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

Hey, good morning, everyone. I'm Brian Gesuale, Senior Analyst at Raymond James. Delighted to have Jacobs here to present their story. Joining me as the company's Chief Executive Officer, Bob Pragada; as well as Jonathan Evans, who's the Vice President of Investor Relations and Corporate Development. Timing is great to hear this story today. We're going to do a fireside chat format. Bob is going to talk about the announced spin that is upcoming here in the second half of the year as well as take you through the pieces of the business and the growth drivers of the company. Bob, Jonathan, thanks for joining us.

Thanks for having us, Brian.

Let's just jump right into this. It's really been a busy 14 months for you since you took the reins as CEO. Last May, you announced the intention to spin or sell the CMS unit, then in November, you agreed to terms with Amentum. Catch everyone up here on the transaction terms, the ownership and governance structure and really the rationale for separating the businesses.

Sure. Brian, is it okay if I don't take them necessarily in that order.

Feel free I'll give you the creative.

Well, first of all, thanks, I didn't expect to be packed out. So great to see everybody. Yes, so last May, we actually announced the separation and spin as an independent company or what we call our Critical Mission Solutions business. It's effectively our government services business in the aerospace and defense world. Think technical scientific services for large government agencies, multiple DoD as well as the Department of Energy and space agencies, predominantly NASA as well as foreign space agencies as well. It's about a $4.5 billion to $5 billion business, represents about 1/3 of the company, a great company, a great business. But it was -- as we were growing in our Infrastructure and Advanced Facilities business, it's pretty clear that from a prioritization and capital allocation perspective, we were starting to see some, for lack of a better word, conflict in how we were allocating capital as well as management attention and the type of corporate structure that we needed to have to manage 2 disparate businesses. So we announced the separation and spin with the intent of being an independent company and that was in May. What we sort of anticipated but then really came through over the course of the summer, we ended up getting outside interest, outside interest in the form of strategics as well as private equity and also an offer to potentially merge the business. So we evaluated each of those over the course of the summer. And saw a real -- a great opportunity to merge in a tax-free format with Amentum, which was a company that was previously a carve-out of AECOM and then acquired a few entities growing in the government services space and also transforming its portfolio into the higher end intelligence and national security elements of government services. And so after evaluation of all of those options, saw it was best for our clients, our employees and our shareholders to go into a merger arrangement. The negotiation also entailed -- I've talked a little bit about the commercials and then maybe governance. It was pretty attractive. Amentum did have in a private equity kind of format. They're larger than twice the size of our CMS business, had a bit of leverage. This was a great opportunity for them to deleverage as they continue to transform the portfolio. And from a CMS perspective, the opportunity was a pure-play government services service only. So this is a company that's not going to have products and so being technology-agnostic in the missions that we serve in that space was a great opportunity. And now to be one of the largest in the government services sector was point #1. So great opportunity for our clients as well as great opportunity for our employees. From a shareholder perspective, we negotiated a roughly $1 billion dividend as a result of the RMT and also an 8% to 12% retained stake. I'll come back to that in a second, that we, Jacobs would -- that would be not our shareholders, but with the company, Jacobs, would need to liquidate that retained stake within 12 months for IRS and tax purposes. Over the course of our IRS filings, that has -- and there's an 8-K on this, I think, the week before last. We ended up modifying that a bit, Brian, where that retained stake is going to be capped for ourselves, for the company at 8%. And then based on the incentives that we have in place, we can go up to 12%. That additional 4% will go to our shareholders. So at the end, our shareholders will have potentially 55% ownership in the new company. And then we'll have 8 with that having a 12-month time on it. The other element of the negotiation was the governance. We really wanted to see this as a merger of equals. So we were able to negotiate a 50-50 Board structure as well as of the 3 management positions, the Executive Chair, CEO and COO. Our current Executive Chair, Steve Demetriou, will be going to the new company as the Executive Chair of the new company. The CEO of Amentum will be the CEO and then President of our CMS business, Steve Arnette will be the COO responsible for all of the business units as well as growth in sales for the new entity. So a real balanced approach to governance.

