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Edited Transcript of TTEK earnings conference call or presentation 14-Nov-19 4:00pm GMT

Q4 2019 Tetra Tech Inc Earnings Call

PASADENA Nov 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Tetra Tech Inc earnings conference call or presentation Thursday, November 14, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dan L. Batrack

Tetra Tech, Inc. - Chairman & CEO

* Steven M. Burdick

Tetra Tech, Inc. - CFO, Executive VP & Treasurer

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Conference Call Participants

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* Andrew John Wittmann

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Marc Frye Riddick

Sidoti & Company, LLC - Business and Consumer Services Analyst

* Noelle Christine Dilts

Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst

* Sean D. Eastman

KeyBanc Capital Markets Inc., Research Division - Senior Equity Research Analyst

* Tate H. Sullivan

Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst

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Presentation

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Operator [1]

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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. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the Investor section of its website at www.tetratech.com. This call is being recorded at the request of Tetra Tech, and its broadcast is the copyright property of Tetra Tech. Any rebroadcast of this information in whole or part without the prior written permission of Tetra Tech is prohibited.

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 open up the call for questions.

I would like to direct your attention to the safe harbor statement in today's presentation. Today's discussion contains forward-looking statements about future growth and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in Tetra Tech's periodic reports filed with the SEC. Except as required by law, Tetra Tech takes no obligation to update its forward-looking statements.

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

(Operator Instructions)

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

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [2]

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Great. Thank you very much, Michelle. And good morning, and welcome to our fourth quarter and fiscal year 2019 earnings conference call.

Fiscal year 2019 was an extraordinary year for us here at Tetra Tech. We grew at double-digit rates across multiple metrics, resulting in record highs for revenue, net revenue, earnings per share and our cash generation. We ended the year with our backlog exceeding $3 billion for the first time in Tetra Tech's history, providing us with excellent visibility and momentum as we enter fiscal year 2020.

As we enter this new decade, we see increased global demand for our differentiated water and environmental services and our high-end Leading with Science approach. I'll begin today's presentation with an overview of our quarterly and annual results and our business outlook, while Steve Burdick, our Chief Financial Officer, will provide additional details on our financial performance and our capital allocation.

We had a very strong fourth quarter, led by our revenue, earnings per share and backlog growth. Our net revenue of $640 million was up 14% from the prior year. Our fourth quarter adjusted earnings per share of $0.88 was up 17% from last year, and our backlog was up 16% year-over-year finishing at just under $3.1 billion, the highest in the history of the company.

In the fourth quarter, we added the firm White Young Green, or WYG, providing us with a new United Kingdom platform. And I'm pleased to say that our initial integration is going extremely well. Our collaboration on operations and business developments already yielded very positive results.

I'd now like to provide an overview of our performance by our customer. In our fourth quarter, we had growth across all of our end markets, especially for the United States, state and local and international sectors. State and local revenues were very strong this quarter with an organic net revenue growth of 31% year-over-year. This is the fourth consecutive year of double-digit growth for our state and local business. This growth is a direct result of municipal water infrastructure work in the metropolitan areas of California, Texas and Florida, and for continuing disaster response and recovery services for past fires and floods.

Work for our U.S. federal clients was 28% of our net revenue in the quarter and was up 8% year-over-year. The increase in U.S. federal work was driven by our consulting work for the Department of Defense, various civilian agencies and for the U.S. state department.

Our U.S. commercial net revenue was 23% of our business and up 1% year-over-year. Our environmental permitting and the renewable energy consulting and design services were up, while some of our larger environmental restoration programs were ramping down in the quarter.

And finally, our international net revenue was up 21% year-over-year driven by local water and environmental work in Canada and Australia, and with the addition of WYG in the United Kingdom during the quarter.

I'd now like to present our performance by our business segments.

Our GSG and our CIG segments both grew at double-digit rates in the fourth quarter. The GSG segment was up 15%, with strong growth in broad-based water and environmental programs, disaster response and our longer-term recovery services. The GSG segment continued to deliver excellent margins at 14.1% for the quarter. Our CIG segment grew by 12% year-over-year and delivered over a 10% margin, up 280 basis points from the same quarter last year and 40 basis points up from the very prior quarter.

For the full fiscal year of 2019, we achieved all-time record highs in net revenue, operating income and earnings per share. Tetra Tech's full year for net revenue was $2,406,000,000, which is 9% up compared to last year. Our operating income was $241 million, up 11% from the prior year. And our earnings per share was over $3 for the first time in the company's history, with an earnings per share of $3.17, up 20% from the prior year.

