Tetra Tech Inc (TTEK) 2006 Q4 法說會逐字稿

Good morning and thank you for joining us today. 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. We'll 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 we will open the lines for questions.

During the course of the conference call, Tetra Tech management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include statements concerning future events and Tetra Tech's future financial performance. These 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 the 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 the conference up for questions and answers after the presentation. With that, I will now turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Thank you and good morning. Welcome to our fourth-quarter earnings conference call. We are glad to present both the fourth-quarter results and the summary of our fiscal year 2006 progress that we have made this last year.

2006 was a significant year for Tetra Tech in both repositioning the Company and refocusing all of our efforts here to clean up historical problem contracts and to focus on our core business. As you will hear through our conference call this morning and the materials we will present, we were primarily focused on closing out some of the noncore programs that were very high risk, changing the overall risk profile of the Company and growing backlog contracts and our overall client mix to our core businesses.

That did result in significant improvement during the year sequentially from quarter one through quarter four, mostly of which quarter four we will present today, an improvement in our operational and financial performance and every metric in our key businesses were up. As you will see today, our revenue was up, our operating income is up, our backlog is up and it's the strongest that we have completed a year and will be entering into fiscal year 2007 that we have had in more than five years.

Tetra Tech made no acquisitions this year. So the growth that we would show, which was more than $100 million in revenue, was all internally or organically driven. So the all growth efforts were focused and as a result of the internal investments and focus on our key businesses.

Fourth quarter resulted in a growth, to provide some specifics here, of over 9%, 9.6%, again internal growth. Backlog up on a year-on-year basis was nearly 20% and not only were we growing revenue and backlog winning new programs, we were more efficient with our cash generation and leveraging our balance sheet than we have been in years. In fact, David King will talk about this as being a new 10-year performance level on our balance sheet.

Our cash this last year exceeded our operating income by over 35% and this is one of the key drivers in our Company. It also contributed to interest income and other contributions of the Company.

In our financial overview for the fourth quarter, you can see revenue up year-on-year by 9.6%. What is noteworthy is not only is that up, but it is new record high for Tetra Tech. New record high both for the year and for the quarter. And it wasn't in one area; it was broad-based, most importantly both in revenue and in backlog. This was driven by our core business areas of Resource Management and Infrastructure.

Revenue net of subcontractors, over $250 million for the quarter, which exceeded our guidance of $238 million to $245 million and earnings per share, $0.22, also exceeded our guidance going into the quarter, which was $0.20 to $0.21 and we were at $0.22. David King will talk about a tax implication and how it affected last year's number for year-to-year comparison, but this year we were above our guidance for the quarter.

I think it is very important here at Tetra Tech and for our shareholders to take a look at how we are trending overall in our revenue, both our gross revenue and our net revenue, which is our staffing. This chart we show over the last eight quarters. We have been increasing sequentially quarter-to-quarter up and these are both record numbers. Revenue for the fourth quarter of 386 is an all-time record from our continuing operations and the same is true with net revenue at 251. The slight dips in our first quarter have this last year actually been less for seasonality and the highs have even been higher than before. So we continue to grow as is reflected even in our backlog.

This year as we complete 2006, fiscal year 2006, our current portfolio mix is overall pretty similar to what it has been before. The overall mix between Resource Management is approaching two thirds of our business. Actually to be precise 63%. Infrastructure, nearly a third at 32% and Communications has been constant at 5%. In fact, has even shrunk just a little bit.

What is most noteworthy in our customer mix as we finish the year is it has been relatively stable with some growth in the federal sector. And what is an observation that I have is our federal business increasing gives us more stability in our business. An artifact of the federal business has been our cost-plus work has increased 40% year-on-year. So of the federal business we have now, 40% more of that is cost-plus.

Now an artifact of this is it does have a bit lower margin, but it is a much lower risk business. It is a faster cash turn. David King, our CFO, will talk about cash generation from that business. It is larger and longer contracts and much more predictable and gives us the strongest base that we have had in what I would estimate more than five years moving into 2007, fiscal year 2007.

It does allow us to focus more on our commercial business. This strong base will give us the ability to focus on a commercial business, which is a higher-margin business and help us drive operating income '07 margins.

New wins. This is again all internally driven this year in 2006. We are at an all-time record of contract capacity also. It is not something that we report, but we have had significant new wins this year and this past quarter. Our overall contract capacity is over $7 billion, highest in Tetra Tech's history.

Since the last earnings call we had a quarter ago, here is a list of a few of the new wins that we have had that are significant. The largest, which is the Air Force combat command called Air Combat Command ACC, a $500 million contract capacity. We have had significant new task orders in Iraq at over $100 million and these two other programs -- you can see both water programs and fixed price programs at $15 million and $20 million respectively.

