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 October 3, 2021.
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.
Beginning in fiscal 2022, we aligned our operations to better serve our clients and markets, and created a new High Performance Buildings ("HPB") division in our Commercial/International Services Group ("CIG") reportable segment. As a result, we transferred some related operations in our Government Services Group ("GSG") reportable segment to our CIG reportable segment. Prior year amounts for reportable segments have been reclassified to conform to the current year presentation.
2. Recent Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2019-12, which simplifies the accounting for income taxes by removing certain exceptions to general principles in Topic 740 and amending certain existing guidance for clarity. We adopted this guidance in the first quarter of fiscal 2022, and the adoption did not have an 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. We adopted this guidance in the first quarter of fiscal 2022, and the adoption did not have an impact on our consolidated financial statements.
In October 2021, the FASB issued ASU 2021-08, which requires the recognition and measurement of contract assets and contract liabilities acquired in a business combination in accordance with Accounting Standards Codification Topic 606, "Revenue from Contracts with Customers" ("ASC 606"). Considerations to determine the amount of contract assets and contract liabilities to record at the acquisition date include the terms of the acquired contract, such as timing of payment, identification of each performance obligation in the contract and allocation of the contract transaction price to each identified performance obligation on a relative standalone selling price basis as of contract inception. ASU 2021-08 is effective for us beginning in the first quarter of fiscal 2023. ASU 2021-08 should be applied prospectively for acquisitions occurring on or after the effective date of the amendments. Early adoption of the proposed amendments would be permitted, including adoption in an interim period. We are currently assessing the impact this standard will have on our consolidated financial statements.
In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832), which requires disclosures for transactions with a government authority that are accounted for by applying a grant or contribution model by analogy, including (1) the types of transactions, (2) the accounting for those transactions, and (3) the effect of those transactions on an entity's financial statements. ASU 2021-10 is effective for us beginning in the first quarter of fiscal 2023, with early adoption permitted. This guidance should be applied prospectively to all transactions that are reflected in the financial statements at the date of initial application and to new transactions that are entered into after that date, or retrospectively. 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:
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | April 3,
2022 | | March 28,
2021 | | April 3,
2022 | | March 28,
2021 |
| | (in thousands) |
| Client Sector: | | | | | | | |
| U.S. state and local government | $ | 156,032 | | | $ | 129,781 | | | $ | 315,040 | | | $ | 254,747 | |
U.S. federal government (1) | 253,272 | | | 267,696 | | | 520,069 | | | 533,561 | |
| U.S. commercial | 171,741 | | | 143,702 | | | 348,646 | | | 301,508 | |
International (2) | 271,699 | | | 213,585 | | | 527,500 | | | 430,052 | |
| Total | $ | 852,744 | | | $ | 754,764 | | | $ | 1,711,255 | | | $ | 1,519,868 | |
| | | | | | | |
| Contract Type: | | | | | | | |
| Fixed-price | $ | 316,304 | | | $ | 272,118 | | | $ | 647,552 | | | $ | 546,551 | |
| Time-and-materials | 408,051 | | | 347,197 | | | 803,700 | | | 702,438 | |
| Cost-plus | 128,389 | | | 135,449 | | | 260,003 | | | 270,879 | |
| Total | $ | 852,744 | | | $ | 754,764 | | | $ | 1,711,255 | | | $ | 1,519,868 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
(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 and six months ended April 3, 2022 and March 28, 2021.
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 |
| April 3,
2022 | | October 3, 2021 |
| (in thousands) |
Contract assets (1) | $ | 114,958 | | | $ | 103,784 | |
| Contract liabilities | (224,978) | | | (190,403) | |
| Net contract liabilities | $ | (110,020) | | | $ | (86,619) | |
| | | |
(1) Includes $18.8 million and $12.2 million of contract retentions as of April 3, 2022 and October 3, 2021, respectively.
