Tetra Tech's (TTEK) CEO Dan Batrack on Q3 2016 Results - Earnings Call Transcript

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Tetra Tech, Inc. (NASDAQ:TTEK) Q3 2016 Earnings Conference Call July 28, 2016 11:00 AM ET


Dan Batrack - Chairman, President & CEO

Steve Burdick - EVP, Treasurer & CFO


Andy Wittmann - Robert W. Baird

Corey Greendale - Stifel

Jordan Bender - Seaport Global

Noelle Dilts - Stifel Nicolaus

Jim Giannakouros - Oppenheimer

Bobby Burleson - Canaccord

Tahira Afzal - KeyBanc Capital Markets


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 will then open up the call for questions.

During the course of the conference call, Tetra Tech management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include statements concerning future events and Tetra Tech's future financial performance. The statements are only predictions 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 of non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted in the Investor Relations section of Tetra Tech's website.

At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answer after the presentation.

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

Dan Batrack

Great. Thank you very much, Brent. And good morning, and welcome to our Third Quarter of Fiscal Year 2016 Earnings Conference Call. Before we begin to review our third quarter performance today, I’d like to announce that today July 28 of 2016 is exactly today 50 years since Tetra Tech's initial founding. Tetra Tech was incorporated on this date back in 1966 by four Ph.D. research scientist, each bringing world class expertise to form their new company, which became Tetra Tech. And this is really a great milestone for Tetra Tech, and I would like to provide some additional comments a bit later in my presentation about this.

But now I’d like to present the financial results for our ongoing operations for the third quarter of fiscal year 2016. We had a very good third quarter demonstrated by all of our financial metrics. Overall, I was very pleased with the company’s performance over the past quarter and the execution of our strategic plan.

Our revenue for the quarter was $662 million, which is up 19% from the prior year. Our net revenue was $496 million, which is up 20% from the prior year, which generated an operating income of $44 million, which is up 8% from last year. This operating income resulted in an associated earnings per share of $0.50 for ongoing operations for the quarter, which is up 16% from the prior year.

And finally, and maybe most significantly, our backlog from our ongoing operations was up 26% year-over-year and finished it over $2.2 billion, which is new record high for us as a corporation.

I'd like now to present our performance by our business operating segment. Our WEI business group generated a $191 million in net revenue for the quarter with a strong 13.8% EBITDA margin. Revenue was stable from the prior year with growth in water, environmental services and federal work here in United States. That collective growth was partially offset by lower revenues from WEI's Canadian operations.

The RME business group, excluding the Coffey acquisition, which we’ll speak to in a moment delivered a solid 10.8% margin for the quarter. The RME group grew organically 2.8% year-over-year, generating revenues of $226 million, and was primarily due to strong performance in our international development work and growth in our waste management services activities.

Our recent acquisition of Coffey generated $79 million in the quarter with an 8.5% EBITDA margin. This margin is a significant improvement for them, they approximately doubled their margin from just the prior quarter, and I'll speak a bit more detail about this a bit later in this morning's call. We expect the margin to continue to improve though, and through a combination of both synergies of the transaction and improved operational performance.

Collectively, the net revenue from our ongoing operations, which is WEI and of the RME Business Group, which actually includes Coffey. Collectively, net revenue was $496 million were up 20.4% year-over-year with a strong 11.3% EBITDA margin for the quarter.

I'd like to also provide an overview of our performance by customer. Our international net revenue was up 52% year-over-year. This was driven by our acquisition of Coffey, which contributed revenues from the Asia-Pacific region and the United Kingdom. Work for our US federal clients was up 20% year-over-year. This revenue increase was driven by organic growth with our US Federal government clients and the addition of Coffey's revenues primarily with US-Aid.

Our US commercial work was up 1% year-over-year, due to strong growth in environmental and solid waste services, which was partially offset by a larger than anticipated reduction in our US oil and gas work. And finally, our United States state and local work grew at 7% year-over-year, that’s a direct result of strong performance of our municipal business in delivering water and solid waste related services for metropolitan areas all across the United States.

Tetra Tech's backlog reached an all-time high in our third quarter. Our total backlog is now $2.265 billion, and is up 21% from last year, and our backlog from ongoing operations is actually up 26%. I do want to make a note here if you're following along on the webcast, you can see in the inset on the graph here that does state that our backlog is funded and authorized work. And you just want to make - take a moment to clarify and reiterate from previous calls. Tetra Tech account's backlog has contracts that we’ve won, that have been signed, contracts that have been funded by our clients and that actually authorized us to work, we include no factored backlog, we include no contribution from future contracts that maybe awarded with funding or any type of factoring of any existing IDIQs or other master service agreements that we have. This is funded and authorized work that we have in hand.

Now during the third quarter, our awards included projects from multi-international development agencies, which included US-aid, UK-aid and Australian-aid. These international development awards included large projects like a major power program in Africa and a large $125 million single award contract for us for engineering services for USA that we announced just this week.

We also advanced our plans to grow data analytics services with an award of a joint NASA/USAID geospatial contract that we announced also during the last two weeks. And for the Department of Defense, the pace of our task orders and awards significantly increased in the third quarter, especially with the army and the air force. Overall, our backlog grew across a broad client base providing us with excellent visibility as we enter the fourth quarter of this fiscal year.

Now if you're following on the webcast, there is a small line at the bottom, it reflects our CM backlog. And at the end of the third quarter, we have reduced the remaining backlog in our legacy RCM construction division, which we’re winding down and it finished the quarter at $38 million. We're very focused on very systematically completing and closing these last remaining projects. In the third quarter, we did have some charges associated with RCM, which Steve Burdick will discuss in just a moment.

