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

Hi. Good afternoon, everyone. My name is Chad Dillard. I'm the lead analyst here at Bernstein for the machinery, engineering and construction sector. I'm really excited today to have Jacobs Solutions joining us. And with Jacobs, we have Bob Pragada, who is the CEO. And we also have Jonathan Evans, who is the Head of Investor Relations. So we're going to have a fireside chat, but I certainly encourage you and the audience to ask your questions. There should be a link via Pigeonhole where you can submit questions, then I'll be able to ask it on your behalf throughout this conversation process. But without further ado, let me actually bring up Bob so he can give a brief overview of Jacobs, and then we can dive into Q&A. Over to you, Bob.

Great. Thanks, Chad, and thanks, everyone, for joining. Thanks to AllianceBernstein for the opportunity to speak. Yes, really proud to talk a little bit about Jacobs from an overview perspective. I won't go back 76 years and replay the history of the last 76 years. But you see kind of a snapshot here today. The company was founded with deep roots in the engineering world and more specifically, in the engineering sector focusing in on the chemical process industry back in 1947. In fact, the company was founded here in New York, in Brooklyn. Dr. Jacobs was a Merck employee working on the first protein synthesis facility in Brooklyn and then took -- went -- left Merck and started his own company, person of one and then grew it to the levels that you see here today. Over time, we've diversified from an end market perspective and in our services to where today, we are deeply embedded in our clients' business, the science-based, technical consulting, still do quite a bit of engineering work in our client sectors and you see the sectors there, heavy in infrastructure, advanced facilities, energy, environment as well as in national security. In '22, looking at the portfolio that we had, we really looked at where -- what are the major global trends that are affecting the earth. And from a skill set standpoint and where we sat with our clients, where are we? And it kind of -- the strategy came off the page. All of that is climate response today, Jacobs is in the middle of every single one of those mega trends whether it be in the water sector, the transportation sector, environmental as well as all of the technical advances that are happening within the life sciences and semiconductor sector as well as a trusted adviser from the early stages of capital investment all the way through to design and operating and maintaining a lot of these facilities. So our strategy in '22 was to really double down on all that's around climate response. But what we also saw was, we really were developing some unique data platforms. And when I say data platforms, software solutions that, coupled with our services, enhance that solution, think about engineering, think about these large-scale complex facilities. It's really the use of data in order to come up with the solution. So we really put a strong focus on that data component and started to invest in software platforms along the way. So we have really transformed the company to be to where it is today. On an EBITDA basis, well over $1.3 billion; and on a top line basis, $15 billion with, I believe, 12 -- do we say 12 now or...

Marching to on a pro forma basis, 12% EBITDA margin.

Yes, $12 billion on a net revenue basis. Now some of you have probably also heard that 3 weeks ago, we announced the spin or the separation of what we call our Critical Mission Solutions business. This is the business that profiles very closely to the government services world. I think Leidos, SAIC, CACI and others. Aerospace, defense really centered around technical scientific services and IT modernization and felt like it was time now in kind of the next generation of our growth to focus our attention on the higher growth, higher-margin component of our business, knowing that in the government services space it would take a bit of prioritization of our capital allocation in order to continue to grow. And if we were going to prioritize our capital, we were definitely going to prioritize it towards those businesses that are strongly embedded in all this climate response. So you see the slide there. This will be -- this is on an FY '22 basis. But post separation of CMS, our business will be nearly $11 billion on the top line and adjusted operating margin of 12% with a target, with regards to stranded costs and otherwise, moving north of there. But really gives us a real focus from a company standpoint on those items that I mentioned as a part of our '22 strategy. So Chad, maybe I'll stop for you there. I can continue...

That's perfect segue. So yes, actually, I just want to dig a little more into the spinoff that you announced a couple of weeks ago. So what does this mean in terms of how you're thinking about your strategy for the RemainCo. How does it refocus your priorities? And maybe you can talk about just like what does it mean from a strategic standpoint?

