Jacobs Solutions Inc (J) — Q3 2018 Earnings Call Transcript

Thank you. Good morning and afternoon to all. Our earnings announcement and Form 10-Q were filed this morning, and we have posted a copy of the slide presentation to our website, which we'll reference in our prepared remarks. I would like to refer you to our forward-looking statement disclaimer, which is summarized on Slide 2. Certain statements contained in this presentation constitute forward-looking statements as such term is defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and such statements are intended to be covered by the safe harbor provided by the same. Statements made in this presentation that are not based on historical fact are forward-looking statements. Although such statements are based on management's current estimates and expectations and currently available competitive, financial, and economic data, forward-looking statements are inherently uncertain, and you should not place undue reliance on such statements as actual results may differ materially. We caution the reader that there are a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from what is contained, projected, or implied by our forward-looking statements. For a description of some risks, uncertainties, and other factors that may occur that could cause actual results to differ from our forward-looking statements, see our annual report on Form 10-K for the period ended September 29, 2017, as well as other filings with the Securities and Exchange Commission. We are under no duty to update any forward-looking statements after the date of this presentation to conform to actual results, except as required by applicable law. Please now turn to Slide 3 for a review of the agenda for today's call. I would like to note a few items regarding our presentation and remarks today. Our results reported today include a review by all three lines of business. For comparative purposes, we have disclosed revenue and operating income for the updated structure reflecting the current quarter and accordingly, the same quarter a year ago. We plan to provide historical segment detail on a rolling-quarter basis. During the presentation, we will discuss comparisons of current quarter results to Jacobs' and CH2M's performance in 2017 calculated on a pro forma basis. The 2017 pro forma figures are adjusted to exclude restructuring and other related charges, the deconsolidation of CH2M's Chalk River joint venture, and CH2M's MOPAC project. We believe this information helps provide additional insight into the underlying trends of our business when comparing current performance against prior periods. Turning to the agenda. Steve will begin by discussing our focus on driving a high-performance culture, a recap of third quarter results, including a market review for each of our lines of business, and provide an update on the CH2M integration. Kevin will then provide some more in-depth discussion of our financial metrics as well as a review of our balance sheet and capital allocation strategy. Steve will then provide an updated outlook along with some closing remarks, and we'll open the call for questions. With that, I'll pass it over to our Chairman and CEO, Steve Demetriou.

Thank you, and welcome to our fiscal year 2018 third quarter earnings call. I'm pleased to report that we're on track to deliver fiscal year 2018 adjusted earnings per share results at the high end of our previous outlook and well above the guidance we shared last November shortly after announcing the CH2M acquisition. Our year-to-date performance reflects strong execution against our major strategic priorities, to further strengthen our winning culture, including an increased focus on inclusion and diversity; to transform our core by executing our work with rigor and discipline; and to profitably grow by capturing higher-margin opportunities in growing end markets and delivering differentiated client-centric solutions. And with regard to the recent CH2M acquisition, we are exceeding the major cultural and financial integration commitments we made a year ago when we announced this transformative acquisition. I will discuss the Jacobs and CH2M combination in more detail later in my remarks. On a pro forma basis, third quarter revenue grew 14% versus the prior year with each line of business posting growth. Adjusted SG&A cost decreased sequentially and was also lower versus the pro forma year-ago quarter, demonstrating significant progress on achieving cost synergies associated with the CH2M acquisition. Our third quarter adjusted earnings were $1.35 per share, an increase of 71% year-over-year. Kevin will cover the components of EPS, including a bridge to GAAP EPS in his remarks. Free cash flow generation was strong in the third quarter, and we demonstrated our ability to delever with gross debt down from the second quarter. I'm also very pleased to report that the third quarter backlog increased sequentially to $27.2 billion and is up 8% on a pro forma basis from last year's third quarter, with all three of our lines of business contributing to the backlog growth. Looking forward, we continue to experience strong demand across both our Aerospace, Technology, Environmental, and Nuclear line of business, ATEN; and our Buildings, Infrastructure, and Advanced Facilities business, BIAF. In addition, supply-demand fundamentals are strengthening in our Energy, Chemicals, and Resources, ECR sector, where we are taking a disciplined approach to capturing opportunities in an improving market. Turning to Slide 5. As I highlighted earlier, culture is a key component of our strategy, and our people are the heart of our business. To that end, we believe inclusion and diversity are critical to enhancing employee engagement, retaining and attracting industry-leading talent, as well as creating a framework for cross-business collaboration, all necessary for achieving profitable growth. Our employee network groups are an important driver of inclusion and diversity and offer our employees an opportunity to connect with others around the world. This picture is from an inaugural global employee network group summit, where seven employee networks of Jacobs and CH2M came together to charter their purpose and business objectives going forward. The summit was an important step to further accelerate our journey of creating a differentiated professional services company. More than 25,000 Jacobs' employees around the globe identify with one of these network groups, and I can tell you that their enthusiasm is infectious. Before turning to the next slide, I would like to note that when the recent wildfires drove some of our employees and families out of their homes around our Redding, California office, our employees set up an emergency fund contributing tens of thousands of dollars within just one week, showing just how authentic our culture of caring is at Jacobs. Turning to Slide 6. Our third quarter revenue and backlog were strong at $27.2 billion, up approximately $700 million versus last quarter. On a pro forma basis, total backlog increased 8% or approximately $2 billion, compared to last year's third quarter. We saw an acceleration in field services backlog, which was driven by an increase in major water infrastructure and life sciences design-build projects. From a line of business perspective, on a pro forma basis, ATEN backlog was up 12% year-over-year, while BIAF increased by 8% and ECR up 3%. Gross margin and backlog are up more than 100 basis points year-over-year, on a reported basis, driven by the higher-margin mix from CH2M. Our Jacobs and CH2M sales teams are now integrated and capitalizing on the tremendous opportunities to leverage each other's strengths, evidenced by our strong bookings and gross margin and backlog performance across the company. Turning to Slide 7. Now let me discuss the performance by line of business, beginning with Aerospace, Technology, Environmental, and Nuclear, ATEN. We posted a strong quarter in ATEN with revenue reaching $1.2 billion, up 24% year-over-year on a pro forma basis and operating profit up more than 22%. The successful ramp-up of our previously awarded major wins, including the Missile Defense Agency and Special Operations Command, are key drivers to this double-digit revenue and profit growth. Backlog was up 12% versus last year's combined third quarter with both legacy Jacobs and CH2M contributing to the growth. And I'm also pleased that the gross margin in the ATEN backlog increased year-over-year. From an end market standpoint, we are benefiting from increases across our major government customers such as the Department of Defense, Department of Energy, intelligence community, and NASA. Within our commercial markets, the 5G wireless build-out continues to provide a robust opportunity for growth with another AT&T win in the quarter. From a competitive standpoint, we believe the highly-fragmented nature of the government services market plays into our strategy that combines strong technical expertise, a unique localized delivery model, and an industry-leading efficient cost structure in order to gain market share. On the back of posting strong double-digit growth in fiscal 2018, we are encouraged that our ATEN pipeline supports further growth over the next several years. Within that pipeline, some of the major opportunities include large-scale nuclear cleanup projects, incremental space opportunities with NASA, as well as overall demand for IT, cyber, and analytics capabilities. During the quarter, we were awarded a scope increase at West Valley nuclear remediation site, and the DOE announced the extension of our plateau remediation contract at Hanford. Our nuclear strength positions us well to capture incremental opportunities during the upcoming DOE nuclear procurement cycle. Within our Environmental business, we were awarded a contract to provide the Defense Threat Reduction Agency solutions for sustainable chemical, biological, and other threat reduction capabilities. This win demonstrates the technical expertise and differentiation that CH2M brings to Jacobs. While CH2M integration growth synergies are a clear focus at this time, I'm pleased to also note that our previous acquisitions in the cybersecurity and analytics market such as Blue Canopy and Van Dyke are also driving revenue synergies. For example, across all of Jacobs, our commercial, private, and other public clients are seeking ATEN's unique and deep expertise in areas such as at-scale network vulnerability assessments, cloud-based security operations management, and organically developed software solutions to solve many complex cyber and AI initiatives. In summary, the ATEN business is executing well against its strategy and positioned to deliver a double-digit year-over-year profit increase in fiscal 2018 with continued strong growth into 2019. Now on to Slide 8 to discuss our Buildings, Infrastructure, and Advanced Facilities line of business, which posted another solid quarter of results. On a pro forma basis, BIAF revenue increased 5% versus last year's third quarter and delivered an 80 basis point increase in operating profit margin on a year-over-year basis. Additionally, revenue and backlog were up nearly $1 billion versus pro forma last year. Overall, we are experiencing strong demand, driven by population growth, aging infrastructure, and increased urbanization with robust growth in the U.S., Middle East, and Asia markets. The U.K. is holding steady in spite of uncertainty in that region. Specifically in the U.S., which makes up over half of our BIAF revenue, we are seeing particular strength in the West Coast, Texas, and in the southeast. Our combination with CH2M is driving increased value for our clients, and it is clear that we have elevated our leadership in many of the most crucial global spending priorities. Water is one of these key priorities and as you recall, was a major component of our 2016 strategy that drove the acquisition of CH2M. In July, I met customers and presented at the Singapore Water Conference, which is a premier event in the water industry. There were over 20,000 participants from more than 100 cities globally in attendance. Our conversations with customers at the conference reinforced our thesis that we are in the early stages of a significant positive water investment cycle that is driven by several factors, including climate change and an increased need for clean water. Our clients are prioritizing upgrades to water filtration, wastewater treatment, conveyance, and distribution that have been delayed far too long. We are not only a leader across these traditional water projects, but we are now bringing next-generation technology to our clients by leveraging data analytics into our end-to-end solution offerings. During the quarter, we were awarded multiple water projects such as San Diego Pure Water and design-build projects in Arizona, Oregon, Northern California, and West Texas. And very importantly, the pipeline over the next 12 months for water projects is strong. In the coming months, BIAF President Bob Pragada and his key leadership will be hosting an investor webcast to provide a more in-depth look into the water market. Another key priority is transportation, which includes aviation, rail, and highways. Within aviation, we're seeing strong demand, coupled with industry analyst expectation that $450 billion will be needed by 2020 to keep pace with a record passenger growth outlook. Virtually every major airport and many of the smaller regional airports are undergoing significant capacity expansions. For example, Heathrow is moving forward with their third runway, LAX and LaGuardia in the midst of expansions and Singapore, Denver, and Dubai are all planning to expand their operations. Our leading position in aviation was recently highlighted with a #1 global ranking by Engineering News-Record, and we believe we are positioned well to further capitalize on this opportunity. From a rail and highway standpoint, urbanization continues to be a major driver globally. During the quarter, we were awarded a significant program for Etihad Rail in the United Arab Emirates to design what will be one of the world's largest freight and passenger rail lines. We've also had domestic wins with the New York City Metro Transit Authority and San Francisco Bay Area Rapid Transit System. Highways continue to show steady performance from both new construction as well as continued operations and maintenance investments. During the quarter, we were awarded two major highway projects on the East Coast of the U.S. and renewed our 15-year O&M contract with the Cheshire East Council in the United Kingdom. With regards to our built environment business, we continue to see solid demand across a variety of verticals, including the U.S. government, health care, education, and sciences. Specifically, we are excited about the investments being made in K-through-12 schools as advances in technology within the classroom are spurring state and local government funding to create tailored learning environments. Finally, our Advanced Facilities business performed better than our expectations during the quarter, driven by an upside in electronics and strong performance in life sciences. From an electronics standpoint, we continue to see strong underlying demand for more data center capacity. Semiconductor and chips are being driven by secular growth factors such as artificial intelligence, emerging chip technologies, edge computing, and vehicle automation. In life sciences, we're seeing pipelines build as U.S. tax legislation is driving potential investment and cell and gene therapy advancements continue to progress. And we're seeing substantial revenue synergy opportunities in the Advanced Facilities pipeline that combines CH2M's design expertise with Jacobs' strength in large-scale EPCM delivery. In summary, the BIAF line of business is positioned for strong growth across a variety of end markets and regions. The combination of Jacobs and CH2M is surpassing our expectations as revenue synergies are beginning to materialize. And now to our Energy, Chemicals, and Resources business on Slide 9. In the third quarter, our revenue in ECR increased 19% year-over-year on a pro forma basis, a further acceleration from the second quarter growth of 17%. The double-digit increase in revenue was driven by several factors, including increased activity in refining maintenance turnarounds and continued strengthening in our mining business. On a pro forma basis, ECR revenue and backlog grew by 3% year-over-year. Consistent with our ECR strategy, we're increasing our sustaining capital footprint, which we view as highly recurring revenue with a more attractive risk posture. I want to reinforce that our strategy in the ECR line of business will be to continue to focus on sustaining capital lower-risk segments of the energy, chemicals, and mining value chain, with a high percentage of our revenue aligned to our clients' OpEx spend. That said, given recent higher commodity prices, we do see incremental client capital budget opportunities that fit within our risk profile across our ECR business. For example, we're seeing an increase in greenfield refining CapEx globally as well as integrated refining and chemical complexes. Currently, we're delivering the front-end engineering design for a number of these major projects and expect to convert many of these into a larger EPC or EPCM role. There are a handful of ethane cracker projects that are moving forward. We participate both delivering the front-end engineering design of crackers and the derivative chemical complexes. In the second wave, we are involved in FEED work for one of the largest crackers as well as several global opportunities for investments in derivative chemical plants. The MARPOL 2020 regulations that require shipping vessels to reduce their sulfur emissions have reached a tipping point whereby refiners are now investing in upgrades. We are currently working on multiple upgrade early engineering works across the globe. As I previously mentioned, our mining business had double-digit revenue growth, mainly driven by studies in early engineering work. We are seeing our customers move forward with major projects in iron ore and copper. We expect a handful of the studies to convert to larger projects in fiscal year 2019. As it stands today, our mining business is approaching $550 million in run rate revenue, which is still well below its previous peak of over $1 billion, indicating potential upside in the business. From a Jacobs Connected Enterprise standpoint, we continue to make progress leveraging our operational domain expertise to capture adjacent digital opportunities within our core ECR customer base. For example, we were awarded follow-on work that is four times the initial engagement from a major chemical customer to remediate vulnerabilities found in their cybersecurity attack surface. Overall, we're pleased with the continued progress of our ECR strategy to drive profitable opportunities. We are confident there are multiple drivers that are likely to translate into further backlog growth in fiscal 2019 and '20. Turning to Slide 10. Just one year since we announced our transformative acquisition of CH2M, we are on pace to exceed our commitments to shareholders, employees, and clients, delivering a stronger value proposition resulting from our combination, which is being very well received in the marketplace. This is reflected in our leading position in industry rankings for major end markets like water and transportation and in Jacobs capturing the top spot among global design firms now ranked #1 by ENR. Specifically, with regard to our commitment to successfully merge the Jacobs and CH2M cultures and businesses, we are very pleased that CH2M voluntary attrition is in line with preannounced levels, we are exceeding projected cost synergies, and we are delivering strong growth. As a result, we expect to outperform the 15% adjusted EPS accretion target in the first 12 months since closing the acquisition in December. And our robust combined backlog points to further growth synergies materializing in our sales pipeline. Although we have more work ahead, I'm very pleased with the progress we have made to date and extremely excited about our future. Now I'll turn the call over to Kevin.

