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

Well, thanks so much for joining us, everybody. My name is Adam Seiden. I'm the US machinery and construction lead at Barclays. And welcome to the 40th edition of the Industrial Select Conference. For this session, we're really pleased to have with us the team from Jacobs. Joining us first is the incoming CFO, Claudia Jaramillo. We have Matt Chiller from the Government Relations side as well as Jonathan Doros from Investor Relations. So the format of this event here is a fireside chat, the conversation with myself and the team. We'll open up the floor for questions at the end if you did have any. I'll also let you know that there are some gadgets on each one of your tables there. That is for our audience response system. If you wouldn't mind as we go through those questions through the session, we would love if you can participate, and we'll talk about those questions as well. So with that, Jacobs' team, thanks so much for being here.

Thank you.

Thank you.

Thank you. Well, I'm really excited here because I feel like I may have the honor of seeing your first presentation since your nod. So maybe to start off there, right? I know your tenure at Jacobs is relatively young, but your experience in the overall broader business industry is quite strong and long. So I'm curious if -- as you think about your transition into the CFO role, what things you're looking to bring from your prior experiences, whether it be at Jacobs or from your prior positions at Schlumberger and so forth.

So thank you, Adam. I'll start with giving a little bit of context about Jacobs, which ties a lot into the [ resource slide ]. I will take this. So first off, my career is mainly in managing [indiscernible] and largely driven by the [indiscernible] platform that we have in multiple sectors. So it's very exciting, and I look at Jacobs and very positive portfolio transformation how the company is positioned in growth sectors where there are macro trends. In some cases, the growth can be multiple years. And in some cases, we think it can go even multiple decades. And those are across all our sectors. We have 4 core sectors, and those are critical infrastructure. As you know, it's energy and environment, we have natural [indiscernible]. So already the portfolio transformation is doing a lot for us. At the same time, we have a [ great ] opportunity. So I told Jacobs if everything is done, then what opportunity you have? I see the opportunity [indiscernible]. The strategy is based on 3 accelerators. And those accelerators are really to enhance growth and margin. And the accelerators primary response being one of the big banks that we see in the world, very challenging problems, both governments and companies are dealing with. They require a lot of domain expertise, which is one of the [indiscernible]. So final response being the first accelerator. The second one being data solutions and the third one, consulting and advisory. So you combine the 2, and we have the opportunity to further enhance our revenue and growth -- revenue growth and margins. And then what's next? So how do we improve it? And it is -- what's next in the strategy is execution. And execution is really how do we do it is focusing, instill an operational discipline and then effectively deploying our capital, focusing on our shareholders. And that leads me to how do I bring my experience? So my experience, I'm an electrical engineer by trait. Now, I did an MBA at Wharton, switched to finance and a lot longer in finance and engineering. And in my career, especially my energy career, I worked in different parts of the world, a long time in the US, managing businesses that are global, Schlumberger, which is my last role before I joined Jacobs. I was the Group Treasurer for Schlumberger in operations in over 100 countries. So I had the opportunity to deal with emerging markets as well as OECD markets. In energy, you deal with a lot of cycles and very difficult cycles. So you need to have the operational discipline. You kind of wait to adjust your cost. You need to have a lot of focus on working capital, all the cash deployment of capital, aligning your operations with the shareholders to make sure -- in energy many times, it's about -- it's a basic [ concept ], you don't do it, you don't survive. And Schlumberger is a very successful company. So that exposure to those P&L positions, one of them, I was the Head of Finance for the North America business. It was at that time, $16 billion business. It was in the longer downturn of the energy industry. That gives you a lot of resiliency, a lot of transformation that you need to drive, both to manage the capital and also to manage the costs and bring the organization to the point where, when you make decisions, what are the KPIs that you used to make those decisions to anticipate what is needed. And I'll finish with that piece, the KPIs, which I believe is very important for us with the strategy. And the strategy, when you communicate these things to the organization and externally, how do you make it simple? And that's the only opportunity that we have, and we are currently working on clarifying our message, making it simpler internally and externally on our strategy and really focusing on the KPIs that are going to show the progress that we're making on the execution of our strategy.

