Tetra Tech Inc (TTEK) 2013 Q2 法說會逐字稿

Good morning and thank you for joining Tetra Tech's earnings call. By now you should have received a copy of the press release. If you have not, please contact the Company's corporate office at 626-351-4664.

With us today from management are Dan Batrack, Chairman and Chief Executive Officer, and Steve Burdick, Chief Financial Officer. They will provide a brief overview of their results and will then open 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. The statements are only predictions and may differ materially from actual future events or results.

Tetra Tech's Form 10-K and 10-Q Reports to the Securities and Exchange Commission identify certain risk factors that could cause actual results to differ materially from the forward-looking statements. Tetra Tech undertakes no duty to update the forward-looking statements.

In addition, since management will be presenting some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted in the investor relations section of Tetra Tech's website.

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. Please go ahead, Mr. Batrack.

Great, thank you very much, and good morning and welcome to our fiscal year 2013 second-quarter earnings release conference call. While as in past, Steve Burdick, our CFO, will present the specifics of our financials for this past quarter, I will start with a brief overview of some of our key financial metrics.

I would like to start off with noting that we performed in aggregate about as we expected and in line with our guidance for the quarter. Our revenue for the second quarter was at $642 million with an associated net revenue of $521 million for the quarter, which is up 9% over the prior year.

The net revenue I'd like to note is largely indicative of our headcount, which should be noted was up over 1000 for the quarter, which resulted in the end of the second quarter at our total staffing at over 14,000 Tetra Tech employees. Our EBITDA was at $54 million for the quarter, up 10% year-over-year.

Operating income was at $38 million, which resulted in a diluted earnings per share of $0.38 which was 9% up over the same quarter prior year.

I am also glad to say that we ended the quarter with our backlog up again over $2 billion levels. That was really a nice way to finish the second quarter for the year.

We saw our continued growth in our international, U.S. commercial, and state and local markets in the US. Our 22% year-over-year international growth was primarily driven by our operations in Western Canada and South America. And we expect these to continue to be big growth drivers for us in the coming quarters.

In the United States, our commercial revenue grew by 16%, supported by growth primarily in the oil and gas midstream services area and water related industrial sectors for our manufacturing clients.

In the United States, U.S. commercial and international work now is at 59% of our net revenues, which means more of our work is in the higher-growth and higher-margin markets than ever before.

As we expected, in our federal, net revenue was down. In fact, it was down 12% year-over-year due to the continued slowdown associated with the fiscal uncertainty and the impacts of sequestration across the United States.

Our U.S. state and local work was 13% of our business this quarter, and it was up year-over-year primarily due to a few larger projects that I have spoken about on previous calls. Although we have seen a localized pickup in some of our municipal orders, and we have seen that market in general strengthening for us.

On the next page on the web cast, performance by mix in our segments, we did see weaker funding from our federal clients and a downturn in mining that impacted our two front-end units. That was primarily the ECS or Engineering Consulting Services group. Where the majority of our mining operations are based, it was both affected by a cyclical downturn in the mining market, which I will speak a bit more to later in this presentation, and delays in authorization of funding for discretionary work we are doing for the U.S. federal work.

Our TSS group was essentially flat with some reductions in federal-related revenue, mostly in the energy efficiency area. About that was offset by strong commercial and industrial revenues in the United States.

RCM, RCM was our best group in performance this past quarter. And it was up significantly, with the newly integrated commercial and oil and gas acquisitions contributing to significant revenue increase. And this has contributed to the continuing emergence of RCM as more of a private sector oriented group, which is actually driving faster revenue growth and higher margins.

The two front-end groups -- Engineering and Consulting Services and Technical Support Services -- now represent about 75% of our business, which is very consistent with our targeted distribution for the three business groups.

Our backlog -- our backlog was actually very good this past quarter and was one of the best performing areas. It was up 5% sequentially and ended the second quarter at $2.027 billion.

This quarter we received over $400 million in commercial related orders. And they came from our mining clients, oil and gas, wind, and just really a very broad base of our industrial customers.

We also booked commercial remediation projects, such as McClellan Park in Northern California. And we announced two major $100 million contract vehicles that we were just recently awarded, one with the US State Department and a second with the U.S. Navy. And what was noteworthy on these is they're both new contracts for us. They're not just rebids.

And we continue to receive task orders across our entire U.S. federal customer base, so we still are seeing some activity there. Overall, the backlog continues to rebalance towards a mix dominated by our commercial and industrial work while we have been maintaining a strong, stable U.S. federal base.

I do expect our federal orders to pick up over the next two quarters as funds for fiscal year 2013 are released from the government because the work still does need to get done this fiscal year. And I believe the slowdown in the first half of the year will actually translate to increase in orders that should contribute to the backlog.

I would now like to turn the presentation over to Steve Burdick, who will provide us a more detailed discussion of the financial results for the second quarter. Steve.

Thank you, Dan. I will begin with the fiscal 2013 second-quarter financial review in a bit more detail. Overall, our second-quarter results met our previous guidance that we have provided.

Comparing the second-quarter results this year to last year, revenue increased by about $18 million or 3% to $642 million, primarily as a result of an increase related to our oil and gas and our commercial markets, both in the US and abroad.

The increase was partially offset by a slowdown in our federal government discretionary projects. Also, net revenue increased more significantly by about 9% to $521 million. The net revenue results were within our guidance range that we had previously given also.

I do want to point out that our net revenue is growing faster than our revenue, because we are involved in more self-performance work, especially in our commercial and international client base, and the self-performance activity has benefited our bottom line. In fact, income from operations increased by about 6% to $38 million on a year-over-year basis.

We did experience a strong growth rate in operating income. And, as previously mentioned, our topline growth is coming from these US and international commercial activities, led by oil and gas work. And these activities do have higher margins, thus our operating income is increasing at a pretty good rate.

Our second quarter income is higher in spite of increased severance costs and decreased utilization in our ECS group, as Dan had mentioned a little bit earlier.

EBITDA also increased by about 10% to $54 million. This improvement resulted in EBITDA margin increasing to about 10.4%. This is better than the prior year for both the quarter and year-to-date.

Our EBITDA increased at a higher rate compared to our operating income due to intangible amortization expense of about $2 million in the current quarter compared to last year.

The SG&A was about $47.5 million for the quarter. This is a decrease from the prior year second quarter of about 9%. The majority of this decrease resulted from our efforts to control costs relative to discretionary G&A spending.

In particular, we took actions to decrease our overhead cost where we saw weakness in the second half of the year. And this includes Eastern Canada, mining, federal and even at corporate.

Tax expense was about $1 million lower at $10.7 million compared to last year. The effective tax rate, therefore, is about 30% for the second quarter, and this compares to about 34.5% for last year.

The primary reason for the decrease was the fact that our foreign entities that we are operating in have lower tax jurisdictions, and thus we are benefiting from a lower tax expense. And we are also benefiting from certain R&D credits that came in the second quarter.

Our EPS of the $0.38 met our previous guidance range and we hit our guidance range as result of solid project performance and our lower SG&A costs.

I would like to point out a few of the more significant balance sheet items. As a result of our revenue growth that we had experienced, we thus have higher accounts receivable balances and higher accounts payable balances based on that growth in our business.

We did experience an increase in our net debt, and the primary driver for this was our recent acquisitions of both AEG and Parkland in the second quarter. Our net debt position was positively impacted by some very good cash flows in the quarter.

So as we -- speaking of the good cash flows, if you are following up on the webcast, you will see that we generated $44.3 million of cash from operations in the quarter. This is about 34% more than the prior year quarter, and these improved results came from an increase in our EBITDA and better working capital.

We expect that our operating cash flow for the year will still be about $150 million to $170 million for fiscal 2013. And this translates to cash generated on a per-share basis of about $2.31 to $2.62, which is quite a bit more than our EPS guidance.

CapEx is higher than the prior year, but in line with our previous guidance. We expect our CapEx to be in the range of about $25 million to $30 million for fiscal 2013. This was a plus-up for our second quarter acquisitions, and our CapEx does continue to represent a ratio of less than 1% of our annual revenue.

Our days sales outstanding of 83 days are slightly higher when compared to last year at this point. Even with the higher DSO, we had a very good operating cash from operations in the quarter.

