Tetra Tech 10-Q 2009
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
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 the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company o
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 27, 2009, 60,222,957 shares of the registrants common stock were outstanding.
TETRA TECH, INC.
Tetra Tech, Inc.
(unaudited - 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 29, 2009, the condensed consolidated statements of income for the three and six months ended March 29, 2009 and March 30, 2008, and the condensed consolidated statements of cash flows for the six months ended March 29, 2009 and March 30, 2008 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, results of operations and cash flows for the periods presented. The consolidated balance sheet as of September 28, 2008 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 28, 2008. The results of operations for the three and six months ended March 29, 2009 are not necessarily indicative of the results to be expected for the fiscal year ending September 27, 2009. Certain prior year amounts have been reclassified to conform to the current year presentation. In the first quarter of fiscal 2009, we began reporting under four reportable segments with reclassification of prior year segment results to conform to the new basis of presentation. Refer to Note 7, Reportable Segments for additional information.
Our international operating units have functional currencies that are different than our reporting currency. Their functional currencies are typically based upon the currencies of the primary country in which they operate. Translation of assets and liabilities to U.S. dollars is based on exchange rates at the balance sheet date. Translation of revenue and expenses to U.S. dollars is based on the average rate during the period. Translation gains or losses are reported as a component of Accumulated other comprehensive income. Gains or losses from foreign currency transactions are included in results of operations, with the exception of inter-company foreign transactions that represent a long-term investment, which are recorded in Accumulated other comprehensive income on our condensed consolidated balance sheet as of March 29, 2009.
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 29, 2009 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 resulting from current events and economic circumstances.
Billed accounts receivable related to federal government contracts were $104.7 million and $100.2 million as of March 29, 2009 and September 28, 2008, respectively. The federal government unbilled receivables, net of progress payments, were $78.4 million and $88.6 million as of March 29, 2009 and September 28, 2008, respectively. The federal government and one commercial client each accounted for more than 10% of our accounts receivable as of March 29, 2009 and September 28, 2008.
3. Goodwill and Intangibles
In the first quarter of fiscal 2008, we acquired 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 has continued our international expansion as it has increased our professional workforce in new geographic areas and technical specialties around the world. ARD is part of our technical support services (TSS) segment. The purchase price consisted of $41.5 million in cash payments. In the second quarter of fiscal 2008, we made other acquisitions that have enhanced our service offerings and expanded our geographic reach in our engineering and architecture services (EAS) segment and environmental consulting services (ECS) segment.
In the second quarter of fiscal 2009, we acquired Wardrop Engineering, Inc. (Wardrop), a Canadian firm that specializes in resource management, energy and infrastructure design and is included in our environmental consulting services segment. This acquisition significantly expands our worldwide presence, adding 13 offices throughout Canada and offices in the United Kingdom and India. During the first half of fiscal 2009, we made other acquisitions that expand our service offerings to USAID in the TSS segment, and to the federal government and commercial clients in the ECS segment. The initial purchase prices for these acquisitions, which are subject to adjustment, were financed with available cash resources and approximately $80 million of borrowings under our revolving credit facility. No pro forma results are presented for the respective interim periods as the effect of these acquisitions was not material, individually or in the aggregate, to our condensed consolidated financial statements.
The changes in the carrying value of goodwill by segment for the six months ended March 29, 2009 were as follows:
The goodwill additions are attributable to the fiscal 2009 acquisitions described above. Substantially all of the goodwill additions are not deductible for income tax purposes. The goodwill adjustments reflect earn-out payments, agreed upon net asset adjustments, and the final purchase price allocations associated with prior acquisitions. The purchase price allocation related to the Wardrop acquisition is preliminary, and subject to adjustment based on the valuation and final determination of the net assets acquired.