Tetra Tech's backlog was up 16% year-on-year on strong orders in the quarter, with the largest increase occurring in just this fourth quarter of the year. The last quarter of the fiscal year is typically our strongest quarter, however, we were also pleased to see a number of long-term pursuits come out with favorable outcomes in the quarter. We ended the quarter with $3,090,000,000 in backlog. As I mentioned earlier, for the first time, over $3 billion in the company.

Strong orders in the quarter also resulted in a sequential 9.1% increase in our backlog from the quarter. And in the fourth quarter, we won new programs and task orders for our differentiated water and environmental services across a very broad base of our clients, both in the United States and internationally.

We continue to expand our contract capacity for global analytics and water-related services. We were also awarded a new contract for a water program in Mongolia that will leverage our analytical, water planning and engineering expertise in providing safe water supplies. In addition, we were awarded multiple task orders for water management, flood protection and dam restoration in the United States, continuing our long-term technical support for key federal agencies, including the U.S. Army Corps of Engineers.

Now I would like to turn the presentation over to Steve Burdick, our Chief Financial Officer, to present the details of our financials from the quarter and the year. Steve?

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Steven M. Burdick, Tetra Tech, Inc. - CFO, Executive VP & Treasurer [3]

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Okay. Thank you, Dan. So as Dan just highlighted, our adjusted revenue, net revenue, operating income and earnings per share for the fourth quarter of 2019 were among the best quarterly results in the history of Tetra Tech. Now on a GAAP basis, the fiscal 2019 fourth quarter revenue of $842 million increased 14% when compared to the revenue of $739 million in the fourth quarter of fiscal 2018. And likewise, the fiscal 2019 fourth quarter net revenue of $628 million increased 14% when compared to the net revenue of $553 million in the fourth quarter of fiscal 2018. So overall, these revenue increases resulted primarily from our U.S. focused environmental and water engineering and consulting work, our international renewable energy and sustainable infrastructure efforts, especially those in Canada and now also in the U.K., and the disaster response and recovery planning activities that we have continued into the fourth quarter.

Also on a GAAP basis, our operating income in the fourth quarter 2019 was $21 million compared to $43 million last year, and earnings per share was $0.21 compared to $0.51 last year. Now on an adjusted basis, we generated a 5% increase in our quarterly operating income year-over-year and a 17% increase in EPS. This increase in operating income and EPS was driven by our revenue growth and by our continued focus on front-end consulting and engineering services. And so for those of you following along on the webcast presentation, I'd like to walk you through a reconciliation of our GAAP results to our adjusted net revenue operating income and earnings per share.

So first, in the fourth quarter, we made a decision to exit our Canadian turnkey pipeline business. And as we've discussed in the past, this part of our business was contributing on revenue but with little or no margin. And as we continue to grow our high-end consulting business, this was no longer core to our long-term strategy. Now although we expect this decision to have cash flow-positive impact on fiscal 2020 as a result of this disposition, we did recognize Q4 charges totaling $19 million for goodwill impairment of about $8 million and severance and asset valuation impairments of about $11 million. Ultimately, we expect to realize longer-term improvement in our operating margins, our working capital and our cash flow while bringing down the risk in our operations.

Also during the fourth quarter, as we previously discussed on the third quarter call, we completed the acquisition of WYG. The acquisition of WYG provides Tetra Tech a solid platform in the U.K., whereby we can further grow our consulting and engineering services for both governmental and commercial clients. And as part of this acquisition, we did incur charges totaling about $10.4 million during the fourth quarter. These before transaction costs and fees of about $3.3 million and one-time integration costs of about $7.1 million for severance, asset valuation issues and lease impairments.

And finally, subsequent to our fiscal year-end, and in fact, just last week, we received an arbitration decision in our favor for a contractual dispute on a project which was contracted for at RCM back in 2008. Although we won the legal arbitration, the amount awarded to us was less than our estimated recovery. And as such, we reduced our revenue and thus, recognized an additional noncash charge of $13.7 million in the fourth quarter. This does resolve one of the last large historical claims.

So now, turning to working capital and our balance sheet. Cash flow generated from operations in fiscal 2019 totaled $209 million. This compares favorably to the prior-year cash flow of $186 million by about $23 million, or an increase of about 12%. This excellent cash flow was a result of our continued focus on collections of accounts receivable and management of our working capital. And among the many benefits of this cash improvement was the management of our debt. Our debt increased only slightly from $131 million last year at this time to $156 million, and our net debt-to-EBITDA settled below 1.0 factor at about 0.6x due to our continued strong cash flows in operation.

And lastly, our day sales outstanding decreased to 77.6 days as of the fourth quarter. This is an improvement of almost 8 days from last year. But we expect to do better in fiscal 2020 with a target DSO of 75 days, which currently, we are a lot closer to now than we were last year.