Thank you, Steve. And moving to Slide 11, you will see a more detailed summary of our financial performance for the third quarter of our fiscal 2018 year. Please note that during my remarks today, I will sometimes discuss comparisons of current quarter results to Jacobs and CH2M's performance in 2017, calculated on a pro forma basis. We believe this information will help provide additional insight into the underlying trends of our business when comparing current performance against prior periods. Third quarter pro forma revenue grew 14% year-over-year, in line with our strong second quarter growth of 16%. We had organic revenue growth across all of our businesses, with an increase of 17% and 8% year-over-year for Jacobs' and CH2M's legacy businesses, respectively. This growth was supported by a greater than $175 million increase in pass-through revenues versus the second quarter of 2018. Gross margins of 18.7% are in line with our strong margin performance year-to-date, as we continue to benefit from the higher gross margin mix from CH2M. I will discuss underlying trends in gross margin later in my remarks. Regarding G&A, we realized good growth leverage on our G&A spend as pro forma G&A was down on an absolute basis both year-over-year and sequentially versus the second quarter, driven by increased momentum in the delivery of our expected cost synergies. As a percentage of sales, adjusted G&A was down approximately 200 basis points year-over-year on a pro forma basis and 160 basis points sequentially. As a result, while GAAP operating profit margin was 5.1%, due to CH2M-related acquisition and integration costs, our adjusted operating profit margin was 6.4%, a year-over-year increase of 80 basis points on a reported basis and up 60 basis points on a pro forma basis. OP as a percent of revenue was also up 80 basis points sequentially, again driven by the building momentum in cost synergies. GAAP EPS was $1.05, up 42%, year-over-year. CH2M acquisition-related restructuring charges to achieve synergies and some professional fees and other transaction-related expenses impacted EPS by $0.27. Additionally, a charge resulting from the reevaluation of certain deferred tax assets and liabilities in connection with U.S. tax reform impacted EPS by $0.04. When excluding these costs, our adjusted EPS was $1.35, which is up 71% versus the year-ago figure. The $1.35 includes $0.07 from discrete tax benefits and a $0.01 benefit from our partial reversal related to a legal matter that we previously discussed in the second quarter. Excluding the impact from tax reform, we are on track to exceed the 15% accretion target that we estimated for the first full year benefit associated with our acquisition of CH2M. We also gained some momentum in DSO, as we reversed the Q2 negative trend we saw last quarter. Importantly, we saw sequential DSO improvement during Q3, given our increased focus on cash flow and accounts receivable management. Finally, turning to our bookings during the quarter. Our pro forma book-to-bill ratio was 1.1x for the trailing 12 months and 1.2x for the third quarter period. On Slide 12, let's look at the sequential trends on revenue and gross margin in more detail. As we have previously stated, we are focused on disciplined project execution, reducing write-downs and targeting higher-margin opportunities throughout the cycles in our end markets. In Q3, our gross margin was 18.7%, which is up year-over-year on a reported basis. Importantly, the Q3 gross margins were impacted by higher pass-through revenues during the quarter when compared to Q2. When adjusting for the impact on margins through the incremental increase in pass-through revenues, underlying gross margins were actually more in line with our Q2 figures. Regarding our line of business performance, let's turn to Slide 13 and begin with ATEN. Revenue on a pro forma basis grew 24% year-over-year, with growth again being most pronounced in the Jacobs legacy portfolio with strong 36% organic growth driven by recent large new wins. For the fourth quarter, we expect mid-single-digit sequential revenue growth off of Q3, resulting in double-digit year-over-year growth, as we continue to ramp the newly awarded contracts. Operating margin for the quarter was 7.3%, down year-over-year due to ramp-up of large contracts. In addition, there was a minimal 10 basis points benefit from a partial reversal of the Q2 legal matter that we discussed last quarter. Excluding this impact, our adjusted operating margin was 7.2% and in line with our 7% to 8% expectation. Longer term, we continue to expect operating margins to improve. BIAF grew revenue 5% year-over-year on a pro forma basis with growth across all regions and strong double-digit growth from CH2M. This growth was partially offset by an expected decline in Advanced Facilities, given the difficult comp we saw in the year-ago period. Operating margin of 8.5% was up 115 basis points from the year-ago quarter and up 90 basis points on a pro forma basis. For the fourth quarter, we continue to expect both sequential and year-over-year growth in BIAF with margins expected to be in the 8% to 9% range. Consistent with our comments last quarter, we see room for margin expansion in BIAF, as we continue to drive strong project delivery metrics and benefit from the scale of the combined businesses. Lastly, our ECR business grew revenue 19% year-over-year, on a pro forma basis. Growth was driven by construction, maintenance and turnaround projects as well as a pickup in front-end mining studies. Operating margin was 5%. While we continue to make good progress driving margin expansion in our ECR business, we are currently evaluating an update in a project estimate. While this impact has been accounted for within our full year updated outlook, it is expected to have a modest impact on Q4 ECR margins. Longer term, we expect ECR margins to continue to expand as we focus on lower-risk, higher-margin opportunities and benefit from a recovery in the energy and commodity end markets. Before turning to the next slide, a note to let you know that our non-allocated corporate overhead costs were $33 million, in line with the year ago. We continue to expect our unallocated corporate overhead costs to be in the range of $25 million to $35 million per quarter, excluding discrete items. We are certainly pleased with the overall strong Q3 financial performance across each line of business. On Slide 14, now let me provide an update on restructuring and acquisition costs. We made great progress in cost synergies in the quarter, and we have now realized a total of over $50 million in cost synergies year-to-date with nearly $30 million realized in Q3 alone. As a result, we now expect that our updated level of synergies for the 2018 fiscal year will approach approximately $75 million. As a result, we are raising our estimate of net cost synergies to $175 million from our previous estimate of $150 million. We still expect $150 million in run rate synergies achieved by the end of fiscal 2019 with the incremental $25 million to be gained in 2020. To achieve these additional savings, we also believe our estimated P&L cost to achieve the incremental benefits will grow to $265 million from previous estimate of $225 million. A couple of other key points. At the end of Q3, we've achieved a run rate of approximately 60% of the revised synergy target of $175 million. By the end of the year, we now expect to achieve a run rate savings of nearly 70% of the total $175 million estimate. Also through Q3, we have incurred $153 million of the now-expected $265 million in cost to achieve these synergies. As it relates to our revised $265 million in costs, we continue to expect that a bit over half of these will be cash-related and be incurred over the next couple of years. Finally, as it relates to our CH2M transaction and change in control costs, we have incurred $91 million through Q3. We are largely completed with these discrete one-time costs. Before we move to the balance sheet, let me provide an update on the Inpex matter, also referenced as the Ichthys matter. There's no change in our expectations relative to when we conducted our original due diligence on the project as part of the acquisition of CH2M. We continue to be early in the process, and we expect that any potential resolution of this matter is well into the future. So now let's get on to the balance sheet and capital allocation on Slide 15. We ended the quarter with cash of $800 million and a gross debt of approximately $2.3 billion. Our gross debt level is down $172 million from our Q2 level, supported by a strong underlying cash flow from operations of $215 million during the quarter. We will continue to use excess cash to pay down the planned larger debt position, as we focus on maintaining our strong investment-grade credit profile. Regardless, our gross debt leverage fell to 1.9x adjusted EBITDA at the end of Q3, as calculated per the terms of our credit agreements. We are now within the high end of the range of our gross debt to adjusted EBITDA target of 1 to 2x. We are also maintaining our dividend program. During the third quarter, we paid $21 million in dividends, and we recently announced that our board has declared a fourth quarter dividend of $0.15 per share. As we further strengthen the balance sheet through the end of the year, we will look to continue to consider additional growth opportunities, continue our dividend program, and reinitiate our return of cash to our shareholders via stock purchases. Now turning it back over to Steve for some closing thoughts.

