Earnings Call Transcript - ACM Q1 2023

Operator, Operator

Good morning, and welcome to the AECOM First Quarter 2023 Conference Call. I would like to inform all participants, this call is being recorded at the request of AECOM. This broadcast is the copyrighted property of AECOM. Any rebroadcast of this information, in whole or part without the prior written permission of AECOM is prohibited. As a reminder, AECOM is also simulcasting this presentation with slides at the Investors section at www.aecom.com. Later, we will conduct a question-and-answer session. I would like to turn the call over to Will Gabrielski, Senior Vice President, Finance, Treasury and Investor Relations. Please go ahead.

Will Gabrielski, Senior Vice President, Finance, Treasury and Investor Relations

Thank you, Operator. I would like to direct your attention to the Safe Harbor statement on Page 1 of today's presentation. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. We use certain non-GAAP financial measures in our presentation. The appropriate GAAP reconciliations are incorporated into our materials, which are posted to our website. Any references to segment margins or segment adjusted operating margins will reflect the performance for the Americas and international segments. When discussing revenue and revenue growth, we will refer to net service revenue or NSR, which is defined as revenue excluding pass-through revenue. NSR and backlog growth rates are presented on a constant currency basis, unless otherwise noted. Today's remarks will focus on continuing operations. On today's call, Troy Rudd, our Chief Executive Officer, will review our key accomplishments, our strategy, and our outlook for the business; Lara Poloni, our President, will discuss key operational successes and priorities; and Gaurav Kapoor, our Chief Financial Officer, will review our financial performance and outlook in greater detail. We will conclude with a question-and-answer session. With that, I will turn the call over to Troy.

