Tetra Tech Inc (TTEK) 2006 Q1 法說會逐字稿

Good morning and thank you for joining us. By now, you should have received a copy of the press release. If you have not, please contact the corporate offices at 626-351-4664 and we will get one to you right away.

With us today from management are Dan Batrack, CEO and COO; Sam Box, President and David King, CFO. 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 may 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 report 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.

At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the Company, we will open up the conference for questions and answers after the presentation. With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Thank you. Good morning and thank you for joining us today. We're very happy to announce our first quarter results and we as a collective team here and I personally feel very good about our performance and progress this quarter. I'd like to start today with an overview of our Q1 results and to begin with, we had very strong revenue and profit performance in all of the key areas; revenue, profit, our cash flow and we have either met or exceeded all of our forecast guidance that we provided earlier this year.

We also had significant challenges that were addressed this last quarter. Most noticeably, we have completed the divestiture of all of our anticipated units and put that behind us. We have completed that this first quarter and that is a big milestone for Tetra Tech. We've also completed the wind down of most of our discontinued operations that we will be completing. We have a very small amount to go forward here in the second quarter. But most notably, we completed the wind down of our largest wireless operation that we had within the Corporation and completed the process and moved that into discontinued operations and have put that behind us. And it is really allowing our entire team and our entire Corporation now to focus on consistent performance. We have now hit three consecutive quarters of meeting or exceeding guidance and we are now focused on strategically building the business. That means filling up the pipeline with the work and contract awards in our key market areas as we move the Corporation forward.

Now the financials we will be presenting today are on the basis of our continuing operations, both in our current period and have been normalized on prior periods for a comparison basis. On the financial overview, revenue completed the first quarter at approximately $341 million, up just over 10% on a quarter-to-quarter basis. We did have very strong federal business on our DoD and EPA customers. We saw a similar increase in our net revenue. We did exceed our guidance materially and it was partially attributed to contributions to Katrina. We did have well in excess of 100 staff on an emergency response basis through our EPA contracts and we also had state and local business funded through our infrastructure business that contributed to the strength and our net revenue during the first quarter.

That did convert into and contribute to the higher than anticipated earnings that we saw the first quarter at $0.17 and we did exceed guidance in that area also with a 41% year-over-year increase in our earnings on a continuing operations basis. Our [customer] mix at the end of the first quarter did remain very similar to what it was a year ago. We feel very good about this particularly as it reflects on continuing operation after the divestitures and wind down have been completed. You can see there has been fairly little change, a 1% change in our federal business, a decrease. We have seen some of the federal funding move over to the state and local business. We have seen increased funding at the state, local area and we have seen Tetra Tech actually capture that business as reflected in the 2% increase in our overall business mix with respect to our clients.

On our actual business segments, the business has been very stable. We have seen a very slight increase in our communications business. We have seen some success in our funding on our fiber to the home and fiber to the premise business and that continues to be strong. But overall this reflects a very stable business and also expects an anticipated mix on into the future.

Most importantly, new wins. Since our last conference call, we have had a number of new wins, including one that we just announced last evening, which was a funding of a new task order that we were awarded for 216 million in the first two months funded for the task order of 15 million for the first 60 day period. As you can see the list of contracts here with the Navy, the EPA and the work that we have in Iraq for the reconstruction. Several of these are recompetes and these were key multiyear wins that put us in a key position to add stability and to begin to recognize new funded backlog as we move into the future.

Most notably, each of these wins that are listed here since this last quarter are single awards. These are not multiple award contracts. There will not be competition on these projects for task orders with other competitors. These are single award contracts just to Tetra Tech. (indiscernible) examples are allowing us to begin filling up our pipeline, begin to buildup new contract value, contract capacity and one thing that Tetra Tech has a very conservative approach to how we are reporting our backlog, it is only funded, authorized and where we can begin expending the funds immediately. So all of these have been added to contract value. Now we're going to be moving this from contract value into backlog in the coming quarters.

