Tetra Tech Inc (TTEK) 2014 Q4 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 will 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 Relations section of Tetra Tech's website.

(Operator Instructions)

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 fourth quarter and FY14 year-end earnings conference call. While Steve Burdick, our Chief Financial Officer, will present the specifics of our financials, I'm going to start this morning with a brief overview of the Company, and then turn to some of our key financial metrics.

In the fourth quarter, we completed a strategic review of the Company, and particularly we're focused on our remediation and construction management segment, which is where most of our construction work is performed. As a result of the valuation, we took the following actions. First, we realigned our front-end segment operations by market sector. And I'm going to speak more to this a bit later in this morning's presentation.

Second, we transferred the complementary and profitable components of RCM into the front-end businesses. And third, we initiated the wind down and exit of the remaining RCM operations. Because of this realignment and the RCM wind down, I will be highlighting the financial results of our two front-end segments, in addition to presenting our overall performance.

So, overall, for the quarter the Company generated $622 million in revenue, $462 million in net revenue, which generated an operating income of $25 million, or an EBITDA of $37 million, which resulted in an earnings per share of $0.35 for the quarter. For the fourth quarter, the total and net revenue were essentially flat for the combined front-end segments of ECS and TSS. But their operating income was up 11% year over year, resulting in $49 million of operating income, with an associated EBITDA of $51 million, which was up 9% over a year earlier. And I would like to note that it was these two segments, ECS and TSS, that generated more than $600 million in orders for the quarter that drove our backlog up to over $2 billion to finish the fiscal year.

I would now like to present our performance by segment. Our ECS, or engineering and consulting services, segment was up 2% on net revenue, and delivered a 12% margin, with improvement across their markets in both the United States and Canada. And the growth in our water-related services took place, both for our government and our commercial clients, within the ECS segment.

Our technical support services segment delivered an excellent 14% margin. And they've just really had a good entire 2014, with their continued [rapid] growth in the oil- and gas-related services, especially in the United States midstreaming engineering sector, and that was designing of pipelines to transport the new production of oil and gas here in the US.

This was offset -- the growth in the oil and gas -- was offset a little bit by a slow ramp-up within federal services for the quarter. But I'm going to talk more about this in our backlog because really we're seeing federal services pick up and be one of our stronger areas. We did continue to wind down our non-core work in the RCM segment, which did result in a 42% drop in their net revenue in this unit year over year, and actually even a much larger reduction in their total revenue from a year earlier.

Our fourth-quarter performance by customer -- let me go over that briefly. The work we performed by our front-end segments, ECS and the TSS, we believe, are most representative of our customer mix that we will have on a go-forward basis now that we are winding down RCM. So, our international work in the ECS and TSS segments was overall flat year over year, and it represented 32% of their revenue. And that would be the revenue from the ECS and TSS segments. Work for our US commercial clients was up 5% from the front-end segments, and it represented 26% of their work for the quarter.

Our federal work was relatively flat year over year, but sequentially it was up from the third quarter, and represented 25% of our front-end business segment work. And finally, our state and local work was down significantly overall, which was a direct result of our decision to exit the RCM state and local construction activities. And it did have a secondary impact on some of the state and local work that we did in our front-end segment design services where they were supporting some of the construction activities within the RCM business segment.

Now, before I turn the presentation over to Steve Burdick to present the details of our financials, I would like to show you the profit contributions by segment, because our collective financial results don't really show you where our operating income came from during the quarter. So, in the fourth quarter -- if you are following along on the webcast, you will be able to see this on our segment performance table -- but in the fourth quarter, our ECS and TSS segments generated $49 million of operating income, while our RCM segment lost $35 million.

We did have about an $8 million in the quarter in corporate expenses and interest charges, which are generally typical for us. And we also had a very unusual $17 million in net purchase price accounting pickups that were primarily due to the forfeiture of earn-outs that came from acquisitions that occurred in 2013 -- primarily in 2013. So, without the net pickups, without the pickups from the net purchase price accounting adjustments, which were not incorporated into our guidance as we came into this year, our fourth quarter would have had a reported 37 -- somewhere between $0.37 to $0.41 for the quarter, if RCM had just broken even and didn't report a loss. And this is one of the reasons why we made the decision to wind down and exit the RCM segment.

So, now, I would like to turn the presentation over to Steve to go over the specifics of some of our financials. Steve?

Thank you, Dan. I will begin with the FY14 fourth-quarter financial overview in a bit more detail. Overall, our fourth-quarter operating results fell in line with management's expectations, as well as the guidance ranges that we had provided for both net revenue and earnings per share.

First, comparing the fourth-quarter results this year to last year, our revenue did decrease by about $76 million, or 11%, to $622 million. This decrease was due to our decision to exit the RCM markets representing low-margin, high-risk, fixed-price work. The year-over-year comparisons were also negatively impact by foreign exchange rates due to the strengthening of the US dollar. Now, this decrease was partially offset by our North American markets, which focused on commercial, and oil and gas activities, which did perform very well.

