Parsons Corp (PSN) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2020 Parsons Corporation Earnings Conference Call. (Operator Instructions) Please be advised that today's conference may be recorded.

I'd now like to hand the conference over to your host today, Mr. David Spille, Vice President of Investor Relations. Please go ahead, sir.

Thank you. Good morning, and thank you for joining us today to discuss our third 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 third 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.

Thank you, Dave. Good morning to everyone on the call, and welcome to Parson's Third Quarter 2020 Earnings Call on this eventful morning of continued vote counting. We had a great third quarter, and this was against a backdrop of challenging global macroeconomic conditions. We delivered record adjusted EBITDA, while also delivering outstanding cash flow. These accomplishments, once again reflect the resiliency of our combined portfolio of Federal Solutions and Critical Infrastructure. After the end of the quarter, we announced the pending $300 million acquisition of Braxton Science & Technology

Group. Braxton reinforces our strong position in a rapidly expanding space market. We're very excited about joining forces with Braxton. It further expands our cutting-edge space capabilities, our strong government and space customer base, and expands our addressable market to include critical ground-based technology systems. This acquisition exceeds all of our quantitative and qualitative M&A thresholds.

Now I'll review a few of our third quarter financial highlights. We reported adjusted EBITDA of $101 million. This is an adjusted EBITDA margin of 10%, achieving, on an interim basis, one of our long-term financial targets announced during our IPO last year. We also generated $145 million of operational cash flow and ended the quarter with a 1.2x book-to-bill ratio driven by 1.5x in Federal Solutions. We continue to execute on our goals of winning larger programs and additional OTA awards. We are also simultaneously delivering strong program performance for our customers. Exemplifying these points during the quarter, we won a $300 million contract with a classified customer, doubled our year-to-date OTA awards over last year and continued to receive high customer satisfaction scores. The above reflects our strong contract performance, which drives margin expansion.

We continue our disciplined balance sheet management and execution of our M&A strategy. We recently closed a $400 million convertible note, taking advantage of historically low pricing. Additionally, we protected shareholders by purchasing a hedging instrument that precludes potential dilution below a stock price of $66 per share. The incremental capital we raised in this transaction was very timely. It will enable us to fully fund our Braxton acquisition while leaving the financial flexibility for additional future M&A transactions.

The acquisition of Braxton underscores our disciplined approach to M&A. We strive to acquire companies that operate in specific, high priority and high-growth markets. Our market strengths are aligned with National Defense priorities of cybersecurity, geospatial and radio frequency intelligence, space, C5ISR and missile defense. These markets are enduring and expected to be insulated from budget cuts. Our core technologies of artificial intelligence, autonomous systems, including counter hypersonics, cloud computing and IoT are also aligned with the nation's technology priorities. So Braxton is well-aligned with Parsons and the nation's top investment priorities.

We also like to acquire companies we work with in the past and have a strong reputation in the market and that benefit from our scale and broader set of capabilities. Braxton perfectly aligns with this aspect of our M&A strategy. We ensure M&A candidate companies have great technology, exceptional management teams and are a strong fit with our agile, innovative and disruptive culture. Braxton meets all of these objectives as well. Braxton also exceeds all of our major financial criteria, with revenue growth and adjusted EBITDA margins above 10%, respectively, and transaction is accretive. Braxton enhances our margin and revenue growth profile and further strengthens our strategy to win large, prime contracts within the DoD and intelligence communities. Braxton builds on our strong track record of successfully acquiring and integrating companies. It is consistent with our recent acquisitions of Polaris Alpha, OGSystems and QRC Technologies. We look forward to welcoming their employees into team Parsons. Carey will elaborate further on the Braxton acquisition in a few minutes.

In summary, we delivered on another strong and successful quarter. We reported record adjusted EBITDA and record EBITDA margins, delivering outstanding cash flow, and achieved a strong book-to-bill ratio. Our operations team continues to be successful in winning large new contracts and OTA awards. Perhaps most importantly, we continue to deliver on our commitments to our customers. We started the fourth quarter by announcing a strategic space acquisition, and this acquisition will further enhance our position in this important and fast-growing market.

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

Thank you, Chuck, and good morning, everyone. Today, I'll organize my remarks into the following 5 key areas: the income statement, cash flow results, the balance sheet, the contract awards and 2020 guidance.

