Earnings Call Transcript - TTEK Q2 2024

Operator, Operator

Good morning, and thank you for joining the Tetra Tech Earnings Call. Tetra Tech is simulcasting this presentation with slides in the Investors section of its website at tetratech.com. This call is being recorded at Tetra Tech's request, and the broadcast is the copyrighted property of Tetra Tech. Any rebroadcast of this information in whole or part without prior written permission from Tetra Tech is prohibited. Today, we have with us Dan Batrack, Chairman and Chief Executive Officer; Steve Burdick, Chief Financial Officer; and Leslie Shoemaker, Chief Sustainability Officer. They will give a brief overview of the results before we open the call for questions. I want to draw your attention to the safe harbor statement in today's presentation. The discussion includes forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected due to various risks and uncertainties, as detailed in Tetra Tech's periodic reports filed with the SEC. Unless required by law, Tetra Tech is not obligated to update its forward-looking statements. Additionally, since management will present some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are available in the Investors section of Tetra Tech's website. Now, I would like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Dan Batrack, CEO

Thank you, Shamal, and good morning. Welcome to our second quarter fiscal year 2024 earnings conference call. I'm eager to provide an overview of Tetra Tech's second quarter results during this hour. In this quarter, our emphasis on high-level consulting has positively influenced our revenue and profit margins, allowing Tetra Tech to surpass the upper limit of our guidance for this past quarter. Additionally, our software as a recurring revenue stream continues to strengthen alongside our consulting services. In March, at the end of our second quarter, we were pleased to see the completion of the U.S. federal budget after several months of continuing resolutions. On April 10 and again on April 19, two new regulations were finalized in the U.S., marking significant progress in the country’s efforts to reduce and nearly eliminate PFAS-related chemicals in our water and environment. I will begin this call with a summary of our second quarter and our operational performance. Our Chief Financial Officer, Steve Burdick, will share insights into our financial performance and capital allocation strategies, while Dr. Leslie Shoemaker, our Chief Innovation and Sustainability Officer, will discuss the importance of the recently announced PFAS regulations and provide an update on our sustainability report released in April. Additionally, we are excited to share our strategic plan for Tetra Tech in 2030 at our first Investor Day in about two weeks on May 14. I will outline our key agenda items later in this call. In the second quarter of fiscal year 2024, our net revenues rose 9% to $1.105 billion. Excluding one-time events related to our support in Ukraine, our year-over-year revenue growth was 12%. Our earnings increased 28% to $135 million, significantly outpacing our revenue growth, which aligns with our goal of improving our margins more quickly. Furthermore, we achieved an all-time high for second-quarter earnings per share at $1.42, a 34% increase from the previous year. Now, I would like to discuss our performance by segments. In the second quarter, our Government Services Group segment increased by 15% compared to last year, excluding Ukraine and disaster response, totaling $466 million, with a robust margin of 13.7%, an increase of 170 basis points from the prior year. The growth in GSG's margin was primarily due to a rise in high-margin environmental and advanced water treatment projects across the U.S. The Commercial/International Group segment grew net revenue by 10% year-over-year, delivering a margin of 13%, an impressive increase of 320 basis points from last year. This margin growth in CIG was mainly driven by the improved margins in RPS, which outperformed our expansion plan, along with growth in higher-margin renewable energy services. Now, I'd like to provide insights into our performance by end customers. Our work for U.S. federal clients was up 14% from the same quarter last year, excluding Ukraine, driven mainly by growth in our federal environmental practice for clients in Defense, NASA, the U.S. Department of Energy, and the U.S. Environmental Protection Agency. Our U.S. state and local revenues also grew organically by 14%, excluding disaster response, primarily fueled by our advanced water treatment work for cities and utilities nationwide. However, our U.S. commercial net revenues were nearly flat year-over-year due to some weather-related delays in larger coal ash projects in the Midwest. In contrast, our international revenues increased by 17% year-over-year. Tetra Tech's international operations, along with RPS, have expanded our water and renewable energy services, particularly in the U.K. and Australia. Now, I would like to discuss our backlog, which ended the second quarter at $4.74 billion, an 11% increase from last year. We also expanded our PFAS-related contract capacity with new awards, including a $464 million U.S. Army environmental remediation services contract and a $375 million NASA environmental restoration contract. Furthermore, we increased our capacity for coal ash remediation with the addition of a $55 million contract. Decarbonization efforts are driving new contracts in the U.K., including a $22 million contract for building system optimization. With the federal budgets now finalized since March 2024, we are noticing a significant increase in the pace of new contract awards and the actual release of task orders under our existing standing contracts. I would now like to turn the presentation over to Steve Burdick, our Chief Financial Officer, to share details about our financials. Steve?

