TETRA TECH INC - Annual Report: 2019 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________________________
FORM 10-K
(Mark One) | ||
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the Fiscal Year Ended September 29, 2019
☐ | 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)
Delaware | 95-4148514 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
3475 East Foothill Boulevard, Pasadena, California 91107
(Address of principal executive offices) (Zip Code)
(626) 351-4664
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
Common Stock, $0.01 par value | TTEK | The NASDAQ Stock Market LLC | ||
Securities registered pursuant to Section 12(g) of the Act:
None
________________________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of the registrant's common stock held by non-affiliates on March 31, 2019, was $3.2 billion (based upon the closing price of a share of registrant's common stock as reported by the Nasdaq National Market on that date).
On November 25, 2019, 54,587,819 shares of the registrant's common stock were outstanding.
DOCUMENT INCORPORATED BY REFERENCE
Portions of registrant's Proxy Statement for its 2020 Annual Meeting of Stockholders are incorporated by reference in Part III of this report where indicated.
TABLE OF CONTENTS
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This Annual Report on Form 10-K ("Report"), including the "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 harbors created under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. 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," "estimates," "seeks," "continues," "may," variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified below under "Risk Factors," and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.
PART I
Item 1. Business
General
Tetra Tech, Inc. is a leading global provider of consulting and engineering services that focuses on water, environment, infrastructure, resource management, energy, and international development. We are a global company that is Leading with Science® to provide innovative solutions for our public and private clients. We typically begin at the earliest stage of a project by identifying technical solutions and developing execution plans tailored to our clients' needs and resources.
Engineering News-Record ("ENR"), the leading trade journal for our industry, has ranked us the number one water services firm for the past 16 years, most recently in its May 2019 "Top 500 Design Firms" issue. In 2019, we were also ranked number one in water treatment/desalination, water treatment and supply, environmental management, environmental science, consulting/studies, solid waste, hydro plants, and wind power. ENR ranks us among the largest 10 firms in numerous other service lines, including engineering/design, chemical and soil remediation, site assessment and compliance, dams and reservoirs, power, transmission and distribution plants, and hazardous waste.
Our reputation for high-end consulting and engineering services and our ability to develop solutions for water and environmental management has supported our growth for more than 50 years. Today, we are proud to be making a difference in people’s lives worldwide through broad consulting, engineering, and technology service offerings. We are working on over 70,000 projects a year, in more than 100 countries on seven continents, from 450 offices, with a talent force of 20,000 associates. We are Leading with Science throughout our operations, with domain experts across multiple disciplines supported by advanced analytics, artificial intelligence ("AI"), machine learning, and digital technology. Our ability to provide innovation and first-of-kind solutions is enhanced by partnerships with our forward-thinking clients. We are diverse and inclusive, embracing the breadth of experience across our talent force worldwide with a culture of innovation and entrepreneurship. We are disciplined in our business delivering value to customers and high performance to our shareholders. In supporting our clients, we seek to add value and provide long-term sustainable consulting, engineering, and technology solutions.
By combining ingenuity and practical experience, our mission is to be the world's leading consulting and engineering firm solving global challenges in water and the environment that make a positive difference in people's lives worldwide.
The following core principles form the underpinning of how we work together to serve our clients:
• | Service. We put our clients first. We listen closely to better understand our clients' needs and deliver smart, cost-effective solutions that meet their needs. |
• | Value. We solve our clients' problems as if they were our own. We develop and implement sustainable solutions that are innovative, efficient and practical. |
• | Excellence. We bring superior technical capability, disciplined project management, and excellence in safety and quality to all of our services. |
• | Opportunity. Our people are our number one asset. Opportunity means new technical challenges that provide advancement within our company, encourage an inclusive and diverse workforce, and ensure a safe workplace. |
We have a strong project management culture that enables us to deliver on more than 70,000 projects in a year. We maintain a strong emphasis on project management at all levels of the organization. Our client-focused project management is supported by strong fiscal management and financial tools. We use a disciplined approach to monitoring, managing, and improving
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our return on investment in each of our business areas through our efforts to negotiate appropriate contract terms, manage our contract performance to minimize schedule delays and cost overruns, and promptly bill and collect accounts receivable.
We have a broad client and contract base built by proactively understanding our clients' priorities and demonstrating a long track record of successful performance that results in repeat business and limits competition. We believe that proximity to our clients is also instrumental to integrating global experience and resources with an understanding of our local clients' needs. Over the past year, we worked in more than 100 countries, helping our clients address complex water, environment, energy and related infrastructure needs.
Throughout our history, we have supported both public and private clients, many for multiple decades of continuous contracts and repeat business. Long-term relationships provide us with institutional knowledge of our clients' programs, past projects and internal resources. Institutional knowledge is often a significant factor in winning competitive proposals and providing cost-effective solutions tailored to our clients' needs.
We are often at the leading edge of new challenges where we are delivering one-of-a-kind solutions. These might be a new water reuse technology, a unique solution to addressing new regulatory requirements, a new monitoring approach for assessing infrastructure assets or a computer model for real time management of water resources.
We combine interdisciplinary capabilities, technical resources, and institutional knowledge to implement complex projects that are at the leading edge of policy and technology development.
Leading with Science
In implementing our projects, we integrate deep domain knowledge, technologies, and practical expertise. These tools and technologies that differentiate us are called Tetra Tech Delta ("TtΔ"). We use this suite of technologies and analytical tools to provide value engineering and cost efficiencies for our clients, while enhancing the effectiveness and responsiveness of our solutions.
TtΔ is our proprietary collection of technology and analytical tools. These advanced analytical solutions enable us to provide clients with real-time reporting, automated and remote data collection, and dashboards for tracking and communicating results. TtΔ is continually evolving and includes cutting-edge tools on interpretive analysis, modeling of physical systems, forecasting and scenario analysis, optimization and operations research.
In implementing our Leading with Science approach, we work with our clients to explore, incubate, and test solutions in our Tetra Tech Innovation Hubs ("Tt I-Hub"). Tt I-Hub provides a collaborative platform for exploration, testing, and formulation of new solutions in partnership with clients, academia and donor agencies.
Leading with Science also means fully leveraging the collective expertise provided by our global talent force of 20,000 associates. We actively share information, ideas, and resources across our global operations through our network structure, guided subject matter teams, and project team building. We also proactively share emerging technology and new ideas through our Tetra Tech Technology Transfer ("T4") program. T4 facilitates our innovation culture through webcasts, blogs, multi-media, and social media across our global operations.
Reportable Segments
In fiscal 2019, we managed our operations under two reportable segments. Our Government Services Group ("GSG") reportable segment primarily includes activities with U.S. government clients (federal, state and local) and all activities with development agencies worldwide. Our Commercial/International Services Group ("CIG") reportable segment primarily includes activities with U.S. commercial clients and international clients other than development agencies. This alignment allows us to capitalize on our growing market opportunities and enhance the development of high-end consulting and technical solutions to meet our growing client demand. We continue to report the results of the wind-down of our non-core construction activities in the Remediation and Construction Management ("RCM") reportable segment. The following table presents the percentage of our revenue by reportable segment:
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Fiscal Year | ||||||
Reportable Segment | 2019 | 2018 | 2017 | |||
GSG | 58.6% | 57.2% | 54.0% | |||
CIG | 43.1 | 44.6 | 48.2 | |||
RCM | — | 0.5 | 0.7 | |||
Inter-segment elimination | (1.7) | (2.3) | (2.9) | |||
100.0% | 100.0% | 100.0% | ||||
For additional information regarding our reportable segments, see Note 19, "Reportable Segments" of the "Notes to Consolidated Financial Statements" included in Item 8. For more information on risks related to our business, segments and geographic regions, including risks related to foreign operations, see Item 1A, “Risk Factors” of this report.
Government Services Group
GSG provides consulting and engineering services primarily to U.S. government clients (federal, state and local) and development agencies worldwide. GSG supports U.S. government civilian and defense agencies with services in water, environment, infrastructure, information technology, and disaster management. GSG also provides engineering design services for U.S. municipal and commercial clients, especially in water infrastructure, solid waste, and high-end sustainable infrastructure designs. GSG also leads our support for development agencies worldwide, especially in the United States, United Kingdom, and Australia.
GSG provides consulting and engineering services for a broad range of water, environment, and infrastructure-related needs primarily for U.S. government clients. The primary GSG markets include water resources analysis and water management, environmental monitoring, data analytics, government consulting, waste management, and a broad range of civil infrastructure master planning and engineering design for facilities, transportation, and local development projects. GSG's services span from early data collection and monitoring, to data analysis and information management, to science and engineering applied research, to engineering design, to construction management, and operations and maintenance.
GSG provides our clients with sustainable solutions that optimize their water management and environmental programs to address regulatory requirements, improve operational efficiencies, and manage assets. Our services advance sustainability and resiliency through the "greening" of infrastructure, design of energy efficiency and resource conservation programs, innovation in the capture and sequestration of carbon, development of disaster preparedness and response plans, and improvement in water and land resource management practices. We provide climate change and energy management consulting, and greenhouse gas ("GHG") inventory assessment, certification, reduction, and management services.
Many government organizations face complex problems due to increased demand and competition for water and natural resources, newly understood threats to human health and the environment, aging infrastructure, and demand for new and more resilient infrastructure. Our integrated water management services support government agencies responsible for managing water supplies, wastewater treatment, storm water management, and flood protection. We help our clients develop more resilient water supplies and more sustainable management of water resources, while addressing a wide range of local and national government requirements and policies. Fluctuations in weather patterns and extreme events, such as prolonged droughts and more frequent flooding, are increasing concerns over the reliability of water supplies, the need to protect coastal areas, and flood mitigation and adaptation in metropolitan areas. We provide smart water infrastructure solutions that integrate water modeling, instrumentation and controls, and real-time controls to create flexible water systems that respond to changing conditions, optimize use of existing infrastructure, and provide clients with the ability to more efficiently monitor and manage their water infrastructure.
We also support government agencies in the full range of disaster response and community resilience services including monitoring and environmental response, damage assessment and program management services, and resilient engineering design and mitigation planning. We have a full suite of innovative software tools and procedures that support our disaster response, planning, and management support services. These tools and procedures address disaster management and community resilience data management needs, including information technology systems, portals, dashboards, data management, data analytics, and statistical analysis.
GSG provides planning, architectural, and sustainable engineering services for U.S. federal, state and local government facilities and commercial high-rise multi-use buildings. We support the government agencies with related infrastructure needs including military housing, and educational, institutional, and research facilities. Our high-performance buildings practice provides sustainable energy, water, and GHG efficient solutions including civil, electrical, mechanical, structural, plumbing and fire protection engineering and design services for buildings and surrounding developments. We also provide engineering services for a wide range of clients with specialized needs, such as security systems, training and audiovisual facilities, clean rooms, laboratories, medical facilities and disaster preparedness facilities.
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GSG provides a wide range of consulting and engineering services for solid waste management, including landfill design and management and recycling facility design, throughout the United States; providing design, construction management, and maintenance services to manage solid and hazardous waste, for environmental, wastewater, energy, containment, mining, utilities, aquaculture, and other industrial clients; designing and installing geosynthetic liners for large lining and capping projects, as well as innovative renewable energy projects such as solar energy-generating landfill caps; and providing full-service solutions for gas-to-energy facilities to efficiently use landfill methane gas.
We provide technical support for the Federal Aviation Administration ("FAA") to optimize the U.S. airspace system and support related aviation systems integration for the U.S. and other countries' metropolitan airports. We provide specialized modeling and data analytics for airspace acoustic analysis. Our aviation airspace services include data management, data processing, communications and outreach, and systems development; and providing systems analysis and information management. We also provide information technology ("IT") support to various federal clients for modernization of IT systems, cloud migration, AI, and machine learning.
We support governments in implementing international development programs for developing nations to help them address numerous challenges, including access to potable water and adapting to the threats of climate change. Our international development services include supporting donor agencies to develop safe and reliable water supplies and sanitation services, support the eradication of poverty, improve livelihoods, promote democracy and increase economic growth; planning, designing, implementing, researching, and monitoring projects in the areas of climate change, agriculture and rural development, governance and institutional development, natural resources and the environment, infrastructure, economic growth, energy, rule of law and justice systems, land tenure and property rights, and training and consulting for public-private partnerships; and building capacity and strengthening institutions in areas such as global health, energy sector reform, utility management, education, food security, and local governance.
Commercial/International Services Group
CIG primarily provides consulting and engineering services to U.S. commercial clients, and international clients that include both commercial and government sectors. CIG supports commercial clients across the Fortune 500, energy utilities, industrial, manufacturing, aerospace, and resource management markets. CIG also provides infrastructure and related environmental and geotechnical services, testing, engineering and project management services to commercial and local government clients across Canada, in Asia Pacific (primarily Australia and New Zealand), the United Kingdom, as well as Brazil and Chile.
CIG provides consulting and engineering services worldwide for a broad range of water, environment, and sustainable infrastructure-related needs in both developed and emerging economies. The primary markets for CIG's services include natural resources, energy, and utilities, as well as civil infrastructure master planning and engineering design for facilities, transportation, and local development projects. CIG's services span from early data collection and monitoring to data analysis and information management, to feasibility studies and assessments, to science and engineering applied research, to engineering design, to construction management, and operations and maintenance.
CIG's environmental services include cleanup and beneficial reuse of sites contaminated with hazardous materials, toxic chemicals, and oil and petroleum products, which cover all phases of the remedial planning process, starting with disaster response and initial site assessment through removal actions, remedial design and implementation oversight; and supporting both commercial and government clients in planning and implementing remedial activities at numerous sites around the world, and providing a broad range of environmental analysis and planning services.
CIG also supports commercial clients by providing design services to renovate, upgrade, and modernize industrial water supplies, and address industrial water treatment and water reuse needs; and provides plant engineering, project execution, and program management services for industrial water treatment projects throughout the world.
CIG's international services, especially in Canada and Asia-Pacific, include high-end analytical, engineering, architecture, geotechnical, and construction management services for infrastructure projects, including roadway monitoring and asset management services, collection of condition data, optimization of upgrades and long-term planning for expansion; multi-modal design services for commuter railway stations, airport expansions, bridges and major highways, and ports and harbors; and designing solutions to repair, replace, and upgrade older transportation infrastructure.
CIG provides infrastructure design services in extreme and remote areas by using specialized techniques that are adapted to local resources, while minimizing environmental impacts, and considering potential climate change impacts. These include providing consulting, geotechnical, and design services to owners of transportation, natural resources, energy and community infrastructure in areas of permafrost or extreme climate regions.
CIG's energy services include support for electric power utilities and independent power producers worldwide, ranging from macro-level planning and management advisory services to project-specific environmental, engineering, construction
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management, and operational services, and advising on the design and implementation of smart grids both in the U.S. and internationally, including increasing utility automation, information and operational technologies, and critical infrastructure security. For utilities and governmental regulatory agencies, services include policy and regulatory development, utility management, performance improvement, asset management and evaluation, and transaction support services. For developers and owners of renewable energy resources such as solar grid and off-grid, on-shore and off-shore wind, biogas and biomass, tidal, and hydropower, and conventional power generation facilities, micro-grid and battery or alternative storage facilities, as well as transmission and distribution assets, services include environmental, engineering, procurement, operations and maintenance, and regulatory support for all project phases.
CIG supports industrial and energy clients, primarily in North America, in the upstream, midstream and downstream market sectors. Our services include environmental permitting support, siting studies, strategic planning and analyses; design of well pads and surface impoundments for drilling sites; water management for exploration activities; design of midstream pipelines and associated pumping stations and storage facilities; construction monitoring, design and construction management for downstream sustaining capital projects; biological and cultural assessments, and site investigations; and hazardous waste site remediation.
CIG also provides environmental remediation and reconstruction services to evaluate and restore lands to beneficial use, including the identification, evaluation and destruction of unexploded ordinance, both domestically and internationally; investigating, remediating, and restoring contaminated facilities at military locations in the U.S. and around the world; managing large, complex sediment remediation programs that help restore rivers and coastal waters to beneficial use; constructing state-of-the-art water treatment plants for commercial clients; and supporting utilities in the U.S. in implementing infrastructure needs.
Remediation and Construction Management
We continued to report the results of the wind-down of our non-core construction activities in the RCM reportable segment in fiscal 2019. As of September 29, 2019, there was no remaining backlog for RCM as the projects were complete.
Project Examples
Project examples are provided on our company website located at tetratech.com, including expert interviews, in-depth articles, and project profiles that demonstrate our services across water, environment, infrastructure, energy, resource management, and international development.
Clients
We provide services to a diverse base of U.S. state and local government, U.S. federal government, U.S. commercial, and international clients. The following table presents the percentage of our revenue by client sector:
Fiscal Year | ||||||
Client Sector | 2019 | 2018 | 2017 | |||
U.S. state and local government | 18.9% | 15.8% | 12.8% | |||
U.S. federal government (1) | 30.3 | 32.9 | 32.7 | |||
U.S. commercial | 23.1 | 26.6 | 27.8 | |||
International (2) | 27.7 | 24.7 | 26.7 | |||
100.0% | 100.0% | 100.0% | ||||
(1) | Includes revenue generated under U.S. federal government contracts performed outside the United States. |
(2) | Includes revenue generated from foreign operations, primarily in Canada, Australia, the United Kingdom, and revenue generated from non-U.S. clients. |
U.S. federal government agencies are significant clients. The U.S. Agency for International Development ("USAID") accounted for 12.4%, 14.0% and 14.3% of our revenue in fiscal 2019, 2018 and 2017, respectively. The Department of Defense ("DoD") accounted for 7.9%, 10.0% and 9.2% of our revenue in fiscal 2019, 2018 and 2017, respectively. We typically support multiple programs within a single U.S. federal government agency, both domestically and internationally. We also assist U.S. state and local government clients in various jurisdictions across the United States. In Canada, we work for several provinces and various local jurisdictions. Our U.S. commercial clients include companies in the chemical, energy, mining, pharmaceutical, retail, aerospace, automotive, petroleum, and communications industries. No single client, except for U.S. federal government clients, accounted for more than 10% of our revenue in fiscal 2019.
Contracts
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Our services are performed under three principal types of contracts with our clients: fixed-price, time-and-materials, and cost-plus. The following table presents the percentage of our revenue by contract type:
Fiscal Year | ||||||
Contract Type | 2019 | 2018 | 2017 | |||
Fixed-price | 33.7% | 33.3% | 33.0% | |||
Time-and-materials | 48.6 | 47.1 | 45.9 | |||
Cost-plus | 17.7 | 19.6 | 21.1 | |||
100.0% | 100.0% | 100.0% | ||||
Under a fixed-price contract, the client agrees to pay a specified price for our performance of the entire contract or a specified portion of the contract. Some fixed-price contracts can include date-certain and/or performance obligations. Fixed-price contracts carry certain inherent risks, including risks of losses from underestimating costs, delays in project completion, problems with new technologies, price increases for materials, and economic and other changes that may occur over the contract period. Consequently, the profitability of fixed-price contracts may vary substantially. Under time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and paid for other expenses. Profitability on these contracts is driven by billable headcount and cost control. Many of our time-and-materials contracts are subject to maximum contract values and, accordingly, revenue related to these contracts is recognized as if these contracts were fixed-price contracts. Under our cost-plus contracts, some of which are subject to a contract ceiling amount, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable, we may not be able to obtain full reimbursement. Further, the amount of the fee received for a cost-plus award fee contract partially depends upon the client's discretionary periodic assessment of our performance on that contract.
Some contracts with the U.S. federal government are subject to annual funding approval. U.S. federal government agencies may impose spending restrictions that limit the continued funding of our existing contracts and may limit our ability to obtain additional contracts. These limitations, if significant, could have a material adverse effect on us. All contracts with the U.S. federal government may be terminated by the government at any time, with or without cause.
U.S. federal government agencies have formal policies against continuing or awarding contracts that would create actual or potential conflicts of interest with other activities of a contractor. These policies may prevent us from bidding for or performing government contracts resulting from or related to certain work we have performed. In addition, services performed for a commercial or government sector client may create conflicts of interest that preclude or limit our ability to obtain work for a private organization. We attempt to identify actual or potential conflicts of interest and to minimize the possibility that such conflicts could affect our work under current contracts or our ability to compete for future contracts. We have, on occasion, declined to bid on a project because of an existing or potential conflict of interest.
Some of our operating units have contracts with the U.S. federal government that are subject to audit by the government, primarily by the Defense Contract Audit Agency ("DCAA"). The DCAA generally seeks to (i) identify and evaluate all activities that contribute to, or have an impact on, proposed or incurred costs of government contracts; (ii) evaluate a contractor's policies, procedures, controls, and performance; and (iii) prevent or avoid wasteful, careless, and inefficient production or service. To accomplish this, the DCAA examines our internal control systems, management policies, and financial capability; evaluates the accuracy, reliability, and reasonableness of our cost representations and records; and assesses our compliance with Cost Accounting Standards ("CAS") and defective-pricing clauses found within the Federal Acquisition Regulation ("FAR"). The DCAA also performs an annual review of our overhead rates and assists in the establishment of our final rates. This review focuses on the allowability of cost items and the applicability of CAS. The DCAA also audits cost-based contracts, including the close-out of those contracts.
The DCAA reviews all types of U.S. federal government proposals, including those of award, administration, modification, and re-pricing. The DCAA considers our cost accounting system, estimating methods and procedures, and specific proposal requirements. Operational audits are also performed by the DCAA. A review of our operations at every major organizational level is conducted during the proposal review period. During the course of its audit, the U.S. federal government may disallow costs if it determines that we accounted for such costs in a manner inconsistent with CAS. Under a government contract, only those costs that are reasonable, allocable, and allowable are recoverable. A disallowance of costs by the U.S. federal government could have a material adverse effect on our financial results.
In accordance with our corporate policies, we maintain controls to minimize any occurrence of fraud or other unlawful activities that could result in severe legal remedies, including the payment of damages and/or penalties, criminal and civil sanctions, and debarment. In addition, we maintain preventative audit programs and mitigation measures to ensure that appropriate control systems are in place.
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We provide our services under contracts, purchase orders, or retainer letters. Our policy requires that all contracts must be in writing. We bill our clients in accordance with the contract terms and periodically based on costs incurred, on either an hourly-fee basis or on a percentage-of-completion basis, as the project progresses. Most of our agreements permit our clients to terminate the agreements without cause upon payment of fees and expenses through the date of the termination. Generally, our contracts do not require that we provide performance bonds. If required, a performance bond, issued by a surety company, guarantees a contractor's performance under the contract. If the contractor defaults under the contract, the surety will, at its discretion, complete the job or pay the client the amount of the bond. If the contractor does not have a performance bond and defaults in the performance of a contract, the contractor is responsible for all damages resulting from the breach of contract. These damages include the cost of completion, together with possible consequential damages such as lost profits.
Growth Strategy
Our management team establishes Tetra Tech's overall business strategy. Our strategic plan defines and guides our investment in marketing and business development to leverage our differentiators and target priority programs and growth markets. We maintain centralized business development resources to develop our corporate branding and marketing materials, support proposal preparation and planning, conduct market research, and manage promotional and professional activities, including appearances at trade shows, direct mailings, advertising, and public relations.
We have established company-wide growth initiatives that reinforce internal coordination, track the development of new programs, identify and coordinate collective resources for major bids, and help us build interdisciplinary teams and provide innovative solutions for major pursuits. Our growth initiatives provide a forum for cross-sector collaboration and the development of interdisciplinary solutions. We continuously identify new markets that are consistent with our strategic plan and service offerings, and we leverage our full-service capabilities and internal coordination structure to develop and implement strategies to research, anticipate, and position us for future procurements and emerging programs.
Business development activities are implemented by our technical and professional management staff throughout the company with the support of company-wide resources and expertise. Our project managers and technical staff have the best understanding of a client's needs and the effect of local or client-specific issues, laws and regulations, and procurement procedures. Our professional staff members hold frequent meetings with existing and potential clients; give presentations to civic and professional organizations; and present seminars on research and technical applications. Essential to the effective development of business is each staff member's access to all our service offerings through our internal technical and geographic networks. Our strong internal networking programs help our professional staff members to pursue new opportunities for both existing and new clients. These networks also facilitate our ability to provide services throughout the project life cycle from the early studies to operations and maintenance. Our enterprise-wide knowledge management systems include skills search tools, business development tracking, and collaboration tools.
To support our growth plans we actively attract, recruit and retain key hires. Our combination of high-end science and consulting coupled with practical applications provides challenging and rewarding opportunities for our associates, thereby enhancing our ability to recruit and retain top quality talent. Our internal networking programs, leadership training, entrepreneurial environment, focus on technical excellence, and global project portfolio help to attract and retain highly qualified individuals.
Our strategic growth plans are augmented by our selective investment in acquisitions aligned with our business. Acquisitions enhance plans to add new technologies, broaden our service offerings, add contract capacity and extend our geographic presence. Our long-established experience in identifying and integrating acquisitions strengthens our ability to integrate and rapidly leverage the resources of the acquired companies’ post-acquisition.
Sustainability Program
Tetra Tech supports clients in more than 100 countries around the world, helping them to solve complex problems and achieve solutions that are technically, socially, and economically resilient. Our high-end consulting and engineering services focus on using innovative technologies and creative solutions to minimize environmental impacts. Our greatest contribution toward sustainability is through the projects we perform every day for our clients. Sustainability is embedded in our projects – from recycling freshwater supplies to recycling waste products, reducing energy consumption, and reducing GHG emissions in developing countries.
Our Sustainability Program enables us to further expand our commitment to sustainability by encouraging, coordinating, and reporting on actions to minimize our collective impacts on the environment. Our Sustainability Program has three primary pillars: Projects – the solutions we provide for our clients; Procurement – our procurement and subcontracting approaches; and Processes – the internal policies and processes that promote sustainable practices, reduce costs, and minimize environmental impacts. In addition, our program is based on the Global Reporting Initiative ("GRI") Sustainability Report Framework, the internationally predominant sustainability reporting protocol for corporate sustainability plans, which includes three fundamental areas: environmental, economic, and social sustainability.
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Our Sustainability Program is led by our Chief Sustainability Officer, who has been appointed by executive management and is supported by other key corporate and operations representatives via our Sustainability Council. We have established a clear set of metrics to evaluate our progress toward our sustainability goals. Each metric corresponds with one or more performance indicators from GRI. These metrics include economic, health and safety, information technology, human resources, and real estate. We continuously implement sustainability-related policies and practices, and we assess the results of our efforts in order to improve upon them in the future. Our executive management team reviews and approves the Sustainability Program and evaluates our progress in achieving the goals and objectives outlined in our plan. We publish an annual sustainability report on Earth Day each year that documents our progress and is posted on our website located at tetratech.com.
Acquisitions and Divestitures
Acquisitions. We continuously evaluate the marketplace for acquisition opportunities to further our strategic growth plans. Due to our reputation, size, financial resources, geographic presence and range of services, we have numerous opportunities to acquire privately and publicly held companies or selected portions of such companies. We evaluate an acquisition opportunity based on its ability to strengthen our leadership in the markets we serve, the technologies and solutions they provide, and the additional new geographies and clients they bring. Also, during our evaluation, we examine an acquisition's ability to drive organic growth, its accretive effect on long-term earnings, and its ability to generate return on investment. Generally, we proceed with an acquisition if we believe that it will strategically expand our service offerings, improve our long-term financial performance, and increase shareholder returns.
We view acquisitions as a key component in the execution of our growth strategy, and we intend to use cash, debt or equity, as we deem appropriate, to fund acquisitions. We may acquire other businesses that we believe are synergistic and will ultimately increase our revenue and net income, strengthen our ability to achieve our strategic goals, provide critical mass with existing clients, and further expand our lines of service. We typically pay a purchase price that results in the recognition of goodwill, generally representing the intangible value of a successful business with an assembled workforce specialized in our areas of interest. Acquisitions are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful or will not have a material adverse effect on our financial position, results of operations, or cash flows. All acquisitions require the approval of our Board of Directors.
Divestitures. We regularly review and evaluate our existing operations to determine whether our business model should change through the divestiture of certain businesses. Accordingly, from time to time, we may divest or wind-down certain non-core businesses and reallocate our resources to businesses that better align with our long-term strategic direction.
For detailed information regarding acquisitions and divestitures, see Note 6, "Acquisitions and Divestitures" of the "Notes to Consolidated Financial Statements" included in Item 8.
Competition
The market for our services is generally competitive. We often compete with many other firms ranging from small regional firms to large international firms.
We perform a broad spectrum of consulting, engineering, and technical services across the water, environment, infrastructure, resource management, energy, and international development markets. Our client base includes U.S. federal government agencies such as the DoD, USAID, the U.S. Department of Energy ("DOE"), the U.S. Environmental Protection Agency ("EPA"), and the FAA; U.S. state and local government agencies; government and commercial clients in Canada, Australia, and the United Kingdom; the U.S. commercial sector, which consists primarily of large industrial companies and utilities; and our international commercial clients. Our competition varies and is a function of the business areas in which, and the client sectors for which, we perform our services. The number of competitors for any procurement can vary widely, depending upon technical qualifications, the relative value of the project, geographic location, the financial terms and risks associated with the work, and any restrictions placed upon competition by the client. Historically, clients have chosen among competing firms by weighing the quality, innovation and timeliness of the firm's service versus its cost to determine which firm offers the best value. When less work becomes available in certain markets, price could become an increasingly important factor.
Our competitors vary depending on end markets and clients, and often we may only compete with a portion of a firm. We believe that our principal competitors include the following firms, in alphabetical order: AECOM; Arcadis NV; Black & Veatch Corporation; Booz Allen Hamilton; Brown & Caldwell; CDM Smith Inc.; Chemonics International, Inc.; Exponent, Inc.; GHD; ICF International, Inc.; Jacobs Engineering Group Inc.; Leidos, Inc.; SAIC; SNC-Lavalin Group Inc.; Stantec Inc.; TRC Companies, Inc.; Weston Solutions, Inc.; and WSP Global Inc.
Backlog
We include in our backlog only those contracts for which funding has been provided and work authorization has been received. We estimate that approximately 62% of our backlog at the end of fiscal 2019 will be recognized as revenue in fiscal
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2020, as work is being performed. However, we cannot guarantee that the revenue projected in our backlog will be realized or, if realized, will result in profits. In addition, project cancellations or scope adjustments may occur with respect to contracts reflected in our backlog. For example, certain of our contracts with the U.S. federal government and other clients are terminable at the discretion of the client, with or without cause. These types of backlog reductions could adversely affect our revenue and margins. Accordingly, our backlog as of any particular date is an uncertain indicator of our future earnings.
At fiscal 2019 year-end, our backlog was $3.1 billion, an increase of $428.0 million, or 16.1%, compared to fiscal 2018 year-end. Approximately $2.1 billion and $1.0 billion of our backlog at the end of fiscal 2019 related to GSG and CIG, respectively.
Regulations
We engage in various service activities that are subject to government oversight, including environmental laws and regulations, general government procurement laws and regulations, and other regulations and requirements imposed by the specific government agencies with which we conduct business.
Environmental. A significant portion of our business involves the planning, design, program management and construction management of pollution control facilities, as well as the assessment and management of remediation activities at hazardous waste sites, U.S. Superfund sites, and military bases. In addition, we contract with U.S. federal government entities to destroy hazardous materials. These activities require us to manage, handle, remove, treat, transport, and dispose of toxic or hazardous substances.
Some environmental laws, such as the U.S. Superfund law and similar state, provincial and local statutes, can impose liability for the entire cost of clean-up for contaminated facilities or sites upon present and former owners and operators, as well as generators, transporters, and persons arranging for the treatment or disposal of such substances. In addition, while we strive to handle hazardous and toxic substances with care and in accordance with safe methods, the possibility of accidents, leaks, spills, and events of force majeure always exist. Humans exposed to these materials, including workers or subcontractors engaged in the transportation and disposal of hazardous materials and persons in affected areas, may be injured or become ill. This could result in lawsuits that expose us to liability and substantial damage awards. Liabilities for contamination or human exposure to hazardous or toxic materials, or a failure to comply with applicable regulations, could result in substantial costs, including clean-up costs, fines, civil or criminal sanctions, third party claims for property damage or personal injury, or the cessation of remediation activities.
Certain of our business operations are covered by U.S. Public Law 85-804, which provides for government indemnification against claims and damages arising out of unusually hazardous activities performed at the request of the government. Due to changes in public policies and law, however, government indemnification may not be available in the case of any future claims or liabilities relating to other hazardous activities that we perform.
Government Procurement. The services we provide to the U.S. federal government are subject to the FAR and other rules and regulations applicable to government contracts. These rules and regulations:
• | require certification and disclosure of all cost and pricing data in connection with the contract negotiations under certain contract types; |
• | impose accounting rules that define allowable and unallowable costs and otherwise govern our right to reimbursement under certain cost-based government contracts; and |
• | restrict the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data. |
In addition, services provided to the DoD are monitored by the Defense Contract Management Agency and audited by the DCAA. Our government clients can also terminate any of their contracts, and many of our government contracts are subject to renewal or extension annually. Further, the services we provide to state and local government clients are subject to various government rules and regulations.
Seasonality
We experience seasonal trends in our business. Our revenue and operating income are typically lower in the first half of our fiscal year, primarily due to the Thanksgiving (in the U.S.), Christmas and New Year's holidays. Many of our clients' employees, as well as our own employees, take vacations during these holiday periods. Further, seasonal inclement weather conditions occasionally cause some of our offices to close temporarily or may hamper our project field work in the northern hemisphere's temperate and arctic regions. These occurrences result in fewer billable hours worked on projects and, correspondingly, less revenue recognized.
Potential Liability and Insurance
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Our business activities could expose us to potential liability under various laws and under workplace health and safety regulations. In addition, we occasionally assume liability by contract under indemnification agreements. We cannot predict the magnitude of such potential liabilities.
We maintain a comprehensive general liability insurance policy with an umbrella policy that covers losses beyond the general liability limits. We also maintain professional errors and omissions liability and contractor's pollution liability insurance policies. We believe that both policies provide adequate coverage for our business. When we perform higher-risk work, we obtain, if available, the necessary types of insurance coverage for such activities, as is typically required by our clients.
We obtain insurance coverage through a broker that is experienced in our industry. The broker and our risk manager regularly review the adequacy of our insurance coverage. Because there are various exclusions and retentions under our policies, or an insurance carrier may become insolvent, there can be no assurance that all potential liabilities will be covered by our insurance policies or paid by our carrier.
We evaluate the risk associated with insurance claims. If we determine that a loss is probable and reasonably estimable, we establish an appropriate reserve. A reserve is not established if we determine that a claim has no merit or is not probable or reasonably estimable. Our historic levels of insurance coverage and reserves have been adequate. However, partially or completely uninsured claims, if successful and of significant magnitude, could have a material adverse effect on our business.
Employees
At fiscal 2019 year-end, we had approximately 20,000 staff worldwide. A large percentage of our employees have technical and professional backgrounds and undergraduate and/or advanced degrees, including the employees of recently acquired companies. Our professional staff includes archaeologists, architects, biologists, chemical engineers, chemists, civil engineers, data scientists, computer scientists, economists, electrical engineers, environmental engineers, environmental scientists, geologists, hydrogeologists, mechanical engineers, oceanographers, project managers and toxicologists. We consider the current relationships with our employees to be favorable. We are not aware of any employment circumstances that are likely to disrupt work at any of our facilities. See Part I, Item 1A, "Risk Factors" for a discussion of the risks related to the loss of key personnel or our inability to attract and retain qualified personnel.
