Jacobs Solutions Inc (J) — Q4 2018 Earnings Call Transcript

Good morning, and afternoon to all. Our earnings announcement was filed this morning and we have posted a copy of the slide presentation to our website, which we will 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 facts are forward-looking statements. Although such statements are based on management's current estimates and expectations and our 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. The potential risks and uncertainties include, among others, the possibility that acquisitions of the ECR business of Jacobs by WorleyParsons will not close, or the closing may be delayed, the ability to recognize the benefits of the ECR disposal, an outcome of legal proceedings and the risk of Jacobs future performance may not achieve its estimated earnings. For a description of these and other risks and 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 year ended September 29, 2017 and our subsequent quarterly report on Form 10-Q for the first quarter of 2018 when filed with the Securities and Exchange Commission, our Annual Report on Form 10-K for the year ended September 28, 2018, as well as our other filings with the SEC. We are not under any duty to update any of these forward-looking statements after the date of this presentation to conform to actual results except as required by applicable law. During the presentation, we will refer to certain non-GAAP financial measures. Please refer to Slide 2 of this presentation for more information on these figures. In addition, during the presentation, we'll discuss our current results to Jacobs and CH2M performance in 2017 calculated on a pro forma basis. We will also discuss pro forma financials that exclude the ECR business in light of the pending divestiture. See Slide 2 for more information on the calculations of these pro forma metrics. We believe this information helps to provide additional insight into the underlying trends of our business and comparing current performance against prior years. Turning to the agenda. Steve will begin with a tribute to our former CEO of Noel Watson and discuss our focus on driving a culture of inclusion and diversity, provide a recap of our fiscal year results, including a market review for each line of business and provide an update on our CH2M integration. Kevin will then provide 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 your questions. With that, I'll now pass it over to Steve Demetriou, our Chair and CEO.

