Jacobs Solutions Inc (J) — Q3 2023 Earnings Call Transcript

Thank you. Good morning. Our earnings announcement and 10-Q were filed this morning, and we have posted a slide presentation on our website, which we'll reference during the call. I would like to refer you to Slide two of the presentation material for information about our forward-looking statements and non-GAAP financial measures. Turning to the agenda. Speaking on today's call will be Jacobs' CEO, Bob Pragada; and CFO, Kevin Berryman. We are also joined by our incoming CFO, Claudia Jaramillo. Bob will begin by providing an overview of recent activities and summarizing highlights from our third quarter results. Kevin will provide a more in-depth discussion of our financial metrics as well as a review of our balance sheet and cash flow. And Claudia will provide an overview of separation-related activities. Finally, Bob will provide details on our updated outlook along with closing remarks, and then we'll open up the call for questions. Before I hand it over to Bob, I want to address some reporting changes that were made in the quarter. We consistently review our reporting practices to be aligned with best practices for our industry and SEC guidelines. After review, we have decided to amend our name convention for revenue, excluding pass-through costs from net revenue to adjusted net rent revenue. Note, this is simply a name change intended to make the non-GAAP nature of this measure more prominent and does not impact measurement. In addition, after an internal review, we have made certain minor adjustments to pass-through revenues in certain prior periods to properly reflect amounts that had not been previously included. As a result, in the materials that we have included in the appendix to this presentation, we have adjusted People & Places adjusted net revenue for fiscal 2022 and fiscal 2023. Note, this change has been deemed as immaterial and has no impact on our reported earnings, operating income or cash flow. With that, I'll turn it over to Bob.

