Tetra Tech Inc (TTEK) 2007 Q3 法說會逐字稿

Good morning and thank you for joining us. By now you should have received a copy of the press release. If you have not, please contact the corporate offices at 626-351-4664 and we will get one to you right away. With us today from management are Dan Batrack, CEO and COO; Sam Box, President; and David King, CFO. They will provide a brief overview of their results and will then open up the call for questions.

During the course of the conference call Tetra Tech management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These 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 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 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 would like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Thank you very much and good morning. Thank you for joining us today to announce our third quarter's financial results. I'm very pleased to announce that we had strong performance across all of our sectors this past quarter. And most importantly, our core markets in water resources and water infrastructure projects are growing primarily at the state and local level with some of our key pursuit areas in conbined sewer overflows and large state watershed projects.

Financially this past quarter was really one of the best performing quarters that we've had in really some time. Our revenue growth's actual number was over $400 million for the quarter, a growth year-on-year of over 12%. Our net revenue was up at over $256 million, 6.7% growth and I'll explain a bit more on our backlog which is perhaps our strongest metric and up over 20% year-on-year.

Operating income, really our core markets have grown strongly and risks are down. We're performing well across all sectors with operating income up over 36%, net income up 58%, and our earnings per share for our shareholders up 50% over last year.

Our portfolio mix between our business sectors didn't change much. Our Resource Management remained 62% infrastructure at 33. We did see additional funding and we have about a year's worth of backlog in our communications group that actually grew a bit this last quarter, making up 5% of our overall portfolio.

But there were changes in our customer mix this past quarter. The largest notable change was in the federal sector. We saw our federal revenues actually decrease on a year-to-year basis by approximately 5%. And that was attributed largely to one single project that we had, a large program that we had with the Department of Energy with the second line of defense program. We're still performing work under this program but it is currently in recompete mode. It contributed just over $10 million of revenue last year at the same period and this year the program is largely dormant.

The project is being recompeted. We have a proposal in and we're waiting very shortly for an announcement to be made and feel very confident in this area and expect it to be a large contributor in the future certainly at similar levels. But it was the single project that represented the reduction in the federal market.

State and local was up 5%. It was a large growth for us and it wasn't any one single project; it was broad growth across the entire country. I'll give a few examples of this in just a moment. And our communications continued to be strong. Our commercial work and international work were very stable from this past quarter.

Our performance by market, I did just explain a bit about the Department of Energy contract that had a reduction. Some of the examples of state and local business that drove the large growth were really again, across all countries. We were successful here this quarter on three prime contracts in Florida with Everglades restoration programs, with the South Florida Water Management District.

We had some excellent wins here. Just recently in California with the Los Angeles County Storm Water program that we were successful; a number of programs with Los Angeles City Bureau of Sanitation that are wastewater programs; city at Pittsburgh, CSO combined sewer overflow programs, a recent success; and actually some pretty good-sized programs in Michigan with wastewater treatment upgrades. So we are seeing strong growth across the entire country with these programs.

These are all million or multimillion dollar programs but typically not large enough to have individual press releases that we would release. Normally those programs are 15 to 20 million or greater for our press releases.

And on the commercial side, our business continues to be very strong with our industrial clients and both excellent performance on revenue growth and also on margin. A list of some of the significant wins we have had this past quarter and in fact one just this past week, GSA alliance, a federal government IT contract. It's a $50 billion programs. It's a new program for Tetra Tech, it's a consolidation of the federal government's multiple IT contracts primarily three very large ones into the single award. There were 29 awardees; we're one of them. It's a basic ordering agreement contract that there will be work that will flow through this over the next several years.

It was highly contested. We have -- we feel really good about being one of just a very select number of contractors that were awarded this and while we don't expect it to be a significant contributor, we do expect it will make a difference for our IT group over the next ten years.

The second contract we won and it's the largest water infrastructure project that Tetra Tech has been selected for in its history was the Poseidon Resources Huntington Beach desalination project. It's expected to be a $250 million program and we've begun with the permitting process and the initial design. So we feel excellent about that win here this past quarter.

We continue to receive work with our key clients at the Air Force and the Corps of Engineers in Iraq and that is continuing at a pretty stable pace. Other large new wins, EPA. We compete with the Region 3 Remedial Action contract at over $60 million. Our Navy work continues to be strong and we did receive a few combined sewer overflow programs, one that is noteworthy at a $15 million program out on the East Coast.