I'd like to go through our long-term capital allocation strategy, which calls for a balance of investing in the growth of our business, managing the balance sheet and returning cash to our shareholders. Our continued strong annualized operating cash flows and especially the $209 million of operating cash flow for the year, allows us to continue to do just that. We've been able to invest in strategic areas while growing the top and bottom line. And to that end, in the fourth quarter, we closed the acquisition of WYG. Moreover, we paid out $8.2 million in dividends in the fourth quarter. And in all of fiscal 2019, we've paid out about $29.7 million in dividends. And just last week, our Board of Directors approved our 22nd consecutive dividend, which will be paid in the month of December at a rate of $0.15 per share. In addition to the dividend payments to our shareholders we completed $25 million in share repurchases in the fourth quarter and a total of $100 million in all of fiscal 2019. Going forward, we look to continuing the quarterly dividend program and utilizing the $125 million remaining under the approved stock buyback program.

So I'm very pleased to share these outstanding financial results for the fourth quarter and all of fiscal 2019. Thank you for your time today, and I will now hand the call back over to Dan.

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [4]

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Great. Thank you, Steve. I'd now like to turn to our outlook for the 2020 fiscal year. We're starting a new fiscal year that is the first of a new decade, and we're entering this new decade with a company that's been built on Leading with Science since our founding of the company over 50 years ago.

It's quite impressive how the first-of-the-kind research that we've done over the years has resulted in the differentiated water and environmental services that we offer our clients today. In past decades, we led the way in water modeling and simulation, we deployed telemetry in extreme environments, designed large-scale river sediment restoration programs, and most recently, applied our real-time cloud-based systems to address the unprecedented disaster-recovery needs here in the United States.

As Tetra Tech has expanded to new geographies and markets, we've scaled our technology to efficiently and effectively address our clients' needs with a talent force of over 20,000 staff worldwide. It's this success that has resulted in our #1 industry-leading rankings with the Engineering News-Record. Today, Tetra Tech's high-end services are in more demand and more relevant than ever before. As our clients address the extremes of climate, the needs for resiliency in the infrastructure, the technology-driven transformation of our cities and the sustainability management of our resources.

At Tetra Tech, we've been combining our domain knowledge with technology that's embedded in the delivery of our services across the over 70,000 projects we perform in a year. We call our technology the Tetra Tech Delta, the tools that differentiate us. These are the technologies that we've developed for our project work, such as specialized software, data collection and sensor solutions with numerous patents and proprietary solutions that we have here in the company.

The Tetra Tech Delta includes software solutions to assess watersheds in coastal regions, techniques to apply real-time control for water management and tools to help our clients manage their capital plans and assets. We help our clients monitor and assess in real time. We decipher the acoustics associated with air traffic. And even autonomously assess infrastructure conditions at high speeds. Our proprietary 3D design apps are also used to augment our high-end design services.

As we've grown, we've also developed the internal systems to scale our technology across our global operations. We have innovation hubs for collaboration with our clients and innovators' program to identify and develop patent submissions, and the technology transfer program that shares the Tetra Tech Delta information worldwide across all of our associates. In 2020 and beyond, we see the Tetra Tech Delta as a significant competitive advantage that brings our world-class solutions to bear on addressing the increasing global focus on climate, resiliency and sustainability.

I'd now like to highlight our outlook on the water and environment markets. Since our founding, Tetra Tech has focused on solving water-related problems for our clients. Our long-term focus on success in this market has resulted in Tetra Tech's #1 ranking with the ENR in water for 16 years in a row.

Our water-related services address the full water cycle, from managing stormwater to protecting our lakes and oceans. Tetra Tech Delta that we provide allows us to design the most cost-effective and sustainable water solutions for our clients.

The water market has seen an increase in attention and funding spurred by concerns associated with extreme events such as sea level rise. The cost for upgrading the shoreline protection in the United States alone is estimated at approximately $400 billion over the next 20 years, roughly equivalent to the cost of building the interstate highway system all across the United States.

Funding is also increasing for resiliency and sustainability. The U.S. Federal Emergency Management Agency, or FEMA, has now established that 6% of its disaster funding will be spent on pre-disaster mitigation. Our market leader, disaster recovery planning and mitigation design capabilities are well-matched to this funding.

We also see the green tech market continuing to expand with more than $25 billion being invested by 2024. For us, this market includes supporting renewable energy, such as offshore and onshore wind and solar, and high-performance green building design.

Another emerging area is ocean stewardship and plastics reduction that is resulting in significant new funding globally. We were just awarded a first-of-its-kind $48 million contract with the U.S. Agency for International Development to assess and develop plastic reductions and mitigation strategies for ocean protection.

As we enter fiscal year 2020, we see a strong growth outlook across all 4 of our major customer sectors. In fiscal year 2020, we expect Tetra Tech's International revenue to grow at a 7% to 12% rate. Our international growth will be driven by water and environmental planning, consulting and engineering work in the United Kingdom, Canada and Australia. We expect our U.S. federal work to be almost 1/3 of our business and grow at a 5% to 10% rate for the year.

This increase in federal work is supported by our current backlog, which will convert to revenue for our civilian, Department of Defense and international development-related services. We expect our U.S. state and local work to continue to be a growth market for us with municipal water and planning services and longer-term disaster recovery work growing at a 10% to 15% rate, continuing our industry-leading performance in this market. This growth rate does exclude the more episodic disaster response services for year-to-year comparisons. I would like to note that we have more than 400 clients in established contracts in these areas in the coastal regions of the United States that we can rapidly respond when a storm event does occur.

And finally, our U.S. commercial work is expected to grow at a 3% to 8% rate, with increases in revenues expected in environmental permitting, renewable energy and green building design.

I'd now like to present our guidance for the first quarter of fiscal year 2020 and for the entire year of fiscal year 2020. Our guidance is as follows: For Q1 of fiscal year '20, our net revenue has a guidance range of $600 million to $640 million, with an associated adjusted diluted earnings per share of $0.75 to $0.80. For the entire year of fiscal year 2020, our net revenue guidance range is from $2.4 billion to $2.6 billion, with an associated adjusted diluted earnings per share of $3.35 to $3.55. Now this earnings guidance does include intangible amortization or noncash charges of $0.14 per share for the year. We do anticipate a 23% effective tax rate for fiscal year 2020. We do anticipate an average of 55.5 million shares outstanding. And this revenue guidance does exclude the contributions of any acquisitions that would be completed during the year.

In summary, we had an excellent fourth quarter and all of fiscal year 2019, setting new records for revenue, net revenue, income and earnings per share for our shareholders. Our backlog reached an all-time high for services that align with long-term growth trends and priorities, providing us excellent visibility as we enter into fiscal year 2020. And as we begin this new decade, our differentiated water and environmental services and Leading with Science approach is well-differentiated and in very high demand and making things very exciting for us and our shareholders with new benefits to our clients as we enter fiscal year 2020.

And with that, Michelle, I'd like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the line of Sean Eastman with KeyBanc Capital Markets.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Senior Equity Research Analyst [2]

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The first question for me is just on the state and local business. So my understanding is the FY '20 outlook reflects a 10% to 15% growth rate in that business when neutralizing the fact that you're not building in any episodic storm response work. The 10% to 15%, just seems like a really high number for that type of end market. So maybe you could just speak to whether the market share gain element's still happening there for Tetra Tech. And maybe how your outlook compares to the underlying growth rate in that end market.

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [3]

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Great. Thank you very much, Sean, for the question. And our state and local market, as I had referenced in my prepared remarks, has been the strongest end market for us in the last 4 years. And in fact, I think in the last 4 years, we've seen double-digit growth, organic growth, in state and local work. In each of the last 4 years, and I would say, even in the prior year, it was the fastest-growing of our clients. And that's not including the episodic growth rates, which have pushed us to 30%, 40% and 50% of growth rates year-over-year for given quarters. Some of it is we are taking some market share, but I'll tell you, we've really been focused on new, emerging focuses of investment by our clients that didn't exist before, and to be their first, to be their best, and to actually set the technology and to set the pace in those areas. And those include, over the past several years, areas of new water supply in the Southwest. So for instance, water reuse as part of capturing wastewater, treating it to a very high level, and then actually creating it as a new water supplies in California and other areas. Actually treating contaminants and desalination. We're the largest desalination designer in the United States. In the Southeast, where there's actual water quality issues, from saltwater intrusion into different wells and other areas. And actually, desalination in other areas in Texas, which is in the east, where there's too much water, and actually establishing new technologies for mitigating it and protecting it from floods; and in the far west, actually new desalination for new water supplies that didn't exist before. So we consider all of this sort of new ground, new funding that isn't taking it from someone else or capturing market share, but actually being the first there to solve problems. So that's been part of the state and local. And the other, exclusive of responding to individual disaster events, we're actually working with our clients now to build a planning and recovery practice, and also, I would add mitigation, such that you could get ahead of the impacts of floods, fires or other events. And this has been a new area that's higher priority in new funding. So I would say some of it is taking market share, but most of it is in moving into new, emerging markets that, in fact, just didn't exist a few years ago.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Senior Equity Research Analyst [4]

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Got it. Very helpful. And next one is more for Steve. I'm just curious if you could speak to the free cash flow outlook for fiscal '20, perhaps relative to the earnings guidance you provided. It sounds like still some work to be done on the DSOs after making a lot of progress in '19. But are there any other moving parts there we should think about as it relates to that net income to free cash flow conversion?

