Tetra Tech Inc (TTEK) 2006 Q2 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 your 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 meanings of the Private Securities Litigation Reform Act of 1995. These include statements concerning future events and Tetra Tech's future financial performance. The statements are only predictions and may differ materially from actual future events or results. Tetra Tech's form 10-K and 10-Q reports to the Securities and Exchange Commission identify certain risk factors that could cause actual results to differ materially from the forward-looking statements. Tetra Tech undertakes no duty to update forward-looking statements.

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

Thank you very much. Good morning and thank you for joining our quarterly investors' call. I'm glad to present the results from our second quarter which we felt was very strong and right on track with our guidance across the board. Today I'll provide an overview of the business from the second quarter, the financial results and then the guidance for the remainder of the fiscal year.

To start with an overview, Tetra Tech did have a very strong second quarter financially with revenue, income and backlog and overall our strategy is working very well with exiting our noncore businesses and focusing on the engineering and resource management business and primarily in the water sector. We are finding that we're strengthening in all areas in the water sector, and the engineering and consulting with overall revenue growth for the quarter, and that was all strong organic growth -- I see somewhat over 7%. Most reassuring here internally is growth in backlog; we've seen over 8% sequential growth and it shows that we're converting our contract capacity into backlog from our core sectors. And finally, David King will talk about the strong cash generation well in excess of $30 million for the quarter.

I'll provide a few details on some of the financial performance for the quarter that we've seen. In revenue, just over $318 million for the quarter and we've seen that growth in all of our client sectors. We've seen it in the federal area, we've steady growth -- state and local was the strongest area of growth and our commercial sector also grew for the quarter. So it wasn't attributable to one area, it was across the board.

Revenue net of contractors, largely labor, that's internal performance. We did exceed our guidance and it was, again, driven broadly across all of our business sectors primarily infrastructure and resource management, our core business areas. And if you had to know one particular area we had strength, we did have some work in Iraq that contributed. So we are seeing steady revenues from the Iraq market.

And finally earnings -- earnings we are at $0.16, right in the middle of the guidance of $0.15 to $0.17. I do want to make a note here that this guidance did include a reserve, approximately $3 million in our resource management business. We did see increase in our margins and our infrastructure business. And excluding the one charge on one project in resource management we saw increased margins in our core business of resource management for the quarter. And we have factored in the overall risk factor for the remaining projects into our guidance for the second quarter. so we performed just as expected.

In our current portfolio mix our customers are very stable; we're not seeing any decrease in our federal markets, which we feel very good about. There certainly has been some question with the budgets whether or not there would be funding at the federal level. We've seen not only actual revenues for the quarter in line with our expectations, but actually new wins and I'll get to that in a moment.

Overall in our segmentation, Tetra Tech had been reporting and is reporting three segments -- resource management, just over 60%; infrastructure, about a third of the business; and communications which reflects our wired line work which is utilities and support of infrastructure business had been the third segment. It has been consistent at 5%. We have completed the restructuring of that business. And during the third quarter we will be looking to combine the communications within the infrastructure business and move to a two segment approach. So we are moving and hope to have that completed here during the third quarter.

A list of some of our new wins -- I think that the list of wins are most indicative of the strength that Tetra Tech has had in the water sector, mostly in the state and local business with wins; BRAC, the base realignment and closure in the Department of Defense; and in coastal engineering wins. Now the top one here on the list, $115 million for EPA's START contract, that's one of our EPA recompetes. We've largely completed the round of the recompetitions for our EPA work and have fared extremely well across the board with those. And this is one of the most recent wins.

We also had a recompete with the Federal Aviation Administration, FAA, and that $60 million is a new award for recompetes if they were successful. We see the first full year of funding and the rest of these Iraq and Navy-based with the BRAC, base realignment and closure contract. And probably most notably, these are new wins but our overall, as we call it, project pipeline which are new contracts, new capacity continues to grow.

And that really, on the next slide, is reflected in -- the first time we've seen over the last six or seven quarters a quarter-to-quarter sequential growth. This is all organic growth. There has been no inquisitive growth included in here. We're up at over 8% and that includes growth in our core watermark areas. The strongest area has been in state and local, but we did see growth in the federal sector. We did see domestic federal sector continue to be steady and we believe that that will continue to grow.

And we've finally seen, as we were anticipating, some new opportunities in the Gulf Coast in our coastal engineering and water resource markets both at the states along the Gulf Coast and for the federal clients. And with that I'll turn it over to David King, our Chief Financial Officer to go over some of the financial results.