Thanks. So turning to Slide 4, before I discuss the results of the quarter, I'd like to honor the memory of former Jacobs' Chairman and CEO, Noel Watson, who passed away in August at the age of 82. A great mentor and friend, Noel was a larger-than-life leader, a man of character who brought tireless passion, perspective, and wisdom to Jacobs, particularly around safety and integrity. During his tenure as CEO, Noel spearheaded the Company's growth sevenfold from $1 billion to $7 billion in revenue with corresponding profit increases. Recruited by our company founder Joe Jacobs, Noel served the firm for more than 50 years, including more than 25 years at the helm of the Company. Foremost, Watson was a dedicated and loving husband, father, and grandfather. He is survived by his wife, Phyllis, their two children, and five grandchildren. In honor of Noel's legacy, we've created the Noel Watson Integrity and Values award to be presented annually to Jacobs' employees who embody the utmost standards of ethics and integrity. Now moving to Slide 5. Our strong performance over the last few years has been supported by a relentless focus on culture, including safety, positive mental health, integrity, and leadership accountability. Building on the solid foundation, we are also concentrating on inclusion and diversity, along with innovation to further strengthen our culture. Recently, we held our first Annual Inclusion Week to increase the velocity of inclusion and diversity within our organization. I am personally co-chairing our Jacobs Women's Network and each of our senior executive leaders are sponsoring one of our other employee network groups. Throughout the year, our PRISM network, which represents our LGBT community, participated in pride celebrations globally. Similarly, our Harambee network, which celebrates people of color, is actively engaged internally as well as externally with our local communities. These are just three examples of the diverse networks within our global Jacobs family. We believe inclusion and diversity will be a key determinant of our success as it drives engagement and empowerment of all Jacobs employees, creativity to solve critical challenges, and attraction and retention of the brightest talent, which together accelerates our efforts to be the employer of choice in our industry. It is proven that companies that achieve broader levels of inclusion and diversity consistently outperform. And to demonstrate our commitment, we are instituting culture-based leadership metrics into annual executive compensation, which will include inclusion and diversity goals for each senior Jacobs leader. Now let me turn to Slide 6 to review our results. We delivered strong fourth quarter and total year 2018 results that exceeded expectations. Our results are a testament to our employees' disciplined focus on operational execution, while delivering a successful year of integration of CH2M, one of the most transformative acquisitions in our industry. This has translated into financial performance levels above our expectations. Our 2018 revenue grew 9% pro forma including CH2M. Our Aerospace, Technology, Environmental, and Nuclear business was a major driver of that growth with a 15% pro forma increase. Our gross margin increased over 100 basis points and adjusted operating profit margins were up 60 basis points to 6%. As a result of the strong performance, our adjusted operating profit grew double digits in all three lines of business. This growth led to adjusted earnings of $4.47 per share, an increase of 38% year-over-year and above the high end of our guidance. This strong performance combined with our proactive portfolio transformation provides us the opportunity to invest in innovation and drive continued profit and margin growth. Now turning to Slide 7 to discuss backlog performance. Our fourth quarter revenue and backlog was $27.3 billion, up 2% year-over-year on a pro forma basis with underlying trends much stronger as large upcoming ATEN renewals of approximately $425 million are not currently in backlog. Furthermore, all lines of business contributed to a pro forma backlog growth. Gross margin and backlog was up more than 100 basis points year-over-year on a reported basis, driven by the higher margin mix from CH2M and a continued focus on winning high-value business. Upon completion of the sale of our Energy, Chemicals and Resources business, our pro forma gross margin and backlog will further improve by more than 150 basis points from the higher margin mix of the remaining ATEN and BIAF portfolio. Before I discuss the performance of our ATEN and BIAF businesses, I'd like to outline the significant improvement of ECR on Slide 8. With the recent announced divestiture of our Energy, Chemicals and Resources business to WorleyParsons which is expected to close in the first half of calendar year 2019, I would like to take a moment to recognize our ECR team. I am very pleased with the team's ability to drive substantial value creation over the last few years. During the recent challenging industry environment, the team successfully shifted resources to capture refining and chemical opportunities and expanded our footprint into new geographies. This was achieved while maintaining a healthy risk posture and a significant reduction of write-downs, driven by improved project execution. As a result, ECR drove a strong financial performance over the last two years with a 42% increase in operating profit versus 2016. Most recently, the business returned to growth with 2018 pro forma revenue up 7% and operating profit margin expanding 60 basis points versus 2017. I'm incredibly proud of the entire ECR team's passion and commitment. They are strongly positioned for future success as they combine with WorleyParsons to create a preeminent leader in the energy and resources industry. While this divestiture is bittersweet, consistent with our strategy, we believe it's the right time to make this change to our portfolio, which allows Jacobs the opportunity to focus 100% on our ATEN and BIAF businesses. Slide 9 highlights our transformed business portfolio as we move forward post the sale of ECR. This newly focused portfolio reflects a stronger sustaining revenue mix and higher value end markets aligned to growth trends where Jacobs has a leadership position, including national government priorities, sustainable infrastructure, and digitally enabled solutions. We intend to leverage our full complement of differentiated capabilities across our ATEN and BIAF portfolios to drive revenue synergies. This is forming the basis of the next phase of our strategy, which we plan to further discuss at our upcoming Investor Day in February. Turning to Slide 10. Now let me discuss the performance of