PAE Incorporated
Q4 2020 Earnings Call Transcript

Published: 11 Mar 2021

[Operator:]

Good morning, ladies and gentlemen, and welcome to PAE's Fourth Quarter 2020 Earnings Conference Call. My name is Josh, and I will be your conference operator today. This call is being recorded. I would like to turn the presentation over now to your host for today's call, Mark Zindler, Vice President of Investor Relations for PAE. Please go ahead, Mr. Zindler.

[Mark Zindler:]

Good morning, and thank you for participating in PAE's Fourth Quarter 2020 Earnings Announcement. We hope you've had an opportunity to read the press release we issued earlier this morning. We have also provided presentation slides on the Investor Relations section of our website.

[John Heller:]

Thank you all for joining us this morning for our Fourth Quarter Earnings Conference Call. I'd like to start by thanking PAE's workforce, including our newest employees who've joined us through our recent acquisitions of CENTRA and Metis. We all know what a challenging year this has been. But amidst this backdrop, we've been successful in turning the myriad of challenges we faced into opportunity. We have served on the front lines of COVID-19 relief efforts while maintaining daily operations and successfully executing several strategic initiatives, including our debt refinancing and 2 acquisitions. Our teams consistently rose to the challenge and delivered exemplary results. Thank you for your dedication and steadfast resolve to deliver. For the agenda for today's call, I'll start with an overview of the key fundamentals of the business and the highlights of the fourth quarter. And I'll conclude my remarks with a discussion on federal procurement trends, PAE's competitive positioning and our perspective on the federal government's top priorities and their impact on PAE. I'm excited to start with the momentum and trajectory of our business. This is a watershed moment for PAE coming off a strong year and in a position of strength to take the next step in our evolution of transitioning our portfolio into higher-value market areas and expanding margins. Looking back on 2020, we did everything we set out to do. We increased margins 60 basis points. We refinanced our debt and completed 2 strategic and accretive acquisitions, all the while navigating the pandemic. We have built a strong foundation, and I'm extremely excited about our prospects for 2021 and beyond.

[Charles Peiffer:]