In the first halves of fiscal 2022 and 2021, we recognized revenue of approximately $93 million and $90 million, respectively, from amounts included in the contract liability balances at the end of fiscal 2021 and 2020, respectively.
We recognize revenue primarily using the cost-to-cost measure of progress to estimate 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. As a result, we recognized net favorable revenue and operating income adjustments of $5.0 million in the first half of fiscal 2022 and $1.1 million in the first half of fiscal 2021.
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 April 3, 2022 and October 3, 2021, our consolidated balance sheets included liabilities for anticipated losses of $11.6 million and $12.7 million, respectively. The estimated cost to complete these related contracts as of April 3, 2022 and October 3, 2021 was approximately $88 million and $104 million, respectively.
Accounts Receivable, Net
Net accounts receivable consisted of the following:
| | | | | | | | | | | |
| Balance at |
| | April 3,
2022 | | October 3,
2021 |
| (in thousands) |
| Billed | $ | 420,094 | | | $ | 432,814 | |
| Unbilled | 251,679 | | | 240,536 | |
| Total accounts receivable | 671,773 | | | 673,350 | |
| Allowance for doubtful accounts | (4,648) | | | (4,352) | |
| Total accounts receivable, net | $ | 667,125 | | | $ | 668,998 | |
| | | |
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. Substantially all of our unbilled receivables at April 3, 2022 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 April 3, 2022 and October 3, 2021 included approximately $11 million for each period, related to claims, including requests for equitable adjustment, on contracts that provide for price redetermination. This amount relates to a single claim in our RCM reportable segment. In May 2022, we received a cash settlement for the $11 million claim in our RCM segment, which will result in an immaterial gain in the third quarter of fiscal 2022. 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 revenue when it is probable that the claim will result in a different contract value than the amount previously estimated. In the first halves of fiscal 2022 and fiscal 2021, we recorded no gains or losses related to claims.
Other than the U.S. federal government, no single client accounted for more than 10% of our accounts receivable at April 3, 2022 and October 3, 2021.
Remaining Unsatisfied Performance Obligations (“RUPO”)
Our RUPO represents a measure of the total dollar value of work to be performed on contracts awarded and in progress. We had $3.6 billion of RUPO as of April 3, 2022. RUPO increases with awards from new contracts or additions on existing contracts and decreases as work is performed and revenue is recognized on existing contracts. RUPO may also decrease when projects are canceled or modified in scope. We include a contract within our RUPO when the contract is awarded and an agreement on contract terms has been reached.
We expect to satisfy our RUPO as of April 3, 2022 over the following periods:
| | | | | |
| Amount |
| (in thousands) |
| Within 12 months | $ | 2,171,878 | |
| Beyond | 1,418,218 | |
| Total | $ | 3,590,096 | |
Although RUPO reflects business that is considered to be firm, cancellations, deferrals or scope adjustments may occur. RUPO is 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 2022, we acquired Piteau Associates (“PAE”), based in Vancouver, British Columbia. PAE is a global leader in sustainable natural resource analytics including hydrologic numerical modeling and dewatering system design. PAE is part of our Commercial/International Services Group (“CIG”) segment. During the first half of fiscal 2022, we completed other immaterial acquisitions, which are part of our GSG segment. The total fair value of the purchase price of all acquisitions during the first half of fiscal 2022 was $70.0 million. This amount is comprised of $44.0 million in initial cash payments made to the sellers, $1.8 million of payables related to estimated post-closing adjustments for net assets acquired, and $24.2 million for the estimated fair value of contingent earn-out obligations, with a maximum of $35.5 million, based upon the achievement of specified operating income targets in each of the five years following the acquisitions.
In fiscal 2021, we acquired Coanda Research and Development Corporation ("CRD"), The Kaizen Company (“KZN”), IBRA-RMAC Automation Solutions (“IRM”), and the partnership interests of Hoare Lea, LLP and Subsidiaries ("HLE"). CRD is based in Burnaby, British Columbia and provides world-class expertise in computational fluid dynamics and utilizes industry-leading capabilities to solve complex engineering science problems for commercial customers, across a broad range of industries. KZN is based in Washington, DC and provides international development advisory and management consulting services offering a suite of innovative tools that support advanced solutions in health, education, governance, peace and stability, and sustainable economic growth. IRM is based in San Diego, California, and provides digital water transformation consulting services and an innovative suite of tools to address complex water system modernization challenges. HLE is a leader in sustainable engineering design based in Bristol, United Kingdom. It was established in 1862 and is an award-winning high-end consultancy firm in the United Kingdom, with more than 900 employees, providing innovative solutions to complex engineering and design challenges for sustainable infrastructure and high performance buildings. CRD and HLE are part of our CIG segment, and KZN and IRM are part of our GSG segment. The total fair value of the purchase price for these acquisitions was $151.7 million. This amount was comprised of $101.4 million in initial cash payments made to the sellers, and $50.3 million for the estimated fair value of contingent earn-out obligations, with a maximum of $74.0 million, based upon the achievement of specified operating income targets in each of the three to four years following the acquisitions.
Goodwill additions resulting from fiscal 2022 business combinations are primarily attributable to the significant technical expertise residing in embedded workforces that are sought out by clients, long-term management experience, the reputation of PAE in its industry, and the synergies expected to arise after the acquisitions in the areas of data management, digitization, modeling, water, and natural resources. The fiscal 2021 goodwill additions represent the significant technical expertise residing in embedded workforces that are sought out by clients and the long-standing reputation of HLE. 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, individually or in the aggregate, 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 one to ten years, and trade names with lives ranging from three 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” 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 three to five years), and the probability outcome percentages we assign to each scenario. Significant increases or decreases to either of these inputs in isolation would result in a significantly higher or lower liability, with a higher liability capped by the contractual maximum of the contingent earn-out obligation. Ultimately, the liability will be equivalent to the amount paid, and the difference between the fair value estimate and amount paid will be recorded in earnings. The amount paid that is less than or equal to the contingent earn-out liability on the acquisition date is reflected as cash used in financing activities in our consolidated statements of cash flows. Any amount paid in excess of the contingent earn-out liability on the acquisition date is reflected as cash used in operating activities in our consolidated statements of cash flows.
We review and re-assess the estimated fair value of contingent consideration on a quarterly basis, and the updated fair value could differ materially from the initial estimates. Changes in the estimated fair value of our contingent earn-out liabilities related to the time component of the present value calculation are reported in interest expense. Adjustments to the estimated fair value related to changes in all other unobservable inputs are reported in operating income. In the first half of fiscal 2022, we evaluated our estimates for contingent consideration liabilities for the remaining earn-out periods for each individual acquisition, which included a review of their financial results to-date, the status of ongoing projects in their RUPO, and the inventory of prospective new contract awards. In addition, we 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. During the first halves of fiscal 2022 and 2021, the total adjustments to our contingent earn-out liabilities in operating income were immaterial.
At April 3, 2022, there was a total potential maximum of $139.6 million of outstanding contingent consideration related to acquisitions. Of this amount, $79.1 million was estimated as the fair value and accrued on our consolidated balance sheet.
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 October 3, 2021 | | $ | 538,433 | | | $ | 570,145 | | | $ | 1,108,578 | |
| Goodwill reallocation | | (51,497) | | | 51,497 | | | — | |
| Acquisition activity | | 23,024 | | | 26,553 | | | 49,577 | |
| | | | | | |
| Translation and adjustments | | 443 | | | 25 | | | 468 | |
| Balance at April 3, 2022 | | $ | 510,403 | | | $ | 648,220 | | | $ | 1,158,623 | |
| | | | | | |
| | | | | | |
Our goodwill balances reflect the goodwill reallocation related to the creation of our new HPB division on the first day of fiscal 2022, which included a transfer of some related operations in our GSG reportable segment to our CIG reportable segment. The foreign currency translation adjustments resulted from 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 $528.1 million and $556.1 million at April 3, 2022 and October 3, 2021, respectively, excluding accumulated impairment of $17.7 million at each date. The gross amounts of goodwill for CIG were $769.7 million and $691.6 million at April 3, 2022 and October 3, 2021, respectively, excluding accumulated impairment of $121.5 million at each date.
