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. In fiscal 2023, o ur reve nue increased 29.1% compared to fiscal 2022. This growth includes approximately $600 million from the acquisition of RPS Group plc ("RPS"), which was completed in the second quarter of fiscal 2023. Excluding RPS, our revenue increased 12.0% in fiscal 2023 compared to last year. This year-over-year growth reflects increased activity in our U.S. Federal, U.S. Commercial and International client sectors.
U.S. Federal Government. Our U.S. federal government revenue increased 30.3% in fiscal 2023 compared to fiscal 2022. This increase was primarily due to more international development and broad-based increases across civilian agencies. During periods of economic volatility, our U.S. federal government business has historically been the most stable and predictable. We expect our U.S. federal government revenue to continue to grow in fiscal 2024. Approximately $1 trillion in new U.S. federal funding passed in 2021 through the Infrastructure Investment and Jobs Act, the Inflation Reduction Act and the CHIPS and Science Act. Each of these programs include substantial planned investments in our key end markets including water, environment and sustainable infrastructure over the next five to ten years.
U.S. State and Local Government. Our U.S. state and local government revenue increased 0.6% in fiscal 2023 compared to fiscal 2022, which includes lower disaster response activity. Excluding disaster response and the contribution from RPS, our state and loca l government revenue increase d 14.9% in fiscal 2023 compared to last year. The increase reflects continued broad-based growth in our U.S. state and local govern ment infrastructure business, particularly with increased revenue from municipal water infrastructure work, including digital water projects. Most of our work for the U.S. state and local governments relates to critical water and environmental programs, which we expect to continue to grow in fiscal 2024.
U.S. Commercial. Our U.S. commercial reven ue increased 16.1% in fiscal 2023 compared to fiscal 2022. Excluding the contribution from RPS, our U.S. commercial revenue increased 8.2% in fiscal 2023 compared to last year. This increase was primarily due to more activity on clean energy and environmental programs, including meeting net zero carbon goals and designing high performance buildings. We expect growth in our U.S. commercial work to continue in fiscal 2024.
International. Our international revenue increased 52.5% in fiscal 2023 compared to fiscal 2022. Excluding the contribution from RPS, our international revenue increased 10.2%, on a constant currency basis, compared to last year. This revenue growth reflects government stimulus spending on infrastructure and commercial acti vities related to an increased focus on sustainability. We expect growth in our international work to continue in fiscal 2024.
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RESULTS OF OPERATIONS
Fiscal 2023 Compared to Fiscal 2022
Consolidated Results of Operations
Fiscal Year Ended
October 1,
2023 October 2,
2022 Change
$ %
($ in thousands, except per share data)
Revenue $ 4,522,550 $ 3,504,048 $ 1,018,502 29.1%
Subcontractor costs (771,461) (668,468) (102,993) (15.4)
Revenue, net of subcontractor costs (1)
3,751,089 2,835,580 915,509 32.3
Other costs of revenue (3,026,060) (2,260,021) (766,039) (33.9)
Gross profit 725,029 575,559 149,470 26.0
Selling, general and administrative expenses (305,107) (234,784) (70,323) (30.0)
Acquisition and integration expenses (33,169) — (33,169) NM
Right-of-use operating lease asset impairment (16,385) — (16,385) NM
Contingent consideration – fair value adjustments (12,255) (329) (11,926) NM
Income from operations 358,113 340,446 17,667 5.2
Interest expense – net (46,537) (11,584) (34,953) (301.7)
Other non-operating income 89,402 19,904 69,498 349.2
Income before income tax expense 400,978 348,766 52,212 15.0
Income tax expense (127,526) (85,602) (41,924) (49.0)
Net income 273,452 263,164 10,288 3.9
Net income attributable to noncontrolling interests (32) (39) 7 17.9
Net income attributable to Tetra Tech $ 273,420 $ 263,125 $ 10,295 3.9
Diluted earnings per share $ 5.10 $ 4.86 $ 0.24 4.9%
(1) We believe that the presentation of "Revenue, net of subcontractor costs", which is a non-U.S. GAAP financial measure, enhances investors' ability to analyze our business trends and performance because it substantially measures the work performed by our employees. 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 2023, revenue and revenue, net of subcontractor costs, increased $1.02 billion, or 29.1%, and $915.5 million, or 32.3%, respectively, compared to fiscal 2022. Excluding the contribution from RPS, our revenue increased 12.0% in fiscal 2023 compared to last year. Our GSG segment's revenue and revenue, net of subcontractor costs, increased $338.0 million, or 18.6%, and $299.0 million, or 22.4%, respectively, in fiscal 2023 compared to the prior year. Our CIG segment's revenue increased $686.2 million, or 39.5%, and revenue, net of subcontractor costs, increased $616.5 million, or 41.1% in fiscal 2023 compared to fiscal 2022. Excluding the contribution from RPS, our CIG segment's revenue increased approximately 6.7% in fiscal 2023 compared to fiscal 2022 (9.5% on a constant currency basis). The fiscal 2023 results for 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 acquisition and integration costs related to the RPS acquisition and related lease impairment charge in fiscal 2023, adjustments to contingent consideration liabilities, and a non-operating benefit from Employee Retention Credits ("ERC's") received in fiscal 2022. Our adjusted earnings per share ("EPS") for fiscal 2023 also excludes non-operating gains on a foreign exchange contract of $89.4 million and non-recurring tax expense items. The foreign exchange gain is reported as "Other non-operating income" in our consolidated statements of income. The effective tax rates applied to the adjustments to EPS to arrive at adjusted EPS average 26% for both fiscal 2023 and 2022. We applied the relevant marginal statutory tax rate based on the nature of the adjustments and the tax jurisdiction in which it occurred. Both EPS and adjusted EPS were calculated using diluted weighted-average common shares outstanding for the respective periods as reflected in our consolidated statements of income.
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Fiscal Year Ended
October 1,
2023 October 2,
2022 Change
$ %
($ in thousands, except per share data)
Income from operations $ 358,113 $ 340,446 $ 17,667 5.2%
Employee retention credits — (6,486) 6,486 NM
Acquisition & integration expenses 33,169 — 33,169 NM
Right-of-use operating lease asset impairment 16,385 — 16,385 NM
Earn-out adjustments 12,255 — 12,255 NM
Adjusted income from operations (1)
$ 419,922 $ 333,960 $ 85,962 25.7%
EPS $ 5.10 $ 4.86 $ 0.24 4.9%
Employee retention credits — (0.08) 0.08 NM
Acquisition & integration expenses 0.56 — 0.56 NM
Right-of-use operating lease asset impairment 0.22 — 0.22 NM
Earn-out adjustments 0.19 — 0.19 NM
Foreign exchange forward contract gain (1.24) (0.28) (0.96) NM
Non-recurring tax items 0.38 — 0.38 NM
Adjusted EPS (1)
$ 5.21 $ 4.50 $ 0.71 15.8%
NM = not meaningful
(1) Non-U.S. GAAP financial measure
Operating income increased $17.7 million, or 5.2%, in fiscal 2023 compared to last year. The fiscal 2023 results include $33.2 million of acquisition and integration expenses (primarily investment banking, legal and other professional fees) for the RPS acquisition and a related $16.4 million of right-of-use ("ROU") lease asset impairment expense. The fiscal 2023 results also include losses of $12.3 million, related to changes in the estimated fair value of contingent earn-out liabilities. The fiscal 2022 results include the benefit of ERC's totaling $6.5 million, which represents reimbursement from the U.S. federal government under the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") for the costs that we incurred during fiscal 2020 to address the COVID-19 pandemic. These amounts were recognized in fiscal 2022 when the funds were received due to the uncertainty related to the computation of qualifying amounts and delayed processing times for our application. These amounts were primarily reflected as a reduction to "Other costs of revenue" in our consolidated statement of income and an increase to "Net cash provided by operating activities" in our consolidated statement of cash flows for fiscal 2022, consistent with the presentation of the related costs recognized in fiscal 2020.
Excluding the acquisition and integration expenses, ROU asset impairment, earn-out losses and the ERC's, our adjusted operating income increased $86.0 million, or 25.7% in fiscal 2023 compared to fiscal 2022. These increases reflect improved results in both GSG and CIG segments, which are described below under "Government Services Group" and "Commercial/International Group", respectively.
Our net interest expense was $46.5 million and $11.6 million in fiscal 2023 and 2022, respectively. Net interest expense in fiscal 2023 included $2.7 million of additional expense for the write-off of previously deferred debt origination fees due to the cancellation of the bridge loan facility that we entered to support our offer to acquire RPS, which was replaced with an amendment to our existing debt facility and $1.1 million of additional expense for the write-off of previously deferred debt origination fees due to the repayment and cancellation of RPS' debt facilities. Excluding these write-offs, our interest expense increased $31.2 million in fiscal 2023 compared to last year primarily due to the additional borrowings to fund the RPS acquisition.
Other non-operating income of $89.4 million in fiscal 2023, reflect gains on a foreign exchange forward contract integrated with the RPS acquisition. Although an effective economic hedge of our foreign exchange risk related to this transaction, the forward contract did not qualify for hedge accounting. As a result, the forward contract was marked-to-market with changes in fair value recognized in earnings each period. The forward contract was settled on January 23, 2023, together with the closing of the RPS acquisition, with a cumulative cash gain of approximately $109 million.
The effective tax rates for fiscal 2023 and 2022 were 31.8% and 24.5%, respectively. Income tax expense in fiscal 2023 included non-operating income tax expenses totaling $20.6 million to (i) increase the tax liability for uncertain tax positions related to certain U.S. tax credits and an intercompany financing transaction, (ii) to recognize the tax liability for
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foreign earnings, primarily in the U.K. and Australia, that are no longer indefinitely reinvested. In addition, income tax expense was reduced by $4.6 million and $10.3 million of excess tax benefits on share-based payments in fiscal 2023 and 2022, respectively. Excluding the impact of the non-operating tax expenses in fiscal 2023 and the excess tax benefits on share-based payments in both years, our effective tax rates in fiscal 2023 and 2022 were 27.8% and 27.5%.
Our EPS was $5.10 in fiscal 2023, compared to $4.86 in fiscal 2022. Excluding the aforementioned non-operating items (including the foreign exchange gain and the non-operating tax items, which are both reported outside of operating income), our adjusted EPS was $5.21 in fiscal 2023, compared to $4.50 in fiscal 2022, an increase of 15.8%. For fiscal 2023, we estimate that RPS increased our adjusted EPS by $0.07 before intangible amortization, which reduced our EPS by $0.37. Excluding RPS, our adjusted EPS was $5.51 in fiscal 2023 representing an increase of 22.4%, compared to fiscal 2022.
Segment Results of Operations
Government Services Group ("GSG")
Fiscal Year Ended
October 1,
2023 October 2,
2022 Change
$ %
($ in thousands)
Revenue $ 2,158,889 $ 1,820,868 $ 338,021 18.6%
Subcontractor costs (523,449) (484,412) (39,037) (8.1)
Revenue, net of subcontractor costs $ 1,635,440 $ 1,336,456 $ 298,984 22.4
Income from operations $ 231,762 $ 198,448 $ 33,314 16.8%
Revenue and revenue, net of subcontractor costs, increased $338.0 million, or 18.6%, and increased $299.0 million, or 22.4%, respectively, in fiscal 2023 compared to fiscal 2022. This increase includes approximately $70 million in revenue in the second quarter of fiscal 2023 related to a distinct international development funded energy program in Ukraine. In addition, the increases reflect higher U.S. state and local government activities related to digital water and U.S. federal programs, partially offset by lower disaster response revenue.
Operating income increased $33.3 million in fiscal 2023 compared to fiscal 2022. The increase in operating income is consistent with the revenue increase noted above. The fiscal 2023 results were reduced by $6.8 million of the aforementioned lease impairment charge and the fiscal 2022 results included $4.4 million of the aforementioned ERC's. Our operating margin, based on revenue, net of subcontractor costs, was 14.2% in fiscal 2023 compared to 14.8% last year. Excluding the lease impairment charge in fiscal 2023 and last year's ERC's, our operating margin increased to 14.6% in fiscal 2023 from 14.5% in fiscal 2022.
