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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

ý         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 1, 2012

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to ___________

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 offices)  (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 period 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 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  ý   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.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o   No  ý

As of July 30, 2012 63,652,062 shares of the registrant’s common stock were outstanding.

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TETRA TECH, INC.

INDEX

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PART I.                 FINANCIAL INFORMATION

Item 1.            Financial Statements

Tetra Tech, Inc.

Condensed Consolidated Balance Sheets

(unaudited - in thousands, except par value)

See accompanying Notes to Condensed Consolidated Financial Statements.

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Tetra Tech, Inc.

Condensed Consolidated Statements of Income

(unaudited – in thousands, except per share data)

See accompanying Notes to Condensed Consolidated Financial Statements.

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Tetra Tech, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited – in thousands)

See accompanying Notes to Condensed Consolidated Financial Statements.

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TETRA TECH, INC.

Notes to Condensed Consolidated Financial Statements

1.                                      Basis of Presentation

The accompanying unaudited condensed consolidated financial statements and related notes of Tetra Tech, Inc. (“we,” “us” or “our”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  They do not include all of the information and footnotes required by GAAP for complete financial statements and, therefore, should be read in conjunction with the audited consolidated financial statements and related notes contained in our Annual Report on Form 10-K for the fiscal year ended October 2, 2011.

Our condensed consolidated financial statements reflect all normal recurring adjustments that are considered necessary for a fair statement of our financial position, results of operations and cash flows for the interim periods presented.  The results of operations and cash flows for any interim period are not necessarily indicative of results for the full year.

Our condensed consolidated financial statements include the accounts of our wholly-owned subsidiaries, and joint ventures of which we are the primary beneficiary.  For the joint ventures in which we do not have a controlling interest, but exert a significant influence, we apply the equity method of accounting (see Note 12, “Joint Ventures” for further discussion).  Certain prior year amounts for Tetra Tech, Inc. and its reportable segments have been revised to conform to the current year presentation.  These revisions include reclassification of $2.5 million and $6.7 million of expenses that were previously reported in “Other costs of revenue” to be part of “Selling, general and administrative (“SG&A”) expenses” for the three and nine-month periods of fiscal 2011, respectively.  In the first quarter of fiscal 2012, we re-aligned certain operating activities in our reportable segments to improve organizational effectiveness and efficiency by better aligning operations with similar client types, project types and financial metrics (see Note 9, “Reportable Segments” for further discussion).  For the three and nine months ended July 1, 2012, “Interest expense – net” on the condensed consolidated statements of income includes $0.2 million and $0.6 million in interest income compared to $0.2 million and $0.5 million for the same periods last year, respectively.

2.                                      Accounts Receivable – Net

Net accounts receivable and billings in excess of costs on uncompleted contracts 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.  Most of our unbilled receivables at July 1, 2012 are expected to be billed and collected within 12 months.  Unbilled accounts receivable at July 1, 2012 and October 2, 2011 include approximately $25 million and $16 million, respectively, related to claims, and requests for equitable adjustment on contracts that provide for price redetermination primarily with the U.S. federal government agencies.  These amounts are management’s estimate of

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the most probable amount to be realized upon the conclusion of the claims settlement process.  We regularly evaluate these claim amounts and record appropriate charges to operating earnings when collection is not deemed to be probable.  No material losses were recognized related to the collectability of claims during the third quarter and first nine months of fiscal 2012 and 2011.  Contract retentions represent amounts withheld by clients until certain conditions are met or the project is completed, which may take several months or years.  The allowance for doubtful accounts is determined based on a review of client-specific accounts, and contract issues resulting from current events and economic circumstances.  Billings in excess of costs on uncompleted contracts represent the amount of cash collected from clients and billings to clients on contracts in advance of revenue recognized.  The majority of billings in excess of costs on uncompleted contracts will be earned within 12 months.  The non-current billings in excess of costs on uncompleted contracts were reported as part of our “Other long-term liabilities” on our condensed consolidated balance sheets.

Billed accounts receivable related to U.S. federal government contracts were $77.2 million and $88.5 million at July 1, 2012 and October 2, 2011, respectively.  U.S. federal government unbilled receivables, net of progress payments, were $111.2 million and $102.7 million at July 1, 2012 and October 2, 2011, respectively.  Other than the U.S. federal government, no single client accounted for more than 10% of our accounts receivable at July 1, 2012 and October 2, 2011.

