Dan L. Batrack - Tetra Tech, Inc. Steven M. Burdick - Tetra Tech, Inc..

Sean D. Eastman - KeyBanc Capital Markets, Inc. Ryan Michael Connors - Boenning & Scattergood, Inc. Jim Giannakouros - Oppenheimer & Co., Inc. Robert Joseph Burleson - Canaccord Genuity, Inc. Justin P. Hauke - Robert W. Baird & Co., Inc. Noelle Christine Dilts - Stifel, Nicolaus & Co., Inc..

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 will 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. The statements are only predictions and may differ materially from actual future events or results.

Tetra Tech's Form 10-K and 10-Q reports to the Security 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. At this time, I would like to inform you that all participants are in a listen-only mode.

At the request of the company, we will open the conference up for questions-and-answers after the presentation. With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack..

Thank you very much, Erin, and good morning, and welcome to our fiscal year 2018 second quarterly earnings conference call. Overall, I'm very pleased with the results of this quarter. Our strong performance resulted in our achieving the highest ever revenue for the first six months of any year in our 51-year history.

We're beginning the second half of the year with momentum and increased visibility especially for our U.S. federal work. And as a result of our strong second quarter performance and increase of visibility in our outlook, we're raising our guidance for revenue and earnings per share for the 2018 fiscal year.

I'll now begin with an overview of our quarterly results and business outlook, and Steve Burdick, our Chief Financial Officer, will provide additional details on our financial performance, tax and our capital allocation. We had a very strong second quarter.

For our second quarter, our revenue from ongoing operations was $699 million, up 5% from last year. Our net revenue was $533 million, up 3% from the prior year, which generated an operating income of $45 million, which resulted in the diluted earnings per share of $0.54 for the quarter, up 13% from the prior year.

I'd now like to provide an overview of our performance by customer. Our second quarter performance was led by strong growth for our U.S. state and local, our U.S. commercial, and our U.S. federal work. State and local revenues continued to be up this quarter with net revenue growth up 26% year-over-year.

This is our seventh sequential quarter of double-digit growth. This increase was a direct result of water infrastructure work in the high growth states across the Southern United States and our continued support for the recovery phase services in response to the hurricanes and fires that struck the United States at the end of 2017. For our U.S.

federal net revenue, in the quarter it was up 7% driven by strong year-over-year growth primarily with the U.S. Department of Defense. Our U.S. commercial net revenue was also up. It was up 6% year-over-year on a broad base of commercial permitting, technical analysis and design work. And this does include a slight uptick in our U.S.

midstream oil and gas services work. And finally, our international revenue, excluding our oil and gas work in Canada, was up double-digits, in fact, up 17% year-over-year reflecting the strength in our Canadian, South American, Australian economies and the addition of our newest acquisition, NDY, in Australia.

Overall, international revenues were down 10% due to the oil and gas pipeline project we completed in Canada last year. I'd now like to present the performance of our two business segments. The Government Services Group, or GSG, and the Commercial and International Business Group, or CIG. The Government Services Group, GSG group, includes our U.S.

federal, our U.S. state and local, and international development businesses. This group also includes our highly successful emergency response practice and our water infrastructure programs. The GSG business group had an excellent second quarter with an 11.8% margin and double-digit revenue growth of 11%.

The growth was driven by increases in all of their end markets, with continued strength in our water infrastructure and our emergency response work.

The Commercial and International Business Group, or CIG, focuses on our global commercial client base with regional operations in Canada, Australia, South America, and it includes our oil and gas, mining, and our energy practices. The CIG margins were improved this quarter to 7.6%, which is up 30 basis points from last year.

This is actually quite a good margin for CIG, considering this is a low point for their highly seasonal Canadian operations. Revenues for CIG, excluding the Canadian oil and gas work, was up 12% for a broad base of infrastructure work in Canada, Australia, South America and our U.S. commercial work.

I'm very pleased to announce that our backlog this past quarter finished at up over $2.5 billion. Our backlog was up 3.3% sequentially as well as being up year-over-year. In the quarter, we had orders across our international development businesses including new programs with the United States, Australian and UK development agencies.

We also received new orders for our recently awarded contracts with the U.S. federal agencies such as the Federal Aviation Administration and the Department of Defense.

And this past quarter, we were awarded a new $40 million data analytics contract for the FAA where we're working with the agency to design a state-of-the-art system for tracking medical records.

