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

Welcome back, everyone. This is Andy Kaplowitz from Citigroup. I am the U.S. Industrial Research Sector Head. Great to have Jacobs with us today. I've known Kevin and Jon. Kevin Berryman, who is the CFO; and Jon Doros, who is the VP of Investor Relations, for a long time now. And very happy to have them here. Jacobs has been on a transformation journey for the last several years. And I don't know if you can call it a transformation anymore, Kevin, because you're kind of already transformed. So let's call it transformed, so the new transformed Jacobs. Kevin, I'll give it to you because I think you have some prepared remarks, and then we'll go right into Q&A.

Yes. Thanks, Andy. And look, I'd like to thank the Citi team and you for arranging all of this. Appreciate being able to spend some time with you all today, so thanks for that. Look, I just wanted to have a few comments. I won't be long at all, but I think it's going to be focused around the transformation of the company and where we've been and where we are right now. And we feel that we've done a very nice job in terms of being able to transition the company to a more value-added services provider, which is coming through in all of our reported numbers these days. And I think, while I agree with you that there has been a great transformation, I'm not so sure we believe we're ultimately done with that effort, Andy. And the recent announcement of the PA partnership that we did in late November of last year is, I think, an indication of that, where while we've been able to transform the company into be a more stable, higher margin, less risky proposition for our investors, we think there's more room to go as it relates to the continuation of our margin profile and the ability to provide even more value-added solutions to our clients. So we're excited about that opportunity, and pleased to be able to spend some time talking to our investors about what that looks like. So over to you.

Thanks, Kevin. So I wanted to ask you about that evolution in terms of -- you partly answered my question already, like where you think you are, you still have more room to go. But maybe talk about that. I mean, you have obviously a large infrastructure business, a large government services business. Where to from here? You mentioned PA Consulting, that is a bit of a different business for you. So I mean, are you going to establish 3 legs, including management consulting? I mean, where do you go from here?

Yes. I think that's a really good question and entirely relevant because of the work that we've done. Just a little quick jaunt down memory lane. The first kind of steps of our transformation were really about realigning the company against higher growth areas, focusing on those businesses where we thought we had capabilities, jettisoning those that we thought were riskier and/or more volatile in nature. And then the second part of that journey was really about starting to build the digital and technology capability sets, which are furthering our ability to provide solutions. And so I think as we sit here today, clearly, we like the 2 businesses that we have. And I think one thing that's not well understood by our investor community is the fact that if you look at our verticals, and you can define our verticals in a very detailed manner or kind of at a higher level, but let's call there's 8 to 10 verticals that we are involved in, whether it be water or environmental, or transportation or infrastructure. Every single one of those are oriented and positioned against long-term decades, long-term growth opportunities. And that's true for cybersecurity and remediation on the nuclear front and national defense and these types of things, too. So there's really not a part of our portfolio that isn't have -- that doesn't have an orientation and focus against a growth algorithm. Some of them are higher growth than others, but, at minimum, they're still all growing and stable from that perspective. So if you think about the next wave of it, it is really continuing to take our business where the technology plays, the cybersecurity efforts is to create a more holistic offering that actually elevates the solutions that we're providing to our clients. I use this as an example, but I think it's relevant and could make it come alive to our folks that are on the call. So think about an airport. And you think about -- we have done work and we've designed airports and we've done all of this great stuff. Airports are becoming cities. And so, think about a smart city application and how retailers are involved in that, how the flow of the customers of that airport are working, what's the transportation impacts as it relates to in and out, how does that all protect it from a cybersecurity effort, how is the digitization and the data that's generated in the management of that facility, how can that be better managed? All of that, we have a full suite of capabilities that many of our competitors don't have. So as we think about now the addition of PA into that agenda, it's even elevating a little bit higher because it's more consulting nature. So I'm going to call it, more point of the spear efforts where they could be designing and consulting on a where or what the future of airports might look like. And then, here we are at Jacobs that we can make that scale happen tomorrow. And so we continue to believe that our journey remains, that there is incremental margin on the bone to go after, and that we are well positioned to be a strong growth opportunity for our investors longer term.

