Jacobs Solutions Inc (J) — Q3 2020 Earnings Call Transcript

Good morning and evening to all. Our earnings announcement was filed this evening and we have posted a copy of this slide presentation and our prepared remarks to our website, which we will reference during the call. I'd like to refer you to our forward-looking statement disclaimer, which is summarized on slide 2. Certain statements contained in this presentation constitute forward-looking statements, as defined in Section 27A of the Securities Act of 1933, and Section 21E of the Securities and Exchange Act of 1934, and such statements are intended to be covered by the safe harbor. Statements made in this presentation that are not based on historical facts are forward-looking statements. Examples include statements concerning the potential effects of the COVID-19 pandemic on our business, financial condition, and expectations regarding future growth, prospects, financial outlook, and business strategy for fiscal 2020 or future years. Although these statements are based on management's current estimates and expectations, forward-looking statements are inherently uncertain and actual results may differ materially. We caution the reader that a variety of risks, uncertainties, and other factors could cause actual results to differ materially. For a description of these risks and uncertainties, see our annual report on Form 10-K and our quarterly report on Form 10-Q. We are not under any duty to update any forward-looking statements after the date of this presentation to conform to actual results, except as required by applicable law. We will refer to non-GAAP financial measures during the presentation. See slide two for more information on these figures. Today's participants will include Jacobs’ Chairman and CEO, Steve Demetriou; President and Chief Operating Officer, Bob Pragada; and President and Chief Financial Officer, Kevin Berryman. Steve will discuss our social justice and equality action plan, provide an update on our response to COVID-19, recap our financial results, and update our outlook.

Thank you, Jon. And thanks everyone for joining us today to discuss our third quarter business performance and strategy update. While the COVID-19 pandemic continues to occupy our time, as leaders, we must not lose sight of speaking up for what's right. Earlier today, we launched Jacobs’ Global Action Plan for advancing justice and equality, developed in direct response to recent social and racial injustices. Our focus on inclusion and diversity, which we call TogetherBeyond, has been a critical success factor in driving improved performance and shareholder returns. Today's launch is our next phase in this journey with four primary pillars centered around culture building and engagement; leadership, commitment and accountability; developing talent; and growing the business. This action plan aims to achieve true equality for all our employees, prioritizing black employees to ensure they have equal opportunity and the tools needed to advance at Jacobs. I'm proud of the employee engagement in the development of this action plan, which included collaboration alongside our Board of Directors and executive leadership team. Our first commitment is to amplify a culture of belonging by expanding our existing Conscious Inclusion program with the commitment to training our 55,000-person global workforce by the end of fiscal year 2021. We're engaging 3,000 Jacobs’ leaders in meaningful dialogues on antiracism and tying senior leadership’s inclusion performance to their compensation. Our second commitment is to recruit, retain, and advance black employees based on merit by increasing their representation at all levels. We're enhancing our leadership development programs and require all senior leaders to mentor at least one black employee. Our third commitment involves driving structural change in broader society, with plans to donate $10 million over the next five years to support black educational and professional development opportunities. Finally, we appointed Jeff Dingle as Vice President of TogetherBeyond to drive this action plan. Advancing justice and equality requires strong leadership and a relentless commitment to deliver on this vision. The time is now for us to get this right, once and for all. Now, moving to slide 5, I want to discuss our continued focus on keeping our people safe during the pandemic. As we approach five months of battling the coronavirus, we've prioritized keeping our people safe and delivering on our commitments. Our strong culture of caring and emphasis on employee well-being has emerged prominently. Our crisis management teams continue to monitor the pandemic and respond accordingly. Regarding our return to the workplace, we are demonstrating flexibility. Our efforts in supporting our clients during COVID-19 have included our pharmaceutical solutions team playing a major role in the retrofit of facilities to develop COVID-19 vaccines and therapeutics. We have also deployed our ION technology for contact tracing with pharmaceutical clients and are creating scenario modeling software used by transit clients globally.

Thank you, Steve. Now, moving on to slide 7 to review our Critical Mission Solutions performance. During the third quarter, our CMS business performed better than the COVID outlook we provided in the second quarter. Our solid third quarter results demonstrate CMS’s resiliency and ability to perform at the highest levels for our clients. Even though we will continue in a COVID-impacted environment through early fiscal 2021, our performance has been encouraging. The underlying demand for our services remains strong, and total CMS backlog is now at $9.1 billion, representing a 3% year-over-year growth on a pro forma basis. While portions of our CMS portfolio can be performed remotely, we did see some impacts in our long-term contracts due to physical distancing protocols. Our U.S. federal civilian business constitutes about 35% of CMS’s revenue, mainly from our NASA and DOE clients. Our support to NASA focuses on meeting national goals like returning to the moon by 2024. Despite challenges, our workers have transitioned well to remote work and our NASA portfolio is expected to return to full capacity by fiscal year-end. Additionally, Jacobs has been highlighted for utilizing AI in building components for NASA's next generation spacesuit. Moving to the nuclear portfolio, while we expected moderate impacts from physical distancing, the business has performed better than expected in the third quarter due to key performance milestones and contract extensions. In our U.S. Intelligence Community sector, which contributes over 20% to CMS’s revenue, we anticipated moderate impacts in Q3 from physical distancing but saw a return to approximately 80% of normal operating levels. Our operating strategy focuses on higher margin opportunities, and transitioning off lower margin contracts will impact short-term revenue growth, but will benefit our unit margins. Overall, Jacobs continues to win new large contracts across the Department of Defense.

