Tetra Tech, Inc.
Q3 2013 Earnings Call Transcript

Published: 8 Aug 2013

[Operator:]

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 [phone]. 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 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.

[Dan L. Batrack:]

Thank you very much, Regina, and good morning, and welcome to our fiscal year 2013 third quarter earnings release conference call. I'll be starting this morning with a few brief comments on our financial performance, followed by a more detailed report from Steve Burdick, our Chief Financial Officer for the corporation. I will then provide some insight into our outlook and our growth plans and our guidance for the fourth quarter and for all of 2013. During the third quarter, we addressed recent issues in a few of our end markets, including, as many of you may know, Eastern Canada, especially, in the province of Québec, and in our mining operations. The places in context, the restructuring actions primarily affected a portion of the ECS business group, within its Eastern Canadian and international mining operations that I just mentioned. But the remainder portion of ECS, I'd like to make clear, right out at the start, and in particular, the U.S. operations continue to provide a solid performance in line with its target market range and, really, has been completely unaffected by any of these issues. We also took action on fixed-price projects and claims, primarily, within our RCM business group. Now I am not happy. And I'd like to share with you, I'm very much not happy with our performance on these projects or the charges that we took during the quarter. And I've taken action to change out staff and to bring on outside counsel to pursue recovery of these disputed amounts, wherever it's appropriate. However, these actions did significantly impact our third quarter performance across several metrics. I would like to assure all of you that I, personally, and the Tetra Tech management team have been very focused this past quarter on addressing these issues and to returning these units to their historic performance levels. I expect that these actions will result in returning Tetra Tech our industry-leading performance in this coming year. As you've seen our GAAP number's reported in the press by now, both in our press release and in the investor presentation. But in order to give you a better understanding of our overall business, I'll be presenting some of our results on a pro forma basis that exclude certain charges associated with the actions that we took in the third quarter. Now, Steve Burdick, our Chief Financial Officer, will describe these in much more detail later in the presentation. But I'd like to get started now. Our financial results for the third quarter of fiscal year 2013 are as follows

[Steven M. Burdick:]

