Aecom (ACM) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the AECOM's Third Quarter 2013 Earnings Conference Call. I would like to inform all participants that this call is being recorded at the request of AECOM. This broadcast is copyrighted property of AECOM. Any rebroadcast of this information in whole or part without prior written permission of AECOM is prohibited. As a reminder, AECOM is also simulcasting this presentation with slides at the Investor section at www.aecom.com. Later, we will conduct a question-and-answer session. I would now like to turn the call over to Lynn Antipas Tyson, Senior Vice President, Investor Relations. You may begin.

Thank you, operator, and good morning, everyone. I'd like to remind you that today's discussion contains forward-looking statements based on the environment as we see it today and, as such, does include risks and uncertainties. Our actual results might differ materially from those projected in those forward-looking statements. Please refer to our press release or Page 2 of our earnings presentation and to our reports filed with the SEC for more information on the specific risk factors that could cause actual results to differ materially. Note that we are using certain non-GAAP financial measures as references in the presentation. The appropriate GAAP financial reconciliations are posted on our website. Please also note that unless otherwise mentioned, all percentages refer to year-over-year progress. Before we get started, I'll note that as part of our Investor Relations outreach, Mike Burke and Steve Kadenacy will be presenting at the D.A. Davidson conference in San Francisco on September 10. The presentation will be webcast, and a copy of the presentation and transcript will be posted on the Investor Relations portion of our website. Beginning today's presentation is John Dionisio, Chairman and Chief Executive Officer. John?

Thanks, Lynn. Good morning, everyone, and thank you for joining us today. With me are Mike Burke, President; Steve Kadenacy, our Chief Financial Officer; and Jane Chmielinsky, our Chief Operating Officer. As you saw in our press release, we reduced our full year fiscal 2013 EPS guidance range to $2.30 to $2.40. This is due primarily to the performance of our business in Australia, which has been significantly impacted by the decline in the Australian mining industry and its effect on all of our end markets in the region as capital programs have been either delayed or put on hold. In addition, year-to-date, our Americas revenue has been flat due to persistent delays in projects being converted from awarded to contracted backlog. This is despite a 23% increase in gross revenue wins. We finished the quarter with $16.8 billion in backlog, up 6%, including $1.9 billion in new wins. We made targeted investments in key hires and niche acquisitions in the emerging geographies, which support a strong growth in Europe, the Middle East, Africa, China and the rest of Asia. In a challenging growth environment, our performance during the quarter was supported by the capital management of our operations, our commitment to improve profitability and liquidity and our disciplined approach to capital allocation. We also benefited from a broad span of our global footprint and increasing growth in emerging geographies. During our prepared comments, Steve, Mike and I will dive deeper into our performance and outlook, and we will also cover the steps we continue to take to optimize our performance and drive organic growth. I now turn it over to Steve.

Thanks, John. Please turn to Slide 5. In the quarter, we executed well on our cost and productivity initiatives, which contributed to improved operating margins. In addition, our free cash flow conversion remained strong. Gross revenue declined 1% while net service revenue was down 6.6% to $1.2 billion. Organic NSR on a constant-currency basis was down 9%. These declines were primarily driven by Australia, the Americas and our MSS segment, which I will expand on later. New wins and backlog remained healthy. As we've mentioned, however, the time to convert backlog to NSR is lengthening. Part of this is driven by the favorable mix shift to our higher-margin construction services business, which has a longer average project life cycle, and part of the lengthening is driven by more cautious approach to project starts in the Americas. Backlog of $16.8 billion was up 6% year-over-year and down 2% sequentially, partly due to currency. Operating margins of 9.1% were up 128 basis points year-over-year and 263 basis points sequentially. On a year-over-year basis, the impact of the decline in NSR was more than offset by improved profitability in MSS and cost control generally. Cost control also benefited margins sequentially. Our tax rate for the quarter was 29.9%. During the quarter, we completed a restructuring that resulted in the return of $148 million of foreign cash, which increased our tax rate by 490 basis points. The impact was roughly 500 basis points lower than we originally anticipated. EPS in the quarter was $0.70, up 11%. Please turn to Slide 8. Looking at PTS. Gross revenue was flat while net service revenue was down 5.4%, primarily driven by the declines in Australia. Americas also contributed to the decline in NSR, which John will elaborate more on in his comments later. Despite the impact of…

