Tetra Tech Inc (TTEK) 2014 Q3 法說會逐字稿

Good morning and thank you for joining the Tetra Tech 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 the results, and we'll then open up the call for questions.

During the course of the conference call Tetra Tech management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include statements concerning future events and Tetra Tech's future financial performance. These statements are only predictions and may differ materially from actual future events or results.

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

In addition, since management will be presenting some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted in the Investor Relation 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, Jennifer. Good morning and welcome to our fiscal year 2014 third quarter earnings conference call. While Steve Burdick, our Chief Financial Officer, will present the specifics of our financials for this past quarter, I'd like to start this call this morning with a brief overview of some of our key financial metrics.

Overall I was fairly disappointed with the Company's collective performance in the third quarter which was particularly impacted by the RCM segment's weak performance this quarter and actually even for this fiscal year to date.

I'm not going to be discussing many of our year-on-year comparisons for the quarter since they're not directly relevant due to the charges that we took in the third quarter of 2013. But for this third quarter, Tetra Tech's revenue was $630 million, which is up sequentially about 7% and inline with the Company's typical seasonal revenue patterns. Our net revenue was $459 million for the quarter which generated an EBITDA of $52 million which is associated with a diluted earnings per share of $0.41 which included a $0.10 gain from an earn-out adjustment that I'll be discussing in a bit more detail later in this conference call.

Our backlog was one of the most important metrics that we have here. It increased by 6% sequentially and is 2% up over last year which finished at just a bit over $1.9 billion. Our cash generation continued to be very strong which was at $58 million for the quarter, and we feel very good about that.

We did just announce and I'm glad to report to you all a second quarterly dividend of $0.07, and based on our strong cash generation and our balance sheet, our Board has committed to spend in the fourth quarter, this quarter we're in now, the remaining $53 million of the previously authorized stock buyback program that we have. And Steve Burdick, our Chief Financial Officer, will discuss this in a bit more detail later on the call.

Now I'd like to review our performance by customer and segment. Our international and US commercial work collectively was about 60% of our business this past quarter in Q3. Our commercial work in the United States was up 14% primarily driven by the oil and gas sector, especially from our midstream consulting and engineering work which is contributing to the Company's highest margins, so that's our most profitable portion of the Company.

Our commercial customers also saw a broad base year-on-year growth with increasing revenues from our Fortune 500 customers which include companies like Mosaic in the mining industry and in manufacturing with Lockheed and General Motors, Republic Waste, and Enbridge. So it's a very, very broad cross-section of claims that grew very strong for us.

Our international revenue which represented about 29% of our business was down slightly, but this was primarily associated with foreign exchange impact and a continued slowdown in mining, which we are still seeing to be the softest area in the Company. However, we did see sequential revenue increases across Canada for energy and our infrastructure services for work in some of the cities and provinces across the country.

At the end of the quarter we saw this increase accelerated as the summer field season in Canada activities ramped up, especially on the far Northern operations, so that picked up just as we expected so it's looking good for us.

The United States Federal Government for us is now stabilizing. We did see a slight increase in revenue in topline revenue with our federal government, and our underlying net revenue was essentially flat year-over-year, so that was actually an improvement over what we've seen over the past many quarters.

Our revenues increased year-over-year for the federal government for some of our key customers with technical services work that we're doing for the Navy, which was up 18% over the prior year, and the Federal Aviation Administration work we're doing was up just about 14% from the prior year.

It wasn't just these two. It wasn't just the Navy and the FAA, but many of our other long-term federal customers did release more new orders which is more typical of their historical purchasing patterns which we see normally more work and more leases late in the summer as it approaches the end of the fiscal year which resulted in an increase in both orders and revenues for the Army Corp of Engineers, USAID, and the Department of Energy for the Company.

And finally, if you exclude the wind down of our three large transportation construction projects, our state and local revenues are up broadly across the country, across the United States with increases ranging between 5% and 10% depending on the geography across the country. And these services include consulting and engineering primarily for water-related municipal projects.

Our backlog was up sequentially 6% rising to just over $1.9 billion which strengthened from federal orders and continued strong commercial and oil and gas related work. As always, we're very conservative in our backlog recognition and we include only orders that are contracted, funding, and authorized to perform by our clients.

This quarter we've booked almost $0.5 billion in commercial orders which is a new record for us in that type of work. At the same time we were rewarded significant orders with the federal government, particularly from USAID, a division of the US State Department, and the FAA, and we did receive two major single award federal contracts which actually goes into our contract capacity but hasn't yet gone into our backlog. And with each type of work we do expect this to convert to backlog over the course of the contract execution.

Now before I ask Steve to present the details of this quarter's financial performance, I'd like to address our earnings for the quarter. We came into the quarter with a midpoint of our guidance that was $0.42. I'm really glad to report that ECS and the TSS business segments, our two front-end groups, generated approximately $41 million of operating income or EBIT. That corresponds roughly to $0.41 of earnings per share. That was right in line with what we expected and in fact even slightly above our own forecast coming into the quarter.

