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

I'm Brian Gesuale, covering analyst of Jacobs Solutions. Really delighted to have the company here to present their story. If it's not obvious, we're going to do a fireside chat appearance. If there are some questions from the audience, please raise your hand, and we'll try to get to those as we go through. But I have Bob Pragada, Chief Executive Officer, here joining me; and Venk Nathamuni, Chief Financial Officer here, joining me as well to take us through the story. Welcome, guys.

Thank you, that's fine.

Bob, maybe we level set here, take a few minutes to set the audience and give investors a perspective on your core services that you provide, the markets you serve, the geographic footprint that you have and really Jacobs right to win.

Sounds good. So just as an overview, we are in the technical advisory, engineering and program delivery market around 3 main verticals. Those 3 verticals are the life sciences and advanced manufacturing world. I'll come back to that in a second. Second is around water and environmental. And our third is what we call critical infrastructure. Critical infrastructure embodies transportation, energy and power and our cities and places business as well. And that really came from deep core roots in the engineering space dating all the way back to the 1940s. I think where we play the strongest is some of the biggest technology innovation as well as some of the biggest issues that are facing the planet today. We're right in the middle of providing solutions for our clients on how to deal with those in the form of delivering capital programs, capital projects to solve. And in today's world of very fast-growing innovation, that's really driving our business as well. The one other thing I would say on that is that you think about a classic engineer, and I'm sure we're going to get to it today, Brian. And you notice I didn't use the word consulting because consulting apparently has now turned into a 4-letter word. But we have, for generations, started with the technology of what the facility or what the structure is designed to do or what the outcome is based on. And then knowing that worked outward, whether it be a molecule or a chip or a structure and done that really well over the test of time.

Sounds great. Let's dig into some of these themes that you're really at the heart of. Maybe let's start with the advanced facilities. Just about every investor that I talked to is really curious about your data center positioning and how AI is transforming that market. When you talk about what Jacobs' role is in this market, how the buying patterns have changed over time? And maybe talk about some of the key metrics and the long-term opportunity that you see for the company.

Right. So probably to level set on it first is kind of what we used to do and now what we're doing. What we did before kind of in the generation of the 25-megawatt -- sorry, 50-megawatt data center started off with specific needs of data need, data storage needs for a client, then moved to cloud. Now it's going to AI. In that first 2, we were the engineer of the white space in that area. So cooling, rack design as well as how that interface with what would be on-site power and water needs in the gray space. That has since -- and so kind of think a $2 million to $5 million type of engagement for a $100 million plant or $150 million plant. That has since really, really transformed into now the gray space and the white space, emerging power and cooling requirements needed for advanced node chips in the GPU world have gone through the roof. And so our knowledge of not only what's going on at the chip level, but interface with the electrical OEMs, the power needs as well as now the cooling needs has expanded our scope in a material way. We're working with every single one of the hyperscalers as well as now the Neocloud providers as well. And that business is growing. In fact, it's doubling pretty much every year for us. The other is what I call kind of the AI ecosystem. We've been in the design of chip manufacturing facilities for 50-plus years. Our power and water capabilities are as a vertical, very, very strong. So as -- and right now, we're the primary engineer for the high-bandwidth memory chip manufacturing plants that are occurring in the U.S. today. Same thing with power and water, and now it's culminating in a data center. So what we can offer to our client across that entire ecosystem has been pretty powerful.

It's still a relatively small business today, but it's growing rapidly. How do you see that opportunity?

Right now, it's 3% of our business. 3%, 4% of our business.

So 3% of our business that's growing at 100% over the last couple of years. And then just to put some context around the dollar value of our engagement there, as Bob mentioned, this typical simple data center would have been, call it, single-digit millions of dollars. Now we're talking about orders of magnitude, actually 2 orders of magnitude higher in some of these cases. And over the course of the last 3 or 4 quarters, we have announced some really big transactions there with some public companies like Hut 8, but also a lot of the private companies and the Neoclouds that are now investing pretty heavily in this space.

Definitely exciting times there, and we're looking forward to hearing more updates on that business as we go forward. Let's maybe run that question back in a different market, talk about pharma and life sciences -- size that market for the audience, talk about the themes driving growth. Where you're ideally positioned and why you win?

