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TETRA TECH INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q, including the "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains forward-looking statements regarding future events and our future results that are subject to the safe harbor provisions created under the Securities Act of 1933 and the Securities Exchange Act of 1934. All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as "expects," "anticipates," "targets," "goals," "projects," "intends," "plans," "believes," "seeks," "estimates," "continues," "may," variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified below under "Part II, Item 1A. Risk Factors" and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. GENERAL OVERVIEW We are a leading provider of consulting, engineering, program management, construction management, construction and technical services that focuses on addressing fundamental needs for water, the environment, energy, infrastructure and natural resources. We are a full-service company that leads with science. We typically begin at the earliest stage of a project by identifying technical solutions to problems and developing execution plans tailored to our clients' needs and resources. Our solutions may span the entire life cycle of consulting and engineering projects and include applied science, research and technology, engineering, design, construction management, construction, operations and maintenance, and information technology. Our commitment to continuous improvement and investment in growth has diversified our client base, expanded our geographic reach, and increased the breadth and depth of our service offerings to address existing and emerging markets. We currently have approximately 14,000 staff worldwide, located primarily in North America. We derive income from fees for professional, technical, program management, construction and construction management services. As primarily a service-based company, we are labor-intensive rather than capital-intensive. Our revenue is driven by our ability to attract and retain qualified and productive employees, identify business opportunities, secure new and renew existing client contracts, provide outstanding services to our clients and execute projects successfully. We provide our services to a diverse base of international and U.S. commercial clients, as well as U.S. federal and U.S. state and local government agencies. The following table presents the percentage of our revenue by client sector: Three Months Ended December 29, December 30, 2013 2012 Client Sector International (1) 25.4 % 25.4 % U.S. commercial 28.8 26.3 U.S. federal government (2) 30.2 34.6 U.S. state and local government 15.6 13.7 100.0 % 100.0 % Includes revenue generated from foreign operations, primarily in Canada, and revenue (1) generated from non-U.S. clients. Includes revenue generated under U.S. federal government contracts performed outside the (2) United States. 18 -------------------------------------------------------------------------------- Table of Contents We manage our business under the following three reportable segments: Engineering and Consulting Services. ECS provides front-end science, consulting engineering and project management services in the areas of surface water management, water infrastructure, solid waste management, mining, geotechnical sciences, arctic engineering, industrial processes and oil sands, transportation and information technology. Technical Support Services. TSS provides management consulting and engineering services and strategic direction in the areas of environmental assessments/hazardous waste management, climate change, international development, international reconstruction and stabilization, energy, oil and gas, technical government consulting, and building and facilities. Remediation and Construction Management. RCM provides full-service support, including construction and construction management, to all of our client sectors, including the U.S. federal government in the United States and internationally, and commercial clients worldwide, in the areas of environmental remediation, infrastructure development, solid waste management, energy, and oil and gas. The following table presents the percentage of our revenue by reportable segment: Three Months Ended December 29, December 30, 2013 2012 Reportable Segment ECS 36.4 % 42.2 % TSS 34.2 37.0 RCM 33.1 24.1 Inter-segment elimination (3.7 ) (3.3 ) 100.0 % 100.0 % We provide services under three principal types of contracts: fixed-price, time-and-materials and cost-plus. The following table presents the percentage of our revenue by contract type: Three Months Ended December 29, December 30, 2013 2012 Contract Type Fixed-price 46.8 % 39.8 % Time-and-materials 34.5 41.0 Cost-plus 18.7 19.2 100.0 % 100.0 % Under fixed-price contracts, we receive a fixed price irrespective of the actual costs we incur. Under time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and also paid for other expenses. Under cost-plus contracts, some of which are subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. Profitability on our contracts is driven by billable headcount and our ability to manage our subcontractors, vendors and material suppliers. A majority of our contract revenue and contract costs are recorded using the percentage-of-completion (cost-to-cost) method. Under this method, revenue is recognized