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Tetra Tech Inc. (NASDAQ:TTEK)

Q3 2008 Earnings Call

November 13, 2008 11:00 am ET

Executives

Dan Batrack – Chairman, Chief Executive Officer and Chief Operating Officer

David King – EVP, Chief Financial Officer and Treasurer

Analysts

John Quealy – Canaccord Adams

Debra Coy – Janney Montgomery Scott

Alan Robinson – Royal Bank of Canada

John Rogers – D.A. Davidson

Corey Greendale – First Analysis Corporation

Chip Moore – Canaccord Adams

Jeffrey Beach – Stifel, Nicolaus & Co.

Richard Eastman – Robert W. Baird & Co.

Min Cho – FBR

Avram Fisher – BMO Capital Markets

Alex Rygiel – Friedman, Billings, Ramsey & Co.

John Rogers – D. A. Davidson & Company

Jeffrey Beach – Stifel Nicolaus & Co.

Richard Paget – Morgan Joseph and Company

Rob Young – William Smith and Company

Operator

Good morning and thank you for joining us. By now you should have received a copy of the press release. If you have not, please contact the corporate offices at 626-351-4664 and we will get one to you right away. With us today from management are Dan Batrack, Chairman and Chief Executive Officer and David King, Chief Financial Officer. They will provide a brief overview of the results and will then open up the call for questions. During the course of the conference call Tetra Tech management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These include statements concerning future events and Tetra Tech's future financial performance. The statements are only predictions. They may differ materially from actual future events or results. Tetra Tech's Form 10-K and 10-Q reports to the Securities and Exchange Commission identify certain risk factors that could cause actual results to differ materially from the forward-looking statements. Tetra Tech undertakes no duty to update forward-looking statements.

At this time I would like to inform you that all participants are in a listen-only mode. At the request of the company we will open the conference up for questions and answers after the presentation. With that I would now like to turn the call over to Mr. Dan Batrack.

Dan Batrack

Welcome to our fourth quarter and fiscal year 2008 earnings release conference call. I'm very happy to present our financial results for what has been a record year in all of our key financial metrics both for the quarter and for the year. While David King, our Chief Financial Officer, will present the specifics of our financials, I did want to cover a couple of the key special highlights in our financial performance here this last quarter and year.

For the entire year of 2008, our performance produced an increase in gross revenue of about $600 million increase over what we performed and generated in 2007. Our net revenue was up more than $230 million and that was driven by an addition of approximately 1,400 additional staff over the year, and that 1,400 staff increase includes about 1,000 staff that we now have working overseas with the addition of additional contracts and an acquisition we brought on that brought us U.S. Agency for International Development work all around the world.

Maybe most significantly our backlog of authorized work grew by 31% or $390 million from a year ago, and this was driven largely by large federal program awards with the Department of Defense, USAID that I just mentioned, FAA and some select very large commercial clients, not only growing revenue top-line our net revenue, backlog growing, but also driving earnings per share at 29% for our shareholders increase over 2007.

Now, while we had very strong first three quarters of the year they were very strong, our fourth quarter was even better and that was the quarter that we're reporting in during this call. During this past quarter we generated our highest ever total revenue for a quarter, net revenue, income, backlog; all of those at the highest level of any quarter in our history. Now, specifically we grew our total revenue by about 50% from the same quarter a year ago. We booked about $725 million in new orders during the fourth quarter and we did both of those while growing our operating income in EPS by about 25% for the fourth quarter.

In the fourth quarter we substantially grew both our federal and our commercial projects in revenues. While our total commercial revenues more than doubled from the prior year, and I'll talk about that on our outlook both on what specifically drove that and what we're seeing for 2009. Our largest client historically, and still for the year, the federal government grew by more than 20% and continues to be our most stable client in providing us with the largest number of orders.

In our smallest client sector, state and local government, we did see a reduction in some of our revenues. We have seen some softening there but it's primarily been attributable to two key client sectors, or project sectors, within the state and local market. First it's been attributable to weak schools programs. We’ve seen a funding for schools, bonds and funding for new infrastructure work with schools within Tetra Tech be very soft. Second, on a year-to-year comparison a year ago we had a large municipal build communications program that accounted for approximately $5 million of net revenue that we saw go away completely with no revenue contribution from that communications program this past quarter. So, those two areas we've seen some softness on our state and local work.

For the fourth quarter, both our federal and our commercial client sectors each represented about 40%, federal just under that and commercial just over that, but both of those about 40%. Our state and local businesses represents only 17% of our revenues, and much of our state and local work is for essential water programs and regulatory driven projects. So, we see this work being relatively stable, although we would consider it flat with some softening in the areas that I had indicated a moment ago. The communication programs that have gone away, some of our schools work we see soft, and an area that we see general softness in the state and local transportation we have very little exposure to so we don't see this to be a highly volatile area for us.

In the resource management group, it continues to represent the dominant part of our business at about 70% of our annual revenues are in this one sector. This group includes the work for our water studies, our modeling work, environmental projects are in this sector and our alternative energy programs are here and that's why it represents as such a large component. Our infrastructure segment, which is about 25% of our revenues, contains about 2,000 engineers that are designing water supply systems, treatment projects and infrastructure programs.

Next page, as I mentioned earlier we booked approximately $725 million in new orders in the fourth quarter, which capped a booking of about $2.5 billion of new orders for the New Year. This is by far the highest that we've ever had in our history and I want to point out a couple of the projects, individual projects that drove this large bookings of new orders.

Eight of our top 10 largest orders for the quarter were with our long-term federal customer base. That not only increased our funded work, but it increased our contract capacity, and if you're following along on our web cast you can take a look at some very, very large contracts. If you take a look at the very top one with USAID a $500 million contract capacity that we received and none of it is represented in backlog. So, not only did we have very strong bookings, which is our backlog driver, but we increased our contract capacity and it's primarily with the federal government to approximately $8 billion. So, we've seen a large increase in our available ability to execute work while also driving new specific orders.

While we continue to grow our backlog sequentially for each of the past seven quarters, and really it's this continued grow of our backlog sequentially one quarter after another which has taken us to our all-time high backlog of about $1.65 billion. Our backlog does come from all of our different clients. They fund their individual orders at different times during the year and it's these funding cycles that can cause some incremental jumps, or some lumpiness in our backlog.

But what I look for and we look for here at Tetra Tech is an overall long-term upward trend, just like you see in this graph if you're following along on the web cast, and it capped most recently with our recent increase by 31% increase in our backlog from a year ago, so while we may see some jumpiness on it on the percent increase or even some variability in it, we're looking for the long-term trend moving this backlog.

At this point I'd like to turn the presentation over to our Chief Financial Officer, David King, to present the details of our financial performance for this past quarter and year.

David King

This, again, as Dan mentioned was a great quarter and excellent year. We exceeded all financial goals while continue to grow our top and bottom lines. We achieved record revenue of $649 million with growth from all segments. Our net revenue was $349 million a growth of 27% exceeded the high-end guidance of $345 million, and our resource management grew 33%, infrastructure grew 6%, communication grew 36%. We also achieved a record high operating income of $30.8 million with operating margins of 8.8% including higher [inaudible]. EBITDA was also a record quarter, $36 million with EBITDA margin of over 10%.

Next slide, before I address this slide and I want to call your attention to our investor report the summary page under segment income. There is a line called elimination/other you will see a higher than normal negative item. This is a line we capture non-segment related costs. The biggest of which is our option expense. The balance is not allowable expenses such as insurance and legal. This particular quarter, fourth quarter, we had some unusual insurance and legal matters and we reserved about $3 million against them. I believe they were appropriate if not conservative.

Let me go back to the slide, SG&A was $43.5 million a growth of 33%. We continue to increase our selling effort while contain our G&A cost structures. As company gets bigger we are also able to leverage our cost structure. For example, the company grew top-line from '07 to '08 on all year basis at 38%. Our G&A costs increased by half of that about 18%.

Net interest expense was about $0.4 million due to strong cash collection but we did experience lower interest yield. Tax was $12.2 million, an increase of 23% due to 26% higher earnings. Our annual effective tax rate was 41.1%. I'd expect for the next year to be again 41.5% tax rate. Diluted EPS was $0.30 a record high. Our guidance was $0.27 to $0.29.

Our accounts receivable was $626 million and our accounts payable was about $223 million a growth of 43% and 45% respectively, both were in line with our revenue growth. Our net debt was a record low of $6.3 million a reduction of 17%. Our debt equity ratio at the yearend was about 11%, debt to total capital ratio was about 10%.

Cash flow, the quarter ended with $25.3 million cash flow from operation it was a great number. Especially whole year we achieved $68 million in cash flow from operation. Our revised guidance was $55 to $65 million. Our associates and project management organization continue to surprise us with excellent collection effort and working capital management.

Our CapEx was $3.9 million. The whole year was $18 million versus our forecast of $20 million. FY09 I expect our CapEx to be $20 to $22 million. DSO was not a strong quarter 74 days as a result of strong cash collection and smart contract term. I do expect the coming year DSO to be in the high 70's especially during the economy in '09 and beyond.

Next slide, the NASDAQ chart, this is my favorite chart. We have successfully grown our company without incurring more debt. A couple of statistic if you will, FY06 we were we a $1.4 billion company, we ended the year with a net of $10 million. FY07 we were a $1.6 billion company, we ended that year with $7.6 million of net debt. This year we achieved $2.1 million, our net debt was $6.3 million. I believe our focus on cash and working capital management will enable us to sustain our growth target without compromising our capital structure.

For the year, Dan already went through some of these numbers, we were 1.25 in net revenue, our guidance was 1.24 income from operation was $106 million with operating margin of 8.5% and EBITDA margin of 10%. EPS $1.02, an increase of 29% exceeded our revised guidance of $0.99 to $1.01. Backlog a record high at $1.65 billion, an increase of 31%.

In summary, we not only exceeded all financial metrics for the fourth quarter but also beat all financial goals for the year. As Dan mentioned we also took our first step into international market with ARD acquisition. We have one of the strongest balance sheets in the industry with nearly no net debt. As a side note, we have a very strong bank syndicate with continual commitment to our space particularly Tetra Tech. All of them are standing tall today in today’s environment and we have their full support.

Back to you Dan.

Dan Batrack

We’re really proud of our performance in 2008. We think so many things did well, but really it’s about how we’re going to perform both in this first quarter and as we go into 2009. And with that I would like to talk for a moment about our outlook for 2009 and how we see the markets that we’re focused on that we’re pursuing and that are our key growth drivers for this next year.

First, the core of Tetra Tech’s business is our water and environment program. It represents about 80% of our revenues and this is still the core of our entire corporation. We see these programs continuing to grow organically, with significant potential to expand beyond the growth rates we've listed on this chart here, ranging in the 4 to 8% that we’re seeing at this point.

With stimulus packages being proposed by the new administration, with bills that have passed previously, such as Water Resource Development Act that we’ve in fact seen no funding for, we have included no upside opportunity from any of those programs in our projections. Anything that would come through a stimulus package, anything that would come through the Water Resource Development appropriation or any other unusual funding we see as additional upside to these programs and to the guidance and the forecasts that we see for this next year organically.

We also see a new focus certainly as part of the platform by the new administration on protecting the environment, and any type of movement to protect the environment with water quality standards, protection of any type of environmental aspects, of soil, air, global warming will also generate substantial upside opportunity that is also not baked into or included in the forecast that we have here. We have been very, I hate to use the word conservative, but appropriate given the market and still showing a strong organic growth.

Our second area, alternative energy is the second growth area for the corporation and it’s not something we started recently. We started this several years ago, and while often it's referred to for the corporation as wind program, that’s not really a fair characterization or a complete characterization. We’re active in wind, solar, nuclear and transmission programs, and even have a project or two associated with geothermal.

So all of the different aspects of alternative energy we have a presence in. Now while this is the smallest part of our revenue, very small at about 8%, it’s been our fastest growing part of the market for us, this past year of that 8% and this is an area that we expect to benefit from the long-term commitment to US energy independence by the administration. It’s not strictly a matter of whether or not the cost effectiveness of these alternative sources of energy to conventional oil and gas is does it match the cents per kilowatt it’s also a function of energy independence. So we expect these to in the long-term continue to go forward.