Sure. I'd say from a service revenue standpoint, it's about $1 billion business for us today. We have been in that space. Actually, Dr. Jacobs was a Merck employee when he started the company back in 1947. So we have been on this journey as small molecule manufacturing turned into biologics and large molecule manufacturing. And we've been right along that innovation journey with our clients. And now with the use of -- here it comes again, the use of AI and drug discovery, new molecules are coming to market at a very rapid pace with capacity needs that have now doubled and tripled over time. That, coupled with these facilities now probably more than industrial manufacturing being onshore here in the U.S. And our focus on, we call it the Tier 1 players, the Lillys, the Merck, the Pfizers, the AstraZeneca and like. That business is growing at a nice high single, low double-digit rate. And we see the protective moat around that because we're in the molecule and understand what's happening and what the utility needs and what the structural needs are going to be working very closely with those clients.

And life sciences and advanced manufacturing together constituted about 25% of our revenue and growing at high single-digit growth rate.

Yes, absolutely. Really exciting areas that we're really monitoring closely. Let's look at one in the water space.

Maybe just one more on Brian, on life sciences, a lot of people think, okay, it's around this -- exclusively around this GLP-1 tsunami that's happening. There is a big component that is around GLP-1s. Now GLP-1 is going from an injectable to tableting form. That is a piece of that growth. The other piece is early-stage innovations that are happening in Alzheimer's, what's going on with antibody drug conjugates and the ability to treat different forms of cancers. All of that is driving this growth. So I just want to add that.

Yes. I appreciate the color there. Let's move on to water. This is another area where you're having amazing success. Take us through the growth drivers again, how your bid pipeline and backlog look and talk about your views on water. And maybe if there's any regional color you can sprinkle in, that would be appreciated.

Good news is that the growth that we're seeing, and it's kind of high single-digit top line growth, that's global. And it's pretty uniform, maybe a little less in the U.S., but pretty uniform across our major geographies, which are North America, Europe, Middle East, Asia and Australia and New Zealand. So that's been a positive. Similar to life sciences, it's a business that we've been in for several decades. And what's unique is, again, concentrating on the science, we work with our clients across the entirety of the life cycle. So everything from inception of I have an issue, I need to figure out a way to solve it to designing it, program managing it, and then we operate and maintain those plants as well. Years of underinvestment that's been in that sector, unfortunately, mostly in the U.S., but then the effects of climate. And so we're seeing the effects of climate hit issues of water scarcity, it's like the extremes, either water scarcity or coastal sea rise and too much flooding issues that we're having. So we're working with states and municipalities as well as national governments outside the U.S. to solve for these issues, and it's driving growth in our business.

Okay. These were some of the handpick themes that I wanted to talk about -- maybe tick through the list because you're top 1, 2 or 3 in every market you serve. Maybe hit some of those and remind people where you're strong at. And then I'd like you to pick out 2 areas that you think you're particularly excited about that we didn't discuss in those first couple of themes.

Okay. Well, we're kind of moving past advanced manufacturing -- I'm sorry, life sciences, advanced manufacturing and water and environmental. We're seeing nice growth in the critical infrastructure business, specifically in transportation. For us, in transportation, the denominator, the available market is pretty huge. But areas that we're -- and over the course of the last few quarters, we've seen that business grow at a high single-digit rate and really driven around growth that we've been participating in around sustainable and decarbonized transportation, rail, transit and then in aviation, kind of sustainable airports as well. And that's been a global phenomenon. So that strong business for us. Cities and places in the early part of '25, late '24 was a business that -- when I say cities and places, what this is not just building design, but large venues. So if you think about the World Expo or the World Cup or the Olympics or these types of large venues, we'll do program management and design of these facilities that a lot of cases have a time requirement to them. And now we're seeing that business grow in the Middle East. And so that has been something that's been a nice tailwind. And then Energy and Power, not only as a vertical for clear reasons, grid modernization and energy transition, but now as a horizontal. Every single one of our verticals has got some element of energy and power requirement that's driving that facility. So we're excited about kind of the entirety of the portfolio. I would not be fully transparent if I didn't mention there is one area, it's our environmental business in the U.S. that over the course of the last year has been a bit soft as deregulation and not even deregulation, but lack of clarity on regulation has put a bit of a pause with some of our private sector clients around environmental planning and environmental remediation. We're starting to see the pipeline come back as a lot of clients, interesting enough, a lot of data center clients are saying, look, the regulations are the regulations. Let's go ahead and commit to those because that's for the long term. So we're starting to see that turn a bit but that has been a bit soft this year.

