Tetra Tech Inc (TTEK) 2008 Q1 法說會逐字稿

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

With us today from management are Dan Batrack, CEO and COO; Sam Box, President; and David King, CFO. They will provide a brief overview of the results and we'll then open the call up 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 of the Securities and Exchange Commission identify certain risks and 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 now like to turn the call over to Dan Batrack.

Thank you very much. Good morning and welcome to our first quarter of 2008 earnings release conference call. While we have had excellent performance in all of our segments over the past 10 quarters, I really pleased to announce this past quarter was our best in over three years. While our gross revenue grew over 25% year-on-year, our net revenue grew at a double-digit rate, our backlog outpaced both of those numbers and grew at an over 27% increase from Q1 of a year ago.

Our increase in income, which was the largest increase on a yearly comparison of all our key metrics, was largely attributed to strong performance in our firm fixed-price contracts that were performed across all of our three clients segments -- federal, state and local, and commercial. Overall, our net income and earnings per share, or EPS, increased about 37% for both of those metrics.

I would like to spend a few moments going over our three primary clients sectors that comprise our business right now. Our largest client sector is the federal government. It has been our largest client sector historically for Tetra Tech and represents almost half of our revenue. In fact, this last quarter it was up to 46%. The federal market while it has always been Tetra Tech's biggest client is really a great place for Tetra Tech to be today, especially in this economy. It represents our largest contracts by far. Federal government represents our longest duration programs, least volatility in fluctuations and funding, and it's these federal contracts that we believe are going to be the first to realize any benefit from any time of federal stimulus funding that would be coming out.

In addition to our long-term clients at the Department of Defense, EPA and FAA, this past quarter we added USAID, [its] affiliate U.S. State Department, which actually offered us new growth opportunities and was a large contributor this last quarter.

Our second largest client sector is the commercial client sector. That accounts for almost precisely a third of our revenue, 33%, and this is where our highest margin work is performed in the Company. The commercial sector is central to our alternative energy in our mining business approach. With mineral prices at an all-time high, states mandating new renewable energy goals of anywhere from 10 to 25% that they are just beginning to embark upon, we see our commercial business having long-term strength and really being extremely removed from economic variability that we are seeing really across the country these days.

The third of that is, one of Tetra Tech's key clients sectors, is state and local. Our state and local is the smallest of our primary client sectors at about 20% and our state and local businesses is dominated by water programs. We've found that the funding for these water programs are extremely resilient to fluctuation in tax receipts, and I will explain why that is the case. Most of our water programs typically fall into one of three categories. The first category is a very large one for Tetra Tech at the state and local level, is regulatory-driven programs. These are typically court order water programs that have either consent decrees that have been legally entered into between different agencies. A good example of these are combined sewer overflows where there is actually regulatory mandates and specific time frames that are required for implementation of these programs. So they have been entered into by multi parties, multilateral agreements and they have fixed time frames and are generally immune from any type of discretionary movement of these programs going forward.

The second water program that we're involved in are critical infrastructure programs at the state and local level. These are typically dams, levees, other type of coastal or water protection structures. These are typically very high-priority programs, are funded outside of annual funding or associated with bonds or other types of special funding support. These are very high-priority programs and typically are mandated to be implemented for all sorts of different reasons, for protection of critical structures in order to obtain lower FEMA insurance rates -- all sorts of different items that make these very little discretion in going forward.

And the third area is what we refer to as just water at the tap. This is programs for clean water, providing clean water at your tap, providing water that actually is removed from your facility or from your homes. And again, these have very little discretion. When new [residences] are built, when new upgrade of water systems, when they turn the tap on, you know immediately whether or not this program is going forward. So again, very little elasticity on this, very little discretion. All three of these -- regulatory-driven programs, critical infrastructure and water at the tap -- are the highest priority, and we see these, again, having very high resiliency and little impact with any type of tax adjustments.

The smallest client sector that we currently have, it's very small but it's growing quickly, is international. We currently do about 1% of our total revenues for clients that are located outside of the country, outside the U.S. This category actually does not include work that we're working for the U.S. federal government overseas or other U.S.-based companies. It's small, but with the addition of ARD this past quarter, we are currently working in over 50 countries and have over 800 staff located overseas today. That was really a very big move this last quarter for us. We're currently looking at how we can leverage our increasing local presence around the world to begin to get work at these local locations. So that's a new area that we see growing very quickly for us.

This past quarter, we had very strong growth in all three of these customers sectors. The federal customer, if you take a look here on the webcast, you can see these numbers here, I will go through them briefly. The federal customer we built on solid performance with our traditional clients. Again, that would be the Department of Defense, EPA and the FAA, but new work with the [USCID] that was brought to us by ARD was a big contributor at the growth rates that we had at the federal level. State and local, really we have had -- this was the fastest-growing area for us of all of our three clients segments and we've had very good success with municipal water programs and primarily at the regulatory level that are driven by regulatory drivers at these CSO programs, or combined sewer overflow programs. That is what primarily drove the growth this past quarter. We are now working in 16 cities at the CSO programs and we added four this past year. They were the primary drivers of state and local.

