Tetra Tech Inc Q2 FY2025 Earnings Call

Good morning, and thank you for joining the Tetra Tech Earnings Call. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the Investor section of its website at Tetra Techh.com. This call is being recorded at the request of Tetra Tech, and this broadcast is the copyrighted property of Tetra Tech. Any rebroadcast of this information in whole or part without the prior written permission of Tetra Tech is prohibited. With us today from management are Dan Batrack, Chairman and Chief Executive Officer; Steve Burdick, Chief Financial Officer; Leslie Shoemaker, Chief Innovation Officer; and Joseph Fong, High Performance Buildings Lead. They will provide a brief overview of the results and will then open up the call for questions. I would like to direct your attention to the safe harbor statement in today’s presentation. Today’s discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today’s forward-looking statements due to various risks and uncertainties, including the risks described in Tetra Tech’s periodic reports filed with the SEC. Except as required by law, Tetra Tech undertakes no obligation to update its forward-looking statements. In addition, since management will be presenting some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted in the Investor section of Tetra Tech’s website. At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the company, we will open the conference for questions and answers after the presentation. With that, I would like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Thank you very much, Christine. And good morning and welcome to our second quarter of fiscal year 2025 earnings conference call. We just had one of the most interesting quarters in the history of the company. Never have we seen our largest client by revenue essentially disappear within just one quarter. If you’d asked me 20 years ago what would have been the impact for quarterly results of this happening? I’m not sure I could have told you, but it certainly wouldn’t have been good. But today, in this quarter, through the incredible diversity of our clients, diversity of the services we provide, and the geographies that we operate in, we had one of the best quarters in the company’s history. Our second quarter was one of the highest revenue quarters that we’ve ever had in the company’s history. It’s the third highest earnings per share and operating income we’ve had in the history of the company, and we increased margins in both of the segments. We did all of this during the months of January, February, and March, which are typically our slowest quarters of the year due to the winter months here in the United States, Canada, Northern Europe, and many holidays taking place during those months in Australia. So it was particularly a very strong quarter for the company. I know I, personally, and the management presenting with me today, are looking forward to presenting our second quarter results and outlook and addressing your questions at the conclusion of the presentation. Presenting with me today will be Steve Burdick, our Chief Financial Officer, who will provide additional details on our financial performance and our new credit facility; Dr. Leslie Shoemaker, our Executive Vice President and Chief Innovation Officer, who will provide an update on water and environmental markets, primarily in the government sector; and Joseph Fong, a global leader in our High Performance Buildings practice, will provide remarks on some of our key data center and digital systems growth markets. Before we begin discussing the drivers and the outlook for 2025, I’d like to first share with you the results for our second quarter. We really had an excellent second quarter. We achieved new quarterly record results for revenue, net revenue, operating income, and earnings per share. Our net revenue increased to $1.1 billion in the quarter, up $51 million more than in the same quarter last year. Our operating income was $130 million for the quarter, which was an increase of 11% from the prior year. And we generated earnings per share of $0.33 for the quarter, which is up 18% from the prior year. I’d like to go over our performance in each of our two segments. For the second quarter, our Government Services Group, or the GSG segment, increased its revenue by 12% year-over-year to $521 million. Our GSG generated a 13.8% margin in the quarter, and that margin is actually inclusive of several million dollars of non-project reimbursable costs that we incurred during the quarter, closing out the majority of the USAID work. If we hadn’t incurred those additional non-reimbursable costs, that margin would have been up an additional somewhere between 30 to 50 additional basis points from this already increased level from the prior year. Our GSG’s revenue growth was driven by work primarily in our state and local government areas, doing work in the water, environment, and disaster response areas. The Commercial/International Group, or the CIG segment, delivered a 13.2% margin for the quarter. Their revenue of $597 million was up just about 2%, with strong growth in our U.S. commercial environmental restoration projects and in our UK water programs, but it was offset by about a 10% reduction in our Australia infrastructure work. For performance by our end customer, work for our U.S. federal clients without USAID and the Department of State was up 16% from the same quarter last year, and now represents about 20% of our revenues in the business. About half of the growth of this 16% COVID growth came from our disaster response activities, while the remaining other half or about 8% came from work that we did primarily for the Department of Defense and very large new programs for the Army Corps of Engineers. Our state and local revenues grew 44% year-over-year. Now that 44% growth; just a little over half came from episodic disaster response activities that we performed during the quarter, while the other portion of the growth or just under half was from ongoing municipal water programs, which were up 19% year-over-year. Our U.S. commercial net revenues were up 5% year-over-year, driven by growth in our environmental, energy, and transmission-related work. Finally, our international work represented about 38% of our revenues in the quarter. It was up slightly on a constant currency basis. I will note we did see double-digit growth in our United Kingdom and Irish water programs and in the United Kingdom’s defense services businesses, but this growth was offset by over a 10% reduction in our Australian infrastructure work. I will say that the slowness in our Australian revenues has been attributed to a major election that took place just less than a week ago. On May 3, there was a new national election, which had many funding programs put on hold leading up to the election that has now been completed and put behind them. I would like to discuss our backlog briefly, which represents work contracted with our clients, funded, and authorized for us to begin work directly by our clients. Tetra Tech’s updated backlog is now $4,310 million, or $4.31 billion. This $4.3 billion captures the de-obligation of approximately $1.1 billion in USAID and Department of State projects that took place in the quarter. And within this $4.31 billion of backlog, we still have about $220 million in place with USAID, mostly for ongoing work in Ukraine in the energy sector. We expect that $220 million to be spent in the second half of this fiscal year. Without USAID and Department of State, our backlog stands at $4.09 billion, which represents a solid book-to-bill of 1.1 times for the quarter, driven by orders across our global operations. We’ll also note there have been a lot of questions about our outlook in the U.S. federal government, looking forward in terms of contract capacity and backlog. I’m pleased to announce that we now hold over $30 billion in contract capacity across the U.S. federal government, primarily for defense and civilian agencies for services we provide that are highly aligned with the administration’s priorities. In the United Kingdom, we also continue to expand our framework contracts with leading water utilities. We added another $100 million in capacity in the UK water utilities to perform high-end water modeling and data analytic work. At this point, I’d like to turn the presentation over to our Chief Financial Officer, Steve Burdick, to provide additional details on our financials year-to-date and, importantly, an update on our capital allocation strategies. So, Steve?