And I'd like to note that Tetra Tech continues to use the strictest criteria for tracking and reporting our backlog, which is only to add contracts that are awarded, funded, and where we've been authorized to go do the work right now.

Due to the recent regulatory changes, by 2019, all public companies in the United States will be required to follow a backlog reporting definition very similar to ours. Now I'd like to turn the presentation over to our CFO, Steve Burdick, to present the details of our financials.

Steve?.

Thank you, Dan. So for those following along on the webcast, in the appendix of this presentation you can find a full reconciliation of our GAAP results which are presented on this slide to our ongoing results, which Dan addressed previously.

So turning to our financial results for the quarter, as Dan just highlighted, revenue, operating income and EPS for the second quarter of 2018 were outstanding. In fact, net revenue of $532.8 million and ongoing EPS of $0.54 both exceeded the upper end of our guidance ranges for the quarter.

The fiscal 2018 second quarter revenue of $700.3 million and net revenue of $532.8 million increased over last year. These increases came from a growth across all our end markets, but were especially led by our state and local projects as well as those activities in the U.S. federal government.

Our continued focus on front-end differentiated consulting and engineering work has resulted in improved profitability for Tetra Tech as well as a decreased risk profile for our overall business. As a result, our second quarter earnings per share of $0.51 increased double-digits over last year.

For the second quarter, cash flow provided by operations totaled $81.3 million. The second quarter is typically a strong cash generator as we move away from the year end and Christmas holidays. In addition, due to the year-to-date 10% increase in revenue, there was a greater need to use our working capital in order to fund this growth.

Our net debt increased year-over-year and totaled $275.8 million at quarter end. Our leverage ratio of net debt to EBITDA remained at the low-end of our target range.

And as a result of our leverage of 1.2 times, we continue to have the ability to invest in our organic growth as well as in acquisitions while having the sufficient capital to deliver returns to our shareholders. Lastly, our days sales outstanding was 92.4 days for the second quarter. Our DSO goal is to be at 75 days or less.

Half of the delta from our actual 92 days to this goal of 75 days is due to the timing of collections from our disaster recovery work that must be processed through several layers of the federal and local government agencies. The other half is due to various ongoing claims that are in the process of being concluded upon with our clients.

These are both timing issues, which should result in improved operating cash flow in future. Our capital deployment strategy calls for balance of investing in our business, managing the balance sheet and returning cash to our shareholders. So, we continue to target a net debt leverage ratio of 1 to 2 times.

So, let me update you on what we've done to-date on capital allocation. We've closed three strategic acquisitions in fiscal 2018; Glumac, BridgeNet, and as Dan just stated, most recently NDY. Ultimately, our strong free cash flow also provides us with sufficient capital to return to shareholders through both buybacks and dividends.

For the second quarter, we paid $5.6 million in dividends and bought back $25 million in stock. And just this week our board of directors approved our 17th consecutive dividend to be paid in June. In fact, we are increasing this dividend by 20% to $0.12 per share per quarter.

Delivering significant returns for shareholder remains a key part of a balanced capital allocation strategy and we plan to continue to provide strong returns for shareholders in the form of buybacks and dividends throughout fiscal 2018. Thanks for your time today and I will now hand the call back over to Dan..

this guidance does exclude $0.18 per share of the one-time impact for the U.S. tax law. That does include intangible amortization of $18 million or $0.22 per share for the year.

Thus anticipate a 26% effective tax rate for the full year, an approximate 57 million average diluted shares outstanding and it does exclude any contributions from acquisitions that we would make in the second half of this year.

In summary, we had a very strong second quarter with net revenues and earnings per share exceeding the high end of our guidance for the quarter. Our strong water infrastructure and hurricane recovery services in key regions of the United States resulted in the seventh consecutive double-digit growth of our state and local business.

The recently passed U.S. federal budgets and strengthening oil and gas markets provide us with greater visibility and upside opportunities in the second half of this fiscal year. And as a result, we've raised our quarterly dividend by 20% and increased our full-year guidance for both net revenue and earnings per share.

And with that Erin, I'd like to open the call up for questions..

The question-and-answer will begin now. Our first question comes from the line of Sean Eastman from KeyBanc Capital..

Hi, Dan, congrats on a solid first half. I just wanted to start out on 2019.

