UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

 

FORM 10-Q

 

(Mark One)

 

 

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 )

 

(626) 351-4664

(Registrant’s 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  ý   No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  ý   No  o

 

As of May 5, 2004, 55,892,846 shares of the registrant’s common stock were outstanding.

 

 

TETRA TECH, INC.

 

INDEX

 

PART I.		FINANCIAL INFORMATION
	Item 1.	Financial Statements
			Condensed Consolidated Balance Sheets
			Condensed Consolidated Statements of Operations
			Condensed Consolidated Statements of Cash Flows
			Notes to Condensed Consolidated Financial Statements
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk
	Item 4.	Controls and Procedures
PART II.		OTHER INFORMATION
	Item 1.	Legal Proceedings
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES

 

2

 

PART I.                 FINANCIAL INFORMATION

 

Item 1.            Financial Statements

 

Tetra Tech, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except par value)

 

		March 28, 2004			September 28, 2003
		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	34,656		$	33,164
Accounts receivable – net		175,814			167,717
Unbilled receivables – net		183,597			164,818
Contract retentions		4,757			4,286
Prepaid expenses and other current assets		23,929			26,037
Income taxes receivable		31,158			20,825
Total current assets		453,911			416,847
PROPERTY AND EQUIPMENT:
Equipment, furniture and fixtures		85,531			84,133
Leasehold improvements		10,757			10,123
Total		96,288			94,256
Accumulated depreciation and amortization		(57,182		)	(53,469		)
PROPERTY AND EQUIPMENT – NET		39,106			40,787
GOODWILL		253,045			210,792
INTANGIBLE AND OTHER ASSETS – NET		26,617			25,054
TOTAL ASSETS		$	772,679		$	693,480
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	92,541		$	93,265
Accrued compensation		44,024			46,743
Billings in excess of costs on uncompleted contracts		17,944			16,307
Other current liabilities		28,162			26,562
Deferred income taxes		29,105			28,992
Current portion of long-term obligations		55,006			11,597
Total current liabilities		266,782			223,466
LONG-TERM OBLIGATIONS		108,278			107,463
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Preferred stock – authorized 2,000 shares of $0.01 par value; no shares issued and outstanding at March 28, 2004 and September 28, 2003		—			—
Exchangeable stock of a subsidiary		13,238			13,239
Common stock – authorized, 85,000 shares of $0.01 par value; issued and outstanding, 54,868 and 54,090 shares at March 28, 2004 and September 28, 2003, respectively		549			541
Additional paid-in capital		225,757			216,908
Accumulated other comprehensive loss		(146		)	(387		)
Retained earnings		158,221			132,250
TOTAL STOCKHOLDERS’ EQUITY		397,619			362,551
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	772,679		$	693,480

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3

 

Tetra Tech, Inc.

Condensed Consolidated Statements of Operations

(unaudited – in thousands, except per share data)

 

		Three Months Ended						Six Months Ended
		March 28, 2004			March 30, 2003			March 28, 2004			March 30, 2003
Revenue		$	331,395		$	245,464		$	668,497		$	478,544
Subcontractor costs		88,577			52,594			183,974			104,692
Revenue, net of subcontractor costs		242,818			192,870			484,523			373,852
Other contract costs		194,701			151,075			388,547			294,449
Gross profit		48,117			41,795			95,976			79,403
Selling, general and administrative expenses		24,152			20,471			48,070			40,956
Income from operations		23,965			21,324			47,906			38,447
Interest expense – net		2,249			2,281			4,621			4,173
Income before income tax expense		21,716			19,043			43,285			34,274
Income tax expense		8,687			7,618			17,314			13,710
Income before cumulative effect of accounting change		13,029			11,425			25,971			20,564
Cumulative effect of accounting change		—			—			—			(114,669		)
Net income (loss)		$	13,029		$	11,425		$	25,971		$	(94,105	)
Basic earnings (loss) per share: (1)
Income before cumulative effect of accounting change		$	0.23		$	0.21		$	0.47		$	0.38
Cumulative effect of accounting change		—			—			—			(2.10		)
Net income (loss)		$	0.23		$	0.21		$	0.47		$	(1.72	)
Diluted earnings (loss) per share:
Income before cumulative effect of accounting change		$	0.23		$	0.21		$	0.45		$	0.37
Cumulative effect of accounting change		—			—			—			(2.07		)
Net income (loss)		$	0.23		$	0.21		$	0.45		$	(1.70	)
Weighted average common shares outstanding:
Basic (1)		55,885			54,608			55,695			54,565
Diluted		57,465			55,419			57,430			55,212

 

(1)           Basic earnings (loss) per share and basic weighted average common shares outstanding have been restated for the periods ended March 30, 2003.  See Note 4 for additional information.

