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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

x                               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 27, 2015

OR

o                                  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to ___________

Commission File Number 0-19655

TETRA TECH, INC.

(Exact name of registrant as specified in its charter)

3475 East Foothill Boulevard, Pasadena, California  91107

(Address of principal executive offices)  (Zip Code)

(626) 351-4664

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x   No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x   No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o   No  x

As of January 25, 2016, 58,624,247 shares of the registrant’s common stock were outstanding.

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TETRA TECH, INC.

INDEX

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PART I.                                                  FINANCIAL INFORMATION

Item 1.           Financial Statements

Tetra Tech, Inc.

Condensed Consolidated Balance Sheets

(unaudited - in thousands, except par value)

See Notes to Condensed Consolidated Financial Statements.

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Tetra Tech, Inc.

Condensed Consolidated Statements of Income

(unaudited – in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

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Tetra Tech, Inc.

Condensed Consolidated Statements of Comprehensive Income

(unaudited – in thousands)

See Notes to Condensed Consolidated Financial Statements.

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Tetra Tech, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited – in thousands)

See Notes to Condensed Consolidated Financial Statements.

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TETRA TECH, INC.

Notes to Condensed Consolidated Financial Statements

1.                                    Basis of Presentation

The accompanying unaudited condensed consolidated financial statements and related notes of Tetra Tech, Inc. (“we,” “us” or “our”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  They do not include all of the information and footnotes required by GAAP for complete financial statements and, therefore, should be read in conjunction with the audited consolidated financial statements and related notes contained in our Annual Report on Form 10-K for the fiscal year ended September 27, 2015.

These financial statements reflect all normal recurring adjustments that are considered necessary for a fair statement of our financial position, results of operations and cash flows for the interim periods presented.  The results of operations and cash flows for any interim period are not necessarily indicative of results for the full year or for future years.

We report our water resources, water and wastewater treatment, environment and infrastructure engineering activities in our Water, Environment and Infrastructure (“WEI”) reportable segment.  Our Resource Management and Energy (“RME”) reportable segment includes our natural resources, energy, waste management, remediation, utilities and international development services.  We report the results of the wind-down of our non-core construction activities in the Remediation and Construction Management (“RCM”) reportable segment.  In the first quarter of fiscal 2016, we re-aligned certain operating units within our reportable segments to improve organizational effectiveness by better aligning operations with similar clients and projects (see Note 10, “Reportable Segments” for further discussion).  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

2.                                      Accounts Receivable – Net

Net accounts receivable and billings in excess of costs on uncompleted contracts consisted of the following:

Billed accounts receivable represent amounts billed to clients that have not been collected.  Unbilled accounts receivable represent revenue recognized but not yet billed pursuant to contract terms or billed after the period end date.  Most of our unbilled receivables at December 27, 2015 are expected to be billed and collected within 12 months.  Contract retentions represent amounts withheld by clients until certain conditions are met or the project is completed, which may be several months or years.  The allowance for doubtful accounts represents amounts that may become uncollectible or unrealizable in the future.  We determine an estimated allowance for uncollectible accounts based on management’s consideration of trends in the actual and forecasted credit quality of our clients, including delinquency and payment history; type of client, such as a government agency or a commercial sector client; and general economic and particular industry conditions that may affect a client’s ability to pay.  Billings in excess of costs on uncompleted contracts represent the amount of cash collected from clients and billings to clients on contracts in advance of revenue recognized.  The majority of billings in excess of costs on uncompleted contracts will be earned within 12 months.

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Once contract performance is underway, we may experience changes in conditions, client requirements, specifications, designs, materials, and expectations regarding the period of performance.  Such changes result in “change orders” and may be initiated by us or by our clients.  In many cases, agreement with the client as to the terms of change orders is reached prior to work commencing; however, sometimes circumstances require that work progresses without obtaining a definitive client agreement. Unapproved change orders constitute claims 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, or other causes of unanticipated additional costs. Revenue on claims is recognized when contract costs related to claims have been incurred and when their addition to contract value can be reliably estimated.  This can lead to a situation in which costs are recognized in one period and revenue is recognized in a subsequent period such as when client agreement is obtained or a claims resolution occurs.

Total accounts receivable at December 27, 2015 and September 27, 2015 included approximately $39 million and $53 million, respectively, related to claims, including requests for equitable adjustment, on contracts that provide for price redetermination.  During the first quarter of fiscal 2016 we collected $13.4 million to settle claims of $8.8 million, which resulted in gains in operating income of $4.6 million in the RCM reportable segment.  We regularly evaluate all unsettled claim amounts and record appropriate adjustments to operating earnings when it is probable that the claim will result in a different contract value than the amount previously estimated.  In the first quarter of fiscal 2016, we also recognized reductions to operating income in our RCM segment and a related increase in the allowance for doubtful accounts of $7.9 million as a result of our updated assessment of the collectability of certain accounts receivable, of which $4.6 million related to unsettled claims.  As a result of the assessment of claims in last year’s first quarter, we recognized revenue and an increase in operating income of $3.2 million related to claims with a federal government client.

