Tetra Tech 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Commission File Number 0-19655
TETRA TECH, INC.
(Exact name of registrant as specified in its charter)
3475 East Foothill Boulevard, Pasadena, California 91107
(Address of principal executive office and zip code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of April 28, 2008, 58,846,440 shares of the registrants common stock were outstanding.
TETRA TECH, INC.
Tetra Tech, Inc.
(in thousands, except par value)
See accompanying Notes to Condensed Consolidated Financial Statements.
Tetra Tech, Inc.
(unaudited in thousands, except per share data)
See accompanying Notes to Condensed Consolidated Financial Statements.
Tetra Tech, Inc.
(unaudited in thousands)
See accompanying Notes to Condensed Consolidated Financial Statements.
TETRA TECH, INC.
1. Basis of Presentation
The accompanying condensed consolidated balance sheet as of March 30, 2008, the condensed consolidated statements of income for the three and six months ended March 30, 2008 and April 1, 2007, and the condensed consolidated statements of cash flows for the six months ended March 30, 2008 and April 1, 2007 of Tetra Tech, Inc. (we, us or our) are unaudited, and, in the opinion of management, include all adjustments necessary for a fair statement of the financial position, the results of operations and cash flows for the periods presented. The condensed consolidated balance sheet as of September 30, 2007 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by U.S. generally accepted accounting principles (GAAP) for complete financial statements.
The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2007. Certain prior year amounts have been reclassified to conform to the current year presentation. The results of operations for the three and six months ended March 30, 2008 are not necessarily indicative of the results to be expected for the fiscal year ending September 28, 2008.
2. Accounts Receivable Net
Net accounts receivable consisted of the following:
Billed accounts receivable represent amounts billed to clients that have not been collected. Unbilled accounts receivable represent revenue recognized but not yet billed pursuant to contract terms or billed after the period end date. Substantially all unbilled receivables as of March 30, 2008 are expected to be billed and collected within 12 months. Contract retentions represent amounts withheld by clients until certain conditions are met or the project is completed, which may be several months or years. The allowance for doubtful accounts was determined based on a review of customer-specific accounts, bankruptcy filings by clients, and contract issues due to current events and circumstances. As of March 30, 2008, our billings in excess of costs on uncompleted contracts increased $23.2 million due primarily to large advance payments from commercial clients on environmental remediation and alternative energy projects.
Billed accounts receivable related to federal government contracts were $117.9 million and $95.5 million as of March 30, 2008 and September 30, 2007, respectively. The federal government unbilled receivables, net of progress payments, were $55.1 million and $88.5 million as of March 30, 2008 and September 30, 2007, respectively. Other than the federal government, no single client accounted for more than 10% of our accounts receivable as of March 30, 2008 and September 30, 2007.
3. Business Combinations, Goodwill and Intangibles
In the third quarter of fiscal 2007, we acquired (i) all of the outstanding shares of Delaney Construction Corporation, Delaney Crushed Stone Products, Inc. and Delaney Leasing Company, Inc.; and (ii) all of the limited
liability company interests of Delaney Properties, LLC (collectively, The Delaney Group or DGI), which provides planning, development and construction services for wind energy programs, Base Realignment and Closure (BRAC) projects, and water and wastewater treatment and conveyance facilities to its broad-based clients. The purchase price consisted of cash payments of approximately $32.5 million. In addition, the former shareholders will receive, over a four-year period from the acquisition date, guaranteed deferred cash payments in the aggregate amount of $9.0 million and contingent earn-out payments up to an aggregate maximum of $12.0 million upon achievement of certain financial objectives. DGI is part of our resource management segment.
In fiscal 2007, we acquired the following small companies or their assets to enhance our service offerings and expand our geographic presence:
The total purchase price for these small acquisitions consisted of the initial cash payments of approximately $8.1 million and, over a three or four-year period from their respective acquisition dates, guaranteed deferred cash payments and/or contingent earn-out payments upon achievement of certain financial objectives.