Thanks, Steve. Please turn to Slide 14. Let me give you an update on the investments we have made through our balanced capital allocation strategy with a focus on how these investments are driving new business opportunities for AECOM. As Steve already mentioned, share repurchases has been the largest use of capital this year, so I will focus my comments on our organic investments and niche acquisitions. Our organic investments allow us to expand the breadth and depth of our offerings to our clients. As you know, a key focus for us is to increase penetration in our top 100 major private and multinational clients. Every year, we estimate these clients invest over $150 billion in CapEx that is addressable by AECOM. These clients span many industries, such as oil and gas, manufacturing, sports, health care, et cetera. The common thread among these large multinational clients is that they are looking for a multinational partner, such as AECOM, to provide integrated delivery around the globe. Our geographic footprint and breadth of service offerings position us well to capitalize on these opportunities. To capture this expected spend and increase our market share with these clients, we continue to invest in the expansion of our key account management program. Through this program, we bring to bear our global capability to provide integrated solutions to these large multinational clients. Examples of these developing approach are recent wins with GE, Shell and ExxonMobil. Early results from this initiative are encouraging with higher levels of growth and profitability from the clients now in the program. Over the next year, our key account management program will continue to allow us this expansion across a broader group of multinational clients across various segments and geographies. The next area of investment is AECOM Capital, which we launched earlier…

Thank you, Mike. As I mentioned in my opening remarks, our business in Australia and the shortfall in growth in the Americas have been the 2 largest contributors to the reduction in guidance for the year. That said, our business in our other geographies remain strong as evidenced by our gains and wins in backlog. To give you a better picture of our geographies, I'd like to spend the next few minutes describing our business in the Americas, EMEA and APAC. Please turn to Slide 15. Let's start in the Americas. Year-to-date, the region accounted for 60% of gross revenue and 50% of net service revenue. Year-to-date, gross revenue was flat. Growth in this region remains challenging due to industry-wide delays in projects being converted to contracted backlog, particularly in our civil infrastructure markets. Our confidence in future growth for this region is supported by over $4.5 billion in gross revenue wins year-to-date, up 23%. Wins in our construction services business, which are best measured in gross revenue, have doubled year-to-date, driven by a rebound in residential and commercial spending in the northeast. And wins in our design business, which are best measured in net service revenue, are up 8% year-to-date, supported by growth in each of our major end markets. Please turn to Slide 16. Year-to-date, our Asia Pacific geography, which includes China, the rest of Asia and Australia, New Zealand, represented 19% of our gross revenue and 26% of our net service revenue. Asia continues to be a strong market for our -- for AECOM and we benefit from significant investments in civil infrastructure, as well as health care. Net service revenue for Asia Pacific, excluding Australia, was up 18% in the quarter and 21% year-to-date. In Australia, net service revenue was down 26% in the quarter and…

[Operator Instructions] Our first question online comes from Mr. Andrew Kaplowitz from Barclays.

John, so slow conversion of backlog in the Americas has seemed to be an issue for a while now, and it seemed like it's gone a little worse in the quarter. I guess the question is, why and where in the business has it gotten worse? Is it because nonresidential, the private side, has slowed down a little more than you would have expected? Or maybe any more color you can give us on the slow conversion of backlog would be helpful.

Yes. I think the -- there are 2 things attributed to the lower-than-expected net service growth in the Americas. One is that a larger percentage of our work is on our higher-margin construction services projects, which have a longer tail in turning into awarded backlog. But in our traditional design business, we, here, in the United States, still are under the influence of a very sluggish economy. The growth areas are in states like New York, California, Texas, Florida, New Jersey, which have start projects because they have dedicated fundings, either through tolls, taxes or bonds. But in the other parts of the country, it just takes longer to get these projects started. And what's happening -- we're finishing projects, okay. So we're finishing projects, and the new projects are not coming onboard. And that's what I think is exasperating the problem as we see it now. But again, what frustrates us is that all being said, we continue to win work and we're making significant investments in winning work. Our gross revenue, as I mentioned, was up 23% year-to-date, and we have in backlog $4.5 billion. So if you just look at it from that perspective, we say, "Wow! That's a real healthy business, and it should be going like gangbusters." But what we're finding out is there's just these delays, which are really frustrating for us. Overall, when we look at in '13, our PTS and construction services business, altogether, have $9.5 billion in total backlog.

John, that's helpful. Maybe if we could shift to MSS. Could you talk a little bit more about that business? And maybe Mike could chime in. It seems like revenue now is sort of on this slowly declining pace. Is that how we should think about it as we go into 2014 or maybe a flattish business? And we know the margins have continued to rise. Can that trend continue? And then just one point of clarification on the MSS backlog. It looks like you moved awarded -- you moved contracted backlog back to awarded. Could you talk about that?

Yes. Let me -- before I turn it over to Mike. I think there is -- when you look at the net service revenue, it looks like it's going down. But it's probably good news because we're closing out some of the low-margin projects. And as Mike will explain, the -- our profitability, as a result, has increased.

Yes. Thanks, John. Yes. When you look at the NSR revenue, obviously, NSR revenue is declining in the quarter. Much of it is attributable to the completion of contracts that were not very profitable for us. So what you're seeing is us burning off and closing out contracts that weren't as profitable. And as we continue to shift our diversification efforts towards more profitable contracts, you see our operating profit up significantly. And as you heard us say before, our profits in -- for the full year will be double what they were in FY '12. So we're continuing to diversify that revenue to more profitable work, and so that's the good news. But there is a continued challenge in Washington around the uncertainty of sequestration. And while sequestration is only expected to create an 8% to 10% cutback in federal budgets, there's some uncertainty right now about where the money will fall and which line items of the budget, which are slowing awards just a bit. So that's what we're seeing right now. With respect to the backlog, it wasn't a move from one to the other, but rather government shifting from 2 contracts, both of them within the overseas contingency operations, theaters of Iraq and Afghanistan. One contract came down and another one came online. So it's just a matter of shifting government priorities from one battle theater to another.

Mike, does that mean that one -- I mean, it looks like there's a big shift, right? So I mean, it's like $500 million, $600 million. Did they take one and say, "Hey, we don't want you to do that." And then give you another one or award you another one, like how would that work? Because it's a big number, it seems.

Yes. It's one contract going down. And Department of Defense money is being allocated to a new region, both of them in the foreign theater.

Our next question online comes from Tahira Afzal from KeyBanc Capital Markets.

I guess my question is, as you look out past this year and you look out to this prospect, especially of the government sector, how do you see 2014? What variances do you put around that? And how proactive can you be if the business continues to be slow on the public sector side? I am more hopeful on the private sector side, but it's more the federal aspect that I'm a little worried about.

So let me take that from a couple of angles. We're not prepared to give guidance on FY '14 yet. But what you heard John say earlier portends well for '14, which is the significant increase in wins. And so we're being successful in the marketplace, pursuing work and winning work, and ultimately, it will convert to revenue. It's just a little slower than expected. So while we're not prepared to give guidance on '14, you could read a lot into, as John likes to say, the barometer of wins. That gives us -- that's the most current signal for the future, and that looks good. With regard to government budgets -- I think you were referring to federal government budgets. As I mentioned, the drop-off in new awards in Washington is greater than the expected decline in government budgets through sequestration. So our view is that there is a temporary decline in awards that is greater than the ultimate reduction in budgets that we will see. And that is simply due to the uncertainty of where the money will fall by line item in the federal budget. So our sense is that right now, the awards are a little slower than they will be coming into '14.

Tahira, let me expand on it a little -- more global position, because we seem to be focusing on the Americas.

Sure, sure.

Australia, this year, we will have about $14 million in severance, which would account for about $0.10 earnings per share. We will not have that next year. We believe we stabilized the organizational structure. We -- the $10 million -- the $14 million represents over 1,000 people, which we've excessed. So going forward, we feel that we've gotten Australia, in '14, back on a healthy footing. And then you look at the growth that we have in APAC, where we need to -- in the Middle East alone, we need to hire 3,000 people, okay. So -- and that -- and those people could come from our India operations, from the U.K., Europe. And then we -- then just look at the backlog that I mentioned to Andy that we have is, in the Americas, $9.5 billion of backlog, which is up 4% year-over-year, and the total backlog for the company is $16.8 billion. So all the signs of future opportunity and growth are positive. The key will be, here, in the Americas, will we move in the public sector. The private sector has grown. And when we're looking at, for instance, private sector in Northeast or in the New York area, anyhow, it's about 30% increase in residential and commercial real estate. And with the transportation bill, with the new Secretary of Transportation saying that they're going to have 7 public-private partnership contract -- projects coming out this year or next and with the amount of TIFIA money, which has increased 500% from the previous transportation bill, which is now -- it creates about 1.5 -- $1.75 billion, I think there are good signs on the horizon. But as Mike said, we're not prepared to give guidance today. But 3 months from now, we'll be giving you guidance, and I think we'll have a clearer picture over the next 60 to 90 days on what's happening.

Our next question comes from Mr. Steven Fisher from UBS.

We've thought about the AECOM story as being very much cash flow improvement driven and return of capital driven, and I think that holds as long as sort of organic growth holds in line. But kind of broadly speaking on the Professional Services side, in particular, it continues to deteriorate, down another 1% this quarter. It was down 7% last quarter, down 8% Professional Services. So I guess my question is, what are you anticipating that metric does over the next couple of quarters, and how are you preparing for that right now?

Well, if you -- from a previous phone call, I mentioned that what we see is growth opportunities in super geographies of Asia, Asia Pacific, and that -- well, we're growing in the Middle East and that the question is in the Americas. We believe that we will get some positive growth in the Americas. But when you look at today, without Australia, our net service revenue is flat. On -- Australia has been a major impact on us. I'd say just from the redundancies, it's $0.10 on the earnings per share. So if we didn't have that redundancy, we would also -- if we didn't have that redundancy, we would've also had a significant increase in their bottom line. So my point is it has put an enormous amount of pressure on AECOM to deliver the top line growth as opposed to bottom line growth that we had anticipated.

Okay. So to be clear, it sounds like you're not anticipating any further deterioration, going from 3% to 7% to 8%. We kind of get a little better from here on that metric?

Yes.

Okay. And then in terms of -- maybe I missed this, but the Afghanistan. I know that's -- you got some good exposure there. Another company in the industry was talking about they're seeing the LOGCAP activity weaken already. I guess I'm wondering what are you seeing in that business and what are you doing to plan for that now.

Yes, sure. Right now, Afghanistan is actually picking up a little bit. We don't -- we just think that's a short-term blip, frankly. But Afghanistan, our operating income out of Afghanistan is about 3% of our total operating EBIT. So just to put in perspective, it's about 3%. That business is going to be dependent on what happens in Washington, frankly. As we know, the status of force agreement predicts a drawdown at the end of '14, and there are discussions about how many troops will be left for the 10-year status of force agreement that goes on after '14. So that's going to depend on which way the wind blows in Washington and how fast or how extensive that drawdown is. But what are we doing to respond to that 3% of our business that, ultimately, the -- at some point in time will go away, we won't be in Afghanistan forever, we have to have -- put an incredible effort into our diversification efforts. So for instance, the State Department and the work we do for USAID in Afghanistan is growing. As we draw troops down, we start spending more money with the State Department on stabilization of the country that's non-troop related. So we are investing, and we're growing our business in USAID. We are growing our business in non-Department of Defense work here in the U.S. We have grown our work in the cyber intel Homeland Security and other government agencies outside of Department of Defense. And we're also focusing our efforts on foreign military sales, where we have opportunities with foreign governments that are purchasing military assets from the U.S. government, and we are bidding on programs to support that. So it's -- Afghanistan is not as big of a part of our business as you might think, and we are very focused on that drawdown and very focused on diversifying of our efforts in the U.S. government space.

Our next question online comes from Mr. Justin Hauke from Robert W. Baird. Justin P. Hauke - Robert W. Baird & Co. Incorporated, Research Division: So I guess my question is on the free cash flow commitments. Is the target -- is it greater than net income this year, or is it still an 80-day DSO target? And if so -- I guess -- I mean, does that -- if you get to 80 days, is that like -- I mean, should we be thinking of another $200 million of free cash flow just from getting to that target, or what's the goal now?

Well, Justin, our primary goal is free cash flow. DSO is a mechanism to get us to the free cash flow numbers that we're targeting. But it's not always a perfect indicator, because there's a lot of ins and outs on the DSO calculation. Revenue, for instance, when it's increasing or decreasing can drive that days. But our goal to exceed net income, we're well on track. We're doing it on a quarterly basis. Our goal is to do it on a full year basis, and we will exceed that for the full year. Whether or not we hit 80 days exactly, we're still targeting that, and we think it's achievable next quarter, at the end of the next quarter. But that's just where we think we should run the business. Ultimately, looking at the free cash flow is where you need to see. Justin P. Hauke - Robert W. Baird & Co. Incorporated, Research Division: Okay. And then I guess my next question, just -- in the quarter, the equity income in the PTS segment, it was pretty light relative to where it's been. Was there anything onetime there, or is this the run rate we should think about at this level going forward?

See, in the PTS segment, you'll probably see a rebound in that in the fourth quarter. There was a -- one of our JVs in the Middle East had a little bit less income than it typically does. But that's a line that we tend not to overly focus on because the accounting rules have us consolidating JVs -- or unconsolidating them and bringing them to the equity line based on the accounting rules. And so it's really better to look at PTS at the bottom line.

Our next question online comes from Mr. John Rogers from D.A. Davidson. John B. Rogers - D.A. Davidson & Co., Research Division: Just, John, I guess or -- could you talk a little bit about what you're seeing in terms of pricing in the market? Any changes there either by region?

I think on a global basis, it is becoming an increasingly more competitive market. Probably, the most competitive is in the Middle East, where there's enormous amount of capital programs, but it is very competitive. Here, in the Americas, we haven't seen much of a change over the past -- this 2 years. It has -- since the recession, it had become more competitive, and it hasn't changed. It hasn't gotten any more seriously competitive. Our margins are remaining constant. And in -- and when we look at Asia and China, they're remaining about the same. There's more competition in Southeast Asia, but our margins are remaining constant. And through some organizational controls and organizational restructuring, we have been able to, overall, as a company, improve our bottom line EBITDA margins. John B. Rogers - D.A. Davidson & Co., Research Division: And as you look out -- I know you're not giving guidance for 2014. But presumably, the mining business is going to continue to stay difficult and it's got relatively stable margins. Where are the market opportunities for AECOM 2014, 2015 that you can either grow into organically or acquisitions?

Okay, that's a good question. For one thing though, I mean, the mining market is a -- what is it, chicken or an egg. The -- I think the real catalyst of the mining market deteriorating was the slowdown in China with their GDP growth. Even though it's strong, it did have -- it was reduced, then it did have an impact on Australia's mining market. And as a result, the Australian economy softened. And so it wasn't only the mining business that was hurt, all our markets, the civil infrastructure markets, the building markets. But on a good note, I mean, we just won a freight rail job from -- going from mining -- mine to port in South Africa, where we're able to utilize our capabilities in Australia. So there are places where there are investments being made in mining. I can't emphasize the opportunities in the Middle East. It's -- right now, it's an incredible market. Since the quarter's end, we just were awarded the Riyadh metro project, which is a 50-kilometer, 25-station capital program, $15 billion in Saudi Arabia. So -- and as I said, we need to hire 3,000 people over the next several months. And the other thing when -- if you recall, Mike's prepared remarks, is our AECOM Capital, where we partnered with some very, very distinguished developers in the investments where we will do the design and the construction of these facilities. And, Mike, maybe you want to go into a little bit more detail on. And I think that's the wave of the future for a good portion of our business as we grow our construction services piece.