All of those programs, I would say that many of those I just have just listed are at the early end and haven't even moved into backlog. This past quarter, third quarter, we booked over $537 million in new orders for the quarter -- $537 million. Extremely strong quarter not only covered all the revenue, replaced all the revenue that we expended, but grew the backlog on a year-to-year basis by $212 million and from the previous quarter by $133 million.

Our backlog currently stands at $1.218 billion, an all-time record for Tetra Tech. And not only a record but a very strong growth on a year-to-year basis, again over 20%. I personally think this is one of the key indicators that I use to manage the business. This is our portal, our view into the future on what our funding looks like. So we feel very good about this.

David King will provide more details on all of the financials for the quarter. David?

Thank you, Dan. Again I echo Dan that this is a strong performing quarter. Revenue grew 12.5% from $359 million to $404 million. Very, very strong growth in the state and local market particularly as Dan indicated, and they all came from our core water infrastructure programs.

Net revenue grew from $240 million to $256 million at the 6.7% at which is the high end of our guidance. Income from operations grew from $16.1 million to $22.1 million at almost 37%. Our operating margin is very encouraging. It's 8.6%. On an Air Force to Air Force basis, this is a 100 basis point improvement over the same quarter last year. By segment, our resource and management delivered 9.4%, infrastructure delivered 9.6%, and our communications unit delivered 7.9%. Our EPS grew from $0.14 to $0.21. Again, our high end of guidance was $0.21.

Our SG&A cost grew from $27.1 million to $31.9 million, at about 18%. Particularly this quarter we have quite a bit of increased funding for our bid and proposal effort and our BD activities, about $3 million. Some you can see from what the [longness] of our contract wins Dan just described and others will come in the near future.

Also as we engage in acquisition, our acquisition related costs such as intangible amortization and other charges will hit our G&A costs, and this quarter we have about $1 million in our SG&A cost for acquisition related charges.

On a net revenue basis, we are 12.5% this quarter versus on a net revenue at 11.3% the same quarter last year. Bear in mind we are also a 12.5% bigger company than on a quarterly basis than last year. Longer-term, I expect SG&A costs to be about between 11.5% and 12%.

Our net interest expense reduced from $1.2 million to about $700,000. As you recall, we eliminated our senior notes earlier in the year which carry a higher fixed rate and to the refinance our credit facility which carry a better rate than our old facility before. And we were able to capitalize on these benefits.

Tax grew from $6.5 million to $9 million and principally due to increased earnings. I expect our effective tax rate to be around 42%.

Our accounts receivable grew from $324 million to $420 million. There are three major factors. Number one, (inaudible) we are -- our gross revenue growth by 12.5%, about $45 million which translates directly into our receivable base. Acquisition during the quarter added about $20 million to our receivable base which we didn't have last year.

Our ERP implementation added about $25 million of receivable base and let me spend a moment or two about ERP implementation. Fiscal '07 we have -- we converted our two largest operating units onto the Oracle platform. One unit, about $200 million gross revenue was on October 1. At the beginning of the year, our largest unit about $500 million worth of gross revenue was converted on April 1 in the mid year.

Conversion disrupts operation (inaudible) particularly impact how we charge and bill our clients. Normally these things take about three to six months to get back to normal. There is no cause for concern, this is not a quality issue. These are two of our strongest operating units and what is substantial U.S. government receivable base. So they simply are -- recovery was simply a little bit slower than what I expected this quarter.

Accounts payable grew from $82.5 million to $138 million at a 67%. Again, had to do with business growth. A big part of this growth together with account receivable growth had to do with our subcontractivity in Iraq which accounted for about $30 million worth. Again, acquisition added about $10 million to our payable base. Again, when you grow the (inaudible) payable and receivable due to Iraq's contractivity, there was no impact on our working capital, if you will.

Net debt increased from $36.8 million to $41.1 million. We had a positive cash flow during the quarter. We had a net borrowing of $31 million due to our Delaney acquisition. Without the Delaney acquisition, our net debt would be about $10 million for the quarter.

