Jacobs Engineering Group Inc. (NYSE:J) Q2 2023 Earnings Call Transcript May 9, 2023

Jacobs Engineering Group Inc. beats earnings expectations. Reported EPS is $1.81, expectations were $1.75.

Operator: Good morning ladies and gentlemen and welcome to the Jacobs Solutions Second Quarter 2023 Earnings Call and Webcast. [Operator Instructions] Please be advised that this call is being recorded. [Operator Instructions] And now at this time, I will turn things over to Mr. Jonathan Evans, Vice President of Corporate Development and Investor Relations. Please go ahead, Mr. Evans.

Jonathan Evans: Thank you. Good morning. Our earnings announcement and 10-Q were filed this morning and we have posted a slide presentation on our website which we’ll reference during the call. In addition, this morning, we published a release announcing our intent to create 2 independent companies with the separation of our Critical Mission Solutions business. I would like to refer you to Slide 2 of the presentation material for information about our forward-looking statements and non-GAAP financial measures. Turning to the agenda. Speaking on today’s call will be Jacobs CEO, Bob Pragada; and CFO, Kevin Berryman. We are also joined by our incoming CFO, Claudia Jaramillo. Bob will begin by providing an overview of today’s portfolio announcement, then summarizing highlights from our second quarter results.

Kevin will provide a more in-depth discussion of our financial metrics as well as a review of our balance sheet and cash flow. Finally, Bob will provide details on our updated outlook along with closing remarks. And then we’ll open up the call for questions. With that, I’ll turn it over to Bob.

Robert Pragada: Thank you, Jonathan and thank all of you for joining us today to discuss our second quarter fiscal year 2023 business performance. Jacobs has a story of 75-year history of delivering value for our clients, employees and shareholders. We have consistently strived to improve our company through a purposeful strategy of transforming our portfolio to capture higher value opportunities in our core and adjacent markets. Turning to Slide 4. Today’s announcement marks a key inflection point as we progress on our journey of continuous improvement and value creation. This morning, Jacobs announced our intent to separate our Critical Mission Solutions business through a spin-off. The decision to separate CMS is a result of a comprehensive review and evaluation to identify opportunities that streamline our portfolio and maximize strategic focus and potential growth opportunities for both future companies.

We will sharpen both companies focus on their distinct strategies and operational initiatives that are most relevant to the specific industries in which they operate. Each company will have a tailored capital allocation and structure that is directed towards their respective growth strategies as well as a strength and ability to attract and retain top talent. Moving forward, in addition to our industry-leading position in core sectors, Jacobs will be a higher growth, higher margin, technology-enabled solutions provider continuing to address the world’s most complex critical infrastructure and sustainability challenges. Jacobs’s core skill sets in technical and consulting services, coupled with data science and technology-enabled expertise will continue to differentiate us from our peers and allow us to provide end-to-end solutions to our global clients.

Our streamlined portfolio will include leading positions in critical infrastructure such as water and environment, energy transition, transportation and the advanced manufacturing sectors. Once the separation is complete, we can focus our attention on building additional capabilities and expertise that matter most to our clients in these areas. And importantly, we’ll achieve even greater alignment with our 3 key accelerators, climate response, data solutions and consulting and advisory. The new CMS will be a leading pure play government services company that provides technical consulting, applied science research, training, intelligent asset management and program management services to federal government agencies. CMS generated approximately $4.4 billion in FY ’22 revenue.

Today’s announcement is another step in Jacobs’ long record of taking bold actions to drive value creation and position our company for an even stronger future. And as we grow and thrive, our partners can achieve more as well. I want to emphasize that this announcement does not change how we work with our clients. As we work towards the separation, it will be business as usual. We remain committed to delivering world-class service to our clients, who will be able to rely on our people they know and trust. Turning to Slide 5. The proposed capital structure, governance and other matters relating to the separation will be communicated at a later date. Subject to satisfaction of customary conditions, we are targeting to complete the separation in the second half of fiscal year 2024 through a distribution that is intended to be tax free to Jacobs shareholders for U.S. federal income tax purposes.

