Tetra Tech Inc
NASDAQ:TTEK
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Tetra Tech Inc
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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 copyrighted property of Tetra Tech. Any rebroadcast of this information in whole or part without 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 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. [Operator Instructions]
With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.
Great, Donna. Thank you very much -- Dana, and good morning, and welcome to our quarterly earnings conference call.
I'm pleased to report that Tetra Tech achieved its best quarterly financial results in the company's history, with all-time high revenue, net revenue, operating income and backlog. Even with this record-breaking revenue performance, we ended the quarter with our backlog up sequentially for the fourth consecutive quarter and up 16% from last year.
With these excellent results, we're raising our annual guidance for both revenue and earnings per share for all of fiscal year 2019. While we had a great third quarter financially, I'm actually even more excited about our geographic expansion and the new services that we're offering to our clients worldwide.
Specifically, at the beginning of the fourth quarter, and on the date of July 9, 2019, we completed the acquisition of WYG, which I'll speak a bit more about later in the prepared remarks, which significantly advances our strategy of the objective to expand our presence in the United Kingdom and in Europe.
Our Leading with Science approach, augmented by artificial intelligence and machine-learning solutions, provided by our recent acquisition of eGlobalTech, is creating opportunities for us, as evidenced by our recent awards of over -- more than $100 million in new data analytics contracts just in the quarter.
So I'll begin today's presentation with a more detailed overview of our quarterly results and business outlook, while Steve Burdick, our Chief Financial Officer, will provide additional details on our financial performance and capital allocation.
We had an excellent third quarter, achieving record highs for revenue, net revenue, operating income, adjusted earnings per share and backlog, as I've indicated earlier. I'll refer here to the adjusted numbers, as shown on the slide, which better reflects our operational performance without the slight differences for nonrecurring items, which our CFO, Steve Burdick, will discuss later in the call.
For our third quarter, our revenue was $826 million, up 8% from last year. Our net revenue was $623 million, up 10% from last year, which generated an operating income of $65 million, which is up 10% from the prior year. This operating income resulted in an adjusted diluted earnings per share of $0.89 for the quarter, which is up 25% from the prior year. And finally, the backlog ended the quarter at $2.834 billion, up 16% year-over-year, and up sequentially for the fourth consecutive quarter, setting another all-time high for the company.
I'd now like to provide an overview of our performance by each of our key end clients. Our record for the third quarter performance was led by our U.S. state and local work, supported by growth across all of our end markets.
Our U.S. state and local revenues were up 52% this quarter and generated 19% of our overall business. Our success in the U.S. state and local market includes: one, our best-in-class water infrastructure services, which continues to grow at a double-digit pace; two, support for disaster response, especially in the areas of California, Puerto Rico and the southeast U.S. coastal regions; and the third area driving our state and local growth is long-term disaster recovery planning, program management and mitigation services.
Our international net revenue was up 12% year-over-year and represented 29% of our business. International growth for the quarter was driven by our industrial clients in Canada, including environmental permitting, geotechnical analysis work and renewable and conventional energy programs.
Work for our U.S. federal clients was 28% of our overall net revenue in the quarter, which is up 4% compared to last year.
Our continued strong performance in this market builds on broad contract capacity in our 3 main federal client sectors, which are the U.S. Agency for International Development or USAID; the Department of Defense; and the third sector would be civil agencies, which would include the Federal Aviation Administration and Environmental Protection Agency, Department of Homeland Security, Department of Human Health and Services and others.
Our U.S. commercial work was 24% of our net revenue in the quarter, which is up 1% year-over-year. We're seeing continued strength in utility markets, on our commercial utility market supporting energy transformation here in the United States. We've also seen growth in the midstream pipeline permitting and environmental work here in the U.S., and we've actually seen very strong growth in our high-performance building designs for our Fortune 100 clients.