All right. Thank you, Kevin. We believe our third quarter performance is strong evidence that we are delivering upon our 3-year strategy. We're excited about the profitable growth opportunities for the company across all lines of business as well as the trajectory of obtaining the remaining CH2M cost synergies. As such, we now expect our fiscal 2018 adjusted earnings per share outlook to be at the high end of our previous range of $4 to $4.40. We're also providing an initial outlook on fiscal 2019 earlier than its normal cadence, given the lack of historical pro forma results and seasonality of the newly combined organization. At this time, we expect fiscal 2019 adjusted EPS to be in the range of $5 to $5.40. Operator, we'll now open up the call for questions.

One, Kevin, I was surprised obviously that you guys provided guidance already for 2019. If you could just walk us through your assumptions by segment and just the level of visibility you have for 2019, so we know how much you have to actually book? I mean, to get to that number. I guess, that's my first question. And then my second question, obviously, some nice progress on the cash flow side. How do we think about the opportunity to lower the DSOs at CH2M in 2019?

Jamie, I'm not going to provide a lot of incremental details, as it relates to the 2019 preliminary guidance we gave. We decided to do that just given the fact that we got these two large organizations coming together and the seasonality of the business and the fact that we're not yet fully performing out. We thought it was a good idea to just give you a preliminary perspective. We feel good about that. We're actually in the midst of our planning process right now. So we got some more work to do before we provide some incremental guidance on 2019. As it relates to the cash flow, as you recall, we discussed in the call on the second quarter that we were a little disappointed in the lack of traction that we had been seeing on our DSO performance. And we had a real full-court press in the organization and got the business leaders focused, and they've been doing a great job on starting to get some traction on that. We saw that kind of negative trend reverse in Q3, so that was great to see. We still think that there's opportunities to continue to deliver improvements in our DSO going forward and that would be into 2019 as well. So more to come on that, but clearly, we continue to believe there's opportunities to improve on that metric going forward.

Okay. So because you wouldn't answer my first question, let me just ask a follow-up. On ATEN, you talked about margins improving from the 7% level, but you didn't say the 7% to 8% level. Am I splitting hairs here or is the higher end less achievable? I guess, I'm just trying to understand the commentary there.

No, we still have the general range of 7% to 8% for that.

This is Sean on for Tahira today. So I understand it's preliminary and you guys don't want to provide too much further guidance around fiscal '19 assumptions, but just hoping to get a little bit more color, maybe just around how you guys are thinking about the top-end, maybe just qualitatively, particularly around how you guys are thinking about the commodity-oriented end markets, for example, the meaningful upside potential in mining you guys are sighting? Any kind of added color on the real key swing factors to get to that top-end would be helpful.

The positive news is that our backlog performance over the past few quarters indicates we anticipate profit growth across all three lines of business. Although we won't go into specifics, ATEN is expected to benefit next year from the full ramp-up of major wins that started in the second half of this year. The two I mentioned in the earnings call, SOCOM and the missile defense, alongside the Nevada nuclear win we announced earlier this year, are key factors. Coupled with additional projected bookings, ATEN is well-positioned for profitable growth next year. BIAF has experienced strong backlog growth recently, with improving margins and a robust global demand profile, instilling confidence in our profit growth for 2019. Regarding the ECR business, while commodities are strengthening, our primary focus remains on driving margin improvement through performance excellence and process enhancements implemented to benefit the ECR business, allowing us to achieve higher margins with existing operations and maintain capital growth. Notably, we are observing stronger demand growth in certain markets, particularly the Middle East, which shows promising prospects for major projects in 2019, potentially providing additional benefits.

Okay. And secondly for me, I think you guys mentioned in the prepared remarks that the U.K. has remained stable for Jacobs thus far. I was just hoping you guys could provide a little bit of color on the size of the U.K. business right now, and what we should expect over the next 12 months, say, as the Brexit impact starts to flow through, anything you guys are planning around there?

The comments I made about uncertainty are meant to be cautious due to the current political negativity in the U.K. However, from Jacobs' perspective, things are looking solid. We have excellent prospects and a strong pipeline of opportunities across major sectors, including water, transportation, climate change, and some energy transmission projects. We're being careful not to overstate the situation as equally optimistic everywhere else, considering the Brexit and political uncertainty. Nevertheless, we believe this is likely just a short-term challenge, and we are very excited about the prospects. The U.K. is our second largest market, particularly in BIAF, making it extremely important. While the U.S. accounts for more than half of our business, the U.K. is a significant part of our remaining operations along with a few other key regions.

I wonder if you could talk about the pro forma revenue growth trend here. It was feeling strong at 14%, but ticked down just a couple of points. And I know, again, you don't want to provide a lot of color into 2019, but just really wondering about the trajectory here, if we should be thinking that this is going to start to trend into these single digits sooner than later? Or if that's going to be still pushed off for a while, because I'm just looking at the differential between the, let's say, ECR backlog growth at 3%, and I think last quarter, it was 2% versus the revenues at '19. So just kind of wondering how all this converges and the trajectory of pro forma revenue growth?

Let me begin and then I'll hand it over to Kevin. During my three years at Jacobs, I've learned that while revenue is important, being overly focused on it can make it challenging to accurately predict and project this business, especially due to pass-through revenues in areas like ECR. For me, the bottom line guidance we've provided is a blend of our revenue growth, gross margin, and the revenue backlog we're building, along with the synergies and cost efficiencies we're implementing company-wide. Our tools are also enabling us to maintain higher margins on future wins compared to the past. It's essential to consider all of these factors together. Specifically regarding ECR, it's vital to recognize that alongside revenue, the execution of our strategy to enhance the quality of our earnings is something we've demonstrated over the past 18 to 24 months.

So Steve, I want to add some comments. In the Q3 figures, I mentioned $175 million in incremental pass-through for the third quarter, translating to 5% growth. Please keep that in mind. Pass-through revenues tend to vary, and they were slightly higher than usual. It's important to note that, especially considering the profile of ECR. When we secure these contracts and implement turnarounds, it happens quite swiftly. Thus, you may see a disconnect between how the backlog is changing and how the revenues are aligning. What's crucial is that our gross margin and backlog remain positive, which we believe will help maintain a lower risk profile in our overall portfolio and allow us to expand our margins in the long term. There will be some fluctuations in the top line as Steve mentioned.

Okay, that's very helpful. And then maybe could you just give us a little more color on the specific project that you called out in ECR that I think is going to have an adjustment in your fourth quarter? Just how far along is it? How comfortable are you that you're going to capture all the cost headwinds in 2018? And how material is it?

Yes, look, I think I'd characterize it appropriately that it's a modest impact on margins. I'll leave it there. We're very comfortable that we have the situation and we're evaluating it and hopefully, it'll even be lower than what I'm suggesting. But ultimately, we're very confident. And it can't be that material given what I just described.

Okay. And when will the project be done?

It's near the end of this year.

I just had a clarification actually. In the footnotes to your segment operating profit reconciliation, Kevin, footnote 3 talks about a $15 million charge associated with a certain project in the quarter. But when I look at the value that you put up, like $33 million seems like that's kind of in line with the range that you've been talking about. So can you just talk about what that is and help us understand a little better?