Thank you, Jonathan. Good day, everyone, and thank you for joining us today to discuss our third quarter fiscal year 2023 business performance. Turning to Slide four. I'd like to begin by recognizing the continued commitment and extraordinary talent of our 60,000-plus teammates here at Jacobs. I've now been in the CEO seat for over six months, and as I spend time with our clients and our people, I continue to be both inspired and appreciative of the dedication and world-class expertise they bring to some of the world's toughest challenges. Now more than ever, our communities require the brightest and best minds to step forward with innovative and technology-enabled solutions to drive better outcomes. I'm proud of all that we do to play our part to enhance and serve those communities. Firstly, I want to provide an update on our previously announced intent to separate the CMS business before I move on to our third quarter results. The company continues to make significant progress on the activities associated with the intended separation. In addition, following the announcement, there has been positive interest from multiple outside parties. We are currently evaluating this interest consistent with our commitment to maximize shareholder value. As previously communicated, a spin-off, which is subject to customary conditions, is expected to be completed in fiscal 2024. Let me reiterate, we are laser-focused on maximizing value for all of our stakeholders. As we progress towards the separation of CMS, our teams continue to work tirelessly to stand up both companies for independent success. In the process, we have identified a number of operational enhancements that we believe will propel each company to greater heights in the future. Consequently, we believe that fiscal year 2024 will be a year of optimization and acceleration. Turning to Slide five, on optimization, we see significant potential to enhance our cost structure and our operating model to continue to drive efficiencies and lead our industry, not just in size but in profitability. This will unleash a more cohesive Jacobs that leverages our digital platforms, consulting and advisory, and global delivery model to accelerate our value-creating growth. On acceleration, for many years, we have highlighted investments in growth, in our people, platforms, and technology-enabled solutions. We've invested behind and proudly managed a portfolio aligned with secular megatrends, critical infrastructure, water scarcity, sustainability, re-shoring, and energy transition. Our clients need us now more than ever, and we are delivering. Jacobs is driving higher growth, higher margin, differentiated expertise, and solutions. Our addressable market is growing, and we are already capitalizing on these opportunities. Turning to Slide six and Q3; I am pleased to report another record quarter as measured by both revenue and operating profit. Notably, our growth is entirely organic. And we continue to drive improving cash conversion, a hallmark of our business model, allowing us to invest behind our growth accelerators, climate response, data solutions, and consulting and advisory. Our People & Places line of business delivered accelerating top line growth with adjusted net revenue up 9% year-over-year and operating profit up 13% year-over-year. Kevin will detail the significant growth we're experiencing in our global business units. We continue to see broad-based green shoots with a gross margin backlog growth of 8% year-over-year. Our pipeline continues to grow faster than our top line, which provides visibility and confidence in our expectations that growth will persist at current rates. CMS remains a pillar of stability. CMS Q3 revenue was 7% higher year-over-year, and operating profit increased 12% behind 36 basis points of margin expansion. CMS continued to book awards at an over 70% win rate. Its pipeline and growth outlook remained robust with major award prospects in fiscal 2024 and minimal forecasted re-compete pursuits. As a result, the Jacobs team is advancing required flight software and hardware testing for the Artemis II missions scheduled for December 2024, the second scheduled flight of the program and notably its first crewed mission. In early July, an integrated team of NASA and Jacobs personnel at Marshall Space Center successfully completed the initial phase of formal qualification testing for the Artemis II SLS flight software, a very exciting time for all involved. PA Consulting sales and backlog once again increased year-over-year, led by sales in the energy and defense sectors. Margins stabilized in Q3 above 21%, supported by strategic cost actions taken during the quarter, and we continue to have the highest confidence in our talented management team. PA continues to see increasing opportunities in energy transition. For example, we assisted a leading offshore wind developer in securing a fixed-price electricity contract in Ireland's first offshore wind auction. PA is also seeing significant interest in its digital expertise from clients who are looking to assess AI-related impacts and opportunities for their businesses. As an example, a leading cybersecurity client hired PA to support the development of a comprehensive strategic plan with specific focus on understanding the power of AI and mitigating cyber threats. Our Divergent Solutions operating unit delivered a strong quarter with 3% adjusted net revenue growth and 72% year-over-year growth in operating profit. During the quarter, we won another competitive pursuit with the Ohio Department of Transportation to extend Streetlights Software-as-a-Service offering. Streetlight already provides statewide modeling and traffic analysis, safety programming, and support for large-scale planning efforts. This new contract is for congestion and freight management functionality to support the state's carbon emission reduction efforts. Turning to Slide seven; looking across the Jacobs enterprise, we continue to see considerable and geographically diverse opportunities in our greater than $2 billion water business. From water reuse to treatment to drinking water coupled with our innovative project delivery offering, demand remains robust. During Q3, we saw healthy growth behind water scarcity-related pursuits. For example, scope increases and new wins with our long-standing partnership with the Singapore Public Utilities Board. Underinvestment in future proofing needs also continues to be a major driver. In the U.S., we have been selected by a large Southern California utility agency to provide program management and strategic funding advisory services to create a more sustainable, drought-resilient local water supply for one of the largest groundwater storage bases. And in New Zealand, we were awarded an extension and expansion of our central interceptor program, the country's largest ever wastewater project. We also continue to see environmental and sustainability projects. For example, we landed a marquee $450 million award from the U.S. EPA's Great Lakes National Program Office and RegionFind Super Fund to provide environmental, technical management services, and associated infrastructure tasks in the Great Lakes area. We also see continuing momentum in legislation and aligned work. IIJA-aligned wins continue to accelerate versus the year-ago period. For example, we were awarded the Brent Spence Bridge, an iconic connector of economic development between Ohio and Kentucky, which has been postponed for many years. We continue to closely support the New Orleans Regional Transit Authority in their successful low and no emissions grant application and subsequent delivery services to provide energy-efficient buses and charging infrastructure. Turning to Slide eight, in summary, we are extremely well poised for this strong growth across sectors we serve, building off our established leadership position and proven track record for operational excellence. Now I'll turn the call over to Kevin to review our financial results in further detail.

Thank you, Bob, and let me turn right to Slide nine for a financial overview of our third quarter results. Third quarter gross revenue grew 9% year-over-year and adjusted net revenue grew 7.5%. Adjusted net revenue grew 8% year-over-year on a constant currency basis. Gross margin in the quarter as a percentage of adjusted net revenue was 25%, down slightly year-over-year, primarily due to PA Consulting. I will provide additional comments regarding our segments later in my remarks. Adjusted G&A as a percentage of adjusted net revenue was 14.7%, over 100 basis points better sequentially and year-over-year, more than offsetting the lower gross margin; Costs were well managed due to discipline and actions taken, and we are still targeting G&A as a percentage of adjusted net revenue to stay well below 16% for the full fiscal year 2023, improving upon the 16.2% figure realized in 2022. GAAP operating profit was $270 million for the quarter and included $52 million of amortization from acquired intangibles, other transaction and separation-related costs, and restructuring efforts of $38 million and a $1.4 million noncash charge related to decreasing our real estate footprint aligned to our future work strategy. The other transaction, separation-related, and restructuring costs of $38 million included three distinct types of costs. The first represents approximately 45% of the $38 million and relates to a restructuring initiative in our PA Consulting business to rightsize the cost structure to align with the company's end market demands. The second cost represents approximately 35% of the amount and is associated with our initial advisory and other costs related to the separation of the CMS. The third bucket, which is approximately 20% of the $34 million, is related to the cost of noncash PA contingent equity-based agreement associated with the PA transaction structure and other miscellaneous incentive costs that were considered part of the total consideration of previous transactions. Excluding these items, adjusted operating profit was $361 million, up over 10% year-over-year. Our total discrete items for the year, excluding the new CMS separation efforts, will remain at the $100 million figure that we have forecasted for the year, well below the total figure of $185 million in 2022. Of this $100 million figure, the total noncash impairment costs will total approximately $45 million. Such impairments will be largely complete as we exit this fiscal year. Of course, as we go forward, our costs will now include expenses to be incurred in connection with the planned separation of CMS. I would let Claudia provide more detail in her prepared remarks. Our adjusted operating profit to adjusted net revenue was 10.7%, up 30 basis points year-over-year. I'll discuss the underlying dynamics during the review by reporting segment. GAAP EPS from continuing operations was $1.29 per share and included a $0.27 impact related to the amortization charge of acquired intangibles; $0.20 from transaction, restructuring, and other related costs; a $0.01 noncash impairment charge related to reducing our real estate footprint; and a $0.05 adjustment to align with our projected annual adjusted tax rate. Excluding these items, third quarter adjusted EPS was $1.82, down 2% year-over-year. Importantly, while down versus the year-ago period, 2022 benefited from the $0.08 cost investment gain associated with the sale of our WatchGuard investment. In addition, in 2023, incremental interest costs of $0.07 have reduced EPS this quarter versus the year-ago figure. The net impact is a $0.15 headwind in EPS year-over-year. As we look ahead to our full year forecast, with Bob providing an overview of our guidance range at the end of our call, we expect Q4 EPS to show healthy growth versus the year-ago period. Q3 adjusted EBITDA was $355 million and was down 2% year-over-year, representing 10.5% of adjusted net revenue. Finally, backlog was up 3% year-over-year. The revenue book-to-bill ratio was 1x, with our gross margin and backlog, again, improving year-over-year. Regarding our LOB performance, let's turn to Slide 10 for Q3. People & Places Solutions continues to see solid momentum, delivering strong revenue and operating profit results. Q3 adjusted net revenue was up 9% year-over-year and up 10% in constant currency. Growth was consistently strong across almost all business units, led by advanced facilities. Europe continues to see some pressure, but was more than offset by strength in the Middle East, Americas, and Asia Pacific. Backlog was flat year-over-year, although gross margins in the backlog were up 8%, as we continue to focus on improving the quality of work Q3 operating profit was up 13% and 15% in constant currency, driven by strong growth leverage and solid G&A management, resulting in operating profit as a percentage of adjusted net revenue of 14.4%, up 60 basis points year-over-year. We expect year-over-year improvement and strong people in places operating profit margin and growth to continue in Q4. Our Advanced Facilities unit, which represents approximately 1/4 of our People & Places revenue and benefits from investments in the life sciences, semiconductor, and electric vehicle supply chains, posted its sixth consecutive quarter of double-digit revenue growth. Despite macroeconomic crosscurrents, our Tier 1 customers continue to pursue robust spending plans underpinned by long-term demand drivers. Our backlog and sales pipeline remain healthy, and we continue to be encouraged about the outlook for this segment. Our People & Places Americas unit reported Q3 operating profit with 10%-plus growth as legislation-driven backlog begins to convert at higher rates. For example, IIJA-related profit is trending nearly 20% ahead of our current plan. We remain enthusiastic about our overall growth opportunities with double-digit pipeline growth led by water, cities and places, and energy and power. Our Q3 international business revenue and operating profit were up high single digits year-over-year as Asia Pacific and the Middle East continue to be a bright spot in the portfolio, supported by Giga Cities and strategic water pursuits. Moving to Critical Mission Solutions; Q3 revenue was up 7% year-over-year and up 8% in constant currency. CMS has benefited from an over 70% win rate year-to-date. And as a result, backlog is up 12% year-over-year. The sales pipeline also remains very healthy as CMS positions for strategic growth in its core focus areas of space, defense, energy, and technology solutions. CMS operating profit and operating profit margin were both up sequentially and year-over-year, consistent with our previous guidance, with operating profit up 12% year-over-year. We continue to expect operating margins to be approximately 8% on a full-year basis as we convert on an IDIQ pipeline of higher margin opportunities. Moving to Divergent Solutions; adjusted net revenue increased 3% year-over-year as we remain focused on higher-margin contracts. This trend should be expected to continue near term before an acceleration in coming quarters as our investments in sales and technology offerings bear fruit. Operating profit margin for the quarter was 9.5%, a sequential improvement as compared to Q2's underlying normalized margin when adjusting for the benefit of a large license sale in the prior quarter. We have increasing confidence that the underlying margin momentum over the past two quarters is durable. As a result, we continue to expect Divergent's quarterly margins to approach 10% in Q4. Turning to PA Consulting. Revenue from PA was up 3% year-over-year with a book-to-bill of 1.1x, an indication of the company's relative performance to peers driven by their value to clients in a tough economic environment. PA's Q3 operating profit margin was 21.2%, up 270 basis points year-over-year and up over 15% year-over-year. PA management continues to take action to improve utilization, and we expect operating profit margins to be 20%-plus for the medium term with potential for longer-term improvement. Our adjusted unallocated corporate costs were $62 million in Q3, consistent with our guidance. We expect our quarterly run rate may remain elevated at or above the recent level for a short period of time. In conjunction with the CMS separation, we have initiated a comprehensive evaluation of our cost structure under a more streamlined business model focused on infrastructure and advanced facilities. Claudia will provide her perspective in her prepared remarks. Turning to Slide 11 to discuss our cash flow and balance sheet, we posted a very strong quarter of cash flow generation, which is indicative of the quality of our earnings despite temporary restructuring and separation-related efforts. Free cash flow was $290 million, resulting in a year-to-date 127% conversion of net income into free cash flow. As a result, we are well positioned to deliver at or above our anticipated 100% recorded and adjusted cash flow conversion targets for the full year. Regarding the deployment of our free cash flow, we remain agile and opportunistic in repurchasing shares. During Q3, we repurchased $125 million in shares at an average price of $115. We ended the quarter with cash of $1.1 billion and gross debt of $3.2 billion, resulting in just over $2.1 billion of net debt. Our Q3 net debt to 2023 expected adjusted EBITDA of approximately 1.5x remains a clear indication of the continued strength of our balance sheet. We remain committed to maintaining investment-grade credit profile both today and as a more focused business post our announced CMS separation. As of the end of Q3, approximately 56% of our debt is tied to floating rate debt, and our weighted average interest rate was 5%. We intend to opportunistically retire floating rate debt in the coming quarters. For your benefit, in the appendix of the presentation, we have included additional detail related to our debt maturities, interest rate derivatives, and quarterly interest expense. Finally, given our strong balance sheet and free cash flow, we remain committed to our quarterly dividend, which increased 13% year-over-year and will be paid on August 25. Before I formally transition the CFO role to Claudia on August 14, I wanted to say a few words on my last earnings call. It has been an honor working with such talented colleagues and witnessing our collective accomplishments over the past 8.5 years. During my tenure, I have observed growth and transformation within our company and I am immensely proud of the achievements we have made together. I extend my heartfelt thanks to the Board, leadership team, and dedicated employees for their unwavering support, passion, and commitment to excellence; to our investors, your trust has been instrumental in our success. While my time as CFO comes to an end, I remain confident in the company's bright future and have no doubt that the company is in good hands with Claudia in the CFO role. I also look forward to supporting Bob in my new role as a special adviser going forward. I will now turn the call over to Claudia.

