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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 28, 2014

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 26, 2015, 61,661,071 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 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

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 28, 2014 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 December 28, 2014 and September 28, 2014 included approximately $78 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 recognized revenue and an increase to operating income of $3.2 million in the first quarter of fiscal 2015 related to the settlement of claims with a federal government client.

Billed accounts receivable related to U.S. federal government contracts were $69.1 million and $57.4 million at December 28, 2014 and September 28, 2014, respectively.  U.S. federal government unbilled receivables were $67.8 million and $73.2 million at December 28, 2014 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 December 28, 2014 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 net unfavorable operating income adjustments of $2.4 million during the first quarter of fiscal 2015 compared to $1.2 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 28, 2014 and September 28, 2014, we recorded a liability for anticipated losses of $16.8 million and $18.6 million, respectively.  The estimated cost to complete the related contracts as of December 28, 2014 was $99.1 million.

3.                                      Mergers and Acquisitions

We made no acquisitions in the first quarter 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.

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 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 2014, we recorded net decreases in our contingent earn-out liabilities and reported related net gains in operating income of $4.6 million.  The fiscal 2014 gains primarily resulted from updated valuations of the contingent consideration liability associated with our fiscal 2013 acquisition of Parkland Pipeline (“Parkland”).  Parkland serves the oil and gas industry in Western Canada.  Subsequent to the acquisition date, we lowered our income projections over the remaining earn-out periods and recorded corresponding reductions of the earn-out liabilities for Parkland.  We also determined that these lower income projections were the result of temporary events, and would not negatively impact Parkland’s longer-term performance or result in goodwill impairment.  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 28, 2014, there was a total maximum of $44.7 million of outstanding contingent consideration related to acquisitions.  Of this amount, $6.8 million was estimated as the fair value and accrued on our condensed consolidated balance sheet. In the first quarter of fiscal 2015, we made no earn-out payments.  In the first quarter of fiscal 2014, we made $1.6 million of earn-out payments to former owners and reported them as cash used in financing activities.

4.                                      Goodwill and Intangible Assets

Effective September 29, 2014, 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 WEI reportable segment.  Our 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 RCM reportable segment.  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

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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 had an estimated fair value that exceeded its carrying value by less than 20%.  As of December 28, 2014, the goodwill amount for GMP was $65.6 million.  Although we believe that our estimate of fair value for GMP is reasonable, if GMP’s financial performance falls significantly below our expectations or market prices for similar businesses decline, the goodwill for GMP 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 $263.7 million and $269.2 million at December 28, 2014 and September 28, 2014, respectively, excluding $31.1 million of accumulated impairment.  The gross amounts of goodwill for RME were $492.6 million and $502.5 million at December 28, 2014 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:

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Foreign currency translation adjustments reduced net identifiable intangible assets by $1.3 million in the first quarter of fiscal 2015.  Amortization expense for the identifiable intangible assets for the first quarters of fiscal 2015 and 2014 was $5.9 million and $8.6 million, respectively.  Estimated amortization expense for the remainder of fiscal 2015 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 $6.9 million and $7.1 million for the first quarters of fiscal 2015 and 2014, respectively.

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 quarter of fiscal 2015, we repurchased through open market purchases a total of 760,926 shares at an average price of $26.50, for a total cost of $20.2 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 shareholders of record as of the close of business on November 26, 2014.  The total dividend of $4.4 million was paid on December 14, 2014.

Subsequent Event.  On January 26, 2015, the Board of Directors declared a quarterly cash dividend of $0.07 per share payable on February 26, 2015 to stockholders of record as of the close of business on February 11, 2015.

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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 fiscal 2015 and 2014 was $2.8 million and $2.3 million, respectively.  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 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 239,247 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.

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 2015 and 2014, 0.8 million and 0.4 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 2015 and 2014 were 26.4% and 33.8%, 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 quarter 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 December 28, 2014, approximately $53 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.

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We review the realizability of deferred tax assets on a quarterly basis by assessing the need for a valuation allowance.  As of December 28, 2014, 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 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 $7.3 million has been provided in prior years.