Thank you, Dan. I would like to begin with the fiscal 2013 third quarter financial overview in a bit more detail. Overall, our third quarter results met our June 18 guidance that we provided relative to both the range of our net revenue and EPS. Now comparing the third quarter results this year to last year, revenue decreased by about $70 million or about 10% to $614.8 million, primarily as a result of the slowdown in operations focused on Eastern Canada, global mining and parts of our U.S. federal government work. In addition, we did have several project adjustments that negatively impacted our third quarter revenue. Similar to revenue, the net revenue also decreased, but less significantly, to about $475 million. As I mentioned, the net revenue results were within the guidance range provided in June. We had a loss from our operations in the quarter of about $99.9 million. Now, excluding the impact of our non-cash goodwill impairment of about $57 million, the loss would've been about $43 million. The operating loss was primarily driven by the same factors that caused revenue to decrease. Now, for those of you following on the webcast, I will provide the details to the results on our -- in our operations and the goodwill adjustment in a bit more granularity on the next slide. Regarding the EBITDA, we did have a loss of about $26 million. Our EBITDA decreased by a lesser amount than our operating income since intangible amortization and depreciation was about $5 million more in the current year quarter compared to last year. As mentioned earlier in this presentation, as well as in our June 18 pre-announcement earnings release, the third quarter income charges were primarily as a result of, one, Eastern Canada, global mining and the charges on 4 larger programs. I would like to walk you through the various moving pieces. And for those of you, like I said, that are following on the webcast or have the downloaded -- or have downloaded the investor presentation, you can follow on the page that's labeled Financial Impact by Category. Now, for Eastern Canada mining, rather than address similar items accounted for in both Eastern Canada and mining, I will address them in aggregate for the 2 lines of business. The first item pertains to the restructuring activities that resulted in severance and office consolidations. We reduced staff in both mining and Eastern Canada, as a result of our drop in revenue. These actions then resulted in a large amount of severance. The other restructuring item was for office consolidations and closures. In order to eliminate excess costs, we closed and consolidated several long-term leased facilities. These actions caused the need to take an impairment charge for future lease liabilities, as well as certain leasehold improvements in property and equipment considered to no longer have a future economic value for Tetra Tech. These actions impacted approximately 450 staff and about 30 offices that, together, aggregated about $13 million in charges. The next issue we tackled resulted from downsizing these operations and managing the utilization of our staff and resources. This resulted in additional costs for our operations. These costs included an underutilized workforce for both internal staff and third-party staff and both leased and owned equipment that was not put to a productive means. The cost of this downsizing and under utilization of resources was about $21 million in these 2 operations. A third item that impacted our quarterly results was the lower revenue experienced for both mining and Eastern Canada. From our original plan, we realized about $65 million shortfall in revenue in the third quarter. As a result of the lower revenue, we realized reduction in profit of about $6 million associated with the loss of work, not including the inefficiencies that I previously noted. In all, about $4 million of the $6 million came out of mining and the other $2 million came out from Eastern Canada. Next I would like to summarize the third quarter events and impact to our operating and financial results due to the 4 fixed-price programs, all of which were about the same in magnitude. Three of these programs are in the RCM segment. Of these programs, 2 are with federal government agencies and 1 is for a state agency infrastructure program. All 3 programs have experienced quarter 3 events, resulting in both increased costs and client notification of change orders, seeking recovery from both our federal and state agency client programs. For instance the additional cost and resulting change orders stemmed from different site conditions, order-initiated design changes, revised work efforts due to newly enacted regulatory requirements and revised project schedules. Management reviewed the recoverability of our change orders and determined that there was a lower probability of collection than we had previously determined. As such, a charge was recorded in the third quarter. The fourth program is a commercial development program performed in our TSS segment. The planned development of the site changed in the third quarter, and management determined that costs expended on milestones had a high probability of not being recoverable, since contracted milestones may not actually be completed. Although we are evaluating our options to recover the amounts owed, we concluded that the accounting rules required a detriment to our operating profit in the third quarter. So in aggregate, these 4 programs had a negative impact on our third quarter results, decreasing our net revenue by about $30 million and our operating income by about $36 million. Now, when we looked across our client sectors, we did experience some softness in other parts of our federal government and international business operations relative to our plan. The federal government reductions were a result of the slowdown and project delays. As an example, we did experience a significant drop in our FAA business in the third quarter. Further, the federal government budget announcements earlier in the year were clarified and impacted us in the third quarter. As such, approximately 3 quarters of the $55 million impact to revenue related to this federal government business. The other portion of the $55 million related to our international business. For instance, flooding that occurred in the province of Calgary during Q3 was definitely not anticipated and was a significant impact. So similar to the actions we took in mining in Eastern Canada, we also took aggressive actions to right-size the operations, where we saw a decrease in utilization. As a result of these changes, we recognized less revenue and, therefore, on a net basis, we recognized a profit shortfall of about $23 million compared to our plan. So for those of you following on the webcast, you will note that this category has both recurring and non-recurring impact to our revenue and income. And so management's estimate of the recurring amount for income based upon the revenue projections was about $5 million this quarter. Another significant third quarter P&L adjustment pertains to purchase accounting for prior acquisitions. Many of our acquisitions have multi-year earn-out provisions as part of the purchase price, and so the accounting for business combinations requires us to estimate the ultimate earn-out liability that we expect to pay. Those estimated liabilities are then revalued each quarter based on our latest estimates. As a result of those determinations and estimates, we recognized the decrease in our liability in the amount of about $8 million in this third quarter. Now, the final item on this slide is goodwill impairment. We had a significant non-cash charge incurred in this quarter for goodwill impairment, and this impairment related to our acquired operations in the ECS segment relative to first, Eastern Canada; second, global mining; and third, in operation focused on the federal government FAA work. Although we were aware of these, I guess, general trends in previous periods, the negative impact on our actual and projected financial results increased beyond our previous expectations and in the third quarter fiscal 2013. That's what triggered an interim goodwill impairment test for 3 of our reporting units, which then, ultimately, resulted in a charge for each. So for Eastern Canada, as we've discussed, poor economic conditions, including budget deficits, reduced customer spending and ongoing government investigations into political corruptions in Québec slowed the procurement process and the business activity in that region. That goodwill amount came up to about $28 million of impairment charges. Our work for mining customers continued to slow in the third quarter fiscal 2013. And, for example, it wasn't until early in the third quarter that commodity prices slid even further, thus impacting our clients' willingness to start new work or even complete ongoing projects. This amount of the goodwill charge came up to about $12 million of the total. And next, we experienced reduced performance from an operating unit with a concentration of work with the FAA as a result of budgetary constraints, and this amount came up to about $17 million. So in total, we recognized a write-down of our goodwill by about $57 million in the third quarter. Now if you add back all of these nonrecurring charges that occurred in the quarter and added back the estimated cost of our underutilized resources, the net revenue in the quarter would've been approximately $517 million, and the margins in each of the 3 segments would've been within our previously published target rates. With that said, I would like to address the other specific line items in our income statement and how these charges impacted the third quarter. So SG&A was about $56.7 million for the quarter. This is an increase from the prior year third quarter of about 7%. Now the majority of the net increase was due to higher intangible amortization that was just under an additional $3 million in the quarter over last year. In addition, certain G&A costs resulted from actions to restructure areas of our business, where onetime costs were incurred in order to realize future lowered costs. The tax provision resulted in a net benefit of about $23.8 million. The taxable benefit results from the fact that we did have losses in the quarter. The effective rate was about 23% for the quarter and 4% year-to-date. Now this rate -- or this effective tax rate is less than the expected annual rate of 34%, since the portion of the goodwill impairment charge that I talked about is not deductible for tax. The loss per share of about $1.21 includes the impact of the noncash goodwill charge, and excluding the impact of goodwill, our loss per share would've been about $0.47. Next, I'd like to point out a few of the more significant balance sheet items that are up here on this slide. As a result of our lower revenue, we experienced both a decrease in our accounts receivable balances and a decrease in our accounts payables balances, when comparing the current year to the prior year. We did experience an increase in our net debt. The primary driver for this was our recent acquisitions of AEG and Parkland. Our net debt position was positively impacted by very good cash flows generated from operations in the third quarter. So as I noted, despite our losses in the quarter, we did have a very good cash flow from operations. In fact, we generated about $53.3 million in the quarter. Most of the losses that I had been talking about in the presentation stemmed from non-recurring and non-cash items. As such, there was less of an impact on our cash from operations. We do expect the operating cash flow to be about $130 million to $150 million for fiscal 2013, and this translates to cash generated on a per share basis of about $2 to about $2.31. CapEx is the same this quarter as in the prior year and is in line with our previous guidance. We expect our CapEx to be in the range of $25 million to $30 million for fiscal 2013, which includes the plus subs from our second quarter acquisitions. This amount continues to represent a ratio of less than 1% of our annual revenue. Days sales outstanding of 80 days are slightly higher, when compared with last year at this point, but even with that higher DSO, our cash from operations was very good. The higher DSO is impacted by the lower revenue base used in the calculation. So even with these operational issues that I've gone through in the third quarter, we are continuing to work hard across all of our operations to really focus on decreasing that DSO to 75 days by the end of the fourth quarter. Now the next graphic, which is our net debt position, shows the impact of our positive operating cash generated and the cash used for our acquisition investment. As you can see on the graphic, our previous net cash position has transitioned to a net debt position due to the borrowings of our recent acquisitions. In addition, due to the completion of the AEG and Parkland acquisitions in the second quarter, we now have a net debt balance of about $66 million, which is less than the balance at the end of the second quarter, which was about $106 million. Now on June 18, we did announce our stock buyback program. In Q3, we purchased 175,700 shares for about $4 million during the last 6 trading days at the end of the third quarter. So looking forward, assuming no additional stock buybacks or acquisitions, we would expect to be back in the net cash position by the end of the calendar year 2013. With that said, I'd just like to reiterate that this management team will continue to leverage our balance sheet

[Dan L. Batrack:]

Thank you, Steve. Just a year ago, we initiated a growth strategy focused on the expansion of work for our oil and gas lines. We added midstream engineering design services, including the acquisition of Rooney Engineering, which took place in June of 2012, so just over a year ago. And Rooney, in collaboration with Tetra Tech's environmental engineering and water experts, we're now winning new and larger projects for a really broad range of midstream pipeline services. Work for these clients is growing organically at more than 25% and is now just beginning to reach the scale where they'll be a significant driver for our overall growth. At the same time, we've increasingly focused on expanding our traditional water-related services to our industrial clients like the steel industry, pulp and paper and other manufacturing areas. In the international markets we're continuing to also expand our oil and gas work for our clients, especially, in Canada, for pipelines in the vicinity of Alberta and, especially, up in the oil sands region in Northern Alberta. In the U.S. public sector, there's been a significant increase in opportunities for city and municipal projects to address their pent-up demand that have actually languished over the past several years. And over the past quarter, we've won additional work in major markets such as in California, Texas, Florida and the East Coast and Georgia. In addition, our ports and harbor work has also seen an increased activity to address the dredging required to accommodate the larger ships that are expected when the Panama Canal expansion opens here in the next year or 2. So, for example, we just announced a $20 million Miami Harbor deepening project. And this is really an excellent application of our expertise in the water and ecological restoration work for large-scale port upgrades. And I expect there to be many more of these as we get closer to the Panama Canal opening up. And in the federal work, we're maintaining our focus on the government's highest priority, nondiscretionary programs that have resulted in major orders from the EPA for modeling and different specialized studies; new contracts with U.S. Agency for International Development, for their clean energy and climate-change-related work; and new contracts for flood protection studies in the New York and New Jersey regions. And these are some of the first federal contracts in the region -- for the work in the region that were affected by Hurricane Sandy, and we expect many more of these in the coming quarter and in the coming year in 2014. I'd now like to share with you how I expect this strategy to affect each of our business segment's performance in the fourth quarter of this year. In fact, the period we're in right now. The expected business in client mix will result in our 3 business segments trending to the target margins identified on this slide, if you're following along on the webcast. And I'll briefly go through these target margins for each of the business segments. For the ECS business segment, it's expected to be in the 8% to 10% range of operating margin, with strong performance in United States and in Western Canada. And I also expect to return to a more stable performance in Eastern Canada markets and with our mining operations. I do expect that these margins will trend up in 2014 to their historical target range, as they have in the past. The TSS business segment, I expect it to remain steady. They've been very consistent. And in the fourth quarter, I expect them to be in the range of 11% to 13% operating margin. And with the increased revenues from our oil and gas and solid waste clients, we're feeling more confident in the performance of RCM business segment. However, after the charges we just incurred in the third quarter, we have provided a very conservative margin range forecast of 5% to 7% for the fourth quarter. But similar to ECS, they do expect the profit margins in RCM to increase in 2014, up to the range that they've been in earlier target ranges. And, in fact, we'll update that in the coming quarters. For our guidance for the fourth quarter and for 2013. Specifically, our guidance for the fourth quarter is for net revenue, a range of $500 million to $540 million, with an associated diluted earnings per share of $0.30 to $0.40. If you take the actual performance in the first 3 quarters and add our guidance for the fourth, that would give us a guidance for the entire year of -- fiscal year 2013 of $1.99 billion to $2.03 billion for net revenue, and with an associated diluted earnings per share of $0.62 to $0.72. And I do want to note that this diluted earnings per share guidance for the entire year does exclude the impact of the non-cash goodwill impairment that Steve went over earlier. It also assumes intangible amortizations of $0.09 per share in the fourth quarter, and there are other assumptions such as it does exclude the contributions of future acquisitions that may take place during this fourth quarter. It does include $0.11 of stock compensation, which is a noncash item. You should assume a 34% effective tax rate for your modeling for the fourth quarter, and with an outstanding number of shares of 65 million average diluted shares. In conclusion, our strategic focus is on water and environment-related work for the rapidly growing North American oil and gas markets and in the United States, on the resurgence of our long-term commercial and state and local markets. Through the third quarter, our oil and gas work has continued to grow, as I had mentioned earlier, organically at more than 25%, and these revenues have tripled for us in just the past 3 years. Our oil and gas operations are consistently delivering some of the highest margins in the company, and that's why this is one of highest focuses for the organization. In solid waste, and includes landfills, we're winning new work for the disposal of coal ash and other energy residuals, and this work is being driven by emerging regulations here in the United States. And we expect this to be a very strong market for us in the coming quarter and coming year. And in the municipal market in United States, for the first time, in 5 years, all of these operations for us have seen a significant increase in their backlog. They're up about 30% with double-digit margins associated with them and a strong pipeline of opportunities currently in hand. We do believe the restructuring actions taken in the third quarter combined with the strengthening of our core markets and our rapidly expanding critical mass in the emerging oil and gas market here in North America have positioned us for a solid performance in the fourth quarter and a return to our industry-leading performance in fiscal year 2014. And with that, I'd like to open the call up for questions. Regina, if you could please transition us to questions from our callers.

[Operator:]

[Operator Instructions] The first question will come from the line of Andrew Wittmann with Baird.

[Andrew J. Wittmann:]

So, I guess, I wanted to kind of dig in a little bit to kind of how you're feeling about for next fiscal year. Can you just talk about some of the puts and takes that you're going to have as you kind of clean up the organization here for rightsizing the business? I mean, if you look at the fourth quarter guidance, at the top end of $0.40, and what we would normally see as a seasonally strong quarter. And that can get us to something in the $1.60 range, if we just go 4x40, but there's probably more to that. And maybe Dan and Steve, if you guys can help us kind of walk through some of the areas that were tough in '13 that might not be as tough, or areas that you expect to be tough in '14 that weren't so much in '13 to try to help us think about next year, that would be helpful.

[Steven M. Burdick:]

Yes. Good question, Andy. Let me start with the fourth quarter. We have not included in our fourth quarter guidance a specific expectation of any charge in any project. We believe we have addressed everything that we evaluated. And we tried to evaluate everything in the company in the fourth quarter, so it's not included anything. I do recognize that a $0.40 upper end, $0.30 to $0.40 is a low -- is a wide range, number one. And number two, the midpoint would be considered low. However, it's simply a function of being conservative going into the fourth quarter after the third quarter. And so it does not reflect a specific softening in any individual project or any individual end market. So let me go to that for 2014. And certainly, before I leave Q4, it is our goal and objective here at the company to focus on operations and ensure that we not miss what we're committing to the Street as our guidance. Now with respect to 2014. I do think that we have cleaned up, so to speak, or made adjustments in the restructuring for mining and Eastern Canada, such that they're viable, profitable at the current low levels of ongoing market conditions, which means revenue. I've actually seen, I've been quite pleased in the short term with some new wins in Canada and believe that it may be a shorter duration as we enter 2014. As a quick comparison, we really were very strong in the first and second quarter of 2013, so those 2 quarters on a year-to-year comparison will be a bit of a headwind. However, sequentially, I think, they'll be flat or up. And in fact, the comparisons on the second half should be quite favorable and show positive indications across the board on Eastern Canada. Now mining is also true. That was very similar. We had a very strong Q1, a very strong Q2 and it was only moving into Q3 that we had the impact. So again, the year-to-year comparisons on Q1 and 2 will be difficult on the mining. And then I expect even with no increase in the amount of work in mining, it'll be quite favorable on the second half of next year. So I think the first half will be difficult, second half will be favorable, so in an aggregate, those 2 should be sort of, call it, neutral or flattish. Now we are seeing -- I do expect to continue to see a slight decrease in federal, as discretionary spending gets more pressure from the federal government. It's unclear at this moment what 2014 brings us, with respect to sequestration. But I do believe any reductions in the federal government, which I do expect some in 2014, will be more than offset by increases in our U.S. and other Canadian and international commercial work. Now the tradeoff that will make the margins much more favorable and make the $0.40 that you indicated. It's easy to take $0.40, multiply it times 4 and get $1.60, but that would not take into effect that we're trading out lower-margin federal work for much higher-margin commercial work, including oil and gas. And so if you, actually, take a look at that, in some instances, the commercial work, the margin on it may be as much as double that of the federal government work. So I think if you take that into account, as we look into 2014, you'll actually find there to be a much higher increase in our earnings per share than you will see in the revenue growth. Now we're not -- it's not our practice at this point to provide specific guidance for 2014. And I expect to do that in our fourth -- in our next call, which addresses the fourth quarter, all of 2013 and our guidance. But I did want to share with you, and I'm glad you did ask, what we're looking at into the marketplace. So that's a quick overview of how we see the different end markets playing out for us.

[Andrew J. Wittmann:]

Great. I guess, maybe just one kind of follow-up question here. The repurchases is new -- a new tool for you. It sounded like it's a little bit lower priority in terms of where your capital might flow. Did we hear that correctly? And do you feel like with the balance sheet deleveraging the way you suggested here in the presentation, that maybe you can do an all of the above strategy.

[Dan L. Batrack:]

Well, I'll let Steve address the specifics on how we have set aside and what we might look at for the buyback. But I do want to make one thing with respect to our capital structure -- make very clear, that first of all, a buyback is a priority. We did put in a grid structure, such that we can trade right through blackout periods and other items. I do want to make it very clear. And I know Steve mentioned this, but I want to reiterate, the amount that we acquired in stock, approximately, $4 million was only for 6 trading days at the end of the third quarter. So it was for a very brief period, and so that should not be representative -- should not be considered representative of what we've done in total at the end of this fourth quarter. And on our next call, we'll give an update on what transpired for the current quarter. So I would not characterize it as not a priority or not a high use -- high-intended use of our capital. But with that said, it will not detract or deter the deployment of capital for acquisitions to give us access to new markets, new geographies and new growth areas that we're focused on. It is not a trade-off of one or the other. And our capital structure and the ability to generate cash, actually, allows us to facilitate both. And with that, maybe I'll have Steve say a word or 2 about our ability to continue, and, in fact, fund acquisitions that are current or even greater rate than we have this past year.

[Steven M. Burdick:]

Yes. So as we put this plan into place, we believe we've put a fairly healthy amount of about $100 million into it. So we consider that to be a large priority. And then going forward, we believe that our capital structure and our cash from operations and everything else that we're looking at will allow us to do all 3, as I mentioned in the -- in my remarks, which is fund our working capital, do the acquisitions that we believe are strategic and important to the growth of the company and, just as important, to make sure that we do the stock buyback. And, in fact, we made sure that once we put the stock buyback in place, that it was -- we were actually going to be in the position to purchase, so we wouldn't have put it in place if we didn't think we were going to utilize it.

[Operator:]

Your next question comes from the line of John Rogers with D.A. Davidson.

[John Rogers:]

A couple of follow-up things. First of all, Dan, as you kind of look back the quarter and think about the business, and given your comments about increased private and commercial sector work, are we heading into a period where we'll see more volatility in margins than what Tetra Tech's experienced in the past? I mean, both up and down, in other words, more project risk?

[Dan L. Batrack:]

Yes, I think that the project risk has largely been associated with, interestingly enough, and the volatility in the third quarter, specifically. And, actually, the types of variability we've seen in previous quarters has actually been with federal government work. Largely, not our commercial work interestingly enough. And, in fact, one observation I've made and we've made here collectively at the company is things that appeared to be quite stable, quite predictable, quite mundane in the past have actually become quite interesting. For instance, the ability for our federal government clients to have funds and monies available to fund change orders on things that otherwise would've been really quite standard and usual. And so we've never heard of the word sequestration here at Tetra Tech prior to this last year, unless it was carbon sequestration at one of our environmental programs. So there's a new paradigm shift, so to speak, on mandated reductions, mandated leaves for procurement officers. So I think those things have made the fixed-price construction work on the larger projects, and for -- that's been primarily, actually, on the government side. A lot of the work that we're doing for the commercial sector, and I'll use oil and gas as an example. A lot of it's on a time and materials basis, unit rate basis, and so that in and of itself doesn't portend to higher volatility or margins. In some instances, it means, you could call it lower risk but more predictable margin bookings. And so I don't make that direct correlation of more volatility because of moving to commercial.

[John Rogers:]

Okay, but what about just more volatility because of the change in the environment, whether we're going to see more contracts [indiscernible].

[Dan L. Batrack:]

Well, I hope we never see another volatility like the third quarter, that's for sure. And we need to be as much more -- I think it's not so much client driven, although it is to the extent that we take contracts that don't give us provisions to stop work or take other actions. So we do need to be -- and we are moving to be more aggressive on future contracts that give us different provisions that may have had it in the past, and that will decrease the volatility. But to the extent that we just moved and assumed some of the risks within contracts, that would result in this volatility, and we are looking to move away from that.

[John Rogers:]

Okay. And then lastly, I mean, you touched on the oil and gas business and the pipeline business being better. What about -- is -- are there other aspects contained [ph] in some of the frac-ing water and anything new there to be thinking about or -- and the opportunities for Tetra Tech?

[Dan L. Batrack:]

The frac-ing water, as we've talked about, that has certainly has some of the largest promise of market expansion and creating a market that doesn't exist today by -- primarily, by regulatory drivers. I've spoke to this before. There's no doubt that either a state and local regulatory drivers or a national regulatory driver in the United States would create a very large market that doesn't exist today for us and would be an incremental contribution. We, actually, are seeing that at the state and local level. We've seen some pretty material moves across the country in that respect. It's not clear to us and, certainly, what is clear to us in the next few quarters, we're not likely to see national standard, but I do expect that it's going to just trend at the state and local level to increased requirements. And it's is going to begin to unfold slowly, unless there's a particular catastrophic impact, and then you could watch it move overnight, but I do think that it's only incrementally upside. And we don't have any of that built into our fourth quarter, and at this moment into 2014. We're already there, we have the capability, we know the clients. And as it unfolds, we're ready to be there. So we don't have a lag or, really, an investment to be had in order to capitalize on this opportunity.

