Tetra Tech, Inc. — Q2 FY2016 Form 10-Q
Business context and reporting period. Tetra Tech provides consulting, engineering, program and construction management services focused on water, environment, infrastructure, resource management, energy and international development. The quarter ended March 27, 2016; comparisons are with the quarter ended March 29, 2015. The six-month period is the first half of fiscal 2016. Results are unaudited and in U.S. dollars.
Financial performance
| Metric | Three months ended Mar. 27, 2016 | Three months ended Mar. 29, 2015 | Six months ended Mar. 27, 2016 | Six months ended Mar. 29, 2015 |
|---|---|---|---|---|
| Revenue | $627.4 million | $564.8 million | $1,188.1 million | $1,145.8 million |
| Gross profit | $74.8 million | $69.8 million | $147.9 million | $148.6 million |
| Operating income | $16.7 million | $30.4 million | $49.6 million | $67.0 million |
| Net income attributable to Tetra Tech | $3.7 million | $19.0 million | $27.0 million | $44.6 million |
| Diluted EPS | $0.06 | $0.31 | $0.45 | $0.71 |
| Operating cash flow | Not presented separately by quarter | $30.2 million | $24.8 million |
- Q2 gross margin was approximately 11.9% versus 12.4%; operating margin was 2.7% versus 5.4%. First-half gross margin was approximately 12.5% versus 13.0%, and operating margin was 4.2% versus 5.8%.
- Management’s non-GAAP “ongoing” results, excluding specified items and RCM, showed Q2 ongoing diluted EPS of $0.37 versus $0.28 and first-half ongoing diluted EPS of $0.79 versus $0.69. These are company-defined measures, not GAAP EPS.
- Cash and equivalents were $113.7 million at March 27, 2016, down from $135.3 million at fiscal year-end. First-half investing cash use was $90.3 million, including $81.3 million for acquisitions; financing provided $37.4 million.
- Current assets were $874.5 million and current liabilities $475.7 million. Total balance-sheet debt was approximately $360.2 million, compared with $192.9 million at September 27, 2015. Credit Agreement borrowings were $357.1 million at a 1.62% weighted-average rate; the reported effective rate including swaps was 2.48%.
Changes versus prior period
- Q2 revenue rose 11.1%, while first-half revenue rose 3.7%. Acquisitions contributed $88.2 million of Q2 revenue; excluding acquisitions, management said first-half ongoing revenue grew 1.0% on a constant-currency basis. A stronger U.S. dollar reduced first-half revenue by $36.3 million.
- Despite revenue growth, GAAP operating income fell 45.2% in Q2 and 26.0% in the first half; attributable net income fell 80.3% and 39.5%, respectively. Acquisition and integration expenses, earn-out fair-value losses, foreign exchange and RCM results affected comparisons.
- RME revenue increased 23.8% in Q2 and 12.0% in the first half; operating income increased 36.8% and 14.7%. WEI revenue declined 4.9% in Q2 and 3.9% year to date, while its Q2 operating income increased 6.1%. RCM continued its planned wind-down and recorded first-half operating losses of $5.7 million.
- Interest expense increased to $4.3 million in Q2 and $5.9 million in the first half, including $1.9 million of Coffey debt prepayment fees in Q2. The first-half effective tax rate was 38.2%, compared with 29.6%; excluding specified tax items, rates were 32.7% and 31.5%.
Outlook, commentary and risks
- Management expected U.S. commercial, international and U.S. state and local government revenue to improve or grow during the remainder of FY2016; it also expected U.S. federal revenue to grow excluding RCM. Management anticipated significantly increased international revenue, including Coffey, on a constant-currency basis. The filing does not provide numerical full-year earnings or revenue guidance.
- Backlog was $2.1 billion, up $245.7 million, or 12.9%, from fiscal year-end. The company cautions that backlog may be canceled or adjusted and does not assure future revenue or profit.
- In January 2016, Tetra Tech acquired Coffey International for a $76.1 million purchase price and assumed $65.1 million of debt, which it subsequently repaid. It also acquired INDUS for $17.8 million, including contingent earn-out consideration. Acquisition allocations remained preliminary. The filing reports combined post-acquisition contributions of $88.2 million revenue and $0.3 million operating income, while its RME discussion attributes $1.9 million of operating income to Coffey; the figures merit reconciliation.
- Unusual and judgment-sensitive items included $15.9 million of acquisition and integration expenses, $1.9 million of debt prepayment charges, $2.8 million of first-half contingent consideration losses, and a $7.9 million increase in the allowance for doubtful accounts associated with RCM receivables and claims. First-half claim settlements generated a $4.6 million operating-income gain.
- Key risks include foreign-exchange exposure, weakness in mining and oil-and-gas markets, reduced U.S. federal defense work and government funding uncertainty, fixed-price contract cost overruns, claims and receivable collectability, acquisition integration, and possible goodwill impairment. Management noted the Waste Management Group’s goodwill could be at risk if revenue growth falls below 2%, comparable-business market prices decline more than 10%, or the discount rate rises to 14% or higher.
- Management said existing cash, operating cash flow and borrowing capacity should meet capital requirements for at least 12 months. At quarter-end the company was compliant with debt covenants: leverage ratio 1.99x versus a 3.00x maximum, and fixed-charge coverage 3.04x versus a 1.25x minimum. It had $288.7 million of revolver availability, of which $204.1 million could be borrowed without breaching covenants.
- Professional liability claims and lawsuits are routine; management did not expect their resolution to materially adversely affect the company, but acknowledged uncertainty and that some claims may exceed insurance. The filing also describes contract-performance guarantees, letters of credit and other contingent exposures.
Most important facts for investors to verify
- Reconcile acquired-business operating-income contributions and assess Coffey and INDUS integration, margins and purchase-price allocations.
- Track underlying revenue and profitability apart from acquisitions, foreign exchange, RCM and one-time acquisition or earn-out items.
- Monitor receivable aging, claims collection, the doubtful-account allowance and fixed-price contract estimates.
- Assess debt growth, covenant headroom, acquisition funding needs and the company’s stated liquidity outlook.
- Review backlog conversion, U.S. federal and defense demand, cyclical resource-sector exposure and the Waste Management Group goodwill assumptions.