Earnings Call Transcript - TTEK Q3 2020

Operator, Operator

Good morning, and thank you for joining the Tetra Tech Earnings Call. By now, you should have received a copy of the press release. If you have not, please contact the Company's corporate office at 626-351-4664. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the Investors section of its website at www.tetratech.com. This call is being recorded at the request of Tetra Tech, and this broadcast is the copyright 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; and Steve Burdick, Chief Financial Officer. They will provide a brief overview of the results, and we'll open up the call for questions. I'd like to direct your attention to the safe harbor statement in today's presentation. Today's discussion contains forward-looking statements about future growth 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 takes 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 Investors section of Tetra Tech's website. At the request of the Company, we will open up 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.

Dan Batrack, CEO

Thank you very much, Michelle, and good morning, and welcome to our fiscal Year 2020 third quarter earnings conference call. I'm pleased to report that in the third quarter, our business delivered solid results, in line with our recently released guidance and projected performance. Overall, our efficiency increased as a result of our ability to leverage high-end virtual and remote working technologies. Our staff's utilization is up and our indirect spending is down, resulting in higher margins and strong cash generation. Demand for our leading with science services continued unabated for this quarter, resulting in our backlog increasing both year-on-year and sequentially. Given our results to date and outlook, we are increasing our earnings per share guidance for fiscal year 2020, and I'll speak to the details of that a bit later in this call. I'll begin with an overview of our performance and customers. While Steve Burdick, our Chief Financial Officer, will provide an overview of our financial results and capital allocation, I will then address our customer outlook and market assessment. We had a strong third quarter across multiple performance measures. Total revenue for the quarter was $710 million, and our net revenue was $560 million, at the upper end of the guidance we provided, slightly exceeding our expectations as a result of outperformance in our CIG segment. We generated an earnings per share from operations of $0.78 for the quarter and $0.83 when we include proceeds from equipment sales associated with the wind-down of our Canadian oil and gas turnkey operations. Our backlog, the best indicator for future growth, was up 8% year-over-year and up 2.6% sequentially, increasing to $3.7 billion. This increase was driven by broad-based orders across all of our end clients. In the third quarter, we had solid performance across our customers, in line with our expectations. Work for our U.S. Federal clients represented 31% of our net revenues in the quarter. During the quarter, we saw a 10% growth in the work that we do for the Department of Defense and 5% growth for civilian agencies. Unfortunately, travel restrictions impacted our ability to provide on-site services for some of our international development projects, offsetting the growth that we saw in these other client groups with the Federal Government, resulting in overall flat revenues on a year-on-year basis for our U.S. Federal work. Excluding last year's Disaster Response contribution, our State and local revenues grew 5% year-on-year. We saw no project delays or cancellations and project bid opportunities increased in the quarter. Although revenue growth was slightly lower than expected, we anticipate that our State and local revenues will return to double-digit growth in the fourth quarter. Our U.S. commercial revenues comprised 25% of our business and were down 7% year-on-year. We saw steady performance for regulatory-driven programs, which represent about half of our U.S. commercial revenues. However, we did see a reduction in oil and gas, commercial buildings work, and some discretionary industrial manufacturing programs. Our international net revenues, representing 30% of our business, grew 3% on a year-on-year basis. Our international government services were stable, while some of the discretionary commercial services were down. Our United Kingdom operations did see some project delays due to regional travel restrictions and field access constraints. Our two business segments include, the first segment, the Government Services Group, which is primarily focused on public sector clients, and the second segment, the Commercial International Group, which includes our U.S. commercial practice and our international operations, primarily based in Canada, the United Kingdom, and Australia. As expected, the GSG segment with its strong public sector base was up 3%, driven by Government consulting services and Advanced Analytics for Water and Environmental Programs. The GSG group also delivered a 13.5% margin for the quarter, which was slightly ahead of our expectations. The CIG segment delivered a double-digit margin of 10.1%, increasing its margin from last year. The strong margin performance was a result of disciplined management and project delivery, which is especially significant in light of this quarter's slowdown in revenue, particularly in that group. For the quarter, our backlog was up 8% year-on-year and 2.6% sequentially, increasing, as I mentioned a bit earlier, to $3.7 billion. The sequential backlog increase was broad-based, with positive book-to-bill in all four of our major client sectors. This increase in our contract and authorized work is the best indicator of the stability and improving outlook for our business as we go forward into the fourth quarter. In addition, we continue to expand our contract capacity with the U.S. Federal Government, with awards from the Department of Defense, the Army Corps of Engineers, Environmental Protection Agency, USAID, and the Department of State. These contracts represent more than $18 billion in capacity across the U.S. Federal agencies and provide the essential framework for us to quickly respond to future stimulus programs and Government initiatives. For example, just in this third quarter, we were awarded the Environmental Protection Agency's Superfund Technical Assessment and Response Team contract for the mid-Atlantic Coastal Region of the United States. Under this single-award contract, we will assist the Environmental Protection Agency in protecting human health and the environment in response to man-made and natural emergencies and disasters. Now I'd like to turn the presentation over to Steve Burdick, our Chief Financial Officer, to present the details of our financials. Steve?