And to your point, I mean, we should just talk about PA now, in the sense that, like you haven't even closed yet, I know. But you mentioned point of the spear, which is very, very interesting stuff, right, because it's, again, somewhat new business for Jacobs in a sense, right? And PA is very U.K.-based, as you know, but you have a nice U.K. presence, but a bigger U.S. presence. So if you can really bring that kind of business home, it could be a huge growth driver for you that's beyond the EPS you gave us for '21 and '22 when it closes. So as you've got to know PA better, do you think that you can do that? And how quickly can you do that?

Look, we've been talking on and off with the PA team for a long time. And one of the key things that came together over that discretion period was an alignment and a clarity as it relates to what's valuable to them, in terms of culture, is valuable to us. And so we enter into this partnership, I think, feeling very good about each other relative to what we think is important and what they think is important. And I think that the structure that we put in place, which is a little bit different than normal, this partnership arrangement, was really important from our perspective because it ensured that we have the commitment and the buy-in to the partner group, which they see as an ability to really make some magic coming together with Jacobs, and we feel the same way. So that ability for 1 plus 1 to equal 3, in terms of the growth, is very much evident. And we think about the things that they could do for our client base and getting them in the mix right away, yes, and the things that they are seeing, in terms of us getting into their client mix and being able to make some magic happen. It's very much already starting to happen in terms of the discussion. Now it's not going to happen day 1, but we have created teams that are being careful in what they're talking about right now because we're not necessarily closed, but starting to think about the potential opportunities to come together and focus on those areas where we're strong and they're strong, and that we really do get to see these growth. And I think that really the reason why PA was excited about joining the Jacobs team, is because they became convinced that, that growth opportunity is there. Otherwise, they would have kind of gone their merry way with another financial sponsor potentially that could have played. They did see the real opportunity for us to come together and get that growth, and especially in the U.S., which you called out, Andy. We're really excited about that.

Yes. So another big growth driver for you guys is climate change, energy transition, and you have a change of administration. So one of the things that you sort of mentioned, Kevin, is that you are seeing sort of more prospects on the climate change side. And obviously, it's a big theme of the conference, right? And so, maybe talk about -- it's early days of the new administration, but sort of the opportunity on that side. And then, alternatively, like I think we talked about this on the earnings call, there was some concern that because the administration changed over, it might impact your government services side, the CMS business, but it really didn't. So tell us why it didn't?

So let me start there, and then I'll go back over to the environmental side. Look, I think we've been very, very purposeful as it relates to our organic growth strategy on the CMS side, and then augmenting that with additional acquisitions that are, I'm going to call it, accelerating or force multiplying our organic growth opportunities in certain high priority spend areas of the U.S. government. And so I think the cyber areas, the Intelligent Asset Management opportunities that we've talked about, the areas relative to our data and the digitization in data of our clients and how they need to protect that, I think it's all just coming together, where we're continuing to see some robustness on the asks from the government. I know, we've heard others talk about a little pick up maybe from that perspective. We really haven't seen it, and I think it's a tribute to the ability that we're positioned really, quite well on that. Not to say that every quarter is going to be a great quarter as it relates to book-to-bill because that's not how it works, but we are feeling that the pipeline that we have, which we did talk about it being greater than $30 billion and the source selection pipeline, which is those things that are about ready to be awarded within the next 6 months or so of plus $10 billion, I think gives us indications that if we just continue to do our business when those -- our fair share of those things, it positions us not only well as we finish up 2021, but into 2022. But let me transition over to the environmental question is, where you started. And it really leverages back to the comment I made, where every vertical that we are in is a good vertical and is faced with really good long-term growth aspects. And you think about our remediation opportunities, specifically in nuclear or -- as well as water. You think about our water business and resiliency and protecting quality of water. And you think about basically the environmental business itself in terms of contaminants and having to protect the globe longer term. And how this all kind of works together in terms of carbonization or decarbonization of our businesses holistically around the globe and becoming more carbon-friendly relative to that. You take those businesses just in themselves, they represent probably $4.5 billion of our portfolio. Those are businesses that are going to specifically benefit from kind of the Biden administration's more proactive, positive view of environmental spend requirements, not only which will support private institutions starting to invest to make sure they're doing their fair share, but also regulatory bodies doing the same thing. But even more important than that is that those businesses are supporting our overall infrastructure. So if I go back to the airport play that I talked about earlier, look, the -- let's make that airport as green as possible as it relates to how it operates, how you get in and out of the airport, how do you protect the data in terms of the management of that. And so our transport business and our infrastructure business is being supported by those same verticals. And so you actually look at our total People & Places business, it's being impacted by all of it. And so we have $4.5 billion that's directly impacted. But then as the service that we're providing and the development of infrastructure and the decarbonization of cities and/or offerings that our clients are looking for, it's going to be part of the solution that we're going to be providing. So we think that, that, obviously, is a very attractive play longer-term for our People & Places business.

