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Mergers and Acquisitions | 6 Months Ended
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Mar. 27, 2016
Mergers and Acquisitions |
Mergers and Acquisitions | 3.Mergers and Acquisitions On January 18, 2016, we acquired control of Coffey International Limited (Coffey), headquartered in Sydney, Australia. Coffey had approximately 3,300 staff delivering technical and engineering solutions in international development and geoscience. Coffey significantly expands Tetra Tech’s geographic presence, particularly in Australia and Asia Pacific, and is part of our RME segment. In addition to Australia, Coffey’s international development business also has operations supporting federal government agencies in the U.S. and the United Kingdom. The fair value of the purchase price for Coffey was $76.1 million in addition to $65.1 million of assumed debt. In connection with the acquisition, we also assumed secured bank term debt of $37.1 million and unsecured corporate bond obligations of $28.0 million, all of which were paid in full in the second quarter of fiscal 2016 subsequent to the acquisition. In the second quarter of fiscal 2016, we also acquired INDUS Corporation (“INDUS”), headquartered in Vienna, Virginia. INDUS is an information technology solutions firm focused on water data analytics, geospatial analysis, secure infrastructure, and software applications management for U.S. federal government customers, and is included in our WEI segment. The fair value of the purchase price for INDUS was $17.8 million. Of this amount, $13.1 million was paid to the sellers and $4.7 million was the estimated fair value of contingent earn-out obligations, with a maximum of $8.0 million, based upon the achievement of specified operating income targets in each of the two years following the acquisition. The following table summarizes the estimated fair values of assets acquired and liabilities assumed as of the respective acquisition dates for our acquisitions completed in fiscal 2016 ($ in thousands):
Accounts receivable |  | $ | 82,736 |
Other current assets |  | 7,846 |
Property and equipment |  | 14,723 |
Goodwill |  | 104,454 |
Backlog and customer relationship intangible assets |  | 26,188 |
Other assets |  | 6,142 |
Current liabilities |  | (74,641) |
Borrowings |  | (65,086) |
Other long-term liabilities |  | (7,945) |
Noncontrolling interests |  | (500) |
Net assets acquired |  | $ | 93,917 |
Backlog and customer relationship intangible assets represent the fair value of existing contracts and the underlying customer relationships and have lives ranging from 1 to 5 years (weighted average of approximately 3 years). The purchase price allocation is preliminary and subject to adjustment based upon the final determination of the net assets acquired and information necessary to perform the final valuation. We have not completed our final assessment of the fair values of purchased receivables, intangible assets, tax balances, contingent liabilities or acquired contracts. The final purchase price allocations may result in adjustments to certain assets and liabilities, including the residual amount allocated to goodwill. Goodwill recognized largely results from a substantial assembled workforce, which does not qualify for separate recognition, as well as expected future synergies from combining operations. The table below presents summarized unaudited consolidated pro forma operating results, assuming we had acquired Coffey and INDUS, including the related acquisition, integration and debt pre-payment charges, at the beginning of fiscal 2015. These pro-forma operating results are presented for illustrative purposes only and are not indicative of the operating results that would have been achieved had the related events occurred at the beginning of fiscal 2015.
|  | Pro-Forma |
|  | Three Months Ended |  | Six Months Ended |
|  | March 27, 2016 |  | March 29, 2015 |  | March 27, 2016 |  | March 29, 2015 |
|  | (in thousands, except per share data) |
Revenue |  | $ | 647,612 |  | $ | 683,436 |  | $ | 1,319,281 |  | $ | 1,376,599 |
Operating income |  | 32,617 |  | 29,046 |  | 62,766 |  | 48,670 |
Net income attributable to Tetra Tech |  | 20,038 |  | 15,844 |  | 39,526 |  | 22,978 |
Earnings per share attributable to Tetra Tech: |  |  |  |  |  |  |  |  |
Basic |  | $ | 0.34 |  | $ | 0.26 |  | $ | 0.67 |  | $ | 0.37 |
Diluted |  | $ | 0.34 |  | $ | 0.26 |  | $ | 0.67 |  | $ | 0.37 |
Since their respective acquisition dates, Coffey and INDUS contributed $88.2 million in revenue and $0.3 million in operating income during the second quarter of fiscal 2016. Amortization of intangible assets since their respective acquisition dates was $1.6 million during the second quarter of fiscal 2016. Acquisition and integration expenses in the accompanying condensed consolidated statements of income are comprised of the following:
|  | Three Months Ended March 27, 2016 |
|  | (in thousands) |
Severance including change in control payments |  | $ | 7,280 |
Professional services |  | 5,685 |
Real estate-related |  | 2,946 |
Total |  | $ | 15,911 |
As of March 27, 2016, $11.7 million of the $15.9 million in acquisition and integration expenses were paid. All acquisition and integration expenses are included in our Corporate reportable segment, as presented in Note 10. In addition, in the second quarter of fiscal 2016, we repaid Coffey’s bank loans and corporate bonds in full, including $1.9 million in pre-payment charges that are included in interest expense. In fiscal 2015, we acquired Cornerstone Environmental Group, LLC (“CEG”), headquartered in Middletown, New York. CEG is an environmental engineering and consulting firm focused on solid waste markets in the United States, and is included in our RME segment. The fair value of the purchase price for CEG was $15.9 million. Of this amount, $11.8 million was paid to the sellers and $4.1 million was the estimated fair value of contingent earn-out obligations, with a maximum of $9.8 million, based upon the achievement of specified financial objectives. The results of this acquisition were included in the consolidated financial statements from the closing date. The acquisition was not considered material to our condensed consolidated financial statements. As a result, no pro forma information has been provided. Goodwill additions resulting from business combinations are primarily attributable