Turning to Slide 6. I want to reinforce the importance of our inclusive and forward-thinking culture. Last quarter, we reinforced our commitment to inclusion and diversity by including a gender quality KPI in our sustainability linked bond. Jacobs remains categorically committed to this goal. Turning to Q2 on Slide number 7. I want to thank our more than 60,000 global teammates for delivering a record second quarter as measured by both revenue and operating profit. Notably, our underlying business remains strong and we continue to drive growth organically. We continue to invest behind and grow share in all key areas of focus against our 3 needle-moving growth accelerators, climate response, data solutions and consulting and advisory. Our People & Places line of business delivered strong performance with net revenue up 7% year-on-year, 10% in constant currency and operating profit up 21% year-over-year, 25% in constant currency.

Our pipeline and gross margin in backlog increased further supported by strong legislative drivers materializing in federal, state and local initiatives. CMS remains a stable base of recurring revenue driven primarily this quarter by the NASA Kennedy rebid award. CMS Q2 revenue was 11% higher than the previous quarter and 5% higher year-over-year. In terms of bookings this quarter, CMS also achieved an impressive overall win rate and the outlook for FY ’23 continues to look strong with its pipeline up double digits year-over-year. We continue to invest behind CMS opening our Japan office during Q2, our first organic office opening since 2004. PA Consulting sales and backlog again increased year-over-year, led by sales in the energy and utilities and defense sectors demonstrating momentum and consistency.

I’m pleased to see margins improved in the quarter to over 20%, supported by milestone incentive achievement. PA continues to benefit from increased opportunities in Europe. For example, PA won a mandate for a private Scandinavian renewable energy company that is currently active in renewable electricity generation and storage. PA is working with the client to create a market entry strategy across offshore and onshore wind in several new European markets. Our divergent solutions operating unit had a strong operating profit quarter with operating profit up 46% year-over-year. During the quarter, we extended our collaboration with Palantir across multiple infrastructure applications. Kevin will give more detail in his comments. Looking across the broader market environment, we continue to see tremendous opportunities for growth in climate response and energy and environment.

For example, our approximately $2 billion water business continues to exceed expectations and reinforce our position in the water sector. Water continues to be a pacesetter with pipeline growth up materially year-over-year. During Q2, we were awarded the Donald advanced water purification facility by the LA Bureau Sanitation, 1 of the largest reuse projects in the U.S. delivering a more sustainable drinking water source in a drought stressed region. Fittingly, we would like to call attention to drinking water week, an opportunity to proudly celebrate the work we do with utility partners to provide safe drinking water to millions of people around the world. Our cities and places pipeline also grew double digits, including key wins in the Middle East, where we are working to reimagine urban development addressing major environmental and quality of life challenges and predominantly powered by clean energy.

Globally, we are seeing significant energy transition opportunities. Last month, we efficiently launched a dedicated business unit in PMPS to focus on significant opportunities in global energy transition to accelerate growth and address the ever-expanding needs of our clients. Turning to Slide 8. During Q2, we were awarded the Gold Medal Award for International Corporate Achievement and Sustainable Development by the World Environment Center, a nongovernmental organization advancing sustainable development through corporate business practices. Their annual Gold Medal Award recognizes 1 international company demonstrating a global vision and a commitment to sustainable development through innovative applications of policies, economic, environmental and social responsibilities.

The independent jury commended our thoughtful approach to sustainability, combining commitments with global initiatives and partnerships with positive and far-reaching impact. Turning to Slide 9. In summary, we remain well positioned with our industry-leading ranking across multiple sectors. This is particularly evident in our advanced manufacturing business, where our long-term pipeline increased double digits year-over-year. Further, in our infrastructure business, legislative actions continue to provide visible growth opportunities despite continued political debate on broader topics. For example, recent wins this quarter include 3 significant intelligent O&M programs in California, Florida and Louisiana which we secured through strong differentiation with the use of our digitally enabled platform.