Now one metric we don't talk about and don't present in our analyst sheets and it is a simple calculation, but we watch this very closely here. In order to grow our backlog at nearly 20% from last year, we not only had to bring in new contracts, convert that into new task orders, but we also had to replace the revenue that we were burning at a new record rate. And even with replacing that revenue, this fourth quarter, $464 million of new orders and on an annual basis for 2006, nearly $1.6 billion in new orders both to replace the revenue that we expended and to add another approximately $170 million in additional backlog.

To take a look at the backlog sequentially over the past eight quarters, if you are following on the webcast and can see the sequential graph here, you will notice that the last four quarters have been significant improvements sequentially each of the past four quarters. The previous year and a half before that was really focused on changing the mix of our backlog and exiting non-core businesses. We had large communication fixed-price contracts that were outside of some of our core businesses. We have exited those. Other high risk programs, exited those. So as you can see, certainly through 2005 and early 2006, it dropped, but that was a planned drop by exiting these large fixed-price contracts.

Now not only is our backlog at just over $1.62 billion, it is the strongest, highest-quality backlog that we have had in years. It is our core business work. And so it is not just the size of the number; it is the quality of the number.

And for the details of the financial performance for Tetra Tech for the fourth quarter, I'll turn it to David King, our Chief Financial Officer.

Thank you Dan. This is, as Dan indicated, this is a strong and pleasant quarter to report. We exceeded all our financial metrics, both formally and informally and I will go through them in a little bit more detail.

Net revenue grew by 7.2%. We had broad-based growth. The Resource Management, Infrastructure, Communication all grew from approximately 7% up to 10% and also in our market segment, federal and state experienced -- both experienced double-digit growth. Income from operations grew from $19.3 million to $20 million. It again reflects business growth. In our margin, which Dan will talk a little bit more in detail, we experienced 8.1% in Q4 and in the pre-option basis, we were at 8.6%.

EPS grew from $0.16 to $0.20 on a pre-option basis, which we gave guidance on was $0.22. Again, as Dan mentioned, we exceeded our guidance of $0.20 to $0.21. Option expense was $0.02 impact.

Our SG&A costs also experienced a large reduction, 22.5%. On a net revenue basis '05 was a 15.2% versus net revenue. It included some exit charges in that particular quarter. On the '06, we were on a pre-option basis at 10.5%. We were also able to achieve some savings in Q4 in terms of our SG&A costs. FY '07, we expect SG&A costs to run about 10.5%, 11.5%.

It is also great to report that we, for probably the first time in Tetra Tech history, had interest income. We effectively had no borrowing in our credit line. With substantial interest income, we had a cash balance of $70 million, $80 million throughout the quarter. We were able to invest that and yield pretty substantial interest income. We expect our FY '07 interest expense to be about $5 million.

Our tax increased from $2.9 million to $8.7 million. Effective tax rate was about 43%. We had a very low tax rate of about 17% in FY '05 due to some goodwill impairment charges. In FY '06, we were profitable and normalized at 43%. We expect our rate to be at about 43% in FY '07.

Our receivable base grew about 12.7% from $305 million to $343 million. It's pretty much in line with our top-line growth on our gross revenue. We also had one or two large milestone-driven payments that we have received in '01, which brought this number down a little bit.

The payable is also in line with our revenue growth. Although I want to point out it grew actually less than our top-line cost growth. Net debt dropped from $65.1 million to $10 million. It reflects the strength in our working capital management. The debt level is the lowest in decades. At the end of the year, we have debt equity ratio of about 21% and debt to capital ratio of about 17%, 18%.

Cash generated from operations -- this was one of the metrics I refer as an informal metric. We achieved $21 million cash flow from operations in the fourth quarter. For the whole year, we did $56 million. Our informal goal was $40 million to $50 million. Or FY '07, we plan to reinvest some of the cash flow in our growth. In '07, expect the cash from operations to be between $45 million and $55 million.

CapEx, they are within range. We expect '07 to be between $10 million to $15 million. DSO, they are in target range. I want to point out that we had converted about 10 operating units in FY '06 and we were still able to achieve DSO of 70 days.

This chart reflects two lines. One is our DSO line and our net debt line. Again if you can see in the late '04 and early '05, we were touching 80 days and today, we will be able to achieve 70 days and 10-day difference represents more than $40 million in our cash flow.

On the net debt again, I mentioned this is one of the lowest debt levels for decades and I expect them to hit zero in the midyear in FY '07 barring any acquisitions. Okay, Dan.

Thank you very much, David. I would like to say a few words on summary on our markets and then move on to guidance for 2007. Our performance by market in the fourth quarter is really in three areas that we highlight. Our strongest performance was in the federal market. That is shown, which is consistent with our overall mix of business that we have. It is the biggest percentage of client mix that we have and is the largest area that we grew in both net revenue and backlog.

