Jacobs Solutions Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2023

There are 13 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Jacobs Solutions Second Quarter 2023 Earnings Call and Webcast. At this time, all participants are in a listen only mode, and please be advised that this call is being recorded. After the speakers' prepared remarks, there will be a question and answer 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.

Operator

Evans.

Speaker 1

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.

Speaker 1

Turning to the agenda. Speaking on today's call will be Jacob's CEO, Bob Regatta and CFO, Kevin Berryman. We are also joined by our incoming CFO, Claudia Peramil. Bob will begin by providing an overview of today's portfolio announcements, then summarizing highlights from our 2nd 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.

Speaker 1

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.

Speaker 2

Thank you, Jonathan, and thank all of you for joining us today to discuss our Q2 fiscal year 2023 business performance. Jacobs has a storied 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.

Speaker 2

This morning, Jacobs announced our intent to separate our Critical Mission Solutions business through a spin off. The decision to separate CMS is the 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 in which they operate. Each company will have a tailored capital allocation and structure that is directed toward their respective growth strategies as well as a strengthened 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.

Speaker 2

Jacobs' 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 to federal government agencies.

Speaker 2

CMS generated approximately $4,400,000,000 in FY 2022 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.

Speaker 2

We remain committed to delivering world class service to our clients we'll 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 twenty twenty four through a distribution that is intended to be tax free to Jacobs shareholders for U. S.

Speaker 2

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 equality KPI in our sustainability linked bond. Jacobs remains categorically committed to this goal. Turning to Q2 and slide number 7.

Speaker 2

I want to thank our more than 60,000 global teammates for delivering a record 2nd 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 and 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 and backlog increased, further supported by strong legislative drivers materializing in federal, state and local initiatives.

Speaker 2

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 'twenty three 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.

Speaker 2

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 and several new European markets. Our Divergent Solutions operating unit had a strong operating profit quarter with operating profit up 46% year over year.

Speaker 2

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 $2,000,000,000 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.

Speaker 2

During Q2, we were awarded the Donald Tillman Advanced water purification facility by the LA Bureau of Sanitation, one of the largest potable reuse projects in the U. S, delivering a more sustainable drinking water source in a drought stressed region. Sittingly, 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.

Speaker 2

Last month, we officially 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 non governmental 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.

Speaker 2

Turning to Slide 9. In summary, we remained 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 and M programs in California, Florida and Louisiana, which we secured through strong differentiation with the use of our digitally enabled platform.

Speaker 2

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.

Speaker 3

Thank you, Bob, and good day to everyone. Turning to Slide 10 for a financial overview of our 2nd quarter results. 2nd 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 Q1, but down year over year.

Speaker 3

I will provide additional comments regarding our segments later in my remarks. Adjusted G and 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 disciplined cost management. We are still targeting G and A as a percentage of net revenue to stay below 16% for the full fiscal year 2023. GAAP operating profit was $290,000,000 for the quarter and included $50,000,000 of amortization from acquired intangibles, A $10,000,000 non cash charge related to decrease in our real estate footprint aligned to our future of work strategy and other acquisition deal related costs and restructuring efforts of $8,000,000 These deal related costs are largely incentive compensation that was considered part of total consideration and PA non cash contingent equity based agreements associated with the PA transaction structure.

Speaker 3

Excluding these items, adjusted operating profit $356,000,000 up 7% year over year. On a constant currency basis, adjusted operating profit was up 11 percent year over year. We remain committed to reducing our restructuring related costs. Consistent with our previous comments, we expect approximately $15,000,000 of restructuring charges for fiscal year 2023. We also expect a total $50,000,000 to $55,000,000 in non cash real estate impairment charges over the course of the year as we continue to further execute our work future of work strategy.

Speaker 3

Finally, We expect $25,000,000 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 non cash 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 and net revenue was 10.4%, up 20 basis points year over year. I'll discuss the underlying dynamics during the review by reporting segment.

Speaker 3

GAAP EPS from continuing operations was $1.70 per share and included a $0.26 impact related to the amortization charge of acquired intangibles, a $0.06 non cash impairment charge related to reducing our real estate footprint, dollars 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, 1st 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 Q3 adjusted results benefited from a one time $0.10 gain on an equity investment.