Billed accounts receivable related to U.S. federal government contracts were $58.0 million and $61.9 million at December 27, 2015 and September 27, 2015, respectively.  U.S. federal government unbilled receivables were $62.3 million and $74.2 million at December 27, 2015 and September 27, 2015, respectively.  Other than the U.S. federal government, no single client accounted for more than 10% of our accounts receivable at December 27, 2015 and September 27, 2015.

We recognize revenue for most of our contracts using the percentage-of-completion method, primarily utilizing the cost-to-cost approach to estimate the progress towards completion in order to determine the amount of revenue and profit to recognize. Changes in those estimates could result in recognition of cumulative catch-up adjustments to the contract’s inception-to-date revenue, costs, and profit in the period in which such changes are made.  As a result, we recognized immaterial net operating income adjustments during the first quarter of fiscal 2016 compared to net unfavorable operating income adjustments of $2.4 million in last year’s first quarter.  Changes in revenue and cost estimates could also result in a projected loss that would be recorded immediately in earnings.  As of December 27, 2015 and September 27, 2015, we recorded a liability for anticipated losses of $8.6 million and $10.5 million, respectively.  The estimated cost to complete the related contracts as of December 27, 2015 was $47.7 million.

3.                                      Mergers and Acquisitions

We made no acquisitions in the first quarter of fiscal 2016.  In fiscal 2015, we acquired Cornerstone Environmental Group, LLC (“CEG”), headquartered in Middletown, New York.  CEG is an environmental engineering and consulting firm focused on solid waste markets in the United States, and is included in our RME segment.  The fair value of the purchase price for CEG was $15.9 million.  Of this amount, $11.8 million was paid to the sellers and $4.1 million was the estimated fair value of contingent earn-out obligations, with a maximum of $9.8 million, based upon the achievement of specified financial objectives.

Goodwill additions resulting from business combinations are primarily attributable to the existing workforce of the acquired companies and the synergies expected to arise after the acquisitions.  Specifically, the goodwill additions related to the fiscal 2015 acquisition primarily represents the value of a workforce with distinct expertise in the solid waste markets.  In addition, these acquired capabilities, when combined with our existing global consulting and engineering business, result in opportunities that allow us to provide services under contracts that could not have been pursued individually by either us or the acquired company.  The results of this acquisition were included in the consolidated financial statements from the closing date.  The acquisition was not considered material to our condensed consolidated financial statements.  As a result, no pro forma information has been provided.

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Most of our acquisition agreements include contingent earn-out agreements, which are generally based on the achievement of future operating income thresholds.  The contingent earn-out arrangements are based on our valuations of the acquired companies, and reduce the risk of overpaying for acquisitions if the projected financial results are not achieved.  The fair values of any earn-out arrangements are included as part of the purchase price of the acquired companies on their respective acquisition dates.  For each transaction, we estimate the fair value of contingent earn-out payments as part of the initial purchase price and record the estimated fair value of contingent consideration as a liability in “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 owners of acquired companies that remain as key employees receive compensation other than contingent earn-out payments at a reasonable level compared with the compensation of our other key employees.  The contingent earn-out payments are not affected by employment termination.

We measure our contingent earn-out liabilities at fair value on a recurring basis using significant unobservable inputs classified within Level 3 of the fair value hierarchy (as described in “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 27, 2015).  We use a probability-weighted discounted income approach as a valuation technique to convert future estimated cash flows to a single present value amount.  The significant unobservable inputs used in the fair value measurements are operating income projections over the earn-out period (generally two or three years), and the probability outcome percentages we assign to each scenario.  Significant increases or decreases to either of these inputs in isolation would result in a significantly higher or lower liability, with a higher liability capped by the contractual maximum of the contingent earn-out obligation.  Ultimately, the liability will be equivalent to the amount paid, and the difference between the fair value estimate and amount paid will be recorded in earnings.  The amount paid that is less than or equal to the contingent earn-out liability on the acquisition date is reflected as cash used in financing activities in our consolidated statements of cash flows.  Any amount paid in excess of the contingent earn-out liability on the acquisition date is reflected as cash used in operating activities.

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.  During the first quarter of fiscal 2016, we recorded an increase in our contingent earn-out liabilities and reported a related loss in operating income of $1.0 million.  This loss represents the final cash settlement during the first quarter of fiscal 2016 of an earn-out liability that was valued at $0 at the end of fiscal 2015.  We recorded no gains or losses related to changes in the estimated fair value of our contingent earn-out liabilities in the first quarter of fiscal 2015.

