Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following analysis of our financial condition and results of operations should be read in conjunction with Part I of this report, as well as our consolidated financial statements and accompanying notes in Item 8. The following analysis contains forward-looking statements about our future results of operations and expectations. Our actual results and the timing of events could differ materially from those described herein. See Part 1, Item 1A, "Risk Factors" for a discussion of the risks, assumptions, and uncertainties affecting these statements.
OVERVIEW OF RESULTS AND BUSINESS TRENDS
General. 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 21,000 associates supported by technological innovation. Our government business, which represents approximately 60% of our revenue, has been stable, while our commercial business experienced 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 fiscal 2021, o ur revenue increased 7.3% compared to fiscal 2020. This year-over-year growth primarily reflects increased activity with government clients, both U.S. and international, as federal and local government agency spending has been a source of economic stability and stimulus during the COVID-19 pandemic. However, this growth was partially offset by lower commercial activity, which has been slower to recover to pre-pandemic levels. Our revenue also includes contributions from acquisitions that did not contribute to our revenue in fiscal 2020. Our year-over-year revenue comparisons were also impacted by the decision to dispose of our Canadian turn-key pipeline activities in fiscal 2019 and the subsequent wind-down of those activities in fiscal 2020.
U.S. State and Local Government. Our U.S. state and local government revenue increased 22.2% i n fiscal 2021 compared to last fiscal year. The 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. Our disaster response activities also increased compared to fiscal 2020. Most of our work for U.S. state and local governments relates to critical water and environmental programs, which we expect to continue to grow next year. The risk of budgetary constraints to our clients is mitigated with the passage of the American Rescue Plan Act of 2021, signed into law on March 11, 2021, which provides financial support for state and local governments.
U.S. Federal Government. Our U.S. federal government revenue increased 8.8% in f iscal 2021 compared to fiscal 2020. This increase includes contributions from acquisitions, which did not have comparable revenue in last fiscal year. During periods of economic volatility, including during the COVID-19 pandemic, our U.S. federal government business has historically been the most stable and predictable. We expect our U.S. federal government revenue to grow in fiscal 2022 due to continued increased advanced analytics activity, and the current administration's focus on long-term infrastructure and climate change.
U.S. Commercial. Our U.S. commercial revenue decreased 5.4% in fiscal 2021 compared to fiscal 2020. The decline was primarily due to reduced industrial activity as a result of the COVID-19 pandemic. We currently expect our U.S. commercial revenue to grow in fiscal 2022 primarily with clients focused on environmental programs, including meeting net zero carbon goals, and from higher demand for renewable energy; however, if conditions due to the COVID-19 pandemic worsen or are prolonged, it could have a negative impact on our revenue for fiscal 2022.
International. Our international revenue increased 7.9% in f iscal 2021 compared to fiscal 2020. The revenue growth primarily reflects government stimulus spending on infrastructure, increased commercial activity related to new regulatory requirements for sustainability, and fewer restrictions related to the COVID-19 pandemic . Our revenue also includes contributions from acquisitions that did not contribute to our revenue in fiscal 2020. We expect these trends and the related growth in our international work to continue in fiscal 2022.
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RESULTS OF OPERATIONS
Fiscal 2021 Compared to Fiscal 2020
Consolidated Results of Operations
Fiscal Year Ended
October 3,
2021 September 27,
2020 Change
$ %
($ in thousands)
Revenue $ 3,213,513 $ 2,994,891 $ 218,622 7.3%
Subcontractor costs (661,341) (646,319) (15,022) (2.3)
Revenue, net of subcontractor costs (1)
2,552,172 2,348,572 203,600 8.7
Other costs of revenue (2,053,772) (1,902,037) (151,735) (8.0)
Gross profit 498,400 446,535 51,865 11.6
Selling, general and administrative expenses (222,972) (204,615) (18,357) (9.0)
Contingent consideration – fair value adjustments 3,273 14,971 (11,698) (78.1)
Impairment of goodwill — (15,800) 15,800 NM
Income from operations 278,701 241,091 37,610 15.6
Interest expense – net (11,831) (13,100) 1,269 9.7
Income before income tax expense 266,870 227,991 38,879 17.1
Income tax expense (34,039) (54,101) 20,062 37.1
Net income 232,831 173,890 58,941 33.9
Net income attributable to noncontrolling interests (21) (31) 10 32.3
Net income attributable to Tetra Tech $ 232,810 $ 173,859 $ 58,951 33.9
Diluted earnings per share $ 4.26 $ 3.16 $ 1.10 34.8
(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. In the course of providing services, we routinely subcontract various services and, under certain 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. Because subcontractor services can vary significantly from project to project and period to period, changes in revenue may not necessarily be indicative of our business trends. Accordingly, we segregate subcontractor costs from revenue to promote a better understanding of our business by evaluating revenue exclusive of costs associated with external service providers.
NM = not meaningful
In fiscal 2021 , revenue and revenue, net of subcontractor costs, increased $218.6 million, or 7.3%, and $203.6 million, or 8.7%, respectively, compared to fiscal 2020. Excluding the net contributions from acquisitions and the impact of the disposal of our Canadian turn-key pipeline activities, our revenue increased 3.2% in fiscal 2021 compared to last fiscal year. Our GSG segment's revenue and revenue, net of subcontractor costs, increased $164.0 million, or 9.2%, and $120.3 million, or 9.3%, respectively, in fiscal 2021 compared to the prior fiscal year. Our CIG segment's revenue increased $59.6 million, or 4.7%, and revenue, net of subcontractor costs, increased $82.7 million, or 7.9% in fiscal 2021 compared to fiscal 2020. Our fiscal 2021 results for our GSG and CIG segments are described below under "Government Services Group" and "Commercial/International Services Group", respectively.
The following table reconciles our reported results to non-U.S. GAAP adjusted results, which exclude certain non-operating accounting-related adjustments, such as gains on non-core dispositions, gains from adjustments to contingent considerations, goodwill impairment charges, non-recurring costs to address COVID-19, and non-recurring tax items. The gains on non-core dispositions in fiscal 2020 relate to the disposal of our Canadian turn-key pipeline activities that commenced in the fourth quarter of fiscal 2019. The goodwill impairment charge in fiscal 2020 did not have related tax benefits. Excluding this charge, the effective tax rates applied to the adjustments to earnings per share ("EPS") to arrive at adjusted EPS averaged 25% and 24% for fiscal 2021 and 2020, respectively. We applied the relevant marginal statutory tax rate based on the nature of the adjustments and tax jurisdiction in which they occur. Both EPS and adjusted EPS were calculated using diluted weighted-average common shares outstanding for the respective periods as reflected in our consolidated statements of income.
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During the second quarter of fiscal 2020, we took actions in response to the COVID-19 pandemic to ensure the health and safety of our employees, clients, and communities. These actions included activating our Business Continuity Plan globally, which enabled 95% of our workforce to work remotely and all of our global offices to remain operational supporting our programs and projects. This required incremental costs for employee relocation, expansion of our virtual private network capabilities, enhanced security, and sanitizing of our offices. In addition, we incurred severance costs to right-size select operations where projects were cancelled specifically due to COVID-19 concerns and the resulting macroeconomic conditions. These incremental costs totaled $8.2 million in the second quarter of fiscal 2020. Although the charges were recognized in the second quarter of fiscal 2020, substantially all of these costs were paid in cash in the third quarter of fiscal 2020.