We expect operating profit growth to outpace organic top line increases as we remain focused on quality of backlog. Now, I’ll turn the call over to Kevin to review our financial results in further detail.

Kevin Berryman: Thank you, Bob and good day to everyone. Turning to Slide 10 for a financial overview of our second quarter results. Second quarter gross revenue grew 6% year-over-year and net revenue grew 5%. Net revenue grew 8% year-over-year on a constant currency basis, a continuation of healthy growth against a tough 10% year ago comparison. Adjusted gross margin in the quarter as a percentage of net revenue was 26% sequentially in line with the first quarter but down year-over-year. I will provide additional comments regarding our segments later in my remarks. Adjusted G&A as a percentage of net revenue was 15.6%, approximately flat sequentially but down 90 basis points year-over-year, more than offsetting the lower gross margin percentage versus last year.

While we felt the impacts from inflationary pressure, costs were managed well overall to a disciplined cost management. We are still targeting G&A as a percentage of net revenue to stay below 16% for the full fiscal year 2023. GAAP operating profit was $290 million for the quarter and included $50 million of amortization from acquired intangibles, a $10 million noncash charge related to decrease in our real estate footprint aligned to our future work strategy and other acquisition deal-related costs and restructuring efforts of $8 million. These deal-related costs are largely incentive compensation that was considered part of total consideration and PA noncash contingent equity-based agreements associated with the PA transaction structure. Excluding these items, adjusted operating profit was $356 million, up 7% year-over-year.

On a constant currency basis, adjusted operating profit was up 11% year-over-year. We remain committed to reducing our restructuring-related costs. Consistent with our previous comments, we expect approximately $15 million of restructuring charges for fiscal year 2023. We also expect a total $50 million to $55 million in noncash real estate impairment charges over the course of the year as we continue to further execute our work — future of work strategy. Finally, we expect $25 million of transaction-related expenses for the full year from deal-related integration and other costs, most of which is performance-based incentives that were factored into our total purchase price consideration for these acquisitions. It also includes the noncash contingent-based equity noted earlier associated with our PA transaction structure.

These costs do not include expenses to be incurred in connection with the planned separation of CMS, given the early stage of our process. Our adjusted operating profit to net revenue was 10.4%, up 20 basis points year-over-year. I’ll discuss the underlying dynamics during the review by reporting segment. GAAP EPS from continuing operations was $1.70 per share and included a $0.20 — $0.26 impact related to the amortization charge of acquired intangibles, a $0.06 noncash impairment charge related to reducing our real estate footprint, $0.03 from transaction, restructuring and other related costs and a $0.25 adjustment to align to our projected annual normalized adjusted tax rate as a result of a large FIN 48 reserve release. Excluding these items, first quarter adjusted EPS was $1.81, up 5% year-over-year.

As we look ahead to our full year forecast, Bob will provide an overview of our narrowed guidance range later in his prepared remarks. We also note that our Q3 EPS is expected to be relatively flat sequentially to Q2. I would like to highlight that the fiscal year 2022 third quarter adjusted results benefited from a onetime $0.10 gain on an equity investment. Q2 adjusted EBITDA was $358 million and was up 5% year-over-year, representing 10.4% of net revenue. Finally, backlog was up 4% year-over-year and 5% on a constant currency basis. The revenue book-to-bill ratio was 1.2x with our gross margin in backlog, again, improving year-over-year. Regarding our LOB performance, let’s turn to Slide 11 for Q2. Our results in the quarter continue to demonstrate the strength of our portfolio and end market resiliency, enabling us to deliver strong, consistent OP growth.