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4

 

Tetra Tech, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited – in thousands)

 

		Six Months Ended
		March 28, 2004			March 30, 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	25,971		$	(94,105	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Cumulative effect of accounting change		—			114,669
Depreciation and amortization		8,823			6,783
Deferred income taxes		113			—
Provision for losses on receivables		2,335			1,853
Loss on disposal of property and equipment		704			—
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable		(9,208		)	4,942
Unbilled receivables		(16,950		)	(12,770		)
Contract retentions		(471		)	329
Prepaid expenses and other assets		782			(2,733		)
Accounts payable		(10,257		)	(21,022		)
Accrued compensation		(4,020		)	(2,603		)
Billings in excess of costs on uncompleted contracts		1,637			528
Other current liabilities		(1,508		)	2,746
Income taxes receivable		(8,151		)	(8,050		)
Net cash used in operating activities		(10,200		)	(9,433		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(7,212		)	(4,000		)
Payments for business acquisitions, net of cash acquired		(31,371		)	(72,193		)
Proceeds on sale of property and equipment		901			—
Net cash used in investing activities		(37,682		)	(76,193		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term obligations		(43,100		)	(5,575		)
Proceeds from borrowings under long-term obligations		87,324			65,000
Net proceeds from issuance of common stock		5,063			675
Net cash provided by financing activities		49,287			60,100
EFFECT OF EXCHANGE RATE CHANGES ON CASH		87			592
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		1,492			(24,934		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		33,164			46,345
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	34,656		$	21,411
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	4,818		$	4,319
Income taxes, net of refunds received		$	24,992		$	22,140
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:
In March 2004, the Company purchased all of the capital stock of Advanced Management Technology, Inc.  In conjunction with this acquisition, liabilities were assumed as follows:
Fair value of assets acquired		$	43,900
Cash paid		(31,371		)
Purchase price receivable		800
Other acquisition costs		(600		)
Liabilities assumed		$	12,729
In March 2003, the Company’s subsidiary, Tetra Tech FW, Inc., purchased certain assets and assumed certain liabilities of Foster Wheeler Environmental Corporation and Hartman Consulting Corporation.  In conjunction with this acquisition, liabilities were assumed as follows:
Fair value of assets acquired					$	108,105
Cash paid					(72,072		)
Purchase price receivable					4,838
Other acquisition costs					(555		)
Liabilities assumed					$	40,316

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5

 

TETRA TECH, INC.

 

Notes To Condensed Consolidated Financial Statements

 

1.             Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of March 28, 2004, the condensed consolidated statements of operations for the three and six months ended March 28, 2004 and March 30, 2003, and the condensed consolidated statements of cash flows for the six months ended March 28, 2004 and March 30, 2003 of Tetra Tech, Inc. (the “Company”) are unaudited, and, in the opinion of management, include all adjustments, consisting of normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented.

 

The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 28, 2003.

 

The results of operations for the three and six months ended March 28, 2004 are not necessarily indicative of the results to be expected for the fiscal year ending October 3, 2004.

 

The Company’s previous financial statement captions for “Gross revenue,” “Net revenue” and “Cost of net revenue” are now referred to as “Revenue,” “Revenue, net of subcontractor costs” and “Other contract costs,” respectively.  This change has not affected the respective amounts or the methodology used to calculate these amounts.

 

2.             Goodwill and Acquired Intangibles

 

Effective September 30, 2002, the Company adopted the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets.  This Statement changed the accounting method for goodwill and indefinite-lived intangible assets from an amortization approach to an impairment-only approach.  As a result of the adoption of SFAS No. 142, the Company recorded a transitional goodwill impairment charge of $114.7 million presented as a cumulative effect of accounting change in the second quarter of fiscal 2003 and reclassified into the first quarter of fiscal 2003 for the current year presentation.  This charge related to the Company’s communications unit, which is part of the infrastructure segment.

 

The SFAS No. 142 goodwill impairment model is a two-step process.  First, it requires a comparison of the book value of net assets to the fair value of the related operations that have goodwill assigned to them.  The Company estimates the fair values of the related operations using a combination of discounted cash flows, peer company comparables and similar transactions in the marketplace.  The cash flow forecasts are adjusted by an appropriate discount rate.  If the fair value is determined to be less than book value, a second step is performed to compute the amount of the impairment.  In this process, an implied fair value for goodwill is estimated, based on the fair value of the operations used in the first step, and is compared to its

 

6

 

carrying value.  The shortfall of the fair value below carrying value represents the amount of goodwill impairment.  SFAS No. 142 requires goodwill to be tested for impairment annually at the same time every year, and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist.