Our net revenue decreased to $462 million, or about 13%, for the same reasons that gross revenue decreased. Although lower than the prior year, this net revenue results were within our expectations and the guidance range provided, due to the fact that we did see strength in our core marks in water, environment, resource management, and infrastructure.

Our operating income was about $24.8 million in the fourth quarter. Overall, the operating margin represents a margin of about 8.3%, and close to 10% without intangible amortization expense. Now, this operating income, as Dan talked about, was primarily driven by the project execution and favorable results in both our ECS and TSS groups. In fact, on a stand-alone basis, our two front-end businesses produced an operating margin of about 12.8%.

In addition, the operating income was impacted by a reduction in overhead costs due, in part, to our right-sizing actions that we have taken over the last couple of years; also, as Dan mentioned, significant non-operating gains on revaluing acquisition-related earn-out liabilities and -- however, our operating income was reduced by project charges in the RCM group.

Now, our EBITDA was about $36.8 million. This EBITDA was driven by the same factors as operating income, but at a higher percentage, as we recognized intangible amortization and depreciation of about $12 million in the quarter. We achieved an EBITDA margin of 13.3% on those front-end businesses. And the higher EBITDA margin on our front-end businesses excludes both any of the purchase accounting earn-out gains, as well as any of the operating results from RCM, which are being exited.

The SG&A was about $48.5 million for the quarter. This is consistent with the prior year's quarter; however, the slight increase was due to about $2 million of charges in G&A from restructuring and impairment costs. We expect our overhead and back-office costs to further decrease as we exit our RCM non-core markets.

The tax provision resulted in a net expense of about zero for the quarter. Now, the effective tax rate is -- was about 25% for the whole year, and the lower rate is due primarily to the non-taxable nature of some of the earn-out adjustments, which offset the tax impact from our profitable operations. Overall, the tax rate was about 34% without the earn-out adjustments and some of the other one-time charges. And as a result, our earnings per share was about $0.35 for the quarter, which was within the guidance range.

I would like to point out a few more of the more significant balance sheet items. As a result of the higher days sales outstanding in the RCM segment, we did experience about a 6% increase in our net accounts receivable balances. Also, the net -- the accounts payable balances increased to $176 million due to the higher [pay-when-paid] subcontracting activities, which -- and these activities took place mostly in our federal and state government projects in the RCM segment.

Our net debt compared to the prior year is about the same. We would have taken down our net debt over the year, as we generated $127 million in cash from operations. Now, offsetting this favorable operating cash flow, we implemented a stock repurchase program in FY13, which utilized cash of about $80 million in FY14. And we paid about $9 million in cash dividends to our shareholders this last year. As such, the capital returned to shareholders totaled $89 million. We also had some CapEx for the year, and, as a result of all those different moving pieces, our net debt remained consistent with the prior year.

As noted in the previous discussion on our balance sheet, we had a solid cash flow from operations. So, for FY14, we generated $127 million of cash flow. However, the fourth quarter was less than the prior year, and this lower amount resulted from the disappointing results in the RCM segment. Going forward, we do expect to generate operating cash upwards of 30% more in 2015, as our forecast indicates cash from operations to be in the range of about $145 million to about $165 million.

Now, CapEx is less than prior year, and slightly lower than our previous guidance for FY14, as we've remained disciplined in our spending based on the strategic decisions we've implemented relative to our RCM segment, and we expect to remain disciplined in our spending for FY15, as our forecasted CapEx range is expected to be somewhere in the $15-million to $25-million range. And this amount continues to represent a ratio of less than 1% of our annual revenue.

Now, days sales outstanding of 87.5 days are higher when compared to last year at this point. The actual DSO is not in line with our expectations, and we have put corrective actions in place to bring this down. Our DSO is higher -- and our DSO is higher due to the performance of our RCM segment. On the other hand, the DSO in our front two segments is less than 75 days, and our efforts in FY15 are focused on reducing this DSO to stay below that 75 days.

Now, for 2014, I would like to give you an overall recap. Net revenue was down 8% to about $1.86 billion. And this activity was lower, due primarily to our decision to exit the RCM market.

Operating income improved quite a bit from last year. Overall, we reported about $154 million in operating income. Now, from an operating perspective, our front-end business in both the ECS and TSS segments managed to perform well, and posted strong earnings. And these operating results from the front end were offset by losses in our RCM segment.

Further, this operating income resulted in EPS of about $1.66. The prior year was -- just to remind everybody -- was negative due to goodwill impairment charges and significant non-cash project charges. Although we had several large non-cash charges and income improvements due to the acquisition accounting, we still managed to generate $127 million in cash from operations. This operating cash generated about $1.96 per share in FY14. As I noted in my previous comments, next year we expect to generate $145 million to $165 million in operating cash, which translates to about $2.30 to $2.60 in cash per share in FY15.

