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Tetra Tech (NASDAQ:TTEK)

F1Q09 Earnings Call

January 29, 2009 11:00 am ET

Executives

Dan Batrack - Chairman and Chief Executive Officer

David King - Chief Financial Officer

Analysts

John Quealy -Canaccord Adams

Debra Coy - Janney

Michael Cox - Piper Jaffray

Corey Greendale - First Analysis

Alan Robinson – Royal Bank of Canada

Richard Padgett - Morgan Joseph

Jeff Beach - Stifel Nicholas

John Rodgers - D.A. Davidson

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 then we will 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 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’s 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 up the conference for questions and answers after the presentation. With that, I would now like to turn the call over to Dan Batrack. Please go ahead Mr. Batrack.

Dan Batrack

Thank you very much and good morning and welcome to our Fiscal Year 2009 First Quarter Earnings Release Conference Call. I am very happy to present our financial results for what was perhaps our strongest first quarter ever certainly on our financial metric basis. While David King, our Chief Financial Officer will present the specifics of our financials.

I will start with a brief overview of some of our key financial metrics of the first quarter. For the first quarter, our total revenue was up about 36% or $168 million over the first quarter of 2008. Our net revenue was up approximately 19%, which represents an addition of more than 250 full time staff than we had here at Tetra Tech a year ago in Q1.

Most of our net revenue is driven by our labor. Our operating income was up more than 25%. And not only was the operating income up 25%, but our margin was up about 0.5 basis point over last year. So, our margins increased with the resulting operating margin of 8.7% for the quarter.

On a percentage basis, our backlog grew at the fastest pace of all. With our backlog growing at slightly above 36% from the same quarter last year and up sequentially about $120 million higher than what we had at the end of the previous quarter.

In the first quarter, we substantially grew both our federal and commercial projects in revenue. Our federal work grew with an extraordinary strength from two primary areas. First was, the Army core of engineers and that was primarily base realignment and closure and contacts and the second was United States Agency for International Development, we saw particular strength there, but those weren't the only major contributors from our federal clients.

We also saw strength with all of the federal clients that we worked with that include on environmental programs, with the Environmental Protection Agency, at the Department of Defense; we saw strength in the Air Force, Navy, Army and Missile Defense Agency and support work we are doing for the Department of Energy and the Federal Aviation Administration was also stronger in the quarter.

The biggest growth on a percentage basis was in our commercial sector. This rapid growth was driven by work in our core service areas of water, energy and environmental remediation work.

This past quarter, we not only completed the installation of more than 200 wind turbines that we actually took them to mechanical completion and turned them over to our clients, but we also began field work under larger sediment remediation program in the United States.

Our Fox River Program that we announced here this past quarter, which is located up in Green Bay, Wisconsin. It is a very large water mediation program. While we saw the strength in both the federal and commercial areas, at the State and local level we continued to see overall weakness.

While we continue to work on essential water programs at the States and cities and that funding looked very strong, we did see further slowdown in our local schools and transportation projects.

If you are following along on our webcast, if you look at our chart on page 4, you will see that our federal government continues to be the largest part of our revenues, currently representing 43% of our revenues. We expect this to continue to grow in the future quarters.

For the past 10 years, we have been reporting our financials in three segments. The three segments have been resource management, infrastructure and communications. As our communication segment has shrunk to less than 5% of our revenues for the past several quarters, for practical purposes, we are only reporting two segments resource management and infrastructure.

Starting this quarter, we will be reporting four segments that reflect how we manage our business. These four segments represent the entire project lifecycle, starting with the front-end studies and research work that Tetra Tech had begun with at its very origins and ending with larger mediation projects and construction management work.

It is this type of projects execution, which is now reflected in our segmentation that is a differentiator for Tetra Tech. We start with science and we can stay with the client and the project all the way through completion.

This is how we run our business and it is going to provide much more visibility into the performance of each of the four segments. As I mentioned, at the outset of our call, our backlog was up significantly.

A direct result of our booking more than $750 million in orders for the quarter, this is the largest quarter of new bookings or new orders that we have ever had in the history of the Company.

Left me point out, again if you are following on our webcast that 10 of our top 12 largest contract awards for the quarter who were at long-term federal customer base. These awards not only increased our funded and authorized work, this reflected directly in our backlog, but also significantly increased our contract capacity with our federal clients.

Our largest contract for the quarter was with the United States Air Force and it is a worldwide environmental remediation contract. We have been an [inaudible] on this contract, it is a very large vehicle that allows us to provide full support services worldwide for the Air Force.

This allows us to provide all of the services in that we offer in Tetra Tech for all of these business segments. The second largest contract award we had during the quarter was the Army core of Engineers long, long time client, but this is a new contract for us and gives us new geographic access, it is the Transatlantic Command Contract. It allows us to provide architectural and engineering work.

It is a new contract for us and this is going to allow us to do work for the core of engineers in locations like Europe, Africa and the Middle-East and in fact we have just been awarded our very first task order here in the last few weeks, so we think this is great new growth area for us and we are very excited about it.

We continue to grow our backlog sequentially now for the last eight quarters, for two years consecutively. And certainly on these calls we have made it clear that we don't expect every single quarter consecutively for this to go up. The consecutive run of eight quarters has taken our backlog to an all-time high of $1.769 billion, just impressive.

Our backlog comes from all of our different clients though, they all fund at different times during the year and their funding cycles can cause some incremental jumps or variances, but what I look for in the backlog is an overall upward trend just like what you see in the graph on our webcast that has been trending up for the past several years.

Although, I will note that we are not looking at any one quarter. We certainly could have a quarter where it is flat or even declining because of timing of an individual project, but I will repeat, long-term trend is what we are looking at. I will also note that, and I think this is very important to watch us very carefully that we added backlog in each and every one of our four business segments.

