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

Sean D. Eastman - KeyBanc Capital Markets, Inc. Andrew John Wittmann - Robert W. Baird & Co., Inc. Noelle Christine Dilts - Stifel, Nicolaus & Co., Inc. Ryan Michael Connors - Boenning & Scattergood, 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. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the Investors section of its website at tetratech.com.

This call is being recorded at the request of Tetra Tech, and this broadcast is the copyrighted property of Tetra Tech. Any rebroadcast of this information in whole or part without the prior written permission of Tetra Tech is prohibited.

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. I would like to direct your attention to the Safe Harbor statement on page 1 of today's presentation.

Today's discussion contains forward-looking statements about future growth and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in Tetra Tech's periodic reports filed with the SEC.

Except as required by law, Tetra Tech takes no obligation to update its 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 Investors section of Tetra Tech's website.

At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions-and-answers after the presentation. With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack..

Great. Thanks, Jennifer, and good morning, and welcome to our fiscal year 2018 third quarter earnings conference call. Overall, we had a very good quarter. Our third quarter generated record revenue, and earnings per share for the company. We had strong double-digit growth in all four of our market sectors.

And consistent with our strategic focus on high-end services and margin expansion, we increased our EBIT margins by 100 basis points over last year. We continued to focus our business on high-end services primarily by expanding and investing in our consulting services. We're also reshaping our portfolio slightly with this plan.

At the end of the quarter, we completed the sale (02:27) of a non-core unit that was focused primarily on utility services. Steve Burdick, our CFO, will talk more specifics about the financials associated with that activity.

Based on our strong performance and outlook, we're raising our guidance for fiscal year 2018 for revenue and earnings per share for the third consecutive [Technical Difficulty] (02:46).

I will now begin with an overview of our [Technical Difficulty] (02:50) results and business outlook and Steve Burdick, our Chief Financial Officer, will provide additional details on our financial [ph] performance (02:56), our tax position and our capital allocation. We had a strong third quarter.

For our third quarter, our revenue from ongoing operations [ph] was (03:07) $161 million, up 12% from last [Technical Difficulty] (03:11) and a record for any quarter in the company's history.

Our net revenue was $569 million, up 14% from the prior year, which generated an operating income of $60 million, up 26% from last year, which resulted in a diluted earnings per share of 71%, up 34% from the prior year, also setting a new record for the company. I'd now like to provide an overview of our performance by our customer.

Our third quarter performance was led by strong growth from our United States state and local clients with additional significant contributions from our U.S. commercial and our U.S. federal clients. Our state and local revenues continued to be up this quarter with a net revenue growth of 26% year-over-year.

This is our eighth consecutive quarter of double-digit state and local growth. This increase was a direct result of our water infrastructure work we perform in the high growth states across the Southern United States, and the recovery, assessment and engineering services that we provide for disasters that have struck the United States in prior years.

Our U.S. Federal net revenue in the quarter was up 10%, driven by a strong year-over-year growth, primarily with the U.S. Department of Defense. Our U.S. Commercial net revenue was also up at 13% year-over-year for a broad-base of commercial permitting, analysis and design work. And this does include an increase in our U.S.

midstream oil and gas services to support essential pipeline development. And finally, our international net revenue was up double digits and 16% year-over-year, reflecting the strengthening Canadian, South American and Australia economies, also includes the addition of our acquisition of NDY [Technical Difficulty] (05:04) earlier this year.

I'd now like to present the performance of our two business segments, the Government Services Group, or as we refer to it, GSG, and the Commercial and International Business Group, or CIG. The Government Services Group, GSG, includes our U.S. Federal, our U.S. state and local and our international development business.

This group also includes our highly successful discovery practice, our water infrastructure programs, our international development businesses. GSG business group had an excellent third quarter with a 14.7% margin in double digits revenue growth of 13%. The growth was very broad-based across all of the major end markets.

The Commercial and International Business Group, CIG, focuses on our global commercial client base with regional operations in Canada, Australia, South America, and includes our oil and gas, mining and energy practices. CIG's revenue grew by 16% driven by infrastructure work in Canada, Australia, and South America. U.S.

