TRC Companies (NYSE:TRR)
Q1 2014 Earnings Call
November 06, 2013 9:00 am ET
Martin H. Dodd - Senior Vice President, General Counsel and Secretary
Christopher P. Vincze - Executive Chairman, Chief Executive Officer and President
Thomas W. Bennet - Chief Financial Officer, Principal Accounting Officer and Senior Vice President
Steve Shaw - Sidoti & Company, LLC
Good morning, and welcome to the TRC Companies' First Quarter Fiscal 2014 Financial Results Conference Call. Today's call is being recorded. [Operator Instructions] At this time, I will turn the call over to Mr. Martin Dodd, General Counsel for TRC. Please go ahead, sir.
Martin H. Dodd
Thanks, Donna, and welcome, everybody. We're glad you could join us today. With me here in Lowell, Massachusetts, are Chris Vincze, our Chairman and Chief Executive Officer; and Tom Bennet, our Chief Financial Officer.
As you know, the primary purpose of today's call is to review our first quarter financial performance. That's the quarter that ends September 27, 2013. Also, in the course of today's presentation, of course, we'll be giving you some insight to where we see the company going and where our markets are headed.
As such, to the extent we talk about future events, those remarks would constitute what are called forward-looking statements as defined under Federal Securities Laws. Forward-looking statements are subject to risks and uncertainties, and they could change materially over time for a variety of reasons, over which we may have no control. For a more complete consideration of factors you should keep in mind with respect to forward-looking statements, please refer to our public SEC filings, including the 10-Q that we filed this morning, our press release and the presentation slides we're using for today's call, which are posted on the Investor Center of our website.
With respect to those slides, we've prepared them as a visual supplement to the presentation. We hope you find them helpful, but you should keep them in consideration of the full context of our 10-Q, the press release and the commentary on the call today.
With that, I'd like to turn the call over to Chris.
Christopher P. Vincze
Thank you, Martin. Welcome again to TRC's fiscal 2014 first quarter earnings call. Our agenda today will be somewhat brief since we just spoke to you a couple of months ago. I'll be providing some financial and operational highlights, comment on our business outlook, Tom is going to provide the financial review of the quarter and then we'll open up the call to any questions you might have.
Overall, another solid quarter. In particular, highlighted by growth in all 3 segments. Two primary reasons for that are our internal investments are paying off and the markets are definitely improving. And I'll speak to both of those issues in a moment.
Other key metrics that you see on our first slide clearly note a generally very positive, strong performance, with the slight exception of our operating income, which is associated with a blemish of the quarter, which I'll be speaking to. TRC did experience some growing pains in our Energy sector. And I'll go through some details of what that means in a moment.
With that said, I would characterize the quarter as successful. Our growth strategies and our markets are gaining momentum. We have a bright outlook with lots of potential for improvement.
Our next slide illustrates our diversified business model. It won't be changing dramatically from quarter-to-quarter, but as you can see, based on our actual performance and the results for the quarter, we did notice some significant growth in both our Infrastructure and Energy segments, where they both moved up from the last presentation.
Shifting into the segment presentations, our next slide, the Environmental segment. As I stated in our press release, TRC incurred an exit strategy cost estimate adjustment in the first quarter. Tom is going to review in detail the full extent of the impact of that accounting. But without those impacts, the Environmental sector grew by about 16% year-over-year. This is really a breakout quarter for our Environmental business, single best quarter for the Environmental sector in years.
Even more exciting is the building momentum of our segment profitability, which you can see grew by about 35%. Primary drivers that we've seen changing that are improving, the increasing of permitting and power plant decommissioning activities. In both cases, the level of activity has surpassed the levels that we've seen through the last 5 years or so. And lots of our activities related to the services providing those areas of markets are really gaining strength.
Secondly, the greenhouse gas rules, which were announced on September 20. And just notably, there were 2.5 million comments since the original promulgation of this rule, the single highest level of comments ever in the history of this country as it relates to any Environmental regulations. Regardless, the rules are going into final form as of September, and that is really going to stimulate much of the things we do both in our Environmental business, and I'll speak to it as well on the Energy side of our business. Here in the Environmental business, it really is supporting some of our air businesses, both in permitting and in measurements.