The next area I'll address is backlog. We did have a slight reduction on a sequential basis of our backlog. That was primarily attributable to three factors. First off, we have been working off some of the backlog associated with our wind down operations. Now this is backlog that we've been looking to get off of our books. It has largely been attributable to large fixed-price contracts that were noncore-related and so we have been expending those and been looking not to replace that type of backlog. So that is one reason for a slight reduction or contribution to the reduction of backlog.

Second, we have seen a change from our federal clients in the mechanisms by which they are funding the programs. Historically, we have seen funding come out on an annual basis. We have received a full twelve months worth of funding or even on a quarterly basis. Now we're seeing the incremental funding decrease from an annual to a quarterly where we had received it previously from a quarterly even down to as small as a monthly basis. And so the incremental funding being both smaller and being on a shorter cycle basis has had some impact on our overall backlog.

And finally, we have seen some impact on the timing of the funding. We have been very successful on the recompetes. We won all of the major recompetes that we have actually competed for this last quarter and while each of the previous contracts have twilighted, they have released funding and obligations they have had under the previous contracts and now that the new contracts have been signed, new task orders will begin to be issued. So we will see these contracts begin to contribute to backlog over the next quarters.

Overall, we feel very positive about the new contracts we have had one, those that we have announced and those that we feel very confident and feel in good position to have awarded here over the next weeks and we will see what we can have announcements with the successes that we will have in the immediate future.

With that, I would like to turn over a detailed discussion of the financials to David King.

Thank you, Dan. Thank you everybody this morning. I also share Dan's optimism in where we are today. If you looked at where we are, our revenue profile has improved. Federal business, state local business and our communications business all improved. Operating margin is moving toward high single digits and as Dan mentioned earlier, our wireless communication business wind down is complete and that particular unit engaging in the largest communication contract we had in the past is being now reported to the discontinued operations during the quarter. And also this quarter we started to expense stock options. We will go into a little more detail later on.

Our income from operations has increased 22% from 14.1 million to 17.1 million attributable to high revenue and overhead efficiency. This number of 17.1 included $1 million -- roughly $1 million in stock option expense. Before the effect of option expense, our margin is about 8%. Our SG&A costs have increased about 17% principally because the option expense, some of the Sarbanes-Oxley costs that we tried to finish in Q1 and we have allocated some money to invest in some strategic growth areas.

Our net interest expense is down despite higher rates during the quarter and higher rates during (indiscernible) terms that we experienced. Tax increased because of higher income. Our rate came up a little principally because the stock option expense did not yield tax benefit and so it's going to be 43% for the year.

Our balance sheet continued to be very, very strong. Our receivable (indiscernible) improved business mix and our continuing focus on billing and collection. Unbilled receivable came up a little higher, about 34%. One is because of high revenue. The other one is we had a few units involving the Oracle conversion during the quarter. So we had a little bit of a delay impact on the building process.

As a whole, our revenue -- our receivable increased about 6% as a whole versus our revenue base increase about 10%. And also we are commenting our receivable base is much more aligned with our revenue base. For example, our infrastructure business is 33% of our business today, about 34% of our receivable base. Our communication is about 5% of our business and is about 6% of our receivable base. So it is much more aligned and it is very comforting.

Our payable increase simply because high revenue and larger subcontractor costs during the quarter. Our net debt continued to have a favorable trend. (indiscernible) from 155 million to $87 million and I see this favorable trend to continue. At this point, at the end of Q1, our debt equity ratio is about 32%. Debt to total capital ratio is about 24%.

Cash flow from operations -- typically at Tetra Tech, Q1, December and Q1 is when we use the most cash, principally the bonus and the 401(k) plan contribution, insurance payment, etc. We anticipate the whole year cash flow to be in the 40 to $50 million range. Our capital expenditure continued to show outstanding control and a minimal investment in our communication business. DSO again is 72 days, demonstrates continuing efficiency. We have forecast it to be in the low 70s on an ongoing basis.

The next slide we are showing trendlines for the past six quarters in terms of our asset and debt management with improved business mix I talked about and our continued focus on cash flow. I expect these trendlines to further improve in the coming quarters. I expect our debt to be in the low 70s at midyear and again, the DSOs to be in the low 70s as well. And I will give the podium back to Dan.