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Steven M. Burdick, Tetra Tech, Inc. - CFO, Executive VP & Treasurer [5]

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Yes. So when we look at our -- first, our net income, our goal is, first, to generate cash from operations that exceeds our net income, first and foremost, and we've been doing that. I think the other thing that is going to be helpful, as you pointed out, is that we are working towards and getting closer to that goal of 75 days in our DSO, and so that will also be helpful. And then as we've moved to a very much a high-end consulting model, we have very, very little need for a lot of CapEx. So our free cash flow is pretty close to our operating cash flow, and I think you'll see an improvement next year over what we did this year.

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Operator [6]

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

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Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [7]

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Great. This is great. I had a couple of questions I just wanted to clarify, just maybe for modeling purposes, then we'll talk a little bit more strategically. But I guess, Steve, I think we estimated around $70 million of net revenue headwind from the shutting down of the pipeline business that would be in the CIG segment? And then I think the net revenue headwind for disaster restoration and response was about $100 million of net revenue in GSG. Are those the right levels to be thinking about as we put our models together in terms of the headwinds that you'll face in 2020 over 2019?

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Steven M. Burdick, Tetra Tech, Inc. - CFO, Executive VP & Treasurer [8]

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Yes, those are the right numbers to use in your model.

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Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [9]

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Okay, cool. And then just as it relates to the disaster and emergency response, I guess, it sounds like you don't have a lot in there for 2020. But can you just talk about -- I mean, there still are disasters happening, including some in your neck of the woods. Is it just too early to assume them because these fires are so recent? Or just what's the opportunity, do you think? Are there discussions happening in some of your legacy projects that you've been on that might give you some visibility, you just haven't booked it yet, so you haven't been comfortable in guiding to that? I'm just trying to get a sense on how much upside potential there could be as you see it here today, Dan?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [10]

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That's a good question, Andy, that, as you just indicated, we had $100 million in fiscal year 2019 of incremental or revenues associated with disaster response activities. I will tell you that, that came very quickly, and in fact, that allowed us to increase our revenue guidance during 2019. So it's not something that we forecast an event 1 or 2 quarters in advance. There have been some fires out here. And in fact, they're just putting them out now, and so it's quite early for that. Our guidance at the midpoint did not include any contribution from disaster response activities. If you went to the -- what would drive it to the higher end of our guidance would be some modest amount of response activities. But if anything similar to what took place in 2019, in fact, occurred, it would drive us not only to the upper end, but probably well past the top end of our guidance range. So we are not only negotiating, we are actually growing the other portion, which we think is -- provides multiyear visibility and predictability. We can include and have included in our guidance, which is actually the longer-term planning and recovery activity, which includes designing alternatives, mitigation, restoration, and identifying which is -- which are the priority items that would then move to longer-term design and implementation of the remedies that would be put in place that are, in fact, even longer programs.

So I think the more predictable activities are growing. They're growing broadly across the country. They're generally a little bit smaller, but have much longer tails. And in total dollars, are probably equivalent to the response, but it's over multiple years, not just a single season or just several quarters.

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Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [11]

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Okay, that's helpful. And I guess I just have 1 last 1 for now, and it has to do with kind of some comments you made earlier this year about trying to achieve a 13% net EBITDA margin at some point in the future. It looks like just, from back of the envelope math here, that somewhere around 12% is probably implicit around that midpoint of guidance for this year. I was wondering what some of the puts and takes are as you look at that 13% to get you from 12% to 13% in the next year. Can you talk about some of the -- either things that you're seeing in the market that will allow that and afford that? Or some of the actions that you will be taking or have already taken to this point, that will help you get to that 13% margin goal.

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [12]

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That's a good question. We're very focused on that. And we have the 2 segments, our government services group and then our commercial and international group. I would say that we have been at the 13% EBITDA margin. And in fact, we've been a little bit higher than that in our government services group. I think for this year, we -- if you actually do the calculation, you'll see it, in the coming quarters, we're anticipating roughly about a 13% margin in our GSG group this year. So we're there in that segment of the company, which then allows me to turn to the CIG, or the commercial international. The step we took to wind down and close out our turnkey Canadian pipeline business will actually help quite a bit. The numbers that were provided earlier by yourself just a moment ago, $70 million in Canada, actually didn't produce any income at all. In fact, it was actually a loss of $4 million, $5 million for the year. So it's just structurally, the things we're doing internally to shed that business, will actually move the CIG margin up. I think for this year, the overall number is about 11%.