Steve Burdick, CFO

Okay, thank you, Dan. I'd like to now review the financial results for the third quarter of fiscal 2020, as well as our financial condition as of the end of the third quarter. Overall, our revenue and net revenue came in about as expected. Fiscal 2020 third quarter revenue was $710 million. In the third quarter, net revenue amounted to $560 million and was in line with our guidance range of $540 million to $560 million. Our revenue and net revenue growth rate was impacted by the completion of large disaster response projects in 2019, as well as our decision last year to dispose of our Canadian turnkey pipeline business. Excluding these two impacts, our net revenue would have been in line with the prior year. While our revenues were down year-over-year, our operating margin and earnings per share improved in relation to our revenue. We managed the business and remain disciplined by controlling our cost structure to align with our revenue. As a result, our adjusted earnings per share of $0.78 came in better than the top end of our Q3 guidance range of $0.72 to $0.75. And the improvement in our operating margin was partially driven by the increase in the CIG segment, which realized a margin of 10.1%. For those of you following on the slide presentation on Page 8, I'd like to summarize the GAAP and reconciliation adjustments. First, we realized gains from noncore equipment dispositions. Due to our decision in Q4 '19 to divest our Canadian pipeline construction management business, we continue to sell the equipment in the third quarter, which resulted in a gain of about $5 million or $0.06 per share. Secondly, we reported a non-operating loss relative to our earn-out liability, and this amount represents a small true-up of the total estimated earn-out liability. Even as the global economic outlook is uncertain in many ways, Tetra Tech remains fiscally disciplined and focused on generating positive cash flows in excess of our net income and proactively strengthening the balance sheet to ensure more than adequate liquidity. Cash flows generated from operations for the third quarter totaled $111 million. This cash flow from operations amounts to about $2.03 of cash per share for the quarter. On a year-to-date basis, we generated $195 million in cash flow, which is a 72% improvement over the first nine months of fiscal 2019. And just as important as these recent periods, over the long term, when we look back at our trailing 12 months, we generated cash from operations at a rate 30% higher compared to the previous trailing 12 months. Our focus on working capital and cash flows has also resulted in our days sales outstanding, or DSO, decreasing to 70 days as of the third quarter. This is an improvement of 10 days from last year and a sequential improvement from last quarter. Our net debt amounts to $136 million, which is a 40% decrease from last year. And our net debt-to-EBITDA came in at 0.5x, which is sequentially less than the leverage of 0.8x in the second quarter. Our long-term capital allocation strategy calls for balance between investing in the growth of our business, managing the balance sheet and providing returns to our shareholders. Over the last trailing 12 months, we have generated $290 million in cash from operations. During the third quarter, we continued to benefit from this strong cash position by providing significant returns to our shareholders through dividends and share buybacks. Regarding our dividend program, during the past quarter, we paid out $9.2 million in dividends and I want to announce that our Board of Directors approved our 25th consecutive dividend, which will be paid in the month of September at a rate of $0.17 per share, which is a 13% increase over last year. Furthermore, we utilized $21 million in the third quarter on our stock buyback program. On a combined basis, we currently have $223 million remaining under both of our previously approved stock buyback programs. As important as successfully implementing our capital allocation strategy is ensuring we have a strong balance sheet and ample liquidity. We have both in terms of our balance sheet at the end of Q3 with available liquidity of over $800 million in the form of cash on hand and funds available under our credit agreements. As a result, Tetra Tech is in a financial position such that we will continue to provide significant returns to our shareholders while investing in strategic growth areas, both organically and through acquisitions that Dan will discuss a bit later in the presentation. I'm pleased to share these financial results for the third quarter. I want to thank you all for your support, and I'll hand the call back over to Dan.

Dan Batrack, CEO

Great. Thank you very much, Steve. I'd now like to discuss our differentiated growth strategy in advanced analytics. As you know, Tetra Tech has a reputation for high-end services in water and environmental consulting. One of the reasons for our success is the ability of our experts to leverage advanced analytics in the delivery of solutions for our clients. Some of the recent applications of advanced analytics for our commercial clients employ autonomous technologies and artificial intelligence, which both increase the speed and volume of data capture and facilitate the interpretation of that data. We're applying these high-end technologies on land, in the air, and at sea to address a wide range of environmental programs for our clients. For our State and local clients, we're leveraging technology to operate water treatment facilities, using digital twins to apply real-time control solutions to optimize water operations and create dynamic dashboards to enable adaptive management. In the Federal market, we're leveraging our artificial intelligence and cloud technologies to interpret, analyze, and dynamically display information to address our Government's clients' rapidly expanding information management needs. It is these interpretive analytics, applied by our experts in collaboration with our clients, that are differentiating us in the marketplace today. Over the past four years, we have significantly expanded the Federal portion of our advanced analytics practice. Since 2016, four industry-leading technology firms have joined us, each bringing new capabilities and client relationships in the fiber market. Over the past four years, our revenues have quadrupled to a run rate of $200 million that we'll see this year. These revenues are a result of acquisitions and a 20% organic growth rate. Today, our Federal advanced analytics practice is fully integrated and has over $1 billion in contract capacity for advanced analytics and IT services with the U.S. Federal Government. We have prioritized the continued growth of this practice with the goal to more than double revenues to $500 million a year on a run rate by the year 2023. I'd now like to present our guidance for the fourth quarter and for all of fiscal year 2020. As we enter our fourth quarter, we see each of our four client end markets: one, the U.S. Federal Government; two, our U.S. State and local clients; three, our U.S. commercial clients; and four, our international operations, all growing sequentially from the third quarter. However, the global pandemic has continued to impact select areas of our business, resulting in delays for projects that we've been awarded. Most notably, travel restrictions have impacted our international development revenues. Incorporating these delays, our guidance is as follows: for the fourth quarter of fiscal year 2020, our net revenue guidance is for revenues of $560 million to $600 million with an associated diluted earnings per share of $0.78 to $0.83. For the entire year, our updated fiscal year 2020 net revenue guidance is for a range of $2.32 billion to $2.36 billion with an associated diluted earnings per share of $3.13 to $3.18. In summary, throughout the ongoing disruption associated with the global pandemic, we're seeing continued demand for our leading-with-science approach and advanced analytics solutions. In this time of change, we are providing solutions to our clients to help them adapt and support their long-term objectives. Our broad-based increase in backlog is for work that is approved and authorized by our clients, providing us with additional visibility as we begin the fourth quarter. As Steve has covered, Tetra Tech's strong balance sheet and access to capital is a result of our disciplined approach to financial management and capital allocation. We're looking forward to solving the world's most complex challenges in water, environment, and the effects of climate change. And Michelle, I would now like to open the call up for questions.

Operator, Operator

Thank you. The question-and-answer session will begin now. The first question comes from the line of Sean Eastman with KeyBanc Capital Markets. Please proceed with your question.

Sean Eastman, Analyst

Hi, team. Thanks for taking my question. I'd just like to start on the backlog. I think it's pretty notable that all sectors and client types drove that sequential increase. I just wonder, did you expect that dynamic this quarter? Do you think that can continue? And how would you characterize Tetra Tech's visibility into fiscal '21 at this point in time?

Dan Batrack, CEO

Well, great question, Sean. It was one of the areas that was a positive surprise for us in the quarter. It was not expected that we would have increased across all four areas. In fact, we did think we would see increases with the U.S. Federal Government, which was up, and we expected increases in State and local, which is also quite predictable, and that was indeed the case. However, we were unsure about both our commercial and much of our international work. I want to reiterate that we did see increases in all four client sectors with our backlog growth because coming into the quarter and even at the time we provided guidance in early June, we expected that our U.S. Federal Government and State and local would carry the majority of our backlog and that we would be challenged in commercial and international, and that was not the case. With respect to visibility, it was an interesting quarter with respect to the buildup in our orders. If you review the slide presentation, you would notice that we have bundled several categories because we saw a record number of individual orders that we received, which is close to an all-time high that we've received from different clients and different programs across the globe in our global operation. I would say that they came in with respect to smaller in size but greater in number. I would say our visibility, particularly in the commercial and international space, is slightly less. We received more orders, but they were generally provided for shorter periods. So we are funded for two months, three months, where we typically would be funded for six, seven, or eight months. This is logical to us. It appears that in this time of uncertainty, some of our clients are being a bit conservative with respect to how much they commit to the future. But I'm quite encouraged, and we collectively feel very good that so many of our different programs and so many different areas and end clients are moving forward. So that's a quick overview of what we saw and how it changed from what we anticipated coming into the quarter.