Executive Officers of the Registrant
The following table shows the name, age and position of each of our executive officers at November 22, 2019:
Name | Age | Position | |||
Dan L. Batrack | 61 | Chairman and Chief Executive Officer | |||
Mr. Batrack joined our predecessor in 1980 and was named Chairman in January 2008. He has served as our Chief Executive Officer and a director since November 2005, and as our President from October 2008 to September 2019. Mr. Batrack has served in numerous capacities over the last 30 years, including project scientist, project manager, operations manager, Senior Vice President and President of an operating unit. He has managed complex programs for many small and Fortune 500 clients, both in the United States and internationally. Mr. Batrack holds a B.A. degree in Business Administration from the University of Washington. | |||||
Leslie L. Shoemaker | 62 | President | |||
Dr. Shoemaker was appointed President in September 2019, having previously served as President of WEI Business Group from April 2015 to November 2017, and CIG from November 2017 to September 2019. Dr. Shoemaker joined us in 1991, and has served in various management capacities, including project and program manager, water resources manager and infrastructure group president. From 2005 to 2015, she led our strategic planning, business development and company-wide collaboration programs. Her technical expertise is in the management of large-scale watershed and master planning studies, development of modeling tools and application of optimization tools for decision making. Additionally, she is our Chief Sustainability Officer who leads our Sustainability Council to implement sustainability-related policies and practices company-wide. Dr. Shoemaker holds a B.A. degree in Mathematics from Hamilton College, a Master of Engineering from Cornell University and a Ph.D. in Agricultural Engineering from the University of Maryland. | |||||
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Name | Age | Position | |||
Steven M. Burdick | 55 | Executive Vice President, Chief Financial Officer | |||
Mr. Burdick has served as our Executive Vice President, Chief Financial Officer since April 2011. He served as our Senior Vice President and Corporate Controller from January 2004 to March 2011. Mr. Burdick joined us in April 2003 as Vice President, Management Audit. Previously, Mr. Burdick served in senior financial and executive positions with Aura Systems, Inc., TRW Ventures, and Ernst & Young LLP. Mr. Burdick holds a B.S. degree in Business Administration from Santa Clara University and is a Certified Public Accountant. | |||||
Derek G. Amidon | 52 | Senior Vice President, President of CIG and the Commercial Account Management Division of CIG | |||
Mr. Amidon was appointed President of CIG in September 2019, in addition to his role as President of CIG's Commercial Account Management Division. Mr. Amidon has served as a project manager, key account manager, operations manager, and regional manager since joining us in 2012. He has managed a variety of complex, high profile programs for key clients, including Fortune 100 companies. His focus has been on leading high value consulting services that deliver scientific, engineering and regulatory solutions for challenging environmental, engineering, permitting and public relations problems for energy, industrial, institutional and custodial trust clients. He has managed projects in the U.S., Africa, Australia, Europe, and the Caribbean. In addition to experience in both public and private consulting and engineering firms over his 24-year career, Mr. Amidon also served in a variety of business leadership and project development roles at Hess Corporation, a leading independent oil and gas company. Mr. Amidon is a registered Professional Engineer. He holds B.S. and M.S. degrees in Civil Engineering from Brigham Young University and a M.S. in Management from Rensselaer Polytechnic Institute. | |||||
Roger R. Argus | 58 | Senior Vice President, President of GSG and the U.S. Government Division of GSG | |||
Mr. Argus is a chemical engineer with 35 years of experience, including 27 years with us in operational leadership, program and project management, and quality assurance for projects encompassing a broad spectrum of environmental, engineering, information technology, and disaster management services. Mr. Argus has also been responsible for managing multidisciplinary contracts and projects in support of the U.S. federal government (i.e., Navy, the U.S. Army Corps of Engineers ("USACE"), and the EPA), state and municipal agencies, and private clients nationwide. The scope of his technical experience includes planning and directing environmental programs, developing data acquisition, management and analytics solutions, fund research and development support for innovative environmental technologies and waste treatment systems, municipal resiliency, and sustainability programs. Mr. Argus holds a B.S. in Chemical Engineering from California State University, Long Beach. | |||||
Jan K. Auman | 64 | Senior Vice President, President of the Global Development Services Division of GSG | |||
Mr. Auman joined us through an acquisition in 2007. He has over 40 years of experience managing large, complex international development and technical assistance operations, having served 10 years with the United States federal government and 30 years in the private sector. With 20 years of residence overseas in eight countries, Mr. Auman has hands-on technical expertise in the areas of natural resources management, conflict resolution, political transformation, institutional development, and policy formulation in the Middle East, the South Pacific, the Caribbean, and Africa. Mr. Auman’s overall direction for our international development operations includes technical, operational, administrative, fiscal, and representational responsibilities involving operations that manage projects in over 60 countries. He holds a B.A. in Political Science and Government from Pennsylvania State University and an M.I.A in International Administration from the School for International Training. | |||||
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Name | Age | Position | |||
William R. Brownlie | 66 | Senior Vice President, Chief Engineer and Corporate Risk Management Officer | |||
Dr. Brownlie was named Senior Vice President and Chief Engineer in September 2009, and Corporate Risk Management Officer in November 2013. From December 2005 to September 2009, he served as a Group President. Dr. Brownlie joined our predecessor in 1981 and was named a Senior Vice President in December 1993. Dr. Brownlie has managed various operating units and programs focusing on water resources and environmental services, including work with USACE, the U.S. Air Force, the U.S. Bureau of Reclamation and DOE. He is a registered professional engineer and has a strong technical background in water resources. Dr. Brownlie holds B.S. and M.S. degrees in Civil Engineering from the State University of New York at Buffalo and a Ph.D. in Civil Engineering from the California Institute of Technology. | |||||
Brian N. Carter | 52 | Senior Vice President, Corporate Controller and Chief Accounting Officer | |||
Mr. Carter joined us as Vice President, Corporate Controller and Chief Accounting Officer in June 2011 and was appointed Senior Vice President in October 2012. Previously, Mr. Carter served in finance and auditing positions in private industry and with Ernst & Young LLP. Mr. Carter holds a B.S. in Business Administration from Miami University and is a Certified Public Accountant. | |||||
Craig L. Christensen | 66 | Senior Vice President, Chief Information Officer | |||
Mr. Christensen joined us in 1998 through the acquisition of our Tetra Tech NUS, Inc. ("NUS") subsidiary. He is responsible for our information services and technologies, including the implementation of our enterprise resource planning system. Previously, Mr. Christensen held positions at NUS, Brown and Root Services, and Landmark Graphics subsidiaries of Halliburton Company where his responsibilities included contracts administration, finance, and system development. Prior to his service at Halliburton, Mr. Christensen held positions at Burroughs Corporation and Apple Computer. Mr. Christensen holds B.A. and M.B.A. degrees from Brigham Young University. | |||||
Preston Hopson | 43 | Senior Vice President, General Counsel and Secretary | |||
Mr. Hopson was appointed Senior Vice President, General Counsel and Secretary to the Board of Directors in January 2018. He also serves as the Chief Compliance Officer. For the prior 10 years, Mr. Hopson served as Vice President, Assistant General Counsel and Assistant Corporate Secretary at the engineering and infrastructure firm AECOM. Prior to this, he was a Senior Associate at the law firm O’Melveny & Myers LLP. Mr. Hopson began his career as a judicial clerk on the U.S. Court of Appeals for the Ninth Circuit. Mr. Hopson holds B.A. and J.D. degrees from Yale University. | |||||
Richard A. Lemmon | 60 | Senior Vice President, Corporate Administration | |||
Mr. Lemmon joined our predecessor in 1981 in a technical capacity and became a member of its corporate staff in a management position in 1985. In 1988, at the time of our predecessor's divestiture from Honeywell, Inc., Mr. Lemmon structured and managed many of our corporate functions. He is currently responsible for insurance, risk management, human resources, safety and facilities. | |||||
Brendan M. O'Rourke | 46 | Senior Vice President, Enterprise Risk Management | |||
Mr. O'Rourke joined us in January 2018 as Vice President, Enterprise Risk Management and was appointed Senior Vice President, Enterprise Risk Management in November 2018. For the prior 10 years, Mr. O'Rourke served as Assistant Vice President of Professional Liability Claims at AIG. Prior to this, he was a Senior Associate at the law firm of Seyfarth Shaw in Boston, Massachusetts. Mr. O'Rourke has more than twenty years of experience in risk management, contract negotiation, claim resolution and litigation within the construction industry. Mr. O'Rourke holds a J.D. from Suffolk Law School and a B.A. from Worcester State University. | |||||
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Name | Age | Position | |||
Mark A. Rynning | 58 | Senior Vice President, President of the U.S. Infrastructure Division of GSG | |||
Mr. Rynning has more than 30 years of experience in the engineering consulting industry, including 27 years with us. He is a registered professional engineer and has served us in numerous capacities including project manager, operations manager, and operating unit leader. He has managed large water infrastructure programs for state and local agencies throughout the United States. Mr. Rynning has broad experience in planning and design of water and wastewater infrastructure, utility master planning, and design of water and wastewater transmission and collection systems. In addition, Mr. Rynning has planned and designed reverse osmosis water treatment plants and advanced wastewater treatment systems. He has provided expert advisory services to numerous municipal clients for utility system acquisitions. He holds a B.S. in Civil Engineering and a Master of Business Administration, both from the University of Florida. | |||||
Bernard Teufele | 54 | Senior Vice President, President of the Canada and South America Division of CIG | |||
Mr. Teufele joined us through an acquisition in 2010. He has over 22 years of consulting engineering experience as a leader of a highly diversified, high-end infrastructure practice and as a technical expert in the field of infrastructure monitoring and asset management. Prior to his current role, Mr. Teufele has managed operating units of increasing size and complexity with a primary focus on infrastructure, environmental sciences, civil transportation, and mining-related services doing work for municipal, provincial, and federal government clients in Canada. He has managed key provincial infrastructure programs in Canada with a particular focus on the monitoring and assessment of roadway infrastructure and the development of asset management programs. Mr. Teufele has a B.Sc. in Applied Science from the University of British Columbia. | |||||
Available Information
Our website address is www.tetratech.com. We made available, free electronic copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports through the “Investor Relations” portion of our website, under the heading “SEC Filings” filed under “Financial Information.” These reports are available on our website as soon as reasonably practicable after we electronically file them with the Securities and Exchange Commission ("SEC"). These reports, and any amendments to them, are also available at the Internet website of the SEC, http://www.sec.gov. Also available on our website are our Corporate Governance Policies, Board Committees, Corporate Code of Conduct and Finance Code of Professional Conduct.
Item 1A. Risk Factors
We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could materially adversely affect our operations. Set forth below and elsewhere in this report and in other documents we file with the SEC are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. Additional risks we do not yet know of or that we currently think are immaterial may also affect our business operations. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could be materially adversely affected.
Continuing worldwide political and economic uncertainties may adversely affect our revenue and profitability.
The last several years have been periodically marked by political and economic concerns, including decreased consumer confidence, the lingering effects of international conflicts, energy costs and inflation. Although certain indices and economic data have shown signs of stabilization in the United States and certain global markets, there can be no assurance that these improvements will be broad-based or sustainable. This instability can make it extremely difficult for our clients, our vendors and us to accurately forecast and plan future business activities, and could cause constrained spending on our services, delays and a lengthening of our business development efforts, the demand for more favorable pricing or other terms, and/or difficulty in collection of our accounts receivable. Our government clients may face budget deficits that prohibit them from funding proposed and existing projects.
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Further, ongoing economic instability in the global markets could limit our ability to access the capital markets at a time when we would like, or need, to raise capital, which could have an impact on our ability to react to changing business conditions or new opportunities. If economic conditions remain uncertain or weaken, or government spending is reduced, our revenue and profitability could be adversely affected.
Changes in applicable tax regulations could negatively affect our financial results.
We are subject to taxation in the United States and numerous foreign jurisdictions. On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act ("TCJA"). The changes to U.S. tax law implemented by the TCJA are broad and complex. The final impacts of the TCJA may differ from the estimates provided elsewhere in this report, possibly materially, due to, among other things, changes in interpretations of the TCJA, any legislative action to address questions that arise because of the TCJA, any changes in accounting standards for income taxes or related interpretations in response to the TCJA, or any updates or changes in estimates we have utilized to calculate the impacts, including impacts from changes to current year earnings estimates and foreign exchange rates.
Demand for our services is cyclical and vulnerable to economic downturns. If economic growth slows, government fiscal conditions worsen, or client spending declines further, then our revenue, profits and financial condition may deteriorate.
Demand for our services is cyclical, and vulnerable to economic downturns and reductions in government and private industry spending. Such downturns or reductions may result in clients delaying, curtailing or canceling proposed and existing projects. Our business traditionally lags the overall recovery in the economy; therefore, our business may not recover immediately when the economy improves. If economic growth slows, government fiscal conditions worsen, or client spending declines, then our revenue, profits and overall financial condition may deteriorate. Our government clients may face budget deficits that prohibit them from funding new or existing projects. In addition, our existing and potential clients may either postpone entering into new contracts or request price concessions. Difficult financing and economic conditions may cause some of our clients to demand better pricing terms or delay payments for services we perform, thereby increasing the average number of days our receivables are outstanding, and the potential of increased credit losses of uncollectible invoices. Further, these conditions may result in the inability of some of our clients to pay us for services that we have already performed. If we are not able to reduce our costs quickly enough to respond to the revenue decline from these clients, our operating results may be adversely affected. Accordingly, these factors affect our ability to forecast our future revenue and earnings from business areas that may be adversely impacted by market conditions.
Our international operations expose us to legal, political, and economic risks in different countries as well as currency exchange rate fluctuations that could harm our business and financial results.
In fiscal 2019, we generated 27.7% of our revenue from our international operations, primarily in Canada, Australia, the United Kingdom and from international clients for work that is performed by our domestic operations. International business is subject to a variety of risks, including:
• | imposition of governmental controls and changes in laws, regulations, or policies; |
• | lack of developed legal systems to enforce contractual rights; |
• | greater risk of uncollectible accounts and longer collection cycles; |
• | currency exchange rate fluctuations, devaluations, and other conversion restrictions; |
• | uncertain and changing tax rules, regulations, and rates; |
• | the potential for civil unrest, acts of terrorism, force majeure, war or other armed conflict, and greater physical security risks, which may cause us to have to leave a country quickly; |
• | logistical and communication challenges; |
• | changes in regulatory practices, including tariffs and taxes; |
• | changes in labor conditions; |
• | general economic, political, and financial conditions in foreign markets; and |
• | exposure to civil or criminal liability under the U.S. Foreign Corrupt Practices Act (“FCPA”), the U.K. Bribery Act, the Canadian Corruption of Foreign Public Officials Act, the Brazilian Clean Companies Act, the anti-boycott rules, trade and export control regulations, as well as other international regulations. |
For example, an ongoing government investigation into political corruption in Quebec contributed to the slow-down in procurements and business activity in that province, which adversely affected our business. The Province of Quebec has adopted legislation that requires businesses and individuals seeking contracts with governmental bodies be certified by a Quebec regulatory authority for contracts over a specified size. Our failure to maintain certification could adversely affect our business.
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International risks and violations of international regulations may significantly reduce our revenue and profits, and subject us to criminal or civil enforcement actions, including fines, suspensions, or disqualification from future U.S. federal procurement contracting. Although we have policies and procedures to monitor legal and regulatory compliance, our employees, subcontractors, and agents could take actions that violate these requirements. As a result, our international risk exposure may be more or less than the percentage of revenue attributed to our international operations.
The United Kingdom's proposed withdrawal from the European Union could have an adverse effect on our business and financial results.
In March 2017, the United Kingdom government initiated a process to withdraw from the European Union ("Brexit") and began negotiating the terms of the separation. Brexit has created substantial economic and political uncertainty and volatility in currency exchange rates, and the terms of the United Kingdom's withdrawal from the European Union remain uncertain. The uncertainty created by Brexit may cause our customers to closely monitor their costs and reduce demand for our services and may ultimately result in new regulatory and cost challenges for our United Kingdom and global operations. Any of these events could adversely affect our United Kingdom, European and overall business and financial results.
We derive a substantial amount of our revenue from U.S. federal, state and local government agencies, and any disruption in government funding or in our relationship with those agencies could adversely affect our business.
In fiscal 2019, we generated 49.2% of our revenue from contracts with U.S. federal, and state and local government agencies. A significant amount of this revenue is derived under multi-year contracts, many of which are appropriated on an annual basis. As a result, at the beginning of a project, the related contract may be only partially funded, and additional funding is normally committed only as appropriations are made in each subsequent year. These appropriations, and the timing of payment of appropriated amounts, may be influenced by numerous factors as noted below. Our backlog includes only the projects that have funding appropriated.
The demand for our U.S. government-related services is generally driven by the level of government program funding. Accordingly, the success and further development of our business depends, in large part, upon the continued funding of these U.S. government programs, and upon our ability to obtain contracts and perform well under these programs. Under the Budget Control Act of 2011, an automatic sequestration process, or across-the-board budget cuts (a large portion of which was defense-related), was triggered. The sequestration began on March 1, 2013. Although the Bipartisan Budget Act of 2013 provided some sequester relief through the end of fiscal year 2015, the sequestration requires reduced U.S. federal government spending through fiscal year 2021. A significant reduction in federal government spending, the absence of a bipartisan agreement on the federal government budget, a partial or full federal government shutdown, or a change in budgetary priorities could reduce demand for our services, cancel or delay federal projects, result in the closure of federal facilities and significant personnel reductions, and have a material and adverse impact on our business, financial condition, results of operations and cash flows.
There are several additional factors that could materially affect our U.S. government contracting business, which could cause U.S. government agencies to delay or cancel programs, to reduce their orders under existing contracts, to exercise their rights to terminate contracts or not to exercise contract options for renewals or extensions. Such factors, which include the following, could have a material adverse effect on our revenue or the timing of contract payments from U.S. government agencies:
• | the failure of the U.S. government to complete its budget and appropriations process before its fiscal year-end, which would result in the funding of government operations by means of a continuing resolution that authorizes agencies to continue to operate but does not authorize new spending initiatives. As a result, U.S. government agencies may delay the procurement of services; |
• | changes in and delays or cancellations of government programs, requirements or appropriations; |
• | budget constraints or policy changes resulting in delay or curtailment of expenditures related to the services we provide; |
• | re-competes of government contracts; |
• | the timing and amount of tax revenue received by federal, and state and local governments, and the overall level of government expenditures; |
• | curtailment in the use of government contracting firms; |
• | delays associated with insufficient numbers of government staff to oversee contracts; |
• | the increasing preference by government agencies for contracting with small and disadvantaged businesses; |
• | competing political priorities and changes in the political climate regarding the funding or operation of the services we provide; |
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• | the adoption of new laws or regulations affecting our contracting relationships with the federal, state or local governments; |
• | unsatisfactory performance on government contracts by us or one of our subcontractors, negative government audits or other events that may impair our relationship with federal, state or local governments; |
• | a dispute with or improper activity by any of our subcontractors; and |
• | general economic or political conditions. |
Our inability to win or renew U.S. government contracts during regulated procurement processes could harm our operations and significantly reduce or eliminate our profits.
U.S. government contracts are awarded through a regulated procurement process. The U.S. federal government has increasingly relied upon multi-year contracts with pre-established terms and conditions, such as indefinite delivery/indefinite quantity (“IDIQ”) contracts, which generally require those contractors who have previously been awarded the IDIQ to engage in an additional competitive bidding process before a task order is issued. As a result, new work awards tend to be smaller and of shorter duration, since the orders represent individual tasks rather than large, programmatic assignments. In addition, we believe that there has been an increase in the award of federal contracts based on a low-price, technically acceptable criteria emphasizing price over qualitative factors, such as past performance. As a result, pricing pressure may reduce our profit margins on future federal contracts. The increased competition and pricing pressure, in turn, may require us to make sustained efforts to reduce costs in order to realize revenue, and profits under government contracts. If we are not successful in reducing the amount of costs we incur, our profitability on government contracts will be negatively impacted. In addition, the U.S. federal government has scaled back outsourcing of services in favor of “insourcing” jobs to its employees, which could reduce our revenue. Moreover, even if we are qualified to work on a government contract, we may not be awarded the contract because of existing government policies designed to protect small businesses and under-represented minority contractors. Our inability to win or renew government contracts during regulated procurement processes could harm our operations and significantly reduce or eliminate our profits.
Each year, client funding for some of our U.S. government contracts may rely on government appropriations or public-supported financing. If adequate public funding is delayed or is not available, then our profits and revenue could decline.
Each year, client funding for some of our U.S. government contracts may directly or indirectly rely on government appropriations or public-supported financing. Legislatures may appropriate funds for a given project on a year-by-year basis, even though the project may take more than one year to perform. In addition, public-supported financing such as U.S. state and local municipal bonds may be only partially raised to support existing projects. Similarly, an economic downturn may make it more difficult for U.S. state and local governments to fund projects. In addition to the state of the economy and competing political priorities, public funds and the timing of payment of these funds may be influenced by, among other things, curtailments in the use of government contracting firms, increases in raw material costs, delays associated with insufficient numbers of government staff to oversee contracts, budget constraints, the timing and amount of tax receipts, and the overall level of government expenditures. If adequate public funding is not available or is delayed, then our profits and revenue could decline.
Our U.S. federal government contracts may give government agencies the right to modify, delay, curtail, renegotiate, or terminate existing contracts at their convenience at any time prior to their completion, which may result in a decline in our profits and revenue.
U.S. federal government projects in which we participate as a contractor or subcontractor may extend for several years. Generally, government contracts include the right to modify, delay, curtail, renegotiate, or terminate contracts and subcontracts at the government’s convenience any time prior to their completion. Any decision by a U.S. federal government client to modify, delay, curtail, renegotiate, or terminate our contracts at their convenience may result in a decline in our profits and revenue.
As a U.S. government contractor, we must comply with various procurement laws and regulations and are subject to regular government audits; a violation of any of these laws and regulations or the failure to pass a government audit could result in sanctions, contract termination, forfeiture of profit, harm to our reputation or loss of our status as an eligible government contractor and could reduce our profits and revenue.
We must comply with and are affected by U.S. federal, state, local, and foreign laws and regulations relating to the formation, administration and performance of government contracts. For example, we must comply with FAR, the Truth in Negotiations Act, CAS, the American Recovery and Reinvestment Act of 2009, the Services Contract Act, and the DoD security regulations, as well as many other rules and regulations. In addition, we must comply with other government regulations related to employment practices, environmental protection, health and safety, tax, accounting, and anti-fraud measures, as well as many other regulations in order to maintain our government contractor status. These laws and regulations affect how we do business with our clients and, in some instances, impose additional costs on our business operations. Although we take precautions to
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prevent and deter fraud, misconduct, and non-compliance, we face the risk that our employees or outside partners may engage in misconduct, fraud, or other improper activities. U.S. government agencies, such as the DCAA, routinely audit and investigate government contractors. These government agencies review and audit a government contractor’s performance under its contracts and cost structure, and evaluate compliance with applicable laws, regulations, and standards. In addition, during the course of its audits, the DCAA may question our incurred project costs. If the DCAA believes we have accounted for such costs in a manner inconsistent with the requirements for FAR or CAS, the DCAA auditor may recommend to our U.S. government corporate administrative contracting officer that such costs be disallowed. Historically, we have not experienced significant disallowed costs as a result of government audits. However, we can provide no assurance that the DCAA or other government audits will not result in material disallowances for incurred costs in the future. In addition, U.S. government contracts are subject to various other requirements relating to the formation, administration, performance, and accounting for these contracts. We may also be subject to qui tam litigation brought by private individuals on behalf of the U.S. government under the Federal Civil False Claims Act, which could include claims for treble damages. For example, as discussed elsewhere in this report, on January 14, 2019, the Civil Division of the United States Attorney's Office ("USAO") filed complaints in intervention in three qui tam actions filed against our subsidiary, Tetra Tech EC, Inc. ("TtEC"), in the U.S. District Court for the Northern District of California. The complaints allege False Claims Act violations and breach of contract related to TtEC's contracts to perform environmental remediation services at the former Hunters Point Naval Shipyard in San Francisco, California. TtEC disputes the claims and will defend this matter vigorously. U.S. government contract violations could result in the imposition of civil and criminal penalties or sanctions, contract termination, forfeiture of profit, and/or suspension of payment, any of which could make us lose our status as an eligible government contractor. We could also suffer serious harm to our reputation. Any interruption or termination of our U.S. government contractor status could reduce our profits and revenue significantly.
If we extend a significant portion of our credit to clients in a specific geographic area or industry, we may experience disproportionately high levels of collection risk and nonpayment if those clients are adversely affected by factors particular to their geographic area or industry.
Our clients include public and private entities that have been, and may continue to be, negatively impacted by the changing landscape in the global economy. While outside of the U.S. federal government no one client accounted for over 10% of our revenue for fiscal 2019, we face collection risk as a normal part of our business where we perform services and subsequently bill our clients for such services. In the event that we have concentrated credit risk from clients in a specific geographic area or industry, continuing negative trends or a worsening in the financial condition of that specific geographic area or industry could make us susceptible to disproportionately high levels of default by those clients. Such defaults could materially adversely impact our revenues and our results of operations.
We have made and expect to continue to make acquisitions. Acquisitions could disrupt our operations and adversely impact our business and operating results. Our failure to conduct due diligence effectively, or our inability to successfully integrate acquisitions, could impede us from realizing all of the benefits of the acquisitions, which could weaken our results of operations.
A key part of our growth strategy is to acquire other companies that complement our lines of business or that broaden our technical capabilities and geographic presence. We expect to continue to acquire companies as an element of our growth strategy; however, our ability to make acquisitions is restricted under our credit agreement. Acquisitions involve certain known and unknown risks that could cause our actual growth or operating results to differ from our expectations or the expectations of securities analysts. For example:
• | we may not be able to identify suitable acquisition candidates or to acquire additional companies on acceptable terms; |
• | we are pursuing international acquisitions, which inherently pose more risk than domestic acquisitions; |
• | we compete with others to acquire companies, which may result in decreased availability of, or increased price for, suitable acquisition candidates; |
• | we may not be able to obtain the necessary financing, on favorable terms or at all, to finance any of our potential acquisitions; |
• | we may ultimately fail to consummate an acquisition even if we announce that we plan to acquire a company; and |
• | acquired companies may not perform as we expect, and we may fail to realize anticipated revenue and profits. |
In addition, our acquisition strategy may divert management’s attention away from our existing businesses, resulting in the loss of key clients or key employees, and expose us to unanticipated problems or legal liabilities, including responsibility as a successor-in-interest for undisclosed or contingent liabilities of acquired businesses or assets.
If we fail to conduct due diligence on our potential targets effectively, we may, for example, not identify problems at target companies, or fail to recognize incompatibilities or other obstacles to successful integration. Our inability to successfully
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integrate future acquisitions could impede us from realizing all of the benefits of those acquisitions and could severely weaken our business operations. The integration process may disrupt our business and, if implemented ineffectively, may preclude realization of the full benefits expected by us and could harm our results of operations. In addition, the overall integration of the combining companies may result in unanticipated problems, expenses, liabilities, and competitive responses, and may cause our stock price to decline. The difficulties of integrating an acquisition include, among others:
• | issues in integrating information, communications, and other systems; |
• | incompatibility of logistics, marketing, and administration methods; |
• | maintaining employee morale and retaining key employees; |
• | integrating the business cultures of both companies; |
• | preserving important strategic client relationships; |
• | consolidating corporate and administrative infrastructures, and eliminating duplicative operations; and |
• | coordinating and integrating geographically separate organizations. |
In addition, even if the operations of an acquisition are integrated successfully, we may not realize the full benefits of the acquisition, including the synergies, cost savings or growth opportunities that we expect. These benefits may not be achieved within the anticipated time frame, or at all.
Further, acquisitions may cause us to:
• | issue common stock that would dilute our current stockholders’ ownership percentage; |
• | use a substantial portion of our cash resources; |
• | increase our interest expense, leverage, and debt service requirements (if we incur additional debt to fund an acquisition); |
• | assume liabilities, including environmental liabilities, for which we do not have indemnification from the former owners. Further, indemnification obligations may be subject to dispute or concerns regarding the creditworthiness of the former owners; |
• | record goodwill and non-amortizable intangible assets that are subject to impairment testing and potential impairment charges; |
• | experience volatility in earnings due to changes in contingent consideration related to acquisition earn-out liability estimates; |
• | incur amortization expenses related to certain intangible assets; |
• | lose existing or potential contracts as a result of conflict of interest issues; |
• | incur large and immediate write-offs; or |
• | become subject to litigation. |
Finally, acquired companies that derive a significant portion of their revenue from the U.S. federal government and do not follow the same cost accounting policies and billing practices that we follow may be subject to larger cost disallowances for greater periods than we typically encounter. If we fail to determine the existence of unallowable costs and do not establish appropriate reserves at acquisition, we may be exposed to material unanticipated liabilities, which could have a material adverse effect on our business.
If our goodwill or intangible assets become impaired, then our profits may be significantly reduced.
Because we have historically acquired a significant number of companies, goodwill and intangible assets represent a substantial portion of our assets. As of September 29, 2019, our goodwill was $924.8 million and other intangible assets were $16.4 million. We are required to perform a goodwill impairment test for potential impairment at least on an annual basis. We also assess the recoverability of the unamortized balance of our intangible assets when indications of impairment are present based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. The goodwill impairment test requires us to determine the fair value of our reporting units, which are the components one level below our reportable segments. In determining fair value, we make significant judgments and estimates, including assumptions about our strategic plans with regard to our operations. We also analyze current economic indicators and market valuations to help determine fair value. To the extent economic conditions that would impact the future operations of our reporting units change, our goodwill may be deemed to be impaired, and we would be required to record a non-cash charge that could result in a material adverse effect on our financial position or results of operations. For example, we had goodwill impairment of $7.8 million in fiscal 2019. We had no goodwill impairment in fiscal 2017 or fiscal 2018.
We could be adversely affected by violations of the FCPA and similar worldwide anti-bribery laws.
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The FCPA and similar anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to foreign government officials for the purpose of obtaining or retaining business. The U.K. Bribery Act of 2010 prohibits both domestic and international bribery, as well as bribery across both private and public sectors. In addition, an organization that “fails to prevent bribery” by anyone associated with the organization can be charged under the U.K. Bribery Act unless the organization can establish the defense of having implemented “adequate procedures” to prevent bribery. Improper payments are also prohibited under the Canadian Corruption of Foreign Public Officials Act and the Brazilian Clean Companies Act. Local business practices in many countries outside the United States create a greater risk of government corruption than that found in the United States and other more developed countries. Our policies mandate compliance with anti-bribery laws, and we have established policies and procedures designed to monitor compliance with anti-bribery law requirements; however, we cannot ensure that our policies and procedures will protect us from potential reckless or criminal acts committed by individual employees or agents. If we are found to be liable for anti-bribery law violations, we could suffer from criminal or civil penalties or other sanctions that could have a material adverse effect on our business.
We could be adversely impacted if we fail to comply with domestic and international export laws.
To the extent we export technical services, data and products outside of the United States, we are subject to U.S. and international laws and regulations governing international trade and exports, including but not limited to the International Traffic in Arms Regulations, the Export Administration Regulations, and trade sanctions against embargoed countries. A failure to comply with these laws and regulations could result in civil or criminal sanctions, including the imposition of fines, the denial of export privileges, and suspension or debarment from participation in U.S. government contracts, which could have a material adverse effect on our business.
If we fail to complete a project in a timely manner, miss a required performance standard, or otherwise fail to adequately perform on a project, then we may incur a loss on that project, which may reduce or eliminate our overall profitability.
Our engagements often involve large-scale, complex projects. The quality of our performance on such projects depends in large part upon our ability to manage the relationship with our clients and our ability to effectively manage the project and deploy appropriate resources, including third-party contractors and our own personnel, in a timely manner. We may commit to a client that we will complete a project by a scheduled date. We may also commit that a project, when completed, will achieve specified performance standards. If the project is not completed by the scheduled date or fails to meet required performance standards, we may either incur significant additional costs or be held responsible for the costs incurred by the client to rectify damages due to late completion or failure to achieve the required performance standards. The uncertainty of the timing of a project can present difficulties in planning the amount of personnel needed for the project. If the project is delayed or canceled, we may bear the cost of an underutilized workforce that was dedicated to fulfilling the project. In addition, performance of projects can be affected by a number of factors beyond our control, including unavoidable delays from government inaction, public opposition, inability to obtain financing, weather conditions, unavailability of vendor materials, changes in the project scope of services requested by our clients, industrial accidents, environmental hazards, and labor disruptions. To the extent these events occur, the total costs of the project could exceed our estimates, and we could experience reduced profits or, in some cases, incur a loss on a project, which may reduce or eliminate our overall profitability. Further, any defects or errors, or failures to meet our clients’ expectations, could result in claims for damages against us. Failure to meet performance standards or complete performance on a timely basis could also adversely affect our reputation.
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The loss of key personnel or our inability to attract and retain qualified personnel could impair our ability to provide services to our clients and otherwise conduct our business effectively.
As primarily a professional and technical services company, we are labor-intensive and, therefore, our ability to attract, retain, and expand our senior management and our professional and technical staff is an important factor in determining our future success. The market for qualified scientists and engineers is competitive and, from time to time, it may be difficult to attract and retain qualified individuals with the required expertise within the timeframe demanded by our clients. For example, some of our U.S. government contracts may require us to employ only individuals who have particular government security clearance levels. In addition, we rely heavily upon the expertise and leadership of our senior management. If we are unable to retain executives and other key personnel, the roles and responsibilities of those employees will need to be filled, which may require that we devote time and resources to identify, hire, and integrate new employees. With limited exceptions, we do not have employment agreements with any of our key personnel. The loss of the services of any of these key personnel could adversely affect our business. Although we have obtained non-compete agreements from certain principals and stockholders of companies we have acquired, we generally do not have non-compete or employment agreements with key employees who were once equity holders of these companies. Further, many of our non-compete agreements have expired. We do not maintain key-man life insurance policies on any of our executive officers or senior managers. Our failure to attract and retain key individuals could impair our ability to provide services to our clients and conduct our business effectively.
Our revenue and growth prospects may be harmed if we or our employees are unable to obtain government granted eligibility or other qualifications we and they need to perform services for our customers.
A number of government programs require contractors to have certain kinds of government granted eligibility, such as security clearance credentials. Depending on the project, eligibility can be difficult and time-consuming to obtain. If we or our employees are unable to obtain or retain the necessary eligibility, we may not be able to win new business, and our existing customers could terminate their contracts with us or decide not to renew them. To the extent we cannot obtain or maintain the required security clearances for our employees working on a particular contract, we may not derive the revenue or profit anticipated from such contract.
Our actual business and financial results could differ from the estimates and assumptions that we use to prepare our consolidated financial statements, which may significantly reduce or eliminate our profits.
To prepare consolidated financial statements in conformity with generally accepted accounting principles in the United States of America ("GAAP"), management is required to make estimates and assumptions as of the date of the consolidated financial statements. These estimates and assumptions affect the reported values of assets, liabilities, revenue and expenses, as well as disclosures of contingent assets and liabilities. For example, we typically recognize revenue over the life of a contract based on the proportion of costs incurred to date compared to the total costs estimated to be incurred for the entire project. Areas requiring significant estimates by our management include:
• | the application of the percentage-of-completion method of accounting and revenue recognition on contracts, change orders, and contract claims, including related unbilled accounts receivable; |
• | unbilled accounts receivable, including amounts related to requests for equitable adjustment to contracts that provide for price redetermination, primarily with the U.S. federal government. These amounts are recorded only when they can be reliably estimated, and realization is probable; |
• | provisions for uncollectible receivables, client claims, and recoveries of costs from subcontractors, vendors, and others; |
• | provisions for income taxes, research and development tax credits, valuation allowances, and unrecognized tax benefits; |
• | value of goodwill and recoverability of intangible assets; |
• | valuations of assets acquired and liabilities assumed in connection with business combinations; |
• | valuation of contingent earn-out liabilities recorded in connection with business combinations; |
• | valuation of employee benefit plans; |
• | valuation of stock-based compensation expense; and |
• | accruals for estimated liabilities, including litigation and insurance reserves. |
Our actual business and financial results could differ from those estimates, which may significantly reduce or eliminate our profits.
Our profitability could suffer if we are not able to maintain adequate utilization of our workforce.
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The cost of providing our services, including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including:
• | our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; |
• | our ability to forecast demand for our services and thereby maintain an appropriate headcount in each of our geographies and operating units; |
• | our ability to manage attrition; |
• | our need to devote time and resources to training, business development, professional development, and other non-chargeable activities; and |
• | our ability to match the skill sets of our employees to the needs of the marketplace. |
If we over-utilize our workforce, our employees may become disengaged, which could impact employee attrition. If we under-utilize our workforce, our profit margin and profitability could suffer.
Our use of the percentage-of-completion method of revenue recognition could result in a reduction or reversal of previously recorded revenue and profits.
We account for most of our contracts on the percentage-of-completion method of revenue recognition. Generally, our use of this method results in recognition of revenue and profit ratably over the life of the contract, based on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to estimated revenue and costs, including the achievement of award fees and the impact of change orders and claims, are recorded when the amounts are known and can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including reductions or reversals of previously recorded revenue and profit.
If we are unable to accurately estimate and control our contract costs, then we may incur losses on our contracts, which could decrease our operating margins and reduce our profits. Specifically, our fixed-price contracts could increase the unpredictability of our earnings.
It is important for us to accurately estimate and control our contract costs so that we can maintain positive operating margins and profitability. We generally enter into three principal types of contracts with our clients: fixed-price, time-and-materials and cost-plus.
The U.S. federal government and certain other clients have increased the use of fixed-priced contracts. Under fixed-price contracts, we receive a fixed price irrespective of the actual costs we incur and, consequently, we are exposed to a number of risks. We realize a profit on fixed-price contracts only if we can control our costs and prevent cost over-runs on our contracts. Fixed-price contracts require cost and scheduling estimates that are based on a number of assumptions, including those about future economic conditions, costs, and availability of labor, equipment and materials, and other exigencies. We could experience cost over-runs if these estimates are originally inaccurate as a result of errors or ambiguities in the contract specifications, or become inaccurate as a result of a change in circumstances following the submission of the estimate due to, among other things, unanticipated technical problems, difficulties in obtaining permits or approvals, changes in local laws or labor conditions, weather delays, changes in the costs of raw materials, or the inability of our vendors or subcontractors to perform. If cost overruns occur, we could experience reduced profits or, in some cases, a loss for that project. If a project is significant, or if there are one or more common issues that impact multiple projects, costs overruns could increase the unpredictability of our earnings, as well as have a material adverse impact on our business and earnings.
Under our time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and paid for other expenses. Profitability on these contracts is driven by billable headcount and cost control. Many of our time-and-materials contracts are subject to maximum contract values and, accordingly, revenue relating to these contracts is recognized as if these contracts were fixed-price contracts. Under our cost-plus contracts, some of which are subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be able to obtain reimbursement for all of the costs we incur.
Profitability on our contracts is driven by billable headcount and our ability to manage our subcontractors, vendors, and material suppliers. If we are unable to accurately estimate and manage our costs, we may incur losses on our contracts, which could decrease our operating margins and significantly reduce or eliminate our profits. Certain of our contracts require us to satisfy
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specific design, engineering, procurement, or construction milestones in order to receive payment for the work completed or equipment or supplies procured prior to achievement of the applicable milestone. As a result, under these types of arrangements, we may incur significant costs or perform significant amounts of services prior to receipt of payment. If a client determines not to proceed with the completion of the project or if the client defaults on its payment obligations, we may face difficulties in collecting payment of amounts due to us for the costs previously incurred or for the amounts previously expended to purchase equipment or supplies.
Accounting for a contract requires judgments relative to assessing the contract’s estimated risks, revenue, costs, and other technical issues. Due to the size and nature of many of our contracts, the estimation of overall risk, revenue, and cost at completion is complicated and subject to many variables. Changes in underlying assumptions, circumstances, or estimates may also adversely affect future period financial performance. If we are unable to accurately estimate the overall revenue or costs on a contract, then we may experience a lower profit or incur a loss on the contract.
Our failure to adequately recover on claims brought by us against clients for additional contract costs could have a negative impact on our liquidity and profitability.
We have brought claims against clients for additional costs exceeding the contract price or for amounts not included in the original contract price. These types of claims occur due to matters such as client-caused delays or changes from the initial project scope, both of which may result in additional cost. Often, these claims can be the subject of lengthy arbitration or litigation proceedings, and it is difficult to accurately predict when these claims will be fully resolved. When these types of events occur and unresolved claims are pending, we have used working capital in projects to cover cost overruns pending the resolution of the relevant claims. A failure to promptly recover on these types of claims could have a negative impact on our liquidity and profitability. Total accounts receivable at September 29, 2019 included approximately $15 million related to such claims.
Our failure to win new contracts and renew existing contracts with private and public sector clients could adversely affect our profitability.
Our business depends on our ability to win new contracts and renew existing contracts with private and public sector clients. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which is affected by a number of factors. These factors include market conditions, financing arrangements, and required governmental approvals. For example, a client may require us to provide a bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions arise, or if we fail to secure adequate financial arrangements or the required government approval, we may not be able to pursue certain projects, which could adversely affect our profitability.
If we are not able to successfully manage our growth strategy, our business and results of operations may be adversely affected.
Our expected future growth presents numerous managerial, administrative, operational, and other challenges. Our ability to manage the growth of our operations will require us to continue to improve our management information systems and our other internal systems and controls. In addition, our growth will increase our need to attract, develop, motivate, and retain both our management and professional employees. The inability to effectively manage our growth or the inability of our employees to achieve anticipated performance could have a material adverse effect on our business.
Our backlog is subject to cancellation, unexpected adjustments and changing economic conditions, and is an uncertain indicator of future operating results.
Our backlog at September 29, 2019 was $3.1 billion, an increase of $428.0 million, or 16.1%, compared to the end of fiscal 2018. We include in backlog only those contracts for which funding has been provided and work authorizations have been received. We cannot guarantee that the revenue projected in our backlog will be realized or, if realized, will result in profits. In addition, project cancellations or scope adjustments may occur, from time to time, with respect to contracts reflected in our backlog. For example, certain of our contracts with the U.S. federal government and other clients are terminable at the discretion of the client, with or without cause. These types of backlog reductions could adversely affect our revenue and margins. As a result of these factors, our backlog as of any particular date is an uncertain indicator of our future earnings.
Cyber security breaches of our systems and information technology could adversely impact our ability to operate.
We develop, install and maintain information technology systems for ourselves, as well as for customers. Client contracts for the performance of information technology services, as well as various privacy and securities laws, require us to manage and protect sensitive and confidential information, including federal and other government information, from disclosure. We also need
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to protect our own internal trade secrets and other business confidential information, as well as personal data of our employees and contractors, from disclosure. For example, the European Union's General Data Protection Regulation, which became effective in May 2018, extends the scope of the European Union data protection laws to all companies processing data of European Union residents, regardless of the company's location. In addition, the California Consumer Privacy Act takes effect in January 2020, increasing the penalties for data privacy incidents. We face the threat to our computer systems of unauthorized access, computer hackers, computer viruses, malicious code, organized cyber-attacks and other security problems and system disruptions, including possible unauthorized access to our and our clients' proprietary or classified information. We rely on industry-accepted security measures and technology to securely maintain all confidential and proprietary information on our information systems. In the ordinary course of business, we have been targeted by malicious cyber-attacks. We have devoted and will continue to devote significant resources to the security of our computer systems, but they may still be vulnerable to these threats. A user who circumvents security measures could misappropriate confidential or proprietary information, including information regarding us, our personnel and/or our clients, or cause interruptions or malfunctions in operations. As a result, we may be required to expend significant resources to protect against the threat of these system disruptions and security breaches or to alleviate problems caused by these disruptions and breaches. We also rely in part on third-party software and information technology vendors to run our critical accounting, project management and financial information systems. We depend on our software and information technology vendors to provide long-term software and hardware support for our information systems. Our software and information technology vendors may decide to discontinue further development, integration or long-term software and hardware support for our information systems, in which case we may need to abandon one or more of our current information systems and migrate some or all of our accounting, project management and financial information to other systems, thus increasing our operational expense, as well as disrupting the management of our business operations. Any of these events could damage our reputation and have a material adverse effect on our business, financial condition, results of operations and cash flows.
If our business partners fail to perform their contractual obligations on a project, we could be exposed to legal liability, loss of reputation and profit reduction or loss on the project.
We routinely enter into subcontracts and, occasionally, joint ventures, teaming arrangements, and other contractual arrangements so that we can jointly bid and perform on a particular project. Success under these arrangements depends in large part on whether our business partners fulfill their contractual obligations satisfactorily. In addition, when we operate through a joint venture in which we are a minority holder, we have limited control over many project decisions, including decisions related to the joint venture’s internal controls, which may not be subject to the same internal control procedures that we employ. If these unaffiliated third parties do not fulfill their contract obligations, the partnerships or joint ventures may be unable to adequately perform and deliver their contracted services. Under these circumstances, we may be obligated to pay financial penalties, provide additional services to ensure the adequate performance and delivery of the contracted services, and may be jointly and severally liable for the other’s actions or contract performance. These additional obligations could result in reduced profits and revenues or, in some cases, significant losses for us with respect to the joint venture, which could also affect our reputation in the industries we serve.
If our contractors and subcontractors fail to satisfy their obligations to us or other parties, or if we are unable to maintain these relationships, our revenue, profitability, and growth prospects could be adversely affected.
We depend on contractors and subcontractors in conducting our business. There is a risk that we may have disputes with our subcontractors arising from, among other things, the quality and timeliness of work performed by the subcontractor, client concerns about the subcontractor, or our failure to extend existing task orders or issue new task orders under a subcontract. In addition, if a subcontractor fails to deliver on a timely basis the agreed-upon supplies, fails to perform the agreed-upon services, or goes out of business, then we may be required to purchase the services or supplies from another source at a higher price, and our ability to fulfill our obligations as a prime contractor may be jeopardized. This may reduce the profit to be realized or result in a loss on a project for which the services or supplies are needed.
We also rely on relationships with other contractors when we act as their subcontractor or joint venture partner. The absence of qualified subcontractors with which we have a satisfactory relationship could adversely affect the quality of our service and our ability to perform under some of our contracts. Our future revenue and growth prospects could be adversely affected if other contractors eliminate or reduce their subcontracts or teaming arrangement relationships with us, or if a government agency terminates or reduces these other contractors’ programs, does not award them new contracts, or refuses to pay under a contract.
Our failure to meet contractual schedule or performance requirements that we have guaranteed could adversely affect our operating results.
In certain circumstances, we can incur liquidated or other damages if we do not achieve project completion by a scheduled date. If we or an entity for which we have provided a guarantee subsequently fails to complete the project as scheduled and the
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matter cannot be satisfactorily resolved with the client, we may be responsible for cost impacts to the client resulting from any delay or the cost to complete the project. Our costs generally increase from schedule delays and/or could exceed our projections for a particular project. In addition, project performance can be affected by a number of factors beyond our control, including unavoidable delays from governmental inaction, public opposition, inability to obtain financing, weather conditions, unavailability of vendor materials, changes in the project scope of services requested by our clients, industrial accidents, environmental hazards, labor disruptions and other factors. As a result, material performance problems for existing and future contracts could cause actual results of operations to differ from those anticipated by us and could cause us to suffer damage to our reputation within our industry and client base.
New legal requirements could adversely affect our operating results.
Our business and results of operations could be adversely affected by the passage of climate change, defense, environmental, infrastructure and other legislation, policies and regulations. Growing concerns about climate change may result in the imposition of additional environmental regulations. For example, legislation, international protocols, regulation or other restrictions on emissions could increase the costs of projects for our clients or, in some cases, prevent a project from going forward, thereby potentially reducing the need for our services. In addition, relaxation or repeal of laws and regulations, or changes in governmental policies regarding environmental, defense, infrastructure or other industries we serve could result in a decline in demand for our services, which could in turn negatively impact our revenues. We cannot predict when or whether any of these various proposals may be enacted or what their effect will be on us or on our customers.
Changes in resource management, environmental, or infrastructure industry laws, regulations, and programs could directly or indirectly reduce the demand for our services, which could in turn negatively impact our revenue.
Some of our services are directly or indirectly impacted by changes in U.S. federal, state, local or foreign laws and regulations pertaining to the resource management, environmental, and infrastructure industries. Accordingly, a relaxation or repeal of these laws and regulations, or changes in governmental policies regarding the funding, implementation or enforcement of these programs, could result in a decline in demand for our services, which could in turn negatively impact our revenue.
Changes in capital markets could adversely affect our access to capital and negatively impact our business.
Our results could be adversely affected by an inability to access the revolving credit facility under our credit agreement. Unfavorable financial or economic conditions could impact certain lenders' willingness or ability to fund our revolving credit facility. In addition, increases in interest rates or credit spreads, volatility in financial markets or the interest rate environment, significant political or economic events, defaults of significant issuers, and other market and economic factors, may negatively impact the general level of debt issuance, the debt issuance plans of certain categories of borrowers, the types of credit-sensitive products being offered, and/or a sustained period of market decline or weakness could have a material adverse effect on us.
Restrictive covenants in our credit agreement may restrict our ability to pursue certain business strategies.
Our credit agreement limits or restricts our ability to, among other things:
• | incur additional indebtedness; |
• | create liens securing debt or other encumbrances on our assets; |
• | make loans or advances; |
• | pay dividends or make distributions to our stockholders; |
• | purchase or redeem our stock; |
• | repay indebtedness that is junior to indebtedness under our credit agreement; |
• | acquire the assets of, or merge or consolidate with, other companies; and |
• | sell, lease, or otherwise dispose of assets. |
Our credit agreement also requires that we maintain certain financial ratios, which we may not be able to achieve. The covenants may impair our ability to finance future operations or capital needs or to engage in other favorable business activities.
Our industry is highly competitive, and we may be unable to compete effectively, which could result in reduced revenue, profitability and market share.
We are engaged in a highly competitive business. The markets we serve are highly fragmented and we compete with many regional, national and international companies. Certain of these competitors have greater financial and other resources than we do. Others are smaller and more specialized and concentrate their resources in particular areas of expertise. The extent of our
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competition varies according to certain markets and geographic area. In addition, the technical and professional aspects of some of our services generally do not require large upfront capital expenditures and provide limited barriers against new competitors. The degree and type of competition we face is also influenced by the type and scope of a particular project. Our clients make competitive determinations based upon qualifications, experience, performance, reputation, technology, customer relationships and ability to provide the relevant services in a timely, safe and cost-efficient manner. This competitive environment could force us to make price concessions or otherwise reduce prices for our services. If we are unable to maintain our competitiveness and win bids for future projects, our market share, revenue, and profits will decline.
Legal proceedings, investigations, and disputes could result in substantial monetary penalties and damages, especially if such penalties and damages exceed or are excluded from existing insurance coverage.
We engage in consulting, engineering, program management, construction management, construction, and technical services that can result in substantial injury or damages that may expose us to legal proceedings, investigations, and disputes. For example, in the ordinary course of our business, we may be involved in legal disputes regarding personal injury claims, employee or labor disputes, professional liability claims, and general commercial disputes involving project cost overruns and liquidated damages, as well as other claims. In addition, in the ordinary course of our business, we frequently make professional judgments and recommendations about environmental and engineering conditions of project sites for our clients, and we may be deemed to be responsible for these judgments and recommendations if they are later determined to be inaccurate. Any unfavorable legal ruling against us could result in substantial monetary damages or even criminal violations. We maintain insurance coverage as part of our overall legal and risk management strategy to minimize our potential liabilities; however, insurance coverage contains exclusions and other limitations that may not cover our potential liabilities. Generally, our insurance program covers workers’ compensation and employer’s liability, general liability, automobile liability, professional errors and omissions liability, property, and contractor’s pollution liability (in addition to other policies for specific projects). Our insurance program includes deductibles or self-insured retentions for each covered claim that may increase over time. In addition, our insurance policies contain exclusions that insurance providers may use to deny or restrict coverage. Excess liability and professional liability insurance policies provide for coverage on a “claims-made” basis, covering only claims actually made and reported during the policy period currently in effect. If we sustain liabilities that exceed or that are excluded from our insurance coverage, or for which we are not insured, it could have a material adverse impact on our financial condition, results of operations and cash flows.
Unavailability or cancellation of third-party insurance coverage would increase our overall risk exposure as well as disrupt the management of our business operations.
We maintain insurance coverage from third-party insurers as part of our overall risk management strategy and because some of our contracts require us to maintain specific insurance coverage limits. If any of our third-party insurers fail, suddenly cancel our coverage, or otherwise are unable to provide us with adequate insurance coverage, then our overall risk exposure and our operational expenses would increase, and the management of our business operations would be disrupted. In addition, there can be no assurance that any of our existing insurance coverage will be renewable upon the expiration of the coverage period or that future coverage will be affordable at the required limits.
Our inability to obtain adequate bonding could have a material adverse effect on our future revenue and business prospects.
Certain clients require bid bonds, and performance and payment bonds. These bonds indemnify the client should we fail to perform our obligations under a contract. If a bond is required for a certain project and we are unable to obtain an appropriate bond, we cannot pursue that project. In some instances, we are required to co-venture with a small or disadvantaged business to pursue certain U.S. federal or state government contracts. In connection with these ventures, we are sometimes required to utilize our bonding capacity to cover all of the payment and performance obligations under the contract with the client. We have a bonding facility but, as is typically the case, the issuance of bonds under that facility is at the surety’s sole discretion. Moreover, due to events that can negatively affect the insurance and bonding markets, bonding may be more difficult to obtain or may only be available at significant additional cost. There can be no assurance that bonds will continue to be available to us on reasonable terms. Our inability to obtain adequate bonding and, as a result, to bid on new work could have a material adverse effect on our future revenue and business prospects.
Employee, agent, or partner misconduct, or our failure to comply with anti-bribery and other laws or regulations, could harm our reputation, reduce our revenue and profits, and subject us to criminal and civil enforcement actions.
Misconduct, fraud, non-compliance with applicable laws and regulations, or other improper activities by one of our employees, agents, or partners could have a significant negative impact on our business and reputation. Such misconduct could include the failure to comply with government procurement regulations, regulations regarding the protection of classified information, regulations prohibiting bribery and other foreign corrupt practices, regulations regarding the pricing of labor and
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other costs in government contracts, regulations on lobbying or similar activities, regulations pertaining to the internal controls over financial reporting, environmental laws, and any other applicable laws or regulations. For example, as previously noted, the FCPA and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Our policies mandate compliance with these regulations and laws, and we take precautions to prevent and detect misconduct. However, since our internal controls are subject to inherent limitations, including human error, it is possible that these controls could be intentionally circumvented or become inadequate because of changed conditions. As a result, we cannot assure that our controls will protect us from reckless or criminal acts committed by our employees or agents. Our failure to comply with applicable laws or regulations, or acts of misconduct could subject us to fines and penalties, loss of security clearances, and suspension or debarment from contracting, any or all of which could harm our reputation, reduce our revenue and profits, and subject us to criminal and civil enforcement actions.
Our business activities may require our employees to travel to and work in countries where there are high security risks, which may result in employee death or injury, repatriation costs or other unforeseen costs.
Certain of our contracts may require our employees travel to and work in high-risk countries that are undergoing political, social, and economic upheavals resulting from war, civil unrest, criminal activity, acts of terrorism, or public health crises. For example, we currently have employees working in high security risk countries such as Afghanistan and Iraq. As a result, we risk loss of or injury to our employees and may be subject to costs related to employee death or injury, repatriation, or other unforeseen circumstances. We may choose or be forced to leave a country with little or no warning due to physical security risks.
Our failure to implement and comply with our safety program could adversely affect our operating results or financial condition.
Our project sites often put our employees and others in close proximity with mechanized equipment, moving vehicles, chemical and manufacturing processes, and highly regulated materials. On some project sites, we may be responsible for safety, and, accordingly, we have an obligation to implement effective safety procedures. Our safety program is a fundamental element of our overall approach to risk management, and the implementation of the safety program is a significant issue in our dealings with our clients. We maintain an enterprise-wide group of health and safety professionals to help ensure that the services we provide are delivered safely and in accordance with standard work processes. Unsafe job sites and office environments have the potential to increase employee turnover, increase the cost of a project to our clients, expose us to types and levels of risk that are fundamentally unacceptable, and raise our operating costs. The implementation of our safety processes and procedures are monitored by various agencies, including the U.S. Mine Safety and Health Administration (“MSHA”), and rating bureaus, and may be evaluated by certain clients in cases in which safety requirements have been established in our contracts. Our failure to meet these requirements or our failure to properly implement and comply with our safety program could result in reduced profitability, the loss of projects or clients, or potential litigation, and could have a material adverse effect on our business, operating results, or financial condition.
We may be precluded from providing certain services due to conflict of interest issues.
Many of our clients are concerned about potential or actual conflicts of interest in retaining management consultants. U.S. federal government agencies have formal policies against continuing or awarding contracts that would create actual or potential conflicts of interest with other activities of a contractor. These policies, among other things, may prevent us from bidding for or performing government contracts resulting from or relating to certain work we have performed. In addition, services performed for a commercial or government client may create a conflict of interest that precludes or limits our ability to obtain work from other public or private organizations. We have, on occasion, declined to bid on projects due to conflict of interest issues.
If our reports and opinions are not in compliance with professional standards and other regulations, we could be subject to monetary damages and penalties.
We issue reports and opinions to clients based on our professional engineering expertise, as well as our other professional credentials. Our reports and opinions may need to comply with professional standards, licensing requirements, securities regulations, and other laws and rules governing the performance of professional services in the jurisdiction in which the services are performed. In addition, we could be liable to third parties who use or rely upon our reports or opinions even if we are not contractually bound to those third parties. For example, if we deliver an inaccurate report or one that is not in compliance with the relevant standards, and that report is made available to a third party, we could be subject to third-party liability, resulting in monetary damages and penalties.
We may be subject to liabilities under environmental laws and regulations.
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Our services are subject to numerous U.S. and international environmental protection laws and regulations that are complex and stringent. For example, we must comply with a number of U.S. federal government laws that strictly regulate the handling, removal, treatment, transportation, and disposal of toxic and hazardous substances. Under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”), and comparable state laws, we may be required to investigate and remediate regulated hazardous materials. CERCLA and comparable state laws typically impose strict, joint and several liabilities without regard to whether a company knew of or caused the release of hazardous substances. The liability for the entire cost of clean-up could be imposed upon any responsible party. Other principal U.S. federal environmental, health, and safety laws affecting us include, but are not limited to, the Resource Conversation and Recovery Act, National Environmental Policy Act, the Clean Air Act, the Occupational Safety and Health Act, the Federal Mine Safety and Health Act of 1977 (the “Mine Act”), the Toxic Substances Control Act, and the Superfund Amendments and Reauthorization Act. Our business operations may also be subject to similar state and international laws relating to environmental protection. Further, past business practices at companies that we have acquired may also expose us to future unknown environmental liabilities. Liabilities related to environmental contamination or human exposure to hazardous substances, or a failure to comply with applicable regulations, could result in substantial costs to us, including clean-up costs, fines, civil or criminal sanctions, and third-party claims for property damage or personal injury or cessation of remediation activities. Our continuing work in the areas governed by these laws and regulations exposes us to the risk of substantial liability.
Force majeure events, including natural disasters and terrorist actions, could negatively impact the economies in which we operate or disrupt our operations, which may affect our financial condition, results of operations, or cash flows.
Force majeure or extraordinary events beyond the control of the contracting parties, such as natural and man-made disasters, as well as terrorist actions, could negatively impact the economies in which we operate by causing the closure of offices, interrupting projects, and forcing the relocation of employees. We typically remain obligated to perform our services after a terrorist action or natural disaster unless the contract contains a force majeure clause that relieves us of our contractual obligations in such an extraordinary event. If we are not able to react quickly to force majeure, our operations may be affected significantly, which would have a negative impact on our financial condition, results of operations, or cash flows.
We have only a limited ability to protect our intellectual property rights, and our failure to protect our intellectual property rights could adversely affect our competitive position.
We rely upon a combination of nondisclosure agreements and other contractual arrangements, as well as copyright, trademark, patent and trade secret laws to protect our proprietary information. We also enter into proprietary information and intellectual property agreements with employees, which require them to disclose any inventions created during employment, to convey such rights to inventions to us, and to restrict any disclosure of proprietary information. Trade secrets are generally difficult to protect. Although our employees are subject to confidentiality obligations, this protection may be inadequate to deter or prevent misappropriation of our confidential information and/or the infringement of our patents and copyrights. Further, we may be unable to detect unauthorized use of our intellectual property or otherwise take appropriate steps to enforce our rights. Failure to adequately protect, maintain, or enforce our intellectual property rights may adversely limit our competitive position.
Assertions by third parties of infringement, misappropriation or other violations by us of their intellectual property rights could result in significant costs and substantially harm our business, financial condition and operating results.
In recent years, there has been significant litigation involving intellectual property rights in technology industries. We may face from time to time, allegations that we or a supplier or customer have violated the rights of third parties, including patent, trademark, and other intellectual property rights. If, with respect to any claim against us for violation of third-party intellectual property rights, we are unable to prevail in the litigation or retain or obtain sufficient rights or develop non-infringing intellectual property or otherwise alter our business practices on a timely or cost-efficient basis, our business, financial condition or results of operations may be adversely affected.
Any infringement, misappropriation or related claims, whether or not meritorious, are time consuming, divert technical and management personnel, and are costly to resolve. As a result of any such dispute, we may have to develop non-infringing technology, pay damages, enter into royalty or licensing agreements, cease utilizing products or services, or take other actions to resolve the claims. These actions, if required, may be costly or unavailable on terms acceptable to us.
Our stock price could become more volatile and stockholders’ investments could lose value.
In addition to the macroeconomic factors that have affected the prices of many securities generally, all of the factors discussed in this section could affect our stock price. Our common stock has previously experienced substantial price volatility. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many
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companies, and that have often been unrelated to the operating performance of these companies. The overall market and the price of our common stock may fluctuate greatly. The trading price of our common stock may be significantly affected by various factors, including quarter-to-quarter variations in our financial results, such as revenue, profits, days sales outstanding, backlog, and other measures of financial performance or financial condition (which factors may, themselves, be affected by the factors described below):
• | loss of key employees; |
• | the number and significance of client contracts commenced and completed during a quarter; |
• | creditworthiness and solvency of clients; |
• | the ability of our clients to terminate contracts without penalties; |
• | general economic or political conditions; |
• | unanticipated changes in contract performance that may affect profitability, particularly with contracts that are fixed-price or have funding limits; |
• | contract negotiations on change orders, requests for equitable adjustment, and collections of related billed and unbilled accounts receivable; |
• | seasonality of the spending cycle of our public sector clients, notably the U.S. federal government, the spending patterns of our commercial sector clients, and weather conditions; |
• | budget constraints experienced by our U.S. federal, and state and local government clients; |
• | integration of acquired companies; |
• | changes in contingent consideration related to acquisition earn-outs; |
• | divestiture or discontinuance of operating units; |
• | employee hiring, utilization and turnover rates; |
• | delays incurred in connection with a contract; |
• | the size, scope and payment terms of contracts; |
• | the timing of expenses incurred for corporate initiatives; |
• | reductions in the prices of services offered by our competitors; |
• | threatened or pending litigation; |
• | legislative and regulatory enforcement policy changes that may affect demand for our services; |
• | the impairment of goodwill or identifiable intangible assets; |
• | the fluctuation of a foreign currency exchange rate; |
• | stock-based compensation expense; |
• | actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the value of certain assets (including the amounts of related valuation allowances), liabilities, and other items reflected in our consolidated financial statements; |
• | success in executing our strategy and operating plans; |
• | changes in tax laws or regulations or accounting rules; |
• | results of income tax examinations; |
• | the timing of announcements in the public markets regarding new services or potential problems with the performance of services by us or our competitors, or any other material announcements; |
• | speculation in the media and analyst community, changes in recommendations or earnings estimates by financial analysts, changes in investors’ or analysts’ valuation measures for our stock, and market trends unrelated to our stock; |
• | our announcements concerning the payment of dividends or the repurchase of our shares; |
• | resolution of threatened or pending litigation; |
• | changes in investors’ and analysts’ perceptions of our business or any of our competitors’ businesses; |
• | changes in environmental legislation; |
• | broader market fluctuations; and |
• | general economic or political conditions. |
A significant drop in the price of our stock could expose us to the risk of securities class action lawsuits, which could result in substantial costs and divert management’s attention and resources, which could adversely affect our business. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, many of whom are awarded equity securities, the value of which is dependent on the performance of our stock price.
Delaware law and our charter documents may impede or discourage a merger, takeover, or other business combination even if the business combination would have been in the short-term best interests of our stockholders.
We are a Delaware corporation and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our stockholders. In addition, our Board of Directors has the power, without stockholder approval, to designate the terms of one or more series of preferred stock
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and issue shares of preferred stock, which could be used defensively if a takeover is threatened. Our incorporation under Delaware law, the ability of our Board of Directors to create and issue a new series of preferred stock, and provisions in our certificate of incorporation and bylaws, such as those relating to advance notice of certain stockholder proposals and nominations, could impede a merger, takeover, or other business combination involving us, or discourage a potential acquirer from making a tender offer for our common stock, even if the business combination would have been in the best interests of our current stockholders.
Item 1B Unresolved Staff Comments
None.
Item 2. Properties
At fiscal 2019 year-end, we owned two facilities located in the United States and leased approximately 450 operating facilities in domestic and foreign locations. Our significant lease agreements expire at various dates through 2029. We believe that our current facilities are adequate for the operation of our business, and that suitable additional space in various local markets is available to accommodate any needs that may arise.
The following table summarizes our ten most significant leased properties by location based on annual rental expenses (listed alphabetically, except for our corporate headquarters):
Location | Description | Reportable Segment | ||
Pasadena, CA | Corporate Headquarters | Corporate | ||
Adelaide, South Australia, Australia | Office Building | CIG | ||
Arlington, VA | Office Building | GSG / CIG | ||
Irvine, CA | Office Building | GSG / CIG | ||
London, United Kingdom | Office Building | GSG / CIG | ||
New York, NY | Office Building | GSG | ||
Pittsburgh, PA | Office Building | GSG / CIG | ||
San Francisco, CA | Office Building | GSG | ||
Sydney, New South Wales, Australia | Office Building | CIG | ||
Vancouver, BC, Canada | Office Building | CIG | ||
Item 3. Legal Proceedings
For a description of our material pending legal and regulatory proceedings and settlements, see Note 18, "Commitments and Contingencies" of the "Notes to Consolidated Financial Statements" included in Item 8.
Item 4. Mine Safety Disclosures
Section 1503 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") requires domestic mine operators to disclose violations and orders issued under the Mine Act by MSHA. We do not act as the owner of any mines, but we may act as a mining operator as defined under the Mine Act where we may be an independent contractor performing services or construction at such mine. Information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Act and Item 104 of Regulation S-K is included in Exhibit 95.
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PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol TTEK. There were approximately 1,300 stockholders of record at September 29, 2019.
Stock-Based Compensation
For information regarding our stock-based compensation, see Note 12, "Stockholders' Equity and Stock Compensation Plans" of the "Notes to Consolidated Financial Statements" included in Item 8.
Performance Graph
The following graph shows a comparison of our cumulative total returns with those of the NASDAQ Market Index, the Standard & Poor's ("S&P") 1000 Index, and the S&P 1500 Construction and Engineering ("C&E") Index. Starting in fiscal 2020, we plan to remove the S&P 1500 C&E Index, as companies in this index are no longer representative of our peer group. At this time, we do not have a comparable peer group due to the combination of our differentiated high-end consulting services and our end-markets. Thus, we have selected the S&P 1000 Index. The graph assumes that the value of an investment in our common stock and in each such index was $100 on September 28, 2014, and that all dividends have been reinvested. During fiscal 2019, we declared and paid dividends in the first and second quarters totaling $0.24 per share ($0.12 each quarter) on our common stock and paid dividends in the third and fourth quarters totaling $0.30 per share ($0.15 each quarter) on our common stock. We declared and paid dividends totaling $0.44, $0.38, $0.34, $0.30 and $0.14 per share in fiscal 2018, 2017, 2016, 2015 and 2014, respectively. We did not pay any dividends prior to fiscal 2014. The comparison in the graph below is based on historical data and is not intended to forecast the possible future performance of our common stock.
ASSUMES $100 INVESTED ON SEPTEMBER 28, 2014
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDED SEPTEMBER 29, 2019
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | ||||||||||||||||||
Tetra Tech, Inc. | $ | 100.00 | $ | 100.02 | $ | 144.04 | $ | 190.72 | $ | 282.12 | $ | 353.75 | |||||||||||
NASDAQ Market Index | 100.00 | 105.06 | 120.60 | 149.17 | 186.71 | 186.28 | |||||||||||||||||
S&P 1500 C&E Index | 100.00 | 80.80 | 97.40 | 109.31 | 120.17 | 112.91 | |||||||||||||||||
S&P 1000 Index | 100.00 | 102.46 | 117.25 | 139.06 | 160.89 | 152.60 | |||||||||||||||||
The performance graph above and related text are being furnished solely to accompany this annual report on Form 10-K pursuant to Item 201(e) of Regulation S-K, and are not being filed for purposes of Section 18 of the Exchange Act, and are not
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to be incorporated by reference into any of our filings with the SEC, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Stock Repurchase Program
On November 5, 2018, our Board of Directors authorized a new stock repurchase program under which we could repurchase up to $200 million of our common stock. This was in addition to the $25 million remaining as of fiscal 2018 year-end under the previous stock repurchase program.
In fiscal 2018, we repurchased through open market purchases under the previous program a total of 1,491,569 shares at an average price of $50.28 for a total cost of $75 million. In the first quarter of fiscal 2019, we expended the remaining $25 million under the previous program by repurchasing 430,559 shares through open market purchases at an average price of $58.06. In the second, third and fourth quarters of fiscal 2019, we repurchased through open market purchases under the new program a total of 1,131,962 shares at an average price of $66.26 for a total cost of $75 million.
A summary of the repurchase activity for the 12 months ended September 29, 2019 is as follows:
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Dollar Value that May Yet be Purchased Under the Plans or Programs (in thousands) | ||||||||||
October 1, 2018 - October 28, 2018 | — | $ | — | — | $ | 225,000 | ||||||||
October 29, 2018 - November 25, 2018 | 85,938 | 65.97 | 85,938 | 219,331 | ||||||||||
November 26, 2018 - December 30, 2018 | 344,621 | 56.09 | 344,621 | 200,000 | ||||||||||
December 31, 2018 - January 27, 2019 | 128,657 | 52.23 | 128,657 | 193,281 | ||||||||||
January 28, 2019 - February 24, 2019 | 145,703 | 54.76 | 145,703 | 185,302 | ||||||||||
February 25, 2019 - March 31, 2019 | 174,695 | 58.97 | 174,695 | 175,000 | ||||||||||
April 1, 2019 - April 28, 2019 | 116,650 | 61.20 | 116,650 | 167,861 | ||||||||||
April 29, 2019 - May 26, 2019 | 126,356 | 66.47 | 126,356 | 159,462 | ||||||||||
May 27, 2019 - June 30, 2019 | 132,908 | 71.19 | 132,908 | 150,000 | ||||||||||
July 1, 2019 - July 28, 2019 | 84,725 | 83.25 | 84,725 | 142,947 | ||||||||||
July 29, 2019 - August 25, 2019 | 104,722 | 79.25 | 104,722 | 134,648 | ||||||||||
August 26, 2019 - September 29, 2019 | 117,546 | 82.07 | 117,546 | 125,000 | ||||||||||
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Item 6. Selected Financial Data
The following selected financial data was derived from our audited consolidated financial statements. The selected financial data presented below should be read in conjunction with the information contained in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our consolidated financial statements and the notes thereto contained in Item 8, "Financial Statements and Supplementary Data," of this report.
Fiscal Year Ended | |||||||||||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | October 2, 2016 | September 27, 2015 | |||||||||||||||
(in thousands, except per share data) | |||||||||||||||||||
Statements of Operations Data | |||||||||||||||||||
Revenue | $ | 3,107,348 | $ | 2,964,148 | $ | 2,753,360 | $ | 2,583,469 | $ | 2,299,321 | |||||||||
Income from operations | 188,762 | 190,086 | 183,342 | 135,855 | 87,684 | ||||||||||||||
Net income attributable to Tetra Tech | 158,668 | 136,883 | 117,874 | 83,783 | 39,074 | ||||||||||||||
Diluted net income attributable to Tetra Tech per share | 2.84 | 2.42 | 2.04 | 1.42 | 0.64 | ||||||||||||||
Cash dividends paid per share | 0.54 | 0.44 | 0.38 | 0.34 | 0.30 | ||||||||||||||
Balance Sheet Data | |||||||||||||||||||
Total assets | $ | 2,147,408 | $ | 1,959,421 | $ | 1,902,745 | $ | 1,800,779 | $ | 1,559,242 | |||||||||
Long-term debt, net of current portion | 263,949 | 264,712 | 341,283 | 331,501 | 180,972 | ||||||||||||||
Tetra Tech stockholders' equity | 989,286 | 966,971 | 928,453 | 869,259 | 856,325 | ||||||||||||||
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following analysis of our financial condition and results of operations should be read in conjunction with Part I of this report, as well as our consolidated financial statements and accompanying notes in Item 8. The following analysis contains forward-looking statements about our future results of operations and expectations. Our actual results and the timing of events could differ materially from those described herein. See Part 1, Item 1A, "Risk Factors" for a discussion of the risks, assumptions, and uncertainties affecting these statements.
OVERVIEW OF RESULTS AND BUSINESS TRENDS
General. In fiscal 2019, our revenue increased 4.8% compared to fiscal 2018. The growth in our fiscal 2019 revenue was led by our U.S. state and local government and international businesses. The net contribution from acquisitions/divestitures and RCM did not significantly impact our overall revenue growth in fiscal 2019 compared to last year.
U.S. State and Local Government. Our U.S. state and local government revenue increased 25.2% in fiscal 2019 compared to last year as we continue to experience an increase in revenue from disaster response and recovery planning activities. Additionally, the increase includes broad-based growth in our U.S. state and local government project-related infrastructure business, particularly with increased revenue from municipal water infrastructure work in the metropolitan areas of California, Texas, and Florida. We expect our U.S. state and local government business to continue to grow in fiscal 2020 excluding the disaster response activities.
U.S. Federal Government. Our U.S. federal government revenue decreased 3.4% in fiscal 2019 compared to fiscal 2018. The decline primarily reflects disrupted activity due to the thirty-day partial U.S. government shutdown that commenced in late December 2018. During periods of economic volatility, our U.S. federal government clients have historically been the most stable and predictable. We anticipate revenue growth in U.S. federal government revenue in fiscal 2020; however, if there is another prolonged U.S. federal government shutdown, our U.S. federal government business could be adversely impacted.
U.S. Commercial. Our U.S. commercial revenue decreased 8.8% in fiscal 2019 compared to fiscal 2018. Our prior year revenue included $53.2 million from our non-core utility field services that were divested in fiscal 2018. Excluding the net impact of this divestiture, our U.S. commercial business declined 2.2% compared to last year. The decline reflects a higher level of subcontractor activity in fiscal 2018. Also, excluding subcontractor activity, our revenue was approximately the same as fiscal 2018. We expect our U.S. commercial revenue to grow modestly in fiscal 2020, primarily due to increased activities for industrial water treatment, environmental programs, high-performance green buildings, and renewable energy.
International. Our international revenue increased 17.4% in fiscal 2019 compared to fiscal 2018. Excluding contributions from acquisitions, our revenue grew 8.9% compared to prior year. The revenue growth primarily reflects increased activity in Canada. Additionally, we experienced an improvement in our infrastructure work in Australia, New Zealand, and Asia-Pacific. We anticipate our total international revenue to continue to grow in fiscal 2020.
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RESULTS OF OPERATIONS
Fiscal 2019 Compared to Fiscal 2018
Consolidated Results of Operations
Fiscal Year Ended | |||||||||||||
September 29, 2019 | September 30, 2018 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 3,107,348 | $ | 2,964,148 | $ | 143,200 | 4.8% | ||||||
Subcontractor costs | (717,711 | ) | (763,414 | ) | 45,703 | 6.0 | |||||||
Revenue, net of subcontractor costs (1) | 2,389,637 | 2,200,734 | 188,903 | 8.6 | |||||||||
Other costs of revenue | (1,981,454 | ) | (1,816,276 | ) | (165,178 | ) | (9.1) | ||||||
Gross profit | 408,183 | 384,458 | 23,725 | 6.2 | |||||||||
Selling, general and administrative expenses | (200,230 | ) | (190,120 | ) | (10,110 | ) | (5.3) | ||||||
Acquisition and integration expenses | (10,351 | ) | — | (10,351 | ) | NM | |||||||
Contingent consideration – fair value adjustments | (1,085 | ) | (4,252 | ) | 3,167 | 74.5 | |||||||
Impairment of goodwill | (7,755 | ) | — | (7,755 | ) | NM | |||||||
Income from operations | 188,762 | 190,086 | (1,324 | ) | (0.7) | ||||||||
Interest expense – net | (13,626 | ) | (15,524 | ) | 1,898 | 12.2 | |||||||
Income before income tax expense | 175,136 | 174,562 | 574 | 0.3 | |||||||||
Income tax expense | (16,375 | ) | (37,605 | ) | 21,230 | 56.5 | |||||||
Net income | 158,761 | 136,957 | 21,804 | 15.9 | |||||||||
Net income attributable to noncontrolling interests | (93 | ) | (74 | ) | (19 | ) | (25.7) | ||||||
Net income attributable to Tetra Tech | $ | 158,668 | $ | 136,883 | $ | 21,785 | 15.9 | ||||||
Diluted earnings per share | $ | 2.84 | $ | 2.42 | $ | 0.42 | 17.4 | ||||||
(1) | We believe that the presentation of "Revenue, net of subcontractor costs", which is a non-GAAP financial measure, enhances investors' ability to analyze our business trends and performance because it substantially measures the work performed by our employees. In the course of providing services, we routinely subcontract various services and, under certain USAID programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with GAAP and industry practice, are included in our revenue when it is our contractual responsibility to procure or manage these activities. Because subcontractor services can vary significantly from project to project and period to period, changes in revenue may not necessarily be indicative of our business trends. Accordingly, we segregate subcontractor costs from revenue to promote a better understanding of our business by evaluating revenue exclusive of costs associated with external service providers. |
NM = not meaningful
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The following table reconciles our reported results to non-GAAP adjusted results, which exclude the RCM results and certain non-operating accounting-related adjustments, such as acquisition and transaction costs, gains/losses from adjustments to contingent consideration, and non-recurring tax benefits. Adjusted results also exclude charges from the disposal of our Canadian turn-key pipeline activities in fiscal 2019 and losses from the divestitures of our non-core utility field services operations and other non-core assets in fiscal 2018. The disposal in fiscal 2019 also resulted in a $7.8 million goodwill impairment charge that is excluded from our adjusted results. Our fiscal 2019 adjusted results exclude a reduction of revenue and a corresponding charge to operating income of $13.7 million from a claim that was resolved in the fourth quarter of fiscal 2019 for a remediation project, where the work was substantially performed in prior years. In addition, our fiscal 2018 adjusted results also exclude a reduction of revenue of $10.6 million and a related charge to operating income of $12.5 million from a claim settlement in the fourth quarter of fiscal 2018 for a fixed-price construction project that was completed in fiscal 2014. The effective tax rates applied to the adjustments to earnings per share ("EPS") to arrive at adjusted EPS averaged 16% and 28% in fiscal 2019 and 2018, respectively. The goodwill impairment charge and certain of the transaction charges in fiscal 2019 did not have a related tax benefit. Excluding these items, the effective tax rate applied to adjustments in fiscal 2019 was 26%. We applied the relevant marginal statutory tax rate based on the nature of the adjustments and tax jurisdiction in which they occur. Both EPS and adjusted EPS were calculated using diluted weighted-average common shares outstanding for the respective periods as reflected in our consolidated statements of income.
Fiscal Year Ended | |||||||||||||
September 29, 2019 | September 30, 2018 | Change | |||||||||||
$ | % | ||||||||||||
Revenue | $ | 3,107,348 | $ | 2,964,148 | $ | 143,200 | 4.8% | ||||||
RCM | 1,542 | (14,199 | ) | 15,741 | NM | ||||||||
Claims | 13,700 | 10,576 | 3,124 | NM | |||||||||
Adjusted revenue | $ | 3,122,590 | $ | 2,960,525 | $ | 162,065 | 5.5 | ||||||
Revenue | $ | 3,107,348 | $ | 2,964,148 | $ | 143,200 | 4.8 | ||||||
Subcontractor costs | (717,711 | ) | (763,414 | ) | 45,703 | NM | |||||||
Revenue, net of subcontractor costs | $ | 2,389,637 | $ | 2,200,734 | $ | 188,903 | 8.6 | ||||||
RCM | 2,785 | (2,648 | ) | 5,433 | NM | ||||||||
Claims | 13,700 | 10,576 | 3,124 | NM | |||||||||
Adjusted revenue, net of subcontractor costs | $ | 2,406,122 | $ | 2,208,662 | $ | 197,460 | 8.9 | ||||||
Income from operations | $ | 188,762 | $ | 190,086 | $ | (1,324 | ) | (0.7) | |||||
Earn-out expense | 3,085 | 5,753 | (2,668 | ) | NM | ||||||||
RCM | 5,933 | 4,573 | 1,360 | NM | |||||||||
Claims | 13,700 | 12,457 | 1,243 | NM | |||||||||
Non-core dispositions | 18,701 | 3,434 | 15,267 | NM | |||||||||
Acquisition/Integration | 10,351 | — | 10,351 | NM | |||||||||
Adjusted income from operations | $ | 240,532 | $ | 216,303 | $ | 24,229 | 11.2 | ||||||
EPS | $ | 2.84 | $ | 2.42 | $ | 0.42 | 17.4 | ||||||
Earn-out expense | 0.04 | 0.08 | (0.04 | ) | NM | ||||||||
RCM | 0.08 | 0.06 | 0.02 | NM | |||||||||
Claims | 0.18 | 0.16 | 0.02 | NM | |||||||||
Non-core dispositions | 0.28 | 0.11 | 0.17 | NM | |||||||||
Acquisition/Integration | 0.19 | — | 0.19 | NM | |||||||||
Non-recurring tax benefits | (0.44 | ) | (0.19 | ) | (0.25 | ) | NM | ||||||
Adjusted EPS | $ | 3.17 | $ | 2.64 | $ | 0.53 | 20.1 | ||||||
NM = not meaningful
In fiscal 2019, revenue and revenue, net of subcontractor costs, increased $143.2 million, or 4.8%, and $188.9 million, or 8.6%, respectively, compared to fiscal 2018. Our adjusted revenue and revenue, net of subcontractor costs, increased $162.1 million, or 5.5%, and $197.5 million, or 8.9%, respectively, compared to last year. This growth includes contributions from the
37
fiscal 2019 acquisitions of eGlobalTech ("EGT") and WYG plc ("WYG"), partially offset by the impact of the divestiture of our non-core utility field services operations in fiscal 2018. Excluding the net impact from these transactions, our adjusted revenue and revenue, net of subcontractor costs, grew $144.2 million, or 5.0%, and $180.5 million, or 8.3%, in fiscal 2019 compared to fiscal 2018. This growth primarily reflects continued growth in our U.S. state and local government water infrastructure revenue. In addition, our revenue from disaster response and recovery planning projects increased compared to last year. Our U.S. state and local government adjusted revenue and revenue, net of subcontractor costs, increased $132.3 million, or 28.8%, and $90.7 million, or 27.1%, respectively, in fiscal 2019 compared to last year. Additionally, in fiscal 2019, our international adjusted revenue, net of subcontractor costs, increased $98.6 million, or 16.3%, primarily due to increased activity in Canada.
Our operating income decreased $1.3 million in fiscal 2019 compared to fiscal 2018. Our operating income in fiscal 2019 was reduced by WYG-related acquisition and integration expenses of $10.4 million. For further detailed information regarding these expenses, see “Fiscal 2019 Acquisition and Integration Expenses” below. In addition, our operating income reflects losses of $1.1 million and $4.3 million related to changes in the estimated fair value of contingent earn-out liabilities and related compensation charges of $2.0 million and $1.5 million in fiscal 2019 and 2018, respectively. These earn-out charges are described below under “Fiscal 2019 and 2018 Earn-Out Adjustments.” The loss from exited construction activities in our RCM segment was $5.9 million in fiscal 2019 compared to $4.6 million last year. Our RCM results are described below under "Remediation and Construction Management." Additionally, our operating income for fiscal 2019 includes charges of $10.9 million related to the planned disposal of our turn-key pipeline activities in Western Canada. This disposal also resulted in a non-cash goodwill impairment charge of $7.8 million in fiscal 2019. Both of these charges are described below under “Fiscal 2019 Impairment of Goodwill.” Our operating income in fiscal 2018, also includes losses of $3.4 million related to the divestitures of our non-core utility field services operations and other non-core assets. These losses are reported in selling, general and administrative expenses in our consolidated statements of income.
Excluding these items and the aforementioned claims in fiscal 2019 and 2018, adjusted operating income increased $24.2 million, or 11.2%, in fiscal 2019 compared to fiscal 2018. The increase reflects improved results in both our GSG and CIG segments. GSG's operating income increased $17.1 million in fiscal 2019 compared to last year. These results are described below under "Government Services Group." CIG's operating income increased $5.2 million ($17.4 million on an adjusted basis) in fiscal 2019 compared to fiscal 2018. These results are described below under "Commercial/International Services Group."
Interest expense, net of interest income, was $13.6 million in fiscal 2019, compared to $15.5 million last year. The decreases reflect reduced borrowings, partially offset by higher interest rates (primarily LIBOR).
The effective tax rates for fiscal 2019 and 2018 were 9.3% and 21.5%, respectively. Theses tax rates reflect the impact of the comprehensive tax legislation enacted by the U.S. government on December 22, 2017, which is commonly referred to as the TCJA. The TCJA significantly revised the U.S. corporate income tax regime by, among other things, lowering the U.S. corporate tax rate from 35% to 21% effective January 1, 2018, while also repealing the deduction for domestic production activities, limiting the deductibility of certain executive compensation, and implementing a modified territorial tax system with the introduction of the Global Intangible Low-Taxed Income ("GILTI") tax rules. The TCJA also imposed a one-time transition tax on deemed repatriation of historical earnings of foreign subsidiaries. In fiscal 2019, we finalized our fiscal 2018 U.S. federal tax return and recorded a $2.4 million tax expense with respect to the one-time transition tax on foreign earnings. As we have a September 30 fiscal year-end, our U.S. federal corporate income tax rate was blended in fiscal 2018, resulting in a statutory federal rate of 24.5% (3 months at 35% and 9 months at 21%), and was 21% in fiscal 2019.
U.S. GAAP requires that the impact of tax legislation be recognized in the period in which the tax law was enacted. As a result of the TCJA, we reduced our deferred tax liabilities and recorded a deferred tax benefit of $10.1 million in fiscal 2018 to reflect our estimate of temporary differences in the United States that were to be recovered or settled in fiscal 2018 based on the 24.5% blended corporate tax rate or based on the 21% tax rate in fiscal 2019 and beyond versus the previous enacted 35% corporate tax rate. We finalized this analysis in the first quarter of fiscal 2019 and recorded an additional deferred tax benefit of $2.6 million.
Valuation allowances of $23.4 million in Australia were released due to sufficient positive evidence being obtained in fiscal 2019. The valuation allowances were primarily related to net operating loss and Research and Development credit carry-forwards and other temporary differences. Excluding the net deferred tax benefits from the TCJA and the release of the valuation allowance, our effective tax rate was 21.9% in fiscal 2019 compared to 25.1% in fiscal 2018; the reduction is primarily due to the reduced U.S. corporate income tax rate.
With respect to the GILTI provisions of the TCJA, we have analyzed our structure and global results of operations and expect to have a GILTI tax of $0.4 million for fiscal 2019, which was included in our fiscal 2019 income tax expense.
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Our EPS was $2.84 in fiscal 2019, compared to $2.42 in fiscal 2018. On the same basis as our adjusted operating income and excluding non-recurring tax benefits, adjusted EPS was $3.17 in fiscal 2019, compared to $2.64 last year.
Segment Results of Operations
Government Services Group ("GSG")
Fiscal Year Ended | |||||||||||||
September 29, 2019 | September 30, 2018 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 1,820,671 | $ | 1,694,871 | $ | 125,800 | 7.4% | ||||||
Subcontractor costs | (491,290 | ) | (482,537 | ) | (8,753 | ) | (1.8) | ||||||
Revenue, net of subcontractor costs | $ | 1,329,381 | $ | 1,212,334 | $ | 117,047 | 9.7 | ||||||
Income from operations | $ | 185,263 | $ | 168,211 | $ | 17,052 | 10.1 | ||||||
Revenue and revenue, net of subcontractor costs, increased $125.8 million, or 7.4%, and $117.0 million, or 9.7%, respectively, in fiscal 2019 compared to fiscal 2018. These increases include contributions from the aforementioned acquisitions in fiscal 2019. Excluding these contributions, revenue and revenue, net of subcontractor costs, increased 4.8% and 6.9%, respectively, in fiscal 2019 compared to last year. These increases reflect continued broad-based growth in our U.S. state and local government project-related infrastructure revenue. In addition, our revenue from disaster response and recovery planning projects increased compared to last year. Overall, our U.S. state and local government adjusted revenue, net of subcontractor costs, increased $136.7 million and $85.7 million, respectively in fiscal 2019 compared to last year. Operating income increased $17.1 million in fiscal 2019 compared to fiscal 2018, primarily reflecting the higher U.S. state and local revenue. Our operating margin, based on revenue, net of subcontractor costs, was stable at 13.9% in both fiscal 2019 and 2018.
Commercial/International Services Group ("CIG")
Fiscal Year Ended | |||||||||||||
September 29, 2019 | September 30, 2018 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 1,342,509 | $ | 1,323,142 | $ | 19,367 | 1.5% | ||||||
Subcontractor costs | (279,468 | ) | (337,390 | ) | 57,922 | 17.2 | |||||||
Revenue, net of subcontractor costs | $ | 1,063,041 | $ | 985,752 | $ | 77,289 | 7.8 | ||||||
Income from operations | $ | 79,633 | $ | 74,451 | $ | 5,182 | 7.0 | ||||||
Revenue and revenue, net of subcontractor costs, increased $19.4 million, or 1.5%, and $77.3 million, or 7.8%, respectively, in fiscal 2019 compared to fiscal 2018. Our fiscal 2019 results included a reduction of revenue and a corresponding non-cash charge to operating income of $13.7 million from a claim that was resolved in the fourth quarter of fiscal 2019 for a remediation project, where the work was substantially performed in prior years. Excluding this claim and the net impact of the aforementioned acquisitions/divestiture, revenue and revenue, net of subcontractor costs, increased 4.0% and 10.3%, respectively, in fiscal 2019 compared to last year. These increases primarily reflect increased international revenue, particularly for broad-based activities in Canada and renewable energy projects globally. Operating income increased $5.2 million in fiscal 2019 compared to fiscal 2018 reflecting the higher revenue. In addition to the aforementioned claim resolution, operating income in fiscal 2019 included the previously described charges of $10.9 million related to the planned disposal of our Canadian turn-key pipeline operations. Operating income in fiscal 2018 included a $12.5 million charge for a claim settlement for a fixed-price construction project that was completed in fiscal 2014. Excluding these charges, our operating income increased $17.4 million in fiscal 2019 compared to last year, and our operating margin, based on revenue, net of subcontractor costs, improved to 9.8% in fiscal 2019 from 8.8% last year.
Remediation and Construction Management ("RCM")
39
Fiscal Year Ended | |||||||||||||
September 29, 2019 | September 30, 2018 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | (1,542 | ) | $ | 14,199 | $ | (15,741 | ) | NM | ||||
Subcontractor costs | (1,243 | ) | (11,551 | ) | 10,308 | 89.2 | |||||||
Revenue, net of subcontractor costs | $ | (2,785 | ) | $ | 2,648 | $ | (5,433 | ) | NM | ||||
Loss from operations | $ | (5,933 | ) | $ | (4,573 | ) | $ | (1,360 | ) | (29.7) | |||
RCM's projects were substantially complete at the end of fiscal 2018. The operating loss of $5.9 million in fiscal 2019 reflects reductions of revenue and related operating losses based on updated evaluations of unsettled claim amounts for two construction projects that were completed in prior years. The operating loss in fiscal 2018 primarily reflects legal costs related to outstanding claims. We recorded no material gains or losses related to claims in fiscal 2018.
Fiscal 2019 Acquisition and Integration Expenses
In fiscal 2019, we incurred acquisition and integration expenses of $10.4 million related to the WYG acquisition. These expenses included $3.3 million of acquisition expenses that were primarily for professional services, such as legal and investment banking, to support the transaction and were all paid in the fourth quarter of fiscal 2019. Subsequent to the acquisition date, we also recorded charges of $7.1 million for integration activities, including the elimination of redundant general and administrative costs, real estate consolidation, and conversion of information technology platforms, substantially all of which will be paid next year.
Fiscal 2019 and 2018 Earn-Out Adjustments
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. We recorded adjustments to our contingent earn-out liabilities and reported losses of $1.1 million and $4.3 million in fiscal 2019 and 2018, respectively. The fiscal 2018 losses resulted from updated valuations of the contingent consideration liabilities for Norman, Disney and Young ("NDY"), Eco Logical Australia ("ELA") and Cornerstone Environmental Group ("CEG"). These valuations included updated projections of NDY's, ELA's, and CEG's financial performance during the earn-out periods, which exceeded our original estimates at their respective acquisition dates. In addition, we recognized charges of $2.0 million and $1.5 million in fiscal 2019 and 2018, respectively, that related to the earn-out for Glumac but was treated as compensation in selling, general and administrative expenses due to the terms of the arrangement, which included an on-going service requirement for a portion of the earn-out.
At September 29, 2019, there was a total maximum of $72.4 million of outstanding contingent consideration related to acquisitions. Of this amount, $53.0 million was estimated as the fair value and accrued on our consolidated balance sheet.
Fiscal 2019 Impairment of Goodwill
During the fourth quarter of fiscal 2019, we performed as strategic review of all of our operations. As a result, we decided to dispose of our turn-key pipeline activities in Western Canada in our Remediation and Field Services ("RFS") reporting unit, which is in our CIG segment. As a result, we incurred severance and project-related charges related to the disposition of $10.9 million, which were reported in the CIG segment's operating income. We also performed an interim goodwill impairment review of our RFS reporting unit and recorded a $7.8 million goodwill impairment charge. The impaired goodwill related to our acquisition of Parkland Pipeline Contractors LTD. As a result of the impairment charge, the estimated fair value of our RFS reporting unit equals its carrying value at September 29, 2019. If the financial performance of the remaining operations in our RFS reporting unit were to deteriorate or fall below our forecasts, the related goodwill may become further impaired.
ASC 606
Prior to the adoption of Accounting Standards Codification Topic 606, "Revenue from Contracts with Customers" ("ASC 606") and the related disclosures of remaining unsatisfied performance obligations ("RUPOs"), we had reported backlog on a quarterly basis. Backlog is not a term recognized under United States generally accepted accounting principles; however, it is a common measurement used in our industry. Backlog generally represents the dollar amount of revenues we expect to realize in the future when we perform the work. RUPOs differ from our backlog.
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The following table provides a reconciliation between RUPOs and backlog as of September 29, 2019:
Amount | |||
(in thousands) | |||
RUPOs | $ | 3,081,471 | |
Items impacting comparability: Contract term | 10,386 | ||
Backlog | $ | 3,091,857 | |
The most significant difference between RUPOs and backlog relates to contract terms. Specifically, our backlog does not consider the impact of termination for convenience clauses within the contracts. The contract term and thus remaining performance obligation on certain of our operations and maintenance contracts, are limited to the notice period required for contract termination (usually 30, 60, or 90 days).
41
Fiscal 2018 Compared to Fiscal 2017
Consolidated Results of Operations
Fiscal Year Ended | |||||||||||||
September 30, 2018 | October 1, 2017 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 2,964,148 | $ | 2,753,360 | $ | 210,788 | 7.7% | ||||||
Subcontractor costs | (763,414 | ) | (719,350 | ) | (44,064 | ) | (6.1) | ||||||
Revenue, net of subcontractor costs (1) | 2,200,734 | 2,034,010 | 166,724 | 8.2 | |||||||||
Other costs of revenue | (1,816,276 | ) | (1,680,372 | ) | (135,904 | ) | (8.1) | ||||||
Gross profit | 384,458 | 353,638 | 30,820 | 8.7 | |||||||||
Selling, general and administrative expenses | (190,120 | ) | (177,219 | ) | (12,901 | ) | (7.3) | ||||||
Contingent consideration – fair value adjustments | (4,252 | ) | 6,923 | (11,175 | ) | NM | |||||||
Income from operations | 190,086 | 183,342 | 6,744 | 3.7 | |||||||||
Interest expense – net | (15,524 | ) | (11,581 | ) | (3,943 | ) | (34.0) | ||||||
Income before income tax expense | 174,562 | 171,761 | 2,801 | 1.6 | |||||||||
Income tax expense | (37,605 | ) | (53,844 | ) | 16,239 | 30.2 | |||||||
Net income | 136,957 | 117,917 | 19,040 | 16.1 | |||||||||
Net income attributable to noncontrolling interests | (74 | ) | (43 | ) | (31 | ) | (72.1) | ||||||
Net income attributable to Tetra Tech | $ | 136,883 | $ | 117,874 | $ | 19,009 | 16.1 | ||||||
Diluted earnings per share | $ | 2.42 | $ | 2.04 | $ | 0.38 | 18.6 | ||||||
(1) | We believe that the presentation of "Revenue, net of subcontractor costs", which is a non-GAAP financial measure, enhances investors' ability to analyze our business trends and performance because it substantially measures the work performed by our employees. In the course of providing services, we routinely subcontract various services and, under certain USAID programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with GAAP and industry practice, are included in our revenue when it is our contractual responsibility to procure or manage these activities. Because subcontractor services can vary significantly from project to project and period to period, changes in revenue may not necessarily be indicative of our business trends. Accordingly, we segregate subcontractor costs from revenue to promote a better understanding of our business by evaluating revenue exclusive of costs associated with external service providers. |
NM = not meaningful
42
The following table reconciles our reported results to non-GAAP adjusted results, which exclude the RCM results and certain non-operating accounting-related adjustments. Adjusted results also exclude losses from the divestitures of our non-core utility field services operations and other non-core assets in fiscal 2018. In addition, our adjusted results also exclude a reduction of revenue of $10.6 million and a related charge to operating income of $12.5 million from a claim settlement in the fourth quarter of fiscal 2018 for a fixed-price construction project that was completed in fiscal 2014. The effective tax rates applied to the adjustments to EPS to arrive at adjusted EPS averaged 28% and 33% in fiscal 2018 and 2017, respectively. We apply the relevant marginal statutory tax rate based on the nature of the adjustments and tax jurisdiction in which they occur. Both EPS and adjusted EPS were calculated using diluted weighted-average common shares outstanding for the respective periods as reflected in our consolidated statements of income.
Fiscal Year Ended | |||||||||||||
September 30, 2018 | October 1, 2017 | Change | |||||||||||
$ | % | ||||||||||||
Revenue | $ | 2,964,148 | $ | 2,753,360 | $ | 210,788 | 7.7% | ||||||
RCM | (14,199 | ) | (18,207 | ) | 4,008 | NM | |||||||
Claim settlement | 10,576 | — | 10,576 | NM | |||||||||
Adjusted revenue | $ | 2,960,525 | $ | 2,735,153 | $ | 225,372 | 8.2 | ||||||
Revenue | $ | 2,964,148 | $ | 2,753,360 | $ | 210,788 | 7.7 | ||||||
Subcontractor costs | (763,414 | ) | (719,350 | ) | (44,064 | ) | NM | ||||||
Revenue, net of subcontractor costs | $ | 2,200,734 | $ | 2,034,010 | $ | 166,724 | 8.2 | ||||||
RCM | (2,648 | ) | 86 | (2,734 | ) | NM | |||||||
Claim settlement | 10,576 | — | 10,576 | NM | |||||||||
Adjusted revenue, net of subcontractor costs | $ | 2,208,662 | $ | 2,034,096 | $ | 174,566 | 8.6 | ||||||
Income from operations | $ | 190,086 | $ | 183,342 | $ | 6,744 | 3.7 | ||||||
Contingent consideration – fair value adjustments | 4,252 | (6,923 | ) | 11,175 | NM | ||||||||
Non-core divestitures | 3,434 | — | 3,434 | NM | |||||||||
Claim settlement | 12,457 | — | 12,457 | NM | |||||||||
Contingent consideration - compensation | 1,501 | — | 1,501 | NM | |||||||||
Subtotal | 211,730 | 176,419 | 35,311 | 20.0 | |||||||||
RCM | 4,573 | 14,712 | (10,139 | ) | NM | ||||||||
Adjusted income from operations | $ | 216,303 | $ | 191,131 | $ | 25,172 | 13.2 | ||||||
EPS | $ | 2.42 | $ | 2.04 | $ | 0.38 | 18.6 | ||||||
Contingent consideration – fair value adjustments | 0.06 | (0.08 | ) | 0.14 | NM | ||||||||
Contingent consideration - compensation | 0.02 | — | 0.02 | NM | |||||||||
RCM | 0.06 | 0.17 | (0.11 | ) | NM | ||||||||
Revaluation of deferred taxes | (0.19 | ) | — | (0.19 | ) | NM | |||||||
Non-core divestitures | 0.11 | — | 0.11 | NM | |||||||||
Claim settlement | 0.16 | — | 0.16 | NM | |||||||||
Adjusted EPS | $ | 2.64 | $ | 2.13 | $ | 0.51 | 23.9 | ||||||
NM = not meaningful
In fiscal 2018, revenue and revenue, net of subcontractor costs, increased $210.8 million, or 7.7%, and $166.7 million, or 8.2%, respectively, compared to fiscal 2017. Our adjusted revenue and revenue, net of subcontractor costs, increased $225.4 million, or 8.2%, and $174.6 million, or 8.6%, respectively, compared to fiscal 2017. This growth includes contributions from the acquisitions of Glumac and NDY, partially offset by the divestiture of our non-core utility field services operations. Excluding the net impact from these transactions, our revenue grew $102.6 million, or 3.8%, in fiscal 2018 compared to fiscal 2017. The growth was due to increased state and local government activity led by our disaster response projects, as well as our U.S. federal government
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and international government business primarily in our GSG segment. These increases were partially offset by a decline in our international oil and gas activities in Western Canada in our CIG segment.
Our operating income increased $6.7 million in fiscal 2018 compared to fiscal 2017. The loss from exited construction activities in our RCM segment was $4.6 million in fiscal 2018 compared to $14.7 million last year. Our RCM results are described below under "Remediation and Construction Management." Additionally, our operating income for fiscal 2018 reflects losses of $4.3 million related to changes in the estimated fair value of contingent earn-out liabilities and a related compensation charge of $1.5 million. Conversely, our operating income for fiscal 2017 reflects gains of $6.9 million related to changes in the estimated fair value of contingent earn-out liabilities. These gains and losses/charges are described below under “Fiscal 2018 and 2017 Earn-Out Adjustments.” Our operating income for fiscal 2018 also includes losses of $3.4 million related to the divestitures of our non-core utility field services operations and other non-core assets. These losses are reported in selling, general and administrative expenses in our consolidated statements of income. Our fiscal 2018 results also include a reduction of revenue of $10.6 million and a related charge to operating income of $12.5 million related to the settlement of a claim in our CIG reportable segment for a fixed-price construction project that was completed in fiscal 2014 prior to our decision to exit similar activities in our RCM segment. Although this settlement resulted in a charge to operating income in the fourth quarter of fiscal 2018, we received cash proceeds of $16.1 million for the related accounts receivable in the first quarter of fiscal 2019.
Excluding these items, adjusted operating income increased $25.2 million, or 13.2%, in fiscal 2018 compared to fiscal 2017. The increase in our operating income reflects improved results in our GSG segment. GSG's operating income increased $30.0 million in fiscal 2018 compared to last year. These results are described below under "Government Services Group."
Interest expense, net was $15.5 million in fiscal 2018 compared to $11.6 million in fiscal 2017. This increase reflects higher interest rates (primarily LIBOR) and additional borrowings to fund business growth, including the fiscal 2018 acquisitions, and other working capital needs.
The effective tax rates for fiscal 2018 and 2017 were 21.5% and 31.3%, respectively. The fiscal 2018 tax rate reflects the impact of the comprehensive tax legislation enacted by the U.S. government on December 22, 2017, which is commonly referred to as the TCJA. The TCJA significantly revised the U.S. corporate income tax regime by, among other things, lowering the U.S. corporate tax rate from 35% to 21% effective January 1, 2018, while also repealing the deduction for domestic production activities, limiting the deductibility of certain executive compensation, and implementing a modified territorial tax system. The TCJA also imposes a one-time transition tax on deemed repatriation of historical earnings of foreign subsidiaries. We analyzed this provision of the TCJA and our related foreign earnings accumulated under legacy tax laws during fiscal 2018. Based on our analysis of tax earnings and profits and tax deficits at the prescribed measurement dates, we have a cumulative net tax deficit and do not believe we have any tax liability related to this tax. As we have a September 30 fiscal year-end, our U.S. federal corporate income tax rate was blended in fiscal 2018, resulting in a statutory federal rate of approximately 24.5% (3 months at 35% and 9 months at 21%), and will be 21% for subsequent fiscal years.
GAAP requires that the impact of tax legislation be recognized in the period in which the tax law was enacted. As a result of the TCJA, we reduced our deferred tax liabilities and recorded a one-time deferred tax benefit of approximately $14.7 million in fiscal 2018 to reflect our estimate of temporary differences in the United States that will be recovered or settled in fiscal 2018 based on the 24.5% blended corporate tax rate or based on the 21% tax rate in fiscal 2019 and beyond versus the previous enacted 35% corporate tax rate. In fiscal 2018, we recognized other non-recurring adjustments to our deferred tax assets and liabilities that resulted in a net deferred tax expense of $3.6 million. Excluding these net deferred tax benefits, our effective tax rate in fiscal 2018 was 27.9%.
The fiscal 2018 divestitures of our non-core utility field services operations and other non-core assets resulted in a pre-tax loss of $3.4 million and incremental tax expense of $2.6 million due to a book/tax basis difference primarily related to the $12.2 million of associated goodwill. In fiscal 2018 and fiscal 2017, the Internal Revenue Service concluded their examinations through fiscal 2016 and other state and international examinations were also completed. As a result, we recognized a net $1.6 million tax expense in fiscal 2018 and a $1.1 million tax expense in fiscal 2017. Excluding these discrete amounts from both periods and the one-time impacts of the TCJA, the effective tax rates for fiscal 2018 and 2017 were 25.1% and 30.7%, respectively.
Our EPS was $2.42 in fiscal 2018, compared to $2.04 in fiscal 2017. On the same basis as our adjusted operating income, EPS was $2.64 in fiscal 2018, compared to $2.13 in fiscal 2017.
Segment Results of Operations
Beginning in fiscal 2018, we aligned our operations to better serve our clients and markets, resulting in two renamed reportable segments. Our GSG reportable segment primarily includes activities with U.S. government clients (federal, state and
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local) and activities with development agencies worldwide. Our CIG reportable segment primarily includes activities with U.S. commercial clients and international activities other than work for development agencies. This alignment allows us to capitalize on our growing market opportunities and enhance the development of high-end consulting and technical solutions to meet our growing client demand. We continue to report the results of the wind-down of our non-core construction activities in the RCM segment.
Government Services Group ("GSG")
Fiscal Year Ended | |||||||||||||
September 30, 2018 | October 1, 2017 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 1,694,871 | $ | 1,487,611 | $ | 207,260 | 13.9% | ||||||
Subcontractor costs | (482,537 | ) | (420,453 | ) | (62,084 | ) | (14.8) | ||||||
Revenue, net of subcontractor costs | $ | 1,212,334 | $ | 1,067,158 | $ | 145,176 | 13.6 | ||||||
Income from operations | $ | 168,211 | $ | 138,199 | $ | 30,012 | 21.7 | ||||||
Revenue and revenue, net of subcontractor costs, increased $207.3 million, or 13.9%, and $145.2 million, or 13.6%, respectively, compared to fiscal 2017. These increases include the aforementioned contribution from our Glumac acquisition. Excluding this contribution, our revenue increased 9.8% in fiscal 2018 compared to fiscal 2017. This increase reflects broad-based revenue growth in our U.S. state and local government project-related infrastructure revenue with particularly increased revenue from municipal water infrastructure work in the metropolitan areas of California, Texas, and Florida. The increase also includes higher revenue from disaster response activities in fiscal 2018 compared to last year due to the unprecedented number of natural disasters in the United States during 2017. The level of our activities was particularly increased by the hurricanes in Florida and Texas, and the fires in California. Our U.S. state and local government revenue and revenue, net of subcontractor costs, increased $114.9 million and $68.7 million, respectively, in fiscal 2018 compared to last year. To a lesser extent, our U.S. federal business also improved compared to fiscal 2017, primarily due to an increase in environmental work for the DoD and DOS. Operating income increased $30.0 million in fiscal 2018 compared to fiscal 2017, reflecting the higher revenue. In addition, our operating margin, based on revenue, net of subcontractor costs, improved to 13.9% in fiscal 2018 from 13.0% in fiscal 2017. This increase in profitability primarily reflects increasing revenue and improved utilization of resources.
Commercial/International Services Group ("CIG")
Fiscal Year Ended | |||||||||||||
September 30, 2018 | October 1, 2017 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 1,323,142 | $ | 1,326,020 | $ | (2,878 | ) | (0.2)% | |||||
Subcontractor costs | (337,390 | ) | (359,082 | ) | 21,692 | 6.0 | |||||||
Revenue, net of subcontractor costs | $ | 985,752 | $ | 966,938 | $ | 18,814 | 1.9 | ||||||
Income from operations | $ | 74,451 | $ | 90,817 | $ | (16,366 | ) | (18.0) | |||||
Revenue and revenue, net of subcontractor costs, decreased $2.9 million, or 0.2%, and increased $18.8 million, or 1.9%, respectively, in fiscal 2018 compared to fiscal 2017. These amounts include the aforementioned contribution from our NDY acquisition. In addition, these year-over-year comparisons were impacted by the divestiture of our non-core utility field services operations in fiscal 2018 and the reduction of revenue of $10.6 million from the settlement of the claim in the fourth quarter of fiscal 2018 for a fixed-price construction project that was completed in fiscal 2014. Excluding the net impact of the acquisition/divestiture and the claim adjustment, revenue and revenue, net of subcontractor costs decreased 3.1% and 2.4%, respectively, in fiscal 2018 compared to fiscal 2017. These results primarily reflect lower oil and gas revenue in Western Canada, which declined $75.6 million in fiscal 2018 compared to fiscal 2017. Operating income decreased $16.4 million, or, 18.0%, in fiscal 2018 compared to fiscal 2017 primarily due to the $12.5 million charge for the claim settlement in the fourth quarter of fiscal 2018 for the fixed-price construction project that was completed in fiscal 2014. Excluding this charge, operating income declined 4.3% in fiscal 2018 compared to fiscal 2017 reflecting the lower revenue. In addition, our operating margin, based on revenue, net of subcontractor costs, declined to 7.6% in fiscal 2018 from 9.4% in fiscal 2017 reflecting the claim settlement in the fourth quarter of fiscal 2018.
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Remediation and Construction Management ("RCM")
Fiscal Year Ended | |||||||||||||
September 30, 2018 | October 1, 2017 | Change | |||||||||||
$ | % | ||||||||||||
($ in thousands) | |||||||||||||
Revenue | $ | 14,199 | $ | 18,207 | $ | (4,008 | ) | (22.0)% | |||||
Subcontractor costs | (11,551 | ) | (18,293 | ) | 6,742 | 36.9 | |||||||
Revenue, net of subcontractor costs | $ | 2,648 | $ | (86 | ) | $ | 2,734 | NM | |||||
Loss from operations | $ | (4,573 | ) | $ | (14,712 | ) | $ | 10,139 | 68.9 | ||||
NM = not meaningful
Revenue decreased $4.0 million and revenue, net of subcontractor costs, increased $2.7 million in fiscal 2018 compared to fiscal 2017. The operating loss in fiscal 2018 primarily reflects legal costs related to outstanding claims. In fiscal 2017, we updated our evaluation of unsettled claims and recognized a reduction in revenue of $4.9 million and a related loss in operating income of $3.6 million. We also recognized unfavorable operating income adjustments of $5.7 million related to our updated estimate of the costs to complete fixed-price construction projects in fiscal 2017. The remaining loss in fiscal 2017 primarily reflect legal costs related to outstanding claims.