Thanks, John. Good morning, and thanks to everyone for joining us on the call. I'll start by providing an overview of our fourth quarter and full year 2020 results, followed by a discussion of 2021 guidance. Looking at the big picture, there are 3 important takeaways. First, our strategy of expanding the business towards high-margin contracts is working, as evidenced by our 60-basis point improvement in margins in 2020. Second, our agility and diverse set of capabilities paid off by quickly responding to the COVID-19 pandemic and winning contracts to provide COVID relief and testing. Not only did those COVID relief opportunities yield strong revenue and margins, but they created past performance to pursue health services work going forward. And third, we put ourselves in a position of strength for the future with the acquisitions and integrations of CENTRA and Metis that further expand our capabilities, customer presence and contract vehicles. Moving to the results, I'll start first with revenue. We delivered a record quarter of revenue, $749 million for PAE on a stand-alone basis and $788 million including the contributions from CENTRA and Metis. The organic year-over-year revenue growth of 7.4% was driven by increases in contract volume, nonlabor revenue and new business opportunities despite the impact from the pandemic. This increase was partially offset by a $62 million negative impact from COVID-19, of which nearly 70% was nonlabor-related. Full year revenue, excluding the acquisitions of approximately $2.7 billion, was at the high end of expectations, driven by the strong fourth quarter. Fourth quarter adjusted EBITDA margins were 5.5% on a stand-alone basis and 5.6% including the contributions from CENTRA and Metis, reflecting a higher mix of nonlabor revenue in the quarter. This performance was at the high end of expectations. We experienced strong program performance, especially in our NSS segment, which was a key factor in driving fourth quarter results. For the full year, we delivered $178 million in adjusted EBITDA, excluding the contributions from the acquisitions. This, too, was at the high end of expectations, and with margins of 6.6%, represents a 60 basis point improvement over 2019 and a -- 40 basis point improvement over our original 2020 guidance. Cash provided by operating activities was about $9 million for the quarter. This was lower than expected but driven entirely by the timing of certain collections. We experienced about $15 million in accounts receivable that we anticipated collecting in December but were delayed until early January. Consequently, our free cash flow for the year was $97 million, which was $13 million below expectations. The reduction of free cash flow was solely a timing issue and we have anticipated this $15 million shift in our 2021 cash flow guidance. Full year cash flow was impacted by 2 nonrecurring items. First, we benefited from $37 million of CARES Act deferred payroll taxes, which will be paid back ratably in 2021 and 2022. Second, we incurred $27 million in M&A and integration expenses in 2020 and currently expect to only incur approximately $7 million of integration expense in 2021. Moving next to our segment results. GMS fourth quarter revenue grew 11% over the period due to increases in contract value, COVID-19 relief opportunities and nonlabor revenue. This growth was partially offset by a nearly $56 million negative impact from COVID-19, of which more than 70% was nonlabor-related. GMS fourth quarter adjusted operating income was $28 million for the quarter at a margin of 4.8%. Margins declined relative to last year due to higher selling, general and administrative expenses and a higher mix of nonlabor revenue. For the full year, GMS revenue of $2.1 billion was comparable to the prior year despite a $147 million negative impact from COVID-19. GMS was successful in offsetting the majority of the COVID-19 impact with increases in contract volume, new business revenue and COVID relief revenue opportunities. GMS delivered $129 million in full year adjusted operating income at a margin of 6.2%, representing a 20-basis point improvement over 2019. The improvement in dollars and margin despite lower revenue year-over-year was driven by strong program performance and a lower mix of nonlabor revenue for the year. Turning to the NSS segment. We generated $194 million of sales, or $155 million excluding the acquisitions for the quarter. This represented a modest reduction compared to last year and is primarily attributable to a $7 million COVID-19 negative impact. Fourth quarter adjusted operating income and margins improved to $13 million and 8.4%, respectively, pre acquisition; and about $16 million and 8.1% including the acquisitions. NSS delivered a 600 basis point improvement over the prior period driven by higher revenue volume and improved program performance. For the full year, NSS delivered $634 million in revenue or $595 million before the acquisitions. Pre acquisitions revenue was negatively impacted by $40 million due to COVID-19. As we have previously discussed, NSS launched 3 small business set-aside contracts in the fourth quarter of 2019. We made a decision to not bid on a fourth contract in 2020 due to its low margins. Excluding these 4 contracts, NSS grew 13% organically year-over-year. Approximately 50% of the growth was in the intelligence and technology services capability area and the remaining 50% was predominantly in the test and training area. With these losses behind us, we are poised to show strong growth in 2021 and beyond. NSS delivered $52 million in adjusted operating income at an 8.1% margin or $49 million at an 8.2% margin, excluding the acquisitions. This represents an approximate 200 basis point improvement over the prior year, driven by strong program performance. Moving next to the integration efforts on CENTRA and Metis. As John mentioned in his remarks, the integration for both acquisitions are on track. Customer-facing activities will be fully integrated by the end of the current quarter, and we expect to be largely integrated by the fourth quarter of 2021. We expect to drive $4 million in cost synergies in 2021 and expect to generate approximately $7 million of full run rate cost synergies by 2022. Now turning to 2021 financial guidance. We expect revenue in the range of $3.05 billion to $3.15 billion with a midpoint of $3.1 billion. We expect adjusted EBITDA in the range of $205 million to $215 million, representing a 20 basis point improvement at the midpoint over 2020. For 2021, we are guiding to cash flow from operations instead of free cash flow, a change to better align with our peer group and a simpler process that will be -- that will tie to the statement of cash flows. We expect at least $120 million in cash flow from operations, which incorporates the $15 million of collected receivables that were originally anticipated in December of 2020. To tie the cash flow guidance back to free cash flow, we expect approximately $5 million in CapEx. Guidance is based on the assumption that we will experience impacts of COVID through the first half of 2021. We are assuming the COVID-19 impact in the first half of 2021 will be comparable to the second half of 2020 COVID impact. The revenue growth implies low single-digit growth in GMS and low double growth -- low double-digit growth in NSS. We anticipate revenue to be back-end-loaded, driven by new business opportunities, a reduced impact from COVID-19 and a second half increase in nonlabor revenue. We expect revenue to increase sequentially, with first quarter revenue to be below the fourth quarter 2020 level. This is in line with historical trends as we typically experience a higher weighting in second half revenue due to increases in nonlabor revenue and contract volume driven by end-of-year government funding and the availability of contract funding with the start of a new fiscal year for the government. At the midpoint of revenue guidance, approximately 85% of our guidance is in backlog, approximately 7% is from recompete contracts and about 8% is from new business awards. With regard to adjusted EBITDA guidance, we expect a sequential increase in dollars consistent with revenue growth throughout the year. Other key assumptions for our 2021 guidance are available in our earnings presentation on the Investors section of our website. With that, operator, let's open the call for questions.

