Tetra Tech, Inc. — Q1 Fiscal 2011 10-Q
Reporting period: Three months ended January 2, 2011; comparison is the three months ended December 27, 2009. Unaudited interim results. Tetra Tech provides consulting, engineering, program and construction management, and technical services focused on water, environment, energy, natural resources, and infrastructure.
Financial performance
| Metric | Q1 FY2011 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $611.1 million | $542.0 million | +12.8% |
| Revenue, net of subcontractor costs (non-GAAP) | $405.6 million | $343.5 million | +18.1% |
| Operating income | $34.3 million | $31.1 million | +10.3% |
| Net income attributable to Tetra Tech | $22.3 million | $18.7 million | +19.2% |
| Diluted EPS | $0.36 | $0.30 | Higher |
| Operating margin | 5.6% | 5.7% | Down slightly |
| Effective tax rate | 31.1% | 39.4% | Lower |
Revenue growth included $84.6 million from recent acquisitions, chiefly BPR. Excluding acquisitions, revenue and revenue net of subcontractor costs declined, reflecting delayed federal awards, lower state and local activity, and wind-downs of certain Defense Department programs; water, energy, and mining demand partly offset weakness. Operating income benefited from growth and favorable claim settlements, but was partly offset by project overruns and $3.8 million of additional intangible amortization. Interest expense rose to $1.3 million from $0.3 million, primarily due to acquisition-related borrowing and earn-out liabilities.
Segment results were mixed: Engineering and Consulting Services revenue increased 52.5% and operating income 60.0%, driven by acquisitions and mining strength; Technical Support Services revenue rose 13.6% but net-of-subcontractor revenue rose only 3.2%; Engineering and Architecture Services revenue increased 3.0%, with operating income more than doubling partly due to a favorable claim settlement; Remediation and Construction Management revenue fell 12.9% and operating income fell 52.2%, amid delayed awards, program wind-downs, and project cost overruns.
Cash flow, balance sheet, and liquidity
- Operating cash flow was $8.9 million, versus cash used of $5.2 million a year earlier. Capital expenditures were $4.2 million.
- Investing cash outflow was $171.0 million, including $166.9 million of net acquisition payments, primarily for BPR. Financing provided $22.6 million, including new borrowings.
- Cash declined to $81.5 million from $220.9 million at fiscal year-end. Accounts receivable were $600.3 million; total assets were $1.475 billion.
- Total debt was $146.4 million, including $4.3 million current and $142.1 million long-term. The company reported $140 million drawn on its $300 million revolving facility, $29 million of standby letters of credit, and approximately $131 million available. Facility borrowings carried a 1.80% weighted-average rate and mature March 30, 2012.
- Facility covenant ratios were within stated limits: leverage ratio 1.47x versus a 2.5x maximum; fixed-charge coverage 2.49x versus a 1.25x minimum. Management said cash, operating cash flow, and borrowing availability should cover requirements for at least 12 months.
Material changes and business developments
- On October 4, 2010, Tetra Tech acquired Canadian engineering and consulting firm BPR for an initial purchase price of approximately $157 million, funded with cash and revolver borrowings. Contingent earn-outs may total up to approximately $40 million; the recorded estimated liability was $31.4 million. Purchase accounting remained preliminary.
- Goodwill increased to $535.1 million, largely from BPR; net intangible assets rose to $75.5 million. Intangible amortization was $6.8 million, versus $3.0 million in the prior-year quarter.
- International revenue increased to 20.7% of total from 7.4%, mainly due to Canadian acquisitions and demand in mining and energy. Federal government revenue declined 5.3%; state and local revenue declined 12.5%; commercial revenue increased 6.0%.
- Backlog was $1.9 billion. The company counts only funded contracts with work authorizations and cautions that backlog may be canceled or adjusted and does not assure revenue or profit.
Outlook, risks, and contingencies
Management expected moderate revenue growth in fiscal 2011 versus fiscal 2010, supported by acquisitions and anticipated business growth, while anticipating a slow economic recovery. It expected federal revenue to be flat, state and local revenue to decline, commercial revenue to grow modestly, and international revenue to grow significantly. Results are seasonal, with typically lower revenue in the first half and higher activity in the second half.
Key risks include delayed or reduced government funding and awards, state and local budget pressure, fixed-price contract overruns and estimation risk, client collection and credit exposure, acquisition integration and earn-out valuation, workforce utilization and retention, foreign currency exposure, and potential impairment of goodwill and intangibles. The company also faces professional liability claims and government-contract compliance and audit risks.
An appeal was pending in the ITC litigation involving acquired subsidiary AMT. Tetra Tech reported a reasonably possible exposure range of $0 to approximately $14.5 million, recorded its best estimate of probable loss, and recorded an equal receivable based on the former owners’ indemnity, which management believed would be honored. Other professional claims are generally insured, subject to deductibles, limits, and coverage exclusions.
Important facts for investors to verify
- How much reported growth and future earnings are attributable to BPR and other acquisitions versus organic performance, particularly in ECS and international markets.
- Whether RCM’s cost overruns and declining results improve, and whether delayed federal awards convert into funded work.
- Cash conversion and receivables collection, given $600.3 million in net receivables and relatively modest quarterly operating cash flow.
- Revolver usage, covenant headroom, refinancing needs before the March 2012 maturity, and sensitivity to interest rates.
- BPR integration, preliminary purchase-price allocation, contingent earn-out estimates, and the carrying values of goodwill and acquired intangibles.
- Resolution of the ITC appeal and collectability of the related indemnification receivable; also monitor contract claims, project estimates, and government funding risks.