Sure. Well, we're -- let me start off by saying that we in the government services space or what we call our CMS business, it's a solid business. However, our peer group and our competitor group in that space, there is a level of capital that's required in order to facilitate growth. What I mean by that is, is that these are large enterprise contracts, 5 to 7 to 10 years, think NASA as well as Department of Energy and the nuclear remediation space as well. And so you bid a few contracts, you win a few contracts, you lose a few contracts, you protest a couple of contracts. And in order to facilitate that growth, you acquire a company. It's a highly fragmented industry and acquisition is a part of the growth vector in that space. So when we kind of step back and we didn't -- we want that business to grow. But again, back to my earlier comment, if we're going to prioritize capital, we were going to prioritize it in the space that's growing at a faster rate as well as an area where we are an industry leader in every end market that we service within the infrastructure world. And so that was kind of the basis. We announced a spin versus running a process on a confidential basis, really so that we could control the narrative. This was all internally based on the assessments and analysis that we did. And then with respect to the great employees that we have as well as our clients, we wanted to control that narrative. And so all of those activities that we would have to do post spin or any other alternatives were going to be the same. And so we wanted to control that narrative with the spin. But at the end of the day, we are absolutely committed to returning the highest amount of shareholder returns as we can. So that's where that was kind of the basis of spin. The new -- the RemainCo heavily focused in, and if you go, Jonathan, to the slide, on these end markets that you see with a real indexing towards the infrastructure world, water, environment, transportation, energy transition and the advanced manufacturing world. And when we say advanced manufacturing, we're predominantly talking about life sciences, semiconductor manufacturing, data centers and the entire EV ecosystem, EV manufacturing, battery manufacturing and then kind of transitioning into transportation, the EV infrastructure that needs to be put in place. So we're really excited about those markets. A lot of legislative actions are happening right now to stimulate these sectors. You hear a lot about it in the U.S. It's happening outside the U.S., too. And so really exciting time for us moving forward.

So can you dig into the time line of the spin? Is there any opportunity to pull it forward? And in terms of like the operating profile of the remaining business, just how to think about like cash conversion, margin potential? How do we think about any dis-synergies from the spend?

Yes. Yes. From a timing standpoint, the time line that we put out, which was kind of the second half of FY '24, and we're on October to September time line. That really was based on the regulatory filings in a classic spin scenario. So if we were to go another route, clearly, that time line would be pulled in. I think what's most important in that time line is that we minimize disruption to our business and continue to deliver on a quarterly basis across the entire enterprise. And that's what our focus is on right now. From a -- I'm sorry, the other part of your question, Chad?

just in terms of like thinking about the operating profile of the remaining business?

Yes. So the operating business, we came out -- for those of you that followed us, back in 2016, we came out with what we called a line of business type of operating model where we had lines of businesses that were tied to our end clients and corporate functions that service the entirety of the enterprise. And that's actually when we had our Energy Chemicals business, our Critical Missions business and our Infrastructure and Advanced Facilities business. Now that we've made some significant investments in our Infrastructure and Advanced Facilities business, in fact, we talk about a separation. Normally, companies are getting smaller, and I put that in air quotes as a catalyst to get bigger. Our peer group now in the infrastructure and advanced facility space, we're still at the top of that peer group and the biggest in that peer group as well. So that's kind of the operating model. But now that line of business structure is one company. And so things that we've previously had and I got to be careful because I don't want to trigger any kind of filings. But that we've segment reported, you'll see more of an approach of the company and how our digital platforms and PA Consulting and the other catalysts that we have to the growth of our business look more as one Jacobs rather than being -- having to compare this segment to this peer group, this segment to that peer group to make it a lot simpler in the messaging.

Got it. Okay. So with the remaining Jacobs, you have a number of, I guess, you can call it, mega trends that are staring you in the face over the next decade or so. Maybe we'll start with infrastructure. I think a lot of folks were expecting a lot of infrastructure dollars to flow already. It seems like there's kind of still on the comm. Maybe you can talk about what you're seeing from your perspective? Why has it taken so long? And then when do you think about when the actual funds will flow?