Steven Burdick, CFO

Thank you, Dan. So I'd like to now provide an update on the results of our first half of the fiscal year as well as our working capital, cash flow, and capital allocation through the second quarter. So net revenues increased by 21% to just under $2.1 billion year-to-date, driven by strong end markets across all geographies and a contribution from RPS. Over the same 6 months, our EBITDA and operating income increased at a higher rate than our top line revenue growth. As Dan discussed earlier in the call, we continue to focus on the front-end cycle for water and environmental projects, which are carrying higher margins across our end markets. As such, EBITDA for the first 6 months came in at $266 million or up 27% year-over-year. Our operating income also increased 23% to $229 million. For the first 6 months of the year, our earnings per share of $2.81 increased compared to last year, primarily driven by the improvement in the second quarter operating margins across both our GSG and CIG operations. Cash flows generated from operations for the second quarter were $103 million and exceeded net income by over 30%. The trailing 12 months totaled $368 million or up 35% from the previous trailing 12-month period. When we look back over our historical financial results, we noted that our cash flow from operations has exceeded our net income every fiscal year for the last 2 decades. Our focus on working capital and cash flows has resulted in our DSO reflecting an industry-leading standard of 55 days versus the industry average at over 80 days. The second quarter results saw an improvement of 4 days from last year. This historical low of the DSO for working capital is sustainable over the longer term as we continue to make cash flows from operations a priority, providing significant insight into our core business. Our net debt amounted to $741 million, and the net debt on an EBITDA multiple was at a leverage of 1.4x. This leverage includes the capital used to acquire LST in the second quarter, and if not for this acquisition, our leverage would have been closer to about 1.2x. Our leverage is well within our target and much lower than when we acquired RPS just over a year ago. In the second quarter, as I mentioned, we did close the LST acquisition. LST is a leading federal government technology consultant focused on the civil agencies in those markets and is part of our GSG segment. As we presented here today, we continue to execute on high-quality operating results with strong cash flows, industry-leading days sales outstanding, and a net debt leverage well within our target range. While this strengthening financial position and balance sheet is occurring, I would like to now present our capital allocation overview as of the second quarter of fiscal 2024. We have a significant amount in liquidity available to invest in both organic and acquisitive priorities, and we have a well-balanced mix of both fixed-rate debt at a 2.25% coupon, which matures in 2028, while our variable rate debt is sitting now just over 6.5% interest rate. This balance helps to mitigate interest rate risk as we look to invest in these key strategic priorities. We have a strong pipeline for acquisitions, which align towards technical leaders, especially in the water and environmental services spaces where we have led the market for the last 20 years. Regarding our dividend program, I'm pleased to announce that our Board of Directors approved a $0.29 quarterly dividend, which is a 12% increase year-over-year to be paid in the third quarter. This is our 36th consecutive quarterly dividend with an annual double-digit increase in the amount paid. As we've revised our capital structure in the last year to take advantage of the credit market to support our financing needs, I want to remind our shareholders that we do have available a significant portion of the $400 million from the stock buyback plan approved by our Board of Directors back in 2022 for future consideration as part of our disciplined capital allocation strategy. Overall, I'm pleased to share these strong results for the start of our fiscal 2024. Thank you for all your support. I will now hand the call over to Leslie to discuss Tetra Tech's differentiated market leadership in water and sustainability. Leslie?

