TETRA TECH INC - Quarter Report: 2020 December (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the quarterly period ended December 27, 2020
OR
| ☐ | 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 Number) | |||||||
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 | ||||||||||||
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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
As of January 19, 2021, 54,228,923 shares of the registrant’s common stock were outstanding.
TETRA TECH, INC.
INDEX
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2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Tetra Tech, Inc.
Consolidated Balance Sheets
(unaudited - in thousands, except par value)
| ASSETS | December 27, 2020 | September 27, 2020 | |||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 163,438 | $ | 157,515 | |||||||
| Accounts receivable, net | 673,763 | 649,035 | |||||||||
| Contract assets | 91,598 | 92,632 | |||||||||
| Prepaid expenses and other current assets | 91,597 | 81,094 | |||||||||
| Income taxes receivable | 15,050 | 19,509 | |||||||||
| Total current assets | 1,035,446 | 999,785 | |||||||||
| Property and equipment, net | 35,141 | 35,507 | |||||||||
| Right-of-use assets, operating leases | 225,787 | 239,396 | |||||||||
| Investments in unconsolidated joint ventures | 7,919 | 7,332 | |||||||||
| Goodwill | 1,017,909 | 993,498 | |||||||||
| Intangible assets, net | 10,893 | 13,943 | |||||||||
| Deferred tax assets | 34,511 | 32,052 | |||||||||
| Other long-term assets | 47,266 | 57,045 | |||||||||
| Total assets | $ | 2,414,872 | $ | 2,378,558 | |||||||
| LIABILITIES AND EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | 135,435 | $ | 111,804 | |||||||
| Accrued compensation | 138,112 | 199,801 | |||||||||
| Contract liabilities | 199,297 | 171,905 | |||||||||
| Short-term lease liabilities, operating leases | 69,612 | 69,650 | |||||||||
| Current portion of long-term debt and other short-term borrowings | 26,179 | 49,264 | |||||||||
| Current contingent earn-out liabilities | 10,945 | 16,142 | |||||||||
| Other current liabilities | 175,141 | 174,890 | |||||||||
| Total current liabilities | 754,721 | 793,456 | |||||||||
| Deferred tax liabilities | 18,462 | 16,316 | |||||||||
| Long-term debt | 275,983 | 242,395 | |||||||||
| Long-term lease liabilities, operating leases | 181,473 | 191,955 | |||||||||
| Long-term contingent earn-out liabilities | 15,074 | 16,475 | |||||||||
| Other long-term liabilities | 63,905 | 80,588 | |||||||||
| Commitments and contingencies (Note 16) | |||||||||||
| Equity: | |||||||||||
Preferred stock - authorized, 2,000 shares of $0.01 par value; no shares issued and outstanding at December 27, 2020 and September 27, 2020 | — | — | |||||||||
Common stock - authorized, 150,000 shares of $0.01 par value; issued and outstanding, 54,193 and 53,797 shares at December 27, 2020 and September 27, 2020, respectively | 542 | 538 | |||||||||
| Accumulated other comprehensive loss | (127,919) | (161,786) | |||||||||
| Retained earnings | 1,232,563 | 1,198,567 | |||||||||
| Tetra Tech stockholders’ equity | 1,105,186 | 1,037,319 | |||||||||
| Noncontrolling interests | 68 | 54 | |||||||||
| Total stockholders' equity | 1,105,254 | 1,037,373 | |||||||||
| Total liabilities and stockholders' equity | $ | 2,414,872 | $ | 2,378,558 | |||||||
See Notes to Consolidated Financial Statements.
3
Tetra Tech, Inc.
Consolidated Statements of Income
(unaudited – in thousands, except per share data)
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| Revenue | $ | 765,104 | $ | 797,623 | |||||||
| Subcontractor costs | (159,933) | (183,600) | |||||||||
| Other costs of revenue | (488,861) | (504,286) | |||||||||
| Gross profit | 116,310 | 109,737 | |||||||||
| Selling, general and administrative expenses | (50,058) | (46,435) | |||||||||
| Income from operations | 66,252 | 63,302 | |||||||||
| Interest expense | (3,026) | (3,349) | |||||||||
| Income before income tax expense | 63,226 | 59,953 | |||||||||
| Income tax expense | (10,778) | (12,636) | |||||||||
| Net income | 52,448 | 47,317 | |||||||||
| Net income attributable to noncontrolling interests | (12) | (7) | |||||||||
| Net income attributable to Tetra Tech | $ | 52,436 | $ | 47,310 | |||||||
| Earnings per share attributable to Tetra Tech: | |||||||||||
| Basic | $ | 0.97 | $ | 0.87 | |||||||
| Diluted | $ | 0.96 | $ | 0.85 | |||||||
| Weighted-average common shares outstanding: | |||||||||||
| Basic | 53,927 | 54,560 | |||||||||
| Diluted | 54,637 | 55,438 | |||||||||
See Notes to Consolidated Financial Statements.
4
Tetra Tech, Inc.
Consolidated Statements of Comprehensive Income
(unaudited – in thousands)
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| Net income | $ | 52,448 | $ | 47,317 | |||||||
| Other comprehensive income, net of tax | |||||||||||
Foreign currency translation adjustment, net of tax | 32,393 | 13,901 | |||||||||
| Gain on cash flow hedge valuations, net of tax | 1,476 | 1,670 | |||||||||
| Other comprehensive income, net of tax | 33,869 | 15,571 | |||||||||
| Comprehensive income, net of tax | $ | 86,317 | $ | 62,888 | |||||||
| Comprehensive income attributable to noncontrolling interests, net of tax | 14 | 9 | |||||||||
| Comprehensive income attributable to Tetra Tech, net of tax | $ | 86,303 | $ | 62,879 | |||||||
See Notes to Consolidated Financial Statements.
5
Tetra Tech, Inc.
Consolidated Statements of Cash Flows
(unaudited – in thousands)
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 52,448 | $ | 47,317 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | 6,238 | 6,235 | |||||||||
| Equity in income of unconsolidated joint ventures | (1,107) | (1,675) | |||||||||
| Distributions of earnings from unconsolidated joint ventures | 931 | 1,447 | |||||||||
| Amortization of stock-based awards | 4,898 | 4,482 | |||||||||
| Deferred income taxes | 954 | 2,173 | |||||||||
| Gain on sale of property and equipment | (7) | (897) | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Accounts receivable and contract assets | (11,400) | 44,040 | |||||||||
| Prepaid expenses and other assets | 11,813 | (2,053) | |||||||||
| Accounts payable | 23,631 | (66,381) | |||||||||
| Accrued compensation | (61,690) | (79,098) | |||||||||
| Contract liabilities | 27,392 | 38,207 | |||||||||
| Other liabilities | (23,373) | (14,917) | |||||||||
| Income taxes receivable/payable | 2,452 | 3,096 | |||||||||
| Net cash provided by (used in) operating activities | 33,180 | (18,024) | |||||||||
| Cash flows from investing activities: | |||||||||||
| Capital expenditures | (1,795) | (3,331) | |||||||||
| Proceeds from sale of property and equipment | 9 | 455 | |||||||||
| Net cash used in investing activities | (1,786) | (2,876) | |||||||||
| Cash flows from financing activities: | |||||||||||
| Proceeds from borrowings | 123,533 | 198,364 | |||||||||
| Repayments on long-term debt | (114,752) | (141,550) | |||||||||
| Repurchases of common stock | (15,000) | (21,177) | |||||||||
| Taxes paid on vested restricted stock | (17,330) | (10,818) | |||||||||
| Stock options exercised | 7,495 | 1,413 | |||||||||
| Dividends paid | (9,198) | (8,190) | |||||||||
| Payments of contingent earn-out liabilities | (7,037) | (9,236) | |||||||||
| Principal payments on finance leases | (538) | — | |||||||||
| Net cash (used in) provided by financing activities | (32,827) | 8,806 | |||||||||
| Effect of exchange rate changes on cash, cash equivalents and restricted cash | 7,356 | 2,200 | |||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | 5,923 | (9,894) | |||||||||
| Cash, cash equivalents and restricted cash at beginning of period | 157,515 | 120,901 | |||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | 163,438 | $ | 111,007 | |||||||
| Supplemental information: | |||||||||||
| Cash paid during the period for: | |||||||||||
| Interest | $ | 1,968 | $ | 3,082 | |||||||
Income taxes, net of refunds received of $1.1 million and $0.3 million | $ | 5,696 | $ | 5,579 | |||||||
| Supplemental disclosures of non-cash investing activities: | |||||||||||
| Reconciliation of cash, cash equivalents and restricted cash: | |||||||||||
| Cash and cash equivalents | $ | 163,438 | $ | 110,833 | |||||||
| Restricted cash | — | 174 | |||||||||
| Total cash, cash equivalents and restricted cash | $ | 163,438 | $ | 111,007 | |||||||
See Notes to Consolidated Financial Statements.