I'd now like to present our performance by our segments. Our largest business group, the Government Services Group, or GSG, delivered another excellent quarter. GSG increased its revenues by 17% year-over-year while delivering a margin of 14.9%, which is up another 20 basis points from the third quarter of last year. This performance was primarily driven by continued strength in the municipal water infrastructure work, disaster response work and the expanding disaster recovery planning projects that we continue to be focused on as well as growth in other federal programs across our organization.
For the third quarter, our Commercial and International Business Group's net revenue grew by 7% and generated a margin of 10% for the quarter. The CIG group's performance continues to strengthen. The commercial, environmental and energy programs across all of North America continued to expand, with particular note of strength in Canada.
Total backlog, as we completed the third quarter is, as I've mentioned earlier, is at $2.834 billion, an all-time high record for us, which is up 16% year-over-year and the fourth consecutive increase. As you can see on the slide, and for following along on our simulcast, our third quarter had orders that were broadly distributed across our commercial, federal and local government clients worldwide.
Notably in the quarter, we were awarded a new contract to provide global analytical support for the U.S. Agency for International Development, or USAID. We see an increase in this type of analytical scope in large scale international development contracts. This scope fits exactly into Tetra Tech's strategy to combine our high-end domain expertise with digital analytical capabilities.
In Washington, D.C., we were awarded the next phase of a major restoration program for the Anacostia River. This program builds upon our monitoring and analysis of the watersheds and rivers throughout the Washington, D.C. area, coupled with our experience with some of the largest river restoration programs in the United States.
Now I'd like to turn the presentation over to our Chief Financial Officer, Steve Burdick, to present the details of our financials for the quarter. Steve?
Thank you, Dan. So as Dan just highlighted, revenue, net revenue, operating income and earnings per share for the third quarter 2019 were the best quarterly results in the history of Tetra Tech. And as previously discussed, I want to point out that our revenue and net revenue in fiscal 2019 reflects the fiscal 2018 third quarter divestiture of our utility field services operations.
So when we take this into account, meaning the prior year divestiture, on a pro forma basis, we actually saw a top line double-digit increase in the third quarter this year compared to last year, where revenue was up about 11% and net revenue was up about 12%.
Now on a GAAP basis, the fiscal 2019 third quarter revenue of $826 million increased 8% when compared to the revenue of $765 million in the third quarter fiscal 2018. Likewise, the fiscal 2019 third quarter net revenue of $623 million increased 9% when compared to the net revenue of $570 million in the third quarter of fiscal 2018.
And overall, these increases resulted primarily from our U.S.-focused municipal water engineering and consulting work; our international infrastructure efforts, especially those in Canada; and the disaster response and recovery planning activities that have continued into the third quarter.
We generated a 17% increase in our quarterly operating income for the year-over-year from $55 million to $65 million. This increase in operating income was driven by the revenue growth and by our continued focus on front-end consulting and engineering services.
On a GAAP basis, our EPS was $0.88 per share, which compares favorably to the prior year GAAP EPS of $0.59. The third quarter EPS is up 49% over last year primarily due to the increase in our net income, which benefited from the increase in our operating income, a decrease in our net interest expense and a lower effective tax rate. Now we did recognize the discrete tax benefit or a few of them in the third quarter, which resulted in an effective tax rate of about 19.6%.
For the third quarter, even if we applied our annualized estimated effective tax rate of 23%, our earnings per share would have still been at a record of 85% -- or $0.85 in the third quarter, which is a significant increase over the prior year and exceeded the top-end of our current year third quarter guidance.
On a year-to-date basis through the third quarter, cash flow generated from operations in fiscal 2019 totaled $113.4 million. This compares favorably to the prior year cash flow for the first 3 quarters of $76.3 million by about $37 million or an increase of about 49%.
The excellent -- this excellent cash flow was a result of our continued focus on collection of accounts receivable and management of our working capital. Among the many benefits of this cash improvement was the management of our debt.
Our net debt increased only slightly from about $223.6 million last year at this time to $225.4 million as of the third quarter this fiscal year. During the quarter, we funded the eGlobalTech and WYG acquisitions, the stock buybacks and a higher dividend amount. Our net debt-to-EBITDA settled just slightly below a 1.0 factor due to our continued strong cash flows from operations.