[Operator:]

Your next question will come from the line of Tahira Afzal with KeyBanc.

[Saagar Parikh:]

This is actually Saagar on for Tahira. The detailed commentary was very helpful. But looking more into the federal side, is there a way to -- if you look at your fiscal '12 EPS of about -- around $1.65, you look at where it is, potentially, your range for fiscal '13, what would you say is the approximate decline year-over-year on an EPS impact basis from the federal slowdown?

[Dan L. Batrack:]

Well, Saagar, what I would lead you to is if you discount the third quarter onetime charges associated with projects and other specific charges we took, we've seen roughly a 15% reduction in our revenues on the federal side. And I've spoke in the past that we have about 1/3 of our federal work is essentially regulatory driven, some would refer to that as nondiscretionary. 1/3 third is high priority, and the last 1/3 is discretionary programs. So let's call that 33% of our federal work. And I have indicated in the past, I felt that perhaps, half of that would be at risk because of budget shortfalls, so half of 33% is 16%. I actually believe that the reduction in margin, x the onetime project charges is roughly similar to that, so about a 15% reduction. The federal work has been sort of 7% to 10% margin, slightly below the company's average. So the EPS impact would be slightly less than that 15% reduction in revenue, but they would be generally in tandem, but slightly less on an EPS basis.

[Saagar Parikh:]

And then you've been talking a lot about your oil and gas business, the growth opportunity there and how high the growth has been. What percentage of revenue approximately is oil and gas now for you guys? And where do you see that going over the next couple of years?

[Dan L. Batrack:]

I think at the end of this year, it could be -- it's trending up quickly, with the addition of Parkland and the growth internally of the other entities we have. We've trended over the past couple of quarters from 10% to 15% of our total revenues. And I expect that to grow quite quickly. I think, this year, we'll be at -- we're just over $300 million in revenue in our oil and gas business for 2013. We should finish that. And that we have stated -- in fact, I stated on the last conference call. And I'll reiterate this here, we do have a goal of building $1 billion oil and gas practice and expect to do that in the next several years, and perhaps, 2 to 3 years. And I'd like to do that on the nearer term than that, of course, but that'll depend on the market and opportunities. We do need to bring in some new acquisitions to give us access to certain geographies and certain additional skill sets and clients. But I'll tell you, it's not just the acquisitions that are going to benefit the joint Tetra Tech, it's also going to be our water, environmental and technical professional modeling and front-end services that will be big benefactors of moving into these markets. So it was 10%, trending to 15% of our revenues here in 2013 and growing rapidly toward $1 billion over the next few years.

[Saagar Parikh:]

And that's a double-digit operating margin business?

[Dan L. Batrack:]

Yes.

[Operator:]

Your next question will come from the line of Corey Greendale with First Analysis.

[Corey Greendale:]

Dan, you've given a bunch of detail on some segments, so this may be slightly repetitive but on this federal government side, can you just speak to what the second derivative is there? Are things still getting worse? Or is it starting to stabilize now that we're past the uncertainty of the sequester?

[Dan L. Batrack:]

Well, it's, actually -- our year-on-year comparisons have been down 15%, pretty much across the board on fiscal year 2013. And if I take you back, to me, it seems like 100 years ago, but it was about 9 months ago, we had an election of a new President, a new administration, we had continuing resolution, and we had a sequestration in Q1. And so that was our year-on-year comparison of Q1, 2, 3 and now 4 to 2012, all have about a 15% reduction. Now if the government doesn't do any further significant reductions, and they sort of stay where they are from 2012, or in other words, if the funding stays stable with the reductions they've made, I expect that it won't get worse. And, in fact, the comps will start getting better. In other words, we should be flat, because it will have already baked into reductions. However, I certainly listen as many in this industry do to the current state of post-reductions budgets for 2014. And what I'll call it is murky or less than clear at this moment. And so I don't know that I would call it worse case, but a reasonable case would be to anticipate a similar type -- a reduction, which would make it not worse, but just sort of a consistent glide slope from what we've seen this last year until we get more clarity from our legislators.

[Corey Greendale:]

All right, that is helpful. And I realize with some of the contract adjustments that some of that stuff is related to the sequester, and there's not much probably one can do about it. It comes with being a service provider of the federal government. But can you put it in perspective relative to years ago, when there were the issues with doing the construction work. And you instituted new practices to make sure all contracts were reviewed at a very high level. Do you think there was something that kind of fell through the cracks there with these contracts? Or was this no matter what your processes were, this was going to be an issue?

[Dan L. Batrack:]

I think to a certain extent -- I hate to say regardless of what had happened with hindsight, there's nothing anybody could have ever done. That makes me feel like a victim. And I don't -- I and we at the company don't feel like victims. We know exactly what we're doing. And every one of these contracts have been reviewed at the corporate level. They're reviewed very carefully through our risk management system. And so these were not projects that were unknown to us. Work we had done in many instances had already been approved with respect to merit. And so we did the work with knowledge, cognizance and approval, so to speak, by our clients. And then you hand them a bill for a big number at the and go, "This is too much." And, of course, we here refer to it is as 2-components merit -- is do you have merit to do it. And then the answer, generally, has been yes. And quantum, do you agree to the amount? And that's where we've really run into a disagreement. And we will to pursue it. I do think it's possible that it's associated with new budget constraints. If you do have the money how can you pay someone? And -- but there is a legal process by which to go through that. And it was during the quarter that we had clarity. We will look to engage this process much earlier. Typically, the quantum or the total dollar amount is submitted at the end, when you actually know how much you've spent. But there is process and contract change that we can make, where we can force that process much, much earlier. And those are some of the things we're looking to do to upgrade our risk management contract process.