Going down on this -- the challenges side of this market. A new phenomenon based on this last quarter, again, just based on the volume of activity and the growth opportunities that we are seeing, is finding some talent. Though most of our business is over the course of the last few years, we certainly had more capacity. We are now certainly detecting, in some cases of our businesses, a need to hire more dramatically. And the company has launched a number of recruiting initiatives to support that future growth potential.
I would caveat everything, while this is all very good news, there are still parts of the market in the Environmental business that haven't fully blossomed. So again, we still anticipate some additional opportunity in the overall market growth, which, again, should only help us that much more.
Shifting into our Energy segment slide. Our Energy business continues to grow nicely. It's been 2 to 3 years of consistent double-digit growth here. Both our organic and acquisition strategies have supported that growth. I would add that the overall markets are still very favorable in terms of the capital spend that will be moving a lot of our service needs going forward.
As you can see on the profit side, we did have a decline on a year-over-year basis. It's really attributable to 2 primary issues: The timing and transitioning of one of our most recent acquisitions, which occurred in the middle of the quarter; and then problematic contracts with a new utility client or a new element of a utility client where we're doing some work.
I would add that we are in negotiation as it relates to some of the issues with that client, and some materiality improvement could happen on the course of the future quarter periods. We've had similar issues in the past year or 2, with a similar situation of a new client. Fortunately, those projects have been completed. And I'm happy to report that in those cases, that particular client has now awarded us millions of dollars of new work in a much more favorable pricing and scoping level for the company. So again, it is part of what we call our growing pains into these markets.
From a segment driver perspective, as I mentioned earlier, the greenhouse gas rule is clearly going to be coming into play as it relates to the Power segment. It basically will negate any future coal plants from being built in the country. The 40% reduction rule of carbon dioxide is based on current technologies, just not a financially viable mechanism, so it will really drive many of the utilities to move forward with different development of new power plants, primarily natural gas use. So it's really going to move activity forward based on, again, these final rulings. So it is a major driver of both the environmental issues, but also now the development of natural gas and natural gas power plants, which we are starting to see those activities begin.
On the challenging side, typical to the project I just mentioned, again, as we are growing rapidly, moving into new geographies, developing new utility clients, clearly, we've stopped ourselves a few times here as a major initiative in the company, which we launched this year, is to expand our quality program. We've hired a former executive of utility with 6 Sigma certifications and are building an activity to support management of some of these growth issues that we've run across here. And that ultimately will support the total business in addition to, obviously, some of these utility issues. So it is forefront in our initiatives and our strategy as a company so that we can continue our profitable growth activities which are clearly working.
Moving on to our next segment, our Infrastructure segment. Not much to add to the slide. Again, nice growth on the top line, continued improvement on the bottom line, and we've been seeing this now for almost 2 full years. The segment drivers continue to be very positive and, again, the challenges are more macro in issue as opposed to anything else. So again, we continue to see great performance by this sector. And I'll speak to some of our investment strategies going forward, which we think will support the growth of this area of business for us going forward.
Our next slide shows our backlog picture, again, continues to be stable. I would actually anticipate a larger backlog growth rate going forward in the next quarters to come. The opportunity funnels continue to grow at record levels, and at some point, those opportunities will fall into our backlog. But certainly, even with that said, we continue to hold a very solid level of backlog.
I thought I'd highlight a couple of the wins in each one of the sectors as I had historically, trying to show a diverse set of awards, as well as reasonably current kinds of activities that are really driving the marketplace.
In our Environmental business, where we typically are not involved with a whole lot of federal work, we do have a very strong reputation with EPA and, in this case, they continue to award us some major projects, where they've had issues in getting to new places in execution. This particular side is a multimillion dollar award in Connecticut and should last for numbers of years with additional phases going forward.
The other project I highlighted is a pipeline project in New York. This is a $3 million to $6 million permitting environmental support construction management services contract for crude oil and products pipeline. This is right on the heels of another pipeline project that we've been working on in New York for about 3 years, with the Texas Eastern and Algonquin pipeline project with Spectra, a $1.2 billion well-executed project, which is now online. So again, we're very familiar with these projects and, ultimately, we anticipate quite a few more, especially pipes coming in and out of parts of the mid-Atlantic.
In our Energy sector, I highlighted the 2 new areas of awards. One is a regional New York utility, providing us a fairly sizable telecommunications engineering contract. It's about a $2.5 million program to develop microwave and DA radio networks. There are lots of utilities that are now having to provide capital upgrades to their whole telecommunications network programs. And as part of our growth strategies of last few years, we are really building up our skill set there. So again, supporting utilities in a slightly different way than just on the transmission and power delivery sides.
The second award that I was -- the Iberdrola NERC studies. In our last call, I mentioned how NERC, which is really the new rules related to the transmission system reliability, is really going to push the utilities to further assess and evaluate whether their systems are as reliable as they need to be by guidelines and process. So in this particular case, we've been awarded by Iberdrola, a very large account of ours, a $2 million assessment study to make sure parts of their service territory meet those compliance issues. And again, we anticipate many more of our utility clients moving forward with those kinds of projects.
In our infrastructure project or infrastructure awards, I listed 2. One is the Pennsylvania Turnpike authority, which just provided us, in fact, this was just awarded to us this past month of October, a $7.2 million project over the next 2 years to work on 6 different bridge deck projects. Which, again, is in our wheelhouse of activity in terms of the mid-Atlantic infrastructure business. And then the second award I mentioned is a design-build project. It's called the Coalfields Expressway. It's about a $13.5 million construction project with TRCs. These are in that $1.5 million range. Again, it's a transportation engineering project related to grade and drain construction works. So again, a good smattering of diverse projects that the company continues to see awarded to us. And in most cases, all of those are more recent awards so, again, I think, in support of our backlog growth.
Our next slide speaks to our growth strategy. We did certainly update this slide from the last one since we are shifting a little bit in terms of some of our thought processes, as it relates to the investment and high margin organic growth opportunities we've list that Utility, power, oil and gas historically have been the absolute investment strategies. And organically, we have also invested in a number of infrastructure, in particular, transportation programs.
As of Q1, we launched a more focused utility power vertical group, where we've brought together through a former utility exec a number of other former utility colleagues with skill sets within our space and are focused on a high-level strategy, business development, sales-oriented focus for the company and in support of all of TRC services across the U.S. for our utility clients. So we're well on our way on that particular strategy and we're looking to build out our oil and gas vertical, and eventually, our transportation vertical as well as we move forward. So again, we are continually building up our strategies of focus within the areas of business and the segments that we view as very strong from a market standpoint and, certainly, from a skill set standpoint.
As far as our strategic acquisition side, again, historically, for the last couple of years since we've launched our acquisition strategy, we really were focusing on our Energy and Environmental businesses. We continue to primarily focus there, but we are also now beginning to look at some transportation and/or infrastructure-related pursuits. So again, we're shifting slightly towards a broader review, again, to service the total portfolio. And it's really related to our confidence in both the marketplace of the infrastructure space, as well as recent historical performance and management leadership that I currently manage that particular side of our business.
Last point on the slide, clearly, we were looking to continue to maintain a balanced strategy, where our acquisitions and our organic growth strategies are balanced. We are truly making sure that in both cases, not only do our acquisitions support strategic expansions geographically and technically, but that ultimately, we take advantage of growing those businesses as part of the total TRC in addition to those other TRC verticals that I mentioned and other sales initiatives. So again, a very balanced strategy and, again, if you can look back over our last 2, 3 years, we've been very focused on maintaining that structure.
Next slide on market outlooks. Again, we are very close to stating that in all 3 cases, all our markets, on a short term and medium term and long-term outlook are very solid. So there hasn't been much change in this particular slide from the last quarter to this quarter. But again, I would summarize that it's a very solid marketplace right now for all 3 segments. We will update this particular slide as we see real future market dynamic shifts. One key point that I did want to pull out on this particular slide is that the environmental regulations are really starting to move forward more aggressively. Clearly, as this administration is in its second term, it really is now moving forward in executing some of the concepts of regulations that were talked about in the first term. But they are really starting to move. And the one I mentioned earlier was the greenhouse gas one. We anticipate others as well will be moving forward, which will, again, support much of our business opportunities.