The gross amount and accumulated amortization of our acquired identifiable intangible assets with finite useful lives as of March 29, 2009 and September 28, 2008, included in Intangible assets - net on the condensed consolidated balance sheets, were as follows:
For the six months ended March 29, 2009, $1.7 million, $11.4 million and $5.4 million were assigned to non-compete agreements, customer relations and backlog, respectively, related to the acquisitions described above. For the three months ended March 29, 2009 and March 30, 2008, amortization expense for acquired identifiable intangible assets with finite useful lives was $2.4 million and $1.1 million, respectively. For the six months ended March 29, 2009 and March 30, 2008, amortization expense was $4.1 million and $2.5 million, respectively. Estimated amortization expense for the remainder of fiscal 2009 and the succeeding years is as follows:
4. Stockholders Equity and Stock Compensation Plans
We account for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R) (SFAS 123R), Share-Based Payment (revised 2004). 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 29, 2009, stock-based compensation expense was $2.5 million and $4.6 million, compared to $2.2 million and $3.9 million for the same periods last year, respectively. These amounts were primarily included in Selling, general and administrative (SG&A) expenses in our condensed consolidated statements of income. In the second quarter of fiscal 2009, we granted 49,000 stock options with exercise prices ranging from $20.34 to $22.40 per share and an estimated weighted-average fair value of $9.32 per share. For the six months ended March 29, 2009, we granted 1,032,200 stock options with exercise prices ranging from $16.98 to $22.40 per share and an estimated weighted-average fair value of $7.58 per share.
5. Earnings Per Share (EPS)
Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding, less unvested restricted stock for the period. 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 and unvested restricted stock 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 29, 2009, 2.4 million and 2.6 million common stock options were excluded from the calculation of dilutive potential common shares, compared to 3.5 million and 4.0 million options for the same periods last year. These options were not included in the computation of dilutive potential common shares because the assumed proceeds per share exceeded the average market price per share for that period. Therefore, their inclusion would have been anti-dilutive.
6. Income Taxes
In 2002, we filed amended tax returns for fiscal years 1997 through 2000 to claim research and experimentation credits (R&E Credits) and to claim refunds due under an approved tax accounting method change for revenue recognition. At the time the refund claims were filed, we were under examination by the Internal Revenue Service (IRS) for those years. The claimed refunds were held pending completion of the IRS examination. In the second quarter of fiscal 2009, we received notification from the IRS that our appeals settlement was approved for fiscal years 1997 through 2001. In the third quarter of fiscal 2009, we received the cash refund of $39.8 million from the IRS settlement, which included interest. The amount of the settlement exceeded the amount of the receivable previously recognized in our financial statements. We have recorded a benefit of $3.3 million in income tax expense in the second quarter of fiscal 2009 to reflect the settlement adjustment and an adjustment to certain unrecognized tax benefits (including related interest) for the fiscal years subsequent to the settlement. These adjustments reduced our effective tax rate from 41.1% for the first quarter of fiscal 2009 to 28.8% and to 35.0% for the three and six months ended March 29, 2009, respectively.
As a result of the settlement described above, we adjusted certain unrecognized tax benefits and reclassified various balance sheet amounts to reflect our tax position as of March 29, 2009. The total adjustment to unrecognized tax benefits was a net decrease of $27.7 million, resulting in a balance of $11.2 million as of March 29, 2009. Included in this balance were approximately $5 million of tax benefits that, if recognized, would affect our income tax provisions. Our current deferred income tax liability of $17.7 million as of March 29, 2009 increased from September 28, 2008 primarily because of the recognition of previously unrecognized tax benefits related to our tax accounting method for revenue recognition. The current tax receivable of $46.5 million as of March 29, 2009 includes the $39.8 million receivable from the IRS associated with the settled years.
We remain in the appeals process with the IRS for fiscal years 2002 through 2004 related to R&E Credits and our tax accounting method for revenue recognition. We are also under examination by the California Franchise Tax Board (FTB) for fiscal years 2001 through 2003 related to R&E Credits. Management believes that it is reasonably possible we will reach a resolution of these audits within the next 12 months. If the resolution is more favorable than expected, the change in unrecognized tax benefits could be significant. However, if the resolution is less favorable than expected, there may be a material increase in our income tax expense in the period in which the determination is made.
We have initiated and are conducting studies for the tax years subsequent to fiscal 2004 to determine if we are entitled to claim federal and state R&E Credits for those years. We expect to substantially complete the studies in the second half of fiscal 2009 and will consider filing amended tax returns to claim any credits. Due to the complexities of the R&E studies, we do not yet have sufficient information to reasonably estimate the income tax benefit of any unclaimed R&E Credits for tax years subsequent to fiscal 2004.
