Jacobs Solutions Inc. (J) Earnings Call Transcript & Summary

Great. Thank you to everybody joining us on the webcast. My name is Joe DeNardi. I'm Stifel's defense and government services analyst. Really happy to have Jacobs with us at the conference today. We have Chairman and CEO, Steve Demetriou; and CFO, Kevin Berryman. Jon Doros is on the call as well. I think we'll just format this as a fireside chat. If folks that are listening have questions that they want to get answered, you can e-mail me at [email protected]. I'll try and balance the discussion between some short-term data points and longer-term strategy. So Steve and Kevin, thank you for taking the time here.

Thank you.

Thank you.

Glad to be here.

Steve, maybe just to start with you, and Kevin, if you have thoughts as well, kind of the obligatory COVID question. If you guys were at 100% in terms of work activity and utilization before all this, where did you bottom out? Where are you at now? Where do you need to be kind of a month from now in order to feel good about the guidance you've provided?

Yes. When -- if you say actual just work and not talk about workplace, we're above 90%. We've had -- we did furlough some employees predominantly in the U.K. associated with a few large enterprise contracts, but that's actually starting to come back. If you talk about remote versus being at the workplace, we're obviously still a majority remote workforce, but the productivity has been extremely high, if not higher, in certain areas. And so the real issue has been more about our clients in certain areas that we weren't able to get at some of the physical work that we needed to do on sites. We talked about that at the last earnings call. That's ramping up nicely, and we really feel good about that pace and believe that as we get through the end of the year that the client base will have adapted to the physical distancing, and we'll be moving into a growth scenario in '21.

Yes. Joe, I would just add, just to comment. We're encouraged. We're encouraged by kind of how we were thinking the scenario would play out. And still, we've got 4 months to go, but we're encouraged.

Okay. And then, Kevin, is there a mechanism in place where -- should we just assume that whatever revenue or earnings has been lost as a result of this will be lost forever? Or is there -- do you think there's a mechanism in place to recapture any of that, whether it's the fee on some of the revenue that you've been billing? How are you thinking about that?

Yes. I don't think we've lost business. We might have had business delayed because of the physical nature of the COVID situation in where -- nuclear is a good example, where you're still going to have to do the work. And so we haven't lost business, might have been delayed, but we haven't lost any.

Got it. Steve, as it relates to maybe to M&A and the KeyW acquisition specifically, I think the sentiment towards that business as a standalone entity wasn't great. And I think that had more to do with the challenges that, that team had with managing expectations and dealing with the leverage that was on the business. And so I think, from a capability standpoint, that was a pretty well-respected business. My sense is that you've inherited some of that negativity and some of the uncertainty around whether you can actually deliver on that pipeline that intrigued you enough to pay what you did for it. Can you talk a little bit about the financial performance of the business since you bought it to the extent that maybe it's been a little bit softer? Is that because you're losing opportunities? Or are the opportunities have just pushed to the right?

Yes. The opportunities are bigger today than they were at the time of the deal, which is positive. The 3 legs of the business: mission IT; cyber; and ISR, specifically space ISR. The first 2, mission IT and cyber are at or above expectations. And it's -- we're at the point now where it's fully integrated with legacy Jacobs, and that mission IT and cyber have actually been a highlight even through COVID-19 and have met or exceeded expectations. The ISR business, the key piece of the real transformation of the acquisition is this low-earth orbit and space intelligence. We -- there was one specific program that we were hoping for early on success, still blowing and going. The government is committed. Unfortunately, the government has been delaying because of some procurement and issues they're trying to work out on their side, and it's just moved to the right. But that's still a great opportunity. We're in the mix -- very much in the mix. We bring differentiated capability that they love, and we expect that we'll phase into that as the government moves that forward. But the good news is there's been a second, third and fourth program that are now out there. The second program, we actually announced a win. It's a classified program. It's hard to talk about this, but a win back several months ago. We're in the final stages of now moving into the next phase, third phase, with a big OEM partner that we're feeling very bullish about, and that's going to play out unexpectedly. And then there's a third and fourth program that's going to go forward. So I -- and then the other piece, Joe, that we need to keep on the table is the P&PS usage now of the KeyW capabilities and technology and innovation are ramping up significantly. Great revenue synergies, areas of smart agriculture, our smart water systems, security opportunities and things like FIFA Cup and major events where drone and ISR capability are coming into play. And the momentum is very significant, and that's another part of the upside. So I think the storyline is as it -- that becomes now a key driver of our P&PS and CMS pipeline that's at record high levels.

Can you quantify that, Steve, at all? I mean, because I would imagine that having some of the capabilities that KeyW has and applying those to the P&PS markets is a differentiator. So like are those revenue synergies, much of that still in front of you? Or are you actually starting to realize some of that?

