Jacobs Solutions Inc (J) — Q2 2021 Earnings Call Transcript

Thank you. Good morning to all. Our earnings announcement was filed this morning. We have posted a copy of this slide presentation on our website, which we will reference during the call. During the presentation, we'll be discussing forward-looking statements, including with respect to the continuing effects of the COVID-19 pandemic, potential government stimulus programs, and our financial outlook, among others. I would like to refer you to our forward-looking statement disclaimer, which is included on Slide 2 regarding these and other forward-looking statements.

Thank you, John, and thanks to all of you for joining us today to discuss our second quarter fiscal year 2021 business performance and key initiatives. As the pandemic lessens its impact here in the United States, it's vital to recognize the significant struggles that are still occurring throughout the world, especially in India. Jacobs made an immediate donation to the United Way in New Delhi for critical medical supplies. And I'm particularly proud of our company and employees who together have donated $200,000 through our internal giving platform collectively. We have and will continue to support those that are still being impacted by the pandemic, including, for example, our operations in the Philippines. Turning to Slide 4, before discussing our second quarter results, it's important to continue to reiterate how we think about our business by aligning and executing against our long-term strategy to drive superior value for our stakeholders. We take a multiyear approach to our rigorous strategy formation. This long-term mindset involves proactively assessing and aligning our portfolio toward large secular growth opportunities where we can deliver sustained double-digit profit growth. The transformation that Jacobs has undergone over the last several years has created significant value measured by relative total shareholder return. As you have seen from our recent organic actions, the PA Consulting investment and the acquisition of the Buffalo Group, we believe there's a significant opportunity to deliver differentiated, digitally enabled solutions as the world accelerates its efforts to modernize infrastructure, improve the global supply chain, and enhance national security. We have started the development of our new corporate strategy for fiscal year 2022 to 2024, which we will present to the investor community later this year.

Thank you, Steve. Moving on to Slide 6 to review the quarterly performance for our Critical Mission Solutions business. During the second quarter, our CMS business continued its strong performance and our workforce is executing at pre-pandemic levels as COVID-19 vaccines are administered broadly across our operational sphere. Total CMS backlog is at $9.8 billion, representing 7% year-over-year growth and up 6% pro forma, excluding the lower margin hampered and classified procurement contract we have previously discussed. The CMS strategy is focused on revenue growth and margin expansion by offering technology-enabled solutions aligned to critical national priorities that drive innovative outcomes. Similar to last quarter, I will discuss four notable market trends positively impacting our CMS business: space exploration intelligence, all-source intelligence, digital modernization, and clean energy. Beginning with space exploration and intelligence. From idea to operations, Jacobs delivers know-how and value to every stage of the space system life cycle for our civil and national security space plans. NASA leads the global exploration and development of deep space with its Artemis program that will carry astronauts to and from the moon's surface and beyond. As NASA's largest service provider, Jacobs is involved in many aspects of the Artemis mission, including the space launch system, the Orion spacecraft, and the exploration ground systems based at Kennedy Space Center. We are proud to have expanded our NASA support to the Wallace Flight facility located in Virginia, and are now providing full life-cycle operations and testing that deploy expertise we have developed at other NASA centers. We remain heavily engaged in the NASA mission portfolio, including the recent support of the SLS hot fire test in the design, fabrication, and full deployment of the calibration device on the Perseverance Rover now exploring Mars. NASA continues to enjoy strong bipartisan congressional support with preliminary FY22 budget, including a 6% increase over 2021. We also support the DoD's joint all-domain intelligence initiative, utilizing satellite connectivity in space and adding more capacity for intel analysis, such as our successful Mango One launch earlier this year. Overall, defense-based spending was up 28% in FY21 and is expected to show strong growth in FY22 as well. Moving on to all-source intelligence. Today's threat levels require intelligence analysts to utilize and coordinate multiple sources, including human, signal, open source, geospatial, and measurement and signature to allow for better decision making in real-time. The Buffalo Group acquisition greatly expanded Jacobs' all-source intelligence capability. We were awarded two exciting wins from the Defense Intelligence Agency in the quarter. Jacobs will provide counterterrorism analytical expertise for the Defense Combating Terrorism Center, DCTC, and integrated intelligence centers in direct support of war fighters around the globe. We were also awarded a prime seat on the $12.6 billion Solutions for Information Technology Enterprise, or SITE III, IDIQ to address the evolving IT requirements vital to the security of the United States. All those specific classified budget details were not provided in the preliminary budget, but redirection of funds towards emerging cyber and intelligence threats from states are anticipated.