Thank you, Dan. This is, again, as Dan mentioned, a strong quarter to report. We stated our revenue call which was 222 to 230. We achieved $238 million with a growth of 7.6% year-to-year and backlog sequentially is 8.3%. We experienced growth, as Dan mentioned, earlier across all our sectors, particularly in the state and local area. Also growth in the -- and also worth mentioning is there is also growth in the right areas -- water, BRAC and our federal customer base.

Income from continuing operations is $16.2 million which is about margin based on net revenues about 7%. We did have a surprise which is mostly water related and took a $3 million charge for the quarter and without a reserve our margin would be in excess of 8%, company as a whole. Again, we see core business improvement in all areas. Our EPS, despite the reserve, we met our guidance of $0.16. And on a net income basis, which is the GAAP basis, we also had 16% -- $0.16 which included the option expense of $0.02 and discontinued operations gain of about $0.02. So again, continuing operations $0.16, net income $0.16.

Our SG&A cost is about $30 million which included, as I mentioned earlier, a $2 million reserve for the job that we mentioned earlier. The total $3 million and other million is in the project cost, our cost of sale. In a normalized basis our G&A should run between 11 and 12%. Net interest expenses we see a favorable trend and I believe this trend will continue. We basically didn't have any borrowing except our senior notes for the quarter and we also experienced some increased interest income with the cash we have in the bank. Our respective tax rate is 43.5%; principally it was driven by part of our option grant that had no tax benefit, as we mentioned, the current quarter as well.

Accounts Receivable reflects principally revenue growth. We do have about $5 million that has to do a temporary impact due to our ERP conversion and cable reflects our [DSR] reduction. Here today we have a better business mix and we have much less communication work and subcontractors. We have more resource management and federal customers and subcontractors which paid provisions. As a whole this better business mix results in better working capital or working capital efficiently and as we get paid quicker we pay our subcontractors.

Net debt of $52.8 million reflects a 48% reduction. We continue to focus on cash together with the working capital efficiency we've continued to manage down that debt. Again, this is a tremendous quarter for cash. We generated $37 million from cash from operations and we are on track to meet 4o to $50 million annual goal. In Q3 we expect to generate about 10 to $15 million. In Q4 we expect to generate 15 to $20 million. We are on track with our forecast on our overall cash goal.

CapEx, we spent a little bit more this quarter basically to replace some old equipment and invest in some new book areas. And I expect that to be 11 to $12 million for the year. [ESR] we continue to see -- we stay at low 70s which I think that's how we're going to finish for the rest of the year. Next slide, please. Again, this is a trend we try to report. We continue to focus a few basic financial metrics, our cash, our working capital efficiency and our debt. I expect our net debt to be between 25 to $30 million as we finish the year for FY '06. Thank you.

Thank you very much, David. I'd like to provide a few words on the market environment. That's the next slide. This is what we're seeing in the market overall. We're seeing that federal spending has been steady. For Tetra Tech Iraq has been a great contribution, it's been a short-term contribution and we see it as an opportunity to offset any type of softening that existed here in the domestic market on the federal side. That we expect as Iraq will ramp down, our domestic programs, particular with BRAC and others are beginning to pick up and the timing of those programs maturing and receiving their funding is actually working very well with the RAC we put in place.

States, we've seen the state budgets and local budgets have a surplus across the country. I believe statistics I've seen all but one state out here in California have actually seems surpluses and we've actually seen that converted into new contracts, new funding and strengthened the state and local budgets. And Tetra Tech has performed very well and that's been the one area of our strongest growth this last quarter.

And finally, the strong economy has allowed the commercial sector to spend more addressing its environmental liabilities and upgrading some of its plants that we address with our water treatment, water processing and other support activities. So we expect the commercial spending to remain strong in most of our sectors. And mostly the one common theme between the federal, the state, the local and commercial is water markets, Tetra Tech's strengthening in, and these are areas that are receiving more funding from our clients.

Our guidance, Q3 -- this is Q3 and the remainder of our financial year. These are in line with our original guidance for the year. What we've done obviously a good way through the year -- we've tightened up our guidance, we've narrowed the range. I think at the beginning of the year we had an 850, 950 for the year net revenue. We've taken that, but the range in half -- 900 to 950. You can see diluted EPS for our third quarter $0.18 to $0.19, shows continued improvement in our operating margins that would correspond also to increase the revenues. And we've also narrowed the guidance for the annual earnings from 69 to 72.