Thank you, Bob. I'll provide a detailed summary of our financial performance for the third quarter of fiscal 2020 on slide nine. Third quarter gross revenue increased 3% year-over-year, while pro forma net revenue declined 4%. The adjustments reflect some declines from the CMS sector due to COVID-19 impacts on operations. Adjusted gross margin as a percentage of net revenue was 23.5%, down 35 basis points year-over-year. Our G&A costs benefited from lower travel and employee-related expenses, but we expect G&A as a percentage of revenue to increase modestly in the fourth quarter. GAAP operating profits improved significantly versus last year, up 116% to $194 million. This included $20 million in restructuring charges and amortization from acquired intangibles. Our adjusted operating profits in net revenue was 8.9%, up 10 basis points year-over-year. Adjusted EBITDA for Q3 was $254 million, or 9.5% of net revenue, reflecting strong performance from CMS and People's and Places Solutions businesses. Our pro forma book-to-bill ratio was 1.1 for Q3, driven by strong performance in People & Places Solutions. CMS had a book-to-bill just under 1 times.

Thank you, Kevin. Given our better than expected transition to a virtual work environment, we’re updating our fiscal 2020 outlook. We now expect adjusted EBITDA to range from $1 billion to $1.50 billion, up from the previous range of $950 million to $1.50 billion. Additionally, we're updating our adjusted EPS guidance to a range of $5.05 to $5.30, above the previous guidance. Importantly, at the midpoint of our revised EPS range, this represents year-over-year growth. We expect the gross impact to second half 2020 earnings to be approximately $0.35 per share due to our success in adapting to physical distancing. As we look into fiscal 2021, we anticipate year-over-year adjusted EBITDA growth, with the second half expected to perform stronger than the first half. I would like to thank everyone for joining us today and for your ongoing support.

First question may be for Bob. When you talked about your P&PS business, could you provide more detail on the public versus private funding areas? How concerned are you regarding the timing of public funded projects in relation to the current environment?

Michael, we're cautiously optimistic about the outcomes, and our backlog is sustainable and resilient. Growth discussions are separate from the dependence on stimulus and reflect the current state.

Could either Bob or Steve describe how sensitive your business is to defense budgets next few years? What gives you confidence that CMS will grow even if the top line DoD budget is flat?

While the overall DoD budget is relatively flat, there are components of it that are growing, including the space budget and cybersecurity. We feel positive about our position aligned with these growth items.

Transitioning to higher margin work may represent a short-term revenue headwind, but it’s essential for long-term profitability. We expect these new projects to enhance margins significantly through 2021.

At your Analyst Day in 2019, you talked about $7-$8 earnings potential for the company. What needs to happen to bridge back to that outlook?

The fundamentals of our strategy remain robust and are strengthened as we diversify the company. Timing is critical, and we believe growth remains on track.

What’s your view on how the defense customer has responded to increased costs due to remote work? Are there signs they accept COVID pass-throughs?

Value-added solutions are being accepted by our government clients, and we’ve been able to secure CARES compensation due to the critical services we provide.

How are your customers reacting to potential re-shoring and bolstering supply chains? And how does work-from-home impact Jacobs’ overall cost structure?

The pandemic opens new opportunities for Jacobs as clients prioritize digital solutions and advanced facilities like semiconductor capacity and data centers.

Could you quantify known headwinds for 2021 regarding revenue growth forecasts for CMS? Also, what percentage of sales are up for recompete?

Recompetes are not substantial for 2021 and we anticipate growth driven by strong pipeline demand. We believe margin enhancements will deliver good operating profit growth.

How have drivers of EBITDA growth changed in the last few months? To what extent has the growth become more margin-driven over time?

While near-term dynamics may be muted, the strong pipeline and ability to grow margins signifies solid growth opportunities for 2021.

What are your assumptions on public project revenue growth in the event of a CR extension? What states show more promise versus others?

We expect robust performance, as most of our backlog remains intact across states with higher funding availability such as California and Texas.

Thank you for your participation in our call today. The pandemic has tested our resilience and the ongoing cultural focus at Jacobs gives us confidence in our strategy moving forward. We foresee growth in EBITDA for 2021 and appreciate your continued support.