Amentum Holdings, Inc. (AMTM) Earnings Call Transcript

Ladies and gentlemen, good morning. My name is Abby, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Jacobs' CMS and C&I to merge with Amentum conference call. Today's conference is being recorded. [Operator Instructions] Thank you. And I will now turn the conference over to Jonathan Evans, Vice President of Corporate Development and Investor Relations. You may begin.

Thank you. Good morning. Last night, we announced our intention to combine our Critical Mission Solutions and Cyber & Intelligence businesses with Amentum in a reverse Morris trust transaction. We have posted a slide presentation on our website, which we'll reference during the call. 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. Speaking on today's call will be Jacobs' Executive Chair, Steve Demetriou; CEO, Bob Pragada; and CFO, Claudia Jaramillo. Steve will provide an overview of the transaction and provide context on the history, which led to the decision to combine with Amentum. Bob will provide an overview of the strategic rationale for the combination for all stakeholders. Lastly, Claudia will provide key financial details about the transaction. After we conclude the prepared remarks, we will open up the call for questions. We have allotted 45 minutes for this call. As we will be hosting our Q4 fiscal year 2023 earnings call in the next hour, please keep all questions to the topic at hand. With that, I'll turn it over to our Executive Chair, Steve Demetriou.

Thanks, Jonathan. I'm excited to speak with all of you this morning. Yesterday, we announced a definitive agreement to combine our Critical Mission Solutions and Cyber & Intelligence businesses with Amentum in a reverse Morris trust transaction. We strongly believe that this combination represents the highest value for our employees, clients and our shareholders. Turning to Slide 3. While we initially announced the separation of CMS as a spin-off back in May, today's transaction announcement is the outcome of a comprehensive review of all alternatives, including inbound inquiries resulting from that initial announcement. As we progress the CMS separation initiative, it became evident that our Cyber & Intelligence unit, part of Divergent Solutions, was better together with CMS. Bob will expand on this point in his remarks. Our Board unanimously concluded that the combination with Amentum was the superior path forward and in the best interest for all stakeholders. It creates a leading pure-play government technology solutions company with an enhanced strategic and financial profile. The merger drives an increased level of growth by combining portfolios with highly complementary capabilities and client sets with minimal overlap. The combination benefits from $50 million to $70 million of expected net cost synergies, and this transaction preserves the tax efficiency of a spin-off for Jacobs' shareholders. This announcement marks a critical milestone in our Jacobs' strategic portfolio transformation that was set in motion back in 2015. Alongside Bob, our Board and other key leaders, we committed to become a more focused, higher-margin company. And as you all know, we took several bold actions, including: first, acquiring CH2M in 2017; second, selling our Energy, Chemicals and Resources business in 2018; and also acquiring a majority stake in PA Consulting in 2020, which brings us to today, the creation of a new leading government services prime. So turning to Slide 4. Over the past several months, I've had the opportunity to spend time with Amentum's leadership and gain a deeper understanding of their business. I've been very impressed with Amentum in their broad and leading-edge capabilities. And importantly, it is evident that our organizations have a shared dedication to providing innovative solutions in serving our clients with excellence. Together, the new company will initially generate approximately $13 billion of annual revenue, with the capabilities to solve the most complex challenges for government clients across the energy, space, cyber and defense markets. With approximately $50 billion in combined backlog and leading backlog coverage, the company will have a stable foundation of long-term contracts aligned with government's highest priority growth areas, creating substantial scale and a track record to deliver more comprehensive solutions for our clients. I look forward to being part of this journey as Amentum's Executive Chair. John Heller, Amentum's CEO, will serve as the CEO of the combined company; and Steve Arnette, EVP and President of CMS, will serve as the COO. The Board will be split 50-50 between Jacobs' and Amentum's nominees, including myself and John Heller. I look forward to working alongside John, Steve and the Board to ensure we bring that same dedicated focus to successfully standing up this new public company while driving significant value-added strategic opportunities for all stakeholders. With that, I'll turn it over to Bob.