We’re also, in that area we’re seeing growth of 15 to 25%, I’ll speak in a moment on how we see that actually being funded for us. We’re also seeing continued growth in the other markets. They’re much smaller for us, but areas such as communication that was very strong this last quarter for the telecoms and information technology, we’re seeing those grow in sort of the middle single digits organically as we go forward.

With this client base, we do have an opportunity to approve our operating margins from what we saw in 2008. The increase in the commercial actually does provide us with better margins, and with acquisitions, I’ll speak to that in just a moment. We do expect to grow our top and bottom line at about 15% inclusive of acquisitions, with 15% or better.

Our guidance, our guidance for the first quarter and all of fiscal year 2009 I’ll cover here. For the first quarter, we are forecasting and providing guidance of $310 million to $330 million as a range for revenue net of subcontractor costs with associated diluted earnings per share of $0.25 to $0.27. For the entire year, our guidance is $1.275, $1 billion $275 million, to $1 billion $375 million or a range of about $100 million with diluted earnings per share of $1.10 to $1.18.

Now a couple of notes, we say this every time every quarter and I’d like to reiterate this just to make sure there’s no confusion. Both our revenue and our earnings guidance includes no contributions from acquisitions, we certainly expect to do that.

We have more opportunities right now than we’ve seen really in several years, so we do expect this to actually transpire but they’re not included in these forecast numbers. We have done acquisitions this last year, and the year prior, and we do have an expense of $0.06 of intangible amortization that is included in these estimates already. And as David has indicated already for those modeling we do anticipate a 41.5% effective tax rate.

In summary, we had a very strong fourth quarter and a great 2008, and I’d like to thank all of the associates at Tetra Tech because they’re the ones who did it, both they and our clients. So really it was an excellent performance for the year. We see our core businesses in water and environmental projects to continue to grow with large additional upside, as I indicated a moment ago. Any type of stimulus any type of additional funding or focus we expect to be on top of these estimates that we’ve provided. In 2009 wind energy projects, we’ve all heard and we are watching very closely with our clients any type of volatility, both in funding or priority of these programs.

For the forecast that we’ve included in our guidance, 90% of the wind projects that we have, have already been funded and again our definition is, we've won the contract, they’ve provided the funding for it, so it’s a contract they have funding and they've authorized to do the work and much of this is underway. So we have a significant upside here also and there’s a number of opportunities that we see going forward that we’re competing for right now.

We did finish with $1 billion $650 million in backlog. We’re entering the New Year with a record high backlog and at this time of volatility, I tell you it’s one of the real strong points of the corporation. Our near-term debt is we're essentially debt free as David King had indicated. Funding all of the acquisitions and our operations with our cash flow from operations has really put us in an excellent position for acquisitions.

We’re ready for acquisitions and our patience I believe has really served us well. We’ve seen more opportunities now, there’s more favorable pricing, we’ve actually watched the multiples come down to what I believe are appropriate levels and are very favorable. As we’ve indicated before our acquisition strategy as we identify entities to join Tetra Tech, they will be accreted the first year. So as we bring these on, they will add to both, obviously our revenue, but also contribute to our earnings for the year.

Something else that’s been very favorable, not only are we seeing the multiples abate but we’ve also seen a shift in the valuation of the dollar overseas. Making the currency exchange rate much more favorable for us on international acquisitions, and we’ve seen a number of them that we’ve evaluated and are looking at, that are not only good opportunities, the price is right but the exchange rate makes it much more attractive. So the patience has really served us well and we’re ready to have some of the very best of the companies join us here in 2009.

And in closing, our 2009 forecast conveys and represents solid growth outlook with organic growth and we’re highly confident moving into this next year. And with that I’d like to open up this call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Quealy – Canaccord Adams

John Quealy – Canaccord Adams

Couple of questions, first on resource management margins ended the full year at 10% can you talk about some of your expectations for that moving forward or some assumptions? How sustainable that number is given your outlook?

Dan Batrack

Well our forecast for the resource management group has been arranged between 9 to 10% typically the fourth quarter is the strongest. We do have some seasonality utilization that’s higher our revenue is higher, so we have more leverage on our indirect costs in the fourth quarter.

We see our resource management group continuing at 9 to 10%. As we add a bit more commercial work as we did this last quarter it'll be at the upper end of that range, and we’d expect that during the early quarters of the year Q1, Q2, during the winter months. Particularly for us, January, February, March we’ll probably be at the lower end of that range, and in the summer months, which is Q3, Q4, we’d expect it to be at the upper range or even above this as you saw this last quarter.

John Quealy – Canaccord Adams

And with regards to headcount, it looks like it was up pretty decently in Q4. Is that roughly the range ahead that you’re planning on keeping to hit this guidance?

Dan Batrack

Yes it is. We will see and we’re watching this carefully, but we typically see a headcount be slightly higher in the late summer months. So the high headcount typically is September 30 to Q4. If you look historically you’ll see a slightly lower headcount in the winter months because field construction activities are a little bit slower, but it’ll move at just a few hundred heads, but we expect it to be at this level.

John Quealy – Canaccord Adams

Lastly, on that alternative energy organic growth expectation between 15 and 25 %, can you give us a little bit more indication of your assumptions behind that given the credit market that we’re in, and some of the concerns in the commercial markets? Can you give us a little bit more detail about how you’re coming up to those numbers?

Dan Batrack

Well let me give you some specifics on one area that we have very high visibility in. Let me give you an example of some wind projects. We had a strong wind revenue contribution in 2008. We went from about $60 million, $50, $60 million to about $160 million in 2008, and we’re forecasting $160 million of wind projects to go up to about $200 million. Of that $200 million as I indicated earlier, we have about 90% of that already in backlog.

The rest of the commercial work that we have across the board for the most part is not in discretionary aspects of work we’re doing for our commercial clients. A lot of it is in regulatory compliance work or other work that has to be done. So it’s not in a discretionary field for the most part. So we don’t see a lot of variability in our forecast, but our forecast has been inherently somewhat conservative. We’re making sure that we’re not getting too far out there.

