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AECOM Technology Corporation (NYSE:ACM)

F4Q09 Earnings Call

November 12, 2009 11:00 am ET

Executives

Paul Cyril – Vice President Investor Relations

John M. Dionisio – President and Chief Executive Officer

Michael S. Burke – Executive Vice President and Chief Financial Officer

Analysts

Steven Fisher - UBS

Andy Kaplowitz - Barclays Capital

Vance Edelson - Morgan Stanley

Avram Fisher - BMO Capital Markets

Andrea Wirth - Robert W. Baird & Co., Inc.

Joe Foresi - Janney Montgomery Scott LLC

John Rogers - D. A. Davidson & Co.

Chase Jacobson - Sterne, Agee & Leach

Sameer Rathod - Macquarie Research Equities

Operator

Good day ladies and gentlemen, and welcome to the fourth quarter AECOM earnings conference call. My name is Angela and I will be your coordinator for today. (Operator Instructions)

And now I’d like to turn the presentation over to your initial host for today’s call, Mr. Paul Cyril, Vice President Investor Relations. Please proceed sir.

Paul Cyril

Thank you Angela, and welcome everyone to AECOM’s fourth quarter 2009 earnings conference call.

If we move to Slide 2, we’ll cover the Safe Harbor statement. As we begin, let me remind everyone that today’s discussion contains forward-looking statements based on the environment as we see it today and as such does include risks and uncertainties. As you know our actual results might differ materially from those projected in these forward-looking statements. Please refer to our press release or Slide 2 of our earnings presentation and to our reports filed with the Securities and Exchange Commission for more information on specific risk factors that could cause actual results to differ materially.

As we begin our call let me remind you of some of the important information about our earnings that are posted on the Investor website, investors.aecom.com. First, we posted our earnings release and updated financial statements on the site for anyone who still needs access. Second, a replay of today’s call will be posted there at around noon Eastern Time and will remain there for approximately two weeks.

Please go to Slide 3. And lastly, since we are using some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted on our website as well.

Presenting today will be John M. Dionisio, President and Chief Executive Officer and Michael S. Burke, Executive Vice President and Chief Financial Officer. John, please go ahead.

John M. Dionisio

Thank you Paul. Good morning everyone and thank you for joining our call today. I will begin today’s call with a few introductory remarks. I will then turn the call over to Mike who will discuss our fourth quarter and fiscal year 2009 financial performance and our outlook for 2010. Following Mike’s comments I will provide an update on market trends, recent wins and our M&A activity.

Fiscal year 2009 was a solid year for AECOM overall. Despite the global recession we executed well. AECOM has a long history of adapting to changing market conditions and 2009 was no exception. We have remained focused on driving strong performance by pursuing opportunities in our key geographies and end markets and consistently realigning our resources.

In the fourth quarter, as signs of economic recovery became more evident, many of our customers began to reactivate programs that were previously delayed or on hold. We are beginning the year with record backlog of $9.5 billion and a diversified pipeline of new opportunities including stimulus funded projects in the United States and around the world.

We have managed our business carefully throughout the economic downturn as demonstrated by our ongoing margin improvements which will position AECOM for continued profitable growth in the years to come.

With that I’d like to turn the call over to Mike. Mike, please go ahead.

Michael S. Burke

Thank you John. Please turn to Slide 6. I will begin with a review of our fourth quarter results and then briefly review our 2009 annual results.

Our fourth quarter gross revenue was flat to last year’s fourth quarter at $1.6 billion. Our net service revenue was down 2% to $989 million. Our fourth quarter results were impacted by weakness in our private facilities market and a continued slowdown in project activity as our customers focused on strategies for obtaining stimulus funding. This weakness was offset by strength in Asia, Australia, the Middle East and our federal government services sector in the United States.

Also, foreign currency headwinds continued to impact our results in the fourth quarter. On a currency neutral basis, our organic revenue growth rate was 1% and net service revenue declined 1%. Net income from continuing operations was $54 million, up 27% year-over-year due to strong execution of our margin improvement initiatives.

Diluted earnings per share from continuing operations was $0.48, up 20% year-over-year. This also reflects a 6% increase in our diluted share count.

Please turn to Slide 7. Our PTS segment accounted for 82% of our fourth quarter gross revenue. Net service revenue in our PTS segment decreased 5% from last year’s record fourth quarter to $921 million. The single largest driver of our year-over-year decline in PTS net revenue was our private facilities business, which declined nearly $45 million from a year ago. The good news is that our PTS segment backlog increased 12% over last year, which bodes well for future quarters. Operating margins in the PTS segment improved over last year, driving operating income to $91 million, a 1% increase over the fourth quarter of 2008.

Continuing operating margin improvement has been driven by our ongoing efforts to streamline our global operations and the rapid integration of our M&A transactions. Three years ago we embarked on a margin improvement initiative that is now producing the intended results.

The performance of our Management Support Services segment, which accounted for 18% of revenue in the fourth quarter, continued to be very strong. Revenue for the quarter was $292 million, up 18% over last year. This growth was entirely organic and reflects the increased activity for the U.S. Air Force under the $10 billion CFT contract. Operating income increased 64% over last year to $10 million.

We have nearly tripled the size of our MSS segment over the past five years, entirely through organic growth. And just last week we announced our first acquisition in this segment, SSI Services, which serves the $50 billion national intelligence market. John will discuss all of our acquisitions in more detail later on.

Going forward, we see strong growth opportunities in the MSS segment. The bottom line is that our prospects for continued growth in this segment, both organic and through M&A, remain very promising. Please turn to the next slide.

In our fourth quarter, our EBITDA margin improved 133 basis points over last year and is up 74 basis points for the full year. We have been saying for some time now that we expect our EBITDA margin to improve by 20 basis points annually, and we are pleased to have exceeded that goal by a wide margin. Over the past three years we have improved our EBITDA margin by 258 basis points. Over this period, and particularly in fiscal year 2009, we have pushed margin improvement initiatives across the enterprise. Some of the margin improvement can also be attributed to better economies of scale. As we have grown we have realized the more synergy from our platform, such as a common Oracle system, our shared services organization and real estate consolidation to name a few.