At December 27, 2015, there was a total maximum of $25.6 million of outstanding contingent consideration related to acquisitions.  Of this amount, $4.2 million was estimated as the fair value and accrued on our condensed consolidated balance sheet.

Subsequent Event.  On January 19, 2016, we announced that our off-market takeover bid for all of the outstanding shares of Coffey International Limited (“Coffey”) was free from all conditions required to close the purchase.  The payment for the shares will occur in the second quarter of fiscal 2016, with a purchase price of approximately $76 million for 100% of the shares.

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4.                                      Goodwill and Intangible Assets

The following table summarizes the changes in the carrying value of goodwill:

We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter.  Our most recent review was performed at June 29, 2015 (i.e. the first day of our fourth quarter in fiscal 2015).  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 increase in the competitive environment; a change in management, key personnel, strategy or customers; negative or declining cash flows; or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.

We estimate the fair value of all reporting units with a goodwill balance based on a comparison and weighting of the income approach (weighted 70%), specifically the discounted cash flow method and the market approach (weighted 30%), which estimates the fair value of our reporting units based upon comparable market prices and recent transactions and also validates the reasonableness of the multiples from the income approach.  The resulting fair value is most sensitive to the assumptions we use in our discounted cash flow analysis.  The assumptions that have the most significant impact on the fair value calculation are the reporting unit’s revenue growth rate and operating profit margin, and the discount rate used to convert future estimated cash flows to a single present value amount.

In the fourth quarter of fiscal 2015, we determined that our Waste Management Group (“WMG”) reporting unit in our RME segment had an estimated fair value that exceeded its carrying value by less than 20%.  In our discounted cash flow model for WMG, we assumed annual revenue growth rates of 3% to 5% based on historical trends in WMG and the solid waste industry, projections for future solid waste activity, and WMG’s backlog and prospects for new orders.  We discounted the resulting cash flows at a rate of 11.0%.  Our market based assessment resulted in a value approximating a 1.0 multiple of revenue for the 12 month period preceding the valuation date.  The discounted cash flow value, combined on a weighted-average basis with the results of our market analysis, resulted in an estimated fair value for WMG of $103.5 million compared to our carrying value including goodwill of $93.9 million. No changes occurred during the first quarter of fiscal 2016 that would significantly change these amounts.  As of December 27, 2015, the goodwill amount for WMG was $56.5 million.

Although we believe that our current estimate of fair value is reasonable, our analysis is primarily dependent on our future level of revenue from our solid waste clients.  However, the extent of our future activity is uncertain.  We currently anticipate that if WMG’s future revenue grows by less than 2.0%, or market prices for similar businesses decline by more than 10%, WMG’s goodwill could become impaired.

Additionally, if the yield on 20-year U.S. treasury bonds (our assumed risk-free rate of return) or the additional return investors require for alternate investments, including those similar to WMG, increases, we may be required to increase the discount rate used in our cash flow analysis.  If all of our operating assumptions remain constant, but we are required to increase the discount rate in our cash flow model to 14.0% or higher, WMG’s goodwill could become impaired.

Foreign exchange impact relates to our foreign subsidiaries with functional currencies that are different than our reporting currency.  The gross amounts of goodwill for WEI were $289.4 million and $293.1 million at December 27, 2015 and September 27, 2015, respectively, excluding $82.4 million of accumulated impairment.  The gross amounts of goodwill for RME were $420.2 million and $423.8 million at December 27, 2015 and September 27, 2015, respectively, excluding $33.2 million of accumulated impairment.

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The gross amount and accumulated amortization of our acquired identifiable intangible assets with finite useful lives included in “Intangible assets - net” on the condensed consolidated balance sheets, were as follows:

Foreign currency translation adjustments reduced net identifiable intangible assets by $0.4 million in the first quarter of fiscal 2016.  Amortization expense for the identifiable intangible assets for the first quarters of fiscal 2016 and 2015 was $4.3 million and $5.9 million, respectively.  Estimated amortization expense for the remainder of fiscal 2016 and succeeding years is as follows:

5.                                      Property and Equipment

Property and equipment consisted of the following:

The depreciation expense related to property and equipment, including assets under capital leases, was $5.3 million and $6.9 million for the first quarters of fiscal 2016 and 2015, respectively.

6.                                      Stock Repurchase and Dividends

On November 10, 2014, the Board of Directors authorized a stock repurchase program under which we may repurchase up to $200 million of our common stock over the next two years.  In the first quarter of fiscal 2016, we repurchased through open market purchases a total of 939,909 shares at an average price of $26.60, for a total cost of $25.0 million under this repurchase program.