Makes a lot of sense. Make it easy for us in the audience to think about the relative strength of the regional markets you're serving. Give us a 1 to 10 or top to bottom of where you're seeing the most regional strength and maybe where the opportunities are most muted in the near term.

I'd say regional strength, the #1 regional strength in both from a critical infrastructure as well as the kind of the tech manufacturing world is the U.S. The U.S. has been on a 1 to 10, I'd call it, I don't know, [ bank ] at 10, yes, close to 10%. Europe, interestingly enough for us, has been good, really driven on the backs of -- talked about transportation and water, even as manufacturing in Europe has tech manufacturing, life sciences and manufacturing has come down a bit. We've seen the water and the transportation business grow. So probably a 5% or 6% right now. Middle East, another 10. I'm going to have too many 10 on that. I got to do my math here. And really, the Middle East really driven around not just the big cities and places or the big venues, but also the infrastructure to support them. So that's been a net positive. Asia has held its own, probably at 5 or 6 as well. And for us, India is our biggest country in Asia. And what we're seeing in India is for a long time, we had our India platform for the rest of the world. And now we're starting to see, especially in semiconductor, a pivot from Taiwan into other areas. So we're seeing that business starting to grow. And Australia and New Zealand has really hung in there for us, really driven on the backs of water and a bit of transportation, too.

It's amazing all these themes are interconnected and you seem to have a piece of the value chain in each spot. Let's maybe talk about the structure of the business. PA Consulting, it's a business we really like. You've had an ownership in that business for a long time, but you're going to own the entirety of it here shortly. Maybe remind people of the transaction details, summarize some of the things that you think that brings strategically to both revenue and cost synergies and what some of your objectives as you bring that business into your fold and under the tent full time is?

Yes. Maybe I'll start off with the origins to level set and then Venk can talk a little bit about now where we go from here. The origins were in -- so what is PA Consulting? PA Consulting is a technical advisory firm that deals with the science as well as the use of clients' capital in order to drive business transformation. But unlike a more of a playbook or textbook kind of approach and a McKinsey or a BCG or others, they go at it from what is this product innovation? How can you deploy capital in order to get higher growth in those components of your business that are going to result in that type of growth expectations at the very front end before the decision has even been made. That's kind of what their bread and butter has been. They do compete against those other firms in the U.K., 80% of the business is the U.K. But where the difference is that they also are the exclusive technical adviser for the Ministry of Defense in the U.K. as well. Carlyle owned 65% of the business and went to market in 2021 with wanting to liquidate their position. And we saw it the congruency to our business from a full asset life cycle standpoint and made that 65% ownership, 35% stayed with the employees and then figured with separate governance and run independently, Venk and I sat on the Board of PA, we started to merge at the top end pursuits as well as opportunistically going to market together and ran it that way, knowing that at time certain that we would make a decision whether to roll that over or to acquire the balance of the equity. So maybe kind of moving forward, what it means.

Yes. So we announced on January 4 that we are buying the remaining 35% that we didn't already own, and we expect that transaction to close probably in the next 3 to 4 weeks. So our plan is to provide an update in terms of both the revenue guidance as well as margin expansion opportunity at our next earnings call. But suffice it to say that as many of you in the room know, the PA Consulting business is best-in-class in terms of margins. So it will be very accretive to our overall corporate average, and we'll quantify that exact accretion in the coming weeks. But equally importantly, it's the fact that the growth has really turned around quite nicely over the last several quarters now, and we feel quite comfortable about high single-digit growth rate for the PA business in its current form, but also the opportunity for us to exercise a lot more of the revenue synergies that Bob alluded to, not only in terms of what we do here in the U.S., but also in Europe and especially taking into account the opportunity that we have in Continental Europe, where today, there's a much bigger opportunity for us to expand both the top line as well as the bottom line. So overall, it's a great strategic fit. We talked about the concept of running the entirety of the asset life cycle all the way from consulting to design to implementation and so forth. So this really fits very well with that overall strategy, and we're already seeing some tremendous traction across the globe. So I will quantify the numbers, but suffice it to say that it's a really good combination for us.