I realize it's earlier than you'd like to provide guidance, but I'm just hoping that you know maybe you can speak to what your markets are telling you in terms of a sustainable growth rate and what could be some of the really key incremental drivers for 2019 particularly given that this year we've seen some pretty outsized growth in the couple of your core markets?.

That's a good question, Sean, and we're certainly not providing guidance into 2019 but we certainly would be happy to share with you what we're seeing in the marketplace as we enter the second half of the year. And they would be indicative of how we expect things to set trends moving into next year. Each of our U.S.

government markets are actually growing quite well. And if you start with the largest single market for us or a single set of clients with U.S. federal government, we expect that to continue to grow at a 5% to 10% rate. You can see for this past quarter we're right in the middle of that 7%.

And now with clarity on the budget, we actually expect that that could increase as we move toward the second half of this year and it would look to probably continue that momentum. The one nice thing about the federal level, they actually increased the debt ceiling and passed it for a two-year period.

So, we don't expect that this will have another short-term review and sort of provides not only a view for one-year of the funding levels, but actually two years, so that looks – looks a bit more promising. State and local, it is interesting, we've – it's been great, it's 26% this past quarter about 9% of that was on the emergency response.

But what I would call our sustainable underlying baseline work of water infrastructure for municipal entities, cities, states, counties, was up at 17% for this past quarter. We expect that to continue at a 10% to 15% rate. There is actually a rising tide.

We've seen additional funding at the states because of bonds, because of tax receipts and others actually mean that there's more dollars going into these programs. So, we do think it has a longer term sustainable support. And there's been a lot of consolidation in our marketplace, which has created a lot of disarray.

So, we have had the opportunity to take market share, which has put us at the upper end of that range of 10% to 15%. In fact, we've been well over 20% in our baseline work. We were above that again this last quarter at 17%. So I expect that to continue well.

I don't want to understate the emergency response or the disaster response activities, because while we get an early very large revenue and quick response to support the short-term needs, longer-term funding, particularly with the federal appropriations of just under $90 billion to actually evaluate what can you do with this infrastructure to make it more resilient, what can you do to recover it, move it, harden it? And those are projects that are actually much larger and much longer, and that's what we would look to transition our short-term work to longer term.

And that largely comes through our state and local clients where we have 400 different clients in standing task orders and contracts with those entities across the country. Now, of course, the one that can be up we don't have it baked into our guidance is – it falls under our U.S. commercial and actually our Canadian activities is oil and gas.

And I will say in Canada, things actually are looking a bit better. In fact, I'd say in the last 30 days to 60 days, we've had more bidding opportunities than we've had in the past year-and-a-half. And so, we do think that that is looking brighter. Now bidding opportunities don't need revenue yet, but it is something we'll keep you updated on.

In international, I just couldn't be happier with the infrastructure support that we're getting on bids and performance in Canada and actually the synergies of the entities that we've acquired in Australia working together.

And as I shared in my prepared comments, we were at 17% international this last quarter if you just take out the one oil and gas project in Canada, and that actually puts it among the best performers in the company. And I see that actually continuing.

So I know that's a little bit of a long answer, but that sort of encompasses all of the major operations in the company out to the end of the year and gives some insight going into 2019..

No, that's helpful. It sounds like there's a lot of momentum, really broad based momentum, across the business. You're hinting at a pretty strong positive growth outlook being sustainable, and I'm looking at the backlog here, it's up around 1% year-over-year.

I assume with what you're saying about the federal budget visibility and potentially some oil and gas that you are expecting some pretty good backlog momentum here in the near-term?.

I do think backlog does look favorable. I'm really glad to see it move back up from last quarter, and this is in light of really very slow federal orders. So, it wasn't the U.S. federal government that drove the backlog going up, it was really broad based contributions from all of the other sectors; state and local, U.S.

commercial, all across international. And so with a little bit of contribution from some of the spending being put in place from the budgets that were just passed at the federal government, we'd look for that to have a favorable longer term continued upside on the backlog trend.

And by the way, at just over $2.5 billion, I believe it's about the third highest backlog in the company's history that we've ever completed a quarter at. So, it's not that far from an all-time high where we're at right now. So, to move up from here is actually pretty encouraging for the company..

Awesome. Thanks so much. Helpful responses..

All right. Thank you, Sean..

And our next question comes from the line of Ryan Connors from Boenning & Scattergood..

Yeah. Great. Thanks for taking my question. So, I wanted to talk about margins a little bit.

It seems like you had some very nice positive momentum on the gross margin line, and I wondered if you can talk to us about the drivers there, in particular whether the improved labor utilization you've talked about in the past is playing a role there, and then where you see that headed going forward?.

Yeah, that's a good question. I'm glad you took note on the gross margins. The, obviously one of the entities that had helped us and was a pleasant surprise during the quarter was the performance in the CIG Group.

It was up 30 points year-over-year, and actually, that's the entity that had the oil and gas large contract that we had in Canada a year ago that was actually quite significant. And with it actually not being present this year compared to a year ago, I expected more pressure and actually it to be flat or even slightly down year-over-year.

But it was up 30 basis points. And that translates into utilization, more work. We actually saw more orders in the U.S. side on the commercial within CIG, and so that actually worked out quite well for us and did translate into the performance for CIG and contributed to the gross margin being up.

I'll also say that utilization with the revenue increase is quite a significant increase in the Government Services Group as it translates into having our existing staff more utilized does contribute to the gross margin, so we don't need to add additional overhead to generate that revenue.

And finally, here at Tetra Tech, we've been very focused for a number of years. We're well over a decade in having moved the entire company to a common platform. So you join Tetra Tech, we actually want to make life easier. We want to run the company in a single accounting, HR, project management platform.

And we did complete a number of the newer acquisitions translating them over to – transitioning them over to our platform, which actually caused us to have to spend less on multiple systems, which then translated over to a greater gross margin. So, we do think those are all increases that should be sustainable.

And the one that I'm really looking to see a move in is CIG. CIG has had – so the Commercial International Group has had margins that are below our Government Services Group because of the cyclical low position we've seen in commodity prices.

And with many of the mining activities now looking like they're coming back, a little bit more stability and upside on oil and gas, it would be great to see our CIG Group not only match our Government Services, but to outpace it.

And I think that probably won't outpace it in 20 – the remainder of 2018, but certainly that's possible in 2019 and that will do a lot to the collective margin of the company. It'll show up and gross, it will flow all the way through operating income and you'll see it in EPS.

So, the upside, GSG has been a great performer, very steady, very predictable, but I think it might be time for CIG to make its big comeback and actually lead the way for us..

Great, that's very helpful, a detailed response. And my second one, Dan, was actually more, more a bit of a housekeeping item, contingent consideration was a headwind in the quarter, obviously you don't look at that as part of your ongoing EPS and guidance. But you know there still is a fairly material liability there on the balance sheet.

So, can you just give us any color about, how we might think about modeling that going forward?.

I'll let – Steve Burdick will update exactly what moved in the quarter on it, because it has sort of a – the opposite effect of what you might think. But our acquisitions all of our acquisitions have joined us, have a contingent consideration which by laymen are known as an earn out.

And so, we do want to make sure that they're actually bought into us that they perform in alignment with what they financially anticipate. And our goal is that we would actually pay every bit of that out.

It actually is embedded in the purchase price and we have a great track record of the performance of the acquisitions, meeting or exceeding their actual performance in the quarter.

But the accounting rules have an interesting opposite impact on the company that if they beat what they even anticipated performing, we do take small charges and actually, I'll have Steve speak to that as to what that impact was just here in the second quarter..

Yeah. Thanks, Dan. So, in the quarter we had about $1.9 million in contingent consideration charges and that resulted, as Dan alluded to, better than expected profitability for two acquisitions. One was an Australian environmental acquisition from a prior year – or from last year.

So they just completed their first year and they did better than expected, so therefore, you're now – that we paid was more than what was originally anticipated. The second one was a solid waste acquisition that we acquired three years ago.

They're completing their third year in their final earn-out, and as a result of their better than expected profitability, we also are paying out more for the earn-out this year than what was expected. So, that's really where it was coming from in the quarter..

Yeah, and Ryan -.

Got it..

...just to note here that it's a point that I think is important for others that have looked to join us that we have paid out in almost all instances the full amount of earn out. And in fact, even greater numbers than anticipated, because of course folks are concerned that if this earn out perhaps is not going to be realized.

Those that have joined us not only realize that number, but the great example this past quarter even more than that, which is actually reflective of a higher than expected performance than they even came in at..

Got it. Okay.

And then I do have one last one, little more bigger picture type question but there's been some talk it seems in some of the industry trade rags about design firms moving back downstream and adding construction and contracting capabilities, that seems like a bit of a reversal of where we've been moving in the industry the last decade or so and certainly runs counter to the direction that of Tetra Tech has moved.