The higher DSO does relate back to our revenue mix, which is weighted more towards our international and commercial work. The payment terms that we have on these projects are less optimal when we compare it to our federal government projects, but offsetting this is the higher profit rates on those international and commercial projects.

In addition, we do see slower the payments from our customers across a broad range of all of our markets due to economic pressures that are still persisting out there. So even with these headwinds, we are working across all of our operations to focus on decreasing the DSO back to a range of about 75 to 80 days by the end of this fiscal year.

Also, for those following on the webcast, the next graphic shows the impact of our positive operating cash generated and, also, the cash used in our acquisition investment. As you can see on the graphic, our previous net cash position has transitioned to about a net debt position due to the borrowings for our recent acquisitions in the quarter for both AEG and Parkland.

In the second quarter we now have a net debt balance of about $106 million and we do expect to bring this back to a net cash position by the fall of 2013.

With that said, this management team will continue to leverage our balance sheet to invest in growth opportunities, to provide higher profit margins, access new markets and ultimately further enhance our shareholder value.

That concludes the second quarter financial review in a bit more detail, and I will hand it back over to Dan.

Great, thank you, Steve. I would like to present an overview of one of our fastest growing market sectors, and that is the oil and gas industry.

For us, oil and gas equals water environment. The services that we are well known for, have over five decades of experience and think we are the best in class [for this].

The demand for energy and the transformation in this sector in North America demands exactly the services that we here at Tetra Tech provide -- from the earliest studies to design and construction management, their needs for water sourcing, water management, environmental permitting and restoration, water treatment and remediation, all things that Tetra Tech are best in class in.

Through a combination of strategic acquisitions, and you saw one this last quarter with Parkland, an investment in our operations for organic growth, we are expanding from Tetra Tech's strong positions in the study areas to the entire project lifecycle which includes design and construction management.

Acquisitions over the past few years that have included Fransen, Rooney and most recently, Parkland, have provided us with an excellent position in the midstream design and construction management in the oil sands, and also in the mainstream shale basins in the United States that are just beginning to grow.

We're going to continue to expand our service -- expand our services and oil and gas through a combination of organic and inquisitive investment in the pipelines and opportunities for acquisitions to round out both geography and services are stronger than ever before for us.

This sector is growing very rapidly for us and I expect our oil and gas revenues to double from 2012. And by the end of 2013, our annual revenues for this year should exceed $300 million. And this is at a scale that will be significant, that will be a significant contributor to Tetra Tech's overall growth.

And we're not stopping there. I expect our oil and gas revenues will triple again in the next 3 to 5 years and our projection here at Tetra Tech is that we will achieve oil and gas related annual revenues of more than $1 billion in this timeframe.

Although our oil and gas and commercial industrial sectors are growing, very strongly for us, mining in the regional markets in Eastern Canada are experiencing some significant challenges that have resulted in impacts on our operations and their financial performance, primarily in the ECS business segment.

In Eastern Canada, recent investigations are affecting the entire construction and engineering community. And as a result, we have seen a significant slowdown in procurements, awards and project initiations across that entire geographic region. This has also been compounded by a weakening economy in Eastern Canada.

Mining, especially in North America and Australia, is also showing a significantly reduced slowing as a result of less capital investment, lower commodity prices and just generally lower demand. We are moving quickly to address these challenges, and I would like to summarize the financial impacts of these headwinds on our operations.

If you're following on the webcast, on the next page this table summarizes the estimated revenue reductions and associated one-time cost of rightsizing our operations in the second half of 2013. More specifically, we anticipate a reduction of approximately $100 million in revenue, split relatively evenly between mining and Eastern Canadian revenues. So, about $50 million each with an approximate $10 million of associated margin or operating impact reduction, so about 10% reduction.

One-time cost from rightsizing -- that includes severance, office space reductions, and all of the associated costs with adjustments in our operations -- are actually more significant. These costs are anticipated to have an impact of about $10 million to $20 million on our operating income in the second half of the year.

Let me actually give you a few details of where that is broken down into. So, over the next two quarters, Q2 and Q3, we anticipate somewhere between $3 million to $6 million of severance; a similar number, $3 million to $6 million, of expense and office closures; with the remainder of the amount associated with lower utilization and back-office reductions.

Now we did begin to initiate these actions at the end of Q2. They did have a $1 million to $2 million impact at the very end of Q2, or the end of March. But most of these costs I expect to fall in the third quarter.

As we expect, these actions will he will be taken very quickly and they should put us in a very good position as we finish this year to go forward.

I would now like to turn to our customer outlook, our next page in our webcast. Over the next six months we expect our U.S. commercial and international revenues to increase to 65% of our business, from 59% where they are today. International will be up -- will be overall flat to slightly up, with strength in Western Canada and South America being offset by weakness in Eastern Canada at least for the near term.

U.S. commercial, we expect to grow and continue to grow at double-digit rates. While U.S. federal revenues and work we have, I expect to continue to decline slightly as the market adjusts to sequestration and declining federal budgets.

At the state and local level, if we exclude the impact of a few large state transportation projects, our state and local business will be flat to slightly up at about 10% of our business. And it has actually been quite solid and growing slowly, but very steadily.

Of the three business groups ECS, Engineering Consulting Services group, will be the most impacted by the mining and Eastern Canadian issues that I have discussed. As a result, I expect the ECS margins in the second half, Q3 and Q4, to be between 7% to 10%, which is a bit below their historical averages, and then they should return to their historical levels that you have seen before.

Both TSS, Technical Support Services, and RCM groups I expect will maintain their margins and in fact be at the high-end of the ranges that we have shown and distributed in the past.

Based on our performance in this past quarter and evaluation of the current business trends and prospects, I have set our fiscal year 2013 Q3 and updated our full-year guidance as follows. For the third quarter, our guidance and revenue for net revenue is $525 million to $575 million, with an associated diluted earnings per share of $0.32 to $0.42.

Now I do recognize that this range is unusually wide for Tetra Tech. And the reason for that being wider in the third quarter is we expect to, on a prospective basis, make the reductions, the office closures, the back-office reductions to mostly take place in the third quarter. In fact, our goal would be to have it all complete, and that is why we have left ourselves quite a wide range here.

For the year, fiscal year 2013, our net revenue guidance range is from $2.15 billion to $2.25 billion with an associated diluted earnings per share of $1.60 to $1.75. Now you do see that for the entire year we expect approximately 36 million (sic) -- $0.36, I am sorry, $0.36 -- impact from intangible amortization, $0.11 stock expense, and overall effective tax rate of 34% for the second half of the year.

And one thing I do want to note, because of the intangible amortization, there is a very large disconnect between our GAAP EPS and cash per share. And I do expect, as you have seen in Steve's presentation, a cash per share of somewhere between $2.31 and $2.62 per share.

In conclusion, our strategy is to focus on international expansion and growth by providing water and environmental services to our industrial and commercial clients. We are expanding our services to our North American oil and gas customers, and I expect those revenues to exceed $300 million here for the fiscal year 2013, which should drive both our top and bottom line of growth, both for the second half of the year and onto the future.

And with that I would like to open the call up for questions, operator.

(Operator Instructions). Noelle Dilts, Stifel.

This is actually Stephen on for Noelle. My first question is surrounding a part -- a little bit more detail around the Parkland business. If you can give us some update on how that business is performing, and if you guys are making any traction towards bidding on some of those larger $100 million-plus EPC type pipeline jobs that you guys had said that maybe that acquisition would open up the opportunity for?

Parkland has been with us for a -- in the second quarter for two months and now one month into the third quarter, so let's call it 90 days they have been with us. And they have been one of the best contributors, both financially and from a collaboration standpoint, that we have ever seen.

Now we do see that their primary size is generally small to mid diameter, so 12 to 24, could maybe go to 36. But 12- to 24-inch is their primary focus on the midstream for the piping systems. But that certainly includes $100 million EPC contracts.

We have seen those opportunities. We have had some success, and as that takes place we will actually press release that, so I won't comment on specific awards. But they have met and in fact exceeded our expectations so far.

They are leveraging and working with the rest of the Company already, and in their first 60 days of the Company, have had joint presentations to some of the largest midstream clients across Canada, and really which represent some of the largest in the world on turnkey projects that wouldn't have happened either without Tetra Tech. And Tetra Tech could have never considered doing this without Parkland.

So, really, it has gone very, very well. And I'm hoping to present both press releases on new wins and financial results that support that here in the coming quarters.

Great, thanks. And, Dan, just one more question here on targeted ECS margins. You mentioned in the commentary you expect that to return to the targeted [9 to 12] range. Is that something that we can expect for fiscal 2014? Is that a goal? Or with some of the -- material CapEx mining cuts that we have seen, is that going to be a stretch in 2014?

Well, I am not intending on this call to actually provide guidance for 2014, but I will talk in general with respect to a period outside of the next two quarters. I do expect the margin is going to go back to those levels, and, in fact, I expect it to be at the upper end of those levels.

That the full amount of work that they do at the front end is the highest margin, is the highest barrier to entry, and, actually, in some instances has the highest value in the Company, because it provides leverage to opportunities for design and construction work now. I do expect it will go back up.

Whether or not mining slowdown continues and as we right-size Eastern Canada for the temporary slowdowns, total revenue growth in the ECS could, and I do expect, will come down. But as soon as we complete these rightsizing activities here this quarter, the third quarter, I expect the margins to come right back up. You'll see the first move in Q4 and then should expect it to be back in to historical levels thereafter. And that does equate to 2014, yes.

Great, thank you.

Alex Rygiel, FBR.

Just one question, I think. You have a shadow backlog of federal awards that have a contract ceiling, but you haven't yet received task orders for. Can you attempt to quantify that and/or comment on the size of that today versus maybe a year or two ago?

Well, I understand what you are referring to as a shadow backlog. We don't use that here. We use it as -- we have got a huge amount of contract capacity with the federal government. In fact, it rivals the highest that we have ever had in the past with contract capacity.

What we have seen, and I will give one short anecdote and then you expand it across the federal work we have, EPA has been very slow to issue task orders. And, in fact, I have personal commitment from very senior individuals within Tetra Tech that the EPA task orders would come out each Friday for about the past four weeks, saying they are converting it from contract capacity to individual task orders. And it is actually quite sizable numbers.

And you can imagine, Friday at two o'clock Pacific Time, five o'clock East Coast time I am calling to account for these orders that have been committed to us. And each time it has been one more week, one more week.

So, our folks might call that shadow backlog. It is something that is impending. They are task orders and proposals that are in. All they have to do is send us an e-mail or a fax and turn it to task orders, which will then go to backlog.

And that is actually sizable, and in fact the largest I have heard of. I don't want to say seen, because we don't track those. But the reality is, if that doesn't happen, they reductions that we are doing in mining will move to the federal government.

And there are many different projects that have all sorts of requirements. So if you want to call it shadow or impending or imminent conversion from contract value to backlog, I expect that to be quite large right now, although I don't have a number on that.

Can you give us a sense for contract capacity you referenced? It is the highest ever. How much higher is it today versus maybe a year ago?

I would say it is up by probably $400 million to $500 million, and it is probably between $10 billion and $11 billion just on the federal side.

Very helpful. Perfect, thank you.

David Rose.

Couple questions on -- one is in terms of your -- said something in the range -- you talked a lot about what it depends on to execute your rightsizing actions. Can you walk us through a little bit of the risk scenario on the top line in terms of net revenues? And then maybe provide a little bit of color in what you're seeing in Latin America, specifically with the new acquisitions or the recent acquisitions.

Yes, the threat, so to speak, of achieving our net revenue guidance for the second half anticipates about a 15% reduction in our mining revenues in the second half. If for some reason that became steeper, there would be some risk there, although I think we have been reasonably conservative in that estimate, and intend to provide both our revenue and are income guidance to encompass the relatively worst-case scenario.

The same is true with Eastern Canada. So I think the likelihood of it going below is relatively small.

And on the federal side?

Federal, federal we have already forecasted. We have gone through this internally a fair amount. We have already anticipated roughly a 15% to 17% reduction in our federal revenues. That represents half of the discretionary work that we have. We have gone through this presentation and calculation in the past.

It has actually been right about what we have anticipated; in fact, amazingly so. I actually think the second half should be incrementally better than what we saw in the first two quarters. So we don't see softness beyond what we have reported these past two quarters on the federal side.

Okay, and then on Latin America, there are two parts to Latin America. Metalica, you have got all the mining business there as well. That is how that business really started, right?

So your commentary was that Latin America was relatively strong. I guess you are referring to reveal Brazil versus Chile. Maybe you can provide a little bit of color on what you're seeing in both of those markets.

Yes, I can. Let's start with Chile, which is Metalica that joined us a couple of years ago. They are primarily copper, Codelco, a little bit of other work. I would call that a stable market. Work looks good. It is stable.

We have seen them actually hit and exceed the forecast as we have entered this year. So they are slightly up beyond what we anticipated coming in. And we have pretty good visibility, but I wouldn't call it a high-growth area.

But we have seen Chile do well for us, and again, primarily driven by mining, and within mining, primarily driven by copper. And these have been long-term projects so I don't expect any short-term -- much of a short-term variability there.

Brazil, Brazil has actually been much stronger for us and we have two activities in Brazil currently. We have a mining, activity which is the dominant practice that we have, and it is primarily associated with an iron ore project. It is really one of the world's largest iron mines that is going to come on, is known as the [Mina Rios], which gives -- it is not just ourselves. There is many, many -- in fact, all of the top mining engineers, consultants and others are working on this.

It is expected to go online in the next year or two. And so we have -- we do have a great amount of visibility with this project. And in fact, the demands in order to accelerate the completion of the project is driving growth there, and I expect that for the next couple of years.

It is not a month or quarterly backlog that we have here. In fact, some of the biggest orders that we have had in the Company have come out of that.

We do have a very small operation doing coastal engineering and marine work to support the oil and gas industry. It is really quite small. It has only been with us here at just over a quarter, and it is doing well.

It is growing -- I won't even use the percentage, because the math of small numbers make it really not meaningful. But if you're doing $2 million, $3 million and you get another $1 million growth it is 30%, 40%. But it is $1 million.

So it is hitting all of our expectations, but it is still quite small as far as scale goes. And so we -- I would really like to hold material contribution details until we get some more scale on that. But it is doing quite well.

Okay, thank you, and I assume we will see more acquisitions in that market as well as North America on oil and gas?

I think you will, yes.

Okay, great, thank you.

Will Gabrielski, Lazard.

This is Jonathan Evans for Will. So I was wondering, you laid out the goal to triple your oil and gas revenue over the next 3 to 5 years. Can you help strip that out maybe into organic versus acquired growth?

I think organic will be about 20%. So I think the organic we are growing at about 20%. The balance will be acquisitive.

Okay. And then maybe just expanding on that a little bit, can you give us a sense of where you expect to grow, whether that is in midstream or actually at the well site itself?

I expect -- let me go up even before that. Tetra Tech is known as leading with science. And really at the very earliest stages of the project initiation, and that is with reservoir analysis and the other work that starts with even regulatory reporting of the overall reserves. And so expect us to start there.

So expect us to continue to lead with science, which gives us really the best unique position. There is really very little or no competition. You don't have multiple people guessing what your reserves are. You have one doing scientific calculation and support for legal opinions for that.

So expect that we will expand there. We are doing some of that work now. And that we will grow both organically and acquisitively there.

Once you move down, I expect more midstream. And midstream being what you see in Parkland with respect to both design build, and Rooney, which is in the Bakken.

So if you take a look at Alberta, I expect to do more work to support both the oil sands movement of oil, whether it is not to the American border and across, or whether or not it is to the Pacific Ocean for sending. We have a very good position with Parkland located in -- not only in Calgary, but also to the west in British Columbia. We look to augment that on the midstream and we look to add similar resources in the United States.

And we have a design capability in the Bakken, so it is the Dakotas, and we would like to add this in the Permian, which is in West Texas. We have offices in Midland. We are doing upfront environmental work, siting work, permitting work and we would actually like to add the capability to do the design and construction management.

So look for growth in West Texas, additional expansion in the Bakken where we already have a good presence, and then adding to the capability that we have in both Alberta and British Columbia, both for natural gas movement to the LNG terminals, which are just in their very infancy, and for additional movement of oil sands oil.