Going forward we expect to continue to strongly execute on our margin improvement plans. These margin improvement initiatives position AECOM to emerge from the recession stronger, as revenue growth accelerates.

Please turn to the next slide. At the end of the fourth quarter our balance sheet remained strong but somewhat under-leveraged with $287 million in cash and cash equivalents and debt of only $169 million. During a period of unprecedented tight credit markets we have been happy to have a strong balance sheet over the past year. That said, our goal is to trend back to our target leverage ratio of 1.5 times EBITDA. We saw a rebound in M&A activity beginning in the third quarter of 2009 and we recently completed three strategic M&A transactions. We’re also looking at a number of additional opportunities that would be a good strategic fit for us and hope to put some of this cash to work in early 2010.

As of September 30 we had $470 million in unused capacity under our $600 million credit facility. Our cash collections were also strong which improved our cash flow to the fourth quarter by more than $59 million over last year. All told, our financial position is strong and we have ample liquidity to pursue our growth and diversification strategy.

Please turn to the next slide. We continued to win business at a steady pace through the fourth quarter. Our wins drove total backlog up to a record $9.5 billion, a 10% increase over last year. Additionally our PTS segment backlog is up 12%. The majority of our growth in backlog was organic and was driven by significant increases in our water business and our Asia Pacific markets. Note that the reported backlog balance does not include some of the major wins that occurred in October and November such as the Department of Homeland Security Headquarters and the Masdar project in Abu Dhabi. And John will touch on these later in the presentation.

I should note that our backlog figures also do not include numerous IDIQ contracts that we have been awarded by the U.S. federal government. Our backlog figures only include specific task orders under the IDIQ contract after they have been awarded. It’s important to understand the changing nature of the IDIQ contracts we have been winning. Many of these contracts have very large contracting capacity, a limited number of participants and provisions that almost insure a minimum of participation in the task orders. Assuming AECOM wins its fair share of task orders under these contracts, they could add substantially to our stated backlog. Currently four of our largest contract vehicles, [Bitrick], [WIRS], AFRICAP and CFT, have a contracting capacity of $16 billion over the next five to ten years. To date only a small percentage of these task orders have been issued and AECOM performed quite well.

Our strong flow of new wins and backlog continue to provide us with good visibility and confidence in our outlook for continued strong performance. Please turn to the next slide.

In spite of the pockets of weaknesses we saw in our business in the second half of 2009, we had a very strong year. Our gross revenue increased by 18% over last year to $6.1 billion. Our net service revenue was also up 16% to $3.8 billion. Foreign currency headwinds continued to impact our 2009 results. On a currency neutral basis, our organic growth was 9% for revenue and 8% for net service revenue.

Net income from continuing operations was $187 million, up 27% year-over-year. Diluted earnings per share from continuing operations was $1.70, up 21% year-over-year. This also reflects a 5% increase in our diluted share count.

Backlog increased 10% to a record $9.5 billion. We closed the year with $287 million in cash and cash equivalents. We are well positioned for continued growth in 2010 with solid book of business and a strong balance sheet. We are pleased with our full year results and our continued strong growth, particularly in what has been a very challenging year. Please turn to the next slide.

Now I would like to update you on our outlook for fiscal 2010. Based on our strong performance in fiscal 2009 and our outlook for continued growth, we expect diluted earnings per share in the range of $1.90 to $2.00 for fiscal 2010. The mid-point of this guidance implies a 15% year-over-year growth in earnings per share. Our guidance includes upsided fiscal year 2010 from the U.S. stimulus package. As we have said we expect stimulus spending will start to make a material contribution to our revenue beginning in the second quarter and continuing into 2011. Consequently, our 2010 results will accelerate after Q1. You should note we have historically realized 20% of our full year earnings in the first quarter. However, in the first quarter we expect to be below our historical average earnings distribution.

This guidance assumes $22 million in amortization expense related to acquired intangible assets, a tax rate of 28% and a diluted share count of 116.7 million shares for fiscal year 2010.

And with that I would now like to turn the call back over to John, who will provide additional detail on our fourth quarter performance and outlook. John, please go ahead.

John M. Dionisio

Thank you very much, Mike. AECOM’s business around the world reflects the uneven recovery of the global recovery. In general, most of our markets are doing well such as our transportation and federal government’s markets in the United States, as well as our global markets in Asia, the Middle East and Canada. We expect these markets will continue to grow through 2010.

We have seen some improvement in the public facilities market and in the water markets. However, our UK and private facilities markets remain soft. Additionally continued product delays also affect our organic growth in the second quarter of 2009. In the United States these delays were due in part to slower than expected stimulus funding. The good news however is that the United States stimulus funds have begun flowing through numerous federal and state agencies.

As I mentioned earlier, we are seeing strength in many of our global markets while higher levels of infrastructure spending continues. Our Hong Kong China business appears to be leading the recovery, driven by the government’s quick implementation of their stimulus packages. Australia, which never actually went into a recession, continues strong. Our Middle East operations in Abu Dhabi, Qatar, Saudi Arabia are expecting double digit infrastructure growth. Canada continues to perform well as the government’s infrastructure investment grew by 18% over last year. We are also excited about opportunities in India, where the government recently announced a five year plan to spend $150 billion on infrastructure projects.

Eight months after the start of the U.S. stimulus package, AECOM has won over $530 million in stimulus funded projects in the transportation, facilities and environmental markets. Just last week we were awarded a large stimulus funded construction management contract for the Department of Homeland Security’s new headquarters. We view this as a positive signal that the U.S. stimulus program is starting to take hold and will be an important part of our growth strategy in 2010 and 2011.

