Tetra Tech Inc

NASDAQ:TTEK

Earnings Call Transcript 2020-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 Investors section of its website at www.tetratech.com. This call is being recorded at the request of Tetra Tech and this broadcast is the copyright 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 open up the call for questions.

I'd like to direct your attention to the Safe Harbor statement in today's presentation. Today's discussion contains forward-looking statements about future growth and financial expectations.

Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties including the risks described in Tetra Tech's periodic reports filed with the SEC. Except as required by law, Tetra Tech takes no obligation to update its forward-looking statements.

In addition since management will be presenting some non-GAAP financial measures as references the appropriate GAAP financial reconciliations are posted in the Investors section of Tetra Tech's website.

At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the company, we will open up the conference for question-and-answers after the presentation.

With that, I would like to turn the call over to Dan Batrack. Please go ahead Mr. Batrack.

[Dan Batrack, Chairman & Chief Executive Officer]

Great. Thank you very much Michelle and good morning and welcome to our fiscal year 2020 first quarter earnings conference call. We had an excellent first quarter and start to our 2020 fiscal year with double-digit growth in net revenue, earnings per share, and backlog and a broad-based strength across our business. In fact, our international and U.S. federal work even exceeded my own expectations for the quarter.

Our backlog grew to $3.17 billion, up sequentially and year-on-year to a new record high providing us with excellent visibility for our fiscal year 2020. We see strong demand across our end markets in water, environment, and sustainable infrastructure services and our Leading with Science approach and advanced analytics solutions are very well-aligned with our clients' needs.

In addition our recent acquisition of WYG in the United Kingdom is providing us with new opportunities to offer our water and environmental services throughout the region.

I'll begin today's presentation with an overview of our first quarter results and our business outlook while Steve Burdick, our Chief Financial Officer will provide additional details on our financial performance and our capital allocation.

We had a very strong first quarter, setting new records for first quarter performance across multiple metrics including net revenue, our adjusted earnings per share, and backlog. Our net revenue was $614 million, up 11% from the prior year, a new first quarter high for us.

We generated an adjusted earnings per share of $0.84 for the quarter, up 20% from last year, also a first quarter high. And our backlog the best indicator for future growth was up 13% year-over-year increasing to $3.17 billion, an all-time high for the company.

I'd like to provide you an overview of our performance by customer. In the first quarter, our growth was driven by strong performance across our business, especially for our international and U.S. federal clients. Our international net revenue was up 25% year-over-year, driven by growth in multiple geographies including water, environment and energy-related work in Canada and Australia and our expanded United Kingdom business from the acquisition of WYG last year.

Work for our U.S. federal clients was up 12% year-over-year and represented 28% of our net revenue in the quarter. The increase in our U.S. federal work was driven by our consulting work for the Department of Defense, civilian agencies, and for the U.S. State Department.

Our U.S. commercial net revenue was up 5% and comprised 24% of our overall business in the quarter. Commercial growth was driven by strong performance in sustainable high performance building design, environmental restoration, and renewable energy services.

Our state and local revenues for municipal water infrastructure and planning services grew at 10% year-over-year this quarter. However, this growth was offset by having less disaster response work in the first quarter of 2020 than we had in 2019. As a result, our overall state and local revenues reduced by 7% on a year-on-year comparison. This effect this offset of reduced disaster response work will even be more pronounced in quarters two, three and four which is already incorporated into our guidance.

I'd now like to present our performance by segment. Our GSG and CIG segments both grew in the first quarter as a result of broad-based demand for our high-end services. The GSG segment was up 9% with strong growth in broad-based water and environmental government services.

GSG excluding the disaster response grew at a very strong rate of 14% year-over-year. Our GSG margins were in line with our expectations at 12.8% for the quarter which is up 50 basis points from last year. Our CIG which is our Commercial and International Group segment grew by 14% year-over-year and delivered a 10.8% margin in the quarter.

Our CIG segment exclusive of the WYG acquisition delivered a 12% margin up about 100 basis points from last year. This is a direct result of strong performance with our U.S. commercial clients as well as our operations in the Canadian, Asia Pacific and South American markets.

As I've mentioned earlier the integration of WYG is going very well. They've already improved their current margin contribution to the low single-digits through this initial transition and they're on plan to achieve a 10% margin on a run rate by the end of the fourth quarter of this year.

For backlog, our backlog was up 13% year-on-year and up sequentially also resulting in an all-time high for the company. In the first quarter, we won new programs and task orders for water and environmental services across a very broad base of our clients both in the United States and internationally.

We continue to expand our contract capacity for high-end analytical and water-related services. An example is the new recent award we had with the United States Environmental Protection Agency for ecological, human health studies and advanced analytics.

We were also awarded a new contract for international work with the U.S. Army Corps of Engineers with the Middle East district and were awarded multiple task orders with the U.S. Army to provide environmental and engineering design services. This broad-based backlog provides us with excellent visibility throughout fiscal year 2020.