Fiscal Year Ended
October 3,
2021 September 27,
2020 Change
$ %
Income from operations $ 278,701 $ 241,091 $ 37,610 15.6
Earn-out adjustments (3,273) (13,371) 10,098 NM
COVID-19 — 8,233 (8,233) NM
Non-core dispositions — (8,525) 8,525 NM
Impairment of goodwill — 15,800 (15,800) NM
Adjusted income from operations (1)
$ 275,428 $ 243,228 $ 32,200 13.2
EPS $ 4.26 $ 3.16 $ 1.10 34.8
Earn-out adjustments (0.04) (0.18) 0.14 NM
COVID-19 — 0.11 (0.11) NM
Non-core dispositions — (0.12) 0.12 NM
Impairment of goodwill — 0.29 (0.29) NM
Non-recurring tax items (0.43) — (0.43) NM
Adjusted EPS (1)
$ 3.79 $ 3.26 $ 0.53 16.3
NM = not meaningful
(1) Non-U.S. GAAP financial measure
Operating income increased $37.6 million in fiscal 2021 compared to fiscal 2020. Our operating income reflects net gains of $3.3 million and $15.0 million related to changes in the estimated fair value of contingent earn-out liabilities in fiscal 2021 and 2020, respectively. The net gain in fiscal 2020 was partially offset by the related compensation charges of $1.6 million. These gains are described below under "Fiscal 2021 and 2020 Earn-Out Adjustments." Our operating income in fiscal 2020 was reduced by the previously described non-recurring charges of $8.2 million to address COVID-19. In addition, our fiscal 2020 results include gains from the sales of non-core equipment of $8.5 million related to the disposal of our Canadian turn-key pipeline activities. Further, our fiscal 2020 operating income reflects a non-cash goodwill impairment charge of $15.8 million, which is described below under "Fiscal 2020 and 2019 Impairment of Goodwill."
Excluding these items, our adjusted operating income increased $32.2 million, or 13.2%, in fiscal 2021 compared to fiscal 2020. The increase reflects improved results in our GSG and CIG segments, which are described below under "Government Services Group" and "Commercial/International Services Group", respectively.
Our net interest expense w as $11.8 million and $13.1 million in fiscal 2021 and 2020, respectively. The decrease primarily reflects lower average borrowings.
The effective tax rates for fiscal 2021 and 2020 were 12.8% and 23.7 %, respectively. Our fiscal 2021 effective tax rate reflects a non-recurring net tax benefit of $21.6 million primarily consisting of valuation allowances in the United Kingdom that were released due to sufficient sustainable profitability being achieved in fiscal 2021. The valuation allowances were primarily related to net operating loss carry-forwards and other temporary differences. The goodwill impairment charge in fiscal 2020 did not have related tax benefits, which increased our effective tax rate by 1.5% in fiscal 2020. Conversely, income tax expense was reduced by $12.9 million and $8.3 million of excess tax benefits on share-based payments in fiscal 2021 and 2020, respectively. Excluding the impact of the fiscal 2021 non-recurring tax items, the non-deductible goodwill impairment charge, and the excess tax benefits on share-based payments, our effective tax rates in fiscal 2021 and 2020 were 25.7% and 25.6%, respectively.
Our EPS was $4.26 in fisc al 2021, compared to $3.16 in fiscal 2020. On the same basis as our adjusted operating income and excluding non-recurring tax benefits in fiscal 2021, EPS was $3.79 in fiscal 2021, compared to $3.26 last fiscal year.
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Segment Results of Operations
Government Services Group ("GSG")
Fiscal Year Ended
October 3,
2021 September 27,
2020 Change
$ %
($ in thousands)
Revenue $ 1,942,958 $ 1,778,922 $ 164,036 9.2%
Subcontractor costs (522,583) (478,839) (43,744) (9.1)
Revenue, net of subcontractor costs $ 1,420,375 $ 1,300,083 $ 120,292 9.3
Income from operations $ 195,297 $ 168,669 $ 26,628 15.8%
Revenue and revenue, net of subcontractor costs, increased $164.0 million, or 9.2%, and $120.3 million, or 9.3%, respectively, in fiscal 2021 compared to fiscal 2020. These increases primarily reflect higher U.S. state and local government activities related to water and environmental programs, and disaster response. The increases also reflect contributions from acquisitions, which did not have comparable revenue in the prior fiscal year.
Operating income increased $26.6 million in fiscal 2021 compared to fiscal 2020 primarily reflecting the revenue growth. In addition, we incurred $1.6 million of incremental costs for actions to respond to the COVID-19 pandemic in the second quarter of fiscal 2020. Our operating margin, based on revenue, net of subcontractor costs, improved to 13.7% in fiscal 2021 compared to 13.0% last fiscal year. Excluding the COVID-19 charges, our operating margin was 13.1% in fiscal 2020. The improved operating margin was primarily due to our increased focus on high-end consulting services and improved labor utilization.
Commercial/International Services Group ("CIG")
Fiscal Year Ended
October 3,
2021 September 27,
2020 Change
$ %
($ in thousands)
Revenue $ 1,325,668 $ 1,266,059 $ 59,609 4.7%
Subcontractor costs (194,459) (217,547) 23,088 10.6
Revenue, net of subcontractor costs $ 1,131,209 $ 1,048,512 $ 82,697 7.9
Income from operations $ 131,720 $ 114,022 $ 17,698 15.5
Revenue and revenue, net of subcontractor costs, increased $59.6 million, or 4.7%, and increased $82.7 million, or 7.9%, respectively, in fiscal 2021 compared to fiscal 2020. The revenue growth in fiscal 2021 primarily reflects increased infrastructure activity in Canada and fewer restrictions related to the COVID-19 pandemic in the second half of fiscal 2021 . The increases also reflect contributions from acquisitions, which did not have comparable revenue in the prior fiscal year, partially offset by the disposal of our Canadian turn-key pipeline activities.
Operating income increased $17.7 million in fiscal 2021 compared to fiscal 2020 primarily due to revenue growth. Additionally, we realized gains of $8.5 million from the disposition of non-core equipment related to our Canadian turn-key pipeline activities, partially offset by $6.6 million of incremental costs for actions to respond to the COVID-19 pandemic in fiscal 2020. Excluding these disposition gains and the COVID-19 charges, operating income increased $19.6 million in fiscal 2021 compared to fiscal 2020. Our operating margin, based on revenue, net of subcontractor costs, improved to 11.6% in fiscal 2021 compared to 10.9% last fiscal year. Excluding the disposition gains and COVID-19 charges, our operating margin was 10.7% in fiscal 2020. The improved operating margin was primarily due to our increased focus on high-end consulting services and improved labor utilization.
