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

Okay. Good afternoon. Welcome, everyone, to this afternoon's fireside chat with Jacobs. I'm Jerry Revich with Goldman Sachs and I'm delighted to have with us today Kevin Berryman, President and Chief Financial Officer; and Jonathan Doros, Senior Vice President of Finance. Kevin, Jon, thank you very much for joining us today.

Pleased to be here, Jerry. Thanks.

Kevin, maybe as a starting point, over the course of your tenure, you folks who have really transformed the portfolio. Can you just talk about the transition that you folks have undergone thus far as you've high graded your technology and margin profile? And then can you talk about how the strategy has evolved as you think about the past -- the next 3 to 5 years compared to the journey we've been on up to this point.

Great. Thanks, Jerry. I love the question. It allows us to talk about how great this company has done over the last few years and not that we're satisfied with where we are, but ultimately, it really is a testament to the people of the organization. Both Steve Demetrio and I came over the course of 2015 and started a process of what I would call a pretty significant transformation of the company. I know a transformation is a well-used word, but it really, I think, is relevant here. I would say we put together, we came in and we did a really deep dive look at a strategy for the company. And actually, it was the first ever kind of long-term strategy that was put in place for Jacobs. And we did 2 things during that first strategy. There was a real sense of wanting to increase the accountability of the organization. So we reorganized, restructured and created for the first time in the history of the company, lines of business, which actually had a specific requirement of performance and ultimately, an ability to understand where they were going and what they were expected to get accomplished. And we were able to develop some great accountability with the leadership of those respective organizations, line of business, which was great because a big part of the first -- that first strategy was the enhancement of our culture. Jacobs had always had very, very strong foundational elements of culture, but really getting to enforcing that and enhancing and nurturing it to a greater extent to become a more connected organization was really, really important. And so that was great, so those things went together. But the other part that we did was a very deep dive on the portfolio. And to determine what businesses we're in, where did we think we could be most successful? What of those businesses was expected to face long-term growth opportunities, and we started to make some choices. And those choices were really critically important, which fundamentally resulted in us acting on some of those choices by investing in CH2M, which was doubling down on, I will call an ESG portfolio that was pretty, pretty astoundingly strong and fortified our capabilities in transportation and infrastructure as well. And certainly put us on the map in a material way in environmental remediation. In addition to that, that led to the sale of our oil and gas business, lower-margin business, more volatile. And so it was important that we did that as well. We were able to hit our targets that we established in that first period. So '19 -- 2018 actually was the end period, and we put together a new strategy in 2019, which was the next phase of it. And it really was about becoming a more stronger value-added solutions provider. And that led to a subsequent series of additional acquisitions that were made, KeyW being one, Buffalo Group being another, Wood Nuclear being another, where higher margin, very much more technically digitally oriented. And the most recent one was an investment in the PA Consulting Group, a strong digital consulting organization that we are now partners with, which closed in March of 2021. And so this whole next wave of having come together, being, I would call it, a more value-added solutions provider, resulting in higher margins. Also, it's going to come to fruition. So 2021 is the ending period of that. We're going to deliver against those expectations. And now the next phase is continuing to drive that agenda going forward. We've just kicked off our next version of our strategy. Our expectation is we're going to continue to push the envelope on what that looks like. And so we're excited about that. And what's really pleasing is whether we were lucky or good, I'll leave it up to you guys to determine. But we are now positioned in every vertical in which we are operating in multisecular, long-term, and I would say, decades-long growth opportunities facing in front of that, whether -- in front of us, whether it's cyber, there's environmental. Whether it's infrastructure, whether it's transportation, whether it's environmental remediation, whether it's protection of our scarce resources, whether it's becoming carbon-neutral, whether it's becoming new energy sources. All of that is very much oriented into our portfolio, not to suggest the work with the Cyber and Intelligence and national security interest of our country and those around the globe, is a big part of what we're doing right now. So we're excited about our future, excited about things are developing in D.C. relative to those matters, and we're excited about talking a little bit more about it this morning.