In commercial, we've just had broad success across most of our client sectors, but particularly in new mining projects I mentioned a moment ago and alternative wind energy programs. This is where we are seeing very high demand, in fact demand that is outstripping supply of consulting and engineers in the marketplace. This is the primary driver in our commercial sector.

One item I would like to point out that is very different and it has become very clear this last quarter is that Tetra Tech now is experiencing different growth rates in our net revenue versus our gross revenue. As Tetra Tech and all of our engineers are pursuing and winning larger projects, these are much bigger turnkey projects, full-service programs. Our gross revenue is going to grow even faster than our net revenue because we're adapting how we execute these projects. This is a change for Tetra Tech. We've had a primary focus on net revenue, self-performing but with using more flexibility of subcontractors. In order to meet fast time frames, we're executing bigger, more complicated projects, we should start having to look at our gross revenue a little bit closer. I will note, though, that both our net revenue and the gross revenue, which includes our subcontractors, are contributing to our operating income, so they're both contributing.

Next, I would like to share with you some of our biggest wins this past quarter. Each of these awards are in our core business area. None of these are tangential, none of these are moving outside of areas that are really of Tetra Tech's key expertise. The biggest award we had this past quarter was a $500 million program. It's a basic working agreement, so it allows for a multiyear performance on multiyear tasks with the Army Corps of Engineers out of the Savannah district. I will note that this $500 million is an overall contract ceiling. We have only recognized approximately $20 million into backlog in tasks right now, and so this leaves us the remaining $480 million that is available for Tetra Tech to access for new task orders over the next four years. So this represents a real long tail, long opportunity just on this one program.

The second-largest set of wins we have had since our last conference call, and I'll actually say most of this new work was not in the first quarter. We've received approximately $170 million in new commercial award work for wind programs. This is for alternate energy turnkey wind turbine programs. Again, most of this was not in the first quarter. In fact, this has been fully funded and will show up in our backlog and we'll begin working on these programs here in the second quarter. In fact, we already have field crews out in the field working on this right now. So this is not even recognized in our revenue or backlog in the first quarter.

The next one here in our list is, we had a recent award of a four-year program for $75 million with a watershed contract. It's with the U.S. EPA and this is going to keep us at the forefront of emerging programs with that client. And this really gives us a lot of stability and keeps us at the front edge of water policy and evaluation of watersheds. So these are three examples of some of the bigger wins we've had this last quarter. You'll also note that during the quarter, we had over $500 million in new orders, and this is one of the largest quarters ever that Tetra Tech has booked in the quarter. So just exceptional performance, particularly being the first quarter which is not historically one of our strongest quarters.

I'd like to say a few words about backlog, and I really want to start with our definition. Tetra Tech's definition in how we track, book and report backlog is quite different than most of peers in this industry. Here is our definition. First, a program has to be awarded to Tetra Tech. It has been a signed contract, it has to be executed and it has to be legally obligated. That's part one, but that is not enough. It has to be, two, funded by the client. The client has to have the funding, the money and the liquidity in order to fund it and to initiate the contract. And finally, it has to be authorized, which is that Tetra Tech has been authorized to do the work, go out, spend the money and get the program done. It's only when all three criteria have met, that it has been awarded, funded and authorized, that we count it into backlog. We believe this is the most conservative definition in the industry and that is what we have used really since inception. So this is nothing new to us.

So to speak specifically to the numbers for the first quarter, the first quarter we completed at the end of Q1 with a total backlog of approximately $1.3 billion in backlog. That is a new record high for Tetra Tech, highest we have ever finished a quarter. It's a 25%, just over 25% growth year-on-year. And only is it a big increase year-on-year, it continued to grow sequentially, which is very strong for us particularly in the first quarter generally being a little bit -- historically a little bit of a softer quarter.

For us here at the Company, this is the best leading indicator, especially in this time of economic volatility. This is the indicator that we look every day we come to work. This is how we can see into our future.

With that, I would like to turn this over to David King and have David go through some of those specific financial metrics and performance for the first quarter.

Thank you, Dan. As a whole, we registered a very strong quarter, if not as Dan mentioned earlier, the best in three years. Our revenue grew to $470 million at the 27.4% together with an equally strong increase, almost 26% off backlog.

Our net revenue grew 13.2% to $277 million. This growth came from all markets -- federal, state and local and commercial, as Dan mentioned earlier. Our income from operations increased from $21.4 million to $22.7 million, an on an as-reported basis 6.3% increase. In FY '07, we had a onetime benefit from litigation reserve reversal. Excluding this benefit, it was an improvement of over 30% as Dan mentioned at the beginning. Also, we experienced improved margin of 8.2%, strong relative to the first quarters. Excluding M&A charges, related charges during the quarter, it was 8.9%.

EPS grew from $0.16 to $0.22, a 37.5% increase.

SG&A cost this quarter was $33.5 million, as I mentioned earlier. Same quarter last year had a $[4 million] benefit and also this quarter particularly, we had an increased proposal effort of about $3 million. And as I mentioned earlier, an M&A related charge about $2 million, mostly had to do with intangible amortization. Normalized [is] meaning adjusted for legal benefit of last year and only the M&A charge for this year, last year was about 11%, this year was about 11.3%. This includes a 3% increase in our proposal effort this quarter which has borne fruit, as you can see our wins earlier and it will bear fruit in the coming quarters.

Net interest of $700,000, a combination of strong cash management and lower borrowings helps us keep our interest costs in check. Tax was $9.2 million, a 31% increase due to increasing earnings. We expect our tax rate for the year to be 41.5%.

On balance sheet, let me point out, you probably noticed there is some movement in our balance sheet. It had to do with FIN-48 adoption. There was no P&L impact, there's no retained earnings impact. It was a pretty much balance sheet reclassification between income tax receivable and deferred tax accounts. If you have -- you need more detailed information, then we can talk off-line after the call.

Accounts receivable increased to $472 million, a 35% increase. A big part of it came from the revenue increase and some acquisition business growth. The same thing with accounts payable, pretty much has to do with our revenue growth. In fact, payable increased at a higher rate than receivable due to a better match of contract terms, especially with more [pay]. Net debt at $60 million due to borrowing of ARD acquisition. In fact, this is better than 10, $15 million and better than our internal goal for the quarter.

Cash used from operations was $18 million. Again, this is better than what we expected for ourselves by 10 to $15 million, especially given the growth in the quarter and the higher bonus and tax payments experienced in the quarter. We expect '08 to be 50 to $60 million and for Q2, we expect to be 15 to $20 million cash flow from operations. CapEx is $4.3 million for the year, we expect to be 14 to $16 million. Our DSO performed as planned, 77.6 days. This is a 2.5 days improvement sequentially, which translates to about 10 to $15 million I mentioned earlier and contributed to strong as flow and net debt performance. I expect DSO to be in the mid to high 70s for the year, for the remainder of 2008, that is.

Last page is on net debt. Again, this is a key [matrix] we track and report. I continue to see that trend to go downwards and barring any future acquisition. It also reflects a key (inaudible), that is we self-fund our acquisitions from our cash flow from operations. Longer-term, we borrow to fund growth and we pay off with our operating cash.

With that, I -- the podium back to Dan.

Thank you very much, David. I would like to move to our guidance, both for the second quarter of 2008 and review our annual guidance for the fiscal year.

For the second quarter, our revenue net of subcontractors, we're providing a guidance range of $260 million to $280 million, with a diluted EPS of $0.19 to $0.21. For the year, our annual forecasted revenue is $1.11 billion to $1.21 billion with a guidance range of $0.87 to $0.93. Based on the strong performance this fourth quarter, we did narrow our guidance range. We moved the bottom end up $0.01 from $0.86 to $0.87. I will note that this guidance range represents approximately a 15% top and bottom line growth in all of our metrics.

One other item here I would like to note that David touched on briefly is that intangible amortization of $0.05 for an impact of $0.05 for 2008 has been factored into our guidance. Once this intangible amortization is complete, this $0.05 is going to flow back into earnings. So I think that is something that is noteworthy.

In summary, I would like to say we have established a strong federal practice. We are winning larger and larger programs, longer duration programs. This federal business for Tetra Tech has always been very good, but in this time of volatility it's even better. It is much better for the entire company. We are positioned well in the emerging alternative energy markets. We're currently working on over 70 wind projects in 35 states right now and we see this market only getting stronger. So the commercial sector we expect not only a lot of stability, but larger growth and very favorable programs.

At the state and local level, certainly I have heard and am very sensitive to variability and volatility in those budgets. But with Tetra Tech working on the most critical water programs at the state and local level, we feel there's a lot of stability there and that these programs are going to be going forward. All in all, strong backlog growth in all segments and we remain extremely confident going into 2008.

With that, I would like to open up the call to questions. Allison?

(OPERATOR INSTRUCTIONS). John Clearly, Canaccord Adams.

Good morning, this is actually Chip Moore on behalf of John. I was wondering if you could delve into backlog a little bit more, maybe talk about some of the planned headcount additions, how that's going, kind of the utilization picture, how that is rising or falling, how we should be looking at that going forward?

We had -- let me speak to backlog. We had backlog increase in all three of our sectors, both at the federal, state and local and commercial. The increase is relatively proportional to the revenue. While we don't break out the specific apportionment of where the backlog is being added, this past quarter it was added relatively in line with our revenue percentages. Headcount, if you take a look sequentially we added over 800 new full-time equivalents, or FTEs. In fact, in total headcount we are well over 1000 this past quarter. A fair amount of that was from acquisitions, but organically are just new hires was a good portion of that number.

We do have new openings, but we don't see that headcount in and of itself as any type of obstacle or deterrent to our continued growth and execution of the work that we have, or our ability to pursue work. Utilization, we're in the upper 60s. We think we still have room for some improvement. But right now, we're running well within a bandwidth of what we would expect to be our normalized run rate.

Okay. And just along those lines and the hiring, would you say that the environment has gotten a little bit easier, perhaps?

I don't think we have really seen much of a change. I would like to think that -- I've certainly heard from some of our folks, primarily in the information technology we've seen folks moving from markets that are sort of tangential to ours, that we've had new folks coming in, a few folks in the engineering from residential housing and some other areas where there is softness. But we haven't seen a material increase in staff availability. It's still tight, but it's manageable.

Looking at the international opportunity just kind of broadly, wondering your thoughts on demand international versus domestic.

Our presence internationally has been primarily or is primarily working in the commercial sector with U.S. multinationals have taken us overseas and we have gone overseas with the Department of Defense and USAID. So most of the work that we have, in fact almost all of the work that we have overseas, is through U.S. nationals.

We're following the money. We're seeing strength both with the State Department through USAID and with the Department of Defense. That in-country work we're still very early and I think any insight that we would have is based on a very small window. So I think with respect to in-country domestic work, we're still in an exploratory phase. So I don't know that I would really even have an opinion on that right now.

Fair enough. And then also just looking at the relative out performance this quarter, it looked like it was mostly in the resource management side. How should we be thinking about that mix going forward? Is that a trend that is likely to continue?

We were a little bit soft in our infrastructure business. Our infrastructure business was flat. In fact, it was, to be precise, it was down 1%, so it was flat. We believe it's primarily attributable to one program. A year ago, we had a large program in the infrastructure, a NASA project that wasn't -- that has not gone forward for us. If we simply factor just that one single program in, we would have had -- last year, it contributed approximately $8 million, so it would have put us at a 6, 7, 8% increase year-over-year. So the rest of our business in infrastructure is growing at about that pace. It will make the year-on-year comps because that program did go all the way through until the fourth quarter last year. So we need to make up for that at nearly a 10% rate on that revenue in order to show an increase. So we do expect that to pick up, but I think we will see our largest gains in resource management. The primary reason is, that is where almost all of our federal work resides.

Okay, great. That's helpful.

Richard Paget, Morgan Joseph.

I wanted to touch upon that a little bit more, maybe. If we do go into a prolonged downturn, where do you see the most risk? And maybe you could talk about past cycles of -- have you had backlog, projects in backlog, ever get canceled?

I'm sorry Richard -- I think the beginning, we may have lost you. If you could repeat, I think I might have lost the beginning of that question.

I just wanted to get a better sense of, if we do go into an economic downturn, where really are the risks in your business? You did say what you do have is relatively resilient and defensible, but where should we think about signs of risk? And have, in past downturns, have you seen backlog or projects get canceled or scaled back?

Good question. I'm not going to say it has never happened, but programs to be canceled once they have been initiated is very unusual for us because of that way that we account for our programs as being fully funded. These are programs that are typically well underway in a midpoint, they're somewhere between initiated to in progress so it's very unusual for us to see those programs cancelled, although it's not impossible.

Where we have seen -- and I'm going back many years for Tetra Tech -- the last impact that I have seen that had a material impact on our business associated with economic volatility was back in the '90s, and it really had to do more with a political impasse back in the -- I think it was 1994 where there was an impasse between the executive and legislative branches, where they just wouldn't pass a budget. So any time that we see at the federal level an impasse where they would move to shut down the government so to speak with funding, that would have an immediate and material impact on us.

I've seen it once back in the early '90s, and right now what we're actually seeing is bipartisan collaboration in order to actually initiate stimulus programs. And besides sending checks back for tax rebates and other approaches, one way for the federal government to do is to open up their federal programs. And we have between 6 and $8 billion of contract capacity. I know that others in our industry actually use that number as their backlog number because that's what they have "under contract." We don't use that number, but certainly the federal government to the extent that they wanted to open up some kind of stimulus program and start spending money through contracts they had, that is where we would, look to see a movement.

And then, do you have any updates on any contracts coming out of WRDA?

No, we're following it very close. There are programs and we're bidding on some large contracts in areas like the Gulf Coast, out in California along the levee, the Sacramento River delta system. But those programs as you track the funding actually are not associated with the Water Resource Development Act. We've been following that very closely. In 2008, funding appropriations have already been put in place, and so we would not expect material movement on fundings directly associated with WRDA until late 2008 or really early 2009.

Alan Robinson, RBC.

Good morning. Given the issues we had last week with the monoline insurers, what kind of feedback or color are you getting from your state and local customers regarding their sort of long-term view on how easy or how difficult it would be for them to get funding? Are you hearing much there, or is the leadtime there so long that it's not impacting?

From our experience, it's the latter, that it's a long lead time. And we had heard nothing on any of our programs, contracts or even from the contracting officers that we work with at the state and local level. So while we are aware of it because we've been watching it, it certainly has not translated down into any communication to us. We've been checking both with our clients and our project staff and we just haven't seen that yet.

And to borrow from a previous questioner, do you have a history or do have any perspective from historical trends with respect to changes in state and local funding availability, or is that relatively smooth?

For our programs, we've seen it be relatively smooth. The states do have to run on a balanced budget program. And so as tax receipts and other funding availability move, certain programs will be impacted. In our experience, the programs that are the most sensitive are typically transportation. These big linear programs, rail and road programs, these are real big programs. They generally don't have a regulatory driver, so they don't have a mandated schedule. The designs for roads, and I would not want to minimize the civil engineering aspect, but it doesn't go obsolete. The grades, the concrete materials, the specifications can be rolled up as drawings, put on the shelf and when funding is available can be reinitiated. I had one of my engineers say once when I challenged him on this, he said, look, no engineer got -- the city staff know immediately from their constituents if the water isn't coming through, but it's not as big a deal if they hit a pothole. So it's not quite the same priority. So we think our water programs are much higher.

Tetra Tech's exposure in the transportation sector is very minimal so we don't really see that as a material impact on any front.

That's very helpful. Just finally, I think I caught you mentioning that you now have 800 staff in the field internationally. Did I hear right?

That's correct.

So that is about 10% of your overall staff. So what kind of proportion can we expect to see the international sector generating over the next couple of years? What kind of proportion of your overall revenue? And perhaps, could you speak to the potential profitability of that revenue stream?

The work that we're doing overseas, these more than 800 staff as I mentioned are in more than 50 different countries. The greatest majority of those staff, over 500 of those staff, are working for the USAID which is a U.S. federal agency within the State Department. And we are in a number of countries. So it's -- we currently classify that as federal revenue, but we are looking to leverage that presence and local activity into in-country work. The remaining roughly 300 people we have overseas are -- we do have some in Iraq, but the rest of them are really, have gone overseas with our multinational mining clients. And there's big activity in Latin America. We're seeing it in Asia, we're seeing it in different areas around the world and the margins there are very good, as they are with most of the mining players.

So I think it's a little bit early for us to predict an exact percentage in the next few quarters, but we do believe over the next year or two we're going to increase our in-country work, what we define as international revenues from its current 1%, and our goal would be to bring it up to 20% or more.

And are there any international acquisitions on the back burner at the moment, or perhaps you could speak generally to what you're looking at with regards to acquisitions generally.

We feel great, and I was hoping that they would be on the front burner for us. But certainly, there is competition overseas. We're not the only ones looking there. But the change in the valuation of the U.S. dollar to many, in fact most international currencies. has made it a little bit more difficult. So we're still looking and there are extremely good strategic fits with Tetra Tech. I think we're the right company for so many overseas. We're going to keep looking. But for us, it comes back to the right Company for the right strategic fit at the right price. And when they hit those two criteria, we'll bring them on. But no doubt, the international currency difference is having some impact.

Jeff Beach, Stifel Nicolaus.

Great quarter. My question is on two of your markets that appear to have high growth potential, wind energy. And regarding this, can you give us just a rough idea about how big wind energy is right now, in terms of your backlog, your current revenues? And then, along with that, if wind energy is going to grow at an extremely high rate, where are you going to get the trained people to work on all of this? Does it present a challenge to you? And then along with it, because it's in so many states, is this a business where the work force travels or where it's being done locally or regionally out of out-of-state offices? The second market, a little bit just combined sewer overflows, can you give us an idea of how big that is now? And then specifically with that, there has been a lot of growth from programs already kind of mandated. Is there a good backlog of business ahead of the pressures and the programs still you have to come in that business?

Let me address, those are very good questions Jeff. Let me address wind first. In 2007, we did somewhere between $30 and $40 million worth of revenue flow through Tetra Tech. Most of that work was upfront planning work. A little bit was engineering. So again, 30 to $40 million in 2007. In 2008, we are forecasting that number, particularly with these new wins, to be in excess of $150 million. So you can calculate nearly a fourfold increase.

The work is not -- the new work, these larger projects that we're receiving -- are not made up of lots of projects. In fact, it's just a -- very few number of that drive most of that revenue. These are EPC, engineering, procure the equipment and construct -- so that they're turnkey projects. We refer to them as EPC. So they are much larger revenue. A handful of locations. We don't need to be present in every state, just where it is windy and they're building them. So we will have staff that will travel to these single locations.

And as far as resources, most of the technical resources that are necessary for this we have in-house. And the one great advantage that we have as a corporation is the flexibility. If for some reason commercial or state programs became soft because of economic pressures, we have the ability to move them to the federal market and actually help exercise and work on some of the backlog we have in that sector. The same is true back on the wind sector. As this ramps up, we can move folks that are currently performing engineering activities. A lot of this work is civil engineering, grade and construction work, site preparation, geotechnical work, soils testing, right of way clearance, environmental impacts, all of those work that we have in-house. So we currently don't see resources as an overall constraining matter on this.

On combining sewer overflows, that's a market we have been focused on. Between CSOs and SSOs, which are single sewers, and the combined sewers, there are approximately 800 cities that have this architecture or this infrastructure. Currently, there is somewhere above 50 different cities of that large number that are under regulatory orders or consent decrees to execute this. As we mentioned, we have about 16 of those that we're taking the lead on with respect to evaluation, engineering, identification of different complaints, alternatives. They are very early in the process as you can tell by the numbers that have gone under regulatory order.

And the revenues in 2007 were about $35 million, 35 to $40 million. And so we see a very large potential upside in this market.

Debra Coy, Janney Montgomery.

I wonder of we can come back a little bit more to the issue of gross revenues and overall revenue growth. The 9% organic growth in gross revenues, obviously significantly outpacing. Dan you talked a little bit earlier about the shift in strategy and I am wondering how we should think about how this is going to translate into EBIT growth and EPS growth. Because we now have four quarters in a row, five I think perhaps, of 15 to now 25% backlog growth. Obviously, that is a gross revenue number. With your shift in strategy, is it possible that we should see more of that flowing down to EBIT growth and bottom-line growth, leaving aside the net revenue portion? And as a related question, how do we think about margins? Margins certainly in the resource business were a bit better than expected this time, even with the ARD acquisition. So can you just kind of talk through your thinking on that a little bit more?

I'm really glad you brought that up, Debra. I want to reiterate, which I wanted to include in the, I attempted to address in my comments, that regardless of whether we self-perform or whether we subcontract or use other vendors, we will have margin on it. And that, that yes, gross revenue, and you've seen it these past few quarters, increase as a percentage of our overall revenue, but let me do a comparison. Our backlog has gone up roughly 25% year-on-year, but our operating income if you exclude the onetime legal reversal we had a year ago, was up over 30%. If you really want to take it all in, net income was up 37%, 36.9% to be precise, and earnings -- if you want to -- and the final measure for our shareholders is diluted earnings per share, EPS, which is up over 37%.

I want to be cautious about using numbers like 30, 36, 37% increase in earnings EPS and net income because our long-term goal is to take both our top line and bottom line up to 15%. As we grow, it will translate into margins that we have indicated before. I will just use a couple of examples. Resource management from the first quarter of '07 was 7.8 this last quarter, 9.4. Infrastructure, which we still have more ability to go up, it was at the lower end of where we're looking to perform. About a year ago at 7.3, this year at 7.9, a large increase. And I almost don't want to comment on communications because they went from 2 to 10%. But that 10%, and I just want to say one word about that. Our communication business because it's a lot of field activity bringing fiber to the home and other field-related activities, is heavily seasonally dependent. So you will see much higher margins and higher utilization of work force in the fall when the weather is good and later in the summer. So that margin will be variable, but always in the black.

So it's hard not to draw the conclusion that if your backlog growth is 20% plus and you still have room on margins that it frankly sounds like 15% is being conservative.

Well, we like to make commitments that we're going to achieve. We have as a management team here for the last three years I think have really -- and I want to make one thing stated for our collective group here. We are not setting a meager or a low bar that's easy for us to go over. I think that 15% top and bottom-line growth is something that we are looking to meet or achieve. I'm very focused on that. I think the credibility of this management team and of all of the engineers and operational staff in this company are committed to these numbers. This last quarter, of course we were well above every one of those metrics and hope that is the case as we move forward every quarter. But as we take a look out in the forecasts on the timing, this is what our internal plans are forecasting. So I have heard words cautious, conservative, sandbagging. These are realistic.

I guess my last, coming back to Richard's earlier question, is part of your a little bit caution or conservatism related to, even though your visibility now looks very good, a little bit of caution related to overall economic risk?

Yes, absolutely. We would be unrealistic to say that we are sitting here in a bubble having our heads buried. Everyday we're looking at the newspapers, there's softness in housing, spinoffs to commercial development related to other related business to the financial sectors that have impacts on industrial. We are being prudent and extremely cautious and we're looking out at of the edge of the horizon every moment to see what might be coming our way. Right now, things look really good. But not to be cautious and vigilant right now would just be not appropriate.

Understood. Last question. Back on the international side, and interesting that we're talking about that a lot more. You did mention and as you have before that your target is to grow that to 20%. It sounds like acquisitions are a little less attractive right now than they might have been given the exchange rates. Are there particular countries or programs where you are seeing opportunity to go and bid directly without having to acquire capacity on the ground?

Well, I think a good example where we have an opportunity of large programs that are coming up that we're pursuing right now is Panama. Panama is an excellent example. They very large water infrastructure programs with the expansion of the locks. We have won several million dollars. So roughly one year, we've gone from zero to an annual rate of approaching $10 million. And we're on a number of the teams that will be competing for the locks and other programs. I don't really want to highlight any single opportunity, but there's a country that has an example. And in the most general sense, I would say we're focusing on commonwealth countries. These are countries like of course the UK, a number of them in Latin America, Asia, where they have regulatory or governmental institutions that put a priority on clean water, clean environment, lower contract risk. Those are really areas that we're focused on. One that also has big opportunity for us is India. We have about 50 individuals, I think it's actually a little more than that, in our India office and we see some great opportunities there also.