Fiscal 2018 and 2017 Earn-Out Adjustments
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. In fiscal 2018, we recorded adjustments to our contingent earn-out liabilities and reported related losses in operating income of $4.3 million. In addition, in fiscal 2018 we recognized a charge of $1.5 million that related to the earn-out for Glumac but was treated as compensation in selling, general and administrative expenses due to the terms of the arrangement, which included an on-going service requirement for a portion of the earn-out.
During fiscal 2017, we recorded updated valuations to our contingent earn-out liabilities and reported net gains in operating income totaling $6.9 million. The fiscal 2017 gains primarily resulted from updated valuations of the contingent consideration liabilities for INDUS Corporation ("INDUS") and CEG, which are both part of our GSG segment.
At September 30, 2018, there was a total potential maximum of $50.6 million of outstanding contingent consideration related to acquisitions. Of this amount, $35.3 million was estimated as the fair value and accrued on our consolidated balance sheet.
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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Capital Requirements. Our primary sources of liquidity are cash flows from operations and borrowings under our credit facilities. Our primary uses of cash are to fund working capital, capital expenditures, stock repurchases, cash dividends and repayment of debt, as well as to fund acquisitions and earn-out obligations from prior acquisitions. We believe that our existing cash and cash equivalents, operating cash flows and borrowing capacity under our credit agreement, as described below, will be sufficient to meet our capital requirements for at least the next 12 months. On November 5, 2018, the Board of Directors authorized a new stock repurchase program under which we could repurchase up to $200 million of our common stock in addition to the $25 million under the previous stock purchase program. In fiscal 2019, we expended the $25 million under the previous stock purchase program and an additional $75 million under the new program. We declared and paid common stock dividends totaling $29.7 million, or $0.54 per share, in fiscal 2019 compared to $24.5 million, or $0.44 per share, in fiscal 2018.
Subsequent Event. On November 11, 2019, the Board of Directors declared a quarterly cash dividend of $0.15 per share payable on December 13, 2019 to stockholders of record as of the close of business on December 2, 2019.
We use a variety of tax planning and financing strategies to manage our worldwide cash and deploy funds to locations where they are needed. Historically, we indefinitely reinvested our foreign earnings, and did not need to repatriate these earnings. However, in fiscal 2018, we evaluated our global tax planning and financing strategies as a result of the recent changes in U.S. tax law. As a result, we completed a one-time repatriation of a portion of our foreign earnings totaling approximately $117 million in fiscal 2018. We paid down debt in the U.S. with most of these funds during the fourth quarter of fiscal 2018. This transaction resulted in a $2.4 million net repatriation tax on a global basis. At September 29, 2019, undistributed earnings of our foreign subsidiaries, primarily in Canada, amounting to approximately $44.0 million, which are expected to be permanently reinvested. Accordingly, no provision for foreign withholding taxes has been made. Upon distribution of those earnings, we would be subject to foreign withholding taxes. Assuming the permanently reinvested foreign earnings were repatriated under the laws and rates applicable at September 29, 2019, the incremental foreign withholding taxes applicable to those earnings would be approximately $1.1 million. We have no need or plans to repatriate additional foreign earnings in the foreseeable future.
Cash Equivalents and Restricted Cash. As of September 29, 2019, cash equivalents and restricted cash were $120.9 million, a decrease of $28.0 million compared to the fiscal 2018 year-end. The decrease was primarily due to payments for acquisitions, stock repurchases and dividends.
Operating Activities. For fiscal 2019, net cash provided by operating activities was $208.5 million compared to $185.7 million in fiscal 2018. The increase primarily resulted from additional cash collections from accounts receivable and improved management of our working capital.
Investing Activities. Net cash used in investing activities was $99.7 million in fiscal 2019, an increase of $57.1 million compared to last year. The increase was primarily the result of proceeds from the divestiture of our non-core utility field services operations in fiscal 2018 that did not recur this year.
Financing Activities. For fiscal 2019, net cash used in financing activities was $135.1 million, a decrease of $46.9 million compared to fiscal 2018. The decrease in net cash used was due to lower net borrowings of long-term debt, partially offset by $25 million more in stock repurchases in fiscal 2019 compared to last year.
Debt Financing. On July 30, 2018, we entered into a Second Amended and Restated Credit Agreement (“Amended Credit Agreement”) with a total borrowing capacity of $1 billion that will mature in July 2023. The Amended Credit Agreement is a $700 million senior secured, five-year facility that provides for a $250 million term loan facility (the “Amended Term Loan Facility”), a $450 million revolving credit facility (the “Amended Revolving Credit Facility”), and a $300 million accordion feature that allows us to increase the Amended Credit Agreement to $1 billion subject to lender approval. The Amended Credit Agreement allows us to, among other things, (i) refinance indebtedness under our Credit Agreement dated as of May 7, 2013; (ii) finance certain permitted open market repurchases of our common stock, permitted acquisitions, and cash dividends and distributions; and (iii) utilize the proceeds for working capital, capital expenditures and other general corporate purposes. The Amended Revolving Credit Facility includes a $100 million sublimit for the issuance of standby letters of credit, a $20 million sublimit for swingline loans, and a $200 million sublimit for multicurrency borrowings and letters of credit.
The entire Amended Term Loan Facility was drawn on July 30, 2018. The Amended Term Loan Facility is subject to quarterly amortization of principal at 5% annually beginning December 31, 2018. We may borrow on the Amended Revolving Credit Facility, at our option, at either (a) a Eurocurrency rate plus a margin that ranges from 1.00% to 1.75% per annum, or (b) a base rate for loans in U.S. dollars (the highest of the U.S. federal funds rate plus 0.50% per annum, the bank’s prime rate or the Eurocurrency rate plus 1.00%) plus a margin that ranges from 0% to 0.75% per annum. In each case, the applicable margin is based on our Consolidated Leverage Ratio, calculated quarterly. The Amended Term Loan Facility is subject to the same interest rate provisions. The Amended Credit Agreement expires on July 30, 2023, or earlier at our discretion upon payment in full of loans and other obligations.
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At September 29, 2019, we had $276.4 million in outstanding borrowings under the Amended Credit Agreement, which was comprised of $240.6 million under the Term Loan Facility and $35.8 million outstanding under the Amended Revolving Credit Facility at a year-to-date weighted-average interest rate of 3.37% per annum. In addition, we had $0.7 million in standby letters of credit under the Amended Credit Agreement. Our average effective weighted-average interest rate on borrowings outstanding during the year-to-date period ending September 29, 2019 under the Amended Credit Agreement, including the effects of interest rate swap agreements was 3.65%. At September 29, 2019, we had $413.3 million of available credit under the Amended Revolving Credit Facility, all of which could be borrowed without a violation of our debt covenants. Commitment fees related to our revolving credit facilities were $0.7 million, $0.6 million, and $0.8 million for fiscal 2019, 2018 and 2017, respectively.
The Amended Credit Agreement contains certain affirmative and restrictive covenants, and customary events of default. The financial covenants provide for a maximum Consolidated Leverage Ratio of 3.00 to 1.00 (total funded debt/EBITDA, as defined in the Amended Credit Agreement) and a minimum Consolidated Interest Coverage Ratio of 3.00 to 1.00 (EBITDA/Consolidated Interest Charges, as defined in the Amended Credit Agreement). Our obligations under the Amended Credit Agreement are guaranteed by certain of our domestic subsidiaries and are secured by first priority liens on (i) the equity interests of certain of our subsidiaries, including those subsidiaries that are guarantors or borrowers under the Amended Credit Agreement, and (ii) the accounts receivable, general intangibles and intercompany loans, and those of our subsidiaries that are guarantors or borrowers.
At September 29, 2019, we were in compliance with these covenants with a consolidated leverage ratio of 1.30x and a consolidated interest coverage ratio of 16.51x. Our obligations under the Amended Credit Agreement are guaranteed by certain of our subsidiaries and are secured by first priority liens on (i) the equity interests of certain of our subsidiaries, including those subsidiaries that are guarantors or borrowers under the Amended Credit Agreement, and (ii) our accounts receivable, general intangibles and intercompany loans, and those of our subsidiaries that are guarantors or borrowers.
In addition to the credit facility, we entered into agreements to issue standby letters of credit. The aggregate amount of standby letters of credit outstanding under these additional agreements and other bank guarantees was $41.4 million, of which $10.2 million was issued in currencies other than the U.S. dollar.
We maintain at our Australian subsidiary an AUD$30 million credit facility, which may be used for bank overdrafts, short-term cash advances and bank guarantees. This facility expires in March 2020 and is secured by a parent guarantee. At September 29, 2019, there were no borrowings outstanding under this facility and bank guarantees outstanding of USD$6.1 million, which were issued in currencies other than the U.S. dollar.
We maintain at our United Kingdom subsidiary a GBP£35 million credit facility, which may be used for bank overdrafts, short-term cash advances and bank guarantees. This facility expires in July 2020 and is secured by a parent guarantee. At September 29, 2019, there were no borrowings outstanding under this facility and bank guarantees outstanding of USD$17.4 million, which were issued in currencies other than the U.S. dollar.
Inflation. We believe our operations have not been, and, in the foreseeable future, are not expected to be, materially adversely affected by inflation or changing prices due to the average duration of our projects and our ability to negotiate prices as contracts end and new contracts begin.
Dividends. Our Board of Directors has authorized the following dividends:
Declaration Date | Dividend Per Share | Record Date | Total Maximum Payment | Payment Date | ||||||||
(in thousands, except per share data) | ||||||||||||
November 5, 2018 | $ | 0.12 | November 30, 2018 | $ | 6,654 | December 14, 2018 | ||||||
January 28, 2019 | $ | 0.12 | February 13, 2019 | $ | 6,616 | February 28, 2019 | ||||||
April 29, 2019 | $ | 0.15 | May 15, 2019 | $ | 8,219 | May 31, 2019 | ||||||
July 29, 2019 | $ | 0.15 | August 14, 2019 | $ | 8,185 | August 30, 2019 | ||||||
November 11, 2019 | $ | 0.15 | December 2, 2019 | N/A | December 13, 2019 | |||||||
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Contractual Obligations. The following sets forth our contractual obligations at September 29, 2019:
Total | Year 1 | Years 2 - 3 | Years 4 - 5 | Beyond | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Debt: | ||||||||||||||||||||
Credit facility | $ | 276,434 | $ | 12,500 | $ | 28,125 | $ | 235,809 | $ | — | ||||||||||
Interest (1) | 30,307 | 8,460 | 15,842 | 6,005 | — | |||||||||||||||
Capital leases | 87 | 72 | 15 | — | — | |||||||||||||||
Operating leases (2) | 343,532 | 108,758 | 117,842 | 62,240 | 54,692 | |||||||||||||||
Contingent earn-outs (3) | 52,992 | 24,977 | 28,015 | — | — | |||||||||||||||
Deferred compensation liability | 29,548 | — | — | — | 29,548 | |||||||||||||||
Unrecognized tax benefits (4) | 9,169 | 977 | 7,551 | 641 | — | |||||||||||||||
Total | $ | 742,069 | $ | 155,744 | $ | 197,390 | $ | 304,695 | $ | 84,240 | ||||||||||
(1) | Interest primarily related to the Term Loan Facility is based on a weighted-average interest rate at September 29, 2019, on borrowings that are presently outstanding. |
(2) | Predominantly represents real estate leases. |
(3) | Represents the estimated fair value recorded for contingent earn-out obligations for acquisitions. The remaining maximum contingent earn-out obligations for these acquisitions total $72.4 million. |
(4) | Represents liabilities for unrecognized tax benefits related to uncertain tax positions, excluding amounts related primarily to outstanding refund claims. We are unable to reasonably predict the timing of tax settlements, as tax audits can involve complex issues and the resolution of those issues may span multiple years, particularly if subject to negotiation or litigation. For more information, see Note 9, "Income Taxes" of the "Notes to Consolidated Financial Statements" included in Item 8. |
Income Taxes
We evaluate the realizability of our deferred tax assets by assessing the valuation allowance and adjust the allowance, if necessary. The factors used to assess the likelihood of realization are our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The ability or failure to achieve the forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets. Based on future operating results in certain jurisdictions, it is possible that the current valuation allowance positions of those jurisdictions could be adjusted in the next 12 months.
As of September 29, 2019 and September 30, 2018, the liability for income taxes associated with uncertain tax positions was $9.2 million and $8.3 million, respectively.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of our unrecognized tax positions may significantly decrease within the next 12 months. These changes would be the result of ongoing examinations.
Off-Balance Sheet Arrangements
In the ordinary course of business, we may use off-balance sheet arrangements if we believe that such arrangements would be an efficient way to lower our cost of capital or help us manage the overall risks of our business operations. We do not believe that such arrangements have had a material adverse effect on our financial position or our results of operations.
The following is a summary of our off-balance sheet arrangements:
• | Letters of credit and bank guarantees are used primarily to support project performance and insurance programs. We are required to reimburse the issuers of letters of credit and bank guarantees for any payments they make under the outstanding letters of credit or bank guarantees. Our Amended Credit Agreement and additional letter of credit facilities cover the issuance of our standby letters of credit and bank guarantees and are critical for our normal operations. If we default on the Amended Credit Agreement or additional credit facilities, our inability to issue or renew standby letters of credit and bank guarantees would impair our ability to maintain normal operations. At September 29, 2019, we had $0.7 million in standby letters of credit outstanding under our Amended Credit Agreement, $41.4 million in standby letters of credit outstanding under our additional letter of credit facilities and $6.1 million of bank guarantees under our Australian facility, and $17.4 million under our United Kingdom facility. |
• | From time to time, we provide guarantees and indemnifications related to our services. If our services under a guaranteed or indemnified project are later determined to have resulted in a material defect or other material |
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deficiency, then we may be responsible for monetary damages or other legal remedies. When sufficient information about claims on guaranteed or indemnified projects is available and monetary damages or other costs or losses are determined to be probable, we recognize such guaranteed losses.
• | In the ordinary course of business, we enter into various agreements as part of certain unconsolidated subsidiaries, joint ventures, and other jointly executed contracts where we are jointly and severally liable. We enter into these agreements primarily to support the project execution commitments of these entities. The potential payment amount of an outstanding performance guarantee is typically the remaining cost of work to be performed by or on behalf of third parties under engineering and construction contracts. However, we are not able to estimate other amounts that may be required to be paid in excess of estimated costs to complete contracts and, accordingly, the total potential payment amount under our outstanding performance guarantees cannot be estimated. For cost-plus contracts, amounts that may become payable pursuant to guarantee provisions are normally recoverable from the client for work performed under the contract. For lump sum or fixed-price contracts, this amount is the cost to complete the contracted work less amounts remaining to be billed to the client under the contract. Remaining billable amounts could be greater or less than the cost to complete. In those cases where costs exceed the remaining amounts payable under the contract, we may have recourse to third parties, such as owners, co-venturers, subcontractors or vendors, for claims. |
• | In the ordinary course of business, our clients may request that we obtain surety bonds in connection with contract performance obligations that are not required to be recorded in our consolidated balance sheets. We are obligated to reimburse the issuer of our surety bonds for any payments made thereunder. Each of our commitments under performance bonds generally ends concurrently with the expiration of our related contractual obligation. |
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions in the application of certain accounting policies that affect amounts reported in our consolidated financial statements and accompanying footnotes included in Item 8 of this report. In order to understand better the changes that may occur to our financial condition, results of operations and cash flows, readers should be aware of the critical accounting policies we apply and estimates we use in preparing our consolidated financial statements. Although such estimates and assumptions are based on management's best knowledge of current events and actions we may undertake in the future, actual results could differ materially from those estimates.
Our significant accounting policies are described in the "Notes to Consolidated Financial Statements" included in Item 8. Highlighted below are the accounting policies that management considers most critical to investors' understanding of our financial results and condition, and that require complex judgments by management.
Revenue Recognition and Contract Costs
On October 1, 2018, we adopted ASC 606, which supersedes most current revenue recognition guidance, including industry-specific guidance. We adopted the standard on a modified retrospective basis which results in no restatement of the comparative periods presented and a cumulative effect adjustment to retained earnings as of the date of adoption. As part of our adoption, the new standard was applied only to those contracts that were not substantially completed as of the date of adoption.
To determine the proper revenue recognition method for contracts under ASC 606, we evaluate whether multiple contracts should be combined and accounted for as a single contract and whether the combined or single contract should be accounted for as having more than one performance obligation. The decision to combine a group of contracts or separate a combined or single contract into multiple performance obligations may impact the amount of revenue recorded in a given period. Contracts are considered to have a single performance obligation if the promises are not separately identifiable from other promises in the contracts.
At contract inception, we assess the goods or services promised in a contract and identify, as a separate performance obligation, each distinct promise to transfer goods or services to the customer. The identified performance obligations represent the “unit of account” for purposes of determining revenue recognition. In order to properly identify separate performance obligations, we apply judgment in determining whether each good or service provided is: (a) capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and (b) distinct within the context of the contract, whereby the transfer of the good or service to the customer is separately identifiable from other promises in the contract.
Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new or changes the existing enforceable rights and obligations. Most
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of our contract modifications are for goods or services that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
We account for contract modifications as a separate contract when the modification results in the promise to deliver additional goods or services that are distinct and the increase in price of the contract is for the same amount as the stand-alone selling price of the additional goods or services included in the modification.
The transaction price represents the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to our customers. The consideration promised within a contract may include fixed amounts, variable amounts, or both. The nature of our contracts gives rise to several types of variable consideration, including claims, award fee incentives, fiscal funding clauses, and liquidated damages. We recognize revenue for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized for the contract will not occur. We estimate the amount of revenue to be recognized on variable consideration using either the expected value or the most likely amount method, whichever is expected to better predict the amount of consideration to be received. Project mobilization costs are generally charged to project costs as incurred when they are an integrated part of the performance obligation being transferred to the client.
Claims are amounts in excess of agreed contract prices that we seek to collect from our clients or other third parties for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price, or other causes of unanticipated additional costs. Revenue on claims is recognized only to the extent that contract costs related to the claims have been incurred and when it is probable that any significant revenue recognized related to the claim will not be reversed. Factors considered in determining whether revenue associated with claims (including change orders in dispute and unapproved change orders in regard to both scope and price) should be recognized include the following: (a) the contract or other evidence provides a legal basis for the claim, (b) additional costs were caused by circumstances that were unforeseen at the contract date and not the result of deficiencies in our performance, (c) claim-related costs are identifiable and considered reasonable in view of the work performed, and (d) evidence supporting the claim is objective and verifiable. This can lead to a situation in which costs are recognized in one period and revenue is recognized in a subsequent period when a client agreement is obtained, or a claims resolution occurs. In some cases, contract retentions are withheld by clients until certain conditions are met or the project is completed, which may be several months or years. In these cases, we have not identified a significant financing component under ASC 606 as the timing difference in payment compared to delivery of obligations under the contract is not for purposes of financing.
For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using a best estimate of the standalone selling price of each distinct good or service in the contract. The standalone selling price is typically determined using the estimated cost of the contract plus a margin approach. For contracts containing variable consideration, we allocate the variability to a specific performance obligation within the contract if such variability relates specifically to our efforts to satisfy the performance obligation or transfer the distinct good or service, and the allocation depicts the amount of consideration to which we expect to be entitled.
We recognize revenue over time as the related performance obligation is satisfied by transferring control of a promised good or service to our customers. Progress toward complete satisfaction of the performance obligation is primarily measured using a cost-to-cost measure of progress method. The cost input is based primarily on contract cost incurred to date compared to total estimated contract cost. This measure includes forecasts based on the best information available and reflects our judgment to faithfully depict the value of the services transferred to the customer. For certain on-call engineering or consulting and similar contracts, we recognize revenue in the amount which we have the right to invoice the customer if that amount corresponds directly with the value of our performance completed to date.
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost measure of progress method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs indicates a loss, a provision for the entire estimated loss on the contract is made in the period in which the loss becomes evident.
Contract Types
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Our services are performed under three principal types of contracts: fixed-price, time-and-materials and cost-plus. Customer payments on contracts are typically due within 60 days of billing, depending on the contract.
Fixed-Price. Under fixed-price contracts, clients pay us an agreed fixed-amount negotiated in advance for a specified scope of work.
Time-and-Materials. Under time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we spend on a project. In addition, clients reimburse us for our actual out-of-pocket costs for materials and other direct incidental expenditures that we incur in connection with our performance under the contract. Most of our time-and-material contracts are subject to maximum contract values, and also may include annual billing rate adjustment provisions.
Cost-Plus. Under cost-plus contracts, we are reimbursed for allowed or otherwise defined costs incurred plus a negotiated fee. The contracts may also include incentives for various performance criteria, including quality, timeliness, ingenuity, safety and cost-effectiveness. In addition, our costs are generally subject to review by our clients and regulatory audit agencies, and such reviews could result in costs being disputed as non-reimbursable under the terms of the contract.
Insurance Matters, Litigation and Contingencies
In the normal course of business, we are subject to certain contractual guarantees and litigation. Generally, such guarantees relate to project schedules and performance. Most of the litigation involves us as a defendant in contractual disagreements, workers' compensation, personal injury and other similar lawsuits. We maintain insurance coverage for various aspects of our business and operations. However, we have elected to retain a portion of losses that may occur through the use of various deductibles, limits and retentions under our insurance programs. This practice may subject us to some future liability for which we are only partially insured or are completely uninsured.
We record in our consolidated balance sheets amounts representing our estimated liability for self-insurance claims. We utilize actuarial analyses to assist in determining the level of accrued liabilities to establish for our employee medical and workers' compensation self-insurance claims that are known and have been asserted against us, as well as for self-insurance claims that are believed to have been incurred based on actuarial analyses but have not yet been reported to our claims administrators at the balance sheet date. We include any adjustments to such insurance reserves in our consolidated statements of income.
Except as described in Note 18, "Commitments and Contingencies" of the "Notes to Consolidated Financial Statements" included in Item 8, we do not have any litigation or other contingencies that have had, or are currently anticipated to have, a material impact on our results of operations or financial position. As additional information about current or future litigation or other contingencies becomes available, management will assess whether such information warrants the recording of additional expenses relating to those contingencies. Such additional expenses could potentially have a material impact on our results of operations and financial position.
Goodwill and Intangibles
The cost of an acquired company is assigned to the tangible and intangible assets purchased and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when a market value is not readily available. Any excess of purchase price over the fair value of net tangible and intangible assets acquired is allocated to goodwill. Goodwill typically represents the value paid for the assembled workforce and enhancement of our service offerings.
Identifiable intangible assets include backlog, non-compete agreements, client relations, trade names, patents and other assets. The costs of these intangible assets are amortized over their contractual or economic lives, which range from one to ten years. We assess the recoverability of the unamortized balance of our intangible assets when indicators of impairment are present based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of the intangible assets would be recognized as an impairment loss.
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. In addition, we regularly evaluate whether events and circumstances have occurred that may indicate a potential change in recoverability of goodwill. We perform interim goodwill impairment reviews between our annual reviews if certain events and circumstances have occurred, including a deterioration in general economic conditions, an increased competitive environment, a change in management, key personnel, strategy or customers, negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods (see Note 7, "Goodwill and Intangible Assets" of the "Notes to Consolidated Financial Statements" in Item 8 for further discussion).
We believe the methodology that we use to review impairment of goodwill, which includes a significant amount of judgment and estimates, provides us with a reasonable basis to determine whether impairment has occurred. However, many of
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the factors employed in determining whether our goodwill is impaired are outside of our control and it is reasonably likely that assumptions and estimates will change in future periods. These changes could result in future impairments.
The goodwill impairment review involves the determination of the fair value of our reporting units, which for us are the components one level below our reportable segments. This process requires us to make significant judgments and estimates, including assumptions about our strategic plans with regard to our operations as well as the interpretation of current economic indicators and market valuations. Furthermore, the development of the present value of future cash flow projections includes assumptions and estimates derived from a review of our expected revenue growth rates, operating profit margins, business plans, discount rates and tax rates. We also make certain assumptions about future market conditions, market prices, interest rates and changes in business strategies. Changes in assumptions or estimates could materially affect the determination of the fair value of a reporting unit. This could eliminate the excess of fair value over carrying value of a reporting unit entirely and, in some cases, result in impairment. Such changes in assumptions could be caused by a loss of one or more significant contracts, reductions in government or commercial client spending, or a decline in the demand for our services due to changing economic conditions. In the event that we determine that our goodwill is impaired, we would be required to record a non-cash charge that could result in a material adverse effect on our results of operations or financial position.
We use two methods to determine the fair value of our reporting units: (i) the Income Approach and (ii) the Market Approach. While each of these approaches is initially considered in the valuation of the business enterprises, the nature and characteristics of the reporting units indicate which approach is most applicable. The Income Approach utilizes the discounted cash flow method, which focuses on the expected cash flow of the reporting unit. In applying this approach, the cash flow available for distribution is calculated for a finite period of years. Cash flow available for distribution is defined, for purposes of this analysis, as the amount of cash that could be distributed as a dividend without impairing the future profitability or operations of the reporting unit. The cash flow available for distribution and the terminal value (the value of the reporting unit at the end of the estimation period) are then discounted to present value to derive an indication of the value of the business enterprise. The Market Approach is comprised of the guideline company method and the similar transactions method. The guideline company method focuses on comparing the reporting unit to select reasonably similar (or "guideline") publicly traded companies. Under this method, valuation multiples are (i) derived from the operating data of selected guideline companies; (ii) evaluated and adjusted based on the strengths and weaknesses of the reporting units relative to the selected guideline companies; and (iii) applied to the operating data of the reporting unit to arrive at an indication of value. In the similar transactions method, consideration is given to prices paid in recent transactions that have occurred in the reporting unit's industry or in related industries. For our annual impairment analysis, we weighted the Income Approach and the Market Approach at 70% and 30%, respectively. The Income Approach was given a higher weight because it has the most direct correlation to the specific economics of the reporting unit, as compared to the Market Approach, which is based on multiples of broad-based (i.e., less comparable) companies. Our last review at July 1, 2019 (i.e. the first day of our fourth quarter in fiscal 2019), indicated that we had no impairment of goodwill, and all of our reporting units had estimated fair values that were in excess of their carrying values, including goodwill. We had no reporting units that had estimated fair values that exceeded their carrying values by less than 25%.
Contingent Consideration
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.
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 "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 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 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 (See Note 2, "Basis of Presentation and Preparation – Fair Value of Financial Instruments" of the "Notes to Consolidated Financial Statements" included in Item 8). 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
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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 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 in our consolidated statements of cash flows.
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.
Income Taxes
We file a consolidated U.S. federal income tax return. In addition, we file other returns that are required in the states, foreign jurisdictions and other jurisdictions in which we do business. We account for certain income and expense items differently for financial reporting and income tax purposes. Deferred tax assets and liabilities are computed for the differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to reverse. In determining the need for a valuation allowance on deferred tax assets, management reviews both positive and negative evidence, including current and historical results of operations, future income projections and potential tax planning strategies. Based on our assessment, we have concluded that a portion of the deferred tax assets at September 29, 2019, primarily net operating losses and certain foreign intangibles, will not be realized, and we have reserved accordingly.
According to the authoritative guidance on accounting for uncertainty in income taxes, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. For more information related to our unrecognized tax benefits, see Note 9, "Income Taxes" of the "Notes to Consolidated Financial Statements" included in Item 8.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of recent accounting standards and the effect they could have on the consolidated financial statements, see Note 2, "Basis of Presentation and Preparation" of the "Notes to Consolidated Financial Statements" included in Item 8.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We do not enter into derivative financial instruments for trading or speculation purposes. In the normal course of business, we have exposure to both interest rate risk and foreign currency transaction and translation risk, primarily related to the Canadian and Australian dollar, and British Pound.
We are exposed to interest rate risk under our Amended Credit Agreement. We can borrow, at our option, under both the Amended Term Loan Facility and Amended Revolving Credit Facility. We may borrow on the Amended Revolving Credit Facility, at our option, at either (a) a Eurocurrency rate plus a margin that ranges from 1.00% to 1.75% per annum, or (b) a base rate for loans in U.S. dollars (the highest of the U.S. federal funds rate plus 0.50% per annum, the bank’s prime rate or the Eurocurrency rate plus 1.00%) plus a margin that ranges from 0% to 0.75% per annum. Borrowings at the base rate have no designated term and may be repaid without penalty any time prior to the Facility’s maturity date. Borrowings at a Eurodollar rate have a term no less than 30 days and no greater than 180 days and may be prepaid without penalty. Typically, at the end of such term, such borrowings may be rolled over at our discretion into either a borrowing at the base rate or a borrowing at a Eurodollar rate with similar terms, not to exceed the maturity date of the Facility. The Facility matures on July 30, 2023. At September 29, 2019, we had borrowings outstanding under the Credit Agreement of $276.4 million at a weighted-average interest rate of 3.37% per annum.
In August 2018, we entered into five interest rate swap agreements with five banks to fix the variable interest rate on $250 million of our Amended Term Loan Facility. The objective of these interest rate swaps was to eliminate the variability of our cash flows on the amount of interest expense we pay under our Credit Agreement. As of September 29, 2019, the notional principal of our outstanding interest swap agreements was $240.6 million ($48.1 million each.) Our year-to-date average effective interest rate on borrowings outstanding under the Credit Agreement, including the effects of interest rate swap agreements, at September 29, 2019, was 3.65%. For more information, see Note 15, “Derivative Financial Instruments” of the “Notes to Consolidated Financial Statements” in Item 8.
Most of our transactions are in U.S. dollars; however, some of our subsidiaries conduct business in foreign currencies, primarily the Canadian and Australian dollar, and British Pound. Therefore, we are subject to currency exposure and volatility because of currency fluctuations. We attempt to minimize our exposure to these fluctuations by matching revenue and expenses
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in the same currency for our contracts. Foreign currency gains and losses were immaterial for both fiscal 2019 and fiscal 2018. Foreign currency gains and losses are reported as part of “Selling, general and administrative expenses” in our consolidated statements of income.
We have foreign currency exchange rate exposure in our results of operations and equity primarily because of the currency translation related to our foreign subsidiaries where the local currency is the functional currency. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions will result in reduced revenue, operating expenses, assets and liabilities. Similarly, our revenue, operating expenses, assets and liabilities will increase if the U.S. dollar weakens against foreign currencies. For fiscal 2019 and 2018, 27.7% and 24.7% of our consolidated revenue, respectively, was generated by our international business. For fiscal 2019, the effect of foreign exchange rate translation on the consolidated balance sheets was a decrease in equity of $21.1 million compared to a decrease in equity of $29.7 million in fiscal 2018. These amounts were recognized as an adjustment to equity through other comprehensive income.
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Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Tetra Tech, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Tetra Tech, Inc. and its subsidiaries (the “Company”) as of September 29, 2019 and September 30, 2018, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended September 29, 2019, including the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of September 29, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 29, 2019 and September 30, 2018, and the results of its operations and its cash flows for each of the three years in the period ended September 29, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 29, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As described in Management's Report on Internal Control over Financial Reporting, management has excluded WYG plc (WYG) from its assessment of internal control over financial reporting as of September 29, 2019, because it was acquired by the Company in a purchase business combination during 2019. We have also excluded WYG from our audit of internal control over financial reporting. WYG is a wholly-owned subsidiary whose total assets and total revenue excluded from management's assessment and our audit of internal control over financial reporting represent approximately 3% and 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended September 29, 2019.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions
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of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Revenue recognition - determination of total estimated contract cost for fixed-price contracts
As described in Note 3 to the consolidated financial statements, the Company’s services are performed under three principal types of contracts: fixed-price, time-and-materials and cost-plus. Under fixed-price contracts, which account for approximately 34% of the Company's total consolidated revenue, the Company’s clients pay an agreed fixed-amount negotiated in advance for a specified scope of work. Revenue on fixed-price contracts is recognized over time as the related performance obligation is satisfied by transferring control of a promised good or service to the Company’s customers. Progress toward complete satisfaction of the performance obligation is primarily measured using a cost-to-cost measure of progress method. The cost input is based primarily on contract cost incurred to date compared to total estimated contract cost. As disclosed by management, this measure includes forecasts based on the best information available and reflects the judgment to faithfully depict the value of the services transferred to the customer. Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost measure of progress method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs for a performance obligation indicates a loss, a provision for the entire estimated loss on the contract is made in the period in which the loss becomes evident.
The principal considerations for our determination that performing procedures relating to revenue recognition - determination of total estimated contract cost for fixed-price contracts is a critical audit matter are there was a significant amount of judgment required by management in determining the total estimated contract cost for fixed-price contracts which, in turn, led to a high degree of auditor judgment, subjectivity and audit effort in performing our procedures to evaluate the total estimated contract costs for fixed-price contracts and the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the determination of total estimated contract cost for fixed-price contracts. These procedures also included, among others, (i) evaluating and testing management’s process for determining the total estimated contract cost for a sample of contracts, which included review of contracts and other documents that support those estimates, and testing of underlying contract costs; (ii) assessing management's ability to reasonably estimate total contract cost by performing a comparison of the actual total estimated contract cost as compared with prior period estimates, including evaluating the timely identification of circumstances that may warrant a modification to the total estimated contract cost and (iii) evaluating management’s methodologies and assessing the consistency of management’s approach over the life of the contract.
Goodwill impairment assessment - Remediation and Field Services reporting unit
As described in Notes 2 and 7 to the consolidated financial statements, the Company's consolidated goodwill balance was $924.8 million as of September 29, 2019, and the goodwill associated with the Remediation and Field Services (RFS) reporting unit was $48.8 million. Management performs an annual goodwill impairment review at the beginning of the fiscal fourth quarter of each year, July 1, 2019, for fiscal 2019, or more frequently when an event occurs or circumstances indicate that the carrying value of the asset may not be recoverable. During the fourth quarter of fiscal 2019, management performed a strategic review of
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the Company's operations. As a result, management decided to dispose of the Canadian turn-key pipeline activities in the RFS reporting unit, which is in the Commercial/International Services Group (CIG) reportable segment. Management performed an interim goodwill impairment review of the RFS reporting unit and recorded a $7.8 million goodwill impairment charge. As a result of the impairment charge, the estimated fair value of the RFS reporting unit equals its carrying value of $61 million at September 29, 2019, including the remaining $48.8 million of goodwill. The impairment test for goodwill involves the comparison of the estimated fair value of each reporting unit to the reporting unit's carrying value, including goodwill. Management estimates the fair value of reporting units based on a comparison and weighting of the income approach, specifically the discounted cash flow method and the market approach. Management's cash flow projections for the RFS Reporting Unit included significant judgments and assumptions relating to revenue growth rate, operating profit margin forecasts and the discount rate.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment of the RFS reporting unit is a critical audit matter are there was significant judgment by management when developing the fair value measurement of the reporting unit which, in turn, led to a high degree of auditor judgment, subjectivity, and effort in performing procedures to evaluate management's cash flow projections and significant assumptions, including revenue growth rate, operating profit margin forecasts and the discount rate. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained from these procedures.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the financial statements. These procedures included testing the effectiveness of controls relating to management's goodwill impairment assessment, including controls over the evaluation of the Company's reporting units. These procedures also included, among others, testing management's process for developing the fair value estimate; evaluating the appropriateness of the discounted cash flow method; testing the completeness, accuracy, and relevance of underlying data used in the cash flow projections; and evaluating the significant assumptions used by management, including revenue growth rate, operating margin forecasts and the discount rate. Evaluating management's assumptions related to revenue growth rates and projected operating income involved evaluating whether the assumptions used by management were reasonable considering (i) the current and past performance of the reporting unit, (ii) the consistency with external market and industry data, and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company's discounted cash flow method and certain significant assumptions, including the discount rate.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
November 27, 2019
We have served as the Company’s auditor since 2004.
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TETRA TECH, INC.