Now I'd like to turn the presentation over to Steve Burdick, Chief Financial Officer to present the details of our financials in the quarter. Steve?

[Steve Burdick, Chief Financial Officer]

Okay. Thank you, Dan. So as Dan just highlighted our revenue, operating income earnings per share and backlog for the first quarter of 2020 were the best first quarter results in the history of Tetra Tech.

On a GAAP basis, the fiscal 2020 first quarter revenue of $798 million increased 11% when compared to the revenue of $717 million in the first quarter of fiscal 2019. Likewise, the fiscal 2020 first quarter net revenue of $614 million increased 11% when compared to the net revenue of $553 million in the first quarter of fiscal 2019.

Overall, these revenue increases resulted primarily from our U.S. commercial environmental and water engineering and consulting work; our international renewable energy and sustainable infrastructure efforts, especially, those in Canada and now also in the UK; and the continued growth of our U.S. government business especially our high-end technology services with our civilian agency clients.

On a GAAP basis, our operating income and earnings per share increased at a higher percentage than our top-line revenue increases. Our operating income for the first quarter of 2020 was $63 million compared to $56 million last year and our earnings per share was $0.85 compared to $0.75 last year.

On an adjusted basis, we generated 20% increase in our quarterly EPS year-over-year and this increase was driven not only by revenue growth, but also by our higher-margin fronting, consulting and engineering services.

I do want to point out that due to our decision in the fourth quarter of fiscal 2019 to divest our Canadian pipeline construction business, we did sell a portion of our assets which resulted in a gain of about $0.01 of EPS which is the reconciling difference between our GAAP and adjusted EPS results. We do expect to have further asset sales over the remainder of fiscal 2020 which we believe will benefit our cash position the rest of this year.

Now related to cash flows used in operations for the first quarter of -- for the first quarter. Those totaled $18 million. The first quarter operating cash is typically negative due to normal seasonality. And in fiscal 2020, we anticipate generating positive cash flows from operations, which are expected to exceed our net income. Our net debt is $224 million and our net debt-to-EBITDA settled at about 0.8 times due to our continued strong annualized cash flows from operations.

And lastly, our day's sales outstanding decreased to 73 days as of the first quarter. This is an improvement of 10 days from last year and four days from the last quarter. Furthermore, our DSO has not been this low since the fourth quarter of 2010. And as we continue to refine and improve our business outlook, we anticipate we could further improve our best-in-class DSO.

Our long-term capital allocation strategy calls for balance of investing in the growth of our business, managing the balance sheet and returning cash to our shareholders. Our continued strong annualized operating cash flow allows us to do just that. We've been able to invest in strategic areas, while growing the top and bottom lines and we have a strong pipeline of strategic M&A opportunities, which can contribute further to an expanded geographic presence high-end technical capabilities, and new customers and client service opportunities.

Regarding our dividend program, we paid out $8.2 million in the first quarter. I'm happy to report that our Board of Directors approved our 23rd consecutive dividend, which will be paid in the month of February at a rate of $0.15 per share. And since we started our dividend program, we have increased the amount each year and we will revisit the amount next quarter and provide an update at that time.

Furthermore, our Board of Directors approved an additional $200 million in stock buybacks to supplement the previously approved program, which has $104 million remaining. This gives us a $304 million of capacity under the approved stock buyback programs.

I'm very pleased to share these outstanding financial results for the first quarter, and I want to thank you for your time today. And I will hand the call back over to Dan.

[Dan Batrack, Chairman & Chief Executive Officer]

Great. Thank you very much, Steve. I'd now like to turn to our outlook for the 2020 fiscal year. As we enter fiscal year 2020, we see strong growth across all four of our major customer sectors. In fiscal year 2020, we expect Tetra Tech's international revenue to grow at a 7% to 12% rate. Our international growth will be driven by water and environmental planning and consulting and engineering work, particularly in Canada, Australia and our new U.K. based operations.

We expect our U.S. federal work to be almost 30% of our business and grow at a 5% to 10% rate for the year. This increase in federal work is supported by our current backlog, which will convert to revenue across our civilian, Department of Defense, and international development service lines.

Our U.S. commercial work is expected to grow at a 3% to 8% rate with increased revenue expected for environmental restoration, renewable energy, and sustainable high-performance building design. We expect our U.S. state and local work for municipal water programs to continue to be a growth market for us with a growth rate of 10% to 15%.

Many of the large municipal markets that we serve include major cities in California, Texas, and Florida and have strong demand for our services and increases in their funding that will continue to drive growth.

I would like to highlight for you two areas we believe to have significant growth opportunities for us in 2020. One is the U.S. federal government and the second is sustainable high-performance buildings. The U.S. federal government is our largest client and it's been our primary client since the very founding of the company. We've built a portfolio of $18 billion in current contract capacity that we can access to support the federal government and rapidly address their priority programs.