As Chuck indicated, we had an outstanding third quarter. Strong program execution and our continued focus on cost management resulted in record adjusted EBITDA and margin, and excellent cash collections drove operating cash flow of $145 million. We also opportunistically raised $400 million of additional capital that fund our Braxton acquisition and enable investment in additional strategic growth opportunities.

Regarding the details of our financial results. Total revenue for the third quarter decreased by $19 million or 2% in the prior year period. This was driven by growth in our Federal Solutions segment, offset by an expected decline in Critical Infrastructure revenue, consistent with our ongoing strategy to roll off low-margin pass-through work. Indirect SG&A expenses decreased $13 million from the third quarter of 2019 driven by lower transaction-related expenses and insurance costs. Adjusted EBITDA of $101 million represents an increase of $12 million from last year, and adjusted EBITDA margin increased 130 basis points to 10%. These increases were primarily driven by higher earnings, among consolidated joint ventures and lower indirect G&A expenses.

I'll turn now to our operating segments, starting first with Federal Solutions, where third quarter revenue grew by $12 million or 2% year-over-year. This increase was driven by higher business volume on new and existing contracts. Federal Solutions adjusted EBITDA decreased $5 million or 9% from the prior year quarter. And our adjusted EBITDA margin decreased from 10.4% to 9.2%. These decreases result from a significant contract milestone incentive fee recognized in the third quarter of 2019, which was not repeated in the current year, and higher pass-through revenue in the current quarter.

And now a few words regarding our Critical Infrastructure segment. Third quarter revenue decreased $31 million or 6% from the prior year period. This decrease was driven primarily by lower volume on contracts with significant pass-through revenue. Critical Infrastructure adjusted EBITDA increased by $16 million or 42% year-over-year. And our adjusted EBITDA margin increased 360 basis points, 10.8%. These increases result primarily from higher earnings on unconsolidated joint ventures and lower IG&A costs.

Next, I'll discuss cash flow and balance sheet metrics. Net DSO at September 30, 2020, stands at 69 days compared to 58 days at the end of Q3 2019. The Our third quarter operating cash flow totaled $145 million driven primarily by strong collections in our Federal Solutions segment. Capital expenditures totaled $6 million in the third quarter of 2020. As noted by Chuck, our balance sheet remains very strong. We ended the quarter with a positive net cash position of $27 million, taking into account the impact of the $300 million, all-cash Braxton acquisition, our pro forma net debt as of September 30, 2020, would total $273 million. This would equate to a pro forma net debt leverage ratio of approximately 0.8x.

Regarding awards, we reported contract awards of $1.2 billion in the third quarter, representing a book-to-bill ratio of 1.2x. On a trailing 12-month basis, our book-to-bill ratio is 1.0x. Our backlog at the end of the third quarter totaled $7.8 billion and continues to represent approximately 2 years revenue at our current run rate.

Now let's turn to our guidance. Given our strong third quarter performance and outlook for the balance of the year, we are narrowing our fiscal year 2020 adjusted EBITDA guidance range and reiterating the revenue and cash flow ranges initially established on March the 10th.

With that, I'll turn the call over to our President and Chief Operating Officer, Carey Smith, to discuss our third quarter operational highlights. Carey?

Thank you, George. As Chuck and George indicated, we had a strong quarter from an operations perspective and completed a significant acquisition that bolsters our space presence. I'm proud of our team's accomplishments, given the challenging conditions we're facing on a few of our contracts due to the COVID-19 pandemic. Despite these challenges, we delivered strong cash flow results and a 10% adjusted EBITDA margin for the first time in our history.

The third quarter was our strongest year-to-date for our Federal Solutions team with a 1.5x book-to-bill, and we won large single-award contracts, strategic space on cyber contracts and other transaction agreements. 70% our total awards in the third quarter were for new business.

We also achieved a historical milestone on our Salt Waste Processing Facility contract by moving into the operations space, and QRC Technologies reported the best quarter in its entire history. As you can imagine, I'm very excited about our Braxton acquisition, which positions us well with key space customers. Notable contract wins in the third quarter include a $307 million contract win with a classified customer, $115 million option year on our Combatant Commands Cyber Mission Support contract where we provide offensive cyber operations, defensive cyber operations and open source intelligence in support of joint all domain operations.

We expanded our rail systems footprint with over $100 million in wins, including a $45 million contract by the Bay Area Rapid Transit district to support the implementation of a communications-based train control system. Once complete, this will be the largest communication-based train controlled installed system in North America.

