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TTEK > SEC Filings for TTEK > Form 10-K on 15-Nov-2012All Recent SEC Filings

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Form 10-K for TETRA TECH INC


15-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following analysis of our financial condition and results of operations should be read in conjunction with Part 1 of this report, as well as our consolidated financial statements and accompanying notes in Item 8. The following analysis contains forward-looking statements about our future results of operations and expectations. Our actual results and the timing of events could differ materially from those described herein. See Part 1, Item 1A, "Risk Factors" for a discussion of the risks, assumptions and uncertainties affecting these statements.

OVERVIEW OF RESULTS AND BUSINESS TRENDS

Management review of fiscal 2012 and outlook for the future. On an overall basis, we experienced significant improvement in our fiscal 2012 operating results compared with fiscal 2011. We continued to focus on organic growth and the pursuit of strategic acquisitions that are expected to enhance our service offerings and expand our geographic presence. Our revenue growth resulted primarily from industrial, energy and environmental management projects for large multi-national companies. The growth was also driven by demand for our water, environmental and infrastructure design services in Canada, Australia and South America, primarily for mining and other commodity-driven businesses. Our overall results were tempered by reduced revenue from our U.S. federal government programs that continued to slow in the current year.

Impact of Recent Business Environment. Current economic conditions have been somewhat volatile and there is increased uncertainty as to whether the U.S. or the global economy will grow modestly, remain stagnant or enter a recession. The economic growth experienced in 2012 may or may not continue, or may continue at a slower rate for an extended period of time. In addition, some economic conditions, such as rates of spending and employment, may continue to be weak. Uncertainty regarding the U.S. federal budget and taxes has added to the uncertainty regarding economic conditions generally. Those conditions could be negatively impacted by the occurrence or threat of a so-called "fiscal cliff" consisting of, among other things, mandatory federal budget reductions, or sequestrations, and the expiration of federal individual tax rate reductions that become effective January 1, 2013. Concerns about the oncoming "fiscal cliff" appear to be restraining business owners from making investment commitments needed to fund future growth. With this uncertainty regarding the future, it is difficult to confidently predict the direction in which the U.S. and global economies are headed. Strong economic expansion generally benefits our business while a tepid economic recovery could adversely impact the demand for our services. It is not possible to predict with certainty whether or when a recovery may occur, or what impact this would have on our business, results of operations, cash flows or financial condition.

International. Our international business grew 11.3% in fiscal 2012 compared to fiscal 2011. The growth was driven by demand for our water, environmental and infrastructure design services globally, primarily from mining and other commodity-driven clients. We expect that our international business will continue its growth during fiscal 2013 as a result of our continued expansion in Canada, our recent expansion into Australia and South America, and demand for our services from broad-based clients worldwide.

U.S. Commercial. Our U.S. commercial business grew 24.3% in fiscal 2012 compared to fiscal 2011. The growth was broad-based with increased revenue from industrial, energy and environmental management projects for large multi-national companies. Many of our largest U.S. commercial clients are experiencing higher environmental and infrastructure capital spending levels following a period of budgetary constraints during the global financial crisis. Therefore, although we expect some economic weakness may continue in certain sectors of our U.S. commercial business, we are cautiously optimistic regarding increased spending by our largest U.S. commercial clients. As such, we expect that our U.S. commercial business will continue its growth in fiscal 2013. Our U.S. commercial clients typically react


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rapidly to economic change. Accordingly, if the U.S. economy experiences a slowdown in fiscal 2013, we would expect our U.S. commercial outlook to change accordingly.

U.S. Federal Government. Our U.S. federal government business declined 9.6% in fiscal 2012 compared to fiscal 2011. This decline resulted primarily from lower revenue on DoD programs, principally from the wind-down of several large New Orleans hurricane protection and environmental remediation programs for USACE. The decline was partially offset by revenue growth from international development services for the DoS, and from our front-end water, environmental and infrastructure engineering and design services for other federal agencies. During periods of economic volatility, our U.S. federal government clients have historically been the most stable and predictable. However, due to the U.S. federal budget uncertainties described above, we remain cautious.