Our current contract capacity supports water and environmental agencies, the Department of Defense, U.S. agency for international development and the Department of State. And most recently, we've added new contract capacity to facilitate the delivery of our high-end advanced analytics and federal IT services.

Just a month ago, more than $1.4 trillion in fiscal 2020 spending bills were approved by the U.S. federal government. The final budget includes increases in Department of Defense, civilian agencies and international development spending all core markets for us here at Tetra Tech. Now, today, without the delays and shutdowns and sequestrations that we've seen in prior years and the budget already in place, we're very optimistic that this will result in increased federal government revenues for us this year.

Another high-growth area for us is the design of sustainable high-performance buildings. We're seeing demand for high and sustainable buildings continue to increase and this is for buildings that generate more power than they use, buildings that capture and recycle water and buildings that minimize waste. We've been investing in growing a high-performance buildings practice into our global operation now for the last few years and we today have a practice with $250 million in annual revenues that operate worldwide.

Our goal, pretty simple is to double this again to $500 million through a combination of organic and acquisitive growth. We're now expanding in this market for both global clients and for regional markets in the United States, Canada, Asia Pacific and the United Kingdom. Sustainable building design is an excellent application of our high-end design capabilities and innovation of Leading with Science as an approach. Working with our clients, we're advancing the state-of-the-art and city infrastructure with different facilities that are better to live in and to work in, while reducing their impact to the environment.

I'd now like to present our guidance for Q2 and for all of fiscal year 2020. Our guidance is as follows. For Q2, net revenue, we're providing guidance of $580 million to $630 million range, with an associated adjusted diluted earnings per share of $0.73 to $0.78. For the entire year, our revenue guidance remains the same at $2.4 billion to $2.6 billion of net revenues with an associated or updated adjusted earnings per share of $3.40 to $3.55, which includes a raise of the lower end by $0.05 based on the performance that we produced this first quarter.

If you're following along on the webcast, you can see the assumptions that are included. It does assume that we have $0.14 per share of intangible amortization. That's a noncash charge, have an effective tax rate for the remainder of the year, up 23%, 55.5 million average diluted shares outstanding. And as in the past, this guidance does not include any contributions from future acquisitions that may occur during the year.

In summary, we had an excellent first quarter and start to fiscal year 2020 setting first quarter records for revenue, net revenue, income and earnings per share. Our backlog reached another all-time high for services that are aligned with our long-term growth strategy that provides us with excellent visibility throughout the remainder of the year. And as we begin fiscal year 2020, we're seeing increased opportunities in demand for our Leading with Science approach in advanced analytics solutions, reaffirming our strategy to focus on these high-end services in water, environment and sustainable infrastructure.

With that now, Michelle, I'd like to open the call up for questions.

[Operator]

Thank you. [Operator Instructions] The first question comes from the line of Sean Eastman with KeyBanc Capital Markets. Please proceed with your question.

[Sean Eastman, KeyBanc Capital Markets]

Hi team. Thanks for taking my questions. First one for me is if we look at the quarter relative to our expectations, I'd say probably CIG margins and the underlying strength in the commercial business were kind of the positive surprises. Just hoping we could get a little more color on the underlying drivers for the commercial business and how sustainable they are as we move through '20?

[Dan Batrack, Chairman & Chief Executive Officer]

Great question, Sean. I would say that CIG's margins was actually one of the bright spots particularly bright spots in the quarter. I think that when you adjust the margin performance of CIG for the WYG addition as we begin to increase their margins, CIG was about 12% which actually brings them within about one percentage point of GSG.

So that increase is very promising. It was driven really in two areas, the top line growth which you saw up at 14%. We saw really strong growth both in U.S. commercial and international.

Canada across the board has been very strong for us. With respect to U.S. commercial to give you a little bit of insight looking forward, if you followed along on the webcast, you'd see we actually called out the task orders or incremental new orders we received in the quarter. The biggest the one sector that stood out a bit more on our backlog growth in the quarter was actually U.S. commercial with a book-to-bill of just about 1.2.

Now we grew our backlog book-to-bill in all areas, but U.S. commercial was the strongest which gives us more confidence in additional work flow through. And typically our U.S. commercial work has higher margins than some of the other sectors such as state and local or U.S. government and so I think that's a good indicator that we're going to continue to see expansion in the CIG margins as we move through fiscal year 2020.

[Sean Eastman, KeyBanc Capital Markets]

That's excellent. And maybe we could just get a quick update on how the WYG integration process is tracking relative to expectations. I know that's kind of an important margin swing factor as we move through the year as well.

[Dan Batrack, Chairman & Chief Executive Officer]

Yes. There's two parts about WYG. One I would talk about the progress, we're making with respect to margin expansion from what was essentially a breakeven business to a 10% run rate. I would say, we're tracking exactly on what our expectations would be.

We don't really see it as either front-end or back-end loaded, but a very linear increase across the year. We were about a couple of percent, I would say roughly 2% margin here in the first quarter which is right on -- right in line with what our expectations are financially.