Our debt and equity ratio is about 19.7%. Our debt to capital ratio at the end of the quarter is about 16.9%. Cash flow from operations, $13.9 million the same quarter last year to $8.1 million this quarter. I talk about ERP implementation which impact us about 10 to $15 million versus our internal plan. Also growth, as I mentioned, also tax, our working capital and reduced cash flow from operations somewhat. Year-to-date we are at the $12 million. I expect to finish the year between 35 to $45 million which is about $10 million less than what we previously forecast.

Capital expenditure grew from $2.6 million to $3.5 million. DSO grew from 71.6 days to 81.6 days. Again, we talk about ERP implementation which accounted for about five to six days. Increasing subcontract activity which accounts for the rest, about six or seven days. I expect to have some recovery by the year end about a two or three days recovery as we finish the end.

To summarize, I am very pleased with the overall results of this quarter. Now I'm turning back to Dan.

Great, thank you very much, David. I'd like to provide an update of Tetra Tech's guidance as we move toward the end of the year. The fourth quarter of the year, the months of July, August and September, are historically Tetra Tech's strongest time of the year. And this reflected in our guidance this year.

Our Q4 of '07 which we are one month into now, our net revenue guidance is 255 to 270 which reflects again, an increase both on a year-to-year basis and sequentially and a diluted EPS of $0.21 to $0.22. With three quarters behind us on an annual basis, we've narrowed both our revenue guidance and our earnings guidance substantially.

Revenue guidance of net revenue of $992 million to $1.007 billion, with a narrowing of our EPS guidance for the year of moving the overall guidance $0.76 to $0.77, pretty narrow guidance. We've moved the low end of our guidance from $0.73 up to $0.76. So really the flow end we've really moved up substantially.

In summary, it's been just really a very strong quarter for the corporation. The higher operative margins in all segments reflect lower business risk across the operation and better execution on our projects. We won significant new -- there are significant new business opportunities out there and particularly in water infrastructure and water related programs, both here in the U.S. and overseas. Some of the biggest opportunities we see here in the U.S. are in the Gulf Coast. We see several billion dollar opportunities, some of which we have underway for competition right now.

And internationally, we have programs in the Panama Canal we've had success and we see very large bidding opportunities and even some programs out in the Red Sea, overseas. We have won several new key contracts many of which I've listed earlier. But we've also had other smaller projects that are going to lead to early success and positioning for base realignment and closure with the Department of Defense. Here this past quarter we've had new planning contracts with the L.A. district, Sacramento district and other locations across the country.

And just recently in the last couple of weeks, a relatively small program, several million dollars, we were selected by the EPA Region 5 for a TMDL program which is a water quality standards valuation program for the Great Lakes area. So great baseline programs.

All of this success and the wins and these new pursuits are reflected in our backlog. And that is really the one metric that we have that shows the success we're having in the marketplace with our competitive advantage, differentiation of Tetra Tech, reflects our relationship with the clients and really the best insight into how we're going to perform in the future.

And with that, I'd like to open up this call to questions. Christian?

(OPERATOR INSTRUCTIONS) Debra Coy, Janney Montgomery.

Thanks, guys. Good morning. A couple of questions. Let me start with the backlog. It is a very impressive number and your new orders in the quarter are an impressive number. Typically you haven't given us new orders on a quarter-to-quarter basis. I mean this looks like two times book to bill ratio. Can you give a sense number one of how that compares to a typical call it book to bill ratios? And secondly, can you give some sense of the timing of how that backlog will convert to revenues over the next couple of years?

Debra, thank you for recognizing that. Our book to bill is -- we're shooting for 2 and we hope to get there. This quarter it was actually just under about 1.5 -- I think it was about 1.3.

So that's --okay. So that's a gross backlog number rather than net?

That is correct.

Okay, got it. Yes.

Our backlog also is a gross number. That reflects the total backlog which would be both net and subcontract revenue (inaudible). But still it is a big number for us. It's one of the highest that we've had on both a percentage and certainly in a gross dollar amount. As far as the expenditure, on an overall basis, our backlog is expended about 75% over the next twelve months and the remaining 25% out to about 18 months. We'd expect all of that to be incurred or expended over the next 12 to 18 months as far as expenditures.

Okay, that is helpful. And on margins then, as we see that converting through and we've seen a continued improvement in your margins right across the board, I was particularly pleasantly surprised by the strong margin in the infrastructure business which is usually a bit lower. Do we think the margins that we're seeing now are sustainable or were there some unusual items in the quarter?

