Tetra Tech, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended December 27, 2015; comparative period ended December 28, 2014. Unaudited interim results. Tetra Tech provides consulting, engineering, program management and construction management services, reported in Water, Environment and Infrastructure (WEI), Resource Management and Energy (RME), and the wind-down Remediation and Construction Management (RCM) segments.
Financial results and liquidity
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Revenue | $560.7 million | $581.1 million | -3.5% |
| Operating income | $32.9 million | $36.6 million | -10.1% |
| Operating margin | 5.9% | 6.3% | Down about 0.4 percentage points |
| Net income attributable to Tetra Tech | $23.2 million | $25.6 million | -9.1% |
| Diluted EPS | $0.39 | $0.41 | Down $0.02 |
| Operating cash flow | $23.6 million | $5.5 million | Up $18.2 million |
Net margin was approximately 4.1%, versus 4.4% in the prior-year quarter. The effective tax rate was 25.7%, compared with 26.4%; Q1 FY2016 tax expense included a $2.0 million benefit from retroactive research and experimentation tax credits.
Cash and cash equivalents were $125.1 million at quarter-end, down $10.2 million from fiscal year-end. Cash used in investing was $2.5 million and cash used in financing was $29.3 million. The company repurchased $25.0 million of shares and paid $4.7 million in dividends during the quarter.
Long-term debt was $177.0 million and current debt was $13.0 million on the balance sheet; the company separately reported $189.6 million outstanding under its credit agreement. The effective borrowing rate, including swaps, was 2.69%. Available revolving credit was $458.7 million, of which $380.9 million was available without violating debt covenants. The company reported covenant compliance: leverage ratio 1.10x and fixed-charge coverage ratio 3.64x. Management said existing cash, operating cash flow and borrowing capacity should meet requirements for at least 12 months.
Material changes and business trends
- Reported revenue declined mainly due to U.S. dollar strength and the planned reduction in RCM construction work. Foreign exchange reduced revenue by $22.1 million. Excluding foreign exchange and exited RCM activities, ongoing revenue increased 2.8%; ongoing operating income increased 0.9% to $40.4 million, on the company’s non-GAAP basis.
- U.S. commercial revenue rose 8.4%, led by waste management and environmental work. International revenue fell 7.7% as reported but grew 7.4% excluding foreign exchange. U.S. federal revenue fell 11.1%, including lower Department of Defense work and reduced RCM activity; state and local revenue declined 3.9% as reported.
- WEI revenue was $240.4 million and operating income $20.0 million; revenue declined 3.0% and operating income 6.9%. RME revenue was $315.7 million and operating income $25.4 million; reported revenue was nearly flat, while revenue excluding foreign exchange increased 4.1%. RCM revenue fell 39.5% to $20.8 million and its operating loss widened to $5.3 million.
- Backlog was $1.8 billion, down $58.3 million, or 3.1%, from fiscal year-end. Management cautioned that backlog can be canceled or adjusted and is not a certain indicator of future earnings.
Outlook, risks and unusual items
- Management expected U.S. commercial revenue to continue improving, international revenue to be stable on a constant-currency basis, U.S. federal revenue to be stable excluding RCM, and state and local government business to grow excluding RCM. No consolidated numerical earnings or revenue guidance was provided in the filing text.
- Management expected remaining RCM work to be substantially complete by fiscal year-end 2016. RCM’s quarter included a $7.9 million reduction for doubtful receivables and claims, partly offset by a $4.6 million gain on settlement of a federal government claim. The company also recorded a $1.0 million operating loss from a contingent earn-out fair-value adjustment.
- The company collected $13.4 million to settle claims of $8.8 million, recognizing the $4.6 million gain. Claims-related receivables totaled approximately $39 million at quarter-end; the allowance for doubtful accounts increased to $37.7 million from $31.5 million at fiscal year-end. Management cited uncertainty around claims collection and project cost estimates.
- A subsequent event: Tetra Tech announced its takeover bid for Coffey International was free from closing conditions; payment of approximately $76 million for all shares was expected in Q2 FY2016.
- Key risks include commodity-price weakness affecting oil, gas and mining work; foreign-exchange exposure, particularly the Canadian dollar; government funding and contract-award uncertainty; fixed-price project overruns and claims collectability; professional-liability claims; and goodwill impairment. The filing notes that Waste Management Group goodwill could be impaired if revenue growth falls below 2%, comparable-market values decline by more than 10%, or the discount rate rises to 14% or higher. The RCM segment had $53 million of remaining backlog.
- Professional errors-and-omissions claims are subject to insurance deductibles and limits, and some claims may exceed or fall outside coverage. Management did not expect the resolution of disclosed claims and lawsuits to materially adversely affect the company, while acknowledging uncertainty.
Important facts for investors to verify
- Whether ongoing growth and management’s qualitative outlook are borne out, particularly in U.S. federal work, international markets and commodity-sensitive businesses.
- Collection and resolution of claims and other receivables, including the adequacy of the doubtful-account allowance and the basis for the RCM claim gain.
- Completion and remaining costs of the RCM wind-down, including whether the segment reaches substantial completion by fiscal year-end.
- Funding and financing of the approximately $76 million Coffey purchase, and its eventual effect on debt, cash flow and results.
- Whether the Waste Management Group reporting unit’s revenue, market valuation and discount-rate assumptions support its goodwill carrying value.
- Debt covenant headroom and liquidity after acquisitions, repurchases, dividends and other cash requirements.