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Edited Transcript of WLDN earnings conference call or presentation 3-Aug-17 9:30pm GMT

Thomson Reuters StreetEvents

Q2 2017 Willdan Group Inc Earnings Call

ANAHEIM Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Willdan Group Inc earnings conference call or presentation Thursday, August 3, 2017 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael A. Bieber

Willdan Group, Inc. - President

* Stacy B. McLaughlin

Willdan Group, Inc. - CFO and VP

* Thomas D. Brisbin

Willdan Group, Inc. - Chairman and CEO

* Tony Rossi

Financial Profiles, Inc. - SVP

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Conference Call Participants

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* John Salvatore Quealy

Canaccord Genuity Limited, Research Division - MD and Analyst

* Moshe Katri

Wedbush Securities Inc., Research Division - MD and Senior Equity Research Analyst

* Sabin Wyatt Carr

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Presentation

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Operator [1]

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Good day, and welcome to the Willdan Group Second Quarter 2017 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tony Rossi of Financial Profiles. Please go ahead.

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Tony Rossi, Financial Profiles, Inc. - SVP [2]

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Thank you, Kevin. Good afternoon, everyone, and thank you for joining us to discuss Willdan Group's financial results for the second quarter ended June 30, 2017. With us today from management are Chairman and Chief Executive Officer, Thomas Brisbin; Chief Financial Officer, Stacy McLaughlin; and Mike Bieber, President of Willdan Group. Management will review prepared remarks and will then open up the call to your questions.

Statements made in the course of today's conference call, which are not purely historical, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements involve certain risks and uncertainties, and it is important to note that the company's future results could differ materially from those in any such forward-looking statements. Factors that could cause actual results to differ materially and other risk factors are listed from time to time in the company's SEC reports, including, but not limited to, the Form 10-K for the year ended December 30, 2016, and subsequent quarterly reports on Form 10-Q. The company cautions investors not to place undue reliance on the forward-looking statements made during the course of this conference call. Willdan Group disclaims any obligation and does not undertake to update or revise any forward-looking statements made today.

In addition to GAAP financial results, Willdan also provides non-GAAP financial measures that we believe enhance investors' ability to analyze our business trends and performance. Our non-GAAP measures include revenue net of subcontractor services and other direct costs and EBITDA. We believe revenue net of subcontractor services and other direct costs allows for an improved measure of the revenue derived from the work performed by our employees. EBITDA is a supplemental measure of operating performance, which removes the impact of certain nonrecurring income and expense items from our operating results. GAAP reconciliations for both of these non-GAAP measures are included at the end of the earnings release we issued today.

With that, I will now turn the call over to Chief Financial Officer, Stacy McLaughlin. Stacy?

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Stacy B. McLaughlin, Willdan Group, Inc. - CFO and VP [3]

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Thanks, Tony. I'd like to add my welcome to those joining us on today's call. I'll start with an overview of our income statement, then our balance sheet, and finally, our guidance.

Total contract revenue for the second quarter of 2017 increased 21.9% to $71.8 million from $58.9 million for the second quarter of 2016. By segment, including both organic and acquisitive revenue, Energy Efficiency Services revenue increased 26.1% to $53.7 million; Engineering Services contract revenue increased 11.1% to $14.1 million; revenue from Public Finance Services increased 14.7% to $3.5 million; and Homeland Security Services revenue decreased 15.1% to $527,000 in the quarter.

With the 1-year anniversary of our acquisition of Genesys Engineering occurring in March, all of the 22% increase in our total contract revenue in the second quarter was organic growth. Net revenue, defined as contract revenue minus subcontractor services and other direct costs, was $30.2 million, an increase of 9.1% from $27.6 million in the year-ago quarter. Direct costs of contract revenue were $53 million for the second quarter of 2017, an increase of 29.1% from $41.1 million in the same period last year. The increase was primarily as a result of the growth in total contract revenue in the Energy Efficiency Services segment and the corresponding increase in subcontractor services and other direct costs.