Now, for those following on the webcast, this next graphic shows how our net debt has changed over the last five years. As you can see on the graphic, our previous net cash position has transitioned to a net debt position due to the borrowings for acquisitions in 2014 and 2013, but it also shows what I mentioned earlier that we have reduced our net debt by a substantial amount. In fact, our experience has always been that we are generating cash at a faster and more consistent pace compared to our net income.

So, as a result of our performance, we've continued to focus on an enhanced capital allocation program, which I would like to give you an update right now. Our current leverage is close to zero, while our target leverage range is about 1 to 2 times EBITDA. Although our long-term target is to return about 33% of our free cash flow 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. As such, we did provide about 82% of -- an 82% return of free cash flow. And we have completed the previously committed $100-million stock buyback that was authorized back in 2013.

So, as of today, I would like to announce our further commitment to provide value to our shareholders. The Board of Directors has approved the declaration of Tetra Tech's quarterly dividend, and this dividend is $0.07 per share. Now, on an annualized basis, this represents about [15%] of our estimated annual free cash flow, and the annualized amount further equates to about 1% yield at our current stock price. This dividend will be paid on December 15 of this year to shareholders of record as of November 26.

In addition to the dividends, Tetra Tech's management and its Board of Directors have committed to a stock buyback program for an additional $200 million, which will be utilized over the next two years. An important aspect to understand is that this cash dividend and stock buyback 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 towards that target range here in 2015. While we have committed to a more significant share buyback program over the next two years, we will update our shareholders on our capital allocation plan at each of our next quarterly conference calls.

And so, with that said, I will now hand the presentation back over to Dan to discuss our outlook and business strategy in a bit more detail.

Great. Thank you very much, Steve.

At the beginning of the fiscal year, we initiated a new alignment of our business segments in the Company. We have now organized around two primary segments, which are both aligned by the market, irrespective of the geography. These two organizational units are designed to be efficient, entrepreneurial, and technically differentiated. Each of these segments are leaders in their markets, and they support our number-one North American rankings, as listed by the Engineering News-Record, in water, environmental management, solid waste, and wind energy. Both our water, environment and infrastructure segments, and the RME, resource management energy, segments, have high profitability, and they're going to help us move toward our goal of greater than a 13% margin for the entire Company. And finally, for the remainder of 2015, we are going to continue to report on the RCM segment, as we exit and wind down all of the remaining projects.

I would now like to give you a brief overview of each of these two segments, and give you a little bit better description and understanding of where they are focused and what some of their markets are. So, for the first segment, the water, environment and infrastructure segment -- we will refer to this as WEI -- this segment has a staff of about 6,500 professionals. They are primarily in North America, and their business is about 75% for government clients. Now, about 35% of their work is for the US federal government, with another 40% for works for states, provinces in Canada, and for local cities. And that would leave the remaining 25% of the work that they perform being done for commercial clients.

The WEI business mix is inherently very low-risk, highly predictable, and very highly predictable, as you might expect, having such a large percentage of government work. They are differentiated by their water consulting and design services for programs like nutrient management and regional modeling, desalination design, flood protection and coastal restoration projects. And WEI also includes our high-end consulting activities in environmental management, and this is where we study and design solutions for hazardous waste removal, and restoration and clean-up programs all across primarily the US and Canada.

The second segment is the resource management and energy group. We will refer to this as RME. Now, it is slightly larger, at 7,500 staff, and is primarily focused on our commercial customers. So, for the resource management and energy group, RME, they are going to lead most of our resource -- natural resource management activities for our clients in the oil and gas, and mining, practices.

This is also the unit that's going to lead our waste management practice that includes delivering high-end solutions to fly ash management for our utility customers. And the RME segment is also where our energy practice primarily resides, which is performing innovative studies for offshore renewable energy projects where we have a lot of our marine activity. They support the permitting and design of transmission and distribution projects across primarily the United States and Canada. And they also provide master planning in emerging economies, such as the work that we do for USAID and the Power Africa program that we're currently managing for the US federal government.

Tetra Tech's biggest differentiator, and this really goes all the way back to the founding of the Company, is providing support to both our public and our private companies and clients in solving their most important and complicated water problems. Now, for our government clients, they have two primary issues that we address: water supply, for areas where there just isn't enough water -- drought areas; and flood protection, for areas where there's just way too much water -- and that's flooding areas.

So, for water supply, we're providing innovative solutions for water reuse, desalination, and other alternatives that we're looking to provide new water supplies to the communities. And in flood management, we're applying our expertise in modeling, things like levee inspection and design to provide cost-effective solutions that manage storm events that capture and divert water, and protect our valuable infrastructure along the coastlines, both along the seaboards and along the rivers that have flooded, both in the US and Canada.

Now, for our commercial clients in oil and gas, mining, energy and manufacturing, we are providing services that address the entire full water cycle. And that's from finding the water that they need, to treating it before and after they use it, and recycling and reusing it whenever possible. So, for many of our commercial clients, especially in the oil and gas sector, water availability is their biggest issue. They just need to find it. And this is where the full lifecycle approach comes into effect. And our understanding of regional water supplies is extremely valuable to our clients. And in the area of treatment, our experts in biological and chemical processes can design the most cost-effective treatment approaches that address our clients' operational objectives.

Now, while our new WEI and RME segments are focused on doing excellent work for our clients, growing our Business and increasing their margins, our objective for the RCM segment is to finish the outstanding work, and wind down the operations during FY15. Now, I expect to complete about $100 million of our current backlog within the RCM unit during 2015, and we are going to be very focused, and intend to sell, divest or otherwise close down the remaining portion of the backlog that otherwise wouldn't operationally be completed. That's about another $20 million, and that would represent all of the remaining work we have in the RCM group.

At the end of the fourth quarter, our backlog was just over $2 billion, and represents the highest backlog that we've had in the Company for over 18 months -- so, for six quarters. This is really quite a positive achievement from us. Notably, the sequential and year-over-year backlog growth was generated organically, from a broad base of orders across our front-end segments; essentially none of this is construction. Throughout the US federal sector, we saw a resurgence of activity, with significant orders from the federal aviation administration, the US EPA, the Navy, Department of Energy, and USAID -- Agency for International Development. And during this last quarter, we also saw awards of significant new contracts, such as the $650-million USAID urban infrastructure contract that we were awarded. And so, this has really been one of the best quarters that we have seen from the federal government in some time.

This overall increase in backlog would have actually been even higher. We reported a 5% increase year over year. If adjusted for the translational FX due to the strengthening dollar against the Canadian currency -- if we actually went back and adjusted it -- the increase would have been closer to 7%. And we grew our backlog significantly -- and I would like to make this note -- while we continued to burn off backlog from our non-core construction businesses. And as you can see at the bottom of the graph, if you're following along on the webcast, we now only have about $120 million in backlog remaining from RCM, and it is down by about two-thirds from just a year ago. So, we've made significant progress in reducing some of this low or no margin, or, in fact, loss revenue that we had in our backlog.

In FY15, we expect all of our operating income to come from the WEI and RME segments. As you can see in the webcast that WEI is expected to have steady growth in the low-single digits, and this will be all organic, while the RME segment will have slightly higher growth rates driven by the stronger industrial demand that we're seeing. We expect both of these segments to generate an EBITDA for the Company in the range of 12% to 13%.

But I do want to note that, in longer term, I actually expect that we will have much higher margins out of the RME group, maybe 100 to 200 basis points higher, but that's partially due to their exposure to the more commodity associated work that they're doing in the oil and gas, and the mining, sectors. So, while they are -- for FY15, we forecast them to be quite similar; in the longer run, RME will actually be a bit higher.

I would now like to turn to our guidance for the first quarter and for FY15. Our guidance for the first quarter for net revenue is from a range of $420 million to $470 million, with a diluted earnings per share of $0.32 to $0.36. For the entire FY15, our guidance is for a range of $1.75 billion to $1.95 billion, with an associated diluted earnings per share of $1.55 to $1.75, with a cash earnings per share, as Steve had mentioned a bit earlier, of $2.30 to $2.60 for the year.

Now, some of the key assumptions that are included in this guidance are: We have assumed a intangible amortization for the fiscal year of $22 million, which would translate into $0.23. That's already incorporated into the guidance. We assume a 33.5% effective tax rate for the year, 64 million shares of diluted shares outstanding, and this guidance does exclude any contributions that would be added during the year from acquisitions or the impact of the share buyback program that Steve Burdick had described a bit earlier.

In summary, our ECS and TSS units had an absolutely solid performance in the fourth quarter, and really for all of FY14. We have implemented a new alignment that significantly reduces the overall risk profile in the Company, while improving our margin across all of our end markets. Our commercial and our government end markets are both improving and look good. And our growth in backlog in areas where we're a market leader supports our confidence in our 2015 guidance, and really supports the success we feel for the Company that is going to come in 2015 and beyond.

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

(Operator Instructions)

The first question comes from Corey Greendale with First Analysis.

good morning, Corey.

Corey, your line is open.

There was no response from that line. Your next question comes from Tahira Afzal with Keybanc.

Hi, folks, and congratulations on a strong performance in ECS and TSS.

Thank you, Tahira.

First question is, Dan, what are your assumptions around oil and gas? It seems that in the longer term you continue to be way up beat on commodities and the contribution. So I would like to get a sense on how you're thinking about that, both anything that's commodity-oriented given all the movements we're seeing at least as a (inaudible) and oil high prices.

Well I will talk about oil and gas first under the work we do in the commodity sector. Our oil and gas was very strong for the year. It was the highest margin-producing unit we had within the Company as an end client. The contribution was quite significant. We've grown it to $400 million. Our goal was to make it $400 million at the Company. And in total revenue, it was just slightly over that. So it not only met, but slightly exceeded our goals for growth.

Now, most of our work is on the midstream. Now, we're associated -- we're really trying to support the design, the permitting and the environmental oversight of the pipelines. Most of the design work is here in the US, and it is mostly associated with the Bakken shale work and it is really pretty simple. It is getting it out of trains and into pipelines.

And right now we've got as much work as we can possibly handle. And we're looking at adding additional capabilities so we can grow this even quicker. Now, we have established, and I didn't put it in this quarter's presentation, but it has not changed, we have rough a three- to five-year goal to take that $400 million and more than increase it by 2.5 times to take it up to $1 billion.

And we actually see that there's plenty of work. We see that the midstream, or the pipeline work, is relatively less affected for oil prices. And certainly in the short term from our -- the work that we have with respect to backlog and opportunities, we have not seen any slowdown in that. So we are very bullish on oil and gas market.

Got it. I guess from the longer term, Bakken's example is considered to be the highest in terms of price point, so the most likely to eventually see some impact. So would you be looking to diversify your exposure within the different shales?

We definitely are. In fact, if we had to pick one area that's our number one focus, it's the Permian in west Texas. So a bit with the Eagle Ford, but mostly the Permian is our next biggest area of focus. We still think, though, that it is the most expensive oil to get out, or one of the most expensive in the US and the Bakken. But the area we're focused on is simply over the next several years would be the pipeline support to move what they have already identified.

So it's not the upstream work that we're involved in that could be significantly impacted more in the transport. But we are moving quickly to the South, to Texas, and we expect that that at some point will be as large or larger than even the Bakken work we're doing.

Got it. Okay. One follow-up and I will just jump bag in the queue. Any thoughts around the Republicans coming in? I assume it is good for your energy and resources segment. Maybe mixed for some of your federal components. So I would love to get your first take on that, Dan.

A bit of time will tell. Certainly we've seen multiple bills being proposed to get the Keystone pipeline moving. And while that particular project is not a big mover for us, it is indicative of the focus on getting more pipelines and movement of the oil and gas in the US underway and allowing it to the move forward. So certain that would be a big positive for us.

I do believe that certainly nobody has the executive in both houses. They don't have all of it. So I do expect additional environmental regulations to continue to move forward. And the one part that I feel very positive about is the oil majors get more and more involved in these activities. They bring their own environmental regulations in cleanup and standards both for water, environment, permitting, in order to minimize and to manage the long-term liability. So, it's not strictly regulatory and government driven. A lot of this is going to be brought in by the oil majors and the more mature oil producers. So I fee pretty good about that.

Thank you.

Thank you, Tahira.

The next question comes from Noelle Dilts with Stifel.

Thanks. Good morning.

Good morning, Noelle.

My first question is a housekeeping question. When I look at your recast segments, the WEI margin was very strong in the quarter. It looks like 16.5%. So I'm just trying to figure out how much of that came from the earn-out reversal. And then also, I was hoping you could speak to what drove the earn-out reversal in the quarter and essentially which segment it was in.

I will speak to the segment with respect to the fourth quarter on the recast at the roughly 16% margin. None of that was associated with earn-out forfeitures. So that was strictly based on operational performance on projects.

Now we -- in some instances on federal programs they ask for project to be closed out by the fiscal year. They performed very well. And so as I have said before, I'm quite happy with a 12% to 13% in this recast. You can see they were a bit higher than that. But none of that was contributed from an accounting reversal or other non cash accounting treatment of earn-outs or anything like that.

And with respect to what drove the pickup, it was primarily the acquisitions that we did in 2013 in the RCM segment. So if you go back and track those, you would see that the pickups were in the RCM segment that offset the charges that we took in the quarter. So while I do understand one is operational and one is a non cash accounting pickup, it was really all affected by the units -- operating units, as we refer to them, in the RCM segment.

Okay. Perfect. And then I was hoping -- you talked about this pickup in government work. Can you speak to -- a couple of quarters ago you talked about just day to day releases of task orders being slow. Can you talk about what you are seeing in terms of task orders versus new ID/IQ contracts, where you're seeing the improvement?

That's a great question because it's across both. It is across all of our end segments. So it is interesting. As good as I feel about the orders that came out, and if you go back to the backlog slide in the presentation, we have a small table that's actually details some of the specific orders that we had. So, for instance, during the quarter we had $77 million in USAID, or the Agency for International Development, the division of the state department issued. So $77 million there. We had over $50 million in Navy task orders. We had the Department of Energy also at about $50 million. The Army Corps of Engineers at just under $40 million. And EPA issued new programs.

But the story that's actually not told in those numbers in our backlog, so when I say $2 billion, we should feel good about that. And we do. But mainly the part we feel even more bullish, and it will translate in coming quarters, is we had even more contract awards. And, in fact, what you saw in a press release by Tetra Tech is actually only a small part of what was awarded.

The one thing that we've had through this economic downturn is any time you win a project of any size, everybody protests it. And you are going through this, I win, oh, I protest, and we go through anywhere from a one to six month period. But if you go through the government release pages, you would find that this past quarter was substantially more beneficial for us on new awards than what you have seen here.

Now, these awards -- these protests go through and they get resolved and they come out. But I would like to tell you it was -- actually, I don't want to tell you. I can't tell you it was just AID or it was just the Navy or just DOE, but I think page 20 in our backlog slide shows it quantitatively and gives examples of some of the contacts. So it's kind of a long answer, very broad-based. And the awards are coming out and task orders across all these vehicles and they're adding more vehicles.

Great. Thank you. Appreciate it.

Thank you, Noelle.

The next question comes from Andy Wittmann with Baird.

Hi. Thanks for taking my question. Dan, I was hoping could you give us some character or some flavor of the charge that you took in the RCM, the $35 million. Is that charges from exiting projects? Or is that a charge from costs on fixed price contracts going higher in your new accounting look of those projects? Just understanding some of the components there I think would be helpful.

That's a great question, Andy. I certainly, by no means, meant to simply say the number $35 million and move on.

So first of all, this was not -- I don't want to say was not unexpected. We certainly didn't expect this. But I knew, and in the last quarterly conference call that I shared with you all over three months ago, I did indicate that we were going to make a strategic decision in RCM and we would drive what was in the best interest of the Company and try to complete it in the fourth quarter. That was quite a high standard that we were going to get it ready, set, go and finish, all in the quarter. That's what we did.

So of the $35 million -- let me break it down into three buckets real quick. The first is, we did reduce staff. We had severance costs. We had separation costs with individuals and we closed down a number of offices. So around $5 million is in what I would call just operational wind-down of offices and staff. Because we dropped our revenue so significantly during the quarter by having turned everything off with new work coming in and accelerating the reduction, we did have about another $5 million of unabsorbed overhead. So now it leaves about $20 million to $25 million left.

We did incur about -- that number, $20 million to $25 million -- in project charges. Now, some of it was very tactical on our part. If a project was on hold, we approached the clients and said what do we have to do to exit the project? So in some instances, we had actually been awarded work and we had bid bonds out. We said, we don't want the work. Take it back. And they cashed our bid bond. So that happened during the quarter.

Other projects -- I felt that it was more important to add certainty to the quarter and put this behind us before going into 2015. So we dramatically accelerated projects by adding more staff, more equipment, paying overtime, subcontracting. So it did incur project charges.

But the focus we had here was I would rather take certainty, even though it added up to $35 million to put this behind us, than to allow this to languish. And I'm not going to say that we were free with taking charges and spending money. But I know that by trying to take and save a dollar now by stretching it out over the next year to save it, the reality is by all that additional time we have issues with respect to completion, moving into the winter weather, staffing changes, all these different things that make what may look like a logical savings not the case. So we drove that number in order to reduce the amount of work we had remaining with RCM. So that's what the $35 million was made up of.

Thank you for that perspective. I also wanted to dig into your comment, Dan, that some of the earn-out reversals were from acquisitions in 2013. As I think back to 2013, that was Parkland. That was AEG, were really the two bigger ones there. I even think maybe, I don't know if Rooney was with the pipeline business. I guess that was earlier.

Two of those businesses are some of the businesses that you have been talking more about growth, more about opportunity. So I was hoping you could help us reconcile the fact that they failed to achieve the ultimate earn-out with the fact that those are some of the better businesses today.

Well you have got our calendar for 2013 down exactly. So you're right on that. Did it not include Rooney. So just to be -- just to reinforce what you said. That was earlier. That was not part of.

So let me just describe very briefly, I'll try to keep this concise. When we came on, we had unbelievably, together with the owners of Parkland, unbelievably optimistic and positive expectations for that business. And here's one artifact that I think is quite misunderstood by sometimes our shareholders and analysts. So I will just spend a moment on this.

An acquisition can come into Tetra Tech and produce very good profit and very good earnings and still not achieve the standards set for the earn-out. Because sometimes there's a perception that if you don't receive the earn-out, they perform poorly or didn't even make money in some instances. That is absolutely not the case.

The valuations that we pay include the entities achieving growth rates that they have identified when they come in. So, for instance, if an entity says we're going to grow 35%, and that's what's required to achieve the earn-out, and they only grow 15%, well, we had 15% that didn't achieve the earn-out thresholds and, therefore, the earn-out component is forfeited, but we still have positive performance in the unit. And so that's the juxtaposition between how can you get an earn-out back without a unit performing poorly.

Got it. Thank you. And then I had two more questions that I think are important, if you will afford me those.

The next one is on the -- basically I guess the guidance and as it relates to some of the components that you sped up here for part of the $35 million to get out of RCM. Are other future charges or costs of exiting RCM included in this guidance range? And how are they included if so?

Well, our guidance is on an earnings per share basis is $1.55 to $1.75. The midpoint would assume that RCM essentially is at zero. There's no operating income contribution nor subtraction. And so the lower end, what would drive us to the lower end, I would believe, would be additional charges that we don't anticipate at this time.

But I will say with $120 million in backlog today, I think we've got our hands on it. I think we firmly understand where we're at. We've got everything -- I will tell you that there are some loss projects in there, but they have been reserved for and we're appropriately reserved.

But if things slide worse for us, that would then potentially drive you to the lower end. However, it is possible that we actually have some recovery on claim or other receivables that maybe RCM might actually contribute. Liquidation of some of the equipment that we have there, which is not insignificant, could be a net favorable outcome.

And we've also assumed sort of a flat mining and a steady state oil and gas. And if there's a pickup in either of those areas I would actually see that that would drive us to the upper end of our range. And if that was particularly strong, it could even go higher.

Great. Last question, I promise here. Just on the buyback, $200 million over two years, is this going to be done under a 10b5-1 plan as you have done some of your other plans? Or is this one a little bit more discretionary now?

No. We are setting up, or have set up a 10b5-1 plan that will go into effect here this quarter.

Got it. So this one isn't like some of the previous plans, Steve, that you said, hey, this much by this date, this one, it may be $200 million. You tell me, is this one you fully expect to do the $200 million in the two years? Or is this one going to be more, should we think of this one as more opportunistic?

It will be both. And we have a grid set up and we have a buyback program set up. And we fully expect to utilize the $200 million over the next two years.

Thank you very much, all of you.

Thanks, Andy.

The next question is from Mike Shlisky with Global Hunter Securities.

Good morning. Could you maybe tell us a little bit about, now that most of the RCM is passed here, can you maybe give us a flavor as to how much fixed price were, if you expect to have in your portfolio going forward? As far as mix goes?

It should be about 30%. So it is going to go down from what had been as high as 50%, down to 30%. So it's going to drop dramatically.

Okay, great. My other question is, you seem a little bit more positive on some of the federal work, given what you said about the backlog and about how that market has been performing. Is there perhaps any upside to your organic growth estimates for 2015 for water? Or is this basically based on what you are seeing today? Or just give us some color as to could you actually exceed low single-digit growth there in the coming year?

Well I think, Mike, I think we could exceed it. Certainly our backlog grew at 5% for the quarter. One quarter doesn't make a long-term trend, but I will tell you it looks, as I described earlier, the contract vehicles coming out give me additional confidence beyond just the orders for the quarter. So I think it is possible that it could go higher. And so we've -- if you take it on a collective basis, between the lower to upper single digits. So depending how you model this, you could you end up with anywhere from a 2% to 7% or 8%. So it is possible, Mike, it could be higher.

Great. Just one last one from me. Is there going to be any large change to your depreciation expenses next year given that some of RCM is, again, in the rear view mirror? Or is that going to be somewhat equal to the past year?

No. We do expect our depreciation costs to go down as our more capital intensive projects and businesses are -- go away.

Is there any kind of number we can get, just roughly speaking, what RCM meant to your overall past numbers?

I would say that our depreciation cost has usually run, say, around $25 million to $30 million a year. We expect that to be down probably 20% from that.

And I would say, Mike, that if you -- you can actually see the effect of our decision and our actions on this. While we've been in the upper $20 millions, just under $30 million in the past, in 2014 we were down to $19 million. So we knocked 30% of our CapEx out as part of directly in connection with the decision to move out of the RCM group.

Okay, great. Got it. Thanks so much.

Great. Thank you, Mike.

The next question is from David Rose with Wedbush Securities.

Good morning. This is actually James Kim calling in for David.

Thank you, James.

So I wanted to start out with a question on the commercial business. Obviously, that business has been performing very well and you had record bookings last quarter. I think it was about $0.5 billion. Are you still seeing strong growth there in terms of bookings?

I know you talked about the strength of oil and gas market, but if you could give us a little bit more color on other end markets? I'm looking at this quarter's performance growth in the quarter was slightly lighter sequentially, granted that you had tougher comps. But just wanted to see if there's any other color from that?

