TETRA TECH INC quarterly report, Q1 FY2015

Tetra Tech, Inc. — Q1 FY2015 Form 10-Q

Reporting period: Three months ended December 28, 2014, compared with the three months ended December 29, 2013. Financial statements are unaudited. Tetra Tech provides consulting, engineering, program management and construction management services. In FY2015, it reorganized reporting into Water, Environment and Infrastructure (WEI), Resource Management and Energy (RME), and Remediation and Construction Management (RCM), which is winding down non-core construction work.

Financial results and position

Metric	Q1 FY2015	Q1 FY2014
Revenue	$581.1 million	$645.8 million
Revenue less subcontractor costs (non-GAAP)	$437.1 million	$483.0 million
Operating income	$36.6 million	$43.7 million
Operating margin	6.3%	6.8%
Net income attributable to Tetra Tech	$25.6 million	$27.3 million
Diluted EPS	$0.41	$0.42
Operating cash flow	$5.5 million	$41.7 million
Capital expenditures	$7.1 million	$6.6 million
Cash and cash equivalents at period end	$98.9 million	$160.8 million at prior-year quarter end

• Revenue fell 10.0%; net income attributable to Tetra Tech fell 6.4%. Lower revenue was partly offset by a lower effective tax rate: 26.4%, versus 33.8%. The current-quarter tax expense included a $1.2 million benefit from retroactively extended research and experimentation credits.
• Cash declined $23.5 million from September 28, 2014, primarily reflecting share repurchases and the dividend. Operating cash flow was down $36.3 million year over year, which management attributed primarily to the timing of trade accounts payable payments.
• At December 28, 2014, total debt was approximately $201.0 million: $199.9 million outstanding under the credit agreement, plus $10.9 million current and $190.1 million long-term debt on the balance sheet. The borrowing rate was 1.58%; the effective rate including swaps was 2.72%. Cash less balance-sheet debt was approximately negative $102.1 million.
• The company reported $844.7 million in current assets and $436.4 million in current liabilities. The credit agreement had a $460 million revolving facility; $147.9 million was available to borrow without violating debt covenants. Covenant ratios were compliant: leverage 1.54x against a 2.50x maximum, and fixed-charge coverage 2.59x against a 1.25x minimum.
• Other comprehensive loss was $25.0 million, largely reflecting $24.5 million of foreign-currency translation loss. Goodwill was $698.8 million and identifiable intangible assets were $55.9 million.

Material changes and segment performance

• The overall revenue decline primarily reflected the exit from selected fixed-price construction markets and the RCM wind-down. Excluding RCM, revenue declined 4.0%; excluding exited RCM activities and currency effects, revenue declined 1.9%.
• WEI: Revenue rose 1.9% to $233.7 million, while operating income declined 1.8% to $21.8 million. Constant-currency revenue increased 4.1%, supported by government infrastructure work; margin eased to 11.9% from 12.3% as the mix shifted toward lower-margin government work.
• RME: Revenue fell 7.7% to $331.7 million and operating income fell 22.7% to $25.7 million. Management cited lower commodity-related activity, particularly mining in Canada and oil and gas, federal remediation project timing, and winter weather. Margin declined to 10.6% from 12.4%.
• RCM: Revenue fell 58.1% to $34.4 million. The segment recorded a $3.4 million operating loss, compared with a $4.1 million loss in the prior-year quarter. Remaining work is expected to be completed primarily in FY2015.
• Prior-year operating income included a $4.6 million gain from contingent earn-out fair-value adjustments; there was no comparable gain in Q1 FY2015. Excluding that prior-year gain, operating income declined 6.3%.
• Backlog was $1.9 billion, down $136.3 million, or 6.8%, from fiscal year-end. Management notes backlog can be canceled or adjusted and is not a certain indicator of future earnings.

Outlook, risks and unusual items

• Management expects modestly higher international revenue in FY2015 on a constant-currency basis, while cautioning that further oil-price declines could hurt the business. It expects U.S. federal revenue to be stable or increase slightly, and state and local government business to continue growing, excluding RCM. These are expectations, not formal earnings guidance.
• Management expects existing cash, operating cash flow and borrowing capacity to meet capital requirements for at least the next 12 months. The company authorized a new $200 million share repurchase program over two years; it repurchased $20.2 million of shares in the quarter and paid a $0.07-per-share dividend. A further $0.07 dividend was declared in January 2015.
• Key operating exposures include commodity-price weakness, foreign-exchange movements, government funding and procurement, project execution and cost estimates, fixed-price contract overruns, weather, client collections, and the cyclical nature of mining and oil and gas markets. A stronger U.S. dollar reduced quarterly revenue by $12.0 million, according to management.
• Contract accounting involves estimates and claims: the company recorded $2.4 million of net unfavorable operating-income adjustments from contract estimate changes, versus $1.2 million a year earlier. It recorded a $3.2 million operating-income benefit from settlement of federal-client claims. Receivables included about $78 million of claims; anticipated contract losses were $16.8 million, with $99.1 million of estimated costs to complete those contracts.
• Goodwill for the Global Mining Practice reporting unit was $65.6 million; estimated fair value exceeded carrying value by less than 20%. A substantial deterioration in performance or comparable-market values could trigger impairment.
• Legal matters include Quebec proceedings concerning alleged pre-acquisition conduct at BPR. A criminal process was expected to continue into 2016; a related class-action appeal was before the Supreme Court of Canada. The financial impact was unknown. Management said ordinary-course professional-liability matters were not expected to have a material adverse effect, while acknowledging uncertainty and possible uninsured or excess-insurance claims.
• The company reported $78 million of claims-related receivables, variable-rate debt exposure partly hedged with swaps, and foreign earnings of approximately $53 million considered permanently reinvested. The filing states that the tax cost of repatriating those earnings was not practicable to determine.

Important facts for investors to verify

• Whether the RCM wind-down proceeds as planned and how much it continues to affect revenue, cash flow and margins.
• Whether weakness in mining, oil and gas, and commodity prices continues, and whether management’s segment outlook is borne out.
• Backlog conversion, federal project timing, government funding, and the quality and collection of unbilled and claims-related receivables.
• Cash generation and working-capital movements, especially the effect of accounts payable timing, alongside planned buybacks and dividends.
• Debt covenant headroom and usable revolving capacity; reported availability without covenant violation was $147.9 million, not the full $460 million facility amount.
• Developments in the BPR legal matters and potential goodwill impairment in the Global Mining Practice.