Our direct costs of contract revenue were 73.8% of our total contract revenue in the second quarter of 2017, up from 69.7% in the first quarter of 2017. We expect to see some volatility in this ratio, as it is a byproduct of the mix of project work that we have in any one particular quarter. However, given the pipeline of work ahead of us, we think that our direct costs as a percentage of contract revenue have most likely peaked, primarily due to less subcontractings required for future projects.

General and administrative expenses for the second quarter were $14.2 million compared to $13.9 million for the prior year period. As a percentage of total contract revenue, our G&A expenses were 19.8% compared with 23.6% in the second quarter of 2016. The improvement in this ratio was primarily driven by increased efficiencies and greater operating leverages as we scale the company. G&A grew just 2.5% quarter-over-quarter while revenue grew 21.9% over the same time period, indicating that our back-office costs are growing at a far slower rate than revenue.

Operating income was $4.6 million for the second quarter of 2017, an increase of 15% over $4 million generated in the second quarter of 2016. EBITDA was $5.6 million for the second quarter of 2017 compared with $5.1 million in the second quarter of 2016. EBITDA margin for the second quarter was 7.8%, down from 8.7% in the same period in the prior year, primarily due to higher pass-through revenue. As a percentage of our net revenue, our EBITDA margin was 18.5% in the second quarter, unchanged from the same period last year.

We recorded an income tax expense of $1.2 million in the second quarter of 2017 compared to $731,000 in the same period last year. Our effective tax rate in the second quarter was 26.9%, up from 18.7% in the year-ago period. The increase in our effective tax rate is due to the energy efficiency commercial building tax deductions that we utilized in 2016, which have not yet been approved by Congress for this year.

Net income for the second quarter of 2017 was $3.3 million or $0.36 per diluted share compared to net income of $3.2 million or $0.37 per diluted share for the second quarter of 2016. While we had an increase in total contract revenue and net revenue over the prior year, combined with better operating leverage with our G&A expenses, the higher effective tax rate offset the positive trends we are seeing in our operations.

Turning to the balance sheet. We had $26.3 million in cash and cash equivalents at June 30, 2017, which is an increase of $3.7 million since the beginning of the fiscal year. The increase was primarily driven by cash generated from operations.

Following the seasonally slower collections that drove our DSO higher in the first quarter, our DSO declined to 64 days at June 30, down from 70 days at the end of the prior quarter.

As of June 30, 2017, we had approximately $1.5 million in outstanding borrowings under our revolving line of credit and no loans outstanding under the term loan facility.

As noted in our press release today, we closed the acquisition of Integral Analytics on July 28. We expect that this acquisition will not affect the company's 2017 revenue or earnings per share forecast. However, in 2018, we expect that the acquisition will add approximately $10 million in revenue and approximately $0.12 in diluted earnings per share. IA's customers typically pay up front for 3 to 5 years software license. Accordingly, we forecast that Integral Analytics will improve Willdan's EBITDA margin by more than 70 basis points, lower our DSO and improve our cash flow in 2018.

Turning to our outlook for fiscal 2017. We have updated our financial targets. We have increased our full year revenue to range from $250 million to $260 million. Our diluted earnings per share is unchanged at $1.08 to $1.21. We have increased our expected diluted share count to 9.2 million shares, depreciation expense to $1.6 million and amortization expense to $2.7 million. Over the second half of the year, we expect our effective tax rate to be 40%.

I'd now like to turn the call over to Tom.

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Thomas D. Brisbin, Willdan Group, Inc. - Chairman and CEO [4]

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Thanks, Stacy, and good afternoon, everyone. We had another good quarter generating revenue and operating earnings that were in line with our expectations. This was a significant increase over the prior year, largely driven by the performance of our Energy Efficiency and Engineering Services.

Through the first half of the year, we have executed well. We're delivering on current programs while effectively staffing up to launch new programs we have won over the past year. We continue to see strong growth in our energy efficiency. Total revenue increased 26% over the second quarter of last year. Most of our major programs were fairly consistent in terms of the revenue contribution, while the increase primarily came from a ramp-up in our work with PacifiCorp and the city of Lawrence, Kansas. We also continue to see more work coming in newer markets such as New Jersey, Connecticut and Oregon. This reflects the trend we are seeing of an increasing number of states and municipalities starting to evolve more funding to energy efficiency, energy resiliency and distributed energy resources. As a result of this trend, along with the new target markets and skill sets that our recent acquisitions have brought, for example, Genesys and 360, we're seeing our energy efficiency revenue become more diversified. Thus, there are meaningful revenue contributions from utilities, state agencies, colleges, hospitals and municipalities.