6
Tetra Tech, Inc.
Consolidated Statements of Stockholders' Equity
Three Months Ended December 29, 2019 and December 27, 2020
(unaudited – in thousands)
| Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Retained Earnings | Total Tetra Tech Equity | Non-Controlling Interests | Total Equity | |||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||||
| BALANCE AT SEPTEMBER 29, 2019 | 54,565 | $ | 546 | $ | 78,132 | $ | (160,584) | $ | 1,071,192 | $ | 989,286 | $ | 178 | $ | 989,464 | ||||||||||||||||||||||||||||||||
| Net income | 47,310 | 47,310 | 7 | 47,317 | |||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | 15,569 | 15,569 | 2 | 15,571 | |||||||||||||||||||||||||||||||||||||||||||
| Distributions paid to noncontrolling interests | — | (13) | (13) | ||||||||||||||||||||||||||||||||||||||||||||
Cash dividends of $0.15 per common share | (8,190) | (8,190) | (8,190) | ||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 4,482 | 4,482 | 4,482 | ||||||||||||||||||||||||||||||||||||||||||||
| Restricted & performance shares released | 185 | 1 | (10,819) | (10,818) | (10,818) | ||||||||||||||||||||||||||||||||||||||||||
| Stock options exercised | 54 | 1 | 1,412 | 1,413 | 1,413 | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued for Employee Stock Purchase Plan | 168 | 1 | 8,715 | 8,716 | 8,716 | ||||||||||||||||||||||||||||||||||||||||||
| Stock repurchases | (244) | (2) | (21,175) | (21,177) | (21,177) | ||||||||||||||||||||||||||||||||||||||||||
| BALANCE AT DECEMBER 29, 2019 | 54,728 | $ | 547 | $ | 60,747 | $ | (145,015) | $ | 1,110,312 | $ | 1,026,591 | $ | 174 | $ | 1,026,765 | ||||||||||||||||||||||||||||||||
| BALANCE AT SEPTEMBER 27, 2020 | 53,797 | $ | 538 | $ | — | $ | (161,786) | $ | 1,198,567 | $ | 1,037,319 | $ | 54 | $ | 1,037,373 | ||||||||||||||||||||||||||||||||
| Net income | 52,436 | 52,436 | 12 | 52,448 | |||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | 33,867 | 33,867 | 2 | 33,869 | |||||||||||||||||||||||||||||||||||||||||||
Cash dividends of $0.17 per common share | (9,198) | (9,198) | (9,198) | ||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 4,898 | 4,898 | 4,898 | ||||||||||||||||||||||||||||||||||||||||||||
| Restricted & performance shares released | 209 | 2 | (17,332) | (17,330) | (17,330) | ||||||||||||||||||||||||||||||||||||||||||
| Stock options exercised | 198 | 2 | 7,493 | 7,495 | 7,495 | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued for Employee Stock Purchase Plan | 124 | 1 | 10,698 | 10,699 | 10,699 | ||||||||||||||||||||||||||||||||||||||||||
| Stock repurchases | (135) | (1) | (5,757) | (9,242) | (15,000) | (15,000) | |||||||||||||||||||||||||||||||||||||||||
| BALANCE AT DECEMBER 27, 2020 | 54,193 | $ | 542 | $ | — | $ | (127,919) | $ | 1,232,563 | $ | 1,105,186 | $ | 68 | $ | 1,105,254 | ||||||||||||||||||||||||||||||||
See Notes to Consolidated Financial Statements.
7
TETRA TECH, INC.
Notes to Consolidated Financial Statements
1. Basis of Presentation
The accompanying unaudited consolidated financial statements and related notes of Tetra Tech, Inc. (“we,” “us,” “our” or "Tetra Tech") have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all of the information and footnotes required by U.S. GAAP for complete financial statements and, therefore, should be read in conjunction with the audited consolidated financial statements and the notes contained in our Annual Report on Form 10-K for the fiscal year ended September 27, 2020.
These financial statements reflect all normal recurring adjustments that are considered necessary for a fair statement of our financial position, results of operations and cash flows for the interim periods presented. The results of operations and cash flows for any interim period are not necessarily indicative of results for the full year or for future years. Certain reclassifications were made to the prior year to conform to current year presentation.
2. Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board ("FASB") issued updated guidance, Accounting Standards Update ("ASU") 2016-13, related to the measurement of credit losses for certain financial assets. This guidance replaces the current incurred loss methodology with an expected credit loss methodology. It requires us to recognize an allowance equal to our current estimate of all contractual cash flows that we do not expect to collect. Our estimate would consider relevant information about past events, current conditions, and reasonable and supportable forecasts impacting the collectability of the reported amounts. We adopted this guidance in the first quarter of fiscal 2021, and the adoption did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued updated guidance modifying certain fair value measurement disclosures. The guidance contains additional disclosures to enable users of the financial statements to better understand the entity’s assumptions 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. We adopted this guidance in the first quarter of fiscal 2021, and the adoption did not have a material impact on our consolidated financial statements.
In December 2019, the FASB issued guidance simplifying the accounting for income taxes by removing certain exceptions to general principles in Topic 740 and amending certain existing guidance for clarity. This guidance is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020 (first quarter of fiscal 2022 for us). Early adoption is permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
In May 2020, the Securities and Exchange Commission issued guidance amending certain financial disclosures about acquired and disposed businesses. The amendments are designed to assist registrants in making more meaningful determinations of whether a subsidiary or an acquired or disposed business is significant, and to improve the related disclosure requirements. The guidance is effective for fiscal years beginning after December 31, 2020 (first quarter of fiscal 2022 for us). We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
3. Revenue and Contract Balances
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 present revenue disaggregated by client sector and contract type:
8
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| (in thousands) | |||||||||||
| Client Sector: | |||||||||||
| U.S. state and local government | $ | 124,966 | $ | 123,836 | |||||||
U.S. federal government (1) | 265,864 | 245,303 | |||||||||
| U.S. commercial | 157,806 | 181,491 | |||||||||
International (2) | 216,468 | 246,993 | |||||||||
| Total | $ | 765,104 | $ | 797,623 | |||||||
| Contract Type: | |||||||||||
| Fixed-price | $ | 274,432 | $ | 271,055 | |||||||
| Time-and-materials | 355,241 | 388,158 | |||||||||
| Cost-plus | 135,431 | 138,410 | |||||||||
| Total | $ | 765,104 | $ | 797,623 | |||||||
(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 three months ended December 27, 2020 and December 29, 2019.
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.
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 retentions, included in contract assets, represent amounts withheld by clients until certain conditions are met or the project is completed, which may extend beyond one year.
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 assets/liabilities consisted of the following:
| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
Contract assets (1) | $ | 91,598 | $ | 92,632 | |||||||
| Contract liabilities | (199,297) | (171,905) | |||||||||
| Net contract liabilities | $ | (107,699) | $ | (79,273) | |||||||
(1) Includes $8.5 million and $12.3 million of contract retentions as of December 27, 2020 and September 27, 2020, respectively.
9
In the first quarter of fiscal 2021, we recognized revenue of approximately $60 million from amounts included in the contract liability balance at the end of fiscal 2020, compared to approximately $64 million for the same period last year.