Hey, thanks, Dan. So, I’d like to now provide an update for the first half of fiscal year relative to our record results, working capital, cash flows, and capital allocation. As Leslie will review later in this call, we continue to focus on our growing core front-end cycle for water and environmental projects, which are carrying higher margins across all of our end markets. In addition, Joseph will present our strategic focus on high-end data centers along with the nexus of both water and power transmission, where we also expect higher growth and margins. As we look back at our year-to-date results, even as revenue was up double-digits, about 11% over last year, our operating income and EBITDA for the first half of the year increased at higher rates of 17% and 12%, respectively. As a result of the double-digit top-line growth, along with our ability to effectively manage and allocate our capital, we were able to increase EPS by 21% over last year, which is just about two times our top-line growth. Now, in the first half of the year, our GAAP results include one-time non-recurring charges. So, please refer to the appendix of this presentation and our Reg G for reconciliation to the adjusted results. This strong financial and operating performance has resulted in the continued ability for the company to exceed and beat EPS consensus every quarter for the last eight years and to improve our annual EBITDA margins by an average of 50 basis points each year over that same eight-year period. As you all probably know, about one month into the quarter, we saw our largest U.S. federal client put a pause on paying our invoices, which had a very negative effect on our working capital for the second quarter. I’m happy to provide a real-time update to let you know that since the end of the second quarter, our USAID client has paid on most of our past two invoices, and we have so far collected over $150 million, which equates to about a 10-day DSO improvement. Now, cash flows generated from operations for the trailing 12 months were $311 million, and these cash flows will continue to exceed our fiscal net income by more than 100%. Including the USAID-related receivables our consolidated DSO stood at 67 days. As I noted, since the end of the second quarter, the payments received of $150 million from USAID has resulted in a consolidated DSO improving to about 57 days. This lower DSO metric provides significant insight into our core business as it reflects the outstanding work that our project managers lead relative to higher quality projects and highly satisfied clients in our broad portfolio across all of our end markets and geographies. The net debt on EBITDA was at a leverage of 1.36 times, which is slightly lower than our average one year ago when it stood at 1.38 times. Now, since the end of the second quarter, with the receipt of these additional payments, our net leverage has lowered to about 1.1 times. And as we continue to execute on high-quality operating results with strong cash flows and healthy working capital, we’ve been able to payout higher dividends, increase stock buybacks, and invest in strategic acquisitions to provide higher returns for all of our shareholders, all while delevering our balance sheet. So, for those of you following along on the presentation, I would like to now present our capital allocation overview. We have a very strong balance sheet, and we further improve the balance sheet as we closed and funded on a new credit facility with a very supportive bank group such that over the next five years through 2030, we have access to more liquidity, about $1.5 billion at more favorable terms and conditions. As we’ve revised our capital structure over the last two years to take advantage of the credit market and to support our financing needs, I want to point out our ability to reduce our average interest rate from the second quarter of fiscal 2024 by 50 basis points to 3.63% and this in an environment of higher uncertainty. So, as I said earlier, Leslie and Joseph will discuss our strategic growth areas later in this presentation. I do want to point out that we have a significant amount of liquidity available to invest in both organic and acquisitive priorities, and we have a well-balanced mix of fixed and floating rate debt to mitigate interest rate risk as we look to grow these higher-margin priorities. Regarding our dividend program, I want to announce that our Board approved a quarterly dividend, which is a 12% increase to be paid in the third quarter. This is our 40th consecutive quarterly dividend with annual double-digit increases in the amounts paid. Based on the lower leverage, which we did fall below one time at the end of 2024, we did reinstitute our stock buyback program, and in the second quarter, we bought back $150 million in stock. We have available a portion of the stock buyback plan approved by our Board of Directors back in 2022. Furthermore, I’m happy to announce that our Board of Directors approved an additional $500 million for a total of $673 million for use in future stock buybacks as part of our capital allocation strategy. I am quite pleased, as you heard Dan, I’m also quite pleased to share these really strong results for the first half of fiscal 2025. I want to thank you for all your support, and I will now hand the call over to Leslie and Joseph to discuss Tetra Tech’s future opportunities.