No, I think that the margins -- first of all, one reason the margins have seen some increase is we've had a bit of the shift in the contract type that we're executing. A bit lower margins that we have seen in our cost plus work which is the lowest risk (multiple speakers).

Right.

-- our net revenue under cost plus contracts actually decreased on a year-to-year basis from 24% to 21%. Our T&M, time and materials, was stable at about 43 but our fixed-price work that we're performing increased by that 3%. So we see better margins in our fixed-price work. As far as margins to expect in the future, our targets have been for Resource Management 9% to 10%, so we think we are close in that range. We still have a bit of room for expansion.

Infrastructure we've historically focused on believed an 8% to 9% margin is sustainable and certainly this was a strong quarter but we'd love to keep it in this range. So we think that it is sustainable, And Communications, we've been looking at a 7% to 8%, so we think we still have some room for expansion there also.

And the mix that you have been seeing you would say that continues, that same mix a bit toward fixed price continues in the backlog that you have in the recent wins?

Yes, that is right. We expect more of our contracts are being procured on either time and materials or a fixed-price basis so we expect that, that movement not dramatically but we do expect the transition a bit more to T&M and fixed-price contract basis.

Okay. And one quick last question. Dan, on the guidance for 4Q, as you noted typically 4Q is the strongest quarter but yet your guidance at least at the lower end of the range suggests flat quarter sequentially on revenue and earnings potentially. What are your risk factors that are giving rise to the lower end of that guidance range? How are you looking at the quarter shaping up? It seems like you are being cautious once again.

Well, the Department of Energy, what has happened, is that it was particularly acute that one project, Department of Energy could have a relatively large reduction, reflect a large reduction in our federal business. We would look at still maintaining some funding but as these procurements move toward the end, many new task orders are just not released until the new contract has been awarded and the work goes to the new contractor. So I don't like to use the word conservatism but we provide our best estimate into the quarter.

And certainly the lower end of the guidance on EPS is in line with this previous quarter; certainly on a margin, we think we had a very strong margin on all of our segments this past quarter. So another quarter at similar numbers still is very strong operating income on all the units. And certainly at the upper end, we're higher than last quarter.

Okay. When do you get visibility on this DOE job?

Well we thought -- I lost two lunch bets because I thought it was going to be in July. But the latest we've heard will be late summer to early fall, probably September-ish, maybe early October. So we are maybe six weeks out.

Okay. All right, understood. Thanks.

Richard Paget, Morgan Joseph.

Good morning, everyone. I wonder if we could kind of get back to backlog trends? I mean the last couple of quarters we've seen some pretty good double-digit growth but then as it translates to net revenues, when do you think we might see an acceleration of those growth rates?

Well, the backlog numbers you can see certainly this quarter was among our strongest at up over 20%. But our overall gross revenue growth was up over 12%. And while certainly there is a difference there, it's much less than the difference between the net revenue and the gross revenue.

Two things, we have subcontract work where we're managing certain construction activities and that includes work in Iraq drove the difference and again, it shows in the top-line growth. And the second is, some of these projects move very quickly and while we added about 300 heads this past quarter in order to meet very fast turns around with commitments that we're making on bidding these projects, we've subcontracted even labor internally, other technical experts in the field that we work with as subs.

So we do currently have 500 positions. Last quarter I talked about 300. We did add 300 on a year-to-year basis from the previous quarter and we're looking for more heads.

Okay, so that's part of a reason why we've seen the trend I guess of the subcontractor costs as a percentage of gross revenues getting larger over time?

Yes.

Okay, so I mean but still going forward with these jumps and backlog, it still would suggest that some of the organic core growth should be accelerating a little bit.

That is what we would think.

Okay.

We're not providing a specific forecast on organic growth as correlated to the backlog. We think backlog is a good indicator particularly when you look at a trend. And Richard, as you've indicated, we've had many sequential quarters where we've seen backlog growing faster than net revenue. We believe that will flow through to net revenue growth.

Right, so directionally.

Yes.

Last week Insituform kind of talked about how they had done some work on new housing starts and how it relates to some sewer spending saying that when a new house goes up, they get a hookup fee for around $1500 which goes to the municipal water budgets which is kind of incremental dollars coming in. Now that that's dried up, they've said they've seen some sewer spending dry up. Now I know that there in a very specific niche part of the market but your comments are that state and local spending has been great. I wondered if you could just kind of give your take on that?