Troy Rudd, CEO

Thank you, Will, and thank you all for joining us today. I'd like to begin by acknowledging the continued commitment of our approximately 50,000 professionals fulfilling our shared purpose of delivering a better world. We have the best teams in the industry, and our widening competitive advantage stems from their passion, technical expertise, and global collaboration. Our continued high win rate, record design backlog, continued margin expansion, and strong cash flow are a testament to the strength of our team and the benefits of our strategy. All of our end markets are growing, and we are aggressively adding to our workforce to deliver on our commitments. Strong end market conditions and the continued growth of our professional workforce differentiate us from many businesses that are seeing macro conditions continue to soften. I also want to highlight that for the third year in a row, we have been recognized as the most admired company in our industry by Fortune. This is a great accomplishment, and I couldn't be more proud of our people. Turning to our financial performance, organic NSR growth accelerated to 8%, which included strong growth across both segments and was led by 9% growth in design, which matches our highest for the past decade. Notably, our growth in the Americas design business continued to accelerate. State and local activity remains strong, and when combined with the unprecedented infrastructure funding in the U.S. and the increases in the recently enacted 2023 U.S. federal budget, we are confident in a multi-year growth cycle. Our segment adjusted operating margin increased by nearly 40 basis points to 14%, which is a new high for our first quarter. Our profitability leads our industry and reflects strong execution, the benefits of our strategy, and our lower risk, higher value backlog composition. We are well advanced in our path to deliver on our 15% fiscal 2024 margin target, and we are increasingly confident in our continued margin expansion over time. Adjusted EBITDA of $224 million and adjusted EPS of $0.86 were consistent with our expectations and included strong underlying operational growth. Consistent with our track record of delivering on our commitments, strong operational performance contributed to 19% growth to year-over-year earnings, which allowed us to deliver on our targets despite macro-related factors. Free cash flow is also strong, which enabled the execution of our returns-focused capital allocation policy. Our primary use of capital includes investments in organic growth opportunities, share repurchases, and our quarterly dividend program. I should highlight that our recent January dividend marked a 20% increase over our prior payment, which is consistent with our intent to grow our per share dividend by a double-digit percentage annually. Importantly, we are prioritizing our investments to pursue transformational growth opportunities where we have a competitive advantage. This resulted in another near record high win rate, strong backlog momentum, and an unprecedented level of visibility. The design backlog increased by 9% to a record high, which is an acceleration from the prior quarter and was driven by a 1.3 book-to-burn ratio. In addition, our pipeline of opportunities is also at an all-time high. This includes a nearly 30% increase in proposals and bids submitted, which is up from 20% growth in the prior quarter. As a result, we are confident that our design backlog will continue to increase as the year progresses. Across our business, the benefits of our Think and Act Globally strategy are apparent in the changing composition of our backlog. Let me share a few examples. During the quarter, we were selected for the sizable water program management contract in Southern California. This win resulted from collaboration between our world-class water and program management practices, which led to an unrivaled technical solution for our client. In addition, this win fortifies our leadership position in this rapidly growing region where last quarter we won the sizable Padre Dam Advanced Water Purification Program in San Diego. As a result, we are well positioned to benefit as the billions of planned investments to address persistent drought and water supply challenges increase. We were also successful in our selection for the Navy Pacific CLEAN program, which builds on our success with this client, including last year's award of the Atlantic CLEAN program. Both programs will run for at least five more years. We are experiencing a similar trajectory in our number one ranked global transportation business. In Canada, we were selected to serve as the technical advisor on a transformative light rail project, creating visibility over the next decade on a marquee project in the region. In addition, while not reflected in our first quarter backlog, we've been notified that we were selected on another nine-figure win in the global rail market. We are very deliberate in how we allocate time and capital, with a focus on the best return and highest value opportunities. As a result, an increasing share of our wins are generated from scope increases and additional phases on existing programs. In fact, our largest first quarter design win was an additional phase to the existing project we already held. Several of our first quarter wins have the potential to increase in value. We've identified more than $500 million of potential incremental opportunity from the first quarter wins that we expect to add to the backlog over time. This demonstrates the more valuable composition of our wins and backlog, and with it contributes to our visibility and confidence. Also contributing to our confidence is the funding growth across our largest end markets. In the U.S., the initial wave of IIJA funding is beginning to materialize in our pipeline, and we continue to expect the benefits from IIJA funds to accelerate through the coming years. An increasing share of our activity today is helping clients position for this funding, and clients are increasingly turning to us to utilize our digital AI-powered tool fund navigator. In Canada, provincial investment in rail infrastructure and a market where we lead is supporting NSR, backlog and pipeline growth. The same is true in the UK, where we have an established position on key frameworks and are converting large pursuits to wins. In Australia, our momentum continued, including another win in the first quarter, which has further extended our backlog visibility. And finally, in the Middle East, our backlog and NSR have increased at a double-digit pace due to our positioning on the substantial infrastructure investments transforming Saudi Arabia. As we look ahead, we remain committed to executing our strategy, which is focused on expanding our addressable market through organic growth in our advisory, digital and program management practices, driving collaboration to fully capture the strength of our global platform, prioritizing our time and capital on the highest returning growth opportunities, investing in digital AECOM at an unprecedented rate to lead our industry through digital transformation, and finally, creating an industry-leading employee value proposition to attract and retain the best professionals in the field. Taken together, we are better positioned than ever to capitalize on the growing set of opportunities in front of us. Our competitive advantages are expanding the long-term earnings power of the company. As a result, we are reaffirming our 2023 financial guidance and remain confident in delivering on our long-term 2024 financial targets and aspirations. With that, let me turn the call over to Lara.

Lara Poloni, President

Thanks, Troy. Please turn to the next slide. I'd also like to acknowledge our teams across the globe for another strong quarter. We've built a culture around collaboration and expanding our competitive advantages, and our strong performance represents the realization of our strategy. In nearly every conversation with our clients, we receive consistent feedback. Our teams are delivering unrivaled technical solutions. Our technical proposal is the most often cited factor in our wins. These technical capabilities are an essential element of our competitive advantage, which is apparent in our consistently strong win rate, and we are winning half of every dollar we bid. The great work we do is a reflection of our professionals, and we are energized by the opportunities ahead. Across our markets, we are ideally positioned to capitalize on the three secular megatrends, including growing global infrastructure investments, investments in sustainability and resilience, and post-COVID supply chain and asset investments. These drivers were prevalent in several of our recent wins. In the U.S., our leadership in sustainability and resilience continues to be a differentiator. For instance, investments to modernize and strengthen the U.S. electric grid are expanding. This was highlighted by our selection to support a key renewable energy client in the U.S. on a large interstate transmission line that will leverage both our technical capabilities and our innovative digital plan engage tool for the NEPA environmental impact statement. In addition, PFAS activity is accelerating ahead of expected regulatory milestones in 2023. We are the leaders in this market, and our backlog for PFAS-related programs increased by 40% in the quarter. Finally, we were selected to advise the City of New York on its Cloudburst program, which creates clustered stormwater management projects in flood-prone and underserved communities across the city. This win positions us to deliver similar services in other metros globally, which plays to our strengths. In Australia, the government is investing at record levels in transportation infrastructure. We won the design contract for a substantial highway tunneling project in the first quarter, building on a series of large transportation wins over the past year. The ingenuity of our global tunneling expertise was critical in developing a technical solution for the client that reduced the environmental and biodiversity impacts of this project. This was a key differentiator in our successful bid. Finally, in the UK, where the government has reaffirmed its commitment to expand its rail network and reconnect communities as part of its leveling-up strategy, we are winning marquee projects that support this vision. To fully capitalize on the accelerating set of opportunities ahead, we are continuing to make investments in our teams. This includes our increased investment in U.S. healthcare benefits, which we rolled out earlier this year, and ongoing investments in technical academies to bring professionals together and foster collaboration. I am pleased to report that we are experiencing a strong return on these investments. Our workforce is growing, employee engagement is high, and employee retention across the globe is ahead of our internal targets. The return on these investments is essential to retaining and attracting the best professionals, which is key to expanding our competitive advantage. Across our business, our technical excellence empowered by a culture of collaboration and focus on pursuing the best growth opportunities have contributed to substantial momentum in our business and energize us as we pursue a record pipeline of opportunities today. With that, I will turn the call over to Gaur.

Gaurav Kapoor, CFO

Thanks, Lara. Please turn to the next slide. The strength of our financial results is a testament to our focused allocation of time and capital to the highest returning opportunities, the strength of our teams, the power of harnessing that strength through collaboration, and our disciplined capital allocation policy that is driven by one key element, return on investment. Importantly, we exited the first quarter with even more momentum than we entered. NSR and backlog growth accelerated, our win rate, especially on transformational pursuits is at historic levels, and funding behind the three secular megatrends driving our business is firmly in place. Just as importantly, we are delivering profitable growth; our segment adjusted operating income margin increased by nearly 40 basis points, which is consistent with the expectations in our fiscal 2023 guidance for a 14.6% margin. Our performance reflects the competitive advantage we are creating by investing to expand our addressable market, collaborating across business lines and geographies, and narrowing the focus of our time and capital on the highest value opportunities. Please turn to the next slide. NSR in the Americas design business increased by 6% and marked an acceleration from the prior quarter. The adjusted operating margin expanded by 50 basis points to a new first-quarter high. Visibility continues to increase with backlog up 7%, driven by a 1.2 book-to-burn ratio. In addition, our contracted backlog is at all-time high, and bid and proposal activity increased by double-digits. These trends are a direct result of our accelerated business development activity we spoke about on our fourth quarter conference call. The growth and profitability profile we are delivering is enabling us to invest to capitalize on the growth opportunities ahead to create the best long-term earnings power, while also continuing to deliver on our margin expansion targets. Please turn to the next slide. Turning to the International segment. NSR growth increased by 12%, led by the UK, Australia, and the Middle East, where we have built an incredibly strong backlog position over the past two years. Margins also expanded, which reflects our narrowed focus on key markets and sectors that drive the most value to the organization. Backlog growth accelerated to double digits with a 1.5 book-to-burn ratio. We are now positioned on several multi-year projects with billions of dollars of committed funding, which creates an enhanced level of visibility. Please turn to the next slide. We had a strong start to the year on cash flow with $84 million of free cash flow in the quarter, which continues to reflect better phasing. It bears repeating: our cash flow remains consistently strong because of the rigor we put into converting earnings to cash and the inherent attributes of our professional services business, which includes high quality clients with strong balance sheets and the higher margin and lower risk nature of our work. As a result, we are able to invest in our organic growth opportunities and have substantial available cash to execute our other capital allocation priorities. After investing in organic growth opportunities, share repurchases remain the highest and best use of our cash flow. Our quarterly dividend is a key element of our long-term commitment to return capital to our shareholders. During the quarter, we've returned approximately $70 million in total, and we have returned approximately $1.6 billion to shareholders over the past two and a half years. Our balance sheet remains in great shape with no bond maturities until 2027, and 80% of our debt is fixed or tapped at highly attractive interest rates for several years to come. Please turn to the next slide. Turning to the financial outlook, we are affirming our guidance for all metrics built on the strong foundation we set in the first quarter and the strength of our strategy that has created strong visibility for the remainder of the year. We continue to expect 10% adjusted EBITDA and EPS growth at the mid-point of the ranges on a constant currency basis, with organic NSR growth accelerating to 8% for the year compared to 5% last year. We also continue to expect segment adjusted operating margin to increase by 40 basis points to 14.6%, which would mark a new annual high and continue to lead our industry. Our ability to expand margins while investing in our teams and delivering accelerating top-line growth is a testament to the strength of our platform. With that, operator, we are ready for questions.

Operator, Operator

Thank you. The first question today comes from Michael Feniger with Bank of America. Please go ahead, Michael.

Michael Feniger, Analyst

Hi everyone, thanks for taking my question. Troy, there's some concerns in the market with these headlines in DC. I think a lot of the headlines want defense budget, but can you just help us understand when we look at your exposure to public funding, how locked in some of the funding is? Are you hearing any issues on the ground about that pipeline seeming like the building could slow off? Just curious if you can comment on some of the headlines we're seeing? And if we flesh that out, what the actual risk to your growth outlook there?

Troy Rudd, CEO

Okay. Yes, Michael, thanks for the question. So I'm going to address that in a few parts. First of all, in terms of the federal government, there certainly is an ongoing debate about spending and debt. Our perspective is that the government will ultimately act rationally. If we go back and look at history, it always does seem to turn out that way. At the very least, there have been some periods of time where the government has been impacted for a few days. For us, we only have low-single-digit exposure to the federal government, and that really has no material impact on our business in the short term. Most importantly, those times of shutdowns are really irrelevant for the long-term performance of our business and the long-term investment cycle in infrastructure. The second part of that question is, when we look at the funding that has come into infrastructure, it has been building for a period of time, and it certainly has been bipartisan. For the most part, those funds have been appropriated. So looking forward, we really don't see there being a significant risk to the funds set aside by the IAG or other acts. In the long term, we see that as not having an impact on the opportunity for our business in the U.S. Going deeper than that, when we look at our state and local governments, they have very significant funding available; we see rainy day funds in state and local governments being at the highest level since I think going back to the 1980s. There are strong underpinnings for the long-term investment set aside for infrastructure, and there certainly is demand for it. The last comment is, while we're focusing on the U.S., the trends we see are global in nature. There will always be blips in terms of long-term opportunity, but we really don't see that being a significant risk to the long-term value of the business.

Michael Feniger, Analyst

Thank you. And Troy, over the last 12 months, many of your public peers have acquired other businesses; you stayed the course and are talking about some increasing win share. How do you view your organic approach versus the M&A approach as we think about capturing some of these bigger projects as the funding levels ramp up into 2024?

Troy Rudd, CEO

Yes. Again, Michael, our focus and strategy has been built on taking advantage of long-term opportunities. We've built a strategy around that, and we're executing against it. In terms of allocating capital, we have been disciplined around our return profile. We said the highest returning opportunities are investments in organic growth. We still believe that, and it is paying off for us. When looking at the next best opportunity, it is certainly returning capital to shareholders. That may change over time, but as of today, investing in organic growth and returning capital to our shareholders is our focus. In contrast to M&A, we find it difficult to be comfortable doing transactions at 15x earnings in businesses that really have organic growth opportunities in the mid-single-digits. While they can reach double-digits at points in time, it's hard for that return on the capital being deployed at a 15x transaction to make sense. We are disciplined to ensure we're providing the best return on capital. Our strategy is built around that, and we don't foresee a change.

Operator, Operator

Our next question comes from Andy Wittmann with Baird. Please go ahead.

Andy Wittmann, Analyst

Great. Thanks for taking my questions, guys. I guess you are guiding NSR growth of organic 8% for this year, and the quarter, you posted that. You've got the benefit of some of the stimulus you referred to and previously even said that you expected the year to accelerate. So it seems to me that the 8% could be conservative. I was wondering if that is the case, or if there is an offset that's developed somewhere in your forecast or planning that we should know about.

Gaurav Kapoor, CFO

Hey Andy, this is Gaurav. I'll take that question. There's no change in our outlook and the plan we have committed to in FY2023. Look, we're early in the year and as you noted correctly, a little bit ahead of our expectations for Q1, and underlying bookings growth was very strong across our design business. But similar to what prior years have taught us, we need to be prudently conservative due to ever-changing macroeconomic conditions. The management team will always be focused on delivering on its commitments.

Andy Wittmann, Analyst

Got it. Thanks. And maybe Gaur, maybe you reiterated the 2024 longer-term guidance here today. In that, you've said that 15% margin would be kind of the target. I guess when I look at that 15% margin, the $475 million with the newer interest expense assumptions does imply a fairly material acceleration in organic growth rates to get to $475 million. What's the most likely way that you get there? Is it by exceeding or well exceeding the 15% margin target? Are you increasing the confidence in the organic growth rate in the medium term?

Gaurav Kapoor, CFO

Yes. Good question again. Thanks for that, Andy. So you're right. There's no change in what we have committed to, including when we spoke just two to three months back. In our FY2024 outlook, we feel confident. In fact, as we sit here today, we're more confident than we were three months ago. It's a dynamic model. The three key pillars we're focused on are growth, margin expansion, and our capital allocation strategy. We have outperformed to date on every single one of those metrics: our growth is ahead of expectations, our margin expansion has been faster, and we expect to deliver on that 15% with the focus being to maximize that delivery as we move forward over the next call it 20 months into 2024. These factors will help us overcome things outside of our control, like FX or interest. This management team is focused on ensuring we put the best foot forward on every single facet we can control. A great example is the strength of our balance sheet, where 80% of our debt is fixed at very favorable interest rates. These headwinds are absolutely there, but we over-delivered on the factors we can control. Our strong book-to-burn over the last 18 months continuing into Q1 supports not only our 2024 model but reinforces strong results we expect to deliver for years to come.

Operator, Operator

The next question comes from Sabahat Khan with RBC Capital Markets. Please go ahead.

Sabahat Khan, Analyst

Hi, great. Thanks and good morning. Just a question on the earlier comments around still continuing to ramp up hiring given the demand outlook. I guess, how are you balancing that against some uncertainty in the backdrop? Do you have enough visibility to support some of this hiring? I know some of your peers have kind of used contract engineers and things like that. Are you using those tools? I'm just trying to understand how you're balancing hiring needs with the evolving backdrop.

Troy Rudd, CEO

Yes, thank you. It's Troy. We're in a unique situation where we are focused on creating capacity in response to the pace at which we're winning work. We are hiring extensively across the business while also working to enhance the capacity of our entire professional team. We're leveraging digital tools on projects and expanding our enterprise capability centers to improve efficiency in our work. Right now, our main goal is to increase capacity to keep up with the rate of our new projects.

