Earnings Call Transcript - TTEK Q1 2025

Operator, Operator

Good morning and thank you for joining Tetra Tech's Earnings Call. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the Investor section of its website at tetratech.com. This call is being recorded at the request of Tetra Tech and the broadcast is the copyrighted property of Tetra Tech. Any rebroadcast of this information in whole or in part without prior written permission of Tetra Tech is prohibited. With us on today's call from Management are Dan Batrack, Chairman and Chief Executive Officer; Steve Burdick, Chief Financial Officer; and Leslie Shoemaker, Chief Innovation Officer. They will provide a brief overview of the results and we 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 statement 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 up the conference for questions and answers after the presentation. With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Dan Batrack, CEO

Thank you very much, Paul, and good morning, and welcome to our first quarter fiscal year 2025 earnings conference call. It's been a very eventful month of January so far. Just over three weeks ago, the Eaton fire struck right here in Pasadena within about a mile of our corporate headquarters, and an equally destructive fire occurred a little over 20 miles away from our headquarters, in the Palisades here in Los Angeles County. Unfortunately, some of the Tetra Tech staff did lose their homes, and many that work here in our Pasadena headquarters were evacuated. In fact, some still remain evacuated all the way up until today. But most importantly, all of the Tetra Tech staff are safe. We certainly send our condolences to those that were unfortunate, as there were fatalities in both of the fires. So, it was not a great start to the month just from a personal impact to Tetra Tech staff and individuals throughout Los Angeles County. Just ten days ago, January brought us the inauguration of President Trump and the incoming of his new administration, which is rapidly aligning the government to their policies and programs, adjusting contracts to areas that are in line with their mandate and much of it has been implemented through executive orders and other actions. In fact, just beginning this week, our USAID or foreign development contracts, for the most part, have all been put on hold for up to 90 days, while the administration embarks upon a review of all of these existing contracts. Now while these may seem like a lot of change in the industry, it's not that dissimilar from what we've seen in temporary government shutdowns. We have seen programs that have been put on hold, typically caused by a budget not being reached through Congress, resulting in similar effects on the marketplace and here at Tetra Tech. But no doubt, Tetra Tech's strength has always been in our ability to respond and adapt to change, whether it's mobilizing our staff to respond to fires or other disasters, or aligning our staff with our clients' priorities. Our staff are in extremely high demand, and we can move quite quickly. Our services continue to be in very high demand for things such as providing clean, secure water supplies, ensuring a healthy environment, or designing and putting in place resilient infrastructure so that it will not be impacted in the future by disasters or other items. Now presenting with me today, I have Steve Burdick, our Chief Financial Officer, who'll be providing additional details on our financial performance and capital allocation for the company. I also have Dr. Leslie Shoemaker, who will provide remarks on some of our key growth markets. But before we get to our drivers and outlook for fiscal year 2025, I'd like to share our results from the first quarter. We had a very strong first quarter and beginning of fiscal year 2025. For the quarter, we achieved new record results, and not just record results for what we would normally perform in the first quarter, but high points for any quarter in the entire history of the company. In fact, our net revenue increased to $1.2 billion in the quarter, up 18% from the prior year and an all-time record for any quarter in the company's history. Our operating income was $138 million for the quarter, an increase of 24% from the prior year. I want to note that a year ago, that was a record high. So, having income up 24% from a record first quarter was quite impressive. This strong performance resulted in an earnings per share increase of 25% over the previous year to $0.35 for the quarter, which was above our guidance range and above consensus provided in the marketplace. Even more impressive was that our backlog grew to $5.44 billion, up 15% from the first quarter of last year. I would like to discuss our performance by segment. Both of our segments contributed significantly to this outstanding performance in the first quarter. The Government Services Group, or GSG segment, increased its revenue by 36% year-over-year to $601 million, and this is the first quarter we've ever had a GSG segment over $600 million — quite an accomplishment. GSG generated a margin of 13.9% for the quarter with revenue growth largely driven by significantly higher-than-anticipated work in Ukraine for our USAID client. While this is important work supporting the U.S. government in this critical mission, the contracts do carry lower margins due to their cost-reimbursable nature. Excluding the Ukraine work, GSG's margin would be about 15.4%, which is very strong for the first quarter with holidays such as Thanksgiving, Christmas, and other times off. The Commercial International Group or CIG segment delivered a 13% margin which is up 50 basis points from last year, in line with our forecasted annual increase in margins. The CIG segment had net revenue of $596 million, which was up 4% year-on-year. I note that this is the closest balance we've had between government services at $601 million and CIG at $596 million — quite balanced for the company. Looking at our end customers, work for our U.S. federal clients was up 32% from the same quarter last year. Without contributions from our Ukraine work, our federal revenues would have grown 7% year-over-year, in line with our forecast. This growth is driven by increases in defense infrastructure and many critical civilian programs we undertake. Our state and local revenues were up an impressive 47% year-over-year, driven primarily by hurricane response activities in areas such as Florida, Georgia, and the Carolinas, in response to Hurricanes Helene and Milton. We also saw growth from digital water modernization and advanced water treatment projects. Excluding the extraordinary hurricane response activities, our state and local revenues would have increased 19% year-on-year. U.S. commercial net revenues were up 7% year-on-year, again in line with our forecast, driven by growth in high-performance buildings, design services, as well as our support for Fortune 500 clients. Finally, our international work represented over a third of our revenues in the quarter, including the United Kingdom and Ireland water programs, differentiated high-end infrastructure services across Canada, and defense infrastructure resiliency work in both the UK and Australia. I'd like to highlight our backlog, which increased to an all-time high of $5.44 billion, up 15% from last year. We won several Army Corps of Engineers contracts for civil works design, sustainable water infrastructure projects, environmental engineering, emergency response, and flood protection activities — all critical programs that are priorities for the incoming administration. In the Midwest, we won a five-year single award for emergency response and preparedness work within that entire region. I'd like to remind you that while Tetra Tech has more than $25 billion in contract capacity with the U.S. Federal Government, our backlog does not include any factored numbers associated with contract capacity or anticipated awards under IDIQ contracts. The work we have here is contracted and authorized for us to go to work. Now I would like to turn the presentation over to Steve Burdick, who can present the details of our financials in the quarter and our capital allocation programs and priorities for the company.

