Tetra Tech Inc

NASDAQ:TTEK

Earnings Call Transcript 2019-Q1

[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 626-351-4664. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the Investor section of its website at www.tetratech.com. This call is being recorded at the request of Tetra Tech and this broadcast is a 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 we’ll 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 Investor 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 Batrack, Chairman and Chief Executive Officer]

Thank you very much, Regina and good morning, and welcome to our quarterly earnings conference call. And I’m very glad to report the results of how we began our 2019 fiscal year.

Tetra Tech achieved its best first quarter in the company’s history with record first quarter net revenue, income and adjusted earnings per share. Another quarter of strong orders across our business also drove our backlog to new record high at $2.79 billion that’s up 15% from last year. With this increased visibility across a very diverse client base, we see significant opportunities for Tetra Tech’s growth in fiscal year 2019 and beyond.

I’ll now provide an overview of our quarterly results and business outlook, while Steve Burdick, our Chief Financial Officer will provide additional details on our financial performance and our capital allocation.

We had an excellent first quarter, achieving record highs for Q1 net revenue, operating income and adjusted earnings per share. For our first quarter, our revenue was $717 million. Our net revenue was $553 million, which generated an operating income of $56 million, which is up 12% from last year. That resulted in a diluted earnings per share from operations of $0.70 for the quarter up 8% from the prior year. And finally backlog was up 15% year-over-year at $2.79 billion the highest in the over 50-year history of the company.

I’d now like to provide an overview of our performance by each of our end client customers. Our record first quarter performance was led by strong growth for international work and continued growth in our U.S. municipal water and U.S. commercial environmental programs. Our international net revenue was up 23% for the quarter year-over-year. International growth was supported by our sustainable infrastructure design work and resource management practices including significant increases in our revenue from Western Canada, which had been a bit slower in previous quarters.

Our U.S. commercial net revenue was up slightly also at just approximately at about 1%. In the United States this growth was primarily due to environmental work for commercial clients as well as services in the energy and oil and gas sectors. Our state and local revenues for the quarter were 17% of our business down 5% collectively due to year-on-year comparisons with the record high disaster recovery revenues that we had in the prior year.

However, our state and local water infrastructure services continued to be very strong with double-digit growth driven by our water projects in the areas of California, Texas and Florida. Work for our U.S. federal clients was 28% of our net revenue in the quarter. On a collective basis, we were down slightly primarily due to budget uncertainties and the lead up to the partial government shutdown that began late in December.

I’d now like to present our performance by our business segments. This quarter we had strong performance by both of our business groups driving up overall margin and performance for the quarter. The GSG our Government Services Business Group delivered another strong quarter with a margin of 12.3%. Note that a year ago, the GSG group was responding to three simultaneous hurricane recovery efforts in the United States. Those were Hurricane Harvey, Irma, Maria and even workout in California a year ago. It was really a high point for our GSG business group.

The GSG group over the past year had strong growth across our federal and state and local markets resulting in a consistent margin performance with only a very slight decline in the year-on-year comparisons for just this first quarter. For the first quarter I’m actually very pleased to report that our commercial and international business groups net revenue grew by 13%, while their margin increased by 180 basis points from last year to a 10.9% margin. And that’s particularly high given it’s the holiday season here in the U.S. in really most of our operations.

The CIG’s group revenue and margin expansion was driven by their infrastructure work in Australia, infrastructure and industrial work in Canada and commercial and environmental programs in the United States. Our total backlog as we completed the first quarter is at $2,793,000,000 an all-time record high up 15% year-over-year and up 5% sequentially from where we closed at the end of last fiscal year.

As you can see on our slide if you’re following along with simulcast, our first quarter had orders that were broadly distributed across both our commercial and our government clients worldwide. Notably in the quarter, we were rewarded task orders to perform international development services, support U.S. Army programs and execute environmental programs for commercial clients. We were also awarded over $200 million in disaster response tasks given us extraordinary visibility which has allowed us to increase our forecast for state and local work for the remainder of the year.

Now, I’d like to turn the presentation over to Steve Burdick, Chief Financial Officer to present the details of our financials for the first quarter of 2019. Steve?

[Steve Burdick, Chief Financial Officer]

Thank you, Dan. So as Dan just highlighted, net revenue, operating income and EPS for the first quarter of 2019 were quite strong. And in fact, are each Tetra Tech records for a first quarter. The fiscal 2019 first quarter revenue was $717 million compared to the revenue of $760 million in the first quarter of fiscal 2018.

The difference is due to lower subcontracting activity as a result of less disaster response projects in the first quarter of 2019 compared to last year where we had multiple hurricanes. In addition, the lower revenue reflects 2018 third quarter divestiture of our field services operations.

