Dan L. Batrack - Chairman, Chief Executive Officer and President Steven M. Burdick - Chief Financial Officer, Executive Vice President and Treasurer.

Corey Greendale - First Analysis Securities Corporation, Research Division David L. Rose - Wedbush Securities Inc., Research Division Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division Noelle C.

Dilts - Stifel, Nicolaus & Company, Incorporated, Research Division Tahira Afzal - KeyBanc Capital Markets Inc., Research Division Will Gabrielski - Stephens Inc., Research Division.

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 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 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.

Now 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 in line with the company's typical seasonal revenue patterns.

Our net revenue was $459 million for the quarter, which generated an EBITDA of $52 million, associated with a diluted earnings per share of $0.41, which included a $0.10 gain from an earnout 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, 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 would like to review our performance by customer and segment. Our international and U.S. 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-based year-on-year growth, with increasing revenues from our Fortune 500 customers, which include companies like Mosaic in the mining industry and then manufacturing with Lockheed and General Motors, Republic Waste, Enbridge. So it's a very, very broad cross-section of clients 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're 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 accelerate as the summer field season in Canada activities ramped up, especially in 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 top line 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, 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 2, it wasn't just the Navy and the FAA, but many of our other long-term federal -- 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 releases 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 Corps of Engineers, USAID and the Department of Energy for the company.

And finally, if you exclude the wind down of our 3 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, funded and authorized to perform by our clients. This quarter, we booked almost $0.5 billion in commercial orders which is a new record for us in that type work.

At the same time, we were awarded significant orders with the federal government, particularly from USAID, division of the U.S. State Department, and the FAA. And we did receive 2 major single award federal contracts, which actually goes into our contract capacity but hasn't yet gone into our backlog.

And this type of work, we do expect this to convert to backlog over the course of contract execution. Now before I asked 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.

And I'm really glad to report that ECS and the TSS business segments, our 2 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 from what we had anticipated coming into the quarter. Our expenses associated with amortization and corporate cost 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 cost had 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 earnout 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 segment, 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'll provide a more detailed discussion of the financial results for the third quarter.

Steve?.

project execution and favorable results in our ECS and TSS groups; a reduction in overhead cost due in part to the rightsizing actions we took last year; and nonoperating gains on revaluing the acquisition-related earnout 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 cost that we took last year.

In addition, we realized the 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 nontaxable nature of some of our earnout 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 earnout 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 earnout 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 -- or the primary driver for this higher net debt last year was the borrowing dues 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 $50 million over the last 3 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 a year-to-date basis, we were on plan and similar to last year 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 remain 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 those 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 poor performance in our RCM segment. But on the other hand, I want to point out that the DSO in our 2 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 of fiscal 2013.

But it also shows what I mentioned earlier, that we've 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 0 while our target range leverage is about 1 to 2x EBITDA.

Although our -- 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 5 this year to shareholders of record as of August 15.

In addition, Tetra Tech 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..

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; does anticipate intangible amortization of $27 million or $0.29 per share, we think we've got that dialed in quite closely; 30% effective tax 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 our shareholders through the dividends and cash buyback, and our end markets are strengthening, in the U.S. 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?.

[Operator Instructions] The first question comes from Tahira Afzal with KeyBanc. Your next question comes from the line of Corey Greendale with First Analysis..

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 I'll say it wasn't that long ago, the RCM segment was performing well.

So I applaud your taking quick action, but what changed so quickly as you think you got to get out of some of these businesses?.

Yes, it's -- the RCM business has performed quite well in primarily 4 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. It's going very well.

We've -- 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 at the best.

It's about a little over $100 million from 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 with solid waste has 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 recovery which is environmental work, the handling of fly ash. And it's very well-positioned to grow so it's gone quite well.

Our 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 before I move to what's not done well, those are the items that have been generating and, collectively, those 4 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 client's almost exclusively the U.S. federal government. We've begun to drift slowly and kind of move from what was core, which is consistent with our water, environmental, energy resource management.

We begin to, as a favor, so to speak or as part of client relationships began to provide services for buildings and other non-core work had begun in the U.S. 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 and Iraq and then following up in Afghanistan. That has gone from cost-plus for water systems to we'll just move adjacent on a slippery slope to buildings and have ultimately ended up in fixed-price work in very hostile work environments. And the reality is with the U.S.

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've mentioned.

So it's spend a little bit on the transportation but it's mostly been the federal government on their U.S. buildings-based work, and on the Middle East, construction activities that went fixed-price..

That is really helpful, Dan. So 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 unit.

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. It -- 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 the loss in the third quarter and with the forecast of this in the fourth quarter of being breakeven are 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, could you comment on what impacts do you expect on the market, the competitive environment, from the AECOM URS acquisition?.

I think it is interesting, they not only announced -- and we watched 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 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 billion dollars, they're moving in that direction and we really are moving in 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, will we -- 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 here today. So I think that they will be very competitive in a market that we're not looking to pursue..

Your next question comes from David Rose with Wedbush Securities..

I have a couple of follow-up questions. One is, I guess, since this is a strategic move you're making, 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. 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 is not changed. 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 the 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 favorable 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 are 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.

And I would call it at a minimal action, which should be one end of the spectrum would be simply exiting the non-core work which we've already embarked, which would represent $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 2 segments.

We are just initiating this. We only just begun this process, but we are going to move quickly through this.

We're already 1/3 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 the 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, in the Utility business, the question is, is there enough overlap with that new landfill business that you like? I mean, I think utilities are your customers as well, the coal-fired power utility.

So is there enough argument for that business?.

That's a good question, David. It's -- well, 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. 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 and -- by 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..

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

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 has -- are there problems or reason that might take us out far -- deeper in time? Just an update on that, I think, would be helpful..

Yes, the time frame's about right. You got that quite well. But 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 look at it in our forecast, it's possible that there is a few dollars, 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 end of September of next year, and we're looking at how we can actually accelerate that..

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 if -- I mean, I know you're going to reclassify the segment.

It sounds like you might.

But if it weren't to be reclassified, if you look at that business just kind of continuing in the 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 expand roughly $720 million of total revenue. Much of it was, in fact, increases in our estimates to 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 costs 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 0 on that if you ran forward and your booking position is proper and you complete the job as expected, you'll have a 0 profit on that job.

So you have $185 million in 2015 at 0. But then you have another $400 million at 10%, let's say. So that's 2/3 at 10%, 1/3 at 0, 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 divested or exited 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 then just, I guess, on the capital allocation plan, Dan, obviously, you've been doing kind of steady share repurchases here but still not seeing 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 2x EBITDA leverage? Or do you feel -- still feel like it's going to be a kind of a slow move there. Thoughts on that would be helpful..

Yes, I think that the board will evaluate this year coming into 2015, as Steve had mentioned, but I do expect that M&A, and it is a focus of ours, that the M&A will contribute. We have moved, I'd say, moved sluggishly but the reality is we haven't move to the 1 to 2x.

We moved back towards 0 net debt, so -- 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 2x. 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 1 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 been having? Margins of that backlog, I think, would be some of the key areas that we'd like to hear about..

Yes. Very little. I want to be hesitant to say none because I know we have small fixed-price projects with our study contracts, small things. But none of it is for fixed-price contracts to go out to an extended period of time. So the margins are consistent with what you've seen in 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..

Our next question comes from Noelle Dilts with Stifel..

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 and the remainder under review included a $14 million project writedown last quarter and -- 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 breakdown.

But have you taken any actions to kind of reduce the risk profile of the Parkland operation?.

Yes, great question. You're right. First of all, it's, with the exception of that 1 project, it's difficult for us to say, it's all going well except for that 1 project when that 1 project is so prominent. So it's -- 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 of that entity to cost-plus. So the risk profile of our Canadian midstream oil and gas, and it's really overwhelmingly 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, in that we moved on extremely fast. And so I would say that's about 180-degree turn.

And with respect to that 1 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, let's 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, 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 till the job's over. And so I feel quite good that we are within just a few days of that being turned over..

Okay, great.

And so just looking at, again, just sticking with profitability on those -- the operations under review, so do 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?.

