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AECOM Technology Corporation (NYSE:ACM)

Q1 FY08 Earnings Call

February 12, 2008, 11:00 AM ET

Executives

Paul Gennaro - Sr. VP and Corporate Communications Officer

John M. Dionisio - President and CEO

Michael S. Burke - EVP, CFO and Chief Corporate Officer

Analysts

Steven Fisher - UBS Securities

Andrew Obin - Merrill Lynch

John Rogers - D. A. Davidson & Co.

Avi Fisher - BMO Capital Markets

Sam Snyder - Renaissance Capital

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter Fiscal 2007 AECOM Earnings Conference Call. My name is Gale and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. [Operator Instructions]. We will conduct a question-and-answer session at the end of this conference. [Operator Instructions]. As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Mr. Paul Gennaro, Senior Vice President of Corporate Communications and Investor Relations. Please proceed, sir.

Paul Gennaro - Senior Vice President and Corporate Communications Officer

Thank you, Gale, and welcome everyone to AECOM's first quarter fiscal 2008 earnings conference call.

Please go to slide 2. 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. Please refer to our press release or slide two of our earnings presentation for more information on the 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 that our earnings are posted on the Investor website, investors.aecom.com. First, we posted our earnings release and updated financial statements on this site for any one who still need to 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 reconciliation are posted on our website as well.

Now, I'd like to turn it over to AECOM President and Chief Executive Officer, John M. Dionisio.

John M. Dionisio - President and Chief Executive Officer

Thank you, Paul. Good morning and welcome to AECOM's first quarter fiscal year 2008 earnings call. We have a lot to present today. During this call, I will provide you with our first quarter performance highlights, as well as some in-depth information about our end markets and key wins.

In addition, we will also discuss the three acquisitions we recently announced and how those advance AECOM's growth strategy. Then Mike will take us through the financial results and revised guidance, followed by a question-and-answer session.

Please go to slide 5. We delivered a very strong first quarter. All of our key performance indicators; revenue, earnings and backlog were up. Our backlog, for example, was $6.8 billion, up 25% over the last year and 14% over the last quarter. Our cost containment initiatives are allowing us to achieve operating leverage and improve our operating margins.

In addition, we announced a number of significant wins and strategic acquisitions during the quarter. Yesterday, we announced two acquisitions; Tecsult and Boyle Engineering and just today, we announced the acquisition of Earth Tech, a business unit of Tyco International.

As you know, one of the primary reasons for the IPO last year was to capitalize on the consolidation opportunities in our industry. We are delighted with the success we have had in acquiring a number of great companies that fit so well with our strategic goals and objectives. Mike and I will talk more about these transactions later in the call. We continue to see solid demand and our industry and business remain strong.

Turning to slide 6, I'd like to remind you of AECOM's long history of consistent growth. Our diversification by markets, geography and customer type has fueled solid growth for many years now. As you can see, AECOM has grown at a compounded annual growth rate of nearly 20% over the past 11 years. Half of this was organic growth and half was from acquisitions. We expect to benefit from our balance in diversified growth strategy, as we capitalize on continued strong demand in each of our market sectors.

Please go to slide number 7. I'd like to discuss each of our end markets in our Professional Technical Services segment. The PTS segment constitutes 80% of our revenue and is well diversified across our core end markets; facilities, transportation, environmental and energy, a business which we are building.

Starting on the right side of our pie chart, our facilities market, which comprises 34% of our PTS revenue, grew by 32% year-over-year. In the United States, approximately 40% of our facilities work is performed for government clients on projects for schools, such as the Los Angeles Unified School District, correctional facilities, court houses and other government building, such as the Pentagon and the new pass terminal like Ground Zero in New York.

Early this year, we announced a major win with the Libyan Housing and Infrastructure Board for five year, $574 million program management assignment, where AECOM will serve as the overall program manager for the Libyan Government's $50 billion capital improvement program. This is a job that cuts across each of our end markets and is a great example of how we are successfully leveraging our world class program management capabilities and our global expertise to win large notable assignments.

Moving on to transportation, this end market comprises 34% of our PTS revenue and has grown 33% over the past year. Our position as the number one transportation consultants allows us to win large multi-year projects. Last week, we were awarded three significant multi-year programs from the New Jersey Department of Transportation, totaling approximately $45 million in revenue. About 85% of our business comes from repeat customers and our continuous 40-year relationship with the New Jersey Department of Transportation is a good example of that.