That's great. Maybe just a quick follow-up. Why was Amentum the ideal partner for you as you sought out and went through the details of this transaction?

Yes. I think when we evaluated, #1, from a financial standpoint, it clearly represented the best for our shareholders. There were sale options, and we have been public about that. But if you consider the tax implications of those sale options, it would not have been most beneficial for our shareholders. And then from a client and from an employee perspective, it did represent -- I mean, I think there's a lot of views on what Amentum is and what it's not. And we actually had those views. In fact, Jonathan was the one that did reverse due diligence. And as competitors and competimates, you form your own views, we started to do the reverse due diligence and saw, wow, this is a company that's got some great, great growth prospects. I don't know, Jonathan, do you want to mention.

Yes. I would add to that. I think it expands the scope of capabilities and the breadth of capabilities, really widening the aperture of what we can bring to the customer. At the same time, it's a business that has very little overlap with CMS and our cyber and telcos business. As we looked at both companies' pipelines of opportunities, tens of billions of dollars of potential contract awards, there was less than 5% overlap in those pipelines. So really a nice synergistic merger, where a lot of mergers basically gone wrong because of dis-synergies and dis-economies of scale, we think that there won't be that sort of day 1 dis-synergy here.

Great. Let's move on now to Jacobs RemainCo, really and focus much of the rest on that. Talk about maybe the scope of that business in terms of revenue, what the profit margins look like, but also maybe help investors understand the mix of sales by line of business, geography, talk about how much of your portfolio is into decarbonization or other environmental elements and maybe government kind of commercial split as you think about what you have left?

Sure. So Brian, you might have to remind me of all the subcomponents of that question, but let me give it a shot. So the independent Jacobs now will be roughly about $11 billion business, but over 50,000 employees around the world, 40 different countries, and I'll come back to that in a second. But acutely focused on the largest global disruptors that are happening today. And when I talk about that, predominantly all that is the result of climate and climate response as well as what's happening in the world of the supply chain kind of realignment and more specifically around life sciences and semiconductor manufacturing. So the business just at a high level is focused in on the infrastructure end markets, in transportation and the multimodal component of that, the advances within infrastructure, the water sector growing at a rate that we haven't seen historically and then the environmental sector. So all of that encompasses our infrastructure component of the business. And then advanced facilities, which is if Dr. Jacobs started his career 75 -- or 80 years ago as an employee of Merck and so the life sciences and the semiconductor clean manufacturing world, we've been a part of that for decades and been an industry leader there. So businesses that are experiencing some generational growth, what does Jacobs do in that space, deep, deep engineering domain knowledge of our clients' business and taken that engineering expertise and really gone up the value chain with regards to higher-end consultancy, science-based consultancy for our clients. So that's everything from state and local transportation agencies, national as well as local water agencies in the environmental sector at the federal level as well as environmental kind of ubiquitous talent that we have that spreads across everything that we do. And then in the advanced facilities world, these are private sector clients, specifically in the life sciences world, the Tier 1 clients. Merck, Lilly, Pfizer. And in the biotech world, Novo Nordisk and I guess Lilly also is considered a biotech company now too and the likes of Roche and Genentech -- Roche, Genentech and Amgen. In the semiconductor space, it's all the big logic as well as memory players. Intel and Samsung and TSMC as well as in the memory space, MyPrime. And so as either capacity is needed to be expanded or new therapies are coming to market and need to be at commercial scale. Jacobs will go in, in those sectors and do the early conceptual design of the facility and then work that all the way through the commissioning and validation in the life sciences part or the commissioning and first wafer out in the semiconductor space. In the split of infrastructure versus advanced facilities is probably 60-40, 60% -- 60%, 65%, 70% in the infrastructure space and 30%, 35% in the advanced facility space.

Fantastic. And maybe just a geographic mix, do you kind of think about it?