Thank you, Steve. Turning to Slide 5. In addition to combining CMS with Amentum, we will also be contributing our Cyber & Intelligence unit from Divergent Solutions. Inclusive of legacy KeyW, our C&I unit has clear connectivity with both CMS and Amentum, and combined, will create a strategic industry player in the cyber and intelligence space. Given growing global security threats, the combined platform can deliver unique capability and intelligence, surveillance and reconnaissance, ISR. We believe this transaction is a great outcome for everyone, including employees, clients and investors. Advancing to Slide 6. Amentum is a global leader in global engineering solutions, complex program management and solutions integration. Like CMS and C&I, it has a large base of stable long-term contracts and strong free cash flow conversion. Moving to Slide 7. The combined company offers a compelling strategic fit and a highly differentiated business that will create a competitive government services product. The combination creates a scaled pure-play leader with capabilities and a talent base to differentiate on the largest, most complex opportunities. The combined business will have the opportunity to capitalize on its backlog and pipeline through expanded capabilities and customer sets, and its strengths are aligned to both the U.S. and global government's highest-priority areas across energy, space exploration, systems integration, modernization, intelligence analysis and defense O&M. Like Jacobs, the businesses have low capital intensity and high free cash flow conversion, which we believe will help facilitate expedited deleveraging. Turning to Slide 8. The businesses are highly complementary with a significant combined pipeline with less than 3% of potential pursuits that overlap with one another. And importantly, the businesses bring deep client relationships with strong evaluation scores, allowing for the ability to drive an agile business strategy to deliver across the program life cycle. Advancing to Slide 9. While the business segments have not yet been decided, we want to provide an illustrative look at the breadth of capabilities and key sectors of the new company. The combined company will be a premier NASA services provider as well as a solutions integrator with programs supporting all 5 major intelligence community clients. A leading provider of technology agnostic solutions for the global nuclear renaissance, it will also be a go-to partner for the U.S. government on complex national security priorities, a truly global leader in logistics and mission support to serve our clients wherever the challenges may arise. And it will be in a strong position to defend against near-peer threats globally, especially in the Indo-Pacific and through program work with AUKUS. Turning to Slide 10. We expect net cost synergies of $50 million to $70 million to be achieved after close with identified synergies through optimization. Both organizations have track records of effective synergy realization, and the parties intend to look for additional opportunities. It is also worth highlighting that Amentum's modern IT infrastructure should allow for seamless integration and allow for CMS and C&I to forego costs that would have been required in a stand-alone spin-off. Moving to Slide 11. Each organization brings an intense focus on the mission and delivery of the highest quality of service for their clients. The organizations share common values, including a commitment to safety, inclusion and diversity and creation of enhanced opportunities for the combined employee base. With that, I'll turn it over to Claudia.

Thank you, Bob. Please turn to Slide 12. The combination strengthens the profile of each company and creates the scale and capability breadth needed to manage clients' largest, most complex challenges. The combined company generated approximately $13 billion in revenue in fiscal year 2023 with minimal contract concentration. The combined company will be a talent powerhouse with over 50% of employees holding clearance. And it will be largely product agnostic, a services prime with prime roles on contracts representing over 80% of revenue. Advancing to Slide 13. The combined business will have near best-in-class backlog coverage and free cash flow conversion and an attractive margin profile with significant improvement opportunities over time. Let's please turn to Slide 14 to recap key details of the transaction. This transaction will be structured as a reverse Morris trust that is intended to be tax-free to Jacobs' shareholders for U.S. federal income tax purposes and will result in the combined independent company being publicly traded. This is consistent with the tax-free nature of the previously announced plan to separate CMS by means of a spin-off. Jacobs and Jacobs' shareholders will own between 58.5% and 63% of the combined company. Jacobs' shareholders will own 51% and Jacobs will retain its stake equal to between 7.5% and 12% of the combined company based on achievement of the operating profit targets prior to close. Jacobs will also receive $1 billion cash dividend, subject to customary adjustments as well as additional value through the disposition of a retained stake within 12 months of close. Jacobs remains committed to an investment-grade credit profile, and we expect to use the proceeds from the transaction to repay debt. As for the combined company, it is expected to have a net leverage profile of 3.8x at close, and we believe there is a clear path to deleveraging below 3x. This transaction is expected to close in the second half of fiscal year 2024. Closing will be subject to regulatory approvals and other customary closing conditions. In the interim, we will continue with separation, transition and integration planning. And we'll host an Investor Day prior to closing. Stay tuned for updates in the months ahead. With that, I'll turn it back to Steve.

Thank you, Claudia. Now turning to Slide 15. In summary, this is a highly strategic combination that maximizes value for all stakeholders. For our clients, the new company will bring an exceptional track record of providing innovative solutions on the largest, most complex programs and a highly efficient cost structure and capability set to provide increased value. For employees, this new company will provide strong cultural alignment and shared values, shared mission and expanded professional growth and development opportunities. And for shareholders, this combination enables participation in the upside of a large leading pure play government services provider with differentiated scale and capabilities. Shareholders will also benefit from the expected synergy realization, a tax-efficient transaction with $1 billion cash dividend as well as the additional value from a retained stake, a win-win for all. I look forward to meeting employees and investors in the months ahead as we work towards the successful combination of these 2 great businesses and ultimately, the close of this transaction and its public listing. Operator, please open up the call for questions.

[Operator Instructions] And we will take our first question from Chad Dillard with Bernstein.