Thank you, Steve. For over 50 years, we’ve supported the U.S. federal government in addressing the nation’s highest priority needs. Today, I’d like to focus on our work with the U.S. Department of Defense worldwide. Highlighted on the slide is the $5 billion in new contract capacity we have been awarded just this fiscal year with U.S. defense agencies. The majority of them announced just within the last 100 days since the inauguration. Today, our largest client at Tetra Tech is the U.S. Army Corps of Engineers. The Corps has a dual mission to support both the nation’s defense programs worldwide and our nation’s infrastructure through their civil works programs across the United States. For national security, we provide engineering design of resilient infrastructure all over the world, including wastewater and water supplies to support military facilities. Our recent awards include coverage of areas like the critical Middle East region, the Pacific region served by the Honolulu District, Central and South America served by the Mobile District, and global defense systems supported by the Huntsville District. For the civil works programs in the United States, we also support the Corps of Engineers and their partners at the state and local level with the high-end engineering analysis and design for essential flood control structures, including dams and levees. We also work on designing and managing the dams and reservoirs used for water supplies, and we work for the Corps to upgrade our inland waterway systems, the engineering of the locks and dams that support the U.S. internal trade and shipping routes. With the proposed increases in defense spending and the renewed interest in U.S. business investments, we see strong future growth opportunities across the defense-related services that we provide. I’d now like to talk about our locally driven work for water supply. This continues to be a high priority in the United States, the United Kingdom, and Ireland, directly in line with our long-term view on this market. Across these markets, we’re seeing continued double-digit growth in revenue through both new clients and new programs to address critical water needs. In the U.S., high-end water treatment demand continues to add and secure new water supplies for our customers. Our project in Cape Coral for brackish water treatment adds a new source in a rapidly growing, high-value region. We see continued demand expanding for potable reuse with the design of a first-of-a-kind plant in Oklahoma for indirect potable reuse to augment their water supply. In areas at risk for coastal flooding with aging infrastructure, such as Gloucester, Massachusetts, we see renewed demand for the modernization of wastewater treatment facilities. With our new contract capacity in the United Kingdom, we’re encouraged to see increased demand for our high-end science-based solutions to address water quality protection as part of the challenge to materially reduce contamination across the country. In Ireland, we are supporting the water utility in their program to fully reengineer their water supplies to meet Dublin’s expanding needs for drinking water. To support these clients in their large investments in Ireland and the United Kingdom, we’re pleased to have recently announced the addition of Carron + Walsh, a leader in program management services for utilities and government agencies. Welcoming them aboard will really extend our ability to provide more project management services. And with that, I’d now like to turn the presentation over to Joseph.