And at this point, I'd now like to turn the presentation over to Steve to present the details of our financials for this past third quarter. Steve?

Steve Burdick

Thank you, Dan. So yes, before presenting our financial results for the third quarter, I would like to walk through a reconciliation of our ongoing operations, which Dan just spoke about to our GAAP financials. So our ongoing operations represent our GAAP financial results, excluding RCM and any fiscal 2016 acquisition and integration costs. And a full reconciliation of our GAAP results to our ongoing operations is included in our third quarter earnings release.

So for the third quarter of fiscal 2016, revenue for ongoing operations totaled $661.7 million and net revenue totaled $496.2 million. Now including RCM, our revenue was roughly $667 million and net revenue was approximately $499 million.

Operating income and earnings per share for the quarter were impacted by integration expenses related to Coffey as well as losses from RCM. So the integration cost for the third quarter totaled roughly $1 million, and the RCM charges were in addition of $4 million for the quarter, representing a total of about $0.06 per share.

So when we exclude these expenses, EPS was $0.50 for the quarter. Now, the RCM results for the quarter were driven by unexpected project delays as well as some legal cost and closeout of claims. We anticipate that the work in RCM will be substantially completed in 2017. And furthermore, just want to point out, due to the fixed price nature of these construction projects, which is really the fundamental reason why we get out of this business, there could be variances either up or down until we get through all of these different issues.

Now the third quarter integration costs are in line with our previous guidance. We are on track to incur about $80 million for the year to complete a successful integration of Coffey.

Now I’d like to review our GAAP financial results. All year-over-year changes for ongoing operations are presented on a constant currency basis to reflect, what I’ll say is that, yes, an apples-to-apples comparison. So gross revenue for the third quarter totaled $667 million compared to $575 million in the previous time period, and this is up 16% year-over-year. Revenue for our ongoing operations increased 19% year-over-year.

Net revenue for the quarter totaled $499 million, and was up 18% year-over-year. Now, net revenue that was in line with our third quarter guidance, which was $475 million to $525 million. And net revenue for our ongoing operations was up 20% year-over-year. As Dan mentioned, besides the impacts of the acquisitions, quarterly revenues improved, due to the growth in our international development and our U.S. state and local infrastructure business.

Now turning to operating income. The operating income for the current quarter was $39 million compared to $41 million in the third quarter of fiscal 2015. Excluding depreciation and amortization, our ongoing EBITDA improved 11% over the previous time period.

The diluted earnings per share were $0.44 for third quarter of 2016. On an ongoing basis, diluted EPS totaled $0.50, which is an improvement of 16% year-over-year. This ongoing EPS is in line with our third quarter guidance, which was $0.47 to $0.52 per share.

Now I’d like to review a few of our cash flow metrics for the quarter. Cash flow from operations totaled $59.6 million compared $109.3 million in the previous time period or the previous year time period. I’d like to note that the third quarter of 2015 included $30 million from claims, which as a result made it our single strongest quarterly cash flow in the company’s history. Nevertheless, with this quarter’s solid cash flow from operations, we expect to meet our full year guidance of $160 million to $180 million of cash flow from operations in fiscal 2016.

Net debt for the quarter totaled roughly $211 million. Now this amount increase, due to the acquisitions completed in fiscal 2016 that were part of the international development and data analytics space as well as due to the repurchases of shares and dividend payments to our shareholders, which I will discuss momentarily.

Turning to our day sales outstanding. We continue to make progress in lowering our DSO. Day sales outstanding of 83 days is lower from last year by 2 days. Now when we exclude the RCM and the different claims, our aggregate DSO in our front two segments was about 76 days. And so throughout the remainder of 2016, we will continue our efforts to reduce our day sales outstanding to be closer to about 70 days.

Before concluding this portion of the call, I’d like to take a few minutes to update you on our capital allocation strategy. So Tetra Tech remains focused on a balanced approach between dividends, share repurchases, acquisitions and organic growth investments. And we target the leverage ratio of about 1 to 2 times net debt to EBITDA. And with the current leverage ratio of 1.1 times net debt to EBITDA, we have sufficient dry powder to invest in organic growth in acquisitions, while still having capital to deliver returns to our shareholders. So let me tell you briefly that how we expect to deploy our capital.

First, we will continue to use our strong cash flow from operations to invest in growing our ongoing operations. We will also invest in CapEx, which has remained at about 1% of our annual revenue. Second, we will invest in additional strategic acquisitions to expand our consulting and engineering capabilities across our target end markets in geographies. We have a combined $500 million in cash and credit facilities available for acquisitions through our banking relationships today and could take on debt if needed.

And third, as part of this balanced approach, we will return capital to our shareholders through buybacks and dividends. In the third quarter, we paid out $5.2 million in dividends and repurchased $25 million in stock, which together over the trailing 12 months totaled about a $119 million. As of the end of the third quarter, we had $25 million available for repurchases remaining under our previously announced $200 million buyback program.

In addition, I’d like to announce that our Board of Directors approved our 10th consecutive dividend. A dividend of $0.09 per share will be paid on August 31st to shareholders of record as of August 12, 2016. So I want to thank you for all your time today, and I will now hand it back - call back over to Dan.

Dan Batrack

Thank you very much, Steve. Before I provide an update on our growth strategies, I’d like to spend just a few moments on the founding of Tetra Tech. As I mentioned at the opening, 50 years ago today, we were founded by four world renowned research scientists and engineers with an entrepreneurial spirit to start a company that was focused on problems - of solving problems of science in the areas of water and environment. And from that time, we’ve grown from those four founders to the 16,000 person, $2.7 billion a year company that you see today, which is Tetra Tech.