10.                               Reportable Segments

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 WEI reportable segment.  Our 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 RCM reportable segment.  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

Our reportable segments are 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 all 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 December 28, 2014 and September 28, 2014.  As of December 28, 2014 we had borrowings of $199.9 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 of our consolidated joint ventures was $2.2 million and $2.6 million for the first quarters of fiscal 2015 and 2014, respectively.  The assets and liabilities of these consolidated joint ventures were immaterial at December 28, 2014 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 December 28, 2014 and September 28, 2014 were $1.7 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 both the first quarter of fiscal 2015 and 2014, we reported $0.7 million of equity in earnings of unconsolidated joint ventures.  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 $20.3 million and $18.4 million, respectively, at December 28, 2014, 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 discribed 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 December 28, 2014, the effective portion of our interest rate swap agreements designated as cash flow hedges before tax effect was $0.3 million, all of which we expect to be reclassified from accumulated other comprehensive income to interest expense within the next 12 months.

As of December 28, 2014, the total notional principal amount of our outstanding interest rate swap agreements which expire in May 2018 was $199.9 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 2015 and the fiscal year ended September 28, 2014.  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 2014 and the first quarter of fiscal 2015.

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14.                               Reclassifications Out of Accumulated Other Comprehensive Income (Loss)

The accumulated balances and reporting period activities for the three months ended December 28, 2014 and December 29, 2013 related to reclassifications out of accumulated other comprehensive income (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.

We acquired BPR Inc. (“BPR”), a Quebec-based engineering firm on October 4, 2010.  Subsequently, we have been informed of the following with respect to pre-acquisition activities at BPR:

On April 17, 2012, authorities in the province of Quebec, Canada charged two former employees of BPR Triax, a subsidiary of BPR, and BPR Triax, under the Canadian Criminal Code with allegations of corruption.  Discovery procedures associated with the charges are currently ongoing, and the legal process is expected to continue into 2016.  We have conducted an internal investigation concerning this matter and, based on the results of our investigation, we believe these allegations are limited to activities at BPR Triax prior to our acquisition of BPR.

On April 19, 2013, a class action proceeding was filed in Montreal in which BPR, BPR’s former president, and other Quebec-based engineering firms and individuals are named as defendants.  The plaintiff class includes all individuals and entities that have paid real estate or municipal taxes to the city of Montreal.  The allegations include participation in collusion to share contracts awarded by the City of Montreal, conspiracy to reduce competition and fix prices, payment of bribes to officials, making illegal political contributions, and bid rigging.  A class certification hearing was held in March 2014, and on May 7, 2014, the court dismissed the action.  On June 5, 2014, the plaintiff filed an appeal, and the defendants then filed a motion to dismiss.  On November 3, 2014, the court dismissed the plaintiff’s appeal.  The plaintiff has filed an appeal with the Supreme Court of Canada.

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The financial impact to us of the matters discussed above is unknown at this time.

16.                               Recent Accounting Pronouncements

In July 2013, the FASB issued an update on the financial statement presentation of unrecognized tax benefits.  We are required to present a liability related to an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed.  The guidance became effective for us in the first quarter of fiscal 2015.  The adoption of this guidance did not have a material impact on our consolidated financial statements.

In April 2014, the FASB issued guidance that changes the threshold for reporting discontinued operations and adds new disclosures.  The new guidance defines a discontinued operation as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on our operations and financial results.  For disposals of individually significant components that do not qualify as discontinued operations, we must disclose pre-tax earnings of the disposed component.  This guidance is effective for us prospectively in the first quarter of fiscal 2016.  Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In May 2014, the 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 or services.  The accounting standard is effective for us in the first quarter of fiscal year 2018.  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 in the process of assessing what impact this new standard may have on our condensed consolidated financial statements.

In August 2014, the FASB issued an amendment to the accounting guidance related to the evaluation of an entity to continue as a going concern.  The amendment establishes management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern in connection with preparing financial statements for each annual and interim reporting period.  The update also gives guidance to determine whether to disclose information about relevant conditions and events when there is substantial doubt about an entity’s ability to continue as a going concern.  This 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 condensed consolidated financial statements.

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.  This 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 condensed 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, and energy.  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 13,000 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 international and U.S. commercial 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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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 WEI reportable segment.  Our 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 RCM reportable segment.  Prior year amounts for reportable segments have been revised to conform to the current-year presentation.

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 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.

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 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 EPCM for full service implementation of commercial projects, especially for oil and gas, industrial, and mining customers.

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

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: