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TTEK > SEC Filings for TTEK > Form 10-K on 20-Nov-2013All Recent SEC Filings

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Form 10-K for TETRA TECH INC


20-Nov-2013

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

General. In fiscal 2013, our revenue declined compared to last year and we reported a net loss. Our financial results were adversely impacted by weakness in our Eastern Canada and global mining operations, and we incurred significant costs to right-size these businesses during the third quarter of fiscal 2013. We also incurred significant charges on certain projects that further reduced our revenue and earnings. To a lesser extent, we experienced an expected decline in revenue from U.S. federal government programs as uncertainty regarding the U.S. federal budget continued to delay project funding. Our earnings were also negatively affected by a non-cash goodwill impairment charge recorded in the third quarter of fiscal 2013.

Impact of Recent Business Environment. Current economic conditions have been somewhat volatile, and there is increased ambiguity as to whether the U.S. or the global economy will grow modestly or remain stagnant. The uncertainty regarding the U.S. federal budget and the impact of tax increases has added to the doubt regarding economic conditions generally. These conditions have been, and could continue to be, negatively impacted by mandatory federal budget reductions, or sequestrations, that became effective in our fiscal second quarter. In addition, concerns over these conditions appear to be restraining business owners from making the significant investment commitments needed to fund future growth.

In Eastern Canada, poor economic conditions, including budget deficits, reduced customer spending and an ongoing government investigation into political corruption in Quebec, have slowed procurements and business activity in that region. As a result, we experienced weaker than expected financial performance in our Eastern Canadian operations and we took actions to right-size the business that resulted in significant severance and office closure charges in the third quarter of fiscal 2013.

Our work for mining customers also slowed more than expected in the third quarter of fiscal 2013 as these customers responded to lower global growth expectations. This was driven in large part by China's report in April 2013 of slower economic growth. As a result, our mining customers experienced a significant reduction in the global demand for commodities that caused a drop in mineral prices. Due to the subsequent slowdown in mining activities, we right-sized our global mining business by reducing staff and closing offices in the third quarter of fiscal 2013.

These events exacerbated negative business trends and adversely impacted our related operations. Consequently, we recorded a non-cash goodwill impairment charge in the third quarter. Persistent negative market conditions and financial results could result in additional goodwill impairment. With these trends and overall uncertainty, it is difficult to confidently predict the future direction in which the U.S. and global economies are headed. Strong economic expansion generally benefits our business while a tepid financial recovery could adversely impact 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.


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International. For fiscal 2013, our international business grew 5.1% compared to last year. The growth was driven by the continued expansion of our services to the oil and gas industry, primarily as a result of acquisitions. We expect that our international business will continue its growth in fiscal 2014 as a result of our continued expansion in Canada and South America, together with demand for our oil and gas, and industrial water services from our largest clients worldwide. However, this growth is expected to be tempered by anticipated reductions in our Eastern Canada and global mining operations.

U.S. Commercial. For fiscal 2013, our U.S. commercial business declined 3.4% compared to last year. This decline resulted from a project charge to revenue on a development project in the third quarter of fiscal 2013. The decline was partially mitigated by the growth in many of our service offerings, including services provided for oil and gas clients that generates relatively high profit margins. In addition, our solid waste management operations increased, primarily due to an acquisition in fiscal 2013. 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 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 fiscal 2014, we would expect our U.S. commercial outlook to change accordingly.

U.S. Federal Government. For fiscal 2013, our U.S. federal business declined 17.7% compared to last year. This decline resulted from a broad-based slowdown of discretionary U.S. federal government programs due in part to the impact of U.S. federal budget uncertainty and the on-going sequestration. Significant project-related charges to revenue in the third quarter further reduced revenue for fiscal 2013. During periods of economic volatility, our U.S. federal government clients have historically been the most stable and predictable. However, due to the uncertainty associated with the U.S. federal budget and sequestration, we remain cautious and expect future revenue to slightly decline.

U.S. State and Local Government. For fiscal 2013, our U.S. state and local government business grew 22.7% compared to last year. 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 in fiscal 2012 and 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 in fiscal 2014 because of our focus on essential programs.