No. We've had a few wins recently. Most of them are classified, so it's hard to talk about. But the few wins that have been attributed to KeyW, we would not have won without them, both in P&PS and in CMS on the mission IT and cyber side. And so I think that we're just going to need to understand that it's so integrated now into Jacobs and a key driver of our margin expansion, differentiated services, opening up agencies -- government agencies that we weren't part of. So as we talk about our intelligent asset management play across a variety of different government agencies, KeyW accelerates that and is a big part of why CMS' pipeline at $30 billion over the course of the next 18 months is at a record high.

Kevin, I think you've talked about kind of that pipeline as resembling maybe the pipeline several years ago. And your success with that is kind of fueling the growth that you had the past few years. Can you maybe talk about how we should think about that in terms of the growth potential over the next few years if you can win your fair share of the CMS pipeline?

Yes. It built the excitement level that we do have on the outlook of the CMS business. And if you think about back in 2017 when we had the last kind of high watermark on our pipeline relative to the CMS business, it was at a $20 billion level at that point in time. And we're really excited then, and we converted on enough of that to really translate into some good growth, as you suggested, in '18 and '19, certainly. And our pipeline right now is at $30 billion, so 50% higher. Certainly, the aperture of things that we are executing against in terms of that pipeline is larger. We've expanded that aperture because of the successes that we've had. We've invested in additional business development initiatives relative to that. We feel like we're very competitive in that pipeline. So our expectations would be that, hopefully, we'll convert on that where we could have some nice solid growth relative to that. Now we currently have a situation where the Hanford revenue, which we all have talked about in the past, that will be [indiscernible] relative to that issue. But notwithstanding that, because of the margin profile of Hanford, which is de minimis, versus the margin profile that was $30 billion, which is accretive to the CMS portfolio, we like the potential opportunities in-source as it relates to the EBITDA growth that we'll see coming out of CMS over the next few years.

Steve, I'm wondering if you could talk a little bit about kind of the nature of the pipeline at CMS. It seems like maybe 2 of the bigger buckets, correct me if I'm wrong, are in Intelligent Asset Management and maybe the weapons or program sustainment, and those are 2 markets where there seems to be a pretty good kind of competitive strategy for entering those markets. Either the DoD wants to make it more competitive and not just hand it to OEMs, like they've done historically, or injecting technology into maybe kind of the boring base operation support market. Can you maybe talk about how much of the pipeline is in those 2 areas relative to how much of your business now is related to weapons, program sustainment or Intelligent Asset Management?

Right. So I think what's exciting is that, first, when you just look at the high level of that $30 billion pipeline over the next 18 months is that it is predominantly new business versus extensions or recompetes. And so -- and it's significantly higher in margin than the pipeline was a year ago and accretive to our current portfolio, as Kevin said. And you just hit the 2 very most important level of -- I would say, a big part of that pipeline is our Intelligent Asset Management. We're actually 3 for 3 in our 3 targeted Navy programs over the last year. We -- most recently, the second one was the West Sound win we announced several months ago. And then last week, the government announced that we have won the Kings Bay in Georgia. And all 3 of those are $400 million to $500 million each, 8-year programs and higher margin than our existing business. And that's the really early stages of what we think is going to be a robust Intelligent Asset Management, cutting across both the Army, Air Force as well as other areas. And what you talked about is the government, over the past many years, has been focused on low-priced, technically acceptable service providers, and that's not working out. There's been issues. They're not getting the efficiency improvements that they need. There's been quality. And so what's intriguing to them is what Jacobs brings is a cost-effective, but highly innovative, high-quality, new way of doing things that are now winning the day in some of these, as you say, sort of mundane ongoing operations that are critical to the government. And so we're excited about that. As you also talked about sustainment, and in sustainment, it's really a sustainment of complex systems. We've got things like air traffic control sustainment systems. There's nuclear weapons, arsenal sustainment systems. And there's some interesting air defense systems. And all of those have sort of common threads that the government is looking for. As you mentioned it, they want to get a differentiated offering versus the sort of current OEM-dominated spectrum, and that's where we're coming in. We've got some very promising, close to being sourced opportunities, and we hope to be demonstrating success on that over the next several months. And so -- then you go beyond that and you've got things like telecom and cyber and mission IT. The whole IT spectrum is a big opportunity for us, where we're operating systems to drive the United States missions. So very exciting pipeline.