[Operator:]

Our first question comes from Chris Moore with CJS Securities.

[Chris Moore:]

Maybe we'll start with -- where Charlie just left off, the 20 basis point margin expansion that you're looking for in fiscal '21. Is that -- to talk a little bit further, that's driven by the mix, program performance, SG&A? A little bit more color there.

[Charles Peiffer:]

Sure. No problem. If you look at the drivers, first of all, the organic revenue growth that we're seeing in NSS, that mix is -- represents about 50% of that improvement. And the balance of the other 50% is split between performance on existing contracts as well as what I'll call expense management. Obviously, we're not growing our SG&A and our expenses in line with the top line growth, that is also providing some margin expansion from that as well.

[Chris Moore:]

Got it. That's helpful. So in terms of CENTRA and Metis, it sounds like most of the year is going to be focused on the integration of the 2. You've talked a lot about the white space growth opportunities there. Is the assumption there that most of that white space opportunity is really kind of fiscal '22 and beyond opportunity?

[John Heller:]

Well, I think it's a real combination. I think there's -- and Chris, this is John. I would say we do believe the IDIQs that both of them bring to the table represent an opportunity in '21 to see expansion of the pipeline, bidding work throughout the year. And with IDIQ task orders, you can have a much faster turnaround. So I think there is a definite expectation that we can see some task order volume hit in '21. I think -- and that -- when we call white space, there's white space there as well, because when you think of either of these companies bidding task orders that could come out on their contracts that are in the hundreds of millions, they might have been too large in scale or they may not have had the overall capability or past performance to bid on a number of those task orders, which now, combining PAE with Metis and CENTRA, we have the ability to bid more. So there's white space on the IDIQs. But then the other factor, and Charlie mentioned this, is about how we've integrated the front end of the business to where we're really operating as one team, but obviously a team with much more past performance. And we've brought on some great people as a result of the acquisition that have experience with different customers, and combining that capability allows us to identify single-award opportunities. Most of those, you would expect, would be more of a '22, '23, just given the time line of acquisition for that. But we've already done really well at identifying additional pipeline. Charlie mentioned the pipeline growth that we've had. So we're excited about what that's already bringing to the table and the prospects for the future.

[Chris Moore:]

Got it. Extremely helpful. Last one for me. Are there any additional small business set-asides on the horizon that you might -- may not be able to bid on, you might have to walk away from?

[Charles Peiffer:]

Right now, when you look at small business set-asides with the acquisitions we just made, there aren't any headwinds like that, which is what also interested us in those acquisitions. So Chris, there isn't anything like that, for the foreseeable future, anyway.

[Operator:]

Our next question comes from Matt Sharpe with Morgan Stanley.

[Matt Sharpe:]

John, Charlie, just wanted to touch on revenue here for a moment, sort of unpack what's buried within it. It looks like it's about 14% at the midpoint of the guide. What does that 14% look like on an organic basis? And just how much Metis and CENTRA revenue is embedded in the $3.05 billion to $3.15 billion range for the year?

[Charles Peiffer:]

So Matt, if you look at the guidance, our core business in GMS, we're expecting low single-digit growth. In the case of our NSS core, pre acquisition, we're looking at low double-digit growth consistent with what we just covered for 2020. And then similar to what we announced when we completed the 2 acquisition transactions, we expect low double-digit growth coming from the 2 acquisitions as well.