[Operator:]

Your next question will come from the line of Steven Folse with Stifel.

[Steven Folse:]

I guess, I'll go back to the oil and gas theme for a second here. It's nice to hear you guys reiterate the $1 billion target within a few years. Is the midstream sector still going to be the primary point of emphasis to get you to that target? Or are you looking to downstream as a material opportunity? And then kind of on that downstream space, we hear a lot about petrochemical and refining boom that's happening on the Gulf Coast. Many large projects there that I'm sure require a lot of environmental and regulatory permitting to work through. Is that something that you guys are working on now? And is that an opportunity in the future? And then how would you kind of size that opportunity.

[Dan L. Batrack:]

Great, great question. Because oil and gas is such a very large field and has different components, our primary focus is going to remain midstream. We do think that whether the price goes up or down, they still have to get it from where they're producing, at the wellhead, so to speak, or where it's being produced to the downstream. So midstream will be our focus. It's where most of our investment has been, and where it will continue to be. But it's funny you mentioned petrochem. We do think that, that will be an increasing opportunity and a contributor to us, especially down in the southern U.S., in Texas, in the surrounding areas. We have a pretty good presence there and expect to grow that. And we do think there's work that can be done. Especially, you're right, before you add a petrochem, the environmental permitting, citing, clearance, especially the safety requirements, reporting requirements and all the chemicals that are produced as byproducts from health and safety issues, all the way through just reporting and tracking of the chemicals, including the engineering work that we would do as maybe part of the process, that would be directly associated with waste management, reprocessing, recycling, all the things that are core to water and environmental experience firm like ourselves. So I'd say midstream, the primary focus. But petrochem in Texas, Louisiana and the sort of the Gulf Coast locations are emerging here and expect to see that in 2014.

[Steven Folse:]

Great. And then, I guess, real quick on the state and local, it's a nice double-digit growth there again for the third consecutive quarter. Are we seeing a wholesale pickup in municipal spending? Or is it still pretty isolated and targeted. Then with the couple of the wins that you had with the Miami harbors and others, is that a run rate that we can expect to continue for the near future?

[Dan L. Batrack:]

Miami was nice, but it's a single project. And it wasn't really single driver. It was very broad-based, but it's been the big cities that have driven it. We haven't seen individual little cities. But as you can see on -- from our presentation. It goes from the East Coast in Georgia to Texas in the Midwest, in California, out here in the West Coast. So it's really been geographically, very broad-based and has generally been where the large population, large budgets are that they have the funds to turn this up. And I really believe that this has been a lot of pent-up demand, where little or nothing has happened over the past several years. And you're sort of seeing a backwash of the things come through the system now so, but not one city, not one state, very broad-based for us.

[Operator:]

Your next question will come from the line of David Rose with Wedbush Securities.

[David L. Rose:]

I have a couple of questions. Trying to get a better sense in terms of the acquisitions and just the goodwill write-down. So we have a goodwill write-down for BPR, is that correct?

[Steven M. Burdick:]

Yes.

[David L. Rose:]

And PRO-telligent for the FAA contract? Well, that's -- okay, so just BPR?

[Steven M. Burdick:]

No. What it is, Eastern Canada was primarily BPR and some other operations that were part of our Eastern Canada operations. Mining, which is our whole global mining practice. And the FAA was related to one of our PC-based companies, AMT.

[David L. Rose:]

And when we think about amortization, were there any intangibles that were changed, customer lists et cetera that would change the amortization outlook for 2014?

[Steven M. Burdick:]

No, there wasn't.

[David L. Rose:]

Okay. And then on the share count, for what we're seeing on, again, after the buyback, what's the share count at the -- when you file today, or when you file for your Q? Which should we look at? How many shares did you buy after the quarter is my question?

[Steven M. Burdick:]

We're not going to disclose that until we get to the end of the fourth quarter.

[David L. Rose:]

Okay. But we can interpret it from the filing, right?

[Steven M. Burdick:]

Well, in the filing, what we have is we've reflected the -- we've reflected in our balance sheet the new share count. Then on a go-forward basis, it's -- we won't have that final share count for the end of the year until the end of the year.

[David L. Rose:]

Okay. That's fair. and maybe I could step back in terms of trying to better understand in the risk management, how you're bracketing the risks around your most recent acquisitions. I mean, if you think about Parkland, what sort of issues are potentially there for us to think about? Or do you see orders pushed out? How are you managing the risk profile of this backlog and the potential products, so that it doesn't turn into a BPR. And I understand they're very different situations, but maybe you can help us better understand your processes.