We are making sure that they are all contributing; we are seeing strength across the entire operation. With that, I would like to turn the presentation over to David King to talk and present the details of some of our financials.

David King

Thank you, Dan. Before I get into quarterly financials let me spend a minute or two on new segmentation, why and how we did it. Tetra Tech started to report three segments resource management, infrastructure and communications in the late 90s, when the company was about $0.5 billion dollars in revenue.

Today, we are a two plus billion dollar company with a very different business profile and management structure. First, as Dan indicated, communication has become a significant part of our portfolio. In fact, it has been less than 5% of our revenue for the past five years.

Second resource management has exceeded 60% of what we have done in the past five years ending 2008 at 69% of the revenue. As we continue to grow the composition of the business continue to change, so as our management and organizational structure. At the beginning of fiscal 2009 we made a change and started to report our four business segments as Dan indicated earlier.

We started our plans, we also indicated in our last year’s Form 10-K and more recently earlier this week actually we posted all of the changes and detail on our website and comparing and cross-working the old segments to the new segments before you. Bottom line, we would no longer report communication as segment is now part of the RCM repetition and construction management.

We also moved to operating units out of infrastructure to better reflect our infrastructure design business. Given this propositional large percentage of resource management we broke it into three segments to provide to you with a better visibility. Frankly this change of segmentation has taken us about two years of thinking and planning, we belief the new segment reflects how we manage our operations, how we serve our clients and how we execute our project. At the end of the day we believe the new segmentation provide you all with better disclosure and more transparency.

Now let me get into the quarterly financials. Q1, again as Dan reported an outstanding quarter for all financial metrics, revenue 36% to $639.7 million and net revenue grew 19% to $330 million. Substantially all growth came from organics.

In addition as Dan indicated we experienced growth from all new segments. Net revenue of $330 million was at the high-end of our guidance. Income from operations grew 26% to $28.6 million at 8.7% operating margin and this is relatively high margin for our first quarter’s performance for a long, long time. EBIDTA grew 26% to $34.1 million, EBIDTA margin is at 10.5%.

SG&A grew 6.5% to $35.7 million. We are simply bigger company today, as I mentioned in the prior quarters we continue to invest heavily in our bid and proposal efforts. In the mean time our G&A cost structures are reaping the benefit of scale continues to increase at a much lower rate than our top line. Net interest grew 39% to 900,000, partially due to the lower interest yield on cash and higher borrowing to fund growth and acquisition.

Tax grew 24.5% to $11.4 million of higher earnings, our annual effective tax rate about 41.1% for fiscal 2009. I want to point out that our tax rate has been moving toward, about 41% from about 42% a couple of years ago as we continue to streamline and integrate our operating structure. Diluted EPS grew 24% to $0.27. Our guidance was $0.25 to $0.27.

Our balance sheets, accounts receivable and accounts payable grew about 37% respectively. They are in line with our revenue growth. Net debt ended this quarter was roughly $44 million as the result of business growth in a small acquisition. I also want to note in the 2008 quarter it was a large acquisition ARD was in the number of $60 million. Cash flow from operations at about $28 million used cash, as you know we typically use cash in our first quarters and as I mentioned we are bigger company and we funded higher bonus in 401(k) plan contribution in Q1.

I expect our cash flow from operation to be $60 million to $70 million for the fiscal 2009 with Wardrop contribution. In our Q2, I expect that to be $15 million to $20 million. CapEx $3.2 million is low for the quarter due to timing of purchase. For the full-year with Wardrop acquisition I expect the CapEx to be $22 million to $25 million.

DSO improved over two days, as a result of a strong collection and that we also benefit, almost half our clients are federal clients. As I mentioned last quarter, I expect DSO even with that profile to be a couple days higher for the year given the current market conditions.

On net debt trends; we ended Q1 as I mentioned at $43.8 million with debt and equity ratio of about 13.8%. With Wardrop acquisition, I expect Q2 to be about $110 million to $120 million in net debt and debt equity ratio of roughly at 30%. At the end of the year, I expect the number to be half of that, to be about $50 million to $60 million and we will be debt free in late fiscal ‘10, we’ll pay them off.

With that, I’d now turn to Dan, to address our first major international acquisition Wardrop Engineering.

Dan Batrack

Thank you very much David. I’d like to continue by presenting, as David just indicated our newest acquisition. While we are always looking for the right acquisition in our core market areas, areas like water, energy or infrastructure. Over these past years we’ve been particularly focused on identifying an international acquisition and we’ve been looking in three countries in areas specially. We have been looking in Australia, the United Kingdom or Canada. Those are the areas we’ve really been spending a lot of time.

We believe these locations provide us the greatest opportunities to expand our services to growth markets while minimizing our cultural, language and integration risks. So, we are looking for high growth area with low risk to the Company’s, we took next step. I’m very pleased to announce that as of yesterday our Wardrop Engineering has joined Tetra Tech and we’re just very happy to have them on board.

I’d like to say few words about them. First of all, Wardrop is the Canadian-based consulting and engineering company. They’ve been in existence for over 50 years. They have approximately 1200 staff and generated a $120 US million in revenue in fiscal year 2008 and their fiscal year matches up with Tetra Tech. So, we’re seeing that with respect to how they’ve been managing their financials.

Their company was founded on water resources, very similar to that of Tetra Tech and those are expanded by its original founder [Len] Wardrop, focused on water resources. Its one of the Canada’s leading consulting and engineering firms focused now, today on natural resource management and energy and infrastructure. All of that sounds just like Tetra Tech and we’ve spent last several months with them and they are just like Tetra Tech.

I’d also like to say one more thing about them having had an opportunity to spend several months going through this process and I really like their management team. Their culture and this was very important to Tetra Tech. To find a company whose culture is very similar to ours and the Tetra Tech Wardrop culture match up very well.

We’re looking forward to moving out aggressively in new opportunities together. I tell you our teams, well its only been one day are often running with opportunities introducing the best technical resources and folks we have to our client’s right out of the gates. So, this is just great addition for Tetra Tech and really fulfilled one of our strategic steps that we’ve been focusing on for the past couple of years.

I’d like to share with you our perspectives of the markets and what we see for the rest of the year at Tetra Tech. First and foremost even in today’s economic environment, we see our revenues in the federal market growing at a rate of slightly greater than 5%. If you’re following along on the webcast these number that we have in both as a target revenue apportionment for the company and the growth rates indicate what we expect to see for the remainder of the year, so for second, third and fourth quarters.

Our first quarter, we’ve just reported those numbers. This is looking out to the remainder of the year. So, our federal government revenues we expect to see to grow at something slightly above 5%. As I had indicated earlier we see two primary drivers. The first, Base Realignment and Closure and that will come primarily through the Army Corps of Engineers, we have the largest contract capacities.

We expect that this work will continue to be driven by preparation for returning soldiers and the cleaning of old bases, those are the primary drivers and we see this with a lot of clarities we go into the rest of the year. The second federal area that we are seeing strength and we see it continuing and even growing as with the United States Agency For International Development, we call it USAID, but if the agency for international development. It’s a department within the State department and we see the United States continue emphasis and we frankly we see growth in this area with the new administration of development as a key part of our foreign policy and so as that receives more and more attention we expect to see this become larger and larger for ourselves

With the work we have in backlog, we see our commercial sector work growing at a rate of about 5% to 10% between here and the end of the year. We see that this be driven primarily by large wind projects, sediment remediation and I talked about Fox River, we have other small ones that we are working and funded, and these are funded pre-funded projects for Brownsville soil and ground water remediation programs, because these types of projects that are going to make up a significant portion of the work that we need to drive our commercial growth for the remainder of the year and I make this clear, most of this is in backlog already. So, these growth numbers are pretty well set with the funding that we have between now and the end of the fiscal year.

As I mentioned earlier, we are seeing softness in our state local outwork and it’s not really in the water programs we have it is primarily in the schools and transportation projects that we have underway. We expect to see a likely reduction in our state and local work of maybe 5% to 10% from the current level we are at today.

Let me walk through this to make sure I’m being clear on this point. Today about 15% of our revenues come from our state and local clients. If you took the upper end of that reduction, if in fact we realize that a 10%, that is 10% of the 15% revenue of the company. So, 10% of 15% would be 1.5% if we recognized a 10% reduction, we’d see state and local revenues potentially representation go down in representation from 15% to 13.5%. So it is about 1% impact.

The reason I wanted to walk through that with a bit more details is it is a very small part of our business. Not only is that a small part of our overall revenues, it also has been the lowest margin over the past year or two. So, in fact the impact on our earnings it is even less than its representation on a revenue basis.

Our international growth; international growths will more than double for the remainder of the fiscal year and that is attributable almost exclusively to the addition of Wardrop to Tetra Tech this quarter and so these numbers are inclusive of Wardrop within Tetra Tech. With that insight and perspective into the economy and where we expect our revenue and income drivers to be, I’d like to present our updated guidance for the second quarter and for all of fiscal year 2009.

Now, this guidance I am going to go over briefly includes the contributions from Wardrop, the new acquisition, but it does not include any special funding from a stimulus package if in fact that comes to past and it does not include any contribution from future acquisitions that in fact we haven’t already closed, Wardrop being an example.

The guidance for the second quarter or net revenue is $315 million to $335 million as a range. Typically it had a range of about $20 million, which we can see here and our diluted earnings per share at the range of $0.24 to $0.26. For the year, for the entire fiscal year of 2009 our guidance for revenue net of sub-contractor cost is $1.35 billion to $1.45 billion. Let me note that if you compared to our previous guidance that we came into the year with this is an increase in revenues by $75 million both on the bottom and top side, we moved up that number.

For earnings per share for the entire year, we have narrowed it and in fact we’ve raised the lower end raised the lower end of our guidance from a $1.10 to $1.12 with the range of a $1.12 to a $1.18 for the year. Just to note as I said, it does include contributions from Wardrop. It will not be an entire fiscal year. They’ve just joined us as I’d mentioned yesterday. So, we’ll have two full quarters and approximately two-thirds of the second quarter.

This, earnings per share does include $0.09 of intangible amortization. So when you take a looking at the earnings that are actually being generated by the corporation, the EPS reported out who’s $0.09 of intangible amortization, which is a non-cash charge that we incur as part of the accounting for some of these expenses. David has already covered the effective tax rate of 41.1% tax rate and David, congratulations it’s moving down. So, we are moving in the right direction.

With that I’d like to move onto another topic here that is really ahead liner. The number one news item on the front page of every newspaper is the economy and the stimulus package. Now, as of yesterday the house version has passed, but we don’t know what the final funding will be until it’s passed by both houses and signed by the President. What we do know is that both the House and the Senate versions, propose funding areas that intersect with the services we provide and the contracts we hold. That we do go.

We’ve identified four major areas in both versions of the stimulus package, for the proposed funding that are directly associated with the work we do. The first area is water programs and no doubt Tetra Tech is a water company and that’s the largest strength that we have. So we’ve identified water programs, second its EPA in the United States Department of Energy programs for support for them. Third is alternative energy and grid upgrading, so our energy practice fits very well there and the fourth area is -- we can’t sure call it others, but it catches the Department of Defense Environmental Cleanup and Building Energy Efficiency upgrade programs.

Now, those four from our perspective, those four are areas that we can provide. From our perspective, the firms that will be most successful capturing this work and executing initially are the ones it have contracts in place today to provide these services. It’s the only way to which can see, that the federal government is going to be able to move this funding into the economy fast. If you’re not a contract holder, certainly it’s possible to become one, but that’s a lengthy process.