On November 9, 2015, the Board of Directors declared a quarterly cash dividend of $0.08 per share payable on December 11, 2015 to stockholders of record as of the close of business on November 30, 2015.  Dividends totaling $4.7 million and $4.4 million were paid in the first quarters of fiscal 2016 and fiscal 2015, respectively.

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Subsequent Event.  On January 25, 2016, the Board of Directors declared a quarterly cash dividend of $0.08 per share payable on February 26, 2016 to stockholders of record as of the close of business on February 12, 2016.

7.                                      Stockholders’ Equity and Stock Compensation Plans

We recognize the fair value of our stock-based compensation awards as compensation expense on a straight-line basis over the requisite service period in which the award vests.  Stock-based compensation expense for the first quarters of both fiscal 2016 and fiscal 2015 was $2.8 million.  The majority of these amounts were included in “Selling, general and administrative (“SG&A”) expenses” in our condensed consolidated statements of income.  In the first quarter of fiscal 2016, we granted 241,932 stock options with an exercise price of $27.16 per share and an estimated weighted-average fair value of $8.05 per share to our non-employee directors and executive officers.  The executive officer options vest over a four-year period, and the non-employee director options vest after one year.  In addition, we awarded 137,777 performance shares units (“PSUs”) to our non-employee directors and executive officers at the fair value of $31.63 per share on the award date.  All of the PSUs are performance-based and vest, if at all, after the conclusion of the three-year performance period.  The number of PSUs that ultimately vest is based 50% on the growth in our diluted earnings per share and 50% on our total shareholder return over the vesting period.  Additionally, we awarded 215,539 restricted stock units (“RSUs”) to our non-employee directors, executive officers and employees at the fair value of $27.16 per share on the award date.  All of the executive officer and employee RSUs have time-based vesting over a four-year period, and the non-employee director RSUs vest after one year.

8.                                      Earnings Per Share (“EPS”)

Basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding, less unvested restricted stock for the period.  Diluted EPS is computed by dividing net income by the weighted-average number of common shares outstanding and dilutive potential common shares for the period.  Potential common shares include the weighted-average dilutive effects of outstanding stock options and unvested restricted stock using the treasury stock method.

The following table sets forth the number of weighted-average shares used to compute basic and diluted EPS:

For the first quarters of fiscal 2016 and 2015, 0.6 million and 0.8 million options, respectively, were excluded from the calculation of dilutive potential common shares because the assumed proceeds per share exceeded the average market price per share during the period.  Therefore, their inclusion would have been anti-dilutive.

9.                                      Income Taxes

The effective tax rates for the first quarters of fiscal 2016 and 2015 were 25.7% and 26.4%, respectively.  During the first quarter of fiscal 2016, the Protecting Americans from Tax Hikes (“PATH”) Act of 2015 was signed into law.  This law permanently extended the federal research and experimentation tax credits (“R&E Credits”) retroactive to January 1, 2015.  Our income tax expense for the first quarter of fiscal 2016 included a tax benefit of $2.0 million attributable to operating income during the last nine months of fiscal 2015, primarily related to the retroactive recognition of the R&E Credits.  Our income tax expense for the first quarter of fiscal 2015 included a similar retroactive tax benefit of $1.2 million attributable to operating income during the last nine months of fiscal 2014.

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At December 27, 2015, approximately $63.3 million of undistributed earnings of our foreign subsidiaries, primarily in Canada, are expected to be permanently reinvested.  Accordingly, no provision for U.S. income taxes or foreign withholding taxes has been made.  Upon distribution of those earnings, we would be subject to U.S. income taxes and foreign withholding taxes. Assuming the permanently reinvested foreign earnings were repatriated under the laws and rates applicable at December 27, 2015, the incremental federal tax applicable to those earnings would be approximately $5.4 million.

We review the realizability of deferred tax assets on a quarterly basis by assessing the need for a valuation allowance.  As of December 27, 2015, we performed our assessment of net deferred tax assets.  Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against our deferred tax assets. Applying the applicable accounting guidance requires an assessment of all available evidence, both positive and negative, regarding the realizability of the net deferred tax assets.  Based upon recent results, we concluded that a cumulative loss in recent years exists in certain foreign jurisdictions.  We have historically relied on the following factors in our assessment of the realizability of our net deferred tax assets:

·                  taxable income in prior carryback years as permitted under the tax law;

·                  future reversals of existing taxable temporary differences;

·                  consideration of available tax planning strategies and actions that could be implemented, if necessary; and

·                  estimates of future taxable income from our operations.

We considered these factors in our estimate of the reversal pattern of deferred tax assets, using assumptions that we believe are reasonable and consistent with operating results.  However, as a result of projected cumulative pre-tax losses in certain foreign jurisdictions for the 36 months ending December 30, 2018, we concluded that our estimates of future taxable income and certain tax planning strategies did not constitute sufficient positive evidence to assert that it is more likely than not that certain deferred tax assets would be realizable before expiration.  Based on our assessment, we have concluded that it is more likely than not that the assets will be realized except for the assets related to loss carry-forwards in foreign jurisdictions for which a valuation allowance of $8.3 million has been provided in prior years.

