Tetra Tech Management Discusses Q1 2013 Results - Earnings Call Transcript

Jan.31.13 | About: Tetra Tech, (TTEK)

Tetra Tech (NASDAQ:TTEK)

Q1 2013 Earnings Call

January 31, 2013 11:00 am ET

Executives

Dan L. Batrack - Chairman, Chief Executive Officer and President

Steven M. Burdick - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Corey Greendale - First Analysis Securities Corporation, Research Division

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

John B. Rogers - D.A. Davidson & Co., Research Division

Steven Folse - Stifel, Nicolaus & Co., Inc., Research Division

David L. Rose - Wedbush Securities Inc., Research Division

James Giannakouros - Oppenheimer & Co. Inc., Research Division

Michael Frederick Legg - Roth Capital Partners, LLC, Research Division

Operator

Good morning, and thank you for joining the Tetra Tech Earnings Call. By now, you should have received a copy of the press release. If you have not, please contact the company's corporate office at (626) 351-4664.

With us today from management are Dan Batrack, Chairman and Chief Executive Officer; and Steve Burdick, Chief Financial Officer. They will provide a brief overview of the results, and we'll 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 and 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.

In addition, since management will be presenting some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted in the Investor Relations section of Tetra Tech's website. [Operator Instructions]

With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Dan L. Batrack

Great. Thank you very much, and good morning, and welcome to our fiscal year 2013 first quarterly earnings release conference call. I have Steve Burdick here with me this morning, our Chief Financial Officer, and he'll be presenting the specifics of our financials. But I'd like to start today's call with a brief overview of some of the key -- first, our key financial metrics for the first quarter.

We began this year with a solid first quarter of 2013 both with revenue and income coming in line with our expectations.

As we anticipated coming into the quarter, we did see our revenues decline with many of our U.S. federal clients, both with the rate of their spending and the issuance of their new orders. This was a direct outcome of the uncertainty associated with the U.S. election and the pending sequestration, which, in fact, is still pending and just pushed out into March.

In the early part of this past quarter, we also experienced some revenue impact on our East Coast operations associated with the Hurricane Sandy event that took place during our first quarter.

As a result, our revenue in the first quarter was at $659 million with a net revenue of $497 million, which was up 1% year-over-year.

However, with the reduction in our federal revenue in the quarter, more of our revenue was associated with our higher-margin commercial work.

As a result, our EBITDA finished at $54 million for the quarter. And our operating income was $42 million, which was up 16% from the same quarter last year. Our diluted earnings per share was $0.41 or up 14% year-on-year. Overall, the quarter was a really in line with our guidance that we had provided coming into the quarter.

Our international work continues to be the fastest growing area in the company. Our international work was up 7% year-on-year based on growth from a broad base of customers, primarily in Canada, Brazil, Chile and Australia.

In the United States, our commercial revenue also grew. It was up 3% year-over-year, supported by growth primarily in the oil and gas and with our industrial clients. The growth in these 2 areas, oil and gas and industrial clients, really offset some of the slowdown we saw in our mining work. Our mining activity had gone from double-digit growth. We saw it slowed down at the end of last fiscal year to sort of mid-single digits. And this first quarter, we saw it flat, not shrinking, but really no material growth.

As expected, our federal net revenue was down. In fact, it was down 13% year-over-year due to the fiscal uncertainty with the U.S. government.

Our state and local work continued to be strong. It was at 13% of our overall business this past quarter, and it was up due to a few larger projects and localized pickups in our municipal or city orders really across the country. It's not -- it's actually a bright spot for us.

All 3 business groups were affected by a broad-based reduction in our federal revenues during the quarter. However, each of the 3 business groups have a much broader balance of services and clients than just with the federal government, and each have specific growth markets that offset the federal market reduction that we saw in the first quarter.

In the first quarter, our ECS group, our biggest one, grew slightly supported by international growth, primarily in South America and Australia. Those were our strongest areas. And we also did see growth in infrastructure work in Canada, primarily associated with the oil and gas markets.

The TSS group was flat during the second quarter. It was really 2 items offsetting each other. We saw growth in the U.S. oil and gas pipeline design, permitting an environmental assessment work, and the growth in that area offset a slight reduction or weakness in the U.S. federal work.

And for RCM, which includes a lot of our U.S. state and local projects and commercial cleanup projects strengthening that areas, RCM maintained its revenue during the quarter.

All 3 of these groups though during the quarter did adjust their resources and indirect costs in anticipation of the market changes we saw primarily on the federal side. So we are moving quite quick on the indirect cost as we see changes there.

At the end of fiscal year 2012, we achieved an all-time, record-high backlog of just under $2.2 billion. We received over $600 million of orders in the fourth quarter of last year.

As we've grown our commercial work both in United States, international -- internationally, we have seen the average duration of a project become much, much shorter, which is typical of our commercial work, and it now comprises a much larger part of our backlog. In fact, in some of the areas, we become much closer to a book-and-burn business. We'll book a project and we'll actually complete it within the 90 days of the quarter, and so any order would be burned up. Now it does mean that we have a much higher margin embedded in our backlog, as the larger portion of our backlog is associated with commercial work.

However, in the quarter, as we expected, orders were slow from our U.S. federal agencies, as they waited for the election results, the budget resolution and decisions on sequestration. This fiscal uncertainty also did have, in the first quarter, some impact on our clients actually moving forward with orders also. So that did have a small impact. Overall, this did result in a sequential reduction of our backlog to $1,938,000,000. However, our backlog is up from the same quarter last year by 2%.

We have been successful this past quarter in winning many large, not only commercial, but federal contracts, but I do expect orders to be slow with the U.S. federal government over the next quarter or 2 as both the sequestration and the budget for 2013 get resolved.

I'd like now to turn the presentation over to Steve Burdick, who will provide us more details and some discussion of the financial results for our first quarter. Steve?

Steven M. Burdick

Okay. Thank you, Dan. I'd like to begin with the first quarter fiscal 2013 financial overview in a bit more detail.

Overall, as Dan said, our first quarter results met our previous guidance. Comparing the first quarter results this year to last year, revenue decreased by about $24.1 million or 4% to $658.5 million, primarily as a result of a reduction in our federal government markets, and this decrease was somewhat tempered by increased revenue related to our oil and gas and our commercial markets.

Net revenue increased by a modest 1%, about $497.2 million. I do want to point out that our net revenue is growing as opposed to our gross revenue because we're involved in more self-performance work, especially for our commercial and international-related projects.

The self-performance work has benefited our bottom line. And in fact, income from operations increased by about 16% to $41.8 million. As opposed to the change in the revenue, we did experience a substantial growth rate in our operating income. We benefited from better project execution in our tests in RCM groups, and we recognized less intangible amortization expense in the quarter.

Also, EBITDA increased by about 6% to $54.1 million, and this improvement resulted in an EBITDA margin increasing to about 10.9% for the quarter.

Looking at the income statement in a little bit more detail. SG&A was $46.4 million for the quarter. This is a decrease from the prior year's first quarter. As I mentioned, the majority of the decrease resulted from lower intangible amortization.

Tax increased to about $14.2 million due to the higher income that we recognized. The effective tax rate is about 35% for the first quarter, and this rate is consistent with our previous guidance and similar to the prior year's effective tax rate.

EPS of $0.41 met the high end of our guidance, and we hit the high end -- the high point of this guidance as a result of solid project performance and lower SG&A costs.

I would like to point out a few of the more significant items in the balance sheet. Accounts receivable increased by about 1% to $674.9 million. Virtually, all of this increase is related to the change in our revenue mix, which is now weighted more towards commercial and international work.

Accounts payable decreased as a result of our lower subcontractor activities and, in fact, this lower amount is reflected in the gross revenue also decreasing.

On a first quarter year-over-year basis, our net debt transitioned to a net cash position. We had a very good cash generation from our operations for the quarter.

In thinking of this good cash flow, I would like to share the following on it: The quarter 1 operating cash flow was $17.8 million in the quarter. This is less than the prior-year quarter. However, I do want to point out that our first quarter is typically lower than other quarters because of year-end bonuses and other payments that occur and a slowdown in collections around the Christmas holidays. Even with that said, we expect our operating cash flow for the year to be between somewhere $150 million to $170 million for all of fiscal 2013. And this translates to cash generated on a per share basis from $2.31 to $2.62 on a per share basis.

The CapEx is about the same as the prior year and in line with our previous guidance. We do expect our CapEx for the year to be in the range of $25 million to -- or $25 million to $30 million for the year, which includes a plus-up for the second quarter acquisitions that we just completed.

Overall, our CapEx amount represents a ratio of less than 1% of our annual revenue. Day sales outstanding at 79 days are slightly higher when we compare it to this year or last year at this point. Even with a higher DSO, we had a very good operating cash results. The higher DSO relates back to what I mentioned earlier in the presentation, which is our revenue mix, which is weighted more towards international and commercial clients. These commercial payment terms are less optimal when we compare it to our federal government work. But offsetting this, we do recognize higher profit rate.

The next graph is the net cash position, and this graphic shows the impact of our positive operating cash results generated and the cash used primarily for acquisitions and in other investments.

As you can see on the graph, our net cash position has remained in place from the end of the last fiscal year. I do want to point out that even though we were in a net cash position, our interest expense for fiscal 2013 would be approximately $8 million as it includes interest on debt outstanding, debt facility fees, deferred debt cost and a significant amount of imputed interest on the earn-out liabilities.

In addition, due to the completion of our AEG and Parkland acquisitions that we've announced in the second quarter, we will be in the net debt position as of the second quarter now, and it's about $150 million. However, we do expect this -- to bring this back into a net cash position by the end of calendar 2013. And if -- furthermore, if we do really well, we could even see ourselves back in the net cash position by the end of the fiscal year.

With that said, the management team is so committed to leveraging our balance sheet and looking for growth opportunities that will provide high profit rates and access to new markets to further enhance our shareholder value.

And with that said, that concludes the first quarter financial review. And I'll turn it back over to Dan.

Dan L. Batrack

Thanks, Steve. I'd like to now introduce you all to 2 new acquisitions that joined Tetra Tech just in the past 30 days.

In fact, the first one I'd like to introduce is AEG, or American Environmental Group, who joined us at the very beginning of second quarter. In fact, it's been just about 30 days exactly today that they joined us. AEG is a top-tier solid waste or landfill consulting, engineering and construction firm headquartered in Ohio. They complement the front-end design capabilities that we have in the Western United States right now, and they bring us a solid waste presence in the Central and Eastern regions of the United States.

And I believe reviewing the industry literature that together -- Tetra Tech together with AEG now makes us collectively the largest solid waste consulting, design engineering and construction firm in the United States. So we're quite proud of that.

We expect that AEG will be accretive on a GAAP basis in the first year. We did include this in a press release here roughly 30 days ago. And they should contribute between $0.01 and $0.02 on a GAAP basis during fiscal year 2013 with that contribution probably being a little closer to $0.01 level and being back-end loaded, and that is after taking all expenses associated with intangible amortization.

Most recently, the second acquisition that joined us was Parkland Pipeline. In fact, they just joined us on Monday. We closed the acquisition just 3 days ago, and they've added a pipeline design, engineering and construction service capability in Alberta, Canada.

The addition of Parkland expands our presence in oil sands and is very complementary to the work that we're currently doing in the -- for engineering work in the region, primarily Alberta. Since Parkland just joined us, we're still looking at some of the details of the purchase accounting. We'll point this out in just a moment on the intangible amortization, but we have not completed that. Again, I'll repeat that we're only 3 days into this, so we are going through the accounting implications of the different noncash charges, but we do expect them to be accretive in the first year. We expect that they'll contribute sort of the similar level to AEG, $0.01 to $0.02. But again, this hasn't been completed, and we'll provide more details on our next quarterly call on this part.

On the next slide, if you're following along on our presentation materials, if you take a look at the slide, our customer outlook, as you can see on this slide, is focused on driving growth in the international and commercial markets while maintaining the public sector revenues that we have here in the United States both for our federal state and local clients that are focused on their priority programs.

Our growth projections for our customers over the next year are going to move the percentages shown on the slide here. And if you don't have the slide, I'll note these. We expect that, over the next 12 months, we're going to continue to grow both our international and U.S. commercial markets to -- on a combined basis to about 65% of our overall revenues.

Those broken into about 35%, so expect our international work to go from just over 30% to 35% over the next 12 months and our U.S. commercial to grow to 30%.

We do expect the balance of our revenues of about 35% to be comprised of the U.S. public sector, and that would be comprised of roughly 25%, where we'll see our federal revenues declining over the next 12 months slightly to represent about 25% of our revenues, and we expect our state and local to remain constant or stable at just about 10% or slightly over.

Now each of our 3 business groups are going to contribute to the growth model shown on this slide, which means growth on the international and U.S. commercial markets.

And I'll start with ECS. We expect our ECS, our largest business grow -- group, to grow in the oil and gas markets in Canada, supported by engineering and infrastructure work, especially in Western Canada along the oil sands and the oil and gas quarters through Alberta and to the West in British Columbia.

With the near-term declines in federal and a slowdown in mining starts and, as I had mentioned earlier in this call, our mining work has remained relatively flat this past quarter, I do expect our margins in the ECS group for the second and perhaps early third quarter will likely be at the lower end of their target range, again, because of pressures or headwinds on the federal market and a flat market in the mining for the immediate future.

The TSS group includes growth markets in oil and gas in the United States, supporting engineering and environmental work in the major shale regions across the U.S. and pipeline design work for interconnections. Now the TSS has relatively stable U.S. federal client base. These are regulatory-mandated projects or very high priority projects with U.S. State Department. So I expect TSS group to continue performing at the high end of their margin range. So I'd expect them up at near the 12%.

I will note that they were above that. They were over 13% this past quarter, and that was associated with the exceptional performance and project closeouts. And so, for those modeling, model it closer to 12%, not materially above that.

In RCM, our Remediation and Construction Management business that focuses on completing our full service capabilities. With the addition of Parkland and AEG, RCM is going to be working across North America in the oil and gas and solid waste commercial markets. The shift to this more commercial business is going to cause our margins to go to the high end. We not only moved their margin target range up materially coming into this fiscal year, but I expect RCM this next quarter and for the rest of the year to be performing at the top end of this target range.

In fact, I've challenged the business group president of RCM to not only match, but to exceed that contributing from the ECS and TSS group. And so, we'll see how that goes here. But I expect in the future RCM is going to be a major contributor to our operating income at a similar margin level as ECS and TSS. So that will be a big change and a contributor to the company.

Now let me -- let's take a look at this for a moment on a consolidated basis. Again if you're following along on the webcast, you can see on this graph, we are projecting continued improvement of our EBITDA margin toward our long-term goal of 13%.

At the midpoint of our guidance -- and I'll get to that on the next slide, but the midpoint of our guidance represents about an 11.5% EBITDA margin, which will be the seventh consecutive year of margin improvement for the company.

And with the larger percentage of our revenue coming from commercial clients, both in United States and internationally and the improved performance in our RCM business group, I expect 2013 to continue to trend with a margin improvement toward our long-term goal.

With that, let me move to updating our guidance both for the second quarter and for all of fiscal year 2013. So based on our performance on this first quarter, we've increased both our EPS and net revenue for the year. And so, I'll start with our second quarter guidance for net revenue and earnings per share.

Second quarter. Our guidance is from $500 million to $550 million. The midpoint of that range, on a year-to-year basis, would represent a 10% increase in our net revenue.

With an associated earnings per share range of $0.38 to $0.42, if you calculated the midpoint, the midpoint would represent a 14% increase in our earnings per share over the same quarter last year.

For the entire year, we did move up our net revenue to $2.15 billion to $2.35 billion, the midpoint of that range would represent an 11% increase with an associated diluted earnings per share of $1.85 to $1.96, the midpoint representing a 17% earnings per share increase. And I will note, if you compare this to our guidance from last quarter, we did bring the bottom end up at $0.05, and we brought the upper end up $0.01. The reason for bringing the bottom end up more at a larger level is we do think that a lot of the uncertainty associated with the federal budget and some of the federal uncertainties have cleared up, the election is behind us so it's pretty clear where the administration is going to be. It's clear with respect to what departments will be in place. The production tax credits had been determined, so we have more clarity on our renewable energy work. So we're seeing much more certainty there. And actually, for our commercial clients, the tax rates have also cleared up. So we've seen all of those clear up. So it's given us much better visibility on the bottom end, so we move that up by $0.05.

Now we still do have a couple of things outstanding. We still have sequestration coming up in March and the budget, so we haven't seen the top end completely cleared up so we've been just a bit more cautious or judicious in bringing the top end up. But even with this, we did bring it up.

Now some of the assumptions, I do want to point out and reiterate one more time that the -- if you're following on the webcast, we do estimate, at this time, $0.37 intangible amortization expense during 2013, but this is preliminary in nature. We have not completed a final purchase price accounting of what that number will be precisely, and we'll update that next quarter. But it is a substantial increase of intangible expense for 2013, and this is about a $0.19 or $0.20 increase over the prior year.

Other assumptions, $0.11 stock compensation expense, 34% effective tax rate and 65 million shares -- diluted shares outstanding.

In conclusion, our strategy to focus on international expansion and growth in the private sector with our industrial and commercial clients has actually been working very, very well. We've continued to expand our services to our North American oil and gas customers and our change in this customer mix has resulted in a material increase in our margin. In fact, the first quarter, we saw 15% year-over-year increase in our operating margin in the first quarter. And based on this performance, we raised both our earnings per share and our net revenue guidance for all of 2013.

And with that, operator, I'd like to open this call up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Corey Greendale with First Analysis.

Corey Greendale - First Analysis Securities Corporation, Research Division

So first of all, I wanted to ask you a little more about the post Hurricane Sandy effect. And I know you said that there was a little bit of an impact in the quarter. I was wondering if you might be able to quantify that? And then, talk a little bit about what you think the future opportunities may be around, kind of, the post Sandy repair and making sure that sort of thing doesn't happen again?

Dan L. Batrack

Well, let me start with the first part of that question, what was the impact in the quarter. We have between 200 and 300 people located in our office just above Madison Square Gardens, so we're sort of mid to downtown area in Manhattan. Just like everyone, they closed that entire operation down, so we had a few hundred people out for about a week. So it was -- we call it -- it wasn't 0, but it wasn't significant and that's why we didn't actually quantify it. But if you want to back into our very high paid engineers in New York at that time a couple of hundred people for a week that was the impact. With respect to the opportunities, we actually look at this as very closely parallel in some respects to New Orleans, but even better for us. The overall dollars that have been allocated for Sandy, we've passed the -- the Congress and federal government passed roughly $60 million here in the past few weeks, including $50 million of it here just this week. Now typically, it has a slow ramp-up. The money is primarily going to be spent by the core of engineers for coastal protection, and it starts with long-term studies. The difference I see between New Orleans and the East Coast is we're much better positioned in the East Coast. We have large offices in Northern New Jersey, in places like Morris Plains. We have offices in clearly Downtown New York and really across the seaboard. The client that's going to be leading this is the clients that we have left -- led with for many years in New York District, the Philly district, the Baltimore District, the New England district. These are long-term clients with us. And we do have a large presence that we can co-locate or co-join the monies and funding given to the local entities that then do co-funding with the core and other federal entities such as FEMA. So we think we're well positioned. It typically takes a few quarters. This is only a few days in now. It will take a few quarters to initiate the studies, and then it would convert to actual solutions, design and then, ultimately, construction. We did approximately $300 million to $400 million worth of revenue in New Orleans, and most of that began anywhere from 3 to 5 years after, the largest part of the revenue, and I would expect, depending on what the final solutions are, it to be somewhat similar to that. So that's sort of our initial look at what this might represent to Tetra Tech.

Corey Greendale - First Analysis Securities Corporation, Research Division

That is all helpful detail. And then, my second question, you were fairly clear about what you're viewing on the federal government segment. But could you just give us a little more sense of what's included in the guidance? Are you assuming, kind of, a Q2 post-election hangover and then things pick up in Q3? Or are you assuming continued weakness throughout the year?

Dan L. Batrack

No. I think you've actually said it well. I'd call it a hangover, probably not bad. The hangover is associated with, still, the budget and the sequestration. So I expect that the individuals who are leading these federal programs are really looking for certainty both with the budget for what they can spend either on a continuing resolution, which is similar levels and what, if anything, sequestration will represent for their programs. So I expect the federal to be somewhat similar during Q2. That's why I have expressed some caution on orders during Q2, and I expect it to abate early in Q3. Now technically, the date is March 27 for the budget. If they hit that to the day, it will be a Q2 event and things will clear up quite quickly in Q3, but I'm still waiting for them to hit one of their scheduled budgets -- or scheduled timing at all. So if you push it out another month, then you're a month into Q3. So I expect this to be a front-end of 2013 Impact; Q1, we just saw; Q2 will be somewhat similar, and I think it will actually abate quite quickly through Q3 and not be an impact in Q4.

Corey Greendale - First Analysis Securities Corporation, Research Division

And if I could just squeeze in one more quick one. You were clear that you thought there was the potential for upside to the RCM segment margin. Just looking at the guidance and given the impact on intangible amortization, I'm having trouble of getting to estimates that assume those acquisitions are accretive unless the RCM margin is above the 6% to 10% range. So can you just give us -- most likely, should we be expecting not only the high end and that it could actually be a little bit north of that?

Dan L. Batrack

Well, I do think that, depending on revenue, revenue will help drive it to that, and it is possible they could be above that level. And in fact, the more and more of the work coming out of RCM is on the commercial side and much, much less of it is on the federal side and even some of the work at the state and local is on a fixed-price basis. So the margins, even on the state and local is higher. So I do believe that the -- I do believe the segment margin could test the upper end and, in fact, be above that. So if your model show that we would have to be above that, that is not outside in expectation that we would have for the RCM group for Q2.

Operator

Your next question comes from the line of Andrew Wittmann with Robert W. Baird.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

I just want to build on that last question a little bit and just be more specific. On those deals, I mean, are the margins on Parkland and AEG -- I mean, are these substantially higher type EBITDA margin businesses? Are these kind of high-teens margin businesses? Could you just give us a sense about how those businesses earned?

Dan L. Batrack

Well, the solid waste business is lower than that. It's probably double-digit, but it's right around 10%. It's a bit of a more mature business. We're well entrenched. Some of it is associated with receipts of waste that come from utilities or even municipalities, so it's a strong business. It's higher than the margins that have been in RCM in the past. So it is accretive with respect to margin basis, but it's, I would say, not in the teens but sort of right around 10%, 11%, right around double digit. Now the oil and gas work, it's quite seasonal, and they do a lot of work in the winter, and they do work in the late summer, so sort of when it's dry and stable or frozen and stable. And so probably 40% or more is late summer, 40% or slightly more in the winter. So you're going to see -- we'll see quite high margins, and they would be in the teens or even upper teens in those seasonal periods, with lower margins in the spring and fall, when things are soggy or where you'd sink in, and so the work is much less so with respect to field activities. So but on an aggregate basis, with respect to the oil and gas work, and not just Parkland, I would say overall, we'd put it more in the low teens, low to mid-teens. But there is a seasonal aspect of it because of the revenue flow in the winter and then these late summer months.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

Got it. And just specific to Parkland. Can you just give us a sense of how much of that business would be more design-like versus construction-like? I think it sounds like there's more of a construction component here. And if that's the case, can you just talk about how that fits in, what is traditionally -- well, you avoided a lot of that in the Tetra Tech strategy -- and how you got comfortable with that?

Dan L. Batrack

Yes, I can, and let's go to the first part. Most of it is construction, sort of 20% design up front, another type of work in planning and prep work, and 80% construction. So they are much, much more predominantly the back end of the construction, and that's why it's going into our RCM group. Now how we got comfortable with it. In the United States, in the lower 48, in order to do pipeline work to -- we brought in Rooney, which is design. A lot of the work performed in the U.S. is the design, which then gives us access to permitting, environmental clearance, right of way assessment, and it brings in all the other services and leverages all the work Tetra Tech does. So the goal is do something quite similar in Canada. But generally speaking, the work for the large midstream, where the piping firms are, you need to have the ability to do the design and the construction. They aren't hiring just a pure constructor or just the design. So for us to actually access an awful lot of work in some of these clients, we needed a back-end capability. So adding the back-end capability, Parkland, which is absolutely best-in-class, does have some front-end design capability, opens up access for Fransen, who joined us a couple years to get involved, and there's Rooney to get involved, in fact, for Tetra Tech to take turnkey bids on very large projects. So to get access to the environmental, the design, the right of way, the clearance. In Canada, we needed to have some more back-end capability.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

If you can afford me one more question, I want to just touch base on mining as well.

Dan L. Batrack

Yes.

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

You kind of mentioned that it softened a little bit since last year's growth rates. How do you get comfortable or what have you seen in the marketplace that makes you feel like it really is flat rather than it might go negative for you for the balance of the year?

Dan L. Batrack

Well, we have seen some areas, very specific metals, that have cost us to go negative. We've seen gold in Canada, it's a specific metal to be under pressure, so we've seen it go slightly negative. We've seen some other precious metals actually go negative on us. We've seen even some pressure on some of the energies, uranium. Pressure on the other side, though, we've seen strength in potash. And so while Canada and portions of U.S. for us have been under pressure, that have been flat, we've actually seen quite good strength out of Australia, Chile and Brazil. And so the iron has continued to be strength, in fact, building orders. Same is true with copper with Codelco in Chile. So we're -- actually, it's not just one single number, and we're not dependent on one move. So I'd say in an aggregate, we have some visibility that does look like it's flat. And if we see a macro uptick even a little bit, we could see this actually could move favorably on us. But we've got pretty fair visibility out the next quarter or 2 to see that it would -- to indicate that it would be flat for us.

Operator

Your next question comes from the line of Tahira from KeyBanc.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

It's actually Saagar on for Tahira. So first off, real quick on the -- on your second quarter guidance in terms of the range that you provided. What gets us to the bottom of the range? What gets us to the top of the range? What are the different parts that are part of that? And then along with that, you mentioned Parkland was closed on Monday. How much of Parkland is included in the guidance. And with that, what's included of Parkland in the backlog?

Dan L. Batrack

Well, in backlog that you see there -- I'll answer the questions from the back forward. In our Q2 backlog chart that we presented, not $1, not $0.01 is included from either AEG or Parkland, nothing. AEG was closed on the first day of Q2, so nothing was included. And obviously, Parkland, which was closed 3 days ago, was a month in to the second quarter, so nothing was included. So there is nothing in it that was essentially purely organic presentation. That's #1. As far as contributions from Parkland, and in fact, I'll say AEG, on a revenue basis for the year for both of them, and again, I'll mention that the Parkland has -- sort of we had 2 months of them here, what I'll call winter, so February and March, so it's a little bit more heavily weighted, and then late summer. But we expect probably $65 million to $70 million on a net revenue basis from Parkland for the year. And you can divide that up on a pro rata basis between late summer and this winter. So you can do that. AEG is a little bit more linear, with winter being slightly a slower part of their business, but around $50 million; so on a combined basis, $100 million, $110 million of net revenue for the entire year. Take the AEG, and you can do it on a relatively linear basis for 3 quarters, a little bit lighter on Q2 because of the winter, and then divide again Parkland on a winter, summer, if that's helpful. Now with respect to the earnings, AEG, because this is a slower period, we'll have essentially no contributions on an EPS for Q2. It's a slower period for them, and so their contribution of $0.01 to $0.02 will be backloaded, so Q3, Q4, as far as contributions, so really nothing for Q2. Almost nothing for Q3, and that will show up mostly late Q3 and Q4. Parkland is sort of divided between the contribution. And again, we're still finalizing this, so I do want to, one more time, add caution that we have not completed our purchase price accounting, but it would be divided up between this winter, quarter Q2 and Q4.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Okay, great. Great color. And then the last question related to your 2Q guidance, the top line. How do you get to the bottom -- or what gets you to the bottom range or the $500 million, and then what gets you to the top, the $550 million?

Dan L. Batrack

Yes, absolutely, and thank you for bringing me back to that. Really, it's the same 2 items. It's just depending on which way they swing for us. The bottom end would indicate a more accentuated delay at the federal level and also continued softness on mining, and maybe some other economic areas that would represent softness on the commercial side, that would represent our performance at the lower end. And conversely, if we actually saw some type of clearance or some type of opening up on the federal work and rebounding on mining, there are a number proposals out there and many things that are pending moving forward. So if we actually saw those open up on mining and if we saw oil and gas just continue as it is, that would move us to the top end. In fact, it could move us through the top end.

Operator

Your next question comes from the line of John Rogers with D.A. Davidson.

John B. Rogers - D.A. Davidson & Co., Research Division

I just want to follow up a little more on the pipeline business and how you expect to position yourself in that market over the next couple of years. I guess to start, how big a project now can you go after from a whole EPC point of view? Is that the strategy? And also in the U.S., would you have to spread to put the work down here?

Dan L. Batrack

Well, first of all, let me start with Canada because we do look at them slightly different. In Canada, they take them on a design-build or an EPCM or even an EPC. So they do take them on more of a turnkey basis in Canada. So I would say the type of project we could take on would be a $200 million project we'd be quite comfortable. And the typical burn rate on that project would be roughly about a year. So they move quite quickly, 12 months, certainly not more than 18 months. So these are not $200 million projects ago many, many years, so that's spread out. We're not going after the very large main trunk lines. We're going after the small to midsized, typically a 20- to 36-inch diameter delivery system. Now whether or not it's a very large diameter or a small diameter, the other systems that we're going to bring in, the other services, which is engineering, which is right of way clearance, which is the environmental permitting, which is dealing in Canada with the first nations, all of that type of work we can do across the board. And we expect those project will be smaller and much broader, but the actual turnkey projects in Canada are probably $200 million. It could be slightly larger, and I would expect that we should be able to pursue those here in 2013. In the United States, most of the work that we're doing is actually on the design side environmental permitting, clearance, wetland mitigation areas, where we have touched on points for you across the environmentally sensitive areas. These projects typically will be mostly design, permitting and construction management or oversight of the owner's engineer for 2013. I don't actually expect in the U.S. our role to move to EPC or turnkey or design-build here in 2013. Now it's possible, it could happen. We are exploring that, but that's generally not the model that we've seen as much here. And so that's why we focused on our professional services, environmental work, permitting and other professional services work. So I think the average size project will be slightly smaller in the U.S.

John B. Rogers - D.A. Davidson & Co., Research Division

Okay, that helps. I just wanted to understand the strategy there a little bit. And in terms of acquisition, your pipeline, I mean, it sounds like you may look for something more in the pipeline construction business in the U.S. But what about kind of the rest of your markets, how does the pipeline for potential acquisitions look not only U.S. but Australia, Brazil?

Dan L. Batrack

Yes, the number of opportunities out there is really quite -- it's quite strong. As you've seen, these acquisitions of AEG, about $100 million a year on revenue, Parkland at roughly $140 million a year, these are nice signs for us. On a combined basis, they actually do move the needle and meet our requirements for half of our growth coming from acquisitions. As Steve had mentioned in his remarks earlier, I do want to state again, so it's really clear, we -- with both of these acquisitions, and we can still do a few more, and just the cash from operations will pay it all off. So as far as the ability and dry powder, if you want to refer to it, or access to capital, it's not an issue. We could do what we just did 2, 3, 4 more times this year and still be very comfortable within the limits we have. Now the areas we're looking at in Canada, I would like more design capability in the oil sands, we want more plant engineering work, we want more water treatment, water processes, waste on the water and environmental side, more restoration work and more pipeline work because there is a huge deficit of pipelines to transport both the oil and gas in Canada both to the U.S. or out to the West Coast to ship. So that's what we'd be looking for in Canada. In the United States, more oil and gas on the design side. Again, midstream is what we're going to be focused on. There are some niche areas for cleanup of mine tailings, wastes, that continues to be strong. We are going to expand in Brazil. As I've mentioned before, we now have with ASA last quarter, a very small coastal engineering firm, look for us to expand there. So we've got 300, 400 people down in Brazil. I'd like to take that and increase it, maybe double that number here this fiscal year, into the environmental areas and again, more mining and oil and gas. Again, for who, for Petrobras, for Vale, for the very largest multinationals in Brazil. In Australia, we continue to be interested in it. And as price points come into the areas that we feel are reasonable, we'll remain disciplined. But when the right opportunities come, we'll move there. I'd say more likely, Canada, oil and gas; U.S., oil and gas and commercial; and then Brazil, commercial with primarily oil and gas and mining.

John B. Rogers - D.A. Davidson & Co., Research Division

Okay. And sorry, one other, if I could. State and local government was -- grew relatively significantly in the quarter. Is that all organic and -- I mean, are we finally seeing states sort of suspend again or just [indiscernible]?

Dan L. Batrack

Well, this is all organic. It's all organic. And in fact, the state and local work has been all organic for -- organic all the way down and organic all the way back up here. We are back to 13%. It's primarily being driven by 2 or 3 larger infrastructure projects we have on the East Coast. And that's why I've been cautious to say that this is a rebounding high-growth area. But I will say that even if you take out these single large projects, we still saw growth. And it's very broad-based at the municipal level for wastewater treatment plants, water supply side. And so we are seeing orders booking up really across the country. We're primarily in Tier 2 cities, the cities between 100,000 and 500,000 in population, and the tax receipts have actually strengthened, and we've seen that really underpin orders growth in that area. Now I'm not yet willing to translate that into that being a big growth area, but I don't feel at risk in that area at this time.