Thanks, Bob. And turning to Slide 9 for a quick financial review. Second quarter gross revenue increased 4% year-over-year and net revenue was up 7%. This was driven by solid underlying business performance, offset by the timing of advanced facilities projects. Acquisitions and FX benefits continue to grow, growing by more than offsetting the burn-off of two lower margin previously disclosed contracts in CMS. Including the pro forma impact from all acquisitions, net revenue was up low single digits. For the second half of fiscal year 2021 compared to 2020, we expect total reported net revenue growth to be up in the low double digits year-over-year. On a pro forma basis for acquisitions, we expect second half revenue to be up low to mid-single digits versus a year ago as growth from the acquisitions and CMS and P&PS growth from a weaker second half of 2020 compare more than offset continued headwinds in CMS from the lower margin contracts coming to an end. Adjusted gross margin in the quarter as a percentage of net revenue was 25.8%, up 260 basis points year-over-year. The higher gross margin on a year-over-year basis was driven primarily by three factors: improvements in CMS gross margin as we continue to remix the portfolio to higher margin business, a favorable impact from lower benefit costs, and the benefit from PA Consulting, which has a strong accretive gross margin profile versus the rest of the portfolio. From a line of business standpoint, CMS gross margins increased strongly on a year-over-year basis as we benefited from higher margin revenue in the base business, new wins, and improved portfolio mix. Gross margin was up slightly year-over-year. Adjusted G&A as a percentage of net revenue was up slightly year-over-year to 15%. As we look forward, we will continue to be disciplined in the management of our G&A costs, but do expect an increase in G&A as a percentage of revenue as a result of an expected rebound in labor-related medical costs, IT-related investments as we move to a flexible workforce, and other investments to drive growth. GAAP operating profit was a negative $41 million and was mainly impacted by a $267 million cost related to the closing of the PA Consulting transaction that we called out in our press release filed this morning. Let me provide additional detail on the nature of this cost. The $267 million represents a portion of the aggregate purchase price consideration for our investment in PA. That per GAAP accounting is treated as compensation given retention-related requirements and distribution of this amount post-closing. We still view the total investment consideration unchanged at £1.4 billion. I'll discuss the cash flotation of the $267 million later in my remarks. In addition, we had $42 million in deal and other costs associated with the PA Consulting investment, $13 million of restructuring, transaction, and other charges, including the Focus 2023 initiative, and $31 million of amortization from acquired intangibles. Adjusting for these items, adjusted operating profit was $311 million, up 32% with both lines of business showing strong organic profit growth. In addition, PA Consulting posted strong double-digit growth in operating profit during their quarter ending April 2, 2021. Our adjusted operating profit to net revenue was 10.5%, up 200 basis points year-over-year on a reported basis and was effectively 10% without the benefit from PA, which is a record for the company.

Thank you, Kevin. Now let me review our total company outlook for fiscal 2021. Given our strong first half performance and the benefit from the PA Consulting investment, we're raising our full-year guidance ranges. We now expect adjusted EBITDA outlook to be a range of $1.2 billion to $1.27 billion versus our previous outlook of $1.075 billion to $1.155 billion. We expect adjusted EPS to now be in a range of $6 to $6.30 versus our previous outlook of $5.30 to $6. Looking beyond fiscal 2021, with optimism building around a major US stimulus package and significant opportunities related to climate change and digital modernization, we are positioned for strong revenue and double-digit adjusted EBITDA growth in fiscal 2022 and beyond.

Maybe one for Bob or Steve, on the infrastructure side. Wondering if you could just focus on two things: timing. How quickly do you think you see it in your numbers, maybe what you're monitoring that will inform that? And then competitively, the industry is obviously a lot more consolidated now than it was in prior cycles. Can you talk about the implications of that for your business and maybe the margin profile for P&PS over this upcoming cycle?