I would like to provide a little bit of detail into which portions contributed in the federal market to us. Largest was the Department of Energy. It's an area that Tetra Tech is significantly underrepresented in. Represents a very large growth area for us and during 2006 from -- 2005 year-on-year, we grew over 30%. 31.4% to be precise. And so we are making very good movements in there. It is a very large market. It is an area that we're underrepresented in and we think this is an area that can continue to be a high-growth area for us this next year.

Now the largest single area that Tetra Tech works for the federal government is with the Department of Defense. It is the biggest base that we have in the federal market and it grew at nearly 8% last year. A big growth area. And we see that continuing here in 2007. Both the base realignment and closure markets are strengthening. They're beginning to move out of some of the planning efforts and into actual implementation and that is where the dollars will actually be expended by the federal government.

Other areas, state and local, we feel very strong. The fourth quarter, it was up over 11%. See that to continue. The tax receipts are very high. Surpluses across all the states are very high and we expect this to continue to be a big driver for the Company.

The one area that is a big focus for Tetra Tech is the commercial area. It is the area of the highest margins. It was actually a slightly declining area for Tetra Tech. Overall, stable, but very slightly declining. If you remove the wind-down operations, if you actually take out the high-risk contracts that we had that we exited in the first and second quarter, this would be a bit different number. In fact, it would have shown a modest growth at about 4%.

But this is an area that we are going to turn our attention to begin to grow. We are not going to deemphasize the federal and state and local markets, but we are going to put an extra ordinary effort here. This will begin to drive our margins as we move out into '07 and beyond.

I do want to say a few words before I go to the next slide about the local elections and national elections that took place here just a week or two ago. A question has been what is the potential impact. There has been a major change in parties. Individuals both at the state, and local and certainly national level have changed.

Overall, we don't see that the elections have made a material impact in our business now whether or not it is a democratically led Congress and different seats or whether or not it is Republican. But overall, with environmental programs, the base realignment and closure programs and the coastal programs are generally priorities for the Democratic Party. So we see that each of these areas would be generally positively impacted by the changes in the seats in this most recent election.

There is a different set of items that were passed during the most recent election other than just seats and it was bonds. Overall, nationally, there were more than $75 billion in state and local bonds that were passed. Most of these were for repairing, upgrading and installing infrastructure.

I would like to spend just a moment on two areas where there were significant bonds passed that Tetra Tech has both a large presence and it is the work that we do. First is right out here in California where we are headquartered. It is the area that Tetra Tech has its biggest presence across the entire country.

Voters out here in California past about $43 billion in bonds and as most of it is associated with upgrading the aging infrastructure. About one quarter of that, just about $10 billion, was associated specifically for flood control, water systems and natural resource projects. That is the work that Tetra Tech does. These aren't programs that already have the designs from implementations. They are starting at the front end and so we think this is a very large opportunity out here in California. There was another $20 billion aggregate of bonds passed for ports, air quality and highway transportation programs, which is also an area of particular strength out here.

Out on the East Coast, Connecticut. Connecticut passed approximately $800 million in bonds to upgrade and to modify their CSOs, their combined sewer operations that they have, overflow plants that they have. And these are in areas that are a particular strength for Tetra Tech and one of the priorities that we're focused on as a company.

We have had a number of wins. We have had over 12 wins in CSOs in 12 different projects in 2006 and we see this type of bonds being passed just strengthening those opportunities as we go into 2007.

Now with all of the opportunities that we do have on the market side with our clients, we are operating in a very new environment financially. In the '90s, Tetra Tech was historically always a 10% margin business. Thought of Tetra Tech, it was 10% margin or slightly better. I did want to spend a moment reviewing how Tetra Tech's performance on margin today and as we go forward equates to how we performed back in the '90s.

If you have access to the webpage, in the very first column, historically, Tetra Tech had a 10% margin. It was always thought of as a 10% operating income firm and I would like to spend a moment comparing that to our '07 guidance. '07, we have net revenue of about $1 billion. I don't know if you'd convert that into actual real dollars. See if you can follow along from our investor sheet.

With an estimate the midpoint of our guidance range, which I will get to the specific guidance on the next page, but it is about $81 million. $81 million on $1 billion is about 8.1%. But some of the items historically that didn't exist as either an expense or just a fact of counting reality with respect to a few of these items just didn't exist back in the '90s.

The first is Sarbanes-Oxley, both SOX and ERP conversions in order to comply with the Sarbanes-Oxley provisions. In fact, there are about a full basis point. It's about $10 million in '07 and was similar type numbers in '06. That is a full basis point. So that would take our 8.1 forecast and move you up to 9.1.

In addition to that option expense, FAS 123(R) option expense is about 0.6 or about $6 million, just over $6 million. If you take those and aggregate them with our forecasted margin that puts us up at 9.7 on an equivalent basis of what we were performing back in the '90s. Now, certainly these numbers we're expecting and continuing to improve margins. Long term, if you want to put a date on long term, that would be 2008 and out.