Sure. Well, we have sovereign nations around the world that have very efficient government platforms that operate at a high level of efficiency and delivery of funds to the market. I'm getting no laughs from the crowd right now. That was a little bit of tongue-in-cheek there. For all good intentions, some of the legislative actions that were taken back in '21 and '22 have been slow to go to the market. Specifically, you've heard a lot about IIJA and those funds are kind of getting stalled up in continuing resolutions that we had in '20 and '21 and '22. . We're now seeing those monies flow. And so we saw it kind of last fall in Q1 and Q2, increase our pipeline, moved into backlog. And if you saw our earnings the last quarter, we reported double digit on a constant currency basis, 25% year-on-year growth in our Infrastructure and Advanced Facilities business. So clearly, we're seeing the benefits of that come through. In Australia and in the U.K., 2 large operating areas for us, we're already seeing those actions come through. And even in the U.K., it's -- even though it's stalled a bit, those programs have not stopped down. So we see it is flowing. I'd say it's in the early stages, for baseball fans that are out there, I'd call it kind of in the second, maybe third inning with some nice tailwinds that are going. It's also important -- and just to bring it back to the U.S., the way that legislation was structured, it was part grant money, which states and municipalities filed for grants and then were approved really going towards underserved areas of the country or some other social equity driver around that. And then an increase in the formulaic distributions that are made to states. The grant money is now flowing, right? The formulaic piece, it took a while for states and transportation agencies to get back to the ability to spend it, we're now starting to see that as well.

Got it. And forgive if I'm wrong, but like the grant money, that's more like the onesie, twosies, $2 million to $5 million. And like the formulaic is probably more like the...

In the grant money, you will see some big, lumpy jobs. For example, the Penn Access job here in New York, the Brent Spence Bridge in Ohio. There's some larger jobs that are there. But yes, they're predominance of some $100 million jobs, $50 million jobs, which we're the consultant on those. So you take a percentage of that, but there's just a lot of them. And then the formulaic piece, we are seeing now in this fiscal year that's starting to flow too. What's been interesting, though, is that a lot of that money is moving towards the transportation world. We're an industry leader in the water space. The pipeline growth, which doesn't have a lot of IIJA facilitation. But as the states were getting transportation money, you saw some reallocations going to really address what is probably the bigger crisis that we're facing right now is in the aging water infrastructure that we have, and it's being exacerbated by climate response. And so our pipeline and for us, it's about a $2 billion business for us. It's probably the fastest-growing segment that we have in the company, and that's just not a U.S. position that's in the U.K. and the Middle East as well as in Southeast Asia, too. So it's really an exciting time in the water market.

Got it. Maybe just like drilling a little bit more into the water market. Can you talk about just like what sets you apart? What makes you different? And how do you bring technology to bear within that space?

I'd say 2 main areas in the water market. One is -- and this is a business, if you remember, in 2017, when we acquired CH2M, it is a world leader in water and water technology. And really, it's the knowledge base of the entire water cycle from conveyance all the way through -- I'm sorry, from resources all the way through conveyance to treatment and then long-term operations and maintenance. So that's science-based knowledge of the water cycle kind of set us apart for several decades. What we've done now is, and if you go back to the data comment that I made earlier, this is -- there's a tremendous amount of data that goes into the design and the operations of this as well as finding new resources for unleashing water. We've now both from a proprietary development of algorithms as well as partnering with some world-class partners like Palantir have now gone into what we call digital water where we're taking digital platforms. We operate about 250 plants in the U.S. alone and utilizing those platforms in order to collect data, index the data, put in the hands of our operators to reduce chemical usage and energy usage and in certain cases, take the off-gas of the solid waste, generate energy and put it back into the grid, right? So we're doing some really unique things. We started with one 15 months ago that grew to 10 sites around the world -- I'm sorry around the country and really big future, in fact, we're speaking with Palantir tomorrow in Palo Alto.