The global water infrastructure market represents a significant growth opportunity for AECOM. We have recently won major programs in both New Zealand and Hong Kong, and the UK government will be awarding around five new water programs with total fees of $140 million. In the United States, the California legislature recently passed an $11 billion water program that paves the way for many new infrastructure projects.

We saw a continued rebound in M&A activity in the fourth quarter of ’09 and two of our recent acquisitions provide entry into new markets. Namely, the $45 billion health and care facilities market and the $50 billion U.S. intelligence market. These are both large, high growth markets that will provide AECOM with significant new growth opportunities going forward. With signs of an economic recovery, we have seen a distinct rebound in project activity.

While there could be a lag before projects get fully mobilized, the economic rebound will have a positive impact on our results. Please turn to Slide 14.

We have heard from Mike about our 2009 performance and outlook for 2010, and I would now like to focus on some key forecasting indicators for 2010. Our fourth quarter wins were strong, totaling $1.8 billion, and this will provide fuel for our growth going forward. In Hong Kong, AECOM was awarded a $60 million project for the redevelopment of the former Kai Tak Airport. This is one of ten major infrastructure related projects approved by the Hong Kong government in 2009.

As I mentioned earlier, we won a significant contract for the Department of Homeland Security to provide construction management for its new headquarters. This is a multi-billion dollar program with an initial task order of $50 million for AECOM. Ultimately, fees from this project could be substantially higher. This is one of the largest government facilities programs in the Untied States and the first phase of this project will largely be supported with stimulus funds.

In Abu Dhabi, AECOM has been awarded a contract for services ranging from design to construction management for the new Masdar City, a 1,500 acre green city which is designed to be entirely carbon neutral and produce zero waste. In our environmental segment we were awarded two major FEMA contracts, including a $73 million contract for the Public and Technical Assistance Services.

And finally in our MSS segment, we won a contract with the U.S. Department of State to provide services for its Africa peacekeeping program with a $1 billion total contracting capacity. This new assignment will boost our position in a region with major long term potential. It also further diversifies our work with the U.S. federal government.

We are currently working on seven of the world’s largest infrastructure projects across several continents. Mega projects are an important part of our growth strategy and have helped AECOM continue to grow through the recession.

There is a very healthy pipeline of mega projects which we are currently pursuing in each of our key market areas, transportation, environmental and facilities. These projects include transit, water system, universities and sports facilities. Please turn to Slide 15.

Now moving on to M&A. As we have said in the past, as we review M&A opportunities we look for companies that do one of two things, either expand our geographic footprint or that have a particular niche of expertise or service offering. In both cases we have been successful in leveraging our client relationships in the existing platform to accelerate growth. During the fourth quarter of FY 2009 and the first month of FY 2010, we continued to execute this strategy by successfully closing three strategic acquisitions.

In August we acquired LAN Engineering, a California based design and construction management firm. This acquisition bolsters AECOM’s transportation presence and expertise in California.

Last month we announced the acquisition of Ellerbe Becket, a 650 person architecture, interiors and engineering firm. This acquisition expands our capabilities in a number of attractive end markets including healthcare, sports and education. These markets provide significant global growth opportunities for AECOM in 2010.

In the healthcare market, for example, the Saudi Arabia government plans to build 240 new hospitals over the next six years. Our acquisition of Ellerbe Becket positions AECOM well for this work.

And last week we announced our acquisition of SSI Services, which has an established reputation in supporting operations for the U.S. intelligence community. The U.S. intelligence market is large and growing with a total spend of nearly $50 billion in 2009.

Looking forward, our M&A pipeline remains robust and we are pursuing several key opportunities with a focus on increasing our penetration of high growth geographies such as India, China, Africa and Latin America and enhancing or expanding our expertise in the power and energy market. Please turn to Slide 16.

Diversification has been a foundation of our business model and has been a key enabler for AECOM’s consistent growth, even through severe economic downturns. As you can see on this slide at the end of fiscal 2009, our business remained well diversified across end markets, geographies and funding sources. We continue to have a well balanced mix of end markets including transportation, environmental and facilities and a growing energy and power business.

Our geographic diversification has been a key success factor, enabling us to capitalize on our high growth and emerging markets in 2009. AECOM as a global company performed 52% of its work outside of the United States, with a strong mix of business across Asia Pacific, the Middle East, Canada and Europe. Our funding sources have not changed significantly. In 2009, approximately 70% of our work continued to be generated from public clients.

In the United States we expect federal funding for the transportation sector to be stable if not growing in 2010. We fully expect under the SAFETEA-LU to remain at current levels until the next new bill is passed. However, there is also a possibility for a second stimulus package for transportation. The second stimulus would increase federal transportation funding by 20% annually for the next two years. It remains clear that with the U.S. employment rate at over 10%, that the federal government will continue to invest in infrastructure to create and sustain new jobs.

In the past we have been asked about the viability of U.S. state and local funding. First note that only 14% of our global revenue is attributable to this funding source. While this funding has been under pressure, in fact monies will be available through various sources, namely federal stimulus program, bonds, dedicated tax measures, public/private partnerships and other dedicated sources such as tolls. For instance, Build America bonds now represent approximately 20% of our municipal bonds with $45 billion issued to date and analysts expect that Build America bonds could reach $100 billion.

In the PPT arena, AECOM is involved in four of the largest programs in the United States. Two in Florida are already moving forward and two in Texas are set to close their financing shortly. As we have said before, AECOM follows the money and this strategy continues to work for us as it has in this past year.

Moving to Slide 17, this is a snapshot of our revenue growth over the past ten years. I wanted to include this chart to illustrate the long term success that our strategy and business model has produced in spite of the economic climate. Over the past ten years, our compound annual growth rate has been 20%, evenly balanced between acquisitive and organic growth. And over the past five years we have grown at 25%. As we position AECOM to emerge stronger from the global recession, I am convinced that we have the right strategy.