Commercial/International Services Group ("CIG")
Fiscal Year Ended
October 1,
2023 October 2,
2022 Change
$ %
($ in thousands)
Revenue $ 2,424,649 $ 1,738,436 $ 686,213 39.5%
Subcontractor costs (309,000) (239,312) (69,688) (29.1)
Revenue, net of subcontractor costs $ 2,115,649 $ 1,499,124 $ 616,525 41.1
Income from operations $ 243,750 $ 194,142 $ 49,608 25.6%
Revenue and revenue, net of subcontractor costs, increased $686.2 million, or 39.5%, and increased $616.5 million, or 41.1%, respectively, in fiscal 2023 compared to fiscal 2022. The RPS acquisition contributed approximately $570 million to revenue growth in fiscal 2023. The remaining revenue growth in fiscal 2023 primarily reflects increased activity on high performance buildings, clean energy and international infrastructure.
Operating income increased $49.6 million in fiscal 2023 compared to fiscal 2022. The RPS acquisition contributed approximately $34 million to operating income in fiscal 2023. Conversely, the fiscal 2023 results were reduced by $8.3 million of the aforementioned lease impairment charge. The fiscal 2022 operating income included $1.9 million of the aforementioned ERC's. Our operating margin, based on revenue, net of subcontractor costs, was 11.5% in fiscal 2023 compared to 13.0% in
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fiscal 2022. Excluding the lease impairment and RPS in fiscal 2023 and the ERC's in fiscal 2022, our operating margin was 13.3% in fiscal 2023 compared to 12.8% in fiscal 2022. The improved operating margin was primarily due to our increased focus on high-end consulting services, project execution and higher labor utilization.
Fiscal 2022 Compared to Fiscal 2021
Consolidated Results of Operations
Fiscal Year Ended
October 2,
2022 October 3, 2021 Change
$ %
($ in thousands, except per share data)
Revenue $ 3,504,048 $ 3,213,513 $ 290,535 9.0%
Subcontractor costs (668,468) (661,341) (7,127) (1.1)
Revenue, net of subcontractor costs (1)
2,835,580 2,552,172 283,408 11.1
Other costs of revenue (2,260,021) (2,053,772) (206,249) (10.0)
Gross profit 575,559 498,400 77,159 15.5
Selling, general and administrative expenses (234,784) (222,972) (11,812) (5.3)
Contingent consideration – fair value adjustments (329) 3,273 (3,602) (110.1)
Income from operations 340,446 278,701 61,745 22.2
Interest expense – net (11,584) (11,831) 247 2.1
Other income 19,904 — 19,904 NM
Income before income tax expense 348,766 266,870 81,896 30.7
Income tax expense (85,602) (34,039) (51,563) (151.5)
Net income 263,164 232,831 30,333 13.0
Net income attributable to noncontrolling interests (39) (21) (18) (85.7)
Net income attributable to Tetra Tech $ 263,125 $ 232,810 $ 30,315 13.0
Diluted earnings per share $ 4.86 $ 4.26 $ 0.60 14.1%
(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 2022, revenue and revenue, net of subcontractor costs, increased $290.5 million, or 9.0%, and $283.4 million, or 11.1%, respectively, compared to fiscal 2021. Excluding the contributions from acquisitions, which did not have comparable revenue in fiscal 2021, our revenue increased 4.1% in fiscal 2022 compared to fiscal 2021. Our GSG segment's revenue and revenue, net of subcontractor costs, increased $48.0 million, or 2.7%, and $70.7 million, or 5.6%, respectively, in fiscal 2022 compared to the prior year. Our CIG segment's revenue increased $238.4 million, or 15.9%, and revenue, net of subcontractor costs, increased $213.3 million, or 16.6% in fiscal 2022 compared to fiscal 2021. The fiscal 2022 results for GSG and CIG segments are described below under "Government Services Group" and "Commercial/International Services Group", respectively.
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The following table reconciles our reported results to non-U.S. GAAP adjusted results, which exclude a non-operating benefit from ERC's received in fiscal 2022 and gains from adjustments to contingent consideration liabilities in fiscal 2021. Our adjusted EPS for fiscal 2022 also excludes a non-operating $19.9 million unrealized gain on the aforementioned foreign exchange contract that served as an economic hedge related to our acquisition of RPS. This gain is reported as "Other non-operating income" in our Consolidated Statement of Income for fiscal 2022. Our adjusted EPS for fiscal 2021 also excludes non-recurring tax items. The effective tax rates applied to the adjustments to EPS to arrive at adjusted EPS average 26% and 25% for fiscal 2022 and 2021, respectively. We applied the relevant marginal statutory tax rate based on the nature of the adjustments and the tax jurisdiction in which it occurred. Both EPS and adjusted EPS were calculated using diluted weighted-average common shares outstanding for the respective periods as reflected in our consolidated statements of income.
Fiscal Year Ended
October 2,
2022 October 3, 2021 Change
$ %
($ in thousands, except per share data)
Income from operations $ 340,446 $ 278,701 $ 61,745 22.2%
Earn-out adjustments — (3,273) 3,273 NM
Employee Retention Credits (6,486) — (6,486) NM
Adjusted income from operations (1)
$ 333,960 $ 275,428 $ 58,532 21.3%
EPS $ 4.86 $ 4.26 $ 0.60 14.1%
Earn-out adjustments — (0.04) 0.04 NM
Employee Retention Credits (0.08) — (0.08) NM
Other income (0.28) — (0.28) NM
Non-recurring tax benefits — (0.43) 0.43 NM
Adjusted EPS (1)
$ 4.50 $ 3.79 $ 0.71 18.7%
NM = not meaningful
(1) Non-U.S. GAAP financial measure
Operating income increased $61.7 million, or 22.2%, in fiscal 2022 compared to fiscal 2021. The fiscal 2022 results included the benefit of ERC's totaling $6.5 million. Excluding the ERC's and the contributions from acquisitions, which did not have comparable results in fiscal 2021, our adjusted operating income increased $31.5 million, or 11.5% in fiscal 2022 compared to fiscal 2021. These increases reflect improved results in both GSG and CIG segments, which are described below under "Government Services Group" and "Commercial/International Services Group", respectively.
Our net interest expense was $11.6 million and $11.8 million in fiscal 2022 and 2021, respectively. The decrease primarily reflects lower average year-over-year borrowings, partially offset by higher borrowing rates.
The effective tax rates for fiscal 2022 and 2021 were 24.5% and 12.8%, respectively. The fiscal 2021 effective tax rate reflects a non-recurring net tax benefit of $21.6 million, primarily consisting of a valuation allowance in the United Kingdom that was released due to sufficient sustainable profitability being achieved in fiscal 2021. The valuation allowance was primarily related to net operating loss carry-forwards. In fiscal 2021, we repatriated approximately $80 million from Canada and recognized a related tax expense of $5.6 million. Also, i ncome tax expense was reduced by $10.3 million and $12.9 million of excess tax benefits on share-based payments in fiscal 2022 and 2021, respectively. Excluding the impact of the fiscal 2021 valuation allowance benefit, the fiscal 2021 Canadian repatriation and the excess tax benefits on share-based payments in both fiscal years, our effective tax rates for fiscal 2022 and 2021 were 27.5% and 25.7%, respectively.
Our EPS was $4.86 in fiscal 2022, compared to $4.26 in fiscal 2021. Excluding the aforementioned non-operating and non-recurring items, our adjusted EPS was $4.50 in fiscal 2022, compared to $3.79 the prior year, an increase of 18.7%.
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Segment Results of Operations
Government Services Group ("GSG")
Fiscal Year Ended
October 2,
2022 October 3, 2021 Change
$ %
($ in thousands)
Revenue $ 1,820,868 $ 1,772,905 $ 47,963 2.7%
Subcontractor costs (484,412) (507,132) 22,720 4.5
Revenue, net of subcontractor costs $ 1,336,456 $ 1,265,773 $ 70,683 5.6
Income from operations $ 198,448 $ 174,755 $ 23,693 13.6%
Revenue and revenue, net of subcontractor costs, increased $48.0 million, or 2.7%, and increased $70.7 million, or 5.6%, respectively, in fiscal 2022 compared to fiscal 2021. The increases primarily reflect higher U.S. state and local government activities related to water and environmental programs and disaster response projects.
Operating income increased $23.7 million in fiscal 2022 compared to fiscal 2021. The fiscal 2022 results included $4.4 million of the aforementioned ERC's. Excluding this benefit, operating income increased 11.0% in fiscal 2022 compared the previous year. Our operating margin, based on revenue, net of subcontractor costs, improved to 14.8% in fiscal 2022 compared to 13.8% in fiscal 2021. Excluding the ERC's, our op erating margin was 14.5% in fiscal 2022. The improved operating margin in fiscal 2022 was primarily due to our increased focus on high-end consulting services, including digital water, and improved labor utilization.
Commercial/International Services Group ("CIG")
Fiscal Year Ended
October 2,
2022 October 3, 2021 Change
$ %
($ in thousands)
Revenue $ 1,738,436 $ 1,500,074 $ 238,362 15.9%
Subcontractor costs (239,312) (214,263) (25,049) (11.7)
Revenue, net of subcontractor costs $ 1,499,124 $ 1,285,811 $ 213,313 16.6
Income from operations $ 194,142 $ 152,262 $ 41,880 27.5%
Revenue and revenue, net of subcontractor costs, increased $238.4 million, or 15.9%, and increased $213.3 million, or 16.6%, respectively, in fiscal 2022 compared to fiscal 2021. The revenue growth primarily reflects increased activity on commercial environmental programs, including meeting net zero carbon goals and high performance buildings. These increases were also due to the international government stimulus spending on infrastructure. Additionally, the fiscal 2022 revenue included contributions from acquisitions, which did not have comparable revenue in fiscal 2021.
Operating income increased $41.9 million in fiscal 2022 compared to fiscal 2021. The fiscal 2022 operating income included $1.9 million of the aforementioned ERC's. Excluding this benefit, operating income increased 26.2% in fiscal 2022 compared the prior fiscal year. Our operating margin, based on revenue, net of subcontractor costs, improved to 13.0% in fiscal 2022 compared to 11.8% in fiscal 2021. Excluding the ERC's, o ur operating margin was 12.8% for fiscal 2022. The improved operating margin was primarily due to our increased focus on high-end consulting services, project execution and labor utilization.
Remediation and Construction Management ("RCM")
RCM's projects were substantially complete at the end of fiscal 2018. In May 2022, we received a cash settlement for the last $11 million RCM claim. This settlement resulted in an immaterial gain in the third quarter of fiscal 2022. There were no significant operating activities in RCM for fiscal 2022 and 2021.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Capital Requirements. As of October 1, 2023, we had $168.8 million of cash and cash equivalents and access to an additional $800 million of borrowing available under our credit facility. We generated $368.5 million of cash from operations
40
in fiscal 2023. 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, cash dividends, capital expenditures 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 amended for the RPS acquisition in the second quarter of fiscal 2023, as described below, will be sufficient to meet our capital requirements for at least the next 12 months.
On October 5, 2021, our Board of Directors authorized a new stock repurchase program under which we could repurchase up to $400 million of our common stock. In fiscal 2023, we did not repurchase any shares of our common stock. At fiscal 2023 year-end, we had a remaining balance of $347.8 million under our stock repurchase program. We declared and paid common stock dividends totaling $52.1 million, or $0.98 per share, in fiscal 2023 compared to $46.1 million, or $0.86 per share, in fiscal 2022.
Subsequent Events. On November 13, 2023, our Board of Directors declared a quarterly cash dividend of $0.26 per share payable on December 13, 2023 to stockholders of record as of the close of business on November 30, 2023.
Cash and Cash Equivalents. As of October 1, 2023, cash and cash equivalents were $168.8 million, a decrease of $16.3 million compared to the fiscal 2022 year-end.
Operating Activities. Cash provided by operating activities increased 9.6% from $336.2 million in fiscal 2022 to $368.5 million in fiscal 2023. The increase primarily reflects improved working capital, partially offset by approximately $37.0 million of additional payments made in fiscal 2023 for the RPS acquisition, primarily related to the acquisition and integration costs.
Investing Activities. Net cash used in investing activities was $771.2 million in fiscal 2023, an increase of $715.5 million compared to fiscal 2022. The increase was primarily due to the RPS acquisition in the second quarter of fiscal 2023.
Financing Activities. In fiscal 2023, net cash provided by financing activities was $382.4 million compared to net cash used in financing activities of $249.6 million in fiscal 2022. The financing activities in fiscal 2023 primarily consisted of additional borrowings to fund the RPS acquisition.
Debt Financing. On October 26, 2022, we entered into a Third Amended and Restated Credit Agreement that provides for an additional $500 million senior secured term loan facility (the "New Term Loan Facility") increasing our total borrowing capacity to $1.55 billion. On January 23, 2023, we drew the entire amount of the New Term Loan Facility to partially finance the RPS acquisition. The New Term Loan Facility is not subject to any amortization payments of principal and matures on the third anniversary of the RPS acquisition closing date.
On February 18, 2022, we entered into Amendment No. 2 to our 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. 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.
On August 22, 2023, we issued $575.0 million in convertible notes that bear interest at 2.25% per annum payable semiannually in arrears on February 15 and August 15 of each year, beginning on February 15, 2024 with a maturity date of August 15, 2028 (the "Convertible Notes"). As of October 1, 2023, $560.8 million of the Convertible Notes was included in long-term debt in our consolidated balance sheets, which is net of $14.2 million of unamortized debt issuance costs. The net proceeds from the Convertible Notes were $560.5 million, $51.8 million of which were used to purchase related capped call transactions on the issue date. The remaining proceeds were used to prepay and terminate the $234.4 million outstanding under the Amended Term Loan Facility, to prepay $89.4 million outstanding under the New Term Loan Facility and to pay down
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borrowings of $185.0 million under the Amended Revolving Credit Facility. See Note 9, "Long-Term Debt" of the "Notes to Consolidated Financial Statements" in Item 8 for further discussion).
At fiscal 2023 year-end, we had $320 million in outstanding borrowings under the Amended Credit Agreement, which was all under the New Ter m Loan Facility, and no borrowings under the Amended Revolving Credit Facility. The weighted-average interest rate of the outstanding borrowings during fiscal 2023 was 5.71%. In addition, we had $0.7 million in standby letters of credit under the Amended Credit Agreement. Our year-to-date weighted-average interest rate on borrowings outstanding during fiscal 2023 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 5.37%. At October 1, 2023, we had $499.3 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 $0.6 million for fiscal year 2023 and $0.7 million each year for fiscal 2022 and 2021, 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 3.25 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. At October 1, 2023, we were in compliance with these covenants with a consolidated leverage ratio of 1.79x and a consolidated interest coverage ratio of 9.84x.
In addition to the Amended Credit Agreement, we maintain other credit facilities, which may be used for short-term cash advances and bank guarantees. At October 1, 2023, there were no outstanding borrowings under these facilities, and the aggregate amount of standby letters of credit outstanding was $54.9 million. As of October 1, 2023, 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.
Dividends. Our Board of Directors has authorized the following dividends:
Dividend Per Share Record Date Total Maximum
Payment
(in thousands) Payment Date
November 7, 2022 $ 0.23 November 21, 2022 $ 12,186 December 9, 2022
January 30, 2023 $ 0.23 February 13, 2023 $ 12,242 February 24, 2023
May 8, 2023 $ 0.26 May 24, 2023 $ 13,840 June 6, 2023
August 7, 2023 $ 0.26 August 23, 2023 $ 13,845 September 6, 2023
November 13, 2023 $ 0.26 November 30, 2023 N/A December 13, 2023
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.
At the end of fiscal 2023 and 2022, the liability for income taxes associated with uncertain tax positions was $62.0 million and $10.6 million, respectively.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of our unrecognized tax positions may not significantly decrease within the next 12 months. These liabilities represent our current estimates of the additional tax liabilities that we may be assessed when the related audits are concluded. If these audits are resolved in a manner more unfavorable than our current expectations, our additional tax liabilities could be materially higher than the amounts currently recorded resulting in additional tax expense.
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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 t he 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 fiscal 2023 year-end, we had $0.7 million in standby letters of credit outstanding under our Amended Credit Agreement and $54.9 million in standby letters of credit outstanding under our additional letter of credit facilities.
• From time to time, we provide guarantees and indemnifications related to our services. If our services under a guaranteed or indemnified project are later determined to have resulted in a material defect or other material deficiency, then we may be responsible for monetary damages or other legal remedies. When sufficient information about claims on guaranteed or indemnified projects is available and monetary damages or other costs or losses are determined to be probable, we recognize such guaranteed losses.
• In the ordinary course of business, we enter into various agreements as part of certain unconsolidated subsidiaries, joint ventures and other jointly executed contracts where we are jointly and severally liable. We enter into these agreements primarily to support the project execution commitments of these entities. The potential payment amount of an outstanding performance guarantee is typically the remaining cost of work to be performed by or on behalf of third parties under engineering and construction contracts. However, we are not able to estimate other amounts that may be required to be paid in excess of estimated costs to complete contracts and, accordingly, the total potential payment amount under our outstanding performance guarantees cannot be estimated. For cost-plus contracts, amounts that may become payable pursuant to guarantee provisions are normally recoverable from the client for work performed under the contract. For lump sum or fixed-price contracts, this amount is the cost to complete the contracted work less amounts remaining to be billed to the client under the contract. Remaining billable amounts could be greater or less than the cost to complete. In those cases where costs exceed the remaining amounts payable under the contract, we may have recourse to third parties, such as owners, co-venturers, subcontractors or vendors, for claims.
• In the ordinary course of business, our clients may request that we obtain surety bonds in connection with contract performance obligations that are not required to be recorded in our consolidated balance sheets. We are obligated to reimburse the issuer of our surety bonds for any payments made thereunder. Each of our commitments under performance bonds generally ends concurrently with the expiration of our related contractual obligation.
CRITICAL ACCOUNTING POLICIES 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
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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 “units 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.
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.
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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.
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 primarily include backlog, client relations and trade names. The costs of these intangible assets are amortized over their contractual or economic lives, which range from one to twelve 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.
Estimated fair value measurements for intangible assets are made using Level 3 inputs including discounted cash flow techniques. Fair value is estimated using a multi-period excess earnings method for backlog and client relations and a relief from royalty method for trade names. The significant assumptions used in estimating fair value of backlog and client relations include (i) the estimated life the asset will contribute to cash flows, such as remaining contractual terms, (ii) revenue growth rates and EBITDA margins, (iii) attrition rate of customers, and (iv) the estimated discount rates that reflect the level of risk associated with receiving future cash flows. The significant assumptions used in estimating fair value of trade names include the royalty rates and discount rates.
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
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available for distribution is calculated for a finite period of years. Cash flow available for distribution is defined, for purposes of this analysis, as the amount of cash that could be distributed as a dividend without impairing the future profitability or operations of the reporting unit. The cash flow available for distribution and the terminal value (the value of the reporting unit at the end of the estimation period) are then discounted to present value to derive an indication of the value of the business enterprise. The Market Approach is comprised of the guideline company method and the similar transactions method. The guideline company method focuses on comparing the reporting unit to select reasonably similar (or "guideline") publicly traded companies. Under this method, valuation multiples are (i) derived from the operating data of selected guideline companies; (ii) evaluated and adjusted based on the strengths and weaknesses of the reporting units relative to the selected guideline companies; and (iii) applied to the operating data of the reporting unit to arrive at an indication of value. In the similar transactions method, consideration is given to prices paid in recent transactions that have occurred in the reporting unit's industry or in related industries. For our annual impairment analysis, we weighted the Income Approach and the Market Approach at 70% and 30%, respectively. The Income Approach was given a higher weight because it has the most direct correlation to the specific economics of the reporting unit, as compared to the Market Approach, which is based on multiples of broad-based (i.e., less comparable) companies . Our last review at July 3, 2023 (i.e., the first day of our fourth quarter in fiscal 2023), 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 45%.
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.
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.