Our environmental business comprises 28% of our revenue and grew 57% year-over-year. The key components of our environmental end markets are environmental management, drinking water, and wastewater treatments and water resources projects. We have consistently stated in our goal, it is our goal to grow our business to 30% of our revenue and we are well on our way to achieving that goal.

About half of our work in this sector is with private multinational clients like Shell, and British Petroleum. New wins in the quarter include a $60 million three-year master service agreement with Chevron of North America.

Our growing energy and power end market is comprised of transmission and distribution services, energy savings program, and renewable energies, which includes solar, wind and hydroelectric. This is a high growth sector we will continue to invest in. One of the acquisitions we announced yesterday, Tecsult is a major player in the global hydropower/dam fuels. We will talk more about this when we discuss our recent acquisitions.

If you look at the next slide, you can see that 52% of our total revenues are derived from work performed outside of the United States. The variety, scope and caliber of the projects we are seeing, both here in United States and abroad, provide us a strong foundation for our future growth prospects. During the third quarter, as measured by net service revenue, our U.S. business grew at a rate of 26%, while our non-U.S. business continued to exceed that at 43%.

Slide 9 portraits the diversified mix of our client base and resources of funding. This diversification allows us to focus our attention on the best source of funding in any market condition. 41% of our revenue is derived from the private sector, 22% is derived from non-U.S. governments, which are experiencing high GDP growth rates. 20% is from U.S. federal government, which has just announced an 11% increase in the DoD budget. 17% of our revenue is derived from state and local governments; of which, a quarter is typically supported by federal funding.

Some investors have expressed their concern regarding municipal funding. This applies to 13% of our revenue base. We are mindful of this issue and believe our diversification will mitigate any possible shortfall. In addition, a significant portion of the 13% is funded by municipal bonds. We have seen an increase in the amount of municipal bonds issued for infrastructure projects. On a year-over-year basis, municipal bonds issued are up 33%.

Going forward, we also see a shift in funding through a more use of fee-based funding source, especially in transportation. That being said, from our perspective, the state and local market in the United States remains active as evidenced by the recent wins we have had in the state and local market, such as Texas, New Jersey and California.

I would now like to provide an update on our recent acquisitions. We have consistently said that we would focus on opportunities in the growing environmental and energy and power end markets. We have also said that we would focus on opportunities that provide us with new capabilities and reinforce our current geographies or provide access to new geographies.

The acquisitions we have announced year-to-date fit well within our stated criteria. Specifically, we advanced acquisitions in the environmental management, drinking water, wastewater and renewable energy markets as well as bolstering our transportation and facilities markets. The acquisitions also expanded our geographic footprints in Canada, Eastern Europe, U.K., Mexico and Australia, as well as the emerging markets in Africa and China.

Since we have so much ground to cover today, I'll focus my remarks on our most recent acquisitions; Boyle Engineering, Tecsult and Earth Tech. Boyle Engineering is a California-based firm, specializing in water, wastewater, stormwater and transportation projects. This acquisition will further strengthen AECOM's growing environmental and transportation practices. Boyle has a very strong presence in Western and Southeast Coast parts of the United States.

Tecsult is a Canada-based engineering firm with significant expertise in hydroelectric. Our combination with Tecsult will bolster AECOM's growing energy practice by boarding the portfolio of expert services we can deliver to clients around the world, while further strengthening our presence in the growing infrastructure market in the Quebec province of Canada.

We expect that you're most interested in Earth Tech, due to the size of the acquisition. As you saw in our recent press release, we have signed a definitive agreement to purchase Earth Tech from Tyco for $510 million in cash. This transaction positions AECOM well to capture additional growth in a number of key end markets, including water, wastewater, environmental, transportation and facilities. It also positions us to continue to broaden our global footprint, particularly in the Americas, the U.K., Europe, Australia and Asia. Earth Tech has revenues of $1.3 billion in 2007 and employed 7,000 people around the world.

This slide provides a snapshot of Earth Tech's business. Earth Tech has three major businesses lines. The largest piece is the Global Consulting & Engineering business. It is comprised of approximately 4,000 staff, primarily located in Canada and the United States. This business is highly complementary and additive to AECOM's operations. The second piece is Earth Tech's Design Build, Design Build/Operations business. It is an engineering-led design build and plant operations practice, largely non-America based. It will be complementary to our consulting businesses in the U.K., Europe and China as well as providing AECOM an entry into Mexico.