U.S. State and Local Government. Our U.S. state and local government business increased 13.0% in fiscal 2012 compared to fiscal 2011. The growth was driven by increased revenue from essential programs. Many state and local government agencies continue to face economic challenges, including budget deficits and difficult cost cutting decisions. 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 will generally progress despite budget pressures as demonstrated by the growth in fiscal 2012. 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 current growth rate in fiscal 2013 compared to fiscal 2012 because of our focus on essential programs.

Reorganization of Operations. Our operating results for fiscal 2012 reflect the execution of a reorganization of our operations initiated in the fourth quarter of fiscal 2012 to improve future growth and profitability. These activities included the consolidation and realignment of certain operating activities to improve organizational effectiveness and achieve efficiencies in our segment management. We also decided to wind down certain unprofitable business activities.

During the implementation of this reorganization plan, we incurred additional costs in the fourth quarter of fiscal 2012, including discretionary compensation-related costs for severance and employee retention. In addition, we recorded charges for lease exit costs, and fixed asset and other long-lived asset impairments primarily associated with office space reductions and relocations. We also incurred contract and other losses to wind down certain India-based activities that are no longer supported by our reorganized business.

Specifically, this reorganization included the elimination of the EAS reportable segment effective at the beginning of fiscal 2013. The operating activities previously reported in this segment have been realigned with operations with similar client types, project types and financial metrics in the ECS and TSS segments. In anticipation of these organizational changes, staffing and office space were reduced during the fourth quarter of fiscal 2012 to reflect a more effective and efficient management structure over our global operations. We also revised the assumptions related to future operating results in our goodwill valuations consistent with the operational review that supported the reorganization. During this evaluation, we identified one small reporting unit in our EAS segment with impairment. This operating unit reported lower than planned operating income during the fourth quarter of fiscal 2012 and projected future operating losses and negative cash flows, which caused a non-cash impairment charge of $0.9 million, representing all of the goodwill in this reporting unit in the fourth quarter of fiscal 2012.

Although we anticipate that these consolidation and reorganization efforts will continue into the first half of fiscal 2013, we do not expect these activities to have a further material effect on our results of


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operations. Conversely, these actions are expected to modestly improve our operating results in fiscal 2013 through lower overhead costs and increased effectiveness in growing our operations organically.

RESULTS OF OPERATIONS

Fiscal 2012 Compared to Fiscal 2011

Consolidated Results of Operations

                                                       Fiscal Year Ended

                                      September 30,     October 2,           Change
                                          2012             2011           $           %
                                                       ($ in thousands)

Revenue                               $    2,711,075   $  2,573,144   $  137,931       5.4 %
Subcontractor costs                         (689,005 )     (780,817 )     91,812      11.8

Revenue, net of subcontractor
costs(1)                                   2,022,070      1,792,327      229,743      12.8
Other costs of revenue                    (1,663,065 )   (1,454,374 )   (208,691 )   (14.3 )
Selling, general and
administrative expenses                     (211,884 )     (193,286 )    (18,598 )    (9.6 )
Contingent consideration - fair
value adjustments                             19,246          1,755       17,491        NM

Operating income                             166,367        146,422       19,945      13.6
Interest expense - net                        (5,571 )       (5,930 )        359       6.1

Income before income tax expense             160,796        140,492       20,304      14.5
Income tax expense                           (56,064 )      (47,510 )     (8,554 )   (18.0 )

Net income including
noncontrolling interests                     104,732         92,982       11,750      12.6
Net income attributable to
noncontrolling interest                         (352 )       (2,943 )      2,591      88.0

Net income attributable to Tetra
Tech                                  $      104,380   $     90,039   $   14,341      15.9

NM = not meaningful

(1)
We believe that the presentation of "Revenue, net of subcontractor costs," a non-GAAP financial measure, enhances investors' ability to analyze our business trends and performance because it substantially measures the work performed by our employees. In the course of providing services, we routinely subcontract various services and, under certain USAID programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with GAAP and industry practice, are included in our revenue when it is our contractual responsibility to procure or manage these activities. The grants are included as part of our subcontractor costs. Because subcontractor services can vary significantly from project to project and period to period, changes in revenue may not necessarily be indicative of our business trends. Accordingly, we segregate subcontractor costs from revenue to promote a better understanding of our business by evaluating revenue exclusive of costs associated with external service providers.