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Remediation and Construction Management ("RCM")
Fiscal Year Ended
October 3,
2021 September 27,
2020 Change
$ %
($ in thousands)
Revenue $ 613 $ 198 $ 415 NM
Subcontractor costs (25) (221) 196 NM
Revenue, net of subcontractor costs $ 588 $ (23) $ 611 NM
Loss from operations $ — $ — $ — NM
NM = not meaningful
RCM's projects were substantially complete at the end of fiscal 2018. There were no significant operating activities in RCM in fiscal 2021 and 2020.
Fiscal 2021 and 2020 Earn-Out Adjustments
We review and re-assess the estimated fair value of contingent consideration on a quarterly basis, and the updated fair value could differ materially from the initial estimates. We recorded adjustments to our contingent earn-out liabilities and reported net gains of $3.3 million and $15.0 million in fiscal 2021 and 2020, respectively. Fiscal 2021 adjustments resulted from the updated valuations of several contingent consideration liabilities, which reflect updated projections of acquired companies' financial performance during their respective earn-out periods. None of these valuation changes were individually material. In fiscal 2020, the net gains primarily resulted from updated valuations of the contingent consideration liabilities for eGlobalTech ("EGT"), Norman, Disney and Young ("NDY"), and Segue Technologies, Inc. ("SEG"). These valuations included updated projections of EGT's, NDY's, and SEG's financial performance during the earn-out periods, which were below our original estimates at their respective acquisition dates. In addition, we recognized charges of $1.6 million in fiscal 2020 that related to the earn-out for Glumac. These charges were treated as compensation in selling, general and administrative expenses due to the terms of the arrangement, which included an on-going service requirement for a portion of the earn-out.
At October 3, 2021, there was a total maximum of $105.4 million of outstanding contingent consideration related to our acquisitions. Of this amount, $59.3 million was estimated as the fair value and accrued on our consolidated balance sheet.
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Fiscal 2020 Compared to Fiscal 2019
Consolidated Results of Operations
Fiscal Year Ended
September 27,
2020 September 29, 2019 Change
$ %
($ in thousands)
Revenue $ 2,994,891 $ 3,107,348 $ (112,457) (3.6)%
Subcontractor costs (646,319) (717,711) 71,392 9.9
Revenue, net of subcontractor costs (1)
2,348,572 2,389,637 (41,065) (1.7)
Other costs of revenue (1,902,037) (1,981,454) 79,417 4.0
Gross profit 446,535 408,183 38,352 9.4
Selling, general and administrative expenses (204,615) (200,230) (4,385) (2.2)
Acquisition and integration expenses — (10,351) 10,351 NM
Contingent consideration – fair value adjustments 14,971 (1,085) 16,056 NM
Impairment of goodwill (15,800) (7,755) (8,045) (103.7)
Income from operations 241,091 188,762 52,329 27.7
Interest expense – net (13,100) (13,626) 526 3.9
Income before income tax expense 227,991 175,136 52,855 30.2
Income tax expense (54,101) (16,375) (37,726) (230.4)
Net income 173,890 158,761 15,129 9.5
Net income attributable to noncontrolling interests (31) (93) 62 66.7
Net income attributable to Tetra Tech $ 173,859 $ 158,668 $ 15,191 9.6
Diluted earnings per share $ 3.16 $ 2.84 $ 0.32 11.3
(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. In the course of providing services, we routinely subcontract various services and, under certain USAID programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with U.S. GAAP and industry practice, are included in our revenue when it is our contractual responsibility to procure or manage these activities. Because subcontractor services can vary significantly from project to project and period to period, changes in revenue may not necessarily be indicative of our business trends. Accordingly, we segregate subcontractor costs from revenue to promote a better understanding of our business by evaluating revenue exclusive of costs associated with external service providers.
NM = not meaningful
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In fiscal 2020, revenue and revenue, net of subcontractor costs, decreased $112.5 million, or 3.6%, and $41.1 million, or 1.7%, compared to fiscal 2019. These comparisons were impacted by the disposal of our Canadian turn-key pipeline activities in the fourth quarter of fiscal 2019 and a decrease in revenue from disaster response activities related to California wildfires. In addition, our fiscal 2019 results included a reduction of revenue of $13.7 million from a claim that was resolved in fiscal 2019. Excluding the disposal, the decreased California wildfire activity, and the 2019 claim resolution, our revenue increased 3.0% in fiscal 2020 compared to fiscal 2019. This increase includes $210.5 million of revenue from acquisitions, which did not have comparable revenue in fiscal 2019. Also excluding the contribution from acquisitions, our revenue in fiscal 2020 decreased 4.4% compared to fiscal 2019 primarily due to the adverse impact of the COVID-19 pandemic on our U.S. commercial and international revenue.
The following table reconciles our reported results to non-U.S. GAAP adjusted results, which exclude the RCM results and certain non-operating accounting-related adjustments, such as acquisition and integration costs, gains/losses from adjustments to contingent considerations, goodwill impairment charges, non-recurring costs to address COVID-19, and non-recurring tax benefits. Adjusted results also exclude charges resulting from the decision to dispose of our Canadian turn-key pipeline activities that commenced in the fourth quarter of fiscal 2019 and subsequent related gains from non-core equipment disposals in fiscal 2020. Our fiscal 2019 adjusted results exclude a charge to operating income of $13.7 million from a claim that was resolved in the fourth quarter of fiscal 2019 for a remediation project, where the work was substantially performed in prior years. The effective tax rates applied to these adjustments to EPS to arrive at adjusted EPS averaged 155% and 16% in fiscal 2020 and 2019, respectively. The goodwill impairment charges in both fiscal years and certain of the transaction charges in fiscal 2019 did not have related tax benefits. Excluding these items, the effective tax rates applied to the adjustments in fiscal 2020 and 2019 were 24% and 26%, respectively. We applied the relevant marginal statutory tax rate based on the nature of the adjustments and tax jurisdiction in which they occur. Both EPS and adjusted EPS were calculated using diluted weighted-average common shares outstanding for the respective periods as reflected in our consolidated statements of income.
During the second quarter of fiscal 2020, we took actions in response to the COVID-19 pandemic to ensure the health and safety of our employees, clients, and communities. These actions included activating our Business Continuity Plan globally, which enabled 95% of our workforce to work remotely and all 450 of our global offices to remain operational supporting our clients' programs and projects. This required incremental costs for employee relocation, expansion of our virtual private network capabilities, enhanced security, and sanitizing our offices. In addition, we incurred severance costs to right-size select operations where projects were cancelled specifically due to COVID-19 concerns and the resulting macroeconomic conditions. These incremental costs totaled $8.2 million in the second quarter of fiscal 2020. Substantially all of these costs were paid in cash in the third quarter of fiscal 2020.