It's actually higher. I think when I said 7, that was an aggregate of the 01, roughly $185 million plus roughly a 10% on the remaining, ongoing RCM operations. So I would, when you're talking about the ongoing, it's actually closer to 10%..

Okay.

And then can you talk about the increasing subcontractor costs in the quarter? What drove that and if you see that continuing moving forward?.

Yes, actually, what contributed to the increased subcontract costs was our extreme focus on completing these -- our fixed-price construction projects. We don't self perform that much of the RCM work. A lot of it is 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 to -- plus subcontract to equal total revenue, subcontracts are less than 20% of the revenue between TSS and ECS, our Engineering and Consulting Services and our Technical Support Services. It's less than 20%.

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

Our next question is from Tahira Afzal with KeyBanc..

Sorry, folks, for falling off the line, the queue, earlier on. So just have a couple of questions. I'm sorry I lost signal and I might have missed out on this.

But number 1, if you look at the pipeline business, and that's 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 swift translations 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 you with a little more detail. We are seeing that the demand for support of moving the oil and gas products, both gas, NGLs and Syncrude from the oil sands pipelines in midstream is under extreme high demand. We expect that to last for several years.

And it had -- we have seen it move to -- 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've 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've highlighted this earlier on. If you look at where the earnout displacement came from, I believe it's from your utilities business, which is the one you're also perhaps looking to reshape.

If you can talk a bit about the fact, where the weakness really came from, what the consideration was that led to that earnout hit in the second quarter. And -- I'm sorry, in the fiscal third quarter.

And really, as we look at the fiscal fourth quarter, what your assumptions are really around that, that's leading to more of a breakeven type of view for RCM?.

Yes, let me start with your question or observation on the earnout pickup. It was not a utility business, it was actually a solid waste. And it was an acquisition that we did within the past 2 years. When we complete acquisitions, most often, a component of the consideration of the purchase price is included in earnout.

And we, together with the owners of the firms that joined us, identify thresholds or estimates of their operating income that we 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 -- a firm that was in the solid waste business exclusively.

They've actually performed quite well. Did earnout -- did recognize and receive all of their earnout 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 earnout and the sales and purchase agreement thresholds. Therefore, it fell to a 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, that will be with us and we expect to be part of the core business of the corporation. But it's just an artifact of the thresholds and the timing with respect to clarity that they wouldn't meet this threshold..

You've had [indiscernible] recent acquisitions been, i.e.

over the last 2 year or 3 , basically, on October, through the first 3 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 earnouts specifically but clearly, you would have preferred if the situation hasn't arrived for the earnout clawback 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's a bigger advocate and a fan of paying out the earnouts. So we want to see them, we want to see them proceed at all. That's good for them. It's good for us. It's what we expect.

But I would say that the multiple that we're paying, all in, including the earnouts or what I would call -- and I've used this before, I've been very clear on this, they have been -- the acquisitions, including earnouts, 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 7x or less trailing earnings, including the earnouts. And so when an earnout is not realized, the multiple then on a trailing 12 months goes down. And that means we're not overpaying 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 the performance varies a bit in the first few years..

And our final question comes from Will Gabrielski with Stephens..

You mentioned that you may not have to even complete some of these problem RCM projects.

What mechanism or what -- 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, there was 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 call it strategics, sometimes call it financials. But there are entities out there that are in the business of taking and completing projects that are not favorable. So 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 relationship you have with your customers are strong enough that they'd understand what you're doing and why?.

Well, it's interesting. Almost all of this, and almost all of it, with the exception of the Canadian pipeline project, but with the exception of that, all of this is, interestingly enough, the U.S. 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 core, disputing determinations 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 -- it almost sounds to me like the restructuring comes from either selling the contracts or the contract's ending and you're 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 to learn concentration of 0 margin revenue?.

No, there are. So for instance, hypothetically, if RCM was discontinued and moved in -- the other components were moved in to 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'd be a business segment SG&A, it would pretty much go away, right? So that would be one.

Number 2, 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 of 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 conclusion on this.

So there are whilst conceptually 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..

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, and the current forecast with these types of work.

Our 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, into the mid 2s, 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 1 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..