Tetra Tech, Inc. — Q2 FY2019 Form 10-Q
Reporting period: Three and six months ended March 31, 2019; comparisons are with the periods ended April 1, 2018. Amounts are in U.S. dollars unless stated otherwise.
Business context
Tetra Tech provides consulting and engineering services focused on water, environment, infrastructure, resource management, energy, and international development. Its principal segments are Government Services Group (GSG) and Commercial/International Services Group (CIG); the company also reported the wind-down of Remediation and Construction Management (RCM), which had no remaining backlog at quarter-end.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | First half FY2019 | First half FY2018 |
|---|---|---|---|---|
| Revenue | $722.6m | $700.3m | $1,440.1m | $1,460.0m |
| Revenue, net of subcontractor costs | $585.4m | $532.8m | $1,138.7m | $1,077.6m |
| Gross profit | $96.5m | $91.4m | $195.2m | $185.6m |
| Income from operations | $47.5m | $42.7m | $103.3m | $91.3m |
| Net income attributable to Tetra Tech | $55.9m | $28.7m | $97.9m | $74.8m |
| Diluted EPS | $1.00 | $0.51 | $1.74 | $1.32 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $99.2m | $23.6m |
Q2 revenue grew 3.2%, while first-half revenue fell 1.4%. First-half revenue included prior-year utility field-services revenue from operations divested in FY2018; management said revenue excluding the net effects of acquisitions and divestitures was comparable year over year. Revenue net of subcontractor costs rose 9.9% in Q2 and 5.7% in the first half. Gross margin was approximately 13.3% in Q2 and 13.6% for the first half, compared with approximately 13.1% and 12.7%, respectively, in the prior-year periods.
Operating income increased 11.3% in Q2 and 13.1% in the first half. Reported first-half net income benefited from tax items; adjusted EPS, excluding RCM, contingent-consideration adjustments, and non-recurring tax benefits, was $0.70 for Q2 versus $0.54 and $1.40 for the first half versus $1.18.
Balance sheet, debt, and liquidity
- At March 31, 2019, cash and cash equivalents were $130.7m, down from $146.2m at September 30, 2018. Total assets were $1.952bn and stockholders’ equity was $990.6m.
- Long-term debt was $243.9m, including its current portion; borrowings under the credit agreement were $243.8m. The company had $449.1m available under its revolving facility and reported compliance with debt covenants: leverage ratio 1.16x versus a 3.00x maximum, and interest coverage 17.4x versus a 3.00x minimum.
- First-half operating cash flow of $99.2m was supported by receivable collections, including claim settlements. Investing activities used $3.4m; financing activities used $110.7m, primarily reflecting debt repayments, $50.0m of share repurchases, dividends, and earn-out payments. Cash, cash equivalents, and restricted cash ended the period at $133.4m.
- Accounts receivable included approximately $53m related to claims. Remaining unsatisfied performance obligations were $2.8bn, with $1.8bn expected to be satisfied within 12 months; cancellations, deferrals, or scope changes remain possible.
Material changes and significant items
- GSG Q2 revenue increased 2.8% and operating income increased 31.1%; growth in state and local infrastructure work helped offset lower subcontractor activity. CIG Q2 revenue increased 4.1% and operating income increased 13.4%, with international infrastructure and oil-and-gas activity contributing to growth.
- First-half federal revenue declined 6.8%, primarily reflecting disruption from the 30-day partial U.S. government shutdown. First-half international revenue increased 18.6%; management attributed much of the growth to Canada and the NDY acquisition, and reported 12.3% growth excluding NDY’s contribution.
- Q2 included a $3.6m CIG operating loss related to settlement of a claim on a project completed in FY2017. RCM recorded a $5.9m operating loss in Q2, largely reflecting updated evaluations of claims on completed construction projects.
- The company acquired eGlobalTech (eGT) in Q2 for a stated fair-value purchase price of $48.4m, including a $24.7m promissory note and contingent earn-outs. The note was paid in full in Q3. In April 2019, the company used approximately $40m for acquisition activities.
- ASC 606 was adopted October 1, 2018 using the modified retrospective method. Adoption reduced opening retained earnings by $2.8m; prior-year results were not restated. The standard modestly affected reported Q2 and first-half revenue and earnings.
Outlook, risks, and contingencies
Management gave no numerical full-year earnings or revenue guidance in the filing. It expected FY2019 growth in state and local government work, U.S. commercial revenue excluding the divested business, and international revenue, and anticipated modest federal revenue growth. Management cautioned that another prolonged federal shutdown could adversely affect federal work. It stated that existing cash, operating cash flows, and borrowing capacity should meet capital requirements for at least the next 12 months.
Key uncertainties include project cost and completion estimates, claims and collections, client funding and contract cancellations, economic and commodity-market conditions, foreign exchange, acquisition integration, and government procurement. The USAO intervened in three qui tam actions concerning Tetra Tech EC’s Hunters Point Naval Shipyard remediation work, alleging False Claims Act violations and breach of contract. The company disputes the claims; it could not determine the probability of outcome or reasonably possible loss. Other professional-liability claims may exceed insurance limits, although management did not expect their resolution to materially affect the company.
Tax results were unusually favorable: the second quarter included release of $22.3m of Australian valuation allowances, and the first half included a $2.6m deferred tax benefit from finalizing TCJA analysis. The reported first-half effective tax rate was negative 0.8%; management cited a 24.8% rate excluding the specified TCJA and valuation-allowance benefits.
The board authorized a $200m repurchase program in addition to the remaining prior authorization. The company repurchased $50m of shares in the first half, leaving $175m authorized at March 31. The quarterly dividend increased to $0.15 per share, declared April 29, 2019.
Important facts for investors to verify
- How much of earnings and EPS growth reflects recurring operating performance versus the Australian valuation-allowance release and other tax benefits.
- Whether receivable collections and cash conversion remain strong, and how the approximately $53m of claim-related receivables are resolved.
- Whether the $2.8bn of remaining performance obligations converts to revenue as expected, given termination rights and potential funding or scope changes.
- The financial and legal exposure, if any, from the Hunters Point litigation and other project claims; the filing provides no clear estimate of potential loss for the Hunters Point matter.
- Post-period acquisition spending, eGT integration and earn-out obligations, continued buybacks, and debt levels relative to the company’s liquidity and covenant headroom.