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. Our most recent annual review at June 28, 2021 (i.e. the first day of our fourth quarter in fiscal 2021) 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. As of June 28, 2021, and after the reallocation of goodwill on the first day of fiscal 2022, we had no reporting units that had estimated fair values that exceeded their carrying values by less than 150%.
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.
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:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Period Ended |
| | April 3, 2022 | | October 3, 2021 |
| | Weighted-
Average
Remaining Life
(in Years) | | Gross
Amount | | Accumulated
Amortization | | Net Amount | | Gross
Amount | | Accumulated
Amortization | | Net Amount |
| | ($ in thousands) | | |
| Client relations | 5.9 | | $ | 46,519 | | | $ | (20,069) | | | $ | 26,450 | | | $ | 69,455 | | | $ | (43,984) | | | $ | 25,471 | |
| Backlog | 1.0 | | 35,742 | | | (30,024) | | | 5,718 | | | 34,577 | | | (30,670) | | | 3,907 | |
| Technology and trade names | 4.1 | | 14,904 | | | (7,592) | | | 7,312 | | | 14,939 | | | (6,327) | | | 8,612 | |
| Total | | | $ | 97,165 | | | $ | (57,685) | | | $ | 39,480 | | | $ | 118,971 | | | $ | (80,981) | | | $ | 37,990 | |
Amortization expense for the three and six months ended April 3, 2022 was $3.2 million and $5.9 million, respectively, compared to $2.2 million and $5.6 million for the prior-year periods. Estimated amortization expense for the remainder of fiscal 2022 and succeeding years is as follows: | | | | | |
| | Amount |
| | (in thousands) |
| 2022 | $ | 7,042 | |
| 2023 | 10,003 | |
| 2024 | 5,937 | |
| 2025 | 5,104 | |
| 2026 | 4,194 | |
| Beyond | 7,200 | |
| Total | $ | 39,480 | |
| |
6. Property and Equipment
Property and equipment consisted of the following:
| | | | | | | | | | | |
| Balance at |
| | April 3,
2022 | | October 3,
2021 |
| | (in thousands) |
| Equipment, furniture and fixtures | $ | 100,574 | | | $ | 94,780 | |
| Leasehold improvements | 36,769 | | | 36,462 | |
| Total property and equipment | 137,343 | | | 131,242 | |
| Accumulated depreciation | (100,628) | | | (93,509) | |
| Property and equipment, net | $ | 36,715 | | | $ | 37,733 | |
| | | |
The depreciation expense related to property and equipment was $3.3 million and $6.7 million for the three and six months ended April 3, 2022, compared to $3.1 million and $5.9 million for the prior-year periods.
7. Stock Repurchase and Dividends
On October 5, 2021, the Board of Directors authorized a new stock repurchase program under which we could repurchase up to $400 million of our common stock in addition to the $147.8 million remaining under the previous stock repurchase program at October 3, 2021. In the first half of fiscal 2022, we repurchased and settled 618,236 shares with an average price of $161.75 per share for a total cost of $100.0 million in the open market. At April 3, 2022, we had a remaining balance of $447.8 million under our stock repurchase program.