We recognize revenue primarily using the cost-to-cost measure of progress method, which involves the estimates of progress towards completion. 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. For the first quarters of fiscal 2021 and 2020, these net adjustments to our operating income were immaterial. 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 December 27, 2020 and September 27, 2020, our consolidated balance sheets included liabilities for anticipated losses of $11.4 million and $13.2 million, respectively. The estimated cost to complete the related contracts as of December 27, 2020 was approximately $135 million.
Accounts Receivable, Net
Net accounts receivable consisted of the following:
| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| Billed | $ | 438,458 | $ | 402,818 | |||||||
| Unbilled | 242,890 | 253,364 | |||||||||
| Total accounts receivable | 681,348 | 656,182 | |||||||||
| Allowance for doubtful accounts | (7,585) | (7,147) | |||||||||
| Total accounts receivable, net | $ | 673,763 | $ | 649,035 | |||||||
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 December 27, 2020 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, including the potential impacts of the coronavirus disease 2019 ("COVID-19") pandemic, that may affect our clients' ability to pay.
Total accounts receivable at December 27, 2020 and September 27, 2020 included approximately $14 million for each period (all in our Remediation Construction Management ("RCM") segment), related to claims, including requests for equitable adjustment, on contracts that provide for price redetermination. 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. Factors considered in determining whether revenue associated with claims (including change orders in dispute and unapproved change orders in regards 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.
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 the first quarters of fiscal 2021 and 2020, we recorded no material gains or losses related to claims.
No single client accounted for more than 10% of our accounts receivable at December 27, 2020 and September 27, 2020.
10
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 $3.2 billion of RUPOs as of December 27, 2020. 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 December 27, 2020 over the following periods:
| Amount | |||||
| (in thousands) | |||||
| Within 12 months | $ | 1,823,137 | |||
| Beyond | 1,341,016 | ||||
| Total | $ | 3,164,153 | |||
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. Acquisitions
In the second quarter of fiscal 2020, we acquired Segue Technologies, Inc. ("SEG"), a leading information technology management consulting firm based in Arlington, Virginia. SEG is part of our Government Services Group ("GSG") segment. The fair value of the purchase price was $40.9 million. This amount was comprised of $29.6 million in initial cash payments made to the sellers, and $11.3 million for the estimated fair value of contingent earn-out obligations, with a maximum of $20.0 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 2020, we acquired BlueWater Federal Solutions, Inc. ("BWF"), a leading information technology management consulting firm based in Chantilly, Virginia. BWF is part of our GSG segment. The fair value of the purchase price was $47.7 million. This amount was comprised of $41.8 million in initial cash payments made to the sellers, $0.7 million of payables related to estimated post-closing adjustments for net assets acquired, and $5.2 million for the estimated fair value of contingent earn-out obligations, with a maximum of $8.0 million, based upon the achievement of specified operating income targets in each of the three years following the acquisition.
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. The fiscal 2020 goodwill additions represent the value of a workforce with distinct expertise in the high-end information technology field, in the areas of data analytics, modeling and simulation, cloud, and agile software development. 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 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 to ten years, and trade names with lives ranging from to five years. For detailed information regarding our intangible assets, see Note 5, “Goodwill and Intangible Assets”.
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”
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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 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 evaluated our estimated fair value of contingent consideration liabilities for each individual acquisition on a quarterly basis, which included a review of their financial results to-date, the status of ongoing projects in their RUPOs, and the inventory of prospective new contract awards. We also considered the potential impact of the global economic disruption due to the COVID-19 pandemic on our operating income projections over the various earn-out periods. 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. For the first quarters of fiscal 2021 and 2020, we had no material adjustments to our contingent earn-out liabilities in operating income .
At December 27, 2020, there was a total potential maximum of $63.9 million of outstanding contingent consideration related to acquisitions. Of this amount, $26.0 million was estimated as the fair value and accrued on our consolidated balance sheet. If the global economic disruption related to the COVID-19 pandemic is prolonged, we could have more significant reductions in our contingent earn-out liabilities and related gains in our operating income in future periods.
5. Goodwill and Intangible Assets
The following table summarizes the changes in the carrying value of goodwill by reportable segment:
| GSG | CIG | Total | ||||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Balance at September 27, 2020 | $ | 516,315 | $ | 477,183 | $ | 993,498 | ||||||||||||||
| Translation | 5,834 | 18,577 | 24,411 | |||||||||||||||||
| Balance at December 27, 2020 | $ | 522,149 | $ | 495,760 | $ | 1,017,909 | ||||||||||||||
Our goodwill balances reflect foreign currency translation adjustments related to our foreign subsidiaries with functional currencies that are different than our reporting currency. These amounts are presented net of reductions from historical impairment adjustments. The gross amounts of goodwill for GSG were $539.9 million and $534.0 million at December 27, 2020 and September 27, 2020, respectively, excluding accumulated impairment of $17.7 million for each period. The gross amounts of goodwill for CIG were $617.3 million and $598.7 million at December 27, 2020 and September 27, 2020, respectively, excluding accumulated impairment of $121.5 million for each period.
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. Our most recent annual review at June 29, 2020 (i.e. the first day of our fourth quarter in fiscal 2020) 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 80%, with the exception of our Asia/Pacific ("ASP") reporting unit, which is in our CIG reportable segment. Our ASP reporting unit had an estimated fair value that exceeded its carrying value by less than 20%.
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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.
On September 2, 2020, Australia announced that it had fallen into economic recession, defined as two consecutive quarters of negative growth, for the first time since 1991 including 7% negative growth in the quarter ending June 30, 2020. This prompted a strategic review of our ASP reporting unit. As a result of the economic recession in Australia, our revenue growth and profit margin forecasts for our ASP reporting unit declined from the previous forecast used for our annual goodwill impairment review as of June 29, 2020. We also performed an interim goodwill impairment review of our ASP reporting unit in September 2020 and recorded a $15.8 million goodwill impairment charge. As a result of the impairment charge, the estimated fair value of our ASP reporting unit equaled its carrying value of $144.9 million, including $95.5 million of goodwill, at September 27, 2020. On September 28, 2020 (the first day of our fiscal 2021), we merged our ASP reporting unit into our Client Account Management reporting unit.
The following table presents the gross amount and accumulated amortization of our acquired identifiable intangible assets with finite useful lives included in “Intangible assets, net” on the consolidated balance sheets:
| December 27, 2020 | September 27, 2020 | ||||||||||||||||||||||||||||
| Weighted- Average Remaining Life (in Years) | Gross Amount | Accumulated Amortization | Gross Amount | Accumulated Amortization | |||||||||||||||||||||||||
| ($ in thousands) | |||||||||||||||||||||||||||||
| Client relations | 2.8 | $ | 47,222 | $ | (40,497) | $ | 60,775 | $ | (53,392) | ||||||||||||||||||||
| Backlog | 0.6 | 30,085 | (27,329) | 37,682 | (32,761) | ||||||||||||||||||||||||
| Trade names | 1.9 | 7,164 | (5,752) | 7,964 | (6,325) | ||||||||||||||||||||||||
| Total | $ | 84,471 | $ | (73,578) | $ | 106,421 | $ | (92,478) | |||||||||||||||||||||
Amortization expense for the three months ended December 27, 2020 was $3.4 million, compared to $2.9 million for the prior-year period. Estimated amortization expense for the remainder of fiscal 2021 and succeeding years is as follows:
| Amount | |||||
| (in thousands) | |||||
| 2021 | $ | 5,600 | |||
| 2022 | 2,741 | ||||
| 2023 | 1,962 | ||||
| 2024 | 590 | ||||
| Total | $ | 10,893 | |||
6. Property and Equipment
Property and equipment consisted of the following:
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| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| Equipment, furniture and fixtures | $ | 94,545 | $ | 90,942 | |||||||
| Leasehold improvements | 34,464 | 34,569 | |||||||||
| Total property and equipment | 129,009 | 125,511 | |||||||||
| Accumulated depreciation | (93,868) | (90,004) | |||||||||
| Property and equipment, net | $ | 35,141 | $ | 35,507 | |||||||
The depreciation expense related to property and equipment was $2.9 million for the first quarter of fiscal 2021, compared to $3.3 million for the prior-year quarter.
7. Stock Repurchase and Dividends
On January 27, 2020, the Board of Directors authorized a new $200 million stock repurchase program, which was included in our remaining balance of $207.8 million as of fiscal 2020 year-end. In the first quarter of fiscal 2021, we repurchased and settled 135,413 shares with an average price of $110.77 per share for a total cost of $15 million in the open market. At December 27, 2020, we had a remaining balance of $192.8 million under our stock repurchase program.
The following table presents dividends declared and paid in the first quarters of fiscal 2021 and 2020:
| Declare Date | Dividend Paid Per Share | Record Date | Payment Date | Dividend Paid (in thousands) | ||||||||||||||||||||||
| November 9, 2020 | $0.17 | November 30, 2020 | December 11, 2020 | $9,198 | ||||||||||||||||||||||
| November 11, 2019 | $0.15 | December 2, 2019 | December 13, 2019 | $8,190 | ||||||||||||||||||||||
Subsequent Event. On January 25, 2021, the Board of Directors declared a quarterly cash dividend of $0.17 per share payable on February 26, 2021 to stockholders of record as of the close of business on February 10, 2021.
8. Leases
In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842)”, which is a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of right-of-use (“ROU”) assets obtained in exchange for lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by lessees for those leases classified as operating leases. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.
We elected to adopt the standard, and available practical expedients, effective September 30, 2019 (the first day of our fiscal 2020). These practical expedients allowed us to keep the lease classification assessed under the previous lease accounting standard (ASC 840) without reassessment under the new standard, and allowed all separate lease components, including non-lease components, to be accounted for as a single lease component for all existing leases prior to adoption of the new standard.
We adopted this new standard under the modified retrospective transition approach without adjusting comparative periods in the financial statements, as allowed under Leases (Topic 842), and implemented internal controls and key system functionality to enable the preparation of financial information on adoption. The standard had a material impact on our consolidated balance sheets but did not have an impact on the consolidated income statements. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases, while accounting for finance leases remained substantially unchanged. Our finance leases are primarily for certain information technology equipment and the related ROU and lease liabilities were immaterial, and included in "Other current liabilities" and "Other long-term liabilities" accordingly on our consolidated balance sheets at December 27, 2020 and September 27, 2020.
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We determine if an arrangement is a lease at inception. Operating leases are included in operating lease ROU assets and current and long-term operating lease liabilities in the consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, incremental borrowing rates are used based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.
Our operating leases are primarily for corporate and project office spaces. To a much lesser extent, we have operating leases for vehicles and equipment. Our operating leases have remaining lease terms of one month to twelve years, some of which may include options to extend the leases for up to five years.
The components of lease costs are as follows:
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| (in thousands) | |||||||||||
| Operating lease cost | $ | 22,069 | $ | 21,172 | |||||||
| Sublease income | (29) | (574) | |||||||||
| Other | — | 18 | |||||||||
| Total lease cost | $ | 22,040 | $ | 20,616 | |||||||
Supplemental cash flow information related to leases is as follows:
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| (in thousands) | |||||||||||
| Operating cash flows for operating leases | $ | 18,800 | $ | 19,715 | |||||||
| Right-of-use assets obtained in exchange for new operating lease liabilities | $ | 10,293 | $ | 262,248 | |||||||
Supplemental balance sheet and other information related to leases are as follows:
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| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| Operating leases: | |||||||||||
| Right-of-use assets | $ | 225,787 | $ | 239,396 | |||||||
| Lease liabilities: | |||||||||||
| Current | 69,612 | 69,650 | |||||||||
| Long-term | 181,473 | 191,955 | |||||||||
| Total operating lease liabilities | $ | 251,085 | $ | 261,605 | |||||||
| Weighted-average remaining lease term: | |||||||||||
| Operating leases | 5 years | 5 years | |||||||||
| Weighted-average discount rate: | |||||||||||
| Operating leases | 2.5 | % | 2.5 | % | |||||||
As of December 27, 2020, we do not have any material additional operating leases that have not yet commenced.
A maturity analysis of the future undiscounted cash flows associated with our operating lease liabilities is as follows:
| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| 2021 | $ | 57,306 | $ | 75,074 | |||||||
| 2022 | 68,072 | 64,972 | |||||||||
| 2023 | 45,590 | 44,733 | |||||||||
| 2024 | 31,380 | 30,991 | |||||||||
| 2025 | 22,112 | 21,466 | |||||||||
| Beyond | 44,928 | 44,169 | |||||||||
| Total lease payments | 269,388 | 281,405 | |||||||||
| Less: imputed interest | (18,303) | (19,800) | |||||||||
| Total present value of lease liabilities | $ | 251,085 | $ | 261,605 | |||||||
9. Stockholders’ Equity and Stock Compensation Plans
We recognize the fair value of our stock-based awards as compensation expense on a straight-line basis over the requisite service period in which the award vests. Stock-based compensation expense for the first quarters of fiscal 2021 and 2020 was $4.9 million and $4.5 million, respectively. Most of these amounts were included in selling, general and administrative expenses on our consolidated statements of income. In the first quarter of fiscal 2021, we awarded 57,542 performance share units (“PSUs”) to our non-employee directors and executive officers at a fair value of $144.33 per share on the award date. All 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 50% on the growth in our diluted earnings per share and 50% on our relative total shareholder return over the vesting period. Additionally, we awarded 107,384 restricted stock units (“RSUs”) to our non-employee directors, executive officers and employees at a fair value of $121.00 per share on the award date. All executive officer and employee RSUs have time-based vesting over a four-year period, and the non-employee director RSUs vest after one year.
10. Earnings per Share (“EPS”)
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Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding, less unvested restricted stock for the period. Diluted EPS is computed by dividing net income by the weighted-average number of common shares outstanding and dilutive potential common shares for the period. Potential common shares include the weighted-average dilutive effects of outstanding stock options and unvested restricted stock using the treasury stock method.
The following table presents the number of weighted-average shares used to compute basic and diluted EPS:
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| (in thousands, except per share data) | |||||||||||
| Net income attributable to Tetra Tech | $ | 52,436 | $ | 47,310 | |||||||
| Weighted-average common shares outstanding – basic | 53,927 | 54,560 | |||||||||
| Effect of dilutive stock options and unvested restricted stock | 710 | 878 | |||||||||
| Weighted-average common shares outstanding – diluted | 54,637 | 55,438 | |||||||||
| Earnings per share attributable to Tetra Tech: | |||||||||||
| Basic | $ | 0.97 | $ | 0.87 | |||||||
| Diluted | $ | 0.96 | $ | 0.85 | |||||||
11. Income Taxes
The effective tax rates for the first quarters of fiscal 2021 and 2020 were 17.0% and 21.1%, respectively. Income tax expense was reduced by $6.1 million and $3.6 million of excess tax benefits on share-based payments in the first quarter of fiscal 2021 and 2020, respectively. Excluding the impact of the excess tax benefits on share-based payments, our effective tax rates in the first quarter of fiscal 2021 and 2020 were 26.8% and 27.1% respectively.
As of December 27, 2020 and September 27, 2020, the liability for income taxes associated with uncertain tax positions was $10.7 million and $9.7 million, respectively. These uncertain tax positions substantially relate to ongoing examinations, which are reasonably likely to be resolved within the next 12 months. These liabilities represent our current estimates of the additional tax liabilities that we may be assessed when the related audits are concluded. If these audits are resolved in a manner more unfavorable than our current expectations, our additional tax liabilities could be materially higher than the amounts currently recorded resulting in additional tax expense.
12. Reportable Segments
We manage our operations under two reportable segments. Our GSG reportable segment primarily includes activities with U.S. government clients (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. Substantially, there has been no remaining backlog for RCM since fiscal 2018 as the projects were complete.
