Tetra Tech, Inc. — Q2 FY2014 Form 10-Q
Reporting period: Fiscal second quarter and first six months ended March 30, 2014; comparisons are with the periods ended March 31, 2013. Tetra Tech provides consulting, engineering, program and construction management, construction, and technical services across water, environment, energy, infrastructure, and natural resources.
Financial performance
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Revenue | $586.3 | $642.0 | $1,232.1 | $1,300.5 |
| Operating income | $46.2 | $37.7 | $89.9 | $79.5 |
| Net income attributable to Tetra Tech | $31.7 | $24.8 | $59.0 | $51.0 |
| Diluted EPS | $0.48 | $0.38 | $0.90 | $0.78 |
| Operating cash flow | — | $56.2 | $62.0 |
- Q2 revenue declined 8.7% year over year; first-half revenue declined 5.3%. Excluding foreign-exchange effects, management reported declines of approximately 3% in Q2 and 2% in the first half.
- Reported operating margin was approximately 7.9% in Q2 versus 5.9% a year earlier, and 7.3% for the first half versus 6.1%. These comparisons include substantial gains from reducing acquisition earn-out estimates; Q2 gains were $21.3 million and first-half gains were $26.0 million.
- First-half operating cash flow fell $5.8 million year over year. Cash and equivalents increased to $167.2 million from $129.3 million at fiscal year-end.
- At March 30, total debt was approximately $206.8 million, including $8.5 million current and $198.2 million long term. The company also reported $205.0 million outstanding under its credit agreement. The $665 million facility had $447.9 million of revolving capacity available, of which $201.1 million could be borrowed without violating covenants.
- Current assets were $889.8 million and current liabilities $460.0 million. The company reported leverage and fixed-charge coverage ratios of 1.46x and 2.93x, respectively, and said it was in compliance with its covenants.
Material changes and operating drivers
- Segment results: ECS first-half revenue fell 14.2% to $461.0 million, while operating income rose 4.9% to $32.0 million. TSS revenue fell 6.0% to $438.0 million, while operating income rose 3.4% to $46.1 million. RCM first-half revenue rose 12.3% to $378.4 million, but operating income fell 85.7% to $3.0 million; in Q2, RCM recorded an operating loss of $5.5 million.
- Revenue weakness reflected U.S. federal budget constraints and shutdown-related disruption, weakness in Eastern Canada and global mining, construction-project wind-downs, unfavorable currency translation, and severe winter weather. Commercial oil and gas and acquired solid-waste and oil-and-gas businesses partly offset declines.
- RCM’s Q2 results were affected by cost overruns and scope changes on a Western Canadian fixed-price oil-and-gas project. Tetra Tech recorded a $5.3 million charge to reverse previously recognized profit, recognized about $10 million in revenue and receivables for change orders it considered recoverable, and estimated approximately $13 million of remaining project costs. Further losses are possible if costs rise or collection is unsuccessful.
- Backlog was $1.8 billion, down $92.3 million, or 4.8%, from fiscal year-end. Management cautioned that backlog may be cancelled or adjusted and is not a reliable indicator of future earnings.
Outlook, risks, and other notable items
- Management said it expected U.S. commercial business to continue growing in FY2014, supported by oil and gas and industrial clients. It anticipated improved year-over-year international comparisons from Q3, while remaining cautious about U.S. federal growth. State and local revenue was expected to decline during the remainder of FY2014 as large transportation projects wound down, partly offset by core water and environmental work. No specific consolidated earnings or revenue guidance was provided in the filing text.
- Management believed cash, operating cash flow, and borrowing capacity would meet capital requirements for at least the next 12 months. A $0.07-per-share quarterly dividend was declared after quarter-end, payable June 4, 2014.
- Key exposures include government spending and contract awards, fixed-price project execution and change-order recoveries, collection of billed and unbilled receivables, foreign exchange (particularly the Canadian dollar), mining and oil-and-gas cycles, acquisition integration and goodwill impairment, and litigation or regulatory matters.
- Foreign-currency translation reduced equity by $37.8 million in the first half. Five reporting units had fair value less than 20% above carrying value; management reported no impairment as of March 30. Goodwill was $709.5 million.
- Outstanding legal matters include Quebec-related allegations concerning pre-acquisition BPR activities and a Montreal class action; their financial impact was described as unknown. A securities class action was voluntarily dismissed with prejudice on April 24, 2014. Management said ordinary-course professional liability claims were not expected to have a material adverse effect, while acknowledging uncertainty.
Important facts for investors to verify
- Whether the Western Canadian project’s costs, change-order recovery, and collection outcomes differ from management’s estimates.
- How much reported earnings growth depends on non-cash earn-out remeasurement gains, and how segment profitability develops without those gains.
- Whether receivable collections, including claims and unbilled balances, improve; net receivables were $656.5 million and claims-related receivables were approximately $61 million.
- Whether federal-government demand, mining, Eastern Canada, weather effects, and foreign exchange continue to weigh on revenue and backlog.
- Whether the low-cushion goodwill reporting units, Quebec legal matters, and credit-facility covenant headroom present material changes in subsequent periods.