And lastly, our days sales outstanding decreased to 80.1 days as of the third quarter. This is an improvement from last year, but we do expect to do better. And you should note that our revenues grew significantly towards the back half of this quarter -- from the second quarter, and this growth required a much heavier use of working capital, which did impact our operating cash flow and temporarily increased our DSO due to the timing of the collections.
Our long-term capital allocation strategy calls for a balance of investing in the growth of our business, managing the balance sheet and returning cash to our shareholders. Continued strong annualized operating cash flows and especially the $113 million of year-to-date operating cash flow through this third quarter allows us to continue to do just that. We've been able to invest in strategic areas while growing the top and bottom lines. And to that end, in the third quarter, we funded the acquisitions of eGlobalTech and WYG, which Dan will speak to later.
But moreover, we paid out $8.2 million in dividends in the third quarter. And year-to-date, we've paid out $21.5 million in dividends.
And just this week, our Board of Directors approved our 22nd consecutive dividend, which will be paid in the month of August at a rate of $0.15 per share.
In addition to the dividend payments to the shareholders, we completed $25 million in share repurchases in the third quarter and $75 million year-to-date in fiscal 2019. Going forward, we will continue -- we will look to continuing the quarterly dividend program and utilizing the $150 million remaining under the approved stock buyback program.
So I am very pleased to share these outstanding financial results for the third quarter, and I want to thank you for your time today. So I will hand the call back over to Dan.
Great. Thank you very much, Steve. As we enter the fourth quarter of our fiscal year 2019, I'd like to provide you with an update on our acquisition strategy. Our strategic plan, as we presented previously here on these quarterly calls, is a growth through a combination of organic growth and acquisitive growth. Acquisitions for Tetra Tech are closely aligned with advancing our strategic objectives. Over the past 2 decades, we've developed a disciplined approach that results in acquisitions that are accretive in their very first year with the company.
Now we have 3 major strategic objectives that acquisitions actually materially support. First, is to build a $500 million a year high-performance building practice that is best-in-class in high-end sustainable building design.
Second, expand our capabilities in data analytics by adding leading consultants that share our vision of domain knowledge that's enabled by cutting-edge digital technology.
And third, to add to our geographic coverage by completing a significant acquisition in the United Kingdom and in the European market.
Now in the past 18 months, we've added 5 new firms that significantly advanced our strategy across all 3 of these objectives. The most recent addition is WYG who joined us just after the quarter close. As I've mentioned earlier, the transaction was actually closed on July 9.
Now I'd like to provide you with some insight into our newest addition, which is WYG.
WYG is a company of 1,600 staff, based in the United Kingdom, with a long-term reputation as a leading consulting and international development firm. They have 26 offices in the United Kingdom and a top-tier client base, which includes the Ministry of Defense, UK Aid and major local utilities such as Sellafield and National Grid.
Now we're already well on our way to align WYG with Tetra Tech, both in advancing growth strategies and in leveraging Tetra Tech's best-in-class enterprise financial systems and our IT resources as we integrate them into our operations.
WYG brings a highly complementary culture and business mix to Tetra Tech, and we expect their financial performance to be aligned with Tetra Tech's, reaching double-digit margins by the end of fiscal year 2020 or roughly in about a 12-month period.
Overall, I expect that not only will the WYG operations be successful, but they will provide an excellent platform for our future organic and acquisitive growth throughout the region.
Now just 3 weeks after WYG has joined us, we're already bidding on new proposals together and positioning for new contracts and new opportunities in the marketplace. We see 4 major growth markets that will leverage our combined resources of the 2 companies.
First, and of course, primarily the leading technical area for our corporation, is the water market. And we believe that the water market in the United Kingdom is where we can position for the next amp cycle and provide our high-end water infrastructure planning and program management services.
The second area will be the environmental restoration market, where WYG has key positions in large-scale restoration programs in military facility remediation contracts.
A third area is addressing the expanding needs for infrastructure and housing across the United Kingdom, which there's a very acute shortage. And we can serve that from our strong geographic coverage and engineering resources that we have both in the United Kingdom and globally.
And finally, international developmental, where our combined team has a significant competitive advantage on a broad range of analytical, digital and development-related services all throughout the United Kingdom and the European Union.
I'd now like to present our guidance for the fourth quarter and our updated guidance for fiscal year 2019.
Our guidance is as follows. For the fourth quarter, we expect our net revenue to be in the range of $610 million to $650 million, with an associated adjusted diluted earnings per share of $0.82 to $0.87. Our updated guidance for all of fiscal year 2019 is for a net revenue ranging from $2.370 billion to an upper range of $2.410 billion, with an associated adjusted diluted earnings per share of $3.10 to $3.15. Now the assumptions associated with this guidance for fiscal year 2019 are provided on the slide here for your reference.
In summary, we had an excellent third quarter, achieving new records for all of our key financial metrics, which include revenue, net revenue, operating income, earnings per share and backlog. We advanced our strategy to expand into the United Kingdom and European Union markets with the closing of WYG in July, and our high-end consulting services are providing us a competitive advantage and increased opportunities for us in the markets that we're surveying, giving us excellent visibility and high confidence as we move to complete fiscal year 2019 and prepare to enter fiscal year 2020.
And with that, Dana, I'd now like to open the call up for questions.
[Operator Instructions] The first question comes from Tahira Afzal with KeyBanc Capital Markets.
It's Sean on for Tahira today. The first one for me is GSG, clearly really explosive growth in state and local, in particular. I wonder if you could characterize where utilization is in that segment versus kind of a normalized range. And at what point do you start to have capacity constraints on growth in light of kind of the performance there over the last 2 years or so?
Great question. We've had -- we have had great success in our state and local markets and our federal activities and our international development activities within GSG. So while state and local, of course, was an exceptional outperformer this past quarter, really we do want to note that it's all 3 areas that have been driving the GSG growth.
Now with respect to utilization, we have said in the past that our margins would range, as a relatively stable business, between 13% to 15%. When staff is highly utilized and we're running very efficiently, we'll be up toward the 15% range. And we are at 14.9%, we're at the upper end of that range. So our utilization has been in the mid- to upper 70s, so we are getting close to what I would call an optimal or a maximum utilization rate. But we still do have more leverage within the workforce. We could add another several percentage of growth within that group on a quarterly basis without adding any additional staff. And in fact, as a comparison, I would point to the fourth quarter of last year where we're well into the 16% margin and that actually is associated largely with utilization of staff. In that particular instance, a year ago, we did have some favorable closeouts also that projects where we had special award fees and things that were extraordinary. So I actually don't see staffing or the ability to access resources as a limiting factor at this time, and I think we have additional upside from what has been exceptional performance, but we can do even better there.
That's very helpful. And the second question for me. I know it's early to talk about 2020, but as we look to fine-tune our forecast, it would be helpful to get a sense for the makeup of backlog as we're entering fiscal 2020 versus what was in backlog entering this year. Just in terms of project size and how rapidly that backlog to revenue burn is implied in that mix?
Well, I know I included in my prepared remarks, if it wasn't 3x, it was 4x. We achieved an all-time high backlog. And while it was a great quarter on so many different financial metrics, the one that, in some respects, I actually felt the best about and do feel the best about is our backlog. And the reason is not only that it's a record, it's the fourth consecutive increase, but the item that was noteworthy for us here at Tetra Tech is this is the first quarter in the history of the company that we exceeded $800 million in one quarter in revenue. Now I know our net revenue was also an all-time high, but the reason the total revenue is noteworthy to us is that at over $800 million, and it wasn't $801 million, $802 million, it was $825 million, that we had to replace all of that revenue expenditure in the quarter and then add more to have a book-to-bill that was greater than 1 on a very high burn rate in this quarter.
And so to have that level of visibility going into the fourth quarter, and I'll tell you, we have more proposals that are being evaluated by our clients, many of which are single awards that we're in direct negotiations with. So I actually feel -- I'm trying not to use the word confident, but I feel quite positive with respect to where this is going to continue to trend as we go into the end of our fourth quarter. And that is the single best leading indicator as to how we're going to perform into next year, which is where our backlog is.
With respect to the composition, it's very broad. While we had great performance in state and local, I will tell you that state and local, we did actually burn slightly more of the backlog that we had coming into the quarter. Obviously, with a 52% increase, that would be obvious. But the increase of new orders across all sectors: commercial, international, state and local, federal, was very broad. And as far as timing goes, as far as execution, it actually continues to be slightly shorter. As we move the company more and more to the front-end of the business on the consulting in the early aspect, the actual burn rate is typically at a year. And we've said in the past, 80% to 85%, I would say we're at 85% or slightly more that would burn in the next 12 months, with only a little bit of it going beyond that.
So we have a lot of visibility. And how were we compared to a year ago? Well, we're up -- we're at 8 33. A year ago, we were at 2 6, so we're up about $200 million. So even with the larger revenue incurred this year. So -- I know it's a little bit long-winded, but I hope it covered the different aspects of your question because it is one of the areas that we feel very best about in the company.
Our next question comes from the line of Tate Sullivan with Maxim Group.
Dan, did I hear you mentioned a $500 million target for your building design work? And if you talked about that before and where you're currently, can you give more context to that comment, please?
Yes, I sure can. We're targeting $500 million high-performance building practice. We're about half that level right now. So we're currently at a run rate of around oh, probably close to $250 million. So we think we can double that business in the next roughly, 3 years -- 3 to 4 years. It won't be organic. Obviously, that would be a very, very steep number for organic growth, but we have been seeing in some of our businesses in certain geography, we've been seeing growth rates between 15% and 20%. Other areas, we've been seeing numbers more in the low to middle-single digits. So 4%, 5%, 6%. So no doubt to achieve that objective, we will need to be both organic, and we'll need to be acquisitive. We have identified a number of excellent partners that we would actually like to come join us. And it would be both to help bring in certain technical expertise that we think would strengthen our team and add additional geographic coverage to some of the high-growth areas. So we're around $250 million now. We think through a combination of organic and acquisitive growth, we'd actually achieve that in the next roughly 3 years.
And then I -- given that segment in the commercial CIG group or the margins in the high-performance building above average or below, can you comment on that below average?
They're actually above average and are certainly, significantly above average compared -- above the current reporting margins out of the CIG group itself. It is one of the areas within CIG that is completely disassociated with any commodity aspects. So in other words, it's not associated with anything like oil and gas or mining. It really has a completely different set of drivers on the commercial side from our large clients. So yes, the margins are quite complementary to where we currently are. And in fact, the goal is to get the other businesses up to the levels that we're seeing in the high-performance building practice.
Okay. And then on the international, is it fair to compare the MYG (sic) [ WYG ] acquisition to the Coffey acquisition from 3 years ago? Are they -- I know different -- completely different geographies, but did you learn it? Did you have experiences integrating Coffey that you can apply to MYG (sic) [ WYG ]? Or shall I not even compare the 2?
No. I think they're absolutely excellent comparables. Obviously, geographically, they're at the other ends of the world to a certain extent, but they're both Commonwealth countries. They have similar drivers with respect to the rule of law and investments in infrastructure priority for water and environmental and sustainability programs, which are -- absolutely go the heart of Tetra Tech. They both had a very strong consulting practice, with a very successful international development arm, which the both of them, both in Coffey and WYG, which are, I hate to use the word plug-and-play, but they plug in and actually get integrated almost immediately.
And I would say that one of the lessons we learned, and we're actually implementing it right now, is it took us about 1.5 years to 2 years to get 100% of Coffey onto our ERP platforms. We expect that we'll have the international development component of WYG on board going into fiscal year 2020, and that's 60 days from today.