But I would say that while we did shed this structural impediment to growing the margin within CIG, we did take on WYG, who I believe will actually move to a double-digit run rate margin by the end of fiscal year 2020. Certainly, we're a public company, and their financials are quite visible, and they were a low- to no-margin business, but that is changing really quite quickly. I do believe, by the end of the year, they'll be contributing at a number above double digits, above 10%. So for this year, we have an 11% margin for CIG. If you actually then calculate a $120 million U.K. business that does not even include growth, which I think we will actually be seeing this year, and you move it to contribute at a higher level. I would think that -- and it seems like a long way away. Fiscal year 2021, but we're halfway through Q1 of fiscal year 2020 already. So it's really not very far away. But I would expect in 2021, we'll have a CIG up at the GSG margins, and you'll see it progress during this year, both with the structural changes we've made with the type of business we have and the increase in the margins for some of the international activities that have joined us.

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Operator [13]

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Our next question comes from the line of Noelle Dilts with Stifel.

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Noelle Christine Dilts, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [14]

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Congratulations on a nice quarter. Thanks for those comments on the CIG margin. I was hoping that you could also comment on how you're thinking about GSG. It sounds like given your expectations around CIG, that you're your guidance assumes a bit of margin compression in GSG. So could you talk about the factors that are playing into that as you look forward?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [15]

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Yes, absolutely, Noelle. Well, we have, and have been very pleased with the GSG margins. They've been running around 14%. I will say, the last 2, 3 years, we have had each and every one of these years, a material amount of response work from hurricanes, from tornadoes, from fires, from ice storms. It has turned from a once every several years or once or twice a decade, into an annual event. And what's happened is it has kept our staff quite highly utilized within the GSG, which has driven our margins, even in some quarterly periods, up to 16% and even 17%, as you all have seen. Since these events actually are not underway for us at this time. We've actually been prudent. Some might say conservative, but I would say, appropriate, in not including or embedding this higher utilization that would then yield a higher margin. I do believe a good run rate for our government services is between 13% and 14%. We're in that range at this time for guidance. And as revenues pick up in that disaster response area that increases utilization, that then translates into more margin, we would look to update our forecast for the year for GSG. So it does -- I would -- while it does look to be a compression or lowering it from its 14% to 13%, I would say it's simply taking into account at the midpoint of our guidance, the lack of inclusion at this time of any response activities for disaster activities.

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Noelle Christine Dilts, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [16]

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And then could you just -- in the past, you've talked about your -- that you still have some capacity to support incremental revenue with your current staff. Any thoughts on where you'd stand today in terms of potentially needing to invest or add folks to meet demand? And curious if you could also comment just on generally, the availability of these skilled that you're looking to hire.

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [17]

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Yes, those are 2 topics that we're focused on here just on an ongoing basis. I wouldn't even say on a quarterly basis, just on an ongoing daily basis. We take a look at, as we submit proposals, how much additional revenue or work could we handle with the existing workforce that we have now. And we think it's probably approaching 10% additional revenue with, in theory, no additional headcount. Now it's not perfect that way because of the 10% increase all came in 1 segment or 1 particular market area, we may be stressed and have to identify more resources. But if you looked at it broadly, we could handle probably a 10% increase in revenue without adding additional resources, which then, of course, much of that would drop right to our margin and income and then earnings for our shareholders.

I would say that it is very market-dependent on the availability of staff. Some markets, there's actually quite high demand, and it is -- that folks in this industry like to use the word war for talent, in some of the statements they use. I would say these are in advanced analytics. These are in areas of very high-end technology differentiation. For the most part, we grow those internally. We don't go out and recruit and bring them in, although they do join us mostly through acquisitions of collective entities, and that did happen just as last year at the high-end, advanced data analytics with eGlobalTech and others that have joined us. So how we've addressed the shortfall or the high demand have actually had collective entities join us. But right now, we could handle a pretty significant increase in revenues with the staffing levels we have within the company.

