AECOM (NYSE:ACM) Q2 2024 Earnings Call Transcript

AECOM (NYSE:ACM) Q2 2024 Earnings Call Transcript May 7, 2024

AECOM isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the AECOM Second Quarter 2024 Conference Call. I would like to inform all participants this call is being recorded at the request of AECOM. This broadcast is the copyright 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. [Operator Instructions] Thank you. I would now like to turn the conference over to Will Gabrielski, Senior Vice President, Finance, Treasury and Investor Relations. Will, you may begin your conference.

Will Gabrielski: Thank you, operator. I would like to direct your attention on 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 have certain non-GAAP financial measures in our presentation. The appropriate GAAP reconciliations are incorporated into our materials, which are posted to our website. Growth rates are presented on a year-over-year basis unless otherwise noted.

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. Our discussion excludes the results of the AECOM Capital business. After the end of the second quarter, we closed a transaction that transitioned the AECOM Capital team to a new platform, while ensuring the team will continue to support AECOM’s existing investment vehicles and investments through completion.

During the quarter, we also incurred a non-cash $103 million loss in discontinued operations related to revisions to estimated contingent consideration receivables recognized at the time of sale of the civil construction business in 2021. 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 and Operations 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: Thank you, Will, and thank you all for joining us today. I’m pleased to report that based on our strong second quarter and first half operational performance, we are increasing the midpoint of our adjusted EBITDA guidance for the full year. The strength of our results rests on the expertise and focus of our 52,000 professionals who have distinguished AECOM in the market. Through our TechEx initiative, we continue to make key investments in the professional and technical development of our people, ensuring that we bring the best of our expertise to our clients around the world. With our unrivaled technical expertise and highly collaborative culture, we are consistently recognized as a leader in all of our markets.

To this point, I’m pleased to report that in late April, we were recognized by ENR as the number one water consulting firm in our industry, adding to our existing leadership positions in the transportation, environment and facilities markets. This accomplishment reflects our scale and record level of investments in growth, which have contributed to us winning work at a record high rate. This recognition also comes at an opportune time when key issues included the impact of climate change, water scarcity and emerging contaminants are creating unprecedented demand and funding. The recent final EPA rules establishing maximum contaminant levels for PFAS stands as a great example. This is a market where we have supported clients for more than two decades and our backlog increased by nearly 50% during the second quarter.

Turning to our second quarter results in more detail. Net service revenue increased by 8% and by 9% when adjusted for year-on-year fluctuations in workdays. Notably, this included strong performance in every key geography as well as growth in the environment, water and transportation end markets. We also delivered records for our adjusted EBITDA, margins, backlog and pipeline of opportunities and adjusted EPS increased by 13%. Cash flow is also strong, which is a testament to the higher returning and lower risk characteristics of our professional services business. Our consistently strong cash flow generation supports our returns-focused capital allocation policy, which is built on organic growth investments and returns to shareholders through repurchases and dividends.

A few key themes across the business underpin our confidence. First, we are winning at near record level and it is clear that our competitive advantage is delivering organic market share gains. In the second quarter, we won approximately $0.50 of every dollar we bid, which marks the tenth consecutive quarter with a win rate at or nearly 50%. On our large pursuits where our competitive advantages are even greater, our win rate is 30% higher. Second, our adjusted EBITDA margin increased by 40 basis points to 15.4%, a new all-time high. Importantly, our strong margins enable us to reinvest in organic growth. Today, we are investing at record levels in business development and digital initiatives to capture a greater share of our record pipeline and compound our advantage over time.

Third, long-term mega trends of global investments in infrastructure, sustainability and resilience and the energy transition are firmly intact. As a result, activity is strong in all of our largest and most profitable markets. For example, in the U.S., funding from the Infrastructure Investment and Jobs Act and strong federal state local trends supported a 1.4 book-to-burn ratio in the quarter. In Canada, the government released a $56 billion 10-year infrastructure investment program, which is double that of the prior multiyear plan. In the UK, near-term election uncertainty has plotted the picture on larger transportation projects. However, our backlog is at record levels and reflects an increasingly diverse set of opportunities. This includes the expected near doubling of funding over the next five years for the AMP8 Water program, where we have existing experience with nearly every large water utility involved.