in the ratio of contract costs incurred compared to total estimated contract costs. Revenue and profit on these contracts are subject to revision throughout the duration of the contracts and any required adjustments are made in the period in which the revisions become known. Losses on contracts are recorded in full as they are identified. Other contract costs include professional compensation and related benefits, together with certain direct and indirect overhead costs such as rents, utilities and travel. Professional compensation represents a large portion of these costs. Our SG&A expenses are comprised primarily of marketing and bid and proposal costs, and our corporate headquarters' costs related to the executive offices, finance, accounting, administration and information technology. Our SG&A expenses also include a portion of stock-based compensation and depreciation of property and equipment related to our corporate headquarters, and the amortization of identifiable intangible assets. Most of these costs are unrelated to specific clients or projects and can vary as expenses are incurred to support company-wide activities and initiatives. 19 -------------------------------------------------------------------------------- Table of Contents We experience seasonal trends in our business. Our revenue and operating income are typically lower in the first half of our fiscal year, primarily due to the Thanksgiving, Christmas and New Year's holidays. Many of our clients' employees, as well as our own employees, take vacations during these holiday periods. Further, seasonal inclement weather conditions occasionally cause some of our offices to close temporarily or may hamper our project field work. These occurrences result in fewer billable hours worked on projects and, correspondingly, less revenue recognized. Our revenue is typically higher in the second half of the fiscal year due to favorable weather conditions during spring and summer months that may result in higher billable hours. In addition, our revenue is typically higher in the fourth fiscal quarter due to the U.S. federal government's fiscal year-end spending. ACQUISITIONS AND DIVESTITURES Acquisitions. We continuously evaluate the marketplace for strategic acquisition opportunities. Due to our reputation, size, financial resources, geographic presence and range of services, we have numerous opportunities to acquire privately and publicly held companies or selected portions of such companies. During our evaluation, we examine the effect an acquisition may have on our long-range business strategy and results of operations. Generally, we proceed with an acquisition if we believe that it would have a positive effect on future operations and could strategically expand our service offerings. As successful integration and implementation are essential to achieving favorable results, no assurance can be given that all acquisitions will provide accretive results. Our strategy is to position ourselves to address existing and emerging markets. We view acquisitions as a key component of our growth strategy, and we intend to use cash, debt or securities, as we deem appropriate, to fund acquisitions. We may acquire other businesses that we believe are synergistic and will ultimately increase our revenue and net income, strengthen our ability to achieve our strategic goals, provide critical mass with existing clients and further expand our lines of service. We typically pay a purchase price that results in the recognition of goodwill, generally representing the intangible value of a successful business with an assembled workforce specialized in our areas of interest. In the second quarter of fiscal 2013, we acquired AEG, headquartered in Richfield, Ohio. AEG provides environmental, design, construction and maintenance services primarily to solid and hazardous waste, environmental, energy and utility clients. Also in the second quarter of fiscal 2013, we acquired Parkland, headquartered in Alberta, Canada. Parkland serves the oil and gas industry in Western Canada, and specializes in the technical support, engineering support and construction of pipelines and oilfield facilities. AEG and Parkland are both included in our RCM segment. We also made other acquisitions that enhanced our service offerings and expanded our geographic presence in our ECS and TSS segments during fiscal 2013 and in the first quarter of fiscal 2014. Divestitures. To complement our acquisition strategy and our focus on internal growth, we regularly review and evaluate our existing operations to determine whether our business model should change through the divestiture of certain businesses. Accordingly, from time to time, we may divest certain non-core businesses and reallocate our resources to businesses that better align with our long-term strategic direction. We did not have any divestitures in the first quarters of fiscal 2014 and 2013. OVERVIEW OF RESULTS AND BUSINESS TRENDS General. In the first quarter of fiscal 2014, our revenue and earnings were stable compared to the same period last year despite significant downturns in three of the markets in which we operate. We experienced an expected decline in revenue from U.S. federal government programs due to the two-week government shutdown in October 2013 and general weakness in federal funding stemming from the implementation of mandatory federal budget reductions, or sequestrations. In addition, our financial results were adversely impacted by declines in our Eastern Canada and global mining operations that began in the second half of fiscal 2013. We took significant actions in the third quarter of fiscal 2013 to right-size these businesses. As a result, each is stable and profitable, although at a lower level of revenue and earnings than a year ago. These areas of weakness were substantially offset by organic and acquisitive growth in our U.S. and Canadian commercial businesses, particularly those in the oil and gas, and solid waste markets. 20 -------------------------------------------------------------------------------- Table of Contents Current economic conditions continue to be volatile, and there is ambiguity as to whether the U.S. or the global economy will grow modestly or remain stagnant. Concerns over general economic conditions appear to be restraining some business owners from making the significant investment commitments needed to fund future growth. Strong economic expansion generally benefits our business while a tepid recovery could adversely impact the demand for our services. It is not possible to predict with certainty whether or when a stronger recovery may occur, or what impact this would have on our business, results of operations, cash flows or financial condition. International. Our international business decreased 2.1% in the first quarter of fiscal 2014 compared to the year-ago quarter. This decline was driven by the lower results in our Eastern Canada and global mining operations, which were strong in the first half of last year and became significantly weaker beginning in the third quarter of fiscal 2013. Due to the timing of this trend, we expect stable results in the first half of fiscal 2014. Further, we anticipate sustained improving year-over-year comparisons beginning in the third quarter of fiscal 2014 due to organic and acquisitive growth in Canada and South America, together with demand for our oil and gas, and industrial water services from our largest clients worldwide. U.S. Commercial. Our U.S. commercial business increased 7.6% in the first quarter of fiscal 2014 compared to the same period last year. An increase in solid waste management operations, primarily due to an acquisition in fiscal 2013, contributed to this growth. In addition, we experienced continued growth from services provided for oil and gas clients, which generate relatively high profit margins. We are optimistic regarding increased spending by our energy-focused clients, particularly in oil and gas, as well as by our larger industrial clients. As such, we expect that our U.S. commercial business will continue to grow in fiscal 2014. Our U.S. commercial clients typically react rapidly to economic change. Accordingly, if the U.S. economy experiences a slowdown or pickup in the remainder of fiscal 2014, we would expect our U.S. commercial outlook to change correspondingly. U.S. Federal Government. Our U.S. federal government business declined 14.2% in the first quarter of fiscal 2014 compared to the year-ago quarter. This decline was as expected, and resulted from the broad-based slowdown in funding for discretionary U.S. federal government programs. The slowdown was due to the mandatory federal budget reductions, or sequestrations, that were in place in fiscal 2013, and the two-week federal government shutdown in October 2013. During periods of economic volatility, our U.S. federal government clients have historically been the most stable and predictable. However, increased Congressional debate on government spending and competing political agendas in the U.S. government, have created uncertainty in the spending habits of our clients. In December 2013, Congress passed and the President signed into law the Murray-Ryan Bipartisan Budget Act of 2013 ("2013 Budget Act"), raising government discretionary spending limits for fiscal years 2014 and 2015. The direct impact of the 2013 Budget Act on the programs we support is unclear at this point, and we remain cautious regarding the ability to grow our U.S. federal government revenue compared to fiscal 2013. U.S. State and Local Government. Our U.S. state and local business increased 11.0% in the first quarter of fiscal 2014 compared to the year-ago quarter. This growth was driven by increased revenue from essential priority programs. Many state and local government agencies are now experiencing improved financial conditions compared to recent years. Simultaneously, states are facing major long-term infrastructure needs, including the need for maintenance, repair and upgrading of existing critical infrastructure and the need to build new facilities. The funding risks associated with our U.S. state and local government programs are partially mitigated by legal requirements that drive some of these programs, such as regulatory-mandated consent decrees. As a result, some programs, such as those focused on municipal water and solid waste, will progress despite budget pressures as demonstrated by the growth this quarter and throughout fiscal 2013. Although we anticipate that many state and local government agencies will continue to face economic challenges, we expect our U.S. state and local government business to continue its growth during the remainder of fiscal 2014 because of our focus on essential programs. 21 -------------------------------------------------------------------------------- Table of Contents |