It's interesting, Kevin, because I cover some water equipment companies that trade at 16 to 20x EBITDA, and you guys don't trade at those levels. And I would argue that you have just as much exposure, if not more, to those kind of themes. So over time, hopefully, you get that recognition. Let me ask you about the CMS side and the comments you made about the $30 billion plus pipeline, right? So the last Analyst Day you had was a couple of years ago. Now, it was finally down in Miami. Hopefully, we're doing that again next year. But at the Analyst Day, you talked about sort of 2% to 3% growth in your CMS business at sort of the core. So given all these acquisitions you made, right? And as you said, sort of compounding the growth, does it seem like that's sort of the minimum? Now, I understand that the defense budget might be flat or maybe even, who knows, but let's say, in a flattish defense budget environment, is 2% to 3% maybe the minimum as you go longer term?

Yes. I think that 2022 and beyond starts to develop into a different dynamic, Andy, and I think it's probably appropriate to explain why that is the case. And look, we have, as you have heard us say for the last 5-plus years, is that we're really interested in not growth for growth's sake, but we're interested in the quality and margin profile of that growth. And so if you think about the CMS business, we're going to put up, what we believe are margin profiles for 2021, which are exactly aligned with the targets that we established back in that Investor Day of 2019. And as part of that, some of the very large enterprise contracts that we have are coming to an end. And actually, they will come to an end during the quarter that we are currently in, our second quarter fiscal 2021, which ends the end of March and that will create a tailwind of roughly -- I mean, excuse me, a headwind in this year of about $600 million in revenue. However, we're not going to drop $600 million in revenue, and we're actually going to replace that with organic and some of the other acquisitions that have been being executed against. So -- and with incremental margin, you're now walking away from some of those pieces that were lower margin from our perspective, and it's getting replaced with the new portfolio that's going to be able to be seen and recognized as we report our results. So I think that does translate into a growth profile that will be more robust going forward. And of course, we'll provide greater highlights regarding that dynamic. I'm not going to give you any guidance as it relates to 2022 and beyond, but I think developing into something that could be translating into a higher level of growth longer term.

It's helpful, Kevin. And sort of to your point, so as these large projects end here in Q2, you're left with just generally higher-margin business, and we're all trying to figure out how high is that margin when it comes down to it. So without putting you on the spot for an exact number, is it fair to say that these projects that are coming in are in the double digits, generally speaking?

Yes. Look, there is a wide range of margin profile that is within the CMS business. And what I would suggest to you is that the contract types can actually play a big role in what that margin profile looks like. For example, reimbursable contracts, which are typically these larger enterprise contracts we have tend to be a little bit lower margin. But the strategy of the CMS team is really, we like those contracts because they're stable, good margin, good cash flow, good DSO performance. And we're augmenting that with, what I will call, more IDIQ, short-term potentially fixed-price kind of related activities, low-risk businesses, but higher margin. And so there is this kind of 2 -- there's 2 gears that are operating within CMS. And consequently, they're -- the business development team is restructuring itself, so it goes after both of those. And so we have that contract type, which affords those higher-margin opportunities is full-on embedded into the team right now. And so we believe that those are going to ultimately provide the ability to have higher margins. I think, in general, our strategy is one where we will think and look to have higher margins long term. I'm not going to talk about the pace of that margin improvement. But I think it goes with the cultural shift we've made over the last 5 years, which is it's not about growth for growth's sake, it's high-quality growth, and where are we good, where we can build that margin profile and where clients actually respect and want the incremental value-add that we can provide.

Kevin, I mean, ever since I've known you, you've been able to extract more margin out, so I expect more going forward, which is great. But like, let me ask you around Focus '23, in the sense that how much does that factor into the margin game? Like you've talked about this $200 million in run rate benefits by '23. Is there a way for us to think about how much comes out of corporate versus how much comes out of the segments? How to think about that?