 

The changes in the carrying value of goodwill by segment for the six months ended March 28, 2004 were as follows:

 

		September 28, 2003			Goodwill Additions			Post-Acquisition Adjustments			March 28, 2004
		(in thousands)
Reporting Unit
Resource management		$	84,141		$	—		$	1,870		$	86,011
Infrastructure		126,651			40,383			—			167,034
Total		$	210,792		$	40,383		$	1,870		$	253,045

 

The goodwill addition of $40.4 million resulted from the acquisition of Advanced Management Technology, Inc. in March 2004.  The post-acquisition adjustment of the $1.9 million related to purchase allocation adjustments made during the first year after the acquisition of assets by Tetra Tech FW, Inc.  See Note 7 for additional information.

 

The gross carrying amounts and accumulated amortization of the Company’s acquired identifiable intangible assets with finite useful lives as of March 28, 2004 and September 28, 2003, included in Intangible and other assets – net in the accompanying Condensed Consolidated Balance Sheets, were as follows:

 

		March 28, 2004						September 28, 2003
		Carrying Amounts			Accumulated Amortization			Carrying Amounts			Accumulated Amortization
		(in thousands)
Identifiable Intangible Assets
Backlog		$	11,842		$	(2,472	)	$	11,125		$	(1,392	)
Non-compete agreements		450			(437		)	450			(435		)
Software		25			(25		)	25			(19		)
Other		—			—			41			(41		)
Total		$	12,317		$	(2,934	)	$	11,641		$	(1,887	)

 

Identifiable intangible assets acquired during the quarter ended March 28, 2004 consisted of backlog of $0.7 million with an amortization period of one year.  Amortization expense for acquired intangible assets with finite useful lives for the six months ended March 28, 2004 and March 30, 2003 were $1.1 million and $0.3 million, respectively.  Estimated amortization expense for the remainder of fiscal 2004 and for the succeeding five years is as follows:

 

7

 

 

3.             Accounting Pronouncements

 

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities.  FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003.  It applies in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities considered to be a special purpose entity (SPE) in which an enterprise holds a variable interest that it acquired before February 1, 2003.  For non-SPE variable interest entities acquired before February 1, 2003, the interpretation must be adopted no later than the first interim or annual period ending after March 15, 2004.  The Company does not have any SPEs and does not have any variable interest entities required to be accounted for under FIN 46.

 

In March 2004, the Emerging Issues Task Force (EITF) reached a final consensus on EITF Issue 03-06, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per Share.  This EITF significantly expands the notion of participating securities that must be included in the basic earnings per share calculation.  Rather than focusing on the security holder’s contractual rights to ultimately receive the undistributed earnings and net assets of the company upon redemption or liquidation, Issue 03-06 defines participation rights based solely on whether the holder would be entitled to receive any dividends if the entity declared them during the period.  The consensus also nullifies the guidance in EITF Topic No. D-95, Effect of Participating Convertible Securities on the Computation of Basic Earnings per Share, by requiring the use of the two-class method of computing basic EPS when participating convertible securities exist.  The EITF is effective for the Company beginning with the quarter ending June 27, 2004.  The Company does not expect that the EITF will have any impact on its basic earnings per share calculation.

 

4.             Earnings Per Share

 

Basic earnings per share (EPS) excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares and the weighted average number of shares of exchangeable stock of a subsidiary (exchangeable shares) outstanding for the period.  Diluted EPS is computed by dividing net income by the weighted average number of common shares outstanding, the weighted average number of exchangeable shares, and dilutive potential common shares for the period.  The Company includes as potential

 

8

 

common shares the weighted average dilutive effects of outstanding stock options using the treasury stock method.  The exchangeable shares are non-voting and are exchangeable on a one-to-one basis, as adjusted for stock splits and stock dividends subsequent to the original issuance, for the Company’s common stock.  The following table sets forth the number of weighted average shares used to compute basic and diluted EPS:

 

		Three Months Ended						Six Months Ended
		March 28, 2004			March 30, 2003			March 28, 2004			March 30, 2003
		(in thousands, except per share data)
Numerator:
Income before cumulative effect of accounting change		$	13,029		$	11,425		$	25,971		$	20,564
Net income (loss)		$	13,029		$	11,425		$	25,971		$	(94,105	)
Denominator for basic earnings per share:
Weighted average shares		54,774			53,373			54,522			53,330
Exchangeable stock of subsidiary		1,111			1,235		(1)	1,173			1,235		(1)
Denominator for basic earnings per share		55,885			54,608		(1)	55,695			54,565		(1)
Denominator for diluted earnings per share:
Denominator for basic earnings per share		55,885			54,608			55,695			54,565
Potential common shares:
Stock options		1,580			811			1,735			647
Denominator for diluted earnings per share		57,465			55,419			57,430			55,212
Earnings per share before cumulative effect of accounting change:
Basic		$	0.23		$	0.21	(1)	$	0.47		$	0.38	(1)
Diluted		$	0.23		$	0.21		$	0.45		$	0.37
Earnings (loss) per share:
Basic		$	0.23		$	0.21	(1)	$	0.47		$	(1.72)	(1)
Diluted		$	0.23		$	0.21		$	0.45		$	(1.70)