Please turn to the last slide. Overall, 2009 was a solid year for AECOM. Our diversified business model enabled us to compete for and win some of the largest projects around the world. While we saw some project delays in the second half of the year, we see that changing in the first and second quarters of 2010 and the various global stimulus packages will provide excellent growth opportunities for the future.

We are beginning fiscal 2010 with record backlog of $9.5 billion, a strong and diversified new business pipeline, expanding mega project opportunities and growing acquisition opportunities. We are enthusiastic about our outlook for 2010 and beyond as world economies continue to improve, stimulus funds make their way into the market and projects move forward at a more rapid pace. I am confident that AECOM will emerge from the global recession with a broader geographic footprint, a deeper skill base, a more diversified service offering and stronger client relationships.

Looking ahead, we will continue to leverage these strengths and our strong balance sheet to pursue new opportunities in both established markets and emerging geographies around the world.

I want to thank you very much and I will now open the call to questions.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions) Your first question comes from Steven Fisher – UBS.

Steven Fisher - UBS

John, you mentioned the balance of organic and acquisitive growth. Could you just give us a sense of what you’re assuming for that balance in 2010?

John M. Dionisio

Mike, why don’t you give them the numbers?

Michael S. Burke

Yes, in 2010 I think as we’ve said in the past, Steve, we have not tried to predict the exact split going forward. We feel very confident that our growth will continue at a 15% compound growth rate at the EPS line and that will be comprised of organic growth, acquisitive growth and margin improvement. But we have not historically given guidance as to the split between those. But over an extended period of time we expect that we would have a healthy balance of both organic and acquisitive growth.

Steven Fisher – UBS

But is it fair to say that maybe you know first part of the year organic growth, at least on the PTS side, would be negative and then kind of ramp up as the year goes on to become positive overall for the year?

Michael S. Burke

That’s a great question. As I mentioned in the discussion about the flow of earnings over the course of the year, we would expect Q1 to be steady with Q4. And then we would begin to see a rapid acceleration of organic revenue growth in the second quarter due to our confidence in the backlog that is increasing quite nicely. Is that responsive to your question, Steve?

Steven Fisher - UBS

Yes. I mean I guess I’m just bottom line wondering if you’re expecting net organic growth in 2010 but it sounds like yes.

Michael S. Burke

Yes. Absolutely.

John M. Dionisio

But as Mike mentioned, it’s not going to accelerate until sometime in the second quarter.

Steven Fisher – UBS

And then I guess wondering how weak the UK and private facilities markets are and when do you think that could flatten out based on kind of the current run rate?

John M. Dionisio

The UK market is a soft market. It has been soft much longer than the markets say in the United States. It’s going to remain soft on both the public side as well as the private facilities side throughout 2010. The good news is we have adjusted our business and we’re in the process of adjusting our business so it’s not going to have a significant impact on our performance in 2010. And also we have had an opportunity and have been able to move staff to and work into the location so we can maintain a solid book of business.

Michael S. Burke

Yes, just to put it into perspective, Steve, the UK is a very small percentage of our business, probably in the 7% range of our total revenue. And then the private sector facilities market is only 10% of our total revenue. And we are already seeing and experience the significant drop in that business from a year ago. But I think to reiterate what John said you know that part of the business we don’t see accelerating for another 12 months or so.

Steven Fisher – UBS

But is the year-over-year decline expected to get smaller? Maybe that’s what you mean by acceleration, but is it going to get less bad as the year goes on?

John M. Dionisio

It’s going to improve as the year goes on, okay? I don’t like to think of less bad but there are certain things that are happening. I mean we’re working on the Crossrail project which is a major program. Also as I mentioned in my talk, they’re starting with their Amp 5 program which is they go out on the street once every five years and getting these IDIQ contracts for waterworks. So there are things that are starting to happen but it’s a long road for the UK.

Steven Fisher – UBS

Switching to MSS, I’m wondering how increasing Afghanistan troop levels and falling Iraq troop levels are expected to affect your revenues there?

John M. Dionisio

That’s a question that seems to be asked of us all the time and our work is to provide support for our troops in Iraq, Afghanistan, Kuwait and we don’t see the decrease in the resources in Iraq impacting us in a negative way. If it increased there we’d probably need some more support. And also I mean the work that we’re doing will carry on beyond the point that American troops are coming out. I mean by the time that we would have to de-mobilize it would probably be a period of a couple of years.

Operator

Your next question comes from Andy Kaplowitz - Barclays Capital.

Andy Kaplowitz - Barclays Capital

Can you give us more color on the U.S. market in general in terms of backlog? Like the backlog was up a healthy amount sequentially. What is the U.S. backlog doing? Is it just kind of stable? Is it going up or is it going down still? Where are we there?

John M. Dionisio

Andy, we don’t divide our backlog up by region but let me just give you a sense of the market. The activity in North America and I assume it’s focusing on the U.S. remains strong. There’s a lot of activity that we’re seeing in our transportation business, in our U.S. government facilities business, as I mentioned that new Department of Homeland Security and also energy. The stimulus funds have flown into and through federal government agencies faster than they have through the state. And so when we look at the backlog we’re very optimistic about growth here in the United States in transportation, facilities, government facilities, as well as energy.

Andy Kaplowitz - Barclays Capital

Maybe John or Mike, is there a way to parse out how much currency helped you on the sequential basis? You know did it add to backlog or sales? Because I have to believe you’re benefiting at least a little bit from the weaker dollar.

Michael S. Burke

Actually it worked against us.

Andy Kaplowitz - Barclays Capital

Year-over-year but sequentially also?

Michael S. Burke

Sequentially also. Our foreign currency headwind in the quarter was about 2% on NSR and it’s just because of the currencies that we do business in. We have only 25% of our revenues are subject to non-dollar denominated currencies and those currencies are the Aussie dollar, the British pound and the Canadian dollar. So the currencies that went the other way, we don’t play in.

Andy Kaplowitz - Barclays Capital

You know your PTS margins, you know in the quarter were pretty strong you know on the net operating basis. And you talked about all the things that you’re doing you know to improve your margins. It seems to me like you know placing is hanging in there just fine, so maybe if you could comment on that. And then if there’s anything else going on. Is it a mixed shift slowly towards higher margin from [maginal] work that’s also helping you? Or what’s going on there?

Michael S. Burke

The gross margins on the project side have moved up very, very slightly. But the story really is on the net line. It’s on better cost control and all of the synergy items and economies of scale that I mentioned earlier. As we continue to grow we’re getting more juice out of the platform that we’ve built.

Andy Kaplowitz - Barclays Capital

But competition hasn’t been a problem during this recession for you guys it seems. Pricing is hanging in there just fine?

Michael S. Burke

On the public side as we’ve always said the public side pricing pressure doesn’t impact us as much that the margins stay relatively constant through good times and bad times. Where you do see some pricing pressure is on the private sector side, which is a smaller part of our business.

Andy Kaplowitz - Barclays Capital

And it’s not anything different than we’ve seen for the last few quarters.

Michael S. Burke

Right. Exactly. As you know 70% of our business is public sector work that’s cost plus.

Operator

Your next question comes from Vance Edelson - Morgan Stanley.

Vance Edelson - Morgan Stanley

The margins have climbed nicely and ahead of expectations so going forward how do you go about generating additional margin expansion from here? Is it scale economies as you grow the business or are there more costs or efficiencies to wring out of the business?

Michael S. Burke

I think it’s a combination of both. As the previous person just talked about, the mix shift as we do shift to more program management, construction management work the margins are a little bit better so it is a mix in our revenues will help a little bit. But the bigger story is wringing costs out of the system whether we have continued to reorganize our company in a way that squeezes costs out of the system. We still think there’s more room for improvement on that front.

Vance Edelson - Morgan Stanley

John, you mentioned the funding for the federal highway bill should remain at current levels until the new bill is signed. What’s the latest on what the new bill might look at? Are you hearing anything there or what do you think the appetite is on Capitol Hill for a new bill and perhaps larger one?

John M. Dionisio

Yes, well initially the Obama administration was talking about an 18 month extension before they passed a new re-authorization bill. That would keep spending at the current levels that they are now which is in transportation about $40 billion a year. Now what we’re hearing is because of the unemployment rate at over 10% that there’s a real drive to accelerate the re-authorization. And as I mentioned a new re-authorization which would be called a re-authorization but it would be almost another stimulus program, which would front end the expenditures to increase the spend from say $40 billion a year to about $50 billion a year. And that seems to be getting strong, strong support.

So I think the key is that the federal government and the Congress as well as the administration what we’re hearing are really concerned that they want to make sure that they keep the flow of funds moving to the states. And then with the stimulus program it would really give a jump start to spending. I mean you know there’s a need for the spending in terms of transportation. So with the unemployment, this is an excellent way of nipping the problem of unemployment and getting people back to work.

Vance Edelson - Morgan Stanley

Mike, on the low debt balance and the zero or negative net debt to EBITDA ratio, given what you’re seeing in the capital markets and changes over the past year, any thoughts on what the ideal capital structure is now and on the idea of perhaps adding leverage?

Michael S. Burke

Absolutely. You know we have been de-leveraged for quite some time and it was certainly a comfortable position to be in a year ago to insure that we didn’t have debt on the balance sheet. But right now we still think the right capital structure for our organization is a debt load of 1.5 times EBITDA. Obviously we have a ways to go to get to that and I think as John mentioned we are now picking up the pace with our M&A strategy, with three recently completed deals and many more very interesting strategic opportunities in the pipeline that hopefully we would be able to put some more debt on the balance sheet that would be very beneficial to us.

Operator

Your next question comes from Avram Fisher - BMO Capital Markets.

Avram Fisher - BMO Capital Markets

You talked about water in your commentary. Where are you seeing the water projects coming from?

John M. Dionisio

Over this past year we’ve seen a lot of activity in China, in Hong Kong. We also won a very nice job in New Zealand. We’re starting to see work developing in the Middle East. I mentioned the opportunities in the UK. In the United States the key has always been the funding. The good news is in California the governor has signed a bill which will have to be passed by two bond issues, but its $11 billion. So we’re seeing a movement where there’s more funding coming into the water market which bodes well for our business. Also Canada. Our Canada business is very strong in terms of water.

Avram Fisher - BMO Capital Markets

You talked about also in the commentary the strength in Asia and Australia, but when I look at the numbers that I have it looks like Asia and Australia net service revenues were down year-over-year quite significantly. I’m trying to sort of.

John M. Dionisio

As a matter of fact Hong Kong was up. Our Hong Kong business which includes parts of China was up I think 30%.

Michael S. Burke

In Australia we had some currency issues that effect that.

Avram Fisher - BMO Capital Markets

In terms of guidance and I know the first question had to do with you know how much is acquired, how much is organic. I thought in the past you’d said about 50% organic, 50% acquired. Are you kind of stepping back from that for 2010?

John M. Dionisio

No. I’ll let Mike go into more detail. But our target has always been we wanted to grow our business half organic and half through acquisition. And that maintains our target. So we’re just not looking to buy EBIT or buy revenue. All our acquisitions are strategic in nature. But Mike can explain how we see 2010 and 2011.

Michael S. Burke

Yes, I think that the message we’d like to deliver is that over the long course it will be about 50-50. It has been that way over the past ten years. It’s been a 50-50 split. However, I wouldn’t like to try and peg that annually or by quarter. You know you look at 2009, we didn’t do a lot of acquisitions throughout the year and then all of a sudden we did three in a row in the past six weeks. So trying to peg that exactly 50-50 on an annual basis is quite difficult. But certainly over the long course we expect to continue on that path.