7. Reportable Segments
In the first quarter of fiscal 2009, we began reporting under four new reportable segments with reclassification of the prior year segment results to conform to the new basis of presentation. Each of the new reportable segments is comprised of similar activities that focus on the services it provides, the markets it serves, the distribution method of its services, its contracting mechanisms, the organization and execution of its projects, the education and discipline of its workforce, and the metrics by which its client projects and staff are measured. In addition, each of our operating groups, which are also our reportable segments, is managed by its own president, who has responsibility for the segments business units. Each president directly reports to our Chief Executive Officer, who is our chief operating decision maker (CODM). The CODM regularly reviews the four reportable segments, allocates resources to these segments and assesses each segments performance. The reportable segments are as follows:
Environmental Consulting Services (ECS). ECS provides front-end science and consulting services and project management skills in the areas of water resources, groundwater services, watershed management, mining and geotechnical sciences, environmental management, and information technology and modeling consulting.
Technical Support Services (TSS). TSS advises clients, studies, designs and implements projects, and conducts research in the areas of remedial and developmental planning, regulatory consulting, climate change and carbon management services, disaster management, systems test and support services, and program management for complex federal government and international development projects.
Engineering and Architecture Services (EAS). EAS provides engineering, architecture, interior and exterior design, Leadership in Energy and Environmental Design (LEED), and program administration services for projects that include water and wastewater conveyance and treatment, building construction, land development and transportation services.
Remediation and Construction Management (RCM). RCM provides a wide array of services, including program management, engineering, procurement and construction, construction management, and operations and maintenance focused on federal construction, environmental remediation including unexploded ordnance (UXO) and wetland restoration, and energy projects including wind, nuclear engineering and other alternative energies, and communications development and construction.
Management evaluates the performance of these reportable segments based upon their respective income from operations before the effect of amortization expense related to acquisitions and other unallocated corporate expenses. 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 costs 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:
Total assets by segment were as follows:
(1) Other expense includes corporate costs not allocable to segments.
Other than the federal government and one commercial client, we had no other single client that accounted for more that 10% of our revenue. All of our segments generated revenue from all client sectors.
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 and U.S. commercial clients was reported as part of our federal government and commercial client sectors, respectively.
8. Pension Plan
In connection with the Wardrop acquisition, we assumed the assets and obligations under Wardrops defined benefit pension plan, which primarily covers a group of active and inactive employees and a limited number of retirees. No new employees are eligible to participate in this plan. Pursuant to the Wardrop purchase agreement, Wardrop agreed to terminate this plan by the end of fiscal 2009. Further, an escrow account was established under the purchase agreement to fully fund the defined benefit pension settlement liability and all post-closing expenses. We assumed the initial net liability of approximately $5.7 million (net of plan assets of approximately $11.3 million) as of the acquisition date. In the second quarter of fiscal 2009, Wardrop purchased insurance annuities for existing pensioners and inactive employees, and settled the obligations with these participants for approximately $12.4 million. This amount was paid with plan assets and a portion of funds in the purchase agreement escrow account. The remaining liability for active employees is estimated to be approximately $4.5 million, which is reported as part of the Other current liabilities on our condensed consolidated balance sheet as of March 29, 2009. There is a corresponding asset related to the escrow account that is reported as part of Prepaid expenses and other current assets on our condensed consolidated balance sheet as of March 29, 2009. The net periodic benefit expense for the second quarter of fiscal 2009 was immaterial.
9. Comprehensive Income
Comprehensive income is comprised of net income and other comprehensive income, which includes translation gains and losses from foreign subsidiaries with functional currencies different than our reporting currency. The following summarizes our comprehensive income:
10. 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.
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 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, the jury awarded $17 million in punitive damages against AMT plus reasonable attorneys fees. The court required AMT to post a $1 million bond which has been done. In July 2008, the Common Pleas Court of Montgomery County denied AMTs motion for judgment notwithstanding the verdict and conditionally denied AMTs motion for a new trial. Further, the court remitted the verdict to $2.0 million in compensatory damages and $5.8 million in punitive damages. ITC accepted the remittitur, and AMT appealed. The appellate court remanded the matter to the trial court for ruling on ITCs motion for prejudgment interest and attorneys fees. The trial court has not yet ruled on ITCs motion. We expect that appeals will follow the courts ruling. We believe that a reasonably possible range of exposure, including our attorneys fees, is from $0 to approximately $14.5 million. As of March 29, 2009, we have recorded a liability representing our best estimate of a probable loss. Further, for the same amount, we have recorded a receivable from the former owners of AMT as we believe it is probable they will fully honor their indemnification agreement with us for any and all costs and damages related to this lawsuit.