Thank you very much, David. I would like to provide a few words on our outlook on the overall business environment. The federal spending for the federal sector is the largest portion for Tetra Tech as a single area and we expect the federal spending to continue to be very strong in the areas that we serve. We understand that there are deficit issues, there are other priorities for the federal government. The areas that Tetra Tech is serving in our core businesses continue to be very strong and it is in the engineering and the water resource market and the EPA funding has been very strong in those areas and we expect it to continue to be very strong. And in fact there is in the federal market that we haven't yet penetrated but in our key pursuit areas is the EPA office of drinking water and other areas that we expect to provide large opportunities for Tetra Tech that are seeing increased funding levels.

The Department of Defense, we're seeing funding in the base realignment enclosure and as they refer to it as the BRAC '05 program. They believe the initial funding is exactly where Tetra Tech has its strength, which is in the upfront planning and preparation phases. That is going to allow us to be positioned well for the later implementation phases of it. This is a priority of the funding for Department of Defense. We think we're well positioned there and finally in FEMA, coastal restoration and planning our big priorities of the overall budgets and these are also areas that fit right into Tetra Tech's core competencies and core capabilities. So in the federal level, we expect these all to be very strong areas for funding and spending.

At the state and local level, as you saw in the first quarter, the first quarter we had some very strong increases in that area but we do see in the water area, both in the planning and infrastructure, those to be priorities of the state and local level. In the Northeast, the infrastructure is very aged. There is a lot of planning, preliminary design and actually upgrading and replacement taking place, which allows significant opportunities for us.

In the Southwest of the United States, a large movement of the demographic spokes moving into the Southwest where these facilities just don't exist. So initial planning, design, the environmental documents and then the actual engineering infrastructure installation all provide very large opportunities for us at the state and local level and we are actually very happy to say that reflect in the increase in that portion of our business.

Commercial spending is up and we have seen Tetra Tech hold its own as we have grown on a year-to-year basis. We haven't seen any erosion in our commercial sector of the business. In fact it is continuing to grow equally with the rest of the pace of the Company. And again we are seeing federal, state and even commercial spending in the water be a priority, which again plays directly to Tetra Tech's core niche in the market.

For guidance for the second quarter fiscal year 2006, we do see an increase in our overall net revenues. We see, as you can see here, a 220 to $230 million guidance for the second quarter with a diluted EPS from our continuing operations of $0.15 to $0.17. We are leaving our 2006 annual guidance unchanged. So for net revenue and for operating income.

In summary, we feel very proud of a solid performance for the first quarter. We are very focused on consistency and moving forward on all fronts, including revenue, operating income, beginning to deliver cash as we get out of the first quarter, which has historically a large cash usage quarter for us and we feel that everything is exactly on track with our initial guidance and we're right on track in all of the metrics.

We are most encouraged with our project pipeline with the new awards. You've seen some yesterday. We will look for more in the future and we feel that that will become an area that we will be focused on as a collective team to grow even stronger into these areas in the marketplace. And finally as again a collective team and I personally and I think I focused on this in the last call, consistent performance, hitting all of our commitments and our guidance. That's what we're focused on here and strategically building the business to become leaders in the areas that we compete in in the marketplace.

And with that, operator, we would like to open up this meeting to questions from the callers.

(OPERATOR INSTRUCTIONS). John Quealy.

Canaccord Adams. A quick question here. In terms of the commercial sector picking up, is this primarily wireline wireless or can you give us a little bit more detail, Dan?

Well it's not wireless. We have truly completed the wind down and the close out of the wireless business completely. We have seen some strength in our wired business but it is very broadly across the country both on the infrastructure business and in the resource management business. We have seen work for some of the large Fortune 100 companies through environmental cleanup, planning, movement of their facilities, commercial design. Some of the segments that are growing in the commercial sector have given us opportunities for environmental planning documents, close out of old facilities and interestingly enough we've seen some new funding out of the automotive industry with some of the closures actually produced many new opportunities as part of the closure process on the environmental restoration planning and actually relocation process. We have seen it broadly in all sectors including the wired, which is primarily fiber to the home and fiber to the premise business.