Avram Fisher - BMO Capital Markets

Were there any major project cancellations or deferrals in the quarter?

John M. Dionisio

No. There were no cancellations. Deferrals, none that I can think of but I have to be honest there’s slowness that’s involved in developing in projects. So they’re not being deferred but they’re just taking longer to one, get signed or two, when we are working on the projects the schedule seems to be extended.

Avram Fisher - BMO Capital Markets

A bunch of people have asked about the gross profit margins in the PTS segment. It was up 100 basis points over the quarter, 90 bips year-over-year. I’m just wondering if I could drill down. I mean is headcount down in that segment? Are you getting better leverage there? Is it sustainable going forward to continue to see sort of year-over-year improvement at the gross profit line of PTS?

Michael S. Burke

You know as I said earlier, gross margins have moved up a little bit. And we will gain some advantage there through changing mix as we try to continue to grow our project management and our CM work. But you know it will slightly improve but we shouldn’t be looking for significant changes in gross margin.

Avram Fisher - BMO Capital Markets

And then what gets you to the high end versus the low end of the guidance? I mean I think it’s probably impossible to quantify how much is stimulus, but you know what could be a risk to the low end of guidance in terms of the stimulus funding looking out for?

Michael S. Burke

You know I think a continued slowness and the money being pushed out from the stimulus package is what could push you to the lower side of that. We don’t anticipate that but I think it’s important to note that when you look at the stimulus monies, the $170 billion portion of the stimulus package that is dedicated to the infrastructure space, you hear the numbers coming out of Washington that 75% of that has been obligated already. The important thing to note is that only 10% of that has actually been laid out to the states. So only 10% of that total amount has been pushed to the states. And then only a fraction of that has actually been spent by the states. And so you have this $170 billion of money moving through the funnel quite slowly and we see that starting to pick up now, but you know to the extent that the government channels at the federal level and the state level bog down a bit trying to process that much money, that could push more of the earnings to the back.

Avram Fisher - BMO Capital Markets

And speaking of the state level areas, I mean I think the general view is that the state budgets are kind of still going to get worse before they get better. How do you protect yourself from sort of the malaise in the state budget level?

Michael S. Burke

You know as John mentioned earlier there’s really a number of different sources. One of them is the public/private partnership. You know there’s four big projects going on now, two of them in Florida, the Miami Tunnel and I595 which have been financed and we won the work on both of those projects. Down in Texas, the LBJ and North Tarrant Expressway are two projects that are awaiting financial close but we’ll be involved in both of those if the financing closes or when the financing closes. And we’re seeing other opportunities on the private side. So we think the private money will come back to the infrastructure markets that will be helpful for us.

Secondly, you heard John mention about the dedicated sources like the Measure R in Los Angeles that’s putting aside $40 billion in sale tax money for more transportation funding. Or the $11 billion water bill that passed the legislature in California a week or so ago. And then John mentioned the Build America bonds also. There’s a number of sources that are coming to play besides general fund money that is challenging.

Avram Fisher - BMO Capital Markets

And in the past you’ve talked about the percent of large projects. Large projects for total NSR or total revenue. Can you just update that number please?

John M. Dionisio

What we’ve said in the past is the top 25 projects make up about 15% of our revenue. And that’s about the same. Really the point is that we have thousands of projects being undertaken at any one time. And as a result, if there was you know some delays or cancellations we have a good mix of work so we’re not held hostage to two or three or four projects. I mean it’s thousands of them that we’re working on.

Operator

Your next question comes from Andrea Wirth - Robert W. Baird & Co., Inc.

Andrea Wirth - Robert W. Baird & Co., Inc.

I wonder if you could just back up a little bit and talk a little bit about the organic growth rate in the quarter. I guess I was a little bit surprised that it did actually turn negative. And I think when we were talking last quarter it sounded like things actually in July were getting a little bit flatter. Just wondering if you could just give a little bit more specifics on what actually you know maybe slowed incrementally in the quarter, you know which markets or geographies specifically are we talking about here.

Michael S. Burke

It’s really difficult to give you a general answer to that because there are so many particular markets. But what we did see was the wins increased quite a bit. So we are winning the work. And as John mentioned the speed to mobilize on those projects was a little slower than we had anticipated. So there was really two pieces to that story. One is the stimulus monies that we were predicting from a year ago we were predicting would start to come in in the fourth quarter didn’t make their way through the government channels as quickly as we had anticipated. But we did see the wins coming in as evidenced by the increase in backlog. But as John mentioned the mobilization on those projects was a little slower. So it was slow getting into the market but then once you won it it was even a little slower for the state to deal with processing that much money through their procurement channels. So that’s really in a nutshell if I had to summarize what happened. And that’s not just in the U.S. Its stimulus packages around the world. We’re dealing with stimulus packages in Hong Kong, in Canada, in the UK, etc.

John M. Dionisio

And if I may just mention, it’s not unique to AECOM. I mean this is an industry type of phenomenon that we’re seeing in the ENC business. But the real good news is that new work is coming in and is out there and there’s some very, very significant opportunities going forward.

Andrea Wirth - Robert W. Baird & Co., Inc.

And then I guess just curious on the India comment. I think you talked about $150 billion you know potential stimulus fund in their infrastructure. Maybe just talk a little bit about your position in India specifically and where you could see some benefits from that.

John M. Dionisio

Okay. In this past year we won two major program management projects in Calcutta and Chennai for light rail and transit systems. We are actively pursuing an acquisition in India and we’re looking at work in the energy to water and the transit markets. Also we’re looking at opportunities on the highway side and highway toll projects. So we have a good position there. We want to expand our position and India is being targeted as one of our key emerging markets.

Andrea Wirth - Robert W. Baird & Co., Inc.

I know you talked about SAFETEA-LU and the potential for a two year extension, a 20% increase. But I’m just curious if you know the short term extensions here have actually had some impact in terms of you know maybe causing some delays in projects going forward. Or do you think it has mostly been stimulus related?