I expect that through Q2, we'll move up to probably a 4%, probably a 6% in Q3 and then in Q4 we'll actually see it increase with the end of Q4 being at 10%. We do have the ability I would think to increase that as far as progress and to be a little bit faster.

But the other portion of integration is really synergies both culturally and end markets with respect to our other operations in the company. And I would say in that area operationally, it's actually exceeding our expectations.

And what I mean by that is, we've seen multi-national clients that we have in the U.S. and Canada that have ongoing operations in the United Kingdom have actually given us work. And our program managers and technical staff now actually represent that we have the on-the-ground local capability to support it for permitting and other technical resources in-country and that's translated into work already for our commercial clients.

And we've actually submitted a significant number of proposals to many of the different major water utilities in the United Kingdom and Northern Ireland that we expect to be very competitive with that would have never been submitted with WYG as a stand-alone.

So actually the cultural embracement of WYG by Canadians Americans and even Australians has far exceeded my expectations and the number of parcels that have gone out a real good indicator that we should be at the top end of revenue synergies as we move through the year.

[Sean Eastman, KeyBanc Capital Markets]

Excellent. And then last one for me higher level you guys talk about you're strategically growing the IT and advanced analytics business. I was just curious, if you could break out roughly what the mix of IT and advanced analytics is today and where you think that could go in say the next three years.

[Dan Batrack, Chairman & Chief Executive Officer]

Well I'll tell you it's -- well it's a small area of the company. And we've -- I spoke of this in the previous quarter that we believe it's -- all IT and advanced data analytics is a bit under 10% of the company's revenue currently. The fastest-growing area for us in the federal government is actually our IT and data analytics.

I would say that, I would want to differentiate it from general IT services that you may find other professional services providing. The IT data analytics that we're focused on are highly domain or technical and client-focused.

So the example that I spoke of in the prepared remarks: for the EPA regarding advanced analytics that we're doing for our ecological evaluations would be an example; for the U.S. state department, we're using data analytics more and more for the monitoring and evaluation work that's being done. It allows them to more effectively evaluate the progress that's being made for the state department expenditures that are being put in place. And so these are highly intertwined between the domain expertise, which Tetra Tech is a market leader on the environment, the water, sustainable design engineers as the cross integration of the advanced analytics.

It's a different way to approach the market. It's much less competition and it really creates a different platform for competing, because it's not how many IT people you have, it's how capable and what type of expertise do you have in this end market domain and how can it actually be automated through artificial intelligence and advanced analytics and that's where we're making great progress. And it actually could be the very front end of a new wave that will transform even that business for us. So I think -- I hope that helps with respect to what the dollar amount is how quickly it's growing and how we see it fitting.

[Sean Eastman, KeyBanc Capital Markets]

Very helpful. Really appreciate it. Thank you.

[Dan Batrack, Chairman & Chief Executive Officer]

Great. Thank you very much, Sean.

[Operator]

Thank you. Our next question comes from the line of Noelle Dilts with Stifel. Please proceed with your question.

[Noelle Dilts, Stifel]

Hi, thanks and congratulations on a good quarter.

[Dan Batrack, Chairman & Chief Executive Officer]

Thank you, Noelle.

[Noelle Dilts, Stifel]

So first, I was just hoping you could comment a bit on the acquisition pipeline what you're seeing in the market. And if you could just touch on your capital allocation strategy. I know it's always been pretty balanced, but if there are any sort of slight preferences as it stands right now in terms of M&A versus repurchase et cetera?

[Dan Batrack, Chairman & Chief Executive Officer]

Yes, good questions. The pipeline for acquisitions continues to be very robust very full. The one thing that we're very encouraged here, our identification of partner that would join Tetra Tech. We like to use the word that they would merge with us because we actually like them to come on board and actually lead their technical discipline for the corporation. They're generally sourced from our 20,000 technical staff that we have in the company and I'll tell you that there's no shortage of opportunities. We do have specific areas that we're looking for, so we've added our own filter to this with respect to priorities.

One area that I just spoke of that is a higher growth area for us in fact the fastest-growing with the U.S. federal government is advanced analytics in IT. That's an area that we're looking at and we have many opportunities, again for folks to come join us and actually help lead that practice for the corporation, which is a different practice than just a monetization by a firm looking to sell. High-performance buildings, we have certain geographies that we think that high-performance building design is a fast-growing area and we have many opportunities there to actually round out and move us to a market-leading position.

And then there's water opportunities in the U.K. that we would actually like to add additional water consulting capability in the U.K. So we have more folks on the ground there. And municipal work in Australia. So there's plenty of different areas that we have openings for and that would fit well with the company and there's no shortage in the pipeline. With respect to capital allocation, number one priority is we want to use our balance sheet to bring in the best partners possible to increase our competitive position, not to make Tetra Tech bigger but to make Tetra Tech better to actually bring in new thought leaders, new technical leaders. And so that is the number one priority for our balance sheet. And the areas that we're focused in I had just spoke to.