We're excited to hear about the margins going forward and see we really structured that business to really have some nice utilization and growth coming out of really profitable growth. One of the questions I get a lot, and I think you've done a lot of work on this, is the retention of some of those people. So maybe just give us a little bit of view on your retention strategies there.

Well, maybe one clarifying point. So yes, it is a big topic, a big point of awareness. Of the proceeds, a little under 50% of those proceeds will be going to nonemployees. So a lot of the employees during the Carlyle to Jacobs inflection point or liquidity event rolled over their proceeds into the next round. So that's kind of point one, which is great. Second point I would say is that we do have retention programs in place as a part of the consideration for now what we know to be the real kind of core of PA. Great thing in this transaction is that we've had a 5-year head start. So we know the business really, really well, where normally if you're making an acquisition, you're then post acquisition, learning about where is the real talent within the company. We know all the talent. And so we've been able to be very, very targeted there. And then the third part I'd say is that now unlike in the first 5 years, there was a PA equity component -- and PA drove the Jacobs performance and equity but weren't incented by it. Today, those will now be aligned. And so what -- the kind of the partner motivator of being tied to the performance of a company. It was PA, now it's going to be the entirety of the enterprise.

Yes. Sounds exciting. Maybe, Bob, so much transformation since you took over as CEO from the spin of CMS to consolidating PA here shortly. You gave a 3-year outlook. Can you maybe update us on how you think about the update is the wrong word. Give us the confidence in that 3-year outlook. What's maybe ahead of schedule, behind schedule? How some of these transformative things kind of give you confidence in what your outlook has been?

Yes. I think that outlook came in February of '25, so exactly a year ago. Good news is that on the top line, on the margin expectations and where we see our business going, we're ahead of plan as well as even on the free cash flow margin as well. And so the confidence that we're -- that continues to build as we look forward is our backlog growth. And last quarter, we posted some numbers that. Yes, -- we were a little nervous even saying those numbers because we were afraid that the 2.0 book-to-bill would be something that turned into an expectation, but we did have -- we had a really nice quarter. But on a trailing 12-month basis, that $1.4 billion gives us confidence that we're going to continue to meet and hopefully exceed the next 3 or 4 years.

And Brian, if I can just add to that. So we laid out a plan for the next 5 years a year ago, and we talked about 6% to 8% revenue growth. So over the last 3, 4 quarters, we've grown at 6%, 7% and then most recent quarter, 8.2%. We raised the guidance for the full year to 6.5% to 10% growth rate and then also expanded our margin target. So if anything, we feel really good about the top line growth acceleration as well as the margin expansion story.

I want to talk a little bit, maybe hit on that margin and free cash flow. That's been a really big source of strength, and we think the outlook is really positive there. We think you're fairly early innings still on that. Can you maybe just talk about the key levers for both of those going forward? And how far you think you are in that expansionary process?