So with respect to what did we learn and how we're moving even more efficiently, that's the case. We'd expect their international development component to be on, on day 1 of fiscal year 2020, which is essentially October 1, and we expect only a few months behind that to have the rest of the business.
That was one of the lessons learned because that allows us to leverage the revenue synergies by being on the same platforms, the same communication, the same financials, just everything. So the intercompany work is augmented by the platform.
And I'd say the other area that we've gotten better at, probably the U.K. is a bit closer to Tetra Tech in the U.S. than Australia was. During this process, we've started identifying proposals and end clients that we can market and that we can actually go visit on day 1. And so that planning took place even on a more accelerated basis than we did Coffey. So Coffey was very successful. I think WYG will match that, perhaps just on a shorter time frame.
Our next question comes from Marc Riddick with Sidoti.
I wanted to touch a little bit on -- I guess, maybe it's sort of piggybacking on this. But I wanted to see if you could delve a little bit deeper into the commentary as to sort of hitting the ground running fairly quickly following the acquisition and having feet on the ground and being out and working together as quickly as you did. Some of the preparation that went into that and as far as the -- and what that might -- sort of what opportunities that might be or whether or not there were any particular industry verticals that were particularly receptive, anything along those lines. That would be really helpful.
Yes, I can give you a couple examples of where we think we expect near-term progress that actually means success that we can identify on our orders on the next quarter with new items contributing to our backlog. But we've had a presence in Europe proper. And in fact, in Germany has been the -- and Frankfurt has been our central office for our European operations. And it's largely been around the U.S. Department of Defense, which then has partnered with the Ministry of Defense in U.K. and other locations.
We've, of course, with a very limited U.K. presence, have been using subcontractors and partners. But with us moving forward, we've initiated that immediately. So the work that we were subbing to others we're immediately pulling back and going to be using WYG on. We have new capabilities in the defense arena that, for the U.S. regarding emerging contaminants that are big drivers like the PFOS and PFAS, which are enormous programs, that will have similar drivers with the Ministry of Defense. So we can actually pull those together. So we think that that's going to work quite well.
We do have new European contracts through the U.S. European District for the U.S. Army Corps of Engineers that we can use now our resources that are in theater, in country and supported really on day 1. So we feel good about that.
And I will say that while it's been just 3 weeks, we've had the great pleasure of reviewing proposals that are going in on a collaborative combined basis for international development. So our UK Aid, or DFID to be precise if you're in the business, business in the U.K., we were probably #7 as far as size. I would say it was somewhat similar numbers for WYG. So combined, we're a top 5 competitor. And I think the capability that we have between what WYG has with the European Union and with the U.K. combined with Tetra Tech's experience in Australia and in USAID and World Bank and others, should make us a very top competitor. And we've submitted proposals, or at least they're in the process of being submitted, for many tens of millions of dollars out the door within the first 30 days of their joining us. So those are real-life examples. And I'll be very happy to give you updates in the coming calls as to how those have translated into wins and a contribution to our backlog.
Okay, that's great. And switching gears, sort of coming back home here for a moment. I know it's sort of early-stage here, but I wanted to see if there were any sort of general thoughts that you might have or might share on the budgetary process and sort of maybe some of the opportunities that might be put forward. It seems as though they would sort of open some opportunities up, but just wanted to get a sense if you had sort of any early thoughts as to what was passed through the House, and then what we might see a benefit for Tetra Tech there?
Well, we feel really -- we're actually really glad to see this move forward. And as you just indicated, sort of gone through the House today. We'll get the Senate's hopefully concurrence on it. The President's indicated he'll sign it. And what it means for us is a 2-year budget deal that addresses both the ceiling and funding both for the defense and for all of the other departments within the government, which, sometimes, we refer to as civil works departments and civil agencies. And look, it's really simple. If you work with respect to the federal government, you have a budget, and you don't know if it's actually going to go forward or not or if there's going to be sequestered information or not, or is it continuing resolution or not. To have that clarity, we'll actually go back and add consistency and predictability with respect to their ability to spend what they've actually been allocated. And so we think this could -- this is a big step back to what I would call a more predictable -- I hate to use normalize because it's -- I don't know what that word means anymore.
That's a strong word.
Yes. But to a much more predictable revenue stream and the diversity that Tetra Tech has within the federal government from defense to the State Department to the other civil departments, I think this is actually a really big deal for us. So I think, for us, it would be predictability, visibility and with 2 years, we haven't seen that in quite a while. So I do think that bodes quite well for our federal business. And I know I've said this on calls in the past, we have well over $10 billion in contract capacity with the federal government, and actually gets closer to the $15 billion number. And so their ability to actually fund programs, and for those that have contract capacity in place right now that do this work, I think it bodes very well for us and others that are in this area.
Our next question comes from Noelle Dilts with Stifel.
Congratulations on a great quarter. My first question, I just wanted to circle back to WYG. I was hoping that you could expand a bit on how you're thinking about the longer-term margin progression? And where there are some opportunities to drive expansion? How you're thinking about that?
Well, I think that obviously, WYG has been a public company. You've seen their filings. Their performance has been at a de minimis profitability. I'm not going to say 0 but let's call it at a couple percent, 1, 2%. So let's say we're starting at that level. As I'd indicated in my prepared remarks, we expect that by the fourth quarter of 2020, which is essentially a year from now, that they'll be running at double-digit. And we'll start -- as I've said before internally, we'll start at 10%, work toward 99%. But they'll be -- the goal will be on a run rate will be at least 10%. And I expect within a couple quarters beyond that, they'll actually be at the Tetra Tech margin in that type of business, which will be 12, 13-plus percent.
I do think that some of the work that they have and some of the commercial clients and the nature by which some of the rate schedules that they use rather than cost reimbursable, which is actually a natural governor to margins that we have in the U.S. in some businesses, they actually use rate schedules for T&M or even -- and more prevalently fixed price, actually had the potential for them to produce a level higher even than what we have here in the U.S. So if you'd ask, when do I think they would achieve that? I think that 12 months from now, in the fourth quarter, they should be at a run rate of 10% or greater. And I think within a couple quarters after that, they should be at or above the Tetra Tech rates that we have within, I'm going to say the GSG because the CIG margins that we've posted even though it was at 10, are at a historical lower level. So I'm going to say that in the mid-teens number. So I don't want to limit by saying they'll be at or above CIG because CIG is going to be above its current CIG margins.
Great. Okay. And just kind of with that comment on CIG. Could you -- again, I know it's a little bit early to think and talk about 2020, but it's been helpful in the past in terms of helping us think about where margins are going. GSG has obviously been very strong over the last 2 years. Are you still feeling like those levels are sustainable moving forward? And any thoughts on kind of how to think about the cadence of margin improvement in CIG? And what you need to see to get to that higher end of your targeted range?
Yes. Well, first of all, I'll start with the easy, predictable comment, which is I do expect GSG to continue at its current performance. And we have both the backlog, the management team and the type of projects and staff to execute it to continue at the type of performance it had. So that's GSG.
With respect to CIG, we do have a few things we need to work through. I think -- I don't think, I have commented on previous calls with respect to some of the work that we have on the highly competitive implementation, construction management in Canada that is essentially revenue being contributed at no margin. I think we will address that. I've indicated last quarter, we're moving that to a priority. We expect to make some progress on that, it will be helpful, first of all, to take. It will be about a $60 million a year business that will contribute in 2019 at no margins. So as we address that, that will help in and of itself moving into 2020. We do have -- I will say though that WYG, if they're starting at a de minimis margin, let's call it a 1% or 2%, and we're going to move them up, I just think that if you take -- I just recognize that as you integrate that number into CIG for the early part of 2020, it will give an optic of suppressing or otherwise reducing the margin in CIG, so what we'll probably do is we'll take a look at providing some transparency as to CIG ex WYG and to give you an update of the progress we're making there. As I do think 2020 will be a year where we'll see CIG perform in the double-digit margins throughout the year, not just towards the spring and summer. I'm glad they did hit double-digit, 10%, here in the spring quarter. There'll be a lot of noise in the fourth quarter because of transaction acquisition costs, as I mentioned, which will go into CIG, but I think in 2020, we should watch CIG's number move into the -- toward the low-teens, maybe 13-ish. So that's the timing and the type of number we're targeting for them.
Our next question comes from Andrew Wittmann with Robert W. Baird.
I guess I wanted to just drill into the really good growth in state and local a little bit more so that we could just have a little bit more insight as we think about this business. And specifically, what I mean is, Dan, I heard you talk about 3 buckets in your state and local commentary, you talked about kind of the water infrastructure work that you do. You talked about the disaster response, which I kind of think of as kind of quick response needed type of stuff. And then you talked about the third bucket, which is kind of planning and forecasting and kind of longer-term projects. And I was hoping you could help us understand, at least in the quarter and maybe even on a year-to-date basis, how each of those buckets have grown? Just as we think about comparisons next year, I think it's probably best to be eyes open on it so we understand what's really happening inside of that.
Yes, absolutely. Andy, you got the 3 buckets, right? So let me start with the one that's been with us the longest, it actually goes back to the founding of the company, our water infrastructure. This is where we do water supply consulting and watershed management, wastewater treatment, some flood control work that we do for the municipalities, some would refer to it as sort of our baseline work. That does represent about a little over 60% of all of the state and local work. Even with all of the contributions for the response and the long-term recovery work, it's up this quarter about 15%. So if I take that 52% and divide it up, how much of that was attributable to those 3 buckets, about 15% of that is attributable to the water infrastructure services business we have. So it continues to perform really quite well and has for several years now.
The second area is the recovery, which is the -- which I referred to as the longer-term plant recovery, planning work, the program management work, the mitigation consulting services. That accounts for an increase of about 5% of that 52%. So between the recovery and the water infrastructure, which have long visibility into those, those are not episodic. Those are not less than 1-year execution programs. About 20% was between those 2. And no doubt, response was the big addition. I actually shared with you all on the last call that if we were something above the 20s or 30s, it would be because of this bucket. And that accounted for about 30%. If you want to be precise, 32% of the increase.
So that's the number that I know that many are looking at, how much of it is replaceable? Or can you grow from? There's no doubt about that. But I will say that a year ago, in the first few quarters, we were responding to Hurricanes Maria and Irma and Harvey. And this year, as other work, we have not included in our Q4 guidance any contribution for additional disaster response or any new episodic event. This -- the forecast that we have, which is even higher than our third quarter, is just based on what we have already. So I would say that it's not all a single quarter. If you are looking out to next year, these others are growing quite quickly on the recovery and water infrastructure, and we would look for that to pick up the load, a lot of the load for what the response work that we're doing right now is. So I believe that touched on a few of your comments. I hope I provided specific numbers as to what contributed in the quarter and how we're looking at it as we go out.
This will conclude the question-and-answer session. I will now turn the conference back over to Dan Batrack to conclude.
Great. Thank you very much, Dana. And thank you all for attending and listening to this presentation and for those that ask questions, for your insight and interest in Tetra Tech.
We've got 2 months left in the fiscal year 2019. We're very focused on making sure this is another great quarter. Although we've got an eye on performance for this quarter, I'll tell you right now we're working diligently to put together our plans for 2020, and I'm really looking forward to sharing those with you on our next quarterly call to tell you not only how we finish the year, but really where we're going next and what our estimates are on our performance for 2020.
So thank you very much, and I look forward to talking to you all next quarter. Goodbye.
Ladies and gentlemen, this concludes our conference for today. Thank you all for your participating, and have a nice day. All parties may disconnect now.