However, we also are committed to and we're supportive of our stock. We think that there's more upside with respect to valuation of the company. We think the best is still yet to come for us and so we're committed to a relatively consistent disciplined repurchase program that you've seen for the past many years. The Board of Directors did approve a $200 million addition to the buyback. That should not be seen as a signal that we're changing our buyback program or our disciplined approach to being in the market, but just giving more visibility and flexibility into the future.

So you did see this last quarter, we've been about $25 million. We're $21 million this last quarter, which is a matter of timing. And so, I would say both on acquisitions, I just shared where we're looking. But as far as disciplined approach on the financial side, we expect that those acquisitions will be accretive on a GAAP basis in year one. And on a buyback, we're looking for it to be on a very regular disciplined manner. But if there is something that is larger and that we would want to put a priority to, we can actually take action on all of those fronts that I'd indicated for acquisitions and we would use buyback as a lever to deemphasize in order to move aggressively to add the right partners to the company.

[Noelle Dilts, Stifel]

Thanks. That's very helpful. Second, just given that it is an election year, I know that generally Tetra Tech is doing pretty well no matter what the administration. But could you just speak to what extent election years tend to cause short-term disruption versus the programs that you – where you feel will just kind of continue and the spending levels should sustain through the elections? That would be helpful. Thanks.

[Dan Batrack, Chairman & Chief Executive Officer]

Yeah. Yeah that's interesting Noelle. I would say that, you're right. Tetra Tech has been in existence for roughly getting close to 55 years. We've seen move from Republicans and Democrats, Democrats back to Republicans and we've not seen a particular change in our revenue from the federal government. However, I will say, we've generally seen a pickup in election years and the reason is neither side of the aisle wants to be someone to provide fiscal constraints to the budget.

So I will say, and we included on the presentation slides, we've seen increases in budget in defense. So, if you're a hawkish, you've seen increases. We've also seen increases in fact some of the largest budgets that EPA has seen in the decade and so EPA is up. We even saw the state department, which then USA Agency for International Development is a component. Their budget is actually up slightly. So this is really budgets up across the board and this is really nobody wanting to create a negative environment moving into an election cycle.

So for fiscal year – for our fiscal year 2020, which concludes at the end of September, before the election, we actually see full funding and spending, and we think it will be robust throughout this year. After the election, we'll see what actually transpired. That's another matter, but certainly, well, through our fiscal 2020, we see very strong spending for these clients.

[Noelle Dilts, Stifel]

Great. Thanks. One last quick question – I guess two. One, are you – given a lot of these natural disasters that have been occurring are you seeing more opportunity around larger multiyear sort of avoidance or even mitigation programs? And then quick book-keeping question, could you give us the backlog contribution from WYG in the quarter?

[Dan Batrack, Chairman & Chief Executive Officer]

Yes. I can give you both of those. So with respect to more opportunities for natural disaster mitigation, we actually saw significant funding come out of the federal government for disasters that took place in 2017 and prior. This was measured well in excess of $10 billion and it includes what they call community development block grants. And what this is, is grants to communities for mitigation and this is right up the alley for Tetra Tech.

Mitigation means flood protection, floodwalls, moving up infrastructure to areas that would be more protected from low-lying events in the case of water floods, for offsets and other mitigation efforts in the case of fire, instances where it would be for earthquakes additional structural and seismic improvements. All of this is the front-end consulting prioritization and even moving into engineering. And so we actually have seen movement and there was a commitment to a percentage of all disaster dollars being put to upfront preparedness and mitigation. So let's do something to mitigate it before it hits. So these are all things that are exactly where we would be huge advocates and fit to our market.

[Operator]

Thank you. Our next question comes from the line of Andrew Wittmann with Robert W. Baird. Please proceed with your question.

[Andrew Wittmann, Robert W. Baird]

Great. Thanks. I think most of my kind of bigger picture questions have been asked and answered, but I thought it would be worth clarifying here since you are calling out your state and local business, excluding the storm or the disaster response work and specifically noting that, the last three quarters of the year have notable headwinds if you could quantify those headwinds just so that we get our models kind of baseline correctly and our expectations set correctly as those quarters unfold.

[Dan Batrack, Chairman & Chief Executive Officer]

Yeah. Absolutely, and that's a good question. And just to complete the answer to the – to Noelle's, WYG essentially contributed nothing to our backlog growth. They contributed $35 million of revenue in the quarter and they contributed about $35 million $36 million in orders. So, when you take the orders minus the revenue, it was about a push. So, WYG in and of itself did not contribute to the increase in the quarter for backlog and that's the WYG UK operation.

With respect to the headwinds, we see about -- make sure I get the precise numbers here. In the first quarter we saw a reduction of around $15 million of year-over-year in the response work, which is the quarter that just happened and that was the number that we used to present some of the adjusted numbers without the response work.