I have included on the slide, if you’re following along on the webcast, a short history to show you how we’ve grown from those early days. We did start in earliest days with consulting [ph] services, especially for flood protection and environmental cleanup. We moved on to adding infrastructure engineering and design services in the 90s, and in the 2000s, we began our international development business followed by the addition of research management energy services.

Now the growth that we’ve delivered over these years has propelled us to the number one rankings that we hold with engineering news record in water, environmental management and solid waste. And today, Tetra Tech is truly a global company. True to our roots in science, and true to the entrepreneurial spirit that our founders initiated the company with. And today, we continue to lead with science across all the markets that we serve in. And it's this foundation is going to enable us to expand in the market leadership in the future.

I would like to today go over Tetra Tech’s market strategy that are currently focused on three primary areas that we’re showing here on our webcast. I’ll go over each of them briefly. The first is foundational markets. It’s the biggest portion of the company and it’s these markets that provide a predictable and reliable revenue that we can rely upon and it provide us institutional history with these clients and actually stability with the organization.

The second area that we’re focused on are growth markets. And these are the areas, where we have new opportunities due to changes in the market place, such as new regulatory requirement changes or new investments by our clients. These are areas that afford us higher growth in the company. And finally, our emerging markets, where we’re applying new technologies that are actually going to be the future of our business, and this represents a small part of our current revenues about 5%, but this is the area of the company that’s growing very fast.

Now I would like to discuss some of these markets in slightly more detail. First, international development. It’s one of the largest growth markets for us and it currently represents about 19% of the business, and we expect it to grow at a rate of 10% to 15% organically this fiscal year. With the acquisition of Coffey, we now have access to a broader client base and even more comprehensive set of qualifications and resources. And we can now together with Coffey leverage over $6 billion in contract capacity for eight agencies worldwide, which has already proven to be a benefit for us in our backlog just this past quarter.

The second area is infrastructure services for our municipal clients. And it’s a focus area for growth in 2016 and beyond. By far, the largest spending is expected to be in the United States, where we have the broadest coverage from coast-to-coast. We expect our state and local, and this is the U.S. state and local business to grow at between 5% and 10% organically, driven by awards per water treatment, water we use and stormwater programs. Now this is also an area that will benefit from our innovation that we're applying in emerging smart water solutions to our clients.

The third area I'd like to highlight is oil and gas, and it's one of the areas that I'm asked most frequently about. Today, our oil and gas business is about 9% of our revenue, and we now expect a decline this year at a rate of between 10% and 15%. Now oil and gas is a cyclical market and although down today, we do expect it to return to growth in the future.

However, I will note even in the current down cycle, our focus on midstream services is proving to be a very good choice. Over 85% of our business is in midstream services and it's one of the strongest sectors in this market. We have long term projects in this area, especially in Canada, and we're well differentiated in our high-end engineering services that we provide.

This has helped to minimize the impact of this cyclical market on Tetra Tech's revenues, especially in comparison to our peers.

Overall, in aggregate, the full Tetra Tech diversified portfolio, which includes these 3 markets I just discussed, are expected to generate a 2% to 5% organic growth across our organization in this fiscal year.

We do believe here at Tetra Tech that profitable growth is an important factor to our overall success. In fact, it's essential. And this applies both to our existing operations and to the acquisitions that join Tetra Tech.

Our strategy in acquiring Coffey was to rapidly integrate them to accelerate our growth in international development, while also applying synergies and operational improvements to bring them in line with Tetra Tech's margins.

I'm very pleased that our - we've made significant initial progress. And actually, this is not unexpected, this is exactly as we had planned along with the management of Coffey.

We moved Coffey from a 4.3% margin when they first joined us, to an 8.5% margin in just 2 quarters since they've been with us. And our plan is to bring Coffey's margins to over 10% this next fiscal year and 12% by 2018.

I'd now like to present our guidance for the fourth quarter and for all of fiscal year 2016.

For the fourth quarter, our net revenue guidance is at a range of $500 million to $550 million, with an associated diluted earnings per share for ongoing operations of $0.55 to $0.60. Also for the quarter, we anticipate a cash earnings per share of $0.90 to $1.20.

For the entire fiscal year of 2016, we expect a net revenue range of $1.9 billion to $2 billion and the associated diluted earnings per share of $1.85 to $1.90.

Cash earnings per share for the year, we anticipate to be $2.70 to $3. If you're following along the webcast, you can review the assumptions that are to be used in your models for calculating the basis of these numbers.

And I do want to note that from last quarter, the annual guidance really has just been narrowed based on the numbers that we provided in the quarter and essentially remains unchanged from what we entered in the second half of the year.

We anticipated a very strong third quarter. We did achieve that. We anticipate a strong fourth quarter. We expect to achieve that. And therefore, we've left our guidance unchanged coming in to the end of the year.

In summary, our ongoing operations had a very strong third quarter. Backlog reached a record high for the company giving us excellent visibility as we enter the fourth quarter of the year. Integration of Coffey is progressing in line with our strategy, with significant margin improvements over the prior quarter. And our teams, both at Tetra Tech and Coffey, are adding new contracts and expanding our international development services worldwide.

In closing, we feel very good about our progress and the performance of the company in the third quarter. And we believe that this is just the beginning. We are happy to announce and celebrate across our entire organization our 50th anniversary and we're looking for 50 more good years to come.

And now I'd like to open the call for questions. Brent, if you could begin the process.

Question-and-Answer Session


The question-and-answer-session will begin now. [Operator Instructions] The first question comes from the line of Tahira Afzal with KeyBanc Capital Markets. Please go ahead.

Sean Eastman

Hi, guys. Great quarter. Thanks for taking my questions. My first question would just be on Coffey. Just any color on what's going to drive this next stage of expansion - margin expansion, would be really helpful. I know this first piece of it has been more on cost rationalization. So what you guys are going to be doing over the next couple of years to improve those margins further? It would be great to hear about.