Now, the fiscal 2019 first quarter net revenue of $553 million increased when compared to the net revenue of $545 million in the first quarter of fiscal 2018. The increase resulted from both our environmental consulting work as well as our international sustainable infrastructure efforts which are part of our CIG group. And similar to the impact our divestiture had on total revenue without this divestiture our net revenue would have increased by about 4% year-over-year.

We also saw a healthy 15% increase in operating income year-over-year from $49 million to $56 million. The uptick in operating income and EBITDA were due to the improvement in margins in our CIG group, the CIG operating income increased by over 25% resulting in margins improving from 9.1% in the prior year to 10.9% in the current quarter. These improvements as Dan discussed were primarily driven by Western Canada and the growing net revenues mentioned earlier.

On a GAAP basis, our EPS was $0.75. Excluding the 2017 tax law impacts our adjusted EPS of $0.70 per share this year is up 8% over the $0.65 last year primarily due to the increase in our operating income. Now, our GAAP results for the prior year earnings per share included about $0.17 per share tax benefit due to the tax law impact on our deferred taxes. We completed that deferred tax assessment for this new tax law in the first quarter of fiscal 2019 and recognized a non-recurring $0.05 per share tax benefit.

For the first quarter cash flow used in operations totaled $15 million. This compares favorably to the prior year cash usage of $58 million, which is an improvement of about $43 million. The first quarter is typically a seasonal cash user. And as such, the negative cash was expected but so far today we are ahead of our operating cash plan for fiscal 2019.

Our net debt totaled $192 million and resulted in a leverage ratio of about 0.8 times. Lastly, our day sale outstanding was 83 days for the first quarter. This is an improvement of two days from last year and our target for DSO is 75 days or less, which we continue to work toward.

Now going to our capital allocation strategy. Our strategy calls for a balance of investing in the growth of our business managing the balance sheet and returning cash to our shareholders. And our continued strong annualized operating cash flows allow us to continue to do just that. We paid out $6.7 million in dividends for the first quarter. And just this week our Board of Directors approved our 20th consecutive dividend, which will be paid out in February at a rate of $0.12 per share.

So delivering significant returns for our shareholders remains a key part of our balanced capital allocation strategy. And as such in the first quarter we exhausted the previous $200 million stock buyback initiated two years ago with a buyback of $25 million. And going forward we will continue to utilize the current $200 million stock buyback program that was just implemented.

I am very pleased to share these outstanding financial results for the quarter and I want to thank you for your time today. I’ll now hand the call back over to Dan.

[Dan Batrack, Chairman and Chief Executive Officer]

Great. Thank you very much, Steve. As we enter the second quarter of fiscal year 2019, we see our growth being supported by positive trends across all four of our client sectors. In fiscal year 2019, we expect a 10% growth rate with our international clients in Canada and Asia Pacific region. This growth will be driven by our sustainable building design services and in industrial consulting and engineering work.

Our United States state and local work is also expected to grow at a 10% rate supported by a combination of municipal water and disaster response recovery services. This demand continues to be quite high for our differentiated services in the state and local markets and we’re very well-positioned through more than 250 offices here in the United States with hundreds of contracts with key cities and municipalities that comprise this market for us.

Our U.S. commercial work is expected to grow at a 5% rate with a combination of growth in the industrial water treatment, environmental cleanup programs, energy and solid waste. We expect our U.S. federal work to be almost 1/3 of our business and grow in 2019 even considering the impact of the longest government shutdown in the United States history. The shutdown did cause us to lower our federal growth rate from 5% to 2% for the full year and I’ll speak about those impacts here next.

I would like to provide some details and a brief update on the recently completed partial government shutdown and its impact on Tetra Tech’s business including that has caused us to adjust our growth rate to 2% for the entire fiscal year. Our U.S. federal work is typically about 1/4 of our business. In the first quarter the U.S. federal was 28% of our business to be precise, and that’s referring to net revenue. We work for numerous federal agencies and we typically think of the work being distributed in three approximately equal components or portions.

First, the Department of Defense is about 1/3 of our federal work; second international development is about 1/3 of our work and third the civilian agencies, which include the Environmental Protection Agency, the Federal Aviation Administration and other civil agencies comprise the final 1/3.

For the quarter the Department of Defense budgets had been approved earlier in 2019 so we saw no impact in the first quarter and we really expect to do nothing in the second quarter from budget shortfalls or spending with the first component of our federal work. The second area, international development, which includes the Department of State and the United States Agency for International Development does not have an approved budget for fiscal year 2019. So it was part of the partial government shutdown. However, our projects were relatively unaffected since they’re operating on previously funded awards.