to the existing workforce of the acquired companies and the synergies expected to arise after the acquisitions. In addition, these acquired capabilities, when combined with our existing global consulting and engineering business, result in opportunities that allow us to provide services under contracts that could not have been pursued individually by either us or the acquired company. Most of our acquisition agreements include contingent earn-out agreements, which are generally based on the achievement of future operating income thresholds. The contingent earn-out arrangements are based on our valuations of the acquired companies, and reduce the risk of overpaying for acquisitions if the projected financial results are not achieved. The fair values of any 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 “Long-term estimated contingent earn-out liabilities” on the 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 owners 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 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 (as described in “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 27, 2015). 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. 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 contingent earn-out liability on the acquisition date is reflected as cash used in financing activities in our consolidated statements of cash flows. Any amount paid in excess of the contingent earn-out liability on the acquisition date is reflected as cash used in operating activities. 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. Adjustments to the estimated fair value related to changes in all other unobservable inputs are reported in operating income. During the second quarter and first half of fiscal 2016, we increased our contingent earn-out liabilities and reported related losses in operating income of $1.8 million and $2.8 million, respectively. The $1.8 million charge in the second quarter reflects our updated valuation of the contingent consideration liability for CEG. This valuation includes our current projection of CEG’s financial performance during the earn-out period, which exceeded our original estimate at the acquisition date. The remaining $1.0 million loss represents the final cash settlement during the first quarter of fiscal 2016 of an earn-out liability that was valued at $0 at the end of fiscal 2015. During the second quarter and first half of fiscal 2015, we decreased our contingent earn-out liabilities and reported a related gain in operating income of $3.1 million. This gain resulted from an updated valuation of the contingent consideration liability for Caber Engineering (“Caber”), which is part of our Oil, Gas & Energy reporting unit in the RME segment. The acquisition agreement for Caber included a contingent earn-out agreement based on the achievement of operating income thresholds (in Canadian dollars) in each of the first two years beginning on the acquisition date, which was in the first quarter of fiscal 2014. The maximum earn-out obligation over the two-year earn-out period was C$8.0 million (C$4.0 million in each year). These amounts could be earned on a pro-rata basis for operating income within a predetermined range in each year. Caber was required to meet a minimum operating income threshold in each year to earn any contingent consideration. These thresholds were C$4.0 million and C$4.6 million in years one and two, respectively. In order to earn the maximum contingent consideration, Caber needed to generate operating income of C$4.4 million in year one and C$5.1 million in year two. The determination of the fair value of the purchase price for Caber on the acquisition date included our estimate of the fair value of the related contingent earn-out obligation. This initial valuation was primarily based on probability-weighted internal estimates of Caber’s operating income during each earn-out period. As a result of these estimates, we calculated an initial fair value at the acquisition date of Caber’s contingent earn-out liability of C$6.5 million in the first quarter of fiscal 2014. In determining that Caber would earn 81% of the maximum potential earn-out, we considered several factors including Caber’s recent historical revenue and operating income levels and growth rates. We also considered the recent trend in Caber’s backlog level and the prospects for the oil and gas industry in Western Canada. Caber’s actual financial performance in the first earn-out period exceeded our original estimate at the acquisition date. As a result, in the fourth quarter of fiscal 2014, we increased the related contingent consideration liability and recognized a loss of $1.0 million. This updated valuation included our assumption that Caber would earn the maximum amount of contingent consideration of $4.0 million in the first earn-out period. In the second quarter of fiscal 2015, we completed our final calculation of the contingent consideration for the first earn-out period and paid contingent consideration of C$4.0 million (USD$3.2 million). At that time we also evaluated our estimate of Caber’s contingent consideration liability for the second earn-out period. This assessment included a review of the status of ongoing projects in Caber’s backlog, and the inventory of prospective new contract awards. We also considered the status of the oil and gas industry in Western Canada, particularly in light of recent decline in oil prices at the time. As a result of this assessment, we concluded that Caber’s operating income in the second earn-out period would be lower than our original estimate at the acquisition date and our subsequent estimates through the first quarter of fiscal 2015. We also concluded that Caber’s operating income for the second earn-out period would be lower than the minimum requirement of C$4.6 million to earn any contingent consideration. Accordingly, in the second quarter of fiscal 2015, we reduced the Caber contingent earn-out liability to $0, which resulted in a gain of $3.1 million. The second earn-out period ended in the first quarter of fiscal 2016 with no further adjustments. At March 27, 2016, there was a total maximum of $17.8 million of outstanding contingent consideration related to acquisitions. Of this amount, $10.8 million was estimated as the fair value and accrued on our condensed consolidated balance sheet.

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