Thank you, Kevin. Turning to Slide 12, I have now been with Jacobs for just over one year and look forward to formally succeeding Kevin next week. He has been a superb partner throughout this transition period, and I feel privileged to help lead this company at such an important inflection point in its history. As EVP of Strategy and Corporate Development, I've overseen the rollout of our strategic stand-up management office at the center of the CMS separation. Our goal is to continue to serve our clients without interruption, optimize both companies' operating models, and effectively manage risk associated with the separation. Due to the hard and tireless work of our teams, we have made significant progress towards effective separation. We can also confidently reinforce that we intend to eliminate separation-related stranded costs. In addition, we have identified value levers that we believe can lead to continued productivity gains at independent Jacobs. Last quarter, we outlined independent Jacobs' target operating profit margins of 12% from separation alone. Yet, we believe there is further upside, and it is our goal to further expand margins post-separation. We'll have more to say about that over time. But one of the most exciting aspects of the separation is the opportunity to drive further growth and profitability with the streamlined Jacobs. Jacobs has a recognized sustainable business model with a strong foundation that aligns purpose with both growth and value creation. I, like the rest of the Jacobs team, am absolutely committed to Jacobs' purpose-led vision. Our vision underpins our commitment to deliver superior results for our shareholders, employees, and broader stakeholders. I look forward to meeting more of our employees, clients, and investors in the weeks and months to come as I assume the CFO position. Thank you, and I will turn the call over to Bob.

Thank you, Claudia. Turning to Slide 13, due to strong year-to-date performance and forward indicators, we reiterate our outlook for FY '23 adjusted EBITDA to a range of $1.42 billion to $1.47 billion and adjusted EPS to $7.25 to $7.45. We will provide guidance for fiscal year 2024 in conjunction with our Q4 earnings release. Turning to Slide 14, in closing, I would like to express my tremendous appreciation for Kevin's contribution to the transformational success of our company over the last 8-plus years. Kevin is a great personal friend and has been a fantastic business partner. I am privileged to have his continued support as my special adviser. We are very fortunate to have Claudia as a critical leader on our team. I look forward to her continued accomplishments and contributions building on her success to date. Operator, we will now open the call for questions.

Good morning, Claudia, Jonathan, and Bob. Great job, Kevin. Thank you. Bob, I'm pleased with the ongoing improvement in backlog margins. Could you provide some insight into the sources of this margin improvement this quarter? Also, as you assess the pipeline and recent bookings, how do you anticipate these will impact our performance as we head into 2024, considering the three largest contributors, including CMS, to our margin improvement expectations for that year?

Yes. Mike, thanks. I'd say right now, the margin improvement is coming from a couple of key drivers. First is around the mix. We are finding a larger part of our portfolio in the consulting advisory component. And when I say that, I'm not saying exclusively PA, that's across the board, even on our infrastructure engagements right now, we're hitting jobs right at the front end where we've got a higher-end, higher-margin consultative service component. So mix is definitely a driver. The second component on current margin expansion is around the operational discipline that we've been working on for quite a while. And so our project delivery as well as the stability in our offering has continued to evolve. Moving forward, as far as the continued expansion, the digital enablement is starting to come through. You can't quite see it just yet, but it's becoming a larger part of our portfolio, and this is broad. This is broad across the enterprise. And then the global delivery model. We've been talking about that for several quarters, but that global delivery model is paying some real dividends, and we see that continuing to rise moving forward.

Good morning, everyone. Kevin, thanks for all your help. You guys mentioned that you had interested parties looking at CMS. To the extent you can, could you give us any more color regarding the interest? Is it from strategic? What's the time frame for when you might make a decision regarding a potential sale? And could you give us any more detail on how to think about CMS' tax basis and how you consider that tax leakage versus a potential spin?

Yes, unfortunately, we can't provide more details right now. I've mentioned that there is strong interest, and we are currently evaluating the situation. I apologize for not being able to share further information.

That's fine, Bob. So let me ask a different question. Regarding People & Places growth moving forward, you mentioned that P&PS adjusted net revenue is up 9% year-over-year. I believe your main peers indicated this morning that they are also experiencing some acceleration in fiscal funding in the U.S. Do you anticipate that IIJA related funding will continue to accelerate from here? And do you think you can maintain or even enhance the growth you achieved in Q3 into '24?

We do see the IIJA component as still being in the early stages, but we are noticing its impact. We've proactively engaged with the grant aspect and provided assistance for grant applications, and this, along with the formula-based funding coming in, has been beneficial. Therefore, we recognize that funding driven by legislation, including the IIJA and other recent legislation, will remain significant. Additionally, this has prompted similar legislative actions globally. For instance, the EU has introduced its Chips Act, and infrastructure stimulus is emerging in other regions, indicating a global movement towards this initiative.

Nice quarter. And congrats, Kevin, and thanks for all your help as well throughout the year. I guess my first question, understanding the margin story that you're talking about consulting mix, project delivery, digital enablement. But as you, depending on what happens with CMS and we have the new Jacobs, is there a greater opportunity on the cost side, just to sort of restructure and streamline costs as well as what you're seeing on the project delivery or mix side? Just wondering if there's a cost story there. And then my second question, it was nice to see the strong cash flow in the repurchase in the quarter here. Can you talk about sort of shorter-term capital allocation priorities, share repurchase and the way that investors should continue to think about things with acquisitions being more on the sideline?

Sure. Go ahead, Claudia.

Thank you, Jamie. Regarding cost opportunities, as I noted in my prepared remarks, we see day one as just the beginning. With a more streamlined strategy and business model, we recognize numerous opportunities for greater efficiencies, especially by better utilizing our global delivery platform. There are many possibilities for cost optimization through enhanced efficiencies, a more focused strategy, and the agility this will provide. Concerning capital allocation, we remain very satisfied with the opportunities within our portfolio. We are concentrating on our organic growth, which we have been nurturing over time. We see potential for continued investment in ourselves to sustain this growth, and we prioritize that along with returning excess cash to our shareholders. These are our key priorities when considering risk-adjusted returns.

Hi, good morning, everyone and Kevin, congratulations. I think in your nearly 9 years, the stock has nearly quadrupled. So well done, and Claudia congratulations again. I'm wondering if you could just ask on advanced facilities just based on the disclosures, it looks like that's about 1/4 of People & Places at this point, so a really good performance so far. Can you just talk about, given the backlog in that business, is there a runway for that portion of the portfolio to be 30% or more of People & Places over the next year or two? Just if you could touch on the backlog, Bob, if you don't mind?

Sure. Yes, Jerry, that's a great way of looking at it. The short answer is yes. We consider it a larger part of our portfolio moving forward. Our backlog is strong, and our confidence in continued growth is bolstered by the fact that we have been in growth mode for the better part of the last four years. The industry is evolving—specifically in life sciences, where previously the focus on technology was driven by oncology, but now we are seeing advancements related to obesity and related drugs that positively impact heart disease. This is reflected in our pipeline and backlog with Tier 1 customers we have collaborated with for a long time. Additionally, the Chips Act and developments in the EV sector provide us with favorable conditions, reinforcing our belief that this segment will become a larger percentage of our portfolio.

Hey, good morning. and congratulations both Kevin and Claudia.

Thanks, Bert.

Thank you, Bert.

Maybe just a follow-up on that question, Bob, if you think that Advanced Facility is going to become a larger part of the business and the rest of the business is sort of already on track to grow high single digits, at least in the medium term. Does that lead you to believe that, that business can continue growing double digits for a period of time?

I think right now, the indications are, yes. But the visibility that we have, we have visibility from a project standpoint probably six to nine months out. What we're basing our confidence in is the continued trends in technology. So the short answer is yes.

Hi, team. Thanks for taking my questions and, Kevin, I just wanted to say a very impressive CFO tenure. Congratulations. I wanted to press Claudia on the efficiencies and streamlining comments a little bit more. And I realize it's early days, but I'm just curious where we should expect to see that enhancement? Is it kind of across all the segments? Is it more so in the corporate costs? And then also, Kevin, I think you made a comment about the corporate costs remaining elevated for a short amount of time. So I wondered if that run rate is expected to step down going into next year? Some clarity there would also be helpful.

Yes, thank you, Sean. I want to emphasize that our work is in progress. A significant part of the separation process involves understanding the various complexities we face. We will provide more updates as we advance. To clarify, there are numerous functions, tasks, and processes involved when integrating different factors, including support functions and workflows. For instance, finance plays a role in quantifying these elements, alongside HR and the delivery model. As we simplify and streamline our operations, we are not only realizing efficiencies but also enhancing our data-sharing capabilities across different locations. This initiative operates on multiple levels. We will continue to share updates as we move forward, and the work is already underway through a structured process managed by our office. We have identified around 25 work streams across various functions and operations. A crucial element of our strategy is our robust global delivery platform, which enables us to gain further efficiencies as we optimize its use.