Great. Thank you, Kevin. And as we think about the capital deployment part of the story, that's been really a major part of where you folks have delivered outsized value over the past couple of years between the divestiture and executing integration extremely well. What does M&A look like for you folks going forward in terms of size of deals in the pipeline and strategic direction of deals? Can you talk about what -- in addition to the portfolio that would be meaningful, would look like today compared to the deals that we've seen you folks execute on?

Thanks, Jerry. So the most recent transaction we did where it was the investment in PA Consulting. Yes, we levered up to do that. So just to -- so everyone's aware, we're probably in the short term, even though our balance sheet is not overly stressed, we're still in the -- of the view that we would like to delever a little bit. So excess capital will probably, at least in the short term, be provided to delever a bit from our gross debt levels. So that's one comment I would make. Second comment I would make is we don't think about an acquisition strategy as acquisition-related. We think of our strategy being our base business and how we want that to evolve over time. And ultimately, at its core, it's an organic growth strategy. And we then envision acquisitions as being accelerants of that strategy. And I think if you look at all of the transactions that we've done over the last 5 years, all of them fit into that category. We had said what our strategy was, and then things became available, which helped support our capability sets in those. In those core strategies, we were executing against and/or accelerated something that was already very, very strong. So where we are today is we love the portfolio, kind of how I ended my commentary on the next phase of our strategy. The portfolio is well-positioned. We don't feel like there is something critical we must do and that the organic growth opportunities facing us are really pretty, pretty nice. And they'll develop further than from where they are now, given that we're still in the midst of COVID, but we see that happening in '22 and beyond. So that then translates into what I would say is -- I'll never say never, but we would say that we would probably see more likely tuck-ins or maybe some larger tuck-ins, but ultimately, augmenting our capability sets in a variety of areas where we already have strength as opposed to something other than that. And so they probably end up being more like bolt-on-oriented, I would say. But I'm not going to say never, never on other opportunities because it will -- we'll see how things develop. And we do believe we have the capacity, the discipline to ensure that when we take those steps relative to acquisitions, they will end up being accretive in value to our shareholders. And now, we think a little bit more broadly in terms of our general stakeholders, whether it's our people and our company or the communities in which we work.

And so Kevin, that's really interesting because considering how much cash your business is throwing off, if we're talking about tuck-ins from here that does suggest room for stock buyback and dividend growth, can you expand on that? So once we've addressed any M&A opportunities, how are you thinking about capital allocation from there? And then along those same lines, you've laid out your leverage targets in the past. If there aren't acquisitions out there that would take you up to those targets, would you move up to those leverage targets with stock buyback?

I think that, in general, the way we think about our deployment of capital is what is the best use of that capital at that particular point in time to maximize our value creation opportunities. And so for example, if we were ever to look at any potential transaction that is an investment in a company or an acquisition, it's going to have to beat ultimately the return profile associated with buying back our shares. Obviously, there's a complexity and an incremental risk profile associated with this. So if it's not going to be better than buying back shares, doesn't make a lot of sense in our mind to do it. So we're always kind of thinking about being agile as it relates to the execution of the various uses of our capital. So I think that means that capital share buybacks can certainly be part of that agenda. I would say probably the lower end of the spectrum, at least currently right now, is on the dividend front. Even though we do have dividends, and we continue to raise them robustly on an annual basis because of the success we've had, but we still feel like there's a great opportunity for us to grow. And so our -- probably our initial opportunities are more aligned with reinvesting back in our business and/or those M&A opportunities that accelerate our organic growth opportunities are more likely. But at the end of the day, we'll see how that plays out. And I just think that, that's how we think about it. We think about being agile, nimble and most enhancing to shareholder value at any particular point in time.

And Kevin, in terms of leverage, would you lever up for stock buyback? Because obviously, your business, given how steady the cash flow is, can support pretty healthy leverage levels?