In the fourth quarter of 2008, a domestic real estate investment trust (the REIT) that owns and rents apartments filed suit against us and a former employee in the United States District Court for the Eastern District of Virginia. The suit alleged 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. On March 30, 2009, the parties definitively settled their dispute and agreed that their claims against each other will be dismissed. The impact to our results of operations for the three months ended March 29, 2009 was not material.
11. Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standard Board (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, FASB issued FASB Staff Position (FSP) No. FAS 157-2, Effective Dates of FASB Statement No. 157, which deferred 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. In October 2008, the FASB also issued FSP No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, which clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market of that financial asset is not active. The FSP observes that revisions resulting from a change in valuation technique or its application should be accounted for as a change in accounting estimate, and any effects on fair-value measurement would be recognized in the period of adoption. Our adoption of SFAS 157 on September 29, 2008 was limited to financial assets and liabilities and had no impact on our condensed consolidated financial statements in the first half of fiscal 2009. We are currently evaluating the anticipated effect of this statement on the non-financial assets and non-financial liabilities in our consolidated financial statements.
In February 2007, the FASB issued SFAS 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 became effective for us as of the beginning of our fiscal year 2009. We did not elect the fair value option for any financial assets or liabilities during the first quarter of fiscal 2009.
In December 2007, the FASB issued SFAS 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, including the requirement to expense transaction costs and to reflect the fair value of contingent purchase price adjustments at the date of acquisition. In April 2009, the FASB issued SFAS No. 141R-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, (SFAS 141R-1). SFAS 141R-1 amends and clarifies SFAS 141R, to require that an acquirer recognizes at fair value, at the acquisition date, an asset acquired or a liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period. If the acquisition-date fair value of such an asset acquired or liability assumed cannot be determined, the acquirer should apply the provisions of SFAS No. 5, Accounting for Contingencies, to determine whether the contingency should be recognized at the acquisition date or after it. SFAS 141R and SFAS 141R-1 is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is after the beginning of the first annual reporting period beginning after December 15, 2008. We will implement the new standard effective in fiscal 2010. For any acquisitions completed after our fiscal 2009, we expect SFAS 141R-1 will have an impact on our consolidated financial statements; however, the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate.
In December 2007, the FASB issued SFAS 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. We do not believe that the adoption of SFAS 160 will have a material effect on our consolidated financial statements.
In December 2007, Emerging Issues Task Force (EITF) 07-01, Accounting for Collaborative Arrangements (EITF 07-01), 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 do not believe that the adoption of EITF 07-01 will have a material effect on our consolidated financial statements.
In April 2008, the FASB issued FSP No. 142-3, Determination of the Useful Life of Intangible Assets (FSP 142-3). FSP 142-3 revises the factors that should be considered in developing renewal or extension assumptions determining the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. FSP 142-3 will be effective for fiscal years beginning after December 15, 2008. We will implement the new standard effective in fiscal 2010. We are currently assessing the effect of FSP 142-3 on our consolidated financial statements.
In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and must be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1, which is applied retrospectively, is effective for us in fiscal 2010. We are currently assessing the effect of FSP EITF 03-6-1 on our consolidated 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, program management, construction and technical services focusing on resource management, infrastructure and the environment. We serve our clients by providing cost-effective and innovative solutions to fundamental needs for water, environmental and energy services. We typically begin at the earliest stage of a project by applying science to problems and developing solutions tailored to our clients needs and resources. Our solutions may span the entire life cycle of the project and include applied science, research and technology, engineering, design, construction management, construction, operations and maintenance, and information technology.
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. Today we are a full-service company with a global reach in the areas of water programs, environmental management and remediation, energy and supporting infrastructure. We continue to focus on organic and acquisitive growth to expand our geographic reach and increase the breadth and depth of our service offerings to address existing and emerging markets. As of March 2009, we had approximately 10,000 employees worldwide, located primarily in North America.
