Tetra Tech, Inc. (NASDAQ:TTEK) Q2 2024 Earnings Call Transcript

Tetra Tech, Inc. (NASDAQ:TTEK) Q2 2024 Earnings Call Transcript May 2, 2024

Tetra Tech, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: 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 Investors section of its website at tetratech.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; and Leslie Shoemaker, Chief Sustainability Officer. They will provide a brief overview of the results and we’ll 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 Investors 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 this presentation.

With that, I would now like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Dan Batrack: Thank you very much, Shamili, and good morning, and welcome to our second quarter fiscal year 2024 earnings conference call. I’m looking forward to providing all of you an overview of Tetra Tech’s second quarter results over this next hour of our call. During the quarter, our focus on high-end consulting continued to reshape our revenue and our profit margins, resulting in Tetra Tech exceeding the high end of our guidance for this past quarter. At the same time, software as a recurring revenue stream continues to gain traction as an offering that we’re providing in tandem with our consulting services. In March, at the end of our second quarter, we were very pleased to see the U.S. federal budget finally get completed after a series of continuing resolutions over the past six months.

On April 10th, and then following the next week on April 19th, two new regulations were finalized in the United States that represent a step change in the country’s efforts to reduce and virtually eliminate the presence of PFAS-related chemicals in our water and in the environment. I’ll begin this call with an overview of our second quarter and the performance across our operations, Steve Burdick, our Chief Financial Officer, who will provide an overview of our financial performance and our capital allocation program, and Dr. Leslie Shoemaker, our Chief Innovation and Sustainability Officer, will provide some early insights into the significance of the recently announced PFAS regulations as well as giving an update of our sustainability report that was just released in April.

On another note, we look forward to presenting our strategic plan for Tetra Tech in 2030 at our inaugural Investor Day that will take place in about two weeks on May 14th, and I’ll provide an overview of our key agenda items later in this call. In the second quarter of fiscal year 2024, our net revenues increased 9% to $1 billion – $1.05 billion in total. Excluding the impact of one-time events associated with our support in Ukraine, our year-on-year revenue growth was 12%, well into the double digits. Our EBITDA, our earnings increased 28% to $135 million and over double the rate of our revenue growth, which is directly in line with our goal to increase our margins more rapidly than our revenue. And finally, in the quarter, we generated an all-time high for our second quarter of earnings per share, which was $1.42, up 34% from the prior year.

I’d now like to present our performance by our segments. In the second quarter, the Government Services Group, or our GSG segment, was up 15% compared to last year, excluding Ukraine and disaster response to a total of $466 million and generated a very strong 13.7% margin, which is up 170 basis points from the prior year. The key driver for GSG’s margin expansion was an increase in the higher-margin environmental and advanced water treatment work that we do all across the United States. The Commercial/International Group, or CIG segment, grew net revenue by 10% year-over-year and delivered a 13% margin, which was up an impressive 320 basis points from last year. This CIG margin expansion was largely driven by the increase in the RPS margins, which are well ahead of the RPS margin expansion plan that we put in place.

In addition, growth in higher margin renewable energy services also contributed to the higher margins that we saw in CIG in the quarter. I’d now like to provide an overview of our performance by our end customers. Work for our U.S. federal clients was up 14% from the same quarter last year, excluding Ukraine. Growth was driven primarily by increases in our federal environmental practice, including for our clients in Defense, NASA of the U.S. Department of Energy and the U.S. Environmental Protection Agency. Our U.S. state and local revenues grew organically 14%, excluding the effects of disaster response, continuing to be driven by the work we do in advanced water treatment for cities and utilities all across the United States. Our U.S. commercial net revenues were essentially flat year-over-year.

We did incur some weather-related delays in our larger coal ash programs that take place in the Midwest of the United States. And finally, our international revenues were up 17% year-over-year. Tetra Tech international operations, together with RPS, that joined us are growing water and renewable energy services, particularly in the geographies of the United Kingdom and in Australia. I’d now like to discuss our backlog, which completed the quarter – second quarter at $4.74 billion, which is up 11% from last year. In the quarter, we further increased our PFAS-related contract capacity with the award of a new $464 million U.S. Army environmental remediation services contract. And we also added a new $375 million NASA environmental restoration contract.