Richard Eastman, Robert W. Baird.

Could I just ask what the acquisition contribution to the backlog was in the quarter?

We don't actually break that out. Typically, if you take a look at our backlog number at about $1.3 billion on an annual run rate of close to 1.8, you'd use that percentage, it would not be materially different than that from the acquisitions that we've brought in, which is primarily just the one, ARD. So if you use those types of percentages, it would be -- approximate the number of contributions.

Okay. That would be sequentially, but if I look year-over-year, again, Delaney's growth, again, I would not think of that as being internal necessarily.

It's interesting on Delaney, and let me say a word about Delaney. There's a lot of synergy with the Delaney Corporation. Once they were bright in, we moved them in with our -- one of our operating units and an awful lot of the work that is being marketed, pursued with our federal clients, even though wind energy programs are being marketed utilizing the Delaney Group. So we would actually look at that if in fact we isolated it and put on its own, it may have materially different growth rates and factors than being part of the Company. So I certainly have a lot of operating managers beneath me telling me that if it wasn't for the collective resources of Tetra Tech, it might be a materially different growth rate. So, I don't know, some of our folks here have a little different perspective on that.

Could I ask David, the question on the payables side, is the increase in payables, is that partially a function of the growth rate in the subcontract portion of the business? Are you contractually required to pay your subs on a certain time line?

Yes, it is proportional to the increase in AR, which mostly (inaudible) on subcontractors. We are required to pay them and we -- on a timing basis, we get paid before they get paid and so that is why there was I mentioned earlier was a matching of contract terms.

Okay, I understand. Lastly, would it be possible to give us the profit contribution at the EBIT line from the subcontract revenue amount?

We are -- we are [shifting] to this new thinking and models. We try to track them more carefully. Currently, we do not have clarity in terms of the contribution. But I will say in the low-single digit.

The question would be, again, if I look at the operating profit as a percentage of gross revenue, it's down year-over-year by 100 basis points. And, again, generally, a markup on a subcontract amount, again, would be low single digits, 2, 3%. How do you get comfortable internally that that profit contribution accommodates your performance risk that you accept on that business? Because you basically from a working capital standpoint that shift in the business model is somewhat costly. You obviously have some performance risk as a sub on that business. And again, there was a time when that markup was much higher and it shrunk given market conditions. And I'm just trying to get a comfort level here that we should be looking at margin comparisons that are based on net revenue versus margin comparisons that are based on gross revenue.

Let me address a couple of those items. First of all, let me address the cash component that we from a working capital standpoint are going to carry a much larger burden of cash. We attempt to move all of our subcontractors as David had presented earlier to a paid when paid. So in fact, we're not taking a working capital risk by funding these subcontractors either during performance or on any terms different than what we're being paid. So the goal is that we don't have working capital expense interest and all the rest of it. So that's number one. Now our AR may go up, and the fact is our accounts receivable, both billed and unbilled, will climb as we use more subcontractors because it's directly related to our overall revenue. But to have a fair comparison of that, you have to take a look at the liabilities also because quite often we won't pay those subs until we get paid. They move to the same payment terms. So on a working capital, we don't really see that as a material risk item for the Company.

Now let me talk about the difference in margins. No doubt, self performance numbers are much higher than subcontract. And you are right, the number is about 2%, 3% as an overall average on use of subs, whereas internal we're in the upper single digits and our intent is to hit 10%. As we have -- how I view this is the lower markup for a lower risk. What we self perform and we build something and it falls down as an example, it's Tetra Tech. We get to go put it back up. If a subcontractor does, we push the risk and we flow all the risk down to them. So we will have them bond the program, we'll have them put letters of credit, we'll have them otherwise guarantee the program and we flow the risk down to these subcontractors. So it's our objective that as we use subs, we're actually mitigating our risk profile materially. I know that we're giving up some margin. Not operating income, because it's all still -- 2% or 3% on subcontract is still contributing to our earnings but it is at a lower rate but it is for a different risk profile than we would have if we self performed.

Okay. So to the question I asked David, your accounts payable in this quarter then is not really representative of this business shift? Basically you decided to pay some payables before year end. Because again, I'm looking at the cash flow statement and I'm saying you used $9.3 million in cash and payables. Your receivables, you used $2.2 million. But on the payables side again, you paid some people here certainly and I'm just trying to -- was that just a discretionary move?

I will break this in two halves. One is, I will describe the growth as an acquisition receivable increase. The other half is the model shift we talked out about earlier, and that is then applied to receivable and payable in terms of split.

Corey Greendale, First Analysis.

First question, again, on the subcontracting, is that something where you think the mix has now settled, or as new contracts come up, you're going to see that mix increasingly shift so an even greater portion of the work is going to be subcontracted?