We have relatively little exposure to the residential market. Certainly we've seen a little bit of softening in affiliated work. We do work for some industrials and commercial clients such as some of the large retail firms and so some of their starts are down. So Geotech has had a little impact and you're talking on the municipal side.

Also work that we're focused on are CSOs, combined sewer overflows, and those are upgrading or modifying the existing systems and plants for current houses and homes that are on the system now. Impacts for new wastewater treatment plants or new water supply that might be impacted by new home construction is really not an area that we are heavily invested in or have much in our portfolio.

Right. Then but I think their thesis was that the new homes were helping fuel the budgets that were for sewer rehab and now that that incremental money is gone, some of the projects might get hidden. I don't know whether since you guys are doing some of the bigger programs for cities under consent decrees that might not make a difference. But I just wondered if on the more grass-roots level you saw anything like that?

No, we haven't seen that. I think you hit exactly right. I was just going to mention that the work that we do is largely driven with agreements between the municipalities and the federal agencies specifically EPA consent decrees. These are program scheduled and funded and really very independent of future development.

Okay and then I wondered if you could comment on WRDA, what kind of impact that would have for you guys?

Well, we think it would be a very positive impact obviously. It is approximately $20 billion. The number continues to move up and down a little bit as it moves its way through Congress. There has been a number of indications that it will go through in its most recent form. We will wait till it gets passed before we get overly aggressive on how we think it will impact us.

But the focus on programs for the Corps of Engineers, it is the first bill that will have been passed in seven years. And so we would expect with the contract vehicles that we hold with the Corps of Engineers, and we are in nearly every district across the United States. So we're in an excellent position. We're one of the few companies that has this type of footprint in contracts so we think that after it passes, as the funding comes through, we're in an excellent position.

But this certainly was forecast to have come through many, many months ago. When it passes, I think we will have it -- have an impact to the company positively. And just to note, the U.S. Army Corps of Engineers is Tetra Tech's second-largest client. And this would have -- the funding will largely be administered by the Corps of Engineers.

Could you just give us kind of a best case scenario of when this would start getting the big influx of jobs bidding? I mean what is the earliest you think this could start really helping you guys out?

Let me use an example and a parallel analogy that might be bonds that pass at the state. So when the state passes bonds, we typically see six months before we see the first RFPs hit the street or the request for proposals. So I would say best best case, you might see some that are teed up, you could see three months would be a very optimistic insight, but I would expect six to nine months the proposals, the awards and to turn into revenue to the consulting and engineering market.

Okay. Thanks. I'll get back into queue.

John Quealy, Canaccord Adams.

Good morning. A question on the acquisition side. Can you comment on appetite? You did mention a little bit on international but more specifically first on the commercial side, Delaney seems to be going well. What else would you look on the commercial side? And if you can give us a characterization of how margins vary in that energy and metals and mining business?

Well, I think you hit both. Delaney was excellent. It's been an excellent acquisition. We've worked with them for a number of years both as teeming partners and we worked with them as a subcontractor and they've been a sub to ours and it was really an excellent transition for them coming into Tetra Tech. And they've come right out of the gate working very well and you've got it right, they have been a great contributor.

We think there are others in alternative energy we're looking at, and also minerals and mining. Commodity prices at a fraction of the current trading levels, are still very attractive for all of our clients. We're looking at all of those sectors. We're trying to be aggressive, but we want to do it at the right price, at the right firm for integration, and at the right time. And the right time is now.

So we are very aggressive in that front, and as soon as we close the right one, we will make a public announcement. But we are looking in both of those areas.

And the margin characteristics of those businesses, can you comment on is it more sort of fixed-price or time and materials; does that help the mix as well as straight-up supply/demand and equities in those end markets?

Well, the margins typically they are T&M. They are typically time and materials for the engineering work. Sometimes where it's a discrete task, it will be fixed-price. But they do have better margins, and typically we would expect it to be 10%, 11%, even 12%. So it will help our overall margin as we contribute firms in that sector.

Two last questions. One, to back up a little bit on the M&A discussion. Obviously, water is a huge part of your business and some very good growth drivers moving forward. Would you just be more inclined to buy mine share in water to get bigger if a big spending cycle is coming, perhaps, in the next several years, or would you move more towards a margin type acquisition?