So I think the idea is, it does come across the entire organization, Andy, which is -- which was one point. But I want to reframe the opportunity. And the reason I want to reframe it is we've done a lot of great work already in creating a cost disciplined company and an ability to, as you saw in the first quarter of our 2021, be very disciplined in the management of our cost structure, which supported the good margin structure that we were able to deliver even in an environment that continues not to be robust in terms of the revenue growth line just because of the COVID dynamic. But we are going to come to an end on this play. And what will be important as we start to accelerate our levels of top line growth, which we believe will happen, what we need to ensure we're positioning ourselves for is that the operating leverage of that growth dynamic is going to be accelerated versus where we have been historically. So I think the business model and how I think about Focus 2023 going forward is less about, okay, we're just going to have this significant reduction in cost. But as we start to see the acceleration of the growth, you're going to see the operating level -- leverage be greater than what has been historically because we're going to be able to do more with less. Hopefully, that's helpful to understand.

And -- it is helpful, Kevin. Is there -- like in my world, like in the other sector I cover in multi-industry, right, we always talk incremental margins, do you guys think like that at all? Like is there a mid to high teens incremental margins that gives that operating leverage for you?

In some cases, yes. Not in all cases, but in some cases, the business opportunities are there in that regard, and that's certainly aspirational for us to continue to drive towards that longer, longer term. But I think, yes, the answer is clearly, yes, but there is a caveat, and I just want to make sure you're sensitized to it, Andy. If you think about our bill ability as an organization, whether that's PA or whether it's us in terms of legacy Jacobs, as we continue to grow the business, our teams that are doing the magic and interacting with clients are not always going to be 100% associated with a billable activity or whether it's a fixed-price contract or whatever. Our accounting standards will always have that piece of their business or their time fall into G&A, fixed cost, right? And so by definition, there is a certain part of our margin structure will result in G&A growing along with the topline.

Got it.

But what I would saw -- see is those pieces will become less as a percent of the total because we're becoming more administratively good, and that the ability to transact, the ability to monitor, the ability to manage and spend more time innovating are going to be translating to that force multiplier on the revenue line, which affords us an ability to have an incremental margin profile. So I think it is not for a cost reduction's sake, it's for unleashing the innovation and capability sets of our teams around the globe.

Very helpful. So I want to go back to a little more short-term in the sense that if I look at P&PS, booking strong, revenue a little weak to start off first half of '21. Like what -- are you looking for anything specifically to get that burn rate up? Like is it just simply getting through the year a little bit, so we see the sort of stabilization? What the administration is going to do? I think people have asked you on the call like you don't necessarily need stimulus about -- that would help. But you tell me, like what do we even look for to see a revenue inflection in that business?

So I think that, Andy, the stimulus is a support to the commentary. I think the $1.9 trillion that has been put on the table, and whether that ends up being exactly that number or a little bit less, is actually a little less important than what's in it. And what's in it is clearly a couple of things that are going to be helpful. Some moneys a little bit more than we thought in terms of transport -- support of transport $20 billion to $30 billion. There's moneys in there for airports. I think it's about $8 billion or $9 billion, which is positive. And then there's environmental stuff that's in there as well that will start to unlock some of those opportunities. But as important as that is there's some state and local support, which allows for the state and local institutions, which we all know have, been pressured from a revenue basis, given the COVID dynamic, tax revenue is not being as robust, is going to be able to -- for them to be keeping the lights on, which facilitates, I think, us to continue to manage through. I'm not saying it's the ability to it to ultimately change, and the inflection point is clear, but it helps. And so, I think that all of those translate into us feeling a developing comfort level that the downsides that we had talked about and the downside aspects of what our guidance had been is going away, and it's really starting to be a more optimistic scenario developing forward. I think, what that translates into, in general, is that we'll be kind of in this flattish environment in the very, very near term. And then, as we approach the end of our physical -- our fiscal year, which ends September 30, is really going to -- we're going to start to develop some incremental momentum. And of course, that would get accelerated if, in fact, the infrastructure bill that everyone has talked about for -- pick your poison of how long it's been talked about, decades or 10 years or whatever, I think the stars are aligning in a more positive way that that's certainly more likely, especially given the desire for the new administration to make sure that we come back out of the COVID dynamic in a more positive economic health environment, and certainly, transportation and infrastructure support, will be helpful in that regard.