Steve Burdick, CFO

Thank you, Dan. I'd like to now provide an update of our GAAP financial results for the first quarter and our working capital, cash flow, and capital allocation. As Dan discussed, we continue to focus on the front-end cycle for water and infrastructure projects, which are carrying higher margins across all of our end markets. Even though revenue was up 16% over last year, our adjusted operating income and EPS for the first quarter increased at an even higher rate, with an adjusted EPS up by 25% over last year. This record financial and operating performance has resulted in a strengthened balance sheet and cash flow position. Even though the decision by one of our subsidiaries to settle litigation did result in a one-time charge material to the first-quarter earnings, that decision will not materially impact our results or strategy going forward. For those on the call or looking at our information, I refer you to our Reg G and the appendix of this presentation for the GAAP to adjusted reconciliation. Cash flows generated from operations for the trailing 12 months were $363 million, exceeding income by more than 100%. Our cash flow from operations has exceeded net income every fiscal year for the last two decades. Our focus on working capital and cash flows has resulted in a DSO of about 55.9 days, much better than our industry peers, which average over 80 days. We consider this a high watermark for sustainable working capital. Our net debt on EBITDA stands at a leverage of 1.33 times, significantly lower than the average of 1.51 times from a year ago. On an adjusted basis without this one-time charge, net leverage was at 1.05 times. As we continue to execute on high-quality operating results with strong cash flows and healthy working capital, we will be able to invest in strategic initiatives, providing higher returns to our shareholders. For those following along in the presentation, I'd like to present our capital allocation overview. Tetra Tech is one of the few firms that can increase dividends, buy back shares, make acquisitions, all while lowering our net debt leverage. We have a strong balance sheet, probably the strongest in our history, with significant liquidity available to invest in organic and acquisitive priorities. We have a strong pipeline for acquisitions focused on technical leaders, especially in the water and environmental sectors where we have led the market for the last 20 years. Regarding our dividend program, I want to announce that our Board of Directors approved a $0.058 dividend, a 12% increase year-over-year to be paid in the second quarter. This is our 39th consecutive quarterly dividend with annual double-digit increases. As we've revised our capital structure to take advantage of credit markets to support our financing needs, our ability to reduce our average interest rate by 57 basis points to 3.44% this quarter versus last year, which is notable in an environment of higher interest rates. Based on reaching a lower leverage by the end of last year, we reinstituted our stock buyback program this last quarter worth $25 million. We have a significant portion of the $400 million stock buyback plan approved by our Board of Directors, part of our capital allocation strategy for future buybacks. I am quite pleased to share these strong results for the first quarter of 2025. I want to thank all of our shareholders and analysts for your support. I will now hand the call back over to Leslie and Dan to discuss Tetra Tech's future global and improving opportunities as well as our fiscal 2025 guidance.