Commercial oil and gas services and U.S. environmental remediation programs also grew during the quarter. The CIG's margin of 10.4% in the quarter was consistent with last year's margin. However, if you exclude just our Canadian oil and gas turnkey services practice, CIG's margin would have been 12.1%, an expansion of 170 basis points over last year.

We completed the third quarter with a backlog of $2.435 billion. We maintained a strong backlog even with the record revenue that we had this quarter. We did book over $700 million in new orders this quarter, and we're seeing a substantial uptick in the number of task orders being released, as the U.S.

government agencies obligate funds from their budgets that were passed just this past March. In the third quarter, we won new programs for international development in the Ukraine for energy security at $85 million; and in Madagascar, for our community programs at $22 million. Both contracts and programs are single awards for Tetra Tech (07:26).

And we continue to build our capacity with the [Technical Difficulty] (07:30) Army Corps of Engineers with the new $60 million in definite delivery, in definite quantity contract for engineering services for locks, dams, and inter-coastal waterways, for the Pacific Northwest region [ph] of the United States (07:43).

As expected, orders are [ph] continuing to (07:47) increase as we enter the fourth quarter, and as the [Technical Difficulty] (07:51) continues to make its way through the federal contracting systems. Now, I'd like to turn the presentation over to Steve Burdick, our Chief Financial Officer to present the details of our financials.

Steve?.

Yeah. Thank you, Dan. So, I want to point out that in the appendix of this earnings presentation, you can find a full reconciliation of our GAAP results, which are presented on this slide to our ongoing results, which Dan just addressed. So, now turning to our financial [Technical Difficulty] (08:19) for the quarter.

As Dan just highlighted, revenue, operating income and EPS for the third quarter 2018 were outstanding. In fact, net revenue and ongoing EPS both exceeded the upper end of our guidance ranges for the quarter.

The fiscal 2018 third quarter revenue of $764.8 million and the net revenue of $570.4 million, increased by 12% and 14% respectively over last year. These increases came from growth across all of our end markets where we are focused on our high-end consulting and engineering services for water, environment and infrastructure.

In addition, our operating income and margin grew faster than our revenue. The increase in the margin is due to improved utilization of our professional staff, while being more efficient in our operations by controlling our G&A and facilities costs.

As a result, our third quarter operating income of $55.5 million and EPS of $0.59 increased double-digits over last year. Further, I do want to point out our SG&A costs, as a percentage of revenue and net revenue, decreased from last year when compared to the third quarter of this year after taking into account two items.

First, we had a true-up of our non-cash increase – of our non-cash stock-based compensation this quarter compared to last year. This was a result of the increase in our stock price, which is applied to the performance-based shares that we have.

And second, we recognized a net loss on a divestiture of the non-core assets amounting to about $3.4 million, which is also recorded in our SG&A. In the third quarter, we divested non-core assets primarily relating to our utility field services.

This divestiture (10:14) will result in core business produce – in our core [Technical Difficulty] (10:18) improved operating margins in DSO while [Technical Difficulty] (10:22) our CapEx spend. Now from a cash base, this divestiture transaction had a positive impact. However, from a GAAP or book basis, we did record a loss.

A majority of this loss is due to the non-cash charge for the related goodwill, which is not tax deductible. And so, the impact [Technical Difficulty] (10:41) EPS loss of about $0.11 this quarter, which is the majority of the difference between our total GAAP EPS and our ongoing EPS.

So for the third quarter, cash flow provided by operations totaled $52.7 million. The third quarter is typically a strong cash generator which is the case this year. Our net debt totaled $223.6 million at quarter end and resulted in a leverage ratio of 0.9 times.

Looking at our balance sheet, we continue to have the ability to self-fund our organic growth and invest in acquisitions while still having sufficient capital to deliver returns to our shareholders. Lastly, (11:26) our day sales outstanding was 81.3 days for the quarter.