The last piece is the Water Assets Facilities business, which consists of design build, finance and operating projects and product businesses. This is largely a non-North America business and a contract operations business in North America.

AECOM plans to divest the water facilities assets acquired from Tyco, since these assets do not align with AECOM's core businesses. We expect the majority of these asset sales will be completed by the time this transaction close. AECOM is in the process of finalizing the Earth Tech business lines to divest. Our preliminary estimate is that we will divest approximately a $175 million to $200 million of assets.

Slide 12 provides a closer look at Earth Tech's Consulting and Engineering business. This business mirrors AECOM's market sector in environment, which represent 60% of the business; transportation, which represents 19, and facilities, which represents 21% of the business. We expect this transaction to close during our fiscal 2008 third quarter. The transaction is subject to customary closing conditions and regulatory approvals.

We have a long track record of successfully integrating acquisitions and we anticipate a smooth successful process of integrating the recent acquisitions into the AECOM family. We believe these transactions position AECOM well with talent and capabilities to continue to meet demand of our services.

Now, I'd like to turn the presentation over to Mike Burke. Mike, it's all yours.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Thank you, John. Let me start with our financial highlights for the first quarter. Our first quarter revenue was $1.1 billion, an increase of 15% compared to last year. Our operating income was up 48% over last year to $44.5 million. We achieved first quarter earnings per share of $0.29 and net earnings of $29.5 million.

Excluding a gain on the sale of a minority stake last year, net earnings were up 63% over the prior year. Backlog in selected-not-booked, a key indicator for our business increased over $800 million in the quarter, and was up 25% over last year. These results pointed a fact that our business remained strong and that we are well positioned for continued growth.

Please go to slide 14. As you know, we report our financial results in two segments; Management Support Services and Professional Technical Services. During the first quarter, revenue in our MSS business was essentially flat with last year, due to a number of past quarter timing delays. Operating income in the MSS segment was all also weak due to increases in reserves related to pending federal government contract resolutions.

We believe both of these items will be quickly offset by the significant new project wins in the quarter. These wins contributed to year-over-year increase of $282 million in our combined backlog and selected-not-booked. Our MSS segment continues to operate in an opportunity rich marketplace and we have a high degree of confidence that this segment will perform as expected for the full year.

Please flip, go slide 15. During the first quarter, our Professional Technical Services segment performed very well. Revenues increased by 19% and net service revenue increased 34%. Net service revenue is an important measure in this business segment due to the fact that we incur many pass-through costs which generate minimal margin.

Operating income for our PTS segment increased 43% versus last year, clearly outpacing our revenue growth. Our PTS backlog in selected-not-booked increased 25%, to $5.5 billion in the first quarter. As a reminder, our backlog is defined as revenue under contract whereas our SNB is revenue related to projects where we have been awarded the projects by the client and we are in the midst of finalizing the contract.

Please go to the next slide. Slide 16 reflects our consolidated revenue and operating income. Total revenues increased 15% and net service revenue increased 34% versus last year. 18% of the growth in NSR was organic and 16% was related to acquisitions. We continue to focus on achieving a healthy balance of organic and acquisitive growth. Our operating income grew 48%, significantly outpacing the growth in our revenue.

Slide 17 shows that our net income for the first quarter increased 16% year-over-year to $29.5 million. Excluding a gain on the sale of a minority equity stake in FY '07, net income increased 63% year-over-year.

Please go to slide 18. During the first quarter, our EBITDA margins improved by a 107 basis points compared to last year and 77 basis points versus last quarter. Our gross margins declined 103 basis points compared to last year and improved 98 basis points versus last quarter. As we discussed in our last earnings call, our gross margins were temporarily impacted by increased labor cost in our non-U.S. markets.

Gross margins improved on a sequential quarter basis as we have taken steps to pass on our higher labor cost as we enter into new contracts. What's important here is the significant improvement in our EBITDA margins. We are very focused on cost reduction initiatives as we continue to scale our business and we expect to see continued strong EBITDA margins.