The following table presents dividends declared and paid in the first halves of fiscal 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Declare Date | | Dividend Paid Per Share | | Record Date | | Payment Date | | Dividend Paid
(in thousands) |
| November 15, 2021 | | $ | 0.20 | | | December 2, 2021 | | December 20, 2021 | | $ | 10,793 | |
| January 31, 2022 | | $ | 0.20 | | | February 11, 2022 | | February 25, 2022 | | 10,769 | |
| | | | | | | | |
| Total dividend paid as of April 3, 2022 | | | | $ | 21,562 | |
| | | | | | | | |
| November 9, 2020 | | $ | 0.17 | | | November 30, 2020 | | December 11, 2020 | | $ | 9,198 | |
| January 25, 2021 | | $ | 0.17 | | | February 10, 2021 | | February 26, 2021 | | 9,212 | |
| | | | | | | | |
| Total dividend paid as of March 28, 2021 | | $ | 18,410 | |
Subsequent Event. On May 2, 2022 the Board of Directors declared a quarterly cash dividend of $0.23 per share payable on May 27, 2022 to stockholders of record as of the close of business on May 13, 2022.
8. Leases
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.
We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use ("ROU") assets and current and long-term operating lease liabilities in the consolidated balance sheets. Our finance leases are primarily for certain information technology equipment. The related ROU assets and lease liabilities were immaterial, and are included in "Property and equipment, net", "Other current liabilities" and "Other long-term liabilities", accordingly, in the consolidated balance sheets at April 3, 2022 and October 3, 2021.
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 at the commencement date also includes any lease payments made to the lessor at or before the commencement date and initial direct costs less lease incentives received. 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.
The components of lease costs are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| April 3,
2022 | | March 28,
2021 | | April 3,
2022 | | March 28,
2021 |
| (in thousands) |
| Operating lease cost | $ | 21,260 | | | $ | 22,640 | | | $ | 43,011 | | | $ | 44,709 | |
| Sublease income | (131) | | | (30) | | | (257) | | | (59) | |
| | | | | | | |
| Total lease cost | $ | 21,129 | | | $ | 22,610 | | | $ | 42,754 | | | $ | 44,650 | |
Supplemental cash flow information related to leases is as follows:
| | | | | | | | | | | | | | |
| | Six Months Ended |
| | April 3,
2022 | | March 28,
2021 |
| (in thousands |
| Operating cash flows for operating leases | | $ | 34,531 | | | $ | 36,399 | |
| Right-of-use assets obtained in exchange for new operating lease liabilities | | $ | 24,875 | | | $ | 33,722 | |
Supplemental balance sheet and other information related to leases are as follows:
| | | | | | | | | | | |
| Balance at |
| April 3, 2022 | | October 3, 2021 |
| (in thousands) |
| Operating leases: | | | |
| Right-of-use assets | $ | 205,087 | | | $ | 215,422 | |
| | | |
| Lease liabilities: | | | |
| Current | 64,789 | | | 67,452 | |
| Long-term | 165,630 | | | 174,285 | |
| Total operating lease liabilities | $ | 230,419 | | | $ | 241,737 | |
| | | |
| Weighted-average remaining lease term: | | | |
| Operating leases | 5 years | | 5 years |
| Weighted-average discount rate: | | | |
| Operating leases | 2.1 | % | | 2.2 | % |
As of April 3, 2022, 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 at April 3, 2022 is as follows:
| | | | | |
| Amount |
| (in thousands) |
| 2022 | $ | 37,021 | |
| 2023 | 60,022 | |
| 2024 | 44,794 | |
| 2025 | 32,918 | |
| 2026 | 22,117 | |
| Beyond | 47,644 | |
| Total lease payments | 244,516 | |
| Less: imputed interest | (14,097) | |
| Total present value of lease liabilities | $ | 230,419 | |
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 three and six months ended April 3, 2022 was $6.6 million and $12.4 million, respectively, compared to $5.7 million and $10.6 million for the same periods last year. Most of these amounts were included in selling, general and administrative expenses on our consolidated statements of income. In the first half of fiscal 2022, we awarded 41,199 performance share units (“PSUs”) to our non-employee directors and executive officers at a fair value of $247.47 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 73,729 restricted stock units (“RSUs”) to our non-employee directors, executive officers and employees at a fair value of $186.91 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”)