 

(1)           The denominator for basic earnings per share and earnings (loss) per share and basic earnings per share before cumulative effect of accounting change have been restated for the three and six months ended March 30, 2003 to include 1,235,000 shares of exchangeable stock of a subsidiary.  These shares are exchangeable for shares of the Company’s common stock and would participate in any dividend paid by the Company.  Previously, the exchangeable shares were included in the denominator for diluted earnings per share, but not basic earnings per share.  In accordance with Emerging Issues Task Force Topic No. D-95, Effect on Participating Convertible Securities on the Computation of Basic Earnings per Share, the exchangeable shares are considered participating shares and, as they are convertible into common stock, must be included in the denominator of the basic earnings per share calculation under the “if converted” method.  This change results in no impact to either of the previously reported basic earnings per share before cumulative effect of accounting change or the basic earnings per share for the three months ended March 30, 2003.  However, for the six months ended March 30, 2003, it results in decreases of $0.01 to previously reported basic earnings per share before cumulative effect of accounting change and $0.04 to previously reported basic loss per share.

 

For the three and six months ended March 28, 2004, 0.9 million and 0.6 million options were excluded from the calculation of diluted potential common shares, respectively.  For the three and six months ended March 30, 2003, 2.9 million and 3.2 million options were excluded

 

9

 

from the calculation of diluted potential common shares, respectively.  For each period, options were excluded because their exercise prices exceeded the average market price for that period.

 

5.             Stock-Based Compensation

 

The Company’s employee stock compensation plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations.  Under this method, no compensation expense is recognized as long as the exercise price equals or exceeds the market price of the underlying stock on the date of the grant.  All non-employee stock-based awards are accounted for at fair value and recorded as compensation expense over the period of service in accordance with SFAS No. 123, Accounting for Stock-Based Compensation and related interpretations.

 

The Company has adopted the disclosure-only provisions of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment of SFAS No. 123.  The following pro forma information regarding net income has been calculated as if the Company had accounted for its employee stock options and stock purchase plan using the fair value method under SFAS No. 123:

 

		Three Months Ended						Six Months Ended
		March 28, 2004			March 30, 2003			March 28, 2004			March 30, 2003
		(in thousands, except per share data)
Net income (loss), as reported		$	13,029		$	11,425		$	25,971		$	(94,105	)
Deduct:  Stock-based employee compensation expense determined under fair value based method for all awards, net of related income tax effects		1,857			1,440			2,873			2,363
Pro forma net income (loss)		$	11,172		$	9,985		$	23,098		$	(94,468	)
Earnings (loss) per share:
Basic – as reported		$	0.23		$	0.21		$	0.47		$	(1.72	)
Basic – pro forma		$	0.20		$	0.18		$	0.41		$	(1.77	)
Diluted – as reported		$	0.23		$	0.21		$	0.45		$	(1.70	)
Diluted – pro forma		$	0.19		$	0.18		$	0.40		$	(1.75	)

 

6.             Cash and Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.  Cash and cash equivalents totaled $34.7 million and $33.2 million for the periods ended March 28, 2004 and September 28, 2003, respectively.

 

10

 

7.             Mergers and Acquisitions

 

On March 7, 2003, the Company acquired through its wholly-owned subsidiary, Tetra Tech FW, Inc. (FWI), certain assets and certain related liabilities of Foster Wheeler Environmental Corporation and Hartman Consulting Corporation, providers of engineering and program management services throughout the United States.  The purchase was valued at approximately $68.1 million and consisted of cash.  The final allocation of purchase price for FWI was adjusted in the second quarter of fiscal 2004, and resulted in a goodwill adjustment of $1.9 million.  The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition:

 

 

On July 31, 2003, the Company acquired 100% of the capital stock of Engineering Management Concepts, Inc. (EMC), an engineering and program management firm that provides information technology and weapons test range and systems logistic support services.  The purchase was valued at approximately $19.0 million, consisted of cash and is subject to a purchase price adjustment based upon the final determination of EMC’s net asset value as of July 31, 2003.  In addition, the former shareholders of EMC have certain earn-out rights that would allow them to receive an aggregate maximum of $2 million upon EMC’s achievement of certain operating profit objectives over a two-year period.  The acquisition resulted in estimated goodwill of $14.9 million.