On slide 19, you could see a snapshot of our balance sheet at December 30th. We ended the quarter with cash and cash equivalents of $327 million and debt of $48 million. As we told you throughout our IPO process and over the past year, we believe the optimal capital structure for this business carries a debt load of about one to two times EBITDA. After we close and fund the acquisitions we have discussed today, we expect to have net debt of approximately $400 million. This would represent net debt of approximately 1.5 times pro forma EBITDA. As John mentioned earlier, we plan to sell a portion of the assets acquired from Earth Tech on or shortly after the closing date of the transaction. We expect that proceeds from these asset sales will allow us to reduce our net debt to less than one time our pro forma EBITDA.

We are pleased to have found some very good opportunities to put to work the proceeds from our IPO and we still have plenty of flexibility to capitalize on additional strategic acquisitions. This flexibility is allowed by our $600 million credit facility, which also has an additional $150 million of accordion feature. In the near term, we will be very focused on integrating our recent acquisitions.

Please go to slide 20. We close the first quarter with $6.8 billion in backlog and selected-not-booked, a record for the company, and a 25% increase over last year. This also represents an $800 million increase in the first quarter alone or a 14% increase in the past three months. This significant increase coupled with our strong performance in Q1 has allowed us to increase our FY '08 full year earnings guidance.

Now turning to our outlook on slide 21, we have revised our outlook for the full year 2008, and now expect to report earnings per share in a range of $1.23 and $1.29, excluding the Earth Tech acquisition. This guidance takes into account our strong growth during the first quarter across service lines and geographies, our strong backlog and the momentum contributed by our recently acquired companies. Our year-over-year EPS growth is distorted by the mid-year IPO and its associated dilution.

Treating the IPO as occurring at the beginning of the fiscal year creates a pro forma EPS growth of 18% in FY '08 that's at mid point of our guidance range. Adjusting for intangible amortization expense, our revised guidance implies 22% year-over-year growth in pro forma cash EPS. As you know, M&A deals in our space carry significant amortization expense in the first year due to the purchase accounting value ascribed to backlog. The assumptions underlying our guidance include the following. $28 million of EBITDA from deals closed in FY 08, excluding Earth Tech, $22 million in total amortization expense related to acquired intangibles, including $13 million from FY 08 acquisitions. It includes a diluted share count of 103.9 million shares and a structural tax rate of 34%. As I just mentioned, we excluded the impact of Earth Tech in this guidance. We expect Earth Tech to be immediately accretive to cash EPS in FY 08 and slightly dilutive to GAAP EPS in FY 08. We expect it to be accretive in FY 09, on both the cash and GAAP basis.

With that, I would now like to open the call up to your questions.

Question And Answer

Operator

Thank you, sir. [Operator Instructions]. Our first question comes from the line of Steven Fisher with UBS. Please go ahead.

Steven Fisher - UBS Securities

Hi. Good morning and congratulations on the various acquisitions in the quarter. Just starting off on Earth Tech, what are the revenues going to be for the business that you're going to be left with, I guess after the sale of... Tyco is going to sell a Brazilian piece, and then you sell off the non-core businesses?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Steven, we obviously have another three and a half months or so to go, and hopefully less than that to close this transaction. We would expect to provide much more detailed guidance at our next quarterly earnings call. So, we are not prepared to issue revenue guidance at this time for the Earth Tech transaction. I think you can get a sense for the size of Earth Tech and the size of the assets that we are prepared to sell off just to give you a ballpark range.

Steven Fisher - UBS Securities

Okay. And then you mentioned that the consulting and engineering piece is going to be complementary to AECOM's business. Can you just elaborate on that a little bit? Is that a matter of customers or projects, regions, just little more color there?

John M. Dionisio - President and Chief Executive Officer

Okay. It's really incredible how similar in terms of organization that Earth Tech is to AECOM and that's a plus. If we look at North America, their operations in Canada and then in the United States mirrors geographies which AECOM are in, and they are very complimentary in terms of clients as well as services. But, Earth Tech is very strong in the federal facilities market, which AECOM is not a major player. They also have a very strong position in the environmental management business on the public side, where AECOM is more focused on the private side.

In addition, some of the expertise they have in transit complementary to AECOM's transit capabilities. And as we spoke during our last earnings call, I mean there is a war on talent, and everyone needs more people and Earth Tech as well as Boyle and Tecsult give us a significant resource of additional talent. And as I said, because of the locations they are in, they match very nicely with AECOM's organization.

Steven Fisher - UBS Securities

Okay, great. That's helpful. And at this point, do you have any more acquisitions planned for fiscal 08? Were there more acquisitions in the pipeline that you would have done, if you didn't do Earth Tech?