On October 1, 2007, we acquired all of the outstanding shares of capital stock of ARD, Inc. (ARD), which provides applied research, planning, design and implementation services focused on a range of water, energy, environmental and institutional issues. ARD manages large, complex international development projects for its clients, predominantly the U.S. Agency for International Development (USAID). This acquisition continues our international expansion as it increases our professional workforce in new geographic areas and technical specialties around the world. ARD is part of our resource management segment. The purchase price consisted of $41.5 million in cash payments, which were paid during the first half of fiscal 2008. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the date of acquisition.
No pro forma information is presented for the second quarter and first half of fiscal 2008 as the ARD acquisition closed on the first day of our fiscal year. The table below presents summarized unaudited consolidated pro forma operating results, assuming we had purchased ARD at the beginning of fiscal 2007:
In the second quarter of fiscal 2008, we acquired certain assets of two civil engineering firms, Daylor Consulting Group, Inc. (Daylor) and WJA P.L.L.C. (WJA). These acquisitions, which were integrated into our infrastructure segment, offer complementary technical expertise and enable us to enhance our infrastructure service offerings. We also acquired all of the outstanding shares of capital stock of INCA Engineers, Inc. (INCA). INCA provides consulting and civil/mechanical engineering services for water infrastructure and transportation projects, including locks, levees and dams projects for the U.S. Army Corps of Engineers (USACE). INCA is part of our resource management segment. The total initial purchase price for these three acquisitions consisted of approximately $10 million in cash. In addition, the sellers have certain earn-out rights that will allow them to receive additional cash payments over a three-year period upon achievement of certain financial objectives.
All of the above acquisitions were accounted for as business combinations. Accordingly, the purchase prices were allocated to the assets acquired and liabilities assumed based on their fair values. The purchase price allocations for fiscal 2008 acquisitions, except for ARD, are preliminary and subject to adjustments based upon the valuation and final determination of the net assets acquired. None of the fiscal 2007 and 2008 acquisitions, except for ARD, were considered material, individually or in the aggregate, as they did not have a material impact on our financial position, results of operations or cash flows for the respective reporting periods and, as such, no pro forma results are presented.
In the first half of fiscal 2008, we recorded $17.9 million, $3.8 million and $0.6 million of goodwill on our condensed consolidated balance sheet as of March 30, 2008 for the ARD, INCA and WJA acquisitions, respectively. These amounts resulted from the excess of the purchase price for each of these individual acquisitions over the fair value of their net tangible and identifiable intangible assets acquired. In addition, we adjusted goodwill for purchase price allocation adjustments related to certain fiscal 2007 acquisitions, and a payment of $1.5 million related to an Internal Revenue Code Section 338(h)(10) election under which the stock purchase was treated as an asset purchase for tax purposes. The changes in the carrying value of goodwill by segment for the six months ended March 30, 2008 were as follows:
The gross amount and accumulated amortization of our acquired identifiable intangible assets with finite useful lives as of March 30, 2008 and September 30, 2007, included in intangible assets net on the condensed consolidated balance sheets, were as follows:
For the six months ended March 30, 2008, $0.6 million, $2.6 million and $8.5 million were assigned to non-compete agreements, customer relations and backlog, respectively. These amounts were related to the preliminary purchase price allocations for ARD, INCA, WJA and Daylor, and, to a lesser extent, adjustments for certain fiscal 2007 acquisitions. For the three months ended March 30, 2008 and April 1, 2007, amortization expense for acquired identifiable intangible assets with finite useful lives was $1.1 million and $0.4 million, respectively. For the six months ended March 30, 2008 and April 1, 2007, the amortization expense was $2.5 million and $0.8 million, respectively. Estimated amortization expense for the remainder of fiscal 2008 and the succeeding years is as follows:
4. Discontinued Operation
In fiscal 2006, we sold Vertex Engineering Services, Inc. (VES) and, accordingly, this operating unit was accounted for as a discontinued operation in the condensed consolidated financial statements for all reporting periods. For both the three and six months ended April 1, 2007, we reported a gain from discontinued operation, net of tax, of approximately $26,000.
In December 2006, we retired our senior secured notes and paid off the remaining principal balance of $72.9 million. In connection with this early debt retirement, we incurred pre-payment premiums of $3.1 million and expensed the remaining unamortized deferred financing costs of $1.1 million in the first quarter of fiscal 2007. In accordance with Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of Financial Accounting Standards Board (FASB) Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, we reported a $4.2 million loss on retirement of debt as part of our income from operations in the first quarter of fiscal 2007.
6. Stockholders Equity and Stock Compensation Plans
We account for stock-based compensation in accordance with SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R). Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the value of the award granted, and recognized over the period in which the award vests. For the three and six months ended March 30, 2008, stock-based compensation expense was $2.2 million and $3.9 million, compared to $1.5 million and $2.6 million for the same periods last year, respectively. These amounts are primarily included in selling, general and administrative (SG&A) expenses in our condensed consolidated statements of income. Stock-based compensation expense for the three and six months ended March 30, 2008 may not be indicative of the total expense to be expected for fiscal year 2008.
7. Earnings Per Share
Basic earnings per share (EPS) is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS is computed by dividing net income by the weighted average number of common shares outstanding and dilutive potential common shares for the period. Potential common shares include the weighted average dilutive effects of outstanding stock options using the treasury stock method.
The following table sets forth the number of weighted average shares used to compute basic and diluted EPS:
For the three and six months ended March 30, 2008, 3.5 million and 4.0 million common stock options were anti-dilutive, compared to 4.1 million options for the same periods last year. These options were excluded from the calculation of dilutive potential common shares because the strike prices were above the average market prices for the reporting periods.
8. Income Taxes
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109, Accounting for Income Taxes (FIN 48). Under FIN 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and disclosure requirements for uncertain tax positions.
We adopted the provisions of FIN 48 on October 1, 2007 and did not record any cumulative effect adjustment to retained earnings as a result of this adoption. The amount of unrecognized tax benefits at October 1, 2007 was $32.1 million, of which $15.4 million would impact our effective tax rate if recognized. The amount of unrecognized tax benefits as of March 30, 2008 was $36.0 million, of which $15.4 million would impact our effective tax rate if recognized. We recognize potential interest and penalties related to unrecognized tax benefits in income tax expense. The amount of interest income accrued as of October 1, 2007 was $8.4 million. The amount of
interest income accrued as of March 30, 2008 was $9.1 million and is included in the non-current income taxes receivable.
While the adoption of FIN 48 did not have a cumulative effect on retained earnings, we recorded certain reclassifications that affected the presentation on our condensed consolidated balance sheet as of March 30, 2008. We recorded a reclassification from deferred tax liability to non-current income taxes payable to reflect the amount of expected tax payments related to temporary differences. Our net deferred tax asset balances reflect the expected future net tax deductions. While unrelated to the adoption of FIN 48, the increase in our current income taxes receivable reflects estimated tax payments in excess of our current provision.
We are currently under examination by the Internal Revenue Service (IRS) for fiscal years 1997 through 2004 and the California Franchise Tax Board (FTB) for fiscal years 2001 through 2003 related to research and experimentation credits (R&E Credits). In addition, during fiscal 2002, the IRS approved our request to change the accounting method for revenue recognition for income tax purposes for some of our businesses. In 2002, we filed amended tax returns for fiscal years 1997 through 2000 to claim R&E Credits and to claim refunds due under the newly approved accounting method. At the time the refund claims were filed, we were under examination by the IRS for those years. The claimed refunds are being held pending completion of the IRS examination. The estimated realizable refunds have been classified as non-current income taxes receivable on our condensed consolidated balance sheets.
During the third quarter of fiscal 2006, we received a 30-day letter from the IRS related to fiscal years 1997 through 2001. We protested the position in the letter and began the IRS appeals process in January 2007. In October 2007, we received an Audit Issue Presentation Sheet (AIPS) from the FTB related to fiscal 2001 through 2003. We have protested the position in the AIPS. Management believes that it is reasonably possible we will reach a resolution of the issues for fiscal years 1997 through 2001 under appeal with the IRS in the next twelve months. If the resolution is favorable, the change in unrecognized tax benefits could be significant and we could receive a significant cash refund. However, if the resolution is unfavorable, there may be a material adverse effect on our financial results as a result of an increase in income tax expense, but no material impact on our cash flow in future periods. At this time, an estimate of the outcome cannot be reliably made. With a few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for fiscal years before 1997.
9. Reportable Segments
We currently manage our business in three reportable segments: resource management, infrastructure and communications. Management established these segments based upon the services provided, the different marketing strategies associated with these services and the specialized needs of their respective clients. Our resource management segment provides engineering, consulting and construction services primarily addressing water quality and availability, environmental restoration, productive reuse of defense facilities, strategic environmental resource planning and alternative energy. Our infrastructure segment provides engineering, systems integration, program management, and construction management services for the development, upgrading, replacement and maintenance of civil infrastructure. Our communications segment provides engineering, permitting, site acquisition and construction management services for utility and telecommunication infrastructure projects.
During the first quarter of fiscal 2006, we developed and started implementing the initial phase of a plan to combine operating units and re-align our management structure. Throughout fiscal 2007 and to date, we consolidated some of our reporting units under common management structure, information systems and back-office functions. These changes have had no impact on our operating segment structure to date. As a result of our exit from the wireless communications business in fiscal 2006, the remaining portion of the communication business, known as the wired business, represents a small part of our overall business. In addition, the wired business operating units increasingly perform services and serve clients that are similar in nature to those of the infrastructure business. The wired business operating units provide engineering, permitting, site acquisition and construction management to state and local governments, telecommunications and cable operators, utility companies and other commercial clients. We continue to assess our operating and management structure, including the alignment of our wired business operating units. Should further changes be effected, we will evaluate the impact on our segment reporting as appropriate.
Management evaluates the performance of these reportable segments based upon their respective income from operations before the effect of amortization expense related to acquisitions. We account for inter-segment
sales and transfers as if the sales and transfers were to third parties; that is, by applying a negotiated fee onto the cost of the services performed. All inter-company balances and transactions are eliminated in consolidation.
The following tables set forth summarized financial information concerning our reportable segments:
(1) Other income (expense) includes corporate costs not allocable to the segments. The three and six months ended April 1, 2007 included $1.8 million and $5.7 million reversals of accrued litigation liabilities, respectively.
10. Major Clients
For the three and six months ended March 30, 2008, we generated 14.5% and 14.4% of our revenue from the USACE, a component of the U.S. Department of Defense (DoD), compared to 13.2% and 11.2% for the same periods last year, respectively. For the three and six months ended March 30, 2008, we generated 13.7% and 14.3% of our revenue from the U.S. Air Force, also a component of the DoD, compared to 13.1% and 13.8% for the same periods last year, respectively. Our resource management and infrastructure segments generated revenue from all client sectors. Our communications segment reported revenue only from state and local government and commercial clients.
The following table presents revenue by client sector:
(1) Includes revenue generated from our international clients. Revenue related to projects performed in foreign countries for U.S. government clients was reported as part of our federal government client sector.
11. Comprehensive Income
We include two components in comprehensive income: net income during a period and other comprehensive income. Other comprehensive income consists of translation gains and losses from subsidiaries with functional currencies different than our reporting currency.
For the three and six months ended March 30, 2008, comprehensive income was $13.6 million and $26.5 million, respectively. For the three and six months ended April 1, 2007, comprehensive income was $10.4 million and $19.8 million, respectively. We recorded an insignificant net translation loss for both the three and six months ended March 30, 2008 and April 1, 2007, respectively.
12. Commitments and Contingencies
We are subject to certain claims and lawsuits typically filed against the engineering, consulting and construction profession, alleging primarily professional errors or omissions. We carry professional liability insurance, subject to certain deductibles and policy limits, against such claims. However, in some actions, parties are seeking damages that exceed our insurance coverage or for which we are not insured. While management does not believe that the resolution of these claims will have a material adverse effect on our financial position, results of operations or cash flows, management acknowledges the uncertainty surrounding the ultimate resolution of these matters.
On January 3, 2007, a stockholder filed a putative shareholder derivative complaint in the Superior Court of the State of California, County of Los Angeles against certain current and former members of our Board of Directors and certain current and former executive officers, alleging proxy fraud, breach of fiduciary duty, abuse of control, constructive fraud, corporate waste, unjust enrichment and gross mismanagement in connection with the grant of certain stock options to our executive officers. We were also named as a nominal defendant in this action. The complaint sought damages on our behalf in an unspecified amount, disgorgement of the options which are the subject of the action, any proceeds from the exercise of those options or from any subsequent sale of the underlying stock and equitable relief. On April 11, 2008, the court entered a Judgment and Order of Dismissal in this matter, and the plaintiff has 60 days to appeal this judgment. Management believes that this lawsuit is without merit and no litigation liabilities have been recorded.
In May 2003, Innovative Technologies Corporation (ITC) filed a lawsuit in Montgomery County, Ohio against Advanced Management Technology, Inc. (AMT) and other defendants for misappropriation of trade secrets, among other claims. In June 2004, we purchased all of the outstanding shares of AMT. As part of the purchase agreement, the former owners of AMT agreed to indemnify us for all costs and damages related to this lawsuit. In December 2007, the case went to trial, and the jury awarded $5.8 million in compensatory damages against AMT. In addition, in January 2008, the jury awarded $17.0 million in punitive damages against AMT plus unquantified legal fees. Based on these awards, AMTs aggregate potential liability is approximately $23.8 million plus the unquantified legal fees. The court entered the above judgments in January 2008. No amounts have been paid to date; however, we have posted a $1.0 million bond as required by the court. Based on our review of this case, including analysis by our legal counsel, we do not believe that it is probable that the judgments will be sustained. We believe that the judgments against AMT could be set aside, reversed, or remanded for a new trial based on the merits of AMTs post-trial motions, which were filed in February 2008. However, should AMT not prevail on the underlying merits of the case, we believe, and have argued in post-trial motions, that the award amounts do not conform to the evidence and that the jury verdicts are not consistent with the courts instructions as a matter of law. If an appeal is necessary, it will be made to the second district court of appeals in Ohio. We believe that the reasonably possible range of exposure is from $0 to approximately $25 million. As we do not believe a loss is probable, no liability has been recorded as of March 30, 2008. Further, we believe the former owners of AMT have the ability and intent to fully indemnify us for any and all costs and damages related to this lawsuit.
A domestic real estate investment trust (the REIT) that owns and rents apartments has informed us that it intends to file suit against us, alleging that employees at one of our operating divisions in Colorado participated in a scheme to defraud the REIT in connection with contracts for environmental clean-up work between us and the REIT. To date, no lawsuit has been filed; however, the REIT has indicated that it intends to file fraud and other claims against us and may seek as much as $30 million in damages. We are in the early stages of the investigation. However, based on the information gathered to date and on the advice of legal counsel, we believe we have defenses and potential counter-claims to the allegations raised by the REIT, and we intend to defend ourselves vigorously if a suit is filed. Given the limited facts available to us at this time, it is not possible to accurately predict the ultimate resolution of this matter.
13. Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued Staff Position No. FAS 157-2, Effective Dates of FASB Statement No. 157, which defers the effective date of SFAS 157 for all
nonrecurring fair value measurements of nonfinancial assets and liabilities until fiscal years beginning after November 15, 2008. We are currently evaluating the impact SFAS 157 may have on our financial statements and disclosures.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 provides companies with an option to measure, at specified election dates, many financial instruments and certain other items at fair value that are not currently measured at fair value. A company that adopts SFAS 159 will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We will implement the new standard effective in fiscal 2009. We are currently evaluating whether we will elect the fair value measurement principles for certain assets and liabilities.
In December 2007, the FASB issued Statement No. 141 (revised 2007), Business Combinations (SFAS 141R). SFAS 141R establishes the principles and requirements for how an acquirer: (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R makes significant changes to existing accounting practices for acquisitions. SFAS 141R is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008. We will implement the new standard effective in fiscal 2010. We are currently evaluating the impact, if any, SFAS 141R will have on our future business combinations.
