PAE Incorporated

Good morning, and thank you for participating in PAE's first quarter 2021 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. Joining me today to discuss our business and financial results is Charlie Peiffer, PAE's 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 forward-looking 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.

Thank you all for joining us this morning for our first quarter earnings conference call. I'd like to start by thanking our customers and PAE's dedicated personnel across the globe who drive our success.

I especially want to recognize our employees. Thank you for your dedication in serving our customers and your resolve in driving our strong performance.

We delivered a very strong quarter based on your accomplishments and commitment to the missions we support. For today's call, I'll start with an overview of the key fundamentals of the business and the highlights of the first quarter.

In addition, I'll address our preliminary thoughts on the Biden administration's initial proposal for the Fiscal Year 2022 budget and other macro trends. Beginning with the first quarter results, we performed well, delivering strong organic revenue growth, profitability and cash flow.

We have experienced a modest increase in actual and planned bid submissions. Win rates are in line with our expectations, and we're seeing a measured return to normalcy from the COVID-19 pandemic.

While we're not out of the woods, we are seeing fewer disruptions to travel; logistics and programs which experienced labor out or disruptions are moving in the right direction. All of which is consistent with the assumptions made in establishing our guidance.

Furthermore, our internal forecast anticipated light award announcements for the first quarter, and our results were in line with those expectations. From a financial perspective, all key measures exceeded expectation.

Moving on to a more detailed financial results. The core business grew approximately 7% year-over-year, and that does not include the positive impact from recent acquisitions.

This increase was driven by new business opportunities and a net increase in contract volume on existing programs. In addition, margins exceeded our expectations despite a higher mix of nonlabor revenue, demonstrating the continued progress we're making, expanding into higher-margin business areas.

Moreover, we had a solid first quarter in terms of cash flow generation, driven by strong working capital management, including the approximate $15 million in accounts receivable that we originally anticipated collecting in December but were delayed into early January. You will notice in the earnings release issued this morning and in our remarks, we are making fewer references to impacts from COVID-19.

The current impact from COVID-19 is consistent with our guidance. Thus, our analysis has been simplified to focus on business trends, excluding specific COVID-19 impacts.

Next, I'll spend a few minutes discussing notable awards this quarter and our expectations for the cadence of future award activity. Going into the year, we knew first half award activity would be light.

We expect to see a moderate pick up in awards in the second quarter and a larger increase in the back half of the year. This is consistent with our original expectations, and our guidance was based on these trends.

Our first quarter awards showcased several promising trends of winning new business in higher-margin areas of our business. For example, we won an attractive task order on the GTACS II IDIQ, providing satellite communication support.

Furthermore, CENTRA and Metis has contributed several high-quality awards providing Survival, Evasion, Resistance and Escape training along with curriculum development for the joint personnel recovery agency as well as intelligence support to the Bureau of Alcohol, Tobacco and Firearms. Our GMS segment added several embassy related awards and a number of contract extensions that further mitigate, recompete risk this year.

As you'll recall from our fourth quarter call, we've begun emphasizing 5 core focus areas of our business: Infrastructure and engineering, mission readiness, business solutions, test and training solutions and intelligence and technology services. Our pipeline continues to shift towards these latter 3 areas, which is a key driver of our margin expansion strategy, and we're looking forward to several notable awards in the second half of the year.

The GTACS and Joint Personnel Recovery Agency contract awards highlighted earlier, illustrate our success expanding our portfolio of test and training and intel and technology services programs. Furthermore, we expect that our existing portfolio of strategic contract vehicles that accelerate growth moving forward.

We expect task order volume on our IDIQs will accelerate in the second half of the year through contract vehicles such as GTACS II, GSS, SAI III and MEGA 5. With regards to the infrastructure and engineering focus area, we continue to build a sizable pipeline of opportunities that provides predictable, low single-digit growth and the scale to pursue higher-margin opportunities in growth areas we are targeting for expansion.

Our mission readiness allows us to deliver critical services utilizing quick reaction times, such as the COVID-19 relief and several opportunities under proposal being prime examples. Subsequent to the end of the quarter, we won an attractive intelligence analytics contract award; I'll further elaborate on.

A key rationale of the CENTRA and Metis acquisitions was to leverage their significant IDIQ portfolio and specialized skill set centered around intelligence and national security markets. To this end, we were awarded a new business task order valued at $65 million to provide counter intelligence and human intelligence support services to a national security customer.

We expect the intelligence analytics market to be an increasing area of focus for the government as the United States and allied nations continue to face heightened geopolitical risk and threats. As we mentioned with the recent new business win, these acquisitions provide PAE a new set of differentiated capabilities with high barriers to entry in market areas with expected growing and sustainable market demand.

Next, regarding the $1.3 billion CBP award, as we previously discussed, we have filed a protest with the Government Accountability Office, and that decision is expected to be made by mid-June. Now I'll provide a summary of the bid pipeline.

At the end of the quarter, we had about $5.7 billion in awards under evaluation, of which $3.2 billion is new business and approximately $2.5 billion are recompete awards. We have also an incremental $1.7 billion in proposal writing process, the majority of which is new business.

In GMS, we expect to benefit from our diversified set of customers' capabilities and our global reach to address an attractive demand environment. Geographically, we're particularly focused on the PACOM region, which we believe will be a region of intense focus for the foreseeable future.

From a customer perspective, we're excited about several pursuits across the Department of State, USAID, U.S. Navy and the Defense Logistics Agency.

Within GMS, we're awaiting approximately $4.5 billion in awards, which includes the protested $1.3 billion CBP contract. Approximately $2.5 billion are recompete awards and about $2 billion are new business opportunities.

Before I move on to the NSS pipeline, I'll spend a few minutes on the Biden administration's decision to withdraw U.S. groups from Afghanistan and the potential impact to PAE.

While the situation remains fluid, I'll start with the basics. Our revenue in Afghanistan is comprised of the Department of State and Defense -- Department of Defense programs.

The Department of State exposure is roughly 4% of revenue, and the DoD is approximately 7% of revenue. Our DoD related exposure is driven by the Afghan led contractor supported National Maintenance Strategy program.

Which provides vehicle maintenance and logistics support for the Afghan military forces. We've had discussions with our customers about the future of this program, but at this time, we do not have enough information to provide a specific outcome.

With regard to our Department of State work, we currently do not anticipate any negative impacts related to our operations in country. In developing our guidance for the year, we took a prudent and conservative approach to account for these potential macro environment risks.

Based on our risk-adjusted forecast and the new business in our plan, we remain confident in our financial guidance for the year. And as we move forward beyond 2021, we believe our pipeline is well positioned to capitalize on the DoD strategic shift towards the Asia Pacific region in addition to new business pursuits focused on a diverse set of federal civilian customers with expected growing spending profiles.

Turning back to the pipeline in our NSS segment. We see significant opportunities with the Department of State through our GSS IDIQ contract award, the Justice Department via our seat on the MEGA 5 contract and a variety of opportunities spread across the national security community, via our seats on GTACS II, SAI 3 and various pursuits within the intel community.

NSS is awaiting about $1.2 billion in awards, the majority of which are new business. Note that the task orders we will bid under the GSS contract are not reflected in the bids under evaluation or in the proposal writing process.

Next, I'll provide my perspectives on the Biden administration's top line budget proposal released in early April. We're pleased with what this initial budget request could mean for PAE.

The proposed defense spending of $753 billion was in line with our expectations. Keep in mind, however, that only 30% of our planned 2021 revenue is tied to defense spending.

Spread fairly evenly among Army, Navy and the Air Force. In addition, we were pleased to see healthy increases among several federal civilian customers.

The budget proposal contained increases for the State Department, Justice Department and Health and Human Services of approximately 12%, 5% and 23%, respectively. Our expectation is that the spending proposed by the Biden administration will be directed to funding priorities such as global health and medical support, science and climate focus, immigration, international development and addressing refugee and humanitarian issues.

In addition, the DoD may likely prioritize a geographic strategic shift towards the Asia Pacific region and a focus on modernization efforts. These are all areas of long-standing PAE expertise and have potential to represent new revenue streams in the future.

With regard to the proposed 12% increase for the State Department and USAID, it's a strong indication of this administration's effort to put diplomacy front and center in their approach to foreign policy. Moreover, the proposed budget increases for the Justice Department and Health and Human Services of 5% and 23%, respectively, are notable.

Given our core competencies and litigation support, business process solutions and our focus on expanding into health services, the budget proposal is very promising. Before I pass things back to Mark, who will address our financial results, I'll take a moment to provide a brief update on the CEO recruitment search process.

Our Board of Directors is committed to performing its search with the utmost diligence. The Board has engaged an executive search firm and will take the time needed to find the best individual for the role.

Right now, we continue to push forward on our strategic plan and the operating rhythm of the business has not lost its step. With that, I'll hand the call over to Mark for an overview of our first quarter financial results.

Thanks, Charlie. Good morning, and thanks to everyone for joining us on the call.

I'll provide an overview of our first quarter 2021 results, followed by a discussion of 2021 guidance. I'll start with key takeaways.

As Charlie discussed, we delivered a strong quarter that exceeded our expectations in terms of revenue, adjusted EBITDA, margins and operating cash flow. We delivered organic revenue growth of 7%, and despite a higher mix of nonlabor revenue compared to our plan, we generated, adjusted EBITDA margins exceeded expectations.

Operating cash flow continues to benefit from strong working capital management across receivables, accounts payable and other accrued expenses, as well as the $15 million in collections that shifted into the first quarter from the prior quarter. Moving to the detailed results.

I'll start first with revenue. We delivered $749 million of first quarter revenue, representing about 7% organic growth over the prior period.

The CENTRA and Metis acquisitions delivered approximately $89 million in revenue, which was in line with our plan, and PAE's core business outperformed relative to our internal plan. Revenue benefited from new business awards, increases in contract volume on existing programs and higher nonlabor revenue.

First quarter adjusted EBITDA margin was 6.3%, modestly higher than expectations despite a higher mix of nonlabor revenue in the quarter. The recent acquisitions added 20 basis points of margin expansion to the consolidated results, which was in line with our expectations.

First quarter adjusted net income grew to $16 million, an approximate 7% increase over the prior year. Cash provided by operating activities was about $55 million for the quarter.

As I discussed, this was higher than expectations and driven by strong working capital management as well as the shift of receivables from December to early January. Moving next to our segment results.

GMS first quarter revenue grew 14% over the prior period due to new business, including COVID relief opportunities, partially offset by reductions in contract volume on certain programs. GMS first quarter adjusted operating income was about $28 million for the quarter at a margin of 5.3%.

Margins declined relative to last year, primarily due to higher nonlabor revenue this quarter but performed in line with expectations. Turning to the NSS segment.

We generated $227 million of revenue, of which about $89 million was attributable to the recent acquisitions. As we've previously discussed, NSS previously lost 3 contracts that shifted to small business.

The last of these programs ended in the first quarter of 2020. Excluding the revenue from this third contract in the prior year comparison and the negative COVID-19 impact on our immigration related work, NSS delivered low single-digit revenue growth over the prior year period.

NSS first quarter adjusted operating income improved to $19 million, driven by the increase in revenue. NSS margins declined relative to last year due to the timing of net profit adjustments in the prior year period, but exceeded expectations for the quarter and were higher than full year fiscal year 2020.

I'll take a moment to discuss the recent 8-K filing describing the impact of accounting for warrants and the requirement to restate our financial results. Historically, the consensus among the leading public accounting and legal firms had permitted equity classification for warrants issued by special purpose acquisition companies or SPACs, based on the fact that warrant agreements included certain standard provisions.

However, in April, the SEC staff issued a statement expressing a view that most warrants issued in connection with a SPAC transaction should be accounted for as liabilities rather than equity instruments of the company. After consultation with our audit firm, PAE determined that the consolidated financial statements and footnote disclosures included in our 2020 annual report on Form 10-K filed with the SEC on March 16, 2021, and the condensed consolidated financial statements included in our quarterly reports for the first, second and third quarters of 2020 must be restated.

Note, there is no cash flow impact associated with the financial reporting changes nor will there be going forward. However, the warrant accounting has the potential to create quarterly GAAP net income volatility due to the mark-to-market requirements.

Moving next to the integration efforts on CENTRA and Metis. As we discussed on the fourth quarter earnings call, the customer-facing integration efforts were completed this quarter.

Our business development and operations teams are fully functioning as one integrated team, which is a tremendous accomplishment. Thanks to the CENTRA, Metis and NSS teams for your dedication and commitment to complete this aspect of the integration so efficiently.

We are now focused on completing the back office integration, including moving to a single instance of our Costpoint accounting system and our Workday human resources system. This is on track to be largely completed by the end of the quarter.

Given the progress we've made to date, the cost synergy estimates remain accurate, about $4 million in expected FY '21 cost savings and realizing $7 million in full run rate cost synergies as we exit the year and plan our budget for fiscal year 2022. Because of the progress we've made integrating the customer-facing activities, we've begun jointly pursuing new programs that were not in our respective bid pipelines prior to these acquisitions.

Consequently, it will not be feasible to separate out the results of CENTRA and Metis by the third quarter of this year. Thus, we expect to identify the revenue contributions of the acquisitions next quarter just as we did this current quarter, but we'll discontinue doing so effective with our third quarter financials.

Moving on to 2021 financial guidance. Based on our first quarter results and our outlook for the remainder of the year, we're reiterating the full year 2021 guidance we provided in March.

As Charlie discussed earlier, our guidance incorporated a risk-adjusted approach to account for uncertainties such as potential Afghanistan withdrawal financial implications. Our financial guidance is as follows: 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 improvement at the midpoint over 2020, and we expect at least $120 million in cash flow from operations. For the remainder of the year, we continue to anticipate revenue and adjusted EBITDA to be moderately back-end weighted, driven by the timing of new business awards.

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.

Maybe we can start -- sort on Afghanistan. So I've seen where others have been directed by their U.S.

government customer to discontinue their contracts. Is that what you're hearing at this point in time?

Is it limited to the DoD.

Good morning, Chris. The way to look at this is that we really had 1 project, a program called National Maintenance Security program, which really wasn't tied to DoD deployment.

It was -- the scope of that project was to help train the Afghan forces on maintenance of equipment. With the decision that the Biden administration has made to demobilize out of Afghanistan, there was a decision to include that program as part of the demobilization.

We're working through the details from the standpoint of timing and cost, but that demobilization effort is underway. I want to note that our exposure is really limited to that 1 program.

The State Department programs do not appear to be impacted. And if you consider the impact, the NMS decision will represent less than 3% of revenue exposure and then less than 2% of adjusted EBITDA impact in 2021.

Our guidance, as we pull that together, contemplated various macro risk elements and factors to consider, such as Afghanistan, and therefore, we're confident in reiterating our guidance.

Last one for me is just in terms of the kind of the book-to-bill assumption that you're making in order to hit the midpoint of your revenue guide this year?

Yes. When you think of -- when we put the plan together, we have always said that the awards would be back-end loaded.

We don't see any change in that just now. I mean, we have a fair amount already in evaluation.

These are multimillion-dollar opportunities. It will be back-end loaded.

We still see a path to submit the numbers that we had targeted at the beginning of the year. We're very excited with the addition of Metis and CENTRA.

That really has bolstered the opportunities that we see. And you can certainly reference the comment that I made regarding the recent award that was made with the Metis acquisition, that $65 million award.

So we're excited that we do have a clear path for the back end of new business as well as the submissions in the second half of the year.

What I wanted to drill a little bit deeper on was on the integration side of CENTRA and Metis. So the back end part is completed, how do you see the revenue synergies evolving, going forward in terms of what you see so far, they -- are they performing in line with your expectations?

Or how does it trend going forward over the next 1 or 2 years?

So good morning, Sameer. When you think about the integration of the 2 acquisitions, as Mark has already articulated, we have great progress on the synergies standpoint.

But really, where the value creation is going to be coming from is really on what we're calling Phase I, which is the utilization and capitalizing on the IDIQ vehicles that really were of interest to us. When you look at those 2 companies from an acquisition perspective, we already see the 1 award that we highlighted in the communication, that's a reflection of some of the traction we're getting.

That was an opportunity that was not included in either company's funnel until the transaction took place. And you could see very quickly, we were able to re-vector, put together a compelling proposal and wind up being successful.

There are more like that. We expect that to continue through the year.

We will also be pursuing some of the single source or single-award opportunities, not just the IDIQ. Those are back-end loaded, but we see excellent opportunities that we could pursue together.

The funnel is very robust. And in some cases, it's even more robust than we originally thought.

So we're excited that it's just a matter of time as these start to work through the procurement cycle, we'll start to see those benefits in the second half of the year. But we've already seen some traction, like I mentioned.

I think that partly or that partially explains the next question I had, which was the book-to-bill declined from 1.2 to 1 this quarter and it hasn't been this low since the second quarter last year. So that metrics should improve going forward as well, as your bookings come back?

Yes, Sameer. It will.

We have a fair amount. We have a handful of multimillion-dollar opportunities already in evaluation.

There will be more going in for submissions in the second quarter. Like we always said, we felt the second half of the year was really where we're going to see the traction on new business awards, and that's still playing out as we had discussed before.

And we currently do not see any change as far as that's concerned. And certainly, the Metis and CENTRA acquisitions are contributing to that as well.

Well, thank you very much for joining us on this first quarter call. And as always, please reach out to me with any questions you have, happy to arrange time to speak with management.

Thank you for your support. Have a great day.