Okay, that is very helpful. Thank you.

Tahira Afzal, KeyBanc.

My first question is in regards to the pipeline side, to these larger opportunities around $100 million that you are seeing on the Bakken side. We seem to be getting the same feedback about the market that it's very strong. But could you talk about the contractual terms you are seeing in general for these larger ones? Are they fixed-price?

And then asking a question in regards to your expansion plans, could you talk a bit about what is making you look at Bakken little more closely? That is where it seems that there is lot of surplus right now, and the questions around the economics are rail versus pipeline. So what are you seeing there that makes you more comfortable on investing a little more there?

A couple questions here. First is the pipeline work and how are we seeing the contracting environment for that.

Most of the work we are doing is either direct negotiation or limited competition for clients that we have had in place for a number of years. They typically tend to be the oil majors. And we have pre-existing terms and conditions in place, and these generally are actually task orders within a very large contract.

The types of payment terms are typically time and materials in some instances, or a fixed unit rate, not a single fixed-price and for a very large project. So the risk is somewhat mitigated, or lower than you might see in an open competitive fixed-price environment.

But they're generally associated with the very largest diameter -- hundreds, multi-hundreds or billion-plus single project, fixed-price projects. Those are large generally large diameter projects, and that is not our focus nor our experience, and really not what we are looking to expand. So I do think that there is sometimes confusion as to where we are at -- going versus some of these much, much larger projects.

With respect to the Bakken, we are already there. We are doing pipeline work. And, yes, the pipeline -- the reason I do understand that rail has appropriate economics. I understand actually with a reduction in coal inventory on the rail line, it adds up a lot of capacity to move natural gas or LNG.

We think that is in addition to, not in place of, the piping work we are doing. There is -- and part of it is it can be moved quicker. But it is not, ultimately, we believe, a replacement. In fact, may be a stopgap between what could happen now.

If I got to move that now, I will put it on a truck or a rail. But if I need it on a continuous basis, I need it on a pipeline. And so we think that it is not a replacement, but it is a stopgap.

Bakken, and by the way, with that said, Bakken is very good for us on a design phase but I would say that we will look for additional opportunities. We do think that it is perhaps overstaffed and, oversaturated, and that is why I didn't focus on, actually, the Permian or West Texas is actually a little bit -- appears to be more attractive from us from where our resources reside within the Company.

Got it, okay; thanks. That is very helpful. The second question I have is in regards to your free cash flow outlook. You are hoping for DSOs to improve. Is that factored into the outlook you provided?

Yes, the outlook that we have for the $150 million to $170 million of cash from operations does contemplate us being able to bring down our DSO down below the 83 days and get back into the 75 to 80 day range.

Got it. Thank you very much.

Andrew Wittmann, Robert W. Baird.

Dan, I just wanted to get a status update on the longer-term goal of the 13% EBITDA margin with the setbacks that you have had this spring. How should investors think about the attainment of that goal?

One, how do you get there? And is there enough organic growth in your end markets to support maybe some margin expansion, as well as maybe the timing that you think is realistic given the environment we are seeing today? Thanks.

Andy, I think if -- that is a great question -- that we have seen a reduction, in fact, most notably, the ECS margin is the lowest we have seen in the past -- five, six, seven, eight years. We haven't seen a margin this low.

I believe it is because the one-time adjustments we have made in some of the cyclical businesses in mining and the initial actions we have taken in Eastern Canada. So I think if you take a look and chart the Company's growth and it is still -- we will see how this models out. But we have had many years of sequential growth of the EBITDA margin, and certainly this year it is still possible, depending on which points you pick in our margin expansion.

I do think this is a one- to two-quarter adjustment in our back-office costs to get our staffing right for the adjustments in the revenue streams in these two areas. But I think that you should see, as we get into the fourth quarter and certainly thereafter, the ECS to be right back.

I think that organic growth, we are seeing most of it in the commercial sectors which carries the margins and, also, the acquisitions. So I think you really need to take a look at -- or we are looking at both the organic growth and the commercial side.

