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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 March 29, 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 April 27, 2015, 60,259,015 shares of the registrant’s common stock were outstanding.

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TETRA TECH, INC.

INDEX

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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 (Loss)

(unaudited – in thousands)

See accompanying 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 28, 2014.

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

Beginning in the first quarter of fiscal 2015, we reorganized our core operations to better align them with our markets, resulting in two renamed reportable segments.  We now report our water resources, water and wastewater treatment, environment, and infrastructure engineering activities in the Water, Environment and Infrastructure (“WEI”) reportable segment.  Our Resource Management and Energy (“RME”) reportable segment includes our oil and gas, energy, mining, 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.  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

2.                                      Accounts Receivable – Net and Revenue Recognition

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 March 29, 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, excluding those related to claims, 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 March 29, 2015 and September 28, 2014 included approximately $80 million and $79 million, respectively, related to claims, including requests for equitable adjustment, on contracts that provide for price redetermination.  We regularly evaluate all 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.  As a result of this assessment, we reduced revenue and operating income by a net $3.0 million in the second quarter of fiscal 2015 as a result of our updated assessment of the collectability of claims with a U.S. state and local government client.  On a year-to-date basis, we have recorded net gains of $0.2 million related to claims.  During both the second quarter and first six months of fiscal 2014, we recognized gains related to settlement of claims of $3.4 million.

Billed accounts receivable related to U.S. federal government contracts were $59.3 million and $57.4 million at March 29, 2015 and September 28, 2014, respectively.  U.S. federal government unbilled receivables were $68.2 million and $73.2 million at March 29, 2015 and September 28, 2014, respectively.  Other than the U.S. federal government, no single client accounted for more than 10% of our accounts receivable at March 29, 2015 and September 28, 2014.

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 unfavorable operating income adjustments of $3.5 million and $5.9 million during the second quarter and first half of fiscal 2015, respectively, compared to $5.3 million in the comparable periods of last year.  Changes in revenue and cost estimates could also result in a projected loss that would be recorded immediately in earnings.  As of March 29, 2015 and September 28, 2014, we maintained a liability for anticipated losses of $13.6 million and $18.6 million, respectively.  The estimated cost to complete the related contracts as of March 29, 2015 was $83.9 million.

3.                                      Mergers and Acquisitions

We made no acquisitions in the first half of fiscal 2015.  In fiscal 2014, we made immaterial acquisitions that enhanced our service offerings and expanded our geographic presence in our WEI and RME reportable segments.

Subsequent Event.  On May 1, 2015, we acquired Cornerstone Environmental Group, an environmental engineering and consulting firm focused on solid waste markets in the United States.  The purchase price was not material.

Goodwill additions resulting from the above business combinations are primarily attributable to the existing workforce of the acquired companies and the synergies expected to arise after the acquisitions.  Specifically, the goodwill additions related to the fiscal 2014 acquisitions primarily represent the value of workforces with distinct expertise in the oil and gas and disaster preparedness 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 companies.  The results of these acquisitions were included in the consolidated financial statements from their respective closing dates.  None of the acquisitions were considered material, individually or in the aggregate, to our condensed consolidated financial statements.  As a result, no pro forma information has been provided for the respective periods.

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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 28, 2014).  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 previous 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 second quarter and first half of fiscal 2015, we recorded a decrease in our contingent earn-out liabilities and reported a related gain in operating income of $3.1 million.  This gain resulted from an updated valuation of the contingent consideration liability for Caber Engineering (“Caber”), which is part of our Oil, Gas & Energy reporting unit in the RME segment.

The acquisition agreement for Caber included a contingent earn-out agreement based on the achievement of operating income thresholds (in Canadian dollars) in each of the first two years beginning on the acquisition date, which was in the first quarter of fiscal 2014.  The maximum earn-out obligation over the two-year earn-out period was C$8.0 million (C$4.0 million in each year).  These amounts could be earned on a pro-rata basis for operating income within a predetermined range in each year.  Caber was required to meet a minimum operating income threshold in each year to earn any contingent consideration.  These thresholds were C$4.0 million and C$4.6 million in years one and two, respectively.  In order to earn the maximum contingent consideration, Caber would need to generate operating income of C$4.4 million in year one and C$5.1 million in year two.

The determination of the fair value of the purchase price for Caber on the acquisition date included our estimate of the fair value of the related contingent earn-out obligation.  This initial valuation was primarily based on probability-weighted internal estimates of Caber’s operating income during each earn-out period.  As a result of these estimates, we calculated an initial fair value at the acquisition date of Caber’s contingent earn-out liability of C$6.5 million in the first quarter of fiscal 2014.  In determining that Caber would earn 81% of the maximum potential earn-out, we considered several factors including Caber’s recent historical revenue and operating income levels and growth rates.  We also considered the recent trend in Caber’s backlog level and the prospects for the oil and gas industry in Western Canada.