Consolidated Balance Sheets
(in thousands, except par value)
ASSETS | September 29, 2019 | September 30, 2018 | |||||
Current assets: | |||||||
Cash and cash equivalents | $ | 120,732 | $ | 146,185 | |||
Accounts receivable – net | 768,720 | 694,221 | |||||
Contract assets | 114,324 | 142,882 | |||||
Prepaid expenses and other current assets | 62,196 | 56,003 | |||||
Income taxes receivable | 13,820 | 11,089 | |||||
Total current assets | 1,079,792 | 1,050,380 | |||||
Property and equipment – net | 39,441 | 43,278 | |||||
Investments in unconsolidated joint ventures | 6,873 | 3,370 | |||||
Goodwill | 924,820 | 798,820 | |||||
Intangible assets – net | 16,440 | 16,123 | |||||
Deferred income taxes | 28,385 | 8,607 | |||||
Other long-term assets | 51,657 | 38,843 | |||||
Total assets | $ | 2,147,408 | $ | 1,959,421 | |||
LIABILITIES AND EQUITY | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 206,609 | $ | 160,222 | |||
Accrued compensation | 203,384 | 180,153 | |||||
Contract liabilities | 165,611 | 143,270 | |||||
Income taxes payable | — | 8,272 | |||||
Current portion of long-term debt | 12,572 | 12,599 | |||||
Current contingent earn-out liabilities | 24,977 | 13,633 | |||||
Other current liabilities | 156,801 | 99,944 | |||||
Total current liabilities | 769,954 | 618,093 | |||||
Deferred income taxes | 12,971 | 30,166 | |||||
Long-term debt | 263,949 | 264,712 | |||||
Long-term contingent earn-out liabilities | 28,015 | 21,657 | |||||
Other long-term liabilities | 83,055 | 57,693 | |||||
Commitments and contingencies (Note 18) | |||||||
Equity: | |||||||
Preferred stock – Authorized, 2,000 shares of $0.01 par value; no shares issued and outstanding at September 29, 2019 and September 30, 2018 | — | — | |||||
Common stock – Authorized, 150,000 shares of $0.01 par value; issued and outstanding, 54,565 and 55,349 shares at September 29, 2019 and September 30, 2018, respectively | 546 | 553 | |||||
Additional paid-in capital | 78,132 | 148,803 | |||||
Accumulated other comprehensive loss | (160,584 | ) | (127,350 | ) | |||
Retained earnings | 1,071,192 | 944,965 | |||||
Tetra Tech stockholders' equity | 989,286 | 966,971 | |||||
Noncontrolling interests | 178 | 129 | |||||
Total stockholders' equity | 989,464 | 967,100 | |||||
Total liabilities and stockholders' equity | $ | 2,147,408 | $ | 1,959,421 | |||
See accompanying Notes to Consolidated Financial Statements.
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TETRA TECH, INC.
Consolidated Statements of Income
(in thousands, except per share data)
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
Revenue | $ | 3,107,348 | $ | 2,964,148 | $ | 2,753,360 | |||||
Subcontractor costs | (717,711 | ) | (763,414 | ) | (719,350 | ) | |||||
Other costs of revenue | (1,981,454 | ) | (1,816,276 | ) | (1,680,372 | ) | |||||
Gross profit | 408,183 | 384,458 | 353,638 | ||||||||
Selling, general and administrative expenses | (200,230 | ) | (190,120 | ) | (177,219 | ) | |||||
Acquisition and integration expenses | (10,351 | ) | — | — | |||||||
Contingent consideration – fair value adjustments | (1,085 | ) | (4,252 | ) | 6,923 | ||||||
Impairment of goodwill | (7,755 | ) | — | — | |||||||
Income from operations | 188,762 | 190,086 | 183,342 | ||||||||
Interest income | 1,732 | 1,824 | 729 | ||||||||
Interest expense | (15,358 | ) | (17,348 | ) | (12,310 | ) | |||||
Income before income tax expense | 175,136 | 174,562 | 171,761 | ||||||||
Income tax expense | (16,375 | ) | (37,605 | ) | (53,844 | ) | |||||
Net income | 158,761 | 136,957 | 117,917 | ||||||||
Net income attributable to noncontrolling interests | (93 | ) | (74 | ) | (43 | ) | |||||
Net income attributable to Tetra Tech | $ | 158,668 | $ | 136,883 | $ | 117,874 | |||||
Earnings per share attributable to Tetra Tech: | |||||||||||
Basic | $ | 2.89 | $ | 2.46 | $ | 2.07 | |||||
Diluted | $ | 2.84 | $ | 2.42 | $ | 2.04 | |||||
Weighted-average common shares outstanding: | |||||||||||
Basic | 54,986 | 55,670 | 56,911 | ||||||||
Diluted | 55,936 | 56,598 | 57,913 | ||||||||
See accompanying Notes to Consolidated Financial Statements.
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TETRA TECH, INC.
Consolidated Statements of Comprehensive Income
(in thousands)
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
Net income | $ | 158,761 | $ | 136,957 | $ | 117,917 | |||||
Other comprehensive income (loss), net of tax | |||||||||||
Foreign currency translation adjustments | (21,109 | ) | (29,656 | ) | 27,894 | ||||||
(Loss) gain on cash flow hedge valuations | (12,125 | ) | 806 | 1,614 | |||||||
Other comprehensive (loss) income attributable to Tetra Tech | (33,234 | ) | (28,850 | ) | 29,508 | ||||||
Other comprehensive income (loss) attributable to noncontrolling interests | 243 | (64 | ) | 8 | |||||||
Comprehensive income | $ | 125,770 | $ | 108,043 | $ | 147,433 | |||||
Comprehensive income attributable to Tetra Tech | $ | 125,434 | $ | 108,033 | $ | 147,382 | |||||
Comprehensive income attributable to noncontrolling interests | 336 | 10 | 51 | ||||||||
Comprehensive income | $ | 125,770 | $ | 108,043 | $ | 147,433 | |||||
See accompanying Notes to Consolidated Financial Statements.
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TETRA TECH, INC.
Consolidated Statements of Equity
Fiscal Years Ended October 1, 2017, September 30, 2018, and September 29, 2019
(in thousands)
Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Total Tetra Tech Equity | Non-Controlling Interests | Total Equity | ||||||||||||||||||||||||
Shares | Amount | |||||||||||||||||||||||||||||
BALANCE AT OCTOBER 2, 2016 | 57,042 | $ | 570 | $ | 260,340 | $ | (128,008 | ) | $ | 736,357 | $ | 869,259 | $ | 144 | $ | 869,403 | ||||||||||||||
Comprehensive income, net of tax: | ||||||||||||||||||||||||||||||
Net income | 117,874 | 117,874 | 43 | 117,917 | ||||||||||||||||||||||||||
Foreign currency translation adjustments | 27,894 | 27,894 | 8 | 27,902 | ||||||||||||||||||||||||||
Gain on cash flow hedge valuations | 1,614 | 1,614 | 1,614 | |||||||||||||||||||||||||||
Comprehensive income, net of tax | 147,382 | 51 | 147,433 | |||||||||||||||||||||||||||
Distributions paid to noncontrolling interests | (24 | ) | (24 | ) | ||||||||||||||||||||||||||
Cash dividends of $0.38 per common share | (21,672 | ) | (21,672 | ) | (21,672 | ) | ||||||||||||||||||||||||
Stock-based compensation | 13,450 | 13,450 | 13,450 | |||||||||||||||||||||||||||
Stock options exercised | 791 | 8 | 18,556 | 18,564 | 18,564 | |||||||||||||||||||||||||
Restricted stock award, restricted & performance shares released | 116 | 2 | (3,472 | ) | (3,470 | ) | (3,470 | ) | ||||||||||||||||||||||
Shares issued for Employee Stock Purchase Plan | 190 | 2 | 4,938 | 4,940 | 4,940 | |||||||||||||||||||||||||
Stock repurchases | (2,266 | ) | (23 | ) | (99,977 | ) | (100,000 | ) | (100,000 | ) | ||||||||||||||||||||
BALANCE AT OCTOBER 1, 2017 | 55,873 | 559 | 193,835 | (98,500 | ) | 832,559 | 928,453 | 171 | 928,624 | |||||||||||||||||||||
Comprehensive income, net of tax: | ||||||||||||||||||||||||||||||
Net income | 136,883 | 136,883 | 74 | 136,957 | ||||||||||||||||||||||||||
Foreign currency translation adjustments | (29,656 | ) | (29,656 | ) | (64 | ) | (29,720 | ) | ||||||||||||||||||||||
Gain on cash flow hedge valuations | 806 | 806 | 806 | |||||||||||||||||||||||||||
Comprehensive income, net of tax | 108,033 | 10 | 108,043 | |||||||||||||||||||||||||||
Distributions paid to noncontrolling interests | (52 | ) | (52 | ) | ||||||||||||||||||||||||||
Cash dividends of $0.44 per common share | (24,477 | ) | (24,477 | ) | (24,477 | ) | ||||||||||||||||||||||||
Stock-based compensation | 19,582 | 19,582 | 19,582 | |||||||||||||||||||||||||||
Restricted & performance shares released | 277 | 3 | (8,874 | ) | (8,871 | ) | (8,871 | ) | ||||||||||||||||||||||
Stock options exercised | 549 | 5 | 13,506 | 13,511 | 13,511 | |||||||||||||||||||||||||
Shares issued for Employee Stock Purchase Plan | 142 | 1 | 5,739 | 5,740 | 5,740 | |||||||||||||||||||||||||
Stock repurchases | (1,492 | ) | (15 | ) | (74,985 | ) | (75,000 | ) | (75,000 | ) | ||||||||||||||||||||
BALANCE AT SEPTEMBER 30, 2018 | 55,349 | 553 | 148,803 | (127,350 | ) | 944,965 | 966,971 | 129 | 967,100 | |||||||||||||||||||||
Comprehensive income, net of tax: | ||||||||||||||||||||||||||||||
Net income | 158,668 | 158,668 | 93 | 158,761 | ||||||||||||||||||||||||||
Foreign currency translation adjustments | (21,109 | ) | (21,109 | ) | 243 | (20,866 | ) | |||||||||||||||||||||||
Loss on cash flow hedge valuations | (12,125 | ) | (12,125 | ) | (12,125 | ) | ||||||||||||||||||||||||
Comprehensive income, net of tax | 125,434 | 336 | 125,770 | |||||||||||||||||||||||||||
Distributions paid to noncontrolling interests | (287 | ) | (287 | ) | ||||||||||||||||||||||||||
Cash dividends of $0.54 per common share | (29,674 | ) | (29,674 | ) | (29,674 | ) | ||||||||||||||||||||||||
Stock-based compensation | 17,618 | 17,618 | 17,618 | |||||||||||||||||||||||||||
Restricted & performance shares released | 183 | 2 | (6,895 | ) | (6,893 | ) | (6,893 | ) | ||||||||||||||||||||||
Stock options exercised | 448 | 5 | 11,746 | 11,751 | 11,751 | |||||||||||||||||||||||||
Shares issued for Employee Stock Purchase Plan | 148 | 2 | 6,844 | 6,846 | 6,846 | |||||||||||||||||||||||||
Stock repurchases | (1,563 | ) | (16 | ) | (99,984 | ) | (100,000 | ) | (100,000 | ) | ||||||||||||||||||||
Cumulative effect of accounting changes | $ | (2,767 | ) | $ | (2,767 | ) | $ | (2,767 | ) | |||||||||||||||||||||
BALANCE AT SEPTEMBER 29, 2019 | 54,565 | $ | 546 | $ | 78,132 | $ | (160,584 | ) | $ | 1,071,192 | $ | 989,286 | $ | 178 | $ | 989,464 | ||||||||||||||
See accompanying Notes to Consolidated Financial Statements.
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TETRA TECH, INC.
Consolidated Statements of Cash Flows
(in thousands)
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
Cash flows from operating activities: | |||||||||||
Net income | $ | 158,761 | $ | 136,957 | $ | 117,917 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Depreciation and amortization | 28,844 | 38,636 | 45,756 | ||||||||
Equity in income of unconsolidated joint ventures, net of distributions | (25 | ) | (568 | ) | (647 | ) | |||||
Amortization of stock-based awards | 17,618 | 19,582 | 13,450 | ||||||||
Deferred income taxes | (37,615 | ) | (29,360 | ) | (9,957 | ) | |||||
Provision for doubtful accounts | 16,964 | 7,167 | 2,847 | ||||||||
Impairment of goodwill | 7,755 | — | — | ||||||||
Fair value adjustments to contingent consideration | 1,085 | 4,252 | (6,923 | ) | |||||||
Loss (gain) on sale of assets and divested business | (232 | ) | 1,045 | (103 | ) | ||||||
Changes in operating assets and liabilities, net of effects of business acquisitions: | |||||||||||
Accounts receivable and contract assets | (10,226 | ) | (46,273 | ) | (64,781 | ) | |||||
Prepaid expenses and other assets | 2,568 | (12,638 | ) | (8,317 | ) | ||||||
Accounts payable | 39,011 | (16,032 | ) | 18,597 | |||||||
Accrued compensation | 18,359 | 27,492 | 13,413 | ||||||||
Contract liabilities | (6,039 | ) | 15,228 | 28,298 | |||||||
Other liabilities | (16,929 | ) | 24,998 | 5,662 | |||||||
Income taxes receivable/payable | (11,386 | ) | 17,596 | (13,725 | ) | ||||||
Cash settled contingent earn-out liability | — | (2,349 | ) | — | |||||||
Net cash provided by operating activities | 208,513 | 185,733 | 141,487 | ||||||||
Cash flows from investing activities: | |||||||||||
Capital expenditures | (16,198 | ) | (9,726 | ) | (9,741 | ) | |||||
Payments for business acquisitions, net of cash acquired | (84,159 | ) | (68,256 | ) | (8,039 | ) | |||||
Proceeds from sale of assets and divested business, net | 651 | 35,348 | 820 | ||||||||
Net cash used in investing activities | (99,706 | ) | (42,634 | ) | (16,960 | ) | |||||
Cash flows from financing activities: | |||||||||||
Repayments on long-term debt | (415,491 | ) | (485,946 | ) | (233,889 | ) | |||||
Proceeds from borrowings | 417,262 | 401,965 | 243,553 | ||||||||
Payments of contingent earn-out liabilities | (12,018 | ) | (1,412 | ) | (1,319 | ) | |||||
Debt pre-payment costs | — | (1,737 | ) | — | |||||||
Repurchases of common stock | (100,000 | ) | (75,000 | ) | (100,000 | ) | |||||
Stock options exercised | 11,751 | 13,520 | 18,555 | ||||||||
Dividends paid | (29,674 | ) | (24,477 | ) | (21,672 | ) | |||||
Taxes paid on vested restricted stock | (6,893 | ) | (8,871 | ) | (3,495 | ) | |||||
Net cash used in financing activities | (135,063 | ) | (181,958 | ) | (98,267 | ) | |||||
Effect of exchange rate changes on cash, cash equivalents and restricted cash | (1,727 | ) | (4,947 | ) | 3,452 | ||||||
Net increase (decrease) in cash, cash equivalents and restricted cash | (27,983 | ) | (43,806 | ) | 29,712 | ||||||
Cash, cash equivalents and restricted cash at beginning of year | 148,884 | 192,690 | 162,978 | ||||||||
Cash, cash equivalents and restricted cash at end of year | $ | 120,901 | $ | 148,884 | $ | 192,690 | |||||
Supplemental information: | |||||||||||
Cash paid during the year for: | |||||||||||
Interest | $ | 12,310 | $ | 15,570 | $ | 11,504 | |||||
Income taxes, net of refunds received of $5.2 million, $2.5 million and $2.1 million | $ | 66,038 | $ | 49,842 | $ | 72,578 | |||||
Reconciliation of cash, cash equivalents and restricted cash: | |||||||||||
Cash and cash equivalents | $ | 120,732 | $ | 146,185 | $ | 189,975 | |||||
Restricted cash | 169 | 2,699 | 2,715 | ||||||||
Total cash, cash equivalents and restricted cash | $ | 120,901 | $ | 148,884 | $ | 192,690 | |||||
See accompanying Notes to Consolidated Financial Statements.
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TETRA TECH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
We are a leading global provider of consulting and engineering services that focuses on water, environment, infrastructure, resource management, energy, and international development. We are a global company that leads with science and is renowned for our expertise in providing water-related services for public and private clients. We typically begin at the earliest stage of a project by identifying technical solutions and developing execution plans tailored to our clients' needs and resources. Our solutions may span the entire life cycle of consulting and engineering projects and include applied science, data analysis, research, engineering, design, construction management, and operations and maintenance.
Beginning in fiscal 2018, we aligned our operations to better serve our clients and markets, resulting in two renamed reportable segments. Our Government Services Group (“GSG”) reportable segment primarily includes activities with U.S. government clients (federal, state and local) and activities with development agencies worldwide. Our Commercial/International Services Group (“CIG”) reportable segment primarily includes activities with U.S. commercial clients and international activities other than work for development agencies. This alignment allows us to capitalize on our growing market opportunities and enhance the development of high-end consulting and technical solutions to meet our growing client demand. We continue to report the results of the wind-down of our non-core construction activities in the Remediation and Construction Management (“RCM”) reportable segment. Certain reclassifications were made to the prior years to conform to the current-year presentation.
2. Basis of Presentation and Preparation
Principles of Consolidation and Presentation. The consolidated financial statements include our accounts and those of joint ventures of which we are the primary beneficiary. All significant intercompany balances and transactions have been eliminated in consolidation.
Fiscal Year. We report results of operations based on 52 or 53-week periods ending on the Sunday nearest September 30. Fiscal years 2019, 2018 and 2017 each contained 52 weeks.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires us to make estimates and assumptions. These estimates and assumptions affect the amounts reported in our consolidated financial statements and accompanying notes. Although such estimates and assumptions are based on management's best knowledge of current events and actions we may take in the future, actual results could differ materially from those estimates.
Cash and Cash Equivalents. Cash and cash equivalents include highly liquid investments with maturities of 90 days or less at the date of purchase. We record cash and cash equivalents as restricted when we are unable to freely use such cash and cash equivalents for our general operating purposes. As of fiscal 2019 and fiscal 2018 year-ends, we had restricted cash of $0.2 million and $2.7 million, respectively, on the consolidated balance sheet, and it was included in our "Prepaid expenses and other current assets".
Insurance Matters, Litigation and Contingencies. In the normal course of business, we are subject to certain contractual guarantees and litigation. In addition, we maintain insurance coverage for various aspects of our business and operations. We record in our consolidated balance sheets amounts representing our estimated liability for these legal and insurance obligations. Any adjustments to these liabilities are recorded in our consolidated statements of income.
Accounts Receivable – Net. Net accounts receivable is primarily comprised of billed and unbilled accounts receivable, contract retentions and allowances for doubtful accounts. 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 September 29, 2019 are expected to be billed and collected within 12 months. Unbilled accounts receivable also include amounts related to requests for equitable adjustment to contracts that provide for price redetermination. These amounts are recorded only when they can be reliably estimated and realization is probable. Contract retentions represent amounts withheld by clients until certain conditions are met or the project is completed, which may be several months or years. Allowances for doubtful accounts represent the amounts that may become uncollectible or unrealizable in the future. We determine an estimated allowance for uncollectible accounts based on management's consideration of trends in the actual and forecasted credit quality of our clients, including delinquency and payment history; type of client, such as a government agency or a commercial sector client; and general economic and particular industry conditions that may affect a client's ability to pay. 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 work performed and revenue recognized. The majority of these amounts will be earned within 12 months.
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Property and Equipment. Property and equipment are recorded at cost and are depreciated over their estimated useful lives using the straight-line method. When property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets and any resulting gain or loss is reflected in our consolidated statements of income. Expenditures for maintenance and repairs are expensed as incurred. Generally, estimated useful lives range from three to ten years for equipment, furniture and fixtures. Buildings are depreciated over periods not exceeding 40 years. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the length of the lease. Assets held for sale are carried at the lower of their carrying amount (i.e., net book value) or fair value less cost to sell and are reported as "Prepaid expenses and other current assets" on our consolidated balance sheets.
Long-Lived Assets. Our policy regarding long-lived assets is to evaluate the recoverability of our assets when the facts and circumstances suggest that the assets may be impaired. This assessment is performed based on the estimated undiscounted cash flows compared to the carrying value of the assets. If the future cash flows (undiscounted and without interest charges) are less than the carrying value, a write-down would be recorded to reduce the related asset to its estimated fair value.
We recognize a liability for contract termination costs associated with an exit activity for costs that will continue to be incurred under a lease for its remaining term without economic benefit to us, initially measured at its fair value at the cease-use date. The fair value is determined based on the remaining lease rentals, adjusted for the effects of any prepaid or deferred items recognized under the lease, and reduced by estimated sublease rentals.
Business Combinations. The cost of an acquired company is assigned to the tangible and intangible assets purchased and the liabilities assumed based on their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when a market value is not readily available. Any excess of purchase price over the fair value of net tangible and intangible assets acquired is allocated to goodwill. Goodwill typically represents the value paid for the assembled workforce and enhancement of our service offerings. Transaction costs associated with business combinations are expensed as they are incurred.
Goodwill and Intangible Assets. Goodwill represents the excess of the aggregate purchase price over the fair value of the net assets acquired in a business acquisition. Following an acquisition, we perform an analysis to value the acquired company's tangible and identifiable intangible assets and liabilities. With respect to identifiable intangible assets, we consider backlog, non-compete agreements, client relations, trade names, patents and other assets. We amortize our intangible assets based on the period over which the contractual or economic benefits of the intangible assets are expected to be realized. We assess the recoverability of the unamortized balance of our intangible assets when indicators of impairment are present based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of the intangible assets would be recognized as an impairment loss.
We test our goodwill for impairment on an annual basis, and more frequently when an event occurs, or circumstances indicate that the carrying value of the asset may not be recoverable. We believe the methodology that we use to review impairment of goodwill, which includes a significant amount of judgment and estimates, provides us with a reasonable basis to determine whether impairment has occurred. However, many of the factors employed in determining whether our goodwill is impaired are outside of our control and it is reasonably likely that assumptions and estimates will change in future periods. These changes could result in future impairments.
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. Our last annual review was performed at July 1, 2019 (i.e., the first day of our fiscal fourth quarter). In addition, we regularly evaluate whether events and circumstances have occurred that may indicate a potential change in recoverability of goodwill. We perform interim goodwill impairment reviews between our annual reviews if certain events and circumstances have occurred, including a deterioration in general economic conditions, an increased competitive environment, a change in management, key personnel, strategy or customers, negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods. We assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. Our operating segments are the same as our reportable segments and our reporting units for goodwill impairment testing are the components one level below our reportable segments. These components constitute a business for which discrete financial information is available and where segment management regularly reviews the operating results of that component. We aggregate components within an operating segment that have similar economic characteristics.
The impairment test for goodwill involves the comparison of the estimated fair value of each reporting unit to the reporting unit's carrying value, including goodwill. We estimate the fair value of reporting units based on a comparison and weighting of the income approach, specifically the discounted cash flow method and the market approach, which estimates the fair value of our reporting units based upon comparable market prices and recent transactions and also validates the reasonableness of the multiples from the income approach. If the fair value of a reporting unit exceeds its carrying amount, the goodwill of that reporting unit is
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not considered impaired. However, if its carrying value exceeds its fair value, our goodwill is impaired, and we are required to record a non-cash charge that could have a material adverse effect on our consolidated financial statements. An impairment loss recognized, if any, should not exceed the total amount of goodwill allocated to the reporting unit.
Contingent Consideration. Most 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.
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 "Current contingent earn-out liabilities" and "Long-term 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. 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 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 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.
Fair Value of Financial Instruments. We determine the fair values of our financial instruments, including short-term investments, debt instruments and derivative instruments based on inputs or assumptions that market participants would use in pricing an asset or a liability. We categorize our instruments using a valuation hierarchy for disclosure of the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows: Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. The classification of a financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair values based on their short-term nature. The carrying amounts of our revolving credit facility approximates fair value because the interest rates are based upon variable reference rates. Certain other assets and liabilities, such as contingent earn-out liabilities and amounts related to cash-flow hedges, are required to be carried in our consolidated financial statements at fair value.
Our fair value measurement methods may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with those used by other market participants, the use of different methodologies or assumptions to determine fair value could result in a different fair value measurement at the reporting date.
Derivative Financial Instruments. We account for our derivative instruments as either assets or liabilities and carry them at fair value. For derivative instruments that hedge the exposure to variability in expected future cash flows that are designated as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (loss) in stockholders' equity and reclassified into income in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument, if any, is recognized in current income. To receive hedge accounting treatment, cash flow hedges must be highly effective in offsetting changes to expected future cash flows on hedged transactions.
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The net gain or loss on the effective portion of a derivative instrument that is designated as an economic hedge of the foreign currency translation exposure generated by the re-measurement of certain assets and liabilities denominated in a non-functional currency in a foreign operation is reported in the same manner as a foreign currency translation adjustment. Accordingly, any gains or losses related to these derivative instruments are recognized in current income. Derivatives that do not qualify as hedges are adjusted to fair value through current income.
Deferred Compensation. We maintain a non-qualified defined contribution supplemental retirement plan for certain key employees and non-employee directors that is accounted for in accordance with applicable authoritative guidance on accounting for deferred compensation arrangements where amounts earned are held in a rabbi trust and invested. Employee deferrals and our match are deposited into a rabbi trust, and the funds are generally invested in individual variable life insurance contracts that we own and are specifically designed to informally fund savings plans of this nature. Our consolidated balance sheets reflect our investment in variable life insurance contracts in "Other long-term assets." Our obligation to participating employees is reflected in "Other long-term liabilities." All income and expenses related to the rabbi trust are reflected in our consolidated statements of income.
Income Taxes. We file a consolidated U.S. federal income tax return. In addition, we file other returns that are required in the states, foreign jurisdictions and other jurisdictions in which we do business. We account for certain income and expense items differently for financial reporting and income tax purposes. Deferred tax assets and liabilities are computed for the difference between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to reverse. In determining the need for a valuation allowance, management reviews both positive and negative evidence, including current and historical results of operations, future income projections and potential tax planning strategies. Based on our assessment, we have concluded that a portion of the deferred tax assets at September 29, 2019 will not be realized.
According to the authoritative guidance on accounting for uncertainty in income taxes, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. This guidance also addresses de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and disclosure requirements for uncertain tax positions.
Concentration of Credit Risk. Financial instruments that subject us to credit risk consist primarily of cash and cash equivalents and net accounts receivable. In the event that we have surplus cash, we place our temporary cash investments with lower risk financial institutions and, by policy, limit the amount of investment exposure to any one financial institution. Approximately 23% of accounts receivable were due from various agencies of the U.S. federal government at fiscal 2019 year-end. The remaining accounts receivable are generally diversified due to the large number of organizations comprising our client base and their geographic dispersion. We perform ongoing credit evaluations of our clients and maintain an allowance for potential credit losses. Approximately 49%, 23% and 28% of our fiscal 2019 revenue was generated from our U.S government, U.S. commercial and international clients, respectively.
Foreign Currency Translation. We determine the functional currency of our foreign operating units based upon the primary currency in which they operate. These operating units maintain their accounting records in their local currency, primarily Canadian and Australian dollars, and British pounds. Where the functional currency is not the U.S. dollar, translation of assets and liabilities to U.S. dollars is based on exchange rates at the balance sheet date. Translation of revenue and expenses to U.S. dollars is based on the average rate during the period. Translation gains or losses are reported as a component of other comprehensive income (loss). Gains or losses from foreign currency transactions are included in income from operations.
Recent Accounting Pronouncements.
New accounting pronouncements implemented by us during fiscal 2019 are discussed below.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09 ("ASC 606"), "Revenue from Contracts with Customers", which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance and the related ASUs were effective for interim and annual reporting periods beginning after December 15, 2017 (first quarter of fiscal 2019 for us). On October 1, 2018, we adopted ASC 606 using the modified retrospective method in which the new guidance was applied retrospectively to contracts that were not substantially completed as of the date of adoption. Results for the reporting period beginning after October 1, 2018 have been presented under ASC 606, while prior period amounts have not been adjusted and continue to be reported in accordance with the previous guidance. See Note 3, "Revenue Recognition" for further discussion of the adoption and the impact on our consolidated financial statements.
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In January 2016, the FASB issued guidance that generally requires companies to measure investments in other entities, except those accounted for under the equity method, at fair value and recognize any changes in fair value in net income. The guidance was effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2017 (first quarter of fiscal 2019 for us). The adoption of this guidance had no impact on our consolidated financial statements.
In March 2016, the FASB issued updated guidance which requires excess tax benefits and deficiencies on share-based payments to be recorded as income tax expense or benefit in the income statement rather than being recorded in additional paid-in capital. It also requires the presentation of employee taxes as financing activities on consolidated statements of cash flows, which was previously classified as operating activities. This guidance was effective for annual and interim periods beginning after December 15, 2016 (first quarter of fiscal 2018 for us), with early adoption permitted. In the first quarter of fiscal 2017, we adopted this guidance. At the beginning of fiscal 2019, we revised the presentation of "Net cash provided by operating activities" and "Net cash (used in) provided by financing activities" in the consolidated statement of cash flows for prior period to adjust the presentation of “Taxes paid on vested restricted stock” and appropriately reflect such amounts as financing activities. The adjustment resulted in an increase of net cash provided by operating activities of $8.9 million and $3.5 million, and an increase of net cash used in financing activities of $8.9 million and $3.5 million for fiscal 2018 and 2017, respectively. We assessed the materiality of these adjustments on our consolidated financial statements for prior periods and concluded that the amounts were not material to any prior interim or annual periods. We elected to revise the presentation for comparability purposes.
In August 2016, the FASB issued guidance to address eight specific cash flow issues to reduce the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance was effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2017 (first quarter of fiscal 2019 for us). The adoption of this guidance had no material impact on our consolidated financial statements.
In October 2016, the FASB issued updated guidance which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The guidance was effective for fiscal reporting periods and interim reporting periods within those fiscal reporting periods, beginning after December 15, 2017 (first quarter of fiscal 2019 for us). The adoption of this guidance had no material impact on our consolidated financial statements.
In November 2016, the FASB issued updated guidance which provides amendments to address the classification and presentation of changes in restricted cash in the statement of cash flows. The guidance was effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2017 (first quarter of fiscal 2019 for us). The adoption of this guidance had no material impact on our consolidated financial statements. We updated certain captions in our consolidated statements of cash flows to include restricted cash, which is reported in our "Prepaid expenses and other current assets" on the consolidated balance sheets.
In May 2017, the FASB issued updated guidance to clarify when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Under the updated guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award changes because of a change in terms or conditions. The guidance was effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2017 (first quarter of fiscal 2019 for us), on a prospective basis. The adoption of this guidance had no impact on our consolidated financial statements.
In August 2018, the Securities and Exchange Commission (“SEC”) published Release No. 33-10532, Disclosure Update and Simplification, which adopted amendments to certain disclosure requirements that have become redundant, duplicative, overlapping, outdated or superseded, considering other SEC disclosure requirements, U.S. GAAP, or changes in the information environment. As such, we removed the disclosure of cash dividends paid per share from our consolidated statements of income.
New accounting pronouncements requiring implementation in future periods are discussed below.
In February 2016, the FASB issued guidance that requires the rights and obligations associated with leasing arrangements be reflected on the balance sheet to increase transparency and comparability among organizations, and further clarified and amended this guidance. Lessees will be required to recognize a right-of-use asset and a lease liability on the balance sheet for leases with terms greater than twelve months or leases that contain a purchase option that is reasonably certain to be exercised. Lessees will classify leases as either finance or operating leases. Substantially all of our leases are operating leases, which will result in lease expense on a straight-line basis over the term of the lease. The guidance is effective for interim and annual reporting periods beginning after December 15, 2018 (first quarter of fiscal 2020 for us). The new guidance will be applied to leases that exist or are entered into on or after September 30, 2019 (first day of our fiscal 2020) without adjusting comparative periods in the financial statements. We expect to utilize the practical expedients that, upon adoption of this guidance, allow us to (1) not reassess whether
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any expired or existing contracts are or contain leases, (2) retain the classification of leases (e.g., operating or finance lease) existing as of the date of adoption and (3) not reassess initial direct costs for any existing leases. We are in the final stages of evaluating our existing lease portfolio, including accumulating all of the necessary information required to properly account for leases under the new guidance. Based on the most recent assessment of existing leases, the adoption of the guidance is expected to result in right-of-use assets and lease liabilities that will be included on the balance sheet as of September 30, 2019 of approximately $300 million. We do not expect the adoption of this guidance to have a material impact on our consolidated statements of income or cash flows. Our current amounts payable under non-cancelable lease commitments are disclosed in Note 11, "Leases".
In June 2016, the FASB issued updated guidance which requires entities to estimate all expected credit losses for certain types of financial instruments, including trade receivables, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The updated guidance also expands the disclosure requirements to enable users of financial statements to understand the entity’s assumptions, models and methods for estimating expected credit losses. This guidance is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019 (first quarter of fiscal 2021 for us). Early adoption is permitted. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
In August 2017, the FASB issued accounting guidance on hedging activities. The amendment better aligns an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The guidance is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2018 (first quarter of fiscal 2020 for us). We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
In February 2018, the FASB issued guidance on reclassification of certain tax effects from accumulated comprehensive income, which allows for a reclassification of stranded tax effects from the Tax Cuts and Jobs Act ("TCJA") from accumulated other comprehensive income to retained earnings. The guidance is effective for fiscal years beginning after December 15, 2018 (first quarter of fiscal 2020 for us). We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
In August 2018, The FASB issued updated guidance modifying certain fair value measurement disclosures. The updated guidance contains additional disclosures to enable users of the financial statements to better understand the entity’s assumption used to develop significant unobservable inputs for Level 3 fair value measurements, but also eliminates the requirement for entities to disclose the amount of and reasons for transfers between Level 1 and Level 2 investments within the fair value hierarchy. This guidance is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019 (first quarter of fiscal 2021 for us). Early adoption is permitted. We do not expect the adoption of this guidance to have an impact on our consolidated financial statements.
3. Revenue Recognition
On October 1, 2018, we adopted ASC 606, "Revenue from Contracts with Customers", which supersedes most current revenue recognition guidance, including industry-specific guidance. We adopted the standard on a modified retrospective basis which results in no restatement of the comparative periods presented and a cumulative effect adjustment to retained earnings as of the date of adoption. As part of our adoption, the new standard was applied only to those contracts that were not substantially completed as of the date of adoption.
To determine the proper revenue recognition method for contracts under ASC 606, we evaluate whether multiple contracts should be combined and accounted for as a single contract and whether the combined or single contract should be accounted for as having more than one performance obligation. The decision to combine a group of contracts or separate a combined or single contract into multiple performance obligations may impact the amount of revenue recorded in a given period. Contracts are considered to have a single performance obligation if the promises are not separately identifiable from other promises in the contracts.
At contract inception, we assess the goods or services promised in a contract and identify, as a separate performance obligation, each distinct promise to transfer goods or services to the customer. The identified performance obligations represent the “unit of account” for purposes of determining revenue recognition. In order to properly identify separate performance obligations, we apply judgment in determining whether each good or service provided is: (a) capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and (b) distinct within the context of the contract, whereby the transfer of the good or service to the customer is separately identifiable from other promises in the contract.
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Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new or changes the existing enforceable rights and obligations. Most of our contract modifications are for goods or services that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
We account for contract modifications as a separate contract when the modification results in the promise to deliver additional goods or services that are distinct and the increase in price of the contract is for the same amount as the stand-alone selling price of the additional goods or services included in the modification.
The transaction price represents the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to our customers. The consideration promised within a contract may include fixed amounts, variable amounts, or both. The nature of our contracts gives rise to several types of variable consideration, including claims, award fee incentives, fiscal funding clauses, and liquidated damages. We recognize revenue for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized for the contract will not occur. We estimate the amount of revenue to be recognized on variable consideration using either the expected value or the most likely amount method, whichever is expected to better predict the amount of consideration to be received. Project mobilization costs are generally charged to project costs as incurred when they are an integrated part of the performance obligation being transferred to the client.
Claims are amounts in excess of agreed contract prices that we seek to collect from our clients or other third parties for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price, or other causes of unanticipated additional costs. Revenue on claims is recognized only to the extent that contract costs related to the claims have been incurred and when it is probable that any significant revenue recognized related to the claim will not be reversed. Factors considered in determining whether revenue associated with claims (including change orders in dispute and unapproved change orders in regard to both scope and price) should be recognized include the following: (a) the contract or other evidence provides a legal basis for the claim, (b) additional costs were caused by circumstances that were unforeseen at the contract date and not the result of deficiencies in our performance, (c) claim-related costs are identifiable and considered reasonable in view of the work performed, and (d) evidence supporting the claim is objective and verifiable. This can lead to a situation in which costs are recognized in one period and revenue is recognized in a subsequent period when a client agreement is obtained, or a claims resolution occurs. In some cases, contract retentions are withheld by clients until certain conditions are met or the project is completed, which may be several months or years. In these cases, we have not identified a significant financing component under ASC 606 as the timing difference in payment compared to delivery of obligations under the contract is not for purposes of financing.
For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using a best estimate of the standalone selling price of each distinct good or service in the contract. The standalone selling price is typically determined using the estimated cost of the contract plus a margin approach. For contracts containing variable consideration, we allocate the variability to a specific performance obligation within the contract if such variability relates specifically to our efforts to satisfy the performance obligation or transfer the distinct good or service, and the allocation depicts the amount of consideration to which we expect to be entitled.
We recognize revenue over time as the related performance obligation is satisfied by transferring control of a promised good or service to our customers. Progress toward complete satisfaction of the performance obligation is primarily measured using a cost-to-cost measure of progress method. The cost input is based primarily on contract cost incurred to date compared to total estimated contract cost. This measure includes forecasts based on the best information available and reflects our judgment to faithfully depict the value of the services transferred to the customer. For certain on-call engineering or consulting and similar contracts, we recognize revenue in the amount which we have the right to invoice the customer if that amount corresponds directly with the value of our performance completed to date.
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost measure of progress method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs indicates a loss, a provision for the entire estimated loss on the contract is made in the period in which the loss becomes evident.
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Contract Types
Our services are performed under three principal types of contracts: fixed-price, time-and-materials and cost-plus. Customer payments on contracts are typically due within 60 days of billing, depending on the contract.
Fixed-Price. Under fixed-price contracts, clients pay us an agreed fixed-amount negotiated in advance for a specified scope of work.
Time-and-Materials. Under time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we spend on a project. In addition, clients reimburse us for our actual out-of-pocket costs for materials and other direct incidental expenditures that we incur in connection with our performance under the contract. Most of our time-and-material contracts are subject to maximum contract values, and may include annual billing rate adjustment provisions.
Cost-Plus. Under cost-plus contracts, we are reimbursed for allowed or otherwise defined costs incurred plus a negotiated fee. The contracts may also include incentives for various performance criteria, including quality, timeliness, ingenuity, safety and cost-effectiveness. In addition, our costs are generally subject to review by our clients and regulatory audit agencies, and such reviews could result in costs being disputed as non-reimbursable under the terms of the contract.
Adoption
Upon adoption on October 1, 2018, under the modified retrospective method, we recorded a cumulative effect adjustment to decrease retained earnings by $2.8 million on October 1, 2018, as well as the following cumulative effect adjustments:
• | A decrease to contract assets of $5.0 million |
• | A decrease to contract liabilities of $1.1 million |
• | An increase to deferred tax assets of $1.1 million |
The decrease in retained earnings primarily resulted from a change in the way we determine the unit of account for projects (i.e. performance obligations). Under previous guidance, we typically accounted for a contract as a single unit of revenue recognition. Upon adoption of ASC 606, we assess the nature of the promises in the contract and recognize revenue based on performance obligations within the respective contract or combined contract.
The following table presents how the adoption of ASC 606 affected certain line items in our consolidated statements of income for fiscal year ended September 29, 2019:
Fiscal Year Ended | |||||||||||
Recognition Under Previous Guidance | Impact of the Adoption of ASC 606 | Recognition Under ASC 606 | |||||||||
(in thousands) | |||||||||||
Revenue | $ | 3,105,621 | $ | 1,727 | $ | 3,107,348 | |||||
Income from operations | 187,035 | 1,727 | 188,762 | ||||||||
Income tax expense | (15,874 | ) | (501 | ) | (16,375 | ) | |||||
Net income attributable to Tetra Tech | 157,442 | 1,226 | 158,668 | ||||||||
The following table presents how the adoption of ASC 606 affected certain line items in our consolidated balance sheet as of September 29, 2019:
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Recognition Under Previous Guidance | Impact of the Adoption of ASC 606 | Recognition Under ASC 606 | |||||||||
(in thousands) | |||||||||||
Assets | |||||||||||
Accounts receivable - net | $ | 770,164 | $ | (1,444 | ) | $ | 768,720 | ||||
Contract assets (1) | 117,750 | (3,426 | ) | 114,324 | |||||||
Liabilities and equity | |||||||||||
Contract liabilities (2) | $ | 168,321 | $ | (2,710 | ) | $ | 165,611 | ||||
Deferred income taxes | 13,590 | (619 | ) | 12,971 | |||||||
Equity (3) | |||||||||||
Retained earnings | $ | 1,072,732 | $ | (1,540 | ) | $ | 1,071,192 | ||||
(1) Previously included in "Account receivable - net".
(2) Previously presented as "Billings in excess of costs on uncompleted contracts".
(3) Includes $2.8 million of cumulative catch-up adjustment to retained earnings on October 1, 2018 upon adoption of ASC 606.
The following table presents how the adoption of ASC 606 affected certain line items in our consolidated statement of cash flows for fiscal year ended September 29, 2019:
Recognition Under Previous Guidance | Impact of the Adoption of ASC 606 | Recognition Under ASC 606 | |||||||||
(in thousands) | |||||||||||
Cash flows from operating activities: | |||||||||||
Net income | $ | 157,535 | $ | 1,226 | $ | 158,761 | |||||
Deferred income taxes | (38,116 | ) | 501 | (37,615 | ) | ||||||
Accounts receivable and contract assets | (17,434 | ) | 7,208 | (10,226 | ) | ||||||
Contract liabilities | 2,896 | (8,935 | ) | (6,039 | ) | ||||||
Net cash provided by operating activities | 208,513 | — | 208,513 | ||||||||
Contract Assets and Contract Liabilities
We invoice customers based on the contractual terms of each contract. However, the timing of revenue recognition may differ from the timing of invoice issuance.
As part of the adoption of ASC 606, contract assets have been bifurcated from billed and unbilled receivables. Contract assets represent revenue recognized in excess of the amounts for which we have the contractual right to bill our customers. Such amounts are recoverable from customers based upon various measures of performance, including achievement of certain milestones or completion of a contract. In addition, many of our time and materials arrangements are billed in arrears pursuant to contract terms that are standard within the industry, resulting in contract assets and/or unbilled receivables being recorded, as revenue is recognized in advance of billings.
Contract liabilities consist of billings in excess of revenue recognized. Contract liabilities decrease as we recognize revenue from the satisfaction of the related performance obligation and increase as billings in advance of revenue recognition occur. Contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. There were no substantial non-current contract assets or liabilities for the periods presented. Net contract liabilities/assets consisted of the following:
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Balance at | |||||||
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Contract assets | $ | 114,324 | $ | 142,882 | |||
Contract liabilities | 165,611 | 143,270 | |||||
Net contract liabilities | $ | (51,287 | ) | $ | (388 | ) | |
We recognized $90.0 million of revenue during fiscal 2019 that was included in contract liabilities as of September 30, 2018. The amount of revenue recognized from changes in transaction price associated with performance obligations satisfied in prior periods during fiscal 2019 was not material. The change in transaction price primarily relates to reimbursement of costs incurred in prior periods.
We recognize revenue from contracts primarily utilizing the cost-to-cost measure of progress method in order to estimate the progress towards completion and determine the amount of revenue and profit to recognize. Changes in those estimates could result in the recognition of cumulative catch-up adjustments to the contract’s inception-to-date revenue, costs and profit in the period in which such changes are made. As a result, we recognized net favorable operating income adjustments of $0.8 million for fiscal 2019, compared to net unfavorable operating income adjustments of $11.2 million for fiscal 2018. Changes in revenue and cost estimates could also result in a projected loss, determined at the contract level, which would be recorded immediately in earnings. As of September 29, 2019 and September 30, 2018, our consolidated balance sheets included liabilities for anticipated losses of $11.5 million and $13.6 million, respectively. The estimated cost to complete the related contracts as of September 29, 2019 was $15.2 million.
Disaggregation of Revenue
We disaggregate revenue by client sector and contract type, as we believe it best depicts how the nature, timing, and uncertainty of revenue and cash flows are affected by economic factors. The following tables provide information about disaggregated revenue and a reconciliation of the disaggregated revenue:
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Client Sector | |||||||||||
U.S. state and local government | $ | 587,364 | $ | 469,231 | $ | 353,062 | |||||
U.S. federal government (1) | 941,102 | 974,384 | 901,136 | ||||||||
U.S. commercial | 719,314 | 788,398 | 764,643 | ||||||||
International (2) | 859,568 | 732,135 | 734,519 | ||||||||
Total | $ | 3,107,348 | $ | 2,964,148 | $ | 2,753,360 | |||||
(1) Includes revenue generated under U.S. federal government contracts performed outside the United States.
(2) Includes revenue generated from foreign operations, primarily in Canada, Australia, the United Kingdom, and revenue generated from non-U.S. clients.
Other than the U.S. federal government, no single client accounted for more than 10% of our revenue for the twelve months ended months ended September 29, 2019 and September 30, 2018.
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Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Contract Type | |||||||||||
Fixed-price | $ | 1,048,157 | $ | 986,910 | $ | 909,197 | |||||
Time-and-materials | 1,509,901 | 1,395,148 | 1,264,546 | ||||||||
Cost-plus | 549,290 | 582,090 | 579,617 | ||||||||
Total | $ | 3,107,348 | $ | 2,964,148 | $ | 2,753,360 | |||||
Remaining Unsatisfied Performance Obligations (“RUPOs”)
Our RUPOs represent a measure of the total dollar value of work to be performed on contracts awarded and in progress. We had $3.1 billion of RUPOs as of September 29, 2019. RUPOs increase with awards from new contracts or additions on existing contracts and decrease as work is performed and revenue is recognized on existing contracts. RUPOs may also decrease when projects are canceled or modified in scope. We include a contract within our RUPOs when the contract is awarded and an agreement on contract terms has been reached.
We expect to satisfy our RUPOs as of September 29, 2019 over the following periods:
Amount | |||
(in thousands) | |||
Within 12 months | $ | 1,896,395 | |
Beyond | 1,185,076 | ||
Total | $ | 3,081,471 | |
Although RUPOs reflect business that is considered to be firm, cancellations, deferrals or scope adjustments may occur. RUPOs are adjusted to reflect any known project cancellations, revisions to project scope and cost, foreign currency exchange fluctuations and project deferrals, as appropriate. Our operations and maintenance contracts can generally be terminated by the clients without a substantive financial penalty. Therefore, the remaining performance obligations on such contracts are limited to the notice period required for the termination (usually 30, 60, or 90 days).
4. Stock Repurchase and Dividends
On November 5, 2018, the Board of Directors authorized a new stock repurchase program under which we could repurchase up to $200 million of our common stock. This was in addition to the $25 million remaining as of fiscal 2018 year-end under the previous stock repurchase program. All of our repurchased shares were through open market purchases. As of the fiscal 2019 year-end, we had $125 million remaining under our new program. The following table summarizes stock repurchase activity for fiscal 2018 and 2019:
Fiscal Year | Stock Repurchase Program | Shares Repurchased | Average Price Paid per Share | Total Cost (in thousands) | |||||||||
2018 | 2018 Program | 1,491,569 | $ | 50.28 | $ | 75,000 | |||||||
2019 | 2018 Program | 430,559 | $ | 58.06 | $ | 25,000 | |||||||
2019 | 2019 Program | 1,131,962 | $ | 66.26 | 75,000 | ||||||||
2019 Total | 1,562,521 | $ | 64.00 | $ | 100,000 | ||||||||
The following table summarizes dividends declared and paid in fiscal 2019 and 2018:
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Declaration Date | Dividend Paid Per Share | Record Date | Payment Date | Dividends Paid (in thousands) | ||||||||
November 5, 2018 | $ | 0.12 | November 30, 2018 | December 14, 2018 | $ | 6,654 | ||||||
January 28, 2019 | $ | 0.12 | February 13, 2019 | February 28, 2019 | 6,616 | |||||||
April 29, 2019 | $ | 0.15 | May 15, 2019 | May 31, 2019 | 8,219 | |||||||
July 29, 2019 | $ | 0.15 | August 14, 2019 | August 30, 2019 | 8,185 | |||||||
Total dividend paid as of September 29, 2019 | $ | 29,674 | ||||||||||
November 6, 2017 | $ | 0.10 | November 30, 2017 | December 15, 2017 | $ | 5,589 | ||||||
January 29, 2018 | $ | 0.10 | February 14, 2018 | March 2, 2018 | 5,583 | |||||||
April 30, 2018 | $ | 0.12 | May 16, 2018 | June 1, 2018 | 6,664 | |||||||
July 30, 2018 | $ | 0.12 | August 16, 2018 | August 31, 2018 | 6,641 | |||||||
Total dividend paid as of September 30, 2018 | $ | 24,477 | ||||||||||
Subsequent Events. On November 11, 2019, the Board of Directors declared a quarterly cash dividend of $0.15 per share payable on December 13, 2019 to stockholders of record as of the close of business on December 2, 2019.
5. Accounts Receivable - Net
Net accounts receivable consisted of the following at September 29, 2019 and September 30, 2018:
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Billed | $ | 522,256 | $ | 464,062 | |||
Unbilled | 300,035 | 267,739 | |||||
Total accounts receivable – gross | 822,291 | 731,801 | |||||
Allowance for doubtful accounts | (53,571 | ) | (37,580 | ) | |||
Total accounts receivable – net | $ | 768,720 | $ | 694,221 | |||
Billed accounts receivable represent amounts billed to clients that have not been collected. Unbilled accounts receivable, which represent an unconditional right to payment subject only to the passage of time, include unbilled amounts typically resulting from revenue recognized but not yet billed pursuant to contract terms or billed after the period end date. Most of our unbilled receivables at September 29, 2019 are expected to be billed and collected within 12 months. The allowance for doubtful accounts represents amounts that are expected to become uncollectible or unrealizable in the future. We determine an estimated allowance for uncollectible accounts based on management's consideration of trends in the actual and forecasted credit quality of our clients, including delinquency and payment history; type of client, such as a government agency or a commercial sector client; and general economic and industry conditions that may affect a client's ability to pay.
Once contract performance is underway, we may experience changes in conditions, client requirements, specifications, designs, materials and expectations regarding the period of performance. Such changes result in change orders and may be initiated by us or by our clients. In many cases, agreement with the client as to the terms of change orders is reached prior to work commencing; however, sometimes circumstances require that work progress without a definitive client agreement. Revenue and any corresponding receivable in these cases are recognized based on the policy described in Note 3, "Revenue Recognition" above.
Total accounts receivable at September 29, 2019 and September 30, 2018 included approximately $15 million and $74 million, respectively, related to claims, including requests for equitable adjustment, on contracts that provide for price redetermination. We regularly evaluate all unsettled claim amounts and record appropriate adjustments to operating earnings when it is probable that the claim will result in a different contract value than the amount previously estimated. In fiscal 2019, we recognized reductions of revenue of $26.7 million and $4.6 million, and related losses in operating income of $28.2 million and $5.7 million in our CIG and RCM segments, respectively, primarily due to the resolution of several claims in fiscal 2019 for amounts lower than we previously expected. In fiscal 2018, we recognized a reduction of revenue of $10.6 million and related losses in operating income of $12.5 million in our CIG segment for a fixed-price construction project that was completed in fiscal 2014 prior to our decision to exit similar activities in the RCM segment.
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On our state and local government contracts, billed accounts receivable were $129.3 million and $89.3 million at September 29, 2019 and September 30, 2018, respectively. The total of unbilled receivables and contract assets were $59.6 million and $38.6 million at September 29, 2019 and September 30, 2018, respectively. Other than the state and local governments and U.S. federal government, no single client accounted for more than 10% of our accounts receivable at September 29, 2019 and September 30, 2018.
6. Acquisitions and Divestitures
In fiscal 2017, we acquired Eco Logical Australia (“ELA”), headquartered in Sydney, Australia. ELA is a multi-disciplinary consulting firm with over 160 staff that provides innovative, high-end environmental and ecological services, and is part of our CIG segment. The fair value of the purchase price for ELA was $9.9 million. Of this amount, $8.3 million was paid to the sellers and $1.6 million was the estimated fair value of contingent earn-out obligations, with a maximum of $1.7 million, based upon the achievement of specified operating income targets in each of the two years following the acquisition.
In fiscal 2018, we acquired Glumac, headquartered in Portland, Oregon. Glumac is a leader in sustainable infrastructure design with more than 300 employees and is part of our GSG segment. The fair value of the purchase price for Glumac was $38.4 million. This amount is comprised of $20.0 million of initial cash payments made to the sellers and $18.4 million for the estimated fair value of contingent earn-out obligations, with a maximum of $20.0 million payable, based upon the achievement of specified operating income targets in each of the three years following the acquisition.
In fiscal 2018, we acquired Norman Disney & Young (“NDY”), a leader in sustainable infrastructure engineering design. NDY is an Australian-based global engineering design firm with more than 700 professionals operating in offices throughout Australia, the Asia-Pacific region, the United Kingdom, and Canada and is part of our CIG segment. The fair value of the purchase price for NDY was $56.1 million. This amount is comprised of $46.9 million of initial cash payments made to the sellers, $1.6 million held in escrow, and $7.6 million for the estimated fair value of contingent earn-out obligations, with a maximum amount of $20.2 million, based upon the achievement of specified operating income targets in each of the three years following the acquisition.
In fiscal 2018, we divested our non-core utility field services operations in the CIG segment for net proceeds after transaction costs of $30.2 million. This operation generated approximately $70 million in annual revenue primarily from our U.S. commercial clients. We also divested non-core assets during the third quarter of fiscal 2018 further described in Note 8, "Property and Equipment" resulting in a pre-tax loss of $3.4 million, which is included in selling, general and administrative expenses for fiscal 2018.
In the second quarter of fiscal 2019, we acquired eGlobalTech ("EGT"), a high-end information technology solutions, cloud migration, cybersecurity, and management consulting firm based in Arlington, Virginia. EGT is part of our GSG segment. The fair value of the purchase price was $49.1 million. This amount was comprised of a $24.7 million promissory note issued to the sellers (which was subsequently paid in full in the third quarter of fiscal 2019), $3.3 million of payables related to estimated post-closing adjustments for net assets acquired, and $21.1 million for the estimated fair value of contingent earn-out obligations, with a maximum of $25.0 million, based upon the achievement of specified operating income targets in each of the three years following the acquisition.
In the fourth quarter of fiscal 2019, we acquired WYG plc (“WYG”), which employs approximately 1,600 staff primarily in the United Kingdom and Europe, delivering consulting and engineering solutions for complex projects across key service areas including planning, water and environment, transport, infrastructure, the built environment, architecture, urban design, surveying, asset management, program management, and international development. WYG’s UK based consulting and engineering business is part of our CIG segment, while its international development business is part of our GSG segment. The fair value of the purchase price was $54.2 million, entirely paid in cash. In addition, we assumed a net debt of $11.5 million, which was subsequently paid in full in the fourth quarter of fiscal 2019. We also incurred $10.4 million in acquisition and transaction costs related to the WYG acquisition in the fourth quarter of fiscal 2019.
Goodwill additions resulting from the above business combinations are primarily attributable to the existing workforce of the acquired companies and the synergies expected to arise after the acquisitions. Fiscal 2018 goodwill additions represent the value of a workforce with distinct expertise in the sustainable infrastructure design market. The goodwill additions related to our fiscal 2019 acquisitions represent the value of a workforce with emerging technology and new techniques that incorporate artificial intelligence, data analytics and advanced cybersecurity solutions for government and commercial clients, and expanding our geographic presence in the UK with a strong platform for growth in the UK and Europe. 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 companies. The results of these
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acquisitions were included in our consolidated financial statements from their respective closing dates. These acquisitions were not considered material to our consolidated financial statements. As a result, no pro forma information has been provided.
Backlog, client relations and trade name intangible assets include the fair value of existing contracts and the underlying customer relationships with lives ranging from 1 to 10 years, and trade names with lives ranging from 3 to 5 years.
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 “Current contingent earn-out liabilities” and “Long-term 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. 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 in our consolidated statements of cash flows.
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.
In fiscal 2019, we recorded adjustments to our contingent earn-out liabilities and reported a related net loss of $1.1 million in operating income. These adjustments resulted from the updated valuations of the contingent consideration liabilities, which reflect updated projections of acquired companies' financial performance during their respective earn-out periods. In fiscal 2018, we recorded adjustments to our contingent earn-out liabilities and reported related losses in operating income of $4.3 million. These losses resulted from updated valuations of the contingent consideration liabilities for NDY, ELA and Cornerstone Environmental Group ("CEG"), as the financial performance during the earn-out periods exceeded our original estimates at the acquisition dates.
At September 29, 2019, there was a total maximum of $72.4 million of outstanding contingent consideration related to acquisitions. Of this amount, $53.0 million was estimated as the fair value and accrued on our consolidated balance sheet.
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The following table summarizes the changes in the carrying value of estimated contingent earn-out liabilities:
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Beginning balance (at fair value) | $ | 35,290 | $ | 2,438 | $ | 8,757 | |||||
Estimated earn-out liabilities for acquisitions during the fiscal year | 27,704 | 32,210 | 1,604 | ||||||||
Increases due to re-measurement of fair value reported in interest expense | 1,489 | 1,005 | 260 | ||||||||
Net increase (decrease) due to re-measurement of fair value reported as losses (gains) in operating income | 1,085 | 4,252 | (6,923 | ) | |||||||
Foreign exchange impact | (558 | ) | (854 | ) | 59 | ||||||
Earn-out payments: | |||||||||||
Reported as cash used in operating activities | — | (2,349 | ) | — | |||||||
Reported as cash used in financing activities | (12,018 | ) | (1,412 | ) | (1,319 | ) | |||||
Ending balance (at fair value) | $ | 52,992 | $ | 35,290 | $ | 2,438 | |||||
7. Goodwill and Intangible Assets
The following table summarizes the changes in the carrying value of goodwill:
GSG | CIG | Total | |||||||||
(in thousands) | |||||||||||
Balance at October 1, 2017 | $ | 361,761 | $ | 379,125 | $ | 740,886 | |||||
Acquisitions | 27,526 | 58,353 | 85,879 | ||||||||
Divestiture | — | (12,160 | ) | (12,160 | ) | ||||||
Translation and other | 454 | (16,239 | ) | (15,785 | ) | ||||||
Balance at September 30, 2018 | 389,741 | 409,079 | 798,820 | ||||||||
Acquisitions | 53,098 | 93,601 | 146,699 | ||||||||
Impairment | — | (7,755 | ) | (7,755 | ) | ||||||
Translation and other | (1,037 | ) | (11,907 | ) | (12,944 | ) | |||||
Balance at September 29, 2019 | $ | 441,802 | $ | 483,018 | $ | 924,820 | |||||
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. Our last review at July 1, 2019 (i.e. the first day of our fourth quarter in fiscal 2019), indicated that we had no impairment of goodwill, and all of our reporting units had estimated fair values that were in excess of their carrying values, including goodwill. All of our reporting units had estimated fair values that exceeded their carrying values by more than 25%.
We also regularly evaluate whether events and circumstances have occurred that may indicate a potential change in the recoverability of goodwill. We perform interim goodwill impairment reviews between our annual reviews if certain events and circumstances have occurred, such as a deterioration in general economic conditions; an increase in the competitive environment; a change in management, key personnel, strategy or customers; negative or declining cash flows; or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods. Although we believe that our estimates of fair value for these reporting units are reasonable, if financial performance for these reporting units falls significantly below our expectations or market prices for similar business decline, the goodwill for these reporting units could become impaired.
During the fourth quarter of fiscal 2019, we performed as strategic review of our operations. As a result, we decided to dispose of our Canadian turn-key pipeline activities in the Remediation and Field Services ("RFS") reporting unit, which is in the CIG reportable segment. We performed an interim goodwill impairment review of the RFS reporting unit and recorded a $7.8 million goodwill impairment charge. As a result of the impairment charge, the estimated fair value of the RFS reporting unit equals its carrying value of $61 million at September 29, 2019, including the remaining $48.8 million of goodwill. If the financial performance of the remaining operations in the RFS reporting unit were to fall below our revenue growth or operating profit margin
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forecasts, or we are required to increase the discount rate used in our cash flow analysis, the related goodwill may become further impaired.
Foreign exchange translation relates to the goodwill balances of our foreign subsidiaries with functional currencies that are different than our reporting currency. The gross amounts of goodwill for GSG were $459.5 million and $407.4 million at September 29, 2019 and September 30, 2018, respectively, excluding $17.7 million of accumulated impairment. The gross amounts of goodwill for CIG were $588.7 million and $507.0 million at September 29, 2019 and September 30, 2018, respectively, excluding $105.7 million and $97.9 million, respectively, of accumulated impairment.
The gross amount and accumulated amortization of our acquired identifiable intangible assets with finite useful lives included in "Intangible assets – net" on the consolidated balance sheets, were as follows:
Fiscal Year Ended | |||||||||||||||||
September 29, 2019 | September 30, 2018 | ||||||||||||||||
Weighted- Average Remaining Life (in years) | Gross Amount | Accumulated Amortization | Gross Amount | Accumulated Amortization | |||||||||||||
($ in thousands) | |||||||||||||||||
Non-compete agreements | — | $ | — | $ | — | $ | 83 | $ | (83 | ) | |||||||
Client relations | 2.8 | 56,779 | (50,455 | ) | 54,639 | (46,449 | ) | ||||||||||
Backlog | 1.2 | 32,229 | (24,968 | ) | 23,371 | (20,007 | ) | ||||||||||
Technology and trade names | 2.3 | 7,714 | (4,859 | ) | 8,144 | (3,575 | ) | ||||||||||
Total | $ | 96,722 | $ | (80,282 | ) | $ | 86,237 | $ | (70,114 | ) | |||||||
Foreign currency translation adjustments reduced net identifiable intangible assets by $0.3 million and $0.9 million in fiscal 2019 and 2018, respectively. Amortization expense for the identifiable intangible assets for fiscal 2019, 2018 and 2017 was $11.6 million, $18.2 million and $22.8 million, respectively.
Estimated amortization expense for the succeeding four years is as follows:
Amount | |||
(in thousands) | |||
2020 | $ | 9,401 | |
2021 | 4,551 | ||
2022 | 1,602 | ||
2023 | 886 | ||
Total | $ | 16,440 | |
8. Property and Equipment
Property and equipment consisted of the following:
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Fiscal Year Ended | |||||||
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Equipment, furniture and fixtures | $ | 114,652 | $ | 131,521 | |||
Leasehold improvements | 34,881 | 31,430 | |||||
Land and buildings | 371 | 413 | |||||
Total property and equipment | 149,904 | 163,364 | |||||
Accumulated depreciation | (110,463 | ) | (120,086 | ) | |||
Property and equipment, net | $ | 39,441 | $ | 43,278 | |||
The depreciation expense related to property and equipment was $17.3 million, $19.6 million and $22.2 million for fiscal 2019, 2018 and 2017, respectively. In the fourth quarter of fiscal 2019, we classified $5.4 million of net assets as held-for-sale and reported them as "Prepaid expenses and other current assets" on our consolidated balance sheet as of September 29, 2019. In fiscal 2018, our property and equipment declined $7.0 million ($3.0 million of which was land and buildings) due to the divestitures of our non-core utility field services operations in the CIG reportable segment and certain non-core assets.
9. Income Taxes
The income before income taxes, by geographic area, was as follows:
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Income before income taxes: | |||||||||||
United States | $ | 185,535 | $ | 180,034 | $ | 166,074 | |||||
Foreign | (10,399 | ) | (5,472 | ) | 5,687 | ||||||
Total income before income taxes | $ | 175,136 | $ | 174,562 | $ | 171,761 | |||||
Income tax expense consisted of the following:
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Current: | |||||||||||
Federal | $ | 30,051 | $ | 46,840 | $ | 45,604 | |||||
State | 8,923 | 9,228 | 8,860 | ||||||||
Foreign | 15,016 | 10,897 | 9,337 | ||||||||
Total current income tax expense | 53,990 | 66,965 | 63,801 | ||||||||
Deferred: | |||||||||||
Federal | (9,108 | ) | (22,072 | ) | (4,251 | ) | |||||
State | (1,195 | ) | (1,471 | ) | (945 | ) | |||||
Foreign | (27,312 | ) | (5,817 | ) | (4,761 | ) | |||||
Total deferred income tax expense | (37,615 | ) | (29,360 | ) | (9,957 | ) | |||||
Total income tax expense | $ | 16,375 | $ | 37,605 | $ | 53,844 | |||||
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Total income tax expense was different from the amount computed by applying the U.S. federal statutory rate to pre-tax income as follows:
Fiscal Year Ended | |||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||
Tax at federal statutory rate | 21.0% | 24.5% | 35.0% | ||
State taxes, net of federal benefit | 3.4 | 4.2 | 3.4 | ||
Research and Development ("R&D") credits | (4.7) | (1.4) | (1.8) | ||
Domestic production deduction | — | (0.2) | (0.7) | ||
Tax differential on foreign earnings | 1.0 | 0.5 | — | ||
Non-taxable foreign interest income | (1.7) | (2.0) | (2.9) | ||
Goodwill | 0.9 | 1.7 | — | ||
Stock compensation | (2.4) | (2.7) | (2.8) | ||
Valuation allowance | (13.5) | (0.5) | (0.5) | ||
Change in uncertain tax positions | 2.4 | 1.9 | 1.8 | ||
Revaluation of deferred taxes | (1.4) | (8.4) | — | ||
Deferred tax adjustments | (0.4) | 2.1 | — | ||
Transition tax on foreign earnings | 1.4 | — | — | ||
Other | 3.3 | 1.8 | (0.2) | ||
Total income tax expense | 9.3% | 21.5% | 31.3% | ||
The effective tax rates for fiscal 2019, 2018 and 2017 were 9.3%, 21.5% and 31.3%, respectively. These tax rates reflect the impact of the comprehensive tax legislation enacted by the U.S. government on December 22, 2017, which is commonly referred to as the TCJA. The TCJA significantly revised the U.S. corporate income tax regime by, among other things, lowering the U.S. corporate tax rate from 35% to 21% effective January 1, 2018, while also repealing the deduction for domestic production activities, limiting the deductibility of certain executive compensation, and implementing a modified territorial tax system with the introduction of the Global Intangible Low-Taxed Income ("GILTI") tax rules. The TCJA also imposed a one-time transition tax on deemed repatriation of historical earnings of foreign subsidiaries. In fiscal 2019, we finalized our fiscal 2018 U.S. federal tax return and recorded a $2.4 million tax expense with respect to the one-time transition tax on foreign earnings. As we have a September 30 fiscal year-end, our U.S. federal corporate income tax rate was blended in fiscal 2018, resulting in a statutory federal rate of 24.5% (3 months at 35% and 9 months at 21%), and was 21% in fiscal 2019.
U.S. GAAP requires that the impact of tax legislation be recognized in the period in which the tax law was enacted. As a result of the TCJA, we reduced our deferred tax liabilities and recorded a deferred tax benefit of $10.1 million in fiscal 2018 to reflect our estimate of temporary differences in the United States that were to be recovered or settled in fiscal 2018 based on the 24.5% blended corporate tax rate or based on the 21% tax rate in fiscal 2019 and beyond versus the previous enacted 35% corporate tax rate. We finalized this analysis in the first quarter of fiscal 2019 and recorded an additional deferred tax benefit of $2.6 million.
Valuation allowances of $23.4 million in Australia were released due to sufficient positive evidence being obtained in fiscal 2019. The valuation allowances were primarily related to net operating loss and R&D credit carry-forwards and other temporary differences. We evaluated the positive evidence against any negative evidence and determined that it was more likely than not that the deferred tax assets will be realized. The factors used to assess the likelihood of realization were the past performance of the related entities, our forecast of future taxable income, and available tax planning strategies that could be implemented to realize the deferred tax assets. Excluding the net deferred tax benefits from the TCJA and the release of the valuation allowance, our effective tax rate in fiscal 2019 was 21.9% in fiscal 2019 compared to 25.1% in fiscal 2018 primarily due to the reduced U.S. corporate income tax rate.
With respect to the GILTI provisions of the TCJA, we have analyzed our structure and global results of operations and expect to have a GILTI tax of $0.4 million for fiscal 2019, which was included in our fiscal 2019 income tax expense.
We are currently under examination by the Canada Revenue Agency for fiscal years 2011 through 2016 and the California Franchise Tax Board for fiscal years 2014 through 2016. We are also subject to various other state audits. With a few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for fiscal years before 2011.
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Temporary differences comprising the net deferred income tax liability shown on the accompanying consolidated balance sheets were as follows:
Fiscal Year Ended | |||||||
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Deferred Tax Assets: | |||||||
State taxes | $ | 764 | $ | 1,220 | |||
Reserves and contingent liabilities | 5,500 | 2,646 | |||||
Allowance for doubtful accounts | 7,506 | 4,259 | |||||
Accrued liabilities | 28,232 | 19,611 | |||||
Stock-based compensation | 6,700 | 6,338 | |||||
Loss carry-forwards | 39,782 | 23,492 | |||||
Valuation allowance | (20,543 | ) | (21,479 | ) | |||
Total deferred tax assets | 67,941 | 36,087 | |||||
Deferred Tax Liabilities: | |||||||
Unbilled revenue | (21,886 | ) | (25,819 | ) | |||
Prepaid expense | (3,026 | ) | (3,524 | ) | |||
Intangibles | (26,482 | ) | (23,319 | ) | |||
Property and equipment | (1,133 | ) | (4,984 | ) | |||
Total deferred tax liability | (52,527 | ) | (57,646 | ) | |||
Net deferred tax assets (liabilities) | $ | 15,414 | $ | (21,559 | ) | ||
At September 29, 2019, undistributed earnings of our foreign subsidiaries, primarily in Canada, amounting to approximately $44.0 million are expected to be permanently reinvested. Accordingly, no provision for foreign withholding taxes has been made. Upon distribution of those earnings, we would be subject to foreign withholding taxes. Assuming the permanently reinvested foreign earnings were repatriated under the laws and rates applicable at September 29, 2019, the incremental foreign withholding taxes applicable to those earnings would be approximately $1.1 million.
At September 29, 2019, we had available unused state net operating loss ("NOL") carry forwards of $43.7 million that expire at various dates from 2024 to 2037; and available foreign NOL carry forwards of $134.7 million, of which $29.7 million expire at various dates from 2024 to 2039, and $105.0 million have no expiration date. We have performed an assessment of positive and negative evidence regarding the realization of the deferred tax assets. This assessment included the evaluation of scheduled reversals of deferred tax liabilities, availability of carrybacks, cumulative losses in recent years, and estimates of projected future taxable income. Although realization is not assured, based on our assessment, we have concluded that it is more likely than not that the assets will be realized except for the assets related to the loss carry-forwards and certain foreign intangibles for which a valuation allowance of $20.5 million has been provided.
At September 29, 2019, we had $9.2 million of unrecognized tax benefits, all of which, if recognized, would affect our effective tax rate. It is not expected that there will be a significant change in the unrecognized tax benefits in the next 12 months. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
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Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Beginning balance | $ | 8,328 | $ | 9,337 | $ | 22,786 | |||||
Additions for current year tax positions | 1,342 | 1,928 | 1,060 | ||||||||
Additions for prior year tax positions | 356 | 1,116 | 2,365 | ||||||||
Reductions for prior year tax positions | (100 | ) | — | (6,875 | ) | ||||||
Settlements | (757 | ) | (4,053 | ) | (9,999 | ) | |||||
Ending balance | $ | 9,169 | $ | 8,328 | $ | 9,337 | |||||
We recognize potential interest and penalties related to unrecognized tax benefits in income tax expense. During fiscal years 2019, 2018 and 2017, we accrued additional interest expense of $0.5 million, $0.6 million and $0.4 million, respectively, and recorded reductions in accrued interest of $0.2 million, $0.3 million and $0.9 million, respectively, as a result of audit settlements and other prior-year adjustments. The amount of interest and penalties accrued at September 29, 2019, September 30, 2018 and October 1, 2017 was $2.4 million, $1.2 million and $1.1 million, respectively.
10. Long-Term Debt
Long-term debt consisted of the following:
Fiscal Year Ended | |||||||
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Credit facilities | $ | 276,434 | $ | 277,127 | |||
Capital leases | 87 | 184 | |||||
Total long-term debt | 276,521 | 277,311 | |||||
Less: Current portion of long-term debt | (12,572 | ) | (12,599 | ) | |||
Long-term debt, less current portion | $ | 263,949 | $ | 264,712 | |||
On July 30, 2018, we entered into a Second Amended and Restated Credit Agreement (“Amended Credit Agreement”) with a total borrowing capacity of $1 billion that will mature in July 2023. The Amended Credit Agreement is a $700 million senior secured, five-year facility that provides for a $250 million term loan facility (the “Amended Term Loan Facility”) a $450 million revolving credit facility (the “Amended Revolving Credit Facility”), and a $300 million accordion feature that allows us to increase the Amended Credit Agreement to $1 billion subject to lender approval. The Amended Credit Agreement allows us to, among other things, (i) refinance indebtedness under our Credit Agreement dated as of May 7, 2013; (ii) finance certain permitted open market repurchases of our common stock, permitted acquisitions, and cash dividends and distributions; and (iii) utilize the proceeds for working capital, capital expenditures and other general corporate purposes. The Amended Revolving Credit Facility includes a $100 million sublimit for the issuance of standby letters of credit, a $20 million sublimit for swingline loans, and a $200 million sublimit for multicurrency borrowings and letters of credit.
The entire Amended Term Loan Facility was drawn on July 30, 2018. The Amended Term Loan Facility is subject to quarterly amortization of principal at 5% annually beginning December 31, 2018. We may borrow on the Amended Revolving Credit Facility, at our option, at either (a) a Eurocurrency rate plus a margin that ranges from 1.00% to 1.75% per annum, or (b) a base rate for loans in U.S. dollars (the highest of the U.S. federal funds rate plus 0.50% per annum, the bank’s prime rate or the Eurocurrency rate plus 1.00%) plus a margin that ranges from 0% to 0.75% per annum. In each case, the applicable margin is based on our Consolidated Leverage Ratio, calculated quarterly. The Amended Term Loan Facility is subject to the same interest rate provisions. The Amended Credit Agreement expires on July 30, 2023, or earlier at our discretion upon payment in full of loans and other obligations.
At September 29, 2019, we had $276.4 million in outstanding borrowings under the Amended Credit Agreement, which was comprised of $240.6 million under the Term Loan Facility and $35.8 million under the Amended Revolving Credit Facility at a year-to-date weighted-average interest rate of 3.37% per annum. In addition, we had $0.7 million in standby letters of credit
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under the Amended Credit Agreement. Our average effective weighted-average interest rate on borrowings outstanding during the year-to-date period ending September 29, 2019 under the Amended Credit Agreement, including the effects of interest rate swap agreements described in Note 15, "Derivative Financial Instruments", was 3.65%. At September 29, 2019, we had $413.3 million of available credit under the Amended Revolving Credit Facility, all of which could be borrowed without a violation of our debt covenants.
