused by the prior year small business set-aside losses are no longer impacting quarter-over-quarter comparisons. NSS second quarter adjusted operating income improved to $19 million, driven by the increase in revenue and program performance. NSS margins declined relative to the same period last year due to the timing of bid and proposal costs this year and net profit adjustments in the prior year quarter. Moving next to the integration efforts of CENTRA and Metis. The back-office integration, including moving to a single instance of our cost-point accounting system and our Workday human resources system is on track to be completed during the third quarter. As a result, we are on track to meet or exceed the cost synergy estimates we've previously communicated, about $4 million in expected fiscal year 2021 cost savings and realizing $7 million in full run rate cost synergies starting in fiscal year 2022. As we discussed last quarter, due to our successful integration efforts, it will not be feasible to separate out the results of CENTRA and Metis by the third quarter of this year. Thus, this will be quarter, we separately identify CENTRA and Metis revenue contributions. Moving on to 2021 financial guidance. Based on our first half results and our outlook for the remainder of the year, we're reiterating the full year 2021 guidance we provided in March. Our financial guidance is as follows

[Operator:]

Our first question comes from the line of Chris Moore with CJS Securities.

[Chris Moore:]

So if you look at first half revenue, first half EBITDA, just kind of simplistically double that, it brings in a little bit below the '21 guidance. So can you maybe walk through the assumptions on hitting revenue and EBITDA guidance kind of particularly in the light of the Afghanistan revenue that will taper off in Q3?

[Charlie Peiffer:]

Sure. Thanks, Chris. As you look at the bridge between first half, second half, the key driver when you look at the top line is really about $150 million of contribution is going to be coming from on-contract growth. Including in that on-contract growth will be task order volume on existing IDIQ. So these are quick-turn opportunities that we have seats on like in Africa, as an example, that will be driving second half versus first half performance. We have roughly about $5 billion in evaluation for new business. As we told you before, we see bids submitted to be in that $10 billion range, and that's -- 70% to 80% of that's going to be new business. So you can see already we have a significant amount of new business already in evaluation this point this year. And then from a new business win rate perspective, we expect to be -- our assumptions are industry average. We're not looking for us to see a significant uptick in our win rate percentage. So it's in the low 30s to mid-30 range, which would be normal. And then we have the nonlabor material orders, which, as you start to see things returning to normal from a COVID perspective, to some extent, you're going to see an uptick where we're going to see a higher percentage of won -- higher percentage of nonlabor revenue contributing in the second half, different than we've seen in the first half.

[Chris Moore:]

Got it. Very, very helpful. Just last one for me. So tighter labor availability, higher wages are front and center. Can you talk a bit about the impact of both on PAE?

[Charlie Peiffer:]

Yes. We haven't seen -- other than our, what I'll call, intel work where it takes time to get people through the funnel, we haven't necessarily seen a big impact from the standpoint of our ability to acquire talent and retain talent. Right now, the biggest area that we're focused on is really the cleared workforce requirements in our intel space and ensuring that we've got a good solid pipeline going forward. But we truthfully haven't seen much of a headwind coming out of the labor market, where we weren't able to hire and retain people on the various programs.

[Operator:]

Our next question comes from the line of Brian Gesuale with Raymond James.

[Brian Gesuale:]

I really did appreciate the commentary with Afghanistan. Could you maybe put a little bit more color on that since it's been so front and center in the news in terms of what we're seeing with Embassy security, how that impacts your workforce, and any specific milestones we should consider over the next few quarters to kind of gauge the business on the Embassy side there?

[Charlie Peiffer:]

Brian, when you step back and look at Afghanistan, as we discussed before, the NMS program is effectively concluding at the end of June. I think the team did a great job in demobilizing and supporting that effort. The feedback that we have received from the customer has been extremely positive with the professionalism that we have taken and the approach we've taken to ensure that we demobilize in an orderly manner and in an effective manner. We have some materials that are going to be en route. So we'll recognize that revenue in the third quarter, but it's really just the tail to the program. When you think about the U.S. statement or U.S. position, the State Department is definitely committed to stay in region and maintain some presence in region, specifically through the Embassy operations. We've seen this play out in prior years. So this is not something new. So we don't expect to see a significant change. We're monitoring the situation in Afghanistan, including the security concerns that have been raised, but we currently don't see any impacts to our revenue or profitability on that program.