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Caber’s actual financial performance in the first earn-out period exceeded our original estimate at the acquisition date.  As a result, in the fourth quarter of fiscal 2014, we increased the related contingent consideration liability and recognized a loss of $1.0 million.  This updated valuation included our assumption that Caber would earn the maximum amount of contingent consideration of C$4.0 million in the first earn-out period.  In the second quarter of fiscal 2015, we completed our final calculation of the contingent consideration for the first earn-out period and paid contingent consideration of C$4.0 million (USD$3.2 million).  At that time we also evaluated our estimate of Caber’s contingent consideration liability for the second earn-out period.  This assessment included a review of the status of on-going projects in Caber’s backlog, and the inventory of prospective new contract awards.  We also considered the status of the oil and gas industry in Western Canada, particularly in light of the recent decline in oil prices.  As a result of this assessment, we concluded that Caber’s operating income in the second earn-out period would be lower than our original estimate at the acquisition date and our subsequent estimates through the first quarter of fiscal 2015.  We concluded that Caber’s operating income for the second earn-out period, which ends in the first quarter of fiscal 2016, would be lower than the minimum requirement of C$4.6 million to earn any contingent consideration.  Accordingly, in the second quarter of fiscal 2015, we reduced the Caber contingent earn-out liability to $0, which resulted in a gain of $3.1 million.

In the second quarter and first six months of fiscal 2014, we recorded net decreases in our contingent earn-out liabilities and reported related gains in operating income of $21.3 million and $26.0 million, respectively.  The fiscal 2014 gains primarily resulted from updated valuations of the contingent consideration liability for Parkland Pipeline (“Parkland”), which is part of our Oil, Gas & Energy reporting unit in our RME segment.

The acquisition agreement for Parkland included a contingent earn-out agreement based on the achievement of operating income thresholds (in Canadian dollars) in each of the first three years beginning on the acquisition date, which was in the second quarter of fiscal 2013.  The maximum earn-out obligation over the three-year earn-out period was C$56.0 million (C$12.0 million, C$22.0 million and C$22.0 million in earn-out years one, two and three, respectively).  These amounts could be earned primarily on a pro-rata basis for operating income within a predetermined range in each year.  To a lesser extent, additional earn-out consideration could be earned for operating income above the high-end of the range up to the contractual maximum of C$56.0 million.  Parkland was required to meet a minimum operating income threshold in each year in order to earn any contingent consideration.  These thresholds were C$34.7 million, C$38.2 million and C$41.9 million in years one, two and three, respectively.  In order to earn the maximum contingent consideration, Parkland would need to generate operating income of C$42.5 million in year one, C$46.4 million in year two, and C$50.6 million in year three.

The determination of the fair value of the purchase price for Parkland on the acquisition date included our estimate of the fair value of the related contingent earn-out obligation.  This initial valuation was primarily based on probability-weighted internal estimates of Parkland’s operating income during each earn-out period.  As a result of these estimates, we calculated an initial fair value at the acquisition date of Parkland’s contingent earn-out liability of C$46.8 million in the second quarter of fiscal 2013.  In determining that Parkland would attain 84% of the maximum potential earn-out, we considered several factors including Parkland’s recent historical revenue and operating income levels and growth rates, the recent trend in Parkland’s backlog level, and the prospects for the midstream oil and gas industry in Western Canada.

In fiscal 2014, we recorded decreases in our contingent earn-out liability for Parkland and reported related net gains in operating income of $44.6 million.  These gains resulted from Parkland’s actual and projected post-acquisition performance falling below our initial expectations concerning the likelihood and timing of achieving the relevant operating income thresholds.  The remaining difference compared to the initial value was due to currency translation, and the related liability was $0 at the end of fiscal 2014.

In the second quarter of fiscal 2014, we updated the estimated cost to complete a large fixed-price contract at Parkland, and determined that the project would be break-even compared to the significant profit estimated the previous quarter when the project was initiated.  As a result, during the second quarter of fiscal 2014 we reversed $5.3 million of profit previously recognized on the project.  This variance, and our updated estimate that the revenue for the remainder of the project would produce no operating income, resulted in our conclusion that Parkland’s operating income in the first and second earn-out periods would fall below the minimum operating income thresholds in each such year.  As a result, we reduced the contingent earn-out liability for the first and second earn-out periods to $0, which resulted in gains totaling $24.7 million ($5.6 million and $19.1 million in the first and second quarters of fiscal 2014, respectively).