But I would say also coming into the quarter we had anticipated that our RCM segment would contribute about $0.10 or about half of what either ECS or TSS would have produced on their own. But the actuality was that for the third quarter RCM reported a $0.02 loss which represented about a $0.12 shortfall of what we had anticipated coming into the quarter.

Our expenses associated with amortization and corporate costs came in just as expected, about $9 million or about $0.08 per share. So if you add all that up, our front-end performance, RCM, our back-end, and then the corporate costs, it resulted in $0.31 earnings per share from our ongoing operations.

Now we did recognize a $0.10 gain associated with the pickup on an earn-out which moved our earnings up to $0.41 on a GAAP basis for the quarter, which technically put us into the guidance range for the quarter. But I do want to point out that we were operationally short from what we had expected. And I also want to point out that the shortfall was from the RCM business segments which caused our operational performance to fall far short of our expectations for the quarter.

I'd now like to turn the presentation over to Steve Burdick who will provide a more detailed discussion of the financial results for the third quarter. Steve?

Thank you, Dan. I will go through the 2014 third quarter as a comparison to the 2013. And overall, and as Dan also mentioned, our third quarter operating results fell short of management's expectation as well as the guidance ranges that we provided for both net revenue and EPS as I will explain.

Now first on the positive side, in comparing the third quarter results this year to last year, our revenue did increase by about $15 million or 2% to $630 million. This increase was due both to -- for the following. Our North American markets, which focus on oil and gas activities, performed very well. And the prior-year revenue was lower relative to some one-time adjustments in last year. Now this increase was partially offset by a slowdown in operations focused on global mining. And finally the year-over-year comparisons were also negatively impacted by our foreign exchange rates due to the strengthening US dollar this year compared to last year.

Now unlike revenue, our net revenue decreased to about $459 million or about 3% year-over-year. Net revenue results were impacted by an increase in our subcontractor costs most notably in our RCM segment. The net revenue results were below our expectations and lower compared to the guidance ranges provide due to the lower revenue in Canada mostly on the mining side and the RCM segment in the United States.

Our operating income was up about $139 million compared to last year. Now I just want to remind everybody that we recorded approximately $100 million in charges in the third quarter fiscal 2013, and as such the comparisons aren't meaningful. But allow me to I guess dissect our current year income results for everybody.

Operating income represents a margin of about 8.5% and close to 10% without the intangible amortization expense. Now the operating income was primarily driven by a few things. Project execution and favorable results in our ECS and test groups, a reduction in overhead costs due in part to the right-sizing actions we took last year, and non-operating gains on revaluing the acquisition-related earn-out liabilities of about $8.9 million. However, our operating income was reduced by the performance in our RCM group.

We achieved an EBITDA margin of about 11.3% this quarter. Our EBITDA was driven by the same factors as operating income but the higher percentage resulted from intangible amortization and depreciation which was about $12.7 million in the current quarter. Now EBITDA without the purchase accounting gain was about 9.3%.

Moving on to our SG&A. That was about $47.2 million for the quarter, and this was a decrease from the prior-year quarter of about 17%. This net decrease was due to the lower intangible amortization which was down about $3.4 million from last year as well as some of the G&A related one-time restructuring and impairment costs that we took last year. In addition, we realized a reduction in our overhead expenses as a result of those actions that we took in fiscal 2013 in response to our decreased revenues in some of our weaker markets.

The tax provision resulted in a net tax expense of about $10 million this quarter. The effective tax rate comes up to about 27%, and this is a lower rate due to the non-taxable nature of some of our earn-out changes. For the entirety of 2014, we anticipate a tax rate of about 30%, and overall the expected rate was about 33.5% without any of the earn-out adjustments.

Overall our earnings per share was $0.41 which was within guidance, and as Dan mentioned and discussed earlier, without the aforementioned net gains from the acquisition-related earn-out contingencies, we would have recognized an EPS of about $0.31.

I'd like to point out a few more of the significant balance sheet items. As a result of our higher revenue we experienced an increase in our accounts receivable balances but also we increased -- we experienced an increase in our DSO in the RCM segment. The accounts payable balance increased due to higher subcontracting activities when comparing the current year to the prior year. These activities took place mostly in our federal and state government projects in the RCM segment.

We did experience a decrease in our net debt compared to the prior year. The prior -- the primary driver for this higher net debt last year was the borrowings used for our fiscal 2013 acquisitions. Now, we have taken that net debt down on a year-to-date basis as we've generated about $114 million in cash from operations. Now offsetting this we implemented a stock repurchase program in fiscal 2013 which so far has utilized about $47 million in cash to date. And our net debt position was also impacted by our CapEx of about $15 million over the last three quarters.

Now as noted in our balance sheet, we had a solid cash flow from operations this quarter. The third quarter was more than the prior year and on the year-to-date basis we were on plan and similar to last year at this time. We anticipate fiscal 2014 cash from operations to be in the range of $150 million to $170 million in cash and the midpoint of our 2014 cash EPS is about $2.45.

CapEx is -- it is less than the prior year and slightly lower than our previous guidance for fiscal 2014. We've remained disciplined in our spending and we have actually decreased the top-end of our CapEx estimate so that we are now in the range of about $20 million to $25 million for fiscal 2014. And this amount continues to represent a ratio of about 1% of our annual revenue.

Day sales outstanding of 86 days are higher when compared with last year at this point. Now the actual DSO, although lower by about 2.5 days on a sequential basis from Q2, is still not in line with our expectations and we've already put corrective actions in place. Our DSO is higher due to the performance in our RCM segment.

But on the other hand I want to point out that the DSO in our two front-end segments is closer to 70 days. Our efforts in fiscal 2014 are focused on reducing DSO to below 80 days with an ultimate goal to be below 75 days.

Now for those following on the webcast, the next graphic shows you how our net debt has changed over the last 5 years. As you can see on this graphic, our previous net cash position has transitioned to a net debt position due to the borrowings for the acquisitions in the second quarter fiscal 2013. But it also shows what I mentioned earlier, that we reduced our net debt by a substantial amount. Our operating cash flow on a year-to-date basis for fiscal 2014 allowed us to decrease our net debt by almost $80 million since the end of 2013. In fact, our experience is that we've been generating cash at a faster and more consistent pace than our net income.

As a result of our performance we have continued to focus on an enhanced capital allocation program for which I would like to give you all an update.

Now at the end of our Q3 our current leverage is close to zero while our target range leverage is about 1 to 2 times EBITDA. And although our target is to return about 33% of our free cash flows through a mix of dividends and buybacks, we have enhanced our returns in 2014 to take advantage of our leverage and provide a greater return to shareholders.

So today I'd like to announce our further commitment to provide value to our shareholders as our Board of Directors has approved the declaration of Tetra Tech's quarterly dividend. This quarterly dividend is $0.07 per share, and this amount if annualized represents about a 15% -- a return of about 15% of our estimated annual cash -- free cash flow, and the annualized amount further equates to about a 1% yield at our current stock price. The dividend will be paid on September 5th of this year to shareholders of record as of August 15th.

In addition Tetra Tech's management and its Board have committed to an open market stock buyback program to ensure that the entire $100 million that's been authorized will be fully utilized prior to the end of fiscal 2014. And so with this buyback the return in 2014 is closer to about 67% of free cash flow.

An important aspect to understand is that these cash dividends and stock buybacks will not impact our growth strategy from either an organic or acquisitive standpoint. In fact, we expect to be active in the M&A market and move our leverage closer towards our target.

Now while we've committed the entire authorized share buyback to be completed in 2014, we will update our shareholders on our fiscal 2015 capital allocation program and plan on our next quarterly conference call.

So with that I will now hand it back over to Dan to discuss our outlook and the business strategy in a bit more detail.

Great. Thanks, Steve. I'd now like to review in a little more detail our business groups and their focus areas. Our two front-end business groups, ECS and TSS, are where our consulting and engineering staff reside, and that's primarily what differentiates us in the market place. This is also where we have the technically challenging projects that provide us highly-reliable margins and low-risk contract terms such as cost-plus contracts or time-and-materials contracts.

By being well differentiated in the market place, we have many projects that are awarded with very limited competition or direct toward or even sole source from our clients who we've been working with for many years. So far after nine months through the year these two front-end groups have performed very well and delivered virtually 100% of the operating income for the Company this year.

The RCM business group has been primarily focused on larger construction projects with a heavy emphasis on projects that have been generated to the front end. They tend to have lower margins, they've generally been much more -- been in a much more competitive bidding environment, and this also includes projects with much higher risk profiles which have resulted in less potential upside and more potential downside risk which in reality is what we've seen again this year from that group.

However, the RCM group does include some very strong performers that have excellent projects and even divisions and primary services that we perform such as the environmental remediation work that we do for the Department of Defense. That resides in the RCM group. And our commercial full-service projects that we do for the Solid Waste Industry in midstream oil and gas, these types of markets and divisions that we have in projects have actually been very good performers for us.

Unfortunately the performance of these projects and divisions within RCM have been more than offset by the charges that have incurred from the high-risk projects in RCM. And it's due to this performance of these projects and these specific areas within the RCM segment that I've initiated a strategic and operational evaluation of this business. It is our intent to complete this evaluation prior to the end of the fourth quarter, and that's the quarter we're in right now.

We'll be reviewing all aspects of this segment including acceleration of exiting non-core activities, which we've already initiated, and if you're following along on the webcast you can see that we have about $185 million remaining of non-core backlog that we need to complete to fully exit this non-core activity. I expect prior to the end of the fourth quarter we'll evaluate alternatives, select a course of action, develop a schedule, and define the financial impacts associated with these actions that we'll be initiating.

Our evaluation will result in specific actions with an implementation plan to eliminate activities that are high risk or low margin or non-core to our business. They don't have to be all three, they just have to be any one of those. My objective is to provide the maximum ability for the Company to deliver high margins, reliable performance, and drive the Company's growth into new markets and geographies as we go forward.

Almost 50 years ago Tetra Tech was founded on the delivery of science-based services in the consulting and engineering field with a commitment to fiscal discipline. By delivering these services, we've evolved into today's Company with a global network of about 14,000 scientists and engineers, we have projects in over 100 countries, and an impressive track record of cash generation and financial performance. It's these services that have propelled Tetra Tech to a number one ranking in the United States by the Engineering News-Record in water, which is a position we've now held for 11 years; environmental management, number one, and this is by size; and number one in solid waste across the United States.

Our technical resources and experience have positioned us very well to address emerging opportunities in global water, environment, and energy management, which are just beginning to grow both in the size and expenditures in these. And it's these challenges of today that are going to provide our engineers and scientists with growth opportunities that'll actually convert to providing financial returns to our shareholders both today and in the future.

I'd now like to present our guidance for the fourth quarter and update our guidance for all of fiscal year 2014. Our updated guidance is as follows. For the fourth quarter our net revenue guidance range is from $450 million to $500 million of net revenue with an associated diluted earnings per share of $0.30 to $0.40. And as I had mentioned earlier in this call, it includes only a very de minimis anticipated contribution from RCM. We expect RCM basically to be breakeven operationally in the fourth quarter. For the fourth quarter we anticipate a cash earnings per share in the range of $0.55 to $0.85 per share.

An update of our annual net revenue, or all of fiscal year 2014, is a range of $1.85 billion to $1.9 billion for the entire year with an associated diluted earnings per share of $1.61 to $1.71 per share and a cash EPS of $2.30 to $2.60.

Now some of the assumptions, if you're following along on the webcast, this guidance for the year does exclude any impacts that we may recognize in the fourth quarter that would be an outcome of the RCM operational review. It does anticipate intangible amortization of $27 million or $0.29 per share. We think we've got that dialed in quite closely. A 30% effective tax rate for the year and 65 million average diluted shares outstanding.

In summary, I feel very positive about the Company. Our core services remain as strong as ever and both the TSS and the ECS which is really the legacy of the Company are performing as well as ever. There is no doubt though that we have difficulties and we have recognized these issues and we're proactively addressing them.

We are generating cash, we are returning value to the shareholders through the dividends and cash buyback, and our end markets are strengthening in the US government and in the oil and gas and in our regional municipal markets all across North America, both in the United States and Canada are actually picking up. And some of our best opportunities are just beginning for the treatment of water and water-related issues in the oil and gas industry.

And with that I'd now like to open the call up for questions. Jennifer?

The question-and-answer session will begin now. (Operator Instructions.) The first question comes from Tahira Afzal with Keybanc. Tahira, your line is open. And I'm sorry, there was no response from that line. And your next question comes from the line of Corey Greendale with First Analysis.

Thank you. Good morning. So first I appreciate some of the color on the RCM segment. Could you just provide a little bit more clarity? You highlighted the pieces that are still going well. Just a little bit more granularity on the pieces that aren't going well? And also it wasn't that long ago that the RCM segment was performing well, so I applaud your taking quick action, but what changed so quickly that made you think you got to get out of some of these businesses?

Yeah, it's -- the RCM business has performed quite well in primarily four areas. And I'll be a little bit more specific than I was on my prepared remarks. The remediation work, work that we're doing for the Department of Defense, and Navy of course is the largest, is going very well. It's been one of the legacy areas of the Company and we really had no issues. They've both met or exceeded their projections, and both their technical and financial performance have been of the best. It's about a little over $100 million in revenue per year, about $110 million, and margins have actually been quite reliable and it's just been great work for us.

About another $100 million was solid waste. That's gone quite well for us. And that's been the turnkey work that we've been working for largely commercial clients and municipal folks with primarily landfills, and that's landfill gas extraction and recovery which is environmental work, and the handling of fly ash, and it's very well positioned to grow, so it's gone quite well.

Oil and gas has gone well in the midstream, primarily in Canada, and we have a small utility business that's done quite well.

The areas that have not done well -- so those have been, just to -- before I move to what's not done well, those are the items that have been generating and collectively those four are about $450 million with about $100 million of it in utilities, which is a little bit tangential to our core environmental and water resource work.

Areas that we followed our clients almost exclusively the US Federal Government. We've begun to drift slowly and kind of moved from what was core, which is consistent with our water, environmental, energy, resource management, we began to as a favor so to speak or as part of client relationships, began to provide services for buildings and other non-core work. It began in the US going from cost-plus to fixed-price in the Gulf Coast, which actually became a problem for us. It began to go from cost reimbursable work in the Middle East in Iraq and then following up in Afghanistan that has gone from cost-plus for water systems to we'll just move adjacent slippery slope to buildings and have ultimately ended up in fixed-price work and very hostile work environments.

And the reality is with the US government's military exiting both Iraq, where we were before, and in Afghanistan, these projects have really become much, much more difficult for us, increased the cost, and ultimately resulted in offsetting the good contributions from the areas that I mentioned.

So it's been a little bit on the transportation but it's mostly been the federal government on their US building space work and on the Middle East construction activities that went fixed-price.

That is really helpful, Dan. So just it sounds like the issues are kind of contained within specific offices or units as opposed to a contract here and a contract there spread across the RCM units. Is that fair?

Yes, that is absolutely correct. And in fact about 4 to 5 months ago it became clear that this work was difficult, margins had come down, execution forecasting had become more difficult, and so we turned off all bidding work. So nothing new had come into the backlog, and we moved aggressively to move these projects to completion and exit it.

And really with this performance, I know one of the questions has to be why now? With a loss in the third quarter and with the forecast of these in the fourth quarter of being breakeven, we're really offsetting all of the good work being contributed by these others. It was just time to aggressively move to formally exit this.

And you're exactly right in your characterization. They're not projects spread out all across RCM. They are in very distinct divisions and units that are, as you say, relatively self-contained.

That's really helpful. And then just curious, can you comment on what impact you expect on the market in the competitive environment from the AECOM URS acquisition?

You know, I think -- it is interesting. They not only announced -- and we watch them. They're a very good company. They're doing very good things. But they're moving very much in a different direction than we are. And in fact based on the announcements that we've made today, you could actually say we're headed in opposite directions. They are moving to a full-service construction-related, and with an announcement they made earlier this week, with Hunt Construction with another $1 billion. They are moving that direction.

And we really are moving the other direction. Now we will complete, and I know this will be a question by some of our shareholders and certainly some of our employees and even clients, will we perform turnkey projects? Yes, we will. But we will perform turnkey projects where the execution of it or the oversight of the construction or implementation is on a cost-plus basis or a time-and-materials basis where we have long-term partnerships with our clients, where we're doing work in our core services of water, environment, natural resource management, energy.

And one thing that we had become not sufficiently disciplined was doing favors for our clients when we were doing non-core work with non-favorable terms. And it really was a slippery slope that has brought us to here today.

So I think that they will be very competitive in a market that we're not looking to pursue.

Great. Thanks very much.

Your next question comes from David Rose with Wedbush Securities.

Good morning. Thank you for taking my call. I have a couple of followup questions. One is I guess since this is a strategic move you're making and maybe you can kind of help paint the picture for us in terms of long-term growth. Does this change the dynamic, the 15% growth, half and half, half organic and half acquisition? And then I have a follow-up question.

No, I don't think it does. I think that what it does is it provides additional clarity as to where that growth will come from. So no, we are not changing our 15% top and bottom line. No, the mix of acquisitive and organic will not change. But it will change a bit, and I think it has added clarity to which segment will the growth come from.

And I know it's been a question that has been on these calls and in other meetings we've had with our shareholders is what do you anticipate the size and contribution of the RCM to be? And it's done for many reasons such as if you're taking on more work that's higher risk and lower margin, what is a resulting margin?

We are going to grow in our front-end government services business and our state and local business, and in our commercial industrial practices. We will do again full turnkey work for our clients under what I would call equitable terms. I don't want to say favorable, that it's more favor to the Company than the client, but I would call it equitable. And this generally includes time-and-materials, cost reimbursable, and others.

But no, we're not stepping back from the growth, but we are stepping back from how much of it will be in fixed-price, low-margin, high-risk, and non-core.

Okay. So we would still see RCM, we just would not see fixed-price RCM?

Well as part of the alternative evaluation, it ranges from simply completing the close down, I would call it a de minimal action which would be one end of the spectrum would be simply exiting the non-core work, which we've already embarked, which would represent the $185 million, all the way to removing the RCM business segment as an operating segment, moving it into discontinued operations and taking the valuable components and moving them to the appropriate alignment with the other two segments.

We are just initiating this. We're only just begun this process, but we are going to move quickly through this. We're already a third through the quarter here with it being essentially the end of July, and before the end of the fourth quarter, by the end of September we will have made the decision and actually communicated to the shareholders through, depending on what the action is, through an appropriate 8-K. But it does not necessarily mean RCM will continue as it is today just reconstituted.

Okay. And then as you called out some of the different businesses that are under review, the utility business, the question is is there enough overlap with that new landfill business that you like? I think utilities are your customers as well in the coal-fired power utilities, so is there enough argument for that business?

That's a good question, David. While the work that we're doing in about -- we do about $100 million in what I would call utility services work. And this happens to be for utilities, but it's mostly for cities and it's primarily in a couple of major cities in the country. We are going to take a look at it, but it's generally been the installation, upgrading, and monitoring of for instance sewer collection systems, laterals, water delivery systems. The actual physical utility type work is generally relatively small amount of CapEx, but it is a little bit of self-performance.

It originally was brought in with supporting specific projects we have, and it's grown to this size. And we'll take a look at whether or not it's key and synergistic with our core business. But that's something that we'll evaluate here over the next 6 to 8 weeks.

Okay. I'm good then. Thank you very much.

And your next question is from Andrew Wittmann with R.W. Baird.

Hi guys. I wanted to dig in a little bit more into some of the issues in RCM and specifically I think last quarter you talked about just the burn off of the non-core projects being I think at the time you called it 12- to 18-months. Is that timeline that would put us into maybe through most of fiscal '15 the same or have other problems arisen that might take us out deeper in time? Just an update on that I think would be helpful.

The timeframe is about right. You've got that quite well. About 95% of that remaining amount of backlog, the $185 million would be complete in fiscal year 2015. So it's just over a year from now, so you're right. It's about 15- to 18-months.

I think there's -- we've looked at it and our forecast is it's possible that there's a few dollars, and just a few million of that would go out perhaps a bit longer, but we're looking at how even that could be accelerated. But right now for practical purposes, all of it would be complete by the end of 2015, which is the end of September of next year, and we're looking at how we can actually accelerate that.

Gotcha. What does that have -- what does that mean for the margins? I know for the fourth quarter obviously you guided flat, but what does it mean for '15 margins with that kind of project that's low or no profit going through? I mean should we expect breakevens to continue? I know you're going to reclassify the segments; it sounds like you might. But if it weren't to be reclassified, if you were to look at the business just kind of continuing in its segment as it is, does that segment look like breakeven for most of next year? Does it get better at the end of next year? How should we be thinking about that?

No, it actually looks a lot better, and let me explain why. We're down to $185 million, so if you say $185 million this year -- let me back up.

In fiscal year 2014 we will book and expend roughly $720 million of total revenue. Much of it was in fact increases in our estimates at complete, it was extending time, and so we were putting negative numbers in that were equal to the positive numbers of the units I talked about. That's how you get to breakeven. Or in fact in the case of the third quarter, that's how you get a $2 million loss when you actually have more losses or increase in forecasted cost on projects you haven't completed. So you then take more charges.

If we actually have it right, if we move to close these, and in fact if we move to look at other alternatives, for instance if we would transfer the project out of the Company completely for example, we would then take no additional charge assuming that the booking position on it was correctly, and so you would have a zero on that -- if you ran forward and your booking position is proper and you complete the job as expected, you'll have a zero profit on that job.

So you have $185 million in 2015 at zero. But then you have another $400 million at 10% let's say. So that's two-thirds at 10%, one-third at zero, so that puts you at 6.6% as an example. So that's if we do nothing with the remaining work and we just hold our positions.

If we perform better, then you would actually have a small income on the $185 million, which pushes that number higher. And if we divest it or exit it from the Company, then we would see the full 10%.

So you shouldn't see breakeven even if things don't go well for us. But all of that I expect to have laid out in a very specific plan here by the end of the quarter. But I'm glad you asked that question. It does put it into context what will come out of this type of entity.

Okay. That's helpful. And just I guess on the capital allocation plan, Dan. Obviously you've been doing kind of steady share repurchases here, but we've still not seen the leverage really move towards those targets. I know -- I guess the Board technically hasn't authorized you to do that yet, but I mean is that the likely outcome here? Do you see us getting more quickly to the 1 to 2 times EBITDA leverage or do you still feel like it's going to be kind of a slow move there? Thoughts on that would be helpful.

Yeah, I think that the Board will evaluate this here coming into 2015 as Steve had mentioned, but I do expect that M&A, and it is a focus of ours, that M&A will contribute. We have moved, I'd say moved sluggishly, but the reality is we haven't moved to the 1 to 2 times, we've moved back towards zero net debt. And that's even with just under 70% of the cash flow moving back to the shareholders.

So I think we could if you just look at it numerically. We could commit that same type of number or even greater and lever up. So I'd like to see us commit much of our free cash flow from operations and then lever up for acquisitions to move to that 1 to 2 times.

So that's sort of the general game plan, and we'll see how that progresses here as we move to the end of the year.

Got it. Maybe just one final question on the backlog. Obviously up 6%. Can you talk to us about the duration of that backlog? Is it longer duration so it's bigger dollars? Is it kind of similar to what you've been having? Margins on that backlog I think would be some of the key areas that we'd like to hear about.

Yes. It's very little. I want to -- we hesitate to say none because I know we have small fixed-price projects with our study contracts to do small things, but none of it is for fixed-price contracts that go out to an extended period of time.

So the margins are consistent with what you've seen at ECS and TSS, so I'd say ranging from sort of an 8% to 15% range is what we've put into it. It's consistent with the contract profiles in ECS and TSS or reimbursable. And it's similar to what we currently have now. So most of that will burn off in sort of a 8- to 12-month period most of it with a little bit of it going on beyond that. So quite similar to what you'd see in ECS and TSS.

Okay. Thank you very much.

Our next question comes from Noelle Dilts with Stifel.

Hi. Good morning. Looking at, just going back to the slide 14 where you've broken out the non-core and remainder under review, am I correct in that the $6 million of profit in the remainder under review included a $14 million project write-down last quarter in Parkland?

Yes, that's correct. Yes.

Okay. And then have you taken any action -- so I mean you talked about oil and gas performing well. I'm assuming that kind of means excluding that write-down, but have you taken any actions to kind of reduce the risk profile of the Parkland operation?

Yeah, great questions. You're right. First of all it's with the exception of that one project. It's difficult for us to say it's all going well except for that one project when that one project is so prominent, so I say that with a huge qualifier.

But what we have done in that entity is most all of the work since roughly the second quarter, which is the beginning of this calendar year, we've moved from fixed-price contracting in that entity to cost-plus. So the risk profile of our Canadian midstream oil and gas, which is really overwhelming Parkland, has moved to cost reimbursable. So the risk profile I would say from December or January of this year, so a little over 6 months ago to today is completely different, and that we moved on extremely fast. And so I would say that's about 180-degree turn.

And with respect to that one project, and I know that we spent a fair amount of time here, we're really quite close to delivering the final project. We're just oh I'd say within the next less than 2 weeks, roughly 10 days it should be complete and fully handed over. And then we will initiate the final negotiation and resolution of where we're at on that.

So one thing I'm extremely aware of and sensitive to is an estimate to complete on a construction project is just an estimate until the job's over. And so I feel quite good that we're within just a few days of that being turned over.

Okay. Great. And so just looking at, again, just sticking with profitability on the operations under review, so would you say that excluding that $14 million charge the 7% margin is about where you want to be in those operations, or is there some room for upside?

Oh it's actually higher. I think -- when I said 7% that was an aggregate of the zero on roughly $185 million plus roughly a 10% on the remaining ongoing RCM operation. So I would -- when you were talking about the ongoing, it's actually closer to 10%.

Okay. And then can you talk about the increase in subcontractor costs in the quarter, what drove that? And if you see that continuing moving forward?

Yeah actually what contributed to the increased subcontractor cost was our extreme focus on completing these fixed-price construction projects. We don't self-perform that much of the RCM work. A lot of it's subcontracted. So when you push and accelerate or try to take these projects to completion, it's driving up subcontract cost in RCM. And as this completes you're going to watch the -- as these projects get worked through, you're going to watch the effect drop our subcontract amount.

In fact if you took out -- we've been doing this as an exercise internally, if you did a pro forma of our financial makeup of net revenue plus subcontract to equal total revenue, subcontracts are less than 20% of the revenue between TSS and ECS, our insuring consulting services and our technical support services, it's less than 20%.

So as we move RCM down, you're going to watch the subcontractor portion decrease accordingly, and therefore increase the margin on our total revenue. And a lot of the subcontract work goes through without markup so it's going to help the overall margins across the Company also.

Great. Thanks.

Our next question is from Tahira Afzal with Keybanc.

Thank you and sorry folks for falling off the line in queue earlier on.

Good morning, Tahira. Glad to have you back.

So I just had a couple of questions. I'm sorry I lost signal and I might have missed out on this. But number one, if you look at the pipeline business in one of your more recent acquisitions, can you talk about what you're seeing there in terms of momentum? I hear in Canada at least there's been a swift translation to cost plus and I don't know if you talked about that earlier on in your call.

I did mention it briefly but I'll provide just a little more detail. We are seeing that the demand for support of moving the oil and gas products, both gas NGLs and [sim] crude from the oil sands of piping. Pipelines in midstream is under extreme high demand. We expect that to last for several years. And we have seen it move to, for the high-quality providers, to cost plus.

I'll repeat this, reiterate this, that our operations in the midstream have moved to cost plus over the past just under 6 months and we've really moved away from the fixed-price work. And so we have seen that phenomenon also and we actually have followed that. And it has changed our risk profile quite dramatically in that component of the business.

Got it. Okay. And secondly, Dan, I don't know if you highlighted this earlier on. If you look at where the earn-out displacement came from, I believe it was from your utilities business, which is the one you're also perhaps looking to reshape. Can you talk a bit about where the weakness really came from, what the consideration was that led to that earn-out hit in the second quarter -- sorry, in the fiscal third quarter? And really as we look at the fiscal fourth quarter, what your assumptions are really around that just leading to more of a breakeven type of view for RCM?

Yeah, let me start with the -- your question or observation on the earn-out pickup. It was not a utility business. It was actually a solid waste. And it was an acquisition that we did within the past two years. When we complete acquisitions, most often a component of the consideration of the purchase price is included in earn-out. And we, together with the owners of the firms that join us, identify thresholds or estimates of their operating income that would contribute to the Company over each of the successive following years.

Now quite often, in fact, not quite often, in every instance these numbers are prepared in collaboration with the firm joining us, and most often they're actually numbers provided by the firm joining us. So in this particular instance it was a solid waste firm that was in the solid waste business exclusively. They've actually performed quite well, did recognize and receive all of their earn-out in the first year, but the second year they have fallen a bit short. Some things are weather contributed to it, but their performance has actually been fairly good. Certainly meets our expectations but did not meet the earn-out and the sales and purchase agreement thresholds. Therefore it fell to recovery, which you saw recognized this quarter.

And so it's not a distressed business. It's not a failing business. It's actually performing well. It's one of our key keepers as you might call it. It will be with us and we expect to be part of the core business of the corporation. But it was just an artifact of the thresholds and the timing with respect to clarity that they wouldn't meet this threshold.

Okay. You know you've had two of your recent acquisitions span over the last two years basically (inaudible) the first three quarters of the year. Any lessons you've learned in terms of M&A going forward, Dan? Maybe in terms of capital allocation in general and in terms of how you look at these acquisitions? Obviously it's good to have earn-out [specificity] but clearly you would have preferred if the situation hadn't arised for the earn-out drawback to begin with.

Well I agree with you, Tahira. There's no doubt that we want to, we expect, and I'll tell you, nobody is a bigger advocate and a fan of paying out the earn-outs. So we want to see them receive it all. That's good for them, it's good for us, it's what we expect.

But I would say that the multiples that we're paying all in including the earn-outs are what I would call, and I've used this before, been very clear on this, they have been -- the acquisitions including earn-outs are accretive in the first year on a GAAP basis. And for the accountants in the crowd that do that calculation, that means a multiple of roughly 7 times or less of trailing earnings including the earn-outs.

And so when an earn-out's not realized, the multiple then on trailing 12 months goes down. And that means we're not over paying for these. That means that -- some people say wow, you got quite a bargain. Well I prefer that they do really well and that we pay the full value, but if the earnings turn out slightly lower, that would mean that the purchase price accordingly has been adjusted. So it's sort of a self-regulating structure that we put together there with -- but I think that this process relatively ensures we don't overpay, even as performance varies a bit in the first few years.

Thank you very much.

And our final question comes from Will Gabrielski with Stephens.

Thank you. You mentioned that you may not have to even complete some of these problem RCM projects. What mechanism or through what process could you possibly have that outcome?

Well you can actually sell a contract. I used to have a car that wouldn't run and I got the local recycler to come take my car for nothing. You might say well there's no value in that car, it didn't run at all. But he came and paid me some amount for it or maybe I even had to pay him. But then it was not in my driveway anymore.

And so there are different mechanisms by which these contracts, if they're appropriately reserved, can go to parties both operational or sometimes called strategics, sometimes called financials. But there are entities out there that are in the business of taking and completing projects that are not favorable. But those are some mechanisms.

When you look at a process like that, is there also -- I mean, depending on which customers you're dealing with here, but I would think there's also some reputational risks through that process, or do you think that the relationships you have with your customers are strong enough that they'd understand what you're doing and why?

Well you know it's interesting. Almost all of this, and almost of all it with the exception of the Canadian pipeline project, but with the exception of that, all of this is interestingly enough the US Federal Government. And it's for the very specific construction divisions of largely the Army Corps of Engineers and other areas, and we're in the process right now of preparing claims and we're in a very contentious, with a construction division of the Corps, disputing the terminations on these contracts where it's our position that there've been significant changes of conditions.

And so to the extent that they would not favorably consider us for fixed-price construction, border crossing, defense posts in Afghanistan with no security around us, that's okay. There are other people that are better suited to do that work.

So I do not see any cross connection or impact to us from the science and technology folks where we're doing the studies, the evaluation, the engineering, the solutions. And in fact to the extent that our science and technology clients and customers are wondering why we're building vertical forts on the borders near Syria, this will eliminate that question from them any longer.

Okay. Fair enough. The restructuring that you're talking about doing in RCM or evaluating right now in RCM, is there -- like it almost sounds to me like the restructuring comes from either selling the contracts or the contracts ending and you not pursuing that work any further. But is there also overhead associated with that or something else that we can think about as supportive of better margins next year besides hopefully just a lower concentration of zero-margin revenue?

No, there are. So for instance, hypothetically if RCM was discontinued and moved in -- the other components were moved into the other segments, you wouldn't have the back office, the support structures. Everything would move to the project execution only. You wouldn't have what -- which would be a business segment SG&A would pretty much go away, right? So that would be one.

Number two, additional costs or charges of it would be so any legacy offices, severance no doubt, even this conference call we're having right now is adding some anxiety to the individuals in RCM to the extent that we have turnover or people that are critical to complete projects. That also adds more uncertainty with respect to can we complete the projects within the forecast that we have today.

So these are all things that we need to look at and why we need the next roughly 6 weeks to come to a conclusion on this. So there are, while it's conceptual and strategically quite an easy process, the difference between a strategic direction and the tactics of having it all come together do require a fair amount of evaluation, and that's what we're going to take this next several weeks to complete.

Okay. I appreciate those answers. Thank you very much.

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, Jennifer. Well I first of all want to thank all of our shareholders for not only being on this call but for understanding us as we work through this. It is something we're not -- we don't feel good about with respect to having to address this. We are moving as quickly as possible. The triggering points that brought us to this point are both the performance year-to-date, and honestly even in 2013 in the current forecast with these types of work. The decision is quite clear, and while we wish we never get into these spots, I think it's not what we have at this instant, but it's the response that we take to exit this and end up with a stronger company.

I will tell you that the charges on a cash basis that we've been taking have already been embedded to the cash that you've seen. And so the cash EPS is a much better indicator of the strength of the Company. And you can see we're well over $2.00 into the mid $2.00s on that performance.

I am committed, myself and the Company, to moving on this quickly. And I will reiterate I actually feel very good about the Company's status, standing, and performance of the overwhelming portion of the number of contracts we have. And while this one area is somewhat difficult, we will work through this quickly and we'll come out even a clear, more focused, more profitable, more consistent, better performing company for our shareholders.

And I'm looking forward to certainly speaking to all of you at the next quarterly call, and depending on the outcome of the evaluation, perhaps even prior to that as we disclose the specifics and the details of the actions that we'll take with respect to RCM and the Company.

And with that I look forward to talking to you next quarter or before. Thank you.

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