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

Okay. Good afternoon, and welcome back to day 2 of Morgan Stanley's Laguna -- or Virtual Laguna Industrials Conference. I'm Matt Sharpe, the firm's government services analyst. And with me today is the team from Jacobs. I'm going to first go through a couple of disclosures here, and then we will jump into our fireside chat. So please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see Morgan Stanley's research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, it's my pleasure to introduce the team from Jacobs here today: Steve Arnette, Senior Vice President; and Jon Doros, Vice President of Investor Relations. Good afternoon, gentlemen, and thanks for joining us.

Thanks for having us, Matt. Glad to be here. Wish we were in Laguna, though.

Yes, absolutely. You and I both. Maybe next year, maybe next year. But hopefully everybody is staying safe, healthy on your end. So maybe we'll just dive into it here. I feel like I've probably teed this off with you guys in years past with a question along these lines. But Jacobs is always evolving itself, and so I feel like it would be a good place to start sort of talking about that evolution or the transformation of the company. You've added some pieces, you've deleted some pieces. And you really elevated the federal business, in particular, obviously, the Critical Mission Solutions business that you run. So maybe you want to run through some of the changes and just sort of level set the group here to tee things off.

Sure. Glad to be here. Thanks, Matt. And yes, I think that the story of Jacobs in the past handful of years really has been one of transformation. But even overall, Jacobs is bigger than Critical Mission Solutions, kind of the strategic decision to exit the energy, chemicals, resources business and focus really on higher-end solutions. They're going to take us to the higher end of the market. And I think that trend very much holds for Critical Mission Solutions as well. Really kind of rethinking from soup to nuts at the company. Even I would say, even the name is something meaningful to us, Critical Mission Solutions, focusing on the most critical missions of certainly the United States government and also allied governments throughout the world. And if you look at the ECR divest, it was certainly something that got a lot of press. But also even within Critical Mission Solutions, some of the steps we've taken to kind of incrementally move that higher-end solutions space where we've done some smaller acquisitions to really kind of get a foothold in kind of cyber, higher-end part of the market. And then more recently, the KeyW acquisition, which has really come in and just really added a great critical mass around cyber, expanded our portfolio of IC customers and mission IT with that part of the market. And it allowed us already to win some new contracts that KeyW would not have won and Jacobs would not have won premerger, and kind of in this high-end cyber training of cyber operators, which is growing, a very quickly growing part of the business. And then the part of the business I'm assigned to -- and I should introduce myself just quickly. I'm Steve Arnette, and I've been with the company for 25 years. And I take care of part of CMS that -- it has a lot of our space work, and there's a lot of legacy work there for Jacobs in the kind of the NASA side of the business. And in fact, if you kind of strip away hardware suppliers, OEMs, and get down to R&D, engineering, kind of the hard-core technical services, we're very proud to have been #1 on that NASA list for a long time. And that kind of high-tech mission delivery capability allowed us to go organically win a big contract with the Missile Defense Agency, unseating a long-term incumbent there. That was more of an OEM company. And so we see on the kind of the space side of things a great organic opportunity to continue to grow. But then the KeyW, coming back to that, they really -- after a lot of work, we -- there's some -- on our side, there's some technology there that we're just really excited about the potential to -- for disruptions in the space-based ISR that is going to be a big key for us. And there's some technology there that's just going to continue to kind of drive us to kind of that high-end solution part of the government space. So you're right, Matt. I mean the [ competitive thrust ] truly has been changed in the past few years, and we're really excited about where that's taking us.

You mentioned a few interesting areas there, cyber or cyber security space, IT. How should we think about the portfolio construction within Critical Mission Solutions today and where that is evolving to? Maybe you can sort of break it down a little bit further for us to help us sort of truly appreciate where your concentrations lie.

Right. And I think that I'm not going to -- the audience here, you guys can see the slides we have in the slides space. And there's a pretty good dissection into kind of 5 or 6 key market areas that -- where CMS today is positioned that I think is fairly self-explanatory. But I'd tell you, I would really like to -- we've kind of reshaped the portfolio to take advantage of a few key areas where we believe we're going to be able to continue to drive organic growth. And I really wanted to focus on, at least in an introductory way, I talked about kind of the space ISR piece. There's 2 others I want to make sure I cover with this group. And one of those is kind of the weapons system sustainment space, where there's a lot of exciting stuff happening. And the third is a Jacobs solution, where we really feel like we're having a notable impact in the market called Intelligent Asset Management. And so those are 3 things that I really want to make sure that I get to cover because that is really how we're shaping the portfolio is through organic growth, winning new business contracts. And so I hope I can cover those.

Yes, absolutely. I mean why don't we sort of get into it right now? That's sort of a natural transition from the portfolio and its composition to sort of the business model and how that's evolved over time, right? I mean a lot of people these days wrongly just think, okay, government services, you're providing people, deploying them. They're being paid by the hour or time material contract. And it's sort of -- and that might have been sort of the business model of a decade ago. But today, it's evolving into something probably very different than that. I mean you mentioned Intelligent Asset Management and weapons systems sustainment. So how is the business model evolving here at the moment? And what are you driving towards?