So can you give us your take on that, what that means from an industry perspective and whether your thinking has changed there at all?.

Yeah I think it's a great question, that's just a great question and I think, what I've observed, I've been in this industry for many decades now personally and of course of the company 50 years and I think, what happens is – what is happening is just really been a fork in the road, so to speak two divergent areas.

And those companies that have consolidated and become larger and it's done more significant transformational acquisitions and in order to perpetuate these larger, to move a much, much larger firm you need a much larger project, which is typically construction. And that's where they've gone.

That is really size over – sort of size over quality or quantity over quality. We are highly focused on quality over quantity and that goes all the way from acquisitions to the type of work. We are a consulting design engineering firm. There's no doubt that's what we are.

We do have the ability with professional capability to follow it all the way as owner's engineer and even provide oversight of the construction and compliance with the design specs of materials, but we have watched a number of firms that are – have gone construction there are many out there that that is their legacy their heritage and they are fantastic at it and we love to team with those folks and become partners and in joint ventures where we do take projects on a full turnkey basis, we'll have them as key partners or subcontractors and vice versa when the construction leads.

But those that are inherently consulting firms or consulting and engineering firms and look to move into construction.

We have seen it be – quite a high risk and generally and we speak this firsthand because we did experience this in 2012, 2013 and saw the light that fortunately in time to backup, put the company in reverse backup and go back down the proper path.

But that the cost, the risks and liabilities of construction when that isn't your first calling of what your company is about can be huge liabilities, and those that recognize that and backup in time will be bruised and battered.

And some of the DSO that Steve has talked about with receivables, even three, four years later are still on items that we're working through on that decision that was made four years ago.

Those that embark upon it now can save their company, those that don't, I can actually, I mean, offline give you a big list of those that didn't backup in time and don't exist today..

Great. Well, that's really instructive. Thanks for your time this morning..

Great. Thank you very much, Ryan..

Our next question comes from the line of Jim Giannakouros from Oppenheimer..

Hi. Good morning..

Good morning, Jim..

If I may tack on to a couple of Ryan's questions, I would have expected just because you've migrated more to I thought cost plus et cetera away from fixed price, as you kind of migrated away from project activity, I am still seeing that 32% or so level in fixed price, that's comparable to what you were doing in fiscal 2015, why hasn't that shifted? Is that a reflection of that you are taking on lower risk fixed price on the frontend, how can, how should I understand that line in your disclosures?.

Yeah that's a great – that's a great observation. I will say that not all fixed price is created equal, not at all. And in fact our goal is to take on fixed price contracts where we have a expertise and where a client has asked us to do something. So, if it's, can you design a pump station for a fixed price? We've designed many thousands of them.

They want certainty in design around designing of a pump station we know how many sheaths it will take. We know what the calcs are, what the structural components are, what – all the different aspects of it, we have typicals to take off of. And so, let's say it's a $1 million dollar design project for a pump station for example. You know, it can rain.

It can snow. We can have strikes out there and it doesn't impact our ability to complete that project on time, on budget in a favorable margin. Whereas $1 million construction project would be fixed price, it has risks of weather, has risks material, has risks of labor and has work – risks of warranty.

And so, while they both would be called fixed price, one actually is fully in our control, it would be self-performed. And the other is something that we're heavily reliant upon others in areas outside of our control and furthermore.

The fixed price is typically direct negotiated on the technical services or the consulting work that we do with our clients under existing contracts where quite often fixed price construction activity would be sometimes we refer to it as rip-and-read for the government, which is just rip open the sheets and see for the lowest prices.

So, I think we have moved while the percentage doesn't look appreciably different. The actual execution and the quality of the work is night and day. It could not be farther different than what it was several years ago..

That's helpful. Thank you. And on Ryan's question on the margins in both segments, I mean, you gave good color that you think Commercial can bounce back with oil and gas if and when that does rebound.

But in Government Services, I mean, I've always thought that 13% or so is kind of the entitlement margin level or at least really good and healthy level year to there.

Does that move either way with how you envision your mix of business or a competitive environment as federal grows going forward? How should we be thinking about the margin progression there? Thanks..

Yeah. It's around 13% so what we've seen an annual basis, we've been hitting that or slightly better here with the GSG Group. We do believe that based on utilization or really volume in that group, that margin could go up a bit from there.