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 | | Six Months Ended |
| | April 3,
2022 | | March 28,
2021 | | April 3,
2022 | | March 28,
2021 |
| | (in thousands, except per share data) |
| Net income attributable to Tetra Tech | $ | 53,040 | | | $ | 45,517 | | | $ | 121,529 | | | $ | 97,953 | |
| | | | | | | |
| Weighted-average common shares outstanding – basic | 53,834 | | | 54,187 | | | 53,916 | | | 54,085 | |
| Effect of dilutive stock options and unvested restricted stock | 512 | | | 549 | | | 576 | | | 630 | |
| Weighted-average common shares outstanding – diluted | 54,346 | | | 54,736 | | | 54,492 | | | 54,715 | |
| | | | | | | |
| Earnings per share attributable to Tetra Tech: | | | | | | | |
| Basic | $ | 0.99 | | | $ | 0.84 | | | $ | 2.25 | | | $ | 1.81 | |
| Diluted | $ | 0.98 | | | $ | 0.83 | | | $ | 2.23 | | | $ | 1.79 | |
11. Income Taxes
The effective tax rates for the first halves of fiscal 2022 and 2021 were 21.9% and 19.2%, respectively. Income tax expense was reduced by $4.8 million and $8.0 million of excess tax benefits on share-based payments in the first halves of fiscal 2022 and 2021, respectively. Excluding the impact of the excess tax benefits on share-based payments, our effective tax rates in the first halves of fiscal 2022 and 2021 were 25.0% and 25.8%, respectively.
As of April 3, 2022 and October 3, 2021, the liability for income taxes associated with uncertain tax positions was $13.9 million and $14.1 million, respectively. These uncertain tax positions substantially relate to ongoing examinations. It is reasonably possible that these liabilities may decrease within the next 12 months as certain examinations are resolved. 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.
On December 28, 2021, the U.S. Department of the Treasury and the Internal Revenue Service released final regulations addressing aspects of the foreign tax credit regime, and represent the third and final regulations that have been issued with respect to the core provisions of the U.S. foreign tax credit regime following the 2017 Tax Cut and Jobs Act. These regulations were primarily effective on March 7, 2022, with certain provisions applicable to prior periods. We do not expect these new regulations to materially impact our consolidated financial statements.
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. There has been no remaining backlog for RCM since fiscal 2018 as the projects were complete.
GSG provides high-end 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 high-end 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, clean energy, industrial, high performance buildings, and aerospace markets. CIG also provides sustainable 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.
At the beginning of fiscal 2022, we aligned our operations to better serve our clients and markets, and created a new HPB division in our CIG reportable segment. As a result, we transferred some related operations in our GSG reportable segment to our CIG reportable segment. Accordingly, amounts related to our segment reporting for the first quarter and first half of fiscal 2021 have been reclassified to conform to the current year presentation.
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.
The following tables summarize financial information regarding our reportable segments:
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | April 3,
2022 | | March 28,
2021 | | April 3,
2022 | | March 28,
2021 |
| | (in thousands) |
| Revenue | | | | | | | |
| GSG | $ | 448,956 | | | $ | 432,570 | | | $ | 905,054 | | | $ | 857,233 | |
| CIG | 416,945 | | | 335,432 | | | 833,231 | | | 691,958 | |
| RCM | — | | | 470 | | | — | | | 470 | |
| Elimination of inter-segment revenue | (13,157) | | | (13,708) | | | (27,030) | | | (29,793) | |
| Total revenue | $ | 852,744 | | | $ | 754,764 | | | $ | 1,711,255 | | | $ | 1,519,868 | |
| | | | | | | |
| | | | | | | |
| Income from operations | | | | | | | |
| GSG | $ | 50,344 | | | $ | 41,473 | | | $ | 101,524 | | | $ | 84,169 | |
| CIG | 40,485 | | | 30,946 | | | 85,792 | | | 65,509 | |
| RCM | — | | | 1 | | | — | | | 1 | |
Corporate (1) | (16,309) | | | (11,613) | | | (25,576) | | | (22,620) | |
| Total income from operations | $ | 74,520 | | | $ | 60,807 | | | $ | 161,740 | | | $ | 127,059 | |
| | | | | | | |
| | | | | | | |
(1) Includes amortization of intangibles, other costs and other income not allocable to our reportable segments.
| | | | | | | | | | | |
| Balance at |
| | April 3,
2022 | | October 3,
2021 |
| | (in thousands) |
| Total Assets | | | |
| GSG | $ | 544,698 | | | $ | 545,533 | |
| CIG | 743,080 | | | 698,916 | |
| RCM | 11,316 | | | 11,360 | |
Corporate (1) | 1,346,531 | | | 1,320,753 | |
| Total assets | $ | 2,645,625 | | | $ | 2,576,562 | |
| | | |
| | | |
(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 October 3, 2021). The carrying value of our long-term debt approximated fair value at April 3, 2022 and October 3, 2021. At April 3, 2022, we had borrowings of $250.0 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.
14. Credit Facility
On February 18, 2022, we entered into Amendment No. 2 to Second Amended and Restated Credit Agreement (“Amended Credit Agreement”) with a total borrowing capacity of $1.05 billion that will mature in February 2027. The Amended Credit Agreement is a $750 million senior secured, five-year facility that provides for a $250 million term loan facility (the “Amended Term Loan Facility”) and a $500 million revolving credit facility (the “Amended Revolving Credit Facility”). In addition, the Amended Credit Agreement includes a $300 million accordion feature that allows us to increase the Amended Credit Agreement to $1.05 billion subject to lender approval. The Amended Credit Agreement provides for, among other things, (i) refinance indebtedness under our Credit Agreement dated as of July 30, 2018; (ii) finance open market repurchases of common stock, acquisitions, and cash dividends and distributions; and (iii) utilize the proceeds for working capital, capital expenditures and other general corporate purposes. The Amended Credit Agreement provides for a reduction in the interest grid for meeting certain sustainability targets related to the (i) reduction of greenhouse gas emissions through the Company’s projects and operational sustainability initiatives and (ii) improvement of peoples’ lives as a result of the Company’s projects that provide environmental, social and governance benefits. 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 $300 million sublimit for multicurrency borrowings and letters of credit.
The entire Amended Term Loan Facility was drawn on February 18, 2022. The Amended Term Loan Facility is subject to quarterly amortization of principal at 5% annually commencing June 30, 2022. We may borrow on the Amended Revolving Credit Facility, at our option, at either (a) a benchmark rate plus a margin that ranges from 1.000% to 1.875% 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 Secured Overnight Financing Rate ("SOFR") rate plus 1.00%, plus a margin that ranges from 0% to 0.875% 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 February 18, 2027, or earlier at our discretion upon payment in full of loans and other obligations.
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 3.25 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.
15. 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. The derivative contracts to hedge interest exposure are categorized within Level 2 of the fair value hierarchy.
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 April 3, 2022, the notional principal of our outstanding interest swap agreements was $206.3 million ($41.3 million each.) The interest rate swaps have a fixed interest rate of 2.79%
and expire in July 2023 for all five agreements. At April 3, 2022 and October 3, 2021, the fair values of the effective portion of our interest rate swap agreements designated as cash flow hedges before tax effect were unrealized losses of $1.8 million and $9.4 million, which were reported in "Other current liabilities" on our consolidated balance sheets. Additionally, the related gains of $4.9 million and $7.6 million for the three and six months ended April 3, 2022, compared to related gains of $1.9 million and $3.4 million for the prior-year periods, were recognized and reported on our consolidated statements of comprehensive income. We expect to reclassify $1.7 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 half of fiscal 2022.