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Fiscal Year Ended
September 27,
2020 September 29, 2019 Change
$ %
Income from operations $ 241,091 $ 188,762 $ 52,329 27.7
COVID-19 8,233 — 8,233 NM
Non-core dispositions (8,525) 10,946 (19,471) NM
RCM — 5,933 (5,933) NM
Claims — 13,700 (13,700) NM
Acquisition/Integration — 10,351 (10,351) NM
Earn-out adjustments (13,371) 3,085 (16,456) NM
Impairment of goodwill 15,800 7,755 8,045 NM
Adjusted income from operations (1)
$ 243,228 $ 240,532 $ 2,696 1.1
EPS $ 3.16 $ 2.84 $ 0.32 11.3
COVID-19 0.11 — 0.11 NM
Non-core dispositions (0.12) 0.14 (0.26) NM
RCM — 0.08 (0.08) NM
Claims — 0.18 (0.18) NM
Acquisition/Integration — 0.19 (0.19) NM
Earn-out adjustments (0.18) 0.04 (0.22) NM
Impairment of goodwill 0.29 0.14 0.15 NM
Non-recurring tax benefits — (0.44) 0.44 NM
Adjusted EPS (1)
$ 3.26 $ 3.17 $ 0.09 2.8
NM = not meaningful
(1) Non-U.S. GAAP financial measure
Our operating income increased $52.3 million in fiscal 2020 compared to fiscal 2019. Our operating income in fiscal 2020 was reduced by the previously described non-recurring charges of $8.2 million to address COVID-19. In addition, our fiscal 2020 results include gains from the sales of non-core equipment of $8.5 million related to the disposal of our Canadian turn-key pipeline activities. Our operating income in fiscal 2019 included charges of $10.9 million related to this disposal. Our operating income in fiscal 2019 also included a $5.9 million loss from exited construction activities in our RCM segment. Our RCM results are described below under "Remediation and Construction Management." Additionally, our operating income in fiscal 2019 included the aforementioned $13.7 million charge for a resolved claim and expenses of $10.4 million related to the acquisition and integration of WYG plc ("WYG"). For further detailed information regarding the WYG-related costs, see " Fiscal 2019 Acquisition and Integration Expenses" below. Ou r fiscal 2020 operating income includes gains of $15.0 million related to changes in the estimated fair value of contingent earn-out liabilities partially offset by related compensation charges of $1.6 million. Our fiscal 2019 operating income reflects losses of $1.1 million related to changes in the estimated fair value of contingent earn-out liabilities and an additional $2.0 million of related compensation charges. These earn-out related amounts are described below under "Fiscal 2020 and 2019 Earn-Out Adjustments." Further, our operating income reflects non-cash goodwill impairment charges of $15.8 million and $7.8 million in fiscal 2020 and 2019, respectively. These charges are described below under "Fiscal 2020 and 2019 Impairment of Goodwill."
Excluding these items, our adjusted operating income increased $2.7 million, or 1.1%, in fiscal 2020 compared to fiscal 2019. The increase reflects improved results in our CIG segment partially offset by lower operating income in our GSG segment. GSG and CIG results are described below under "Government Services Group" and "Commercial/International Services Group", respectively.
Our net interest expense was $13.1 million in fiscal 2020 compared to $13.6 million fiscal 2019. The decrease primarily reflects lower interest rates (primarily LIBOR), and to a lesser extent, lower average borrowings.
The effective tax rates for fiscal 2020 and 2019 were 23.7% and 9.3%, respectively. The goodwill impairment charges in fiscal 2020 and 2019 and certain of the transaction charges in fiscal 2019 did not have related tax benefits, which increased our effective tax rates by 1.5% and 1.1% in fiscal 2020 and 2019, respectively. Conversely, income tax expense was reduced by $8.3 million and $6.4 million of excess tax benefits on share-based payments in fiscal 2020 and 2019, respectively. Additionally, we finalized the analysis of our deferred tax liabilities for the Tax Cuts and Jobs Act's ("TCJA's") lower tax rates
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in the first quarter of fiscal 2019 and recorded a deferred tax benefit of $2.6 million. Also, valuation allowances of $22.3 million in Australia were released due to sufficient positive evidence obtained during the second quarter of fiscal 2019. The valuation allowances were primarily related to net operating loss and research and development credit carryforwards and other temporary differences. We evaluated the positive evidence against any negative evidence and determined that it was more likely than not that the deferred tax assets would be realized. The factors used to assess the likelihood of realization were the past performance of the related entities, our forecast of future taxable income, and available tax planning strategies that could be implemented to realize the deferred tax assets.
Excluding the impact of the non-deductible goodwill impairment charges and transaction costs, the excess tax benefits on share-based payments, the net deferred tax benefits from the TCJA, and the valuation allowance release, our effective tax rates in fiscal 2020 and 2019 were 25.6% and 24.6%, respectively.
Our EPS was $3.16 in fiscal 2020, compared to $2.84 in fiscal 2019. On the same basis as our adjusted operating income and excluding non-recurring tax benefits in fiscal 2019, EPS was $3.26 in fiscal 2020, compared to $3.17 in fiscal 2019.
Segment Results of Operations
Government Services Group ("GSG")
Fiscal Year Ended
September 27,
2020 September 29, 2019 Change
$ %
($ in thousands)
Revenue $ 1,778,922 $ 1,820,671 $ (41,749) (2.3)%
Subcontractor costs (478,839) (491,290) 12,451 2.5
Revenue, net of subcontractor costs $ 1,300,083 $ 1,329,381 $ (29,298) (2.2)
Income from operations $ 168,669 $ 185,263 $ (16,594) (9.0)
Revenue and revenue, net of subcontractor costs, decreased $41.7 million, or 2.3%, and $29.3 million, or 2.2%, respectively, in fiscal 2020 compared to fiscal 2019. These declines primarily reflect the previously described decrease in revenue from disaster response activities related to California wildfires offset by revenue from acquisitions, which did not have comparable revenue in fiscal 2019. Excluding the contributions from acquisitions and the California wildfire disaster response activities, our revenue in fiscal 2020 was substantially the same as fiscal 2019 as increases in federal information technology activity were offset by lower international development revenue.
Operating income decreased $16.6 million in fiscal 2020 compared to fiscal 2019 primarily reflecting the lower disaster response revenue. Also, we incurred $1.6 million of incremental costs for actions to respond to the COVID-19 pandemic in the second quarter of fiscal 2020. Our operating margin, based on revenue, net of subcontractor costs, was 13.0% in fiscal 2020 compared to 13.9% in fiscal 2019. Excluding the COVID-19 charges, our operating margin was 13.1% in fiscal 2020.
Commercial/International Services Group ("CIG")
Fiscal Year Ended
September 27,
2020 September 29, 2019 Change
$ %
($ in thousands)
Revenue $ 1,266,059 $ 1,342,509 $ (76,450) (5.7)%
Subcontractor costs (217,547) (279,468) 61,921 22.2
Revenue, net of subcontractor costs $ 1,048,512 $ 1,063,041 $ (14,529) (1.4)
Income from operations $ 114,022 $ 79,633 $ 34,389 43.2
Revenue and revenue, net of subcontractor costs, decreased $76.5 million, or 5.7%, and $14.5 million, or 1.4%, respectively, in fiscal 2020 compared to fiscal 2019. Our year-over-year revenue comparisons were impacted by the disposal of our Canadian turn-key pipeline activities in the fourth quarter of fiscal 2019, and a reduction in revenue and a corresponding charge to operating income of $13.7 million in fiscal 2019 for a remediation project where the work was substantially
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performed in prior years. Excluding the disposal and t he fiscal 2019 claim resolution, our revenue decreased 2.2% due to lower subcontractor activity and the adverse impact of the COVID-19 pandemic on our U.S. and international commercial revenue.
Operating income increased $34.4 million in fiscal 2020 compared to fiscal 2019. This comparison was also impacted by the disposal of our Canadian turn-key pipeline activities. Our fiscal 2020 operating income includes gains of $8.5 million from the disposition of non-core equipment and our fiscal 2019 operating income includes charges of $10.9 million related to these activities. In addition, we incurred $6.6 million of incremental costs for actions to respond to the COVID-19 pandemic in the second quarter of fiscal 2020. Excluding the Canadian turn-key pipeline activities, the COVID-19 charges, and the aforementioned $13.7 million claim in fiscal 2019, our operating income increased $7.9 million, or 7.5%, in fiscal 2020 compared to fiscal 2019. On the same basis, our operating margin, based on revenue, net of subcontractor costs, improved to 10.7% in fiscal 2020 from 9.7% in fiscal 2019.
Remediation and Construction Management ("RCM")
Fiscal Year Ended
September 27,
2020 September 29, 2019 Change
$ %
($ in thousands)
Revenue $ 198 $ (1,542) $ 1,740 NM
Subcontractor costs (221) (1,243) 1,022 NM
Revenue, net of subcontractor costs $ (23) $ (2,785) $ 2,762 NM
Loss from operations $ — $ (5,933) $ 5,933 NM
NM = not meaningful
RCM's projects were substantially complete at the end of fiscal 2018. The operating loss of $5.9 million in fiscal 2019 reflects reductions of revenue and related operating losses based on updated evaluations of unsettled claim amounts for two construction projects that were completed in prior years.
Fiscal 2019 Acquisition and Integration Expenses
In fiscal 2019, we incurred acquisition and integration expenses of $10.4 million related to the WYG acquisition. These expenses included $3.3 million of acquisition expenses that were primarily for professional services, such as legal and investment banking, to support the transaction and were all paid in the fourth quarter of fiscal 2019. Subsequent to the acquisition date, we also recorded charges of $7.1 million for integration activities, including the elimination of redundant general and administrative costs, real estate consolidation, and conversion of information technology platforms, substantially all of which were paid in fiscal 2020.
Fiscal 2020 and 2019 Earn-Out Adjustments
We review and re-assess the estimated fair value of contingent consideration on a quarterly basis, and the updated fair value could differ materially from the initial estimates. We recorded adjustments to our contingent earn-out liabilities and reported net gains of $15.0 million and losses of $1.1 million in fiscal 2020 and 2019, respectively. The fiscal 2020 net gains primarily resulted from updated valuations of the contingent consideration liabilities for EGT, NDY, and SEG. These valuations included updated projections of EGT's, NDY's, and SEG's financial performance during the earn-out periods, which were below our original estimates at their respective acquisition dates. In addition, we recognized charges of $1.6 million and $2.0 million in fiscal 2020 and 2019, respectively, that related to the earn-out for Glumac. These charges were treated as compensation in selling, general and administrative expenses due to the terms of the arrangement, which included an on-going service requirement for a portion of the earn-out.
At September 27, 2020, there was a total maximum of $70.9 million of outstanding contingent consideration related to acquisitions. Of this amount, $32.6 million was estimated as the fair value and accrued on our consolidated balance sheet.
Fiscal 2020 and 2019 Impairment of Goodwill
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 in June 2020. This prompted a strategic review of our Asia/Pacific ("ASP") reporting unit, which is in our CIG reportable segment. As a result of the economic recession in Australia, our revenue growth and profit margin forecasts for the 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
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charge. The impaired goodwill related to our acquisitions of Coffey International Limited ("Coffey") and NDY. 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 former ASP reporting unit into our Client Account Management reporting unit.
During the fourth quarter of fiscal 2019, we performed a strategic review of all operations. As a result, we decided to dispose of our turn-key pipeline activities in Western Canada in our Remediation and Field Services ("RFS") reporting unit, which is in our CIG reportable segment. As a result, we incurred severance and project-related charges related to the disposition of $10.9 million, which were reported in the CIG segment's operating income. We also performed an interim goodwill impairment review of our RFS reporting unit and recorded a $7.8 million goodwill impairment charge. The impaired goodwill related to our acquisition of Parkland Pipeline Contractors Ltd. As a result of the impairment charge, the estimated fair value of the RFS reporting unit equaled its carrying value at September 29, 2019.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Capital Requirements. As of October 3, 2021 , we h ad $166.6 million of cash and cash equivalents and access to an additional $749 million of borrowing capacity available under our credit facility. We generated $304.4 million of cash from operations in fiscal 2021. To date, w e 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. In the fourth quarter of fiscal 2021, we repatriated approximately $80 million from Canada and recognized a related tax expense of $5.6 million. At this time, we also determined that our remaining undistributed earnings in Canada of approximately $20.1 million are no longer being indefinitely reinvested and recorded an additional deferred tax liability/expense of $3.1 mill ion. At October 3, 2021, undistributed earnings of our other foreign subsidiaries, primarily in Australia and the U.K. of approximately $50.9 million are expected to be indefinitely reinvested in these foreign countries. Accordingly, no provision for foreign withholding taxes has been made. Assuming the indefinitely reinvested foreign earnings were repatriated under the laws and rates applicable at October 3, 2021, the incremental taxes applicable to those earnings would not be material. We currently have no need or plans to repatriate undistributed foreign earnings, other than from Canada, in the foreseeable future; however, this could change due to varied economic circumstances.
On January 27, 2020, the Board of Directors authorized a $200 million stock repurchase program, which was included in our remaining balance of $207.8 million as of fiscal 2020 year-end. In fiscal 2021, we repurchased and settled 479,369 shares with an average price of $125.16 per share for a total cost of $60.0 million in the open market. At October 3, 2021, we had a remaining balance of $147.8 million under our stock repurchase program. We declared and paid common stock dividends totaling $40.0 million, or $0.74 per share, in fiscal 2021 compared to $34.7 million, or $0.64 per share, in fiscal 2020.
Subsequent Events. 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. On November 15, 2021, the Board of Directors also declared a quarterly cash dividend of $0.20 per share payable on December 20, 2021 to stockholders of record as of the close of business on December 2, 2021.
Cash and Cash Equivalents. As of October 3, 2021, cash and cash equivalents were $166.6 million, an increase of $9.1 million compared to the fiscal 2020 year-end. The increase was due to net cash provided by operating activities, partially offset by net repayments of long-term debt, stock repurchases, dividends, as well as payments for business acquisitions and contingent earn-out payments.
Operating Activities. In fiscal 2021, net cash provided by operating activities was $304.4 million compared to $262.5 million in fiscal 2020. The increase primarily reflects an increase in earnings adjusted for non-cash items of $24.1 million and improved working capital from faster collections of our accounts receivable in fiscal 2021 compared to the prior fiscal year.
