Business Context and Reporting Period
Jacobs Engineering Group Inc. (now associated with Jacobs Solutions Inc.) filed this unaudited Form 10-Q for the three months ended December 29, 2017, the first quarter of fiscal 2018. The company provides engineering, construction, technical, operations and maintenance, and consulting services through four operating segments: Aerospace & Technology, Buildings & Infrastructure, Industrial, and Petroleum & Chemicals.
The quarter included the December 15, 2017 acquisition of CH2M HILL Companies, Ltd. (CH2M), which materially changed the company’s scale, asset base, debt profile, operating results and reporting structure.
Financial Highlights
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $2.750 billion | $2.552 billion | Up 7.8% |
| Gross profit | $487.2 million | $419.3 million | Up 16.2% |
| Gross margin | 17.7% | 16.4% | Up 130 basis points |
| Operating profit | $47.6 million | $88.6 million | Down 46.2% |
| Operating margin | 1.7% | 3.5% | Down approximately 180 basis points |
| Net earnings attributable to Jacobs | $2.2 million | $60.5 million | Down 96.4% |
| Diluted EPS | $0.02 | $0.50 | Down $0.48 |
| Cash flow from operations | $46.9 million | $110.4 million | Down 57.5% |
Gross profit benefited from higher volumes, CH2M contributions, portfolio mix and project execution. Reported operating and net earnings were substantially reduced by CH2M transaction costs, restructuring charges, higher corporate expenses and discrete tax items.
- CH2M contributed approximately $131 million of revenue and $15.7 million of net earnings during the post-acquisition period; its results included approximately $30 million of pre-tax restructuring and transaction costs.
- CH2M transaction costs were $67.9 million, including personnel, professional services, real estate-related and other expenses.
- Restructuring and other charges were $19.3 million, compared with $31.7 million in the prior-year quarter.
- The effective income tax rate was 93.9%, compared with 28.8% in the prior-year quarter, primarily because of approximately $29 million of net discrete Tax Cuts and Jobs Act items.
Liquidity, Debt and Cash Flow
- Cash and cash equivalents were $1.060 billion at December 29, 2017, up from $774.2 million at September 29, 2017.
- Operating cash flow was $46.9 million. Investing cash flow used $1.389 billion, primarily for the CH2M acquisition, while financing activities provided $1.626 billion.
- Long-term debt was $2.588 billion, compared with $235.0 million at fiscal year-end, consisting primarily of a $1.5 billion term loan and $1.085 billion drawn under the revolving credit facility.
- The revolving credit facility had approximately $512 million of available borrowing capacity after direct borrowings and facility letters of credit. The facility expires in February 2020; the term loan matures in December 2020.
- The company stated that it was in compliance with its debt covenants and believed available cash, borrowing capacity and operating cash flow were adequate for the next twelve months.
- The company paid $18.1 million of dividends during the quarter and declared an additional $0.15-per-share quarterly dividend payable in March 2018. No shares were repurchased during the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue increased $198.7 million, driven primarily by $131 million of CH2M revenue and higher legacy Aerospace & Technology and Buildings & Infrastructure volumes.
- Segment operating profit increased to $176.8 million from $138.7 million. All four segments reported higher segment operating profit, led by Industrial, which increased 51.7%.
- Aerospace & Technology revenue rose 25.0%, Buildings & Infrastructure revenue rose 13.4%, Industrial revenue was substantially flat, and Petroleum & Chemicals revenue declined 3.2%.
- Consolidated operating profit declined because higher segment profit was more than offset by increased corporate expenses, $19.3 million of restructuring charges and $67.6 million of CH2M transaction costs.
- Backlog increased to $26.2 billion from $18.1 billion, including $6.6 billion attributable to CH2M. Backlog is subject to client cancellation, funding, scope and cost changes and is not necessarily indicative of future revenue.
- Goodwill increased to $5.721 billion from $3.010 billion, and intangible assets increased to $921.0 million from $332.9 million, principally because of the CH2M purchase accounting.
Guidance, Outlook, Commentary and Risks
- Management expected CH2M-related restructuring activities to continue through 2019 and targeted annual cost savings of $150 million after completion. The activities were not expected to involve exiting service types or client end-markets.
- Management expected to realign reporting into three global business lines by no later than the second half of fiscal 2018: Aerospace, Technology, Environmental and Nuclear; Buildings, Infrastructure and Advanced Facilities; and Energy, Chemicals and Resources.
- The company was evaluating the potential effects of new revenue-recognition guidance, including possible changes to performance obligations, contract combinations, cumulative catch-up adjustments and the timing of revenue recognition. The filing states that the impact could be significant but was not yet clear.
- The Tax Cuts and Jobs Act accounting was provisional. The company recorded a $24 million deferred-tax remeasurement benefit and a $53 million valuation allowance charge, while its estimate of the transition tax was currently zero but remained subject to refinement, particularly for acquired CH2M foreign earnings.
- Approximately $2.585 billion of borrowings were subject to variable interest rates. Management estimated that a 1% increase in floating rates would have increased quarterly interest expense by approximately $2.4 million.
- A CH2M-related Australian consortium dispute involved the company’s claim of $665.5 million and a counterclaim preliminarily estimated by the opposing party at approximately $1.66 billion. The company denied liability and did not expect a material adverse effect based on information available at filing, but acknowledged the matter could materially affect results if liability were imposed.
- Other contingencies included a Singapore arbitration claim exceeding $167 million and ongoing government contract, tax, litigation, guarantee, insurance and professional-liability exposures. Management stated that these matters were not expected to have a material adverse effect.
- CH2M had previously reported a material weakness relating to project cost estimates for long-term contracts. Jacobs had not fully assessed CH2M’s internal controls as of the filing date and was testing remediation efforts; CH2M represented approximately 42% of consolidated assets at period-end.
Important Facts for Investors to Verify
- Whether CH2M integration delivers the targeted $150 million of annual cost savings and whether restructuring charges continue as expected through 2019.
- The final CH2M purchase price allocation, including goodwill, intangible assets, pension obligations, tax balances and contingent liabilities.
- Deleveraging progress, covenant compliance, variable-rate exposure and remaining revolving-credit availability.
- The final accounting impact of the Tax Cuts and Jobs Act and the new revenue-recognition standard.
- Resolution and potential cash or earnings exposure from the Australian consortium arbitration and other disclosed legal contingencies.
- Progress in remediating CH2M’s project-estimation control weakness and the effect of the integration on financial reporting controls.