We decreased our DSO by [Technical Difficulty] (11:33) from the second quarter of this year largely due to the collection related to the receivables on our disaster recovery projects, which was a timing issue that we discussed on last quarter's call. And we do remain committed to a DSO target of 75 days or less.

Now turning to our capital allocation strategy, this calls for balance of investing in our business, managing our balance sheet and returning cash to our shareholders, and we continue to target a net debt [Technical Difficulty] (12:05) ratio of about 1 to 2 times.

Just to point out, we just recently closed on an [Technical Difficulty] (12:11) credit facility. And overall, the total facility [Technical Difficulty] (12:15) $1 billion and is comprised of a term-loan, a revolver and an accordion feature.

The credit facility extends to July 2023, and the amended facility lowers our borrowing cost while providing greater operational flexibility. This credit facility provides Tetra Tech the further ability to drive growth and support our long-term strategy through organic and acquisitive growth.

And our strong free cash flows allow us to continue to utilize our capital to return cash for shareholders through both buybacks and dividends. And for the third 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 18th consecutive dividend to be paid in August of $0.12 per share. And so delivering significant returns for shareholders remains a key part of our balanced capital allocation strategy. So, I want to thank you all for your time today, and I will now hand the call back over to Dan..

Great. Thank you very much, Steve. I'd now like to give you an update on the three key markets that we expect to drive our growth in the fourth quarter and well into fiscal year 2019. First, our U.S.

Federal business is very strong with further expansion expected as we win new work funded by the budget increases that were put into place by the government earlier this year. For the U.S.

Department of Defense, we're seeing bidding activities picking up as the various departments we work with begin to award their 2018 funds before the end of the fiscal year. We're also seeing more clarity on the priorities of the Department of Defense's spending as they work on strengthening the workforce and the preparedness of the military.

Increasingly, we're seeing an emphasis on resilience, in infrastructure, water supplies and even power generation. In this long-term trend with the Department of Defense, is directly in line with our focus on sustainable infrastructure and water services.

In addition, the Department of Defense is turning their attention to assessing and implementing solutions for newly emerging contaminants associated with military activities.

Tetra Tech here provides both the high-end evaluation services as well as the water treatment solutions to [Technical Difficulty] (14:38) in addressing this entire new class of [Technical Difficulty] (14:42).

Overall, we have the ability to support the military by leveraging our contract capacity to support both their ongoing and their emerging needs. Our United States state and local work continues to be very strong growth market for us. We continue to support our clients across the United States in addressing water supply treatment and management needs.

Our fastest growing municipal water markets continue to be in the southern states especially in locations such as California, Texas and Florida where concerns over the security of water supplies continues to create new opportunities for our services.

We're also supporting our state and local clients in their long-term recovery programs for past disasters and floods. And as we're addressing these near-term needs of our clients for post-disaster support for the floods and fires that have and, unfortunately, still are occurring even this year.

This year again, throughout the country, we're seeing unprecedented fires across multiple regions and repeated flooding of extreme events in the East and the Southeast. In California, out here where our headquarters resides, alone there's been more than 200,000 acres burned this year, and these fires unfortunately have not yet been fully contained.

We do here at Tetra Tech have more than 400 state and local clients, who're calling us to help them navigate the aftermath of these and other events when they occur. While our U.S.

Federal and our United States state and local projects provide us with good visibility and continued momentum, the oil and gas market also provides us upside for both revenue growth and margin expansion.

As a firm that specializes in midstream consulting and engineering services, we're well positioned to capitalize on the build-out of the oil and gas pipeline related infrastructure or the takeaway capacity that's needed here in the United States. As the U.S.

oil and gas production continues to increase both in volume and efficiency, the associated midstream infrastructure needs to increase as well. We work on pipeline infrastructure from the early permitting and assessment all the way through detailed design.

Tetra Tech has specialized expertise in permitting and design for complex geology and river crossings and even in challenging urban settings. As the U.S.

oil and gas companies invest in building out the essential infrastructure to deliver this product to refineries, cities and even export terminals, we expect increased opportunities and demand for our services. At this point, I'd like to present our guidance for the fourth quarter and our updated guidance for all of fiscal year 2018.

Our guidance is as follows. For the fourth quarter, our net revenue range for guidance is from $550 million to $575 million, with an associated diluted earnings per share on an ongoing basis of $0.70 to $0.75.

Now based on our performance to-date and business outlook, we've raised our guidance for fiscal year 2018 for both net revenue and earnings per share as follows.

For the entirety of fiscal year 2018, our net revenue guidance range is from $2.2 billion to $2.22 billion with an associated diluted earnings per share on an ongoing basis of $2.59 to $2.64.

Some of the key assumptions for this guidance include for the entire year – does include intangible amortization of $19 million or approximately $0.24 per share. That does anticipate a 26% effective tax rate for the entire year, and for the fourth quarter, we anticipate a 28% effective tax rate.

This does assume approximately 57 million average diluted shares outstanding, and does exclude any contributions from acquisitions that would take place in the remainder of the fourth quarter. In summary, our third quarter performance not only exceeded our guidance for both revenue and earnings per share, but set an all-time record for the company.

We had double-digit growth in all four of our key markets, a strong sign of the broad-based strength of our business. Our industry leading water infrastructure and disaster recovery services resulted in the eighth consecutive quarter of double-digit growth for state and local businesses.

And the increasing pace of Federal contract awards and orders that we're receiving is providing us with additional momentum as we enter the fourth quarter. And as a result, we've increased our full year guidance for the third consecutive quarter this year. And at this point, I'd like to open the call for questions.

Jennifer?.

The question-and-answer session will begin now. The first question comes from Sean Eastman with KeyBanc Capital..

Hi. Thanks, team. So first off, just congratulations on another really great quarter. Congratulations on your success. I guess I just wanted to start out here. We're getting to the point in the year where we're all looking out to fiscal 2019.

And one interesting dynamic here is that clearly really broad-based momentum in the top line, but it's not necessarily being matched in the backlog we're seeing in the quarter.

So, I was just hoping to get a little bit more color on the line of sight you have on new awards and backlog momentum, and just on the sustainability of some of these growth rates we've seen in the last couple quarters..

Great. Well, thank you for your comment, Sean, and thank you for your question. I'll start with the question that the backlog hasn't actually matched revenue growth in this particular quarter.

I think if you take a look over the past eight quarters, you'd see in the graph that we provided that our backlog actually has increased quite significantly and consistently over the past couple years, past eight quarters.

I will note this quarter we were down slightly and in fact while the mathematic calculation, arithmetic calculation would show that we're 4% down year-over-year. And some of that was attributed to FX.

Since our international activities have been so successful, the strong dollar actually did contribute to a re-evaluating of the backlog a bit so that accounted for a portion of it. The other was the reduction was the divestiture of the field utility services business also caused a portion that we actually took out of our backlog.

So with those two, actually, it moves our number to be a little bit closer to flat to minus just 1% or 2%. Now what I would say is there's really two items that account for that.

Number one, when we have a number that is far higher than even our own guidance range and that we have a revenue quarter that is at such a extremely high level and in fact, as I'd commented, at a record level, that does naturally put a bit more pressure on your backlog because you're burning it at a quite high level.

But I would say even with that, our backlog held quite well. And this is at a time where the U.S. Federal Government is only 90 days. This is essentially at the beginning of the quarter, the budget was passed and authorizations put in place for the U.S.

federal government, and we did begin to see that actually flow through contracts which we've seen a number of announcements from us and we've actually begun now to see the task orders come through. So this is quite expected from us, for us given the timing of the federal government.

So backlog at this quarter, actually felt quite good about and don't feel that that represents an area of concern at this time. Now with respect to – is the growth rates sustainable? We do believe that the broad-based nature of this is probably the strongest overall footing that we've had in the past.

Our growth while it was [Technical Difficulty] (23:25) state and local at 26% just run by one state or one location it [Technical Difficulty] (23:33) fundamental based business.