Okay. And my follow-up would be for Bob. I think it was relative to P&PS, but I think you made a comment about being able to continue to grow at current rates. So I just wanted to flesh out as much as we can relative to the top line growth expectations for RemainCo on a go forward?

Sure. We're sticking to the 6% to 9% long-term top line growth rate, and that was what my comment was referring to. And right now, we've got some nice tailwinds behind us. So the higher end of that range is where we are.

Hi. Good morning, guys. And I just want to extend my congrats to you, Kevin. So I want to spend some time on the water business. I think you talked about it being a $2 billion business. Can you give a little more color on what you're seeing in terms of pipeline from a pipeline perspective? How to think about the growth rate and margin relative to the broader P&PS targets?

The pipeline in the water sector globally is likely the fastest-growing area in our business, with a growth rate of 30% to 40% year-on-year. This growth is robust, driven by infrastructure regulations and the need for water in drought-affected regions, not just in the U.S. but also influenced by climate change and our response to it. The funding for this need comes from various sources, including user fees and government initiatives worldwide. All of the drivers are strong and persistent, with a high demand supported by governments and municipalities. We are directly engaged in this area and, as you know, we have been a leader in the sector for decades, which is becoming increasingly evident.

That's helpful. And how should we think about just the growth rate of that business and margins relative to the broader P&PS segment?

Yes. I'd say margins right now are above kind of the mean margins within the sector today. I think there's some room there. And I think that it's going to continue to be a major part of our overall enterprise-wide portfolio moving forward.

That's helpful. And then I think you talked about some restructuring PA. Just trying to get a sense for how to think about any future costs? How to think about margin benefits? And when you think we'll actually kind of get the full run rate of those cost-saving initiatives?

Are you talking specifically on PA or what...

Just PA.

Well, look, the cost actions have been taken. So we're expecting on a go-forward basis that, that will improve the margins. We have been talking about utilization and rightsizing the business for a while. Ultimately, the management team got to the point where they decided to proactively go after it as opposed to grow into it. And so we're excited about the ability for that to have taken place. Really good work by the management team. And so that run rate is effectively being embedded into the business going forward.

Yes. And sustainable.

Thanks. Good morning, Kevin. I wanted to focus on the profit growth in P&PS. Bob, you mentioned earlier about the top line at the high end, specifically a 13% year-over-year profit growth in Q3. Where do you see that heading? It was still in double digits, but it was a decrease from 21% in the previous quarter. Do you think this will stabilize into a low double-digit growth trend moving forward, or is there potential for a reacceleration? I'm trying to understand how to set expectations for profit growth in Q4 and into 2024.

Yes. Steve, I think that from a sustained standpoint, we've been vocal that we could drive double-digit growth from a bottom line perspective. I think there was an earlier question around mix. So we're going to have events where we might get some pops in the business. But I'd say on a sustained go-forward basis that double-digit growth in the sustaining area where it's at now is the way to think about it.

Okay. That's helpful. And then a bigger picture question here. Bob, I'm curious how you're managing the business with regard to the broader economic outlook? There's clearly lots of talk about different types of landings for the economy. What are you planning for at the moment? You're about seven to eight weeks away from the start of our next fiscal year, so how is that affecting the decisions you're making today? Obviously, you're sort of been proactive in streamlining operations, but curious if the different economic landings are factoring into your decision-making one way or the other?

Yes, I would like to mention a couple of points, Steve. Over the years, Kevin and I have been very intentional in our strategy, and now you're hearing Claudia express the same sentiments. We are confident in the end markets we are focusing on, which have strong underlying support. While no one can claim they are immune to recession, the positive factors driving these markets are here to stay and are likely less impacted by inflation compared to other consumer-driven sectors. Even in areas where we are exposed to the wider consumer market, we are seeing opportunities in life sciences, chips, and manufacturing that are influenced by significant geopolitical and economic shifts. From a portfolio perspective, we feel robust, and regardless of how the economy unfolds, we are assured of those positive factors. Additionally, regarding our operations and cost management, we are currently making significant improvements to our operating model, particularly in relation to the CMS separation, which is allowing us to enhance our internal resilience. Lastly, as Claudia mentioned earlier, we are focusing on cost optimization. As you know, Steve, we have long been dedicated to effective cost and resource management, and this commitment will continue as we work towards a more streamlined structure.

Great. Good morning. Thank you for taking my questions. And Kevin, it's been a pleasure. I guess I wanted to ask about some of the cash restructuring costs. It looks like they're down the new outlook for them. The split of cash is up a little bit, noncash real estate down a little bit. I suppose that's probably related to the $17 million for PA taken in the quarter on cash restructuring. But I guess there's kind of two questions that come out of this. One is, do you think that this round of restructuring charges can flow through to the profit line, recognizing in the past, the various restructuring programs we've had in the past have generally been reinvested for growth? And the second question would be, given that '23 is a little bit higher on the cash restructuring costs, what do you think the outlook for '24 could be? Obviously, the CMS spin or potential sale is a big factor, but do you think that the costs will be up or down versus the roughly $55 million of cash cost that you expect to recognize in 2023?

Kevin, go ahead.

Thanks, Andy. Let me try to address that. As Claudia mentioned in her prepared remarks, we are currently focusing on the CMS separation efforts, so it’s too early to provide any insights on that. Regarding your comment about cash for 2023, I believe you’re basically right. As for whether the funds will contribute to our bottom line or be reinvested, Claudia has clearly stated that we see significant stranded cost opportunities, which will require a lot of effort to pursue. We’ll leave it at that for now. Fundamentally, I think during our Q4 earnings release and outlook for 2024, Claudia and Bob will offer more details.

And what I would add to that, Andy, is we use the cash conversion as a key metric for us. So it's really important to show the cash conversion, and we have shown strong cash conversion. So all these numbers are to help our investors understand the numbers. Hopefully, that helps to analyze the numbers. But the cash conversion remains very strong, and we are very committed to maintaining that strong delivery.

Got it. I guess for my follow-up question, I would just ask about Divergent here. I heard the comments for the fourth quarter. This business has always had kind of an implicit ramp that you believe that some of the contracts that you're on will start contributing more significantly. I guess the question is, what's the visibility you have into that ramp? And do you still believe that that revenue ramp can lead to better fixed cost coverage and push margins up more materially even than you've realized in the last couple of quarters, which has been notable for sure?

Yes, we do see that. If you analyze Divergent, the fastest growth is coming from the platforms we've developed around transportation and water, which are expanding quickly. However, we’re not seeing that reflected at the top line because these platforms are enhancing growth at the bottom line for Divergent and contributing to margin expansion in P&PS. This is related to the digital enablement mentioned in an earlier question as well. From a bottom line perspective, we do have visibility into this, driven by infrastructure, transportation, and water, and we are now introducing these platforms into the energy sector too. We will provide more updates on how this will continue to stimulate P&PS.

Okay. Great. I'm curious about the infrastructure stimulus money you've mentioned. Which end markets is that focused on, and where are you finding success? Looking ahead to the next 12 to 18 months, which end markets do you expect to see more funding from initiatives like IIJA, IRA, or the chipset? How is that funding currently being distributed by end market?

Sure. Sabahat, we're currently in the early stages, focusing mainly on transportation. We're seeing substantial activity in this area. Recently, we've started some work in New Orleans related to upgrading the bus systems and other transport initiatives. This falls under transportation, now incorporating some clean energy elements, and we anticipate some applications related to the IRA as well. Regarding larger projects, including efforts related to lead pipes and general water infrastructure, we expect those to rise too. So, our focus is transportation first, then moving into clean energy associated with transportation, and eventually addressing water infrastructure.

Great. I have a question about the cost improvements you've mentioned regarding P&PS. I'm trying to clarify whether your full commitment to the plan is linked to the timing of the sale or separation of the CMS business, or if it is an ongoing process that will provide significant benefits in your fiscal '24 results. I'm attempting to understand if these two events are connected in terms of when you will implement changes and the savings expected in fiscal '24.

Yes. The comments regarding PA focus on its alignment with specific end markets where it has strengths. Resources are allocated according to those strengths, while other markets are less active. This is specifically related to PA. On the other hand, CMS involves the connection between CMS and the overall company, along with Bob's remarks about our examination of the operating model. We are aiming for efficiency gains and increased productivity, particularly as we implement cost reductions with a more streamlined strategy and execution.

In the 2024, Sabahat, which I think is the last part with P&PS, the answer is yes.

All right. Thanks, everyone, for joining and look forward to continued growth and success. Kevin, thank you so much, and welcome Claudia to the future. Thanks, everyone. Look forward to talking to you next time.