Dan Batrack

Good morning, Sean, and thanks for the question. Well, you're right, moving from 4% up to we believe up to 9%, I think, we have a bit more upside on cost synergies. So we're currently about 8.5%, so we think we've got another 50 basis points or more to move this into 9% or slightly higher just on cost synergies. But we do believe that moving it from a 9% up to the 10% will be basically operational efficiencies. We believe that increase in utilization focused on higher profit clients with programs that actually have better margins in them, we'll drive it through 2017. And we believe that they will achieve margins in line with that of Tetra Tech.

Most of their business have similar clients and similar end services that they provide that we do, and we think that there's no reason that they can't move up to the similar operational efficiencies as we have. And in fact and in more strengthening market, some of the rates in pricing, that can be employed in the markets are even more favorable than North America during a more robust economic time.

So we think that when things are going well, particularly in commodities, they will actually be at margins higher than this and in fact, higher than what we've identified here. And in fact, higher than that of Tetra Tech currently. And in more challenged times, we think that they can be in line with Tetra Tech, which we'll be moving to.

So the next movements will be in operational efficiencies, and we think that, that is in a relatively subdued market. When a stronger market comes up, we expect this number to go up even more from what you've seen here.

Tahira Afzal

Dan, we're playing a bit of tag team, this is Tahira, and I apologize I'm tagging off another earnings call. But first of all, congratulations, a very good quarter. I guess my question is more around - we're approaching the end of this year, and investors have started looking out to fiscal year '17. You started to see book-to-bill pick up. And I'd like to get a sense from you, how sustainable that is? You know you've got a big Canadian pipeline project that drops off next year. Given the momentum you're seeing in your other end markets, do you feel comfortable you can grow backlog into next year?

Dan Batrack

Good morning, Tahira, and thank you for the question. I think it's a great question. We had a very good backlog growth this past quarter. In fact, we think it was one of the stronger items for the company in the quarter on our financial metrics. The one thing that we saw as the backlog go up sequentially by over $100 million and year-over-year by about $400 million and while we think that is good, what we actually think was better, was actually new contracts that were awarded during this last quarter.

We actually had - we added over well over $1 billion of new contract capacity. And what I'm quite pleased at here in the company, is that many of these contracts, including the one that we announced this week, were single awards. These are not projects and contracts that were awarded where quarter multiple entities have to compete for task orders or entities for government organizations that don't fill these contracts. They typically fill them to the full level and quite often, we see them get extended due to the priorities of the program execution.

So the real key for us is, how do we convert contract capacity into backlog which then converts into revenue. And actually, the indicators of our contract capacity are extremely strong and actually, even stronger than the backlog growth.

And those are reasons that we feel that we can actually sustain the backlog growth, which we'll then convert into revenue. And I'll repeat very briefly. What we have in backlog, I believe we are the most conservative in any of the markets that we participate in and we only included backlog contracts that are signed, clients have funding, and they have authorized us to execute the work right now.

Our backlog also has a period of execution, typically 80% of it or more is within 1 year. And the remaining component would be finished within the following year. So this is all short-term backlog, not something that stretches out multi years, as might be associated with construction or other type of activity. So all of those give us confidence in not only where we are at today, but in the momentum that we have moving into the fourth quarter in 2017.

Tahira Afzal

Got it. That’s actually very helpful. And I know Sean already asked a question for me Dan, so I’m going to hop back in the queue.

Dan Batrack

Great. Thank you, Tahira and Sean.


Your next question comes from the line of Bobby Burleson with Canaccord. Please go ahead.

Bobby Burleson

Yes. Good morning. Congratulations on the strong results.

Dan Batrack

Thank you, Bobby.

Bobby Burleson

So just curious, you talked about smart water or some third party kind of analysis out there shows that growing to $18 billion kind of market opportunity by 2020. And I'm wondering what's the underlying growth rate that you guys are expecting there for the broader market that you're selling into?

Dan Batrack

Well, the broader market, we can see the statistics showing, growing from a very small current spend to the numbers that you just quoted, at $18 billion. We've seen some ramps that have it going quite quickly. We ourselves currently have a - about a $25 million in annual revenue contribution to our business, so that's relatively small. We actually think that number could grow by an order of magnitude or tenfold over the next 3 to 5 years.

So we do think that through a combination of employing this probably on the commercial side first, the earliest adopters, because there are significant economic benefits for a smart water application and commercial wastewater treatment plants, water supply facilities. But ultimately moving into government agencies with respect to water management and they have things called combines to overflows that would actually be very well served by smart water technology.

And so we think it will be a slower ramp as it begins to be adopted by some of the larger funders, which are government. But we think that it's - for us, we expect it to go up tenfold. A lot of that $18 billion is both for telecommunications up to data back to the central locations, such that instrumentation can then be put in place to make it automated and actually make the smart water system. And we are looking for partnerships because we think a combined turnkey solution, provided with a combination of data transmitters and actually, the suppliers of the smart water instrumentation and sensors, is the way to go, and we're well down the road on that.

Bobby Burleson

Great. And then just following up on smart water. Just curious in terms of the INDUS acquisition you guys did in April, where the progress is on integrating their information management technology into your consulting?

Dan Batrack

We started that already. We're actually moving to have a full integration of INDUS. And actually they're a Tetra Tech IT Center now. So we're moving their legacy for existing clients. Of course, we'll use their brand. But we think the most powerful offering we have, combine Tetra Tech bases.

So they have worked largely with federal government agencies, including EPA and we've combined them already with our EPA subject matter experts and so that we can take a combination of the data sets they've been managing and understanding what to do with the data and then take it and look for additional applications for our federal government clients. So I don't want to claim too much early success, it has been roughly an entire 90 days since they've joined us, it's just a bit over that.