Investing Activities. Net cash used in investing activities was $93.0 million in fiscal 2021, an increase of $30.0 million compared to last fiscal year. The increase was due to higher payments for business acquisitions in fiscal 2021 and the proceeds from sales of equipment related to the disposal of our Canadian turn-key pipeline activities in fiscal 2020.
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Financing Activities. In fiscal 2021, net cash used in financing activities was $210.1 million, an increase of $47.1 million compared to fiscal 2020. The increase was due to the net change in overdrafts and higher net repayments on long-term debt, partially offset by lower stock repurchases compared to last fiscal year.
Debt Financing. On July 30, 2018, we entered into a Second Ame nded and Restated Credit Agreement (“Amended Credit Agreement”) with a total borrowing capacity of $1 billion that will mature in July 2023. The Amended Credit Agreement is a $700 million senior secured, five-year facility that provides for a $250 million term loan facility (the “Amended Term Loan Facility”), a $450 million revolving credit facility (the “Amended Revolving Credit Facility”), and a $300 million accordion feature that allows us to increase the Amended Credit Agreement to $1 billion subject to lender approval. The Amended Credit Agreement allows us to, among other things, (i) refinance indebtedness under our Credit Agreement dated as of May 7, 2013; (ii) finance certain permitted open market repurchases of our common stock, permitted acquisitions, and cash dividends and distributions; and (iii) utilize the proceeds for working capital, capital expenditures and other general corporate purposes. The Amended Revolving Credit Facility includes a $100 million sublimit for the issuance of standby letters of credit, a $20 million sublimit for swingline loans, and a $200 million sublimit for multicurrency borrowings and letters of credit.
The entire Amended Term Loan Facility was drawn on July 30, 2018. The Amended Term Loan Facility is subject to quarterly amortization of principal at 5% annually beginning December 31, 2018. We may borrow on the Amended Revolving Credit Facility, at our option, at either (a) a Eurocurrency rate plus a margin that ranges from 1.00% to 1.75% per annum, or (b) a base rate for loans in U.S. dollars (the highest of the U.S. federal funds rate plus 0.50% per annum, the bank’s prime rate or the Eurocurrency rate plus 1.00%) plus a margin that ranges from 0% to 0.75% per annum. In each case, the applicable margin is based on our Consolidated Leverage Ratio, calculated quarterly. The Amended Term Loan Facility is subject to the same interest rate provisions. The Amended Credit Agreement expires on July 30, 2023, or earlier at our discretion upon payment in full of loans and other obligations.
At October 3, 2021, we had $212.5 million in outstanding borrowings under the Amended Credit Agreement, which was comprised of $212.5 million under the Amended Term Loan Facility and no borrowings outstanding under the Amended Revolving Credit Facility. The weighted-average interest rate of the outstanding borrowings during fiscal 2021 was 1.25%. In addition, we had $0.7 million in standby letters of credit under the Amended Credit Agreement. Our weighted-average interest rate on borrowings outstanding during fiscal 2021 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" included in Item 8, was 3.30%. At October 3, 2021, we had $449.3 million of available credit under the Amended Revolving Credit Facility, all of which could be borrowed without a violation of our debt covenants. Commitment fees related to our revolving credit facilities were $0.7 million each year for fiscal 2021 , 2020 and 2019, respectively.
The Amended Credit Agreement contains certain affirmative and restrictive covenants, and customary events of default. The financial covenants provide for a maximum Consolidated Leverage Ratio of 3.00 to 1.00 (total funded debt/EBITDA, as defined in the Amended Credit Agreement) and a minimum Consolidated Interest Coverage Ratio of 3.00 to 1.00 (EBITDA/Consolidated Interest Charges, as defined in the Amended Credit Agreement). Our obligations under the Amended Credit Agreement are guarant eed 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 October 3, 2021, we were in compliance with these covenants with a consolidated leverage ratio of 0.87x and a consolidated interest coverage ratio of 26.38x.
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 October 3, 2021, there was no outstanding borrowings under these facilities and the aggregate amount of standby letters of credit outstanding was $53.4 million. As of October 3, 2021, we had no bank overdrafts related to our disbursement bank accounts.
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.
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Dividends. Our Board of Directors has authorized the following dividends:
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 $ 9,212 February 26, 2021
April 26, 2021 $ 0.20 May 12, 2021 $ 10,831 May 28, 2021
July 26, 2021 $ 0.20 August 20, 2021 $ 10,800 September 3, 2021
November 15, 2021 $ 0.20 December 2, 2021 N/A December 20, 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 unlikely that the current valuation allowance positions of those jurisdictions could be adjusted in the next 12 months.
As of October 3, 2021 and September 27, 2020, the liability for income taxes associated with uncertain tax positions was $14.1 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 changes would be the result of ongoing examinations.
Off-Balance Sheet Arrangements
In the ordinary course of business, we may use off-balance sheet arrangements if we believe that such arrangements would be an efficient way to lower our cost of capital or help us manage the overall risks of our business operations. We do not believe that such arrangements have had a material adverse effect on our financial position or our results of operations.
The following is a summary of our off-balance sheet arrangements:
• Letters of credit and bank guarantees are used primarily to support project performance and insurance programs. We are required to reimburse the issuers of letters of credit and bank guarantees for any payments they make under the outstanding letters of credit or bank guarantees. Our Amended Credit Agreement and additional letter of credit facilities cover the issuance of our standby letters of credit and bank guarantees and are critical for our normal operations. If we default on the Amended Credit Agreement or additional credit facilities, our inability to issue or renew standby letters of credit and bank guarantees would impair our ability to maintain normal operations. At October 3, 2021, we had $0.7 million in standby letters of credit outstanding under our Amended Credit Agreement and $53.4 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 an d construction contrac ts. 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
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remaining amounts payable under the contract, we may have recourse to third parties, such as owners, co-venturers, subcontractors or vendors, for claims.
• In the ordinary course of business, our clients may request that we obtain surety bonds in connection with contract performance obligations that are not required to be recorded in our consolidated balance sheets. We are obligated to reimburse the issuer of our surety bonds for any payments made thereunder. Each of our commitments under performance bonds generally ends concurrently with the expiration of our related contractual obligation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions in the application of certain accounting policies that affect amounts reported in our consolidated financial statements and accompanying footnotes included in Item 8 of this report. In order to understand better the changes that may occur to our financial condition, results of operations and cash flows, readers should be aware of the critical accounting policies we apply and estimates we use in preparing our consolidated financial statements. Although such estimates and assumptions are based on management's best knowledge of current events and actions we may undertake in the future, actual results could differ materially from those estimates.
Our significant accounting policies are described in the "Notes to Consolidated Financial Statements" included in Item 8. Highlighted below are the accounting policies that management considers most critical to investors' understanding of our financial results and condition, and that require complex judgments by management.