We derive revenue from fees for professional, technical, project management and construction services. As primarily a service-based company, we are labor-intensive rather than capital-intensive. Our revenue is driven by our ability to attract and retain qualified and productive employees, identify business opportunities, secure new and renew existing client contracts, provide outstanding services to our clients and execute projects successfully.
We provide 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:
In the first quarter of fiscal 2009, we began reporting under four new reportable segments with reclassification of the prior year segment results to conform to the new basis of presentation. Each of the new reportable segments is comprised of similar activities that focus on the services it provides, the markets it serves, the distribution method of its services, its contracting mechanisms, the organization and execution of its projects, the education and discipline of its workforce, and the metrics by which its client projects and staff are measured. In addition, each of our operating groups, which are also our reportable segments, is managed by its own president, who has responsibility for the segments business units. Each president directly reports to our Chief Executive Officer, who is our CODM. The CODM regularly reviews the four reportable segments, allocates resources to these segments and assesses each segments performance. The reportable segments are as follows:
Environmental Consulting Services. ECS provides front-end science and consulting services and project management skills in the areas of water resources, groundwater services, watershed management, mining and geotechnical sciences, environmental management, and information technology and modeling consulting.
Technical Support Services. TSS advises clients, studies, designs and implements projects, and conducts research in the areas of remedial and developmental planning, regulatory consulting, climate change and carbon management services, disaster management, systems test and support services, and program management for complex federal government and international development projects.
Engineering and Architecture Services. EAS provides engineering, architecture, interior and exterior design, LEED, and program administration services for projects that include water and wastewater conveyance and treatment, building construction, land development and transportation services.
Remediation and Construction Management. RCM provides a wide array of services, including program management, engineering, procurement and construction, construction management, and operations and maintenance focused on federal construction, environmental remediation including UXO and wetland restoration, and energy projects including wind, nuclear engineering and other alternative energies, and communications development and construction.
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 when it is our responsibility to procure and manage these activities under a contract. The grants are reported as part of our Subcontractor costs on our condensed consolidated statements of income. Because subcontractor services can change significantly from project to project and from period to period, 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 12 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 the non-contract related portion of stock-based compensation, depreciation of property and equipment, and the full amount of 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:
· General economic or political conditions;
· Unanticipated changes in contract performance that may affect profitability, particularly with contracts that are fixed-price or have funding limits;
· Seasonality of the spending cycle of our public sector clients, notably the U.S. government, the spending patterns of our commercial sector clients, and weather conditions;
· Budget constraints experienced by our federal, 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; and
· Changes in accounting rules.
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 holiday periods. Further, seasonal inclement weather conditions occasionally cause some of our offices to close temporarily or may hamper our project field work. These occurrences result in fewer billable hours worked on projects and, correspondingly, less revenue recognized. Our revenue is typically higher in the second half of the fiscal year, due to favorable weather conditions during spring and summer months that 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.
BUSINESS TREND ANALYSIS
General. Overall, we continued to deliver strong financial results in the second quarter of fiscal 2009, which reflected improvement compared to the same quarter last year. Our performance was driven by our continuing focus on long-term value creation through the execution of our growth strategy. We invested in business development activities to grow our business organically and made strategic acquisitions to enhance our service offerings and further expand our geographical presence. In addition, we continued to implement and enforce project management policies and programs that focus on contract execution and risk management controls. We also focused on cost control and the strategic management of our portfolio of businesses.
Due to the general weakness in the economy, we anticipate that our revenue will grow moderately in fiscal 2009. In addition, we expect that the federal governments stimulus plan contained in the recently enacted American Recovery and Reinvestment Act of 2009 (ARRA), which is intended to create jobs, jump-start the economy and loosen the credit markets, will provide us with additional business opportunities. However, because the timing and magnitude of any potential benefit to our business from the ARRA are uncertain, contributions from the ARRA have not been factored into our outlook or guidance. Furthermore, we expect a continuing period of considerable weakness in the economy even if government stimulus efforts succeed. As such, we recognize that the current economic forces that have severely impacted both the domestic and international economies could affect our future work for the U.S. federal government, state and local government, commercial and international businesses, which constituted approximately 52%, 13%, 30% and 5% of our revenue in the second quarter of fiscal 2009, respectively.