Another focus we’ve done both on our wind and our alternative energy in general. We started this about a year ago simply by the nature of whether work was coming out, but we had begun moving our focus for pursuit of these alternative energy including wind, transmission projects from developers that were leaving these projects to utilities. So most of the work that we’re both performing now and for the clients that we’re working for in that area, which represents a good component of our commercial revenue, it’s for utilities.

Operator

Your next question comes from Debra Coy – Janney Montgomery Scott.

Debra Coy – Janney Montgomery Scott

First question's on the guidance. Obviously it is the perennial issue of Tetra Tech being conservative on the outlook, but just starting with first quarter mid-point as your guidance range, puts you flat with last year and I’m wondering how you’re coming to that. One of the things I’ve wondered about is the transition to a new administration, perhaps slowing some things down but I would think that would be more of a Q2 impact then a 1Q impact. How are you looking at the year shaping up?

Dan Batrack

Well let me start with income on the first quarter. Our income is up double digits, in fact in the mid-teens on a 2008 Q1 EPS to 2009. So we see that up very strong, and again that’s all organic.

Debra Coy – Janney Montgomery Scott

I was looking at a different set of numbers, I’ve got it. So the second quarter then, would you expect that we would see any impact of a slowdown related to government transition, or do you not really anticipate that?

Dan Batrack

What we see is interesting. Simply the platform of the new administration and in fact, just for those I want to make sure for others, we are seeing again organically without any additional contribution sort of a mid-teens increase on our income from a year ago. Now with administrations on the federal government, we have seen this before. We’re not new to this business. We’ve been in this business for about 30 years. Just for the federal government as a major contractor for environmental and water programs and some of the programs, some of the administrations that have come in with great expectations, and we expect that's going to be a big plus up immediately. We don’t see it.

The government is [inaudible] David King, is that it’s a major aircraft carrier that doesn’t turn very quickly. We expect the programs that we’ve been funded for to carry through to the end of the year. The majority of our backlog is disproportionately weighted toward a federal government their longer programs. The contracts have enormous capacity behind the funds that we already have in place.

There are certain stimulus packages that are being proposed now that could have a very short-term plus up, but other then those we generally see the funding move very little. We’ve also seen administrations that have come in that have been appearing to be less then positive for us. We’ve also not seen impact. These programs move very slowly, but with that said, the priorities for the new administration from an international standpoint are emphasizing development in countries and we’re one of the largest US Agency of International Development contractors that can provide full service capability.

So we think that we can be a valuable contributor and partner with the federal government on this and that can represent significant upsize, and that’s something that has to take place ongoing and I think it’ll get additional contribution. The Obama administration has talked about the environment, protection of water, protection of health for citizens, protection of our resources, and those are all EPA programs. The EPA folks right now that we’ve talked to are very happy encouraged, almost euphoric. And as one of the largest EPA hazardous waste environmental contractors that translate into the contractors that do work for them, that’s us.

And finally, the defenses they move out of Iraq and other locations back to the states, and Afghanistan. We’d expect that they transition to Afghanistan. We can take the work we’re doing in Iraq and move it over. So, it can be a plus up and certainly keep the Iraq work steady and anything that moves back here is a big upside for us. In fact, we’ve finally seen these past few quarters some of the backlog work began to come out.

Debra Coy – Janney Montgomery Scott

And finally on the subject of the economy and following up on John’s question about the strength and the commercial work. How should we think about the range of your guidance for fiscal '09 between the 110 to the 118? What are the contingency factors that push you down to the bottom end of the range? What are the, it sounds like you haven’t really built in too much of this upside potential. How do we think about the delta between the top end and bottom end of that range?

Dan Batrack

Well certainly the bottom still represents a good growth for us. We have factored in some contingency in the event of the obligation of some of the work that’s been funded on the wind. We don’t see that, we haven’t seen it, we’ve started these projects, but we’ve factored that in. Our biggest moving piece quite frankly is the state and local. It’s just not clear exactly how soft that may be.

Now I think we as a corporation are in pretty good shape. Again it’s about 17% of our revenues. It's typically [inaudible] few quarters have been 15 to 17%, relatively small. The projects that we have we think they don’t have a lot of discretion. A lot of them are regulatory driven. A lot of them are watershed based so that they are precursors to water supply, but I think that there’s going to be large pressure on state and local tax budgets, income from all sorts of different funding areas.

So, if state and local is impacted dramatically and we get more then our share, and maybe more, and if we see some de-obligation of some of our commercial work that could put as at the low end. High end could be less impact on our state and local, and in fact executing the work that we already have in our backlog should put us at sort of midpoint to the high end.

Debra Coy – Janney Montgomery Scott

Have you seen any de-obligations across your entire portfolio to date?

Dan Batrack

No. We really haven’t.

Debra Coy – Janney Montgomery Scott

Okay. Last question and it’s just a quick one for David. How are you thinking about operating cash flow for next year David? Are you still in the $55 to $65 million forecast range, or how should we think about that?

David King

Yes, 55 to 65, yes. That’s correct.

Operator

Your next question comes from Alan Robinson – Royal Bank of Canada.

Alan Robinson – Royal Bank of Canada

Dan could you just clear up on that last comment that you made regarding your guidance. If I quote you right you said that to hit the middle to high end of your guidance you just needed to execute on your backlog. Did I get that right?

Dan Batrack

I would say the middle. That’s right. If all of the programs go through and we have favorable performance on our fixed price work that we have in hand, we would be at the middle to upper end. I would say that that’s right. The difference being favorable execution on the fixed price would push it above the midpoint. As planned would be the midpoint, and the bottom end of that guidance is, I hate to use the word worse case, but essentially that’s what it is. It’s worse case from what we see.

Alan Robinson – Royal Bank of Canada

Then in terms of a comment you made when you referred to your backlog in your prepared comments. You said that you expected some variability. Could you expand on that? Are you referring to the potential for a single quarter decline, or do you see the potential for a series of longer-term year-on-year declines in backlog?

Dan Batrack

No. Actually what I was trying to suggest, I’m glad you asked it on a question because I want to be prepared for a single quarter. In fact, we’ve always been prepared for any single quarter decline in backlog sequentially. We’ve had a great run if you took a look at the charts that we've run. Essentially as far back as the chart goes, we’ve had sequential increase quarter after quarter after quarter and very large increases year-on-year. For instance this last quarter a 30% plus, sequentially over 5% again moving very quickly.