Yes. Look, I think what I've said in the past is having debt levels in the 2 to 3x is comfortable, I think, from our perspective, at the high end of that range, I'd be less comfortable doing share buybacks, lower end of that range? Certainly, yes. So I think that's how I think about it. And so maybe that gives some perspectives, and I'm not going to go into any more details as it relates to where that dividing line may be. But certainly, I think levering up for something that's special from a strategic perspective makes better sense than levering up on the share buyback, at the same level.

And in terms of M&A that fits the strategy, what are the white spaces where you folks want to invest inorganically? Can you give us a flavor?

Yes. Look, I think there is ultimately continued opportunities, we think, in the government services side to look at ways to -- I'm going to call it be more point of the spear-related activities, higher value added, and certainly, PA can potentially play a role there. So I think that, that certainly, government services could play a part in that agenda. I think there are some various locations, geographic expansion opportunities. I think we'll be very, very thoughtful and disciplined, in terms of how that might look because we don't want to get over in too far over our skis as it relates to that. We want to ensure that our fundamental position of not being a company that is changes the risk profile in a material way. We want to make sure that we adhere to that. I think that the areas we now are in, relative to where we might have been 5 years ago, and even 5 years ago, I wouldn't have called us a risky proposition. But I think we're even a less risky proposition today. And I think we're comfortable with that continuing trend, that analytics. And depending upon where you might think you might want to be in a potential growth opportunity, we're not going to get over our skis and get ahead of ourselves there.

Okay. And then in terms of environmental opportunities for you folks, can you talk about what part of the portfolio you're seeing the highest interest level in? And where is there a compelling case for customer ROI across your offerings?

Look, I think it's one of the biggest opportunities we have as a company. And we've -- and I'm sure this is going to be front and, at least, at minimum or front and center discussion relative to our strategy work that we're embarking upon right now, Jerry. But if you think about it, and we've quoted a number that's approaching $5 billion of what we call environmental-related business. The actual number is higher than that because the way that we're embedding into the capability sets that we have from an environmental perspective, whether it's remediation, whether it's nuclear cleanup, whether it's incorporating into transportation, infrastructure, more sustainable offerings. All of that is front and center. And so I think that with certainly the current administration, that is clearly an area of focus and priority. And I think that, that is certainly something that's very exciting for us. And if you think of a company that's got clearly almost $5 billion of revenue associated with that, we're one of the largest, if not the largest. And so it's a capability set. It's part of this idea of that we have this collaborative capability set of true things, whether its cyber that gets built into a transportation infrastructure offering, or its sustainability initiatives that are allowing for that project to be more sustainable in terms of how it's impacting the local economies of our constituents and our clients. I think all of that is going to play out in a way that allows us to be more competitive and more compelling for the offerings that we can provide to our clients.

And in terms of the part of the portfolio where you're seeing the biggest cadence and demand acceleration out of the environmental offerings, can you talk about where the interest level has meaningfully picked up?

Boy, I think across the board, I mean, I don't want to sound flippant, but the work that we've been able to do over the last 5 years into transforming the portfolio, we're really well-positioned. And I think that water is clearly there, in terms of it being a focus area of investment. Transportation, clearly, with the latest discussion on transportation, infrastructure, bills that are being bandied about in Washington, D.C. You add that to already positioned bills in place in the U.K. and in Australia and in Singapore, clearly, those are big markets for us. And clearly, those things are starting to come to fruition. I think the investment in cyber across all of our portfolio, but specifically and the government service side is critically important. The digitization and the IT modernization of the government systems, I think it's just becoming more clear, whether you talk about the issues that we were dealing with a couple of months ago. We're talking about the latest issue with the pipeline relative to the cyber attacks. It is just becoming that much more important. And so all of these places and categories within the construct of a potentially total DoD spend, which may not be all that impressive, but the areas that need to be spent on and are being recognized as needing to be spent against, are double-digit and potentially high single-digit numbers, which we're excited about being part of. And I know, Jon, I can't remember which ones I might have missed in that. But I think that if you look at holistically, there's not many verticals that we have. Space is another one and space intelligence. The war for national security is becoming real and more real. And the technology needs to make sure that, that's supported or right up our alley relative to capabilities.