Speaker 3

Q2 adjusted EBITDA was $358,000,000 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 1.2 times with our gross margin and backlog again improving year over year. Regarding our LOV 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.

Speaker 3

People in 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 1.1 times. Gross margin and backlog was up nearly double digits in constant currency.

Speaker 3

Q2 operating profit was up 21% and 25% in constant currency, driven by strong growth and G and A control. Operating profit as a percentage of net revenue 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 and Places operating profit margin, resulting in strong double digit growth and 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 thirds of this business.

Speaker 3

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 very strong year ago comparisons. Our People and Places Americas unit reported record Q2 profit with 30% year over year growth as high quality backlog begins to convert to revenue at improving incremental margins. We remain enthusiastic about our growth opportunities as backlog and sales pipelines remain robust as we compare to stronger year ago comparisons.

Speaker 3

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.

Speaker 3

S. 5 gs Telecom Investments. Q2 revenue was up 5% year over year and up 7% in constant currency. CMS book to bill was just over 1 point 4 times benefiting from the Kennedy Award that we previously disclosed. As a result, backlog is up 8% year over year.

Speaker 3

The sales pipeline also remains strong with $30,000,000,000 in new opportunities that we are pursuing. In addition, We are awaiting award on $10,000,000,000 in new business opportunities that are in the endgame select process. CMS gross profit margins improved sequentially due to mix. CMS operating profit and OP margin were both up sequentially from Q1 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 twenty twenty three 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.

Speaker 3

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 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 Diversion Solutions strategy and a core offering of the reporting unit, although deals of this side should not be expected to recur at every quarter.

Speaker 3

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 as 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.

Speaker 3

Dollars, but up over 11% in local currency. PA once again reported a book to bill over 1 times. We continue to expect revenue growth in British pounds to remain near or above 10% through the second half of fiscal twenty twenty three. 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.

Speaker 3

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 $60,000,000 in Q2, an increase over our previous run rate estimate, driven by inflationary pressure in healthcare 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 healthcare costs and incentive costs. Turning to Slide 12 to discuss our cash flow and Sure. Balance sheet.

Speaker 3

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 $97,000,000 resulting in approximately 100% conversion of net income into free cash flow for the first half of fiscal year twenty twenty three. 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 $1,200,000,000 and a gross debt of $3,500,000,000 resulting in just over $2,200,000,000 of net debt.

Speaker 3

Our Q2 net debt to 2023 expected adjusted EBITDA of approximately 1.4 times 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 Jacobs' inaugural issuance of a $500,000,000 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.

Speaker 3

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 which will be paid on June 23. With that, I'll now turn the call back over to Bob.

Speaker 2

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 FY2023 adjusted EBITDA to a range of $1,420,000,000 to $1,470,000,000 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.

Operator

Thank you, Mr. We'll take our first question this morning from Jamie Cook of Credit Suisse.

Speaker 4

Hi, good morning and congratulations on a nice quarter. I guess my first question, just sort of related to the spin. Can you just sort of help us Talk through your decision to spin versus sell the asset and or any sort of Dis synergies associated with spinning the CMS business? And then I have a follow-up question after that.

Speaker 2

Okay. So maybe I'll start off and then Kevin I'll turn it over to you. With regards to the second part first, Jamie, we do not see dis synergies with the spin. On the spin specifically, we were looking for the most optimal tax free benefit for our shareholders, as well as our confidence in the business that it has the credibility and the horsepower to operate successfully as an independent entity. So Those are kind of the drivers we're looking to obviously maximize shareholder value.

Speaker 2

Kevin, do you want to add?

Speaker 3

Yes. Look, I think we've evaluated all our alternatives. And at the end of the day, given the facts and circumstances that Bob has highlighted, we're excited about the announcement of the spin. But as circumstances change or anything comes to light, we would certainly have to consider that because we are interested in maximizing shareholder value.

Speaker 4

And then I guess just my other just sort of now that we're sort of splitting the businesses, is there any way you could sort of frame how you think about Longer term or medium term organic growth or margin targets associated with the different businesses as they sit today? Thank you.