The Tetra Tech has, if you following along at our webcast which should list some of the contracts here in each of these four areas. Tetra Tech has more than $8 billion in contract capacity that were already awarded competitively to us from our key customers and that’s mostly federal and they are the clients and the customers that are going to be responsible forgetting this work done in the stimulus packages.

We have our Project Managers out in the field right now, actively identifying projects with our Counterparts at the federal government and other clients, where can start working immediately and putting people to work and is no doubt the underlying focus on this is an economic stimulus package put people to work. We’ve got people ready, we have additional capacity, we can ramp up substantially and if they would like want to fill it all up we are here ready for it.

Alright, in summary this past quarter is interesting and some folks would say the economy is slowing; maybe it’s going to be slow time, that’s not what we’ve seen. We have seen this be one of the busiest we’ve ever had. We successfully grew the company at 36% from the prior year. We completed our first major international acquisition and we increased our staff to more than 10,000 for the first time the ever and I’ll tell you these are all contributing members of Tetra Tech, so we feel great about that.

We’ve organized our reporting segments to provide more transparency for more than just that. This structuring has allowed us to be prepared for further growth. This is how we run our business and this is how we’re going to manage it and it will help facility future growth as we go forward. With our current outlook on the markets, we were able to raise our revenue guidance and narrow our earnings per share guidance, raising the lower end and finally as I just went over, if a stimulus package comes to position, we’re well positioned and ready to move quickly on it.

With that, I’d like to open up the call to questions. Dennis.

Question-and-Answer Session

Operator

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

John Quealy -Canaccord Adams

Just a couple things on the deal, did you disclose price on that or price metrics? Was it in range with standard E and C multiples?

Dan Batrack

John we did not disclose the terms of the acquisition and for competitive purposes we would elect not to do that, but I would indicate that it is inline with the multiples that we have paid for other acquisitions.

John Quealy -Canaccord Adams

In terms of backlog, what show you look for in Q2? What was the relative contribution from this business?

Dan Batrack

3 to 5 months.

John Quealy -Canaccord Adams

So, in dollars of 3 months to 5 months of business would be in backlog at anyone given time?

Dan Batrack

Let me backup. The backlog that we have is funded and authorized, the $1.7 plus billion. About 75% to 80% of that amount would be expended over the next 12 months and the remaining 20% to 25% would be expended over roughly the next six months. So, most all of the backlog would be expended or is slated for completion of the work in the next 18 months. Does that answer the question?

John Quealy -Canaccord Adams

It doesn’t actually, I should have been clear. I was asking about the acquisition, how much backlog would that add upon consolidation?

David King

I am sorry the backlog, because of the consulting and engineering aspect of the business they are mostly commercial in nature. It is a much shorter amount of contract duration and so typically three to four months of their annual revenues are in backlog. So, relative compared to Tetra Tech is a much smaller percentage.

John Quealy -Canaccord Adams

Okay and then just two more housekeeping questions on the acquisition. Was it primarily geography or business line that was attractive here?

Dan Batrack

Both, we looked a lot of companies and this is one that they hit it right. One of all the locations in the world, we were anxious to get located in it was Canada for some simple reasons like language, culture, time zone some practical things. Two great end markets and great clients. They have a lot of natural resource work. They do lots of work in the nuclear industry for the energy, which is a major component of their work. They provide a lot of water resource work and natural resource mining brings as lot of new mining client. So its clients, its technical service and its geography really hit all of the areas that we have hoped to add to the company.

John Quealy -Canaccord Adams

My last two questions; first on the cash flow, I’m sorry I missed it. Did you mention cash flow from operation expectations for fiscal ‘09?

David King

Yes.

John Quealy -Canaccord Adams

I will go back and look at that. Dan may be for you. If the stimulus does come to fruition, as if currently envisioned, do you think the margin profile of this work changes at all on the water and wastewater side or the stuff you have folks would be targeting or do you think it still keep this sort of 8.5 trending towards 9 EBIDTA margins across-the-board?

Dan Batrack

Thanks a question received frequently, quite often from our own staff. We’ve think the margins again remain similar to what we had before, because this $8 billion that I referred to and that in our slide presentations we’ve actually presented the detail of it. These are contracts where the fee or unit rates have already been negotiated and so these are contract terms, scope of work and rates have already been established on these for the most part. So, I would expect the margins to be similar to what you have seen before from us.

Operator

Your next question comes from of Debra Coy - Janney

Debra Coy - Janney

Dan just a step back and kind of looking at the growth outlook, it has been hard to judge things given crosscutting current in the economy and the other new stuff you are doing, but I guess I’m still having a hard time reconciling this kind of backlog growth. Then you ran through your rough growth expectations for the segments and if we add all those together it comes up to something like 6% to 7% growth. How do we reconcile that with 35% backlog growth?

Dan Batrack

I don’t want to say it’s simply from the newspaper, but it’s difficult to get up in the morning and listen to the financial abundance and the newspapers. It certainly, it seems that the negative sentiments out there from forecasters are probably, 5 to 1 from anybody who has the rosy outlook. Certainly our backlog is up, we feel good and with our clients we have great visibility primarily driven by our federal side.

I don’t want to say that we’ve are being cautious, but unless we have specific authorization to complete the work in a very short period of time, we are being judicious with respect to our forecast. They are longer term projects. We’ve had good success in getting work that goes out. So, some of the work is not as immediate, so it’s booked and execute in one or two quarters and so some of the work does go out to the end of this fiscal year and even into early fiscal year 2010.

Finally a lot of the work and the backlogs that we have are disproportionately weighted toward our federal work. In fact the composition of our backlog is about 60% from our federal clients. Now it represents sort of mid 40’s in revenue, but all the way up it just over 6 and the federal work, very low-risk, longer visibility, but in some instances a bit lower margin. So, for those reasons we’ve been judicious with respect to our guidance.

Debra Coy - Janney

Sure and certainly, I think everybody is cautious on the state and local and the even in the industrial economy and I guess it is the federal piece that isn’t making quite as much sense to me given the bookings that you’ve already done that you are still looking for only somewhere around 5% growth in that segment and I guess what you are saying is that a fair amount of the backlog is fairly backend loaded on the federal side? Or is it cut out over the full six quarters?

David King

That’s true; there is some other that’s a bit more back loaded. Although, I wouldn’t say particularly, but do let me mention one large moving piece for us on the federal side. We had a pretty fair amount of work both in fiscal year 2008 and even in the first quarter from work we were doing for the department of defense in Iraq and our forecast has been, if that is going to not only ramp down, but complete in totality. So, for instance, I’ll give you one example. Our unexpected ordinance program where we were supporting the Army Corps of Engineers, in fact has completed on December 31, both the work and the prospect for work under the current vehicles have all completed.

Now it has been a contributor of about $25 million per quarter on the total revenue basis and even with that going from 25 to zero, we are still forecasting a growth in our federal business. So, when you take it in context of these two moving pieces our underlying federal work is actually very, very strong, but we do have that one counter moving piece that’s tampered the overall growth in that.

Debra Coy - Janney

Okay, that is true. Then just on the ongoing mix, you said you do expect the federal government piece as a percentage of the total to continue to grow, but you also said that Wardrop is primarily commercial. How should we think about, I mean I guess that means Wardrop fits into the 5% to 10% growth profile that you outlined for commercial, is that how we should think about that and is pretty much the entire bulk of that the $100 million in that revenues go to the commercial side or is there a mix there?

David King

Actually we are going to classify it for in these quarterly investor calls. We were going to classify it under international and so the drivers for commercial are mostly going to be U.S. domestics. So, this would be projects like the Fox River, the remaining wind projects that we have that are in backlog and some of these other large property remediation projects we have and so you will see the international work going from these past quarters at 1%, maybe 2% up to more than 5% and so that’s were it will be reflected. Within that international work, their clients are primarily commercial within Canada and other multinationals.

Debra Coy – Janney

And kind of what sort of growth rate are they seeing or expecting to see over the next year or so?

David King

About 10%

Debra Coy – Janney

Okay. Last question we have been looking for and expecting a sizable international acquisition for a while. I am curious as to your thought on the acquisition outlook now. I mean at this it; is this big one you have been working on; is there more stuff in the pipeline? How are you thinking about your acquisition strategies for the rest of the year?

Dan Batrack

Well, I will start with the word more.

Debra Coy – Janney

Mike is not going to get a break?

Dan Batrack

No, in fact, we told him that the negotiating part was his easy part because he got to stay home for the most part and just work long hours, but he didn’t seem to work long hours, our M&A department.

First of all, Wardrop is a large acquisition for us at over a thousand technical staff, it’s big, but it’s not the only one. In fact we were looking for a firm that would serve as what we referred to as a platform acquisition that has the systems, the history, the maturity of this management team and systems, that would allow us to do additional tuck ins and additional expansion and a pen to that organization.

We believe that firms in Canada and in particular Wardrop specifically have presence in other overseas locations. For example they do have an office in the UK with a fair number of staff; in India. They have start-up project locations in many different locations around the world, including China and so we are looking at all of these locations that would be either from a tuck-in acquisition to even another platform acquisition in another area of the world.

So we are not done, but it has to be the right deal, at the right time, at the right price. So, if we find a firm that meets all those criteria’s like Wardrop did, we’ll take action again and there are opportunities out there.

Debra Coy – Janney

Alright thank you.

Operator

Your next question comes from Michael Cox - Piper Jaffray.

Michael Cox - Piper Jaffray

My first question is on the projections that you outlined for your end market customers. The state and local, it seems that the projection for your area of decline is a little bit less than you’ve seen in the last couple of quarters. I was wondering if you could give the factors that are leading to perhaps a little bit better outlook on that side.

Dan Batrack

Yes, I don’t necessarily call this a silver lining, but a lot of the projects that we have with schools and transportation have been put on hold, so that’s one reason. So the sort of the low hanging fruit from our client standpoint have been taken off the table, so there’s less to be taken down, but note we had two projects on a year-on-year comparison.

A communications project that we had a year ago was called Utopia. It was a fiber communication project for a number of municipalities in the State of Utah and that program has completely twilight for us and its over, it’s been completed. So, on a year-on-year comparison it is being gone, so sequentially there’s no more to go away.

We also have some city work in the State of New York, in fact in the city that we’ve seen the reduction and the reduction in that program. While there is still some of it, the material portion has already been recognized. So, we see the areas that are soft, are getting close to hitting bed rock. The other programs that we have that are primarily water driven are much less volatile with respect to funding or requirement to get the work done.

Michael Cox - Piper Jaffray

Okay and on the wind component of your business, I believe entering the fiscal year you had said it was $200 million in the backlog; can you give us an update as to where that stands today?

David King

We expended about half of that in the first quarter and so about $100 million of that was expended. That was really the single largest driver of that commercial growth in the first quarter and so we have about $100 million left that will expend over the remaining three quarter Q2, Q3 and Q4. Although I will note that the winter months of January, February and March is a lot less field work and so that wind work will be a bit more back loaded into Q3 and Q4 than in the second quarter.

Michael Cox - Piper Jaffray

Okay, that’s helpful. My last question on the cash flow statement, it looks like the provision for losses on contracts popped-up a bit in the quarter. Anything to read into there?

David King

Nothing abnormal. We just increased our disciple, looking our projects and receivables and take some food and actions.

Operator

Your next question comes from Corey Greendale - First Analysis.

Corey Greendale - First Analysis

By any chance could you give us some sense of how creative you expect the Wardrop acquisition to be a full-year basis, like looking out to fiscal 2010?

