AECOM : Value Creation Update Transcript 117.4 KB

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AECOM Value Creation Update

EVENT DATE/TIME: JUNE 17, 2019 / 12:00PM GMT

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JUNE 17, 2019 / 12:00PM GMT, AECOM Value Creation Update

CORPORATE PARTICIPANTS

Michael S. Burke AECOM - Chairman of the Board & CEO

Randall A. Wotring AECOM - COO

W. Troy Rudd AECOM - Executive VP & CFO

Will Gabrielski AECOM - VP of IR

CONFERENCE CALL PARTICIPANTS

Andrew John Wittmann Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

Jamie Lyn Cook Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst Michael Stephan Dudas Vertical Research Partners, LLC - Partner

Steven Fisher UBS Investment Bank, Research Division - Executive Director and Senior Analyst

Tahira Afzal KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst

PRESENTATION

Operator

Good morning, and welcome to today's AECOM Conference Call. I would like to inform all participants 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 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. (Operator Instructions)

I would like to turn the call over to Will Gabrielski, Vice President, Investor Relations.

Will Gabrielski AECOM - VP of IR

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 are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation, which is posted on our website. Our discussion of financial performance and guidance refers to adjusted financial metrics as defined and reconciled in today's press release and the presentation accompanying this call. Beginning today's presentation is Mike Burke, AECOM's Chairman and Chief Executive Officer. Mike?

Michael S. Burke AECOM - Chairman of the Board & CEO

Thank you, Will. Joining me today are Randy Wotring, our Chief Operating Officer; and Troy Rudd, our Chief Financial Officer. I will begin the call with an overview of the proposed spinoff, Troy will review preliminary financial details, then Randy will provide an overview of the government services business and its competitive advantages that have contributed to double-digit revenue growth over the last 3 quarters and a record backlog position. We'll then conduct a question-and-answer session.

Please turn to Slide 3. This morning, we announced that the Board of Directors has unanimously approved the plan to pursue a spinoff of the company's Management Services segment into a stand-alone government services business. Upon completion, the business will continue to be a leader with scale in the fragmented government services sector with $4 billion of trailing 12-month revenue, a record $20 billion backlog and a more than $30 billion pipeline of pursuits.

The business has strong capabilities across the U.S. Departments of Defense and Energy, which account for approximately 75% of the revenue. In addition, the business has growing exposure to intelligence and cybersecurity markets, a robust classified business with high barriers to entry, long-duration contracts and more than 10,000 employees with security clearance. These are all competitive advantages that have contributed to our success.

This announcement builds on the value-enhancing actions we have taken and continue to take and is part of our ongoing comprehensive strategic and financial review to maximize long-term value.

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JUNE 17, 2019 / 12:00PM GMT, AECOM Value Creation Update

As we conducted this review, it was clear to us that through a spinoff, both AECOM and the stand-alone government services business could unlock value from a sharpened strategic focus and an ability to pursue growth strategies best suited to each company's businesses, end markets and strategic growth objectives.

Please turn to Slide 4. The spinoff is expected to benefit all stakeholders by creating 2 companies with unique and compelling investment attributes and by positioning both companies to operate with a honed focus on their respective core markets to drive long-term strategic and financial success. Each company will also benefit from having dedicated employees with a sharpened focus and incentive plan opportunities that are directly aligned with each company's business objectives. And both companies and their respective clients will benefit from targeted investments in their respective core capabilities to support their long-term growth ambitions.

Specific to the stand-alone government services business, we expect a number of benefits that create a compelling investment thesis. First, the business will position to scale in the highly fragmented and rapidly growing government services market. This scale, which is the result of several years of heightened organic growth investments and a win rate of approximately 50% over this period, has resulted in a consistent ranking as a Top 20 government services business by Bloomberg and Washington Technology.

Second, the business will benefit from a sharpened focus on its core capabilities, enabling the company to direct capital for the best growth opportunities with the highest return potential. The business will also be in a position to participate in the ongoing consolidation of the government services sector to enhance its value proposition to clients and to expand its share of client wallet by adding complementary capabilities over time to its already strong platform.

Third, the business will be able to pursue a capital structure and capital allocation policy optimized for a low-risk profile and consistently strong free cash flow generation. Fourth, the business will benefit from a Board of Directors with specific backgrounds and experiences tailored to the business.

Lastly, the business will be positioned to attract new investors. Valuation multiples in the government services market are near all-time highs and new investment opportunities have been scarce. We expect investors to be able to better value a stand-alone investment and recognize the strong team, consistently strong business performance, lower risk profile, above-peer growth rate and consistently strong cash flow.

Please turn to Slide 5. The Management Services segment is in the strongest position possible to continue to build on its momentum as a stand-alone government services company. This strength followed several years of investments in growth. Backlog has increased by 127% since the start of fiscal 2017. Organic revenue has increased by double digits in each of the past 3 quarters, and we have a $30 billion pipeline of pursuits and expect the Department of Energy to award more than $30 billion of projects in the coming years that the business is ideally positioned toward.

These successes and solid execution have resulted in 18% year-over-year adjusted operating income growth in the first half of fiscal 2019, which underscores our confidence in the future. It is one of our top priorities to ensure that we continue to deliver for our clients. To this point, today, we have also announced that John Vollmer and the existing leadership team are expected to continue to lead the business. In addition, Randy Wotring is expected to be named Chairman of the Board of Directors. These executives have a long history of excellence with AECOM and predecessor companies and their continued leadership adds to the expected high level of continuity and certainty. In addition, the business has maintained many independent systems, which simplifies the separation process.

Please turn to Slide 6. The decision to separate Management Services segment into a stand-alone government services business is part of an ongoing commitment to maximizing growth and long-term value and build on the many value-enhancing actions that we have taken over the past 2 years and that we will continue to take as we go forward. These actions include stock repurchases under our $1 billion Board authorization, the already executed $225 million margin-enhancing G&A restructuring plan, our ongoing exit from hard-bidfixed-price construction markets, our plan to exit from more than 30 countries to hone our focus and our decision to no longer pursue at-risk construction work in international markets.

Importantly, we are off to a strong start in fiscal 2019, and today, we reaffirmed our fiscal 2019 financial guidance as well as the

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JUNE 17, 2019 / 12:00PM GMT, AECOM Value Creation Update

long-term forecast through fiscal 2022. These include at least a 5% revenue CAGR, 9% adjusted EBITDA CAGR, 12% to 15% EPS CAGR and at least $1 billion of adjusted EBITDA in fiscal 2020.

With that, I will turn the call over to Troy to discuss a few financial details and key milestones we are tracking. Troy?

W. Troy Rudd AECOM - Executive VP & CFO

Thanks, Mike. Please turn to Slide 8. We're excited about today's announcement and the prospects for long-term value creation. Importantly, as Mike detailed, both companies and all stakeholders stand to benefit. The stand-alone government services business is expected to have approximately $4 billion of revenue and a 6% adjusted operating margin in fiscal 2019 and strong prospects for continued growth. We expect that on a stand-alone basis, profitability will be upwards of 5% higher, inclusive of estimated public company costs.

Over time, we expect profitability will be further enhanced through a dedicated growth strategy, prudent capital allocation and hurdle rate specific to the government services business as well as incentives that most closely align employees with their performance.

With respect to a few key points from the transaction. First, we expect the spinoff to be tax free to AECOM and AECOM shareholders for U.S. federal income tax purposes. The transaction is subject to certain customary closing conditions.

Second, we expect to complete the spin in the second half of fiscal 2020. Importantly, the business will be further delevered at this point, positioning both companies for success. Third, both businesses are expected to be capitalized with ample liquidity to support their operations and strategic investment plans. We expect the stand-alone government services business' strong free cash flow will enhance financial flexibility to pursue growth and to return capital to owners.

Finally, we expect to address any stranded corporate costs and other overhead costs that result from the separation over the course of this next year. We do not expect any earnings dilution associated with stranded costs.

Please turn to Slide 9. I want to underscore that the strength and quality of the new entity's cash flow will support the company's day 1 capital structure plan and long-term value creation opportunity. The stand-alone business' largest client is the U.S. Federal Government, which accounts for approximately 93% of revenue, is growing and is less susceptible to macro variability and cyclicality.

DSOs in the business typically run between 50 and 60 days, which result in a very strong cash flow conversion cycle. On a normalized basis, adjusted EBITDA converts to unlevered free cash flow, after excluding cash flow from noncontrolling interests, at more than 80%, and cash flow is typically well in excess of net income. This is expected to provide the stand-alone business with financial flexibility to pursue growth ambitions and potentially return capital to owners.

Please turn to Slide 10. The stand-alone government services business has built a record backlog position over the past several years. The win rate remains high, and we have won longer duration work in the classified sector, where barriers to entry are high. This visibility is especially valuable in the government services sector as it limits the impact from short-term budget fluctuations. Importantly, our more than $30 billion pipeline of pursuits positions us well for additional backlog growth and added long-term visibility.

Please turn to Slide 11. As Mike noted, we are reaffirming all fiscal 2019 financial guidance today, including 12% adjusted EBITDA growth at the midpoint of the range. We continue to expect adjusted EBITDA in fiscal 2020 of at least $1 billion. Based on our record backlog and strong momentum across our markets, we anticipate growth across the entire portfolio next year.

With that, I'll turn the call over to Randy.

Randall A. Wotring AECOM - COO

Thanks, Troy. Please turn to Slide 13. I've been a part of our government services organization for more than 35 years, serving in many different functions, including in the leadership position from 2004 until my appointment as Chief Operating Officer of AECOM in 2017. I can confidently say that this business has the people, systems, capabilities and entrepreneurial culture to continue to be a leader in the

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JUNE 17, 2019 / 12:00PM GMT, AECOM Value Creation Update

aerospace and defense sector.

As such, I am looking forward to serving as the Chairman of the Board of the stand-alone business upon completion of the separation, and I'm excited to be joined by John Vollmer and the existing Management Services leadership team that is expected to remain in their roles. The business is as energized as ever to deliver on its financial and strategic initiatives in the near term and by the opportunities created as a stand-alone company.

Mike and Troy have already detailed the strong recent financial performance of the business and the technical aspects of the separation. I will speak briefly about end-market trends, our competitive differentiation in the marketplace and long-term growth priorities. Following several years of investments in our capabilities and in business development, MS is poised to succeed as an independent company and capitalize on its many strengths. We have built an industry-leading record of safely executing our clients' mission, which has been made possible by the use of innovative technologies to enhance our offering and more efficiently deliver our work.

In addition, we have developed a critical mass of highly qualified personnel, including more than 10,000 people with some level of security clearance, which is an important qualification for many of our customers and the programs we support and is a key differentiator and competitive advantage.

Please turn to Slide 14. As we look at current market dynamics and our strategic growth priorities, it is clear that we are in the early innings of what we believe will be a sustained upcycle for spending across our markets. For the Department of Defense, which accounts for approximately half of the business' revenue, priorities are aligned with markets where we are poised to benefit, including growth in cybersecurity and intelligence and underlying strength across their markets. The President's fiscal 2020 budget calls for another strong increase in defense spending. Discussions are underway between the House and Senate on another 2-year budget agreement to avoid caps on spending under the Budget Control Act and to provide certainty for our clients and service providers.

Importantly, our business was not materially impacted during the last government shutdown and most of our work is considered essential, which limits impacts during periods of funding uncertainty.

For the Department of Energy, which accounts for approximately 25% of revenue, demand is strong, and we are pursuing 2 growth paths. First is the high level of bidding activity we are seeing and expect to see for several more years in the environmental management program for the Department of Energy. We have 2 major bids submitted at Hanford, including a substantial takeaway opportunity with decisions expected this summer. And we are pursuing several other environmental management large opportunities.

Second, we are actively seeking opportunities to expand the DOE practice into the NNSA market. We were recently awarded similar work in the U.K. for the Atomic Weapons Establishment, which underscores client recognition of our capabilities. We expect to pursue a number of Tier 2 opportunities ahead of a larger Tier 1 opportunity in the coming 3 to 5 years. We're also leveraging our leadership position in the DOE decommissioning market into the commercial market. We are executing on the more than $1 billion decommissioning of the SONGS nuclear plant in California and expect to play a key role in the $200 billion plus global opportunity set, as the majority of existing nuclear reactors reach or exceed their original end-of-life dates.

Importantly, the business has a solid foundation for growth, both in existing and new markets. We are actively expanding our cyber and intelligence market capabilities, pursuing international growth opportunities as demonstrated by our U.K. Atomic Weapons Establishment win and a recent selection for a framework contract at the Dounreay site in the U.K. and through other organic investments. The stand-alone government services business will have the financial flexibility to balance returns of capital to owners and to pursue complementary acquisitions over time.

With that, I will turn the call over to Mike.

Michael S. Burke AECOM - Chairman of the Board & CEO

Thanks, Randy. Before turning the call over to Q&A, I want to thank the senior leaders and all employees at AECOM for their contributions to our success over the past several years. Through their dedication to our shared success, we have delivered strong organic

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