One other point just to pull out on here is the decommissioning expenditures in our Environmental business. We are having discussions with over a dozen utilities on many, many different projects. And again, a lot of the impetus to move forward to understand what to do with many of these former or soon-to-be former coal-fired power plants. And again, we certainly anticipate lots of opportunity around that whole decommissioning market, more than we even thought about just a year ago.
Last slide, before I turn it over to Tom, just reemphasizes our strong position, which has been fairly consistent for the last number of quarters. We continue to be very well positioned in markets with solid, short, long and medium-term outlooks, which continues to improve, which is, again, very good news, not something we've really said consistently here for years. We're executing a focused profitable growth strategy, with potential for improvements, certainly as it relates to some of the growth pains I discussed earlier. We have a very strong balance sheet and cash position. We continue to finance our deals with cash flow and have the cash capacity and flexibility to do much more than that. Our backlog continues to grow. We anticipate it growing at a more dramatic clip in the near future. So again, very positive outlook of the business.
With that said, Tom?
Thomas W. Bennet
Thanks, Chris. Good morning, everyone. Starting with Slide 12, I'll review of some of the financial details for our fiscal first quarter, compared with the first quarter of the prior fiscal year. As Chris highlighted, our net service revenue of $81.3 million in the quarter was up 8% compared to the first quarter of last year, benefiting from growth in each of the 3 segments.
Looking at EBITDA. EBITDA was $6.4 million or up 5% for the quarter. Our EBITDA margin of 7.9% was down slightly compared to the 8.2% ratio in the prior year quarter. Note that the EBITDA statistics is a non-GAAP financial measure, and is calculated by adding depreciation and amortization expense back to the operating income amount. A reconciliation of GAAP to non-GAAP measures is provided at the end of the slide on Slide 15.
Operating income of $4.6 million (sic) [$4.3 million] in the quarter was down $0.3 million or 8% compared to the same quarter of the prior year. That decrease was the net of a number of factors, including the $0.6 million increase in intangible asset amortization expense stemming from recent acquisitions.
Earnings per share for the first quarter was $0.08 per diluted share compared to $0.15 per diluted share on the same quarter the prior year. It looks ugly on the chart, but the difference in our effective tax rate accounts for much of the difference in the year-over-year EPS. As I mentioned in our Q4 investor call, in fiscal 2014, we graduated to a 40% combined federal estate tax rate that is typical of companies in our space. By comparison, in the same quarter of the prior fiscal year, we had only $0.2 million of cash expense and an overall tax rate of about 5%.
Moving to Slide 13 for some more details on the income statement. As Chris mentioned, for the first time in a while, we have a fairly significant insurance recoverable item in the financial results. A net $12.3 million insurance recoverable was recorded in the quarter compared to $1.7 million in the prior period. The current quarter recoverables related to a cost estimate increase for a large exit strategy project. The additional cost on the project will be funded by the insurance policy that was procured by the client for the purposes of covering costs in excess of the original estimate. As I'll explain in further moment, the net impact of that item in the quarter was essentially 0.
Looking at cost of services, which were $78.4 million in the quarter, they were up $14.7 million or 23% compared to the same quarter of the prior year. Cost of services was affected by a costs reserve associated with the exit strategy insurance recoverable item.
We put a table in the upper right corner of Slide 13 to depict the individual components of the cost related to the insurance recoverable item. The overall impact of the insurance recoverable items at the bottom line in Q1 is 0 as it's offset by a $5.1 million of reduction in gross in net revenue due to a corresponding percent complete accounting adjustment to the project and is further offset by a $7.4 million cost reserve, which occurs in the cost of services line item. Complicated, but it nets to 0.
Expressed as a percentage of NSR, the cost of services ratio was 96.5% in the quarter compared with 84.7% in the same quarter of the prior year. Again, this ratio is impacted by the $7.2 million cost reserve I just mentioned.
The G&A cost ratio was 10.8% in the quarter compared to 9.5% in the prior period comparison. The G&A ratio was negatively impacted due to acquisition, integration and legal-related reserves and costs.
One final item on this page, as I mentioned earlier, due to the difference in effective tax rates, income tax expense in the quarter was $1.7 million, an increase of $1.5 million compared to the $0.2 million of tax expense in the same quarter of prior year.
Moving to Slide 14 for some comments on DSO and cash. Our DSO or days sales outstanding metric was 95 days at the end of the quarter compared with 86 days in the prior year, and 83 days in the immediately prior fourth quarter. 4 days of the increase resulted from the mathematical impact of the exit strategy item and its impact on NSR, and will resolve itself over the course of the next quarter. Remainder of the DSO increase is related to seasonal fluctuation and specific project billing performance, and those items will be the focus of our attention in reducing DSO to our target of 80 days or less. While the DSO measure is higher than our desired target, we were pleased with our quarter end cash balance. We ended the quarter with $22 million of cash, increase of $3.9 million or 21% compared with the $18.1 million cash balance as of the June 30 end of the prior fiscal year, and up $7 million or 47% from the $14.9 million cash balance in the comparable quarter of the prior year.
Free cash flow for the quarter was a negative $0.5 million compared to negative a $4.5 million in the first quarter of the prior year. Cash flow items in the quarter included the $1.1 million of positive cash flow from operating activities, offset in part by $1.6 million of capital expenditure activity. The quarter end cash balance was also impacted by the net $2.4 million cash flow associated with the USS acquisition.
That concludes my remarks today. We'll now go back to Donna to open up the Q&A session.
[Operator Instructions] Our first question is coming from Steve Shaw of Sidoti & Company.
Steve Shaw - Sidoti & Company, LLC
What's the key to staying competitive as you guys are seeing some larger players come into a market like the energy market?
Christopher P. Vincze
Obviously, having great service and execution of value propositions that client expect. And again, while we go through some of our growing pains of learning those things, the company's culture is to absorb the pain ourselves, but provide the client more than what they anticipated or expected. Certainly, assumingly that, that is what they're paying for. Our history has shown that, that has really worked in virtually every case around the country. And Energy, as the example you bring up, where we've spoken to clients, we continue to grow those clients by significant levels as we bring our services and our technologies and our skill sets to bear. So it's a relationship, it's execution and it's vigilance on understanding their business better than some of their people do.
Steve Shaw - Sidoti & Company, LLC
Okay. And then regarding pricing pressures. Is that coming from more competitors or less projects or a combination of the 2?
Christopher P. Vincze
Less projects is not the problem right now. In fact, it's going the other way. There's more work than their own people can manage. The pricing pressures are more of the institutional procurement cycle that occurs, where bigger companies are finding ways to save money, so they are going back to their vendors, suppliers and using processes to try to squeeze it. That's the biggest issue, in particular, in the energy side. There is some additional pressure in some cases where the bigger companies are going after smaller projects and are willing to absorb certain rates just to get those projects onboard. But that's a smaller area of issue. It's really the institute and pursuit of efficiency within their structure.
Steve Shaw - Sidoti & Company, LLC
Okay. And then jumping over to the infrastructure side. We saw nice results in this quarter. Is that sustainable through the year? I mean, with the timing and how some federal and municipal budgets are sort of getting back to course here?
Christopher P. Vincze
I would say on a general trend, we are definitely seeing state budgets improve dramatically. Initiatives to spend money on infrastructure, Republican or Democrat states, is moving forward. Gas taxes have been increased in probably 50% of the country. So at the state levels, we are seeing more investment happen. Now is it safe to say every quarter you'll see that kind of result? That's unlikely because, again, there will be lumpiness to the process. On macro trend, you're definitely seeing a robust transportation market that we've not seen for years.
[Operator Instructions] At this time, I would like to turn the floor back over to management for any additional or closing comments.
Christopher P. Vincze
Thank you, Donna. We'd just like to thank everybody for their participation and support of TRC. Certainly, we wish everyone a great holiday season. We'll be talking again in February. And I can't help myself but shout out to the Red Sox for a great World Series win. So for you Yankees fans, I apologize for my obnoxious -- but anyway, have a great day, and we'll see you guys in February.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.
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