Operator

Your next question comes from the line of Noelle Dilts with Stifel, Nicolaus.

Steven Folse - Stifel, Nicolaus & Co., Inc., Research Division

This is actually Steven on for Noelle. I have a question about -- could you talk a little bit more about margin weakness in ECS? I know that some of that synergies with the federal spending coming down and a little bit of weakness in mining, but I think there's also some severance charges in there. Could you maybe give a little bit direction or quantify the impact during the quarter from that?

Dan L. Batrack

Yes, absolutely, Steven. We did see federal weakness. Primarily, it was concentrated in our ECS group. So more of the discretionary programs that we have at the federal level, whether it's energy efficiency studies or even research work we do for EPA, a lot of that was impacted in the ECS group. And so we did move quickly to make sure we're right-sized or that we have the right number of staff for the projects we have, so we did do reductions. Mining, we were very aggressively growing and staffing up as we were growing at a double-digit level, and we watched it flatten out. And because of the timing of mining projects, we actually adjusted staff, which is we laid staff off. And we did take severance costs. We did take downsizing costs associated with giving their computers to other people and all the rest of that. I don't -- I wouldn't classify that as restructuring, but overall, it was just cost of keeping our business at the right size. And I would say, during the first quarter, it impacted us maybe 100 basis points, so about 1%. So it was -- and by the way, we're going to continue to be very quick and very fast in making the adjustments based on the workloads that our clients have. And that's why I indicated that I expect ECS margins to stay at a lower level as we take these charges and these adjustments here through the second quarter and maybe even into the third quarter. And where I came with the third quarter is when I see the budget actually open up and the workload begin to flow better both through the federal and perhaps mining, then I'll expect that to rebound right up to its historical levels.

Steven Folse - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And then do you think that in some of these actions you say there could be a little bit of weakness through 2Q, maybe into 3Q. I think that there'll be material savings over maybe 4Q or into 2014?

Dan L. Batrack

Well, I think it's going to bounce back. I think what will happen is that we'll keep it right-sized. But as the revenues increase and come back from some of these clients, we're going to bring staff back on, which will give us leverage in the back office, which will bring the margins back up. And so especially with the mining, as that becomes commercial work, increases its percentage, that will drive the margins back up. So I think that we'll go from 8%, we could even test the lower end of 8% this next quarter, but I think we'll move back to historical 11% to 12% here. I expect that perhaps late Q3, so I don't think we'll fully be back in Q3, but I do expect Q4 and into '14 to be right back to those levels.

Operator

Your next question comes from the line of David Rose with Wedbush Securities.

David L. Rose - Wedbush Securities Inc., Research Division

Just a quick follow-up to another question I had earlier. On the USAID awards, I mean, you just announced these 2 combined awards that are pretty significant. And I'm just wondering about the timing of this, is this something that was the awards were provided to you just in the last week or is this something that happened just after this early January to get sort of a sense of what the State Department is doing in terms of releasing awards?

Dan L. Batrack

What's interesting is these are -- if you take a look at our press release -- well, let me come to the first part. These are awards that we were notified here in January, when we signed it, just received approval, that's why we just released it here yesterday. So these are very recent awards. But if you did take a look at the backlog page from the presentation, what's noteworthy, they are very good contract vehicles. They do allow us to continue doing work for USAID in developing countries and priority areas around the world. However, I do want to differentiate an award of a contract versus release of funding. And so for instance, the U.S. Agency's USAID Clean Energy contract does have a ceiling of $350 million, but they did not issue individual task orders for it yet. And I actually expect that to begin flowing here later in the second and third quarter. We have not seen -- I will say that USAID, we've not seen any material disruption in the funding or levels. You can see that in the test margins. They continue these priority programs very much, as we anticipated, continue to move forward, and this gives us just more contract capacity to move forward. So I expect more wins to come out of USAID. But they haven't yet translated this material increase in our contract capacity to increase in the revenue. I think that's still yet to come in Q3 and toward the end of the year once the budget gets cleared up.

Operator

Your next question comes from the line of Jim Giannakouros, and that's with Oppenheimer.

James Giannakouros - Oppenheimer & Co. Inc., Research Division

Can you just give us a little bit more color on the seasonality that we should be expecting from -- I guess Parkland is the one that should swing most dramatically from 2Q to 3Q, and just thinking how things progress. And then also just given your comments on the profitability, given the different revenue levels, does it swing to a breakeven in the slow quarters, or is it still a profitable entity, let's say, in 3Q -- of your 3Q?

Dan L. Batrack

Well, Parkland, first of all, I hope they're on the phone here because we're just so glad to have them onboard. Really, we see them as the best-in-class in Alberta for the midstream pipeline. Now from -- let's forget about accounting impact and just talk about their business just for a moment. From a cash basis or from a project basis, they're quite profitable in the winter and summer. I would say that 40% to 45% of the work is done in the winter and a similar number in the summer, and 5% to 10% is done in the spring, and 5% to 10% in the fall. So now they are in and of themselves very adept -- and they fit actually quite well this way -- very adept at adjusting their costs associated with the volume of work. So if you took a look at them on their own, they would actually be profitable, very profitable, during the winter and summer, and they're breakeven or slightly profitable in the spring and fall. The difficulty, though, when we introduced the accountants to our world is that they have intangible amortization or they actually are going to take charges on a more even basis on a quarterly. So where you have high profit in a Q2, and in fact, just Q2 but kind of the winter months, in Q4, mostly summer, we're going to find that they're going to contribute on a GAAP EPS basis. However, on the spring and fall, so maybe sort of Q3-ish and maybe Q1, we'll actually find for the first period, for the first year or 2, as intangible amortization is quite high, they will actually be dilutive on those quarters because of the still very high intangible amortization during those quarters. So the contribution in -- roughly, and it's not precisely Q2, these months we're in now, but the winter and summer, will actually be quite nice, while the intangibles are still very high. And Q3 and Q1, generally speaking, will actually be probably dilutive on a GAAP basis. But when you consolidate it on an annual, it is accretive on a GAAP basis on the first 12 months or the first annual period. So this is a little bit of detail, but I do want to point out again, that business that you and I would run without accounting charges for this amortization, they are making money both in the summer, the winter, the fall and the spring.