Federal Government. In the second quarter of fiscal 2009, our federal government business grew compared to the same quarter last year. This growth was driven primarily by USAID, the U.S. Department of Energy (DOE), and domestic U.S. Department of Defense (DoD) projects. However, the wind-down of our Iraq-related projects for the DoD largely offset this growth. During periods of economic volatility, our federal government business has historically been the most stable and predictable. Due to the DoDs current funding practices on projects in Iraq and the changing geopolitical landscape in Iraq and the United States, our revenue from federal government projects is anticipated to be flat in fiscal 2009. We have also experienced some delays in existing and near-term projects due to the diversion of attention to ARRA project planning efforts at some federal contracting offices.
State and Local Government. In the second quarter of fiscal 2009, our state and local government business was flat compared to the same quarter last year. This flatness resulted primarily from the economic conditions described below, offset by increased activity on water and environmental projects in several states. Many state and local government agencies are continuing to face challenging economic conditions, including budget deficits, declining tax revenues and difficult cost-cutting decisions. Simultaneously, states are facing major long-term infrastructure needs, including the maintenance, repair and upgrading of existing critical infrastructure and the need to build new facilities. The funding risks associated with our state and local government programs are partially mitigated by the regulatory requirements driving some of these programs, such as regulatory-mandated consent decrees, as well as demographic shifts and increasing demand for water and wastewater services. As a result, some programs will generally progress despite budget pressures, and we anticipate that infrastructure projects, especially those focused on the need for demand-driven water resource requirements, will be initiated and funded in fiscal 2009. However, due to the economic weakness across most states, we expect that our state and local government revenue will decline moderately in fiscal 2009. We will remain vigilant in monitoring and evaluating state and local government budgets, and will continue to assess any potential impact on our state and local government business, including the potential uncertainty of our clients ability to sell their infrastructure bonds and/or fund their ongoing operating requirements.
Commercial. In the second quarter of fiscal 2009, our commercial business experienced strong growth compared to the same quarter last year. This growth was driven by increased demand for our wind and other alternative energy services, as well as water programs. To a lesser extent, our growth was attributable to environmental engineering and development projects. We anticipate that our commercial business will experience strong growth in fiscal 2009 compared to fiscal 2008 due to our backlog for wind and other alternative energy services, as well as water programs. We also anticipate some growth in the transmission requirements for renewable energy sources. However, we may experience lower revenue than anticipated if planned alternative energy projects are delayed or cancelled due to declining energy prices or other reasons. Additionally, due to the current economic conditions, we will most likely experience project delays and reduced workload related to our real estate development and mining and industrial sectors during the remainder of fiscal 2009.
International. In the second quarter of fiscal 2009, we expanded our international presence through the acquisition of Wardrop, which specializes in resource management, energy and infrastructure design for commercial clients throughout Canada and elsewhere worldwide. As a result of this acquisition, we anticipate that our international business will experience significant growth in fiscal 2009 compared to fiscal 2008. However, as with the U.S. commercial business, global economic weakness could result in lower revenue than anticipated if planned mining or energy projects are delayed or cancelled due to declining commodity or energy prices.
We continuously evaluate the marketplace for strategic acquisition opportunities. Due to our reputation, size, financial resources, geographic presence and range of services, we have numerous opportunities to acquire both privately held companies and subsidiaries of publicly held companies. During our evaluation, we examine the effect an acquisition may have on our long-range business strategy and results of operations. Generally, we proceed with an acquisition if we believe that it would have a positive effect on future operations and could strategically expand our service offerings. As successful integration and implementation are essential to achieving favorable results, no assurance can be given that all acquisitions will provide accretive results. Our strategy is to position ourselves to address existing and emerging markets. We view acquisitions as a key component of our growth strategy, and we
intend to use 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 ability to achieve our strategic goals, provide critical mass with existing clients and further expand our lines of service. Because we typically acquire service businesses with limited tangible assets, our acquisitions generally result in recognition of goodwill and other identifiable intangible assets.
In the second quarter of fiscal 2009, we acquired Wardrop, a Canadian firm that specializes in resource management, energy and infrastructure design and is included in our ECS segment. This acquisition significantly expands our worldwide presence, adding 13 offices throughout Canada and offices in the United Kingdom and India. During the first half of fiscal 2009, we made other acquisitions in the TSS segment that expand our service offerings to USAID, and in the ECS segment that broaden our energy services to the federal government and commercial clients.