Now for the third category for civilian agencies, which include the United States Environmental Protection Agency, the Federal Aviation Administration, National Science Foundation and others we did see an immediate impact with approximately 50% of our projects put on a hold for the partial government shutdown. We did see this deepen as the shutdown extended and our clients’ contingency funds were depleted.

Now we did see some impact prior to the shutdown in December due to the uncertainty in the budgets for the affected agencies. And we expect to see some overhang here in the second quarter and here at the beginning of February as agencies restart their programs and catch up on procurement and contract awards that were actually set aside while the government was shutdown. And we have estimated the impact and we do estimate that the impact of the partial government shutdown in the second quarter to be about $15 million in revenue, which has an associated earnings of about 2% – $0.02 impact to our earnings for the second quarter.

During the quarter, we saw continued strength in a wide range of services especially those related to sustainability. In fact, these services were remarkably unaffected by the U.S. budgetary disputes that I just referred to and further demonstrates the resilience of our diversified mix of business.

I’d like to highlight three major areas that exemplify our differentiated business model and growth opportunities for the remainder of the year. Water infrastructure programs continue to be very strong for us, primarily led by services for the high-growth regions of Texas, California and Florida that I mentioned earlier. We provide sustainable water management design services that help our clients secure reliable water supplies, prepare for droughts and strengthen the resilience of their infrastructure when extreme events like hurricanes and big storms do occur.

Our sustainable buildings practice now leverages the global capabilities of a $200 million business to provide our clients with high-end designs. Our teams are working on building designs that are first of the kind buildings that generate more power than they use, buildings that capture and recycle water and buildings that create a more functional and healthy workspace than it existed before.

And finally, our disaster response and recovery business continues to evolve. Addressing the cumulative demand to address both new disasters and long-term recovery needs for those that have occurred in the past several years. We maintained over 400 contracts with local clients and continue to enhance our proprietary software to deliver the highest quality services across all types of disasters. Sustainability-related services are very well aligned with Tetra Tech including our focus on water and environment, our commitment to forward-looking solutions and our Leading with Science approach to problem-solving.

I’d now like to present our guidance for the second quarter and for all of fiscal year 2019. Our guidance is as follows. For the second quarter our net revenue guidance range is from $520 million to $570 million with an associated diluted earnings per share of $0.61 to $0.66. For the entire year we reiterate our net revenue guidance range of $2.2 billion to $2.4 billion and that is associated with a diluted earnings per share – and it would be an adjusted diluted earnings per share of $2.80 to $2.95. This does not include the 5% benefit that we just realized in the first quarter from the tax benefit from the earlier tax law or this number would be higher.

There are a number of assumptions included in this guidance range. It does include a non-cash intangible amortization for the year of approximately $9 million, which represents $0.12 per share. We do assume that we’ll be at a 26% effective tax rate for the year. It assumes 56 million average diluted shares outstanding and it does exclude contributions from future acquisitions. And as I mentioned, this does not include a 5% contribution from the one-time non-recurring tax benefit that we saw here in the first quarter.

In summary, we had an excellent first quarter and a great start to 2019 with record revenue income and adjusted earnings per share. Our backlog reached an all-time high driven by orders across a broad base of our business. Our focus on high-end sustainability ability services and water and environment is resulting in increased opportunities in fiscal year 2019 and new markets that we’ve never even seen orders from before.

And in closing, I’m very pleased with how we began this fiscal year. Our resilient and flexible business model focused on high-end consulting services provides us excellent opportunities, consistent demand from our clients and a proven ability to navigate changes in the market.

And with that Regina, I’d now like to open the call for questions.

[Operator]

[Operator Instructions] The first question comes from the line of Ryan Connors with Boenning & Scattergood. Please go ahead.

[Ryan Connors, Boenning & Scattergood]

Great. Thanks for taking my question. I wanted to actually probe on the government shutdown just a little bit first and ask whether those issues have had any impact on competitive dynamics. And I guess, what I mean by that is even though the impact on your clients was minimal aside from the civilian agencies. Is there any sign that other competitors are shifting resources into your markets as a result of some of the other federal markets that were impacted?

[Dan Batrack, Chairman and Chief Executive Officer]

We have not seen that. We’ve not seen it. There was none of the work that we had was either up for recompetes or actually had any flexibility with respect to moving people into the market, while 35 days if you’re not working it seemed like an eternity. The procurement cycle and the preparation and positioning for work in these other markets is often many, many quarters, if not, a few years in the preparation to prepare for servicing and responding to these activities.

So the impact to us was really having people go home on existing work that we were in plays on. And those that were not affected were really long-term contracts that are typically multi-year. So this 35-day shutdown has not, at least we’ve seen at this point changed any competitive dynamic by bringing new people into the market. If anything, what we’ve heard is individuals called to ask if we have subcontract work for them with our state and local and commercial work to look how they could actually leave servicing the federal government. Because they’re highly concentrated in the components that were impacted, this – we do feel quite fortunate that the impact of the company is quite modest. But for those that are much more concentrated than those that were impacted it could be just the side of catastrophic.