3.                                      Mergers and Acquisitions

In fiscal 2012, we made acquisitions that enhanced our service offerings and expanded our geographic presence in our Engineering and Consulting Services (“ECS”) and Technical Support Services (“TSS”) segments.  The aggregate fair value of the purchase price for these acquisitions was approximately $65 million.  Of this amount, $19 million of estimated contingent earn-outs as of the respective acquisition dates was recorded as a liability on our condensed consolidated balance sheet at July 1, 2012.  Goodwill additions resulting from business combinations are largely attributable to the existing workforce of the acquired companies and synergies expected to arise after the acquisitions.  No pro forma results are presented for the respective interim periods as the effect of these acquisitions was not considered material, individually or in aggregate, to our condensed consolidated financial statements.

At the beginning of the first quarter of fiscal 2011, we acquired all of the outstanding capital stock of BPR, Inc. (“BPR”), a Canadian scientific and engineering services firm that provides multidisciplinary consulting and engineering support for water, energy, industrial plants, buildings and infrastructure projects.  This acquisition further expanded our geographic presence in eastern Canada, and enabled us to provide clients with additional services throughout Canada.  BPR is part of our ECS segment.  As of the acquisition date, the estimated fair value of the purchase price was approximately $186 million, which resulted in $128.1 million of goodwill.  The goodwill amount represented the value paid for the assembled work force, the international geographic presence in eastern Canada, and engineering and consulting expertise.  The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the acquisition date:

In fiscal 2011, we made other acquisitions that enhanced our service offerings and expanded our geographic presence in the ECS and TSS segments.  The aggregate fair value of the purchase price for these acquisitions was approximately $100 million.  For fiscal 2011 acquisitions, the fair value purchase price included estimated contingent earn-out liabilities as of the respective acquisition dates in the aggregate amount of $58.5 million.

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Certain of our acquisition agreements include contingent earn-out arrangements, which are generally based on the achievement of future operating income thresholds.  The contingent earn-out arrangements are based upon our valuations of the acquired companies and reduce the risk of overpaying for acquisitions if the projected financial results are not achieved.  For acquisitions completed prior to fiscal 2010, contingent earn-out payments are accrued as “Contingent earn-out liabilities” when the related operating income thresholds have been achieved, and a corresponding increase in goodwill is recorded.  These contingent earn-out payments are reflected as cash flows used in investing activities on the condensed consolidated statements of cash flows in the period paid.  At July 1, 2012, there was a maximum of $6.0 million for contingent consideration related to acquisitions completed prior to fiscal 2010 that will be recorded as an addition to goodwill if earned.

For acquisitions consummated in or after fiscal 2010, the fair values of these earn-out arrangements are included as part of the purchase price of the acquired companies on their respective acquisition dates.  For each transaction, we estimate the fair value of contingent earn-out payments as part of the initial purchase price and record the estimated fair value of contingent consideration as a liability in “Estimated contingent earn-out liabilities” and “Other long-term liabilities” on the condensed consolidated balance sheets.  We consider several factors when determining that contingent earn-out liabilities are part of the purchase price, including the following:  (1) the valuation of our acquisitions is not supported solely by the initial consideration paid, and the contingent earn-out formula is a critical and material component of the valuation approach to determining the purchase price; and (2) the former shareholders of acquired companies that remain as key employees receive compensation other than contingent earn-out payments at a reasonable level compared with the compensation of our other key employees.  The contingent earn-out payments are not affected by employment termination.