We’ve realized that for instance the federal government. The federal government issues a lot of work at the end of their fiscal year. So during the month of September, which is the end of our fourth quarter, we see a lot of federal government funding. But during the first quarter of the year for us is October, November, December not a lot happens in November.

Sort of right about this date forward you move into Thanksgiving and then you move into Christmas, and it’s our largest set of clients. And so where you see it slow down I don’t want there to be any concern by our shareholders or analysts or the public. That one quarter that doesn’t continue to increase sequentially really means anything particularly dire.

I do not see a long-term flat or declining backlog for us, but I did want to indicate right out front that it is possible and would not be unusual to see some lumpiness and see a single quarter that is not increasing. Commercial lumpiness and timing of these projects is just inherent with the client.

Alan Robinson – Royal Bank of Canada

Then moving on to commodity prices, given the drop in commodity prices we’ve seen since the summer months. Has this impacted yet what you are seeing in terms of your pipeline for mine closures?

Dan Batrack

Not particularly. On the mining business we really haven’t seen it impact us at this point. In fact, and I’m moving away from mining where they’re generating the commodities from a client standpoint we’ve actually seen some favorable impact by seeing the construction cost actually moderate. A lot of these fixed price projects that we’ve put together, which is a good component of our portfolio we were pricing with the oil at a $140, $150 a barrel.

We were pricing with some of these commodity prices at higher levels. So it’s given us some additional opportunity on our fixed price contracts where we have executions. So we haven’t’ really seen it on our mining for the work that we’re doing, but we have seen in it other areas additional margin opportunity.

Alan Robinson – Royal Bank of Canada

Since you mentioned energy and fuel cost there. Is there much of an impact in terms of your operating cost in terms of these lower energy prices we’re seeing?

Dan Batrack

A little bit, but I wouldn’t say it’s a big mover.

Operator

Your next question will come from John Rogers – D.A. Davidson.

John Rogers – D.A. Davidson

A couple of things, first of all, David you mentioned the $3 million of legal expense or legal reserves in the quarter. What was that for?

David King

It’s not exclusive legal reserve and every quarter we excess our legal and insurance matters and particularly those not allowable under the federal government contractors. We will chew them up and we assess them and we will just reserve against them. So, it’s a one-time, it’s not going to be in a run rate next year.

John Rogers – D.A. Davidson

Just so I’m clear. Whenever there are questions on federal contracts that’s where you put the reserves for those?

David King

No. It’s not just federal contracts. It can be a legal dispute with another party and you will see some of the disclosure in the case and so it’s not government contract related. The reason why I use the word government contract is because in the context of unallowable under the government contract.

John Rogers – D. A. Davidson

Then of your current backlog that you have now, what portion of that is construction work and/or fixed price work?

Dan Batrack

It’s about 45% fixed price in the backlog.

John Rogers – D. A. Davidson

And is that lump summed or just fixed unit price?

Dan Batrack

It’s a combination of both. We haven’t broken that number out into the two, but it’s a combination of both.

John Rogers – D. A. Davidson

And the construction piece of it? Is that still growing? It started out very small and I know it's grown a little bit.

Dan Batrack

It’s about 10 to 15%.

John Rogers – D. A. Davidson

And that’s mostly wind or alternative energy?

Dan Batrack

Yes, and also included component of reconstruction work that we’ve done in Iraq also.

John Rogers – D. A. Davidson

Oh right, okay, and then if I look at your numbers. If I don’t have this math right correct me, but it looks like about $130 million a little over of net revenue from acquisitions over the past year. Would it be fair to use your average margins for those acquired businesses? I’m just trying to figure how much the acquisitions added in 2009, or 2008.

Dan Batrack

I think that’s fair, although the largest acquisition represents by far the lion's share of those numbers, plus from ARD, which is I believe a 100% federal contractor and a lot of that work is cost reimbursable. So we’ve talked before about the margins of cost reimbursable T&M and fixed price. So if you can apply a combination of either those types of margins that we presented I think you’ll get them right.

John Rogers – D. A. Davidson

But that would suggest somewhere around $0.10 or so from acquisitions last year.

Dan Batrack

Well we have intangible amortization that is a great gift that we get with the acquisitions that carries on for about three years, and so while we did have acquisition the prior year, Delany's that contributed to that sixth sense. A good portion of it was from this most recent acquisition. So you need to take that into account.

John Rogers – D. A. Davidson

Good point, okay. I’m just trying to think about this next year. And in terms of the acquisition opportunities that you’re looking at, you mentioned that pricing is becoming more reasonable. Unfortunately public market values have also come down quite a bit. Are the deals that you are looking at now would they be immediately accretive?

Dan Batrack

Yes. You know our motto –

John Rogers – D. A. Davidson

Using cash.

Dan Batrack

No they are more accretive cash, but our definition of accretive is all in. Cost of interest which obviously will get baked into that David’s financial models, and cost of intangible amortization all offset by the contribution of the earnings brought by the firm. So our thresholds, the firms have to be synergistic. They have to be in the spaces that we are in. They have to be complementary with the type of work that they provide to our clients. They're at different geography, and they have to be accretive on a GAAP basis, all in on the first year.

So, we consider it an appropriate standard, most people consider it a high, and some liberal folks consider it unrealistic, but they're out there and they're the best picks.

John Rogers – D.A. Davidson

Okay, and then just last thing, in terms of the acquisitions as you look at them and with your operating companies will they all operate as Tetra Tech, or will they keep their existing brands, what's your thought on that?

Dan Batrack

There is a transition. They all will transition to Tetra Tech, but certainly there's value in the brand names that they bring with long, long histories with these clients. And the very small firms, the ones that we internally refer to them -- we've talked, we've presented this as a, what we call a tuck in, which are primarily resources. They come in and they're Tetra Tech on day one. They're integrated into our operations and it's just they go to work on our contracts and assimilate on day one.

The larger, the very like larger, like ARD, Delaney they have very high brand recognition, they do introduce themselves as Tetra Tech and we begin that transition. So, depending on the company there's a different transition timing and plan.

John Rogers – D.A. Davidson

Okay, but in typically is that one to two years, or longer?

Dan Batrack

One to three, one to three years.

Operator

Your next question comes from Richard Eastman – Robert W. Baird & Co.

Richard Eastman – Robert W. Baird & Co.

Just two questions, one is Dan, if I look at the private commercial business and I pull out some guesstimated acquisitions, and I pull out, and I don't want to not give you credit for a wind, but if I pull that out, it still looks like the year-over-year growth in private commercial was up kind of in the high teens. And net revenue. Can you just, what else in there drove that kind of growth?

Dan Batrack

Well we announced here, well first of all it's a combination of Fortune 100 firms, where we're doing different environmental compliance and retrofitting of different processes for their, for instance air emissions, updating of their scrubbers design work for sort of large industry that had specific drivers.

We've also seen and you saw it the very large growth in our communications and that's almost all private work when you talk about the major telecom, telecommunications companies. Then we also saw a contributor as a large project, Carson Marketplace which is a large development project in Los Angeles that just got started this year, that on a year-to-year comparison didn't exist the previous year announced this probably mid second quarter.

And so really it's not any single project but pretty broad across for the Fortune 100, one or two larger development projects and we've done a commercial project that a sediment remediation project in the upper Midwest that is just at the very beginning of it that also is another accretive program with respect to revenue.

Large program that should go for many, many years up toward a decade, but and ramp up very large. So we've seen strength across really a broad sector of the company, both with types of clients, types of work from sediment remediation which is a natural play for us as we're leaders in not only in the country but in the world in that area all the way to new development programs.

Richard Eastman – Robert W. Baird & Co.

As you said, I'm just curious to sediment remediation that would be for a commercial, a commercial customer, that's not a state funded.

Dan Batrack

No, we have some that are state funded, but that is a 100% commercial program.

Richard Eastman – Robert W. Baird & Co.

Okay, and then just David, I wanted, could you just clarify, someone I think previously asked cash from operations, I think that was an '09 estimate are you suggesting that if your DSO stretches out that that might more than offset any growth in EBIT? You suggested 55 to 65 million and you did 68 this year?

David King

Yes, and your networking capital increase we actually had impact, much more impact than the gross revenue per day impact, so we try to give you a reasonable number.

Richard Eastman – Robert W. Baird & Co.

Okay, so it might be flat as to down a little bit.

David King

Yes.

Operator

Your next question comes from Richard Paget – Morgan Joseph and Company.

Richard Paget – Morgan Joseph and Company

I know you guys aren't including any of this in your guidance, but I wondered if you could maybe get some more specific of any bonding measures that were passed recently that might benefit you and/or anything specifically in one of these stimulus packages that we should look for that would hit your end markets?

Dan Batrack

Well, let me handle this some transit and we'll go around a couple markets that we have particularly strong presence and infrastructure. In the northwest in fact in the state of Washington Sound Transit passed a multi-billion dollar bond measure that in fact is supposed to move forward here as early as 2009 with significant funding.

And we have a large number of engineers, a good component of our engineering staff for design and that support touch down points for bridges so, soil programs, soil stability, engineering is a large presence. In addition of the firm INCA which is really best in class in the country in that area, and it's headquartered for us in Seattle putting us in a great spot to capitalize growth so, that's one.

In California high speed rail program is a state bonded program also a multi-billion dollar program that we'll have right of way clearance, which is what we do, geo tech, environmental permitting, assessment work and preliminary civil design. So we use all of ours and it's an area where our largest headcount is present in offices and obviously our corporate headquarters.

A $400 million bond issue in Pennsylvania for water and waterway upgrade programs. We have very large presence in Philadelphia and in Pittsburg and a number of other locations throughout Pennsylvania we're well positioned.

And then at the federal level, there are a number of fast track stimulus programs that would look to go to state funded for revolving accounts, which are for water programs and other water infrastructure projects. And if, and I consider this analogous to a stimulation, stimulus program is, if the funding goes into a program like the bill that has been passed for the water resource development there's 900 programs there that haven't been appropriated.

If they want to put those, if they want to put people to work if they want to, this is our opinion, if they want to put the economy to work put people out on projects, fund these projects. Engineers will go to work, constructors will go to work, and the first folks to get those since these projects have been identified already are the folks, are the firms that have contracts with the Corps of Engineers which is the primary implementing arm for this, and they're going to go to the folks that hold those contracts.

And the Corps is and it's always been our first or second largest client in all of Tetra Tech we have a nearly a 30 year history. We're in a great position if those programs go forward. So, those are some that are out there. They're not baked into our guidance. I'm glad you said that in the beginning but those are example of three state programs and a couple of federal ones that could represent real upside for us.

Richard Paget – Morgan Joseph and Company

Okay, getting back to the acquisition market, you guys been, I think everyone else knows that the [ENC] multiples have come down in half and some cases more than that. What kind of multiples were you seeing maybe six to nine months ago on acquisitions or at least the seller's expectations and what do you think they can come to or what are they around now?

Dan Batrack

Well a year ago, even nine months ago, even as recently as six months ago, they were a multiple of 10 times trailing earnings and higher. And in fact that we saw, you all have probably tracked these well as us, have seen transactions take place at 12, 13 times trailing for firms that were in the public space.

So we sell them, certainly above 10 and firms that had a good track record and felt good used these public acquisitions and mergers as benchmarks, and so it's very difficult to talk to the folks and use a number under 10 and under eight. They did, and you couldn't even get it onto their doorstep.

Now we're seeing numbers probably six to nine; certainly ones where there's a lot of synergy and where you have a real close relationship as a partner and subcontractor to us for many, many years and there's natural fits. There's reasons on why it might be a little bit lower than that, but I don't see anybody who's actually going to have any success at numbers above nine, and that was well below a lower benchmark that we saw a year ago.

Richard Paget – Morgan Joseph and Company

And then is it still safe to assume that most of the buyers our there the strategics versus any

of the private equity guys coming in?

Dan Barack

Yes, it’s interesting. That’s exactly what we’re seeing. In fact, I would say that even as recently as 30 days ago when we were communicating our reality to potential acquisitions, that it’s not 10, 11, 12, 13, not even nine or eight, these lower numbers they locked away and interestingly in the last handful of days literally that we’ve received calls back that well they decided to go with private equity because they like those numbers. And they’ve come back and said well, that didn’t really work out. What number were you talking to us about? Our number is that minus three now.

So at any rate, private equity we’ve seen from all practical purposes really fall off completely. They’re gone. I would also say that there’s firms that, while we’re doing well, some of our peers are doing very well, not everybody in this space is and so the folks that have leveraged themselves up, we see them off the table. So, even strategics we’ve seen cold down as competition pretty materially.

Operator:

Your next question comes from Corey Greendale – First Analysis Corporation.

Corey Greendale – First Analysis Corporation

Dan, earlier you did a good job of talking through the margins for the resource management segment, both what drove them in the quarter and your expectations for next year. Could you just do the same thing for the infrastructure and communication segments?

Dan Batrack

Well let me start with communications because I’d like to bring any expectation that this last quarter in which they generated 25% back in line. Look, the communication operations managers, staff and their clients, is really excellent. We expect it to continue to be a strong contributor, but not at 25%.

As the workload comes in and spikes things up, we’ll expect to have these types of pleasant surprises where it’s very high, but on an ongoing basis for the year and kind of on a longer-term communications we look to be up 7 to 8%.

And again, we’ll have spikes above that but you should take a look at current communications. Infrastructure, historically, we’ve said that we expect an 8 to 9% margin. This last quarter, I know we were, and fourth quarter is typically our strongest quarter, and we saw 7.8%, so we were just under that range of 8 to 9%.

We did see some softness. We are reacting to it, we are going to adjust our size and costs in the areas where there’s directly affected, for instance in schools and [utopia]. So we do expect to still be in that range, but certainly with the variability in the state budgets it could be at the lower end of that range.

But again, resource management we’re seeing such a – 70% of our revenue's in resource management versus 25 and infrastructure we’re seeing at, on a relative basis, that having a much less impact on our overall margin.

Corey Greendale – First Analysis Corporation

And I know it’s a small part of the business, but communications. It’s a little surprising to see it spike up in the quarter, the net revenue. I mean, given some projects winding down. So what drills the revenue up there?

Dan Batrack

The big telecoms. We had the major telecommunication carriers in multiple locations across the country provided us really a lot of work. If we had an opportunity to take not only did we have more people in the field and headcount go up and go into overtime and obviously those bigger revenues and higher utilization on a fixed overhead base helped contribute to margins.

But, we’re so busy we took some of our fixed overhead office staff that are telecom professionals and put them out in the field in trucks and got them busy. So it’s had an additional impact on reducing your back office costs, which we normally would look at as fixed.

So all of that ultimately contributed to the very large margin and also the revenue and none of that was project closeout. For instance, there was no settlement, there was no one-time major recognition as part of a project closeout. It was just excellent performance for the quarter.

Corey Greendale – First Analysis Corporation

And then I also wanted to ask about the federal government work which, year-over-year growth was still good but if you look at it sequentially, the net revenue from federal government was down, which is not the historical pattern given the usual fiscal year end spending. Can you just address that question?

Dan Batrack

Yes I can. Iraq. One word for the most part. Iraq. We saw significant revenues in Iraq in 2008 and late 2007. It’s really running at the high point from late fiscal year '07 all the way through early summer and we’re seeing our work in Iraq ramp down. Now, each of the past two years I’ve spent a bit more time talking about Iraq.

We think we see with more clarity our timing and project load in Iraq and it’s ramping down. But other projects within the federal government are ramping up. The USAID work, the work that we’re doing in the Gulf Coast in the Corps of Engineers in the New Orleans district and others are ramping up, and our plan all along was, or our expectation was Iraq would ramp down while these other projects ramped up and in fact that’s the phenomenon you saw sequentially. It was the beginning of a reduction in our Iraq work.

Corey Greendale – First Analysis Corporation

Do you know how much revenue from Iraq was still in the Q4 numbers?

Dan Batrack

I’ll have to take a look at that. It’s about, on a gross basis about $60 million; on a net basis about $15 million.

Corey Greendale – First Analysis Corporation

And you expect it to continue ramping down from there?

Dan Batrack

Yes I do. I do.

Operator

Your next question is from Jeffrey Beach – Stifel, Nicolaus & Co.

Jeffrey Beach Stifel Nicolaus & Co.

I may have missed a couple of things, but did you provide the acquired revenues in the fourth quarter?

Dan Batrack

We include in our investor analyst sheet here the amount – we include our year-to-year net revenue growth organically. So if you take that from the total growth you have the acquisitive growth for the fourth quarter.

Jeffrey Beach Stifel Nicolaus & Co.

And in terms of the outlook for the communications I have what you had in the backlog and what you look for. Are you looking for growth or some contraction in that business in ’09?

Dan Batrack

We’re seeing still growth but we’re seeing it grow at sort of a 4 to 6% pace, so sort of middle, single digit growth.

Jeffrey Beach Stifel Nicolaus & Co.

All right, and then spend a minute on what’s occurring in your wind power effort. In terms of looking out at '09 and the business that you’ve booked versus '08, I think you’re expanding the scope of the work that you do in and around wind or even alternative energy. Can you talk about that for a minute, about the new functions you do and how much that is adding to growth in ’09?

And then can you also talk about what you see? Right now you’re forecasting mostly what’s in your backlog, but does the outlook right now look good for funding and a lot more wind power projects coming on stream over the next couple of quarters?

Dan Batrack

Let me start with the type of services that we’re providing. And I need to put this in context. Let me put it in context of how we’ve gone from 2007, 2008 and then 2009 and show you how the revenues are ramping up and how that’s associated with the type of work we’re doing. We did around $50 to $60 million in 2007 in work for wind projects. It was primarily associated with up-front services with very little bit of implementation.

So it was right of way clearance, environmental permitting, regulatory permitting, geotechnical testings, and foundation engineering work. And we felt that we would then work with our both developers, wind developers and utilities to help them select constructors and then we would often do some type of quality control review or construction management. We felt since we’re doing all of this work, why don’t we take it on a turnkey basis?