10.                               Reportable Segments

Our reportable segments are described as follows:

WEI:  WEI provides consulting and engineering services worldwide for a broad range of water and infrastructure-related needs in both developed and emerging economies.  WEI supports both public and private clients including federal, state/provincial, and local governments, and global and local commercial and industrial clients.  The primary markets for WEI’s services include water resources analysis and water management, environmental restoration, government consulting, and a broad range of civil infrastructure master planning and engineering design for facilities, transportation, and regional and local development.  WEI’s services span from early data collection and monitoring, to data analysis and information technology, to science and engineering applied research, to engineering design, to construction management and operations and maintenance.

RME:  RME provides consulting and engineering services worldwide for a broad range of resource management and energy needs.  RME supports both private and public clients, including global industrial and commercial clients, U.S. federal agencies in large scale remediation, and major international development agencies.  The primary markets for RME’s services include natural resources, energy, remediation, waste management, utilities and international development.  RME’s services span from early data collection and monitoring, to data analysis and information technology, to science and engineering applied research, to engineering design, to construction management and operations and maintenance.  RME supports engineering, procurement and construction management for full service implementation of commercial projects.

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RCM:  We report the results of the wind-down of our non-core construction activities in the RCM reportable segment.  The remaining work performed in this segment will be substantially complete by the end of fiscal 2016.

Management evaluates the performance of these reportable segments based upon their respective segment operating income before the effect of amortization expense related to acquisitions and other unallocated corporate expenses.  We account for inter-segment sales and transfers as if the sales and transfers were to third parties; that is, by applying a negotiated fee onto the costs of the services performed.  All significant intercompany balances and transactions are eliminated in consolidation.

The following tables set forth summarized financial information regarding our reportable segments:

Reportable Segments

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Major Clients

Other than the U.S. federal government, no single client accounted for more than 10% of our revenue.  All of our segments generated revenue from all client sectors.

The following table represents our revenue by client sector:

11.          Fair Value Measurements

The fair value of long-term debt was determined using the present value of future cash flows based on the borrowing rates currently available for debt with similar terms and maturities (Level 2 measurement, as described in “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 27, 2015).  The carrying value of our long-term debt approximated fair value at December 27, 2015 and September 27, 2015.  As of December 27, 2015, we had borrowings of $189.6 million outstanding under our amended credit agreement, which were used to fund our business acquisitions, working capital needs, and contingent earn-outs.

12.          Joint Ventures

Consolidated Joint Ventures

The aggregate revenue of our consolidated joint ventures was $0.5 million and $2.2 million for the first quarters of fiscal 2016 and 2015, respectively.  The assets and liabilities of these consolidated joint ventures were immaterial at December 27, 2015 and September 27, 2015.  These assets are restricted for use only by those joint ventures and are not available for our general operations. Cash and cash equivalents maintained by the consolidated joint ventures at December 27, 2015 and September 27, 2015 were $0.5 million and $0.7 million, respectively.

Unconsolidated Joint Ventures

We account for our unconsolidated joint ventures using the equity method of accounting.  Under this method, we recognize our proportionate share of the net earnings of these joint ventures within “Other costs of revenue” in our condensed consolidated statements of income.  For the first quarters of fiscal 2016 and 2015, we reported $0.2 million and $0.7 million of equity in earnings of unconsolidated joint ventures, respectively.  Our maximum exposure to loss as a result of our investments in unconsolidated joint ventures is typically limited to the aggregate of the carrying value of the investment.  Future funding commitments for our unconsolidated joint ventures are immaterial.  The unconsolidated joint ventures are, individually and in the aggregate, immaterial to our condensed consolidated financial statements.

The aggregate carrying values of the assets and liabilities of the unconsolidated joint ventures were $13.7 million and $11.9 million, respectively, at December 27, 2015, and $17.1 million and $15.2 million, respectively, at September 27, 2015.

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13.          Derivative Financial Instruments

We use certain interest rate derivative contracts to hedge interest rate exposures on our variable rate debt.  We enter into foreign currency derivative contracts with financial institutions to reduce the risk that cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations.  Our hedging program is not designated for trading or speculative purposes.

We recognize derivative instruments as either assets or liabilities on the accompanying condensed consolidated balance sheets at fair value (Level 2 measurement, as described in “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 27, 2015).  We record changes in the fair value (i.e., gains or losses) of the derivatives that have been designated as accounting hedges in our condensed consolidated balance sheets as accumulated other comprehensive loss.