We are going to continue to improve margins. We continue to push them up into 9%, 9.5%. I spoke a few moments ago about the 10% perhaps being mitigated just a bit to maybe 9.5% based on the increased percentage of the cost-plus work. Certainly this has potential upside based on the commercial spending in other areas. We do expect SOX, Sarbanes-Oxley, compliance costs go down. In fact, I would expect after 2007 that number to be cut in half. And as Tetra Tech completes its ERP conversion moving to a common platform to meet these requirements of Sarbanes-Oxley, that will also decrease.

Now option expense, it's a longer-term issue. We don't expect it to have any dramatic reduction, but we do expect to have it mitigated a bit and you can see. So if you take our future, which will be late '07, really '08 and out long term, you will see up at 9, 9.5. You add a SOX back in of 0.5%, or maybe $5 million a year. Option expense of 0.5%, that would put us at an equivalency historical basis of 10%, 10.5%. We'd be both at and even above where we had historically run.

Guidance -- guidance for 2007. I will start with the overall annual guidance and I will move to the quarter of which we are about halfway through already. 2007 revenue guidance, our net revenue -- our revenue net of subcontractor costs, $975 million to 1.25 billion with an earnings per share diluted EPS of $0.70 to $0.76 per share.

If you take the midpoint of the $0.70 to $0.76 and it would be $0.73, that would be a 16% increase in operating income from '06 to '07, which is -- and I would like to make a note before I get into what comprises this. We know that some of our analysts have actually included a contribution from acquisitions to our overall growth both on top line and the bottom line, both revenue and operating income. We are focused here at achieving 15% on both in a long term, which would include acquisitions. This guidance includes no contribution from acquisitions. Doesn't mean we're not focused on it; we just haven't included it into this guidance.

This also does reflect the impact of the 123 stock expensing. Has already been included and assumes an effective tax rate of 43%. I think what is noteworthy here is revenue is up, income is up with no contribution of acquisitions.

And in summary for this morning's phone call, I would just like to highlight a few areas that we feel particularly proud of for the year. And really the platform for moving into 2007. We are building on a record backlog. Record revenue. We are delivering organic growth according to plan. Our plan was to be in the mid to upper single digits 5%, 6%, 7% organic growth. Achieved that here in '06; forecasting that in '07.

We are producing strong revenue, profit and cash results. Not only were they at record levels for '06, but every one of the forecast and guidance we are providing are up in all of those categories.

And finally, what is our visibility looking out into '07 and beyond? We see all of our core markets strengthening. Our revenue up, headcount up, operating income up and our backlog up in the core businesses and funding from our clients in the areas that we do work. And with that, I would like to turn it over for -- open the presentation up for questions.

(OPERATOR INSTRUCTIONS). Debra Coy, Janney Montgomery.

A couple of questions. First, Dan, can you talk about what you are seeing in terms of potential opportunities on the commercial side that you have laid out that you really targeted the government work and looking to kind of pick up the pace again on the commercial side, where do you see the opportunities there?

I see them in a couple of areas. I see them in the manufacturing market. Back in the early '90s, aerospace went through a huge consolidation realignment. We are seeing a similar type, almost a mirror replay of that in the manufacturing side in the automotive industry.

We are seeing a very large closeout and consolidation of manufacturing plants. There are very large opportunities for where they are consolidating for the new plants. We are seeing them for obviously early design infrastructure work. But for the closure of the plant, it is the commercial version of BRAC, base realignment and closure. So the investigation work, the cleanup work, taking the balance sheet liabilities off their books and these are the largest of our manufacturers in the automotive industry. Huge opportunities. And we have very little representation there now.

We have great presence geographically throughout the entire Rust Belt with the entire automotive footprint and so we are well-positioned there.

Second area is mining. Mining is a new focus. We have begun moving on this this last quarter, began investing in it. The largest of the mining business commodities are up substantially even though there has been variability and they have softened a bit, they are still at very high levels from what they have seen over the past five to ten years.

In the U.S.?

Both for the U.S. and internationally. We are seeing big movements in Canada. We are seeing big movements in Latin America and a lot of it is driven even by firms here in the U.S. Certainly all the way up and down the Rocky Mountain area.

Mining, manufacturing and then certainly seeing other infrastructure businesses where they are relocating and moving to sunshine states where we are seeing new facilities being installed for manufacturing all throughout the South. Mostly it is the southwest we are seeing very large opportunities. So those are a couple three areas that we think are big opportunities that are '07.

That's helpful. The other questions are if you could just give some sense, it's very early to tell, but if you have any sense based on past experience of when some of these big new bond funds might fall out. I know you are at the front end of the pyramid if you will, but kind of what would you expect with all the new flood control spending that appears likely when you might start to see some of that.