James Giannakouros - Oppenheimer & Co. Inc., Research Division

That's helpful. And now with RCM having -- you're including Parkland and some other entities, could you just remind us, I guess, the breakout, I guess, high level by end market knowing that, obviously, RCM, you're growing more into higher-margin oil and gas, how should we be thinking about the RCM business just from an end-market perspective?

Dan L. Batrack

Well, they are moving significantly more on the commercial side. And it is increasing. That's what's driving, it is most definitely the client mix or the end client mix. This is the first international revenue that we'll have for RCM. So and prior to this current quarter, international, meaning outside the U.S., RCM would be 0. And so this is the first move internationally, known as the international oil and gas. And it's, again, double digit, and they're now -- they've really almost turned this upside down. They've gone from a very large percent government to 60% to 70% commercial. That's what's driving this material change in the margins and which will bring them on par. I think perhaps even in these high season periods, where some construction takes place, they could actually be the highest margin in the company because of these end markets. So that's really how they transform 60% to 70% commercial loan.

Operator

Our final question comes from the line of Michael Legg with Roth Capital.

Michael Frederick Legg - Roth Capital Partners, LLC, Research Division

Could you comment a little bit about the duration of the backlog from a commercial and international, a little bit more detail, maybe you can give us the average time in months first, the federal piece, and what percentage it is in backlog?

Dan L. Batrack

Yes, absolutely. Commercial -- well, first of all, our commercial backlog, relatively speaking, now represents more than half of our overall backlog. That is an amazing statement for us here at the company, so more than half because even though federal had -- historically had over the past years trended to be much less than 50%, then less than 40%, and now down to 30%, still the size and duration of the federal work had carried a big portion of our backlog. But now it's less than half. So commercial is more than half with respect to the overall magnitude of the composition. Now as far as duration goes, the front-end work, which is the ECS and test work within -- with our commercial work, is very quick. I'd say the average task order or project is 3 to 4 months, so it turns over quite quickly, 3x to 4x. Again, as I've mentioned, almost a book-and-burn business. The size of the project, the duration, is quite similar to a government project. It's just that it gets funded in much smaller pieces, so you don't see it. I will say that the construction work that's commercial is a bit longer, and it may be 9 to 12 months, something like that, but I say our overall characterization of our backlog, how long it expends, still is probably 70% to 80% within the next 12 months, with the remainder of the backlog being finished up within the following 6 months. So all of the projects we have that are in our backlog will be burned essentially in entirety within the next 18 months or less, with the most of it well within the next year. So this is not a backlog that is spread out over 2, 3, 4 years. This is all near-term funding. And that's why we have pretty good visibility. And I'll also point out that Tetra Tech has historically had both EPS ranges for our guidance and revenue that are amazingly more narrow than you see from others. And the reason is this backlog funds our next quarters, so we have very high visibility.

Michael Frederick Legg - Roth Capital Partners, LLC, Research Division

Okay. And then you mentioned in the Oil and Gas business that we've seen a decline from double-digit growth down to basically flat revenue now. Can you give us a little comment on the outlook for that business?

Dan L. Batrack

Yes, I actually did not say that. If I did say it, I misspoke. Let me clarify, that's mining, not oil and gas. Yes, mining, we saw it go from double digit or better to -- in 2012, we saw it flatten out. We saw that the large EPC or the large capital expenditure projects within the mining has very -- with the world's largest mining companies, the BHPs, the Rio Tintos, the world's largest, put their CapEx projects on hold last spring and summer. Those that focus on network watch there not only go flat but go quite negative, that's not our business. Our business is primarily the front-end exploratory work, the front-end support of their overall portfolio. So we didn't see impact. We sort of ran 1 to 2 quarters behind everyone else, and so we saw a much later impact of the slowdown in the mining and much shallower. That brought us from double-digit growth to sort of in the early fall, sort of September, October, we saw it drop to sort of single-digit growth, and now we've seen it flat. And that's mining, and that's been primarily because of the slowdown across most mining sectors although I did give some details here a bit earlier as to which ones were seeing strength versus a bit more weakness. But overall, with our visibility, I think we see out the next few quarters as to a flat business. It could turn off though if we see some of these large miners actually put their projects back online.

Operator

This will conclude the question-and-answer session. I will now turn the conference back over to Dan Batrack to conclude.

Dan L. Batrack

Well, first of all, I want to thank everyone of you for your questions and interest in Tetra Tech. As has always been the case, you show your insight and understanding of our business quite well. I do think -- I do feel quite good with the business and do want to state openly here the change in our backlog was not unexpected or surprised, and actually, the quarter came out quite as expected. I'm very happy with the acquisitions. And I do want to point out we're sitting here at the end of the first quarter of a 4-quarter year and moved up our guidance already. We still have 3 more quarters to go this year, and I'm expecting strong performance as we move forward. And we'll provide you updates next quarter on both how our acquisitions faired, contributing to the company, and how our base business is progressing. And I look forward to speaking with you all again next quarter, and have a great day. Bye.

Operator

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

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