Speaker 2

Yes, maybe I'll answer the first part and then you talk about margin targets, Kevin. So as far as our growth expectations for the business, They're very strong and in line with what we articulated in our 2022 strategy for the segment reporting. So we feel that pipeline as well as the opportunities in front of us with the platform that we have Looking very, very bright for the RemainCo post spin. Kevin, do you want to add anything?

Speaker 3

Yes. Look, As we talked in the prepared remarks, as we look at the 2 businesses and we talk about 2022 kind of Pro form a, we had done something. We had a 12% margin for the People in Places business operating profit margin and about 8% for CMS. We think that our spend will ultimately allow the 2 incremental individual companies to focus on their respective opportunities and in a manner that allows for, if anything, an acceleration in growth. I do would like to say that In the event that the spin is able to be executed, we are we do realize that there will be some incremental CMS Public company costs that would have to be incurred, but we will think we'll be able to offset and then some with our opportunities to streamline our 2 organizations.

Speaker 4

Okay. That's very helpful. Thank you.

Operator

Thank you. We go next now to Andy Kaplowitz at Citi. Good morning, everyone.

Speaker 2

Hi, Andy.

Speaker 5

Congrats on the announcement. So backlog continues to rise in P&PS. Obviously, there are some So do you see backlog growth continuing there sequentially over time? And can you sustain that 10% year over year constant currency growth that you have in the segment?

Speaker 2

Let me answer the backlog growth. Right now, the way our pipeline is lining up, Andy, the answer is yes. We do see consistent opportunity to increase our backlog and grow the business. As far as the 10% constant currency growth on the top line, I think that's going to be dependent on the phasing of the jobs, how these jobs come out, especially on the infrastructure side as well as in our private sector business. Those early phases of the job tend to be more study and higher end consulting work.

Speaker 2

And then as we move through subsequent phases, kind of where The larger revenue the revenue opportunities are. So I wouldn't want to go and say that that's going to be A consistent quarterly topic, but definitely a target if you were to aggregate over a period of time.

Speaker 5

Maybe a similar question with CMS. You've got you did get a backlog uplift from Kennedy and I think You mentioned that the pipeline is up double digits, but how are you thinking about backlog in CMS moving forward? What is the risk that that ceiling debate could Slow down bookings a bit for a

Speaker 3

couple of

Speaker 2

quarters. Actually, we see the backlog potential in CMS being strong. The pipeline of work that we have and not just the rebid, but the new work that's coming down the pike, They provide some real opportunity for us to continue that backlog growth. So we feel confident about that.

Speaker 3

Great. Thanks, Bob.

Operator

Thank you. We go next now to Michael Dudas at Vertical Research Partners.

Speaker 2

Good morning, gentlemen, Claudia.

Speaker 4

Good morning.

Speaker 2

Good morning.

Speaker 6

So with regard to the spin and Is there any of the businesses in CMS, I guess you highlighted 5 gs maybe staying with the business, the automotive side, anything from CMS that may stay with Jacobs and maybe vice versa, given some of the demands for Security and issues that have been leveraged from CMS to your customer base on the PPMS side.

Speaker 2

Yes. Michael, just to clarify one point, we didn't actually 5 gs and automotive are a part of the segment and that's actually what we were reporting today. So I just wanted to clarify that point. I would say as far as what stays, what goes, We're early in that process. And so to be direct and to provide clarity, it is the CMS segment today.

Speaker 6

Got it. But there's could you're still debating whether things could adjust between now and when you set things up, correct? Is that what I understand?

Speaker 2

No, we're not. We're not. Okay. And so I just want to provide clarity on that.

Speaker 6

Got it. Terrific. Second question is, It seems like again the last couple of quarters your new projects into new contracts in the backlog have come in at better margin rates than prior. I assume you anticipate that going forward in both in all the segments and how do you see the execution Getting that margin from the backlog to the bottom line, is that something that we can see more acceleration as we maybe track into fiscal year 2024?

Speaker 2

Yes. So on the margins themselves, I mean, I think it's clearly, it's been a part of our strategy for not just 2022, but 2019 as well. We are in we continue to going up the value chain for our clients. And as we do that and we're getting more into the higher end consultancy work, We're seeing the incremental effect on our booked margin. As far as how that's dropping into the bottom line, I think 2 parts, Michael, that you're highlighting.