Aerospace, Technology, Environmental, and Nuclear, ATEN. During the quarter, our ATEN business continued to significantly outpace the growth of the market and our public government services peers with 19% year-over-year pro forma growth. Key to this performance were a number of long-term enterprise contract wins with the U.S. government, including the Missile Agency and Special Operations Command, which have created a strong base of recurring revenue. Backlog was up 2% versus last year's combined fourth quarter, which more than offset the impact of the burn off by a few large programs that will be rebid soon. Together, these renewable opportunities account for approximately $425 million of annual revenue not yet reflected in our backlog. Gross margin and backlog increased 50 basis points compared to 2017. The upside to this dynamic is that the nature of these long-term large-scale enterprise contracts create strong financial stability. From an end market perspective, we are well positioned against U.S. federal government's high priorities within the Department of Defense, Department of Energy, Intelligence Community, and NASA. Contributing to the stability of our portfolio, many of our large contracts are aligned to mission-critical areas within the federal budget and are less discretionary in nature. Furthermore, given the highly fragmented nature of the government services market, we believe that our strong technical expertise, unique localized delivery model, and industry-leading efficient cost structure will allow us to continue to gain market share over time. During the quarter, we were awarded several transactions, including the U.S. Student Financial Aid Program. They also provide predictive cyber analytics to modernize the FSA's security operation center to protect against threat actors seeking to infiltrate government information systems. A five-year sub-contract for the U.S. Air Force was awarded to provide software development and sustainment for the Air Force Financial Systems Office, bringing our software engineering capabilities to three core applications. We were also awarded a 10-year sole-source classified contract for continuity of senior government officials’ communications, which attests to the capabilities of our telecommunications, IT, and cybersecurity teams. And turning to the commercial part of our ATEN business, we continue to see strength in telecom. The business is mainly professional services such as consulting, engineering, and program management of communications infrastructure development. The 5G wireless build-out provides a significant opportunity for growth over the next five years. During the quarter, we had another key win with AT&T, continuing the expansion of our geographical footprint in the United States. We are also seeing accelerating opportunities to leverage ATEN capabilities into our BIAF client base, such as smart infrastructure solutions. We believe that leveraging these technology capabilities across the rest of our portfolio will drive additional revenue synergies. So, in summary, the ATEN business had outstanding performance in fiscal 2018 and we are encouraged by the opportunities we see going forward, including continued profitable growth in fiscal 2019. Now on to Slide 11 to discuss our Buildings, Infrastructure and Advanced Facilities line of business, BIAF, which posted yet another solid quarter of results. On a pro forma basis, BIAF backlog increased 3% year-over-year with gross margin and backlog up 70 basis points. From a macro standpoint, we continue to see a robust pipeline of global opportunities driven by the major trends of urbanization and population growth, leading to an increasing need to invest in upgrading supporting infrastructure. The results of the U.S. midterm elections were favorable for infrastructure spending and state ballot measures such as the California gas tax. In the UK, we are aligned with well-funded multi-year programs such as the Environment Agency's TEAM2100 and we recently won Highways England's Routes to Market, a six-year program to transform England's motorways. Asia Pacific demand is underpinned by strong public investment in rail and other infrastructure investments. As outlined in our recent Water Investor conference call, we see multi-decade demand drivers for our water business, including in the near term being on the front end of a major water upcycle in the U.S. We recently were awarded several major water opportunities such as program management with the City of Chicago, O&M with the City of Waterbury, Connecticut, and a more than 10-year program for California WaterFix. Water is one of the areas where we are driving innovation. As a great example, the City of Atlanta has selected Jacobs to develop the digital transformation and smart water utility action plan to define how best to align technologies to address goals such as infrastructure resilience, operational efficiency, and cybersecurity. Within transportation, aviation continues to be strong in the United States and Asia, and we recently closed a contract for the design of a major terminal renovation at Baltimore Washington International Airport. Transit and rail are strong globally, and during the quarter, we closed a significant consulting engagement with Melbourne Metro. With regards to our Built Environment business, healthcare, education, and federal buildings are clearly beneficiaries of the broader demand drivers. During the quarter, in education, we won a program management opportunity with the Omaha Public Schools District. We're also seeing a trend unfold for more mixed-use infrastructure, which is allowing for potential revenue synergies between our Buildings Group and other infrastructure teams. Financially, our Advanced Facilities business continues to perform above our expectations, driven by our life sciences and electronics businesses with major wins during the quarter in both sectors. We had a sizable win with a U.S.-based semiconductor manufacturer and, in October, we closed a $400 million EPCM project with a confidential life sciences customer. In summary, our BIAF line of business has shown a track record of consistent strong performance. Revenue and margins have increased from both higher value engagements and improving project execution. Before I turn the call over to Kevin, let me make a few additional comments about CH2M. We are clearly demonstrating that the CH2M acquisition has been a strategic and financially accretive use of capital. The cost synergies that underwrote our valuation are well ahead of our original plan and our revenue synergy pipeline is gaining strong momentum. From a culture standpoint, the teams are now fully integrated and focused on delivering our profitable growth agenda.