 

On March 5, 2004, the Company acquired 100% of the capital stock of Advanced Management Technology, Inc. (AMT), an engineering and program management firm that provides systems engineering, program management and information management services to federal government agencies.  The purchase was valued at approximately $31.2 million, consisted of cash and is subject to a purchase price adjustment based upon the final determination of AMT’s net asset value as of March 5, 2004.  Further, the former shareholders of AMT retained the right to receive proceeds from approximately $18.6 million in AMT accounts receivable as these proceeds are collected.  In addition, the former shareholders have certain earn-out rights that would allow them to receive an aggregate maximum of $5 million upon AMT’s achievement of certain operating profit objectives over a two-year period.  The acquisition resulted in estimated goodwill of $40.4 million.

 

All of the acquisitions above were accounted for as purchases and, accordingly, the purchase prices of the businesses acquired were allocated to the assets and liabilities acquired based upon their fair values.  The excess of the purchase cost of the acquisitions over the fair value of the net tangible and identifiable intangible assets acquired was recorded as goodwill and

 

11

 

is included in Goodwill in the accompanying Condensed Consolidated Balance Sheets.  The results of operations of each of the companies acquired have been included in the Company’s financial statements from the dates of acquisition.

 

The table below presents summarized pro forma operating results assuming that the Company had acquired FWI, EMC and AMT at the beginning of the six-month periods presented.  These amounts are based on historical results and assumptions and estimates which the Company believes to be reasonable.  The pro forma results do not reflect anticipated cost savings and do not represent results that would have occurred if these acquisitions had actually taken place at the beginning of respective periods.

 

		Pro Forma Six Months Ended
		March 28, 2004			March 30, 2003
		(in thousands, except per share data)
Revenue		$	706,815		$	707,757
Revenue, net of subcontractor costs		508,619			504,952
Income from operations		49,329			47,524
Income before cumulative effect of accounting change		26,610			25,355
Cumulative effect of accounting change		—			(114,669		)
Net income (loss)		26,610			(89,314		)
Earnings per share before cumulative effect of accounting change:
Basic		$	0.48		$	0.46
Diluted		$	0.46		$	0.46
Earnings (loss) per share:
Basic		$	0.48		$	(1.64	)
Diluted		$	0.46		$	(1.62	)
Weighted average shares outstanding:
Basic		55,695			54,565
Diluted		57,430			55,212

 

8.             Accounts Receivable and Unbilled Receivables

 

Accounts receivable and unbilled receivables are presented net of allowances for doubtful accounts and for the potential disallowance of billed and unbilled costs.  The allowance for doubtful accounts as of March 28, 2004 and September 28, 2003 was $14.0 million and $14.1 million, respectively.  The allowance for disallowed costs as of March 28, 2004 and September 28, 2003 was $2.3 million and $1.7 million, respectively.  Disallowance of billed and unbilled costs is primarily associated with contracts with the federal government which contain clauses that subject contractors to several levels of audit.  The Company establishes reserves on contract receivables when collectibility is doubtful plus an allowance for which some potential loss is determined to be probable and estimatable based upon current events and circumstances, and past history.  Management believes that resolution of these matters will not have a material adverse impact on the Company’s financial position or results of operations.

 

12

 

A significant portion of the growth in accounts receivable results from the Company’s contract with Nextel Operations, Inc. (Nextel).  This client accounted for approximately 16% of the Company’s total gross billed and unbilled receivables as of March 28, 2004, as compared to approximately 10% as of September 28, 2003.  Under the Nextel contract, the Company is unable to bill for its services until certain milestones are reached.  Accordingly, increased working capital was required to finance the growth in accounts receivable as the Company’s services increased under the contract.  In March 2004, the Company and Nextel agreed to amend their contract to provide for accelerated payments based on milestone changes and increased pricing for certain of its services.

 

9.             Operating Segments

 

The Company’s management has organized and managed its operations in two operating segments: resource management and infrastructure.  The resource management operating segment provides engineering and consulting services relating primarily to water quality and availability, environmental restoration, productive reuse of defense facilities and strategic environmental resource planning to both public and private organizations. The infrastructure operating segment provides engineering and program management services for the additional development, as well as the upgrading and replacement, of existing civil, communications and security infrastructure to both public and private organizations.  Management has established these operating segments based upon the services provided, the different marketing strategies associated with the services and the specialized needs of their respective clients.

 

The Company accounts 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.  Management evaluates the performance of these operating segments based upon their respective income from operations before the effect of any acquisition-related amortization.  All inter-company balances and transactions are eliminated in consolidation.