[Brian Gesuale:]

Great. And if I'd just one follow-up. It sounds like the opportunities in the PACOM region are certainly pretty significant for you and you've talked about strategically focusing on that area. Can you maybe give us a little bit of the high points to the strategy there and some of the opportunities that you're looking at as you look to build that PACOM domain.

[Charlie Peiffer:]

Sure. That's always been an area of focus of ours. It started with retaining the recompete win on Guam. It's the largest port -- U.S. port in the area. There's going to be expansion on the island. So we're well positioned to help support that expansion. The Marine Corps is looking to establish a foothold there, so that's positive for us. So we see that as a great opportunity, and that's a long-term contract. So we're in the first year of our performance. And then we look beyond that, and it's areas like DLA. There are opportunities that are coming up to support the specific region that we think we're properly positioned. And I think our recent win on DLA Korea, even though it's been protested, it's just a statement that we can be competitive and provide what we think is a more effective solution to the customer. And then you look at the recent awards that we had with Iwatuni -- Iwakuni that it's going to continue to expand. There's opportunities that we see really that touches the areas I talked about, which is DLA, what I'll call, facility support and BOSS operations. And there are other opportunities that we're looking at that will give us a good presence in PACOM outside of what normally would be awarded under LOGCAP.

[Operator:]

Our next question comes from the line of Sameer Kalucha with Deutsche Bank.

[Sameer Kalucha:]

You noted some acceleration in proposal costs. So I was wondering if you could provide more color on where the spend is going. What kind of projects or proposals these elevated costs are being focused on?

[Charlie Peiffer:]

Yes. No problem. The -- our comment about the front-end loading of our bid and proposal spending was really driven by a couple of items. First of all, it's the acceleration of opportunities in areas that have traditionally been in our core markets. So for example, its international development, foreign diplomacy, immigration services and then also OCONUS infrastructure. You couple that with what we call the white space or revenue synergies coming out of the acquisition. So things like SOCOM training, logistics and intel analysis are really the key drivers why you see an uptick in spending. And we've discussed this before that we expect, when we're all said and done with that $10 billion worth of bid submission, that $1.5 billion to $2 billion of that is going to come out of the acquisitions of CENTRA and Metis. And we've already seen that in the first half of the -- through the first half of the year with the reference of the SOCOM training, the logistics and intel analysis. So we're excited that these opportunities have been presented, was really part of our strategy, and you can start to see that play out just with the bids submitted and the amount of we spent in the first half.

[Sameer Kalucha:]

Got it. And then maybe just to maybe a little bit elaboration or clarification on the cash flow timing. What kind of contracts or what kind of projects is that related to? And do you anticipate any similar things going forward?

[Charlie Peiffer:]

We -- from an expectation standpoint, we don't expect something similar going forward. As we discussed, the $31 million was received -- collected between June 28 and June 30, which falls in our fiscal -- do not fall -- does not fall in our fiscal second quarter, falls in our fiscal third quarter. We anticipated collecting them in the second quarter. It didn't happen from a timing perspective. I wouldn't say that we're going to expect a deviation from the payment habits of those customers. It's a situation where we expected the collection, and it just didn't happen. We are focused on making sure and taking steps to improve those processes to ensure that there's not a repeat in the future. I wouldn't call it a systemic issue. It's more that we had a handful of contracts that -- each one had a different set of circumstances that drove those collections to fall outside of the quarter, but I would not call it a systemic issue. We've already addressed those. They were collected. The organization already is -- identified what we have to do to ensure that those contracts get billed and collected in the quarter or in the month in this case, and we're very comfortable that, that has already been put in place.

[Sameer Kalucha:]

Got it. And then just a last one. On management changes, you did bring up, the CEO search is on track. You're still on -- in the 3 to 6 months that you outlined. What about the other senior positions like the GMS President that changed during the quarter as well? Any color you can provide there, any updates?