Well, in water we are looking for -- we have a lot of capacity internally. We're looking for adding water for geographic coverage. There are certain areas that we don't have a large presence in the states. Most of it is down on the Gulf Coast, so we look to add for the geographic presence and resources.

And certainly with respect to water and really all areas on the international presence, we have little or no presence overseas, and so that is an area that we would look. In the water, most of the work in the water market is on the state, local and federal. So all wastewater treatment plants and water supplies are cities, counties and sometimes states. And a lot of that work is either T&M that is based on a cost plus buildup or is actually a cost plus.

So we believe that acquisitions in the waterfront would likely not be at a higher margin contribution than we have now. It would simply add more clients, more geographic presence and more work. I do believe in alternative energy and mining, they would be very accretive to our margin, in addition to obviously income.

My last question, I'm sorry if I missed it. Cash flow expectations for '07 on a free cash flow basis excluding acquisitions, what are you folks looking for for the full year?

It's 35 to $45 million before CapEx, so if you would take out 10 to $15 million CapEx, that is the free cash flow.

Great. Thanks, David. Thank you.

Richard Eastman with Robert Baird.

Hi, could you just disclose what the net revenue contribution was from Delaney in the third quarter?

It was about $10 million.

Okay. And would it run at a similar pace for the fourth quarter? When you gave guidance, are you kind of thinking 10 to $11 million there?

That is correct. We'd expect it to be just a little bit better than that. We believe for Delaney, this is a little bit stronger period for them, so it should be just a bit more than that.

And then in the existing backlog, could you tell us what amount is in the backlog for the Iraq UXO project?

Rick, this is Sam. For Iraq, we have pretty good visibility into 2008. With regards to the captured enemy ammunition business, we have backlog through Q1 of '08. And if you recall our previous calls, these funding cycles are kind of quarter to quarter. So we should see more visibility on that as the year moves on.

On the reconstruction work, we have good visibility through the third quarter of 2008 in backlog and are still seeing proposals sent our way for additional work.

And then just one additional question. I just want to circle back for a second. The amount of work that's subcontracted out has grown. Would that continue to grow, though, as you work into your backlog given some of the projects that you've announced? So should we think 36% or higher? Is the trend upwards or downwards hiring?

Rick, we think that is topped out. We think -- I would say that the trend that you've seen has really led to this sort of top out number. So I wouldn't look at movement as a trend where it's going to continue to go. I think this is really at an upper level. In fact I'd expect it to begin to move back down, the subcontract portion to move back down.

Could you just remind me your markup on that subcontract work, is it in kind of 5%-ish? Or what do you get for oversight there?

Sometimes it is as low as zero. And the work that we have is -- it can be anywhere from zero in some instances up to 5% but most of the contribution then is from the construction management or oversight labor for the subcontractors. And that is with respect to the federal contracts that we have.

Okay, so maybe a median is 3% on that or something, 2% or 3%?

Yes, that is correct.

Okay. And then I guess just as a clarification, when I look at the net revenue guidance or when I back into the net revenue guidance for the fourth quarter, it is kin of minus 3% to plus 3%. And again, what you are accounting for there is primarily this deal [we run off]. Is that --?

That's correct.

That's what we should think of? Okay. Very good. Thank you.

Corey Greendale, First Analysis.

Question on the backlog and I'm sorry if I missed this, but do you know how much of the backlog was acquired with Delaney?

Approximately $40 million.

So it was about 17% growth on an organic basis?

Yes.

The second question is, I guess you kind of touched on this a bit, Dan. But in terms of the availability of labor being a kind of the bottleneck in terms of getting new work, is labor really the limiting factor at this point even more than winning new contracts or do you see that easing up a bit?

Well, I wouldn't say that labor has been an issue with respect to our getting new contracts. That hasn't been an issue. We're growing very quickly there. It has been an issue with us to fill positions. It is certainly not an issue with respect to our being able to compete and win work and not even execute it. It is just -- it has had an impact in our strategy for execution in order to meet schedules, we've had to bring on additional subcontractors.

And certainly there is on the federal sector and even on the state and local there's a pretty heavy emphasis on small business or minority set-aside requirements that this shortage of labor lends itself very easily to us in giving work and subcontracting to those types of entities. That is a requirement anyway.

Can you talk about your price of labor? Is there a kind of pressure on wages because of the lack of supply?

Not particularly. We haven't seen pricing pressure, nothing other than just a standard cost of living that is built into our escalation on our contracts right now.