We've also awarded the TransLink Bradway line of British Columbia, Canada for over $44 million, where Parsons will design the system elements for the fully-driverless rapid transit system as well as provide system assurance. And after the third quarter, we were selected as the preferred proponent for the Edmonton Light Rail transit contract in Western Canada as a 50-50 joint venture partner. This $2 billion program is the second stage of the Valley Line and applies the latest light rail technology. Finally, we were awarded a $51 million recovery of air base denied by ordinance or (inaudible) win, where we employ the Parsons developed ZEUS-directed energy system. The ZEUS laser can hit targets more than 300 meters away and is powerful enough to detonate cluster bombs, land mines and general-purpose bombs. This program is also the first Department of Defense ground-based laser system placed into production. Our momentum of winning other transaction agreements or OTA contracts continues.

During the third quarter, we won strategic new OTA contracts, bringing our total award value to more than $200 million year-to-date, which is double the amount we had in 2019. Our program execution on the Salt Waste Processing Facility contract has also been strong. During the third quarter, we were thrilled to celebrate the start of operations at this facility. 18 years ago, the Department of Energy and Parsons embarked on a mission to revolutionize the treatment of radioactive waste produced during the cold war and contained in the underground liquid waste storage tanks at the Savannah River site. We're now able to process radioactive waste 8x faster than historical treatment rates. The startup of the Salt Waste Processing Facility is a testament to the commitment and dedication of the Parsons workforce at this first-of-a-kind facility.

We also continue to be pleased with QRC Technologies performance as we book large orders with the United States Marine Corps and the United States Special Operations Command in the third quarter. These sales demonstrate the continued reliance upon QRC signals intelligence and integrated network survey products by our critical Department of Defense customers.

The successful integration of QRC has enabled us to increase slight margin product sales and also enhanced our ability to win larger awards. As Chuck indicated, we're very excited to welcome the Braxton employees into the Parsons family. Braxton complements our existing space portfolio, increases our product offerings and adds critical intellectual property that expands capabilities for the United States Air Force, space force, the Department of Defense Research Laboratories and the intelligence community.

Braxton's product portfolio of greater than 50 proprietary commercial off-the-shelf products, along with the development and sustainment of key government off-the-shelf products provides mission-critical solutions for spacecraft ground control and spacecraft integration.

Braxton's unique mix of products and services solve complex engineering problems, including command control and communications, cybersecurity and data processing. As the prime contractor for the satellite prototyping and integration contract, Braxton supports the United States Space Force, Enterprise Ground Services Program, or EGS. EGS is a next-generation architecture that will unify spacecraft ground control operations across multiple major government agencies. With this acquisition, Parsons is better positioned to capitalize on the rapid space market growth driven by the proliferation of low earth orbit constellations, small satellite expansion and space cyber resiliency. Braxton has a strong reputation in the industry, a history of technology disruptiveness, and we look forward to leveraging both their technology and their expertise.

Parsons is fortunate to have known and worked with Braxton in the space community, and we're collaborating already in areas including space situational awareness and NOAA's Space Weather systems. Our portfolios are extremely complementary and will enable end-to-end space solutions for the war fighter.

With synergy spanning space situational awareness, satellite operations, space protection and resiliency, cybersecurity and space modeling and simulation, Parsons and Braxton together will accelerate growth in the global space market.

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

Thank you, Carey. In summary, our team's third quarter execution was very strong. We delivered strong financial results and exceptional program performance for our customers. We also further strengthened our balance sheet with a $400 million convertible note offering, and we quickly put this capital to work with a strategic acquisition that will drive additional growth in our space market.

Before we begin the Q&A session, I'm pleased to announce that we will be conducting our first Virtual Investor Day on March 11 next year. This will be a great opportunity to learn more about our strategic vision, hear from market line leaders and participate in various Q&A sessions. We look forward to the event and your participation.

Now we'll open the line for questions.

(Operator Instructions)

Our first question comes from the line of Sheila Kahyaoglu with Jefferies.

First question, maybe, George, for you. Looking at the implied cash flow ramp in Q4. It's over 50% of the total, and I know you guys are Q4 heavy. But can you give us some of the moving -- major moving pieces around working capital and if any one-off items there?

Yes, certainly, Sheila. As you indicated, we had a nice quarter in the third quarter, building our momentum in the second quarter. Traditionally, the fourth quarter is a very strong quarter for us. As I indicated in my prepared remarks, Federal Solutions was a major contributor in the third quarter. We anticipate significant strength from Critical Infrastructure in the fourth, including in the Middle East.

Okay. And then maybe another question on the business, just parsing out space and geospatial and cyber and intel. Those 2 businesses were up 37% and 20% in the quarter. So pretty significant numbers, and definitely areas that are more insulated from broader budget trends. Are there any ways to maybe quantify the success that you're seeing in these 2 businesses, whether win rates, book-to-bill? Sorry if I missed it, and if you said it. And just trying to get a sense of the runway for growth.

Thank you, Sheila, and thank you for your questions. We're very bullish on our cyber and intel and space and geospatial markets. Those were obviously both helped and appended greatly by the acquisitions of Polaris Alpha and OGSystems. And our win rates have been very strong, also appended by the larger contracts that we're winning than we had historically won without the acquisitions that we garnered. And our win rates have been very strong. Carey, mentioned a couple of the wins that we had this last quarter. And we continue to be very bullish on the strong growth of those 2 units and our missile defense C5ISR unit going forward. Carey, any additional color you'd like to add to that?

Yes. Sheila, under cyber and intelligence, we had growth on our Combatant Commands Cyber Mission Support contract. And as I mentioned during the remarks, QRC's organic growth was the best it's been in the history of the company. We also had strong organic growth across the whole portfolio of C&I contracts and our very strong win rates continue there.

Within space and geospatial, there were 2 primary areas. One was our launch manifest system integration contract and the second one was the T-REX Special Operations contract.

Our next question comes from Gavin Parsons with Goldman Sachs.

Guys, the pipeline has grown pretty significantly over this year and over the last few years, and we haven't seen that convert to backlog yet and I know you've discussed the dynamic of awarded but unbooked value like contracts like CCMS.

So I guess my question is, one, when would you expect to see that increase in the pipeline actually start to drive backlog growth? And two, is there any way to quantify that unbooked value?

Well, as we've mentioned in the past, Gavin, our approach on IDIQ contracts, be they single-award or multiple award, is to book those very conservatively. So although we may have won a billion-dollar contract or in the case of, say CCMS, contract north of $500 million. We're only booking it in pieces per year, whereas I think some of our other companies in the space would book the whole item.

And so that -- what that gives us is, one, we're never getting too far out in front of our headlights. But two, the confidence that our backlog will continue to build on contracts we've already won, but just haven't booked the entire backlog yet, given our booking policies.

So we expect our backlog continue to grow in the next 2 years at least, but that's where we've got some pretty good visibility. Carey, anything you'd like to add on that regarding any of the specifics?

I agree with what you said, Chuck, and the 2 that I would point to in cyber and intelligence that we're currently getting work on would be Combatant Commands Mission Support contract, and we very conservatively only booked the base and option year 1 there. And the other one was a contract called (inaudible) classified contract we booked last year, and we did receive the (inaudible) task order the last quarter on that contract.

Great. That makes sense. For clarification, what is the COVID revenue headwind in dollar terms this quarter?

Yes. If we look at COVID -- and it gets tougher to estimate, Gavin, because, one, we're kind of comparing actual numbers to planned numbers. But you kind of spread it apart, you'd look at Federal Solutions as, for example -- and they may be growing in the high single digits since COVID. And that's nominally $50 million of headwinds that we're facing in that market, probably close to 75% across the portfolio.

So if that's a $50 million revenue headwind this year, and you haven't reduced your revenue guidance for the year, obviously, to your point, that implies much better core growth. So assuming that's a net impact, and there's not some big tailwind from kind of COVID benefits that go away next year. I mean should we think about you making up that full amount of COVID headwind on top of the core business growth continuing next year? Or is that double counting growth next year?

Yes, I think that's double counting. Here's the way I would think of it. Some of our contracts, like Antartica, where they just aren't allowing us on the ice for a year. They've been very fortunate to not have any COVID cases, and they want to keep it that way. Or Kwajalein Island where the Marshall (inaudible) made those same decisions. Both of those decisions, we don't control. So when they decide to allow us on the Ice or when they allow -- decide to allow us back on the islands, think of it as, we pick up where we left off and whatever that duration that we were not on ice or on island, then that just extends the contract out in time.

Same can be said, quite frankly, for FAA, who has also taken a very cautious role with their unions in terms of continuing the workload. So a lot of that has just gone down to a base load and then the work that we didn't do will add to the end of our contracts.

Our next question comes from Joseph DeNardi with Stifel.

Chuck, can you just talk about kind of appetite for additional M&A? Obviously, you have the capacity to do more on the balance sheet, but just from kind of an internal bandwidth standpoint, should we assume that you all are done for a period until you digest what you've done? Or are you still in the market?

Yes. I would not jump to the conclusion that we are done. We are still in the market. We've shown in the past, the ability to pull off multiple acquisitions per year. We have the infrastructure built to do that. And more of what -- either accelerates or slows our acquisition assimilation is the quality of the companies that are out in the market space. And I think as I've said in past calls, at any given time, we're talking to 5 to 10 different companies. And -- that are -- we're primarily pulling out of our supply chain.

Got it. That's helpful. And then maybe you all want to save this for the Investor Day, but could you provide some kind of qualitative commentary around expectations for 2021? I mean even if it's directional revenue and margins.

Yes. We'll be announcing that with our Q4 earnings call. But I think the general takeaway is we remain very bullish on the company and our markets. And we aren't seeing anything out of the election day or anything else that gives us any pause for caution.

Okay. And then just as it relates to Braxton, any dissynergies or overlap between the 2 businesses that could present some revenue dissynergies in the near-term we should be aware of?

Yes. Thank you, Joseph. No. There's no dissynergies. There was a couple of very minor OCI contracts. We're talking like nominally 5 people that have no material impact on the revenue or profit generations or the integrations. So one of the great things about Braxton is there was not a lot -- there wasn't really any overlap. We were working side by side. And so now we're greater as one.

Our next question comes from Tobey Sommer with Truist Securities.

When you look at Braxton and the area in which it plays. What does the pipeline look like for RFPs and so much as you're aware, where the combination of the 2 companies may better situate you to win work once the company is, in fact -- the acquisition is closed?

Yes. The activity in the space market right now is very strong, partially because space is becoming such a crowded frontier with all of the lower orbit satellites being launched. But obviously, we have a great deal of activity from private industry as well as from governments, China expanding and the like. We also, from a National Defense perspective, have a lot of satellites in orbit that are being controlled by multiple systems. And the beauty of an enterprise ground system, enterprise ground services like the work that Braxton does is it allows the defense department as others to be able to control and communicate between those multiple systems at 1 point.

And that's an area that is going to have a lot of growth. Has shown a lot of growth already, but will grow even more in the years ahead. So we're very excited about the space market.

Could you refresh us on the arc and pace of runoff in the Critical Infrastructure unit in sort of the time period of that being a headwind in your current thinking?

Yes. So what -- we've been pretty consistent on that. We think in 2022, probably midyear, we'll have all of that off the books. The work we're booking now including our latest big win are our really, really margin-rich contracts. And so we continue to expect the margin to expand in Critical Infrastructure. So we're going to continue to grow that bottom line at a healthy rate. And the top line will be muted as we said it during the IPO. And after that, then we'll be out of the mode of running off that low-margin backlog. And we should see top line and bottom line growing at the same rate.

Last question for me. Could you speak to the medium and long-term financial impacts of what you've learned from the pandemic, work-from-home, et cetera? There may be some benefits in there as well as the discrete headwinds we've discussed already on the call.

Yes. Great question. One of the things we've learned is that the public wants confidence in the infrastructure they use. And whether that is just better education over the ventilation systems or improvement there too, more physical separation, better cleaning regimens. So there's going to be a lot of modifications to physical infrastructure to improve distancing and cleaning and all of those kinds of attributes.

But the other thing that it's proven for our customers is that you can do a lot of things virtually in terms of controlling these networks, and you can do it safely from a cyber perspective.

So whether it's virtualizing these transportation nodes and replacing servers with cloud-based operations that allow for much more efficiency and a better use of taxpayer dollar going forward. We think there's going to be a big emphasis on this SaaS models, the ability for contractors to deliver infrastructure and then charge for that on a pay-as-you-go basis.

I'm very bullish on the infrastructure industry. It's -- we think it's going to go through a lot of transformation, which will be very good for customers for companies like ours.

Our next question comes from Ron Epstein with Bank of America.

A couple of quick questions. What is your organic growth? Right. So if you back out all the acquisitions year-on-year, what is your organic growth? And what would be your organic book-to-bill, if that makes sense?