Dan Batrack

Well, we think on a full year basis for 2010 as an example, we expect it to be approximately $0.04 to $0.05 after intangible, amortization and interest expense. We expect it to be somewhat nominal here for 2009 because of it coming in later in the year. Normally, we see reduced profitability in the first few months as people join the company and certainly we had expenses associated with the acquisition. Many of those were capitalized, but certainly there are expenses of our own staff and others supporting the acquisition that represent expense that we otherwise wouldn’t have had.

Corey Greendale - First Analysis

I know those expenses are included in the $0.02 for this year, correct?

Dan Batrack

That’s correct.

Corey Greendale - First Analysis

Okay. Second question I had is how are you looking at the stimulus bill? Are you looking at this as kind of incremental to what you’ve gotten otherwise or are you looking at it as more re-enforcing your ability to take advantage of contracts that you were thinking you had a pretty good chance of getting a decent amount out of away.

Dan Batrack

Incremental, I see it is incremental. We see that many projects that would not move forward otherwise because of funding or prioritization, will in fact be mobilized by the clients and so see them as incrementally an addition to what we would otherwise compete for both in our forecast that we provided.

Corey Greendale - First Analysis

So, with that in mind and given the strong backlog growth, do you think that the guidance you’ve been giving of 7% to 8% organic growths that’s probably conservative and it should be above that now?

Dan Batrack

Well, in the last summer I certainly had some of my associates and competitors, peers saying that the stimulus was going to be in place in August and I had others saying it was going to happen before the end of the election and then we others say that certainly Bush would mobilize it prior to the inauguration and transfer and now we’re hearing perhaps President’s Day mid-February. Until it happens and I said this before, I would really want to stay away from speculation on the stimulus package.

I go back to the statement I made earlier; until it’s been passed by the House, the Senate and the President, it’s just not clear to what’s exactly, what contribution on incremental or any other basis it will be. So, I’m not trying to dodge the question, but anytime I would come out and say that we are being conservative and it should be a higher number on something that hasn’t past, I think it’s just very speculative and we’re trying to stay away from that.

Corey Greendale - First Analysis

Okay and then if I could just follow-up on some questions that Debra was asking before this. I understand conservative and based on just the general economic outlook. As I’m calculating it, the guidance, it looks like it calls for a pretty meaningful slowing in organic growth in the March quarter once you backed in Wardrop.

So, I’m getting like at the high-end of the guidance range, maybe 7% organic growth and I understand Iraq also, but I think that was already gone this quarter, so that shouldn’t be changing. So, is there anything in specific that you would point to that is slowing or is going away or is it just overall conservatism given the economic the state of affairs?

Dan Batrack

We don’t use the word conservative here; we think we’re judicious, but let me give you an example, the two that are moving, two of the bigger pieces. Number one, we touched on this on our earlier question, wind. We have a $200 million forecast for the year. We still believe that that is achievable, but half of that was in the first quarter and as I indicated earlier, the remaining $100 million will be mostly or more heavily weighted to Q3 and Q4. So, that would be one reason, why you’ll see a reduction in organic growth, so wind is a big one.

On Iraq I gave examples of the unexported ordinance and there is reconstruction work we’ve done there also that is slowing materially and essentially it is going to move to zero here. We believe in the latter quarters Q2 will be a major reduction.

So, those are two programs that are reducing in the 10’s of millions of dollars and that are what’s going to account for organic growth moving down to 7% or 8% as you indicated. So, those are two very specific examples.

Operator

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

Alan Robinson – Royal Bank of Canada

Correct me if I’m wrong, it doesn’t appear that you gained any new wind project orders this quarter, is that correct? And could you more broadly discuss the current landscape in terms of interest in new wind projects given the lower cost of oil and gas?

Dan Batrack

Well, let me answer the first question. Wind projects; if you look on our presentation on page six significant new wins, we did book approximately $20 million worth of new wind projects during the quarter. Now, I’ll acknowledge that’s not as nearly as larger of a number as we have in previous quarters, but we still did see new work come in for the quarter and so this still has some steady initial evaluation.

We are however seeing a substantial number of projects be pushed out. We’ve been told by our clients that they are not cancelled, but they are delayed. So, new projects we are seeing and the number of opportunities declined materially. We have been contacted by our clients and we are following very closely the production tax credits and certainly if that passes and is put in place, we expect that to have a material impact on the number of opportunities coming out, but certainly the number of opportunities for our clients are down, but we still are booking work.

Alan Robinson – Royal Bank of Canada

Okay, and then just a follow-up question regarding the acquisition. It looks like the $75 million increase in net revenue guidance you suggested in your release, does that represent about low double digits growth; am I looking at it correctly there year-on-year?

Dan Batrack

Yes, that’s correct.

Alan Robinson – Royal Bank of Canada

Okay, and then if you look at the subcontractor costs at Wardrop they are much lower than yours on a relative basis obviously given their mix of business. Is this likely to change post acquisition? I guess what I’m getting at is, do you have opportunities for cross selling some of the business that you do which has higher subcontractor costs?

Dan Batrack

That’s a really good question Alan and it’s one of the key synergies that Wardrop looked to Tetra Tech. They have just excellent relationships with their clients and are anxious to offer them full turnkey services that Tetra Tech’s model. So your answer is, yes. If the synergies are successful and we believe they will be, we will see the subcontractor component go up with Wardrop, but that would only be directly associated with substantial increases in the revenue and a much higher growth rate than even the 10% we’d indicated.

So, when I said we are up and out the door within 24 hours, a lot it is going right to these clients with the capability that we have on the large scale remediation and construction management and self performance model, that we can now take these projects a 100% within the Tetra Tech Wardrop organization.

Alan Robinson – Royal Bank of Canada

Okay interesting and then last question just regarding the guidance you gave, again the impact of Wardrop I guess really. Am I reading this correctly that you expect $0.11 of accretion on the cash basis, but after netting out $0.09 of amortization costs that works out to $0.02 on the GAAP basis for the rest of the year, is that right?

David King

We expect $0.09 to $0.10 cash accretion not $0.11 and so amortization probably will be $0.03 and interest cost and everything, at least a $0.04 of amortization.

Alan Robinson – Royal Bank of Canada

Okay and where does the $0.09 come from that you have on the slides there?

David King

Cash.

Alan Robinson – Royal Bank of Canada

Okay and then in terms of the second quarter guidance of $0.24 to $0.26, are there one time costs included in that?

David King

There are some internal costs, opportunity costs lost, that those people are chargeable otherwise and couldn’t be charging as part of the due diligence process will be factoring in our guidance.

Alan Robinson – Royal Bank of Canada

Okay, but there are no specific onetime GAAP charges in the $0.24 to $0.26 guidance?

David King

No, there is not.

Operator

Your next question comes from Richard Padgett - Morgan Joseph.

Richard Padgett - Morgan Joseph

You’ve mentioned this on the wind projects, that you saw some clients delaying a little bit. Have you seen that in other projects, in other of your end markets which might explain maybe disconnect between some of your backlog growth and expectations for growth? Some people maybe sitting on their hands waiting to see what the stimulus package is going to mean for them and just the holding pattern for some of the work to be done?

David King

Well, certainly we have in our state and local numbers of transports that we would normally expect and again for us we’ve seen it mostly in our schools work in the Northeast, in transportation projects broadly across the entire organization, we’ve seen those slowdown. With respect to task orders we’re kind of existing vehicles and that accounts for our forecast with our state and local business. That is one location.

We have seen some of our industrial commercial clients slowdown certain expansion projects they have and we’ve seen for instance, automobile industry and some of the larger mining companies with capital expenditure budgets slowdown certain projects. We’ve also seen a counter effect where we’ve seen some of these firms reduced their internal staffing and actually outsourced that work to us. So, we’ve seen things moving in an opposite directions.

Capital projects are slowing down, but our staffing request to support their business going up. So, there’s a lot of moving pieces certainly in the commercial side. So, we’ve not seen any project at the federal level cancelled or slowed down, that we haven’t seen. State and local we haven't seen any projects cancelled, although the pipeline of new opportunities we’ve seen slow a bit. Commercial is really a mixed bag, some areas were up, some are down and then we’ve talked about wind already.

Richard Padgett - Morgan Joseph

With the new sub-segments, could you maybe give us an example per different segment just to help us fully better understand exactly? The pyramid, maybe if you give us some project examples just to help to better understand?

Dan Batrack

Absolutely. To us internally this is just so logical. This is how we follow our project. So, let me start at the beginning where we start with science. Our ECS, our environmental consulting services group, consulting up-front research, work we would do for the United States Environmental Protection Agency for watershed management, modeling, evaluation of freight and transport, for contaminants across all of the watersheds across United States would be a contract that we have in hand that would be in that group.

Work that we did for Fox River up-front for evaluation of sediment dispersion, volume calculations, the science would be in that group. Typically higher margins, we would have something to 10% to 12% margins with that group, higher barrier to entry and very few competitors at on the national level that would enter and that would be our ECS group. In fact that’s the origins of Tetra Tech. That’s where it all started for us, upfront science. The second group and that usually we would prefer that to be our entry point to a client. We want to start right at the beginning before even a solution has been identified.

The second group TSS, technical support services. Our projects like USAID, where they would like us to mobilize hundreds of staff to work in country, in places like Afghanistan, Columbia and Nepal, a number of other countries, this would be our technical support services, where we have staff in the government location for instance and this will defense agency, if we’re working in their facilities along with them on a support staff basis, that would be in this group.

Our EPA emergency response work on the Katrina or other disaster where we need to mobilize a large number of support staff on a large dedicated program, it would be here. So, it is sort of the next part down the project execution. Slightly lower margins, higher utilization, larger number of dedicated staff, so it 9% to 11%.

Once we’ve studied and responded, we want to design it and that’s our third area. Engineering and architectural services, EAS design it. A lot of the works we do are for municipalities and that’s why it has so much of state and local work; a little bit lower margins for state and local. Over half of our state and locals are with this group, a fair amount more than that, so a 6% to 8% margin.

Finally after we’ve studied it, we’ve responded, we’ve design it we want to build it, we want to actually implement it, we want to see the project to completion and that’s our remediation and construction management. To be the largest in gross revenue it would represent the largest disparity between gross and net revenue by the nature of the work and even those margins because we are not competitively bidding this work, we are hoping that it is best value and it is coming through our pipeline of starting with science. The margins may be 7% to 9% and that completes how we execute a project for the client and that’s how we are organized.

Operator

Your next question comes from Jeff Beach - Stifel Nicholas.

Jeff Beach - Stifel Nicholas

Wardrop, just a little bit more description of the company offices in Canada, UK, India, can you give us an idea of the business in these various locations? A little bit of that let’s say longer term revenue growth such as over the last five years and just a general comment about the relative profitability of the company?

Then finally it sounds like you are looking for growth this year, but you are serving international markets such as the U.K. where they don’t necessarily have our stimulus package. Are you looking out at tougher times to fund projects ahead past what’s in your backlog?

Dan Batrack

So there’s a lot of area, so let me start the beginning. 1,200 staff; they have about 15 offices, 13 in Canada. Their largest concentration of offices and staff are in the Greater Toronto area, but they have staff from Toronto through the oil producing areas of Calgary and out to a very large office out in the West and Vancouver. So, really across Canada they have excellent coverage.

That does represent the locations of about 95% of their staff. They do have locations in both India, and in the U.K. and those offices in the U.K. about 25 to give you an idea, so it’s not a single startup. It’s actually some significant presence, similar in India.