Let me start with a couple of high-level comments, Joe. We expect the final decision on this matter to come later this summer, potentially extending into early fall. As a result, we anticipate seeing momentum build sometime in 2022. The strategic driver for us is that whether we consider the Biden proposal or the more diluted Republican version, we expect it to land somewhere in between, and both indicate significant growth and many opportunities for various companies. For us, as a margin-focused company, our experience over the past few years highlights that, as demand for resources increases, we possess the best global integrated capability to deliver those resources effectively while concentrating on high-margin opportunities that will develop in both our businesses and the P&PS at CMS.

Maybe to add on the competitive climate, so Joe, where we sit with regard to framework agreements that we've had, not just in the US, but stimulus is also affecting the UK and Australia and other locations around the world, are pretty ideal for where those monies would flow. So if you look at transportation frameworks, water frameworks that we've been on for several years, it’s going to position us extremely well. And those are pretty secure because the money needs to flow pretty quickly. So coupled with the fact that we're on these higher-end services, I think the competitive climate we stand will fare well.

Bob, maybe I could follow up in a sense that, during the 2019 Analyst Day, you listed a 4% to 6% target for P&PS, which was called something else at the time but it’s similar sort of the move forward. Are you able to give us any color regarding the ballpark of organic growth Jacobs may be able to deliver above and beyond that? And then if for some reason the stimulus doesn't go through, given all these trends that you've been talking about, ESG, sustainability, advanced facilities, is 4% to 6% the baseline you could do more than that you think going over the next couple of years?

We're not going to provide any guidance relative to 2022 at this point in time. But I think we're feeling pretty good about the developing momentum. So we certainly, as we work through it, I think it's important to note Steve's comments relative to we're not going to go after everything. We're going to go after those things that ultimately give us the best margin potential. So I think we're excited about what 2022 can ultimately look to and certainly, I would suggest it's probably not going down.

Really outstanding performance from PA Consulting out of the gate for you folks. I'm wondering can you talk about whether the $300 million quarterly run rate that the business was on in March. How has that momentum translated into the second quarter? And how much variability is there in that business given the length of engagements now that we're getting to know the business a bit more?

Jerry, I think the client engagements and the client stickiness, call it, is solid. And so yes, the size of the engagement might be different than we would have historically seen at Jacobs. But the longevity with their clients really just from the technology and the value they're contributing shows the future to be really bright. So we're feeling very positive.

Just to build on the other part of your question, Jerry, is PA Consulting did a really great job positioning themselves to win in sort of COVID solutions, and Bob talked about that and still got some runway on it. But what they're also now seeing is several of their other markets picking up, and so that bodes well as some of the COVID work starts to phase out, this other work is phasing in.

Just a question on the space exploration and intelligence vertical, you highlighted in the remarks. Can you just give us some color on the commercial dynamics? You seem unique in that you're touching the very large launch but also have exposure on the small sat side with assets like Mango that you mentioned. Are you leveraged to one end of the market or the other, large or small sat? Just how should we think about Jacobs sitting into the conversation over cube sats versus some of these larger opportunities?

Well, just, again, maybe to start with the broader space for us is it's pretty wide-ranging for us. As we have always been a major player with deep space exploration and NASA being a major client for ours, and we're solidly positioned there around Artemis and the research and development work they're doing around hypersonics and space architecture, et cetera. And now with the KeyW acquisition ramping up very nicely, the whole low earth orbit, ISR, and rapid solutions. And then you go beyond there with missile defense and some of the other aspects of space, it's become a very major market for us, specifically. Bob, around the commercial sector?

I think that the adjacent and knock-on effects of what we're doing, not just exploration but how that feeds into intelligence is strong. If you look at the Mango One launch, the application centered around intelligence but also the application into 5G and other commercial applications is going to continue to broaden markets that we haven't had exposure to in the past. So other things that Steve said is really expanding that aperture on the applications.

I guess two questions. My first question, sort of going back to potential infrastructure, Bill, Steve. Are there any investments that you think are required from Jacobs in order to capitalize on it? Do you feel like you have the right labor for your niches, or do you go back and sort of contemplate M&A again? So I guess that's my first question. And then my second question, I think you noted revenues from ESG are approaching $5 billion or so. Can you talk to sort of what the underlying growth trends that you're seeing in that business and how to think about the profitability of the businesses that are more ESG focused?