[Ryan Connors, Boenning & Scattergood]

Okay. Interesting, my next question was on energy. You didn’t mention energy much. Obviously a couple of years ago, we did have the issue with Canada when the last time energy prices kind of rolled over. So can you just reset us on that business with energy prices down again and whether there’s – what the risk profile looks like there?

[Dan Batrack, Chairman and Chief Executive Officer]

Yes. That’s a great question. When we talk about energy at least one aspect for it, for us energy is actually more and more has been evolving to renewable energy, wind, solar, geothermal, other items. But certainly, when you’re talking about oil and gas theory that was most acutely impact was the Canadian oil and gas for obvious reasons higher production cost in the oil sands. It was quite a challenge or a headwind in 2018. We have seen that abate. And part of the reason for the increase in the margin is the really financial challenges we had in 2018 really abated. We have seen work picked up. We’ve seen it be steady, and we’ve seen the steady increase in the United States, a bit more in Western Canada, Alberta and the oil sands.

We have said that to the work head adjusted enough that it was 80% of our oil and gas work was in the U.S. and Canada had pulled back to about 20%. U.S. has continued to grow, but Canada actually has turned around and released with a bit more work both in engineering and on turnkey work. And again I’m speaking mostly for Tetra Tech about midstream or pipelines work. So pump stations, right away clearance, compressor stations, this type of work. And that actually has been strengthening across both Canada and the U.S. But because it was such a low point strength in Canada, which we saw the results help contribute to the performance of CIG.

We have seen the mix moved to more of 70/30 because of the impact in Canada with the U.S. being 70 and 30 and we’re working off of about $100 million basis last year, and we think that number might go up to somewhere between 100 and 150 this year. Still a little bit early. But I would say it’s a positive contributor. But I certainly wouldn’t – we didn’t highlight it because it wasn’t a big needle mover because it’s on a small base now and isn’t actually something driving the company, but it’s also not something holding us back for this quarter.

[Ryan Connors, Boenning & Scattergood]

Got it. And I do have one last one. And I know it’s a sense of topic, and there’s probably not too much you can say. But you continue to get your name dragged through the mud pretty unfairly, and some of these getting pretty unbalanced press reports on this Hunters point story. And those articles are kind of making their rounds out there in the investment community. So I just want to give you the opportunity to make any comments that you can about that situation and how we should all be thinking about that.

[Dan Batrack, Chairman and Chief Executive Officer]

Well, I – we are – you’re highly aware of what we think our completeness representations in the media. And the characterization of what’s transpired. We take all legal matters very seriously in this particular instance. Unfortunately, our subsidiary, Tetra Tech EC, did have two low-level individuals in its organization who behaved criminally about eight years ago and violated the high ethical standards of this organization and the organization of Tetra Tech EC. The wrongful – the wrongdoing was immediately addressed back at that time, and this is 2011 and 2012 by Tetra Tech EC.

With the client’s oversight and input, we did complete at that time an extensive investigation and implementation of corrective actions, all of which were summarized in a public report that was submitted to all agencies, reviewed and approved at that time, including with our client. There is now a civil legal process, which in some ways is actually beneficial because perhaps we can move away from this unsubstantiated media publications that is not grounded in reality or fact in any manner. And Tetra Tech EC will vigorously defend its record and is confident it’ll prevail following an impartial and transparent legal process and scientific review of the actual facts and not this fabrication. So that, I can share with you.

[Ryan Connors, Boenning & Scattergood]

Well, that’s very helpful. Thank you, Dan.

[Operator]

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

[Tahira Afzal, KeyBanc]

Thanks. Dan, congrats to you and your team on a good quarter.

[Dan Batrack, Chairman and Chief Executive Officer]

Thank you, Tahira.

[Tahira Afzal, KeyBanc]

With that it seems like the world is becoming more subject to extreme weather. And I know your state and local outlook was based on that this year. But is there sustainability to it when you talk across with your clients? And I know you do a lot of extensive studies. Do you think this will be unfortunately an ongoing source of revenues for you going forward?

[Dan Batrack, Chairman and Chief Executive Officer]

That’s a good question. In previous quarters, certainly most of the quarters for 2018, we actually had a slide in a bit more detail just on our disaster response and recovery. The one area that we wanted to highlight previously, and I’m glad you asked this question, it gives me a chance to note this. That we really are following our clients not just from the response activity, which is doing the very initial evaluation of what happened and the hazardous issues that exist with respect to the fires and the debris or the water that’s come out of wastewater treatment plants and immediate response between one month and one year.

But we’re moving more and more into the assessments of the overall impact of these disasters in the long term planning for a recovery. And we think that’s more like a two to five-year program. And the overall size of that is much larger. We’ve had a number of successes, where we’ve actually followed our clients not just from the initial response but also to the planning and recovery. And that’s actually making up a bigger and bigger part of the disaster recovery work.

And then of course, beyond that there’s actual implementation of the planned work, which is the detailed design and the oversight and the insurance of the final construction of levees and dams and dikes and water facilities at higher levels and actually even new types of treatment facilities or infrastructure is typically a 10-year process. In fact that’s about how long we worked in Katrina in the New Orleans area. We were there for about – between 10 and 15 – 10-plus years. So we do saying it’d be much, much more a longer tail, actually larger and bringing more of the resources within the company. But let me just say one word about this is being episodic. No doubt, you have a hurricane and it’s something that’s a big impact and it’s a disaster. And we do need to take it extremely serious.

In the 1980s it was thought off you see these events once every 10 years. In the 1990s maybe it was a twice or three times in 10 years, while sitting here in the last few years, there are big events in 2015, 2016, there were more. 2017, there were more. 2018, it was a record. And of course, we’ve just had the largest fire and the largest financially measured disaster with the California fires in the world this last year. So what was considered a single episodic event that would never happen again is becoming more a reoccurring event. So I wouldn’t – it is moving to can you plan it on a calendar? No. But can you anticipate that there may be some during the year? It certainly appears to be the case.

And so we’re building on our one-of-a-kind, best-in-the-industry technology that we brought to the marketplace. It makes us physically more competitive, and it actually brings a better work product and a faster turnaround for our clients so they can actually get the residents and citizens and communities back to where they were before quicker than ever. So for those reasons we think we’re going to fair very well for the upfront work. But staying with the programs all the way through completion we think is actually building to be a fabric of the company in our revenue stream. It’s not just what we do after the recovery it’s what we do we do planning and the long-term work.

[Tahira Afzal, KeyBanc]

So I mean it seems, Dan, that typically if you go back 10 years, you’ve had some cyclicality in your state and local business, muni budgets and what have you. But it seems this time, things are little different just because the result of work going on, and there could be a longer deal versus how the cyclicality of the economy in the U.S. behaves.

[Dan Batrack, Chairman and Chief Executive Officer]

That’s true. I do want to point out one-item that when we began 2019, fiscal year 2019, on this call three months ago, our forecast was for a 5% growth in our state and local business, which was anticipated some headwind from the non-recurring work that had happened a year ago with – on Harvey. But we did book over $200 million in disaster response and recovery work in the quarter. And while we had many things that we felt were very favorable with a very good quarter perhaps that was the one standout that was – we think give us a lot more confidence. And that’s what caused us to double the growth rate for state and local market for the entire year, and we think that’s all embodied in skews two, three and four.

[Tahira Afzal, KeyBanc]

Got it. Okay. And then just as a follow-up on margins structure. I know you talked about it. You made some niche acquisitions earlier on. Do you feel the asset business is now starting to gain traction that that’s an area of M&A focus for you? Or do you feel you’re at a point where you can grow that organically now?

[Dan Batrack, Chairman and Chief Executive Officer]

The infrastructure design business, we think – so we would refer to it internally as our high-performance building practice. We have – at the eastern seaboard of the U.S., well positioned. We have clients, relationships, staff. We’re on the West Coast from Vancouver, British Columbia all the way down through San Diego. We have what I do think is a best-in-class, globally, Australian platform that we can utilize. We do think that we could add something in Europe. And we do have an office and a presence with just under 100 people. But a lot of that is then offshore to the U.S., Australia and other areas. But we do think we could add an acquisition there. But the rest of it should be an organic growth rate focus and it is among the highest margin business we have in the company. So it’s getting to the scale that it actually can impact the overall margin of the corporation as it continues to grow top line.

[Tahira Afzal, KeyBanc]

Got it. Thank you very much and congrats again, Dan.

[Operator]

Our next question comes from the line of Tate Sullivan with Maxim Group. Please go ahead.

[Tate Sullivan, Maxim Group]

Hi, thank you. Dan, you gave good detail earlier on international net revenue growth partly coming from Canada. But can you – were there other areas that contributed? I think you pointed out 23% year-over-year international growth?

[Dan Batrack, Chairman and Chief Executive Officer]

Yes. It was Western Canada. And while, I commented on the pickup in the oil and gas work midstream in Western Canada that was only a component of it. It was not isolated to that. We also saw municipal infrastructure work, that’s water supply, water treatment. But we saw actually a little bit of a pickup in some of the mining activity on the industrial side in Western Canada. So while I do note oil and gas only because it was a bit of a, matter of fact, quite a significant headwind a year ago. It’s contributing now. But these other areas were equally strong in Western Canada. So I would say it is really broad-based strength in Canada that set helped on the top line.

I would also say that we’re seeing top line growth in our infrastructure work, primarily high- performance building practice in Australia and the Asia Pacific work – region. So we do have multinational clients that have taken us to some of the Asian countries, places like Hong Kong, the Philippines and other areas where we’re doing design work. But it is primarily being done out of our Asia Pacific Center of Excellence out of Melbourne. So that all [Audio Dip] the revenue growth. And then as I had spoken earlier on about the presentation and the question earlier, the abatement of the headwind or the costs that were embedded for our oil and gas in Canada is actually moderated. So that helped contribute to margins, and then just the high-performance buildings practice at a higher margin business contributed to the significant increase in margin in CIG group.

[Tate Sullivan, Maxim Group]

And on that – the sustainable buildings, just a point of clarification. When you talk about that – when you talk about environmental work for commercial clients, is that the same as international sustainable infrastructure work? Or is that different?

[Dan Batrack, Chairman and Chief Executive Officer]

That’s different. That’s different. So when we will talk about sustainable infrastructure work we’re primarily talking about high-performance buildings. And we’re moving more and more from lead platinum building, gold buildings, platinum buildings all the way up to the highest designation, which is not only a net zero, but we’re actually moving to a net positive whereas I mentioned buildings were actually producing more energy, producing more water. And you kind of wonder, how do you actually produce maybe energy? But how do you produce more water?

We actually have buildings that were designed that capture water systems from rain. So they actually go onto reservoirs. They’re served as cooling chambers. So it actually decreases energy use. So it’s really a all-encompassing upgrading for existing buildings. If it’s a renovation or for green fields or new construction we’re actually leading most of the high-end buildings for a number of our clients around the world, so high end, when we say sustainable infrastructure is primarily those buildings. And environmental work is actually assessing impacts to legacy operations as to impacts to air for air emissions, soil for any discharges, and of course, the groundwater, surface water, lakes and estuaries. And so that’s environmental assessment and cleanup work including evaluation of new emerging chemicals to go back and evaluate sites that even been cleaned up earlier. So that’s really two different items, not simply restating the same end markets.

[Tate Sullivan, Maxim Group]

Okay. Thank you. And that answered my other question with more. You mentioned about $200 million in sustainable buildings. So that’s about 9% at least of my net revenue forecast for 2019. So it’s not all – it’s not linked directly to the new built construction you do retrofit existing buildings as well. Is that correct?

[Dan Batrack, Chairman and Chief Executive Officer]

Yes. That’s correct. And actually the division of that or the partitioning of that is about 50-50. It’s about 50% rehabilitation, renovation of existing buildings. And the other half is actually new construction for first-of-a-kind facility. So it is both.

[Tate Sullivan, Maxim Group]

Okay great. And just one last one for me. You mentioned renewable energy work. Is that permitting-related work for new renewable energy spreads? Or what is that exactly?

[Dan Batrack, Chairman and Chief Executive Officer]

Yes. It’s mostly a permitting. It’s also the assessment work. We’ve done more offshore. We’ve done more permitting work both for sliding, permitting and impact evaluation for the offshore Marine wind generation market, I believe, than all other entities combined. Tetra Tech has done the majority of the environmental upfront evaluation, permitting work, evaluation of environmental impacts. All of that work, I believe, more than all others combined. And then there has been a few announcements where, if I’d add, individuals ask, this one you haven’t gotten. And it’s because we’ve done all of the adjacent facilities, and there’s actually a conflict created because we’ve monopolized that entire area with respect to the data collection in that area. So that’s what I’m referring to with renewable energy market and the type of work we do there.

[Tate Sullivan, Maxim Group]

Okay. Thank you very much. Have a good rest of the day.

[Operator]

Your next question comes from the line of Andrew Wittmann with Baird. Please go ahead.

[Andrew Wittmann, Baird]

Great and good morning. I guess, I wanted to just dig into the guidance a little bit more. Summarized kind of what I see here. Looks like basically the top line you had the government shutdown to the negative better disaster restoration as exemplified by the backlog that you called down to kind of offsetting that. That gives revenue in line. You beat the expectation, you beat the guide on margins. And I guess I haven’t heard anything here today to suggest that there’s anything particularly unusual in the guidance. So when I look at it kind of feels like given that you beat the quarter, you raised the guidance actually not quite as much. It just kind of feel that your outlooks for the margin for the balance of the year are not changed from your initial guidance despite the beat in this quarter. I guess I wanted to get some help reconciling that. And is that a level of conservatism in the EPS guidance? Or is there some sort of change that you’re expecting to happen?