Overall, our fiscal 2012 operating results improved significantly compared with fiscal 2011. Revenue and revenue, net of subcontractor costs, increased $137.9 million and $229.7 million, respectively, in fiscal 2012 compared to the prior year. The growth was driven by strong results in our U.S. commercial business, the continued expansion of our international business, and contributions from acquisitions completed during fiscal 2012 and 2011. To a lesser extent, our U.S. state and local government market also


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contributed to the growth. Our revenue, net of subcontractor costs, in our U.S. federal government business increased slightly versus last year; however, the related revenue declined due to decreased revenue from certain construction management projects for the DoD that had a high level of subcontracting activities. As a result, our overall revenue, net of subcontractor costs, grew at a higher rate than revenue compared to last year.

Revenue and revenue, net of subcontractor costs, for our U.S. commercial business increased $140.7 million and $75.2 million, respectively, in fiscal 2012 compared to fiscal 2011. The growth was experienced across all of our reportable segments, and was primarily attributable to increased revenue from industrial, energy and environmental management projects for large multi-national companies. Revenue and revenue, net of subcontractor costs, for our international business increased $67.7 million and $112.1 million, respectively, in fiscal 2012 versus the prior year. The growth was driven by increased activity on our water, environmental and infrastructure design projects in Canada, Australia and South America, primarily for mining and other commodity-driven businesses. Additionally, revenue, net of subcontractor costs, grew at a faster pace than revenue due to increased self-performance on international projects in fiscal 2012. Revenue and revenue, net of subcontractor costs, for fiscal 2012 included contributions from acquisitions totaling $133.2 million and $122.3 million, respectively. Approximately one-third of these amounts were contributed by our international acquisitions. Our overall revenue growth was partially offset by declines in revenue and revenue, net of subcontractor costs, on DoD programs totaling $135.4 million and $49.6 million, respectively, in fiscal 2012 compared to fiscal 2011. These reductions resulted primarily from the wind-down of several large New Orleans hurricane protection projects for USACE and environmental remediation programs for the DoD.

Operating income increased 13.6% in fiscal 2012 compared to fiscal 2011 primarily due to growth in our revenue and revenue, net of subcontractor costs. In addition, operating income increased at a higher rate than revenue due to better project performance in fiscal 2012. In fiscal 2011, operating income was reduced by contract costs incurred for project overruns of $21.0 million on several fixed-priced construction management projects in the RCM segment, and on an international development program in the TSS segment. These fiscal 2011 items were partially mitigated by a $10.6 million government performance-based incentive award fee on a large environmental remediation program in the RCM segment and a $2.0 million net favorable project settlement in the EAS segment.

In the fourth quarter of fiscal 2012, operating income was adversely impacted by $16.9 million of costs related to the reorganization of our operations as described above in the "Overview of Results and Business Trends." These costs included $6.4 million of compensation-related expenses for severance and employee retention. In addition, we recorded $4.4 million of lease exit costs, fixed asset write-downs and other long-lived asset impairments associated with office space reductions and relocations. Further, we incurred operational losses of $5.2 million for winding down certain India-based activities that are no longer supported by our reorganized business model. We also identified one small reporting unit in the EAS segment in which goodwill was impaired. This reporting unit realized lower than planned operating income during the fourth quarter of fiscal 2012, and projected future operating losses and negative cash flows that resulted in a $0.9 million non-cash goodwill impairment charge. Operating income in fiscal 2012 also included net gains of $19.2 million related to changes in the estimated fair value of our contingent earn-out liabilities during fiscal 2012, $17.3 million of which were recognized in the fourth quarter, compared to $1.8 million during fiscal 2011.

The $17.3 million net decrease in our contingent consideration liability in the fourth quarter of fiscal 2012 included $12.5 million related to our determination in that quarter that one of our acquisitions in the TSS segment would not achieve the operating income we previously expected for the earn-out period. The remaining fourth quarter net earn-out adjustments primarily related to several of our recent acquisitions in the ECS segment for which the earn-out periods concluded in the fourth quarter of fiscal 2012.