We couldn't be better positioned from a standpoint of the M&A activity that's behind us. Obviously, CH2M combined with Jacobs positions us to be the major player here. And by the way, we have to keep reminding everyone, one of the biggest acquisitions in our industry is going very well. When you look at what we paid for that compared to what it's generating today, it's extremely attractive financially, but obviously, Jamie, helps us position to be a big winner. But then you have on top of that the PA Consulting acquisition, which now provides end-to-end capability from front-end consulting all the way through delivery and ultimately things like O&M, etc. So from a climate change extent, so as far as other M&A, we're going to continue to look at things that can move us up the food chain from a margin standpoint, possibly some geographic expansion. But as far as the US infrastructure stimulus opportunity, I think we're extremely well positioned with the organic capability we have today. And on the climate change side, when you look at the $5 billion, it's really wide-ranging what we're in. But as you look at the growth going forward, it's going to be everything from how do we help our clients adapt and mitigate. So whether it's sea-level rise, flooding, bush fires, and droughts, the whole energy transition equation moving away from fossil fuels into clean energy, and that's both working with our government and private clients; everyone is looking to reduce their carbon footprint. That’s where we come in around the whole decarbonization and eliminating or reducing greenhouse gases and then things like natural resource stewardship, which is critical across the globe. It's a global opportunity. We’re positioned well as an end-to-end solutions provider and bringing some unique tools and innovation because it’s going to require digital transformation to achieve these types of climate change transformative expectations by our clients.

So at the risk of making this a broad question or maybe something that gone on your Investor Day, could you just run through some of your key margin initiatives and where you see the most progress made and where you have the most upside potential here? I know you've got the CMS margin mix. You've got the future of awards and a few other things. Maybe just kind of give us an update on the margin potential?

When you talk about margin initiatives, it's been both organic and inorganic. One of the things we're extremely proud of around our Critical Mission Solutions line of business is all the recent acquisitions: KeyW, Wood Nuclear, Buffalo Group. They're all performing very well, strong first half versus the first half pro forma, and they're all margin-accretive to our CMS line of business. And so from that standpoint, I think that's a key addition to our margin enhancement. But then it really goes back to what we were talking about earlier, to our whole global integrated delivery profile to not only bring the best resources but be more efficient in certain aspects of the whole delivery model and much more around the whole business acumen, commercial acumen side now versus several years ago and really identifying where the margin opportunities are, not just going after any business for the sake of growth. Bob, what else on that front?

Yes, I think it's just staying on that digital theme, Steve, and we're looking at it both externally and internally. So for example, rationalizing our internal platforms on how we transact our business is going to have derivative benefits. Kevin's talked about it before with regard to operating leverage. And then externally, if you have to point to one, it really is around the digitization of our offering. So autonomous design, machine learning, looking at the digitization of the global delivery model, and then how that can provide value solutions in a more efficient way, so it's a big opportunity.

…focus on just some of the cybersecurity issues that we've seen materialize over the weekend and really focus on the need to reinforce the infrastructure in the US. And I just want to get a sense of how you guys are thinking about deploying what's been more about focused cybersecurity initiatives to the private sector and how are you thinking about your go-to-market strategy there?

Chad, I think we missed the first part of your question. It sounds like it's around cyber, but can you just kind of reask it and you summarize it?

So I just wanted to get a sense of how you're thinking about the opportunities on cybersecurity given that there's been a kind of attack on the critical infrastructure here in the US over the weekend. And then you guys have had a strong heritage in the government side and just wanted to understand how you're developing opportunities on the cyber side and what your go-to-market strategy is there?

We're actually in the middle of it right now and I can't speak too much into the details, but the events I think that you were highlighting over the weekend, we are engaged in that too. Kind of the portal there on leveraging it in the private sector has been our strong heritage also in the private sector with the other portfolio offerings that we have. Specifically, if it's in the hydrocarbon space, we did quite a bit of environmental remediation and regulatory work in that space. Using that as the portal in order to bring in our cyber expertise, whether it be OT or IT has been a strong initiative and we're seeing some traction there, not just in an emergency situation but also as a part of cyber hardening of these companies. And then in other private sectors that we have, whether it be facility, specialized manufacturing, all those things that we do for the government, the roadmap points to our ability to leverage our longstanding private sector relationships and do the same. So you'll see more of that coming in the coming months and coming quarters.