It was also [Technical Difficulty] (23:36) recovery work which we've moved as a descriptor from emergency response to disaster recovery, because it's not just the immediate aftermath, it's actually the longer term assessment, re-evaluation, planning and redesign for the long-term sustainable infrastructure that will replace those areas that are designed, that have been damaged.

So we feel quite good about that, and in many respects we think that we've moved into a new market that has a longer tail and a larger volume that will pass through it to help our clients in the long term. And of course, the U.S. Federal budgets, they speak for themselves.

They are at all-time high and they haven't actually begun to flow to task orders to the public or to the contracting community that's just beginning right now. And of course, oil and gas, we're really at a low point still and it represents an upside opportunity even to the guidance that we've provided for the fourth quarter.

So, if in fact strengthens, that is one of the areas that would represent a reason that could take us to the high end or even above that. So we feel that the balanced position of the company does allow for the continued performance at these levels..

That's great answer. Secondly, I just wanted to move to the margins. GSG smashes out of the park, was quite a bit stronger than I thought on the operating margin. So, I'm wondering exactly what's driving this continued expansion. I assume that there's a utilization benefit in there but perhaps some more color on the mix in there.

And then also if you could just comment on sort of margin upside drivers into next year and what we need to see to see more expansion over the next 12 months, say?.

Oh, good question, Sean. We certainly give recognition to our GSG operating leaders. They did a exceptional job, but I wouldn't say smashed it out of the park. 14.7% is good; in fact, is quite good, but we were at 15.1% in the fourth quarter last year. So it's not a high watermark for us, and we can do better. And we are not hitting on all cylinders.

And we can actually do a bit better. And in the case of GSG, two items drove that to increase margin in the third quarter. First was a volume.

So increased utilization; as we've spoken before and if you're familiar with this business that increased utilization actually drops an awful lot of it to the bottom line, and that's why you saw a significant increase in the margin. And the second was actually performance on projects.

Our folks actually did an excellent job of performance and deliverables. We did do well with respect to receipt of award fees. We did do well with respect to close out of projects that we completed during the quarter at the upper end of the booking ranges of the margins.

So I would say the increase was a combination and roughly equally from both volume, which is utilization, and the second is outright good technical performance on behalf of our clients projects. I do think and we have talked about this that we can do better on an annual basis.

Our Q3 and Q4 are seasonal high points for our businesses in general, because we have more folks out in the field doing biological surveys, field surveys, civil work, monitoring both for environmental programs and sustainable infrastructure design activities. So we have more folks actually out in the field in addition to the office.

So while we are looking for equal or even better performance in the fourth quarter and if you certainly take the midpoints of our ranges, you would see that while we had a very good third quarter, we have embedded margins that are even higher in our fourth quarter. So with respect to is it sustainable, we've put that into our guidance..

Excellent. Thanks for taking my questions and congratulations again..

Great. Thank you, Sean..

Our next question comes from Andy Wittmann with Baird..

Okay. Hey, guys. Thanks for taking my question. I'd just pick up where we left off there on the fourth quarter guidance implications in the margins, but particularly, kind of looks like implicit in the fourth quarter guidance, here is maybe a growth rate slight deceleration.

I was just wondering, Dan, is that comps, is that conservatism? Certainly, I think you gave us some color on that. You did mention the margin profile that's embedded in there.

So, really maybe we focus more on the top line guidance?.

Yeah. So I think the – what you saw is that we increased our EPS guidance for the fourth quarter, but you did see that the revenue was a bit more muted. So, let me address that. I want to be very clear on this that we did divest in entity that was our utility field services.

It was a lower margin business, but the revenue was originally included in our guidance for the year, but it was not anticipated that we would actually divest this.

So, if you take just the component of our field services, a division that is now not going to be contributing on a topline revenue in the fourth quarter and pro forma or add that back in, you would find that we would be at a double-digit growth rate with respect to our revenue forecast for the fourth quarter.

So, when you normalize that, we did bring down the growth rate just slightly due to taking that contribution out, but we did not adjust it down with respect to our EPS which is actually the reflection of our increased margin across the business..