Leslie Shoemaker, Chief Innovation Officer

Thank you, Steve. As Dan mentioned earlier, we see continued strong demand for our services, especially essential water services. Water is at the forefront of recovery needs post-disasters and is essential to cities and growing communities across the United States and internationally. Today, we're working with our clients to recharge aquifers to combat seawater intrusion in coastal regions such as our innovative water treatment design in Hampton Roads, Virginia. We're treating contaminated groundwater to create reliable new water supplies worldwide, from water treatment in Dayton, Ohio all the way to military facilities in Australia. We're also designing new structures to protect hurricane-prone regions along the coastlines in the United States. Here in the U.S., our inland waterways locks and dam systems are undergoing the first significant upgrade in over 50 years, led by the Army Corps of Engineers. Tetra Tech designers are currently supporting the update of this inland navigation system across the U.S., essential to interstate commerce. We're innovators in many of those designs with first-of-a-kind solutions. Across our water markets, we're employing our Triple S or software subscription solutions and our Delta Technologies to leverage AI and optimize water systems. Our trained engineers, scientists, and technical professionals, along with our experience working on the largest U.S. disasters and our proprietary software systems, make Tetra Tech the leading U.S. consulting and engineering firm for response to fires, hurricanes, and tornadoes. We've worked on disaster response and recovery for many years, increasingly integrated into our services both in preparing for disasters and responding to post-disaster needs. We categorize disaster response and recovery into three phases. Phase I is focused on monitoring and response immediately post-disaster. We maintain over 500 contracts with clients throughout state and local governments for high-risk regions coast-to-coast. We've worked in the last three months on Hurricanes Milton and Helane in the Southeastern United States and have just begun our support for the Eaton and Palisades fires in California. After about a year, we enter Phase II, performing detailed damage assessments and consulting services, laying the groundwork for long-term engineering designs that can span over 10 years. Currently, we're supporting Maui in recovering from the Lahaina fire, which has complex restoration needs due to its island location and severity, such as designing entirely new landfill structures to receive fire residues. Hurricanes also entail significant long-term recovery planning and engineering needs that Tetra Tech provides. Today, we're designing flood protection structures and providing resiliency services for severe damage caused by Hurricane Harvey in Texas and Hurricane Maria in Puerto Rico. We are innovating in this space by integrating our AI solutions with our recovery practices. For example, we utilize artificial intelligence to analyze post-fire satellite imagery and provide first-of-a-kind landslide risk assessments using this technology. With the increasing frequency and severity of disasters, this has become a significant driver for our business. Now I would like to turn the call over to Dan to present our guidance.

Dan Batrack, CEO

Thank you, Leslie. I'd now like to present our guidance for the second quarter of the fiscal year and our updated guidance for all of fiscal year 2025. Our guidance is as follows: for the second quarter, our net revenue guidance range is from $1 billion to $1.1 billion with an associated adjusted earnings per share of $0.30 to $0.33. The updated guidance for the entire year for net revenue is a range of $4.365 billion to $4.765 billion with an associated adjusted earnings per share of $1.37 to $1.52. If you're following along on the webcast or have access to the presentation, you can view the assumptions regarding intangible amortization, tax rates, and other items for any modeling questions you may have. In summary, we had a really good first quarter. We achieved all-time record revenues for net revenue and backlog in any quarter in the history of the company. We're seeing strong demand for our differentiated services across our core business areas of water, environment, and infrastructure around the world. Specifically, our disaster preparedness, response, and recovery services are in higher demand. Demand for our water design services continues to grow both in the United States and the United Kingdom, and our federal IT practice is supporting the modernization of government services, aligning with the new administration's priorities. Together, these drivers and changes in our business mix, particularly with disaster response, have contributed to an increase in our earnings per share guidance for fiscal year 2025. Now I would like to open the call for questions. Paul, ready to receive any questions that you may have.