[Charlie Peiffer:]

Sure. I want to first just comment on our operating rhythm, and then we'll talk about where we are in the search. We haven't changed the operating rhythm we had when John was here as the CEO, and Chuck was here as -- Chuck Anderson was here as the President. So our operating rhythm hasn't changed whatsoever. So there's been no change from that regard, and there never will be. We're not deviating from our strategy. Our strategy is clear. We're executing that strategy. So there's no change in operating rhythm or change in focus. We talked about where with the CEO search. The replacement of the President position is really something that's going to be contingent on when the CEO is brought on board. I don't think it's appropriate right now to fill that position. I'd rather wait to ensure that the CEO has an opportunity to put his or her thumbprint on the organization. And -- so you're going to see that follow the CEO replacement. It doesn't mean that we haven't started. We have started to pull together slates to understand what's possible, both internally and externally. And so we're working through that. So we'll be well positioned to move out and start that process once it's clear where we're going with the CEO search, and who winds up in that position.

[Operator:]

Our next question comes from the line of Matt Sharpe with Morgan Stanley.

[Matt Sharpe:]

Charlie, I just wanted to touch on the intelligence community since it's one of your sort of strategic growth areas. Even if I strip out CENTRA and Metis from the quarter, it looks like you're seeing some pretty good underlying demand and growth there, which is somewhat in contrast to your peers, where we've heard either ongoing or reemerging challenges around getting new business awarded. So maybe you can just share your perspective or observations on that customer set at the moment and what you're seeing in terms of demand and sort of the award flow at the moment?

[Charlie Peiffer:]

So when you think of intel pre and post acquisition, the way I would look at it is this way. We have some near-term opportunities that certainly line up with the core business that only strengthens our position with the acquisition of Metis and CENTRA. And we do see the continuation of those awards. There has been some delay. Some -- even one of our recompetes has been delayed. So it's -- I'm not saying we haven't seen that in the market. That is true. It's not only in the intel space, it's across the entire industry. But put that aside, the -- we do see an opportunity to continue to grow that business organically with what we had as a core, but even more importantly, through the acquisitions, the additional organic opportunities we have. As I mentioned in our response to the question regarding , if you think about the amount of opportunities that we have in evaluation -- in proposal and through qualification and potentially will be bid towards the end of this year, there's a pretty -- there's a good solid pipeline of intel work that has come about. And I think we're well positioned to compete. In some cases, our competitors are reaching out to us asking if we could team with them. So I think that's a sign that people see that PAE with the acquisitions, a much stronger competitor and someone to reckon with in the future.

[Matt Sharpe:]

Got it. Fantastic. And then just maybe one on revenue here. Any update with respect to challenges tied to COVID-19 within GMS? Any risk there associated with sort of the reemergence of the Delta variant or travel or logistics operations?

[Charlie Peiffer:]

We haven't -- we have not seen any impact related to that. Each operation kind of stands on its own. But given the requirements that are in place by the customer, the vaccination level, the approach on site, all those requirements are in place and operating. And so we have not seen any significant impact as it relates to the Delta variant at this point.

[Matt Sharpe:]

Got it. And then one last one, if I may. The CapEx change quarter-over-quarter guide. I think you were at $5 million last quarter, $20 million this quarter, you mentioned some program requirements. But what exactly is that? And how should we think about the CapEx profile going forward? Is this a sustaining line item here or a one-timer?

[Charlie Peiffer:]

Yes. We've always said before that our CapEx would be in the $5 million range. And we always said that any CapEx spending other than some infrastructure cost is really going to be program-driven. So in this case here, we're talking about investments on the Guam contract. It's a combination of new cranes that need to be put in place. It's a large port with a fair amount of volume. And then also, there are -- there's support equipment also that's being procured on the contract. So we're incurring that cost, but we are getting that recovered back through the customer with billing depreciation. So there's no issue there. We're recovering our costs. We'll recover the cost over the life of the contract. And it's just that this is CapEx that's specific to the contract. And it's significant in the -- from the standpoint that I just want to get everyone calibrated that we're in year 15 of a 10-year contract. So over that time period, there wasn't a lot of investment. So at some point in time, the equipment had to be replaced, and that's where we are in this contract today.

[Operator:]

There are no further questions. I will now turn the call back to Mark Zindler for closing remarks.

[Mark Zindler:]

Well, thank you very much. Thanks for your continued support, and thanks for participating on today's call. If there are any questions, please reach out to me. Thank you so much.

[Charlie Peiffer:]

Take care.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.