Tetra Tech, Inc. — Q3 FY2016 Form 10-Q
Reporting period: Three and nine months ended June 26, 2016; comparatives are the periods ended June 28, 2015. Unaudited results. Tetra Tech provides consulting, engineering, program and construction management services across water, environment, infrastructure, resource management, energy and international development.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Revenue | $666.9m | $575.1m | $1,855.0m | $1,720.9m |
| Gross profit | $85.1m | $81.7m | $233.0m | $230.3m |
| Operating income | $39.1m | $40.7m | $88.7m | $107.7m |
| Net income attributable to Tetra Tech | $25.7m | $26.2m | $52.7m | $70.8m |
| Diluted EPS | $0.44 | $0.43 | $0.89 | $1.14 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $89.8m | $134.1m |
Q3 gross margin was approximately 12.8%, versus 14.2% a year earlier; operating margin was 5.9%, versus 7.1%. For the nine-month periods, gross margin was approximately 12.6% versus 13.4%, and operating margin was 4.8% versus 6.3%.
Management’s non-GAAP ongoing diluted EPS was $0.50 for Q3 and $1.31 year to date, compared with $0.43 and $1.12, respectively. These figures exclude specified items including RCM results, acquisition/integration costs, earn-out adjustments and, for year-to-date EPS, the retroactive research-credit benefit; they are not GAAP results.
Financial position and liquidity
- Cash and cash equivalents were $153.9m at June 26, up from $135.3m at fiscal year-end September 27, 2015. Current assets were $932.6m and current liabilities $513.6m.
- Borrowings under the credit agreement were approximately $364.5m, including $184.5m term debt and $180.0m revolver borrowings. The weighted-average borrowing rate was 1.76%; including swaps, the effective rate was 2.43%. Available revolver capacity was $278.7m, of which $184.4m was available without violating debt covenants.
- Leverage and fixed-charge coverage ratios were 2.07x and 2.97x, respectively, versus maximum leverage of 3.00x and minimum coverage of 1.25x; the company reported compliance with covenants.
- Nine-month investing cash outflow was $92.2m, primarily including $81.3m for acquisitions; financing cash inflow was $18.5m. The company repurchased $75.0m of shares and paid $14.6m of dividends.
- Management said cash, operating cash flow and borrowing capacity should meet capital requirements for at least the next 12 months.
Changes, acquisitions and operating drivers
- Reported revenue rose 16.0% in Q3 and 7.8% year to date. Coffey and INDUS, acquired in FY2016, contributed a combined $116.9m of Q3 revenue and $205.1m since acquisition. Excluding those contributions and other stated adjustments, underlying performance was more subdued; the company attributed pressure to foreign exchange, weaker Canadian activity and reduced construction work.
- Q3 operating income fell 4.0%; nine-month operating income fell 17.7%. Year-to-date results included $16.9m of acquisition and integration expenses, $2.8m of contingent earn-out losses (versus a $3.1m gain in the prior period), and $1.9m of Coffey debt prepayment fees in interest expense. The effective tax rate was 34.3% year to date versus 30.6%, with acquisition/integration and debt-prepayment costs receiving no tax benefit.
- RME revenue increased 31.5% in Q3 and 18.4% year to date, largely reflecting Coffey; RME operating income rose 15.8% and 15.1%. WEI operating income was nearly flat in both comparisons, while its year-to-date revenue declined 1.5%. RCM, which is winding down non-core construction, reported operating losses of $4.0m in Q3 and $9.7m year to date.
- Operating cash flow declined $44.3m year to date, primarily due to collection timing, including lower claim collections, and $16.9m of paid acquisition/integration costs. The allowance for doubtful accounts increased to $39.7m from $31.5m at fiscal year-end.
- Backlog was $2.3bn, up $363.6m, or 19.1%, from fiscal year-end; management cautioned that backlog may be cancelled or adjusted and is not a reliable measure of future earnings.
Outlook, risks and contingencies
- Management expected year-over-year improvement in U.S. commercial revenue and growth in U.S. state/local and federal revenue during the remainder of FY2016, excluding RCM. It anticipated higher international revenue, primarily from Coffey. No specific consolidated earnings or revenue guidance range is provided in the filing text.
- The RCM wind-down work was expected to be substantially complete in FY2017; remaining RCM backlog at quarter-end was $38m. Its losses included cost-to-complete revisions, legal expenses, claim resolutions and $7.9m of receivable collectability losses, partly offset by a $4.6m claim settlement gain.
- Key exposures include project-cost and percentage-of-completion estimates, fixed-price contract overruns, collection and resolution of claims, client funding and contract cancellations, government procurement and audit requirements, commodity-sensitive mining and oil/gas demand, foreign exchange (especially the Canadian dollar), acquisition integration, and interest-rate and covenant risks.
- Accounts receivable included approximately $43m of claims. Management reported ordinary-course professional liability claims and lawsuits; some claims may exceed insurance or be uninsured, though management did not expect them to have a material adverse effect. Performance guarantees, letters of credit and bank guarantees also create contingent exposure.
- Goodwill was $727.8m. The filing highlighted possible impairment sensitivity at the Waste Management Group reporting unit if revenue growth falls below 2%, comparable market prices decline by more than 10%, or the discount rate reaches 14% or higher. The company also maintained an $8.9m valuation allowance for certain foreign tax-loss carryforwards.
Most important facts for investors to verify
- Whether acquisition-driven growth translates into sustained organic revenue and profit growth, particularly as Coffey is integrated.
- Receivable quality, claim recoveries, allowance adequacy and cash-conversion trends given lower operating cash flow and the $43m of claims receivable.
- Progress and remaining costs of the RCM wind-down, including contract estimates and collectability risks.
- Debt, covenant headroom and borrowing costs, especially if acquisition funding or interest rates increase.
- Backlog conversion, government spending and commodity-linked demand, together with goodwill impairment assumptions and foreign-exchange effects.