John M. Dionisio

No, the thing is the re-authorization, and we have five of them, okay? They are six year programs. And what that does is give states a forward-looking view of what their financing will be. It’s not a matter of the money. It’s about the fact that they see in advance how much money is going to be coming through. And so they can plan. And they can plan on some major programs. With the extension and if it’s only a six month extension or if it’s an 18 month extension, even though everyone is confident that if there’s one 18 month extension there may be another one before a new bill would be passed, the concern that some states have that makes them uneasy is that they don’t have that visibility. And so there might be an issue that they will not start some of the larger programs and they will focus in on some of the smaller ones.

Now we haven’t seen that impacting us, but it took two years for them to pass the SAFETEA-LU bill several years ago. And during that time we saw some of the state spending was changed from as I said the major projects to the smaller projects. We were fortunate that we had as we have today major programs which would straddle any of that softness. So it’s not a matter of the amount of money coming out and the amount of money being spent. It’s how the money is being spent and the type of projects.

Andrea Wirth - Robert W. Baird & Co., Inc.

I don’t know if you’ve given this number out but attacking the acquisition question from a little differently, in terms of the acquisitions you’ve actually completed now how much revenue should we expect you know to contribute from those three that have been done in 2010?

Michael S. Burke

Andrea, we have not historically for competitive reasons we haven’t broken out revenue before deals when we announced them. Of course we do announce in our MD&A going forward how much of that revenue comes from acquisitions. But most people try to take. We do announce how many employees they have and most people try and take a headcount on that. And those rules of thumb would still apply here if you’re trying to build a model.

Operator

Your next question comes from Joe Foresi - Janney Montgomery Scott LLC.

Joe Foresi - Janney Montgomery Scott LLC

My first question here is just we’ve been talking about stimulus dollars and the flow and what you’re expecting, have you made any changes, any hires in your business to get ready for 2010? And if so, what have you changed to get ready for stimulus?

John M. Dionisio

We know there’s going to be an increase in activity here in the United States, just by the fact of the amount of work that we’ve won. We’ve made some key hires in program managers to be assigned to programs that we’ve won here in the United States, as well as in some places in Latin America. And to key places that are in transit, in some of the highway work and as I said the mega programs. And also our PPP project. So we don’t think of it as stimulus work, we think of it as the money that’s coming in on these major programs and as a result we are in the process of looking for key people and making some key hires.

Joe Foresi - Janney Montgomery Scott LLC

A second question here is any fears or any projects that you have any worries about at this particular point in time, maybe either in London or the U.S.? Anything that could get delayed that would cause there to be any kind of friction in your numbers and any part that you have any concern over?

John M. Dionisio

Joe, I don’t think there’s anything material. No matter what the environment, you’re always concerned about certain programs. But right now we’ve pressure tested all of our big projects and looking where the funding is and we’re not concerned that there’s going to be any cancellations. As I mentioned to someone before what we do see is just some projects are the schedules are being drawn out. But you know right now what we’re focusing in on is getting those projects from backlog into revenue. And we’re working with our clients to try and expedite that because the funding’s in place, the contracts are ready, it’s just a matter of that with many of the agencies there’s a lot of work coming out and they just don’t have the infrastructure to process the work. That I think is probably the biggest problem that we’re seeing on both the federal side and the state side. And Mike mentioned, this funnel that we have with all this work coming out and these states just don’t have that infrastructure.

Joe Foresi - Janney Montgomery Scott LLC

So would you say that the conversion rate from backlog to revenue has slowed because there’s kind of a [proof] of problem there? Or has it stayed the same?

John M. Dionisio

I think in terms of you seeing it in terms of our organic growth, the backlog is continuing to increase and our book-to-burn is increasing. And part of that is because you know the slowness in moving projects into revenue.

Joe Foresi - Janney Montgomery Scott LLC

On the competitive environment, have you seen or are you preparing for any particular changes headed into 2010 as you go out and compete for these projects versus your peers? Is there any particular trend that you would cite as one that maybe you’d put your finger on as wanting to take a look at?

John M. Dionisio

I think the one trend that we are anticipating and not that we have seen a significant amount of it is on the private side. Okay? As we’ve mentioned the private facility side has been hurt during this recession. And clearly there is some pricing pressure on the private side. But we haven’t seen it so significant that it’s causing us to walk away from projects.

On the public side here in the United States, the federal government’s books slower is its best quality and you know we don’t have the price pressures. A matter of fact, I was in Hong Kong a couple of weeks ago and we won two projects but [inaudible] the low bidder. I mean, so people are picking us on quality rather than price. So it’s a mixed bag. But we’re not seeing any real serious change. It’s all part of how we do business and how we’ve done business in the past.

Operator

Your next question comes from John Rogers - D. A. Davidson & Co.

John Rogers - D. A. Davidson & Co.

In terms of the other income in the quarter, what was that?

Michael S. Burke

The other income consisted of a number of items. The two most significant items would be our deferred comp plan and some real estate that we hold. But the real estate is a small piece. The real component, John, is and let me try and explain this as clearly as I can, in the deferred compensation plan there was an offsetting amount to the income that you see on that line.

And so the offsetting amount is an additional salary expense which would be buried up above the line. This is the other side of that transaction. Because the deferred comp plan, we have hedged the employees’ assets [watch] and choice. So that $4 million, if I could make my own accounting rules I would have pushed that above the line and offset it with the compensation expense.

John Rogers - D. A. Davidson & Co.

So going forward as it was last quarter, I mean what causes that number to go up or down?

Michael S. Burke

Yes. The markets. Understanding there’s an employee on the other side that made an asset selection choice, if the market goes up our employee salary expense goes up and that other income goes up to offset it. If the market goes down, it goes the other way. So if you looked a year ago, you would see it going down and this year you see it going up in sync with the markets.