[Dan L. Batrack:]

Well, first of all, the client mix of Parkland versus BPR will probably not be different. Parkland's 100% commercial for the oil and gas industry, 100% and BPR, which is in Eastern Canada had much municipal government and other mix of business. So there's the 2 different types of work. As far as the risks with Parkland, much of the work that they have is on a unit rate or -- and that's unit rate for staffing and hours for professional services, for engineering, a unit rate for pipeline installations, so x dollars per foot or per linear unit. And so it's not a singular lump sum in many instances, so the profile is somewhat different than what we saw in the contracts that were impacted. With respect to being prepared for immediate turnoff of the work, which was similar to what we saw in Eastern Canada, with respect to these items that Steve had talked about, which were budgets. We watch very closely, the outlook for midstream, which is the pipeline demands. And this -- again, Parkland is located in the greater Calgary area. And their work opportunities would be anything coming down from the oil sands down, which is Fort McMurray down through Edmonton and Alberta, Calgary and then anything moving out to the West Coast. And, actually, if you follow the piping opportunities for delivery of both natural gas and different types of crude, including the oil sands, I believe there's an enormous deficit representing many, many years. Some represent the demand going out even farther than that, including the requirement to supply product for proposed LNG export terminals out of Canada. Simply, a small diameter for the collection of different oil producing. So we take a look at the drivers, what's going to drive the workload. It's not a political process. It's not a regulatory process. It's a demand for energy in the oil and gas industry. So I don't see that as a short term. And the other thing that we saw in Canada, we kept a very large staff on board for continued workload. Parkland inherently moves its staff up and down as the seasons move. So we have the ability to adjust our cost basis seasonally. And, in fact, it's just part of the business of what they do. So this isn't a new thought for them or new experience. They move that from very high staffing in the winter to very low in the spring, back up in the summer, down in the fall. So it's just the very nature of their business to adjust their cost basis with the amount of work flow that comes to their business.

[David L. Rose:]

So implicit in your guidance, I think, you provided you were talking about year-on-year and how your comparisons were more challenged in the first half. You didn't have Parkland or AEG in the first half. How should we think about the accretive impact of those business in the first half of 2014?

[Dan L. Batrack:]

Well, It's a great point. Great point, David. What I was trying to describe, and maybe I should be a bit clearer, I think that the comparisons in the first half, Q1 and Q2, will be difficult on the mining and Eastern Canada. That was my reference with respect to difficult comps, because they were really quite strong in those periods. Our year-on-year comps on the federal government for the first half of the year should be quite more favorable. We don't see any material downturn. And in our U.S. commercial and international work other than Eastern Canada and mining, actually, expect it to be quite up quite a bit by contributed by Parkland, AEG and just the general growth in those end markets. So I did not mean that the year-on-year comparisons will be difficult, because the overall comp, specifically, with respect to mining and Eastern Canada. I think the others, actually, will be quite favorable.

[Operator:]

Our final question will come from the line of Alex Rygiel with FBR Capital Markets.

[Alexander J. Rygiel:]

Dan, real quick. You referenced coal ash and saw waste sort of picking up in the U.S. here. Can you expand on that a little bit?

[Dan L. Batrack:]

Yes, there've been pending regulations requiring that the fly ash or the residuals from coal-fired plants actually not be just deposited in surface impoundments. This has largely been driven by sort of the catastrophe that took place on Tennessee River here a year or 2 ago. And it's actually driven -- and this is an example of sort of a catastrophic event drives immediate and quick regulatory requirements. And so all of the fly ash and the coal residuals that come from coal-fired power plants and other energy residuals are moving to regulatory requirements for disposal and lined and especially designed landfills essentially. And that requires design and new business opportunities requirements that didn't exist before. We are, as Tetra Tech, the largest professional design engineering, landfill firm as reported by the Engineer-News Record in the United States. And it's our objective not only to remain #1 but to actually distance ourselves from the others, as the specialty area grows. I think we're one of the largest liner designer. Liner, meaning, the material that would line and contain these wastes. So one of the largest in the United States. And I think, technically, we like to say the most advanced with respect to the techniques and staff that we use to install these. And so when you have that unique position, not too many competitors and certainly, I believe, almost none on a national basis. I think it gives us a good opportunity to capitalize on this new market that's being driven by -- you can say driven by regulatory requirements, which is true, but by a real life risk that exists by not doing this. So it's not something being driven just anomalously by regulatory requirement. It actually is something that's happened. It was an incredible catastrophe. And there's a purpose to protect life, property and the environment. So that's what's going to drive this. It's just started. And there's an enormous number of power plants from the country that generate this type of waste that will require to be handled and put into these proceeding facilities.

[Operator:]

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

[Dan L. Batrack:]

Well, I'd like to thank every one of our shareholders and others that follow Tetra Tech for both being on this call, following Tetra Tech and being supportive of this. This is quite an unusual third quarter. We take it extremely seriously. We did try to let everybody know, and we did let all of the shareholders and the public know. As soon as we had an indication that there was something that was not consistent with our forecast for the third quarter, and it is our goal as it has been for the many, many decades that we've been here both as an individual managers and as a corporation to perform to the levels that we guide, and in fact, to get back to where we expect to be, which is a industry-leading performer, both financially, technically and from a management standpoint. And I really do look forward to reporting our fourth quarter performance, concluding fiscal year '13 after this third quarter and sharing with you our outlook for fiscal year 2014. And I look forward to talking to you on the next call. And thank you very much, and talk to you then. Bye.

[Operator:]

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