And maybe I would just add like CoStar resiliency and some blood resiliency, that's probably the only other one that is going to be a lot of money spent, or where we're positioned extremely well.

And in terms of Critical Mission Solutions, you alluded to it, Kevin, when you folks look at the addressable market for your products, in particular, what do you view the end market growth as? Because, obviously, in totality, the budget is not really exciting, but within parts of your addressable market, the outlook is more positive. Can you just expand on that? And step us through what that weighted average end market outlook looks like for your business?

Yes. I think it's the targeted areas that need to be targeted for national government resiliency. I'm going to use resiliency from a perspective of national security and certain state actor threats that are out there, whether that's space intelligence, whether it is cyber, all-encompassing full cyber, analytical and data intelligence. Whether it is the modernization of the IT infrastructure of the government, whether it's national security-related activities associated with hypersonics and the related opportunities to make sure that the country and/or other countries are protected from certain state actors. I think we all know, all you got to do is read the news that those are areas that we are in robust discussions with a variety of whether it's intelligence agencies, whether it's NASA, whether it's other entities. 5G is another opportunity that we're involved in. The electrification of automobiles is another area, given some of the R&D work that we do with certain of the auto manufacturers. I mean, I can go on and on and on, but they're -- I mean, we're pretty excited. And so not that it's going to happen immediately, but we do believe that this developing momentum is something that we're excited about in '22 and '23.

And then in terms of the focus 2023 cost reduction targets, can you talk about how the initiatives are going versus initial plan and any changes to the plan, considering the sharper recovering global economic activity that we've had since you laid out the program?

Yes. I would have -- look, I would have envisioned actually 9 months ago. Jerry, a much more robust, I would say, opportunity to actually have a net reduction in our cost because we are in the midst of the pandemic at that point in time. I think of it now more as an operational leverage issue because given this kind of developing growth dynamic, I'm alluding to, at the end of the day, this is going to reduce our -- allow us to continue to reduce our real estate footprint. Allow us to memorialize and continue to have lower levels of traffic because technology offerings that we now have. Our plan is not that it's going to be a further reduction from our levels right now because we're still in the midst of the pandemic, but it's a memorialization and institutionalization of lower travel levels that we will be able to benefit from longer-term. But this whole other digitization of our processes, standardization of our processes, the ability to further leverage our global talent pool is going to result in us as we start to see these potential incremental growth opportunities, we're not going to have to add as many people. And that's going to be really important because I think there is going to be developing war for talent, over and above what already has been a developing war for talent over the last couple of years. And I think those that can leverage off of the existing capability sets that we have in terms of talent pools and not -- and have those people excited and energized and not leaving. On top of the fact that we're going to be able to leverage them better by not having to add that many more people to accelerate our levels of growth and to satisfy what we think is going to be a great growth profile. I think that's going to be an operating leverage that's going to allow us to continue to build and grow our operating profit leverage. And so it's really, I think, because of this developing growth, much more about operating leverage. And I think it's going to position us well to have incremental margin profile going forward.

And in terms of the key performance metrics that you folks look at for each of the lines of business, can you talk about how those have evolved over the past couple of years, any meaningful differences in terms of how you're implementing the strategy through the key metrics?