Sure, Andy. We did experience that charge, but we also had some higher-than-normal adjustments due to actuarial work done in Q3, which mostly balanced that out. So when you look at that number, there's both a positive and a negative impact that resulted in the figure you're seeing. That’s why there isn’t a significant change.

What was the other corporate charge? It seems like a pretty decent amount there.

Fringe.

No, no. It offset the incremental $15 million. It was a benefit.

Right. I'm just saying what was the charge related to?

Project, a project that's being evaluated.

Steve, in your prepared remarks, you talked about current backlog at 100 basis points, I believe, greater than a year ago. Just to clarify that, what are some of the drivers in that change relative to the CH2 backlog you brought on? Is it the mix issue relative to just the better disciplined bidding or a better environment on grabbing a little bit better incremental margins as you're being more disciplined in putting projects in the backlog?

So as we've mentioned that it's up 100 basis points based on Jacobs' standalone reported or Jacobs' standalone backlog margin last year and because of the CH2M side. We've talked about the fact that the water business is a higher-margin business and so that's a major contributor. But I'm also pleased that when you look at the overall backlog performance from third quarter last year to third quarter this year, on a pro forma basis, both the Jacobs and the CH2M side of the business from last year have grown the backlog on the revenue side. So it's really a combination of good sort of combined performance, but especially some of the higher-margin businesses that we acquired with the CH2M business.

Excellent. Steve, following up on ATEN, among the five delineation markets mentioned in your presentation, which one or two appear more promising despite the significant transition in backlog revenues? Additionally, is there a mix benefit or detriment concerning the expected growth in new revenue and business in this segment as we approach 2019?

I'll answer both regionally and by sector. Regionally, we see the strongest pipeline moving into 2019 in the U.S. with our core A&T business, supported by significant wins and a promising pipeline of opportunities. The nuclear business, especially what we acquired from CH2M, operates in cycles, and we anticipate that 2019 and 2020 will experience an up-cycle with several large projects on the horizon. This is going to be crucial for us as we move forward. I would highlight these as two specific opportunities. The weapon sustainment area is also vital to us, as indicated in our strategy. Additionally, due to our successful acquisitions and the focus on the Jacobs Connected Enterprise, we expect substantial growth in cybersecurity and digital analytics.

You folks have had really strong win rates in ATEN over the past year. Can you just talk about as you ramp up the revenue on those projects, as you mentioned earlier, how does the prospect list look in terms of your ability to continue to grow backlog in that business? Can you just give us a sense for the bookings outlook relative to the revenue ramp that you've laid out earlier in the call?

It's a great question, Jerry, one that I consider every quarter during our business reviews. The good news is that despite the historically high wins we experienced in 2017 and 2018, we still have a very strong pipeline of opportunities in the ATEN business. To reiterate, especially in the U.S., we see potential across various military sectors and in cybersecurity, as well as with NASA opportunities, both through expansions and by deepening our relationships with existing clients. Therefore, the pipeline is solid, and we are not solely relying on the ramp-up from previous wins; we are confident in our ability to secure new business and achieve further successes. And so we're expecting continued backlog growth in ATEN as we move into '19.

Okay, good.

I have a question about earnings seasonality. Historically, we observe sequential earnings growth in the fourth quarter, but the implied guidance indicates that this may not happen this time. I'm curious if this is due to a significant project coming to an end or if there are seasonal differences related to the CH2M side. My interest lies in the fact that applying typical seasonality suggests the fourth quarter exit rate could imply that 2019 guidance is quite conservative, especially when considering the cost savings and the planned 8% growth backlog. I'm hoping to get more insight into this.

Well, first thing, $1.35 had some discrete benefits in it, so you got to recognize that. You take the tax, and you take the balance out for those items, you're really getting closer to a $1.25 figure. And then ultimately, our view is our taxes will be up a little bit more as we finalize the figures for the full year. So there'd probably be a little bit higher tax rate than what we've seen in the balance. And if you look at all of those numbers, we think we're targeting a pretty respectable underlying operating result that is actually quite attractive.

And just a question on ATEN. Can you just talk about when missile defense and the SOCOM projects hit the full run rate?

All of our projects have stages since they are multiyear undertakings. However, I would say most of the ramp-up will be completed by the first half of next year, likely more heavily concentrated in the next six months, but extending into the first fiscal year of next year.

I was hoping to get some insight into the revenue synergies mentioned in your press release, specifically if they are coming from regional growth or particular markets you want to highlight. Additionally, any metrics on employee engagement or assumption ratios and their impact year-to-date would be appreciated.

We've had some early successes attributed to the combined company, and the most significant impact we've seen is in the pipeline, which is promising because it indicates greater opportunities for revenue synergies in the future. This is evident across various areas we've discussed. The integration of CH2M's water and environmental expertise into Jacobs is enhancing our capabilities, not just in Infrastructure, where we are securing more business in water and environmental sectors, but also in our industrial sectors like mining and oil and gas. We're witnessing this growth globally. The merger positions us well for substantial nuclear projects in the future, which are also in the pipeline. Over the next year, we'll focus on discussing actual wins that can be directly linked to revenue synergies, as the first six to nine months have primarily centered on cost synergies. On the cultural and personnel front, things are progressing very well. Our attrition rates remain stable, which is often a concern during a merger of this magnitude. We believe that our Integration Management Office is effectively managing the integration process. We're maintaining momentum by actively engaging with our teams worldwide, addressing issues promptly, and fostering excitement both within Jacobs and among our clients. It's still early days, as we're only in our second full quarter of reporting, but we remain committed to cultivating a best-in-class culture moving forward as a combined entity.