Got it. That's really helpful. And when you talked a little bit about the past and also a little bit about the present and the future here at Jacobs and one thing, if I think about the last couple of years, there's been -- certainly, there's been a strategic change. The business has become higher quality, less volatile. But in order to do that also the business has made several transactions to get there. So in your current role at Jacobs, certainly you've been exposed to a little bit of that process. But I'm curious, as you step into the CFO team, what type of -- how acquisitive do you think Jacob needs to be? What type of risk parameters do you tend to put up when you're looking at deals and how you look at your diligence when you're thinking about growth in the future?

Yes. Great question, especially because one of my roles right now before I started the transition into CFO was strategic combined with corporate development. So I've been dealing with a lot of [indiscernible]. And I can't tell you because of our expertise and all the different parts of infrastructure, we have opportunities presented to us. Every week, we have real opportunity. The strategy gives us a lot of -- it gives us solid foundation to make a decision yes or no. And the strategy is not only the growth accelerators, the strategy also has a very clear component of revenue growth and margin improvement. So we apply the lenses of how does this [ fit ] into the growth accelerators? Is it aligned? And then the second is, does it -- is it aligned with the growth and margin profile? Those are the first, the first lenses that we apply to those opportunities. Now that's more evaluating specific opportunities. If I flip back on what I talked about effective capital deployment, I'd like to look at the capital deployment through the shareholders' lens because at the end of the day, this is our shareholders' capital. So we deploy thinking on the shareholders' capital, and that's my whole philosophy. And when we do that, we have 2 options that are not mutually exclusive. So one is we return excess capital to our shareholders through dividend or share repurchases, or we do the -- we do M&A transactions. Now M&A transactions, the bar needs to be high. Why high? Because M&A is always risk. Given with the best due diligence, you have an integration. And integration, that's something that we've been including [indiscernible] and the conversation. So from the moment that we started evaluating some of these deals as I joined the company and John is part of some of those conversations. I was not in the team, how we want to integrate this transaction. This transaction is not about how we do the due diligence, how we close the deal, how we negotiated this, how are we going to monetize the synergies if it is [indiscernible], if it is costs, all these different things, how are we going to work towards the integration? And I'm just illustrating that because that's where the risk is. [indiscernible] the thing that you don't see what value it brings to the company. And the high bar is knowledge that M&A is risky and needs to be on a risk-adjusted basis, higher than the cost of capital, well above the cost of capital. So all those combined, if I think about the last few months and think what our portfolio is, the likelihood of something taking place tends to be low because the bar is higher already through the lenses of the strategies, the margins and the risk-adjusted basis is above the cost of capital.

Got it. And maybe to transition to the business and we're talking about less quality, higher quality. And one of those legs that the company has brought in PA consulting. Now if you think about the business, on margins, margins have progressed a little bit here. And given that the Street has a little bit less history with that asset, I'm curious, as you've gotten up to speed as well, if you could tell us a little bit about what we're seeing here is that more of a regression to the mean as to where the markets be in that business? And then what type of business could this be in the next 3 years, 5 years and so forth?

Yes. That's a very topical question. And so first, I want to refresh the concept of why we did the transaction. PA has very much the same drivers as the rest of Jacobs. And it is a lot of sustainability. And many of these things that PA does has sustainable and many of the customers we work for are the same as is in the government and the energy transition phase, lot of energy transition, decarbonization, many of the same markets. So with that, the difference and one of the big drivers of the transaction is they start much earlier than us. So they start their conversations starting from the boardroom. And what happens is we can go together to the customer or they go first and then we follow. We can be their implementation arm, or we can bring them with us to start the planning, [ internal planning ]. When we look at PA, so they've been growing, they have had double-digit growth, very healthy. And we also -- they're also ahead of the business model that we have. They are accretive. So all very positive. Now when we focus on the last couple of quarters, what happens is their backlog and pipeline has been growing. Most recently, it was over 24% on a constant currency basis. So the underlying growth is there. What has changed is the burn rate. And our objective is to grow double-digit operating profit in a long term. So we're managing the business to deliver double digit in our long-term growth. With that in mind, this is still a business that is exposed to macro drivers. And in the last couple of quarters, in particular, it was impacted by some of the UK government challenges. And how we saw that? So backlog still good. Pipeline is still good. We saw it in the burn rate. So the way it works is we signed the framework agreement, let's say, with the NHS in the UK, if not the framework agreement, but the burn rate is not the same because we're managing focus on the long term and targeting double-digit operating profit. We're being careful not to destroy the knowledge. Now we have taken measures to raise higher way ahead of the burn, because we had it in the backlog and the pipeline. What we have done is, we have applied measures just to let the burn aligned with the resources that we have. But again, we are reiterating our commitment to the double-digit operating profit ramping to 20%.