So I was hoping you guys could talk a little bit more about -- just how to think about the growth algorithm margin profile of the newly -- I guess, soon to be publicly traded company. How do you think about cash conversion? Yes, maybe you can start there.

Yes. Maybe I'll address the growth profile, and then Claudia could talk a little bit about the cash conversion. We're excited. If you look at the client sets that both companies participate in, there are -- it's very complementary, number one. And number two, the combined skill sets really put that growth trajectory into not just competitive, but we would say in the top of the industry on what the growth opportunities are. And there's real diversity in the portfolio, too. There's a high concentration that's within the defense departments and kind of the defense industry. But you couple that with the aerospace world and the energy and specifically, the DoE and some of the other regulated industries -- regulated energy industries in Europe, and those have got some strong secular trends around them. So overall, we feel strongly about the growth profile. And then from a value standpoint, the margin expansion was what was compelling when we looked at this opportunity.

Yes. So Chad, with that, I will only add to the conversion. If you look at the comparisons that we added in our materials, it's important to note how you can look at our track record on the combined company, high cash conversion and it's really top tier. So it's the strength of our markets and our efficiency in the conversion.

Got it. That's helpful. And then second question is just about recompetes for both the CMS business and Amentum, like as you're looking out over the next like 12 to 18 months. Anything notable? And then secondly, just how to think about the size of the pipeline of the new combined business?

Yes. The pipeline is strong. And that was another compelling aspect, Chad, is that if you look at both companies' recompetes, I would say most of them are kind of past [ is ] over the course of the next, I think, 18 months. It doesn't have a big component of that $50 billion pipeline that we're looking at.

We will take our next question from Michael Dudas with Vertical Research.

So first, maybe from a more -- choosing to partner with Amentum, what are some of the -- I guess, you touched on some of the cultural issues, but some of the skill sets that combined can drive maybe better conversion of the pipeline and backlog or things that could supercharge some of the growth and the excitement you talked about, Bob, and maybe the margin and maybe the net revenue growth profile?

Go ahead, Steve.

Yes. So the -- I think what Bob was talking about a few minutes ago that this is an unrivaled combination with the combination of the breadth of mission delivery and the domain expertise that both firms bring. And some of the examples, like, that you were asking about are the opportunity to inject technologies and capabilities around 5G, space technology, intelligent asset management, data analytics, digital engineering. The combination of what both of these firms bring to the megatrends that Bob was alluding to, I think, provide a tremendous opportunity not only for margin enhancement, but significant growth.

Maybe one thing to add as well is that it's the first of kind at this scale government services prime without an equipment component or an OEM component. So it's a pure-play services business, which is technology agnostic. So kind of take what Steve said and tack on the fact that this is an area to have long-term partnerships with clients not tied to a specific technology, but more of what's going to drive the mission will be really important.

And then just a quick follow-up. Shifting C&I business to the new public company. What are you going to -- from the Jacobs ongoing RemainCo, like what are you going to miss? Or are there opportunities to have relationships to kind of -- maybe have the 2 companies work together on certain things, maybe how that plays through in some of the decision relative to lose that for the RemainCo company relative to what's going to happen with Amentum and you guys?

Yes, Mike, it's a good question. And it was a decision that -- initially, we had not talked about that when we announced the separation. But when we got the inbound inquiries and we started to see what the power of specifically on this one would be with our C&I business, there's a component of that C&I business, it's a big component, that we weren't planning to separate the CMS business when we created Divergent Solutions. But when this opportunity came and now the opportunity to have nearly combined with Amentum a $1.5 billion C&I business that does not have overlap with RemainCo, it became really compelling. So this is the component of our C&I business that is exclusively based on DoD, the intelligence and the security sector and made a really nice fit. Still allowing for RemainCo to retain some skills within cyber OT and where we've been put -- really been enabling and accentuating our offering in the infrastructure space. So that will all remain.

And we will take our next question from Jerry Revich with Goldman Sachs.

Bob, part of the '25 strategy for CMS on a stand-alone basis was just to drive structurally higher margins each year. And I'm wondering, as you look at the Amentum pipeline, how much visibility do you have on a similar potential path to higher margins on a stand-alone basis in terms of -- based on what's margin and backlog? Can you just peel that onion back for us? So just help us understand the profit profile. What's in backlog in Amentum? And maybe just update us on how good you feel about the CMS stand-alone margin improvement cadence based on what's in backlog?

Jerry, it's a great question. It was actually one of the catalysts for -- in the evaluation of the inbounds and the assessment that drove us this way. We feel very optimistic that this is going to not only trend on the same path of that margin expansion trajectory that we had -- that we won for CMS, but now in a stand-alone form, it's likely going to accelerate with the diversification of skill sets, access to new clients and an investment profile that's going to be similar to pure-play competitors, which is also going to accelerate that margin expansion, too.