In the fourth quarter of fiscal 2014, we updated our projection of Parkland’s operating income for the third earn-out period.  This assessment included a review of the projects in Parkland’s backlog, the inventory of prospective new contract awards, and the forecast for economic activity in the Western Canada oil and gas sector.  As a result of this assessment, we concluded that Parkland’s operating income in the third earn-out period would be lower than our original estimate at the acquisition date and would fall below the minimum operating income threshold.  As a result, we reduced the remaining contingent earn-out liability balance for the third earn-out period to $0, which resulted in a gain of $19.9 million.

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Each time we determined that Parkland’s and Caber’s operating income would be lower than our original estimate at the acquisition date, we also evaluated the related goodwill for potential impairment.  In each case, we determined that the lower income projections were the result of temporary events, and did not negatively impact the reporting unit’s longer term performance or result in a goodwill impairment.

At March 29, 2015, there was a total maximum of $20.6 million of outstanding contingent consideration related to acquisitions.  Of this amount, there were no accruals on our condensed consolidated balance sheet.  In the first half of fiscal 2015, we made $3.2 million of earn-out payments to former owners, and reported this amount as cash used in financing activities.  In the first half of fiscal 2014, we made $10.6 million of earn-out payments to former owners.  Of this amount, we reported $9.3 million as cash used in financing activities and $1.3 million as cash used in operating activities.

4.                                      Goodwill and Intangible Assets

Effective September 29, 2014, we reorganized our core operations into our WEI and RME reportable segments.  The results of the wind-down of our non-core construction activities are reported in the RCM reportable segment.  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

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 at June 30, 2014 (i.e. the first day of our fourth quarter in fiscal 2014), 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.

The reorganization of our core operations, described further in Note 10, “Reportable Segments”, also impacted the definition of our reporting units used for goodwill impairment testing.  As a result, as of September 29, 2014, we performed impairment testing for goodwill under our new segment structure and determined that the estimated fair value of each reporting unit exceeded its corresponding carrying amount including recorded goodwill, and, as such, no impairment existed as of September 29, 2014.  However, our Global Mining Practice (“GMP”) reporting unit, which is part of our RME reportable segment, had an estimated fair value that exceeded its carrying value by less than 20%.

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 our discounted cash flow model for GMP as of September 29, 2014, we assumed annual revenue growth rates of 3% to 5% based on historical trends in GMP and the mining industry, projections for future mining activity, and GMP’s backlog and prospects for new orders.  We discounted the resulting cash flows at a rate of 14%.  Our market-based assessment resulted in a value approximating a 0.7 multiple of revenue, net of subcontractor costs, for the 12 month period preceding the valuation date.  The discounted cash flow value, combined on a weighted-basis with the results of our market analysis, resulted in an estimated fair value for GMP of approximately $102.8 million compared to our carrying value including goodwill of approximately $91.8 million.  As of March 29, 2015, the goodwill amount for GMP was $61.4 million.

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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 mining clients.  However, the extent of future activity is uncertain, particularly in light of the significant contraction in the mining sector over the last two years.  We currently anticipate that if GMP’s future revenue declines by 20% or more, or market prices for similar businesses decline by more than 15%, GMP’s goodwill could become impaired.

Additionally, if the yield to maturity 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 GMP, 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 15.5% or higher, GMP’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 $253.7 million and $269.2 million at March 29, 2015 and September 28, 2014, respectively, excluding $31.1 million of accumulated impairment.  The gross amounts of goodwill for RME were $475.2 million and $502.5 million at March 29, 2015 and September 28, 2014, respectively, excluding $26.4 million of accumulated impairment.

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 $3.3 million in the first half of fiscal 2015.  Amortization expense for the identifiable intangible assets for the three and six months ended March 29, 2015 was $4.8 million and $10.8 million, respectively, compared to $6.7 million and $15.3 million for the prior-year periods.  Estimated amortization expense for the remainder of fiscal 2015 and succeeding years is as follows:

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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 $5.9 million and $12.8 million for the three and six months ended March 29, 2015, respectively, compared to $6.6 million and $13.7 million for the prior-year periods.  In the first six months of fiscal 2015, we sold assets comprised primarily of equipment of $3.6 million for net proceeds of $9.8 million, and recognized a corresponding gain of $6.2 million.  This equipment was primarily related to our RCM segment.

6.                                      Stock Repurchase and Dividends

In June 2013, our Board of Directors authorized a stock repurchase program under which we could repurchase up to $100 million of our common stock.  Stock repurchases could be made on the open market or in privately negotiated transactions with third parties.  From the inception of this program through September 28, 2014, we repurchased through open market purchases a total of 3.9 million shares at an average price of $25.59 per share, for a total cost of $100 million.

On November 10, 2014, the Board of Directors authorized a new stock repurchase program under which we may repurchase up to $200 million of our common stock over the next two years.  In the first half of fiscal 2015, we repurchased through open market purchases a total of 2.7 million shares at an average price of $25.11, for a total cost of $68.7 million under this new repurchase program.

