Mergers and Acquisitions

6 Months Ended

Mar. 31, 2013

Mergers and Acquisitions

Mergers and Acquisitions

3. Mergers and Acquisitions

On December 31, 2012, the first day of our fiscal 2013 second quarter, we acquired American Environmental Group, Ltd. (“AEG”), a solid waste management specialist headquartered in Richfield, Ohio.  AEG provides environmental, design, construction and maintenance services primarily to solid and hazardous waste, environmental, energy and utility clients.  On January 28, 2013, we acquired Parkland Pipeline Contractors Ltd., Parkland Pipeline Equipment Ltd., Park L Projects Ltd. and Parkland Projects Ltd. (collectively, “Parkland”), headquartered in Alberta, Canada.  Parkland serves the oil and gas industry in Western Canada, and specializes in the technical support, engineering support and construction of pipelines and oilfield facilities.  AEG and Parkland are both included in our RCM segment.  We also made other acquisitions that enhanced our service offerings and expanded our geographic presence in our ECS segment during the first half of fiscal 2013. The aggregate fair value of the purchase prices for fiscal 2013 acquisitions was $249.0 million.  Of this amount, $169.7 million was paid to the sellers, $4.0 million was accrued in accordance with the purchase agreements, and $75.3 million was the estimated fair value of contingent earn-out obligations, with an aggregate maximum of $86.7 million, based upon the achievement of specified financial objectives as described below.

In fiscal 2012, we made acquisitions that enhanced our service offerings and expanded our geographic presence in our ECS and TSS segments. The aggregate fair value of the purchase prices for these acquisitions was $63.2 million.  Of this amount, $42.2 million was paid to the sellers, $2.0 million was accrued in accordance with the purchase agreements, and $19.0 million was the estimated fair value of contingent earn-out obligations, with an aggregate maximum of $20.0 million, based upon the achievement of specified financial objectives as described below.

Goodwill additions resulting from business combinations were primarily attributable to the intangible value of a successful business with an assembled workforce specialized in our areas of interest.  The results of our acquisitions were included in the condensed consolidated financial statements from their respective closing dates.  The purchase price allocations related to the fiscal 2013 acquisitions are preliminary, and subject to adjustment based on the valuation and final determination of net assets acquired.  We do not believe that any adjustment will have a material effect on our consolidated results of operations.  No acquisitions in the first half of fiscal 2013 and in fiscal 2012 were considered material, individually or in the aggregate, to our condensed consolidated financial statements.  As a result, no pro forma information has been provided for the respective periods.

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 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 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 our condensed consolidated statements of cash flows in the period paid.  At March 31, 2013, there was a maximum of $3.0 million of contingent consideration remaining for an acquisition completed prior to fiscal 2010 that will be recorded as an addition to goodwill, if earned.

For acquisitions completed during or subsequent to fiscal 2010, 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 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 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 30, 2012).  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 condensed 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.

At March 31, 2013, there was a total maximum of $118.4 million of outstanding contingent consideration related to acquisitions completed during or subsequent to fiscal 2010.  Of this amount, $101.5 million was estimated as the fair value and accrued on our condensed consolidated balance sheet.  The aggregate current estimated earn-out liabilities of $29.7 million and $35.4 million are reported in “Estimated contingent earn-out liabilities”, and the aggregate non-current estimated earn-out liabilities of $71.8 million and $16.1 million are reported in “Long-term estimated contingent earn-out liabilities” on our condensed consolidated balance sheets at March 31, 2013 and September 30, 2012, respectively.  In the first six months of fiscal 2013, $24.4 million of earn-outs were paid to former owners. Of this amount, we reported $24.0 million as cash used in financing activities and $0.4 million as cash used in operating activities. In the first six months of fiscal 2012, $20.5 million of earn-outs were paid to former owners. Of this amount, we reported $18.1 million as cash used in financing activities, $0.6 million as cash used in operating activities and $1.8 million as cash used in investing activities.