Yes. Thank you, Ron. You look at our organic growth. And as we said, going forward, since COVID are Federal Solutions unit is growing in the mid- to upper single digits. And our Critical Infrastructure, which albeit lumpy in the runoff of that work, arguably we're running that as a flat unit over, say, 3- to 4-year period. And we're still on track to drive those 2 overall growth rates.

COVID, obviously, has had some impact. What's the great news there is the agility of the team to be able to pivot and to sell more products because they've got GOTS products or COTS products, which may not be as material to the top line, but have had a very important impact on the bottom line as well as the pivot to more professional services and IT-oriented services in our Critical Infrastructure business.

Now a second question, with all the M&A you guys do, how do you measure that you're, in fact, creating value, right? I mean a lot of times, M&A doesn't.

So what's your internal process to kind of gate check that? We bought this for x, and it actually creates value for us.

That's a great question, Ron, and one that our Board has been laser focused on for the last 15 years, given that we are an acquisitive company. So for -- on a quarterly basis, after we make an acquisition, we report back to the Board on the forecast that we had made, we typically take the rates and plans of the companies, put in really ground truth those numbers and get our -- develop our own set of numbers on what we think rates will be: growth rates, profit rates, et cetera. And then we track those for a year. After a year, it gets very difficult to track those as, to your point, the synergies.

Now you start winning jobs as a total Parsons entity as opposed to a Polaris Alpha and OGSystems or Braxton. But on a year-end basis, what we've generally found is the cost synergies are greater than we forecast. The revenue synergies have been greater than we forecast and the core businesses we've bought have generally been meeting their plans.

So the net-net of all of that is we've been creating more shareholder value out of those acquisitions that have helped compensate for things like COVID.

But are you looking at cash-on-cash returns, right? If you buy a $1 billion for -- if you buy a business for $300 million, when do you expect to get the $300 million back, is it 3 years out, 5 years out?

Well, generally, it's been more in the area of 3 to 4 years out, cash-on-cash returns. And they've generally all been -- well, they have all been margin accretive. They've been margin accretive.

Got it. Got it. And then maybe one last one. I know there's a lot of uncertainty because of the election and so on and so forth. But you guys must have some sense of directionality into 2021. Can you share some thoughts on that?

Yes. So clearly, I think we and everyone else understands the priorities of the Trump administration fairly clearly. So the challenge for us was to get a good line of sight on the Biden administration, should it end up with a Biden presidency. So I spent quite a bit of time speaking with both sides of the aisle in Congress and Senate, transition team members. And what we came away with is, their emphasis on national defense priorities are very aligned. The emphasis on the underlying technologies to help defend our nation are aligned.

If there was 1 difference is that the Biden administration seemed to be more focused on a large infrastructure bill and how they would fund that and put that in place. So to us, that was the primary difference. We remain very bullish regardless of how the outcome ends up.

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

The margin-rich contracts, you mentioned there in Critical Infrastructure. Can you just give us some color there, what technology is driving that or geographies and why is Parsons winning?

Yes. So that's a great question. There is really 2 things that drive the margin richness. One is the expansion of our underlying technology portfolio to include things like iNET, or intersection-as-a-service, bringing technologies we've developed in Federal Solutions over.

Secondly, has been the phenomenal margins that we've been generating out of Canada. And a lot of that has to do with our business model. But it's also just a very infrastructure-rich environment and we have much less competition today then say, there were in the infrastructure market 5 to 10 years ago.

So as a result of that, margins have increased substantially in North America with a corresponding decline in risk transfer. And we have leveraged our design expertise into outsized returns on some of these large infrastructure projects. And the latest one is just a great example.

Some of this comes through the books as -- since it's -- we don't consolidate a lot of these -- they're for minority partners and joint ventures. That's what really gives the upside impact to our EBITDA margins.

And then just on the commentary on the long-term COVID changes, I know you talked about work-from-home, more comfort for the customer. Any way you're willing to put some estimate on maybe your real estate footprint consolidation. We've heard from others in the industry, some pretty large assumptions. Is there any way you're able to put a finer point on that?

Yes. Well, I think it's -- you hit the nail on the head. Between real estate leases and some associated IT costs, we think that our populus will kind of break down 1/3, 1/3, 1/3. And I'm not implying that it's going to be equal 1/3, maybe a better way of saying that will be 3 buckets.