My final question is kind of the big picture on the acquisitions side. I mean clearly I think you are paying a bit of a penalty this morning for expectations hinting kind of built in that there would be acquisitions. You've have been quiet on that front. What do you see in terms of, without making any promises, kind of what your level of confidence is that you see opportunities that will come through on that in the fairly short term? And then I will get back in line.

I will start with the bonds. Typically our experience has been it is approximately 6 months from the time they pass to the time they get it organized to start actually releasing the proposals and the opportunities is somewhere in the six-month range. We think that most of these areas and I think I gave examples of California for flood control. We have substantial amount of work for the counties and for the state, state water resources control group.

In fact I would think that we are one of the dominant players out here in California. That we would expect the work that we are doing now then to have funds and our contract capacity is used up quicker through these bond funds. So we would expect -- you look for the second half of the year from the bonds, but much of this contract capacity is in place already.

On the acquisition side, it is a primary focus for us now. We have moved and mobilized teams in this area. We are very focused on it, but as we have indicated before, we want to do the right deal that is a strategic fit that makes sense for Tetra Tech and is in the engineering and consulting space sector.

There are opportunities out there. I want to make one thing clear. There definitely are opportunities out there. But we do not want and I do not want to provide a specific timeframe that would provide an expectation from our investors and our shareholders that would expect a date and a time or a magnitude.

We want to do the right deal that is certainly going to be accretive to the Company, that is going to be lasting, that isn't going to be a distraction and something that is going to add instability to the solid base that we have built. I am confident that we will take action in this area in 2007. I am very confident. But I am not going to provide a forecast that it is going to be in the next two weeks, two months or two quarters.

That's fair enough. Obviously, we also want you to do a good deal. Thanks, Dan. I will get back in line.

Richard Eastman, Robert W. Baird.

Could you just give a sense of when we look at the guidance, the net revenue guidance for fiscal '07, just a straight calculation as you are looking for organic growth of about 2% to 7% and could you just break that down by business group and maybe where you expect high-end verse low-end growth rates?

We don't provide the growth on a unit basis. I will tell you that you are right. The range puts you around 5% in the middle. But let me add a word or two about a primary factor that has driven or mitigated a bit that organic net revenue growth number.

We think the numbers, as you said 2%, 3% to 7%, 5% if you pick the midpoint, is sort of what we have targeted here. But we factored in a softening of probably three points to four points of work that we expect to have a downturn in funding from Iraq. We had a great year in 2006. I have referred to it here internally as a bit of a headwind that -- we find it very difficult to have a specific forecast for a month, a quarter, or certainly for a year at what level the funding will be present in Iraq.

So what we have done is we have forecasted roughly six months in our 2007 guidance for contributions from Iraq. So we have decreased our expected revenue by 50% approximately going into '07 from Iraq and that, as I just mentioned, accounts for a couple, two, three points, three points. So that is really -- if you factor that out, that would move this into higher range up that amount.

We are midway through the first quarter and we have seen no softening. In fact as Sam Box runs that program for us and Sam, would you just say a word on our Iraq program?

I think that there is no question that we are being conservative, but as we move along day-to-day and month-to-month, we are going to, as Dan said, hopefully be able to upgrade this forecast, but right now, we are trying to be conservative and understand where we are at. We have a new administration coming in from the Congressional standpoint. A lot of uncertainty there, but our UXO work continues on and reconstruction work will be a question mark as we move on through the year.

And then Dan, one thing I would maybe disagree a little bit, I think -- you know, I am not so sure that the guidance falls below consensus because all of us were assuming acquisitions. The thing that steps out at me is the operating margin on the core business of 8.1%, we are exiting this quarter virtually at that rate with the first half of the year, maybe the first three quarters, penalized by some restructuring. I am not sure that I see much leverage in the 8.1% '07 guidance. Is that due to mix of business and more of this cost-plus business? Why is that 8.1% margin not more like 9% or better?

Well, first of all, I would take a look at our overall performance for fiscal year '06. We did leave Q4 and I'll come back to that in a moment at 8.1%, but for the year, we were at 7.4%. 7.4% up to 8.1% both and as you compound that with the overall top-line growth puts you at just over 15% growth on income.

We want to focus just on margin. We do have seasonality. We do have a seasonal high point, which is our fourth quarter. Fourth quarter historically has been the high point every year and it is an outlier on the up end of our operating income per quarter. So when you take a look at the fourth quarter, we were 8.1%. You are absolutely right. Our forecast for '07 is 8.1% as an average for the year. And so we have pegged it at a level equal to our fourth quarter.

Now no doubt there was some challenges in our first and second quarter as part of exiting certain contracts. In fact, our Infrastructure operating income number on a margin basis was down this fourth quarter. If you take a look at it, it's 6.5%. It was not a softening of their performance. We aggressively went after a few claims that we had and settled them out.