Got it. So there's a clear path. There's a path to improve the business and improve the operating profit within the business. Now from an ownership perspective, how attractive of an opportunity is it to become a full owner of the asset today? Maybe start with that.

Yes. I'd say that it was attractive from day 1. So like anything in M&A, you go with an IT and then it really comes down to who is around the table, the seller and the buyer. And then the rest is -- it goes on to my prior comment, which is integration. So the moment you acquire the company, you're making commitments to your different orders and what is the deal model? How much you're going to grow? And what you want to do is you want to incentivize the organization to do it. What are the KPIs? And in this case, very focused on operating profit growth. It's a company that is its partners, but we wanted to incentivize the partners to keep that healthy growth and the healthy margin. And at that moment provided the right structure and we still have to [ fulfill ] that. They were also looking at this asymmetry of information. They were looking at us potentially, there is this large company that is going to come in and probably paint everything in different colors, change all our policies and all that. So there's asymmetry of information that happens in most acquisitions. And for us, we wanted to protect this entrepreneurship [indiscernible] and all that. So that's where the model does not acquire at 100%. And I know quite honestly it is what you can achieve at that moment. The way the deal is structured is there is a mechanism for us to reach 100%. We have seen and we have, as I said, we are ahead of the business case. So it's working very well. They're incentivized to deliver the right margins. They're incentivized to deliver the growth. And we're really -- now that the trust is developed that they see we're not going to change everyone, that we're going to change all the policies, it's more for us to say when is the right time and now we have a very close collaboration. Over time, we're going to be looking at opportunistic resourcing.

That's helpful. And maybe shifting to Divergent Solutions a little bit. So the company broke that out for the Street this past quarter. Can you remind us what are the major profit drivers of the Divergent Solutions pool today, and how does that mix change over the next couple of years here?

Yes. This is probably one of my favorite topics, and I'll tell you why one of my favorite topics. Again, my background, a lot of the energy industry, the energy industry uses lots of data. And the power of data, and it's not only the energy, I think our daily life, the power of data, how you can extract so much value, how you can be more efficient and get better insight [indiscernible]. In divergent, the rationale is really we -- with all the domain expertise that we have, visit an infrastructure, visit an advanced facilities, you name it, energy transition, it generates a lot of data. We also use a lot of data. So Divergent Solutions is really that. It's leveraging the data that we produce and the data that our customers have and then data that is publicly available. At the creation of Divergent Solutions, the largest share of Divergent Solutions is our cyber intelligence. That is mainly federal agencies and so on. So a long history, strong domain expertise, you have some of the best experts in the world. And so that is shown in the margins that we have today. Now there is, let's call it the 1/4 of the business roughly that is more linked to infrastructure. And that one has a few portfolio pieces that are more of a start-up. So they're early stage. And I'll give you an example. So one is water. Water is one of them, and we recently signed a partnership with Palantir. So that is water. And how do you use that? So we have our wastewater treatment facilities. We have our domain experts, our data scientists and the computing power of Palantir. And with that, we have shown that we can reduce power consumption by around 30%. So with that, you reduce power consumption, you reduce carbon emissions and so on. So that is going to more our traditional P&PS customers, and we go with data. This is all data. We also have StreetLight Data, which was an acquisition that we made about a year ago. This is more in the transportation space. So that one is to optimize the size, planning, it could be infrastructure? Is it road? Is it to EV charging infrastructure, to modernize the infrastructure as well, so more in the transportation. So that is the other piece that is less visible because today is roughly 1/4. That's more the early stage. So what you see in the margins of [ Ps ] is more that investment phase, where we pulled different enrollments that we had in parts of P&PS and CMS, People & Places Solutions and our Critical Mission Solutions. It's part of one organization. And the reason we're doing that is, again, getting the operational discipline. Say, okay, we're going to develop this, and we're going to make it scalable as opposed to [ bespoke ] and [ only one can be allowed ].

Excellent. I want to transition to PPS and Matt on some of the government things. Before I do that, just lastly on Divergent Solutions, I know the business -- that the company has been challenging the business to get to 10% margins by year-end. How realistic is that? What's the pathway to achieve that?

What we see now is second half of the year with this part that we described at the end that is tied into infrastructure, we see that as very visible. We're focusing on that. And I would say, besides what you see today within divergent is the margin enhancement piece that divergent has, or a effect that divergent has on P&PS, because it's the partnership between divergent and P&PS when they go to market because those are the same customers. And I think you were saying, Matt has excellent examples of some of the divergent elements, for example, StreetLight Data and IIJA and all of that. So I think you'll have a good opportunity to [indiscernible].

Excellent. Well, with that, Matt, so maybe if we start thinking about IIJA, how is the funding rollout been on IIJA broadly? Is the industry happy with the pace and the speed and ultimately bringing it back to Jacobs, has it met Jacobs' expectations?

That's a great question. Thanks for having me. I would say that I think most folks were generally and certainly internally, there's a certain amount of frustration. You see $550 billion come out, historic numbers across a wide variety of fields. We care about well north of 90% of the money that was in the IIJA. The agencies certainly have a lot of stepping up to do within places like US Department of Transportation and EPA and others. They're adding over 1,000 people each to these competitive grants discretionary departments. It's a lot of work to get that started, and we appreciate that. So I think we wanted it to roll out a little bit quicker. It did get there. Certainly, there were also some branded programs. There had never been a decade of rich program like that, the Protect program for transportation [indiscernible]. Certainly, the NEVI program for electric vehicle is also brand new. And each one of those 3 had a formula program as well as the discretionary program, and they just weren't able to put all of it up in year one. I understand that. I think we wanted to see it. But towards the end of the first fiscal year, the money started flowing. We feel much better about where we are right now. We track this on a micro level. We've got some of the best folks that are really dedicated to doing nothing but following this money and figuring out what to do, how to take full advantage of it for our clients. And to that point, we're seeing the same grants. We had an expectation of when certain grants were going to be coming out this year. The pace of play is ticking up by 1 to 3 months on a lot of these. They are really coming out a lot faster, and we're also going to see those new programs that I referenced. Those will be up at a full speed this year. So we feel really good about it. And I think the money in most of these accounts will be picking up year-over-year. We've had the big increase on the transportation and funding side, and a number of other programs are going to ramp up. And I think that the bill lasts for fiscal year '26, which is great. And that's really where a lot of the money caps out on paper, but there's a longer tail on a lot of this money. So the life of the bill in real for what it means to us and our clients and our ability to do work off this bill will extend far beyond. So we're really excited about the long-term potential there.

Got it. And one of the things that's been very topical is, of course, inflation to the broader economy, but that affects most of the construction projects. So curious, as you see when you're talking with your customers in the state and local municipalities has higher construction costs as a whole. Has that impacted that rollout that you were just talking about? And now that we're seeing a little bit of a leveling off here, it's also coincidentally when you're starting to see the pace of [indiscernible] increase. Could be coincidental, but just curious how you characterize that?

That's a great question. I think it's never helpful to have that level of inflation, but at the same time, this is by far the largest increase that we've ever seen historically across the traditional modes of infrastructure. The last Surface Transportation Reauthorization Bill, so basically the vehicle for funding highways and bridges, that had been level plus inflation for better than in decades. And then you get your jump from FY '21 to '22 of about 21%, 22% nationwide, huge growth. I can appreciate the concern that you're going to have inflation to eat into that. Our internal analysis as well as some things that I read for folks that I trust, you have to have a high sustained 8%, 9% growth for the entirety -- the entire life of the bills to really eat way the whole thing, which I don't think is likely. But even in addition to that, that's just the formula side. You have huge discretionary thoughts that we've been talking about across every mode of transportation that wasn't there before. This is something else that all of our clients across all of these modes can lean on. We're helping them win that money. It's something that wasn't there. And then in addition to all of that, you've got just opening up new money that wasn't there before. Things like hydrogen hubs, we talked about the EV charging system that really you're injecting billions of dollars into that market. So we're going to see a whole bunch of market creation. If you look at -- the other thing I would add very briefly is on the Inflation Reduction Act, which we haven't gotten to yet. But that money is coming. That money is coming very soon. Really important to note that that's front-loaded. It was built in a different way where the federal government can spend enormous chunks in year 1, and that's coming in the next 6 months to 9 months. There's a solar program coming out through EPA, the local governments and communities. It's a $7 billion program. If that was IIJA, that would be spread year-over-year for 5 years. You're going to spend all $7 billion in year 1. So those types of things are going to be [indiscernible] better positioned than we are. We've really skated to where the puck is going to be. We're already there and we're prepared. You look at the things that we've done. I know that StreetLight was mentioned. Those types of investments, we've stepped up on a very robust grants team in advance of IIJA passing. I think we're just -- we're there in a position for the opportunity.

That's great. And another topical point in the government right now is the conversation around the debt ceiling. So just curious if you could talk about how much out of the IIJA funding or whether it's IRA or CHIPS, based on your own calculations or mostly you talk to, how much of that can get caught up if we hit budget control [indiscernible]?

It's early in the morning for me to try to put everyone to sleep for this early talk, but I'll try. The really interesting thing is the structure of how these bills were put together, which is to say normally in a service transportation bill, you'd have an authorized number and then the appropriators separate committee, they are going to come in and they're going to hit those numbers every year. They're going to cut the check for it. What's different is that this was front-loaded. It was paid for in both bills, actually, all 3, for IIJA, Inflation Reduction and CHIPS. The science portion of CHIPS was just authorized, but the semiconductor piece was paid for. Other than that, everything was front-loaded. Money is guaranteed. It's already there, and it's just sitting in the treasury and it basically dumps down into each year. So that money is good to go. Should we see a broader agreement on some sort of a deficit reduction bill? The annual appropriations piece will continue. Congress continues every year to dump money into those infrastructure accounts. Could you see a low single-digit reduction in some of those for the money that would sit on top of each of those bills? You could, and that's certainly a concern. But the wide bulk of the money is there and it's guaranteed and [ flocked in ].

Got it. And just also actually extending to CMS as well. I don't know if you had any comments on that from a deficit ceiling standpoint, if there could be any impacts on that side of the business?

I think -- I mean, we do rely on the federal government. I think any of these conversations are concerned, the starting point for this negotiation is not in a good place, but that's not where it's going to end up. I mean going back to FY '22 levels without touching Defense and Veterans Affairs, would have very large cuts. But this is -- the house representatives is not making this decision themselves. And even within the house, there are very broad ranges of opinion. But the Senate doesn't agree to that. The administration doesn't agree with that. There's going to be a long negotiation that will get resolved hopefully on the sooner end, well in advance of the end of this fiscal year, and we'll see where it ends up. And it will -- it's not unusual to have a federal budget discussion tied to the [ debt ]. It will come to some sort of agreement. I think we'll have some stability at that point.

Got it. And just in our last minute here. Can I just go to the audience response questions here? Claudia, this is your around here. You've got a blank screen. This is my time where I could be a game show host, if the questions come off. All right. Perfect. So there's a clicker on your table here. Do you currently own the stock? I bet you guys can see the answers there. Yes, with a couple of different ways and 4 would be no. Guys, have we started the response? From the back. Perfect. All right. 75% say no. Next question. What is your general bias towards the stock right now? One, positive. 2, negative. 3, neutral. You know when the responses go through, but we're lack of the time right here. At the back, you could just flip up the results there. 65% say neutral. Next question. In your opinion, through cycle EPS growth for Jacobs Solutions will be one, above peers; 2, behind peers, or 3, below peers? All right. Above peers with [ confidences ] and responses. Next question. In your opinion, what should Jacobs Solutions do with excess cash? Bolt-on M&A, larger M&A, share repos, do the debt pay down and internal investments? This is a CFO's favorite question. We could see -- if we could see.

You should know that.

Yes, there you go. Well, share repos seems to win. Next question. In your opinion, on what multiple the '23 earnings should Jacobs Solutions trade and is there a different multiple? I will let the audience read those. All right. 16 to 18, I believe, is the majority answer. Next question, please. I think we're towards the end here. What do you see as the most significant share price headwind facing Jacobs Solutions? Core growth, margin performance, capital deployment and execution. Execution. And next one should be the last. Okay. Does [indiscernible] feel like an active role in your investment decision-making -- decision relating sorry, to the company? All right. No is the most popular answer here. That's an interesting one to end on. So with that, Claudia and Matt, John, thanks so much for being here, and appreciate it.

Thank you.