Thank you, Leslie. Tetra Tech’s market-leading water and energy expertise has become a key competitive advantage in driving our high-performance buildings’ fastest growth market, high-tech data centers. With over $500 billion in future investment forecasted in new computing infrastructure and current global energy consumption by data centers expected to double, not only are we seeing the increased demand for data center building design, but we are also seeing increased demand for our differentiated services, water and energy. Our strategy to focus on unlocking the bottlenecks that our data center clients are experiencing with water and power availability issues has provided Tetra Tech with the opportunity to leverage our water and energy services to engage earlier in the development of data center projects. To meet the increased water demand and quality needs for our data center clients, we are bringing our expertise to source, treat, procure, and transport critical water supplies to support innovative liquid cooling strategies. On energy, the higher power loads needed to support AI data centers are driving increased demand for power, resulting in significant interest from our data center clients and land developers for our transmission services to bring these power sources to our prospective data center sites. This needed work outside of the data center building has created additional opportunities for Tetra Tech to support our global data center clients and positions us to win the downstream buildings work. With our hyperscale clients raising their spending forecast for data centers and related infrastructure, we anticipate continued growth in this end market for our water, energy, and high-performance building services. Through the first half of the year, our data centers and advanced manufacturing business is tracking toward $120 million this year, a 20% year-on-year growth. Having added several new contract vehicles this fiscal year to support our hyperscale and co-location data center clients in the U.S., United Kingdom, and Australia, we are anticipating 20% to 25% growth in the coming years. Just last week, we announced that the SAGE Group, a global leader in digital systems and automation, will be joining Tetra Tech. SAGE will bring to Tetra Tech over 800 digital automation experts and new software and proprietary technologies from their base of operations in Australia. SAGE significantly broadened our expertise to address the needs of clients across water, manufacturing, and defense. SAGE joined Tetra Tech’s digital systems practice, where we support water utilities across the United States and provide high-end systems integration essential to optimizing utility operations and facilitating secure remote access and automation. Our team working together will continue to advance the science of digital automation, transforming operations to work more efficiently, access data more securely, and integrate the instrumentation that is rapidly expanding. The addition of SAGE Group further advances the strategy that we initiated in 2019 to expand in the areas of digital systems and automation. Since then, the evolution of instrumentation technology and, more recently, the advent of generative AI has made digital systems even more integral to the operation of a wide range of water, manufacturing, industrial, and defense clients. Today, estimates of future spending in digital automation and smart infrastructure exceed $2 trillion worldwide. Over the past four years, through a combination of organic growth and the acquisition of four companies, we have established a high-end digital systems practice that is working with the largest water utilities and major cities in the United States. With the addition of SAGE, Tetra Tech’s digital systems practice will broaden to additional clients and now serve our clients globally. This collective group brings expanded expertise, shared proprietary technology, and significant partnerships with the top instrumentation vendors globally. We project growth to result in a $500 million annual revenue business for our digital systems practice by 2030. Given our significant home field advantage with clients in the areas of water and high-performance buildings, Tetra Tech is uniquely positioned to deliver value from data centers and digital transformation investments across our key geographies in the U.S., the United Kingdom, Canada, and Australia. With that, I will turn the presentation back to Dan.

Great. Thank you very much, Joseph. I’d now like to present our guidance for the third quarter of fiscal year 2025 and updated guidance for the entire year. For the third quarter of fiscal year 2025, our net revenue guidance ranges from $1.1 billion to $1.2 billion of net revenue with an associated adjusted EPS of a range of $0.35 to $0.40. Our updated guidance, in fact, raised the lower end quite significantly based on this last quarter, is now a range of $4.4 billion to $4.765 billion with an associated adjusted earnings per share of $1.42 to $1.52. The midpoints of this annual guidance show that 6% of net revenue growth with an adjusted earnings per share of 17%, and this is all-inclusive of USAID and others that have been adjusted downward during the year. Some of the assumptions, if you’re following along the webcast, include about $35 million intangible amortization cost during the year, which would actually be included; this includes $8 million in both Q3 and Q4. Effective tax rate at 27.5%, depreciation of $24 million, interest expense of $34 million to $38 million, and 267 million diluted shares outstanding. This guidance does not include the contribution of SAGE, which we expect to close later in the year or any other acquisitions that we may transact after this phone call. In summary, we just had a great second quarter and an excellent first half of the year with record performance in both the first and second quarters. We continue to see strong demand for our differentiated leading with science services in the areas of water, environmental, and infrastructure markets that we work in. Our digital systems and automation growth strategy is actually working quite well and is advancing with the announcement of the SAGE Group that will be joining Tetra Tech, not only to give us more resources and bring us new clients but to add a big new geography for us with their presence in Australia. As Steve covered, I thought quite well and it’s been really a highlight of the quarter for us, putting in place a new $1.5 billion credit facility, which will support all of our capital allocation strategies. Steve and our financial team just did a great job in coming up with better terms than we even had in our previous credit facilities. All of this together just puts us in a great position to continue to grow our business and support our clients worldwide. And with that, Christine, I’d like to open the call up for questions.

The question-and-answer session will begin now. Thank you. Our first question comes from Tim Mulrooney with William Blair. Please go ahead with your question.

Good morning, everybody. You had a really strong quarter in state and local, even excluding the disaster response. One question we’ve been getting a lot is if the Trump administration’s efforts to reduce federal expenditures will leak into the state general funds, which in turn could negatively affect your state and local business. I know some of this business is backed by muni bonds and user fees, but for the parts that aren’t, can you talk about whether or not you’re seeing any pressure there or expect to see any pressure?