In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements an Amendment of ARB No. 51 (SFAS 160). SFAS 160 establishes accounting and reporting standards that require: (i) noncontrolling interests to be reported as a component of equity; (ii) changes in a parents ownership interest while the parent retains its controlling interest to be accounted for as equity transactions, and (iii) any retained noncontrolling equity investment upon the deconsolidation of a subsidiary to be initially measured at fair value. We do not currently have any less than wholly-owned consolidated subsidiaries. SFAS 160 is to be applied prospectively at the beginning of the first annual reporting period on or after December 15, 2008. We will implement the new standard effective in fiscal 2010.
In December 2007, Emerging Issues Task Force (EITF) 07-01, Accounting for Collaborative Arrangements was issued to prescribe the accounting for collaborations. It requires certain transactions between collaborators to be recorded in the income statement on either a gross or net basis when certain characteristics exist in the collaboration relationship. EITF 07-01 is effective in fiscal 2010 for all of our collaborations. We are currently evaluating the impact, if any, EITF 07-01 will have on our financial statements.
This Quarterly Report on Form 10-Q, including Managements 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. 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, as well as under the heading 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 any forward-looking statements for any reason.
We are a leading provider of consulting, engineering, construction and technical services focused on resource management and infrastructure. We serve our clients by defining problems and developing innovative and cost-effective solutions. Our solution usually begins with a scientific evaluation of the problem, one of our differentiating strengths. Our solution may span the life cycle of a project, which includes research and development, applied science and technology, engineering design, program management, construction management, construction, and operations and maintenance.
Since our initial public offering in December 1991, we have increased the size and scope of our business, expanded our service offerings, and diversified our client base and the markets we serve through internal growth and strategic acquisitions. We expect to focus on internal growth and continue to pursue complementary acquisitions that expand our geographic reach and increase the breadth and depth of our service offerings to address existing and emerging markets. As of March 30, 2008, we had approximately 7,900 full-time equivalent employees worldwide, located primarily in North America.
We derive our revenue from fees for professional and technical services. As 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 federal and state and local government agencies, as well as commercial and international clients. The following table presents the approximate percentage of our revenue, net of subcontractor costs, by client sector:
(1) Includes revenue generated from our international clients. Revenue related to projects performed in foreign countries for U.S. government clients was reported as part of our federal government client sector.
We manage our business in three reportable segments: resource management, infrastructure and communications. Management established these segments based upon the services provided, the different marketing strategies associated with these services and the specialized needs of their respective clients. Our resource management segment provides engineering, consulting and construction services primarily addressing water quality and availability, environmental restoration, productive reuse of defense facilities, strategic environmental resource planning and alternative energy. Our infrastructure segment provides engineering, systems integration, program management, and construction management services for the development, upgrading, replacement and maintenance of civil infrastructure. Our communications segment provides engineering, permitting, site acquisition and construction management services for utility and telecommunication infrastructure projects.
The following table represents the approximate percentage of our revenue, net of subcontractor costs, by reportable segment:
Our services are provided under three principal types of contracts: fixed-price, time-and-materials and cost-plus. The following table presents the approximate percentage of our revenue, net of subcontractor costs, by contract type:
Contract revenue and contract costs are recorded primarily using the percentage-of-completion (cost-to-cost) method. Under this method, revenue is recognized in the ratio that contract costs incurred bear to total estimated 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.
In the course of providing our services, we routinely subcontract services and, under certain USAID programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with industry practice and GAAP, are included in revenue. The grants are reported as part of our subcontractor costs on our condensed consolidated financial statements. Because subcontractor services can change significantly from project to project, changes in revenue may not be indicative of our business trends. Accordingly, we also report revenue less the cost of subcontractor services, and our discussion and analysis of financial condition and results of operations uses revenue, net of subcontractor costs, as a point of reference.
For analytical purposes only, we categorize our revenue into two types: acquisitive and organic. Acquisitive revenue consists of revenue derived from newly acquired companies that are reported individually as separate operating units during the first twelve months following their respective acquisition dates. Organic revenue consists of our total revenue less any acquisitive revenue.