 

The following tables set forth summarized financial information concerning the Company’s reportable segments:

 

13

 

Reportable Segments (in thousands):

 

		Resource Management			Infrastructure			Total
Three months ended March 28, 2004
Revenue		$	204,655		$	136,414		$	341,069
Revenue, net of subcontractor costs		141,661			99,173			240,834
Gross profit		31,040			16,992			48,032
Segment income from operations		18,429			6,985			25,414
Depreciation expense		1,684			1,804			3,488
Three months ended March 30, 2003
Revenue		$	145,927		$	106,800		$	252,727
Revenue, net of subcontractor costs		105,282			86,029			191,311
Gross profit		21,254			20,505			41,759
Segment income from operations		10,333			9,796			20,129
Depreciation expense		1,232			1,920			3,152
Six months ended March 28, 2004
Revenue		$	417,113		$	266,110		$	683,223
Revenue, net of subcontractor costs		284,350			196,352			480,702
Gross profit		58,086			37,607			95,693
Segment income from operations		32,821			16,749			49,570
Depreciation expense		3,402			3,715			7,117
Six months ended March 30, 2003
Revenue		$	268,612		$	221,507		$	490,119
Revenue, net of subcontractor costs		196,830			173,829			370,659
Gross profit		39,595			39,729			79,324
Segment income from operations		20,474			16,962			37,436
Depreciation expense		2,142			4,025			6,167

 

14

 

Reconciliations (in thousands):

 

		Three Months Ended
		March 28, 2004			March 30, 2003
Revenue
Revenue from reportable segments		$	341,069		$	252,727
Elimination of inter-segment revenue		(11,658		)	(8,822		)
Other revenue		1,984			1,559
Total consolidated revenue		$	331,395		$	245,464
Revenue, net of subcontractor costs
Revenue, net of subcontractor costs from reportable segments		$	240,834		$	191,311
Other revenue		1,984			1,559
Total consolidated revenue, net of subcontractor costs		$	242,818		$	192,870
Gross profit
Gross profit from reportable segments		$	48,032		$	41,759
Other		85			36
Total consolidated gross profit		$	48,117		$	41,795
Income from operations
Segment income from operations		$	25,414		$	20,129
Other income (expense)		(888		)	1,376
Amortization of intangibles		(561		)	(181		)
Total consolidated income from operations		$	23,965		$	21,324

 

 

		Six Months Ended
		March 28, 2004			March 30, 2003
Revenue
Revenue from reportable segments		$	683,223		$	490,119
Elimination of inter-segment revenue		(18,547		)	(14,768		)
Other revenue		3,821			3,193
Total consolidated revenue		$	668,497		$	478,544
Revenue, net of subcontractor costs
Revenue, net of subcontractor costs from reportable segments		$	480,702		$	370,659
Other revenue		3,821			3,193
Total consolidated revenue, net of subcontractor costs		$	484,523		$	373,852
Gross profit
Gross profit from reportable segments		$	95,693		$	79,324
Other		283			79
Total consolidated gross profit		$	95,976		$	79,403
Income from operations
Segment income from operations		$	49,570		$	37,436
Other income (expense)		(577		)	1,327
Amortization of intangibles		(1,087		)	(316		)
Total consolidated income from operations		$	47,906		$	38,447

 

15

 

Major Clients:

 

The Company’s revenue from the federal government was approximately $150.4 million and $76.0 million for the three months ended March 28, 2004 and March 30, 2003, respectively. Revenue from the federal government was approximately $297.5 million and $136.4 million for the six months ended March 28, 2004 and March 30, 2003, respectively.  Both the resource management and infrastructure operating segments report revenue from the federal government.  For the three months ended March 28, 2004, the Company generated approximately 15% and 10% of its revenue from the U.S. Army Corps of Engineers and the U.S. Navy, respectively.  For the six months ended March 28, 2004, the Company generated approximately 9% and 10% of its revenue from the U.S. Army Corps of Engineers and U.S. Navy, respectively.  For the three and six months ended March 30, 2003, no single client accounted for more than 10% of the Company’s revenue.

 

The Company’s revenue, net of subcontractor costs, from the federal government was approximately $101.9 million and $53.6 million for the three months ended March 28, 2004 and March 30, 2003, respectively.  Revenue, net of subcontractor costs, from the federal government was approximately $201.0 million and $97.3 million for the six months ended March 28, 2004 and March 30, 2003, respectively.  Both the resource management and infrastructure operating segments report revenue from the federal government.  For the three and six months ended March 28, 2004, the U.S. Army Corps of Engineers and the U.S. Navy each accounted for approximately 10% of revenue, net of subcontractor costs.  For the three and six months ended March 30, 2003, no single client accounted for more than 10% of the Company’s revenue, net of subcontractor costs.

 

10.          Comprehensive Income

 

Comprehensive income is the change in equity of a business enterprise during a period that is not the result of transactions with owners.  The Company includes two components in its 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 the Company’s reporting currency.  Comprehensive income was $12.9 million and $11.9 million for the three months ended March 28, 2004 and March 30, 2003, respectively.  Comprehensive income was $26.2 million for the six months ended March 28, 2004.  Comprehensive loss was $93.5 million for the six months ended March 30, 2003.  For the three months ended March 28, 2004, the Company realized net translation loss of $0.1 million.  For the three months ended March 30, 2003, the Company realized net translation gain of $0.5 million.  For the six months ended March 28, 2004 and March 30, 2003, the Company realized net translation gain of $0.2 million and $0.6 million, respectively.