RESULTS OF OPERATIONS
Overall, our results for the second quarter of fiscal 2009 improved 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. Our business continued to experience revenue growth organically and from acquisitions. The organic growth was driven primarily by demand in our commercial business for wind energy and water programs. Our federal government business also grew due primarily to increased activity on BRAC and USAID contracts, largely offset by the wind-down and completion of reconstruction and UXO projects in Iraq.
The following table presents the percentage relationship of certain items to revenue, net of subcontractor costs:
For the three and six months ended March 29, 2009, revenue increased $60.9 million, or 13.2%, and $229.2 million, or 24.6%, compared to the same periods last year, respectively. For both periods, we experienced revenue growth in our commercial business due primarily to demand for our wind energy and water programs, our international business resulting from our Wardrop acquisition, and our federal government business driven primarily by increased activity on BRAC and USAID programs, largely offset by the wind-down and completion of Iraq-related projects. For the six-month period, the growth was partially offset by revenue declines from our state and local government clients due to budget and spending constraints as well as the completion of several large contracts.
For the three and six months ended March 29, 2009, revenue, net of subcontractor costs, increased $44.9 million, or 15.6%, and $97.7 million, or 17.3%, compared to the same periods last year, respectively, for the reasons described above. The growth rates deviated from our revenue growth due to contract mix as subcontractor services can change significantly from project to project and from period to period. More specifically, the level of our subcontracting activities declined for the three-month period due to the wind-down and completion of Iraq-related contracts, which were subcontracted in large part to local Iraqis. Overall, our subcontracting activities remain high due to wind energy and BRAC programs. Further, our program management activities on federal government contracts typically result in higher levels of subcontracting activities that are partially driven by government-mandated small business set-aside requirements.
For the three and six months ended March 29, 2009, other contract costs increased $36.3 million, or 15.8%, and $81.1 million, or 18.0%, compared to the same periods last year, respectively. The cost increase tracked our increase in revenue, net of subcontractor costs. For the three and six months ended March 29, 2009, as a percentage of revenue, net of subcontractor costs, other contract costs were 80.0% and 80.3%, compared to 79.9% and 79.8% for the same periods last year, respectively. The slight percentage increase resulted from increased costs related to regulatory and project delays, subcontractor issues and project start-up costs. In addition, we recorded provisions for losses on accounts receivable in certain commercial markets due to the continuing economic slowdown.
For the three and six months ended March 29, 2009, gross profit increased $8.6 million, or 14.8%, and $16.6 million, or 14.6%, compared to the same periods last year, respectively, for the reasons described above. For the three and six months ended March 29, 2009, as a percentage of revenue, net of subcontractor costs, gross profit was 20.0% and 19.7%, compared to 20.1% and 20.2% for the same periods last year, respectively. The percentage decrease resulted from the cost increases noted above, partially mitigated by favorable claim settlements and higher profit margins on certain wind energy, water, telecommunication and international development projects.
For the three and six months ended March 29, 2009, SG&A expenses increased $5.6 million, or 16.9%, and $7.7 million, or 11.6%, compared to the same periods last year, respectively. The increase resulted from our business growth, including the additional amortization expense of intangible assets related to our recent acquisitions and higher business development activities. For the three and six months ended March 29, 2009, as a percentage of revenue, net of subcontractor costs, SG&A expenses were 11.6% and 11.2%, compared to 11.5% and 11.8% for the same periods last year, respectively.
For the three and six months ended March 29, 2009, net interest expense decreased $0.6 million, or 41.5%, and $0.3 million, or 16.4%, compared to the same periods last year, respectively. The decrease resulted from lower interest expense on our borrowings due to lower interest rates, partially offset by lower interest income from short-term cash investments also due to lower interest rates.
For the three and six months ended March 29, 2009, income tax expense decreased $1.9 million, or 20.0%, and increased $0.3 million, or 1.6%, compared to the same periods last year, respectively. Our effective tax rates were 35.0% and 41.5% for the first half of fiscal years 2009 and 2008, respectively. The lower effective tax rate resulted from a tax settlement with the IRS related to R&E Credits and an approved tax accounting method change for revenue recognition.
Additional Information by Reportable Segment
Environmental Consulting Services