And in terms of other acquisitions and mergers we've seen in government solutions, the idea has been to essentially improve the resume of the combined entities and go after a bigger TAM. Is there an update that you can share with us in terms of, hey, now the combined companies can address an incremental TAM of XYZ because we're going to get the best of both companies from a resume standpoint? Is there a way to maybe quantify what that opportunity might look like for the combined entity versus stand-alone?

Yes. So at a high level, Jerry, the -- just recapping again. If you just look at the megatrends around energy, the nuclear renaissance associated with that as well as the multi-decade remediation decommissioning side, the whole space -- the space race renewed the commercialization, space intelligence and then go to the defense side with the near-peer threats and the global instability and then the whole intelligence side with cyber and data analytics and again, the global instability. And then there's tremendous opportunity around digital modernization, IT modernization, hypersonics, et cetera, injecting our combined technologies. We look at that overall as a $1.5 trillion global opportunity. That's made up of those major 5 areas.

And we will take our next question from Andy Kaplowitz with Citigroup.

Congrats on the deal. How did you decide on the net leverage for the new company? Obviously, it seems a little high for the NewCo, but you did talk about deleveraging it quickly. I would assume no debt is coming from Jacobs NewCo. And then Jacobs RemainCo will get that $1 billion of cash. So it seems like we'd have a strong balance sheet. What do you do with that extra cash?

So Andy, I'll first start with the new company, the combined company. So this is not inconsistent with the leverage levels that we've seen in similar transactions in the government services industry. And with that, I will add that with a very solid cash flow generation and cash flow conversion, this is where we have a high degree of confidence that we can deleverage over time. So we see -- we -- as I mentioned in the prepared remarks, we expect the business to deleverage. And we see this 3x. And I think in 18 to 24 months, it's a good time horizon. But again, this is not inconsistent with leverage levels in other transactions in the government services industry. Now for independent Jacobs, so what we say RemainCo, which is we mentioned the plans for the use of proceeds. And this is the strength of the balance sheet. And investment-grade product profile is very important to maintain optionality, strategic optionality, and that's the main plan at the moment.

Okay. And then maybe talking about the synergies, can you give us more color into the $50 million to $70 million? How did you come up with the synergy target? And what does it include? Because I would assume scale alone helps you defray bidding costs, for example. And then how do you think about revenue synergies moving forward beyond that?

Yes. Andy, that's probably the 2 biggest areas. There's several. But the combined company overhead recoverability, just in the rate structure, is going to be a big part of the synergy in the combined indirect that we would be bringing to bear. And that's almost kind of a day 1 that it gets reconciled over a period of quarters. As far as the revenue synergies go, Steve mentioned it before, the combined entity being able to have access to a broad range of frameworks with the skill sets, and that kind of gets acutely focused on a very specific skill set, is going to open up those revenue synergies and make the combined entity available, not just qualified but differentiated, to bid on a whole new subset of opportunities that they wouldn't have done individually. So there was some real energy behind both.

Just one quick follow-up to Jerry's question. Do you think the combined margin of the NewCo could be similar to the peers over time?

Over time, I think the answer is yes.

And we will take our next question from Steven Fisher with UBS.

Congratulations. Just curious how you would frame kind of this transaction different from what you contemplated initially back in May when you announced the potential spin. I mean I don't know if you had assumed that it would have been merged with another entity at that point. But is this structure allowing for maybe more of a dividend than would have been possible? Does it enable maybe a more efficient capital structure on the Jacobs side that would allow for more capital returns to Jacobs' shareholders in the future? Just curious how this compared to what you originally contemplated.

Yes. Steve, the short answer is yes on multiple fronts. And maybe just to start in kind of a couple of key buckets. The first is the horsepower of the combined entity and what it does for the world and our client base. And so that we kind of started with how is this differentiated in the space? And how is it going to be differentiated amongst its competitive peers? The second, when you incorporated the benefits of the synergies, the cash proceeds as well as kind of the near and longer-term value for our shareholders, it stood out as well. And then the tax benefits were compelling. And so if you kind of looked at that as a pool of benefits and then compared it to what we announced last May, it kind of stood out.

Okay. And what will govern the timing of the expected reduction of that 7.5% to 12% stake? Will that be done over time or all at once? And are there any particular tax implications of that stake sale?

I'm sorry, I missed it. So the equity stake of 7.5% to 12% [ upper end ]?

Yes. What will govern the timing of -- I know it's kind of within 12 months to close, but what will govern the timing of that? Will just -- that be all at once? Or [ how will ] you do that?

So Steven, the 7.5% to 12% is linked to our operating profit and is based on the 9 months, so from here until closing. We -- this gives us the ability to benefit from the upside. So that's really -- it will be fixed at closing.