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Noelle Christine Dilts, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [18]

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One last question. You've talked about this a bit in the past, but could you just remind us of the key buckets that will drive the margin improvement at WYG, kind of how you're moving from that essentially breakeven level today up to the double digits?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [19]

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Yes, absolutely. I think one is, we have changed the, I'd call it the back office organization structure, at Tetra Tech and all of our different divisions. We are highly focused on a seller-doer model with the senior principles and the management roles are practitioners. And that goes all the way up from the, I would say, from my role, all the way down through the organization. It does leave Tetra Tech with a very thin, extremely knowledgeable group of executives, that are also practitioners, that are leading by example. I think that there have been a number of acquisitions that WYG put together and had created a bit more of an administrative back office, which we are working with them. In fact, we initiated it even during due diligence, discussing with them the philosophical approach where we'll -- what we do when we come to work is we're not focused on how we manage our staff, we're focused on how we solve the problem for our clients, from the top, all the way to the bottom. And that process has already been put in place. I believe that will fundamentally change the, I guess, you'd call it, the SG&A, but I think it also embeds it in the overhead costs embedded in the execution of the operations, and that all falls to the bottom line. It also happens to have the benefit of putting our best technical people closer to our clients. It also makes us much more nimble, able to make decisions quickly, effectively and based on what we see at the front line. And the number of layers it has to go through the organization, it eliminates it to a very direct communication. So all of that's being put in place. We've also immediately taken our best-in-class experts within Tetra Tech and actually link them up with their colleagues and have submitted proposals that, in fact, have already won some programs in the first 90 days of their joining us. So the ultimate proof for folks joining us is more clients, more projects, more success and growth and increased margins. And that's what I expect to see this year with WYG.

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Operator [20]

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Your next question comes from the line of Marc Riddick with Sidoti.

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Marc Frye Riddick, Sidoti & Company, LLC - Business and Consumer Services Analyst [21]

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I wondered if you could spend a little time talking about maybe what your views are currently, as far as acquisition pipeline, given the opportunity that WYG is presented and that platform being added. Just wondering if maybe what the platform may look like for you? And to that extent, maybe how much time you're spending looking at those types of opportunities maybe this time of year versus a year ago or 2 years ago?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [22]

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Well, I think that having WYG join us is actually a big move for us because it really felt important to actually set a best-in-class platform across all of the U.K. with a presence in Europe in order to access that collective market, and that is what WYG brought to us. With the exception of the financial performance, I would tell you, they look a lot like Tetra Tech. They are technical leaders in planning work, in environmental work, in infrastructure design work, supporting the environmental and planning activities within the nuclear industry. And a lot of work with respect to local municipal planning support. The one area that I didn't mention just now is actually the area that is the ultimate hallmark for Tetra Tech, which is water. And so now, with WYG presence as a platform, and actually, we think it will be best in class, it's our intent to both bring in our technical experts, what we've initiated already, bringing the Tetra Tech Delta tools of the differentiation to the U.K., and we would look to expand now in the U.K., our water practice, and I think that would include through acquisitions, of people that are best-in-class in that sector, thought leaders, and best technical engineers and consultants. So what area are we looking in, we'd like to expand that part of our business in the U.K., and we think that, that's a high priority for us. And we feel more emboldened to do that now that we have a platform that we could have it enjoined.

Here in the U.S., we're very much focused on technical leaders in advanced analytics that can take their tools and expertise and actually help augment the -- we refer to it as domain, but technical experts that we have within the various disciplines of water, environment, sustainability program management. So advanced analytics here in the U.S. Water in the U.K. will be a big contributor. And then I would say other areas that would actually help us access different client sets that we can actually offer our water and environment and sustainable design services.

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Marc Frye Riddick, Sidoti & Company, LLC - Business and Consumer Services Analyst [23]

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Okay, that's great. That clarity. And I wanted to talk a little bit about maybe what you're seeing with commercial customers and their level of activity, receptivity, maybe some of the comments, the conversations that you're having with them. And to get a sense of -- there certainly seems to be a willingness to act, but I was wondering if you were getting a sense of that increasing. Or if there's any opportunity for maybe a little bit of a pullback concern with potential upcoming economic slowdown or that type of -- those types of conversations?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [24]

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Yes, yes. it's a great question, Marc, because certainly, there's a lot of concern or apprehension that an economic slowdown, even as far as going to a recession, could be on the horizon. I will tell you, we're looking at that very closely, but it hasn't yet come visited us. So I'll give you just as an observation from the front line, we haven't seen a pullback. And in fact, on the commercial side, which I do agree will be the first ones that will make a move, and we'll see a change in their funding. We haven't seen that yet. The areas that are particularly strong for us are our high-performance green building designs. These are buildings that actually make a better workplace for the occupants. It reduces the carbon footprint drastically, and our definition of drastically is they would actually be a net 0 or a 0 emitter of greenhouse gases or actual use of energy. It would generate as much energy as they actually consume. And the same is true with water for a complete 100% self-contained water. And waste is the other component. So that business has actually gotten very busy. It has been busy, and it continues to grow at among our fastest rates and is high-margin. And renewable energy has also been very busy for us, particularly on the planning side and the upfront permitting side. Offshore wind, we believe, is at the very beginning. So the amount of energy produced, offshore wind is minuscule right now. But the actual offtakes are in very high demand. So we see that increasing. And then our other base business, which is consulting on environmental for sort of our Fortune 100 clients that we've seen to be very stable at this point. I will say a lot of the work we do on the environmental side and the water with respect to compliance is a little less susceptible to an economic downturn because there are regulatory drivers for compliance and completion of cleaning these that are under regulatory directives. So while things might slow down, they still have deadlines and commitments to achieve.