In summary, Tetra Tech is achieving its organic growth. Our long-term growth plans here at Tetra Tech are to achieve approximately a 15% growth on top line while maintaining the bottom line. The first up of that are the components of the overall growth objectives are to achieve approximately half of that internally, organic growth and have of it acquisitive growth. As you can see both with our backlog and our growth that we've had in net revenue this last quarter, we're well on our way to achieving those growth numbers. So we think that we're right on target there.

Our strong revenue, as you can see, we're growing, and profit. I'd like to just say a few words on our margin. As we've indicated, our goal is to continue to increase our margins across all segments. Now the first quarter of fiscal 2006 on an aggregate basis we were about 7.5%. The second quarter, if you exclude the one charge on one project, Tetra Tech would have been approximately 8.2 seeing increases in our resource management margin and on our infrastructure margin. As you can see from our guidance, we expect to move to the upper 8's and into the 9% on an aggregate basis or Q3 and Q4 up toward the double-digits that we had originally forecasted. So we think we're on target not only for growth top line, but continued margin improvement across all of our sectors.

Clearly to accomplish that we need to strengthen our backlog and to win new contracts that will be converted into backlog and we're right on track for that. As you can see both the backlog increased and a precursor to the actual backlog increasing is overall vehicles that allow us to have that capacity and we've seen that increase over the past several quarters.

And finally, the opportunities that we're seeing are not only in the market in general but are in our core strengths -- in the water market, in the resource management sector and in the engineering. And so we feel very good about that, very strong, on our performance. And are glad to be getting back to our historical higher margins up to double-digits. And with that I'd like to open up this quarter's call to questions.

(OPERATOR INSTRUCTIONS). John Quealy, Canaccord Adams.

Good morning. Just a couple quick questions. On the revenue growth, you mentioned 15% total with perhaps half of that coming from organic initiatives and the other half from M&A. Revenue growth looked pretty good this quarter in this 7.5 or 7.6. Could you see that spike higher than your guided range in the near-term as backlog gets converted in the next two or three quarters? And that's just part one of the question.

Yes, certainly we feel very good about the 7% quarter-to-quarter sequential growth. We do believe that we will have organic growth higher than that in certain sectors. We have seen some flattening in system support and security; if we could see that strengthening that could help our internal growth pick up even further. The answer is yes, in the short-term we can see quarterly spikes even in organic growth.

And then on the M&A side, you've talked in the past about potential activity in the water spaces, one of several that looks interesting for you for acquisitions. Can you comment more on the financing side here? That is coming down; cash flow was up pretty good quarter on quarter. Can you comment on what the mix would be for funding, whether the cash flow right now can support a fairly sizable acquisition?

Yes, I believe so. Combination of cash and our credit line, we have a total capacity of more than $200 million to do the acquisition which can help us land a pretty sizable acquisition. And we have full support at the banks and if we are looking at (indiscernible) transactions we will have their support -- we've been in discussions with the banks.

My last question on the competitive space in water. We're seeing some large E&C competitors come in the market in water in a bigger way. Can you comment on how things are going? Obviously it's a good end market that people want to get involved with, but can you comment on some of your larger E&C payers coming into water?

Actually feel pretty good about that. The larger E&C contractors that are entering this space are entering at a level far below the vertical entry point. They’re entering at construction management, they're taking on the actual construction activities and we've seen very little or no entry from a competitive standpoint up at the engineering, up at the design -- the earlier work and certainly at the science. So the portion that Tetra Tech is focused on, which is earlier in the overall performance which is everything from the conceptual science all the way down through the design, we're seeing very little entry of new competitors in this space.

Great, thank you.

Debra Coy, Stanford Washington Research.

Can you give us a little bit more color on this problem contract in the quarter that caused the $3 million reserve? Is that one of the contracts that's part of your ongoing business? Is that one of the things that you're winding down? Can you talk a little bit more about what happened there and what we should expect to see going forward?

Yes, Debra, it is one of the -- it was in the resource management -- let me start at the beginning of the story. It was in the resource management business. It's a noncore business. It's not an area that we aren't shutting down or discontinuing the resource management operating unit. So it's a wind down effect so that's why it was included in continuing operations. It was a single project that -- it was a high-risk project; we knew it was a high-risk project going into the quarter and had factored it into our guidance in the event there was any variability in the final performance during the quarter.

It was out here on the West Coast and we had severe weather impacts. We had problems with the constructability associated with weather and so it required some reconstruction and overall we took a $3 million reserve. So we believe we've fully reserved for it and that project is largely complete in the second quarter.

Now obviously that lends the question, how many more of these are there across our entire portfolio on what I'd call problematic contracts, non-core projects? We have one remaining project. It's a much smaller size, on the order of magnitude of about $3 million and we expect it to be complete late this third quarter, potentially even into the fourth quarter. We have it fully reserved; we believe we have very good visibility into it.

