Jacobs Engineering Group Inc. (now Jacobs Solutions Inc.) — Q1 FY2019 Form 10-Q
Reporting period: Three months ended December 28, 2018, compared with the three months ended December 29, 2017. The filing was dated February 6, 2019. Results are unaudited. The company reported 140.4 million common shares outstanding at December 28, 2018 and 139.5 million at January 29, 2019.
Business context and reporting period
Jacobs provides engineering, construction, technical, operations and maintenance, and consulting services globally. Continuing operations were reported through two operating segments: Aerospace, Technology and Nuclear (ATN), and Buildings, Infrastructure and Advanced Facilities (BIAF). The Energy, Chemicals and Resources (ECR) business was classified as held for sale and reported as discontinued operations.
The December 2018 quarter included a full quarter of CH2M results, whereas the prior-year comparable quarter included only 15 days of CH2M results following the December 15, 2017 acquisition. Jacobs also adopted ASC 606 using the modified retrospective method at the beginning of fiscal 2019.
Key financial metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $3.084 billion | $1.784 billion | +72.9% |
| Gross profit | $568.5 million | $342.1 million | +66.2% |
| Gross margin | 18.4% | 19.2% | Down 80 bps |
| Operating profit | $113.1 million | $(4.7) million | Improved $117.8 million |
| Continuing-operations earnings attributable to Jacobs | $64.9 million | $(34.2) million | Improved $99.1 million |
| Discontinued-operations earnings attributable to Jacobs | $59.4 million | $36.4 million | +63.2% |
| Total earnings attributable to Jacobs | $124.3 million | $2.2 million | Improved $122.1 million |
| Diluted EPS | $0.86 | $0.02 | Improved $0.84 |
| Continuing-operations diluted EPS | $0.45 | $(0.27) | Improved $0.72 |
Direct contract costs were $2.515 billion, and selling, general and administrative expense was $455.4 million. Interest expense increased to $25.3 million from $7.1 million, primarily because of debt used to finance the CH2M acquisition. The effective tax rate on continuing operations was 24.7%, compared with negative 405.8% in the prior-year quarter, which was affected by significant Tax Cuts and Jobs Act items.
Segments, backlog and remaining performance obligations
- ATN: Revenue was $1.035 billion, up 45.6%; segment operating profit was $72.2 million, up 18.2%.
- BIAF: Revenue was $2.049 billion, up 90.9%; segment operating profit was $159.5 million, up 138.5%.
- Backlog: Continuing-operations backlog was $20.335 billion at December 28, 2018, up from $18.911 billion at December 29, 2017.
- Remaining performance obligations: Approximately $12.4 billion, with 57% expected to be recognized within twelve months and 43% thereafter. Cancellations, scope changes, foreign-exchange movements and deferrals could affect timing and amount.
Cash flow, liquidity and debt
| Metric | December 28, 2018 | September 28, 2018 |
|---|---|---|
| Cash and cash equivalents | $886.7 million | $772.2 million |
| Long-term debt, net | $2.669 billion | $2.144 billion |
| Receivables and contract assets | $2.682 billion | $2.514 billion |
| Total equity | $5.841 billion | $5.944 billion |
- Operating cash flow was $(224.7) million, compared with $46.9 million in the prior-year quarter, primarily because of working-capital increases, including receivables.
- Investing cash flow was $(22.6) million, versus $(1.389) billion in the prior-year period, which included the CH2M acquisition.
- Financing cash flow was $345.7 million, including $527.3 million of net debt proceeds, offset by $141.8 million of share repurchases and $28.6 million of dividends.
- Available borrowing capacity under the revolving credit facility was $923.9 million. The company had $472.1 million of letters of credit outstanding and $1.3 billion of surety bonds.
- Jacobs stated that it was in compliance with its debt covenants and believed available liquidity was sufficient for operations, debt service, dividends, share repurchases and its acquisition strategy for the next twelve months.
Material changes and unusual items
- ECR divestiture: Jacobs agreed to sell ECR to WorleyParsons for approximately $3.3 billion, consisting of $2.6 billion in cash and 58.2 million WorleyParsons ordinary shares, subject to adjustments. Closing was expected in the first half of calendar 2019 and remained subject to regulatory and other conditions, including CFIUS approval and required restructuring steps.
- ECR generated $1.165 billion of revenue and $60.2 million of net earnings in the quarter. Its assets and liabilities were classified as held for sale.
- CH2M integration: Continuing-operations restructuring and other charges were $47.2 million, including approximately $34.2 million related to CH2M restructuring and integration. These activities were expected to continue through fiscal 2019, with targeted annual cost savings of $175 million upon completion.
- ASC 606 adoption: Adoption reduced retained earnings by $37.2 million, net of tax. The new revenue guidance increased reported Q1 revenue by $6.3 million and continuing-operations net earnings by $5.1 million relative to the prior guidance.
- Pension item: A U.K. court ruling regarding pension equalization increased the pension liability by approximately $38.2 million, with the offset recorded in other comprehensive income.
- Capital allocation: Jacobs repurchased 2.3 million shares for $141.8 million during the quarter. On January 17, 2019, the board authorized an additional $1.0 billion repurchase program and declared a quarterly dividend of $0.17 per share.
Outlook, risks and contingencies
Management expected CH2M restructuring and integration activities to continue through fiscal 2019 and targeted $175 million of annual cost savings after completion. No specific earnings or revenue guidance was provided in the filing.
- The ECR sale could be delayed or not completed if closing conditions, regulatory approvals, restructuring steps or property transfers are not satisfied.
- Jacobs disclosed a material weakness in disclosure controls relating to deferred-tax accounting and recoverability of deferred tax assets associated with the CH2M acquisition. Management reported significant remediation progress but concluded that controls were not effective as of December 28, 2018.
- A potential increase of 1% in floating interest rates was estimated to increase quarterly interest expense by approximately $5.0 million.
- The company identified potential exposure from government contract audits, litigation, guarantees, insurance claims and tax examinations. Significant disclosed matters included the NPMC arbitration claim exceeding $167 million and the JKC consortium dispute, involving approximately $530 million of Jacobs-related affirmative claims and approximately $1.7 billion of preliminary opposing claims. Management did not expect material adverse effects based on information available, but noted that the JKC matter could be material if liability were established.
- Additional or extended U.S. government shutdowns could cause program cancellations, stop-work orders, payment delays, reduced government staffing and lower demand for government-related services.
Investor verification checklist
- Verify completion timing, final consideration and cash proceeds from the ECR sale, including the value of the WorleyParsons shares and any working-capital adjustments.
- Assess the effect of CH2M integration costs, restructuring charges and the $175 million cost-savings target on future margins and cash flow.
- Reconcile reported revenue, earnings and retained earnings effects of ASC 606 with prior-period and non-GAAP presentations.
- Monitor operating cash conversion, receivables and contract assets, debt repayment capacity, variable-rate exposure and remaining revolving-credit availability.
- Track remediation of the material weakness in tax-related disclosure controls.
- Review developments in the JKC and NPMC disputes, government-contract audits, tax audits and other guarantees or surety obligations.
- Distinguish continuing-operations performance from ECR discontinued operations when evaluating growth, margins, backlog and valuation.