Sean Eastman, Analyst

Very helpful. And the next one for me is just concerns around State and local budgets are really front of mind for the investment community these days. So can you just sort of level set for us on what the reality is for Tetra Tech, basically, what you're seeing today? What are the really important swing factors there we have to watch and think about as we look at the trajectory of Tetra Tech's State and local business over the next year or two?

Dan Batrack, CEO

Well, it's a really good question. I would say that probably the largest departure between what we're hearing and what we're seeing is with our State and local clients and our State and local work. What we're hearing is that budgets are under pressure, and there are pullbacks with respect to reductions in staffing and other items at the State and local level. But what we're seeing here at Tetra Tech is that we have not seen our revenues pull back yet. We've actually seen revenues and the cadence of the work and the projects moving forward relatively uninterrupted from what we saw prior to the global pandemic. With respect to looking forward, we're assessing the number of solicitations or requests for proposals or different submittals to the clients in response to inquiries that they've made. Actually, this past quarter, that number has gone up. Now we haven't seen the increase in our proposal submittals or responses to our clients translate into an unusual increase in awards. What we've seen is that the awards and the projects that have been delivered to us have continued at a steady pace that we would have seen before. These projects are not being awarded to others. It appears that they may be being prepared so that they can respond quickly to stimulus or other types of funding that may come into the cities and the States and Counties so they can move quite quickly. I do note, and this isn't just during this financial crisis or the global financial crisis, but you can go back to the 2008-2009 global financial crisis. When the Federal stimulus came forward, the first shovel-ready projects, there simply weren't that many projects that had been designed or ready to go. So I think our clients have learned from the previous financial crisis and are becoming more prepared and able to move quickly. In short, we are seeing revenues moving forward relatively unabated, and our bidding opportunities are increasing. Things look stable moving forward. I will also note that the State and local clients, typically in the work that we provide for them, under the water environment and sustainable infrastructure, are lagging indicators. Typically, when the financial impacts hit, it takes almost three years before we see the order flow and the work progressing. While it may be further out, we don't want to accept that inevitability. We think that Congress is negotiating for different stimulus programs that will help support local agencies and Governmental entities. So it's possible, with the right type of stimulus programs, we might actually see these revenues go up even further.

Sean Eastman, Analyst

I'm going to sneak in one more, guys. Just clearly, cash flow, Tetra Tech's financial position is a bright spot here. But just thinking about how you guys will be putting that to work. Any update on the acquisition pipeline? Are there more WYGs and Coffeys coming up in the pipeline? And just given this backdrop we're in, any kind of color on how, what we should expect from a capital deployment perspective in the immediate term would be great.

Dan Batrack, CEO

Well, we are focused on fulfilling the strategies that we have identified, both on this call and previous calls, by building out our advanced data analytics in the Federal sector that we've presented, and other areas in the water sectors. The pipeline is actually robust and quite full. There are multiple drivers. Not everyone has been as fiscally conservative and successful as ourselves, which has created additional opportunities for us. I would also say that some are beginning to explore transactions, as they may fear changes in the tax regimen after this calendar year. So our goal is not to remain inactive, we are looking for the best-in-class to join us. There are plenty of opportunities, and I expect our sequence of having the best and brightest join us to continue.

Noelle Dilts, Analyst

Hi, guys. Good morning. Congrats on operating well in a tough environment. So I have a couple of margin questions. Dan, I know in the past, you've talked about the idea that over time, we could see convergence or coming together of CIG and GSG margins. Just kind of curious how you're thinking about that at this point and kind of how we should think about the longer-term margin goals for each of the divisions?