Interesting. Okay. So I actually want to jump over to the Inflation Reduction Act, one of the newer fiscal spending opportunities. Like how big of a multiplier effect do you expect? And maybe you can talk about where you play, what sort of pipeline do you see ahead?

Yes. I think the biggest piece of that is kind of the electrification of cities, electrification of everything. The conversion or transition to renewables is a big piece. But even from a generation standpoint, once that conversion happens, we've got to be able to transmit it. And so the electrification work is really -- it's embedded in the IRA and driving the business. Where Jacobs plays is in the front-end consultancy around that. And PA has very strong skills in that as well, not just here in the U.S., but we're doing a lot of this work in Australia as well as in Europe. Kind of the wraparound that's creating the sense of urgency, specifically in IRA and then the Europeans have a version as well is energy security. And I think the invasion of Ukraine kind of exacerbated that and has been a driver in our business too.

Got it. Okay. I'm just kind of rounding it out with CHIPS Act. Maybe you guys have a pretty strong leading role on the semiconductor side. Can you talk about just like your pipeline with respect to the CHIPS Act and also just where do you get involved in the overall design process?

Sure. So it's interesting. Unlike IIJA where these are -- this is direct funding that came from the federal government to the states, the CHIPS Act, and IRA too to a certain extent, is a lot more incentive and subsidy based. So companies got out ahead of it, started to announce fabs in the U.S. A lot of it was driven by reshoring. And now the CHIPS Act is going to facilitate that kind of the balancing of the ratio of manufacturing from East Asia to back to the Western world. And so that started actually 3 years ago. And Intel was big on the forefront of that. We're actually -- I'll get to kind of what we do, but we're the engineer of record for Intel. So when they're announcing 5 new fabs across the country and in Europe, we were put right in the middle of that from the beginning. So the CHIPS Act hasn't even flown yet or hasn't even really hit the ground, but we're already seeing kind of the front end of companies getting prepared for those incentives that are coming through. What we do, and we've been doing it since probably the late '70s is the technology within chip manufacturing sits within the tool. So these are big OEMs, Applied Materials, ASML, et cetera. And then those tools, though, require process media, chemicals, gas, water. So we design one of these tools and as chips are becoming more and more technically complex, the tools are getting bigger and bigger and more complex, which are requiring a utility matrix in the utility systems that are more and more complex. And so we designed from the process train outward in these facilities, which then drive the -- it's interesting the inverse relationship. The smaller the chip the bigger the tool the bigger the building because of the vibration controls. And these are all in clean manufacturing environments. So it's a space that we have had an industry position -- industry-leading position for several years.

Got it. Okay. So as you think about like the revenue curve, let's say, over the next like 6, 7 years, you've got IIJA, you've got Inflation Reduction Acts, CHIPS Act, layer on some reshoring, like how do you think about the curve of when you see the inflection of all these -- all these opportunities moving all together? And then like when do you think about when you hit the plateau in terms of growth?

Yes. Well, hopefully, we don't hit a plateau because I think all of these mega trends aren't going to be solved within 5, 10, potentially even 20 years. But -- so we see -- we're very optimistic about what that future looks like. Our growth rates in markets that have traditionally grown 2% to 4%, 3% to 5%, but with big denominators from a TAM standpoint, those are growing at -- we've been growing at 1.5x to 2x what the markets have grown at. So saying 4% to 6%, these markets are growing. We're targeting high single-digit revenue growth. Now what's happening with the mix of our services getting more into the consultative services realm that double-digit growth, we're focusing in on margin and OP growth. So that double-digit margin or OP growth is really our focus for the out years.

Got it. Got it. Okay. So within People & Places, I think you guys had kind of like a 6% to 9% revenue CAGR target.

Yes.

I think you guys announced that back in April -- March of '22.

Yes.

Okay. So it's before, a lot of these -- some of these acts came together. So how do we think about that new growth rate now that we have this next decade of a lot more spending ahead?

Yes. So I think that's -- my previous comment applies -- the top line, high single-digit growth is something that we're really committed to continuing on and then really putting our effort in diversifying, continue to go up the value chain from a consultative services perspective and drive double-digit growth with margin expansion. But I think the margin expansion potential here, especially with the spin and cash generation, we're already at 1x free cash flow that's got some real opportunity as well.

Got you. Okay. So with all the growth ahead, maybe we can shift gears to talk about just staffing and the amount of hiring that you need to do ahead of things but I guess, not too far ahead of things to actually maintain your utilization and your margins. So can you talk about like your approach and your strategy on that?

Sure. So maybe I'll start off with just going back 10 years, we used to model growth to headcount and it was a direct correlation. And so we even used to talk about in order to get to x billion in revenue, we needed to be at 100,000 employees. Those have now de-linked. And so what we're doing today, and I'll just take our People & Places business, our Infrastructure and Advanced facilities business, we've got roughly 50,000 people in that business today. Our growth with digital platforms and where we sit in the value chain, I think that we can grow, we're still going to need more headcount but we can grow at a faster rate than headcount with those digital platforms. The second is how we deliver projects and programs and engagements. In the past, specifically in the infrastructure world, we kind of turned this corner in the advanced manufacturing world is where the talent sits. If we were doing a job 10 years ago for MTA in New York, all of the people that were working on that job sat in New York, right, and were employees of our New York operation. Today, that's not the case. We have talent that sits in Europe, in Asia, in Australia and New Zealand that are working on programs and projects and engagements all around their work. So that global delivery model is helping from our ability to scale as well. So we get a talent arbitrage, and we get a scaling opportunity at the same time. And I think coming out of COVID that really showed itself. While we're talking about things in the West like great resignation and trying to get people back to work, we doubled our size in India, in the Philippines as well as in other areas. So the global delivery model is really helping.

Got it. Okay. So a question for you on the Middle East. First of all, how much of your business comes from this region? And can you talk about just like what the pipeline looks like, given there's, I guess, a number of projects that are coming forward?

From a geography standpoint, it's our fastest growing area. It represents today, Jon, 8%?

Under 10%.

it's under 10%, single-digit percent but growing at a very fast rate. And it's just not tied into these giga projects that you kind of see in the headline news. It really is a holistic view to growth. And I'd say it's happening the fastest right now in Saudi. And so across our infrastructure spectrum, water and energy, probably the most, we're seeing some really solid growth. And then we're the program manager on 2 of the largest programs that are there. And so that's also facilitating the growth. You said -- you made your comment earlier, Chad, about not getting out ahead. We have been in the Middle East for a long time. We were when we had our petroleum and chemicals business, is not getting out ahead of where the spend curve is going. So we're being very cautious about that. We've unfortunately, during our history had some starts and stops in the Middle East. So we've been cautious about that as well as helping the country get more Saudization in the staff. We got a lot of expats that are there, too. But what also helps is just like the Emirates did back 10, 15 years ago that now allowing for our work to be done in India, which before in Saudi it was never allowed. It's now completely accepted.

Interesting. Okay. There are a couple of questions from the audience. So maybe I'll get rolling on that. So how does the Palantir partnership bring -- what does the Palantir partnership bring that you couldn't produce in-house? In what areas are there similar fits for more partnerships?

Yes. So what it brings that we can't do in-house is speed and efficiency. This is their business. They're in the business of collecting, assessing, analyzing large, large quantities of data, right? Started off in the intelligence space and now with partnership with us, moving into the infrastructure space. So that ability to scale and scale fast, it gives us that platform. And what we bring to them is that domain and science expertise of water, of transportation, of advanced manufacturing. So we're really excited about that. Machine learning, digital twins, we had that before, but now this AI enablement is really helping and Palantir is really doing a great job there.

Got it. Okay. Next question from the audience. Where will your highest growing geographies be in the next 5 to 10 years?