The work that they do and again I’d indicated that their clients are largely commercial. The categories of their work or about 50% of their work is what we’ve referred to in resource management and a lot of that is in mining and other natural resources that exist in Canada.

So, they work for many of the large multinational firms. For instance Chemical is the worlds largest uranium mining firm and they are a major support firm for consulting engineering work for Chemical and so the uranium even with the commodity volatility continues to be very strong. They work for a number of the major gold producing mining firms which also has been very strong and it takes them both in Canada and around the world on projects and about again 50% of their work is in this resource management category.

About 40% of the work is in energy and they do a lot of work on the nuclear side of energy on balance plant, a lot of it is for Ontario Power, Hydro One, also in Canada for hydroelectric power. So those are a couple of examples. Very long-term clients, these nuclear power plants in support of these that didn't come yesterday and it’s not going away tomorrow, so it’s very long, lot’s of stability and they have an excellent reputation and position

The final 10% of their work is infrastructure. Bridges transportation is a component of it and while this is actually one of the areas that I believe Wardrop is quite excited about Tetra Tech's resources and with over 2,000 infrastructure engineers and our engineering in architectural group, they are excited about the additional resources, because the numbers that I provided during our presentation earlier are only for the United States stimulus package. They are very large stimulus packages being proposed around the world and certainly Canada is one of them.

They are excited about it and we are collectively about the opportunity to use our collective resources to be a large benefactor of anything that happens in Canada and it will be far larger than it would have been without Tetra Tech having been on board.

Finally the water has become a very small part of what wardrobe is today to one of our goals is to move Tetra Tech up there and with wardrobe to be the dominant water consulting and engineering firm in Canada it has the world’s largest water resources and we should be there and now we are.

Jeff beach - Stifel Nicholas

In the sense of the longer-term revenue growth over many years?

David King

Certainly they’ve grown very, very fast; they’ve grown well in excess of 10% here in the past few years. We have identified 10% as a number that we’d expect even through the economic volatile period, but if in fact we can leverage this full service capability on these projects, the number will be materially higher. I don’t want to forecast on how large those numbers are. Some of our people are positively euphoric and I will share that with all of you as soon as it transpires. Now, the profitability is inline with the growth, it’s about 10%.

Jeff beach - Stifel Nicholas

The second thing on wind energy prospects; if the current house bill would move ahead; I haven't seen any changes yet to add investment tax credits. If what you are seeing now moves ahead is there sufficient stimulus in the current plan to really jump start and boost wind energy and bring back more of a relative profitability compared to other energy sources? Is this plan as it’s proposed right now going to do the job?

David King

Well, we certainly are watching this very closely and we are looking for those types of responses from our clients, because they are the ones who will openly make that determination.

We’ve had early indications, the answer is yes, but we want to be the cautious about speculating that being converted from a bill as it exists today in the house and you’re right, we haven’t seen this multiyear production tax credit. Specifically in that version, we understand there are different aspects of it in the senate and so it may be changed materially to incorporate that. So I would put it all under speculation at this time, but there is no doubt that everyone from utilities who are the developers are being very hopeful that they’ll be aspects here that’ll allow them to get back in the game quickly.

Operator

Your final question comes from John Rodgers - D.A. Davidson.

John Rodgers - D.A. Davidson

I know you haven’t given the terms of the Wardrop acquisition, but can you give us a sense of what the combination does your balance sheet in terms of leverage level.

David King

I briefly mentioned that in the net as live, but here we will be borrowing against our credit line to fund part of the acquisition costs. At the peak, at the end of Q2 I expect to be about 30% debt-to-equity ratio and soft from that point out.

John Rodgers - D.A. Davidson

That’s when you’re referring a deed. You’d expected that your current rate had that paid off over what two years, is that what you said?

David King

About 12 to 18 months.

John Rodgers - D.A. Davidson

Secondly in terms of just acquisition opportunities that you’re seen in the market, has pricing come down substantially? I am thinking more on the private side?

Dan Batrack

We have seen pricing coming down and we’ve actually seen it on construction commodities. So projects that we had that were in place we’ve seen that come down, but we’ve not seen pricing pressure with respect to the rates that are being bid.

John Rodgers - D.A. Davidson

Sorry Dan, I was wondering about potential acquisitions.

Dan Batrack

We have seen it come down, but I will say that we have seen more while there are plenty of opportunities, what it appears to be is that the private companies are taking a bit longer to recognize what the street delivers to us everyday, adjustment or value. Many of them have seven side lines. So, we are seeing I would less overall opportunities; although there still a good number of them, but the ones out there have actually tempered their expectations materially.

So, we consider it to be an attractive, I hate the word attractive, I think it’s a fair market for acquisitions. I think before it was unfair to the acquirer. So now, I think it is fair, there are opportunities out here and I can’t think a better example than the one we just completed. With wardrobe there is a $100 million a year, 1000 personnel organization that is really the highest quality that exists anywhere in the market, there is out here looking for the right partner. So, it exists and there is the proof.

John Rodgers - D.A. Davidson

By the way, was this an auction situation or negotiation? Do you have many competitors for wardrobe?

Dan Batrack

Negotiation. They certainly did have their choices and they did have their alternative. So, it wasn’t just Tetra Tech and so I feel very good about this also, but we’re not the only multi billion dollars consulting and engineering firm out there. So they did have choices and out of all of those that were available, it was Tetra Tech that they choose.

Operater

This will complete the Q-and-A session. I will now turn the conference back over to Dan Batrack to conclude.

Dan Batrack

Great, thank you very much Dennis and thank you all for your questions. I now there are a lot of different aspects taking place in the market today and cover both our earnings growth and stimulus package acquisitions and our outlook and I though they were all excellent questions. With that I look forward to talking to you next quarter. Thank you very much and talk to you then.

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. F1Q09 (Qtr End 12/28/08) Earnings Call Transcript

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