But that’s why I think it’s more important to look at total EBITDA margins because those two then net against each other rather than looking at the presentation of operating margins as they’re shown on the financial statement.

John Rogers - D. A. Davidson & Co.

Relative to I guess SSI but how many people do you have employed on the Management Support Services side?

Michael S. Burke

10,000.

John Rogers - D. A. Davidson & Co.

In terms of pricing for the work that you’ve got out there, any change in the multipliers or anything that you’re seeing, are you seeing more pressure on the private sector versus the public sector? Because John you talked about the strengths in the government stimulus programs worldwide but I get the sense you know a lot of companies, whether they were in it before or not, are also chasing that work. And I’m just trying to get a sense if that increased competition is having any effect on pricing.

John M. Dionisio

We’ve seen pricing pressure on the private side. We haven’t seen any significant, and I’m not saying there isn’t any, but we haven’t seen any significant pricing pressure on the public side.

John Rogers - D. A. Davidson & Co.

Just to be clear, Mike you talked about you know increased opportunities to leverage up the balance sheet if you saw acquisitions. And should we take away from this that you are seeing definitely more opportunities? Is your pipeline filling up?

Michael S. Burke

Oh, our pipeline is more full than it’s ever been.

John Rogers - D. A. Davidson & Co.

Is it a series of private companies? I mean is it similar to what you’ve done so far? Or are there some very large opportunities, a la Earth Tech out there?

Michael S. Burke

No. There are some opportunities like that but I think you know you should expect more of the same. You know we’ve just completed three deals in the last six weeks and you know those fall in our sweet spot. There are some opportunities that are on the bigger scale side but I think you should expect more of the same of what we’ve done in the past.

John Rogers - D. A. Davidson & Co.

And in this kind of environment, given what rates are and multiples, would it be fair to assume that almost any deal at this point would be immediately accretive?

Michael S. Burke

From a cash EPS perspective definitely, John. As you know the amortization, intangible asset amortization has a big hit in year one when you amortize your backlog. But clearly from a cash EPS perspective they would be very accretive right out of the block.

Operator

Your next question comes from Chase Jacobson - Sterne, Agee & Leach.

Chase Jacobson - Sterne, Agee & Leach

The gross margin in the MSS segment has fluctuated quite a bit over the last several quarters. I was just wondering if you would comment on what impacted it this quarter and kind of how we should think about it going forward.

Michael S. Burke

It depends on how you’re looking at it. Are you looking at it as gross revenue?

Chase Jacobson - Sterne, Agee & Leach

Net revenue.

Michael S. Burke

How we look at that business is we look at the EBIT that it produces. That segment can fluctuate from quarter-to-quarter for varying reasons. One big reason is the joint venture accounting. Right? If you have a 49% ownership versus a 51% ownership, the economics are obviously 2% off, but the presentation on the balance sheet really throws off the margins. Secondly, you have award fees that we generally take a very conservative position on recognizing award fees. And we try not to recognize them until they are relatively certain. And so because in that segment you have a small number of very large contracts, when one award pops in in the quarter it can jump those numbers around. So I would encourage you not to try to look at it on a quarterly basis but rather try and look at it on an annual basis is probably the best way to look at it.

Chase Jacobson - Sterne, Agee & Leach

And then I just wanted to go back to the highway bill stuff real quick. You talked about the funding being flat and the possibility of a multi-month extension, but the fact of the matter is that we’re on essentially a month-to-month extension right now. I was just curious as to how you were thinking about that in your guidance next year, if you’re thinking assuming you know a six or a 12 month extension or if you’re thinking about it in kind of the current state of affairs on more of a month-to-month basis.

John M. Dionisio

When we’re looking at the highway authorization, we’re looking at the projects that are coming out versus the extensions on that. And we haven’t seen any reduction in the work that’s being advertised coming out. We’re mindful of the fact that things could change, but right now we’re working under the assumption that this $40 billion of annual expenditure by the federal government will continue, okay, throughout whatever extension they have, a 16 month, 18 month, 6 months. Because of the need for this money for two reasons, one to repair the infrastructure and two to get people back to work.

Operator

Your next question comes from Sameer Rathod - Macquarie Research Equities.

Sameer Rathod - Macquarie Research Equities

Just a couple of quick things. First on SAFETEA-LU and the current I guess re-authorization, isn’t the run rate closer to $32 billion due to the $8.7 billion rescission and not $40 billion? Or is that not correct?

John M. Dionisio

Yes. It depends on if the rescission is going to happen or not happen, but yes you’re technically.

Sameer Rathod - Macquarie Research Equities

My next question is how much of your current backlog is stimulus related?

John M. Dionisio

I don’t break it down that way. I don’t know if we keep records that way.

Michael S. Burke

We don’t. I can tell you that we have won $530 million of projects from stimulus funded projects that originally went into the backlog. What I can’t tell you is how much of them burnt off.

Sameer Rathod - Macquarie Research Equities

My last question and I just want to be clear, what was the organic growth rate on the backlog?

Michael S. Burke

Well almost all of the backlog growth was organic because we only did two very small acquisitions in FY ’09.

Operator

And ladies and gentlemen, at this time I’d like to turn the call back over to AECOM for any closing comments.

John M. Dionisio

I want to thank everyone for their interest in AECOM and just to wrap up, as we look forward we look at 2010 in light of the fact of our strong wins, our record backlog levels, in terms of opportunities we see significant opportunities in mega projects around the globe. And also our M&A pipeline remains robust. So as we look to the future and we’re looking at the second half of the year and look past the first quarter, we’re very optimistic of the growth we’re projecting in our outlook.

So with that I want to say thanks again and we’ll see you and hear from you again in three months. Have a good day. Thank you.

Operator

Ladies and gentlemen, we thank you for your participation in today’s conference. This does conclude your presentation and you may now disconnect. Have a wonderful day.

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Source: AECOM Technology Corporation F4Q09 (Qtr End 09/30/09) Earnings Call Transcript
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