Thank you, Steve, and good morning and good afternoon to everyone. Let's proceed to Slide 12, where you can see a more detailed summary of our financial performance for the fourth quarter of fiscal 2018. In the fourth quarter, our pro forma revenue increased by 7% year-over-year, with growth across all businesses, particularly from ATEN, which saw a 19% rise. Our gross margins for the quarter were 19%, up 130 basis points year-over-year, benefiting from a better gross margin mix from CH2M. We also reduced our G&A spending, with pro forma G&A down in absolute terms year-over-year and flat compared to Q3, thanks to our continued success in realizing expected cost synergies from CH2M. This was slightly offset by higher incentive accrual adjustments in the quarter. Our GAAP operating profit margin was 5.8%, affected by costs related to the CH2M acquisition and integration. The adjusted operating profit margin for the quarter was 6.8%, an increase of 130 basis points. Operating profit as a percentage of revenue improved by 40 basis points sequentially, again due to the progress in cost synergies. Our GAAP EPS for the quarter was a negative $0.16, which included a $1.18 per share charge related to tax reform impacts on our CH2M opening balance sheet, resulting from our end-of-year review process of CH2M's deferred tax assets and liabilities. Additionally, there was a $0.18 charge for restructuring related to the CH2M acquisition and other transaction expenses, along with another $0.10 charge from the sale of our Guimar joint venture in Brazil, most of which was non-cash. This joint venture was previously part of our ECR business. Ignoring these items, the fourth-quarter adjusted EPS was $1.31, representing a 34% year-over-year increase. Our DSOs improved sequentially as we focused more on cash collections from the uplift we experienced in the first half of the year, supporting solid cash flows for the quarter, although we recognize there is still more work to do in this area. Regarding our bookings in the quarter, our pro forma book-to-bill ratio was 1.03 times. Now, let’s review our full-year performance on Slide 13. Our results clearly reflect our focused execution of our profitable growth strategy, with revenue increasing by 9% on a pro forma basis. The GAAP operating profit margin was 4.3%, while the adjusted operating margin was 6%, which is a 60 basis point increase from last year. Operating profits for both Jacobs and CH2M's legacy businesses increased by double digits, leading to a combined pro forma growth of 13%. The GAAP EPS was $1.28, and when excluding the same items as previously mentioned for the quarter, the adjusted EPS was $4.47, up 38% year-over-year and exceeding both our initial outlook and the upper end of our current guidance. Our successful execution of the CH2M integration plan has resulted in outperforming our original accretion objectives for the acquisition. Although we did not meet our internal DSO targets this year, we still see improvement opportunities and remain focused on enhancing our performance moving forward. Finally, for the year, our book-to-bill ratio was 1.04 times. Before moving to the next slide, we plan to file our Form 10-K in the upcoming days. Please remember that we are still finalizing our year-end audit processes, especially concerning income taxes, which are complicated this year due to U.S. tax reform and the CH2M acquisition. There might be some final audit adjustments in our final reported U.S. GAAP results that will be outlined in our Form 10-K, but we do not anticipate any changes to our adjusted results at this time. Regarding our business performance, I’ll now turn to Slide 14 and start with ATEN. In addition to the strong revenue performance, as Steve mentioned, ATEN also saw solid operating profit growth for the quarter and the full year, at 14% and 12%, respectively. The operating profit margin for the quarter was 7.3%, while for the year it was 7.5% when excluding a previous legal matter discussed in Q2. This aligns with our expectation of 7% to 8%, and we anticipate continued improvement in ATEN’s operating profit margins as we shift towards higher value engagements. Fourth quarter BIAF revenue saw a 1% year-over-year increase. As noted, our revenue growth in earlier quarters has outpaced backlog growth due to timing, and the fourth quarter's revenue growth has adjusted that difference. For the year, pro forma revenue growth was 8%, reflecting the overall momentum of the business line. On a pro forma basis, both fourth quarter and annual operating profits increased by 5% and 11%, respectively, with an operating profit margin of 8% for the quarter, up 30 basis points. For the year, the operating profit margin was 7.8%, a 20 basis point increase. We see room for further margin expansion in BIAF through a combination of executing our higher gross margin backlog, strong project delivery, and targeting higher margin opportunities within our pipeline. Based on early successes in fiscal 2019 and ongoing advancements in our pipeline, we anticipate an acceleration in gross margins and backlog by the end of the first half of fiscal year 2019. Lastly, our ECR operating profits grew by 19% and 23% on a pro forma basis for the fourth quarter and full year, respectively. The fourth quarter's operating profit included a $9 million charge related to fixed-price projects accrued in corporate expenses in Q3 2018. We are very pleased with the financial success of our ECR business since we initiated our strategy in 2016, and in fiscal 2019, we expect our ECR businesses to be classified as discontinued operations and assets held for sale in our financial statements. Our non-allocated corporate overhead costs for the quarter were $3 million, benefited by a $15 million reversal of the project reserve previously noted, with $9 million now reflected in ECR's operating profit. For the full year, unallocated corporate expenses were $116 million, within the lower end of our expected range due to ongoing strong performance against synergies and lower-than-expected fringe-related costs, offset slightly by higher incentive accruals resulting from our robust performance. We expect fringe-related costs to return to a more typical level in fiscal 2019, particularly in Q1, as we conclude our medical plan calendar year, when costs generally peak. Now regarding synergies, on Slide 15, due to the pending divestiture of ECR expected in the first half of calendar 2019, we will adjust our synergy commentary to remove any one-time costs and synergies linked to the ECR part of the CH2M integration. All future figures will exclude these impacts. We achieved $85 million in synergies for the year, surpassing our earlier estimate of $75 million, which included ECR. This clearly shows our outperformance. We still expect to meet our previously raised synergy target of $175 million without ECR, and on a comparable basis, we are raising our synergy estimate again, anticipating our run rate in synergies to approach $175 million nearing the end of fiscal 2019. We estimate that the P&L cost to realize these savings will be $265 million, with over 60% of one-time costs in cash. As for Q4, we have incurred $171 million of the expected $265 million needed to achieve these synergies, excluding ECR-related one-time costs. Lastly, concerning our CH2M transaction and change in control costs, we have totaled $91 million through Q4, a figure that remains the same as previously indicated in Q3. Now turning to the balance sheet on Slide 16. Before we discuss the balance sheet, I want to update you on Inpex, a contingent liability we took on through the CH2M acquisition regarding our project in Darwin, Australia. As you're aware, we've mentioned this item since announcing the CH2M acquisition. In Q4 2018, we updated our opening balance sheet reserves for Inpex, which is still undergoing arbitration. We are actively pursuing our claims against the counterparty while defending our position. We believe this adjustment is prudent as we continue to evaluate this matter throughout the fiscal year. Importantly, we modeled various potential outcomes when assessing the CH2M transaction, and even including this reserve, our financial model remains largely consistent with the anticipated overall returns of the transaction. Consequently, we do not expect this reserve, should it turn into an actual cash cost, to significantly affect our original internal rate of return expectations associated with the transaction. As previously disclosed, we do not anticipate a resolution of this matter until at least fiscal year 2020. We ended the quarter with about $800 million in cash and approximately $2.2 billion in gross debt, which was down $194 million from our Q3 level, bolstered by solid cash flow from operations of $212 million. Our cash flow from operations for the quarter included a voluntary $50 million pension payment we made to minimize cash taxes and pension and insurance fees. With that discretionary contribution, our underlying cash flow from operations exceeded $250 million, reflecting an improving cash flow trend as we advance through our integration efforts. As a result, our gross debt leverage improved to 1.7 times adjusted EBITDA at the end of Q4, as per our credit agreement terms, landing at the high end of our gross debt to adjusted EBITDA target of 1 to 2 times. Notably, our net debt to adjusted EBITDA ratio is now at 1.1 times. On the right side of the slide, considering the expected $2.6 billion in net proceeds from the sale of ECR, our pro forma net cash position for Q4 would be around $1.2 billion, which positions us well to allocate capital in ways that generate incremental value for shareholders, as outlined on Slide 17. We have a proven history of disciplined, value-driven capital allocation that has delivered strong returns for Jacobs' shareholders. As stated during the ECR transaction announcement, our capital deployment strategy will evaluate both organic and external growth opportunities, as well as returning capital to shareholders. We will provide more details at our February Investor Day as we approach the completion of the transaction. Now I’ll hand it back to Steve for some closing remarks.

Thanks, Kevin. Turning to Slide 18, we finished fiscal 2018 on a strong note and ahead of the goals we set in our three-year strategy. Our transformed portfolio has now positioned the Company to accelerate its growth agenda in a more focused way. We reaffirm our previous fiscal 2019 adjusted EPS guidance in the range of $5 to $5.40, assuming a full year of ECR operations. For Q1, consistent with our annual guidance and incorporating the seasonality of our business, we expect adjusted EPS in the range of $0.85 to $1.15, including ECR. Until we close the sale of ECR, we will continue to provide EPS guidance on a quarterly basis. Consistent with the announced transaction, we continue to expect fiscal 2019 adjusted pro forma EBITDA excluding ECR on a full-year basis to be in the range of $920 million to $1 billion. We continue to work on the next phase of our strategy, and we look forward to sharing this with you at our Investor Day in February. Operator, we'll now open up the call for questions.

First question is, if you can talk about the new Jacobs segments ATEN and BIAF and where your early thoughts may be for the FY19 outlook. And also, if you could address the free cash conversion characteristics for the new Jacobs going forward?

Good morning, Lucy. Thanks for the question. So we're very positive about both of our lines of businesses that you mentioned, ATEN and BIAF as we go into fiscal year 2019. ATEN, we've got a very strong sales pipeline that we're confident will drive profitable growth in both fiscal year '19 and into fiscal year '20. We believe we're in all the right areas with regard to that business, long duration recurring revenue contracts. Over 90% of that business consists of these long-term contracts, and also our pipeline is significantly stronger as we enter 2019 compared to 2018. Whether it's intelligence community, defense, cyber, SOCOM, Missile Defense, we've got a rich pipeline as well as military infrastructure and, as I mentioned, some of the commercial activities around 5G, etc. On BIAF, similarly, we're very excited about the pipeline of our business. What's come out of the mid-term elections is extremely positive for this business and we see a very robust pipeline of opportunities in the Americas around transportation, both rail and highways. Aviation continues to be extremely strong in the U.S. Water, as a result of all the drivers of aged infrastructure and climate change resilience, is extremely strong in the U.S. On the advanced facility side in the U.S., both life sciences and electronics, we have a rich pipeline of activity going forward. Outside of the U.S., Middle East is extremely strong, almost across the board, similar to the U.S. story. We've got tremendous opportunity in aviation in the Middle East as well as Australia and India. Even in the UK with its Brexit uncertainty, the scope and scale of all our UK programs continues to move forward, and we're penetrating broader Europe. We're pretty positive about the outlook for 2019 in BIAF as well. Kevin, on the free cash flow conversion?