Steve, when you think about -- or Kevin, when you think about maybe the effects on your end markets and budgets in some of those end markets as a result of COVID, you would think some maybe, I don't know, structurally impaired for a period of time, airports, maybe some of the headquarters design work you do, then maybe state and local budgets come under pressure. On the positive side, you've got onshoring. So how do you think about kind of the relative headwinds and tailwinds affecting those markets for you all? Do you need some sort of stimulus or infrastructure-focused spending to offset the state and local budget pressure? What's the right way to think about that, do you think?

Well, let me just kind of start with airports because it's an interesting dynamic. I mean we clearly look at that sector where we've had a lot of success. And on the surface, you get worried about air traffic and all that. But there's actually been a strong wave of new work that airports want to get at right now. It's contactless airports, reshaping the interior of airports and, in many cases, taking the downtime to get at aging infrastructure and upgrade of airport. I mean Denver is a great opportunity. I was just on with the CEO of the client, and we just recently won some big piece of business. And they're making a commitment to move forward with that. And then as I mentioned, others are reshaping their investments. As far as the state and local budget goes, it's clearly a big topic right now with our clients. Obviously, the mayors and governors have been very active in both lobbying for federal support as well as coming up with new funding mechanisms. Cuomo -- Governor Cuomo has been doing both very actively, been very vocal, come up with some new bond opportunities to fill the gap. But I think the expectation is high on some sort of relief and support over the course of the next 30 to 60 days. A lot of kind of consensus is it will happen sometime in July, where Congress and the Senate will come together and put in as part of the next CARES Act a state and local support and probably not as high as the $850 billion that Congress came out with a couple of weeks ago, but could be somewhere in the $350 billion to $500 billion based on what we're hearing talking to key members of The Hill.

Do you think the concern that investors have relative to the impact on the state and local spending is consistent with what you're actually hearing from some of your customers in those markets? Or is the concern kind of exaggerated?

Well, I think there needs to be concern until it happens, so I don't want to be cavalier about it. But I think the government focused on the federal side and quickly got that done very successfully, which we're seeing the benefits on our Critical Mission Solutions and some of our federal work on P&PS. And we're confident that the government is going to do something around the state and local as a stopgap. I think the real discussion is more around the timing and the size of the infrastructure stimulus set. It's been long waited well before COVID-19, the need to fix aging infrastructure, get that smart technology in the United States and in the United Kingdom with a labor party there. And we're pretty confident that it's a matter of time rather than if they're going to do it. I think in the U.S., there's probably a higher probability it's going to happen after the election for that large infrastructure build. But the discussions that are going on right now at The Hill, both parties are talking about year-over-year growth versus the current highway spending, the FAST Act replacements. And the only question is, when are they going to agree on that, who's going to get the credit, whether that's going to come after the election or not.

In terms of the tailwind maybe from onshore, your near shoring, can you talk about maybe how advanced some of the conversations you're having with some of the customers are at this point and to the extent you can frame what the opportunity could be there over the next few years?

Well, that's really an important topic in our Advanced Facilities. We're the largest player in the global life science pharmaceutical, the major player in semiconductor and also in areas like telecom, data centers. But you take the life sciences. It is -- I think the COVID-19 dynamics of things moving in lightning speed compared to historically on key decisions that corporations are making is now showing its positive nature in the life sciences. We have all the major players that are working on vaccines and therapies have approached us some -- doing some immediate new programs, where -- which we're going to be jumping into, some on an exclusive basis. And I -- then on -- layer on top of that is the whole reshoring that you've talked about because of the lessons learned around the supply chain and wanting to be less dependent. And the good news is whatever happens in that scenario, we're going to be well positioned because of our global integrated delivery capabilities, no matter where those sites end up being. But it's moving fast, and it's the reason why it's one of our most bullish sectors in fiscal year '21 as we sit here now and things that we're in the mix on.

I think one of the decisions you all made was to support headcount through this and -- with the hopes that the business would eventually kind of return to normal, and it seems like it's on the path towards that. Is -- are you seeing any dislocations out there, competitors that are struggling, where there may be opportunities to acquire talent?

Yes. Look, the decision to make that -- the decision we made on retaining talent really had 2 major drivers. One was we did believe that -- and it's playing through very nicely that this was a short-term physical distancing issue, that even though physical distancing will continue, that our clients and ourselves will adapt and will get back to the workplace. It's happening, and we feel really good about that ramp-up. The second was to strategically demonstrate to our employees our commitment in a health pandemic situation that our employees come first. And we believe that, that is going to pay big dividends, tied in with the fact that the business is ramping up and that we're not going to rightsize one day and then quickly rehire another day, that's going to not only help us retain at a higher level than our peers, but to attract talent that we're already seeing the benefit of. Our recruitment team has been talking about it and benefiting from it. So this is part of our cultural journey that is the next phase of talent attraction and retention.