Thanks for that question, Tim. It’s a really good question. I actually received the flip side of that same question about three or four years ago when the IIJA was put in place and when some of the ARA funding was put in place for additional funding at the state and local level. At that time, the questions I was receiving were with this very large amount of funding coming from the federal government to the state, do you see your growth rates, which at that time, state and local were maybe between 15% and 20%? Do you see those growing substantially? I see those being overflow to other areas but not seeing a material increase. I also expect that on the tail end of the funding of those programs when the federal government grants and other items and loans decline, I expect not to see a decline at that time. Now that we’re at the end of the funding, we’re not seeing any reduction. I know that there have been with the current administration and the proposed budget have talked about reductions in things like the state revolving fund out of EPA. But if you read further down into those documents, it actually says that it’s somewhat duplicative of the large funding coming out of WIFIA for EPA, which is a water infrastructure funding mechanism. So, we have not seen any signs of any type of reduction or pressure at this time. The areas that we’re focused on here are the very large population states in the southern part of the U.S., like Florida and Texas, which both have very large surplus budgets. In places like California that have very large deficits in the general fund, we’ve seen very large bonds passed that will carry through multiyear periods. So, at this point, I don’t see any near-term pressure in our state and local projects that we have. A lot of these are multiyear projects, which are funded either semiannually or annually. So while it may not be in our backlog, we expect the next phases to move forward because these are multiyear programs. One quarter of a water supply system or one quarter of a wastewater treatment plant isn’t very valuable. Even if there was an impact, these are typically very late-cycle indicators within respect to our state and local. So no impact now. I don’t see it coming in the near future. If for some reason things change, I expect it to be a few-year delay before we see it in our funding.

Okay. That’s really helpful. Thanks, Dan. We can also see it in the numbers. It seems like it’s performing at a really high level. So, that’s helpful color. Thanks. One more from me. I recently saw Lee Zeldin’s list of top priorities for environmental deregulation at the EPA, which was released in March. I’m curious if you’ve had a chance to review those, the 31 proposed actions, and what the company is doing internally to prepare for those potential changes. I’m thinking about this both from a risk standpoint but also an opportunity standpoint. Thank you.

Yeah, Zeldin, the EPA Administrator with this administration has come out just recently with a number of proposed changes to the EPA’s regulatory regimes. I would say those are proposals. We’re watching them very carefully to see how they progress and how they finally end up. But what is interesting, most of the work we do, and I don't know, I might approximate it at something like 90% of the work we do on the environmental side is driven by state and local regulations. The remaining 10% we do that is driven by federal government regulations are mostly on superfund sites that I would say are outside the proposed regulations that have been proposed by Administrator Zeldin. One thing I have found interesting is there are emerging contaminants that have received a lot of attention. Of course, PFAS, these forever chemicals, is probably one of the more covered topics. Administrator Zeldin was part of the commissions and groups that reviewed putting these regulatory actions in place, and he spoke at a number of different forums here over the past month about the importance of regulating these, to remove them from the drinking water supply and protect human health in the country. It’s going to be moving forward with regulations but looking for not the water delivery or the utilities to pay the costs for this to remove, but actually have the responsible parties who impacted the water supplies pay for it. He even called out the federal government as being one of the largest contributors to PFAS in the environment, which then works its way to the drinking water supply. Now, we’ve worked for the federal government since our founding nearly 60 years ago. The Department of Defense is the location where it comes from due to firefighting and other chemical uses and discharges. We have an enormous amount of contract capacity here. I expect some of these things that will go forward with EPA’s enforcement investigations will likely be led by the Department of Defense. I believe we’re very well-positioned there. So, there are numerous federal regulations being proposed and discussed. We don’t see them having a direct impact on the contracted work we have, other than some positive outcomes with respect to investigation and cleaning up some persistent chemicals that have become priorities these days. So those are good questions. We’re watching it closely to see how they change. But as it relates directly to the work we’re contracting for, we don’t see much of an impact. Thank you, Tim.

Yeah, good morning. Thank you for taking my questions. So, if I can just start on the core margin progression, how you think that plays out once the dust settles on the USAID cancellations and productivity normalizes? I know you’ve given us a 50 basis point annual target at the Analyst Day, but I’m just wondering how you think about it now.

Yeah. That’s a good question. One of the questions at the end of Investor Day was, what do you think about your business if all your USAID work was gone? My initial comment was, well, our margins are going up. So let me address that. I had indicated along with Steve Burdick and our other presenters that we would increase our margins annually by about 50 basis points, and that’s with AID. I think the baseline of our overall margin profile without AID is now higher. I would say that we were starting at a 13.5% or 14%. Just with the removal of AID, the underlying business has about a 50 basis point increase, might be slightly more than that, on the overall margin of the company. I think we didn’t expect that the margins would increase concerning the USAID work in the investor meeting we had. With USAID in there, I think the margins should grow slightly faster than the 50 basis points. So we have a new higher baseline, and I see a faster growth rate concerning margin growth over the five years that we called out on Investor Day. Your question regarding whether our profile on margins has been impacted by AID going away? I believe that they’re going to be better, and they’re going to be higher.