In fiscal 2013, we entered into three interest rate swap agreements that we designated as cash flow hedges to fix the variable interest rates on a portion of borrowings under our term loan facility.  In the first quarter of fiscal 2014, we entered into two interest rate swap agreements that we designated as cash flow hedges to fix the variable interest rates on the borrowings under the term loan facility.  At December 27, 2015, the effective portion of our interest rate swap agreements designated as cash flow hedges before tax effect was $1.2 million, all of which we expect to be reclassified from accumulated other comprehensive loss to interest expense within the next 12 months.

As of December 27, 2015, the total notional principal amount of our outstanding interest rate swap agreements which expire in May 2018 was $189.6 million and the weighted average fixed interest rate was 1.32%.

The fair values of our outstanding derivatives designated as hedging instruments were as follows:

The impact of the effective portions of derivative instruments in cash flow hedging relationships on income and other comprehensive income from our foreign currency forward contracts and interest rate swap agreements was immaterial for the first three months of fiscal 2016 and the fiscal year ended September 27, 2015.  Additionally, there were no ineffective portions of derivative instruments.  Accordingly, no amounts were excluded from effectiveness testing for our foreign currency forward contracts and interest rate swap agreements.  We had no derivative instruments that were not designated as hedging instruments for fiscal 2015 and the first quarter of fiscal 2016.

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14.          Reclassifications Out of Accumulated Other Comprehensive Loss

The accumulated balances and reporting period activities for the three months ended December 27, 2015 and December 28, 2014 related to reclassifications out of accumulated other comprehensive loss are summarized as follows:

15.          Commitments and Contingencies

We are subject to certain claims and lawsuits typically filed against the engineering, consulting and construction profession, alleging primarily professional errors or omissions.  We carry professional liability insurance, subject to certain deductibles and policy limits, against such claims.  However, in some actions, parties are seeking damages that exceed our insurance coverage or for which we are not insured.  While management does not believe that the resolution of these claims will have a material adverse effect, individually or in aggregate, on our financial position, results of operations or cash flows, management acknowledges the uncertainty surrounding the ultimate resolution of these matters.

16.          Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard that will supersede existing revenue recognition guidance under current U.S. GAAP.  The new standard is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods and services.  The accounting standard is effective for us in the first quarter of fiscal year 2019.  Companies may use either a full retrospective or a modified retrospective approach to adopt this standard, and management is currently evaluating which transition approach to use.  We are currently assessing what impact this new standard may have on our consolidated financial statements.

In June 2014, the FASB issued updated guidance intended to eliminate the diversity in practice regarding share-based payment awards that include terms which provide for a performance target that affects vesting being achieved after the requisite service period.  The new standard requires that a performance target which affects vesting and could be achieved after the requisite service period be treated as a performance condition that affects vesting and should not be reflected in estimating the grant-date fair value.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  We do not expect the adoption of this guidance to have an impact on our consolidated financial statements.

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In January 2015, the FASB issued an amendment to the accounting guidance related to the income statement presentation of extraordinary and unusual items.  The amendment eliminates from U.S. GAAP the concept of extraordinary items.  The guidance is effective for us in the first quarter of fiscal 2017.  We do not expect the adoption of this guidance to have an impact on our consolidated financial statements.

In February 2015, the FASB issued updated guidance which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  We do not expect the adoption of this guidance to have an impact on our consolidated financial statements.

In April 2015, the FASB issued updated guidance intended to simplify, and provide consistency to, the presentation of debt issuance costs.  The new standard requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In August 2015, the FASB issued updated guidance relating to the SEC Staff Announcement at the June 18, 2015 Emerging Issues Task Force meeting on the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements.  The updated guidance allows for the deferral and presentation of debt issuance costs as an asset which may be amortized ratably over the term of the line-of-credit arrangement, regardless of whether there are any related outstanding borrowings. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In September 2015, the FASB issued updated guidance to simplify measurement-period adjustments in business combinations.  The updated guidance eliminated the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively.  Instead, an acquirer will recognize a measurement-period adjustment during the period in which it determines the amount of the adjustment.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In November 2015, the FASB issued updated guidance as a part of its ongoing Simplification Initiative, with the objective of reducing complexity in accounting standards.  The updated guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet.  This guidance does not change the offsetting requirements for deferred tax liabilities and assets, which results in the presentation of one amount on the balance sheet.  The guidance is effective for interim and annual reporting periods beginning December 15, 2016, with early adoption permitted.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

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Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbor provisions created under the Securities Act of 1933 and the Securities Exchange Act of 1934.  All statements other than statements of historical facts are statements that could be deemed forward-looking statements.  These statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management.  Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” variations of such words, and similar expressions are intended to identify such forward-looking statements.  In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements.  Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified below under “Part II, Item 1A. Risk Factors” and elsewhere herein.  Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements.  We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

GENERAL OVERVIEW

We are a leading provider of consulting, engineering, program management, and construction management services that focuses on addressing fundamental needs for water, environment, infrastructure, resource management, energy, and international development.  We typically begin at the earliest stage of a project by identifying technical solutions to problems and developing execution plans tailored to our clients’ needs and resources.  Our solutions may span the entire life cycle of consulting and engineering projects, and include applied science, research and technology, engineering, design, construction management, construction, operations and maintenance, and information technology.  Our commitment to continuous improvement and investment in growth has diversified our client base, expanded our geographic reach, and increased the breadth and depth of our service offerings to address existing and emerging markets.  We currently have approximately 16,000 staff worldwide, located primarily in North America.