And I think -- I have to think for a moment -- the past many acquisitions, certainly Parkland, 100% commercial oil and gas; AEG essentially all commercial work. You go before that -- Rooney, all commercial work. So, really, we have been adding both acquisitively acquisitively on the sides that carry higher margins, just intrinsically by the nature of their work and the growth internally.

So I think -- when we going to get there? I have said in the past that as we grow towards 70%, and that would be 40% international, which turns out to be mostly commercial, and 30% U.S. commercial, so as we drive the combined percentage of those two toward 70% we should achieve 13% EBITDA margin.

I actually -- if you go back to my previous presentations as to the time frame, I -- we are not in a position to actually change that. So I think we had said 2 to 3 years in the past. So I think we are about two years out from achieving that. Unless we accelerate both international and commercial, it could be sooner.

And you see we are up to 59%, almost 60%. It is really quite a big move, mid-30%'s now on international. So we're getting there. And I think as we add more oil and gas another commercial and industrial work in the US, it will move the commercial work up to our goal too.

So, timing, I think about -- probably two-ish years, something like this. What is it associated with? Movement of international to 40% and commercial to 30%. And does it have to be organic? Yes, it has to include organic, but acquisitive will contribute to that meaningfully.

Thanks, that is very helpful. And I am just curious in Eastern Canada, Dan, when you look at what is happening there today, clearly the contracting pace has set down as investigations are ongoing. But you guys did have an investment with BPR there, and, clearly, it is going to undergo some changes here.

But who comes out the winner when it is all said and done? And what does that market look like long-term now that it has had a pretty different way of doing business in the past that needs to change going forward?

Well, I think it's -- everybody has gotten beat up. Nobody has been un-impacted by the slowdown in the contracting. I do think that there is going to be a bit of a buildup like a reservoir work behind a dam a little bit.

If they don't contact, don't contract, don't contract -- you still have to upgrade your water treatment plants. You still have to upgrade your transportation routes. You still have to upgrade your general infrastructure.

This work isn't just going away. And the largest population centers are in Eastern Canada from Toronto, Ontario, East and in Quebec. It's the second-biggest. So the work, I believe, still has to be done.

So I do think you will see an unleashing of this. I do think it is still a couple of quarters out before they get this all sorted out. But then I think there will be a bit of a catch up, a little bit like you're going to see on the federal this year toward the end of the year.

And then I think you'll get back to a normal level, which will probably be slightly less than we saw a year ago or two years ago, because things have slowed down a little bit. But I think you're going to see maybe several quarters, if not a year or more, of just general catch-up because of what they haven't embarked upon.

Coming out of this, is the BPR Tetra Tech franchise a net winner or a net loser, just given the broad base of people that we're -- of companies that were implicated here. Do you have a sense about who is going to come out competitively better positioned when this all settles?

It is our goal, of course, for us to come out better. It is our objective, but I will say it is still quite early. These investigations and all of the new rules that are coming out for contracting are still very early. We are watching them quite closely like all the others.

But I will know one thing; some say that because of difficulties with the existing engineers and contractors in Quebec, others will swoop in. Well, unless you speak French and not France French, Canadian French, it is very difficult to do work there. So the natural barriers that exist in the province are not going away.

The work products need to be delivered in French. The work needs to be delivered in French. The community and all of the implementation have to be in that.

And to have between 1500 and 2000 French engineers and technical staff in the province, I think we are very well positioned with resources and contracts and capabilities. I do think there is going to be some sorting out. But it is not just a vacuum that can be filled by anyone else, even including Canada, coming from the west. There are very large natural barriers.

So I feel reasonable about how this is all going to sort out.

Great, and then just one final book question -- bookkeeping question maybe for Steve. When you look at the backlog, how much of the backlog was acquired during the quarter, Steve, just to get a better sense about what the organic trends look like?

It was about half of the increase was through the acquisitions.

About half of the sequential increase?

Yes.

Okay, great. Thank you very much for your time gentlemen.

Thank you very much, Andy. With that I would like to thank you very much for your questions and interest in Tetra Tech. And I do look forward to speaking with you again next quarter, and giving you an update on our progress as we move toward the end of the year.

And with that, goodbye. Have a great day and talk to you next quarter. Bye.

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