Okay. Great. That helps clarify that. Thank you for that. Just, Steve, maybe one for you here. I'm curious on the tax rate here. You guys guided at 28%. It's been running year-to-date kind of lower than that.

Is that 28% exclusive of the ASU changes that you (29:51) made on stock comp and could that lower the tax rate, if more stock options and things like that vest and are traded in?.

Well, I think part of the reason for the year-to-date lower tax rate is that when the tax law went into effect, we had to revalue our deferred taxes at a lower rate, so that was quite a significant pickup. And so that was – that's really the cause for that lower tax rate. But on an ongoing basis, I think the stock option deductibility ends this year.

So there may be some benefit for the rest of this year, but after that, it goes away. And so when we look at what our ongoing tax rate should be on a go-forward basis, it's probably in that range of 28%, similar to what we're looking at for the year..

Okay. All right. Thanks for that. And then, Dan, maybe just one final one, just on capital and return of capital. You guys slightly under your target here after the good cash flow this quarter, fourth quarter is usually even better cash flow, certainly to finish the year unless you do something in this quarter.

Looks like you've been trending well beneath your targets. The buyback has been really programmatic at $25 million a quarter.

Do you think that as you get into next year that there's an opportunity for change either in the buyback policy or more material uptake in the dividend?.

Those are both good questions. We are not to just leave our cash or leverage idle. We are active in identifying strategic partners to join us that will actually add new technical capabilities that actually increase both our standing and position and clients that we serve. We're not looking (31:56) we're looking for quality.

And so, one use of capital that would factor into that. But we are looking at both the (32:06) authorized because for the buyback as we enter into essentially the completion or very close to the completion of expending the $200 million that was authorized two years ago.

So, we are going to look as a board at both the buyback and the dividend and we'll have an update specifically on those as we enter 2019. But at this time, we don't have an update on that..

Okay. Thank you very much..

Right. Thank you, Andy..

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

Hi. Good afternoon and – oh, for you, good morning and congratulations on the nice quarter..

Thank you, Noelle..

Dan, I thought you sounded a little bit more – incrementally more positive on federal, I think when we last spoke in June. You felt that maybe that was a little bit less predictable in terms of just the work release.

What's giving you more confidence as we look forward?.

Well, when we spoke and I had the opportunity to be with you and had the materials distributed to our collective shareholders. I was a bit more cautious on federal partially because of the international development and state department. The U.S.

was in a position where we had an excellent Secretary of State, but was a little bit less familiar with the workings of the government in the timing and the release of task orders and contracts and the facilitation of the government business. The current Secretary of State is much more versed in that.

It's been a couple of months now, and it's actually part of the – if you wanted to call it a little bit of apprehension was a lack of clarity on that particular area. And the U.S. State Department and its U.S. international aid division does represent about a third, about a third of the federal work we have.

And so, having a lack of full clarity on that particular area gave just a moment of hesitation to not have full clarity where that piece was going. And we're quite clear on defense and our civil agencies, which represent the other two, roughly 32 pieces.

But if you say that we sound a bit more confident, I think that's directly associated with clarity that we're seeing on that particular area that may not have existed a few months ago..

Perfect. That's really helpful. And then, as we think about the divestiture of the utility business, how do we think about what that kind of means for margins longer term? And in the past, you've kind of talked about longer term margin goals toward the higher end of the – toward the 13% to 15% range for GSG and even into the mid-teens for CIG.

How are we thinking about that at this point?.

Well, making this slight shaping of the portfolio actually will help move that direction. I think the – there's two different drivers for margin expansion between the two different segments. They're slightly different. The performance on the margin basis for our government work is primarily driven by volume and utilization.

So as utilization goes up, and I will say, certainly performance on the projects, but because much of the work we have with the government is cost plus, our time and materials or has other definitions with respect to margin, we perform well, and we have sufficient volume to keep our staff fully utilized.

That will drive us to the upper range of 15%, whereas the CIG or the commercial work, or the commercial and international work is primarily driven by the mix of work. It's actually different. And so, I think as things pick up, we need to move out of anything that's become commoditized.