And just as observation having gone through the last couple years of these types of construction projects -- I personally observed the variabilities in the late fall and the winter months where you have rain and snow and all sorts of other events make it a higher risk. Moving into the spring and summer we think we're well on track to having this complete. So we think we've taken the risk and put it behind us now.

Okay, that's helpful. And then just coming back to talking a little bit more about growth. You said to John you thought that you can continue to spike higher and certainly the organic growth is pretty impressive in the quarter. Can you sort out how much of this is coming from Iraq which you mentioned as being a key contributor and kind of outlined it that as Iraq winds down that big contract that you expect to make it up in other areas? What I'm getting at is how far do you think Tetra Tech is from fairly sustainable mid single or 5 to 7 or 6 to 8% growth that you're targeting? Are we there or will we still see some ups and downs over the next several quarters based on what you're seeing in the marketplace?

We do have some contribution from Iraq, but we think that less than half of it was from Iraq on the net basis. Iraq contributed primarily to the very top line, lots of subcontractor work. So we think that this is indicative and the work we're winning, while we have had -- and you saw the release this morning -- we have had some new Iraq awards. Most of that work that was announced today for the reconstruction activities, much of it is subcontract work. So its contribution to net is going to be relatively small. So we think that the contribution toward this mid to 5 to 7% organic growth internally, our domestic programs with our core clients and we're looking to maintain those numbers.

Great. And final question, on the acquisition front, you have said that you're -- David just said again that you're capable of doing a relatively large deal. You've certainly indicated that you're interested in that. Can you give us any updates or your views on the environment? Are there companies out there to buy that you're interested in? Are there competitors for acquisitions? What are you seeing in your acquisition pipeline? As far as you can comment.

I won't comment on specific targets as I give you the names and stock symbols or their private (multiple speakers). But we are seeing -- there are a couple of things going on in the market. This is a very attractive sector. The investors and the owners of these firms are seeing their markets strengthen also. It's great to be in a market that not only you're a market leader in; you know that the Engineering News Record came out about a week ago, just over a week ago, and still ranked Tetra Tech number one in the watermark across the entire industry. So we feel that folks that are looking to take and for synergy to play with the number one player -- not a member two or three player, but with the top player have some natural inclination to be interested in Tetra Tech.

Now folks do believe that they're valuable and they are. This market is strong, it's robust and we're looking for folks that are growing at a rate equal to or even better than Tetra Tech. And we think there's lots of opportunity out there. Much of it is privately held, so it can be done -- I won't say behind the scenes -- but it can be done with the individual owners. And there are even a few public companies that maybe their multiples haven't quite tracked as high as Tetra Tech and some of the very front market leaders to be good opportunities.

We see it as an opportunity rich environment. No doubt it is not cheap, cheap; but with the market growing I think there's plenty of accretion in the value of Tetra Tech stock on the inquisitive front.

Okay. Are you willing to forecast whether we would see a deal of some sort in the next 12 months?

No.

We will not. And again, what Dan mentioned was probably a broad-based valuation issue (multiple speakers). That we need to be prudent. Again, I think we are able and willing but I don't think we are totally ready yet.

I think the two words would be the right deal at the right price we would move on very weakly and do certainly it is possible within the next 12 months and that we should not be considered -- it could happen well within that period, it should not be considered unusual.

Okay. Thanks very much.

Richard Eastman.

Robert Baird. Just a couple quick -- could you just add a little bit more color on the state and local growth rate? I know from what you're saying municipalities were bigger spenders, but if you look at the growth by customer it was really skewed toward state and local and is that -- again, is that best described as municipalities spending more on water projects?

That's right, Rick. If you want to get right down to it that's exactly what it was. Municipality on water treatment plants, WTPs, is up. We've also seen some new contracts. We had a new statewide water resource contract down on the Gulf Coast with the state of Mississippi that helped drive that. We have a couple other state contracts down in the Gulf Coast that are water-related to coastal engineering for water quality and shoreline protection. So we've seen some of it at the state and local at the state, but I would say two-thirds of that would be related to municipal water treatment programs.

And is that also having a meaningful impact on the sequential backlog growth or is that driven more by federal?

No, state and local did contribute (multiple speakers)

(multiple speakers) large enough projects and they're coming in with big enough task orders that they would influence that number?

They are. We have state and local projects out of Colorado at about $6 million for infrastructure for a water program. We had one in Southern California of $3 million; we had a couple in Detroit at 3 to $4 million. And there are two phenomenon. We've talked about this on previous calls. The federal are larger dollars and longer performance periods of state. And then local are smaller dollars and shorter funding and, of course, commercial are generally the smallest and the shortest.

So certainly you don't see single awards that hit generally Tetra Tech's disclosure for press releases. You don't see a single state project at 20 or 50 or $100 million. But we've had a substantial number of projects between 1, 2, 7 or $8 million. But yes, it has contributed to our backlog.

Are there any aggressive efforts on your part to link into some of the larger multinational E&C companies to do -- somehow partner on some of the global water projects that might be out there as opposed to trying to approach those yourself? Because the global water market, you've always approached that as pursuing U.S.-funded projects. But I'm curious, have you had any discussions with some of the larger E&C companies to try to piggyback onto their efforts and do more of the design work for them?

We are. We started with a very conservative approach with respect to a risk of currency and the ability to get paid on the international front. We've been partnering with international firms to pursue USAID, U.S. funding, U.S. dollars performance overseas. So that's been a first step. We have gone overseas with large E&C contractors, a little bit more on the C side, the construction side. We are a big partner with Perini as an example and we certainly provided those to leases. We're doing a fair amount of work in both Afghanistan, Iraq and other portions of the Middle East with these large international -- called the E&C contractors. And so they are examples where we're not taking the lead, but we're a partner for handling both the science and the engineering portion.

So yes, we have embarked upon that and we have a number of strategies to begin expanding our international footprint. And as you can see, we've seen no appreciable movement yet on our international presence and so it's a great area of opportunity. We're at about 1% right now.

Okay, and then just a very last question. For a while we were talking about the federal systems support area. Where's that initiative? Are we still looking to expand that? Has there been growth there and is that still a priority area?

I touched on it just briefly during the actual presentation. On our systems support and security we've seen steady revenues. They represent about 10% of our overall revenue base. We've seen that remain constant. We've not seen a growth on the top line and in fact we've noticed some of our competitors actually begin to hit a topping of their topline growth. That's consistent with what we've seen. We haven't seen any erosion in the top line but the bottom line, the margins have continued to be among the best in our Company, they've been double-digits and we don't see anything changing in that area.

We originally -- going back a couple years ago -- saw that as a growth area, a very high growth area, valuations -- and that was going to be through acquisitive growth -- to create a larger critical mass. Evaluations had kept us from moving in that area aggressively. But as things change we'll continue to even include looking in that area.

Okay, very good. Thank you.

Richard Paget, Morgan Joseph.

Good morning, everybody. Most of my questions have been answered, but just getting back to the state and local, is a lot of the funding being driven by tax revenues being up on a year-over-year basis?

Our tax and usage -- tax and usage. That's where the funding is coming from and we're seeing large requirements from demographics being driven for new infrastructure requirements in the Southwest and the Southeast and certainly for regulatory compliance activities and user fee contributions up in the Northeast and Upper Midwest.

Getting back to the regulatory issues, specifically with CSOs, have you guys seen more consent decrees handed out, especially to the bigger municipalities?

We have seen more consent decrees and we've seen the consent decrees that have been executed which are not an insignificant number, actually watch municipalities move toward complying with them. So there have been a very large number of consent decrees out there, only a very small amount that have been actually acted upon. And then we've seen some movement in additional consent decrees. But the existing population of consent decrees to be complied with are really at the very beginning of that overall lifecycle or regulatory cycle.

So your sense is going forward that they will start more actively enforcing than they have been in the past?

Absolutely. Well, a consent decree is an agreement between a local agency, an individual being enforced and the enforcing entity. And so, if they don't meet the conditions upon the consent decree, which are schedules, contractors, work being performed, then it will move to an actual enforcement action which is much more expensive and provides even more opportunities for us. So if we saw municipalities in fact not meet their requirements, the obligations of their consent decree, well generally it's perceived as you could almost add another zero to the overall implementation cost if you're going to do it through an enforcement action.

Okay, great. That's it for me. Thanks.

John Rogers, D.A. Davidson.

Good morning. On the federal side what are you seeing in terms of BRAC activity? Is that still a couple of quarters out or -- from Tetra Tech's point?

There are two BRACs, there are two flavors of BRACs right now that we see. There's the new BRAC that we talked about internally and that's the BRAC 2005. That's approximately $20 billion and it's interesting, we've seen new BRAC numbers recently up as high -- (indiscernible) as much as double that in recent meetings with the military. They're beginning to talk about major redeployments of repatriated forces.