Dan Batrack, CEO

Well, I'm actually glad you asked that. I have been off on my prediction on timing. I'm not going to acknowledge that I'm off with respect to destination because I do think our CIG or Commercial International Group will close the gap. My goal was originally that it would take place by the end of this fiscal year, which is roughly 60 days from now. I do believe the pandemic has pushed this back, but I think it's pushed it back maybe one quarter, perhaps two quarters. As for longer-term goals, under normal operating environments, I think our Government Services Group will yield margins between 12% and 13%. While they have operated above that level consistently, I would say I’m satisfied, and I think it’s good management if GSG runs around 13%. Therefore, if they are around 13%, GSG is running well, with a narrow range of 12% to 13%, indicating low volatility. I do believe our CIG business can achieve 13%. Its range may drop to 11% or 12% in a challenging environment but in a strong one, it could reach up to 15%. The volatility in the Commercial Business is the result of quicker changes based on economic conditions. I foresee our CIG group achieving margins similar to our Government Services Group in the next two quarters.

Noelle Dilts, Analyst

Great. That's very helpful. And then, sorry if I missed this, but just going back to last quarter, you discussed starting to get some clarity when we begin to see State and municipal budgets released, offering better assessment of potential pockets of weakness or areas that may be impacted by some of the coronavirus pressure on State and local government. If I could get some clarity there on how you're viewing that? I understand that a lot of that work is funded by long-term measures or user fees, but are there any areas where you might be a little more concerned on the State and local side?

Dan Batrack, CEO

Well, again, just headline risks with respect to challenges that our clients are facing keeps me sensitive and highly attuned to that. But I will say that our project staff, working with our counterparts at our clients, have not observed any pullbacks in projects at this time. We know that budgets were released on July 1 for the States' next fiscal year 2021. While some may forecast reductions, and in some cases, potentially significant reductions, we are focused on programs related to water supply, wastewater treatment, flood control, and environmental restoration and stewardship. These do not appear to have been reduced, at least not from our counterparts. We have directly inquired how they reconcile our programs moving forward in light of budget challenges, and the general response has been it's not clear that these reductions will occur. A variety of modeling assumptions indicate tax receipts from properties may decrease later if property valuations change and that updates will come mid-year or late year if significant changes occur in their programs. But for now, we have not seen those from our counterparts at the State and local level.

Sam England, Analyst

Just a couple from me. The first one, you touched on the growth in some of the technology-focused businesses you've acquired. Could you give us a bit more color around the cross-selling opportunities that they create and where you see them accelerating growth in any of your legacy business areas?

Dan Batrack, CEO

Well, I think that's a great opportunity for us. The Federal Advanced Data Analytics and IT Services carry their own book of business with modernization, data presentation, and dashboard development. What we've been offering to our long-term legacy clients are services that have been developed where we've created best-in-class solutions that we can translate effortlessly to other clients. While I didn't speak in detail today on our commercial and international application of advanced data analytics, we believe the technologies and lessons learned can be cross-sold and provided at a substantial savings to our commercial and international clients. This truly differentiates Tetra Tech, allowing us to leverage lessons learned from government investments and offer them to our clients. This represents a significant growth opportunity that we think candidates for additional margin, ultimately closing the gap and perhaps exceeding our GSG margins. Regarding international development, the travel delays indeed have been an obstacle. However, this presents a backlog opportunity for work needing to be completed once restrictions ease. Nonetheless, there are two perspectives on backlog. Some view that once lifted, there will be a rush of work that needs to be complete. Conversely, we see it more as a finite throughput of projects being pushed to the right of the schedule rather than growing larger. For example, if a project had been scheduled to be completed by the end of 2021, a 6-month delay would simply mean it completes by mid-2022. Therefore, while delays are not ideal, we anticipate revenue will still come through eventually.

Gerry Sweeney, Analyst

Great. And congrats on a nice quarter.

Dan Batrack, CEO

Great. Thank you, Gerry.

Operator, Operator

Thank you. This will conclude the question-and-answer session. I will now turn the conference back over to Dan Batrack to conclude.

Dan Batrack, CEO

Great. Thank you very much, Michelle, and thank you all very much for your insight and your questions, and mostly for your support of Tetra Tech. On behalf of myself and the 20,000 employees at Tetra Tech, we are committed to leading science, promoting sustainability through our services, and supporting our clients with solutions in water, environment, and infrastructure. I look forward to our next call, where I'll share how we performed in the third quarter and all of fiscal year 2020, as well as our forecast and guidance for fiscal year 2021. Thank you very much, and have a great rest of the day and a great rest of the summer. Stay safe. Thank you.

Operator, Operator

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