People & Places Solutions continues to drive our momentum. Overall, PMPS delivered strong revenue and operating profit results driven by an alignment to the secular growth trends and legislative drivers previously highlighted. Q2 net revenue was up 7% year-over-year and up 10% in constant currency. Growth was consistently strong across almost all business units although Europe continues to see some pressure. Backlog grew 4% year-over-year behind a book-to-bill of 1.1x. Gross margin in backlog was up nearly double digits in constant currency. Q2 operating profit was up 21% and 25% in constant currency, driven by strong growth and G&A control. Operating profit as a percentage of net revenue was 13.5%, up over 150 basis points year-over-year, again, driven by solid revenue growth and continued cost discipline.

We continue to expect year-over-year improvement in People & Places operating profit margin resulting in strong double-digit growth in full year operating profit. Our Advanced Facilities unit which benefits from the investments in the life sciences, semiconductor and electric vehicle supply chains posted another quarter of double-digit revenue growth. We continue to monitor the macro demand trends across sectors that impact our advanced manufacturing clients and we continue to see robust demand from our life sciences clients which comprise approximately 2/3 of this business. In semiconductors, the evolving macro backdrop has led some smaller clients to evaluate project timing but we remain confident in the long duration opportunity ahead for Jacobs.

Our backlog and sales pipeline remains robust across a diverse set of customers. And as a result, we continue to expect our Advanced Facilities growth rate to persist against a very strong year ago comparisons. Our People & Places Americas unit reported record Q2 profit with 30% year-over-year growth as our high-quality backlog begins to convert to revenue at improving incremental margins. We remain enthusiastic about our growth opportunity as backlog and sales pipelines remain robust as we compare to stronger year-ago comparisons. In particular, our water sales pipeline of opportunities continues to shine, up double digits. Our international business, Q2 revenue and operating profit were up single digits year-over-year. Asia Pacific and the Middle East continues to grow, driven by strong pipelines in transportation, cities and places and energy transition.

Moving to Critical Mission Solutions CMS benefits from highly recurring multiyear contracts that require limited overhead support. The business is aligned to space exploration, national security, nuclear remediation priorities and U.S. 5G telecom investments. Q2 revenue was up 5% year-over-year and up 7% in constant currency. CMS book-to-bill was just over 1.4x benefiting from the Kennedy award that we previously disclosed. As a result, backlog is up 8% year-over-year. The sales pipeline also remains strong with $30 billion in new opportunities that we are pursuing. In addition, we are awaiting award on $10 billion in new business opportunities that are in the end gain select process. CMS gross profit margins improved sequentially due to mix.

CMS operating profit and OP margin were both up sequentially from Q1 and consistent with our previous guidance but down slightly versus the very strong year ago quarter. We expect operating margins to improve in the second half of fiscal 2023, with full year CMS margins expected to approach 8% on a full year basis as we convert on an IDIQ pipeline of higher-margin opportunities. Moving to Divergent Solutions. Net revenue declined 3% year-over-year as we focus on quality growth opportunities that will translate into higher margins. We continue to expect net revenue growth to accelerate in the second half of our fiscal year as we start to see growth from our investments in sales, data solutions and technology offerings. Operating profit for the — operating profit margin for the quarter was above our corporate average at 11.1%.

During the quarter, we recognized a large license sale which expanded the margin by more than 300 basis points. Sales of these types of solutions are now a longer-term financial benefit of our Divergent Solutions strategy and a core offering of the reporting unit. Although deals of this size should not be expected to recur every quarter. Even excluding the benefits of the license sale, the underlying margin momentum seen in Q2 continued to improve sequentially for our previous guidance. As a result, we expect Divergent quarterly margins to approach 10% as we near the end of the fiscal year the scale begins to further mitigate the impact of the continued investments for growth. Turning to PA Consulting. Revenue from PA was up 1% year-over-year in U.S. dollars but up over 11% in local currency.