The Amended Credit Agreement contains certain affirmative and restrictive covenants, and customary events of default. The financial covenants provide for a maximum Consolidated Leverage Ratio of 3.00 to 1.00 (total funded debt/EBITDA, as defined in the Amended Credit Agreement) and a minimum Consolidated Interest Coverage Ratio of 3.00 to 1.00 (EBITDA/Consolidated Interest Charges, as defined in the Amended Credit Agreement). Our obligations under the Amended Credit Agreement are guaranteed by certain of our domestic subsidiaries and are secured by first priority liens on (i) the equity interests of certain of our subsidiaries, including those subsidiaries that are guarantors or borrowers under the Amended Credit Agreement, and (ii) the accounts receivable, general intangibles and intercompany loans, and those of our subsidiaries that are guarantors or borrowers.
At September 29, 2019, we were in compliance with these covenants with a consolidated leverage ratio of 1.30x and a consolidated interest coverage ratio of 16.51x. Our obligations under the Amended Credit Agreement are guaranteed by certain of our subsidiaries and are secured by first priority liens on (i) the equity interests of certain of our subsidiaries, including those subsidiaries that are guarantors or borrowers under the Amended Credit Agreement, and (ii) our accounts receivable, general intangibles and intercompany loans, and those of our subsidiaries that are guarantors or borrowers.
In addition to the credit facility, we entered into agreements to issue standby letters of credit. The aggregate amount of standby letters of credit outstanding under these additional agreements and other bank guarantees was $41.4 million, of which $10.2 million was issued in currencies other than the U.S. dollar.
We maintain at our Australian subsidiary an AUD$30 million credit facility, which may be used for bank overdrafts, short-term cash advances and bank guarantees. This facility expires in March 2020 and is secured by a parent guarantee. At September 29, 2019, there were no borrowings outstanding under this facility and bank guarantees outstanding of USD$6.1 million, which were issued in currencies other than the U.S. dollar.
We maintain at our United Kingdom subsidiary a GBP£35 million credit facility, which may be used for bank overdrafts, short-term cash advances and bank guarantees. This facility expires in July 2020 and is secured by a parent guarantee. At September 29, 2019, there were no borrowings outstanding under this facility and bank guarantees outstanding of USD$17.4 million, which were issued in currencies other than the U.S. dollar.
The following table presents scheduled maturities of our long-term debt:
Amount | |||
(in thousands) | |||
2020 | $ | 12,572 | |
2021 | 12,515 | ||
2022 | 15,625 | ||
2023 | 235,809 | ||
Total | $ | 276,521 | |
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11. Leases
We lease office and field equipment, vehicles and buildings under various operating leases. In fiscal 2019, 2018 and 2017, we recognized $79.3 million, $77.8 million and $71.3 million of expense related to operating leases, respectively. The following amounts are payable under non-cancelable operating and capital lease commitments for the next five fiscal years and beyond:
Operating | Capital | ||||||
(in thousands) | |||||||
2020 | $ | 108,758 | $ | 72 | |||
2021 | 66,418 | 15 | |||||
2022 | 51,424 | — | |||||
2023 | 36,463 | — | |||||
2024 | 25,777 | — | |||||
Beyond | 54,692 | — | |||||
Total | $ | 343,532 | $ | 87 | |||
Net present value | $ | 87 | |||||
12. Stockholders' Equity and Stock Compensation Plans
At September 29, 2019, we had the following stock-based compensation plans:
• | Employee Stock Purchase Plan ("ESPP"). Purchase rights to purchase common stock are granted to our eligible full and part-time employees, and shares of common stock are issued upon exercise of the purchase rights. An aggregate of 3,454,102 shares may be issued pursuant to such exercise. The maximum amount that an employee can contribute during a purchase right period is $5,000. The exercise price of a purchase right is the lesser of 100% of the fair market value of a share of common stock on the first day of the purchase right period or 85% of the fair market value on the last day of the purchase right period (December 15, or the business day preceding December 15 if December 15 is not a business day). |
• | 2005 Equity Incentive Plan ("2005 EIP"). Key employees and non-employee directors may be granted equity awards, including stock options, restricted stock and restricted stock units ("RSUs"). Options granted before March 6, 2006 vested at 25% on the first anniversary of the grant date, and the balance vests monthly thereafter, such that these options become fully vested no later than four years from the date of grant. These options expire no later than ten years from the date of grant. Options granted on and after March 6, 2006 vest at 25% on each anniversary of the grant date. These options expire no later than eight years from the grant date. RSUs granted to date vest at 25% on each anniversary of the grant date. |
Our Compensation Committee has also awarded restricted stock to executive officers and non-employee directors under the 2005 EIP. Restricted stock grants generally vest over a minimum three-year period, and may be performance-based, determined by EPS growth, or service-based. No awards have made under the 2005 EIP since the adoption of the 2018 Equity Incentive Plan described below.
• | 2015 Equity Incentive Plan ("2015 EIP"). Key employees and non-employee directors may be granted equity awards, including stock options, performance share units ("PSUs") and RSUs. Shares issued with respect to awards granted under the 2015 EIP other than stock options or stock appreciation rights, which are referred to as "full value awards", are counted against the 2015 EIP's aggregate share limit as three shares for every share or unit actually issued. No awards have made under the 2015 Equity Incentive Plan since the adoption of the 2018 Equity Incentive Plan on March 8, 2018 described below. |
• | 2018 Equity Incentive Plan ("2018 EIP"). Key employees and non-employee directors may be granted equity awards, including stock options, performance share units ("PSUs") and RSUs. Shares issued with respect to awards granted under the 2018 EIP other than stock options or stock appreciation rights, which are referred to as "full value awards", are counted against the 2018 EIP's aggregate share limit as one share for every share or unit issued. At September 29, 2019, there were 2.7 million shares available for future awards pursuant to the 2018 EIP. |
The stock-based compensation and related income tax benefits were as follows:
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Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Total stock-based compensation | $ | 17,618 | $ | 19,582 | $ | 13,450 | |||||
Income tax benefit related to stock-based compensation | (4,016 | ) | (5,288 | ) | (4,715 | ) | |||||
Stock-based compensation, net of tax benefit | $ | 13,602 | $ | 14,294 | $ | 8,735 | |||||
Stock Options
Stock option activity for the fiscal year ended September 29, 2019 was as follows:
Number of Options (in thousands) | Weighted- Average Exercise Price per Share | Weighted- Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value (in thousands) | |||||||||
Outstanding on September 30, 2018 | 1,355 | $ | 30.87 | |||||||||
Exercised | (456 | ) | 26.21 | |||||||||
Forfeited | (5 | ) | 23.48 | |||||||||
Outstanding at September 29, 2019 | 894 | 33.28 | 5.08 | $ | 46,176 | |||||||
Vested or expected to vest at September 29, 2019 | 894 | 33.28 | 5.08 | 46,176 | ||||||||
Exercisable on September 29, 2019 | 671 | 30.75 | 4.33 | 36,346 | ||||||||
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between our closing stock price on the last trading day of fiscal 2019 and the exercise price, times the number of shares) that would have been received by the in-the-money option holders if they had exercised their options on September 29, 2019. This amount will change based on the fair market value of our stock. At September 29, 2019, we expect to recognize $2.0 million of unrecognized compensation cost related to stock option grants over a weighted-average period of 1 year.
No stock options were granted in fiscal 2019. The weighted-average fair value of each stock option granted during fiscal 2018 and 2017 was $14.82 and $12.35, respectively. The aggregate intrinsic value of options exercised during fiscal 2019, 2018 and 2017 was $20.4 million, $14.4 million and $16.4 million, respectively.
The fair value of our stock options was estimated on the date of grant using the Black-Scholes option pricing model. There were no options granted in fiscal 2019. The following assumptions were used in the calculation for fiscal 2018 and 2017:
Fiscal Year Ended | |||
September 30, 2018 | October 1, 2017 | ||
Dividend yield | 1.0% | 1.0% | |
Expected stock price volatility | 36.1% - 38.8% | 36.1% - 38.8% | |
Risk-free rate of return, annual | 1.7% - 2.9% | 1.7% - 1.9% | |
For purposes of the Black-Scholes model, forfeitures were estimated based on historical experience. For the fiscal 2018 and 2017 year-ends, we based our expected stock price volatility on historical volatility behavior and current implied volatility behavior. Our risk-free rate of return was based on constant maturity rates provided by the U.S. Treasury. The expected life was based on historical experience.
Net cash proceeds from the exercise of stock options were $11.8 million, $13.5 million and $18.6 million for fiscal 2019, 2018 and 2017, respectively. Our policy is to issue shares from our authorized shares upon the exercise of stock options. The actual income tax benefit realized from exercises of nonqualified stock options and disqualifying dispositions of qualified options for fiscal 2019, 2018 and 2017 was $6.4 million, $5.1 million and $4.9 million, respectively.
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RSU and PSU
RSU awards are granted to our key employee and non-employee directors. The fair value of the RSU was determined at the date of grant using the market price of the underlying common stock as of the date of grant. All of the RSUs have time-based vesting over a four-year period, except that RSUs awarded to directors vest after one year. The total compensation cost of the awards is then amortized over their applicable vesting period on a straight-line basis.
PSU awards are granted to our executive officers and non-employee directors. All of the PSUs are performance-based and vest, if at all, after the conclusion of the three-year performance period. The number of PSUs that ultimately vest is based on 50% on the growth in our EPS and 50% on our relative total shareholder return over the vesting period. For the performance-based awards, our expected performance is reviewed to estimate the percentage of shares that will vest. The total compensation cost of the awards is then amortized over their applicable vesting period on a straight-line basis.
A summary of the RSU and PSU activity under our stock plans is as follows:
RSU | PSU | ||||||||||||
Number of Shares (in thousands) | Weighted- Average Grant Date Fair Value per Share | Number of Shares (in thousands) | Weighted- Average Grant Date Fair Value per Share | ||||||||||
Nonvested balance at October 2, 2016 | 499 | $ | 27.16 | 277 | $ | 31.65 | |||||||
Granted | 226 | 41.00 | 99 | 48.36 | |||||||||
Vested | (186 | ) | 26.98 | — | — | ||||||||
Forfeited | (28 | ) | 30.15 | — | — | ||||||||
Nonvested balance at October 1, 2017 | 511 | 33.19 | 376 | 36.05 | |||||||||
Granted | 199 | 48.16 | 99 | 57.40 | |||||||||
Vested | (184 | ) | 31.85 | (270 | ) | 31.66 | |||||||
Adjustment (1) | — | — | 131 | 31.66 | |||||||||
Forfeited | (38 | ) | 36.39 | (13 | ) | 41.80 | |||||||
Nonvested balance at September 30, 2018 | 488 | 39.56 | 323 | 44.27 | |||||||||
Granted | 179 | 66.26 | 90 | 80.41 | |||||||||
Vested | (180 | ) | 36.95 | (108 | ) | 31.63 | |||||||
Adjustment (1) | — | — | 79 | 31.63 | |||||||||
Forfeited | (17 | ) | 48.56 | — | — | ||||||||
Nonvested balance at September 29, 2019 | 470 | 50.42 | 384 | 53.67 | |||||||||
(1) | For fiscal 2018, includes a payout adjustment of 130,730 PSUs due to the actual performance level achieved for PSUs granted in fiscal 2015 that vested fiscal 2018. For fiscal 2019, includes a payout adjustment of 79,465 PSUs due to the actual performance level achieved for PSUs granted in fiscal 2016 that vested during fiscal 2019. |
During fiscal 2019, 2018 and 2017, we awarded 179,478, 198,960 and 226,241 shares of RSUs, respectively, to our key employees and non-employee directors. The weighted-average grant-date fair value of RSUs granted during fiscal 2019, 2018 and 2017 was $66.26, $48.16 and $41.00, respectively. At September 29, 2019, there were 469,568 RSUs outstanding. RSU forfeitures result from employment terminations prior to vesting. Forfeited shares return to the pool of authorized shares available for award.
During fiscal 2019, 2018 and 2017, we awarded 89,816, 99,217 and 99,180 shares of PSUs, respectively, to our executive officers and non-employee directors. The weighted-average grant-date fair value of PSUs granted during fiscal 2019, 2018 and 2017 was $80.41, $57.40 and $48.36, respectively.
The stock-based compensation expense related to RSUs and PSUs for fiscal 2019, 2018 and 2017 was $15.4 million, $15.5 million and $10.6 million, respectively, and was included in total stock-based compensation expense. At September 29, 2019, there was $23.1 million of unrecognized stock-based compensation costs related to nonvested RSUs and PSUs that will be substantially recognized by the end of fiscal 2021.
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ESPP
The following table summarizes shares purchased, weighted-average purchase price, cash received and the aggregate intrinsic value for shares purchased under the ESPP:
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands, except for purchase price) | |||||||||||
Shares purchased | 148 | 141 | 190 | ||||||||
Weighted-average purchase price | $ | 46.38 | $ | 40.38 | $ | 26.02 | |||||
Cash received from exercise of purchase rights | $ | 6,844 | $ | 5,727 | $ | 4,940 | |||||
Aggregate intrinsic value | $ | 277 | $ | 337 | $ | — | |||||
The grant date fair value of each award granted under the ESPP was estimated using the Black-Scholes option pricing model with the following assumptions:
Fiscal Year Ended | |||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||
Dividend yield | 1.0% | 1.0% | 1.0% | ||
Expected stock price volatility | 26.7% | 24.0% | 22.4% | ||
Risk-free rate of return, annual | 2.6% | 1.8% | 0.9% | ||
Expected life (in years) | 1 | 1 | 1 | ||
For fiscal 2019, 2018 and 2017, we based our expected stock price volatility on historical volatility behavior and current implied volatility behavior. The risk-free rate of return was based on constant maturity rates provided by the U.S. Treasury. The expected life was based on the ESPP terms and conditions.
Stock-based compensation expense for fiscal 2019, 2018 and 2017 included $0.9 million, $0.6 million and $0.5 million, respectively, related to the ESPP. The unrecognized stock-based compensation costs for awards granted under the ESPP at September 29, 2019 and September 30, 2018 were $0.2 million and $0.2 million, respectively. At September 29, 2019, ESPP participants had accumulated $4.3 million to purchase our common stock.
13. Retirement Plans
We maintain defined contribution plans in various countries where we have employees. This primarily includes 401(k) plans in the United States. For fiscal 2019, 2018 and 2017, employer contributions to the U.S. plans were $23.3 million, $22.4 million and $11.4 million, respectively.
We have established a non-qualified deferred compensation plan for certain key employees and non-employee directors. Eligible employees and non-employee directors may elect to defer the receipt of salary, incentive payments, restricted stock, PSU and RSU awards, and non-employee director fees, which are generally invested by us in individual variable life insurance contracts we own that are designed to informally fund savings plans of this nature. At September 29, 2019 and September 30, 2018, the consolidated balance sheets reflect assets of $30.4 million and $29.4 million, respectively, related to the deferred compensation plan in "Other long-term assets," and liabilities of $29.5 million and $30.2 million, respectively, related to the deferred compensation plan in "Other long-term liabilities."
14. Earnings per Share
The following table sets forth the number of weighted-average shares used to compute basic and diluted EPS:
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Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands, except per share data) | |||||||||||
Net income attributable to Tetra Tech | $ | 158,668 | $ | 136,883 | $ | 117,874 | |||||
Weighted-average common shares outstanding – basic | 54,986 | 55,670 | 56,911 | ||||||||
Effect of diluted stock options and unvested restricted stock | 950 | 928 | 1,002 | ||||||||
Weighted-average common stock outstanding – diluted | 55,936 | 56,598 | 57,913 | ||||||||
Earnings per share attributable to Tetra Tech: | |||||||||||
Basic | $ | 2.89 | $ | 2.46 | $ | 2.07 | |||||
Diluted | $ | 2.84 | $ | 2.42 | $ | 2.04 | |||||
For fiscal 2018, 0.1 million options were excluded from the calculation of dilutive potential common shares. For fiscal 2019 and 2017, no options were excluded from the calculation of dilutive potential common shares. 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.
15. Derivative Financial Instruments
We use certain interest rate derivative contracts to hedge interest rate exposures on our variable rate debt. We also enter into foreign currency derivative contracts with financial institutions to reduce the risk that cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. Our hedging program is not designated for trading or speculative purposes.
We recognize derivative instruments as either assets or liabilities on the accompanying consolidated balance sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives that have been designated as cash flow hedges in our consolidated balance sheets as accumulated other comprehensive income, and in our consolidated statements of income for those derivatives designated as fair value hedges.
In fiscal 2018, we entered into five interest rate swap agreements that we designated as cash flow hedges to fix the interest rates on the borrowings under our term loan facility. As of September 29, 2019, the notional principal of our outstanding interest swap agreements was $240.6 million ($48.1 million each.) The interest rate swaps have a fixed interest rate of 2.79% and expire in July 2023 for all five agreements. At September 29, 2019 and September 30, 2018, the fair value of the effective portion of our interest rate swap agreements designated as cash flow hedges before tax effect was $(10.9) million and $1.3 million, respectively, of which we expect to reclassify $2.1 million from accumulated other comprehensive income to interest expense within the next 12 months.
The fair values of our outstanding derivatives designated as hedging instruments were as follows:
Fair Value of Derivative Instruments as of | |||||||||
Balance Sheet Location | September 29, 2019 | September 30, 2018 | |||||||
(in thousands) | |||||||||
Interest rate swap agreements | Other long-term assets | $ | — | $ | 1,244 | ||||
Interest rate swap agreements | Other current liabilities | $ | 11,009 | $ | — | ||||
Changes in the fair value of the interest rate swap agreements are presented on the Consolidated Statements of Comprehensive Income as follows:
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Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
(Loss) gain recognized in other comprehensive income, net of tax | |||||||||||
Interest rate swap agreements | $ | (12,125 | ) | $ | 806 | $ | 1,614 | ||||
There were no ineffective portions of derivative instruments. Accordingly, no amounts were excluded from effectiveness testing for our interest rate swap agreements. We had no other derivative instruments that were not designated as hedging instruments for fiscal 2019, 2018 and 2017.
16. Reclassifications Out of Accumulated Other Comprehensive Income
The accumulated balances and reporting period activities for fiscal 2019 and 2018 related to reclassifications out of accumulated other comprehensive income are summarized as follows:
Foreign Currency Translation Adjustments | Gain (Loss) on Derivative Instruments | Accumulated Other Comprehensive Income (Loss) | |||||||||
(in thousands) | |||||||||||
Balances at October 1, 2017 | $ | (98,946 | ) | $ | 446 | $ | (98,500 | ) | |||
Other comprehensive income (loss) before reclassifications | (29,656 | ) | 1,215 | (28,441 | ) | ||||||
Amounts reclassified from accumulated other comprehensive income | |||||||||||
Interest rate contracts, net of tax (1) | — | (409 | ) | (409 | ) | ||||||
Net current-period other comprehensive income (loss) | (29,656 | ) | 806 | (28,850 | ) | ||||||
Balances at September 30, 2018 | $ | (128,602 | ) | $ | 1,252 | $ | (127,350 | ) | |||
Other comprehensive loss before reclassifications | (21,109 | ) | (11,247 | ) | (32,356 | ) | |||||
Amounts reclassified from accumulated other comprehensive income | |||||||||||
Interest rate contracts, net of tax (1) | — | (878 | ) | (878 | ) | ||||||
Net current-period other comprehensive loss | (21,109 | ) | (12,125 | ) | (33,234 | ) | |||||
Balances at September 29, 2019 | $ | (149,711 | ) | $ | (10,873 | ) | $ | (160,584 | ) | ||
(1) | These amounts are reclassified to "Interest expense" in our consolidated statements of income when the interest rate contracts are settled. |
17. Fair Value Measurements
Derivative Instruments. For additional information about our derivative financial instruments (see Note 2, "Basis of Presentation and Preparation" and Note 15, "Derivative Financial Instruments").
Contingent Consideration. We measure our contingent earn-out liabilities at fair value on a recurring basis (see Note 2, "Basis of Presentation and Preparation" and Note 6, "Acquisitions and Divestitures" for further information).
Debt. The fair value of long-term debt was determined using the present value of future cash flows based on the borrowing rates currently available for debt with similar terms and maturities (Level 2 measurement). The carrying value of our long-term debt approximated fair value at September 29, 2019 and September 30, 2018. At September 29, 2019, we had borrowings of $276.4 million outstanding under our Amended Credit Agreement, which were used to fund our business acquisitions, working capital needs, stock repurchases, dividends, capital expenditures and contingent earn-outs.
18. Commitments and Contingencies
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We are subject to certain claims and lawsuits typically filed against the consulting and engineering profession, alleging primarily professional errors or omissions. We carry professional liability insurance, subject to certain deductibles and policy limits, against such claims. However, in some actions, parties are seeking damages that exceed our insurance coverage or for which we are not insured. While management does not believe that the resolution of these claims will have a material adverse effect, individually or in aggregate, on our financial position, results of operations or cash flows, management acknowledges the uncertainty surrounding the ultimate resolution of these matters.
On July 15, 2019, following an initial January 14, 2019 filing, the Civil Division of the United States Attorney's Office ("USAO") filed an amended complaint in intervention in three qui tam actions filed against our subsidiary, Tetra Tech EC, Inc. ("TtEC"), in the U.S. District Court for the Northern District of California. The complaint alleges False Claims Act violations and breach of contract related to TtEC's contracts to perform environmental remediation services at the former Hunters Point Naval Shipyard in San Francisco, California. TtEC disputes the claims and will defend this matter vigorously. We are currently unable to determine the probability of the outcome of this matter or the range of reasonably possible loss, if any.
19. Reportable Segments
We managed our operations under two reportable segments. Our GSG reportable segment primarily includes activities with U.S. governments (federal, state and local) and all activities with development agencies worldwide. Our CIG reportable segment primarily includes activities with U.S. commercial clients and international clients other than development agencies. Additionally, we continue to report the results of the wind-down of our non-core construction activities in the RCM reportable segment.
Our reportable segments are described as follows:
GSG: GSG provides consulting and engineering services primarily to U.S. government clients (federal, state and local) and development agencies worldwide. GSG supports U.S. government civilian and defense agencies with services in water, environment, infrastructure, information technology, and disaster management. GSG also provides engineering design services for U.S. municipal and commercial clients, especially in water infrastructure, solid waste, and high-end sustainable infrastructure designs. GSG also leads our support for development agencies worldwide, especially in the United States, United Kingdom, and Australia.
CIG: CIG primarily provides consulting and engineering services to U.S. commercial clients, and international clients that include both commercial and government sectors. CIG supports commercial clients across the Fortune 500, energy, utilities, industrial, manufacturing, aerospace, and resource management markets. CIG also provides infrastructure and related environmental and geotechnical services, testing, engineering and project management services to commercial and local government clients across Canada, in Asia Pacific (primarily Australia and New Zealand), the United Kingdom, as well as Brazil and Chile.
RCM: We continued to report the results of the wind-down of our non-core construction activities in the RCM reportable segment for fiscal 2019. As of September 29, 2019, there was no remaining backlog for RCM as the projects were complete.
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 revenues and transfers as if they 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.
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The following tables set forth summarized financial information concerning our reportable segments:
Reportable Segments
Fiscal Year Ended | |||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||
(in thousands) | |||||||||||
Revenue | |||||||||||
GSG | $ | 1,820,671 | $ | 1,694,871 | $ | 1,487,611 | |||||
CIG | 1,342,509 | 1,323,142 | 1,326,020 | ||||||||
RCM | (1,542 | ) | 14,199 | 18,207 | |||||||
Elimination of inter-segment revenue | (54,290 | ) | (68,064 | ) | (78,478 | ) | |||||
Total revenue | $ | 3,107,348 | $ | 2,964,148 | $ | 2,753,360 | |||||
Income from operations | |||||||||||
GSG | $ | 185,263 | $ | 168,211 | $ | 138,199 | |||||
CIG | 79,633 | 74,451 | 90,817 | ||||||||
RCM | (5,933 | ) | (4,573 | ) | (14,712 | ) | |||||
Corporate (1) | (70,201 | ) | (48,003 | ) | (30,962 | ) | |||||
Total operating income | $ | 188,762 | $ | 190,086 | $ | 183,342 | |||||
(1) | Includes goodwill and intangible assets impairment charges, amortization of intangibles, other costs and other income not allocable to segments. The intangible asset amortization expense for fiscal 2019, 2018 and 2017 was $11.6 million, $18.2 million and $22.8 million, respectively. Additionally, Corporate results included income (loss) for fair value adjustments to contingent consideration liabilities of $(1.1) million, $(4.3) million and $6.9 million for fiscal 2019, 2018 and 2017, respectively. Corporate results in fiscal 2019 also included a $7.8 million goodwill impairment charge described further in Note 7 - "Goodwill and Intangible Assets". |
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Total Assets | |||||||
GSG | $ | 587,040 | $ | 468,010 | |||
CIG | 450,276 | 478,197 | |||||
RCM | 15,608 | 25,683 | |||||
Corporate (1) | 1,094,484 | 987,531 | |||||
Total assets | $ | 2,147,408 | $ | 1,959,421 | |||
(1) | Corporate assets consist of intercompany eliminations and assets not allocated to reportable segments including goodwill, intangible assets, deferred income taxes and certain other assets. |
Geographic Information
Fiscal Year Ended | |||||||||||||||||||||||
September 29, 2019 | September 30, 2018 | October 1, 2017 | |||||||||||||||||||||
Revenue | Long-Lived Assets (2) | Revenue | Long-Lived Assets (2) | Revenue | Long-Lived Assets (2) | ||||||||||||||||||
United States | $ | 2,247,780 | $ | 51,859 | $ | 2,232,013 | $ | 57,256 | $ | 2,018,841 | $ | 58,233 | |||||||||||
Foreign countries (1) | 859,568 | 46,113 | 732,135 | 28,235 | 734,519 | 33,152 | |||||||||||||||||
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(1) | Includes revenue and long-lived assets from our foreign operations, primarily in Canada, Australia and the United Kingdom, and revenue generated from non-U.S. clients. |
(2) | Excludes goodwill, intangible assets and deferred income taxes. |
20. Related Party Transactions
We often provide services to unconsolidated joint ventures. For fiscal 2019, 2018 and 2017, our revenue included $99.1 million, $75.0 million and $56.1 million, respectively, related to services we provided to unconsolidated joint ventures, and incurred the related reimbursable costs of approximately $98.5 million, $76.6 million and $53.9 million, respectively. Our consolidated balance sheets also included the following amounts related to these services:
September 29, 2019 | September 30, 2018 | ||||||
(in thousands) | |||||||
Accounts receivable - net | $ | 19,351 | $ | 20,279 | |||
Contract assets | 9,681 | 10,584 | |||||
Contract liabilities | 111 | 193 | |||||
21. Quarterly Financial Information – Unaudited
In the opinion of management, the following unaudited quarterly data for the fiscal years ended September 29, 2019 and September 30, 2018 reflect all adjustments necessary for a fair statement of the results of operations.
As a result of the TCJA, we reduced our deferred tax liabilities and recorded a one-time deferred tax benefit of approximately $14.7 million in the first quarter of fiscal 2018. In the third quarter of fiscal 2018, we recognized losses of $3.4 million related to the divestiture of our non-core utility field services operations and other non-core assets. We settled a claim related to a fixed-price construction project completed in fiscal 2014 and recognized a reduction in revenue of $10.6 million and a related loss in operating income of $12.5 million in the fourth quarter of fiscal 2018.
In the second quarter of fiscal 2019, deferred tax valuation allowances of $23.4 million in Australia were released due to sufficient positive evidence obtained. During the fourth quarter of fiscal 2019, we decided to dispose of the turn-key pipeline activities in our CIG segment. As a result, we recorded a $7.8 million goodwill impairment charge and other charges for severance and other disposition costs totaling $10.9 million. Also in the fourth quarter of fiscal 2019, we incurred acquisition and transaction charges of $10.4 million related to the acquisition of WYG.
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First Quarter | Second Quarter | Third Quarter | Fourth Quarter | ||||||||||||
(in thousands, except per share data) | |||||||||||||||
Fiscal Year 2019 | |||||||||||||||
Revenue | $ | 717,431 | $ | 722,621 | $ | 825,793 | $ | 841,502 | |||||||
Income from operations | 55,711 | 47,545 | 64,841 | 20,665 | |||||||||||
Net income attributable to Tetra Tech | 41,997 | 55,911 | 49,233 | 11,527 | |||||||||||
Earnings per share attributable to Tetra Tech: | |||||||||||||||
Basic | $ | 0.76 | $ | 1.01 | $ | 0.90 | $ | 0.21 | |||||||
Diluted | $ | 0.75 | $ | 1.00 | $ | 0.88 | $ | 0.21 | |||||||
Weighted-average common shares outstanding: | |||||||||||||||
Basic | 55,390 | 55,143 | 54,819 | 54,617 | |||||||||||
Diluted | 56,366 | 55,985 | 55,768 | 55,618 | |||||||||||
Fiscal Year 2018 | |||||||||||||||
Revenue | $ | 759,749 | $ | 700,262 | $ | 764,795 | $ | 739,343 | |||||||
Income from operations | 48,589 | 42,716 | 55,496 | 43,285 | |||||||||||
Net income attributable to Tetra Tech | 46,034 | 28,725 | 33,322 | 28,802 | |||||||||||
Earnings per share attributable to Tetra Tech: | |||||||||||||||
Basic | $ | 0.82 | $ | 0.51 | $ | 0.60 | $ | 0.52 | |||||||
Diluted | $ | 0.81 | $ | 0.51 | $ | 0.59 | $ | 0.51 | |||||||
Weighted-average common shares outstanding: | |||||||||||||||
Basic | 55,855 | 55,841 | 55,537 | 55,341 | |||||||||||
Diluted | 56,875 | 56,673 | 56,390 | 56,349 | |||||||||||
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures and changes in internal control over financial reporting
At September 29, 2019, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on our management's evaluation (with the participation of our principal executive officer and principal financial officer), our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), were effective.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Exchange Act Rule 13a-15(f), internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officer and effected by our Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with U.S. GAAP. Internal controls include those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even effective internal control over financial reporting can only provide reasonable assurance of achieving their control objectives.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we assessed the effectiveness of our internal control over financial reporting at September 29, 2019, based on the criteria in Internal Control – Integrated Framework (2013) issued by the COSO. Based upon this assessment, management has concluded that our internal control over financial reporting was effective at September 29, 2019.
PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Form 10-K, has issued a report on our internal control over financial reporting. This report, dated November 27, 2019, appears on pages 57-59 of this Form 10-K.
Consistent with the guidance issued by the Securities and Exchange Commission Staff, management has excluded WYG, which we acquired July 9, 2019, from its evaluation of the effectiveness of our internal control over financial reporting as of September 29, 2019. The total assets and revenue related to WYG are approximately 3% and 1%, respectively, of the related consolidated financial statement amounts as of and for the fiscal year ended September 29, 2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the three months ended September 29, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item relating to our directors and nominees, regarding compliance with Section 16(a) of the Exchange Act, and regarding our Audit Committee is included under the captions "Item No. 1 – Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in our Proxy Statement related to the 2020 Annual Meeting of Stockholders and is incorporated by reference.
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Pursuant to General Instruction G(3) of Form 10-K, the information required by this item relating to our executive officers is included under the caption "Executive Officers of the Registrant" in Part I of this Report.
We have adopted a code of ethics that applies to our principal executive officer and all members of our finance department, including our principal financial officer and principal accounting officer. This code of ethics, entitled "Finance Code of Professional Conduct," is posted on our website. The Internet address for our website is www.tetratech.com, and the code of ethics may be found through a link to the Investor Relations section of our website.
We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K for any amendment to, or waiver from, a provision of this code of ethics by posting any such information on our website, at the address and location specified above.
Item 11. Executive Compensation
The information required by this item is included under the captions "Item No. 1 – Election of Directors" and "Executive Compensation Tables" in our Proxy Statement related to the 2020 Annual Meeting of Stockholders and is incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item relating to security ownership of certain beneficial owners and management, and securities authorized for issuance under equity compensation plans, is included under the caption "Security Ownership of Management and Significant Stockholders" in our Proxy Statement related to the 2020 Annual Meeting of Stockholders and is incorporated by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item relating to review, approval or ratification of transactions with related persons is included under the caption "Related Person Transactions," and the information required by this item relating to director independence is included under the caption "Item No. 1 – Election of Directors," in each case in our Proxy Statement related to the 2020 Annual Meeting of Stockholders and is incorporated by reference.
Item 14. Principal Accounting Fees and Services
The information required by this item is included under the caption "Item No. 4 – Ratification of Independent Registered Public Accounting Firm" in our Proxy Statement related to the 2020 Annual Meeting of Stockholders and is incorporated by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a.) | 1. | Financial Statements |
The Index to Financial Statements and Financial Statement Schedule on page 56 is incorporated by reference as the list of financial statements required as part of this Report. | ||
2. | Financial Statement Schedule | |
The Index to Financial Statements and Financial Statement Schedule on page 56 is incorporated by reference as the list of financial statement schedules required as part of this Report. | ||
3. | Exhibits | |
The exhibit list in the Index to Exhibits on pages 99 is incorporated by reference as the list of exhibits required as part of this Report. | ||
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TETRA TECH, INC.
SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Fiscal Years Ended
October 1, 2017, September 30, 2018 and September 29, 2019
(in thousands)
Balance at Beginning of Period | Charged to Costs, Expenses and Revenue | Deductions (1) | Other (2) | Balance at End of Period | ||||||||||||||||
Allowance for doubtful accounts: | ||||||||||||||||||||
Fiscal 2017 | $ | 35,233 | $ | 2,848 | $ | (6,233 | ) | 411 | $ | 32,259 | ||||||||||
Fiscal 2018 | 32,259 | 7,167 | (4,485 | ) | 2,639 | 37,580 | ||||||||||||||
Fiscal 2019 | 37,580 | 16,964 | (6,147 | ) | 5,174 | 53,571 | ||||||||||||||
Income tax valuation allowance: | ||||||||||||||||||||
Fiscal 2017 | $ | 25,447 | $ | (121 | ) | $ | — | $ | — | $ | 25,326 | |||||||||
Fiscal 2018 | 25,326 | 900 | — | (4,747 | ) | 21,479 | ||||||||||||||
Fiscal 2019 | 21,479 | 255 | (23,714 | ) | 22,523 | 20,543 | ||||||||||||||
(1) | Primarily represents uncollectible accounts written off, net of recoveries for the allowance for doubtful accounts. The income tax valuation amount represents the release of valuation allowances in Australia. |
(2) | Includes allowances from acquisitions, loss in foreign jurisdictions, currency adjustments, and valuation allowance adjustments related to net operating loss carry-forwards. |
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INDEX TO EXHIBITS
99
95. | ||
101 | The following financial information from our Company's Annual Report on Form 10-K, for the period ended September 29, 2019, formatted in eXtensible Business Reporting Language: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statement of Comprehensive Income, (iv) Consolidated Statements of Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.+(1) | |
_______________________________________________________________________________
* | Indicates a management contract or compensatory arrangement. | |
+ | Filed herewith. | |
(1 | ) | Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Annual Report on Form 10-K shall not be deemed to be "filed" for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of the section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
TETRA TECH, INC. | ||
By: | /s/ DAN L. BATRACK | |
Date: November 22, 2019 | Dan L. Batrack Chairman and Chief Executive Officer | |
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dan L. Batrack and Steven M. Burdick, jointly and severally, his attorney-in-fact, each with the full power of substitution, for such person, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might do or could do in person, hereby ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/s/ DAN L. BATRACK | Chairman and Chief Executive Officer | November 22, 2019 | ||
Dan L. Batrack | (Principal Executive Officer) | |||
/s/ STEVEN M. BURDICK | Executive Vice President, Chief Financial Officer | November 22, 2019 | ||
Steven M. Burdick | (Principal Financial Officer) | |||
/s/ BRIAN N. CARTER | Senior Vice President, Corporate Controller | November 22, 2019 | ||
Brian N. Carter | (Principal Accounting Officer) | |||
/s/ ALBERT E. SMITH | Director | November 22, 2019 | ||
Albert E. Smith | ||||
/s/ GARY R. BIRKENBEUEL | Director | November 22, 2019 | ||
Gary R. Birkenbeuel | ||||
/s/ HUGH M. GRANT | Director | November 22, 2019 | ||
Hugh M. Grant | ||||
/s/ PATRICK C. HADEN | Director | November 22, 2019 | ||
Patrick C. Haden | ||||
/s/ J. CHRISTOPHER LEWIS | Director | November 22, 2019 | ||
J. Christopher Lewis | ||||
/s/ JOANNE M. MAGUIRE | Director | November 22, 2019 | ||
Joanne M. Maguire | ||||
/s/ KIMBERLY E. RITRIEVI | Director | November 22, 2019 | ||
Kimberly E. Ritrievi | ||||
/s/ J. KENNETH THOMPSON | Director | November 22, 2019 | ||
J. Kenneth Thompson | ||||
/s/ KIRSTEN M. VOLPI | Director | November 22, 2019 | ||
Kirsten M. Volpi | ||||
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