Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following analysis of our financial condition and results of operations should be read in conjunction with Part I of this report, as well as our consolidated financial statements and accompanying notes in Item 8. The following analysis contains forward-looking statements about our future results of operations and expectations. Our actual results and the timing of events could differ materially from those described herein. See Part 1, Item 1A, "Risk Factors" for a discussion of the risks, assumptions and uncertainties affecting these statements.
The discussion and analysis for fiscal 2024 compared to fiscal 2023 can be found under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended September 29, 2024.
OVERVIEW OF RESULTS AND BUSINESS TRENDS
General. Our revenue growth of 4.7% i n fiscal 2025 was primarily due to increased activity in the U.S. state and local and U.S. federal government client sectors. The overall growth includes $80 million from our recent acquisitions, that did not have comparable revenue for fiscal 2024. Excluding the impact of these acquisitions, our revenue increased 3.2% compared to last fiscal year.
The table below presents our revenue by client sector (amounts in thousands):
Fiscal Year Ended
September 28,
September 29,
Change
Client sector
U.S. federal government (1)
U.S. state and local government
U.S. commercial
International (2)
Total
(1) Includes revenue generated under U.S. federal government contracts performed outside the United States.
(2) Includes revenue generated from non-U.S. clients, primarily in Australia, Canada and the United Kingdom.
U.S. Federal Government
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Revenue
Our U.S . federal government sector grew 2.6% in fiscal 2025 primarily due to increased disaster response work related to the Palisades and Eaton fires in Southern California, which occurred in early January 2025. The revenue growth also includes approximately $35 million of revenue from recent acquisitions that did not have comparable revenue in fiscal 2024.
On January 20, 2025, President Trump signed Executive Order 14169, titled "Reevaluating and Realigning United States Foreign Aid", which initiated a 90-day pause on all U.S. foreign development assistance programs to assess their alignment with U.S. foreign policy objectives with few exemptions. Following a six-week review, on February 27, 2025, U.S. Secretary of State Rubio announced the cancellation of 83% of USAID programs, totaling approximately 5,200 contracts. Subsequently, we were notified that virtually all of our contracts with USAID were terminated for convenience with immediate effect. In fiscal 2025, our U.S. federal government revenue included $576.4 million from USAID programs compared to $677.2 million last fiscal year. We currently expect no significant USAID revenue in fiscal 2026. However, we do expect our U.S. federal revenue to grow next fiscal year, excluding USAID and disaster response activities.
U.S. State and Local Government
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Revenue
In fiscal 2025, our U.S. state and local government revenue grew 28.8% compared to fiscal 2024 partially due to increased disaster response activity related to Hurricanes Helene and Milton. Excluding the disaster response work, our U.S. state and local government revenue increased 13.3% in fiscal 2025 compared to last fiscal year. This growth was due to continued investment by our clients in water infrastructure, including digital water automation. Most of our work for the U.S. state and local governments relates to critical water and environmental programs, which we expect to continue to grow in fiscal 2026.
U.S. Commercial
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Revenue
Our U.S. commercial revenue declined 1.1% in fiscal 2025 primarily due to lower activity related t o renewable ener gy, partially offset by increased environmental services compared to fiscal 2024. We expect our U.S. commercial revenue, excluding renewable energy, to grow in fiscal 2026.
International
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Revenue
For fiscal 2025, our international revenue increased 1.7% primarily due to growth on water planning and design activities in the United Kingdom, partially offset by lower infrastructure work in Australia. We expect the growth in our international work to continue in fiscal 2026.
RESULTS OF OPERATIONS
Fiscal 2025 Compared to Fiscal 2024
Consolidated Results of Operations
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands, except per share data)
Revenue
Subcontractor costs
Revenue, net of subcontractor costs (1)
Other costs of revenue
Gross profit
Selling, general and administrative expenses
Legal contingency costs
Impairment of goodwill
Acquisition and integration expenses
Contingent consideration – fair value adjustments
Income from operations
Interest expense – net
Income before income tax expense
Income tax expense
Net income
Net income attributable to noncontrolling interests
Net income attributable to Tetra Tech
Diluted earnings per share
(1) We believe that the presentation of "Revenue, net of subcontractor costs", which is a non-U.S. GAAP financial measure, enhances investors' ability to analyze our business trends and performance because it substantially measures the work performed by our employees. In the course of providing services, we routinely subcontract various services and, under certain international development programs, issue grants. Generally, these subcontractor costs and grants are passed through to our clients and, in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") and industry practice, are included in our revenue when it is our contractual responsibility to procure or manage these activities. Because subcontractor services can vary significantly from project to project and period to period, changes in revenue may not necessarily be indicative of our business trends. Accordingly, we segregate subcontractor costs from revenue to promote a better understanding of our business by evaluating revenue exclusive of costs associated with external service providers.
NM = not meaningful
Our revenue growth in fiscal 2025 reflects increases in both our GSG and CIG reportable segments. For fiscal 2025, our GSG segment's revenue and revenue, net of subcontractor costs, increased $190.6 million, or 7.7%, and $219.8 million, or 11.5%, respectively, compared to last year. Our CIG segment's revenue increased $57.9 million, or 2.1%, and revenue, net of subcontractor costs, increased $75.7 million, or 3.1% in fiscal 2025 compared fiscal 2024. The fiscal 2025 results for GSG and CIG segments are described below under "Government Services Group" and "Commercial/International Group", respectively.
The following table reconciles our reported results to non-U.S. GAAP adjusted results. For fiscal 2025, our adjusted results exclude a non-cash goodwill impairment charge of $92.4 million related to our GDS reporting unit, which resulted from the aforementioned cancellation of USAID programs in the second quarter of fiscal 2025. This charge is further described in Note 6, "Goodwill and Intangible Assets" of the “Notes to Consolidated Financial Statements”. Additionally, for fiscal 2025, our adjusted results exclude a non-recurring charge of $115.0 million related to legal contingencies as described in Note 18, "Commitments and Contingencies" of the “Notes to Consolidated Financial Statements”. Our adjusted results also exclude adjustments to contingent consideration liabilities in fiscal 2025. Our fiscal 2024 adjusted results exclude acquisition and integration costs and adjustments to contingent consideration liabilities. We determined that there is no tax benefit in fiscal 2025 for $31.3 million of the legal contingency charge and $58.3 million of the goodwill impairment charge. The effective tax rate applied to the remaining adjustments in fiscal 2025 to arrive at the adjusted earnings per share ("EPS") w as 24.6%. Th e effective tax rate applied to the adjustments to EPS to arrive at adjusted EPS in fiscal 2024 was 17%, which reflects certain integration costs/ that were not tax deductible. We applied the relevant marginal statutory tax rate based on the nature of
the adjustment and the tax jurisdiction in which it occurred. Both EPS and adjusted EPS were calculated using the diluted weighted-average common shares outstanding for the respective periods as reflected in our Consolidated Statements of Income.
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands, except per share data)
Income from operations
Legal contingency costs
Impairment of goodwill
Acquisition and integration expenses
Earn-out adjustments
Adjusted income from operations (1)
EPS
Legal contingency costs
Impairment of goodwill
Acquisition and integration expenses
Earn-out adjustments
Adjusted EPS (1)
NM = not meaningful
(1) Non-U.S. GAAP financial measure
Excluding the non-recurring charges and the earn-out gains, our operating income increased $93.2 million, or 18.3% in fiscal 2025 compared to last year. The increase reflects improved results in both of our reportable segments, which are described below under "Government Services Group" and "Commercial/International Services Group", respectively.
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Interest expense – net
Net interest expense decreased in fiscal 2025 primarily due to lower average interest rates and higher interest income compared to fiscal 2024.
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Income tax expense
The effective tax rates for fiscal 2025 and 2024 were 34.3% and 28.1%, respectively. Income tax expense was reduced by $1.6 million and $4.5 million of excess tax benefits on share-based payments in fiscal 2025 and 2024, respectively. In addition, in fiscal 2025, we recognized a $92.4 million goodwill impairment as described in Note 6, “Goodwill and Intangible Assets” of the “Notes to Consolidated Financial Statements”. We determined that $58.3 million of goodwill impairment is not deductible for income tax purposes. We also recognized a $115.0 million non-recurring charge related to legal contingencies as described in Note 18, "Commitments and Contingencies" of the “Notes to Consolidated Financial Statements”. We determined that $31.3 million of this charge is not tax deductible. Furthermore, income tax expense in fiscal 2024 included $4.2 million of expense for the settlement of various tax positions that were under audit for fiscal ye ars 2011 throug h 2021. Excluding the impact of the excess tax benefits on share-based payments, the goodwill impairment and the legal contingency charge in fiscal 2025 and the settlement amounts in fiscal 2024, our effective tax rates in fiscal 2025 and 2024 were 27.4% and 28.1%, respectively.
In December 2021, the OECD released Pillar Two Model Rules (also referred to as the global minimum tax or Global Anti-Base Erosion "GloBE" rules), which were designed to ensure large multinational enterprises pay a minimum 15% level of tax on the income arising in each jurisdiction in which they operate. Several jurisdictions in which we operate have enacted these rules, which are effective from the first quarter of fiscal 2025. We are continually monitoring developments and evaluating the potential impacts. We did not have a material tax charge as a result of implementation of these rules in fiscal 2025.
On June 28, 2025, the G7 released a statement confirming that agreement has been reached concerning the operation of a side-by-side solution to the application of Pillar Two to US parented groups. The statement notes that this side-by-side system will fully exclude US parented groups from the under taxed profits rule (UTPR) and the income inclusion rule (IIR) in respect of both their domestic and foreign profits.
On July 4, 2025, the U.S. government enacted a comprehensive tax and spending bill which includes, among other provisions, changes to the U.S. corporate income tax system including the allowance of immediate expensing of qualifying research and development expenses, restoring 100% bonus depreciation, and permanent extensions of certain provisions within the Tax Cuts and Jobs Act. Certain provisions that apply to Tetra Tech are effective beginning in fiscal 2025 and through fiscal 2027. We did not have any material change to our total income tax expense; howeve r, $0.4 million in t ax expense is deferred rather than current in fiscal 2025 due to the accelerated current deductions as a result of these tax law changes.
Segment Results of Operations
Government Services Group ("GSG")
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Revenue
Subcontractor costs
Revenue, net of subcontractor costs
Income from operations
The revenue growth in fiscal 2025 of 7.7% compared to last fiscal year primarily reflects increases in the previously described U.S. government activities related to disaster response. This increase was partially offset by a revenue decline of approximately $100 million related to the aforementioned cancellation of contracts with USAID.
Operating income increased in fiscal 2025 primarily due to the aforementioned revenue growth. Our operating margin, based on revenue, net of subcontractor costs, for fiscal 2025 was 16.0% compared to 14.7% in fiscal 2024. The improved operating margin reflects improved project execution including higher labor utilization.
Commercial/International Services Group ("CIG")
Fiscal Year Ended
September 28,
September 29,
Change
($ in thousands)
Revenue
Subcontractor costs
Revenue, net of subcontractor costs
Income from operations
The revenue growth in fiscal 2025 of 2.1% compared to fiscal 2024, includes a 12.3% increase in our operations in the United Kingdom reflecting higher demand for our water planning and design services. The growth in the United Kingdom was partially offset by lower infrastructure activities in Australia.
Our operating income increased due to the aforementioned revenue growth. Additionally, our operating income in fiscal 2024 was reduced by $3.6 million of integration costs related to RPS. Excluding the integration costs last year, our operating margin, based on revenue, net of subcontractor costs, improved approximately 50 basis points to 14.3% in fiscal 2025
compared to 13.8% in fiscal 2024. The improved operating margin was primarily due to our continued focus on high-end consulting services and improved project execution.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Capital Requirements. At September 28, 2025, we h ad $167.5 million of cash and cash equivalents and access to an additional $999.3 million of borrowing available under our credit facility. We generated $457.7 million of cash from operations in fiscal 2025. Our primary sources of liquidity are cash flows from operations and borrowings under our credit facilities. Our primary uses of cash are to fund working capital, cash dividends, share repurchases, capital expenditures and repayment of debt, as well as to fund acquisitions and earn-out obligations from prior acquisitions. We believe that our existing cash and cash equivalents, operating cash flows and borrowing capacity under our credit agreement as described below, will be sufficient to meet our capital requirements for at least the next 12 months.
On May 5, 2025, our Board of Directors authorized an additional $500 million stock repurchase program in addition to the previous $400 million stock repurchase program authorized on October 5, 2021. In fiscal 2025, we repurchased and settled 7,304,697 shares with an average price of $34.22 per share for a total cost of $250.0 million in the open market. In fiscal 2024 and 2023, we did not repurchase any shares of our common stock. At fiscal 2025 year-end, we had a remaining balance of $597.8 million under our stock repurchase program. We declared and paid common stock dividends totaling $65.0 million, or $0.246 per share, in fiscal 2025 compared to $58.8 million, or $0.220 per share, in fiscal 2024.
Subsequent Events. On November 10, 2025, our Board of Directors declared a quarterly cash dividend of $0.065 p er share payable on December 12, 2025 to stockholders of record as of the close of business on December 1, 2025.
Cash and Cash Equivalents. The following tables summarize information regarding our cash and cash equivalents (amounts in thousands):
Fiscal Year Ended
September 28,
September 29, 2024
Change
Cash and cash equivalents
Fiscal Year Ended
September 28,
September 29,
Change
Net cash provided by (used in):
Operating activities
Investing activities
Financing activities
Effect of exchange rate changes
Net increase (decrease) in cash and cash equivalents
Operating Activities. The 27.6% increase in cash from operating activities in fiscal 2025 compared to last year was primarily due to higher operating earnings, timely cash collections for work on the aforementioned disaster response in fiscal 2025 and cash collections on terminated USAID programs. The overall increase was partially offset by payments of $97 million for the aforementioned legal contingency in fiscal 2025.
Investing Activities. Our cash used in investing activities for fiscal 2025 includes net payments of $97.3 million for the CAW and SAGE acquisitions, compared to $93.7 million for the LST and CCE acquisitions completed in fiscal 2024.
Financing Activities. In fiscal 2025, our cash used in financing activities reflects the share repurchases of $250 million as our share repurchase program was reactivated this fiscal year. These share repurchases were funded by our cash generated from operating activities. We did not repurchase any shares in fiscal 2024. The overall increase in cash used in financing activities was partially offset by a $31 million decrease in payments for contingent consideration in fiscal 2025 compared to fiscal 2024.
Debt Financing. On February 18, 2022, we entered into Amendment No. 2 to the Second Amended and Restated Credit Agreement (“Second Amended Credit Agreement”) with a total borrowing capacity of $1.05 billion that was scheduled to mature in February 2027. The Second Amended Credit Agreement consisted of a $750 million senior secured, five-year facility that provided for a $250 million term loan facility ("Second Term Loan Facility") and a $500 million revolving credit facility ("Second Revolving Credit Facility"). On October 26, 2022, we entered into a Third Amended and Restated Credit
Agreement (“Third Amended Credit Agreement”) that provided for an additional $500 million senior secured term loan facility ("Third Term Loan Facility") increasing our total borrowing capacity to $1.55 billion. On January 23, 2023, we drew the entire amount of the $500 million term loan facility which was scheduled to mature in January 2026. On May 5, 2025 we repaid all facilities in full as detailed below.
On August 22, 2023, we issued $575.0 million in Convertible Notes that bear interest at 2.25% per annum payable semiannually in arrears on February 15 and August 15 of each year, beginning on February 15, 2024 with a maturity date of August 15, 2028. The net proceeds from the Convertible Notes were $560.5 million, $51.8 million of which were used to purchase related capped call transactions on the issue date. The remaining proceeds were used to prepay and terminate the $234.4 million outstanding under the Second Term Loan Facility, to prepay $89.4 million outstanding under the Third Term Loan Facility and to pay down borrowings of $185.0 million under the Second Revolving Credit Facility. See Note 9, "Long-Term Debt" of the "Notes to Consolidated Financial Statements" for further discussion.
On May 5, 2025, we entered into a Fourth Amended and Restated Credit Agreement (“Amended Credit Agreement”) with a total borrowing capacity of $1.5 billion that will mature in May 2030. The Amended Credit Agreement is a $1.1 billion senior secured, five-year facility that provides for a $250 million 3-year term loan facility (the “3Y Term Loan Facility”), a $250 million 5-year term loan facility (“the 5Y Term Loan Facility”), and a $600 million revolving credit facility (the “Amended Revolving Credit Facility”). In addition, the Amended Credit Agreement includes a $400 million accordion feature that allows us to increase the Amended Credit Agreement to $1.5 billion subject to lender approval. The 5Y Term Loan Facility is subject to quarterly amortization of principal, based upon the annual percentages of the original stated amount thereof (Year 1: 0.0%, Year 2: 0.0%, Year 3: 5.0%, Year 4: 10.0%, Year 5: 10.0%), with the first payment being due at the end of the first full fiscal quarter following the second anniversary of the Amendment Effective Date. The Amended Credit Agreement provides for, among other things, (i) refinance indebtedness under our Third Amended Credit Agreement; (ii) finance open market repurchases of common stock, acquisitions, and cash dividends and distributions; and (iii) utilize the proceeds for working capital, capital expenditures and other general corporate purposes. The Amended Credit Agreement provides for a reduction in the pricing levels of the Consolidated Leverage Ratio and the removal of the Secured Overnight Financing Rate ("SOFR") credit spread adjustment. The Amended Revolving Credit Facility includes a $100 million sublimit for the issuance of standby letters of credit, a $20 million sublimit for swingline loans, and a $400 million sublimit for multi-currency borrowings and letters of credit.
The entire 3Y Term Loan Facility and 5Y Term Loan Facility were drawn on May 5, 2025. The proceeds from these term loans were used to pay down our Third Term Loan Facility and the Second Revolving Credit Facility in full on May 5, 2025. On September 26, 2025, the 3Y Term Loan Facility was repaid in full. We may borrow on the Amended Revolving Credit Facility, at our option, at either (a) a benchmark rate plus a margin that ranges from 1.000% to 1.750% per annum, or (b) a base rate for loans in U.S. dollars (the highest of the U.S. federal funds rate plus 0.50% per annum, the bank’s prime rate or the SOFR rate plus 1.00%, plus a margin that ranges from 0% to 0.75% per annum). In each case, the applicable margin is based on our Consolidated Leverage Ratio, calculated quarterly. The 5Y Term Loan Facility is subject to the same interest rate provisions. The Amended Credit Agreement expires on May 5, 2030, or earlier at our discretion upon payment in full of loans and other obligations.