Yes. So I think -- so just for context, in fiscal '25, we did about 110 basis points of margin expansion, and we've guided for another 50 to 80 basis points of margin expansion every year. That does not even include the PA consulting contribution, which we'll quantify in the coming weeks. But at a high level, multiple drivers of that margin expansion for us. So number one being operating leverage. So we made a commitment that as we grow the top line at, call it, 8% to 8.5%, that we'll grow the OpEx at a substantially lower pace. So we'll continue to exercise that discipline. And then there are multiple aspects of our gross margin expansion story. So for those who are not familiar with Jacobs, we have a very robust global delivery model where we can implement these really highly complex functions, engineering functions in places like Poland and India and Philippines regardless of where those projects originate. So that gives us tremendous margin arbitrage and ability to expand margins and also more importantly, from a customer standpoint, being able to provide 24/7 customer service. So we're still in the early innings of that journey, and we're seeing some good traction in terms of global delivery acceptance, and that's driving margin expansion in fiscal '26 and beyond. The other thing is we talk about our commercial models, how we go to market in terms of how we serve our clients. So today, the vast majority of our contracts are what we call cost reimbursable models, but we're also increasing the mix of what we call fixed price models as well. So the advantage of the fixed price model is that once you understand the scope and the risk associated with the project, you can implement a lot of efficiencies that you'll pass on to the client, but also keep some of that efficiencies for ourselves. So that's another big driver. And then the last but not least is what we call mix. So as we look at the entirety of the asset life cycle, going all the way from consulting to design to implementation and operations and maintenance, as that mix moves more towards the high end of the service type, if you will, that also is added to the overall margin. So multiple levers of margin expansion, and that's on the gross margin and EBITDA margin side. And then ultimately, the test of true efficiency is free cash flow and free cash flow margin. And on that front, we made some really good progress already, both in terms of working capital performance, but also in terms of how we're generating these free cash flow revenue -- free cash flow numbers and translating that into free cash flow margin. So we're well on our path to get to the 10% plus. And this quarter, we announced an update to the guidance I said we're going to get to 7% to 8.5% this year.

Yes, I've been really impressed with the trajectory of that margin and profit expansion and cash flow. Let's maybe move into kind of net leverage. I feel like this business generates a lot of free cash. You're maybe a little bit underlevered at the moment. You've been returning a lot of capital to shareholders. So I want you to go into all of those elements. But also, as I think about PA and being able to put bolt-ons around that, are there properties that would make sense to combine with that, that would be complementary? Or should we still stick to kind of most of it going back to shareholders?

Yes, Brian, really good point. So just for context, in the quarter that we reported, our balance sheet, obviously, in really fantastic condition. We said 0.8x is a leverage ratio as of last quarter. We did publicly announce that we're going to take on some debt to finance the PA transaction. As a matter of fact, last week, we raised about $1.3 billion in debt, really well received by the market at interest rates that are substantially lower than what we're paying before. So it should lower our interest expense in a meaningful way. And again, we'll quantify that in the next earnings call. But our goal and our stated ambition is to stay within the 1 to 1.5x leverage ratio such that we maintain our investment-grade rating. So as we raise this particular tranche of debt, we will be slightly above that range, but generating a lot of free cash flow such that over the next 3 or 4 quarters, we'll be able to come back within that range. So a solid commitment to maintaining our investment-grade rating. On the buyback front and the dividend front, so a huge believer in continuing to raise our dividend. So over the last 5 years, we have doubled our dividends. And in the most recent quarter, we announced a 12.5% increase in the dividend. In addition to that, we made a commitment last year at our Investor Day to return at least 65% of our free cash flow in the form of dividends and buybacks. Last year, we did well in excess of -- well in excess of 100% free cash flow return. And over the last 5 quarters, we've returned more than $1 billion of cash in the form of buybacks and dividends. And this first quarter, we did about $250 million of buybacks. We're already on track to exceed our 65% free cash flow return. So very strong commitment to continuing to return cash to shareholders in the form of both buybacks and dividends.

Great. Last one, as we're closing up on time here. Bob, no follow-up for me, drop the mic moment, talk to the audience about why they should consider Jacobs in their portfolio.

Exciting business. We're in end markets like we were talking about before we started, Brian, in each of our end markets, the level of innovation that is driving our clients' business is exciting. And what's even more exciting is we're in the middle of that science and that innovation. Unlike maybe what would be thought of as a classic engineer, we don't work from a client's requirements and then work from the outward in to where it's proprietary to the client. We're actually with our client at the molecular level, at the chip level, at the molecule level and working outward. And so I think that whether it be NVIDIA or it be Lilly or it be Micron or it be any one of the public sector clients that we have, that's something that gets really, really exciting about the future.

Great. Mic drop. We're out. Thanks so much, Bob, Ven. I appreciate you and the audience. Thanks for joining us.

Thank you.