Yes. Let me talk about the long-term ones first because we have fundamentally changed them keenly. There was originally in Jacobs, he focused on earnings growth -- earnings growth alone, which, that's easy to do if you decide to spend money on acquisitions. And what we have done is now we've divvied up our payouts on performance shares and performance shares is something that's a new concept as well. But ultimately, half of it is driven by our ability to grow and grow our earning. But half of it is required to be dealt with in the terms of not only you got to do that, you got to return -- increase your return profile at the same time. So you can't buy growth. I think that whole dynamic of those 2 metrics being front and center relative to long-term is really critically important because you got to do both. And I think that's important. On the short-term more side, we pushed our participation levels. We've doubled it down well lower into the organization because we think that's important to engage people. And we've incorporated ideas and thoughts about both growth, operating profit and the balance sheet. And we've simplified though, to a certain extent, by talking about our accounts receivable and DSO leverage. And in my mind, that's an annual representation of ROIC because what operators can do in the short-term is affect ROIC through improved DSOs and the ability to collect money faster, get better terms and whatnot. And if you look at our balance sheet, that's really where the leverage is in terms of short term. The other things are more about acquisitions and whether you do it, you get a return. The things that our operators can really drive every day, day in, day out is DSOs. And so all of that is part and partial to our annual results. And so we got -- we get paid on growth in terms of how our backlog is growing, not revenue growth but profitability growth of our backlog. Operating profit and that operating profit is always established in a way that improves our margin profile. And then, of course, adding DSO to it, the combination of translates into consistent with our long-term targets, ROIC and growth.

And Kevin, on the point on growth in profit and backlog, you folks have steadily grown margins and you've steadily grown margins in backlog. Has that runway continued in terms of the backlog growth that we've seen? Have we stay on that trajectory?

Yes, we have. And I think that it's now well-recognized that if there is opportunities out there that are not accretive to the kind of margin profile, there better be some damn good reasons as to why we're doing that. Look, our margins are on average of a big mix of business. So it's not like everything is going to be higher margin. But our expectation is our pipeline grows and our margin profile and better backlog ultimately is as well. And I think it's very well-recognized by our people. And I think that has happened. It's continuing to happen, and I would expect that it will be part of our new strategy going forward. There's one thing that we haven't really talked about. And I think it's important to talk about it, Jerry, if I could just go on a little bit of a tangent. Partial to this success in our transformation of a company and the financial performance has been an extraordinary change and are, what I will say, drive for becoming a different type of company for our employees. And being front and center relative to inclusion and diversity, being front and center and a leader in terms of recognizing what company we want to be relative to societal issues that are out there. And how does that translate into us being a company of individuals that every single one of our 55,000 people feel like they are engaged. Part of the agenda can be heard and are driving forward consistent with what our strategy is. Our attrition rates right now at our historical low levels. We think that's been a critical part of that. We know that as we come out of COVID, probably there will be some incremental pressures on that as well. But I will tell you, it has been a big part of our journey of a company is that we want to be recognized and noted as an employer of choice. And maybe I should change that and say not an employer of choice, but say, the employer of choice because it's about our people and how they can help drive our agenda of change and excite being excited about being part of it. And if they are, and they feel like they're a participant in that journey. That's going to work for us because we have the best people in the world.

And I'm wondering if we could talk about PA Consulting next. What have you folks learned since you've acquired business beyond the fact that the revenue run rate is higher than we would have thought in the middle of the pandemic?

Well, one thing, remember, Jerry, and I just want to make it clear that we have not acquired them. We've invested in a partnership with them, and there is a specific strategy of PA Consulting being an independent entity, and there's reasons for that. It's a consulting, very high value-add consulting company, which has EBITDA margins that are double kind of our existing portfolio. And we want to make sure that, that magic continues. And so I think what we've found, very early days -- I don't know that it's a surprise necessarily, but it's a confirmation of is that the excitement level between the 2 relative organizations and seeing the opportunity to coming together and how PA can benefit from us, and us benefiting from PAA is real. And if anything, I would say that the amount of opportunities we're seeing, we're going to have to be very thoughtful because we don't want to be disruptive to our respective organizations going after bright shiny things. That don't necessarily move the needle, and that's a high-class problem to have. And it gets to the question you just said, the organic growth appears to be pretty strong right now. So let's make sure that we can be accretive to very strong organic growth, not diffuse it. So I think they've started strong. We're a couple of months in. So let's be clear. We're very early into the process. We like what we've seen and the other point I would say is we're a lot more like than people would have thought we would be. And that's another confirmation of the diligence and process of coming together. And the more and more people interact, the more and more they are saying, "Well, we're kind of very similar in how we think and what's important to us as an organization."