In the UK market, we also have ongoing investments through transportation frameworks and new opportunities around energy transition. And in Australia, the ongoing $120 billion infrastructure investment program is advancing, and we are already working on several key projects that support this pipeline. Finally, and most importantly, our decision to build a global program management advisory business has been a game changer. I want to expand upon why this has been the case and why we have set a longer-term ambition of delivering 50% of our revenue through program management advisory services. Our investment in program management was born from an emerging need we identified in the market, resulting from a few accelerating trends. First, project size and complexity continue to increase, including a tenfold increase over the past 10 years in the number of multibillion-dollar projects in the U.S. alone.

At the same time, our clients are increasingly facing internal capacity and capability constraints to deliver on their ambitious objectives, which has created more demand for technical expertise and program management consulting services to augment their in-house capabilities. Lastly, while plenty of companies offer a program management capability, we saw a void in that none combined this capability with the deep technical expertise and the culture of global collaboration that we have. Program management advisory services also include several financial benefits to the organization, including elevating the value of our technical expertise, expanding our addressable market share of higher margin, lower risk elements of an infrastructure project or program, creating more visibility through larger multiyear wins and elevating our role with clients, which leads to more opportunities over time.

As a result, we set out to truly redefine how global program management is delivered. We invested to bring on the best program management and digital resources in the industry and we focused our resources on the biggest opportunities. I’m pleased to report that we have over delivered on our initial goal to double program management revenue within two years. And today, program management represents 15% of our net service revenue. In fact, we have won 15 of our last 16 large pursuits, including several defining wins. These include the FEMA PATAC win this quarter, which further establishes AECOM as a leader for FEMA on disaster response work. We are also the program management for California High-Speed Rail, the largest high-speed rail investment underway globally and for the U.S. Navy on its largest environmental contracts.

Taken together, we are energized by the strength of our performance, trends across our markets, our record backlog and pipeline and the clear advantages created by the execution of our strategy. With that, I will turn the call over to Lara.

Lara Poloni: Thanks, Troy. I am proud of our continued strong performance. Today, not only are we winning larger and higher-value pursuits, but we are winning at a consistently higher rate than ever before. These accomplishments are the culmination of several elements of our strategy that are bearing fruit. First, the volume of investment and opportunity across our industry is at unprecedented levels. To fully capitalize, we have built our strategy on allocating our time and resources to our largest clients where we see the greatest growth opportunities. Reflective of this effort, revenue with our top 200 clients, who represent more than 50% of our revenue, has grown multiple times faster than the rest of the business over the past several years.

Importantly, our backlog with these clients is growing even faster, which underscores the confidence we have in our growth outlook. Second, through our program management business, we are elevating the value of our technical expertise within our number one ranked transportation, water, environment and facilities businesses. As a result, we are also winning more larger projects than ever before. Our share of wins, valued at more than $50 million, has doubled and wins valued at greater than $100 million have tripled over the past few years. Large wins enhance earnings visibility and capitalize on our company’s global scale and industry-leading technical expertise. Third, our focus on technical excellence and career development is paying dividends.

We have been very intentional about reinvesting to build global technical practice networks and technical academies to support our strategy and drive collaboration across the business. These programs are a key part of what we refer to as TechEx, which is designed to elevate our culture through technical development programs for our teams. These investments are contributing to our low employee attrition, which is at levels that rival the lows we experienced even prior to the pandemic. Finally, our focus on high growth end markets is contributing to our strong revenue and backlog trends. This includes the nearly 50% backlog growth for PFAS related work this quarter and we expect net service revenue growth to accelerate following the recent final EPA water rule.

Importantly, we already hold every major environmental contract vehicle, including the key vehicles for PFAS related work for all of the Department of Defense, NASA and many other civilian agencies of the U.S. government. This strength was further solidified with our recent selection by the U.S. Army for a $464 million multiple award contract. Our number one position in water and environment has us well positioned to continue to capitalize. This also includes nearly 20% growth in our digital consulting practice, where our infrastructure clients are turning to our capabilities and deep knowledge of their assets to help drive automation and digitization opportunities. In addition, investments in electrification and renewable energy are driving a record pipeline of opportunities and continued growth.

In the UK alone we have recently been selected for marquee programs, including for the SCAPE Power Utilities Consultancy framework and for the Great Grid Upgrade. On the latter, in particular, the integration of our global design centers into our offering provided a key advantage in addressing a local shortage for electrical grid design experts. We also realized some key milestones in our data center business during the quarter, including a landmark win for us in the U.S. As we look ahead, we are well positioned as these markets continue to accelerate. With that, I will turn the call over to Gaurav.

Gaurav Kapoor: Thanks Lara. Our second quarter and first half results extended our track record of delivering on our financial and strategic objectives. We delivered another quarter with strong net service revenue growth and our adjusted EBITDA margin expanded to new highs. As a result, adjusted EBITDA increased by 10% to $268 million in the quarter and adjusted EPS increased by 13% to $1.04. Turning to the Americas segment, net services revenue increased by 10%, we also delivered strong profitability with an adjusting operating margin of 18%, which continues to be at the top of our industry. Our business development investment in the quarter was 50 basis points higher as a percentage of net revenue than what was built into our plan, so we can continue to take advantage of robust pipelines for all of our end markets with record win rates in our largest, most profitable businesses.

This is a great example of how we prioritize organic investments that drive a greater than 40% ROI and give us more confidence in our near and longer term margin expansion objectives. To that point, our backlog increased to a record high and wins in our Water, Environment and Transportation end markets contributed to a 1.3 book-to-burn ratio. Notably, we won FEMA’s public assistance contract for disaster recovery and our zone is amongst the most active, including the Caribbean and New York area. We also won a landmark rail tunnel replacement contract for Amtrak’s Frederick Douglass Tunnel and were selected to provide program management services for San Diego Airport’s Capital Improvement Program, including the replacement and expansion of the new Terminal 1.

The scale and significance of these wins underscores the strength of our capabilities. Turning to the International segment, net services revenue increased by 6%. I should note that we had fewer working days this year as compared to last year, which impacted our growth by approximately 200 basis points. Importantly, the adjusted operating margin expanded by 240 basis points to 10.9%, which is a new high and reflects substantial progress on our commitment to deliver best-in-class margins in this segment. In addition, our backlog increased across all of our largest geographies, which provides for continued strong visibility. Looking ahead, demand trends across all our markets remain strong. In the Middle East, our clients are undertaking unprecedented infrastructure programs.

While there have been reports of extended timelines for one element of Neon, we do not expect this to impact our trajectory. In fact, our headcount for Neon client is at an all time high, which we expect will be maintained well into the future. In the UK, our revenue increase, and backlog is at an all time high and we have built substantial positions on key frameworks that will continue to benefit us through periods of uncertainty. And accelerating energy transition and water investments that Troy mentioned is not impacted by the near term political considerations. Turning to cash flow. Fee cash flow was $161 million in the first half of the year and enabled the return of $145 million to shareholders through repurchases and dividends. Further enabling our returns-focused capital allocation policy, we successfully completed a strategic amendment and extension of our credit facilities after the quarter ended.

This transaction allowed us to lock in historically attractive pricing and extend the maturity of our debt. As a result of the refinance, 70% of our debt is fixed or capped and we are operating from a position of strength and certainty on our cost of debt. Reflecting this strong financial outperformance, to date, we are increasing our adjusted EBITDA guidance for fiscal 2024. We continue to expect strong net services revenue growth of 8% to 10%, a record segment adjusted operating margin of 15.6% and 20% adjusted earnings per share growth for the full year. We also reaffirmed our expectations to convert adjusted net income to free cash flow at a rate of 100% or greater. Our tax rate in the third quarter is expected to be again in the high 20s.

With that operator, we’re ready for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Michael Feniger with Bank of America. Please go ahead.

Michael Feniger: Hi. Thanks everyone for taking my question. I just want to start off with the Americas. Seeing the investment there, obviously margins came down a little bit. It’s just interesting to see AECOM making business development investments at this part of the cycle. Like what does it suggest that you guys are seeing in the pipeline? How that’s informing your thoughts really, on the growth outlook into 2025? And what’s kind of the timeframe should we think about this incremental investment that’s coming, the business? Is this something we should expect also maybe in Q3, it’s bracketed in the second half, just helping to get in front of what you guys maybe are expecting to see growth wise in 2025. Any help there would be helpful.