We derive income from fees for professional, technical, program management, construction and construction management services.  As primarily a service-based company, we are labor-intensive rather than capital-intensive.  Our revenue is driven by our ability to attract and retain qualified and productive employees, identify business opportunities, secure new and renew existing client contracts, provide outstanding services to our clients and execute projects successfully.  We provide our services to a diverse base of U.S. commercial and international clients, as well as U.S. federal and U.S. state and local government agencies.  The following table presents the percentage of our revenue by client sector:

(1)                          Includes revenue generated from foreign operations, primarily in Canada, and revenue generated from non-U.S. clients.

(2)                          Includes revenue generated under U.S. federal government contracts performed outside the United States.

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Our reportable segments are as follows:

Water, Environment and Infrastructure.  WEI provides consulting and engineering services worldwide for a broad range of water and infrastructure-related needs in both developed and emerging economies.  WEI supports both public and private clients including federal, state/provincial, and local governments, and global and local commercial and industrial clients.  The primary markets for WEI’s services include water resources analysis and water management, environmental restoration, government consulting, and a broad range of civil infrastructure master planning and engineering design for facilities, transportation, and regional and local development.  WEI’s services span from early data collection and monitoring, to data analysis and information technology, to science and engineering applied research, to engineering design, to construction management and operations and maintenance.

Resource Management and Energy.  RME provides consulting and engineering services worldwide for a broad range of resource management and energy needs.  RME supports both private and public clients, including global industrial and commercial clients, U.S. federal agencies in large scale remediation, and major international development agencies.  The primary markets for RME’s services include natural resources, energy, remediation, waste management, utilities and international development.  RME’s services span from early data collection and monitoring, to data analysis and information technology, to science and engineering applied research, to engineering design, to construction management and operations and maintenance.  RME supports EPCM for full service implementation of commercial projects.

Remediation and Construction Management.  We report the results of the wind-down of our non-core construction activities in the RCM reportable segment.  The remaining work performed in this segment will be substantially complete by the end of fiscal 2016.

The following table presents the percentage of our revenue by reportable segment:

We provide services under three principal types of contracts: fixed-price, time-and-materials, and cost-plus.  The following table presents the percentage of our revenue by contract type:

Under fixed-price contracts, we receive a fixed price irrespective of the actual costs we incur.  Under time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and also paid for other expenses.  Under cost-plus contracts, some of which are subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based.  Profitability on our contracts is driven by billable headcount and our ability to manage our subcontractors, vendors, and material suppliers.  A majority of our contract revenue and contract costs are recorded using the percentage-of-completion (cost-to-cost) method.  Under this method, revenue is recognized in the ratio of contract costs incurred compared to total estimated contract costs.  Revenue and profit on these contracts are subject to revision throughout the duration of the contracts and any required adjustments are made in the period in which the revisions become known.  Losses on contracts are recorded in full as they are identified.

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Other contract costs include professional compensation and related benefits, together with certain direct and indirect overhead costs such as rents, utilities, and travel.  Professional compensation represents a large portion of these costs.  Our SG&A expenses are comprised primarily of marketing and bid and proposal costs, and our corporate headquarters’ costs related to the executive offices, finance, accounting, administration, and information technology. Our SG&A expenses also include a portion of stock-based compensation and depreciation of property and equipment related to our corporate headquarters, and the amortization of identifiable intangible assets.  Most of these costs are unrelated to specific clients or projects, and can vary as expenses are incurred to support company-wide activities and initiatives.

We experience seasonal trends in our business.  Our revenue and operating income are typically lower in the first half of our fiscal year, primarily due to the Thanksgiving, Christmas, and New Year’s holidays.  Many of our clients’ employees, as well as our own employees, take vacations during these holiday periods.  Further, seasonal inclement weather conditions occasionally cause some of our offices to close temporarily or may hamper our project field work.  These occurrences result in fewer billable hours worked on projects and, correspondingly, less revenue recognized.  Our revenue is typically higher in the second half of the fiscal year due to favorable weather conditions during spring and summer months that may result in higher billable hours.  In addition, our revenue is typically higher in the fourth fiscal quarter due to the U.S. federal government’s fiscal year-end spending.