That's a great question, Matt. And I think that -- I mean part of transitioning to high-end solutions is being able to deploy technologies. And I'll kind of talk about that to deliver better technical solutions, better mission solutions. But part of it is also kind of the business drivers. And if you look, for instance, at -- for decades in some locations, we've been kind of the trusted NASA services provider for literally some of our big enterprise contracts going back more than 30 years. And the typical [ or a majority of ] this is out of a cost-plus award fee type of a structure. Now we're very proud because if you go back and look at our average award fee scores, we average, I think, 95% to 96%. I would put our record and compare it to anyone. And that's allowed us to have a rebid success rate of something north of 95%, which is great. But really as we -- it's not just about the technology for customers like NASA, but even MDA if you look at where we're almost 3 years in now on that new contract and really helping that customer transition to more of an incentive structure, not a typical cost-plus type contract where we say that if we -- the contractor can deliver excellent support to enable the mission, to drive the mission. Of course, that missile defense is inherently 24/7/365, second-by-second. Then getting into some alternate contract models that incentivize that type of performance, where you can -- as you deliver critical work, if they're -- you're delivered effectively to all the performance standards. And potentially there are under-runs, so there could be some sharing of those things to provide opportunities to increment unit margins. And also the -- a lot of the other places where we're focusing growth, like Intelligent Asset Management, that is a huge part. And I'm just going to focus on the Department of Defense for a minute. They've got $700 billion-plus annual budget. And if you kind of peel away the budget, there's something like conservatively, $40 billion that's spent on base operations. And if you think about the legacy of that part of their mission, it's been, in short words I'm going to call it the legacy approach kind of a standing army at the ready, personnel there with a pretty narrowly defined role, but we've got to have them there just to make sure if something needs to happen to enable the mission. And that's all logical and kind of interval-based, every 4 weeks, we'll go in do this and we'll do that. And well, as we develop technology with customers like NASA or the Mission Defense Agency or Ford or whoever it might be, we've realized there really is a better way to do that, there's been so much evolution in the IoT space around smart sensors. We've developed kind of in some of our NASA contracts, some pretty unique algorithms to be able to monitor, whether it be a vibration trace remoter or an acoustic signature of some complex system, to be able to detect when might this critical asset need a maintenance intervention. And so kind of really just throwing out the whole standing army interval-based maintenance to more of a smaller team of technology-enabled knowledge workers. And so it's great for the people, and it's great for being able to not have systems down as often for maintenance. And we're just driving a better solution at Intelligent Asset Management. Now on the business side of things, the great thing is a big preponderance of that budget that goes to base operations. Legacy, if it's kind of low price, technically acceptable, we're helping customers think about best value, but it tends to be fixed price. And so as we go and we come and we show the customer, here's the transformation we can deploy from your current state to an IAM state, kind of a couple of years is typical. The customer can realize savings, but we, too, as we bring efficiencies can drive unit margins. And that solution now, we've market tested it. It's allowed us to go win 3 consecutive contracts with the Navy, first in Mayport in Florida, then at West Sound on the West Coast, most recently at Kings Bay in Georgia, which we'll hope to start phasing in soon. And the bottom line of that story is that we're really making good on delivering a better operations support solution. We're making good on the cost models for the customer as well as for Jacobs. And so the technology things are interesting always to engineers like me, but the fact is it's allowing us to drive kind of incremental margin improvement for the business in those areas.

Yes, yes. So just sort of a follow-up question on this. It seems as though this is the early phase of adoption for the DoD as well as other federal agencies. Where are we? What inning are we in, in terms of adoption? And then what do you see as sort of margin potential? You mentioned sort of improved or better economics of this model a couple of times. And where can that go? And how accretive can this type of business be relative to the services of a -- old?

Now I think it's a great question. I think that if you kind of snapshot some of the legacy business, high tech, cost-plus award fee, maybe supporting customers to highly trust Jacobs to support their critical mission, those kinds of contracts, highly competed, tend to be I'm going to say mid-single-digit kind of operating profit producers. And -- but if you look at where we're going, first of all as we rewin those contracts and deploy technology, we continue to deliver great mission support. Even on some of those contract types, as we rebid we're able to increment the margin, for sure. But then when you get into things like IAM or you get into the new space domain, we're able to incorporate some ISR technology from KeyW. It really does get into a solid double-digit kind of a territory. So if you're comparing old contract A to a new contract B, there can be a pretty dramatic difference or step change in unit margin across the old contract to the next contract. There is still -- our business is built with large long-duration enterprise contracts. And so it's not an overnight transformation for the whole Critical Mission Solutions business. But even if you look at the quarter 3 results we presented and compare that to a year ago, there was, I think, a solid 80 basis point gain. I think that is existing work where we're performing well as well as the new business we're going after. It's going to allow us to continue that trend. One other thing I want to say just supporting that is we have really enjoyed a couple of year period here. And maybe I'll talk a little bit more specifically about the part of the business I'm assigned to, but it really holds for CMS. We've had a couple of years where we haven't had a big burden of rebids, and I'm really proud of what we've done with that. We've been able to -- we kind of strategically enhanced our new business capture capability. We kind of built out that team, attracted more talent. And it's paid off. A few years ago, there was IRES. Right now, today, we won away from a longtime incumbent, the NORAD mission with the Air Force, which we're phasing in that workforce today. And so we've built a pipeline without the burden of a lot of rebids, a lot of new business targets, enterprise, higher tech, more critical missions. If you look at our 18-month pipeline for CMS, that's something like 30 billion. I think we've got like 10 billion in new business, no rebid and final source selection today. History says we're going to win our share of that. We've had a great win rate going. And so I think we're going to be able to organically attract more of this new business with a better margin profile into the business, and it's -- we think it's a sustainable trend organically.

So let's stay on that point here for a moment, that sort of the pipeline, some of your new wins, right? You mentioned the NORAD contract win. I think you've been pretty active with NASA, and then you had some sort of base ops conversions. What are the building blocks right now to sort of top line growth? And are there any sort of must-wins or watch items within the pipeline that investors should be looking for over the next, I don't know, 12 months or so? Or how should we start thinking about growth here, especially with the backdrop of COVID? Are you seeing any slowing as it relates to that? Just any additional incremental color on the pipeline and building blocks would be useful.