There'll be those employees that are going to come back to work full-time in our offices. And that will be driven either by their personal choice or the choice of our customers and our teams where they need the collaboration and working day-to-day, side-by-side. A second group will choose to work from home on a permanent basis. They -- we're already leaning that direction either from their child care perspectives or aging parents or some other criteria that they're using, and we can support that. We've proven that. We've done it now for 7 months straight.

And then thirdly, it will be a group. And I think this will probably be the largest group of our workforce, who will choose a hybrid option. And in that option, they might be working in office 3 days a week and working from home 2 days a week. All of that leads to a net reduction of real estate costs, which you can't get day 1 because we often have leases that probably average 3 to 4 years out in terms of termination. But we can see each year, our real estate costs coming down and improving the efficiency of the use of our overhead dollars. And if I was to be a betting person, I would say, on the high end, we look at somewhere around 40%, 50% reduction. And on a more conservative side, probably somewhere in that 30%.

So as I'm sitting here today, those are the kinds of percentages that I'm looking at. And George and I are working on in our financial planning.

And then just one on Braxton, how does it fit into the SaaS kind of conversation? And then how much of it is focused on hardware versus software?

Yes. So Braxton is a very product-rich company, albeit most of it got product or government off-the-shelf products. They do have a very successful cuts product, commercial off-the-shelf, that's right around -- a little less than 10% of revenues.

It all -- a lot of this is going to depend on what we think is going to take shape and an emphasis by federal government customers to drive more efficiency in our contracting means and methods and improve their -- your use of taxpayer dollars.

And in that regard, a lot of these products do hold SaaS potential. So we're building our portfolio of products that we can take into a SaaS model, and it will be getting the government to actually change their contracting methods. In the meantime, we can sell those COTS products off-the-shelf, and those carry much, much higher margins.

(Operator Instructions)

Our next question comes from Cai von Rumohr with Cowen.

Yes. So most of your peers who have already reported have indicated favorable indirect expenses as a result of COVID. The 3 things they mentioned are: less travel expense, less medical expense because people are scared to have electric surgery in the hospitals because of COVID, less vacation paid time off and, hence, higher labor utilization. Could you comment on the potential positive impacts from COVID on your business, what you saw in the third quarter?

Yes. I think that since COVID began, we've obviously seen reduced travel, Cai. But I'm sure that's true for almost every business. Bad for the travel industry, but good for the overhead of other companies. And as you said, we've seen medical costs decline as well as fewer folks are doing elective surgeries or going into their doctor visits. And vacation is probably off a bit, although I think we have seen and we've tried to promote people continue to take vacations to promote good mental well-being. But certainly, those are the 3 areas we've seen positive wins from.

Right. And what sort of impact? Because your margin at Fed Solutions was down not only year-over-year but was down sequentially.

Yes. So a lot of that, Cai, as you know, goes to the award fees, which tend to be lumpy. We've got large award fees we received last year of the Salt Waste Processing Facility. And this year has come off of some of the chemical weapons demilitarization, work that we've done. So those episodic award fees when they hit have a big determination on that multiple. The good news is that the margins are increasing steadily over time of the core Federal Solutions market. As we run off more of that pass-through revenue there out of Engineered Solutions, predominantly. And we garner for, one, more fixed-price level of effort work. And two, greater product sales.

Great. And then you mentioned in terms of new opportunities that you're likely a major subcontractor to Northrop on GBSD. And you also had, I believe it was called Detect Wise to -- a portal to detect COVID at airports. Could you comment on those 2 opportunities?

Sure. Yes, the -- obviously, Northrop Grumman is signed their contract. We're in discussions with Northrop and Bechtel. The initial focus is obviously getting the missiles themselves worked out and prototypes in manufacturing. And we continue to work on the areas of our predominant expertise around blast systems, hardened systems, communication systems and the like. So we fully expect to be under contract sometime in Q4, maybe early Q1 next year. And just reminding against -- again, we don't have any of that in our guidance. We don't put things in guidance or plans until we have signed contracts.

Regarding Detect Wise, it will continue to make sales where in airports, as you pointed out, several other industrial and infrastructure customers will continue to make sales on a weekly basis and continues to grow.

Again, I'm not sure that, that will ever be material, but it showed the resiliency and also, quite frankly, gave a huge jump start to our program to launch a new product quarter.

And what we're seeing now are new products coming out of our cyber and intel group, our space and geospatial group, the new (inaudible) to software product for our missile defense teams. And those are right down the middle of the fairway of our market focus.

Our next question comes from Louie DiPalma with William Blair.

Chuck, you and Carey referenced several recent defense wins, including the cyber combatant commands and the use of commercial off-the-shelf software. I'm under the impression that Parsons developed the sensor ingestion software for the army's high-profile distributed common ground system program, and this program is high-profile because it involves the convergence of like several like high-growth areas like data analytics, AI and software development.

So are you able to like broadly discuss like Parsons software data analytics capabilities. And I'm asking because there are several other programs in the pipeline that you're involved with such as the air force advanced battle management system. So I'm just wondering how you're positioned in these hydro areas?

That's a great question. And let me -- I'll take the initial response and have Carey provide a little more color. But what I can say is data analytics is a very important strategic asset and capability that we have. When we talk about artificial intelligence, and we talk about correspondingly, the high-speed processors we create, the hardware kit that we create and the data analytics that we provide in converting that large stream of raw data into information with the analytics through the high-speed processors and the analytics we are performing and then ultimately converting that into actionable knowledge with our AI algorithms.

That is a key element of what we're doing across all of our market sectors. That's pretty ubiquitous. And as you say, it is critical to these large new programs coming out.

The other area, before I pass it to Carey, I just wouldn't underemphasize is the work we're doing in electromagnetic warfare, and specifically in the area of high-end lasers. And our ZEUS laser system, which is embedded in our Rad Bow products that we're now -- we announced we're selling to the Air Force. That is another great area of R&D and application and commercialization for us. Carey, as you to take that in a little more depth?

Yes. We've been the army mission partner for 15 years, helping them understand data and analytics and working with them to develop off-the-shelf software that collects information from various sensor feeds and put that data into the appropriate battle field operating systems for the operational side of the army. As you mentioned, Parsons did develop the sensor ingestion software for the distributed common ground system army. And our software is responsible for standardizing all the incoming sensor data, including the integrated sensor architecture messages that we format them into the DCGSA system to be able to easily process and analyze that. And that is critical in helping the army and Department of Defense, mine the data and track the insurgence.

We're also involved in big data platforms and other areas, including defensive cyber mission operations program, where we service the lead system integrator for the army on the DCO.

And then I would want to point out also in the Critical Infrastructure area, we do a lot of data analytics. If you look at our intelligent network system, you look at the work that we're doing in the tooling market with our partner in the [LOG].

George, I was wondering, and this might be a question better for the Analyst Day, but are you able to ballpark, quantify like what the Critical Infrastructure margin would be today if you didn't have the low-margin contracts that you expect to churn off by the middle of 2022?

Yes. I'd say at this point, it would go up moderately. But as Chuck suggested in a response to an earlier question, a good part of that runoff has already occurred. So we would have some uplift. If I were to put a number on it, I would say it might be another 50 basis points.

Next question comes from the line of Joseph DeNardi with Stifel.

Chuck, you mentioned earlier kind of still being in the M&A market. Can you remind us where you're willing to take the balance sheet? And should we assume that using equity is off the table or not necessarily just kind of in the context of the convert? And I know that wasn't particularly dilutive, but I just want to get your view on use of equity and M&A going forward.

Yes. In terms of the last part of that question first. I think the kinds of acquisitions we're looking on a day-to-day are going to be cash-based acquisitions. If we were to contemplate some sort of large transformative deal, I don't think I would take equity off the table. But certainly, on the types of deals we've historically done and the kinds of deals that we're looking at today.

And looking at the areas we said we would invest in, obviously, cyber and intel, in terms of market areas, cyber and intelligence, space and geospatial, missile defense, C5ISR and our connected communities work, where we're doing the advanced electronics, software and hardware development work for infrastructure.

And then in terms of areas -- technologies we're investing in, again, areas that either benefit from our work or add to our capabilities in our artificial intelligence, including high-speed processing and data analytics, cloud computing, predominantly migration of large platforms to the cloud and creation of new cloud applications. The autonomous systems. And in autonomous systems, we include counter hypersonics. So that's ARC land and space.

And lastly, IOT. And whether it's our Pearl flash geospatial sensors or QRC, radio frequency sensors and processors, all of the work that we do around the IoT in terms of creating new data streams and then analyzing and processing those data streams.

That's all the time we have for questions today. I'd like to turn the call back to Dave Spille for closing remarks.

Thank you very much for joining us this morning. If you have any questions, please don't hesitate to give me a call. And we look forward to speaking with many of you over the coming weeks. And with that, we'll end today's call. Have a great day.

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