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, sustainable 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 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, 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.
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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.
Reportable Segments
The following tables summarize financial information regarding our reportable segments:
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| (in thousands) | |||||||||||
| Revenue | |||||||||||
| GSG | $ | 468,623 | $ | 457,404 | |||||||
| CIG | 311,024 | 351,164 | |||||||||
| RCM | — | 145 | |||||||||
| Elimination of inter-segment revenue | (14,543) | (11,090) | |||||||||
| Total | $ | 765,104 | $ | 797,623 | |||||||
| Income from operations | |||||||||||
| GSG | $ | 47,700 | $ | 42,048 | |||||||
| CIG | 29,559 | 31,632 | |||||||||
| RCM | — | 1 | |||||||||
Corporate (1) | (11,007) | (10,379) | |||||||||
| Total | $ | 66,252 | $ | 63,302 | |||||||
(1) Includes amortization of intangibles, other costs and other income not allocable to our reportable segments.
| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| Total Assets | |||||||||||
| GSG | $ | 659,042 | $ | 649,417 | |||||||
| CIG | 481,545 | 479,238 | |||||||||
| RCM | 14,256 | 14,258 | |||||||||
Corporate (1) | 1,260,029 | 1,235,645 | |||||||||
| Total | $ | 2,414,872 | $ | 2,378,558 | |||||||
(1) Corporate assets consist of intercompany eliminations and assets not allocated to our reportable segments including goodwill, intangible assets, deferred income taxes and certain other assets.
13. Fair Value Measurements
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, as described in “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 27, 2020). The carrying value of our long-term debt approximated fair value at December 27, 2020 and September 27, 2020. At December 27, 2020, we had borrowings of $288.5 million outstanding under our Amended Credit Agreement, which were used to fund business acquisitions, working capital needs, stock repurchases, dividends, capital expenditures and contingent earn-outs.
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14. Derivative Financial Instruments
We often use certain interest rate derivative contracts to hedge interest rate exposures on our variable rate debt. Also, we may enter in foreign currency derivative contracts with financial institutions to reduce the risk that cash flows and earnings could adversely be 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 rate on the borrowings under our term loan facility. As of December 27, 2020, the notional principal of our outstanding interest swap agreements was $225.0 million ($45.0 million each.) The interest rate swaps have a fixed interest rate of 2.79% and expire in July 2023 for all five agreements. At December 27, 2020 and September 27, 2020, the fair value of the effective portion of our interest rate swap agreements designated as cash flow hedges before tax effect was $(14.0) million and $(15.5) million, which were reported in "Other current liabilities" on our consolidated balance sheets. Additionally, the related gains of $1.5 million and $1.7 million for the first quarters of fiscal 2021 and 2020, respectively, were recognized and reported on our consolidated statements of comprehensive income. We expect to reclassify $5.7 million from accumulated other comprehensive loss to interest expense within the next twelve months. There were no other derivative instruments designated as hedging instruments for the first quarter of fiscal 2021.
15. Reclassifications Out of Accumulated Other Comprehensive Income
The accumulated balances and activities for the first quarters of fiscal 2021 and 2020 related to reclassifications out of accumulated other comprehensive income are summarized as follows:
| Three Months Ended | |||||||||||||||||
| Foreign Currency Translation Adjustments | Gain (Loss) on Derivative Instruments | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Balances at September 29, 2019 | $ | (149,711) | $ | (10,873) | $ | (160,584) | |||||||||||
| Other comprehensive income before reclassifications | 13,899 | 2,153 | 16,052 | ||||||||||||||
| Amounts reclassified from accumulated other comprehensive income | |||||||||||||||||
Interest rate contracts, net of tax (1) | — | (483) | (483) | ||||||||||||||
| Net current-period other comprehensive income | 13,899 | 1,670 | 15,569 | ||||||||||||||
| Balances at December 29, 2019 | $ | (135,812) | $ | (9,203) | $ | (145,015) | |||||||||||
| Balances at September 27, 2020 | $ | (146,275) | $ | (15,511) | $ | (161,786) | |||||||||||
| Other comprehensive income before reclassifications | 32,391 | 2,978 | 35,369 | ||||||||||||||
| Amounts reclassified from accumulated other comprehensive income | |||||||||||||||||
Interest rate contracts, net of tax (1) | — | (1,502) | (1,502) | ||||||||||||||
| Net current-period other comprehensive income | 32,391 | 1,476 | 33,867 | ||||||||||||||
| Balances at December 27, 2020 | $ | (113,884) | $ | (14,035) | $ | (127,919) | |||||||||||
(1) This accumulated other comprehensive component is reclassified to “Interest expense” in our consolidated statements of income. See Note 14, “Derivative Financial Instruments”, for more information. | |||||||||||||||||
16. Commitments and Contingencies
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
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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 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.
17. Related Party Transactions
We often provide services to unconsolidated joint ventures. Revenue generated from the services we provided to unconsolidated joint ventures for the first quarters of fiscal 2021 and 2020 was approximately $22 million and $29 million, respectively. Related reimbursable costs for the first quarters of fiscal 2021 and 2020 were approximately the same as our revenue since these reimbursable costs are pass-through costs. Our consolidated balance sheets also included the following amounts related to these services:
| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| Accounts receivable, net | $ | 27,707 | $ | 20,884 | |||||||
| Contract assets | 4,589 | 3,261 | |||||||||
| Contract liabilities | 2,297 | 478 | |||||||||
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including 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 harbor provisions created under the Securities Act of 1933 and the Securities Exchange Act of 1934. 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 “Part II, Item 1A. 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.
GENERAL OVERVIEW
Tetra Tech, Inc. is a leading global provider of consulting and engineering services that focuses on water, environment, sustainable 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.
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 55 years. Today, we are proud to be making a difference in people’s lives worldwide through broad consulting, engineering, and technology service offerings. In fiscal 2020, we worked on over 65,000 projects, in more than 100 countries on seven continents, with a talent force of 20,000 associates. We are Leading with Science® throughout our operations, with domain experts across multiple disciplines supported by our advanced analytics, artificial intelligence, machine learning, and digital technology solutions. 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 talented workforce 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, we have helped to advance sustainable solutions for managing water, protecting the environment, providing energy, and engineering the infrastructure for our cities and communities.
We derive income from fees for professional, technical, program management, and construction management services. As primarily a professional services company, we are labor-intensive rather than capital-intensive. Our revenue is driven by our ability to attract and retain qualified and productive employees, identify business opportunities, secure new and renew existing client contracts, provide outstanding services to our clients and execute projects successfully. We provide services to a diverse base of U.S. state and local government, U.S. federal government, U.S. commercial, and international clients.
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The following table presents the percentage of our revenue by client sector:
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| Client Sector | |||||||||||
| U.S. state and local government | 16.3 | % | 15.5 | % | |||||||
U.S. federal government (1) | 34.8 | 30.8 | |||||||||
| U.S. commercial | 20.6 | 22.7 | |||||||||
International (2) | 28.3 | 31.0 | |||||||||
| Total | 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.
We manage 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. Additionally, 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. Substantially, there has been no remaining backlog for RCM since fiscal 2018 as the projects were complete.
Government Services Group (“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, sustainable 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.
Commercial/International Services Group (“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, 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.
The following table presents the percentage of our revenue by reportable segment:
| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| Reportable Segment | |||||||||||
| GSG | 61.2 | % | 57.3 | % | |||||||
| CIG | 40.7 | 44.0 | |||||||||
| Inter-segment elimination | (1.9) | (1.3) | |||||||||
| Total | 100.0 | % | 100.0 | % | |||||||
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:
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| Three Months Ended | |||||||||||
| December 27, 2020 | December 29, 2019 | ||||||||||
| Contract Type | |||||||||||
| Fixed-price | 35.9 | % | 34.0 | % | |||||||
| Time-and-materials | 46.4 | 48.7 | |||||||||
| Cost-plus | 17.7 | 17.3 | |||||||||
| Total | 100.0 | % | 100.0 | % | |||||||
Under fixed-price contracts, clients agree to pay a specified price for our performance of the entire contract or a specified portion of the contract. Under time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and paid for other expenses. Under 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. Profitability on these contracts is driven by billable headcount and our cost control. We recognize revenue from contracts using the cost-to-cost measure of progress method to estimate the progress towards completion to 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. On a quarterly basis, we review and assess our revenue and cost estimates for each significant contract. Changes in revenue and cost estimates could also result in a projected loss that would be recorded immediately in earnings.