We saw that margins in Resource Management as you can see was up 9.8% and that is after option expense, after application off all SOX and the rest of the costs and so it was a good opportunity for us to take out these claims and leave them behind as we left '06. And so the Infrastructure business is solid.

Obviously we are very focused on making estimates that we can meet and achieve and I leave that to you to determine whether or not you feel that is conservative, but the margins are up materially from '06 and we expect to continue to push those.

And let me ask you a question on the schedule that you provided in the slide presentation, you have SOX and ERP at 1% of I presume net revenue. I am not sure why that is not just included in the operating margin line. I mean it is a metric everybody faces these days, but is there -- are you implying that there is a $10 million increase or $10 million expense in '07 for SOX and ERP? Is that what you are implying there?

I will let David provide some details, but what I am implying by that number is that there is a $10 million increase over a baseline that we would have had on prior years that we would not have had and that we expect to break down as we go out. There is no doubt that those are not just redefinitions of costs that we had before. Those are new costs. And they are somewhat similar to that in '06.

And then --

What Dan was referring to first is to pro-forma for you compared with how historical margin, number one and also demonstrate to you the potential for us to improve as we work off these today's environment type of issues. Sarbanes-Oxley is a $4 million to $5 million cost for us both external and internal and ERP is a decision we made several years ago to really consolidate the Company through a system platform and to be more efficient in the future. And that will stay with us for two more years and will be rotated off, substantially off. So what we also try to demonstrate to you in addition to what Dan referred to already about pushing the margin up, we also are going to have some synergy in the future that we will not be repeating, but we have been experiencing in '06 and '07 and perhaps '08.

Is the comparable '06 number about $10 million as well or is that stepping up?

It is about the same.

It is about the same. Okay. And then Dan, just one last question. You talked about the growth in the DOE area and you're underrepresented there. Could you just give us a sense of what projects are coming through the DOE, maybe an example or two what type of project that they are focused on?

Absolutely. I will give you two that are coming up relatively soon. The largest of the complexes is -- Hanford has mission support contracts coming up. A big issue on Hanford -- Hanford installation for the Department of Energy is located on the Columbia River on the state of Washington and the big driver there is groundwater.

Big issue is it is the nation's repository for a high-level nuclear spent fuels and so the nuclear waste materials go there, get stored in tanks or other repositories and reportedly then leaks into the river or certain is a big concern. The driver is groundwater programs. It has now moved to the number one priority.

That mission support contracts that will go out ranging anywhere from $400 million to $1 billion over a life of seven to ten years. Annual revenue spent in the area of just the groundwater management programs that are beginning are $75 million or more per year, per year and those are labor-driven contracts. And it is one that will be coming up here within this next year.

Another program -- we have a presence at Oak Ridge National Laboratory and they're looking to do a major upgrade of the ORNL, Oak Ridge National Laboratory Facility and the Y-12 facilities and in preparation for upgrading of the facilities, they will be evaluating the old buildings and taking them down, cleaning up the soils and preparing it for reconstruction. We have a large presence there and we believe that we are well-suited to team and participate with some of the biggest players in DOE.

And there are others that we have a large presence at Savannah River. It's a large program that will be coming up for -- refer to it as the overall management contract. Very large programs. And then other smaller programs that are currently underway and out on the street are programs like Moab, which is a Utah site for the Department of Energy, which is about $100 million a year program. The proposal is underway right now. So these are all $70 million to $100 million a year, which would be Tetra Tech's apart.

Do you have contract capacity in place and you are pursuing task orders against those? Is that how we should view that?

No, I would say these are new open competitions that we will be competing for in the contracts. These are not vehicles that we already hold.

[Mark Seagal], Canaccord Adams.

I'm wondering if you can just provide the breakdown between federal and state and local, just the make-up of sales there in your Resource Management and Infrastructure segment.

Absolutely. The state and local business overall, the Company is approximately 16% of our overall revenues for the fourth quarter and similar to that for the year and our federal is overall 49%.

Okay. And can you break that out by segment or --?

This is Sam Box. If you look at our federal sector work, the majority of that work really falls inside Resource Management with some minor elements in the Infrastructure area. When you move into the -- and then also in Resource Management, there is a portion of state and local and commercial. If you move into the -- just looking at the state and local business in Infrastructure, virtually all of it is state and local business. And then when you move into our Communications arena, that is all predominately commercial with some local municipality work like our Project UTOPIA.

Okay. Great. And secondly, you guys mentioned opportunity -- California and Connecticut where there has been significant bond activity. Just wondering your take on things, if you see other states following suit quickly or if we are going to see sort of a lull in bond activity going forward here.

We do. Big bonds are coming out of the Gulf Coast states do. The biggest of which is Texas. Texas is the biggest and actually the Gulf Coast states of Louisiana, Mississippi, Alabama and even Florida have large bond funds, bond measures coming up that have federal matching funds. Certainly there's large throughout all the Gulf Coast states, large federal opportunities. It has been an area that we have been focused on from our coastal engineering focus and we have had some good success there. This is areas that will both be state and local bond fund supported, but also federal funds that have been infused into those areas.

Some of the areas that we have big wins in with the New Orleans District with the Army Corps of Engineers, which is largely being administrated locally. In Louisiana, we have had a recent win down there as part of a team for $150 million contract that we are participating on for a levee and coastal restoration evaluation. We are bidding on I believe it is just about $100 million of new opportunities on vehicles that we have over this next quarter. So we would expect these Gulf Coast states to be also big contributors to us.

Corey Greendale, First Analysis.

A couple of questions on the margins as well. I think, Dan, you mentioned the Infrastructure margin, there are some charge-offs there. Do you know what that 6.5% would have been excluding that?

This is David. This is about $2 million charge in Q4 to exit those litigation -- potential litigation on book for the last couple of years and we felt that we should put them behind us and move on. So you will add that back on.

Okay. And could you -- in the past, you talked about your margin expectations by segment. Would you be willing to do that for fiscal '07?

Well, the '07 numbers, we believe that, as you can see, '06 for Resource Management was 8.3%. We would expect that to improve up toward the 9% level, just over. Communications at 7.3%. We would expect it to increase toward the 8% level. Communications, which doesn't really move our number much, but was down at 5% because of some delayed programs that have now since started. We would expect them to be somewhere in the 9% range.

Okay. David, in your comments, you'd mentioned that you were talking about the cash flow from operations expectation, which the range is down a little bit from what it came out this year. You mentioned some investments in the business. What types of investments and also can you talk about the magnitude of those investments?

It has to do with what Dan talked about, those opportunities and what we plan is about $5 million to $10 million.

So basically add back that $5 million to $10 million to get apples-to-apples with what it was in fiscal '06?

Yes.

And then questions on a couple of the specific contracts. On Iraq, Sam, could you just comment on the reasons for the conservatism? Is it just sort of for the sake of being conservative or have you received indications from them that it is likely to ramp down?

I guess I would say here is Iraq for us for the last six months to a year has been kind of a month-to-month quarter-to-quarter basis as to how they are funding programs and we just have taken a conservative base. Do we have any indication that things won't continue? I would say that nothing significant, but we certainly don't have I guess what I would call a solid base of confidence that in fact we could predict and expect a full year success like we had in '06 over there.

And could you update us on the status of UTOPIA and how much it is baked into your '07 numbers from that?

UTOPIA is just starting up here in November. It's a modest contribution for quarter one. We believe that for the year, it is -- overall, it's a modest contribution. We believe it is around the $15 million on gross and overall net, probably closer to $10 million. $7 million to $10 million is a range.

And my last question is, Dan, in thinking about acquisitions, could you just -- what are the hurdles at this point? Is it that you're ready to go and seller expectations are still too high on price or are you still looking for the right thing or just what the status is a little bit more?

Nobody is in the bargain basement right now and overall, that is a good thing though. It is not good for our pocketbooks. What it is good for is Tetra Tech is certainly at the forefront with respect to capability of its balance sheet, both cash on the table, as David mentioned. We haven't touched our revolver so we can move on an opportunity very quickly.

I think you can hear a strong story from Tetra Tech on all the metrics, on all the opportunities and all the clients and what I think you should take as a positive indication for the sector and that this isn't just a three-month, six-month or one-year issue is that the whole market is that way -- the whole sector -- I'm sorry -- this whole sector is feeling the same level of strength. It is driving multiples up.

Fortunately our multiple is high enough that we have the ability to acquire these firms and still have it be accretive. So with our multiple, we have much more range to make one of these deals happen. We do have a number of opportunities we are looking at, but we do want to get the right firm. For us, I would never discount price. There is no doubt. We never discount that that is an important factor, but the fit and its contribution more than just the initial quarters as we go forward are really the driving factors and they are out there.

Actually would you mind if I sneak in one more quick housekeeping one? I am looking at the pieces of the guidance. I am looking at interest expense and it looks like you are looking for interest expense to be similar to what it was in '06 and given that debt is down given that you had that higher interest rate at the beginning of '06 when you were out of compliance with the covenants, what are the moving pieces that would get interest at the same level in '07 as '06? Are you assuming debt comes back up for some reason?

We did have some contribution in Q4 to do with some of the notes receivable and interest relating to those notes receivable in the Q4. And it is about slightly over $0.5 million. There will be one -- most of it will be one-time contributions.

I'll follow up with you off-line on that. Thanks, guys.

Matthew McKay, Jefferies & Co.

First question, just on the backlog, I'm wondering if it reflects any of the new funding cycle in the government fiscal year '07.

(technical difficulty) end-of-year funding actually wasn't unusually an outlier from what we have seen in other Q4 funding. So end-of-year funding that we received from the federal government was not necessarily higher than we have seen in past years. So I don't think it was not driven from that. It was just broad strength across all sectors for us.