Great. Thank you, Dan. If I can ask a follow-up on the $200 million of USAID backlog that you still have, can you comment on how you’re seeing that it burns thus far this quarter, so we can get a sense of what is left to burn?

Yeah. It’s interesting. We have about $220 million in total for work in Ukraine. We currently expect based on tasks that we have that we’ll perform the work in Q3 and Q4. We think about $200 million of the $220 million can be completed this year and relatively even revenues to roughly $100 million in each quarter. Work in Ukraine, as you follow any of the news headlines, is highly variable. It could go down or it could go up depending on political will and commitments and other items. But we expect that to be incurred or spent by the government and authorized to us on a relatively even amount between Q3 and Q4. A small amount of that, though, is associated with our demobilization of the other USAID contracts, for which we’ve received termination for convenience notices. Those costs are reimbursable at the project level for incurred project costs. A small part of that will be demobilizing here through the rest of this year from repatriating staff to the U.S. and closing down field offices and transferring government-owned property back to the appropriate owners. That’s how we see that progressing between now and the end of the year.

I appreciate that. Thank you, Dan.

Great. Thanks and good afternoon. To your comments early on the preamble around this being a dynamic evolution was quite interesting relative to what we may have thought a year ago. If you can talk about your discussions with some of your larger government partners, public sector partners and their visibility into the back half of this year into 2026, their level of confidence, visibility; have things sort of stabilized? The headlines seem to have stabilized, but just curious what your customers are seeing on a ground level as it relates to the projects ahead and the funding they have.

I’ll start with the federal government since that’s where most of the variability, maybe you can call it volatility, has been centered. There has been uncertainty till today, but we tend to look at not what they say, but what they do. That’s one of our items here: don’t listen to what they say, watch what they do. Watching what the U.S. administration has done to support the military’s readiness, I think Leslie Shoemaker’s comment that we’ve added about $5 billion of new contract capacity with defense, the U.S. Department of Defense. Most of that has actually been since the inauguration certainly since the election. We take a look at the contracts that have been put in place and the geographies, which aligned with the administration’s global priorities. In many respects, we feel better about the funding streams and the clarity within DoD and even the Corps of Engineers. I think the slide in the presented materials gives a good example. Don’t be surprised if you see quite a bit more coming out with new awards to the company. So what we’re hearing from our clients is they’re committing to funding; it’s not going to be hollow vehicles. I say this historically; the Department of Defense has had very large contract capacities, but they’ve only used a portion of it for task orders. We’re being told they’re going to spend what they contract for, which provides additional confidence. Our largest civilian agency client is the Federal Aviation Administration or FAA. Secretary Duffy has said that modernizing in a safe way the air traffic control system is the top priority period. There’s few better situated than us in that area. It's not just because we’ve been a long-time incumbent and we’ve been there which is true. We’ve been working on the cutting edge, including rolling out some new space-based communication systems. I know some of you might recognize that as Starlink, but we’ve already been doing that. We’re actually working for them, and there’s a big difference between wanting to get in and being in. We feel positive in the U.S. EPA. They talked about a 65% reduction initially; recently, they talked about a 50% reduction. The work in our contracts have been unaffected, which has been a pleasant surprise. We are the contract holder of many, or most of the start contracts, which includes responding to the East Palestine train derailment. That has been a priority to ensure the response capability at the federal level to protect citizens in the event of unique events. We might be in the right spot to not be impacted and to be in the right part of the 50% that’s going to remain. So I covered a few areas since you asked the public sector or the government. That’s what we’re seeing at the federal level; things look very strong at the state and local level. Our three big focuses, Florida, Texas, California, have large funds. I think Leslie did a good job in her presentation of some of the new cutting-edge programs we’re implementing, like potable reuse, taking wastewater treatment water and using that as a new drinking water supply.

Great. And then kind of looking at fiscal 2023 targets, obviously, a bit of a surprise from USAID this year. As you look ahead to the next three to five years while tying in your commentary about the margins a bit early, how are you feeling about the medium-term outlook? Do you feel like you’re on track for the medium-term targets you laid out?

Yeah, I think we are. I feel very good about it, specifically about some of our geographic diversification. The last two acquisitions have brought in an entity in Ireland, Carron + Walsh, of course bringing in SAGE, which is located in Australia. Both of those have fungible expertise, particularly SAGE. The expertise concerning automation and programming, the use of IoT, and robotics are not confined to geography; it’s easily transported to work across Canada, the U.S., and Europe. I think in the medium term, growing our commercial work which carries even higher margins adding additional geographic reach in places like Ireland that have significant infrastructure; multiyear, if not multi-decade programs, for sure, looks favorable for us through the medium term. Certain comments around the office here, some have asked how clear is next week? How clear is two weeks from now? I say, well, I’d like good clarity in a week or two. But in some respects, I see clearer in five years because some of the short-term variability and volatility fluctuates, but the primary tailwinds driving Tetra Tech aren’t changing. Coastal flooding, coastal protection, and water supplies where they don’t exist because of drought conditions, brackish water due to over drafting or over pumping in places like Florida and low-lying areas. None of these problems are going away; if anything, they’re being exacerbated. Where will they be next week, next month, or next midterm? There’s variability. But if you survey out a bit longer, the tailwinds and the drivers of our business are not changing at all. If anything, they’re just becoming more important.