At fiscal 2025 year-end, we had $200 million in outstanding borrowings under the Amended Credit Agreement, which consisted of $200 million under the 5Y Term Loan Facility and no borrowings under the Amended Revolving Credit Facility. The weighted-average interest rate of the outstanding borrowings under the credit facilities during fiscal 2025 was 5.63%. In addition, we had $0.7 million in standby letters of credit under the Amended Credit Agreement. At September 28, 2025, we had $599.3 million of available credit under the Amended Revolving Credit Facility, all of which could be borrowed without a violation of our debt covenants. Commitment fees related to our revolving credit facilities were $0.8 million, $0.8 million, and $0.6 million for fiscal year 2025, 2024 and 2023, respectively.
The Amended Credit Agreement contains certain affirmative and restrictive covenants, and customary events of default. The financial covenants provide for a maximum Consolidated Leverage Ratio of 3.50 to 1.00 (total funded debt/EBITDA, as defined in the Amended Credit Agreement) and a minimum Consolidated Interest Coverage Ratio of 3.00 to 1.00 (EBITDA/Consolidated Interest Charges, as defined in the Amended Credit Agreement). Our obligations under the Amended Credit Agreement are guaranteed by certain of our domestic subsidiaries and are secured by first priority liens on (i) the equity interests of certain of our subsidiaries, including those subsidiaries that are guarantors or borrowers under the Amended Credit Agreement, and (ii) the accounts receivable, general intangibles and intercompany loans, and those of our subsidiaries that are guarantors or borrowers. At September 28, 2025, we were in compliance with these covenants with a consolidated leverage ratio of 1.13x and a consolidated interest coverage ratio of 17.31x .
In addition to the Amended Credit Agreement, we maintain other credit facilities, which may be used for short-term cash advances and bank guarantees. At September 28, 2025, there were no outstanding borrowings under these facilities, and the aggregate amount of standby letters of credit outstanding wa s $53.8 million. At September 28, 2025 , we had no bank overdrafts related to our disbursement bank accounts.
Inflation. We believe our operations have not been, and, in the foreseeable future, are not expected to be, materially adversely affected by inflation or changing prices due to the average duration of our projects and our ability to negotiate prices as contracts end and new contracts begin.
Dividends. Our Board of Directors has authorized the following dividends:
Dividend Per Share
Record Date
Total Maximum
Payment
(in thousands)
Payment Date
November 11, 2024
November 27, 2024
December 13, 2024
January 27, 2025
February 12, 2025
February 26, 2025
May 5, 2025
May 23, 2025
June 5, 2025
July 28, 2025
August 15, 2025
August 29, 2025
November 10, 2025
December 1, 2025
December 12, 2025
Income Taxes
We evaluate the realizability of our deferred tax assets by assessing the valuation allowance and adjust the allowance, if necessary. The factors used to assess the likelihood of realization are our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The ability or failure to achieve the forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets. Based on future operating results in certain jurisdictions, it is unlikely that the current valuation allowance positions of those jurisdictions could be adjusted in the next 12 months.
At the end of fiscal 2025 and 2024, the liability for income taxes associated with uncertain tax positions was $52.8 million and $50.1 million, respectively.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of our unrecognized tax positions may significantly decrease within the next 12 months. These liabilities represent our current estimates of the additional tax liabilities that we may be assessed when the related audits are concluded. If these audits are resolved in a manner more unfavorable than our current expectations, our additional tax liabilities could be materially higher than the amounts currently recorded resulting in additional tax expense.
Off-Balance Sheet Arrangements
In the ordinary course of business, we may use off-balance sheet arrangements if we believe that such arrangements would be an efficient way to lower our cost of capital or help us manage the overall risks of our business operations. We do not believe that such arrangements have had a material adverse effect on our financial position or our results of operations.
The following is a summary of our off-balance sheet arrangements:
• Letters of credit and bank guarantees are used primarily to support project performance and insurance programs. We are required to reimburse the issuers of letters of credit and bank guarantees for any payments they make under the outstanding letters of credit or bank guarantees. Our Amended Credit Agreement and additional letter of credit facilities cover the issu ance of our standby letters of credit and bank guarantees and are critical for our normal operations. If we default on the Amended Credit Agreement or additional credit facilities, our inability to issue or renew standby letters of credit a nd bank guarantees would impair our ability to maintain normal operations. At fiscal 2025 year-end, we had $0.7 million in standby letters of credit outstanding under our Amended Credit Agreement and $53.8 million in standby l etters of credit outstanding under our additional letter of credit facilities.