Thanks. My next question -- you went through a couple of different dynamic shifts in the backlog in terms of how projects are awarded now. Can you comment on how that will change if anything your operating procedures whether it is headcount, staffing issues, overhead absorption or is this basically already taken into consideration with your outlook and guidance here?

It has been taken into account with our outlook and guidance. It is largely an optic associated with reporting our backlog. The actual funding and the visibility into the programs are there. We still have the programs that we have planned, that we have programmed. Simply the funding coming in rather than on a quarterly and a full annual basis has been on a shorter cycle. But we have seen the actual spending increase from our clients across the board. We actually did have a little bit of an impact on the reporting of backlog because of the continuing resolution in Congress for the Department of Defense appropriation that wasn't signed until the end of December, December 30th. So as part of the continuing resolution, it restricted the Department of Defense to allow funding on a month-to-month basis. I believe it was 75% of a monthly expenditure. So we received a very nominal amount of funding that has since been passed and we have seen new orders after the first of the year. So we expect this not to impact our staffing or our planning process at all.

And then just two last financial questions. On the uptick in the DSO number in communications, is that related to the Oracle issue?

Yes. (indiscernible) about a couple of days.

And then lastly, David, last year Q2 you had a pretty good cash flow for some onetime items. Can you give us a range of cash flow that is going to be a cash use or a cash generation in Q2 this year?

There will be generation in Q2 in the range of 10 to $15 million.

Jeff Beach.

Stifle Nicholas. I have got two questions. One, on the last conference call, you had talked about some of the big opportunities coming and combined sewer outflows, BRAC, some other things and then your first very big contract, which I considered today coming out is in UXO. Just looking ahead over the next nine to twelve months, are there other big contracts similar to this that you're working on that could be awarded?

Yes there are. We do have a number of large programs that are currently in competition. So stations around the street there with existing clients. We see them at the state and local level, large programs with the South Florida Water Management District, very large water programs with water retention design and construction management of large water retention basins, large hydraulic programs for water. Those are measured in the 2 to $400 million or larger single opportunities. These are funded programs.

We see Army Corps of Engineers programs referred to as [amaytalk] and there are others that are out there that are measured in the 2 to $500 million range and we also see similar programs with the US Navy. So we see all of those coming out here in the next three to six months that will be competed and awarded. So we feel those are some of our key targets (indiscernible).

And on the stock option expense, are you, when you report your segments, are you allocating that by revenues?

Yes. We will push down and reallocate back to the segments.

So that communications gets us a very small amount and the other two operations get the bulk of it?

Yes. Communications get almost minimal.

Richard Rossi.

Morgan Joseph. First, I may have missed it but did you give us an indication of how much revenues the Katrina issues may have contributed in the quarter?

We did not provide that but it was between 5 to $7 million. Approximately two thirds of that was in our resource management group and it was funded through our EPA programs and approximately one third of it came from state and local contracts that were associated with our infrastructure operations that were starting up in wastewater treatment plants and other infrastructure facilities.

Not that it's overly critical but is it fair to assume that given the emergency nature of those services that the margins on those jobs were above the norm or above the average?

Not necessarily. The two thirds of the work or better that came through our EPA contracts had been prenegotiated. It was at established rates. It did help with respect to utilization. So it did help on our overall indirect costs. So we moved those off at a disproportionate level for the first quarter off of indirect costs and onto direct billing. But the profit margins on those were already predetermined on a negotiated basis for the contracts we had in place. Some of the state and local work did have a premium to it because the expedited basis but it was the smaller portion that we actually expended in the first quarter.

Going forward in the Gulf, obviously there are opportunities there, how much of those opportunities are dependent on final plans being approved for things like the rebuilding of New Orleans or at least initial plans being approved. There's a lot of discussion now as to how they are going to reconstruct the city, etc. Is the workflow that you are hoping to see out of that area dependent on those kinds of decisions or are the jobs you're looking at more a function of the general reconstruction where it would be considered more essential regardless of what final rebuilding plans are?

I think that plays into one of Tetra Tech's unique strengths that we have. We are not a constructor. We are not a constructor. We're not going in their exclusively to implement design in plans that have been reviewed, studies that have been completed and plans that have been approved. Tetra Tech is largely on the front end. We are going to provide the studies, the conceptual designs, the actual engineering. So all of this work -- there are no off the shelf plans that are going to be grabbed and handed out for public bid and then awarded. These all are just entering now the conceptual study phase. They will then move toward a feasibility study and those are all of the areas that -- Tetra Tech holds a number of contracts with the Army Corps of Engineers and other federal entities and we believe that will play to our strength. A lot of that work will go through existing vehicles that will not be competed that we have in place now. So we think that's actually one of the areas that will provide us a long-term advantage.

Again with prenegotiated pricing.

All the contracts that we have in place now are prenegotiated and have established rates on them, yes.

You mentioned that the win list that you had in the handout is going to work its way into backlog. Give us a sense of how you see that dropping in over the next few quarters.

We do see it ramping up as we see with any of these larger contracts. Initial past quarters will be provided. So we see it ramping up. We haven't actually provided guidance to our specific forecast on the conversion of a contract value into backlog but we do see it ramping up and we also are looking to add to the new win list by increasing our overall contract values.

And getting back to this shift in the way they are funding some of these projects annual to quarterly, from quarterly to monthly, why? I mean what is occurring that is causing the shift? Is it a flow of tax receipts, etc. coming in? Is it a change in just the general way the business is going to be done?

We have seen and certainly we have different data points but we have seen that there has been a question as to how much federal funds will be diverted to the war effort, to the disaster recovery efforts and so the amounts that have been provided for immediate funding to many of the different entities have been less and so they have been refunded and so it has simply flowed down to our contracts. Now many of these programs are -- they are in the middle of the programs. They can't be truncated. They can't be terminated in the middle are very, very difficult. It is just that the fundings are coming in more discreet blocks than simply having excess of funds, excess of -- it's not directly related to receipts but it is allocation of the funds within the federal government.

So there is very little if any concern that going forward these projects that you are in the middle of might be diminished in importance to your revenue flows?

We don't think of that as a high-risk item for Tetra Tech, not at all.

Also, just one other thing. SG&A was up relative to what I was looking for and what -- could you give us some guidance as to the general directions of SG&A going forward over the next few quarters?

We will between 11 -- about 11%.

So you're coming down a bit. Now is the -- where are the costs for 123R?

In SG&A.

So the costs are in the SG&A line. So if I take that out, you are still slightly over 11. So it is running around that range.

Right.

Very good. That's it for now.

Matthew McKay.

Jefferies & Co. Just sort of one last stab at the previous question actually on the incremental funding. How much of that do you think is due to just the continuing resolutions and how much of it is due to as I think you sort of said sort of a relocation of bonds or potentially sort of tighter budget in DoD?

We think it's a combination of both. A good portion of it was the continuing resolution. We would have seen funding on a number of contracts that were in place that we were continuing on. We saw a change through the first quarter. It typically would have been a full quarter and we expect to see that now and in fact, a number of these we have seen the funding right after the first of the year and the resolution was passed. So I would say it was evenly split between onetime events from the first quarter from continuing resolution. But we have seen an overall shift, not just unique to Tetra Tech but in the industry from longer funding single funding periods for full year to shorter incremental periods.

And then just turn it over to BRAC, what should we expect in terms of timing of spending on BRAC? When does that really start to ramp up?

Well the back half are going to be the big dollars; the front will be the planning. We have seen some initial funding through existing vehicles we have primarily with the Army Corps of Engineers. We are in overall planning activities. They have been measured in the 10 to $20 million range. Overall, it is a ten-year cycle but it is certainly bell shaped with the upfront beginning to ramp up now. Large construction, relocation and closure activities will be in the middle. You'll be talking to six to seven years, between four to seven years with the heavy dollars spent in the middle and then you'll have final close out with O&M activities, operation maintenance and final close out at the tail end of that ten-year period.