John M. Dionisio - President and Chief Executive Officer

Right now, we have a few other acquisitions that we are looking at that are in the pipeline. But, we're not in any position to make any announcements today.

Steven Fisher - UBS Securities

Okay. And then lastly, I will get back in the queue. In terms of the MSS business, given that a couple of contracts you have announced recently, is it fair to assume that kind of a gross revenues are going to show growth in 2008 over 2007, despite I guess, some of the timing delays you've seen on some of the projects?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Yes, Steve. I think as I mentioned in my prepared comments that we had a very significant increase in our wins in the quarter. We had almost $300 million of new wins in the first quarter that will be delivered in the remaining quarters of the year. Just in the past few weeks, we won another $60 million contract with the federal government. So, the wins are coming in very nicely in that business. And really the task order delays were just simply that delay is in getting the notice to proceed from the federal government, and we have received those and we would expect that revenue to grow nicely in the rest of the year as well into 09.

Steven Fisher - UBS Securities

Okay, great. I'll get back in queue. Thanks.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Andrew Obin with Merrill Lynch. Please go ahead.

Andrew Obin - Merrill Lynch

Yes. Good morning.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Good morning, Andrew.

Andrew Obin - Merrill Lynch

Just a question on Earth Tech acquisition. It seems like you have a lot of... you're getting a lot of exposure to water, wastewater, environmental management. And I was just wondering if you could comment on the outlook for these end markets, particularly given concerns about the levels of state and local funding for these projects going forward?

John M. Dionisio - President and Chief Executive Officer

Okay, that's been concern that we have heard and we read about, but again let me go back to AECOM's model, which is that of diversification. We are not just say, a U.S. based company or North American-based company, as we showed 50% of our work is generated outside the United States. So our market is global. What we see here though in the North America, Canada and then the United States is that the environmental management markets of water, waste water and water resources market do remain strong. And what we also see with the... the capabilities we'll have now with the addition of Earth Tech and Boyle, it will give us a critical mass that will leverage us... in a global platform to provide services in places where we would... we were hoping to be able to provide them, but we didn't have the resources and that is in the Middle East, Europe and in Asia, in China.

Again looking at the... if you look at the charts that we showed of the AECOM's and it is excluding Earth Tech and Boyle, AECOM revenue 13% of it, is with U.S. State and local fund, local government where most of the funding is municipal. Of that a significant piece is bond issues so the, the funding is in place, when we add Earth Tech and Boyle that 13% will go up to about 16%. So, our exposure as a total enterprise is not that significant, and it were all diversified. As well so we can capture now the opportunities in what we think is going to be a very strong global water and wastewater market.

Andrew Obin - Merrill Lynch

But are you guys seeing anything specific that is different, specifically for water and wastewater in North America, or is the acquisition more sort of... you get the international exposure and you are willing to tower a temporarily bump in North America, because of the international exposure. Or are you seeing something more positive in North American funding over the next several years that outsiders perhaps are not aware of?

John M. Dionisio - President and Chief Executive Officer

Well, first of all, the demand and the need in North America is there. The funding is the question. Now, why we wanted to expand our capabilities? Because we believe that we had more room in that marketplace. I mean the position that we had previously was the one which we felt that we could grow and also grow here in the United States, because we could get a larger share of the market and compete with some of the major... the other major players, and also as I mentioned, to leverage our expertise outside the United States. But, we don't look... we don't feel that we are going to get a bumping off in terms of our performance, here in the United States. We are going to... we really were confident that we are going to see our market grow, both organically through these as well as through acquisitions.

Andrew Obin - Merrill Lynch

And sort of this applies for Earth Tech's, both domestic and international business?

John M. Dionisio - President and Chief Executive Officer

I am sorry.

Andrew Obin - Merrill Lynch

This applies to Earth Tech, both domestic and international business?

John M. Dionisio - President and Chief Executive Officer

Correct.

Andrew Obin - Merrill Lynch

Thank you very much.

Operator

Thank you. Our next question comes from the line of John Rogers with D. A. Davidson & Co. Please go ahead.

John Rogers - D. A. Davidson & Co.

Hey good morning.

John M. Dionisio - President and Chief Executive Officer

Good morning.

John Rogers - D. A. Davidson & Co.

Mike or John, the acquisitions that you have completed so far... fiscal year-to-date excluding Earth Tech obviously, how much revenue is associated with those, as an aggregate?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

John as you know, we typically do not give guidance as to revenue especially gross revenue because of large pass-through class. I think as I stated earlier, our guidance outlook for FY '08 includes about $20 million of EBITDA for deals that were completed during the year.

John Rogers - D. A. Davidson & Co.

All right.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Most of those deals are... or still those deals are signed and ready to either have closed or ready to close and so you so could apply our general margins to get a sense for the revenue. But we have made a decision not to give specific revenue guidance.

John Rogers - D. A. Davidson & Co.

Okay, all right, that's fair enough. But then on Earth Tech, can you give us... I don't know if you can, but sense on multiples or anything that you are looking at on based on the $500 million price?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

I think John, it safe to say we think it was a very fair value deal for us. For competitive reasons, we would not be prepared to disclose the exact multiple of the transaction.

John Rogers - D. A. Davidson & Co.

And then I guess lastly, then in terms of the assets that you're looking at selling off or is it something where you're already in discussions or have pretty good ideas on where those assets are going to end up or is it a marketing process that you will have to undertake once the deal is closed?

John M. Dionisio - President and Chief Executive Officer

No, we have... we have had discussions with some potential buyers, there is a significant interest. I mean these are these are business, which are profitable and doing well, they just have to... they did not fit into our core business, but we don't... we feel very positive about being able to divest of these.

John Rogers - D. A. Davidson & Co.

Okay. Okay, fair enough. Thank you and congratulations.

John M. Dionisio - President and Chief Executive Officer

Thanks very much.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Thank you, John.

Operator

Thank you. Our next question comes from the line of Avi Fisher with BMO Capital Markets [ph]. Please go ahead.

Avi Fisher - BMO Capital Markets

Hi. Good morning. That's BMO Capital Markets.

John M. Dionisio - President and Chief Executive Officer

Good morning.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Good morning Avi.

Avi Fisher - BMO Capital Markets

I guess the biggest thing that jumped out of me in the PTS segment was your net revenues as a percent of gross is now almost 30... 73%, and it's been trending up. Why don't you look at that number? Is that a trend that's going to continue? Is that going to stabilize here? Are you in-sourcing more of your work? I'm just trying to figure out what caused that?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

There is a couple of things driving that Avi. One is that to the extent to we have grown our business outside the U.S. we tend to have less pass-through costs outside the U.S. So as our U.S. business could... our non-U.S. business continues to grow as a percentage of the total pie, they are just their contracting methodologies typically have less pass-through costs. So therefore, your net service revenue as a percentage of gross revenue tends to be higher.

An additional fact and a very positive fact is that, as we continue to broaden the array of services that we deliver through the strategic acquisitions, we now can deliver more of the services that are required by our clients and therefore, we... it's not as necessary to sub-contract that work. So, to the extent we keep adding to our... adding arrows to our clover, we will continue to provide a greater share of the work that our clients require.

Avi Fisher - BMO Capital Markets

Got you. Okay, so just to make sure, more in-sourcing and more fixed price contracts that are contract methods overseas?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

That's correct.

Avi Fisher - BMO Capital Markets

Got you. And one final question on Earth Tech. How much of their work is BRAC-related, you talked about their federal environmental? Or, do they have exposure to BRAC?

John M. Dionisio - President and Chief Executive Officer

Yes, they do. I just... Avi, I'm sorry. I just don't have in the tip of my fingers right now.

Avi Fisher - BMO Capital Markets

Okay. I could follow up with you on that later.

John M. Dionisio - President and Chief Executive Officer

Yes, we are more then happy too.

Avi Fisher - BMO Capital Markets

Alright. Thanks very much.

John M. Dionisio - President and Chief Executive Officer

Thank you, Avi.

Operator

Thank you. Our next question comes from the line of Sam Snyder with Renaissance Capital. Please go ahead.

Sam Snyder - Renaissance Capital

Good morning. Just two questions, can you just quantify or give some color on the non-GAAP EPS contribution you expect to north trend in 2008. And second question is can you just give an idea why net cash flow from operating activities is negative in the quarter?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

I'm sorry the first question, Steven [ph] I didn't get the first question.

Sam Snyder - Renaissance Capital

Just if you could speak to the contributions, I guess non-GAAP contributions from the Earth Tech acquisition you could see in 2008?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Yes. As we stated in our press release, we expect this to be accretive on a cash basis in FY '08, but we are not prepared at this time to give specific guidance on that. We will be prepared at our next earnings call, which will be closer to the closed date, we will have a better sense for the exact assets that we plan on disposing of and the contribution from the asset that we expect to keep. So, we'll have a lot more information for you at that time.

Sam Snyder - Renaissance Capital

Okay. Fair enough.

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

What was your second question?

Sam Snyder - Renaissance Capital

Second question, just some color on what was affecting the CFFO in the quarter, I mean it's negative $36 million, that was positive $43 million last year. What was dragging that down?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

Sure. A couple of things driving that; first of all, our first quarter is always our slowest quarter on a cash flow and it's also always our slowest quarter on general performance, just because of cyclicality of our business. However, there are a couple of things driving that. First of all, in our federal government practice, we did have one large $15 million payment from the federal government that was delayed up in the payment process; that did come though in January. So, that was just an item that float over into the next quarter.

Another big item is that we pay our fiscal year-end bonuses in December, so we have a large cash outflow for our annual bonuses that go out in the first quarter. And then the third item is in our European operations. We implemented Oracle; we brought them on to our company-wide Oracle platform late in the first quarter. And in connection with the implementation of Oracle, we had a slight delay in getting some of our invoices out in Europe. But those invoices are now getting out and we have no reason to believe that that will have any long-term impact on our receivables, so just a timing delay for that quarter.

Sam Snyder - Renaissance Capital

Okay. Great, thanks.

John M. Dionisio - President and Chief Executive Officer

If I may, I'd like to follow-up with Avi. I just... just to give you an idea, I don't know what all the BRAC numbers are, but to give you an idea. A third of Earth Tech's consulting business, consulting and engineering business is in the federal sector, if that helps Avi.

Operator

Thank you. Our next question comes from the line of Chattin Vincent [ph] with Paradigm Capital. Please go ahead.

Unidentified Analyst

Hi. Could you comment on the relative size of your Middle East business? I guess that's out about 40% is non-U.S. and kind of what you are seeing there in the half of those markets?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

I can give you a sense for relative size on an earnings basis. On an EBITDA basis, it would be approximately 8% of our total business in the business in the Middle East, exclusive... that's the historical number. That number will change significantly depending on where you include the Libya contract. We tend to think about region together, although Libya is in Northern Africa obviously, but we tend to think about region together. But right now, the Middle East business runs about 8%.

Unidentified Analyst

Okay and kind of what do you guess see think in terms of helping that business in backlog going up in the next couple of years?

Michael S. Burke - Executive Vice President, Chief Financial Officer and Chief Corporate Officer

And just as point of clarification, the Middle East business, the numbers that I was giving you were our traditional engineering consulting business in the Middle East. We have a very significant presence there through our MSS segment, the Federal government O&M business. So I was giving you the traditional consulting engineering work done interest the Middle East. Obviously, we have another several hundred million dollars of revenue derived from the Middle East from the U.S. Federal government. And I'm sorry; Jeff [ph] is there... there was a follow-up question that I cut you off?

Operator

Thank you. Our next question comes from the line of Steven Fisher with UBS. Please go ahead.

Steven Fisher - UBS Securities

Hi, just a couple of follow-ups. If state and local governments have to cut their spending, which is kind of it seems like this point they may have to, what types of projects do you think would be likely to get cut first?

John M. Dionisio - President and Chief Executive Officer

My sense is that some of the discretionary non-essential projects will need to be postponed in terms of may be the construction. But as we had found, I have been in this business 37 years, and there have been several cycles over that time, several things happen when state and municipalities cut back on their spending, that too in the construction site. They usually increase their planning side, because they want to get ready for when the come out of the cycle. And, again because of the type of work that we do, we do the financial analysis of upfront planning and preliminary engineering. That's why we have not been impacted as say as hard as if we were a contractor.

Steven Fisher - UBS Securities

Would you say it should... construction and transportation. Is it water? Is it transit systems, across the board?

John M. Dionisio - President and Chief Executive Officer

I think the... it's the combination again, but we haven't as I said, up until now we have not seen any impact on our business. All our numbers are strong and as Mike mentioned, we had significant wins in various states and here in the Northeast and west, the south. The funding is in place, the transportations through '09. And again we have go through another re-authorization. On the waterside, depending upon what happens with revenue, there could be some softness, but we are not anticipating a significant downturn at all. I believe we are just going to continue to move along may be at a constant rate, rather then growing rate.

Steven Fisher - UBS Securities

Okay. And then the other question is, I was just wondering what your expectations are for the large capital program at this point, any kind of expectation for timing of next response from the army or participation?

John M. Dionisio - President and Chief Executive Officer

Now your guess is as good as mine. It's a long process.

Steven Fisher - UBS Securities

Okay, great thanks.

Operator

[Operator Instructions]. I am showing there are no questions in the queue and I will turn it back over to management for any closing remarks.

John M. Dionisio - President and Chief Executive Officer

Well, I want to thank every one for tuning in this morning and listening to our first quarter earnings call for FY '08. As we said, it was -- it's been a positive first quarter for us and we feel very strong about the future as well as we feel very excited about the mergers and acquisition that we have announced in this first quarter. I believe there is someone else on this screen, if they want to ask their question.

Operator

Okay. That question comes from the line of Tareq Yusuf [ph] with Rockbay Capital. Please go ahead.

Unidentified Analyst

Thank you very much for taking my question. There seems to be a tremendous amount of concern on the part of investors when it comes to state and local budget. And the resulting impact not just on your company, but some of your competitors and I was hoping that you guys could elaborate a little bit more on that and perhaps provide a little bit more reassurance or what your personal views are on that issue, specially considering that its a very pertinent subject that constantly comes up.

John M. Dionisio - President and Chief Executive Officer

I think I have spoken as frankly as I could about that subject and each... every one looks at it a little bit differently. We feel that our strategy and the model that we put together, a business model that we put together and what in our experience over past cycle, we feel as a result of what we have, we don't anticipate any blip in terms of our future growth. Now, we again... I can't say more than that. We're constantly looking at it. We're constantly managing our business. Our strategy has been in seeing the development in the economies we have, was to target large multi-year projects, almost annuity projects that would last for five to ten years, and many of the projects we have are like that, so with funding that's in place. And so we feel with that model and that strategy, we are able to straddle any of the cyclical changes that may occur in the economy.

Unidentified Analyst

Okay. I mean I was just... I don't know, at an industrial conference down in Florida hosted by one of the investment banks, and the key theme that was kind of emphasized was, there's something that you read in the press which suggest that perhaps there is a slowdown. But, when you look at the underlying fundamentals and the businesses, and the orders that are coming in, in the backlog, in fact you've not seen any evidence of a slowdown. And that's what you seems to be reiterating as well, is that correct?

John M. Dionisio - President and Chief Executive Officer

That's exactly right. What we're seeing in the... we scrub our performance on a regular basis and review the performance with all our key managers around the U.S. as well as the world and we're still seeing a very strong market. And we see there, based upon the needs, there is funding in place. So, that's almost... I tell you it's almost when you listen to some of the reports, both in the print and media, it's almost as if it's a self fulfilling prophecy that something bad is going to happen, but we're not seeing that right now. But again, we are not just sitting back, not taking actions. We have a strategy in place to defend ourselves against any type of shortfalls which may occur.

Unidentified Analyst

And then the last comment I would make. I mean other than that's been emphasized, this is a secular trend. And perhaps, you might see a period three, six months of slowdown, but ultimately the demand is there and sequentially in getting the work done. And I'm sure that in terms of business planning, you guys take a very long-term view on your investment decision as opposed to saying, no, we are not going to make this particular investment, because next three to six months might potentially be slow, when you look at a longer-term picture and see the tremendous amount of demand on the infrastructure side in North America?

John M. Dionisio - President and Chief Executive Officer

Yes, that's exactly correct.

Unidentified Analyst

Okay. Thank you very much.

John M. Dionisio - President and Chief Executive Officer

Thank you.

Operator

Thank you. There are no further questions. I'll turn it back to you management.

John M. Dionisio - President and Chief Executive Officer

Okay. I want to again thank everyone for attending this earnings call, and look forward to speaking with you by 90 days. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the first quarter fiscal 2007 AECOM conference call. If you like to listen to a replay of today's conference, please dial 303-590-3000 or 800-405-2236, enter the passcode 11107746. Once again, that is 303-590-3000 or 800-405-2236, enter the passcode 11107746. Thank you for your participation. You may now disconnect.

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Source: AECOM Technology Corp. F1Q08 (Qtr. End 12/31/07) Earnings Call Transcript
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