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Operator [25]

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Our next question comes from the line of Tate Sullivan with Maxim Group.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [26]

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Just a couple of follow-up. First off, Steven, on the exit of the Canadian turnkey business, is that a similar runoff, or -- would you call it, say the RCM process? Or is that an actual divestment to another company? What is that process going to look like?

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Steven M. Burdick, Tetra Tech, Inc. - CFO, Executive VP & Treasurer [27]

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Yes. It's a pretty quick runoff here in early 2020 with really selling the assets of the company, disposing a bit through a liquidation.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [28]

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Okay. So different from -- so the project will end faster than the RCM projects in that effect?

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Steven M. Burdick, Tetra Tech, Inc. - CFO, Executive VP & Treasurer [29]

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Yes.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [30]

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Okay. Great. And then, I mean, that will help your receivables as opposed to RCM. It seemed to take a little bit to end the projects in the arbitrage. Did you say RCM has no more remaining arbitrage? Or did you say just a couple left on that?

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Steven M. Burdick, Tetra Tech, Inc. - CFO, Executive VP & Treasurer [31]

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There's no more backlog left in RCM. So all the projects are complete.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [32]

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Okay. And then, Dan, just following up, great comments on the GSG margins. And then ignoring the unpredictable actual disaster-related work, how many years does the multiyear disaster recovery work be?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [33]

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Well, I think the planning work typically will go from 2 to 5 years, and that's just the program management and coming up with the master plan for recovery, prioritizing what the infrastructure should be replaced, how it should be replaced. And then -- and so typically, how we looked at this is 12 to 18 months is the response activity. They want that done quick so that you can actually get to the planning. Planning starts right around a year and moves out for anywhere from very small events, it would be a couple of years of planning, larger ones, might be 5 years or more. And then you move to the actual implementation, which is the design of the infrastructure. In the case of Katrina, Tetra Tech did several hundred millions of dollars of work, both in the late planning and the actual infrastructure design work, and that took out from 5 to 10 years out. So the time from an event taking place to the time the infrastructure has been designed and largely put in place is sort of a decade-long window. And much of this were just in the upfront of activities on this. So that's sort of a time frame. And for each of these phases, they do get larger. So the design and implementation of a large seawall or a lock and dam system is very large, both in total installed cost, but also the design and the permitting activities for those structures. So that's generally the time frames.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [34]

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Okay. And last for me, is exiting the Canadian pipeline business, are you still -- U.S. oil and gas, is that a positive margin business? And is all oil and gas exposure, is it fair to say less than 5% now after the exit of the Canada business?

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [35]

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Yes. It's -- overall, it is less than 5%. What had happened before, and I've characterized this over the past 5 years, that in the U.S., we have always been exclusively consulting a design activity. So consulting for permitting, monitoring, environmental assessments, biological monitoring and then the design -- the actual design for linear corridors, we continue to do that work. That is a good business for us. There is demand for that. In fact, there is insufficient pipeline capacity to take the availability of the resource of the oil and gas to market. So that continues to be a good business for us. We do that -- we do some of that type of consulting work in Canada, although we had seen in Canada that to do that work, you also needed, in many instances, to do the full turnkey business. So we do oil and gas work on consulting, but it's much smaller in Canada. And collectively, U.S. and Canada would be less than 5% of our oil and gas exposure.

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Operator [36]

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This concludes our question-and-answer session. I'd like to turn the conference back over to Dan Batrack to conclude.

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Dan L. Batrack, Tetra Tech, Inc. - Chairman & CEO [37]

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Great. Thank you very much, Michelle, and I thank all of you for your questions, your insight and your interest in Tetra Tech. Again, we here at Tetra Tech think we had a great 2019. But we feel even better about 2020. We think we are better-poised. We think the markets are coming our way. We don't think that we have to build a company to be situated or capable of responding to these significant trends and priorities in the marketplace. We, in a large extent, we've been here solving these problems before they've become recently a higher priority for funding. So we're looking for a great 2020, a very good first quarter, and I look forward to talking to you all to report the results of our first quarter of fiscal year 2020. And I hope you have a great rest of the week. Thank you.

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Operator [38]

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