Got it. Kevin, maybe one for you, similar to something I asked on the earnings call. I think, but at your last Investor Day, you provided longer-term margin targets. I think CMS high 8%, and PPS low to mid-13%. No one's modeling that. Obviously, there's the uncertainty with COVID. But if you just kind of forget about that and think about margins in the back half of next year, is there any reason to think that you can't meet those margin targets that you provided?

Yes. Look, first off, we haven't really given specific kind of commentary relative to 2021 specifically, so I'll disappoint perhaps a little bit in talking about the views relative to that. But let me talk fundamentally about the medium to long term. And look, the strategy is firmly in place in terms of how we thought about driving the business, what that would translate in terms of margin profile. And look, I think we'll be giving some incremental perspective as we kind of approach the end of 2020 on how 2021 plays out. But there's no fundamental change in terms of our strategy relative to margin improvements. That will happen. That kind of translates in the timing of ultimately how that plays out relative to what the original guidance was. We're working through that. We're actually doing a lot of scenario planning right now on 2021, so I'm going to defer making any comments relative to it. But look, at the end, as it relates to the opportunity to grow margins, it's a fundamental piece of our strategy, and we fundamentally believe we're going to be able to continue to do it. And we'll provide incremental updates as we approach the end of this fiscal and have a better clarity as to how things are playing out in 2021.

Okay. Kevin, has anything moved against you from a margin standpoint that stands out, I mean, I guess, other than COVID? I mean it seems like the Wood Group acquisition helped you from a margin standpoint. The pipeline sounds like it's accretive to margins. Is there anything that's going against you relative to the Investor Day 16 months ago?

Other than, let's call it, the term dynamics associated with COVID, no. And I would point to our half year results that we reported in our May earnings call and look at the first 18 months of our journey associated with the targets that we had established. I would say that, in general, we were very pleased on our journey as it relates to how we were going to be able to transition to the reaching of those objectives that we had established. So no, other than COVID, no.

Okay. And then, Steve, the business has obviously undergone pretty significant transformation in the past several years. If I look at the composition of the Board, it's changed a little bit, but not dramatically. Is that something that you think about the need to maybe keep the Board in sync with the nature of the business? And would it be beneficial to you to have somebody like a Bruce Tanner, Lockheed's former CFO? As you compete more directly against some of the OEMs, would that benefit you to have that experience on the Board? Is that something you think about at all?

Yes. No, a great question. And the Board dynamics are a critical part. It's something I'm -- as Chair I'm playing a big role on. We -- our last 3 Board members we brought on, one elevated our capability around risk management, which is extremely important in our industry. The second 2, both females, obviously strengthened our diversity, but also 1 brought us financial expertise excellence as we go through a transition around audit committee, et cetera. And the third brought significant experience in information technology, data analytics, the whole Chief Innovation Officer capability of that person. And we're going to have an opportunity over the next 2 years, some coming sooner than later, to continue to refresh the Board as some reach retirement. And we are focused heavily around strengthening our government services capabilities around technology innovation, especially in the Critical Mission Solutions side and some other areas to drive international growth and continuing to diversify our Board to get the benefits of a fully inclusive and diverse Board. So it is a strategic part of our transformation of the company going forward.

That's helpful. Kevin, I meant to ask you and maybe kind of a broader question, but I know that the DSOs is a compensation metric for you all and one that you're pretty keenly focused on. But is -- are margins also part of that? And is there any compensation tied to reaching the margin target that you all did provide at the Investor Day?

Margin, it's interesting. Cash flow is a really important part of the metrics that we talked in. And the definition of cash flow ultimately is if you think about the balance sheet, the side of that equation is DSO. That's the way that we can fundamentally drive it. And if you look at our balance sheet, it's basically goodwill and DSOs on the asset side, which are the primary drivers. And obviously, the short-term ability to improve cash flow is on the DSO side. So as it relates to margin, it is a critical part of how we now talk about our ability to grow. And so the -- it is probably one of the most important discussions we have on our quarterly business reviews, which is about what's going on with margin, what does the backlog look like, how are we going after the business that translates into incremental margin improvement because the reality is it kind of fundamentally talks about the need to be more, I'm going to call it, value-added solutions based. We don't have specific targets associated with that because margin doesn't ultimately deliver anything. But we do have the dynamic of operating profit growth, which is a key part of our objectives, both on an annual basis and long-term basis. And so that's how we think about that. And it's more embedded into, what I would call, the development of, I would say, business acumen within the construct of the company. And that we're not interested in just growing. We're interested in good growth, which is embedded into every review that we have in the company.

Got it. That's helpful. I think I'll leave it there. I'll give you guys a couple of minutes before your next meeting with Steve and Kevin. Thank you for taking the time.

Thank You, Joe.

Thanks, Joe.