I just wanted to go back to PA Consulting. I'm not sure if I'm looking at this the right way, but PA did $0.09 of accretion in the month of March. But if I take that out of the accretion update for the full year, it kind of implies they're doing $0.04 a month for the remaining six months of the fiscal year. So I'm trying to understand that. And then also whether the previous expectation of $0.52 to $0.57 of accretion on a full-year basis in fiscal '22 is still a good way to think about it?

So a couple of comments, Sean. This is Kevin. So as you think about the pace of their profitability over the course of their quarters, they, like us, we have four, four or five months within each quarter. And the way they handle their fixed costs and how they amortize that over the months versus the amount of revenue they get in that last month, their last month tends to be the strongest month in the quarter. So effectively, don't necessarily take that $0.09 and assume that all the way through. So I think that that's one thing to recognize. So if you look and take away the $0.09 and kind of go to your remaining kind of, let's call it, $0.04 a month for the remaining six months, it is basically that number. We think that that is really strong performance consistent with what we had in our deal model. And ultimately, we're hoping given the strong start that maybe there could be some opportunity to improve on that over the balance of the year. But so far, they started strong. And Steve mentioned the comment about their current work being really, really strong in the first quarter, but some of that’s going to go away over their second, third, and fourth calendar quarters for their year. And they have to do a really good job on replacing that over the balance of the year. So we feel good about the guidance we've provided. And ultimately, hopefully, that pipeline will continue to translate into incremental backlog, which could result in potentially being a little bit higher. But I think we're being prudent in terms of our guidance for PA at this point in time.

Maybe for Bob, maybe to elaborate a little bit more on life science and advanced manufacturing. Certainly, the news flow and the supply chain issues with regard to the electronics industry have been front center for many investors. Are we getting to a point where there's going to be a significant investment that's going to show up and run through your PM work in the next six to 12 months? And even on the Life Science side, is it more of a global opportunity? Certainly globally positioned. But we've been hearing more about US supply chain, but are you going to be more driven globally, whether it's a vaccine side, biologics, or some of the electronics opportunities that you're working with your clients there?

Michael, let me kind of unpack both sides of that. On the semiconductor side, I'm not sure if you asked about that or life sciences; it is global. It's probably more focused in on the US for us right now. When I say US, US clients as well as agent clients that are building in the US. You're even seeing it in the stimulus bill with President Biden's efforts in order to increase that capacity here on US soil, as global supply chains have been kind of rejiggered. And so we do see that having a positive effect on Jacobs. I don't know if it's necessarily six months; it's probably got a longer tail on that, easing through the next 12 to 24 months, but that's a strong trend. And it's both not only on the logic side, but it's also on memory chips and some of the lower-end chips that you're hearing from some of the automotive issues that are going around. On life sciences, that is probably more global as it pertains to us, and that is the rebalancing of the product portfolio, all of this attention that’s been placed on vaccines, specifically around the coronavirus. Great development that's happening within the oncology world. And as I said in the remarks, that's driving a real need for contract manufacturing, probably like nothing we've seen in history because of the volumes that are needed and the speed to market around these new therapies. So overall, really, really solid picture for at least the next couple of years.

There were a few mentions on the call about increasing investments in SG&A and IT, travel and medical. I understand the investments are for the better growth outlook. When we think about your tentative guide for double-digit EBITDA growth in 2022, is there any leverage on top of that top line or the initiatives around the margin? Is it really all set to really expand incrementals in 2023 and beyond? Just curious how we should think about that trade-off with a better growth outlook and some inflationary pressures that'd be building as we think of the double digits and beyond for 2022 and 2023?

So a couple of comments, Michael. First one on the margin front or the percent of revenue that SG&A represents. We're still in a good spot relative to historical numbers. So don’t think of this as being something that's going to be a big challenge for us, but we do find it necessary to make these investments. I think the next comment I would make is that’s what Focus 2023 is really all about to ensure that we get improved operating leverage through the process and system enhancements that we're talking about, which will allow us as the growth dynamic begins to accelerate, which we talked about, assuming it's going to happen in 2022, and that's going to be really important for two reasons: one, to get the operating leverage, but I think the other way to think about it is if we can get that growth and afford ourselves the same ability not to hire at the same level that we've had to in past growth spurts, that's going to be really, really strong for us. So there obviously is a war for talent. And to the extent that we're going to be able to supply that incremental growth with less headcount having to be added to support it, that's going to be a big positive for us.