Operator, Operator

Our first question is from Tim Mulrooney with William Blair. Please go ahead with your question.

Tim Mulrooney, Analyst

Good morning. Thanks for taking my question. Just a couple of quick ones on the guide. Can you walk us through what's assumed at the midpoint of your guidance range for USAID work? And what gives you confidence that some of this work will likely turn back on after that 90-day review?

Dan Batrack, CEO

That's a good question. So we have assumed, on an annual basis, for the midpoint of our annual guidance, that we would do approximately $400 million worth of USAID work for the entire year. In the first quarter, we did about $200 million. So we have assumed we'd do approximately another $200 million at midpoint between now and the end of fiscal year. While we do our 90-day review, there are a number of different scenarios that can unfold. One is projects can be put back on continuation and that can take place anywhere between now and the end of the 90-day period. Alternatively, projects can be delayed or even terminated. While we've brought down our forecast by about a third to a half, we assumed we would do that much less work for USAID. Still, I believe our guidance is conservative enough to support both the lower end and midpoint.

Tim Mulrooney, Analyst

Okay, that's very helpful. So, it sounds like the midpoint of your guidance is almost a worst-case scenario where you're just collecting demobilization revenue because nothing really gets turned back on. But is that really your expectation? I mean you've been doing this for a long time. These USAID projects, some of them I know are in areas of the world that are strategically important. Is it your expectation that some of these projects likely will turn back on after the 90-day review?

Dan Batrack, CEO

I'll share our perspective because it aligns with the priorities of every administration. Foreign policy comprises three legs: diplomacy, defense, and development. Development work saves significant costs in defense, and our projects align with national security. Work we've done in areas like the South China Sea and the Philippines is critical. Given that context, I believe a large portion of our work will turn back on.

Sangita Jain, Analyst

Dan, if you could help us understand the disaster response. I think there's some revenue that you factored into the top end of your guidance. So, if you can help us understand how much flex there is beyond what is in your guidance for this year and next year?

Dan Batrack, CEO

Great question. Coming into this year, we assumed we would continue working in response to hurricanes. We expect that in fiscal year 2025, new revenues will start in Q2, and we anticipate $40 million to $50 million of incremental revenue will be included in our guidance for fiscal year 2025. This will offset the potential reduction during the 90-day hold on USAID. Disaster work is generally more profitable due to higher utilization and overtime hours. Hence, it enables us to maintain our upper-end profit guidance.

Steve Burdick, CFO

Yes, we're fortunate to have a strong acquisition pipeline. We are very prudent in capital allocation to ensure that acquisitions make Tetra Tech better, focusing on technical leadership, especially in water and environmental spaces. Our geographic presence extends across Asia Pacific, North America, and Northern Europe.

Sabahat Khan, Analyst

I just wanted to follow up a little bit on some of the other buckets. And as you think about the rest of fiscal 2025, obviously, there's some puts and takes on the civil and DoD side as well. Maybe you can just put a finer point on your expectations on how those two segments may evolve for the rest of the year?

Dan Batrack, CEO

The USAID work is only one-third of our federal work. Our Department of Defense work continues to grow well, with budgets that are untouched and a focus on modernization. We expect growth in that area at a rate of 5% to 10% and possibly stronger due to the increasing focus on defense infrastructure. The civilian programs also appear very solid, and we see growth in those areas as well. In summary, we've indicated that we expect between now and 2030, Tetra Tech would organically grow at a rate between 6% and 10%, with an anticipated operating margin expansion of 50 basis points. We don't see anything changing with our long-term growth drivers.

Operator, Operator

This will conclude the Q&A session. I will now turn the conference back over to Dan Batrack to conclude.

Dan Batrack, CEO

Thank you very much, Paul, and I want to thank all of you, all of our shareholders, analysts, and stakeholders, and especially employees who are doing a phenomenal job with their clients. We have many individuals engaged in foreign development for the benefit of the United States. I commend them for their focus on the mission. I look forward to speaking with all of you in 90 days as we address these changing items. Thank you, and goodbye.