[Dan Batrack, Chairman and Chief Executive Officer]

No. It’s a good observation, Andy. No doubt about it. We did increase our EPS earnings per share guidance by raising the lower end by $0.05. There are certainly some discussion here about raising it more or raising both the bottom and the top including perhaps even at a greater number given the beat in Q1 and our guidance for Q2. The item that you could say is conservative, I would say appropriately cautious, is that when we released our guidance yesterday, we completed the documents to prepare the release.

The government had just been turned back on for 48 hours two days. And coming off of a 35-day shutdown, I thought it would be prudent to actually work through Q2 and actually see what the actual impacts are to both the top and potentially the bottom line. And it seemed that with such an immediate proximity to being turned on to actually sort of go all in as if it had never happened before. It was certainly possible but it had to be prudent, we would be modest are appropriate with respect to the EPS increase. And I will look to give you more clarity and update that in the call just 90 days from now.

We’ll have a great insight and actually know what the overall impact to Tetra Tech was in the second quarter. But there’s no – just to be clear, there’s no issue that we see out in the remainder of the year in any of our other end markets that would lead us to adjust downward or otherwise be more conservative with the performance we expect in the year.

[Andrew Wittmann, Baird]

Okay. That’s helpful color. And then I guess the only other thing here, you guys used to give kind of cash flow targets. And I guess, there isn’t one now. And just wondering, you said you’re above planned, I guess, versus last year. Last year had a lot of working capital consumed because of the disaster restoration work which is known the government always leverages their providers balance sheets a little bit. So it’s good that it’s better. You said you’re on track. You said you’re actually above planned. I guess the question is, what’s planned for cash flow?

[Steve Burdick, Chief Financial Officer]

Yes. So I would say our plan every year is to generate more cash flow from operations as compared to our net income. And so we did that the last couple of years, and that’s our goal this year. So as our net income will increase this year, we expect our cash flow to also increase.

[Andrew Wittmann, Baird]

And maybe, Steve, you can just keep going a little bit more. You guys have had a DSO target out there. Still kind of hearing the low 80s rather than the targeting the 70s, the RCM project had been one of the main reasons. That one, at least as you see on the income statement, is not much of a factor. But how much of RCM is affecting the DSO level? And is there an opportunity as the year progresses you think we start getting closer to the DSO target?

[Steve Burdick, Chief Financial Officer]

Yes. I think – as you pointed out, RCM has become very minimal in terms of revenue or they were basically breakeven. And the one thing that we do need to do to wrap up the RCM operations is to get the claims resolved. We hope to get those results quicker than the longer term. But as we do resolve those, we don’t expect to spend more cash we expect to be able to collect on those receivables which will have a positive impact both on our DSO and on our cash flow from operations.

[Andrew Wittmann, Baird]

But can you just refresh all of us what the RCM opportunity is in your view for the claim?

[Steve Burdick, Chief Financial Officer]

Yes. It’s probably couple days DSO, probably five, six days, something like that. And so it’s – could be quite beneficial as we get those results.

[Andrew Wittmann, Baird]

Got it. And is there – is that the goal for the year just to get that maybe resolved this year? Is there any DSO opportunity that you’re seeing this year on the rest of the DSO? Is there a target for another couple of days on top of the five or six to get to basically where your target is?

[Steve Burdick, Chief Financial Officer]

We’re always targeting to do better than what we’ve done in the past. So that is the goal, and that’s what we’re working towards for the rest of our operations, though.

[Andrew Wittmann, Baird]

Of course. Okay, I going to leave it there. Thank you for your time.

[Operator]

Your next question comes from the line of Noelle Dilts with Stifel. Please go ahead.

[Noelle Dilts, Stifel]

Hi, thanks. Good morning. So my first question. You touched on margins a bit in the Q&A session. But could you help us just to understand how you’re kind of thinking about margins for each segment for the year? You definitely had a pretty strong GSG margin in 2018. I think you came in for the year at about 13.9%. Is that a number that you think you can beat in 2019. And then if you just touch on how you think about margins over the long term and kind of your target for GSG and CIG?

[Dan Batrack, Chairman and Chief Executive Officer]

Absolutely, so we did have a very good year last year at 13.9% for GSG. I think that number was really driven by exceptional performance in the fourth quarter. In fact it was a high mark – high watermark for GSG. It’s probably the right metaphor given there a lot of thought of water work. But at 16.33% in the fourth quarter really drove that number up there. We’ve always felt that if we performed the work well, that has an overall mix. Our Government Services business can be between a 13% and 15% margin on an annual basis. So we were right in the middle. I think we can achieve that number where we did last year. What did of course, it was in the fourth quarter. It wasn’t higher margin work, it was higher volume work which actually increased utilization which then translated to the bottom line that drove that number high. I wouldn’t say that 16-plus percent for a given quarter is something that’s easily achieved, it certainly possible.

But if you were even in the 15% range, maybe a little bit better in the fourth quarter and we’d be quite pleased year. So if we keep the volume up we should be able to be very close to what the overall margin was last year. Now with – so again, the longer term goal 13% to 15%, if volume is quite high, we can think we could be up at 50%. We were roughly 39%. So we have another 110 basis point that we could probably add to that business, if things are relatively optimal. So there is upside there.

CIG, there’s actually significant upside. Last year we were at 8.7%. You can see we started out of the gate this year at just under 11%. We do think that if the work has run well and the economy is strong and there is some commodities work here with respect to mining work and oil and gas another energy resource work that number should be able to match or beat the government services margins. So we think that a year recovery last year at 8.7%. Our goal would be to get a closer to 11% this year. So significantly close the gap with GSG. We do think it I would hope that may be an optimal quarter they could match on a given quarter and actually beat GSG and may be late this year as things begin to pickup perhaps in some of these end markets.

And our longer term goal would be that in a down market with a lot of headwinds, we would see out of CIG in some much wider range, they could be at 10% or below, which is what you saw last year. We think in what would be a solid year with plenty of work flow there should be closer to 15%. And then may be 14% to 15% so a bit higher than the GSG in a very robust market, the number should be between 15% and 20%. So in a challenging market, there’ll be a fair amount a bit below. In a strong market, they’ll be above. And I think that with respect to this year, we’re looking for them probably not to match the GSG margin in aggregate. But we think it will be much closer. So if you look at the 39% for GSG last year it will be at 11% maybe 11 plus this year. And so you’d see on a collective basis for the Corporation, CIG has the single biggest contribution on a relative basis because of its move.

[Noelle Dilts, Stifel]

Okay, that’s very helpful. Thanks for that color. My second question, I was just hoping that you could expand a little bit upon, how you’re thinking about M&A in terms of – one, your capital allocation priorities. And two, you mentioned you’re up a little bit last quarter and little bit up earlier today, kind of how you’re thinking about markets that are attractive, geographies that are attractive and kind of the size of targets that you’d be looking at?

[Dan Batrack, Chairman and Chief Executive Officer]

Well. We generally are somewhat agnostic of size, and what we’re looking for is technical fit and to be best-in-class technically in a markets. We do like firms are focused on water, renewable energy, environmental work. Areas that were underrepresented in environment and water is the Asia Pacific market, basically Australia and New Zealand. We can grow a lot of that organically but we are looking to bring on some additional partners there. So that would be one area.

We think we could then leverage the capabilities and experience we have here in the U.S. We are looking to add more program management expertise with respect to disaster recovery here in the U.S. And we’re actually – we think that there’s some promising entities that would do well both for them and for us to join us to actually build even faster on their planning and recovery portion of the business. So there is a technical and client area that we can make some big progress and, I think, would translate very quickly to top and bottom line and add a longer tail or longer continuity with the recovery business. That’s another area we’re focused on.

We think there are not a lot of natural consolidators of that particular marketplace, and we think we’re one of them. And in some areas, we’re clearly the market leader in the upfront assessments area. And then Europe, the reason where Europe – obviously, mature market, uncertainty with the EU and Brexit and the rest of it, but we do have a number of international clients that are either based in Europe or here. But on the commercial side, they’ve asked us to service them, and we are significantly underrepresented in resources in those areas. So we do think that that is the reason why we would go there. We’re not looking to go to Europe for it naturally to be a growth market for us. It’s not a badge of honor that if we can add some more multilingual resources that that’s great for us. It’s actually to service our clients and to provide continuity for the work that we are providing to them.

So that is an area that we’d be looking. So those would be some of the areas that are higher priority for us. We have been as you would note. We continue to bring on a very high talent to the company through acquisitions. But we’ve also remained very discipline. And so we don’t feel a necessity to add top line just to drive any type of growth. It actually needs to fit our strategy be best-in-class and actually have those join us want to make this the career that will carry them to the end of their professional days.

[Noelle Dilts, Stifel]

Thanks so much.

[Operator]

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

[Dan Batrack, Chairman and Chief Executive Officer]

Well, thank you very much, Regina. And I want to thank every one of you for your insight, your questions and your interest in Tetra Tech. I’ll be looking forward to speaking with you again next quarter, and we’re going to be focused on our business and making it better next quarter than the quarter we had before. So I look forward to talking to you at the end of the second quarter. I hope you have a great week and I hope you warm up here on the East Coast and Midwest of the United States. Have a great week. Bye.

[Operator]

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