Speaker 2

One is That kind of excellence in project delivery, which has been a part of our DNA for decades, that continues to be high on our list on delivering not only to our clients' expectation, but within our financial expectation as we're booking these shops. As far as the last part of your question on the timing About dropping to the bottom line, we're seeing a nice pace in the marketplace and this kind of goes to all segments of our business. After a period of time, I think in the beginning of Q1 and maybe in the back half of last year, That was having an effect on our top line and some of our actuals to forecast. That has reconciled back and hence the performance this quarter. And so all indications that we're getting from our clients is that's going to continue.

Speaker 6

Excellent. Thanks, Matt.

Operator

We'll go next now to Sean Eastman of KeyBanc Capital Markets.

Speaker 7

Hi, everyone. Thanks for taking my questions. First one is kind of high level. Just rewinding to the Strategy Day from last year, We kind of got a vibe from that update that you guys were kind of embarking on a deeper integration of the business units with the Divergent Solutions segment kind of being a bridge. And today, we're kind of talking about a more exciting outlook as Separate entities.

Speaker 7

So I'm just curious what changed there. I hope that's a fair question.

Speaker 2

Yes. Sean, we're constantly looking at our portfolio and doing an evaluation on how we're executing externally with our clients and the effect that that is having on advancing our strategy. So is it To reflect back on what we where we were before, I don't think we're doing anything that's different from what we articulated in our strategy. And so we feel confident in the decision that we made today.

Speaker 7

Okay, understood. And then Relative to the Divergent Solutions dynamic between investing in growth and kind of releasing margins, Any update post the review you guys did on how you're balancing those two things?

Speaker 3

Well, look, I think that we are continuing to invest in what we think is A great opportunity to enable Divergent, actually people in places and PA to benefit from some of the overall investments being made in Digital data capabilities for the total Jacobs. And so those investments continue because we believe there is strong rationale for a very large return relative to that. So we're not making any choices relative to those investments. We continue to make them and we're confident in the ability that We continue to make them and we're confident in the ability that the scale is growing as it did in the quarter and how we've communicated a sequential growth in terms of the top line, which will translate into a growth leverage factor that translates into margin improvement. As we highlighted in our prepared remarks, nothing's changed.

Speaker 3

We feel good about that. We see visibility forward to be able to do that. So investments continue and our growth is going to allow for us to get to the margin profile that we've communicated.

Speaker 7

Understood. Appreciate it. I'll turn it over.

Operator

Thank you. We'll go next now to Bert Subin at Stifel.

Speaker 1

Hey, good morning. So your updated earnings guidance range seems to contemplate maybe a slight payback, Maybe a slightly more tempered growth path in the second half of this fiscal year. Can you just walk us through what you see as the potential positive drivers that

Speaker 2

Kevin, why don't you start off from a market standpoint? I'll talk to them.

Speaker 3

Yes. Look, clearly, As we look going forward, I think there's a couple of things to highlight. Certainly, Got inflationary pressure on the medical costs. Now ultimately, we're going to be able to pass that along to our clients. But in the short term, certainly, we're seeing Some pressure in that.

Speaker 3

We saw it in Q1. Q1 is, as you know, the last year of our medical plan. So we wanted to get a Better read on our Q2, which now is in the next planned year. We continue to see that occurring in Q2. So we're Projecting that that's going to continue through the full year.

Speaker 3

So assuming that that didn't happen that obviously would be a positive, but right now That's what our expectations are. Our interest rates obviously are higher year over year And we think we're at, hopefully, the top end of kind of what the interest rate scenarios are going to look like and that, if anything, we're going to be able to trend down. If that happens, we're not counting on it, but certainly that would allow for us to be able to have some incremental performance in our EPS figures as well. I think the underlying business is actually quite strong.

Speaker 2

Absolutely.

Speaker 3

And so absent some of these dynamics, I think putting it into context, we don't really see a situation where our business is slowing.

Speaker 2

Well said.

Speaker 1

Okay, great. And maybe just a follow-up to the CMS spin announcement, now that you're doing that portfolio rationalization, how should we think about capital allocation maybe over the next 4 quarters, does the transaction not taking place for another year lead to maybe a more of a conservative view toward M and A and buybacks or Do you go full steam ahead here now that you have the plan underway?

Speaker 2

Go ahead, Kevin. Yes, go ahead.

Speaker 3

So look, I think that clearly We have in front of us a lot of execution that is really imperative for us to do well against, whether that be on our business or it be the actual execution of the spin of CMS. So that is clearly Job number 1. Number 2 is because of that, certainly, I think there is a relatively high bar right now from a financial People growth margin perspective as it relates to actually deploying additional capital in the M and A. Never say never, but we think the bar is pretty high at this particular moment. So having said all of that, there certainly is opportunities to invest back in our shares as appropriate.

Speaker 3

And I think that you might want to Think about that potentially happening over the course of the next several months.

Speaker 2

Yes. Just want to add is we really like what we got.

Operator

We'll go next now to Steven Fisher of UBS.

Speaker 8

Thanks. Good morning. How should we think about the second half '24 timing for the spin, I think that's within the normal range for these types of transactions, but still seems like it's a bit long dated. Is there any potential to Accelerate that if it stays a spin? And what are the factors there?

Speaker 8

Just curious if the debt ceiling discussions and continuing resolutions and federal budget. Is that all a factor or is it more just the internal process?

Speaker 3

No, look, it is certainly a process both internal but also external. So as you may be aware, The process of putting in place a structure and an organization that facilitates an ability on day 1 to execute and manage a publicly traded Company is not inconsequential. And so we're not going to rush that process. And I think a 12 to 18 month is actually a fairly aggressive stance in some respects. So I don't think we're going to be able, if in fact it continues to be oriented around the spend to do much better than that.

Speaker 3

But of course, we'll do whatever we can to accelerate for sure.

Speaker 8

Okay. Thanks. And then P and PS is going to really be the biggest contributor to profits post spin. So there's going to be a lot of focus on that and particularly the margins. So just looking at the sequential margins this Quarter were down in P and PS, but up 150 basis points year over year.

Speaker 8

It sounds like you think we should focus on the year over year there, But I'm curious about how we should think about mix within P&PS and how might that affect margins on a quarter to quarter basis?

Speaker 2

Yes, Steve, a couple of things. One is that we were pretty clear last quarter that on the quarter to quarter or at least Q1 that had some And then for all of us to be aware that we put margin targets out at our strategy day and just To do kind of a midterm report on that, we're actually a year ahead of where we said we were going to be on our margin profile. So that's a Look at it over the period of time, we're up. So I hope that clarifies that. Okay.

Speaker 2

Thanks a lot, Bob.

Speaker 3

So one thing, just to crystallize and make sure that you caught it correctly, Our margins in CMS Q1?

Operator

No, PMPS, yes. Oh, PMPS, I'm sorry.

Speaker 2

Yes,

Operator

yes. I'm sorry.

Speaker 2

And as far as that continuing, Steve, I missed one part of your question. As far as that continuing, we evaluate based on our clients And trends that we're seeing in the marketplace and as we said in the script, those have been very, very strong in the PMPS world. So we continue to have confidence in our business.

Operator

Great. Thank you. Thank you. We go next now to Chad Dillard of AllianceBernstein.

Speaker 9

Hi, good morning guys. Just wanted to dig into the spin a little bit more with the I guess like the remaining Jacobs business. Can you talk about like what the cash conversion profile looks like and how you'll think about capital allocation once the spend is done and if there's Any potential gaps that need to be filled on the capability side once it's complete?

Speaker 3

So we're early in our process, Chad. We do know that People in Places and CMS both have good cash flow characteristics. Actually, People in Places has a lower DSO level than the current CMS organization. So we're working through all of We'll provide incremental details relative to when we get to that space to really give greater clarity, but I think you're going to see both businesses being robust in terms of their cash flow capabilities longer term.

Speaker 2

Yes. And Chad, on the second part that you asked about the capabilities, We feel strongly that we've got a really solid platform today. In areas where we continue to innovate is around Our digital platforms and our digital enablement and the partnership that we have with Palantir and with others, that is a That's a those are strong platforms in order to grow without making huge investments. So we're really comfortable where we sit today.

Speaker 9

That's helpful. And then second question on PA with respect to the margins. I know you guys talked about operating margins getting to like the 20% range in the second half. But maybe kind of thinking a little bit longer term, I just would like to understand what's the path to bringing you back to, I guess, what your target range would be? Yes,

Speaker 3

I would say that we're thinking longer term that there's no cap ultimately at the 20% level. So we'll work to continue to drive with the management team an ability to get back to margins that are north of 2020 longer term.

Speaker 10

Thanks.

Operator

We're next now to Michael Feniger of Bank of America.

Speaker 11

Hey, guys. Thanks for taking my question. I'm just curious there's obviously headlines. I know someone brought up the government shutdown, but there's also headlines with the House Bill Potentially trying to repeal the IRA clean energy tax incentives, many think that's not likely. But I'm just curious On the ground through the channel on fieldwork, are any of these headlines starting to slow project activity?

Speaker 11

As these headlines pick up, Does it maybe push something out to the right in the near term that we should be aware of?

Speaker 2

So Michael, the short answer is no. IIJA, that's why we made specific commentary about that in the script, has really started to incrementalize in our business and we can see it not only in our pipeline, but in our bookings. And it's realizing itself and that was the That's why we specifically called out PMPS Americas on the 30% year over year growth. So we're not seeing that at all. And just one other just Clarifying point on IIJA, it's a law, right?

Speaker 2

So as far as it being repealed, There would have to be significant there would have to be a new law. And so we feel confident about that. On some of these other items, those were actually in the early stages. And we had not even we had not seen the effects of those in our pipeline or in our work. So the fact that there's a debate about those now, it's not really having that material effect on the business.

Speaker 11

Good to know. And just lastly, there was a comment about Europe. It seems that there's some mixed signals, some positives and negatives. What are you kind of seeing in Europe when we think of like the PA and the PPS business?

Speaker 2

Yes, interesting. I kind of separated Between PA and PMPS, our PA business in the UK specifically is actually growing And it's been really, really strong. And that's kind of a testament to no different than Jacobs historically. Real strong capabilities in those areas of global priorities and national priorities and it's around the defense sector that PA has a Strong relationship with MOD, as well as in Energy and Utilities, which in fact is turning into a security issue in broader Europe. So that's really driving the PA business.

Speaker 2

What's driving the PA and the PMPS business is the energy Security issue in the broader continental Europe as well as in Scandinavia. And I'll give you just one statistic. A year ago, 2 years ago of our U. K. Platform, which you know is really, really strong, about 90% of our folks that were based in the U.

Speaker 2

K. Worked in U. K. Business. Today, that's about sixty-forty is where we have our talent from the UK working on programs and projects and engagements all throughout Europe, as well as globally.

Speaker 2

And that goes into Kevin and I have been really vocal about that over the course of the last 3 or 4 years about tying that global talent. So it doesn't totally dampen the effect of some of the economic headwinds in Europe, but our diversity is helping in that front.

Speaker 3

Thank you.

Operator

Thank you. We go next now to Gautam Khanna at Cowen.

Speaker 10

Yes. Thank you. Good morning and congrats, Kevin and Claudia.

Speaker 3

Thank you. Thank you.

Speaker 10

Yes. Hey, I just wanted to Go back to, I think it was the first question in the Q and A on any sort of dis synergies. And I don't mean Quantitative necessarily, but are there any linkages that CMS and PA or CMS and P and PS We're able to just be more competitive on bids because you could bid the broader qualifications of the entire enterprise that might be lost. And I was also thinking just when PA was acquired, I felt one of the thrusts was to bring them outside of the UK, which you just talked about, but into the U. S.

Speaker 10

And into some of the government customers. And does that potential opportunity maybe look Less optimistic if CMS is not under the same roof. Thanks.

Speaker 2

Yes. So Galpin, it's Bob. What are the things that We looked at this really, really hard. And as far as the dis synergies go, we feel Pretty confident that that's not going to be of any materiality at all. Now that said, Similar to what we've done in the past, our relationship post spin with CMS is going to continue to be very strong.