And certainly have been asked, so how is it utility field services was core and it's not core? We do look at our businesses. At one time, that business actually was more design work, upfront work, and then we were doing it on a turnkey.

And over the past several years, it's migrated more and more to the field services or the field implementation, which actually caused margins to drop precipitously. It caused the overall use of CapEx to increase, because as we do more work in the field, we needed more trucks and other CapEx in PPE equipment.

And it also included increasing our risk profile with insurance, because if you drive over a mailbox or break someone's curb, (36:55) insurance and other issues. So, we do look at this, we continue to take the small piece of the lower margin and commoditize this out of the business.

In this case, it actually migrated that way [Technical Difficulty] (37:07) where it was advantageous for us to move this to a business, where it would be a better fit. I do think that will help us move the margins up.

But really as we add oil and gas and mining and other commercial activities, I would like to see, certainly in the next year or so, my goal would be to have CIG's margins eclipse and go above and beyond that of GSG. Part of that's the business mix and it's a reflection of the work out in the marketplace.

But certainly, that's what we're focused on, and that would make a substantial difference on the overall margin of the collective company, and obviously, translate right through to performance for our shareholders..

Thanks. That's extremely helpful..

Thank you, Noelle..

We also have another question from the line of Ryan Connors with Boenning & Scatter..

Great. Thanks for taking my question, and I apologize if I make you run over any ground, because I've been hopping back and forth here, but you briefly mentioned utilization on that last response there.

And I wondered if you could update us on the utilization picture across the company on a consolidated basis, kind of where we stand, any metrics you can provide us, and whether we're any closer to the point where we start to generate that real margin leverage that you've talked about in the past..

Yeah. Actually, I think you're seeing the margin leverage show up now in the 14.7% in GSG, but across the company, we're probably just around the 70% level. But I think that's a bit of a miss – would be a number that would maybe not be as valuable as to taking a look at one level below, because we actually see the GSG utilization is higher.

And so, it's in the low 70s and the CIG is actually in the upper 60s.

And so, you can see that when we take a look at it, when we would have to add additional staff or begin to incur additional incremental cost, we still have some more room for expansion in the GSG market, but we're closer to that point, whereas CIG, I think we have plenty of capacity to increase both utilization and so the synergistic effect of the return or implication of increasing margins is twofold in CIG.

It's both the business mix at a higher margin and the increase in utilization. So, it does have the ability to swing much quicker and we do have more capacity there. But on an aggregate basis, we're right around 70%, we [Technical Difficulty] (39:43) to understand the underlying composition, as we look at in these two different components..

Got it. And then, while we're on the topic of human capital, just from a big picture standpoint, job market has been very good. There's a lot of talk about wage growth and benefits improving and things like that.

I mean given that you are a people business, I mean what's your outlook for any related cost pressures you could face or is that not a factor? Just give us your view on that side..

Yeah. I actually look at it from two different buckets. And I just spent briefly what the two are. Number one is the staff retaining and holding [Technical Difficulty] (40:28) we have. We'd like to see of the staff that are [Technical Difficulty] (40:32) we're getting, and are important to our performance of company. We'd like to see a 0% turnover.

And the goal is we've [Technical Difficulty] (40:40) quite well on that front. It's with respect to compensation, because what you are talking about is the financial pressures that may be available to an individual to go take a job somewhere else for more.

Now, Tetra Tech has done well with respect to its existing employees, because we have a large component of compensation based on performance. And so, the amount in addition to the base salary and benefits, the upside can be quite substantial based on performance, and it goes directly to the operating divisions.

And so, they've done quite well, and so that's been very competitive and in fact quite favorable given the overall market landscape. We have had a bit of a challenge with respect to attracting some of the best and brightest because the – from the competitors, as there's a lot of change and churn in the marketplace.

Some of the salaries that are being offered as a entry point are quite substantial. And in fact, we take a look at them and find it interesting. We have been using our equity a little bit to attract them, and that does seem to level the playing field almost immediately.