We also augmented our contract capacity for coal ash remediation with an addition of a $55 million single-award contract in the quarter. And finally, decarbonization continues to drive new awards in the United Kingdom with addition of a $22 million single-award contract for building system optimization. With the federal budgets now fully in place, since March 24, or really at the end of our second quarter, we’re already seeing a significant uptake in the pace of new contract awards and more importantly, the actual release of task orders under our existing standing contracts. At this point, I’d now like to turn the presentation over to Steve Burdick, Chief Financial Officer, to present some details of our financials. Steve?

Steve Burdick: 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 six months, our EBITDA and operating income increased at a higher rate than our top line revenue growth. And 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 six months came in at $266 million, or up 27% year-over-year.

And our operating income also increased 23% to $229 million. And so for the first six months of the year, our earnings per share of $2.81 increased compared to last year. And the increase was primarily driven by the improvement in the second quarter operating margins across both our GSG and CIG operations. Now cash flows generated from operations for the second quarter were $103 million and exceeded net income by over 30%. And the trailing 12 months totaled $368 million, or up 35% from the previous trailing 12-month period. And 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 two 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 four 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. And this lower DSO metric also 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 all of our geographies. Our net debt amounted to $741 million. And the net debt on an EBITDA multiple was at a leverage of 1.4 times. 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 1.2 times.

Our leverage is well within our target and much lower than when we acquired RPS just over a year ago. So 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. So, 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. And 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 is aligned towards technical leaders, especially in the water and environmental services spaces where we have led the market for the last 20 years. And regarding our dividend program, I am 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. And 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.

So just as Dan also said, I’m also pleased to share these really strong results for the start of our fiscal 2024. I want to thank you for all your support. And I will now hand the call over to Leslie to discuss Tetra Tech’s differentiated and market leadership in water and sustainability. Leslie?

Leslie Shoemaker: Thank you, Steve. On Earth Day, April 22nd, just ten 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 storages 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. And finally, we continue to progress to our goal of beneficially impacting one 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 billion people challenge in 2021. So I would now like to move to talking a bit about the recently announced PFAS-related regulations, both for drinking water and the EPA’s Circular program. These two announcements have really created a step change in the overall regulation of the removal of PFAS sources throughout the United States.

And I can’t understate how well this has aligned with what we do and the services Tetra Tech provides in environmental work 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 nine days later, 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 pressing questions associated with who pays for these increased treatment requirements. Now 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 five years and well beyond.

We are really looking forward to further expanding on our strategies associated with PFAS and other items during our upcoming Investor Day, which now Dan will give you an overview of.

Dan Batrack: Great. Well, thank you very much, Leslie. I and all at 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. And there just 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, you’ve just heard from; and six of our key management members are going to be there to provide you with an update on our strategy spanning from now all the way 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.

And also during the Investor Day, we’re going to describe the strategies and goals that we’re 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 of net revenue, with an associated earnings per share of $1.50 to $1.55. And our guidance for fiscal year of 2024, which has been raised, 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.

After following along on the simulcast, you – this morning you can see some of the assumptions, I’ll touch on them very briefly. Our earnings per share guidance range does include 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. And this guidance does exclude 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 with sciences services across the water and environmental markets that we’re working 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. And as a result, the strong performance that we had in the last quarter and the confidence in our outlook I’m very pleased to have shared with you that we’ve raised our fiscal year 2024 guidance for both net revenue and earnings per share. And with that, operator, I’d now like to open the call for questions.

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Q&A Session

Operator: And the question-and-answer session will begin now. [Operator Instructions] The first question comes from Tim Mulrooney with William Blair. Please proceed with your question.

Tim Mulrooney: Yes. Good morning, and thanks for taking my questions. 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 regs are passed. And what I mean by that is the MCLs, they’ve got a five-year grace period for remediation. And 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 regs?

Dan Batrack: Well, you’re right, Tim. I’m extremely interested in this having spent much of my career several decades on the environmental investigation and assessment, both working on circa working on retro [ph] programs both the federal government and commercial side. So I’m extremely interested and somewhat knowledgeable on PFAS and thank goodness, I have Dr. Leslie Shoemaker, both a Ph.D. and engineering, a leading modeler for the federal government for many years, for decades, a member of the National Academy of Engineers. So 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 I’ve always been asked, is it coming out, if this is 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 three years and a day from April 10, you got to monitor it at the municipal level. And five years and a day, you actually have to treat it to remove it from your water delivery systems. So 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 I think roughly $37 billion, an upfront cost to upgrade the treatment plants. There’s other numbers from many different groups and agencies and advocacy practices that have the numbers much higher.

So I think those – other than the federal government, who had a lower number, all of the independent entities have numbers that are higher and some nobody is going to rush to put that numbers in place until they can actually do it the most effective way. And I think what Dr. Shoemaker commented on is, we’ve been contacted already regarding, can you tell us what we’re going to have to do, is it here? Is it coming? What are the different options, and a lot of the options are, can we draw from water supplies that are not impaired? And could we actually manage our systems, and if there is a hotspot, can we actually bifurcate it or isolate it and move it to be treated or addressed by the responsible party, which was her comment on, there’s going to be a lot of work done between now and when implementation is put in place even to monitoring, with respect to those that caused it, will pay for it.

And it will be their responsibility, which means there is going to be a lot of upfront modeling, analysis and the rest of it that will take place. And I think that will be the first large wave that comes in because you’re going to have to implement what’s been impacted and if it’s being addressed by other parties, best to have them take care of their responsibility. So anything to add, Leslie?

Leslie Shoemaker: No, I think you have it spot on. And that early analysis and sort of can’t understate how much Tetra Tech does in that space. And we think of it as accelerating the consulting side, this upfront work. So it’s essentially doubling it as we go on a run rate into 2025. We do roughly $60 million a year in PFAS-related work. So it gives you sort of a sense of what that first wave might look like. And as Dan pointed out directly in our wheelhouse to do the analysis and modeling scale for PFAS, whoever the client may be.

Tim Mulrooney: Got it. I understood. I appreciate such a detailed response. I’ll leave it there and hop back into queue. Thank you.

Dan Batrack: Great. Thank you very much, Tim.

Operator: Thank you. Our next question comes from the line of Sangita Jain with KeyBanc Capital Markets. Please proceed with your question.

Sangita Jain: Yes. Hi, thanks so much for taking my questions. So if I can ask one on, aside from the PFAS rules, there was also new limits on pollutant discharges from coal plants, in wastewater from coal plants, does that, in any way, add to your scope since you do work with coal-ash remediation.

Dan Batrack: It does. It does. In fact, we see that as an additional driver for the work that we’re doing. The coal ash both compliance and remediation cleaning up of these very large ponds and effluence discharges, which are creating new ponds are now seeing more regulations. And it’s really interesting. There’s been a lot of questions about administration changes. Obviously, there’s election here in the United States and questions as to if there’s a change of administration, can these regulations be rolled back or changed or modified, they’re being inculcated so deeply at the – from the federal level and sort of embedded at the state level that to untwine these is really complicated at best. And so I believe these are going to go forward.

The work that we have both to treat the effluent standards at combusted coal locations or coal-fired power plants and the resulting impoundments that they have, we think it’s going to be an additional driver. That’s just another case in point, there’s been questions, it’s not, if it’s coming, it’s when it’s coming, and when it’s going to be implemented. And by almost all standards, and it’s not a direct reference to inflation, but things cost more later to do than they do sooner in this particular front. So the work that we’re doing on combusted coal residuals, remediation and management of these large impoundments that almost all are in close proximity to water bodies, mainly rivers and things, which really prompted many of these regulations with failures of these impoundments that caused enormous environmental and even human health impacts and in some instances, even fatalities.

So I expect this to continue moving forward. We are no doubt one of the leaders. We work for some of the largest utilities across the United States, and I expect this to actually pick up as an additional – it’s not new, an additional opportunity and become more of a tailwind as we go forward.