Over the past few years, we have positioned Willdan to capitalize on a rapidly evolving market for distributed energy resources. And today, we look -- and today, we took another significant step with the acquisition of Integral Analytics. They're a recognized leader in data analytics. IA, for short, merges economics with power engineering to provide more precise forecasting and utility operation decisions. As we have done with acquisitions in the past, we have gotten to know Integral by working with them as a partner on current programs, and we've seen firsthand the value that they provide.

Integral Analytics works as a prime contractor for more than 40 investor-owned and municipal utilities. They offer a number of different software applications that provide a variety of analytical capabilities, including: one, harnessing disparate, granular data sets to produce confident planning decisions about the distribution system; two, evaluating the costs, benefits and risk of demand side management programs, including energy efficiency, demand response and smart grid programs and services; and three, managing system load cost to provide operators of microgrids with a mathematically guaranteed lowest-cost option for producing power.

The level of insight that they can provide through their proprietary data analytics software and their ability to use mathematical optimization to improve efficiencies and reduce capital investments for utilities is simply unparalleled. As an example, PG&E and California Public Utility Commission (sic) [California Public Utilities Commission] recently published a white paper discussing their use of Integral Analytics, which produced a 3% to 10% reduction in CapEx spending across various areas of utility. The California PUC referred to Integral Analytics as the gold standard and said that all other utilities should be using these mathematical tools to optimize their CapEx spending.

With the revenue for the global utility analytics market expected to grow from less than $500 million today to $3.5 billion in 2025, this acquisition puts us in an excellent position to capitalize on another high-growth area for the energy industry. From a strategic standpoint, the addition of IA and its mathematical data optimization is going to serve as a powerful differentiator for Willdan in the market. Quite simply, we will be able to differentiate and optimize our energy efficiency programs in a way that has not been offered to the utility and distributed energy resources market. This acquisition will also further diversify our revenue by taking us into a different budget area for the utilities, such as the planning side of their operations. Willdan will also be able to build on IA's recurring revenue software model. Dr. Tom Osterhus, he's IA's founder, and his team will be the architect for additional technology investments and business models for Willdan.

From a financial standpoint, Integral will have a significant impact on our level of profitability. Integral projects had a much higher margin profile which, once blended with our current margins, is expected to increase our EBITDA margin by more than 70 basis points in 2018. They are also expected to contribute about $10 million in revenue and $0.12 to diluted EPS.

From both a strategic and financial standpoint, we view the acquisition of IA as a game changer, and one that will significantly enhance our ability to win new programs and deliver superior results for our clients.

Looking ahead to the second half of 2017, we continue to be confident in our ability to deliver a strong year of revenue and earnings growth. We have new energy efficiency programs starting up in Oregon and Washington, while our LCR program with San Diego Gas & Electric continues to ramp up. This year, we are targeting 1 megawatt of energy savings in the LCR program before ramping up to 4 megawatts in 2018.

Overall, we feel good about our ability to sustain our momentum. We are very excited about the opportunities that the Integral Analytics acquisition will provide. We expect to continue profitable growth and create additional value for our shareholders in the future.

With that, I would now like to turn the call back to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Moshe Katri with Wedbush Securities.

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Moshe Katri, Wedbush Securities Inc., Research Division - MD and Senior Equity Research Analyst [2]

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Nice performance on DSOs and expenses for the quarter. Can we get an update on some of the large potential opportunities on the West Coast, California, Illinois and New York? And then maybe also an update on some of the opportunities in what you guys called load pockets last time we met?

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Thomas D. Brisbin, Willdan Group, Inc. - Chairman and CEO [3]

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Okay. California, we're expecting that they will make a decision, time frame October, November, on how they're going to outsource energy efficiency through the utilities. I said on the phone before, they're mandated to go from 20%, the mandate originally was 100% outsourcing, they've settled on a number of 60%, and we expect to see a decision October, November on how they're going to procure it. So California is kind of lagging behind, I'd say, about 6 months right now. Illinois, they basically increased -- Illinois Commerce Commission wants more energy efficiency from Commonwealth Edison and the utilities served by Illinois Commerce Commission. And the proposals we sent in about 7 months ago, we turned them in again with the bigger values, and we're waiting to hear on -- they're going to have an oral before they finalize their decisions. So we're at the point that we've turned in the proposals, and we'll be waiting for an oral hopefully in August. New York. New York, the Brooklyn-Queens demand side management program that we participated in, which we call a load pocket, is -- seems to be in the direction kind of New York is going. They came out with 2, what they're calling, nonwire solutions, and it's basically load pockets in New York. They've identified 2 which we've proposed on, and we expect 5 more coming out either the end of August or beginning of September. So the Brooklyn-Queens model, at least on the East Coast, for load pockets and how to reduce the amount of energy seems to be the direction the East Coast is going. And just as a reminder for Brooklyn-Queens, which is the model for the nation, when they asked for 30 -- 50 megawatts, Willdan delivered 35 of the 37 that they've gotten. So we feel that we're well positioned both on the East Coast and nationally to work in that type of environment.

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Moshe Katri, Wedbush Securities Inc., Research Division - MD and Senior Equity Research Analyst [4]

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Okay. And then just as a follow-up. IA clearly has a different business model. Maybe you can share with us, how do you go to market with it? And when you look -- when you're talking to sales, how are they planning to kind of market this offering, considering the legacy part of the business that looks totally different?

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Thomas D. Brisbin, Willdan Group, Inc. - Chairman and CEO [5]

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Mike's been working with this acquisition day and night, and we -- he's going to answer that question.

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Michael A. Bieber, Willdan Group, Inc. - President [6]

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Yes, there's 2 aspects to it, Moshe. First, they have a customer set which is 2/3 new to Willdan. 2/3 of the utilities and municipalities they work for, we don't work for here at Willdan. So we'll be cross-selling Willdan's historical services to those customers over the next few years. Secondly, we have customers that they don't work for, like Con Edison, one of our largest customers here which Integral Analytics does not serve, and many others like that. We'll be cross-selling those services to customers that we have good relationships. So we've got a strategy that we've laid out over the last 2 weeks. We have detailed targets, which we've already started cross-selling even before the acquisition closed, and we'll be working very hard on that over the next 6 months.

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Moshe Katri, Wedbush Securities Inc., Research Division - MD and Senior Equity Research Analyst [7]

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Brilliant. And then a final question on margins. How should we think about margins beyond 2017? And maybe we could talk about some of the levers here in the model.

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Michael A. Bieber, Willdan Group, Inc. - President [8]

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Well, first, we mentioned that, in Tom's script, Integral Analytics should contribute about 70 basis points to our margin if all things other than Integral Analytics are static. That's '18 over '17. So that'll be a good contributor. Secondly, you mentioned over the longer term. We've mentioned that we believe that we could move this model up towards 9%-or-higher EBITDA over the next several years. The primary leverage is back-office costs, as we get larger, are more effectively absorbed. They're not increasing, as you've seen SG&A increase more slowly than the pace of revenue growth. So we're better able to absorb those costs, and that will also contribute to margin improvement over the next 3 years.

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Operator [9]

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We'll take our next question from John Quealy with Canaccord.

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John Salvatore Quealy, Canaccord Genuity Limited, Research Division - MD and Analyst [10]

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Congratulations on the deal. A couple of questions. First, on the IA deal. If I read the 8-K, this was a $18 million purchase price, cash and shares, with a $12 million earn-out, is that right?

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Thomas D. Brisbin, Willdan Group, Inc. - Chairman and CEO [11]

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That's what the 8-K says.

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John Salvatore Quealy, Canaccord Genuity Limited, Research Division - MD and Analyst [12]

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Mike, in terms of -- to your point about maybe an accretive $10 million in the guide in the fiscal '18 time frame from IA, I imagine, those contracts, that would be applicable to the earn-out if they were to get that. Or just walk us through in terms of the $10 million. Is that the stuff that's already been specifically identified, and the guys currently -- or men and women, I guess, at that firm are chasing as -- those contracts down now and part of their earn-out?

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Michael A. Bieber, Willdan Group, Inc. - President [13]

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Yes. So as mentioned in the 8-K, they have a 3-year earn-out. $10 million represents the weighted average pipeline, which we've gone through in due diligence, and which they've been cross-selling over the last 6 months. Their sales cycle lasts anywhere from 6 months to a year. So anything in the '18 pipeline right now, for the most part, has already been begun and the $10 million is our best estimate on the weighted pipeline in 2018.

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John Salvatore Quealy, Canaccord Genuity Limited, Research Division - MD and Analyst [14]

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Got it. Okay. And just back to your point about the sales cycle of IA. As utilities acquire this analytic capability, is this put out to RFP? Are these rate case or [rate case-enabled]? Do you mind just giving us a little bit of context on, those of us on the outside, how we can try to dig into win rates and timing on RFPs and things like that?

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Michael A. Bieber, Willdan Group, Inc. - President [15]

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Many of their procurements, I would say more than half, are not competitively procured. They go in and make technical presentations, and the customers buy that software application. In other instances, they need to go out for competitive procurement, and they'll write a specification which only few in this world can meet. Integral Analytics have very few technical competitors, and with one of their applications has no competitors. So this is -- there's only a few players in this market.

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John Salvatore Quealy, Canaccord Genuity Limited, Research Division - MD and Analyst [16]

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Got you. And my last question on that IA. So given the sort of license-based model, this is on-prem software or is this all cloud or a mixture? I know you said cloud in the release, but I just wanted to get more technical.

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Michael A. Bieber, Willdan Group, Inc. - President [17]

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It can be either. And Integral Analytics actually doesn't care. The software can be hosted at the client's house or can be hosted by Integral Analytics in the cloud.

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John Salvatore Quealy, Canaccord Genuity Limited, Research Division - MD and Analyst [18]

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Got you. Okay. Back to the core business as it is today, maybe for Stacy, just in terms of your comments around the subcontractor piece of gross profit in trends and in peaks. What sort of degradation in the peak would you expect maybe back half of '17 into '18? What sort of magnitude should we be looking for, for that?

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Stacy B. McLaughlin, Willdan Group, Inc. - CFO and VP [19]

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For the last half of 2017, we would expect it to decline, but fully, not a drastic drop-off. But we would expect it to decline from the $58.6 million that we had year-to-date through June.

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Operator [20]

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(Operator Instructions) We go next to Wyatt Carr with Western International Securities.

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Sabin Wyatt Carr, [21]

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The first one I have is regarding the Internal Revenue Code 179D. You said that they are not available in 2017, but is this something that you still think will be enacted and will be available later in the year?

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Stacy B. McLaughlin, Willdan Group, Inc. - CFO and VP [22]

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It hasn't been approved by Congress yet in 2017 because of the discussion by the administration of the change in corporate tax rates. At this point, we cannot take any type of deduction related to that, and we are uncertain of whether or not that will be approved. It has shown in the past that it has been approved each year, but we cannot take any type of tax deductions for that right now because we are uncertain of that.

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Sabin Wyatt Carr, [23]

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Okay, Stacy. And one other just quick question. On the acquisition of IA, is that already reflected in the balance sheet that was released today?

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Stacy B. McLaughlin, Willdan Group, Inc. - CFO and VP [24]

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No, it is not because the balance sheet today is as of June 30, 2017, and the acquisition closed on July 28. So it will be reflected in the balance sheet that comes out for the third quarter.

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Operator [25]

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And ladies and gentlemen, there are no further questions at this time. I'll turn it back over to management for any additional or closing remarks.

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Thomas D. Brisbin, Willdan Group, Inc. - Chairman and CEO [26]

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Okay. We'd like to thank all of you for participating on our call today and for your continued interest in Willdan, and have a great day and thank you.

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Operator [27]

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Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.