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

Good morning, everyone. This is Sheila Kahyaoglu with the Jefferies aerospace and defense equity research team. Today, we're very lucky to have the Jacobs team with us again. Kevin Berryman, its President and CFO; and Valerie Roberts, SVP of Global Transformation and Strategy for Jacobs; as well as Jonathan Doros, who runs the IR team. With that, we have a few prepared remarks from Kevin and Valerie, and we'll head into a fireside chat. Kevin, with that, the floor is yours.

All right. Thanks, Sheila. I'm going to be very brief, just some preliminary comments to give you a sense of Jacobs. Jacobs has been in the midst of a transformation over the last several years. And in a part, the big part of that was creating a new portfolio that we felt was more aligned with long-term secular trends and, consequently, an ability to deliver in times of economic challenges and in times of robust growth opportunities. So while we entered into Q3 with an expectation that there would be some challenges associated with COVID, which obviously there were, we're very pleased with our Q3 performance because I think it gives a very clear indication of the stability and opportunities that we continue to have with our portfolio and able to deliver very solid results in a very challenging environment. So excited about the ability for our portfolio to continue to show the abilities to deliver over a spectrum of scenarios economic-wise. And pleased that we're able to be here with you, Sheila, to talk a little bit more about Jacobs. Thanks.

That's super helpful. And then I guess, just -- sorry, Valerie, do you have comments?

Did you want me to touch on Critical Mission Solutions to begin?

Sure.

Sure. I mean we'll talk a bit about this part of the business today. We're roughly a $5 billion business. And our business really is as close to our clients' mission we can get. Our focus is around what we call the tip of the spear critical missions. Keeps us with great resiliency throughout different funding and administration cycles. We've got a broad-based portfolio, really good capabilities, cyber, mission IT, ISR, test ranges, aerospace, nuclear and some specialized commercial work and design build. Very heavy in government, 88-plus percent of our portfolio is the government, and whether it's U.S., U.K. or Australia. And we've got a very good platform of contracts that tend to be long term in nature, 5-plus years, gives great recurring revenue. And we've been expanding that actually into some of the shorter-cycle IDIQ. So a great portfolio, driven by national priorities, great resilience from long-term contracts and a pretty low-risk portfolio, a lot of cost reimbursable with some aspects that are fixed price. Just wanted to touch on the Critical Mission Solutions business for a moment.

No, that's helpful. And then maybe, we'll just start on COVID since it seems to be top of mind, especially for IT services companies. It seems you've been largely able to move that without any significant disruption. So maybe can you talk about where you're seeing the Critical Mission Solutions business stand? And if you want to touch on people and places as well?

So let me take a kind of overview perspective on the 2 businesses that we have in the corporate -- from a corporate perspective, and then I'll turn it over to Valerie for any other specific comments on CMS. Look, when we entered Q3, we did believe that there was going to be some challenges and primarily associated with our ability to be on site, on those premises that require us to be intimately involved in dealing with solutions for our customers. And clearly, that was a challenge in some instances. I would say that the original expectations versus what we were able to accomplish actually came across where the trough was not really as bad as we ultimately thought it was going to be. So we were able to figure out how to get on site in a COVID-compliant manner with much of our customers, and we were ultimately able to transition to a virtual work environment for almost 90% of our employees around the globe. So we're able to kind of maintain a level of continuity associated with the delivery with our clients. And I would say probably the biggest improvement versus what we were concerned about entering into Q3 was in CMS, because we do have a lot of critical mission work that we do on-site, on-premise with our customers, when we were concerned about our ability to actually do as much work as we ended up doing. So maybe, Valerie, you can make some comments as it relates to CMS. But pretty happy with how we ended up, and we would expect that going forward into Q4 and 2021, we'll be able to continue to improve from our current levels.