And we have been performing higher than that particularly in the summer quarters where we've got a lot of our field crews and survey folks out busy. That's pretty happy at 11.8% in this winter months of January, February and March with the Government Group. So, I do think it has a bit of movement, but I think 13%, could we do 14%, yes, for annual.

Could it get 15%? Possibly. But by the nature of the government work on T&M cost plus largely, I do believe it's range bound within a point or two with respect to the upside. And so that's not what's going to be the primary driver of the overall enterprise's margins going up. You have seen CIG and as you mentioned, we do have opportunity there.

I said 8% or so, 9% at the bottom of the cycle. At the top of the cycle, it will be between 15% and 20% and our governments are between 10% and 15% depending on where on the government funding they are. So, the swings are much larger and it could put the collective company then at longer term we could hit 15% or greater if we hit the top of the cycle.

So, CIG or the Commercial and International activities will be those that have the greatest range. And since we're at the bottom, it has the biggest upside. But I've actually been very happy with the numbers that have been – have performed out of GSG and there is some upside, but it's not significant on margin, it is on revenue.

So, top line will drive that operating income generation..

Got it. Thanks. And one more, if I may, on the guidance for the rest of this year. I mean, you seem comfortable on the federal side, commercial seems strong, oil and gas firming, as you've mentioned.

But your outlook, correct me if I'm wrong, first – it really reflects first half outperformance, it doesn't really reflect an increase in the fiscal second half outlook.

Can you talk about what's keeping you conservative there, and then any color on revenue breakout? I apologize if I missed any comments on your – on what's embedded in your guide from a segment perspective net revenues? Thanks..

No, I think you've got it exactly right, Jim. What we did is based on the outperformance of the beating of our own guidance, our own estimates for Q1 and Q2, we just flowed that through the annual guidance. So that's what the amount has increased. Certainly on the revenue side, we have had a bit better margin.

So, you did see us move the increase on EPS even more so. Now, there's – a little bit of that is tax, no doubt about it, the new tax legislation was put in place. But we went from – I'll give an example. On our guidance coming into the fiscal year, we were at $2.20 EPS, and with this latest increase, we've gone up to $2.50.

So, we've increased it $0.30, and that actually is much greater than what just the beat in the Q1 and Q2 because we didn't beat by $0.30 in the first two quarters. Now again, there is some contribution from tax.

What we did do is we already had embedded in the year's forecast for ourselves increases in federal between 5% and 10%; state and local, 10% to 15%; U.S. commercial, 5% to 10%; and international, ex the Canadian issue, a large project twilighting, 10% to 15%. Those are all pretty healthy numbers.

They were already embedded in the growth rates, and so that's why we didn't move up it even further in the second half with those numbers increasing because we already had embedded pretty healthy growth rates..

Okay. Thank you.

And any color on the growth rates by segment expected – the expectations there for FY 2018?.

We do have those. I'll just give you those by segment. GSG, government is between – state and local were between 5% and 10%, and that's with the international development. About 5% – our federal between 5% and 10%, and state and local 10% and 15%.

So, it puts you between both of those at sort of a middle-to-upper single digits, which you've seen between 7% and 10%. And on – if you ex oil and gas, we've seen it between 5% and 10% on our CIG, ex the one project in Canada..

Thank you..

Great. Thank you, Jim..

Our next question comes from the line of Bobby Burleson from Canaccord..

Hey. Good morning..

Good morning, Bobby..

Curious if we can – it sounds like mining is coming back somewhat and in Australia to a certain degree. And I'm wondering if we can maybe characterize or go back to the way we discussed the Coffey margins in the past. It seemed like mining coming back was – it was always kind of a call option on that.

Can you just kind of talk about what the potential impact on margins might be if we think about the Coffey business in Australia?.

Yeah. That's – you've got that exactly right. So, we actually, at the very bottom of the cycle when Coffey joined us a few years ago, had very low margins, sort of just above breakeven.

We believed that by adding additional work for them in some of the municipal and government clients that we have that we could bring them up to 10%, and which we're right about there. We did achieve that in roughly one year going from breakeven up to right about double-digits. We're happy there. But that was without the mining work coming back.

At the top of the cycle, you've seen reports from other mining sector clients. These numbers are 20% and north. They're about a $200 million a year operation in Australia itself in the immediate surrounding area. And so, if you think about that, we're at 10%. We could double that number if we get to the top of the cycle.