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Income tax expense increased due to higher pre-tax income. Our effective tax rate for fiscal 2012 was 34.9% compared to 33.8% for fiscal 2011. The prior-year tax rate benefitted from the extension of R&E credits. There was a $1.2 million benefit from R&E credits for the last nine months of fiscal 2010 that was recorded in the first quarter of fiscal 2011. With the expiration of the R&E credits on December 31, 2011, we have not estimated a benefit from these credits beyond the expiration date.

Segment Results of Operations

Engineering and Consulting Services

                                                        Fiscal Year Ended

                                         September 30,    October 2,          Change
                                             2012            2011           $         %
                                                         ($ in thousands)

Revenue                                  $    1,036,588    $  930,067   $ 106,521     11.5 %
Subcontractor costs                            (169,088 )    (160,150 )    (8,938 )   (5.6 )

Revenue, net of subcontractor
costs(1)                                 $      867,500    $  769,917   $  97,583     12.7

Operating income                         $       88,091    $   88,135   $     (44 )      -

(1)
Represents a non-GAAP financial measure. For more information, see the "Consolidated Results of Operations" discussion above.

Revenue and revenue, net of subcontractor costs, increased $106.5 million and $97.6 million, respectively, in fiscal 2012 compared to fiscal 2011. The growth was primarily driven by demand for our water, environmental and infrastructure design services globally, and our continued international expansion into Canada, Australia and South America. In fiscal 2012, recent acquisitions contributed $40.5 million and $38.8 million to revenue and revenue, net of subcontractor costs, respectively.

Despite the growth in revenue and revenue, net of subcontractor costs, operating income was stable compared to fiscal 2011. Seasonal inclement weather conditions at our larger Canadian operations during the first half of fiscal 2012 contributed to the lower operating margin. The adverse working conditions resulted in lower staff utilization on projects and higher indirect expenses. In addition, operating income was negatively impacted by $1.1 million of severance and other discretionary compensation-related costs associated with reorganization in the fourth quarter of fiscal 2012. Further, the wind-down of several high-profit water and mining-related projects had a negative effect in comparison to fiscal 2012 operating income.


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Technical Support Services

                                                         Fiscal Year Ended

                                          September 30,    October 2,         Change
                                              2012            2011          $         %
                                                         ($ in thousands)

Revenue                                   $      919,862    $  867,130   $ 52,732      6.1 %
Subcontractor costs                             (326,922 )    (364,106 )   37,184     10.2

Revenue, net of subcontractor costs(1)    $      592,940    $  503,024   $ 89,916     17.9

Operating income                          $       67,411    $   59,113   $  8,298     14.0

(1)
Represents a non-GAAP financial measure. For more information, see the "Consolidated Results of Operations" discussion above.

Revenue and revenue, net of subcontractor costs, increased $52.7 million and $89.9 million, respectively, in fiscal 2012 compared to fiscal 2011. This growth was primarily driven by the expansion of international development services provided to the DoS. Revenue and revenue, net of subcontractor costs, from DoS services increased $80.7 million and $71.5 million, respectively, this fiscal year compared to fiscal 2011. Virtually all of the increase in DoS revenue resulted from an acquisition completed in the fourth quarter of fiscal 2011. An increase in U.S. commercial business contributed $20.0 million and $19.1 million of additional revenue and revenue, net of subcontractor costs, compared to fiscal 2011. An acquisition completed in fiscal 2012 contributed approximately one-half of this commercial growth. Revenue, net of subcontractor costs, grew at a faster rate than revenue due to reduced workload on, and completion of, certain USAID and EPA programs that had a high level of subcontracting activities in fiscal 2011.

Operating income increased $8.3 million in fiscal 2012 compared to fiscal 2011 due to increased revenue, net of subcontractor costs. Acquisitions completed in the fourth quarter of fiscal 2011 and during fiscal 2012 contributed $6.7 million to the operating income increase. Further, fiscal 2011 operating income was negatively affected by $1.2 million of contract costs overruns on an international development program. The overall increase was partially offset by $2.2 million of severance and other discretionary compensation-related costs associated with our reorganization in the fourth quarter of fiscal 2012.

Engineering and Architecture Services

                                                       Fiscal Year Ended

                                       September 30,     October 2,          Change
                                           2012             2011           $          %
                                                        ($ in thousands)

Revenue                                $      318,755    $   308,112   $  10,643       3.5 %
Subcontractor costs                           (99,688 )      (83,916 )   (15,772 )   (18.8 )

Revenue, net of subcontractor
costs(1)                               $      219,067    $   224,196   $  (5,129 )    (2.3 )

Operating income                       $       12,485    $    22,597   $ (10,112 )   (44.7 )

(1)
Represents a non-GAAP financial measure. For more information, see the "Consolidated Results of Operations" discussion above.


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Revenue increased $10.6 million in fiscal 2012 compared to fiscal 2011 due to contributions from design-build projects for U.S. government clients. The growth also resulted from demand for our building and facility design services from several large U.S. commercial clients and increased workload on multiple international development projects for USAID. The growth was partially offset by reduced activity on certain infrastructure design projects for U.S. government clients in fiscal 2012. Despite the revenue growth, revenue, net of subcontractor costs, declined $5.1 million compared to last year due primarily to increased subcontracting activities on several large design-build projects that transitioned into the construction management phase during fiscal 2012.

Operating income declined $10.1 million in fiscal 2012 compared to fiscal 2011 due partially to lower revenue, net of subcontractor costs. In addition, $2.1 million of severance and other discretionary compensation-related costs associated with our reorganization in the fourth quarter of fiscal 2012 contributed to the decrease. This segment also incurred $5.2 million of contract and other losses for certain India-based activities. Our reorganized business model, with the elimination of the EAS segment at the beginning of fiscal 2013, no longer supports these operations. Further, fiscal 2011 operating income benefitted from a favorable $2.0 million net project settlement on a U.S. commercial infrastructure project.

Remediation and Construction Management

                                                         Fiscal Year Ended

                                          September 30,    October 2,         Change
                                              2012            2011          $         %
                                                         ($ in thousands)

Revenue                                   $      621,957    $  604,651   $ 17,306      2.9 %
Subcontractor costs                             (279,394 )    (309,461 )   30,067      9.7

Revenue, net of subcontractor costs(1) $ 342,563 $ 295,190 $ 47,373 16.0

Operating income $ 22,374 $ 13,183 $ 9,191 69.7

(1)
Represents a non-GAAP financial measure. For more information, see the "Consolidated Results of Operations" discussion above.

Revenue and revenue, net of subcontractor costs, increased $17.3 million and $47.4 million, respectively, in fiscal 2012 compared to fiscal 2011. Our U.S. commercial business grew $96.5 million and $57.2 million in revenue and revenue, net of subcontractor costs, respectively, due primarily to expanded programs in our mining and energy businesses. Our U.S. state and local government business contributed $38.5 million and $31.4 million of revenue and revenue, net of subcontractor costs, respectively, due to several large infrastructure projects. The growth was partially offset by a revenue decline of $107.6 million, and a corresponding $33.2 million decrease in revenue, net of subcontractor costs, resulting from the wind-down of several large New Orleans hurricane protection projects for USACE and environmental remediation programs for the DoD at the end of fiscal 2011. The decline in revenue was larger than the related decline in revenue, net of subcontractor costs, because the USACE and DoD projects had a relatively high level of subcontractor costs.

Operating income increased $9.2 million due partially to the increase in revenue, net of subcontractor costs, compared to fiscal 2011. In addition, fiscal 2011 operating income was adversely impacted by $20.0 million of contract cost overruns on several fixed-price infrastructure and energy projects and a $1.3 million charge for lease exit costs. These fiscal 2011 items were partially mitigated by $10.6 million of government performance-based incentive award fees on a large environmental remediation program with the DoD. In fiscal 2012, we benefitted from $2.9 million of gains related to the settlement of project claims and change orders partially offset by $2.4 million of project-related losses.


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