Yes, that's exactly right. Going in at the beginning of quarter 3 where COVID has just really begun, we thought we would have more impacts in the CMS business. And working very closely with our clients, we found ways to actually maintain good productivity. We were doing things such as splitting shifts to get into our skips, where we do 1 week on, 1 week off, continuing to work case-by-case with each one of our clients on how could we ensure that we could continue to progress the programmatic milestones, which were critical, yet keep our people safe. Very rapidly transitioned to remote working for the bulk of our workforce. In some of the sites where we have to have physical presence, we took a bit more time there, but then came up with different protocols to work social distancing, appropriate PPE, et cetera, so that we could make progress on those sites. So case-by-case with our clients, working closely through what are the options on the CARES Act, how do we ensure that we keep our workforce employed and paid and taking that learning now because COVID hasn't quite left the scene, as we all know. So given the kind of resiliency we found in our business and have been able to work now, taking all of those learnings and then letting that play forward as we deal with other COVID scenarios to keep our productivity high, keep our people employed and keep our margins healthy.

No, that's super helpful. And just to start off, I guess let's stick on CMS. How do we think about the budget outlook? Because I have a question we've been getting a lot, especially given the upcoming elections, is the DoD budgets might be more pressured. So how do we think about Jacobs' dispositioning with the overall budget?

We actually feel very good about it, Sheila. I think the top line view, when everyone talks DoD budget, and everyone says, well, it's going to be flattish, there's a concern relative to what the growth opportunities may exist. But we're kind of oriented and targeted towards certain parts of the overall DoD budget, so we're actually showing pretty strong growth. So I'll ask Valerie to make some additional comments, but if you think about where we're targeted, whether it's in cyber, whether it's space, whether it's cybersecurity, all of these areas are actually seeing mid to sometimes even double-digit growth areas. So we feel like we've, over the transformation period over the last couple of years, we've reoriented that portfolio to being very much targeted towards the higher mission-critical areas of U.S. spend. And so if you think about those areas, we actually feel pretty good about the growth algorithm associated with where we're playing. So while overall it looks like it's a flat, where we're playing is actually up single to double-digit growth areas.

And you touched on this a little bit. So -- sorry, Valerie, go ahead.

Yes. I was just going to say one thing that continues, regardless of administration, what we're going to see in the next 5 to 10 years is we have to protect the U.S. from both internal and external threats and preparing for that increased rivalry with China and Russia. So if you think about that and then you think about the programs where we're playing and those areas are -- continue to see growth because of where we play. I also put it together with a bit of a fragmented market and our ability to gain market share, both from the capabilities we've been developing organically and through acquisition as well as how we position against competition. There's opportunity for continued growth in these markets.

And then you guys touched upon this a little bit just now, but FED/CIV is the largest part of CMS. How should we think about bookings and maybe the pipeline there, particularly with NASA as you ramp with Artemis and then just the trajectory of the NASA business and outside -- near-term pursuits.

So pretty excited about the FED/CIV business, specifically, a lot of the work that's going on with the Artemis program, a priority of the U.S. government to get to the moon again, first woman on the moon, ultimately and beyond. So Valerie can give some additional color, but that is high priority. The 2024 date that's been characterized as the target is important. And if you miss that date, there is certain kind of lunar schedules, which create a challenge to be able to get there for the foreseeable future. So I think that it's pretty positive and actually an area that hasn't been known for targeted growth in NASA, but certainly, we're expecting that to happen. Valerie, anything to add?

Yes. We do a lot of work around NASA. We're their largest non-OEM services provider there and have over 5,000 people working on that Artemis program. And we've got another 1,000 supporting other aspects of the NASA program. When it comes to Artemis, our role there is really interesting because we accept all the hardware. We do the quality checks, the integration. We do the loading, and we support all of the launch. So as we look at that profile of budget over time, we've got a really solid position on how we contribute and will grow with that program. So it's an exciting area for us.

That's great. And of course, this leads into my next question. Jacobs has a healthy pipeline. What's the makeup versus the current portfolio? What markets are overweight in the pipeline relative to the business today? And how do we think about the Intelligent Asset Management business contributing to that as well?