Sabahat Khan, Analyst

Great. And then just the comments around the increased win rates, particularly on larger projects. Could you share some color on whether these are changes that you've made to win these projects? Are these structural changes that could last throughout the economic cycle? How do you adjust your approach to bidding, considering the demand environment over the next 12 to 24 months may moderate? Just a little bit of color on maybe the changes you've made and how sustainable you think some of those impacts are?

Troy Rudd, CEO

Yes. I think these are highly sustainable. We've focused our strategy on creating competitive advantages, and we're seeing that pay off. The payoff is our backlog is growing, and the composition of our backlog is changing meaningfully, creating long-term visibility and more opportunities for our team. We've exposed ourselves to more client spending on projects. In the past, if you were a design business, you were exposed to certain components of project spending. By building out an advisory and program management business, our program management growth has now exceeded over 30% per year, exposing us to much more of that client budget. That's a structural change that we believe will not change. In terms of creating competitive advantage, it's built around investing in our teams, providing the best technical solutions to our clients, and leveraging investments in digital AECOM to enhance our delivery.

Lara Poloni, President

Yes. Sabahat, the technical academy is a great example of this point of differentiation. Another key element of our investment in our people and the return on these investments is critical. We've invested in technical academies with great uptake and engagement from all of our employees. This ongoing technical learning is how we differentiate ourselves. Typical anecdotal feedback indicates that on nine out of ten recent enterprise-critical wins, AECOM earned top technical scores, highlighting our technical prowess as a key reason for our successes.

Operator, Operator

Our next question comes from Andy Kaplowitz with Citigroup. Please go ahead.

Andy Kaplowitz, Analyst

Book-to-bill accelerated bids. How are you doing? So book-to-bill accelerated in Q1 to 1.3x. I think you mentioned a 30% increase in bids and proposals from last year. You obviously had nice movement in contracted backlog as well. So just two questions: Can you maintain this kind of book-to-bill based on your increased proposals for the next few quarters? Do you see Americas NSR growth based on current conditions continuing to rise from 6%? Or is it more that double-digit international growth that will carry you to the 8% growth for the year?

Troy Rudd, CEO

So yes, the answer to your question is yes. I see it being able to maintain the high book-to-burn. Given the fact that, as Lara pointed out in our prepared comments, we're actually winning $1 out of every $2 that we bid. Our capture rate is at 50%, and frankly, it's been that way now for five quarters. We create a lot of confidence when winning what we define as important. With our significantly growing pipeline, yes, we do believe that as we keep winning at this rate, we're going to keep building our backlog at the same rate. We do have confidence around that. I'll pass it to Gaur to answer your second question.

Gaurav Kapoor, CFO

Yes. As we look forward, what drives our confidence in the market includes our priority in the marketplace and our success metrics. Our strategy is simple—we focus on the nine key geographies that have significant funding macroeconomic tailwinds. Our people are some of the best professionals in the industry. We are significantly investing to ensure their technical brand continues to outpace competition. This is all enabling us to sustain what we've achieved and continue to capitalize on future funding that will become available.

Operator, Operator

Our next question comes from Alex Dwyer with KeyBanc Capital Markets. Please go ahead.

Alex Dwyer, Analyst

Hi guys, I just wanted to get your thoughts on IIJA and where we'll see it go to the model first. In your water and environment business, what would it be transportation? Is there a major difference in the margin profile between the work you do in these two end markets? I just wanted to get your thoughts there.

Troy Rudd, CEO

Yes, I see no difference in terms of how IIJA funds will roll out across our portfolio covered by all our business lines. I expect broad growth across sectors and no specific margin profile differences between them. What we've seen is that margins within our backlog continue to improve. Thank you, Operator. I want to thank everyone for joining us on the call today. I appreciate the questions from our analysts. I want to thank our teams for their great contributions to the first quarter, and the work they’ve done to create momentum across our business and opportunities for our professionals. We observe numerous volatile market conditions, but we are fortunate to be in an industry benefiting from favorable long-term funding trends. I am proud to say our team has created a great opportunity to capitalize on these prospects for the long term. Thank you to all the professionals here at AECOM. We'll talk to you next quarter.

Operator, Operator

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.