ACQUISITIONS AND DIVESTITURES

Acquisitions.  We continuously evaluate the marketplace for strategic acquisition opportunities.  Due to our reputation, size, financial resources, geographic presence, and range of services, we have numerous opportunities to acquire privately and publicly held companies or selected portions of such companies.  During our evaluation, we examine the effect an acquisition may have on our long-range business strategy and results of operations.  Generally, we proceed with an acquisition if we believe that it would have a positive effect on future operations and could strategically expand our service offerings.  As successful integration and implementation are essential to achieving favorable results, no assurance can be given that all acquisitions will provide accretive results.  Our strategy is to position ourselves to address existing and emerging markets.  We view acquisitions as a key component of our growth strategy, and we intend to use cash, debt, or securities, as we deem appropriate, to fund acquisitions.  We may acquire other businesses that we believe are synergistic and will ultimately increase our revenue and net income, strengthen our ability to achieve our strategic goals, provide critical mass with existing clients, and further expand our lines of service.  We typically pay a purchase price that results in the recognition of goodwill, generally representing the intangible value of a successful business with an assembled workforce specialized in our areas of interest.

For detailed information regarding acquisitions, see Note 3, “Mergers and Acquisitions” of the “Notes to Condensed Consolidated Financial Statements”.

Divestitures.  To complement our acquisition strategy and our focus on internal growth, we regularly review and evaluate our existing operations to determine whether our business model should change through the divestiture of certain businesses. Accordingly, from time to time, we may divest certain non-core businesses and reallocate our resources to businesses that better align with our long-term strategic direction.  We did not have any divestitures in the first quarters of fiscal 2016 and 2015.

OVERVIEW OF RESULTS AND BUSINESS TRENDS

General.  In the first quarter of fiscal 2016, our revenue declined 3.5% compared to the prior-year quarter.  This decline primarily resulted from adverse foreign exchange rate fluctuations as the U.S. dollar strengthened over the last 12 months against most of the foreign currencies in which we conduct our international business, particularly the Canadian dollar.  In addition, our lower revenue reflects a reduction in construction activities compared to last year’s first quarter, which resulted from our decision in fiscal 2014 to exit from select fixed-price construction markets.  On a constant currency basis, the revenue from our ongoing business, excluding RCM, increased 2.8% compared to the year-ago quarter.

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U.S. Commercial.  Our U.S. commercial business increased 8.4% in the first quarter of fiscal 2016 compared to the year-ago quarter.  This growth primarily reflects increased waste management and environmental activities.  We expect our U.S. commercial revenue to continue to show year-over-year improvement in fiscal 2016.

International.  Our international business decreased 7.7% in the first quarter of fiscal 2016 compared to the same period last year due to foreign exchange rate fluctuations.  Excluding the impact of foreign exchange, our international business grew 7.4% compared to the prior-year quarter.  This growth reflects increased midstream oil and gas activities in Western Canada that were partially offset by lower upstream oil and gas revenue due to lower oil prices and continued weakness in our mining operations, particularly in Canada and South America.  We anticipate stable international revenue in fiscal 2016 on a constant currency basis. However, if commodity prices continue to remain low or decrease further, our international business would likely be negatively impacted.

U.S. Federal Government.  Our U.S. federal government business declined 11.1% in the first quarter of fiscal 2016 compared to the year-ago quarter.  The aforementioned reduction in fixed-price construction activities in the RCM segment contributed to this decline.  Excluding these activities, our U.S. federal government revenue decreased 7.2% in the first quarter of fiscal 2016 compared to the prior-year quarter.  Additionally, we experienced reduced activity on projects for the U.S. Department of Defense (“DoD”), which more than offset increases in revenues from civilian federal projects.  During periods of economic volatility, our U.S. federal government clients have historically been the most stable and predictable.  We expect our U.S. federal revenue to be stable during the remainder of fiscal 2016, excluding the RCM segment.

U.S. State and Local Government.  Our U.S. state and local government business decreased 3.9% in the first quarter of fiscal 2016 compared to the same period in fiscal 2015.  The decline resulted from the aforementioned reduction in certain construction activities, especially those related to state transportation projects in the RCM segment.  Excluding these activities, our U.S. state and local government revenue increased 3.3% in the current quarter compared to the year-ago quarter.  Many state and local government agencies are experiencing improved financial conditions that enable them to address major long-term infrastructure requirements, including the need for maintenance, repair, and upgrading of existing critical infrastructure and the need to build new facilities.  As a result, we experienced broad-based growth in U.S. state and local government project-related infrastructure revenue.  We expect our U.S. state and local government business to continue to show growth during fiscal 2016, excluding the RCM segment.

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RESULTS OF OPERATIONS

Consolidated Results of Operations