So this should really sort of peak in terms of growth '07-'08 time frame then.

That's correct.

And then going over -- just on acquisitions. What is the mindset now in terms of acquisitions now that you've sort of moved passed a lot of the restructuring efforts that you have done as well as potential size of any acquisitions and what areas you would focus on?

We do feel we have the luxury now with three strong quarters in a row. We are beginning to leave all of the periods of covenants and any of the financial performance issues we're putting behind us with all of the banks and the other lenders. That does give us the latitude and the flexibility to initiate this process. Now we have begun looking into the market. I will start with your last question, which is where would we look. We are looking in our core markets. We're looking in areas that are complementary to the services that we provide. We are synergistic with this in adjacent field. We're not looking to move into entire new areas, new hot growth areas that are not consistent with our core capabilities and market strength.

As far as size goes, we are looking for something larger than smaller. I think that an optimal area may be somewhere between 1 to 300 million. We certainly would look and evaluate something smaller than that, slightly smaller or certainly larger. But I think as we have referred to in the past, our optimal area is probably 1 to 300 million. We have found through our nearly 50 acquisitions in the last decade that the larger acquisitions provide the systems, the reliability, predictability and maturity that represent a much lower risk profile for management and integration. So we have learned a lot and it has given us new focus where we go.

So when you talk about complementary -- in the past, you made a few smaller acquisitions on the securities side. Is that something that is still of interest in today's world, any water related projects would demand more of a security mindset too?

Absolutely. We have a system of support and security group that is in a very hot market. You're right to focus on the water aspect of that. Puts together a very nice, very hot growth area within that overall homeland security aspect. Threatened vulnerability assessments all the way through management ports are all very high growth areas right now and we are looking at those.

Thanks a lot, guys. Nice quarter.

Corey Greendale.

First Analysis. First question, just one more for me anyway on the timing and the federal funding coming through. It doesn't sound like you're changing your expectation on DSR or does that suggest it's not a very big change or is this -- it's not really a cash impact change, more of just an approval of funding timing change?

Yes. We do not see any major shift or changes. If you look further, we have a very constant correlation between our backlog and our revenue base over a long period of time.

Okay. So it's not really a change in the cash timing of getting paid from the Fed contracts; it's more of an approval timing?

Yes.

Okay. Second question on the state and local markets. I was hoping just to get a little more color there because it looked like they improved fairly. They had a nice bump up sequentially. Were there any specific kind of large projects that contributed to that or was it just a lot of little things put together?

It was a lot of little things across the country. We saw strength in the Northwest in our water infrastructure business. We saw strength in the Southwest on a number of awards that ranged between 1 to $10 million on a number of municipalities and state contracts. And we saw strength in the Northeast. So the three geographic areas we saw strength for the Northeast associate with infrastructure, Northwest and Southwest with new planning and we did see, as I mentioned earlier, a few million dollars from state and local work for Katrina response. So it was really spread geographically across and no single large award that drove that increase at all.

And X the Katrina impact, would you say that was largely the budget, the market getting better or do you think you're taking share somewhat there too?

We've seen, at least at this point, that the market is getting better, the funding has increased at the state level. We haven't yet fully recognized our taking marketshare. Although that is a very high priority in our focus. We will not only ride the rising tide with the funding but we also want to capture more marketshare from our competitors.

And Dan, on those larger contracts that are out for bid that you mentioned earlier, what is your sense? How much is price a lever on those? Is it getting more competitive on price or is that not really the main lever?

We haven't seen that. What was very satisfying for us is on our EPA contracts, price itself was not a determining factor, was not the primary determining factor. We have seen folks try to be predatory by taking very aggressive and innovative pricing strategies that at a minimum we think would have some significant margin impact to these competitors had it not been successful. We have elected not to go that direction at all as part of focusing back on our margin, our core business and keeping our work. So we have not seen price itself become a determining factor. Qualifications, presence and client relationships and those areas we're very strong in.