Okay. And as you look ahead for the next 12 months, are there any other projects of any size like the DOE one that could be coming up for rebid that could go dormant for a while that we should we be thinking at about as we are modeling?

No, no. It's a single large one and we felt that the reprocurement cycle would have been much faster but it's just one that happens to have gone slow. But, no, we have no others that would have a material impact on our any one of our client sectors.

Thank you.

Francesca McCann, Stanford Group.

Hello, there. Good morning. Just a couple of quick questions. On the international opportunities, I know that you said that there are at the beginning you said there are plenty of contract opportunities there. And then you talked about acquisitions. There are also opportunities there but it doesn't seem like that is a portion of the business that you have grown very much.

I guess how quickly do you see this part of the business growing let's say ex acquisitions, how much are you putting effort into really ramping up your international work?

Well, we are putting a fair amount of emphasis on international. Let me describe two aspects of our international focus. We have work internationally in Europe right now. We have offices in Europe. We've located in Germany with other projects officers in other EU countries and that work has taken us -- has taken Tetra Tech overseas through our Department of Defense clients primarily the Air Force and some Army work.

We are doing work in Panama. We have offices in Panama and that has taken us offshore in this case with USAID, a U.S. federal client. We have work in the Philippines with USAID, Thailand with USAID and in India with USAID. There is a strategy to take Tetra Tech offshore or overseas for these opportunities. There is other projects, the Red Sea to the Dead Sea which is USAID and World Bank has been to go internationally with a U.S. federal client, low-risk, no risk of payment, no currency risk and a client we're familiar with and excellent payment terms to help David and the Corporation with DSO.

And one thing I may want to add is the way we report our international work is based on the funding, where the funding is coming from and not based on fiscal physical locations. I do agree with Dan that we are increasing our international work but we just didn't report it that way.

That is right, so --

Okay, so that actually would be my follow-up question then. Is everything you just mentioned seems like it should have contributed more than just 1%. So if -- I guess if you do break it down geographically, how would -- what percent of revenues would be coming from international right now?

It's about 10%, Francesca. What we are looking to do is we're looking to take our presence in these countries and others that we are in and we're looking to take and leverage it to in-country opportunities. So work that we would be doing for an individual country or multinationals that would be located in these different locations around the world, those are some of our pursuits.

We are not looking -- the reason you haven't and we haven't seen the international portion of our contribution from clients that are offshore increase, is we are not looking at taking our domestic U.S.-based staff and exporting them overseas and just opening project offices. We're actually looking to have in-country acquisitions that we'd use as a platform to export our service and technology differentiators. And so likely we will not see a large increase in what we defined as our international presence or revenue contribution until we do an acquisition.

Okay. That makes sense. Also backlog mix, did you -- I don't believe you went over that. Any breakdown that you are able to give us there?

It is similar to the backlog mix. It is similar to our revenue breakout. It is slightly more emphasized toward the federal sector. So our larger contracts are on the federal side so it is similar to our business mix and revenue with a bit more emphasis on the federal side.

Okay, thank you. And then what about commercial opportunities other than things you might be looking for on the inquisitive front, what are you seeing for contract potential there?

Well, we are seeing good strength in the industrials. We've had press releases before about the automotive industry that they go through a transformation. The new area that we would expect to be a major contributor to our commercial portfolio would be the alternative energy and specifically wind. Much of the work we're doing for the wind sector are commercial developers of energy. And so most of the new big wind programs you are going to see that we'll win. And good fortune if we're successful. You'll see announcements on because they are larger programs. All will be on the commercial sector which again helps our margin and helps diversify our portfolio.

Okay, so still though the auto industrial's alternative energy win but not -- just because those we've talked about for the last couple of quarters. But anything new there or not at this stage?

Those are the two areas we're reporting our largest investments in. We're currently working, let me give maybe some information on wind. We are currently working to permit about $7.5 billion worth of constructed projects in the wind sector.

Okay.

It's close to 10,000 megawatts which on a financial basis converts to about somewhere between $7.5 billion to $10 billion. It won't all go to construction depending on permitting and which ones are issued, noticed to proceed first. And that is almost all commercial work. Very big programs.

Okay, excellent. And then just one quick follow-up to the international question, the approximate 10% of revenues right now. How are margins for those contracts particularly your largest ones with either USAID or DOD?

Well, those are all modest margins. The federal government work we're doing particularly overseas, much of it is cost plus fixed fee. Whether or not we're doing that work here domestically or overseas it's all the same margin. So it is cost plus, is 6% to 8%, in that type of range.

Okay. So they are not great margins right now?

Well, it's federal government (inaudible). They will pay all your costs, they will -- low-risk.

Okay, perfect. Thank you.

Matthew McKay, Jefferies & Co.

Thanks for taking my question, guys. I don't think anyone has talked about where you are in ramping up on BRAC opportunities. I know you go through studies I think at the front end but then the work starts to ramp up. So if you could just give some color on that, that would be helpful.

It is ramping up slowly. I think that what we've seen from on the ground at these bases, we have a presence for instance, an example on the Air Force. We're at every Air Force installation within the complex. We are seeing a slow move on BRAC. The work that has been planning, which you mentioned, we are doing planning through a number of the different Army Corps districts and for the Air Force. But we've seen relatively slow movement.

We do believe that it has been partially affected by revenue or funding diversion to the war effort and so we think that that will slow down the process. They are moving, all three branches are moving on joint base locations. One of the larger joint base locations that we're looking at providing support to is Guam, it's an example where the Navy, Army and Air Force are going to be co-joined at a location. So there are individual magnet locations for joint basing that are moving forward but much of the base closures and realignments here domestically has been a pretty slow process.

So are we looking later in '08 then when it potentially becomes a more material top-line driver then?

We internally have looked at it as if it is somewhat offset with Iraq. We think that as the troops come back from Iraq, they will come to new bases and funding will be diverted or redesignated from the war effort to the realignment bases where they will be returning to. So we are looking as if the Iraq work that we're doing as it begins to ramp down will be offset by the base realignment enclosure process speeding up.

So it's a bit of a forecast as to when that is likely to happen but certainly we would expect it to be in '08 and that will be certainly incorporated into our guidance for fiscal year '08 as we put it together. BRAC and our Iraq work will be a significant part of our valuation.

Yes. All right. So thinking about -- I noticed you mentioned that SG&A increased partially because of ramping up some business development costs. There is a lot of business that you've won that is in backlog or projects that are early stages ramping up. Are we, when we look out to '08, are we getting to a point where the organic growth rate should start to accelerate here?

Absolutely. We think that the organic growth rate will generally on a trend follow our backlog growth. We are not providing a specific correlation. We have in the past indicated that we don't want to break out net revenue organic growth because we want the flexibility to self perform which is obviously our preference. But have the latitude to meet our clients' requirements by using subcontractors. And again, if you look at our top top-line growth, gross revenue, and backlog growth, they are much closer.

Okay. And just a last question, you talked earlier about the mix moving more toward some fixed-price work. And I just wanted to get a little bit more color on that type of work, just kind of length of contracts, ability to adjust any higher cost. Just trying to get a feel for what kind of risk exposure there is on those fixed-price contracts?

Well, typically the fixed-price contracts are very well defined in scope and so out of the scope items, our change orders are changing conditions. So we are not taking performance risk. It is risk that we have defined in advance. We typically will buy out or lock down any commodity risk in those before we get started. And a lot of the work is on some of the fixed-price programs where it might be turnkey and has construction.

We will have subcontractors lock down in their price with different types of surety or bonds that we push out the risk to subcontractors, or certainly have them co-join us in this. So no doubt, fixed-price is higher risk than cost plus but the margins can be materially higher. So with Sam Box at the highest level, we take those very, very seriously. We are not looking to take more work on a fixed-price and put our Company at risk. That is the one area we've spent significant amount of time in the past year developing and strengthening our risk management particularly on fixed-price.

And just to note, every single fixed-price contract over $3 million, which is relatively small for a Tetra Tech size gets reviewed here at corporate headquarters and gets Sam Box, our President of the Corporation's personal review and approval before the bid can be submitted.

Okay, great. Thanks a lot, guys.

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

Great, thank you very much. I will keep the conclusion short. We feel very good about the third quarter but we realized the third quarter is behind us. And what we are really focused on is the fourth quarter and fiscal year '08 this time we're beginning to look into. I appreciate all your support and I would hope to have additional announcements as we're successful on new key programs that we're both rebidding and other large ones we are pursuing.

Thank you very much and look forward to talking to you all next quarter. Thanks.

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