Tetra Tech, Inc. — Q3 2017 Form 10-Q
Business context and period. Tetra Tech provides consulting and engineering services in water, environment, infrastructure, resource management, energy and international development. The quarter ended July 2, 2017; comparisons are with the quarter ended June 26, 2016. Fiscal year-to-date figures cover nine months.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Revenue | $685.5 million | $666.9 million | $2,018.2 million | $1,855.0 million |
| Operating income | $45.9 million | $39.1 million | $128.7 million | $88.7 million |
| Net income attributable to Tetra Tech | $30.0 million | $25.7 million | $83.4 million | $52.7 million |
| Diluted EPS | $0.52 | $0.44 | $1.44 | $0.89 |
| Gross margin | 13.2% | 12.8% | 12.5% | 12.6% |
| Operating margin | 6.7% | 5.9% | 6.4% | 4.8% |
Margins are calculated from reported revenue and profit figures. Revenue net of subcontractor costs, a company-presented non-GAAP measure, was nearly flat year over year in Q3, while it rose 7.3% year to date.
- Cash flow: Operating cash flow was $71.6 million for the nine months, down from $89.8 million. The company cited approximately $23 million of tax payments related to completed examinations. Investing activities used $14.6 million, versus $92.2 million, mainly reflecting the prior-year Coffey and INDUS acquisitions. Financing activities used $79.3 million, including $60.0 million of share repurchases and $16.0 million of dividends.
- Liquidity and debt: Cash was $138.8 million at July 2, 2017, down from $160.5 million at fiscal 2016 year-end. Credit-agreement borrowings were $325.3 million, with $299.1 million of revolving capacity available. The company reported compliance with its debt covenants: leverage ratio 1.54x versus a 3.00x maximum; fixed-charge coverage 2.04x versus a 1.25x minimum. Current assets were $962.3 million and current liabilities $489.0 million.
- Other measures: Backlog was $2.5 billion, up $154.8 million, or 6.5%, from fiscal year-end. The board authorized a $200 million repurchase program; $60 million had been used through the period. The quarterly dividend increased to $0.10 per share.
Changes versus the prior period
- Q3 revenue rose 2.8%; nine-month revenue rose 8.8%. Management said the year-to-date comparison includes acquisition contributions and is not fully comparable. Excluding first-half Coffey and INDUS contributions, nine-month ongoing revenue increased 4.0%.
- WEI revenue increased 5.6% in Q3 and 14.3% year to date; management cited infrastructure growth, particularly U.S. state and local work, and improved project performance.
- RME Q3 revenue was nearly flat, while revenue net of subcontractor costs fell 5.7%. Year-to-date growth included Coffey; excluding its contribution, RME revenue and revenue net of subcontractor costs declined, reflecting weaker North American oil and gas activity.
- RCM continued winding down non-core construction. Its nine-month operating loss was $12.8 million, versus $9.7 million a year earlier. The quarter’s loss narrowed to $1.3 million from $4.0 million.
- Reported year-to-date operating income includes a $7.1 million gain from lower acquisition earn-out estimates; the prior-year period included a $2.8 million earn-out loss and $16.9 million of acquisition and integration expenses. Management’s non-GAAP ongoing diluted EPS was $1.50 for nine months, compared with $1.29.
Outlook, commentary and risks
- Management expected U.S. federal and U.S. state and local government revenue to grow during the remainder of fiscal 2017; U.S. commercial revenue to be stable; and international revenue to be lower, with the Canadian oil and gas decline expected to worsen in Q4. It expected strong state and local government growth.
- The company said existing cash, operating cash flows and borrowing capacity should meet capital requirements for at least the next 12 months. This is management’s assessment, not a guarantee.
- RCM’s remaining backlog was $10.7 million and was expected to be substantially completed in calendar 2017.
- Key operating risks include economic and government-spending volatility; cyclical oil, gas and mining demand; contract cost overruns and performance estimates; claims collection; acquisition integration; foreign exchange; and dependence on qualified personnel. Fixed-price work and percentage-of-completion accounting expose results to revisions in estimated costs and contract revenue.
- Unsettled contract claims totaled approximately $49 million in receivables. The company recorded $4.9 million of revenue reductions and $3.6 million of related operating losses on claims in the first nine months; it also recorded $5.7 million of unfavorable construction cost-to-complete adjustments. Anticipated contract loss liabilities were $8.7 million at July 2.
- Professional liability claims and lawsuits are typical for the industry; some claims may exceed insurance coverage or be uninsured. Management did not expect their resolution to materially adversely affect the company, but acknowledged uncertainty.
- The company recognized a $7.1 million earn-out valuation gain in Q2, principally after lowering expected earn-outs for INDUS and Cornerstone Environmental Group. The filing notes these valuations use significant unobservable assumptions.
Important facts for investors to verify
- How much of reported growth and earnings improvement is attributable to acquisitions, earn-out revaluations, tax benefits, and other nonrecurring items versus underlying operations.
- Whether cash generation improves after the large tax payments, and whether receivables, claims and contract billings convert to cash as expected.
- Progress and final costs in the RCM wind-down, including resolution of claims and fixed-price construction estimates.
- Whether Canadian oil and gas weakness and lower international revenue develop as management anticipated, and whether government-sector growth persists.
- Backlog conversion, project profitability, credit-facility headroom and continued compliance with debt covenants.