Great. Thanks for that. Just one last query that’s more for Steve. You laid out a little bit of your capital allocation philosophy and it sounds like it’s a bit of all of the above on return of capital on M&A. Can you share if there is a sort of rank order you prefer at this point between share buybacks versus M&A? Or is there enough capital to pursue M&A while doing some elevated return of capital?

Yeah. I think we have the ability to do all of the above as we’ve been able to show. After acquiring RPS, we put our stock buyback program on hold until we got our net leverage down below one, and we did that on time as we forecasted. Our goals are to continue our double-digit increase in our cash dividends to shareholders. We want to grow and invest in organic growth in areas that Joseph, Leslie, and Dan have talked about today. We want to complement that organic growth with important acquisitions. With the liquidity we have available, we can continue our stock buyback program. If our net leverage falls below one, we’ll have even more liquidity to ramp up our buyback program.

Good morning.

Good morning, Ryan.

Congratulations on proving out that you still have a very attractive business, despite all the doom and gloom. I wanted to explore the USAID thing from the standpoint of capabilities and assets. With regard to utilization, are there any metrics you can share around utilization? Presumably, there were some folks working heavily with USAID who are now maybe underutilized, yet that doesn’t appear to be showing up in the margins, at least not in the second quarter. So, anything you can share about the utilization rates of those people?

Yes, it’s very insightful. Utilization has gone down in that group. But, I will say that in the quarter, you wouldn’t have seen it on an aggregate basis because we staffed up a lot of people for the fires out here in LA responding to disasters. So, yes, we had a reduction in what I call the AID staff. However, you wouldn’t have seen it on aggregate because of the offsets that were very high; 100%, frankly, people working 100-hour weeks. We did incur costs. We did hold folks until they went to termination for convenience, and we ourselves held people longer while we looked to determine whether we could place them at other locations. Most of this was put on hold. So, the progression went: we were working full tilt until the inauguration. We quickly received stop work orders. We minimized costs but kept everyone on board, since we expected things back online. Then it went to termination for convenience. Their utilization did drop. You wouldn’t have seen it on aggregate because of the offsets that had very high utilization. So that offset it. We did incur costs. We did retain a lot of people for longer periods as we were evaluating the situation. But I expect that as we move through this termination for convenience, utilization will return to an upward trend across the board. Even as the fires diminish with very large high utilizations, you’ll see the business utilization go up. So, it may seem like we sailed through without change, but under the surface, AID went down while fires went up. And I expect that to flip back over in the coming quarters.

Got it. Okay. That really helps explain it. Thank you. My second question was around the backlog. Given the nature of the business, the backlog is something that investors focus on, as it provides a line of sight to things. There’s obviously a hole there from USAID considering its size, but you’ve also won some nice contracts. How long do you think it would take? Are we talking quarters, a year or more, or a couple of years to get back to pre-deal backlog?

That’s really interesting. We spent some time looking at that. Our visibility with respect to the book of business we have ex-USAID is actually about the same or slightly up. If you take a look at what if you take USAID out, you notice our backlog is just right about $4.1 billion, $4.09 billion. But if you take a look at the midpoint of our net revenue, without USAID, it’s about $4 billion. We have about a year’s worth of visibility or contracted authorized work. With our overall contract capacity going up, I hope to see our visibility stretch out more than a year. When it has been more than a year, it’s been because of the multiyear funding from USAID. If you take that out and examine the underlying business, there’s actually no hole. We have funding that’s at a similar level or slightly up from where it had been before. With respect to converting contracts we’ve won, I think those are going to take place if what we’re hearing from clients aligns with expectations, as I shared earlier. If they start reinforcing funding, we could see that backlog grow much faster and potentially go into uncharted territory with respect to visibility.

Got it. Okay. That’s very helpful, Dan. Thanks for your time.