We perform fair value measurements in accordance with the Financial Accounting Standards Board’s (“FASB”) guidance on “Fair Value Measurements and Disclosures”.  This standard defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  When determining the fair value measurements for assets and liabilities required to be recorded at their fair values, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the assets or liabilities, such as inherent risk, transfer restrictions, and risk of nonperformance.  This standard establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three levels:

We measure our contingent earn-out liabilities at fair value on a recurring basis using significant unobservable inputs classified within Level 3 of the fair value hierarchy.  We use a probability weighted discounted income approach as a valuation technique to convert future estimated cash flows to a single present value amount.  The significant unobservable inputs used in the fair value measurements are operating income projections over the earn-out period (generally two or three years), and the probability outcome percentages we assign to each scenario.  Significant increases or decreases to either of these inputs in isolation would result in a significantly higher or lower liability with a higher liability capped by the contractual maximum of the contingent earn-out obligation.  At July 1, 2012, there was a maximum of $80.5 million for contingent consideration outstanding related to acquisitions completed in or after fiscal 2010.  We review and re-assess the estimated fair value of contingent consideration on a quarterly basis, and the updated fair value could differ materially from the initial estimates.  Changes in the estimated fair value of our contingent earn-out liabilities related to the time component of the present value calculation are reported in interest expense and did not have a material impact on earnings in the first nine months of fiscal 2012 or 2011.  Adjustments to the estimated fair value related to changes in all other unobservable inputs are reported in operating income, and resulted in gains of $1.7 million and $2.0 million for the third quarter and first nine months of fiscal 2012, respectively, compared to gains of $1.1 million and $1.6 million, respectively, for the same periods in fiscal 2011.

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Ultimately, the liability will be equivalent to the amount paid, and the difference between the fair value estimate and amount paid will be recorded in earnings.  The amount paid that is less than or equal to the liability on the acquisition date is reflected as cash used in financing activities in our condensed consolidated statements of cash flows.  Any amount paid in excess of the liability on the acquisition date is reflected as cash used in operating activities.

The aggregate current estimated earn-out liabilities of $48.3 million and $64.1 million are reported in “Estimated contingent earn-out liabilities”, and the aggregate non-current estimated earn-out liabilities of $19.0 million and $11.0 million are reported in “Other long-term liabilities” on the condensed consolidated balance sheets at July 1, 2012 and October 2, 2011, respectively.  In the first nine months of fiscal 2012, $30.4 million of earn-outs were paid to former shareholders.  Of this amount, we reported $18.1 million as cash used in financing activities, $0.6 million as cash used in operating activities and $11.7 million as cash used in investing activities.  In the first nine months of fiscal 2011, $21.8 million of earn-outs were paid to former shareholders, all of which was reported as cash used in investing activities.

4.                                      Goodwill and Intangibles

The following table summarizes the changes in the carrying value of goodwill:

(1)              Transfers resulted from a realignment of certain operating activities in our reportable segments (See Note 9, “Reportable Segments” for more information).

(2)              Currency translation adjustments relate to our foreign subsidiaries with functional currencies different than our reporting currency.

(3)                Adjustments resulted from contingent earn-out payments related to acquisitions completed prior to fiscal 2010.

(4)              Gross amount of goodwill for the Engineering and Architecture Services segment was $122.7 million for both July 1, 2012, and October 2, 2011.  For both periods, accumulated impairment losses for this segment were $105 million,  reflecting impairment charges in fiscal 2005.  There were no impairment losses in the other reportable segments.

The gross amount and accumulated amortization of our acquired identifiable intangible assets with finite useful lives included in “Intangible assets - net” on the condensed consolidated balance sheets, were as follows:

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In the first nine months of fiscal 2012, the increases in gross amounts are attributable to the fiscal 2012 acquisitions described in Note 3, “Mergers and Acquisitions” and, to a lesser extent, foreign currency translation adjustments.  Amortization expense for these intangible assets for the three and nine months ended July 1, 2012 was $6.9 million and $22.1 million, respectively, compared to $7.0 million and $20.7 million for the same periods last year.  Estimated amortization expense for the remainder of fiscal 2012 and succeeding years is as follows:

5.                                      Property and Equipment - Net

Property and equipment consisted of the following:

For the three and nine months ended July 1, 2012, the depreciation expense related to property and equipment, including assets under capital leases, was $6.1 million and $19.7 million, respectively, compared to $7.0 million and $20.4 million for the same periods last year.

6.                                      Stockholders’ Equity and Stock Compensation Plans

We recognize the fair value of our stock-based compensation awards as compensation expense on a straight-line basis over the requisite service period in which the awards vest.  For the three and nine months ended July 1, 2012, stock-based compensation expense was $2.5 million and $8.2 million, respectively, compared to $2.5 million and $7.8 million for the same periods last year.  The majority of these amounts was included in SG&A expenses in our condensed consolidated statements of income.  No equity awards were granted in the third quarter of fiscal 2012.  For the nine months ended July 1, 2012, we granted 458,249 stock options with exercise prices of $22.53 - $25.27 per share and an estimated weighted-average fair value of $8.10 per share.  In addition, we awarded 105,567 shares of restricted stock in the first quarter of fiscal 2012 to our directors and executive officers at the fair value of $22.53 per share on the award date.  All of these restricted shares are performance-based and vest over a three-year period.  The number of restricted shares that ultimately vest is based on the growth in our diluted earnings per share.  In the first quarter of fiscal 2012, we also awarded 181,348 restricted stock units (“RSUs”) to our employees at the fair value of $22.53 per share on the award date.  All of the RSUs have time-based vesting over a four-year period.

7.                                      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.

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The following table sets forth the number of weighted-average shares used to compute basic and diluted EPS:

For the three and nine months ended July 1, 2012, 2.1 million and 2.9 million options were excluded from the calculation of dilutive potential common shares, respectively, compared to 2.9 million and 2.7 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.

8.                                      Income Taxes

The effective income tax rate for the first nine months of fiscal 2012 was 34.8% compared to 33.4% for the same period last year.  In the first quarter of fiscal 2011, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was signed into law, including a retroactive extension of federal research and experimentation credits (“R&E credits”) for amounts incurred from January 1, 2010 through December 31, 2011.  As a result of the retroactive extension, a $1.2 million benefit from R&E credits for the last nine months of fiscal 2010 was included in our first quarter of fiscal 2011 tax expense, resulting in a lower effective tax rate in fiscal 2011.  With the expiration of federal R&E credits on December 31, 2011, we have not estimated a benefit from these credits beyond the expiration date.  Should the R&E credits provision be retroactively extended, additional benefits will be reflected in our effective tax rate during the quarter reporting period of enactment.

9.                                      Reportable Segments

In the first quarter of fiscal 2012, we implemented organizational changes that resulted in a realignment of certain operating activities in our reportable segments.  This realignment resulted from the organic growth of new activities in a component of an existing reportable segment due to changing business conditions.  These new activities are not regularly reviewed by our Chief Operating Decision Maker (“CODM”) to assess performance or make decisions about the resources to be allocated to them and do not individually meet the definition of a reportable operating segment.  The changes are intended to improve organizational effectiveness and efficiency by better aligning operations with similar characteristics such as client types, project types, required resources and financial metrics.  Prior year amounts have been reclassified to conform to the current year presentation.

Our reportable segments are as follows:

Engineering and Consulting Services (“ECS”).  ECS provides front-end science, consulting engineering services and project management in the areas of surface water management, groundwater, waste management, mining and geotechnical sciences, arctic engineering, industrial processes, and information technology.

Technical Support Services (“TSS”).  TSS advises clients through the study, design and implementation phases of projects.  TSS provides management consulting and strategic direction in the areas of environmental assessments/hazardous waste management, climate change, international development/stabilization, energy services, and technical government staffing services.

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Engineering and Architecture Services (“EAS”).  EAS provides engineering and architecture design services, including Leadership in Energy and Environmental Design (“LEED”) and sustainability services, together with technical and program administration services for projects related to water infrastructure, buildings, and transportation and facilities.

Remediation and Construction Management (“RCM”).  RCM is focused on providing full-service support to U.S. federal government, U.S. state and local governments, and U.S. commercial clients.  RCM’s service lines include environmental remediation, construction management, infrastructure development, and alternative energy.

Management evaluates the performance of these reportable segments based upon their respective segment operating income 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 significant intercompany balances and transactions are eliminated in consolidation.

The following tables present certain financial information for our reportable segments:

Major Clients

Other than the U.S. federal government, no single client accounted for more than 10% of our revenue.  Each of our segments generated revenue from all client sectors.

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The following table represents our revenue by client sector:

10.                               Comprehensive Income

Comprehensive income is comprised of net income, translation gains and losses from foreign subsidiaries with functional currencies different than our reporting currency, and unrealized gains and losses on hedging activities.  The components of comprehensive income, net of related tax, are as follows: