Jacobs Solutions Inc (J) — Q1 2015 Earnings Call Transcript

Thank you very much, and welcome to Jacobs' first quarter 2015 conference call. With us today is our EVP and CFO, Kevin Berryman, who will present the financial highlights for the quarter; Chairman Noel Watson will present our growth strategy; and George Kunberger, our Executive Vice President of Sales and Marketing, will provide a business overview and end-market outlook. Noel will wrap up the prepared remarks before we take questions. As you're aware, we issued the press release last night, and it can be found on jacobs.com, along with the presentation we plan to review this morning. As a reminder, statements made in this webcast that are not based on historical fact are forward-looking statements. Although such statements are based on management's current estimates and expectations, which we believe to be reasonable and currently available competitive financial and economic data, forward-looking statements are inherently uncertain, and you should not place undue reliance on such statements as actual results may differ materially. There are a variety of risks, uncertainties, and other factors that could cause actual results to differ from what is contained, projected, or implied by our forward-looking statements. For a description of some of the factors that may occur that could cause actual results to differ from our forward-looking statements, see our annual report on Form 10-K for the period ended September 26, 2014, and particularly the discussions contained under Item 1 - Business; Item 1A - Risk Factors; Item 3 - Legal Proceedings; and Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as the company's other filings with the Securities and Exchange Commission. The company undertakes no obligation to release publicly any revisions or updates to any forward-looking statements that are discussed on this webcast. The safe harbor statement can be found on Slide 2 of our webcast presentation. With that, I now would like to turn the call over for some opening remarks to Kevin Berryman.

Thank you, Michelle, and good morning, everyone, and welcome to the call this morning. Before diving into some of the financial results, I thought I would spend a little bit of time giving you some introductory comments, considering this is my first earnings call with Jacobs. A couple of notes: I am very excited to be part of the team here at Jacobs, a recognized leading company in the engineering and construction space. During discussions on the onboarding process with the board and the executive management team, it was very clear to me that this was a collaborative and talented team that operates with a very high level of integrity. That was very important to me. However, there was a little more than that. It was clear during those discussions that the team was very interested in driving an even stronger performance agenda going forward and longer term. I joined this company because I think I can contribute and help drive the development of that performance agenda, which we all collectively believe is going to add significant shareholder value longer term. A couple of comments about some of the changes going on in the company: Clearly, there's been some management transition. We are in the midst of a CEO transition. I am coming onboard after John Prosser retired after decades of service to the company. I want to communicate that, from my perspective, there has been no loss of focus as it relates to what's going on in this company. My initial perspective about the quality of the team has been overly confirmed over my first weeks here in the job. The talent continues to deliver against its execution plan. That is driven by the leadership of Noel Watson. I have had the pleasure of getting to know Noel over the last few weeks. He has a strong pulse on the industry, the team, and our sales initiatives. He is providing strong leadership during this transition period for the company. What does all of that mean? It means that traction has not been lost in this company. People are focused, and they are executing. I’m feeling very good about where we are at this point in time. So let me turn to Slide 4. In honor of Mr. John Prosser, I will use his same slide for our discussion of financial results. In short, the company delivered a very solid quarter. Earnings per share were $0.77, up 8.5% versus a year ago. The quarter was relatively straightforward in that there were no real drivers, pluses or minuses, but there were some incremental cost headwinds that we were able to overcome. Some of that was associated with foreign exchange, with the strengthening of the dollar over the quarter that had a slight headwind relative to our earnings per share performance and the executive transition cost. These costs, if taken together, probably amounted to $0.03. Our $0.77 reported would have been closer to $0.80. Regardless of whether it's $0.77 or $0.80, it is in line with the expectations that we had set for ourselves at the beginning of the quarter. Overall, it was a solid quarter. Cash flow remains strong, and our net debt figure of $80 million remains near year-end levels, driven by having $670 million in cash, which largely offsets the outstanding debt by the end of the quarter. Our strong ending cash position illustrates the strength of the cash flow dynamics of the company, as this position was achieved even as our share buyback program ramped up in Q1. During the quarter, we bought back 2.5 million shares at a total value of about $113.7 million. Program-to-date, we have utilized nearly 40% of the $500 million authorization and have spent about $192 million. We are currently being more aggressive with our share buyback program given Jacobs' share price. Backlog rose to a record $19.1 billion, nearly up 6% from the year-ago period and also up from $18.4 billion last quarter. This is a strong indication of the opportunity for Jacobs, noting the headwinds in certain of our end markets. It is a testament to the diversity of our company and its ability to grow even when market conditions are challenging. The backlog growth was despite several significant cancellations during the quarter, but our sales strength was able to overcome these cancellations, resulting in a strong book-to-bill for the quarter of over 1.2 and a trailing 12-month book-to-bill of 1.08. Before I turn to my comments on outlook, let’s turn to Slide 5 and discuss the backlog. You can see that the increase was driven by the professional services area, which bodes well for potential future work for the company. Specifically, the professional services backlog grew $900 million in the quarter or nearly 7.5% from the year-ago figure. Regarding our outlook, we face some headwinds in specific parts of our business, particularly regarding oil and commodity prices, which are creating real challenges as we work through those affected end markets. Coupled with foreign exchange pressures that we expect to see for the remainder of the year, this prompts us to take a more cautious outlook for the year, suggesting it is more aligned with the lower half of our prior guidance from last quarter. However, our diversity is a strength. It translates into the robust, record backlog. The cautious outlook is short-term in nature, with Q2 likely impacted more than the second half of the year as we realign our resources from weaker to stronger end-market opportunities. At the same time, we must remain disciplined in managing our fixed cost structure. We will do this to ensure we have an appropriate cost structure to operate successfully in any end-market environment. Before turning over to Noel, a few quick comments. I look forward to meeting all of you, our analysts, and shareholders, as I finalize my onboarding process. Thank you to John Prosser, who has been supportive during my transition. John, thank you for that. Noel, over to you.

Thanks, Kevin. Let’s look at Slide 6. We’re going to talk about our relationship-based business model. Kevin mentioned market diversity. Many of you know I've been around a long time, and years ago we decided it was important to be in more than a single market, which we have leveraged over the decades. We have a wide variety of end markets and a geographic spread across the globe. We are thankful for this diversity today, given some headwinds in a couple of markets. When I took this position, I didn't anticipate $45 oil and $2.50 copper; however, we need to deal with it. Yet many of our markets are strong right now, and I will let George discuss that. Our cash position is good, and in a market like this, it's a good opportunity to drive down costs, and we must do that. Now moving to Slide 7, which illustrates our relationship-based business model. This slide has been around as long as I have, and it hasn’t changed. It starts with our drive to service a smaller group of clients well, knowing their businesses, providing outstanding performance, and creating continuity and repurchase loyalty. Nothing will change about our model, despite past transitions. We are aiming for steady earnings growth and recapturing the 15% growth we've discussed over the years. With that, I'll pass it over to George to talk about market diversity during Slide 8.

Good morning, everyone. It's George Kunberger. I'm delighted to make my debut here today alongside Noel and Kevin. Let's start with Slide 8, which depicts our diversity representation. This slide doesn’t change often as it is based on a 12-month trailing backlog. However, I want to point out some aspects: The diversification on the process side is about 46%, down from 48% last quarter. The public sector side increased from about 35% to 37%, reflecting the strengthening in the public sector market. As we evolve over 12 months, that increase in public institutional presence results from the full 12-month utilization of SKM. We also have geographic diversification that adds value and flexibility to our operations. I look at the current environment through the lens of $45 oil, and I think it looks pretty good right now. Now moving to Slide 9, let's discuss various market sectors. The backlog in the public and institutional area grew nicely at a rate of about 16% on an annualized basis. I would characterize the market as good to strong, both geographically and consistently strong through the rest of the year. Specific to defense spending, the U.S. market is stabilizing and ramping up in the U.K. and Australia. There's significant opportunity related to redeployment of bases in Asia-Pacific, positioning us well. In the nuclear cleanup space, both the U.S. and U.K. markets are expanding. In transportation and utility infrastructure, there's pent-up demand globally, though it's more steady than explosive. We are well-positioned globally to capture opportunities, with markets for healthcare, education, and social development growing. In the Middle East, investments of $800 billion to $900 billion are planned over the next 5 to 6 years, and our market position in that region is strong. Overall, I am optimistic about the marketplace, with strong and steady growth expected moving forward. Now let's move to the industrial sector, which comprises various components. I want to start with pharma. There are exciting developments happening in immuno-oncology. This results in significant capital spending primarily in the Western world, where Jacobs is a strong contender. While competition is re-entering the space, we are capturing more than our fair share. The mining and metals sector remains depressed. I don't expect significant growth in that sector for a while, but there are opportunities in sustaining capital worldwide. Major companies are still exploring potential expansion projects, although capital spending rates remain low. We aim to capture brownfield projects and joint ventures, and we have quite a few opportunities. In consumer products, our relationships remain steady. Jacobs is well positioned in high-tech spaces with key clients that are yielding results, as well. Next let’s discuss the process world. The upstream sector is uncertain but remains viable. The Canadian oil sands work is facing challenges due to oil pricing pressures; however, good projects continue to move forward. In the U.S. shale oil business, companies are reallocation resources to areas with more ROI, such as the Permian Basin and Bakken. In the refining marketplace, there are projects aimed at improving overall effectiveness and productivity. There are still many good ROI projects in refining that will continue for the foreseeable future. Our strategy is robust in this industry. The chemical marketplace remains strong as we have secured several major projects. While there will be fluctuations, I am optimistic about sustained strength in that market.

Thanks, George. Moving on to Slide 12 regarding acquisitions. Historically, we've achieved about 1/3 of our growth through acquisitions. We are currently focused on organic growth and not pursuing any acquisitions until the right opportunity arises. On Slide 13, I want to reiterate that our model works. We have strong relationships with major clients, and our success in remote locations, such as our relationship with Aramco in Saudi Arabia, confirms our approach. Our diversification has been valuable; if we were heavily concentrated in oil and gas, we would struggle, but we are maintaining performance across multiple sectors. Given the recent headwinds we face, we will focus on cost advantages, slightly reducing costs across the board without being drastic. This adjustment is essential in maintaining our competitiveness, especially in the heavy process business. I think now we'll open it up for questions.

One question about the second quarter being weaker due to realigning resources and another question about whether we can get a sense of the cost impact.

You'll take one, and I'll take the other one.

Regarding Q2 versus the balance of the year, we need to address cancellations and realign resources, which results in short-term pressures until everything is in place. We're not discussing another substantial restructuring but focused on disciplined and targeted opportunities to control costs to ensure success in different market environments. Comparatively, EPS growth year-over-year will be more challenging in Q2 versus the balance of the year.

How much were the cancellations and where did they occur?

They were primarily in the oil and gas process industry, totaling about $400 million out of our revenue stream.

How much of the prospect list do you think goes away?

The prospect list remains robust. While we've seen a couple of postponed projects, new opportunities continue to emerge, particularly in the chemical market, offsetting some reductions in the upstream and midstream areas.

As resources are interchangeable between job areas, we can remain agile in responding to opportunities.

Is it more difficult to grow backlog currently due to the market?

Despite headwinds, we expect backlog growth over the next three quarters as we are optimistic based on new prospects emerging despite market uncertainties.

What is the outlook for margins in light of the oil and gas sector challenges?

While some markets may see slight margin declines, I do not expect significant reductions on average across the board.

What impact from foreign exchange should we expect this year?

The dollar's strength has implications for our reported earnings. We anticipate about a $0.05 to $0.08 impact for the full year, which we will monitor as we adjust our operating agenda accordingly.

How do backlog growth and reductions in guidance reconcile?

The reconciliation is driven by the burn rate of new business and how cancellations impact us.

Is the long-term project cadence affecting revenue burn?

We don't place non-starting projects in the backlog. Some of these will be three-year jobs and so the revenue burn can take longer.

What major programs are driving government revenue growth?

The recent growth in national programs is partially attributed to the FNS acquisition, which has added significant contributions.

How do you anticipate revenue burn shaping up?

We have a major award in the downstream space; however, significant visibility will not occur until late next year as we finalize engineering and procurement.

When should we expect to see the cost reductions take hold?

We expect to see a combination of cost reductions pass to the bottom line, though some may have to be passed on as price reductions.

How is market capacity affecting labor rates?

Craft labor rates are currently stable; however, we are adjusting resources from the oil patch to brownfield projects in downstream.

How did you manage your cautious outlook based on customer feedback?

We conducted a lot of detailed work, but many variables made it difficult to pin down precise forecasts. We ultimately found it prudent to take a cautious approach.

Three weeks in, I find many opportunities to enhance performance, but it’s too soon to discuss specific actions or strategies.

How much revenue in 2015 is booked into backlog?

Roughly 65% of the revenue has been booked into backlog, which is encouraging.

What’s the mix of service versus maintenance projects?

The balance between process and public sector leans slightly towards public sector but overall is roughly 50-50.

How much cash is in the U.S. versus internationally?

Much of our cash is outside the U.S., but we can access funds to support share buyback initiatives without pressure to finance it differently.

What are the implications for margins if public outgrows process?

We do not believe the impact of mix on margins will be measurable.

What is driving the decline in field services revenue?

The drop in field services revenue stems from a reduction of spending in the oil sands, although we are gaining market share in maintenance services. We expect a steady book and burn as we focus on maintenance and sustaining capital projects.

Is funding for recent major projects coming through?

Funding for the Sellafield project is in place, and work continues to ramp up successfully.

Was your comment about year-over-year growth based on adjusted EPS or GAAP EPS?

The reference was to adjusted EPS.

What are the cost savings from the SKM integration so far?

Cost savings realized in Q1 speak to our restructuring efforts. We expect those savings will continue through the year.

What are your expectations for refiners concerning the new Tier 3 standards?

Tier 3 spending has not fully manifested, primarily due to delays in compliance. However, we view our positioning in this area positively and, along with ISA 84 spending, expect enduring opportunities.

What was the driver behind SG&A expense this quarter?

SG&A was elevated due to the full quarter impact of SKM; however, we are committed to monitoring costs diligently.

We are nearing the end of our session and need to conclude. Kevin is available for any remaining questions, so please feel free to reach out. Thank you for joining us today, and we're excited about our progress, recognizing some uncertainties ahead. Thank you, and have a great day.