And then if we could just shift gears to Critical Mission Solutions. Obviously, a really sizable pipeline in that part of the portfolio, can you just update us on the timing of expected awards? What are the major projects that are coming up and the award cadence?

Yes. Look, we have -- we've always said that the pipeline for CMS was going to be back half-oriented. It still remains back half-oriented. There is -- it kind of -- it will leak into the first part of 2022 is my belief because just as it relates to the timing of the nature. And it always is perhaps that -- I'm not so sure it's COVID-related. Probably, some of it's COVID-related. But our government is an entity that's big, and things tend to be a little bit later than we always hope that it will happen. So but nonetheless, we still think it's a back half of 2021. There's -- it's a couple of projects in the nuclear arena that we expect to happen and be led over the next couple of quarters. We think there's a space intelligence opportunity that's really benefiting from the acquisition of KeyW that's coming to what we believe will be, hopefully, a third quarter, perhaps fourth quarter opportunity. There's another large one. We're not able to really talk about it at this point in time because it's still in the midst of kind of coming together. But I think that those are some big ones that are happening. There's a couple of others that are a little bit lower size, but still of substance that we also feel are going to be happening more in the cyber intelligence field. And those are really nice ones as well, but they're not the huge needle movers, but really important. And so a lot of that comes together over the next 6 months. And hopefully, we won't get delayed from what I'm talking about. But always, always considered it to be a back half pipeline execution, and we're still feeling that.

And just a clarification, Kevin, the space intelligence, 3Q or 4Q, was that a comment on your fiscal quarters?

Yes, yes, yes.

Okay. Terrific. And then people at places, solutions, your backlog has gotten longer over, call it, the past year. Can you talk about what the pipeline looks like there? And I know a big chunk of that work is going to be book and burn, but can you help us understand out of the longer-dated work, what do we have coming down the pipeline that's meaningful?

Yes. Look, I think probably the near-term aspects are -- we're seeing in the last, I would say, month, where there appears to be at the state and local level, a little bit greater comfort that the monies are around. And so not that, that's translating into work immediately, but the pipeline starting to build, which is great to see, more so than it was. We saw a little stagnation in pipeline in some of the areas, kind of earlier this year, and that's starting to come back. So those things will tend to be a little bit more book and burn, but I'm not so sure it happens all that fast, given where we are in the fiscal year for 2021. But we're seeing that pipeline build, which is nice. I think that's a function of that comfort level and also seeing ahead to what is expected to happen because of the infrastructure bill that the jobs plan that's out there for the U.S. So these are U.S. comments, obviously. And I think the other piece is, certainly, 5G is robust. And I think that the electronics and pharma businesses is robust as well. And we had made some comments earlier on relative to that. So that could maybe help if the companies are ready to execute quickly because the design work will -- is happens immediately. So those aren't necessarily big, big, big numbers, but very profitable numbers as you kick off those projects. So I think all of that is, I would say, you heard a different tonality probably on our earnings call this past quarter when we talked about our second quarter results. And it really is kind of a confluence of things on both sides of the business and then PA was a cherry on top of the cake.

Got it. Terrific. Well, we're at the end of our allotted time. Kevin, Jonathan, thank you very much for telecommuting to join our conference. It is -- we're nicely connect and great to see. And hopefully, next -- come around, it won't be as virtual, the conference. Thank you, everyone, for joining in, and have a great day.

Good to see you, Jerry, and thanks for asking us to participate. Glad to do it.