Now, we're not anywhere close to that. In fact, we're just hopefully getting some lift off of the bottom. So, it will be incremental on the upside. But we think that number could add in their particular region and their generation as many as an additional 10 points. So you can do that math.

On $200 million, you can get $20 million, which is actually pretty meaningful to the company..

And it sounds like not much head count growth would be necessary to do that?.

No, I think it would require some head count growth. We did downsize one thing that we were aggressive on with our management in Australia was we did actually to get to the 10%. It wasn't just transferring work across, it was actually rightsizing our back office indirect expenses. So, we did close down offices, we did downsize staff.

So we are, as is the hallmark of the company, we do staff to the work we have. So if....

Okay..

... we pick up that type of level, it would drive both top line, it would drive margin, and we would need to add staff..

Okay.

And then in terms of disaster recovery, we've got this $89 billion supplemental funding at the federal level, and I'm wondering when do we see those dollars flowing through? And this next phase of work you guys are doing, what's the size of those types of projects, and any difference in the margins you might see?.

The timing is – we have included in previous quarterly investor calls and we've had it – I believe it is on our home website with respect to sort of the different phases of the work.

So, when an event takes place in the first three months to six months, that was our first quarter and part of second quarter is get out there, do the initial valuation get things up and operating that's sort of the initial emergency response activity. They're hallmarked quite lots and lots of projects, high spend and short duration.

Then we typically will go down, you'll have and projects then will begin to come about at the roughly the one-year period and then they'll go out for several years, which is actually doing a more detailed engineering structural evaluation, civil evaluation process incoming up with feasible alternatives. We have had some success in that area.

Historically, we've been primarily focused just on the first phase. But we're very focused on what I think is actually the strongest aspect we have technically, which is what do you do to fix it now so that will last and what do you do to harden it or make it more resilient, and that can even include pick it up and move it to higher ground.

And so those are things that we're doing now.

We've had some good success at the local level, at the programmatic level, and I expect there to be a slight dip in the spending that you – typically quarters three and four after an event and then pick back up, and they will be larger projects typically 10 times the size and duration that are typically measured in years.

So, anywhere from one to three or four years. And so I'd expect to see those actually pick up probably be in early fiscal year 2019. And they would actually be larger and longer in duration.

And then of course once the selection of the alternative has been done and that you've done the feasibility study that would work into a preliminary design then it moves to actual implementation and we could be the consultant design, an oversight engineer or the owner's engineer and those projects are another order of magnitude larger than even the feasibility and those will go out five to seven, eight, even 10 years which we saw on Katrina down in the New Orleans area..

Okay, great. And it sounds like there's better visibility at the federal level in terms of this two year funding. And I'm wondering is that changing the types of projects you're seeing.

Is there going to be a longer duration work that maybe you hadn't been seeing when we were kind of just with one year visibility?.

We hope so. We hope that it actually gives a bit more confidence to those at the different civil and defense departments that we work for. But to be fair, we're just over 30 days since it was actually just signed. And so, we're still very early on that.

And I think we'll be able to give more insight – first hand insight probably in the next quarter or two, as we see it translate from. We now have the money and the funds and we're able to then move it to appropriations and projects that move forward. So, we're really very early on it.

But it is a good sign that they can add additional confidence that they can move forward with the funding that's in place..

Okay, great. Thank you..

Great. Thank you very much, Bobby..

And our next question comes from the line of Justin Hauke from Baird..

Thanks. Two really quick ones here. So, just on the emergency response work and I appreciate your comments on the opportunity that it would develop over time. But just to kind of orient expectations for next year, it looks like the impact was about $5 million for the quarter and about I guess $25 million year-to-date.

So, it's – you know, call it 2% of your revenue.

Should we be thinking of that as a headwind, looking into the beginning of next year because that that work is lumpy and the longer term opportunity wouldn't be as programmatic on that or is that not the right number to be thinking about?.

No. I think you've got the numbers pretty good.

So, I think that and we've been aware of this that given the response work we did at the very end of the fourth quarter, which is really the month of September we're in the federal calendar but really primarily in our first quarter, which was the month of October-November-December, those were the months that we did roughly $25 million of incremental additional contribution to our first quarter of this fiscal year, which of course help drive this up to a record performance in this first half.