So what we’ve done from 2007 to 2008, we went from around $50ish million in wind work to about $160. And essentially that’s a threefold increase. The threefold increase was by Tetra Tech taking a turnkey execution all the way from the permitting, all the way through commissioning and setting up these turbines.

In fact, in the last three to four months, Tetra Tech has stood up, I mean having installed and are currently up and rotating, it's practically about 215 turbines in the Wyoming area. The previous year we wouldn’t have done that. We wouldn’t have done permitting. Someone else would have done that. For our forecast, implementing that type of work, our wind forecast is going from about 160 in 2008 to about just over 200, and that’s with the work we see. We do see other opportunities coming out, we have been provided a number of bidding opportunities, and it's driven by these turbines.

They've been purchased and a number of these turbines they can't send back or there's very large expenses for them returning them or not taking possession. So we see a fair amount of work at least through 2009 and opportunities coming up.

Jeffrey Beach Stifel Nicolaus & Co.

And then just one minute on within your commercial business and your backlog, outside of alternative energy, is there vulnerability going through the course of 2009 to see reductions in some of the programs with your CapEx, with your commercial clients? Is this what you saw in the last recession?

Dan Barack

Well we do think there's some vulnerability and we have factored it in. We've taken a number of the projects we have and clients and we've internally put factors on them or cautious outlooks on them.

Certainly our crystal ball isn't perfect. We think we've – we're looking at our clients very closely to make sure that they have liquidity that they're going to be in business, that our receivables and the outlook are of high quality. But we have factored for some amount of reduction.

Operator

And your final question will come from the line of Rob Young – William Smith and Company.

Rob Young – William Smith and Company

I was hoping that you could talk a little bit about the effect on backlog and how it flows into revenue, given the greater portion of net revenue attributable to commercial?

Dan Barack

Our net to gross won't change as a percentage. It's probably 35 to 40% of our total revenues, and it's also reflected in our backlog as in subcontracts, so 35 to 40%, the rest is all net. Our backlog again is a bit more weighted toward federal, because they're longer-term programs than it commercial; they're a bit shorter.

Am I answering your question with respect to our backlog components and its partitioning between gross and net?

Rob Young – William Smith and Company

Yes, I guess from what I understand it's been about 75% of the backlog is expected in the first 12 months, with the remaining coming in the first 18 months.

Dan Barack

That's correct.

Rob Young – William Smith and Company

And I was just wondering if the growing commercial allocation has any affect on that timeframe?

Dan Barack

Yes, we really haven't seen the amount of our backlog grow to represent the commercial, as we have with its actual percentage of revenue. The work that we've received on commercial is much more what we call book and burn, you receive it quickly it's a quick order. You get it, burn it even, expend the funds before the quarter is up.

So we've not seen the commercial component grow, if I understand your question, we have not seen it grow and increase the amount of our backlog that would be expended within the first 12 months. You've got it exactly right, all of our backlog I think with very little exception, would be expended within an 18 month period, with 75% to maybe 80% in the next 12 months.

Rob Young – William Smith and Company

And then just looking at your guidance, I know it's been touched on throughout, but looks like it's about 6% top line growth from net of subcontractors, and then about 14% growth or so on an earnings basis.

And those growth characteristics look like from an earning standpoint, as a little bit more optimistic than the actual results have been in prior periods. And I was just hoping that you could possibly comment on that. Is that basically factoring in better than historical margins or?

Dan Barack

It is. The increase in our commercial work does have higher margins. We do see two items driving up. One is the percentage of the work that we have with commercial has gone up, and I believe they're archived on our Web page on the investors section. What I find fortuitous is about a year ago, we made a decided concerted focus to increase our commercial work.

And if you take a look at the partitioning, we had arrows in there that we wanted to drive the work up to 40% or greater in order to increase the margins. So that's what we've seen, number one, and number two, a percentage of fixed price work also is driving higher margins. And a third item, is as we go forward the roll off, and I'll call it the roll off or twilighting of intangible amortizations associated with these acquisitions that we've done a couple years ago, we have an expense.

And as that expense rolls off or decreases, typically our intangible amortization has about a three-year lifespan, and it's a bit more heavily weighted to the first year, a little less the second and smallest in the third. So as it rolls off you're going to see an increase in our margin because of decrease of our intangible amortization affect.

Rob Young – William Smith and Company

And then with future acquisition opportunities you mentioned that the multiples are coming down. Does that imply that the size of the acquisition that you might look for has grown?

Dan Barack

Yes, we continue to see synergistic tuck-ins as I described earlier, but the opportunities that we've seen are larger and are just really good fit. And so we are looking for these larger acquisitions, and they're out there.

Rob Young – William Smith and Company

With that, would there be possibilities of heightened integration risk at all?

Dan Barack

I don't think so. Delaney Group is running it; in fact two years ago it came in. And we've seen their revenues increase by 50% or more than under Tetra Tech and the synergies between the front-end services and the other construction management that we have internally has actually caused them to grow at a level even faster than they had forecasted prior to Tetra Tech.

The exact same thing is true with ARD with the U.S. Agency for International Development. The integration and synergies of providing full services to their client really drives this integration faster and it's really for one reason, to offer the client more full services so they don't have to go to multiple contractors.

So it's really worked very well and we haven't seen that with, those are two examples of $100 million plus per year revenue run rate companies. And so that's where we spend our biggest amount of time on due diligence, is it the right cultural fit, is it the right synergies, and are they going to fit well? Because we're not bringing them on to turn them around, these are top performers right out of the gate.

Rob Young – William Smith and Company

Well that's all I have and congratulations on the quarter, thanks.

Dan Barack

With that I'd like to close this conference call. I'd like to thank everyone for participating. I can see its 9:15 here out on the West Coast, so lots of questions. I was really glad to receive all of those. These are things that we've been focused on for the past several years, and we're glad to see the focus on the markets, our clients, and the growth actually convert to the best results that this company has ever seen. And that is for 2008.

We are confident that things are even better as we move into 2009. Even with the uncertainties of the economy, and so both the markets, the clients, and the direction that we selected several years ago, are really bearing out to be the right moves. And with that I'll look forward to talking to you all next quarter. Thank you.

Operator

Ladies and gentlemen this concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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Source: Tetra Tech Inc. Q3 2008 Earnings Call Transcript
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