James, oil and gas was the strongest. But I would say that the other areas that were strong for us were commercial utility work. So our utilities have been strong. That's work we've done for right-of-way valuation for a number of the commercial utilities across the country. And that would be both on shore and offshore. And so that would be one. Our industrial clients have been quite strong. And I would say that the one area that is seeing some strength in some very small pockets is actually -- and I want to qualify this -- is in the mining sector, but mine closures.

So because of the downturn in commodity prices, a lot of mining sites have gone inactive, which then trigger environmental restoration, which is cleanup, management, capture of the groundwater and these items. We've had some very nice programs on we call restoration projects or environmental cleanup projects and monitoring projects.

But with that said, we continue to see -- if you ask is there a soft spot is in our commercial sector? We're still very cautious on the mining up-front siting and even operations. So we see that to continue to be the one watch area on the commercial sector.

Okay. Appreciate the color there. Next question, regarding subcontractor costs for ECS and TSS, obviously for RCM you are trying to wind down the business. And you tend to subcontract out a lot of the construction work. But just wanted to get some more color there on the increase that we saw in the quarter for ECS and TSS. I know you talked about it being sort of under the normal level being around 20%, but it seems like it's higher this quarter. Is there anything that we should be sort of taking out from that? Or is that just an anomaly there?

Well I would say there's a little bit of seasonality. So in our two front-end segments, the field work that they do is not construction related. This is where we go out in the field and do surveying, data collection, collection of samples, both water and soil. We do marine work where we will subcontract the actual marine vessels that we're on. We don't own the large vessels. So I would say that it would be seasonal effect. But, no, there's no what I would call a macro change in the subcontract.

And, in fact, you are going to see, as you just identified, as we move out of RCM, the amount that we subcontract will move from when RCM was a large part of the business where it was up to size 40% or even more, you are going to see it go down to 20% or even less. And so, no, we think 20% is the right. And there was no unusual effect during the last quarter that would indicate that that number is going up.

Okay. And my last question is on the California Water Bond, $7.5 billion. I know it's a very recent event and it is probably going to take several years to play out, but just wanted to see what your expectations might be there, and if this is something that you think will have a somewhat meaningful impact going forward.

I do. I think it is going to make a difference in especially our front-end water business. Now I will say that's a very big number. It is over five years. And I do think the first studies that are going to come out -- the first funds that are going to come out are right up our alley because it is going to be feasibility studies, alternative analysis, evaluations of different technologies. And a lot of it is for water storage, reservoirs and other supply at the local level.

And that fits us very well. So it's still very early, and the two big items, if I had to pick the two that are -- we're most focused on is the green infrastructure aspect of that bond and water supply, which, of course, is directly aimed at the drought out here in California.

So, yes, it will be a contributor. It just got passed. It hasn't been earmarked. And it is going to be administered by our clients, are going to get the money to spend for the folks we're currently working with. So we feel pretty good about where we're positioned for that.

And I will tell you where will you actually see the rubber hit the road, so to speak, is when you start seeing it in our backlog in orders. And so I'll make a particular point of pointing those out as they come to light.

Okay, thank you.

Thank you, James.

Our final question comes from Tahira Afzal with Keybanc.

Thanks. I just had one follow-up.

Could you kind of give us an idea of -- I know you are undertaking some initiatives to improve your DSOs going forward. Could you give us an idea of how you bake that in DSO cash for operations guidance next year, as in, if you are behind to some degree on that, are we still within that bandwidth?

I'm glad you asked that, Tahira, because let me give you my perspective on that. The cash EPS range, or the total cash from operations that Steve Burdick had shared and presented during this call, is based on a constant DSO between 70 to 75 from our two front-end segments; that would be ECS and TSS, and does not actually translate that reduction of the difference between, let me say, 75 days and the 87 days, does not translate that into additional cash from operations.

Now it is my objective that those days are tied up in partial completion, milestone billing and converting the work that we've already completed. So I don't have to spend revenue to get that DSO in. I just got to go collect that money.

And that's what we're very focused on. So if we can drop those days, and you can do the math, we're around $7 million a day, 365 days a year to generate $2.5 billion, that could actually drop to the cash bottom line and actually increase that number you see quite substantially. But we did not factor that into our cash EPS or cash flow from operations in the guidance that we have provided. So that's all up side.

Great. Thank you very much for the clarification.

Great. Thank you very much, Tahira.

And thank you all for you questions and interest in Tetra Tech. I know it's been, from an accounting standpoint, a bit messy with respect to the wind-down of RCM and the earn-out pickups. But I will tell you that we're very excited about the opportunities we have in water and the new challenges that we have for our scientists and engineers and how that our strong reputation in these markets are going to put us in an excellent position as we come into this next year.

We're also very excited about our new alignment that we have in place. And it provides us a very sharp focus for the future and we're very positive on our outlook and our growth opportunities. And with that, I'm going to look forward to speaking to you all next quarter. Thank you very much. Bye.

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