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RESULTS OF OPERATIONS

Fiscal 2013 Compared to Fiscal 2012

Consolidated Results of Operations

                                                    Fiscal Year Ended

                                 September 29,     September 30,           Change
                                     2013              2012             $         % (2)
                                                    ($ in thousands)
Revenue                          $    2,613,755    $    2,711,075   $  (97,320 )     (3.6 )%
Subcontractor costs                    (588,923 )        (689,005 )    100,082       14.5

Revenue, net of subcontractor
costs (1)                             2,024,832         2,022,070        2,762        0.1
Other costs of revenue               (1,757,842 )      (1,663,065 )    (94,777 )     (5.7 )
Selling, general and
administrative expenses                (199,732 )        (210,970 )     11,238        5.3
Contingent consideration -
fair value adjustments                    9,560            19,246       (9,686 )    (50.3 )
Impairment of goodwill                  (56,600 )            (914 )    (55,686 )       NM

Operating income                         20,218           166,367     (146,149 )    (87.8 )
Interest expense - net                   (7,686 )          (5,571 )     (2,115 )    (38.0 )

Income before income tax
expense                                  12,532           160,796     (148,264 )    (92.2 )
Income tax expense                      (14,038 )         (56,064 )     42,026       75.0

Net income (loss) including
noncontrolling interests                 (1,506 )         104,732     (106,238 )   (101.4 )
Net income attributable to
noncontrolling interest                    (635 )            (352 )       (283 )    (80.4 )

Net income (loss)
attributable to Tetra Tech       $       (2,141 )  $      104,380   $ (106,521 )   (102.1 )

(1)
We believe that the presentation of "Revenue, net of subcontractor costs", which is 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. (2)
NM = not meaningful

Our revenue and operating income were adversely impacted by weakness in certain areas of our business that resulted in reduced revenue, significant costs to right-size the related operations, and a non-cash goodwill impairment charge in the third quarter of fiscal 2013. In addition, we recorded project-related charges that reduced revenue and increased project costs. As a result of these factors, revenue decreased $97.3 million, or 3.6%, and operating income decreased $146.1 million, or 87.8%, compared to last year. However, revenue, net of subcontractor costs, was flat because the revenue decline was offset by an increase in self-performed work compared to last year.

Our fiscal 2013 results reflect the decline in our international business due to the impact of Eastern Canada, as well as the reduction in our commercial work due to the slow-down in global mining activities. Revenue and revenue, net of subcontractor costs, on a combined basis for these operations decreased $104.0 million and $83.0 million, respectively, compared to last year. Further, our revenue and


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revenue, net of subcontractor costs, declined $178.6 million and $99.2 million, respectively, in our U.S. federal government business due to a broad-based slowdown as a result of budgetary constraints, including the impact of sequestration, primarily impacting discretionary programs.

The project charges that reduced revenue primarily related to adverse developments on certain projects in the third quarter in fiscal 2013, and our subsequent evaluations and conclusions concerning the collectability of the related unbilled accounts receivable. These charges included amounts related to claims, including requests for equitable adjustment, on three programs with U.S. federal and state and local government clients. In addition, we recorded a project-related charge on a commercial development contract due to a change in client ownership and the related modification of plans for completion of the project. These events adversely affected the collectability of certain related receivables and the profitability expectations for the project. Collectively, the project charges on these four programs reduced our fiscal 2013 revenue and revenue, net of subcontractor costs, by $29.6 million.

The overall revenue decline was partially offset by increased activity on certain U.S. state and local government projects that were considered essential programs. Our fiscal 2013 revenue and revenue, net of subcontractor costs, from these activities increased $72.5 million and $50.3 million, respectively, compared to last year. Acquisitions completed in fiscal 2012 and 2013 contributed additional revenue in the aggregate amount of $194.1 million in fiscal 2013.

Operating income decreased $146.1 million, or 87.8%, in fiscal 2013 compared to last year. The decrease largely resulted from a non-cash goodwill impairment charge of $56.6 million in the third quarter of fiscal 2013. Excluding this charge, our operating income was $76.8 million for fiscal 2013 compared to $166.4 million in the prior year. The remaining decline in operating income, excluding goodwill impairment, from last year was primarily due to project-related charges as well as the slowdown in our Eastern Canada and global mining operations. The project-related charges on the four programs described above collectively reduced our fiscal 2013 operating income by $40.1 million. In addition, the weaker results in our Eastern Canada and global mining operations and the resulting charges to right-size these businesses, as described above, reduced operating income by $48.4 million in fiscal 2013 compared to last year. These right-sizing costs are not expected to recur at this level.

The decline in operating income also reflected the higher amortization of intangibles of $2.7 million in fiscal 2013 compared to last year, due to fiscal 2013 acquisitions. Additionally, the gains related to changes in the estimated fair value of our contingent earn-out liabilities decreased to $9.6 million in fiscal 2013 from $19.2 million in the prior year.

In fiscal 2013, we recorded $14.0 million of income tax expense compared to $56.1 million in the prior year. The decrease was primarily due to lower operating income and, to a lesser extent, increased estimates of R&E credits for fiscal 2013. Our fiscal 2013 effective tax rate was 112.0% compared to 34.9% for the prior year. The rate increase resulted from a goodwill impairment charge that was substantially not deductible for tax purposes.