Yeah. We talked, Lucy, when we did the announcement on the ECR transaction is that, fundamentally, there are two things that are going to help us going forward with our new portfolio after the transaction closes. The first one is that the ECR business, while having done a great job in improving its margin profile over the last two or three years, is still the lowest margin business that we have. The operating profit margin is in the neighborhood of a couple of hundred basis points lower than the rest of the portfolio. So clearly when that business exits, we will have a higher margin profile, which clearly will translate into a higher level of cash flow conversion going forward. The second piece is that the DSOs for the ECR business tend to be higher than the rest of the business, and certainly there are some structural issues associated with that business, which is obviously very competitive in nature. Consequently, as we think about our cash flow conversion, both of those items will translate into our results in cash flow improving versus where we are. Having said all of that, unlike the numbers that we were able to put up in the back half, this is a kind of a messy year on our cash flow, because we've got a lot of things going on with the integration efforts with CH2M, but in the back half of the year, we are approaching $500 million of operating free cash flow in Q3, Q4. So we're developing into as we progress through the integration process a really strong picture as it relates to our cash flow dynamics going forward.

Very helpful color. Thank you. And just a follow-up question is probably on top of everyone's mind, which is your capital deployment plan, maybe with a focus on ATEN and under a couple of underlying contexts to that is, one, your budget priorities in areas such as base, intel, cyber cloud, and secondly, perhaps, if you're looking for margin accretive transactions where you can both serve as 7% to 8% target.

Yeah. So we're going to spend some more time in February on our Investor Day outlining our strategy, and we believe we're going to want to wait there to discuss more about how M&A fits because, as you know, it's important for M&A to be consistent with strategy. As we finalize our next phase of that strategy, we want that to be cohesive. But you just mentioned the federal budget. I talked about the positive nature of that on our infrastructure, and we're also net positive on our Aerospace, Technology, Environmental, and Nuclear business. There's a lot of talk about what's going to happen with defense spending, but we believe based on our discussions on the Street that the major focus is going to continue to be on both parties around cyber security, around mission, the intelligence community, around the SOCOM which we're a big player, Missile Defense, also base military infrastructure where that's a big market for us. We believe that the federal budget will be there for us to continue to grow our backlog, but, as I mentioned during my remarks, our strategy in ATEN and our unique approach to going to the market, we're continuing to be positioned to gain share in this environment going forward as well. So to finish off, we will come back around capital deployment and more specifics around the topic I just mentioned, across both our BIAF and ATEN businesses.

I have two questions, mainly for Kevin. First, when you discussed or announced the sale of the ECR business, you mentioned taking steps to offset the dilution from the sale. However, I didn't see much guidance on how to approach that for 2019. Can you provide any updates? Second, I appreciate the information regarding the balance sheet reserve, but I don't believe you specified the amount. Can you provide more details on that? Additionally, some partners completing various case projects are facing balance sheet challenges. How do you view the potential risk to Jacobs, particularly concerning Chiyoda?

So a couple of things, Jamie, to respond to the questions. The first one on kind of the opportunity for our go-forward elimination of stranded costs. I think the way that we’re thinking about this, and we've already started the process, is that as we look to finish and execute the final transaction close, which we're expecting to occur sometime in the first half of calendar year, we will have had a very clear outline as it relates to what costs will go with the transaction to help support the ECR business and what costs will not, and we will have taken actions to fundamentally largely offset any stranded costs that remain. Our view is that we'll be able to do that. If you think about the dynamic associated with our reported results, while we are going to have a lower base in terms of corporate overhead allocation, we assume we will be largely able to exit without many challenges associated with the remaining co-business. So that hopefully provides a little bit of incremental color. As we work through that with WorleyParsons and as we get to the final transition services agreement and understanding what costs we need to provide to them and how that works, we'll provide more updates, but it's true, it's a little too preliminary about that particular issue. In terms of the buyback, certainly the opportunity, we will continue to explore buybacks on a short-term basis and take actions at minimum to offset the share creep from incentive comp that happens on an annual basis and we will continue to evaluate a share buyback in the near term associated with that. Lastly, regarding the Inpex matter. Look, we're in the early stages of this arbitration process. I can tell you that we feel we've been very prudent as it relates to the incremental reserves that we've put on the books regarding this matter. It's hard for us to think about something that would equate to the numbers you might be alluding to. I think we've done a very deep dive on this issue during our diligence and have been doing additional deep dives over the course of this year. We believe that the matter at hand is prudent and not aggressive from Jacobs' perspective.

Kevin, you mentioned an expected acceleration in gross margin and backlog by mid-fiscal '19. What gives you that confidence? Is that based on some bookings that you already have now in backlog after we're into Q1, and how quickly could you see that translate into reported margins?

Thanks, Steven. It's kind of two things. One, the preliminary wins that we've seen in October of our fiscal 2019 and the pipeline, which is transitioning from a pipeline opportunity to a win, which fundamentally is getting to the point where it might not close in October or the first quarter of this year, but certainly in the second quarter of next year. The developing pipeline as well as winners to date create a pretty bullish view that we have as it relates to BIAF going forward into 2019.

Okay. And the second half of that was, how quickly could that translate into the reported margins? Is that like the second half of the year?

Certainly, the second half would be the expectation. If some of those larger things happen in Q1, which we're unsure about the timing of what might happen, certainly could happen a little bit sooner than that, but I would say, for purposes of just being conservative, I would say more second half than second quarter related.

Okay. And then could you just talk about the expected trajectory of the pro forma revenue growth in ATEN? Certainly still strong double digits this quarter. Do you anticipate that that would moderate to single-digit growth over the course of fiscal '19, and if so, should we expect really the offset to be in higher margins there, maybe getting closer to the 8% of your 7% to 8% range?

So a couple of things. First, the very strong double-digit revenue growth that we saw in 2018 was a ramp, but the underlying business was strong as well, and so we fundamentally believe the benefits of large project ramp-ups will dissipate as we enter 2019. We're still going to see good revenue growth. We probably will be in more of a single-digit range, but the overall outlook for '18 continues to remain good solid growth. Of course, margin profiles will continue to improve over time. I think that's aligned with our original strategy from 2016. If anything, ATEN's ability to drive innovation is going to be a driver to our ability to grow margin profile longer term.

Steve or Kevin, can you give us a little more color on what you're seeing in BIAF? Last quarter you mentioned that sales would improve sequentially, margin would be in the 8.5% range and backlog was still up sequentially. Sales were down a little, margin was at the bottom of the range in the quarter. You mentioned UK is pretty solid for you guys, but obviously, the geopolitical situation is pretty unstable. Did you see anything that was a little weaker than you thought? Then I think, Kevin, you also mentioned that the 8% growth you saw in FY18 was more representative of that business. Is that kind of what we should be thinking for '19, sort of mid to high single-digit growth for BIAF?

On BIAF, sequentially, if you're looking at operating profit margins, there were a couple of dynamics in the fourth quarter that had some one-time cleanup of past project work that created a little noise versus last year and sequentially. When you also look at our strong performance in the business, there were some compensation accruals that got put in there, and when you normalize that, sequentially, we had sequential profit growth and strong margin performance. As we go into fiscal year '19, the opportunities are significant and, in fact, many wins that we've discussed today came in October. Those wins are not yet on the backlog. Numerous opportunities in the built environment and energy distribution will be reflected in our backlog growth in BIAF as we continue to progress. I can't really say anything other than we expect to see steady ramp-up in backlog and BIAF as well.

We are feeling good about both ATEN and BIAF in terms of growth profiles for next year. We have been seeing pretty large growth levels in BIAF, which comparing to our backlog growth has been good, solid sustainable growth, but the growth was stronger. As you look at the fourth quarter numbers, we've settled back to an annual number that's probably more in line with the underlying momentum. So, yes, we're probably back into mid-single-digit growth for revenue, and I think longer term, we can improve margin profile again.

That's helpful, guys. And then just asking for a bit more color on ATEN backlog in the sense that this was the first quarter it was down a little sequentially. Once again, still up year-over-year and still a good result. Last quarter you sounded confident that backlog can rise in 2019 in ATEN. Steve, I think you mentioned the $225 million of renewables would be bid out soon. Do you still have confidence in the backlog increase, and should we think it's more back-end loaded or are your projects piled up toward the end of fiscal '19 or are they available throughout the year?