I know we're around 40%. I think that that will not move largely, but it is possible that it may actually go up a little bit. But I would not expect very large moves. I think that the current mix represents a much more execution of these turnkey programs. So this is much larger than we have historically had reported, and wouldn't look for the subcontracting portion to move back down, and in fact it even could move up slightly.

When you talk about the 15% growth, which top line should we be thinking about with that number?

Gross revenue, although we're going to continue to -- in a very perfect world, we would look for gross revenue, net revenue, operating income and EPS. We would like to run the gambit. But certainly in the types of programs that we're pursuing right now, gross revenue would be the best tracking [metric].

So the thinking is that as this change anniversaries looking a year out from now, gross revenue and net revenue growth would be a lot closer than this?

I actually think that for a time, gross revenue will grow at a faster rate than net revenue.

Yes, after that anniversaries, if we just -- once we lap that change, it should be closer together, yes?

That is correct.

I'm sorry, that question was trivial, I was just getting back to whether the mix continues to shift. And still thinking about that growth as half acquired and half organic?

Yes. I think in the long run, that is the healthiest for the Company. We put a priority on growing organically, we want to compete with the resources we have and grow. But I do acknowledge, a year ago we had no acquisitions and it was all organic. This year we have had some acquisitive additions and it is a bit more on a net basis, acquisitive contribution. So it will slosh around a little bit between the two, but as a target we're looking to have that split down the middle.

I wanted to follow up on the margin a little bit. The resource management margin as you mentioned came in I think towards the high end of what you were looking for, for the full year. I believe seasonally Q1 tends to be a little bit weaker than some of the later quarters. Can you talk about just a little bit more about what drove that strength and whether that's something that's sustainable and whether we would see that margin tick up as the year goes on as we have in past with seasonality?

When we're looking resource management and we talk about the range with these opportunities that we have with intangible amortization and with the additional cost of 123-R that we had historically had not seen, we are targeting between 9 to 10% for resource management. So we're in that range. You're right, first quarter typically was a bit lower historically. We had very strong performance mostly from firm fixed-price contracts that we're performing very well on. So that's what really drove it in the first quarter. I do believe for the year, our target is still 9 to 10%. Typically as we move into the winter months, there is an impact with the addition of Delaney and some of the other groups. It used to be Q1 was our lowest quarter and then to Q2, 3, 4 each sequentially contributed more both in margin and revenues. With the change in some of the business mix we actually see, our fiscal quarter Q2 January, February, March, which are the dead winter months, to be the lowest. So you should see margin reflect the seasonal impact of Q1 fall it's okay, Q2 dead winter, low; Q3 spring pickup and summer the best.

John Rogers, D.A. Davidson.

I just want to follow up on the margins for a second. As the proportion of subcontract revenue increases, your margins and as a portion of net revenue I understand will rise and we have seen that of late. Is there any impact in this from pricing? Are you seeing any changes in pricing or revenue mix impacting margins as well?

No, we haven't seen pricing pressure, interestingly enough, we really haven't. I would say that it has been very stable on the pricing pressure in the competitive environment. So, no, we have not seen any pressures down, but we also haven't seen any of our competitors disappear and make it a lot easier. I will say that some of the commercial work we focused on a couple of years ago in mining and commercial energy have helped. Those are much higher demand areas. (MULTIPLE SPEAKERS) and higher margin, that is right.

As far as the mix, as far as cost plus is still about 30%, time (inaudible) materials about 40% and the remaining is fixed-price at about 30, so we really haven't seen that materially shift either.

Just in terms of the revenue growth itself, is there any revenue that you were self performing that you're subcontracting now, or is there any work that you were self performing and are now subcontracting?

I think it has been -- the work that we have brought on, we've utilized more subcontractors, which you see in the split. A year ago today, which these year-on-year comparisons are representative of, we had some large contracts. One is the NASA contract I had mentioned in the engineering, our infrastructure group. Another was a Department of Energy second line of defense overseas program that was largely self performed, had a large self performance component. And it is currently not under contract. We're still awaiting a final contracting decision on that with a client. And so I'd say some of these large programs that we were fully self performing have really tailed off, and in the case of Department of Energy we're waiting for the decision on recompetes. And it has been picked up with other larger programs that are longer duration that have more of a turnkey design (inaudible) component to it.

And it's those two projects then I assume are accounting for the negative net organic growth?

Yes. If you put those two in, our net revenue would be up. It would be up in the upper single digits, and in fact our gross revenue organic would be in the teens.

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. Thank you for your excellent questions. I think they're very insightful and really gave us an opportunity to explain some of the business mix that we are seeing in the marketplace.

We, like you, have been watching the volatility in the housing markets, commercial development programs, financial markets. And I think back to our decision more than 10 years ago for Tetra Tech to focus on our federal clients on these critical water programs at the state and local government and most recently these last couple of years to move a focus to alternative energy and in specifically the wind market. And looking back, I am very happy this put us in an excellent position in these markets for stability and our ability to deliver financial performance to all of our investors.

With that, I'll look forward to this call next quarter and thank you very much for attending.

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