It will be a difficult comp on our state and local work, because of that contribution if no additional events take place, then you would have that, it will partially be offset we believe by work that will do on the more programmatic level identifying longer term solutions. So, I think that will be mitigated, because that does ramp up.

Now if you do have another active hurricane or flood season or storm season and you end up with something similar to last year and you have this programmatic work, if you put those two together you could actually say, you'd build up higher even than last year. But you're right they are episodic, they are lumpy.

And certainly we are doing some work for many municipalities in preparation for the hurricane season that starts in June officially and the preparedness work so that perhaps the impacts won't be as much. But our year-to-year comps that will be a bit more difficult on state and local really will become most acute in Q1 of 2019..

Okay, good. That's helpful. I just wanted to make sure we were kind of thinking about that the right way. And then the second part of the question sort of same theme, but obviously the Commercial margins were good this quarter.

Government Services Group were down a little bit, I was a little surprised by that given that the storm work was a little bit higher margin.

So, was there a difficult comp on that on a year-over-year basis or anything else in the margin just for the segment?.

Yeah, that's a great point. I thought we were pretty good during the second quarter. What I would call representative of our ongoing operations in Government Services of 11.8%, that was actually a very solid, in fact maybe even a little better because of our revenue flow through than we'd expect.

Yet that was 100 basis points or 1% lower than we had last year. Last year we had a lot of projects on our Government Services side that actually came to close out and as part of close out and better performance on the projects we had pickups.

And so, there were one-time adjustments for absolute completion of the projects and that's why last year if you take a look in the Government Services Group, it was really an all-time high margin quarter. So, it's a year-to-year comp. It is not a has something come down..

Got it..

It is down from that comparable, but if you take a look at historical performance in the second quarter, the Government Services Group was really, really on top of their game..

Yeah. Okay. All right. I just wanted to check on that. That's it. Thank you. Appreciate it..

Great. Thank you, Justin..

And our final question comes from the line of Noelle Dilts from Stifel..

Hi. Thanks. First, I just wanted to dig a little bit more into Canada you talked about seeing some improving conditions there.

Can you talk about what you're seeing particularly on the oil and gas side of these bigger projects or more kind of small-to-medium opportunities that you're seeing?.

Yes, in fact, what I would say is the increased opportunities in Canada have really been in the oil and gas midstream, so the pipeline sides for us. It's been mostly small to middle diameter of work. It's not been on the large transmission for us.

So, we have seen more that have come out, they have come out from the majors up there, and we have responded to those. We should know here as we enter towards summer, if we're successful or not.

We do think that things have picked up a bit and some of the capacity of some of the very large transmission folks have gotten busier with a few projects that were awarded a year ago. So, perhaps there is a little less supply in the market, some have been driven out of the market, others have gotten a bit busier because of other types of projects.

So, we hope the competition is a little bit down. The necessity or the priority of actually having these projects online at a given time schedule actually increases the likelihood that they'll go forward and that they need someone who has available capacity and that's definitely us.

So, that's where we're seeing the increase in Canada and it is mostly in Alberta is where we've seen it, which is also coincident with where our capability and resources are. So, we would hope to be successful..

Thanks. And then second, I recognize this is a sensitive topic, but Tetra Tech has been in the news recently on this Hunters Point project.

So, can you just help us understand what you think is important for investors who are seeing these headlines to know and really what we should think of as important from an investment perspective?.

Yeah. Well, it's a good question, Noelle. We are definitely aware of the allegations of former employees of a subcontractor that had worked for us up in the Bay Area.

I will say, we've come out publicly both with press releases and I'll repeat it that we emphatically deny these allegations and this extreme speculation and outright sensationalization in the media. In fact, the relationship to it in reality is long since departed in the most significant ways.

We do stand by all of the work and these allegations are definitely not representative of any part of Tetra Tech whatsoever. Now with all that said, we do take any allegation regardless of how salacious it is very seriously. We are investigating and assessing these further.

We have taken this seriously and looked into it immediately upon being aware of these, which actually goes back many years. This is for activities that took place primarily a decade or more ago and these are allegations from someone who is a former con – a former employee of a subcontractors quite removed.

We will give you an update if there is any impact if any as our assessment develops that's really sort of an overview of that activity..

Thanks..

Thank you, Noelle..

Well with that, I'd like to thank you all for your insight, for following the company, for your questions and interest in Tetra Tech, and we really do look forward to the second half of this year and speaking with all of you again on next quarter. Thank you very much, and goodbye..

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