And so it's just been a quarter. But as far as integration and collaboration, we've submitted many proposals together already in a joint client meetings. So we're off to a fast run. And as we begin to win new programs, we'll have actually substance to them in dollar amount, or significant dollars were actually press release them and make this a bit more visible and highlighted as we move forward in future quarters.

Bobby Burleson

Okay, great. Thanks for that. And then I guess lastly, you've had a pickup in federal. And I'm wondering, does that position you with maybe better visibility towards the high end of your organic growth expectations, just given the nature of that business, is that kind of what you guys needed to get a trajectory maybe that makes it high-end more achievable?

Dan Batrack

Bobby, that's exactly right. I think, 2 things are happening right now, that we are seeing more our contracts signed. We are seeing more funding in past quarters come through. You've seen it in our backlog and its flow through to revenue. We've seen a significant improvement in our federal revenues sequentially.

But I will say this fourth quarter, if you went back a year ago to the same call, we saw, which is quite unusual for us, our federal funding and revenues in the fourth quarter of a year ago actually declined sequentially from the third, which is quite unusual. If we just held our revenues flat from this last third quarter of this year, you would see a year-over-year increase, which would drive the organic numbers you're talking about. And we're actually seeing things strengthen. So part of it is also our comp.

We're heading into much better comparisons from the previous year. And those should easily support the organic growth numbers that we forecasted. If it picks up a little bit stronger, it would put us towards the high-end, but I do believe it you're right, the single biggest move on our organic growth rate within our guidance and for the company is how the federal runs.

Bobby Burleson

Okay, great. Thank you and congratulations.

Dan Batrack

Great. Thank you, Bobby.


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

Andrew Wittmann

Thanks. Dan, actually the comments that you made, that single-award contracts are more likely to be funded is new to me. So I'm just curious as to how much more likely - what's the delta between that and some of the IDIQ work that you've been awarded in the past?

Dan Batrack

That's a great question. I'm not sure I can put a percentage to it. But let me describe a little bit qualitatively and I'll leave it to you to convert it to quantitative numbers. But what we've seen is single awards typically are for specific work that needs to get complete. It has policy priorities that drive it to get complete, and also the typically larger and longer programs. We normally see single-award contracts actually get filled to their capacity, much more often than IDIQs.

Our multiple award IDIQs are in definite delivery and definite quantity contracts. Quite often, we see particularly in Department of Defense, IDIQs may not get filled or your calculation as to your portion that what it might be is very speculative. And so that's why we've never included any of those factored, adjusted, percentile, or anything else in our backlog. And so the difference is quite significant. And I wouldn't care to put a percentage on it, but it's a significant percentage.

Andrew Wittmann

Okay. Thank you for that. Just digging into federal a little bit more. I think, last quarter, there were some really good performing business like aid, some of the Department of Defense work was a little bit weaker. But can you just give us some of the buckets and some of the variance you're seeing there, as to how that all sums up to federal being a kind of the net positive?

Dan Batrack

Let's say, I'd indicated in my prepared comments that we have double-digit increases in international development. That's primarily driven by US-aid, that's U.S. Federal. It is no doubt our largest grower. We've seen it move from sort of middle single digits, 5%, 6%, 7%, to between 10% and 15%. And we think it's growing sufficiently strong that, that will be the overall growth rate for the year. So that's the biggest single contributor. Now we have the contract capacity. We have the task orders. We have work that's just ramping up now. We're being considered for other work where we think we provide the best service, the lowest price and the best technical approach to the clients. So I expect that we should be considered for more work than we even see today there. So I expect to it to remain at the forefront of the growth and continue.

And again, I'll point to an announcement this week, which I'd mentioned earlier for a more than $100 million engineering support. I would say that - I talked about briefly on the geospatial contract between NASA and USAID, which was announced just in the past 2 weeks. If you go before that a few weeks, you can see a $80 million increase in ceiling for Power Africa. And my only point on those is, it's not one country, it's not one geography and it's not one department with our clients, so it's very broad-based. And so I expect it to continue.

Second largest area is Department of Defense. And we've actually seen a number of smaller awards. We've done a lot of work with the Army through the Army Corps districts. They have over 50 districts and we've had a number of different single awards for design contracts, flood control, environmental planning, facility consolidation, real estate efficiency with respect to energy usage. And these contracts are typically between $5 million and $15 million, they range from 1 to 3 years.

So you typically might spend something less than $5 million per year. But when you multiply that times a dozen districts, it actually becomes significant and that's what we've seen. We also were competing for some of the larger programs on the environmental side. We'd expect to be competitive on those, and we will press release those.

And I think, that they are larger program are typically on the environmental side and they're more programmatic. And so take a look for press releases on that front, which would support this. I think we feel confident with respect to we'll fare well over a number of different competitions. We'd love to win everyone, but certainly, we'll win our share or better. So I think, that's why DoD is increasing, because of the contract awards, the single award and that's how they divided up between the districts in some of these larger programs.

I'll also say that, while we saw sort of minus 10% to 15% year-over-year DoD decreases in the past few quarters, we've seen that improve dramatically and I expect no reason to believe that, that won't continue through the fourth quarter, that's why we feel better. And by the final area, the final bucket is the civil works, which is Federal Aviation Administration, a National Science Foundation, Environmental Protection Agency, those are all have been funded quite well. And even areas such as NASA programs have been contributing well. So that's sort of low to middle single digits, 3%, 4%, and 5%.