The number does get bigger. Q2 is about $25 million. So the quarter coming up, we see about $25 million; Q3 $35 million; and Q4 about $30 million. So, those are the numbers that -- and those are the numbers that we'll see as headwinds with respect to the overall state and local. But when you actually adjust for those out that's what I was referring to, to this 10% to 15% municipal growth in our state and local activities -- and by the way those numbers, because those are in the future for Q2, Q3 and Q4, that's assuming that there are no events. So, if there are any type of events that we mobilize or we actually respond to anything that would offset these numbers accordingly.

[Andrew Wittmann, Robert W. Baird]

Okay. Super. That's helpful. And then I guess kind of the obligatory question here is, you guys beat your midpoint by $0.07 yet your midpoint of the annual guidance only went up $0.025. I was wondering Dan, if you could just give us some perspectives behind that thought process and why it didn't flow through the full $0.07 that you beat to the midpoint.

[Dan Batrack, Chairman & Chief Executive Officer]

Yeah. That's a good question. That's a really good question. Now we had a very good first quarter. You're right we did beat by $0.07. And that we looked at it, I'd call it prudently or silverly. We're 90 days into the fiscal year. We're one quarter in. And actually as of this phone call or conference call for one quarter and one month in. We've got another update on both our performance in Q2 once we hit midyear, and we'll look to update that.

But it just felt that it was so early in the year that we wouldn't make a move on either our revenue or the top end of our earnings. But no doubt with the $0.07 beat we did move our bottom end up $0.05. It covered most of all of that. So I would say there should be nothing read into that with respect to cautionary. That was not the intent. It was just being prudent or appropriate given being so early in the fiscal year.

[Andrew Wittmann, Robert W. Baird]

Thank you. That’s all I have today.

[Dan Batrack, Chairman & Chief Executive Officer]

Great. Thank you very much, Andy.

[Operator]

Thank you. Our next question comes from the line of Ryan Connors with Boenning and Scattergood. Please proceed with your question.

[Ryan Connors, Boenning and Scattergood]

Thank you. Good morning. Wanted to just actually stick with that last theme right there on guidance and just looking actually at the revenue guidance. The mid and the higher end looks certainly healthy, but the low end of $2.4 billion really implies minimal growth at all year-over-year in revenue. So, I'm just curious what the different variables are that get you to the high and low end of that guidance that leads you to keep that low end in place given the backlog dynamics you've talked about everything looking pretty strong.

[Dan Batrack, Chairman & Chief Executive Officer]

Yeah. That's a good question. And so, let me share with you how we're looking at the numbers for guidance both at the low as a high-end and then of course the imputed midpoint. Last year we were at $2.4 billion, and I do understand that the low end for this year of our guidance range on net revenue is $2.4 billion. But, last year in that $2.4 billion, there were two revenue contributions that currently don't exist and that we actually would adjust what we see last year.

So, the two items are: number one, our Canadian midstream construction practice where we were doing turnkey activities contributed $70 million of net revenue that is not in our revenue stream. And the disaster response work was $100 million, and I just gave the detail of the breakdown of that by quarter.

By the way, we were trying to be very open and very transparent on the contribution of that through this last year because we knew this year-on-year comparison would be in place. So, if you take $2.4 billion from last year, if you take out $170 million, which is $100 million from disaster and $70 million from our midstream Canadian pipeline work, I would say last year's number is really $2.230 billion.

If you compare $2.230 billion to the midpoint of our guidance for this year at $2.5 billion, that's a 12% increase just at the midpoint. And that is a better way.

And at the low end that you'd mentioned, at our $2.4 billion would represent an 8% increase. Obviously, I can use the high end and it moves us well into the upper double-digits. So really our range moves from sort of an 8% to 18% with the midpoint at 12-ish, if you actually look at what our ongoing operations are producing or what our guidance represents.

[Ryan Connors, Boenning and Scattergood]

Got it. Okay. Apples to apples good. Now the other – my other question was you mentioned – you called out a few kind of opportunities here like the sustainable buildings, the federal side. But one thing you didn't talk about that you've talked about in the past is emerging contaminants on the water side and specifically PFAS. Can you just give us an update there, what you're seeing, how that market's developing for you?

[Dan Batrack, Chairman & Chief Executive Officer]

Yes. We have spoken in past quarters about the PFOS and PFAS, which are – for those that are less familiar with the acronym, it's chemical components of firefighting and fire retardants that are used, primarily at the defense facilities, where they've been practicing or employing firefighting, chemical uses or at firefighting stations or airports where other activities have taken place.

It actually is – it is one of the big drivers on the environmental portion, primarily the groundwater work that we're doing. Most of the work we're doing right now is for the Department of Defense and that's really for all three branches Army, Navy and the Air Force.

And the work is first for identification of the presence of these chemicals. And what fits very well for Tetra Tech and we're one of the leaders in this, which is modeling for fate and transport. Fate is what it may actually convert to over time, as it moves through the geology. And then of course transport where is it going and how fast it will it impact the surrounding municipal water waste.

We've not only had success in the U.S., and I would say it's growing quickly with respect to percentage of the environmental work we're doing for DOD. But we're also doing this work in Australia for their Department of Defense and we're just beginning to do this with MOD the Ministry of Defence in the U.K. So those are the three defense agencies that we're working in.

We have not seen – although, we've done one demonstration pilot program self-performed for treatability with respect to what you actually do with it to treat it once it's been identified but this is very early. It's growing very fast. It's one of the most frequent topics that we are discussing and contracting for with our clients.

And of course, the surrounding communities are very interested. And this is very early because there are no enforceable action levels for PFOS yet that have come out either at the state level or the federal level which is the Environmental Protection Agency here in the United States. And so I would say this is – the old proverbial where are we in the nine innings? Maybe the bottom of the first or the top of the second but we're very early in this.

[Ryan Connors, Boenning and Scattergood]

Got it. Got it. Okay. And then I did have one last one Dan. I know this is a topic we haven't heard about in a while. But in terms of the Hunters point, it seems like the new – looking at some of the news flow, Tetra Tech continues to get vindicated. I guess there was just another study last week out saying that there's not as much of an issue there in radiation as some of the alarmists had said in the lawsuit and so forth.

But in terms of process I know there's not much you can say about the legal process but are there certain milestones or a timetable where we can kind of get – where we'll get to closure on that? Anything you could share with us on how that kind of plays out?

[Dan Batrack, Chairman & Chief Executive Officer]

Well, I would say yes what to look for and we can do a better job, although we try to remain – because of the legal nature of the topic, we've tried to remain quiet on this matter and let the legal process play out. You've certainly seen that we vehemently stand – deny these salacious allegations and stand by the work that one of our divisions performed.

But we've had a number of these suits these civil suits dismissed with prejudice and so they're gone and so we could perhaps make those a bit more visible. But a number of them have been dismissed with prejudice. Others have withdrawn on their own. And so the number has moved if you want to say in our favor and we'll attempt to make that visible to the investment community.

But I would say the rest of it is just a legal process that takes time and will take its own life. And we feel with -- I hate to even call it favorable with actual recognition of what the status is which is that the work was done was completely in accordance with the work we were contracted for and met or exceeded all contractual components that we performed.

[Ryan Connors, Boenning and Scattergood]

Well, it’s good to hear. We look for that. And thanks a lot for your time this morning.

[Dan Batrack, Chairman & Chief Executive Officer]

Absolutely, Ryan.

[Operator]

Thank you. Our next question comes from the line of Marc Riddick with Sidoti. Please proceed with your question.

[Marc Riddick, Sidoti]

Hi. Good morning.

[Dan Batrack, Chairman & Chief Executive Officer]

Good morning, Marc.

[Marc Riddick, Sidoti]

So we've covered quite a bit this morning. A lot of my original questions were already answered, but the one area we haven't gone over a little bit I was wondering if you could give a bit of an update as to thoughts around CapEx needs and maybe some areas that may need to be worked on whether it be office space or IT investment or some of the things that we might be looking at whether it's something that you already have in your model for this fiscal year or maybe some things we should be thinking about for the years to come. Thanks.

[Dan Batrack, Chairman & Chief Executive Officer]

Yes Marc. I'll talk about the strategy and sort of the overarching approach. I'll let Steve then actually follow up with some specific numbers to put it in context of where we're trending to. But actually as we continue to shape the portfolio to more and more front-end work the requirement for any type of self-performance activities that would be less field trucks less of that type of activity will drop our PP&E or property plant equipment, which that goes into depreciation.

So from CapEx on that side, we become less and less and lighter and lighter capital-intensive. The CapEx that we do have is actually focused on professional service items such as the computers and the other analytic tools necessary. We have actually dropped our CapEx requirements with respect to our back office IT requirements, because we have gone as a corporation largely to the cloud. And in fact, we're moving -- our goal is to move essentially 100% to the cloud.

So it even eliminates the IT purchases of hardware that then continues to decrease our depreciation numbers. It gives us high reliability faster turnaround and speed. But with respect to numbers where we have trended over the past couple of years and what our focus is for this year Steve can give you a few numbers.

[Steve Burdick, Chief Financial Officer]

Sure. So I think over the last couple of years and into this year our CapEx needs come up to about 0.5% of revenue. And if you were following Tetra Tech for a number of years prior to getting out of the RCM business is that CapEx requirement was well above 1% of revenue. So, we brought that down and it's quite appropriate for where we're headed in the future.

[Dan Batrack, Chairman & Chief Executive Officer]

Yeah, one thing I'd like Marc is -- and we're very focused here at Tetra Tech on EBIT or operating income and D as far as I'm concerned depreciation. If we're purchasing something that we need that's part of what our business requires. And so, I actually am very encouraged to watch our EBIT or earnings before interest and taxes become very similar almost identical to our EBITD with depreciation.

So those two should converge to be essentially the same and it's probably 50 basis points or even less right now difference between those two, which is a really good indication of the operating earnings powers of the business.

[Operator]

Our next question comes from the line of Tate Sullivan with Maxim Group. Please proceed with your question.

[Tate Sullivan, Maxim Group]

Hi. Thank you. A couple of follow-up on the high-performance building and thanks for the detail on that and I know you've mentioned the $200 million target to double the revenue on that business. Just the $250 million current annual run rate is that -- is there a similar rate of subcontractor revenue in that? Or is that -- can I look at that as a net revenue number? If you can share please.

[Dan Batrack, Chairman & Chief Executive Officer]

On that it actually has less subcontract, but most of it is self-performance. Because the high-performance building design, the work that we're focused on primarily is MEP. So it's the mechanical electrical and the water hydraulics for water delivery and fire suppression work, and so that's the work we're focused on.

We do essentially almost all of that in-house, whereas other investigative and study and research work we may have third-party laboratories or maybe even marine vessels that we subcontract to collect data.

That's for the most part not the case, with respect to our high-performance buildings. So, I would say the net revenue of that number is probably 90%. So, it has a much higher self-performance component than other revenues across the company that we have.

[Tate Sullivan, Maxim Group]

Thank you. Can you remind me how long has it been that you've had this target? Maybe it's been two quarters? And did something change in the competitive landscape that gives you that confidence to double that? Or I mean, is it your international scale now? Can you comment on that, please?

[Dan Batrack, Chairman & Chief Executive Officer]

Yes. It's been the last couple of quarters. I think you saw the first time we came out with this and actually identified it as an area that we were going to invest in. And see that it was a more material contributor, was in 2019.

The reason we identified it as a key driver, is it definitely fits in with the environmental sustainable focus of the company it has with respect to its end clients. Many of the -- many of our investors have recognized that it represents a big E of ESG, without a doubt, on the environment side.

And with respect to what has given us more confidence with respect to the progress we'll make we're seeing it grow at probably at a double-digit rate organically. And with the addition of WYG in the U.K. who did bring a high-performance building on the government side, that's given us much better visibility and opportunities in a new marketplace that we hadn't had before.

And so, I think it's really having a good foothold. And the presence in Australia with our primary location for the buildings practice in Melbourne is growing well. In the U.S. we have both the East and West Coast.

And then, of course with now a new footprint in the U.K. it's allowing us to service the global clients that we were primarily limited to, if you went back a couple of years ago, just the U.S.

So, we feel the marketplace is much bigger for us. We think our footprint actually represents where our clients have facilities and the opportunities. And that's allowed us to come out with a stated goal of where we'd like to take this business which is doubling it.

[Tate Sullivan, Maxim Group]

Thank you. And on WYG real quick and the follow-up is did you mention the current margin? Did you say -- I know it was public before you bought it. But I thought you mentioned something about, single-digits or low-single digits.

[Dan Batrack, Chairman & Chief Executive Officer]

Low-single digits, so in the first quarter we were probably about 2%. I know that in the very first quarter it was essentially a breakeven, which would have been in the fourth quarter which was a quarter that they joined us. So, we have moved it up. But in Q1 they were about a 2% contribution for the revenues.

[Tate Sullivan, Maxim Group]

Okay. And last for me, you mentioned muni program growth in California, Texas and Florida. Was that water utility CapEx announcement you -- or can you -- was it anecdotal or just customer feedback?

[Dan Batrack, Chairman & Chief Executive Officer]

No. That's actually the numbers that we're seeing internally with Tetra Tech's revenues growth. And those are the areas that are primarily driving the top line growth.

So the numbers that Tetra Tech is seeing in our municipal water, revenue growth is about 10%, and I'd call that both our state city and county work. So I saw that collectively our municipal work. And we're seeing again the 10% year-over-year growth.

We have seen -- in the past we've seen even faster growth. We've seen actually through much of 2019, we're in the 20%. This is the 10% to 15% that we've stated. And if you'd asked, where are we seeing the biggest contribution toward that growth. That's where the California, Texas and Florida.

And we see large initiatives and funds and bonds that have been put in place in all three of those that give good visibility to their funding levels to keep that moving forward throughout 2020.

[Tate Sullivan, Maxim Group]

Okay. Thank you very much. That's all for me.

[Dan Batrack, Chairman & Chief Executive Officer]

Thank you, Tate.

[Operator]

Thank you. This concludes the end of the question-and-answer session. I'd like to turn the conference back over to Mr. Dan Batrack to conclude.

[Dan Batrack, Chairman & Chief Executive Officer]

Great, thank you very much, Michelle. And thank all of you for being on this call, for your very insightful questions and your interest in Tetra Tech. We look forward to another strong quarter of performance, particularly building on a record first quarter performance that we just finished.

And I really look forward to speaking with all of you, again next quarter. I hope you have a great rest of the week.

And have a good day. Thank you. Bye.

[Operator]

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