Troy Rudd: Thank you, Michael. So, let me start by saying maybe there is a different belief about where we are in the cycle. We seem to get this question and it indicates that maybe people believe we are late in the cycle. And what we’re finding is, in fact, we’re not late in the cycle. We view this as we’re in the beginning of some really long-term trends around the investment infrastructure. And so certainly the investments in traditional infrastructure, you see the appetite for it and you see the funding that’s available. But also there is investments in infrastructure that are just improving the sustainability and the resilience of that infrastructure. And we see that happening for a long period of time. And then beyond that, there is a large energy transition that is taking place.

And I won’t get into a lot of detail about that, but I will point out something like a win that we have in the UK, the UK Great Grid project, where there has been a long-term investment in actually renewables, and now there is a very large investment being made in making sure that that energy can actually transmit it to the communities that it will benefit. So we don’t really view this as we’re late in the cycle. We believe we’re early in the cycle. And then the other things that give us confidence are the fact that we’ve worked to expand our addressable market share. So, by building and investing in a program management advisory business, we’re actually exposing ourselves to significant more of our customer spend. And we think that has a long-term impact on us.

And then we are winning at an outsized rate. And so we believe that we’re taking market share. So it’s really all three of those things lining up together that give us really great confidence in the long-term and sort of in the midterm or the short term if you want to look at it in particular in the U.S., there is a budget that’s been put in place in March. So there is funding through the year. There is money that’s been put in place that will benefit the midterm. When you look at the IIJA and you look at the IRA, so there is certainly funding in the U.S. and then at the state and local level there is a lot of funding. But I also don’t want to give the impression that’s the only place in the world where there’s – it’s set up well and sort of the mid-term for us because when we look at Canada and the UK and we look at Australia, there are great long-term packages that have been put in place by those governments to invest in infrastructure.

And just to remind everybody, we did say that and we continue to say this, there’s 90% of our business is generated in those four markets. So again, we believe that we’re early in a long-term investment in the infrastructure cycle.

Michael Feniger: Thanks for that. And just to ask actually about the free cash flow to see in the quarter, I think it was positive $74 million. Is there anything one-time going on there? Or is this something where AECOM is kind of starting to smooth out that free cash flow profile? And just a follow-up with that. I think the first half of free cash flow is tracking above your target on the conversion rate. I’m just curious if some of the growth you guys are seeing maybe in program management advisory, is there a step function change where actually free cash flow can consistently track above that 100% conversion rate based on your end markets and the capital-light structure, if there’s anything we should kind of take away from that first half performance. Thanks, everyone.

Gaurav Kapoor: Hey, good morning, Michael. This is Gaurav. I’ll take that question. So there’s – first and foremost, there’s nothing unusual in the first half cash flow, including the second cap that we’ve generated. It’s consistent with what we’ve communicated when this management team took over. The culture that we’ve tried to percolate, and now you’re seeing it in our DNA in every facet of our results is of continuous improvement and cash flow phasing is also part of that. The second thing I would also say is in terms of what we expect and what we’ve committed to, remember, our guidance is 100% plus on free cash flow. And that’s been consistent with what we have historically delivered.

Operator: Your next question comes from the line of Jamie Cook with Truist Securities. Please go ahead.

Jamie Cook: Hi, good morning. Nice quarter. I guess two questions. One, as you think about winning larger projects and moving the business more towards program management. Can you just talk to what you’re seeing in terms of like the gross margin that you’re seeing in backlog? I’m just wondering if over time, there’s an opportunity for greater operating leverage in the business model as you move to some of these larger projects or more technical projects? And then my second follow-up question. Can you just talk about your capability in the grid T&D. It sounds like you’ve been winning some share there, maybe the market underappreciates the opportunity for you guys in utility transmission and distribution. And then wait, sorry, one last, you didn’t answer the last question.

The 50 bps on investment. Was that a pull forward? Or is that incremental? I’m just trying to see if you kept your guidance the same with incremental investment. I know that was a lot, but I was out for two quarters. So I gave myself an extra one. Thanks.

Troy Rudd: Jamie will give you the benefit of the extra question.

Jamie Cook: Thank you.

Troy Rudd: So I’ll take the first one. Lara will take the second one, and Gaurav will take the third one. So we’ll distribute. So first of all, with respect to program management, that business, we actually see it have very similar margins to what the rest of the design business has had over the years. But similar to the design business, we also see the margin improving over time. The one – I guess, I’ll say the one point about the program management business, and you described it, I think you made the reference to leverage, which is there certainly is leverage in that business because what we have found is that when you undertake a large program management project that over time for various reasons, that the workload will expand.