Jacobs Solutions Inc. (J) Q3 2018 Earnings Report, Transcript and Summary

Good morning. My name is Krista, and I'll be your operator today. At this time, I would like to welcome everyone, to the Jacobs to hold its fiscal Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. I will now turn the call over to your host, Jonathan Doros from Investor Relations. You may begin.

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 in regards to our presentation and remarks today. Our results reported today include a review by all 3 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 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 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 3 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 7 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 could 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 setup an emergency fund contributing tens of thousands of dollars within just 1 week, showing just how authentic our culture of caring is at Jacobs. Turning to Slide 6. Our third quarter revenue and backlog was 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 is 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 plus-ups 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 was 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 continues to show steady performance from both new construction as well as continued operations and maintenance investments. During the quarter, we were awarded 2 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 the 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 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 has 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 4x 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 1 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 business, 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 a 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 the 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 LOB 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 150 -- 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 cost 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 onetime 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.

[Operator Instructions]. Your first question comes from the line of Jamie Cook from Credit Suisse.

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 CH2 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 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, that was great to see. We still think that there's opportunities to continue to deliver improvements in our DSA -- 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 7% -- 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.

Your next question comes from the line of Tahira Afzal from KeyBanc Capital Markets.

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.

I think the good news is that -- as evidenced by our backlog performance over the last couple of quarters, is that we're expecting profit growth across all three lines of business. And again, we're not prepared to go into detail, but ATEN is benefiting -- will benefit next year from the full ramp-up of all the major wins that they've begun to ramp up in the second half of this year. So the two that I mentioned in the earnings call, SOCOM and the missile defense, but also the [indiscernible] and the Nevada nuclear win that we had announced earlier this year. So that coupled with additional expected bookings, ATEN is positioned well for profitable growth next year. BIAF, as I mentioned, very strong backlog growth recently and the margin's improving in the backlog, and a very robust global demand profile gives us confidence that we should see profit growth there in 2019. And on the ECR business, as you mentioned, commodities are strengthening, but where we're focused, first and foremost, is continue to drive margin improvement with performance excellence and some of the process improvements and new tools that we've implemented that are specifically going to benefit the ECR business and gain higher margins with existing business and continue to focus on sustaining capital growth. But clearly, we're seeing demand growth in certain markets more than others. I'd say the Middle East for us is starting to show some good prospects for 2019 on some of the major projects. And so we should benefit there as well.

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 sort of -- are statements of caution, just because it is uncertain, and we don't -- we have a lot of political negativity going on now in the U.K. But from a Jacobs' standpoint, things are pretty solid. I mean, we have excellent prospects. We have a good pipeline of opportunities. It's across all the major sectors that we talked about, water and transportation and climate change and even the energy side on some transmission opportunities. And so we're just trying to be careful not to get ahead of ourselves and claim that as equally exciting as everywhere else, just because of the Brexit and political uncertainty. But as we sit here today, we believe, that's potentially just short term, and we're extremely excited about the prospects. U.K. is our -- what Kevin, our second largest market for the company, specifically in BIAF. And so it's extremely important. We mentioned that the U.S. is more than half, but clearly, U.K. makes an important part of the other remaining size of the business along with a few other key regions.

Your next question comes from the line of Steven Fisher from UBS.

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 going to be still pushed off 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?

So let me just start and then I'll turn it over to Kevin. As I've said, for the three years that I've been at Jacobs, revenue is important, but it's -- but overly focus on it becomes very difficult to really predict and project this business, because of pass-through revenues, especially in the area of some of the businesses you mentioned like ECR. And so I think for me, it's the bottom line guidance we gave you is really a combination of our revenue growth, our gross margin and our revenue backlog that we're gaining, the synergies and cost efficiencies that we're driving across the company, our tools that are giving us the opportunity to preserve higher margins for wins that we get going forward compared to the past. And you really just got to look at it across all of those. And I think from an ECR-specific standpoint that you've mentioned, I think equally important to revenue is the whole strategy execution of driving a higher quality of earnings business that we've been proving over the last 18 to 24 months.

So Steve, just some additional commentary. In the Q3 figures, I noted $175 million incremental pass-through for the third quarter. That's 5% of growth effectively. So just note that. And pass-through revenues kind of fluctuate, and they were a little bit higher than they normally are in the -- so I'll just make that comment and you interpret as you wish. I do believe, especially given the mix of the profile of ECR, for example, since you pointed that out, when you win these contracts and you do the turnaround, it's pretty quick-burn stuff. So you win it and it happens pretty quickly. And so you can get some of this disconnect as it relates to the -- how the backlog is trending versus how the revenues kind of come together. So I think, look, what's important is that our gross margin and backlog continues to be positive, and we think that, that is leading us to be able to ensure that we have that kind of lower risk profile in our total portfolio with an ability to continue to expand our margins longer term. And there will be some fluctuation around the top line just because of the things that Steve said as well.

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 long 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.

Your next question comes from the line of Andy Wittmann from Baird.

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 is -- 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?

Yes, no problem, Andy. Look, we had -- yes, we had that, but we also had a little bit higher-than-normal fringe kind of true-ups, given actuarial work that was performed over the Q3, which largely offset that. So you kind of see that number, there's a plus in there and there's a minus in there, which netted to kind of the number that you're looking at. So that's why you're not seeing a big change.

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

Fringe.

Fringe, it was fringe.

The fringe was the $15 million?

No.

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.

Okay, all right. Just -- and then just also here on some of the numbers, it looks like some of your purchase accounting has moved around a little bit. It looks like it's all contained on the asset side of the balance sheet, Kevin. But goodwill is up, intangible is down. Can you just talk about what some of the drivers of that are? I guess, it's a good thing that we're not seeing the liability side increasing, but just given some investor sensitivity to this and other deals in the past, I thought it'd give you a chance to talk about some of the purchase accounting migration that's happened in the last couple of quarters.

Yes, look, the largest percentage of that is really related to our -- the preliminary estimates of customer list and PP&E fair value, which ultimately went down versus what ultimately we had in the original estimate. Certainly, some of that was in our -- in the ECR business, which we got from CH2M, and that's a big chunk of it. There's some other moving pieces in it. We do have some project accruals that are in there in terms of some potential risk. But if you look at the first two that I mentioned, the PP&E fair value and customer list values and customer -- and brand values, that kind of stuff, that's about $200-plus million of the incremental changes in the opening balance sheet.

Your next question comes from the line of Michael Dudas from Vertical Research.

Steve, in your prepared remarks, you talked about current backlog at 100 bps, 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. And Steve, following up on ATEN. Of the 5 delineation markets that you put through on your presentation, what 1 or 2 -- you'll have to get through this big bump in transition on the positive side on the backlog of revenues, what 1 or 2 look more promising than some of the others? And is there a mix benefit or detriment relative to where you see the growth in new revenue contribution and new business in that segment going into 2019?

I'll just answer both regionally and sector-wise. Clearly, regionally, we see the strongest pipeline moving into 2019 in the U.S. with our core A&T business, as and evidenced by obviously some major wins, but also pipeline of opportunities. The nuclear -- as you know, the nuclear business, especially what we acquired from CH2M goes in certain cycles and where the 2019, '20 is expected to be an up-cycle on several large projects coming on the board. And so that's going to be important to us, as we go forward as well. I'd say those are 2 specific opportunities. The weapon sustainment area is important to us, as we mentioned in our strategy. And also because of the successful acquisitions and the Jacobs Connected Enterprise focus, we're expecting strong growth in cybersecurity and digital analytics, et cetera, as mentioned in my prepared remarks.

Your next question comes from the line of Jerry Revich from Goldman Sachs.

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 ask every quarter when we're sitting in our business reviews. And the good news is that in spite of the unprecedented or historical high win back in 2017 and '18 time frame, we still have an extremely strong pipeline of opportunities in the ATEN business. And I'm just kind of repeating what I said, especially in the U.S., as it relates to all of the different military sides and the cybersecurity side, NASA opportunities, both plus-ups as well as expanding our presence across all of our existing clients. So it's -- we -- the pipeline is strong, and so we're not just depending upon the ramp-up of the previous wins, but we're confident in continuing to put wins on the board with new business.

And so just for context, does that translate into backlog growth? Can you just maybe put a finer point on that?

Yes, we're still -- we're expecting continued backlog growth in ATEN as we move into '19.

Okay. And can we just circle up into the CH2M accounting so how much of the brand adjustment is greater integration? And did you get any benefit in the quarter from the accounting change in terms of the way it flowed through the P&L, Kevin? It's just a little counterintuitive considering how well the business is performing to see goodwill adjusted higher. Can you just flesh that out more in addition to what you mentioned in an earlier question?

Jerry. No real fundamental change, and let's call the incremental noncash charges associated with our business in Q3 versus Q2. Now look, we're continuing to evaluate it. We'll look at it, again, in Q4. But if there's any material change, we'll be providing that insight to you. As of right now, as of Q3, Q3 was very similar to Q2.

Okay. But in terms of just the business context, I mean, what's driving a negative adjustment to brand values when the business is performing well, the trade main values, et cetera? Can you just give us more context considering the business is performing well?

The value of Jacobs is a huge number. The value of CH2M and how we're integrating it into our company and driving holistic view what the new Jacobs organization looks like has actually reduced the value of the CH2M offering. So this is a discussion about the CH2M brand. I don't want to make a comment as if it wasn't important historically for that company, but within the construct of what we're doing about it and with the value proposition it has for us, it is a very different picture. So as you -- if you were to go to Denver, for example, to the previous headquarters, you won't see very much CH2M there, you'll see Jacobs. And that's because we're driving against an aligned one Jacob entity, which is reducing the value implications associated with CH2M.

Your next question comes from the line of Chad Dillard from Deutsche Bank.

I just had a question on earnings seasonality. Historically, if -- you see sequential earnings growth in the fourth quarter, but the implied guidance suggest that, that's not the case. So I was just curious whether it's a big project winding down or differences in seasonality related to the CH2M side? I ask because if I apply the typical seasonality, the fourth quarter exit rate would suggest 2019 guidance is pretty conservative, and especially if I factor in the cost savings and the pro forma 8% growth backlog. So just hoping to get some color there.

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 $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 end up having stages, because these are multiyear projects. So -- but I would say the majority of the ramp-up is going to be completed in -- by the first half of next year, probably more heavily weighted to the next 6 months, but through the first fiscal year next year.

Your next question comes from the line of Anna Kaminskaya from Bank of America Merrill Lynch.

I was hoping to get, maybe some color about revenue synergies that you highlight in your press release on -- whether they're coming from a regional upside, any particular markets you want to highlight here. And any metrics on, I don't know, employee engagement or assumption ratios, how that has an impact year-to-date.

Right. We've clearly had some preliminary or early-on wins that we attribute to the combined company. But the biggest impact so far is in the pipeline, which is exciting, because we see the bigger opportunities for revenue synergies ahead of us. And it's really coming in all the other areas that we talked about. Clearly, bringing CH2M's water and environmental capabilities across all of Jacobs, not only in the Infrastructure side where the combined strength is winning business and more business in water and environmental, but bringing those capabilities to the industrial side like our mining business and east oil and gas business and same thing with environmental. And so we're seeing it across the globe. Nuclear, the combination positions us well for the big nuclear jobs going forward, and so that's kind of in the pipeline as well. So again, I think we'll spend more time over the next year talking about actual wins and better attributable to revenue synergies, whereas these first 6 to 9 months has been more about the cost synergies. With regard to the culture and the people, it's going extremely well. As I mentioned, attrition rates are stable, which is always a concern and challenge during a merger of this size. And so we believe that the whole integration process, the IMO, Integration Management Office, that we put in place, which we believe, is a best-in-class process, is paying dividends. We're clearly keeping the momentum up on getting out in front of our people across the globe, not only communicating, engaging, but understanding where issues are and adjusting to those quickly and, again, there's a lot of excitement within the hallways of Jacobs' offices, but also at the client level, which is equally important. So it's early. We're -- this is only our second full quarter of reporting. And we're not going to let up on the focus to just really drive the right best-in-class culture going forward on a combined basis.

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's everything. If you look at the 3-year history of the company, back in 2016, Jacobs' standalone was less than 5% operating profit margin. We finished 2017 over 5%, closer to 5.5%. And we just put on the board a third quarter that has ramped up throughout this year over 6%. And so for us, it's not only to drive earnings growth, but to continue to demonstrate that we're going to have higher quality of earnings. And so it's to focus on the high -- the best end markets to make sure that we continue evaluating our existing portfolio to make sure that those -- everything we do, everything, is going to deliver margin growth. And if there's anything that we believe is not going to achieve that, we're going to assess alternative strategies. But clearly, the acquisition side of it as well will continue to be part of our strategy moving forward. And I think we've reiterated -- we've mentioned several times, we want to demonstrate our success capabilities on merging CH2M and Jacobs, and the more we do that, the more confidence we have on pulling the trigger on other things that will drive similar performance and margin improvement and earnings growth going forward.

Your next question comes from the line of Andrew Kaplowitz from Citi.

Steve, maybe you could talk just a little bit more about your conversations you're having with EC&R 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 EC&R backlog? Or is the inflection more on catching up on turnarounds, environmental spend, more of the sustaining type work?

It's both. But first of all on the trade war, I mean, clearly, that's giving some of our clients, especially on the mining side, copper, for example, some concern as they're anticipating what's expected to be a supply-demand situation that's going to be very positive for that business over the next couple of years, but yet concerned about all the trade war noise in the short term. But what we continue to hear from those clients are that they believe it's short term, that it's not causing them to significantly slow down any of the conversion of studies into full projects over the next 12 to 24 months. And the same thing I would say from the oil and gas and chemicals side. The -- for us, I think the key is that we're going to stay committed even as the market starts rising to our -- our strategy to demonstrate that we can have sustainable growth and steady performance through the ups and downs of this industry. And I think we've proved that over the last 3 years, 4 years during the down market where Jacobs' backlog reduced significantly less than the rest of the industry. And now as we go forward, we want to make sure that what we put on the board for backlog growth not only has good low risk sustaining capital, maintenance and turnaround growth, which we expect, but that as we do participate in some of the larger projects that projects that we won't regret winning and we'll be able to preserve the margins and deliver the performance as we've done in the past and even in a better way with our new strategy of performance excellence. There are -- there's clearly an appetite for more risk out there that our clients are pushing on our industry, and so we're being careful and we passed on certain initiatives in the ECR business, because we didn't feel like it met our risk profile, but there are other opportunities emerging now that do meet our risk profile that we're going to attempt to win, and we think the balance of that coupled with the sustaining capital maintenance focus is going to be a successful strategy over the next several years in an improving market.

And Kevin, since you and Steve got there, you guys have done a really good job on the execution side. Maybe you could evaluate EC&R execution in general, as we sit here today. You gave -- you already gave us color on the charge and the potential modest issue in Q4, but could you tell us of the charge in Q3 was a CH2 project or a legacy Jacobs project? And you think EC&R margin could dip below 5% for a while before it comes back up?

Look, I think there's been tremendous improvement in execution across the entire portfolio, probably mostly in ECR and BIAF, because ATEN actually has -- had already had a pretty high level of execution performance prior to, but ECR and BIAF, both of those organizations have done a wonderful job over the last couple of years in improving our potential loss margin versus as-sold margin. That's kind of how we think about it. And as you and I have talked in the past, we -- there's always things that are happening. We get a little bit of a pickup, because we get an incentive payment or we get a little bit of a knock and we lose a little bit versus the as-sold margin. But the key is we want to protect that as-sold margin and go after the incremental incentives. And the amount of activity that we're seeing in terms of that -- those tickdowns versus the as-sold margins becoming smaller and smaller and smaller. Now look, we never want that number to be zero because I think that, that means that we're being too safe in terms of how we grow the business. But it's getting almost to a level where we continue to try and look for benefit absolutely. But we've gotten substantially reduced in terms of those potential ongoing aggravating kind of losses on a margin basis. And so the ECR business, I think, we'll continue to be able to have this 5-plus percent margin, I think, going forward and the expectation is we want it to be higher longer term. Could there be a blip here and there? Of course. if in fact the $15 million that we talked about, that was a Jacobs, but within the context of the holistic view of write-downs or losses versus as-sold margin, an extraordinary reduction where we're probably 1/3 of the numbers that we were back at our high point in 2015.

But Andrew, maybe -- just specifically, I think building on what Kevin said is that this is not something that we're expecting to drag into 2019, so it's a one quarter commentary.

Your next question comes from the line of Brent Thielman from D.A. Davidson.

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.

And then I guess, also in that segment as you think about going after your some of these capital project opportunities when they come to fruition, what -- I mean, any sense what the margin opportunity is relative to that 5% that the segment's been running at?

Modestly higher. I mean, we're -- as Kevin kind of outlined, we've had success in that business that is -- if you go back to 2016, we're up about 100 basis points in that business from low 4s to a 5% or 4% to 5%. And our ECR team has certain strategies to take that higher.

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 like one that doesn't exist in our industries today. So thank you again, and we look forward to talking to you next quarter.

And this concludes today's conference call. Thank you for your participation, and you may now disconnect.