Leslie Shoemaker, Chief Sustainability Officer

Thank you, Steve. On Earth Day, April 22nd, just 10 days ago, we released our 2024 sustainability report. At Tetra Tech, we report both on the company's internal operational metrics as well as tracking our project impacts worldwide. In alignment with our commitments to the UN Sustainable Development Goals and science-based targets initiative, we're pleased to have further reduced our emissions from Scope 1 and 2, both on a per person and absolute basis collectively. Emission reductions have benefited from our initiatives to reduce office space by 30% as well as the highly efficient use of cloud-based computing and data storage that we use in our operations. This year, we continue to expand our Scope 3 emissions coverage by including a global assessment of employee commuting frequency and practices. Our commitment to doing our part in the reduction of global greenhouse gas emissions is best realized by the project work we do, which since 2021 has removed over 153.6 million metric tons of carbon equivalent emissions. This exceeds our entire Scope 1, 2, and 3 from internal operational admissions by more than 2,000 times. Finally, we continue to progress towards our goal of beneficially impacting 1 billion people's lives by 2030 through our project work. To date, we have positively impacted 625 million people's lives since we launched the 1 billion people challenge in 2021. I'd now like to move to talk a bit about the recently announced PFAS-related regulations, both for drinking water and the EPA Circular program. These 2 announcements have really created a step change in the overall regulation of the removal of PFAS sources throughout the United States. I can't understate how well this aligns with what we do and the services Tetra Tech provides in environmental and analytical work all across the United States. The PFAS water treatment MCLs addressing 6 different PFAS compounds announced April 10, 2024, are the first new drinking water pollutant limits to be announced since 1996. These limits provide, for the first time, a consistent threshold and a schedule for implementation and remove the state-specific variability and lack of clarity that has existed across the United States. Just 9 days later, the EPA announced that PFAS compounds will also be considered hazardous substances and assessed through the risk-based circular process. Taken together, these regulations affect our clients across the United States, including cities, municipalities, industries, federal defense, and civilian agencies. We see the first wave of work for us as data analysis and modeling to assess key questions that our clients have: Where is PFAS present? Where is it migrating? What are the mitigation strategies, and ultimately, how can we define treatment solutions? This type of analysis will also spawn additional research specifically to support critical questions associated with those who are responsible for these increased treatment requirements. We expect to see a quick ramp-up of data analysis and modeling services as we enter 2025 that directly leverages our expertise, client relationships, and the contract vehicles that we hold in this space. This analytical work will become a springboard for us, providing a competitive advantage for the long-term design and implementation services we expect to see over the next 5 years and well beyond. We are looking forward to further expanding on our strategies associated with PFAS and other items during our upcoming Investor Day, which Dan will give you an overview of.

Dan Batrack, CEO

Great. Well, thank you very much, Leslie. I and all Tetra Tech are very pleased to host our inaugural Investor Day, which is going to be held via simulcast on May 14, 2024, at 09:00 a.m. in the morning Eastern Time. There could not be a better time for us to provide a long-term outlook and a deeper discussion into the opportunities that are right in front of us now. During the meeting, myself; Steve Burdick, our Chief Financial Officer; Dr. Leslie Shoemaker, whom you've just heard from; and 6 of our key management members will provide you with an update on our strategy spanning from now through 2030. We'll describe during the Investor Day our growth strategies that encompass the entire full water cycle as well as emerging opportunities at the nexus between environment, renewable energy transition, and building decarbonization. We will also describe the strategies and goals that we are setting in place to expand our recurring revenues, and we'll establish and share with you both our revenue and margin expansion targets that we've established for this period. At this time during the call, I'd like to provide our guidance for the third quarter and our updated guidance for all of fiscal year 2024. Our guidance is as follows: for net revenue in the third quarter, our net revenue range is estimated between $1.05 billion and $1.1 billion, with an associated earnings per share of $1.50 to $1.55. Our guidance for the fiscal year of 2024 has been raised and represents a net revenue range of $4.21 billion to $4.31 billion with an associated earnings per share of $6.15 to $6.25. Following along on the simulcast, you can see some of the assumptions—I'll touch on them very briefly. Our earnings per share guidance range includes intangible amortization of $49 million for the year or $0.66 per share, and if you’re following along on the slide presentation, you can see it broken down per quarter. But we do estimate that we will have an effective tax rate of 27% for the year, 54 million average diluted shares outstanding. This guidance excludes any additional acquisitions that we would complete from this phone call today forward through the end of the year. In summary, we see a very strong demand for our differentiated leading scientific services across the water and environmental markets that we're engaged in. Our second quarter results set new records for revenue, operating income, and earnings per share while maintaining industry-leading days sales outstanding and cash flow that Steve Burdick went over. Our strategic focus on high-end water and environmental consulting is driving margin expansion and is growing our operating income. As a result, I am very pleased to share that we have raised our fiscal year 2024 guidance for both net revenue and earnings per share. With that, operator, I would now like to open the call for questions.

Operator, Operator

The first question comes from Tim Mulrooney with William Blair.

Timothy Mulrooney, Analyst

I'll leave the questions about the quarter and the guide to others. We'd really like to dig into PFAS with you for a moment, given all the recent events that have occurred here. Dan, I noticed something that we've discussed together, and I know this is an issue you care a lot about and know a lot about. So for my first question, I'm curious how you're thinking about timing now that these regulations are passed. What I mean by that is the MCLs; they've got a 5-year grace period for remediation. The super fund designation, I think, takes quite a while to unfold. So in your mind, is this not a 2024, 2025 story, or do you expect some folks to start moving quickly to get ahead of these new regulations?

Dan Batrack, CEO

Well, you're right. I'm extremely interested in this having spent much of my career several decades on environmental investigation and assessment, working on various programs on both the federal government and commercial sides. So I'm extremely interested and somewhat knowledgeable about PFAS. Thank goodness I have Dr. Leslie Shoemaker, a PhD and engineer, a leading modeler for the federal government for decades, a member of the National Academy of Engineers. If I ever need any more detailed advice, I've got Dr. Shoemaker at my back all the time. But with respect to timing, I'll just say a couple of words on that. With the regulations coming out, it really answered a couple of things. We've been working with our clients for years and years and have always been asked, is it coming, is this really going to happen? Well, that's off the table now; it did happen. Second was, when is it going to happen? We've got the dates. So 3 years and a day from April 10, you have to monitor it at the municipal level. And in 5 years and a day, you will need to treat it to remove it from your water delivery systems. I would say that things aren't going to move immediately with respect to treatment; are people going to get ahead to upgrade their plans? I've seen numbers from the American Water Works Association at roughly $37 billion in upfront costs to upgrade the treatment plants. There are other numbers from various groups and agencies that are much higher. So I think that—other than the federal government, who had a lower number—all of the independent entities have numbers that are higher, and nobody is going to rush to put those numbers in place until they can effectively do it. I think that will be the first large wave of work because you will need to implement what's been impacted, and if it's being addressed by other parties, it’s best to have them take care of their responsibility. So anything to add, Leslie?

Leslie Shoemaker, Chief Sustainability Officer

No, I think you have it spot on. And that early analysis is crucial—Tetra Tech excels in that space. We essentially think of it as accelerating the consulting side, this upfront work. So it's basically doubling as we go along into 2025. We do roughly $60 million a year in PFAS-related work, giving you a sense of what that first wave might look like. Dan pointed out that it’s directly in our wheelhouse in terms of the analysis and modeling for PFAS, regardless of the client.

Operator, Operator

Our next question comes from the line of Sangita Jain with KeyBanc Capital Markets.

Sangita Jain, Analyst

If I can ask one on, aside from the PFAS rules, there were also new limits on pollutant discharges from coal plants' wastewater. Does that in any way add to your scope since you do work with coal-ash remediation?

Dan Batrack, CEO

It does. In fact, we see that as an additional driver for the work that we're doing. Coal ash compliance and remediation, cleaning up these large ponds and treating effluent discharges, which are creating new ponds, are now subject to more regulations. There have been many questions regarding administration changes. Obviously, there's an election here in the United States, and questions as to whether these regulations can be rolled back or altered; however, they are deeply embedded from the federal to the state level, and untwining them is really complicated at best. So I believe these will go forward. The work that we have regarding treatment and the effluent standards at coal-fired power plants, as well as the resulting impoundments, will serve as additional motivation for our future work. It's no longer a question of if it's coming but rather when it will be implemented. Most standards indicate that the costs increase when delayed, and we know the work we are doing regarding combusted coal residuals, remediation, and management of these impoundments is vital, especially as they are located near water bodies. I expect this to continue moving forward. We are, without a doubt, one of the leaders in this area, and I anticipate this will become an increasing opportunity and greater tailwind going forward.

Sangita Jain, Analyst

Great. If I can follow up with one. You mentioned software subscriptions in your prepared remarks becoming a bigger part of the portfolio. Should we expect more on that in a couple of weeks? Will you quantify that for us in terms of revenue and margin targets?

Dan Batrack, CEO

Yes. In fact, one item I'll comment on just to put it in context, and we'll provide more details on where we are, what the growth rates are, and what we expect the margins to be. It is a different approach we’re taking here. Many think of software-as-a-recurring-revenue as, perhaps, in the old days: a CD disk in a cellophane wrapper sold to someone. This is being executed in tandem with consulting services where we serve well over 20,000 significant clients, including the largest government agencies and Fortune-100 companies. Implementing these software programs as part of our consulting work adds value for our clients, strengthening our trusted relationships and offering cost savings. We will elaborate more during our Investor Day but know that we approach this as domain experts who can highlight value and savings through our consulting fees and software’s real-time decision-making capabilities. We’ve already secured 2,000 licenses with one existing client, and we’ll share further details on what we have today and how we view our progress. I welcome you and others on this call to join our Investor Day on May 14.

Operator, Operator

Our next question comes from the line of Sabahat Khan with RBC Capital Markets.

Sabahat Khan, Analyst

Great, obviously a strong growth year this year. We're seeing some margin improvement. If you could help us think through the medium term a little bit as you head into calendar '25 and onwards, maybe just some of the bigger picture growth drivers. I'm not sure if that's some of the stuff you're saving for Investor Day, but I’d love to get a bit of perspective as you're going to face tough comparisons from the strong growth over the past couple of years. How should we think about medium-term growth algorithms, perhaps?

Dan Batrack, CEO

Well, I don't want to give too big a preview or you won't show up on May 14, but I think one of the things that we want to approach on our Investor Day, and I'll touch on it here, is we really do want to look beyond just what is 2025. For fiscal year 2025—which is just around the corner—we'll provide specific details on our guidance for the first quarter and for fiscal year 2025 once we complete fiscal year 2024. Our goal, which has been clearly communicated, is between 10% and 15% top-line growth. A portion of this growth is acquisition-based, with respect to adding new clients, rounding out critical scales, and geographies important for market leadership. In the strong environment we see today economically, we observe that organic growth is becoming larger, whereas the acquired component is smaller. Conversely, when economic cycles slow, we would expect the acquisitive component to strengthen. From a growth perspective, if you take half of the 15% organic, you see it trending toward mid- to upper-single digits and possibly higher. But that reflects our perspective from a longer-term standpoint, with no significant deviation from our previous communications. We believe the combination of our work and the introduction of software services will enhance margins significantly. This leads us to reassess what the upper limits could be on government contracts. The value we provide our clients will yield higher margins for ourselves while maximizing client savings. It’s a win-win. We’ll provide further details on our expectations for the next five years on May 14, with emphasis on clean water, environment protection, climate change mitigation, and resilience against natural degradation.

Steven Burdick, CFO

Well, I like these questions because we can provide specific answers because we have press releases documenting them. Take, for example, revenue synergy observed in the U.K. AMP programs. In the United Kingdom, the priority for their AMP8 or Asset Management Program over the next 5 years focuses on CSOs and impacts from sewer overflows. While it’s new, Tetra Tech has been doing extensive work on this front for over 20 years. The investments from the U.S. EPA and state and local agencies supported this work. Our expertise—especially Dr. Shoemaker's—couples well with solutions provided through RPS. Recently we won a $125 million, 10-year program management contract for United Utilities that we announced a couple of months ago. This 10-year program grants us the ability to provide technological advancements through this partnership. Additionally, we've experienced significant wins in offshore wind and with other renewable energy clients, where RPS’s technologies and Tetra Tech’s environmental modeling expertise combine effectively. These collaborations have led to tens of millions of dollars in contracts already. I anticipate more successes in U.K water, renewable energy globally, and defense, fueled by shared contract capacities between government agencies.

Operator, Operator

Our next question comes from the line of Tate Sullivan with Maxim Group.

Tate Sullivan, Analyst

Leslie, did you mention earlier that 60 million number for PFAS-related work was for what you've done in fiscal year '24, or can you reiterate that or talk about that number, please?

Leslie Shoemaker, Chief Sustainability Officer

The 60 million figure pertains to our annual PFAS work largely within investigation and consulting, including significant work for the U.S. Defense Department. We anticipate this will increase notably next year as we ramp up investigatory efforts, so we expect to double our run rate from that 60 million figure this year.

Tate Sullivan, Analyst

And could you clarify if the city of Dayton PFAS work is unique and large scale compared to what other cities might do? Or is that a suitable blueprint for what Tetra Tech could offer to other cities?

Leslie Shoemaker, Chief Sustainability Officer

I think it’s an excellent example of early work; a few municipalities are ahead of the curve regarding managing water sources and implementing treatment solutions that align with anticipated PFAS regulations. That said, these efforts showcase design work we’ll likely see more of in the future. However, many municipalities are still looking to adopt similar frameworks.

Dan Batrack, CEO

You mentioned earlier about U.K. work and looking forward to hearing more on May 14. In your presentation, you pointed out U.K. water planning and design work. Is that associated with future U.K. AMP8 expenditure?

Steven Burdick, CFO

The discussed U.K. planning and design work flows from existing contracts held there. Tetra Tech has several framework contracts in the United Kingdom and Ireland, which represent this work. The most notable aspect is that AMP8, while on the horizon, hasn’t officially begun yet, and our execution includes work from previously established contracts.

Operator, Operator

And this will conclude the Q&A session. I'll now turn the conference back over to Dan Batrack to conclude.

Dan Batrack, CEO

Thank you very much, Shamal, and thank you for your questions. Thank you for your interest in Tetra Tech. We consider the detailed results of our second quarter and our first half of the year that we've just gone through as vital. We're really looking forward to spending time with all of you here on May 14 to go through more details of what's driving our business and our outlook for the next 5 years. So, I won't say goodbye until the next quarterly call. I’ll say so long until we can discuss more during our Investor Day presentation in a couple of weeks. I appreciate you attending, and I'll talk to you soon.

Operator, Operator

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