PA once again reported a book-to-bill over 1x. We continue to expect revenue growth in British pounds to remain near or above 10% during the second half of fiscal 2023. Turning to profitability. Q2 operating profit margin for PA was 21.8%, up 370 basis points sequentially due to fixed price milestone achievements and lower incentive costs. As PA continues to take actions to improve utilization, we expect OP margins to be around 20% in the back half, relatively close to their year-to-date OP margin performance. Our unallocated corporate costs were $60 million in Q2, an increase over our previous run rate estimate, driven by inflationary pressure in health care and digital investments. For the full year, we now expect our quarterly run rate for the balance of the year and unallocated corporate costs to be in line with our Q2 level, driven by inflationary pressure in health care costs and incentive costs.

Turning to Slide 12 to discuss our cash flow and balance sheet. We posted another strong quarter of cash flow generation which is indicative of the quality of earnings power and cash conversion capabilities. Free cash flow was $97 million, resulting in approximately 100% conversion of net income into free cash flow for the first half of fiscal year 2023. As a result, we are well positioned to deliver our anticipated 100% reported and adjusted cash flow conversion targets for the full year. Regarding the deployment of our free cash flow, we will remain agile and opportunistic in repurchasing shares. We ended the quarter with cash of $1.2 billion and a gross debt of $3.5 billion resulting in just over $2.2 billion of net debt. Our Q2 net debt to 2023 expected adjusted EBITDA of approximately 1.4x is a clear indication of the continued strength of our balance sheet.

We remain committed to maintaining an investment-grade credit profile. As of the end of Q2, approximately 60% of our debt is tied to floating rate debt and our weighted average interest rate was 4.8%. In February, Jacobs completed the refinancing of existing debt and Jacob’s inaugural issuance of a $500 million sustainability-linked bond. The bond was priced at a competitive fixed rate and includes a KPI aligned with Jacobs commitment to increase gender diversity and leadership positions and to substantially reduce our greenhouse gas emissions. For your benefit, in the appendix of this presentation, we have included additional detail related to our debt maturities, interest rate derivatives and quarterly interest expense. Finally, given our strong balance sheet and free cash flow, we remain committed to our quarterly dividend which increased 13% year-over-year and which will be paid on June 23.

With that, I’ll now turn the call back over to Bob.

Robert Pragada: Thank you, Kevin. Turning to Slide 13. Due to our continued momentum across our business, we feel confident in our ability to reach our previously stated objectives and narrow our outlook for FY ’23 adjusted EBITDA to a range of $1.42 billion to $1.47 billion and adjusted EPS to $7.25 to $7.45. Finally, with today’s announcement, we are reinforcing our continuous commitment to take proactive actions to create greater shareholder value as well as strategic and value-creating benefits for both future companies and their respective stakeholders. Operator, we will now open the call for questions.

Q&A Session

Operator: [Operator Instructions] We’ll take our first question this morning from Jamie Cook of Credit Suisse.

Operator: We go next now to Andy Kaplowitz at Citi.

Operator: We go next now to Michael Dudas at Vertical Research Partners.

Operator: We’ll go next now to Sean Eastman of KeyBanc Capital Markets.

Operator: We’ll go next now to Bert Subin at Stifel.

Operator: We’ll go next now to Steven Fisher of UBS.

Operator: We’ll go next now to Chad Dillard of Alliance Bernstein.

Operator: Next now to Michael Feniger of Bank of America.

Operator: We go next now to Gautam Khanna at Cowen.

Operator: And we’ll take our final question this morning from Andy Wittmann of Baird.

Operator: And Mr. Pragada, I’d like to turn things back to you, sir, for any closing comments this morning.

Robert Pragada: Yes, thank you. It’s exciting times ahead. We’re really looking forward to what the future brings. Thank you, everyone, for joining the call and we’ll be very close to the market continue — as things continue to develop and progress. Thank you, everyone.

Operator: Thank you. And ladies and gentlemen, that will conclude the Jacob Solutions second quarter 2023 earnings call and webcast. We’d like to thank you all so much for joining us and wish you all a great rest of your day. Goodbye.