Other contract costs include professional compensation and related benefits, together with certain direct and indirect overhead costs such as rents, utilities, and travel. Professional compensation represents a large portion of these costs. Our "Selling, general and administrative expenses" ("SG&A") are comprised primarily of marketing and bid and proposal costs, and our corporate headquarters’ costs related to the executive offices, finance, accounting, administration, and information technology. Our SG&A expenses also include a portion of stock-based compensation and depreciation of property and equipment related to our corporate headquarters, and the amortization of identifiable intangible assets. Most of these costs are unrelated to specific clients or projects, and can vary as expenses are incurred to support company-wide activities and initiatives.
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.
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. For detailed information regarding acquisitions, see Note 4, “Acquisitions” of the “Notes to Consolidated Financial Statements”.
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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.
OVERVIEW OF RESULTS AND BUSINESS TRENDS
General. As the coronavirus disease 2019 ("COVID-19") spread globally, we responded quickly to ensure the health and safety of our employees, clients and the communities we support. Our high-end consulting focus and the technologies we deployed have allowed our staff to support clients and projects remotely without interruption. We remain focused on providing clients with the highest level of service and our 450 global offices are operational, supporting our programs and projects. By Leading with Science®, we are responding to the challenges of COVID-19, with the commitment of our 20,000 staff supported by technological innovation. Our government business, which represents approximately 60% of our revenue, has been stable, while our commercial business experienced relatively more impact. Much of our commercial business has continued due to regulatory drivers, but we have seen project delays in the industrial sectors. Our diversified end-markets have allowed us to redeploy staff to areas of uninterrupted or increased demand, and we have made decisions to align our cost structures with our clients' projects. The actions we have taken to navigate through this worldwide pandemic, the strength of our balance sheet, and our technical leadership position us well to address the global challenges of providing clean water, environmental restoration, and the impacts of climate change.
In first quarter of fiscal 2021, our revenue decreased 4.1% compared to the prior-year period. Our revenue includes contributions from acquisitions that did not contribute to our revenue in the first quarter of fiscal 2020. Our year-over-year revenue comparisons were also impacted by the decision to dispose of our Canadian turn-key pipeline activities in the fourth quarter of fiscal 2019 and the subsequent wind-down of those activities in fiscal 2020, which included the disposal of related equipment.
U.S. State and Local Government. Our U.S. state and local government revenue increased 0.9% in the first quarter of fiscal 2021 compared to the same period last year. This comparison was impacted by a reduction in subcontractor activity. Our U.S. state and local revenue, net of subcontractor costs, increased 11.0% in the first quarter of fiscal 2021 compared to the first quarter of fiscal 2020. This increase reflects continued 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. Most of our work for U.S. state and local governments relates to critical water and environmental programs, which we expect to increase further next year. However, further budgetary constraints to our clients could negatively impact our business. Conversely, increased disaster response activity could cause our fiscal 2021 revenue to exceed our current expectations.
U.S. Federal Government. Our U.S. federal government revenue increased 8.4% in the first quarter of fiscal 2021 compared to the prior-year period. This increase includes the contributions from acquisitions completed in fiscal 2020. These contributions were partially offset by reduced international development activities as COVID-19 travel restrictions have caused some project delays. During periods of economic volatility, our U.S. federal government business has historically been the most stable and predictable. We expect our U.S. federal government revenue to grow modestly in fiscal 2021 due to continued increased federal advanced analytics activity. However, U.S. federal spending amounts and priorities could change significantly from our current expectations, which could have a significant positive or negative impact on our fiscal 2021 revenue.
U.S. Commercial. Our U.S. commercial revenue decreased 13.1% in the first quarter of fiscal 2021 compared to the same period last year. This decline was primarily due to reduced industrial activity as a result of the COVID-19 pandemic. We currently expect the adverse impact of the COVID-19 pandemic to our U.S. commercial revenue to continue to be more significant than to our U.S. government programs and projects throughout most of this fiscal year.
International. Our international revenue decreased 12.4% in the first quarter of fiscal 2021 compared to the prior-year period. Excluding the impact of the aforementioned prior-year disposal of our Canadian turn-key pipeline activities, our international revenue decreased 10.2% in the first quarter of fiscal 2021 compared to the same period last year. The revenue decline primarily reflects the adverse impact of the COVID-19 pandemic, partially offset by increased renewable energy activity in Canada. In light of the COVID-19 pandemic, we currently expect our overall international government work to be stable for fiscal 2021; however, our international commercial activities could have a significant adverse impact if the current economic conditions due to COVID-19 are prolonged.
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RESULTS OF OPERATIONS
Consolidated Results of Operations
| Three Months Ended | |||||||||||||||||||||||
| December 27, 2020 | December 29, 2019 | Change | |||||||||||||||||||||
| $ | % | ||||||||||||||||||||||
| ($ in thousands) | |||||||||||||||||||||||
| Revenue | $ | 765,104 | $ | 797,623 | $ | (32,519) | (4.1)% | ||||||||||||||||
| Subcontractor costs | (159,933) | (183,600) | 23,667 | 12.9 | |||||||||||||||||||
Revenue, net of subcontractor costs (1) | 605,171 | 614,023 | (8,852) | (1.4) | |||||||||||||||||||
| Other costs of revenue | (488,861) | (504,286) | 15,425 | 3.1 | |||||||||||||||||||
| Gross profit | 116,310 | 109,737 | 6,573 | 6.0 | |||||||||||||||||||
| Selling, general and administrative expenses | (50,058) | (46,435) | (3,623) | (7.8) | |||||||||||||||||||
| Income from operations | 66,252 | 63,302 | 2,950 | 4.7 | |||||||||||||||||||
| Interest expense | (3,026) | (3,349) | 323 | 9.6 | |||||||||||||||||||
| Income before income tax expense | 63,226 | 59,953 | 3,273 | 5.5 | |||||||||||||||||||
| Income tax expense | (10,778) | (12,636) | 1,858 | 14.7 | |||||||||||||||||||
| Net income | 52,448 | 47,317 | 5,131 | 10.8 | |||||||||||||||||||
| Net income attributable to noncontrolling interests | (12) | (7) | (5) | (71.4) | |||||||||||||||||||
| Net income attributable to Tetra Tech | $ | 52,436 | $ | 47,310 | $ | 5,126 | 10.8 | ||||||||||||||||
| Diluted earnings per share | $ | 0.96 | $ | 0.85 | $ | 0.11 | 12.9% | ||||||||||||||||
(1) We believe that the presentation of “Revenue, net of subcontractor costs”, which is a non-U.S. GAAP financial measure, enhances investors’ ability to analyze our business trends and performance because it substantially measures the work performed by our employees. While providing services, we routinely subcontract various services and, under certain U.S. Agency for International Development programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with U.S. GAAP and industry practice, are included in our revenue when it is our contractual responsibility to procure or manage these activities. The grants are included as part of our subcontractor costs. 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. | |||||||||||||||||||||||
In the first quarter of fiscal 2021, revenue and revenue, net of subcontractor costs, decreased $32.5 million, or 4.1%, and $8.9 million, or 1.4%, respectively, compared to the same period last year. Excluding the net contributions from the aforementioned acquisitions/disposal, our revenue decreased 7.5% in the first quarter of fiscal 2021 compared to the prior-year quarter. The decline was primarily due to the adverse impact of the COVID-19 pandemic, particularly on our U.S. and international commercial revenue.
The following table reconciles our reported results to non-U.S. GAAP adjusted results, which exclude the gains on non-core equipment disposals in the first quarter of fiscal 2020 related to the disposal of our Canadian turn-key pipeline activities. For the first quarter of fiscal 2020, the effective tax rate applied to the adjustment to earnings per share ("EPS") to arrive at adjusted EPS was 28.0%. We applied the relevant marginal statutory tax rate based on the nature of the adjustment and tax jurisdiction in which it occurred. 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.
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| Three Months Ended | |||||||||||||||||||||||
| December 27, 2020 | December 29, 2019 | Change | |||||||||||||||||||||
| $ | % | ||||||||||||||||||||||
| ($ in thousands) | |||||||||||||||||||||||
| Income from operations | $ | 66,252 | $ | 63,302 | $ | 2,950 | 4.7% | ||||||||||||||||
| RCM | — | (1) | 1 | NM | |||||||||||||||||||
| Non-core equipment disposal | — | (800) | 800 | NM | |||||||||||||||||||
Adjusted income from operations (1) | $ | 66,252 | $ | 62,501 | $ | 3,751 | 6.0% | ||||||||||||||||
| EPS | $ | 0.96 | $ | 0.85 | $ | 0.11 | 12.9% | ||||||||||||||||
| Non-core equipment disposal | — | (0.01) | 0.01 | NM | |||||||||||||||||||
Adjusted EPS (1) | $ | 0.96 | $ | 0.84 | $ | 0.12 | 14.3% | ||||||||||||||||
NM = not meaningful
(1) Non-GAAP financial measure
Our operating income increased $3.0 million in the first quarter of fiscal 2021 compared to the same period last year. Our GSG segment's operating income increased $5.7 million in the first quarter of fiscal 2021 compared to the first quarter of fiscal 2020. These results are described below under "Government Services Group." Our CIG segment's operating income decreased $2.1 million in the first quarter of fiscal 2021 compared to the year-ago quarter. These results are described below under "Commercial/International Services Group."
Our net interest expense was $3.0 million in the first quarter of fiscal 2021 compared to $3.3 million in the prior-year period. The decrease primarily reflects lower interest rates (primarily LIBOR).
The effective tax rates for the first quarters of fiscal 2021 and 2020 were 17.0% and 21.1%, respectively. Income tax expense was reduced by $6.1 million and $3.6 million of excess tax benefits on share-based payments in the first quarters of fiscal 2021 and 2020, respectively. Excluding the impact of the excess tax benefits on share-based payments, our effective tax rates for the first quarters of fiscal 2021 and 2020 were 26.8% and 27.1%, respectively.
Our EPS was $0.96 in the first quarter of fiscal 2021 compared to $0.85 in the year-ago quarter. On the same basis as our adjusted operating income, EPS was $0.96 in the first quarter of fiscal 2021 compared to $0.84 in the first quarter of fiscal 2020.
Segment Results of Operations
Government Services Group
| Three Months Ended | |||||||||||||||||||||||
| December 27, 2020 | December 29, 2019 | Change | |||||||||||||||||||||
| $ | % | ||||||||||||||||||||||
| ($ in thousands) | |||||||||||||||||||||||
| Revenue | $ | 468,623 | $ | 457,404 | $ | 11,219 | 2.5% | ||||||||||||||||
| Subcontractor costs | (123,705) | (127,697) | 3,992 | 3.1 | |||||||||||||||||||
| Revenue, net of subcontractor costs | $ | 344,918 | $ | 329,707 | $ | 15,211 | 4.6 | ||||||||||||||||
| Income from operations | $ | 47,700 | $ | 42,048 | $ | 5,652 | 13.4% | ||||||||||||||||
Revenue and revenue, net of subcontractor costs, increased $11.2 million, or 2.5%, and $15.2 million, or 4.6%, respectively, in the first quarter of fiscal 2021 compared to the year-ago quarter. These increases reflect higher U.S. state and
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local government activity for water and environmental programs and contributions from the aforementioned acquisitions. These increases were partially offset by lower international development revenue due to project delays caused by COVID-19. Operating income increased $5.7 million in the first quarter of fiscal 2021 compared to the year-ago quarter, reflecting the higher revenue and an improved operating margin. Our operating margin, based on revenue, net of subcontractor costs, improved to 13.8% in the first quarter of fiscal 2021 compared to 12.8% in the same period last year primarily due to improved labor utilization.
Commercial/International Services Group
| Three Months Ended | |||||||||||||||||||||||
| December 27, 2020 | December 29, 2019 | Change | |||||||||||||||||||||
| $ | % | ||||||||||||||||||||||
| ($ in thousands) | |||||||||||||||||||||||
| Revenue | $ | 311,024 | $ | 351,164 | $ | (40,140) | (11.4)% | ||||||||||||||||
| Subcontractor costs | (50,771) | (66,885) | 16,114 | 24.1 | |||||||||||||||||||
| Revenue, net of subcontractor costs | $ | 260,253 | $ | 284,279 | $ | (24,026) | (8.5) | ||||||||||||||||
| Income from operations | $ | 29,559 | $ | 31,632 | $ | (2,073) | (6.6)% | ||||||||||||||||
Revenue and revenue, net of subcontractor costs, decreased $40.1 million, or 11.4%, and $24.0 million, or 8.5%, respectively, in the first quarter of fiscal 2021 compared to the year-ago quarter. Excluding the impact of the disposal of our Canadian turn-key pipeline activities, revenue and revenue, net of subcontractor costs, decreased 9.9% and 6.5%, respectively, in the first quarter of fiscal 2021 compared to the prior-year quarter. The declines primarily reflect the adverse impact of the COVID-19 pandemic. Operating income decreased $2.1 million in the first quarter of fiscal 2021 compared to the same period last year, reflecting the lower revenue partially offset by an improved operating margin. Additionally, operating income in the first quarter of fiscal 2020 included gains of $0.8 million from the disposition of non-core equipment. Our operating margin, based on revenue, net of subcontractor costs, improved to 11.4% in the first quarter of fiscal 2021 compared to 11.1% (10.8% adjusted for the non-core gain) in the same period last year. This improvement was primarily due to our increased focus on high-end consulting services.
Remediation and Construction Management
RCM's projects were substantially complete at the end of fiscal 2018. There were no significant activities in RCM for the first quarters of fiscal 2021 and 2020.
Backlog
The following table provides a reconciliation between remaining unsatisfied performance obligations ("RUPOs") and backlog:
| Balance at | |||||||||||
| December 27, 2020 | September 27, 2020 | ||||||||||
| (in thousands) | |||||||||||
| RUPOs | $ | 3,164,153 | $ | 3,218,973 | |||||||
| Items impacting comparability: | |||||||||||
| Contract term | 23,908 | 20,312 | |||||||||
| Backlog | $ | 3,188,061 | $3,239,285 | ||||||||
Backlog generally represents the dollar amount of revenues we expect to realize in the future when we perform the work. The 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
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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).
Financial Condition, Liquidity and Capital Resources
Capital Requirements. As of December 27, 2020, we had $163.4 million of cash and cash equivalents and access to an additional $686 million of borrowings available under our credit facility. During the first quarter of fiscal 2021, we generated $33.2 million of cash from operations. To date, we have not experienced any significant deterioration in our financial condition or liquidity due to the COVID-19 pandemic and our credit facilities remain available.
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 including any additional resources needed to address the COVID-19 pandemic.
We use a variety of tax planning and financing strategies to manage our worldwide cash and deploy funds to locations where they are needed. We have no need or plans to repatriate foreign earnings at this time.
On January 27, 2020, the Board of Directors authorized a new $200 million stock repurchase program, which was included in our remaining balance of $207.8 million as of fiscal 2020 year-end. In the first quarter of fiscal 2021, we repurchased and settled 135,413 shares with an average price of $110.77 per share for a total cost of $15 million in the open market. At December 27, 2020, we had a remaining balance of $192.8 million under our stock repurchase program.
On November 9, 2020, the Board of Directors declared a quarterly cash dividend of $0.17 per share payable on December 11, 2020 to stockholders of record as of the close of business on November 30, 2020.