That's good to hear. One last question is it looks like -- if you look at the revenue generated per FTE, that was up fairly nicely. First of all, can you just verify for me is that the effect of taking out kind of more idle capacity with the head count reductions and secondly, do you have sense -- I know it is not that simple. I will depend on what kind of contract it is -- but do you have a sense what kind of annual revenue base you can support with this level of FTEs without having to start ramping up?

Well the first part is -- part of it is associated with head count reduction from discontinued operations. That is part of it. But as I've mentioned during earlier in the call, we were able to take capacity that normally the individual staff is that the first quarter, we begin to move into the winter months, we have slowdowns because of the holidays, we have Thanksgiving, we have Christmas, we have generally time off because of vacations associated with those. So we were able to convert a lot of that type of indirect time into direct billings per employee associated with Katrina. So we did put probably 100, 150 individuals on the EPA contract, others that might have been slow, we would have been supporting other indirect activities in infrastructure, and we moved them over to billable activities.

So we did see an increase and it was nice -- not that is anytime is nice to plan a disaster -- but to come in a soft quarter actually worked out very well for us because we had the capacity internally to pick up this work without having to increase staff, only to have reduce it or adjust head counts in the out quarters. So it really helped other overall staff leveling.

And in terms of the level of revenue you could support with? Level of staffing?

We are going to be adding people in order to continue this. We do expect our overall head count to increase here at the quarters -- continue through the year.

(OPERATOR INSTRUCTIONS)

Friedman, Billings, Ramsey. A couple of questions. First of all, kind of going back to Rich Rossi's question about backlog. Do you expect backlog to be up in the second quarter sequentially or should it be relatively flat given the Fed funding shift?

Certainly, we are going to drive to increase our backlog. That is our objective. But it is not our overall focus. We think that our backlog is solid, is sustainable, and the overall funding coming through our programs are solid, not only to sustain, but grow our overall business. And certainly that was reflected in our gross and net revenues this past quarter, and we expect to continue, as we've just provided in guidance, to increase our net revenue and we don't expect backlog to be an issue.

Also, in David's remarks, regarding SG&A mentioned that there was some increased cost due to strategic initiative investments. Can you provide any details around that?

We have formalized some of the corporate functions here in terms of how we do acquisitions. We have allocated funding to identify those leads in our marketing development efforts in the key area that Dan talked about. And we get everything in place in Q1 and Q2. And you will see that was principal cost of the object.

Well, regarding your communications business should we expect --should we expect throughout the year to see a ramp-up or a growth in communications revenue? Was there anything that was somewhat one-time in nature during the quarter?

That's a great question. There is a bit of an optics issue with respect to the large increase on a sequential quarter basis on communications. And that was attributable to the normalizing the revenues associated with our discontinued operations, both a combination of divested and discontinued operations.

By going back and removing from our revenue stream on the previous quarters, specifically Q4, all the revenues associated with our wireless communication and the wired communication entity that we divested, it did give the optics of a sequential quarter-on-quarter substantial increase. If you take a look at the overall representation of the communication business as a percentage of our overall revenue mix, it's about 5%; it was 4% previously on a quarter-to-quarter comparison. We do expect to grow, but not abnormally different than we would expect to grow the rest of the business. So we are going to continue to increase growth in our top line and bottom line and we expect communication to grow commensurate with that, not disproportionately larger.

Our final question comes from John Rogers. Please state your question and affiliation.

D. A. Davidson. Just a couple of things. First of all, in terms of the -- I think it was a number of quarters back you'd talked about opportunities to consolidate some of your locations and streamline some of the operating offices. Is that process finished now?

We are continuing. We were at a high point probably 12 to even perhaps 18 months ago with an office count approaching 350. We now are currently down closer to the 250 number, so we have consolidated office locations. There have been a combination of consolidating offices and staff into single locations and actually closing out other locations that just weren't viable or were closed out as part of the discontinued operations and divestitures. So we continue to look for savings on overhead and to become -- and drive that back into lowering our rates, becoming more competitive or dropping it to margin.