First off, when we're thinking about PA Consulting, I know you guys have spoken to double-digit EBITDA growth and about 12% revenue prior to the deal here. But regarding the strategic partnership, how are you thinking about that going forward? Does that still feel like something comfortable, or are there more opportunities now that the partnership is intact?

There's more than we expected. The level of engagement and our collaborative efforts are strong. We initially thought we would be involved in around 40 to 50 collaborative pursuits with a gestation period of 12 to 18 months, but that number is likely doubled now. We're becoming heavily engaged, and we anticipate even more strength as travel restrictions ease and we can meet clients together. This is very promising and contributes to our optimism for the future.

I just wanted to clarify two things here. One on the guidance and one on the cash flow, probably both the questions for Kevin. But I guess just, Kevin, I just want to make sure we understand the new guidance correctly. I look at about 10 months of contribution of the EBITDA numbers that you previously talked about with PA, equates to about $130 million. Again, regardless of seasonality, it's kind of a rough and tough number. Your guidance, the EBITDA side is up roughly that amount. Is this a way of kind of saying like, hey, the organic outlook is still good but it's largely unchanged with most of the EBITDA raise from the acquisition? And then on the EPS side, was there anything below the line that allowed you to take up the lower end of that EPS range a little bit more? Just maybe if you could talk about that. And then just on the free cash flow, if it's just worth clarifying the cash flow from operations, there was a $230 million benefit in the quarter on accrued liabilities. I'm guessing that might be associated with the $267 million that's going to be a cash outflow next quarter, but I don’t know. So I was wondering if you could just clarify that benefit to this quarter's cash flow from operations?

Let me address the second point first. You're correct; the $267 million reflects a reduction in total consideration. This amount will flow through the profit and loss statement in the third quarter. So that dynamic is indeed in play, and you’re right about how it operates. The total consideration remains unchanged at £1.4 billion in sterling, which is important to note. Regarding guidance, we maintained the previous guidance of $0.09, believing it to be appropriate. As I mentioned earlier, while their first quarter was very strong, they need to capitalize on the pipeline ahead of them to maintain momentum. We will see how that unfolds as the year progresses. If they continue at the same pace as in Q1, there could be some upside, but we are being cautious. Remember, this business is built on consistently driving towards new contracts. On the base business, we performed well in Q2, which was a key factor for increasing our base business guidance. Given the investments we are considering on the general and administrative side, we anticipate that will balance any potential upward momentum on the top line. The pipeline looks promising, particularly with state, local, and government clients, which is a positive sign. We see this coming together more towards the end of fiscal 2021, better positioning us for 2022 compared to 2021.

Just wanted to ask you a follow-up on CMS in the sense that you guided revenue to flat all, and I think for the second half 2021, given the higher headwind from the two new contracts. But you do have easier comparisons if I look at Q3 versus last year, the pandemic disruption. And so are you seeing any delays in that project conversion there in CMS? And then if you look at backlog growth, it looks solid in Q2. So do you see book-to-bill continue to be at or above 1 in the second half of '21?

We've discussed this for several quarters. We're concluding two low-margin large contracts, the Hanford contract and another classified contract we've mentioned previously. When we set those aside, our critical mission solutions business, excluding acquisitions, is growing at about 8%. Additionally, the benefits from our acquisitions are continuing to increase year over year. We're optimistic about our alignment with growth trends, despite a flat defense budget. Areas like space intelligence, hypersonics, and other mentioned sectors are showing healthy growth. There's a notable shift in funding, including DoD initiatives for climate change and infrastructure modernization, which are beneficial for us. Overall, we're very satisfied with the revenue growth in Critical Mission Solutions. Thank you. So as I close the call, our thoughts are with the people, our people in India, including our Jacobs colleagues, and we'll continue to support them in dealing with the current significant challenges of the pandemic. Looking to the future, we're excited about our strong performance and our solid foundation that provides Jacobs as we develop our new strategy and chart an exciting future together. Thank you.