• From time to time, we provide guarantees and indemnifications related to our services. If our services under a guaranteed or indemnified project are later determined to have resulted in a material defect or other material deficiency, then we may be responsible for monetary damages or other legal remedies. When sufficient information about claims on guaranteed or indemnified projects is available and monetary damages or other costs or losses are determined to be probable, we recognize such guaranteed losses.
• In the ordinary course of business, we enter into various agreements as part of certain unconsolidated subsidiaries, joint ventures and other jointly executed contracts where we are jointly and severally liable. We enter into these agreements primarily to support the project execution commitments of these entities. The potential payment amount of an outstanding performance guarantee is typically the remaining cost of work to be performed by or on behalf of third parties under engineering and construction contracts. However, we are not able to estimate other amounts that may be required to be paid in excess of estimated costs to complete contracts and, accordingly, the total potential payment amount under our outstanding performance guarantees cannot be estimated. For cost-plus contracts, amounts that may become payable pursuant to guarantee provisions are normally recoverable from the client for work performed under the contract. For lump sum or fixed-price contracts, this amount is the cost to complete the contracted work less amounts remaining to be billed to the client under the contract. Remaining billable amounts could be greater or less than the cost to complete. In those cases where costs exceed the
remaining amounts payable under the contract, we may have recourse to third parties, such as owners, co-venturers, subcontractors or vendors, for claims.
• In the ordinary course of business, our clients may request that we obtain surety bonds in connection with contract performance obligations that are not required to be recorded in our consolidated balance sheets. We are obligated to reimburse the issuer of our surety bonds for any payments made thereunder. Each of our commitments under performance bonds generally ends concurrently with the expiration of our related contractual obligation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions in the application of certain accounting policies that affect amounts reported in our consolidated financial statements and accompanying footnotes included in Item 8 of this report. In order to understand better the changes that may occur to our financial condition, results of operations and cash flows, readers should be aware of the critical accounting policies we apply and estimates we use in preparing our consolidated financial statements. Although such estimates and assumptions are based on management's best knowledge of current events and actions we may undertake in the future, actual results could differ materially from those estimates.
Our significant accounting policies are described in the "Notes to Consolidated Financial Statements" included in Item 8. Highlighted below are the accounting policies that management considers most critical to investors' understanding of our financial results and condition, and that require complex judgments by management.
Revenue Recognition and Contract Costs
To determine the proper revenue recognition method for contracts under Accounting Standards Codification Topic 606, "Revenue from Contracts with Customers", we evaluate whether multiple contracts should be combined and accounted for as a single contract and whether the combined or single contract should be accounted for as having more than one performance obligation. The decision to combine a group of contracts or separate a combined or single contract into multiple performance obligations may impact the amount of revenue recorded in a given period. Contracts are considered to have a single performance obligation if the promises are not separately identifiable from other promises in the contracts.
At contract inception, we assess the goods or services promised in a contract and identify, as a separate performance obligation, each distinct promise to transfer goods or services to the customer. The identified performance obligations represent the “units of account” for purposes of determining revenue recognition. In order to properly identify separate performance obligations, we apply judgment in determining whether each good or service provided is: (a) capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and (b) distinct within the context of the contract, whereby the transfer of the good or service to the customer is separately identifiable from other promises in the contract.
Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new or changes the existing enforceable rights and obligations. Most of our contract modifications are for goods or services that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
We account for contract modifications as a separate contract when the modification results in the promise to deliver additional goods or services that are distinct and the increase in price of the contract is for the same amount as the stand-alone selling price of the additional goods or services included in the modification.
The transaction price represents the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to our customers. The consideration promised within a contract may include fixed amounts, variable amounts or both. The nature of our contracts gives rise to several types of variable consideration, including claims, award fee incentives, fiscal funding clauses and liquidated damages. We recognize revenue for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized for the contract will not occur. We estimate the amount of revenue to be recognized on variable consideration using either the expected value or the most likely amount method, whichever is expected to better predict the amount of consideration to be received. Project mobilization costs are generally charged to project costs as incurred when they are an integrated part of the performance obligation being transferred to the client.
For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using a best estimate of the standalone selling price of each distinct good or service in the contract. The standalone selling price is typically determined using the estimated cost of the contract plus a margin approach. For contracts containing variable consideration, we allocate the variability to a specific performance obligation within the contract if such variability relates
specifically to our efforts to satisfy the performance obligation or transfer the distinct good or service, and the allocation depicts the amount of consideration to which we expect to be entitled.
We recognize revenue over time as the related performance obligation is satisfied by transferring control of a promised good or service to our customers. Progress toward complete satisfaction of the performance obligation is primarily measured using a cost-to-cost measure of progress method. The cost input is based primarily on contract cost incurred to date compared to total estimated contract cost. This measure includes forecasts based on the best information available and reflects our judgment to faithfully depict the value of the services transferred to the customer. For certain on-call engineering or consulting and similar contracts, we recognize revenue in the amount which we have the right to invoice the customer if that amount corresponds directly with the value of our performance completed to date.
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost measure of progress method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs indicates a loss, a provision for the entire estimated loss on the contract is made in the period in which the loss becomes evident.
Contract Types
Our services are performed under three principal types of contracts: fixed-price, time-and-materials and cost-plus. Customer payments on contracts are typically due within 30 to 45 days of billing, depending on the contract.
Fixed-Price . Under fixed-price contracts, clients pay us an agreed fixed-amount negotiated in advance for a specified scope of work.
Time-and-Materials . Under time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we spend on a project. In addition, clients reimburse us for our actual out-of-pocket costs for materials and other direct incidental expenditures that we incur in connection with our performance under the contract. Most of our time-and-material contracts are subject to maximum contract values, and also may include annual billing rate adjustment provisions.
Cost-Plus . Under cost-plus contracts, we are reimbursed for allowed or otherwise defined costs incurred plus a negotiated fee. The contracts may also include incentives for various performance criteria, including quality, timeliness, ingenuity, safety and cost-effectiveness. In addition, our costs are generally subject to review by our clients and regulatory audit agencies, and such reviews could result in costs being disputed as non-reimbursable under the terms of the contract.
Goodwill and Intangibles
The cost of an acquired company is assigned to the tangible and intangible assets purchased and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when a market value is not readily available. Any excess of purchase price over the fair value of net tangible and intangible assets acquired is allocated to goodwill. Goodwill typically represents the value paid for the assembled workforce and enhancement of our service offerings.
Identifiable intangible assets primarily include backlog, client relations and trade names. The costs of these intangible assets are amortized over their contractual or economic lives, which range from one to 12 years. We assess the recoverability of the unamortized balance of our intangible assets when indicators of impairment are present based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of the intangible assets would be recognized as an impairment loss.
Estimated fair value measurements for intangible assets are made using Level 3 inputs including discounted cash flow techniques. Fair value is estimated using a multi-period excess earnings method for backlog and client relations and a relief from royalty method for trade names. The significant assumptions used in estimating fair value of backlog and client relations include (i) the estimated life the asset will contribute to cash flows, such as remaining contractual terms, (ii) revenue growth rates and EBITDA margins, (iii) attrition rate of customers, and (iv) the estimated discount rates that reflect the level of risk associated with receiving future cash flows. The significant assumptions used in estimating fair value of trade names include the royalty rates and discount rates.
We perform our annual goodwill impairment review at the beginning of our fiscal fourth quarter. In addition, we regularly evaluate whether events and circumstances have occurred that may indicate a potential change in recoverability of goodwill. We perform interim goodwill impairment reviews between our annual reviews if certain events and circumstances have occurred, including a deterioration in general economic conditions, an increased competitive environment, a change in management, key personnel, strategy or customers, negative or declining cash flows or a decline in actual or planned revenue or
earnings compared with actual and projected results of relevant prior periods (se e Note 6, "Goodwill and Intangible Assets" of the "Notes to Consolidated Financial Statements" in Item 8 for further discussion).
We believe the methodology that we use to review impairment of goodwill, which includes a significant amount of judgment and estimates, provides us with a reasonable basis to determine whether impairment has occurred. However, many of the factors employed in determining whether our goodwill is impaired are outside of our control, and it is reasonably likely that assumptions and estimates will change in future periods. These changes could result in future impairments.
The goodwill impairment review involves the determination of the fair value of our reporting units, which for us are the components one level below our reportable segments. This process requires us to make significant judgments and estimates, including assumptions about our strategic plans with regard to our operations as well as the interpretation of current economic indicators and market valuations. Furthermore, the development of the present value of future cash flow projections includes assumptions and estimates derived from a review of our expected revenue growth rates, operating profit margins, business plans, discount rates and terminal growth rates. We also make certain assumptions about future market conditions, market prices, interest rates and changes in business strategies. Changes in assumptions or estimates could materially affect the determination of the fair value of a reporting unit. This could eliminate the excess of fair value over carrying value of a reporting unit entirely and, in some cases, result in impairment. Such changes in assumptions could be caused by a loss of one or more significant contracts, reductions in government or commercial client spending or a decline in the demand for our services due to changing economic conditions. In the event that we determine that our goodwill is impaired, we would be required to record a non-cash charge that could result in a material effect on our results of operations or financial position.
We use two methods to determine the fair value of our reporting units: (i) the Income Approach and (ii) the Market Approach. While each of these approaches is initially considered in the valuation of the business enterprises, the nature and characteristics of the reporting units indicate which approach is most applicable. The Income Approach utilizes the discounted cash flow method, which focuses on the expected cash flow of the reporting unit. In applying this approach, the cash flow available for distribution is calculated for a finite period of years. Cash flow available for distribution is defined, for purposes of this analysis, as the amount of cash that could be distributed as a dividend without impairing the future profitability or operations of the reporting unit. The cash flow available for distribution and the terminal value (the value of the reporting unit at the end of the estimation period) are then discounted to present value to derive an indication of the value of the business enterprise. The Market Approach is comprised of the guideline company method and the similar transactions method. The guideline company method focuses on comparing the reporting unit to select reasonably similar (or "guideline") publicly traded companies. Under this method, valuation multiples are (i) derived from the operating data of selected guideline companies; (ii) evaluated and adjusted based on the strengths and weaknesses of the reporting units relative to the selected guideline companies; and (iii) applied to the operating data of the reporting unit to arrive at an indication of value. In the similar transactions method, consideration is given to prices paid in recent transactions that have occurred in the reporting unit's industry or in related industries. For our annual analysis, we weighted the Income Approach and the Market Approach at 70% and 30%, respectively. The Income Approach was given a higher weight because it has the most direct correlation to the specific economics of the reporting unit, as compared to the Market Approach, which is based on multiples of broad-based (i.e., less comparable) companies . Our last review at June 30, 2025 (i.e., the first day of our fourth quarter in fiscal 2025), indicated that we had no of goodwill, and all of our reporting units had estimated fair values that were in excess of their carrying values, including goodwill. We had no reporting units that had estimated fair values that exceeded their carrying values by less than 38%, except for our Global Development Services reporting unit which was in the second quarter of fiscal 2025 .
Contingent Consideration
Certain of our acquisition agreements include contingent earn-out arrangements, which are generally based on the achievement of future operating income thresholds. The contingent earn-out arrangements are based upon our valuations of the acquired companies and reduce the risk of overpaying for acquisitions if the projected financial results are not achieved.
The fair values of these earn-out arrangements are included as part of the purchase price of the acquired companies on their respective acquisition dates. For each transaction, we estimate the fair value of contingent earn-out payments as part of the initial purchase price and record the estimated fair value of contingent consideration as a liability in "Estimated contingent earn-out liabilities" and "Long-term estimated contingent earn-out liabilities" on the consolidated balance sheets. We consider several factors when determining that contingent earn-out liabilities are part of the purchase price, including the following: (1) the valuation of our acquisitions is not supported solely by the initial consideration paid, and the contingent earn-out formula is a critical and material component of the valuation approach to determining the purchase price; and (2) the former shareholders of acquired companies that remain as key employees receive compensation other than contingent earn-out payments at a reasonable level compared with the compensation of our other key employees. The contingent earn-out payments are not affected by employment termination.
We measure our contingent earn-out liabilities at fair value on a recurring basis using significant unobservable inputs classified within Level 3 of the fair value hierarchy (See Note 2, "Basis of Presentation – Fair Value of Financial Instruments" of the "Notes to Consolidated Financial Statements" included in Item 8). We use a probability weighted discounted income approach as a valuation technique to convert future estimated cash flows to a single present value amount. The significant unobservable inputs used in the fair value measurements are operating income projections over the earn-out period (generally two or three years), and the probability outcome percentages we assign to each scenario. Significant increases or decreases to either of these inputs in isolation would result in a significantly higher or lower liability with a higher liability capped by the contractual maximum of the contingent earn-out obligation. Ultimately, the liability will be equivalent to the amount paid, and the difference between the fair value estimate and amount paid will be recorded in earnings. The amount paid that is less than or equal to the liability on the acquisition date is reflected as cash used in financing activities in our consolidated statements of cash flows. Any amount paid in excess of the liability on the acquisition date is reflected as cash used in operating activities in our consolidated statements of cash flows.
We review and re-assess the estimated fair value of contingent consideration on a quarterly basis, and the updated fair value could differ materially from the initial estimates. Changes in the estimated fair value of our contingent earn-out liabilities related to the time component of the present value calculation are reported in interest expense. Adjustments to the estimated fair value related to changes in all other unobservable inputs are reported in operating income.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of recent accounting standards and the effect they could have on the consolidated financial statements, see Note 2, "Basis of Presentation" of the "Notes to Consolidated Financial Statements" included in Item 8.