16. Reclassifications Out of Accumulated Other Comprehensive Income
The accumulated balances and activities for the three and six months ended April 3, 2022 and March 28, 2021 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) |
| Balance at December 27, 2020 | $ | (113,884) | | | $ | (14,035) | | | $ | (127,919) | |
| Other comprehensive income before reclassifications | 10,973 | | | 3,382 | | | 14,355 | |
| Amounts reclassified from accumulated other comprehensive loss | | | | | |
Interest rate contracts, net of tax (1) | — | | | (1,492) | | | (1,492) | |
| Net current-period other comprehensive income | 10,973 | | | 1,890 | | | 12,863 | |
| | | | | |
| | | | | |
| Balance at March 28, 2021 | $ | (102,911) | | | $ | (12,145) | | | $ | (115,056) | |
| | | | | |
| Balance at January 2, 2022 | $ | (116,320) | | | $ | (6,728) | | | $ | (123,048) | |
| Other comprehensive income before reclassifications | 2,807 | | | 6,332 | | | 9,139 | |
| Amounts reclassified from accumulated other comprehensive loss | | | | | |
Interest rate contracts, net of tax (1) | — | | | (1,394) | | | (1,394) | |
| Net current-period other comprehensive income | 2,807 | | | 4,938 | | | 7,745 | |
| | | | | |
| | | | | |
| Balance at April 3, 2022 | $ | (113,513) | | | $ | (1,790) | | | $ | (115,303) | |
| | | | | |
| Six Months Ended |
| Foreign
Currency
Translation
Adjustments | | Gain (Loss)
on Derivative
Instruments | | Accumulated Other Comprehensive Income (Loss) |
| (in thousands) |
| Balance at September 27, 2020 | $ | (146,275) | | | $ | (15,511) | | | $ | (161,786) | |
| Other comprehensive loss before reclassifications | 43,364 | | | 6,360 | | | 49,724 | |
| Amounts reclassified from accumulated other comprehensive loss | | | | | |
Interest rate contracts, net of tax (1) | — | | | (2,994) | | | (2,994) | |
| Net current-period other comprehensive income | 43,364 | | | 3,366 | | | 46,730 | |
| | | | | |
| Balance at March 28, 2021 | $ | (102,911) | | | $ | (12,145) | | | $ | (115,056) | |
| | | | | |
| Balance at October 3, 2021 | $ | (115,634) | | | $ | (9,394) | | | $ | (125,028) | |
| Other comprehensive income before reclassifications | 2,121 | | | 10,364 | | | 12,485 | |
| Amounts reclassified from accumulated other comprehensive loss | | | | | |
Interest rate contracts, net of tax (1) | — | | | (2,760) | | | (2,760) | |
| Net current-period other comprehensive income | 2,121 | | | 7,604 | | | 9,725 | |
| | | | | |
| Balance at April 3, 2022 | $ | (113,513) | | | $ | (1,790) | | | $ | (115,303) | |
| | | | | |
(1) This accumulated other comprehensive component is reclassified to “Interest expense” in our consolidated statements of income. See Note 15 “Derivative Financial Instruments”, for more information. |
17. 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 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.
18. Related Party Transactions
We often provide services to unconsolidated joint ventures. Our revenue related to services we provided to unconsolidated joint ventures for the three and six months of fiscal 2022 was approximately $24 million and $50 million, respectively, compared to $24 million and $46 million for the same periods last year. Related reimbursable costs for the three and six months of fiscal 2022 were approximately $22 million and $47 million. Related reimbursable costs for the three and six months of fiscal 2021 were approximately $23 million and $44 million. Our consolidated balance sheets also included the following amounts related to these services:
| | | | | | | | | | | |
| Balance at |
| April 3,
2022 | | October 3, 2021 |
| (in thousands) |
| Accounts receivable, net | $ | 16,711 | | | $ | 19,082 | |
| Contract assets | 4,185 | | | 5,092 | |
| Contract liabilities | 3,909 | | | 3,026 | |