Great. And I just wanted to get more color or commentary on your note on Page 15, kind of, you continue to evaluate portfolio. Does it relate to your existing portfolio, do you find noncore asset or is that in relation to you redeploying cash into incremental acquisitions? Or is it both?

I think it encompasses everything. Reviewing the company's performance over the past three years, back in 2016, Jacobs' standalone operating profit margin was under 5%. By the end of 2017, we were above 5%, nearing 5.5%. Most recently, we reported a third quarter margin exceeding 6%. Our goal is not just to drive earnings growth, but also to ensure higher quality earnings. We are concentrating on the best end markets and continually assessing our current portfolio to ensure all our efforts lead to margin growth. If we identify any areas unlikely to produce that growth, we will consider alternative strategies. Acquisitions will also remain a key part of our future strategy. We have consistently emphasized our success in integrating CH2M and Jacobs, and as we continue to demonstrate that success, we grow more confident in pursuing additional opportunities that can yield similar performance and margin improvements in earnings as we move forward.

Steve, maybe you could talk just a little bit more about your conversations you're having with ECR customers. Obviously, a lot of noise out there with the threat of trade wars, but oil prices are relatively high, it does seem like you've turned the corner here in ECR. You tend to be a little earlier cycle than some E&Cs, given your sustaining model. So you said you're seeing an increasingly strong inflection of business projects, and you could see continued nice step-up in the ECR backlog? Or is the inflection more on catching up on turnarounds, environmental spend, more of the sustaining type work?

It's both. Regarding the trade war, it's clear that some of our clients, particularly in the mining sector like copper, are experiencing concerns as they anticipate a supply-demand scenario that will be beneficial for their business in the coming years, while also being worried about the short-term impacts of the trade war. However, our clients believe this is a temporary situation, and it's not significantly hindering their progress in converting studies into full projects over the next 12 to 24 months. The same applies to the oil, gas, and chemicals sectors. Our focus is to remain committed to our strategy that emphasizes sustainable growth and stable performance despite market fluctuations. We have demonstrated this over the last few years, where Jacobs’ backlog decreased much less than the industry average during the downturn. Looking ahead, we aim to ensure that our backlog growth will not only include low-risk sustaining capital, maintenance, and turnaround projects, but also that we engage in larger projects that we will feel confident about winning, all while preserving margins and maintaining performance through our new performance excellence strategy. There is definitely a rising appetite for risk from our clients, which leads us to be cautious—passing on some initiatives in the ECR business that did not align with our risk profile. That said, there are emerging opportunities that fit our profile, and we believe that balancing these with our focus on sustaining capital maintenance will prove to be a successful strategy in an improving market over the next several years.

Kevin, since you and Steve joined, you both have performed very well in terms of execution. Could you assess the overall execution in EC&R at this point? You previously mentioned the potential modest issue in Q4, but can you clarify if the charge in Q3 was related to a CH2 project or a legacy Jacobs project? Do you believe the EC&R margin may drop below 5% for some time before recovering?

There has been significant improvement in execution across our entire portfolio, particularly in ECR and BIAF. ECR and BIAF have both excelled over the past few years in enhancing our potential loss margin compared to the as-sold margin. We constantly evaluate our performance, recognizing there will be fluctuations due to incentive payments or minor losses against the as-sold margin. Our focus is on safeguarding the as-sold margin while pursuing additional incentives. The impact of those downturns compared to as-sold margins is becoming increasingly minimal. We don't aim for that number to be zero, as that could indicate overly cautious growth, but we are making strides in reducing potential ongoing margin losses. I believe the ECR business can maintain a margin above 5% going forward, with an expectation for even higher margins in the long term. There may be occasional fluctuations, but the magnitude of losses is significantly less than it was at our peak in 2015.

But Andrew, specifically, I want to emphasize that we do not expect this situation to extend into 2019; it is just a commentary for one quarter.

Just a couple of quick follow-ups on ECR. The backlog, 80% reimbursable. Understand the appetite for a little more risk here going forward, but is it your desire to sustain the portfolio that's still majority reimbursable there?

Yes. No change to our strategy there.

As you consider pursuing capital project opportunities as they materialize, do you have any insight into the potential margin opportunity compared to the 5% that the segment has been performing at?

We're seeing a modest increase. As Kevin mentioned, we've had success in that business, which has improved from low 4s to about 5% since 2016, representing an increase of roughly 100 basis points. Our ECR team has specific strategies geared towards further growth in that area. Okay. Thank you. Thanks again for joining our call and would like to end the call by reiterating that we're well on our way to our mission to create a new kind of professional services company, and we like to describe it as one that doesn't exist in our industries today. So thank you again, and we look forward to talking to you next quarter.