Our 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. In addition, we include stock-based compensation, depreciation of property and equipment, as well as
amortization of identifiable intangible assets, in SG&A expenses. Most of these costs are unrelated to a specific client or project and can vary as expenses are incurred to support corporate activities and initiatives.
Our revenue, expenses and operating results may fluctuate significantly from quarter to quarter as a result of numerous factors, including:
· Unanticipated changes in contract performance that may affect profitability, particularly with contracts that are fixed-price or have funding limits;
· The seasonality of the spending cycle of our public sector clients, notably the federal government, the spending patterns of our commercial sector clients, and weather conditions;
· Budget constraints experienced by our federal as well as state and local government clients;
· Acquisitions or integration of acquired companies;
· Divestiture or discontinuance of operating units;
· Employee hiring, utilization and turnover rates;
· The number and significance of client contracts commenced and completed during a quarter;
· Creditworthiness and solvency of clients;
· The ability of our clients to terminate contracts without penalties;
· Delays incurred in connection with a contract;
· The size, scope and payment terms of contracts;
· Contract negotiations on change orders and collections of related accounts receivable;
· The timing of expenses incurred for corporate initiatives;
· Reductions in the prices of services offered by our competitors;
· Threatened or pending litigation;
· The impairment of our goodwill or identifiable intangible assets;
· Changes in accounting rules; and
· General economic or political conditions.
We experience seasonal trends in our business. Our revenue is typically lower in the first half of the fiscal year, primarily due to the Thanksgiving, Christmas and New Years holidays. Many of our clients employees, as well as our own employees, take vacations during these holidays. Further, seasonal inclement weather conditions occasionally may cause some of our offices to close temporarily or 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 that result in higher billable hours. In addition, our revenue is typically higher in the fourth fiscal quarter due to the federal governments fiscal year-end spending.
ACQUISITIONS AND DIVESTITURES
Acquisitions. We continuously evaluate the marketplace for strategic acquisition opportunities. Due to our reputation, size, geographic presence and range of services, we have numerous opportunities to acquire both
privately held companies and subsidiaries or divisions of publicly held companies. Once an opportunity is identified, we examine the effect an acquisition may have on our long-range business strategy and our 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 achieve 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 both cash and 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 strategic goals, provide critical mass with existing clients, and further expand our lines of service. These factors will likely contribute to purchase prices that result in the recognition of goodwill and other identifiable intangible assets.
In the third quarter of fiscal 2007, we acquired DGI, which provides planning, development and construction services for wind energy programs, BRAC projects, and water and wastewater treatment and conveyance facilities to its broad-based clients. This acquisition enables us to provide a wider range of service to our current and prospective wind energy clients, as DGI offers complementary capabilities and customer relationships. DGI is part of our resource management segment. In fiscal 2007, we also acquired VCL, VNL, STE, MEG, GORE and NEA. The purchase prices consisted of initial cash payments and, over a four-year period from their respective acquisition dates, guaranteed deferred cash payments, and/or contingent earn-out payments upon achievement of certain financial objectives. MEG has been integrated into our infrastructure segment, and the other acquisitions have been integrated into our resource management segment.
On October 1, 2007, we acquired ARD, which provides applied research, planning, design and implementation services focused on a range of water, energy, environmental and institutional challenges. ARD manages large, complex international development projects for its clients, predominantly USAID. This acquisition continues our international expansion, as it increases our professional workforce by approximately 730 employees in new geographic areas and technical specialties around the world. The purchase price consisted of $41.5 million in cash payments, which were paid during the first half of fiscal 2008. ARD is part of our resource management segment.
In the second quarter of fiscal 2008, we acquired certain assets of two civil engineering firms, Daylor and WJA. These acquisitions, which were integrated into our infrastructure segment, offer complimentary technical expertise and enable us to enhance our infrastructure service offerings. We also acquired all of the outstanding shares of capital stock of INCA, which provides consulting and civil/mechanical engineering services for water and transportation projects. INCA is part of our resource management segment.
None of the fiscal 2007 and 2008 acquisitions, except for ARD, were considered material, individually or in the aggregate, as they did not have a material impact on our financial position, results of operations or cash flows for the respective reporting periods.
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 continue to divest certain non-core businesses and reallocate our resources to businesses that better align with our long-term strategic direction. We had no divestitures in fiscal 2007 and or in the first half of fiscal 2008.
BUSINESS TREND ANALYSIS
General. Our business continues to grow as we focus on organic growth and pursue complementary acquisitions that expand our geographic reach and increase the breadth of our service offerings to address existing and emerging markets. In the second quarter of fiscal 2008, we experienced overall revenue growth of 33.3% from acquisitive and organic revenue from all client sectors compared to the same quarter last year.
Federal Government. In the second quarter of fiscal 2008, our federal government business experienced strong revenue growth of 42.9% compared to the same quarter last year. Approximately half of this growth was driven by acquisitive revenue from our ARD acquisition and, to a lesser extent, our DGI and INCA acquisitions. The balance of this growth resulted primarily from the continuation of increased activity on our Iraq and domestic projects with the DoD. However, this growth was partially offset by reduced workload that resulted from the
completion of certain large contracts with the U.S. Department of Energy (DOE) and the National Aeronautics and Space Administration (NASA). We anticipate that our federal government business will experience moderate growth in fiscal 2008 compared to fiscal 2007 due primarily to our increased work with USAID and increased BRAC spending. Due to the DoDs funding practices on projects in Iraq, it is difficult to forecast the continuation of our reconstruction and unexploded ordnance (UXO) projects. Consequently, our federal government business growth may be adversely impacted by a potential reduction in our Iraq project workloads.
State and Local Government. In the second quarter of fiscal 2008, our state and local government business grew 12.0% compared to the same quarter last year. This growth resulted primarily from the DGI and INCA acquisitions and, to a lesser extent, increased activity on water and civil infrastructure projects. This growth was partially offset by reduced activity and a funding delay on certain large projects with a few state and local government clients. Many states over the past two years experienced budget surpluses due to stable financial conditions, and voters in several states in 2006 approved infrastructure bond measures. Additional infrastructure bond measures are being considered for ballots in 2008 and 2010. However, due to the crisis in the housing industry, the resulting lower property and sales tax revenues, and general U.S. economic weakness, states overall are projecting slower growth in spending in fiscal 2008 compared to fiscal 2007. Despite this slow-down, many states still face major long-term infrastructure needs, including the maintenance, repair and upgrading of existing infrastructure and the need to build new facilities. Consequently, we anticipate that infrastructure projects will be initiated and funded during the remainder of 2008, and our state and local government business will experience modest growth in fiscal 2008.
Commercial. In the second quarter of fiscal 2008, our commercial business experienced growth of 28.7% from organic and, to a lesser extent, acquisitive revenue compared to the same quarter last year. This growth was driven largely by increased demand for our alternative energy services and, to a lesser extent, increased activity on environmental remediation and telecommunications infrastructure projects. We anticipate that our commercial business will experience moderate growth in fiscal 2008.
RESULTS OF OPERATIONS
Overall, our results for the second quarter of fiscal 2008 reflect a significant improvement as compared to the same quarter last year due to our focus on organic growth and the strategic pursuit of acquisitions that enhance our service offerings and expand our geographical presence. We continued to experience business growth from all client sectors and all reportable segments, particularly from international development projects associated with our ARD acquisition, reconstruction and UXO projects in Iraq, and alternative energy and civil infrastructure projects. Our contract costs did not increase to the same extent as our revenue growth, due largely to improved performance on our fixed-priced contracts. Our SG&A expenses increased as we incurred higher marketing and business development costs to drive our business growth. We also reported increased SG&A expenses related to our acquisitions. In addition, our SG&A expenses for the second quarter of fiscal 2007 benefited from a reversal of certain accrued litigation liabilities. Our interest expense also increased due to higher borrowings associated with our fiscal 2008 acquisitions compared to the same quarter last year.