Really excited about the pipe that we have with the CMS business. It's over $30 billion. And we haven't had those size -- that size of a pipeline in a long time. Last time, we had a big number was back in the '17 timetable when we had $20 billion of pipe. And that was ultimately converted pretty successfully, and we had strong growth in '17, '18, '19. So really excited about it. I would say that there's 2 characteristics of the pipe right now. One is that we still have some fairly large enterprise contracts that are in there and things about -- you mentioned specifically one area that we're doing, Intelligent Asset Management, where we've had a couple of large wins, and we expect to see other continued things, which is an indication of the ability for us to utilize technology and innovation to provide incremental value-added services to something that has been evolving over time. And so that's part of it. I would say we have also a lot of opportunities for us to continue to build smaller project profiles, IDIQ-related activities, which actually support our ability to help grow margin. So I don't know if there's anything else you'd like to add, but that $30 billion is out there and we expect that we're going to be able to get a chunk of it, which allows us to have a pretty solid growth profile into 2021 and beyond.

Yes. I think you'd see us with a little bit more exposure around the Department of Defense and IT in that pipeline, pushing a little bit further into Air Force and Navy. And so I think you'll see a little bit more variation as we go forward.

That's helpful. And then you guys can't win them all. Just with Hanford, Central Plateau rolling off and the tanks contract loss, how do we think about the nuclear business and opportunities there with the recent Woods acquisition?

Look, we've had actually, absent some of the dynamics you just highlighted. We have had a lot of rebid success in 2020, actually. We've had, I think, 5 of the 6 things that were up for rebid have been extended and/or created a stability of our portfolio going forward. So we feel like that's continuing to be an important part of our portfolio, will support a stability in our top line growth as it relates to those activities. And while we weren't excited about some of those outcomes, we're still excited about that business in general. The recent Wood acquisition in the U.K., Wood Nuclear acquisition is exciting because it has a leading position in R&D in the nuclear side. And so we're going to be leveraging that in a more robust manner to not only support our capabilities here in the U.S. but, certainly, potentially expand into other markets in Europe.

And then just on the other recent acquisition has been KeyW, talk about some of the capabilities that I know you guys have, that KeyW's brought to the portfolio and maybe opportunities that opens up. What we've seen in other acquisitions is it takes time for these capabilities to result into bookings. So maybe just what you're seeing there.

Yes, KeyW, important acquisition. I'll let Valerie make some comments here because she was intimately involved in the due diligence and the integration of that business. But there are basically 3 parts of that which are all exciting to us and we feel like provides us great opportunities for incremental growth long term. Cybersecurity, combining with capabilities that we already had, which strengthens our offerings to our clients in that particular area. There's mission IT-related activities, really exciting there, which augmented kind of our work that we were doing in that particular area. And then space intelligence, which is really probably the most exciting potential large growth area that came into our portfolio with the KeyW acquisition and really excited about that. We have several things in the pipeline, which are hopefully going to be converting in the next year to 2, which would really translate into us being on the leading edge of providing incremental defense capabilities as it relates to space intelligence longer term. So Valerie, do you want to take over and add some additional commentary?

Yes, yes. I mean we -- Kevin said that I was very close with this particular acquisition, and our excitement actually continues to build around the capabilities, the client intimacy that's been gained, really our foothold in government services within the national capital region. We're really at the table now in a number of client spaces that we wanted to gain access to. So we're seeing the fruits of that labor in those 3 areas that Kevin mentioned. The other thing that I would bring up around that acquisition has been our sales capability. They had excellent BD capabilities and capabilities around GWACs and IDIQs. As part of our transformation, we really have a long history of what we call the big game hunting those long-term enterprise contracts, which are a core foundation to our business. Capabilities and capacity is brought with KeyW to complement that and expand further our BD into another arena has been very effective for us. So great acquisition for us.

That's helpful. And then maybe turning to the people side of the business for a minute. We've seen a lot of our coverage struggle a little bit and seeing cracks and whether it's selling into airports or state and local munis and international budgets. Sort of what are you seeing there? How do you anticipate the challenges filtering into 2021?

Well, I was saying Q3 specifically, which we just announced earlier this week, Q3 actually turned out to be a pretty positive picture for us. And we had expected that it would be challenged as well. And while there were some challenges, we came through with some performance levels that were better than anticipated. I think the bottom line is that we were able to leverage one of the key proponents of our strategy in People & Places, which is a global integrated delivery capability. So while we perform locally, as it relates to executing against projects, we have global teams that are executing against it. So when COVID hit and we had to go virtual, we ultimately went where almost 90% of our people corporate-wide, which I already had mentioned, to be working virtually. The productivity was extraordinarily high, didn't change. So we were a little concerned going into Q3 that there could be some drag as it relates to that, but that didn't happen. So that just gives us incremental confidence of our ability to continue to drive the strategic agenda relative to our People & Places business. Now certainly COVID is creating a dynamic with challenges on revenue streams for federal governments and state and local institutions, and what we've seen is that the pipeline that we have for People & Places actually continues to grow so the demand is there. And the benefit of Jacobs is that with the strong framework agreements that we have with very intimate -- client intimacy, we're continuing to be able to execute against those existing framework agreements and maintaining a level of sustainability with our current business. As we think ahead, clearly, there's dynamics in the U.S. right now between the 2 parties negotiating, and we would expect something ultimately come together, which will allow us to kind of keep going for the short term, which allows us to have relative stability in the business over the foreseeable short term. But we would expect that there will be some incremental discussions on the ability to get to something larger from an infrastructure perspective, because I think both parties are, one, supportive of that because of the infrastructure deficit we have longer term in not only in the U.S. but in the U.K. and the rest of the globe. So that, I think, momentum is building relative to them regardless of who -- what administration. We think that those are going to be some positive opportunities for us kind of going further into 2021 and beyond. The other thing that certainly was helpful for us and People & Places played a big role in it is the ability for us to drive our free cash flow in the quarter was driven by both CMS, but PPS -- P&PS as well. And so our free cash flow for the quarter was over $330 million for the Q3. And certainly, I think it's indicative of that stability and more improved structure underlying our portfolio, which allows us to kind of deliver cash even in times of brute economic disruption.

No, it's a helpful picture, Kevin. And then just switching gears a little bit, but you do have some areas that are "COVID winners," whether it's pharma, life sciences. What trends are you seeing from either the CMS business or people business in terms of COVID potential opportunities?

A lot of opportunity. So if you think about where we play, it's in our advanced facilities businesses, and there's 2 large pieces of that. There is our electronics business, primarily semiconductor work that we do for the largest semiconductor players in the world, and there's the pharma side. And what we've seen on the pharma side clearly is an intensity level that's ongoing which we are directly involved with to evaluate vaccines and therapeutics and how each of the top players are going to be playing a role in that. And so I would say of the top 6 in the industry, we're right there with 4 and potentially 5, actively, proactively consulting with them as it relates to hoping to come up with something that will come relatively soon to help mitigate some of the impacts of this virus that we're all struggling to deal with. So that's really exciting work. On the semiconductor side, actually, electronics, the other part and impacts associated with COVID are virtual working. And so that's also creating great opportunities associated with our business there. And we are deeply involved with several clients as it relates to investment profile supporting incremental capacity in that regard. Overarching all of that is kind of the geopolitical dynamic and reshoring efforts that all of our customers are thinking about and considering, and we're very much integrated into their discussions relative to how that might play out for their portfolio and their asset mix and how that looks U.S. versus other locations around the globe.

That's helpful. And then just switching gears a little bit, moving on to profitability. How do we think about your margin profile? If we look at CMS, you have a substantial pipeline and some of it is related to higher-margin work, like the IAM platform that's highly leverageable. So kind of how do we think about how you execute on that pipeline and the potential margin ramp?

Look, I would say there's been a lot of discussion about our margin profile and -- over the course of 2020, and I think CMS specifically is poised to do some really exciting stuff on the margin front. The fact that actually we are winding down a large procurement contract, which is with a confidential client, and of course, our nuclear business, why we like it, it is relatively lower margin versus the rest of the portfolio. So those are going to be winding down and becoming a pretty significantly less percentage of the business, but very, very little impact on the profitability in the short term. And with all of the other pipeline items that we talked about, you mentioned Intelligent Asset Management, everything we're winning is at a much significantly higher margin than balance of the businesses which are falling off. So I think as we enter into Q4 and into 2021, you're going to see some pretty nice changes in our margin profile, and our expectation is that's going to help support our overall company margin. As you know, Sheila, as part of our strategy when we implemented that and talked to the investment community in February of 2019, margin enhancement was a key part of it. And we think we're going to be well on track as it relates to some of those targets that we established back in 2021, even under the situation with COVID.

Just to dig into that a little bit more, Kevin. Is there a mix we could think about where the pipeline is shifting? 60% is higher margin relative to the current portfolio? Or is there a number you've provided for that?

We haven't provided specifically, but I would tell you that if you look at our pipeline and if you look at the backlog, we track these ultimately and the margin profile fundamentally across each one of those is higher in margin, which we think afford us an opportunity to continue to drive that. Jon, I don't think we've provided any incremental delineation on that, but maybe I could ask Valerie to make some additional comments because she's obviously intimately involved in the growth objectives being established for the team in CMS.

Yes. When we look at our pipeline and our backlog, and we've talked about it, we have a strong foundation of these long-term enterprise contracts. And they're 5 to 10 years in duration. So you kind of imagine that we've got a big balance to that set of type of contracts in our backlog. We understand when those will burn off and when we'll rebid. So when we're thinking about it, we think about, all right, the burn-off and the rebid cycle there. And as we reap it, what are the offerings we're bringing and how our solutions are looking so we can bring things in like IAM and other capabilities that will increase the basic margin profile on some of those contracts. So that's kind of the backlog thought. And then looking at the pipeline, we've been speaking types of contracts, large contracts, we like them, they're a great part of our portfolio. But looking once again at what's our technology-enabled solution, how can we bring an offering that would shift that margin higher, right, so we'll have our burn-off of the large ones, we'll have the new large ones and then we've also been expanding what I call the shorter-cycle work. Whether they're projects or IDIQs, those have the highest margin profile of the suite of what we do. And as I mentioned again, the KeyW acquisition and the capabilities of the IDIQ and the GWAC contract. So we've got a full focus in that area to expand that part of our business.

Then just 2 more questions before we wrap it up, guys. In terms of free cash flow and capital deployment, Kevin, good quarter in terms of conversion in a relatively tough period. How do we think about free cash flow conversion going forward? Some of the drivers of that DSOs, organic revenue growth, acquisitions, how do you think about the puts and takes?

Yes. One of the aspects of the transformation in the portfolio is that we believe that we have a portfolio going forward that's going to be more cash generative than we have had in the past. So we're excited about that. And certainly, Q3 was an indication of the power of the portfolio relative to that cash flow capability. So what we did is we had suspended a share buyback program that we had in place. We decided that we would suspend that just in an abundance of caution, given COVID as it was developing. We have since kind of now paid back some of the excess gross debt that we've had. We've got a net debt that's approaching onetime basically. So we have a very, very strong balance sheet. I think, ultimately, with now a view that the Fed certainly is -- seems to be taking a stance that they're going to do whatever it takes to ensure that credit markets continue to be functioning, that allows us, we believe, to be starting to think about the implementation and utilization of some of that capital. And so while I think we're being cautious on the M&A front, even though there's a pipeline that we continue to manage and interact with potential opportunities, we're going to be pretty cautious just given the COVID dynamic. And I would say that we're now thinking about what are the next steps relative to share buyback. I'm not going to talk or discuss specifics as it relates to when that will happen or size of it or whatever. But certainly, we do believe there's opportunities to invest in ourselves by buying back some shares.

It's always tough on talking to a CFO with almost a net cash position. So seems easy. So it seems like your priorities, it's fair to say is half share repo and half acquisitions depending on what COVID and the budget environment potentially brings?

Yes. I think that's probably true. Although any time we look at an M&A opportunity, Sheila, we're always going to measure that return profile versus an investment in our own shares. So for us to consider and think about those strategic M&A, we're going to be very disciplined and thoughtful in the execution of that. It's really got to give you a higher return than just buying back shares because, certainly, there's a different risk profile associated with those 2 execution of capital.

That's perfect. And on that note, we'll wrap it up. Thank you, Kevin, Valerie and Jonathan, for being with us today. And we look forward to talking to you soon. That concludes our webcast, everyone. Thank you for joining.

Thanks, Sheila.

Thank you.

Bye.