So you have the new BRAC, the base realignment and closure is at the very beginning. And we've talked about this in the past as looking like a bellcurve that is having a very small tale, growing to be very large while the cleanups of these sites and the construction of new facilities is about a ten-year process, a bit more. And so the bulk of the dollars will be spent between maybe years 3 and 7. We are at the very beginning, we're in years one and two. Tetra Tech has been awarded contracts through the Army Corps of Engineers and through the Air Force and the Navy to do environmental studies and upfront planning documents and so the revenues from the 2005 BRAC are a very small amount. We expect them to grow much larger in '07 and then a real ramp up of the curve in '08.

Now the other works -- you saw an announcement here a few weeks ago with Hunters Point for the Navy. It was a $20 million task order and that's BRAC related for closure of some of the more problematic -- some of the harder bases to close front the previous round. So we're still seeing strong revenues from the previous BRAC rounds, which go back almost ten years when they initiated, and we're just seeing the beginning of a ramp up of the new BRAC.

And because of your science expertise shouldn't you be at the front end of that curve?

Way are.

I mean as opposed to a C company?

No, we think that if you want to look at the bellcurve front tale, or the front ramp up portion is our part of the market. We think that the studies, the engineering -- so I'd say up through if you wanted to call it a ten-year period. I'd say up through years three and four, even three years five are our best and then it moves to pure construction. And then at the very tale end operations, maintenance and optimization, which are going back and reevaluating how everything is performed. So we see again some strong performance at the tail end. So we think that you're right, we're moving into the best part of BRAC for us.

But it sounds like it will probably show up then more into I guess it would be fiscal '07?

Fiscal '07 is when you'll see a material move with the new BRAC funding and in '08.

And then one other question. Just on the options expense, you noted in the release that you expect total expense this year to be $0.08 to $0.09. So that's about $0.02 and $0.03 in the next two quarters?

Yes, we forecast about $0.02 per quarter.

And David, going forward it should continue to run at that rate given your plans?

Yes, we see that, although I think as we ramp up with our new plant and (indiscernible) the tax impact will be very different. We are not there yet -- able to forecast the tax rate impact on that yet.

Okay, but you mean that a portion of it would not be deductible?

Yes.

Okay, great. Thank you.

Cory Greendale, First Analysis.

First, just quickly on the margins I think -- Dan, I think you said that you expect margin to trend up kind of high 8's.

That's correct.

Is there any reason to think that if you look at the margins by segments backing out the charge in the (indiscernible) management segment that the margin in each segment shouldn't be going up sequentially Q3 and Q4?

That's right, that's exactly right. We saw that if I back out the one charge on one project you would have seen resource management Q1 go from 8.5. We saw on a normalized basis for Q2 up at 8.7 and we'd look to achieve 9% resource management and we'll move up to -- in Q3 and in Q4. We saw even stronger movement in infrastructure and I feel very positive about infrastructure, not only on the funding but the margins are back where they should be and in fact we're going to see margins -- we're already seeing them reach our historical highs and I believe we still have more room to go.

In infrastructure Q1 we are at 6.1 and we're at 8.6 on Q2 and we're seeing continued strong run in Q2. And the only area that we saw a little bit of softening, and it's on a percentage basis, it's a very small part of our business and we talked about moving it to consolidation with infrastructure was our communications. That was at 8 and went down to just about 5% and that was associated with one project, UTOPIA, our single largest project transitioning from Phase I to Phase II. So we expect that to get back.

And the infrastructure you (indiscernible) is more upside. What drove that impressive improvement sequentially?

Workload, utilization. We're beginning to apply our resources, make them more billable. We've been able to use our labor base much more efficiently as revenues continue to climb.

And then I'm just curious with the 15% topline target you talked about. As you look at the organic part of that, how do you think about that 7% coming from taking share of the market versus market growth versus entering new markets?

That's a great question and it's a complicated question because the 7% is a combination, as you can see. We actually saw a reduction on a sequential quarterly basis on our communications business. And so in some sectors we're seeing numbers higher than that or we're seeing growth. Others we're seeing just flat performance. So it's really -- on a consolidated basis we've seen this 7%. But we do see our core markets strengthening and should continue to contribute at those types of growth numbers on a net basis.

So it sounds like you think it's the market strength and growth as opposed to your having to take meaningful share in order to get to those kinds of numbers?

I think that we are taking share on infrastructure. I think resource management is growing, that we're I guess you'd say holding our own and the overall numbers are growing in the marketplace. So it's a rising tide on resource management and I think that's driving one component. But I think infrastructure, we're actually taking market share in addition to writing and increasing an increasing funding base from all the clients.