Subsequent Event. On January 25, 2021, the Board of Directors declared a quarterly cash dividend of $0.17 per share payable on February 26, 2021 to stockholders of record as of the close of business on February 10, 2021.
Cash Equivalents and Restricted Cash. As of December 27, 2020, cash equivalents and restricted cash were $163.4 million, an increase of $5.9 million compared to the fiscal 2020 year-end. The increase was due to net cash provided by operating activities, net proceeds from borrowings, stock options exercised and the effect of exchange rate changes on cash, partially offset by stock repurchases, taxes paid on vested restricted stock, dividends and contingent earn-out payments.
Operating Activities. For the first quarter of fiscal 2021, net cash provided by operating activities was $33.2 million, an increase of $51.2 million compared to the prior-year quarter. The increase was primarily due to strong collections on our accounts receivable.
Investing Activities. For the first quarter of fiscal 2021, net cash used in investing activities was $1.8 million, a decrease of $1.1 million compared to the year-ago quarter, due to reduced capital expenditures compared to the same quarter last year.
Financing Activities. For the first quarter of fiscal 2021, net cash used in financing activities was $32.8 million, compared to net cash provided by financing activities of $8.8 million in the prior-year quarter. The change was primarily due to a reduced net borrowing.
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.
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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.
As of December 27, 2020, we had $288.5 million in outstanding borrowings under the Amended Credit Agreement, which was comprised of $225.0 million under the Term Loan Facility and $63.5 million outstanding under the Amended Revolving Credit Facility at a year-to-date weighted-average interest rate of 1.34% 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 three months ended December 27, 2020 under the Amended Credit Agreement, including the effects of interest rate swap agreements described in Note 14, “Derivative Financial Instruments” of the “Notes to Consolidated Financial Statements”, was 3.28%. At December 27, 2020, we had $386.3 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 December 27, 2020, we were in compliance with these covenants with a consolidated leverage ratio of 1.18x and a consolidated interest coverage ratio of 20.51x.
In addition to the Amended Credit Agreement, we maintain other credit facilities, which may be used for bank overdrafts, short-term cash advances and bank guarantees. At December 27, 2020, there were no borrowings outstanding under these facilities and the aggregate amount of standby letters of credit outstanding was $69.3 million. As of December 27, 2020, we had bank overdrafts of $13.5 million related to our U.S. disbursement bank accounts. This balance is reported in the "Current portion of long-term debt and other short-term borrowings" on our consolidated balance sheet as of December 27, 2020. The change in bank overdraft balance is classified as cash flows from financing activities on our consolidated statements of cash flows as we believe these overdrafts to be a form of short-term financing from the bank due to our ability to fund the overdraft with the overdraft protection on the bank accounts or our other credit facilities if needed.
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 in fiscal 2021:
| Dividend Per Share | Record Date | Total Maximum Payment (in thousands) | Payment Date | ||||||||||||||||||||
| November 9, 2020 | $ | 0.17 | November 30, 2020 | $ | 9,198 | December 11, 2020 | |||||||||||||||||
| January 25, 2021 | $ | 0.17 | February 10, 2021 | N/A | February 26, 2021 | ||||||||||||||||||
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, particularly in the United Kingdom where we have a valuation allowance of approximately $12.5 million primarily related to the realizability of net operating loss carry-forwards.
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As of December 27, 2020 and September 27, 2020, the liability for income taxes associated with uncertain tax positions was $10.7 million and $9.7 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 liabilities represent our current estimates of the additional tax liabilities that we may be assessed when the related audits are concluded. If these audits are resolved in a manner more unfavorable than our current expectations, our additional tax liabilities could be materially higher than the amounts currently recorded resulting in additional tax expense.
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 December 27, 2020, we had $0.7 million in standby letters of credit outstanding under our Amended Credit Agreement and $69.3 million in standby letters of credit outstanding under our additional letter of credit facilities.
•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 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
Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the fiscal year ended September 27, 2020. To date, there have been no material changes in our critical accounting policies as reported in our 2020 Annual Report on Form 10-K.
New Accounting Pronouncements
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For information regarding recent accounting pronouncements, see “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Quarterly Report.
Financial Market Risks
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 December 27, 2020, we had borrowings outstanding under the Credit Agreement of $288.5 million at a year-to-date weighted-average interest rate of 1.34% 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 December 27, 2020, the notional principal of our outstanding interest swap agreements was $225.0 million ($45.0 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 December 27, 2020, was 3.28%. For more information, see Note 14, “Derivative Financial Instruments” of the “Notes to Consolidated Financial Statements”.
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 in the same currency for our contracts. For the first quarters of fiscal 2021 and 2020, we reported $1.3 million and $0.5 million of foreign currency losses, respectively, in “Selling, general and administrative expenses” on 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 the first quarters of fiscal 2021 and 2020, 28.3% and 31.0% of our consolidated revenue, respectively, was generated by our international business. The effect of foreign exchange rate translation on the consolidated balance sheets was an increase in our equity by $32.4 million and $13.9 million for the first quarters of fiscal 2021 and 2020, respectively. These amounts were recognized as adjustments to equity through other comprehensive income.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Please refer to the information we have included under the heading “Financial Market Risks” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 2 of this Form 10-Q which is incorporated herein by reference.
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Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures and changes in internal control over financial reporting. As of December 27, 2020, 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 Rule 13a-15(e) and 15d-15(e) under the Exchange Act), were effective.
Changes in internal control over financial reporting. There were no other changes in our internal control over financial reporting that occurred during the first quarter of fiscal 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For information regarding legal proceedings, see Note 16, "Commitments and Contingencies" included in the "Notes to Consolidated Financial Statements" included in Part I, Item 1 of this Form 10-Q which is incorporated herein by reference.
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Item 1A. Risk Factors
There have been no material changes in our risk factors disclosed in Part I, Item 1A in our 2020 Annual Report on Form 10-K. For updated disclosures related to interest and exchange rate risks, see “Financial Market Risks” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 2 of this Form 10-Q which is incorporated herein by reference.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On January 27, 2020, the Board of Directors authorized a new $200 million stock repurchase program, which was included in our remaining balance of $207.8 million as of fiscal 2020 year-end. In the first quarter of fiscal 2021, we repurchased and settled 135,413 shares with an average price of $110.77 per share for a total cost of $15 million in the open market. At December 27, 2020, we had a remaining balance of $192.8 million under our stock repurchase program.
Below is a summary of the stock repurchases that were traded and settled during the first quarter of fiscal 2021:
| 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) | ||||||||||||||||||||||
| September 28, 2020 – October 25, 2020 | 45,574 | $ | 102.67 | 45,574 | $ | 203,134 | ||||||||||||||||||||
| October 26, 2020 – November 22, 2020 | 46,975 | 110.67 | 46,975 | 197,935 | ||||||||||||||||||||||
| November 23, 2020 – December 27, 2020 | 42,864 | 119.50 | 42,864 | 192,813 | ||||||||||||||||||||||
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 Mine Safety and Health Administration. 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.
Item 6. Exhibits
The following documents are filed as Exhibits to this Report:
| 101 | The following financial information from our Company’s Quarterly Report on Form 10-Q, for the period ended December 27, 2020, formatted in Inline eXtensible Business Reporting Language: (i) Consolidated Balance Sheets (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements. | ||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Dated: January 29, 2021 | TETRA TECH, INC. | ||||||||||
| By: | /s/ DAN L. BATRACK | ||||||||||
| Dan L. Batrack | |||||||||||
| Chairman and Chief Executive Officer | |||||||||||
| (Principal Executive Officer) | |||||||||||
| By: | /s/ STEVEN M. BURDICK | ||||||||||
| Steven M. Burdick | |||||||||||
| Executive Vice President, Chief Financial Officer | |||||||||||
| (Principal Financial Officer) | |||||||||||
| By: | /s/ BRIAN N. CARTER | ||||||||||
| Brian N. Carter | |||||||||||
| Senior Vice President, Corporate Controller | |||||||||||
| (Principal Accounting Officer) | |||||||||||
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