 

16

 

11.          Litigation

 

The Company is subject to certain claims and lawsuits typically filed against the engineering and consulting profession, alleging primarily professional errors or omissions.  The Company carries professional liability insurance, subject to certain deductibles and policy limits, against such claims.  Management’s opinion is that the resolution of these claims will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

On December 2, 2002, a jury in Washington County Court in Bartlesville, Oklahoma handed down a $4.1 million verdict against the Company in a contract dispute with Horsehead Industries, Inc., doing business as Zinc Corporation of America.  The Company has filed an appeal with respect to the verdict and the associated legal fees, and is also pursuing other legal alternatives related to the case.  The Company established a $4.1 million reserve for this matter in selling, general and administrative expenses in the Condensed Consolidated Statement of Operations for the year ended September 29, 2002.

 

17

 

Item 2.            Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding future events and our future results that are subject to the safe harbor provisions created under the Securities Act of 1933 and the Securities Exchange Act of 1934.  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.  Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements.  Readers are referred to the risks and uncertainties identified below, under “Risk Factors,” and elsewhere herein.  We undertake no obligation to revise or update any forward-looking statements for any reason.

 

Overview

 

Tetra Tech, Inc. is a leading provider of consulting, engineering and technical services in the areas of resource management and infrastructure.  As a consultant, we assist our clients in defining problems and developing innovative and cost-effective solutions.  These services span the lifecycle of a project and include research and development, applied science and technology, engineering design, construction management, and operations and maintenance.  Our clients include a diverse base of government and commercial organizations located in the United States and, to a lesser extent, internationally.

 

Since our initial public offering in December 1991, we have increased the size and scope of our business and have expanded our service offerings through a series of strategic acquisitions and internal growth.  As of March 28, 2004, we had more than 8,000 full-time equivalent employees worldwide, located primarily in North America in more than 345 locations.

 

We derive our revenue from fees from professional services.  Our services are billed under various types of contracts with our clients, including fixed-price, time-and-materials, and cost-plus contracts.  In the second quarter of fiscal 2004, 35.0%, 40.6% and 24.4% of our revenue, net of subcontractor costs, was derived from fixed-price, time-and-materials and cost-plus contracts, respectively; while in the second quarter of fiscal 2003, 41.9%, 39.3% and 18.8% of our revenue, net of subcontractor costs, was derived from these types of contracts, respectively.  For the six months ended March 28, 2004, 34.6%, 41.6% and 23.8% of our revenue, net of subcontractor costs, was derived from fixed-price, time-and-materials and

 

18

 

cost-plus contracts, respectively; while for the six months ended March 30, 2003, 40.7%, 41.3% and 18.0% of our revenue, net of subcontractor costs, was derived from these types of contracts, respectively.

 

Contract revenue and contract costs are recorded primarily using the percentage-of-completion (cost-to-cost) method.  Under this method, revenue on long-term contracts is recognized in the ratio that contract costs incurred bear to total estimated costs.  Revenue and profit on long-term contracts are subject to revision throughout the lives 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.  We do not have any material loss contracts at this time.

 

In the course of providing our services, we routinely subcontract services. These subcontractor costs are passed through to our clients and, in accordance with industry practice and generally accepted accounting principles, are included in revenue.  Because subcontractor services can change significantly from project to project, changes in revenue may not be indicative of business trends.  Accordingly, we also report revenue, net of subcontractor costs, which is 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 baseline.

 

For analytical purposes only, we segregate from our revenue, net of subcontractor costs, the revenue derived from companies acquired during the current year, as well as the revenue recognized from acquired companies during the first 12 months following their respective dates of acquisition.  Revenue recognized from acquired companies during such first 12 months is referred to as acquisitive revenue.  Organic revenue, net of subcontractor costs, is measured as revenue, net of subcontractor costs, 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 the majority of these costs.  Our selling, general and administrative (SG&A) expenses are comprised primarily of marketing and bid and proposal costs, as well as our corporate headquarters’ costs related to the executive offices, corporate finance, and accounting, administration and information technology costs.  These costs are generally unrelated to specific client projects and can vary as expenses are incurred to support corporate activities and initiatives.

 

We provide our services to a diverse base of federal, state and local government agencies, and commercial and international clients.  The following table presents, for the periods indicated, the approximate percentage of revenue, net of subcontractor costs, attributable to these client sectors:

 

19

 

		Three Months Ended				Six Months Ended
Client Sector		March 28, 2004		March 30, 2003		March 28, 2004		March 30, 2003
Federal government		42.0	%	27.8	%	41.5	%	26.0	%
State and local government		16.2		23.3		16.7		23.4
Commercial		39.0		47.1		39.6		48.6
International		2.8		1.8		2.2		2.0
		100.0	%	100.0	%	100.0	%	100.0	%

 

We manage our business in two operating segments:  resource management and infrastructure.  The resource management operating segment provides engineering and consulting services relating primarily to water quality and availability, environmental restoration, productive reuse of defense facilities and strategic environmental resource planning to both public and private organizations.  The infrastructure operating segment provides engineering and program management services for the additional development, as well as the upgrading and replacement, of existing civil, communications and security infrastructure to both public and private organizations.  The following table presents, for the periods indicated, the approximate percentage of revenue, net of subcontractor costs, attributable to our operating segments:

 

		Three Months Ended				Six Months Ended
Operating Segment		March 28, 2004		March 30, 2003		March 28, 2004		March 30, 2003
Resource management		58.3	%	54.6	%	58.7	%	52.6	%
Infrastructure		40.8		44.6		40.5		46.5
Other revenue		0.9		0.8		0.8		0.9
		100.0	%	100.0	%	100.0	%	100.0	%

 

Results for the second quarter of fiscal 2004 reflect a continuation of trends we have seen over the last several quarters.  The principal trend is the growth of our federal government business, which is characterized by larger, longer-term contracts.  Our revenue, net of subcontractor costs, from the federal government in the second quarter of fiscal 2004 increased by 90.1% from the second quarter of fiscal 2003.  This increase was due primarily to acquisitions and growth in federal spending and was partially offset by slower spending by state and local government agencies, which are facing ongoing budget constraints.  Our revenue from state and local government agencies in the second quarter of fiscal 2004 decreased by 12.7% from the same period last year.  Spending in the commercial sector, in which demand is tied to economic and end-market conditions, has grown modestly.  Our revenue from commercial clients in the second quarter of fiscal 2004 increased by 4.5% from the prior year period.

 

Overall, our revenue, net of contractor costs, increased 25.9% in the second quarter of fiscal 2004 from the same period last year, driven by growth in the resource management and infrastructure segments of 34.6% and 15.3%, respectively.  Substantially all of this improvement, including the increase in revenue from the federal government, is attributable to contributions from acquisitions over the last year.  Our total organic revenue, net of subcontractor costs, in the

 

20

 

second quarter increased by 0.5% from the prior year period.  Our growth in organic revenue, net of subcontractor costs, in the resource management and infrastructure sectors in the second quarter was 0.4% and 0.8%, respectively, from the prior year period.  Historically, our growth in organic revenue, net of subcontractor costs, has typically ranged from negative 5% during times of difficult economic conditions to positive 10% during times of favorable economic conditions.  To the extent that general economic conditions improve, we expect organic growth to improve from current levels.

 

Our resource management business continued to benefit from increased business with federal government clients, primarily as a result of our Foster Wheeler Environmental Corporation (FWI) acquisition in March 2003.  The strength in federal government work was offset in part by the weak commercial and state and local government markets.

 

Our infrastructure business benefited from our acquisitions of Engineering Management Concepts, Inc. (EMC) in July 2003 and Advanced Management Technology, Inc. (AMT) in March 2004, which provided additional federal government work.  With the exception of communications, the commercial and state and local government markets remained weak, due to the corporate capital expenditures awaiting more favorable economic conditions and continuing budget issues resulting in delays for school, highway and transit projects.  This weakness has impacted our margins in the infrastructure area due to overstaffing in certain offices in anticipation of delayed projects.  Management continues to monitor and take appropriate action to reduce costs in overstaffed markets.  However, we do not expect improvement in our infrastructure margins until late this fiscal year.

 

Recent Acquisition

 

As part of our growth strategy, we expect to pursue complementary acquisitions to expand our geographical reach and the breadth and depth of our service offerings, particularly in the areas of water and homeland security.  During the second quarter of fiscal 2004, we made the following acquisition:

 

Advanced Management Technology, Inc. — In March 2004, we acquired 100% of the outstanding shares of capital stock of AMT.  The purchase was valued at approximately $31.2 million.  AMT is a Virginia-based engineering and program management firm that provides systems engineering, program management and information management services to federal government agencies.

 

Results of Operations

 

Revenue.  Revenue increased $85.9 million, or 35.0%, to $331.4 million for the three months ended March 28, 2004 from $245.5 million for the comparable period last year.  Revenue increased $190.0 million, or 39.7%, to $668.5 million for the six months ended March 28, 2004 from $478.5 million for the comparable period last year.  This growth resulted primarily from the FWI, EMC and AMT acquisitions.

 

21