So are you nearly finished then with that process? I mean 250 -- is it your intent to take that to 150 or -- without --?

That's good question. We don't have a specific end point. We are continuing to evaluate the profitability and the generation of revenue per head count and per office on a continuing basis. We think we're very close to an optimal position now but we will continue to evaluate that and that is driven by the contract work we have. We are not committed to specific locations for just presence. They are there to drive revenue and the resulting operating income. So we will continue to evaluate those based on workload and try to shift those as quickly as possible depending on workload both going up or workload going down.

And then on the communications business, just so I am clear, primary you mentioned in some of your comments about fiber or wiring to the home, how much of your communications business is working for the major telephone companies now and what do you expect it to be?

When we say fiber to the home, about -- well first of all, let me back up. Approximately 60% -- approximately 60% to 70% is fiber to the home or fiber to the other premise. There are two funding sources or two clients that we're working for. Some of them are the telephone or the carriers, the commercial clients. They include Verizon. They include other -- SBC is a client that is growing very aggressively in that area. But we're also working for some of the municipalities that are growing and that have decided to take this to a public function or a public offering and Utopia is the largest in the country and we are providing that service for Utopia. So it is both on a commercial basis for the carriers and from municipalities.

And do you expect that to remain? I know it is a small portion but to be the main driver for your communications business going forward?

We do, we do. This is our refocusing on our core area. Our margins are better. The competition is less and it is an area that we have a competitive advantage.

And the last thing is what about in terms of pricing for your services, is there -- a lot of companies in general in this industry talk about pressure on wages and pricing and I'm just curious for your thoughts there.

We have seen in our industry and we talked about the engineering and resource management industry. That is what Tetra Tech is, engineering and resource management and there continues to be and it continues to become more accentuated competition for resources. Our resources are not in large surplus and so as resources become balanced with the demand or in fact become even more scarce, there is some pressure on pricing for the resources to bring in internally. Now (indiscernible) been a question, how do you compete for those? One is just to pay more money. Another way to do it is to provide the only contracts that these individuals perform services on.

So one thing and the list of the awards that we listed in today's call as I have mentioned are single awards. There aren't two or three contract holders on these; there's one. There's only one task order provided for the UXO in Iraq. So we're not necessarily having to compete for the resources that they will either work for Tetra Tech or two or three of our competitors to compete for this. The competition is done on these EPA contracts. You want to provide the services for EPA that are unique set of services and that is the area that you are providing those in. It does begin to limit those that are offering the service and so we think it gives us a big advantage in bringing those resources on.

And are your multipliers or your markups staying roughly constant or are you getting leverage there?

They are every competitive. We haven't seen any appreciable increase and we do have -- we do have a number of [postry] [imbersible] contracts for where we have seen direct pressures on pricing. We have been able to pass that on to our customers through our rate structure.

Thank you very much.

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

Thank you very much. I would like to thank all of you for being on this call today and for following Tetra Tech for a number of quarters. Those of you who have been following us for a number of years have seen what I hope you would recognize as three strong quarters and with each successive quarter getting stronger than the prior. I think the first thing that we attempted to accomplish as a team was elimination of these write offs, of these surprises, of anything that would cause us to miss guidance earlier. We think we have accomplish that and quarter one was a milestone quarter for us through the divestitures and wind down. So that was something to put behind us and is over.

Number two is stability, predictability and increase in the margins. I think we began to see that during the last two quarters, in particularly returning to our historic margins and our core businesses and we feel very good about that.

And finally we are very confident on our revenue and filling up the pipeline as I referred to it, which is the contracts, the contract value and converting that into backlog and growing the company both top line and bottom line as we continue through the year. We are absolutely committed here at Tetra Tech. Everyone in the team here at the executive level all the way down through the last individual in our office to growing to becoming the most competitive organization in this industry and to going out and to become leaders in every one of the markets we're competing in.

So I appreciate your support and we will look to continue to increase our performance in the future and to keep these last three quarters just the beginning of where we are going. Thank you very much and we'll talk to you certainly next quarter.

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