So in fiscal '07, given that you probably have I think probably around $6 billion of unfunded backlog, should we expect to see a decent amount of that move into funded?

You know our backlog -- it's a great question. I think our backlog is -- our goal is to continue to generate more backlog, more new orders then we expend in revenue. So that would obviously continue to increase backlog. I think that we have indicated in the past that the real goal is long-term trend, not just one quarter.

We had a very strong, very strong fourth quarter, again 20% year-on-year increase on backlog. We're forecasting it will continue at that pace. I think that I would caution not to look at just one single quarter as an indication of where our contract capacity and are funding is going, but look at the long-term trend. Certainly the graph that we presented today showed that it is not a single point, but a multiple point trend.

So I do think that some of the programs are being funded for shorter. I know we have indicated this over the past year. So backlog could actually be flat or declining for a given quarter just based on shorter funding cycles. But overall, it will continue to grow.

Okay. And then that just actually leads into my next question. Is there any upcoming inflection points on contracts?

No, there are not. Other than Iraq, we have no single contract that has a short funding period or is up for bid that rebid or that would be potentially at risk not in the short term.

And then just a couple of smaller questions. Is Iraq included in DoD revenue as you define it?

Yes, yes it is.

It is. And then actually just sort of a follow-up question on that interest expense line. Given that the net cash balance is turning positive this year, just $5 million of net interest expense -- it just seems high. Is there a lot of unused debt capacity that you are paying a fee on or --? I'm just trying to get my hands around why it is $5 million.

We still have a lot of fixed obligation. We still have $75 million worth of senior notes on the books. And substantially that cost will be offset by our interest income. We also have a credit line of $150 million, which is pretty much committed but not spent and those require us to pay some facility fee on that.

That's helpful. Thank you very much.

James Ragan, Crowell, Weedon & Co.

Just to follow up on the debt question. In the outlook for 2007, are you, ex-acquisition, are you -- would you anticipate any increase in the debt level?

No, we do not. We expect cash flow to be positive throughout the year with exception of Q1. And we believe our Q1 deficit -- typically we do have a deficit in Q1 because of the bonus and 401(k) plan and all happen in Q1. We do believe we will fund this with our own cash.

Okay. Great. Then a separate question I guess for Dan or whoever. In your slide presentation, there is a comment on the quarter about strong demand for water-related services. Could you just talk about -- maybe give us a flavor of what some of those services are where you are seeing strength?

I think the two particular areas we are seeing our best strength are at state and local level, consolidated sewer overflows, CSO. We have seen a 12, I think I had mentioned, (indiscernible) one size 12 new CSO projects that we were awarded in 2006. We continue to be positioned very well and this market is just still at the very beginning of it. It is just entering a growth stage and we expect to get our fair share and more of that market. It is a Midwest and upper Midwest, Northeast market primarily driven. So we expect that to be a very large area.

The other area for water resources is the coastal engineering and flood protection work. Big issues with respect to controlling, pumping, storing, conveying, in other words moving water, so it is going to drive our Infrastructure business. It is not only where you are going to put the water or how you are going to handle it; it is how you are going to move it and where you are going to put it is driven by the water quality itself. And so that is going to drive our Resource Management work, which is water quality issues, daily maximum loads with respect to contaminants in this water, where it can be put for beneficial use, how it can be discharged either to wetlands or treated through other mechanisms. So that's a very big area for us.

In our EPA work at the federal level, we expect to -- we are clearly the dominant contractor with the EPA Office of Water. We expect to maintain that position and even strengthen it. More this is an area that is growing for EPA. So we think there is good opportunity there both in an area that we are a dominant player Office of Water, but the Office of Drinking Water this next year, which is an area that we are just moving into.

I would like to conclude this call with an acknowledgment of the team here at Tetra Tech and also to the investors by standing behind us. This has been a big year for Tetra Tech. We concluded two of our actions that were key drivers for us. One was to exit and to leave the non-core businesses. And I will only mention it this time because it is part of the 2006 summary, but that was largely done -- the heavy lifting was done in the first and second quarter and really that is behind us.

The second is initiating organic growth with the facilities, the staff and the resources we have internally. And we have moved that and have that well underway driving backlog. I feel very, very comfortable and very confident in that area.

And the third area, only with those two in place and giving us a solid foundation could we actually move successfully into the third phase, which is initiating our acquisition strategy, putting that underway and as I have said too many times during this call, that is a priority for us.

I want to reiterate one other item. This entire team here is focused on meeting expectations. The guidances that we provide to the Street, we want to hit every one of those. We want to take the volatility out of the system. We want to hit or exceed all of our guidances that we provide. And that is what we are focused on as we move on into fiscal year 2007. So thank you for staying with us and I look forward to talking to you on the next call. Thank you.

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