That's actually an exciting piece. So right now, either the U.S., outside the U.S. split by revenue is about 65%-35%. And that 65% for U.S. is either U.S. clients doing work on U.S. soil or U.S. clients doing work outside the U.S. That's how we kind of track that revenue and then 35% outside the U.S. The bigger geographies outside the U.S., U.K., Middle East, India, Southeast Asia and Australia, New Zealand. Interesting dynamic that's forming and after the separation of our government services business, this will get further accentuated. Of that split, 65%-35%, our headcount actually goes the other way. So about 55% of our people are outside the U.S., 45% in the U.S. And now with really optimizing global talent, we're able to take global talent from wherever it sits and bring teams together to deploy solutions locally. And so every single one of our teams looks like -- it really looks like the United Nations, which is great.

That sounds fantastic. You're #1 or #2 in just about every major market you serve from water to design firms, semis, data center, solar, transportation, you kind of run the gamut there. But I want to double-click on the mix of business by those vertical markets. I think you have a $2 billion or a little bit bigger water business. When we think of your portfolio across some of these big water, transport and some of these other markets, how do you kind of segment those?

Yes. Maybe I'll go by net revenue because in the advanced facility space, we do have some pass-throughs as well. So about $2 billion of our global business is in water, $3.5 billion, $4 billion in transportation, Jonathan?

Over $3 billion in transportation.

Over $3 billion in transportation. And then our cities and places business, which is kind of our institutional facilities, giga cities that are showing up all over, but kind of think buildings as well as the support infrastructure around buildings, that's the other $2 billion as well.

Great. It also seems that many of these businesses benefit from regulatory tailwinds, whether IIJ.

Yes, I left out the biggest piece and another $2 billion in advanced facilities, that math doesn't work.

I was thinking things weren't quite that -- let's go back to where I was starting to go with regulatory tailwinds. It seems your business would be prone to benefit from many of those, whether this is IIJA, Chips Act, PFAS legislation and more. Would you maybe frame some of the bigger regulatory tailwinds from 1 being modest to 5 being gusty and explain what time frames they have, will or could benefit your portfolio?

Yes. So maybe I'll go through the 3 big ones. And then maybe there's a fourth. It's not necessarily a legislative act, but it's probably more of a regulatory shift. So the 3 big ones are IIJA and to a certain extent, IRA, I'm kind of comping that into the same category. The EU Chips bill or Chips Act and then the U.S. Chips Act. So probably the most gusty is IIJA. A lot of narratives that you probably heard about IIJA, we would characterize it this way. The profile of the bill and the profile of where the bill is going to be spent is still very much intact. The timing by which either the grant money or the uptick on the formulaic money, that has probably taken longer than we expected. From a statistical standpoint, it's a 5-year bill that was approved in the fall of '21 and where we are today, 3 years into it, we're about 50-ish percent appropriated, 25% spend. So you can kind of see that, that's got a tail on it. And there's a whole slew of reasons. Continue resolutions that happened in '21 to '22, '21 then continued resolute back to a '21 government year that has CARES Act money and all kinds of other things in it. So fundamentally, it really didn't get started getting out to the states until '23 and now. And we're seeing those in some of the larger programs. And at the end of the quarter, Brian, you'll see some big announcements that are coming out from us that we're really excited about. The second around the state of the U.S, U.S. Chips Act. Again, a lot of narrative and keep in mind, some of this was direct funded, other was subsidy-based. So you build the plant and it's operating and then you receive the tax subsidies that are affiliated with it. Companies, whether it be Korean companies or Taiwanese companies as well as the American companies started those facilities and we've been involved with all of them. That's probably 50%, not even 50%. As far as targeted, it's probably 50%. As far as spend, it's not even 1%. There's a lot more to go there. And then what doesn't get hit the news that much is the EU Chips Act. And so facilities around the Germany area, Italy and a few other areas are also coming about. So those would be the 3. The rating on the second one, the Chips Act, I'd probably say 2 to 3 only just because of timing. And then on EU, same kind of 3. So 5 IIJA, 3 on the others, we're bullish. The one that is not a legislative act is what's happening right now with regards to the FDA and the EU around regulation on drug approvals. And that has -- we've seen that started to kind of open up a little bit. It started during the pandemic and we had to get interim approvals for vaccines, but that's also affecting the industry in a positive way and accelerating some jobs.

Let's maybe pivot now away from government and think about PA Consulting. That's one of the only businesses really that's been impacted by the macro over the last couple of years. Can you talk about some of the actions you've taken with that unit? What you're seeing from a demand perspective and discuss maybe the time line for that business to reach back to its optimal model?

Sure. So maybe just for those in the audience that don't know about PA. So PA Consulting is a high-end science-based consulting organization that takes kind of a different approach to business transformation for their clients as compared to maybe a McKinsey or a Bain. First, it's science-based, the end markets that PA sits in are the same end markets as Jacobs. So all those are end markets that we just talked about. PA is in those markets as well and they use digital consulting from a science-based standpoint and product innovation to drive transformation for a client as compared to maybe a McKinsey or Bain model where you come in with a playbook on different elements of the business, they use that as a catalyst going in. About $1 billion business, 20-plus percent operating profit margins, we're a 65% owner. So just to level set on PA. It is 80% based in the U.K. and had a growing position in the U.S. as well as Scandinavia, those are probably the 3 main geographies and has been hit, say, kind of early '23 by the U.K. macro that has come about. So kind of flattish on the top line this year after -- we made the investment in March '21. And in the first 18 -- first 2 years, they grew 20% plus compounded for the first 2 years, came down to 10%, and it's now kind of flattish as the U.K. kind of goes through some reinvention of government almost there and we're coming back. Margins have stayed robust. And what's exciting right now with what we're seeing with PA, so we're taking actions. We took actions to continue with utilization, some investments that we had made with regards to maybe hiring forward on some consultants. We've pulled those back, leaned out the corporate structure a bit. So that utilization is still relatively high, positioned well for growth and the pipeline continues to be strong and sales performance has been good. So we're monitoring the cost and playing it forward. The great news about PA right now is part of the investment model was the collaboration with Jacobs and being able to go kind of from the beginning of inception of how is deployment of capital going to transform our clients' business, PA would get involved. And then as that started to actualize in some form of deployment of that capital on a project or an engagement or an initiative, Jacobs would get involved. That collaboration early days was tough when PA was red hot. You're also going to see some big wins coming out this quarter on the PA collaboration. So we're bullish.

Sounds great. Let's talk about -- I want to talk a little bit about margins. It's -- you don't have to go too far back to see Jacobs as a kind of mid- to high-single-digit kind of margin story. You've transformed the business nicely into low teens, high 12%, call it. You've got plans now for post-spin to take those margins even higher. Can you talk about how you get the next 300 basis points, some of the low-hanging fruit, some of the other stuff that you'll shake the tree on?

Yes. So Brian, maybe just to calibrate kind of the last 8 years, we're probably a 5% to 6% EBITDA business in 15%. And with the moves that we made investment in infrastructure, divestiture of our oil and gas business, got that up to mid-10s, so 10.5%, 10.6%. Post-spin, we'll move into the -- as a starting point, 13.8% EBITDA margins with a road map that takes us into -- probably not allowed to say the number, but kind of more Accenture like EBITDA margins moving forward. We've got a line of sight to that. And really, that comes from the profile of our 50% of our stand-alone business is going to be in -- higher in consultancy and 50% in mission-critical engineering work for the clients that I mentioned before. And so there's a mix element. There's also what we're getting some really nice traction around is the digital enablement. So we're able to take some higher-end software platforms. I haven't said the 2 letters yet, and I'll get to that in a second. Some higher-end software platforms and take things like what technology can do around mobility analytics, and use of that in transportation networks and what goes on with water treatment plants and the data that comes off of what's needed to optimize water as well as digital replication in the tech manufacturing world with regards to how these systems and layouts come together and enhance margins. So when you think about 13.8 plus, part of that continues to be cost optimization, leaner corporate structure, then we've got the -- what's happening with digital enablement. We also are doing a lot around AI right now, too. And that's with AI with our own large language model because if you think about what we've been doing for 75-plus years. We have been in the middle of designing and program managing some of the most complex facilities in the world. So all of that data we have, and it is at the codes and standards of the world and so we're creating that model. We're being very careful about how we do that because we don't want -- help me again, Jonathan, what's its called, when the model goes outside the model.