Yes. There's a comment earlier about the private sector, and probably the hottest market right now in the United States is the private sector residential multi-family construction or otherwise known as apartment buildings. We are seeing a lot of activity in that space. And through AECOM Capital, as I mentioned, just in the first year of that initiative, we will add $750 million of construction revenue backlog to AECOM in that market. So we're seeing a lot of opportunity in that market. We're seeing a number of things from that. First of all that when we bring some capital to the table, and you don't need to bring a lot of capital to the table here, but when you bring capital to the table, your sales efforts, your sales and marketing costs are much lower. So we drive higher margins, and we have a different seat at the table than we do if we are just a service provider. So we're fairly bullish on that market and that opportunity.

Did that answer your question, John? John B. Rogers - D.A. Davidson & Co., Research Division: Yes, it helps. I mean -- I guess what I was struggling with is back comments a little earlier about still slower organic growth, flat margins and investing a lot of free cash flow back into share repurchase. I'm just trying to think about the growth over the next couple of years, how that gets revived.

Look, John, I think as John mentioned earlier, to be clear, that without the Australian declines, we had flat revenue. So -- and on top of that, we had a 6% increase in our backlog year-over-year. So we are adding wins to the backlog with -- the mining sector, as fast as it turns down, it comes back just as fast. There's a very fast on-off spigot on mining CapEx as you know. And so we think that Australia, the mining sector, will come back. It always does. It's just a matter of time. And the rest of the business, while it had -- it was flattish, the wins were up. So that's how we see it coming back.

[Operator Instructions] Our next question online comes from Sameer Rathod from Macquarie.

A couple of quick questions. Can you comment on the receivables? I know in prior quarters, you generated cash by selling receivables. And as a follow-up to that, can you comment on what percent of your cash flow over -- in the past year has been generated by selling receivables?

During the quarter, it was about $9 million net. Without the sale of receivables during the year, which was about $65 million net, we would still be around 90% of our net income. So really, the sale of receivables is to help us balance that cash-out throughout the year, and it's been quite effective in doing so.

Okay. I guess my next question is on organic growth. If I look at your new orders by quarters over -- since 2008, over the past 5 years, it seems like they're pretty stable, call it, between $1.5 billion to $2.5 billion, but during this time, AECOM has done several large acquisitions. So you would -- I would expect the orders would be greater than the stable range. Does this mean organic growth has been negative in this time?

If you're going back to 2008, I don't have that much history at my fingertips, but we did experience a decline in NSR in the past year. We had a very slight negative organic growth during that period. So the answer to that question I think is, yes, over the immediate past, but I can't comment going back to 2008.

Okay. Well, I guess my only point is if you had done several acquisitions, you would expect a proportional increase in new orders, but it seems like orders have kind of been stable. It doesn't even have to be back to 2008. But even if I go back to 2009, 2010, 2011, it seems like the orders are stable but you're doing lots of acquisitions. So I just -- to kind of understand the organic growth behind some of these acquisitions that you've done. That's all.

Well, again, just speaking for the current year, our organic year-over-year backlog growth is 4.4%. That's organic.

And at this time, I show no further questions. I now turn the call back over to Mr. John Dionisio for closing remarks.

Okay. well, first of all, I want to thank all the people calling in and their interest in AECOM. But before we close the call, I wanted to reinforce our confidence in our future growth, which is based upon the operating controls that we have put in place, that we're confident we'll achieve our earnings growth in the future despite any lingering sluggishness in the global macroeconomic headwinds. And second, we remain to have -- remain having a persistent focus on cash and liquidity, which will give us the flexibility to continue to invest in profitable growth while also returning cash to our shareholders. And lastly, the fact that where we stand today, with an increase in our gross total backlog, up 4% from FY '12 third quarter to FY '13 third quarter, with a number of $9.5 billion and with the growth in the Americas of up to 23%, I mean, we have all the -- I believe we have all the tools and -- at our disposal to have organic growth and continue to grow and be successful as we look into FY '12. So with that, I want to, again, thank you all for joining us, and I look forward to speaking to you all in about 90 days. So thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.