The bottom line is that our ATEN pipeline is up 20% year-over-year, which is significant. We now have 17 opportunities valued at $100 million or more compared to 11 last year. So, a 50% increase in larger programs, and we know we have a strong win rate. That gives us confidence around ramping our backlog. Some of the rebid opportunities may start to progress in the second half of the year, allowing us to put some back on the backlog. Thus, we see sequential growth over the next 12 months.

As you look at your mix of public sector versus private sector clients, more primarily in BIAF, do you see any differential in growth rates or opportunities, international versus domestic? It sounds like there's a little bit more interest and excitement as you mentioned in the Middle East and even in the UK that could help lever that growth rate outside the U.S. relative to your business here.

When we look at our advanced facilities business, which is heavily on the commercial sector, we've got strong opportunities in the U.S. and in Europe, certainly. The electronics business is strong across the board, which gives us some bullish outlooks across the commercial sector. We see positive funding at federal, state, and local levels in addition to P3 funding and we feel we have strong pipelines across the board for transportation, as well as water and environmental services. I don't think we differentiate growth rates; we see a strong outlook in BIAF in all those markets.

As we look at the M&A pipeline, although there isn’t a specific absolute timeframe, we continue to work hard on the CH2M integration. We’re excited about the work that our teams have done to date, and the profile of the margins and cost synergies is progressing well. We will certainly consider smaller acquisitions and the potential for share buybacks could also be considered prior to our Investor Day in February.

Do capabilities in ATEN allow you to win projects in BIAF? Maybe things like cybersecurity in ATEN for something like smart cities in BIAF, or can these two segments win as stand-alone operations?

We've set our line of business structure with the three lines originally, and as we go forward with them, we believe it positions us to win in the marketplace with these two remaining lines. There is important connectivity that we are driving forward, and Darren Kraabel, who comes from ATEN, has a new role overseeing Technology and Innovation. His mission with our leadership, including Terry Hagen and Bob Pragada, is to drive revenue synergies. One of our main opportunities is to leverage cybersecurity in our ATEN business across BIAF. That strategy is clearly present and evolving.

Steve, I’m wondering if you could put a finer point on the timing of bid opportunities across the two remaining businesses over fiscal '19. How balanced is the large project bookings opportunity over the course of the year that you described in ATEN? Also, can you comment on any major upcoming renewals or contract rollovers you have?

From an ATEN perspective, we actually feel stable regarding rebids and don't see a significant deterioration. Some rebid opportunities have moved to the right but we can predict confirmations in the next couple of quarters. Our new opportunities from winning proposals will underpin our growth. It’s a strong pipeline for both ATEN and BIAF, and there are numerous opportunities out there. I can't specify quarter by quarter timing because of the nature of our business.

We’ve been principle with our reserves for Inpex as we continue through the overall arbitration process. We believe that there has been a prudent step as it relates to our pushes and we have a variety of ways to interpret this matter. We’re confident in our current position.

To wrap up the discussion on cash deployment, can you remind us of your return hurdles on acquisitions and the timeline for those returns? If you find a big strategic acquisition, would you be willing to push some of those hurdles? Also, given what's happening in the market, what would the company look like in the next downturn?

The two key words for our M&A decisions are strategic and disciplined. We believe that if we undertake M&A, it should create shareholder value. For future acquisitions to align with our strategic vision, we want to ensure they are cohesive and can provide growth. For downturn preparedness, we expect our remaining businesses to benefit from long-term trends. We will continue focusing on innovation and market segment demands to mitigate declines.

The portfolio post-ECR sale will aim for stable volatility driven by secular needs, underpinning both business sectors and their efficiency. Our outcomes will highlight the effectiveness of innovations.

Thanks. I apologize, I got disconnected. So I apologize if I'm asking questions that may have been asked before. Kevin, just in terms of quarterly cadence of EPS, you've been very helpful in the past. Is there a more back-end loaded profile going forward, or is it kind of spread equally among the quarters?

The lowest quarter in the year is our first quarter, driven by a couple of factors. First, there is a seasonal impact due to holidays, lower revenue burns, and accommodations while winter conditions prevail. This aspect impacts results as well. We typically can range from 15% down to 20% or 25% down versus Q4. The first quarter’s guidance reflects that low base. Overall EPS cadence will see a back-end stronger profile.

Thank you, everyone, for joining us today. We are focused on building a stronger Jacobs that presents a compelling proposition for our employees, clients, investors, and value for our shareholders. We believe this transformation creates inspiring opportunities for employees while driving a high-performance culture that reflects accountability and inclusion. We look forward to our Investor Day in February.