And for us it's beneficial, because not only this is something that is important and someone's interested in taking a position in the company, but it's a multi-year vesting, so, when they get here, they get sticky and they stay and then they're in the category with respect to they're long-term career employees with this company, hopefully to stay here and retire at some quite aged level.

So, I think we're doing extremely well with what we have, and we're doing okay with respect to the market and the market fields. But we do have enough work that's cost reimbursable or T&M that's economically indices that we do pass on to our clients, so it's not put pressures on our margins..

Got it. Okay. Well, that's very helpful. And thanks for your time today..

Great. Thank you very much, Ryan..

We also have a question from Sean Eastman with KeyBanc Capital..

Hi, gentlemen. Just a quick follow up from me. Just in light of the strong cash flow this quarter, some cash coming in the door from the divestment, just wanted to get an update on the M&A pipeline, what you guys are looking at, maybe just the big focus in terms of filling out the gaps in the operations..

Yeah, it's a good question, Sean. We are continued to put a priority on identifying the best and brightest entities to come join us. We've actually had a nice steady process of entities joining Tetra Tech.

I will say that for the larger firms and for the larger entities, so I'll start both with what's available, what the pressures are and then what we're looking for. But as you move up in scale, I will say that there is a scarcity premium for some of the larger firms, which typically hasn't been the target of Tetra Tech.

So, looking for something that's transformative or particularly large, that particular dynamic hasn't played into our calculation, because that hasn't been the primary area of our focus. Our area has been looking for entities that range from 50 people to 1,000 people.

And in fact, we've had two entities that joined us this year that were best in class, one was 300, 350 engineers here in the U.S. at the high-end buildings, sustainable design practice, and one that was over 700 engineers. So, these are direct negotiated deals. These are accretive for ourselves and valuable for those that are joining us.

So, we do think that in the sort of, make it round numbers, from 100 people to 1,000 people. There's actually a good number of opportunities out there that are direct negotiation, that are looking to join Tetra Tech to actually fulfill their career, and take it to new higher level that is not achievable on their own.

I will say that the public deals that are run by investment bankers are quite heady. We do follow those. It is interesting that those that are looking to go through a banker or through an auction process have fared quite well in valuation. I'm not sure how they fell, how they fared subsequent to the acquisition.

I'll allow that discussion to take place, transaction by transaction, but with respect to what we're looking for the type of firms, we actually think the evaluations are still appropriate and accretive to the company. Where we're looking to go? We'd like to go to Europe.

We have a number of clients that we're servicing, and we're servicing them through a limited presence we have both in the UK and the Continent, so we would like to round out to further expand the work with the clientele we have and add new subs.

We would also like to expand a bit with respect to our municipal and water work in Australia and the Asia Pacific region. It's a priority for us. We think it's an area that we can move to be a top tier competitor and service provider.

So, take a look for Australia and New Zealand and the surrounding area for municipal area, where we are – we would like to turn Australia and New Zealand into a service area that looks just like what we're doing in Canada and the United States.

And so that's an area that we're quite interested in, and we're actually looking to expand at the very high end of the consulting, and top-end engineering work with respect to work that we can do for the oil and gas clients that would be quite differentiated and perhaps less tied to the cyclicality of just the price, something that would be more in demand through the different market cycles.

So, those are actually areas that we are specifically looking for. And then, I just addressed some of the evaluations out there..

Thanks so much. I really appreciate it..

Great. Thank you very much..

This will conclude the Q&A session. And I will now turn the conference back over to Dan Batrack to conclude..

Thank you very much, Jennifer. And I'd like to thank all of you for your insight, for your questions and your interest in Tetra Tech, certainly for those associates that I work with that have contributed to an excellent quarter, and in fact, a record quarter.

I'd like to thank all of you personally for having had an excellent performance during the quarter. And I'm looking for us to even eclipse these high marks. And so, I look forward to speaking with all of the investors and analysts, and our shareholders again next quarter. Hope you have a good rest of the week. And thank you 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..