Great. Thanks for taking my questions this morning, guys. I wanted to confirm some of the moving parts and then talk a bit about the outlook. Based on my calculations in the second quarter, it was about $130 million on USAID, not $180 million, about $50 million in net revenue on disaster. You said you have $220 million for USAID in the back half of the year spread between the two quarters. It seems like a lot of the USAID work that’s continuing here, if not all of it, is in Ukraine. We know what you’ve got in your backlog because you only put what’s funded in your backlog. But does this contract, like, expire? Is it out of option years or task orders? I guess I’m asking, because I believe your guidance says that these numbers you articulated here are what’s in the guidance and nothing else is in the guidance. But the Ukraine work is ongoing. This is a USAID contract that’s gotten special dispensation to keep getting funded. So I was just wondering if there’s a new contract that needs to be awarded and it’s out for competitive bid, which would mean it’s less likely for you. I think you can see where I’m going with this, but I was hoping you could comment on that.

Absolutely. I’m quite familiar with all those moving pieces. To clarify, in the quarter, it was about $130 million of USAID and Department of State work. Your $50 million is almost right on for disasters, split between work supporting Hurricane Milton and Helene in the Southeast and the fires in the West. Now, the $220 million or technically $220 million, is contracted and is only a small part of the contract ceilings we have in place. We announced back in the fall when that $200 million became available. It’s called the SPARC contract for USAID and is for continuing previous efforts supporting energy infrastructure in Ukraine. That contract capacity is about $450 million, and this $220 million is a small part of that. So do we have to go out and win something? No. That $450 million energy contract for Ukraine through USAID is a single award. We are the only contract holder. Will they double that number with a stroke of a pen or email? Definitely. Can they write to say you’re done? It could happen. That would lead to demobilization and it wouldn’t go to zero. You would still have to return, repatriate, and handle government-owned property. The amount we have in our guidance for the second half of the year regarding AID has already been contracted, and the task order is already issued. Normally, I would say it’s very difficult to undo a task order given there is equipment heading there. Regarding the potential scenario of extreme volatility, I wouldn’t risk taking any change off the table. I think we’re prepared and flexible as we navigate this. To repeat my earlier point; no, we don’t need to win a new contract; no, we don’t have to have new task orders issued; yes, it’s authorized, but things can change because of location and variability.

Yeah. So, basically, your guidance approach hasn’t really changed. You laid this out last quarter, saying this is kind of what we thought the downside could be, and you’re still modeling exactly what you have and not assuming anything else for the guidance. We know the backlog is always what’s contracted and funded, but your guidance sometimes takes a different approach here. I appreciate the way you approached this volatile area. I guess, my follow-up final question is just on the backlog and not Department of State. Was any of the 1.1 that came out attributed to other areas of federal civilian, or was that all USAID and State Department stuff?

To be precise, there was some other funding, but it was measured. I think in aggregate everything else we tracked fairly closely. It was around $10 million or less. I think we had $1 million or $2 million out of EPA, and we had a couple of million out of FEMA. A couple hundred thousand out of the National Science Foundation. So, yes, there were a few other small pieces, but it was 99.9% USAID and State Department.

Good morning, everybody. Dan, thanks for taking me in here.

Yeah, of course.

So maybe a shift to your international work. Can you give a sense? You talked about slow growth in Australia. It seems like the UK is recovering both on the election-oriented side. How would you evaluate the 1% or 2% growth you had this quarter? How does that look for the second half of the year? As you look a bit further, is there an opportunity for acceleration of international exposure and growth given some shifts in what you’re doing in the UK? Can you comment on that?

That’s another good question. The one thing I’ll note is there has been uncertainty. I’ve talked quite a bit about variability and changes in funding and priorities within the U.S. federal government’s budgets that we work for. However, I have to join the club and mention tariffs or international clarity. The impact on our international commercial has been some slowdowns in initiation of new activities with respect to buildings, siding, permitting, and other items that have slowed down. Our clients are looking for clarity as to whether they will have different tariffs. Regardless of whether it is 30%, 10%, or 150%, they just want clarity. If the number is 30%, fine; if it’s 150%, then they’ll proceed accordingly with those rules. For us, this brings advantages; during recessionary environments, some of our businesses actually perform quite well as clients may opt to redesign or reduce capacity in their work rather than eliminate it. The growth rates on international are probably one of the areas we have questions on. I think it’s partially dependent on clarity regarding international trade such as tariffs. These have not caused our revenues to decline; long-term programs like those we have in Australia, Canada, and the UK are unaffected. Our long-term programs are seeing nice growth rates that provide significant visibility, while clients that can move quickly are the ones we can see more variability from. We’ll likely see more tempered growth rate in international right now. Thank you very much, Christine, and thank you all for joining the call today. I appreciate your support through these periods. I hope we were able to answer some of your questions regarding impacts from USAID, State Department, and others in the federal government. I am very cognizant of the questions regarding the impact on Tetra Tech due to these changes. I look forward to presenting our results in the third quarter. I’ll talk to you in 90 days. I hope you all are safe and prosperous between now and our next conversation. Thank you very much.

Ladies and gentlemen, this concludes our conference for today. Thank you all for participating, and have a nice day. All parties may disconnect now.