Hallucinations.

Hallucinations. We don't want hallucinations and bridge is going -- being designed off of stuff that's not real. So that was generative design is kind of the next phase of where we go with that.

You've been very clear in one of the early adopters using, I think, Palantir's Foundry in your water business. And you've talked about implementing that further throughout the organization. Is that something you're able to use internally or bring to your other infrastructure markets? How do you think about that?

We have. Yes. It started with water. And it really started with the operations and maintenance of large-scale water treatment plants. And so we've been able to partnership with Palantir. It's interesting because these algorithms were developed for just the ubiquitous world of intelligence data gathering and then indexing and analyzing it at that level. We took those same kind of algorithms and applied them to the water operations and maintenance world and have been able to reduce chemical usage and energy usage of these water treatment plants and extend the life, which has been great. We operate 250 plants in the U.S. We've been able to deploy that and I think we're in the mid-teens right now. So a big upside there. We've been able to take that same type of platform and go into the transportation world. So -- and we also have a software platform StreetLight Data that in combination with StreetLight Data is doing some wonders. Because think about it, $1.1 trillion being spent in the IIJA, the needs for just the U.S., not the world, is about 3x that amount, right? So the use of technology in order to extend the capital dollar is key. Some of the best jobs we've ever done are jobs that we didn't design because they didn't get designed, right? We figured out other ways of solving for the outcome rather than having to put in new rail lines and new highways and other things.

Great. Last question from me before we go through this, about your capital structure of RemainCo and what your capital deployment priorities are as you presumably you're going to continue to shift and transform this business over time.

Yes. So we already operate with 100% conversion of our adjusted free cash flow today. It will be -- and the adjustments are not great when you consider the things that we're doing to over 100% moving forward. So our cash flows are really, really strong. We -- so -- and we have a low leverage rate today. The dividend that comes in as a result of the transaction for tax purposes needs to go to pay down debt. So we will be beyond, that's a technical term, beyond investment grade. And then the actual retained stake in the disposition of the retained stake has to go towards that, too. So we're going to be in a position where we will be in a material way, net cash. And so return to shareholders is our #1 priority in the form of buybacks as well as continued increase on our dividend. And without the government services component, the pay ratio on our dividend already goes up. So it's a really strong story on returning to our shareholders. This was investment in ourselves. My comment around the digital enablement that's happening in the business is real. And so we're doing make buy kind of analysis on these platforms when do we buy, when do we develop ourselves. The one last thing I would say is that when we think about our equity and share buybacks, we look at the PA equity as ours, too. So that's a great opportunity to continue to deploy back towards investment in it.

Great. Maybe just last one, no follow-up for me. 30 seconds, maybe explain to investors quickly what's unique and why they should consider Jacobs for an investment straight from the boss.

Absolutely. I've been in this industry for 30-plus years. I have not seen the generational tailwinds in the sectors that we serve the way I've seen them today and they're not going away. So whether it be 2-degree climate conduct hold or everything that's going on with the water infrastructure world and what the world needs as a result of climate, Jacobs is right in the middle of it. And every time you hear about capacity when it comes to chips or GLP-1 drugs or the next solution to Alzheimer's, you think about Jacobs. We're doing some things internally to clean that up and it's showing right now. So it's exciting times.

Great. Bob, Jonathan, thank you so much for joining us. Thanks, everybody.

Thank you.