Speaker 2

And so our ability to work together, collaborate and partner for the benefit of our client is going to continue to be there. So That's always going to be there. In fact, we've demonstrated that in our history with a previous divestiture that we did, and that relationship continues to this date to be very, very strong. On the PA outside of the UK, really that entrance into the U. S, which we're in real time and having success on was around the private sector in the U.

Speaker 2

S, not the government sector and more specifically around energy and utilities and Health and Life Sciences. And those opportunities have continued to bound. In fact, today in the U. S, we have Probably 50 active pursuits with a lot of cases bids in play with PA And we're feeling really confident about that.

Speaker 10

Thank you. And if I might follow-up, Just on the decision to spin versus an outright sale, can you talk a little bit about what the tax basis of CMS would be? Because presumably, When you announced something like this that potential suitors would also be interested, I would imagine. So what is the tax basis of the enterprise CMS?

Speaker 3

So we've evaluated all the opportunities and depending upon if you were to do some type of other Structure will ultimately determine what the tax base basis is. But clearly, if we did some type of other transaction, there would be some tax implications that would occur. So the fact that we've centered around executing against the spend is a tax efficient way of addressing the opportunity to create 2 separate very strong companies. And so look, I think that's how we're executing. That's our plan at this particular point in time.

Speaker 3

It takes a little bit of time given some of the discussions that we've had in the past. But that's one of the reasons that we consider the spin to be a highly attractive option. But as we go through the process and determine If we get any additional facts or circumstances that could change that, we'll consider that because we are Ultimately interested in ensuring that we maximize shareholder value.

Speaker 10

Thanks, guys.

Operator

Thank you. And we'll take our final question this morning from Andy Wittmann of Baird.

Speaker 12

Great. Thanks. So I was going to ask here on some of the capitalization, I guess, of NewCo and Some of the cash cost to spin off. So could you, Kevin, comment on what you think a realistic range for cash cost to effectuate the spin would be as well as your thoughts on where the debt would set. I would guess that you'd keep them ratable or similar leverage based on the relative EBITDAs.

Speaker 12

But I guess from a practical standpoint, I guess NewCo probably gets spun out what with no debt and then would Borrow and then pay like a cash dividend back to RemainCo to achieve the capitalization. So kind of a lot in here, but I guess there's another aspect to it, which is as you're arranging new debt in today's debt markets, what's the net impact And interest expense from having to recapitalize a new company.

Speaker 3

So look, I'll make my first comment in response to Your detailed questions is, we remain committed to the Jacobs remain co that it's going to be investment grade rating. So I think That gives you a ground post that you can certainly evaluate what the potential options may or may not look like. The second thing I would say is we're a little bit too early in the process. We have kept this to a very small group of executives and team members up until this point in time. And now we are, as we publicly announced, we're going to go through a very detailed, Thoughtful, disciplined process that will answer all of these questions.

Speaker 3

I do think that the way we would characterize the leverage Factors that are going to be appropriate relative to the businesses in which they are. So, I think I'll just leave it there. I think you can interpret what that may or may not mean, but we think ultimately that there is an ability to have a Standalone organization that will that is now CMS, which is going to be have an ability to be quite successful longer term and people in places and PA and divergent as well as the remain co Jacobs.

Speaker 12

Got it. And then I guess just for My follow-up, I think I heard on your revenue outlook for Divergent that you're expecting good acceleration. Maybe I missed it, but did you have a comment on the second half revenue performance that you're expecting for CMS? I think previously, This business also was expected to see an acceleration. I just wanted to make sure I heard your latest on that one.

Speaker 3

Well, look, we didn't really comment about CMS, although I think what I would focus on in CMS is really more about the margin, sequential improvement, which we think is really important as we get the business back to that level of 8% for the full year, which is what we characterized. And so perhaps I'll leave it there because we didn't really talk about CNS

Speaker 10

numbers. Okay. Thanks.

Operator

Still growing. Very much growing. Thank you. And Mr. Percotta, I'd like to turn things back to you, sir, for any closing comments this morning.

Speaker 2

Yes. Thank you. It's exciting 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 as continue as things continue to develop and progress.

Speaker 2

Thank you, everyone.

Operator

Thank you. And ladies and gentlemen, that will conclude the Jacobs Solutions' Q2 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.

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Earnings Conference Call
Jacobs Solutions Q2 2023
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