Revenue Recognition and Contract Costs
To determine the proper revenue recognition method for contracts under ASC 606, we evaluate whether multiple contracts should be combined and accounted for as a single contract and whether the combined or single contract should be accounted for as having more than one performance obligation. The decision to combine a group of contracts or separate a combined or single contract into multiple performance obligations may impact the amount of revenue recorded in a given period. Contracts are considered to have a single performance obligation if the promises are not separately identifiable from other promises in the contracts.
At contract inception, we assess the goods or services promised in a contract and identify, as a separate performance obligation, each distinct promise to transfer goods or services to the customer. The identified performance obligations represent the “unit of account” for purposes of determining revenue recognition. In order to properly identify separate performance obligations, we apply judgment in determining whether each good or service provided is: (a) capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and (b) distinct within the context of the contract, whereby the transfer of the good or service to the customer is separately identifiable from other promises in the contract.
Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new or changes the existing enforceable rights and obligations. Most of our contract modifications are for goods or services that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
We account for contract modifications as a separate contract when the modification results in the promise to deliver additional goods or services that are distinct and the increase in price of the contract is for the same amount as the stand-alone selling price of the additional goods or services included in the modification.
The transaction price represents the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to our customers. The consideration promised within a contract may include fixed amounts, variable amounts, or both. The nature of our contracts gives rise to several types of variable consideration, including claims, award fee incentives, fiscal funding clauses, and liquidated damages. We recognize revenue for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized for the contract will not occur. We estimate the amount of revenue to be recognized on variable consideration using either the expected value or the most likely amount method, whichever is expected to better predict the amount of consideration to be received. Project mobilization costs are generally charged to project costs as incurred when they are an integrated part of the performance obligation being transferred to the client.
Claims are amounts in excess of agreed contract prices that we seek to collect from our clients or other third parties for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price, or other causes of unanticipated additional costs. Factors considered in determining whether revenue associated with
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claims (including change orders in dispute and unapproved change orders in regard to both scope and price) should be recognized include the following: (a) the contract or other evidence provides a legal basis for the claim, (b) additional costs were caused by circumstances that were unforeseen at the contract date and not the result of deficiencies in our performance, (c) claim-related costs are identifiable and considered reasonable in view of the work performed, and (d) evidence supporting the claim is objective and verifiable. This can lead to a situation in which costs are recognized in one period and revenue is recognized in a subsequent period when a client agreement is obtained, or a claims resolution occurs. In some cases, contract retentions are withheld by clients until certain conditions are met or the project is completed, which may be several months or years. In these cases, we have not identified a significant financing component under ASC 606 as the timing difference in payment compared to delivery of obligations under the contract is not for purposes of financing.
For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using a best estimate of the standalone selling price of each distinct good or service in the contract. The standalone selling price is typically determined using the estimated cost of the contract plus a margin approach. For contracts containing variable consideration, we allocate the variability to a specific performance obligation within the contract if such variability relates specifically to our efforts to satisfy the performance obligation or transfer the distinct good or service, and the allocation depicts the amount of consideration to which we expect to be entitled.
We recognize revenue over time as the related performance obligation is satisfied by transferring control of a promised good or service to our customers. Progress toward complete satisfaction of the performance obligation is primarily measured using a cost-to-cost measure of progress method. The cost input is based primarily on contract cost incurred to date compared to total estimated contract cost. This measure includes forecasts based on the best information available and reflects our judgment to faithfully depict the value of the services transferred to the customer. For certain on-call engineering or consulting and similar contracts, we recognize revenue in the amount which we have the right to invoice the customer if that amount corresponds directly with the value of our performance completed to date.
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost measure of progress method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs indicates a loss, a provision for the entire estimated loss on the contract is made in the period in which the loss becomes evident.
Contract Types
Our services are performed under three principal types of contracts: fixed-price, time-and-materials and cost-plus. Customer payments on contracts are typically due within 60 days of billing, depending on the contract.
Fixed-Price . Under fixed-price contracts, clients pay us an agreed fixed-amount negotiated in advance for a specified scope of work.
Time-and-Materials . Under time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we spend on a project. In addition, clients reimburse us for our actual out-of-pocket costs for materials and other direct incidental expenditures that we incur in connection with our performance under the contract. Most of our time-and-material contracts are subject to maximum contract values, and also may include annual billing rate adjustment provisions.
Cost-Plus . Under cost-plus contracts, we are reimbursed for allowed or otherwise defined costs incurred plus a negotiated fee. The contracts may also include incentives for various performance criteria, including quality, timeliness, ingenuity, safety and cost-effectiveness. In addition, our costs are generally subject to review by our clients and regulatory audit agencies, and such reviews could result in costs being disputed as non-reimbursable under the terms of the contract.
Insurance Matters, Litigation and Contingencies
In the normal course of business, we are subject to certain contractual guarantees and litigation. Generally, such guarantees relate to project schedules and performance. Most of the litigation involves us as a defendant in contractual disagreements, workers' compensation, personal injury and other similar lawsuits. We maintain insurance coverage for various aspects of our business and operations. However, we have elected to retain a portion of losses that may occur through the use of various deductibles, limits and retentions under our insurance programs. This practice may subject us to some future liability for which we are only partially insured or are completely uninsured.
We record in our consolidated balance sheets amounts representing our estimated liability for self-insurance claims. We utilize actuarial analyses to assist in determining the level of accrued liabilities to establish for our employee medical and workers' compensation self-insurance claims that are known and have been asserted against us, as well as for self-insurance claims that are believed to have been incurred based on actuarial analyses but have not yet been reported to our claims
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administrators at the balance sheet date. We include any adjustments to such insurance reserves in our consolidated statements of income.
Except as described in Note 17, "Commitments and Contingencies" of the "Notes to Consolidated Financial Statements" included in Item 8, we do not have any litigation or other contingencies that have had, or are currently anticipated to have, a material impact on our results of operations or financial position. As additional information about current or future litigation or other contingencies becomes available, management will assess whether such information warrants the recording of additional expenses relating to those contingencies. Such additional expenses could potentially have a material impact on our results of operations and financial position.
Goodwill and Intangibles
The cost of an acquired company is assigned to the tangible and intangible assets purchased and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when a market value is not readily available. Any excess of purchase price over the fair value of net tangible and intangible assets acquired is allocated to goodwill. Goodwill typically represents the value paid for the assembled workforce and enhancement of our service offerings.
Identifiable intangible assets include backlog, non-compete agreements, client relations, trade names, patents and other assets. The costs of these intangible assets are amortized over their contractual or economic lives, which range from one to ten years. We assess the recoverability of the unamortized balance of our intangible assets when indicators of impairment are present based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of the intangible assets would be recognized as an impairment loss.
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. In addition, we regularly evaluate whether events and circumstances have occurred that may indicate a potential change in recoverability of goodwill. We perform interim goodwill impairment reviews between our annual reviews if certain events and circumstances have occurred, including a deterioration in general economic conditions, an increased competitive environment, a change in management, key personnel, strategy or customers, negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods (se e Note 6, "Goodwill and Intangible Assets" of the "Notes to Consolidated Financial Statements" in Item 8 for further discussion).