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Segment Results of Operations

Engineering and Consulting Services

                                                    Fiscal Year Ended

                                  September 29,     September 30,           Change
                                      2013              2012             $           %
                                                     ($ in thousands)
Revenue                           $    1,035,983    $    1,155,256   $ (119,273 )   (10.3 )%
Subcontractor costs                     (130,547 )        (164,364 )     33,817      20.6

Revenue, net of subcontractor
costs                             $      905,436    $      990,892   $  (85,456 )    (8.6 )

Operating income                  $       44,598    $       96,220   $  (51,622 )   (53.6 )

In fiscal 2013, revenue and revenue, net of subcontractor costs, decreased $119.3 million and $85.5 million, respectively, compared to last year. These results reflected the decline in our Canadian operations that are focused on municipal government and mining activities, as well as in our U.S. operations that are focused on federal government and mining-related business. The aggregate revenue and revenue, net of subcontractor costs, from these operations were $104.0 million and $83.0 million lower, respectively, in fiscal 2013 than in the prior year. Our operating income decreased $51.6 million in fiscal 2013 compared to last year. The decrease was primarily attributable to the causes described above, together with lower staff utilization and $10.3 million of severance and office-related closure costs incurred in the third quarter of fiscal 2013. Including these right-sizing costs, the combined reduction in operating income from our Eastern Canada and mining operations was $48.4 million for fiscal 2013.

Technical Support Services

                                                     Fiscal Year Ended

                                    September 29,     September 30,          Change
                                        2013              2012             $         %
                                                      ($ in thousands)
Revenue                             $      932,375    $    1,020,779   $ (88,404 )   (8.7 )%
Subcontractor costs                       (272,443 )        (332,164 )    59,721     18.0

Revenue, net of subcontractor
costs                               $      659,932    $      688,615   $ (28,683 )   (4.2 )

Operating income                    $       71,842    $       71,767   $      75      0.1

Revenue and revenue, net of subcontractor costs, declined $88.4 million and $28.7 million, respectively, in fiscal 2013 compared to last year. These declines were driven by reduced activity on U.S. federal government programs across several agencies. Revenue and revenue, net of subcontractor costs, from these programs decreased by $127.8 million and $50.6 million, respectively, compared to last year. The declines also were attributable to a $12.3 million negative revenue adjustment related to a project charge on a U.S. commercial development project in the third quarter of fiscal 2013. This charge resulted from a change in client ownership and the related modification in completion plans for the project. These revenue declines were partially mitigated by the growth in our work for oil and gas clients. We generated


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$42.3 million of revenue in fiscal 2013 compared to $10.6 million last year, from a company we acquired in the third quarter of fiscal 2012 that provides services for oil and gas clients. The overall decreases in revenue and revenue, net of subcontractor costs, were also partially mitigated by increased activity on our state and local government programs. Despite the aforementioned revenue declines, our operating income in fiscal 2013 was flat compared to last year, due to relatively higher profit margins on oil and gas projects.

Remediation and Construction Management

                                                     Fiscal Year Ended

                                   September 29,     September 30,           Change
                                       2013              2012             $          %
                                                      ($ in thousands)
Revenue                            $      725,689    $      621,957   $ 103,732       16.7 %
Subcontractor costs                      (266,225 )        (279,394 )    13,169        4.7

Revenue, net of subcontractor
costs                              $      459,464    $      342,563   $ 116,901       34.1

Operating income                   $       (6,706 )  $       22,374   $ (29,080 )   (130.0 )

Revenue and revenue, net of subcontractor costs, increased $103.7 million and $116.9 million, respectively, in fiscal 2013 compared to last year. These increases were attributable to additional work in our U.S. commercial and international oil and gas businesses that resulted from the acquisitions we completed in the second quarter of fiscal 2013. On a combined basis, these acquisitions contributed $170.3 million of revenue in fiscal 2013. In addition, our revenue and revenue, net of subcontractor costs, in our state and local government business continued to grow in fiscal 2013. The overall increases were partially offset by the aforementioned project-related charges that reduced our fiscal 2013 revenue and revenue, net of subcontractor costs, by $17.3 million. These project charges related to adverse changes in the estimated collectability of unbilled accounts receivable and estimated costs at completion. These included claims and requests for equitable adjustment on three programs with U.S. federal and state and local government clients. We reported $6.7 million of operating loss in the RCM segment for fiscal 2013. The project-related charges described above contributed $27.7 million to the fiscal 2013 operating loss. The remaining decrease in operating income compared to the prior year was attributable to lower utilization of labor and equipment resources related to decreased revenue.


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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                                      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                     (210,970 )     (193,286 )    (17,684 )    (9.1 )
Contingent consideration - fair
value adjustments                             19,246          1,755       17,491        NM
Impairment of goodwill                          (914 )            -         (914 )      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

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 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


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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 our former 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 . . .

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