Thanks very much.

Jeff Beach, Stifel Nicolaus.

Can you talk about the organic growth and outlook in a couple of areas that we didn't hear about today, homeland security, airports, ports, other kinds of programs and then what's the outlook in your nuclear work ahead?

Homeland security, we're not forecasting a growth in that area. We are forecasting a stable revenue run rate on the securities side. We've seen airports under substantial pressure. So we've seen airports in search of additional funding locations from anywhere, from the airline, really from any location. The federal government appears to be stepping back; we haven't seen them contribute to the airports. We've seen the commercial sector under pressure with deal prices. But for airports we've not seen that as a growth area for us area for us.

But ports, we have seen some investment. We have a strong position and I think we'll continue to hold our own and this is just an area we're not forecasting as a contributor to Tetra Tech's overall net growth on a quarter-to-quarter basis. We expect to maintain our overall position, but it won't be a material contributor. And on Department of Energy, Second Line of Defense is our single largest program. It continues to be funded very well and that is -- as we've talked about in the past, it's installing radioactive detectors for isotopes in foreign ports around the world.

On the nuclear front I was referring more to is there any increased activity in terms of different services you're providing the nuclear power plants?

This is Sam. With regard to nuclear power plants, we do have opportunities in supporting owners as owners engineers. So we have opportunities in front of us today and that arena. None of those have matured to a natural selection, but we do have opportunities in front of us, which is interesting for us. And we have a strong resume to place against that opportunity. And with regards to just DOE in general, we continue to see a lot of opportunity in the -- I'll call it the second-tier contractor level which is Tetra Tech is playing in right now with regards to opportunities in front end studies, engineering as well as specialized field remediation work.

All right, thanks.

Matthew McKay, Jefferies & Co.

Just a couple questions here. First of all, can you give out what the pipeline size is at this point and just comparable as to what it was about a year ago or any color on that?

We've seen it grow. We've seen it grow from about 5 to $7.5 billion in overall contract capacity. So we've had our overall capacity grow by 20% or more than that. And obviously you can see it's translating into backlog. So from about 5 to $7 billion.

And just to be clear, how you define the pipeline is the unfunded portion of the backlog, correct?

What we do is we -- let me use an example of one that was on an earlier slide, the Federal Aviation Administration is a three-year award for $60 million. Annual funding is -- so we took -- originally when that was awarded we took none of that into backlog. Our backlog is we believe the most conservative report; it is contracts been awarded, it's been funded. So they've received funding from their clients or their original funding source and they've authorized us to expend all of those funds. And so an example of the FAA where we had a $60 million award, they a few weeks later provided us $17 million of funding and authorization to go ahead and cover us through the first year.

So in our backlog of that $60 million award only 17 of it was -- or is currently recognized in backlog. There is not multiple awards on that contract, there's only one awardee. It's only Tetra Tech and so as the time frame continues then the next period will award. And so the unfunded portion is not reflected in backlog and we call that our project pipeline. That's what we have under contract and we need to convert that to backlog.

Great, very helpful. And then a question, maybe more for Mike, but if you could just update us on the hiring status on the business development side?

We've continued to focus on that. We're building our business development staff, we're investing in organic growth. We're directly investing in new proposals, and so we're actively recruiting in the marketplace. We've added a couple of new staff there and we look forward to adding two or three more key hires through the remainder of this fiscal year.

Great. And then just a couple of things. I noticed on my cash flow that it looked like there was almost a $2 million payment for an acquisition in the quarter. What was that?

It was a -- in fact, we put it out as an acquisition. It was a very small group of people that we bring over and (indiscernible) acquisition.

All right. And then just sort of looking -- as your business kind of evolved, you've got less payments to subcontractors and it looks like it's swinging around the balance sheet a little bit. Accounts payable declined fairly significantly for the second quarter in a row and should be expect accounts payable in particular to stay down at these levels as well as have a lower mix of subcontractor payments or is that going to bounce back up?

I expect the subcontractor level to actually slightly increase because of the revenue increase. And payable should be a little higher as we move to the second half of the year.

Okay. But sort of down around these levels is sustainable?

Yes.

Okay, great. Thanks a lot, guys.

Min Cho, Friedman Billings Ramsey.

Good morning, just a couple of quick questions. First, it sounds like your business is obviously improving across all of your end markets. Given the current project pipeline and the other opportunities that you're seeing out there, will this support continued sequential improvements in your backlog or do you still expect that to be somewhat lumpy?

I would like to think it's not going to be lumpy, but from a practical standpoint, I think it will be lumpy. The timing of our clients' funding individual staff orders or individual periods does have the potential to be lumpy. So I think that looking at a single quarter is not representative of a long-term trend. I think you need to take a look at multiple quarters to see where we are headed.

We believe that the first indication is, is your overall contract capacity increasing and then where is your backlog following. But it is possible based on timing of conversion of contract capacity -- to backlog it is possible for it to be a bit lumpy.

Obviously, a hot topic in the sector continues to be labor shortages, and it sounds like it is occurring more on a regional basis. Can you talk about any impact that you're seeing today within your own business or even on the subcontracting level?

I'm glad you said that, on a regional basis. We have got -- certainly seen many folks characterize this as a phenomenon of labor shortage or engineering shortage or technical staff. We're seeing it very much on a regional basis. We're seeing a little bit of a challenge in the Southwest, California, Arizona, and Nevada. We're seeing a little bit in Florida. We are seeing no shortage at all of resources in the Upper Midwest and in the New England area.

What we have done, we haven't -- it's been something that we are looking at to hire new staff, but we have been using a balancing of our resources internally. So we have folks that we're -- that will be taking that. It may not be optimally utilized in Upper Midwest in the New England area, and have deployed them to projects that we have where there is a higher demand.

The one final question, just some clarity. In your communications business is that all UTOPIA now, or are there still some other municipal projects there?

We only have one municipal project on the wireline side; that is UTOPIA. It's by far the largest, but we do have a few turnkey buildouts for some of the commercial carriers, Verizon being the biggest.

Thank you, good luck.

[James Cappello], Kern Capital.

Regarding the one remaining problem contract that you possibly see, do you see that you are fully reserved for it? Are you fully reserved for the $3 million or what you hadn't collected yet, and what is that amount?

The $3 million is not the amount that we have reserved on the project. We've taken reserves on this on earlier quarters. The $3 million reflects the amount of remaining work to be performed, and certainly it will move from being a remaining contract capacity, we would refer to it as. So it will go to unbilled build. We will receive it. We don't see any issues on the terms and conditions or collectibility on the remaining amount that is going to be incurred.

When I referred to reserve, we do an estimate of what it's going to take from us from today through completion of the project. And if, in fact, there was any liability, we would have and have reserved for any type of difficulty that would be encountered from here through the completion.

So what is the total amount that you have reserved for the whole portfolio at this point?

It is about 12% of our receivables. We continue to liquidate those reserves, and reason why is the liquidation reserve also have (indiscernible) with our tax planning. And there are certain tax requirements that you cannot liquidate reserve too quickly.

Okay. The $3 million in the quarter that you took, what was the size of the contract originally and how long has it been going through the P&L?

The overall project was approximately 7 to $8 million, was the original contract, original contract value. This is a contract that goes back -- and that is a great question. We do want to make that note; this is not a contract that was entered into in the last year and a half. This is a contract that goes back more than two years, and prior to the systems and the contractual procedures that we put in place.

I'm glad you asked that question. I want to make that clear point. This is not a new contract that we took on in the last 18 months. This goes back two to three years before some of the systems we have in place. So $7.5 million varies -- you can imagine over that period of time the complications of taking this long to complete a $7 million contract.

What was the contract? What were you fulfilling?

That was a construction project. It was well outside our core business, but we don't disclose the client or the specific project.

Can you tell me what industry? Was it water related? Was it telecom related?

It was just in the non-core construction area.

Okay. Is there any more of those type contracts in the pipeline or backlog?

No, the one that I had referenced that will be complete late this quarter or basically the summer. We think we have very good visibility on that. Other than that, no.

Okay, great. Thank you.

That will conclude the question-and-answer session. I will now turn the conference back over to Dan Batrack to conclude.

I'd like to conclude with we feel really good as a management team here. We think we have had a very clear objective of exiting the non-core business -- we're there -- returning our margins back to where they had historically been. We are well on track for that for this year. And finally, and the part that takes a little bit longer, is returning to a growth company. And the first part is internal; we have full control of that. And it is not only riding a rising tide as one of the questions asked, but it is taking market share, and we have an absolute focus on that.

We think that with great work from all of our operations and David King and our financial staff that the financial generation of cash and liquidity have gone way up. So it has made well within our capability of moving on the right target for the right price on an acquisitive side. So, all in all, I think we are right on track where we've expected. I really appreciate all of your support through this period, and look forward to talking to you next quarter. Thank you very much.

Thank you, ladies and gentlemen. This concludes our conference for today. Thank you all for participating. Have a nice day. All parties may disconnect now.