We believe the methodology that we use to review impairment of goodwill, which includes a significant amount of judgment and estimates, provides us with a reasonable basis to determine whether impairment has occurred. However, many of the factors employed in determining whether our goodwill is impaired are outside of our control and it is reasonably likely that assumptions and estimates will change in future periods. These changes could result in future impairments.
The goodwill impairment review involves the determination of the fair value of our reporting units, which for us are the components one level below our reportable segments. This process requires us to make significant judgments and estimates, including assumptions about our strategic plans with regard to our operations as well as the interpretation of current economic indicators and market valuations. Furthermore, the development of the present value of future cash flow projections includes assumptions and estimates derived from a review of our expected revenue growth rates, operating profit margins, business plans, discount rates, and terminal growth rates. We also make certain assumptions about future market conditions, market prices, interest rates and changes in business strategies. Changes in assumptions or estimates could materially affect the determination of the fair value of a reporting unit. This could eliminate the excess of fair value over carrying value of a reporting unit entirely and, in some cases, result in impairment. Such changes in assumptions could be caused by a loss of one or more significant contracts, reductions in government or commercial client spending, or a decline in the demand for our services due to changing economic conditions. In the event that we determine that our goodwill is impaired, we would be required to record a non-cash charge that could result in a material adverse effect on our results of operations or financial position.
We use two methods to determine the fair value of our reporting units: (i) the Income Approach and (ii) the Market Approach. While each of these approaches is initially considered in the valuation of the business enterprises, the nature and characteristics of the reporting units indicate which approach is most applicable. The Income Approach utilizes the discounted cash flow method, which focuses on the expected cash flow of the reporting unit. In applying this approach, the cash flow available for distribution is calculated for a finite period of years. Cash flow available for distribution is defined, for purposes of this analysis, as the amount of cash that could be distributed as a dividend without impairing the future profitability or operations of the reporting unit. The cash flow available for distribution and the terminal value (the value of the reporting unit at the end of the estimation period) are then discounted to present value to derive an indication of the value of the business enterprise. The Market Approach is comprised of the guideline company method and the similar transactions method. The guideline company method focuses on comparing the reporting unit to select reasonably similar (or "guideline") publicly traded companies. Under this method, valuation multiples are (i) derived from the operating data of selected guideline companies;
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(ii) evaluated and adjusted based on the strengths and weaknesses of the reporting units relative to the selected guideline companies; and (iii) applied to the operating data of the reporting unit to arrive at an indication of value. In the similar transactions method, consideration is given to prices paid in recent transactions that have occurred in the reporting unit's industry or in related industries. For our annual impairment analysis, we weighted the Income Approach and the Market Approach at 70% and 30%, respectively. The Income Approach was given a higher weight because it has the most direct correlation to the specific economics of the reporting unit, as compared to the Market Approach, which is based on multiples of broad-based (i.e., less comparable) companies . Our last review at 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. We had no reporting units that had estimated fair values that exceeded their carrying values by less than 150%.
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 in June 2020. This prompted a strategic review of our ASP reporting unit, which is in our CIG reportable segment. As a result of the economic recession in Australia, our revenue growth and profit margin forecasts for the 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. The impaired goodwill related to our acquisitions of Coffey and NDY. As a result of the impairment charge, the estimated fair value of our ASP reporting unit equals 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 former ASP reporting unit into our Client Account Management reporting unit.
During the fourth quarter of fiscal 2019, we performed an interim goodwill impairment review of our RFS reporting unit and recorded a $7.8 million goodwill impairment charge. As a result of the impairment charge, the estimated fair value of the RFS reporting unit equaled its carrying value of $61 million at September 29, 2019, including the remaining $48.8 million of goodwill.
Contingent Consideration
Certain of our acquisition agreements include contingent earn-out arrangements, which are generally based on the achievement of future operating income thresholds. The contingent earn-out arrangements are based upon our valuations of the acquired companies and reduce the risk of overpaying for acquisitions if the projected financial results are not achieved.
The fair values of these earn-out arrangements are included as part of the purchase price of the acquired companies on their respective acquisition dates. For each transaction, we estimate the fair value of contingent earn-out payments as part of the initial purchase price and record the estimated fair value of contingent consideration as a liability in "Estimated contingent earn-out liabilities" and "Long-term estimated contingent earn-out liabilities" on the consolidated balance sheets. We consider several factors when determining that contingent earn-out liabilities are part of the purchase price, including the following: (1) the valuation of our acquisitions is not supported solely by the initial consideration paid, and the contingent earn-out formula is a critical and material component of the valuation approach to determining the purchase price; and (2) the former shareholders of acquired companies that remain as key employees receive compensation other than contingent earn-out payments at a reasonable level compared with the compensation of our other key employees. The contingent earn-out payments are not affected by employment termination.
We measure our contingent earn-out liabilities at fair value on a recurring basis using significant unobservable inputs classified within Level 3 of the fair value hierarchy (See Note 2, "Basis of Presentation and Preparation – Fair Value of Financial Instruments" of the "Notes to Consolidated Financial Statements" included in Item 8). We use a probability weighted discounted income approach as a valuation technique to convert future estimated cash flows to a single present value amount. The significant unobservable inputs used in the fair value measurements are operating income projections over the earn-out period (generally two or three years), and the probability outcome percentages we assign to each scenario. Significant increases or decreases to either of these inputs in isolation would result in a significantly higher or lower liability with a higher liability capped by the contractual maximum of the contingent earn-out obligation. Ultimately, the liability will be equivalent to the amount paid, and the difference between the fair value estimate and amount paid will be recorded in earnings. The amount paid that is less than or equal to the liability on the acquisition date is reflected as cash used in financing activities in our consolidated statements of cash flows. Any amount paid in excess of the liability on the acquisition date is reflected as cash used in operating activities in our consolidated statements of cash flows.
We review and re-assess the estimated fair value of contingent consideration on a quarterly basis, and the updated fair value could differ materially from the initial estimates. Changes in the estimated fair value of our contingent earn-out liabilities related to the time component of the present value calculation are reported in interest expense. Adjustments to the estimated fair value related to changes in all other unobservable inputs are reported in operating income.
Incom e Taxes
52
We file a consolidated U.S. federal income tax return. In addition, we file other returns that are required in the states, foreign jurisdictions and other jurisdictions in which we do business. We account for certain income and expense items differently for financial reporting and income tax purposes. Deferred tax assets and liabilities are computed for the differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to reverse. In determining the need for a valuation allowance on deferred tax assets, management reviews both positive and negative evidence, including current and historical results of operations, future income projections and potential tax planning strategies. Based on our assessment, we have concluded that a portion of the deferred tax assets at October 3, 2021, primarily loss carryforwards, will not be realized, and we have reserved accordingly.
According to the authoritative guidance on accounting for uncertainty in income taxes, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. For more information related to our unrecognized tax benefits, see Note 8, "Income Taxes" of the "Notes to Consolidated Financial Statements" included in Item 8.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of recent accounting standards and the effect they could have on the consolidated financial statements, see Note 2, "Basis of Presentation and Preparation" of the "Notes to Consolidated Financial Statements" included in Item 8.