Andrew Wittmann

That's a very helpful answer. Just one final one for me. As you look at the fourth quarter guidance numbers, growth rates that you had on Slide 13, it does imply the acceleration you talked about the comp issue. The easy comp and some of the federal stuff for 4Q, that's going to help optically accelerate the organic growth rate. But I guess how much can we extrapolate that, that fourth quarter? Is it really just a comp? Or should - do you see the organic growth rate accelerating from here as we move into '17?

Dan Batrack

Well, no doubt the comp will look good, but as I've indicated, Q3 as a high point for the year. Certainly a high point compared to last year and I expect it to increase sequentially from there. So I would say it's not just a year-over-year comp, actually the absolute number is going up. I am going to refrain from providing any 2017 outlook at this time. I think, you can certainly take a look at our backlog and contract capacity, you get some indication, but in our next call, we'll not only present the results of our fourth quarter, but we'll actually provide guidance details and specific insight into 2017 as well. If you please, just remain a bit - a bit refrain from discussing our 2017 outlook.

Andrew Wittmann

All right. That make sense. Thank you.

Dan Batrack

Great. Thank you very much, Andy.


Your next question comes from the line of Corey Greendale with First Analysis.

Corey Greendale

Hey, good morning.

Dan Batrack

Good morning, Corey.

Corey Greendale

And Congratulations on 50 years and if Dr. Wong is listening congratulations to him as well.

Dan Batrack

Thank you.

Corey Greendale

So actually, I want to pick up on that last question, but maybe I'll ask it in slightly different and broader way. So historically - recently, you haven't had in your slides kind of a long-term growth expectations. I've sort of been hanging onto one that you've laid out a while ago. So can you talk about whether kind of a mid-teens growth with half of that being organic is realistic and kind of what - it's been a while since you've consistently grown that fast organically, so what would have to happen to get to upper single-digit organic growth consistently?

Dan Batrack

Well, that's a great question, Corey. We have included it. We typically include that on our - going into the year, our slides and our presentation materials, going into a fiscal year. But I will reiterate it for you, it's materials that we have included in our shareholder investor component of our website.

So we are targeting on an aggregate basis, and that means both organic and acquisitive, about a 15% top line growth, with margin expansion that should allow the bottom line to grow slightly greater than that. Now the partitioning of that 15% between organic and acquisitive, I would say that back in the 2000s and for us, even into the early 2010, '11, '12, because the government's stimulus program had driven revenues quite quickly where we're well-situated, we were looking at half-and-half, half acquisitions, half organic.

So that's what you'd seen before, which is the upper single - middle to upper single digits. And we have tempered that, because of a slower GDP growth around the world. We've seen that remain tempered. We've seen the large contributions of stimulus programs in the U.S. common sort of work through the system. And so we've been targeting about a 5% organic growth rate, with a 10% acquisitive contribution to that to get to the 15%.

Now I think, that you see even for this year, that we have a range of 2% to 5%. You can actually model that out, and see if the federal government contributes a bit greater here in this fourth quarter, we could hit up toward that 5%, so we'd achieve that number. So if the question is, when are you going to achieve it? This year. And what's the number? Potentially 5%, but we'd have provided a range today of 2% to 5% for the year. The 10%, of course, the question is, are there opportunities out there? And what are you interested in? We're interested in smart water.

We're interested in data analytics. We're interested in federal and commercial IT, with respect to big data here in the United States. We're interested in geographic presence on the East Coast to help us with new regulatory compliance, such as the combusted coal residuals or the coal ash rules, we're interested in that.

And we're also interested in places like Asia Pacific, specifically, Australia, for firms that would help move this more into the municipal business where we can provide water supply, water treatment, infrastructure, flood control for the cities and the east of Australia is our top priority. There's lots of opportunities out there, having 10% contribute to that component at the right pricing is more than possible and combined 5% organic and 10% acquisitive, would get us to roughly a 15% annual compounded growth rate.

Corey Greendale

Okay. And I apologize, if that's on the list and I just didn't notice it, but that's very helpful. Thank you for elaborating on that. Specifically, in Coffey, you talked about the margin profile. Can you give us some sense of what the organic growth? I've know it's kind of an up and down. How should we be thinking about their organic growth profile with an anniversary next year?

Dan Batrack

That's a great question. I think, Coffey is, you really have to - we really look at Coffey as 2 or 3 different businesses. And let me start with the one that we think is the strongest, at least in the short term. About 1/3 of their business or a bit more, is USAID. And that's the portion that they have here in the United States. I do think that there has been in the marketplace a misperception as to what Coffey is.

It was a Australian publicly-listed firm, but with most of the revenue outside of Australia and in fact, the majority, the single largest component was here in the United States. So we expect it to grow at rates similar to what we're seeing for USAID, which is the 10% to 15%. So you need to look at 30% to 40% of their business is growing at that rate, which is similar to ours on the USAID.

The second component would be their international development work outside of the United States and that would be the U.K. and Australia, let's say, it's growing, but at a lower rate. And so that organic rate maybe between 0 and 5% depending on the quarter, we're still working through that. And the third component is the work that they're actually doing in Asia Pacific, which is more specifically, in Australia and New Zealand. And that's primarily the geotechnical work in soil science and environmental activities.

And that work has been very challenged as is everybody's business in that area. It's been very flat, in fact, declining a bit. And it is one of our top priorities to move them into areas that will see more funding, which is the municipal work in cities like Melbourne, Sydney, and Brisbane and the other large population centers. We are one of the word leaders in that. And in fact, in North America, we are the leader in those markets.

And we would like to take that technology and technical capability, export it to Australia and actually combine that with the staffing and other new acquisitions that we could bring to see that become a growth area for us too. But I would say right now, you've got those 3 different pieces. If you integrate them, you're probably looking at somewhere between low single digits 2%, 3%, 4% on an integrated basis, but that will change as we move into 2017.