On November 10, 2014, the Board of Directors declared a quarterly cash dividend of $0.07 per share to stockholders of record as of the close of business on November 26, 2014.  On January 26, 2015, the Board of Directors declared a quarterly cash dividend of $0.07 per share to stockholders of record as of the close of business on February 11, 2015.  A total of $8.6 million was paid in dividends for the first half of fiscal 2015.

Subsequent Event.  On April 27, 2015, the Board of Directors declared a quarterly cash dividend of $0.08 per share payable on May 29, 2015 to stockholders of record as of the close of business on May 14, 2015.

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 three and six months ended March 29, 2015 was $2.6 million and $5.4 million, respectively, compared to $3.2 million and $5.5 million for the same periods last year.  The majority of these amounts were included in “Selling, general and administrative (“SG&A”) expenses” in our condensed consolidated statements of income.  There were no material stock compensation awards in the second quarter of fiscal 2015.  For the six months ended March 29, 2015, we granted 266,420 stock options with an exercise price of $27.26 per share and an estimated weighted-average fair value of $8.20 per share.  In addition, we awarded 155,265 performance shares units (“PSUs”) to our non-employee directors and executive officers at the fair value of $27.26 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 239,747 restricted stock units (“RSUs”) to our non-employee directors, executive officers and employees at the fair value of $27.26 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.

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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 both three and six months ended March 29, 2015, 1.3 million options were excluded from the calculation of dilutive potential common shares, compared to 0.3 million and no options for the same periods last year.  These options were not included in the computation 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 half of fiscal 2015 and 2014 were 29.6% and 30.3%, respectively.  During the first quarter of fiscal 2015, the Tax Increase Prevention Act of 2014 was signed into law.  This law retroactively extended the federal research and experimentation credits (“R&E credits”) for amounts incurred from January 1, 2014 through December 31, 2014.  Our income tax expense for the first half of fiscal 2015 includes a tax benefit of $1.2 million attributable to operating income during the last nine months of fiscal 2014, primarily related to the retroactive recognition of these tax credits.

At March 29, 2015, approximately $56.7 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.  Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable; however, the potential foreign tax credit associated with the deferred income would be available to partially reduce the resulting U.S. tax liabilities.

We review the realizability of deferred tax assets on a quarterly basis by assessing the need for a valuation allowance.  As of March 29, 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.

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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 these certain foreign jurisdictions for the 36 months ending September 27, 2015, 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 $7.4 million has been provided in prior years.

10.                               Reportable Segments

Beginning in the first quarter of fiscal 2015, we reorganized our core operations into our WEI and RME reportable segments.  The results of the wind-down of our non-core construction activities are reported in the RCM reportable segment.  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

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 management, environmental restoration, government consulting, and a broad range of civil infrastructure requirements 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 oil and gas, energy, mining, remediation, utilities, waste management, 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 (“EPCM”) for full service implementation of commercial projects, especially for oil and gas, industrial, and mining customers.

RCM:  We report the results of the wind-down of our non-core construction activities in the RCM reportable segment.  We plan to complete the remaining work performed in this segment primarily in fiscal 2015.

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Management evaluates the performance of these reportable segments based upon their respective segment operating income before the effect of amortization expense related to acquisitions and other unallocated corporate expenses.  We account for inter-segment 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 28, 2014).  The carrying value of our long-term debt approximated fair value at March 29, 2015 and September 28, 2014.  As of March 29, 2015, we had borrowings of $237.9 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 from our consolidated joint ventures for the three and six months ended March 29, 2015 was $1.6 million and $3.8 million, respectively, compared to $3.5 million and $6.2 million for the same periods last year.  The assets and liabilities of these consolidated joint ventures were immaterial at March 29, 2015 and September 28, 2014.  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 March 29, 2015 and September 28, 2014 were $1.3 million and $1.4 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 three and six months ended March 29, 2015, we reported $1.2 million and $1.8 million of equity in earnings of unconsolidated joint ventures, respectively, compared to $0.8 million and $1.5 million for the same periods last year.  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 $17.6 million and $15.4 million, respectively, at March 29, 2015, and $20.1 million and $18.0 million, respectively, at September 28, 2014.

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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 28, 2014).  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 income (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 March 29, 2015, the effective portion of our interest rate swap agreements designated as cash flow hedges before tax effect was $1.8 million, all of which we expect to reclassify from accumulated other comprehensive income to interest expense within the next 12 months.

As of March 29, 2015, the total notional principal amount of our outstanding interest rate swap agreements which expire in May 2018 was $197.3 million and the weighted average fixed interest rate was 1.32%.

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