[Matt Sharpe:]

Got it. And then just for the COVID-19 impact, I think 2020 looked like it was about $125 million for the year. Is that a net number that accounts for any sort of COVID-19 response revenue? And then maybe just a little bit of color on how you're thinking about it into 2021. I know you mentioned during your prepared remarks that it was front-end loaded, but just any sort of cadence or overall expectation for that level.

[Charles Peiffer:]

Yes. When we look at overall COVID headwinds, $187 million gross, with the lion's share of that coming from GMS just because of the nature of the business with higher nonlabor volume. And then the headwinds were offset by the, what I'll call, COVID-19 response revenue, which was predominantly in GMS as well. And if we were to net that out, we were roughly, net, around $80 million to $85 million of net negative impact once you netted out about $100 million or so of COVID-related revenue for the year.

[Matt Sharpe:]

Okay. Got it. And then I just want to touch on awards and bookings here for a moment as well. Did you guys -- I know you mentioned you didn't see any sort of impact from, I guess, the overall government activity on the quarter. But was the 0.7x book-to-bill consistent with your expectation? And then how are you thinking about book-to-bill trends into 2021? Is there a target that you need to reach in order to sort of achieve the high end versus the low end of your revenue range? Or what do you actually need to do in order to push towards the upper end?

[John Heller:]

Yes. I would say just, first of all, I'll talk on kind of the trends. We definitely saw a lower volume from an expectation standpoint of actual awards in 2020. So some of that is carried over into 2021. The effects of COVID, I think, have been a big part of that, just the impact on the ability for acquisition teams to collaborate and get things accomplished, A. B, the fact that any contract that involved travel, so individuals that had to travel across the U.S. or outside of the U.S. in particular, the government slowed those acquisitions down because to do a contract transition that required personnel to travel and kind of transition a contract that was overseas or had significant travel in the United States, that was severely impacted by the inability of people to travel. The government recognized that and held back on certain awards that we saw -- that we expected in 2020. So as -- I would think that even in the first quarter, first half of 2021, with COVID still having an impact on the overall workplace and the ability to travel sort of residual there. But we're expecting that, as the vaccine is mostly distributed, we're hearing about military bases opening back up, government offices returning to normal, I think we'll probably get back to a regular pace of activity by the second half of the year. From a book-to-bill standpoint, expectations for 2021, Charlie, I don't know if you've got a factor there.

[Charles Peiffer:]

Yes, no problem. So Matt, the book-to-bill for a total year basis should be around 1.5x. It could be slightly higher than that, but it would be in that range to support the guidance that we have provided.

[Operator:]

Our next question comes from Ashish Sabadra with Deutsche Bank.

[Ashish Sabadra:]

Congrats on solid results and a good guide. Just going back to the bid pipeline. I understand IDIQs are not imputed, if I'm not mistaken. But I was just wondering if you could help us just quantify, how much task orders do you have in the proposal phase? Or how do we think about the potential for task orders on an annualized basis this year? And maybe any color going forward as well.

[John Heller:]

Yes. First of all, just in terms of what we have in proposal today is around $1.1 billion, which is pretty consistent. A lot of that is task order-oriented. So those are quick-turnaround, meaning that we'll see a lot of those bids go in shortly. And because of the expansion of IDIQs, we probably anticipate a more steady volume. Whereas in the past, we would see spikes in volume and then it would drop back off when you're bidding $200 million, $300 million, $400 million, $500 million bids, versus, say, a higher volume of smaller opportunities. We also expect in the back half of the year, the GSS contract that we won in the fourth quarter, that task order volume will start to come out. And that's a pretty significant number. But overall, our expectation from both businesses is with a pretty healthy bid pipeline for the year that would exceed what we saw last year. So last year was in that $6 billion to $7 billion bid. So this year, we're expecting a higher volume, just based on timing, of what we see in our pipeline.

[Ashish Sabadra:]

That's great. That's very helpful color. And maybe just -- I was wondering if you could comment on some of the contracts that are coming up for renewal this year, in particular, the 2 Iraq contracts, both OMSS and BLISS as well as the AFRICAP. Any color on when should we -- how should we think about the renewal for those contracts?

[Charles Peiffer:]

So if you look at our recompetes, OMSS and BLISS, based on what we hear from the customer, we don't expect that to be awarded until 2022. So Ashish, that's going to move to the right. As far as other contracts, from an award standpoint in 2021, as we highlighted, we have about 7% of the volume that we have in 2021 guidance is related to recompetes. It's the resolution CBP. Johnson Space Center is a contract that we expect to be awarded in late 2021. And then we have decisions on Pax River as well as AUTEC. They are the significant drivers. And then we do have some of the recompete activity on MEGA. John highlighted that we won a seat on MEGA V. So those task orders will be recompeted in 2021, as well as the new task orders will be coming up for us to bid on, which is the primary driver for some of the growth that we see coming out of '21 on the MEGA contract for us. But those are the major drivers for recompetes in...

[John Heller:]

And AFRICAP, you mentioned AFRICAP, and that -- I mean, we would just expect a normal task order season on AFRICAP in 2021, as we've seen in the decades in the past. So there's nothing out of the ordinary expected there.

[Charles Peiffer:]

And when they awarded under the new contract, well, I think it was 2 years ago, they were awarding a contract for a period of performance that were more in the 5-year arrangement. In the past, it was 3. So you're going to see a slightly different profile on AFRICAP now, which is different than what you've seen in the past just because they have contracts with longer period of performance.

[Operator:]

Our next question comes from Josh Sullivan with The Benchmark Company.

[Josh Sullivan:]

Just looking at the strategic goals breakdown chart here, where do you think is the most significant change in that model over the last 6 months? And then as we look forward maybe 3 years, how do you think this is going to change?

[John Heller:]

And you're talking about the strategic growth areas?

[Josh Sullivan:]

Yes, I'm looking at intelligence, infrastructure, mission readiness, business solutions.

[John Heller:]

Yes. Yes. And what we're expecting, just based on the investments we're making, the pipeline that we're pursuing, is right now you look at the business solutions, test and training solutions and intelligence and technology services representing about 50% of revenue, growing organically to closer to 60% over the next few years. We really, with the Metis and CENTRA acquisitions, see momentum in the intelligence and technology services. Our GSS award can really put some momentum behind the business solutions and training. ETSC and other range work, and other contracts that we were awarded will provide continued momentum in the test and training solutions area. So we feel strongly that these 3 areas have really come together strategically well for us in terms of the capabilities and, with the last 2 acquisitions, should continue to drive good growth at a higher rate than the infrastructure and engineering and mission readiness, although we still have a great pipeline there as well. Our market positions are very strong in those areas, and we continue to expect to win our fair share in those areas as well. We just expect a lower growth rate as compared to the other 3.

[Josh Sullivan:]

Right. And then, I mean, I guess, kind of relatedly, I mean, if we do see some funding shifts back to the State Department, I know you talked about the biometric and visa opportunities. But are there any other areas where you think we could see upside? Or maybe any holes in M&A which you want to fill in that area?

[John Heller:]

Well, we would expect that contracts like AFRICAP will -- where the U.S. government identifies key regions of the world that will become a priority for engagement by the U.S. government, we have GATA and ICITAP are 2 other contracts. ICITAP was awarded last year, that Justice Department contract. But obviously, we'll link with the State Department in terms of identifying areas of the world where the U.S. government wants to engage and that spending will follow. So from an acquisition standpoint, we really do feel like we have a great foothold across the different capability areas in support of the State Department. Obviously, our relationships there are strong. So we really don't see a need to leverage acquisition to expand. However, USAID is an area that we have pushed into over the last couple of years through the acquisition of Macfadden. We do see significant opportunities for growth that fits PAE very well. It's not an area that we have done a significant amount of business in, in the past, so we think it represents great white space for growth. But we -- again, we don't think we need M&A to allow us to achieve our organic growth goals.

[Operator:]

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Mark Zindler for any further remarks.

[Mark Zindler:]

Thanks, everyone, for joining us this morning and for your continued interest in PAE. If you have any questions, please don't hesitate to give me a call. Thanks a lot, and have a great day.

[Operator:]

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