Corey Greendale

Very helpful. And then on the acquisitive growth side, so you're already back to the low end of your target leverage range. Should we assume as you get below that, that you are more likely to allow that to happen for a while to preserve capacity for acquisition, as opposed to accelerating the repurchase program?

Steve Burdick

I think - Corey, this is Steve. I think, that's a good question. As Dan said, we have quite a bit of acquisitions that we're looking at or potential acquisitions. And so I think looking at the stock buyback is something that in slower acquisition times that can go up and to keep our leverage up. And as we complete future acquisitions in the future, we could temper that down a bit. So it's something that we want to keep balanced on a go forward basis, but our overall goal is to stay between 1 and 2 times net debt to EBITDA.

Dan Batrack

And Corey, I'm going to add just a word on that to give you sort of a qualitative feel to this. I think, we're more inclined to go over the 2 than we are under the 1 . And let me tell you what that means. What that means is, if we don't have acquisitions, what you just had identified is, if we don't have acquisitions, we generate cash, we'll clearly go below 1.

But we do certainly have both the buyback dividends and other means to return cash to shareholders to keep us in that range. So I would feel more comfortable with us remaining between the 1x and 2x with our ability to lever up for the acquisitions that could take you conceivably to the upper end or slightly over and then come back down rather than just see our balance sheet become under levered and actually find ourselves not fully deployed into the marketplace and returning to our shareholders. So just to put this in context, I think, we should maybe perceive it as the other side of this mix than going low.

Corey Greendale

That's very helpful to know, Dan. And not to try nearly [indiscernible] too much on that, but then, with that in mind, I mean, is there an upper bound that these things wouldn't be comfortable going over a three times? Or how should we think about that?

Dan Batrack

It's really - I would say that under, what I would call, under our current strategy, you can easily get to 3. I think, that it's difficult to do the calculations and get us to three unless there is something that's is approaching, something - getting close to transformative acquisition. Because you can't deploy that type of cash without significantly moving the revenue side of it, given the discipline we have on the multiples for acquisitions that we pay. So you can do that math and say, how we do ever get above 3 for instance and not have the revenue significantly moved.

With that said, if there was an appropriate transformative acquisition, we are always looking for the right combinations that will benefit our position for our clients and projects in the marketplace. We are not adding anybody, whether it's a tuck-in or a strategic acquisition, just for revenue contributions, that's not the goal, it's to strengthen our leadership position or to penetrate a new market that we're not in today. That's why we actually do acquisitions. So we would do, if it actually met that criteria, for geography clients, and increasing margins, we would look for transformative and then I would say, take these multiples off the table, and we'll talk about that when we've identified the right opportunity.

Corey Greendale

That’s very helpful. Thanks. And again, congratulations.

Dan Batrack

All right. Thank you, Corey.


Your next question comes from the line of Ryan Cassil with Seaport Global. Please go ahead.

Jordan Bender

This is Jordan Bender in for Ryan today. I was wondering if state and local infrastructure organic growth appears to be accelerating and you've talked about 5% to 10% growth rate there, given industry dynamics, how sustainable is that growth rate?

Dan Batrack

It's a good question, Jordan. We have had many, many quarters sequentially, where we've been between 5% and 10%. You saw this last quarter, 7%. Interesting that it falls almost right in the middle. I don't know that I would say it's accelerating, we're doing quite well, but I would say, I see it sustained. And so I think, it may go up, maybe the upper end of that range, it may go to 8% or 9%, you may see it go down to 5% or 6% depending upon timing of individual projects. We do see a pretty clear series of opportunities and funding projects that we have coming forward that should see it remain at this level.

We've actually picked up some winning projects in new geographies that we hadn't been before, we're actually bringing in new technologies and new engineering approaches. I think, that will allow us to continue. There are places such as California that have big bond funds that were put in place, and the funding is actually just hitting the Street, so to speak or hitting procurement just now. And I think, '17 will be a much bigger year.

And so that also gives us more visibility to make what I would call, this type of growth rate sustainable. But we're not forecasting that it's going to accelerate and move for instance, into the double digit. So I think, between a 5% and 10% range is what we see in the foreseeable future.

Jordan Bender

Okay. Thank you. Also my question here, oil and gas project activity appears to be picking up based on the commentary from others in the industry. Have you seen any increase from the front end activity to this point? Or is it just too early to tell?

Dan Batrack

Yes. It's a great, question, Jordan. Actually, we've seen - I've listened to the commentary of other service providers. And I certainly listen very closely and meet with our clients. In the United States, we've seen it continue to be slow. And in fact, I would say that it's even seen as far as opportunities to become a little bit slower, which is why we actually reported a slightly lower forecast for this year than we had coming up into the middle of the year.

We thought we would be down, maybe 5% or 6% year-over-year. We're about $400 million in 2015, up until midyear, maybe even slightly into third quarter, we were thinking maybe $375 million, and we're now thinking maybe $325 million to $350 million. So a slightly - a slight decrease. I'm really glad to hear the commentary from others, that they see it picking up. But I listen to what they say, but actually watch and believe what we see. And so it's - in the U.S., it's been slow. I have spoken to this in the past, we've seen orders and projects that are smaller in durations, smaller in dollars, that's almost a book and burn per quarter. In that way, things can move quite quickly, that's why you can see a change maybe even month-to-month and certainly quarter-to-quarter. But we've not seen that pickup. But as soon as we do, I assure you, we'll report it back to you all and you'll see it in our results. But what I will also say, we're not seeing a cliff or any type of steep drop off, so this all sort of within a range of what we would expect given the market position today.

Jordan Bender

Awesome. Thanks. That’s my questions.

Dan Batrack

Great. Thank you, Jordan.


Your next question comes from the line of Noelle Dilts with Stifel. Please go ahead.

Noelle Dilts

Thanks. Good morning. Congratulations on a good quarter.

Dan Batrack

Great. Thank you, Noelle.

Noelle Dilts

My first question, just expanding kind of on that last commentary on oil and gas, how are you thinking about the growth rate of that division as you move into that end market, I should say, if you move into 2017?

Dan Batrack

Well, coming - throughout this year and actually over the past couple of years, we've - about half of our revenues have been in Canada and half in the U.S. So as we enter 2017, again, I'm not going to talk about what our forecast for '17 is, but I will talk about Q4, and what our visibility is today. We do have most of the fourth quarter and I have talked about, about half of our Canadian work is actually in backlog through most of '17. So only because we've spoken about that before. So I think, the Canadian revenues, at least through '17, look fairly well-funded.

And so I expect little volatility there through '17. In the U.S., it's been a very short visibility. I don't want to say volatile because that's not really true. We haven't seen volatility in the revenues, but we have seen shortening of the visibility because past quarters have become smaller, shorter duration and so very short and choppy. It makes it very difficult for us to have forecast in the U.S. out into '17. I will say that there are a number of RFPs for some of our long-term clients that we do see that would represent longer term projects that would give us visibility out farther. I think, there's 2 questions, one, will they go forward with their projects, which are very front end? And 2, will we be successful in having them awarded to us? So those are sort of the 2 components. But right now it's too early for us to provide any type of visibility beyond really a quarter or two in the U.S. oil and gas.

Noelle Dilts

Okay. And then I apologize if I missed this early in the call. But in WEI you mentioned Canadian infrastructures being down. Can you expand on what the drivers of that decline are?

Dan Batrack

Yes. The funding and spending, because of the downturn on the commercial side, which is mostly the energy side, so it's the oil and gas being by far the biggest driver. I've seen a lot of softening as you might be aware from the oil sands, and that's actually filtered out into apprehension on the - of the provincial and some of the municipal work in Canada. We have seen drops that roughly offset the U.S. state and local growth.

It really span all the way from core back in the east all the way through British Columbia in the West. And even in some of the northern territories, we've just seen a very broad slowdown in spending as Canada's and the other commodity-driven countries go through what, in some areas, are recessions. I think, some in oil-producing provinces might say depressions in certain areas.

But I will say, we are encouraged by RFPs request for proposals coming out, that may be associated with the national government's stimulus program. And our biggest portion of the work we have in Canada is on the municipal and provincial side. And so we would be one of the benefactors of that spending. So while it looks a bit gloomy up there right now, just part of an overall slowdown, and the numbers are sort of a 4%, 5% reduction at that level, we do think that there could be something that would turn it around. It's specific. It's the national stimulus program. It's immediate. They wanted to happen now and we're very well-positioned across the country.

Noelle Dilts

Great. Thank you.


Our final question comes from the line of Jim Giannakouros with Oppenheimer.

Jim Giannakouros

Hi. Good morning, guys. Thanks for taking my question.

Dan Batrack

Thanks, Jim

Jim Giannakouros

Coffey - sorry if I missed it on Coffey, but net-net EPS contribution in '16, $0.05 to $0.07, is that still intact? Or did that [ph] in-chop given the margin expansion you're seeing?

Steve Burdick

Yes. That's probably right about where we are in terms of their contribution.

Dan Batrack

Yes. And I would say to that, that, if that number - should that number be increased, our forecast was sort of that range. We had always, including in our investor call last quarter, we had always anticipated that the margin was going to increase to these levels. So while - so for our analysts and maybe even investor too, are surprised that we accomplished what we said, we're not surprised. So that was already baked into our contribution for Coffey.

Jim Giannakouros

Got it. I don't know if there was some wiggle room there on that accretion estimate, but it doesn't look like there was on. On U.S. federal, I guess, just USAID versus DoD, are you seeing margin stability or improvement there from - solely from a pricing perspective as your projects funnel apparently is growing. I get that you should be seeing higher margins over time just from a higher utilization rate, but just again focusing on the pricing environment in U.S. federal and then I guess the same question for state and local.

Dan Batrack

Because a lot of the work that we do, and I will say that this may be an artifact of the portion of the business that we are in, we really are in the very front end consulting, technical evaluation, feasibility study, upfront science and data collection. We are at the very front end where a lot of our work is based on selection of technical qualifications, history of performing the work and solutions being proposed.

A lot of that work is cost-plus, or some of the work is cost-plus where it's - there is not pricing power, meaning, that you can get a higher or lower pre-negotiated fee that was set. It has not changed materially and so we've not seen very [indiscernible] there. We've also not seen on our time and materials for fixed-price work the ability to increase the prices.

So I would say that the margins is far as from a pricing standpoint, both at the state and local and federal level have remained constant. You're right, there is a margin expansion based on utilization and leverage of back office and all the rest of it. But with respect to pure pricing power in dollars per hour on a T&M rate or something like that, we've not seen any particular upside or any new pressures that are new to the market. So I'd say that's been very static.

Jim Giannakouros

Thank you. That’s all I had.

Dan Batrack

Great. Thank you very much, Jim.


So this will conclude the Q&A session. I will now turn the conference back over to Dan Batrack to conclude it.

Dan Batrack

Great. Thank you very much, Brent. And thank you all very much for your questions and interest. I really appreciate your support, and your following the company. Clearly, your question show that you have a deep understanding of where we are and I'm very glad to have been able to communicate a very good third quarter and our forecast for the fourth quarter. I look forward to speaking with every one of you again next quarter, and have a great rest of the summer. And I'll talk to you soon. Bye.


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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